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generate, have generated, or could reasonably have been expected
to generate." Sec. 1.861-8(e)(2)(ii), Income Tax Regs.3
Interest deductions are apportioned on the basis of values of
assets which produce income in such groupings, according to the
"asset method" set out in section 1.861-8(e)(2)(v), Income Tax
Regs.
The use of the asset method requires the taxpayer to place
its assets in either the statutory or residual grouping,
according to the type of income the assets produce. The asset
values are determined by an average of the asset values at the
beginning and the end of the year. Sec. 1.861-8(e)(2)(v), Income
Tax Regs. On the basis of the ratio of asset values, the
taxpayer apportions the deductions to those two groupings. Id.;
see sec. 1.861-8(g), Examples (1) and (2), Income Tax Regs.4
3 There are certain exceptions to this broad rule that do not
apply here. Sec. 1.861-8(e)(2)(iii) and (iv), Income Tax Regs.
In addition, a taxpayer may elect to apportion interest expense
according to gross income. Sec. 1.861-8(e)(2)(vi), Income Tax
Regs. Because petitioner did not so elect and neither party
contends that the gross income method should be used, we do not
discuss the rules for its application.
4 Sec. 1.861-8(g), Income Tax Regs., provides:
Example (1)--Interest--(i) * * * [X has $150,000 of
interest expense.]
Tentative apportionment on the basis of assets * * *
Assets * * * that generate
U.S.-source income * * * ..................$3,200,000
Assets * * * that generate
foreign-source income * * * ............... 800,000
Total...................................... 4,000,000
(continued...)
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