[Federal Register Volume 71, Number 34 (Tuesday, February 21, 2006)]
[Rules and Regulations]
[Pages 8802-8805]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-1465]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9250]
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: Final regulations.

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SUMMARY: This document contains final regulations that address the 
interaction of section 304 and section 367. These regulations provide 
that section 367(a) and (b) do not apply to a deemed section 351 
exchange resulting from a section 304(a)(1) transaction. These 
regulations may apply to taxpayers transferring stock to related 
foreign corporations.

DATES: Effective Date: This regulation is effective February 21, 2006.
    Applicability Dates: For dates of applicability, see Sec.  
1.367(a)-3(e)(1)(G) and Sec.  1.367(b)-6(a)(1).

FOR FURTHER INFORMATION CONTACT: Tasheaya L. Warren Ellison, (202) 622-
3870 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Background

    On May 25, 2005, the IRS and Treasury published in the Federal 
Register a notice of proposed rulemaking (REG-127740-04; 2005-24 I.R.B. 
1254; [70 FR 30036]) under section 367(a) and (b) of the Internal 
Revenue Code (proposed regulations) pursuant to the regulatory 
authority under section 367. The proposed regulations would 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). The proposed regulations would further provide that if, 
pursuant to section

[[Page 8803]]

304(a)(1), a foreign corporation is treated as acquiring the stock of 
another foreign corporation in a transaction to which section 351(a) 
applies, such deemed section 351 exchange is not an acquisition subject 
to section 367(b).
    A public hearing was not held with respect to the proposed 
regulations because no requests to speak were received. However, 
several written comments were received.
    After consideration of the comments, the proposed regulations are 
adopted, as revised by this Treasury decision. The comments received 
and the revisions are discussed below.

Explanation of Provisions and Summary of Comments

A. Nonapplication of Section 367(a) and (b) to Deemed Section 351 
Exchanges

    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. To the extent the distribution 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. Under section 
301(c)(1), the distribution is first treated as a dividend to the 
extent of certain earnings and profits of the acquiring corporation and 
the issuing corporation. See sections 316 and 304(b). Then under 
section 301(c)(2) and (3), the remaining portion of the distribution is 
applied against and reduces the adjusted basis of the stock, and 
finally is treated as gain from the sale or exchange of property.
    Section 367(a)(1) provides that if, in connection with certain 
nonrecognition transactions, including section 351, a United States 
person transfers property to a foreign corporation, such foreign 
corporation shall not, for purposes of determining the extent to which 
gain shall be recognized on such transfer, be considered to be a 
corporation. In addition, certain section 351 exchanges can cause the 
exchanging shareholder to include in income a deemed dividend under 
section 367(b). Sec.  1.367(b)-4.
    Under current law, certain section 304(a)(1) transactions can also 
be subject to section 367. The result of this overlapping application 
is considerable complexity, uncertainty, and the risk of multiple 
income inclusions. In such a transaction, a U.S. person could recognize 
income (dividend or capital gain) equal to the built-in gain in the 
stock of the issuing corporation under section 367, and income 
(dividend or capital gain) pursuant to section 304. The total income 
recognized could exceed the fair market value of the transferred stock 
of the issuing corporation.
    The proposed regulations would exclude from the application of 
sections 367(a) and (b) a deemed section 351 exchange that arises by 
reason of a transaction described in section 304(a)(1). The IRS and the 
Treasury believe that the interests of the government are protected, 
and the policies underlying section 367(a) and (b) are preserved, in a 
section 304(a)(1) transaction without regard to the application of 
section 367. The IRS and Treasury believe that, in most or all cases, 
the income recognized in a section 304 transaction will equal or exceed 
the transferor's inherent gain in the stock of the issuing corporation 
transferred to the foreign acquiring corporation. Elimination of the 
application of section 367(a) and (b) in this context will also serve 
the interests of sound tax administration by creating greater certainty 
and simplicity in these transactions, and by avoiding the over-
inclusion of income that could result when section 367 and section 304 
both apply to such transactions. As a result, this Treasury decision 
finalizes the proposed regulations and makes section 367(a) and (b) 
inapplicable to deemed section 351 exchanges pursuant to section 
304(a)(1) transactions.
    Commentators did note that in certain cases, depending on how the 
basis and distribution rules are applied, the amount of income 
recognized under section 304(a) may not equal or exceed the 
transferor's inherent gain in the stock of the issuing corporation. In 
the example cited, P, a domestic corporation, owns all the stock of F1 
and F2, both of which are foreign corporations. P has an adjusted basis 
of $0 in its F1 stock and $100x in its F2 stock. P's stock of F1 and F2 
each has a fair market value of $100x. Neither F1 nor F2 has current or 
accumulated earnings and profits. P sells its F1 stock to F2 for its 
fair market value of $100x in a transaction subject to section 
304(a)(1). Under section 304(a)(1), the transaction is treated as if P 
had transferred its F1 stock to F2 in exchange for F2 stock in a 
transaction to which section 351(a) applies, and then F2 had redeemed 
such deemed issued stock.
    These commentators posit that P in the above example may not 
recognize income or gain because the adjusted basis of both the F2 
stock that is treated as being issued in the deemed section 351 
exchange, and the adjusted basis of the F2 stock already held by P 
prior to the transaction, is available for reduction under section 
301(c)(2). On these particular facts (i.e., no earnings and profits in 
either the acquiring corporation or the issuing corporation), this 
basis position would mean that income or gain is not recognized as a 
result of the transaction. The IRS and the Treasury believe, however, 
that current law does not provide for the recovery of the basis of any 
shares other than the basis of the F2 stock deemed to be received by P 
in the section 351(a) exchange (which would take a basis equal to P's 
basis in the F1 stock). Thus, in the case described, P would recognize 
$100x of gain under section 301(c)(3) (the built-in gain on the F1 
stock), and P would continue to have a $100x basis in its F2 stock that 
it holds after the transaction. This issue will be addressed as part of 
a larger project regarding the recovery of basis in all redemptions 
treated as section 301 distributions. This larger project will be the 
subject of future guidance. Comments are requested about the 
appropriate treatment of basis in such redemptions.

B. Adjustments Under Section 304(b)(6)

    Section 304(b)(6) provides that in the case of any acquisition to 
which section 304(a) applies, where the acquiring or issuing 
corporation is a foreign corporation, the Secretary shall prescribe 
regulations, as appropriate, in order to eliminate a multiple inclusion 
of any item in income and to provide appropriate basis adjustments 
(including modifications to the application of sections 959 and 961). 
The preamble to the proposed regulations requested comments on basis 
adjustments under section 304(b)(6). The preamble also requested 
comments regarding similar adjustments that could be made outside the 
context of section 304(b)(6).
    Several comments were received in response to this request, and 
will be considered in a separate guidance project. The IRS and Treasury 
request additional comments on section 304(b)(6), particularly comments 
that would take into account the effect of section 362(e), enacted on 
October 22, 2004, by the American Jobs Creation Act of 2004 (Pub. L. 
108-357).

[[Page 8804]]

    Comments also were received regarding the application of section 
959 to previously taxed amounts in connection with section 304(a)(1) 
transactions. These comments are being considered in a separate 
guidance project under section 959, and therefore are not addressed in 
these final regulations.

C. Transfer of Issuing Stock in Return for Property and Stock of 
Acquiring

    The proposed regulations would apply to exclude a section 351 
exchange from the application of section 367(a) only to the extent the 
exchange is treated as such by reason of section 304(a)(1). Thus, 
section 367(a) would continue to apply to applicable transfers of 
property subject to section 351 by reason other than the operation of 
section 304(a)(1).
    One commentator notes that the proposed regulations would not 
address the treatment of stock sales for an amount less than the fair 
market value of the transferred stock where the acquiring corporation 
would be deemed to issue stock to the transferor other than as a result 
of the application of section 304(a)(1). See, for example, section 
367(c)(2). The commentator states that in such a case the transfer 
would be, in part, a section 304(a)(1) transaction and, in part, a 
section 351(a) exchange (other than by reason of section 304(a)(1)). 
The commentator requests guidance on such transactions, including, for 
example, whether such a transaction would be bifurcated and, if so, how 
the basis in the transferred stock would be allocated between the two 
parts of the transaction. The same bifurcation and related issues occur 
in section 304(a)(1) transactions where the acquiring corporation 
actually issues its own stock in partial consideration for the stock of 
the issuing corporation.
    As was the case with the proposed regulations, these final 
regulations only apply to the extent of deemed section 351 exchanges 
resulting from section 304(a)(1) transactions. In addition, these 
regulations could apply to certain transactions that are, in part, 
still subject to the stock transfer rules of section 367(a) (e.g., a 
section 304(a)(1) transaction in which both acquiring stock and 
property are used as consideration). The issues raised by this 
commentator are relevant to a wide range of transactions, and are not 
limited to section 304 transactions that are subject to these 
regulations. As a result, the IRS and Treasury believe that the 
resolution of these issues is beyond the scope of this project, and 
this comment is not addressed in these final regulations.

D. Effective Dates

    The proposed regulations stated that the rules would apply to 
section 304(a)(1) transactions occurring on or after the date of 
publication of the regulations in the Federal Register. Several 
commentators requested that the final regulations be made retroactive 
at the election of the taxpayer.
    These final regulations adopt the general effective date contained 
in the proposed regulations and therefore apply to section 304(a)(1) 
transactions occurring on or after February 21, 2006. In response to 
the comments received, however, the final regulations provide that 
taxpayers may rely on the final regulations for all (but not less than 
all) section 304(a)(1) transactions that occurred in all their open tax 
years; in such cases, any gain recognition agreements filed pursuant to 
Sec.  1.367(a)-8 with respect to such transactions shall terminate and 
have no further effect.

Effect on Other Documents

    Rev. Rul. 91-5 (1991-1 C.B. 114) and Rev. Rul. 92-86 (1992-2 C.B. 
199) are modified to the extent inconsistent with these regulations.

Special Analyses

    The IRS and the Treasury have determined that the adoption of these 
regulations 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, 
the notice of proposed rulemaking was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

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 participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

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


0
Par. 2. Section 1.367(a)-3 is amended as follows:

0
1. A sentence is added to paragraph (a) immediately following the 
second sentence.

0
2. The new fourth sentence of paragraph (a) is amended by removing the 
language ``However'' and adding ``In addition'' in its place.

0
3. Adding new paragraph (e)(1)(G).
    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) * * * (1) * * *
    (G) Except as otherwise provided in this paragraph (e)(1)(G), the 
third sentence of paragraph (a) of this section shall apply to section 
304(a)(1) transactions occurring on or after February 21, 2006. 
However, taxpayers may rely on the third sentence of paragraph (a) of 
this section for all section 304(a)(1) transactions occurring in open 
tax years; in such cases any gain recognition agreements filed pursuant 
to Sec.  1.367(a)-8 with respect to such transactions shall terminate 
and have no further effect.
* * * * *

0
Par. 3. In Sec.  1.367(b)-4, a sentence is added to paragraph (a) 
immediately following the first sentence 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)

[[Page 8805]]

applies, such deemed section 351 exchange is not an acquisition subject 
to section 367(b). * * *
* * * * *

0
Par. 4. In Sec.  1.367(b)-6, paragraph (a)(1) is amended by adding a 
sentence to the end to read as follows:


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

    (a) Effective date--(1) In general. * * * The second sentence of 
paragraph (a) in Sec.  1.367(b)-4 shall apply to section 304(a)(1) 
transactions occurring on or after February 21, 2006; however, 
taxpayers may rely on this sentence for all section 304(a)(1) 
transactions occurring in open tax years.
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.

    Approved: February 8, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 06-1465 Filed 2-17-06; 8:45 am]
BILLING CODE 4830-01-P