REG-135866-02 |
July 3, 2006 |
Notice of Proposed Rulemaking
Section 1248 Attribution Principles
Internal Revenue Service (IRS), Treasury.
Notice of proposed rulemaking.
This document contains proposed regulations under section 1248 of the
Internal Revenue Code (Code) that provide guidance for determining the earnings
and profits attributable to stock of controlled foreign corporations (or former
controlled foreign corporations) that are (were) involved in certain nonrecognition
transactions. The proposed regulations are necessary in order to supplement
and clarify existing guidance in the regulations under section 1248. The
proposed regulations affect persons subject to the regulations under section
1248, as well as persons to which regulations under other Code provisions,
such as section 367(b), apply to the extent that those regulations incorporate
the principles of the proposed regulations. In addition, the proposed regulations
provide that with respect to the sale by a foreign partnership of the stock
of a corporation, the partners in such foreign partnership shall be treated
as selling or exchanging their proportionate share of the stock of such corporation
for purposes of section 1248.
Written or electronic comments and requests for a public hearing must
be received by August 30, 2006.
Send submissions to: CC:PA:LPD:PR (REG-135866-02), room 5203, Internal
Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044.
Submissions may be hand-delivered Monday through Friday between the hours
of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-135866-02), Courier’s Desk,
Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC or
sent electronically, via the IRS Internet site at www.irs.gov/regs or
via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-135866-02).
FOR FURTHER INFORMATION CONTACT:
Concerning the proposed regulations, Michael Gilman at (202) 622-3850
(not a toll-free number); concerning the submissions of comments and request
for hearing, Richard Hurst at Richard.A.Hurst@irscounsel.treas.gov (preferred)
or at (202) 622-7180 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Section 1248(a) of the Code provides that certain gain recognized on
the sale or exchange of stock of a foreign corporation by a United States
person will be included in the gross income of that person as a dividend if:
(1) the foreign corporation was a controlled foreign corporation at any time
during the five-year period ending on the date of the sale or exchange; and
(2) the United States person owned or is considered to have owned, within
the meaning of section 958, 10 percent or more of the total combined voting
power of the foreign corporation at any time during that five-year period
(section 1248 shareholder). The amount of gain included in income as a dividend
under section 1248(a) is limited to the earnings and profits attributable
to the stock that is sold or exchanged which were accumulated in taxable years
of the foreign corporation beginning after December 31, 1962, and during the
period or periods the stock was held by the United States person while the
foreign corporation was a controlled foreign corporation. A distribution
treated as an exchange of stock is also included. See §1.1248-1(b).
In addition, section 1248 may also apply to certain distributions of the
stock of a foreign corporation as provided under section 1248(f).
The section 1248 regulations provide for both a simple case method and
a complex case method for computing a controlled foreign corporation’s
earnings and profits attributable to stock disposed of in a transaction to
which section 1248 applies. See §§1.1248-2 and 1.1248-3. A taxpayer
may use the simple case method under §1.1248-2, which requires few adjustments
in the earnings and profits calculation under section 1248, if it meets several
criteria (e.g., the foreign corporation has only one
class of stock and a constant number of shares outstanding on each day of
each post-1962 taxable year which falls within the relevant holding period).
If these criteria are not satisfied, a taxpayer must use the complex case
method under §1.1248-3. The complex case method provides additional
rules to address situations involving multiple classes of stock, changes in
a shareholder’s ratable share of a corporation’s earnings and
profits, and other complicating factors.
Under §1.1248-1(a), the period of ownership of stock of a United
States person for purposes of attributing earnings and profits to that stock
includes the period that the United States person actually held the stock
or is considered to have held such stock pursuant to section 1223. Section
1223(1) provides that the period for which the taxpayer has held property
received in an exchange, shall include the period for which the taxpayer held
the property exchanged if the property received in the exchange has the same
basis in whole or in part in the taxpayer’s hands as the property exchanged.
Section 1223(2) provides that the period for which the taxpayer is considered
to have held property acquired shall include the period for which that property
was held by any other person if the property acquired has the same basis in
whole or in part in the taxpayer’s hands as it would have in the hands
of that other person.
Section 1248(c)(2) generally provides that, if the United States person
selling, exchanging, or distributing stock in a foreign corporation has the
required ownership interest in lower-tier foreign corporations, certain earnings
and profits of those lower-tier foreign corporations will be attributed to
stock of the foreign corporation that the U.S. person sells, exchanges, or
distributes. For this provision to apply, the United States person must have
owned or be considered to have owned, within the meaning of section 958, 10
percent or more of the total combined voting power of the lower-tier foreign
corporation at any time during the five-year period preceding the sale.
Although section 1248(a) applies only to sales or exchanges of stock
in a foreign corporation by a United States person, section 964(e) applies
section 1248 principles to certain dispositions of stock in a foreign corporation
by a controlled foreign corporation. Section 964(e)(1) provides that if a
controlled foreign corporation that owns stock in a foreign corporation sells
or exchanges such stock, gain recognized on such sale or exchange shall be
included in the gross income of such controlled foreign corporation as a dividend
to the same extent that it would have been included under section 1248(a)
if the controlled foreign corporation were a United States person.
Section 367(b) addresses certain exchanges described in sections 351,
354, 355, 356, and 361 that do not involve a transfer of property described
in section 367(a). One of the underlying policies of section 367(b) is the
preservation of the potential application of section 1248. See H.R. Rep.
No. 94-658, 94th Cong., 1st Sess., at 242 (November 12, 1975). Regulations
under section 367(b) require certain exchanging shareholders to include in
income as a deemed dividend the section 1248 amount attributable to stock
of a foreign corporation as a result of an acquisition by a foreign corporation
of the stock or assets of a foreign corporation in an exchange described in
section 351 or a reorganization described in section 368(a)(1). For example,
an exchanging shareholder must include the section 1248 amount attributable
to the stock exchanged in income if the exchange results in its loss of status
as a section 1248 shareholder. See §1.367(b)-4(b)(1). For this purpose,
the section 1248 amount generally is determined by reference to the amount
that would be included in income as a dividend under section 1248 and the
regulations under that section if the stock were sold by the exchanging shareholder.
See §1.367(b)-2(c).
Explanation of Provisions
The Treasury Department and the IRS believe that it is important that
the section 1248 regulations make explicit that only the appropriate amount
of earnings and profits are attributed to stock of a foreign corporation for
purposes of section 1248 following relevant nonrecognition transactions.
The proposed regulations provided in §1.1248-8 supplement and clarify
the existing rules under §§1.1248-2 and 1.1248-3. The results obtained
under the proposed regulations are consistent with the results provided under
section 1248 and the existing regulations under sections 367(b) and 1248.
However, some taxpayers have raised concerns that those existing regulations
may attribute an excessive amount of earnings and profits to stock after certain
nonrecognition transactions. The Treasury Department and the IRS believe
that this view is not a correct interpretation of the existing regulations.
Nevertheless, in order to remove this uncertainty, the proposed regulations
clarify how the principles of section 1248 should be applied so that a section
1248 shareholder or a foreign corporation to which section 964(e) applies
includes the appropriate amount in income as a dividend upon the sale or exchange
of stock of a current or former controlled foreign corporation.
The proposed regulations provide rules for accurately attributing earnings
and profits to stock of a foreign corporation that is received by an exchanging
shareholder, or received by an acquiring corporation, pursuant to one or more
restructuring transactions in which the holding period of such stock is determined
by application of section 1223(1) or 1223(2), and in which the exchanging
shareholder is not required, as a result of the exchange, to include in income
the section 1248 amount pursuant to §1.367(b)-4(b). The proposed regulations
also provide rules for attributing earnings and profits to stock of a foreign
corporation that participates in a restructuring transaction that is held
by a non-exchanging shareholder in such a restructuring transaction.
For purposes of the proposed regulations, a restructuring transaction
is a transaction that qualifies as a nonrecognition transaction (within the
meaning of section 7701(a)(45)) under section 351, 354, 356, or 361. The
proposed regulations provide special rules for liquidations described in section
332 and consequently, these transactions are not included in the definition
of a restructuring transaction. An exchanging shareholder is defined in the
proposed regulations as a person that, in a restructuring transaction qualifying
for nonrecognition under section 354, 356, or 361(a), exchanges stock of an
acquired corporation for stock in either a foreign acquiring corporation or
a foreign corporation that is in control of the acquiring corporation. In
a restructuring transaction qualifying for nonrecognition under section 351,
the proposed regulations define an exchanging shareholder as a person that
exchanges property (including stock) for stock in a foreign acquiring corporation.
An acquiring corporation is defined in the proposed regulations as a corporation
that, in a restructuring transaction, acquires the stock or assets of an acquired
corporation. For purposes of the proposed regulations, a foreign corporate
shareholder is a foreign corporation that owns stock of another foreign corporation,
and has a section 1248 shareholder that is also a section 1248 shareholder
of the other foreign corporation. A non-exchanging shareholder is defined
in the proposed regulations as a person that, at the time of the restructuring
transaction, is either a section 1248 shareholder or a foreign corporate shareholder
of the acquiring corporation and that is not an exchanging shareholder with
respect to that corporation.
The proposed regulations also set forth rules for the attribution of
earnings and profits for purposes of section 1248 with respect to stock of
a foreign corporation that receives assets and liabilities of a foreign corporation
in a complete liquidation described in section 332 if the foreign distributee
is a foreign corporate shareholder of the liquidating corporation. In addition,
the proposed regulations provide that with respect to the sale by a foreign
partnership of the stock of certain foreign corporations, the partners in
such foreign partnership shall be treated as selling or exchanging their proportionate
share of the stock of such corporations for purposes of section 1248.Finally,
the proposed regulations provide additional rules to ensure the proper attribution
of earnings and profits to stock of controlled foreign corporations or foreign
corporate shareholders as a result of certain nonrecognition transactions.
B. Attribution of Earnings and Profits to Stock in a Foreign
Corporation as a Result of a Restructuring Transaction
1. Earnings and profits attributable to the stock that an
exchanging shareholder receives
Some taxpayers have expressed concern that an excessive amount of earnings
and profits could be attributed to stock that an exchanging shareholder receives
in a restructuring transaction under the existing section 1248 regulations
through the application of the holding period rules of section 1223(1). For
example, in a transaction described in section 351, a domestic corporation
(DC1) contributes property to a foreign acquiring corporation (FA) in exchange
for 80 percent of the voting stock in FA. Prior to the transaction, FA was
wholly owned by another domestic corporation (DC2). Assume in the transaction
that DC1 does not recognize gain under section 367(a) and the regulations
under that section or include income under section 367(b) and the regulations
under that section. The basis of the stock in FA received by DC1 in the transaction
will be determined pursuant to section 358, and in determining DC1’s
holding period in the FA stock, DC1 will include, under section 1223(1), the
period DC1 held the property it contributed to FA. Some taxpayers incorrectly
interpret the existing section 1248 regulations to require that, if DC1 subsequently
sells or exchanges the FA stock received in the restructuring transaction,
the earnings and profits accumulated by FA before the transaction (i.e.,
before DC1’s period of actual ownership of the FA stock), but within
the section 1223(1) holding period, are attributed to the FA stock received
and sold by DC1. This interpretation would result in the inappropriate attribution
of such accumulated earnings and profits to the FA stock held by both DC2
and DC1 (if DC2 sells or exchanges its FA stock, the accumulated earnings
and profits of FA that were attributed to the FA stock sold by DC1 would correctly
be attributed under the existing section 1248 regulations to the FA stock
held by DC2).
This interpretation of the existing section 1248 regulations is not
correct and any such double attribution is not intended. However, to provide
greater certainty, the proposed regulations clarify that excessive attribution
of earnings and profits does not occur as a result of restructuring transactions.
The proposed regulations provide that where an exchanging shareholder receives,
in a restructuring transaction, stock in a foreign corporation, the holding
period of which is determined under section 1223(1), and the exchanging shareholder
is either a section 1248 shareholder or a foreign corporate shareholder with
respect to that foreign corporation immediately after the restructuring transaction,
the earnings and profits attributable to the stock the exchanging shareholder
receives shall be determined on the basis of the type of property exchanged.
If the property exchanged is not stock of a foreign acquired corporation
with respect to which the exchanging shareholder is a section 1248 shareholder
or a foreign corporate shareholder immediately before the transaction, the
earnings and profits attributable to the foreign corporation stock received
by the exchanging shareholder shall be determined in accordance with §1.1248-2
or §1.1248-3 (whichever is applicable) without regard to any portion
of the section 1223(1) holding period in that stock that reflects periods
prior to the restructuring transaction.
If, on the other hand, the property exchanged is stock in a foreign
acquired corporation with respect to which the exchanging shareholder is either
a section 1248 shareholder or a foreign corporate shareholder with respect
to the foreign corporation immediately before the transaction, the proposed
regulations provide that the earnings and profits attributable to the stock
received by the exchanging shareholder shall equal the sum of the earnings
and profits attributable to: (1) the stock of the foreign acquired corporation
accumulated prior to the restructuring transaction; and (2) the stock of the
foreign corporation that the exchanging shareholder receives in the restructuring
transaction without regard to any portion of the section 1223(1) holding period
in that stock that is prior to the restructuring transaction. The earnings
and profits attributable to any portion of the section 1223(1) holding period
in the foreign acquiring stock that is prior to the restructuring transaction
remain attributable through the operation of the existing section 1248 regulations
to the foreign acquiring stock held by non-exchanging shareholders. See proposed
§1.1248-8(b)(4) and (7), Example 2.
The proposed regulations provide an exception to this general rule,
however, in certain triangular reorganizations involving a foreign issuing
corporation that controls a domestic acquiring corporation. This exception
applies, for example, where a United States person (DC) exchanges its stock
in a foreign acquired corporation (FS) for stock of a foreign issuing corporation
(FI) that controls the domestic acquiring corporation (DA) in a restructuring
transaction (i.e., a triangular reorganization described
in section 368(a)(1)(B)). To prevent the attribution of FS’s pre-acquisition
earnings and profits to stock owned by both DC and DA, the proposed regulations
provide that the earnings and profits attributable to the FI stock received
by DC shall consist solely of the earnings and profits attributable to the
FI stock received (determined under §1.1248-2 or §1.1248-3, whichever
is applicable, and proposed §1.1248-8, if applicable) without regard
to any portion of DC’s section 1223(1) holding period in the FI stock
received that includes periods of time prior to the restructuring transaction.
See proposed §1.1248-8(b)(7), Example 5. As discussed
in paragraph (B)(2) of this preamble, the earnings and profits attributable
to the FS stock for periods before the triangular reorganization generally
are attributed to the FS stock owned by DA after the transaction.
2. Earnings and profits attributable to stock in a foreign
corporation that certain acquiring corporations receive
In addition to potential excessive attribution resulting from section
1223(1) holding periods discussed above, some taxpayers are concerned that
an excessive amount of earnings and profits could be attributed to stock under
the existing section 1248 regulations through the application of the section
1223(2) holding period rules to an acquiring corporation in a restructuring
transaction. For example, in a transaction described in section 351, a foreign
corporation (FP) that owns 100 percent of the stock of another foreign corporation
(FS) and 100 percent of the stock of a domestic corporation (DC), transfers
its FS stock to DC. Prior to the transaction, FP was not a section 1248 shareholder
or a foreign corporate shareholder with respect to FS. DC’s basis in
the FS stock received by DC in the restructuring transaction will be determined
pursuant to section 362, and in determining DC’s holding period in the
FS stock, DC will include, under section 1223(2), the period FP held the FS
stock. Some taxpayers incorrectly interpret the existing section 1248 regulations
to require that if DC subsequently sells or exchanges the FS stock received
in the restructuring transaction, the earnings and profits accumulated by
FS before the transaction (i.e., before DC’s period
of actual ownership of the FS stock), but within the 1223(2) holding period,
are attributed to the FS stock received and sold by DC. This interpretation
would result in the attribution of earnings and profits to the FS stock held
by DC even though such earnings and profits were accumulated by FS when it
was not a controlled foreign corporation.
Such interpretation of the existing section 1248 regulations is not
correct. However, to provide greater certainty, the proposed regulations
clarify that excessive attribution of earnings and profits does not occur
as a result of such transactions. The proposed regulations provide that where,
in a restructuring transaction, an acquiring corporation receives stock in
a foreign acquired corporation, the holding period of which is determined
under section 1223(2), and the acquiring corporation is either a section 1248
shareholder or a foreign corporate shareholder with respect to that foreign
acquired corporation immediately after the restructuring transaction, the
earnings and profits attributable to the foreign acquired corporation stock
that the acquiring corporation receives shall be determined depending on whether
the exchanging shareholder was a section 1248 shareholder or a foreign corporate
shareholder with respect to the acquired corporation. If the exchanging shareholder
is neither a section 1248 shareholder nor a foreign corporate shareholder
with respect to the foreign acquired corporation immediately before the restructuring
transaction, the proposed regulations provide that the earnings and profits
attributable to the stock of the foreign acquired corporation shall be determined
in accordance with §1.1248-2 or §1.1248-3 (whichever is applicable)
without regard to any portion of the section 1223(2) holding period in that
stock that is prior to the restructuring transaction.
However, in a restructuring transaction where the acquiring corporation
receives stock of a foreign acquired corporation with respect to which an
exchanging shareholder is either a section 1248 shareholder or a foreign corporate
shareholder immediately before the transaction, the proposed regulations modify
the approach discussed above in order to ensure the proper amount of earnings
and profits is attributable to stock that the acquiring corporation receives.
For example, assume a domestic corporation (DC1) has owned all the stock
of a foreign corporation (FS) since its formation. In a transaction described
in section 368(a)(1)(B), DC1 transfers all its FS stock to another domestic
corporation (DC2), in exchange for DC2 voting stock. The section 1248 amount
attributable to the FS stock is $100 but section 367(b) does not require DC1
to include it in income as a deemed dividend. See §1.367(b)-4(a) (income
inclusion rules only apply when there is a foreign acquiring corporation).
If DC2 subsequently recognizes gain upon the sale or exchange of its stock
in FS and if the earnings and profits attributable to that stock do not include
the earnings and profits that accumulated before DC2’s actual period
of ownership, then those earnings and profits would escape inclusion in income
as a dividend under section 1248.
To ensure the proper attribution of earnings and profits in these situations,
the proposed regulations provide that where the stock exchanged in the restructuring
transaction is stock of a foreign corporation, with respect to which the exchanging
shareholder is either a section 1248 shareholder or a foreign corporate shareholder
immediately before the restructuring transaction, the earnings and profits
attributable to the stock of the acquired corporation will be determined with
regard to the portion of the section 1223(2) holding period in that stock
that the exchanging shareholder took into account for purposes of attributing
earnings and profits to that stock. See proposed §1.1248-8(b)(7), Example
3 and Example 5.
3. Earnings and profits attributable to stock held by a non-exchanging
shareholder
The proposed regulations generally provide that the earnings and profits
attributable to stock of an acquiring corporation held by a non-exchanging
shareholder immediately prior to a restructuring transaction continue to be
attributed to such stock, and the earnings and profits of the acquired corporation
accumulated prior to the restructuring transaction attributable to the stock
of an acquired corporation are not attributed to the non-exchanging shareholder’s
stock in the acquiring corporation. See proposed §1.1248-8(b)(7), Example
2 and Example 4.
However, a special rule applies to a nonexchanging shareholder that
owns stock in a foreign corporation that is both an acquiring corporation
and an exchanging shareholder in the same restructuring transaction (i.e.,
an upstream merger). This rule is necessary because the acquiring corporation
does not receive stock in exchange for its stock in the acquired corporation
and, as a result, the general attribution rules in the proposed regulations
would not preserve the earnings and profits attributable to such acquired
corporation stock. For example, assume a domestic corporation (DC) owns all
the stock of a controlled foreign corporation (CFC1), CFC1’s only asset
is 79 percent of the stock of another controlled foreign corporation (CFC2),
and the other 21 percent of the CFC2 stock is owned by an unrelated party
(X). Pursuant to a restructuring transaction described in section 368(a)(1)(C),
CFC2 transfers all its assets to CFC1. In exchange, CFC1 assumes the liabilities
of CFC2 and transfers to CFC2 voting stock representing 21 percent of the
stock of CFC1. CFC2 distributes the voting stock to X and liquidates. In
such a transaction, the earnings and profits attributable to the CFC1 stock
held by DC (i.e., the nonexchanging shareholder) shall
be the sum of the earnings and profits attributable to the stock of CFC1 (i.e.,
the foreign acquiring corporation) immediately before the restructuring transaction
(including amounts attributed under section 1248(c)(2)) and the earnings and
profits attributable to the stock of CFC1 accumulated after the restructuring
transaction (including amounts attributed under section 1248(c)(2)). See
proposed §1.1248-8(b)(7), Example 8. Cf. proposed
§1.1248-8(c) (providing similar rules for liquidations described in section
332).
4. Reduction in earnings and profits attributable to stock
to prevent multiple inclusions with respect to the same earnings and profits
The proposed regulations require that, to the extent consistent with
the principles of section 1248, adjustments to earnings and profits attributable
to stock shall be made so that section 1223(1) and (2) and the proposed regulations
are applied in a manner that results in earnings and profits being taken into
account only once. Accordingly, the proposed regulations provide that upon
the sale by a controlled foreign corporation of stock of another foreign corporation
to which earnings and profits had been attributed under the rules of the proposed
regulations, proportionate reductions shall be made to the earnings and profits
attributed to the stock of the selling foreign corporate shareholder owned
by a section 1248 shareholder. See proposed §1.1248-8(b)(7), Example
7. For example, assume a section 1248 shareholder owns 80 percent
of a controlled foreign corporation (CFC1) and an unrelated foreign person
owns the remaining 20 percent of CFC1. The section 1248 shareholder receives
the CFC1 stock in exchange for the stock of its wholly owned foreign subsidiary
(CFC2) in a restructuring transaction described in section 368(a)(1)(B).
Immediately before the transaction, $100 of earnings and profits is attributable
to the CFC2 stock owned by the section 1248 shareholder. As previously discussed,
the proposed regulations provide for the attribution of the $100 of CFC2’s
pre-acquisition earnings and profits to the CFC1 stock received by the section
1248 shareholder in the transaction and to the CFC2 stock received by CFC1
in the transaction. Assume that CFC2 accumulates another $100 of earnings
and profits after the transaction, and in a subsequent year, CFC1 sells 30
percent of its stock in CFC2. If the requirements of section 964(e) are met,
CFC1 will include in its gross income as a dividend $30 of CFC2’s pre-acquisition
earnings and profits and $30 of CFC2’s post-acquisition earnings and
profits. In order to prevent the attribution of a portion of these earnings
and profits to the section 1248 shareholder’s stock in CFC1, the proposed
regulations provide that the earnings and profits attributable to the section
1248 shareholder’s stock in CFC1 will be reduced by $54, $24 (80 percent
of $30) of the earnings and profits accumulated by CFC2 after the restructuring
transaction and $30 of the earnings and profits accumulated by CFC2 prior
to the restructuring transaction.
5. Special rule regarding section 381
The proposed regulations also provide a special rule in order to avoid
possible double counting of earnings and profits as a result of the operation
of section 381(a) in a restructuring transaction and the proposed rules.
Under section 381, an acquiring corporation succeeds to and takes into account
the earnings and profits of the transferor or distributor corporation as of
the close of the day of the transfer or distribution. Because the earnings
and profits carry over from one corporation to another corporation at the
close of the day, the same earnings and profits accumulated by the transferor
or distributor corporation before the transaction could also be considered
to have been accumulated by the transferee or distributee corporation after
the transfer or distribution. For example, assume a domestic corporation
(DC1) owns 100 percent of controlled foreign corporation (CFC1) that generates
$100 of earnings and profits. CFC1 merges into another controlled foreign
corporation (CFC2) in a reorganization described in section 368(a)(1)(A),
and DC1 receives 25 percent of the CFC2 stock in exchange for its CFC1 stock
in the merger. If, for purposes of section 1248, the $100 of earnings and
profits of CFC1 is attributable to the CFC2 stock received by DC1, and is
also taken into account by CFC2 pursuant to section 381, the same $100 of
earnings and profits would be taken into account twice.
Except with respect to upstream mergers, the proposed regulations attribute
the pre-acquisition earnings and profits of the transferor, where appropriate,
to the stock received by the exchanging shareholder. Therefore, in order
to prevent the double counting of earnings and profits, the proposed regulations
provide that earnings and profits of another corporation to which the foreign
corporation succeeded through the operation of section 381 will not be attributed
to its stock. See proposed §1.1248-8(b)(6) and (7), Example
4, and (c)(2) and (3).
6. Attribution of earnings and profits following certain
liquidations
Under the existing section 1248 regulations, issues have arisen as to
whether the so-called hovering deficit rule under section 381(c)(2)(B) applies
for purposes of attributing earnings and profits to stock of the foreign distributee
corporation following certain liquidations of foreign corporations under section
332. The hovering deficit rule generally restricts access to certain deficits
in earnings and profits following section 381 transactions. The Treasury
Department and the IRS believe that the hovering deficit rule should not apply
in these types of section 332 liquidations because section 1248(c)(2) generally
provides for the attribution of a foreign subsidiary’s earnings and
profits (including any deficits) to the stock of its foreign parent. Thus,
the foreign parent already had, in effect, access to the deficit of the foreign
subsidiary pursuant to section 1248(c)(2) prior to the section 332 liquidation.
In that case, application of the hovering deficit rule is not appropriate
for section 1248 purposes.
Accordingly, the proposed regulations provide a special rule that clarifies
application of the hovering deficit rule to a distributee foreign corporate
shareholder in a section 332 liquidation. In this circumstance, the earnings
and profits of the distributing foreign corporation to which the foreign distributee
corporation succeeds through the operation of section 381 will not be taken
into account by the foreign distributee for purposes of section 1248 and consequently,
the hovering deficit rule will not apply. Instead, the proposed regulations
provide a rule for attributing earnings and profits of the foreign liquidating
corporation to the stock of the foreign distributee in such a liquidation
that is consistent with the principles of section 1248(c)(2). In such a case,
the earnings and profits attributable to the distributee stock shall be the
sum of: (1) the earnings and profits attributable to the stock of the distributee
immediately before the liquidation (including amounts attributed under section
1248(c)(2)); and (2) the earnings and profits attributable to the stock of
the distributee accumulated after the liquidation (including amounts attributed
under section 1248(c)(2)). See proposed §1.1248-8(b)(7), Example
3, and (c).
C. Sale or Exchange of Stock by a Foreign Partnership
A domestic partnership is treated as a United States person for purposes
of section 1248. See section 7701(a)(30)(B) and §1.1248-1(a)(1). Accordingly,
the sale by a domestic partnership of the stock of a foreign corporation is
subject to section 1248(a). Section 1248 and the existing regulations do
not, however, address specifically sales or exchanges of stock by foreign
partnerships with United States persons as partners.
The legislative history of subchapter K of the Code provides that, for
purposes of interpreting Code provisions outside of that subchapter, a partnership
may be treated as either an entity separate from its partners or an aggregate
of its partners, depending on which characterization is more appropriate to
carry out the purpose of the particular Code section under consideration.
H.R. Conf. Rep. No. 2543, 83rd Cong. 2d. Sess. 59 (1954). The purpose of
section 1248 is to ensure that earnings and profits of controlled foreign
corporations (or former controlled foreign corporations) are taxed as a dividend
when certain United States persons recognize gain on the sale or exchange
of stock in such corporations. In cases in which the United States person
is a partner in a foreign partnership and recognizes income on the sale of
stock of a foreign corporation by such foreign partnership, the purpose of
section 1248 is fulfilled only if the partnership is treated as an aggregate
for section 1248 purposes. Treatment of a foreign partnership as an entity,
in contrast, could result in partners in the partnership inappropriately receiving
capital gain treatment on the sale by the partnership of stock of the foreign
corporation.
Thus, under proposed §1.1248-1(a)(4), a foreign partnership is
treated as an aggregate of its partners for purposes of section 1248(a).
Under the proposed regulations, for example, the partners in a foreign partnership
shall be treated as selling or exchanging their proportionate share of stock
held by the foreign partnership. The proposed regulations also apply section
1248(a) in cases where the stock in a corporation that is sold or exchanged
is held through tiers of foreign partnerships. This treatment of the foreign
partnership as an aggregate, rather than as an entity, for purposes of applying
section 1248 is necessary to reflect properly the attributable earnings and
profits as a dividend.
D. Removal of Rule under §1.367(b)-2(d)(3)(ii) Limiting
Amounts Attributable to Holding Periods Determined under Section 1223
Section 1.367(b)-3 requires that an exchanging shareholder, as defined
in §1.367(b)-3(b)(1), include the all earnings and profits amount (as
defined generally in §1.367(b)-2(d)) in income as a deemed dividend (with
respect to its stock in the foreign acquired corporation) when a domestic
corporation acquires the assets of the foreign corporation in a section 332
liquidation or a section 368(a)(1) asset acquisition. Section 1.367(b)-2(d)(3)(ii)
excludes, for purposes of determining the all earnings and profits amount,
amounts attributable to holding periods determined under section 1223(2) during
which there was no direct or indirect ownership by a United States person.
Pursuant to §1.367(b)-2(d)(3)(i)(A)(1), the all
earnings and profits amount with respect to stock of a foreign corporation
is determined according to the attribution principles of section 1248 and
the regulations under that section. Since the rules of proposed §1.1248-8(b)(2)
conform to the rule set forth in §1.367(b)-2(d)(3)(ii), the proposed
regulations remove paragraph (d)(3)(ii) from §1.367(b)-2.
E. Revision of §1.367(b)-4(d) Providing Rules for Subsequent
Exchanges
Section 1.367(b)-4 applies to an acquisition by a foreign corporation
of the stock or assets of a foreign corporation in an exchange described in
section 351 or a reorganization described in section 368(a)(1). If the exchange
meets certain criteria, an exchanging shareholder, as defined in §1.367(b)-4(b)(1)(i)(A),
must include in income as a deemed dividend the section 1248 amount attributable
to the stock that it exchanges. If in a particular exchange, income is not
required to be included pursuant to §1.367(b)-4(b), §1.367(b)-4(d)
provides rules governing the attribution of earnings and profits to the stock
received by the exchanging shareholder in the non-inclusion exchange for purposes
of applying section 367(b) or section 1248 to subsequent sales or exchanges
of that stock.
Because proposed §1.1248-8 provides rules for the attribution of
earnings and profits to stock with respect to the §1.367(b)-4(b) non-inclusion
exchanges, the proposed regulations remove the substantive rules and examples
in §1.367(b)-4(d) from the final regulations. In their place, taxpayers
are referred to proposed §1.1248-8.
1. Attribution to stock shareholder receives by gift
The proposed regulations do not apply to determine the earnings and
profits attributable to stock in a foreign corporation that a United States
person receives as a gift. The Treasury Department and the IRS seek comments
as to whether additional guidance is needed to address the attribution of
earnings and profits with respect to stock of a foreign corporation that a
United States person receives by gift.
2. Attribution of earnings and profits to stock shareholder
receives under section 355
The proposed regulations do not apply to determine the earnings and
profits attributable to stock in a foreign corporation that a United States
person receives in a distribution to which section 355 applies. The Treasury
Department and the IRS seek comments as to whether additional guidance is
needed to address the attribution of earnings and profits with respect to
stock of a foreign corporation that a United States person receives in such
distributions.
3. Effect on §§1.1248-4 and 1.1248-5
The proposed regulations do not address the interaction of proposed
§1.1248-8 with §§1.1248-4 and 1.1248-5. The Treasury Department
and the IRS seek comments as to whether additional guidance on how the proposed
regulations should affect those sections of the existing regulations.
It has been determined that this notice of proposed rulemaking is not
a significant regulatory action as defined in Executive Order 12866. Therefore,
a regulatory assessment is not required. It has also been determined that
section 553(b) of 5 U.S.C. chapter 5 does not apply to these regulations,
and, because the regulations do not impose a collection of information on
small entities, the Regulatory Flexibility Act, 5 U.S.C. chapter 6, does not
apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking
will be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small businesses.
Comments and Requests for a Public Hearing
Before the proposed regulations are adopted as final regulations, consideration
will be given to any written comments (a signed original and 8 copies) or
electronic comments that are submitted timely to the IRS. The Treasury Department
and the IRS request comments on the clarity of the proposed rules and how
they may be made easier to understand. All comments will be made available
for public inspection and copying. A public hearing will be scheduled if
requested in writing by any person that submits timely written or electronic
comments. If a public hearing is scheduled, notice of the date, time, and
place for the public hearing will be published in the Federal
Register.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.367(b)-2(c)(1) and (2) and (d)(3), and 1.367(b)-4(d) also
issued under 26 U.S.C. 367(b)(1) and (2).* * *
Sections 1.1248-1(a)(1), (4), and (5), and 1.1248-8 also issued under
26 U.S.C. 1248(a) and (c)(1) and (2).* * *
Par. 2. Section 1.367(b)-2 is amended by:
1. Amending the last sentence of paragraph (c)(1)(ii) by removing the
language “, as modified by §1.367(b)-4(d) (as applicable)”
and adding the language “. See §1.1248-8.” in its place.
2. Removing Example 4 in paragraph (c)(2).
3. Amending the last sentence of paragraph (d)(3)(i)(B)(2)
by removing the language “, as modified by paragraph (d)(3)(ii) of this
section and §1.367(b)-4(d) (as applicable)” and adding the language
“. See §1.1248-8.” in its place.
4. Removing paragraph (d)(3)(ii).
5. Redesignating paragraph (d)(3)(iii) as paragraph (d)(3)(ii).
Par. 3. Section 1.367(b)-4(d) is revised to read as follows:
§1.367(b)-4 Acquisition of foreign corporate stock
or assets by a foreign corporation in certain nonrecognition transactions.
* * * * *
(d) Rules for subsequent sales or exchanges.
If an exchanging shareholder (as defined in §1.1248-8(b)(1)(iv)) is not
required to include in income as a deemed dividend the section 1248 amount
under paragraph (b) of this section in a section 367(b) exchange described
in paragraph (a) of this section (non-inclusion exchange), then, for purposes
of applying section 367(b) or section 1248 to subsequent sales or exchanges,
and subject to the limitation of §1.367(b)-2(d)(3)(ii) (in the case of
a transaction described in §1.367(b)-3), the determination of the earnings
and profits attributable to the stock an exchanging shareholder receives in
the non-inclusion exchange shall be determined pursuant to the rules of section
1248 and the regulations under that section.
Par. 4. Section 1.1248-1 is amended by:
1. Amending the first sentence of paragraph (a)(1) by removing the
language “(or was considered as held by reason of the application of
section 1223)” and adding the language “(or was considered as
held by reason of the application of section 1223, taking into account §1.1248-8)”
in its place.
2. Adding a new third sentence in paragraph (a)(1).
3. Redesignating paragraph (a)(4) as paragraph (a)(5).
4. Adding new paragraph (a)(4).
5. Adding Example 4 in newly designated paragraph
(a)(5).
The additions read as follows:
§1.1248-1 Treatment of gain from certain sales or exchanges
of stock in certain foreign corporations.
(a) In general. (1) * * * See §1.1248-8
for additional rules regarding the attribution of earnings and profits to
the stock of a foreign corporation following certain nonrecognition transactions.
* * *
* * * * *
(4) For purposes of paragraph (a)(1) of this section, stock of a corporation
that is owned by a foreign partnership shall be considered as owned proportionately
by its partners. Consequently, if a foreign partnership sells or exchanges
stock of a corporation, the partners in such foreign partnership shall be
treated as selling or exchanging their proportionate share of the stock of
such corporation. Stock considered to be owned by a partner by reason of
the application of the first sentence of this paragraph (a)(4) shall, for
purposes of applying such sentence, be treated as actually owned by such partner.
(5) * * *
Example 4. (i) Facts. X,
a domestic corporation, and Y, a foreign corporation that is not a controlled
foreign corporation, are partners in foreign partnership Z. X has a 60% interest
in Z, and Y has a 40% interest in Z. All parties are calendar year taxpayers.
On January 1, year 1, Z forms foreign corporation H, a controlled foreign
corporation that conducts a business in Country C. On December 31, year 2,
Z sells all of the H stock for $600 when Z’s adjusted basis in the stock
is $100. Therefore, Z recognizes a gain of $500 on the sale, of which $300
is allocable to X as a 60% partner. At the time of the sale, H had $300 of
earnings and profits, $180 of which (i.e., 60% of $300)
is attributable to X’s 60% share of the H stock.
(ii) Analysis. Pursuant to section 1248(a) and
paragraphs (a)(1) and (4) of this section, X and Y are treated as selling
60% and 40%, respectively, of the H stock. X includes in its gross income
as a dividend $180 of the gain recognized on the sale. Because Y is a foreign
corporation that is not a CFC, neither section 1248 nor section 964 applies
to the sale of Y’s 40% share of the H stock.
(iii) Alternative facts. If, instead, X owned
its 60% interest in Z through another foreign partnership, the result would
be the same.
* * * * *
§§1.1248-2, 1.1248-3, 1.1248-7 [Amended]
Par. 5. In §§1.1248-2, 1.1248-3, and 1.1248-7, for each entry
in the “Section” column, remove the language in the “Remove”
column and add the language in the “Add” column in its place.
Par. 6. Section 1.1248-8 is added to read as follows:
§1.1248-8 Earnings and profits attributable to stock
following certain non-recognition transactions.
(a) Scope. This section sets forth rules for
the attribution of earnings and profits for purposes of section 1248 and §1.1248-1(a)(1)
and to supplement the rules in §§1.1248-2 and 1.1248-3 with respect
to—
(1) Stock that an exchanging shareholder receives, or an
acquiring corporation receives, in restructuring transactions.
Except as otherwise provided in this paragraph (a), stock of a foreign corporation
that an exchanging shareholder receives, or an acquiring corporation receives,
pursuant to a restructuring transaction (as defined in paragraph (b)(1)(vii)
of this section) in which the holding period of such stock is determined by
application of section 1223(1) or 1223(2), whichever is appropriate. This
section shall not apply to an exchange otherwise described in this paragraph
(a)(1) if, as a result of the exchange, the exchanging shareholder is required
to include in income as a deemed dividend the section 1248 amount pursuant
to §1.367(b)-4(b). See paragraphs (b)(2) and (3) of this section;
(2) Nonexchanging shareholders. Stock of a foreign
corporation that participates in a restructuring transaction that is held
by a non-exchanging shareholder (as defined in paragraph (b)(1)(vi) of this
section) in the restructuring transaction. See paragraph (b)(4) of this section;
(3) Application of section 381. Stock of a foreign
corporation that receives assets in a transfer to which section 361(a) applies
in connection with a reorganization described in section 368(a)(1)(A), (C),
(D), (F), or (G), or in a distribution to which section 332 applies, and to
which section 381(c)(2)(A) and §1.381(c)(2)-1(a) apply. See paragraph
(b)(6) of this section; or
(4) Section 332 liquidations. Stock of a foreign
corporation that receives the assets and liabilities of a foreign corporation
in a complete liquidation described in section 332 if the foreign distributee
is a foreign corporate shareholder (as defined in paragraph (b)(1)(v) of this
section) of the liquidating corporation. See paragraph (c) of this section.
(b) Earnings and profits attributable to stock following
a restructuring transaction—(1) Definitions.
The following definitions apply for purposes of this section—
(i) Acquired corporation is a corporation whose
stock or assets are acquired in exchange for stock in (or stock in and other
property of) either the acquiring corporation or a foreign corporation that
controls, within the meaning of section 368(c), the acquiring corporation
in a restructuring transaction.
(ii) Acquiring corporation is a corporation that
acquires the stock or assets of an acquired corporation in a restructuring
transaction.
(iii) Controlled foreign corporation is a corporation
described in section 957.
(iv) Exchanging shareholder is a person that exchanges—
(A) In a restructuring transaction qualifying as a nonrecognition transaction
within the meaning of section 7701(a)(45) and described in section 354, 356,
or 361(a), stock in an acquired corporation for stock in either a foreign
acquiring corporation or a foreign corporation that is in control, within
the meaning of section 368(c), of an acquiring corporation (whether domestic
or foreign); or
(B) In a restructuring transaction qualifying as a nonrecognition transaction
within the meaning of section 7701(a)(45) and described in section 351, property
(including stock) for stock in a foreign acquiring corporation.
(v) Foreign corporate shareholder is a foreign
corporation that—
(A) Owns stock of another foreign corporation; and
(B) Has a section 1248 shareholder that is also a section 1248 shareholder
of the other foreign corporation.
(vi) Non-exchanging shareholder is, at the time
the acquiring corporation participates in a restructuring transaction, either
a section 1248 shareholder or a foreign corporate shareholder of the acquiring
corporation that is not an exchanging shareholder with respect to that corporation.
(vii) Restructuring transaction is a transaction
qualifying as a nonrecognition transaction within the meaning of section 7701(a)(45)
and described in section 351, 354, 356, or 361.
(viii) Section 1248 shareholder is any United
States person that satisfies the ownership requirements of section 1248(a)(2)
and §1.1248-1(a)(2) with respect to a foreign corporation.
(2) Earnings and profits attributable to stock that an exchanging
shareholder receives in a restructuring transaction. Where, in
a restructuring transaction, an exchanging shareholder receives stock in a
foreign corporation, the holding period of which is determined under section
1223(1), and the exchanging shareholder is either a section 1248 shareholder
or a foreign corporate shareholder with respect to that foreign corporation
immediately after the restructuring transaction, the earnings and profits
attributable to the stock the exchanging shareholder receives shall be determined
pursuant to the rules in paragraphs (b)(2)(i), (ii) and (iii) of this section.
(i) Exchanging shareholder exchanges property that is not
stock of a foreign acquired corporation with respect to which the exchanging
shareholder is a section 1248 shareholder or a foreign corporate shareholder.
Where the exchanging shareholder exchanges in a restructuring transaction
property that is not stock of a foreign acquired corporation with respect
to which the exchanging shareholder is a section 1248 shareholder or a foreign
corporate shareholder immediately before such transaction, the earnings and
profits attributable to the stock that the exchanging shareholder receives
in the restructuring transaction shall be determined in accordance with §1.1248-2
or §1.1248-3, whichever is applicable, without regard to any portion
of the section 1223(1) holding period in that stock that is prior to the restructuring
transaction. See paragraph (b)(7), Example 1 of this
section.
(ii) Exchanging shareholder exchanges stock of a foreign
corporation with respect to which the exchanging shareholder is either a section
1248 shareholder or a foreign corporate shareholder. Except as
provided in paragraph (b)(2)(iii) of this section, where the exchanging shareholder
exchanges in a restructuring transaction stock of a foreign acquired corporation
with respect to which the exchanging shareholder is either a section 1248
shareholder or a foreign corporate shareholder immediately before such restructuring
transaction, the earnings and profits attributable to the stock that the exchanging
shareholder receives in the restructuring transaction shall be the sum of
the earnings and profits attributable to—
(A) The stock of the foreign acquired corporation exchanged (determined
in accordance with §1.1248-2 or §1.1248-3, whichever is applicable,
and this section, if applicable) that was accumulated before the restructuring
transaction; and
(B) The stock of the foreign corporation that the exchanging shareholder
receives in the restructuring transaction (determined in accordance with §1.1248-2
or §1.1248-3, whichever is applicable, and this section, if applicable),
without regard to any portion of the section 1223(1) holding period in that
stock that is prior to the restructuring transaction. See paragraph (b)(7), Example
2, Example 4, and Example 6 of
this section.
(iii) Exchanging shareholder receives stock in a foreign
corporation that controls a domestic acquiring corporation. Where
the acquiring corporation is a domestic corporation and the exchanging shareholder
receives in a restructuring transaction stock in a foreign corporation that
controls (within the meaning of section 368(c)) the domestic acquiring corporation,
the earnings and profits attributable to the stock that the exchanging shareholder
receives in the restructuring transaction shall consist solely of the amount
of earnings and profits attributable to such stock (determined in accordance
with §1.1248-2 or §1.1248-3, whichever is applicable, and this section,
if applicable) without regard to any portion of the section 1223(1) holding
period in that stock that is prior to the restructuring transaction. See
paragraph (b)(7), Example 5 of this section.
(3) Earnings and profits attributable to stock in a foreign
corporation certain acquiring corporations receive in a restructuring transaction.
Where an acquiring corporation receives, in a restructuring transaction,
stock in a foreign acquired corporation, the holding period of which is determined
under section 1223(2), and the acquiring corporation is either a section 1248
shareholder or a foreign corporate shareholder with respect to that foreign
acquired corporation immediately after the restructuring transaction, the
earnings and profits attributable to the foreign acquired corporation stock
that the acquiring corporation receives shall be determined pursuant to the
rules in paragraphs (b)(3)(i) and (ii) of this section.
(i) Stock of a foreign corporation with respect to which
the exchanging shareholder is neither a section 1248 shareholder nor a foreign
corporate shareholder. The earnings and profits attributable to
the stock of the foreign acquired corporation that the acquiring corporation
receives in a restructuring transaction where the exchanging shareholder is
neither a section 1248 shareholder nor a foreign corporate shareholder with
respect to that foreign acquired corporation immediately before the restructuring
transaction shall be determined in accordance with §1.1248-2 or §1.1248-3,
whichever is applicable, without regard to any portion of the section 1223(2)
holding period in that stock that is prior to the restructuring transaction.
(ii) Stock of a foreign corporation with respect to which
the exchanging shareholder is either a section 1248 shareholder or a foreign
corporate shareholder. The earnings and profits attributable to
the stock of a foreign acquired corporation that the acquiring corporation
receives in the restructuring transaction where the exchanging shareholder
is either a section 1248 shareholder or a foreign corporate shareholder with
respect to that foreign corporation immediately before the restructuring transaction
shall be determined in accordance with §1.1248-2 or §1.1248-3, whichever
is applicable, with regard to the portion of the section 1223(2) holding period
of the stock that the exchanging shareholder took into account for purposes
of attributing earnings and profits to that stock (determined in accordance
with this section). See paragraph (b)(7), Example 3, Example
5, and Example 7 of this section.
(4) Earnings and profits attributable to stock held by a
non-exchanging shareholder in a foreign acquiring corporation.
(i) Except to the extent paragraph (b)(4)(ii) of this section applies, see
§1.1248-2 or §1.1248-3 (whichever is applicable) and, as applicable,
paragraph (b)(6) of this section for the determination of the earnings and
profits attributable to the stock held by a non-exchanging shareholder in
a foreign acquiring corporation. See also paragraph (b)(7), Example
2 and Example 4 of this section.
(ii) Where a non-exchanging shareholder holds stock in a foreign corporation
that is also an exchanging shareholder and a foreign acquiring corporation
in the same restructuring transaction—
(A) The earnings and profits attributable to such stock shall be the
sum of the earnings and profits attributable to the stock of such foreign
corporation immediately before the restructuring transaction (including amounts
attributed under section 1248(c)(2)) and the earnings and profits attributable
to the stock of the foreign acquiring corporation accumulated after the restructuring
transaction (including amounts attributed under section 1248(c)(2)); and
(B) Paragraph (b)(6) of this section applies. See paragraph (b)(7), Example
8 of this section.
(iii) Where the acquiring corporation is a foreign corporate shareholder
with respect to stock of a foreign acquired corporation, paragraph (b)(3)
of this section shall not apply for purposes of determining the earnings and
profits attributable to stock in the foreign acquiring corporation owned by
a non-exchanging shareholder thereof (see section 1248(c)(2)). See paragraph
(b)(7), Example 6 of this section.
(5) Reduction in earnings and profits attributable to stock
to prevent multiple inclusions with respect to the same earnings and profits.
To the extent consistent with the principles of section 1248, adjustments
to earnings and profits attributable to stock shall be made such that section
1223(1) and (2) and this section are applied in a manner that results in earnings
and profits being taken into account only once. Thus, for example, when a
controlled foreign corporation sells or exchanges all or part of the stock
of another foreign corporation to which earnings and profits are attributable
pursuant to this paragraph (b) or paragraph (c) of this section, proportionate
reductions shall be made to the earnings and profits attributed to the stock
of the selling foreign corporate shareholder owned by a section 1248 shareholder.
See paragraph (b)(7), Example 7 of this section.
(6) Special rule regarding section 381. Solely
for purposes of determining the earnings and profits (or deficit in earnings
and profits) attributable to stock pursuant to this paragraph (b), the earnings
and profits of a corporation shall not include earnings and profits that are
treated as received or incurred under section 381(c)(2)(A) and §1.381(c)(2)-1(a).
See paragraph (b)(7), Example 4 of this section.
(7) Examples. The application of this paragraph
(b) is illustrated by the following examples. Unless otherwise indicated,
in the following examples assume that—
(i) There is no immediate gain recognition pursuant to section 367(a)(1)
and the regulations under that section (either through operation of the rules
or because the appropriate parties have entered into a gain recognition agreement
under §§1.367(a)-3(b) and 1.367(a)-8);
(ii) There is no income inclusion required pursuant to section 367(b)
and the regulations under that section, and all reporting requirements in
those regulations are complied with;
(iii) References to earnings and profits are to earnings and profits
that would be includible in income as a dividend under section 1248 and the
regulations under that section if stock to which the earnings and profits
are attributable were sold or exchanged by its shareholder;
(iv) Each corporation has only a single class of stock outstanding
and uses the calendar year as its taxable year; and
(v) Each transaction is unrelated to all other transactions.
Example 1. A section 351 exchange of
property other than stock in a foreign corporation with respect to which the
exchanging shareholder is either a section 1248 shareholder or a foreign corporate
shareholder. (i) Facts. DC1, a domestic
corporation, has owned all the stock of CFC, a foreign corporation, since
CFC’s formation on January 1, year 3. On December 31, year 5, DC2,
a domestic corporation unrelated to DC1, contributes property it has held
since January 1, year 1, to CFC in exchange for voting stock of CFC in a restructuring
transaction that is an exchange under section 351. The property that DC2
contributes is not stock in a foreign corporation with respect to which DC2
was either a section 1248 shareholder or a foreign corporate shareholder.
DC2 receives 80% of the voting stock of CFC in the restructuring transaction
and its holding period in that CFC stock, determined pursuant to section 1223(1),
began on January 1, year 1. CFC has $100 of accumulated earnings and profits
on December 31, year 5. On December 31, year 7, when the accumulated earnings
and profits of CFC are $200, DC2, a section 1248 shareholder with respect
to CFC, sells its CFC stock.
(ii) Analysis. Under paragraph (b)(2)(i) of this
section, the earnings and profits attributable to the CFC stock sold by DC2
are $80. This amount consists of none of the $100 of earnings and profits
accumulated by CFC before the restructuring transaction, and 80% of the $100
of earnings and profits of CFC accumulated after the restructuring transaction.
Example 2. A section 351 exchange of
controlled foreign corporation stock by a United States person for stock in
a controlled foreign corporation in a restructuring transaction.
(i) Facts. The facts are the same as in Example
1 except as follows. The property that DC2 contributes is 100%
of the stock in CFC2, a foreign corporation. DC2 has owned all the stock
of CFC2 since CFC2’s formation on January 1, year 2, and CFC2 has $200
of earnings and profits as of December 31, year 5. CFC2 does not accumulate
any additional earnings and profits from December 31, year 5, to December
31, year 7. On December 31, year 7, when the accumulated earnings and profits
of CFC are $200, DC2, a section 1248 shareholder with respect to CFC, sells
its CFC stock. Also on that date, DC1 sells its CFC stock.
(ii) Analysis. (A) DC2 sale.
Pursuant to paragraph (b)(2)(ii) of this section, the earnings and profits
attributable to the CFC stock sold by DC2 are $280. This amount consists
of all of the $200 of earnings and profits of CFC2 accumulated before the
restructuring transaction (see also section 1248(c)(2)), none of the $100
of earnings and profits accumulated by CFC before the restructuring transaction,
and 80% of the $100 of earnings and profits of CFC accumulated after the restructuring
transaction.
(B) DC1 sale. Pursuant to paragraph (b)(4) of
this section, the earnings and profits attributable to the CFC stock sold
by DC1, a non-exchanging shareholder in the restructuring transaction, are
$120. This amount consists of all of the $100 of earnings and profits of
CFC accumulated before the restructuring transaction, none of the $200 of
earnings and profits of CFC2 accumulated before the restructuring transaction,
and 20% of the $100 of earnings and profits of CFC accumulated after the restructuring
transaction.
Example 3. A section 351 exchange of
controlled foreign corporation stock by a United States person for stock in
a domestic corporation in a restructuring transaction. (i) Facts.
DC1, a domestic corporation, has owned all of the stock of CFC, a foreign
corporation, since CFC’s formation on January 1, year 1. DC1 has also
owned all the stock of DC2, a domestic corporation, since DC2’s formation
on January 1, year 1. On December 31, year 2, DC1 contributes the stock of
CFC to DC2 in exchange for stock in DC2 in a restructuring transaction that
is an exchange described in section 351. On December 31, year 2, CFC has
$100 of accumulated earnings and profits. DC2 has a basis in the CFC stock
determined under section 362, and is considered to have held the CFC stock
since January 1, year 1, pursuant to section 1223(2). On December 31, year
4, when the accumulated earnings and profits of CFC are still $100, DC2 sells
its CFC stock.
(ii) Analysis. Under paragraph (b)(3)(ii) of
this section, $100 of accumulated earnings and profits of CFC is attributable
to the stock of CFC sold by DC2, even though DC2 did not hold the stock of
CFC during the time CFC accumulated the earnings and profits.
Example 4. Acquisition of a controlled
foreign corporation by a controlled foreign corporation in a reorganization
described in section 368(a)(1)(C) (or section 368(a)(1)(B)). (i)
Facts. DC1, a domestic corporation, has owned all the
stock of CFC1, a foreign corporation, since its formation on January 1, year
1. DC2, a domestic corporation unrelated to DC1, has owned all of the stock
of CFC2, a foreign corporation, since its formation on January 1, year 2.
On December 31, year 3, pursuant to a restructuring transaction that is a
reorganization described in section 368(a)(1)(C), CFC1 transfers all of its
assets to CFC2 in exchange for 25% of the voting stock of CFC2. CFC1 distributes
the CFC2 stock to DC1 and the CFC1 stock is cancelled. DC1’s holding
period in the CFC2 stock, determined under section 1223(1), begins on January
1, year 1. On December 31, year 3, CFC1 has $100 of accumulated earnings
and profits and CFC2 has $200 of accumulated earnings and profits. CFC2 succeeds
to the $100 of CFC1 accumulated earnings and profits in the reorganization
under section 381. From January 1, year 4 to December 31, year 5, CFC2 incurred
a deficit in earnings and profits in the amount of ($200). On December 31,
year 5, both DC1 and DC2 sell their stock in CFC2.
(ii) Analysis. (A) DC1.
Pursuant to paragraph (b)(2)(ii) of this section, $50 of earnings and profits
is attributable to the CFC2 stock sold by DC1. This amount consists of $100
of CFC1’s earnings and profits accumulated before the restructuring
transaction, reduced by 25% of CFC2’s ($200) post-restructuring transaction
deficit in earnings and profits. None of the $200 of CFC2’s earnings
and profits accumulated by CFC2 prior to the reorganization is attributed
to the CFC2 stock sold by DC1. Also, none of the earnings and profits CFC2
succeeded to under section 381 is attributed to the CFC2 stock sold by DC1,
pursuant to paragraph (b)(6) of this section.
(B) DC2. Pursuant to paragraph (b)(4) of this
section, there is $50 of accumulated earnings and profits attributable to
the CFC2 stock sold by DC2. This amount consists of all of the $200 of CFC2’s
earnings and profits accumulated by CFC2 prior to the reorganization, reduced
by 75% of CFC2’s deficit in earnings and profits in the amount of ($200)
incurred after the restructuring transaction. None of the $100 of CFC1 accumulated
earnings and profits succeeded to under section 381 is attributable to the
CFC2 stock sold by DC2, pursuant to paragraph (b)(6) of this section.
(C) Section 368(a)(1)(B) reorganization. If,
instead of DC1 acquiring its 25% interest in CFC2 pursuant to a reorganization
described in section 368(a)(1)(C), DC1 had transferred the stock of CFC1 to
CFC2 in exchange for 25% of the voting stock of CFC2 in a reorganization described
in section 368(a)(1)(B), the results would be the same as described in paragraphs
(ii) (A) and (B) of this Example 4.
Example 5. Acquisition of the stock
of a foreign corporation that controls a domestic acquiring corporation in
a triangular reorganization described in section 368(a)(1)(C).
(i) Facts. DC1, a domestic corporation, has owned
all the stock of CFC1, a foreign corporation, since its formation on January
1, year 1. CFC1 has owned all the stock of CFC2, a foreign corporation, since
its formation on January 1, year 1. FC, a foreign corporation that is not
a controlled foreign corporation, has owned all of the stock of DC2, a domestic
corporation, since its formation on January 1, year 2. On December 31, year
3, pursuant to a restructuring transaction that was a triangular reorganization
described in section 368(a)(1)(C), CFC1 transfers all of its assets, including
the CFC2 stock, to DC2 in exchange for 60% of the voting stock of FC. CFC1
transferred the voting stock of FC to DC1 and the CFC1 stock was cancelled.
Pursuant to section 1223(1), DC1 is considered to have held the stock of
FC since January 1, year 1. Under section 1223(2), DC2 is considered to have
held the stock of CFC2 since January 1, year 1. On December 31, year 3, CFC1
has $100 of earnings and profits, CFC2 has $300 of earnings and profits, and
FC has $200 of earnings and profits. DC1 includes the $100 all earnings and
profits amount attributable to its CFC1 stock in income as a deemed dividend
under §1.367(b)-3 upon the exchange of CFC1 stock for FC stock. Pursuant
to the lower tier earning exclusion of §1.367(b)-2(d)(3)(ii), that amount
does not include the $300 of earnings and profits of CFC2. From January 1,
year 4, until December 31, year 5, FC (now a controlled foreign corporation)
accumulates an additional $50 of earnings and profits. From January 1, year
4 until December 31, year 5, CFC2 accumulates an additional $100 of earnings
and profits. On December 31, year 5, DC1 sells its stock in FC and DC2 sells
its stock in CFC2.
(ii) Analysis. (A) DC1.
Pursuant to paragraph (b)(2)(iii) of this section, there is $30 of earnings
and profits attributable to the stock of FC sold by DC1. This amount consists
of 60% of the $50 of earnings and profits accumulated by FC after the restructuring
transaction, and none of the earnings and profits accumulated by CFC1, CFC2,
or FC before the restructuring transaction.
(B) DC2. Pursuant to paragraph (b)(3)(ii) of
this section, there is $400 of earnings and profits attributable to the stock
of CFC2 sold by DC2. This amount consists of all of the earnings and profits
accumulated by CFC2 during DC2’s section 1223(2) holding period.
Example 6. Acquisition of the stock
of a foreign corporation that controls a foreign acquiring corporation in
a reorganization described in section 368(a)(1)(C). (i) Facts.
DC1, a domestic corporation, has owned all the stock of CFC1, a foreign corporation,
since its formation on January 1, year 1. CFC1 has owned all the stock of
CFC2, a foreign corporation, since its formation on January 1, year 1. FC,
a foreign corporation that is not a controlled foreign corporation, has owned
all of the stock of FC2, a foreign corporation, since its formation on January
1, year 2. On December 31, year 3, pursuant to a restructuring transaction
that was a triangular reorganization described in section 368(a)(1)(C), CFC1
transfers all of its assets, including the CFC2 stock, to FC2 in exchange
for 60% of the voting stock of FC. CFC1 transferred the voting stock of FC
to DC1 and the CFC1 stock was cancelled. Pursuant to section 1223(1), DC1
is considered to have held the stock of FC since January 1, year 1. Under
section 1223(2), FC2 is considered to have held the stock of CFC2 since January
1, year 1. On December 31, year 3, CFC1 has $100 of earnings and profits,
CFC2 has $300 of earnings and profits, FC has $200 of earnings and profits,
and FC2 has no earnings and profits. From January 1, year 4, until December
31, year 5, FC (now a controlled foreign corporation) accumulates an additional
$50 of earnings and profits. From January 1, year 4 until December 31, year
5, CFC2 accumulates an additional $100 of earnings and profits. FC2, a controlled
foreign corporation after the restructuring transaction, accumulates $100
of earnings and profits from January 1, year 4, until December 31, year 5.
On December 31, year 5, DC1 sells its stock in FC.
(ii) Analysis. Pursuant to paragraphs (b)(2)(ii)
and (b)(4)(iii) of this section, there is $550 of earnings and profits attributable
to the stock of FC sold by DC1. This amount consists of all $400 of the
CFC1 and CFC2 earnings and profits accumulated before the restructuring transaction
(see also section 1248(c)(2)), and 60% of the $250 of the earnings and profits
accumulated by FC, FC2, and CFC2 after the restructuring transaction.
Example 7. Acquisition of controlled
foreign corporation stock by a controlled foreign corporation in a reorganization
described in section 368(a)(1)(B), followed by a sale of the acquired stock
by the acquiring controlled foreign corporation. (i) Facts.
DC1, a domestic corporation, has owned all of the outstanding stock of CFC1,
a foreign corporation, since its formation on January 1, year 1. CFC1 has
owned all of the outstanding stock of CFC3, a foreign corporation, since its
formation on January 1, year 1. DC2, a domestic corporation unrelated to
DC1, has owned all of the outstanding stock of CFC2, a foreign corporation,
since its formation on January 1, year 2. On December 31, year 3, pursuant
to a restructuring transaction that is a reorganization described in section
368(a)(1)(B), CFC1 transfers all of the stock of CFC3 to CFC2 in exchange
for 40% of CFC2’s stock. On December 31, year 3, CFC2 and CFC3 have,
respectively, $40 and $20 of earnings and profits. On December 31, year 5,
when the accumulated earnings and profits of CFC3 are $50 ($20 of earnings
and profits as of December 31, year 3, plus $30 of earnings and profits generated
from January 1, year 4, through December 31, year 5), CFC2 sells the stock
of CFC3 in a transaction to which section 964(e) applies.
(ii) Analysis. (A) CFC2.
Pursuant to paragraph (b)(3)(ii) of this section, there is $50 of earnings
and profits attributable to the CFC3 stock sold by CFC2. This amount consists
of the accumulated earnings and profits attributable to CFC2’s entire
section 1223(2) holding period in the CFC3 stock.
(B) CFC1, DC2, and DC1. Under paragraph (b)(5)
of this section, the earnings and profits attributable to the CFC2 stock held
by CFC1 and DC2, and the earnings and profits attributable to the CFC1 stock
held by DC1, will be reduced (regardless of whether CFC2 recognizes gain on
its sale of CFC3 stock).
(1) CFC1. The earnings and
profits attributable to the CFC2 stock held by CFC1 will be reduced by $32,
or the amount of earnings and profits as of December 31, year 5, that would
have been attributable to the CFC2 stock held by CFC1 pursuant to paragraph
(b)(2)(ii) of this section. This amount consists of all of the $20 of earnings
and profits accumulated by CFC3 before the restructuring transaction and 40%
of the $30 of earnings and profits accumulated by CFC3 after the restructuring
transaction (.40 X $30 = $12).
(2) DC1. The earnings and
profits attributable to the CFC1 stock held by DC1 will also be reduced by
$32, or the amount of earnings and profits that would have been attributable
to the CFC1 stock held by DC1 as of December 31, year 5.
(3) DC2. The earnings and
profits attributable to the CFC2 stock held by DC2 will be reduced by $18,
or the amount of earnings and profits that would have been attributable to
the CFC2 stock held by DC2 as of December 31, year 5, under paragraph (b)(4)
of this section. This amount consists of 60% of the $30 (.60 X $30 = $18)
of earnings and profits accumulated by CFC3 after the restructuring transaction.
(C) Partial sale by CFC2. If, instead of selling
100% of the CFC3 stock, on December 31, year 5, CFC2 sells only 50% of its
CFC3 stock, paragraph (b)(5) of this section requires CFC1 to reduce the earnings
and profits of CFC3 attributable to its CFC2 stock to $16. Similarly, DC1
would be required to reduce the earnings and profits of CFC3 attributable
to its CFC1 stock by $16. Paragraph (b)(5) of this section also requires
DC2 to reduce the CFC3 earnings and profits attributable to its CFC2 stock
by $9. These reductions occur without regard to whether CFC2 recognizes gain
on its sale of CFC3 stock.
Example 8. Acquisition of the assets
of a lower-tier controlled foreign corporation by an upper-tier controlled
foreign corporation in a restructuring transaction described in section 368(a)(1)(C).
(i) Facts. DC, a domestic corporation, has owned all
the stock of CFC1, a controlled foreign corporation, since its formation on
January 1, year 1. CFC1 is a holding company that has owned 79% of the stock
of CFC2, a controlled foreign corporation, since its formation on January
1, year 1. The other 21% of CFC2 stock is owned by X, an unrelated party.
On December 31, year 1, CFC2 has $200 of earnings and profits. On December
31, year 1, CFC1 has no accumulated earnings and profits. On December 31,
year 1, pursuant to a restructuring transaction described in section 368(a)(1)(C),
CFC2 transfers all its properties to CFC1. In exchange, CFC1 assumes the
liabilities of CFC2 and transfers to CFC2 voting stock representing 21% of
the stock of CFC1. CFC2 distributes the voting stock to X and liquidates.
The liabilities assumed do not exceed 20% of the value of the properties
of CFC2. From January 1, year 2, to December 31, year 3, CFC1 accumulates
$100 of earnings and profits. On December 31, year 3, DC sells its CFC1 stock.
(ii) Analysis. Pursuant to paragraphs (b)(4)(ii)
of this section, there is $237 of earnings and profits attributable to DC’s
CFC1 stock. This amount consists of 79% of CFC2’s $200 of earnings
and profits accumulated before the restructuring transaction (see section
1248(c)(2)), and 79% of CFC1’s $100 of earnings and profits accumulated
after the restructuring transaction. Pursuant to paragraph (b)(6) of this
section, none of CFC2’s $200 of earnings and profits to which CFC1 succeeded
under section 381 would be attributable to DC’s CFC1 stock.
(c) Earnings and profits attributable to stock of a foreign
distributee corporation that is a foreign corporate shareholder with respect
to a foreign liquidating corporation—(1) General
rule. If a foreign corporation (liquidating corporation) makes
a distribution of property in complete liquidation under section 332 to a
foreign corporation (distributee), and immediately before the liquidation
the distributee was a foreign corporate shareholder with respect to the liquidating
foreign corporation, the amount of earnings and profits attributable to the
distributee stock, upon its subsequent sale or exchange will be determined
under this paragraph (c)(1). The earnings and profits attributable will be
the sum of the earnings and profits attributable to the stock of the distributee
immediately before the liquidation (including amounts attributed under section
1248(c)(2)) and the earnings and profits attributable to the stock of the
distributee accumulated after the liquidation (including amounts attributed
under section 1248(c)(2)).
(2) Special rule regarding section 381. Solely
for purposes of determining the earnings and profits (or deficit in earnings
and profits) attributable to stock under this paragraph (c), the attributed
earnings and profits of a corporation shall not include earnings and profits
that are treated as received or incurred pursuant to section 381(c)(2)(A)
and §1.381(c)(2)-1(a).
(3) Example. (i) Facts.
DC, a domestic corporation, has owned all of the stock of CFC1, a foreign
corporation, since its formation on January 1, year 1. CFC1 is an operating
company that has owned all of the stock of CFC2, a foreign corporation, since
its formation on January 1, year 1. On December 31, year 2, CFC1 has $200
of accumulated earnings and profits and CFC2 has a ($200) deficit in earnings
and profits. On December 31, year 2, CFC2 distributes all of its assets and
liabilities to CFC1 in a liquidation to which section 332 applies. From January
1, year 3, until December 31, year 4, CFC1 accumulates no additional earnings
and profits. On December 31, year 4, DC sells its stock in CFC1.
(ii) Analysis. Pursuant to paragraph (c)(1) of
this section, there are no earnings and profits attributable to DC’s
CFC1 stock. This amount consists of the sum of the earnings and profits
attributable to the CFC1 stock immediately before the liquidation (100% of
the $200 accumulated earnings and profits of CFC1 and 100% of CFC2’s
($200) deficit in earnings and profits) and the amount of earnings and profits
accumulated after the section 332 liquidation (see also section 1248(c)(2)).
(d) Effective date. This section applies to income
inclusions that occur on or after the date these regulations are published
as final regulations in the Federal Register.
Mark E. Matthews, Deputy
Commissioner for Services and Enforcement.
Note
(Filed by the Office of the Federal Register on June 1, 2006, 8:45 a.m.,
and published in the issue of the Federal Register for June 2, 2006, 71 F.R.
31985)
The principal authors of the proposed regulations are Michael I. Gilman
of the Office of Associate Chief Counsel (International) and Mark R. Pollard,
formerly of the Office of Associate Chief Counsel (International). However,
other personnel from the Treasury Department and the IRS participated in their
development.
* * * * *
Internal Revenue Bulletin 2006-27
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