[Federal Register Volume 70, Number 100 (Wednesday, May 25, 2005)]
[Proposed Rules]
[Pages 30036-30040]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10267]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-127740-04]
RIN 1545-BD46


Application of Section 367 in Cross Border Section 304 
Transactions; Certain Transfers of Stock Involving Foreign Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed amendments to the regulations 
under section 367 relating to certain transfers of stock involving 
foreign corporations in transactions governed by section 304. 
Specifically, these proposed regulations provide that if, pursuant to 
section 304(a)(1), a U.S person is treated as transferring stock of a 
domestic or foreign corporation to a foreign corporation in exchange 
for stock of such foreign corporation in a transaction to which section 
351(a) applies, such deemed section 351 exchange is not a transfer to a 
foreign corporation subject to section 367(a). These proposed 
regulations also provide that if, pursuant to section 304(a)(1), a 
foreign acquiring corporation is treated as acquiring the stock of a 
foreign acquired corporation in a transaction to which section 351(a) 
applies, such deemed section 351 acquisition is not an acquisition 
subject to section 367(b).

DATES: Written or electronic comments and requests for a public hearing 
must be received by August 23, 2005.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-127740-04), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington,

[[Page 30037]]

DC 20044. Submissions may be hand delivered between the hours of 8 a.m. 
and 4 p.m. to: CC:PA:LPD:PR (REG-127740-04), Courier's Desk, Internal 
Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. 
Alternatively, taxpayers may submit electronic comments directly to the 
IRS internet site at http://www.irs.gov/regs or via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS and REG-127740-
04).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Tasheaya L. Warren Ellison, (202) 622-3870; concerning submissions of 
comments, Sonya Cruse, (202) 622-4693 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

A. Section 367(a)

    A U.S. person's transfer of appreciated property (including stock) 
to a foreign corporation in connection with any exchange described in 
sections 332, 351, 354, 356, or 361 generally is treated under section 
367(a)(1) as a taxable transaction, unless an exception applies. 
Congress enacted section 367(a) to prevent the avoidance of U.S. tax on 
transfers of appreciated property outside the United States in 
nonrecognition transfers involving foreign corporations. S.R. Rep. No. 
169, Vol. 1, 98th Cong. 2d Sess., at 360 (Apr. 2, 1984).
    In the case of a U.S. person's transfer of stock to a foreign 
corporation in an exchange described in section 367(a)(1), Sec.  
1.367(a)-3 provides exceptions to the general gain recognition rule of 
section 367(a)(1), if certain conditions are satisfied including, in 
some instances, the filing of a gain recognition agreement (GRA). See 
Sec.  1.367(a)-3(b) (transfer of stock in a foreign corporation) and 
(c) (transfer of stock in a domestic corporation).

B. Section 367(b)

    Section 367(b) addresses transactions covered by sections 332, 351, 
354, 355, 356, and 361 in which there is no transfer of property 
described in section 367(a). Section 367(b) provides that a foreign 
corporation shall be considered to be a corporation for purposes of 
these subchapter C provisions, except to the extent provided in 
regulations. The status of a foreign corporation as a corporation for 
these purposes may allow various participants to the transaction to 
qualify for nonrecognition treatment.
    One of the underlying policies of section 367(b) is the 
preservation of the potential application of section 1248. H. R. Rep. 
No. 94-658, 94th Cong., 1st Sess., at 242 (November 12, 1975). Section 
1248 generally recharacterizes gain recognized by a U.S. person (a 
section 1248 shareholder) that owns 10 percent or more of the total 
combined voting power of a controlled foreign corporation, as defined 
in section 957, or, in certain instances, stock of a former controlled 
foreign corporation, upon the disposition of the stock of such 
corporation as dividend income to the extent of the earnings and 
profits that are attributable to such stock (section 1248 amount).
    Consequently, Sec.  1.367(b)-4(b)(1) generally requires a section 
1248 shareholder (or, in certain instances, a foreign corporation that 
has a section 1248 shareholder) to include in income its section 1248 
amount as a result of certain section 367(b) transactions, including 
certain section 351 exchanges, if as a result of the transaction 
section 1248 shareholder status or controlled foreign corporation 
status is lost.

C. Section 304

    Section 304 was enacted to prevent withdrawals of corporate 
earnings by controlling shareholders in transactions that result in 
capital gains treatment. See H.R. Rep. No. 2014, 105th Cong. 1st Sess., 
at 465 (June 24, 1997). Section 304(a)(1) generally provides that, for 
purposes of sections 302 and 303, if one or more persons are in control 
of each of two corporations and in return for property one of the 
corporations (the acquiring corporation) acquires stock in the other 
corporation (the issuing corporation) from the person (or persons) so 
in control, then such property shall be treated as a distribution in 
redemption of the acquiring corporation stock.
    Prior to 1997, section 304(a)(1) provided that, to the extent of a 
distribution treated as a distribution to which section 301 applies, 
the issuing corporation stock would be treated as having been 
transferred by the person from whom acquired, and as having been 
received by the acquiring corporation as a contribution to the capital 
of the acquiring corporation. Section 304 was amended by section 1013 
of the Taxpayer Relief Act of 1997, Pub. L. 105-34 (111 Stat. 788, 918) 
(August 5, 1997) to provide that, to the extent that a stock 
acquisition covered by section 304(a)(1) is treated as a distribution 
to which section 301 applies, the transferor and the acquiring 
corporation are treated as if (1) the transferor transferred the stock 
of the issuing corporation to the acquiring corporation in exchange for 
stock of the acquiring corporation in a transaction to which section 
351(a) applies, and (2) the acquiring corporation then redeemed the 
stock it is treated as having issued. Because the acquiring corporation 
is treated as receiving the stock of the issuing corporation in a 
transaction to which section 351 applies, the transferor's basis in the 
stock of the issuing corporation carries over to the acquiring 
corporation under section 362.
    In the case of an acquisition to which section 304(a) applies, 
section 304(b)(2) generally provides that the determination of the 
amount that is a dividend (and the source thereof) is made as if the 
property were distributed first by the acquiring corporation to the 
extent of its earnings and profits, and then by the issuing corporation 
to the extent of its earnings and profits. In a transaction involving a 
foreign acquiring corporation, section 304(b)(5) may limit the amount 
of the earnings and profits of the foreign acquiring corporation that 
will be taken into account for purposes of section 304(b)(2)(A).

D. Application of Section 367 to Section 304(a)(1) Transactions

    The application of section 367(a) and (b) to certain section 
304(a)(1) transactions involving a foreign corporation has been 
addressed in various published guidance. See, e.g., Rev. Rul. 91-5 
(1991-1 C.B. 114) (holding that section 367 applied to the deemed 
contribution to capital of target corporation stock under prior law 
because section 367(c)(2) resulted in the stock transfer constituting a 
section 351 exchange). Moreover, in the preamble to the proposed 
regulations regarding redemptions taxable as dividends (REG-150313-01, 
67 FR 64331 October 18, 2002), the IRS and Treasury indicated that 
certain international provisions may apply to section 304(a)(1) 
transfers, and provided as an example the application of section 367 
and the regulations promulgated thereunder to a deemed section 351 
exchange involving foreign corporations. The IRS and Treasury also 
stated that further guidance on the application of the international 
provisions to section 304(a)(1) transactions would be forthcoming.
    The IRS and Treasury have determined that the policies underlying 
section 304 (prevention of withdrawals of corporate earnings through 
the use of transactions that result in capital gains treatment), 
section 367(a) (prevention of U.S. tax avoidance through transfers of 
appreciated property to foreign corporations), and section 367(b) 
(inter alia, preservation of the potential application of section 1248) 
are

[[Page 30038]]

preserved if section 367(a) and (b) are not applied to a deemed section 
351 exchange resulting from a section 304(a)(1) transaction. In 
addition, the IRS and Treasury believe that the interests of sound tax 
administration are served by not applying section 367(a) and (b) to a 
deemed section 351 exchange resulting from a section 304(a)(1) 
transaction. Consequently, these proposed regulations provide that 
section 367(a) and (b) will not apply to a deemed section 351 exchange 
resulting from a section 304(a)(1) transaction. These proposed 
regulations do not address section 351 transactions other than those 
exchanges treated as section 351 exchanges by reason of section 
304(a)(1).
1. Application of Section 367(a)
    In a section 304(a)(1) transaction in which a U.S. person transfers 
the stock of an issuing corporation to a foreign acquiring corporation, 
without the application of section 367(a), the U.S. person will 
nevertheless recognize an amount of income that is at least equal to 
the inherent gain in the stock of the issuing corporation that is being 
transferred to the foreign acquiring corporation. This income 
recognition results from the construct of the transaction as a 
distribution in redemption of the acquiring corporation shares. The 
income recognized may be in the form of dividend income, gain on the 
disposition of stock, or both. Section 301(c)(1), (3). Thus, the policy 
underlying section 367(a), which is to prevent the avoidance of U.S. 
tax on transfers of appreciated property to a foreign corporation in 
certain nonrecognition transactions, is maintained through the 
operation of subchapter C principles even if section 367(a) is not 
applied to a section 304(a)(1) transaction. Moreover, as discussed 
below, the application of section 367(a) to a section 304(a)(1) 
transaction may, in certain instances where the U.S. transferor files a 
GRA, result in a total income inclusion that is greater than the fair 
market value of the stock being transferred. The IRS and Treasury 
believe that this result is inconsistent with the policies of section 
367.
    For instance, in order to avoid recognizing gain on a section 351 
transfer of appreciated foreign stock to a foreign corporation under 
section 367(a)(1), a U.S. person may be required to enter into a GRA. 
See Sec.  1.367(a)-3(b)(1)(ii). As noted, when a U.S. person transfers 
stock of a wholly owned foreign corporation (the foreign issuing 
corporation) to a wholly owned foreign acquiring corporation in 
exchange for property, section 304(a)(1) treats the U.S. person as 
having received foreign acquiring corporation stock in a deemed section 
351 exchange, and then as having that stock immediately redeemed by the 
foreign acquiring corporation. If the U.S. person were to enter into a 
GRA, the application of section 367(a) to such a transaction will 
likely result in the GRA remaining in existence after the deemed 
redemption of the foreign acquiring corporation's stock. A U.S. person 
may, in fact, recognize income but, as a result of the GRA, not 
recognize any gain in the section 304(a)(1) transaction (e.g., the 
section 304(a)(1) transaction results in dividend income to the U.S. 
corporate transferor equal to the consideration paid by the foreign 
acquiring corporation). In such a case, because the U.S. person has not 
recognized the inherent gain in the transferee foreign corporation's 
stock deemed to be received in the section 304(a)(1) transaction, the 
GRA will not be terminated. See Sec.  1.367(a)-8(h)(1) (requiring a 
transaction in which all realized gain (if any) is recognized currently 
to terminate a GRA). As a result, the U.S. transferor would remain 
subject to the GRA provisions contained in Sec.  1.367(a)-8. If the GRA 
subsequently were triggered pursuant to Sec.  1.367(a)-8(e) (e.g., if 
the foreign issuing corporation disposes of substantially all of its 
assets to an unrelated party during the 5-year GRA period), the U.S. 
transferor may be subject to a total income inclusion that is greater 
than the fair market value of the stock being transferred.
    The application of section 367(a) to the transaction described 
above also results in administrative burdens for both the IRS and 
taxpayers. For instance, the conditions contained in Sec.  1.367(a)-
3(b) and (c) require a determination of the value and class of stock 
either received by the U.S. person in the transaction or owned by the 
U.S. person immediately after the transfer. See, e.g., Sec.  1.367(a)-
3(b)(1)(i) and (ii) and (c)(1)(i), (ii), and (iii). To the extent the 
transaction is described in section 304(a)(1), the foreign acquiring 
corporation does not actually issue any stock to the U.S. person. 
Therefore, in order to apply the above provisions, the IRS and 
taxpayers must make determinations based on the stock that is deemed to 
be issued by the foreign acquiring corporation.
    For the reasons stated above, the IRS and Treasury have decided to 
exercise their regulatory authority under section 367(a) such that 
section 367(a) will not apply to deemed section 351 exchanges resulting 
from section 304(a)(1) transactions.
2. Application of Section 367(b)
    As discussed above in the preamble under heading B, Sec.  1.367(b)-
4(b)(1) provides that, in the case of a section 351 exchange of stock 
of a foreign acquired corporation by a U.S. person that is a section 
1248 shareholder of such corporation (or a controlled foreign 
corporation that has a section 1248 shareholder) to a foreign acquiring 
corporation, the section 1248 shareholder (or a controlled foreign 
corporation that has a section 1248 shareholder) must include in income 
its section 1248 amount, unless the requisite section 1248 shareholder 
status or controlled foreign corporation status is maintained 
immediately after the exchange. However, in a section 304(a)(1) 
transaction in which section 1248 shareholder status and controlled 
foreign corporation status is maintained immediately after the deemed 
section 351 exchange, such that there is no section 1248 inclusion, the 
transferor may be treated as receiving a dividend from the foreign 
acquired corporation pursuant to section 304(b)(2)(B). Thus, in a 
section 304(a)(1) transaction, some or all of the earnings that make up 
the section 1248 amount that section 367(b) seeks to preserve may be 
immediately included in income by the exchanging shareholder.
    Additionally, application of Sec.  1.367(b)-4(b)(1) can, in some 
instances, create administrative burdens and be problematic. Section 
1.367(b)-4(b)(1) requires a determination of the type and amount of 
stock received in the deemed section 351 exchange to determine whether 
the necessary section 1248 shareholder status and controlled foreign 
corporation status is maintained. Moreover, the application of Sec.  
1.367(b)-4(b)(1) to a section 304(a)(1) transaction often can be 
problematic because the necessary section 1248 shareholder status and 
controlled foreign corporation status may be treated as satisfied in 
the construct of the deemed section 351 exchange even though such 
status is immediately lost as a result of the deemed redemption 
transaction. For instance, the necessary section 1248 shareholder 
status and controlled foreign corporation status may be satisfied 
immediately after the deemed section 351 exchange when a U.S. 
corporation transfers a controlled foreign corporation (the foreign 
issuing corporation) to a foreign acquiring corporation in a section 
304(a)(1) transaction, by taking into consideration the deemed issued 
stock by the foreign acquiring corporation. However, if both the U.S. 
corporate transferor and the

[[Page 30039]]

foreign acquiring corporation are wholly owned by the same foreign 
parent, the necessary section 1248 shareholder status and controlled 
foreign corporation status will not be satisfied immediately after the 
deemed redemption transaction.
    For the reasons listed above, the IRS and Treasury have decided to 
exercise their regulatory authority under section 367(b) such that 
section 367(b) will not apply to deemed section 351 exchanges resulting 
from section 304(a)(1) transactions.

E. Request for Comments

    Section 304(b)(6) grants the Secretary authority to prescribe 
regulations that are appropriate in order to eliminate multiple 
inclusions of any item of income by reason of section 304(a) and to 
provide appropriate basis adjustments (including modifications to the 
application of sections 959 and 961) in section 304(a) transactions in 
which the acquiring or issuing corporation is a foreign corporation. 
The IRS and Treasury are considering whether to issue regulations under 
section 304(b)(6) to adjust (1) the acquiring corporation's basis of 
the issuing corporation stock it acquires in the transaction, and (2) 
the transferor's basis of the issuing corporation stock in situations 
in which the transferor continues to own issuing corporation stock 
immediately after the transaction, to the extent that the transferor is 
treated under section 304(b)(2)(B) as receiving a distribution from the 
earnings and profits of the issuing corporation. Comments are requested 
regarding how such adjustments should be made, particularly if 
different classes of issuing corporation stock are acquired or retained 
in the section 304(a)(1) transaction. Comments also are requested as to 
how, and to what extent, these types of adjustments should be made 
outside the context of section 304(b)(6) (e.g., in a section 304(a)(1) 
transaction in which both the acquiring corporation and issuing 
corporation are domestic corporations).

Effective Dates

    The proposed regulations are proposed to apply to section 304(a)(1) 
transactions occurring on or after the date of publication of these 
regulations as final in the Federal Register.

Effect on Other Documents

    If these proposed regulations are adopted as final regulations, 
Rev. Rul. 91-5 (1991-1 C.B. 114) and Rev. Rul. 92-86 (1992-2 C.B. 199) 
will be modified to the extent inconsistent with such final 
regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
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 
these regulations do not impose a collection of information on small 
entities, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department request comments on the clarity of 
the proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by any person who 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place of the hearing will be published in 
the Federal Register.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

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

    Par. 2. Section 1.367(a)-3 is amended as follows:
    1. A sentence is added to paragraph (a) immediately following the 
second sentence.
    2. The new fourth sentence of paragraph (a) is amended by removing 
the language ``However'' and adding ``Additionally'' in its place.
    3. The first sentence of paragraph (e)(1) is removed and two 
sentences are added in its place.
    The additions read as follows:


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

    (a) In general. * * * However, if, pursuant to section 304(a)(1), a 
U.S. person is treated as transferring stock of a domestic or foreign 
corporation to a foreign corporation in exchange for stock of such 
foreign corporation in a transaction to which section 351(a) applies, 
such deemed section 351 exchange is not a transfer to a foreign 
corporation subject to section 367(a). * * *
* * * * *
    (e) Effective dates--(1) In general. The rules in paragraphs (a), 
(b) and (d) of this section generally apply to transfers occurring on 
or after July 20, 1998. However, the third sentence of paragraph (a) of 
this section shall apply to section 304(a)(1) transactions occurring on 
or after the date these regulations are published as final regulations 
in the Federal Register. * * *
* * * * *
    Par. 3. In Sec.  1.367(b)-4, a sentence is added to the end of 
paragraph (a) 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. * * * However, if pursuant to section 304(a)(1), a 
foreign acquiring corporation is treated as acquiring the stock of a 
foreign acquired corporation in a transaction to which section 351(a) 
applies, such deemed section 351 exchange is not an acquisition subject 
to section 367(b).
* * * * *
    Par. 4. Section 1.367(b)-6 is amended by revising paragraph (a)(1) 
to read as follows:


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, generally apply to section 367(b) 
exchanges that occur on or after February 23, 2000. However, the last 
sentence of paragraph (a) in Sec.  1.367(b)-4 shall apply to section 
304(a)(1) transactions occurring on or

[[Page 30040]]

after the date these regulations are published as final regulations in 
the Federal Register.
* * * * *

Cono R. Namorato,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 05-10267 Filed 5-20-05; 2:48 pm]
BILLING CODE 4830-01-P