[Federal Register Volume 62, Number 15 (Thursday, January 23, 1997)]
[Rules and Regulations]
[Pages 3458-3461]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-1521]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8710]
RIN 1545-A073
Revisions of the Section 338 Consistency Rules With Respect to
Target Affiliates That Are Controlled Foreign Corporations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the
consistency rules under section 338 of the Internal Revenue Code of
1986 that are applicable to certain cases involving controlled foreign
corporations. The final regulations substantially revise and simplify
the stock and asset consistency rules. The final regulations include
the provisions of the consistency rules applicable to controlled
foreign corporations contained in recent proposed and temporary
regulations. The final regulations would affect taxpayers that own
controlled foreign corporations.
EFFECTIVE DATE: These regulations are effective January 20, 1997.
FOR FURTHER INFORMATION CONTACT: Kenneth D. Allison at (202) 622-3860
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final Income Tax Regulations (26 CFR part 1)
under section 338 of the Internal Revenue Code.
[[Page 3459]]
On January 20, 1994, temporary regulations (TD 8516) were published
in the Federal Register (59 FR 2956) under section 338 of the Internal
Revenue Code. See 1994-1 C.B. 119. A notice of proposed rulemaking
(INTL-0177-90) cross-referencing the temporary regulations was
published in the Federal Register for the same day (59 FR 3045). See
1994-1 C.B. 818. The temporary regulations provided rules to replace
the asset and stock consistency rules of Secs. 1.338-4T and 1.338-5T.
The temporary regulations included consistency rules applicable to
certain cases involving controlled foreign corporations (CFCs).
No written comments responding to the notice were received. No
public hearing was requested or held. The proposed regulations under
section 338 are adopted as revised by this Treasury decision, and the
corresponding temporary regulations are removed.
Explanation of Provisions
The preamble to the temporary and proposed regulations (1994-1 C.B.
119) contains a discussion of the provisions. Changes to the temporary
and proposed regulations are noted below.
Section 1.338-4T(h)(3) of the temporary regulations is clarified by
stating that the basis of the stock of a controlled foreign corporate
target affiliate is not increased by section 1248 earnings attributable
to the disposition of an asset in which a carryover basis is taken
under this section.
Section 1.338-4T(h)(4) of the temporary regulations addresses a
situation in which the income or gain from the disposition of a
controlled foreign corporation target affiliate (CFC T affiliate) asset
is not subject to the consistency rules of paragraph (h)(2). The
regulation states that if a CFC T affiliate pays a dividend to a target
(T) or a domestic T affiliate wholly or partially out of the earnings
generated by the disposition of that asset, and the dividend increases
the basis of the T stock under Sec. 1.1502-32, then the basis of the
stock of the CFC T affiliate is reduced by the amount of the dividend
that was paid from the earnings and profits resulting from the asset
disposition. This rule applies to any actual dividend, amount treated
as a dividend under section 1248 (or that would have been so treated
but for section 1291) or amount included in income under section
951(a)(1)(B).
The final regulations retain this rule. The final regulations also
add a special ordering rule, in Sec. 1.338-4(h)(4)(ii), clarifying that
any such dividend is first considered attributable to earnings and
profits resulting from the disposition of the asset.
Section 1.338-4(h)(4)(ii) is clarified to state that the basis of
the stock of a controlled foreign corporation may not be reduced below
zero under the carryover basis rules of Sec. 1.338-4.
Section 1.338-4(h)(2)(iv)(A) and Sec. 1.338-4(h)(4)(iii)(A) are
added to allow the purchasing group in certain instances to increase
the basis of the CFC T stock by the amount of either the basis increase
denied under Sec. 1.338-4(h)(2)(ii) or the basis reduction required
under Sec. 1.338-4(h)(4)(ii). The rule applies when the purchasing
group disposes of an asset acquired from CFC T that is subject to the
consistency rules to an unrelated party in a taxable transaction and
includes in U.S. gross income the greater of (i) the income or gain
equal to the basis amount denied to the asset under either Sec. 1.338-
4(h)(2)(i) or Sec. 1.338-4(g) and Sec. 1.338-4(h)(4)(i), respectively,
or (ii) the gain recognized on the asset.
Similarly, Sec. 1.338-4(h)(2)(iv)(B) and Sec. 1.338-4(h)(4)(iii)(B)
are added to allow the purchasing group to increase the basis of an
asset acquired from CFC T that is subject to the consistency rules by
the basis amount denied to the asset under either Sec. 1.338-4(h)(2)(i)
or Sec. 1.338-4(g) and Sec. 1.338-4(h)(4)(i). The rule applies when the
purchasing group disposes of the stock of CFC T to an unrelated party
in a taxable transaction and includes in U.S. gross income the greater
of (i) the gain equal to the basis increase denied under Sec. 1.338-
4(h)(2)(ii) or the basis reduction required under Sec. 1.338-
4(h)(4)(ii), respectively, or (ii) the gain recognized in the stock.
Special Analyses
It has been determined that this final regulation is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29, 1996
the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Therefore, a regulatory flexibility analysis is not required. Pursuant
to section 7805(f) of the Internal Revenue Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on its impact on small businesses.
Drafting Information: The principal author of these regulations
is Kenneth D. Allison of the Office of Associate Chief Counsel
(International), IRS. However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entry for Section 1.338-4T(h) to read as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In Sec. 1.338-0, the outline of topics is amended by
revising the entry for Sec. 1.338-4(h) and removing the entry for
Sec. 1.338-4T to read as follows:
Sec. 1.338-0 Outline of topics.
* * * * *
Sec. 1.338-4 Asset and stock consistency.
* * * * *
(h) Consistency for target affiliates that are controlled
foreign corporations.
(1) In general.
(2) Income or gain resulting from asset dispositions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate that is a controlled
foreign corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Increase in asset or stock basis.
(5) Examples.
* * * * *
Par. 3. Section 1.338-4 is amended as follows:
1. Paragraph (a)(5) is amended by removing the language ``Section
1.338-4T(h)'' and adding ``Paragraph (h) of this section'' in its
place.
2. Paragraph (c)(4) is amended by removing the language
``Sec. 1.338-4T(h)(2)'' and adding ``paragraph (h)(2) of this section''
in its place.
3. Paragraph (d)(2)(iii) is amended by removing the language
``Sec. 1.338-4T(h)(3)'' and adding ``paragraph (h)(3) of this section''
in its place.
4. Paragraph (g)(2) is amended by removing the language
``Sec. 1.338-4T(h)(4)'' and adding ``paragraph (h)(4) of this section''
in its place.
5. Paragraph (h) is revised.
6. Paragraph (j)(3)(i)(A)(2) is amended by removing the language
``Sec. 1.338-4T(h)'' and adding ``paragraph (h) of this section'' in
its place.
[[Page 3460]]
The revision reads as follows:
Sec. 1.338-4 Asset and stock consistency.
* * * * *
(h) Consistency for target affiliates that are controlled foreign
corporations--(1) In general. This paragraph (h) applies only if target
is a domestic corporation. For additional rules that may apply with
respect to controlled foreign corporations, see paragraph (g) of this
section. The definitions and nomenclature of Sec. 1.338-1 (b) and (c)
and paragraph (e) of this section apply for purposes of this section.
(2) Income or gain resulting from asset dispositions--(i) General
rule. Income or gain of a target affiliate that is a controlled foreign
corporation from the disposition of an asset is not reflected in the
basis of target stock under paragraph (c) of this section unless the
income or gain results in an inclusion under section 951(a)(1)(A),
951(a)(1)(C), 1291 or 1293.
(ii) Basis of controlled foreign corporation stock. If, by reason
of paragraph (h)(2)(i) of this section, the carryover basis rules of
this section apply to an asset, no increase in basis in the stock of a
controlled foreign corporation under section 961(a) or 1293(d)(1), or
under regulations issued pursuant to section 1297(b)(5), is allowed to
target or a target affiliate to the extent the increase is attributable
to income or gain described in paragraph (h)(2)(i) of this section. A
similar rule applies to the basis of any property by reason of which
the stock of the controlled foreign corporation is considered owned
under section 958(a)(2) or 1297(a).
(iii) Operating rule. For purposes of this paragraph (h)(2)--
(A) If there is an income inclusion under section 951 (a)(1) (A) or
(C), the shareholder's income inclusion is first attributed to the
income or gain of the controlled foreign corporation from the
disposition of the asset to the extent of the shareholder's pro rata
share of such income or gain; and
(B) Any income or gain under section 1293 is first attributed to
the income or gain from the disposition of the asset to the extent of
the shareholder's pro rata share of the income or gain.
(iv) Increase in asset or stock basis--(A) If the carryover basis
rules under paragraph (h)(2)(i) of this section apply to an asset, and
the purchasing corporation disposes of the asset to an unrelated party
in a taxable transaction and recognizes and includes in its U.S. gross
income or the U.S. gross income of its shareholders the greater of the
income or gain from the disposition of the asset by the selling
controlled foreign corporation that was reflected in the basis of the
target stock under paragraph (c) of this section, or the gain
recognized on the asset by the purchasing corporation on the
disposition of the asset, then the purchasing corporation or the target
or a target affiliate, as appropriate, shall increase the basis of the
selling controlled foreign corporation stock subject to paragraph
(h)(2)(ii) of this section, as of the date of the disposition of the
asset by the purchasing corporation, by the amount of the basis
increase that was denied under paragraph (h)(2)(ii) of this section.
The preceding sentence shall apply only to the extent that the
controlled foreign corporation stock is owned (within the meaning of
section 958(a)) by a member of the purchasing corporation's affiliated
group.
(B) If the carryover basis rules under paragraph (h)(2)(i) of this
section apply to an asset, and the purchasing corporation or the target
or a target affiliate, as appropriate, disposes of the stock of the
selling controlled foreign corporation to an unrelated party in a
taxable transaction and recognizes and includes in its U.S. gross
income or the U.S. gross income of its shareholders the greater of the
gain equal to the basis increase that was denied under paragraph
(h)(2)(ii) of this section, or the gain recognized in the stock by the
purchasing corporation or by the target or a target affiliate, as
appropriate, on the disposition of the stock, then the purchasing
corporation shall increase the basis of the asset, as of the date of
the disposition of the stock of the selling controlled foreign
corporation by the purchasing corporation or by the target or a target
affiliate, as appropriate, by the amount of the basis increase that was
denied pursuant to paragraph (h)(2)(i) of this section. The preceding
sentence shall apply only to the extent that the asset is owned (within
the meaning of section 958(a)) by a member of the purchasing
corporation's affiliated group.
(3) Stock issued by target affiliate that is a controlled foreign
corporation. The exception to the carryover basis rules of this section
provided in paragraph (d)(2)(iii) of this section does not apply to
stock issued by a target affiliate that is a controlled foreign
corporation. After applying the carryover basis rules of this section
to the stock, the basis in the stock is increased by the amount treated
as a dividend under section 1248 on the disposition of the stock (or
that would have been so treated but for section 1291), except to the
extent the basis increase is attributable to the disposition of an
asset in which a carryover basis is taken under this section.
(4) Certain distributions--(i) General rule. In the case of a
target affiliate that is a controlled foreign corporation, paragraph
(g) of this section applies with respect to the target affiliate by
treating any reference to a dividend to which section 243(a)(3) applies
as a reference to any amount taken into account under Sec. 1.1502-32 in
determining the basis of target stock that is--
(A) A dividend;
(B) An amount treated as a dividend under section 1248 (or that
would have been so treated but for section 1291); or
(C) An amount included in income under section 951(a)(1)(B).
(ii) Basis of controlled foreign corporation stock. If the
carryover basis rules of this section apply to an asset, the basis in
the stock of the controlled foreign corporation (or any property by
reason of which the stock is considered owned under section 958(a)(2))
is reduced (but not below zero) by the sum of any amounts that are
treated, solely by reason of the disposition of the asset, as a
dividend, amount treated as a dividend under section 1248 (or that
would have been so treated but for section 1291), or amount included in
income under section 951(a)(1)(B). For this purpose, any dividend,
amount treated as a dividend under section 1248 (or that would have
been so treated but for section 1291), or amount included in income
under section 951(a)(1)(B) is considered attributable first to earnings
and profits resulting from the disposition of the asset.
(iii) Increase in asset or stock basis--(A) If the carryover basis
rules under paragraphs (g) and (h)(4)(i) of this section apply to an
asset, and the purchasing corporation disposes of the asset to an
unrelated party in a taxable transaction and recognizes and includes in
its U.S. gross income or the U.S. gross income of its shareholders the
greater of the gain equal to the basis increase denied in the asset
pursuant to paragraphs (g) and (h)(4)(i) of this section, or the gain
recognized on the asset by the purchasing corporation on the
disposition of the asset, then the purchasing corporation or the target
or a target affiliate, as appropriate, shall increase the basis of the
selling controlled foreign corporation stock subject to paragraph
(h)(4)(ii) of this section, as of the date of the disposition of the
asset by the purchasing corporation, by the amount of the basis
reduction under paragraph (h)(4)(ii) of this section. The preceding
sentence shall apply only to the extent that the
[[Page 3461]]
controlled foreign corporation stock is owned (within the meaning of
section 958(a)) by a member of the purchasing corporation's affiliated
group.
(B) If the carryover basis rules under paragraphs (g) and (h)(4)(i)
of this section apply to an asset, and the purchasing corporation or
the target or a target affiliate, as appropriate, disposes of the stock
of the selling controlled foreign corporation to an unrelated party in
a taxable transaction and recognizes and includes in its U.S. gross
income or the U.S. gross income of its shareholders the greater of the
amount of the basis reduction under paragraph (h)(4)(ii) of this
section, or the gain recognized in the stock by the purchasing
corporation or by the target or a target affiliate, as appropriate, on
the disposition of the stock, then the purchasing corporation shall
increase the basis of the asset, as of the date of the disposition of
the stock of the selling controlled foreign corporation by the
purchasing corporation or by the target or a target affiliate, as
appropriate, by the amount of the basis increase that was denied
pursuant to paragraphs (g) and (h)(4)(i) of this section. The preceding
sentence shall apply only to the extent that the asset is owned (within
the meaning of section 958(a)) by a member of the purchasing
corporation's affiliated group.
(5) Examples. This paragraph (h) may be illustrated by the
following examples:
Example 1. Stock of target affiliate that is a CFC. (a) The S
group files a consolidated return; however, T2 is a controlled
foreign corporation. On December 1 of Year 1, T1 sells the T2 stock
to P and recognizes gain. On January 2 of Year 2, P makes a
qualified stock purchase of T from S. No section 338 election is
made for T.
(b) Under paragraph (b)(1) of this section, paragraph (d) of
this section applies to the T2 stock. Under paragraph (h)(3) of this
section, paragraph (d)(2)(iii) of this section does not apply to the
T2 stock. Consequently, paragraph (d)(1) of this section applies to
the T2 stock. However, after applying paragraph (d)(1) of this
section, P's basis in the T2 stock is increased by the amount of
T1's gain on the sale of the T2 stock that is treated as a dividend
under section 1248. Because P has a carryover basis in the T2 stock,
the T2 stock is not considered purchased within the meaning of
section 338(h)(3) and no section 338 election may be made for T2.
Example 2. Stock of target affiliate CFC; inclusion under
subpart F. (a) The S group files a consolidated return; however, T2
is a controlled foreign corporation. On December 1 of Year 1, T2
sells an asset to P and recognizes subpart F income that results in
an inclusion in T1's gross income under section 951(a)(1)(A). On
January 2 of Year 2, P makes a qualified stock purchase of T from S.
No section 338 election is made for T.
(b) Because gain from the disposition of the asset results in an
inclusion under section 951(a)(1)(A), the gain is reflected in the
basis of the T stock as of T's acquisition date. See paragraph
(h)(2)(i) of this section. Consequently, under paragraph (b)(1) of
this section, paragraph (d)(1) of this section applies to the asset.
In addition, under paragraph (h)(2)(ii) of this section, T1's basis
in the T2 stock is not increased under section 961(a) by the amount
of the inclusion that is attributable to the sale of the asset.
(c) If, in addition to making a qualified stock purchase of T, P
acquires the T2 stock from T1 on January 1 of Year 2, the results
are the same for the asset sold by T2. In addition, under paragraph
(h)(2)(ii) of this section, T1's basis in the T2 stock is not
increased by the amount of the inclusion that is attributable to the
gain on the sale of the asset. Further, under paragraph (h)(3) of
this section, paragraph (d)(1) of this section applies to the T2
stock. However, after applying paragraph (d)(1) of this section, P's
basis in the T2 stock is increased by the amount of T1's gain on the
sale of the T2 stock that is treated as a dividend under section
1248. Finally, because P has a carryover basis in the T2 stock, the
T2 stock is not considered purchased within the meaning of section
338(h)(3) and no section 338 election may be made for T2.
(d) If P makes a qualified stock purchase of T2 from T1, rather
than of T from S, and T1's gain on the sale of T2 is treated as a
dividend under section 1248, under paragraph (h)(1) of this section,
paragraphs (h)(2) and (3) of this section do not apply because there
is no target that is a domestic corporation. Consequently, the
carryover basis rules of paragraph do not apply to the asset sold by
T2 or the T2 stock.
Example 3. Gain reflected by reason of section 1248 dividend;
gain from non-subpart F asset. (a) The S group files a consolidated
return; however, T2 is a controlled foreign corporation. In Years 1
through 4, T2 does not pay any dividends to T1 and no amount is
included in T1's income under section 951(a)(1)(B). On December 1 of
Year 4, T2 sells an asset with a basis of $400,000 to P for
$900,000. T2's gain of $500,000 is not subpart F income. On December
15 of Year 4, T1 sells T2, in which it has a basis of $600,000, to P
for $1,600,000. Under section 1248, $800,000 of T1's gain of
$1,000,000 is treated as a dividend. However, in the absence of the
sale of the asset by T2 to P, only $300,000 would have been treated
as a dividend under section 1248. On December 30 of Year 4, P makes
a qualified stock purchase of T1 from T. No section 338 election is
made for T1.
(b) Under paragraph (h)(4) of this section, paragraph (g)(2) of
this section applies by reference to the amount treated as a
dividend under section 1248 on the disposition of the T2 stock.
Because the amount treated as a dividend is taken into account in
determining T's basis in the T1 stock under Sec. 1.1502-32, the sale
of the T2 stock and the deemed dividend have the effect of a
transaction described in paragraph (g)(1) of this section.
Consequently, paragraph (d)(1) of this section applies to the asset
sold by T2 to P and P's basis in the asset is $400,000 as of
December 1 of Year 4.
(c) Under paragraph (h)(3) of this section, paragraph (d)(1) of
this section applies to the T2 stock and P's basis in the T2 stock
is $600,000 as of December 15 of Year 4. Under paragraphs (h)(3) and
(4)(ii) of this section, however, P's basis in the T2 stock is
increased by $300,000 (the amount of T1's gain treated as a dividend
under section 1248 ($800,000), other than the amount treated as a
dividend solely as a result of the sale of the asset by T2 to P
($500,000)) to $900,000.
* * * * *
Sec. 1.338-4T [Removed]
Par. 4. Section 1.338-4T is removed.
Par. 5. In Sec. 1.338(i)-1, paragraphs (a) and (b) are revised to
read as follows:
Sec. 1.338(i)-1 Effective dates.
(a) In general. Sections 1.338-1 through 1.338-5 (except
Sec. 1.338-4(h)), 1.338(b)-1, and 1.338(h)(10)-1 generally are
applicable for targets with acquisition dates on or after January
20, 1994. Section 1.338-4(h) is applicable for targets with
acquisition dates on or after January 20, 1997. Section 1.338-4T(h)
(as contained in 26 CFR part 1 as revised April 1, 1996) is
generally applicable for targets with acquisition dates on or after
January 20, 1994, and before January 20, 1997.
(b) Elective retroactive application. A target with an
acquisition date on or after January 14, 1992 and before January 20,
1994 may apply Secs. 1.338-1 through 1.338-5, 1.338-4T(h) (as
contained in 26 CFR part 1 as revised April 1, 1996), 1.338(b)-1,
and 1.338(h)(10)-1 by including a statement with its return
(including a timely filed amended return) for the period that
includes the acquisition date to the effect that it is applying all
of these sections pursuant to this paragraph (b). A target with an
acquisition date on or after January 14, 1992, and before January
20, 1997, may choose to apply Sec. 1.338-4(h) for the period that
includes the acquisition date pursuant to paragraph (b) of this
section.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: January 13, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-1521 Filed 1-22-97; 8:45 am]
BILLING CODE 4830-01-U