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In connection with the resolution of the "step 1
controversy", we also address the validity and effect of
petitioner's attempted retroactive liability election under
section 1.884-1(e)(3), Income Tax Regs. Section 1.884-1(e)(3),
Income Tax Regs., provides an election under which a foreign
corporation may reduce its U.S.-connected liabilities. The
effect of the election is to decrease the amount of interest
expense allocated to ECI and, consequently, decrease the amount
of excess interest.18
On its original returns, petitioner computed the interest
allocable to ECI based on all assets, including the Ginter and
Gomes properties, as "step 1 assets". In step 2, petitioner's
U.S.-connected liabilities were reported as equal to its
worldwide liabilities. Finally, in step 3, petitioner treated
all of its worldwide liabilities, including the advances from its
parent and another related corporation, as shown on the books of
its U.S. trade or business. On the original returns,
18 Sec. 1.884-1(e)(3), Income Tax Regs., containing the
election for reducing the amount of excess interest, was
promulgated in 1992, after the years in issue but before
petitioner filed amended returns for those years. The temporary
regulations under sec. 884 that existed during the years in issue
did not provide for a similar election. Respondent does not
argue that petitioner should not be permitted to retroactively
apply the regulatory election to the years in issue. Treating
this as a concession by respondent for purposes of this case, we
do not make any decision regarding the validity of retroactive
application of the sec. 1.884-4(e), Income Tax Regs., election to
years prior to the year in which the regulation was promulgated.
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