Treasury Regulations · 26 CFR

§ 1.863-7. Allocation of income attributable to certain notional principal contracts under section 863(a).

In effect eCFR current as of October 15, 2026

Regulation text, no changes From the eCFR, current as of October 15, 2026. The eCFR is an authoritative but unofficial editorial compilation of the Code of Federal Regulations; the official text is the annual CFR on govinfo. Compare it with this section on ecfr.gov (external site) or the official annual CFR on govinfo (external site).

Regulation under 26 U.S.C. § 863

Cite as 26 CFR § 1.863-7

At a glance

Read from the text and its source citation. Not part of the regulation.

Status: In the current eCFR
Issued: January 14, 1991 by T.D. 8330
Last amended: December 5, 2013 by T.D. 9648
Issued under: 26 U.S.C. § 863
Length: 1,225 words · about 5 min to read
Cross-references: cites 5 Code sections and 4 regulations; cited by 5

¶(a) Scope—

¶(1) Introduction. This section provides rules relating to the source and, in certain cases, the character of notional principal contract income. However, this section does not apply to income from a section 988 transaction within the meaning of section 988 and the regulations thereunder, relating to the treatment of certain nonfunctional currency transactions. Further, this section does not apply to a dividend equivalent described in section 871(m) and the regulations thereunder. Notional principal contract income is income attributable to a notional principal contract as defined in § 1.446-3(c). An agreement between a taxpayer and a qualified business unit (as defined in section 989(a)) of the taxpayer, or among qualified business units of the same taxpayer, is not a notional principal contract, because a taxpayer cannot enter into a contract with itself.

¶(2) Effective/applicability date.This section applies to notional principal contract income includible in income on or after February 13, 1991. However, any taxpayer desiring to apply paragraph (b)(2)(iv) of this section to notional principal contract income includible in income prior to February 13, 1991, in lieu of temporary Income Tax Regulations § 1.863-7T(b)(2)(iv) may (on a consistent basis) so choose. See paragraph (c) of this section for an election to apply the rules of this section to notional principal contract income includible in income before December 24, 1986. With respect to a dividend equivalent described in section 871(m) and the regulations thereunder, this section applies to payments made on or after January 23, 2012.

¶(b) Source of notional principal contract income—

¶(1) General rule. Unless paragraph (b)(2) or (3) of this section applies, the source of notional principal contract income shall be determined by reference to the residence of the taxpayer as determined under section 988(a)(3)(B)(i).

¶(2) Qualified business unit exception. The source of notional principal contract income shall be determined by reference to the residence of a qualified business unit of a taxpayer if—

¶(i) The taxpayer's residence, determined under section 988(a)(3)(B)(i), is the United States;

¶(ii) The qualified business unit's residence, determined under section 988(a)(3)(B)(ii), is outside the United States;

¶(iii) The qualified business unit is engaged in the conduct of a trade or business where it is a resident as determined under section 988(a)(3)(B)(ii); and

¶(iv) The notional principal contract is properly reflected on the books of the qualified business unit. Whether a notional principal contract is properly reflected on the books of such qualified business unit is a question of fact. The degree of participation in the negotiation and acquisition of a notional principal contract shall be considered in this determination. Participation in connection with the negotiation or acquisition of a notional principal contract may be disregarded if the district director determines that a purpose for such participation was to affect the source of notional principal contract income.

¶(3) Effectively connected notional principal contract income. Notional principal contract income that under principles similar to those set forth in § 1.864-4(c) arises from the conduct of a United States trade or business shall be sourced in the United States and such income shall be treated as effectively connected to the conduct of a United States trade or business for purposes of sections 871(b) and 882(a)(1).

¶(c) Election—

¶(1) Eligibility and effect. A taxpayer described in paragraph (b)(2)(i) of this section may make an election to apply the rules of this section to all, but not part, of the taxpayer's income attributable to notional principal contracts for all taxable years (or portion thereof) beginning before December 24, 1986, for which the period of limitations for filing a claim for refund under section 6511(a) has not expired. A taxpayer not described in paragraph (b)(2)(i) of this section that is engaged in trade or business within the United States may make an election to apply the rules of this section to all, but not part, of the taxpayer's income described in paragraph (b)(3) of this section for all taxable years (or portion thereof) beginning before December 24, 1986, for which the period of limitations for filing a claim for refund under section 6511(a) has not expired. If a taxpayer makes an election pursuant to this paragraph (c)(1) in the time and manner provided in paragraph (c) (2) and (3) of this section, then, with respect to such taxable years (or portion thereof), no tax shall be deducted or withheld under sections 1441 and 1442 with respect to payments made by the taxpayer pursuant to a notional principal contract the income attributable to which is subject to such election. The election may be revoked only with the consent of the Commissioner.

¶(2) Time for making election. The election specified in paragraph (c)(1) of this section shall be made by May 14, 1991.

¶(3) Manner of making election. The election described in paragraph (c)(1) of this section shall be made by attaching a statement to the tax return or an amended tax return for each taxable year beginning before December 24, 1986, in which the taxpayer accrued or received notional principal contract income. The statement shall—

¶(i) Contain the name, address, and taxpayer identifying number of the electing taxpayer;

¶(ii) Identify the election as a “Notional Principal Contract Election under § 1.863-7”; and

¶(iii) Specify each taxable year described in paragraph (c)(1) of this section in which payments were made.

¶(d) Example. The operation of this section is illustrated by the following example:

¶Example.

(1) On January 1, 1990, X, a calendar year domestic corporation, entered into an interest rate swap contract with FZ, an unrelated foreign corporation. X does not have a qualified business unit outside the United States. Under the contract, X is required to pay FZ fixed rate dollar amounts, and FZ is required to pay X floating rate dollar amounts, each determined solely by reference to a notional dollar denominated principal amount specified under the contract. The contract is a notional principal contract under § 1.863-7(a) because the contract provides for the payment of amounts at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for a promise to pay similar amounts.

(2) Assume that during 1990 X had notional principal contract income of $100 in connection with the notional principal contract described in (1) above. Also assume that the contract provides that payments more than 30 days late give rise to a $5 fee, and that X receives such a fee in 1990. Under paragraph (b)(1) of this section, the source of X's $100 of income attributable to the swap agreement is domestic. The $5 fee is not notional principal contract income.

¶(e) Cross references. See § 1.861-9T(b) for the allocation of expense to certain notional principal contracts. For rules relating to the source of income from nonfunctional currency notional principal contracts, see § 1.9 88-4T. For rules relating to the taxable amount of notional principal contract income allocable under this section to sources inside or outside the United States, see § 1.863-1(c).

[T.D. 8330, 56 FR 1362, Jan. 14, 1991, as amended by T.D. 9572, 77 FR 3109, Jan. 23, 2012; T.D. 9648, 78 FR 73080, Dec. 5, 2013]

Cross-references

Computed from the citations in the text of 26 CFR.

Code sections it cites

Regulations it cites

Cited by 5 other regulations

Amendment history

From the source citation at the end of the section, newest first. T.D. is a Treasury decision; FR is the Federal Register.

December 5, 2013Amended by T.D. 9648 (78 FR 73080)
January 23, 2012Amended by T.D. 9572 (77 FR 3109)
January 14, 1991Issued by T.D. 8330 (56 FR 1362)

Where it sits in 26 CFR

Subchapter A Income tax
Part 1 Income taxes
Regulations applicable to taxable years prior to december 30, 1996