[Federal Register Volume 61, Number 251 (Monday, December 30, 1996)]
[Rules and Regulations]
[Pages 68633-68641]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32375]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8702]
RIN 1545-AT42
Certain Transfers of Domestic Stock or Securities by U.S. Persons
to Foreign Corporations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to certain
transfers of stock or securities of domestic corporations by United
States persons to foreign corporations pursuant to the corporate
organization, reorganization, or liquidation provisions of the Internal
Revenue Code. These final regulations modify the rules contained in the
temporary regulations to reflect certain taxpayer comments received in
response to those temporary regulations. This
[[Page 68634]]
action is necessary to provide the public with guidance to comply with
the Tax Reform Act of 1984.
DATES: These regulations are effective January 29, 1997. For dates of
applicability of these regulations, see Sec. 1.367(a)-3(c)(11).
FOR FURTHER INFORMATION CONTACT: Philip L. Tretiak at (202) 622-3860
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1478. Responses to these collections of information
are required in order for U.S. shareholders that transfer stock or
securities in section 367(a) exchanges to qualify for an exception to
the general rule of taxation under section 367(a)(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.
The estimated one-time burden per respondent: 10 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
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 May 16, 1986, temporary and proposed regulations under sections
367 (a) and (d) and section 6038B were published in the Federal
Register (51 FR 17936). These regulations were published to provide the
public with guidance necessary to comply with changes made to the
Internal Revenue Code by the Tax Reform Act of 1984. The IRS and the
Treasury Department later issued Notice 87-85 (1987-2 C.B. 395), which
set forth substantial changes to the 1986 regulations, effective with
respect to transfers occurring after December 16, 1987. A further
notice of proposed rulemaking, containing rules under section 367(a),
as well as under section 367(b), was published in the Federal Register
on August 26, 1991 (56 FR 41993). The 1991 proposed section 367(a)
regulations were generally based upon the positions announced in Notice
87-85, but the regulations made certain modifications to Notice 87-85,
particularly with respect to transfers of stock or securities of
foreign corporations. Subsequently, the IRS and the Treasury Department
issued Notice 94-46 (1994-1 C.B. 356), announcing modifications to the
positions set forth in Notice 87-85 (and the 1991 proposed regulations)
with respect to transfers of stock or securities of domestic
corporations occurring after April 17, 1994.
Most recently, temporary and proposed regulations were published in
the Federal Register on December 26, 1995 (60 FR 66739 and 66771). The
temporary regulations, which are generally effective for transfers
occurring after April 17, 1994, but cease to be effective when the
final regulations take effect, generally incorporated the positions
announced in Notice 94-46, with certain modifications. These final
regulations generally follow the rules set forth in the temporary
regulations, with changes as described below.
Explanation of Provisions
Section 367(a)(1) generally treats a transfer of property
(including stock or securities) by a U.S. person to a foreign
corporation in connection with an exchange described in section 332,
351, 354, 356 or 361 as a taxable exchange unless the transfer
qualifies for an exception to this general rule.
Rules that address transfers of stock or securities of domestic
corporations are contained in the final regulations described herein.
Rules that address transfers of stock or securities of foreign
corporations under section 367(a) are contained in Notice 87-85.
The final regulations retain the general rules set forth in the
temporary regulations, which provide that a U.S. person that exchanges
stock or securities in a U.S. target company (UST) for stock of a
foreign corporation (the transferee foreign corporation (or TFC)) in an
exchange described in section 367(a) will qualify for nonrecognition
treatment if certain reporting requirements are satisfied and each of
the following conditions is met:
(i) U.S. transferors must receive no more than 50 percent of the
voting power and value of the stock of the TFC in the transfer (i.e.,
the 50-percent ownership threshold is not exceeded);
(ii) U.S. officers, directors and 5-percent or greater shareholders
of the U.S. target must not own, in the aggregate, more than 50 percent
of the voting power and value of the TFC immediately after the transfer
(i.e., the control group case does not apply);
(iii) The U.S. person (exchanging U.S. shareholder) either must not
be a 5-percent transferee shareholder immediately after the transfer
or, if the U.S. person is a 5-percent transferee shareholder, must
enter into a 5-year gain recognition agreement (GRA) with respect to
the UST stock or securities it exchanged. (Without such GRA, the
transfer by the 5-percent transferee shareholder will not qualify for
nonrecognition treatment; however, transfer by other U.S. transferors
not subject to the GRA requirement may qualify if all other
requirements are met.); and
(iv) The active trade or business requirement must be satisfied.
If one or more of the foregoing requirements is not satisfied, the
transfer by the U.S. person of stock or securities of a domestic
corporation in exchange for stock of a TFC is taxable under section
367(a).
In response to suggestions from commentators, however, the final
regulations make a number of modifications to the temporary
regulations, principally in two areas: (i) the treatment of transfers
of ``other property'' in the context of the 50-percent ownership
threshold requirement, and (ii) the active trade or business
requirement.
Transfers of ``Other Property''
Under the temporary regulations, if U.S. transferors receive more
than 50 percent of the stock (by vote or value) of the TFC, the 50-
percent ownership threshold is exceeded and the transfer is taxable
under section 367(a)(1). The temporary regulations define a ``U.S.
transferor'' as a U.S. person who transfers (directly, indirectly or
constructively) stock or securities of the U.S. target company or
``other property'' for stock of the TFC in an exchange described in
section 367. Persons who transfer U.S. target company stock or other
property are presumed to be U.S. persons.
The inclusion of ``other property'' in the class of tainted
transferred property was designed to prevent the avoidance of the 50-
percent ownership threshold through ``stuffing'' transactions. For
example, assume that FC, a foreign corporation, and UST, an unrelated
U.S. corporation, seek to combine their
[[Page 68635]]
operations in a new foreign joint venture company (JV). The
shareholders of each company will transfer their respective stock
interests in UST and FC to JV in a transaction that would qualify as a
section 351 exchange unless the transaction was taxable under section
367(a)(1). Assume that FC has all foreign shareholders. The value of
the stock of UST is 550x; the value of the stock of FC is 450x. Because
UST is more valuable than FC, UST's shareholders would receive more
than 50 percent of JV's stock. Consequently, even if the transaction
would otherwise qualify for an exception to the general rule of
taxation under section 367(a)(1), the transaction would be taxable
because the 50-percent ownership threshold would be exceeded. If,
however, a U.S. person (X) contributed at least 100x in cash (or
property) to JV, JV would not issue more than 50 percent of its stock
to the UST shareholders, and, therefore, the 50-percent ownership
threshold would not be exceeded. The temporary regulations, however,
treat X as a U.S. transferor, so that the 50-percent ownership
threshold would be exceeded in this case.
Commentators have pointed out that the term ``other property''
raises issues in the joint venture context that are broader than the
``stuffing'' example described above. Because the term ``other
property'' is broad enough to include stock of a foreign company, the
transfer of UST stock could be taxable under section 367(a)(1) even if
UST were less valuable than the foreign ``target'' company (i.e., in
cases where U.S. transferors would receive less than 50 percent of the
stock of the joint venture company/TFC). Assume similar facts as in the
earlier example, except that FC is widely-held and the shareholders of
UST receive 40 percent of the stock of JV, while the shareholders of FC
receive the remaining 60 percent. No cash or any other property is
transferred to the JV. In such case, if the stock of FC constitutes
``other property,'' UST shareholders would not qualify for an exception
to section 367(a)(1) if they were unable to prove that the U.S.
shareholders of FC, if any, received no more than 10 percent of the
stock of JV in the exchange.
Although the IRS and the Treasury Department remain concerned with
``stuffing'' transactions, the final regulations consider the active
trade or business test to be the primary safeguard for preventing tax-
motivated transactions from qualifying for an exception under these
section 367(a) regulations. In particular, because the active trade or
business test addresses ``stuffing'' transactions that occur within the
36-month period prior to the acquisition, the final regulations
eliminate consideration of transfers of other property with regard to
the 50-percent ownership threshold. Thus, any TFC stock received by
U.S. persons in exchange for transfers of other property will not be
taken into account in determining whether the 50-percent ownership
threshold is exceeded.
Active Trade or Business Test: In General
The final regulations modify the ``active trade or business''
requirement that must be satisfied for a U.S. transferor to qualify for
an exception to the general rule of taxability under section 367(a)(1).
Under the requirement contained in the temporary regulations, no
exception under section 367(a)(1) is available unless (i) the TFC or an
affiliate was engaged in an active trade or business for the entire 36-
month period prior to the exchange (the 36-month test), and (ii) such
business was substantial in relation to the business of the U.S. target
company (the substantiality test). For this purpose, an affiliate is
generally defined by reference to the rules in section 1504(a) (without
the exclusion of foreign corporations).
The active trade or business test under the final regulations
includes (i) a modified 36-month test, (ii) a new anti-avoidance rule
requiring that the transaction not be undertaken with an intention that
the TFC cease its active trade or business, and (iii) a modified
substantiality test. The final regulations make a number of other
modifications and clarifications to the active trade or business test.
For example, the final regulations permit the TFC to consider only an
80-percent owned foreign subsidiary (referred to as a ``qualified
subsidiary''), and not an affiliate, to satisfy the active trade or
business test on its behalf.
Active Trade or Business Test: 36-Month Test and Intent Test
Under the 36-month test contained in the temporary regulations, the
TFC or an affiliate is required to be engaged in an active trade or
business for the entire 36 months immediately preceding the date of the
transfer. Under the final regulations, this test can be satisfied by
acquired businesses that have a 36-month operating history, unless they
are acquired with the principal purpose of satisfying the active trade
or business test.
In addition to the 36-month test, the active trade or business test
in the final regulations contains a requirement that the transaction
not be undertaken with an intention that the TFC cease its active
business. The IRS and the Treasury Department believe that if a TFC
with a 36-month active business history does not intend to maintain
such business, but is only used as a vehicle to acquire the UST, an
``inversion'' transaction rather than a synergy of two businesses has
been effected.
Under the temporary regulations, there is uncertainty as to whether
an affiliate of a newly-formed TFC can satisfy the active trade or
business test on behalf of the TFC for the (36-month) period prior to
the exchange. Subject to a stuffing rule, the final regulations clarify
that, for purposes of determining whether a TFC satisfies the 36-month
test, the TFC may take into account an active business of a company
that is a qualified subsidiary immediately after the transaction, even
if such company was not a qualified subsidiary for all or part of the
36 months prior to the transaction. Thus, for example, if the TFC is a
new foreign joint venture company, it will not be disqualified from
satisfying the active trade or business test solely because its
qualifying active trade or business was engaged in by a qualified
subsidiary whose stock is received in the exchange.
Under the temporary regulations, it is unclear whether a newly-
formed joint venture TFC could satisfy the active trade or business
test if, in the transaction, it received both stock of a UST (from U.S.
transferors) and an active trade or business (i.e., a foreign branch)
that had been operating for at least 36 months prior to the exchange
(from foreign transferors). This uncertainty arose because the active
trade or business test in the temporary regulations required that
either the TFC or an affiliate satisfy the 36-month requirement.
Although the temporary regulations did not intend to establish a
preference for transfers of stock (i.e., affiliates) vis-a-vis assets,
the temporary regulations did not expressly provide that a TFC could
utilize a newly-transferred foreign branch to satisfy the TFC's active
trade or business requirement.
The final regulations clarify that, subject to a stuffing rule, the
TFC may satisfy the active trade or business test if it receives in the
exchange foreign assets that constituted an active trade or business
during such 36-month period.
Active Trade or Business Test: Qualified Subsidiaries
The final regulations permit a TFC to take into account only
qualified subsidiaries, rather than affiliates, to satisfy the active
trade or business test.
[[Page 68636]]
This aspect of the active trade or business test has been narrowed
because the IRS and the Treasury Department do not believe that a TFC
should satisfy the active trade or business exception merely because
its parent company (or an affiliate of the parent company) is engaged
in an active trade or business.
For example, assume that foreign parent (FP), which is engaged in
an active business outside the United States (either directly or
through a subsidiary), forms a foreign subsidiary (FS) and contributes
cash to FS. Shareholders of a U.S. target company (UST) then transfer
all of the stock of UST in exchange for 20 percent of the stock of FS
in a transaction described in sections 368(a)(1)(B) and 367(a). If FS
is permitted to satisfy the active trade or business test by taking
into account FP's business, UST has effectively ``gone offshore'' in an
inversion transaction. Because the shareholders of UST receive stock of
FS (which is the TFC), and not FP, such shareholders will have no
interest in FP's active business. In contrast, if the shareholders
received stock of FP in an exchange described in section 367(a), such
persons would participate in FP's active business, and the active trade
or business test under the final regulations would be satisfied.
Active Trade or Business Test: Partnership Interests
The temporary regulations did not address whether the TFC could
satisfy the active trade or business requirement by taking into account
an interest in a partnership engaged in an active trade or business.
The final regulations permit a TFC (or a qualified subsidiary) to
take into account the active trade or business engaged in outside the
United States by any qualified partnership as there defined.
Active Trade or Business Test: Substantiality Test
Under the temporary regulations, the second prong of the active
trade or business requirement is the substantiality test. The active
trade or business of the TFC is required to be ``substantial'' vis-a-
vis the active trade or business of the UST, but the temporary
regulations do not define substantiality.
The final regulations modify the substantiality requirement. Under
the final regulations, the substantiality test no longer compares the
active trade or business of the TFC vis-a-vis the UST. Instead, it
requires that the entire value of the TFC be at least equal to the
entire value of the UST at the time of the transaction. However, for
this purpose, the value of the TFC may include the value of assets
(including stock) acquired within the 36-month period prior to the
transaction only if (i) such assets were acquired in the ordinary
course of business, or (ii) such assets (or their proceeds) do not
produce and are not held for the production of passive income (as
defined under section 1296(b)), and were not acquired with the
principal purpose of satisfying the active trade or business test. A
special rule applies if the asset acquired by the TFC in the 36-month
period prior to the exchange is stock of a qualified subsidiary or
qualified partnership engaged in an active trade or business. In such
case, the value of the stock or partnership interest may be taken into
account, but must be reduced in accordance with the principles
described above.
When formulating the substantiality test under the final
regulations, the IRS and the Treasury Department considered and
rejected other alternatives considered to be more complex and
burdensome for taxpayers. For example, a comparison of the active
business of the TFC vis-a-vis the active business of the UST for the
36-month period prior to the acquisition, taking into account the
property, payroll and sales of the two companies, was considered and
rejected.
Indirect and Constructive Transfers
One commentator suggested that the IRS clarify the definition of
``U.S. Transferor'' contained in the temporary regulations, which
refers to a U.S. person who transfers ``directly, indirectly or
constructively'' UST stock or other property. The IRS and the Treasury
Department believe that the reference to ``direct, indirect and
constructive'' transfers may have been unclear and, thus, the final
regulations delete such reference. Such technical modification does not
modify the substantive law in which indirect and constructive transfers
may be treated as transfers subject to section 367(a)(1) (see
Sec. 1.367(a)-1T(c)(2) with respect to the ``indirect'' stock transfer
rules; constructive transfers include, but are not limited to, section
367(a) transfers that result from section 304 transactions and section
367(a) transfers that result from a change in classification of an
entity from a foreign partnership to a foreign corporation).
GRA Term
Under the temporary regulations, a 5-percent transferee shareholder
is required to file a GRA. The duration is 5 years if all U.S.
transferors own less than 50 percent of the total voting power and
total value of the TFC stock immediately after the transfer. The
duration of the GRA is 10 years if the U.S. transferors own 50 percent
or more of the TFC stock immediately after the transaction, or if the
5-percent transferee shareholder is unable to prove that all U.S.
transferors own less than 50 percent of the total voting power and
total value of the TFC immediately after the transfer. Thus, in
determining whether a 5- or 10-year GRA is appropriate, the temporary
regulations take into account cross-ownership (i.e., consideration of
stock owned independently of the transaction) by all U.S. transferors,
and contain a presumption that a 10-year GRA is required.
For example, assume that UST shareholders receive 30 percent of the
stock of the TFC in a nonrecognition transaction that qualifies for an
exception under section 367(a). Assume further that one UST
shareholder, X, a U.S. person, transfers stock of UST in the section
367(a) exchange and owns 5 percent of the TFC after the transaction.
Under the temporary regulations, X is required to file a 10-year GRA
unless X can prove that all U.S. transferors in the aggregate own less
than 50 percent of the voting power and value of the TFC immediately
after the transfer (taking into account the 30 percent received in the
transaction by U.S. target shareholders plus any other stock that such
persons may own independently of the transaction). If the companies are
publicly traded or widely held, it is burdensome and may be impractical
for X to rebut the presumption that U.S. transferors own 50 percent or
more of the TFC stock.
In response to comments received and in the interest of
simplification, the final regulations provide that any 5-percent
transferee shareholder that is required to file a GRA upon the transfer
of domestic stock or securities is required to file a 5-year GRA; 10-
year GRAs will no longer be required in the case of 5-percent
transferee shareholders who transfer domestic stock or securities.
Other Areas in Which Comments Were Received
After careful consideration by the IRS and the Treasury Department,
the positions set forth in the temporary regulations were generally not
modified in response to certain comments other than those described
above. For example, the final regulations did not modify: (i) The
amount of stock U.S. transferors could receive without exceeding the
ownership threshold (i.e., not more than 50 percent), (ii) testing the
50-percent ownership threshold at
[[Page 68637]]
the time of the exchange, and (iii) the presumption that all
shareholders of the U.S. target company are U.S. persons.
PLR Option in Limited Instances
The final regulations provide that, in limited instances, the IRS
may consider issuing private letter rulings to taxpayers that (i)
satisfy all of the requirements contained in these regulations, with
the exception of the active trade or business test, or (ii) make a good
faith effort, but are unable to establish non-adverse applicability of
the ownership attribution rules. The IRS and the Treasury Department
are aware that the active trade or business test is mechanical in
nature and, thus, in limited instances, a taxpayer may demonstrate an
ongoing and substantial active trade or business even though it fails
to meet the test set forth in the final regulations. However, in no
event will the IRS rule on the issue of whether a TFC acquired an
active business with the principal purpose of satisfying the 36-month
test and/or the substantiality test.
Other Matters
The IRS and the Treasury Department expect to issue additional
final regulations under section 367(a) to address the transfer of stock
or securities of foreign corporations and other matters contained in
the 1991 proposed regulations not addressed herein. Until the 1991
proposed regulations are finalized, the positions originally announced
in Notice 87-85 will continue to govern the availability of section
367(a) exceptions for transfers of stock or securities of foreign
corporations. See Sec. 1.367(a)-3(d).
Special Analyses
It has been determined that this 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 economic impact on a substantial number of
small entities. This certification is based on the fact that the number
of U.S. target companies that are acquired by foreign corporations in
nonrecognition transactions subject to section 367(a), and thus are
subject to collection of information, is estimated to be only 100 per
year. Moreover, because these regulations will primarily affect large
shareholders and U.S. multinational corporations with foreign
operations, it is estimated that very few of the 100 transactions will
involve 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 Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on its 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.
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 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.367(a)-3 is added to read as follows:
Sec. 1.367(a)-3 Treatment of transfers of stock or securities to
foreign corporations.
(a) In general. This section provides rules concerning the transfer
of stock or securities by a U.S. person to a foreign corporation in an
exchange described in section 367(a). In general, a transfer of stock
or securities by a U.S. person to a foreign corporation that is
described in sections 351, 354 (pursuant to a reorganization described
in section 368(a)(1)(B)) or section 361 (a) or (b) is subject to
section 367(a)(1) and, therefore, is treated as a taxable exchange,
unless one of the exceptions set forth in paragraph (c) or (d) of this
section or Sec. 1.367(a)-3T(b) applies. For additional rules relating
to an exchange involving a foreign corporation in connection with which
there is a transfer of stock, see section 367(b) and the regulations
under that section. For additional rules regarding a transfer of stock
or securities in an exchange described in section 361 (a) or (b), see
section 367(a)(5) and any regulations under that section.
(b) [Reserved] For further guidance, see Sec. 1.367(a)-3T(b).
(c) Transfers by U.S. persons of stock or securities of domestic
corporations to foreign corporations--(1) In general. Except as
provided in section 367(a)(5), a transfer of stock or securities of a
domestic corporation by a U.S. person to a foreign corporation that
would otherwise be subject to section 367(a)(1) under paragraph (a) of
this section shall not be subject to section 367(a)(1) if the domestic
corporation the stock or securities of which are transferred (referred
to as the U.S. target company) complies with the reporting requirements
in paragraph (c)(6) of this section and if each of the following four
conditions is met:
(i) Fifty percent or less of both the total voting power and the
total value of the stock of the transferee foreign corporation is
received in the transaction, in the aggregate, by U.S. transferors
(i.e., the amount of stock received does not exceed the 50-percent
ownership threshold).
(ii) Fifty percent or less of each of the total voting power and
the total value of the stock of the transferee foreign corporation is
owned, in the aggregate, immediately after the transfer by U.S. persons
that are either officers or directors of the U.S. target company or
that are five-percent target shareholders (as defined in paragraph
(c)(5)(iii) of this section) (i.e., there is no control group). For
purposes of this paragraph (c)(1)(ii), any stock of the transferee
foreign corporation owned by U.S. persons immediately after the
transfer will be taken into account, whether or not it was received in
the exchange for stock or securities of the U.S. target company.
(iii) Either--
(A) The U.S. person is not a five-percent transferee shareholder
(as defined in paragraph (c)(5)(ii) of this section); or
(B) The U.S. person is a five-percent transferee shareholder and
enters into a five-year agreement to recognize gain with respect to the
U.S. target company stock or securities it exchanged in the form
provided in Sec. 1.367(a)-3T(g); and
(iv) The active trade or business test (as defined in paragraph
(c)(3) of this section) is satisfied.
(2) Ownership presumption. For purposes of paragraph (c)(1) of this
section, persons who transfer stock or securities of the U.S. target
company in exchange for stock of the transferee foreign corporation are
presumed to be U.S. persons. This presumption may be rebutted in
accordance with paragraph (c)(7) of this section.
(3) Active trade or business test--(i) In general. The tests of
this paragraph (c)(3), collectively referred to as the
[[Page 68638]]
active trade or business test, are satisfied if:
(A) The transferee foreign corporation or any qualified subsidiary
(as defined in paragraph (c)(5)(vii) of this section) or any qualified
partnership (as defined in paragraph (c)(5)(viii) of this section) is
engaged in an active trade or business outside the United States,
within the meaning of Sec. 1.367(a)-2T(b) (2) and (3), for the entire
36-month period immediately before the transfer;
(B) At the time of the transfer, neither the transferors nor the
transferee foreign corporation (and, if applicable, the qualified
subsidiary or qualified partnership engaged in the active trade or
business) have an intention to substantially dispose of or discontinue
such trade or business; and
(C) The substantiality test (as defined in paragraph (c)(3)(iii) of
this section) is satisfied.
(ii) Special rules. For purposes of paragraphs (c)(3)(i) (A) and
(B) of this section, the following special rules apply:
(A) The transferee foreign corporation, a qualified subsidiary, or
a qualified partnership will be considered to be engaged in an active
trade or business for the entire 36-month period preceding the exchange
if it acquires at the time of, or any time prior to, the exchange a
trade or business that has been active throughout the entire 36-month
period preceding the exchange. This special rule shall not apply,
however, if the acquired active trade or business assets were owned by
the U.S. target company or any affiliate (within the meaning of section
1504(a) but excluding the exceptions contained in section 1504(b) and
substituting ``50 percent'' for ``80 percent'' where it appears
therein) at any time during the 36-month period prior to the
acquisition. Nor will this special rule apply if the principal purpose
of such acquisition is to satisfy the active trade or business test.
(B) An active trade or business does not include the making or
managing of investments for the account of the transferee foreign
corporation or any affiliate (within the meaning of section 1504(a) but
excluding the exceptions contained in section 1504(b) and substituting
``50 percent'' for ``80 percent'' where it appears therein). (This
paragraph (c)(3)(ii)(B) shall not create any inference as to the scope
of Sec. 1.367(a)-2T(b) (2) and (3) for other purposes.)
(iii) Substantiality test--(A) General rule. A transferee foreign
corporation will be deemed to satisfy the substantiality test if, at
the time of the transfer, the fair market value of the transferee
foreign corporation is at least equal to the fair market value of the
U.S. target company.
(B) Special rules. (1) For purposes of paragraph (c)(3)(iii)(A) of
this section, the value of the transferee foreign corporation shall
include assets acquired outside the ordinary course of business by the
transferee foreign corporation within the 36-month period preceding the
exchange only if either--
(i) Both--
(A) At the time of the exchange, such assets or, as applicable, the
proceeds thereof, do not produce, and are not held for the production
of, passive income as defined in section 1296(b); and
(B) Such assets are not acquired for the principal purpose of
satisfying the substantiality test; or
(ii) Such assets consist of the stock of a qualified subsidiary or
an interest in a qualified partnership. See paragraph (c)(3)(iii)(B)(2)
of this section.
(2) For purposes of paragraph (c)(3)(iii)(A) of this section, the
value of the transferee foreign corporation shall not include the value
of the stock of any qualified subsidiary or the value of any interest
in a qualified partnership, held directly or indirectly, to the extent
that such value is attributable to assets acquired by such qualified
subsidiary or partnership outside the ordinary course of business and
within the 36-month period preceding the exchange unless those assets
satisfy the requirements in paragraph (c)(3)(iii)(B)(1) of this
section.
(3) For purposes of paragraph (c)(3)(iii)(A) of this section, the
value of the transferee foreign corporation shall not include the value
of assets received within the 36-month period prior to the acquisition,
notwithstanding the special rule in paragraph (c)(3)(iii)(B)(1) of this
section, if such assets were owned by the U.S. target company or an
affiliate (within the meaning of section 1504(a) but without the
exceptions under section 1504(b) and substituting ``50 percent'' for
``80 percent'' where it appears therein) at any time during the 36-
month period prior to the transaction.
(4) Special rules--(i) Treatment of partnerships. For purposes of
this paragraph (c), if a partnership (whether domestic or foreign) owns
stock or securities in the U.S. target company or the transferee
foreign corporation, or transfers stock or securities in an exchange
described in section 367(a), each partner in the partnership, and not
the partnership itself, is treated as owning and as having transferred,
or as owning, a proportionate share of the stock or securities. See
Sec. 1.367(a)-1T(c)(3).
(ii) Treatment of options. For purposes of this paragraph (c), one
or more options (or an interest similar to an option) will be treated
as exercised and thus will be counted as stock for purposes of
determining whether the 50-percent threshold is exceeded or whether a
control group exists if a principal purpose of the issuance or the
acquisition of the option (or other interest) was the avoidance of the
general rule contained in section 367(a)(1).
(iii) U.S. target has a vestigial ownership interest in transferee
foreign corporation. In cases where, immediately after the transfer,
the U.S. target company owns, directly or indirectly (applying the
attribution rules of sections 267(c) (1) and (5)), stock of the
transferee foreign corporation, that stock will not in any way be taken
into account (and, thus, will not be treated as outstanding) in
determining whether the 50-percent threshold under paragraph (c)(1)(i)
of this section is exceeded or whether a control group under paragraph
(c)(1)(ii) of this section exists.
(iv) Attribution rule. Except as otherwise provided in this
section, the rules of section 318, as modified by the rules of section
958(b) shall apply for purposes of determining the ownership or receipt
of stock, securities or other property under this paragraph (c).
(5) Definitions--(i) Ownership statement. An ownership statement is
a statement, signed under penalties of perjury, stating--
(A) The identity and taxpayer identification number, if any, of the
person making the statement;
(B) That the person making the statement is not a U.S. person (as
defined in paragraph (c)(5)(iv) of this section);
(C) That the person making the statement either--
(1) Owns less than 1 percent of the total voting power and total
value of a U.S. target company the stock of which is described in Rule
13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or
regulation to generally the same effect) promulgated by the Securities
and Exchange Commission under the Securities and Exchange Act of 1934
(15 USC 78m), and such person did not acquire the stock with a
principal purpose to enable the U.S. transferors to satisfy the
requirement contained in paragraph (c)(1)(i) of this section; or
(2) Is not related to any U.S. person to whom the stock or
securities owned by the person making the statement are attributable
under the rules of section 958(b), and did not acquire the stock
[[Page 68639]]
with a principal purpose to enable the U.S. transferors to satisfy the
requirement contained in paragraph (c)(1)(i) of this section;
(D) The citizenship, permanent residence, home address, and U.S.
address, if any, of the person making the statement; and
(E) The ownership such person has (by voting power and by value) in
the U.S. target company prior to the exchange and the amount of stock
of the transferee foreign corporation (by voting power and value)
received by such person in the exchange.
(ii) Five-percent transferee shareholder. A five-percent transferee
shareholder is a person that owns at least five percent of either the
total voting power or the total value of the stock of the transferee
foreign corporation immediately after the transfer described in section
367(a)(1). For special rules involving cases in which stock is held by
a partnership, see paragraph (c)(4)(i) of this section.
(iii) Five-percent target shareholder and certain other 5-percent
shareholders. A five-percent target shareholder is a person that owns
at least five percent of either the total voting power or the total
value of the stock of the U.S. target company immediately prior to the
transfer described in section 367(a)(1). If the stock of the U.S.
target company (or any company through which stock of the U.S. target
company is owned indirectly or constructively) is described in Rule
13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or
regulation to generally the same effect), promulgated by the Securities
and Exchange Commission under the Securities Exchange Act of 1934 (15
USC 78m), then, in the absence of actual knowledge to the contrary, the
existence or absence of filings of Schedule 13-D or 13-G (or any
similar schedules) may be relied upon for purposes of identifying five-
percent target shareholders (or a five-percent shareholder of a
corporation which itself is a five-percent shareholder of the U.S.
target company). For special rules involving cases in which U.S. target
company stock is held by a partnership, see paragraph (c)(4)(i) of this
section.
(iv) U.S. Person. For purposes of this section, a U.S. person is
defined by reference to Sec. 1.367(a)-1T(d)(1). For application of the
rules of this section to stock or securities owned or transferred by a
partnership that is a U.S. person, however, see paragraph (c)(4)(i) of
this section.
(v) U.S. Transferor. A U.S. transferor is a U.S. person (as defined
in paragraph (c)(5)(iv) of this section) that transfers stock or
securities of one or more U.S. target companies in exchange for stock
of the transferee foreign corporation in an exchange described in
section 367.
(vi) Transferee foreign corporation. A transferee foreign
corporation is the foreign corporation whose stock is received in the
exchange by U.S. persons.
(vii) Qualified Subsidiary. A qualified subsidiary is a foreign
corporation whose stock is at least 80-percent owned (by total voting
power and total value), directly or indirectly, by the transferee
foreign corporation. However, a corporation will not be treated as a
qualified subsidiary if it was affiliated with the U.S. target company
(within the meaning of section 1504(a) but without the exceptions under
section 1504(b) and substituting ``50 percent'' for ``80 percent''
where it appears therein) at any time during the 36-month period prior
to the transfer. Nor will a corporation be treated as a qualified
subsidiary if it was acquired by the transferee foreign corporation at
any time during the 36-month period prior to the transfer for the
principal purpose of satisfying the active trade or business test,
including the substantiality test.
(viii) Qualified partnership. (A) Except as provided in paragraph
(c)(5)(viii)(B) or (C) of this section, a qualified partnership is a
partnership in which the transferee foreign corporation--
(1) Has active and substantial management functions as a partner
with regard to the partnership business; or
(2) Has an interest representing a 25 percent or greater interest
in the partnership's capital and profits.
(B) A partnership is not a qualified partnership if the U.S. target
company or any affiliate of the U.S. target company (within the meaning
of section 1504(a) but without the exceptions under section 1504(b) and
substituting ``50 percent'' for ``80 percent'' where it appears
therein) held a 5 percent or greater interest in the partnership's
capital and profits at any time during the 36-month period prior to the
transfer.
(C) A partnership is not a qualified partnership if the transferee
foreign corporation's interest was acquired by that corporation at any
time during the 36-month period prior to the transfer for the principal
purpose of satisfying the active trade or business test, including the
substantiality test.
(6) Reporting requirements of U.S. target company. (i) In order for
a U.S. person that transfers stock or securities of a domestic
corporation to qualify for the exception provided by this paragraph (c)
to the general rule under section 367(a)(1), in cases where 10 percent
or more of the total voting power or the total value of the stock of
the U.S. target company is transferred by U.S. persons in the
transaction, the U.S. target company must comply with the reporting
requirements contained in this paragraph (c)(6). The U.S. target
company must attach to its timely filed U.S. income tax return for the
taxable year in which the transfer occurs a statement titled ``Section
367(a)--Reporting of Cross-Border Transfer Under Reg. Sec. 1.367(a)-
3(c)(6),'' signed under penalties of perjury by an officer of the
corporation to the best of the officer's knowledge and belief,
disclosing the following information--
(A) A description of the transaction in which a U.S. person or
persons transferred stock or securities in the U.S. target company to
the transferee foreign corporation in a transfer otherwise subject to
section 367(a)(1);
(B) The amount (specified as to the percentage of the total voting
power and the total value) of stock of the transferee foreign
corporation received in the transaction, in the aggregate, by persons
who transferred stock or securities of the U.S. target company. For
additional information that may be required to rebut the ownership
presumption of paragraph (c)(2) of this section in cases where more
than 50 percent of either the total voting power or the total value of
the stock of the transferee foreign corporation is received in the
transaction, in the aggregate, by persons who transferred stock or
securities of the U.S. target company, see paragraph (c)(7) of this
section;
(C) The amount (if any) of transferee foreign corporation stock
owned directly or indirectly (applying the attribution rules of
sections 267(c) (1) and (5)) immediately after the exchange by the U.S.
target company;
(D) A statement that there is no control group within the meaning
of paragraph (c)(1)(ii) of this section;
(E) A list of U.S. persons who are officers, directors or five-
percent target shareholders and the percentage of the total voting
power and the total value of the stock of the transferee foreign
corporation owned by such persons both immediately before and
immediately after the transaction; and
(F) A statement that includes the following--
(1) A statement that the active trade or business test described in
paragraph (c)(3) of this section is satisfied by the transferee foreign
corporation and a description of such business;
(2) A statement that on the day of the transaction, there was no
intent on the
[[Page 68640]]
part of the transferee foreign corporation (or its qualified
subsidiary, if relevant) or the transferors of the transferee foreign
corporation (or qualified subsidiary, if relevant) to substantially
discontinue its active trade or business; and
(3) A statement that the substantiality test described in paragraph
(c)(3)(iii) of this section is satisfied, and documentation that such
test is satisfied, including the value of the transferee foreign
corporation and the value of the U.S. target company on the day of the
transfer, and either one of the following--
(i) A statement demonstrating that the value of the transferee
foreign corporation 36 months prior to the acquisition, plus the value
of any assets described in paragraph (c)(3)(iii)(B) of this section
(including stock) acquired by the transferee foreign corporation within
the 36-month period, less the amount of any liabilities acquired during
that period, exceeds the value of the U.S. target company on the
acquisition date; or
(ii) A statement demonstrating that the value of the transferee
foreign corporation on the date of the acquisition, reduced by the
value of any assets not described in paragraph (c)(3)(iii)(B) of this
section (including stock) acquired by the transferee foreign
corporation within the 36-month period, exceeds the value of the U.S.
target company on the date of the acquisition.
(ii) For purposes of this paragraph (c)(6), an income tax return
will be considered timely filed if such return is filed, together with
the statement required by this paragraph (c)(6), on or before the last
date for filing a Federal income tax return (taking into account any
extensions of time therefor) for the taxable year in which the transfer
occurs. If a return is not timely filed within the meaning of this
paragraph (c)(6), the District Director may make a determination, based
on all facts and circumstances, that the taxpayer had reasonable cause
for its failure to file a timely filed return and, if such a
determination is made, the requirement contained in this paragraph
(c)(6) shall be waived.
(7) Ownership statements. To rebut the ownership presumption of
paragraph (c)(2) of this section, the U.S. target company must obtain
ownership statements (described in paragraph (c)(5)(i) of this section)
from a sufficient number of persons that transfer U.S. target company
stock or securities in the transaction that are not U.S. persons to
demonstrate that the 50-percent threshold of paragraph (c)(1)(i) of
this section is not exceeded. In addition, the U.S. target company must
attach to its timely filed U.S. income tax return (as described in
paragraph (c)(6)(ii) of this section) for the taxable year in which the
transfer occurs a statement, titled ``Section 367(a)--Compilation of
Ownership Statements Under Reg. Sec. 1.367(a)-3(c),'' signed under
penalties of perjury by an officer of the corporation, disclosing the
following information:
(i) The amount (specified as to the percentage of the total voting
power and the total value) of stock of the transferee foreign
corporation received, in the aggregate, by U.S. transferors;
(ii) The amount (specified as to the percentage of total voting
power and total value) of stock of the transferee foreign corporation
received, in the aggregate, by foreign persons that filed ownership
statements;
(iii) A summary of the information tabulated from the ownership
statements, including--
(A) The names of the persons that filed ownership statements
stating that they are not U.S. persons;
(B) The countries of residence and citizenship of such persons; and
(C) Each of such person's ownership (by voting power and by value)
in the U.S. target company prior to the exchange and the amount of
stock of the transferee foreign corporation (by voting power and value)
received by such persons in the exchange.
(8) Certain transfers in connection with performance of services.
Section 367(a)(1) shall not apply to a domestic corporation's transfer
of its own stock or securities in connection with the performance of
services, if the transfer is considered to be to a foreign corporation
solely by reason of Sec. 1.83-6(d)(1).
(9) Private letter ruling option. The Internal Revenue Service may,
in limited circumstances, issue a private letter ruling to permit the
taxpayer to qualify for an exception to the general rule under section
367(a)(1) if--
(i) A taxpayer is unable to satisfy all of the requirements of
paragraph (c)(3) of this section relating to the active trade or
business test of paragraph (c)(1)(iv) of this section, but such
taxpayer meets all of the other requirements contained in paragraphs
(c)(1)(i) through (c)(1)(iii) of this section, and such taxpayer is
substantially in compliance with the rules set forth in paragraph
(c)(3) of this section; or
(ii) A taxpayer is unable to satisfy any requirement of paragraph
(c)(1) of this section due to the application of paragraph (c)(4)(iv)
of this section. Notwithstanding the preceding sentence, in no event
will the Internal Revenue Service rule on the issue of whether the
principal purpose of an acquisition was to satisfy the active trade or
business test, including the substantiality test.
(10) Examples. This paragraph (c) may be illustrated by the
following examples:
Example 1. Ownership presumption. (i) FC, a foreign corporation,
issues 51 percent of its stock to the shareholders of S, a domestic
corporation, in exchange for their S stock, in a transaction
described in section 367(a)(1).
(ii) Under paragraph (c)(2) of this section, all shareholders of
S who receive stock of FC in the exchange are presumed to be U.S.
persons. Unless this ownership presumption is rebutted, the
condition set forth in paragraph (c)(1)(i) of this section will not
be satisfied, and the exception in paragraph (c)(1) of this section
will not be available. As a result, all U.S. persons that
transferred S stock will recognize gain on the exchange. To rebut
the ownership presumption, S must comply with the reporting
requirements contained in paragraph (c)(6) of this section,
obtaining ownership statements (described in paragraph (c)(5)(i) of
this section) from a sufficient number of non-U.S. persons who
received FC stock in the exchange to demonstrate that the amount of
FC stock received by U.S. persons in the exchange does not exceed 50
percent.
Example 2. Filing of Gain Recognition Agreement. (i) The facts
are the same as in Example 1, except that FC issues only 40 percent
of its stock to the shareholders of S in the exchange. FC satisfies
the active trade or business test of paragraph (c)(1)(iv) of this
section. A, a U.S. person, owns 10 percent of S's stock immediately
before the transfer. All other shareholders of S own less than five
percent of its stock. None of S's officers or directors owns any
stock in FC immediately after the transfer. A will own 15 percent of
the stock of FC immediately after the transfer, 4 percent received
in the exchange, and the balance being stock in FC that A owned
prior to and independent of the transaction. No S shareholder
besides A owns five percent or more of FC immediately after the
transfer. The reporting requirements under paragraph (c)(6) of this
section are satisfied.
(ii) The condition set forth in paragraph (c)(1)(i) of this
section is satisfied because, even after application of the
presumption in paragraph (c)(2) of this section, U.S. transferors
could not receive more than 50 percent of FC's stock in the
transaction. There is no control group because five-percent target
shareholders and officers and directors of S do not, in the
aggregate, own more than 50 percent of the stock of FC immediately
after the transfer (A, the sole five-percent target shareholder,
owns 15 percent of the stock of FC immediately after the transfer,
and no officers or directors of S own any stock of FC immediately
after the transfer). Therefore, the condition set forth in paragraph
(c)(1)(ii) of this section is satisfied. The facts assume that the
condition set forth in paragraph (c)(1)(iv) of this section is
satisfied. Thus, U.S. persons that are not five-percent transferee
shareholders will not recognize gain on the exchange of S shares
[[Page 68641]]
for FC shares. A, a five-percent transferee shareholder, will not be
required to include in income any gain realized on the exchange in
the year of the transfer if he files a 5-year gain recognition
agreement (GRA) and complies with section 6038B.
Example 3. Control Group. (i) The facts are the same as in
Example 2, except that B, another U.S. person, is a 5-percent target
shareholder, owning 25 percent of S's stock immediately before the
transfer. B owns 40 percent of the stock of FC immediately after the
transfer, 10 percent received in the exchange, and the balance being
stock in FC that B owned prior to and independent of the
transaction.
(ii) A control group exists because A and B, each a five-percent
target shareholder within the meaning of paragraph (c)(5)(iii) of
this section, together own more than 50 percent of FC immediately
after the transfer (counting both stock received in the exchange and
stock owned prior to and independent of the exchange). As a result,
the condition set forth in paragraph (c)(1)(ii) of this section is
not satisfied, and all U.S. persons (not merely A and B) who
transferred S stock will recognize gain on the exchange.
Example 4. Partnerships. (i) The facts are the same as in
Example 3, except that B is a partnership (domestic or foreign) that
has five equal partners, only two of whom, X and Y, are U.S.
persons. Under paragraph (c)(4)(i) of this section, X and Y are
treated as the owners and transferors of 5 percent each of the S
stock owned and transferred by B and as owners of 8 percent each of
the FC stock owned by B immediately after the transfer. U.S. persons
that are five-percent target shareholders thus own a total of 31
percent of the stock of FC immediately after the transfer (A's 15
percent, plus X's 8 percent, plus Y's 8 percent).
(ii) Because no control group exists, the condition in paragraph
(c)(1)(ii) of this section is satisfied. The conditions in
paragraphs (c)(1)(i) and (iv) of this section also are satisfied.
Thus, U.S. persons that are not five-percent transferee shareholders
will not recognize gain on the exchange of S shares for FC shares.
A, X, and Y, each a five-percent transferee shareholder, will not be
required to include in income in the year of the transfer any gain
realized on the exchange if they file 5-year GRAs and comply with
section 6038B.
(11) Effective date. This paragraph (c) applies to transfers
occurring after January 29, 1997. However, taxpayers may elect to apply
this section in its entirety to all transfers occurring after April 17,
1994, provided that the statute of limitations of the affected tax year
or years is open.
(d) Transfers of stock or securities of foreign corporations. For
guidance, see Notice 87-85 (1987-2 C.B. 395). See Sec. 601.601(d)(2) of
this chapter.
(e) through (h) [Reserved]. For further guidance, see
Sec. 1.367(a)-3T(e) through (h).
Par. 3. In Sec. 1.367(a)-3T, paragraphs (a), (c) and (d) are
revised to read as follows:
Sec. 1.367(a)-3T Treatment of transfers of stock or securities to
foreign corporations (temporary).
(a) [Reserved]. For further information, see Sec. 1.367(a)-3(a).
* * * * *
(c) and (d) [Reserved]. For further information, see Sec. 1.367(a)-
3(c) and (d).
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 4. The authority for citation for part 602 continues to read
as follows:
Authority: 26 U.S.C. 7805.
Par. 5. Section 602.101, paragraph (c) is amended by revising the
entry for 1.367(a)-3T and adding an entry to the table 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(a)-3................................................. 1545-0026
1545-1478
1.367(a)-3T................................................ 1545-0026
* * * * *
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: December 11, 1996.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 96-32375 Filed 12-27-96; 8:45 am]
BILLING CODE 4830-01-U