CHEVRON SAYS SECTION 864 REGULATIONS DRAW INTEREST ALLOCATION RULES SO NARROWLY THAT THEY MISS INTENDED ARBITRAGE TRANSACTIONS.

Through a series of examples, Ross argues that the definition of an "integrated financial transaction under the present regulations is so restrictive as to cause the direct allocation exception in section 864(e)(7)(B) to be of extremely limited use to most corporate Treasury Departments contemplating arbitrage transactions." He says that, "despite a clear indication in the Conference Report that Congress intended to authorize arbitrage techniques commonly found in business today, the present regulations in no way facilitate their use."

Enclosed are eight copies of comments submitted by Chevron Corporation pertaining to proposed and temporary regulations for the direct allocation of interest expense in the case of certain integrated financial transactions. These regulations issued under the authority of Internal Revenue Code Section 864(e)(7) and published in the Federal Register of September 14, 1988 (T.D. 8228), interest Chevron because of their application to the foreign tax credit rules and certain other international tax provisions.

We appreciate the opportunity to comment on this important subject. If we can be of further assistance with respect to this submission, please contact Mr. A. P. Ashford at (415) 894-3621, or Mr. M. H. Burnside at (415) 894-3612.

Yours very truly,

Chevron Corporation (Chevron), a United States integrated petroleum company with operations in the U.S. and abroad, appreciates this opportunity to comment on the temporary and proposed regulations (sometimes referred to herein as "Regulations") under Internal Revenue Code Section 864(e)(7) providing for the direct allocation of interest expense incurred to carry out an integrated financial transaction to any interest income derived from such a transaction. These regulations are of particular interest to Chevron, and other taxpayers in an excess foreign tax credit position, since the direct allocation of interest expense to U.S. sources in a U.S. integrated financial transaction would help preserve our foreign tax credit limitation position. For comparison, if Chevron were required to allocate interest expense partially to foreign source income, our foreign tax credit limitation would be reduced, effectively increasing our worldwide tax liability.

The "integrated financial transactions" that Congress intended to benefit were broadly identified in one sentence of the Conference Report, at page II-606 as ARBITRAGE TRANSACTIONS, wherein interest expense incurred on funds borrowed to acquire certain assets is directly allocated against income from such assets. Unfortunately, in spite of this specific mention of arbitrage transactions clearly indicating Congress's intention to include arbitrage techniques commonly employed in the business community, the Regulations are so narrowly drawn as to thwart any realistic opportunity to allocate directly interest expense when arbitrage transactions are used.

To illustrate common arbitrage transactions that Chevron might use if such transactions met the definition of an "integrated financial transaction" under the Regulations, the following five examples have been prepared by the Money Markets Group of the Chevron Treasury Department. In all cases, the examples will only generate a net gain if interest expense is directly allocated to its associated interest income. Chevron believes that four out of five of the possible transactions are excluded under the current definition of an integrated financial transaction and therefore are denied the benefit Congress intended to extend to arbitrage transactions under Internal Revenue Code Section 864(e)(7)(B).

1. TRUE "MATCHED BOOKING"

2. "TIME THE MARKET"

Borrow: Same as Example

In Example 2 and the following examples, it is unclear whether the anti-rollover provision of Reg. section 1.861- 10T(c)(3) would apply since the Day 1 investment would have been neither sold nor liquidated by the taxpayer but rather, at maturity, would simply be reinvested in compliance with the requirements to qualify it as an integrated financial transaction. However, unless or until the regulatory language defining rollovers is clarified, no serial investments are certain to meet the definition of an integrated financial transaction.

3. INVEST TO THE AVERAGE MATURITY DATE

Borrow: Same as Example 1

Invest: $50 million for 12 days at 9.20%

COMMENT: The return on the portion of the 12-day investment identified with the 4-day $25 million loan would be insufficient to fulfill the terms and conditions of the 4-day $25 million loan agreement with respect to the amount and timing of payments of principal and interest under Regulation section 1.861- 10T(c)(2)(ii). (Presumably, some sort of "bridge" loan would be made to the borrower to pay off the matured 4-day loan prior to the maturity of the 12-day investment.) Similarly, the 20-day $25 million loan would cost more in interest than its matched portion of the 12-day investment would earn, thus failing the above-stated requirement that the return on investment be sufficient to fulfill the terms and conditions of the loan with regard to the amount and timing of the loan payments. For either reason, this example would not qualify as an integrated financial transaction.

4. "Ride the Yield Curve"

Borrow: On Day 1, $50 million for 29 days at 9.15%

5. Rising Rate Strategy

Borrow: On Day 1, $50 million for 38 days at 9.15%

As these examples and comments amply demonstrate, the definition of an integrated financial transaction under the present Regulations is so restrictive as to cause the direct allocation exception in Section 864(e)(7)(B) to be of extremely limited use to most corporate Treasury Departments contemplating arbitrage transactions. Chevron's specific concerns in the foregoing examples center on the definitional requirements for an integrated financial transaction that,

(1) only one identified term investment may be made for each debt incurred, thus ruling out serial or rollover investments,

(2) the identified term investment must be made within ten days after incurring such indebtedness,

(3) the return on the investment must be sufficient to repay in timely fashion a specific preceding loan rather than only requiring repayment by the completion of the entire integrated financial transaction, and

(4) the debt incurred and the investment mature within ten business days of each other.

In addition, Chevron is concerned from a tax policy point of view, that, despite a clear indication in the Conference Report that Congress intended to authorize arbitrage techniques commonly found in business today, the present Regulations in no way facilitate their use.

Accordingly, Chevron requests that the temporary regulations be reconsidered and redrawn to permit a broader range of integrated financial transactions, particularly of arbitrage transactions as described above and of which Congress was aware when it passed the Tax Reform Act of 1986. To this end, we would be pleased to arrange a meeting between Internal Revenue Service or Treasury personnel and our Money Markets Group to discuss the above examples or other related aspects of arbitrage transactions.

J. J. ROSS