[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8597]
RIN 1545-AT58
Consolidated groups and controlled groups--intercompany transactions and
related rules.

AGENCY:  Internal Revenue Service (IRS), Treasury.
ACTION:  Final regulations.
SUMMARY:  This document contains final regulations amending the intercompany
transaction system of the consolidated return regulations.  The final
regulations also revise the regulations under section 267(f), limiting losses
and deductions from transactions between members of a controlled group. 
Amendments to other related regulations are also included in this document.
DATES:  These regulations are effective July 18, 1995.
     For dates of applicability, see the "Effective dates" section under the
"SUPPLEMENTARY INFORMATION" portion of the preamble and the effective date
provisions of the new or revised regulations. 
FOR FURTHER INFORMATION CONTACT:  Concerning the regulations relating to
consolidated groups generally, Roy Hirschhorn of the Office of Assistant Chief
Counsel (Corporate), (202) 622-7770; concerning stock and obligations of
members of consolidated groups, Victor Penico of the Office of Assistant Chief
Counsel (Corporate), (202) 622-7750; concerning insurance issues, Gary Geisler
of the Office of Assistant Chief Counsel (Financial Institutions and
Products), (202) 622-3970; concerning international issues, Philip Tretiak of
the Office of Associate Chief Counsel (International), (202) 622-3860; and
concerning controlled groups, Martin Scully, Jr. of the Office of Assistant
Chief Counsel (Income Tax and Accounting), (202) 622-4960.  (These numbers are
not toll-free numbers.)
SUPPLEMENTARY INFORMATION:
A.  Paperwork Reduction Act
     The collections of information contained in these final regulations have
been reviewed and approved by the Office of Management and Budget in
accordance with the requirements of the Paperwork Reduction Act (44 U.S.C.
3504(h)) under control number 1545-1433.  The estimated average annual burden
per respondent is .5 hours.
     Comments concerning the accuracy of this burden estimate and suggestions
for reducing this burden should be sent to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, PC:FP, Washington, DC 20224, and 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.
B.  Background
     This document contains final regulations under section 1502 of the
Internal Revenue Code of 1986 (Code) that comprehensively revise the
intercompany transaction system of the consolidated return regulations. 
Amendments are also made to related regulations, including the regulations
under section 267(f), which apply to transactions between members of a
controlled group.
     The proposed regulations were published in the Federal Register on April
15, 1994 (59 FR 18011).  The notice of hearing on the proposed regulations,
Notice 94-49, 1994-1 C.B. 358, 59 FR 18048, contains an extensive discussion
of the issues considered in developing the proposed regulations.  The IRS
received many comments on the proposed regulations and held public hearings on
May 4, 1994 and August 8, 1994.
     After consideration of the comments and the statements made at the
hearings, the proposed regulations are adopted as revised by this Treasury
decision.  The principal comments and revisions are discussed below.  However,
a number of other changes have been made to the proposed regulations. 
References in the preamble to P, S, and B are references to the common parent,
the selling member, and the buying member, respectively.  No inference is
intended as to the operation of the prior regulations or other rules.
C.  Principal Issues Considered in Adopting the Final Regulations.
     1.   Retention and modification of the deferred sale approach.
     The proposed regulations generally retain the deferred sale approach of
prior law but comprehensively revise the manner in which deferral is achieved
to eliminate many of the inconsistent combinations of single and separate
entity treatment under prior law.  Notwithstanding these revisions, the
results for most common intercompany transactions remain unchanged.
     Commentators uniformly supported the retention of the deferred sale
approach.  Some comments, however, suggested that the rules of prior law
should be retained, with modifications only where necessary to address a
specific problem.  Since the adoption of the prior regulations in 1966,
however, developments in business practice and the tax law have greatly
increased the problems of accounting for intercompany transactions.  Although
additional amendments could have been made to the prior regulations, further
amendments would risk raising additional inconsistencies or uncertainties
without providing a unified regime.  By comprehensively revising the
intercompany transaction system, the proposed regulations provide a unified
regime and eliminate many of the inconsistencies of prior law, without
changing the results of most common transactions.  The final regulations
therefore generally retain the approach of the proposed regulations.
     2.   General v. mechanical rules.
     The prior intercompany transaction regulations were generally mechanical
in operation.  The proposed regulations rely less on mechanical rules and,
instead, provide broad rules of general application based on the underlying
principles of the regulations.  To supplement the broad rules, the proposed
regulations provide examples illustrating the application of the rules to many
common intercompany transactions.
     Some commentators supported the proposed regulations' use of broad rules
based on principles.  Others suggested that the final regulations should
retain the mechanical rules of prior law.  Mechanical rules provide more
certainty for transactions clearly covered by those rules.  For transactions
that are not clearly covered, however, mechanical rules provide much less
guidance.
     The final regulations retain the approach of the proposed regulations. 
This approach is flexible enough to apply to the wide range of transactions
that can be intercompany transactions.  For example, the final regulations do
not require special rules to coordinate with the depreciation rules under
section 168, the installment reporting rules under sections 453 through 453B,
and the limitations under sections 267, 382, and 469.  Flexible rules adapt to
changes in the tax law and reduce the need for continuous updating of the
regulations.
     3.  Timing rules of 1.1502-13 as a method of accounting.
     The proposed regulations provide that "the timing rules of this section
are a method of accounting that overrides otherwise applicable accounting
methods."  A group's ability to change the manner of applying the intercompany
transaction regulations is therefore subject to the generally applicable rules
for accounting method changes.  Several comments objected to this treatment.
     Commentators pointed out that treating the timing provisions of these
regulations as a group's method of accounting may increase the burden and
complexity of correcting improper applications of the regulations (for
example, necessitating requests for accounting method changes for the
treatment of intercompany transactions).  This treatment also raises questions
about members coming into a group and leaving a group (for example, whether
requests to change a method of accounting are required when a taxpayer
becomes, or ceases to be, a member).  Various technical points were also
raised as to the effect of a shared accounting method on each member of a
group, the propriety of applying accounting method rules only to certain
transactions or classes of transactions, the interaction of the intercompany
transaction rules with separate entity accounting methods of members, and the
linkage of the selling member's method of accounting for its intercompany
items with the buying member's method of accounting for its corresponding
items.
     The intercompany transaction regulations provide guidance on the
appropriate time for taking into account items of income, deduction, gain, and
loss from intercompany transactions to clearly reflect the consolidated
taxable income of the group.  Clear reflection of income is the central
principle of section 446.  Under section 446, any treatment that does or could
change the taxable year in which taxable income is reported is a method of
accounting.  See Rev. Proc. 92-20, 1992-1 C.B. 685.  The timing rules of the
intercompany transaction regulations affect the taxable year in which items
from intercompany transactions are taken into account in the computation of
consolidated taxable income.  Accordingly, the timing rules of these
regulations are properly viewed as a method of accounting.  Moreover, treating
the timing rules as a method of accounting assures that the provisions will be
applied consistently from year to year under the principles of section 446.
     The final regulations retain the general approach of the proposed
regulations, treating the timing rules of 1.1502-13 as a method of accounting
under section 446.  The regulations also contain several provisions intended
to reduce the administrative burden that commentators believe might result
from this treatment.  The final regulations treat the timing rules as an
accounting method for intercompany transactions, to be applied by each member,
and not as an accounting method of the group as a whole.  However, an
application of the timing rules of this section to an intercompany transaction
will be considered to clearly reflect income only if the effect of the
transaction on consolidated taxable income is clearly reflected.  This
treatment more closely conforms to the general practice of separate taxpayers
having their own methods of accounting, thereby alleviating technical and
administrative issues that were raised with respect to characterization of the
method as the method of the group as a whole, rather than as the method of
each member.  
     To reduce potential administrative burdens further, the final
regulations generally provide automatic consent under section 446(e) to the
extent changes in method are required when a member enters or leaves a group. 
In addition, for the first taxable year of the group to which the final
regulations apply, consent is granted for any changes in method that are
necessary to comply with the final regulations.  For other years, members must
obtain the Commissioner's consent to change their methods of accounting for
intercompany transactions under applicable administrative procedures of
section 446(e), currently Rev. Proc. 92-20.  The regulations provide that
changes will generally be effected on a cut-off basis (that is, the new method
will apply to intercompany transactions occurring on or after the first day of
the consolidated return year for which the change is effective).  Changes in
methods of accounting for intercompany transactions generally will otherwise
be subject to the terms and conditions of applicable administrative
procedures.  The IRS may determine, however, that other terms and conditions
are appropriate in the interest of sound tax administration (for example, if a
taxpayer misapplies the regulations to avoid matching S's intercompany item
with B's corresponding item).  See section 10 of Rev. Proc. 92-20.
     Paragraph (e)(3) of the final regulations continues the procedure
whereby the common parent may request consent from the IRS to report
intercompany transactions on a separate entity basis.  Rev. Proc. 82-36 (1982-
1 C.B. 490), which provides procedures for obtaining consent under the prior
regulations, will be updated and revised.  Until new procedures are provided,
taxpayers may rely on the principles of Rev. Proc. 82-36 in making
applications under these final regulations.
     If consent under paragraph (e)(3) of these regulations is obtained or
revoked, the final regulations provide the Commissioner's consent under
section 446(e) for each member to make any changes in methods of accounting
necessary to conform members' methods of accounting to the consent or
revocation.  Any change in method under this provision must be made as of the
beginning of the first year for which the consent (or revocation of consent)
under paragraph (e)(3) is effective.
     A group that has received consent under the prior intercompany
transaction regulations not to defer items from deferred intercompany
transactions will be considered to have obtained the consent of the
Commissioner to take items from the same class (or classes) of intercompany
transactions into account on a separate entity basis under these regulations.
     4.  Single entity treatment of attributes.
          a.  In general
     The prior intercompany transaction system used a deferred sale approach
that treated the members of a consolidated group as separate entities for some
purposes and as a single entity for other purposes.  In general, the amount,
location, character, and source of items from an intercompany transaction were
given separate entity treatment, but the timing of items was determined under
rules that produced a single entity effect.
     The matching rule of the proposed regulations expands single entity
treatment by requiring the redetermination of the attributes (such as
character and source) of items to produce a single entity effect.  Several
comments supported the broader single entity approach taken by the proposed
regulations.  Other comments asked that separate entity treatment of
attributes be retained.
     The commentators arguing for retention of separate entity treatment
claimed that single entity treatment does not always result in more rational
tax treatment, and may not reflect the economic results of a group's
activities as accurately as separate entity treatment.  They also argued that
taxpayers should have the ability to avoid arbitrary results or administrative
burdens by separately incorporating business operations.  The Treasury and the
IRS believe that single entity treatment of both timing and attributes
generally results in a clear reflection of consolidated taxable income.  In
particular, single entity treatment minimizes the effect of an intercompany
transaction on consolidated taxable income.  In addition, single entity
treatment minimizes the tax differences between a business structured
divisionally and one structured with separate subsidiaries.  The final
regulations therefore retain the approach of the proposed regulations and
generally adopt single entity treatment of attributes.
     Nevertheless, in certain situations it may be appropriate to provide
separate entity treatment.  The Treasury and the IRS believe that these
situations are relatively rare, and that any exceptions from single entity
treatment should be specifically provided in regulations.  For example, a
separate entity election is permitted under Prop. Reg. 1.1221-2(d) (published
in the Federal Register on July 18, 1994, 59 FR 36394) in the case of certain
hedging transactions.  See also 1.263A-9(g)(5).  The Treasury and the IRS
welcome comments on other situations in which this type of relief might be
appropriate.
          b.  Conflict or allocation of attributes.
     The proposed regulations provide specific rules for certain cases in
which separate entity attributes are redetermined under the matching rule. 
Some commentators believe that the proposed regulations do not provide
sufficient guidance as to the manner in which these rules are to be applied. 
In response to these comments, the attribute redetermination provisions of the
matching rule have been revised.
     For example, the regulations have been revised to clarify that the
separate entity attributes of S's intercompany item and B's corresponding item
are redetermined under the matching rule only to the extent necessary to
produce the same effect on consolidated taxable income as if the intercompany
transaction had been between divisions.  Thus, the redetermination is required
only to the extent the separate entity attributes differ from the single
entity attributes.
     The final regulations generally retain the rule of the proposed
regulations under which the attributes of B's corresponding item control the
attributes of S's intercompany items to the extent the corresponding and
intercompany items offset in amount.  However, the final regulations provide
an exception to this rule to the extent its application would lead to a result
that is inconsistent with treating S and B as divisions of a single
corporation.  To the extent B's corresponding item on a separate entity basis
is excluded from gross income or is a noncapital, nondeductible amount (such
as a deduction disallowed under section 265), however, the attribute of B's
item will always control.  This assures the proper operation of attribute
limitation provisions contained elsewhere in the regulations.
     To the extent B's corresponding item and S's intercompany item do not
offset in amount, the final regulations provide that redetermined attributes
are allocated to S's intercompany item and B's corresponding item using a
method that is reasonable in light of all of the facts and circumstances,
including the purposes of these regulations and any other rule affected by the
attributes of S's items or B's items.  This rule provides taxpayers
considerable flexibility to allocate attributes, but the regulations also
provide that an allocation method will be treated as unreasonable if it is not
used consistently by all members of the group from year to year.
          c.  Source of income.
     Several commentators opposed single entity treatment for determining the
source of income or loss from an intercompany transaction, arguing that the
separate entity treatment under prior law more accurately measures the source
of income of the members of the group.  The final regulations, however, retain
the single entity treatment of source for the same reasons that the single
entity treatment of other attributes is retained.  The final regulations
modify the example in the proposed regulations to reflect the changes made to
the attribute allocation rules.
     Some comments suggested that a single entity approach would
inappropriately reduce the foreign source income of consolidated groups that
produce a natural resource abroad and sell it to customers within the United
States.  For example, assume that one member extracts a commodity abroad and
sells it to a second member, with title passing within a foreign country.  The
second member sells the commodity to unrelated customers with title passing in
the United States.  Assume that the first member's income is 80 percent of the
group's income and would be treated solely as foreign source income under a
separate entity approach.  Under a single entity approach, the intercompany
transaction is treated as occurring between divisions of a single corporation. 
If the special sourcing rule for production and sale of natural resources
under the section 863 regulations does not apply because of "peculiar
circumstances," the income of the group will be subject to the so-called 50/50
rule of the section 863 regulations, and a portion of the group's foreign
source income could be recharacterized as domestic source.  Revisions to the
section 863 regulations are being considered to address these issues.  The
Treasury and the IRS welcome comments regarding possible revisions to the
section 863 regulations.
     Another commentator noted that under the single entity approach, a pro
rata allocation of the group's foreign and U.S. source income (as illustrated
in Example 17 of paragraph (c) of the proposed regulations) could cause a
member that qualified as an "80/20" company under section 861(a)(1)(A) to lose
that status.  As a result, the member could be required to withhold Federal
income tax on interest payments to a foreign lender.  As indicated above, the
final regulations revise the attribute rules to clarify that a redetermination
is made only to the extent it is necessary to achieve the effect of treating S
and B as divisions of a single corporation and to provide that redetermined
attributes are allocated to S and B using a method that is reasonable in light
of the purposes of 1.1502-13 and any other affected rule.  Thus, the group is
not required to allocate U.S. and foreign source income on a pro rata basis,
and a member that qualifies as an 80/20 company under current law generally
need not lose that status solely as the result of the allocation from a
transaction similar to that described in the example.
     Commentators also suggested that the pro rata allocation methodology of
the proposed regulations could be inconsistent with U.S. income tax treaties
that require the United States to treat income that may be taxed by the treaty
partner as derived from sources within the treaty partner.  As revised, the
attribute rules do not require the group to allocate U.S. and foreign source
income on a pro rata basis.  Thus, the regulations will generally be
consistent with any source rules contained in U.S. income tax treaties.  To
the extent, however, that a U.S. income tax treaty provides benefits to a
taxpayer, these regulations do not prevent a taxpayer from claiming those
benefits.
     The final regulations expand the example to illustrate the determination
of source if an independent factory or production price exists, and also for a
sale of mixed source property within the group that is subsequently sold
outside the group if, incident to the sale, services are performed by one
member for another member or intangibles are licensed from one member to
another member.
     Example 18 of paragraph (c) of the proposed regulations (Example 15 of
the final regulations) addresses the application of section 1248 to
intercompany transactions and has been revised to reflect the changes made to
the attribute allocation provisions.  Issue 3 of Rev. Rul. 87-96 (1987-2 C.B.
709) will no longer be applicable to the extent it is inconsistent with
Example 15 and these regulations.
          d.  Limitation on attribute redetermination.  
     The proposed regulations contain a provision limiting the treatment of
S's intercompany income or gain as excluded from gross income under the
matching rule to situations in which B's corresponding item is a deduction or
loss that is permanently disallowed directly under other provisions of the
Code or regulations.  The final regulations clarify that the Code or
regulations must explicitly provide for the disallowance of B's deduction or
loss.  Thus, B's amount that is realized but not recognized under any
provision of the Code or regulations, such as in a liquidation under section
332, is not permanently and explicitly disallowed, notwithstanding that the
amount may be considered a corresponding item because it is a "disallowed or
eliminated amount."
     5.  Deemed Items.
     The proposed regulations provide rules under which certain basis
adjustments are deemed to be items, and certain amounts are deemed not to be
items.  Under the proposed regulations an adjustment reflected in S's basis
that is a substitute for an intercompany item is generally treated as an
intercompany item (the deemed intercompany item rule).  An adjustment
reflected in B's basis that is a substitute for a corresponding item is
generally treated as a corresponding item (the deemed corresponding item
rule).  In addition, a deduction or loss is not treated as an intercompany
item or a corresponding item to the extent it does not reduce basis (the
amounts not deemed to be items rule).  Commentators found these rules to be
confusing.  In addition, the rules generally overlap with other rules of the
proposed regulations.
     For example, the deemed intercompany item rule overlaps with the rule of
the proposed regulations under which S's items must be taken into account even
if they have not yet been taken into account under S's separate entity
accounting method.  If, under its method of accounting, S's income from an
intercompany transaction is treated as a basis reduction, both rules could
apply.
     Similarly, the deemed corresponding item rule overlaps with the
acceleration rule.  S's intercompany item is taken into account under the
acceleration rule to the extent it will not be taken into account under the
matching rule.  Thus, an adjustment to B's basis may result in accelerating
S's intercompany item, to the extent the intercompany item is not reflected in
B's basis following the adjustment.  Because this is the same result that
would occur under the deemed corresponding item rule, it is not necessary to
treat the basis adjustment as a corresponding item under the matching rule. 
For example, B's reduction in the basis of property acquired from S under
section 108(b) will cause S's intercompany gain to be accelerated to the
extent the basis reduction exceeds S's basis in the property prior to the
intercompany transaction.
     The amounts deemed not to be items rule treats certain amounts that are
within the definition of intercompany items as not being intercompany items to
achieve a result consistent with these regulations and other Code provisions. 
Commentators indicated that this rule has limited application, does not
achieve its desired effect in all cases, and is confusing to readers.
     For these reasons, the deemed item rules and the amounts deemed not be
items rule have been eliminated in the final regulations.  Because the deemed
item rules overlap with other provisions, their effects have been retained in
the final regulations.  In addition, to achieve the intended effect of the
amounts deemed not be items rule, the attribute provisions of the final
regulations have been modified to permit the Commissioner to treat
intercompany gain as excluded from gross income when that treatment is
consistent with these regulations and other applicable provisions of the Code. 

     6.  The acceleration rule.
     The acceleration rule requires S and B to take into account their items
from an intercompany transaction to the extent the items cannot be taken into
account to produce the effect of treating S and B as divisions of a single
corporation.  The acceleration rule applies, for example, when either S or B
leaves the group.  Under the proposed regulations, the attributes of S's items
from intercompany property transactions are determined under the principles of
the matching rule "as if B resold the property to a nonmember affiliate." 
Under this rule, S's gain from the sale of depreciable property is always
treated as ordinary income under section 1239.  This treatment is appropriate
if the property remains in the group, as it would, for example, if the
acceleration rule applies because S leaves the group.  Many commentators
objected to this treatment of S's attributes in other situations, arguing, for
example, that if B leaves the group while it still owns the property, the
rules should treat the property as sold to a person whose relationship to the
group is the same as B's relationship to the group after it becomes a
nonmember.  The commentators argued that section 1239 should not apply if B is
unrelated.
     In response to these comments, the final regulations revise the
acceleration rule to provide that if the property is owned by a nonmember
immediately after the event causing acceleration occurs, S's attributes are
determined under the principles of the matching rule as if B had sold the
property to that nonmember.  In applying this rule, if the nonmember is
related for purposes of any provision of the Code or regulations to any party
to the intercompany transaction (or any related transaction) or to P, the
nonmember is treated as related to B for purposes of that provision. 
Accordingly, that relationship may affect the attributes of S's intercompany
item.
     Under both the prior regulations and the proposed regulations, if S
sells an asset to B at a gain and B then transfers the asset to a partnership,
S's gain is taken into account under the acceleration rule.  Some commentators
argued that gain should not be taken into account, at least to the extent of
the member's share of the asset owned through the partnership, treating the
partnership, in effect, as an aggregate of its partners, rather than as an
entity.  One commentator argued that continued deferral would be similar to
the treatment currently available under the remedial allocation method under
1.704-3 if appreciated property is transferred to the partnership without a
prior intercompany transfer.
     The final regulations retain the rule of the proposed regulations.  One
of the purposes of the acceleration rule is to prevent basis created in an
intercompany transaction from affecting nonmembers prior to the time the group
takes into account the transaction that created the basis.  Allowing property
that B purchased from S at a gain to be contributed to a partnership without
acceleration would allow the basis created in the intercompany transaction to
be reflected by the partnership prior to the group taking into account the
gain.  While rules could be developed to prevent this basis from affecting
nonmembers in most circumstances, the rules would be unduly complex.  For
example, the rules would have to take into account the allocation of
liabilities under section 752 and basis adjustments under section 755. 
Moreover, these rules would not resemble the remedial allocation method under
1.704-3 but instead would more closely resemble the deferred sale method
under the proposed regulations under section 704(c).  However, this method was
explicitly rejected when final regulations were issued.  See 1.704-3(a)(1).
     7.  Transactions involving stock of members.
          a.  Single entity treatment of stock.
     In contrast to their predominantly single entity approach, the proposed
regulations generally retain separate entity treatment of stock of members. 
For example, section 1032, which enables a member to sell its own stock
without recognition of gain or loss, is not extended to sales of the stock of
other members.  Notice 94-49 (1994-1 C.B. 358) discusses the difficulties of
extending single entity treatment to stock.
     Several comments recommended greater single entity treatment of stock. 
Some recommended a limited approach under which single entity treatment would
apply only to stock of the common parent.  Under this approach section 1032
treatment would be expanded so that any member could sell stock of the common
parent without recognizing any gain or loss.  As a corollary, gain or loss
would be recognized when a corporation owning stock of the common parent
joined the group, treating the stock, in effect, as redeemed.
     This suggestion was generally not adopted in the final regulations,
because single entity treatment of P stock would significantly increase the
complexity of the regulations and would require significant additional
guidance dealing with the effect of this treatment on other provisions of the
Code.  For example, the regulations would have to coordinate single entity
treatment of P stock with the reorganization provisions of the Code and
applicable case law.  Similarly, the regulations would have to address
situations in which the common parent of the group changes, as well as a
variety of collateral consequences.
     Nevertheless, the Treasury and the IRS believe that limited single
entity treatment of stock is needed to prevent disparities caused by separate
entity treatment.  Therefore, temporary regulations published elsewhere in
this issue of the Federal Register provide a limited single entity approach to
P stock that generally limits the ability of a group to create loss with
respect to P stock and eliminates gain in certain circumstances.  The
feasibility of expanding single entity treatment for stock of members will
continue to be studied.  Comments and suggestions on this subject are welcome.
          b.  Liquidations.
     The proposed regulations provide that if S sells stock of a corporation
(T) to B and T later liquidates into B in a transaction to which section 332
applies, S's intercompany gain is taken into account under the matching rule,
even though the T stock is never held by a nonmember after the intercompany
transaction.  This treatment is similar to the treatment under prior
regulations and has applied to liquidations under section 332 since 1966 and
to deemed liquidations under 338(h)(10) since 1986, although the proposed
regulations provide relief not previously available for these transactions.
     Some commentators suggested that this rule should be eliminated because
it could lead to two layers of tax inside the consolidated group.  The final
regulations, however, retain the rule (with the elective relief as described
below).  As more fully explained in Notice 94-49, the location of items within
a group is a core principle underlying the operation of these regulations,
which like the prior regulations, adopt a deferred sale approach, not a
carryover basis approach.  Taking intercompany gain into account in the event
of a subsequent nonrecognition transaction is necessary to prevent the
transfer and liquidation of subsidiaries from being used to affect
consolidated taxable income or tax liability by changing the location of items
within a group (a result that would be equivalent to a carryover basis
system).  For example, assume that S has an asset with a zero basis and a $100
value.  The group would like to shift this built-in gain to B.  To do so, S
could transfer the asset to T, a newly formed subsidiary.  After the transfer,
S has a zero basis in the T stock under section 358, and T has a zero basis in
the asset under section 362.  S then sells the T stock to B for $100 and
realizes a $100 gain, which is not taken into account.  T later liquidates
into B, which receives the asset with a zero basis under section 334.  If the
transaction is not recharacterized as a direct transfer of assets or is not
subject to adjustment under section 482, and S's gain on the sale of the T
stock is treated as tax-exempt (or if it is indefinitely deferred), the series
of transactions has the effect of a transfer of the asset by S to B in a
carryover basis transaction.
     The Treasury and the IRS rejected a carryover basis system for the
reasons detailed in Notice 94-49.  While a carryover basis system might be
feasible in limited circumstances, extensive rules to prevent avoidance
transactions would be required.  The result would be to burden the
consolidated return regulations with an unworkable combination of rules for
both a deferred sale approach and a carryover basis approach.  Accordingly,
the rule of the proposed regulations has been retained.  The regulations have
been modified, however, to permit S to determine the amount of its taxable
gain by offsetting intercompany gain with intercompany loss on shares of stock
having the same material terms.
          c.  Liquidation relief.
     The proposed regulations provide elective relief that, in certain
circumstances, eliminates or offsets gain taken into account under the
matching rule as a result of a section 332 liquidation (or a comparable
nonrecognition transaction, such as a downstream merger).  In response to
comments, the final regulations broaden the circumstances under which this
relief is available by eliminating the requirements that T have no minority
shareholders and that T not have made substantial noncash distributions during
the previous 12-month period.
     The available relief depends on the form of the transaction that causes
S's intercompany gain to be taken into account.  In the case of a liquidation
of T under section 332, relief is provided by treating the formation by B of a
new subsidiary (new T) as if it were pursuant to the same plan or arrangement
as the liquidation (thus allowing treatment as a reorganization if other
applicable requirements are met).  The final regulations expand the scope of
this relief over that provided in the proposed regulations by allowing the
transfer of assets to new T to be completed up to 12 months after the timely
filing (including extensions) of the group's return for the year of T's
liquidation, so long as the transaction occurs pursuant to a written plan, a
copy of which is attached to the return.  In the case of a deemed liquidation
of T as the result of an election under section 338(h)(10) in connection with
B's sale of the T stock to a nonmember, relief is provided by treating the
deemed liquidation as if it were governed by section 331 instead of section
332.  The amount of loss taken into account on the deemed liquidation is
limited to the amount of the intercompany gain with respect to the T stock
that is taken into account as a result of the deemed liquidation.
     Some commentators requested that the relief applicable for a deemed
liquidation resulting from a section 338(h)(10) election be extended to actual
liquidations under section 332--that is, the liquidation would be a taxable
event both to T and to B (with T's gain or loss not deferred, and B's basis in
the T stock adjusted under 1.1502-32 to reflect T's gain or loss from the
taxable liquidation).  This suggestion was not adopted.  The suggestion would
result in the group currently taking into account gain from, and increasing
the basis of, property that continues to be held within the group.  Adopting
the commentators' suggestion could give groups the ability to selectively
avoid the deferral of gain on intercompany transactions by instead engaging in
stock sales and liquidations.  Such selectivity would be contrary to the
purpose of these regulations and could create the potential for abusive
transactions.
     d.  Effective date of relief provisions.
     As proposed, the effective date of the relief provisions follows the
general effective date of the regulations, applying only if both the
intercompany transaction and the triggering event occur in years beginning
after the final regulations are filed with the Federal Register.  Commentators
requested retroactive application of the relief provisions to varying degrees. 
For example, some commentators suggested that the relief should extend to
transactions after the date the regulations are finalized.  Others suggested
that the relief should apply for any open year.
     In response to these comments, the final regulations adopt an effective
date that allows groups to elect to apply the relief provisions to certain
transactions that occur on or after July 12, 1995, regardless of whether the
sale of the T stock from S to B occurred prior to July 12, 1995.
     The final regulations neither provide relief for duplicated gains nor
preclude losses taken into account under the prior regulations in periods
prior to the effective date of the regulations.  Broader retroactivity would
result in significant additional administrative burdens for the IRS.  In
addition to an increase in amended returns, taxpayers that made elections to
avoid triggering S's gain (for example, under section 338) might seek to
revoke these elections.  Revocation of these elections could raise difficult
valuation issues for assets that were disposed of long ago, as well as
questions with respect to other rules that have since been amended.  In
addition, relief for prior years would be somewhat arbitrary.  For example,
many taxpayers, such as those whose gain was taken into account from a
liquidation of T into B, would be unable to benefit from the relief (because
the relief requires T to be reformed within a limited time period).  By
allowing elective relief only for transactions occurring after the date the
regulations are filed, the final regulations provide the most relief possible
without creating these problems.
     8.  Obligations of members.
          a.  Deemed satisfaction and reissuance.
     In addition to the general matching provisions, the proposed regulations
provide rules applicable to intercompany obligations that generally operate to
match an obligor's items with an obligee's items from intercompany
obligations.  This matching results from a deemed satisfaction and reissuance
of an intercompany obligation when either member realizes income or loss with
respect to the intercompany obligation from the assignment or extinguishment
of all or part of the remaining rights or obligations under the intercompany
obligation, or from a comparable transaction, such as marking to market.  For
example, if one member is a dealer in securities that holds a security issued
by another member, the dealer might be required to mark to market the security
issued by the other member at year-end under section 475.  Under the proposed
regulations, marking to market the other member's security will result in a
deemed satisfaction and reissuance of the security, so that the marking member
and the issuing member take offsetting gain and loss into account.
     Commentators objected to the deemed satisfaction and reissuance
provision as requiring significant recordkeeping and burdensome computations
that are not required for financial statement or internal management reporting
purposes.  Commentators suggested that Prop. Reg. 1.446-4(e)(9) (published in
the Federal Register on July 18, 1994, 59 FR 36394), which permits separate
entity treatment for certain hedging transactions between members, should be
extended beyond hedging transactions to other intercompany obligations,
provided one party to the transaction marks its position to market.  Separate
entity treatment would avoid the deemed satisfaction and reissuance rule if
one member is a dealer in securities required to mark its securities to
market.
     The final regulations do not adopt this suggestion.  The rules of
1.446-4 limit the nonmarking member's ability to selectively recognize gain
or loss on its position in the intercompany obligation.  Without a limitation
of this type, separate entity treatment would allow taxpayers to achieve
results that are contrary to the purposes of these regulations (for example,
by allowing a member to mark a loss position in an intercompany obligation
while the other member defers realization of the associated gain). 
Accordingly, separate entity treatment is not made available in the final
regulations to other types of intercompany obligations.
     The Treasury and the IRS recognize that Prop. Reg. 1.446-4(e)(9)
provides an important exception to the general single entity treatment of
these final regulations.  The Treasury and the IRS anticipate that the
proposed section 446 regulations will be finalized shortly.
          b.  Cancellation of intercompany indebtedness.
     The proposed regulations do not affect the application of section 108 to
the cancellation of intercompany indebtedness.  For example, under the
proposed regulations if S loans money to B, a cancellation of the loan subject
to section 108(a) may result in:  (i) excluded income to B; (ii) a noncapital,
nondeductible expense to S (under the matching rule); and (iii) a reduction of
B's tax attributes (such as its basis in depreciable property).  As a result,
B's tax attributes are reduced even though the group has not excluded any
income on a net basis.  Accordingly, the final regulations provide that
section 108(a) does not apply to the cancellation of intercompany
indebtedness.  As a result of this change, the general principles of the
matching rule will prevent transactions to which section 108(a) would
otherwise apply from having inappropriate effects on basis and consolidated
taxable income.  In the preceding example, S and B will have offsetting
ordinary income and ordinary loss, and B's tax attributes will not be reduced. 
However, no inference is intended as to whether the extinguishment of a loan
between S and B would be properly characterized as a transaction giving rise
to cancellation of indebtedness income within the meaning of sections
61(a)(12) and 108, or as a contribution to capital, a dividend or other
transaction.
          c.  Obligations becoming intercompany obligations.
     Under the proposed regulations, if an obligation becomes an intercompany
obligation, it is treated as satisfied and reissued immediately after the
obligation becomes an intercompany obligation.  This treatment applies to both
the issuer and the holder.  The attributes of the issuer's items and the
holder's items are separately determined, and thus may not match. 
Commentators requested that the rules be revised to allow for single entity
treatment of attributes, to avoid the mismatch of ordinary income with capital
loss.
     This suggestion was not adopted.  The use of separate return attributes
for gain and loss assures that the attributes of gain or loss will be the same
whether the obligation is retired immediately before the transaction in which
the obligation becomes an intercompany obligation, or is deemed retired as a
result of that transaction.  Providing for the use of single entity attributes
would result in undue selectivity.  In addition, the separate entity treatment
of attributes in these circumstances best reflects the fact that the income
and loss taken into account accrued before the issuer and the holder joined in
filing a consolidated return.
     Commentators also noted that, under 1.1502-32, downward stock basis
adjustments would be required upon the expiration of any capital losses
created by the deemed satisfaction if a member joins the group while holding
an obligation of another member.  Because the proposed regulations provide
that the deemed satisfaction and reissuance is treated as occurring
immediately
after the obligation becomes an intercompany obligation, these losses could
not be waived under 1.1502-32(b)(4).  In response to this comment, the final
regulations provide that, solely for purposes of 1.1502-32(b)(4) and the
effect of any elections under that provision, the joining member's loss from
the deemed satisfaction and reissuance is treated as a loss carryover from a
separate return limitation year.  Thus, the group may elect to waive the
capital losses and avoid the downward basis adjustment.
          d.  Warrants and similar instruments.
     The proposed regulations do not provide special rules for the treatment
of warrants to acquire a member's stock.  The proposed regulations could,
however, be read to include warrants within the definition of intercompany
obligations.
     Under section 1032, warrants and other positions in stock of the issuer
are treated like stock.  See, for example, Rev. Rul. 88-31, 1988-1 C.B. 302. 
The treatment of warrants as intercompany obligations subject to a single
entity regime is inconsistent with the general separate entity treatment of
stock under these regulations.  Accordingly, the final regulations provide
that warrants and other positions with respect to a member's stock are not
treated as obligations of that member.  Instead, these instruments are
governed by the rules generally applicable to stock of a member.  In addition,
the final regulations provide that the deemed satisfaction and reissuance rule
for intercompany obligations will not apply to the conversion of an
intercompany obligation into the stock of the obligor.
     9.  Anti-avoidance rule.
     The purpose of the intercompany transaction regulations is to clearly
reflect the taxable income (and tax liability) of the group as a whole by
preventing intercompany transactions from creating, accelerating, avoiding, or
deferring consolidated taxable income (or consolidated tax liability).  The
proposed regulations provide that transactions which are engaged in or
structured with a principal purpose to achieve a contrary result are subject
to adjustment under the anti-avoidance rule, notwithstanding compliance with
other applicable authorities.  Some commentators criticized this rule as being
overly broad, unnecessary, and more appropriately placed in other regulations,
such as 1.701-2 (the partnership anti-abuse regulation).  Other commentators
supported the use of anti-avoidance rules but criticized the particular
examples.  The Treasury and the IRS continue to believe that the anti-
avoidance rule is necessary to prevent transactions that are designed to
achieve results inconsistent with the purpose of the regulations and therefore
the final regulations retain the rule.  Routine intercompany transactions that
are undertaken for legitimate business purposes generally will be unaffected
by the anti-avoidance rule.
     The anti-avoidance provision can apply to transactions that are
structured to avoid treatment as intercompany transactions.  For example, if
property is indirectly transferred from one member to another using a
nonmember intermediary to achieve a result that could not be achieved by a
direct transfer within the group, the anti-avoidance rule might apply.  Thus,
transactions that take place indirectly between members but are not
intercompany transactions (including, for example, transactions involving the
use of fungible property, trusts, partnerships, and intermediaries) will be
analyzed to determine whether they are substantially similar (in whole or in
part) to an intercompany transaction, in which case the anti-avoidance rule
might apply.
     The examples from the proposed regulations have been revised to better
illustrate the effect of the anti-avoidance rule.  Example 2 of the proposed
regulations, which involved a transfer outside of the group to a partnership,
has been eliminated.  However, the transaction described in that example, as
with any other transaction, is subject to challenge under other authorities. 
See, for example, 1.701-2.
     10.  Transitional anti-avoidance rule.
     To prevent manipulation, the proposed regulations provide that if a
transaction is engaged in or structured on or after April 8, 1994, with a
principal purpose to avoid the final regulations, to duplicate, omit, or
eliminate an item in determining taxable income (or tax liability), or to
treat items inconsistently, appropriate adjustments must be made in years to
which the final regulations apply to prevent the avoidance, duplication,
omission, elimination, or inconsistency.
     Commentators objected to this rule, arguing that it had the effect of
treating the proposed regulation as an immediately effective temporary
regulation.  These commentators also raised questions as to when the rule
applies and what "appropriate adjustments" will be necessary.
     Because of the prospective application of the regulations, and
particularly because members could otherwise engage in transactions entirely
within the group with a principal purpose to avoid the application of the
final regulations with almost no transaction costs, this rule is retained in
the final regulations, with minor clarifications.
     11.  Dealers in securities.
     If S is a dealer in securities under section 475 and sells securities to
B, a nondealer, the proposed regulations require S to treat any gain or loss
on the sale as an intercompany item.  Furthermore, under the single entity
approach of the matching rule, B must continue to mark to market securities
acquired from S.
     Several commentators argued that this approach is inconsistent with
proposed regulations under section 475, which require S to mark to market the
security immediately before the transfer, and take any gain or loss into
account immediately (that is, the gain or loss is not subject to deferral
under the prior intercompany transaction regulations).
     Although the rules applicable to these types of transactions under the
proposed regulations and the proposed section 475 regulations differ, the
effects of these transactions on consolidated taxable income are generally the
same.  That is, the dealer's gain or loss is taken into account in the taxable
year of the transfer.
     The approach of the proposed intercompany transaction regulations is
consistent with the general single entity principle, and has been retained in
the final regulations.  Nevertheless, the Treasury and the IRS will continue
to consider the most appropriate treatment of these transactions, in view of
the underlying purposes of these regulations and section 475.  The Treasury
and the IRS anticipate that upcoming regulations under section 475 will
address any remaining inconsistencies in the approach, and will provide
exceptions to the single entity approach if appropriate.  Comments and
suggestions on this subject are welcome.
     12.  Changes to section 267 regulations.  
     The proposed regulations under section 267(f) generally provide that
losses from sales or exchanges of property between related parties are taken
into account in the same manner as is provided in the timing provisions of the
regulations under 1.1502-13.  Several technical changes have been
incorporated into the final regulations under section 267.
     For example, the regulations clarify that to the extent S's loss would
have been treated as a noncapital, nondeductible amount under the attribute
rules of the regulations under 1.1502-13, the loss is deferred under section
267(f) until S and B are no longer in a controlled group relationship with
each other.  Section 267 is intended to prevent a taxpayer from taking a loss
into account from the sale or exchange of property when the property continues
to be held by a member of the same controlled group.  Under 1.1502-13, S's
loss might be taken into account but redetermined to be noncapital or
nondeductible, permanently preventing the loss from being taken into account. 
It could be argued that this is the result of the attribute provisions of
1.1502-13, which do not apply under section 267(f), not a result of the
timing provisions of 1.1502-13, and thus, a controlled group member could
take its loss into account.  The change made in the final regulations assures
that the purpose of section 267 is not defeated as a result of the non-
application of the attribute redetermination rules of 1.1502-13 for purposes
of section 267(f).
     The proposed regulations also require loss deferral similar to section
267(d) when B transfers property acquired at a loss from S to a nonmember
related party.  This provision has been modified in the final regulations to
include parties described in section 707(b) as related parties to prevent
avoidance of the rules of section 267 through the use of related partnerships.
     13.  Election to deconsolidate.
     Section 1.1502-75 authorizes the Commissioner to grant all groups, or
groups in a particular class, permission to discontinue filing consolidated
returns if any provision of the Code or regulations has been amended and the
amendment could have a substantial adverse effect relative to the filing of
separate returns.  The Commissioner has determined that it is generally
appropriate to grant permission to discontinue filing consolidated returns as
a result of the amendments made in these regulations.  To lessen taxpayer
burden and ease administrability, permission will be granted without requiring
the group to demonstrate any adverse effect.  The Treasury and the IRS intend
to issue, prior to January 1, 1996, a revenue procedure pursuant to which
groups may receive permission to deconsolidate effective for their first
taxable year to which these regulations apply.  Permission for a group to
deconsolidate will be granted under terms and conditions similar to those
prescribed in Rev. Proc. 95-11 (1995-4 I.R.B. 48).
D.  Effective Dates
     The regulations are effective in years beginning on or after July 12,
1995.  For dates of applicability, see 1.1502-13(l).
E.  Special Analyses
     It has been determined that this Treasury Decision is not a significant
regulatory action as defined in EO 12866.  Therefore, a regulatory assessment
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 on the fact that these regulations will primarily
affect affiliated groups of corporations that have elected to file
consolidated returns, which tend to be larger businesses.  The regulations
also govern certain transactions between members of controlled groups of
corporations, but generally produce the same results for such transactions as
current law.  The regulations do not significantly alter the reporting or
recordkeeping duties of small entities.  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 Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted to the
Small Business Administration for comment on its impact on small business.
List of Subjects
26 CFR Part 1
     Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
     Reporting and recordkeeping requirements
Adoption of Amendments to the Regulations
     Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
     Paragraph 1.  The authority citation for part 1 is amended by revising
the entries for 1.1502-13 and 1.1502-33, and 1.1502-80, as set forth below;
by removing the entries for sections "1.469-1", "1.469-1T", "1.1502-13T",
"1.1502-14", and "1.1502-14T"; and adding the remaining entries in numerical
order to read as follows:
     Authority:  26 U.S.C. 7805 * * *
Section 1.108-3 also issued under 26 U.S.C. 108, 267, and 1502. * * *
Section 1.267(f)-1 also issued under 26 U.S.C. 267 and 1502. * * *
Section 1.460-4 also issued under 26 U.S.C. 460 and 1502. * * *
Section 1.469-1 also issued under 26 U.S.C. 469.
Section 1.469-1T also issued under 26 U.S.C. 469.  * * *
Section 1.1502-13 also issued under 26 U.S.C. 108, 337, 446, 1275, 1502 and
1503. * * * 
Section 1.1502-17 also issued under 26 U.S.C. 446 and 1502.  
Section 1.1502-18 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-26 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-33 also issued under 26 U.S.C. 1502. * * *
Section 1.1502-79 also issued under 26 U.S.C. 1502.
Section 1.1502-80 also issued under 26 U.S.C. 1502. * * *
     Par. 2.  In the list below, for each location indicated in the left
column, remove the language in the middle column from that section, and add
the language in the right column.

                                 Affected
     Section                                  Remove                                    Add
1.167(a)-
(11)(d)(3)(v)(b), 1st
sentencewhich results in
"deferred gain or
loss" within the
meaning of paragraph
(c) of 1.1502-13
1.167(c)-1(a)(5)
, 1.1502-13, and
1.1502-14 
1.1502-13              1.263A-7T(e)(1)(ii),
1st sentencea deferred
intercompany
transactionan intercompany
transaction
1.263A-7T(e)(1)(ii),
4th sentence
1.1502-13(c)(2)1.1502-131.263A-7T(e)(1)(ii),
4th sentencedeferred
1.263A-7T(e)(1)(ii),
7th sentence"deferred intercompany
transaction""intercompany
transaction"
1.263A-7T(e)(1)(ii),
7th sentencedefinedas used
1.263A-
7T(e)(1)(iii)(A)
Example, 2nd sentence1.1502-13(c) 1.1502-13
1.263A-
7T(e)(1)(iii)(A)
Example, 4th sentence
1.1502-13(c)1.1502-13
1.279-6(b)(4), 1.1502-13T,
1.1502-14, or
1.1502-14T
1.337(d)-1(a)(5)
Example 8(i), 5th
sentence1.1502-13(c)1.1502-13
1.337(d)-1(a)(5)
Example 8(ii), 1st
sentence1.1502-13(c)1.1502-131.337(d)-1(a)(5)
Example 8(ii), 2nd
sentence1.1502-13(f)(1)(i),
1.267(f)-2T(e)(1)1.1502-13, 1.267(f)-1
1.337(d)-2(g)(1), 2nd
sentence1.1502-13T, 1.1502-14,
and 1.1502-14T1.1502-14 (as
contained in the 26
CFR part 1 edition
revised as of April 1,
1995)
1.338-4(f)(4) Example
(2)(a)1.1502-13(f)1.1502-13
1.341-7(e)(10)paragraph (c)(1) of
1.1502-14 for the
deferral1.1502-13 for the
treatment
1.861-8T(d)(2)(i),
concluding text1.1502-13(c)(2)1.1502-13
1.861-8T(d)(2)(i),
concluding textdeferred
1.861-8T(d)(2)(i),
concluding text1.1502-13(a)(2)1.1502-13
1.861-9T(g)(2)(iv),
paragraph headingdeferred
1.861-9T(g)(2)(iv),
1st sentencedeferred intercompany
transactionsintercompany
transactions
1.1502-3(a)(2)1.1502-13(a)(1)1.1502-13(b)
1.1502-4(j) Example
(1), 8th sentence
Under 1.1502-13Under 1.1502-13 (as
contained in the 26
CFR part 1 edition
revised as of April 1,
1995)
1.1502-9(f) Example
(6)a restoration event
under section 1.1502-
13(f) occursthe intercompany gain
is taken into account
under section 1.1502-
13
1.1502-12(a)1.1502-13 and
1.1502-141.1502-13
1.1502-12(g)(2)a deferred
intercompany
transaction as defined
in 
1.1502-13(a)(2)an intercompany
transaction as defined
in 1.1502-13
1.1502-22(a)(3)1.1502-14,
1.1502-22(a)(5)
Example (i)paragraph (d), (e), or
(f) of 1.1502-13
1.1502-13             
               
1.1502-26(b), second
sentence
paragraph (a)(1) of
1.1502-141.1502-13
1.1502-47(e)(4)(iii),
first sentence1.1502-13(f),
1.1502-14,1.1502-13,
1.1502-47(e)(4)(iv)
Example 4, third
sentencedeferred intercompany
transactions (see
1.1502-13(a)(2))intercompany
transactions (see
1.1502-13)
1.1502-47(e)(4)(iv)
Example 4, fourth
sentence
1.1502-13(f)(1)(iv)1.1502-131.1502-47(e)(4)(iv)
Example 4,         
chart header
Deferred intercompany
transactions betweenIntercompany
transactions between
1.1502-47(e)(4)(iv)
Example 4,         
chart header
1.1502-13(f)(1)(iv)
1.1502-131.1502-47(f)(3), first
sentence     1.1502-14,
1.1502-47(r), second
sentencedeferred
1.1503-2(d)(4) Example
1 (iii), fourth
sentence
deferred


1.1503-2(d)(4) Example
1 (iii), fourth
sentence1.1502-13(a)(2)1.1502-13
1.1552-1(a)(2)(ii)(c)1.1502-141.1502-13(f) and (g)

     Par. 3.  Section 1.108-3 is added to read as follows:
1.108-3  Intercompany losses and deductions.
     (a)  General rule.  This section applies to certain losses and
deductions from the sale, exchange, or other transfer of property between
corporations that are members of a consolidated group or a controlled group
(an intercompany transaction).  See section 267(f) (controlled groups) and
1.1502-13 (consolidated groups) for applicable definitions.  For purposes of
determining the attributes to which section 108(b) applies, a loss or
deduction not yet taken into account under section 267(f) or 1.1502-13 (an
intercompany loss or deduction) is treated as basis described in section
108(b) that the transferor retains in property.  To the extent a loss not yet
taken into account is reduced under this section, it cannot subsequently be
taken into account under section 267(f) or 1.1502-13.  For example, if S and
B are corporations filing a consolidated return, and S sells land with a $100
basis to B for $90 and the $10 loss is deferred under section 267(f) and
1.1502-13, the deferred loss is treated for purposes of section 108(b) as $10
of basis that S has in land (even though S has no remaining interest in the
land sold to B) and is subject to reduction under section 108(b)(2)(E). 
Similar principles apply, with appropriate adjustments, if S and B are members
of a controlled group and S's loss is deferred only under section 267(f).
     (b)  Effective date.  This section applies with respect to discharges of
indebtedness occurring on or after September 11, 1995.
1.167(a)-11 [Amended]
     Par. 4.  Section 1.167(a)-11(d)(3)(v)(e) is amended by removing the
second sentence of Example (3).
     Par. 5.  In  1.263A-1, paragraph (j)(1)(ii)(B), the last sentence is
revised to read as follows:
1.263A-1  Uniform capitalization of costs.
* * * * *
     (j) * * *
     (1) * * *
     (ii) * * *
     (B) * * *  See 1.1502-13.
* * * * *
     Par. 6.  Section 1.267(f)-1 is revised to read as follows:
1.267(f)-1  Controlled groups.
     (a)  In general--(1)  Purpose.  This section provides rules under
section 267(f) to defer losses and deductions from certain transactions
between members of a controlled group (intercompany sales).  The purpose of
this section is to prevent members of a controlled group from taking into
account a loss or deduction solely as the result of a transfer of property
between a selling member (S) and a buying member (B).
     (2)  Application of consolidated return principles.  Under this section,
S's loss or deduction from an intercompany sale is taken into account under
the timing principles of 1.1502-13 (intercompany transactions between members
of a consolidated group), treating the intercompany sale as an intercompany
transaction.  For this purpose:
     (i)  The matching and acceleration rules of 1.1502-13(c) and (d), the
definitions and operating rules of 1.1502-13(b) and (j), and the simplifying
rules of 1.1502-13(e)(1) apply with the adjustments in paragraphs (b) and (c)
of this section to reflect that this section--
     (A)  Applies on a controlled group basis rather than consolidated group
basis; and
     (B)  Generally affects only the timing of a loss or deduction, and not
its attributes (e.g., its source and character) or the holding period of
property.
     (ii)  The special rules under 1.1502-13(f) (stock of members) and (g)
(obligations of members) apply under this section only to the extent the
transaction is also an intercompany transaction to which 1.1502-13 applies.
     (iii)  Any election under 1.1502-13 to take items into account on a
separate entity basis does not apply under this section.  See 1.1502-
13(e)(3).
     (3)  Other law.  The rules of this section apply in addition to other
applicable law (including nonstatutory authorities).  For example, to the
extent a loss or deduction deferred under this section is from a transaction
that is also an intercompany transaction under 1.1502-13(b)(1), attributes of
the loss or deduction are also subject to recharacterization under 1.1502-13. 
See also, sections 269 (acquisitions to evade or avoid income tax) and 482
(allocations among commonly controlled taxpayers).  Any loss or deduction
taken into account under this section can be deferred, disallowed, or
eliminated under other applicable law.  See, for example, section 1091 (loss
eliminated on wash sale).
     (b)  Definitions and operating rules.  The definitions in 1.1502-13(b)
and the operating rules of 1.1502-13(j) apply under this section with
appropriate adjustments, including the following:
     (1)  Intercompany sale.  An intercompany sale is a sale, exchange, or
other transfer of property between members of a controlled group, if it would
be an intercompany transaction under the principles of 1.1502-13, determined
by treating the references to a consolidated group as references to a
controlled group and by disregarding whether any of the members join in filing
consolidated returns.
     (2)  S's losses or deductions.  Except to the extent the intercompany
sale is also an intercompany transaction to which 1.1502-13 applies, S's
losses or deductions subject to this section are determined on a separate
entity basis.  For example, the principles of 1.1502-13(b)(2)(iii) (treating
certain amounts not yet recognized as items to be taken into account) do not
apply.  A loss or deduction is from an intercompany sale whether it is
directly or indirectly from the intercompany sale.
     (3)  Controlled group; member.  For purposes of this section, a
controlled group is defined in section 267(f).  Thus, a controlled group
includes a FSC (as defined in section 922) and excluded members under section
1563(b)(2), but does not include a DISC (as defined in section 992). 
Corporations remain members of a controlled group as long as they remain in a
controlled group relationship with each other.  For example, corporations
become nonmembers with respect to each other when they cease to be in a
controlled group relationship with each other, rather than by having a
separate return year (described in 1.1502-13(j)(7)).  Further, the principles
of 1.1502-13(j)(6) (former common parent treated as continuation of group)
apply to any corporation if, immediately before it becomes a nonmember, it is
both the selling member and the owner of property with respect to which a loss
or deduction is deferred (whether or not it becomes a member of a different
controlled group filing consolidated or separate returns).  Thus, for example,
if S and B merge together in a transaction described in section 368(a)(1)(A),
the surviving corporation is treated as the successor to the other
corporation, and the controlled group relationship is treated as continuing.
     (4)  Consolidated taxable income.  References to consolidated taxable
income (and consolidated tax liability) include references to the combined
taxable income of the members (and their combined tax liability).  For
corporations filing separate returns, it ordinarily will not be necessary to
actually combine their taxable incomes (and tax liabilities) because the
taxable income (and tax liability) of one corporation does not affect the
taxable income (or tax liability) of another corporation.
     (c)  Matching and acceleration principles of 1.1502-13--(1) 
Adjustments to the timing rules.  Under this section, S's losses and
deductions are deferred until they are taken into account under the timing
principles of the matching and acceleration rules of 1.1502-13(c) and (d)
with appropriate adjustments.  For example, if S sells depreciable property to
B at a loss, S's loss is deferred and taken into account under the principles
of the matching rule of 1.1502-13(c) to reflect the difference between B's
depreciation taken into account with respect to the property and the
depreciation that B would take into account if S and B were divisions of a
single corporation; if S and B subsequently cease to be in a controlled group
relationship with each other, S's remaining loss is taken into account under
the principles of the acceleration rule of 1.1502-13(d).  For purposes of
this section, the adjustments to 1.1502-13(c) and (d) include the following:
     (i)  Application on controlled group basis.  The matching and
acceleration rules apply on a controlled group basis, rather than a
consolidated group basis.  Thus if S and B are wholly-owned members of a
consolidated group and 21% of the stock of S is sold to an unrelated person,
S's loss continues to be deferred under this section because S and B continue
to be members of a controlled group even though S is no longer a member of the
consolidated group.  Similarly, S's loss would continue to be deferred if S
and B remain in a controlled group relationship after both corporations become
nonmembers of their former consolidated group.
     (ii)  Different taxable years.  If S and B have different taxable years,
the taxable years that include a December 31 are treated as the same taxable
years.  If S or B has a short taxable year that does not include a December
31, the short year is treated as part of the succeeding taxable year that does
include a December 31.
     (iii)  Transfer to a section 267(b) or 707(b) related person.  To the
extent S's loss or deduction from an intercompany sale of property is taken
into account under this section as a result of B's transfer of the property to
a nonmember that is a person related to any member, immediately after the
transfer, under sections 267(b) or 707(b), or as a result of S or B becoming a
nonmember that is related to any member under section 267(b) (for example, if
S or B becomes an S corporation), the loss or deduction is taken into account
but allowed only to the extent of any income or gain taken into account as a
result of the transfer.  The balance not allowed is treated as a loss referred
to in section 267(d) if it is from a sale or exchange by B (rather than from a
distribution).
     (iv)  B's item is excluded from gross income or noncapital and
nondeductible.  To the extent S's loss would be redetermined to be a
noncapital, nondeductible amount under the principles of 1.1502-13 but is not
redetermined because of paragraph (c)(2) of this section, then, if paragraph
(c)(1)(iii) of this section does not apply, S's loss continues to be deferred
and is not taken into account until S and B are no longer in a controlled
group relationship.  For example, if S sells all of the stock of corporation T
to B at a loss and T subsequently liquidates into B in a transaction
qualifying under section 332, S's loss is deferred until S and B (including
their successors) are no longer in a controlled group relationship.  See
1.1502-13(c)(6)(ii).
     (v)  Circularity of references.  References to deferral or elimination
under the Internal Revenue Code or regulations do not include references to
section 267(f) or this section.  See, e.g., 1.1502-13(a)(4) (applicability of
other law).
     (2)  Attributes generally not affected.  The matching and acceleration
rules are not applied under this section to affect the attributes of S's
intercompany item, or cause it to be taken into account before it is taken
into account under S's separate entity method of accounting.  However, the
attributes of S's intercompany item may be redetermined, or an item may be
taken into account earlier than under S's separate entity method of
accounting, to the extent the transaction is also an intercompany transaction
to which 1.1502-13 applies.  Similarly, except to the extent the transaction
is also an intercompany transaction to which 1.1502-13 applies, the matching
and acceleration rules do not apply to affect the timing or attributes of B's
corresponding items.
     (d)  Intercompany sales of inventory involving foreign persons--(1) 
General rule.  Section 267(a)(1) and this section do not apply to an
intercompany sale of property that is inventory (within the meaning of section
1221(1)) in the hands of both S and B, if--
     (i)  The intercompany sale is in the ordinary course of S's trade or
business; 
     (ii)  S or B is a foreign corporation; and
     (iii)  Any income or loss realized on the intercompany sale by S or B is
not income or loss that is recognized as effectively connected with the
conduct of a trade or business within the United States within the meaning of
section 864 (unless the income is exempt from taxation pursuant to a treaty
obligation of the United States).
     (2)  Intercompany sales involving related partnerships.  For purposes of
paragraph (d)(1) of this section, a partnership and a foreign corporation
described in section 267(b)(10) are treated as members, provided that the
income or loss of the foreign corporation is described in paragraph
(d)(1)(iii) of this section.
     (3)  Intercompany sales in ordinary course.  For purposes of this
paragraph (d), whether an intercompany sale is in the ordinary course of
business is determined under all the facts and circumstances.
     (e)  Treatment of a creditor with respect to a loan in nonfunctional
currency.  Sections 267(a)(1) and this section do not apply to an exchange
loss realized with respect to a loan of nonfunctional currency if--
     (1)  The loss is realized by a member with respect to nonfunctional
currency loaned to another member;
     (2)  The loan is described in 1.988-1(a)(2)(i);
     (3)  The loan is not in a hyperinflationary currency as defined in
1.988-1(f); and
     (4)  The transaction does not have as a significant purpose the
avoidance of Federal income tax.
     (f)  Receivables.  If S acquires a receivable from the sale of goods or
services to a nonmember at a gain, and S sells the receivable at fair market
value to B, any loss or deduction of S from its sale to B is not deferred
under this section to the extent it does not exceed S's income or gain from
the sale to the nonmember that has been taken into account at the time the
receivable is sold to B.
     (g)  Earnings and profits.  A loss or deduction deferred under this
section is not reflected in S's earnings and profits before it is taken into
account under this section.  See, e.g., 1.312-6(a), 1.312-7, and 1.1502-
33(c)(2).
     (h)  Anti-avoidance rule.  If a transaction is engaged in or structured
with a principal purpose to avoid the purposes of this section (including, for
example, by avoiding treatment as an intercompany sale or by distorting the
timing of losses or deductions), adjustments must be made to carry out the
purposes of this section.
     (i)  [Reserved]
     (j)  Examples.  For purposes of the examples in this paragraph (j),
unless otherwise stated, corporation P owns 75% of the only class of stock of
subsidiaries S and B, X is a person unrelated to any member of the P
controlled group, the taxable year of all persons is the calendar year, all
persons use the accrual method of accounting, tax liabilities are disregarded,
the facts set forth the only activity, and no member has a special status.  If
a member acts as both a selling member and a buying member (e.g., with respect
to different aspects of a single transaction, or with respect to related
transactions), the member is referred as to M (rather than as S or B).  This
section is illustrated by the following examples.
     Example 1.  Matching and acceleration rules.  (a)  Facts.  S holds land
for investment with a basis of $130.  On January 1 of Year 1, S sells the land
to B for $100.  On a separate entity basis, S's loss is long-term capital
loss.  B holds the land for sale to customers in the ordinary course of
business.  On July 1 of Year 3, B sells the land to X for $110.

     (b)  Matching rule.  Under paragraph (b)(1) of this section, S's sale of
land to B is an intercompany sale.  Under paragraph (c)(1) of this section,
S's $30 loss is taken into account under the timing principles of the matching
rule of 1.1502-13(c) to reflect the difference for the year between B's
corresponding items taken into account and the recomputed corresponding items. 
If S and B were divisions of a single corporation and the intercompany sale
were a transfer between the divisions, B would succeed to S's $130 basis in
the land and would have a $20 loss from the sale to X in Year 3. 
Consequently, S takes no loss into account in Years 1 and 2, and takes the
entire $30 loss into account in Year 3 to reflect the $30 difference in that
year between the $10 gain B takes into account and its $20 recomputed loss. 
The attributes of S's intercompany items and B's corresponding items are
determined on a separate entity basis.  Thus, S's $30 loss is long-term
capital loss and B's $10 gain is ordinary income.

     (c)  Acceleration resulting from sale of B stock.  The facts are the
same as in paragraph (a) of this Example 1, except that on July 1 of Year 3 P
sells all of its B stock to X (rather than B's selling the land to X).  Under
paragraph (c)(1) of this section, S's $30 loss is taken into account under the
timing principles of the acceleration rule of 1.1502-13(d) immediately before
the effect of treating S and B as divisions of a single corporation cannot be
produced.  Because the effect cannot be produced once B becomes a nonmember, S
takes its $30 loss into account in Year 3 immediately before B becomes a
nonmember.  S's loss is long-term capital loss.

     (d)  Subgroup principles applicable to sale of S and B stock.  The facts
are the same as in paragraph (a) of this Example 1, except that on July 1 of
Year 3 P sells all of its S and B stock to X (rather than B's selling the land
to X).  Under paragraph (b)(3) of this section, S and B are considered to
remain members of a controlled group as long as they remain in a controlled
group relationship with each other (whether or not in the original controlled
group).  P's sale of their stock does not affect the controlled group
relationship of S and B with each other.  Thus, S's loss is not taken into
account as a result of P's sale of the stock.  Instead, S's loss is taken into
account based on subsequent events (e.g., B's sale of the land to a
nonmember).

     Example 2.  Distribution of loss property.  (a)  Facts.  S holds land
with a basis of $130 and value of $100.  On January 1 of Year 1, S distributes
the land to P in a transaction to which section 311 applies.  On July 1 of
Year 3, P sells the land to X for $110.

     (b)  No loss taken into account.  Under paragraph (b)(2) of this
section, because P and S are not members of a consolidated group, 1.1502-
13(f)(2)(iii) does not apply to cause S to recognize a $30 loss under the
principles of section 311(b).  Thus, S has no loss to be taken into account
under this section.  (If P and S were members of a consolidated group,
1.1502-13(f)(2)(iii) would apply to S's loss in addition to the rules of this
section, and the loss would be taken into account in Year 3 as a result of P's
sale to X.)

     Example 3.  Loss not yet taken into account under separate entity
accounting method.  (a)  Facts.  S holds land with a basis of $130.  On
January 1 of Year 1, S sells the land to B at a $30 loss but does not take
into account the loss under its separate entity method of accounting until
Year 4.  On July 1 of Year 3, B sells the land to X for $110.

     (b)  Timing.  Under paragraph (b)(2) of this section, S's loss is
determined on a separate entity basis.  Under paragraph (c)(1) of this
section, S's loss is not taken into account before it is taken into account
under S's separate entity method of accounting.  Thus, although B takes its
corresponding gain into account in Year 3, S has no loss to take into account
until Year 4.  Once S's loss is taken into account in Year 4, it is not
deferred under this section because B's corresponding gain has already been
taken into account.  (If S and B were members of a consolidated group, S would
be treated under 1.1502-13(b)(2)(iii) as taking the loss into account in Year
3.)

     Example 4.  Consolidated groups.  (a)  Facts.  P owns all of the stock
of S and B, and the P group is a consolidated group.  S holds land for
investment with a basis of $130.  On January 1 of Year 1, S sells the land to
B for $100.  B holds the land for sale to customers in the ordinary course of
business.  On July 1 of Year 3, P sells 25% of B's stock to X.  As a result of
P's sale, B becomes a nonmember of the P consolidated group but S and B remain
in a controlled group relationship with each other for purposes of section
267(f).  Assume that if S and B were divisions of a single corporation, the
items of S and B from the land would be ordinary by reason of B's activities.

     (b)  Timing and attributes.  Under paragraph (a)(3) of this section, S's
sale to B is subject to both 1.1502-13 and this section.  Under 1.1502-13,
S's loss is redetermined to be an ordinary loss by reason of B's activities. 
Under paragraph (b)(3) of this section, because S and B remain in a controlled
group relationship with each other, the loss is not taken into account under
the acceleration rule of 1.1502-13(d) as modified by paragraph (c) of this
section.  See 1.1502-13(a)(4).  Nevertheless, S's loss is redetermined by
1.1502-13 to be an ordinary loss, and the character of the loss is not
further redetermined under this section.  Thus, the loss continues to be
deferred under this section, and will be taken into account as ordinary loss
based on subsequent events (e.g., B's sale of the land to a nonmember).

     (c)  Resale to controlled group member.  The facts are the same as in
paragraph (a) of this Example 4, except that P owns 75% of X's stock, and B
resells the land to X (rather than P's selling any B stock).  The results for
S's loss are the same as in paragraph (b) of this Example 4.  Under paragraph
(b) of this section, X is also in a controlled group relationship, and B's
sale to X is a second intercompany sale.  Thus, S's loss continues to be
deferred and is taken into account under this section as ordinary loss based
on subsequent events (e.g., X's sale of the land to a nonmember).

     Example 5.  Intercompany sale followed by installment sale.  (a)  Facts. 
S holds land for investment with a basis of $130x.  On January 1 of Year 1, S
sells the land to B for $100x.  B holds the land for investment.  On July 1 of
Year 3, B sells the land to X in exchange for X's $110x note.  The note bears
a market rate of interest in excess of the applicable Federal rate, and
provides for principal payments of $55x in Year 4 and $55x in Year 5.  Section
453A applies to X's note.

     (b)  Timing and attributes.  Under paragraph (c) of this section, S's
$30x loss is taken into account under the timing principles of the matching
rule of 1.1502-13(c) to reflect the difference in each year between B's gain
taken into account and its recomputed loss.  Under section 453, B takes into
account $5x of gain in Year 4 and in Year 5.  Therefore, S takes $20x of its
loss into account in Year 3 to reflect the $20x difference in that year
between B's $0 loss taken into account and its $20x recomputed loss.  In
addition, S takes $5x of its loss into account in Year 4 and in Year 5 to
reflect the $5x difference in each year between B's $5x gain taken into
account and its $0 recomputed gain.  Although S takes into account a loss and
B takes into account a gain, the attributes of B's $10x gain are determined on
a separate entity basis, and therefore the interest charge under section
453A(c) applies to B's $10x gain on the installment sale beginning in Year 3.

     Example 6.  Section 721 transfer to a related nonmember.  (a)  Facts.  S
owns land with a basis of $130.  On January 1 of Year 1, S sells the land to B
for $100.  On July 1 of Year 3, B transfers the land to a partnership in
exchange for a 40% interest in capital and profits in a transaction to which
section 721 applies.  P also owns a 25% interest in the capital and profits of
the partnership.

     (b)  Timing.  Under paragraph (c)(1)(iii) of this section, because the
partnership is a nonmember that is a related person under sections 267(b) and
707(b), S's $30 loss is taken into account in Year 3, but only to the extent
of any income or gain taken into account as a result of the transfer.  Under
section 721, no gain or loss is taken into account as a result of the transfer
to the partnership, and thus none of S's loss is taken into account.  Any
subsequent gain recognized by the partnership with respect to the property is
limited under section 267(d).  (The results would be the same if the P group
were a consolidated group, and S's sale to B were also subject to 1.1502-13.)

     Example 7.  Receivables.  (a)  Controlled group.  S owns goods with a
$60 basis.  In Year 1, S sells the goods to X for X's $100 note.  The note
bears a market rate of interest in excess of the applicable Federal rate, and
provides for payment of principal in Year 5.  S takes into account $40 of
income in Year 1 under its method of accounting.  In Year 2, the fair market
value of X's note falls to $90 due to an increase in prevailing market
interest rates, and S sells the note to B for its $90 fair market value.

     (b)  Loss not deferred.  Under paragraph (f) of this section, S takes
its $10 loss into account in Year 2.  (If the sale were not at fair market
value, paragraph (f) of this section would not apply and none of S's $10 loss
would be taken into account in Year 2.)

     (c)  Consolidated group.  Assume instead that P owns all of the stock of
S and B, and the P group is a consolidated group.  In Year 1, S sells to X
goods having a basis of $90 for X's $100 note (bearing a market rate of
interest in excess of the applicable Federal rate, and providing for payment
of principal in Year 5), and S takes into account $10 of income in Year 1.  In
Year 2, S sells the receivable to B for its $85 fair market value.  In Year 3,
P sells 25% of B's stock to X.  Although paragraph (f) of this section
provides that $10 of S's loss (i.e., the extent to which S's $15 loss does not
exceed its $10 of income) is not deferred under this section, S's entire $15
loss is subject to 1.1502-13 and none of the loss is taken into account in
Year 2 under the matching rule of 1.1502-13(c).  See paragraph (a)(3) of this
section (continued deferral under 1.1502-13).  P's sale of B stock results in
B becoming a nonmember of the P consolidated group in Year 3.  Thus, S's $15
loss is taken into account in Year 3 under the acceleration rule of 1.1502-
13(d).  Nevertheless, B remains in a controlled group relationship with S and
paragraph (f) of this section permits only $10 of S's loss to be taken into
account in Year 3.  See 1.1502-13(a)(4) (continued deferral under section
267).  The remaining $5 of S's loss continues to be deferred under this
section and taken into account under this section based on subsequent events
(e.g., B's collection of the note or P's sale of the remaining B stock to a
nonmember).

     Example 8.  Selling member ceases to be a member.  (a)  Facts.  P owns
all of the stock of S and B, and the P group is a consolidated group.  S has
several historic assets, including land with a basis of $130 and value of
$100.  The land is not essential to the operation of S's business.  On January
1 of Year 1, S sells the land to B for $100.  On July 1 of Year 3, P transfers
all of S's stock to newly formed X in exchange for a 20% interest in X stock
as part of a transaction to which section 351 applies.  Although X holds many
other assets, a principal purpose for P's transfer is to accelerate taking S's
$30 loss into account.  P has no plan or intention to dispose of the X stock.

     (b)  Timing.  Under paragraph (c) of this section, S's $30 loss
ordinarily is taken into account immediately before P's transfer of the S
stock, under the timing principles of the acceleration rule of 1.1502-13(d). 
Although taking S's loss into account results in a $30 negative stock basis
adjustment under 1.1502-32, because P has no plan or intention to dispose of
its X stock, the negative adjustment will not immediately affect taxable
income.  P's transfer accelerates a loss that otherwise would be deferred, and
an adjustment under paragraph (h) of this section is required.  Thus, S's loss
is never taken into account, and S's stock basis and earnings and profits are
reduced by $30 under 1.1502-32 and 1.1502-33 immediately before P's transfer
of the S stock.

     (c)  Nonhistoric assets.  Assume instead that, with a principal purpose
to accelerate taking into account any further loss that may accrue in the
value of the land without disposing of the land outside of the controlled
group, P forms M with a $100 contribution on January 1 of Year 1 and S sells
the land to M for $100.  On December 1 of Year 1, when the value of the land
has decreased to $90, M sells the land to B for $90.  On July 1 of Year 3,
while B still owns the land, P sells all of M's stock to X and M becomes a
nonmember.  Under paragraph (c) of this section, M's $10 loss ordinarily is
taken into account under the timing principles of the acceleration rule of
1.1502-13(d) immediately before M becomes a nonmember.  (S's $30 loss is not
taken into account under the timing principles of 1.1502-13(c) or 1.1502-
13(d) as a result of M becoming a nonmember, but is taken into account based
on subsequent events such as B's sale of the land to a nonmember or P's sale
of the stock of S or B to a nonmember.)  The land is not an historic asset of
M and, although taking M's loss into account reduces P's basis in the M stock
under 1.1502-32, the negative adjustment only eliminates the $10 duplicate
stock loss.  Under paragraph (h) of this section, M's loss is never taken into
account.  M's stock basis, and the earnings and profits of M and P, are
reduced by $10 under 1.1502-32 and 1.1502-33 immediately before P's sale of
the M stock.

     (k)  Cross-reference.  For additional rules applicable to the
disposition or deconsolidation of the stock of members of consolidated groups,
see 1.337(d)-1, 1.337(d)-2, 1.1502-13T(f)(6), and 1.1502-20.
     (l)  Effective dates--(1)  In general.  This section applies with
respect to transactions occurring in S's years beginning on or after  July 12,
1995.  If both this section and prior law apply to a transaction, or neither
applies, with the result that items are duplicated, omitted, or eliminated in
determining taxable income (or tax liability), or items are treated
inconsistently, prior law (and not this section) applies to the transaction.
     (2)  Avoidance transactions.  This paragraph (l)(2) applies if a
transaction is engaged in or structured on or after April 8, 1994, with a
principal purpose to avoid the rules of this section applicable to
transactions occurring in years beginning on or after July 12, 1995, to
duplicate, omit, or eliminate an item in determining taxable income (or tax
liability), or to treat items inconsistently.  If this paragraph (l)(2)
applies, appropriate adjustments must be made in years beginning on or after
July 12, 1995, to prevent the avoidance, duplication, omission, elimination,
or inconsistency.
     (3)  Prior law.  For transactions occurring in S's years beginning
before July 12, 1995, see the applicable regulations issued under sections 267
and 1502.  See, e.g., 1.267(f)-1, 1.267(f)-1T, 1.267(f)-2T, 1.267(f)-3,
1.1502-13, 1.1502-13T, 1.1502-14, 1.1502-14T, and 1.1502-31 (as contained in
the 26 CFR part 1 edition revised as of April 1, 1995).
1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 [Removed]
     Par. 7.  Sections 1.267(f)-1T, 1.267(f)-2T, and 1.267(f)-3 are removed.
     Par. 8.  Section 1.460-0 is amended in the table of contents by revising
the entries for 1.460-4 to read as follows:
1.460-0  Outline of regulations under section 460.
* * * * *
1.460-4  Methods of accounting for long-term contracts.
     (a) through (i)  [Reserved]
     (j)  Consolidated groups and controlled groups.
     (1)  Intercompany transactions.
     (i)  In general.
     (ii)  Definitions and nomenclature.
     (2)  Example.
     (3)  Effective dates.
     (i)  In general.
     (ii)  Prior law.
     (4)  Consent to change method of accounting.

* * * * *

     Par. 9.  Section 1.460-4 is amended by:
     1.   Revising the section heading.
     2.   Adding and reserving paragraphs (a) through (i).
     3.   Adding paragraph (j).
     The revisions and additions read as follows:
1.460-4  Methods of accounting for long-term contracts.
     (a) through (i)  [Reserved]
     (j)  Consolidated groups and controlled groups--(1)  Intercompany
transactions--(i)  In general.  Section 1.1502-13 does not apply to the
income, gain, deduction, or loss from an intercompany transaction between
members of a consolidated group, and section 267(f) does not apply to these
items from an intercompany sale between members of a controlled group, to the
extent--
     (A)  The transaction or sale directly or indirectly benefits, or is
intended to benefit, another member's long-term contract with a nonmember;
     (B)  The selling member is required under section 460 to determine any
part of its gross income from the transaction or sale under the percentage-of-
completion method (PCM); and
     (C)  The member with the long-term contract is required under section
460 to determine any part of its gross income from the long-term contract
under the PCM.
     (ii)  Definitions and nomenclature.  The definitions and nomenclature
under 1.1502-13 and 1.267(f)-1 apply for purposes of this paragraph (j).
     (2)  Example.  The following example illustrates the principles of
paragraph (j)(1) of this section.
     Example.  Corporations P, S, and B file consolidated returns on a
calendar-year basis.  In 1996, B enters into a long-term contract with X, a
nonmember, to manufacture 5 airplanes for $500 million, with delivery
scheduled for 1999.  Section 460 requires B to determine the gross income from
its contract with X under the PCM.  S enters into a contract with B to
manufacture for $50 million the engines that B will install on X's airplanes. 
Section 460 requires S to determine the gross income from its contract with B
under the PCM.  S estimates that it will incur $40 million of total contract
costs during 1997 and 1998 to manufacture the engines.  S incurs $10 million
of contract costs in 1997 and $30 million in 1998.  Under paragraph (j) of
this section, S determines its gross income from the long-term contract under
the PCM rather than taking its income or loss into account under section
267(f) or 1.1502-13.  Thus, S includes $12.5 million of gross receipts and
$10 million of contract costs in gross income in 1997 and includes $37.5
million of gross receipts and $30 million of contract costs in gross income in
1998.

     (3)  Effective dates--(i)  In general.  This paragraph (j) applies with
respect to transactions and sales occurring pursuant to contracts entered into
in years beginning on or after July 12, 1995.
     (ii)  Prior law.  For transactions and sales occurring pursuant to
contracts entered into in years beginning before July 12, 1995, see the
applicable regulations issued under sections 267(f) and 1502, including
1.267(f)-1T, 1.267(f)-2T, and 1.1502-13(n) (as contained in the 26 CFR part
1 edition revised as of April 1, 1995).
     (4)  Consent to change method of accounting.  For transactions and sales
to which this paragraph (j) applies, the Commissioner's consent under section
446(e) is hereby granted to the extent any changes in method of accounting are
necessary solely to comply with this section, provided the changes are made in
the first taxable year of the taxpayer to which the rules of this paragraph
(j) apply.  Changes in method of accounting for these transactions are to be
effected on a cut-off basis.
     Par. 10.  In 1.469-0, the table of contents is amended by:
     1.   Revising the entries for 1.469-1:
     a.   Paragraphs (a) through (d)(1).
     b.   Paragraphs (g)(5) through (h)(3).
     c.   Paragraphs (h)(5) through (k).
     2.   Revising the entries for 1.469-1T, paragraphs (c)(8), and (h)(1),
(2), and (6).  The revisions read as follows:
1.469-0  Table of contents.
* * * * *
1.469-1  General rules.

     (a) through (c)(7) [Reserved]
     (c)(8)  Consolidated groups.
     (c)(9) through (d)(1)  [Reserved]

* * * * *

     (g)(5)  [Reserved]
     (h)(1)  In general.
     (h)(2)  Definitions.
     (h)(3)  [Reserved]

* * * * *

     (h)(5)  [Reserved]
     (h)(6)  Intercompany transactions.
     (i)  In general.
     (ii)  Example.
     (iii)  Effective dates.
     (h)(7) through (k)  [Reserved]

1.469-1T  General rules (temporary).

* * * * *

     (c)(8)  [Reserved]

* * * * *

     (h)(1)  [Reserved]
     (h)(2)  [Reserved]

* * * * *

     (h)(6)  [Reserved]

* * * * *

     Par. 11.  Section 1.469-1 is amended by adding paragraphs (c)(8),
(h)(1), (h)(2) and (h)(6) to read as follows (paragraphs (a) through (c)(7),
(c)(9) through (d)(1), (g)(5), (h)(3),(h)(5) and (h)(7) through (k) continue
to be reserved):
1.469-1  General rules.
     (a) through (c)(7) [Reserved]
     (c)(8)  Consolidated groups.  Rules relating to the application of
section 469 to consolidated groups are contained in paragraph (h) of this
section.
     (c)(9) through (d)(1)  [Reserved]
* * * * *
     (g)(5)  [Reserved]
     (h)(1)  In general.  This paragraph (h) provides rules for applying
section 469 in computing a consolidated group's consolidated taxable income
and consolidated tax liability (and the separate taxable income and tax
liability of each member).
     (2)  Definitions.  The definitions and nomenclature in the regulations
under section 1502 apply for purposes of this paragraph (h).  See, e.g.,
1.1502-1 (definitions of group, consolidated group, member, subsidiary, and
consolidated return year), 1.1502-2 (consolidated tax liability), 1.1502-11
(consolidated taxable income), 1.1502-12 (separate taxable income), 1.1502-13
(intercompany transactions), 1.1502-21 (consolidated net operating loss), and
1.1502-22 (consolidated net capital gain or loss).
     (3)  [Reserved]
* * * * *
     (5)  [Reserved]
     (6)  Intercompany transactions--(i)  In general.  Section 1.1502-13
applies to determine the treatment under section 469 of intercompany items and
corresponding items from intercompany transactions between members of a
consolidated group.  For example, the matching rule of 1.1502-13(c) treats
the selling member (S) and the buying member (B) as divisions of a single
corporation for purposes of determining whether S's intercompany items and B's
corresponding items are from a passive activity.  Thus, for purposes of
applying 1.469-2(c)(2)(iii) and 1.469-2T(d)(5)(ii) to property sold by S to
B in an intercompany transaction--
     (A)  S and B are treated as divisions of a single corporation for
determining the uses of the property during the 12-month period preceding its
disposition to a nonmember, and generally have an aggregate holding period for
the property; and
     (B)  1.469-2(c)(2)(iv) does not apply.
     (ii)  Example.  The following example illustrates the application of
this paragraph (h)(6).
     Example.  (i)  P, a closely held corporation, is the common parent of
the P consolidated group.  P owns all of the stock of S and B.  X is a person
unrelated to any member of the P group.  S owns and operates equipment that is
not used in a passive activity.  On January 1 of Year 1, S sells the equipment
to B at a gain.  B uses the equipment in a passive activity and does not
dispose of the equipment before it has been fully depreciated.

     (ii)  Under the matching rule of 1.1502-13(c), S's gain taken into
account as a result of B's depreciation is treated as gain from a passive
activity even though S used the equipment in a nonpassive activity.

     (iii)  The facts are the same as in paragraph (a) of this Example,
except that B sells the equipment to X on December 1 of Year 3 at a further
gain.  Assume that if S and B were divisions of a single corporation, gain
from the sale to X would be passive income attributable to a passive activity. 
To the extent of B's depreciation before the sale, the results are the same as
in paragraph (ii) of this Example.  B's gain and S's remaining gain taken into
account as a result of B's sale are treated as attributable to a passive
activity.

     (iv)  The facts are the same as in paragraph (iii) of this Example,
except that B recognizes a loss on the sale to X.  B's loss and S's gain taken
into account as a result of B's sale are treated as attributable to a passive
activity.

     (iii)  Effective dates.  This paragraph (h)(6) applies with respect to
transactions occurring in years beginning on or after July 12, 1995.  For
transactions occurring in years beginning before July 12, 1995, see 1.469-
1T(h)(6) (as contained in the 26 CFR part 1 edition revised as of April 1,
1995).
     (h)(7) through (k)  [Reserved]
1.469-1T [Amended]
     Par. 12.  Section 1.469-1T is amended by removing and reserving
paragraphs (c)(8), (h)(1), (2), and (6).
     Par. 13.  Section 1.1502-13 is revised to read as follows:
1.1502-13  Intercompany transactions.
     (a)  In general--(1)  Purpose.  This section provides rules for taking
into account items of income, gain, deduction, and loss of members from
intercompany transactions.  The purpose of this section is to provide rules to
clearly reflect the taxable income (and tax liability) of the group as a whole
by preventing intercompany transactions from creating, accelerating, avoiding,
or deferring consolidated taxable income (or consolidated tax liability).
     (2)  Separate entity and single entity treatment.  Under this section,
the selling member (S) and the buying member (B) are treated as separate
entities for some purposes but as divisions of a single corporation for other
purposes.  The amount and location of S's intercompany items and B's
corresponding items are determined on a separate entity basis (separate entity
treatment).  For example, S determines its gain or loss from a sale of
property to B on a separate entity basis, and B has a cost basis in the
property.  The timing, and the character, source, and other attributes of the
intercompany items and corresponding items, although initially determined on a
separate entity basis, are redetermined under this section to produce the
effect of transactions between divisions of a single corporation (single
entity treatment).  For example, if S sells land to B at a gain and B sells
the land to a nonmember, S does not take its gain into account until B's sale
to the nonmember.
     (3)  Timing rules as a method of accounting--(i)  In general.  The
timing rules of this section are a method of accounting for intercompany
transactions, to be applied by each member in addition to the member's other
methods of accounting.  See 1.1502-17.  To the extent the timing rules of
this section are inconsistent with a member's otherwise applicable methods of
accounting, the timing rules of this section control.  For example, if S sells
property to B in exchange for B's note, the timing rules of this section apply
instead of the installment sale rules of section 453.  S's or B's application
of the timing rules of this section to an intercompany transaction clearly
reflects income only if the effect of that transaction as a whole (including,
for example, related costs and expenses) on consolidated taxable income is
clearly reflected.
     (ii)  Automatic consent for joining and departing members--(A)  Consent
granted.  Section 446(e) consent is granted under this section to the extent a
change in method of accounting is necessary solely by reason of the timing
rules of this section--
     (1)  For each member, with respect to its intercompany transactions, in
the first consolidated return year which follows a separate return year and in
which the member engages in an intercompany transaction; and
     (2)  For each former member, with respect to its transactions with
members that would otherwise be intercompany transactions if the former member
were still a member, in the first separate return year in which the former
member engages in such a transaction.
     (B)  Cut-off basis.  Any change in method of accounting described in
paragraph (a)(3)(ii)(A) of this section is to be effected on a cut-off basis
for transactions entered into on or after the first day of the year for which
consent is granted under paragraph (a)(3)(ii)(A) of this section.
     (4)  Other law.  The rules of this section apply in addition to other
applicable law (including nonstatutory authorities).  For example, this
section applies in addition to sections 267(f) (additional rules for certain
losses), 269 (acquisitions to evade or avoid income tax), and 482 (allocations
among commonly controlled taxpayers).  Thus, an item taken into account under
this section can be deferred, disallowed, or eliminated under other applicable
law, for example, section 1091 (losses from wash sales).
     (5)  References.  References in other sections to this section include,
as appropriate, references to prior law.  For effective dates and prior law
see paragraph (l) of this section.
     (6)  Overview--(i)  In general.  The principal rules of this section
that implement single entity treatment are the matching rule and the
acceleration rule of paragraphs (c) and (d) of this section.  Under the
matching rule, S and B are generally treated as divisions of a single
corporation for purposes of taking into account their items from intercompany
transactions.  The acceleration rule provides additional rules for taking the
items into account if the effect of treating S and B as divisions cannot be
achieved (for example, if S or B becomes a nonmember).  Paragraph (b) of this
section provides definitions.  Paragraph (e) of this section provides
simplifying rules for certain transactions.  Paragraphs (f) and (g) of this
section provide additional rules for stock and obligations of members. 
Paragraphs (h) and (j) of this section provide anti-avoidance rules and
miscellaneous operating rules.
     (ii)  Table of examples.  Set forth below is a table of the examples
contained in this section.
Matching rule.  (1.1502-13(c)(7)(ii))

     Example 1.  Intercompany sale of land.
     Example 2.  Dealer activities.
     Example 3.  Intercompany section 351 transfer.
     Example 4.  Depreciable property.
     Example 5.  Intercompany sale followed by installment
                     sale.
     Example 6.  Intercompany sale of installment
                     obligation.
     Example 7.  Performance of services.
     Example 8.  Rental of property.
     Example 9.  Intercompany sale of a partnership
                     interest.
     Example 10.  Net operating losses subject to section
                     382 or the SRLY rules.
     Example 11.  Section 475.
     Example 12.  Section 1092.
     Example 13.  Manufacturer incentive payments.
     Example 14.  Source of income under section 863.
     Example 15.  Section 1248.

Acceleration rule.  (1.1502-13(d)(3))

     Example 1.  Becoming a nonmember--timing.
     Example 2.  Becoming a nonmember--attributes.
     Example 3.  Selling member's disposition of installment          
               note.
     Example 4.  Cancellation of debt and attribute
                    reduction under section 108(b).
     Example 5.  Section 481.

Simplifying rules--inventory.  (1.1502-13(e)(1)(v))

     Example 1.  Increment averaging method.
     Example 2.  Increment valuation method.
     Example 3.  Other reasonable inventory methods.

Stock of members.  (1.1502-13(f)(7))

     Example 1.  Dividend exclusion and property
                    distribution.
     Example 2.  Excess loss accounts.
     Example 3.  Intercompany reorganization.
     Example 4.  Stock redemptions and distributions.
     Example 5.  Intercompany stock sale followed by section
                     332 liquidation.
     Example 6.  Intercompany stock sale followed by section
                     355 distribution.

Obligations of members.  (1.1502-13(g)(5))

     Example 1.  Interest on intercompany debt.
     Example 2.  Intercompany debt becomes nonintercompany
                     debt.
     Example 3.  Loss or bad debt deduction with respect to
                     intercompany debt.
     Example 4.  Nonintercompany debt becomes
                     intercompany debt.
     Example 5.  Notional principal contracts.

Anti-avoidance rules.  (1.1502-13(h)(2))

     Example 1.  Sale of a partnership interest.
     Example 2.  Transitory status as an intercompany
                     obligation.
     Example 3.  Corporate mixing bowl.
     Example 4.  Partnership mixing bowl.
     Example 5.  Sale and leaseback.


Miscellaneous operating rules.  (1.1502-13(j)(9))

     Example 1.  Intercompany sale followed by section
                     351 transfer to member.
     Example 2.  Intercompany sale of member stock
                     followed by recapitalization.
     Example 3.  Back-to-back intercompany transactions--
                    matching.
     Example 4.  Back-to-back intercompany transactions--
                    acceleration.
     Example 5.  Successor group.
     Example 6.  Liquidation--80% distributee.
     Example 7.  Liquidation--no 80% distributee.

     (b)  Definitions.  For purposes of this section--
     (1)  Intercompany transactions--(i)  In general.  An intercompany
transaction is a transaction between corporations that are members of the same
consolidated group immediately after the transaction.  S is the member
transferring property or providing services, and B is the member receiving the
property or services.  Intercompany transactions include--
     (A)  S's sale of property (or other transfer, such as an exchange or
contribution) to B, whether or not gain or loss is recognized;
     (B)  S's performance of services for B, and B's payment or accrual of
its expenditure for S's performance;
     (C)  S's licensing of technology, rental of property, or loan of money
to B, and B's payment or accrual of its expenditure; and
     (D)  S's distribution to B with respect to S stock.
     (ii)  Time of transaction.  If a transaction occurs in part while S and
B are members and in part while they are not members, the transaction is
treated as occurring when performance by either S or B takes place, or when
payment for performance would be taken into account under the rules of this
section if it were an intercompany transaction, whichever is earliest. 
Appropriate adjustments must be made in such cases by, for example, dividing
the transaction into two separate transactions reflecting the extent to which
S or B has performed.
     (iii)  Separate transactions.  Except as otherwise provided in this
section, each transaction is analyzed separately.  For example, if S
simultaneously sells two properties to B, one at a gain and the other at a
loss, each property is treated as sold in a separate transaction.  Thus, the
gain and loss cannot be offset or netted against each other for purposes of
this section.  Similarly, each payment or accrual of interest on a loan is a
separate transaction.  In addition, an accrual of premium is treated as a
separate transaction, or as an offset to interest that is not a separate
transaction, to the extent required under separate entity treatment.  If two
members exchange property, each member is S with respect to the property it
transfers and B with respect to the property it receives.  If two members
enter into a notional principal contract, each payment under the contract is a
separate transaction and the member making the payment is B with respect to
that payment and the member receiving the payment is S.  See paragraph (j)(4)
of this section for rules aggregating certain transactions.
     (2)  Intercompany items--(i)  In general.  S's income, gain, deduction,
and loss from an intercompany transaction are its intercompany items.  For
example, S's gain from the sale of property to B is intercompany gain.  An
item is an intercompany item whether it is directly or indirectly from an
intercompany transaction.
     (ii)  Related costs or expenses.  S's costs or expenses related to an
intercompany transaction are included in determining its intercompany items. 
For example, if S sells inventory to B, S's direct and indirect costs properly
includible under section 263A are included in determining its intercompany
income.  Similarly, related costs or expenses that are not capitalized under
S's separate entity method of accounting are included in determining its
intercompany items.  For example, deductions for employee wages, in addition
to other related costs, are included in determining S's intercompany items
from performing services for B, and depreciation deductions are included in
determining S's intercompany items from renting property to B.
     (iii)  Amounts not yet recognized or incurred.  S's intercompany items
include amounts from an intercompany transaction that are not yet taken into
account under its separate entity method of accounting.  For example, if S is
a cash method taxpayer, S's intercompany income might be taken into account
under this section even if the cash is not yet received.  Similarly, an amount
reflected in basis (or an amount equivalent to basis) under S's separate
entity method of accounting that is a substitute for income, gain, deduction
or loss from an intercompany transaction is an intercompany item.
     (3)  Corresponding items--(i)  In general.  B's income, gain, deduction,
and loss from an intercompany transaction, or from property acquired in an
intercompany transaction, are its corresponding items.  For example, if B pays
rent to S, B's deduction for the rent is a corresponding deduction.  If B buys
property from S and sells it to a nonmember, B's gain or loss from the sale to
the nonmember is a corresponding gain or loss; alternatively, if B recovers
the cost of the property through depreciation, B's depreciation deductions are
corresponding deductions.  An item is a corresponding item whether it is
directly or indirectly from an intercompany transaction (or from property
acquired in an intercompany transaction).
     (ii)  Disallowed or eliminated amounts.  B's corresponding items include
amounts that are permanently disallowed or permanently eliminated, whether
directly or indirectly.  Thus, corresponding items include amounts disallowed
under section 265 (expenses relating to tax-exempt income), and amounts not
recognized under section 311(a) (nonrecognition of loss on distributions),
section 332 (nonrecognition on liquidating distributions), or section 355(c)
(certain distributions of stock of a subsidiary).  On the other hand, an
amount is not permanently disallowed or permanently eliminated (and therefore
is not a corresponding item) to the extent it is not recognized in a
transaction in which B receives a successor asset within the meaning of
paragraph (j)(1) of this section.  For example, B's corresponding items do not
include amounts not recognized from a transaction with a nonmember to which
section 1031 applies or from another transaction in which B receives exchanged
basis property.
     (4)  Recomputed corresponding items.  The recomputed corresponding item
is the corresponding item that B would take into account if S and B were
divisions of a single corporation and the intercompany transaction were
between those divisions.  For example, if S sells property with a $70 basis to
B for $100, and B later sells the property to a nonmember for $90, B's
corresponding item is its $10 loss, and the recomputed corresponding item is
$20 of gain (determined by comparing the $90 sales price with the $70 basis
the property would have if S and B were divisions of a single corporation). 
Although neither S nor B actually takes the recomputed corresponding item into
account, it is computed as if B did take it into account (based on reasonable
and consistently applied assumptions, including any provision of the Internal
Revenue Code or regulations that would affect its timing or attributes).
     (5)  Treatment as a separate entity.  Treatment as a separate entity
means treatment without application of the rules of this section, but with the
application of the other consolidated return regulations.  For example, if S
sells the stock of another member to B, S's gain or loss on a separate entity
basis is determined with the application of 1.1502-80(b) (non-applicability
of section 304), but without redetermination under paragraph (c) or (d) of
this section.
     (6)  Attributes.  The attributes of an intercompany item or
corresponding item are all of the item's characteristics, except amount,
location, and timing, necessary to determine the item's effect on taxable
income (and tax liability).  For example, attributes include character,
source, treatment as excluded from gross income or as a noncapital,
nondeductible amount, and treatment as built-in gain or loss under section
382(h) or 384.  In contrast, the characteristics of property, such as a
member's holding period, or the fact that property is included in inventory,
are not attributes of an item, but these characteristics might affect the
determination of the attributes of items from the property.
     (c)  Matching rule.  For each consolidated return year, B's
corresponding items and S's intercompany items are taken into account under
the following rules:
     (1)  Attributes and holding periods--(i)  Attributes.  The separate
entity attributes of S's intercompany items and B's corresponding items are
redetermined to the extent necessary to produce the same effect on
consolidated taxable income (and consolidated tax liability) as if S and B
were divisions of a single corporation, and the intercompany transaction were
a transaction between divisions.  Thus, the activities of both S and B might
affect the attributes of both intercompany items and corresponding items.  For
example, if S holds property for sale to unrelated customers in the ordinary
course of its trade or business, S sells the property to B at a gain and B
sells the property to an unrelated person at a further gain, S's intercompany
gain and B's corresponding gain might be ordinary because of S's activities
with respect to the property.  Similar principles apply if S performs
services, rents property, or engages in any other intercompany transaction.
     (ii)  Holding periods.  The holding period of property transferred in an
intercompany transaction is the aggregate of the holding periods of S and B. 
However, if the basis of the property is determined by reference to the basis
of other property, the property's holding period is determined by reference to
the holding period of the other property.  For example, if S distributes stock
to B in a transaction to which section 355 applies, B's holding period in the
distributed stock is determined by reference to B's holding period in the
stock of S.
     (2)  Timing--(i)  B's items.  B takes its corresponding items into
account under its accounting method, but the redetermination of the attributes
of a corresponding item might affect its timing.  For example, if B's sale of
property acquired from S is treated as a dealer disposition because of S's
activities, section 453(b) prevents any corresponding income of B from being
taken into account under the installment method.
     (ii)  S's items.  S takes its intercompany item into account to reflect
the difference for the year between B's corresponding item taken into account
and the recomputed corresponding item.
     (3)  Divisions of a single corporation.  As divisions of a single
corporation, S and B are treated as engaging in their actual transaction and
owning any actual property involved in the transaction (rather than treating
the transaction as not occurring).  For example, S's sale of land held for
investment to B for cash is not disregarded, but is treated as an exchange of
land for cash between divisions (and B therefore succeeds to S's basis in the
property).  Similarly, S's issuance of its own stock to B in exchange for
property is not disregarded, B is treated as owning the stock it receives in
the exchange, and section 1032 does not apply to B on its subsequent sale of
the S stock.  Although treated as divisions, S and B nevertheless are treated
as:
     (i)  Operating separate trades or businesses.  See, e.g., 1.446-1(d)
(accounting methods for a taxpayer engaged in more than one business).
     (ii)  Having any special status that they have under the Internal
Revenue Code or regulations.  For example, a bank defined in section 581, a
domestic building and loan association defined in section 7701(a)(19), and an
insurance company to which section 801 or 831 applies are treated as divisions
having separate special status.  On the other hand, the fact that a member
holds property for sale to customers in the ordinary course of its trade or
business is not a special status.
     (4)  Conflict or allocation of attributes.  This paragraph (c)(4)
provides special rules for redetermining and allocating attributes under
paragraph (c)(1)(i) of this section.  
     (i)  Offsetting amounts--(A)  In general.  To the extent B's
corresponding item offsets S's intercompany item in amount, the attributes of
B's corresponding item, determined based on both S's and B's activities,
control the attributes of S's offsetting intercompany item.  For example, if S
sells depreciable property to B at a gain and B depreciates the property, the
attributes of B's depreciation deduction (ordinary deduction) control the
attributes of S's offsetting intercompany gain.  Accordingly, S's gain is
ordinary.
     (B)  B controls unreasonable.  To the extent the results under paragraph
(c)(4)(i)(A) are inconsistent with treating S and B as divisions of a single
corporation, the attributes of the offsetting items must be redetermined in a
manner consistent with treating S and B as divisions of a single corporation. 
To the extent, however, that B's corresponding item on a separate entity basis
is excluded from gross income, is a noncapital, nondeductible amount, or is
otherwise permanently disallowed or eliminated, the attributes of B's
corresponding item always control the attributes of S's offsetting
intercompany item.
     (ii)  Allocation.  To the extent S's intercompany item and B's
corresponding item do not offset in amount, the attributes redetermined under
paragraph (c)(1)(i) of this section must be allocated to S's intercompany item
and B's corresponding item by using a method that is reasonable in light of
all the facts and circumstances, including the purposes of this section and
any other rule affected by the attributes of S's intercompany item and B's
corresponding item.  A method of allocation or redetermination is unreasonable
if it is not used consistently by all members of the group from year to year.
      (5)  Special status.  Notwithstanding the general rule of paragraph
(c)(1)(i) of this section, to the extent an item's attributes determined under
this section are permitted or not permitted to a member under the Internal
Revenue Code or regulations by reason of the member's special status, the
attributes required under the Internal Revenue Code or regulations apply to
that member's items (but not the other member).  For example, if S is a bank
to which section 582(c) applies, and sells debt securities at a gain to B, a
nonbank, the character of S's intercompany gain is ordinary as required under
section 582(c), but the character of B's corresponding item as capital or
ordinary is determined under paragraph (c)(1)(i) of this section without the
application of section 582(c).  For other special status issues, see, for
example, sections 595(b) (foreclosure on property securing loans), 818(b)
(life insurance company treatment of capital gains and losses), and 1503(c)
(limitation on absorption of certain losses).
     (6)  Treatment of intercompany items if corresponding items are excluded
or nondeductible--(i)  In general.  Under paragraph (c)(1)(i) of this section,
S's intercompany item might be redetermined to be excluded from gross income
or treated as a noncapital, nondeductible amount.  For example, S's
intercompany loss from the sale of property to B is treated as a noncapital,
nondeductible amount if B distributes the property to a nonmember shareholder
at no further gain or loss (because, if S and B were divisions of a single
corporation, the loss would not have been recognized under section 311(a)). 
Paragraph (c)(6)(ii) of this section, however, provides limitations on the
application of this rule to intercompany income or gain.  See also 1.1502-32
and 1.1502-33 (adjustments to S's stock basis and earnings and profits to
reflect amounts so treated).
     (ii)  Limitation on treatment of intercompany items as excluded from
gross income.  Notwithstanding the general rule of paragraph (c)(1)(i) of this
section, S's intercompany income or gain is redetermined to be excluded from
gross income only to the extent one of the following applies:
     (A)  Disallowed amounts.  B's corresponding item is a deduction or loss
and, in the taxable year the item is taken into account under this section, it
is permanently and explicitly disallowed under another provision of the
Internal Revenue Code or regulations.  For example, deductions that are
disallowed under section 265 are permanently and explicitly disallowed.  An
amount is not permanently and explicitly disallowed, for example, to the
extent that--
     (1)  The Internal Revenue Code or regulations provide that the amount is
not recognized (for example, a loss that is realized but not recognized under
section 332 or section 355(c) is not permanently and explicitly disallowed,
notwithstanding that it is a corresponding item within the meaning of
paragraph (b)(3)(ii) of this section (certain disallowed or eliminated
amounts));
     (2)  A related amount might be taken into account by B with respect to
successor property, such as under section 280B (demolition costs recoverable
as capitalized amounts);  
     (3)  A related amount might be taken into account by another taxpayer,
such as under section 267(d) (disallowed loss under section 267(a) might
result in nonrecognition of gain for a related person);
     (4)  A related amount might be taken into account as a deduction or
loss, including as a carryforward to a later year, under any provision of the
Internal Revenue Code or regulations (whether or not the carryforward expires
in a later year); or
     (5)  The amount is reflected in the computation of any credit against
(or other reduction of) Federal income tax (whether allowed for the taxable
year or carried forward to a later year).
     (B)  Section 311.  The corresponding item is a loss that is realized,
but not recognized under section 311(a) on a distribution to a nonmember (even
though the loss is not a permanently and explicitly disallowed amount within
the meaning of paragraph (c)(6)(ii)(A) of this section).
     (C)  Other amounts.  The Commissioner determines that treating S's
intercompany item as excluded from gross income is consistent with the
purposes of this section and other applicable provisions of the Internal
Revenue Code and regulations.
     (7)  Examples--(i)  In general.  For purposes of the examples in this
section, unless otherwise stated, P is the common parent of the P consolidated
group, P owns all of the only class of stock of subsidiaries S and B, X is a
person unrelated to any member of the P group, the taxable year of all persons
is the calendar year, all persons use the accrual method of accounting, tax
liabilities are disregarded, the facts set forth the only corporate activity,
no member has any special status, and the transaction is not otherwise subject
to recharacterization.  If a member acts as both a selling member and a buying
member (e.g., with respect to different aspects of a single transaction, or
with respect to related transactions), the member is referred to as M, M1, or
M2 (rather than as S or B).
     (ii)  Matching rule.  The matching rule of this paragraph (c) is
illustrated by the following examples.
     Example 1.  Intercompany sale of land followed by sale to a nonmember.