Temporary regs curb abuses in triangular reorganizations involving foreign corporations
T.D. 9400, 05/23/2008, Reg. § 1.367(a)-3T, Reg. § 1.367(b)-14T, Preamble to Prop Reg 05/23/2008
IRS has issued temporary (along with final and proposed regs) under Code Sec. 367(b) to curb abusive triangular reorganizations involving foreign corporationssometimes referred to as “Killer B” transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48, and their text serves as the text of the proposed regs.
Statutory background. A U.S. person’s transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354, Code Sec. 356, or Code Sec. 361 exchanges, generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.
No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent’s stock provided by it to its subsidiaryunder a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent’s stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target’s stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent’s stock that it exchanges for the target’s stock in a reverse triangular merger. (Code Sec. 361)
A corporation’s distribution of property to its shareholder with respect to its stock is included in the shareholder’s gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation’s current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation’s stock, and any amount of the distribution in excess of the shareholder’s basis is treated as gain from the sale or exchange of the corporation’s stock. (Code Sec. 301(c)(2), Code Sec. 301(c))
Background on prior IRS notices. In Notice 2006-85, 2006-41 IRB 677, IRS announced that it would issue regs under Code Sec. 367(b) to curb abuses where triangular reorganizations involving foreign corporations had the effect of repatriating the subsidiary’s foreign earnings to the parent without a corresponding dividend to the parent that would be subject to U.S. income tax (see Federal Taxes Weekly Alert 09/28/2006). The regs would treat the transfer of property from the parent to the subsidiary as a distribution of property under Code Sec. 301(c). IRS later issued Notice 2007-48, 2007-25 IRB 1428, to amplify and broaden the reach of Notice 2006-85 to cover transactions where the subsidiary acquires stock of its parent from a person unrelated to its parent, such as from the public on the open market (see Federal Taxes Weekly Alert 06/07/2007).
IRS has now issue final, temporary and proposed regs under Code Sec. 367(b) to address these other transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48 , and their text serves as the text of the proposed regs. The final regs revise an existing final reg and add a cross-reference.
Temporary regs. IRS has issued temporary regs that apply to triangular reorganizations where P or S (or both) is foreign and, in connection with the reorganization, S acquires, in exchange for property, all or a portion of the P stock that is used to acquire T’s stock or assets. The “in connection with” standard is a broad standard that includes any transaction related to the reorganization even if the transaction is not part of the plan of reorganization. For example, the temporary regs apply to a triangular reorganization regardless of whether P controls S (under Code Sec. 368(c)) when S acquires the P stock that is used in the reorganization. (Reg. § 1.367(b)-14T(a)(1))
The temporary regs make adjustments for P and S that have the effect of a distribution of property from S to P under Code Sec. 301. The amount of the deemed distribution is equal to the amount of money plus the fair market value of other property that S used to acquire P stock. For this purpose, “property” has the meaning in Code Sec. 317(a) , but includes any liability assumed by S in exchange for the P stock (notwithstanding Code Sec. 357(a)) and any S stock used by S to acquire the P stock from a person other than P. To the extent S buys P stock from a person other than P, immediately after taking into account the deemed distribution to P, P is deemed to contribute to S the property deemed distributed to P. (Reg. § 1.367(b)-14T(b)(1))
The deemed distribution is treated as a transaction separate from, and occurring immediately before, the triangular reorganization. Thus, P is not be treated as receiving the property from S in exchange for P stock, and the transfer of P stock in the triangular reorganization is subject to the generally applicable provisions, e.g., Reg. § 1.1032-2. (Reg. § 1.367(b)-14T(b)(2)) The deemed distribution is treated as a distribution for all purposes of the Code. (Reg. § 1.367(b)-14T(c)(1)) Similarly, a deemed contribution of property is treated as a contribution of property for all purposes of the Code. For example, appropriate adjustments to P’s basis in the S stock and other affected items must be made according to applicable Code provisions. (Reg. § 1.367(b)-14T(c)(2))
Ordering rules generally require the deemed distribution and, in cases where S buys P stock from a person other than P, the deemed contribution to be taken into account before the transfers undertaken under the triangular reorganization. If P controls S (under Code Sec. 368(c)) at the time of the purchase, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately before the purchase. If P doesn’t control S (under Code Sec. 368(c) ) at the time that S purchases the P stock, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately after P acquires control of S. Thus, in a transaction where S purchases the P stock from a person other than P, after taking into account the adjustments made under these temporary regs, S’s purchase and transfer of P stock under the triangular reorganization are taken into account under generally applicable Code provisions, such as Code Sec. 304, Code Sec. 354, Code Sec. 356, Code Sec. 358, and Code Sec. 368. (Reg. § 1.367(b)-14T(b)(3))
Under the temporary regs, appropriate adjustments are made if in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of the regs. (Reg. § 1.367(b)-14T(d)) For example, if S is a newly formed corporation and, in connection with the reorganization, P contributes to S another corporation with positive earnings and profits (S2) to facilitate S’s purchase of the P stock or to facilitate the repayment of an obligation incurred by S to purchase the P stock, then, under the temporary regs, the earnings and profits of S may be deemed to include S2’s earnings and profits. (T.D. 9400, 05/23/2008)
Effective date. For rules addressing transactions described in Notice 2006-85, the temporary regs are generally applicable to transactions occurring on or after Sept. 22, 2006. For rules addressing transactions described in Notice 2007-48, the temporary regs are generally applicable to transactions occurring on or after May 31, 2007. Other reg rules are generally applicable to transactions occurring on or after May 23, 2008. Limited transition relief applies. (Reg. § 1.367(b)-14T(e))