[Federal Register Volume 65, Number 15 (Monday, January 24, 2000)]
[Rules and Regulations]
[Pages 3589-3609]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1377]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 7, and 602

[TD 8862]
RIN 1545-AI32


Stock Transfer Rules

AGENCY:  Internal Revenue Service (IRS), Treasury.

ACTION:  Final and temporary regulations.

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SUMMARY:  This document contains final regulations addressing the 
application of nonrecognition exchange provisions in Subchapter C of 
the Internal Revenue Code to transactions that involve one or more 
foreign corporations. These regulations provide guidance for taxpayers 
engaging in those transactions in order to determine the extent to 
which income shall be included and appropriate corresponding 
adjustments shall be made.

DATES:  Effective Date. These regulations are effective as of February 
23, 2000.
    Applicability Dates. These regulations apply to section 367(b) 
exchanges that occur on or after February 23, 2000. However, taxpayers 
may choose to apply these regulations to section 367(b) exchanges that 
occur before February 23, 2000, as specified in Sec. 1.367(b)-6(a)(2).

FOR FURTHER INFORMATION CONTACT:  Mark D. Harris, (202) 622-3860 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have 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 1545-1271. Responses to these collections of information 
are mandatory.
    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 average annual reporting burden in these final 
regulations is 4 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, OP:FS: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 these collections 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 December 27, 1977, the IRS and Treasury issued proposed and 
temporary regulations under section 367(b) of the Internal Revenue Code 
(Code). Subsequent guidance updated and amended the 1977 temporary 
regulations (the 1977 regulations) several times over the next 14 
years. On August 26, 1991, the IRS and Treasury issued proposed 
regulations Secs. 1.367(b)-1 through 1.367(b)-6 (the 1991 proposed 
regulations). Comments to the 1991 proposed regulations were received, 
and a public hearing was held on November 22, 1991. In June of 1998, 
the IRS and Treasury issued final regulations under sections 367(a) and 
(b) (the 1998 regulations). The 1998 regulations addressed transactions 
under section 367(b) only to the extent the transactions are also 
subject to the stock transfer rules of section 367(a). Thus, the 1977 
regulations have remained in effect to the extent not superseded by the 
1998 regulations. The preamble to the 1998 regulations stated that the 
IRS and Treasury would issue guidance at a later date to address the 
portions of the 1991 proposed regulations related to section 367(b) 
that were not addressed in the 1998 regulations.
    After consideration of the 1977 regulations and their updates and 
amendments, the 1991 proposed regulations and their updates and 
amendments, the 1998 regulations, and all comments received with 
respect to such regulations, the IRS and Treasury adopt Secs. 1.367(b)-
1 through 1.367(b)-6 as final regulations under section 367(b).

Overview

A. General Policies of Section 367(b)

    Section 367(b) governs corporate restructurings under sections 332, 
351, 354, 355, 356, and 361 (except to the extent described in section 
367(a)(1)) in which the status of a foreign corporation as a 
``corporation'' is necessary for application of the relevant 
nonrecognition provisions. Section 367(b) provides that a foreign 
corporation that is a party to one of the enumerated nonrecognition 
transactions shall be respected as a corporation, and thereby the 
parties involved in the transaction shall obtain the benefits of the 
applicable nonrecognition exchange provisions and their related 
provisions (such as section 381) (together, the Subchapter C 
provisions), except to the extent provided in regulations.
    The principal purpose of section 367(b) is to prevent the avoidance 
of U.S. tax that can arise when the Subchapter C provisions apply to 
transactions involving foreign corporations. The potential for tax 
avoidance arises because of differences between the manner in which the 
United States taxes foreign corporations and their shareholders and the 
manner in which the United States taxes domestic corporations and their 
U.S. shareholders.
    The Subchapter C provisions generally have been drafted to apply to 
domestic corporations and U.S. shareholders, and thus do not fully take 
into account the cross-border aspects of U.S. taxation (such as 
deferral, foreign tax credits, and section 1248). Section 367(b) was 
enacted to help ensure that international tax considerations in the 
Code are adequately addressed when the Subchapter C provisions apply to 
an exchange involving a foreign corporation. Because determining the 
proper interaction of the Code's international and Subchapter C 
provisions is ``necessarily highly technical,'' Congress granted the 
Secretary broad regulatory authority to provide the ``necessary or 
appropriate'' rules, rather than enacting a complex

[[Page 3590]]

statutory regime. H.R. Rep. No. 658, 94th Cong., 1st Sess. 241 (1975).
    Accordingly, as the preamble to the 1991 proposed regulations 
stated, the section 367(b) regulations require adjustments or 
inclusions in order to prevent the material distortion of income that 
can occur when the Subchapter C provisions apply to an exchange 
involving a foreign corporation. The 1991 proposed regulations 
simplified the 1977 regulations and were generally favorably received 
by taxpayers. The final regulations adopt the 1991 proposed regulations 
with modifications. The modifications are based on further 
considerations of fairness, simplicity, and administrability.
    The final regulations also incorporate the section 367(b) rules 
contained in the 1998 regulations. The 1998 regulations finalized 
portions of the 1991 proposed regulations to the extent necessary to 
address the overlap between section 367(b) and the section 367(a) stock 
transfer rules. Because the scope of the final regulations is broader 
than that overlap, the final regulations adopt the 1998 section 367(b) 
provisions in a manner appropriate to their incorporation into the 
final regulations.
    The IRS and Treasury are also issuing other guidance under section 
367(b). Temporary and proposed regulations (published elsewhere in this 
issue of the Federal Register) address the elimination of an election 
available to certain taxpayers under the 1977 regulations and the 1991 
proposed regulations. In addition, the IRS and Treasury intend to issue 
other proposed regulations that provide rules regarding the combination 
and separation of corporate-level tax attributes in applicable section 
367(b) exchanges.

B. Specific Policies in Context of Inbound Nonrecognition Transactions

    Section 1.367(b)-3 addresses transactions in which a foreign 
corporation transfers assets to a domestic corporation pursuant to a 
Subchapter C provision. These transactions include a section 332 
liquidation of a foreign corporation into a domestic parent corporation 
and an asset reorganization, such as a C, D, or F reorganization, of a 
foreign corporation into a domestic corporation (inbound nonrecognition 
transactions). Section 381 generally provides rules regarding the 
extent to which corporate attributes carry over in such transactions.
    The principal policy consideration of section 367(b) with respect 
to inbound nonrecognition transactions is the appropriate carryover of 
attributes from foreign to domestic corporations. This consideration 
has interrelated shareholder-level and corporate-level components. At 
the shareholder level, the section 367(b) regulations are concerned 
with the proper taxation of previously deferred earnings and profits. 
At the corporate level, the section 367(b) regulations are concerned 
with both the extent and manner in which tax attributes carry over in 
light of the variations between the Code's taxation of foreign and 
domestic corporations.
    The section 367(b) regulations have historically focused on the 
carryover of earnings and profits and bases of assets, simultaneously 
addressing the shareholder and corporate level concerns by accounting 
for any necessary adjustments through an income inclusion by the U.S. 
shareholders of the foreign acquired corporation (and without limiting 
the extent to which the domestic acquiring corporation succeeds to the 
attributes). The 1991 proposed regulations required a U.S. shareholder 
of the foreign acquired corporation (or, in certain cases, a foreign 
subsidiary of the U.S. shareholder) to currently include in income the 
allocable portion of the foreign acquired corporation's earnings and 
profits accumulated during the U.S. shareholder's holding period (all 
earnings and profits amount). The requirement to include in income the 
all earnings and profits amount results in the taxation of previously 
unrepatriated earnings accumulated during a U.S. shareholder's (direct 
or indirect) holding period. This income inclusion prevents the 
conversion of a deferral of tax into a forgiveness of tax and generally 
ensures that the section 381 carryover basis reflects an after-tax 
amount. However, the all earnings and profits amount inclusion does not 
consider tax attributes that accrue during a non-U.S. person's holding 
period.
    Commentators criticized the scope of the 1991 proposed regulations, 
arguing that the all earnings and profits amount should be limited to 
the amount that a shareholder would include in income as a deemed 
dividend under section 1248. The scope of the all earnings and profits 
amount is broader than the section 1248 amount because, for example, 
the all earnings and profits amount is calculated without regard to 
whether the foreign corporation is a CFC and without regard to a 
shareholder's gain in the stock. However, this view too narrowly 
construes the role of section 367(b) by focusing on potential 
shareholder-level consequences without adequately considering the 
section 367(b) policy of determining the appropriate carryover of 
corporate-level attributes in inbound nonrecognition transactions. 
Thus, the final regulations retain the 1991 proposed regulations' 
definition of all earnings and profits amount. The final regulations 
also generally retain (subject to a new de minimis exception) the 
taxation of all exchanging U.S. shareholders in inbound nonrecognition 
transactions.
    In finalizing these regulations, the IRS and Treasury considered 
whether future section 367(b) regulations should limit the extent to 
which tax attributes carry over from foreign to domestic corporations. 
Such a limitation would more directly implement the section 367(b) 
policy related to the carryover of attributes and, as a result, reduce 
the class of U.S. persons required to have an income inclusion in 
connection with an inbound nonrecognition transaction. Such a 
limitation would also enable the section 367(b) regulations to address 
the carryover of attributes attributable to a non-U.S. person's holding 
period. The IRS and Treasury request comments as to the merits of an 
attribute carryover limitation, as well as other approaches that could 
address the carryover of tax attributes related to a non-U.S. person's 
holding period under section 367(b).

C. Specific Policies in Context of Foreign-to-Foreign Nonrecognition 
Transactions and Section 355 Distributions

    Section 1.367(b)-4 addresses transactions in which a foreign 
corporation acquires the stock or assets of another foreign corporation 
in an exchange described in section 351 or a section 368(a)(1)(B), (C), 
(D), (E), (F) or (G) reorganization (foreign-to-foreign nonrecognition 
transactions). Section 1.367(b)-5 provides rules regarding a 
distribution by a foreign corporation of the stock or securities of a 
domestic or foreign corporation described in section 355. The historic 
policy objective of section 367(b) in both of these contexts has been 
to preserve the potential application of section 1248. Thus, the amount 
that would have been recharacterized as a dividend under section 1248 
upon a disposition of the stock (section 1248 amount) generally must be 
included in income as a dividend at the time of the section 367(b) 
exchange to the extent such section 1248 amount would not be preserved 
immediately following the section 367(b) exchange.
    The final regulations do not address all of the policy 
considerations raised by the application of the Subchapter C provisions 
to transactions described in Secs. 1.367(b)-4 and 1.367(b)-5. For

[[Page 3591]]

example, current rules regarding the carryover or separation of foreign 
corporations' earnings and profits do not adequately consider the 
international aspects of the Code, most notably the foreign tax credit. 
Forthcoming proposed regulations will consider these issues. Until the 
IRS and Treasury promulgate such regulations, taxpayers should use a 
reasonable method (consistent with existing law and taking proper 
account of the purposes of the foreign tax credit regime) to determine 
the carryover and separation of earnings and profits and related 
foreign taxes.

Explanation of Provisions

    The IRS received numerous comments on the 1991 proposed 
regulations. The following discussion summarizes the comments and 
changes to the 1991 proposed regulations.

A. Sec. 1.367(b)-1(c): Notice Requirements

    Section 1.367(b)-1(c) of the 1991 proposed regulations required any 
person that realizes income in a section 367(b) exchange to file a 
notice with respect to the exchange, regardless of such person's status 
as a U.S. person and its percentage ownership in the corporation that 
is a party to the section 367(b) exchange. Commentators criticized this 
notice requirement as overly broad. The 1998 regulations limited the 
notice requirement to shareholders that realize income and file a tax 
return under section 6012. The final regulations further revise the 
notice requirement and generally narrow its scope by requiring notice 
only with respect to persons and transactions that may be subject to an 
inclusion under the final regulations' operative provisions.

B. Sec. 1.367(b)-2: Definitions and Special Rules

1. Sec. 1.367(b)-2(d): All Earnings and Profits Amount
    Section 1.367(b)-2(d) of the 1991 proposed regulations generally 
defined ``all earnings and profits amount'' as the allocable share of 
net positive earnings and profits accrued by a foreign corporation 
during a shareholder's holding period. The 1991 proposed regulations 
provided that the all earnings and profits amount is determined 
according to the attribution principles of section 1248. Because the 
section 1248 attribution rules incorporate the section 1223 holding 
period rules, commentators were concerned that the definition of all 
earnings and profits amount inappropriately included earnings and 
profits attributable to the holding period of non-U.S. persons by 
virtue of the rules of section 1223(2).
    In response, the final regulations amend the definition of all 
earnings and profits amount to exclude amounts attributable to the 
holding period of non-U.S. persons. This modification applies to the 
extent the non-U.S. person was not directly or indirectly owned by U.S. 
persons with a 10 percent or greater interest when the earnings and 
profits accumulated. An example in the final regulations illustrates 
this new rule.
    When applying the attribution principles of section 1248 for 
purposes of determining the all earnings and profits amount, the 
requirements of section 1248 unrelated to computing the amount of 
earnings and profits attributable to a shareholder's block of stock 
should not apply. The final regulations explicitly state this 
principle. The 1991 proposed regulations applied this principle, for 
example, when they provided that the all earnings and profits amount is 
calculated without regard to whether the foreign corporation is a 
controlled foreign corporation (CFC). The final regulations further 
specify that the all earnings and profits amount includes earnings 
attributable to an exchanging shareholder's stock, without regard to 
whether the exchanging shareholder owned 10 percent of the stock of the 
foreign acquired corporation. A new example in the final regulations 
illustrates these rules.
2. Sec. 1.367(b)-2(e): Treatment of Deemed Dividends
    Section 1.367(b)-2(e) of the 1991 proposed regulations provided 
that a deemed dividend shall be treated as an actual dividend. Thus, a 
deemed dividend was considered as paid out of the earnings and profits 
of a foreign corporation and was considered as having been paid through 
intermediate owners (when appropriate). One commentator noted that an 
inclusion under the 1991 proposed regulations could yield a different 
result from an inclusion under section 1248 because section 1248 treats 
a corporation as having paid the section 1248 amount directly to an 
exchanging shareholder despite any intermediate owners.
    A deemed dividend under section 367(b) is distinguishable from a 
section 1248 inclusion because a section 1248 inclusion is not treated 
as a dividend at the corporate level. Thus, a corporation does not 
reduce its earnings and profits with regard to an inclusion under 
section 1248. Instead, the shareholder-level inclusion is considered 
eligible to be treated as previously taxed earnings and profits (PTI) 
upon a subsequent distribution. In light of this distinction between 
section 367(b) and section 1248, the final regulations retain the rule 
in Sec. 1.367(b)-2(e) of the 1991 proposed regulations.
3. Final Regulation Sec. 1.367(b)-2(j): Sections 985 Through 989
    Section 1.367(b)-2(k) of the 1991 proposed regulations provided 
rules regarding currency exchange inclusions or adjustments that result 
from a section 367(b) exchange. The final regulations apply the 
principles of the 1991 proposed regulations, but provide the following 
modifications.
    The 1991 proposed regulations required an acquired corporation that 
participates in a transaction described in section 381(a) to change its 
functional currency if the acquiring corporation has a different 
functional currency. The rule was intended to ensure that taxpayers use 
the correct functional currency after a section 367(b) exchange. 
However, functional currency is determined separately for each 
qualified business unit (QBU). In addition, the functional currency of 
a QBU of either the acquired or acquiring corporation may change as a 
result of a section 367(b) exchange. Accordingly, the final regulations 
provide that a QBU is deemed to have automatically changed its 
functional currency when its functional currency, as determined after a 
section 367(b) exchange, is different than before the exchange. Thus, 
the QBU is required to make appropriate adjustments under Sec. 1.985-5.
    The 1991 proposed regulations provided that, if an exchanging 
shareholder is required to include in income either the all earnings 
and profits amount or the section 1248 amount, then immediately before 
the exchange and solely for purposes of computing exchange gain or loss 
under section 986(c), the shareholder is treated as receiving a 
distribution of PTI from the appropriate foreign corporation. The 
purpose of this provision was to ensure that exchange gain or loss 
under section 986(c) is subject to current inclusion when the earnings 
of the foreign corporation are no longer deferred or to the extent a 
taxpayer does not retain its interest in PTI.
    Section 1.367(b)-2(j)(2) of the final regulations expands the rules 
regarding the treatment of exchange gain or loss on PTI under section 
986(c). An exchanging shareholder that is a U.S. person is required to 
recognize its section 986(c) gain or loss to the extent that deferral 
has ended with respect to

[[Page 3592]]

a foreign corporation's earnings (as can occur in the case of an 
inbound or foreign-to-foreign nonrecognition transaction) or the U.S. 
person has a diminished interest in the PTI after the exchange (as can 
occur in the case of a section 355 distribution by a foreign 
corporation). A different rule applies when a U.S. person indirectly 
holds (through a foreign exchanging shareholder) its interest in the 
foreign corporation with regard to which the PTI inclusion is measured. 
In that case, the indirect U.S. shareholder does not recognize section 
986(c) gain or loss at the time of the section 367(b) exchange. In 
order to preserve such section 986(c) gain or loss for future inclusion 
by the indirect U.S. shareholder, the foreign exchanging shareholder is 
treated as having received a distribution of the PTI.
    Other rules under sections 985 through 989, such as the branch 
termination rules, may also apply to the transaction.

C. Sec. 1.367(b)-3: Repatriation of Foreign Corporate Assets in Certain 
Nonrecognition Transactions

    Section 1.367(b)-3 provides rules with respect to inbound 
nonrecognition transactions.
1. Sec. 1.367(b)-3(b): Exchanges of Stock
    Section 1.367(b)-3(b) of the 1991 proposed regulations generally 
provided that if an exchanging shareholder is either (i) a 10 percent 
U.S. shareholder of the foreign acquired corporation or (ii) a foreign 
corporation with respect to which a U.S. person is either a section 
1248 shareholder or a domestic corporation that meets the stock 
ownership requirements of section 902, the shareholder must include in 
income as a deemed dividend the all earnings and profits amount 
attributable to its stock in the foreign acquired corporation. The 
final regulations generally retain this rule. However, in order to 
provide greater consistency among its various ownership thresholds, the 
final regulations revise Sec. 1.367(b)-3(b)(ii) so that Sec. 1.367(b)-
3(b) applies to a foreign corporation with respect to which there is, 
in general, a 10 percent U.S. shareholder.
    The 1991 proposed regulations provided that the same country 
dividend exception in section 954(c)(3)(A)(i) does not apply to an 
exchanging shareholder that is a CFC. Commentators criticized this 
rule, stating that a deemed dividend under section 367(b) should not be 
treated more harshly than an actual dividend and that taxpayers can 
circumvent this rule by having a lower-tier foreign corporation 
distribute a dividend before an asset transfer. However, unlike a 
dividend distribution that qualifies for the same country dividend 
exception, an inbound asset transfer represents a current repatriation 
of earnings into the United States. Accordingly, the final regulations 
retain the rule in the 1991 proposed regulations that the same country 
dividend exception does not apply to an exchanging shareholder that is 
a CFC.
    The 1991 proposed regulations generally required the recognition of 
exchange gain (or loss) to the extent that an exchanging shareholder's 
capital account in a foreign acquired corporation appreciated (or 
depreciated) as a result of changes in currency exchange rates. Such 
gain (or loss) is reflected in the basis of assets when translated at 
the spot rate. The preamble to the 1991 proposed regulations invited 
comments regarding the calculation of such exchange gain (or loss), 
particularly in cases when a shareholder acquired the foreign corporate 
stock by purchase rather than in connection with the corporation's 
formation. None of the comments suggested a method for determining and 
tracking shareholder capital accounts. Most comments focused on the 
potential complexity and compliance burdens created by the rule. After 
considering the administrability issues associated with the exchange 
gain (or loss) calculation, the final regulations do not adopt the 
provision requiring the recognition of exchange gain (or loss) on a 
shareholder's capital account. However, the final regulations reserve 
the issue for further consideration.
    Sections 7.367(b)-5(b) and 7.367(b)-7(c)(2)(ii) of the 1977 
regulations, and Sec. 1.367(b)-3(b)(2)(iii) of the 1991 proposed 
regulations provided an exchanging shareholder with an opportunity to 
recognize the gain (but not the loss) that it realizes in the exchange 
(taxable exchange election), rather than including the all earnings and 
profits amount in income as a deemed dividend. This taxable exchange 
election, however, is inconsistent with the policies of section 367(b) 
that apply to inbound transactions. These policies, as previously 
discussed, are unrelated to an exchanging shareholder's outside gain on 
its stock.
    Moreover, when the all earnings and profits amount exceeds a 
shareholder's gain on its stock, merely limiting the shareholder's 
inclusion to its outside stock gain creates the potential for the 
duplication and importation of losses. See TAM 9003005 (September 28, 
1989) (interpreting the 1977 regulations) (available at IRS Freedom of 
Information Act Reading Room, 1111 Constitution Avenue, NW., 
Washington, DC 20224). The 1991 proposed regulations attempted to 
address this aspect of the taxable exchange election by requiring 
various attributes of the foreign acquired corporation (such as basis 
in its assets) to be reduced (attribute reduction regime) to the extent 
the all earnings and profits amount exceeds an exchanging shareholder's 
stock gain.
    However, the taxable exchange election in the 1991 proposed 
regulations had other shortcomings. The election added substantial 
complexity to the regulations by requiring timely coordination between 
electing shareholders and the acquiring corporation to carry out the 
required attribute reductions. In addition, the attribute reduction 
regime can be unfair in situations involving more than one exchanging 
U.S. shareholder. For example, consider an inbound C, D, or F 
reorganization involving two U.S. shareholders of the foreign acquired 
corporation, one that makes the taxable exchange election (because its 
gain on the stock is less than its all earnings and profits amount) and 
one that does not. In connection with the electing shareholder's 
taxable exchange election, the 1991 proposed regulations required a 
proportionate reduction in certain tax attributes of the foreign 
acquired corporation. This reduction effectively allowed the electing 
shareholder to transfer to the acquiring corporation the burden created 
by its decision not to include in income its full all earnings and 
profits amount and, thereby, to effectively shift a portion of this 
burden to the non-electing shareholder (that has already paid U.S. tax 
on its full share of the foreign corporation's earnings and profits).
    Finally, a taxable exchange election is not required by the 
statute. Section 367(b) directs the Secretary to prescribe regulations 
that provide the necessary or appropriate tax consequences that should 
accompany the application of the Subchapter C provisions to 
transactions involving foreign corporations. Section 367(b)(2) 
specifically provides that the section 367(b) regulations may include 
the circumstances under which ``gain shall be recognized currently or 
amounts included in gross income currently as a dividend, or both * * 
*.'' Thus, the statute authorizes the IRS and Treasury to require an 
inclusion of amounts, as distinct from gain. As previously discussed, 
the all earnings and profits amount appropriately measures an 
exchanging shareholder's income

[[Page 3593]]

inclusion in connection with an inbound nonrecognition transaction.
    After balancing the above considerations against the benefits of 
the taxable exchange election, the final regulations do not adopt the 
taxable exchange election. However, in order to provide taxpayers an 
opportunity to comment on this change to the 1977 regulations and the 
1991 proposed regulations, the IRS and Treasury are concurrently 
issuing temporary and proposed regulations that provide the taxable 
exchange election in modified form. This election permits an exchanging 
shareholder to elect to treat a transaction as a taxable exchange, but 
modifies the attribute reduction regime by limiting its application to 
a section 332 liquidation or to an inbound asset reorganization in 
which the foreign acquired corporation is wholly owned (directly or 
indirectly) by one U.S. person. This limited application of the 
attribute reduction regime eliminates the potentially unfair results 
that can arise when attributes are reduced in a transaction involving 
multiple exchanging shareholders. This also reduces (although does not 
eliminate) the potential for the duplication and importation of losses 
that can arise in the absence of attribute reduction. The temporary 
regulation is effective for one year from the effective date of the 
final regulations.
2. Sec. 1.367(b)-3(c): Exchanges of Stock by Other U.S. Persons
    Section 1.367(b)-3(c) of the 1991 proposed regulations provided a 
special rule for U.S. persons that are not subject to the 
Sec. 1.367(b)-3(b) requirement to include in income the all earnings 
and profits amount (generally, shareholders owning less than 10 percent 
of the foreign acquired corporation, hereinafter small shareholders). 
The 1991 proposed regulations required these small shareholders to 
recognize the gain on their stock in the foreign acquired corporation. 
This rule was included because of administrative concerns, since small 
shareholders may not have sufficient information to calculate their all 
earnings and profits amounts. In addition, a foreign acquired 
corporation may not have adequate information about its small 
shareholders' inclusions to properly adjust its earnings and profits 
for the deemed dividends that would arise in these situations.
    Commentators requested that the final regulations provide small 
shareholders the option of including in income the all earnings and 
profits amount, rather than recognizing the gain on their stock. In 
response, the final regulations include such an election, provided that 
a small shareholder has sufficient information to substantiate its all 
earnings and profits amount and provided that the small shareholder 
furnishes proper certification to the foreign acquired corporation (or 
its successor in interest) so that the corporation can properly reduce 
its earnings and profits. Electing small shareholders must also comply 
with the section 367(b) notice requirement. A less extensive section 
367(b) notice procedure is available if the foreign acquired 
corporation has never had earnings and profits that would result in any 
shareholder having an all earnings and profits amount.
    Commentators also requested an election that would permit a 
domestic acquiring corporation to include in income the all earnings 
and profits amounts on behalf of the foreign acquired corporation's 
small shareholders. The final regulations do not adopt this suggestion 
because of its substantial administrative difficulties. For example, it 
is unlikely that a publicly traded foreign corporation (or its domestic 
acquirer) could ascertain each small shareholder's correct holding 
period in the stock of the foreign acquired corporation, which would be 
necessary to properly determine such a cumulative all earnings and 
profits amount inclusion.
    The final regulations also include a new de minimis exception, 
which applies to small shareholders whose stock in the foreign acquired 
corporation has a fair market value below $50,000 on the date of the 
exchange. These shareholders are not required to include gain or a 
deemed dividend under the section 367(b) regulations.
3. Sec. 1.367(b)-3(d): Carryover of Certain Attributes
    Section 1.367(b)-3(d) of the 1991 proposed regulations clarified 
that a domestic acquiring corporation may succeed to foreign taxes paid 
or accrued by a foreign acquired corporation that are eligible for 
credit under section 906. A domestic acquiring corporation may not 
succeed to any other foreign taxes paid or accrued by a foreign 
acquired corporation because the earnings that carry over to a domestic 
acquiring corporation (other than earnings related to the taxes 
eligible for credit under section 906) are not subject to double 
taxation at the corporate level. This rule is consistent with the 
general policy of section 367(b) to permit the carryover of corporate 
tax attributes only when appropriate. The final regulations retain the 
rules of Sec. 1.367(b)-3(d), and add an example that illustrates their 
application.

D. Sec. 1.367(b)-4: Acquisition of Foreign Corporate Stock or Assets by 
a Foreign Corporation in Certain Nonrecognition Transactions

    Section 1.367(b)-4 of the 1991 proposed regulations addressed 
foreign-to-foreign nonrecognition transactions. In general, if the 
exchange in such a transaction results in a section 1248 shareholder of 
the foreign acquired corporation losing its section 1248 shareholder 
status, Sec. 1.367(b)-4(b) required the exchanging shareholder to 
currently include its section 1248 amount in income as a deemed 
dividend. The 1991 proposed regulations generally did not require an 
income inclusion in circumstances when a section 1248 shareholder 
retains its status. In the case of a lower-tier transaction (where the 
exchanging shareholder is a foreign corporation), the section 1248 
amount was not included as foreign personal holding company income 
(FPHCI) under section 954(c). This provision permitted deferral of the 
section 1248 amount by preserving such earnings and profits as earnings 
of the foreign corporation that is the exchanging shareholder. The 
final regulations retain these general rules.
1. Sec. 1.367(b)-4(b): Recognition of Income
    Section 1.367(b)-4(b) of the 1991 proposed regulations provided an 
exception to its general rule if an exchanging shareholder receives 
stock of a domestic corporation. This provision, which the 1991 
proposed regulations included in response to a criticism of the 1977 
regulations, was intended to provide relief in cases when a domestic 
acquiring corporation issues its own stock in exchange for CFC stock 
and succeeds to the section 1248 amount allocable to the transferor 
U.S. shareholder. Because Sec. 1.367(b)-4(a) of the 1991 proposed 
regulations already limited the application of Sec. 1.367(b)-4 to an 
acquisition by a foreign corporation, such relief was unnecessary.
    Moreover, the provision inadvertently did not require an inclusion 
of a section 1248 amount that may not be preserved immediately after 
the exchange. This could occur, for example, if a foreign acquiring 
corporation uses the stock of its domestic parent corporation to 
acquire the stock or assets of a foreign target corporation from a 
section 1248 shareholder. Accordingly, the final regulations do not 
adopt the 1991 proposed regulations' provision regarding receipt of 
stock of a domestic corporation in a transaction described in 
Sec. 1.367(b)-4.

[[Page 3594]]

2. Sec. 1.367(b)-4(d): Special Rule for Applying Section 1248 to 
Subsequent Exchanges
    The 1998 regulations revised the rules of the 1991 proposed 
regulations regarding the application of section 367(b) and section 
1248 to exchanges that follow a Sec. 1.367(b)-4 exchange in which an 
exchanging shareholder is not required to include a section 1248 amount 
in income. Because of the limited scope of the 1998 regulations, its 
rule only addressed the application of section 367(b) and section 1248 
following a stock transfer by a direct U.S. shareholder. The final 
regulations incorporate the principles of the 1998 regulations and 
expand their application to the class of transactions subject to 
Sec. 1.367(b)-4, including asset transfers and transactions in which 
the exchanging shareholder is a foreign corporation. The final 
regulations also address the interaction of these rules with section 
964(e), by providing the extent to which they apply to subsequent 
section 964(e) sales and exchanges. Two new examples in the final 
regulations, as well as an expanded restatement of the example provided 
in the 1998 regulations, illustrate the application of these rules.
    Commentators also requested that the IRS and Treasury clarify the 
carryover of earnings and profits and tax accounts in transactions 
where an exchanging shareholder is not required to include a section 
1248 amount, as well as the application of section 902 to distributions 
by a foreign acquiring corporation after such a section 367(b) 
exchange. The IRS and Treasury will address these issues in forthcoming 
proposed regulations.

E. Sec. 1.367(b)-5: Distributions of Stock Described in Section 355

1. Sec. 1.367(b)-5(b): Distribution by a Domestic Corporation
    Section 1.367(b)-5(b) of the 1991 proposed regulations generally 
provided that a domestic corporation must recognize gain on a section 
355 distribution of foreign stock to individuals. The final regulations 
retain this general rule, consistent with the recently promulgated 
final regulations under section 367(e) (governing a section 355 
distribution by a domestic corporation of foreign stock to foreign 
persons).
    Commentators requested that the final regulations clarify the 
proper method for determining whether a distributee is an individual. 
The same issue arises under section 367(e), and the final regulations 
adopt the approach of the section 367(e) regulations. Thus, a 
distributee is presumed to be an individual except to the extent that 
the distributing corporation certifies that the distributee is not an 
individual. However, a publicly traded distributing corporation may use 
a reasonable analysis with respect to distributees that are not five 
percent shareholders of publicly traded stock to demonstrate the number 
of distributees that are not individuals. A reasonable analysis 
includes a determination of the actual number of distributees that are 
not individuals or a reasonable statistical analysis of shareholder 
records and other relevant information. Section 1.367(b)-2(k) 
(Sec. 1.367(b)-2(l) of the 1991 proposed regulations) has also been 
amended to adopt the look-through provisions provided in Sec. 1.367(e)-
1(b)(2) for purposes of determining the identity of distributees when 
the domestic distributing corporation stock is held by a partnership, 
trust or estate.
2. Sec. 1.367(b)-5(c): Pro Rata Distribution by a CFC
    Section 1.367(b)-5(c) of the 1991 proposed regulations provided 
that, when a CFC distributes stock of a controlled corporation on a pro 
rata basis in a section 355 transaction, a distributee must reduce its 
post-distribution basis in either the distributing or controlled 
corporation stock to the extent its section 1248 amount attributable to 
such corporation is reduced as a result of the distribution. To the 
extent the reduction of the section 1248 amount exceeds the stock 
basis, the distributee must include the difference in income as a 
deemed dividend. The final regulations retain this general rule, 
subject to the following refinements.
    The final regulations add new Sec. 1.367(b)-5(c)(3), which provides 
that the basis adjustment provided in Sec. 1.367(b)-2(e)(3)(ii) shall 
not apply if a deemed dividend is included in income pursuant to 
Sec. 1.367(b)-5(c). Under Sec. 1.367(b)-2(e)(3)(ii), a shareholder's 
basis is increased by the amount of a deemed dividend inclusion. In the 
context of a Sec. 1.367(b)-5(c) inclusion, the Sec. 1.367(b)-
2(e)(3)(ii) basis increase would undermine the purpose of the section 
367(b) regulations, because the basis increase would correspondingly 
decrease the shareholder's built-in gain, thereby reducing the section 
1248 amount that is intended to be preserved after the transaction.
    Furthermore, some taxpayers commented that the Sec. 1.367(b)-
5(c)(2) basis reduction can lead to the creation of phantom gain; that 
is, it can leave a shareholder with a cumulative amount of post-
distribution built-in gain in the stock of the distributing and 
controlled corporations that exceeds its predistribution built-in gain. 
As a result, commentators requested that a reduction in the basis in 
one of the corporations give rise to a corresponding increase in the 
basis of the stock of the other corporation. In response, 
Sec. 1.367(b)-5(c)(4) of the final regulations provides a basis 
redistribution rule, under which the basis of the stock of the 
distributing or controlled corporation (as applicable) is increased by 
the amount of the required decrease in basis in the other stock under 
Sec. 1.367(b)-5(c)(2). However, basis cannot be increased above the 
fair market value of the stock and also cannot be increased to the 
extent the increase diminishes the postdistribution section 1248 amount 
with respect to such stock. This basis redistribution rule also applies 
with regard to deemed dividend inclusions under Sec. 1.367(b)-5(c)(2). 
An example in the final regulations illustrates the application of 
these new rules.
3. Sec. 1.367(b)-5(d): Non-Pro Rata Distribution by Controlled Foreign 
Corporation
    Section 1.367(b)-5(d) of the 1991 proposed regulations provided 
that, if a CFC distributes controlled corporation stock on a non-pro 
rata basis, each distributee must include in income the amount of any 
reduction in its section 1248 amount with regard to either the 
distributing or controlled corporation. For this purpose, the 1991 
proposed regulations treated a shareholder of the distributing 
corporation that does not exchange stock in the distributing 
corporation for stock in the controlled corporation (non-participating 
shareholder) as a distributee.
    The 1991 proposed regulations provided that a non-participating 
shareholder may make an election (taxable distribution election), under 
which the distributing and controlled corporations are not treated as 
corporations for purposes of gain (but not loss) recognition by all 
persons affected by the taxable status of the transaction. The preamble 
to the 1991 proposed regulations invited comments as to whether the 
benefits of the taxable distribution election to non-participating 
shareholders are outweighed by the potential adverse effects on the 
other shareholders.
    In response, commentators uniformly criticized the taxable 
distribution election. They argued that the election was inequitable 
because it enabled a non-participating shareholder (who may be a small 
shareholder) to unilaterally and retroactively invalidate the section

[[Page 3595]]

355 transaction for all parties involved. Commentators also pointed out 
that the taxable distribution election could distort the economic 
incentives in cross-border restructurings by requiring participating 
shareholders to consider identifying and making contractual 
arrangements (which could include monetary arrangements) with each non-
participating shareholder in order to prevent them from electing to 
invalidate the section 355 transaction. Commentators thus argued in 
favor of not adopting the taxable distribution election in the final 
regulations.
    The taxable distribution election is also not required by the 
statute. Section 367(b) directs the Secretary to prescribe regulations 
that provide the necessary or appropriate tax consequences that should 
accompany the application of the Subchapter C provisions to 
transactions involving foreign corporations. Section 367(b)(2) 
specifically provides that the section 367(b) regulations ``shall 
include (but shall not be limited to) regulations dealing with the sale 
or exchange of stock or securities in a foreign corporation by a U.S. 
person. * * *'' Accordingly, the section 367(b) regulations may address 
the tax consequences of a non-pro rata distribution to both 
participating and non-participating shareholders. In both cases, the 
diminution in a shareholder's potential section 1248 amount following a 
section 355 transaction appropriately measures the shareholder's 
inclusion with regard to a section 355 transaction involving a 
distributing corporation that is a controlled foreign corporation. 
Differing results depending on whether a shareholder is a participating 
shareholder or a non-participating shareholder can also be viewed as 
artificial, given that the distinction is often merely a function of 
alternative planning strategies.
    In light of all of the above considerations, the final regulations 
do not adopt the taxable distribution election. As a result, all 
shareholders of a CFC that distributes stock on a non-pro rata basis 
must include in income the amount of any reduction in their section 
1248 amount with respect to either the distributing or controlled 
corporation.
4. Final Regulation Sec. 1.367(b)-5(f): Exclusion of Deemed Dividend 
From FPHCI
    Commentators noted that the 1991 proposed regulations did not 
automatically exclude a Sec. 1.367(b)-5(c) or (d) deemed dividend 
inclusion by an exchanging foreign corporate shareholder from FPHCI. 
Accordingly, the deemed dividend generally would be subpart F income 
and currently includible in income by a U.S. shareholder of the 
exchanging foreign corporation. As in the case of a lower-tier foreign-
to-foreign transaction described in Sec. 1.367(b)-4, the potential 
application of section 1248 can be preserved by excluding the deemed 
dividend from FPHCI. Thus, the final regulations adopt the suggestion 
and provide that a Sec. 1.367(b)-5(c) or (d) deemed dividend inclusion 
by a foreign corporation is not included in FPHCI under section 954(c).
5. 1991 Proposed Regulation Sec. 1.367(b)-5(f): Adjustments to Earnings 
and Profits
    Section 1.367(b)-5(f) of the 1991 proposed regulations provided 
rules regarding the allocation of earnings and profits of a foreign 
transferor corporation in connection with a section 355 distribution. 
After further consideration, the IRS and Treasury have not included 
Sec. 1.367(b)-5(f) of the 1991 proposed regulations in the final 
regulations. Forthcoming proposed regulations will more fully consider 
the allocation of earnings and profits in section 355 distributions 
where either (or both) the distributing or controlled corporation is a 
foreign corporation.

F. Sec. 1.367(b)-6: Effective Date

    The final regulations apply to section 367(b) exchanges that occur 
on or after February 23, 2000. The preamble to the 1991 proposed 
regulations solicited comments on whether the final regulations should 
provide an election to apply the regulations retroactively to exchanges 
that occur on or after August 26, 1991 (the date the 1991 proposed 
regulations were published in the Federal Register). Given the length 
of time that has elapsed since the issuance of the 1991 proposed 
regulations, the IRS and Treasury do not believe that such an election 
would be appropriate. This determination is consistent with the 1998 
revision to Sec. 1.367(b)-2(d) of the 1991 proposed regulations, which 
deleted the proposed special retroactive effective date for the 
definition of the all earnings and profits amount. A taxpayer may, 
however, elect to apply the final regulations to section 367(b) 
exchanges that occur (or occurred) before February 23, 2000, if the due 
date for the taxpayer's timely filed Federal tax return (including 
extensions) for the taxable year in which the section 367(b) exchange 
occurs (or occurred) is after February 23, 2000.

Removed Provisions

    These regulations finalize substantially all of the 1991 proposed 
regulations. In connection with the finalization of these regulations, 
the 1977 regulations (other than Sec. 7.367(b)-12) and the section 
367(b) provisions contained in the 1998 regulations are removed. 
Section 7.367(b)-12 is retained to address distributions with respect 
to (or a disposition of) stock that was subject to certain provisions 
of the 1977 regulations in effect prior to February 23, 2000.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 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.
    Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on the impact of the proposed regulations on small business.
    Drafting Information. The principal author of these regulations is 
Mark Harris of the Office of Associate Chief Counsel (International). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects

26 CFR Parts 1 and 7

    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, 7, and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
revising the entry for Sec. 1.367(b)-2 and by adding entries in 
numerical order to read in part as follows:

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

    Section 1.367(b)-2 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-3 also issued under 26 U.S.C. 367(a) and (b). * 
* *

[[Page 3596]]

    Section 1.367(b)-5 also issued under 26 U.S.C. 367(a) and (b).
    Section 1.367(b)-6 also issued under 26 U.S.C. 367(a) and (b). * 
* *


    Par. 2. Section 1.367(a)-3 is amended as follows:
    1. Paragraph (d)(3) Example 11, paragraph (ii), the third sentence, 
the reference ``Sec. 7.367(b)-7(c)(1)(i) of this chapter'' is removed 
and ``Sec. 1.367(b)-4(b)'' is added in its place.

    2. Paragraph (d)(3) Example 11A, paragraph (ii), the second, third 
and fourth sentences are removed and a sentence is added in their 
place.

    3. Paragraph (e)(2), in the third, fourth, and fifth sentences, the 
parenthetical ``(as in effect before February 23, 2000; see 26 CFR part 
1, revised as of April 1, 1999)'' is added immediately after 
``Sec. 7.367(b)-7 of this chapter'' each place it appears.

    4. Paragraph (g)(2)(iv), the parenthetical ``(as in effect before 
February 23, 2000; see 26 CFR part 1, revised April 1, 1999)'' is added 
immediately after ``7.367(b)-2(b) of this chapter.''

    The revisions read as follows:


Sec. 1.367(a)-3  Treatment of transfers of stock or securities to 
foreign corporations.

* * * * *
    (d) * * *
    (3) * * *
    Example 11A. * * *
    (ii) Result. * * * Assuming Sec. 1.367(b)-4(b) does not apply, 
there is no income inclusion under section 367(b), and the amount of 
the gain recognition agreement is $50.

    Par. 3. Section 1.367(b)-0 is added to read as follows:


Sec. 1.367(b)-0  Table of contents.

    This section lists the paragraphs contained in Secs. 1.367(b)-0 
through 1.367(b)-6.

Sec. 1.367(b)-1  Other transfers.

(a) Scope.
(b) General rules.
(1) Rules.
(2) Example.
(c) Notice required.
(1) In general.
(2) Persons subject to section 367(b) notice.
(3) Time and manner for filing notice.
(i) United States persons described in Sec. 1.367(b)-1(c)(2).
(ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2).
(4) Information required.
(5) Abbreviated notice provision.
(6) Supplemental published guidance.

Sec. 1.367(b)-2  Definitions and special rules.

(a) Controlled foreign corporation.
(b) Section 1248 shareholder.
(c) Section 1248 amount.
(1) Rule.
(2) Examples.
(d) All earnings and profits amount.
(1) General rule.
(2) Rules for determining earnings and profits.
(i) Domestic rules generally applicable.
(ii) Certain adjustments to earnings and profits.
(iii) Effect of section 332 liquidating distribution.
(3) Amount attributable to a block of stock.
(i) Application of section 1248 principles.
(A) In general.
(1) Rule.
(2) Example.
(B) Foreign shareholders.
(ii) Limitation on amounts attributable to holding periods 
determined under section 1223.
(A) Rule.
(B) Example.
(iii) Exclusion of lower-tier earnings.
(e) Treatment of deemed dividends.
(1) In general.
(2) Consequences of dividend characterization.
(3) Ordering rules.
(4) Examples.
(f) Deemed asset transfer and closing of taxable year in certain 
section 368(a)(1)(F) reorganizations.
(1) Scope.
(2) Deemed asset transfer.
(3) Other applicable rules.
(4) Closing of taxable year.
(g) Stapled stock under section 269B.
(h) Section 953(d) domestication elections.
(1) Effect of election.
(2) Post-election exchanges.
(i) Section 1504(d) elections.
(j) Sections 985 through 989.
(1) Change in functional currency of a qualified business unit.
(i) Rule.
(ii) Example.
(2) Previously taxed earnings and profits.
(i) Exchanging shareholder that is a United States person.
(ii) Exchanging shareholder that is a foreign corporation.
(3) Other rules.
(k) Partnerships, trusts and estates.

Sec. 1.367(b)-3  Repatriation of foreign corporate assets in 
certain nonrecognition transactions.

(a) Scope.
(b) Exchange of stock owned directly by a United States shareholder 
or by certain foreign corporate shareholders.
(1) Scope.
(2) United States shareholder.
(3) Income inclusion.
(i) Inclusion of all earnings and profits amount.
(ii) Examples.
(iii)Recognition of exchange gain or loss with respect to capital 
[reserved].
(4) [Reserved].
(c) Exchange of stock owned by a United States person that is not a 
United States shareholder.
(1) Scope.
(2) Requirement to recognize gain.
(3) Election to include all earnings and profits amount.
(4) De minimis exception.
(5) Examples.
(d) Carryover of certain foreign taxes.
(1) Rule.
(2) Example.

Sec. 1.367(b)-4  Acquisition of foreign corporate stock or assets 
by a foreign corporation in certain nonrecognition transactions.

(a) Scope.
(b) Income inclusion.
(1) Exchange that results in loss of status as section 1248 
shareholder.
(i) Rule.
(ii) Examples.
(2) Receipt by exchanging shareholder of preferred or other stock in 
certain instances.
(i) Rule.
(ii) Examples.
(3) Certain recapitalizations.
(c) Exclusion of deemed dividend from foreign personal holding 
company income.
(1) Rule.
(2) Example.
(d) Rules for subsequent exchanges.
(1) In general.
(2) Subsequent dispositions by a foreign acquiring corporation.
(3) Examples.

Sec. 1.367(b)-5  Distributions of stock described in section 355.

(a) In general.
(1) Scope.
(2) Treatment of distributees as exchanging shareholders.
(b) Distribution by a domestic corporation.
(1) General rule.
(2) Section 367(e) transactions.
(3) Determining whether distributees are individuals.
(4) Applicable cross-references.
(c) Pro rata distribution by a controlled foreign corporation.
(1) Scope.
(2) Adjustment to basis in stock and income inclusion.
(3) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
(4) Basis redistribution.
(d) Non-pro rata distribution by a controlled foreign corporation.
(1) Scope.
(2) Treatment of certain shareholders as distributees.
(3) Inclusion of excess section 1248 amount by exchanging 
shareholder.
(4) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
(i) Limited application.
(ii) Interaction with predistribution amount.
(e) Definitions.
(1) Predistribution amount.
(2) Postdistribution amount.
(f) Exclusion of deemed dividend from foreign personal holding 
company income.
(g) Examples.

Sec. 1.367(b)-6  Effective dates and coordination rules.

(a) Effective date.
(1) In general.
(2) Exception.
(b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3).

[[Page 3597]]

(c) Use of reasonable method to comply with prior published 
guidance.
(1) Prior exchanges.
(2) Future exchanges.
(d) Effect of removal of attribution rules.


    Par. 4. Sections 1.367(b)-1 and 1.367(b)-2 are revised to read as 
follows:


Sec. 1.367(b)-1  Other transfers.

    (a) Scope. The regulations promulgated under section 367(b) (the 
section 367(b) regulations) set forth rules regarding the proper 
inclusions and adjustments that must be made as a result of an exchange 
described in section 367(b) (a section 367(b) exchange). A section 
367(b) exchange is any exchange described in section 332, 351, 354, 
355, 356 or 361, with respect to which the status of a foreign 
corporation as a corporation is relevant for determining the extent to 
which income shall be recognized or for determining the effect of the 
transaction on earnings and profits, basis of stock or securities, 
basis of assets, or other relevant tax attributes. Notwithstanding the 
preceding sentence, a section 367(b) exchange does not include a 
transfer to the extent the foreign corporation fails to be treated as a 
corporation by reason of section 367(a)(1). See Sec. 1.367(a)-
3(b)(2)(ii) for an illustration of the interaction of section 367(a) 
and (b).
    (b) General rules--(1) Rules. The following general rules apply 
under the section 367(b) regulations--
    (i) A foreign corporation in a section 367(b) exchange is 
considered to be a corporation and, as a result, all of the related 
provisions (e.g., section 381) shall apply, except to the extent 
provided in the section 367(b) regulations; and
    (ii) Nothing in the section 367(b) regulations shall permit--
    (A) The nonrecognition of income that would otherwise be required 
to be recognized under another provision of the Internal Revenue Code 
or the regulations thereunder; or
    (B) The recognition of a loss or deduction that would otherwise not 
be recognized under another provision of the Internal Revenue Code or 
the regulations thereunder.
    (2) Example. The following example illustrates the rules of this 
paragraph (b):

    Example--(i) Facts. DC, a domestic corporation, owns 90 percent 
of P, a partnership. The remaining 10 percent of P is owned by a 
person unrelated to DC. P owns all of the outstanding stock of FC, a 
controlled foreign corporation. FC liquidates into P.
    (ii) Result. FC's liquidation is not a transaction described in 
section 332. Nothing in the section 367(b) regulations, including 
Sec. 1.367(b)-2(k), permits FC's liquidation to qualify as a 
liquidation described in section 332.

    (c) Notice Required--(1) In general. A notice under this paragraph 
(c) (section 367(b) notice) must be filed with regard to any person 
described in paragraph (c)(2) of this section. A section 367(b) notice 
must be filed in the time and manner described in paragraph (c)(3) of 
this section and must include the information described in paragraph 
(c)(4) of this section.
    (2) Persons subject to section 367(b) notice. The following persons 
are described in this paragraph (c)(2)--
    (i) A shareholder described in Sec. 1.367(b)-3(b)(1) that realizes 
income in a transaction described in Sec. 1.367(b)-3(a);
    (ii) A shareholder that makes the election described in 
Sec. 1.367(b)-3(c)(3);
    (iii) A shareholder described in Sec. 1.367(b)-4(b)(1)(i)(A)(1) or 
(2) that realizes income in a transaction described in Sec. 1.367(b)-
4(a); and
    (iv) A shareholder that realizes income in a transaction described 
in Sec. 1.367(b)-5(c) or 1.367(b)-5(d) and that is either--
    (A) A section 1248 shareholder of the distributing or controlled 
corporation; or
    (B) A foreign corporation with one or more shareholders that are 
described in paragraph (c)(2)(iv)(A) of this section.
    (3) Time and manner for filing notice--(i) United States persons 
described in Sec. 1.367(b)-1(c)(2). A United States person described in 
paragraph (c)(2) of this section must file a section 367(b) notice 
attached to a timely filed Federal tax return (including extensions) 
for the person's taxable year in which income is realized in the 
section 367(b) exchange. In the case of a shareholder that makes the 
election described in Sec. 1.367(b)-3(c)(3), notification of such 
election must be sent to the foreign acquired corporation (or its 
successor in interest) on or before the date the section 367(b) notice 
is filed, so that appropriate corresponding adjustments can be made in 
accordance with the rules of Sec. 1.367(b)-2(e).
    (ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2). Each 
United States person listed in this paragraph (c)(3)(ii) must file a 
section 367(b) notice with regard to a foreign corporation described in 
paragraph (c)(2) of this section. Such notice must be attached to a 
timely filed Federal tax return (including extensions) for the United 
States person's taxable year in which income is realized in the section 
367(b) exchange and, if the United States person is required to file a 
Form 5471 (Information Return of U.S. Persons With Respect To Certain 
Foreign Corporations), the section 367(b) notice must be attached to 
the Form 5471. The following persons are listed in this paragraph 
(c)(3)(ii)--
    (A) United States shareholders (as defined in Sec. 1.367(b)-
3(b)(2)) of foreign corporations described in paragraph (c)(2)(i) of 
this section; and
    (B) Section 1248 shareholders of foreign corporations described in 
paragraph (c)(2)(iii) or (iv) of this section.
    (4) Information required. Except as provided in paragraph (c)(5) of 
this section, a section 367(b) notice shall include the following 
information--
    (i) A statement that the exchange is a section 367(b) exchange;
    (ii) A complete description of the exchange;
    (iii) A description of any stock, securities or other consideration 
transferred or received in the exchange;
    (iv) A statement that describes any amount required, under the 
section 367(b) regulations, to be taken into account as income or loss 
or as an adjustment to basis, earnings and profits, or other tax 
attributes as a result of the exchange;
    (v) Any information that is or would be required to be furnished 
with a Federal income tax return pursuant to regulations under section 
332, 351, 354, 355, 356, 361 or 368 (whether or not a Federal income 
tax return is required to be filed), if such information has not 
otherwise been provided by the person filing the section 367(b) notice;
    (vi) Any information required to be furnished with respect to the 
exchange under sections 6038, 6038A, 6038B, 6038C or 6046, or the 
regulations under those sections, if such information has not otherwise 
been provided by the person filing the section 367(b) notice; and
    (vii) If applicable, a statement that the shareholder is making the 
election described in Sec. 1.367(b)-3(c)(3). This statement must 
include--
    (A) A copy of the information the shareholder received from the 
foreign acquired corporation (or its successor in interest) 
establishing and substantiating the shareholder's all earnings and 
profits amount with respect to the shareholder's stock in the foreign 
acquired corporation; and
    (B) A representation that the shareholder has notified the foreign 
acquired corporation (or its successor in interest) that the 
shareholder is making the election described in Sec. 1.367(b)-3(c)(3).
    (5) Abbreviated notice provision. In the case of a foreign acquired 
corporation that has never had earnings

[[Page 3598]]

and profits that would result in any shareholder having an all earnings 
and profits amount, a shareholder making the election described in 
Sec. 1.367(b)-3(c)(3) may satisfy the information requirements of 
paragraph (c)(4) of this section by filing a section 367(b) notice that 
includes--
    (i) A statement from the foreign acquired corporation (or its 
successor in interest) that the foreign acquired corporation has never 
had any earnings and profits that would result in any shareholder 
having an all earnings and profits amount; and
    (ii) The information described in paragraphs (c)(4) (i) through 
(iii) of this section.
    (6) Supplemental published guidance. The section 367(b) notice 
requirements may be updated or amended by revenue procedure or other 
published guidance.


Sec. 1.367(b)-2  Definitions and special rules.

    (a) Controlled foreign corporation. The term controlled foreign 
corporation means a controlled foreign corporation as defined in 
section 957 (taking into account section 953(c)).
    (b) Section 1248 shareholder. The term section 1248 shareholder 
means any United States person that satisfies the ownership 
requirements of section 1248 (a)(2) or (c)(2) with respect to a foreign 
corporation.
    (c) Section 1248 amount--(1) Rule. The term section 1248 amount 
with respect to stock in a foreign corporation means the net positive 
earnings and profits (if any) that would have been attributable to such 
stock and includible in income as a dividend under section 1248 and the 
regulations thereunder if the stock were sold by the shareholder. In 
the case of a transaction in which the shareholder is a foreign 
corporation (foreign shareholder), the following additional rules shall 
apply--
    (i) The foreign shareholder shall be deemed to be a United
    States person for purposes of this paragraph (c), except that the 
foreign shareholder shall not be considered a United States person for 
purposes of determining whether the stock owned by the foreign 
shareholder is stock of a controlled foreign corporation, and
    (ii) The foreign shareholder's holding period in the stock of the 
foreign corporation shall be determined by reference to the period that 
the foreign shareholder's section 1248 shareholders held (directly or 
indirectly) an interest in the foreign corporation. This paragraph 
(c)(1)(ii) applies in addition to the section 1248 regulations' 
incorporation of section 1223 holding periods, as modified by 
Sec. 1.367(b)-4(d) (as applicable).
    (2) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1--(i) Facts. DC, a domestic corporation, owns all of 
the outstanding stock of FC1, a controlled foreign corporation 
(CFC). FC1 owns all of the outstanding stock of FC2, a CFC. DC has 
always owned all of the stock of FC1, and FC1 has always owned all 
of the stock of FC2.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount 
with respect to its FC1 stock is computed by reference to all of 
FC1's and FC2's earnings and profits. See section 1248(c)(2). 
Because FC1's section 1248 shareholder (DC) always indirectly held 
all of the stock of FC2, FC1's section 1248 amount with respect to 
its FC2 stock is computed by reference to all of FC2's earnings and 
profits.
    Example 2--(i) Facts. DC, a domestic corporation, owns 40 
percent of the outstanding stock of FC1, a foreign corporation. The 
other 60 percent of FC1 stock is owned (directly and indirectly) by 
foreign persons that are unrelated to DC. FC1 owns all of the 
outstanding stock of FC2, a foreign corporation. On January 1, 2001, 
DC purchases the remaining 60 percent of FC1 stock.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount 
with respect to its FC1 stock is computed by reference to FC1's and 
FC2's earnings and profits that accumulated on or after January 1, 
2001, the date FC1 and FC2 became controlled foreign corporations 
(CFCs). See section 1248(a). Because FC1 is not considered a United 
States person for purposes of determining whether FC2 is a CFC, 
FC1's section 1248 amount with respect to its FC2 stock is computed 
by reference to FC2's earnings and profits that accumulated on or 
after January 1, 2001, the date FC2 became an actual CFC.
    Example 3--(i) Facts. FC1, a foreign corporation, owns all of 
the outstanding stock of FC2, a foreign corporation. DC is a 
domestic corporation that is unrelated to FC1, FC2, and their direct 
and indirect owners. On January 1, 2001, DC purchases all of the 
outstanding stock of FC1.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount 
with respect to its FC1 stock is computed by reference to FC1's and 
FC2's earnings and profits that accumulated on or after January 1, 
2001, the first day DC held the stock of FC1. See section 1248(a). 
FC1's section 1248 amount with respect to its FC2 stock is computed 
by reference to FC2's earnings and profits that accumulated on or 
after January 1, 2001, the first day FC1's section 1248 shareholder 
(DC) indirectly held the stock of FC2.
    Example 4--(i) Facts. DC, a domestic corporation, directly owns 
all of the outstanding stock of FC1 and FC2, controlled foreign 
corporations. DC has always owned all of the stock of FC1 and FC2. 
On January 1, 2001, DC contributes all of the stock of FC2 to FC1 in 
a nonrecognition exchange that does not require an income inclusion 
under the section 367(a) or 367(b) regulations. See Secs. 1.367(a)-8 
and 1.367(b)-4.
    (ii) Result. Under this paragraph (c), DC's section 1248 amount 
with respect to its FC1 stock is computed by reference to all of 
FC1's and FC2's earnings and profits. See section 1248(c)(2). 
Because FC1's section 1248 shareholder (DC) always held (directly or 
indirectly) all of the stock of FC2, FC1's section 1248 amount with 
respect to its FC2 stock is computed by reference to all of FC2's 
earnings and profits.

    (d) All earnings and profits amount--(1) General rule. The term all 
earnings and profits amount with respect to stock in a foreign 
corporation means the net positive earnings and profits (if any) 
determined as provided under paragraph (d)(2) of this section and 
attributable to such stock as provided under paragraph (d)(3) of this 
section. The all earnings and profits amount shall be determined 
without regard to the amount of gain that would be realized on a sale 
or exchange of the stock of the foreign corporation.
    (2) Rules for determining earnings and profits--(i) Domestic rules 
generally applicable. For purposes of this paragraph (d), except as 
provided in sections 312(k)(4) and (n)(8), 964 and 986, the earnings 
and profits of a foreign corporation for any taxable year shall be 
determined according to principles substantially similar to those 
applicable to domestic corporations.
    (ii) Certain adjustments to earnings and profits. Notwithstanding 
paragraph (d)(2)(i) of this section, for purposes of this paragraph 
(d), the earnings and profits of a foreign corporation for any taxable 
year shall not include the amounts specified in section 1248(d). In the 
case of amounts specified in section 1248(d)(4), the preceding sentence 
requires that the earnings and profits for any taxable year be 
decreased by the net positive amount (if any) of earnings and profits 
attributable to activities described in section 1248(d)(4), and 
increased by the net reduction (if any) in earnings and profits 
attributable to activities described in section 1248(d)(4).
    (iii) Effect of section 332 liquidating distribution. The all 
earnings and profits amount with respect to stock of a corporation that 
distributes all of its property in a liquidation described in section 
332 shall be determined without regard to the adjustments prescribed by 
section 312(a) and (b) resulting from the distribution of such property 
in liquidation, except that gain or loss realized by the corporation on 
the distribution shall be taken into account to the extent provided in 
section 312(f)(1). See Sec. 1.367(b)-3(b)(3)(ii) Example 3.
    (3) Amount attributable to a block of stock--(i) Application of 
section 1248 principles--(A) In general--(1) Rule. The all earnings and 
profits amount with respect to stock of a foreign corporation is 
determined according to the attribution principles of section

[[Page 3599]]

1248 and the regulations thereunder. The attribution principles of 
section 1248 shall apply without regard to the requirements of section 
1248 that are not relevant to the determination of a shareholder's pro 
rata portion of earnings and profits. Thus, for example, the all 
earnings and profits amount is determined without regard to whether the 
foreign corporation was a controlled foreign corporation at any time 
during the five years preceding the section 367(b) exchange in 
question, without regard to whether the shareholder owned a 10 percent 
or greater interest in the stock, and without regard to whether the 
earnings and profits of the foreign corporation were accumulated in 
post-1962 taxable years or while the corporation was a controlled 
foreign corporation.
    (2) Example. The following example illustrates the rules of this 
paragraph (d)(3)(i)(A):

    Example--(i) Facts. On January 1, 2001, DC, a domestic 
corporation, purchases 9 percent of the outstanding stock of FC, a 
foreign corporation. On January 1, 2002, DC purchases an additional 
1 percent of FC stock. On January 1, 2003, DC exchanges its stock in 
FC in a section 367(b) exchange in which DC is required to include 
the all earnings and profits amount in income. FC was not a 
controlled foreign corporation during the entire period DC held its 
FC stock.
    (ii) Result. The all earnings and profits amount with respect to 
DC's stock in FC is computed by reference to 9 percent of FC's 
earnings and profits from January 1, 2001, through December 31, 
2001, and by reference to 10 percent of FC's earnings and profits 
from January 1, 2002, through January 1, 2003.

    (B) Foreign shareholders. In the case of a transaction in which the 
exchanging shareholder is a foreign corporation (foreign shareholder), 
the following additional rules shall apply--
    (1) The attribution principles of section 1248 shall apply without 
regard to whether the person directly owning the stock is a United 
States person; and
    (2) The foreign shareholder's holding period in the stock of the 
foreign acquired corporation shall be determined by reference to the 
period that the foreign shareholder's United States shareholders (as 
defined in Sec. 1.367(b)-3(b)(2)) held (directly or indirectly) an 
interest in the foreign acquired corporation. This paragraph 
(d)(3)(i)(B)(2) applies in addition to the section 1248 regulations' 
incorporation of section 1223 holding periods, as modified by paragraph 
(d)(3)(ii) of this section and Sec. 1.367(b)-4(d) (as applicable).
    (ii) Limitation on amounts attributable to holding periods 
determined under section 1223--(A) Rule. In applying the attribution 
principles of section 1248 and the regulations thereunder to determine 
the all earnings and profits amount with respect to the stock of a 
foreign corporation, earnings and profits attributable to a section 
1223(2) holding period that relates to a period of direct ownership of 
the stock of the foreign corporation by a non-United States person 
shall not be included, except to the extent of earnings and profits 
attributable to a period when the stock of the foreign corporation was 
indirectly owned by United States shareholders (as defined in 
Sec. 1.367(b)-3(b)(2)).
    (B) Example. The following example illustrates the rules of this 
paragraph (d)(3)(ii):

    Example--(i) Facts. (A) FC1 is a foreign corporation. The 
outstanding stock of FC1 is directly owned by the following 
unrelated persons: 20 percent by DP, a domestic partnership; 20 
percent by DC, a domestic corporation; 20 percent by FC, a foreign 
corporation that is directly and indirectly owned by foreign 
persons; 20 percent by FP, a foreign partnership that is equally 
owned by 2 partners, DI, a United States citizen, and FI, a 
nonresident alien; and 20 percent by a variety of minority 
shareholders, none of whom owns, applying the ownership rules of 
section 958, 10 percent or more of the outstanding stock of FC (the 
small shareholders).
    (B) FC1 owns all of the outstanding stock of FC2, a foreign 
corporation that is not a controlled foreign corporation subject to 
the rules of section 953(c). FC2 has net positive earnings and 
profits. In a reorganization described in section 368(a)(1)(B), DA, 
a domestic corporation, acquires all of the stock of FC2 from FC1 in 
exchange for DA voting stock.
    (ii) Result. (A) Under section 1223(2), DA holds the stock of 
FC2 with a holding period that includes the period that FC2 was held 
by FC1. As a result, the rules of this paragraph (d)(3)(ii) apply 
for purposes of computing DA's all earnings and profits amount.
    (B) In applying the attribution principles of section 1248, 
earnings and profits attributable to a section 1223(2) holding 
period that refers to a period of direct ownership of the stock of a 
foreign corporation by a non-United States person are not included, 
except to the extent the stock of the foreign corporation was 
indirectly owned by United States shareholders as defined in 
Sec. 1.367(b)-3(b)(2). Accordingly, DA's all earnings and profits 
amount does not include the FC2 earnings and profits attributable to 
FC, FI, and the small shareholders. DA's all earnings and profits 
amount does include the FC2 earnings and profits attributable to DP, 
DC, and DI. See Sec. 1.367(b)-2(k) for rules concerning the 
treatment of partnerships under the section 367(b) regulations.

    (iii) Exclusion of lower-tier earnings. In applying the attribution 
principles of section 1248 and the regulations thereunder to determine 
the all earnings and profits amount with respect to stock of a foreign 
corporation, the earnings and profits of subsidiaries of the foreign 
corporation shall not be taken into account notwithstanding section 
1248(c)(2).
    (e) Treatment of deemed dividends--(1) In general. In certain 
circumstances these regulations provide that an exchanging shareholder 
shall include an amount in income as a deemed dividend. This paragraph 
provides rules for the treatment of the deemed dividend.
    (2) Consequences of dividend characterization. A deemed dividend 
described in paragraph (e)(1) of this section shall be treated as a 
dividend for purposes of the Internal Revenue Code. The deemed dividend 
shall be considered as paid out of the earnings and profits with 
respect to which the amount of the deemed dividend was determined. 
Thus, for example, a deemed dividend that is determined by reference to 
the all earnings and profits amount or the section 1248 amount will 
never be considered as paid out of (and therefore will never reduce) 
earnings and profits specified in section 1248(d), because such 
earnings and profits are excluded in computing the all earnings and 
profits amount (under paragraph (d)(2)(ii) of this section) and the 
section 1248 amount (under section 1248(d) and paragraph (c)(1) of this 
section). If the deemed dividend is determined by reference to the 
earnings and profits of a foreign corporation that is owned indirectly 
(i.e., through one or more tiers of intermediate owners) by the person 
that is required to include the deemed dividend in income, the deemed 
dividend shall be considered as having been paid by such corporation to 
such person through the intermediate owners, rather than directly to 
such person.
    (3) Ordering rules. In the case of an exchange of stock in which 
the exchanging shareholder is treated as receiving a deemed dividend 
from a foreign corporation, the following ordering rules concerning the 
timing, treatment, and effect of such a deemed dividend shall apply. 
See also paragraph (j)(2) of this section.
    (i) For purposes of the section 367(b) regulations, the gain 
realized by an exchanging shareholder shall be determined before 
increasing (as provided in paragraph (e)(3)(ii) of this section) the 
basis in the stock of the foreign corporation by the amount of the 
deemed dividend.
    (ii) Except as provided in paragraph (e)(3)(i) of this section, the 
deemed dividend shall be considered to be

[[Page 3600]]

received immediately before the exchanging shareholder's receipt of 
consideration for its stock in the foreign corporation, and the 
shareholder's basis in the stock exchanged shall be increased by the 
amount of the deemed dividend. Such basis increase shall be taken into 
account before determining the gain otherwise recognized on the 
exchange (for example, under section 356), the basis that the 
exchanging shareholder takes in the property that it receives in the 
exchange (under section 358(a)(1)), and the basis that the transferee 
otherwise takes in the transferred stock (under section 362).
    (iii) Except as provided in paragraph (e)(3)(i) of this section, 
the earnings and profits of the appropriate foreign corporation shall 
be reduced by the deemed dividend amount before determining the 
consequences of the recognition of gain in excess of the deemed 
dividend amount (for example, under section 356(a)(2) or sections 
356(a)(1) and 1248).
    (4) Examples. The following examples illustrate the rules of this 
paragraph (e):

    Example 1. DC, a domestic corporation, exchanges stock in FC, a 
foreign corporation, in a section 367(b) exchange in which DC 
includes the all earnings and profits amount in income as a deemed 
dividend. Under paragraph (e)(2) of this section, a deemed dividend 
is treated as a dividend for purposes of the Internal Revenue Code. 
As a result, if the requirements of section 902 are met, DC may 
qualify for a deemed paid foreign tax credit with respect to the 
deemed dividend that it receives from FC.
    Example 2. DC, a domestic corporation, exchanges stock in FC1, a 
foreign corporation that is a controlled foreign corporation, in a 
transaction in which DC is required to include the section 1248 
amount in income as a deemed dividend. A portion of the section 1248 
amount is determined by reference to the earnings and profits of FC1 
(the upper-tier portion of the section 1248 amount), and the 
remainder of the section 1248 amount is determined by reference to 
the earnings and profits of FC2, which is a wholly owned foreign 
subsidiary of FC1 (the lower-tier portion of the section 1248 
amount). Under paragraph (e)(2) of this section, DC computes its 
deemed paid foreign tax credit as if the lower-tier portion of the 
section 1248 amount were distributed as a dividend by FC2 to FC1, 
and as if such portion and the upper-tier portion of the section 
1248 amount were then distributed as a dividend by FC1 to DC.
    Example 3. DC, a domestic corporation, exchanges stock in FC, a 
foreign corporation that is a controlled foreign corporation, in a 
transaction in which DC realizes gain of $100 (prior to the 
application of the section 367(b) regulations). In connection with 
the transaction, DC is required to include $40 in income as a deemed 
dividend under the section 367(b) regulations. In addition to 
receiving property permitted to be received under section 354 
without the recognition of gain, DC also receives cash in the amount 
of $70. Under paragraph (e)(3) of this section, the $40 deemed 
dividend increases DC's basis in its FC stock before determining the 
gain to be recognized under section 56. Thus, in applying section 
356, DC is considered to realize $60 of gain on the exchange, all of 
which is recognized under section 356(a)(1).

    (f) Deemed asset transfer and closing of taxable year in certain 
section 368(a)(1)(F) reorganizations--(1) Scope. This paragraph applies 
to a reorganization described in section 368(a)(1)(F) in which the 
transferor corporation is a foreign corporation.
    (2) Deemed asset transfer. In a reorganization described in 
paragraph (f)(1) of this section, there is considered to exist--
    (i) A transfer of assets by the foreign transferor corporation to 
the acquiring corporation in exchange for stock (or stock and 
securities) of the acquiring corporation and the assumption by the 
acquiring corporation of the foreign transferor corporation's 
liabilities;
    (ii) A distribution of such stock (or stock and securities) by the 
foreign transferor corporation to its shareholders (or shareholders and 
security holders); and
    (iii) An exchange by the foreign transferor corporation's 
shareholders (or shareholders and security holders) of their stock (or 
stock and securities) for stock (or stock and securities) of the 
acquiring corporation.
    (3) Other applicable rules. For purposes of this paragraph (f), it 
is immaterial that the applicable foreign or domestic law treats the 
acquiring corporation as a continuation of the foreign transferor 
corporation.
    (4) Closing of taxable year. In a reorganization described in 
paragraph (f)(1) of this section, the taxable year of the foreign 
transferor corporation shall end with the close of the date of the 
transfer and the taxable year of the acquiring corporation shall end 
with the close of the date on which the transferor's taxable year would 
have ended but for the occurrence of the reorganization if--
    (i) The acquiring corporation is a domestic corporation; or
    (ii) The foreign transferor corporation has effectively connected 
earnings and profits (as defined in section 884(d)) or accumulated 
effectively connected earnings and profits (as defined in section 
884(b)(2)(B)(ii)).
    (g) Stapled stock under section 269B. For rules treating a foreign 
corporation as a domestic corporation if it and a domestic corporation 
are stapled entities, see section 269B. The deemed conversion of a 
foreign corporation to a domestic corporation under section 269B is 
treated as a reorganization under section 368(a)(1)(F).
    (h) Section 953(d) domestication elections--(1) Effect of election. 
A foreign corporation that elects under section 953(d) to be treated as 
a domestic corporation shall be treated for purposes of section 367(b) 
as transferring, as of the first day of the first taxable year for 
which the election is effective, all of its assets to a domestic 
corporation in a reorganization described in section 368(a)(1)(F). 
Notwithstanding paragraph (d) of this section, for purposes of 
determining the consequences of the reorganization under Sec. 1.367(b)-
3, the all earnings and profits amount shall not be considered to 
include earnings and profits accumulated in taxable years beginning 
before January 1, 1988.
    (2) Post-election exchanges. For purposes of applying section 
367(b) to post-election exchanges with respect to a corporation that 
has made a valid election under section 953(d) to be treated as a 
domestic corporation, such corporation shall be treated as a domestic 
corporation as to earnings and profits that were taken into account at 
the time of the section 953(d) election or which accrue after such 
election, and shall be treated as a foreign corporation as to earnings 
and profits accumulated in taxable years beginning before January 1, 
1988. Thus, for example, if the section 953(d) corporation subsequently 
transfers its assets to a domestic corporation (other than another 
section 953(d) corporation) in a transaction described in section 
381(a), the rules of Sec. 1.367(b)-3 shall apply to such transaction to 
the extent of the section 953(d) corporation's earnings and profits 
accumulated in taxable years beginning before January 1, 1988.
    (i) Section 1504(d) elections. An election under section 1504(d), 
which permits certain foreign corporations to be treated as domestic 
corporations, is treated as a transfer of property to a domestic 
corporation and will generally constitute a reorganization described in 
section 368(a)(1)(F). However, if an election under section 1504(d) is 
made with respect to a foreign corporation from the first day of the 
foreign corporation's existence, then the foreign corporation shall be 
treated as a domestic corporation, and the section 367(b) regulations 
will not apply.
    (j) Sections 985 through 989--(1) Change in functional currency of 
a qualified business unit--(i) Rule. If, as a result of a transaction 
described in section 381(a), a qualified business unit (as defined in 
section 989(a)) (QBU) has a different functional currency determined 
under the rules of section

[[Page 3601]]

985(b) than it used prior to the transaction, then the QBU shall be 
deemed to have automatically changed its functional currency 
immediately prior to the transaction. A QBU that is deemed to change 
its functional currency pursuant to this paragraph (j) must make the 
adjustments described in Sec. 1.985-5.
    (ii) Example. The following example illustrates the rule of this 
paragraph (j)(1):

    Example--(i) Facts. DC, a domestic corporation, owns 100 percent 
of FC1, a foreign corporation. FC1 owns and operates a qualified 
business unit (QBU) (B1) in France, whose functional currency is the 
euro. FC2, an unrelated foreign corporation, owns and operates a QBU 
(B2) in France, whose functional currency is the dollar. FC2 
acquires FC1's assets (including B1) in a reorganization described 
in section 368(a)(1)(C). As a part of the reorganization, B1 and B2 
combine their operations into one QBU. Applying the rules of section 
985(b), the functional currency of the combined operations of B1 and 
B2 is the euro.
    (ii) Result. FC2's acquisition of FC1's assets is a section 
367(b) exchange that is described in section 381(a). Because the 
functional currency of the combined operations of B1 and B2 after 
the exchange is the euro, B2 is deemed to have automatically changed 
its functional currency to the euro immediately prior to the section 
367(b) exchange. B2 must make the adjustments described in 
Sec. 1.985-5.

    (2) Previously taxed earnings and profits--(i) Exchanging 
shareholder that is a United States person. If an exchanging 
shareholder that is a United States person is required to include in 
income either the all earnings and profits amount or the section 1248 
amount under the provisions of Sec. 1.367(b)-3 or 1.367(b)-4, then 
immediately prior to the exchange, and solely for the purpose of 
computing exchange gain or loss under section 986(c), the exchanging 
shareholder shall be treated as receiving a distribution of previously 
taxed earnings and profits from the appropriate foreign corporation 
that is attributable (under the principles of section 1248) to the 
exchanged stock. If an exchanging shareholder that is a United States 
person is a distributee in an exchange described in Sec. 1.367(b)-5(c) 
or (d), then immediately prior to the exchange, and solely for the 
purpose of computing exchange gain or loss under section 986(c), the 
exchanging shareholder shall be treated as receiving a distribution of 
previously taxed earnings and profits from the appropriate foreign 
corporation to the extent such shareholder has a diminished interest in 
such previously taxed earnings and profits after the exchange. The 
exchange gain or loss recognized under this paragraph (j)(2)(i) will 
increase or decrease the exchanging shareholder's adjusted basis in the 
stock of the foreign corporation for purposes of computing gain or loss 
realized with respect to the stock on the transaction. The exchanging 
shareholder's dollar basis with respect to each account of previously 
taxed income shall be increased or decreased by the exchange gain or 
loss recognized.
    (ii) Exchanging shareholder that is a foreign corporation. If an 
exchanging shareholder that is a foreign corporation is required to 
include in income either the all earnings and profits amount or the 
section 1248 amount under the provisions of Sec. 1.367(b)-3 or 
1.367(b)-4, then, immediately prior to the exchange, the exchanging 
shareholder shall be treated as receiving a distribution of previously 
taxed earnings and profits from the appropriate foreign corporation 
that is attributable (under the principles of section 1248) to the 
exchanged stock. If an exchanging shareholder that is a foreign 
corporation is a distributee in an exchange described in Sec. 1.367(b)-
5(c) or (d), then the exchanging shareholder shall be treated as 
receiving (immediately prior to the exchange) a distribution of 
previously taxed earnings and profits from the appropriate foreign 
corporation. Such distribution shall be measured by the extent to which 
the exchanging shareholder's direct or indirect United States 
shareholders (as defined in section 951(b)) have a diminished interest 
in such previously taxed earnings and profits after the exchange.
    (3) Other rules. See sections 985 through 989 for other currency 
rules that may apply in connection with a section 367(b) exchange.
    (k) Partnerships, trusts and estates. In applying the section 
367(b) regulations, stock of a corporation that is owned by a foreign 
partnership, trust or estate shall be considered as owned 
proportionately by its partners, owners, or beneficiaries under the 
principles of Sec. 1.367(e)-1(b)(2). Stock owned by an entity that is 
disregarded as an entity separate from its owner under Sec. 301.7701-3 
is owned directly by the owner of such entity. In applying 
Sec. 1.367(b)-5(b), the principles of Sec. 1.367(e)-1(b)(2) shall also 
apply to a domestic partnership, trust or estate.

    Par. 5. Section 1.367(b)-3 is added to read as follows:


Sec. 1.367(b)-3  Repatriation of foreign corporate assets in certain 
nonrecognition transactions.

    (a) Scope. This section applies to an acquisition by a domestic 
corporation (the domestic acquiring corporation) of the assets of a 
foreign corporation (the foreign acquired corporation) in a liquidation 
described in section 332 or an asset acquisition described in section 
368(a)(1).
    (b) Exchange of stock owned directly by a United States shareholder 
or by certain foreign corporate shareholders--(1) Scope. This paragraph 
(b) applies in the case of an exchanging shareholder that is either--
    (i) A United States shareholder of the foreign acquired 
corporation; or
    (ii) A foreign corporation with respect to which there are one or 
more United States shareholders.
    (2) United States shareholder. For purposes of this section (and 
for purposes of the other section 367(b) regulation provisions that 
specifically refer to this paragraph (b)(2)), the term United States 
shareholder means any shareholder described in section 951(b) (without 
regard to whether the foreign corporation is a controlled foreign 
corporation), and also any shareholder described in section 
953(c)(1)(A) (but only if the foreign corporation is a controlled 
foreign corporation subject to the rules of section 953(c)).
    (3) Income inclusion--(i) Inclusion of all earnings and profits 
amount. An exchanging shareholder shall include in income as a deemed 
dividend the all earnings and profits amount with respect to its stock 
in the foreign acquired corporation. For the consequences of the deemed 
dividend, see Sec. 1.367(b)-2(e). Notwithstanding Sec. 1.367(b)-2(e), 
however, a deemed dividend from the foreign acquired corporation to an 
exchanging foreign corporate shareholder shall not qualify for the 
exception from foreign personal holding company income provided by 
section 954(c)(3)(A)(i), although it may qualify for the look-through 
treatment provided by section 904(d)(3) if the requirements of that 
section are met with respect to the deemed dividend.
    (ii) Examples. The following examples illustrate the rules of 
paragraph (b)(3)(i) of this section:

    Example 1--(i) Facts. DC, a domestic corporation, owns all of 
the outstanding stock of FC, a foreign corporation. The stock of FC 
has a value of $100, and DC has a basis of $30 in such stock. The 
all earnings and profits amount attributable to the FC stock owned 
by DC is $20, of which $15 is described in section 1248(a) and the 
remaining $5 is not (for example, because it accumulated prior to 
1963). FC has a basis of $50 in its assets. In a liquidation 
described in section 332, FC distributes all of its property to DC, 
and the FC stock held by DC is canceled.
    (ii) Result. Under paragraph (b)(3)(i) of this section, DC must 
include $20 in income as a deemed dividend from FC. Under section

[[Page 3602]]

337(a) FC does not recognize gain or loss in the assets that it 
distributes to DC, and under section 334(b), DC takes a basis of $50 
in such assets. Because the requirements of section 902 are met, DC 
qualifies for a deemed paid foreign tax credit with respect to the 
deemed dividend that it receives from FC.
    Example 2--(i) Facts. DC, a domestic corporation, owns all of 
the outstanding stock of FC, a foreign corporation. The stock of FC 
has a value of $100, and DC has a basis of $30 in such stock. The 
all earnings and profits amount attributable to the FC stock owned 
by DC is $75. FC has a basis of $50 in its assets. In a liquidation 
described in section 332, FC distributes all of its property to DC, 
and the FC stock held by DC is canceled.
    (ii) Result. Under paragraph (b)(3)(i) of this section, DC must 
include $75 in income as a deemed dividend from FC. Under section 
337(a) FC does not recognize gain or loss in the assets that it 
distributes to DC, and under section 334(b), DC takes a basis of $50 
in such assets. Because the requirements of section 902 are met, DC 
qualifies for a deemed paid foreign tax credit with respect to the 
deemed dividend that it receives from FC.
    Example 3--(i) Facts. DC, a domestic corporation, owns 80 
percent of the outstanding stock of FC, a foreign corporation. DC 
has owned its 80 percent interest in FC since FC was incorporated. 
The remaining 20 percent of the outstanding stock of FC is owned by 
a person unrelated to DC (the minority shareholder). The stock of FC 
owned by DC has a value of $80, and DC has a basis of $24 in such 
stock. The stock of FC owned by the minority shareholder has a value 
of $20, and the minority shareholder has a basis of $18 in such 
stock. FC's only asset is land having a value of $100, and FC has a 
basis of $50 in the land. Gain on the land would not generate 
earnings and profits qualifying under section 1248(d) for an 
exclusion from earnings and profits for purposes of section 1248. FC 
has earnings and profits of $20 (determined under the rules of 
Sec. 1.367(b)-2(d)(2) (i) and (ii)), $16 of which is attributable to 
the stock owned by DC under the rules of Sec. 1.367(b)-2(d)(3). FC 
subdivides the land and distributes to the minority shareholder land 
with a value of $20 and a basis of $10. As part of the same 
transaction, in a liquidation described in section 332, FC 
distributes the remainder of its land to DC, and the FC stock held 
by DC and the minority shareholder is canceled.
    (ii) Result. Under section 336, FC must recognize the $10 of 
gain it realizes in the land it distributes to the minority 
shareholder, and under section 331 the minority shareholder 
recognizes its gain of $2 in the stock of FC. Such gain is included 
in income by the minority shareholder as a dividend to the extent 
provided in section 1248 if the minority shareholder is a United 
States person that is described in section 1248(a)(2). Under 
Sec. 1.367(b)-2(d)(2)(iii), the $10 of gain recognized by FC 
increases its earnings and profits for purposes of computing the all 
earnings and profits amount and, as a result, $8 of such increase 
(80 percent of $10) is considered to be attributable to the FC stock 
owned by DC under Sec. 1.367(b)-2(d)(3)(i)(A)(1). DC's all earnings 
and profits amount with respect to its stock in FC is $24 (the $16 
of initial all earnings and profits amount with respect to the FC 
stock held by DC, plus the $8 addition to such amount that results 
from FC's recognition of gain on the distribution to the minority 
shareholder). Under paragraph (b)(3)(i) of this section, DC must 
include the $24 all earnings and profits amount in income as a 
deemed dividend from FC.
    Example 4--(i) Facts. DC1, a domestic corporation, owns all of 
the outstanding stock of DC2, a domestic corporation. DC1 also owns 
all of the outstanding stock of FC, a foreign corporation. The stock 
of FC has a value of $100, and DC1 has a basis of $30 in such stock. 
The assets of FC have a value of $100. The all earnings and profits 
amount with respect to the FC stock owned by DC1 is $20. In a 
reorganization described in section 368(a)(1)(D), DC2 acquires all 
of the assets of FC solely in exchange for DC2 stock. FC distributes 
the DC2 stock to DC1, and the FC stock held by DC1 is canceled.
    (ii) Result. DC1 must include $20 in income as a deemed dividend 
from FC under paragraph (b)(3)(i) of this section. Under section 
361, FC does not recognize gain or loss in the assets that it 
transfers to DC2 or in the DC2 stock that it distributes to DC1, and 
under section 362(b) DC2 takes a basis in the assets that it 
acquires from FC equal to the basis that FC had therein. Under 
Sec. 1.367(b)-2(e)(3)(ii) and section 358(a)(1), DC1 takes a basis 
of $50 (its $30 basis in the stock of FC, plus the $20 that was 
treated as a deemed dividend to DC1) in the stock of DC2 that it 
receives in exchange for the stock of FC. Under Sec. 1.367(b)-
2(e)(3)(iii) and section 312(a), the earnings and profits of FC are 
reduced by the $20 deemed dividend.
    Example 5--(i) Facts. DC1, a domestic corporation, owns all of 
the outstanding stock of DC2, a domestic corporation. DC1 also owns 
all of the outstanding stock of FC1, a foreign corporation. FC1 owns 
all of the outstanding stock of FC2, a foreign corporation. The all 
earnings and profits amount with respect to the FC2 stock owned by 
FC1 is $20. In a reorganization described in section 368(a)(1)(D), 
DC2 acquires all of the assets and liabilities of FC2 in exchange 
for DC2 stock. FC2 distributes the DC2 stock to FC1, and the FC2 
stock held by FC1 is canceled.
    (ii) Result. FC1 must include $20 in income as a deemed dividend 
from FC2 under paragraph (b)(3)(i) of this section. The deemed 
dividend is treated as a dividend for purposes of the Internal 
Revenue Code as provided in Sec. 1.367(b)-2(e)(2); however, under 
paragraph (b)(3)(i) of this section the deemed dividend cannot 
qualify for the exception from foreign personal holding company 
income provided by section 954(c)(3)(A)(i), even if the provisions 
of that section would otherwise have been met in the case of an 
actual dividend.
    Example 6--(i) Facts. DC1, a domestic corporation, owns 99 
percent of USP, a domestic partnership. The remaining 1 percent of 
USP is owned by a person unrelated to DC1. DC1 and USP each directly 
own 9 percent of the outstanding stock of FC, a foreign corporation 
that is not a controlled foreign corporation subject to the rule of 
section 953(c). In a reorganization described in section 
368(a)(1)(C), DC2, a domestic corporation, acquires all of the 
assets and liabilities of FC in exchange for DC2 stock. FC 
distributes to its shareholders DC2 stock, and the FC stock held by 
its shareholders is canceled.
    (ii) Result. (A) DC1 and USP are United States persons that are 
exchanging shareholders in a transaction described in paragraph (a) 
of this section. As a result, DC1 and USP are subject to the rules 
of paragraph (b) of this section if they qualify as United States 
shareholders as defined in paragraph (b)(2) of this section. 
Alternatively, if they do not qualify as United States shareholders 
as defined in paragraph (b)(2) of this section, DC1 and USP are 
subject to the rules of paragraph (c) of this section. Paragraph 
(b)(2) of this section defines the term United States shareholder to 
include any shareholder described in section 951(b) (without regard 
to whether the foreign corporation is a controlled foreign 
corporation). A shareholder described in section 951(b) is a United 
States person that is considered to own, applying the rules of 
section 958(a) and 958(b), 10 percent or more of the total combined 
voting power of all classes of stock entitled to vote of a foreign 
corporation. Under section 958(b), the rules of section 318(a), as 
modified by section 958(b) and the regulations thereunder, apply so 
that, in general, stock owned directly or indirectly by a 
partnership is considered as owned proportionately by its partners, 
and stock owned directly or indirectly by a partner is considered as 
owned by the partnership. Thus, under section 958(b), DC1 is treated 
as owning its proportionate share of FC stock held by USP, and USP 
is treated as owning all of the FC stock held by DC1.
    (B) Accordingly, for purposes of determining whether DC1 is a 
United States shareholder under paragraph (b)(2) of this section, 
DC1 is considered as owning 99 percent of the 9 percent of FC stock 
held by USP. Because DC1 also owns 9 percent of FC stock directly, 
DC1 is considered as owning more than 10 percent of FC stock. DC1 is 
thus a United States shareholder of FC under paragraph (b)(2) of 
this section and, as a result, is subject to the rules of paragraph 
(b) of this section. However, for purposes of determining DC1's all 
earnings and profits amount, DC1 is not treated as owning the FC 
stock held by USP. Under Sec. 1.367(b)-2(d)(3), DC1's all earnings 
and profits amount is determined by reference to the 9 percent of FC 
stock that it directly owns.
    (C) For purposes of determining whether USP is a United States 
shareholder under paragraph (b)(2) of this section, USP is 
considered as owning the 9 percent of FC stock held by DC1. Because 
USP also owns 9 percent of FC stock directly, USP is considered as 
owning more than 10 percent of FC stock. USP is thus a United States 
shareholder of FC under paragraph (b)(2) of this section and, as a 
result, is subject to the rules of paragraph (b) of this section. 
However, for purposes of determining USP's all earnings and profits 
amount, USP is not treated as owning the FC shares held by DC1.

[[Page 3603]]

Under Sec. 1.367(b)-2(d)(3), USP's all earnings and profits amount 
is determined by reference to the 9 percent of FC stock that it 
directly owns.

    (iii) Recognition of exchange gain or loss with respect to 
capital. [Reserved]
    (4) Reserved. For further guidance concerning section 367(b) 
exchanges occurring before February 23, 2001, see Sec. 1.367(b)-
3T(b)(4).
    (c) Exchange of stock owned by a United States person that is 
not a United States shareholder--(1) Scope. This paragraph (c) 
applies in the case of an exchanging shareholder that is a United 
States person not described in paragraph (b)(1)(i) of this section 
(i.e., a United States person that is not a United States 
shareholder of the foreign acquired corporation).
    (2) Requirement to recognize gain. An exchanging shareholder 
described in paragraph (c)(1) of this section shall recognize 
realized gain (but not loss) with respect to the stock of the 
foreign acquired corporation.
    (3) Election to include all earnings and profits amount. In lieu 
of the treatment prescribed by paragraph (c)(2) of this section, an 
exchanging shareholder described in paragraph (c)(1) of this section 
may instead elect to include in income as a deemed dividend the all 
earnings and profits amount with respect to its stock in the foreign 
acquired corporation. For the consequences of a deemed dividend, see 
Sec. 1.367(b)-2(e). Such election may be made only if--
    (i) The foreign acquired corporation (or its successor in 
interest) has provided the exchanging shareholder information to 
substantiate the exchanging shareholder's all earnings and profits 
amount with respect to its stock in the foreign acquired 
corporation; and
    (ii) The exchanging shareholder complies with the section 367(b) 
notice requirement described in Sec. 1.367(b)-1(c), including the 
specific rules contained therein concerning the time and manner for 
electing to apply the rules of this paragraph (c)(3).
    (4) De minimis exception. This paragraph (c) shall not apply in 
the case of an exchanging shareholder whose stock in the foreign 
acquired corporation has a fair market value of less than $50,000 on 
the date of the section 367(b) exchange.
    (5) Examples. The following examples illustrate the rules of 
this paragraph (c):

    Example 1--(i) Facts. DC1, a domestic corporation, owns 5 
percent of the outstanding stock of FC, a foreign corporation that 
is not a controlled foreign corporation subject to the rule of 
section 953(c). Persons unrelated to DC1 own the remaining 95 
percent of the outstanding stock of FC. DC1 has owned its 5 percent 
interest in FC since FC was incorporated. DC1's stock in FC has a 
basis of $40,000 and a value of $100,000. The all earnings and 
profits amount with respect to DC1's stock in FC is $50,000. In a 
reorganization described in section 368(a)(1)(C), DC2, a domestic 
corporation, acquires all of the assets and liabilities of FC in 
exchange for DC2 stock. FC distributes DC2 stock to its 
shareholders, and the FC stock held by its shareholders is canceled.
    (ii) Alternate result 1. If DC1 does not make the election 
described in paragraph (c)(3) of this section, then the general rule 
of paragraph (c)(2) of this section applies and DC1 must recognize 
its $60,000 gain in the FC stock. Under section 358(a)(1), DC1 has a 
$100,000 basis (its $40,000 basis in the FC stock, plus the $60,000 
recognized gain) in the DC2 stock that it receives in exchange for 
its FC stock. Because DC1 is not a shareholder described in section 
1248(a)(2), section 1248 does not apply to recharacterize any of 
DC1's gain as a dividend.
    (iii) Alternate result 2. If DC1 makes a valid election under 
paragraph (c)(3) of this section, then DC1 must include in income as 
a deemed dividend the $50,000 all earnings and profits amount with 
respect to its FC stock. Under Sec. 1.367(b)-2(e)(3) and section 
358(a)(1), DC1 has a $90,000 basis (its $40,000 basis in the FC 
stock, plus the $50,000 that was treated as a deemed dividend to 
DC1) in the DC2 stock that it receives in exchange for its FC stock. 
Because DC1 owns less than 10 percent of the voting stock of FC, DC1 
does not qualify for a deemed paid foreign tax credit under section 
902.
    Example 2--(i) Facts. The facts are the same as in Example 1, 
except that DC1's stock in FC has a fair market value of $48,000 on 
the date DC1 receives the DC2 stock.
    (ii) Result. Because DC1's stock in FC has a fair market value 
of less than $50,000 on the date of the section 367(b) exchange, the 
de minimis exception of paragraph (c)(4) of this section applies. As 
a result, DC1 is not subject to the gain or income inclusion 
requirements of this paragraph (c).

    (d) Carryover of certain foreign taxes--(1) Rule. Unused foreign 
tax credits allowable to the foreign acquired corporation under section 
906 shall carry over to the domestic acquiring corporation and become 
allowable under section 901, subject to the limitations prescribed by 
the Internal Revenue Code (for example, sections 383, 904 and 907). The 
domestic acquiring corporation shall not succeed to any other foreign 
taxes paid or incurred by the foreign acquired corporation.
    (2) Example. The following example illustrates the rules of this 
paragraph (d):

    Example--(i) Facts. DC, a domestic corporation owns 100 percent 
of the outstanding stock of FC, a foreign corporation. FC has net 
positive earnings and profits, none of which are attributable to 
DC's FC stock under Sec. 1.367(b)-2(d)(3). FC has paid foreign taxes 
that are not eligible for credit under section 906. In a liquidation 
described in section 332, FC distributes all of its property to DC, 
and the FC stock held by DC is canceled.
    (ii) Result. The liquidation of FC into DC is a section 367(b) 
exchange. Thus, DC is subject to the section 367(b) regulations, and 
must file a section 367(b) notice pursuant to Sec. 1.367(b)-1(c). 
Pursuant to the provisions of paragraph (d)(1) of this section, the 
foreign taxes paid by FC do not carryover to DC because FC's foreign 
taxes are not eligible for credit under section 906.


    Par. 6. Section 1.367(b)-4 is revised to read as follows:


Sec. 1.367(b)-4  Acquisition of foreign corporate stock or assets by a 
foreign corporation in certain nonrecognition transactions.

    (a) Scope. This section applies to an acquisition by a foreign 
corporation (the foreign acquiring corporation) of the stock or assets 
of another foreign corporation (the foreign acquired corporation) in an 
exchange described in section 351 or a reorganization described in 
section 368(a)(1)(B), (C), (D), (E), (F) or (G). See Sec. 1.367(a)-
3(b)(2) for additional rules that may apply.
    (b) Income inclusion. If an exchange is described in paragraph 
(b)(1)(i), (2)(i) or (3) of this section, the exchanging shareholder 
shall include in income as a deemed dividend the section 1248 amount 
attributable to the stock that it exchanges.
    (1) Exchange that results in loss of status as section 1248 
shareholder--(i) Rule. An exchange is described in this paragraph 
(b)(1)(i) if--
    (A) Immediately before the exchange, the exchanging shareholder 
is--
    (1) A United States person that is a section 1248 shareholder with 
respect to the foreign acquired corporation; or
    (2) A foreign corporation, and a United States person is a section 
1248 shareholder with respect to such foreign corporation and with 
respect to the foreign acquired corporation; and
    (B) Either of the following conditions is satisfied--
    (1) Immediately after the exchange, the stock received in the 
exchange is not stock in a corporation that is a controlled foreign 
corporation as to which the United States person described in paragraph 
(b)(1)(i)(A) of this section is a section 1248 shareholder; or
    (2) Immediately after the exchange, the foreign acquiring 
corporation (or, in the case of a reorganization described in section 
368(a)(1)(B), the foreign acquired corporation) is not a controlled 
foreign corporation as to which the United States person described in 
paragraph (b)(1)(i)(A) of this section is a section 1248 shareholder.
    (ii) Examples. The following examples illustrate the rules of this 
paragraph (b)(1):

    Example 1--(i) Facts. FC1 is a foreign corporation that is 
owned, directly and indirectly (applying the ownership rules of 
section 958), solely by foreign persons. DC is a domestic 
corporation that is unrelated to FC1. DC owns all of the outstanding 
stock of

[[Page 3604]]

FC2, a foreign corporation. Thus, under Sec. 1.367(b)-2(a) and (b), 
DC is a section 1248 shareholder with respect to FC2, and FC2 is a 
controlled foreign corporation. Under Sec. 1.367(b)-2(c)(1), the 
section 1248 amount attributable to the stock of FC2 held by DC is 
$20. In a reorganization described in section 368(a)(1)(C), FC1 
acquires all of the assets and assumes all of the liabilities of FC2 
in exchange for FC1 voting stock. The FC1 voting stock received does 
not represent more than 50 percent of the voting power or value of 
FC1's stock. FC2 distributes the FC1 stock to DC, and the FC2 stock 
held by DC is canceled.
    (ii) Result. FC1 is not a controlled foreign corporation 
immediately after the exchange. As a result, the exchange is 
described in paragraph (b)(1)(i) of this section. Under paragraph 
(b) of this section, DC must include in income, as a deemed dividend 
from FC2, the section 1248 amount ($20) attributable to the FC2 
stock that DC exchanged.
    Example 2--(i) Facts. The facts are the same as in Example 1, 
except that the voting stock of FC1, which is received by FC2 in 
exchange for its assets and distributed by FC2 to DC, represents 
more than 50 percent of the voting power of FC1's stock under the 
rules of section 957(a).
    (ii) Result. Paragraph (b)(1)(i) of this section does not apply 
to require inclusion in income of the section 1248 amount, because 
FC1 is a controlled foreign corporation as to which DC is a section 
1248 shareholder immediately after the exchange.
    Example 3--(i) Facts. The facts are the same as in Example 1, 
except that FC2 receives and distributes voting stock of FP, a 
foreign corporation that is in control (within the meaning of 
section 368(c)) of FC1, instead of receiving and distributing voting 
stock of FC1.
    (ii) Result. For purposes of section 367(a), the transfer is an 
indirect stock transfer subject to section 367(a). See 
Sec. 1.367(a)-3(d)(1)(iv). Accordingly, DC's exchange of FC2 stock 
for FP stock under section 354 will be taxable under section 367(a) 
(and section 1248 will be applicable) if DC fails to enter into a 
gain recognition agreement in accordance with Sec. 1.367(a)-8. Under 
Sec. 1.367(a)-3(b)(2), if DC enters into a gain recognition 
agreement, the exchange will be subject to the provisions of section 
367(b) and the regulations thereunder, as well as section 367(a). If 
FP and FC1 are controlled foreign corporations as to which DC is a 
(direct or indirect) section 1248 shareholder immediately after the 
reorganization, then the section 367(b) result is the same as in 
Example 2--that is, paragraph (b)(1)(i) of this section does not 
apply to require inclusion in income of the section 1248 amount. 
Under these circumstances, the amount of the gain recognition 
agreement would equal the amount of the gain realized on the 
indirect stock transfer. If FP or FC1 is not a controlled foreign 
corporation as to which DC is a (direct or indirect) section 1248 
shareholder immediately after the exchange, then the section 367(b) 
result is the same as in Example 1--that is, DC must include in 
income, as a deemed dividend from FC2, the section 1248 amount ($20) 
attributable to the FC2 stock that DC exchanged. Under these 
circumstances, the amount of the gain recognition agreement would 
equal the amount of the gain realized on the indirect stock 
transfer, less the $20 section 1248 amount inclusion.
    Example 4--(i) Facts. DC1, a domestic corporation, owns all of 
the outstanding stock of DC2, a domestic corporation. DC2 owns 
various assets including all of the outstanding stock of FC2, a 
foreign corporation. The stock of FC2 has a value of $100, and DC2 
has a basis of $30 in such stock. The section 1248 amount 
attributable to the FC2 stock held by DC2 is $20. DC2 does not own 
any other stock in a foreign corporation. FC1 is a foreign 
corporation that is unrelated to DC1, DC2 and FC2. In a 
reorganization described in section 368(a)(1)(C), FC1 acquires all 
of the assets and liabilities of DC2 in exchange for FC1 voting 
stock that represents 20 percent of the outstanding voting stock of 
FC1. DC2 distributes the FC1 stock to DC1, and the DC2 stock held by 
DC1 is canceled. DC1 properly files a gain recognition agreement 
under Sec. 1.367(a)-8 to qualify for nonrecognition treatment under 
section 367(a) with respect to DC2's transfer of the FC2 stock to 
FC1. See Sec. 1.367(a)-8(f)(2).
    (ii) Result. Pursuant to paragraph (b)(1)(i)(A) of this section, 
DC2 is the exchanging shareholder that is a section 1248 shareholder 
with respect to FC2, the foreign acquired corporation. Immediately 
after the exchange, DC2 is not a section 1248 shareholder with 
respect to FC1, the corporation whose stock is received in the 
exchange (because the DC2 stock is canceled). Thus, paragraph 
(b)(1)(i)(B) of this section is satisfied and, as a result, 
paragraph (b)(1)(i) of this section applies to DC2's section 361 
exchange of FC2 stock. Accordingly, under paragraph (b) of this 
section, DC2 must include in income, as a deemed dividend from FC2, 
the section 1248 amount ($20) attributable to the FC2 stock that DC2 
exchanges. This result arises without regard to whether FC1 and FC2 
are controlled foreign corporations immediately after the exchange. 
For the tax treatment of DC2's transfer of assets (other than stock) 
to FC1, see sections 367(a)(1) and (a)(3), and the regulations 
thereunder. Because the exchange is also described in section 361(a) 
or (b), see section 367(a)(5) and any regulations thereunder. If any 
of the assets transferred are intangible assets, see section 367(d) 
and the regulations thereunder.

    (2) Receipt by exchanging shareholder of preferred or other stock 
in certain instances--(i) Rule. An exchange is described in this 
paragraph (b)(2)(i) if--
    (A) Immediately before the exchange, the foreign acquired 
corporation and the foreign acquiring corporations are not members of 
the same affiliated group (within the meaning of section 1504(a), but 
without regard to the exceptions set forth in section 1504(b), and 
substituting the words ``more than 50'' in place of the words ``at 
least 80'' in sections 1504(a)(2)(A) and (B));
    (B) Immediately after the exchange, a domestic corporation meets 
the ownership threshold specified by section 902(a) or (b) such that it 
may qualify for a deemed paid foreign tax credit if it receives a 
distribution from the foreign acquiring corporation (directly or 
through tiers); and
    (C) The exchanging shareholder receives preferred stock (other than 
preferred stock that is fully participating with respect to dividends, 
redemptions and corporate growth) in consideration for common stock or 
preferred stock that is fully participating with respect to dividends, 
redemptions and corporate growth, or, in the discretion of the 
Commissioner or the Commissioner's delegate (and without regard to 
whether the stock exchanged is common stock or preferred stock), 
receives stock that entitles it to participate (through dividends, 
redemption payments or otherwise) disproportionately in the earnings 
generated by particular assets of the foreign acquired corporation or 
foreign acquiring corporation.
    (ii) Examples. The following examples illustrate the rules of this 
paragraph (b)(2):

    Example 1--(i) Facts. FC1 is a foreign corporation. DC is a 
domestic corporation that is unrelated to FC1. DC owns all of the 
outstanding stock of FC2, a foreign corporation, and FC2 has no 
outstanding preferred stock. The value of FC2 is $100 and DC has a 
basis of $50 in the stock of FC2. Under Sec. 1.367(b)-2(c)(1), the 
section 1248 amount attributable to the stock of FC2 held by DC is 
$20. In a reorganization described in section 368(a)(1)(B), FC1 
acquires all of the stock of FC2 and, in exchange, DC receives FC1 
voting preferred stock that constitutes 10 percent of the voting 
stock of FC1 for purposes of section 902(a). Immediately after the 
exchange, FC1 and FC2 are controlled foreign corporations and DC is 
a section 1248 shareholder of FC1 and FC2, so paragraph (b)(1)(i) of 
this section does not require inclusion in income of the section 
1248 amount.
    (ii) Result. Pursuant to Sec. 1.367(a)-3(b)(2), the transfer is 
subject to both section 367(a) and section 367(b). Under 
Sec. 1.367(a)-3(b)(1), DC will not be subject to tax under section 
367(a)(1) if it enters into a gain recognition agreement in 
accordance with Sec. 1.367(a)-8. Even though paragraph (b)(1)(i) of 
this section does not apply to require inclusion in income by DC of 
the section 1248 amount, DC must nevertheless include the $20 
section 1248 amount in income as a deemed dividend from FC2 under 
paragraph (b)(2)(i) of this section. Thus, if DC enters into a gain 
recognition agreement, the amount is $30 (the $50 gain realized less 
the $20 recognized under section 367(b)). If DC fails to enter into 
a gain recognition agreement, it must include in income under 
section 367(a)(1) the $50 of gain realized ($20 of which is treated 
as a dividend under section 1248). Section 367(b) does not apply in 
such case.
    Example 2--(i) Facts. The facts are the same as in Example 1, 
except that DC owns

[[Page 3605]]

all of the outstanding stock of FC1 immediately before the 
transaction.
    (ii) Result. Both section 367(a) and section 367(b) apply to the 
transfer. Paragraph (b)(2)(i) of this section does not apply to 
require inclusion of the section 1248 amount. Under paragraph 
(b)(2)(i)(A) of this section, the transaction is outside the scope 
of paragraph (b)(2)(i) of this section because FC1 and FC2 are, 
immediately before the transaction, members of the same affiliated 
group (within the meaning of such paragraph). Thus, if DC enters 
into a gain recognition agreement in accordance with Sec. 1.367(a)-
8, the amount of such agreement is $50. As in Example 1, if DC fails 
to enter into a gain recognition agreement, it must include in 
income $50, $20 of which will be treated as a dividend under section 
1248.
    Example 3--(i) Facts. FC1 is a foreign corporation. DC is a 
domestic corporation that is unrelated to FC1. DC owns all of the 
outstanding stock of FC2, a foreign corporation. The section 1248 
amount attributable to the stock of FC2 held by DC is $20. In a 
reorganization described in section 368(a)(1)(B), FC1 acquires all 
of the stock of FC2 in exchange for FC1 voting stock that 
constitutes 10 percent of the voting stock of FC1 for purposes of 
section 902(a). The FC1 voting stock received by DC in the exchange 
carries voting rights in FC1, but by agreement of the parties the 
shares entitle the holder to dividends, amounts to be paid on 
redemption, and amounts to be paid on liquidation, that are to be 
determined by reference to the earnings or value of FC2 as of the 
date of such event, and that are affected by the earnings or value 
of FC1 only if FC1 becomes insolvent or has insufficient capital 
surplus to pay dividends.
    (ii) Result. Under Sec. 1.367(a)-3(b)(1), DC will not be subject 
to tax under section 367(a)(1) if it enters into a gain recognition 
agreement with respect to the transfer of FC2 stock to FC1. Under 
Sec. 1.367(a)-3(b)(2), the exchange will be subject to the 
provisions of section 367(b) and the regulations thereunder to the 
extent that it is not subject to tax under section 367(a)(1). 
Furthermore, even if DC would not otherwise be required to recognize 
income under this section, the Commissioner or the Commissioner's 
delegate may nevertheless require that DC include the $20 section 
1248 amount in income as a deemed dividend from FC2 under paragraph 
(b)(2)(i) of this section.

    (3) Certain recapitalizations. An exchange pursuant to a 
recapitalization under section 368(a)(1)(E) shall be deemed to be an 
exchange described in this paragraph (b)(3) if the following conditions 
are satisfied--
    (i) During the 24-month period immediately preceding or following 
the date of the recapitalization, the corporation that undergoes the 
recapitalization (or a predecessor of, or successor to, such 
corporation) also engages in a transaction that would be described in 
paragraph (b)(2)(i) of this section but for paragraph (b)(2)(i)(C) of 
this section, either as the foreign acquired corporation or the foreign 
acquiring corporation; and
    (ii) The exchange in the recapitalization is described in paragraph 
(b)(2)(i)(C) of this section.
    (c) Exclusion of deemed dividend from foreign personal holding 
company income--(1) Rule. In the event the section 1248 amount is 
included in income as a deemed dividend by a foreign corporation under 
paragraph (b) of this section, such deemed dividend shall not be 
included as foreign personal holding company income under section 
954(c).
    (2) Example. The following example illustrates the rule of this 
paragraph (c):

    Example--(i) Facts. FC1 is a foreign corporation that is owned, 
directly and indirectly (applying the ownership rules of section 
958), solely by foreign persons. DC is a domestic corporation that 
is unrelated to FC1. DC owns all of the outstanding stock of FC2, a 
foreign corporation. FC2 owns all of the outstanding stock of FC3, a 
foreign corporation. Under Sec. 1.367(b)-2(c)(1), the section 1248 
amount attributable to the stock of FC3 held by FC2 is $20. In a 
reorganization described in section 368(a)(1)(B), FC1 acquires from 
FC2 all of the stock of FC3 in exchange for FC1 voting stock. The 
FC1 voting stock received by FC2 does not represent more than 50 
percent of the voting power or value of FC1's stock.
    (ii) Result. FC1 is not a controlled foreign corporation 
immediately after the exchange. Under paragraph (b)(1) of this 
section, FC2 must include in income, as a deemed dividend from FC3, 
the section 1248 amount ($20) attributable to the FC3 stock that FC2 
exchanged. The deemed dividend is treated as a dividend for purposes 
of the Internal Revenue Code as provided in Sec. 1.367(b)-2(e)(2); 
however, under this paragraph (c) the deemed dividend is not foreign 
personal holding company income to FC2.

    (d) Rules for subsequent exchanges--(1) In general. If income is 
not required to be included under paragraph (b) of this section in a 
section 367(b) exchange described in paragraph (a) of this section 
(non-inclusion exchange) then, for purposes of applying section 367(b) 
or 1248 to subsequent exchanges, the determination of the earnings and 
profits attributable to an exchanging shareholder's stock received in 
the non-inclusion exchange shall include a computation that refers to 
the exchanging shareholder's pro rata interest in the earnings and 
profits of the foreign acquiring corporation (and, in the case of a 
stock transfer, the foreign acquired corporation) that accumulate after 
the non-inclusion exchange, as well as its pro rata interest in the 
earnings and profits of the foreign acquired corporation that 
accumulated before the non-inclusion exchange. See also section 
1248(c)(2)(D)(ii). The earnings and profits attributable to the stock 
received by an exchanging shareholder in the non-inclusion exchange 
shall not include any earnings and profits of the foreign acquiring 
corporation that accumulated before the non-inclusion exchange. In the 
case of a non-inclusion exchange in which the exchanging shareholder is 
a foreign corporation, this paragraph (d)(1) shall also apply for 
purposes of determining the earnings and profits attributable to the 
exchanging foreign corporation's shareholders, as well as for purposes 
of determining the earnings and profits attributable to the exchanging 
foreign corporation when applying section 964(e) to subsequent sales or 
exchanges of the stock of the foreign acquiring corporation.
    (2) Subsequent dispositions by a foreign acquiring corporation. In 
the case of an exchange by a foreign acquiring corporation that is 
subject to section 367(b) or 964(e) and that follows a non-inclusion 
exchange (as defined in paragraph (d)(1) of this section), the rules of 
paragraph (d)(1) of this section shall not apply. However, as a result 
of such a subsequent exchange, proportionate reductions shall be made 
to the earnings and profits that accumulated before the non-inclusion 
exchange and that were attributed under paragraph (d)(1) of this 
section. Such reductions shall be made without regard to whether gain 
is recognized on the subsequent sale or exchange.
    (3) Examples. The following examples illustrate the rules of this 
section:

    Example 1--(i) Facts. DC1, a domestic corporation, owns all of 
the outstanding stock of FC1, a foreign corporation. DC1 has owned 
all of the stock of FC1 since FC1's formation. FC1 has $20 of 
earnings and profits, all of which is eligible for inclusion in the 
section 1248 amount attributable to DC1's stock in FC1. DC2, a 
domestic corporation, owns all of the outstanding stock of FC2, a 
foreign corporation. DC2 has owned all of the stock of FC2 since 
FC2's formation. FC2 has $40 of earnings and profits, all of which 
is eligible for inclusion in the section 1248 amount attributable to 
DC2's stock in FC2. DC1 and DC2 are unrelated. In a reorganization 
described in section 368(a)(1)(B), DC1 transfers all of the stock of 
FC1 to FC2 in exchange for 40 percent of FC2 stock. DC1 enters into 
a five-year gain recognition agreement under the provisions of 
Secs. 1.367(a)-3(b) and 1.367(a)-8 with respect to its transfer of 
FC1 stock to FC2.
    (ii) Result. (A) DC1's transfer of FC1 to FC2 is not described 
in paragraph (b)(1)(i), (2)(i), or (3) of this section. As a result, 
DC1 is not required to include in income the section 1248 amount 
attributable to its FC1 stock and the rules of paragraph (d)(1) of 
this section apply. Thus, for purposes of applying section 367(b) or 
1248 to subsequent exchanges of FC2 stock, the determination of the 
earnings

[[Page 3606]]

and profits attributable to DC1's stock in FC2 will include a 
computation that refers to 40 percent of the post-reorganization 
earnings and profits of FC1 and FC2, and that refers to 100 percent 
of the $20 of pre-reorganization earnings and profits of FC1. The 
earnings and profits attributable to DC1's stock in FC2 will not 
include any of the $40 of earnings and profits accumulated by FC2 
prior to the transaction. Those earnings and profits are 
attributable to DC2 under section 1248. However, paragraph (d)(1) of 
this section does not apply for purposes of applying section 367(b) 
or 964(e) to subsequent exchanges of FC1 stock by FC2. For these 
purposes, the determination of the earnings and profits attributable 
to FC2's stock in FC1 is made under the principles of section 1248 
and, as a result, includes a computation that refers to the $20 of 
earnings and profits attributable to FC2's section 1223(2) holding 
period in the FC1 stock.
    (B) In the event FC2 exchanges FC1 stock in a transaction that 
is subject to section 367(b) or 964(e), a proportionate reduction 
must be made to the $20 of earnings and profits that was previously 
attributed under paragraph (d)(1) of this section to DC1's stock in 
FC2. Thus, for example, if FC2 sells 50 percent of its FC1 stock (at 
a time when there have been no other reductions that affect the $20 
of FC1 earnings and profits), paragraph (d)(2) of this section 
requires DC1 to proportionately reduce the $20 of earnings and 
profits that was previously attributed to its FC2 stock (to $10). 
This reduction occurs without regard to whether FC2 recognizes gain 
on its sale of FC1 stock.
    Example 2--(i) Facts. The facts are the same as in Example 1, 
except that in a reorganization described in section 368(a)(1)(C), 
FC1 transfers all of its assets to FC2 in exchange for 40 percent of 
FC2 stock. FC1 then distributes the stock of FC2 to DC1, and the FC1 
stock held by DC1 is canceled. None of FC1's assets include stock.
    (ii) Result. FC2's acquisition of FC1 is not described in 
paragraph (b)(1)(i), (2)(i), or (3) of this section. As a result, 
DC1 is not required to include in income the section 1248 amount 
attributable to its FC1 stock and the rules of paragraph (d)(1) of 
this section apply. Thus, for purposes of applying section 367(b) or 
1248 to subsequent exchanges, the determination of the earnings and 
profits attributable to DC1's stock in FC2 will include a 
computation that refers to 40 percent of the post-reorganization 
earnings and profits of FC2, and that refers to 100 percent of the 
pre-reorganization earnings and profits of FC1. The earnings and 
profits attributable to DC1's stock in FC2 will not include any of 
the $40 of earnings and profits accumulated by FC2 prior to the 
transaction. Those earnings and profits are attributable to DC2 
under section 1248.
    Example 3--(i) Facts. DC1, a domestic corporation, owns all of 
the outstanding stock of FC1, a foreign corporation. FC1 owns all of 
the outstanding stock of FC3, a foreign corporation. DC1 has owned 
all of the stock of FC1 since FC1's formation, and FC1 has owned all 
of the stock of FC3 since FC3's formation. FC3 has $20 of earnings 
and profits, all of which is eligible for inclusion in the section 
1248 amount attributable to DC1's stock in FC1 and in the section 
1248 amount attributable to FC1's stock in FC3. Such earnings and 
profits are similarly eligible for inclusion as a dividend 
attributable to FC1's stock in FC3 under section 964(e). DC2, a 
domestic corporation, owns all of the outstanding stock of FC2, a 
foreign corporation. DC2 has owned all of the stock of FC2 since 
FC2's formation. FC2 has $40 of earnings and profits, all of which 
is eligible for inclusion in the section 1248 amount attributable to 
DC2's stock in FC2. DC1 and DC2 are unrelated. In a reorganization 
described in section 368(a)(1)(B), FC1 transfers all of the stock of 
FC3 to FC2 in exchange for 40 percent of FC2 stock.
    (ii) Result. (A) FC1's transfer of FC3 to FC2 is not described 
in paragraph (b)(1)(i), (2)(i), or (3) of this section. As a result, 
FC1 is not required to include in income the section 1248 amount 
attributable to its FC3 stock and the rules of paragraph (d)(1) of 
this section apply. Thus, for purposes of applying section 367(b) or 
1248 to subsequent exchanges of FC1 stock, the determination of the 
earnings and profits attributable to DC1's stock in FC1 will include 
a computation that refers to 40 percent of the post-reorganization 
earnings and profits of FC2 and FC3, and that refers to 100 percent 
of the $20 of pre-reorganization earnings and profits of FC3. The 
earnings and profits attributable to FC1's stock in FC2 will not 
include any of the $40 of earnings and profits accumulated by FC2 
prior to the transaction. Those earnings and profits are 
attributable to DC2 under section 1248. For purposes of applying 
section 367(b) or 964(e) to subsequent exchanges of FC2 stock, the 
determination of the earnings and profits attributable to FC1's 
stock in FC2 will include a computation that refers to 40 percent of 
the post-reorganization earnings and profits of FC2 and FC3, and 
that refers to 100 percent of the $20 of pre-reorganization earnings 
and profits of FC3. The earnings and profits attributable to FC1's 
interest in FC2 do not include any of the $40 of earnings and 
profits accumulated by FC2 prior to the transaction. However, 
paragraph (d)(1) of this section does not apply for purposes of 
applying section 367(b) or 964(e) to subsequent exchanges of FC3 
stock by FC2. For these purposes, the determination of the earnings 
and profits attributable to FC2's stock in FC3 is made under the 
principles of section 1248 and, as a result, includes a computation 
that refers to the $20 of earnings and profits attributable to FC2's 
section 1223(2) holding period in the FC3 stock.
    (B) In the event FC2 exchanges FC3 stock in a transaction that 
is subject to section 367(b) or 964(e), a proportionate reduction 
must be made to the $20 of earnings and profits that was previously 
attributed under paragraph (d)(1) of this section to DC1's stock in 
FC1 (for purposes of subsequent application of section 367(b) or 
1248) as well as to FC1's stock in FC2 (for purposes of subsequent 
application of section 367(b) or 964(e)). Thus, for example, if FC2 
sells 50 percent of its FC3 stock (at a time when there have been no 
other reductions that affect the $20 of FC3 earnings and profits), 
paragraph (d)(2) of this section requires DC1 and FC1 to 
proportionately reduce the $20 of earnings and profits that was 
previously attributed to their FC1 and FC2 stock, respectively (to 
$10). These reductions occur without regard to whether FC2 
recognizes gain on its sale of FC3 stock.

    Par. 7. Sections 1.367(b)-5 and 1.367(b)-6 are added to read as 
follows:


Sec. 1.367(b)-5  Distributions of stock described in section 355.

    (a) In general--(1) Scope. This section provides rules relating to 
a distribution described in section 355 and to which section 367(b) 
applies. For purposes of this section, the terms distributing 
corporation, controlled corporation, and distributee have the same 
meaning as used in section 355 and the regulations thereunder.
    (2) Treatment of distributees as exchanging shareholders. For 
purposes of the section 367(b) regulations, all distributees in a 
transaction described in paragraph (b), (c), or (d) of this section 
shall be treated as exchanging shareholders that realize income in a 
section 367(b) exchange.
    (b) Distribution by a domestic corporation--(1) General rule. In a 
distribution described in section 355, if the distributing corporation 
is a domestic corporation and the controlled corporation is a foreign 
corporation, the following general rules shall apply--
    (i) If the distributee is a corporation, then the controlled 
corporation shall be considered to be a corporation; and
    (ii) If the distributee is an individual, then, solely for purposes 
of determining the gain recognized by the distributing corporation, the 
controlled corporation shall not be considered to be a corporation, and 
the distributing corporation shall recognize any gain (but not loss) 
realized on the distribution.
    (2) Section 367(e) transactions. The rules of paragraph (b)(1) of 
this section shall not apply to a foreign distributee to the extent 
gain is recognized under section 367(e)(1) and the regulations 
thereunder.
    (3) Determining whether distributees are individuals. All 
distributees in a distribution described in paragraph (b)(1) of this 
section are presumed to be individuals. However, the shareholder 
identification principles of Sec. 1.367(e)-1(d) (including the 
reporting procedures in Sec. 1.367(e)-1(d)(2) and (3)) shall apply for 
purposes of rebutting this presumption.
    (4) Applicable cross-references. For rules with respect to a 
distributee that is a partnership, trust or estate, see Sec. 1.367(b)-
2(k). For additional rules relating to a distribution of stock of a 
foreign corporation by a domestic corporation, see section 1248(f) and 
the

[[Page 3607]]

regulations thereunder. For additional rules relating to a distribution 
described in section 355 by a domestic corporation to a foreign 
distributee, see section 367(e)(1) and the regulations thereunder.
    (c) Pro rata distribution by a controlled foreign corporation--(1) 
Scope. This paragraph (c) applies to a distribution described in 
section 355 in which the distributing corporation is a controlled 
foreign corporation and in which the stock of the controlled 
corporation is distributed pro rata to each of the distributing 
corporation's shareholders.
    (2) Adjustment to basis in stock and income inclusion. If the 
distributee's postdistribution amount (as defined in paragraph (e)(2) 
of this section) with respect to the distributing or controlled 
corporation is less than the distributee's predistribution amount (as 
defined in paragraph (e)(1) of this section) with respect to such 
corporation, then the distributee's basis in such stock immediately 
after the distribution (determined under the normal principles of 
section 358) shall be reduced by the amount of the difference. However, 
the distributee's basis in such stock shall not be reduced below zero, 
and to the extent the foregoing reduction would have reduced basis 
below zero, the distributee shall instead include such amount in income 
as a deemed dividend from such corporation.
    (3) Interaction with Sec. 1.367(b)-2(e)(3)(ii). The basis increase 
provided in Sec. 1.367(b)-2(e)(3)(ii) shall not apply to a deemed 
dividend that is included in income pursuant to paragraph (c)(2) of 
this section.
    (4) Basis redistribution. If a distributee reduces the basis in the 
stock of the distributing or controlled corporation (or has an 
inclusion with respect to such stock) under paragraph (c)(2) of this 
section, the distributee shall increase its basis in the stock of the 
other corporation by the amount of the basis decrease (or deemed 
dividend inclusion) required by paragraph (c)(2) of this section. 
However, the distributee's basis in such stock shall not be increased 
above the fair market value of such stock and shall not be increased to 
the extent the increase diminishes the distributee's postdistribution 
amount with respect to such corporation.
    (d) Non-pro rata distribution by a controlled foreign corporation--
(1) Scope. This paragraph (d) applies to a distribution described in 
section 355 in which the distributing corporation is a controlled 
foreign corporation and in which the stock of the controlled 
corporation is not distributed pro rata to each of the distributing 
corporation's shareholders.
    (2) Treatment of certain shareholders as distributees. For purposes 
of the section 367(b) regulations, all persons owning stock of the 
distributing corporation immediately after a transaction described in 
paragraph (d)(1) of this section shall be treated as distributees of 
such stock. For other applicable rules, see paragraph (a)(2) of this 
section.
    (3) Inclusion of excess section 1248 amount by exchanging 
shareholder. If the distributee's postdistribution amount (as defined 
in paragraph (e)(2) of this section) with respect to the distributing 
or controlled corporation is less than the distributee's 
predistribution amount (as defined in paragraph (e)(1) of this section) 
with respect to such corporation, then the distributee shall include in 
income as a deemed dividend the amount of the difference. For purposes 
of this paragraph (d)(3), if a distributee owns no stock in the 
distributing or controlled corporation immediately after the 
distribution, the distributee's postdistribution amount with respect to 
such corporation shall be zero.
    (4) Interaction with Sec. 1.367(b)--2(e)(3)(ii)--(i) Limited 
application. The basis increase provided in Sec. 1.367(b)--2(e)(3)(ii) 
shall apply to a deemed dividend that is included in income pursuant to 
paragraph (d)(3) of this section only to the extent that such basis 
increase does not increase the distributee's basis above the fair 
market value of such stock and does not diminish the distributee's 
postdistribution amount with respect to such corporation.
    (ii) Interaction with predistribution amount. For purposes of this 
paragraph (d), the distributee's predistribution amount (as defined in 
paragraph (e)(1) of this section) shall be determined without regard to 
any basis increase permitted under paragraph (d)(4)(i) of this section.
    (e) Definitions--(1) Predistribution amount. For purposes of this 
section, the predistribution amount with respect to a distributing or 
controlled corporation is the distributee's section 1248 amount (as 
defined in Sec. 1.367(b)--2(c)(1)) computed immediately before the 
distribution (and after any section 368(a)(1)(D) transfer connected 
with the section 355 distribution), but only to the extent that such 
amount is attributable to the distributing corporation and any 
corporations controlled by it immediately before the distribution (the 
distributing group) or the controlled corporation and any corporations 
controlled by it immediately before the distribution (the controlled 
group), as the case may be, under the principles of Secs. 1.1248-
1(d)(3), 1.1248-2 and 1.1248-3. However, the predistribution amount 
with regard to the distributing group shall be computed without taking 
into account the distributee's predistribution amount with respect to 
the controlled group.
    (2) Postdistribution amount. For purposes of this section, the 
postdistribution amount with respect to a distributing or controlled 
corporation is the distributee's section 1248 amount (as defined in 
Sec. 1.367(b)-2(c)(1)) with respect to such stock, computed immediately 
after the distribution (but without regard to paragraph (c) or (d) of 
this section (whichever is applicable)). The postdistribution amount 
under this paragraph (e)(2) shall be computed before taking into 
account the effect (if any) of any inclusion under section 356(a) or 
(b).
    (f) Exclusion of deemed dividend from foreign personal holding 
company income. In the event an amount is included in income as a 
deemed dividend by a foreign corporation under paragraph (c) or (d) of 
this section, such deemed dividend shall not be included as foreign 
personal holding company income under section 954(c).
    (g) Examples. The following examples illustrate the rules of this 
section:

    Example 1--(i) Facts. USS, a domestic corporation, owns 40 
percent of the outstanding stock of FD, a controlled foreign 
corporation (CFC). USS has owned the stock since FD was 
incorporated, and FD has always been a CFC. USS has a basis of $80 
in its FD stock, which has a fair market value of $200. FD owns 100 
percent of the outstanding stock of FC, a foreign corporation. FD 
has owned the stock since FC was incorporated. Neither FD nor FC own 
stock in any other corporation. FD has earnings and profits of $0 
and a fair market value of $250 (not considering its ownership of 
FC). FC has earnings and profits of $300, none of which is described 
in section 1248(d), and a fair market value of $250. In a pro rata 
distribution described in section 355, FD distributes to USS stock 
in FC worth $100; thereafter, USS's FD stock is worth $100 as well.
    (ii) Result--(A) FD's distribution is a transaction described in 
paragraph (c)(1) of this section. Under paragraph (c)(2) of this 
section, USS must compare its predistribution amounts with respect 
to FD and FC to its respective postdistribution amounts. Under 
paragraph (e)(1) of this section, USS's predistribution amount with 
respect to FD or FC is its section 1248 amount computed immediately 
before the distribution, but only to the extent such amount is 
attributable to FD or FC. Under Sec. 1.367(b)-2(c)(1), USS's section 
1248 amount computed immediately before the distribution is $120, 
all of which is

[[Page 3608]]

attributable to FC. Thus, USS's predistribution amount with respect 
to FD is $0, and its predistribution amount with respect to FC is 
$120. These amounts are computed as follows: If USS had sold its FD 
stock immediately before the transaction, it would have recognized 
$120 of gain ($200 fair market value $80 basis). All of the gain 
would have been treated as a dividend under section 1248, and all of 
the section 1248 amount would have been attributable to FC (based on 
USS's pro rata share of FC's earnings and profits (40 percent  x  
$300)).
    (B) Under paragraph (e)(2) of this section, USS's 
postdistribution amount with respect to FD or FC is its section 1248 
amount with respect to such corporation, computed immediately after 
the distribution (but without regard to paragraph (c) of this 
section). Under Sec. 1.367(b)-2(c)(1), USS's section 1248 amounts 
computed immediately after the distribution with respect to FD and 
FC are $60 and $0, respectively. These amounts, which are USS's 
postdistribution amounts, are computed as follows: Under the normal 
principles of section 358, USS allocates its $80 predistribution 
basis in FD between FD and FC according to the stock blocks' 
relative values, yielding a $40 basis in each block. If USS sold its 
FD stock immediately after the distribution, none of the resulting 
gain would be treated as a dividend under section 1248. If USS sold 
its FC stock immediately after the distribution, it would have a $60 
gain ($100 fair market value--$40 basis), all of which would be 
treated as a dividend under section 1248.
    (C) The basis adjustment and income inclusion rules of paragraph 
(c)(2) of this section apply to the extent of any difference between 
USS's postdistribution and predistribution amounts. In the case of 
FD, there is no difference between the two amounts and, as a result, 
no adjustment or income inclusion is required. In the case of FC, 
USS's postdistribution amount is $60 less than its predistribution 
amount. Accordingly, under paragraph (c)(2) of this section, USS is 
required to reduce its basis in its FC stock from $40 to $0 and 
include $20 in income as a deemed dividend from FC. Under paragraph 
(c)(3) of this section, the basis increase provided in 
Sec. 1.367(b)-2(e)(3)(ii) does not apply with regard to the $20 
deemed dividend. Under the rules of paragraph (c)(4) of this 
section, USS increases its basis in FD by the amount by which it 
decreased its basis in FC, as well as by the amount of its deemed 
dividend inclusion ($40 + $40 + $20 = $100).
    Example 2--(i) Facts. USS1 and USS2, domestic corporations, each 
own 50 percent of the outstanding stock of FD, a controlled foreign 
corporation (CFC). USS1 and USS2 have owned their FD stock since it 
was incorporated, and FD has always been a CFC. USS1 and USS2 each 
have a basis of $500 in their FD stock, and the fair market value of 
each block of FD stock is $750. FD owns 100 percent of the 
outstanding stock of FC, a foreign corporation. FD owned the stock 
since FC was incorporated. Neither FD nor FC own stock in any other 
corporation. FD has earnings and profits of $0 and a fair market 
value of $750 (not considering its ownership of FC). FC has earnings 
and profits of $500, none of which is described in section 1248(d), 
and a fair market value of $750. In a non-pro rata distribution 
described in section 355, FD distributes all of the stock of FC to 
USS2 in exchange for USS2's FD stock.
    (ii) Result--(A) FD's distribution is a transaction described in 
paragraph (d)(1) of this section. Under paragraph (d)(2) of this 
section, USS1 is considered a distributee of FD stock. Under 
paragraph (d)(3) of this section, USS1 and USS2 must compare their 
predistribution amounts with respect to FD and FC stock to their 
respective postdistribution amounts. Under paragraph (e)(1) of this 
section, USS1's predistribution amount with respect to FD or FC is 
USS1's section 1248 amount computed immediately before the 
distribution, but only to the extent such amount is attributable to 
FD or FC. USS2's predistribution amount is determined in the same 
manner. Under Sec. 1.367(b)-2(c)(1), USS1 and USS2 each have a 
section 1248 amount computed immediately before the distribution of 
$250, all of which is attributable to FC. Thus, USS1 and USS2 each 
have a predistribution amount with respect to FD of $0, and each 
have a predistribution amount with respect to FC of $250. These 
amounts are computed as follows: If either USS1 or USS2 had sold its 
FD stock immediately before the transaction, it would have 
recognized $250 of gain ($750 fair market value--$500 basis). All of 
the gain would have been treated as a dividend under section 1248, 
and all of the section 1248 amount would have been attributable to 
FC (based on USS1's and USS2's pro rata shares of FC's earnings and 
profits (50 percent x $500)).
    (B) Under paragraph (d)(3) of this section, a distributee that 
owns no stock in the distributing or controlled corporation 
immediately after the distribution has a postdistribution amount 
with regard to that stock of zero. Accordingly, USS2 has a 
postdistribution amount of $0 with respect to FD and USS1 has a 
postdistribution amount of $0 with respect to FC. Under paragraph 
(e)(2) of this section, USS1's postdistribution amount with respect 
to FD is its section 1248 amount with respect to such corporation, 
computed immediately after the distribution (but without regard to 
paragraph (d) of this section). USS2's postdistribution amount with 
respect to FC is determined in the same manner. Under Sec. 1.367(b)-
2(c)(1), USS1's section 1248 amount computed immediately after the 
distribution with respect to FD is $0 and USS2's section 1248 amount 
computed immediately after the distribution with respect to FC is 
$250. These amounts, which are USS1's and USS2's postdistribution 
amounts, are computed as follows: After the non-pro rata 
distribution, USS1 owns all the stock of FD and USS2 owns all the 
stock of FC. If USS1 sold its FD stock immediately after the 
distribution, none of the resulting $250 gain ($750 fair market 
value $500 basis) would be treated as a dividend under section 1248. 
If USS2 sold its FC stock immediately after the distribution, it 
would have a $250 gain ($750 fair market value--$500 basis), all of 
which would be treated as a dividend under section 1248.
    (C) The income inclusion rule of paragraph (d)(3) of this 
section applies to the extent of any difference between USS1's and 
USS2's postdistribution and predistribution amounts. In the case of 
USS2, there is no difference between the two amounts with respect to 
either FD or FC and, as a result, no income inclusion is required. 
In the case of USS1, there is no difference between the two amounts 
with respect to its FD stock. However, USS1's postdistribution 
amount with respect to FC is $250 less than its predistribution 
amount. Accordingly, under paragraph (d)(3) of this section, USS1 is 
required to include $250 in income as a deemed dividend. Under 
Sec. 1.367(b)-2(e)(2), the $250 deemed dividend is considered as 
having been paid by FC to FD, and by FD to USS1, immediately prior 
to the distribution. This deemed dividend increases USS1's basis in 
FD ($500 + $250 = $750).


Sec. 1.367(b)-6  Effective dates and coordination rules.

    (a) Effective date--(1) In general. Sections 1.367(b)-1 through 
1.367(b)-5, and this section, apply to section 367(b) exchanges that 
occur on or after February 23, 2000.
    (2) Exception. A taxpayer may, however, elect to have 
Secs. 1.367(b)-1 through 1.367(b)-5, and this section, apply to section 
367(b) exchanges that occur (or occurred) before February 23, 2000, if 
the due date for the taxpayer's timely filed Federal tax return 
(including extensions) for the taxable year in which the section 367(b) 
exchange occurs (or occurred) is after February 23, 2000. The election 
under this paragraph (a)(2) will be valid only if--
    (i) The electing taxpayer makes the election on a timely filed 
section 367(b) notice;
    (ii) In the case of an exchanging shareholder that is a foreign 
corporation, the election is made on the section 367(b) notice that is 
filed by each of its shareholders listed in Sec. 1.367(b)-1(c)(3)(ii); 
and
    (iii) The electing taxpayer provides notice of the election to all 
corporations (or their successors in interest) whose earnings and 
profits are affected by the election on or before the date the section 
367(b) notice is filed.
    (b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3). 
In the case of a recapitalization described in Sec. 1.367(b)-4(b)(3) 
that occurred prior to July 20, 1998, the exchanging shareholder shall 
include the section 1248 amount on its tax return for the taxable year 
that includes the exchange described in Sec. 1.367(b)-4(b)(3)(i) (and 
not in the taxable year of the recapitalization), except that no 
inclusion is required if both the recapitalization and the exchange 
described in Sec. 1.367(b)-4(b)(3)(i) occurred prior to July 20, 1998.
    (c) Use of reasonable method to comply with prior published 
guidance--

[[Page 3609]]

(1) Prior exchanges. The taxpayer may use a reasonable method to comply 
with the following prior published guidance to the extent such guidance 
relates to section 367(b): Notice 88-71 (1988-2 C.B. 374); Notice 89-30 
(1989-1 C.B. 670); and Notice 89-79 (1989-2 C.B. 392) (see 
Sec. 601.601(d)(2) of this chapter). This rule applies to section 
367(b) exchanges that occur (or occurred) before February 23, 2000, or, 
if a taxpayer makes the election described in paragraph (a)(2) of this 
section, for section 367(b) exchanges that occur (or occurred) before 
the date described in paragraph (a)(2) of this section. This rule also 
applies to section 367(b) exchanges and distributions described in 
paragraph (d) of this section.
    (2) Future exchanges. Section 367(b) exchanges that occur on or 
after February 23, 2000, (or, if a taxpayer makes the election 
described in paragraph (a)(2) of this section, for section 367(b) 
exchanges that occur on or after the date described in paragraph (a)(2) 
of this section) are governed by the section 367(b) regulations and, as 
a result, paragraph (c)(1) of this section shall not apply.
    (d) Effect of removal of attribution rules. To the extent that the 
rules under Secs. 7.367(b)-9 and 7.367(b)-10(h) of this chapter, as in 
effect prior to February 23, 2000 (see 26 CFR part 1, revised as of 
April 1, 1999), attributed earnings and profits to the stock of a 
foreign corporation in connection with an exchange described in section 
351, 354, 355, or 356 before February 23, 2000, the foreign corporation 
shall continue to be subject to the rules of Sec. 7.367(b)-12 of this 
chapter in the event of any subsequent exchanges and distributions with 
respect to such stock, notwithstanding the fact that such subsequent 
exchange or distribution occurs on or after the effective date 
described in paragraph (a) of this section.


Secs. 1.367(b)-7 through 1.367(b)-9  [Removed]

    Par. 8. Sections 1.367(b)-7 through 1.367(b)-9 are removed.

    Par. 9. Section 1.381(b)-1, paragraph (a)(1), the second sentence 
is amended by removing the reference ``7.367(b)-1(e)'' and adding 
``1.367(b)-2(f)'' in its place.

PART 7--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX REFORM ACT 
OF 1976

    Par. 10. The authority citation for part 7 is amended by removing 
the entries for Secs. 7.367(b)-1, 7.367(b)-2, 7.367(b)-3, 7.367(b)-4, 
7.367(b)-5, 7.367(b)-6, 7.367(b)-7, 7.367(b)-8, 7.367(b)-9, 7.367(b)-
10, 7.367(b)-11, and 7.367(b)-13; and continues to read in part as 
follows:

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

    Par. 11. Sections 7.367(b)-1 through 7.367(b)-11 and 7.367(b)-13 
are removed as of February 23, 2000.

     Par. 12. Section 7.367(b)-12 is amended by revising paragraph (a) 
to read as follows:


Sec. 7.367(b)-12  Subsequent treatment of amounts attributed or 
included in income (temporary).

    (a) Application. This section applies to distributions with respect 
to, or a disposition of, stock--
    (1) To which, in connection with an exchange occurring before 
February 23, 2000, an amount has been attributed pursuant to 
Sec. 7.367(b)-9 or 7.367(b)-10 (as in effect prior to February 23, 
2000; see 26 CFR Part 1 revised as of April 1, 1999); or
    (2) In respect of which, before February 23, 2000, an amount has 
been included in income or added to earnings and profits pursuant to 
Sec. 7.367(b)-7 or 7.367(b)-10 (as in effect prior to February 23, 
2000); see 26 CFR Part 1 revised as of April 1, 1999).
* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 13. The authority citation for part 602 continues to read as 
follows:

    Authority:  26 U.S.C. 7805.

    Par. 12. In Sec. 602.101, paragraph (b) is amended in the table by 
adding an entry in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
 CFR part or section where identified and
                 described                     Current OMB control No.
------------------------------------------------------------------------
                  *        *        *        *        *
1.367(b)-1................................  1545-1271
                  *        *        *        *        *
------------------------------------------------------------------------


John M. Dalrymple,
Acting Deputy Commissioner of Internal Revenue.
    Approved: December 22, 1999.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 00-1377 Filed 1-21-00; 8:45 am]
BILLING CODE 4830-01-U