367 Outline

PLANNING FOR OUTBOUND TRANSFERS UNDER
THE SECTION 367(A) AND 367(B) REGULATIONS, INCLUDING
EXPATRIATIONS
Bobbe Hirsh, Alan S. Lederman, and Martin B. Tittle
May 15, 2007
© 2007 Bobbe Hirsh, Alan S. Lederman, and Martin B. Tittle
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PROFESSIONAL BIOGRAPHIES
BOBBE HIRSH
Bobbe Hirsh (telephone 312-781-6809, e-mail [email protected]) is a partner
in the law firm of Bell, Boyd & Lloyd LLP, located in its Chicago office. She graduated
cum laude from Harvard Law School, where she was articles editor of the Harvard
International Law Journal. She holds an M.S.B.A. in accounting from the University if
Denver. Bobbe is also a CPA.
Bobbe publishes extensively in the field of international taxation and has
contributed to a number of PLI publications, including Foreign Investment in the United
States after the Tax Reform Act of 1986 (1987), International Tax Planning for the U.S.
Multinational Corporation (1988), Foreign Investment in the United States 1988,
Foreign Investment in the United States 1989, Foreign Investment in the United States -
A Practical Approach for the 1990s (1990), Transfer Pricing and the Foreign Owned
Corporation: Sections 482 and 6038A & C (1991), and Tax Planning for Domestic and
Foreign Partnerships, LLCs, Joint Ventures and Other Strategic Alliances (1999-2007).
She is also a frequent contributor to The Journal of Taxation, The Journal of
International Taxation, and various other professional publications. She co-authored,
with Mr. Lederman, The NAFTA Guide, published by Harcourt Brace.
Bobbe serves on the Board of Advisors of the Journal of International Taxation
and the Journal of Taxation of Financial Products and is a member of the Board of
Directors of International Tax Forum. In addition to writing, Bobbe is a frequent speaker
at professional conferences on a variety of international tax and trade issues.
ALAN S. LEDERMAN
Alan S. Lederman, P.A., is of counsel in the Miami office of the Florida law firm
of Akerman Senterfitt (telephone 305-349-4528, e-mail [email protected]).
He graduated cum laude from Harvard Law School and received an M.B.A. from
Harvard Business School. Mr. Lederman also is a CPA. Mr. Lederman has taught in the
masters program at the University of Miami law school.
Alan often speaks at conferences for professionals. These conferences include
those sponsored by the NYU Institute on Federal Taxation, the American Bar
Association, the Florida Bar, the American Law Institute, and the American Management
Association. His articles have often appeared in The Journal of Taxation, The Journal of
International Taxation, TAXES, The AICPA Tax Adviser, The ABA Tax Lawyer, The
Proceeding of the NYU Annual Tax Institute, BNA Tax Management International
Journal, Airfinance Journal, and other professional periodicals. He has also written two
BNA Tax Management Portfolios.
In addition to the area of taxation, Alan practices in the field of international law.
In this connection, he has lectured on topics such as the euro currency, the Helms Burton
law, and the money-laundering statutes to such groups as the ABA International Law
Section. He co-authored with Ms. Hirsh The NAFTA Guide, published by Harcourt
Brace.
MARTIN B. TITTLE
Martin B. Tittle (telephone 202-344-7592, e-mail [email protected]) is an
independent consultant who practices in Washington, D.C. and Ann Arbor, Michigan.
He works with foreign and U.S. multinationals on a wide range of tax issues pertaining to
their cross-border activities. Martin graduated magna cum laude from the University of
Michigan Law School.
Martin's articles have been published by Tax Notes International, The IBFD
Bulletin of International Taxation, and the Inter-American Development Bank. He is
also a contributor to The Canada-U.S. Tax Treaty, a treatise that Thomson Carswell will
be publishing in fall 2007. In 2005, Martin worked closely with Nardi Bress as vice-
chair of the ABA Tax Section's report on the proposed Sec. 367(a) regulations. In
addition to writing, Martin frequently speaks at professional conferences on a variety of
tax-related topics.
PLANNING FOR OUTBOUND TRANSFERS UNDER
THE SECTION 367(A) AND 367(B) REGULATIONS, INCLUDING
EXPATRIATIONS
I. SECTION 367(A) OUTBOUND TRANSFERS......... 1
A. Transfers .................................................................. 4
B. Tax Consequences Under Sec. 367(a)..................... 9
C. Sec. 367(a)(2) - Foreign Stock or Securities Exception 11
D. Section 367(a)(3) - Active Trade or Business Exception 13
E. Treas. Reg. Sec. 1.367(a)-3 ................................... 30
II. OUTBOUND TRANSFERS UNDER SECTION 367(B) 159
A. Outbound Transactions Covered by both Section 367(a) and (b) 160
B. Effect of Section 367(b) ...................................... 162
C. Section 367(b) Notice.......................................... 166
III. REPORTING REQUIREMENTS .......................... 167
A. Section 6038B ..................................................... 167
B. Time and Manner of Reporting ........................... 169
C. Information Required for Section 6038B(a)(1)(A) Transfers 170
D. Failure to Comply with Reporting Requirements 175
E. General Reporting and Recordkeeping Requirements 177
IV. PROPOSED BASIS AND HOLDING PERIOD RULES 184
B. Shareholder's Exchange of Foreign Target Stock for CFC Stock 184
C. P's Stock of S or T Following A Triangular Asset Reorganization 186
D. Examples ............................................................. 190
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PLANNING FOR OUTBOUND TRANSFERS UNDER
THE SECTION 367(A) AND 367(B) REGULATIONS, INCLUDING
EXPATRIATIONS
Bobbe Hirsh, Alan S. Lederman, and Martin B. Tittle
I. SECTION 367(A) OUTBOUND TRANSFERS
Internal Revenue Code Secs. 61 and 368 express sometimes conflicting goals that
mesh and are resolved, at least in part, in Sec. 367(a). Sec. 61 expresses a policy of
worldwide, as opposed to territorial, income taxation. Sec. 368 expresses a policy of
facilitating corporate restructurings as required by business exigencies by exempting
certain corporate reorganizations from taxation. Treas. Reg. Sec. 1.368-1(b). As has
been noted by some commentators, it is possible to utilize Sec. 368 tax-free exchanges,
along with Sec. 351 tax-free organizations and Sec. 332 tax-free liquidations, in the
cross-border context in a manner that does not advance any business interest other than
an escape from U.S. taxation. See, e.g., Samuel C. Thompson, Jr., "Impact of Code
Section 367 and the European Union's 1990 Council Directive on Tax-Free Cross-Border
Mergers and Acquisitions, " 66 U. Cin. L. Rev. 1193, 1209-11 (1998).
The purpose of Sec 367(a) is generally to prevent the tax-free removal of property
from United States taxing jurisdiction when the ability of the U.S. to tax the profits from
that property cannot be preserved, even in cases when the transaction advances a business
interest. Sec. 367(a)(1) denies corporate status to the foreign transferee in Secs. 332, 351,
354, 356, and 361 exchanges when a U.S. person transfers property to a foreign
corporation. Because corporate status is required by those provisions for the transaction
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to qualify for nonrecognition treatment, Section 367(a)(1) causes the transaction to be
taxable by the U.S.
There are two primary exceptions to the application of Sec. 367(a)(1), but each of
them are subject to certain exceptions, and there are also exceptions to those exceptions
that may negate their effect. These nested levels of exceptions will be classified as
primary, secondary, and tertiary.
The first primary exception, the “stock or securities” exception, is found in Sec.
367(a)(2), which provides that, except as provided by regulations, Sec. 367(a)(1) does not
apply to the transfer of stock or securities of a foreign corporation that is a party to an
exchange or reorganization. .
The second exception, the “active trade or business” exception, is found in Sec.
367(a)(3), which provides that, except as provided by regulations, Sec. 367(a)(1) "shall
not apply to any property transferred to a foreign corporation for use by such corporation
in the active conduct of a trade or business outside of the United States." Sec. 367(a)(4)
states that, unless the regulations provide otherwise, a transfer of a partnership interest by
a U.S. person to a foreign corporation is treated as a transfer of that person's "pro rata
share of the assets of the partnership." Not qualifying for this exception are tainted
assets, including Sec. 1221(a) and (c) property (inventory and taxpayer created
copyrights, compositions, and similar property), installment obligations, accounts
receivable, and similar property, foreign currency and foreign currency denominated
property, and property transferred by the lessor of the property. Also not included is
intangible property, the transfer of which is generally subject to its own special rules
under Sec. 367(d) except for outbound Sec. 332 liquidations.
3
Sec. 367(a)(5) is the source of the secondary exception to the Sec. 367(a)(2) and
(3) exceptions. It states that even if the exceptions in Secs. 367(a)(2) or (3) would
otherwise apply, the qualifying outbound transfer will nevertheless be subject to tax
under Sec. 367(a)(1) if it involves "an exchange described in subsection (a) or (b) of
section 361." This secondary exception was initially limited to C, D, F and G asset
However, now that the proposed expansion of A reorganizations to include mergers with
foreign corporations has been made final, this exception applies to them as well. Sec.
367(a)(5) is subject to its own tertiary exception where the transferor is controlled (within
the meaning of Sec. 368(c)) by five or fewer domestic corporations and regulations’ basis
adjustments and other conditions are complied with. In applying the "five or fewer" test,
all members of the same Sec. 1504 affiliated group are treated as one corporation. Sec.
367(a)(5).
Finally, Sec. 367(a)(6) is a catchall provision that allows the Secretary of the
Treasury to exempt additional transactions from the purview of Sec. 367(a)(1) by
regulation. Sec. 367(a)(5) does not contain any reference to Sec. 367(a)(6) and,
therefore, the limitations in 367(a)(5) would not apply to an exception authorized under
Sec. 367(a)(6).
For purposes of these provisions, a "U.S. person" includes U.S. citizens or
residents and domestic partnerships, corporations, trusts and estates. See Treas. Reg.
Secs. 1.367(a)-3(c)(5)(iv) and 1.367(a)-1T(d)(1); I.R.C. Secs. 6013(g)-(h) and
7701(a)(30). A nonresident alien and a foreign corporation are not U.S. persons even if
they are engaged in a U.S. trade or business.
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A "foreign corporation" is any corporation that is not created or organized in or
under the laws of the United States or a state. I.R.C. Sec.7701(a)(3) and (5); Treas. Reg.
Sec. 301.7701-5. Whether an entity is a corporation is determined under the "check-the-
box" regulations. Treas. Reg. Secs. 301.7701-1 and 301.7701-2. A foreign corporation in
which more than 50% of the stock, by vote or value, is owned directly, indirectly or
constructively by U.S. shareholders, as defined in Sec. 951(b), is a "controlled foreign
corporation" (CFC), although the ownership threshold is reduce to more than 25% in the
case of a foreign insurance company. Sec. 957
Only transfers described in Secs. 332, 351, 354, 356 or 361 are subject to Sec.
367(a). Outbound Sec. 355 distributions are excluded from the coverage of Sec. 367(a).
They are governed by Sec. 367(e)(1). As noted, Sec. 367(a) does not apply to outbound
transfers of intangible property (within the meaning of Sec. 936(h)(3)(B)) as they are
governed by Sec. 367(d). In addition, Sec. 367(a) does not apply to deemed Sec. 351
exchanges resulting from a Sec. 304(a)(1) transaction.
A. Transfers
Transfers include not only direct transfers, but also indirect or constructive
transfers. Direct transfers include B reorganizations (exchanges of stock for voting
stock), A and C reorganizations (exchanges of assets for voting stock), acquisitive D
reorganizations (exchanges of assets for stock of a commonly controlled acquirer) and
transfers to controlled corporations (Sec. 351).
Historically, regulations issued under Sec. 368(a)(1)(A) and its predecessors have
(with minor variations) interpreted the phrase "statutory merger or consolidation" to
apply only to a merger or consolidation effected pursuant to the laws of the United States
5
or of a State or the District of Columbia. Based on these regulations, Rev. Rul. 57-465,
1957-2 C.B. 250, held that a merger accomplished under foreign law could not qualify as
an A reorganization.
The requirement that a merger be effected under U.S. law generally was
understood (or at least assumed) to mean that a merger of two corporations could qualify
as an A reorganization only if both corporations were domestic. Where either or both of
the corporations was foreign, it was generally understood (or at least assumed) that the
transaction would qualify for tax-free treatment, if at all, only as a C or D reorganization.
Pursuant to Treas. Reg. Sec. 1.368-2(b)(1)(ii), a statutory merger or consolidation
is now defined as "a transaction effected pursuant to the statute or statutes necessary to
effect the merger or consolidation," provided that, pursuant to such statute or statutes, the
following occur simultaneously: (1) all of the assets (other than those distributed in the
transaction) and liabilities (except to the extent satisfied or discharged in the transaction)
of the target corporation (and its disregarded entities) become the assets and liabilities of
the acquiring corporation (and its disregarded entities), and (2) the target corporation
ceases its separate legal existence for all purposes (except for certain litigation purposes
relating to assets or obligations arising, or relating to activities engaged in, prior to the
transaction).
Under the new regulations, mergers involving foreign corporations can qualify as
A reorganizations. A merger must still satisfy the requirements of Sec. 367(a), however,
to achieve non-recognition treatment. Notably, a shareholder's transfer of stock pursuant
to a merger (or other reorganization) may constitute an indirect transfer subject to Sec.
367(a) in certain circumstances.
6
Indirect transfers subject to Sec. 367(a) include certain triangular A, B, or C
reorganizations, as well as certain asset reorganizations followed by a contribution of
assets to a controlled subsidiary. These are discussed in Section E.3, below.
Note: An "asset reorganization," for purposes of Treas. Reg. Sec. 1.367(a)-3, "is
defined as a reorganization described in Sec. 368(a)(1) involving a transfer of assets
under Sec. 361." Treas. Reg. Sec. 1.367(a)-3(a).
Treas. Reg. Sec. 1.367(a)-3(a) directs readers to Treas. Reg. Sec. 1.367(a)-1T(c)
for "rules regarding other indirect or constructive transfers of stock or securities subject
to Sec. 367(a)." The general rule in Treas. Reg. Sec. 1.367(a)-1T(c) is a broad, "catchall"
rule that provides that Sec. 367(a)(1) applies to any "transfer of property by a U.S. person
to a foreign corporation pursuant to an exchange described in Sec. 332, 351, 354, 355,
356, or 361 . . . whether it is made directly, indirectly, or constructively." Sec. 1.367(a)-
1T(c)(1). The intent and effect of this Catchall Rule has been synthesized as: "If, at the
end of the day, assets of the target corporation reside in a corporation other than the
foreign corporation, the stock of which was used to acquire such assets, the stock transfer
rules of Sec. 367(a)(1) should apply to that acquisition with respect to those assets that lie
outside the corporate solution of such foreign corporation." See Bernard T. ["Nardi"]
Bress, "The New Section 367 Regulations: Going Beyond Form Over Substance," 9 J.
Int'l Tax'n 10, 21 (October 1998). The Catchall Rule "gives the [I.R.S.] general authority
to recast any asset acquisition, not just those [in Sec. 1.367(a)-3(d)(1)], as indirect stock
transfers for Sec. 367(a)(1) purposes." Id.
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The Catchall Rule ends by directing the reader to five nonexclusive examples, in
subparagraphs (3) through (7) of Sec. 1.367(a)-1T(c), of "indirect or constructive
transfers that are described in Sec. 367(a)(1)."
First, a transfer by a domestic or foreign partnership is treated as an indirect
transfer by the U.S. partners of their proportionate shares of the partnership's property.
The U.S. partners' proportionate shares are determined under Secs. 701 through 761.
Thus, where a partnership has five equal partners, two of whom are U.S. persons, and the
partnership transfers assets to a foreign corporation in an exchange described in Sec. 351,
the exchange is considered an indirect transfer of those assets by each of the partners,
with the consequence that each U.S. partner is treated as transferring 20% of each asset to
the foreign corporation.
If a U.S. partner recognizes gain on the partnership's transfer of property to the
foreign corporation, then the U.S. partner's basis in the partnership is increased by the
amount of gain recognized, the foreign corporation's basis in the assets received is also
increased by the amount of gain recognized, and solely for purposes of determining the
partnership's basis in the stock of the foreign corporation, the U.S. partner is treated as
having newly acquired an interest in the partnership, thereby permitting the partnership to
make an optional adjustment to basis under Secs. 743 and 754. Treas. Reg. Sec. 1.367(a)-
1T(c)(3).
A transfer under Sec. 367(a) by a U.S. partner of an interest in a domestic or
foreign partnership is treated as an indirect transfer of a proportionate share of the
partnership's property in an exchange described in Sec. 367(a). Therefore, the application
of the exceptions to Sec. 367(a)(1) are determined with reference to the property of the
8
partnership, rather than the partnership interest itself. A U.S. partner's proportionate
share of the partnership's property is determined under Secs. 701 through 761. Thus, for
example, when a U.S. person who owns a 20% interest in a partnership transfers a 5%
interest in the partnership to a foreign corporation in an exchange described in Sec. 351,
the exchange is treated as an indirect transfer of the partnership's assets, and the partner is
thereby treated as transferring a 5% interest in each of the assets to the foreign
corporation.
If a U.S. partner is treated as transferring a proportionate share of the partnership's
property, then his basis for the stock of the foreign corporation is increased by the amount
of any gain recognized, the foreign corporation's basis in the partnership interest is also
increased by the amount of any gain recognized, and solely for purposes of determining
the partnership's basis in its property, the U.S. partner is treated as having newly acquired
an interest in the partnership for an amount equal to the gain recognized, thereby
permitting the partnership to make an optional adjustment to basis under Secs. 743 and
754. Treas. Reg. Sec. 1.367(a)-1T(c)(3).
The foregoing rule on the transfer of a partnership interest does not apply if the
interest transferred is a limited partnership interest that is regularly traded on an
established securities market. Treas. Reg. Sec. 1.367(a)-1T(c)(3). Instead, the transfer is
treated as a transfer of stock or securities. The partnership must be organized under the
laws of a state or the District of Columbia. An established securities market is a national
securities exchange registered under the Securities Act of 1934, a foreign national
securities exchange that is officially recognized, sanctioned or supervised by
governmental authority, or an over-the-counter market. A class of interests is regularly
9
traded if it is regularly quoted by brokers or dealers making a market in such interests. A
class of interests is presumed to be regularly traded if the partnership has 500 or more
partners.
Second, a transfer by a U.S. trust or estate is treated as a transfer by the entity,
not by its beneficiaries. Thus, a transfer by a foreign trust or estate is not subject to Sec.
367(a) even if the beneficiaries of the trust or estate are U.S. persons. However, if the
trust is a grantor trust, whether domestic or foreign, the grantor is treated as the
transferor. Treas. Reg. Sec. 1.367(a)-1T(c)(4).
Third, termination of a Sec. 1504(d) election is treated as a constructive transfer
to a foreign corporation. Treas. Reg. Sec. 1.367(a)-1T(c)(5).
Fourth, if a foreign entity is classified for U.S. tax purposes as an entity that is not
taxable as a corporation, and subsequently a change is made in the entity's governing
documents, articles, or agreements so that it thereafter is taxable as a corporation, the
change in classification is considered a transfer of property to a foreign corporation in
connection with an exchange described in Sec. 351 that may be subject to Sec. 367(a).
Treas. Reg. Sec. 1.367(a)-1T(c)(6).
Finally, a contribution to the capital of a foreign corporation may be a transfer
described in Sec. 367(a)(1) if the foreign corporations is controlled by the contributing
entity See Sec. 367(c)(2) and the regulations thereunder. This provision could be
important if the contributing entity already owns all the stock of the foreign controlled
corporation.
B. Tax Consequences Under Sec. 367(a)
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If a transfer is subject to Sec. 367(a) and an exception does not apply, then the
foreign corporation is not treated as a corporation under any of the nonrecognition
provisions. Accordingly, gain is recognized as if there had been a taxable sale of the
property transferred. No loss, however, may be recognized. Treas. Reg. Sec. 1.367(a)-
1T(b)(3)(ii). The gain required to be recognized, however, cannot exceed the gain that
would have been recognized on a taxable sale computed as if each item of property had
been sold individually and with no offset of individual losses against individual gains.
Treas. Reg. Sec. 1.367(a)-1T(b)(3)(i).
The character and source of the gain are determined as if the property were sold in
a taxable transaction to the transferee foreign corporation. If the realized gain exceeds
the limitation, then the limitation is applied by making proportionate reductions in the
amounts of ordinary income and capital gain. Further, appropriate adjustments to
earnings and profits, basis, and other affected items are to be made, taking into account
the gain recognized. Treas. Reg. Sec. 1.367(a)-1T(b)(4). For example, when a domestic
corporation transfers inventory with a fair market value of $1 million and an adjusted
basis of $800,000 to a foreign corporation in an exchange described in Sec. 351, with title
passing in the United States, the corporation is required under Sec. 367(a)(1) to recognize
a gain of $200,000. This gain is treated as ordinary income under Secs. 1201 and 1221
from sources within the United States. The domestic corporation's basis in the foreign
corporation's stock is increased by the $200,000 gain recognized, and the foreign
corporation's basis in the inventory is also increased by the $200,000 gain recognized.
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C. Sec. 367(a)(2) - Foreign Stock or Securities Exception
The first statutory exception to Sec. 367(a)(1) is for transfers of foreign stock.
Except for certain transfers by corporations described above, a transfer by a U.S. person
of stock or securities of a foreign corporation to another foreign corporation is not subject
to Sec. 367(a)(1) if either of the following conditions is met:
1. The U.S. person owns less than 5% (applying the attribution rules
of Sec. 318, as modified by Sec. 958(b)) of both the total voting power and the total value
of the stock of the transferee foreign corporation immediately after the transfer; or
2. The U.S. person enters into a five-year gain recognition agreement
with respect to the transferred stock or securities.
Treas. Reg. Sec. 1.367(a)-3(b).
In certain circumstances, a transfer of domestic stock is deemed to be a transfer of
foreign stock. See Section E.3.b(7).
If a transfer of foreign stock or securities is described in both Sec. 367(a) and
Sec. 367(b), the regulations generally provide that the transfer will be subject to both
provisions. Treas. Reg. Sec. 1.367(a)-3(b)(2)(i). This general, "overlap" rule, however, is
subject to two important exceptions.
Under the first exception, Sec. 367(b) will not apply if a foreign corporation is not
treated as a corporation under Sec. 367(a)(1). Treas. Reg. Sec. 1.367(a)-3(b)(2)(i)(A).
Treas. Reg. Sec. 1.367(a)-3(b)(2)(ii) provides the following example: Assume that a
domestic corporation owns all of the stock of a CFC, its basis in the foreign corporation's
stock is $50, the value of the foreign corporation's stock is $100, and the Sec. 1248
amount with respect to the foreign corporation's stock is $30. If an unrelated foreign
12
corporation that is not a CFC acquires all of the foreign corporation's stock from the
domestic corporation in exchange for 20% of the voting stock of the unrelated foreign
corporation in a Sec. 368(a)(1)(B) reorganization, the domestic corporation must enter
into a five-year gain recognition agreement, or else it will be required to recognize the
$50 gain that it realized on the exchange, $30 of which will be treated as a dividend under
Sec. 1248. However, if it enters into a five-year gain recognition agreement, although no
gain will be recognized under Sec. 367(a)(1), the exchange will still be subject to Sec.
367(b). Therefore, the domestic corporation will be required to recognize the Sec. 1248
amount of $30 on the exchange. See Section II, below. The deemed dividend of $30 that
is recognized by the domestic corporation will increase its basis in the foreign
corporation's stock that it receives in the exchange. Treas. Reg. Sec. 1.367(a)-3(b)(2)(ii).
Under the second "overlap" exception, only Sec. 367(b) will apply in the case of
an inbound triangular asset reorganization to which the indirect stock transfer rules would
otherwise apply if the "all earnings and profit amount" triggered under Sec. 367(b) is
greater than the gain that would be subject to Sec. 367(a). Treas. Reg. Sec. 1.367(a)-
3(b)(2)(i)(B).
Note: Under prior regulations, Sec. 367(b) and the regulations thereunder did not
apply if the transferee corporation was not treated as a corporation under Sec. 367(a).
Therefore, if the all earnings and profits amount was greater than the Sec. 367(a) gain, an
exchanging shareholder was permitted to choose to trigger gain under Sec. 367(a), by
opting not to enter into a gain recognition agreement, in order to avoid inclusion of the all
earnings and profits amount. The current regulations do not permit taxpayers to avoid
13
Sec. 367(b) in this manner. (For a definition of the term "all earning and profits amount,"
see Section II below.)
D. Section 367(a)(3) - Active Trade or Business Exception
The second statutory exception to Sec. 367(a)(1) is for transfers of property that
will be used by the transferee foreign corporation in the active conduct of a trade or
business outside the United States. Sec. 367(a)(3). Although the meaning of "property"
in the context of Sec. 367(a)(3) has been debated in the past, it is now accepted that it
includes stock and securities, and that Sec. 367(a)(3) is the basis for preserving
nonrecognition in the case of outbound transfers of domestic stock. See Phillip Tretiak,
"U.S. Section 367(a) Stock Transfers in 1998: All You Need to Know!" 17 Tax Notes
Int'l 39, 40 n.8 (July 6, 1998); Bernard T. Bress, "The New Section 367 Regulations:
Going Beyond Form Over Substance," 9 J. Int'l Tax'n 10, 21-22 (October 1998). (Philip
Tretiak was the author of the 1998 final Sec. 367 regulations.)
To qualify for the Sec. 367(a)(3) exception, the Sec. 6038B reporting
requirements must be satisfied. Treas. Reg. Sec. 1.367(a)-2T(a)(2). See Section III.A
below for a discussion of these reporting requirements.
1. Active Conduct of a Trade or Business
Whether property is transferred for use in the active conduct of a trade or business
outside the United States requires four factual determinations:
a. What is the trade or business of the transferee?
b. Do the activities of the transferee constitute the active
conduct of that trade or business?
c. Is the trade or business conducted outside the U.S.?
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d. Is the transferred property used or held for use in the trade
or business?
Treas. Reg. Sec. 1.367(a)-2T(b)(1). Each of these determinations is made taking into
account all facts and circumstances.
A trade or business is a specific unified group of activities that constitute, or could
constitute, an independent economic enterprise carried on for profit. For example, the
activities of a foreign selling subsidiary could constitute a trade or business if they could
be independently carried on for profit, even though the subsidiary acts exclusively on
behalf of, and has operations fully integrated with, its parent corporation. The group of
activities must ordinarily include every operation that forms a part of, or a step in, a
process by which an enterprise may earn income or profit, and must ordinarily include
the collection of income and the payment of expenses. The holding for one's own
account of investments in stocks, securities, land, or other property, including casual sales
thereof, does not constitute by itself a trade or business. Likewise, any activity giving
rise to expenses that would be deductible only under Sec. 212, if the activity were
conducted by an individual, does not constitute a trade or business. Treas. Reg. Sec.
1.367(a)-2T(b)(2). For a trade or business to be actively conducted, the officers and
employees of the corporation must carry out substantial managerial and operational
activities. In making this determination, the activities of independent contractors are
disregarded, although incidental activities may be carried out on behalf of the corporation
by independent contractors. The officers and employees of the corporation include
officers and employees of related entities that are available to, supervised by, and are paid
or reimbursed by the corporation. Whether a trade or business that produces rents or
15
royalties is an active trade or business is determined under the principles of Treas. Reg.
Sec. 1.954-2(d)(1), without regard to whether the rents or royalties are received from an
unrelated person. Treas. Reg. Sec. 1.367(a)-2T(b)(3).
For a trade or business to be conducted outside the United States, the primary
managerial and operational activities must be conducted outside the United States, and
the transferred property must be located outside the U.S. immediately after the transfer.
Thus, the active trade or business exception will not apply if the domestic business
continues to operate in the United States after the transfer. As long as the primary
managerial and operational activities of the trade or business are conducted outside the
Unites States and substantially all of the transferred property is located outside the United
States, incidental items of transferred property may be located in the United States. Treas.
Reg. Sec. 1.367(a)-2T(b)(4).
Property is used or held for use in a foreign corporation's trade or business if it is:
a. Held for the principal purpose of promoting the present
conduct of the trade or business;
b. Acquired and held in the ordinary course of the trade or
business, or
c. Otherwise held in a direct relationship to the trade or
business. Property is considered held in a direct relationship to a trade or business if it is
held to meet the present needs of the trade or business, and not its anticipated future
needs. Thus, property held for future diversification into a new trade or business, future
expansion of a trade or business, future plant replacement, or future business
16
contingencies is not held in a direct relationship to a trade or business. Treas. Reg. Sec.
1.367(a)-2T(b)(5).
If the transferee foreign corporation transfers the property to another person as
part of the same transaction in which it received the property, the initial transfer will not
qualify for the active trade or business exception. A transfer within six months of the
initial transfer will be considered part of the same transaction. Whether a transfer more
than six months after the initial transfer is considered part of the same transaction will be
determined under the step transaction doctrine. Notwithstanding, the active trade or
business exception will apply if the subsequent transfer is to a controlled corporation
under Sec. 351 or a partnership under Sec. 721, each subsequent transferee is either a
corporation in which the preceding transferor owns common stock, or a partnership in
which the preceding transferor is a general partner, and the ultimate transferee uses the
property in the active conduct of a trade or business outside the United States. Treas. Reg.
Sec. 1.367(a)-2T(c).
2. Exceptions
The Code contains a number of exceptions to the active trade or business
exception. In addition, the Internal Revenue Service has promulgated regulatory
exceptions under the authority granted by Sec. 367(a)(3).
a. Tainted Assets
The active trade or business exception does not apply to transfers of tainted assets,
which are five categories of liquid or passive assets. I.R.C Sec. 367(a)(3)(B).
Inventory, Copyrights and Similar Property.
17
Regardless of its use in an active trade or business, Sec. 367(a)(1) applies to the
transfer of stock in trade, property of a kind which would properly be included in
inventory if on hand at the close of the taxable year, and property held primarily for sale
to customers in the ordinary course of business. Inventory includes raw materials and
supplies, partially completed goods, and finished products. Also subject to Sec. 367(a)(1)
are copyrights; literary, musical, or artistic compositions; letters or memoranda; and
similar property held by the person whose personal efforts created such property. In the
case of a letter, memorandum, or similar property, the property must be held by the
person from whom such property was prepared or produced. This property is also subject
to Sec. 367(a)(1) if it is held by a person whose basis for such property is determined, for
purposes of determining gain from a sale or exchange, by reference to the basis of such
property in the hands of the person who created it or from whom it was prepared or
created. Treas. Reg. Sec. 1.367(a)-5T(b).
Installment Obligations.
Regardless of their use in an active trade or business, Sec. 367(a)(1) applies to the
transfer of installment obligations, accounts receivable, or similar property, but only to
the extent that the principal amount of such obligation has not previously been included
by the transferor in its taxable income. Treas. Reg. Sec. 1.367(a)-5T(c).
Foreign Currency.Regardless of its use in an active trade or business, Sec. 367(a)(1)
applies to the transfer of foreign currency or other property denominated in foreign
currency, including installment obligations, futures contracts, forward contracts, accounts
receivable, or any other obligation entitling its payee to receive payment in a currency
other than U.S. dollars. However, if the transferred property is denominated in the
18
currency of the country in which the transferee foreign corporation is organized, and was
acquired in the ordinary course of the transferor's business that will be carried on by the
transferee foreign corporation, then Sec. 367(a)(1) will apply only to the extent that gain
is required to be recognized with respect to previously realized income reflected in
installment obligations, as described above. The gain required to be recognized is limited
to the gain realized upon the transfer of foreign currency and property denominated in
foreign currency, minus any loss realized as part of the same transaction upon the transfer
of such property. However, if the result is a loss, it will not be recognized. Treas. Reg.
Sec. 1.367(a)-5T(d).
Intangible Property.Regardless of its use in an active trade or business, a transfer of
intangible property pursuant to Sec. 332 is subject to Sec. 367(a)(1) unless it constitutes
foreign goodwill or going concern value. Treas. Reg. Sec. 1.367(a)-5T(e). Outbound
transfers of intangible property pursuant to Sec. 351 or Sec. 361 are governed by Sec.
367(d).
Leased Tangible Property.Regardless of its use in an active trade or business, Sec.
367(a)(1) applies to a transfer of tangible property leased by the transferor to others at the
time of the transfer, unless either of the following two conditions is met.
(1) If the transferee will not lease the property to third
parties, the transferee was the lessee of the property at the time of the transfer, or
(2) If the transferee will lease the property to third
parties, the transferee satisfies the conditions for an active leasing business described
below.
Treas. Reg. Sec. 1.367(a)-5T(f).
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b. Foreign Branches
The active trade or business exception may not apply to a gain realized on a
transfer of the assets of a foreign branch of a U.S. person if the foreign branch previously
deducted losses. Sec. 367(a)(3)(C). A foreign branch is an integral business operation
carried on by a U.S. person outside the United States. Whether the activities of a U.S.
person outside the United States constitute a foreign branch operation is determined
under all the facts and circumstances. Evidence of the existence of a foreign branch
includes, but is not limited to, the existence of a separate set of books and records and the
existence of an office or other fixed place of business used by employees or officers of
the U.S. person to carry out business activities outside the United States. Activities
outside the United States constitute a foreign branch if the activities constitute a
permanent establishment under the terms of a treaty between the United States and the
country in which the activities are conducted. Treas. Reg. Sec. 1.367(a)-6T(g)(1).
If a U.S. person has more than one foreign branch, then this exception applies
separately to each foreign branch that is transferred to a foreign corporation. Thus, the
previously deducted losses of one foreign branch may not be offset, for purposes of
determining the gain to be recognized, by the income of another foreign branch that is
also transferred to a foreign corporation. Similarly, the losses of one foreign branch are
not recaptured on a transfer of the assets of a separate foreign branch. Whether the
foreign activities of a U.S. person are conducted through more than one foreign branch is
determined under all the facts and circumstances. A separate branch generally exists if a
particular group of activities is sufficiently integrated to constitute a single business that
could be operated as an independent enterprise. Treas. Reg. Sec. 1.367(a)-6T(g)(2).
20
The activities of two domestic corporations outside the United States will be
considered a single foreign branch if the two corporations are members of the same
consolidated group of corporations, and the activities of the two corporations in the
aggregate would constitute a single foreign branch if conducted by a single corporation.
Notwithstanding, gains of a foreign branch of a domestic corporation arising in a year in
which that corporation did not file a consolidated return with the second domestic
corporation cannot be applied to reduce the previously deducted losses of the foreign
branch of the second corporation, but may be applied to reduce such losses of the foreign
branch of the first corporation upon the transfer of the two branches to a foreign
corporation, even though the two domestic corporations file a consolidated return for the
year in which the transfer occurs and the two branches are considered at that time to
constitute a single foreign branch. Treas. Reg. Sec. 1.367(a)-6T(g)(3).
A U.S. transferor's failure to transfer any property of a foreign branch to the
foreign corporation is irrelevant to the determination of the previously deducted losses of
the branch that are subject to recapture. Thus, if the activities with respect to property
constituted a part of the branch operation, then the losses generated by those activities
will be subject to recapture, notwithstanding the lack of a transfer of thee property. Treas.
Reg. Sec. 1.367(a)-6T(g)(4).
Gain recognition is required in an amount equal to the sum of the "previously
deducted branch ordinary losses" and the "previously deducted branch capital losses."
Treas. Reg. Sec. 1.367(a)-6T(b). The gains recognized retain their character as ordinary
or capital, all capital gains are long-term, and all are treated as from sources outside the
U.S. The previously deducted branch losses are computed separately for each taxable
21
year prior to the transfer (a "branch loss year"), and are calculated separately for the
previously deducted branch ordinary loss and the previously deducted branch capital loss.
Treas. Reg. Sec. 1.367(a)-6T(c).
The previously deducted branch ordinary loss for each branch loss year is then
reduced by the amount of any expired net ordinary loss with respect to that branch loss
year. Expired net ordinary losses arising in years other than the branch loss year reduce
the previously deducted branch ordinary loss for the branch loss year only to the extent
that the previously deducted branch ordinary loss exceeds the net operating loss, if any,
incurred by the transferor in the branch loss year. The previously deducted branch
ordinary losses are reduced in order, proceeding from the first branch loss year to the last
branch loss year. For each branch loss year, expired net operating losses are applied in
the order in which they arose. Treas. Reg. Sec. 1.367(a)-6T(d)(2).
An expired net ordinary loss exists with respect to a branch loss year to the extent
that:
• The transferor incurred a net operating loss;
• The net operating loss arose in the branch loss year or was available for
carryover or carryback to the branch loss year;
• The net operating loss did not result in a net operating loss deduction for any
taxable year prior to the year of the transfer, nor reduce any previously
deducted branch ordinary loss of any foreign branch previously transferred to
a foreign corporation; and
• The period during which the transferor can claim a net operating loss
deduction for that net operating loss has expired.
22
Treas. Reg. Sec. 1.367(a)-6T(d)(2)(ii).
The previously deducted branch capital loss for each branch loss year is similarly
reduced by the amount of any expired net capital loss with respect to that branch loss
year. Expired net capital losses arising in years other than the branch loss year reduce the
previously deducted branch capital loss for the branch loss year only to the extent that the
previously deducted branch capital loss exceeds the net capital loss, if any, incurred by
the transferor in the branch loss year. The previously deducted branch capital losses are
reduced in order, proceeding from the first branch loss year to the last branch loss year.
For each branch loss year, expired net capital losses are applied in the order in which they
arose. Treas. Reg. Sec. 1.367(a)-6T(d)(3).
An expired net capital loss exists with respect to a branch loss year to the extent
that the transferor incurred a net capital loss, that net capital loss arose in the branch loss
year or was available for carryover or carryback to the branch loss year, the net capital
loss was neither allowed for any taxable year prior to the year of the transfer, nor reduced
any previously deducted branch capital loss of any foreign branch previously transferred
to a foreign corporation, and the period during which the transferor can claim a capital
loss deduction with respect to that net capital loss has expired. Treas. Reg. Sec. 1.367(a)-
6T(d)(3)(ii).
After the reductions for expired net operating and capital losses, the previously
deducted branch ordinary loss and the previously deducted branch capital loss for each
branch loss year are further reduced proportionately by the amount of any expired foreign
tax credit loss equivalent with respect to that branch loss year. The previously deducted
branch losses are reduced in order, proceeding from the first branch loss year to the last
23
branch loss year. For each branch loss year, expired foreign tax credit loss equivalents
are applied to reduce the previously deducted branch loss for that year in the order in
which the expired foreign tax credits arose. Treas. Reg. Sec. 1.367(a)-6T(d)(4).
A foreign tax credit loss equivalent exists with respect to a branch loss year if:
(A) The transferor paid, accrued, or is deemed to have paid creditable foreign
taxes in a taxable year;
(B) The creditable foreign taxes were paid, accrued, or deemed paid in the
branch loss year or were available for carryover or carryback to the branch loss
year;
(C) No foreign tax credit with respect to the foreign taxes paid, accrued, or
deemed paid was taken, and such taxes did not reduce any previously deducted
branch loss of the foreign branch for a prior taxable year or of any previously
deducted branch losses of any foreign branch previously transferred to a foreign
corporation; and
(D) The period during which the transferor can claim a foreign tax credit for
the foreign taxes paid, accrued, or deemed paid has expired.
Treas. Reg. Sec. 1.367(a)-6T(d)(4)(ii).
The amount of the foreign tax credit loss equivalent for a branch loss year is the
amount of creditable foreign taxes divided by the highest rate of tax to which the
transferor was subject in the branch loss year. Treas. Reg. Sec. 1.367(a)-6T(d)(4)(iii).
The previously deducted branch ordinary loss and the previously deducted branch
capital loss for each branch loss year are then further reduced proportionately by the
amount of any expired investment credit loss equivalent with respect to that branch year.
24
The previously deducted branch losses are reduced in order, proceeding from the first
branch loss year to the last branch loss year. For each branch loss year, expired
investment credit loss equivalents are applied to reduce the previously deducted branch
loss for that year in the order in which the expired investment credits were earned. Treas.
Reg. Sec. 1.367(a)-6T(d)(5).
An investment credit loss equivalent exists with respect to a branch loss year if:
(A) The transferor earned an investment credit;
(B) The investment credit was earned in the branch loss year or was available
for carryover or carryback to the branch loss year;
(C) The investment credit earned by the transferor in the credit year did not
reduce any previously deducted branch loss of the foreign branch for a preceding
taxable year or of the previously deducted losses of any foreign branch previously
transferred to a foreign corporation; and
(D) The period during which the transferor can claim the investment credit
has expired.
Treas. Reg. Sec. 1.367(a)-6T(d)(5)(ii).
The amount of the investment credit loss equivalent for the branch loss year is 85% of the
amount of the investment credit divided by the highest rate of tax to which the transferor
was subject in the branch loss year. Treas. Reg. Sec. 1.367(a)-6T(d)(5)(iii).
Five additional amounts further reduce the sum of the previously deducted branch
ordinary losses and the sum of the previously deducted branch capital losses as
determined above. Treas. Reg. Sec. 1.367(a)-6T(e). Amounts representing ordinary
income first reduce the sum of the previously deducted branch ordinary losses and then
25
the sum of the previously deducted branch capital losses. Similarly, amounts
representing capital gains first reduce the sum of the previously deducted branch capital
losses and then the sum of the previously deducted branch ordinary losses. These five
amounts are as follows:
(A) Any taxable income of the foreign branch recognized through the close of the
taxable year of the transfer, whether before or after any taxable year in which losses were
incurred.
(B) Any amount recognized under Sec. 904(f)(3) due to the transfer.
(C) Any gain recognized under Sec. 367(a)(1) (other than under this foreign branch
rule) on the transfer of the assets of the foreign branch to the foreign corporation.
(D) Any portion of any amount recognized under Sec. 904(f)(3) upon a previous
transfer of property that was attributable to the losses of the foreign branch, provided that
the amount did not reduce any gain otherwise required to be recognized under Sec.
367(a)(3)(C).
(E) Any amounts previously recognized upon a previous transfer of assets of the
foreign branch.
d. Section 361 Transfers
The active trade or business exception also does not apply to a Sec. 361 exchange
(exchanges by corporations of property for stock). Sec. 367(a)(5). However, the active
trade or business exception will apply if five or fewer domestic corporations control
(within the meaning of Sec. 368(c)) the transferor. All members of the same affiliated
group (within the meaning of Sec. 1504) are treated as one corporation for this purpose.
Sec. 367(a)(5). Although this control group exception is subject to basis adjustments and
26
the satisfaction of other conditions to be prescribed in regulations, no regulations have
been issued.
c. Depreciated Property
If depreciated U.S. property is transferred to a foreign corporation in an exchange
described in Sec. 367(a)(1), then the transferor must recognize ordinary income even
though the property will be used in the active conduct of a trade or business outside the
United States. The amount includable in gross income is the amount that would have
been includable in the transferor's gross income as ordinary income under Secs.
617(d)(1), 1245(a), 1250(a), 1252(a), or 1254(a), whichever is applicable, had the
transferor sold the property for its fair market value in a taxable transaction. The active
trade or business exception will apply to any realized gain in excess of the required
depreciation recapture. Treas. Reg. Sec. 1.367(a)-4T(b). Depreciated U.S. property is
mining property defined in Sec. 617(f)(2), Sec. 1245 property, Sec. 1250 property, farm
land defined in Sec. 1252(a)(2), or oil, gas, or geothermal property, any of which was
used in the United States or qualified as Sec. 38 property prior to its transfer. Treas. Reg.
Sec. 1.367(a)-4T(b)(2).
If depreciated U.S. property was used partly within and partly without the United
States, then the amount required to be included in ordinary income is the full recapture
amount times a fraction, the numerator of which is U.S. use and the denominator of
which is total use. The full recapture amount is the amount that would be included in the
transferor's income if the property had been used entirely in the United States. U.S. use is
the number of months that the property either was used in the United States or qualified
27
as Sec. 38 property, and total use is the total number of months that the property was used
(or available for use) by the transferor or a related person.
d. Leased Property
Tangible property (including non-U.S. real property) transferred to a foreign
corporation for lease to others will be used in the active conduct of a trade or business
outside the United States only if the following three conditions are met:
(1) The foreign corporation's leasing of the property
constitutes the active conduct of a leasing business;
(2) The lessee is not expected to, and does not use the
property in the United States; and
(3) The foreign corporation has need for substantial
investment in assets of the type transferred.
The active conduct of a leasing business requires that the employees of the
foreign corporation perform substantial marketing, customer service, repair and
maintenance, and other substantial operational activities with respect to the transferred
property outside of the United States. Treas. Reg. Sec. 1.367(a)-4T(c)(1).
Tangible property that will be used by the foreign corporation in the active
conduct of a trade or business, but will be leased during occasional brief periods when the
property would otherwise be idle, qualifies for the active trade or business exception.
Similarly, real property located outside the United States that is transferred to a foreign
corporation for use primarily in the active conduct of a trade or business qualifies for the
active trade or business exception if no more than 10% of the square footage of the
property will be leased to others. Treas. Reg. Sec. 1.367(a)-4T(c)(2).
28
e. Property to be Sold
Property will not qualify for the active trade or business exception if, at the time
of the transfer, it is reasonable to believe that in the reasonably foreseeable future the
foreign corporation will sell or otherwise dispose of any material portion of the
transferred property other than in the ordinary course of business. Treas. Reg. Sec.
1.367(a)-4T(d).
f. Working Interest in Oil and Gas Properties
A working interest in oil and gas properties will be considered to be transferred
for use in the active conduct of a trade or business if:
(1) The transfer satisfies the detailed conditions set
forth in Treas. Reg. Sec. 1.367(a)-4T(e)(2);
(2) At the time of the transfer, the foreign corporation
has no intention to farm out or otherwise transfer any part of the transferred working
interest; and
(3) During the first three years after the transfer there
are no farmouts or other transfers of any part of the transferred working interest as a
result of which the foreign corporation retains less than a 50% share of the transferred
working interest.
Treas. Reg. Sec. 1.367(a)-4T(e)(1).
g. Compulsory Transfers
29
Property that was previously used in the country in which the transferee foreign
corporation is organized will be presumed to be transferred for use in the active conduct
of a trade or business outside of the United States, if:
(1) The transfer is legally required by the foreign
government as a necessary condition of doing business in that country; or
(2) The transfer is compelled by a genuine threat of
immediate expropriation by the foreign government.
Treas. Reg. Sec. 1.367(a)-4T(f).
h. Transfers of Certain Property to Foreign Sales Corporations
("FSCs")
Sec. 367(a) does not apply to a transfer of property by a U.S. person to a foreign
corporation that is an FSC if:
(1) The transferee FSC uses the property to generate
exempt foreign trade income;
(2) The property is not excluded property, as defined in
Sec. 927(a)(2); and
(3) The property consists of a corporate name or
tangible property that is appropriate for use in the operation of an FSC office.
The foregoing rule does not apply if, within three years after the original transfer,
the original transferee FSC (or a subsequent transferee FSC) disposes of the property
other than in the ordinary course of business or through a transfer to another FSC. Treas.
Reg. Sec. 1.367(a)-4T(h).
30
As the result of a decision by the World Trade Organization ("WTO") that FSCs
constitute an export subsidy violating WTO agreements, the FSC provisions of the Code
were repealed effective October 1, 2000, for new FSCs and January 1, 2002 for FSCs in
existence on September 30, 2000, except for certain transactions pursuant to a binding
contract that was in effect on September 30, 2000. The Tax Increase Prevention and
Reconciliation Act of 2005 repealed the grandfathering of binding contracts for tax years
beginning after May 17, 2006. See Sec. 513, Pub.L. 109-222 (2006).
E. Treas. Reg. Sec. 1.367(a)-3
Although Treas. Reg. Sec. 1.367(a)-3 briefly addresses the Sec. 367(a)(2) foreign
stock exception, its main focus lies in implementation of the Sec. 367(a)(3) active
business exception with respect to transfers of domestic stock. As noted in Section I.D
above, although the authority for excluding transfers of domestic stock from Sec. 367(a)
has in the past been attributed to Secs. 367(a)(2) or (6), since 1998 it has been generally
conceded to arise from Sec. 367(a)(3), the active trade or business exception. See Phillip
Tretiak, "U.S. Section 367(a) Stock Transfers in 1998: All You Need to Know!" 17 Tax
Notes Int'l 39, 40 n.8 (July 6, 1998); Bernard T. Bress, "The New Section 367
Regulations: Going Beyond Form Over Substance," 9 J. Int'l Tax'n 10, 21-22 (October
1998). (Philip Tretiak was the author of the 1998 final 367 regulations.)
Treas. Reg. Sec. 1.367(a)-3 begins with general statements regarding its purpose
and scope. A transfer of stock or securities by a U.S. person to a foreign corporation that
is described in Sec. 351, 354 (including a reorganization described in Sec. 368(a)(1)(B)
and including an indirect stock transfer described in Sec. 1.367(a)-3(d)), 356 or 361(a) or
(b) is subject to Sec. 367(a)(1) unless an exception in 1.367(a)-3(b), (c), or (e) applies.
31
The 1.367(a)-3(b) exception is discussed in Section I.C, above. The exceptions in
1.367(a)-3(c) and (e) are discussed below in paragraphs 1 and 5 of this Section E.
The 2006 final version of 1.367(a)-3 made the following three changes to the
prior regulation:
1) The prior exception for Sec. 354 exchanges of stock that occur in the course of
Code Sec. 368(a)(1)(E) and certain non-indirect-stock-transfer asset reorganizations is
expanded to include exchanges of both stock and securities under both Sec. 354 and 356.
Treas. Reg. Sec. 1.367(a)-3(a). This change is congruent with the expansion of statutory
mergers to include mergers that occur pursuant to foreign law because Sec. 356 addresses
exchanges that would comply with Sec. 354 except for the presence of "boot," or
consideration in addition to approved stock and securities, and boot is more widely used
in statutory mergers than in those reorganizations addressed in the prior version of Sec.
1.367(a)-3. Treas. Reg. Sec. 1.368-2(b)(1)(ii)-(iii); T.D. 9242 (Jan. 26, 2006).
2) The prior exception for Sec. 354 exchanges that occur in the course of those
Code Sec. 368(a)(1)(C), (D), and (F) reorganizations

that are not recharacterized by the
indirect stock transfer rules of Treas. Reg. Sec. 1.367(a)-3(d) is reframed as an exception
for "asset reorganizations." Treas. Reg. Sec. 1.367(a)-3(a). The term "asset
reorganization" is defined as a Sec. 368(a)(1) reorganization involving a transfer of assets
under Sec. 361. Treas. Reg. Sec. 1.367(a)-3(a).
3) Because a reverse triangular/reverse subsidiary merger frequently involves a
contribution of parent stock to the merging subsidiary as part of the merger, the
expansion of statutory mergers to include foreign corporations raised the possibility that
Sec. 367(a) would apply to the transfer of this stock to a foreign target under Sec. 361.
32
To avoid this result, the 2006 final regulation exempts these transfers. Parent stock not
provided as part of the plan of reorganization will continue to be treated as property of
the subsidiary, and therefore subject to 367(a). Treas. Reg. Sec. 1.367(a)-3(a).
Less than a month following the release of the final Treas. Reg. Sec. 1.367(a)-3
regulations on Jan. 26, 2006, new regulations were issued that amended Treas. Reg. Sec.
1.367(a)-3 to exempt certain Sec. 304(a)(1) transfers by a U.S. person of stock of a
domestic or foreign corporation to a foreign corporation in exchange for stock of such
foreign corporation. Treas. Reg. Sec. 1.367(a)-3(a); T.D. 9250 (Feb. 21, 2006). Sec.
304(a)(1) generally provides that, for purposes of Secs. 302 and 303, if one or more
persons is in control of each of two corporations (i.e., "brother-sister" corporations), and
in return for property, one corporation (the acquiring corporation) acquires stock in the
corporation (the issuing corporation) from the controlling person or persons, then the
property is treated as received as a distribution in redemption of the acquiring
corporation's stock.
To the extent that such distribution is treated as a Sec. 301 dividend, the transferor
is treated as having transferred the stock of the issuing corporation to the acquiring
corporation in a Sec. 351 exchange for stock of the acquiring corporation and the
acquiring corporation is then treated as redeeming the stock that it is treated as having
issued. The distribution is treated as a dividend to the extent of earnings and profits of
the acquiring corporation and then of the issuing corporation. Any remaining portion of
the distribution reduces the adjusted basis of the stock, to the extent that it exceeds such
basis, is treated as gain from the sale or exchange of property. If Sec. 367(a) applied to
the transaction, then a U.S. taxpayer could have multiple income inclusions from the
33
same transaction: first, dividend and/or gain under Sec. 304, and second, dividend and/or
gain equal to the built-in gain in the stock of the issuing corporation under Sec. 367. Such
income inclusions could potentially exceed that value of the transferred stock of the
issuing corporation, which is the reason, along with undue complexity, that the IRS gave
as the rationale for the new regulation.
The IRS reasoning is that the income recognized in a Sec. 304(a)(1) transaction
generally equals or exceeds the transferor's inherent gain in the stock of the issuing
corporation. The IRS, in its explanation of the new provision, denies that it is possible
that the income recognized will not equal or exceed the inherent gain. For example, if the
acquiring and issuing corporations (F1 and F2, respectively) have no earnings and profits,
the stock of the issuing corporation has a positive fair market value (say $100) and is
transferred for consideration equal to such value ($100), and the U.S. shareholder has no
basis in F1 but $100 of basis in F2, the IRS maintains that U.S. shareholder would
recognize the $100 of built-in gain in the F1 stock and continue to have $100 of basis in
the F2 stock that the U.S. shareholder continues to hold. The IRS states that it does not
believe that current law allows the U.S. shareholder to recover its basis in the F2 stock
that it holds, but only the F2 stock deemed to have been received in the Sec. 351(a)
exchange, which would take a basis under Sec. 362 equal to the U.S. shareholder's basis
in the F1 stock. The IRS further announced that this issue will be addressed as part of a
project dealing with the recovery of basis in redemptions treated as Sec. 301 dividends.
The final T.D. 9250, like the earlier proposed regulations (REG-127740-04, 2005-
24 I.R.B. 1254), bifurcates a transfer of issuing stock in return for both property and the
stock of acquiring into two transactions: a transfer for property which is treated as a Sec.
34
351 exchange by reason of Sec. 304(a)(1), and a transfer for stock which is treated as a
Sec. 351 exchange other than by operation of Sec. 304(a)(1). If the sale of stock is for an
amount less than the fair market value of the transferred stock, the acquiring company is
deemed to issue stock to the transferor other than as a result of Sec. 304(a)(1). In both
cases, Sec. 367 would not apply to only the portion of the transaction in which the stock
is treated as transferred for property (i.e., the portion of the transaction treated as a Sec.
351 exchange by operation of Sec. 304), and Sec. 367 would apply to the portion of the
transaction in which the consideration for the issuing corporation's stock is, or is deemed
to be, stock of the acquiring corporation.
The new provisions in T.D. 9250 apply to Sec. 304(a)(1) transactions occurring
on or after February 21, 2006. Taxpayers can also apply them to transactions that
occurred in all their open tax years, but if they elect to do so, they must apply the new
provisions to all of the Sec. 304(a)(1) transactions that took place during all such open tax
years. Any gain recognition agreements (discussed in Section I.E.2 below) that had been
filed for such transactions will terminate and have no further effect.
1. Transfers of Stock or Securities of Domestic Corporations
The paragraphs in this subsection detail the requirements set forth in Treas. Reg.
Sec. 1.367(a)-3(c), "Transfers by U.S. persons of stock or securities of domestic
corporations to foreign corporations."
a. Introduction
The 2006 final version of Sec. 1.367(a)-3 in T.D. 9243 made only one change to
subparagraph (c): The definition of "transferee foreign corporation" in paragraph
(c)(5)(vi) was changed from "the foreign corporation whose stock is received in the
35
exchange by U.S. persons" to "except as provided in [Treas. Reg. Sec. 1.367(a)-3]
(d)(2)(i)(B), . . . the foreign corporation whose stock is received in the exchange by U.S.
persons."
This definition is, unfortunately, at odds with the definition of "transferee foreign
corporation" in 1.367(a)-3(d)(2)(i). That definition reads, "Except as provided in
paragraph [Treas. Reg. Sec. 1.367(a)-3](d)(2)(i)(B), the transferee foreign corporation
shall be the foreign corporation that issues stock or securities to the U.S. person in the
exchange." Treas. Reg. Sec. 1.367(a)-3(d)(2)(i). There does not appear to be any reason
for the omitting the word "securities" in paragraph (c)(5)(vi) when it is included in
paragraph (d)(2)(i), and the version of paragraph (c)(5)(vi) in the 2005 proposed
regulation included the word "securities" and was, in fact, identical to the definition in
paragraph (d)(2)(i).
In light of the implementation of Notice 2005-6, 2005-5 I.R.B. 448, in the 2006
final regulations, it is likely that omission of the word "securities" in paragraph (c)(5)(vi)
was an oversight. See T.D. 9243 (Jan. 26, 2006) at Preamble, Summary of Comments
and Explanation of Provisions, Sec. B.2. Nevertheless, because the I.R.S. stated in the
T.D. 9243 preamble that it intentionally chose to omit "securities" from some provisions
(the example given was Treas. Reg. Sec. 1.367(a)-8(e)(1)(i)), taxpayers and their advisors
would do well to be cautious until guidance is issued addressing this discrepancy in the
definition of "transferee foreign corporation."
There is one unchanged portion of Treas. Reg. Sec. 1.367(a)-3(c) that deserves
mention because it could be confusing to practitioners who are new to this regulation or
who do not deal with it frequently. Paragraph (c) contains two subparagraphs with
36
almost identical title phrases. Paragraph (c)(7), titled "Ownership Statements," sets forth
the procedure for rebutting the presumption in paragraph (c)(2) that all target transferors
are U.S. persons. Paragraph (c)(5)(i), titled "Ownership Statement," outlines the form
and factors to be included in a statement submitted pursuant to paragraph (c)(7).
b. The provisions of Treas. Reg. Sec. 1.367(a)-3(c)
(1) Except as provided in Sec. 367(a)(5), a transfer by a
U.S. person of stock or securities of a domestic corporation to a foreign corporation is not
subject to Sec. 367(a)(1) if the following five conditions are met:
(A) The domestic corporation whose stock or
securities were transferred (the "U.S. target company") complies with the relevant
reporting requirements (see Section I.E.1.b(4) below).
(B) Fifty percent or less of both the total voting
power and the total value of the stock of the transferee foreign corporation is received in
the transaction, in the aggregate, by U.S. transferors (the "50% threshold").
(C) No more than 50% of both the total voting
power and the total value of the stock of the transferee foreign corporation is owned, in
the aggregate, immediately after the transfer by U.S. persons that are either officers or
directors of the U.S. target company or that are 5% target shareholders (i.e., there is no
"control group"). For purposes of this condition, any stock of the transferee foreign
corporation owned by U.S. persons immediately after the transfer is taken into account,
whether or not it was received in the exchange.
37
(D) Either the U.S. person is not a 5% transferee
shareholder, or the U.S. person enters into a five-year gain recognition agreement to
recognize gain with respect to the U.S. target company stock or securities it exchanged.
(E) The active trade or business test is satisfied
(see Section I.E.1.b(3) below).
Treas. Reg. Sec. 1.367(a)-3(c)(1).
For purposes of these conditions, any person who transfers stock or securities of
the U.S. target company is presumed to be a U.S. person unless this presumption is
rebutted, as described below.
(2) Definitions
The following definitions apply in determining whether the five conditions set
forth above are satisfied.
Ownership Statement. An ownership statement is used to rebut the presumption
of ownership by a U.S. person. It is a statement, signed under the penalties of perjury,
stating:
• The identity and taxpayer identification number, if any, of the person making the
statement.
• That the person making the statement is not a U.S. person.
• That the person making the statement either owns less than 1% of the total voting
power and total value of the U.S. target company's stock, and that he did not
acquire the stock with a principal purpose of enabling the U.S. transferors to
satisfy the ownership condition to avoid Sec. 367(a)(1); or that the person is not
related to any U.S. person to whom the stock or securities owned by him could be
38
attributed under Sec. 958(b), and that he did not acquire the stock with a principal
purpose of enabling the U.S. transferors to satisfy the ownership condition to
avoid Sec. 367(a)(1).
• The person's citizenship, permanent residence, home address, and U.S. address, if
any.
• The person's ownership (by voting power and by value) in the U.S. target
company prior to the exchange and the amount of stock of the transferee foreign
corporation (by voting power and value) received by him in the exchange.
Treas. Reg. Sec. 1.367(a)-3(c)(5)(i).
5% Transferee Shareholder. A 5% transferee shareholder is a person that owns at
least 5% of either the total voting power or the total value of the stock of the transferee
foreign corporation immediately after the transfer. Treas. Reg. Sec. 1.367(a)-3(c)(5)(ii).
5% Target Shareholder. A 5% target shareholder is a person that owns at least
5% of either the total voting power or the total value of the stock of the U.S. target
company immediately prior to the transfer. Treas. Reg. Sec. 1.367(a)-3(c)(5)(iii).
Qualified Subsidiary. A qualified subsidiary is a foreign corporation at least 80%
owned (by total voting power and total value), directly or indirectly, by the transferee
foreign corporation. A corporation will not be treated as a qualified subsidiary if it was
affiliated with the U.S. target company (within the meaning of Sec. 1504(a)) at any time
during the 36-month period prior to the transfer. Nor will a corporation be a qualified
subsidiary if it was acquired by the transferee foreign corporation at any time during the
36-month period prior to the transfer for the principal purpose of satisfying the active
39
trade or business test, including the substantiality test. Treas. Reg. Sec. 1.367(a)-
3(c)(5)(vii).
Qualified Partnership. A qualified partnership is a partnership in which the
transferee foreign corporation has active and substantial management functions as a
partner with regard to the partnership's business, or has at least a 25% interest in the
partnership's capital and profits. A partnership is not a qualified partnership if the U.S.
target company or any affiliate of the U.S. target company (within the meaning of Sec.
1504(a)) held a 5% or greater interest in the partnership's capital and profits at any time
during the 36-month period prior to the transfer. Nor will a partnership be a qualified
partnership if the transferee foreign corporation's interest was acquired at any time during
the 36-month period prior to the transfer for the principal purpose of satisfying the active
trade or business test, including the substantiality test.
Treas. Reg. Sec. 1.367(a)-3(c)(5)(viii).
(3) Active Trade or Business Test
The active trade or business test is satisfied if the following conditions are met:
• The transferee foreign corporation, or any qualified subsidiary or qualified
partnership, is engaged in an active trade or business outside the United States,
within the meaning of Treas. Reg. Sec. 1.367(a)-2T(b)(2) and (3), for the entire
36-month period immediately before the transfer;
• At the time of the transfer, neither the transferors nor the transferee foreign
corporation (and, if applicable, the qualified subsidiary or qualified partnership
engaged in the active trade or business) have an intention to substantially dispose
of or discontinue such trade or business; and
40
• The substantiality test described below is satisfied.
Treas. Reg. Sec. 1.367(a)-3(c)(3)(i).
A transferee foreign corporation, qualified subsidiary, or qualified partnership
will be considered to be engaged in an active trade or business for the entire 36-month
period preceding the exchange if it acquires at the time of, or any time prior to, the
exchange a trade or business that has been active throughout the entire 36-month period
preceding the exchange. This special rule does not apply, however, if the acquired active
trade or business assets were owned by the U.S. target company or any affiliate (within
the meaning of Sec. 1504(a)) at any time during the 36-month period prior to the
exchange. Nor does this special rule apply if the principal purpose of the acquisition was
to satisfy the active trade or business test. Further, an active trade or business does not
include managing investments for the account of the transferee foreign corporation or any
affiliate. Treas. Reg. Sec. 1.367(a)-3(c)(3)(ii).
A transferee foreign corporation satisfies the substantiality test if, at the time of
the exchange, the fair market value of the transferee foreign corporation is at least equal
to the fair market value of the U.S. target company. For purposes of this condition, the
value of the transferee foreign corporation includes assets acquired outside the ordinary
course of its business during the 36-month period preceding the exchange only if either of
the following conditions is met:
• At the time of the exchange, such assets or, as applicable, the proceeds thereof, do
not produce, and are not held for the production of, passive income as defined in
Sec. 1296(b), and such assets were not acquired for the principal purpose of
satisfying the substantiality test; or
41
• Such assets consist of the stock of a qualified subsidiary or an interest in a
qualified partnership.
Further, the value of the transferee foreign corporation will not include the value
of the stock of any qualified subsidiary or any interest in a qualified partnership to the
extent that such value is attributable to assets acquired by the qualified subsidiary or
partnership outside the ordinary course of its business and within the 36-month period
preceding the exchange unless those assets satisfy either of the two conditions set forth
above. The value of the transferee foreign corporation also will not include the value of
assets received within the 36-month period prior to the exchange, notwithstanding that
either of the two conditions set forth above are met, if such assets were owned by the
U.S. target company or an affiliate at any time during the 36-month period prior to the
exchange. Treas. Reg. Sec. 1.367(a)-3(c)(3)(iii).
If a partnership (whether domestic or foreign) owns stock or securities in the U.S.
target company or the transferee foreign corporation, or transfers stock or securities in an
exchange described in Sec. 367(a), each partner in the partnership, and not the
partnership itself, is treated as owning or having transferred a proportionate share of the
stock or securities. An option (or an interest similar to an option) will be treated as
exercised and, thus, will be counted as stock for purposes of determining whether the
50% threshold is exceeded or whether a control group exists if a principal purpose for the
issuance or acquisition of the option (or other interest) was the avoidance of Sec.
367(a)(1). Treas. Reg. Sec. 1.367(a)-3(c)(4).
If immediately after the transfer the U.S. target company owns, directly or
indirectly (applying the attribution rules of Secs. 267(c)(1) and (5)), stock of the
42
transferee foreign corporation, that stock will not in any way be taken into account (and,
thus, will not be treated as outstanding) in determining whether the 50% threshold is
exceeded or whether a control group exists. The stock attribution rules of Sec. 318, as
modified by the rules of Sec. 958(b), apply for purposes of determining the ownership or
receipt of stock, securities or other property. Treas. Reg. Sec. 1.367(a)-3(c)(4).
(4) Reporting Requirements
Where 10% or more of the total voting power or the total value of the stock of the
U.S. target company is transferred by U.S. persons, a U.S. transferor qualifies for the
exception in Treas. Reg. Sec. 1.367(a)-3(c) only if the U.S. target company complies with
the following reporting requirements. The U.S. target company must attach to its timely
filed U.S. income tax return for the taxable year in which the transfer occurs a statement
titled: "Section 367(a) -- Reporting of Cross-Border Transfer Under Reg. Sec. 1.367(a)-
3(c)(6)." The statement must be signed under the penalties of perjury by an officer of the
corporation to the best of the officer's knowledge and belief, and must disclose the
following information:
• A description of the transaction in which a U.S. person or persons transferred
stock or securities in the U.S. target company to the transferee foreign corporation
in a transfer otherwise subject to Sec. 367(a)(1);
• The amount (specified as to the percentage of the total voting power and the total
value) of stock of the transferee foreign corporation received in the transaction, in
the aggregate, by persons who transferred stock or securities of the U.S. target
company;
43
• The amount (if any) of transferee foreign corporation stock owned directly or
indirectly (applying the attribution rules of Secs. 267(c)(1) and (5)) immediately
after the exchange by the U.S. target company;
• A statement that there is no control group;
• A list of U.S. persons who are officers, directors or 5% target shareholders and
the percentage of the total voting power and the total value of the stock of the
transferee foreign corporation owned by such persons both immediately before
and immediately after the transaction; and
• A statement that includes the following:
(A) A statement that the active trade or business
test is satisfied by the transferee foreign corporation and a description of such business;
(B) A statement that on the day of the
transaction, there was no intent on the part of the transferors or the transferee foreign
corporation (or any qualified subsidiary or qualified partnership, if relevant) to
substantially dispose of or discontinue its active trade or business; and
(C) A statement that the substantiality test is
satisfied, and documentation that such test is satisfied, including the value of the
transferee foreign corporation and the value of the U.S. target company on the day of the
transfer, and either one of the following:
(D) A statement demonstrating that the value of
the transferee foreign corporation 36 months prior to the acquisition, plus the value of
any assets acquired by the transferee foreign corporation within the 36-month period, less
44
the amount of any liabilities acquired during that period, exceeds the value of the U.S.
target company on the acquisition date; or
(E) A statement demonstrating that the value of
the transferee foreign corporation on the date of the acquisition, reduced by the value of
any assets acquired by the transferee foreign corporation within the 36-month period,
exceeds the value of the U.S. target company on the date of the acquisition.
Treas. Reg. Sec. 1.367(a)-3(c)(6).
An income tax return will be considered timely filed if it is filed, together with the
required statement, on or before the last day for filing the federal income tax return
(including extensions) for the taxable year in which the transfer occurs. If a return is not
timely filed, the District Director may make a determination, based on all facts and
circumstances, that the taxpayer had reasonable cause for its failure to timely file a return,
and if such a determination is made, the timely-filed requirement will be waived. Treas.
Reg. Sec. 1.367(a)-3(c)(6).
To rebut the ownership presumption, the U.S. target company must obtain
ownership statements from a sufficient number of persons that transfer U.S. target
company stock or securities that are not U.S. persons to demonstrate that the 50%
threshold is not exceeded. In addition, the U.S. target company must attach to its timely
filed U.S. income tax return (as described above) for the taxable year in which the
transfer occurs a statement titled: "Section 367(a) - Compilation of Ownership Statements
under Reg. Sec. 1.367(a)-3(c)." The statement must be signed under the penalties of
perjury by an officer of the corporation, and must disclose the following information:
45
(A) The amount (specified as to the percentage of total voting power and total value) of
stock of the transferee foreign corporation received, in the aggregate, by U.S. transferors;
(B) The amount (specified as to the percentage of total voting power and total value) of
stock of the transferee foreign corporation received, in the aggregate, by foreign persons
that filed ownership statements; and
(C) A summary of the information tabulated from the ownership statements, including:
• The names of the persons that filed ownership statements stating that they
were not U.S. persons;
• The countries of residence and citizenship of such persons; and
• Each of such person's ownership (by voting power and by value) in the
U.S. target company prior to the exchange and the amount of stock of the
transferee foreign corporation (by voting power and value) received by
such persons in the exchange.
Treas. Reg. Sec. 1.367(a)-3(c)(7).
(5) Private Letter Rulings
The Internal Revenue Service may, in limited circumstances, issue a private letter
ruling to permit a taxpayer to qualify for the exception in Treas. Reg. Sec. 1.367(a)-3(c)
if:
• The taxpayer is unable to satisfy all of the requirements relating to the active trade
or business test in paragraph (c)(1)(iv), but it meets all of the other requirements
in paragraphs (c)(1)(i) through (c)(1)(iii) and is substantially in compliance with
the active trade or business rules set forth in paragraph (c)(3) (see, e.g. Ltr. Rul.
200536017); or
• The taxpayer is unable to satisfy any requirement of paragraph (c)((1) due to the
application of the stock attribution rules of Sec. 318.
46
Notwithstanding the foregoing, the Internal Revenue Service will not rule on
whether the principal purpose of an acquisition was to satisfy the active trade or business
test, including the substantiality test. Treas. Reg. Sec. 1.367(a)-3(c)(9).
(6) Examples in Treas. Reg. Sec. 1.367(a)-3(c)(10)
The exception provided by paragraph (c) is illustrated by the following examples.
Example 1. ForCo Corp., a foreign corporation, issues 51% of its stock to
the shareholders of USCo Inc., a domestic corporation, in exchange for their
USCo stock in a transaction described in Sec. 367(a)(1). All shareholders of
USCo who receive stock of ForCo are presumed to be U.S. persons. Unless this
ownership presumption is rebutted, the paragraph (c)(1) exception will not be
available because more than 50% of ForCo is owned by U.S. persons. As a result,
all U.S. persons that transferred USCo stock will recognize gain on the exchange.
To rebut the ownership presumption, USCo must comply with the reporting
requirements and obtain ownership statements from a sufficient number of non-
U.S. persons who received ForCo stock to demonstrate that the amount of ForCo
stock received by U.S. persons in the exchange did not exceed 50%.
Example 2. Assume the same facts as in Example 1 except that ForCo
issues only 40% of its stock to the shareholders of USCo in the exchange, and that
ForCo satisfies the active trade or business test. Angela Aline, a U.S. person,
owns 10% of USCo's stock immediately before the transfer. All other USCo
shareholders own less than 5% of its stock. None of USCo's officers or directors
owns any stock in ForCo immediately after the transfer. Angela will own 15% of
the stock of ForCo immediately after the transfer, 4% received in the exchange
47
(10% of 40%) and the balance being stock she owned prior to and independent of
the transaction. No USCo shareholder besides Angela owns 5% or more of ForCo
stock immediately after the transfer. USCo satisfies the reporting requirements.
The conditions for the exception in paragraph (c)(1)(i) are satisfied
because, even after application of the presumption of U.S. ownership, U.S.
transferors did not receive more than 50% of ForCo's stock in the transaction.
There is no control group because 5% target shareholders and officers and
directors of USCo do not, in the aggregate, own more than 50% of the stock of
ForCo immediately after the transfer (Angela, the sole 5% target shareholder,
owns only 15% of the ForCo stock immediately after the transfer, and no officers
or directors of USCo own any stock of ForCo immediately after the transfer).
Thus, U.S. persons that are not 5% transferee shareholders will not recognize any
gain on the exchange of USCo shares for ForCo shares. Angela, a 5% transferee
shareholder, will not recognize any gain on the exchange if she enters into a five-
year gain recognition agreement.
Example 3. Assume the same facts as in Example 2 except that Barney
Bly, another U.S. person, is a 5% target shareholder, owning 25% of USCo's
stock immediately before the transfer. Barney owns 40% of the stock of ForCo
immediately after the transfer, 10% received in the exchange (25% of 40%), and
the balance being stock in ForCo that he owned prior to and independent of the
transaction. A control group exists because Angela and Barney, each a 5% target
shareholder, together own more than 50% of ForCo immediately after the transfer
(counting both stock received in the exchange and stock owned prior to and
48
independent of the exchange). As a result, the control group condition is not
satisfied, and all U.S. persons (not merely Angela and Barney) who transferred
USCo stock will recognize gain on the exchange.
Example 4. Assume the same as in Example 3 except that Barney is Beta
Partnership, a partnership (domestic or foreign) that has five equal partners, only
two of whom, Filmore Millard and Mary Squire, are U.S. persons. Filmore and
Mary are treated as the owners and transferors of 5% each (20% of 25%) of the
USCo stock owned and transferred by Beta, and as owners of 8% each (20% of
40%) of the ForCo stock owned by Beta immediately after the transfer. U.S.
persons that are 5% target shareholders thus own a total of 31% of the ForCo
stock immediately after the transfer (Angela's 15% plus Filmore's 8% plus Mary's
8%). Because no control group exists and the other conditions are met, the
condition in paragraph (c)(1)(ii) is satisfied. Thus, U.S. persons that are not 5%
transferee shareholders will not recognize any gain on the exchange of USCo
shares for ForCo shares. Angela, Filmore and Mary, each a 5% transferee
shareholder, will not recognize gain on the exchange if they enter into five-year
gain recognition agreements.
2. Five-Year Gain Recognition Agreements (GRAs)
a. In general.
Five-year gain recognition agreements (GRAs) are required for nonrecognition
under the exceptions provided in Treas. Reg. Sec. 1.367(a)-3(b) and (c) where the U.S.
transferor owns 5% or more of the transferee foreign corporation after the transfer. Treas.
Reg. Sec. 1.367(a)-8T. The GRA regulations were substantially revised on Feb. 5, 2007
49
with the publication of Treas. Reg. Sec. 1.367(a)-8T in T.D. 9311. Following is a tabular
comparison of the provisions in the old and the new regulations.
[NEW] Treas. Reg. Sec. 1.367(a)-8T [OLD] Treas. Reg. Sec. 1.367(a)-8
a) In general a) In general
1. Definitions
(i) Asset reorganization
(ii) Common parent
(iii) Consolidated group
(iv) Disposition
(v) GRA
(vi) Initial transfer
(vii) Nonrecognition transaction
(viii) Transferee foreign corporation
(ix) Transferred corporation
(x) Triggering event
(xi) U.S. transferor
2. Filing requirements 1. Filing requirements
2. GRA forms
3. Who must sign 3. Who must sign
b) GRA b) GRA
1. Contents 1. Contents
2. Description of property transferred 2. Description of property transferred
3. Terms of agreement 3. Terms of agreement
4. Waiver of period of limitation 4. Waiver of period of limitation
5. Annual certification 5. Annual certification
(See Sec. (d)(8), infra.) c) Failure to comply
1. General rule (re filing GRA)
(See Sec. (e)(10), infra.) 2. Reasonable cause exception
c) Use of security d) Use of security
d) Triggering events (unless relief in e) or
g); see also 1.367(a)-3(d)(2)(iv)
1. Disposition of transferred corp stock
or securities (SOS)
e) Disposition (in whole or in part) of
stock of transferred corporation
1. Definition of disposition
2. Partial disposition
3. Deemed disposition
2. Disposition of substantially all (sub
all) of transferred corp's assets
(i) Sub all asset transfer
3. Disposition of transferee stock (not
SOS)
4. Deconsolidation
5. Consolidation
6. Indiv. U.S. transferor becomes non-
citizen nonresident
(ii) Indiv. U.S. transferor becomes
non-citizen nonresident
50
[NEW] Treas. Reg. Sec. 1.367(a)-8T [OLD] Treas. Reg. Sec. 1.367(a)-8
citizen nonresident non-citizen nonresident
7. Indiv. dies; trust/estate goes out of
existence
8. Failure to comply (See Sec. (c), supra.)
e) Exceptions (to triggering events)
1. Certain nonrecognition transactions
(i) Dispositions of transferee stock
(ii) Dispositions of transferred corp
SOS
(iii) Disposition of transferred corp
assets
2. Recapitalizations
(i) Transferred corp
(ii) Transferee corp
3. Certain asset reorganizations
(i) Transfers of transferee corp stock
(ii) Transfers of transferred corp SOS
(iii) Sub all asset transfers by
transferred corp
4. Certain triangular reorganizations
(i) Triangular transferee corp reorgs
(ii) Triangular transferred corp reorgs
5. Compulsory transfers
6. Certain liquidations and upstream
reorgs of transferred into transferee
7. Death of indiv. U.S. transferor
8. Deconsolidation
9. Consolidation
10. Reasonable cause for failure to
comply
(See Sec. (c)(2), supra.)
(Parallel provision transferred to Treas.
Reg. Sec. 1.367(a)-3T(e))
f) Effect on GRA if U.S. transferor goes
out of existence
f) Gain recognized in connection with
certain nonrecognition transactions
g) Effect on GRA of certain nonrecogni-
tion transactions
1. Transfers of transferee corp stock or
securities (SOS)
1. Dispositions of transferred corp SOS 2. Transfer of transferred corp SOS
2. Sub all dispositions of transferred
corp assets
3. Asset transfers by transferred corp
g) Transactions that terminate the GRA
or reduce the amount of gain required to
be recognized pursuant to a GRA
h) Transactions that terminate the GRA
1. Taxable disposition of transferee
stock (not SOS) by U.S. transferor
1. Taxable dispositions of transferee
SOS by U.S. transferor
51
[NEW] Treas. Reg. Sec. 1.367(a)-8T [OLD] Treas. Reg. Sec. 1.367(a)-8
2. Some sub all asset dispositions by a
domestic transferred corp
2. Some sub all asset dispositions by a
domestic transferred corp
3. Distribution or transfer by transferee
of transferred corp's SOS under Secs.
337, 355 or 361
h) Effective date
(1) Definitions applicable to GRAs
Treas. Reg. Sec. 1.367(a)-8T(a)(1), "Definitions," is entirely new. The only
separately stated definition in Treas. Reg. Sec. 1.367(a)-8 was a placeholder definition in
Treas. Reg. Sec. 1.367(a)-8(a)(2) for GRA forms that would be developed in the future.
That definition was excluded from Treas. Reg. Sec. 1.367(a)-8T.
(A) In general, the term asset reorganization
means a reorganization described in Sec. 368(a)(1) involving the transfer of assets by one
corporation to another pursuant to Sec. 361. Reorganizations described in Sec.
368(a)(1)(D) or (G) are asset reorganizations for GRA purposes only if the requirements
of Sec. 354(b)(1)(A) and (B) are met. With respect to the asset reorganization exceptions
to triggering events in Treas. Reg. Sec. 1.367(a)-8T(e)(3)(ii) and (iii), the following
reorganizations are not asset reorganizations:
i) Triangular asset reorganizations
described in Secs. 1.358-6(b)(2)(i) through (iii) or in Secs. 368(a)(1)(G) and (a)(2)(D)
(i.e., forward triangulars, reverse triangulars, and triangular Cs and Gs). For rules that
address exceptions to triggering events regarding triangular reorganizations, see Treas.
Reg. Sec. 1.367(a)-8T(e)(4). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(i)(A).
52
ii) Asset reorganizations where, after
the reorganization, the same corporation is both the transferee foreign corporation (or
successor transferee foreign corporation, as applicable) and the transferred corporation
(or the successor transferred corporation, as applicable); for example, the acquisition of
the transferee foreign corporation's assets by the transferred corporation in a
reorganization described in Sec. 368(a)(1). For rules applicable to certain upstream and
downstream reorganizations involving the transferee foreign corporation and transferred
corporation, see Treas. Reg. Sec. 1.367(a)-8T(e)(6) and (g)(3). Treas. Reg. Sec. 1.367(a)-
8T(a)(1)(i)(B).
(B) The term common parent means a
corporation that controls an affiliated group of corporations that files its Federal income
tax returns on a consolidated basis. Treas. Reg. Sec. 1.367(a)-8T(a)(1)(ii).
(C) The term consolidated group has the
meaning set forth in Sec. 1.1502-1(h). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(iii).
(D) The term disposition means any transfer
that would constitute a disposition for any purpose of the Internal Revenue Code and the
regulations thereunder. It also includes an indirect disposition of the stock of the
transferred corporation as described in Treas. Reg. Sec. 1.367(a)-3(d). It does not,
however, include a redemption of stock under Sec. 302(d) to the extent the redemption is
treated as a distribution to which Sec. 301(c)(1) applies. Treas. Reg. Sec. 1.367(a)-
8T(a)(1)(iv). Although not mentioned in this definition of "disposition," taxpayers and
their advisors should also consult the Catchall Rule in Treas. Reg. Sec. 1.367(a)-1T(c)(1).
As noted in Section I.A above, the Catchall Rule includes within the ambit of Sec.
53
367(a)(1) any "transfer of property by a U.S. person to a foreign corporation pursuant to
an exchange described in section 332, 351, 354, 355, 356, or 361 . . . whether it is made
directly, indirectly, or constructively."
(E) The term gain recognition agreement
(usually abbreviated "GRA") means an agreement described in Treas. Reg. Sec. 1.367(a)-
8T(b). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(v).
(F) The term initial transfer means a transfer in
connection with which a GRA is filed in connection with an exchange described in Secs.
1.367(a)-3(b) through (d) and 1.367(a)-3T(e). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(vi).
(G) The term nonrecognition transaction means
any disposition of property in a transaction in which gain or loss is not recognized in
whole or in part for purposes of I.R.C. Subtitle A. Treas. Reg. Sec. 1.367(a)-8T(a)(1)(vii).
(H) The term transferee foreign corporation is
defined as the foreign corporation the stock of which is received in an exchange
described in Sec. 367(a) by a U.S. transferor. Unfortunately, this definition ignores the
situation addressed in Treas. Reg. Secs. 1.367(a)-3(d)(1)(iii)(B) and (d)(2)(i)(B). Those
sections discuss triangular/subsidiary B reorganizations involving a foreign acquiring
corporation with a domestic parent, and the latter section instructs that in such a
reorganization, "the transferee foreign corporation shall be the foreign acquiring
corporation," even though it is stock of the domestic parent that is received by the U.S.
transferor in the exchange. While it is likely that the definition above and the one in
Treas. Reg. Sec. 1.367(a)-3(d)(2)(i)(B) can be harmonized (see, e.g., the definition of
"transferred corporation" in Treas. Reg. Sec. 1.367(a)-8T(a)(1)(ix), set forth in Section
54
I.E.2.a(1)(I) below), taxpayers and their advisors would do well to be cautious until
guidance resolving this discrepancy is issued. Treas. Reg. Sec. 1.367(a)-8T(a)(1)(viii).
(I) Transferred corporation. Other than in the
case of an indirect stock transfer, the term transferred corporation means the corporation
the stock or securities of which are transferred by a U.S. transferor to a foreign
corporation in an exchange described in Sec. 367(a)(1). In the case of an indirect stock
transfer, the term transferred corporation has the meaning set forth in Sec. 1.367(a)-
3(d)(2)(ii). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(ix).
(J) The term triggering event means an event
described in Treas. Reg. Sec. 1.367(a)-8T(d), except as provided in Treas. Reg. Sec.
1.367(a)-8T(e) (exceptions to triggering events) and Treas. Reg. Sec. 1.367(a)-8T(g)
(terminations of GRAs). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(x).
(K) The term U.S. transferor means a U.S.
person (as defined in Sec. 1.367(a)-1T(d)(1)) that transfers stock or securities of the
transferred corporation in exchange for stock or securities of the transferee foreign
corporation in an exchange described in Sec. 367(a). For the application of the rules of
Treas. Reg. Sec. 1.367(a)-8T to indirect transfers involving partnerships and interests
therein, see Sec. 1.367(a)-1T(c)(3). Treas. Reg. Sec. 1.367(a)-8T(a)(1)(xi).
This definition is problematic because the definition of "transferred corporation,"
in Treas. Reg. Sec. 1.367(a)-8T(a)(1)(ix) (see Section I.E.2.a(1)(I) above) imports the
definition of "transferred corporation" in Treas. Reg. Sec. 1.367(a)-3(d)(2)(ii) for indirect
stock transfers, and that definition states that, in general, "the transferred corporation
shall be the acquiring corporation." A better formulation would have used the definition
55
of U.S. transferor in Treas. Reg. Sec. 1.367(a)-3(c)(5)(v): "A U.S. transferor is a U.S.
person (as defined in [Treas. Reg. Sec. 1.367(a)-3](c)(5)(iv) [which incorporates Sec.
1.367(a)-1T(d)(1) by reference]) that transfers stock or securities of one or more U.S.
target companies [defined in the front language of Treas. Reg. Sec. 1.367(a)-3(c)(1) as
"domestic corporation's] the stock or securities of which are transferred"] in exchange for
stock of the transferee foreign corporation in an exchange described in Sec. 367." Once
again, taxpayers and their advisors would do well to be cautious in applying definition of
"U.S. transferor" in Treas. Reg. Sec. 1.367(a)-8T(a)(1)(xi) to indirect stock transfers.
(2) Filing requirements
A U.S. transferor's GRA must be attached to, and filed by the due date
(including extensions) of, the U.S. transferor's income tax return for the taxable year that
includes the date of the initial transfer, except that if the U.S. transferor is a member of a
consolidated group for the taxable year in which the transfer was made, the agreement
must be attached to the consolidated group's tax return. If a new GRA is entered into
pursuant to a triggering event exception in Treas. Reg. Sec. 1.367(a)-8T(e), the new GRA
must be attached to, and filed by the due date (including extensions) of, the applicable
income tax return for the taxable year that includes the date of the triggering event.
Taxpayers that fail to comply with these timeliness requirements should determine
whether the reasonable cause exception in Treas. Reg. Sec. 1.367(a)-8T(e)(10) applies. If
it does not, then the failure to comply with constitute a triggering event pursuant to Treas.
Reg. Sec. 1.367(a)-8T(d)(8). Treas. Reg. Sec. 1.367(a)-8T(a)(2).
(3) Who must sign
A GRA must be signed under the penalties of perjury by:
56
• In the case of a corporate U.S. transferor, a responsible officer, except that
if the U.S. transferor (or successor U.S. transferor designated in a new
GRA entered into under Treas. Reg. Sec. 1.367(a)-8T(e)) is a member, but
not the common parent of a consolidated group for the taxable year in
which the transfer was made (or for the taxable year in which a new GRA
is entered into under Treas. Reg. Sec. 1.367(a)-8T(e)) the agreement must
be entered into by the common parent and signed by a responsible officer
of such common parent.
• In case of an individual, by the individual U.S. transferor (including a
partner who is treated as a transferor pursuant to Treas. Reg. Sec.
1.367(a)-1T(c)(3)).
• In the case of a trust or estate, by a trustee, executor, or equivalent
fiduciary.
• In a bankruptcy case under Title 11 of the United States Code, by the
debtor in possession or trustee.
An agreement may also be signed by an agent authorized to do so under a general
or specific power of attorney. Additionally, the filing and signing requirements for a
GRA, certification, or other information required by Treas. Reg. Sec. 1.367(a)-8T are
considered satisfied by the attachment and filing of an unsigned copy with the taxpayer's
U.S. federal income tax return as long as the taxpayer retains the original in its records in
the manner specified by Treas. Reg. Sec. 1.6001-1(e). Treas. Reg. Sec. 1.367(a)-8T(a)(3).
b. Gain recognition agreement (GRA)
(1) Contents
57
The GRA must set forth the following information, with the heading "GAIN
RECOGNITION AGREEMENT UNDER SEC. 1.367(a)-8T", and with paragraphs
labeled to correspond with the numbers set forth in the Regulations:
1. A statement that the document submitted constitutes the U.S. transferor's
agreement to recognize gain in accordance with the requirements of Treas. Reg. Sec.
1.367(a)-8T;
2. A description of the property transferred, as described in Treas. Reg. Sec.
1.367(a)-8T(b)(2) and Section E.2.b.(2) below;
3. The U.S. transferor's agreement to recognize gain, as described in Treas. Reg.
Sec. 1.367(a)-8T(b)(3) and Section E.2.b.(3)below;
4. A waiver of the period of limitations, as described in Treas. Reg. Sec.
1.367(a)-8T(b)(4) and Section E.2.b.(4)below;
5. An agreement to file a certification, as described in Treas. Reg. Sec. 1.367(a)-
8T(b)(5) and Section E.2.b.(5) below, with the U.S. transferor's tax returns for the five
full taxable years following the year of the transfer;
6. A statement that arrangements have been made in connection with the
transferred property to ensure that the transferor will be informed of any triggering
events; and
7. A statement as to whether, if all or a portion of the GRA is triggered pursuant
to Treas. Reg. Sec. 1.367(a)-8T(d), the taxpayer elects to include the required amount in
the year of the triggering event rather than in the year of the initial transfer (a "triggering
year election"). Treas. Reg. Sec. 1.367(a)-8T(b)(1). As the example in Treas. Reg. Sec.
1.367(a)-8T(e)(1) illustrates, foregoing the election and choosing by default to include
58
gain in the year of the initial transfer freezes the portion of that gain that may be
recharacterized as a dividend pursuant to Sec. 1248. Making the election, on the other
hand, leaves the Sec. 1248 amount open until the year of the triggering event. Treas. Reg.
Sec. 1.367(a)-8T(b)(1). For a definition of a Sec. 1248 amount, see Section II below.
(2) Description of property transferred
The GRA must include a description of each property transferred by the U.S.
transferor, an estimate of the fair market value of the property as of the date of the initial
transfer, a statement of the cost or other basis of the property and any adjustments
thereto, the date on which the property was acquired by the U.S. transferor, and the
following information:
(A) The type or class, amount, and
characteristics of the stock or securities transferred, as well as the name, address, and
place of incorporation of the issuer of the stock or securities, and the percentage (by
voting power and value) that the stock represents of the total stock outstanding of the
transferred corporation;
(B) The name, address and place of
incorporation of the transferee foreign corporation, and the percentage of stock (by voting
power and value) that the U.S. transferor received or will receive in the transaction;
(C) If stock or securities are transferred
pursuant to Sec. 1.367(a)-3T(e) (i.e., in a transaction in which the U.S. transferor goes out
of existence), a statement that the conditions set forth in the second sentence of Sec.
367(a)(5) and any regulations under that section have been satisfied, and an explanation
59
of any basis or other adjustments made pursuant to Sec. 367(a)(5) and any regulations
thereunder;
(D) If the transferred corporation is a domestic
corporation, the taxpayer identification number of the transferred corporation, together
with a statement describing whether, and if so, how, Sec. 7874 applies to the transfer, and
a statement that all of the requirements of Sec. 1.367(a)-3(c)(1) are satisfied;
(E) If the transferred corporation is a foreign
corporation, a statement as to whether the U.S. transferor was a Sec. 1248 shareholder, as
defined in Sec. 1.367(b)-2(b), of the transferred corporation immediately before the
exchange, and, if so, a statement as to whether the U.S. transferor is a Sec. 1248
shareholder with respect to the transferee foreign corporation stock received, and whether
any reporting requirements or other rules contained in regulations under Sec. 367(b) are
applicable, and, if so, whether they have been satisfied; and
(F) If the transaction involved the transfer of
assets other than stock or securities and the transaction was subject to the indirect stock
transfer rules of Treas. Reg. Sec. 1.367(a)-3(d) (see Section E.3 below), a statement as to
whether the reporting requirements under Sec. 6038B have been satisfied with respect to
the transfer of property other than stock or securities, and an explanation of whether gain
was recognized under Sec. 367(a)(1) and whether Sec. 367(d) was applicable to the
transfer of such assets, or whether any tangible assets qualified for nonrecognition
treatment under the active trade or business exception
Treas. Reg. Sec. 1.367(a)-8(b)(2).
(3) Terms of agreement
60
If before the close of the fifth full taxable year (not less than 60 months)
following the close of the taxable year of the initial transfer, there is a triggering event,
then, unless a triggering year election was made, by the 90th day thereafter the U.S.
transferor must file an amended Federal income tax return for the year of the initial
transfer and recognize the gain realized but not recognized upon the initial transfer.
The gain recognition period can be from just over 60 months to just under 72
months since it expires at the end of the fifth full taxable year after the year of the
transfer. For example, if a calendar year taxpayer transfers assets in January, 2003, the
gain recognition periods ends December 31, 2008, or 72 months later. However, if the
transfer is in December, 2003, the gain recognition period still ends December 31, 2008,
or 60 months later.
The U.S. transferor must pay the resulting increase in tax, plus interest. If a
triggering year election was made, then the U.S. transferor must include the gain realized
but not recognized on the initial transfer in income on its Federal income tax return for
the taxable year that includes the date of the triggering event, and interest must be paid
on any additional tax due. If a taxpayer makes a triggering year election but fails to
include the gain realized in income, the Commissioner may, in his discretion, include the
gain in the taxpayer's income in the year of the initial transfer. No special limitations
apply with respect to net operating losses, capital losses, credits against tax, or similar
items. Treas. Reg. Sec. 1.367(a)-8T(b)(3)(i)-(ii).
If additional tax is due, then interest must also be paid on that tax at the rates
determined under Sec. 6621 for the period between the due date for the U.S. transferor's
Federal income tax return for the year of the initial transfer and the date on which the
61
additional tax is paid. If a triggering year election was made, a taxpayer should include
the amount of gain as taxable income on its Federal income tax return (together with
other income or loss items) and include the amount of interest in its payment (or reduce
the amount of any refund due by the amount of the interest). A taxpayer must also attach
to its Federal income tax return a separate schedule with the heading "Calculation of
Section 367 Tax and Interest," on which the amount of tax attributable to the gain and the
interest required to be paid under Treas. Reg. Sec. 1.367(a)-8T are separately identified
and calculated. Treas. Reg. Sec. 1.367(a)-8T(b)(3)(iii).
If a U.S. transferor is required to recognize gain under Treas. Reg. Sec. 1.367(a)-
8T as a result of a triggering event, then the transferee foreign corporation's basis in the
transferred stock or securities shall be increased (as of the date of the initial transfer) by
the amount of gain required to be recognized by the U.S. transferor, and the U.S.
transferor's basis in the stock of the transferee foreign corporation received (or deemed
received) in the initial transfer shall be increased by the amount of gain required to be
recognized (as of the date of the initial transfer). Other appropriate basis adjustments
may also be made if they are consistent with the principles of Treas. Reg. Sec. 1.367(a)-
8T(b)(3)(iv), but in no case should an increase in basis include any tax or interest
required to be paid on the gain recognized. Additionally, the transferred corporation's net
asset basis should not be increased as a result of gain recognized due to the occurrence of
a triggering event. Treas. Reg. Sec. 1.367(a)-8T(b)(3)(iv).
(4) Waiver of period of limitation
The U.S. transferor must file, with the GRA, a waiver of the period of limitation
on assessment of tax upon the gain realized on the initial transfer. The waiver shall be
62
executed on Form 8838 "Consent to Extend the Time to Assess Tax Under Section 367--
Gain Recognition Agreement" and shall extend the period for assessment of such tax to a
date not earlier than the eighth full taxable year following the taxable year of the initial
transfer. The waiver shall also contain such other terms with respect to assessment as
may be considered necessary by the Commissioner to ensure the assessment and
collection of the correct tax liability for each year for which the waiver is required. The
waiver should be signed by a person who would be authorized to sign the GRA pursuant
to the provisions of Treas. Reg. Sec. 1.367(a)-8T(a)(3). However, as noted in that
section, an unsigned copy attached to and filed with the taxpayer's U.S. Federal income
tax return satisfies the filing and signing requirements as long as the taxpayer retains the
original in its records in the manner specified by Treas. Reg. Sec. 1.6001-1(e). Treas.
Reg. Sec. 1.367(a)-8T(b)(4).
(5) Annual certification
The U.S. transferor must file with its income tax return for each of the five full
taxable years following the taxable year of the initial transfer a certification that there has
not been a triggering event, and a description of any exception under Treas. Reg. Sec.
1.367(a)-8T(e) if such an exception is relied upon for the position that there has not been
a triggering event. The U.S. transferor must include with its annual certification a
statement describing any dispositions of assets by the transferred corporation that are not
made in the ordinary course of business. The annual certification pursuant to Treas. Reg.
Sec. 1.367(a)-8T(b)(5) must be signed (but not necessarily under the penalties of perjury)
by a person who would be authorized to sign the agreement pursuant to the provisions of
Treas. Reg. Sec. 1.367(a)-8T(a)(3). However, as noted in that section, an unsigned copy
63
attached to and filed with the taxpayer's U.S. Federal income tax return satisfies the filing
and signing requirements as long as the taxpayer retains the original in its records in the
manner specified by Treas. Reg. Sec. 1.6001-1(e). Treas. Reg. Sec. 1.367(a)-8T(b)(5).
c. Use of Security
The U.S. transferor may be required to furnish a bond or other security that
satisfies the requirements of Treas. Reg. Sec. 301.7101-1 if the Area Director, Field
Examination, Small Business/Self Employed or the Director of Field Operations, Large
and Mid-Size Business (Director) determines that such security is necessary to ensure the
payment of any tax on the gain realized, but not recognized, upon the initial transfer.
Such bond or security generally will be required only if the stock or securities transferred
are a principal asset of the U.S. transferor and the Director has reason to believe that a
disposition of the stock or securities may be contemplated. Treas. Reg. Sec. 1.367(a)-
8T(c).
d. Triggering events.
If there is a triggering event described Treas. Reg. Sec. 1.367(a)-8T(d) during the
term of the GRA, the U.S. transferor must include in income the gain realized, but not
recognized, upon the initial transfer as provided in Treas. Reg. Sec. 1.367(a)-8T(b)(3)(i).
In addition, the U.S. transferor must pay any interest required by Treas. Reg. Sec.
1.367(a)-8T(b)(3)(iii). See Treas. Reg. Sec. 1.367(a)-3(d)(2)(iv) for additional triggering
events when a GRA has been filed in connection with an indirect stock transfer. Except to
the extent provided in Treas. Reg. Secs 1.367(a)-8T(e) and (g), if any of the following
events occur during the term of the GRA, it shall constitute a triggering event:
64
(1) Disposition of the Stock or Securities of the
Transferred Corporation
A disposition, in whole or in part, by the transferee foreign corporation (or any
other person) of the transferred stock or securities received by the transferee foreign
corporation in the initial transfer. For purposes of Treas. Reg. Sec. 1.367(a)-8T(d)(1), a
reference to transferred stock or securities also includes stock or securities of the
transferred corporation the basis of which is determined (directly or indirectly) in whole
or in part, by reference to the basis of the stock or securities transferred in the initial
transfer. A disposition of all or a portion of the stock or securities of the transferred
corporation by installment sale is treated as a disposition of the stock or securities in the
year of the installment sale.
If the transferee foreign corporation or any other person disposes of only a portion
of the stock or securities of the transferred corporation, then the U.S. transferor is
required to recognize only a proportionate amount of the gain realized, but not
recognized, upon the initial transfer. The proportion required to be recognized shall be
determined by reference to the fair market value of the transferred stock or securities
disposed of and the total fair market value of the transferred stock or securities
immediately before the disposition. Treas. Reg. Sec. 1.367(a)-8T(d)(1).
(2) Disposition of substantially all of the transferred
corporation's assets
A disposition of substantially all of the transferred corporation's assets (including
stock in a subsidiary corporation or an interest in a partnership) by the transferred
corporation or any other person. Solely for purposes of Treas. Reg. Sec. 1.367(a)-
65
8T(d)(2), the term substantially all has the meaning provided under Sec. 368(a)(1)(C).
Accordingly, the determination of whether substantially all of the transferred
corporation's assets have been disposed of shall be made under all the facts and
circumstances.
For purposes of Treas. Reg. Sec. 1.367(a)-8T(d)(2), dispositions of stock in
connection with an asset reorganization of a corporation all or a portion the stock of
which is owned by the transferred corporation, or a liquidation of a corporation the stock
of which is owned by the transferred corporation in an amount satisfying the
requirements of Sec. 1504(a)(2) and to which Secs. 332 and 337 apply, shall not be taken
into account.
If the initial transfer was an indirect stock transfer, see Treas. Reg. Sec. 1.367(a)-
3(d)(2)(v). If the transferred corporation is a domestic corporation, see Treas. Reg. Sec.
1.367(a)-8T(g)(2).
For an example of when a disposition of substantially all the transferred
corporation's assets by a person other than the transferred corporation is a triggering
event, see paragraph Treas. Reg. Sec. 1.367(a)-8T(e)(6)(ii). Treas. Reg. Sec. 1.367(a)-
8T(d)(2).
(3) Disposition of the stock of the transferee foreign
corporation
A disposition in whole or in part, by the U.S. transferor of the stock of the
transferee foreign corporation that is received (or deemed received) in the initial transfer.
For purposes of Treas. Reg. Sec. 1.367(a)-8T(d)(3), a reference to stock described in the
preceding sentence shall also include stock of the transferee foreign corporation the basis
66
of which is determined, directly or indirectly, in whole or in part, by reference to the
basis of the stock of the transferee foreign corporation that is received (or deemed
received) in the initial transfer.
If the U.S. transferor disposes of only a portion of the stock of the transferee
foreign corporation that is received (or deemed received) in the initial transfer, then the
U.S. transferor is required to recognize only a proportionate amount of the gain realized,
but not recognized, upon the initial transfer. The proportion required to be recognized
shall be determined by reference to the fair market value of the transferee foreign
corporation stock disposed of and the total fair market value of the transferee foreign
corporation stock immediately before the disposition. Treas. Reg. Sec. 1.367(a)-8T(d)(3).
(4) Deconsolidation
A U.S. transferor that is a member of a consolidated group ceases to be a member
of the consolidated group, other than by reason of an acquisition of the assets of the U.S.
transferor in a transaction to which Sec. 381(a) applies, or by reason of joining a new
consolidated group as part of the same transaction. However, in the case of a transaction
to which Sec. 381(a) applies, see Treas. Reg. Sec. 1.367(a)-8T(d)(3) (providing that a
triggering event includes a disposition of the stock of the transferee foreign corporation).
Treas. Reg. Sec. 1.367(a)-8T(d)(4). For an exception to this triggering event, see Treas.
Reg. Sec. 1.367(a)-8T(e)(8).
(5) Consolidation
A U.S. transferor becomes a member of a consolidated group. Treas. Reg. Sec.
1.367(a)-8T(d)(5). For an exception to this triggering event, see Treas. Reg. Sec.
1.367(a)-8T(e)(9).
67
(6) Individual U.S. transferor becomes a non-citizen
nonresident
A U.S. transferor that is an individual loses U.S. citizenship, or a U.S. transferor
that is a long-term resident ceases to be taxed as a lawful permanent resident (as defined
in Sec. 877(e)(2)). Immediately before the date that the U.S. transferor loses U.S.
citizenship or ceases to be taxed as a long-term resident, the GRA will be triggered. No
additional inclusion is required under Sec. 877 with respect to the transferred stock or
securities, and a GRA under Sec. 877 may not be used to avoid taxation under Sec.
367(a) resulting from the trigger of the Sec. 367(a) GRA. Treas. Reg. Sec. 1.367(a)-
8T(d)(6).
(7) Death of an individual; trust or estate goes out of
existence
An individual U.S. transferor dies, or a U.S. transferor that is a trust or estate goes
out of existence. Treas. Reg. Sec. 1.367(a)-8T(d)(7). For an exception to the portion of
this triggering event that concerns the death of an individual U.S. transferor, see Treas.
Reg. Sec. 1.367(a)-8T(e)(7). Treas. Reg. Sec. 1.367(a)-8T(d)(7).
(8) Failure to comply
The failure to comply in any material respect with the requirements of Treas. Reg.
Sec. 1.367(a)-8T or with the terms of a GRA (for example, a failure to file an annual
certification or Form 8838). Such a material failure to comply shall extend the period for
assessment of tax until three years after the date on which the Director of Field
Operations or Area Director receives actual notice of the failure to comply. For a
"reasonable cause" exception to this triggering event, see Treas. Reg. Sec. 1.367(a)-
68
8T(e)(10). Treas. Reg. Sec. 1.367(a)-8T(d)(8).
e. Exceptions
Notwithstanding Treas. Reg. Sec. 1.367(a)-8T(d), the following events shall not
constitute triggering events:
(1) Certain nonrecognition transactions
(A) Dispositions of stock of the transferee
foreign corporation by the U.S. transferor
i) Transfers to a corporation or
partnership
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv) (which
addresses recognition of gain when the U.S. transferor disposes of stock of the transferee
foreign corporation in a nonrecognition transaction), a disposition of stock of the
transferee foreign corporation by the U.S. transferor in an exchange to which Sec. 351,
354 (but only in a reorganization described in Sec. 368(a)(1)(B)), or 721 applies, will not
be a triggering event under Treas. Reg. Sec. 1.367(a)-8T(d)(3), and the original GRA will
terminate without further effect, if the U.S. transferor complies with requirements similar
to those contained in Treas. Reg. Sec. 1.367(a)-8T(e)(1)(ii), providing for notice and an
agreement to recognize gain in the case of a direct or indirect disposition of the stock
previously held by the U.S. transferor. See Treas. Reg. Sec. 1.367(a)-8T(e)(3)(i) for
dispositions of the transferee foreign corporation stock in certain asset reorganizations.
Treas. Reg. Sec. 1.367(a)-8T(e)(1)(i)(A).
ii) Liquidations of the U.S. transferor
under Secs. 332 and 337
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The disposition of the transferee foreign corporation stock pursuant to a
liquidation of the U.S. transferor under Secs. 332 and 337 will not be a triggering event
under Treas. Reg. Sec. 1.367(a)-8T(d)(3), and the original GRA shall terminate without
further effect, if the following conditions are satisfied:
(1) The distributee is a domestic corporation described in Sec. 332(b)(1).
(2) The domestic distributee corporation (successor U.S. transferor) enters into a
new GRA pursuant to which it agrees to recognize gain (during the remaining term of the
original GRA), with respect to the initial transfer, modified by substituting the successor
U.S. transferor in place of the original U.S. transferor, and agreeing to treat the successor
U.S. transferor as the original U.S. transferor for purposes of Treas. Reg. Sec. 1.367(a)-
8T. If, however, in connection with a liquidation described in Sec. 332, the U.S.
transferor recognizes gain under Sec. 336 with respect to a portion of the stock of the
transferee foreign corporation, and the conditions described in Treas. Reg. Sec. 1.367(a)-
8T(g)(1) are satisfied, the new GRA that the successor U.S. transferor enters into shall
reflect the gain realized, but not recognized, on the initial transfer (subject to adjustment
for prior partial dispositions) less that proportion corresponding to gain recognized under
Sec. 336. The proportion is determined by reference to the relative fair market values of
the transferee foreign corporation stock received (or deemed received) in the initial
transfer on which the U.S. transferor recognized gain under Sec. 336 and the total fair
market value of the transferee foreign corporation stock received (or deemed received) by
the U.S. transferor in the initial transfer that is distributed by the U.S. transferor in the
liquidation.
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(3) The successor U.S. transferor makes the "triggering year election" described in
Treas. Reg. Sec. 1.367(a)-8T(b)(1)(vii). However, if the U.S. transferor was a member of
a consolidated group in the year of the initial transfer, and the successor U.S. transferor is
also a member of the original consolidated group immediately after the liquidation, no
such election must be made.
(4) The successor U.S. transferor provides with its next annual certification
(described in Treas. Reg. Sec. 1.367(a)-8T(b)(5)) the new GRA, a notice of the
liquidation, and Form 8838 to extend the period for assessment of the tax on the initial
transfer to a date not earlier than the eighth full taxable year following the taxable year of
the initial transfer. Treas. Reg. Sec. 1.367(a)-8T(e)(1)(i)(B).
(B) Transfers of stock or securities of the
transferred corporation by the transferee foreign corporation to a corporation or
partnership
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1)(i) (which
addresses gain recognized by the U.S. transferor when the transferee foreign corporation
recognizes gain in a nonrecognition transaction) a disposition of stock or securities of the
transferred corporation by the transferee foreign corporation in an exchange to which
Sec. 351, 354 (but only in a reorganization described in Sec. 368(a)(1)(B)), or 721
applies, will not be a triggering event described in Treas. Reg. Sec. 1.367(a)-8T(d)(1),
and the original GRA shall terminate without further effect, if the following conditions
are satisfied:
(1) The transferee foreign corporation receives (or is deemed to receive) in
exchange for the property disposed of, stock in a corporation, or an interest in a
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partnership, that acquired the transferred stock or securities (or receives stock in a
corporation that controls the corporation acquiring the transferred stock or securities in
the case of a triangular Sec. 368(a)(1)(B) reorganization).
(2) The U.S. transferor provides a notice of the transfer with its next annual
certification under Treas. Reg. Sec. 1.367(a)-8T(b)(5), setting forth--
(a) A full description of the transfer;
(b) The applicable nonrecognition provision; and
(d) The name, address, and taxpayer identification number (if any) of the new
transferee of the transferred stock or securities.
(3) The U.S. transferor provides with its next annual certification a new GRA
pursuant to which it agrees to recognize gain (during the remaining term of the original
GRA) with respect to the initial transfer, and in which it agrees that any of the following
events also constitutes a triggering event:
(a) A disposition of the stock or securities or partnership interest that the
transferee foreign corporation received in exchange for the transferred stock or securities
(other than in a disposition which itself qualifies under the rules of Treas. Reg. Sec.
1.367(a)-8T(e)).
(b) The corporation or partnership that acquired the transferred stock or securities
disposes of such property (other than in a disposition which itself qualifies under the rules
of Treas. Reg. Sec. 1.367(a)-8T(e)).
(c) Any other disposition that has the effect of an indirect disposition of the
transferred stock or securities.
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Paragraph (3)(c) above appears to be an attempt to create a catchall rule. A
conservative interpretive approach would treat it as if it were an application by analogy of
Treas. Reg. Sec. 1.367(a)-1T(c)(1). That regulation, as noted in Section I.A above,
applies Sec. 367(a)(1) to several nonexclusive, enumerated nonrecognition exchanges,
including transactions pursuant to Secs. 351 and 354, "whether [they are] made directly,
indirectly, or constructively." Treas. Reg. Sec. 1.367(a)-8T(e)(1)(ii).
(C) Transfers of the transferred corporation's
assets to a corporation or partnership
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1)(ii) (which
addresses the portion of gain that must be recognized in a nonrecognition transaction), a
disposition of substantially all of the transferred corporation's assets by the transferred
corporation in an exchange to which Sec. 351, 354 (but only in a reorganization described
in Sec. 368(a)(1)(B)--for example, where stock in a subsidiary corporation comprises
substantially all of the transferred corporation's assets), or 721 applies, will not be a
triggering event under Treas. Reg. Sec. 1.367(a)-8T(d)(2), and the original GRA shall
terminate without further effect, if the transferred corporation receives (or is deemed to
receive) in exchange for all or a portion of its assets stock in a corporation or an interest
in a partnership that acquired the assets of the transferred corporation (or receives stock
in a corporation that controls the corporation acquiring the assets) and the U.S. transferor
complies with requirements similar to those contained in Treas. Reg. Sec. 1.367(a)-
8T(e)(1)(ii) (providing for notice and an agreement to recognize gain in the case of a
direct or indirect disposition of the assets previously held by the transferred corporation).
See Treas. Reg. Sec. 1.367(a)-8T(e)(3)(iii) for dispositions of substantially all of the
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transferred corporation's assets in certain asset reorganizations. Treas. Reg. Sec.
1.367(a)-8T(e)(1)(iii).
(2) Recapitalizations
(A) Transferred corporation
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1) (which
provides that the U.S. transferor must recognize gain if the transferee foreign corporation
recognizes gain in a nonrecognition transaction), a transaction described in Sec.
368(a)(1)(E) of the transferred corporation will not be a triggering event under Treas.
Reg. Sec. 1.367(a)-8T(d)(1). The description of this exception that is required to be filed
with the annual certification under Treas. Reg. Sec. 1.367(a)-8T(b)(5) must include a
description of the type or class, amount, and characteristics of the stock or securities that
the transferred corporation issued in the reorganization. Treas. Reg. Sec. 1.367(a)-
8T(e)(2)(i).
(B) Transferee foreign corporation
A Sec. 368(a)(1)(E) reorganization of the transferee foreign corporation will not
be a triggering event under Treas. Reg. Sec. 1.367(a)-8T(d)(3). The description of this
exception that is required to be filed with the annual certification under Treas. Reg. Sec.
1.367(a)-8T(b)(5) must include a description of the type or class, amount, and
characteristics of the stock or securities that the transferee foreign corporation issued in
the reorganization. See Treas. Reg. Sec. 1.367(a)-8T(g)(1) for rules regarding the
recognition of gain by the U.S. transferor in connection with nonrecognition exchanges.
Treas. Reg. Sec. 1.367(a)-8T(e)(2)(ii).
(3) Certain asset reorganizations
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(A) Transfers of transferee foreign corporation's
stock by U.S. transferor
Except to the extent provided Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv) (which
addresses recognition of gain when the U.S. transferor disposes of stock of the transferee
foreign corporation in a nonrecognition transaction), if the U.S. transferor transfers all or
a portion of the stock of the transferee foreign corporation to a domestic acquiring
corporation (successor U.S. transferor) pursuant to an asset reorganization, the exchanges
made pursuant to such asset reorganization will not be triggering events described in
Treas. Reg. Sec. 1.367(a)-8T(d)(3), and the original GRA shall terminate without further
effect, if the following conditions are satisfied:
(1) The common parent of the original consolidated group, successor U.S.
transferor, or new common parent, as applicable, enters into a new GRA pursuant to
which the successor U.S. transferor agrees to recognize gain (during the remaining term
of the original GRA) with respect to the initial transfer, modified by substituting the
successor U.S. transferor in place of the original U.S. transferor and agreeing to treat the
successor U.S. transferor as the original U.S. transferor for purposes of Treas. Reg. Sec.
1.367(a)-8T.
(2) The successor U.S. transferor or new common parent makes the "triggering
year election" described in Treas. Reg. Sec. 1.367(a)-8T(b)(1)(vii) (see Section
I.E.2.b.(1) above). However, if the U.S. transferor was a member of a consolidated group
in the year of the initial transfer, and the successor U.S. transferor is also a member of the
original consolidated group immediately after the asset reorganization, no such election
must be made.
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(3) The successor U.S. transferor provides with its next annual certification
(described in Treas. Reg. Sec. 1.367(a)-8T(b)(5))--
(a) The new GRA;
(b) A notice of the transfer setting forth a full description of the transfer
(including the date of such transfer), and the successor U.S. transferor's name, address,
and taxpayer identification number; and
(c) Form 8838 to extend the period for assessment of the tax on the initial transfer
to a date not earlier than the eighth full taxable year following the taxable year of the
initial transfer. Treas. Reg. Sec. 1.367(a)-8T(e)(3)(i). Treas. Reg. Sec. 1.367(a)-
8T(e)(3)(i).
(B) Transfers of transferred corporation stock or
securities by a transferee foreign corporation to a foreign acquiring corporation
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1) (which
provides that the U.S. transferor must recognize gain if the transferee foreign corporation
recognizes gain in a nonrecognition transaction), if the transferee foreign corporation
transfers all or a portion of the stock or securities of the transferred corporation to a
foreign acquiring corporation (successor transferee foreign corporation) in an asset
reorganization, the exchanges made pursuant to such reorganization will not be triggering
events described in Treas. Reg. Sec. 1.367(a)-8T(d)(1) or (d)(3), and the original GRA
shall terminate without further effect, if the following conditions are satisfied:
(1) The U.S. transferor or common parent, as applicable, enters into a new GRA
pursuant to which the U.S. transferor agrees to recognize gain (during the remaining term
of the original GRA), with respect to the initial transfer, substituting the successor
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transferee foreign corporation in place of the original transferee foreign corporation, and
agreeing to treat the successor transferee foreign corporation as the original transferee
foreign corporation for purposes of Treas. Reg. Sec. 1.367(a)-8T.
(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) the new GRA and a notice of the transfer setting
forth a full description of the transfer (including the date of such transfer), and the
successor transferee foreign corporation's name, address, and taxpayer identification
number (if any). Treas. Reg. Sec. 1.367(a)-8T(e)(3)(ii).
(C) Transfers of substantially all of the
transferred corporation's assets
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(2) (which
addresses the method of computing the gain the U.S. transferor must recognize if the
transferee foreign corporation recognizes gain in connection with a nonrecognition
transaction), if the transferred corporation transfers substantially all of its assets to an
acquiring corporation (successor transferred corporation) pursuant to an asset
reorganization, the exchanges made pursuant to such asset reorganization will not be
triggering events under Treas. Reg. Sec. 1.367(a)-8T(d)(1) or (d)(2), and the original
GRA shall terminate without further effect, if the following conditions are satisfied:
(1) The U.S. transferor or common parent, as applicable, enters into a new GRA
pursuant to which the U.S. transferor agrees to recognize gain (during the remaining term
of the original GRA), with respect to the initial transfer, modified by--
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(a) Substituting the successor transferred corporation in place of the original
transferred corporation and agreeing to treat the successor transferred corporation as the
original transferred corporation for purposes of Treas. Reg. Sec. 1.367(a)-8T; and
(b) Treating only the assets acquired by the successor transferred corporation
from the original transferred corporation pursuant to the asset reorganization as the assets
subject to the triggering event rules under Treas. Reg. Sec. 1.367(a)-8T(d)(2).
(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) the new GRA and a notice of the transfer setting
forth a full description of the transfer (including the date of such transfer), and the
successor transferred corporation's name, address, and taxpayer identification number (if
any). Treas. Reg. Sec. 1.367(a)-8T(e)(3)(iii).
(4) Certain triangular reorganizations
(A) Triangular asset reorganizations of the
transferee foreign corporation
For purposes of Treas. Reg. Sec. 1.367(a)-8T(e)(4), the term triangular asset
reorganization means a triangular reorganization described in Sec. 1.358-6(b)(2)(i)
through (iii) (i.e., forward subsidiary mergers, subsidiary C reorganizations, and reverse
subsidiary mergers) or in Secs. 368(a)(1)(G) and (a)(2)(D) where the acquiring subsidiary
is foreign. Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1) (which
addresses gain recognized by the U.S. transferor when the transferee foreign corporation
recognizes gain in a nonrecognition transaction) or Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv)
(which addresses recognition of gain when the U.S. transferor disposes of stock of the
transferee foreign corporation in a nonrecognition transaction), the exchanges made
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pursuant to a triangular asset reorganization of the transferee foreign corporation will not
be triggering events under Treas. Reg. Sec. 1.367(a)-8T(d)(1) or (d)(3), and the original
GRA shall terminate without further effect, if the following conditions are satisfied:
(1) The U.S. transferor or common parent, as applicable, enters into a new GRA
pursuant to which the U.S. transferor agrees to recognize gain (during the remaining term
of the original GRA), with respect to the initial transfer, and in which the U.S. transferor
agrees to--
(a) If the parent corporation of the foreign acquiring subsidiary is foreign, treat
such foreign parent as the original transferee foreign corporation for purposes of Treas.
Reg. Sec. 1.367(a)-8T and treat as a triggering event a disposition of the stock of the
foreign acquiring subsidiary, or, in the case of a reorganization described in Sec.
368(a)(2)(E), the corporation originally identified as the transferee foreign corporation;
and
(b) If the parent corporation of the foreign acquiring subsidiary is domestic, treat
the foreign acquiring subsidiary as the original transferee foreign corporation for
purposes of Treas. Reg. Sec. 1.367(a)-8T, and apply the principles of Treas. Reg. Sec.
1.367(a)-8T(g) to taxable dispositions by the domestic parent corporation of the foreign
acquiring subsidiary or, in the case of a reorganization described in Sec. 368(a)(2)(E), the
corporation originally identified as the transferee foreign corporation. In the case of a
reorganization described in Sec. 368(a)(2)(E) where the transferee foreign corporation is
the merged corporation, rather than the surviving corporation, then the surviving
corporation shall be treated as the transferee foreign corporation for purposes of Treas.
Reg. Sec. 1.367(a)-8T.
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(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) the new GRA and a notice of the transfer setting
forth a full description of the transfer (including the date of such transfer) and the name,
address, and taxpayer identification number (if any) for the parent corporation of the
foreign acquiring subsidiary. Treas. Reg. Sec. 1.367(a)-8T(e)(4)(i).
(B) Triangular asset reorganizations of the
transferred corporation
Except to the extent provided in Treas. Reg. Sec. 1.367(a)-8T(f)(1) or (f)(2)
(which address recognition of gain by the U.S. transferor due to transfers of stock or
securities or sub all dispositions of assets by the transferee foreign corporation in
nonrecognition transactions), the exchanges made pursuant to a triangular asset
reorganization of the transferred corporation will not be triggering events in Treas. Reg.
Sec. 1.367(a)-8T(d)(1) or (d)(2), and the original GRA shall terminate without further
effect, if the following conditions are satisfied:
(1) The U.S. transferor or common parent, as applicable, enters into a new GRA
pursuant to which the U.S. transferor agrees to recognize gain (during the remaining term
of the original GRA), in accordance with the rules of Treas. Reg. Sec. 1.367(a)-8T(b),
with respect to the initial transfer, and in which the U.S. transferor agrees to--
(a) Treat a disposition of the stock of the acquiring parent as a triggering event;
(b) If the reorganization is a triangular C reorganization or a subsidiary
reorganization described in Sec. 368(a)(2)(D), treat a disposition of the stock of the
foreign acquiring subsidiary as a triggering event; and
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(c) If the reorganization is a reverse subsidiary merger described in Sec.
368(a)(2)(E) and the merged corporation is the transferred corporation, treat a disposition
of the stock of the surviving corporation as a triggering event.
(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) the new GRA and a notice of the transfer setting
forth a full description of the transfer (including the date of such transfer) and the name,
address, and taxpayer identification number (if any) for the parent corporation of the
foreign acquiring subsidiary. Treas. Reg. Sec. 1.367(a)-8T(e)(4)(ii).
(5) Compulsory transfers
A compulsory transfer under Sec. 1.367(a)-4T(f)(2) that is not reasonably
foreseeable by the U.S. transferor is not a triggering event under Treas. Reg. Secs.
1.367(a)-8T(d)(1) through (d)(3). Compulsory transfers under Treas. Reg. Sec. 1.367(a)-
4T(f)(2) are either legally required by a foreign government as a necessary condition of
doing business in that country or compelled by a genuine threat of immediate
expropriation by a foreign government. Treas. Reg. Sec. 1.367(a)-8T(e)(5).
(6) Certain liquidations and upstream reorganizations
of the transferred corporation into the transferee foreign corporation
A transfer of assets by the transferred corporation to the transferee foreign
corporation pursuant to a liquidation described in Sec. 332, where the transferee foreign
corporation is described in Sec. 332(b)(1), or pursuant to a reorganization described in
Sec. 368(a), and related exchanges of stock or securities of the transferred corporation
will not be triggering events under Treas. Reg. Sec. 1.367(a)-8T(d)(1) or (d)(2). The
description of this exception that is required to be filed with the annual certification under
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Treas. Reg. Sec. 1.367(a)-8T(b)(5) must include a description of the transaction. In such a
case, the original GRA shall continue to apply during the remainder of its term. If,
however, in connection with a liquidation described in Sec. 332, the transferred
corporation recognizes gain under Sec. 336 with respect to a portion of its assets, such
assets shall be treated as disposed of for purposes of Treas. Reg. Sec. 1.367(a)-8T(d)(2)
(which addresses disposition of substantially all of the transferred corporation's assets).
Treas. Reg. Sec. 1.367(a)-8T(e)(6).
(7) Death of an individual U.S. transferor
If the U.S. transferor is an individual and such individual dies, the individual's
death will not be a triggering event under Treas. Reg. Sec. 1.367(a)-8T(d)(7), if the
person winding up the affairs of the U.S. transferor--
(1) retains, for the duration of the waiver of the statute of limitations relating to
the GRA, assets to meet any possible liability of the U.S. transferor under the duration of
the GRA;
(2) provides security pursuant to Treas. Reg. Sec. 1.367(a)-8T(c) for any possible
liability of the U.S. transferor under the GRA; or
(3) obtains a ruling from the Internal Revenue Service providing for successors to
the U.S. transferor under the GRA. Treas. Reg. Sec. 1.367(a)-8T(e)(7).
(8) Deconsolidation
A deconsolidation described in Treas. Reg. Sec. 1.367(a)-8T(d)(4) will not be a
triggering event, and the original GRA shall terminate without further effect, if the
following conditions are satisfied:
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(1) The U.S. transferor enters into a new GRA pursuant to which the U.S.
transferor agrees to recognize gain (during the remaining term of the original GRA) with
respect to the initial transfer and makes the "triggering year election" described in Treas.
Reg. Sec. 1.367(a)-8T(b)(1)(vii).
(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) notice of the deconsolidation. Treas. Reg. Sec.
1.367(a)-8T(e)(8).
(9) Consolidation
A consolidation described in Treas. Reg. Sec. 1.367(a)-8T(d)(5) will not be a
triggering event, and the original GRA shall terminate without further effect, if the
following conditions are satisfied:
(1) The common parent of the consolidated group that includes the U.S. transferor
immediately after the consolidation enters into a new GRA pursuant to which the U.S.
transferor agrees to recognize gain (during the remaining term of the original GRA) with
respect to the initial transfer and in which it makes the "triggering year election"
described in Treas. Reg. Sec. 1.367(a)-8T(b)(1)(vii).
(2) The U.S. transferor provides with its next annual certification (described in
Treas. Reg. Sec. 1.367(a)-8T(b)(5)) a notice of the consolidation. Treas. Reg. Sec.
1.367(a)-8T(e)(9).
(10) Reasonable cause exception for failure to comply
(A) Request for relief
A failure to comply described in Treas. Reg. Sec. 1.367(a)-8T(d)(8) will not be a
triggering event, and the timeliness requirement with respect to a GRA shall be
83
considered satisfied notwithstanding a failure to file the agreement in a timely manner, if
the person required to file the GRA, annual certification, or Form 8838 is able to
demonstrate to the Area Director, Field Examination, Small Business/Self Employed or
the Director of Field Operations, Large and Mid-Size Business (Director) having
jurisdiction of the taxpayer's tax return for the taxable year, that such failure was due to
reasonable cause and not willful neglect.
In determining whether the person has reasonable cause, the Director shall
determine whether, based on all the facts and circumstances, the person acted reasonably
and in good faith. The Director shall notify the person in writing within 120 days of the
filing if it is determined that the failure to comply was not due to reasonable cause, or if
additional time will be needed to make such determination. For this purpose, the 120-day
period shall begin to run on the date the Service notifies the person in writing that the
request has been received and assigned for review. Once such period commences, if the
person is not again notified within 120 days, then the person shall be deemed to have
established reasonable cause. The reasonable cause exception of Treas. Reg. Sec.
1.367(a)-8T(e)(10) shall apply only if, once the person becomes aware of the failure to
file or comply with the agreement, the person complies with the requirements for
granting relief that are set forth in Treas. Reg. Sec. 1.367(a)-8T(e)(10)(ii). Treas. Reg.
Sec. 1.367(a)-8T(e)(10)(i).
(B) Requirements for granting reasonable cause
relief
Requests for reasonable cause relief will only be considered if, once the person
becomes aware of the failure to file or comply with the agreement, the person attaches all
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the documents that should have been filed, as well as a complete written statement setting
forth the reasons for the failure to timely comply, to an amended return that amends the
return to which the documents should have been attached pursuant to the rules of Sec.
367(a) and the regulations under that paragraph
In addition to the requirement of Treas. Reg. Sec. 1.367(a)-8T(e)(10)(ii)(A), the
person must provide a copy of the amended return and all required attachments to the
Director as follows:
(1) If the taxpayer is under examination for any taxable year when the person
requests relief, the taxpayer must provide a copy of the amended return and attachments
to the personnel conducting the examination.
(2) If the taxpayer is not under examination for any taxable year when the person
requests relief, the taxpayer must provide a copy of the amended return and attachments
to the Director having jurisdiction over the taxpayer's return. Treas. Reg. Sec. 1.367(a)-
8T(e)(10)(ii).
f. Gain recognized in connection with certain nonrecognition
transactions
(1) Dispositions of transferred stock or securities
If a disposition of the transferred stock or securities occurs in connection with a
nonrecognition transaction described in Treas. Reg. Sec. 1.367(a)-8T(e)(1)(ii), (e)(2)(i),
(e)(3)(ii), (e)(3)(iii), or (e)(4) and gain is recognized by the transferee foreign corporation
in connection with the transaction (for example, under Secs. 351(b) or 356(a)(1)), the
U.S. transferor must recognize gain pursuant to the GRA as determined under Treas. Reg.
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Sec. 1.367(a)-8T(f)(1)(ii). Treas. Reg. Sec. 1.367(a)-8T(f)(1)(i) shall not apply to the
extent that the gain recognized is treated as a dividend under Sec. 356(a)(2).
The portion of the GRA that must be recognized under Treas. Reg. Sec. 1.367(a)-
8T(f)(1)(i), if any, is the gain that would be recognized by the transferee foreign
corporation on such disposition (but not in excess of the amount of the GRA). For
purposes of Treas. Reg. Sec. 1.367(a)-8T(f)(1)(ii), the gain that would be recognized in
the nonrecognition transactions listed in Treas. Reg. Sec. 1.367(a)-8T(f)(1)(i) by the
transferee foreign corporation shall be calculated before taking into account any basis
increase that may apply under Treas. Reg. Sec. 1.367(a)-8T(b)(3)(iv) as a result of the
gain that the U.S. transferor is required to recognize. If the amount of gain that the
transferee foreign corporation would be required to recognize is less than the amount of
the gain subject to the GRA, then the new GRA filed pursuant to Treas. Reg. Sec.
1.367(a)-8T(e)(1)(ii), (e)(2)(i), (e)(3)(ii), (e)(3)(iii), or (e)(4) shall provide that the U.S.
transferor shall recognize the remaining portion of the gain that was realized, but not
recognized, on the initial transfer if a subsequent triggering event occurs. Treas. Reg. Sec.
1.367(a)-8T(f)(1).
(2) Dispositions of substantially all of the transferred
corporation's assets
If a disposition of substantially all of the assets of the transferred corporation
occurs in connection with a nonrecognition transaction described in Treas. Reg. Sec.
1.367(a)-8T(e)(1)(iii), (e)(3)(iii), or (e)(4)(ii) and gain is recognized on such disposition
(for example, under Sec. 351(b) or 356(a)(1)), the U.S. transferor must recognize gain
pursuant to the GRA to the extent of such gain recognized (but not in excess of the gain
86
realized, but not recognized, on the initial transfer). Treas. Reg. Sec. 1.367(a)-8T(f)(2)
shall not apply to the extent that recognized gain is treated as a dividend under Sec.
356(a)(2). Treas. Reg. Sec. 1.367(a)-8T(f)(2).
g. Transactions that terminate the GRA or reduce the amount
of gain required to be recognized pursuant to a GRA
Notwithstanding Treas. Reg. Sec. 1.367(a)-8T(d), the following events shall not
constitute triggering events and instead shall either terminate the GRA, or reduce the
amount of gain required to be recognized pursuant to a GRA:
(1) Taxable disposition of stock of the transferee
foreign corporation by U.S. transferor
If the U.S. transferor disposes of all the stock of the transferee foreign corporation
that is received (or deemed received) in the initial transfer, then the GRA shall terminate
without further effect if--
(A) Immediately before the disposition, the aggregate basis of the transferee
foreign corporation stock disposed of does not exceed the sum of the aggregate basis of
the transferred stock or securities immediately before the initial transfer plus any increase
in the basis of such stock or securities as a result of the recognition of gain on the initial
transfer. For purposes of Treas. Reg. Sec. 1.367(a)-8T(g)(1)(i)(A), an increase in basis of
the stock disposed of as a result of an income inclusion with respect to such stock (for
example, pursuant to Sec. 961) shall not be taken into account; and
(B) All realized gain (if any) in the stock disposed of is recognized currently and
included in taxable income as a result of the disposition. Treas. Reg. Sec. 1.367(a)-
8T(g)(1)(i).
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(A) Partial dispositions
If the U.S. transferor disposes of a portion of the stock of the transferee foreign
corporation that is received (or deemed received) in the initial transfer in a transaction
that satisfies the conditions described in Treas. Reg. Secs. 1.367(a)-8T(g)(1)(i)(A) and
(B), such disposition will not be a triggering event and the gain recognition shall remain
in effect. For purposes of determining whether the condition described in Treas. Reg.
Sec. 1.367(a)-8T(g)(1)(i)(A) is satisfied, however, the aggregate basis of the stock of the
transferee foreign corporation disposed of is compared to the aggregate basis of the
transferred stock or securities exchanged for such stock at the time of the initial transfer.
If a subsequent triggering event occurs -- i.e., if the GRA is triggered after a
partial disposition described in Treas. Reg. Sec. 1.367(a)-8T(g)(1)(ii)(A) -- then the U.S.
transferor shall be required to recognize only a proportionate amount of the gain subject
to the GRA that otherwise would be required to be recognized on a subsequent triggering
event. Except as provided in Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv), the proportion
required to be recognized shall be determined by reference to the percentage of stock
(based on relative fair market value) of the transferee foreign corporation received (or
deemed received) in the initial transfer that is retained by the U.S. transferor. Treas.
Reg. Sec. 1.367(a)-8T(g)(1)(ii).
(B) Certain nonrecognition transactions
The rules described in Treas. Reg. Secs. 1.367(a)-8T(g)(1)(iv)(A) through (C)
apply if the U.S. transferor disposes of all or a portion of the stock of the transferee
foreign corporation received (or deemed received) in the initial transfer pursuant to a
nonrecognition transaction described in Treas. Reg. Sec. 1.367(a)-8T(e)(1)(i), (e)(2)(ii),
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(e)(3)(i), or (e)(3)(ii), the condition described in Treas. Reg. Sec. 1.367(a)-8T(g)(1)(i)(A)
is satisfied with respect to such disposition, and gain is recognized in connection with the
disposition (for example, under Secs. 351(b), 356(a)(1), or 336). If, however, only a
portion of the stock of the transferee corporation stock is disposed of pursuant to Treas.
Reg. Sec. 1.367(a)-8T(g)(1)(iv), then for purposes of determining whether the condition
described in Treas. Reg. Sec. 1.367(a)-8T(g)(1)(i)(A) is satisfied, the aggregate basis of
the stock disposed of is compared to the aggregate basis of the transferred stock or
securities exchanged for such stock at the time of the initial transfer. Treas. Reg. Sec.
1.367(a)-8T(g)(1)(iv).
i) U.S. transferor files new GRA
Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv)(A) applies if the U.S. transferor (or
successor U.S. transferor, as applicable) enters into a new GRA as provided in Treas.
Reg. Sec. 1.367(a)-8T(e)(1)(i), (e)(3)(i), or (e)(3)(ii), as applicable. In such a case, the
amount of gain subject to the new GRA shall equal the amount of gain realized, but not
recognized, on the initial transfer, less any gain recognized by the U.S. transferor in
connection with the nonrecognition transaction. If the amount of gain recognized on the
transfer is equal to or greater than the amount of gain realized, but not recognized, on the
initial transfer, then the original GRA shall terminate without further effect. Treas. Reg.
Sec. 1.367(a)-8T(g)(1)(iv)(A).
ii) U.S. transferor does not file a new
GRA
Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv)(B) applies if the U.S. transferor (or
successor U.S. transferor, as applicable) fails to enter into a new GRA as provided in
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Treas. Reg. Sec. 1.367(a)-8T(e)(1)(i), (e)(3)(i), or (e)(3)(ii), as applicable. In such a case,
the amount required to be recognized by the U.S. transferor pursuant to the GRA shall be
the amount of gain realized, but not recognized, on the initial transfer, less any gain
recognized by the U.S. transferor in connection with the nonrecognition transaction.
Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv)(B).
iii) Special rule for recapitalizations
Because Treas. Reg. Sec. 1.367(a)-8T(e)(2)(ii) does not require the U.S. transferor
to enter into a new GRA, the amount of gain subject to the GRA shall equal the amount
of gain realized, but not recognized, on the initial transfer, less any gain recognized by
the U.S. transferor in connection with the nonrecognition transaction described in Treas.
Reg. Sec. 1.367(a)-8T(e)(2)(ii). Treas. Reg. Sec. 1.367(a)-8T(g)(1)(iv)(C).
(C) Election to reduce basis
For purposes of Treas. Reg. Secs. 1.367(a)-8T(g)(1)(i), (ii) and (iv), the U.S.
transferor may elect to reduce its aggregate basis in the stock disposed of effective
immediately before the disposition such that the condition described in paragraph
(g)(1)(i)(A) is satisfied (i.e., the aggregate basis of the transferee foreign corporation
stock disposed of does not exceed the sum of the aggregate basis of the transferred stock
or securities immediately before the initial transfer plus any increase in the basis of such
stock or securities as a result of the recognition of gain on the initial transfer). If such an
election is made pursuant to Treas. Reg. Sec. 1.367(a)-8T(g)(1)(v), the U.S. transferor
may increase its basis in other stock of the transferee foreign corporation it holds, if any,
by a corresponding amount but not above the fair market value of such stock.
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The election allowed by Treas. Reg. Sec. 1.367(a)-8T(g)(1)(v) is made by filing
with the U.S. transferor's income tax return for the taxable year in which the disposition
of the transferee foreign corporation stock occurs, a statement setting forth the following
information, with the heading "Election to Reduce Stock Basis Under Sec. 1.367(a)-
8T(g)(1)(v)":
(1) A description of the transferee foreign corporation stock that the U.S.
transferor has disposed of.
(2) An estimate of the fair market value of the stock as of the date of the
disposition.
(3) A comparison of the basis of the transferee foreign corporation stock before
and after the election that is made pursuant to Treas. Reg. Sec. 1.367(a)-8T(g)(1)(v).
(4) The date on which the transferee foreign corporation stock was disposed of by
the U.S. transferor. Treas. Reg. Sec. 1.367(a)-8T(g)(1)(v).
(2) Certain dispositions by a domestic transferred
corporation of substantially all of its assets
If, immediately before the initial transfer, the U.S. transferor owned an amount of
stock in the transferred corporation described in Sec. 1504(a)(2), and the transferred
corporation is domestic, then the GRA shall terminate without further effect if the
transferred corporation disposes of substantially all of its assets in a transaction in which
all realized gain is recognized currently. If an indirect stock transfer necessitated the
filing of the GRA, such agreement shall terminate if, immediately before the indirect
transfer, the U.S. transferor owned an amount of stock in the acquired corporation
described in Sec. 1504(a)(2) (or, in the case of a Sec. 368(a)(1)(A) and (a)(2)(E)
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reorganization described in Sec. 1.367(a)-3(d)(1)(ii), the U.S. transferor owned an
amount of stock in the acquiring corporation described in Sec. 1504(a)(2)) and the
transferred corporation disposes of substantially all of its assets (taking into account Sec.
1.367(a)- 3(d)(2)(v)) in a transaction in which all realized gain is recognized currently.
Treas. Reg. Sec. 1.367(a)-8T(g)(2).
(3) Distribution or transfer by transferee foreign
corporation of stock or securities of transferred corporation under Sec. 337, 355 or 361
(A) Scope
Treas. Reg. Sec. 1.367(a)-8T(g)(3) applies if the transferee foreign corporation
distributes or transfers the stock or securities that initially necessitated the filing of the
GRA (and any additional stock received after the initial transfer) pursuant to any of the
following transactions:
(A) A liquidating distribution to the U.S. transferor or a domestic corporation that
is a member of the same consolidated group of which the U.S. transferor is then a
member and that qualifies under Secs. 332 and 337, if such domestic distributee
corporation is described in Sec. 332(b)(1).
(B) A distribution to the U.S. transferor, a domestic corporation that is a member
of the same consolidated group of which the U.S. transferor is a member, or an individual
that is a United States person, that qualifies under Sec. 355.
(C) A transfer to the U.S. transferor or a domestic corporation that is a member of
the same consolidated group of which the U.S. transferor is then a member and to which
Sec. 361 applies (but, if in connection with a reorganization described in Sec.
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368(a)(1)(D) or (G), only if the requirements of Sec. 354(b)(1)(A) and (B) are met)..
Treas. Reg. Sec. 1.367(a)-8T(g)(3)(i).
(B) General rule
If a distribution or transfer is described in Treas. Reg. Sec. 1.367(a)-8T(g)(3)(i),
the GRA shall terminate without further effect, provided that immediately after such
distribution or transfer the basis in the transferred stock or securities in the hands of the
domestic corporation or individual, as applicable, does not exceed the basis that the U.S.
transferor had in the transferred stock or securities immediately before the initial transfer.
For purposes of Treas. Reg. Sec. 1.367(a)-8T(g)(3)(ii), only the basis in the stock or
securities transferred shall be taken into account, and increases to stock basis as a result
of income inclusions with respect to stock (for example, pursuant to Sec. 961) shall not
be taken into account. In the case of a transaction described in Treas. Reg. Sec. 1.367(a)-
8T(g)(3)(i)(B), any reductions or redistributions of stock basis under Sec. 1.367(b)-
5(c)(2) or (4), respectively, shall be made before applying the rules of Treas. Reg. Sec.
1.367(a)-8T(g)(3)(ii). Treas. Reg. Sec. 1.367(a)-8T(g)(3)(ii).
(C) Election to reduce basis in stock or
securities of transferred corporation
For purposes of Treas. Reg. Sec. 1.367(a)-8T(g)(3)(ii), the domestic corporation
or individual, as applicable, may elect to reduce the basis in the stock or securities
transferred to equal the basis the U.S. transferor had in the corresponding transferred
stock or securities immediately before the initial transfer, such that the GRA shall
terminate without further effect. If such an election is made, the domestic corporation or
individual may increase its basis in other stock of the transferred corporation it holds, if
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any, by a corresponding amount but not above the fair market value of such stock. Treas.
Reg. Sec. 1.367(a)-8T(g)(3)(iii).
The election pursuant to Treas. Reg. Sec. 1.367(a)-8T(g)(3)(iii) is made by filing
with the domestic corporation's or individual's income tax return for the taxable year in
which the distribution or transfer occurs, a statement setting forth the following
information, with the heading "Election to Reduce Stock Basis Under Sec. 1.367(a)-
8T(g)(3)(iii)":
(1) A description of the stock or securities received.
(2) An estimate of the fair market value of the stock or securities as of the date of
their receipt.
(3) A statement comparing the basis of the stock or securities before and after the
election.
(4) The date on which the stock or securities were received. Treas. Reg. Sec.
1.367(a)-8T(g)(3)(iv).
h. Effective dates for Treas. Reg. Sec. 1.367(a)-8T
In general, the rules of Treas. Reg. Sec. 1.367(a)-8T apply to GRAs filed with
respect to transfers of stock or securities under Treas. Reg. Secs. 1.367(a)-3(b) through
(d) and 1.367(a)-3T(e) occurring on or after March 7, 2007 and before Feb. 1, 2010,
when all of Treas. Reg. Sec. 1.367(a)-8T expires. The rules of Treas. Reg. Sec. 1.367(a)-
8T(f) apply to GRAs filed with respect to transfers of stock or securities under Treas.
Reg. Secs. 1.367(a)-3(b) through (d) and 1.367(a)-3T(e) occurring on or after August 6,
2007. In addition, the rules of Treas. Reg. Sec. 1.367(a)-8T do not apply to GRAs filed
with respect to such a transfer of stock or securities occurring on or after March 7, 2007,
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if such transfer was entered into pursuant to a written agreement which was (subject to
customary conditions) binding before February 5, 2007, and at all times thereafter. Solely
for purposes of Treas. Reg. Sec. 1.367(a)-8T(h), a transfer described in the preceding
sentence shall be deemed to be a transfer occurring before March 7, 2007 to which the
rules of Sec. 1.367(a)-8 (see 26 CFR part 1, revised April 1, 2006) apply. See Treas. Reg.
Sec. 1.367(a)-8T(h)(2)(iii) for the ability to apply the rules of Treas. Reg. Sec. 1.367(a)-
8T with respect to GRAs filed before March 7, 2007. Treas. Reg. Sec. 1.367(a)-
8T(h)(1)(i).
For matters that occurred between July 20, 1998 and March 7, 2007, the
corresponding rules of Sec. 1.367(a)-8 (see 26 CFR part 1, revised April 1, 2006) apply.
For matters covered in Treas. Reg. Sec. 1.367(a)-8T for periods before July 20, 1998, the
corresponding rules of Sec. 1.367(a)-3T(g) (see 26 CFR part 1, revised April 1, 1998) and
Notice 87- 85 ((1987-2 CB 395); see Sec. 601.601(d)(2)(ii) of this chapter) apply. In
addition, if a U.S. transferor entered into a GRA for transfers before July 20, 1998, then
the rules of Sec. 1.367(a)-3T(g) (see 26 CFR part 1, revised April 1, 1998) continue to
apply in lieu of Treas. Reg. Sec. 1.367(a)-8T in the event of any direct or indirect
nonrecognition transfer of the same property. See also, Sec. 1.367(a)-3(h) (addressing
former ten-year GRAs). Treas. Reg. Sec. 1.367(a)-8T(h)(1)(ii).
To the extent that Treas. Reg. Sec. 1.367(a)-8T contains rules that were not
contained in Treas. Reg. Sec. 1.367(a)-8, some or all of new rules may be applied to
GRAs filed with respect to transfers of stock or securities, for all open years, on or after
July 20, 1998. Treas. Reg. Sec. 1.367(a)-8T(h)(2)(i). If a taxpayer failed to file a GRA
with respect to a transfer of stock or securities on or after July 20, 1998 and before March
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7, 2007, the taxpayer must first obtain reasonable cause relief under Sec. 1.367(a)-8(c)(2)
to file the GRA before the taxpayer may apply Treas. Reg. Sec. 1.367(a)-8T(h)(2)(i).
Treas. Reg. Sec. 1.367(a)-8T(h)(2).
Treas. Reg. Sec. 1.367(a)-8T(h)(2)(ii) provides the time and manner in which
taxpayers may apply Treas. Reg. Sec. 1.367(a)-8T(h)(2)(i). Notwithstanding the rules
provided in Sec. 1.367(a)-8T(a)(2), all agreements, certifications, or other information
related to such GRA that should have been filed on or before March 7, 2007 shall be
treated as having been timely filed, provided they are attached to a Federal income tax
return amending the taxpayer's Federal income tax return for the taxable year in which
they should have been attached. The amended return described in the preceding sentence
must be filed before August 6, 2007. A taxpayer that wishes to apply Treas. Reg. Sec.
1.367(a)-8T(h)(2)(i) but that fails to meet the filing requirement described in the
preceding sentence must request reasonable cause relief as provided in Treas. Reg. Sec.
1.367(a)-8T(e)(10). Treas. Reg. Sec. 1.367(a)-8T(h)(2)(ii).
Finally, a taxpayer that entered into a GRA to which Sec. 1.367(a)-8 (see 26 CFR
part 1, revised April 1, 2006) applies may apply the rules of Treas. Reg. Sec. 1.367(a)-8T
in a tax year ending on or after March 7, 2007 by attaching the agreement, certification,
or other information related to such GRA that the rules of Treas. Reg. Sec. 1.367(a)-8T
require in accordance with the rules of this section and with the time and manner rules
provided in Sec. 1.367(a)- 8T(a)(2). Treas. Reg. Sec. 1.367(a)-8T(h)(2)(iii).
3. Indirect Stock or Securities Transfers
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The paragraphs in this subsection detail the requirements set forth in Treas. Reg.
Sec. 1.367(a)-3(d), "Indirect stock transfers in certain nonrecognition transfers ."
a. Treas. Reg. Sec. 1.367(a)-3(d)(1) -- In general
If a U.S. person exchanges stock or securities of a domestic or foreign corporation
for stock or securities of a foreign corporation (or a domestic corporation that controls a
foreign acquirer in a subsidiary B reorganization) pursuant to Secs. 354 or 356, and that
exchange falls into one of six listed categories, then that U.S. person will be treated as
having made an indirect transfer of stock or securities to a foreign corporation that is
subject to the rules of Treas. Reg. Sec. 1.367(a)-3. Treas. Reg. Sec. 1.367(a)-3(d)(1). The
six listed categories are as follows:
(1) Forward Subsidiary Merger and Subsidiary G
Reorganization
In a forward subsidiary merger (i.e., a merger described in Secs. 368(a)(1)(A) and
(a)(2)(D)) or a subsidiary G reorganization (i.e., a reorganization described in Secs.
368(a)(1)(G) and (a)(2)(D)) treated as an indirect stock or securities transfer, a U.S.
person exchanges stock or securities of the acquired corporation for stock or securities of
a foreign corporation that controls the acquiring corporation. The acquiring corporation
can be either domestic or foreign. Treas. Reg. Sec. 1.367(a)-3(d)(1)(i). For purposes of
applying the GRA requirements, the foreign parent is considered to be the foreign
transferee, and the acquiring corporation is considered to be the transferred corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(i) and (ii).
(2) Reverse Subsidiary Merger
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In a reverse subsidiary merger (i.e., a merger described in Secs. 368(a)(1)(A) and
(a)(2)(E)) treated as an indirect stock or securities transfer, a U.S. person exchanges stock
or securities of the acquiring corporation for stock or securities of a foreign corporation
that controls the acquired corporation. Treas. Reg. Sec. 1.367(a)-3(d)(1)(ii). For purposes
of applying the GRA requirements, the foreign parent is considered to be the transferee
corporation, and the acquiring corporation is considered to be the transferred corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(i) and (ii).
(3) Subsidiary B Reorganization
In a subsidiary B reorganization treated as an indirect stock transfer, a U.S. person
exchanges stock or securities of the acquired corporation for voting stock of a foreign or
domestic corporation that controls the acquiring corporation. Treas. Reg. Sec. 1.367(a)-
3(d)(1)(iii)(A) and (B). If the parent is foreign, it is considered to be the transferee
corporation for purposes of the GRA requirements, but if the parent is domestic, then
the foreign acquiring corporation (i.e., the foreign subsidiary) is deemed to be the
transferee corporation. Treas. Reg. Sec. 1.367(a)-3(d)(2)(i)(A) and (B). In both cases, the
acquired corporation is considered to be the transferred corporation. Treas. Reg. Sec.
1.367(a)-3(d)(2)(ii).
(4) Subsidiary C reorganization
In a subsidiary C reorganization treated as an indirect stock or securities transfer,
the acquired corporation (whether domestic or foreign) transfers substantially all of its
properties to the acquiring corporation (whether domestic or foreign) and a U.S. person
exchanges stock of the acquired corporation for voting stock or securities of a foreign
corporation that controls the acquiring corporation. Treas. Reg. Sec. 1.367(a)-3(d)(1)(iv).
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For purposes of applying the GRA requirements, the foreign parent is considered to be
the transferee corporation, and the acquiring corporation is considered to be the
transferred corporation . Treas. Reg. Sec. 1.367(a)-3(d)(2)(i) and (ii). However, if the
subsidiary C reorganization is followed by drop-down, or "controlled asset transfer" (see
paragraph (e) below), then the transferred corporation is considered to be the controlled
corporation. Treas. Reg. Sec. 1.367(a)-3(d)(2)(i) and (ii).
(5) Reorganization Followed by a Drop-down of Assets
Drop-downs are given a new name in the 2005 proposed and 2006 final versions
of Treas. Reg. Sec. 1.367(a)-3: controlled asset transfers. See Treas. Reg. Sec. 1.367(a)-
3(d)(1), front language; REG 125628-01, 70 Fed. Reg. 749 (Jan. 5, 2005); T.D. 9243, 71
F.R. 4276 (Jan. 26, 2006). Controlled asset transfers, or "CATs," are defined as follows:
"For purposes of [Treas. Reg. Sec. 1.367(a)-3](d), if a corporation acquiring assets in an
asset reorganization described in Sec. 368(a)(1) transfers all or a portion of such assets to
a corporation controlled (within the meaning of Sec. 368(c)) by the acquiring corporation
as part of the same transaction, the subsequent transfer of assets to the controlled
corporation will be referred to as a controlled asset transfer. See Sec. 368(a)(2)(C)."
This language includes reorganizations under Sec. 368(a)(1)(D) and outbound
reorganizations under Sec. 368(a)(1)(F). See Treas. Reg. Sec. 1.367(a)-1T(f). Expansion
of the indirect stock transfer rules of Sec. 1.367(a)-3 to include D reorganizations
followed by CATs had been widely anticipated since 2002. See Rev. Rul 2002-85, 2002-
2 C.B. 986; Notice 2002-77, 2002-2 C.B. 997. To make the change from "drop-down" to
"controlled asset transfer" less confusing, we will use the term "drop-down/CAT."
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An indirect stock or securities transfer includes any exchange of stock or
securities for stock or securities of a foreign acquiring corporation pursuant to an asset
reorganization (other than a subsidiary C reorganization, a forward or reverse subsidiary
merger, or a "same-country" F reorganization) followed by a drop-down/CAT of some or
all of the acquired assets to a controlled corporation. The drop-down/CAT is considered
an indirect transfer of stock or securities only to the extent that such assets are transferred
to the controlled corporation. The remaining assets are treated as having been transferred
in an asset transfer (to which the provisions of Sec. 367(a), as well as Sec. 367(d), may
apply). Treas. Reg. Sec. 1.367(a)- 3(d)(1)(v).
Note: A "same-country" F reorganization is defined as one in which "both the
acquired corporation and the acquiring corporation are foreign corporations and are
created or organized under the laws of the same foreign country." Id.
(6) Successive Section 351 Transfers
If a U.S. person transfers property other than stock or securities to a foreign
corporation in an exchange described in Sec. 351, and all or a portion of those assets are
transferred in connection with the same transaction to a second corporation controlled by
the foreign corporation in an exchange described in Sec. 351, the "re-transfer," or second
Sec. 351 exchange is considered an indirect transfer of stock . Any assets that are not re-
transferred to the transferee corporation's controlled corporation are subject to the general
rules of Sec. 367(a). Treas. Reg. Sec. 1.367(a)-3(d)(1)(vi). For purposes of the GRA
requirements, the corporation that issues stock or securities to the U.S. person in the
exchange is considered to be the foreign transferee, and the controlled corporation is
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considered to be both the acquiring and the transferred corporation. Treas. Reg. Sec.
1.367(a)-3(d)(2)(i) and (ii).
b. Special Rules for Indirect Transfers -- Treas. Reg. Sec.
1.367(a)-3(d)(2)
For purposes of the indirect transfer rules, the following rules and definitions
apply:
(1) Transferee foreign corporation
Except in the case of certain subsidiary B reorganizations, the transferee foreign
corporation is the foreign corporation that issues stock or securities to the U.S. person in
the exchange. In a subsidiary B reorganization involving a foreign acquiring corporation
with a domestic parent, the transferee foreign corporation is the foreign acquiring
corporation. Treas. Reg. Sec. 1.367(a)-3(d)(2)(i).
(2) Transferred corporation and transferred property
In subsidiary B reorganizations, the transferred corporation is the acquired
corporation. In a reorganization followed by a drop-down/CAT, the transferred
corporation is the controlled corporation to which the assets are transferred. In
cascading, or multiple Sec. 351 transactions, the transferred corporation is last
corporation in the chain; the corporation to which the assets are transferred in the final
Sec. 351 transfer. In all other cases, the transferred corporation is the acquiring
corporation. Transferred property is the stock or securities of the transferred corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(ii).
(3) Amount of gain
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The amount of gain that a U.S. person must include in income as the result of a
triggering event is determined using the provisions of Sec. 1.367(a)-8T(b)(3)(i) and (d)..
Treas. Reg. Sec. 1.367(a)-3(d)(2)(iii).
(4) Gain recognition agreements (GRAs) involving
multiple parties
The U.S. transferor's agreement to recognize gain must include appropriate
provisions requiring the transferor to recognize gain in the event of an indirect
disposition of the stock or securities of the transferred corporation. For example, in a
subsidiary B reorganization involving a foreign parent, a disposition of the transferred
stock must include an indirect disposition of such stock by the transferee foreign
corporation, such as a disposition of such stock by the acquiring corporation or a
disposition of the stock of the acquiring corporation by the transferee foreign corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(iv). If the subsidiary B parent were domestic, however,
its disposition of the stock of the foreign acquiring corporation in a taxable transaction
would terminate the gain recognition agreement (GRA) if the principles of Sec. 1.367(a)-
8T(g)(1)(i)(A) and (B) were satisfied. Treas. Reg. Sec. 1.367(a)-3(d)(2)(iv).
(5) Asset transfer trigger
A GRA may also be triggered by disposition of substantially all of the transferred
corporation's assets. Treas. Reg. Sec. 1.367(a)-8T(d)(2). To determine whether the
transferred corporation has disposed of substantially all of its assets in the case of a
reorganization described in Treas. Reg. Sec. 1.367(a)-3(d)(1), the following assets are
taken into account if they are not fully taxable under Sec. 367 in the taxable year that
includes the indirect transfer:
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(A) In the case of a forward subsidiary merger,
a subsidiary C reorganization, or a subsidiary G reorganization, the assets of the acquired
corporation.
(B) In the case of a reverse subsidiary merger,
the assets of the acquiring corporation immediately prior to the transaction.
(C) In the case of an asset reorganizations
described in Treas. Reg. Sec. 1.367(a)-3(d)(1)(v) (i.e., all asset reorganizations other than
forward subsidiary mergers, subsidiary C and G reorganizations, reverse subsidiary
mergers, and same-foreign-country F reorganizations) followed by a drop-down/CAT of
assets, the assets of the acquired corporation that are dropped down.
(D) In the case of a forward subsidiary merger, a
subsidiary C reorganization, or a subsidiary G reorganization followed by a drop-
down/CAT, the assets of the acquired corporation, including the assets that were dropped
down.
(E) In the case of a forward subsidiary merger, a
subsidiary C reorganization, or a subsidiary G reorganization followed by a drop-
down/CAT, the assets of the acquired corporation, including the assets that were dropped
down.
(F) In the case of successive Sec. 351
exchanges, the assets that are both transferred to the foreign corporation initially, and
subsequently transferred by the foreign corporation to the controlled corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(v).
103
(6) Coordination between asset transfer rules and
indirect stock transfer rules
Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi) addresses the rules for coordination between
the asset transfer rules and the indirect stock transfer rules," and it is extensively revised
by the 2005 proposed and 2006 final versions of Treas. Reg. Sec. 1.367(a)-3. The prior
version of the regulation began by stating the general rule: for a transfer (or deemed
transfer) of assets from a domestic corporation to a foreign corporation "(other than in an
exchange described in Sec. 354), the rules of Sec. 367, including Secs. 367(a)(1), (a)(3)
and (a)(5), as well as Sec. 367(d), and the regulations thereunder shall apply prior to the
application of the rules of this section." An exception provided that Sec. 367(a) would
not apply if 1) the foreign acquiring corporation re-transferred the assets back to a
domestic corporation in a paragraph (d)(1)(vi) or Sec. 368(a)(2)(C) transfer and 2) the
domestic transferee's basis was no greater than that of the original domestic transferor.
The 2006 final regulation does not change the general rule other than to delete its
negative description of covered exchanges ("(other than in an exchange described in Sec.
354)") and insert a positive description: "in an exchange described in Sec. 351 or 361."
Regarding the exception, however, the final regulation makes sweeping changes.
First, it expands the scope of the exception from Sec. 367(a) alone to both Sec. 367(a)
and Sec. 367(d). Then, the exchanges to which the exception applies are changed from
all those "described in [Treas. Reg. Sec. 1.367(a)-3](d)" to those mentioned in the new
general rule: Sec. 351 and 361 exchanges.
Next, the final regulation divides the exception into two parts. Re-transfers to a
domestic corporation that occur in the course of multiple Sec. 351 exchanges are left
104
virtually unchanged. Re-transfers that involve an exchange described in Sec. 361,
however, are subject to new anti-inversion limitations. Either a qualifying transaction
must meet the requirements of the second and third sentences of Sec. 367(a)(5) (i.e., the
transferor, or domestic acquired corporation, is controlled by five or fewer domestic
corporations, makes certain basis adjustments, and meets other conditions prescribed in
future Sec. 367(a)(5) regulations), or it must satisfy the requirements of Treas. Reg. Secs.
1.367(a)-3(c)(1)(i), (ii), (iv), and (c)(6) and file a "Required Statement" pursuant to new
paragraph (d)(vi)(C). Treas. Reg. Secs. 1.367(a)-3(d)(2)(vi)(B)(i) and (ii).
The Required Statement is similar to but broader than a GRA. First, it must be
executed, not just by the target, but by the foreign acquiring corporation too. Cf. Treas.
Reg. Sec. 1.367(a)-3(d)(2)(vi)(C) with Treas. Reg. Sec. 1.367(a)-8T(a)(3). Second, it
lacks finality and certainty because there is no time limit on its requirement that the target
recognize gain if the foreign acquirer disposes of any stock of its domestic controlled
corporation in a "gain recognition transaction" (GRT). Treas. Reg. Sec. 1.367(a)-
3(d)(2)(vi)(C).
A GRT is defined as "a transaction . . . where a principal purpose of the transfer
by the domestic acquired corporation is the avoidance of U.S. tax that would have been
imposed on the domestic acquired corporation on the disposition of the re-transferred
assets. A transfer may have a principal purpose of tax avoidance even though the tax
avoidance purpose is outweighed by other purposes when taken together." Treas. Reg.
Sec. 1.367(a)-3(d)(2)(vi)(D)(1).
There is a rebuttable presumption that a disposition of any stock by the foreign
acquiring corporation within two years of the original transfer, whether in a recognition
105
or nonrecognition transaction, has a principal purpose of tax avoidance, but this
presumption does not transform the Required Statement into the equivalent of a two-year
GRA, as some commentators stated with respect to the 2005 proposed regulations. See
Philip A. McCarty and Michael A. DiFronzo, "New Proposed 367 Regulations Address a
Potpourri of Issues," 34 Tax Mgmt. Int'l J. 219, 228 (2005).
Finally, Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi)(E) prescribes a method involving
hypothetical fair market values for calculating the GRT gain and discusses the interest to
be paid on the additional tax.
As explained in the preamble to the 2005 proposed regulation, these new
restrictions in Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi) are motivated by the concern that
asset reorganizations otherwise qualifying for tax-free treatment could be used to
facilitate corporation inversion transactions or divisive transactions.
(7) New rule changing status of domestic acquired
corporation to a foreign corporation
After the 2005 proposed regulations were promulgated, one commentator
suggested that, in asset reorganizations involving a drop-down/CAT, the indirect stock
transfer rules should be applied based on the status of the controlled subsidiary, rather
than the status of the acquired corporation. The IRS and Treasury agreed in part with this
suggestion and adapted it in Treas. Reg. Sec. 1.367(a)-3(d)(2)(vii), which was added by
the 2006, final regulation. See T.D. 9243 (Jan. 26, 2006) at Preamble, Summary of
Comments and Explanation of Provisions, Sec. E.
Under this new rule, a U.S. person that exchanges stock or securities of a
domestic corporation for stock or securities of a foreign corporation under Sec. 354 (or
106
Sec. 356) will be treated for purposes of Treas. Reg. Sec. 1.367(a)-3 as having made an
indirect stock transfer of the stock or securities of a foreign corporation (and not of a
domestic corporation) to a foreign corporation subject to the strictures of Treas. Reg. Sec.
1.367(a)-3(b) (but not Treas. Reg. Sec. 1.367(a)-3(c)), if the following requirements are
met:
The acquired domestic corporation must be a subsidiary member (within the
meaning of Treas. Reg. Sec. 1.1502-1 (c)) of a consolidated group (within the meaning of
Treas. Reg. Sec. 1.1502-1(h)) immediately before the transaction, and the transaction
must fit into one of two categories:
1) it must be a forward subsidiary merger, a subsidiary G reorganization, or a
subsidiary C reorganization, as described in Treas. Reg. Secs. 1.367(a)-3(d)(1)(i) and
(iv), and the acquiring corporation must foreign; or
2) it must be an asset reorganization other than a forward subsidiary merger, a
subsidiary C or G reorganization, a reverse subsidiary merger, or a same-foreign-country
F reorganizations, followed by a drop-down/CAT of assets, as described in Treas. Reg.
Secs. 1.367(a)-3(d)(1)(v), but only to the extent that the drop-down/CAT is to a foreign
corporation. Treas. Reg. Sec. 1.367(a)-3(d)(2)(vii)(A).
This recasting of domestic stock or securities as foreign stock or securities applies
only if the transferred stock or securities remain in foreign corporate solution. If they are
retransferred to a domestic controlled corporation in one or more successive transfers as
part of the same transaction, then the recharacterization of this rule does not occur, and
the entire indirect stock transfer remains subject to Treas. Reg. Sec. 1.367(a)-3(c). Treas.
Reg. Sec. 1.367(a)-3(d)(2)(vii)(B).
107
4. Examples illustrating the rules of Treas. Reg. Secs. 1.367(a)-3(d)
Of the twenty-seven examples in Treas. Reg. Sec. 1.367(a)-3(d)(3) that illustrate
the application of the rules in Treas. Reg. Secs. 1.367(a)-3(d), the following eleven are
particularly interesting and include all the examples added by the 2005 proposed and
2006 final regulations. Like all the examples in Treas. Reg. Sec. 1.367(a)-3(d)(3), these
eleven assume that I.R.C. Sec. 7874 does not apply.
108
a. Example 2: Reverse subsidiary reorganization
Facts: As the diagrams below show, Newco merges into W, and stock of W is
distributed to F. A, W's parent & sole shareholder, gets 40 percent of F's stock in an
exchange described in Sec. 354. After the transaction, A is a shareholder of F, which
owns W, which contains the former assets of Newco (if any).
Result: F is treated as the transferee, and the surviving subsidiary, W, is treated as
the transferred corporation. Because this is an indirect stock transfer under Treas. Reg.
Sec. 1.367(a)-3(d)(1)(ii) (i.e., A is considered to have transferred its W stock to F),
taxation of the exchange under Sec. 367(a)(1) will apply unless the requirements of
Treas. Reg. Sec. 1.367(a)-3(c)(1) are satisfied, including execution of a GRA by A.
Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 2.
Comment: There were no examples of a reverse triangular merger in the prior
regulations. This example, along with Example 11, fills that void.
Before After
A
US
S/Hs
Foreign
F
Foreign
W
US
40%
perce
nt
100%
A
US
W
US
Newco
US
F
Foreign
F Stock
W Stock
100% 100%
Merger
109
b. Example 5A: Subsidiary B reorganization
Facts: As the diagrams below show, acquiring parent F is domestic, and it owns
all of acquiring subsidiary S, which is foreign. S acquires all the stock of Y, wholly
owned by U, in exchange for10 percent of F's voting stock.
Before After
U
US
S/Hs
F
US
S
Foreign
Y
US
10%
90%
100%
100%
U
US
Voting Stock
F
US
Y
US
S
Foreign
100%
100%
Y Stock
Result: Although F would usually be the transferee foreign corporation (and
although the 2005 proposed regulations made that happen with a truly obtuse, domestic-
deemed-foreign rule), under the 2006 final regulations, S is the transferee foreign
corporation (see Treas. Reg. Sec. 1.367(a)-3(d)(2)(i)(B)), and Y is the transferred
corporation. U's exchange of its Y stock for stock of F is treated as an indirect transfer of
Y stock to a foreign corporation, S, under paragraph (d)(1)(iii)(B). This exchange is not
taxable under Code Sec. 367(a)(1) provided the requirements of Treas. Reg. Sec.
1.367(a)-3(c)(1) are satisfied. In determining whether the 50-percent-or-less ownership
110
requirement of Treas. Reg. Secs. 1.367(a)-3(c)(i) and (ii) is satisfied, U's indirect
ownership of S stock (through its direct ownership of F stock) is taken into account.
U must file a GRA to prevent the exchange from being taxed under Sec.
367(a)(1). If Y sold substantially all of its assets (within the meaning of Sec.
368(a)(1)(C)), the gain recognition agreement would be terminated because U owned an
amount of stock in Y described in Sec. 1504(a)(2) (at least 80% by vote and value)
immediately before the transaction and Y is a domestic corporation. See Treas. Reg. Sec.
1.367(a)-8T(g)(2). In addition, if F disposed of the stock of S in a taxable transaction the
gain recognition agreement would be terminated if the principles of Treas. Reg. Sec.
1.367(a)-8T(g)(1)(i)(A) and (B) are satisfied (i.e., the basis for S stock does not exceed
the aggregate basis of the Y stock S received in the initial transfer and all realized gain is
recognized currently). Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 5A.
111
c. Example 6: Subsidiary C reorganization
This is an old example (it was Example 5 in the prior, 1998 regulation), but it is
important to discuss it briefly because its facts are the basis for five of the nine new
examples.
Facts: As the diagrams below show, domestic target Z transfers its assets to
foreign acquiring parent F's domestic subsidiary R, and Z's domestic parent V gets 30
percent of the stock of F in return. R operates an historical business.
Before After
A&Ls
V
US
F
Foreign
Z
US
R
US
Stock
100%
100%
V
US
F
Foreign
R
Z A&Ls
US
30% 70%
S/Hs
Result: This exchange is an indirect stock transfer under Treas. Reg. Sec.
1.367(a)-3(d)(1)(iv), so V can avoid taxation under Sec. 367(a) only if the transaction
complies with the requirements of Treas. Reg. Sec. 1.367(a)-3(c)(1) and V files a GRA.
F is the transferee corporation, and R is the transferred corporation. The GRA will be
triggered if F disposes of its R stock, or if R disposes of substantially all the assets it
acquired from Z. To determine whether R has made a sub all disposition under Treas.
Reg. Sec. 1.367(a)-8T(d)(2) (which imports the sub all rules of I.R.C. Sec. 368(a)(1)(C)),
see Treas. Reg. Sec. 1.367(a)-3(d)(2)(v)(A). Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 6.
112
d. Example 6A: Straight C reorganization followed by a
drop-down/CAT
Facts: The facts are the same as in Example 6 with the following changes and
additions: the transaction is differently structured; F's subsidiary R is now foreign; V and
Z file a consolidated Federal income tax return; and V's subsidiary, Z, has three
businesses -- A, B, and C. Businesses A and B qualify for the active business exemption
in Sec. 367(a)(3); business C does not. Z transfers all three businesses to F, and F, in
turn, transfers businesses B and C in a drop-down/CAT to its wholly-owned subsidiary R.
Before After
F
Foreign
A
R
Foreign
B, C
V
US
S/Hs
30% 70%
V
US
Z
US
A B C*
F
Foreign
R
Foreign
ABC
B&C
100%
Voting
Stock
* Z has 3 separate businesses: A,
B, and C. A and B are active under
Code sec. 367(a)(3); C is not.
100%
c
o
n
s
Result: As in Example 6, F is the transferee corporation, and R is the transferred
corporation. The transfer of the Business A assets by Z to F does not constitute an
indirect stock transfer under Treas. Reg. Sec. 1.367(a)-3(d), and subject to Sec. I.R.C.
Sec. 367(a)(5), the Business A assets qualify for the Sec. 367(a)(3) active trade or
business exception and are not subject to Sec. 367(a). Z must recognize gain on the
transfer of Business C because it does not qualify for an exception under Sec. 367(a)(1).
113
Business B may qualify for the exception under Sec. 367(a)(3) and Treas. Reg. Sec.
1.367(a)-2T(c)(2) for assets that will be used by R in an active trade or business outside
the U.S. Pursuant to Treas. Reg. Secs. 1.367(a)-3(d)(1) and (d)(2)(vii)(A)(2), V is
deemed to transfer the stock of a foreign corporation to F in a Sec. 354 exchange subject
to the rules of Treas. Reg. Secs. 1.367(a)-3(b) and (d). Therefore, to avoid tax under
I.R.C. Sec. 367(a)(1), V must execute a GRA. Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 6A.
Comment: This new example illustrates the application of new Treas. Reg. Sec.
1.367(a)-3(d)(2)(vii), which deems a domestic acquired corporation (here, Z) to be a
foreign corporation if it is a subsidiary in a consolidated group and is transferred in a
Treas. Reg. Sec. 1.367(a)-3(d)(1)(i), (iv), or (v) indirect stock transfer to a foreign
transferred corporation.
Note: In the context of indirect stock transfers, the term "foreign transferred
corporation" does not mean "the corporation that was transferred," or "the corporation
whose assets were transferred." See Treas. Reg. Secs. 1.367(a)-3(d)(2)(ii) and 1.367(a)-
8T(a)(1)(viii). In most cases, it means the corporation that, at the end of the day, is still
in existence and owns something new.
114
e. Example 6B: Straight C reorganization followed by a
drop-down/CAT to a domestic controlled corporation illustrating application of Treas.
Reg. Sec. 1.367(a)-3(d)(2)(vi)(B)(i)
Facts: Example 6B uses the same facts as Example 6A, except that R is a
domestic corporation.
Before After
F
Foreign
A
R
US
B, C
V
US
S/Hs
30% 70%
V
US
Z
US
A B C*
F
Foreign
R
US
ABC
B&C
100%
Voting
Stock
* Z has 3 separate businesses: A,
B, and C. A and B are active under
Code sec. 367(a)(3); C is not.
100%
c
o
n
s
Result: Business B continues to qualify for the Code Sec. 367(a)(3), "active
conduct of trade or business" exception. The fact that R is now domestic allows Business
C to escape Sec. 367(a) taxation, too, thanks to the exception in Treas. Reg. Sec.
1.367(a)-3(d)(2)(vi)(B). The exception has two parts: one (in subparagraph (i)) that is
available for domestic acquired corporations controlled by five or fewer domestic
corporations, and another (in subparagraph (ii)) that applies if control is more diverse or
is not corporate. Because Z is controlled by V, it qualifies for the subparagraph (i)
exception. That notwithstanding, V is still deemed under paragraph (d) to have made an
indirect stock transfer, this time of both Business B and C, and so must execute a GRA.
The GRA is larger here than in Example 6A because Business C's escape from Sec.
115
367(a) brings it within the indirect stock transfer rules and therefore requires the gain on
its assets to be included. Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 6B.
116
f. Example 6C: Straight C reorganization followed by a
drop-down/CAT to a domestic controlled corporation illustrating application of Treas.
Reg. Sec. 1.367(a)-3(d)(2)(vi)(B)(ii)
Facts: The facts here are the same as in Example 6B with the following
exceptions: 1) V, Z's domestic parent, has been replaced by an unstated number of
individuals, none of whom qualify as 5 percent shareholders of Z pursuant to Treas. Reg.
Sec. 1.367(a)-3(c)(5)(iii); 2) no U.S. persons who are officers or directors of Z own F
stock immediately after the transfer; and 3) F is engaged in an active trade or business
outside the U.S. that satisfies the requirements of Treas. Reg. Sec. 1.367(a)-3(c)(3).
Before After
No 5%
S/Hs
Z
US
A B C*
F
Foreign
R
US
ABC
B&C
100%
Voting
Stock
* Z has 3 separate businesses: A,
B, and C. A and B are active under
Code sec. 367(a)(3); C is not.
100%
F
Foreign
A
R
US
B, C
Former
Z S/Hs
S/Hs
30% 70%
Result: First, Business A assets are now taxable under Sec. 367(a)(1) because the
Sec. 367(a)(3) exception is blocked by Sec. 367(a)(5). (The internal exception in Sec.
367(a)(5) does not apply as it did in Exs. 6A and 6B because there is no domestic
corporation controlling Z.)
Second, unless the requirements in paragraph Treas. Reg. Sec. 1.367(a)-
3(d)(2)(vi)(B) are met, Businesses B and C are tested under Secs. 367(a) and (d) before
they are examined under Treas. Reg. Sec. 1.367(a)-3(d). The requirements in Treas. Reg.
117
Sec. 1.367(a)-3(d)(2)(vi)(B)(i) cannot be met because Z is not owned by domestic
corporations. However, the Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi)(B)(ii) requirements
(namely, compliance with Treas. Reg. Secs. 1.367(a)-3(c)(1)(i), (ii), (iv), (c)(6), and
(d)(2)(vi)(C)) are or can be met. Therefore, the gain on both Business B and C is eligible
for nonrecognition. No GRA is necessary because Z will execute the Required Statement
mandated by Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi)(B)(ii). Treas. Reg. Sec. 1.367(a)-
3(d)(3) Ex. 6C.
118
g. Example 9: Indirect stock transfer by reason of a drop-
down/CAT, illustrating Treas. Reg. Sec. 1.367(a)-3(d)(2)(vii)(B)
Facts: This example uses the same basic, subsidiary C reorganization fact pattern
as Example 6 with the variations added by Example 8 and a few additional changes. As
the diagrams below show, acquiring subsidiary R is now foreign, domestic target Z and
its domestic parent V file a consolidated return, and Z owns two businesses, A and B.
Business B qualifies for the Code Sec. 367(a)(3) exception, but Business A does not. V
receives 30 percent of the stock of F when Z transfers A and B to R. R, as part of the
same transaction, transfers Business A to its wholly-owned domestic subsidiary M in a
CAT.
Result: The transaction is an indirect stock transfer in which more than 5 percent
of transferee corporation F is received by U.S transferor V. The transferred corporation is
M.
As in Example 6C, unless the requirements in Treas. Reg. Sec. 1.367(a)-
3(d)(2)(vi)(B) are met, the transfer of Businesses A and B will be tested under Secs.
367(a) and (d) before they are examined under the indirect stock transfer rules of Treas.
Reg. Sec. 1.367(a)-3(d). Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi)(B) can only apply to
Business A, and because its requirements can be met, Business A's built-in gain is
eligible for non-recognition. Because the "domestic-deemed-foreign" rule in Treas. Reg.
Sec. 1.367(a)-3(d)(2)(vii)(A) cannot apply (R's drop-down/CAT to domestic corporation
M vitiates it pursuant to Treas. Reg. Sec. 1.367(a)-3(d)(2)(vii)(B)), the gain attributable
to Business A will be subject to the Treas. Reg. Sec. 1.367(a)-3(c) requirements
regarding transfer of domestic stock.
119
Before Drop-down/CAT
F
Foreign
R
Z's A&Ls
Foreign
V
US
100%
M
US
100%
S/Hs
70% 30%
Business A
F
Foreign
R
Business B
Foreign
V
US
100%
M
Business A
US
100%
S/Hs
70% 30%
V
US
Z
US
A B
F
Foreign
R
Foreign
100% 100% stock
A&L
c
o
n
s
After Drop-down/CAT
Business B is subject to the general coordination rule, and it also escapes taxation
because, when examined first under the asset transfer rules, it qualifies for the Sec.
367(a)(3) exception. Because the "domestic-deemed-foreign" rule in Treas. Reg. Sec.
1.367(a)-3(d)(2)(vii)(A) does apply to the transfer of Business B, the gain attributable to
120
Business B will be subject to the Treas. Reg. Sec. 1.367(a)-3(b) requirements regarding
transfer of foreign stock.
V must execute a GRA for all the unrecognized gain pursuant to Treas. Reg. Secs.
1.367(a)-3(b), (c), and (d). Three events will be able to trigger the GRA: disposition of
R stock by F, disposition of M stock by R, and a Treas. Reg. Sec. 1.367(a)-8T(d)(2)
disposition of substantially all the Business A and B assets by M and R. Treas. Reg. Sec.
1.367(a)-3(d)(3) Ex. 9.
Comment: Like Example 6C, this example demonstrates the order of precedence
in the coordination of the asset transfer and indirect stock transfer rules. The general
coordination rule is that transactions are tested against the Sec. 367(a) rules first, and only
if they are not taxed at that point does the possibility of taxation under the indirect stock
transfer rules arise. However, if the "drop-down/CAT to a domestic subsidiary"
exception in Treas. Reg. Sec. 1.367(a)-3(d)(2)(vi)(B) applies, it does not rescue gain that
has already been deemed taxable under the general rule; rather, it steps in front of the
general rule and prevents it application entirely.
121
h. Example 10: Concurrent application of asset transfer and
indirect stock transfer rules in a forward subsidiary reorganization
Facts: The facts are, again, the same as in Example 8 (which draws many of its
facts from Example 6). F owns R; V and Z file a consolidated return; Business B
qualifies for the Sec. 367(a)(3) exemption, and Business A does not. Business A has a
fair market value (FMV) of $90 and a basis of $50; Business B has a FMV of $110 and a
basis of $50; and V's Z stock has a FMV of $200 and basis of $100. The only change is
that the transaction is a forward subsidiary merger instead of a subsidiary C
reorganization.
Before After
100%
V
US
Z
US
A B
F
Foreign
R
Foreign
100%
stock
A&L
c
o
n
s
F
Foreign
R
Z's A&L
Foreign
V
US
100%
S/Hs
70% 30%
Result: As in Example 8, the transfer of assets directly from Z to R is tested
under Sec. 367(a) first. There is no Sec. 367(a) exception for Business A, so a $40 gain
must be recognized. Because V and Z file a consolidated Federal income tax return, that
$40 is added to V's basis in its Z stock, creating a new basis of $140. Sec. 367(a)(3)
exempts Business B from the purview of Sec. 367(a)(1) because the application of Sec.
367(a)(5) is blocked by its internal exception (Z is owned by one domestic corporation,
V).
122
The "domestic-deemed-foreign" rule in Treas. Reg. Sec. 1.367(a)-3(d)(2)(vii)(A)
applies to the transfer of Business B, so the gain attributable to Business B will be subject
to the Treas. Reg. Sec. 1.367(a)-3(b) requirements regarding transfer of foreign stock.
Therefore, if the requirements of Treas. Reg. Secs. 1.367(a)-3(b) and (d) are met,
including execution by V of a GRA for $60 (the $200 FMV of V's Z stock minus V's
updated $140 basis), the transfer of Business B will be nonrecognition. Only if F sells
some of its R stock, or R disposes of substantially all of the Business B assets before the
GRA expires, will V be required to pay tax. Only the Business B assets will count with
respect to the "disposition of substantially all assets" GRA trigger because the Business A
assets were taxed under Sec. 367(a). Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 10.
Comment: The basic fact pattern in the example -- a domestic corporation and a
foreign corporation participating in a statutory merger described in Code Sec.
368(a)(1)(A)/(a)(2)(D) -- illustrates the new Treas. Reg. Sec. 1.368-2(b)(1)(ii), which
expands the definition of mergers under Code Sec. 368(a)(1)(A) to include transactions
effected pursuant to non-U.S. statutes and thus brings those transactions within the
purview of Sec. 367(a). Two other examples -- 11 (a reverse triangular merger) and 15
(another forward triangular) -- also involve statutory mergers between domestic and
foreign corporations.
123
i. Example 11: Concurrent application of Sec. 367(a) and (b)
in a reverse subsidiary reorganization
Facts: The facts are new, but the pattern is still fairly familiar. As the diagrams
show, F owns D, which is identified as an "operating corporation," and V owns Z. D,
which has a basis of $60 and FMV of $100, merges into Z in a reverse subsidiary
reorganization, and V swaps its Z stock for 55 percent of F. In the end, V is a controlling
shareholder of F, which owns Z.
Before After
V
US
S/Hs
Foreign
F
Foreign
Z/D
Foreign
55%
perce
nt
100%
V
US
Z
Foreign
D
US
F
Foreign
F Stock
100% 100%
Merger
Z Stock
Result: First, this transaction falls under the purview of Treas. Reg. Sec.
1.367(a)-3(b) because it is a foreign-to-foreign indirect stock transfer. The transferee
foreign corporation is F and Z is the transferred corporation. If V does not execute a
GRA, its exchange of Z stock for F stock will be taxable under Sec. 367(a)(1) and Sec.
1248 will be applicable. If V executes a GRA, then the exchange will be subject to the
provisions of Sec. 367(b) and the regulations promulgated thereunder as well as Sec.
367(a).
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Second, assuming execution of a GRA, no income inclusion is required under
Treas. Reg. Sec. 1.367(b)-4(b) because after the exchange, both the merging subsidiary's
foreign parent F (which gives up 55 percent of its stock) & foreign target Z (which was a
controlled foreign corporation (CFC) before transaction) end up as CFCs as to which V is
a Sec. 1248 shareholder.
Third, the GRA may be triggered if V disposes of F stock (Treas. Reg. Sec.
1.367(a)-8T(d)(3)), if F disposes of Z stock (Treas. Reg. Sec. 1.367(a)-8T(d)(1)), or if Z
disposes of substantially all the assets it had prior to the transaction (see Treas. Reg. Secs.
1.367(a)-8T(d)(2) and 1.367(a)-3(d)(2)(v)(B)).
Finally, the transfer of D's assets to Z is taxable under Sec. 367(a) because Sec.
367(a)(5) blocks application of the Sec. 367(a)(3) "active trade or business" exception.
Therefore, D must recognize $40 of gain. Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 11.
Comment: This is a particularly interesting example because there are two
separate but overlapping exchanges that have Sec. 367(a) consequences: first, the
transfer of D to Z, and second, the transfer of Z stock to F.
As noted above in the comments following Example 10, this is one of three new
examples that are predicated on new Treas. Reg. Sec. 1.368-2(b)(1)(ii), which expands
the definition of mergers under Code Sec. 368(a)(1)(A) to include transactions effected
pursuant to non-U.S. statutes and thus brings those transactions within the purview of
Sec. 367(a).
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j. Example 12: Concurrent application of direct and indirect
stock transfer rules
Facts: As the diagrams below show, the example posits a subsidiary C
reorganization in which domestic subsidiary E (owned by domestic parent D) transfers
both stock of E's wholly-owned subsidiary N and the assets of Business X to O, a foreign
subsidiary of foreign parent F. Both D's gain on the indirect stock transfer of E's stock
and E's gain on the transfer of N may qualify for nonrecognition. However, because D,
E, and N file a consolidated return, both GRAs must be executed by consolidated parent
D.
Before After
D
US
S/Hs
Foreign
F
Foreign
O/E
Business X
Foreign
N
US
40%
60%
100%
100%
D
US
E
US
Business X
N
US
O
Foreign
F
Foreign
A&Ls
Voting
Stock
100% 100%
100%
c
o
n
s
Result: E's transfer of its assets, including the N stock, must be tested under the
general rules of Sec. 367(a) before consideration of D's indirect transfer of the stock of E.
E's transfer of the assets of Business X qualifies for nonrecognition under Sec. 367(a)(3).
E's transfer of its N stock could qualify for nonrecognition treatment if D satisfies the
126
requirements in Sec. 1.367(a)-3T(e). The explanation in the example says that, in this
portion of the analysis, O is the transferee foreign corporation and N is the transferred
corporation. However, calling O the transferee foreign corporation contravenes Treas.
Reg. Sec. 1.367(a)-3(d)(2)(i) because, according to the facts, no one receives stock of O
in any part of transaction. The analysis accompanying the example should acknowledge
this and provide an appropriate explanation.
Pursuant to Treas. Reg. Secs. 1.367(a)-3(d)(1) and (d)(2)(vii)(A)(1), D is deemed
to transfer the stock of a foreign corporation to F in a Sec. 354 exchange subject to the
rules of Treas. Reg. Secs. 1.367(a)-3(b) and (d), and therefore may enter into a gain
recognition agreement for such indirect stock transfer as provided in Treas. Reg. Sec.
1.367(a)-3(b) and Treas. Reg. Sec. 1.367(a)-8T. As to this transfer, F is the transferee
foreign corporation; O is the transferred corporation. The amount of the GRA is $60.
See also Sec. 367(a)(5) and any regulations issued thereunder. Treas. Reg. Sec. 1.367(a)-
3(d)(3) Ex. 12.
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k. Example 15: Alternate concurrent application of indirect
stock transfer rules and Sec. 367(b) illustrating Treas. Reg. Sec. 1.367(a)-3(b)(2)(i)(B)
Facts: As the diagrams below show, F owns Newco, and P owns FC. P's basis in
FC is $50, FC's FMV is $100, and FC's all earnings and profits amount ("all E&P") is
$60. In a forward subsidiary merger, Newco gets the assets of FC, and P exchanges its
FC stock for 20 percent of F's stock.
Before After
100%
P
US
FC
Foreign
A B
F
Foreign
Newco
US
100%
stock
A&L
F
Foreign
Newco
FC's A&L
US
P
US
100%
S/Hs
80% 20%
Result: As noted in Sec. I.C above, in the 1998 final regulations, taxation under
Sec. 367(a) preempted taxation under Sec. 367(b) in cases where both sections could
apply. That meant that if greater tax would be due under Sec. 367(b), the U.S. transferor
could "choose" the lesser taxation under Sec.367(a) by foregoing a GRA. That result
undermined the policy underlying Sec. 367(b), and the rule now (in Treas. Reg. Sec.
1.367(a)-3(b)(2)(i)(B)) requires that Sec. 367(b) apply first in the case of inbound
subsidiary reorganizations if, as in this example, the all E&P amount is greater than the
gain subject to Sec. 367(a).
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P's Sec. 354 exchange is considered an indirect stock transfer under Treas. Reg.
Sec. 1.367(a)-3(d)(1)(i). Further, because the assets of foreign corporation FC are
acquired by Newco, a domestic corporation, in an asset reorganization, the transaction is
also subject to Secs. 1.367(b)-3(a) and (b). This overlap between Treas. Reg. Sec.
1.367(b)-3 and the indirect stock rules of Treas. Reg. Sec. 1.367(a)-3(d), plus the fact that
FC's relevant all E&P amount ($60) is greater than the gain subject to Sec. 367(a) ($50),
means that the Sec. 367(b) rules, and not the Sec. 367(a) rules, apply to the exchange.
See Sec. 1.367(a)-3(b)(2)(i)(B).
The fact that Sec. 367(a) does not apply here means that there is no need for a
GRA. That is a sensible result because, if the transaction were secondarily subject to Sec.
367(a) (that is, if Sec. 367(b) and Sec. 367(a) applied sequentially in this situation,
instead of alternatively), there would be no gain to report. The $60 gain reported and
taxed under Sec. 367(b) would be added to P's $50 basis in its FC stock, and the resulting
new basis of $110 would be greater than FC's $100 fair market value. Result: zero tax
due under Sec. 367(a).
If FC's relevant E&P amount had been less than the potential Sec. 367(a) gain,
then P could have either paid tax on the gain under Sec. 367(a), foregone a GRA, and
been free of Sec. 367(b) taxation forever, or it could have paid tax on the lesser all E&P
amount under Sec. 367(b), adjusted its basis in the FC stock pursuant to Treas. Reg. Sec.
1.367(b)-2(e)(3)(ii), and then executed a GRA for the remaining gain from the
transaction. Treas. Reg. Sec. 1.367(a)-3(d)(3) Ex. 15.
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5. Transfers by a domestic corporation to a foreign corporation in a
Sec. 361 exchange -- new Treas. Reg. Sec. 1.367(a)-3T(e)
On Feb. 5, 2007, two new paragraphs -- (e) and (f) -- were added to Treas. Reg.
Sec. 1.367(a)-3 by Treas. Reg. Sec. 1.367(a)-3T. T.D. 9311, 2007-10 I.R.B. 635, 72 Fed.
Reg. 5174, 5183 (Feb. 5, 2007). Paragraph (f) states the effective date for paragraph (e):
in general, March 7, 2007.
Treas. Reg. Sec. 1.367(a)-3T(e) is a repositioning and expansion of a provision
that was in Treas. Reg. Sec. 1.367(a)-8(f)(2)(i) and that was modified in Section 4.01 of
Notice 2005-74. That provision addressed the avoidance of gain recognition under Sec.
367(a)(1) when the U.S. transferor goes out of existence as part of a transaction that
would qualify for a GRA.
Under new Treas. Reg. Sec. 1.367(a)-3T(e), if a U.S. transferor is a domestic
corporation that transfers stock or securities to a foreign corporation in a Sec. 361
exchange that would otherwise be taxable under Sec. 367(a)(1), that transfer will not be
subject to Sec. 367(a)(1) if four conditions are met. The limitation to a transfer of stock
or securities seems odd in light of the fact that Sec. 361 applies to transfers of property,
which can include but would not be limited to stock or securities. That notwithstanding,
the four conditions are:
a. First, the U.S. transferor has to satisfy the conditions set
forth in the second sentence in Sec. 367(a)(5) and any regulations promulgated
thereunder, such as that the U.S. transferor is controlled (within the meaning of Sec.
368(c)) by 5 or fewer domestic corporations and that appropriate basis adjustments are
made. Treas. Reg. Sec. 1.367(a)-3(e)(1)(i). Although only the second sentence of Sec.
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367(a)(5) is mentioned, Sec. E of the preamble to T.D. 9311 indicates that the last
sentence of Sec. 367(a)(5), which provides that all members of a Sec 1504 affiliated
group shall be treated as one corporation, is also intended to apply.
b. Second, "[i]n the case of transferred property that is stock
or securities of a domestic corporation, the conditions set forth in [Treas. Reg. Sec.
1.367(a)-3(c) must be] satisfied." Treas. Reg. Sec. 1.367(a)-3(e)(1)(ii). The quoted
language suggests that the specific mention of "stock or securities" in the front language
of 1.367(a)-3(e)(1) may not be intended to be limiting. The reference to "transferred
property" is troubling because that term is undefined except in the context of indirect
stock transfers, where it means the stock or securities of the transferred corporation.
Treas. Reg. Sec. 1.367(a)-3(d)(2)(ii). The term "transferred corporation," in turn, is
defined, in the context of indirect stock transfers, as the acquiring corporation. Id. What
is probably meant in Treas. Reg. Sec. 1.367(a)-3(e)(1)(ii) is "a transfer of stock or
securities of a domestic corporation," which is the predicate for application of Treas. Reg.
Sec. 1.367(a)-3(c). However, until the term "transferred property" is clarified, taxpayers
and their advisors would do well to be cautious in interpreting it.
c. Third, all domestic corporate shareholders of the U.S.
transferor immediately before the transaction that own 5 percent or more (pursuant to the
attribution rules of Sec. 318 as modified by Sec. 958(b)) of the voting power or total fair
market value of the stock of the transferee corporation immediately after the transaction
must enter into gain recognition agreements (GRAs) for their pro rata share of the gain
realized but not recognized in the transaction. In addition, those GRAs must designate
the corporate shareholders as U.S. transferors for purposes of Treas. Reg. Sec. 1.367(a)-
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3(b) and (c) and 1.367(a)-8T. Each corporation's pro rata share is determined by the fair
market value of the U.S. transferor stock or securities owned. Treas. Reg. Sec. 1.367(a)-
3(e)(1)(iii).
d . Fourth, each of the GRAs must contain the election
described in Sec. 1.367(a)-8T(b)(1)(vii) to recognize gain in the year the GRA is
triggered, rather than in the year of the transaction. Treas. Reg. Sec. 1.367(a)-3(e)(1)(iv).
If a transaction addressed by Treas. Reg. Sec. 1.367(a)-3T(e)(1) is a forward
subsidiary merger, a subsidiary C reorganization, a reverse subsidiary merger, or a
subsidiary G reorganization, the GRAs must include, as an additional triggering event,
the indirect dispositions of the transferred stock or securities. Treas. Reg. Sec. 1.367(a)-
3(e)(2).
Treas. Reg. Sec. 1.367(a)-3(e)(3) provides the following example: US1 and US2,
two unrelated domestic corporations, own 60% and 40% respectively of UST, another
domestic corporation that owns 100% of FC, a foreign corporation. In Year 1, UST
transfers all of its FC stock to foreign corporation FA in a reorganization described in
Sec. 368(a)(1)(A). After the transfer, US1 and US2 own 6% and 4% respectively of the
stock of FA. (Unstated but apparent are the additional facts that the stock of FC is the
entirety of UST's assets, and that after the transfer of all its assets to FC, UST goes out of
existence, as required by Treas. Reg. Sec. 1.368-2(b)(ii)(B).)
The Sec. 1248 amount in Year 1 with respect to the FC stock is $0. The notice
requirement under Sec. 1.367(b)-1(c) is satisfied. Sec. 7874 does not apply to the
transaction. US1 and US2 satisfy the conditions set forth in the second sentence of Sec.
367(a)(5), including making appropriate basis adjustments.
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With respect to GRAs, US1 must comply with the paragraph (e)(1)(iii)
requirements because it owns more than 5% of FA after the transaction, or else pay tax
pursuant to Sec. 367(a)(1) on its 60% share of the gain realized on the transfer of the FC
shares. Not surprisingly, it executes a five-year GRA pursuant to Treas. Reg. Sec.
1.367(a)-8T. US2, which ends up with only 4% of FA, has no GRA obligation.
In Year 4, FA triggers US1's GRA by selling 30% of the FC stock for cash.
Pursuant to the GRA, US1 must recognize 18% of the original, realized-but-unrecognized
gain on the FC shares (30% of its 60% share of UST) in Year 4, plus interest.
If in Year 1 US1 and US2 had been part of a consolidated group with common
parent USP, then USP would have filed a GRA on behalf of both US1 and US2. (US2
would have been included because its stake in FA after the transfer of FC would have
exceeded 5% after application of the Sec. 318 attribution rules, modified by Sec. 958(b).)
Therefore, when the GRA was triggered in Year 4, both US1 and US2 would have had to
recognize gain, with US2's portion being 12% of the original, total gain on the FC shares
(i.e., 30% of its 40% share of UST).
6. Expatriation Under Treas. Reg. Sec. 1.367(a)-3(c)
The rules of Treas. Reg. Sec. 1.367(a)-3(c) have been the basis of many high-
profile foreign acquisitions of U.S. corporations. For example, the acquisition of
Chrysler by Daimler–Benz, a German corporation, the acquisition of AirTouch by
Vodafone, a U.K. corporation, and the acquisition of ARCO by BP Amoco, also a U.K.
corporation, were non-recognition transactions designed to qualify under Treas. Reg. Sec.
1.367(a)-3(c).
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Treas. Reg. Sec. 1.367(a)-3(c) transactions replace the U.S. parent corporation of
a multinational group with a foreign parent corporation. They offer financial and U.S.
securities law advantages, as well as U.S. corporate tax advantages. For this reason,
Treas. Reg. Sec. 1.367(a)-3(c) has attracted much attention.
a. U.S. Corporate Tax Advantages
The U.S. corporate tax advantages of Treas. Reg. Sec. 1.367(a)-3(c) transactions
are greatest when the foreign subsidiaries of the foreign acquirer undertake overseas
expansion in low tax jurisdictions that would otherwise have been undertaken by foreign
subsidiaries of the acquired U.S. target. If the acquired U.S. target's foreign subsidiaries
undertook that expansion, the U.S. target would be subject to U.S. corporate tax on the
resulting income, if not currently under Subpart F, at least upon repatriation of the profits
or on disposition of the expanded business, sheltered only to the extent of available
foreign tax credits.
By contrast, if the foreign acquirer of the U.S. target establishes a foreign
subsidiary to undertake the foreign expansion, no U.S. corporate tax would be owed with
respect to the foreign subsidiary's earnings. The U.S. corporate tax base of this foreign
income disappears. As noted in "News Analysis: Last Corporate Taxpayer Out The Door,
Please Turn Out the Lights," 1999 TNT 30-5:
Daimler Chrysler . . . raises the question of the
effect of cross-border investments on U.S. tax collections. .
. . [C]ross-border tax collection is not a zero-sum game in
which income not taxed by one country is taxed by another.
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It may be taxed nowhere, due to tax arbitrage, income
shifting, and tax havens.
That is, in the AirTouch/Vodafone combination,
Britain will not necessarily collect the tax that the United
States will be foregoing. The combined companies will
operate in 23 of the roughly 185 countries in the world. . . .
Extensive planned future expansion into the rest of the
world's countries will be out of U.S. tax jurisdiction,
whereas if AirTouch had pursued these opportunities alone,
the new businesses might have been CFCs. AirTouch
currently operates in 13 foreign countries; foreign
operations provide 40 percent of its revenue. Vodafone and
AirTouch expect after-tax cost savings of $330 million
annually, to be achieved through cost savings and
something called "application of global best practices."
Tax savings can arise in various ways at different levels. Sometimes the foreign
merger partner is incorporated in a European or other foreign country with an integrated
tax system that, unlike the U.S., provides a reduced rate of tax on, or a deduction for,
income distributed as dividends. Certain other foreign countries integrate the tax system
by allowing the shareholders of a corporation an imputation credit for the local country
income tax paid by the corporation. Having the foreign corporation be the surviving
135
parent prevents the loss of this tax benefit for the shareholders resident in that foreign
country. This tax benefit may or may not be provided for U.S. shareholders, depending
on the foreign country's tax law and the provisions of the country's income tax treaty with
the United States.
To the extent that foreign expansion takes place in low or no tax countries,
another tax advantage of having a foreign corporate parent arises when the foreign
corporation is a tax resident of a foreign country that either does not tax foreign business
income or allows a participation exemptions for the business income of a foreign
subsidiary. In such a case, the corporate parent's tax on the profits from the foreign
expansion is eliminated, potentially providing a significant advantage over having a U.S.
corporation remain the parent of the world-wide group. Alternatively, if the foreign
parent's country of residence has more lax tax laws than the U.S. with respect to
controlled foreign corporations, indefinite parent-level tax deferral may be more easily
obtained than if a U.S. corporation served as the group's parent.
Some of the expatriation transactions have involved shifting the pre-expatriation
foreign subsidiaries of the expatriated U.S. parent to the post-expatriation foreign parent.
This is accomplished by the U.S. former parent (now a U.S. subsidiary of a foreign
parent) exchanging its shares in its foreign subsidiaries for stock of the tax-haven foreign
parent. In that way, the former foreign subsidiaries of the U.S. parent become sister
foreign subsidiaries, to that U.S. subsidiary, of the new foreign parent. This transaction is
generally taxable to the former U.S. parent (see Treas. Reg. Sec. 1.367(b)-4(b)(1)),
except to the extent deemed paid tax credits are available under Secs. 1248 and 902.
However, following the transfer, future foreign income of those foreign subsidiaries can
136
avoid being subject to the U.S. anti-deferral rules and indeed escapes all future U.S.
corporate taxation.
Despite the U.S. corporate tax advantages, the empirical evidence on whether past
pure inversion transactions of publicly traded U.S. companies have enhanced the stock
price by more than the tax toll charge seems inconclusive. See "Market Nonreaction to
Inversions," 2003 TNT 9-49.
The benefit of eliminating the U.S. parent level tax on future foreign expansion
afforded by Treas. Reg. Sec. 1.367(a)-3(c) transactions can be offset, however, by other
considerations. First, to the extent that the acquiring foreign parent is subject to its home
county tax on the earnings of a new low-tax foreign subsidiary, the advantage is of
avoiding parent level tax is lost. Moreover, to the extent that the acquiring foreign
parent's home country tax system has its own anti-deferral rules, the advantage of
escaping the U.S. anti-deferral rules are reduced.
A second potential adverse tax consequence of having a foreign corporate parent
is a potential corporate level tax on income from the acquired U.S. target. For example,
post-acquisition dividends paid by the acquired U.S. target to the new foreign parent are,
in the absence of an applicable treaty, subject to 30% U.S. dividend withholding tax. In
addition, to the extent that such dividends are included in the foreign parent's income and
not sheltered from the parent's home country tax by credits or otherwise, the U.S. target's
earnings are again subject to a corporate level tax. However, the foreign parent often
qualifies for a significantly reduced rate of tax on dividends under a U.S. income tax
treaty. Furthermore, the foreign parent may qualify for a foreign tax credit for the
withholding tax and a deemed paid foreign tax credit for the U.S. corporate tax paid by
137
the U.S. target. This would be the case, for example, where the acquiring foreign parent
is a U.K. corporation. In the case of a German foreign parent, the U.S. withholding tax
on dividends would be reduced to 5% under the U.S.-German income tax treaty, and this
additional tax would be mitigated since the German parent is subject to little or no
German corporate tax on those dividends due to a participation exemption or alternative
tax credit for the U.S. corporate income and withholding taxes.
A third offsetting aspect is the U.S. transfer price regulations. If the new foreign
subsidiary uses intangible assets of the U.S. target, the acquired U.S. target will be
required to include in income an arms' length charge for those intangibles, determined
under the U.S. transfer pricing rules.
b. Financial Advantages
A foreign corporation whose shares were not publicly traded in the United States
will usually list its shares on a U.S. stock exchange in connection with a Treas. Reg. Sec.
1.367(a)-3(c) acquisition of a publicly traded U.S. corporation. See, e.g., Ltr. Rul.
200020018, discussed below. There are numerous financial advantages to a foreign
corporation listing its shares on NASDAQ-AMEX or the New York Stock Exchange or
trading OTC. There are more than 1,000 foreign corporations listed on U.S. stock
exchanges. Such exchange listing gives the foreign corporate shares liquidity often
available nowhere else.
The financial advantages generated by such liquidity include:
Providing the foreign corporation access to new equity capital through stock issuances;
Permitting the founding shareholders of the foreign corporation to dispose of some or all
of their holdings;
138
Making the foreign corporation's shares more desirable to U.S. shareholders of potential
corporate targets in current and tax-deferred Treas. Reg. Sec. 1.367(a)-3(c) transactions;
Making the foreign corporation's stock more desirable to employee stock option grantees;
and
Boosting the market value of the stock.
c. U.S. Securities Law Advantages
A foreign acquirer whose shares are first listed on a U.S. stock exchange in
connection with a Treas. Reg. Sec. 1.367(a)-3(c) transaction will typically achieve
favorable classification as a "foreign private issuer" for purposes of the U.S. securities
laws. A 1997 SEC study concluded that of the more than 1,000 foreign private issuers
listed on U.S. securities exchanges, about 35% were listed on the NYSE, 43% were listed
on the NASDAQ National Market, NASDAQ Small Cap and AMEX exchanges, and
22% were listed on the OTC.
Foreign private issuers are subject to less burdensome and, thus, less costly U.S.
securities law compliance obligations than are listed U.S. corporations, including the U.S.
target in a Treas. Reg. Sec. 1.367(a)-3(c) transaction. Thus, in an acquisition by a foreign
parent of a U.S.-exchange-listed U.S. corporation, there can potentially be significant
administrative cost savings.
Definition of Foreign Private Issuer
Under 17 CFR Sec.240.3b-4, a foreign private issuer includes a corporation
incorporated outside the U.S. if a majority of its voting shares are directly and indirectly
held of record by non-U.S. residents. Foreign corporate voting stock held in U.S. and
certain foreign brokerage accounts is traced through to determine record ownership.
139
Because Treas. Reg. Sec. 1.367(a)-3(c)(1)(i) requires the U.S. transferors to receive not
more than 50% of the total voting power and value of the stock of the acquiring foreign
parent corporation, this foreign private issuer test is generally met.
Since there are some differences in the tests, foreign private issuer status may not
be available in every case. For example, Treas. Reg. Sec. 1.367(a)-3(c)(1) generally
ignores pre-existing ownership in the acquiring foreign parent by both non-target U.S.
stockholders and target U.S. stockholders outside the U.S. target's control group of
officers, directors, and 5% shareholders. By contrast, pre-existing U.S. record ownership
in the target that becomes U.S. record ownership in the listed foreign acquiring parent can
count against foreign private issuer status.
There is another way for the foreign parent to qualify as a foreign private issuer,
even if a majority of its stock is owned of record by U.S. residents. Under 17 CFR
Sec.240.3b-4, such a foreign parent will be viewed as a foreign private issuer if: (1) a
majority of the foreign parent's officers and directors are not U.S. citizens or resident; (2)
its business is administered outside the United States; and (3) a majority of the foreign
parent's business is located outside the U.S.
Since Treas. Reg. Sec. 1.367(a)-3(c) generally requires that the acquiring foreign
corporation be greater in market value than the U.S. target, it is often feasible to satisfy
the alternative test of 17 CFR Sec.240.3b-4. Of course, in some cases there may be
difficulties. For example, the acquiring foreign parent in a Treas. Reg. Sec. 1.367(a)-3(c)
transaction may already have significant U.S. assets, which, when added to the U.S.
target's assets, constitute a majority of the foreign issuer's assets. In that case, the foreign
140
parent cannot rely on this alternative test. Rather, it would have to qualify under the
ownership test to achieve its status as a foreign private issuer.
Benefits of Foreign Private Issuer Status
(1) Foreign private issuers generally file an annual
Form 20-F, not an annual Form 10-K. Form 20-F generally requires less disclosure than
Form 10-K. Form 20-F is generally due 6 months after year-end, as distinguished from 3
months after year-end for Form 10-K.
(2) Foreign private issuers need not file quarterly Form
10-Qs.
(3) Foreign private issuers are generally exempt from
the proxy rules of Sec. 14(a) of the 1934 Act. In Ltr. Rul. 200406013,
the Service ruled that a U.S. company with a foreign parent that was a "foreign private
issuer", and its subsidiaries were not subject to the Sec. 162(m) compensation deduction
limitation because under the SEC rules neither the foreign parent nor the U.S. company
were required to file nor filed a summary compensation table with the SEC. Similarly,
Ltr. Rul. 200419013 favorably ruled that Sec. 162(m) was inapplicable to the short year
consolidated return of an acquired public U.S. corporation that was acquired by a foreign
private issuer before the U.S. corporation's due date for proxy filings, on the grounds that
the post-acquisition proxy filings of the foreign private issuer acquirer was neither
required to nor did contain the summary compensation schedule for the pre-acquisition
compensation of the acquired U.S. company's officers.
(4) Foreign private issuers are generally exempt from
the Sec. 16(b) rules concerning restitution of certain short-term profits.
141
(e) Foreign private issuers are generally exempt
from SEC Regulation FD (2000), prohibiting selective disclosure of material nonpublic
information. However, the preamble to SEC Regulation FD, 65 Fed. Reg. 515716
(8/24/2000), states "the Commission has determined to exempt foreign private issuers at
this time, as it has in the past exempted them from certain U.S. reporting requirements
such as Forms 10-Q and 8-K. Today's global markets pose new regulatory issues. In
recognition of this fact, the Commission will be undertaking a comprehensive review of
the reporting requirements of foreign private issuers. In the interim, we remind foreign
private issuers of their obligations to make timely disclosure of material information
pursuant to applicable self-regulatory organization rules and policies, and our expectation
that the markets will enforce these obligations. Also, while Regulation FD will not apply,
foreign private issuers in their disclosure practices remain subject to liability for conduct
that violates, and meets the jurisdictional requirements of, the antifraud provisions of the
federal securities laws."
d. Practical Difficulties
Despite the potential U.S. corporate tax, financial, and SEC advantages, there are
several practical difficulties in arranging a Treas. Reg. Sec. 1.367(a)-3(c) transaction.
First, U.S. target shareholders are usually reluctant to accept as consideration stock of a
foreign corporation, unless that foreign corporation is very well known in the United
States and is, or simultaneously with the acquisition becomes, traded on a U.S. or major
foreign stock exchange. Second, due to high valuations of some potential U.S. target
corporations on the U.S. stock markets, it is often difficult to find complementary foreign
acquirers with higher market capitalization. For these two reasons, most of the high
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profile non-recognition transactions under Treas. Reg. Sec. 1.367(a)-3(c) have involved
very large, well-known foreign companies like BP Amoco, Daimler Benz, and Vodafone.
Sec. 355(e) generally triggers tax to a U.S. target corporation that spins off a
subsidiary in contemplation of being acquired by a foreign or U.S. corporation in a tax-
free reorganization. Therefore, such a spin-off is often not feasible, even if it would
reduce the value of the U.S. target to below that of the foreign acquirer to satisfy Treas.
Reg. Sec. 1.367(a)-3(c).
Not all Treas. Reg. Sec. 1.367(a)-3(c) transactions must be of the magnitude of
BP Amoco-ARCO, Daimler-Benz-Chrysler or Vodafone-AirTouch, however. For
example, the authors are aware of a number of relatively small private U.S. companies
that have been acquired in Treas. Reg. Sec. 1.367(a)-3(c) transactions by larger
corporations traded on foreign stock exchanges.
e. IRS Private Rulings
In several situations it has been necessary for taxpayers to incur the delay and
expense of obtaining rulings from the IRS concerning substantial compliance under
Treas. Reg. Sec. 1.367(a)-3(c)(9). Most commonly, a ruling has been necessitated
because of uncertainty as to whether the foreign acquirer is worth more than the U.S.
target. Such valuation uncertainty can occur when there are upward movements in the
value of the U.S. target stock or downward movements in the value of the foreign
acquirer stock between the date on which the terms of the acquisition are agreed and the
effective date of the acquisition. Such valuation uncertainty can also arise because of
acquisitions of passive assets by the foreign acquirer during the 36 months before the
acquisition (such as an initial public offering for cash not undertaken for the purpose of
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stuffing the foreign acquirer), which, absent an IRS ruling are excluded under Treas. Reg.
Sec. 1.367(a)-3(c)(3)(iii)(B)(1)(i)(A) in determining whether the foreign acquirer is worth
at least as much as the U.S. target.
There have been several favorable private letter rulings issued under Treas. Reg.
Sec. 1.367(a)-3(c)(9), including those approving the Daimler-Benz-Chrysler and
Vodafone-AirTouch acquisitions. See, e.g. Ltr. Ruls. 200709054 200440009,
200203015, 200122026, 20002018, 199903048, 9849014, and 9720024.
Letter Ruling 20002018
A typical ruling under Treas. Reg. Sec. 1.367(a)-3(c)(9) is Ltr. Rul. 20002018.
There, a U.S. corporation merged with and into a newly created U.S. subsidiary of a
previously privately held foreign corporation in a forward triangular merger (Sec.
368(a)(2)(D)). The U.S. target's shareholders received cash and stock of the foreign
acquiring corporation's parent. Simultaneously, the foreign acquirer made an initial
public offering pursuant to firm commitments in place before the Treas. Reg. Sec.
1.367(a)-3(c) transaction.
Various representations regarding satisfaction of Treas. Reg. Sec. 1.367(a)-3(c)(3)
were made. In particular, it was represented that the foreign parent's pre-acquisition
value (as determined for purposes of the initial public offering price of the foreign
corporate acquirer) would exceed the U.S. target's pre-acquisition value, as required by
Treas. Reg. 1.367(a)-3(c)(3)(iii)(A). However, the parties recognized that if the value of
the foreign corporate acquirer's post-acquisition shares unexpectedly fell well below the
initial public offering price at the close of the merger date, the IRS might argue, contrary
to the underwriter's initial public offering valuation, that the U.S. target was worth more
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than the foreign acquirer. In other words, if the cash received by the U.S. target's
shareholders in the forward triangular merger, a fixed dollar amount, exceeded the excess
of the closing value of the foreign acquirer shares owned by the pre-acquisition foreign
corporate acquirer's shareholders over the foreign acquirer shares issued to the U.S. target
shareholders, then Treas. Reg. Sec. 1.367(a)-3(c)(3)(a)(iii)(A) could perhaps cause the
transaction to be taxable.
Ltr. Rul. 20002018 allowed the use of the underwriter's appraised value of the
foreign acquirer established before the merger to value the foreign parent in its initial
public offering, even though the foreign parent stock could fall below that value
immediately after the transaction. Ltr. Rul. 200020018 also permitted acquisitions by the
foreign corporate acquirer of passive assets outside the ordinary course of business within
the preceding 36 months, e.g. stock issuances for cash not undertaken for the purpose of
stuffing the foreign corporate acquirer, to be included in the value of foreign corporate
acquirer's market value in determining whether the value of the foreign corporate acquirer
exceeded the value of the U.S. target. (Ltr. Rul. 200252002 permitted issuance of
convertible debt within the preceding 36 months not undertaken for purposes of stuffing
the foreign corporate acquirer.) Because the aggregate initial public offering price value
of the foreign parent stock and the cash issued to U.S. target's shareholders exceeded the
value of the foreign corporate acquirer, non-recognition was permitted under Treas. Reg.
Sec. 1.367(a)-3(c)(3).
f. Criticism of Treas. Reg. Sec. 1.367(a)-3(c) As Too Narrow
The approach taken by Sec. 367(a) and Treas. Reg. Sec. 1.367(a)-3(c) to prevent
corporate expatriation abuses is to impose a capital gain on the exchange of shares in a
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non-qualifying expatriation share transaction. Some view gain recognition as an
insufficient cost to eliminate the perceived abuse of eliminating the U.S. corporate tax
base on foreign income of predominantly U.S.-owned businesses.
First, Sec. 367(a) can be avoided by effective initial tax planning. For example,
Global Crossings, Ltd., a former NYSE-listed world-wide telecommunications company
whose key executives live and work in Los Angeles, was initially established as a tax-
haven company, specifically as a Bermuda company. Thus, the Global Crossings, Ltd.,
corporate parent did not pay U.S. corporate tax on its and its foreign subsidiaries' income
to the extent that they avoided having income effectively connected with a U.S. trade or
business. A similar approach was taken by Accenture, the former consulting arm of
Arthur Andersen, which incorporated in a tax haven at the time of its initial public
offering.
Second, the consequences of Sec. 367(a) are minimal when the capital gains tax
imposed on the shareholders in a taxable share exchange transaction is small. This tax
does not apply at all to a tax-exempt exchanging U.S. shareholder of the U.S. target, such
as a U.S. pension fund, charity, or IRA, to a U.S. shareholder with a basis in the U.S.
target's stock greater than the value of the foreign corporate stock received on the
exchange, or to a foreign shareholder.
Sometimes some of the U.S. shareholders of the U.S. target will have a low basis
in their U.S. target stock, e.g., the founding U.S. shareholders, while other shareholders
will either have a relatively high tax basis or be tax exempt or foreign entities. A
"partially taxable exchange" is a technique sometimes used to avoid U.S. tax on a
transaction not qualifying under Treas. Reg. Sec. 1.367(a)-3(c). An example of such an
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exchange was the 1998 Fruit of the Loom expatriation transaction, pursuant to which
Fruit of the Loom, Inc., a U.S. corporation, became a subsidiary of a newly created
Cayman Islands corporation, Fruit of the Loom, Ltd. The goal of the transaction was
apparently to avoid future U.S. corporate taxes on Central American income of the
Cayman Island corporation's new Central American subsidiaries. The public
shareholders of U.S. Fruit of the Loom, other than the founder, William Farley, and his
group, exchanged their shares for shares of the Cayman Islands corporation. The
transaction was taxable to them under Treas. Reg. Sec. 1.367(a)-3(c) for various reasons,
including the newly created Cayman Island parent's lack of a 36-month active business
history, its smaller value than that of the U.S. corporation, and its having issued more
than 50% of its shares to the target U.S. corporation. However, little shareholder tax was
apparently paid since U.S. pension funds owned much of the exchanged shares. The
William Farley group received exchangeable participating preferred stock in the U.S.
corporation, making the transaction arguably tax-deferred to them under Sec. 1036. In
addition, U.S. withholding tax on dividends would be avoided to the extent that they
would be paid to the William Farley group rather than to the foreign parent.
A third reason why Sec. 367(a) is viewed by some as inadequate to prevent
corporate expatriations is that the shareholder level gain triggered under Sec. 367(a) can
wholly fail to correspond to the magnitude of the U.S. corporate tax that will be avoided
on the future foreign income. Absent Sec. 367(a) recognition, the foreign corporate stock
received on the exchange receives a tax basis carried over from the U.S. corporate stock
exchanged. As a consequence, Sec. 367(a) accelerates, not creates, U.S. shareholder
level tax. This acceleration of shareholder capital gain tax is not related to the permanent
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elimination of U.S. corporate tax on future foreign income. Although the shareholder
level capital gain tax may be increased in amount because of the public's increased
valuation of the foreign corporate stock due to the expatriation transaction itself, such
increase is still not necessarily related to the permanent elimination of U.S. tax on future
foreign income.
These inadequacies in Treas. Reg. Sec. 1.367(a)-3 led to the enactment of Sec.
7874, described below, in the American Jobs Creation Act of 2004.
Before 2002, there was also some concern that because neither the exchanging
U.S. shareholders in a taxable Treas. Reg. Sec. 1.367(a)-3(c) transaction nor the Service
received Forms 1099 reporting the U.S. shareholder's gain, such gain was often not
reported by the U.S. shareholder. See "Preliminary Report Reviews Corporate Inversion,
Implications," 2002 TNT 98-49. Beginning in 2002, various proposed temporary, and
final regulations have addressed this problem. See "Corporate Inversion Reporting Under
Final Regulations," 104 Journal of Taxation (Jan. 2006). For 2006 and later transactions,
Treas. Reg. Sec. 1.6043-4(h) Example (1) generally provides that if the U.S. inverted
corporation's stock is valued at more than $100 million, IRS Forms 1099-CAP must be
issued by that U.S. corporation to any U.S. individual shareholder receiving more than
$1,000 of cash and taxable foreign corporate stock in a wholly or partially taxable Treas.
Reg. Sec. 1.367(a)-3(c) transaction. Treas. Reg. Sec. 1.6045-3(a) generally provides that
brokers who know or have reason to know that an individual U.S. customer exchanged
U.S. corporate stock in a change of control transaction must file an IRS Form 1099-B for
that customer. Treas. Reg. Sec. 1.6043-4(a)(1) requires the inverted domestic corporation
to file an IRS Form 8806 reporting its acquisition by its foreign parent. The American
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Jobs Creation Act of 2004 enacted Sec. 6043A, which requires the acquiring foreign
corporation (or acquired U.S. corporation, if required by Treasury) to file reports with the
Service and furnish information reporting to shareholders with respect to acquisitions that
trigger gain to the acquired U.S. corporation's shareholders.
Acceleration of the capital gains tax has not proved to be a barrier to expatriation
when the projected future income is large. For this reason, several public companies
have engaged in expatriation stock exchange transactions that are fully taxable under
Treas. Reg. Sec. 1.367(a)-3(c), i.e., they have formed tax-haven shell subsidiaries with
U.S. subsidiaries that merge with the publicly-traded U.S. target. The U.S. shareholders
of the publicly-traded U.S. target receive shares of the foreign holding company. In such
cases, the foreign holding company shares are taxable to all of the exchanging taxable
U.S. shareholders. However, the benefit of avoiding future U.S. corporate tax on future
foreign earnings has been achieved. Such transactions include the 2001 Ingersoll Rand,
and 1999 PXRE Corporation and Everest Reinsurance Holdings expatriation transactions.
The 2001 Ingersoll Rand expatriation is discussed in "Ingersoll Rand's Permanent
Holiday," 2002 TNT 3-4. See also "U.S. Companies File In Bermuda To Slash Tax
Bills," New York Times, February 18, 2002, discussing the proposed 2002 expatriation
of Stanley Works, for 159 years a U.S. manufacturer of hammers and wrenches. That
news article suggests that perhaps the fear of being viewed as anti-patriotic, more so than
the Treas. Reg. Sec. 1.367(a)-3(c) shareholder-level capital gains tax toll-charge, is now
the main impediment to far more U.S. public companies expatriating.
In an information-based global economy, it is not difficult to arrange to exempt
income from U.S. taxation. In the international software, internet sales, consulting,
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financial services, and communications industries, the source of income from a
transaction can often be sourced offshore, even where some of the income producing
activity of the transaction takes place in the United States. The Sec. 482 regulations,
including the global trading regulations, attempt to capture some U.S. tax on world-wide
operations conducted partly in the United States. Nevertheless, significant tax savings
can often be achieved. Such an environment can make expatriation transactions
attractive, notwithstanding Treas. Reg. Sec. 1.367(a)-3(c).
g. Criticism of Treas. Reg. Sec. 1.367(a)-3(c) As Too Broad
In contrast to those who believe that Treas. Reg. Sec. 1.367(a)-3(c) is too weak,
many have suggested that the criteria for non-recognition in Treas. Reg. Sec. 1.367(a)-
3(c) are too strict. For example, some argue that in lieu of requiring that the foreign
acquirer be as larger than the U.S. target, the foreign acquirer should only have to be of
significant value as compared to the U.S. target, for example, 25% or even less, as the
purpose of looking at values is to provide an indication that something other than a pure
inversion transaction has occurred, i.e., a tax-motivated transaction in which a primarily
U.S. owned multinational group replaces the U.S. parent corporation with a foreign
holding company. Indeed, T.D. 9265 (6/6/06) states that the Treasury is considering
amending Treas. Reg. Sec. 1.367(a)-3(c) as result of the enactment of Sec. 7874. Others
have argued that the capital structure of the two corporations should not be given the
heavy emphasis that it has in Treas. Reg. Sec. 1.367(a)-3(c). For example, if a foreign
acquirer's gross assets are far larger than those of the U.S. target, but it utilizes far more
debt than the U.S. target to fund its operations, then the foreign acquirer's equity market
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value may be less than the U.S. target's equity market value, with the consequence that
Treas. Reg. Sec. 1.367(a)-3(c)(3)(iii)(B) would preclude non-recognition treatment.
Still others criticize that the Treas. Reg. Sec. 1.367(a)-3(c) criteria ignores a key
indication of whether the transaction is a tax motivated expatriation, namely the relative
sizes of the actual and projected U.S. and foreign operations of the acquired U.S. target.
Rather, Treas. Reg. Sec. 1.367(a)-3(c) focuses solely on the combined values of the U.S.
and foreign operations and compares this melded figure to the value of the foreign
corporate acquirer, which is a value that is irrelevant to future U.S. corporate tax
avoidance. Larger, as well as smaller, foreign corporate acquirers have the same
incentive to shift foreign income producing operations away from subsidiaries of the
acquired U.S. target. The irrelevance of the Treas. Reg. Sec. 1.367(a)-3(c) criteria can be
illustrated by the example of a U.S. target with assets located only in the U.S. and no
plans for overseas expansion which cannot qualify for a Treas. Reg. Sec. 1.367(a)-3(c)
non-recognition transaction with a smaller foreign acquirer, even though there is clearly
no anticipated U.S. corporate tax avoidance from placing the U.S. company under foreign
ownership since the U.S. company has neither existing nor projected foreign operations.
By contrast, Lycos, a U.S. multinational internet company with large expansion potential
outside the U.S., qualified under Treas. Reg. Sec. 1.367(a)-3(c) to be acquired by the
Spanish international internet company Terra because Terra's market value exceeded that
of Lycos. Treas. Reg. Sec. 1.367(a)-3(c) provided non-recognition even though the
potential opportunities to avoid U.S. corporate tax on what might otherwise have been the
foreign earnings of subsidiaries of a U.S. taxpayer could be great. Indeed, as some have
pointed out in connection with the Vodafone and Daimler-Benz transactions, the larger
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the foreign operations of the foreign acquirer, the easier it is for the acquiring foreign
parent's foreign subsidiaries to use the acquired U.S. technology to earn post-acquisition
income free of U.S. tax, and, paradoxically, the easier it is to qualify for non-recognition
under Treas. Reg. Sec. 1.367(a)-3(c).
Treas. Reg. Sec. 1.367(a)-3(c) triggers gain and imposes an interest charge on 5%
U.S. target shareholders if the foreign transferor disposes of the U.S. target within five
years, even if that U.S. target shareholder has no control of the foreign corporation's post-
transaction divestiture policy, a penalty that some view as manifestly unfair. Indeed,
many question the continuing validity of the U.S. policy of taxing corporate business
profits earned abroad that have otherwise avoided the plethora of anti-tax avoidance
provisions which the United States already has in place.
h. Section 7874(b) - 80% identity of stockownership - Section
367 transactions
The American Jobs Creation Act of 2004 enacted Sec. 7874, concerning corporate
expatriations. Sec. 7874 generally applies to covered corporate expatriation transactions
completed after March 3, 2003 for taxable years ending after March 3, 2003.
Proposed legislation would apply to expatriations that took place between March
20,2002 and March 3, 2003, to treat the expatriated corporation as domesticating in 2007.
See "Baucus Praises Passage of Small Business and Work Opportunity Act," 2007 TNT
12-38.
Sec. 7874(b) operates to treat as a U.S. corporation, and thus as taxable on its
worldwide income, an acquiring foreign corporation where there is at least 80% identity
of stockownership with the acquired U.S. corporation. Sec. 7874(b) applies where,
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pursuant to a plan or a series of related transactions: (1) an acquiring foreign corporation
directly or indirectly acquires substantially all the properties held directly or indirectly by
a domestic corporation; (2) the former shareholders of the U.S. corporation hold, by
reason of holding stock in the U.S. corporation, 80% or more, by vote or value, of the
stock of the acquiring foreign corporation after the transaction; and (3) the acquiring
foreign corporation, considered together with all foreign and U.S. corporations connected
to it by a chain of greater than 50% ownership, does not have substantial business
activities in the acquiring foreign corporation's country of incorporation compared to the
total worldwide business activities of that chain of corporations. In this situation, the top-
tier acquiring foreign corporation is treated a U.S. corporation for all purposes of the
Code. Where the acquiring foreign corporation, when recharacterized as a U.S.
corporation, becomes the parent of a U.S. consolidated group, Treas. Reg. Sec. 1.1502-
77T (2006) allows the IRS to designate a U.S. corporate member of the affiliated group,
rather the foreign parent, as the consolidated group's agent.
Expatriations of U.S. partnerships are also covered by Sec. 7874(b). If (1) an
acquiring foreign corporation directly or indirectly acquires substantially all the
properties constituting a trade or business of the U.S. partnership; (2) the former partners
of the U.S. partnership hold, by reason of holding a capital or profits interest in the U.S.
partnership, 80% or more, by vote or value, of the stock of the acquiring foreign
corporation after the transaction; and (3) the acquiring foreign corporation, considered
together with all foreign and U.S. corporations connected to it by a chain of greater than
50% ownership, does not have substantial business activities in the acquiring foreign
corporation's country of incorporation compared to the total worldwide business activities
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of that chain of corporations. In this situation, the top-tier acquiring foreign corporation is
treated a U.S. corporation for all purposes of the Code.
The Conference Report, at footnote 432, indicates, Treas. Reg. Sec. 1.7874-2T(h)
(2006) confirms, that because the acquiring foreign corporation described in Sec. 7874(b)
is treated as domestic, the Sec. 367(a) rules do not apply. Thus, for example, Treas. Reg.
Sec. 1.367(a)-3(c)(1)(i), which would otherwise trigger recognition on an exchange of
U.S. corporation stock for foreign corporate stock because the exchanging U.S.
shareholders obtain a majority of stock of the foreign corporate acquirer, apparently will
not trigger gain in a transaction described in Sec. 7874(b). Rather, only the U.S.–to-U.S.
domestic reorganization or similar (e.g., Sec. 351) requirements need be met.
Similarly, in the context of an acquisition of a U.S. partnership's business by a
foreign corporation covered by Sec. 7874(b), Sec. 367(a)(4) and Treas. Reg. Sec.
1.367(a)-1T(c)(3), which generally trigger gain to U.S. partners with respect to
appreciated assets (other than certain assets used by the foreign corporate transferee in an
active foreign business) presumably would not apply. Rather, the transaction would be
entitled to partner-level non-recognition to the extent allowable under Sec. 351.
In determining whether the former shareholders of the U.S. corporation have
received the triggering 80% of foreign-acquirer stock, the Service is entitled to exclude
from the numerator and denominator of such 80% test stock of the foreign acquirer sold
in a public offering related to the expatriation transaction. In addition, the Service can
exclude from the numerator and denominator of such 80% test stock in the acquiring
foreign corporation held by all foreign and U.S. corporations connected to the foreign
acquiring corporation by a chain of greater than 50% ownership.
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The transfer of assets or liabilities, including by contribution or distribution, may
be disregarded by the Service if the transfers are part of a plan the principal purpose is
which is to avoid the purposes of Sec. 7874. In addition, the Treasury has authority to
prevent avoidance of Sec. 7874 through the use of related persons, pass-through or other
non-corporate entities, or other intermediaries, and through transactions designed to
qualify or disqualify a corporation as a member of the chain of 50%-or-greater
ownership. Similarly, Treasury is granted authority to treat certain non-stock instruments
as stock, and certain stock as not stock, where necessary to carry out the purposes of Sec.
7874.
Commentators and IRS officials have noted that Sec. 7874(b) has unintended
scope because foreign stockholders in the transferred U.S. corporation that continue as
stockholders in the transferee foreign holding company may in certain cases be counted
in the numerator and denominator of the 80% test. Thus, for example, a foreign
individual, who transfers all the stock of a wholly owned U.S. corporation into a newly
created wholly owned foreign holding company, will cause that new foreign holding
company to be treated as a U.S. corporation under Sec. 7874(b). See 2005 TNT 53-2,
"Practitioners Fault Scope of Jobs Act's Anti-Inversion Rule."
In 2006, the Treasury issued Treas. Reg. Sec. 1.7874-1T and Treas. Reg. Sec.
1.7874-2T. Treas. Reg. Sec. 1.7874-1T modifies the stockownership computation.
Favorably, Treas. Reg. Sec. 1.7874-1T(c)(1) and (e) Examples (2) and (3) generally
allows a foreign-owned foreign corporate group to transfer the stock or assets of a U.S.
subsidiary to another member of that foreign-owned foreign corporate group without the
foreign corporate transferee being recharacterized as a U.S. corporation under Sec. 7874.
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Conversely, Treas. Reg. Sec. 1.7874-1T(b) and (e) Example (1), stock of the acquiring
foreign corporation held by an entity that is at least 50% owned directly or indirectly by
the acquiring foreign corporation is ignored in applying the 80% and 60% tests, and
therefore is ineffective to prevent the IRS finding that the 80% or 60% tests is met. See
"Watch Your Fractions -- Calculating the Reach of the Sec.7874 Anti-Inversion Rules,"
35 Tax Mgt Intl J. No. 3 (March 10, 2006); "Section 7874 Temporary Regulations:
Treasury and IRS Waive Taxpayers Through the Stoplight," J. Intl. Tax (July 2006).
Treas. Reg. Sec. 1.7874-2T(b), provides that acquisitions of U.S. corporate stock,
and acquisitions of interests in a U.S. or foreign partnership that own U.S. corporate
stock, but not acquisitions of stock in foreign corporations that already own U.S.
corporate stock, may be subject to Sec. 7874. Treas. Reg. Sec. 1.7874-2T(c), provides
generally that stock of the foreign corporate acquirer is counted in the numerator of the
60% and 80% tests if it is received in exchange for the interest in the U.S. corporation or
U.S. partnership. Treas. Reg. Sec. 1.7874-2T(d)(2) provides a safe harbor whereby an
acquiring foreign corporation will avoid Sec. 7874 if, after the acquisition, within its
country of incorporation, the acquiring foreign corporation's expanded affiliated group
maintains at least 10% of the group's employees, assets and sales. See "'Substantial
Activity' Under the Anti-Inversion Regs," 2006 TNT 172-33; "Substantial Business
Activities: Old Wine in a New Vessel," Tax Mgt. Int'l J. (Feb. 9, 2007). . Where the safe
harbor of Treas. Reg. Sec. 1.7874-2T(d)(2) is not available, Rev. Proc. 2007-7, 2007-1
IRB 227, Sec. 4.01(29), provides that private letter rulings ordinarily will likewise not be
available. Treas. Reg. Sec. 1.7874-2T(e) generally treats publicly traded foreign
partnerships as foreign corporations for purposes of Sec. 7874. Treas. Reg. Sec. 1.7874-
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2T(f) generally provides that options, convertible securities, and non-vested stock issued
by the foreign corporate acquirer in exchange for the acquired U.S. corporation or
partnership interests is treated as exercised in applying the 50% and 80% tests.
i. Section 7874(a) and Section 4985- 60% to 80% identity of
stockownership transactions Sec. 7874(a) covers inversion transactions that would be
covered by Sec. 7874(b), except that the 80% ownership threshold is not met. In this
case, if a 60% ownership threshold is met, then a second set of rules applies to the
transaction. Under these rules, unlike the 80% ownership threshold rules, the acquiring
corporation is treated as foreign. Thus, the transaction will be tested under the domestic
and Sec. 367 rules. Because Treas. Reg. Sec. 1.367(a)-3(c)(1)(i) generally requires
recognition where the exchanging U.S. shareholders receive more than 50% of the stock
of the foreign corporate acquirer, if the 60% threshold of Sec. 7874(a) is reached, the
transaction will generally be not entitled to non-recognition.
Under Sec. 7874(a), any applicable U.S.-corporate-level income or gain required
incident to establishing the inverted structure may not be offset by tax attributes such as
net operating loss carry-forwards or foreign tax credits.
Sec. 4985 generally imposes a non-deductible excise tax, at the highest individual
capital gains rates, on certain officers, directors, and 10% or greater owners of private or
publicly held corporations with respect to the value of non-qualified stock options and
certain other stock-based compensation, in a U.S. corporation expatriating in an
acquisition described in Sec. 7874 that triggers gain at the level of the acquired U.S.
shareholders. Thus, it appears that transactions entitled to shareholder level non-
recognition under Treas. Reg. Sec. 1.367(a)-3(c) are not subject to Sec. 4985.
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j. Commentary on Section 7874. Many commentators have
suggested that the Treasury and IRS issue guidance on Sec. 7874 narrowing its scope and
concentrating on the abuse to which Sec. 7874 was directed. For example, the NYSBA
Tax Section has recommended the following, in 2006 TNT 56-32, "NYSBA Comments
on Temporary Regs. on Affiliated Stock Rule": (1) generally allowing non-participating
preferred stock in the foreign corporate acquirer, and certain non-in-the-money stock
rights in the foreign corporate acquirer, issued to exchanging U.S. shareholders, to be
excluded in applying the 80% and 60% tests; (2) eliminating Treas. Reg. Sec. 1.367(a)-
3(c) or else relaxing its 50% upper limit of exchanging U.S. stockholder ownership in
view of the 60% test of Sec. 7874 (see also 2005 TNT 80-14
"NYSBA Calls for Removal of Regs on U.S.-Foreign Stock Transfers"; and (4) while
endorsing the view that Sec. 7874(g) allows the Treasury to apply Sec. 7874 to
acquisitions by foreign pass-through entities, such application should be limited to only
treating the acquiring foreign partnership as a U.S. partnership, not as a U.S. corporation.
For other commentary on regulatory issues facing the IRS under Sec. 7874, and IRS
officials' comments, see, e.g. 2006 TNT 43-11, "IRS Previews Anti-Inversion Guidance;"
"News Analysis: More Questions for Inversion Regulations," 2006 TNT 51-11; "New
Anti-Inversion Announcement: When Is a Foreign Check-the-Box Partnership a
Surrogate Foreign Corporation?," 35 Tax Mgt Intl J. No. 3 (March 10, 2006); "Effective
Date Issue for Possible Extension (by Regulation) of Sec.7874 to `Inversions' with a
Partnership on Top," 35 Tax Mgt Intl J. No. 3 (March 10, 2006). Cf. "Grassley Promises
Scrutiny of Halliburton 's Move to Dubai," 2007 TNT 49-31. The Congressional
Research Service observes that Sec. 7874 and other anti-expatriation rules are in effect
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seeking to lock-in world-wide taxation. They thus may be largely unnecessary if the U.S.
were to adopt a territorial tax system. However, if the territorial tax system were limited
to excluding from the U.S. tax base active business income, Sec. 7874 may still be
necessary to preserve the U.S. tax base on passive income. See "CRS Updates Report on
Corporate Inversions, Expatriation, at fn. 32, 2007 TNT 10-73.
l. Non-tax, Non-securities Legal Consequences
There are several U.S. international trade legal consequences that potentially
could change when a foreign parent is substituted for a U.S. parent in a Treas. Reg. Sec.
1.367(a)-3(c) transaction. Compare "Canadian Companies Beware: The U.S. Foreign
Corrupt Practices Act Applies To You!," 36 Alberta Law Review 455 (1998), pointing
out that under 15 U.S.C. Sec.78dd-1, foreign private issuers of U.S. listed securities are
subject to the foreign corrupt practices act to the same extent as U.S. issuers, with 31
CFR Sec.515.201, 515.329 and 555.559(a) (certain Cuban embargo regulations are
applicable only to those non-U.S. companies that are controlled by U.S. companies, U.S.
citizens, and U.S. residents, and thus are no longer applicable to foreign subsidiaries of a
foreign-controlled foreign parent). In evaluating a proposed transaction governed by
Treas. Reg. Sec. 1.367(a)-3(c), U.S. laws concerning foreign corporate acquisitions of
sensitive U.S. industries must be considered. See, e.g., 47 U.S.C. Sec. 310(b)(3), (4)
(Federal Communications Commission can prohibit holding of broadcast licenses by U.S.
subsidiaries of foreign corporations); 31 CFR Part 300 (President's power to prevent
merger transactions creating foreign control that threaten to impair the national security).
Sec. 835 of the Homeland Security Act of 2002 generally prohibits the Secretary
of Homeland Security from entering into a contract with a corporation that results from a
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2003 or later inversion transaction in which shareholders of the former U.S. parent
receive at least 80% of the new foreign parent stock.
m. Treasury Study
Sec. 806(c) of the American Jobs Creation Act of 2004 provides that the Treasury
is, before January 2007, to deliver to Congress a study of Secs. 7874 and 4985, and other
Code provisions as they relate to corporate expatriations. Treasury is to include any
recommendations to improve the effectiveness of such provisions in carrying out their
purposes.
Secs. 806(a) and 806(b) of that Act require a transfer pricing study and tax treaty
study to be delivered to Congress by June 30, 2005.
II. OUTBOUND TRANSFERS UNDER SECTION 367(B)
The original design of Sec. 367 was for paragraph (a) to apply to outbound
transfers by U.S. persons, while paragraph (b) was to apply to inbound and foreign-to-
foreign transfers. Historically, the two paragraphs were exclusive, and in an overlap
situation, such as a Sec. 368(a)(1)(B) reorganization involving a U.S. person's exchange
of stock of a foreign corporation for stock of another foreign corporation, the transaction
was subject only to Sec. 367(b). In 1998, new Sec. 367(a) regulations were adopted that
subject such transactions to both paragraphs, requiring a taxpayer to enter into a gain
recognition agreement under Sec. 367(a) to the extent that the U.S. transferor's gain is not
recognized under Sec. 367(b).
Unlike Sec. 367(a), Sec. 367(b) requires the recognition of a deemed dividend of
certain amounts in certain transactions to preserve non-recognition treatment. To
understand the application of Sec. 367(b), certain basic definitions must be understood:
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Sec. 1248 Amount – The net positive earnings and profits that would have been
attributable to the stock of a foreign corporation and includable in gross income as a
dividend under Sec. 1248 if the stock were sold by the shareholder; i.e., the net positive
post-1962 earnings and profits of a CFC, but not including the earnings and profits of any
lower tier subsidiaries.
All Earnings and Profits Amount – The net positive earnings and profits for all
years of the foreign corporation, regardless of whether it was a CFC, but only during the
shareholder's holding period, including the time that the shareholder held less than 10%
of the stock. Certain adjustments are allowed, such as for previously taxed income and a
U.S. effectively connected loss.
Sec. 1248 Shareholder - Any U.S. person who owns, directly or indirectly, at least
10% of the voting stock of a foreign corporation.
A. Outbound Transactions Covered by both Section 367(a) and (b)
The transactions covered by both Section 367(a) and (b) are:
1. Sec. 368(a)(1)(B) reorganizations where the U.S. person exchanges
stock of a foreign acquired corporation for voting stock of a foreign acquiring corporation
(Treas. Reg. Sec. 1.367(a)-3(b)(2));
2. Sec. 368(a)(1)(E) recapitalizations of foreign corporations where
the U.S. person exchanges either common stock or preferred stock that fully participates
in dividends, redemptions and corporate growth for preferred stock that does not fully
participate in dividends, redemptions and corporate growth, if the recapitalized foreign
corporation is acquired, during the period commencing two years before the
recapitalization through two years after, in an exchange in which a domestic corporation
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meets the ownership threshold specified by Sec. 902(a) or (b) so that it may qualify for a
deemed paid foreign tax credit (Treas. Reg. Sec. 1.367(b)-4(b)(3));
3. Mergers described in Secs. 368(a)(1)(A) and (a)(2)(D) or (a)(2)(E)
where the U.S. person exchanges stock or securities of a foreign acquired corporation for
stock or securities of the foreign corporation that controls the acquiring corporation, or
exchanges stock or securities of a foreign acquiring corporation for stock or securities of
the foreign corporation that controls the acquired corporation;
4 . Triangular Sec. 368(a)(1)(B) reorganizations where the U.S.
person exchanges voting stock of a foreign acquired corporation for voting stock of a
foreign corporation in control of the acquiring corporation; (Under the proposed
regulations, this category would also include triangular B reorganizations where the U.S.
person exchanges voting stock of a foreign acquired corporation for voting stock of a
domestic corporation that controls a foreign acquiring corporation. See Prop. Treas. Reg.
Sec. 1.367(a)-3(d)(1)(iii); but see also Prop. Treas. Reg. Sec. 1.367(b)-4(b)(1)(ii).)
5. Triangular Sec. 368(a)(1)(C) reorganization where the U.S. person
exchanges stock or securities of a foreign corporation for voting stock of a foreign
corporation that controls the acquiring foreign corporation;
6. Sec. 368(a)(1)(C) and (a)(2)(C) reorganizations where the U.S.
person exchanges stock or securities of a foreign acquired corporation for voting stock or
securities of a foreign acquiring corporation, and the foreign acquiring corporation
transfers the stock or securities to a foreign corporation it controls. If less than all of the
assets are transferred to the controlled subsidiary, the transaction is subject to Sec. 367(b)
to the extent of the assets transferred. Under the proposed regulations, this category
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would also include A, D and F reorganizations where the U.S. person exchanges stock or
securities of a foreign acquired corporation and the foreign acquiring corporation
transfers assets to a controlled subsidiary. See Prop. Treas. Reg. Sec. 1.367(a)-3(d)(1)(v).
See also Notice 2002-77, 2002-2 C.B. 997 (D reorganization followed by drop-
down/CAT treated as an indirect transfer).
B. Effect of Section 367(b)
If an exchange is described below, the exchanging shareholder must include in
gross income as a deemed dividend the Sec. 1248 amount attributable to the stock that it
exchanges. Treas. Reg. Sec. 1.367(b)-4(b). If the Sec. 1248 amount is included in gross
income by a foreign corporation as a deemed dividend, the deemed dividend is not
treated as foreign personal holding company income under Sec. 954(c).
1. Exchange that Results in Loss of Status as a Sec. 1248 Shareholder
Deemed dividend treatment is required if the following requirements are met:
a. Immediately before the exchange the exchanging
shareholder is:
A Sec. 1248 Shareholder with respect to the foreign acquired corporation; or
A foreign corporation having as a shareholder a Sec. 1248 Shareholder with respect to
both the foreign corporation and the foreign acquired corporation; and
b. Either:
Immediately after the exchange the stock received is not stock in a corporation that is a
CFC as to which the U.S. person described in a above is a Sec. 1248 Shareholder; or
Immediately after the exchange the foreign acquiring corporation (or, in the case of a
reorganization described in Sec. 368(a)(1)(B), the foreign acquired corporation) is not a
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CFC as to which the U.S. person described in a above is a Sec. 1248 Shareholder. Treas.
Reg. Sec. 1.367(b)-4(b)(1).
Pursuant to the Sec. 367 regulations proposed on January 5, 2005, inclusion of the
Sec. 1248 amount would not be required under Treas. Reg. Sec. 1.367(b)-4(b)(1) if,
pursuant to a triangular A, B or C reorganization, the exchanging shareholder receives
stock of a domestic corporation and, immediately after the exchange, (i) such domestic
corporation is a Sec. 1248 Shareholder of the acquired corporation (in the case of a
triangular B reorganization) or the surviving corporation (in the case of a forward or
reverse subsidiary merger) and (ii) such acquired or surviving corporation is a CFC.
Prop. Treas. Reg. Sec. 1.367(b)-4(b)(1)(ii); see also Prop. Treas. Reg. Sec. 1.367(b)-
4(b)(1)(iii), Ex. 3B. Undoubtedly, it was also intended that the domestic corporation
must be a Sec. 1248 Shareholder of the acquiring corporation in a triangular C
reorganization in order for the exception to apply, but the proposed regulations appear to
omit this requirement. It is understood that the IRS will remedy this omission when the
proposed regulations are finalized.
As noted in the preamble to the proposed regulations, where these requirements
are satisfied, the Sec. 1248 amount need not be triggered, because it can be preserved in
the shares of the foreign corporation owned by the domestic corporation. The proposed
regulations prescribe detailed rules for preserving the Sec. 1248 amount in reorganization
transactions. See Prop. Treas. Reg. Sec. 1.367(b)-13. These rules are discussed in IV,
below.
2. Receipt by Exchanging Shareholder of Preferred or Other Stock in
Certain Instances
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Deemed dividend treatment is required if the following requirements are met:
a. Immediately before the exchange the foreign acquired
corporation and the foreign acquiring corporations are not members of the same affiliated
group (as defined in Sec. 1504(a) but without regard to the exceptions set forth in Sec.
1504(b), and substituting the words "more than 50" in place of the words "at least 80" in
Secs. 1504(a)(2)(A) and (b));
b. Immediately after the exchange, a domestic corporation
meets the ownership threshold specified by Sec. 902(a) or (b) so it may qualify for a
deemed paid foreign tax credit if it receives a distribution from the foreign acquiring
corporation (directly or through tiers); and
c. The exchanging shareholder receives:
preferred stock, other than preferred stock that is fully participating with respect to
dividends, redemptions and corporate growth, in consideration for common stock or
preferred stock that is fully participating with respect to dividends, redemptions and
corporate growth; or
in the discretion of the Commissioner or the Commissioner's delegate, and without regard
to whether the stock exchanged is common stock or preferred stock, receives stock that
entitles it to participate (through dividends, redemption payments or otherwise)
disproportionately in the earnings generated by particular assets of the foreign acquired
corporation or foreign acquiring corporation.
3. Non-Inclusion Exchanges.
If deemed dividend treatment is not required under the foregoing rules (a "non-
inclusion exchange"), then special earnings and profits calculations are necessary in
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applying Sec. 367(b) or 1248 to subsequent exchanges. The earnings and profits
attributable to stock received in the non-inclusion exchange includes the exchanging
shareholder's pro rata interest in the earnings and profits of the foreign acquiring
corporation, and in the case of a stock transfer, the foreign acquired corporation, that
accumulate after the non-inclusion exchange, as well as its pro rata interest in the
earnings and profits of the foreign acquired corporation that accumulated before the non-
inclusion exchange. The earnings and profits attributable to the stock received in the
non-inclusion exchange, however, does not include any earnings and profits of the
foreign acquiring corporation that accumulated before the non-inclusion exchange. If the
exchanging shareholder in the non-inclusion exchange was a foreign corporation, the
foregoing rules also apply to determine the earnings and profits attributable to the
exchanging foreign corporation's shareholders, as well as to determine the earnings and
profits attributable to the exchanging foreign corporation, when applying Sec. 964(e) to
subsequent sales or exchanges of the stock of the foreign acquiring corporation.
The proposed regulations prescribe detailed rules for preserving the Sec. 1248
amount in reorganization transactions. See Prop. Treas. Reg. Sec. 1.367(b)-13. These
rules are discussed in IV, below.
C. Section 367(b) Notice
The Sec. 367(b) Regulations impose notice requirements with respect to all
transactions falling within its purview. A U.S. person who is a Sec. 1248 Shareholder of
a foreign acquired corporation must file a notice if it realizes income on an overlap
transaction. Similarly, a U.S. person who is a Sec. 1248 Shareholder of a foreign
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corporation that owned a foreign acquired corporation must file a notice if the foreign
corporation realizes income on an overlap transaction. Treas. Reg. Sec. 1.367(b)-1(c).
The notice must be attached to the U.S. person's timely filed federal income tax
return for the taxable year in which the income is realized. A Sec. 1248 Shareholder of a
foreign corporation described above must file the notice with its timely-filed Federal
income tax return for the taxable year in which income is realized if the U.S. person is
required to file a Form 5471 (Information Return of U.S. Person With Respect to Certain
Foreign Corporations), by attaching the notice to the Form 5471.
The notice must contain the following:
1. A statement that the exchange is one to which Sec. 367(b) applies;
2. A complete description of the exchange;
3. A description of any stock, securities or other consideration
received in the exchange;
4. A statement which describes any amount required under Sec.
367(b) to be taken into account as income or loss or as an adjustment to basis, earnings
and profits or other tax attributes as a result of the exchange;
5. Any information that is or would be required to be furnished with a
federal income tax return pursuant to regulations under Secs. 332, 351, 354, 355, 356,
361, or 369 (whether or not a federal income tax return is required to be filed), if such
information has not otherwise been provided; and
6. Any information required to be furnished under Sec. 6038, 6038A,
6038B, 6038C or 6046, if such information has not otherwise been provided.
Treas. Reg. Sec. 1.367(b)-1(c)(4).
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III. REPORTING REQUIREMENTS
Sec. 367 has its own reporting and gain recognition requirements. They are
discussed in the foregoing paragraphs. In addition, Sec. 6038B imposes general reporting
requirements with respect to transactions described in Sec. 367. Further, there are
specific reporting and recordkeeping requirements under each of the non-recognition
provisions to which Sec. 367 applies.
A. Section 6038B
Sec. 6038B requires each U.S. person who transfers property to a foreign
corporation in an exchange described in Sec. 332, 351, 354, 355, 356, or 361, or who
makes a distribution described in Sec. 336 to a person who is not a U.S. person, to
provide certain information as required by Regulation. I.R.C. Sec.6038B(a). A U.S.
person that transfers stock or securities on or after July 20, 1998, will be considered to
have satisfied the Sec. 6038B reporting requirement if either:
1. The U.S. transferor owned less than 5% of both the total voting
power and the total value of the transferee foreign corporation immediately after the
transfer (taking into account the attribution rules of Sec. 318, as modified by Sec.
958(b)), and either:
a. The U.S. transferor qualified for non-recognition treatment
with respect to the transfer (i.e., the transfer was not taxable under Treas. Reg. Sec.
1.367(a)-3(b) or (c)); or
b. The U.S. transferor is a tax-exempt entity and the income
was not unrelated business income; or
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c. The transfer was taxable to the U.S. transferor under Treas.
Reg. Sec. 1.367(a)-3(c), and such person properly reported the income from the transfer
on its timely-filed (including extensions) federal income tax return for the taxable year
that includes the date of the transfer; or
2. The U.S. transferor owned 5% or more of the total voting power or
the total value of the transferee foreign corporation immediately after the transfer (taking
into account the attribution rules of Sec. 318, as modified by Sec. 958(b)), and either:
a. The transferor (or one or more successors) properly entered
into a gain recognition agreement under Treas. Reg. Sec. 1.367(a)-8; or
b. The transferor is a tax-exempt entity and the income was
not unrelated business income; or
c. The transferor properly reported the income from the
transfer on its timely-filed (including extensions) federal income tax return for the taxable
year that includes the date of the transfer.
Treas. Reg. Sec. 1.6038B-1(b)(2)(i).
A U.S. person that transfers cash to a foreign corporation must report the transfer
if:
1. Immediately after the transfer such person holds directly,
indirectly, or by attribution (determined under the rules of Sec. 318(a), as modified by
Sec. 6038(e)(2)) at least 10% of the total voting power or the total value of the foreign
corporation; or
2. The amount of cash transferred by such person or any related
person (determined under Sec. 267(b)(1) through (3) and (10) through (12)) to such
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foreign corporation during the 12-month period ending on the date of the transfer exceeds
$100,000.
Treas. Reg. Sec. 1.6038B-1(b)(3)
B. Time and Manner of Reporting
Any U.S. person that makes a transfer described in Sec. 6038B(a)(1)(A), 367(d)
or 367(e)(1), is required to report and must attach the required information to Form 926,
"Return by Transferor of Property to a Foreign Corporation." Notwithstanding any
statement to the contrary on Form 926, the form and attachments must be attached to, and
filed by the due date (including extensions) of, the transferor's federal income tax return
for the taxable year that includes the date of the transfer. If the transferor is a
corporation, Form 926 must be signed by an authorized officer of the corporation. If,
however, the transferor is a member of an affiliated group that files a consolidated federal
income tax return, but is not the common parent corporation, then an authorized officer of
the common parent corporation must sign Form 926. If two or more persons transfer
jointly-owned property to a foreign corporation, then each person must report with
respect to the particular interest transferred, specifying the nature and extent of the
interest. However, a husband and wife who file a joint federal income tax return may file
a single Form 926 with their joint return. Treas. Reg. Sec. 1.6038B-1(b)(1).
The date of a transfer is the first date on which title to, possession of, or rights to
the use of stock, securities, or other property passes pursuant to the plan for purposes of
Subtitle A of the Code. A transfer deemed to occur as a result of the termination of an
election under Sec. 1504(d) is considered to occur on the date the contiguous country
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corporation first fails to continue to qualify for the election. A transfer deemed to occur
as a result of a change in the classification of an entity caused by a change in its
governing documents, articles, or agreements (as described in Treas. Reg. Sec. 1.367(a)-
1T(c)(6)) is considered to occur on the date that such changes take effect for purposes of
Subtitle A of the Code. A transfer made by an alien individual who is considered a U.S.
resident by reason of a timely election under Sec. 6013 (g) or (h) is considered to occur
for purposes of Sec. 6038B, but not for purposes of Sec. 367, on the later of the date on
which the election under Sec. 6013 (g) or (h) is made, or the date on which the transfer
would otherwise be considered to occur under the foregoing rules. Treas. Reg. Sec.
1.6038B-1(b)(4).
C. Information Required for Section 6038B(a)(1)(A) Transfers
A U.S. person that transfers property to a foreign corporation in an exchange
described in Sec. 6038B(a)(1)(A), including cash and unappreciated property, must
provide the following information, in paragraphs labeled to correspond with the number
or letter set forth in the Regulation. If a particular item is not applicable to the transfer,
the U.S. person must list its heading and state that it is not applicable.
1. Transferor. The name, U.S. taxpayer identification number, and
address of the U.S. person making the transfer.
2. Transfer. The following information concerning the transfer:
a. The name, U.S. taxpayer identification number (if any),
address, and country of incorporation of the transferee foreign corporation; and
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b . A general description of the transfer, and any wider
transaction of which it forms a part, including a chronology of the transfers involved and
an identification of the other parties to the transaction to the extent known.
3 . Consideration received. A description of the consideration
received by the U.S. person making the transfer, including its estimated fair market value
and, in the case of stock or securities, the class or type, amount, and characteristics of the
interest received.
4. Property transferred. A description of the property transferred.
The description must be divided into the following categories, and must include the
estimated fair market value and adjusted basis of the property, as well as any additional
information specified below.
5. Active business property. Describe any transferred property (other
than stock or securities) to be used in the active conduct of a trade or business outside of
the United States. Provide a general description of the business conducted (or to be
conducted) by the transferee, including the location of the business, the number of its
employees, the nature of the business, and copies of the most recently prepared balance
sheet and profit and loss statement. Property listed within this category may be identified
by general type.
6. Stock or securities. Describe any transferred stock or securities,
including the class or type, amount, and characteristics of the transferred stock or
securities, as well as the name, address, place of incorporation, and general description of
the corporation issuing the stock. In addition, provide the following information if
applicable:
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If the stock or securities are considered to be transferred for use in the active conduct of a
trade or business outside of the United States under the rules of Temp. Treas. Reg. Sec.
1.367(a)-3T(d)(2), provide information supporting the application of the rule; and
If any provision of Treas. Reg. Sec. 1.367(a)-3 applies to except the transfer of stock or
securities from the rule of Sec. 367(a)(1), provide information supporting the claimed
application of such provision. If the transferor is entering into a gain recognition
agreement, attach the agreement and waiver as required by Treas. Reg. Sec. 1.367(a)-8.
7. Depreciated property. Describe any property that is subject to
depreciation recapture under the rules of Temp. Treas. Reg. Sec. 1.367(a)-4T(b). Property
within this category must be separately identified to the same extent as was required for
purposes of the previously claimed depreciation deduction. Specify with respect to each
asset the relevant recapture provision, the number of months in which such property was
in use within the United States, the total number of months the property was in use, the
fair market value of the property, a schedule of the depreciation deduction taken with
respect to the property, and a calculation of the amount of depreciation required to be
recaptured.
8. Property to be leased. Describe any property to be leased to other
persons by the transferee foreign corporation unless the property is considered to be
transferred for use in the active conduct of a trade or business and was thus listed under
item 1 above. If the rules of Temp. Treas. Reg. Sec. 1.367(a)-4T(c)(2) apply to except
the transfer from Sec. 367(a)(1), provide information supporting the claimed application
of such provision.
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9. Property to be sold. Describe any transferred property that is to be
sold or otherwise disposed of by the transferee foreign corporation, as described in Temp.
Treas. Reg. Sec. 1.367(a)-4T(d).
10. Transfers to FSCs. Describe any property that is subject to the
special rule of Temp. Treas. Reg. Sec. 1.367(a)-4T(g) for transfers to FSCs. Provide
information supporting the claimed application of that rule.
11. Tainted property. Describe any property that is subject to Temp.
Treas. Reg. Sec. 1.367(a)-5T (concerning property that is subject to the rule of Sec.
367(a)(1) regardless of whether it is transferred for use in the active conduct of a trade or
business outside of the United States). The description must be divided into the
following categories:
12. Inventory, etc. Property described in Temp. Treas. Reg. Sec.
1.367(a)-5T(b);
13. Installment obligations, etc. Property described in Temp. Treas.
Reg. Sec. 1.367(a)-5T(c);
14. Foreign currency, etc. Property described in Temp. Treas. Reg.
Sec. 1.367(a)-5T(d);
15. Intangible property. Property described in Temp. Treas. Reg. Sec.
1.367(a)-5T(e); and
16. Leased property. Property described in Temp. Treas. Reg. Sec.
1.367(a)-4T(f).
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If any exception in Temp. Treas. Reg. Sec. 1.367(a)-5T applies to the transferred
property (making Sec. 367(a)(1) not applicable to the transfer), provide information
supporting the claimed application of such exception.
17. Foreign loss branch. Provide the information specified in item 5
below.
18. Other intangibles. Describe any intangible property sold or
licensed by the transferor to the transferee foreign corporation, and set forth the general
terms of each sale or license.
19. Transfer of foreign branch with previously deducted losses. If the
property transferred is property of a foreign branch with previously deducted losses
subject to Temp. Treas. Reg. Sec. 1.367(a)-6T, provide the following information:
20. Branch operation. Describe the foreign branch the property of
which is transferred, in accordance with the definition of Temp. Treas. Reg. Sec.
1.367(a)-6T(g).
21. Branch property. Describe the property of the foreign branch,
including its adjusted basis and fair market value. For this purpose property must be
identified with reasonable particularity, but may be identified by category rather than
listing every asset separately. Substantially similar property may be listed together for
this purpose, and property of minor value may be grouped into functional categories.
22. Previously deducted losses. Set forth a detailed calculation of the
sum of the losses incurred by the foreign branch before the transfer, and a detailed
calculation of any reduction of such losses, in accordance with Temp. Treas. Reg. Sec.
1.367(a)-6T(d) and (e).
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23. Character of gain. Set forth a statement of the character of the gain
required to be recognized, in accordance with Temp. Treas. Reg. Sec. 1.367(a)-6T(c)(1).
24. Application of Sec. 367(a)(5). If the asset is transferred in an
exchange described in Sec. 361(a) or (b), a statement that the conditions set forth in the
second sentence of Sec. 367(a)(5) and any Regulations under that Sec. have been
satisfied, and an explanation of any basis or other adjustments made pursuant to Sec.
367(a)(5) and any Regulations thereunder. Temp Treas. Reg. Sec. 1.6038B-IT(c); Treas.
Reg. Sec. 1.6038B-1(c).
D. Failure to Comply with Reporting Requirements
If a U.S. person is required to file a notice or otherwise comply with the
requirements of Sec. 6038B and fails to do so, then with respect to the particular property
as to which there was a failure to comply:
a. That property will not be considered to have been
transferred for use in the active conduct of a trade or business outside of the United States
for purposes of Sec. 367(a) and the Regulations thereunder;
b. The U.S. person must pay a penalty under Sec. 6038B(b)(1)
equal to 10% of the fair market value of the transferred property at the time of the
exchange, but in no event will the penalty exceed $100,000 unless the failure was due to
intentional disregard; and
c. The period of limitations on assessment of tax on the
transfer of that property will not expire before three years after the date on which the
Secretary of the Treasury is furnished the information required to be reported.
Treas. Reg. Sec. 1.6038B-1(f)(1).
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A failure to comply with the requirements of Sec. 6038B is:
a. The failure to report at the proper time and in the proper
manner any material information required to be reported; or
b . The provision of false or inaccurate information in
purported compliance with the requirements of this section.
Treas. Reg. Sec. 1.6038B-1(f)(2).
The foregoing provisions will not apply if the transferor shows that its failure to
comply was due to reasonable cause and not willful neglect. The transferor may do so by
providing a written statement to the District Director having jurisdiction of the taxpayer's
return for the year of the transfer, setting forth the reasons for the failure to comply.
Whether a failure to comply was due to reasonable cause will be determined by the
District Director under all the facts and circumstances. Treas. Reg. Sec. 1.6038B-1(f)(3).
If the transferor fails to qualify for the reasonable cause exception, and if the transferors
knew of the rule or Regulation that was disregarded, the failure will be considered an
intentional disregard of Sec. 6038B, and the monetary penalty described above will not
be limited to $100,000. Treas. Reg. Sec. 1.6038B-1(f)(4).
E. General Reporting and Recordkeeping Requirements
1. Section 332 (Treas. Reg. Sec. 1.332-6)
Permanent records in substantial form must be kept by every corporation
receiving distributions in complete liquidation under the exception in Sec. 332 showing
the information required to be submitted with its return. The plan of liquidation must be
adopted by each of the corporate parties thereto; and the adoption must be shown by the
acts of its duly constituted responsible officers, and appear upon the official records of
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each corporation. For the taxable year in which the liquidation occurs, or, if the plan of
liquidation provides for a series of distributions over a period of more than one year, for
each taxable year in which a distribution is received under the plan, the recipient must file
with its return a complete statement of all facts pertinent to the nonrecognition of gain or
loss, including:
a. A certified copy of the plan of complete liquidation, and of
the resolutions under which the plan was adopted and the liquidation was authorized,
together with a statement under oath showing in detail all transactions incident to, or
pursuant to, the plan.
b. A list of all the properties received upon the distribution,
showing the cost or other basis of such properties to the liquidating corporation at the
date of distribution and the fair market value of such properties on the date distributed.
c. A statement of any indebtedness of the liquidating
corporation to the recipient corporation on the date the plan of liquidation was adopted
and on the date of the first liquidating distribution. If any such indebtedness was acquired
at less than face value, the cost thereof to the recipient corporation must also be shown.
d. A statement as to its ownership of all classes of stock of the
liquidating corporation (showing as to each class the number of shares and percentage
owned and the voting power of each share) as of the date of the adoption of the plan of
liquidation, and at all times since, to and including the date of the distribution in
liquidation. The cost or other basis of such stock and the date or dates on which
purchased must also be shown.
2. Section 351 (Treas. Reg. Sec. 1.351-3)
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Every person who receives the stock or securities of a controlled corporation, or
other property as part of the consideration, in exchange for property under Sec. 351, must
file with its income tax return for the taxable year in which the exchange is consummated
a complete statement of all facts pertinent to such exchange, including:
a. A description of the property transferred, or its interest in
the property, together with a statement of the cost or other basis thereof, adjusted to the
date of transfer.
b. With respect to stock of the controlled corporation received
in the exchange, a statement of:
The kind of stock and preferences, if any;
The number of shares of each class received; and
The fair market value per share of each class at the date of the exchange.
c. With respect to securities of the controlled corporation
received in the exchange, if any, a statement of:
The principal amount and terms; and
The fair market value at the date of exchange.
d. The amount of money received, if any.
e. With respect to other property received, if any:
A complete description of each separate item;
The fair market value of each separate item at the date of exchanges; and
In the case of a corporate shareholder, the adjusted basis of the other property in the
hands of the controlled corporation immediately before the distribution of such other
property to the corporate shareholder in connection with the exchange.
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f. With respect to any liabilities of the transferors assumed by
the controlled corporation, a statement of:
The nature of the liabilities;
When and under what circumstances created;
The corporate business reason for assumption by the controlled corporation; and
Whether such assumption eliminates the transferor's primary liability.
Every such controlled corporation must file with its income tax return for the
taxable year in which the exchange is consummated:
a. A complete description of all the property received from
the transferors.
b. A statement of the cost or other basis thereof in the hands
of the transferors adjusted to the date of transfer.
c. The following information with respect to the capital stock
of the controlled corporation:
(A) The total issued and outstanding capital stock immediately prior to and immediately
after the exchange, with a complete description of each class of stock;
(B) The classes of stock and number of shares issued to each transferor in the exchange,
and the number of shares of each class of stock owned by each transferor immediately prior
to and immediately after the exchange, and
(C) The fair market value of the capital stock as of the date of exchange, which was
issued to each transferor.
d. The following information with respect to any securities of
the controlled corporation:
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(A) The principal amount and terms of all securities outstanding immediately prior to
and immediately after the exchange,
(B) The principal amount and terms of securities issued to each transferor in the
exchange, with a statement showing each transferor's holdings of securities of the
controlled corporation immediately prior to and immediately after the exchange,
(C) The fair market value of the securities issued to the transferors on the date of the
exchange, and
(D) A statement as to whether the securities issued in the exchange are subordinated in
any way to other claims against the controlled corporation.
e. The amount of money, if any, which passed to each of the
transferors in connection with the transaction.
f. With respect to any other property which passed to each
transferor:
(A) A complete description of each separate item;
(B) The fair market value of each separate item at the date of exchange, and
(C) In the case of a corporate transferor, the adjusted basis of each separate item in the
hands of the controlled corporation immediately before the distribution of such other
property to the corporate transferor in connection with the exchange.
g. The following information as to the transferor's liabilities
assumed by the controlled corporation in the exchange, if any:
(A) The amount and a description thereof,
(B) When and under what circumstances created, and
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(C) The corporate business reason or reasons for assumption by the controlled
corporation.
Permanent records in substantial form must be kept by every taxpayer who
participates in an exchange described in Sec. 351, showing the information listed above,
to facilitate the determination of gain or loss from a subsequent disposition of stock or
securities and other property, if any, received in the exchange.
3. Section 355 (Treas. Reg. Sec. 1.355-5)
Every corporation that makes a distribution of stock or securities of a controlled
corporation, as described in Sec. 355, must attach to its return for the year of the
distribution a detailed statement setting forth such data as may be appropriate to show
compliance with the provisions of Sec. 355. Every taxpayer who receives a distribution
of stock or securities of a corporation that was controlled by a corporation in which it
holds stock or securities must attach to its return for the year in which such distribution is
received a detailed statement setting forth such data as may be appropriate in order to
show the applicability of Sec. 355. Such statement must include, but is not be limited to,
a description of the stock and securities surrendered (if any) and received, and the names
and addresses of all of the corporations involved in the transaction.
4. Section 368 (Treas. Reg. Sec. 1.368-3)
The plan of reorganization must be adopted by each of the corporate parties
thereto, and the adoption must be shown by the acts of its duly constituted responsible
officers, and appear upon the official records of the corporation. Each corporation a party
to a reorganization must file as a part of its return for its taxable year in which the
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reorganization occurred a complete statement of all facts pertinent to the nonrecognition
of gain or loss in connection with the reorganization, including:
a. A copy of the plan of reorganization, together with a
statement, executed under the penalties of perjury, showing in full the purposes thereof
and in detail all transactions incident to, or pursuant to, the plan.
b. A complete statement of the cost or other basis of all
property, including all stock or securities, transferred incident to the plan.
c. A statement of the amount of stock or securities and other
property or money received from the exchange, including a statement of all distributions
or other disposition made thereof. The amount of each kind of stock or securities and
other property received must be stated on the basis of the fair market value thereof at the
date of the exchange.
d. A statement of the amount and nature of any liabilities
assumed upon the exchange, and the amount and nature of any liabilities to which any of
the property acquired in the exchange is subject.
Every taxpayer, other than a corporation a party to the reorganization, who
receives stock or securities and other property or money on a tax-free exchange in
connection with a corporate reorganization must incorporate in its income tax return for
the taxable year in which the exchange takes place a complete statement of all facts
pertinent to the nonrecognition of gain or loss, including:
a. A statement of the cost or other basis of the stock or
securities transferred in the exchange, and
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b. A statement in full of the amount of stock or securities and
other property or money received in the exchange, including any liabilities assumed on
the exchange, and any liabilities to which property received is subject. The amount of
each kind of stock or securities and other property (other than liabilities assumed upon
the exchange) received must be set forth upon the basis of the fair market value thereof at
the date of the exchange.
Permanent records in substantial form must be kept by every taxpayer who
participates in a tax-free exchange in connection with a corporate reorganization showing
the cost or other basis of the transferred property and the amount of stock or securities
and other property or money received (including any liabilities assumed on the exchange,
or any liabilities to which any of the properties received were subject), to facilitate the
determination of gain or loss from a subsequent disposition of such stock or securities
and other property received from the exchange.
IV. PROPOSED BASIS AND HOLDING PERIOD RULES
Prop. Treas. Reg. Sec. 1.367(b)-13 sets forth detailed basis and holding period
rules ("BAHP rules") designed to preserve the Sec. 1248 amount in connection with
certain tax-free transactions involving foreign corporations. These rules generally apply
if an exchanging shareholder of stock of a foreign corporation is either (i) a Sec. 1248
Shareholder with respect to the foreign corporation or (ii) a foreign corporation that has a
Sec. 1248 Shareholder that is also a Sec. 1248 Shareholder with respect to the foreign
corporation whose shares are exchanged. An exchanging shareholder that falls within
either category is referred to herein as a "Section 367(b) Shareholder."
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As noted in the preamble to the proposed regulations, the latter category is needed
to preserve the application of Sec. 964(e). Sec. 964(e) treats a CFC's gain from the sale
or exchange of shares of another foreign corporation as a dividend to the extent that such
amount would have been so treated under Sec. 1248(a) if the CFC were a U.S. person.
B. Shareholder's Exchange of Foreign Target Stock for CFC Stock
1. Scope
Prop. Treas. Reg. Sec. 1.367(b)-13(b) generally applies to any shareholder who
exchanges stock of a foreign corporation (target) for stock of a CFC in an exchange to
which Sec. 354 (or Sec. 356) applies if:
a. Immediately before the exchange, the exchanging
shareholder was a Sec. 367(b) Shareholder with respect to the foreign target;
b . The exchange is not taxable under Treas. Reg. Sec.
1.367(b)-4(b).
Notwithstanding the foregoing, however, Prop. Treas. Reg. Sec. 1.367(b)-13(b)
does not apply to any exchange that is described in both Sec. 351 and Sec. 354 (or Sec.
356) if, in connection with the exchange, the shareholder exchanges property for stock in
an exchange to which neither Sec. 354 nor Sec. 356 applies or any liabilities of the
exchanging shareholder are assumed in the exchange. Prop. Treas. Reg. Sec. 1.367(b)-
13(b)(4). As explained in the preamble to the proposed regulations, the purpose of this
limitation is to avoid a conflict with the basis rules applicable to Sec. 351 exchanges
(including the application of Sec. 357(c)). Treasury and the IRS are considering
approaches for the preservation of the Sec. 1248 amount in Sec. 351 exchanges in which
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liabilities are assumed or other property is received and the preamble requests comments
in this regard.
In the case of a triangular reorganization, Prop. Treas. Reg. Sec. 1.367(b)-13(b)
applies only to the shareholder's exchange of target stock for stock of the parent of the
surviving corporation. The parent corporation's basis and holding period for each share
of stock of the surviving corporation is determined under Prop. Treas. Reg. Sec. 1.367(b)-
13(c), discussed below.
2. BAHP Rules
If Prop. Treas. Reg. Sec. 1.367(b)-13(b) applies, then the basis and holding period
of each share of stock received in the exchange will be the same as the basis and holding
period of the share(s) exchanged therefor, as adjusted under Treas. Reg. Sec. 1.358-1, so
that the Sec. 1248 amount in the shares exchanged will be preserved in the shares
received. Prop. Treas. Reg. Sec. 1.367(b)-13(b)(2)(i).
Each share received will also reflect the target corporation's previously
accumulated earnings and profits (or deficits in earnings and profits), as determined for
purposes of Sec. 1248 (referred to below simply as "E&P" or "E&P deficits") to the
extent allocable to the share(s) exchanged. Prop. Treas. Reg. Sec. 1.367(b)-13(d)(2).
Thus, for example, if an exchanging Sec. 367(b) Shareholder owns two blocks of stock of
the target, the shares received in the exchange will be divided into two blocks that reflect
the bases, holding periods and E&P of the target shares exchanged therefor. See Prop.
Treas. Reg. Sec. 1.367(b)-13(e), Ex. 1.
If the exchanging Sec. 367(b) Shareholder subsequently disposes of any shares
received in the exchange, and is not otherwise able to identify which shares were
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received for particular shares surrendered in the exchange, the shareholder may designate
which shares were received for which surrendered shares, provided that such designation
is made on or before the first date on which the basis of such shares is relevant (e.g., on
or before the date of the disposition). Prop. Treas. Reg. Sec. 1.367(b)-13(b)(2)(ii).
C. P's Stock of S or T Following A Triangular Asset Reorganization
Prop. Treas. Reg. Sec. 1.367(b)-13(c) sets forth BAHP rules applicable to the
parent corporation's stock of the surviving corporation following a triangular asset
reorganization, i.e., a triangular C reorganization, forward triangular merger or reverse
triangular merger. These rules purport to apply to all "triangular reorganizations" but that
term is defined (misleadingly) to exclude triangular B reorganizations. See Prop. Treas.
Reg. Sec. 1.367(b)-13(a)(2)(iii).
1. Terminology: P, S and T
In the case of a triangular asset reorganization, the terms P, S and T are defined as
follows:
a. P is a corporation (i) that is party to the reorganization, (ii)
that is in control of another party to the reorganization, and (iii) whose stock is
transferred pursuant to the reorganization.
b. S is a corporation that is party to the reorganization and that
is controlled by P.
c. T is the other corporation that is party to the reorganization.
Prop. Treas. Reg. Sec. 1.367(b)-13(a)(2)(iii).
2. Scope
a. Certain Reverse Triangular Mergers
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The rules of Prop. Treas. Reg. Sec. 1.367(b)-13(c) apply to a reverse triangular
merger if:
(A) Immediately before the transaction, P was a Sec. 367(b) Shareholder with respect to
S; and
(B) P's exchange of S stock is not taxable under Treas. Reg. Sec. 1.367(b)-3(a) and (b)
or Sec. 1.367(b)-4(b).
b. Other Triangular Asset Reorganizations
The rules of Prop. Treas. Reg. Sec. 1.367(b)-13(c) also apply to any other
triangular asset reorganization (whether or not a reverse triangular merger) if:
(A) Immediately before the transaction, T had at least one Sec. 367(b) Shareholder; and
(B) With respect to at least one Sec. 367(b) Shareholder of T, the exchange is not
taxable under Treas. Reg. Sec. 1.367(b)-3(a) and (b) or Sec. 1.367(b)-4(b).
3. BAHP Rules
a. General Rule
Under the BAHP rules for triangular asset reorganizations, each share of stock of
the surviving corporation (S or T) held by P must be divided into "portions" attributable
to the S and T shares held immediately before the exchange. Prop. Treas. Reg. Sec.
1.367(b)-13(c)(2). The manner in which such shares are divided into portions depends on
the type of reorganization.
b. Forward Subsidiary Merger or Triangular C Reorganization
In a forward subsidiary merger or a triangular C reorganization, each share of S
stock owned by P after the exchange generally will be divided into:
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(A) one portion that reflects the basis, holding period and E&P of such share prior to the
reorganization, and
(B) one portion for each block of T stock surrendered by the former T shareholders
pursuant to the reorganization, with each such portion reflecting the former T shareholder's
basis, holding period and E&P in the T stock allocable thereto, provided that immediately
prior to the merger T had at least one Sec. 367(b) Shareholder. See Prop. Treas. Reg. Sec.
1.367(b)-13(c)(2)(i)(A) and (ii)(A); see also Prop. Treas. Reg. Sec. 1.367(b)-13(d)(2). For
this purpose, however, all shares of T stock exchanged by non-Sec. 367(b) Shareholders of
T are aggregated. Prop. Treas. Reg. Sec. 1.367(b)-13(d)(1)(i). If, immediately prior to the
reorganization, T had no Sec. 367(b) Shareholders, then the basis of the portion attributable
to the T stock surrendered by the former T shareholders is determined under the "over-the-
top" basis rules of Treas. Reg. Sec. 1.358-6(c). Prop. Treas. Reg. Sec. 1.367(b)-
13(c)(2)(ii)(B).
Note: The proposed regulations divide the "apportioning" process into two steps.
In the first step, each post-reorganization S share is divided into an "S portion" and a "T
portion." In the second step, if there is more than one block of T stock to be taken into
account, the T portion is then subdivided into additional portions. These steps are
combined in the discussion above.
c. Reverse Subsidiary Merger
In the case of a reverse subsidiary merger, each T share received by P generally
will be divided into:
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(A) one portion for each block of S stock surrendered by P in the merger, with each
such portion reflecting P's basis, holding period and E&P in the S stock allocable thereto,
and
(B) one portion for each block of T stock surrendered by the former T shareholders in
the merger, with each such portion reflecting the former T shareholder's basis, holding
period and E&P in the T stock allocable thereto, provided that immediately prior to the
merger T had at least one Sec. 367(b) Shareholder. Prop. Treas. Reg. Sec. 1.367(b)-
13(c)(2)(i)(B) and (ii)(A); see also Prop. Treas. Reg. Sec. 1.367(b)-13(d)(2). For this
purpose, however, shares of T stock exchanged by non-Sec. 367(b) Shareholders of T are
aggregated. Prop. Treas. Reg. Sec. 1.367(b)-13(d)(1)(i). If, immediately prior to the
merger, T had no Sec. 367(b) Shareholder, then the basis of the portion attributable to the T
stock surrendered by the former T shareholders in the merger is determined under the
"over-the-top" basis rules of Treas. Reg. Sec. 1.358-6(c). Prop. Treas. Reg. Sec. 1.367(b)-
13(c)(2)(ii)(B).
Note: The proposed regulations divide the "apportioning" process into two steps.
In the first step, each post-reorganization T share is divided into an "S portion" and a "T
portion." In the second step, if there is more than one block of S or T stock to be taken
into account, the S or T portion (as the case may be) is further divided into separate
portions. These steps are combined in the discussion above.
d. De Minimis Rule
If the value of the S stock immediately before the reorganization is less than 1%
of the value of the surviving corporation immediately thereafter, then P may use a
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simplified method to determine the basis and holding period of its shares of the surviving
corporation. Under the simplified method:
(A) The rules above are first applied without treating any portion of the stock of the
surviving corporation as attributable to the S stock owned by P immediately before the
exchange, and
(B) P's basis in its S stock (as determined immediately before the exchange) is then
aggregated, and an allocable portion of such aggregate basis is added to the basis of each
share (or portion of a share) of stock of the surviving corporation. Prop. Treas. Reg. Sec.
1.367(b)-13(c)(2)(i)(C).
D. Examples
The proposed regulations include a number of examples illustrating the operation
of the BAHP rules. The examples below are drawn from (but are not identical to) the
examples in Prop. Treas. Reg. Sec. 1.367(b)-13(e).
Example 1. (i) Facts. US1, a domestic corporation, owns all the stock of
FT, a foreign corporation with 100 shares of stock outstanding. Each FT share is
valued at $10x. US1 owns a 60-share block of FT stock with a basis of $300x, a
holding period of 10 years, and $240x of E&P, and also a 40-share block of FT
stock with a basis of $600x, a holding period of 2 years, and $80x of E&P. US2, a
domestic corporation, owns all of the stock of FP, a foreign corporation, which
owns all of the stock of FS, a foreign corporation. FT merges into FS with FS
surviving in an A reorganization. Pursuant to the reorganization, US1 receives 50
shares of FS stock with a value of $1,000x for its 100 FT shares.
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(ii) Application of BAHP Rules. The BAHP rules of Prop. Treas. Reg.
Sec. 1.367(b)-13(b) apply to the FS shares received by US1 in the reorganization,
because US1 was a Sec. 367(b) Shareholder of FT before the exchange, US1
receives CFC shares in the exchange, and the exchange is not taxable under Treas.
Reg. Sec. 1.367(b)-4(b). Under those rules, 30 of the FS shares received by US1
in the reorganization are attributable to the 60-share block of FT stock exchanged
by US1 and therefore have a basis of $300x ($10x per share), a 10-year holding
period, and $240x of E&P ($8x per share). Similarly, 20 of the FS shares
received by US1 in the reorganization are allocable to the 40-share block of FT
stock exchanged by US1 and therefore have a basis of $600x ($30x per share), a
2-year holding period, and $80x of E&P ($4x per share).
Example 2. (i) Facts. The facts are the same as in Example 1, except that
the reorganization is a forward triangular merger and US1 receives 50 shares of
FP stock, instead of FS stock. Prior to the transaction, FP owned two blocks of
FS stock. Each block consisted of 10 shares with a value of $200x ($20x per
share). The shares in the first block had a basis of $50x ($5x per share), a holding
period of 10 years, and $50x ($5x per share) of E&P. The shares in the second
block had a basis of $100x ($10x per share), a five-year holding period, and $20x
($2x per share) of E&P.
(ii) Application of BAHP Rules. The application of the BAHP rules of
Prop. Treas. Reg. Sec. 1.367(b)-13(b) to the FS shares received by US1 is the
same as in Example 1. The BAHP rules of Prop. Treas. Reg. Sec. 1.367(b)-13(c)
apply to FP's FS shares, because FT had a Sec. 367(b) Shareholder before the
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exchange (US1) and US1's exchange of FT shares for FP shares in the
reorganization is not taxable under Treas. Reg. Sec. 1.367(b)-3(a) and (b) or Sec.
1.367(b)-4(b). Under those rules, each share of FS stock owned by FP includes
(A) a portion that reflects FP's basis and holding period in, and the E&P allocable
to, such FS share prior to the reorganization, i.e., with a basis of $5x, a value of
$20x, a 10-year holding period, and $5x of E&P for each FS share in the first
block, and a basis of $10x, a value of $20x, a holding period of 5 years, and $2x
of E&P for each FS share in the second block, (B) a portion that reflects US1's
basis and holding period in, and the E&P allocable to, the 60-share block of FT
stock exchanged in the reorganization, i.e., with a basis of $15x ($300x / 20 FS
shares), a value of $30x ($600x / 20 FS shares), a holding period of 10 years, and
$12x of E&P ($240x / 20 FS shares), and (C) a portion that reflects US1's basis
and holding period in, and the E&P allocable to, the 40-share block of FT stock
exchanged in the reorganization, i.e., with a basis of $30x ($600x / 20 FS shares),
a value of $20x ($400x / 20 FS shares), a holding period of 2 years, and $4x of
E&P ($80x / 20 FS shares).
(iii) Assume that, immediately after the reorganization, FP sells one FS
share from the first block for $70x. FP is treated as disposing of each divided
portion of such share, and the amount realized is allocated among the portions
based on the relative fair market values at the time such portions were created.
Prop. Treas. Reg. Sec. 1.367(b)-13(d)(1)(ii). Upon such disposition, FP
recognizes a gain of $15x ($20x value - $5x basis), $5x of which is treated as a
dividend under Sec. 1248, on the first portion; a gain of $15x ($30x value - $15x
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basis), $12x of which is treated as a dividend under Sec. 1248, on the second
portion; and a capital loss of $10x ($20x value - $30x basis) on the third portion.
Example 2A. (i) Facts. The facts are the same as in Example 2, except that
FS merges into FT with FT surviving in a reverse triangular merger. Pursuant to
the merger, US1 receives 50 shares of FP stock with a value of $1,000x in
exchange for its two blocks of FT stock, and FP receives 10 shares of FT stock
with a value of $1,400x in exchange for its two blocks of FS stock. Immediately
after the exchange, US1 is a Sec. 1248 Shareholder of FP and FT.
(ii) BAHP Rules.
(A) The basis and holding period of the FP shares received by US1 and the
stock of the surviving corporation held by FP are the same as in Example 2,
except that each share of the surviving corporation (FT, instead of FS) will be
divided into four portions instead of three portions. Each FT share received by FP
in the exchange will include (in addition to the two portions reflecting the basis,
holding period and E&P of the two blocks of FT shares surrendered by US1) one
portion (reflecting basis, holding period and E&P) for each block of FS stock
exchanged by FP.
(B) The portion attributable to the first block of FS stock will have a basis
of $5x ($50x / 10 FT shares), a value of $20x ($200x / 10 FT shares), a 10-year
holding period, and $5x of E&P ($50x / 10 FT shares). The portion attributable to
the second block of FS stock will have a basis of $10x ($100x / 10 FT shares), a
value of $20x ($200x / 10 FT shares), a five-year holding period, and $2x of E&P
($20x / 10 FT shares). The portion attributable to the first block of FT stock
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exchanged by US1 will have a basis of $30x ($300x / 10 FT shares), a value of
$60x ($600x / 10 FT shares), a 10-year holding period, and $24x of E&P ($240x /
10 FT shares). The portion attributable to the second block of FT stock exchanged
by US1 will have a basis of $60x ($600x / 10 FT shares), a value of $40x ($400x /
10 FT shares), a 2-year holding period, and $8x of E&P ($80x / 10 FT shares).
Example 3. (i) Facts. USP, a domestic corporation, owns all the stock of
FS, a foreign corporation with 10 shares of stock outstanding. Each share of FS
stock has a value of $10x, a basis of $5x, a holding period of 10 years, and $7x of
E&P. FP, a foreign corporation, owns all the stock of FT, another foreign
corporation. Neither FP nor FT has any Sec. 1248 Shareholders. FT's assets have
a value of $100x, a basis of $50x, and no liabilities. FP's FT shares have a value
of $100x and a basis of $75x. FT merges into FS with FS surviving in a forward
triangular merger. Pursuant to the reorganization, FP receives USP stock with a
value of $100x in exchange for its FT stock.
(ii) Application of BAHP Rules.
(A) As written, Prop. Treas. Reg. Sec. 1.367(b)-13(c) does not apply,
because the transaction is not a reverse triangular merger and T had no Sec.
367(b) Shareholders immediately before the exchange. See Prop. Treas. Reg.
Sec. 1.367(b)-13(c)(1). This clearly was an oversight, however, and it is apparent
from Example 3 (and informal discussions with the drafter of the proposed
regulations) that Treasury and the IRS intended Prop. Treas. Reg. Sec. 1.367(b)-
13(c) to apply. This glitch likely will be remedied when the proposed regulations
are finalized. Such amendment is assumed for purposes of the discussion below.
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(B) Each share of FS stock is divided into (i) a portion that reflects the
basis and holding period of, and the E&P allocable to, such FS share immediately
before the exchange, i.e., a basis of $5x, a value of $10x, a 10-year holding
period, and $7x of E&P and (ii) a portion that reflects the basis of FT's net assets
immediately before the exchange, i.e., a basis of $5x ($50x / 10 FS shares) and a
value of $10x. The basis of FT's net assets (and not FP's basis in the FT stock) is
used (pursuant to the "over-the-top" basis rules of Treas. Reg. Sec. 1.358-6(c))
because FT did not have a Sec. 367(b) Shareholder immediately before the
transaction. No E&P is attributed to the second portion. Consequently, if USP
sells one FS share for $20x immediately after the reorganization, USP recognizes
$5x of gain ($10x value - $5x basis) on the first portion, all of which is treated as
a dividend under Sec. 1248, and $5x of gain ($10x value - $5x basis) on the
second portion, none of which is treated as a dividend under Sec. 1248 (because
no E&P is allocable thereto).
Example 4. (i) Facts. US, a domestic corporation, owns all of the stock of
FT, a foreign corporation. The FT stock constitutes a single block of stock with a
value of $1,000x, a basis of $600x, and holding period of 5 years. USP, a
domestic corporation, forms FS, a foreign corporation, pursuant to the plan of
reorganization and capitalizes it with $10x of cash. FS merges into FT with FT
surviving in a reverse triangular merger (which is also a B reorganization).
Pursuant to the reorganization, US receives USP stock with a value of $1,000x in
exchange for its FT stock, and USP receives 10 shares of FT stock with a value of
$1,010x in exchange for its FS stock.
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(ii) Application of BAHP Rules.
(A) The BAHP rules of Prop. Treas. Reg. Sec. 1.367(b)-13(c) apply to
USP's FS shares because (i) the reorganization is a reverse triangular merger, (ii)
USP was a Sec. 367(b) Shareholder of FS immediately before the merger, and
(iii) USP's exchange of FS stock for FT stock is not taxable under Treas. Reg.
Sec. 1.367(b)-3(a) and (b) or Sec. 1.367(b)-4(b). Alternatively, the BAHP rules
of Prop. Treas. Reg. Sec. 1.367(b)-13(c) would apply because (i) US was a Sec.
367(b) Shareholder of FT immediately before the merger, and (ii) US's exchange
of FT stock for USP stock is not taxable under Treas. Reg. Sec. 1.367(b)-3(a) and
(b) or Sec. 1.367(b)-4(b).
(B) Pursuant to Prop. Treas. Reg. Sec. 1.367(b)-13(c), because FT had a
Sec. 367(b) Shareholder immediately prior to the merger (US), each FT share
received by USP must include one portion that corresponds to the FT stock
surrendered in the merger, i.e., with a basis of $60x ($600x / 10 FT shares), a
value of $100x ($1,000x / 10 FT shares), and a five-year holding period.
(C) Because the value of the FS stock immediately before the exchange
($10x) is less than 1% of value of the FT stock immediately after the exchange
($1,010x), the de minimis rule applies. Thus, USP may determine its basis in
each share of FT stock by (i) first applying the BAHP rules of Prop. Treas. Reg.
Sec. 1.367(b)-13(c) without treating any portion of such share as attributable to
the FS stock owned by USP immediately before the exchange and (ii) increasing
the basis of each FT share (or portion of an FT share) by a proportionate amount
of USP's aggregate basis in its FS shares (as determined immediately before the
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exchange). If USP chooses to use this method, its basis in each FT share will
equal $60x (as determined above) plus $1x ($10x / 10 FT shares) for a total basis
of $61x and a total value of $101x. The entire share will have a five year holding
period.
(D) Although not stated in the example in the proposed regulations, the
BAHP rules of Prop. Treas. Reg. Sec. 1.367(b)-13(b) do not apply to US's
exchange of FT shares for USP shares. Those rules only apply to an exchanging
shareholder who receives shares of a CFC in exchange for shares of a foreign
target corporation.
Example 5. (i) Facts. US, a domestic corporation, owns all of the stock of
FT, a foreign corporation. The FT stock held by US constitutes one block of stock
with a basis of $170x, a value of $200x, a holding period of 5 years, and $10x of
E&P. FP, a foreign corporation, owns all the stock of FS, a foreign corporation.
FS has 10 shares of stock outstanding. No U.S. person is a Sec. 1248 Shareholder
of FP or FS. The FS stock held by FP has a basis of $50x ($5x per share) and a
value of $100x ($10x per share). FT merges into FS with FS surviving in a
forward triangular merger. Pursuant to the merger, US receives 20 shares of FP
stock with a value of $200x for its FT stock in an exchange that qualifies for
nonrecognition under Sec. 354. Immediately after the exchange, FP is a CFC and
US is a Sec. 1248 Shareholder of both FP and FS.
(ii) Application of BAHP Rules.
(A) The BAHP rules of Prop. Treas. Reg. Sec. 1.367(b)-13(c) apply to
FP's stock of FS because (i) US was a Sec. 367(b) Shareholder of FT immediately
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before the merger, and (ii) US's exchange of FT stock for USP stock is not taxable
under Prop. Treas. Reg. Sec. 1.367(b)-3(a) and (b) or Sec. 1.367(b)-4(b).
(B) Under the BAHP rules, each share of FS is divided into (i) an "FS
portion" that reflects the basis, holding period and E&P of the FS stock held by
FP immediately before the exchange i.e., a basis of $5x, a value of $10x, a five-
year holding period and $1x of E&P and (ii) an "FT portion" that reflects the
basis, holding period and E&P of the FT stock surrendered by US in the
exchange, i.e. a basis of $17x ($170x / 10 FS shares), a value of $20x ($200x / 10
FS shares) a five-year holding period and $1x of E&P ($10x / 10 FS shares).
(iii) Subsequent disposition.
(A) Several years after the merger, FP sells all of its FS stock in a
transaction governed by Sec. 964(e) for $210x (i.e., $21x per share), and FS has
incurred a post-merger E&P deficit of $30x (i.e., $3x per share). Note that the
value of the FS stock has declined by $90x since the merger.
(B) With respect to each share of FS, FP is treated as disposing of each
divided portion of the share, and the amount realized is allocated among the
portions based on the relative fair market values at the time such portions were
created. Prop. Treas. Reg. Sec. 1.367(b)-13(d)(1)(ii). At that time, each FS share,
which had a value of $30x, had an "FS portion" with a value of $10x, representing
one-third of the total share value, and an "FT portion" with a value of $20x,
representing two-thirds of the total share value. Accordingly, for each share, one-
third of the $21x amount realized (i.e., $7x) is allocated to the "FS portion" and
two-thirds (i.e., $14x) is allocated to the "FT portion". These ratios may
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alternatively be arrived at by comparing the value of the FS stock to the total
value of the FS and FT stock ($100x / $300x, i.e., one-third) and the value of the
FT stock to the total value of the FS and FT stock ($200x / $300x, i.e., two-thirds)
immediately prior to the reorganization.
(C) Pursuant to Prop. Treas. Reg. Sec. 1.367(b)-13(d)(3), any E&P (or
E&P deficit) accumulated by the surviving corporation, FS, after the
reorganization is attributed to the divided portions of shares of stock in proportion
to their relative fair market values (as of the time such portions were created).
Accordingly, for each FS share, one-third of the $3x-per-share post-merger E&P
deficit (i.e., $1x) is allocated to the "FS portion" and two-thirds (i.e., $2x) is
allocated to the "FT portion".
(D) When FP disposes of its FS stock, FP is treated as disposing of each
divided portion of each share. With respect to each "FS portion", FP recognizes a
gain of $2x ($7x value - $5x basis), which is not recharacterized as a dividend
under Sec. 1248 because the $1x of post-reorganization E&P deficit allocable to
such portion offsets the $1x of pre-merger E&P allocable to such portion. With
respect to each "FT portion", FP recognizes a loss of $3x ($14x value - $17x
basis).