SLOB Rules--Final Regulations Under Section 414(r)

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations under section 414(r) of the Internal Revenue Code concerning qualified retirement plans maintained by an employer. The final regulations provide the exclusive rules for determining whether an employer operates qualified separate lines of business under section 414(r) for purposes of applying the minimum coverage requirements of section 410(b) and the minimum participation requirements of section 401(a)(26). This document also contains related amendments to the regulations under sections 401(k) and (m), and 410(b).

 These final regulations reflect the enactment of section 414(r) by the Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085 (TRA '86), and subsequent changes made by the Technical and Miscellaneous Revenue Act, Pub. L. No. 100-647, 102 Stat. 3342(1988) (TAMRA), and the Public Debt Limit Increase Act, Pub. L. No. 101-140, 103 Stat. 830 (1989) (PDLIA '89). The regulations provide the public with the guidance necessary to comply with the law and affect sponsors of and participants in tax-qualified retirement plans and certain other employee benefit plans.

 EFFECTIVE DATES: These regulations are effective for plan years beginning on or after January 1, 1992, and are applied to those plan years except as set forth in section 204(b)(1) of PDLIA '89 and section 1.414(r)-1(d)(9).

 FOR FURTHER INFORMATION CONTACT: Thomas G. Schendt or Rhonda G. Migdail, at 202-633-0849 (not a toll-free number).

 SUPPLEMENTARY INFORMATION: On February 1,1991, the Internal Revenue Service published in the Federal Register proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 414(r) and related provisions of the Internal Revenue Code of 1986(56 FR 3988). Written comments were received from the public on the proposed regulations. In addition, a public hearing on the proposed regulations was announced on February 1, 1991 (56 FR 4022). The public hearing was held on May 16, 1991. After consideration of all of the written comments received and the statements made at the public hearing, the proposed regulations under section 414(r) are adopted as modified by this Treasury Decision.

PAPERWORK REDUCTION ACT

 The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1980(44 U.S.C. 3504(h)) under control number 1545-1221. The estimated average burden per respondent is five hours.

 These estimates are an approximation of the average time expected to be necessary for the collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time depending on their particular circumstances.

 Comments regarding the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Office, T:FP, Washington, DC 20224, and to the Office of Management and Budget, Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

STATUTORY AUTHORITY

 This document contains amendments to the Income Tax Regulations (26 CFR Part 1) under sections 414(r), 401(k) and (m), and 410(b) of the Code. These amendments reflect the enactment of sections 414(r) and 410(b)(5) by sections 1112(a) and 1115(a) of TRA '86 (100 Stat. 2440, 2452), the enactment of section 401(a)(26)(G) by section 1011(h)(3) of TAMRA (102 Stat. 3464), and subsequent statutory changes made by section 3021(b)(2)(A) of TAMRA (102 Stat. 3632) and sections 203 and 204 of PDLIA '89(103 Stat. 830, 832). These regulations are to be issued under the authority of sections 414(r), 410(b)(6)(G), 401(a)(26)(G), and 7805 of the Code.

OVERVIEW

 Pursuant to section 414(b) and (c), all employees of corporations that are members of the same controlled group of corporations, and all employees of trades or businesses that are under common control, are treated as employed by a single employer for purposes of the employee benefit provisions of the Code generally. Similarly, all employees of members of an affiliated service group are treated as employed by a single employer pursuant to section 414(m). Accordingly, all employees of a single employer, determined after the application of these provisions, are taken into account for purposes of applying the minimum coverage requirements of section 410(b) and the minimum participation requirements of section 401(a)(26) to a qualified retirement plan maintained by an employer. See also section 414(n) and (o).

 Section 410(b)(5) provides an exception to this general rule for purposes of section 410(b) if an employer operates qualified separate lines of business under section 414(r). If the employer is treated as operating qualified separate lines of business under section 414(r), section 410(b)(5) generally permits the employer to apply the minimum coverage requirements separately with respect to the employees of each qualified separate line of business. A similar exception is provided for purposes of applying the minimum participation requirements of section 401(a)(26) and the 55-percent average benefits test of section 129(d)(8).

LEGISLATIVE BACKGROUND

 Sections 410(b)(5) and 414(r) were added to the Code by sections 1112(a) and 1115(a) of TRA '86. During legislative consideration of TRA '86, Congress expressed dissatisfaction with the existing minimum coverage tests, particularly with the lack of objective criteria under the nondiscriminatory classification test of section 410(b)(1)(B) as in effect at that time. In order to clarify the application of the nondiscriminatory classification test, Congress directed the Internal Revenue Service to establish criteria for determining whether a nondiscriminatory classification exists. Congress also proposed conditioning future use of the test on satisfaction by the employer of a new average benefit percentage test. Under the proposed statutory changes, an employer would be permitted to test a plan for minimum coverage under the nondiscriminatory classification test only if the average employer- provided contributions or benefits of all its nonhighly compensated employees equaled at least 70 percent of the average employer- provided contributions and benefits of all its highly compensated employees. The new average benefit percentage test would be based on the benefits or contributions of all employees of the employer, regardless of what plan they were covered under or, indeed, whether they were covered under any plan of the employer at all.

 Thus, under section 410(b), as modified by TRA '86, every plan of the employer must satisfy, on an employer-wide basis, either the percentage test as provided in section 410(b)(1)(A), the ratio test as provided in section 410(b)(1)(B), or the average benefit percentage test as provided in section 410(b)(2). To satisfy the average benefit percentage test of section 410(b)(2), an employer must satisfy the nondiscriminatory classification test of section 410(b)(2)(A)(i) and the average benefit percentage test of section 410(b)(2)(A)(ii).

 During legislative consideration of TRA '86, concern was expressed that, where an employer operates separate lines of business that compete in fundamentally different markets, the plans maintained by the employer might not satisfy the average benefit percentage test of section 410(b)(2)(A)(ii), even though the plans could satisfy the nondiscriminatory classification test of section 410(b)(2)(A)(i). The argument was made that it would be inappropriate to require the employer to satisfy the average benefit percentage test on an employer-wide basis if the level of benefits varied significantly among the employer's separate lines of business for competitive market reasons. Satisfying the test could require the employer either to increase benefits provided to employees in one line of business substantially above the level offered by its competitors in that line of business, or to decrease benefits in its other lines of business substantially below the level offered by its competitors in those lines of business. In either event, the employer could be placed at a competitive disadvantage.

 Congress addressed these concerns by establishing the qualified- separate-line-of-business rules of sections 410(b)(5) and 414(r). Under these rules, if an employer is treated as operating qualified separate lines of business under section 414(r), the employer need not satisfy the percentage test, the ratio test, or the average benefit percentage test on an employer-wide basis. Rather, the employer is permitted to test its plans for minimum coverage on a qualified-separate-line-of-business basis (i.e., separately with respect to the employees of each qualified separate line of business). See section 410(b)(5)(A); H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-523(1986). However, even if an employer is treated as operating qualified separate lines of business under section 414(r), Congress still required every plan of the employer to satisfy the nondiscriminatory classification test on an employer-wide basis. See section 410(b)(5)(B).

DEVELOPMENT OF FINAL REGULATIONS AND SUMMARY OF SIGNIFICANT MODIFICATIONS

 The approach taken in the proposed regulations for determining lines of business allowed the employer the flexibility to determine its own lines of business. This approach shifted the determination of an employer's lines of business away from essentially unanswerable questions -- such as where one economic market ends and another begins, or whether one product or service is sufficiently differentiated from another product or service -- and placed the emphasis on the second requirement under the statute, i.e., that those lines of business be organized and operated separately from one another. See H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-523 to -524 (1986) (indicating that the manner in which the employer organizes itself is of primary relevance, and that a separate line of business will be a separate self-sustaining unit). By focusing the inquiry on separateness, objective tests can be provided that describe the requirements for determining whether a line of business is operated separately. These objective tests provide certainty to the employer and the Service and permit the regulations to be applied in a uniform manner.

 In general, these final regulations retain the objective approach taken in the proposed regulations. The final regulations have revised the proposed regulations in response to comments and have incorporated a number of helpful suggestions received from employers during the comment period. In developing the final regulations, the Treasury and the Service have placed a high priority on harmonizing basic concepts used in various portions of the regulations and on simplifying the operation of certain mechanical rules. Emphasis has also been placed on increasing access to the safe harbors and the determination letter process, as well as on providing more flexibility in the methods for determining the employees of a qualified separate line of business. Changes have also been made to clarify the proposed regulations.

The following is a brief summary of the more significant substantive modifications in the final regulations.

•   o The exclusive-service standard has been eliminated from the separate workforce and separate management tests. The substantial-service standard, which previously had applied only for purposes of determining the employees of a qualified separate line of business, has been modified and expanded to apply both for purposes of the separateness tests and for determining the employees of a qualified separate line of business.

•   o The separate management test has been further liberalized by lowering the 90 percent threshold to 80 percent and by modifying the concept of top-paid employee to exclude employees who provide less than one-quarter of their services to a line of business.

•   o The separate tangible asset test has been eliminated.

•   o New administrative safe harbors have been provided for lines of business acquired in merger or acquisition transactions and for lines of business that provide benefits comparable to benefits provided by other lines.

•   o Access to the dominant line of business method of determining employees of a separate line of business has been expanded, enabling more employers to use the method.

•   o Access to the individual determination process has been expanded in a number of respects.

•   o Certain employer-wide plans are permitted to be tested on an employer-wide basis even though the employer is treated as operating qualified separate lines of business.

•   o The requirements for determining that a plan of a separate line of business satisfies the nondiscriminatory classification test on an employer-wide basis have been liberalized.

•   o Employers are permitted to apply the minimum participation rules on a qualified-separate-line-of-business basis even if the employer chooses to apply the minimum coverage rules on an employer-wide basis.

OVERVIEW OF THE REGULATIONS

 Section 414(r) generally provides that an employer is treated as operating qualified separate lines of business during any year if the employer operates separate lines of business for bona fide business reasons and satisfies certain other conditions under the Code. The rules in the regulations are the exclusive rules for determining whether an employer is treated as operating qualified separate lines of business.

 The final regulations require that a qualified separate line of business satisfy the requirements in section 1.414(r)-1 in order to satisfy section 414(r). An employer is treated as operating qualified separate lines of business only if: (1) the employer identifies all the property and services it provides to customers and designates the property and services provided by each of its lines of business; (2) each line of business is organized and operated separately from the remainder of the employer and is therefore a separate line of business; and (3) each separate line of business meets the additional statutory requirements (including administrative scrutiny) and thus constitutes a qualified separate line of business. The regulations provide a flowchart illustrating the application of these requirements. See section 1.414(r)-0(c).

 An employer is treated as operating qualified separate lines of business only if all the property and services provided by the employer to its customers are provided exclusively by qualified separate lines of business. Thus, if an employer is treated as operating qualified separate lines of business, every portion of the employer must be included in a qualified separate line of business.

I. Line of business

 Under the final regulations, as under the proposed regulations, an employer must first determine its lines of business in order to demonstrate that it maintains qualified separate lines of business. A line of business is a portion of an employer that is identified by the property or services it provides to customers of the employer. Section 1.414(r)-2 of the final regulations provides rules for determining the employer's lines of business.

 In determining its lines of business, the employer first identifies all the property and services it provides to its customers and then designates the property and services provided by each of its lines of business. Thus, an employer may use its discretion to determine its lines of business in a manner that conforms to its business operations and that also satisfies the remaining requirements of section 414(r). Once the employer has designated its lines of business, the designations must be applied consistently for purposes of all requirements of the regulations. The one constraint, intended to address cases of obvious abuse, is that the manner in which the employer designates its lines of business must be reasonable and must comport with its bona fide business operations. Subject to this constraint, the employer essentially is free to designate its lines of business in any manner it chooses.

 This approach was favorably received by commentators, as it accommodates the diverse organizational and operational characteristics of employers and provides each employer with the flexibility to determine the lines of business it operates for purposes of section 414(r). The final regulations do not modify these provisions.

II. Separate line of business

 Under the proposed regulations, in order to demonstrate that it maintained qualified separate lines of business, an employer was required to show that its lines of business were organized and operated separately from one another, and therefore were separate lines of business. Whether a line of business was a separate line of business was determined by satisfying each of the five objective criteria specified in the proposed regulations. These criteria focused on the degree of organizational and operational independence of each line of business. Thus, a line of business was required to meet the separate organizational unit test, the separate financial accountability test, the separate workforce test, the separate management test and the separate tangible asset test. The preamble to the proposed regulations noted that the crafting of these criteria depended on empirical data that was not generally available during the drafting of the proposed regulations. Comments on the objective separateness criteria were specifically requested.

 In general, the final regulations follow the approach taken in the proposed regulations and require a line of business to satisfy the specified objective criteria. However, to accommodate many of the commentators' suggestions, the final regulations make a number of adjustments to the separateness criteria. Section 1.414(r)-3 of the final regulations provides rules for determining whether a line of business is a separate line of business.

a. Separate organizational unit and separate financial accountability

 The separate organizational unit test and the separate financial accountability test have been retained in the final regulations. Thus, each line of business must be formally organized by the employer as a separate organizational unit (or units) within the employer, i.e., a corporation, a partnership, a division, or other similar unit. Similarly, each line of business must be a separate profit center (or centers) within the employer. For this purpose, the employer's books and records must indicate separate revenue and expense information for each profit center comprising the line of business.

b. Separate workforce and separate management

 Under the proposed regulations, each line of business was required to have its own separate workforce. Satisfaction of this test depended upon the degree to which each line shared personnel with other portions of the employer. Thus, a line of business had its own separate workforce if at least 90 percent of the employees of the employer who provide any services to the line of business provided their services exclusively to the line of business.

 Similarly, each line of business was required to have its own separate management. The proposed regulations provided that a line of business had its own separate management only if at least 90 percent of the top-paid employees who provided services to the line of business provided their services exclusively to the line of business. Top-paid employees were defined as the top 10 percent, by compensation, of all employees who provided services to the line of business.

 The final regulations continue to require that a separate line of business have a separate workforce and separate management. However, both of these criteria have been modified in significant respects based on comments and empirical data received during the comment period.

 Under the proposed regulations, employers needed to determine which employees provided "exclusive" services to a line of business for purposes of determining whether a line of business satisfied the separate workforce and management tests. By contrast, when assigning employees to qualified separate lines of business for purposes of applying certain nondiscrimination (e.g., minimum coverage) and other rules, employers needed to determine which employees provided "substantial" (i.e., at least 75 percent) of their services to the line. The comments on the proposed regulations indicated that the separate workforce and management tests were too rigid. This was confirmed by empirical data submitted during the comment period. Further, the Treasury and the Service determined that considerable simplification could be achieved by harmonizing the critical level of service required for purposes of testing separateness and for purposes of assigning employees. Thus, under the final regulations, the separate workforce and management tests are based on the same substantial-service standard that is used for purposes of assigning employees among an employer's qualified separate lines of business. Use of this standard, in lieu of the exclusive-service standard, has the effect of liberalizing both the separate workforce and management tests.

 The comments on the proposed regulations indicated that many employers had particular difficulty in satisfying the separate management test. Empirical data received during the comment period indicated that, in addition to the expansion of the substantial- service standard described above, further modification to that test was necessary and appropriate. In response, two additional changes have been made to the separate management test. First, the 90 percent threshold has been reduced to 80 percent. In addition, the definition of top-paid employee has been modified to exclude those employees who provide less than 25 percent of their services to the line of business.

 As an alternative to adjusting the objective separateness criteria under the proposed regulations, a number of commentators suggested that it was appropriate to modify the separate management test and the separate workforce test by disregarding employees in support functions, such as financial, tax, accounting, legal, and data processing functions. This suggestion has not been adopted in the final regulations. The determination of those employees in support functions is essentially a subjective determination and, thus, inconsistent with providing objective criteria for demonstrating that a line of business is a separate line of business.

c. Separate tangible assets

 Many commentators noted that the data necessary to demonstrate satisfaction of the separate tangible asset test was information that employers do not currently maintain and that was not readily available. Commentators also noted that it was difficult for service- intensive businesses in which tangible assets were not a material income-producing factor to satisfy this requirement. In response to these concerns, the separate tangible asset test has been eliminated in the final regulations.

d. Rules relating to certain nonresident aliens

 Under the proposed regulations, for purposes of the separate workforce and separate management test, generally all employees who rendered services to the employer were required to be taken into account, including employees who were "excludable employees" for qualified plan purposes. An employer, however, was permitted to exclude nonresident aliens who received no income from sources within the United States, but only if the nonresident alien provided services exclusively to a line of business. Thus, nonresident aliens who provided services to more than one line of business (i.e., residual shared employees) were required to be taken into account.

 A number of comments suggested that the proposed regulations be modified to permit an employer to disregard all nonresident aliens with no income from sources within the United States for purposes of satisfying the separate workforce and separate management tests. Commentators argued that it was frequently difficult or impossible to obtain the necessary data. After careful consideration of the concerns expressed in comments, the final regulations do not adopt the suggested modification. The rule adopted in the final regulations is necessary to provide consistent treatment of businesses, regardless of whether their workforces, including management employees, are primarily based in the United States or primarily based outside the United States. Because section 414(r) is a relief provision from the generally applicable minimum coverage and participation requirements, and its availability is dependent upon an employer demonstrating that the separateness criteria have been satisfied, all employers, whether foreign or domestic, must demonstrate that they satisfy the separateness requirements.

III. Qualified separate line of business

 The third requirement an employer must satisfy to demonstrate that it maintains qualified separate lines of business is that it meets the three statutory requirements of section 414(r)(2). To satisfy these requirements, (1) each separate line of business must have at least 50 employees, (2) the employer must notify the Secretary that it treats itself as operating qualified separate lines of business, and (3) each line must satisfy administrative scrutiny.

 Section 1.414(r)-4 of the regulations provides rules for determining whether a separate line of business satisfies the 50- employee requirement and the notice requirement. A separate line of business satisfies administrative scrutiny if it satisfies either the statutory safe harbor or one of the alternative administrative safe harbors, or if the employer requests and receives an individual determination from the Commissioner. Section 1.414(r)-5 provides rules for determining whether a separate line of business satisfies either the statutory safe harbor or one of the alternative administrative safe harbors. Section 1.414(r)-6 of the regulations provides rules for requesting an individual determination from the Commissioner as to whether a separate line of business satisfies administrative scrutiny.

a. Fifty-employee requirement

 The 50-employee requirement of section 414(r)(2)(A) must be satisfied on each day of the testing year. The proposed regulations provided that, in satisfying this requirement, the employer was required to take into account all employees who provided services exclusively to the separate line of business, including collectively bargained employees. However in accordance with section 414(r)(2)(A), those employees who would be excluded when determining the number of employees in the top-paid group for purposes of section 414(q), subject to certain modifications, were not taken into account. See section 1.414(q)-1T, Q&A-9(g). For example, employees who normally work less than 17-1/2 hours per week, or who normally do not work more than six months a year, are not taken into account.

 Several commentators criticized these rules on the grounds that they did not include an alternative simplified test permitting plans to test for compliance on a representative day during the testing year comparable to that permitted under section 401(a)(26) (relating to minimum participation). After careful consideration of these comments, the final regulations retain the rules as set forth in the proposed regulations. The Treasury and the Service believe that the 50-employee requirement contained in section 414(r)(2)(A) represents a Congressional judgment that, in order to qualify as a separate line of business, the business must employ a significant number of employees on a consistent basis during the year.

b. Notice requirement

 Under the proposed regulations and under the final regulations, an employer satisfies the notice requirement of section 414(r)(2)(B) only if it notifies the Secretary that the employer treats itself as operating qualified separate lines of business under section 414(r). This notice must be made in the time and manner prescribed in the final regulations and in revenue procedures, notices and other guidance of general applicability.

 The notice required by section 414(r) specifying each of the employer's qualified separate lines of business is given with respect to all the qualified separate lines of business of the employer. In general, the notice is given with respect to all plans of that employer for plan years beginning in the testing year (i.e., the calendar year). Thus, except as otherwise permitted, the separate application of the requirements of section 410(b) or 401(a)(26) with respect to the employees of each separate line of business must be consistent for all plans of the employer with plan years beginning in the same testing year.

 The Service expects incorporate the required notice into the procedure for requesting a determination letter with respect to the qualified status of a plan of the employer (Form 5300). For an employer that does not wish to apply for a determination letter with respect to the qualified status of its plans, it is contemplated that notice will be given on a revised Form 5310. In addition, once notice has been given for one testing year, it is anticipated that the notice will apply with respect to subsequent testing years unless the employer takes timely action to provide a new notice.

 Notice 90-57, 1990-2 C.B. 344, provided that notice under section 414(r)(2)(B) would not be required until further guidance is issued. It is anticipated that further guidance describing these notice procedures will be issued in the near future.

c. Administrative scrutiny

 To satisfy the administrative scrutiny requirement of section 414(r)(2)(C), a separate line of business may meet either the statutory safe harbor test or one of the administrative safe harbors as provided in section 1.414(r)-5. A separate line of business that does not satisfy any of these safe harbors nonetheless satisfies the administrative scrutiny requirement if the employer requests and receives from the Commissioner, pursuant to section 1.414(r)-6, an individual determination that the separate line of business satisfies administrative scrutiny. Each separate line of business of an employer must satisfy the administrative scrutiny requirement, but need not satisfy this requirement in the same manner as the employer's other separate lines of business.

1. Statutory safe harbor

 Under the final regulations, as under the proposed regulations, a qualified separate line of business satisfies the safe harbor of section 414(r)(3) if the percentage of highly compensated employees of the separate line of business falls within a range that is at least 50 percent but no more than 200 percent of the highly competed employee percentage of the employer as a whole. Section 1.414(r)-5(b) provides the requirements for the application of this safe harbor. Additionally, under a special rule, if at least 10 percent of all highly compensated employees of the employer perform services exclusively for a particular separate line of business, that separate line of business will be deemed to satisfy the 50-percent requirement of the statutory safe harbor. However, a separate line of business that satisfies this special 10-percent rule still must satisfy the 200-percent requirement of the statutory safe harbor.

2. Administrative safe harbors

 The legislative history of section 414(r) provides that the Secretary is to establish guidelines pursuant to section 414(r)(2)(C) of the Code identifying those circumstances that warrant additional scrutiny, e.g., if benefits provided to employees in a particular line of business fare significantly better or worse than benefits provided in other lines, or if benefits provided to highly compensated employees are significantly better than benefits provided to nonhighly compensated employees. Where it is determined that special scrutiny is needed, the separate line of business will only satisfy administrative scrutiny if the employer receives an individual determination to this effect from the Commissioner.

 The proposed regulations satisfied the statutory requirement of providing guidelines through the development of three administrative safe harbors. These administrative safe harbors delineated situations that the Service had determined passed administrative scrutiny without the need for an individual determination.

 The final regulations retain the three administrative safe harbors set forth in the proposed regulations, with modifications to permit greater access to the safe harbors. The final regulations have also been modified to add two additional administrative safe harbors. The five administrative safe harbors are set forth in section 1.414(r)-5(c) through (g) of the final regulations.

i. Industry category safe harbor

 One administrative safe harbor contained in the proposed regulations was the industry category safe harbor. This safe harbor was satisfied only if the separate line of business was in a different industry or industries from every other separate line of business of the employer. The proposed regulations provided that the Commissioner would prescribe these industry categories by revenue procedure or other guidance of general applicability.

 This safe harbor has been retained in the final regulations. However, the final regulations have been modified to permit an employer to disregard foreign operations in determining whether a separate line of business is in a different industry or industries from every other separate line of business of the employer.

 Concurrently with the issuance of the final regulations, the Internal Revenue Service is issuing a revenue procedure setting forth the industry categories for purposes of this administrative safe harbor. A proposed revenue procedure was contained in an appendix to the proposed regulations, which provided a list of industry categories. The 12 industry categories set forth in the proposed revenue procedure were developed by the Treasury and the Service based on the Census Bureau's Standard Industrial Classification codes ("SIC codes") at the two-digit level, with modifications. Certain SIC codes were eliminated because they were determined to be inappropriate for this purpose. For example, Business Services (two- digit SIC code 73) includes paralegal services while (two-digit SIC code 81) includes lawyers. Other SIC codes were combined in an attempt to minimize overlap in the industry categories of a particular property or service.

 In general, the revenue procedure ( Rev. Proc. 91-64, 1991-50 I.R.B. (December 16, 1991) is consistent with the proposed revenue procedure. Commentators requested that the 12 industry categories set forth in the proposed revenue procedure be expanded (e.g., to the full two-digit, three-digit or four-digit SIC codes). After careful consideration of those comments, however, the Treasury and the Service continue to believe that it is inappropriate to expand the categories as suggested for the reasons set forth above. As noted in the preamble to the proposed regulations, the industry categories are provided through a revenue procedure, rather than in the regulations, in order to facilitate future modifications based on the experience of taxpayers and the Service with the categories. Thus, future modifications to the categories may be made based on that experience.

ii. FAS 14 safe harbor

 The second administrative safe harbor contained in the proposed regulations was the reportable business segments safe harbor. This safe harbor required that a separate line of business be reported as one or more reportable industry segments in accordance with the Statement of Financial Accounting Standards No. 14, Financial Reporting for Segments of a Business Enterprise ("FAS 14"). This safe harbor was satisfied if the employer reported a separate line of business as a reportable industry segment on its annual report required to be filed in conformity with Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 This safe harbor has been retained in the final regulations, but has been modified in response to comments. First, commentators noted that employers may actually report as industry segments portions of the business that are not required to be reported as industry segments. Since the manner in which an employer meets its FAS 14 reporting requirements is indicative of actual business operations, the safe harbor can now be satisfied if the separate line of business is actually reported as an industry segment, without regard to whether it is a reportable industry segment. In addition, commentators noted that certain foreign-owned employers are required to file different, but comparable, forms under the Securities Exchange Act of 1934. Thus, the safe harbor has been expanded to cover employers who are required to file Form 20-F with Item 18 financials in lieu of the Form 10-K.

iii. Minimum or maximum benefits safe harbor

 The third and final administrative safe harbor provided under the proposed regulations was the minimum or maximum benefits safe harbor. If the highly compensated employee percentage ratio of the separate line of business was less than 50 percent, then, under the minimum benefit requirement, at least 80 percent of the nonhighly compensated employees in that separate line of business were required to benefit under a plan, and each of these employees was required to receive at least a specified minimum benefit. For defined contribution plans, the minimum benefit was an allocation rate of at least three percent of an employee's compensation for the year. For defined benefit plans, the minimum benefit was the employer-derived accrued benefit that would result in an accrual rate equal to 0.75 percent of compensation. The employees who were considered for this 80 percent test included all employees who satisfied the lowest age and service requirements under any plan of the employer. For purposes of the minimum benefit safe harbor, elective contributions and employer matching contributions were not taken into account.

 If the highly compensated employee percentage ratio of the separate line of business was more than 200 percent, then, under the maximum benefit requirement in the proposed regulations, each highly compensated employee who benefited under a plan in that separate line of business was required to receive no more than a specified maximum benefit. For defined contribution plans, the maximum benefit was an allocation rate of no more than 10 percent of an employee's compensation for the year. For defined benefit plans, the maximum benefit was calculated in the same manner as the minimum benefit, except that it equalled the employer-derived accrued benefit that would result in an accrual rate equal to 2.5 percent of compensation. Unlike the minimum benefit determination, early retirement subsidies and employer matching contributions were taken into account.

 The employer was permitted to provide for the minimum benefit in a combination of defined benefit and defined contribution plans as long as the combined percentage of the minimum benefit provided to the employee in each plan equalled at least 100 percent. Similarly, under the maximum benefit rules, if benefits were provided through a combination of defined benefit and defined contribution plans, the combined percentage of the benefits provided could not exceed 100 percent of the maximum.

 Further, the minimum or maximum benefit limits required that a plan provide for specific benefit formulas that could be satisfied on a plan design basis. An employee's accrual or allocation rate under a plan, however, was required to be determined without regard to any plan provision the effect of which was to make the operation of the minimum or maximum benefits formula contingent on the failure of the separate line of business otherwise to satisfy the requirement of administrative scrutiny.

 Many commentators argued that it was inappropriate for the age and service eligibility requirements for a plan in one separate line of business to have an impact on the minimum benefit testing of another separate line of business. Commentators also argued that it was inequitable to count employer matching contributions against the maximum benefit limitation but not include credit for the same type of contributions towards the minimum benefit requirement. Commentators also requested that the minimum benefit test be applied on the basis of average benefit accruals.

 The final regulations reflect many of these suggestions. First, the minimum benefit requirement has been modified to exclude nonhighly compensated employees who do not meet the lowest age and service eligibility requirements of any plan that benefits employees in the separate line of business (rather than the lowest age and service eligibility requirements determined on an employer-wide basis).

 In addition, the minimum benefit standard can be satisfied on the basis of the average benefit accruals or allocations provided to nonhighly compensated employees in a separate line of business. In contrast to the 80 percent requirement in the general rule, the averaging is based on 100 percent of the nonhighly compensated employees in the separate line of business. Also, in order to use the averaging approach, the employer must still provide the minimum benefit to at least 60 percent of the individual nonhighly compensated employees in the separate line of business. A parallel change has been made to the maximum benefit safe harbor, so that a separate line of business will satisfy the safe harbor if the average of the accrual rates or allocation rates of the highly compensated employees is less than 80 percent of the maximum benefit under the general rule. This averaging option permits a separate line of business to satisfy the minimum and maximum benefit requirements on an operational rather than a design basis.

 The proposed regulations had excluded employer matching contributions from the minimum benefit determination because of a concern that treating matching contributions as minimum benefit allocations could cause a plan to violate the contingent benefit rule of section 401(k)(4)(A) and cause the matching contributions not to be treated as matching contributions within the meaning of section 1.401(m)-1(f)(12)(ii). If the employer uses the averaging option in order to satisfy the minimum benefit safe harbor, the contingency issue is not relevant in determining employees' average allocations. Consequently, the final regulations permit matching contributions to be counted for purposes of determining whether the average allocation satisfies the three percent minimum benefit requirement in the context of averaging.

 Commentators noted that the safe harbor did not accommodate plans that determine benefits on a basis other than three- or five- year average annual compensation. The final regulations have not been modified to accommodate these alternative plan designs because no single specified benefit percentage could be developed that would provide benefits comparable to the benefits specified in the regulations for all employees.

iv. Average benefits safe harbor

 A number of commentators noted that the minimum or maximum benefits safe harbor provided an absolute standard. The comments suggested that it might also be appropriate to provide a standard that took into account the relative level of benefits of one line compared to the level of benefits in other lines. In response to these comments, an additional administrative safe harbor has been added to the final regulations.

 If the highly compensated employee percentage ratio of the separate line of business is less than 50 percent, the separate line of business will satisfy this new administrative safe harbor if the actual benefit percentage of the nonhighly compensated employees of the separate line of business is at least equal to the actual benefit percentage of all other nonhighly compensated employees of the employer. For this purpose, the actual benefit percentage is calculated in the same manner as under the section 410(b) average benefit percentage test, taking into account all employees employed on the first testing day and based on the benefits provided under plans of the employer in plan years ending in the testing year. Similarly, if the highly compensated employee percentage ratio of the separate line of business is greater than 200 percent, the separate line of business will satisfy the new administrative safe harbor if the actual benefit percentage of the highly compensated employees of the separate line of business does not exceed the actual benefit percentage of all other highly compensated employees of the employer.

v. Merger and acquisition safe harbor

 The final regulations have also adopted an administrative safe harbor for separate lines of business that are acquired through certain mergers and acquisitions entitled to the transition relief provided under section 410(b)(6)(C). This safe harbor is satisfied if the three specified requirements are met. The first requirement is that the employer designate the acquired business as a line of business. The second requirement is that the line of business satisfy the separateness criteria. The third requirement is that there not be any significant changes in the workforce of the acquired separate line of business. Under the final regulations, a significant change in the workforce of the acquired separate line of business occurs if fewer than 90 percent of the employees of the acquired separate line of business were employees of the line for the immediately preceding year or if more than 10 percent of the employees of the acquired separate of business for the immediately preceding testing year are not employees of the separate line of business in the current testing year. This administrative safe harbor is available for a four-year period.

3. Individual determinations

 A separate line of business that does not satisfy either the statutory safe harbor or any of the administrative safe harbors nonetheless satisfies the requirement of administrative scrutiny if the employer requests and receives from the Service an individual determination that the separate line of business satisfies administrative scrutiny. Section 1.414(r)-6 of the regulations provides the rules and conditions that apply to an employer's request for that determination.

 Under the proposed regulations, this determination process was limited to those situations in which the separate line of business did not satisfy any of the administrative safe harbors, but provided benefits that were within a specified range of the minimum or maximum benefit safe harbor. This method of obtaining a determination has been retained in the final regulations. A number of commentators suggested that greater access to the determination process would be appropriate and suggested a number of possible changes. In response to these comments, the final regulations have expanded access to the determination process in a number of respects.

 Under the final regulations, an employer is permitted to request an individual determination if the separate line of business falls within a specified range of the statutory safe harbor or within a specified range of the average benefits safe harbor. In addition, an employer is permitted to request an individual determination if 90 percent of the property or services provided by the separate line of business falls within one or more of the specified industry categories and if no more than 10 percent of the property or services provided by any other separate line of business falls within the same industry category or categories. In cases where an employer is not required to file a Form 10-K or Form 20-F, a determination may be requested if there is a certification from a certified public accountant that the separate line of business would have been reportable as one or more industry segments on either the Form 10-K or the Form 20-F if the employer had been required to file the applicable form. Finally, a determination may be requested if the separate line of business manages a government facility pursuant to a government contract that specifies the benefits to be provided under a qualified plan.

 Once an employer satisfied the conditions to request a determination, the proposed regulations enumerated the factors that would be taken into account in determining whether to grant an individual determination. This enumeration has been retained in the final regulations, but has been expanded. Thus, additional factors to be taken into account are whether the separate line of business is in certain regulated industries and the degree to which the separate line of business has its own tangible assets.

 As under the proposed regulations, the final regulations limit the determination process to the determination of whether a separate line of business satisfies administrative scrutiny. It is not available to determine whether other requirements of these regulations are satisfied. For example, the Service will not issue determination letters or rulings with respect to whether a designated line of business is separate, or whether a separate line of business satisfies administrative scrutiny under the statutory safe harbor or one of the alternative administrative safe harbors. The Service has determined that, where the separate line of business does not satisfy any of the safe harbors and does not fall within the circumstances specified in the final regulations for obtaining an individual determination, the separate line of business will not satisfy administrative scrutiny.

IV. Separate operating units

 Section 414(r)(7) provides that the term "separate line of business" includes an operating unit in a separate geographic area separately operated for bona fide business reasons. As contemplated in the legislative history, the distinguishing characteristic between a line of business and an operating unit is that a line of business provides different property or services from other portions of the employer, while an operating unit provides the same property or services as another portion of the employer but in a separate geographic area. In all other respects, the statute and legislative history apply the same requirements to an operating unit as apply to a line of business (e.g., operation for bona fide business reasons, separateness, 50 employees, notice, and administrative scrutiny). See section 414(r)(1), (2), and (7); H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-523 to -526 (1986).

 Because the proposed regulations permitted the employer to designate two or more lines of business that provide the same property or services, the concept of an operating unit was subsumed within the concept of a line of business. Consistent with the statute and legislative history, the proposed regulations required an operating unit to satisfy the same requirements applicable to a line of business. Thus, an employer was permitted to designate an operating unit as a line of business and treat it as a qualified separate line of business if it satisfied the requirements provided in the proposed regulations.

 Some commentators suggested that it would be appropriate to recognize a separate operating unit as a separate line of business if it met only certain of the separateness criteria. After consideration of these comments, the final regulations do not adopt the suggested modifications. Requiring a separate operating unit to satisfy the same separateness criteria as a line of business is consistent with the statutory requirements and the legislative history. Moreover, the final regulations have expanded access to the determination process, and, as under the proposed regulations, the degree to which a separate line of business is operated in a distinct geographic area from the employer's other lines of business is a factor taken into account in the Commissioner's determination of whether a separate line of business satisfies administrative scrutiny.

V.Determination of employees of a qualified separate line of business

 For purposes of testing plans benefiting employees of a qualified separate line of business under sections 410(b), 401(a)(4), and 401(a)(26), and for purposes of applying the statutory safe harbor and certain other administrative safe harbors, an employer must determine which employees are treated as employees of each qualified separate line of business.

 The proposed regulations provided the procedures for assigning employees among an employer's qualified separate lines of business. Consistent with the statute and the legislative history, the employees of a qualified separate line of business consist of all employees who provide substantial services to the qualified separate line of business, and all other employees who are allocated in accordance with the regulations to the qualified separate line of business.

a. Assignment of substantial-service employees

 The proposed regulations required employees to be assigned to a qualified separate line of business if they provided substantial services to the qualified separate line of business. For purposes of the proposed regulations, an employee provided substantial services to a qualified separate line of business if at least 75 percent of the employee's services were provided to the qualified separate line of business, or if at least 50 percent of the employee's services were provided to the qualified separate line of business and the employee's regular place of work was at a facility used exclusively by the qualified line of business.

 The final regulations continue to require that substantial- service employees be assigned to the qualified separate line of business with respect to which the substantial services are provided but modify this assignment rule in two significant respects. First, only those employees who provide at least 75 percent of their services to the qualified separate line of business are required to be treated as substantial-service employees. Thus, employees who provide at least 50 percent of their services to a qualified separate line of business and whose regular place of work is at a facility used exclusively by the qualified separate line of business are no longer required to be treated as substantial-service employees with respect to the line of business. Second, the final regulations further liberalize these assignment rules by permitting employers to treat employees who provide between 50 percent and 75 percent of their services to a particular qualified separate line of business as substantial-service employees with respect to that line of business and, thus, assign those employees to that qualified separate line of business, regardless of whether they work at an exclusive facility. This option may be exercised by the employer on an employee-by- employee basis. If the employer does not elect this option with respect to an employee, that employee is treated as a residual shared employee and assigned to a qualified separate line of business of the employer under the allocation method selected by the employer. As under the proposed regulations, the final regulations provide that the determination of whether the 75-percent and 50-percent thresholds are satisfied must be made in a manner that is reasonably reliable and uniform with respect to all similarly-situated employees.

 The proposed regulations did not address situations where employees are transferred from one qualified separate line of business of the employer to another. Commentators suggested that short-term transfers of employees between qualified separate lines of business created difficulties for employers. Since these employees are expected to return to their original qualified separate line of business, employers generally wanted to continue provide these employees with the same benefits as under that qualified separate line of business. Under the final regulations, a substantial-service employee who is temporarily transferred from one qualified separate line of business to another may continue to be treated as a substantial-service employee of the first qualified separate line of business in the year of the transfer and in the subsequent year.

b. Assignment of residual shared employees

 The proposed regulations referred to employees who did not provide substantial services to any qualified separate line of business of the employer as "residual shared employees." All residual shared employees were required to be assigned under the same allocation method, and each residual shared employee was required to be allocated to only one qualified separate line of business. The proposed regulations provided three alternative allocation methods, i.e., the dominant line method, the pro-rata method and the HCE percentage method. These three methods have been retained in the final regulations, but with certain liberalizing and clarifying modifications made in response to comments.

1. Dominant line of business method of allocation

 Under the first method for allocating residual shared employees, an employer is permitted to allocate all its residual shared employees to its dominant line of business. For this purpose, the dominant line of business is determined based on the number of substantial-service employees assigned to the qualified separate line of business. Generally, under the proposed regulations, a dominant line of business was that qualified separate line of business that employed at least 55 percent of all substantial-service employees who provided their services to any qualified separate line of business. Under an alternative definition of dominant line, the 55-percent threshold was reduced to 45 percent if each qualified separate line of business of the employer satisfied the administrative scrutiny requirement under either the statutory safe harbor or the minimum or maximum benefits safe harbor.

 The final regulations reduce the 55-percent threshold to 50 percent. The final regulations also modify the alternative definition of dominant line by substituting a 35-percent requirement for the 45-percent requirement in the proposed regulations. In addition, under the final regulations, access to this alternative definition has been expanded to a qualified separate line of business that accounts for at least 60 percent of the employer's gross revenues or 60 percent of all the employer's employees (including collectively bargained employees).

2. Pro-rata method of allocation

 The second method permits the employer to allocate residual shared employees among its qualified separate lines of business on a pro-rata basis. See H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II- 524 (1986). Under this method, all residual shared employees are allocated among the employer's qualified separate lines of business in proportion to the percentage of all substantial-service employees who provide their services to each qualified separate line of business. This allocation method has been retained in the final regulations without substantive changes.

3. HCE percentage ratio method of allocation

 The third method of allocation permits the employer to allocate residual shared employees among its qualified separate lines of business in a manner consistent with the statutory safe harbor for satisfying administrative scrutiny. In the proposed regulations, a highly compensated residual shared employee was required to be allocated to the qualified separate line of business with the lowest highly compensated employee percentage ratio less than 50 percent. Similarly, a nonhighly compensated residual shared employee was required to be allocated to the qualified separate line of business with the highest highly compensated employee percentage ratio greater than 200 percent. This procedure was continued until all qualified separate lines of business of the employer had a highly compensated employee percentage ratio between 50 and 200 percent or, if sooner, until no residual shared employees remained to be allocated. Any remaining residual shared employees were permitted to be allocated to any qualified separate line of business as long as their allocation did not cause the qualified separate line of business to violate the statutory safe harbor. This method of allocation facilitated the satisfaction of the statutory safe harbor through appropriate allocation of residual shared employees.

 The final regulations modify the HCE percentage method of allocation contained in the proposed regulations by providing employers more freedom to choose which residual shared employees are allocated to a particular qualified separate line of business. For example, employers are permitted to allocate highly compensated residual shared employees to a particular line of business that has an HCE percentage ratio of less than 50 percent even though there is another qualified separate line of business which has an even lower HCE percentage ratio.

VI. Vertical integration

 For purposes of testing separateness under the proposed regulations as well as under the final regulations, a line of business must take into account all employees whose services contribute to the preparation of property for sale to customers or the provision of services to customers by that line of business. A line of business that is vertically integrated with any other line of business of the employer generally will not satisfy the separateness criteria because too many employees generally will be shared between the vertically integrated lines of business.

 Consistent with the legislative history of section 414(r), the proposed regulations contained an optional rule to assist an employer in satisfying the separateness criteria in certain limited circumstances where one line of business (the "upstream line of business") provides property or service to another line of business (the "downstream line of business"), i.e., where the two lines of business are vertically integrated with one another. See H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-523 (1986). In order to take advantage of this optional rule, employers had to satisfy two requirements. First, the number of units of the property or service provided to customers of the employer by the upstream line of business was required to equal at least 50 percent of the total number of units of the same type of property or service provided by the upstream line of business to all persons (including customers of the employer, the downstream line of business, and all other lines of business of the employer). Second, the downstream line of business was required either to use, consume, or modify substantially the property or service provided by the upstream line of business, or to provide the same property or service to customers of the employer at a different level in the chain of commercial distribution than the upstream line of business.

 If the requirements of this optional rule were satisfied, the downstream line of business was treated as if the relevant property or service had been provided to it by a person other than the employer (rather than by the upstream line of business). Accordingly, that portion of an employee's services that contributed solely to the provision of the property or service from the upstream line of business to the downstream line of business was not considered under this optional rule to be provided to the downstream line of business. This treatment applied for purposes of the separateness requirements of section 1.414(r)-3, as well as the 50-employee requirement of section 1.414(r)-4(b), and the determination of the employees of a qualified separate line of business under section 1.414(r)-7.

 A number of comments were received regarding the requirement that at least 50 percent of the number of units of the same type of property or service provided by the upstream line of business to all persons be provided to customers of the employer. Some commentators suggested that the 50-percent threshold was too high; others suggested that this requirement should be eliminated. The Treasury and the Service believe that this requirement is an objective way of demonstrating that the upstream line is an independently viable business. Since the legislative history indicates that special rules are appropriate for vertically integrated businesses that are independently viable, this requirement has been retained in the final regulations. However, in response to the comments received, and based on the limited empirical data received during the comment period with respect to this portion of the regulations, the 50-percent threshold has been reduced to 25 percent. Further, examples in the final regulations clarify that whether the property or service provided by the upstream line of business to customers of the employer is of the same type as that provided to its downstream line of business may be determined without distinguishing among sub-categories of property or service (e.g., leaded and unleaded gasoline are both treated as gasoline products).

VII. Separate application of statutory requirements

a. Section 410(b)

 Section 410(b)(5)(A) provides that, if an employer is treated as operating qualified separate lines of business under section 414(r), the employer is permitted to apply the requirements of section 410(b) separately with respect to the employees of each qualified separate line of business. Under section 410(b)(5), a plan satisfies the requirements of section 410(b) only if (1) the plan satisfies the reasonable classification test under section 410(b)(5)(B) on an employer-wide basis, and (2) the plan satisfies section 410(b) on a qualified-separate-line-of-business basis. In general, these requirements have been retained in the final regulations. Section 1.414(r)-8 of the regulations applies these statutory requirements.

1. Employer-wide application

 Section 410(b)(5)(B) provides that a plan must benefit a classification of employees found by the Secretary to be nondiscriminatory on an employer-wide basis. A plan benefiting employees of a separate line of business satisfies this requirement only if the plan satisfies either the ratio percentage test of section 1.410(b)-2(b)(2) or the nondiscriminatory classification test of section 1.410(b)-4 (without regard to the average benefit percentage test of section 1.410(b)-5) on an employer-wide basis. For this purpose, the nonexcludable employees of all the other qualified separate lines of business are taken into account.

 Although the nondiscriminatory classification test is applied in the same manner as it would be under section 1.410(b)-4, the proposed regulations provided that, in the case of a plan that fell between the safe and unsafe harbors, the employer's satisfaction of the qualified-separate-line-of-business requirements was an additional favorable circumstance to be taken into account for purposes of satisfying section 1.410(b)-4(c)(3). Except in unusual circumstances, this fact was determinative.

 Several commentators suggested that plans falling into the unsafe harbor contained in the current regulations under section 410(b) may have received favorable determinations from the Service under the provisions of section 410(b) as in effect before `86. Some of these commentators suggested that employers with plans that fall below the unsafe harbors should nevertheless be able to receive a favorable determination from the Service with respect to the employer-wide application of section 410(b)(5)(B). The Treasury and the Service believe that objective standards are more administrable and are consistent with the legislative history. Thus, the suggestion to permit favorable determinations with respect to whether these employers satisfy the nondiscriminatory classification standard of section 410(b)(5)(B) has not been adopted. However, the final regulations have been liberalized to take these comments into account. Thus, under these final regulations, solely for purposes of the employer-wide application of section 410(b)(5)(B), the unsafe harbor percentage in section 1.410(b)-4(c)(4)(ii) is reduced by five percentage points if the plan (including any component plans or rate groups that are used to satisfy section 401(a)(4)) has a ratio percentage of at least 90 percent with respect to employees of the qualified separate line of business.

2. Qualified-separate-line-of-business application

 Under both the proposed and final regulations, a plan satisfies section 410(b) on a qualified separate-line-of-business basis if the plan satisfies either the ratio percentage test of section 1.410(b)- 2(b)(2) or the average benefit test of section 1.410(b)-2(b)(3) (including the nondiscriminatory classification test of section 1.410(b)-4 and the average benefit percentage test of section 1.410(b)-5). In testing a plan on a qualified-separate-line-of business basis, the employees of all other qualified separate lines of business are excluded. See section 1.410(b)-6(e).

3. Special rule for employer-wide plans

 Under the proposed regulations, if the employer chose to apply the requirements of section 410(b) on a qualified-separate-line-of- business basis, it was required to do so with respect to all its plans, all its employees, and all its qualified separate lines of business. Several commentators criticized the requirement in the proposed regulations that all plans be tested on a qualified- separate-line-of-business basis and suggested that an employer be permitted to test certain plans on an employer-wide basis. The comments indicated a particular concern where, in addition to the plans maintained by separate lines of business, an employer maintains an additional or supplemental plan for all its employees (e.g., an employer-wide section 401(k) plan). The final regulations retain the general rule that an employer choosing to apply the requirements of section 410(b) on a qualified-separate-line-of-business-basis must do so with respect to all its plans, all its employees and all its qualified separate lines of business. However, in response to comments, the final regulations also adopt a special rule for certain employer-wide plans. Under the final regulations, a plan is not required to be tested on a qualified-separate-line-of-business basis if the plan satisfies the percentage test of section 410(b)(1)(A) (i.e., the plan benefits at least 70 percent of the nonhighly compensated employees of the employer).

4. Definition of "plan"

 Under both the proposed and final regulations, for purposes of satisfying sections 410(b) and 401(a)(4), the term "plan" means a plan as determined under section 1.410(b)-7. Therefore, pursuant to section 1.410(b)-7(c)(5), the portion of the plan that benefits employees of one qualified separate line of business is treated as a separate plan from the other portions of the same plan that benefit employees of other qualified separate lines of business unless the plan is an employer-wide plan tested under the special rule described above.

5. Coordination with section 401(a)(4)

 The proposed regulations provided that, if section 401(a)(4) requires a group of employees under the plan to satisfy section 410(b), the group of employees must satisfy section 410(b) in the same manner described above as if they were the only employees covered under the plan. See sections 1.414(r)-8(c), 1.401(a)(4)-4(b), and 1.401(a)(4)-9(c)(1). This rule has been retained in the final regulations.

b. Section 40l(a)(26)

 Section 401(a)(26)(G) provides that, with the consent of the Secretary, the employer may choose to apply section 401(a)(26) on a qualified-separate-line-of-business basis. Under the proposed regulations, if the employer chose to apply the requirements of section 40l(a)(26) in this manner, it was required to do so with respect to all its plans, all its employees, and all its qualified separate lines of business.

 The proposed regulations further provided that, if an employer chose to apply section 401(a)(26) on a qualified-separate-line-of- business basis, the consent of the Secretary would be granted only on the condition that the employer also applied section 410(b) on a qualified-separate-line-of-business basis. This limitation has been eliminated under the final regulations. Thus, an employer is permitted to apply section 401(a)(26) on a qualified-separate-line- of-business basis without regard to whether it also applies to section 410(b) on that basis.

c. Section 129(d)(8)

 The application of the separate line of business rules to section 129(d)(8) is reserved in the final regulations. Until guidance is issued relating to the application of section 414(r) for purposes of section 129(d)(8) of the Code, an employer will be treated as operating qualified separate lines of business for purposes of section 129(d)(8) if it reasonably determines that it meets the requirements of section 414(r). See Public Debt Limit Increase Act, Pub. L. No. 101-140, section 204(b), 103 Stat. 830, 833 (1989). The Treasury and the Service welcome comments on the application of the separate line of business requirements set forth in the regulations for purposes of section 129(d)(8).

d. Other Code sections

 As under the proposed regulations, the final regulations provide that under no circumstances may the requirements of any section of the Code (other than those referred to above) be applied separately with respect to the employees of a qualified separate line of business unless the section specifically cross-references, or is specifically cross-referenced by, section 414(r). Thus, for example, the separate line of business rules do not apply (without limitation) to sections 79(d)(3), 105(h), 117(d)(3), 120(c)(2), 125(g)(3), 127(b)(2), 129(d)(3), 132, 195, 401(a)(3) (as in effect on September 1, 1974), 414(q)(4), 501(c)(17)(A)(ii), 501(c)(17)(B)(iii), 501(c)(18)(B), and 505(b)(1)(A).

VIII. Certain governmental and tax-exempt employers

 The application of the qualified-separate-line-of-business rules to plans of governmental and tax-exempt employers was reserved under the proposed regulations. Commentators requested clarification of the application of section 414(r) to these employers in light of the reservation. Accordingly, the final regulations provide that the qualified-separate-line-of-business rules apply to plans of governmental and tax-exempt employers that are subject to the requirements of sections 410(b) and 401(a)(26). Nevertheless, the Treasury and the Service recognize that plans maintained by governmental and tax-exempt employers may have some unique features that arise because the sponsoring employer is tax-exempt. While a limited number of comments have been received on such features, additional comments are specifically requested from governmental and tax-exempt employers regarding the appropriate modifications to the regulations to take into account the operation of governmental and tax-exempt employers. A section in the final regulations has been reserved for rules that will address these unique features.

 In the interim, while these regulations are generally effective for plan years beginning on or after June 1, 1992, the Treasury and the Service recognize that, in some respects, the unique nature of governmental and tax-exempt employers may make exact adherence to some of the provisions of the regulations impossible. For example, governmental and tax-exempt employers generally do not provide property or services to customers for consideration, as required by section 1.414(r)-2. Similarly, such employers are generally not organized around separate profit centers as required by section 1.414(r)-3. Thus, pending issuance of further guidance, in these and other limited respects, a reasonable good faith effort by governmental and tax-exempt employers to satisfy the requirements of section 414(r) consistent with the statutory and regulatory requirements will be acceptable. Compliance is reasonable and in good faith in this context only if the employer makes every reasonable effort to satisfy all relevant portions of this regulation.

IX. Testing year basis of application

 As under the proposed regulations, for purposes of determining whether an employer operates qualified separate lines of business for bona fide business reasons, the employer must apply the requirements of sections 1.414(r)-1 through 1.414(r)-7 of the final regulations on the basis of the testing year. The testing year is the calendar year. Similarly, an employer's plans are tested under sections 401(a)(4), 401(a)(26) and 410(b) separately with respect to the employees of each qualified separate line of business for all plan years that begin in the testing year.

X. Averaging rules

 For purposes of determining the percentages used to test whether lines of business satisfy the requirements of the regulations, the proposed regulations permitted the employer to use up to a three-year moving average, absent large fluctuations. In determining whether the specific percentages had been satisfied, this rule permitted the employer to average the results for the current testing year with the results for the preceding one or two testing years. However, only years after the effective date of the proposed regulations were permitted to be taken into account.

 In general, the averaging rules were favorably received by the commentators, but some suggested that the averaging period should be extended. Other commentators suggested that the averaging rules should also permit an employer to take into account years before the effective date. In response to these comments, the final regulations provide for an averaging period of up to five years and permit years before the effective date of the final regulations to be taken into account, provided the employer has the information necessary to use the applicable provision.

XI. Failure to comply

a. Line of business fails to comply with the final regulations

 If an employer applies sections 401(a)(26) and 410(b) to its plans on a qualified-separate-line-of-business basis and any of its lines of business fail to meet the requirements of these final regulations, then all of its lines of business will fail to meet the requirements of section 414(r). In that event, each plan must satisfy sections 401(a)(26) and 410(b) on an employer-wide basis in order to satisfy section 401(a).

b. Plan failure to comply with section 410(b)

 If an employer applies section 410(b) separately with respect to the employees of each qualified separate line of business, and a plan fails to meet the requirements of section 410(b) or 401(a)(4) on that basis, that plan will fail to satisfy section 401(a). Furthermore, the plan may not attempt to meet the requirements of sections 410(b) and 401(a)(4) on an employer-wide basis unless it is being tested under the special rule for employer-wide plans described above. However, this failure generally will not affect the employer's treatment under section 414(r) as operating qualified separate lines of business.

ADDITIONAL AUTHORITY

 The rules in the regulations regarding section 414(r) are the exclusive rules for determining whether the requirements of that section are met. The regulations also provide, however, that the Commissioner may, in revenue rulings, notices, and other guidance of general applicability, provide any additional rules that may be necessary or appropriate in applying the definition of a separate line of business under section 414(r).

EFFECTIVE DATE AND RELIANCE ON THE PROPOSED REGULATIONS

 These regulations are generally effective for plan years beginning on or after January 1, 1992. However, in the case of any plan year beginning on or before the date the Service begins issuing determinations under section 414(r)(2)(C), an employer is treated as operating separate lines of business if the employer reasonably determines that it meets the requirements of section 414(r) (other than paragraph (2)(C) thereof). Whether an employer reasonably determines that it meets the requirements of section 414(r) generally will be determined on the basis of all relevant facts and circumstances, including the extent to which the employer has resolved unclear issues in its favor. For plan years beginning after the effective date of section 414(r) and before the effective date of these final regulations, operation in accordance with these final regulations or in accordance with the proposed regulations published in the Federal Register on February 1, 1991 (56 FR 3968), is a reasonable interpretation of section 414(r).

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations and, therefore, an initial Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for these regulations was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal authors of these final regulations are Thomas G. Schendt and Rhonda G. Migdail of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), Internal Revenue Service. However, personnel from other offices of the Service and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR Part 1 (1401-0 through 1.419(A)-2T)

Bonds, Employee benefit plans, Income taxes, Reporting and recordkeeping requirements, Securities, Trusts and Trustees.

26 CFR Part 602

Reporting and recordkeeping requirements.

Treasury Decision 8376

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority for Part 1 is amended by adding the following citations:

Authority: 26 U.S.C. 7805 * * * Sections 1.414(r)-0 through 1.414(r)-7 also issued under 26 U.S.C. 414(r). Section 1.414(r)-8 also issued under 26 U.S.C. 410(b) and 414(r). Section 1.414(r)-9 also issued under 26 U.S.C. 401(a)(26) and 414(r). Section 1.414(r)- 10 also issued under 26 U.S.C. 129 and 414(r). Section 1.414(r)-11 also issued under 26 U.S.C. 414(r).

Par. 2. Section 1.401(k)-0 is amended by adding a new heading for paragraph (e)(9) in section 1.401(k)-1 to the table of contents to read as set forth below.

SECTION 1.401(K)-0 CERTAIN CASH OR DEFERRED ARRANGEMENTS, TABLE OF CONTENTS.

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(e) * * *

(8) * * *

(9) Consistent application of separate lines of business rules

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Par. 3. Section 1.401(k)-1(e) is amended by adding a new paragraph (e)(9) to read as set forth below.

SECTION 1.401(k)-1 CERTAIN CASH OR DEFERRED ARRANGEMENTS.

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(e) ADDITIONAL REQUIREMENTS FOR QUALIFIED CASH OR DEFERRED ARRANGEMENTS. * * *

(9) CONSISTENT APPLICATION OF SEPARATE LINE OF BUSINESS RULES. If an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1(b) for purposes of applying section 410(b), and applies the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to the portion of the plan that consists of contributions under the cash or deferred arrangement, then the requirements of section 401(k) and this section must be applied on an employer-wide rather than a qualified-separate- line-of-business basis to all of the plans or portions of plans taken into account in determining whether the cash or deferred arrangement is a qualified cash or deferred arrangement, regardless of whether those plans or portions of plans also satisfy the requirements necessary to apply the special rule in section 1.414(r)-1(c)(2)(ii). Conversely, if an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1(b) for purposes of applying section 410(b), and does not apply the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to the portion of the plan that consists of contributions under the cash or deferred arrangement, then the requirements of section 401(k) and this section must be applied on a qualified-separate-line-of-business rather than an employer-wide basis to all of the plans or portions of plans taken into account in determining whether the cash or deferred arrangement is a qualified cash or deferred arrangement, regardless of whether one or more of those plans or portions of plans is tested under the special rule section 1.414(r)-1(c)(2)(ii). This requirement applies solely for purposes of determining whether the cash or deferred arrangement is a qualified cash or deferred arrangement under section 401(k) and this section. The rules of this paragraph are illustrated by the following example.

EXAMPLE. (i) Employer A maintains a profit-sharing plan that includes a cash or deferred arrangement in which all of the employees of Employer A are eligible to participate. Employer A is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1 (b) for purposes of applying section 410(b). However, Employer A applies the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to the portion of its profit-sharing plan that consists of elective contributions under the cash or deferred arrangement (and to no other plans or portions of plans). Employer A makes qualified nonelective contributions to the profit-sharing plan for the 1995 plan year, and the profit- sharing plan provides that these qualified nonelective contributions may be used to satisfy the actual deferral percentage test.

(ii) Under these facts, the requirements of sections 401(a)(4) and 410(b) must be applied on an employer-wide rather than a qualified-separate-line-of-business basis in determining whether the qualified nonelective contributions made to the profit-sharing plan satisfy the requirements of section 1.401(k)- 1(b)(5), and thus whether they may be taken into account under the actual deferral percentage test. Therefore, in order for the nonelective contributions to be used to satisfy the actual deferral percentage test, both (1) the total amount of nonelective contributions under the profit-sharing plan, including the qualified nonelective contributions to be used to satisfy the actual deferral percentage test, and (2) the total amount of nonelective contributions under the profit-sharing plan, excluding the qualified nonelective contributions to be used to satisfy the actual deferral percentage test, must satisfy the requirements of section 401(a)(4) on an employer- wide basis. Of course, in order for the profit-sharing plan to satisfy section 401(a), it must still satisfy sections 410(b) and 401(a)(4) on a qualified-separate-line-of-business basis.

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Par. 4. Section 1.401(m)-0 is amended by adding the new heading for paragraph (c)(3) in section 1.401(m)-1 to the table of contents to read as set forth below.

SECTION 1.401(m)-0 EMPLOYEE AND MATCHING CONTRIBUTIONS, TABLE OF CONTENTS.

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(c) * * *

(2) * * *

(3) Consistent application of separate line of business rules

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Par. 5. Section 1.401(m)-1(c) is amended by adding a new paragraph (c)(3) to read as set forth below.

SECTION 1.401(m)-1 EMPLOYEE AND MATCHING CONTRIBUTIONS.

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(c) ADDITIONAL REQUIREMENTS. * * *

(3) CONSISTENT APPLICATION OF SEPARATE LINE OF BUSINESS RULES. If an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1(b) for purposes of applying section 410(b), and applies the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to the portion of the plan that consists of matching contributions or to the portion of the plan that consists of employee contributions (the "matching and employee contribution portions"), then the requirements of this section, section 401(m), and section 1.401(m)-2 must be applied on an employer-wide rather than a qualified-separate-line-of-business basis to all of the plans or portions of plans taken into account in determining whether those requirements are satisfied by the matching and employee contribution portions of the plan (regardless of whether the other plans or portions of plans also satisfy the requirements necessary to apply the special rule in section 1.414(r)-1(c)(2)(ii)). Conversely, if an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1(b) for purposes of applying section 410(b), and does not apply the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to either the matching or employee contribution portions of the plan, then the requirements of this section, section 401(m) and section 1.401(m)-2 must be applied on a qualified-separate-line-of-business rather than an employer-wide basis to all of the plans or portions of plans taken into account in determining whether those requirements are satisfied by the matching and employee contribution portions of the plan (regardless of whether one or more of the other plans or portions of plans is tested under the special rule section 1.414(r)-1(c)(2)(ii)). This requirement applies solely for purposes of determining whether the requirements of this section, section 401(m), and section 1.401(m)-2 are satisfied by the matching and employee contribution portions of the plan. The rules of this paragraph are illustrated by the following example.

EXAMPLE. (i) Employer A maintains a profit-sharing plan that includes a cash or deferred arrangement in which all of the employees of Employer A are eligible to participate. Under the profit-sharing plan, each $1.00 of elective contributions under the cash or deferred arrangement is matched by $0.50 of employer contributions. Employer A is treated as operating qualified separate lines of business under section 414(r) in accordance with section 1.414(r)-1(b) for purposes of applying section 410(b). However, Employer A applies the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to the portion of its profit-sharing plan that consists of matching contributions. Employer A makes qualified nonelective contributions to the profit-sharing plan for the 1995 plan year.

(ii) Under these facts, the requirements of sections 401(a)(4) and 410(b) must be applied on an employer-wide rather than a qualified-separate-line-of-business basis in determining whether these qualified nonelective contributions (and any elective contributions under the cash or deferred arrangement) satisfy the requirements of section 1.401(m)-1(b)(5), and thus whether they may be taken into account under the actual contribution percentage test. Thus, in order for the nonelective contributions to be used to satisfy the actual contribution percentage test, both (1) the total amount of nonelective contributions under the profit-sharing plan, including the qualified nonelective contributions to be used to satisfy the actual contribution percentage test, and (2) the total amount of nonelective contributions under the profit-sharing plan, excluding the qualified nonelective contributions to be used to satisfy the actual contribution percentage test, must satisfy the requirements of section 401(a)(4) on an employer-wide basis. Further, in order for any elective contributions under the cash or deferred arrangement to be used to satisfy the actual contribution percentage test, the total amount of elective contributions, including any treated as matching contributions under the actual contribution percentage test, must satisfy the requirements of section 401(k)(3) on an employer-wide basis. Of course, in order for the profit-sharing plan to satisfy section 401(a), it must still satisfy sections 410(b) and 401 (a)(4) on a qualified-separate-line-of-business basis.

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Par. 6. Section 1.410(b)-6(e) is revised as set forth below.

SECTION 1.410(b)-6 EXCLUDABLE EMPLOYEES.

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(e) EMPLOYEES OF QUALIFIED SEPARATE LINES OF BUSINESS. If an employer is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)- 1(b), in testing a plan that benefits employees of one qualified separate line of business, the employees of the other qualified separate lines of business of the employer are treated as excludable employees. The rule in this paragraph (e) does not apply for purposes of satisfying the nondiscriminatory classification requirement of section 410(b)(5)(B). See sections 1.414(r)-1(c)(2) and 1.414(r)-8 (separate application of section 410(b) to the employees of a qualified separate line of business). In addition, the rule in this paragraph (e) does not apply to a plan that is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) for a plan year.

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Par. 7. Section 1.410(b)-7 is amended by revising paragraphs (c)(4), (d)(4) and (e) as set forth below.

SECTION 1.410(b)-7 DEFINITION OF PLAN AND RULES GOVERNING PLAN DISAGGREGATION AND AGGREGATION.

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(c) MANDATORY DISAGGREGATION OF CERTAIN PLANS. * * *

(4) PLANS BENEFITING EMPLOYEES OF QUALIFIED SEPARATE LINES OF BUSINESS. If an employer is treated as operating qualified separate lines of business for purses of section 410(b) in accordance with section 1.414(r)-1(b), the portion of a plan that benefits employees of one qualified separate line of business is treated as a separate plan from the portions of the same plan that benefit employees of the other qualified separate lines of business of the employer. See sections 1.414(r)-1(c)(2) and 1.414(r)-8 (separate application of section 410(b) to the employees of a qualified separate line of business). If a plan satisfies the reasonable classification requirement of section 1.410(b)-4(b) before the application of this paragraph (c)(4), then any portion of that plan that is treated as a separate plan as a result of the application of this paragraph (c)(4) is deemed to satisfy that requirement. The rule in this paragraph (c)(4) does not apply to a plan that is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) for a plan year.

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(d) PERMISSIVE AGGREGATION FOR RATIO PERCENTAGE AND NONDISCRIMINATORY CLASSIFICATION TESTS. * * *

(4) SPECIAL RULE FOR PLANS BENEFITING EMPLOYEES OF A QUALIFIED SEPARATE LINE OF BUSINESS. For purposes of paragraph (d)(1) of this section, an employer that is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b) is permitted to aggregate the portions of two or more plans that benefit employees of the same qualified separate line of business (regardless of whether the employer elects to aggregate the portions of the same plans that benefit employees of the other qualified separate lines of business of the employer), provided that none of the plans is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii). Thus, the employer is permitted to apply paragraph (d)(1) of this section with respect to two or more separate plans determined after the application of paragraphs (b) and (c)(5) of this section, but may not aggregate a plan that is tested under the special rule for employer- wide plans in section 1.414(r)-1(c)(2)(ii) for a plan year with any portion of a plan that does not rely on that special rule for the plan year. In all other respects, the provisions of this paragraph (d) regarding permissive aggregation apply, including (but not limited to) the disaggregation rules under paragraph (d)(2) of this section (including the mandatory disaggregation rule of paragraph (c)(5) of this section), and the prohibition on duplicative aggregation under paragraph (d)(3) of this section. This paragraph (d)(4) applies only in the case of an employer that is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b). See sections 1.414(r)-1(c)(2) and 1.414(r)-8 (separate application of section 410(b) to the employees of a qualified separate line of business).

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(e) DETERMINATION OF PLANS IN TESTING GROUP FOR AVERAGE BENEFIT PERCENTAGE TEST -- (1) IN GENERAL. For purposes of applying the average benefit percentage test of section 1.410(b)-5 with respect to a plan, all plans in the testing group must be taken into account. For this purpose, the plans in the testing group are the plan being tested and all other plans of the employer that could be permissively aggregated with that plan under paragraph (d) of this section. Whether two or more plans could be permissively aggregated under paragraph (d) of this section is determined (i) without regard to the rule in paragraph (d)(4) of this section that portions of two or more plans benefiting employees of the same line of business may not be aggregated if any of the plans is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii), (ii) without regard to paragraph (d)(5) of this section, and (iii) by applying paragraph (d)(2) of this section without regard to paragraphs (c)(1) through (c)(3) of this section.

(2) EXAMPLES. The following example illustrates the rules of this paragraph (e).

EXAMPLE 1. Employer X is treated as operating two qualified separate lines of business for purposes of section 410(b) in accordance with section 414(r), QSLOB1 and QSLOB2. Employer X must apply the rules in section 1.414(r)-8 to determine whether its plans satisfy section 410(b) on a qualified-separate-line- of-business basis. Employer X maintains the following plans:

(a) Plan A, the portion of Employer X's employer-wide section 401(k) plan that benefits all noncolletively bargained employees of QSLOB1,

(b) Plan B, the portion of Employer X's employer-wide section 401(k) plan that benefits all noncolletively bargained employees of QSLOB2,

(c) Plan C, a defined benefit plan that benefits all hourly noncollectively bargained employees of QSLOBl,

(d) Plan D, a defined benefit plan that benefits all collectively bargained employees of QSLOBl,

(e) Plan E, an ESOP that benefits all noncollectively bargained employees of QSLOBl,

(f) Plan F, a profit-sharing plan that benefits all salaried noncollectively bargained employees of QSLOBl.

Assume that Plan F does not satisfy the ratio percentage test of section 1.410(b)-2(b)(2) on a qualified-separate-line-of- business basis, but does satisfy the nondiscriminatory classification test of section 1.410(b)-4 on both an employer- wide and a qualified-separate-line-of-business basis. Therefore, to satisfy section 410(b), Plan F must satisfy the average benefit percentage test of section 1.410(b)-5 on a qualified- separate-line-of-business basis. The plans in the testing group used to determine whether Plan F satisfies the average benefit percentage test of section 1.410(b)-5 are Plans A, C, E, and F.

EXAMPLE 2. The facts are the same as in Example 1, except that Employer X applies the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) to its employer-wide section 401(k) plan. To satisfy section 410(b), Plan F must satisfy the average benefit percentage test of section 1.410(b)-5. Since paragraph (c)(4) of this section no longer applies to Plans A and B, they are treated as a single plan (Plan AB). The plans in the testing group used to determine whether Plan F satisfies the average benefit percentage test of section 1.410(b)-5 are therefore Plans AB, C, E, and F. However, the employees of QSLOB 2 continue to be excludable employees for purposes of determining whether Plan F satisfies the average benefit percentage test. See section 1.410(b)-6(e).

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Par. 8. Sections 1.414(r)-0 through 1.414(r)-11 are added to read as set forth below

SECTION 1.414(r)-TABLE OF CONTENTS.

(a) IN GENERAL. Sections 1.414(r)-1 through 1.414(r)-11 provide rules for determining whether an employer is treated as operating qualified separate lines of business under section 414(r) of the Internal Revenue Code of 1986 as added to the Code by section 1115(a) of the Tax Reform Act of 1986 (Pub. L. No. 99-514), as well as rules for applying the requirements of sections 410(b), 401(a)(26), and 129(d)(8) separately with respect to the employees of each qualified separate line of business of an employer. Paragraph (b) of this section contains a listing of the headings of sections 1.414(r)-1 through 1.414(r)-11. Paragraph (c) of this section provides a flowchart showing how the major provisions of sections 1.414(r)-1 through 1.414(r)-6 are applied.

(b) TABLE OF CONTENTS. The following is a listing of the headings of sections 1.414(r)-1 through 1.414(r)-11.

 SECTION 1.414(r)-1 REQUIREMENTS APPLICABLE TO QUALIFIED SEPARATE LINES OF BUSINESS

[FLOWCHART OMITTED]

SECTION 1.414(r)-1 REQUIREMENTS APPLICABLE TO QUALIFIED SEPARATE LINES OF BUSINESS.

(a) IN GENERAL. Section 414(r) prescribes the conditions under which an employer is treated as operating qualified separate lines of business. If an employer is treated as operating qualified separate lines of business under section 414(r), certain requirements under the Code may be applied separately with respect to the employees of each qualified separate line of business. These requirements are limited to the minimum coverage requirements of section 410(b) (including the nondiscrimination requirements of section 401(a)(4)), the minimum participation requirements of section 401(a)(26), and the 55-percent average benefits test of section 129(d)(8). This section provides the exclusive rules for determining whether an employer is treated as operating qualified separate lines of business under section 414(r), as well as rules for applying the requirements of sections 410(b), 401(a)(26), and 129(d)(8) separately with respect to the employees of a qualified separate line of business.

(b) CONDITIONS UNDER WHICH AN EMPLOYER IS TREATED AS OPERATING QUALIFIED SEPARATE LINES OF BUSINESS -- (1) IN GENERAL. An employer is treated as operating qualified separate lines of business under section 414(r) only if all property and services provided by the employer to its customers are provided exclusively by qualified separate lines of business. Thus, once an employer has determined its qualified separate lines of business under paragraph (b)(2) of this section, no portion of the employer may remain that is not included in a qualified separate line of business. In addition, once the employer has determined the employees of its qualified separate lines of business under paragraph (b)(3) of this section, every employee must be treated as an employee of a qualified separate line of business, and no employee may be treated as an employee of more than one qualified separate line of business.

(2) QUALIFIED SEPARATE LINE OF BUSINESS -- (i) IN GENERAL. A qualified separate line of business is a portion of the employer that is a line of business within the meaning of paragraph (b)(2)(ii) of this section, that is also a separate line of business within the meaning of paragraph (b)(2)(iii) of this section, and, finally, that satisfies the requirements of section 414(r)(2) in accordance with paragraph (b)(2)(iv) of this section.

(ii) LINE OF BUSINESS. A line of business is a portion of an employer that is identified by the property or services it provides to customers of the employer. For this purpose, the employer is permitted to determine the lines of business it operates by designating the property and services that each of its lines of business provides to customers of the employer. Rules for determining an employer's lines of business are provided in section 1.414(r)-2.

(iii) SEPARATE LINE OF BUSINESS. A separate line of business is a line of business that is organized and operated separately from the remainder of the employer. The determination of whether a line of business is organized and operated separately from the remainder of the employer is made on the basis of objective criteria. These criteria generally require that the line of business be organized into one or more separate organizational units (e.g., corporations, partnerships, or divisions), that the line of business constitute one or more distinct profit centers within the employer, and that no more than a moderate overlap exist between the employee workforce and management employed by the line of business and those employed by the remainder of the employer. Rules for determining whether a line of business is organized and operated separately from the remainder of the employer and thus constitutes a separate line of business are provided in section 1.414(r)-3. These rules include an optional rule for vertically integrated lines of business.

(iv) QUALIFIED SEPARATE LINE OF BUSINESS -- (A) IN GENERAL. A qualified separate line of business must satisfy the three statutory requirements in section 414(r)(2). A separate line of business that satisfies these three statutory requirements in accordance with paragraphs (b)(2)(iv)(B) through (b)(2)(iv)(D) of this section constitutes a qualified separate line of business.

(B) FIFTY-EMPLOYEE REQUIREMENT. Under section 414(r)(2)(A), a separate line of business must have at least 50 employees. Rules for determining whether this requirement is satisfied are provided in section 1.414(r)-4(b).

(C) NOTICE REQUIREMENT. Under section 414(r)(2)(B), the employer must notify the Secretary that it treats itself as operating qualified separate lines of business under section 414(r) for purposes of applying the requirements of section 410(b), 401(a)(26), or 129(d)(8) separately with respect to the employees of the separate line of business. Rules and procedures for complying with this requirement are provided in section 1.414(r)-4(c).

(D) REQUIREMENT OF ADMINISTRATIVE SCRUTINY. Under section 414(2)(C), a separate line of business must pass administrative scrutiny. A separate line of business may satisfy this requirement in one of two ways. First, a separate line of business that satisfies any of the safe harbors in section 1.414(r)-5 satisfies the requirement of administrative scrutiny. These safe harbors implement the statutory safe harbor of section 414(r)(3) as well as the guidelines prescribed under section 414(r)(2)(C). Second, a separate line of business that does not satisfy any of the safe harbors in section 1.414(r)-5 nonetheless satisfies the requirement of administrative scrutiny if the employer requests and receives an individual determination from the Commissioner that the separate line of business satisfies the requirement of administrative scrutiny. Rules and procedures applicable to requesting and receiving an individual determination are provided in section 1.414(r)-6. A separate line of business is permitted to satisfy the requirement of administrative scrutiny in any manner permitted under this paragraph (b)(2)(iv)(D), regardless of how any other separate line of business of the employer satisfies the requirement.

(3) DETERMINING THE EMPLOYEES OF A QUALIFIED SEPARATE LINE OF BUSINESS. In order to apply certain provisions under these regulations, it is necessary to determine the employees of a qualified separate line of business. For these purposes, the employees of a qualified separate line of business consist of all employees who are substantial-service employees with respect to the qualified separate line of business, and all other employees who are assigned to the qualified separate line of business. Rules for making these determinations are provided in section 1.414(r)-7. These rules apply solely for the purposes specified in these regulations (see section 1.414(r)-7(a)(2) for a comprehensive listing of these purposes). These rules do not apply for any other purpose (e.g., the determination under section 1.414(r)-3 of whether a line of business is organized and operated separately from the remainder of the employer).

(c) SEPARATE APPLICATION OF CERTAIN CODE REQUIREMENTS TO EMPLOYEES OF A QUALIFIED SEPARATE LINE OF BUSINESS -- (1) IN GENERAL. If an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with paragraph (b)of this section, the requirements of sections 410(b), 401(a)(26), and 129(d)(8) may be applied separately with respect to the employees of each qualified separate line of business. Paragraphs (c)(2) through (c)(4) of this section provide for the separate application of these requirements. In general, the requirements of a Code section are applied separately with respect to the employees of a qualified separate line of business by treating those employees as if they were the only employees of the employer. Paragraph (c)(5) of this section prescribes the limited conditions under which other Code requirements may be applied separately with respect to the employees of a qualified separate line of business.

(2) SEPARATE APPLICATION OF SECTION 410(b) -- (i) GENERAL RULE. Except as provided in paragraph (c)(2)(ii) of this section, an employer is permitted to apply the requirements of section 410(b) separately with respect to the employees of each qualified separate line of business operated by the employer only if the employer does so with respect to all its plans, all its employees, and all its qualified separate lines of business. For this purpose, the requirements of section 410(b) encompass the requirements of section 401(a)(4) (including, but not limited to, the permitted disparity rules of section 401(l), the actual deferral percentage test of section 401(k)(3) and the actual contribution percentage test of section 401(m)(2)). Rules for applying section 410(b) separately with respect to the employees of a qualified separate line of business are provided in section 1.414(r)-8. An employer may apply the rules of section 414(r) for purposes of section 410(b) even if it does not apply the rules of section 414(r) for purposes of section 401(a)(26).

(ii) SPECIAL RULES FOR EMPLOYER-WIDE PLANS. Notwithstanding paragraph (c)(2)(i) of this section, an employer that is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with paragraph (b) of this section may apply the requirements of section 410(b) on an employer-wide rather than a qualified-separate-line-of-business basis with respect to any plan (within the meaning of section 1.414(r)-8(d)(2), but without regard to the mandatory disaggregation rule of section 1.410(b)- 7(c)(4) for portions of a plan that benefit employees of different qualified separate lines of business) that benefits a group of employees that satisfies the percentage test of section 410(b)(1)(A) (i.e., benefits at least 70 percent of the employer's nonexcludable nonhighly compensated employees). If section 401 (a)(4) requires that a group of employees under the plan described in the preceding sentence satisfy section 410(b) for purposes of satisfying section 401(a)(4), the percentage test of section 410(b)(1)(A) must be satisfied by each such group of employees. See section 1.414(r)-8(c). The rules of this paragraph (c)(2)(ii) are illustrated by the following example.

EXAMPLE. Employer A maintains a single profit-sharing plan, Plan W, and three pension plans, Plans X, Y and Z, each benefiting employees of a different one of Employer A's three qualified separate lines of business. Contributions to the profit-sharing plan are made pursuant to a cash or deferred arrangement in which all employees of Employer A are eligible to participate. Assume that, as a result, Plan W satisfies the requirements to be tested under this paragraph (c)(2)(ii). None of the pension plans benefits more than 70 percent of the nonexcludable employees of Employer A. Employer A is treated as operating qualified separate lines of business for purposes of applying section 410(b) to its qualified plans. The requirements of sections 410(b) and 401(a)(4) must therefore be applied to Plans X, Y and Z separately with respect to the employees of each of the three qualified separate line of business operated by Employer A. Since Plan W benefits at least 70 percent of the nonexcludable employees of Employer A, however, the requirements of sections 410(b) and 401(a)(4) (including section 401(k)) may be applied to Plan W on an employer-wide basis.

(3) SEPARATE APPLICATION OF SECTION 401(a)(26) -- (i) GENERAL RULE. Except as provided in paragraph (c)(3)(ii) of this section, an employer is permitted to apply the requirements of section 401(a)(26) separately with respect to the employees of each qualified separate line of business operated by the employer only if the employer does so with respect to all its plans, all its employees, and all its qualified separate lines of business. Rules for applying the requirements of section 401(a)(26) separately with respect to the employees of a qualified separate line of business are provided in section 1.414(r)-9. An employer may apply the rules of section 414(r) for purposes of section 401(a)(26) even if it does not apply the rules of section 414(r) for purposes of section 410(b).

(ii) SPECIAL RULE FOR EMPLOYER-WIDE PLANS. Notwithstanding paragraph (c)(3)(i) of this section, an employer that is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with paragraph (b)of this section may apply the requirements of section 401(a)(26) on an employer-wide rather than a qualified-separate-line-of-business basis with respect to any plan (within the meaning of section 1.414(r)-9(c)(2), but without regard to the mandatory disaggregation rule of section 1.401 (a)(26)-2(d)(6) for portions of a plan that benefit employees of different qualified separate lines of business), but only if the special rule for employer-wide plans in paragraph (c)(2)(ii) of this section is applied to the same plan for the same plan year.

(4) SEPARATE APPLICATION OF SECTION 129(d)(8). [Reserved]

(5) SEPARATE APPLICATION OF OTHER CODE REQUIREMENTS. Under no circumstance may the requirements of any section of the Code (other than a section described in paragraphs (c)(2) through (c)(4) of this section) be applied separately with respect to the employees of a qualified separate line of business unless the section specifically cross-references, or is specifically cross-referenced by, section 414(r). The Code sections whose requirements may not be applied separately with respect to the employees of a qualified separate line of business include, but are not limited to, sections 79(d)(3), 105(h), 117(d)(3), 120(c)(2), 125(g)(3), 127(b)(2), 129(d)(3), 132, 195, 401(a)(3) (as in effect on September 1, 1974), 414(q)(4), 501(c)(17)(A)(ii), 501(c)(17)(B)((iii)), 501(c)(18)(B), and 505(b)(1)(A).

(d) APPLICATION OF REQUIREMENTS -- (1) IN GENERAL. The requirements of paragraphs (b) and (c) of this section must be applied in accordance with the rules in this paragraph (d).

(2) INTERPRETATION. The provisions of this section and of sections 1.414(r)-2 through 1.414(r)-11 are to be interpreted in a reasonable manner consistent with the purpose of section 414(r) to recognize an employer's operation of qualified separate lines of business for bona fide business reasons and not for reasons of evading the requirements of any section of the Code, including sections 410(b), 401(a)(26), and 129(d)(8). See section 414(r)(1) and (r)(7). Thus, for example, an employer is not permitted to apply these regulations in a manner that may literally comply with the other provisions of this section and of sections 1.414(r)-2 through 1.414(r)-11, but that does not reflect the employer's operation of qualified separate lines of business for bona fide business reasons.

(3) SEPARATE OPERATING UNITS. No additional requirements beyond those provided in these regulations apply to a separate operating unit. Thus, a separate operating unit that satisfies the requirements of paragraph (b)(2) of this section is deemed to satisfy the geographic separation requirement of section 414(r)(7) and accordingly is treated as a qualified separate line of business for all purposes under this section, including the separate application of section 401(a)(26).

(4) CERTAIN MERGERS AND ACQUISITIONS. A portion of an employer that is acquired in a transaction described in section 410(b)(6)(C) and section 1.410(b)-2(f) (i.e., an asset or stock acquisition, merger, or other similar transaction involving a change in the employer of the employees of a trade or business) is deemed to satisfy the requirements to be a qualified separate line of business, other than the 50-employee requirement and the notice requirement of paragraphs (b)(2)(iv)(B) and (b)(2)(iv)(C) of this section, respectively. In addition, the acquired employees are not taken into account, and the property and services provided by the acquired portion to customers of the employer are disregarded, for purposes of determining whether the employer's remaining lines of business satisfy the requirements of sections 1.414(r)-3 through 1.414(r)-6. The rules in this paragraph (d)(4) apply only for those testing years with first testing days that fall within the transition period described in section 410(b)(6)(C). For this purpose, the transition period described in section 410(b)(6)(C) lasts only for so long as the conditions in that section are satisfied. For the definition of "first testing day," see section 1.414(r)-11(b)(7). See section 1.414(r)-5(d)(4), Example 1, for an example of the application of the rule in this paragraph (d)(4). See also section 1.414(r)-5(d) for an administrative safe harbor applicable to certain separate lines of business acquired in a transaction described in this section.

(5) GOVERNMENTAL AND TAX-EXEMPT EMPLOYERS -- (i) GENERAL RULE. Except as provided in paragraph (d)(5)(ii) of this section, the rules of this section are applicable in determining whether section 401(a)(26) is satisfied by a plan maintained by an employer that is exempt from tax under Subtitle A of the Internal Revenue Code (including a governmental plan within the meaning of section 414(d)). Similarly, except as provided in paragraph (d)(5)(ii) of this section, the rules of this section are applicable in determining whether section 410(b) is satisfied by a plan that is subject to section 410(b) (including by virtue of section 1.410(b)-2(e)) and is maintained by an employer that is exempt from tax under Subtitle A of the Internal Revenue Code (including a governmental plan within the meaning of section 414(d)).

(ii) ADDITIONAL RULES. [Reserved]

(6) TESTING YEAR BASIS OF APPLICATION -- (i) SECTION 414(r). Whether an employer is treated as operating qualified separate lines of business under section 414(r) in accordance with paragraph (b) of this section is determined on a year-by-year basis with respect to the testing year. It is therefore possible for an employer to satisfy paragraph (b) of this section for one testing year and to fail to satisfy it for another testing year. It is also possible for an employer to satisfy paragraph (b) of this section for two testing years but to have designated its lines of business differently in each of those two testing years. In determining whether an employer satisfies paragraph (b) of this section for a testing year, the requirements of that paragraph are applied solely with respect to the testing year. Thus, all property and services provided by the employer to its customers during the testing year must be provided exclusively by portions of the employer that for the testing year constitute qualified separate lines of business. Furthermore, each employee of the employer must respectively be treated as an employee of one and only one of those qualified separate lines of business for all purposes with respect to the testing year.

(ii) SECTIONS 410(b), 401(a)(26), AND 129(d)(8). For purposes of paragraph (c) of this section, relating to the separate application of sections 410(b), 401(a)(26), and 129(d)(8) to the employees of a qualified separate line of business, the determination whether an employer operates qualified separate lines of business in accordance with paragraph (b)of this section for a testing year generally applies for all plan years beginning in the testing year. Rules for the separate application of sections 410(b), 401(a)(26), and 129(d)(8) are respectively provided in sections 1.414(r)-8, 1.414(r)- 9, and 1.414(r)-10.

(7) AVERAGING RULES. The employer is permitted to apply certain provisions of these regulations on the basis of a consecutive-year average (not to exceed five consecutive years) under the averaging rules of section 1.414(r)-11(c).

(8) DEFINITIONS. In applying the provisions of this section and of sections 1.414(r)-2 through 1.414(r)-11, the definitions in sections 1.414(r)-11(b) and 1.410(b)-9 govern, unless otherwise provided.

(9) EFFECTIVE DATE -- (i) GENERAL RULE. The provisions of this section and of sections 1.414(r)-2 through 1.414(r)-11 apply to plan years and testing years beginning on or after January 1, 1992.

(ii) REASONABLE COMPLIANCE -- (A) IN GENERAL. With respect to plan years beginning before the date on which the Commissioner begins issuing determinations under section 414(r)(2)(C), and on or after the first day of the first plan year to which section 414(r) applies under section 1112(a) of the Tax Reform Act of 1986, an employer is treated as operating qualified separate lines of business if the employer reasonably determines that it meets the requirements of section 414(r) (other than the requirement of administrative scrutiny under section 414(r)(2)(C)).

(B) DETERMINATION OF REASONABLE COMPLIANCE. Whether an employer reasonably determines that it meets the requirements of section 414(r) generally will be determined on the basis of all relevant facts and circumstances, including the extent to which the employer has resolved unclear issues in its favor. For the period described in paragraph (d)(9)(ii)(A) of this section, the Internal Revenue Service will consider the employer's compliance with the terms of these final regulations (other than the requirement of administrative scrutiny under paragraph (b)(2)(iv)(D) of this section) to constitute a reasonable determination that the employer meets the requirements of section 414(r) (other than the requirement of administrative scrutiny under section 414(r)(2)(C)).

(C) EFFECT ON OTHER PLANS. If an employer sponsors a plan that has a plan year beginning within the period described in paragraph (d)(9)(ii)(A) of this section, the employer's reasonable determination of its qualified separate lines of business for the testing year in which that plan year begins, and the allocation of employees to those qualified separate lines of business, must also be used for purposes of applying section 1.414(r)-8 and section 1.414(r)-9 for plan years that begin in that testing year but after the end of the period described in paragraph (d)(9)(ii)(A) of this section.

(e) ADDITIONAL RULES. The Commissioner may, in revenue rulings, notices, and other guidance of general applicability, provide any additional rules that may be necessary or appropriate in applying the qualified separate line of business requirements of section 414(r). These additional rules may include, for example, new safe harbors in section 1.414(r)-5 and new conditions under which an individual determination may be requested under section 1.414(r)-6.

SECTION 1.414(r)-2 LINE OF BUSINESS.

(a) GENERAL RULE. A line of business is a portion of an employer that is identified by the property or services it provides to customers of the employer. For this purpose, an employer is permitted to determine its lines of business by designating the property or services that each of its lines of business provides to customers of the employer. Paragraph (b)of this section explains how an employer determines its lines of business for a testing year. Paragraph (c) of this section provides examples illustrating the application of this section.

(b) EMPLOYER DETERMINATION OF ITS LINES OF BUSINESS -- (1) IN GENERAL. An employer determines its lines of business for a testing year first by identifying all the property and services it provides to its customers during the testing year, and then by designating which portion of the property and services is provided by each of its lines of business.

(2) PROPERTY AND SERVICES PROVIDED TO CUSTOMERS. Property, whether real or personal, tangible or intangible, is provided by an employer to a customer during a testing year if the employer provides the property to or on behalf of the customer during the testing year for consideration. Similarly, services are provided by an employer to a customer during a testing year if the employer renders the services to or on behalf of the customer during the testing year for consideration. An individual item of property or service is taken into account under this paragraph (b)(2) only if the employer provides the item during the testing year to a person other than the employer in the ordinary course of a trade or business conducted by the employer during the testing year, and the person to whom the employer provides the item is acting in the capacity as a customer of the employer. It is not necessary that both property or services actually be provided, and consideration for the property or services actually be paid, during the current testing year. For an employer to be considered to provide property and services to customers for consideration during a testing year under this paragraph (b)(2), it is sufficient that: the property or services actually be provided to customers during the testing year; the consideration actually be paid by customers during the testing year; or the employer actually incur significant costs during the testing year associated with the provision of the property or services to a specified customer or specified customers.

(3) EMPLOYER DESIGNATION -- (i) IN GENERAL. Once the employer has identified all the property and services it provides to its customers during the testing year under paragraph (b)(2) of this section, the employer determines its lines of business for the testing year by designating which portion of those property and services is provided by each of its lines of business. For this purpose, the employer must apportion all the property and services identified under paragraph (b)(2) of this section among its lines of business. An employer generally is not required to designate its lines of business for the testing year in the same manner as it designates its lines of business for any other testing year.

(ii) ABILITY TO COMBINE UNRELATED TYPES OF PROPERTY OR SERVICES IN A SINGLE LINE OF BUSINESS. For purposes of this paragraph (b)(3), there is no requirement that a line of business provide only one type of property or service, or only related types of property or services. Nor is there any requirement that a line of business provide solely property or solely services. Thus, the employer is permitted to combine in a single line of business dissimilar types of property or services that are otherwise unrelated to one another.

(iii) ABILITY TO SEPARATE RELATED TYPES OF PROPERTY OR SERVICES INTO TWO OR MORE LINES OF BUSINESS. For purposes of this paragraph (b)(3), there is no requirement that all property or services of related types or the same type be provided by a single line of business. Thus, the employer is permitted to designate two or more lines of business that provide related types of property or services, or the same type of property or service. An employer might designate two or more lines of business that provide property or services of related types or the same type, for example, where the lines of business manufacture, prepare, or provide the property or services in different geographic areas (e.g., in different regions of the country or the world), or at different levels in the chain of commercial distribution (e.g., wholesale versus retail), or in different types of transactions (e.g., sale versus lease), or for different types of customers (e.g., governmental versus private), or subject to different legal constraints (e.g., regulated versus unregulated), or if the lines of business have developed differently (e.g., one line of business was acquired while another line of business developed internally). Notwithstanding the foregoing, an employer is not permitted to designate two or more lines of business that provide property or services of related types or the same type, if the employer's designation is unreasonable. An employer's designation would be unreasonable, for example, if the designation separated two types of property or services in different lines of business, but the employer did not provide those types of property or services separately from one another to its customers. Similarly, an employer's designation would be unreasonable if it separated two types of property or services in different lines of business, but the provision of one type of property or service was merely ancillary or incidental to, or regularly associated with, the provision of the other type of property or service. See generally section 1.414(r)- 1(d)(2) (requiring an employer's operation of qualified separate lines of business to be for bona fide business reasons).

(iv) AFFILIATED SERVICE GROUPS. An employer is not permitted to designate its lines of business in a manner that results in separating employees of an affiliated service group (within the meaning of section 414(m)) from other employees of the employer. See section 414(r)(8).

(c) EXAMPLES -- (1) IN GENERAL. Paragraphs (c)(2) and (c)(3) of this section provide examples that illustrate the application of this section.

(2) EXAMPLES ILLUSTRATING EMPLOYER DESIGNATION. The following examples illustrate the application of paragraph (b)(3) of this section relating to an employer's designation of the property or services provided to customers by each of its lines of business.

EXAMPLE 1. Employer A is a domestic conglomerate engaged in the manufacture and sale of consumer food and beverage products and the provision of data processing services to private industry. Employer A provides no other property or services to its customers. Pursuant to paragraph (b)(3) of this section, Employer A apportions all the property and services it provides to its customers among three lines of business, one providing all its consumer food products, a second providing all its consumer beverage products, and a third providing all its data processing services. Employer A has three lines of business for purposes of this section.

EXAMPLE 2. The facts are the same as in Example 1, except that Employer A determines that neither the consumer food products line of business nor the consumer beverage products line of business would satisfy the separateness criteria of section 1.414(r)-3 for recognition as a separate line of business. Accordingly, pursuant to paragraph (b)(3) of this section, Employer A apportions all the property and services it provides to its customers between only two lines of business, one providing all its consumer food and beverage products, and a second providing all its data processing services. Employer A has two lines of business for purposes of this section.

EXAMPLE 3. The facts are the same as in Example 2, except that Employer A also owns and operates a regional commuter airline, a professional basketball team, a pharmaceutical manufacturer, and a leather tanning company. Pursuant to paragraph (b)(3) of this section, Employer A apportions all the property and services it provides to its customers among three lines of business, one providing all its consumer food and beverage products, a second providing all its data processing services, and a third providing all the other property and services provided to customers through Employer A's regional commuter airline, professional basketball team, pharmaceutical manufacturer, and leather tanning company. Even though the third line of business includes dissimilar types of property and services that are otherwise unrelated to one another, paragraph (b)(3)(ii) of this section permits Employer A to combine these property and services in a single line of business. Employer A has three lines of business for purposes of this section.

EXAMPLE 4. The facts are the same as in Example 2, except that Employer A has recently acquired Corporation L, whose only product is a well-known brand of gourmet ice cream. Although Employer A manufactures and sells other ice cream products, it does not manufacture or market the newly acquired brand of gourmet ice cream except through Corporation L. Pursuant to paragraph (b)(3) of this section, Employer A apportions all the property and services it provides to its customers among three lines of business, one providing only the newly acquired brand of gourmet ice cream, a second providing all its other consumer food and beverage products (including the other ice cream products manufactured and sold by Employer A), and a third providing all its data processing services. Even though the gourmet ice cream line of business provides the same type of property as the consumer food and beverage line of business (i.e., ice cream), paragraph (b)(3)(iii) of this section permits Employer A to separate its ice cream products between two different lines of business. Employer A has three lines of business for purposes of this section.

EXAMPLE 5. The facts are the same as in Example 2, except that Employer A operates the data processing services portion of its business in two separate subsidiaries, one serving customers in the eastern half of the United States and the other serving customers in the western half of the United States. Pursuant to paragraph (b)(3) of this section, Employer A apportions all the property and services it provides to its customers among three lines of business, one providing all its consumer food and beverage products, a second providing data processing services to customers in the eastern half of the United States, and a third providing data processing services to customers in the western half of the United States. Even though the second and third lines of business provide the same type of service (i.e., data processing services), paragraph (b)(3)(iii) of this section permits Employer A to separate its data processing services into two lines of business. Employer A has three lines of business for purposes of this section.

EXAMPLE 6. Employer B is a diversified engineering firm offering civil, chemical, and aeronautical engineering services to government and private industry. Employer B provides no other property or services to its customers. Employer B operates the aeronautical engineering services portion of its business as two separate divisions, one serving federal government customers and the other serving customers in private industry. Pursuant to paragraph (b)(3) of this section, Employer B apportions all the property and services it provides to its customers among four lines of business, one providing all its civil engineering services, a second providing all its chemical engineering services, a third providing aeronautical engineering services to federal government customers, and a fourth providing aeronautical engineering services to customers in private industry. Even though the third and fourth lines of business include the same type of service (i.e., aeronautical engineering services), paragraph (b)(3)(iii) of this section permits Employer B to separate its aeronautical engineering services into two lines of business. Employer B has four lines of business for purposes of this section.

EXAMPLE 7. Among its other business activities, Employer C manufactures industrial diesel generators. At no additional cost to its buyers, Employer C warrants the proper functioning of its diesel generators for a one-year period following sale. Pursuant to its warranty, Employer C provides labor and parts to repair or replace any components that malfunction within the one-year warranty period. Because Employer C does not provide the industrial diesel generators, on the one hand, and the warranty repair services and replacement parts, on the other hand, separately from one another to its customers, under paragraph (b)(3)(iii) of this section it would be unreasonable for Employer C to separate these property and services in different lines of business.

EXAMPLE 8. Among its other business activities, Employer D leases office photo-copying equipment. Employer D also provides photo-copying supplies and repair services to its lessees for a separate charge. Employer D generally does not provide such supplies and repair services to persons other than its lessees. Lessees of Employer D's equipment are permitted to use photo- copying supplies and repair services from suppliers other than Employer D). Because the provision of the photo-copying supplies and repair services are merely ancillary or incidental to the provision of the leased photo-copiers, under paragraph (b)(3)(iii) of this section it would be unreasonable for Employer D to separate these property and services in different lines of business.

EXAMPLE 9. Employer E operates a medical clinic. The employees of the clinic include physicians, nurses, and laboratory technicians, all of whom participate in providing medical and related services to patients of the clinic. Under paragraph (b)(3)(iii) of this section, it would be unreasonable for Employer E to separate the services of the physicians, nurses, and laboratory technicians in different lines of business.

EXAMPLE 10. Employer F is a law firm. The employees of the firm include lawyers, paralegals, and secretaries, all of whom participate in rendering legal and related services to clients of the firm. Under paragraph (b)(3)(iii) of this section, it would be unreasonable for Employer F to separate the services of the lawyers, paralegals, and secretaries in different lines of business.

EXAMPLE 11. Employer G is a management consulting firm. The employees of the firm include management consultants, secretaries, and other support staff personnel, all of whom participate in rendering management consulting and related services to clients of the firm. Under paragraph (b)(3)(iii) of this section, it would be unreasonable for Employer G to separate the services of the management consultants, secretaries, and other support staff personnel in different lines of business.

(3) EXAMPLES ILLUSTRATING PROPERTY AND SERVICES PROVIDED TO CUSTOMERS. The following examples illustrate the application of paragraph (b)(2) of this section relating to property and services provided to customers of the employer.

EXAMPLE 1. Employer H operates several dairy farms and dairy product processing plants. The dairy farms provide their entire output of milk and milk by-products to Employer H's dairy product processing plants. Under paragraph (b)(2) of this section, the dairy farms' provision of milk and milk by-products to the dairy product processing plants does not constitute the provision of property or services to customers of Employer H, because the milk and milk by-products are not provided to a person other than Employer H.

EXAMPLE 2. The facts are the same as in Example 1, except that the dairy farms also sell milk and milk by-products to retail distributors unrelated to Employer H. Although the dairy farms' provision of milk and milk by-products to Employer H's dairy product processing plants does not constitute the provision of property or services to customers of Employer H, the dairy farms' provision of milk and milk by-products to independent retail distributors does constitute the provision of property or services to customers of Employer H under paragraph (b)(2) of this section.

EXAMPLE 3. Among its other business activities, Employer J manufactures automobiles. Employer J operates a cafeteria at one of its automobile manufacturing facilities. The cafeteria is intended primarily for use by employees of Employer J, but non- employees are not prohibited from using the cafeteria. The cafeteria charges the same prices to employees and non- employees. Under paragraph (b)(2) of this section, the provision of cafeteria services to employees of Employer J does not constitute the provision of property or services to customers of Employer J, because the cafeteria services are provided to the employees in their capacity as employees of Employer J and not as customers of Employer J.

EXAMPLE 4. Employer K sells books and periodicals to members of the public and provides telecommunications services to private industry. Employer K periodically acquires and disposes of businesses in both asset and stock transactions. In addition, for its own investment purposes, Employer K acquires and disposes of corporate and other securities. Under paragraph (b)(2) of this section, the sale by Employer K of businesses and investment securities does not constitute the provision of property or services to customers of Employer K, because the sales are not made in the ordinary course of a trade or business conducted by Employer K. However, the sale of published materials and the provision of telecommunications services to persons unrelated to Employer K does constitute the provision of property or services to customers of Employer K.

EXAMPLE 5. Employer L is active in the financial services industry. Subsidiary 1 of Employer L is a brokerage firm that is regulated as a broker-dealer under applicable federal and state law. In its capacity as a dealer, Subsidiary 1 holds in its own inventory securities of unrelated corporations and regularly sells these securities to unrelated persons. Under paragraph (b)(2) of this section, the sale by Subsidiary 1 of the securities to unrelated persons constitutes the provision of property or services to customers of Employer L, because the sales are made in the ordinary course of Subsidiary 1's trade or business as a broker-dealer.

EXAMPLE 6. The facts are the same as in Example 5. Subsidiary 2 of Employer L is an insurance company that is regulated under applicable state insurance laws. In managing its investments, Subsidiary 2 regularly makes use of the brokerage services of Subsidiary 1 (which Subsidiary 1 regularly provides to unrelated persons as well). Under paragraph (b)(2) of this section, Subsidiary 1's provision of brokerage services to Subsidiary 2 does not constitute the provision of property or services to customers of Employer L, because the brokerage services are not provided to a person other than Employer L. However, Subsidiary 1's provision of brokerage services to unrelated persons does constitute the provision of property or services to customers of Employer L.

EXAMPLE 7. Employer M is a shipbuilder. In a testing year, Employer M enters into a contract with a customer to construct a new cargo ship for delivery two years later. Employer M incurs significant costs designing and planning for the production of the new ship during the testing year, but receives no payments from the customer during that year. Under paragraph (b)(2) of this section, Employer M is treated as providing the cargo ship to the customer during the testing year.

EXAMPLE 8. The facts are the same as in Example 7, except that, pursuant to a request from the customer, Employer M also incurred significant costs developing a prototype and submitting a bid on the new cargo ship in the prior testing year, and that these costs were not reimbursed by the customer. Under paragraph (b)(2) of this section, Employer M is also treated as providing the cargo ship to the customer in the prior testing year.

SECTION 1.414(r)-3 SEPARATE LINE OF BUSINESS.

(a) GENERAL RULE. A separate line of business is a line of business (as determined under section 1.414(r)-2) that is organized and operated separately from the remainder of the employer. Paragraph (b) of this section sets forth the rules for determining whether a line of business is organized and operated separately from the remainder of the employer. Paragraph (c) of this section provides certain supplementary rules necessary to apply the requirements of paragraph (b) of this section, as well as examples illustrating the application of those requirements. Paragraph (d) of this section provides an optional rule for lines of business that are vertically integrated.

(b) SEPARATE ORGANIZATION AND OPERATION -- (1) IN GENERAL. A line of business is organized and operated separately from the remainder of the employer for a testing year only if it satisfies all the requirements of paragraphs (b)(2) through (b)(5) of this section for the testing year.

(2) SEPARATE ORGANIZATIONAL UNIT. The line of business must be formally organized as a separate organizational unit or group of separate organizational units within the employer. For this purpose, an organizational unit is a corporation, partnership, division, or other unit having a similar degree of organizational formality. This requirement must be satisfied on every day of the testing year.

(3) SEPARATE FINANCIAL ACCOUNTABILITY. The line of business must be a separate profit center or group of separate profit centers within the employer. This requirement must be satisfied on every day of the testing year. In addition, the employer must maintain books and records that provide separate revenue and expense information that is used for internal planning and control with respect to each profit center comprising the line of business.

(4) SEPARATE EMPLOYEE WORKFORCE. The line of business must have its own separate employee workforce. A line of business has its own separate employee workforce only if at least 90 percent of the employees who provide services to the line of business are substantial-service employees with respect to the line of business. See paragraph (c)(2) of this section to determine how the percentage in the preceding sentence is calculated for the testing year.

(5) SEPARATE MANAGEMENT. The line of business must have its own separate management. A line of business has its own separate management only if at least 80 percent of the employees who are top- paid employees with respect to the line of business are substantial- service employees with respect to the line of business. See paragraph (c)(3) of this section to determine how the percentage in the preceding sentence is calculated for the testing year.

(c) SUPPLEMENTARY RULES -- (1) IN GENERAL. This paragraph (c) provides certain supplementary rules necessary to apply the requirements of paragraph (b) of this section, as well as examples illustrating the application of those requirements.

(2) DETERMINATION OF SEPARATE EMPLOYEE WORKFORCE. The percentage in paragraph (b)(4) of this section is the fraction (expressed as a percentage) --

(i) The numerator of which is the number of substantial-service employees with respect to the line of business within the meaning of section 1.414(r)-11(b)(2); and

(ii) The denominator of which is the total number of employees who provide services to the line of business within the meaning of paragraph (c)(5) of this section.

(3) DETERMINATION OF SEPARATE MANAGEMENT. The percentage in paragraph (b)(5) of this section is the fraction (expressed as a percentage) --

(i) The numerator of which is the number of employees who are both top-paid employees and substantial-service employees with respect to the line of business within the meaning of section 1.414(r)-11(b)(3) and (2), respectively; and

(ii) The denominator of which is the total number of top-paid employees with respect to the line of business within the meaning of section 1.414(r)-11(b)(3).

(4) EMPLOYEES TAKEN INTO ACCOUNT -- (i) GENERAL RULE. For purposes of applying this paragraph (c), only employees who are employees of the employer on the first testing day are taken into account. For this purpose, there are no excludable employees (except as provided in paragraph (c)(4)(ii) of this section). Consequently, all employees who are employees on the first testing day are taken into account, including collectively bargained employees. For the definition of "first testing day," see section 1.414(r)-11(b)(7).

(ii) EXCLUSION OF CERTAIN NONRESIDENT ALIENS. For purposes of determining the fractions in paragraphs (c)(2) and (c)(3) of this section with respect to a line of business, an employer is permitted to exclude all employees who are described in section 410(b)(3)(C) (i.e., nonresident aliens who receive no earned income within the meaning of section 911(d)(2) from the employer that constitutes income from sources within the United States within the meaning of section 861(a)(3)) who are substantial-service employees with respect to that line of business within the meaning of section 1.414(r)- 11(b)(2). Thus, for example, if a nonresident alien employee described in the preceding sentence provides 75 percent of the employee's services to one line of business, and 25 percent to another line of business, the employer is permitted to disregard the employee in determining the separate workforce and separate management fractions in paragraphs (c)(2) and (c)(3) of this section with respect to the first line of business, but not the second line of business.

(5) SERVICES TAKEN INTO ACCOUNT -- (i) PROVISIONS OF SERVICES TO A LINE OF BUSINESS. An employee provides services to a line of business if more than a negligible portion of the employee's services contributes to providing the property or services provided by the line of business to customers of the employer. All of the services of each employee who provides services to the employer contribute, whether directly or indirectly, to the provision of property or services to customers of the employer, and therefore each employee who provides services to the employer must be treated as providing more than a negligible portion of the employee's services to one or more lines of business operated by the employer.

(ii) PERIOD FOR WHICH SERVICES ARE PROVIDED. Only services performed by an employee during the testing year that contribute to providing the property or services provided by a line of business to customers are taken into account. An employee's services during the testing year are considered to contribute to providing the property or services provided by a line of business to customers of the employer if --

(A) The employee's services during the testing year contribute to providing such property or services to customers of the employer during the testing year; or

(B) It is reasonably anticipated that the employee's services during the testing year will contribute to providing such property and services to customers of the employer after the close of the testing year.

(iii) DETERMINATION OF SERVICES. The determination of whether an employee provides services to a line of business, and the determination of the percentage of an employee's services provided to a line of business, must be made in a manner that is reasonably reliable with respect to all employees and uniform with respect to similarly-situated employees.

(6) EXAMPLES OF THE SEPARATE EMPLOYEE WORKFORCE REQUIREMENT. The following examples illustrate the application of the separate employee workforce requirement in paragraph (b)(4) of this section and the supplementary rules of this paragraph (c). Unless otherwise specified, it is assumed that the employees and their services described in these examples are taken into account under paragraphs (c)(4) and (5) of this section for the testing year.

EXAMPLE 1. Employer A operates three lines of business as determined under section 1.414(r)-2. One of Employer A's lines of business manufactures and sells tires and other automotive products. Employee M is a tire press operator in Employer A's tire factory. Employee N is the manager of the tire factory. Under these facts, the services of Employees M and N contribute to providing tires to customers of Employer A. Both employees therefore provide services to Employer A's tire and automotive products line of business within the meaning of paragraph (c)(5) of this section.

EXAMPLE 2. The facts are the same as in Example 1. In addition, none of the services of Employees M and N that contribute to providing property or services to customers contribute to providing any property or service other than tires to customers of Employer A. Under these facts, Employees M and N provide at least 75 percent of their respective services to Employer A's tire and automotive products line of business. Therefore Employees M and N are substantial-service employees with respect to Employer A's tire and automotive products line of business within the meaning of section 1.414(r)-11(b)(2), and do not provide any services within the meaning of paragraph (c)(5) of this section to any of Employer A's other lines of business.

EXAMPLE 3. The facts are the same as in Example 2. Employer A's second line of business manufactures and sells construction machinery, and Employer A's third line of business manufactures and sells agricultural equipment. As part of these lines of business, Employer A operates a construction machinery factory and an agricultural equipment factory on the same site as the tire factory described in Example 2. Employer A's facilities at the site include a health clinic and a fitness center that serve the employees of the construction machinery factory, the agricultural equipment factory, and the tire factory. Employee O is a nurse in the health clinic, and Employee P is a fitness instructor in the fitness center. Both employees therefore provide services within the meaning of paragraph (c)(5) of this section to Employer A's tire and automotive products line of business, construction machinery line of business, and agricultural equipment line of business. In addition, under these facts, Employer A determines (in accordance with paragraph (c)(5)(iii) of this section) that approximately 33 percent of the services of Employees O and P are provided to each of Employer A's three lines of business. As a result, neither Employee O or P provide at least 75 percent of their respective services to any of Employer A's lines of business. Therefore, Employees O and P are not substantial-service employees with respect to any of Employer A's three lines of business within the meaning of section 1.414(r)-11(b)(2).

EXAMPLE 4. The facts are the same as in Example 3. Employee Q is the president and chief executive officer of Employer A and is responsible for reviewing the performance of all Employer A's lines of business. Under these facts, the services of Employee Q contributes to providing property and services to customers of each of Employer A's three lines of business. Employee Q therefore provides services to each of these three lines of business. Employer A determines (in accordance with paragraph (c)(5)(iii) of this section) that Employee Q provides the following percentages of his services to Employer A's three lines of business: tire and automotive products -- 40 percent; construction machinery -- 40 percent, and agricultural equipment -- 20 percent. Employee Q does not provide at least 75 percent of his services to any of Employer A's lines of business. Therefore, Employee Q is not a substantial-service employee with respect to any of Employer A's three lines of business within the meaning of section 1.414(r)-11(b)(2).

EXAMPLE 5. The facts are the same as in Example 4, except that Employer A also owns 75 percent of Corporation X. Corporation X is not treated as part of Employer A within the meaning of section 1.410(b)-9. Employee R is an accountant in the accounting department of Employer A. Employee R devotes all of his time to maintaining the accounting books and records of the tire and automotive products line of business of Employer A and the accounting books and records of Corporation X. Employer A determines (in accordance with paragraph (c)(5)(iii) of this section) that Employee R provides 40 percent of his services directly to the tire and automotive products line of business. Employer A also determines (in accordance with paragraph (c)(5)(iii) of this section) that Employee R provides the following percentages of the remainder of Employee R's services (i.e., his provision of services of maintaining the accounting books and records of Corporation X) indirectly to Employer A's three lines of business by virtue of the services he provides to Corporation X: tire and automotive products -- 25 percent; construction machinery -- 20 percent, and agricultural equipment -- 15 percent. Therefore, Employee R provides 65 percent of his services to the tire and automotive products line of business of Employer A (i.e., 40 percent directly and 25 percent indirectly).

EXAMPLE 6. The facts are the same as in Example 5. Employee S is a lawyer in the legal department located at the headquarters who devotes all her time to product liability suits filed against the construction machinery line of business. Under these facts, the services of Employee S contribute to providing property and services to customers of Employer A in the construction machinery line of business, and therefore Employee S provides services to that line of business. Because Employee S's services do not contribute to providing property or services in any other of Employer A's lines of business within the meaning of paragraph (c)(5) of this section, Employee S provides more than 75 percent of her services to the construction machinery line of business and therefore is a substantial- service employee with respect to Employer A's construction machinery line of business within the meaning of section 1.414(r)-11(b)(2).

EXAMPLE 7. The facts are the same as in Example 6. Employer A also maintains a separate facility that houses a centralized procurement, marketing, and billing operation for all of its lines of business. None of the procurement, marketing, or billing employees specializes in any particular line of business. Under these facts, the services of the procurement, marketing, and billing employees contribute to providing property and services to customers of Employer A in each of Employer A's three lines of business. Employer A determines (in accordance with paragraph (c)(5)(iii) of this section) that each of the procurement, marketing, and billing employees provides approximately an equal proportion of their services to each of Employer A's three lines of business. These employees therefore provide services to all of Employer A's lines of business within the meaning of paragraph (c)(5) of this section. However, none of them provides at least 75 percent of his services to any line of business. Therefore, these employees are not substantial- service employees with respect to any of Employer A's three lines of business within the meaning of section 1.414(r)- 11(b)(2).

EXAMPLE 8. The facts are the same as in Example 7. Employee T works for the construction machinery line of business. During the testing year, he is temporarily detailed to the agricultural equipment line of business. His temporary detail lasts for one week, after which he returns to his regular duties with the construction machinery line of business. Under these facts, Employee T does not provide more than a negligible portion of his services during the testing year to the agricultural equipment line of business. Accordingly, Employee T does not provide services to the agricultural equipment line of business within the meaning of paragraph (c)(5) of this section. In addition, because Employee T provides at least 75 percent of his services to the construction machinery line of business, Employee T is a substantial-service employee with respect to Employer A's agricultural equipment line of business within the meaning of section 1.414(r)-11(b)(2).

EXAMPLE 9. The facts are the same as in Example 8, except that, during the testing year but before the first testing day, Employee T retires from employment with Employer A. Under paragraph (c)(5)(ii) of this section, Employee T is not taken into account in determining whether Employer A's construction machinery line of business has its own separate employee workforce within the meaning of paragraph (b)(4) of this section.

EXAMPLE 10. Employer B is a multinational controlled group of corporations that engages in the exploration, production, refining, and marketing of petrochemical products. Employer B operates two lines of business as determined under section 1.414(r)-2. The first line of business (the "exploration, production, and refining line of business") provides lubricating oil, gasoline, and other petrochemical products to wholesale customers of Employer B as well as to the second line of business. The wholesale customers of Employer B include independent jobbers, independent franchisees that operate retail filling stations under Employer B's trademark and tradename, as well as chemical and plastics manufacturers. The second line of business (the "retail marketing line of business") provides lubricating oil and gasoline products to retail customers of Employer B through filling stations owned and operated by Employer B. Employee U is an attendant at a filling station owned and operated by Employer B. Employee U performs no other services for Employer B. Under these facts, Employee U provides at least 75 percent of his services to Employer B's retail marketing line of business and therefore is a substantial- service employee with respect to that line of business within the meaning of section 1.414(r)-11(b)(2), and does not provide any services within the meaning of paragraph (c)(5) of this section to any of Employer B's other lines of business.

EXAMPLE 11. The facts are the same as in Example 10. Employer B operates a refinery that produces lubricating oil, gasoline, and other petrochemical products. Employee V is an operating engineer at the refinery who is involved at a stage in the refining process before lubricating oil and gasoline products have been separated from other types of petrochemical products. Employee V performs no other services for Employer B. Under these facts, Employee V's services contribute to providing property and services to customers of Employer B in both the exploration, production, and refining line of business and the retail marketing line of business. Employee V therefore provides services to both lines of business within the meaning of paragraph (c)(5) of this section. See paragraph (d) of this section, however, for an optional rule for vertically integrated lines of business.

EXAMPLE 12. The facts are the same as in Example 11. Employee W is a petroleum engineer who conducts geological studies of potential future drilling sites. Although Employee W's services during the testing year will not contribute to providing lubricating oil, gasoline, and other petrochemical products to customers of Employer B during the testing year, it is reasonably anticipated (in accordance with paragraph (c)(5)(ii)(B) of this section) that her services during the testing year will contribute to providing such products to customers of Employer B after the close of the testing year. Under these facts, Employee W provides her services to both of Employer B's lines of business within the meaning of paragraph (c)(5) of this section.

(7) EXAMPLES OF THE SEPARATE MANAGEMENT REQUIREMENT. The following examples illustrate the application of the separate management requirement in paragraph (b)(5) of this section and the supplementary rules of this paragraph (c).

EXAMPLE 1. Employer C operates three lines of business as determined under section 1.414(r)-2. One of its lines of business is the operation of a chain of athletic equipment and apparel stores. Of Employer C's total workforce, 10,500 employees provide more than a negligible amount of the services they provide to Employer C to the athletic equipment and apparel stores line of business, and 10,000 of these employees provide at least 25 percent of their services to the athletic equipment and apparel stores line of business, within the meaning of paragraph (c)(5) of this section. Of the 1,000 employees who constitute the top 10 percent by compensation of these 10,000 employees, 930 are substantial-service employees with respect to that line of business. Because 930 is 93 percent of 1,000, at least 80 percent of the top-paid employees who provide services to the line of business are substantial-service employees with respect to that line of business. Employer C's athletic equipment and apparel stores line of business therefore has its own separate management and thus satisfies the requirement of paragraph (b)(5) of this section.

EXAMPLE 2. The facts are the same as in Example 1. Employee X is a vice president of the accounting department located at the headquarters, who devotes all of his time supervising the staff of Employer C's accounting department. Employer C determines (in accordance with paragraph (c)(5)(iii) of this section) that 10 percent of Employee X's services contribute to providing property and services to customers of Employer C's athletic equipment and apparel stores line of business and 45 percent of Employee X's services contribute to providing property and services to customers to each of Employer C's other two lines of business. Because Employee X does not provide at least 25 percent of his services to Employer C's athletic equipment and apparel stores line of business, Employee X is not one of the 10,000 employees described in Example 1 and therefore cannot be a top-paid employee within the meaning of section 1.414(r)-11(b)(3) with respect to the athletic equipment and apparel stores line of business. Therefore, Employee X is not taken into account in determining whether the athletic equipment and apparel stores line of business satisfies the separate management requirement of paragraph (b)(5) of this section.

EXAMPLE 3. Employer D operates four lines of business as determined under section 1.414(r)-2. One of its lines of business is a machine tool shop. Sixty of Employer D's employees provide at least 25 percent of their services to the machine tool shop line of business. Of the six employees who constitute the top 10 percent by compensation of those 60 employees, four are substantial-service employees with respect to the line of business. Because four is 67 percent of six, 80 percent of the top-paid employees with respect to the machine tool shop line of business are not substantial-service employees with respect to that line of business. Therefore the machine tool shop line of business does not satisfy the separate management requirement of paragraph (b)(5) of this section.

EXAMPLE 4. The facts are the same as in Example 3, except that, in addition, another of Employer D's line of business is an automotive repair shop, and 80 of Employer D's employees provide at least 25 percent of their services to that line of business. Employer D combines the machine shop line of business with the automotive repair shop line of business and treats them as a single line of business. As a result, Employer D has three lines of business as determined under section 1.414(r)-2. Assume that 150 of employer D's employees provide more than 25 percent of their services to the machine tool shop/automotive repair shop line of business within the meaning of paragraph (c)(5) of this section. Of the 15 employees who constitute the top 10 percent by compensation of these 150 employees, 12 are substantial-service employees with respect to that line of business. Because 12 is 80 percent of 15, at least 80 percent of the top-paid employees with respect to the machine tool shop/automotive repair shop line of business are substantial- service employees with respect to that line of business. Therefore, the machine tool shop/automotive repair shop line of business satisfies the separate management requirement of paragraph (b)(5) of this section.

(d) OPTIONAL RULE FOR VERTICALLY INTEGRATED LINES OF BUSINESS -- (1) IN GENERAL. If two lines of business satisfy the requirements of this paragraph (d) with respect to a type of property or service for a testing year, the employer is permitted to apply the optional rule in this paragraph (d) for the testing year.

(2) REQUIREMENTS. Two lines of business satisfy the requirements of this paragraph (d) with respect to a type of property or service only if --

(i) One of the lines of business (the "upstream line of business") provides property or services to the other line of business (the "downstream line of business");

(ii) The upstream line of business provides the same type of property or service to customers of the employer (in accordance with the employer's designation for the testing year under section 1.414(r)-2);

(iii) The number of units of the property or service provided to customers of the employer by the upstream line of business equals at least 25 percent of the total number of units of the same type of property or service provided by the upstream line of business to all persons (including customers of the employer, the downstream line of business, and all other lines of business of the employer), when measured on a uniform basis; and

(iv) The downstream line of business uses, consumes, or substantially modifies the property or service in the course of itself providing property or services to customers of the employer or, alternatively, provides the property or service to customers of the employer at a different level in the chain of commercial distribution than the upstream line of business (e.g., retail versus wholesale).

(3) OPTIONAL RULE -- (i) TREATMENT OF EMPLOYEES. For purposes of determining the lines of business to which an employee provides services under paragraph (c)(5) of this section, an employee is not treated as providing services to the downstream line of business if --

(A) The employee is considered to provide services to the downstream line of business under paragraph (c)(5) of this section (applied without regard to the optional rule in this paragraph (d)); and

(B) The employee is so considered solely because the employee's services contribute to providing the property or service from the upstream line of business to the downstream line of business.

(ii) PURPOSES FOR WHICH OPTIONAL RULE APPLIES. If an employer applies the optional rule in this paragraph (d), the treatment specified in paragraphs (d)(3)(i)(A) and (B) of this section applies for all the following purposes and only for the following purposes --

(A) The separate employee workforce and separate management requirements of paragraphs (b)(4) and (b)(5) of this section;

(B) The 50-employee requirement of section 1.414(r)-4(b); and

(C) The determination of the employees of a qualified separate line of business under section 1.414(r)-7.

(4) EXAMPLES. The following examples illustrate the application of the optional rule in this paragraph (d).

EXAMPLE 1. Employer E operates two lines of business as determined under section 1.414(r)-2, one engaged in upholstery textile manufacturing and the other in furniture manufacturing. During the testing year, the upholstery textile line of business provides 300,000 yards of upholstery textiles to customers of Employer E and 100,000 yards of upholstery textiles to Employer E's furniture line of business. The furniture line of business uses the upholstery textiles provided to it by the upholstery textile line of business in the manufacture of upholstered furniture for sale to customers of Employer E. Thus, the upholstery textile line of business provides 75 percent of its total output of upholstery textiles during the testing year to customers of Employer E. In addition, the furniture line of business substantially modifies the upholstery textiles provided to it by the upholstery textile line of business in providing upholstered furniture products to customers of Employer E. Under these facts, Employer E's two lines of business satisfy the requirements of this paragraph (d) with respect to upholstery textiles for the testing year.

EXAMPLE 2. Employer B is a multinational controlled group of corporations that engages in the exploration, production, refining, and marketing of petrochemical products. See Example 10 under paragraph (c)(7) of this section. Employer B operates two lines of business as determined under section 1.414(r)-2. The first line of business ("the exploration, production, and refining line of business") provides lubricating oil, gasoline, and other petrochemical products to wholesale customers of Employer B as well as the second line of business. The wholesale customers of Employer B include independent jobbers, independent franchisees that operate retail filling stations under Employer B's trademark and tradename, as well as chemical and plastics manufacturers. The second line of business (the "retail marketing line of business") provides lubricating oil and gasoline products to retail customers of Employer B through filling stations owned and operated by Employer B. During the testing year, the exploration, production, and refining line of business provides 25,000 gallons of lubricating oil, 100,000 gallons of unleaded and 150,000 gallons of leaded gasoline to the retail marketing line of business, and 75,000 gallons of lubricating oil, 500,000 gallons of unleaded gasoline and 15,000 gallons of leaded gasoline to wholesale customers of Employer B. Thus, the exploration, production, and refining line of business provides 75 percent of its output of lubricating oil during the testing year to whole sale customers of Employer B. In addition, because unleaded and leaded gasoline is the same type of property (i.e., gasoline), the exploration, production, and refining line of business provides 67 percent of its output of gasoline products during the testing year to wholesale customers of Employer B. Furthermore, the retail line of business provides lubricating oil and gasoline products to customers of Employer B at different levels in the chain of commercial distribution than the exploration, production, and refining line of business. Under these facts, Employer B's two lines of business satisfy the requirements of this paragraph (d) with respect to both lubricating oil and gasoline products for the testing year.

EXAMPLE 3. The facts are the same as in EXAMPLE 2. Employer B operates a refinery that produces lubricating oil, gasoline, and other petrochemical products. Employee V is an operating engineer at the refinery who is involved at a stage in the refining process before lubricating oil and gasoline products have been separated from other types of petrochemical products. Employee V performs no other services for Employer B. Absent application of the optional rule in this paragraph (d), Employee V would be considered to provide services to both of Employer B's lines of business. See EXAMPLE 11 under paragraph (c)(7) of this section. However, because Employee V's services to the retail marketing line of business contribute solely to providing lubricating oil and gasoline products from the exploration, production, and refining line of business to the retail marketing line of business, under the optional rule in paragraph (d)(3)(i) of this section Employee V is not treated as providing services to the retail marketing line of business.

EXAMPLE 4. The facts are the same as in EXAMPLE 3. Employee W is a petroleum engineer who conducts geological studies of potential future drilling sites. Employee W performs no other services for Employer B. Absent application of the optional rule in this paragraph (d), Employee W would be considered to provide services to both of Employer B's lines of business. See EXAMPLE 12 under paragraph (c)(7) of this section. However, because Employee W's services to the retail marketing line of business contribute solely to providing lubricating oil and gasoline products from the exploration, production, and refining line of business to the retail marketing line of business, under the optional rule in paragraph (d)(3)(i) of this section Employee W is not treated as providing services to the retail marketing line of business.

EXAMPLE 5. The facts are the same as in EXAMPLE 4. Employee Y is a vice president in Employer B's home office. As part of his senior management responsibilities, Employee Y helps to set the rate of production at Employer B's refineries in the United States and also helps to set the price charged at the pump at the retail filling stations owned and operated by Employer B in this country. Absent application of the optional rule in this paragraph (d), Employee X would be considered to provide services to both of Employer B's lines of business within the meaning of paragraph (c)(5) of this section for purposes of satisfying the separate workforce requirement of paragraph (b)(4) of this section. Because Employee X helps to set the price charged at the pump by Employer B's retail marketing line of business, Employee X's services to the retail marketing line of business are not limited to contributing solely to providing lubricating oil and gasoline products from the exploration, production, and refining line of business to the retail marketing line of business, as required under paragraph (d)(3)(i)(B) of this section. Accordingly, even though Employer B's two lines of business satisfy the requirements of this paragraph (d) with respect to both lubricating oil and gasoline products for the testing year, and even though Employer B applies the optional rule in this paragraph (d), Employee X is still considered to provide services to both of Employer B's lines of business.

SECTION 1.414(r)-4 QUALIFIED SEPARATE LINE OF BUSINESS -- FIFTY- EMPLOYEE AND NOTICE REQUIREMENTS.

(a) IN GENERAL. This section sets forth the rules for determining whether a separate line of business (as determined under section 1.414(r)-3) satisfies the 50-employee and notice requirements of section 1.414(r)-1(b)(2)(iv)(B) and (C), respectively.

(b) FIFTY-EMPLOYEE REQUIREMENT. A separate line of business satisfies the 50-employee requirement of section 1.414(r)- 1(b)(2)(iv)(B) for a testing year only if on each day of the testing year there are at least 50 employees who provide services to the separate line of business for the testing year and do not provide services to any other separate line of business of the employer for the testing year within the meaning of section 1.414(r)-3(c)(5). For this purpose, all employees of the employer are taken into account (including collectively bargained employees), except employees described in section 1.414(q)-1T, Q&A-9(g) (i.e., the same employees, subject to certain modifications, who are excluded in determining the number of employees in the top-paid group under section 414(q)(4)).

(c) NOTICE REQUIREMENT -- (1) GENERAL RULE. A separate line of business satisfies the notice requirement of section 1.414(r)- 1(b)(2)(iv)(C) for a testing year only if the employer notifies the Secretary that it treats itself as operating qualified separate lines of business for the testing year in accordance with section 1.414(r)- 1(b). The employer's notice for the testing year must specify each of the qualified separate lines of business operated by the employer and the section or sections of the Code to be applied on a qualified- separate-line-of-business basis. See section 1.414(r)-1(c). The employer's notice must take the form, must be filed at the time and the place, and must contain any additional information prescribed by the Commissioner in revenue procedures, notices, or other guidance of general applicability. No other notice, whether actual or constructive, satisfies the requirement of this paragraph (c).

(2) EFFECT OF NOTICE. Once an employer has provided the notice prescribed in this paragraph (c) for a testing year, and the time for filing the notice for the testing year has expired without its being modified, withdrawn, or revoked, the employer is deemed to have irrevocably elected to apply the requirements of the section or sections of the Code specified in the notice separately with respect to the employees of each qualified separate line of business specified in the notice for all plan years that begin in the testing year. The Commissioner may, in revenue procedures, notices, or other guidance of general applicability, provide for exceptions to the rule in this paragraph (c)(2) as well as for the effect that will be given to the employer's notice for purposes of any future testing year.

SECTION 1-414(r)-5 QUALIFIED SEPARATE LINE OF BUSINESS -- ADMINISTRATIVE SCRUTINY REQUIREMENT -- SAFE HARBORS.

(a) IN GENERAL. A separate line of business (as determined under section 1.414(r)-3) satisfies the administrative scrutiny requirement of section 1.414(r)-1(b)(2)(iv)(D) for a testing year if the separate line of business satisfies any of the safe harbors in paragraphs (b) through (g) of this section for the testing year. The safe harbor in paragraph (b) of this section implements the statutory safe harbor of section 414(r)(3). The safe harbors in paragraphs (c) through (g) of this section constitute the guidelines provided for under section 414(r)(2)(C). A separate line of business that does not satisfy any of the safe harbors in this section nonetheless satisfies the requirement of administrative scrutiny if the employer requests and receives an individual determination from the Commissioner under section 1.414(r)-6 that the separate line of business satisfies the requirement of administrative scrutiny.

(b) STATUTORY SAFE HARBOR -- (1) GENERAL RULE. A separate line of business satisfies the safe harbor in this paragraph (b) for the testing year only if the highly compensated employee percentage ratio of the separate line of business is --

(i) At least 50 percent; and

(ii) No more than 200 percent.

(2) HIGHLY COMPENSATED EMPLOYEE PERCENTAGE RATIO. For purposes of this paragraph (b), the highly compensated employee percentage ratio of a separate line of business is the faction (expressed as a percentage), the numerator of which is the percentage of the employees of the separate line of business who are highly compensated employees, and the denominator of which is the percentage of all employees of the employer who are highly compensated employees.

(3) EMPLOYEES TAKEN INTO ACCOUNT. For purposes of this paragraph (b), the employees taken into account are the same employees who are taken into account for purposes of applying section 410(b) with respect to the first testing day. For this purpose, employees described in section 410(b)(3) and (b)(4) are excluded. However, section 410(b)(4) is applied with reference to the lowest minimum age requirement applicable under any plan of the employer, and with reference to the lowest service requirement applicable under any plan of the employer, as if all the plans were a single plan under section 1.410(b)-6(b)(2). The employees of the separate line of business are determined by applying section 1.414(r)-7 to the employees taken into account under this paragraph (b)(3). An employee is treated as a highly compensated employee for purposes of this paragraph (b) if the employee is treated as a highly compensated employee for purposes of applying section 410(b) with respect to the first testing day. For the definition of "first testing day," see section 1.414(r)-11(b)(7).

(4) TEN-PERCENT EXCEPTION. A separate line of business is deemed to satisfy paragraph (b)(1)(i) of this section for the testing year if at least 10 percent of all highly compensated employees of the employer provide services to the separate line of business during the testing year and do not provide services to any other separate line of business of the employer during the testing year within the meaning of section 1.414(r)-3(c)(5).

(5) DETERMINATION BASED ON PRECEDING TESTING YEAR. A separate line of business that satisfied this safe harbor for the immediately preceding testing year (without taking into account the special rule in this paragraph (b)(5)) is deemed to satisfy the safe harbor for the current testing year. The preceding sentence applies to a separate line of business only if the employer designated the same line of business in the immediately preceding testing year as in the current testing year and either --

(i) The highly compensated employee percentage ratio of the separate line of business for the current testing year does not deviate by more than 10 percent (not 10 percentage points) from the highly compensated employee percentage ratio of the separate line of business for the immediately preceding testing year; or

(ii) At least 95 percent of the employees of the separate line of business for the current testing year were also employees of the separate line of business for the immediately preceding testing year, and no more than five percent of the employees of the separate line of business for the immediately preceding testing year are not employees of the separate line of business for the current testing year.

(6) EXAMPLES. The following examples illustrate the application of the safe harbor in this paragraph (b).

EXAMPLE 1. (i) Employer A operates three separate lines of business as determined under section 1.414(r)-3, that respectively consist of a railroad, an insurance company, and a newspaper. Employer A employs a total of 400 employees, 100 of whom are highly compensated employees. Thus, the percentage of all employees of Employer A who are highly compensated employees is 25 percent. After applying section 1.414(r)-7, the distribution of highly and nonhighly compensated employees among Employer A's separate lines of business is as follows:

                         Employer-            Insurance

EXAMPLE 2. (i) Employer B operates three separate lines of business as determined under section 1.414(r)-3, that respectively consist of a dairy products manufacturer, a candy manufacturer, and a chain of housewares stores. Employer B employs a total of 1,000 employees, 100 of whom are highly compensated employees. Thus, the percentage of all employees of Employer B who are highly compensated employees is 10 percent. After applying section 1.414(r)-7, the distribution of highly and nonhighly compensated employees among Employer B's separate lines of business is as follows:

                        Employer-    Dairy              Housewares

EXAMPLE 3. (i) The facts are the same as in Example 2, except that Employer B operates only two separate lines of business as determined under section 1.414(r)-3, one consisting of the dairy products manufacturer and the candy manufacturer, and the other consisting of the chain of housewares stores. After applying section 1.414(r)-7, the distribution of highly and nonhighly compensated employees among Employer B's separate lines of business is as follows:

                                         Candy/Dairy   Housewares

(c) SAFE HARBOR FOR SEPARATE LINES OF BUSINESS IN DIFFERENT INDUSTRIES -- (1) IN GENERAL. A separate line of business satisfies the safe harbor in this paragraph (c) for the testing year if it is in a different industry or industries from every other separate line of business of the employer. For this purpose, a separate line of business is in a different industry or industries from every other separate line of business of the employer only if --

(i) The property or services provided to customers of the employer by the separate line of business (as designated by the employer for the testing year under section 1.414(r)-2) fall exclusively within one or more industry categories established by the Commissioner for purposes of this paragraph (c); and

(ii) None of the property or services provided to customers of the employer by any of the employer's other separate lines of business (as designated by the employer for the testing year under section 1-414(r)-2) falls within the same industry category or categories.

(2) OPTIONAL RULE FOR FOREIGN OPERATIONS. For purposes of satisfying this paragraph (c), an employer is permitted to disregard any property or services provided to customers of the employer during the testing year by a foreign corporation or foreign partnership (as defined in section 7701(a)(5)), to the extent that income from the provision of the property or services is not effectively connected with the conduct of the trade or business within the United States within the meaning of section 864(c). Thus, for example, an employer is permitted to take into account only property and services provided to customers of the employer by its domestic subsidiaries and property and services provided by its foreign subsidiaries that generate income effectively connected with the conduct of a trade or business within the United States in determining whether the property or services provided to customers of the employer by a separate line of business fall exclusively within one or more industry categories and also whether the property or services provided by any other separate line of business fall with the same industry category or categories.

(3) ESTABLISHMENT OF INDUSTRY CATEGORIES. The Commissioner shall, by revenue procedure or other guidance of general applicability, establish industry categories for purposes of this paragraph (c).

(4) EXAMPLES. The following examples illustrate the application of the safe harbor in this paragraph (c). For purposes of these examples, it is assumed that, pursuant to paragraph (c)(3) of this section, the Commissioner has established the following industry categories (among others): transportation equipment and services; banking, insurance, and finance; machinery and electronics; and entertainment, sports, and hotels.

EXAMPLE 1. Among its other business activities, Employer C operates a commercial airline that constitutes a separate line of business under section 1.414(r)-3. In addition, no other separate line of business of Employer C provides to customers of Employer C any property or services in the transportation equipment and services industry category. Under these facts, the separate line of business described in this example satisfies the safe harbor in this paragraph (c).

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that Employer C also operates a trucking company that constitutes another separate line of business of Employer C under section 1.414(r)-3. Because the commercial airline and the trucking company both provide to customers of Employer C services in the transportation equipment and services industry category, neither separate line of business satisfies the safe harbor in this paragraph (c).

EXAMPLE 3. Among its other business activities, Employer D operates a commercial bank and a luxury hotel that together constitute a single separate line of business under section 1.414(r)-3. No other separate line of business of Employer D provides to customers of Employer D property or services in either the banking, insurance, or financial industry category, or the entertainment, sports, or hotel industry category. Under these facts, the separate line of business described in this example satisfies the safe harbor in this paragraph (c).

EXAMPLE 4. The facts are the same as in EXAMPLE 3, except that Employer D also manufactures computers in the United States and abroad. Employer D apportions its computer operations by designating these operations between two separate lines of business, one consisting of its domestic operations located in the United States and the second consisting of its foreign operations by a foreign subsidiary. Because both lines of business provided property and services in the machinery and electronics industry category to customers of Employer D, neither separate line of business would satisfy the safe harbor in this paragraph (c). However, pursuant to the optional rule in paragraph (c)(2) of this section, Employer D disregards the property and services provided by its foreign computer subsidiary. As a result, no other separate line of business of Employer D provides to customers of Employer D any property or services in the machinery and electronics industry category. Under these facts, Employer D's domestic computer operations separate line of business satisfies the safe harbor in this paragraph (c).

(d) SAFE HARBOR FOR SEPARATE LINES OF BUSINESS THAT ARE ACQUIRED THROUGH CERTAIN MERGERS AND ACQUISITIONS -- (1) GENERAL RULE. A portion of the employer that is acquired through a transaction described in section 410(b)(6)(C) and section 1.410(b)-2(f) (i.e., an asset or stock acquisition, merger, or other similar transaction involving a change in the employer of the employees of a trade or business) (the "acquired line of business") satisfies the safe harbor in this paragraph (d) for each testing year in the transition period provided in paragraph (d)(3) of this section if each of the following requirements is satisfied --

(i) For each testing year within the transition period the employer designates the acquired line of business as a line of business within the meaning of section 1.414(r)-2;

(ii) On the first testing day in each testing year in the transition period:

(A) The acquired line business constitutes a separate line of business within the meaning of section 1.414(r)-3 (taking into account section 1.414(r)-1(d)(4));

(B) At least 90 percent of the employees who are substantial- service employees with respect to the acquired line of business were also substantial-service employees with respect to the acquired line of business for the immediately preceding testing year; and

(C) No more than 10 percent of the employees who were substantial-service employees with respect to the acquired line of business for the immediately preceding testing year are not substantial-service employees with respect to the acquired line of business in the respective testing year.

See section 1.414(r)-11(b)(2) for the definition of "substantial- service employee." If the transaction described in paragraph (d)(1)(i) of this section occurs after the first testing day in a testing year, the determinations required by paragraphs (d)(1)(iii)(B) and (C) of this section with respect to that testing year must be made on the date of the transaction.

(2) EMPLOYEES TAKEN INTO ACCOUNT. For purposes of this paragraph (d), the employees taken into account are the same employees who are taken into account for purposes of applying section 410(b) with respect to the first testing day. For this purpose, employees described in section 410(b)(3) and (b)(4) are excluded. However, section 410(b)(4) is applied with reference to the lowest minimum age requirement, and with reference to the lowest service requirement applicable under any plan of the employer that benefits employees of the separate line of business, as if all the plans were a single plan under section 1.410(b)-6(b)(2). The employees of the separate line of business are determined by applying section 1.414(r)-7 to the employees taken into account under this paragraph (d)(2).

(3) TRANSITION PERIOD. The transition period for purposes of this safe harbor is the period that begins with the first testing year beginning after the date that the transaction described in paragraph (d)(1) of this section occurs. The employer is permitted, but not required, to extend the transition period to include one, two, or three of the testing years immediately succeeding that first testing year.

(4) EXAMPLES. The following examples illustrate the application of the safe harbor in this paragraph (d).

EXAMPLE 1. Employer E is treated as operating three qualified separate lines of business pursuant to section 1.414(r)-1(b). In 1996, Employer E acquires a company that employs 4,000 employees who manufacture and sell pharmaceutical supplies, and designates that portion as a line of business under section 1.414(r)-2. Under section 1.414(r)-1(d)(4), the pharmaceutical supplies line of business is deemed to satisfy the requirements to be a qualified separate line of business (other than the 50-employee and notice requirements) for testing year 1996. In addition, the determination of whether Employer E's remaining three lines of business constitute qualified separate lines of business for testing year 1996 is made without taking into account the acquired employees and by disregarding the property and services provided to customers of Employer E by the pharmaceutical supplies line of business.

EXAMPLE 2. The facts are the same as in Example 1, except that by the first testing day in 1997 ("Transition Year 1"), Employer E employs an additional 300 employees who provide services solely for the pharmaceutical supplies line of business and no terminations of employment have occurred, increasing the line's number of employees who are substantial-service employees with respect to the pharmaceutical supplies line of business from 4,000 to 4,300. Assume that, on that first testing day in Transition Year 1, the pharmaceutical supplies line of business satisfies the requirements of 1.414(r)-3, and therefore constitutes a separate line of business. Because 4,000 is 93 percent of 4,300, at least 90 percent of the employees who are substantial-service employees with respect to the pharmaceutical supplies line of business for Transition Year 1 were also substantial-service employees with respect to the pharmaceutical supplies line of business for testing year 1996 (the immediately preceding testing year). Under these facts, the pharmaceutical supplies separate line of business satisfies the safe harbor in this paragraph (d) for Transition Year 1.

EXAMPLE 3. The facts are the same as in Example 2, except that, before the first day of the next testing year ("Transition Year 2"), Employer E permanently transfers 200 of the 4,300 employees who were substantial-service employees with respect to the pharmaceutical line of business on the first testing day in Transition Year 1 to a different line of business and does not hire any additional employees for the pharmaceutical supplies line of business. Therefore, by the first testing day in Transition Year 2, the number of employees who are substantial- service employees with respect to the pharmaceutical line of business of Employer E has decreased from 4,300 to 4,100. Assume that, on that first testing day in Transition Year 2, the pharmaceutical supplies line of business constitutes a separate line of business more than 10 percent of the employees who were substantial-service employees of the pharmaceutical line of business for Transition Year 1 are not substantial-service employees of the pharmaceutical line of business in Transition Year 2. Under these facts, the pharmaceutical supplies separate line of business continues to satisfy the safe harbor in this paragraph (d) for Transition Year 2.

(e) SAFE HARBOR FOR SEPARATE LINES OF BUSINESS REPORTED AS INDUSTRY SEGMENTS -- (1) IN GENERAL. A separate line of business satisfies the safe harbor in this paragraph (e) for the testing year if, for the employer's fiscal year ending latest in the testing year, the separate line of business is reported as one or more industry segments on its annual report required to be filed in conformity with either --

(i) Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 ("Form 10-K"); or

(ii) Form 20-F, Annual Report Pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with Item 18 financials ("Form 20-F"), and the employer timely files either the Form 10-K or Form 20-F with the Securities and Exchange Commission ("SEC").

(2) REPORTED AS AN INDUSTRY SEGMENT IN CONFORMITY WITH FORM 10-K OR FORM 20-F. For purposes of this paragraph (e), a separate line of business is reported as one or more industry segments in conformity with either Form 10-K or Form 20-F only if --

(i) The separate line of business consists of one or more industry segments within the meaning of paragraphs 10(a), 11(b), and 12 through 14 of the Statement of Financial Accounting Standards No. 14, Financial Reporting for Segments of a Business Enterprise ("FAS 14"); and

(ii) The property or services provided to customers of the employer by the separate line of business (as designated by the employer for the testing year under section 1.414(r)-2) is identical to the property or services provided to customers of the employer by the industry segment or segments (as determined under paragraphs 10(a), 11(b), and 12 through 14 of FAS 14).

(3) TIMELY FILING OF FORM 10-K OR FORM 20-F. For purposes of this paragraph (e), a Form 10-K or Form 20-F is timely filed with the SEC if it is filed within the required period as provided under 17 C.F.R. section 240.12b-25(b)(2)(ii). Therefore, the required period for timely filing of the Form 10-K is the 90-day period after the end of the fiscal year covered by the annual report (including the 15-day extension), and the required period for timely filing of the Form 20-F is the six month period after the end of the fiscal year covered by the annual report (including the 15-day extension).

(4) EXAMPLES. The following examples illustrate the application of the safe harbor in this paragraph (e).

EXAMPLE 1. Among its other business activities, Employer F operates a bearing manufacturing firm that constitutes a separate line of business under section 1.414(r)-3. Employer F is required to file an annual Form 10-K with the SEC. On its timely filed Form 10-K, Employer F reports its bearing manufacturing operations as an industry segment in accordance of FAS 14 (as determined under paragraphs 10(a), 11(b), and 12 through 14 of FAS 14). The group of bearing products provided by the separate line of business (as designated by Employer F under section 1.414(r)-2) is identical to the group of bearing products provided by the industry segment (as determined under paragraphs 10(a), 11(b), and 12 through 14 of FAS 14). Under these facts, the separate line of business described in this example satisfies the safe harbor in this paragraph (e).

EXAMPLE 2. The facts are the same as in Example 1, except that Employer F has apportioned its bearing manufacturing operations between two separate lines of business as determined under section 1.414(r)-3, one engaged in the manufacture of bearings for use in the automotive industry, and a second engaged in the manufacture of bearings for use in the aerospace industry. Because neither separate line of business provides a group of property or services to customers of Employer F that is identical to the group of bearing products provided by the industry segment reported on Employer F's annual Form 10-K, neither separate line of business described in this example satisfies the safe harbor in this paragraph (e).

(f) SAFE HARBOR FOR SEPARATE LINES OF BUSINESS THAT PROVIDE THE SAME AVERAGE BENEFITS AS OTHER SEPARATE LINES OF BUSINESS -- (1) GENERAL RULE. A separate line of business satisfies the safe harbor in this paragraph (f) for the testing year only if the level of benefits provided to employees of the separate line of business satisfies paragraph (f)(2) or (f)(3) of this section, whichever is applicable.

(2) SEPARATE LINES OF BUSINESS WITH A DISPROPORTIONATE NUMBER OF NONHIGHLY COMPENSATED EMPLOYEES -- (i) APPLICABILITY OF SAFE HARBOR. This paragraph (f)(2) applies to a separate line of business that for the testing year has a highly compensated employee percentage ratio of less than 50 percent (as determined under paragraph (b)(2) of this section).

(ii) REQUIREMENT. A separate line of business satisfies this paragraph (2) only if the actual benefit percentage of the group of nonhighly compensated employees of the separate line of business for the testing period that ends with or within the testing year is at least as great as the actual benefit percentage of the group of all other nonhighly compensated employees of the employer for the same testing period. See section 1.410(b)-5(c) and (d)(3)(ii) for the definitions of actual benefit percentage and testing period, respectively. In determining actual benefit percentages for purposes of this paragraph (f)(2)(ii), the special rule in section 1.410(b)- 5(e)(3) (permitting an employer to determine employee benefit percentages separately for defined contribution and defined benefit plans) may not be used.

(3) SEPARATE LINES OF BUSINESS WITH A DISPROPORTIONATE NUMBER OF HIGHLY COMPENSATED EMPLOYEES -- (i) APPLICABILITY OF SAFE HARBOR. This paragraph (f)(3) applies to a separate line of business that for the testing year has a highly compensated employee percentage ratio of more than 200 percent (as determined under paragraph (b)(2) of this section).

(ii) REQUIREMENT. A separate line of business satisfies this paragraph (f)(3) only if the actual benefit percentage of the group of highly compensated employees of the separate line of business for the testing period that ends with or within the testing year is no greater than the actual benefit percentage of the group of all other highly compensated employees of the employer for the same testing period. See section 1.410(b)-5(c) and (d)(3)(ii) for the definitions of actual benefit percentage and testing period, respectively. In determining actual benefit percentages for purposes of this paragraph (f)(3)(ii), the special rule in section 1.410(b)-5(e)(3) (permitting an employer to determine employee benefit percentages separately for defined contribution and defined benefit plans) may not be used.

(4) EMPLOYEES TAKEN INTO ACCOUNT. An employee of a separate line of business (as determined under section 1.414(r)-7) is taken into account for a testing period for purposes of this paragraph (f) only if the employee is an employee of the separate line of business on the first testing day, and would not be an excludable employee for purposes of applying the average benefit percentage test of section 1.410(b)-5 to a plan for a plan year included in that testing period. In determining whether an employee is an excludable employee for purposes of the average benefit percentage test, the employer is assumed not to be operating qualified separate lines of business under section 1.414(r)-1(b). An employee is treated as a highly compensated employee for purposes of this paragraph (f) if the employee is treated as a highly compensated employee for purposes of applying section 410(b) on the first testing day. See section 1.414(r)-11(b)(7) for the definition of "first testing day".

(5) EXAMPLE. The rules of this paragraph (f) are illustrated by the following example.

EXAMPLE. (i) Employer G is treated as operating two separate lines of business, Line 1 and Line 2, in accordance with section 1.414(r)-1(b). Employer G maintains three qualified plans. Plan A is a calendar-year profit-sharing plan that benefits all employees of Employer G. Plan B is a defined benefit plan with a plan year ending March 31 that benefits all employees of Line 1. Plan C is a defined benefit plan with a plan year ending November 30 that benefits all employees of Line 2.

(ii) In 1995, Line 1 has a highly compensated employee percentage ratio of 25 percent. Employer G's first testing day is March 31. After applying the rules of section 1.414(r)-7, the nonhighly compensated employees of Line 1 and Line 2 on March 31, 1995, are N1-N80 and N81-N100, respectively. N1 is an excludable employee under section 1.410(b)-6 for purposes of the average benefit percentage test during the testing period that includes the plan years of Plans A, B, and C that end in 1995 (the "1995 testing period"), and would therefore not be taken into account in determining whether any of those plans satisfied the average benefit percentage test of section 1.410(b)-5 for plan years included in that testing period, because N1 does not satisfy the minimum age and service conditions under any plan of the employer. All other employees of Line 1 and Line 2 on March 31, 1995, are nonexcludable employees for purposes of the average benefit percentage test during the 1995 testing period.

(iii) In order for Line 1 to satisfy the requirements of this paragraph (f) for 1995, the actual benefit percentage of N2-N80 for the 1995 testing period under Plans A, B and C must be at least as great as the actual benefit percentage of N81-N100 for the same testing period under the same plans. N1 is not taken into account because N1 is an excludable employees for purposes of the average benefit percentage test for the 1995 testing period. Any other employees who were taken into account for purposes of the average benefit percentage test for the 1995 testing period are excluded because they are not employees of Line 1 or Line 2 on March 31, 1995.

(g) SAFE HARBOR FOR SEPARATE LINES OF BUSINESS THAT PROVIDE MINIMUM OR MAXIMUM BENEFITS -- (1) IN GENERAL. A separate line of business satisfies the safe harbor in this paragraph (g) for the testing year only if the level of benefits provided to employees of the separate line of business satisfies paragraph (g)(2) or (g)(3) of this section, whichever is applicable. For this purpose, the level of benefits is determined with respect to all qualified plans of the employer that benefit employees of the separate line of business for plan years that begin in the testing year.

(2) MINIMUM BENEFIT REQUIRED -- (i) APPLICABILITY. This paragraph (g)(2) applies to a separate line of business that for the testing year has a highly compensated employee percentage ratio of less than 50 percent (as determined under paragraph (b)(2) of this section).

(ii) REQUIREMENT. A separate line of business satisfies this paragraph (g)(2) only if one of the following requirements is satisfied --

(A) At least 80 percent of all nonhighly compensated employees of the separate line of business either accrue a benefit for the plan year that equals or exceeds the defined benefit minimum in paragraph (g)(2)(iii) of this section, receive an allocation for the plan year that equals or exceeds the defined contribution minimum in paragraph (g)(2)(iv) of this section, or accrue a benefit and receive an allocation that together equal or exceed the combined plan minimum in paragraph (g)(4) of this section. The defined benefit minimum must be provided in a defined benefit plan, and the defined contribution minimum must be provided in a defined contribution plan.

(B) The separate line of business would satisfy the requirements of paragraph (g)(2)(ii)(A) of this section if the 80 percent threshold were reduced to 60 percent, and the average of the accrual rates or allocation rates of all nonhighly compensated employees in the separate line of business equals or exceeds the minimum amount described for each individual employee in paragraph (g)(2)(ii)(A) of this section.

(iii) DEFINED BENEFIT MINIMUM -- (A) IN GENERAL. The defined benefit minimum for a plan year is the employer-derived accrual that would result in a normal accrual rate for the plan year equal to 0.75 percent of compensation. For purposes of this paragraph (g)(2)(iii), the normal accrual rate is the percentage (not less than 0) determining by subtracting the employee's normalized accrued benefit as of the end of the plan year (expressed as a percentage of average annual compensation as of the end of the plan year) from the employee's normalized accrued benefit as of the end of the prior plan year (expressed as a percentage of average annual compensation as of the end of the prior plan year).

(B) NORMAL FORM AND EQUIVALENT BENEFITS. The benefit that is tested for purposes of this paragraph (g)(2)(iii) is the accrued retirement benefit commencing at normal retirement age. If the normal form of benefit for a plan being tested is other than a straight life annuity beginning at a normal retirement age of 65, the benefit must be normalized (within the meaning of section 1.401(a)(4)-12) to a straight life annuity commencing at age 65. No adjustment is permitted for early retirement benefits or for any ancillary benefit, including disability benefits.

(C) COMPENSATION DEFINITION. The underlying definition of compensation used for purposes of determining accrual rates under this paragraph (g)(2)(iii) must be a definition of compensation that automatically satisfies section 414(s) without a test for nondiscrimination (see section 1.414(s)-1(c)).

(D) AVERAGE COMPENSATION REQUIREMENT. For purposes of determining accrual rates, compensation must be average annual compensation within the meaning of section 1.401(a)(4)-3(e)(2) determined using a five year averaging period. The compensation history to be taken into account are all years beginning with the first year in which the employee benefits under the plan, and ending with the last plan year in which the employee participates in the plan. However, a plan may disregard in a reasonable and consistent manner: years before 1992, years more than 10 years preceding the current plan year, years in which an employee has less than 1,000 hours of service (see section 1.401(a)(4)-3(b)(8)(x)(A)(2) and years for which the employer does not use this paragraph (g)(2) to satisfy this safe harbor with respect to the separate line of business. If a plan provides a defined benefit minimum that uses three consecutive years (in lieu of five) for calculating average annual compensation, the 0.75 percent annual accrual rate in paragraph (g)(2)(iii)(A) of this section is multiplied by 93.3 percent, resulting in a normal accrual rate equal to 0.70 percent.

(E) SPECIAL RULES. The special rules of section 1.401(a)(4)-3(f) apply for purposes of determining whether a benefit accrual satisfies the minimum benefit requirement. For example, benefits may be determined on other than a plan year basis as permitted by section 1.401(a)(4)-3(f)(6). A plan described in section 412(i) may be used to provide the defined benefit minimum described in this paragraph (g)(2). In such case, the rules in section 1.416-1, M-17, apply to such a plan. For purposes of this paragraph (g)(2)(iii) an employee is treated as accruing a benefit equal to the minimum benefit in paragraph (g)(2)(iii)(A) of this section if the reason that the employee does not accrue such a benefit is either --

(1) The application of a plan provision that applies uniformly to all employees in the plan and limits the service used for purposes of benefit accrual to a specified maximum no less than 25 years, or

(2) The employee has attained normal retirement age and fails to accrue a benefit solely because of the provisions of section 41 1(b)(1)(II)(iii) regarding adjustments for delayed retirement.

(iv) DEFINED CONTRIBUTION MINIMUM -- (A) IN GENERAL. The defined contribution minimum for a plan year is an allocation that results in an allocation rate for the plan year (within the meaning of section 1.401(a)(4)-2(c)) equal to three percent of an employee's plan year compensation. Plan year compensation must be based on a definition of compensation that automatically satisfies section 414(s) without a test for nondiscrimination (see section 1.414(s)-1(c)). For this purpose, allocations that are taken into account do not include matching contributions described in section 1.401(m)-1(f)(12), elective contributions described in section 1.401(k)-1(g)(3), any adjustment in allocation rates permitted under section 401(l) or imputed disparity under section 1.401(a)(4)-7.

(B) MODIFIED ALLOCATION DEFINITION FOR AVERAGING. For purposes of determining whether the average allocation rates for all nonhighly compensated employees of the separate line of business satisfy the minimum benefit requirement in paragraph (g)(2)(ii)(B) of this section, matching contributions described in section 1.401(m)- 1(f)(12) are treated as employer allocations.

(3) MAXIMUM BENEFIT PERMITTED -- (i) APPLICABILITY. This paragraph (g)(3) applies to a separate line of business that for the testing year has a highly compensated employee percentage ratio that exceeds 200 percent (as determined under paragraph (b)(2) of this section).

(ii) REQUIREMENT. A separate line of business satisfies this paragraph (g)(3) only if one of the following requirements is satisfied --

(A) No highly compensated employee of the separate line of business accrues a benefit for the plan year that results in an accrual rate that exceeds the defined benefit maximum in paragraph (g)(3)(iii) of this section, receives an allocation that exceeds the defined contribution maximum in paragraph (g)(3)(iv) of this section, or accrues a benefit and receives an allocation that together exceed the combined plan maximum in paragraph (g)(4) of this section. All benefits provided by qualified defined benefit plans are subject to the defined benefit maximum, and all benefits provided by qualified defined contribution plans are subject to the defined contribution maximum.

(B) The average of the accrual rates or allocation rates of all highly compensated employees of the separate line of business is no more than 80 percent of the maximum amount for any individual employee described in paragraph (g)(3)(ii)(A) of this section.

(iii) DEFINED BENEFIT MAXIMUM -- (A) IN GENERAL. The defined benefit maximum is the employer-derived accrued benefit that would result from calculating a normal accrual rate equal to 2.5 percent of compensation.

(B) DETERMINATION OF DEFINED BENEFIT MAXIMUM. The accrual rate used for the defined benefit maximum is determined in the same manner as the normal accrual rate used for the defined benefit minimum is determined under paragraph (g)(2)(iii) of this section, except as provided below. Thus, a defined benefit plan may provide, in addition to the defined benefit maximum, any benefit the value of which is not taken into account under paragraph (g)(2)(iii) of this section. For example, a plan may provide disability benefits described in section 1.401(a)(4)-3(d)(6)(vi) or ancillary benefits described in section 1.401(a)(4)-4(e)(2).

(C) ADJUSTMENT FOR DIFFERENT COMPENSATION DEFINITIONS. If a plan subject to the defined benefit maximum determines accrual rates by using three consecutive years (in lieu of five) for purposes of determining average annual compensation, the 2.5 percent annual accrual rate in paragraph (g)(3)(iii)(B) of this section is multiplied by 93.3 percent, resulting in a maximum accrual rate equal to 2.33 percent. Compensation may be less inclusive than the compensation described in paragraph (g)(2)(iii)(C) of this section. However, no adjustment is made to the maximum normal accrual rate because of the use of a definition of compensation that is less inclusive than the compensation described in paragraph (g)(2)(iii)(C) of this section.

(D) ADJUSTMENT FOR CERTAIN SUBSIDIES. If the plan provides subsidized optional forms of benefit, the accrual rate for purposes of this paragraph (g)(3) must be determined by taking those subsidies into account. An optional form of benefit is considered subsidized if the normalized optional form of benefit is larger than the normalized normal retirement benefit under the plan. In the case of a plan with subsidized optional forms, the determination of accrual rate for the plan year under paragraph (g)(2)(iii)(A) of this section is modified by substituting the largest of the sums of the normalized QJSAs and QSUPPs determined for each age in section 1.401(a)(4)-3(d)(2)(ii)(C) for the normalized accrued benefit as of the end of the current plan year, and the largest of the sums of the norms QJSAs and QSUPPs determined for each age in section 1.401(a)(4)-3(d)(2)(ii)(D) for the normalized accrued benefit as of the end of the prior plan year.

(iv) DEFINED CONTRIBUTION MAXIMUM. The defined contribution maximum is an allocation that results in an allocation rate for the plan year (within the meaning of section 1.401(a)(4)-2(c)) equal to 10 percent of an employee's plan year compensation. Compensation may be less inclusive than the compensation described in paragraph (g)(2)(iv)(A) of this section. However, no adjustment is made to the defined contribution maximum because of the use of a definition of compensation that is less inclusive than the compensation described in paragraph (g)(2)(iv)(A) of this section. For this purpose, allocations that are taken into account do not include elective contributions described in section 1.401(k)-1(g)(3), any adjustment in allocation rates permitted under section 401(f) or imputed disparity under section 1.401(a)(4)-7 but do include employer matching contributions under section 1.401(m)-1((f)(12).

(4) DUPLICATION OF BENEFITS OR CONTRIBUTIONS -- (i) PLANS OF THE SAME TYPE. In the case of an employee who benefits under more than one defined benefit plan, the defined benefit minimum required or the defined benefit maximum permitted under this paragraph (g) is determined by reference to the employee's aggregate employer-provided benefit under all qualified defined benefit plans of the employer. In the case of an employee who benefits under more than one defined contribution plan, the defined contribution minimum required or the defined contribution maximum permitted under this paragraph (g) is determined by reference to the employee's aggregate employer-provided allocations under all qualified defined contribution plans of the employer.

(ii) PLANS OF DIFFERENT TYPES. In the case of an employee who benefits under both a defined benefit plan and a defined contribution plan, a percentage of the minimum benefit required or the maximum benefit permitted under this paragraph (g) may be provided in each type of plan as long as the combined percentage equals at least 100 percent in the case of the minimum benefit required and does not exceed 100 percent in the case of the maximum benefit permitted. Thus, for example, if a highly compensated employee benefits under both types of plans and accrues an aggregate adjusted normal accrual rate equal to 1.25 percent of average annual compensation under all defined benefit plans of the employer (i.e., 50 percent of the defined benefit maximum described in paragraph (g)(3)(iii) of this section), in order to comply with the maximum benefit safe harbor, the employee may not receive an aggregate allocation under all defined contribution plans of the employer in excess of five percent of plan year compensation (i.e., 50 percent of the defined contribution maximum described in paragraph (g)(3)(iv) of this section).

(iii) SPECIAL RULE FOR FLOOR-OFFSET ARRANGEMENTS. In the case of a floor-offset arrangement (as described in section 1.401(a)(4)- 8(d)), the minimum or maximum benefit rules are applied to each plan as if the other plan did not exist. Thus, the defined benefit plan must provide at least 100 percent of the defined benefit minimum (or no more than 100 percent of the defined benefit maximum) based on the gross benefit prior to offset, and the defined contribution plan must provide at least 100 percent of the defined contribution minimum (or no more than 100 percent of the defined contribution maximum).

(5) CERTAIN CONTINGENCY PROVISIONS IGNORED. For purposes of this paragraph (g), an employee's accrual or allocation rate under a plan is determined without regard to any plan provision the effect of which is to make the operation of the minimum or maximum benefit formula contingent on the failure of the separate line of business otherwise to satisfy the requirement of administrative scrutiny.

(6) EMPLOYEES TAKEN INTO ACCOUNT. For purposes of this paragraph (g), an employee is taken into account if the employee is taken into account for purposes of applying section 410(b) with respect to any testing day for the testing year. For this purpose, employees described in section 410(b)(3) and (b)(4) are excluded. However, section 410(b)(4) is applied with reference to the lowest minimum age requirement applicable, and with reference to the lowest service requirement applicable under any plan of the employer that benefits employees of the separate line of business, as if all the plans were a single plan under section 1.410(b)-6(b)(2). The employees of the separate line of business are determined by applying section 1.414(r)-7 to the employees taken into account under this paragraph (g)(6). An employee is treated as a highly compensated employee for purposes of this paragraph (g) if the employee is treated as a highly compensated employee for purposes of applying section 410(b) on any testing day for the testing year. For the definition of "testing day," see section 1.414(r)-11(b)(6).

SECTION 1.414(r)-6 QUALIFIED SEPARATE LINE OF BUSINESS -- ADMINISTRATIVE SCRUTINY REQUIREMENT -- INDIVIDUAL DETERMINATIONS.

(a) IN GENERAL. A separate line of business (as determined under section 1.414(r)-3) that does not satisfy any of the safe harbors in section 1.414(r)-5 for a testing year nonetheless satisfies the administrative scrutiny requirement of section 1.414(r)- 1(b)(2)(iv)(D) if the employer requests and receives from the Commissioner an individual determination under this section that the separate line of business satisfies the requirement of administrative scrutiny for the testing year. This section implements the individual determinations provided for under section 414(r)(2)(C). Paragraph (b) of this section prescribes the conditions under which an employer is permitted to request an individual determination under this section. Paragraph (c) of this section describes the factors the Commissioner will take into account in determining whether to grant an individual determination under this section.

(b) CONDITIONS UNDER WHICH AN EMPLOYER IS PERMITTED TO REQUEST AN INDIVIDUAL DETERMINATION. An employer is permitted to request an individual determination under this section with respect to a separate line of business for a testing year only if --

(1) The employer follows the procedures prescribed by the Commissioner in revenue procedures, notices, or other guidance of general applicability for requesting an individual determination under this section; and

(2) The separate line of business satisfies at least one of the following requirements:

(i) The highly compensated employee percentage of the separate line of business for the testing year, as determined under section 1.414(r)-5(b), is at least 40 percent and not more than 250 percent;

(ii) Ninety percent of the gross revenues of the separate line of business result from the provision of property or services that fall exclusively within one or more industry categories established by the Commissioner, as determined under section 1.414(r)-5(c), and no more than ten percent of the gross revenues of any of the employer's other separate lines of business result from property or services provided to customers of the employer that fall within the same industry category or categories;

(iii) The employer is not required to file Form 10-K or 20-F, but there is a certification from an independent certified public accountant that the employer would have been required to report the separate line of business as one or more reportable industry segments on either the Form 10-K or the Form 20-F if the employer had been required to file the applicable SEC report for the employer's fiscal year ending in the testing year, and the separate line of business therefore would have satisfied the administrative safe harbor in section 1.414(r)-5(e);

(iv) The separate line of business has a highly compensated employee percentage, as determined under section 1.414(r)-5(b), of less than 40 percent, and either --

(A) The separate line of business would satisfy the average benefits safe harbor of section 1.414(r)-5(f)(2)(ii) if the actual benefit percentage of the nonhighly compensated employees of the other separate lines of business were reduced by one-third; or

(B) The separate line of business would satisfy the minimum benefit safe harbor of section 1.414(r)-5(g) if the minimum benefit were reduced by one-third;

(v) The separate line of business has a highly compensated employee percentage, as determined under section 1.414(r)-5(b), of more than 250 percent, and either --

(A) The separate line of business would satisfy the average benefits safe harbor of section 1.414(r)-5(f)(3)(ii) if the actual benefit percentage of the highly compensated employees of the other separate lines of business were increased by one-third; or

(B) The separate line of business would satisfy the maximum benefit safe harbor of section 1.414(r)-5(g) if the maximum benefit were increased by one-third; or

(vi) The separate line of business manages a government facility pursuant to a government contract that specifies the benefits to be provided under a qualified plan.

(c) FACTORS TAKEN INTO ACCOUNT IN DETERMINING WHETHER TO GRANT AN INDIVIDUAL DETERMINATION -- (1) IN GENERAL. Paragraphs (c)(2) through (c)(12) of this section list the factors the Commissioner will take into account in determining whether to grant an individual determination under this section. No one factor is necessarily determinative.

(2) DIFFERENCES IN PROPERTY OR SERVICES. The degree to which the property or services provided by the separate line of business differ from the property or services provided by the employer's other lines of business.

(3) SEPARATENESS OF ORGANIZATION AND OPERATION. The degree to which the separate line of business is organized and operated separately from the remainder of the employer, including the degree of vertical integration of the separate line of business with any other line of business of the employer and the degree to which the separate line of business has its own tangible assets.

(4) NATURE OF BUSINESS COMPETITION. The nature of the business competition faced by the separate line of business, the degree to which competitors of the separate line of business are organized as independent stand-alone companies that do not engage in other lines of business, and the type and level of benefits provided by competitors of the separate line of business to their employees.

(5) HISTORICAL FACTORS. Whether the separate line of business was acquired from another employer, whether it developed separately within the employer, and whether it was operated separately before the enactment of the Tax Reform Act of 1986.

(6) GEOGRAPHIC FACTORS. The degree to which the separate line of business is operated in a distinct geographic area from the employer's other lines of business, and the impact geographic factors have on the employer's compensation and benefit policies.

(7) SAFE HARBORS. The degree to which the separate line of business fails to satisfy the safe harbors of section 1.414(r)-5, in particular, the average benefits and minimum or maximum benefits safe harbors of section 1.414(r)-5(f) and (g).

(8) SIZE. The size of the separate line of business relative to the remainder of the employer.

(9) ALLOCATION METHOD. Which allocation method for residual shared employees the employer applies under section 1.414(r)-7(c), and the impact the allocation method will have on the composition of the groups of employees who are treated as employees of each of the employer's lines of business.

(10) OTHER LINES OF BUSINESS. The degree to which the employer's other lines of business satisfy the requirements of a qualified separate line of business for the testing year under section 1.414(r)-1(b)(2).

(11) REGULATED INDUSTRIES. Whether the separate line of business furnishes or sells electrical energy, water or sewage disposal services; gas or steam through a local distribution system; telephone services or other communication services; or transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof.

(12) OTHER RELEVANT FACTORS. Any other factor or special circumstance the Commissioner deems relevant in determining whether to grant an individual determination under this section with respect to the separate line of business.

SECTION 1.414(r)-7 DETERMINATION OF THE EMPLOYEES OF AN EMPLOYER'S QUALIFIED SEPARATE LINES OF BUSINESS.

(a) INTRODUCTION -- (1) IN GENERAL. This section provides the rules for determining the employees of each qualified separate line of business operated by an employer. Paragraph (a)(2) of this section lists the specific provisions of the regulations for which these rules apply. Paragraph (b) of this section provides the procedure for assigning the employees of the employer among the qualified separate lines of business of the employer and for determining the day or days on which such assignments must be made. Under this procedure, each employee (i.e., a substantial-service employee or a residual shared employee as defined in section 1.414(r)-11(b)(2) and (4)) is assigned to a single qualified separate line of business in a consistent manner for all purposes listed in paragraph (a)(2) of this section with respect to the testing year and plan years beginning within the testing year. Paragraph (c) of this section provides the assignment and allocation methods for assigning residual shared employees among qualified separate lines of business, and paragraph (d) of this section provides an optional rule for assigning employees who are transferred on a temporary basis from a qualified separate line of business to another qualified separate line of business.

(2) PURPOSES FOR WHICH THE SECTION APPLIES. This section applies solely for purposes of determining whether --

(i) A separate line of business satisfies the statutory safe harbor of section 1.414(r)-5(b) for a testing year (see section 1.414(r)-5(b)(3) for the employees taken into account for this purpose);

(ii) A separate line of business satisfies the merger and acquisition safe harbor of section 1.414(r)-5(d) for a testing year (see section 1.414(r)-5(d)(2) for the employees taken into account for this purpose);

(iii) A separate line of business satisfies the average benefits safe harbor of section 1.414(r)-5(f) for a testing year (see section 1.414(r)-5(f)(4) for the employees taken into account for this purpose);

(iv) A separate line of business satisfies the minimum or maximum benefits safe harbor of section 1.414(r)-5(g) for a testing year (see section 1.414(r)-5(g)(6) for the employees taken into account for this purpose);

(v) A plan of the employer satisfies sections 410(b) and 401(a)(4) for a plan year (see section 1.414(r)-8(d)(3) for the employees taken into account for this purpose); or

(vi) A plan of the employer satisfies section 401(a)(26) for a plan year (see section 1.414(r)-9(c)(3) for the employees taken into account for this purpose).

(b) ASSIGNMENT PROCEDURE -- (1) IN GENERAL. To apply the provisions listed in paragraph (a)(2) of this section with respect to a testing year or plan year, as the case may be, each of the employees taken into account under that provision must be assigned to a qualified separate line of business of the employer on one or more testing days (or section 401(a)(26) testing days) during the year. The first day for which this assignment procedure is required for a testing year is the first testing day. See section 1.414(r)-11(b)(6), (7) and (8) (definitions of "testing day", "first testing day" and "section 401(a)(26) testing day"). Section 1.414(r)-8 may require that the assignment procedure be repeated for testing days that fall after the first testing day (including testing days that fall after the close of the testing year in a plan year that begins in the testing year). Accordingly, new employees may be taken into account for the first time on these later testing days who were not taken into account on the first testing day. Section 1.414(r)-9 may have the same effect with respect to section 401(a)(26) testing days that fall after the first testing day.

(2) ASSIGNMENT FOR THE FIRST TESTING DAY. The employees taken into account under a provision described in paragraph (a)(2) of this section with respect to the first testing day for a testing year are assigned among the employer's qualified separate lines of business by applying the following procedure to each of those employees --

(i) An employee who is a substantial-service employee with respect to a qualified separate line of business within the meaning of section 1.414(r)-11(b)(2) must be assigned to that qualified separate line of business;

(ii) An employee who is a residual shared employee within the meaning of section 1.414(r)-11(b)(4) with respect to a qualified separate line of business must be assigned to a qualified separate line of business under paragraph (c) of this section.

Each employee assigned to a qualified separate line of business under paragraph (b)(2)(i) of this section or this paragraph (b)(2)(ii) remains assigned to the same qualified separate line of business for all purposes with respect to the testing year listed in paragraph (a)(2) of this section and for all plan years beginning in that testing year. Once an employee is assigned to a qualified separate line of business with respect to a particular testing day or section 401(a)(26) testing day, that employee remains assigned to that qualified separate line of business after the employee terminates employment. However, after the employee terminates employment, that employee will in most cases not be taken into account with respect to a subsequent testing day or section 401(a)(26) testing day for purposes of applying one or more of the provisions in paragraph (a)(2) of this section.

(3) ASSIGNMENT OF NEW EMPLOYEES FOR SUBSEQUENT TESTING DAYS. After the first testing day for the testing year, the employees taken into account under a provision described in paragraph (a)(2) of this section with respect to a subsequent testing day (or a section 401(a)(26) testing day) for the testing year may include one or more employees who previously have not been assigned to a qualified separate line of business for any purpose listed in paragraph (a)(2) of this section with respect to the testing year. An employee may not previously have been assigned to a qualified separate line of business for any purpose with respect to the testing year if, for example, the employee has just been hired or has just become a nonexcludable employee. Previously unassigned employees are assigned among the employer's qualified separate lines of business by applying the procedure in paragraph (b)(2) of this section to those employees. In determining whether an employee who is not employed by the employer during the testing year is a substantial-service or a residual shared employee with respect to a qualified separate line of business (including whether the residual shared employee is eligible for assignment under paragraph (c)(2) of this section), section 1.414(r)-3(c)(5) is applied with reference to services performed by the employee during a period in the immediately succeeding testing year that are reasonably representative of the employee's services for the employer.

(4) SPECIAL RULE FOR EMPLOYERS USING ANNUAL OPTION UNDER SECTION 410(b). Notwithstanding the fact that paragraphs (b)(1) through (b)(3) of this section generally only require employees to be assigned on testing days beginning with the first testing day, if a plan is tested under section 410(b) using the annual option of section 1.410(b)-8(a)(4) (including for purposes of the average benefit percentage test), employees must be assigned on every day of the plan year of that plan for purposes of this paragraph (b). Thus, all employees who provide services at any time during the plan year of a plan that is tested using the annual option of section 1.410(b)- 8(a)(4) must be assigned to a line of business even if they terminate employment before the first testing day within the meaning of section 1.414(r)-11(b)(7) of the testing year in which the plan year begins.

(c) ASSIGNMENT AND ALLOCATION OF RESIDUAL SHARED EMPLOYEES -- (1) IN GENERAL. All residual shared employees must be assigned among an employer's qualified separate lines of business. An employer is permitted to assign certain residual shared employees under paragraph (c)(2) of this section. All residual shared employees who are not assigned under paragraph (c)(2) of this section must be assigned among an employer's qualified separate lines of business under one of the allocation methods provided in paragraphs (c)(3) through (c)(5) of this section. An employer is permitted to select which method of allocation to apply for the testing year to these other residual shared employees. However, the same allocation method must be used for all these other residual shared employees, and for all purposes listed in paragraph (a)(2) of this section with respect to the testing year.

(2) OPTION FOR ASSIGNING CERTAIN RESIDUAL SHARED EMPLOYEES. For purposes of this section, if a residual shared employee provides at least 50 percent of the employee's services to a qualified line of business within the meaning of section 1.414(r)-3(c)(5), the employer is permitted to assign that residual shared employee to that qualified separate line of business. This optional rule may be applied separately with respect to each residual shared employee. Thus, an employer is permitted to determine, on an individual employee basis, whether a residual shared employee is assigned under this optional rule to a qualified separate line of business.

(3) DOMINANT LINE OF BUSINESS METHOD OF ALLOCATION -- (i) IN GENERAL. Under the method of allocation in this paragraph (c)(3), all residual shared employees who are not assigned under paragraph (c)(2) of this section are allocated to the employer's dominant line of business. This method does not apply unless the employer has a dominant line of business within the meaning of paragraph (c)(3)(ii) or (c)(3)(iv) of this section. If an employer has more than one dominant line of business under this paragraph (c), the employer must select which qualified separate lines of business is its dominant line of business.

(ii) DOMINANT LINE OF BUSINESS. An employer's dominant line of business is that qualified separate line of business that has an employee assignment percentage of at least 50 percent.

(iii) EMPLOYEE ASSIGNMENT PERCENTAGE -- (A) DETERMINATION OF PERCENTAGE. The employee assignment percentage of a qualified separate of business is the fraction (expressed as a percentage) --

(1) The numerator of which is the sum of the number of substantial-service employees with respect to the qualified separate line of business assigned to that line of business under paragraph (b) of this section, and the number of residual shared employees with respect to the qualified separate line of business who are assigned to that qualified separate line of business under paragraph (c)(2) of this section; and

(2) The denominator of which is the total number of these employees who are assigned to all qualified separate lines of business of the employer under paragraphs (b) and (c)(2) of this section.

(B) EMPLOYEES TAKEN INTO ACCOUNT. The employee assignment percentage is calculated solely with respect to employees who are taken into account for purposes of satisfying section 410(b) with respect to the first testing day. Therefore, this percentage is calculated only once for all purposes with respect to a testing year. The employees described in section 410(b)(3) and (4) are excluded. However, section 410(b)(4) is applied with reference to the lowest minimum age requirement applicable under any plan of the employer, and with reference to the lowest service requirement applicable under any plan of the employer, as if all the plans were a single plan under section 1.410(b)-6(b)(2).

(iv) OPTION TO APPLY REDUCED PERCENTAGE. An employer is permitted to determine whether it has a dominant line of business by substituting "35 percent" for "50 percent" in paragraph (c)(3)(ii) of this section. This option is available for a testing year only if --

(A) The qualified separate line of business accounts for at least 60 percent of the employer's total gross revenues for the employer's latest fiscal year ending in the testing year;

(B) The employee assignment percentage would be at least 60 percent if collectively bargained employees were taken into account; or

(C) Each qualified separate line of business of the employer satisfies either the statutory safe harbor of section 1.414(r)-5(b), the average benefits safe harbor of section 1.414(r)-5(f), or the minimum or maximum benefits safe harbor of section 1.414(r)-5(g). Whether a qualified separate line of business satisfies either of these safe harbors is determined after the application of this section, including the assignment of all residual shared employees under this paragraph (c)(3).

(v) EXAMPLES. The following examples illustrate the application of the method of allocation in this paragraph (c)(3).

EXAMPLE 1. (i) Employer A operates four qualified separate lines of business as determined under section 1.414(r)-1(b) for the testing year, consisting of a software developer, a health food products supplier, a real estate developer, and a ski equipment manufacturer. In applying this section for the first testing day with respect to the testing year, Employer A determines that it has a total of 21,000 employees, of whom 10,000 are substantial-service employees not excludable under section 410(b)(3) or (b)(4). Assume that no residual shared employees is assigned under the optional rule in paragraph (c)(2) of this section. Pursuant to paragraph (b) of this section, these 10,000 employees are assigned among Employer A's qualified separate lines of business as follows:

                             Ski

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that, after allocating all residual shared employees to the ski equipment line of business, the software, ski equipment and health food supplier lines of business each would satisfy the statutory safe harbor of section 1.414(r)-5(b), and that the real estate development line of business would satisfy the minimum or maximum benefits safe harbor of section 1.414(r)- 5(g). Under these facts, Employer A is permitted to apply the method of allocation in this paragraph (c)(3) to allocate all its residual shared employees to the ski equipment line of business, because the employee assignment percentage of the ski equipment line of business exceeds 35 percent and each qualified separate line of business satisfies either the statutory safe harbor of section 1.414(r)-5(b) or the minimum or maximum benefits safe harbor of section 1.414(r)-5(g).

EXAMPLE 3. (i) The facts are the same as in Example 1, except that, Employer A chooses not to satisfy the minimum or maximum benefits safe harbor of section 1.414(r)-5(g) Instead, Employer A combines the real estate developer and ski equipment manufacturer into a single line of business. As a result, Employer A has three qualified separate lines of business as determined under section 1.414(r)-1(b). Assume that no residual shared employee becomes a substantial-service employee as a result of the new combination. Employer A's substantial-service employees are assigned among Employer A's qualified separate lines of business as follows:

 Ski

EXAMPLE 4. (i) The facts are the same as in Example 1, except that, of the remaining 11,000 employees of Employer A, 10,000 employees are substantial-service employees who are collectively bargained employees. Pursuant to paragraph (b) of this section, the 10,000 substantial-service employees and the 10,000 substantial-service employees who are collectively bargained employees are assigned among Employer A's qualified separate lines of business as follows:

 Software     Health     Real        Ski

(4) PRO-RATA METHOD OF ALLOCATION -- (i) IN GENERAL. Under the method of allocation in this paragraph (c)(4), all residual shared employees who are not assigned under paragraph (c)(2) of this section are allocated among an employer's qualified separate lines of business in proportion to the employee assignment percentage of each qualified separate line of business, as determined under paragraph (c)(3)(iii) of this section.

(ii) ALLOCATION PROCEDURE. The procedure for allocating residual shared employees under the method in this paragraph (c)(4) is as follows --

(A) The number of highly compensated residual shared employees who are allocated to each qualified separate line of business is equal to the product determined by multiplying the total number of highly compensated residual shared employees of the employer by the employee assignment percentage determined with respect to the qualified separate line of business under paragraph (c)(4)(i) of this section;

(B) The number of nonhighly compensated residual shared employees who are allocated to each qualified separate line of business is equal to the product determined by multiplying the total number of nonhighly compensated residual shared employees of the employer by the employee assignment percentage determined with respect to the qualified separate line of business under paragraph (c)(4)(i) of this section;

(C) For purposes of this procedure, the employer is permitted to determine which highly compensated residual shared employees and which nonhighly compensated residual shared employees are allocated to each qualified separate line of business, provided that the required number of highly and nonhighly compensated residual shared employees are allocated to each qualified separate line of business.

(iii) EXAMPLES. The following example illustrates the application of the method of allocation in this paragraph (c)(4).

EXAMPLE 1. The facts are the same as in Example 1 under paragraph (c)(3)(iv) of this section and that there are no additional residual shared employees after the first testing day. Of Employer A's 1,000 residual shared employees, 800 are highly compensated employees and 200 are nonhighly compensated employees. Employer A applies the pro-rata method of allocation in this paragraph (c)(4). Under these facts, the 1,000 residual shared employees are allocated among Employer A's qualified separate lines of business as follows:

 Software     Health     Real        Ski

(ii) HIGHLY COMPENSATED EMPLOYEE PERCENTAGE ASSIGNMENT RATIO. For purposes of this paragraph (c)(5), the highly compensated employee percentage assignment ratio of a qualified separate line of business is the fraction (expressed as a percentage)--

(A) The numerator of which is the percentage of all employees who have previously been assigned to the qualified separate line of business under this section with respect to the testing year who are highly compensated employees; and

(B) The denominator of which is the percentage of all employees who have previously been assigned to any qualified separate line of business under this section with respect to the testing year who are highly compensated employees.

Thus, the highly compensated employee percentage assignment ratio of each of the employer's qualified separate lines of business is recalculated each time a residual shared employee is allocated to a qualified separate line of business under this paragraph (c)(5).

(iii) ALLOCATION PROCEDURE. The procedure for allocating all residual shared employees under the method in this paragraph (c)(5) is as follows --

(A) If there are any qualified separate lines of business with a highly compensated employee percentage assignment ratio of less than 50 percent (as determined immediately before the employee is allocated to a qualified separate line of business), the highly compensated residual shared employee must be allocated to one of these qualified separate lines of business;

(B) If there are any qualified separate lines of business with a highly compensated employee percentage assignment ratio greater than 200 percent (as determined immediately before the employee is allocated to a qualified separate line of business), the nonhighly compensated residual shared employee must be allocated to one of these qualified separate lines of business;

(C) If there are no qualified separate lines of business with a highly compensated employee percentage assignment ratio less than 50 percent, a highly compensated residual shared employee may be allocated to any qualified separate line of business with a highly compensated employee percentage assignment ratio of no more than 200 percent, provided that the employee's allocation to the qualified separate line of business does not cause its highly compensated employee percentage assignment ratio to exceed 200 percent (as determined immediately after the employee is allocated to the qualified separate line of business);

(D) If there are no qualified separate lines of business with a highly compensated employee percentage assignment ratio greater than 200 percent, a nonhighly compensated residual shared employee may be allocated to any qualified separate line of business with a highly compensated employee percentage assignment ratio of no less than 50 percent, provided that the employee's allocation to the qualified separate line of business does not cause its highly compensated employee percentage assignment ratio to fall below 50 percent (as determined immediately after the employee is allocated to the qualified separate line of business);

(E) For purposes of this procedure, the employer is permitted to determine which highly compensated residual shared employees and which nonhighly compensated residual shared employees are allocated to each qualified separate line of business, provided that the requirements of this paragraph (c)(5)(iii) are satisfied.

(d) OPTIONAL RULE FOR ASSIGNING CERTAIN TRANSFERRED EMPLOYEES -- (1) IN GENERAL. If the requirements of this paragraph (d) are satisfied, an employer is permitted to apply the optional rule in this paragraph (d) with respect to an employee. This optional rule applies only for purposes of satisfying the provisions listed in paragraph (a)(2) of this section and therefore does not apply for any other purpose (e.g., the determination under section 1.414(r)-3 of whether a line of business is organized and operated separately from the remainder of the employer).

(2) REQUIREMENTS. An employee satisfies the requirements of this paragraph (d) only if --

(i) During a testing year, the employee is transferred from a qualified separate line of business of the employer (the "prior line of business") to another qualified separate line of business of the employer (the "current line of business");

(ii) The transfer is for a temporary period of time; and

(iii) In the immediately preceding testing year, the employee was a substantial-service employee with respect to the prior line of business within the meaning of section 1.414(r)-11(b)(2).

(3) OPTIONAL RULE. For purposes of this section, an employee may be assigned to the prior line of business for the testing year in which the transfer occurs and, if the transfer extends beyond that testing year, the testing year immediately succeeding that testing year.

SECTION 1.414(r)-8 SEPARATE APPLICATION OF SECTION 410(b).

(a) GENERAL RULE. If an employer is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b) for a testing year, the requirements of section 410(b) must be applied in accordance with this section separately with respect to the employees of each qualified separate line of business for purposes of testing all plans of the employer for plan years that begin in the testing year (other than a plan tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) for such a plan year). Conversely, if an employer is not treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b) for a testing year, the requirements of section 410(b) must be applied on an employer-wide basis for purposes of testing all plans of the employer for plan years that begin in the testing year. See section 1.414(r)-1(c)(2) and (d)(6). Paragraph (b) of this section explains how the requirements of section 410(b) are applied separately with respect to the employees of a qualified separate line of business for purposes of testing a plan. Paragraph (c) of this section explains the coordination between sections 410(b) and 401(a)(4). Paragraph (d) of this section provides certain supplementary rules necessary for the application of this section.

(b) RULES OF SEPARATE APPLICATION -- (1) IN GENERAL. If the requirements of section 410(b) are applied separately with respect to the employees of each qualified separate line of business operated by the employer for a testing year, a plan (other than a plan that is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii) for a plan year) satisfies the requirements of section 410(b) only if --

(i) The plan satisfies section 410(b)(5)(B) on an employer-wide basis; and

(ii) The plan satisfies section 410(b) on a qualified-separate- line-of-business basis.

(2) SATISFACTION OF SECTION 410(b)(5)(B) ON AN EMPLOYER-BASIS -- (i) GENERAL RULE. Section 410(b)(5)(B) provides that a plan is not permitted to be tested separately with respect to the employees of a qualified separate line of business unless the plan benefits a classification of employees found by the Secretary to be nondiscriminatory. A plan satisfies this requirement only if the plan satisfies either the ratio percentage test of section 1.410(b)- 2(b)(2) or the nondiscriminatory classification test of section 1.410(b)-4 (without regard to the average benefit percentage test of section 1.410(b)-5), taking into account the other applicable provisions of sections 1.410(b)-1 through 1.410(b)-10. For this purpose, the nonexcludable employees of the employer taken into account in testing the plan under section 410(b) are determined under section 1.410(b)-6, without regard to the exclusion in section 1.410(b)-6(e) for employees of other qualified separate lines of business of the employer. Thus, in testing a plan separately with respect to the employees of one qualified separate line of business under this paragraph (b)(2), the otherwise nonexcludable employees of the employer's other qualified separate lines of business are not treated as excludable employees. However, under the definition of "plan" in paragraph (d)(2) of this section, these employees are not treated as benefiting under the plan for purposes of applying this paragraph (b)(2).

(ii) APPLICATION OF FACTS AND CIRCUMSTANCES REQUIREMENTS UNDER NONDISCRIMINATORY CLASSIFICATION TEST. The fact that an employer has satisfied the qualified-separate-line-of-business requirements in sections 1.414(r)-1 through 1.414(r)-7 is taken into account in determining whether a classification of employees benefiting under a plan that falls between the safe and unsafe harbors satisfies section 1.410(b)-4(c)(3) (facts and circumstances requirements). Except in unusual circumstances, this fact will be determinative.

(iii) APPLICATION OF UNSAFE HARBOR PERCENTAGE TO PLANS SATISFYING RATIO PERCENTAGE TEST AT 90 PERCENT LEVEL. If a plan benefits a group of employees for a plan year that would satisfy the ratio percentage test of section 1.410(b)-2(b)(2) on a qualified- separate-line-of-business basis under paragraph (b)(3) of this section if that percentage were increased to 90 percent, the unsafe harbor percentage in section 1.410(b)-4(c)(4)(ii) may be reduced by five percentage points (not five percent) for the plan year. Thus, if the requirements of this paragraph (b)(2)(ii) are satisfied, the unsafe harbor percentage in section 1.410(b)-4(c)(4)(ii) may be treated as 35 percent, reduced by 3/4 of a percentage point for each whole percentage point by which the nonhighly compensated employee concentration percentage exceeds 60 percent (but in no event less than 15 percent).

(3) SATISFACTION OF SECTION 410(b) ON QUALIFIED-SEPARATE-LINE- BUSINESS BASIS. A plan satisfies section 410(b) on a qualified- separate-line-of-business basis only if the plan satisfies either the ratio percentage test of section 1.410(b)-2(b)(2) or the average benefit test of section 1.410(b)-2(b)(3) (including the nondiscriminatory classification test of section 1.410(b)-4 and the average benefit percentage test of section 1.410(b)-5), taking into account the other applicable provisions of sections 1.410(b)-1 through 1.410(b)-10. For this purpose, the nonexcludable employees of the employer taken into account in testing the plan under section 410(b) are determined under section 1.410(b)-6, taking into account the exclusion in section 1.410(b)-6(e) for employees of other qualified separate lines of business of the employer. Thus, in testing a plan separately with respect to the employees of one qualified separate line of business under this paragraph (b)(3), all employees of the employer's other qualified separate lines of business are treated as excludable employees.

(4) EXAMPLES. The following examples illustrate the application of this paragraph (b).

EXAMPLE 1. (i) Employer A is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b) for the 1993 testing year with respect to all of its plans. Employer A operates two qualified separate lines of business as determined under section 1.414(r)-1(b)(2), Line 1 and Line 2. Employer A maintains only two plans, Plan X which benefits solely employees of Line 1, and Plan Y which benefits solely employees of Line 2. In testing Plan X under section 410(b) with respect to the first testing day for the plan year of Plan X beginning in the 1993 testing year, it is determined that Employer A has 2,100 nonexcludable employees, of whom 100 are highly compensated employees and 2,000 are nonhighly compensated employees. After applying section 1.414(r)-7 to these employees, 50 of the highly compensated employees and 100 of the nonhighly compensated employees are treated as employees of Line 2, and the remaining 50 highly compensated employees and the remaining 1,900 nonhighly compensated employees are treated as employees of Line 1.

(ii) All of the highly compensated employees and 1,300 of the nonhighly compensated employees who are treated as employees of Line 1 benefit under Plan X. Thus, on an employer-wide basis, Plan X benefits 50 percent of all Employer A's highly compensated employees (50 out of 100) and 65 percent of all Employer A's nonhighly compensated employees (1,300 out of 2,000). Plan X consequently has a ratio percentage determined on an employer-wide basis of 130 percent (65% divided by 5O%), see section 1.410(b)-9, and could satisfy section 410(b) under the ratio percentage test of section 1.410(b)-2(b)(2) if that section were applied on an employer-wide basis without regard to the provisions of this paragraph (b). Under paragraph (a) of this section, however, the requirements of section 410(b) must be applied separately with respect to the employees of each qualified separate line of business operated by Employer A for all plans of Employer A for plan years that begin in the 1993 testing year. This rule does not apply to plans tested under the special rule for employer-wide plans in section 1.414(r)- 1(c)(2)(ii). Plan X benefits only 65 percent of the nonhighly compensated employees of Employer A, however, and therefore cannot satisfy the 70 percent requirement necessary to be tested under that rule. As a result, for the plan year of Plan X beginning in the 1993 testing year, Plan X is not permitted to satisfy section 410(b) on an employer-wide basis and, instead, is only permitted to satisfy section 410(b) separately with respect to the employees of each qualified separate line of business operated by Employer A, in accordance with paragraphs (b)(2) and (b)(3) of this section.

EXAMPLE 2. The facts are the same as in EXAMPLE 1. All the employees treated as employees of Line 2 benefit under Plan Y, and none of the employees treated as employees of Line 1 benefit under Plan Y. Thus, Plan Y benefits 50 percent of all Employer A's highly compensated employees (50 out of 100) and only 5 percent of all Employer A's nonhighly compensated employees (100 out of 2,000). Thus, while Plan Y has a ratio percentage of 100 percent (100% divided by 100%) on a qualified-separate-line-of- business basis, it has a ratio percentage of only 10 percent (5% divided by 50%) on an employer-wide basis. See section 1.410(b)- 9. Because 10 percent is less than 15 percent (the unsafe harbor percentage applicable to Employer A under section 1.410(b)- 4(c)(4)(ii), after the reduction provided for in paragraph (b)(2)(ii) of this section), Plan Y does not satisfy the nondiscriminatory classification test of section 1.410(b)-4 on an employer-wide basis. Nor does Plan Y satisfy the ratio percentage test of section 1.410(b)-1(b)(2) on an employer-wide basis, since 10 percent is less than 70 percent. Under these facts, Plan Y does not satisfy section 410(b)(5)(B) on an employer-wide basis in accordance with paragraph (b)(2) of this section for the plan year of Plan Y beginning in the 1993 testing year, and therefore fails to satisfy section 410(b) for that year. This is true even though Plan Y satisfies section 410(b) on a qualified-separate-line-of-business basis in accordance with paragraph (b)(3) of this section.

EXAMPLE 3. (i) The facts are the same as in EXAMPLE 1, except that plan X benefits only 950 of the employees of Line 1. Assume plan X satisfies the reasonable classification requirement of section 1.410(b)-4(b) on an employer-wide basis. Plan X benefits 50 percent of all Employer A's highly compensated employees (50 out of 100) and 47.5 percent of all Employer A's nonhighly compensated employees (950 out of 2,000). Plan X consequently has a ratio percentage determined on an employer-wide basis of 95 percent (47.5% divided by 50%) see section 1.410(b)-9, and thus satisfies section 410(b)(5)(B) on an employer-wide basis.

(ii) Plan X has a ratio percentage determined on a qualified-separate-line-of-business basis of 50 percent (50% = 100%). Because 50 percent is less than 70 percent, Plan X must satisfy the nondiscriminatory classification test of section 1.410(b)-4 and the average benefit percentage test of section 1.410(b)-5 on a qualified-separate-line-of-business basis in order to satisfy the other requirements of section 410(b). Plan X satisfies the nondiscriminatory classification requirement of section 1.410(b)-4(c) on a qualified-separate-line-of-business because its ratio percentage determined on a qualified-separate- line-of-business basis is more than 22.25 percent, the safe harbor percentage applicable to Line 1 under section 1.410(b)- 4(c)(4)(i). Because Plan X satisfies the reasonable classification requirement of section 1.410(b)-4(b) on an employer-wide basis, it is also deemed to satisfy this requirement on a qualified-separate-line-of-business basis. See section 1.410(b)-7(c)(4). In determining whether Plan X satisfies the average benefit percentage test of section 1.410(b)-5, only Plan X and only employees of Line 1 are taken into account. See sections 1.410(b)-6(e) and 1.410(b)-7(e).

EXAMPLE 4. The facts are the same as in Example 3, except that, prior to the 1993 testing year, Employer A merges Plan X and Plan Y so that they form a single plan within the meaning of section 414(l). Under the definition of "plan" in paragraph (d)(2) of this section, however, the portion of the newly merged plan that benefits employees of Line 2 (former Plan Y) is still treated as a separate plan from the portion of the newly merged plan that benefits employees of Line 1 (former Plan X). The portion of the newly merged plan that benefits employees of Line 2 (former Plan Y) fails to satisfy section 410(b) for the reasons stated in EXAMPLE 3. Under these facts, because the portion of the newly merged plan that benefits employees of Line 2 fails to satisfy section 410(b), the entire newly merged plan falls to satisfy section 410(b) for the plan year of the newly merged plan that begins in the 1993 testing year. See paragraph (d)(5) of this section.

(c) COORDINATION OF SECTION 401(a)(4) WITH SECTION 410(B) -- (1) GENERAL RULE. For purposes of these regulations, the requirements of section 410(b) encompass the requirements of section 401(a)(4) (including, but not limited to, the permitted disparity rules of section 401(l), the actual deferral percentage test of section 401(k)(3), and the actual contribution percentage test of section 401(m)(2)). Therefore, if the requirements of section 410(b) are applied separately with respect to the employees of each qualified separate line of business of an employer for purposes of testing one or more plans of the employer for plan years that begin in a testing year, the requirements of section 401(a)(4) must also be applied separately with respect to the employees of the same qualified separate lines of business for purposes of testing the same plans for the same plan years. Furthermore, if section 401(a)(4) requires that a group of employees under the plan satisfy section 410(b) for purposes of satisfying section 401(a)(4), section 410(b) must be applied for this purpose in the same manner provided in paragraph (b) of this section. See, for example, sections 1.401(a)(4)-2(c)(1) and 1.401(a)(4)-3(c)(1) (requiring each rate group of employees under a plan to satisfy section 410(b)), section 1.401(a)(4)-4(b) (requiring the group of employees to whom each benefit, right, or feature is currently available under a plan to satisfy section 410(b)), and section 1.401(a)(4)-9(c)(1) (requiring the group of employees included in each component plan into which a plan is restructured to satisfy section 410(b)). Thus, the group of employees must satisfy section 410(b)(5)(B) on an employer-wide basis in accordance with paragraph (b)(2) of this section and also must satisfy section 410(b) on a qualified-separate-line-of-business basis in accordance with paragraph (b)(3) of this section, in both cases as if the group of employees were the only employees benefiting under the plan.

(2) EXAMPLES. The following examples illustrate the application of the rule in this paragraph (c).

EXAMPLE 1. Employer B is treated as operating qualified separate lines of business for purposes of section 410(b) in accordance with section 1.414(r)-1(b) for the 1993 testing year. Employer B operates two qualified separate lines of business as determined under section 1.414(r)-1(b)(2), Line 1 and Line 2. Employer B maintains Plan Z, which benefits employees in both Line 1 and Line 2. Under the definition of "plan" in paragraph (d)(2) of this section, the portion of Plan Z that benefits employees of Line 1 is treated as a separate plan from the portion of Plan Z that benefits employees of Line 2. Under this paragraph (c), this result applies for purposes of both section 410(b) and section 401(a)(4).

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that Plan Z benefits solely employees of Line 1. In testing Plan Z under section 401(a)(4) for the plan year of Plan Z beginning in the 1993 testing year, Employer B restructures Plan Z into several component plans (within the meaning of section 1.401(a)(4)-9(c)). Under section 1.401(a)(4)-9(c)(1), each of these component plans is required to satisfy section 410(b). This paragraph (c) requires that each of the component plans be tested separately with respect to the employees of each qualified separate line of business operated by Employer B. This testing must be done in accordance with paragraph (b) of this section. Consequently, each component plan must satisfy section 410(b)(5)(B) on an employer-wide basis in accordance with paragraph (b)(2) of this section and must also satisfy section 410(b) on a qualified-separate-line-of-business basis in accordance with paragraph (b)(3) of this section.

EXAMPLE 3. The facts are the same as in EXAMPLE 1, except that Plan Z is a profit-sharing plan, and contributions to Plan Z are made pursuant to cash or deferred arrangement in which all employees of Employer B are eligible to participate. Assume that, as a result, Plan Z satisfies the requirements to be tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(2)(ii). Under these facts, the requirements of sections 410(b), 401(a)(4) and 401(k), including the actual deferral percentage test of section 401(k)(3) and section 1.401(k)-1(b), would generally be required to be applied separately to the portions of Plan Z that benefit the employees of Line 1 and Line 2, respectively. However, if Plan Z is tested under the special rule in section 1.414(r)-1(c)(2)(ii), these requirements must be applied on an employer-wide basis.

(d) SUPPLEMENTARY RULES -- (1) IN GENERAL. This paragraph (d) provides certain supplementary rules necessary for the application of this section.

(2) DEFINITION OF PLAN. For purposes of this section, the term "plan" means a plan within the meaning of section 1.410(b)-7(a) and (b), after application of the mandatory disaggregation rules of section 1.410(b)-7(c) (including the mandatory disaggregation rule for portions of a plan that benefit employees of different qualified separate lines of business) and the permissive aggregation rules of section 1.410(b)-7(d). Thus, for purposes of this section, the portion of a plan that benefits employees of one qualified separate line of business is treated as a separate plan from the other portions of the same plan that benefit employees of other qualified separate lines of business of the employer, unless the plan is tested under the special rule for employer-wide plans in section 1.414(r)- 1(c)(2)(ii) for the plan year.

(3) EMPLOYEES OF A QUALIFIED SEPARATE LINE OF BUSINESS. For purposes of applying paragraph (b) of this section with respect to a testing day, the employees of each qualified separate line of business of the employer are determined by applying section 1.414(r)- 7 to the employees of the employer otherwise taken into account under section 410(b) for the testing day. For purposes of applying paragraph (c) of this section with respect to a testing day, the employees of each qualified separate line of business of the employer are determined by applying section 1.414(r)-7 to the employees of the employer otherwise taken into account under section 401(a)(4) for the testing day. For the definition of "testing day," see section 1.414(r)-11(b)(6).

(4) CONTRIBUTIONS AND BENEFITS ATTRIBUTABLE TO A QUALIFIED SEPARATE LINE OF BUSINESS. For purposes of this section, all allocations to an employee's account, all benefits accrued by an employee, and all other benefits, rights, and features applicable to an employee under any plan of the employer are treated as if they had been provided under a plan maintained by the qualified separate line of business to which the employee is assigned under 1.414(r)-7 for the testing year.

(5) CONSEQUENCES OF FAILURE. If a plan fails to satisfy either paragraph (b)(2), (b)(3), or (c)(1) of this section, the plan (and any plan of which it constitutes a portion) fails to satisfy section 401(a). However, this failure alone does not cause the employer to fail to be treated as operating qualified separate lines of business in accordance with section 1.414(r)-1(b), unless the employer is relying on benefits provided under the plan to satisfy the minimum benefit portion of the safe harbor in section 1.414(r)-5(g)(2) with respect to at least one of its qualified separate lines of business.

SECTION 1.414(r)-9 SEPARATE APPLICATION OF SECTION 401(a)(26).

(a) GENERAL RULE. If an employer is treated as operating qualified separate lines of business for purposes of section 401(a)(26) in accordance with section 1.414(r)-1(b) for a testing year, the requirements of section 401(a)(26) must be applied separately with respect to the employees of each qualified separate line of business for purposes of testing all plans of the employer for plan years that begin in the testing year (other than a plan tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(3)(ii) for such a plan year). Conversely, if an employer is not treated as operating qualified separate lines of business for purposes of section 401(a)(26) in accordance with section 1.414(r)-1(b) for a testing year, the requirements of section 401(a)(26) must be applied on an employer-wide basis for purposes of testing all plans of the employer for plan years that begin in the testing year. See section 1.414(r)-1(c)(3) and (d)(6). Paragraph (b) of this section explains how the requirements of section 401(a)(26) are applied separately with respect to the employees of a qualified separate line of business for purposes of testing a plan. Paragraph (c) of this section provides certain supplementary rules necessary for the application of this section.

(b) REQUIREMENTS APPLICABLE TO A PLAN. If the requirements of section 401(a)(26) are applied separately with respect to the employees of a qualified separate line of business for a testing year, a plan (other than a plan that is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(3)(ii) for a plan year) satisfies section 401(a)(26) only if it satisfies the requirements of sections 1.401(a)(26)-1 through 1.401(a)(26)-9 on a qualified-separate-line-of-business basis. For this purpose, the nonexcludable employees of the employer taken into account in testing the plan under section 401(a)(26) are determined under section 1.401(a)(26)-6(b), taking into account the exclusion in section 1.401(a)(26)-6(b)(8) for employees of other qualified separate lines of business of the employer. Thus, in testing a plan separately with respect to the employees of one qualified separate line of business under this paragraph (b), all employees of the employer's other qualified separate lines of business are treated as excludable employees.

(c) SUPPLEMENTARY RULES -- (1) IN GENERAL. This paragraph (c) provides certain supplementary rules necessary for the application of this section.

(2) DEFINITION OF PLAN. For purposes of this section, the term "plan" means a plan within the meaning of section 1.401(a)(26)-2(c) and (d), including the mandatory disaggregation rule of section 1.401(a)(26)-2(d)(6) for portions of a plan that benefit employees of different qualified separate lines of business. Thus, for purposes of this section, the portion of a plan that benefits employees of one qualified separate line of business is treated as a separate plan from the other portions of the same plan that benefit employees of other qualified separate lines of business of the employer, unless the plan is tested under the special rule for employer-wide plans in section 1.414(r)-1(c)(3)(ii) for the plan year.

(3) EMPLOYEES OF A QUALIFIED SEPARATE LINE OF BUSINESS. For purposes of applying paragraph (b)(2) of this section with respect to a section 401(a)(26) testing day, the employees of each qualified separate line of business of the employer are determined by applying section 1.414(r)-7 to the employees of the employer otherwise taken into account under section 401(a)(26) for the section 401(a)(26) testing day. For the definition of "section 401(a)(26) testing day," see section 1.414(r)-11(b)(8).

(4) CONSEQUENCES OF FAILURE. If a plan fails to satisfy paragraph (b)(2) of this section, the plan (and any plan of which it constitutes a portion) fails to satisfy section 401(a). However, this failure alone would not cause the employer to fail to be treated as operating qualified separate lines of business in accordance with section 1.414(r)-1(b), unless the employer is relying on benefits provided under the plan to satisfy the minimum benefit portion of the safe harbor in section 1.414(r)-5(g)(2) with respect to at least one of its qualified separate lines of business.

SECTION 1.414(r)-10 SEPARATE APPLICATION OF SECTION 129(d)(8). [Reserved]

SECTION 1.414(r)-11 DEFINITIONS AND SPECIAL RULES.

(a) IN GENERAL. This section contains certain definitions and special rules applicable under these regulations. Paragraph (b) of this section provides certain definitions that apply for purposes of these regulations. Paragraph (c) of this section provides averaging rules under which certain provisions of these regulations may be applied on the basis of a two-year or a three-year average.

(b) DEFINITIONS -- (1) IN GENERAL. In applying the provisions of this section and of sections 1.414(r)-1 through 1.414(r)-10, unless otherwise provided, the definitions in this paragraph (b) govern in addition to the definitions in section 1.410(b)-9.

(2) SUBSTANTIAL-SERVICE EMPLOYEE. An employee is a substantial- service employee with respect to a line of business for a testing year if at least 75 percent of the employee's services are provided to that line of business for that testing year within the meaning of section 1.414(r)-3(c)(5).

(3) TOP-PAID EMPLOYEE. An employee is a top-paid employee with respect to a line of business for a testing year if the employee is among the top 10 percent by compensation of those employees who provide at least 25 percent of their services to that line of business for that testing year within the meaning of section 1.414(r)-3(c)(5). For purposes of this paragraph (b)(3), an employee's compensation is the compensation used to determine the employee's status as a highly or nonhighly compensated employee under section 414(q) for purposes of applying section 410(b) with respect to the first testing day. For this purpose, only compensation received during the determination year (within the meaning of section 1.414(q)-1T, Q&A-13) is taken into account. See section 1.414(r)- 3(c)(7) for examples of the determination of top-paid employee.

(4) RESIDUAL SHARED EMPLOYEE. An employee is a residual shared employee with respect to a line of business for a testing year if, for that testing year, the employee provides services to that line of business within the meaning of section 1.414(r)-3(c)(5), and the employee is not a substantial-service employee within the meaning of paragraph (b)(2) of this section with respect to that line of business.

(5) TESTING YEAR. The term "testing year" means the calendar year.

(6) TESTING DAY. The term "testing day" means any day on which section 1.410(b)-8(a)(1) requires any plan (within the meaning of section 1.414(r)-8(d)(2)) of the employer actually to satisfy section 410(b) with respect to a plan year that begins in the testing year. Thus, if a plan is required to satisfy section 410(b) on one day within each quarter of the plan year under the quarterly testing option of section 1.410(b)-8(a)(3), each of those four days is a testing day. Similarly, if a plan is required to satisfy section 410(b) on every day of the plan year under the daily testing option of section 1.410(b)-8(a)(2), every day of the plan year is a testing day.

(7) FIRST TESTING DAY. The term "first testing day" means the testing day that occurs earliest in time of all the testing days under all plans of the employer with respect to the testing year. If a plan is tested under the annual testing option of section 1.410(b)- 8(a)(4) (other than for purposes of the average benefit percentage test of section 1.410(b)-5) for a plan year that begins in a testing year, then, solely for purposes of determining the first testing day in a testing year, the employer may treat any day in the plan year as a testing day, provided that the coverage of each plan of the employer on the day selected is reasonably representative of the coverage of the plan over the entire plan year. The first testing day with respect to a testing year must fall within that testing year.

(8) SECTION 401(a)(26) TESTING DAY. The term "section 401(a)(26) testing day" means any day on which section 1.401(a)(26)-7(a) or (b) requires any plan of the employer actually to satisfy section 401(a)(26) with respect to a plan year that begins in the testing year. In no event may a section 401(a)(26) testing day with respect to a testing year fall before the first testing day for that testing year. For purposes of this paragraph (b)(8), the term "plan" has the same meaning as in section 1.414(r)-9(c)(2).

(c) AVERAGING RULES -- (1) IN GENERAL. The provisions specified in this paragraph (c) are permitted to be applied based on the average of the percentages for the current testing year and the consecutive testing years (not to exceed four consecutive testing years) immediately preceding the current testing year.

(2) SPECIFIED PROVISIONS. The provisions specified in this paragraph (c) are --

(i) The 90-percent separate employee workforce requirement of section 1.414(r)-3(b)(4);

(ii) The 80-percent separate management requirement of section 1.414(r)-3(b)(5);

(iii) The 25-percent provision-to-customers requirement of section 1.414(r)-3(d)(2)(iii);

(iv) The minimum and maximum highly compensated employee percentage ratios under the statutory safe harbor of section 1.414(r)-5(b)(1)(i) and (ii) (50 percent and 200 percent, respectively), but not the 10-percent exception in section 1.414(r)- 5(b)(4);

(v) The employee assignment percentage applied for purposes of the dominant line of business method of allocating residual shared employees under section 1.414(r)-7(c)(3) and the pro-rata method for allocating residual shared employees under section 1.414(r)-7(c)(4).

(3) AVERAGING OF LARGE FLUCTUATIONS NOT PERMITTED. A provision is not permitted to be applied based on an average determined under this paragraph (c) if the percentage for any testing year taken into account in calculating the average falls below a minimum percentage, or exceeds a maximum percentage, by more than 10 percent (not 10 percentage points) of the respective minimum or maximum percentage. Thus, for example, the statutory safe harbor of section 1.414(r)-5(b) is not permitted to be applied based on an average determined under this paragraph (c) if the percentage for any testing year taken into account in calculating the average falls below 45 percent (which is 10 percent below the 50-percent minimum) or exceeds 220 percent (which is 10 percent above the 200-percent maximum).

(4) CONSISTENCY REQUIREMENTS. A provision is permitted to be applied on an averaging basis under this paragraph (c) regardless of how any other provision is applied, except in the case of the separate employee workforce and separate management requirements of section 1.414(r)-3(b)(4) and (5), which each must be applied on the same basis as the other. A provision is also permitted to be applied on an averaging basis under this paragraph (c) for a testing year, regardless of how the provision is applied for any other testing year. However, once a provision is applied on an averaging basis under this paragraph (c) for a testing year, it must be applied on the same basis to all the employer's lines of business to which the provision is applied for the testing year. The percentage for a preceding testing year may be taken into account under this paragraph (c) only if --

(i) The employer calculates the percentage for the preceding testing year in the same manner as the employer calculates the percentage for the current testing year;

(ii) The employer is treated as operating qualified separate lines of business in accordance with section 1.414(r)-1(b) for the preceding testing year; and

(iii) The employer designated the same lines of business in the preceding testing year as in the current testing year.

PART 602 -- OMB CONTROL NUMBER UNDER THE PAPERWORK REDUCTION ACT

Par. 9. The authority citation for part 602 continues to read:

Authority: 26 U.S.C. 7805.

SECTION 602.101 [Amended]

Par. 10. Section 602.101(c) is amended by inserting in the appropriate place in the table, "section 1.414(r)-1 . . . 1545-1221".