Taiyo Hawaii Company, Ltd. - Page 31

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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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