Taiyo Hawaii Company, Ltd. - Page 33

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          citing section 1.884-1(e)(3)(ii), Income Tax Regs.  We agree with           
          respondent that petitioner has not shown the requisite                      
          circumstances for a liability reduction as required by section              
          1.884-1(e)(3)(ii), Income Tax Regs.                                         
               Now, we consider petitioner's argument that the Ginter and             
          Gomes properties should not be included in the step 1 asset                 
          category.  If petitioner is correct that the two properties do              
          not belong in the step 1 category, the amount of petitioner's               
          liabilities subjected to the excess interest provisions and the             
          amount of the excess interest tax would be reduced.                         
               The question we must decide is whether unimproved real                 
          property which is not currently being developed is a step 1                 
          asset.  To be included in "step 1", the asset must produce or be            
          able to produce ECI with the conduct of a U.S. trade or business.           
          Sec. 1.882-5(b)(1), Income Tax Regs.  Section 864(c) governs the            
          determination of whether an asset generates ECI.  If a foreign              
          corporation is engaged in a U.S. trade or business, income from             
          U.S. sources is generally placed into one or the other of two               
          categories pursuant to section 864(c)(2) and (3) to determine               
          whether the income is effectively connected with a U.S. trade or            
          business.  Section 864(c)(2) applies to fixed or determinable               
          annual or periodic income and to gains from the sale of capital             
          assets.  To determine whether such gain or income is ECI, section           
          864(c)(2) provides two tests: (1) Whether the income is derived             

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