[Federal Register Volume 61, Number 158 (Wednesday, August 14, 1996)]
[Rules and Regulations]
[Pages 42165-42178]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-20663]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8682]
RIN 1545-AU23


Treatment of Section 355 Distributions by U.S. Corporations to 
Foreign Persons

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: These temporary regulations amend the Income Tax Regulations 
relating to the distribution of stock and securities under section 355 
of the Internal Revenue Code of 1986 by a domestic corporation to a 
person that is not a United States person. These regulations are 
necessary to implement section 367(e)(1) as added by the Tax Reform Act 
of 1986. The text of these 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.

EFFECTIVE DATE: These regulations are effective September 13, 1996.

FOR FURTHER INFORMATION CONTACT: Philip L. Tretiak at (202) 622-3860 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These regulations are being issued without prior notice and public 
procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). 
For this reason, the collection of information contained in these 
regulations has been reviewed and, pending receipt and evaluation of 
public comments, approved by the Office of Management and Budget under 
control number 1545-1487. Responses to this collection of information 
are required in order for a U.S. corporation that distributes domestic 
stock or securities to a foreign person to qualify for an exception to 
the general rule of taxation provided by the regulations under section 
367(e)(1).
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On January 16, 1990, temporary regulations under section 367(e)(1) 
and 367(e)(2) were published in the Federal

[[Page 42166]]

Register (55 FR 1406). A cross-referenced Notice of Proposed Rulemaking 
was published on that same date (55 FR 1472). These regulations were 
proposed to implement section 367(e) of the Internal Revenue Code of 
1986 (Code), as revised by sections 631(d)(1) and 1810(g) of the Tax 
Reform Act of 1986 (100 Stat. 2085, 2272, Public Law 99-514 [1986-3 
C.B. (Vol. 1) 1, 189, 745]). On January 15, 1993, final regulations 
under section 367(e)(1) were published in the Federal Register.

Need for Temporary Regulations

    Under the current regulations, in certain circumstances the gain 
recognition exception may be dependent on the form rather than the 
substance of a taxpayer's transaction. As a result, certain taxpayers 
may be subject to strict restrictions under this exception, while other 
taxpayers arguably may avoid the restrictions by structuring their 
transactions in a different fashion (even though the substance of the 
transactions is similar). Based on these considerations, it is 
determined that immediate regulatory guidance will ensure the efficient 
administration of the tax laws and that it would be impracticable and 
contrary to the public interest to issue this Treasury decision with 
prior notice under section 553(b).

Explanation of Provisions

    Section 355 provides that, if certain requirements are met, a 
distributing corporation (Distributing) does not recognize gain or loss 
on the distribution of the stock or securities of a controlled 
corporation (Controlled) to Distributing's shareholder or shareholders 
(Distributee(s)). However, section 367(e)(1) provides that, in the case 
of any distribution described in section 355 (or so much of section 356 
as relates to section 355) by a domestic corporation to a Distributee 
who is not a United States person (an outbound section 355 
distribution), to the extent provided in regulations, gain shall be 
recognized under principles similar to the principles of section 367.
    The existing regulations under section 367(e)(1) provide different 
tax treatment to Distributing in an outbound section 355 distribution 
depending upon whether Controlled is a foreign corporation or a 
domestic corporation. If Controlled is a foreign corporation, an 
outbound section 355 distribution by Distributing is taxable, with no 
exceptions. If Controlled is a domestic corporation, however, the 
existing regulations provide that the distribution is taxable, but 
permit three exceptions: (i) a FIRPTA exception in cases where both 
Distributing and Controlled are U.S. real property holding corporations 
(as defined in section 897(c)(2)) at the time of the distribution, (ii) 
a publicly traded exception in certain cases where Distributing is 
publicly traded in the United States at the time of the distribution, 
and (iii) a gain recognition agreement (GRA) exception described in 
detail below.
    The new temporary regulations retain the general framework of the 
existing regulations by permitting no exceptions in the case of an 
outbound section 355 distribution of foreign stock and the same three 
exceptions in the case of an outbound section 355 distribution of 
domestic stock. However, the new temporary regulations substantially 
modify the GRA exception.
    The temporary regulations retain many of the provisions from the 
existing regulations. However, the IRS and Treasury have decided to 
reissue all of the regulations under section 367(e)(1) as temporary 
regulations to obtain a uniform set of regulations.

GRA Exception Under the Existing Regulations

    The GRA exception in the existing regulations contains a number of 
specific requirements, all of which must be satisfied for the 
distributing corporation to defer taxation under the exception.
    In general, if Distributee is a resident of a country that has an 
income tax treaty with the United States and meets certain other 
requirements, Distributing can defer its gain by entering into a GRA. 
Under the GRA, if a (foreign) Distributee sells all or a portion of the 
stock of either Distributing or Controlled within 60 months after the 
close of the taxable year in which the distribution occurs, 
Distributing agrees to amend its return and include the deferred gain 
in income based upon the proportion of the stock that is sold by 
Distributee. Thus, for example, if Distributee sells 10 percent of its 
stock of Distributing or Controlled, Distributing is required to amend 
its return to include 10 percent of the deferred gain. There is no 
special rule (i.e., no full trigger of the deferred gain) if 
Distributee sells a substantial amount of its stock of either company. 
In addition, there is no special rule that triggers gain in the case of 
a nonrecognition transaction (such as the issuance of additional stock 
by either Distributing or Controlled to third parties through a public 
offering) that results in a substantial reduction of the percentage of 
stock owned by Distributee(s).
    The existing regulations generally provide that the GRA will not be 
triggered if Distributee transfers the stock of either Distributing or 
Controlled in certain nonrecognition transactions (permitted 
transactions). The transfer of the stock of either company in a 
(second) section 355 distribution, however, is not permitted.
    In the case of a permitted transaction, the existing regulations 
provide special successor-in-interest rules under which the deferred 
gain generally will be taxable unless Distributee maintains a direct or 
indirect 80 percent interest in the stock of Distributing and 
Controlled that it owned immediately after the distribution. For 
example, if Distributing distributed the stock of Controlled in an 
outbound section 355 distribution that qualified for the GRA exception 
and, within the term of the GRA, Distributee then contributed the stock 
of Distributing to a new company (Newco) in a section 351 exchange and 
received 100 percent of Newco, the successor-in-interest rules apply. 
Thus, Distributee generally would be required to maintain an 80 percent 
indirect interest in Distributing. Under these rules, (i) Distributee's 
sale of up to 20 percent of the stock of Newco, or (ii) Newco's sale of 
up to 20 percent of the stock of Distributing would result in a 
corresponding trigger of the deferred gain. The issuance of new stock 
by Newco or Distributing of up to 20 percent to unrelated persons, 
however, would not result in any trigger of the GRA. If, however, Newco 
(or Distributing) issued more than 20 percent of its stock to unrelated 
persons (or any other nonrecognition transaction reduced Distributee's 
indirect interest in Distributing to below 80 percent as a result of a 
nonrecognition transaction), the entire gain would be triggered.

Reasons for Change/Overview of Temporary Regulations

    The treatment of non pro rata outbound section 355 distributions is 
not adequately addressed in the existing regulations. For example, 
assume that a foreign parent (FP) owns all of the stock of 
Distributing, a domestic corporation, which, in turn, owns all of the 
stock of Controlled, also a domestic corporation. Assume that the 
distribution of Controlled by Distributing to FP qualifies for the GRA 
exception. If FP then contributes all of the stock of Distributing to a 
newly formed foreign corporation (Newco), the successor rules would 
apply, and FP would be required to maintain a direct or indirect 80 
percent interest in Distributing.
    The outcome under the existing regulations arguably is 
substantially different, however, if the corporations structured the 
distribution as a non pro

[[Page 42167]]

rata distribution. For example, assume that FP first forms Newco and 
transfers to Newco a percentage of the Distributing stock (the 
percentage equal to the value of Distributing (without the Controlled 
stock) divided by the combined value of Distributing and Controlled) in 
an exchange under section 351. Distributing then distributes the stock 
of Controlled to FP in exchange for FP's stock of Distributing (a non 
pro rata section 355 distribution). After the distribution, FP owns all 
of the stock of Controlled and all of the stock of Newco; Newco owns 
all of the stock of Distributing. Under the existing regulations, FP is 
a Distributee. However, because FP has no direct interest in 
Distributing after the distribution, the regulations effectively treat 
FP as a Distributee only with respect to Controlled. Moreover, because 
Newco does not actually receive stock of Controlled in the distribution 
(even though its percentage ownership interest in Distributing 
increases as a result of the distribution), it is arguably not a 
Distributee with respect to the Distributing stock. As a result, 
because the taxpayer structures the transaction in this manner (rather 
than a section 355 distribution followed by a section 351 exchange as 
in the first hypothetical), if the steps of the transaction are 
respected and in the absence of the application of other sections of 
the Code, Distributing could take the position that there are no 
restrictions in the existing regulations with respect to (i) the sale 
by FP of Newco stock, or (ii) the sale by Newco of Distributing stock.
    To remedy this potential disparity in treatment between pro rata 
and non pro rata distributions, the temporary regulations expand the 
definition of Distributee in the GRA exception (referred to as Foreign 
Distributee under such exception) to include all persons that were 
shareholders of Distributing immediately prior to the distribution. 
Thus, for example, in the second hypothetical above, Newco and FP would 
both be Foreign Distributees. Provided that nonrecognition treatment is 
claimed under the GRA exception with respect to Newco and FP (referred 
to as Qualified Foreign Distributees in the case of Foreign 
Distributees for which nonrecognition may be claimed), the GRA would be 
triggered by either (i) the sale by FP of Newco stock, or (ii) the sale 
by Newco of Distributing stock.
    Second, even in the case of pro rata distributions, the IRS and 
Treasury believe that the results obtained under the existing 
regulations are too dependent upon the form of the transaction. This is 
principally because taxpayers could be subject to the stricter 
successor-in-interest rules if their transactions were structured in a 
particular way, but might be subject to the more liberal distributee 
rules if the order of the steps of the particular transaction are 
reversed.
    In the preamble to the existing regulations, the IRS and Treasury 
stated that the successor-in-interest rules were ``designed to provide 
taxpayers with flexibility to restructure their operations, without 
imposing undue administrative burdens on the Service.'' The IRS 
solicited taxpayer comments on the scope of these rules. A number of 
commentators have stated that the rules are overly restrictive.
    The temporary regulations harmonize the treatment of the 
distributee and successor-in-interest rules in order to minimize the 
importance of the form of a particular transaction. In addition, as 
discussed below, the temporary regulations liberalize the strict 
successor rules by replacing the 80-percent threshold (computed on an 
individual Distributee basis) with a 50-percent threshold (computed 
with reference to all Qualified Foreign Distributees as a group).
    The temporary regulations follow the existing regulations by 
providing that a sale by a Qualified Foreign Distributee of the stock 
of either Controlled or Distributing triggers gain in the same 
proportion as the percentage of stock that is sold. However, the 
temporary regulations provide that a sale by Qualified Foreign 
Distributee(s) of either Distributing or Controlled that results in a 
substantial transformation results in a trigger of the full amount of 
the deferred gain. A substantial transformation is defined as a greater 
than 50-percent (direct or indirect) reduction, on an aggregate basis, 
in either the total voting power or the total value of the stock of 
Controlled or Distributing held by Qualified Foreign Distributee(s) 
immediately after the distribution. The new temporary regulations also 
provide that a nonrecognition transaction that results in a substantial 
transformation (such as the issuance of stock by Distributing or 
Controlled in a public offering) generally causes a trigger of the full 
amount of the deferred gain. No gain will be triggered if a 
nonrecognition transaction does not result in a substantial 
transformation.
    The temporary regulations also expand the types of post-
distribution nonrecognition transactions that are permitted 
transactions to include section 355 distributions. A post-distribution 
section 355 transaction may qualify for nonrecognition treatment if the 
foreign distributee (referred to as a Substitute Distributee) that 
receives stock of Distributing and/or Controlled qualifies as a 
Qualified Foreign Distributee. In such case, the Substitute Distributee 
will replace the initial Qualified Foreign Distributee as the person 
whose ownership interest is considered for purposes of determining 
whether a disposition or substantial transformation has occurred (on a 
cumulative, aggregate basis) with respect to such stock.
    In addition, the temporary regulations provide that foreign persons 
that owned stock or securities of Distributing within two years prior 
to the distribution and that own (directly, indirectly, or 
constructively) 50 percent or more of the stock of Distributing or 
Controlled immediately after the distribution will also be considered 
Foreign Distributees. Thus, for example, if F1, a foreign corporation, 
transfers the stock of US1 to F2 in exchange for all of the stock of F2 
in a section 351 exchange and, within two years after the transfer, US1 
distributes all of the stock of US2, its wholly owned subsidiary, to F2 
in a section 355 exchange, F1 is also treated as a Foreign Distributee 
under this rule. (F1 would have been treated as a Foreign Distributee 
without the operation of this rule if the section 355 distribution 
occurred prior to the section 351 exchange.)
    The IRS and the Treasury also believe that certain procedural 
aspects of the GRA exception need modification. The temporary 
regulations enhance reporting and security requirements, extend the 
term of the GRA from 5 to 10 years, and delete other requirements that 
are believed to be unnecessary in light of the modifications herein.
    To address the security concerns of the IRS resulting from the 
liberalization of the successor-in-interest rules and the expansion of 
permissible post-distribution nonrecognition transactions to include 
section 355 distributions, the assets of Distributing are more closely 
monitored to insure that such corporation has sufficient funds to pay a 
potential tax on the deferred gain. In addition, Controlled must agree 
to be secondarily liable (after Distributing) for the tax on the 
deferred gain.
    Moreover, the new temporary regulations extend the term of the GRA 
from 5 to 10 years in order to conform the GRA term under section 
367(e)(1) to the GRA term under section 367(a). Under section 367(a), 
the GRA term in the case of outbound stock transfers is 10 years when 
U.S. transferors own at least 50 percent of the stock of a foreign 
transferee company. See Sec. 1.367(a)-3T(c)(3) and Notice 87-85 (1987-2 
C.B. 395). The IRS and Treasury believe that

[[Page 42168]]

the GRA term under section 367(e)(1) should be no less than the term 
under section 367(a) when U.S. transferors control the transferee 
because, once the GRA under section 367(e)(1) expires, the sale of 
Distributing or Controlled stock by a Qualified Foreign Distributee 
likely will not be subject to Federal income taxation. In contrast, 
under section 367(a), even if the GRA lapses, an amount approximating 
the deferred gain likely will be subject to Federal income taxation if 
the U.S. transferor later sells the stock of the transferee foreign 
corporation.
    Finally, the IRS and Treasury believe that section 367(e)(1) 
distributions should be subject to some form of section 6038B 
reporting, as are transfers described under sections 367(a) and 367(d). 
Thus, the temporary regulations extend limited section 6038B reporting 
to section 367(e)(1) transactions. The reporting requirements under 
section 6038B will be deemed satisfied in the case of a taxpayer that 
qualifies for one of the three exceptions to taxation under the 
regulations if the taxpayer complies with the applicable reporting 
requirements relating to the relevant exception. This change is also 
intended to extend the statute of limitations under section 6501(c)(8) 
in cases where distributing corporations do not properly report their 
outbound section 355 distributions. Separately, the temporary 
regulations provide new notice and reporting rules in cases where 
Distributing qualifies for either the FIRPTA or publicly traded 
exception.

Specific changes to GRA Exception in Temporary Regulations

    The specific requirements of the GRA exception, as amended, are as 
follows:

(A) Ten or Fewer Qualified Foreign Distributees

    The existing regulations provide that Distributing is permitted to 
claim nonrecognition with respect to 10 or fewer individual or 
corporate foreign distributees. A ruling is required in the case of a 
foreign distributee that holds its interest in Distributing through a 
partnership, trust, or estate (whether foreign or domestic). This 
requirement is unchanged in the temporary regulations.

(B) Active Trade or Business

    The existing regulations provide that, if Distributee is a foreign 
corporation, it must be engaged in an active trade or business. This 
requirement is removed in the temporary regulations.

(C) Value of Distributing

    The existing regulations provide that, immediately after the 
distribution, the value of Distributing must be at least equal to the 
value of the distributed stock and securities. This requirement is 
waived by the existing regulations if Distributing and Controlled are 
members of the same consolidated group at the time of the distribution. 
This requirement is revised in the temporary regulations to provide 
that the value of Distributing (the value of its assets less all of its 
liabilities) must be at least equal to the amount of the deferred gain 
on all testing dates during the GRA period. (Alternatively, 
Distributing may satisfy this test using the adjusted basis of its 
assets instead of fair market value.) A testing date is the last day of 
each taxable year of Distributing and any day in which Distributing 
distributes money or property to its shareholders (regardless of 
whether such distribution is treated as a dividend). The waiver in the 
existing regulations if Distributing and Controlled are members of the 
same consolidated group is eliminated in the temporary regulations.

(D) Treaty Residence

    The existing regulations provide that all Distributees are required 
to be residents of a country that maintains a comprehensive income tax 
treaty with the United States that contains an exchange of information 
provision. This requirement is not changed in the temporary 
regulations.

(E) Continuity of Interest Rule

    The existing regulations provide that the Distributee is required 
to continue to own, for a 60-month period, all of the stock of 
Distributing and Controlled that it owns at the time of the 
distribution. This requirement is maintained, but the period is 
increased to 120 months.

(F) Distributing Must Remain in Existence

    The existing regulations provide that Distributing cannot go out of 
existence pursuant to the distribution. This requirement is maintained 
in the temporary regulations.

(G) GRA

    The existing regulations provide that Distributing is required to 
enter into a 5-year GRA and receive annual certifications from 
Distributees, stating that they continue to own the stock that they 
held immediately after the distribution. The temporary regulations 
increase the GRA term to 10 years.

(H) Annual Certifications

    The existing regulations provide that Distributees must provide 
their certifications directly to Distributing. Under the temporary 
regulations, Controlled also must provide an annual statement to 
Distributing, containing information regarding whether any of its 
Qualified Foreign Distributees have disposed of their stock in 
Controlled during the relevant taxable year.

Special Analyses

    It has been determined that this temporary regulation is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It is hereby certified that this 
regulation does not have a significant impact on a substantial number 
of small entities. This certification is based on the fact that the 
number of corporations that distribute stock or securities to foreign 
persons in transactions that qualify under section 355, and thus become 
subject to the collection of information contained in these 
regulations, is estimated to be only 260 per year. Moreover, because 
these regulations will primarily affect large multinational 
corporations with foreign shareholders, it is estimated that out of the 
260 annual transactions subject to reporting, very few, if any, will 
involve small entities. Therefore, the regulations do not significantly 
alter the reporting or recordkeeping duties of small entities. Thus, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) 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 their impact on small business.

Drafting Information

    The principal author of these regulations is Philip L. Tretiak of 
the Office of Associate Chief Counsel (International), within the 
Office of Chief Counsel, IRS. However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

[[Page 42169]]

Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for Sec. 1.367(e)-1 and adding an entry in numerical 
order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.367(e)-1T also issued under 26 U.S.C. 367(e)(1) * * *


Sec. 1.367  [Amended]

    Par. 2. Sections 1.367(e)-0 and 1.367(e)-1 are removed.
    Par. 3. Sections 1.367(e)-0T and 1.367(e)-1T are added to read as 
follows:


Sec. 1.367(e)-0T  Treatment of section 355 distributions by U.S. 
corporations to foreign persons; table of contents.

    This section lists captioned paragraphs contained in Sec. 1.367(e)-
1T.


Sec. 1.367(e)-1T  Treatment of section 355 distributions by U.S. 
corporations to foreign persons.

(a) Purpose and scope.
(b) Recognition of gain required.
(1) In general.
(2) Computation of gain of the distributing corporation.
(3) Treatment of foreign distributee.
(4) Nonapplication of section 367(a) principles that provide for 
exceptions to gain recognition.
(5) Partnerships, trusts, and estates.
(i) In general.
(ii) Written statement.
(6) Anti-abuse rule.
(c) Nonrecognition of gain.
(1) Distribution by a U.S. real property holding corporation of 
stock in a second U.S. real property holding corporation.
(2) Distribution by a publicly traded corporation.
(i) Conditions for nonrecognition.
(ii) Recognition of gain if foreign distributee owns 5 percent of 
distributing corporation.
(iii) Reporting requirements.
(iv) Timely filed return.
(v) Relation to other nonrecognition provisions.
(3) Distribution of certain domestic stock to 10 or fewer qualified 
foreign distributees.
(i) In general.
(ii) Conditions for nonrecognition.
(iii) Agreement to recognize gain.
(iv) Waiver of period of limitation.
(v) Annual certifications and other reporting requirements.
(vi) Special rule for nonrecognition transactions.
(vii) Recognition of gain.
(viii) Failure to comply.
(d) Other consequences.
(1) Exchange under section 897(e)(1).
(2) Dividend treatment under section 1248.
(3) Distribution of stock of a passive foreign investment company. 
[Reserved]
(4) Reporting under section 6038B.
(e) Examples.
(f) Effective date.


Sec. 1.367(e)-1T  Treatment of section 355 distributions by U.S. 
corporations to foreign persons (temporary).

    (a) Purpose and scope. This section provides rules concerning the 
recognition of gain by a domestic corporation on a distribution that 
qualifies for nonrecognition under section 355 of stock or securities 
of a domestic or foreign corporation to a person who is not a U.S. 
person. Paragraph (b) of this section states as a general rule that 
gain recognition is required on the distribution. Paragraph (c) of this 
section provides exceptions to the gain recognition rule for certain 
distributions of stock or securities of a domestic corporation. 
Paragraph (d) of this section refers to other consequences of 
distributions described in this section. Paragraph (e) of this section 
provides examples of these rules. Finally, paragraph (f) of this 
section specifies the effective date of this section.
    (b) Recognition of gain required--(1) In general. (i) If a domestic 
corporation (distributing corporation) makes a distribution that 
qualifies for nonrecognition under section 355 of stock or securities 
of a domestic or foreign corporation (controlled corporation) to a 
person who is not a qualified U.S. person, then, except as provided in 
paragraph (c) of this section, the distributing corporation shall 
recognize gain (but not loss) on the distribution under section 
367(e)(1). No gain is required to be recognized under this section with 
respect to a distribution to a qualified U.S. person of stock or 
securities that qualifies for nonrecognition under section 355. For 
purposes of this section, a qualified U.S. person is--
    (A) A citizen or resident of the United States; and
    (B) A domestic corporation.
    (ii) In the case of stock or securities owned through a 
partnership, trust, or estate, see paragraph (b)(5) of this section.
    (2) Computation of gain of the distributing corporation. The gain 
recognized by the distributing corporation under paragraph (b)(1) of 
this section shall be equal to the excess of the fair market value of 
the stock or securities distributed to persons who are not qualified 
U.S. persons (determined as of the time of the distribution) over the 
distributing corporation's adjusted basis in the stock or securities 
distributed to such distributees. For purposes of the preceding 
sentence, the distributing corporation's adjusted basis in each unit of 
each class of stock or securities distributed to a distributee shall be 
equal to the distributing corporation's total adjusted basis in all of 
the units of the respective class of stock or securities owned 
immediately before the distribution, divided by the total number of 
units of the class of stock or securities owned immediately before the 
distribution.
    (3) Treatment of distributee. If the distribution otherwise 
qualifies for nonrecognition under section 355, each distributee shall 
be considered to have received stock or securities in a distribution 
qualifying for nonrecognition under section 355, even though the 
distributing corporation may recognize gain on the distribution under 
this section. Thus, the distributee shall not be considered to have 
received a distribution described in section 301 or a distribution in 
an exchange described in section 302(b) upon the receipt of the stock 
or securities of the controlled corporation. Except where section 
897(e)(1) and the regulations thereunder cause gain to be recognized by 
the distributee, the basis of the distributed domestic or foreign 
corporation stock in the hands of the foreign distributee shall be the 
basis of the distributed stock determined under section 358 without any 
increase for any gain recognized by the domestic corporation on the 
distribution.
    (4) Nonapplication of section 367(a) principles that provide for 
exceptions to gain recognition. Paragraph (b)(1) of this section 
requires recognition of gain notwithstanding the application of any 
principles contained in section 367(a) or the regulations thereunder. 
The only exceptions to paragraph (b)(1) of this section are contained 
in paragraph (c) of this section. None of these exceptions applies to 
distributions of stock or securities of a foreign corporation.
    (5) Partnerships, trusts, and estates--(i) In general.
    For purposes of this section, stock or securities owned by or for a 
partnership (whether foreign or domestic) shall be considered to be 
owned proportionately by its partners. In applying this principle, the 
proportionate share of the stock or securities of the distributing 
corporation considered to be owned by a partner of the partnership at 
the time of the distribution shall equal the partner's distributive 
share of gain that would be realized by the partnership from a sale of 
stock of the distributing corporation immediately before the 
distribution (without regard to whether, under the particular facts, 
any gain would actually be realized on the sale

[[Page 42170]]

for U.S. tax purposes), determined under the rules and principles of 
sections 701 through 761 and the regulations thereunder. For purposes 
of this section, stock or securities owned by or for a trust or estate 
(whether foreign or domestic) shall be considered to be owned 
proportionately by the persons who would be treated as owning such 
stock or securities under sections 318(a)(2)(A) and (B). In applying 
section 318(a)(2)(B), if a trust includes interests that are not 
actuarially ascertainable and a principal purpose of the inclusion of 
the interests is the avoidance of section 367(e)(1), all such interests 
shall be considered to be owned by foreign persons. In a case where an 
interest holder in a partnership, trust, or estate that owns stock of 
the distributing corporation is itself a partnership, trust, or estate, 
the rules of this paragraph (b)(5) apply to individuals or corporations 
that own (direct or indirect) interests in the upper-tier partnership, 
trust or estate.
    (ii) Written statement. If, prior to the date on which the 
distributing corporation must file its income tax return for the year 
of the distribution, the corporation obtains a written statement, 
signed under penalties of perjury by an interest holder in a 
partnership, trust, or estate that receives a distribution described in 
paragraph (b)(1) of this section from the corporation, which statement 
certifies that the interest holder is a qualified U.S. person (as 
defined in paragraph (b)(1)(i) of this section), no liability shall be 
imposed under paragraph (b)(1) of this section with respect to the 
distribution to the partnership, trust, or estate to the extent of the 
interest holder's interest in the partnership, trust, or estate, unless 
the distributing corporation knows or has reason to know that the 
statement is false, or it is subsequently determined that the interest 
holder, in fact, was not a qualified U.S. person at the time of the 
distribution. The written statement must set forth the amount of the 
interest holder's proportionate interest in the partnership, trust, or 
estate as determined under paragraph (b)(5)(i) of this section and must 
set forth the amount of such entity's proportionate interest in the 
distributing and controlled corporation, as well as the interest 
holder's name, taxpayer identification number, home address (in the 
case of an individual) or office address and place of incorporation (in 
the case of a corporation). The written statement must be retained by 
the distributing corporation with its books and records for a period of 
three calendar years following the close of the last calendar year in 
which the corporation relied upon the statement.
    (6) Anti-abuse rule. If a domestic corporation is directly or 
indirectly formed or availed of by one or more foreign persons to hold 
the stock of a second domestic corporation for a principal purpose of 
avoiding the application of section 367(e)(1) and the requirements of 
this section, any distribution of stock or securities to which section 
355 applies by such second domestic corporation shall be treated for 
Federal income tax purposes as a distribution to such foreign person or 
persons, followed by a transfer of the stock or securities to the first 
domestic corporation. The qualification of the distribution to the 
foreign person for an exception to the general gain recognition rule of 
paragraph (b)(1) of this section, and the consequences of the transfer 
to the first domestic corporation under this section, shall be 
determined in accordance with all of the facts and circumstances.
    (c) Nonrecognition of gain--(1) Distribution by a U.S. real 
property holding corporation of stock in a second U.S. real property 
holding corporation. Gain shall not be recognized under paragraph (b) 
of this section by a domestic corporation making a distribution that 
qualifies for nonrecognition under section 355 of stock or securities 
of a domestic controlled corporation to a person who is not a qualified 
U.S. person (as defined in paragraph (b)(1)(i) of this section) if the 
conditions specified in paragraphs (c)(1) (i) and (ii) of this section 
are both satisfied:
    (i) Immediately after the distribution, both the distributing and 
controlled corporations are U.S. real property holding corporations (as 
defined in section 897(c)(2)). For the treatment of the distribution 
under section 897, see section 897(e)(1) and the regulations 
thereunder.
    (ii) The distributing corporation attaches to its timely filed 
Federal income tax return for the taxable year in which the 
distribution occurs a statement titled ``Section 367(e)(1)--Reporting 
of Section 355 Distribution by U.S. Real Property Holding 
Corporation'', signed under penalties of perjury by an officer of the 
corporation, disclosing the following information--
    (A) A statement that the distribution is one to which paragraph 
(c)(1) of this section applies; and
    (B) A description of the transaction in which one U.S. real 
property holding corporation distributes the stock of another U.S. real 
property holding corporation in a transaction that is described under 
section 355.
    (iii) For purposes of this paragraph (c)(1), an income tax return 
(including an amended return) will be considered a timely filed Federal 
income tax return if it is filed prior to the time that the Internal 
Revenue Service discovers that the reporting requirements of this 
paragraph have not been satisfied.
    (2) Distribution by a publicly traded corporation--(i) Conditions 
for nonrecognition. Except as provided by paragraph (c)(2)(ii) of this 
section, gain shall not be recognized under paragraph (b) of this 
section by a domestic corporation making a distribution that qualifies 
for nonrecognition under section 355 of stock or securities of a 
domestic controlled corporation to a person who is not a qualified U.S. 
person (as defined in paragraph (b)(1)(i) of this section) if both of 
the following conditions are satisfied:
    (A) Stock of the domestic controlled corporation with a value of 
more than 80 percent of the outstanding stock of the corporation is 
distributed with respect to one or more classes of the outstanding 
stock of the distributing corporation that are regularly traded on an 
established securities market, as defined in Sec. 1.897-1(m) (1) and 
(3), located in the United States. Stock is considered to be regularly 
traded if it is regularly quoted by brokers or dealers making a market 
in such interests. A broker or dealer is considered to make a market 
only if the broker or dealer holds himself out to buy or sell interests 
in the stock at the quoted price.
    (B) The distributing corporation satisfies the reporting 
requirements contained in paragraph (c)(2)(iii) of this section.
    (ii) Recognition of gain if distributee owns 5 percent of 
distributing corporation. If, at the time of the distribution, the 
distributing corporation knows or has reason to know that any 
distributee who is not a qualified U.S. person (as defined in paragraph 
(b)(1)(i) of this section) owns, directly, indirectly, or 
constructively (using the rules of sections 897(c)(3) and (c)(6)(C), 
but subject to the rules of paragraph (b)(5) of this section), more 
than 5 percent (by value) of a class of stock or securities of the 
distributing corporation with respect to which the stock or securities 
of the controlled corporation is distributed (a 5-percent shareholder), 
the distributing corporation will qualify for nonrecognition under 
paragraph (c)(2)(i) of this section if, with respect to such 5-percent 
shareholder, either--

[[Page 42171]]

    (A) The distribution qualifies for nonrecognition under paragraph 
(c)(3) of this section; or
    (B) The distributing corporation recognizes gain (but not loss) on 
the distribution under paragraph (b) of this section.
    (iii) Reporting Requirements. To qualify for nonrecognition 
treatment under paragraph (c)(2)(i) of this section, the distributing 
corporation must attach to its timely filed Federal income tax return, 
for the taxable year in which the distribution occurs a statement 
titled ``Section 367(e)(1)--Reporting of Section 355 Distribution by 
U.S. Publicly Traded Corporation to Foreign Persons,'' signed under 
penalties of perjury by an officer of the corporation, disclosing the 
following information:
    (A) A statement that the distribution is one to which paragraph 
(c)(2) of this section applies.
    (B) A description of the transaction in which the distributing 
corporation that is publicly traded on a U.S. securities market 
distributed stock or securities of a domestic controlled corporation.
    (C) The U.S. securities market on which the stock of the 
distributing corporation is publicly traded.
    (D) A statement that, at the time of the distribution, either--
    (1) The distributing corporation does not know or have reason to 
know that any distributee who is not a qualified U.S. shareholder (as 
defined in paragraph (b)(1)(i) of this section) is a 5-percent 
shareholder; or
    (2) The distributing corporation knows or has reason to know that 
one or more distributees who are not qualified U.S. persons are 5-
percent shareholders, and, that with respect to each such 5-percent 
shareholder, either--
    (i) Gain will not be recognized because the requirements of 
paragraph (c)(3) of this section are satisfied; or
    (ii) Gain (but not loss) will be recognized in accordance with 
paragraph (b) of this section.
    (iv) Timely filed return. For purposes of this paragraph (c)(2), an 
income tax return (including an amended return) will be considered a 
timely filed Federal income tax return if it was received prior to the 
time that the Internal Revenue Service discovers that the reporting 
requirements of this paragraph (c)(2) have not been satisfied.
    (v) Relation to other nonrecognition provisions. If the 
distribution of the stock and securities of the controlled corporation 
also qualifies for nonrecognition under paragraph (c)(1) of this 
section, the distributing corporation shall be entitled to 
nonrecognition under paragraph (c)(1) of this section and not this 
paragraph (c)(2).
    (3) Distribution of certain domestic stock to 10 or fewer qualified 
foreign distributees--(i) In general. (A) Gain shall not be recognized 
under paragraph (b) of this section by a domestic corporation making a 
distribution that qualifies for nonrecognition under section 355 of 
stock or securities of a domestic controlled corporation with respect 
to a foreign distributee (defined in paragraph (c)(3)(i)(B) of this 
section) that is a qualified foreign distributee (defined in paragraph 
(c)(3)(i)(C) of this section), provided that each of the conditions 
contained in paragraph (c)(3)(ii) of this section is satisfied. If one 
or more foreign distributees are not treated as qualified foreign 
distributees, the distributing corporation shall recognize a percentage 
of the gain realized on the distribution, equal to the percentage of 
its stock owned immediately before the distribution, directly or 
indirectly, by foreign distributees who are not qualified foreign 
distributees. See paragraph (b)(5) of this section for rules regarding 
the ownership of stock held by a partnership, trust, or estate.
    (B) For purposes of this paragraph (c)(3), the term foreign 
distributee is any person who is not a qualified U.S. person (as 
defined in paragraph (b)(1)(i) of this section) if such person--
    (1) Owned stock or securities of the distributing corporation 
immediately prior to the distribution;
    (2) Owned stock or securities of the distributing corporation 
within two years prior to the distribution and directly, indirectly, or 
constructively (using the rules of section 318) owns 50 percent or more 
of either the total voting power or the total value of the stock of the 
distributing or controlled corporation immediately after the 
distribution; or
    (3) Is a transferee or substitute distributee, as defined in 
paragraph (c)(3)(vi) (C) or (D) of this section.
    (C) For purposes of this section, except as provided by paragraph 
(c)(3)(i)(D) of this section, the term qualified foreign distributee is 
a foreign distributee that, during the entire period for which the 
agreement to recognize gain (described in paragraph (c)(3)(iii) of this 
section) is in effect with respect to the distributee, is either an 
individual or a corporation (as defined in section 7701(a)(3)), 
resident of a foreign country that maintains a comprehensive income tax 
treaty with the United States which contains an information exchange 
provision. However, no more than ten foreign distributees in total may 
be current or former qualified foreign distributees (including any 
transferee or substitute distributees as defined in paragraph 
(c)(3)(vi) (C) or (D) of this section) during the entire term of the 
gain recognition agreement. See, however, paragraph (c)(3)(vi)(G) of 
this section for special rules applicable to substitute distributees.
    (D) Unless the distributing corporation obtains a ruling from the 
Internal Revenue Service to the contrary, no foreign distributee shall 
be treated as a qualified foreign distributee if it holds its interest 
in the distributing corporation through a partnership, trust or estate, 
characterized as such under the taxation laws of the United States or 
any entity that is treated as fiscally transparent under the taxation 
laws of the foreign country in which it is a resident if such country 
maintains a comprehensive income tax treaty with the United States 
which contains an information exchange provision.
    (ii) Conditions for nonrecognition. A distribution of stock or 
securities described in paragraph (c)(3)(i) of this section to a 
qualified foreign distributee shall not result in the recognition of 
gain if each of the following conditions is satisfied:
    (A) If more than ten foreign distributees, at any time during the 
entire term of the gain recognition agreement, are eligible to be 
qualified foreign distributees, the distributing corporation shall 
designate the foreign distributees to be considered qualified foreign 
distributees for which nonrecognition is claimed under this paragraph 
(c)(3).
    (B) Immediately after the distribution and on each testing date 
beginning after the distribution and during the period that the 
agreement to recognize gain (described in paragraph (c)(3)(iii) of this 
section) is in effect, the value of the distributing corporation (that 
is, the fair market value of the assets of the distributing 
corporation, less all liabilities of the distributing corporation) must 
exceed the amount of gain that the distributing corporation realized, 
but did not recognize (on or after the distribution) under this 
paragraph (c)(3), as a consequence of the distribution with respect to 
qualified foreign distributees. This requirement will be deemed 
satisfied for any testing date upon which the adjusted basis of the 
distributing corporation's assets, less all liabilities of the 
distributing corporation, exceeds the amount of the deferred gain. A 
testing date is--
    (1) The last day of any taxable year of the distributing 
corporation during which the agreement to recognize gain is in effect; 
and

[[Page 42172]]

    (2) Any date upon which the distributing corporation distributes 
property to its shareholders under section 301(a).
    (C) At all times until the close of the 120-month period following 
the end of the taxable year of the distributing corporation in which 
the distribution was made, except under the circumstances and subject 
to the consequences prescribed in paragraphs (c)(3) (vi) and (vii) of 
this section, all qualified foreign distributees must continue to own, 
directly or indirectly, all of the stock and securities of the 
distributing and controlled corporations that the qualified foreign 
distributee owned, directly or indirectly, immediately after the 
distribution (including any stock and securities of the distributing or 
controlled corporation later acquired from the distributing or 
controlled corporation for which the distributee has a holding period 
determined under section 1223 by reference to the stock or securities).
    (D) The distribution of stock or securities described in paragraph 
(c)(3)(i) of this section must not be a distribution pursuant to which 
the distributing corporation goes out of existence.
    (E) The distributing corporation must file an agreement to 
recognize gain, and the controlled corporation must agree to be 
secondarily liable in the event that the distributing corporation does 
not pay the tax due upon a recognition event described in paragraph 
(c)(3)(vii) of this section. The agreement is described in paragraph 
(c)(3)(iii) of this section and filed by the distributing corporation 
with its Federal income tax return for its taxable year in which the 
distribution is made.
    (F) For each of the taxable years of the distributing corporation, 
beginning with the taxable year of the distribution and ending with the 
taxable year that includes the close of the 120-month period following 
the end of the taxable year of the distributing corporation in which 
the distribution was made, all qualified foreign distributees and the 
controlled corporation must provide to the distributing corporation the 
annual certifications described in paragraph (c)(3)(v) of this section, 
and the distributing corporation must file the certifications with its 
tax return.
    (iii) Agreement to recognize gain. The agreement to recognize gain 
required by this paragraph (c)(3)(iii) shall be prepared by or on 
behalf of the distributing corporation and signed under penalties of 
perjury by an authorized officer of the distributing corporation. An 
authorized officer of the controlled corporation must also sign the 
agreement under penalties of perjury, agreeing to extend the statute of 
limitations and accept liability for the tax in the event that the 
distributing corporation fails to pay the tax upon a recognition event. 
The agreement provided by the distributing corporation shall set forth 
the following items, under the heading ``GAIN RECOGNITION AGREEMENT 
UNDER Sec. 1.367(e)-1T(c)(3)(iii)'', with paragraphs labeled to 
correspond with such items:
    (A) A declaration that the distribution is one to which paragraph 
(c)(3) of this section applies.
    (B) A description of each qualified foreign distributee, which 
shall include the qualified foreign distributee's--
    (1) Name;
    (2) Address;
    (3) Taxpayer identification number (if any); and
    (4) Residence and citizenship (in the case of an individual) or 
place of incorporation and country of residence (in the case of a 
qualified foreign distributee that is a corporation for Federal income 
tax purposes under section 7701(a)(3)).
    (C) A description of the stock and securities of the distributing 
and controlled corporations owned (directly or indirectly) by each 
qualified foreign distributee, including--
    (1) The number or amount of shares;
    (2) The type of stock or securities;
    (3) The fair market values of the stock and securities of the 
controlled corporation owned (directly or indirectly) by the qualified 
foreign distributee(s), determined immediately before and immediately 
after the distribution;
    (4) The distributing corporation's adjusted basis (immediately 
before the distribution) in the stock and securities of the controlled 
corporation distributed to the qualified foreign distributees;
    (5) The fair market value of the distributing corporation (fair 
market value of its assets, less all liabilities of the distributing 
corporation) immediately after the distribution. Such amount must 
exceed the amount of gain that the distributing corporation realized, 
but did not recognize under this paragraph (c)(3), on the distribution 
to qualified foreign distributees. Alternatively, the fair market value 
standard will be deemed satisfied if the adjusted basis of the assets 
of the distributing corporation, less all liabilities of the 
distributing corporation, exceeds the amount of the deferred gain.
    (6) For each applicable valuation, a summary of the method 
(including appraisals, if any) used for determining the fair market 
values required by this paragraph (c)(3)(iii).
    (D) The distributing corporation's agreement to recognize gain in 
accordance with paragraph (c)(3)(vii) of this section.
    (E) The controlled corporation's agreement to be secondarily liable 
for the distributing corporation's tax liability, pursuant to the gain 
recognition agreement described in this paragraph (c)(3)(iii).
    (F) A waiver of the period of limitations by both the distributing 
and controlled corporation as described in paragraph (c)(3)(iv) of this 
section.
    (G) An attached statement from each qualified foreign distributee 
declaring that the qualified foreign distributee will provide to the 
distributing corporation the annual certifications described in 
paragraph (c)(3)(v)(A) of this section for each of the taxable years of 
the distributing corporation, beginning with the taxable year of the 
distribution and ending with the taxable year that includes the close 
of the 120-month period following the taxable year of the distributing 
corporation in which the distribution was made. The attached statements 
shall be signed under penalties of perjury by an authorized officer in 
the case of any qualified foreign distributee that is a corporation for 
Federal income tax purposes or by the individual in the case of a 
qualified foreign distributee that is an individual.
    (H) An attached statement from the controlled corporation declaring 
that it will provide to the distributing corporation the annual 
certifications described in paragraph (c)(3)(v)(B) of this section.
    (I) An agreement by the distributing corporation to attach to its 
tax returns the annual certifications of the qualified foreign 
distributees and the controlled corporation described in paragraphs 
(c)(3)(v)(A) and (B) of this section, respectively, and to meet any 
other reporting requirement in accordance with paragraph (c)(3)(v) of 
this section.
    (iv) Waiver of period of limitation. The distributing corporation 
and the controlled corporation must file, with the gain recognition 
agreement described in paragraph (c)(3)(iii) of this section, a waiver 
of the period of limitation on the assessment of tax upon the gain 
realized on the distribution to the qualified foreign distributee(s). 
The waiver shall be executed on Form 8838, substitute form, or such 
other form as may be prescribed by the Commissioner for this purpose 
and shall extend the period for assessment of such tax to a date not 
earlier than the close of the thirteenth full year following the 
taxable year that includes the distribution. A

[[Page 42173]]

properly executed Form 8838, substitute form, or such other form 
authorized by this paragraph (c)(3)(iv) shall be deemed to be consented 
to and signed by a Service Center Director or the Assistant 
Commissioner (International) for purposes of Sec. 301.6501(c)-1(d) of 
this chapter.
    (v) Annual certifications and other reporting requirements. For 
each of the taxable years of the distributing corporation, beginning 
with the taxable year of the distribution and ending with the taxable 
year that includes the close of the 120-month period following the end 
of the taxable year of the distributing corporation in which the 
distribution was made, the distributing corporation must file with its 
Federal income tax return the annual certifications for that year 
described in this paragraph (c)(3)(v).
    (A) Each current qualified foreign distributee must provide to the 
distributing corporation an annual certification, signed under 
penalties of perjury by an authorized officer of the qualified foreign 
distributee that is a corporation or by the qualified foreign 
distributee that is an individual (as the case may be). Each annual 
certification must identify the distribution with respect to which it 
is given by setting forth the date and a summary description of the 
distribution. In the annual certification, the qualified foreign 
distributee must declare that--
    (1) The qualified foreign distributee continues to satisfy 
paragraph (c)(3)(i)(C) of this section; and
    (2) The qualified foreign distributee continues to own, directly or 
indirectly, without interruption, the stock and securities of the 
distributing and controlled corporations (except to the extent the 
stock or securities have been disposed of in a transfer described in 
paragraph (c)(3)(vi) of this section).
    (B) The controlled corporation must provide a certification to the 
distributing corporation, signed under penalties of perjury by an 
authorized officer of the corporation, that lists each current 
qualified foreign distributee holding (directly or indirectly) stock of 
the controlled corporation and its direct or indirect ownership 
interest in the controlled corporation at both the first day and the 
last day of the taxable year for which the distributing corporation 
files its Federal income tax return, and certifies the accuracy of that 
list.
    (C) The distributing corporation must attach to the annual 
certifications described in paragraphs (c)(3)(v)(A) and (B) of this 
section, a statement signed under penalties of perjury by an authorized 
officer of the corporation, in which the corporation declares that, to 
the best of its knowledge, the annual certifications are true.
    (D) The distributing corporation must also attach to the annual 
certifications a separate statement indicating--
    (1) The names and addresses of each current and each former 
qualified foreign distributee;
    (2) The percentage of direct or indirect ownership that the 
qualified foreign distributees retain in the distributing corporation 
at year-end; and
    (3) A certification that the value of the distributing corporation 
(or the adjusted basis of its assets), less all of the liabilities of 
the distributing corporation on all testing dates, exceeded the amount 
of the gain deferred as of the testing date.
    (vi) Special rule for nonrecognition transactions. (A) Gain shall 
not be recognized under paragraph (c)(3)(vii) of this section if the 
distributing or controlled corporation is acquired by a successor-in-
interest (described in paragraph (c)(3)(vi)(B) of this section), or 
upon a direct or indirect disposition by a qualified foreign 
distributee of stock or securities of a distributing or controlled 
corporation (or a successor-in-interest) that is subject to a gain 
recognition agreement described in paragraph (c)(3)(iii) of this 
section, if the requirements of this paragraph (c)(3)(vi) are satisfied 
and the disposition consists of a transfer described in section 332, 
337, 351, 354, 355, 356, or 361 that does not result in a substantial 
transformation (as defined in paragraph (c)(3)(vii)(B) of this 
section). For special rules regarding transfers described in section 
355, see paragraph (c)(3)(vi)(G) of this section.
    (B) For purposes of this section, the term successor-in-interest 
refers to any domestic corporation that acquires the assets of the 
distributing or controlled corporation in a transaction described in 
section 381(a) to which this paragraph (c)(3)(vi) applies.
    (C) For purposes of this section, the term transferee distributee 
refers to:
    (1) Any corporation whose stock or securities are exchanged for the 
stock or securities of the distributing or controlled corporation (or a 
successor-in-interest), or of another transferee distributee, in a 
transaction described in section 351, 354, or sections 361 and 
381(a)(2), to which this paragraph (c)(3)(vi) applies.
    (2) Any corporation that acquires the assets of any qualified 
foreign distributee, transferee distributee or substitute distributee 
in a transaction described in section 381(a).
    (D) For purposes of this section, the term substitute distributee 
refers to any person that acquires the stock or securities of the 
distributing or controlled corporation (or a successor-in-interest), or 
of a qualified foreign distributee, in a section 355 distribution.
    (E) Gain shall not be recognized under paragraph (c)(3)(vii) of 
this section in a transaction involving a transfer of the assets of the 
distributing or controlled corporation to a successor-in-interest, only 
if the following information and agreements are included with the first 
annual certification thereafter filed under paragraph (c)(3)(v) of this 
section:
    (1) A description of the transaction (including a statement of 
applicable Internal Revenue Code provisions, and a description of stock 
or securities transferred, exchanged, or received in the transaction).
    (2) A description of the successor-in-interest (including the name, 
address, taxpayer identification number, and place of incorporation of 
the successor in interest).
    (3) An agreement of the successor-in-interest, signed under 
penalties of perjury by an authorized officer of the successor-in-
interest corporation, to succeed to all of the responsibilities and 
duties of the distributing corporation or the controlled corporation 
(as the case may be) under this paragraph (c)(3) as if the successor-
in-interest were the distributing or controlled corporation.
    (F) Gain shall not be recognized under paragraph (c)(3)(vii) of 
this section in a transaction described in paragraph (c)(3)(vi)(A) of 
this section in which a qualified foreign distributee, directly or 
indirectly, disposes of, and a transferee distributee acquires, stock 
or securities of the distributing or controlled corporation (or a 
successor-in-interest), or another transferee distributee, only if the 
transferee distributee is either a qualified U.S. person or qualifies 
as a qualified foreign distributee under this paragraph (c)(3) and the 
following information and agreements are included with the first annual 
certification thereafter filed under paragraph (c)(3)(v) of this 
section:
    (1) A description of the transaction (including a statement of 
applicable Internal Revenue Code provisions, and a description of the 
stock or securities of the distributing or controlled corporation (or a 
successor-in-interest) owned, directly or indirectly, by qualified 
foreign distributees immediately after the transaction).
    (2) An agreement of the distributing corporation and the controlled 
corporation (amending the agreement described in paragraph (c)(3)(iii) 
of this section), signed under penalties of perjury by an authorized 
officer of the corporation, to recognize gain (in the

[[Page 42174]]

case of the distributing corporation) and to be secondarily liable (in 
the case of the controlled corporation) in accordance with the 
provisions of this paragraph (c)(3) upon the occurrence of a 
disposition, directly or indirectly, by the foreign transferee 
distributee of any stock or securities of the distributing or 
controlled corporation (or a successor-in-interest) (other than a 
disposition that itself satisfies the requirements of this paragraph 
(c)(3)(vi)).
    (3) An agreement of each foreign transferee distributee, signed 
under penalties of perjury by the individual or an authorized officer 
of the corporation, to comply with all of the responsibilities, 
qualifications and duties of a qualified foreign distributee under this 
paragraph (c)(3), with respect to the stock or securities of the 
distributing or controlled corporation (or a successor-in-interest) 
owned, directly or indirectly, by the transferee distributee.
    (G) Gain shall not be recognized under paragraph (c)(3)(vii) of 
this section in the case of a section 355 distribution by a qualified 
foreign distributee of stock or securities of the distributing or 
controlled corporation (or a successor-in-interest), or of another 
qualified foreign distributee. The qualified foreign distributee that 
distributed the stock or securities is no longer required to comply 
with the rules of this section applicable to qualified foreign 
distributees, provided such person no longer has any interest, directly 
or indirectly, in the distributing and controlled corporation. Thus, 
for example, such person is not counted as a qualified foreign 
distributee for purposes of limiting gain recognition to 10 or fewer 
foreign distributees. In order for this provision to apply, the 
substitute distributee must either be a qualified U.S. person or 
satisfy the requirements applicable to qualified foreign distributees 
contained in this paragraph (c)(3) and must include with the first 
annual certification thereafter filed under paragraph (c)(3)(v) of this 
section the following information and agreements:
    (1) A description of the transaction (including a statement of 
applicable Internal Revenue Code sections, and a description of the 
stock or securities distributed in the transaction).
    (2) An agreement of the distributing corporation and the controlled 
corporation (amending the agreement described in paragraph (c)(3)(iii) 
of this section), signed under penalties of perjury by an authorized 
officer of the corporation, to recognize gain (in the case of the 
distributing corporation) and to be secondarily liable (in the case of 
the controlled corporation) in accordance with the provisions of this 
paragraph (c)(3) upon the occurrence of a disposition, directly or 
indirectly, by a foreign substitute distributee of any stock or 
securities received by the substitute distributee in the transaction.
    (3) An agreement of each foreign substitute distributee, signed 
under penalties of perjury by the individual or authorized officer of 
the corporation, to succeed to all of the responsibilities, 
qualifications and duties of a qualified foreign distributee under this 
paragraph (c)(3), with respect to the stock or securities of the 
distributing or controlled corporation (or a successor-in-interest) 
received by such substitute distributee.
    (vii) Recognition of gain. (A) (1) The distributing corporation 
must file, within 90 days of a transaction described in this paragraph 
(c)(3)(vii)(A), an amended return for the year of the distribution and 
recognize gain realized but not recognized upon such distribution, if, 
prior to the close of the 120-month period following the end of the 
taxable year of the distributing corporation in which the distribution 
was made, either--
    (i) A qualified foreign distributee sells (or otherwise disposes 
of) the stock or securities of the distributing or controlled 
corporation that the qualified foreign distributee owned (directly or 
indirectly) (other than pursuant to a transfer described in paragraph 
(c)(3)(vi) of this section); or
    (ii) Any other transaction (e.g., a public offering or 
reorganization) results in a substantial transformation (as defined in 
paragraph (c)(3)(vii)(B) of this section) in either the distributing or 
controlled corporation (or both).
    (2) For purposes of this paragraph (c)(3)(vii)(A), a disposition 
includes, but is not limited to, any disposition treated as a sale or 
exchange under this subtitle (e.g., section 301(c)(3)(A), 302(a), 
351(b) or 356(a)(1)). For the computation of gain in the case of a sale 
(or similar disposition), see paragraph (c)(3)(vii)(C) of this section. 
For the computation of gain in the case of other transactions, see 
paragraphs (c)(3)(vii) (D) and (F) of this section. For special rules 
regarding substitute distributees, see paragraph (c)(3)(vii)(E) of this 
section.
    (B) A transaction is treated as a substantial transformation if, as 
a result of such transaction, the qualified foreign distributees, 
transferee distributees and substitute distributees own, in the 
aggregate, less than 50 percent of either the total voting power or the 
total value of the stock of the distributing or the controlled 
corporation, directly or indirectly, that the qualified foreign 
distributees owned immediately after the distribution.
    (C) In the case of a sale (or similar disposition), directly or 
indirectly, by a qualified foreign distributee of the stock or 
securities of the distributing or controlled corporation (or a 
successor-in-interest) that does not result in a substantial 
transformation, the distributing corporation shall be required to 
recognize a proportionate amount of the gain realized but not 
recognized under this paragraph (c)(3), equal to the percentage of 
stock of the distributing or controlled corporation, as the case may 
be, sold (or otherwise disposed of), directly or indirectly, by the 
qualified foreign distributee. However, if the sale (or other 
disposition) of stock or securities by a qualified foreign distributee 
results in a substantial transformation, the distributing corporation 
(or its successor-in-interest) must recognize the entire deferred gain 
that has not already been recognized under paragraph (c)(3)(vii) of 
this section.
    (D) In the case of a nonrecognition transaction that results in a 
substantial transformation, the distributing corporation must recognize 
the entire deferred gain that has not already been recognized under 
paragraph (c)(3)(vii) of this section. If a nonrecognition transaction 
does not result in a substantial transformation, the distributing 
corporation does not recognize any gain provided that the requirements 
of paragraph (c)(3)(vi) of this section are satisfied.
    (E) A sale (or other disposition), directly or indirectly, by a 
substitute distributee, of all or a portion of the stock or securities 
of the distributing or controlled corporation (or a successor-in-
interest) that the substitute distributee received in the section 355 
distribution shall be treated as a disposition of such stock or 
securities by a qualified foreign distributee (in accordance with 
paragraph (c)(3)(vii)(C) of this section) for purposes of computing 
gain under this paragraph (c)(3)(vii).
    (F) Other transactions or events shall trigger gain under this 
paragraph (c)(3)(vii) as follows:
    (1) If a qualified foreign distributee ceases to satisfy the 
requirements for a qualified foreign distributee contained in paragraph 
(c)(3)(i)(C) of this section (or any other specified requirements in 
paragraph (c)(3) of this section), the qualified foreign distributee 
shall be treated as if it sold all of the stock and securities that it 
owned, directly or indirectly, in the distributing and controlled 
corporation (or a successor-

[[Page 42175]]

in-interest), on the date that such person ceased to meet the 
requirements.
    (2) If a substitute distributee ceases to satisfy the requirements 
for a qualified foreign distributee contained in paragraph (c)(3)(i)(C) 
of this section (or any other specified requirements in paragraph 
(c)(3) of this section), the substitute distributee shall be treated as 
if it sold all of the stock and securities of the distributing or 
controlled corporation (or a successor-in-interest) that it received in 
the distribution, on the date that it ceased to meet the requirements.
    (3) If the distributing corporation (or a successor-in-interest) 
fails to satisfy the requirement contained in paragraph (c)(3)(ii)(B) 
of this section on any testing date during which the agreement to 
recognize gain is in effect, such failure will be treated as if a 
substantial transformation has occurred on such date.
    (4) If either the distributing or controlled corporation (or a 
successor-in-interest) is acquired in a section 381(a) exchange and the 
acquirer is not a successor-in-interest that satisfies the requirements 
of paragraph (c)(3)(vi)(E), such acquisition will be treated as if a 
substantial transformation has occurred on the date of the acquisition.
    (G) A qualified foreign distributee that sells (or otherwise 
disposes of) all of its interest, directly or indirectly, in the 
distributing and controlled corporation ceases thereafter to be a 
qualified foreign distributee. In addition, where one qualified foreign 
distributee owns all of the stock of another qualified foreign 
distributee, and both persons have identical direct or indirect 
interests in the distributing or controlled corporation, the direct or 
indirect sale (or other disposition) by one qualified foreign 
distributee of all of its interest in the distributing or controlled 
corporation (under paragraph (c)(3)(vii) of this section) will 
terminate the qualified foreign distributee status for the second 
qualified foreign distributee. The principles of this paragraph 
(c)(3)(vii) shall generally be applied so that any gain relating to the 
same stock of the distributing or controlled corporation by more than 
one person is not taxed more than once under this paragraph 
(c)(3)(vii). In any event, gain recognized pursuant to this paragraph 
(c)(3)(vii), on a cumulative basis, shall not exceed the amount of gain 
that the distributing corporation would have recognized under section 
367(e)(1) if its initial distribution of the stock or securities of the 
controlled corporation was fully taxable under paragraph (b) of this 
section.
    (H) If additional tax is required to be paid by the distributing 
corporation (or a successor-in-interest) for the year of the 
distribution, interest must be paid by the distributing corporation (or 
the controlled corporation if the distributing corporation fails to pay 
the tax due) on that amount at the rates determined under section 
6621(a)(2) with respect to the period between the date that was 
prescribed for filing the distributing corporation's original income 
tax return for the year of the distribution and the date on which the 
additional tax for that year is paid.
    (I) Net operating losses, capital losses, or credits against tax 
that were available in the year of the distribution and that are unused 
(whether or not they have expired since the distribution) at the time 
of gain recognition described in this paragraph (c)(3)(vii) may be 
applied (respectively) by the distributing corporation against any gain 
recognized or tax owed by reason of this provision, but no other 
adjustments shall be made with respect to any other items of income or 
deduction in the year of distribution or other years.
    (viii) Failure to comply. (A) Except as otherwise provided in 
paragraph (c)(3)(viii)(B) of this section, if the distributing 
corporation or the controlled corporation fails to comply in any 
material respect with the requirements of this paragraph (c)(3) or with 
the terms of an agreement submitted pursuant hereto, or if the 
distributing corporation knows or has reason to know of any failure of 
another person to so comply, the distributing corporation shall treat 
the initial distribution of the stock or securities of the controlled 
corporation as a taxable exchange in the year of the distribution. In 
such event, the period for assessment of tax shall be extended until 
three years after the date on which the Internal Revenue Service 
receives actual notice of such failure to comply.
    (B) If a person fails to comply in any material respect with the 
requirements of this paragraph or with the terms of an agreement 
submitted pursuant thereto, the provisions of paragraph (c)(3)(viii)(A) 
of this section shall not apply if the person is able to show that such 
failure was due to reasonable cause and not willful neglect, provided 
that the person achieves compliance as soon as the person becomes aware 
of the failure. Whether a failure to materially comply was due to 
reasonable cause shall be determined by the district director under all 
the facts and circumstances.
    (d) Other consequences--(1) Exchange under section 897(e)(1). With 
respect to the treatment under section 897(e)(1) of a foreign 
distributee on the receipt of stock or securities of a domestic or 
foreign corporation where the foreign distributee's interest in the 
distributing domestic corporation is a United States real property 
interest, see section 897(e)(1) and the regulations thereunder.
    (2) Dividend treatment under section 1248. With respect to the 
treatment as a dividend of a portion of the gain recognized by the 
domestic corporation on the distribution of the stock of certain 
foreign corporations, see sections 1248(a) and (f) and the regulations 
thereunder.
    (3) Distribution of stock of a passive foreign investment company. 
[Reserved]
    (4) Reporting under section 6038B. Notice shall be required under 
section 6038B with respect to a distribution described in this section. 
See Sec. 1.6038B-1T(e).
    (e) Examples. The rules of paragraphs (b), (c), and (d) of this 
section are illustrated by the examples below. In all examples, assume 
that all foreign companies are treated as corporations for Federal 
income tax purposes and are not treated as fiscally transparent under 
the taxation laws of the relevant foreign country.

    Example 1. (i) FC, a Country Z company, owns all of the 
outstanding stock of DC1, a domestic corporation. DC1 owns all of 
the outstanding stock of DC2, another domestic corporation. The fair 
market value of the DC1 stock is 300x, and FC has a 100x basis in 
the DC1 stock. The fair market value of the DC2 stock is 180x, and 
DC1 has a 80x basis in the DC2 stock. Neither DC1 nor DC2 is a U.S. 
real property holding corporation. Country Z does not maintain an 
income tax treaty with the United States.
    (ii) In a transaction qualifying for nonrecognition under 
section 355, DC1 distributes all of the stock of DC2 to FC. After 
the distribution, the DC1 stock has a fair market value of 120x.
    (iii) Under paragraphs (b) (1) and (2) of this section, DC1 
recognizes gain of 100x, which is the difference between the fair 
market value (180x) and the adjusted basis (80x) of the stock 
distributed. Under paragraph (d)(1) of this section and section 358, 
FC takes a basis of 40x in the DC1 stock, and a basis of 60x in the 
DC2 stock.
    Example 2. (i) C, a citizen and resident of Country F, owns all 
of the stock of DC1, a domestic corporation. DC1, in turn, owns all 
of the stock of DC2, also a domestic corporation. The fair market 
value of the DC1 stock is 500x, and C has a 100x basis in the DC1 
stock. The DC2 stock has a fair market value of 200x, and DC1 has a 
180x basis in the DC2 stock.
    (ii) In a transaction qualifying for nonrecognition under 
section 355, DC1 distributes to C all of the stock of DC2. DC1 and 
DC2 are U.S. real property holding corporations immediately after 
the distribution. After the distribution, the DC1 stock has a fair 
market value of 300x.

[[Page 42176]]

    (iii) Under paragraph (c)(1) of this section, provided that DC1 
complies with the reporting requirements contained in paragraph 
(c)(1)(ii) of this section, DC1 does not recognize gain on the 
distribution of the DC2 stock because DC1 and DC2 are U.S. real 
property holding corporations immediately after the distribution.
    (iv) Under section 897(e) and the regulations thereunder, C is 
considered to have exchanged DC1 stock with a fair market value of 
200x and an adjusted basis of 40x for DC2 stock with a fair market 
value of 200x. Because DC2 is a U.S. real property holding 
corporation, and its stock is a U.S. real property interest, C does 
not recognize any gain under section 897(e) on the distribution. C 
takes a basis of 40x in the DC2 stock, and its basis in the DC1 
stock is reduced to 60x pursuant to section 358.
    Example 3. (i) All of the outstanding common stock of DC, a 
domestic corporation that is not a U.S. real property holding 
corporation, is regularly traded on an established securities market 
located in the United States. None of the foreign shareholders of DC 
(directly, indirectly, or constructively) owns more than five 
percent of the common stock of DC. DC owns all of the stock of DS, a 
domestic corporation. The stock of DS has appreciated in the hands 
of DC.
    (ii) In a transaction qualifying for nonrecognition under 
section 355, DC distributes all of the stock of DS to the common 
shareholders of DC.
    (iii) Under paragraph (c)(2) of this section, DC does not 
recognize gain on the distribution of the DS stock to any foreign 
distributee, provided that DC complies with the reporting 
requirements contained in paragraph (c)(2)(iii) of this section. 
Each shareholder's basis in the DC and DS stock is determined 
pursuant to section 358.
    Example 4. (i) FC, a company resident in Country X, owns all of 
the stock of DC1, a domestic corporation. DC1, in turn, owns all of 
the stock of DC2, a domestic corporation. The fair market value of 
the DC1 stock is 1,000x, and FC has a basis in the DC1 stock of 
800x. The DC2 stock has a fair market value of 500x at the time of 
the distribution, and DC1 has a 100x basis in the DC2 stock. Neither 
DC1 nor DC2 is a U.S. real property holding corporation. Country X 
maintains an income tax treaty with the United States that includes 
an information exchange provision.
    (ii) In a transaction qualifying for nonrecognition under 
section 355, DC1 distributes to FC all of the stock of DC2. 
Immediately after the distribution, the DC1 stock has a fair market 
value of 500x. Thus, the value of DC1 exceeds 400x, the amount of 
the deferred gain on the distribution.
    (iii) Under paragraph (c)(3) of this section, DC1 will not 
recognize gain on the distribution of the DC2 stock to (foreign 
distributee) FC if FC is a qualified foreign distributee (as 
described in paragraph (c)(3)(i)(C) of this section) and DC1 enters 
into a gain recognition agreement (in which DC2 agrees to be 
secondarily liable), as described in paragraph (c)(3)(iii) of this 
section, and DC1, DC2 and FC otherwise comply with all of the 
provisions of paragraph (c)(3) of this section. Pursuant to section 
358, FC will take a 400x basis in the DC2 stock and FC's basis in 
the DC1 stock will be reduced to 400x.
    Example 5. (i) Assume the same facts as in Example 4. In 
addition, two years after DC1's distribution of DC2 stock to FC, FC 
sells 25 percent of the DC2 stock to Y, an unrelated corporation. 
One year later, FC sells an additional 30 percent of its DC2 stock 
to Z, another unrelated corporation.
    (ii) Under paragraph (c)(3)(vii) of this section, upon FC's sale 
of 25 percent of its DC2 stock, DC1 is required to file an amended 
return for the year in which the DC2 stock was distributed to FC, 
and recognize 100x of gain, which represents 25 percent of the gain 
realized but not recognized on the distribution.
    (iii) Upon FC's second sale of 30 percent of its DC1 stock, DC1 
is required to file another amended return for the year of the 
distribution and recognize the balance of the deferred gain, or 
300x, because such sale results in a substantial transformation 
(within the meaning of paragraph (c)(3)(vii)(B) of this section).
    Example 6. (i) Assume the same facts as in Example 5, except 
that FC did not sell an additional 30 percent of its DC2 stock. 
Instead, DC2 issued additional stock in a public offering that 
reduced FC's interest in DC2 to less than 50 percent.
    (ii) The public offering caused a substantial transformation 
because, as a result of the public offering, the interest of FC in 
DC2 was reduced to less than 50 percent of the amount of stock that 
FC owned in DC2 immediately after the distribution. Thus, the result 
is the same as in Example 5.
    Example 7. (i) Assume the same facts as in Example 4 In 
addition, one year after DC1's distribution of DC2 stock to FC, FC 
transfers all of the DC2 stock to FS, a company resident in Country 
X, in exchange for all of the FS stock, in a transaction described 
in section 351.
    (ii) FS is described as a transferee distributee under paragraph 
(c)(3)(vi)(C) of this section. The transfer by FC of DC2 stock to FS 
is a nonrecognition transaction under paragraph (c)(3)(vi) of this 
section provided all of the requirements in paragraph (c)(3)(vi)(F) 
of this section are satisfied. (FS is counted, together with FC, for 
purposes of limiting nonrecognition treatment to up to ten qualified 
foreign distributees during the time that the gain recognition 
agreement is in effect.) DC1 will not recognize gain under the gain 
recognition agreement upon FC's transfer of the stock of DC2 to FS 
if DC1 enters into a new agreement, agreeing to recognize gain if FS 
sells DC2 stock, and the provisions of paragraph (c)(3)(vi) of this 
section are satisfied. A sale by FC of FS stock would be treated as 
a recognition event under paragraph (c)(3)(vii) because such sale 
would constitute an indirect disposition by FC of the DC2 stock.
    Example 8. (i) P1, an entity treated as a partnership for 
Federal income tax purposes, owns all of the outstanding stock of 
DC1, a domestic corporation. DC1 owns all of the outstanding stock 
of DC2, another domestic corporation. The fair market value of the 
DC1 stock is 900x and P1 has an 900x basis in the DC1 stock. The 
fair market value of the DC2 stock is 600x and DC1 has a 400x basis 
in the DC2 stock. Neither DC1 nor DC2 is a U.S. real property 
holding corporation.
    (ii) FC, a company resident in country X, and USP, a U.S. 
corporation, are the sole partners of P1. Under the rules and 
principles of sections 701 through 761, FC is entitled to a 60 
percent, and USP is entitled to a 40 percent, distributive share of 
each item of P1 income and loss. Country X maintains an income tax 
treaty with the United States that includes an information exchange 
provision.
    (iii) In a distribution qualifying for nonrecognition under 
section 355, DC1 distributes all of the stock of DC2 to P1. 
Paragraph (b)(5)(i) of this section provides that stock owned by a 
partnership is considered to be owned proportionately by its 
partners. Under paragraph (b)(5)(ii) of this section, if USP 
certifies to DC1 that it is a qualified U.S. person (and DC1 does 
not know or have reason to know that the certification is false), no 
Federal income tax shall be imposed with respect to the distribution 
by DC1 of DC2 to P1, to the extent of USP's 40 percent interest in 
P1.
    (iv) Paragraph (c)(3)(i)(D) of this section provides that no 
foreign distributee may be treated as a qualified foreign 
distributee with respect to stock of the distributing corporation 
owned through a partnership, unless the distributing corporation 
receives a ruling from the Internal Revenue Service to the contrary. 
Thus, DC1 may not avoid recognition of the remaining 60 percent of 
the realized gain (relating to the interest of P1 owned by FC) by 
entering into a gain recognition agreement pursuant to paragraph 
(c)(3) of this section, unless DC1 obtains a ruling to the contrary.
    Example 9. (i) DC1, a domestic corporation, owns all of the 
stock of DC2, also a domestic corporation. The stock of DC1 is owned 
equally by three shareholders: A, a domestic corporation, B, a U.S. 
citizen, and FB, a Country Y company.
    (ii) A short time before DC1 adopted a plan to distribute the 
stock of DC2 to its shareholders, but after the board of directors 
of DC1 began contemplating the distribution, FB formed Newco, a 
domestic corporation, and contributed its DC1 stock to Newco in a 
transaction qualifying for nonrecognition under section 351. A valid 
business purpose existed for FB's transfer of the DC1 stock to 
Newco, but this purpose would have been fulfilled irrespective of 
whether FB transferred the DC1 stock to Newco before the 
distribution of DC2, or after the distribution of DC2 (in which case 
FB would have transferred the stock of DC1 and DC2 to Newco).
    (iii) Pursuant to paragraph (b)(6) of this section, the District 
Director may determine that FB formed Newco for a principal purpose 
of avoiding section 367(e)(1). In such case, for Federal income tax 
purposes, FB will be treated as having received the stock of DC2 in 
a section 355 distribution, and then as having transferred the stock 
to Newco in a section 351 transaction.
    (iv) If B was not a shareholder of DC1 so that A and FB were 
equal (50 percent) shareholders, FB would be treated as a foreign 
distributee within the meaning of

[[Page 42177]]

paragraph (c)(3)(i)(B) of this section without the application of 
paragraph (b)(6) of this section. In such case, DC1 would recognize 
50 percent of the gain realized on the distribution of the DC2 
stock, unless FB was a qualified foreign distributee within the 
meaning of paragraph (c)(3)(i) of this section and the conditions 
under paragraph (c)(3)(ii) of this section were satisfied.
    Example 10. (i) DC1, a domestic corporation, owns all of the 
stock of DC2, also a domestic corporation. The stock of DC1 is owned 
by FP, a company resident in Country X. Country X maintains in 
income tax treaty with the United States that includes an 
information exchange provision. The DC2 stock has a fair market 
value of 500x at the time of the distribution, and DC1 has a basis 
of 100x in the DC2 stock. The stock of DC1 has a value of 500x 
(excluding DC1's investment in DC2). Neither DC1 nor DC2 is a U.S. 
real property holding corporation.
    (ii) FP forms a holding company resident in Country X, Newco, 
and transfers 50 percent of its DC1 stock to Newco in an exchange 
described in section 351. Immediately after those transactions, DC1 
distributes all of its DC2 stock to FP in exchange for FP's stock of 
DC1 in a transaction described in section 355. Thus, after the non 
pro rata distribution, FP owns all of the stock of DC2, and FP also 
owns all of the stock of Newco, which, in turn, owns all of the 
stock of DC1.
    (iii) Newco and FP are foreign distributees (under paragraph 
(c)(3)(i)(B)(1) of this section) because they owned stock of DC1 
immediately prior to the distribution. Assuming that all of the 
requirements of the gain recognition agreement exception under 
paragraph (c)(3) of this section are satisfied (so that both FP and 
Newco are qualified foreign distributees under paragraph 
(c)(3)(i)(C) of this section), DC1 will not be immediately taxable 
on the 400x gain realized on the distribution of the stock of DC2. 
Gain will be triggered under the gain recognition agreement under 
paragraph (c)(3)(vii) of this section if FP sells stock of Newco 
(because such sale would be an indirect disposition by FP of the 
stock of DC1), if Newco sells stock of DC1, or if FP sells stock of 
DC2.
    Example 11. (i) Assume the same facts as in Example 10, except 
that Newco is a company resident of Country Z, and Country Z does 
not maintain an income tax treaty with the United States that 
includes an information exchange provision.
    (ii) DC1 may still enter into a gain recognition agreement under 
paragraph (c)(3) of this section. Both FP and Newco are foreign 
distributees, but Newco is not a qualified foreign distributee. 
Thus, DC1 must recognize 50 percent, or 200x, of the 400x deferred 
gain on the distribution of DC2 stock. Such (50 percent) portion 
equals the percentage of the DC1 stock owned by foreign distributees 
that are not qualified foreign distributees (the 50 percent of the 
stock owned by Newco). DC1 may defer 50 percent of the gain, with 
respect to the portion of its stock owned by FP, a qualified foreign 
distributee, provided that it meets the requirements of paragraph 
(c)(3) of this section.
    Example 12. (i) FC, a company resident in Country X, owns all of 
the stock of DC1, a domestic corporation (and has owned DC1 for many 
years). Country X maintains an income tax treaty with the United 
States that includes an information exchange provision. DC1, in 
turn, owns all of the stock of DC2, a domestic corporation. DC1 has 
a basis of 200x in the DC2 stock, and the DC2 stock has a value of 
500x. Immediately after the distribution of DC2 described below, DC1 
has a value of more than 300x.
    (ii) DC1 distributes all of the stock of DC2 to FC (a qualified 
foreign distributee) in a transaction described under section 355, 
and satisfies all of the requirements of paragraph (c)(3) of this 
section to qualify for an exception to the general rule of taxation 
under section 367(e)(1). Two years after the initial distribution, 
FC distributes all of the stock of DC2 to its sole shareholder, FP, 
a resident of Country X, in a transaction described under section 
355.
    (iii) Under paragraph (c)(3)(vi)(D) of this section, FP is a 
substitute distributee with respect to the DC2 stock. Provided that 
the requirements of paragraph (c)(3)(vi)(G) of this section are 
satisfied, FP replaces FC as a qualified foreign distributee with 
respect to the DC2 stock (although FC is still a qualified foreign 
distributee with respect to the DC1 stock). FC is no longer required 
to maintain an interest in DC2 for purposes of determining whether a 
substantial transformation occurs. Thus, a sale by FP of the stock 
of FC would not trigger gain under paragraph (c)(3)(vii) of this 
section.
    Example 13. (i) DC1, a domestic corporation, owns all of the 
stock of DC2, also a domestic corporation. The stock of DC1 is owned 
by two shareholders: FP and FX. FP, a company resident in Country Z, 
owns 25 percent of the stock of DC1. FX, a company resident in 
Country X, owns 75 percent of the stock of DC1. Country X maintains 
an income tax treaty with the United States that includes an 
information exchange provision; Country Z does not. The fair market 
value of DC2 is 500x and DC1 has a basis of 100x in the DC2 stock. 
Immediately after the distribution described below, DC1 has a value 
in excess of 400x.
    (ii) FP formed FS, a company resident in Country X, and 
transferred its 25 percent interest in DC1 to FS in exchange for all 
of the stock of FS in an exchange described in section 351. Within 
two years of the exchange, DC1 distributed all of the stock of DC2 
to its shareholders.
    (iii) Under paragraph (c)(3) of this section, DC1 may defer a 
portion of its gain realized on the distribution of DC2. DC1 must 
immediately recognize 25 percent of the realized gain, or 100x, 
because FP, a 25 percent (indirect) shareholder is a foreign 
distributee (within the meaning of paragraph (c)(3)(i)(B) of this 
section), but may not be treated as a qualified foreign distributee 
(within the meaning of paragraph (c)(3)(i)(C) of this section). DC1 
may defer 75 percent of its realized gain if FX is a qualified 
foreign distributee and DC1 enters into a gain recognition agreement 
(in which DC2 agrees to be secondarily liable), and the provisions 
of paragraph (c)(3) of this section are otherwise met. DC1 need not 
include FS as a qualified foreign distributee because FP and FS had 
identical 25 percent ownership interests in DC1, and DC1 is taxable 
with respect to such 25 percent interest. Thus, under paragraph 
(c)(3)(vii)(G) of this section, a sale by FS of its DC1 or DC2 stock 
will not result in an additional trigger of the gain recognition 
agreement under paragraph (c)(3)(vii) of this section.
    (iv) If FP was instead a resident of Country X, DC1 could defer 
its entire realized gain if both FP and FS were qualified foreign 
distributees. In such case, DC1 would have three qualified foreign 
distributees. (DC1 is limited to ten qualified foreign distributees, 
including transferee and substitute distributees during the term of 
the gain recognition agreement.) If FS sold its entire interest in 
either DC1 or DC2, DC1 would be required to amend its Federal income 
tax return for the year of the transfer and include 100x in income. 
In such case, neither FP nor FS would be considered a qualified 
foreign distributee immediately after the sale (and, as a result, 
FP's sale of its FS stock would not trigger additional gain under 
paragraph (c)(3)(vii)(G) of this section). The result would be the 
same if FP sold all of the stock of FS (as such sale is an indirect 
disposition by FP of all its stock of DC1 and DC2). (In such case, 
the sale by FS of its stock of DC1 or DC2 would not trigger 
additional gain under paragraph (c)(3)(vii)(G) of this section.)

    (f) Effective date. This section shall be effective with respect to 
distributions occurring on or after September 13, 1996. However, 
taxpayers may elect to apply the rules of this section with respect to 
distributions occurring on or after December 31, 1995.
    Par. 4. Section 1.6038B-1T is amended by revising the second 
sentence of paragraph (b)(2)(i) and adding the text of paragraph (e) to 
read as follows:


Sec. 1.6038B-1T  Reporting of transfers described in section 367 
(temporary).

* * * * *
    (b) * * *
    (2) * * * (i) * * * For special reporting rules applicable to 
transfers described under section 367(e)(1), see paragraph (e) of this 
section; no reporting is required for transfers described in section 
367(e)(2). * * *
* * * * *
    (e) * * * (1) In general. If a domestic corporation (distributing 
corporation) makes a distribution described in section 367(e)(1), the 
distributing corporation must comply with the reporting requirements 
under this paragraph (e)(1). Form 926 and other requirements described 
in this section need not be met by the distributing corporation in the 
case of a distribution described in section 367(e)(1).
    (2) Reporting requirements if transaction is taxable under section 
367(e)(1). If the distribution is taxable to the distributing 
corporation under

[[Page 42178]]

section 367(e)(1) and the regulations thereunder, the distributing 
corporation must attach to its Federal income tax return for the 
taxable year that includes the date of the transfer a statement titled 
``Section 367(e)(1) Reporting--Compliance With Section 6038B'', signed 
under penalties of perjury by an officer of the corporation, disclosing 
the following information:
    (i) A description of the transaction in which the U.S. distributing 
corporation distributed stock or securities of a controlled corporation 
(whether domestic or foreign) to one or more foreign distributees.
    (ii) The basis and fair market value of the stock and securities 
that were distributed by the distributing corporation in the 
transaction.
    (3) Reporting requirements if transaction qualifies for an 
exception to section 367(e)(1). If the distributing corporation 
qualifies for an exception under Sec. 1.367(e)-1T(c)(1), the 
requirements of section 6038B are satisfied if the distributing 
corporation complies with the reporting requirements contained in 
Sec. 1.367(e)-1T(c)(1)(ii). If the distributing corporation qualifies 
for an exception under Sec. 1.367(e)-1T(c)(2), the requirements of 
section 6038B are satisfied if the distributing corporation complies 
with the reporting requirements contained in Sec. 1.367(e)-
1T(c)(2)(iii). If the distributing corporation qualifies for an 
exception under Sec. 1.367(e)-1T(c)(3), the requirements of section 
6038B are satisfied if the distributing corporation complies with the 
reporting requirements contained in Sec. 1.367(e)-1T(c)(3).
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
    Par. 5. The authority for citation for part 602 continues to read 
as follows:

    Authority: 26 U.S.C. 7805.

    Par. 6. In Sec. 602.101, paragraph (c) is amended by removing the 
entry for ``1.367(e)-1'' and adding an entry in numerical order to read 
as follows:
Sec. 602.101  OMB Control numbers.
* * * * *
    (c) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described         control 
                                                                 No.    
------------------------------------------------------------------------
                                                                        
              *        *        *        *        *                     
1.367(e)-1T................................................    1545-1487
                                                                        
              *        *        *        *        *                     
------------------------------------------------------------------------

Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved:
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 96-20663 Filed 8-09-96; 12:19 pm]
BILLING CODE 4830-01-U