[Federal Register Volume 59, Number 13 (Thursday, January 20, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-666]


[[Page Unknown]]

[Federal Register: January 20, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[T.D. 8516]
RIN 1545-AS29

 

Revisions of the Section 338 Consistency Rules With Respect to 
Target Affiliates That Are Controlled Foreign Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: These amendments to the income regulations revise the 
consistency rules under section 338 of the Internal Revenue Code of 
1986 applicable to certain cases involving controlled foreign 
corporations. This action is necessary to simplify and update the 
existing regulations. These regulations are substantially identical to 
the consistency rules applicable to controlled foreign corporations 
contained in recent proposed regulations. The regulations would affect 
taxpayers that own controlled foreign corporations. The text of these 
temporary regulations also serves as the text of the proposed 
regulations set forth in the notice of proposed rulemaking on this 
subject in the Proposed Rules section of this issue of the Federal 
Register.

DATES: These regulations are effective on January 20, 1994.
    For applicability of these regulations, see ``Effective Dates'' 
under the SUPPLEMENTARY INFORMATION portion of the preamble.

FOR FURTHER INFORMATION CONTACT: Kenneth D. Allison at (202) 622-3860 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    A notice of proposed rulemaking was published on January 14, 1992, 
in the Federal Register (57 FR 1409) under section 338 of the Internal 
Revenue Code. See 1992-1 C.B. 1000. The notice provided rules to 
replace the asset and stock consistency rules of Secs. 1.338-4T and 
1.338-5T. The notice included consistency rules applicable to certain 
cases involving controlled foreign corporations (CFCs). Comments on the 
notice were received and a public hearing was held on March 26, 1992. 
After considering the comments and statements made at the hearing, 
those proposed regulations, with the exception of certain consistency 
rules applicable to controlled foreign corporations, were adopted as 
revised by Treasury Decision 8515, published elsewhere in this issue of 
the Federal Register, and the corresponding temporary regulations were 
removed.
    Several comments were received concerning the international 
consistency rules. Some comments questioned the need to apply the 
carryover basis rules to an asset disposed of by a CFC while also 
adjusting the basis in the stock of the CFC. Other comments questioned 
the propriety of imposing consistency requirements on foreign assets 
held by CFCs, which are frequently sold in the context of an 
acquisition for foreign tax planning purposes.
    No changes were in response to the comments received. Elimination 
of either the carryover basis rule for assets or the adjustment to CFC 
stock basis would complicate the regulation by requiring additional 
anti-avoidance rules to ensure collection of the appropriate amount of 
tax. In view of the complexity of the issues involved, the Service 
intends to continue studying the international consistency rules and 
may make further changes to the rules if warranted. However, in view of 
the need for immediate guidance, these rules are being issued as 
temporary regulations.

Need for Temporary Regulations

    The provisions contained in this Treasury decision are needed 
immediately to provide guidance to the public with respect to the 
international consistency rules under section 338. Therefore, it is 
found impractical and contrary to public interest to issue this 
Treasury decision with prior notice under section 553(b) of Title 5 of 
the United States Code. In addition, the previously published proposed 
regulations cannot be finalized, as certain issues relating to the 
operation and scope of these regulations are being studied.

Explanation of Provisions

    The temporary and proposed regulations under Sec. 1.338-4T(h) are 
substantially identical to the previously proposed regulations. The 
preamble to the previously proposed regulations contains a discussion 
of the provisions.
    References to new section 951(a)(1)(C) of the Internal Revenue Code 
have been added to paragraph (h)(2) of this section to incorporate the 
effect of new section 956A (Sec. 13231, Public Law 103-66, 107 Stat. 
312, 495) on the consistency rules.
    References to section 1291 have been added in various paragraphs of 
this section to clarify that an amount otherwise treated as a dividend 
under section 1248 does not lose its character for purposes of these 
regulations, where section 1248 is overridden by section 1291. The 
references to section 1291 in this context contemplate the application 
of the consistency rules to the full amount that is subject to section 
1291(g)(2)(C). See also, Sec. 1.1291-5(e) of the proposed regulations. 
In addition, a provision was added to paragraph (h)(2)(ii) of this 
section to deny a stock basis increase where there is an indirect 
disposition by a domestic target or target affiliate of a section 1291 
fund that is subject to the consistency rules. See Sec. 1.1291-
3(e)(4)(iii) of the proposed regulations.

Effective Dates

    These regulations are generally effective for targets with 
acquisition dates on or after January 20, 1994. Taxpayers may elect to 
apply these regulations, together with section 338 regulations issued 
as temporary and final regulations elsewhere in the Federal Register, 
to a target with an acquisition date on or after January 14, 1992, and 
before January 20, 1994.

Special Analyses

    It has been determined that this temporary regulation is not a 
significant regulatory action as defined in Executive Order 12866. It 
also has been determined that section 553(b) of the Administrative 
Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act 5 
U.S.C. chapter 6) do not apply to these regulations, and therefore, a 
Regulatory Flexibility Analysis is not required. Pursuant to section 
7805(f) of the Internal Revenue Code, a copy of these temporary 
regulations will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Kenneth D. Allison of 
the Office of Associate Chief Counsel (International), within the 
Office Chief Counsel, Internal Revenue Service. However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List and Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1, is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * * Section 1.338-4T(h) also issued 
under 26 U.S.C. 338. * * *
    Par 2. Section 1.338-4T is revised to read as follows:


Sec. 1.338-4T  Asset and stock consistency (temporary).

    (a) through (g) [Reserved]
    (h) Consistency for target affiliates that are controlled foreign 
corporations--(1) In general. This paragraph (h) applies only if target 
is a domestic corporation. See Sec. 1.338-4(g) for additional rules 
that may apply with respect to controlled foreign corporations. The 
definitions and nomenclature of Sec. 1.338-1 (b) and (c) and 
Sec. 1.338-4(e), apply for purposes of this section.
    (2) Income or gain resulting from asset dispositions--(i) General 
rule. Income or gain of a target affiliate that is a controlled foreign 
corporation from the disposition of an asset is not reflected in the 
basis of target stock under Sec. 1.338-4(c) unless the income or gain 
results in an inclusion under section 951(a)(1)(A), 951(a)(1)(C), 1291 
or 1293.
    (ii) Basis of controlled foreign corporation stock. If, by reason 
of paragraph (h)(2)(i) of this section, the carryover basis rules of 
Sec. 1.338-4 apply to an asset, no increase in basis in the stock of a 
controlled foreign corporation under section 961(a) or 1293(d)(1), or 
under regulations issued pursuant to section 1297(b)(5), is allowed to 
target or a target affiliate to the extent the increase is attributable 
to income or gain described in paragraph (h)(2)(i) of this section. A 
similar rule applies to the basis of any property by reason of which 
the stock of the controlled foreign corporation is considered owned 
under section 958(a)(2) or 1297(a).
    (iii) Operating rule. For purposes of this paragraph (h)(2)--
    (A) If there is an income inclusion under section 951(a)(1) (A) or 
(C), the shareholder's income inclusion is first attributed to the 
income or gain of the controlled foreign corporation from the 
disposition of the asset to the extent of the shareholder's pro rata 
share of such income or gain; and
    (B) Any income or gain under section 1293 is first attributed to 
the income or gain from the disposition of the asset to the extent of 
the shareholder's pro rata share of the income or gain.
    (3) Stock issued by target affiliate that is a controlled foreign 
corporation. The exception to the carryover basis rules of Sec. 1.338-4 
provided in Sec. 1.338-4(d)(2)(iii) does not apply to stock issued by a 
target affiliate that is a controlled foreign corporation. After 
applying the carryover basis rules of this section to the stock, the 
basis in the stock is increased by the amount treated as a dividend 
under section 1248 on the disposition of the stock (or that would have 
been so treated but for section 1291).
    (4) Certain distributions--(1) General rule. In the case of a 
target affiliate that is a controlled foreign corporation, Sec. 1.338-
4(g) applies with respect to the target affiliate by treating any 
reference to a dividend to which section 243(a)(3) applies as a 
reference to any amount taken into account under Sec. 1.1502-32 in 
determining the basis of target stock that is--
    (A) A dividend;
    (B) An amount treated as a dividend under section 1248 (or that 
would have been so treated but for section 1291); or
    (C) An amount included in income under section 951(a)(1)(B).
    (ii) Basis of controlled foreign corporation stock. If the 
carryover basis rules of this section apply to an asset, the basis in 
the stock of the controlled foreign corporation (or any property by 
reason of which the stock is considered owned under section 958(a)(2)) 
is reduced by the sum of any amounts that are treated, solely by reason 
of the disposition of the asset, as a dividend, amount treated as a 
dividend under section 1248 (or that would have been so treated but for 
section 1291), or amount included in income under section 951(a)(1)(B).
    (5) Examples. This paragraph (h) may be illustrated by the 
following examples:

    Example 1. Stock of target affiliate that is a CFC. (a) The S 
group files a consolidated return; however, T2 is a controlled 
foreign corporation. On December 1 of Year 1, T1 sells the T2 stock 
to P and recognizes gain. On January 2 of Year 2, P makes a 
qualified stock purchase of T from S. No section 338 election is 
made for T.
    (b) Under Sec. 1.338-4(b)(1), Sec. 1.338-4(d) applies to the T2 
stock. Under paragraph (h)(3) of this section, Sec. 1.338-
4(d)(2)(iii) does not apply to the T2 stock. Consequently, 
Sec. 1.338-4(d)(1) applies to the T2 stock. However, after applying 
Sec. 1.338-4(d)(1), P's basis in the T2 stock is increased by the 
amount of T1's gain on the sale of the T2 stock that is treated as a 
dividend under section 1248. Because P has a carryover basis in the 
T2 stock, the T2 stock is not considered purchased within the 
meaning of section 338(h)(3) and no section 338 election may be made 
for T2.
    Example 2. Stock of target affiliate CFC; inclusion under 
subpart F. (a) The S group files a consolidated return; however, T2 
is a controlled foreign corporation. On December 1 of Year 1, T2 
sells an asset to P and recognizes subpart F income that results in 
an inclusion in T1's gross income under section 951(a)(1)(A). On 
January 2 of Year 2, P makes a qualified stock purchase of T from S. 
No section 338 election is made for T.
    (b) Because gain from the disposition of the asset results in an 
inclusion under section 951(a)(1)(A), the gain is reflected in the 
basis of the T stock as of T's acquisition date. See paragraph 
(h)(2)(i) of this section. Consequently, under Sec. 1.338-4(b)(1), 
Sec. 1.338-4(d)(1) applies to the asset. In addition, under 
paragraph (h)(2)(ii) of this section, T1's basis in the T2 stock is 
not increased under section 961(a) by the amount of the inclusion 
that is attributable to the sale of the asset.
    (c) If, in addition to making a qualified stock purchase of T, P 
acquires the T2 stock from T1 on January 1 of Year 2, the results 
are the same for the asset sold by T2. In addition, under paragraph 
(h)(2)(ii) of this section, T1's basis in the T2 stock is not 
increased by the amount of the inclusion that is attributable to the 
gain on the sale of the asset. Further, under paragraph (h)(3) of 
this section, Sec. 1.338-4(d)(1) applies to the T2 stock. However, 
after applying Sec. 1.338-4(d)(1), P's basis in the T2 stock is 
increased by the amount of T1's gain on the sale of the T2 stock 
that is treated as a dividend under section 1248. Finally, because P 
has a carryover basis in the T2 stock, the T2 stock is not 
considered purchased within the meaning of section 338(h)(3) and no 
section 338 election may be made for T2.
    (d) If P makes a qualified stock purchase of T2 from T1, rather 
than of T from S, and T1's gain on the sale of T2 is treated as a 
dividend under section 1248, under paragraph (h)(1) of this section, 
paragraphs (h)(2) and (3) of this section do not apply because there 
is no target that is a domestic corporation. Consequently, the 
carryover basis rules of Sec. 1.338-4 do not apply to the asset sold 
by T2 or the T2 stock.
    Example 3. Gain reflected by reason of section 1248 dividend; 
gain from non-subpart F asset. (a) The S group files a consolidated 
return, however, T2 is a controlled foreign corporation. In Years 1 
through 4, T2 does not pay any dividends to T1 and no amount is 
included in T1's income under section 951(a)(1)(B). On December 1 of 
Year 4, T2 sells an asset with a basis of $400,000 to P for 
$900,000. T2's gain of $500,000 is not subpart F income. On December 
15 of Year 4, T1 sells T2, in which it has a basis of $600,000, to P 
for $1,600,000. Under section 1248, $800,000 of T1's gain of 
$1,000,000 is treated as a dividend. However, in the absence of the 
sale of the asset by T2 to P, only $300,000 would have been treated 
as a dividend under section 1248. On December 30 of Year 4, P makes 
a qualified stock purchase of T1 from T. No section 338 election is 
made for T1.
    (b) Under paragraph (h)(4) of this section, Sec. 1.338-4(g)(2) 
applies by reference to the amount treated as a dividend under 
section 1248 on the disposition of the T2 stock. Because the amount 
treated as a dividend is taken into account in determining T's basis 
in the T1 stock under Sec. 1.1502-32, the sale of the T2 stock and 
the deemed dividend have the effect of a transaction described in 
Sec. 1.338-4(g)(1). Consequently, Sec. 1.338-4(d)(1) applies to the 
asset sold by T2 to P and P's basis in the asset is $400,000 as of 
December 1 of Year 4.
    (c) Under paragraph (h)(3) of this section, Sec. 1.338-4(d)(1) 
applies to the T2 stock and P's basis in the T2 stock is $600,000 as 
of December 15 of Year 4. Under paragraphs (h)(3) and (4)(ii) of 
this section, however, P's basis in the T2 stock is increased by 
$300,000 (the amount of T1's gain treated as a dividend under 
section 1248 ($800,000), other than the amount treated as a dividend 
solely as a result of the sale of the asset by T2 to P ($500,000) to 
$900,000.

    (i) and (j) [Reserved]
    (k) Effective dates. Except as provided in Sec. 1.338(i)-1(b) 
(allowing elective retroactive application of this section in limited 
cases), this section is effective for targets with acquisition dates on 
or after January 20, 1994. As provided in Sec. 1.338(i)-1(b), this 
section may be applied electively to a target with an acquisition date 
on or after January 14, 1992, and before January 20, 1994.
Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: December 22, 1993.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-666 Filed 1-12-94; 2:54 pm]
BILLING CODE 4830-01-U