[Federal Register Volume 71, Number 106 (Friday, June 2, 2006)]
[Proposed Rules]
[Pages 31985-31996]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-8551]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-135866-02]
RIN 1545-BA93


Section 1248 Attribution Principles

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under section 1248 
of the Internal Revenue Code (Code) that provide guidance for 
determining the earnings and profits attributable to stock of 
controlled foreign corporations (or former controlled foreign 
corporations) that are (were) involved in certain nonrecognition 
transactions. The proposed regulations are necessary in order to 
supplement and clarify existing guidance in the regulations under 
section 1248. The proposed regulations affect persons subject to the 
regulations under section 1248, as well as persons to which regulations 
under other Code provisions, such as section 367(b), apply to the 
extent that those regulations incorporate the principles of the 
proposed regulations. In addition, the proposed regulations provide 
that with respect to the sale by a foreign partnership of the stock of 
a corporation, the partners in such foreign partnership shall be 
treated as selling or exchanging their proportionate share of the stock 
of such corporation for purposes of section 1248.

DATES: Written or electronic comments and requests for a public hearing 
must be received by August 31, 2006.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-135866-02), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
135866-02), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington DC or sent electronically, via the IRS Internet 
site at www.irs.gov/regs or via the Federal eRulemaking Portal at 
http://www.regulations.gov (IRS-REG-135866-02).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Michael Gilman at (202) 622-3850 (not a toll-free number); concerning 
the submissions of comments and request for hearing, Richard Hurst at 
[email protected] (preferred) or at (202) 622-7180 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Section 1248(a) of the Code provides that certain gain recognized 
on the sale or exchange of stock of a foreign corporation by a United 
States person will be included in the gross income of that person as a 
dividend if: (1) The foreign corporation was a controlled foreign 
corporation at any time during the five-year period ending on the date 
of the sale or exchange; and (2) the United States person owned or is 
considered to have owned, within the meaning of section 958, 10 percent 
or more of the total combined voting power of the foreign corporation 
at any time during that five-year period (section 1248 shareholder). 
The amount of gain included in income as a dividend under section 
1248(a) is limited to the earnings and profits attributable to the 
stock that is sold or exchanged which were accumulated in taxable years 
of the foreign corporation beginning after December 31, 1962, and 
during the period or periods the stock was held by the United States 
person while the foreign corporation was a controlled foreign 
corporation. A distribution treated as an exchange of stock is also 
included. See Sec.  1.1248-1(b). In addition, section 1248 may also 
apply to certain distributions of the stock of a foreign corporation as 
provided under section 1248(f).
    The section 1248 regulations provide for both a simple case method 
and a complex case method for computing a controlled foreign 
corporation's earnings and profits attributable to stock disposed of in 
a transaction to which section 1248 applies. See Sec. Sec.  1.1248-2 
and 1.1248-3. A taxpayer may use the simple case method under Sec.  
1.1248-2, which requires few adjustments in the earnings and profits 
calculation under section 1248, if it meets several criteria (e.g., the 
foreign corporation has only one class of stock and a constant number 
of shares outstanding on each day of each post-1962 taxable year which 
falls within the relevant holding period). If these criteria are not 
satisfied, a taxpayer must use the complex case method under Sec.  
1.1248-3. The complex case method provides additional rules to address 
situations involving multiple classes of stock, changes in a 
shareholder's ratable share of a corporation's earnings and profits, 
and other complicating factors.
    Under Sec.  1.1248-1(a), the period of ownership of stock of a 
United States person for purposes of attributing earnings and profits 
to that stock includes the period that the United States person 
actually held the stock or is considered to have held such stock 
pursuant to section 1223. Section 1223(1) provides that the period for 
which the taxpayer has held property received in an exchange, shall 
include the period for which the taxpayer held the property exchanged 
if the property received in the exchange has the same basis in whole or 
in part in the taxpayer's hands as the property exchanged. Section 
1223(2) provides that the period for which the taxpayer is considered 
to have held property acquired shall include the period for which that 
property was held by any other person if the property acquired has the 
same basis in whole or in part in the taxpayer's hands as it would have 
in the hands of that other person.
    Section 1248(c)(2) generally provides that, if the United States 
person selling, exchanging, or distributing stock in a foreign 
corporation has the required ownership interest in lower-tier foreign 
corporations, certain earnings and profits of those lower-tier foreign 
corporations will be attributed to stock of the foreign corporation 
that the U.S. person sells, exchanges, or distributes. For this 
provision to apply, the United States person must have owned or be 
considered to have owned, within the meaning of section 958, 10 percent 
or more of the total combined voting power of the lower-tier foreign 
corporation at any time during the five-year period preceding the sale.
    Although section 1248(a) applies only to sales or exchanges of 
stock in a foreign corporation by a United States person, section 
964(e) applies section 1248 principles to certain dispositions of stock 
in a foreign corporation by a controlled foreign corporation. Section 
964(e)(1) provides that if a controlled foreign corporation that owns 
stock in a foreign corporation sells or exchanges such stock, gain 
recognized on such sale or exchange shall be included in the gross 
income of such controlled foreign corporation as a dividend to the same 
extent that it would have been included under section 1248(a) if the 
controlled foreign corporation were a United States person.

[[Page 31986]]

    Section 367(b) addresses certain exchanges described in sections 
351, 354, 355, 356, and 361 that do not involve a transfer of property 
described in section 367(a). One of the underlying policies of section 
367(b) is the preservation of the potential application of section 
1248. See H.R. Rep. No. 94-658, 94th Cong., 1st Sess., at 242 (November 
12, 1975). Regulations under section 367(b) require certain exchanging 
shareholders to include in income as a deemed dividend the section 1248 
amount attributable to stock of a foreign corporation as a result of an 
acquisition by a foreign corporation of the stock or assets of a 
foreign corporation in an exchange described in section 351 or a 
reorganization described in section 368(a)(1). For example, an 
exchanging shareholder must include the section 1248 amount 
attributable to the stock exchanged in income if the exchange results 
in its loss of status as a section 1248 shareholder. See Sec.  
1.367(b)-4(b)(1). For this purpose, the section 1248 amount generally 
is determined by reference to the amount that would be included in 
income as a dividend under section 1248 and the regulations under that 
section if the stock were sold by the exchanging shareholder. See Sec.  
1.367(b)-2(c).

Explanation of Provisions

A. Scope

    The Treasury Department and the IRS believe that it is important 
that the section 1248 regulations make explicit that only the 
appropriate amount of earnings and profits are attributed to stock of a 
foreign corporation for purposes of section 1248 following relevant 
nonrecognition transactions. The proposed regulations provided in Sec.  
1.1248-8 supplement and clarify the existing rules under Sec. Sec.  
1.1248-2 and 1.1248-3. The results obtained under the proposed 
regulations are consistent with the results provided under section 1248 
and the existing regulations under sections 367(b) and 1248. However, 
some taxpayers have raised concerns that those existing regulations may 
attribute an excessive amount of earnings and profits to stock after 
certain nonrecognition transactions. The Treasury Department and the 
IRS believe that this view is not a correct interpretation of the 
existing regulations. Nevertheless, in order to remove this 
uncertainty, the proposed regulations clarify how the principles of 
section 1248 should be applied so that a section 1248 shareholder or a 
foreign corporation to which section 964(e) applies includes the 
appropriate amount in income as a dividend upon the sale or exchange of 
stock of a current or former controlled foreign corporation.
    The proposed regulations provide rules for accurately attributing 
earnings and profits to stock of a foreign corporation that is received 
by an exchanging shareholder, or received by an acquiring corporation, 
pursuant to one or more restructuring transactions in which the holding 
period of such stock is determined by application of section 1223(1) or 
1223(2), and in which the exchanging shareholder is not required, as a 
result of the exchange, to include in income the section 1248 amount 
pursuant to Sec.  1.367(b)-4(b). The proposed regulations also provide 
rules for attributing earnings and profits to stock of a foreign 
corporation that participates in a restructuring transaction that is 
held by a non-exchanging shareholder in such a restructuring 
transaction.
    For purposes of the proposed regulations, a restructuring 
transaction is a transaction that qualifies as a nonrecognition 
transaction (within the meaning of section 7701(a)(45)) under section 
351, 354, 356, or 361. The proposed regulations provide special rules 
for liquidations described in section 332 and consequently, these 
transactions are not included in the definition of a restructuring 
transaction. An exchanging shareholder is defined in the proposed 
regulations as a person that, in a restructuring transaction qualifying 
for nonrecognition under section 354, 356, or 361(a), exchanges stock 
of an acquired corporation for stock in either a foreign acquiring 
corporation or a foreign corporation that is in control of the 
acquiring corporation. In a restructuring transaction qualifying for 
nonrecognition under section 351, the proposed regulations define an 
exchanging shareholder as a person that exchanges property (including 
stock) for stock in a foreign acquiring corporation. An acquiring 
corporation is defined in the proposed regulations as a corporation 
that, in a restructuring transaction, acquires the stock or assets of 
an acquired corporation. For purposes of the proposed regulations, a 
foreign corporate shareholder is a foreign corporation that owns stock 
of another foreign corporation, and has a section 1248 shareholder that 
is also a section 1248 shareholder of the other foreign corporation. A 
non-exchanging shareholder is defined in the proposed regulations as a 
person that, at the time of the restructuring transaction, is either a 
section 1248 shareholder or a foreign corporate shareholder of the 
acquiring corporation and that is not an exchanging shareholder with 
respect to that corporation.
    The proposed regulations also set forth rules for the attribution 
of earnings and profits for purposes of section 1248 with respect to 
stock of a foreign corporation that receives assets and liabilities of 
a foreign corporation in a complete liquidation described in section 
332 if the foreign distributee is a foreign corporate shareholder of 
the liquidating corporation. In addition, the proposed regulations 
provide that with respect to the sale by a foreign partnership of the 
stock of certain foreign corporations, the partners in such foreign 
partnership shall be treated as selling or exchanging their 
proportionate share of the stock of such corporations for purposes of 
section 1248. Finally, the proposed regulations provide additional 
rules to ensure the proper attribution of earnings and profits to stock 
of controlled foreign corporations or foreign corporate shareholders as 
a result of certain nonrecognition transactions.

B. Attribution of Earnings and Profits to Stock in a Foreign 
Corporation as a Result of a Restructuring Transaction

1. Earnings and Profits Attributable to the Stock That an Exchanging 
Shareholder Receives
    Some taxpayers have expressed concern that an excessive amount of 
earnings and profits could be attributed to stock that an exchanging 
shareholder receives in a restructuring transaction under the existing 
section 1248 regulations through the application of the holding period 
rules of section 1223(1). For example, in a transaction described in 
section 351, a domestic corporation (DC1) contributes property to a 
foreign acquiring corporation (FA) in exchange for 80 percent of the 
voting stock in FA. Prior to the transaction, FA was wholly owned by 
another domestic corporation (DC2). Assume in the transaction that DC1 
does not recognize gain under section 367(a) and the regulations under 
that section or include income under section 367(b) and the regulations 
under that section. The basis of the stock in FA received by DC1 in the 
transaction will be determined pursuant to section 358, and in 
determining DC1's holding period in the FA stock, DC1 will include, 
under section 1223(1), the period DC1 held the property it contributed 
to FA. Some taxpayers incorrectly interpret the existing section 1248 
regulations to require that, if DC1 subsequently sells or exchanges the 
FA stock received in the restructuring transaction, the earnings and 
profits accumulated by FA before

[[Page 31987]]

the transaction (i.e., before DC1's period of actual ownership of the 
FA stock), but within the section 1223(1) holding period, are 
attributed to the FA stock received and sold by DC1. This 
interpretation would result in the inappropriate attribution of such 
accumulated earnings and profits to the FA stock held by both DC2 and 
DC1 (if DC2 sells or exchanges its FA stock, the accumulated earnings 
and profits of FA that were attributed to the FA stock sold by DC1 
would correctly be attributed under the existing section 1248 
regulations to the FA stock held by DC2).
    This interpretation of the existing section 1248 regulations is not 
correct and any such double attribution is not intended. However, to 
provide greater certainty, the proposed regulations clarify that 
excessive attribution of earnings and profits does not occur as a 
result of restructuring transactions. The proposed regulations provide 
that where an exchanging shareholder receives, in a restructuring 
transaction, stock in a foreign corporation, the holding period of 
which is determined under section 1223(1), and the exchanging 
shareholder is either a section 1248 shareholder or a foreign corporate 
shareholder with respect to that foreign corporation immediately after 
the restructuring transaction, the earnings and profits attributable to 
the stock the exchanging shareholder receives shall be determined on 
the basis of the type of property exchanged.
    If the property exchanged is not stock of a foreign acquired 
corporation with respect to which the exchanging shareholder is a 
section 1248 shareholder or a foreign corporate shareholder immediately 
before the transaction, the earnings and profits attributable to the 
foreign corporation stock received by the exchanging shareholder shall 
be determined in accordance with Sec.  1.1248-2 or Sec.  1.1248-3 
(whichever is applicable) without regard to any portion of the section 
1223(1) holding period in that stock that reflects periods prior to the 
restructuring transaction.
    If, on the other hand, the property exchanged is stock in a foreign 
acquired corporation with respect to which the exchanging shareholder 
is either a section 1248 shareholder or a foreign corporate shareholder 
with respect to the foreign corporation immediately before the 
transaction, the proposed regulations provide that the earnings and 
profits attributable to the stock received by the exchanging 
shareholder shall equal the sum of the earnings and profits 
attributable to: (1) The stock of the foreign acquired corporation 
accumulated prior to the restructuring transaction; and (2) the stock 
of the foreign corporation that the exchanging shareholder receives in 
the restructuring transaction without regard to any portion of the 
section 1223(1) holding period in that stock that is prior to the 
restructuring transaction. The earnings and profits attributable to any 
portion of the section 1223(1) holding period in the foreign acquiring 
stock that is prior to the restructuring transaction remain 
attributable through the operation of the existing section 1248 
regulations to the foreign acquiring stock held by non-exchanging 
shareholders. See proposed Sec.  1.1248-8(b)(4) and (7), Example 2.
    The proposed regulations provide an exception to this general rule, 
however, in certain triangular reorganizations involving a foreign 
issuing corporation that controls a domestic acquiring corporation. 
This exception applies, for example, where a United States person (DC) 
exchanges its stock in a foreign acquired corporation (FS) for stock of 
a foreign issuing corporation (FI) that controls the domestic acquiring 
corporation (DA) in a restructuring transaction (i.e., a triangular 
reorganization described in section 368(a)(1)(B)). To prevent the 
attribution of FS's pre-acquisition earnings and profits to stock owned 
by both DC and DA, the proposed regulations provide that the earnings 
and profits attributable to the FI stock received by DC shall consist 
solely of the earnings and profits attributable to the FI stock 
received (determined under Sec.  1.1248-2 or Sec.  1.1248-3, whichever 
is applicable, and proposed Sec.  1.1248-8, if applicable) without 
regard to any portion of DC's section 1223(1) holding period in the FI 
stock received that includes periods of time prior to the restructuring 
transaction. See proposed Sec.  1.1248-8(b)(7), Example 5. As discussed 
in paragraph (B)(2) of this preamble, the earnings and profits 
attributable to the FS stock for periods before the triangular 
reorganization generally are attributed to the FS stock owned by DA 
after the transaction.
2. Earnings and Profits Attributable to Stock in a Foreign Corporation 
That Certain Acquiring Corporations Receive
    In addition to potential excessive attribution resulting from 
section 1223(1) holding periods discussed above, some taxpayers are 
concerned that an excessive amount of earnings and profits could be 
attributed to stock under the existing section 1248 regulations through 
the application of the section 1223(2) holding period rules to an 
acquiring corporation in a restructuring transaction. For example, in a 
transaction described in section 351, a foreign corporation (FP) that 
owns 100 percent of the stock of another foreign corporation (FS) and 
100 percent of the stock of a domestic corporation (DC), transfers its 
FS stock to DC. Prior to the transaction, FP was not a section 1248 
shareholder or a foreign corporate shareholder with respect to FS. DC's 
basis in the FS stock received by DC in the restructuring transaction 
will be determined pursuant to section 362, and in determining DC's 
holding period in the FS stock, DC will include, under section 1223(2), 
the period FP held the FS stock. Some taxpayers incorrectly interpret 
the existing section 1248 regulations to require that if DC 
subsequently sells or exchanges the FS stock received in the 
restructuring transaction, the earnings and profits accumulated by FS 
before the transaction (i.e., before DC's period of actual ownership of 
the FS stock), but within the 1223(2) holding period, are attributed to 
the FS stock received and sold by DC. This interpretation would result 
in the attribution of earnings and profits to the FS stock held by DC 
even though such earnings and profits were accumulated by FS when it 
was not a controlled foreign corporation.
    Such interpretation of the existing section 1248 regulations is not 
correct. However, to provide greater certainty, the proposed 
regulations clarify that excessive attribution of earnings and profits 
does not occur as a result of such transactions. The proposed 
regulations provide that where, in a restructuring transaction, an 
acquiring corporation receives stock in a foreign acquired corporation, 
the holding period of which is determined under section 1223(2), and 
the acquiring corporation is either a section 1248 shareholder or a 
foreign corporate shareholder with respect to that foreign acquired 
corporation immediately after the restructuring transaction, the 
earnings and profits attributable to the foreign acquired corporation 
stock that the acquiring corporation receives shall be determined 
depending on whether the exchanging shareholder was a section 1248 
shareholder or a foreign corporate shareholder with respect to the 
acquired corporation. If the exchanging shareholder is neither a 
section 1248 shareholder nor a foreign corporate shareholder with 
respect to the foreign acquired corporation immediately before the 
restructuring transaction, the proposed regulations provide that the 
earnings and profits attributable to the stock of the foreign acquired 
corporation shall be determined in accordance with Sec.  1.1248-2 or 
Sec.  1.1248-3 (whichever is

[[Page 31988]]

applicable) without regard to any portion of the section 1223(2) 
holding period in that stock that is prior to the restructuring 
transaction.
    However, in a restructuring transaction where the acquiring 
corporation receives stock of a foreign acquired corporation with 
respect to which an exchanging shareholder is either a section 1248 
shareholder or a foreign corporate shareholder immediately before the 
transaction, the proposed regulations modify the approach discussed 
above in order to ensure the proper amount of earnings and profits is 
attributable to stock that the acquiring corporation receives. For 
example, assume a domestic corporation (DC1) has owned all the stock of 
a foreign corporation (FS) since its formation. In a transaction 
described in section 368(a)(1)(B), DC1 transfers all its FS stock to 
another domestic corporation (DC2), in exchange for DC2 voting stock. 
The section 1248 amount attributable to the FS stock is $100 but 
section 367(b) does not require DC1 to include it in income as a deemed 
dividend. See Sec.  1.367(b)-4(a) (income inclusion rules only apply 
when there is a foreign acquiring corporation). If DC2 subsequently 
recognizes gain upon the sale or exchange of its stock in FS and if the 
earnings and profits attributable to that stock do not include the 
earnings and profits that accumulated before DC2's actual period of 
ownership, then those earnings and profits would escape inclusion in 
income as a dividend under section 1248.
    To ensure the proper attribution of earnings and profits in these 
situations, the proposed regulations provide that where the stock 
exchanged in the restructuring transaction is stock of a foreign 
corporation, with respect to which the exchanging shareholder is either 
a section 1248 shareholder or a foreign corporate shareholder 
immediately before the restructuring transaction, the earnings and 
profits attributable to the stock of the acquired corporation will be 
determined with regard to the portion of the section 1223(2) holding 
period in that stock that the exchanging shareholder took into account 
for purposes of attributing earnings and profits to that stock. See 
proposed Sec.  1.1248-8(b)(7), Example 3 and Example 5.
3. Earnings and Profits Attributable to Stock Held by a Non-Exchanging 
Shareholder
    The proposed regulations generally provide that the earnings and 
profits attributable to stock of an acquiring corporation held by a 
non-exchanging shareholder immediately prior to a restructuring 
transaction continue to be attributed to such stock, and the earnings 
and profits of the acquired corporation accumulated prior to the 
restructuring transaction attributable to the stock of an acquired 
corporation are not attributed to the non-exchanging shareholder's 
stock in the acquiring corporation. See proposed Sec.  1.1248-8(b)(7), 
Example 2 and Example 4.
    However, a special rule applies to a nonexchanging shareholder that 
owns stock in a foreign corporation that is both an acquiring 
corporation and an exchanging shareholder in the same restructuring 
transaction (i.e., an upstream merger). This rule is necessary because 
the acquiring corporation does not receive stock in exchange for its 
stock in the acquired corporation and, as a result, the general 
attribution rules in the proposed regulations would not preserve the 
earnings and profits attributable to such acquired corporation stock. 
For example, assume a domestic corporation (DC) owns all the stock of a 
controlled foreign corporation (CFC1), CFC1's only asset is 79 percent 
of the stock of another controlled foreign corporation (CFC2), and the 
other 21 percent of the CFC2 stock is owned by an unrelated party (X). 
Pursuant to a restructuring transaction described in section 
368(a)(1)(C), CFC2 transfers all its assets to CFC1. In exchange, CFC1 
assumes the liabilities of CFC2 and transfers to CFC2 voting stock 
representing 21 percent of the stock of CFC1. CFC2 distributes the 
voting stock to X and liquidates. In such a transaction, the earnings 
and profits attributable to the CFC1 stock held by DC (i.e., the 
nonexchanging shareholder) shall be the sum of the earnings and profits 
attributable to the stock of CFC1 (i.e., the foreign acquiring 
corporation) immediately before the restructuring transaction 
(including amounts attributed under section 1248(c)(2)) and the 
earnings and profits attributable to the stock of CFC1 accumulated 
after the restructuring transaction (including amounts attributed under 
section 1248(c)(2)). See proposed Sec.  1.1248-8(b)(7), Example 8. Cf. 
proposed Sec.  1.1248-8(c) (providing similar rules for liquidations 
described in section 332).
4. Reduction in Earnings and Profits Attributable to Stock to Prevent 
Multiple Inclusions with Respect to the Same Earnings and Profits
    The proposed regulations require that, to the extent consistent 
with the principles of section 1248, adjustments to earnings and 
profits attributable to stock shall be made so that section 1223(1) and 
(2) and the proposed regulations are applied in a manner that results 
in earnings and profits being taken into account only once. 
Accordingly, the proposed regulations provide that upon the sale by a 
controlled foreign corporation of stock of another foreign corporation 
to which earnings and profits had been attributed under the rules of 
the proposed regulations, proportionate reductions shall be made to the 
earnings and profits attributed to the stock of the selling foreign 
corporate shareholder owned by a section 1248 shareholder. See proposed 
Sec.  1.1248-8(b)(7), Example 7. For example, assume a section 1248 
shareholder owns 80 percent of a controlled foreign corporation (CFC1) 
and an unrelated foreign person owns the remaining 20 percent of CFC1. 
The section 1248 shareholder receives the CFC1 stock in exchange for 
the stock of its wholly owned foreign subsidiary (CFC2) in a 
restructuring transaction described in section 368(a)(1)(B). 
Immediately before the transaction, $100 of earnings and profits is 
attributable to the CFC2 stock owned by the section 1248 shareholder. 
As previously discussed, the proposed regulations provide for the 
attribution of the $100 of CFC2's pre-acquisition earnings and profits 
to the CFC1 stock received by the section 1248 shareholder in the 
transaction and to the CFC2 stock received by CFC1 in the transaction. 
Assume that CFC2 accumulates another $100 of earnings and profits after 
the transaction, and in a subsequent year, CFC1 sells 30 percent of its 
stock in CFC2. If the requirements of section 964(e) are met, CFC1 will 
include in its gross income as a dividend $30 of CFC2's pre-acquisition 
earnings and profits and $30 of CFC2's post-acquisition earnings and 
profits. In order to prevent the attribution of a portion of these 
earnings and profits to the section 1248 shareholder's stock in CFC1, 
the proposed regulations provide that the earnings and profits 
attributable to the section 1248 shareholder's stock in CFC1 will be 
reduced by $54, $24 (80 percent of $30) of the earnings and profits 
accumulated by CFC2 after the restructuring transaction and $30 of the 
earnings and profits accumulated by CFC2 prior to the restructuring 
transaction.
5. Special Rule Regarding Section 381
    The proposed regulations also provide a special rule in order to 
avoid possible double counting of earnings and profits as a result of 
the operation of section 381(a) in a restructuring transaction and the 
proposed rules. Under section 381, an acquiring corporation succeeds to 
and takes into account the earnings and

[[Page 31989]]

profits of the transferor or distributor corporation as of the close of 
the day of the transfer or distribution. Because the earnings and 
profits carry over from one corporation to another corporation at the 
close of the day, the same earnings and profits accumulated by the 
transferor or distributor corporation before the transaction could also 
be considered to have been accumulated by the transferee or distributee 
corporation after the transfer or distribution. For example, assume a 
domestic corporation (DC1) owns 100 percent of controlled foreign 
corporation (CFC1) that generates $100 of earnings and profits. CFC1 
merges into another controlled foreign corporation (CFC2) in a 
reorganization described in section 368(a)(1)(A), and DC1 receives 25 
percent of the CFC2 stock in exchange for its CFC1 stock in the merger. 
If, for purposes of section 1248, the $100 of earnings and profits of 
CFC1 is attributable to the CFC2 stock received by DC1, and is also 
taken into account by CFC2 pursuant to section 381, the same $100 of 
earnings and profits would be taken into account twice.
    Except with respect to upstream mergers, the proposed regulations 
attribute the pre-acquisition earnings and profits of the transferor, 
where appropriate, to the stock received by the exchanging shareholder. 
Therefore, in order to prevent the double counting of earnings and 
profits, the proposed regulations provide that earnings and profits of 
another corporation to which the foreign corporation succeeded through 
the operation of section 381 will not be attributed to its stock. See 
proposed Sec.  1.1248-8(b)(6) and (7), Example 4, and (c)(2) and (3).
6. Attribution of Earnings and Profits Following Certain Liquidations
    Under the existing section 1248 regulations, issues have arisen as 
to whether the so-called hovering deficit rule under section 
381(c)(2)(B) applies for purposes of attributing earnings and profits 
to stock of the foreign distributee corporation following certain 
liquidations of foreign corporations under section 332. The hovering 
deficit rule generally restricts access to certain deficits in earnings 
and profits following section 381 transactions. The Treasury Department 
and the IRS believe that the hovering deficit rule should not apply in 
these types of section 332 liquidations because section 1248(c)(2) 
generally provides for the attribution of a foreign subsidiary's 
earnings and profits (including any deficits) to the stock of its 
foreign parent. Thus, the foreign parent already had, in effect, access 
to the deficit of the foreign subsidiary pursuant to section 1248(c)(2) 
prior to the section 332 liquidation. In that case, application of the 
hovering deficit rule is not appropriate for section 1248 purposes.
    Accordingly, the proposed regulations provide a special rule that 
clarifies application of the hovering deficit rule to a distributee 
foreign corporate shareholder in a section 332 liquidation. In this 
circumstance, the earnings and profits of the distributing foreign 
corporation to which the foreign distributee corporation succeeds 
through the operation of section 381 will not be taken into account by 
the foreign distributee for purposes of section 1248 and consequently, 
the hovering deficit rule will not apply. Instead, the proposed 
regulations provide a rule for attributing earnings and profits of the 
foreign liquidating corporation to the stock of the foreign distributee 
in such a liquidation that is consistent with the principles of section 
1248(c)(2). In such a case, the earnings and profits attributable to 
the distributee stock shall be the sum of: (1) the earnings and profits 
attributable to the stock of the distributee immediately before the 
liquidation (including amounts attributed under section 1248(c)(2)); 
and (2) the earnings and profits attributable to the stock of the 
distributee accumulated after the liquidation (including amounts 
attributed under section 1248(c)(2)). See proposed Sec.  1.1248-
8(b)(7), Example 3, and (c).

C. Sale or Exchange of Stock by a Foreign Partnership

    A domestic partnership is treated as a United States person for 
purposes of section 1248. See section 7701(a)(30)(B) and Sec.  1.1248-
1(a)(1). Accordingly, the sale by a domestic partnership of the stock 
of a foreign corporation is subject to section 1248(a). Section 1248 
and the existing regulations do not, however, address specifically 
sales or exchanges of stock by foreign partnerships with United States 
persons as partners.
    The legislative history of subchapter K of the Code provides that, 
for purposes of interpreting Code provisions outside of that 
subchapter, a partnership may be treated as either an entity separate 
from its partners or an aggregate of its partners, depending on which 
characterization is more appropriate to carry out the purpose of the 
particular Code section under consideration. H.R. Conf. Rep. No. 2543, 
83rd Cong. 2d. Sess. 59 (1954). The purpose of section 1248 is to 
ensure that earnings and profits of controlled foreign corporations (or 
former controlled foreign corporations) are taxed as a dividend when 
certain United States persons recognize gain on the sale or exchange of 
stock in such corporations. In cases in which the United States person 
is a partner in a foreign partnership and recognizes income on the sale 
of stock of a foreign corporation by such foreign partnership, the 
purpose of section 1248 is fulfilled only if the partnership is treated 
as an aggregate for section 1248 purposes. Treatment of a foreign 
partnership as an entity, in contrast, could result in partners in the 
partnership inappropriately receiving capital gain treatment on the 
sale by the partnership of stock of the foreign corporation.
    Thus, under proposed Sec.  1.1248-1(a)(4), a foreign partnership is 
treated as an aggregate of its partners for purposes of section 
1248(a). Under the proposed regulations, for example, the partners in a 
foreign partnership shall be treated as selling or exchanging their 
proportionate share of stock held by the foreign partnership. The 
proposed regulations also apply section 1248(a) in cases where the 
stock in a corporation that is sold or exchanged is held through tiers 
of foreign partnerships. This treatment of the foreign partnership as 
an aggregate, rather than as an entity, for purposes of applying 
section 1248 is necessary to reflect properly the attributable earnings 
and profits as a dividend.

D. Removal of Rule under Sec.  1.367(b)-2(d)(3)(ii) Limiting Amounts 
Attributable to Holding Periods Determined under Section 1223

    Section 1.367(b)-3 requires that an exchanging shareholder, as 
defined in Sec.  1.367(b)-3(b)(1), include all the earnings and profits 
amount (as defined generally in Sec.  1.367(b)-2(d)) in income as a 
deemed dividend (with respect to its stock in the foreign acquired 
corporation) when a domestic corporation acquires the assets of the 
foreign corporation in a section 332 liquidation or a section 368(a)(1) 
asset acquisition. Section 1.367(b)-2(d)(3)(ii) excludes, for purposes 
of determining the all earnings and profits amount, amounts 
attributable to holding periods determined under section 1223(2) during 
which there was no direct or indirect ownership by a United States 
person. Pursuant to Sec.  1.367(b)-2(d)(3)(i)(A)(1), the all earnings 
and profits amount with respect to stock of a foreign corporation is 
determined according to the attribution principles of section 1248 and 
the regulations under that section. Since the rules of proposed Sec.  
1.1248-8(b)(2) conform to the rule set forth in Sec.  1.367(b)-
2(d)(3)(ii), the

[[Page 31990]]

proposed regulations remove paragraph (d)(3)(ii) from Sec.  1.367(b)-2.

E. Revision of Sec.  1.367(b)-4(d) Providing Rules for Subsequent 
Exchanges

    Section 1.367(b)-4 applies to an acquisition by a foreign 
corporation of the stock or assets of a foreign corporation in an 
exchange described in section 351 or a reorganization described in 
section 368(a)(1). If the exchange meets certain criteria, an 
exchanging shareholder, as defined in Sec.  1.367(b)-4(b)(1)(i)(A), 
must include in income as a deemed dividend the section 1248 amount 
attributable to the stock that it exchanges. If in a particular 
exchange, income is not required to be included pursuant to Sec.  
1.367(b)-4(b), Sec.  1.367(b)-4(d) provides rules governing the 
attribution of earnings and profits to the stock received by the 
exchanging shareholder in the non-inclusion exchange for purposes of 
applying section 367(b) or section 1248 to subsequent sales or 
exchanges of that stock.
    Because proposed Sec.  1.1248-8 provides rules for the attribution 
of earnings and profits to stock with respect to the Sec.  1.367(b)-
4(b) non-inclusion exchanges, the proposed regulations remove the 
substantive rules and examples in Sec.  1.367(b)-4(d) from the final 
regulations. In their place, taxpayers are referred to proposed Sec.  
1.1248-8.

F. Request for Comments

1. Attribution to Stock Shareholder Receives by Gift
    The proposed regulations do not apply to determine the earnings and 
profits attributable to stock in a foreign corporation that a United 
States person receives as a gift. The Treasury Department and the IRS 
seek comments as to whether additional guidance is needed to address 
the attribution of earnings and profits with respect to stock of a 
foreign corporation that a United States person receives by gift.
2. Attribution of Earnings and Profits to Stock Shareholder Receives 
Under Section 355
    The proposed regulations do not apply to determine the earnings and 
profits attributable to stock in a foreign corporation that a United 
States person receives in a distribution to which section 355 applies. 
The Treasury Department and the IRS seek comments as to whether 
additional guidance is needed to address the attribution of earnings 
and profits with respect to stock of a foreign corporation that a 
United States person receives in such distributions.
3. Effect on Sec. Sec.  1.1248-4 and 1.1248-5
    The proposed regulations do not address the interaction of proposed 
Sec.  1.1248-8 with Sec. Sec.  1.1248-4 and 1.1248-5. The Treasury 
Department and the IRS seek comments as to whether additional guidance 
on how the proposed regulations should affect those sections of the 
existing 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 5 U.S.C. chapter 5 does not 
apply to these regulations, and, because the regulations do not impose 
a collection of information on small entities, the Regulatory 
Flexibility Act, 5 U.S.C. chapter 6, does not apply. Pursuant to 
section 7805(f) of the Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small businesses.

Comments and Requests for a Public Hearing

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

Drafting Information

    The principal authors of the proposed regulations are Michael I. 
Gilman of the Office of Associate Chief Counsel (International) and 
Mark R. Pollard, formerly of the Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS 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 is amended by adding 
entries in numerical order to read in part as follows:

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

    Sections 1.367(b)-2(c)(1) and (2) and (d)(3), and 1.367(b)-4(d) 
also issued under 26 U.S.C. 367(b)(1) and (2). * * *
    Sections 1.1248-1(a)(1), (4), and (5), and 1.1248-8 also issued 
under 26 U.S.C. 1248(a) and (c)(1) and (2). * * *


Sec.  1.367(b)-2  [Amended]

    Par. 2. Section 1.367(b)-2 is amended by:
    1. Amending the last sentence of paragraph (c)(1)(ii) by removing 
the language ``, as modified by Sec.  1.367(b)-4(d) (as applicable)'' 
and adding the language ``. See Sec.  1.1248-8.'' in its place.
    2. Removing Example 4 in paragraph (c)(2).
    3. Amending the last sentence of paragraph (d)(3)(i)(B)(2) by 
removing the language ``, as modified by paragraph (d)(3)(ii) of this 
section and Sec.  1.367(b)-4(d) (as applicable)'' and adding the 
language ``. See Sec.  1.1248-8.'' in its place.
    4. Removing paragraph (d)(3)(ii).
    5. Redesignating paragraph (d)(3)(iii) as paragraph (d)(3)(ii).
    Par. 3. Section 1.367(b)-4(d) 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.

* * * * *
    (d) Rules for subsequent sales or exchanges. If an exchanging 
shareholder (as defined in Sec.  1.1248-8(b)(1)(iv)) is not required to 
include in income as a deemed dividend the section 1248 amount 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 section 1248 to subsequent sales 
or exchanges, and subject to the limitation of Sec.  1.367(b)-
2(d)(3)(ii) (in the case of a transaction described in Sec.  1.367(b)-
3), the determination of the earnings and profits attributable to the 
stock an exchanging shareholder receives in the non-inclusion exchange 
shall be determined pursuant to the rules of section 1248 and the 
regulations under that section.
    Par. 4. Section 1.1248-1 is amended by:

[[Page 31991]]

    1. Amending the first sentence of paragraph (a)(1) by removing the 
language ``(or was considered as held by reason of the application of 
section 1223)'' and adding the language ``(or was considered as held by 
reason of the application of section 1223, taking into account Sec.  
1.1248-8)'' in its place.
    2. Adding a new third sentence in paragraph (a)(1).
    3. Redesignating paragraph (a)(4) as paragraph (a)(5).
    4. Adding new paragraph (a)(4).
    5. Adding Example 4 in newly designated paragraph (a)(5).
    The additions read as follows:


Sec.  1.1248-1  Treatment of gain from certain sales or exchanges of 
stock in certain foreign corporations.

    (a) In general. (1) * * * See Sec.  1.1248-8 for additional rules 
regarding the attribution of earnings and profits to the stock of a 
foreign corporation following certain nonrecognition transactions. * * 
*
* * * * *
    (4) For purposes of paragraph (a)(1) of this section, stock of a 
corporation that is owned by a foreign partnership shall be considered 
as owned proportionately by its partners. Consequently, if a foreign 
partnership sells or exchanges stock of a corporation, the partners in 
such foreign partnership shall be treated as selling or exchanging 
their proportionate share of the stock of such corporation. Stock 
considered to be owned by a partner by reason of the application of the 
first sentence of this paragraph (a)(4) shall, for purposes of applying 
such sentence, be treated as actually owned by such partner.
    (5) * * *

    Example 4. (i) Facts. X, a domestic corporation, and Y, a 
foreign corporation that is not a controlled foreign corporation, 
are partners in foreign partnership Z. X has a 60% interest in Z, 
and Y has a 40% interest in Z. All parties are calendar year 
taxpayers. On January 1, year 1, Z forms foreign corporation H, a 
controlled foreign corporation that conducts a business in Country 
C. On December 31, year 2, Z sells all of the H stock for $600 when 
Z's adjusted basis in the stock is $100. Therefore, Z recognizes a 
gain of $500 on the sale, of which $300 is allocable to X as a 60% 
partner. At the time of the sale, H had $300 of earnings and 
profits, $180 of which (i.e., 60% of $300) is attributable to X's 
60% share of the H stock.
    (ii) Analysis. Pursuant to section 1248(a) and paragraphs (a)(1) 
and (4) of this section, X and Y are treated as selling 60% and 40%, 
respectively, of the H stock. X includes in its gross income as a 
dividend $180 of the gain recognized on the sale. Because Y is a 
foreign corporation that is not a CFC, neither section 1248 nor 
section 964 applies to the sale of Y's 40% share of the H stock.
    (iii) Alternative facts. If, instead, X owned its 60% interest 
in Z through another foreign partnership, the result would be the 
same.
* * * * *


Sec. Sec.  1.1248-2, 1.1248-3, 1.1248-7  [Amended]

    Par. 5. In Sec. Sec.  1.1248-2, 1.1248-3, and 1.1248-7, for each 
entry in the ``Section'' column, remove the language in the ``Remove'' 
column and add the language in the ``Add'' column in its place.

------------------------------------------------------------------------
           Section                   Remove                  Add
------------------------------------------------------------------------
Sec.   1.1248-2(a)(1).......  (or was considered    (or was considered
                               to be held by         to be held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(a)(2)(ii)...  (or is considered to  (or is considered to
                               have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(a)(3).......  (or is considered to  (or is considered to
                               have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(c)(4).......  (or is considered to  (or is considered to
                               have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(e)(1),        (or is considered to  (or is considered to
 introductory text.            have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(e)(2).......  (or is considered as  (or is considered as
                               held by reason of     held by reason of
                               the application of    the application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-2(e)(3)(i)....  (or is considered to  (or is considered to
                               have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(a)(1).......  (or was considered    (or was considered
                               to be held by         to be held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(c)(1)(ii)...  (or was considered    (or was considered
                               to have held by       to have held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(e)(2)(i)....  (during the period    (during the period
                               such share, or        such share, or
                               block, was            block, was
                               considered to be      considered to be
                               held by such person   held by such person
                               by reason of the      by reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(e)(3).......  (during the period    (during the period
                               such share, or        such share, or
                               block, was            block, was
                               considered to be      considered to be
                               held by such person   held by such person
                               by reason of the      by reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(e)(5).......  (or another person    (or another person
                               who actually owned    who actually owned
                               the stock during      the stock during
                               such taxable year     such taxable year
                               and whose holding     and whose holding
                               of the stock is       of the stock is
                               attributed by         attributed by
                               reason of the         reason of the
                               application of        application of
                               section 1223 to the   section 1223,
                               person who sold or    taking into account
                               exchanged the         Sec.   1.1248-8, to
                               stock).               the person who sold
                                                     or exchanged the
                                                     stock).

[[Page 31992]]

 
Sec.   1.1248-3(e)(6), in     by reason of the      by reason of the
 both locations.               application of        application of
                               section 1223 to       section 1223 to
                               such person.          such person, taking
                                                     into account Sec.
                                                     1.1248-8.
Sec.   1.1248-3(f)(2)(ii)...  (or was considered    (or was considered
                               to have held by       to have held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(f)(5)(ii)...  (during the period    (during the period
                               such stock was        such stock was
                               considered to be      considered to be
                               held by such person   held by such person
                               by reason of the      by reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-3(f)(5)(iv)...  (during the period    (during the period
                               such share (or        such share (or
                               block) was            block) was
                               considered to be      considered to be
                               held by such person   held by such person
                               by reason of the      by reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-7(b)(3)(i)....  (or was considered    (or was considered
                               to have held by       to have held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-7(b)(3)(iii)..  (or is considered to  (or is considered to
                               have held by reason   have held by reason
                               of the application    of the application
                               of section 1223).     of section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
Sec.   1.1248-7(b)(4).......  (or was considered    (or was considered
                               to have held by       to have held by
                               reason of the         reason of the
                               application of        application of
                               section 1223).        section 1223,
                                                     taking into account
                                                     Sec.   1.1248-8).
------------------------------------------------------------------------

    Par. 6. Section 1.1248-8 is added to read as follows:


Sec.  1.1248-8  Earnings and profits attributable to stock following 
certain non-recognition transactions.

    (a) Scope. This section sets forth rules for the attribution of 
earnings and profits for purposes of section 1248 and Sec.  1.1248-
1(a)(1) and to supplement the rules in Sec. Sec.  1.1248-2 and 1.1248-3 
with respect to--
    (1) Stock that an exchanging shareholder receives, or an acquiring 
corporation receives, in restructuring transactions. Except as 
otherwise provided in this paragraph (a), stock of a foreign 
corporation that an exchanging shareholder receives, or an acquiring 
corporation receives, pursuant to a restructuring transaction (as 
defined in paragraph (b)(1)(vii) of this section) in which the holding 
period of such stock is determined by application of section 1223(1) or 
1223(2), whichever is appropriate. This section shall not apply to an 
exchange otherwise described in this paragraph (a)(1) if, as a result 
of the exchange, the exchanging shareholder is required to include in 
income as a deemed dividend the section 1248 amount pursuant to Sec.  
1.367(b)-4(b). See paragraphs (b)(2) and (3) of this section;
    (2) Nonexchanging shareholders. Stock of a foreign corporation that 
participates in a restructuring transaction that is held by a non-
exchanging shareholder (as defined in paragraph (b)(1)(vi) of this 
section) in the restructuring transaction. See paragraph (b)(4) of this 
section;
    (3) Application of section 381. Stock of a foreign corporation that 
receives assets in a transfer to which section 361(a) applies in 
connection with a reorganization described in section 368(a)(1)(A), 
(C), (D), (F), or (G), or in a distribution to which section 332 
applies, and to which section 381(c)(2)(A) and Sec.  1.381(c)(2)-1(a) 
apply. See paragraph (b)(6) of this section; or
    (4) Section 332 liquidations. Stock of a foreign corporation that 
receives the assets and liabilities of a foreign corporation in a 
complete liquidation described in section 332 if the foreign 
distributee is a foreign corporate shareholder (as defined in paragraph 
(b)(1)(v) of this section) of the liquidating corporation. See 
paragraph (c) of this section.
    (b) Earnings and profits attributable to stock following a 
restructuring transaction--(1) Definitions. The following definitions 
apply for purposes of this section--
    (i) Acquired corporation is a corporation whose stock or assets are 
acquired in exchange for stock in (or stock in and other property of) 
either the acquiring corporation or a foreign corporation that 
controls, within the meaning of section 368(c), the acquiring 
corporation in a restructuring transaction.
    (ii) Acquiring corporation is a corporation that acquires the stock 
or assets of an acquired corporation in a restructuring transaction.
    (iii) Controlled foreign corporation is a corporation described in 
section 957.
    (iv) Exchanging shareholder is a person that exchanges--
    (A) In a restructuring transaction qualifying as a nonrecognition 
transaction within the meaning of section 7701(a)(45) and described in 
section 354, 356, or 361(a), stock in an acquired corporation for stock 
in either a foreign acquiring corporation or a foreign corporation that 
is in control, within the meaning of section 368(c), of an acquiring 
corporation (whether domestic or foreign); or
    (B) In a restructuring transaction qualifying as a nonrecognition 
transaction within the meaning of section 7701(a)(45) and described in 
section 351, property (including stock) for stock in a foreign 
acquiring corporation.
    (v) Foreign corporate shareholder is a foreign corporation that--
    (A) Owns stock of another foreign corporation; and
    (B) Has a section 1248 shareholder that is also a section 1248 
shareholder of the other foreign corporation.
    (vi) Non-exchanging shareholder is, at the time the acquiring 
corporation participates in a restructuring transaction, either a 
section 1248 shareholder or a foreign corporate shareholder of the 
acquiring corporation that is not an exchanging shareholder with 
respect to that corporation.
    (vii) Restructuring transaction is a transaction qualifying as a 
nonrecognition transaction within the meaning of section 7701(a)(45) 
and described in section 351, 354, 356, or 361.
    (viii) Section 1248 shareholder is any United States person that 
satisfies the ownership requirements of section 1248(a)(2) and Sec.  
1.1248-1(a)(2) with respect to a foreign corporation.
    (2) Earnings and profits attributable to stock that an exchanging 
shareholder receives in a restructuring transaction. Where, in a 
restructuring transaction, an

[[Page 31993]]

exchanging shareholder receives stock in a foreign corporation, the 
holding period of which is determined under section 1223(1), and the 
exchanging shareholder is either a section 1248 shareholder or a 
foreign corporate shareholder with respect to that foreign corporation 
immediately after the restructuring transaction, the earnings and 
profits attributable to the stock the exchanging shareholder receives 
shall be determined pursuant to the rules in paragraphs (b)(2)(i), (ii) 
and (iii) of this section.
    (i) Exchanging shareholder exchanges property that is not stock of 
a foreign acquired corporation with respect to which the exchanging 
shareholder is a section 1248 shareholder or a foreign corporate 
shareholder. Where the exchanging shareholder exchanges in a 
restructuring transaction property that is not stock of a foreign 
acquired corporation with respect to which the exchanging shareholder 
is a section 1248 shareholder or a foreign corporate shareholder 
immediately before such transaction, the earnings and profits 
attributable to the stock that the exchanging shareholder receives in 
the restructuring transaction shall be determined in accordance with 
Sec.  1.1248-2 or Sec.  1.1248-3, whichever is applicable, without 
regard to any portion of the section 1223(1) holding period in that 
stock that is prior to the restructuring transaction. See paragraph 
(b)(7), Example 1 of this section.
    (ii) Exchanging shareholder exchanges stock of a foreign 
corporation with respect to which the exchanging shareholder is either 
a section 1248 shareholder or a foreign corporate shareholder. Except 
as provided in paragraph (b)(2)(iii) of this section, where the 
exchanging shareholder exchanges in a restructuring transaction stock 
of a foreign acquired corporation with respect to which the exchanging 
shareholder is either a section 1248 shareholder or a foreign corporate 
shareholder immediately before such restructuring transaction, the 
earnings and profits attributable to the stock that the exchanging 
shareholder receives in the restructuring transaction shall be the sum 
of the earnings and profits attributable to--
    (A) The stock of the foreign acquired corporation exchanged 
(determined in accordance with Sec.  1.1248-2 or Sec.  1.1248-3, 
whichever is applicable, and this section, if applicable) that was 
accumulated before the restructuring transaction; and
    (B) The stock of the foreign corporation that the exchanging 
shareholder receives in the restructuring transaction (determined in 
accordance with Sec.  1.1248-2 or Sec.  1.1248-3, whichever is 
applicable, and this section, if applicable), without regard to any 
portion of the section 1223(1) holding period in that stock that is 
prior to the restructuring transaction. See paragraph (b)(7), Example 
2, Example 4, and Example 6 of this section.
    (iii) Exchanging shareholder receives stock in a foreign 
corporation that controls a domestic acquiring corporation. Where the 
acquiring corporation is a domestic corporation and the exchanging 
shareholder receives in a restructuring transaction stock in a foreign 
corporation that controls (within the meaning of section 368(c)) the 
domestic acquiring corporation, the earnings and profits attributable 
to the stock that the exchanging shareholder receives in the 
restructuring transaction shall consist solely of the amount of 
earnings and profits attributable to such stock (determined in 
accordance with Sec.  1.1248-2 or Sec.  1.1248-3, whichever is 
applicable, and this section, if applicable) without regard to any 
portion of the section 1223(1) holding period in that stock that is 
prior to the restructuring transaction. See paragraph (b)(7), Example 5 
of this section.
    (3) Earnings and profits attributable to stock in a foreign 
corporation certain acquiring corporations receive in a restructuring 
transaction. Where an acquiring corporation receives, in a 
restructuring transaction, stock in a foreign acquired corporation, the 
holding period of which is determined under section 1223(2), and the 
acquiring corporation is either a section 1248 shareholder or a foreign 
corporate shareholder with respect to that foreign acquired corporation 
immediately after the restructuring transaction, the earnings and 
profits attributable to the foreign acquired corporation stock that the 
acquiring corporation receives shall be determined pursuant to the 
rules in paragraphs (b)(3)(i) and (ii) of this section.
    (i) Stock of a foreign corporation with respect to which the 
exchanging shareholder is neither a section 1248 shareholder nor a 
foreign corporate shareholder. The earnings and profits attributable to 
the stock of the foreign acquired corporation that the acquiring 
corporation receives in a restructuring transaction where the 
exchanging shareholder is neither a section 1248 shareholder nor a 
foreign corporate shareholder with respect to that foreign acquired 
corporation immediately before the restructuring transaction shall be 
determined in accordance with Sec.  1.1248-2 or Sec.  1.1248-3, 
whichever is applicable, without regard to any portion of the section 
1223(2) holding period in that stock that is prior to the restructuring 
transaction.
    (ii) Stock of a foreign corporation with respect to which the 
exchanging shareholder is either a section 1248 shareholder or a 
foreign corporate shareholder. The earnings and profits attributable to 
the stock of a foreign acquired corporation that the acquiring 
corporation receives in the restructuring transaction where the 
exchanging shareholder is either a section 1248 shareholder or a 
foreign corporate shareholder with respect to that foreign corporation 
immediately before the restructuring transaction shall be determined in 
accordance with Sec.  1.1248-2 or Sec.  1.1248-3, whichever is 
applicable, with regard to the portion of the section 1223(2) holding 
period of the stock that the exchanging shareholder took into account 
for purposes of attributing earnings and profits to that stock 
(determined in accordance with this section). See paragraph (b)(7), 
Example 3, Example 5, and Example 7 of this section.
    (4) Earnings and profits attributable to stock held by a non-
exchanging shareholder in a foreign acquiring corporation. (i) Except 
to the extent paragraph (b)(4)(ii) of this section applies, see Sec.  
1.1248-2 or Sec.  1.1248-3 (whichever is applicable) and, as 
applicable, paragraph (b)(6) of this section for the determination of 
the earnings and profits attributable to the stock held by a non-
exchanging shareholder in a foreign acquiring corporation. See also 
paragraph (b)(7), Example 2 and Example 4 of this section.
    (ii) Where a non-exchanging shareholder holds stock in a foreign 
corporation that is also an exchanging shareholder and a foreign 
acquiring corporation in the same restructuring transaction--
    (A) The earnings and profits attributable to such stock shall be 
the sum of the earnings and profits attributable to the stock of such 
foreign corporation immediately before the restructuring transaction 
(including amounts attributed under section 1248(c)(2)) and the 
earnings and profits attributable to the stock of the foreign acquiring 
corporation accumulated after the restructuring transaction (including 
amounts attributed under section 1248(c)(2)); and
    (B) Paragraph (b)(6) of this section applies. See paragraph (b)(7), 
Example 8 of this section.
    (iii) Where the acquiring corporation is a foreign corporate 
shareholder with respect to stock of a foreign acquired corporation, 
paragraph (b)(3) of this section shall not apply for purposes of

[[Page 31994]]

determining the earnings and profits attributable to stock in the 
foreign acquiring corporation owned by a non-exchanging shareholder 
thereof (see section 1248(c)(2)). See paragraph (b)(7), Example 6 of 
this section.
    (5) Reduction in earnings and profits attributable to stock to 
prevent multiple inclusions with respect to the same earnings and 
profits. To the extent consistent with the principles of section 1248, 
adjustments to earnings and profits attributable to stock shall be made 
such that section 1223(1) and (2) and this section are applied in a 
manner that results in earnings and profits being taken into account 
only once. Thus, for example, when a controlled foreign corporation 
sells or exchanges all or part of the stock of another foreign 
corporation to which earnings and profits are attributable pursuant to 
this paragraph (b) or paragraph (c) of this section, proportionate 
reductions shall be made to the earnings and profits attributed to the 
stock of the selling foreign corporate shareholder owned by a section 
1248 shareholder. See paragraph (b)(7), Example 7 of this section.
    (6) Special rule regarding section 381. Solely for purposes of 
determining the earnings and profits (or deficit in earnings and 
profits) attributable to stock pursuant to this paragraph (b), the 
earnings and profits of a corporation shall not include earnings and 
profits that are treated as received or incurred under section 
381(c)(2)(A) and Sec.  1.381(c)(2)-1(a). See paragraph (b)(7), Example 
4 of this section.
    (7) Examples. The application of this paragraph (b) is illustrated 
by the following examples. Unless otherwise indicated, in the following 
examples assume that--
    (i) There is no immediate gain recognition pursuant to section 
367(a)(1) and the regulations under that section (either through 
operation of the rules or because the appropriate parties have entered 
into a gain recognition agreement under Sec. Sec.  1.367(a)-3(b) and 
1.367(a)-(8);
    (ii) There is no income inclusion required pursuant to section 
367(b) and the regulations under that section, and all reporting 
requirements in those regulations are complied with;
    (iii) References to earnings and profits are to earnings and 
profits that would be includible in income as a dividend under section 
1248 and the regulations under that section if stock to which the 
earnings and profits are attributable were sold or exchanged by its 
shareholder;
    (iv) Each corporation has only a single class of stock outstanding 
and uses the calendar year as its taxable year; and
    (v) Each transaction is unrelated to all other transactions.

    Example 1. A section 351 exchange of property other than stock 
in a foreign corporation with respect to which the exchanging 
shareholder is either a section 1248 shareholder or a foreign 
corporate shareholder. (i) Facts. DC1, a domestic corporation, has 
owned all the stock of CFC, a foreign corporation, since CFC's 
formation on January 1, year 3. On December 31, year 5, DC2, a 
domestic corporation unrelated to DC1, contributes property it has 
held since January 1, year 1, to CFC in exchange for voting stock of 
CFC in a restructuring transaction that is an exchange under section 
351. The property that DC2 contributes is not stock in a foreign 
corporation with respect to which DC2 was either a section 1248 
shareholder or a foreign corporate shareholder. DC2 receives 80% of 
the voting stock of CFC in the restructuring transaction and its 
holding period in that CFC stock, determined pursuant to section 
1223(1), began on January 1, year 1. CFC has $100 of accumulated 
earnings and profits on December 31, year 5. On December 31, year 7, 
when the accumulated earnings and profits of CFC are $200, DC2, a 
section 1248 shareholder with respect to CFC, sells its CFC stock.
    (ii) Analysis. Under paragraph (b)(2)(i) of this section, the 
earnings and profits attributable to the CFC stock sold by DC2 are 
$80. This amount consists of none of the $100 of earnings and 
profits accumulated by CFC before the restructuring transaction, and 
80% of the $100 of earnings and profits of CFC accumulated after the 
restructuring transaction.
    Example 2. A section 351 exchange of controlled foreign 
corporation stock by a United States person for stock in a 
controlled foreign corporation in a restructuring transaction. (i) 
Facts. The facts are the same as in Example 1 except as follows. The 
property that DC2 contributes is 100% of the stock in CFC2, a 
foreign corporation. DC2 has owned all the stock of CFC2 since 
CFC2's formation on January 1, year 2, and CFC2 has $200 of earnings 
and profits as of December 31, year 5. CFC2 does not accumulate any 
additional earnings and profits from December 31, year 5, to 
December 31, year 7. On December 31, year 7, when the accumulated 
earnings and profits of CFC are $200, DC2, a section 1248 
shareholder with respect to CFC, sells its CFC stock. Also on that 
date, DC1 sells its CFC stock.
    (ii) Analysis. (A) DC2 sale. Pursuant to paragraph (b)(2)(ii) of 
this section, the earnings and profits attributable to the CFC stock 
sold by DC2 are $280. This amount consists of all of the $200 of 
earnings and profits of CFC2 accumulated before the restructuring 
transaction (see also section 1248(c)(2)), none of the $100 of 
earnings and profits accumulated by CFC before the restructuring 
transaction, and 80% of the $100 of earnings and profits of CFC 
accumulated after the restructuring transaction.
    (B) DC1 sale. Pursuant to paragraph (b)(4) of this section, the 
earnings and profits attributable to the CFC stock sold by DC1, a 
non-exchanging shareholder in the restructuring transaction, are 
$120. This amount consists of all of the $100 of earnings and 
profits of CFC accumulated before the restructuring transaction, 
none of the $200 of earnings and profits of CFC2 accumulated before 
the restructuring transaction, and 20% of the $100 of earnings and 
profits of CFC accumulated after the restructuring transaction.
    Example 3. A section 351 exchange of controlled foreign 
corporation stock by a United States person for stock in a domestic 
corporation in a restructuring transaction. (i) Facts. DC1, a 
domestic corporation, has owned all of the stock of CFC, a foreign 
corporation, since CFC's formation on January 1, year 1. DC1 has 
also owned all the stock of DC2, a domestic corporation, since DC2's 
formation on January 1, year 1. On December 31, year 2, DC1 
contributes the stock of CFC to DC2 in exchange for stock in DC2 in 
a restructuring transaction that is an exchange described in section 
351. On December 31, year 2, CFC has $100 of accumulated earnings 
and profits. DC2 has a basis in the CFC stock determined under 
section 362, and is considered to have held the CFC stock since 
January 1, year 1, pursuant to section 1223(2). On December 31, year 
4, when the accumulated earnings and profits of CFC are still $100, 
DC2 sells its CFC stock.
    (ii) Analysis. Under paragraph (b)(3)(ii) of this section, $100 
of accumulated earnings and profits of CFC is attributable to the 
stock of CFC sold by DC2, even though DC2 did not hold the stock of 
CFC during the time CFC accumulated the earnings and profits.
    Example 4. Acquisition of a controlled foreign corporation by a 
controlled foreign corporation in a reorganization described in 
section 368(a)(1)(C) (or section 368(a)(1)(B)). (i) Facts. DC1, a 
domestic corporation, has owned all the stock of CFC1, a foreign 
corporation, since its formation on January 1, year 1. DC2, a 
domestic corporation unrelated to DC1, has owned all of the stock of 
CFC2, a foreign corporation, since its formation on January 1, year 
2. On December 31, year 3, pursuant to a restructuring transaction 
that is a reorganization described in section 368(a)(1)(C), CFC1 
transfers all of its assets to CFC2 in exchange for 25% of the 
voting stock of CFC2. CFC1 distributes the CFC2 stock to DC1 and the 
CFC1 stock is cancelled. DC1's holding period in the CFC2 stock, 
determined under section 1223(1), begins on January 1, year 1. On 
December 31, year 3, CFC1 has $100 of accumulated earnings and 
profits and CFC2 has $200 of accumulated earnings and profits. CFC2 
succeeds to the $100 of CFC1 accumulated earnings and profits in the 
reorganization under section 381. From January 1, year 4 to December 
31, year 5, CFC2 incurred a deficit in earnings and profits in the 
amount of ($200). On December 31, year 5, both DC1 and DC2 sell 
their stock in CFC2.
    (ii) Analysis. (A) DC1. Pursuant to paragraph (b)(2)(ii) of this 
section, $50 of earnings and profits is attributable to the CFC2 
stock sold by DC1. This amount

[[Page 31995]]

consists of $100 of CFC1's earnings and profits accumulated before 
the restructuring transaction, reduced by 25% of CFC2's ($200) post-
restructuring transaction deficit in earnings and profits. None of 
the $200 of CFC2's earnings and profits accumulated by CFC2 prior to 
the reorganization is attributed to the CFC2 stock sold by DC1. 
Also, none of the earnings and profits CFC2 succeeded to under 
section 381 is attributed to the CFC2 stock sold by DC1, pursuant to 
paragraph (b)(6) of this section.
    (B) DC2. Pursuant to paragraph (b)(4) of this section, there is 
$50 of accumulated earnings and profits attributable to the CFC2 
stock sold by DC2. This amount consists of all of the $200 of CFC2's 
earnings and profits accumulated by CFC2 prior to the 
reorganization, reduced by 75% of CFC2's deficit in earnings and 
profits in the amount of ($200) incurred after the restructuring 
transaction. None of the $100 of CFC1 accumulated earnings and 
profits succeeded to under section 381 is attributable to the CFC2 
stock sold by DC2, pursuant to paragraph (b)(6) of this section.
    (C) Section 368(a)(1)(B) reorganization. If, instead of DC1 
acquiring its 25% interest in CFC2 pursuant to a reorganization 
described in section 368(a)(1)(C), DC1 had transferred the stock of 
CFC1 to CFC2 in exchange for 25% of the voting stock of CFC2 in a 
reorganization described in section 368(a)(1)(B), the results would 
be the same as described in paragraphs (ii) (A) and (B) of this 
Example 4.
    Example 5. Acquisition of the stock of a foreign corporation 
that controls a domestic acquiring corporation in a triangular 
reorganization described in section 368(a)(1)(C). (i) Facts. DC1, a 
domestic corporation, has owned all the stock of CFC1, a foreign 
corporation, since its formation on January 1, year 1. CFC1 has 
owned all the stock of CFC2, a foreign corporation, since its 
formation on January 1, year 1. FC, a foreign corporation that is 
not a controlled foreign corporation, has owned all of the stock of 
DC2, a domestic corporation, since its formation on January 1, year 
2. On December 31, year 3, pursuant to a restructuring transaction 
that was a triangular reorganization described in section 
368(a)(1)(C), CFC1 transfers all of its assets, including the CFC2 
stock, to DC2 in exchange for 60% of the voting stock of FC. CFC1 
transferred the voting stock of FC to DC1 and the CFC1 stock was 
cancelled. Pursuant to section 1223(1), DC1 is considered to have 
held the stock of FC since January 1, year 1. Under section 1223(2), 
DC2 is considered to have held the stock of CFC2 since January 1, 
year 1. On December 31, year 3, CFC1 has $100 of earnings and 
profits, CFC2 has $300 of earnings and profits, and FC has $200 of 
earnings and profits. DC1 includes the $100 all earnings and profits 
amount attributable to its CFC1 stock in income as a deemed dividend 
under Sec.  1.367(b)-3 upon the exchange of CFC1 stock for FC stock. 
Pursuant to the lower tier earning exclusion of Sec.  1.367(b)-
2(d)(3)(ii), that amount does not include the $300 of earnings and 
profits of CFC2. From January 1, year 4, until December 31, year 5, 
FC (now a controlled foreign corporation) accumulates an additional 
$50 of earnings and profits. From January 1, year 4 until December 
31, year 5, CFC2 accumulates an additional $100 of earnings and 
profits. On December 31, year 5, DC1 sells its stock in FC and DC2 
sells its stock in CFC2.
    (ii) Analysis. (A) DC1. Pursuant to paragraph (b)(2)(iii) of 
this section, there is $30 of earnings and profits attributable to 
the stock of FC sold by DC1. This amount consists of 60% of the $50 
of earnings and profits accumulated by FC after the restructuring 
transaction, and none of the earnings and profits accumulated by 
CFC1, CFC2, or FC before the restructuring transaction.
    (B) DC2. Pursuant to paragraph (b)(3)(ii) of this section, there 
is $400 of earnings and profits attributable to the stock of CFC2 
sold by DC2. This amount consists of all of the earnings and profits 
accumulated by CFC2 during DC2's section 1223(2) holding period.
    Example 6. Acquisition of the stock of a foreign corporation 
that controls a foreign acquiring corporation in a reorganization 
described in section 368(a)(1)(C). (i) Facts. DC1, a domestic 
corporation, has owned all the stock of CFC1, a foreign corporation, 
since its formation on January 1, year 1. CFC1 has owned all the 
stock of CFC2, a foreign corporation, since its formation on January 
1, year 1. FC, a foreign corporation that is not a controlled 
foreign corporation, has owned all of the stock of FC2, a foreign 
corporation, since its formation on January 1, year 2. On December 
31, year 3, pursuant to a restructuring transaction that was a 
triangular reorganization described in section 368(a)(1)(C), CFC1 
transfers all of its assets, including the CFC2 stock, to FC2 in 
exchange for 60% of the voting stock of FC. CFC1 transferred the 
voting stock of FC to DC1 and the CFC1 stock was cancelled. Pursuant 
to section 1223(1), DC1 is considered to have held the stock of FC 
since January 1, year 1. Under section 1223(2), FC2 is considered to 
have held the stock of CFC2 since January 1, year 1. On December 31, 
year 3, CFC1 has $100 of earnings and profits, CFC2 has $300 of 
earnings and profits, FC has $200 of earnings and profits, and FC2 
has no earnings and profits. From January 1, year 4, until December 
31, year 5, FC (now a controlled foreign corporation) accumulates an 
additional $50 of earnings and profits. From January 1, year 4 until 
December 31, year 5, CFC2 accumulates an additional $100 of earnings 
and profits. FC2, a controlled foreign corporation after the 
restructuring transaction, accumulates $100 of earnings and profits 
from January 1, year 4, until December 31, year 5. On December 31, 
year 5, DC1 sells its stock in FC.
    (ii) Analysis. Pursuant to paragraphs (b)(2)(ii) and (b)(4)(iii) 
of this section, there is $550 of earnings and profits attributable 
to the stock of FC sold by DC1. This amount consists of all $400 of 
the CFC1 and CFC2 earnings and profits accumulated before the 
restructuring transaction (see also section 1248(c)(2)), and 60% of 
the $250 of the earnings and profits accumulated by FC, FC2, and 
CFC2 after the restructuring transaction.
    Example 7. Acquisition of controlled foreign corporation stock 
by a controlled foreign corporation in a reorganization described in 
section 368(a)(1)(B), followed by a sale of the acquired stock by 
the acquiring controlled foreign corporation. (i) Facts. DC1, a 
domestic corporation, has owned all of the outstanding stock of 
CFC1, a foreign corporation, since its formation on January 1, year 
1. CFC1 has owned all of the outstanding stock of CFC3, a foreign 
corporation, since its formation on January 1, year 1. DC2, a 
domestic corporation unrelated to DC1, has owned all of the 
outstanding stock of CFC2, a foreign corporation, since its 
formation on January 1, year 2. On December 31, year 3, pursuant to 
a restructuring transaction that is a reorganization described in 
section 368(a)(1)(B), CFC1 transfers all of the stock of CFC3 to 
CFC2 in exchange for 40% of CFC2's stock. On December 31, year 3, 
CFC2 and CFC3 have, respectively, $40 and $20 of earnings and 
profits. On December 31, year 5, when the accumulated earnings and 
profits of CFC3 are $50 ($20 of earnings and profits as of December 
31, year 3, plus $30 of earnings and profits generated from January 
1, year 4, through December 31, year 5), CFC2 sells the stock of 
CFC3 in a transaction to which section 964(e) applies.
    (ii) Analysis. (A) CFC2. Pursuant to paragraph (b)(3)(ii) of 
this section, there is $50 of earnings and profits attributable to 
the CFC3 stock sold by CFC2. This amount consists of the accumulated 
earnings and profits attributable to CFC2's entire section 1223(2) 
holding period in the CFC3 stock.
    (B) CFC1, DC2, and DC1. Under paragraph (b)(5) of this section, 
the earnings and profits attributable to the CFC2 stock held by CFC1 
and DC2, and the earnings and profits attributable to the CFC1 stock 
held by DC1, will be reduced (regardless of whether CFC2 recognizes 
gain on its sale of CFC3 stock).
    (1) CFC1. The earnings and profits attributable to the CFC2 
stock held by CFC1 will be reduced by $32, or the amount of earnings 
and profits as of December 31, year 5, that would have been 
attributable to the CFC2 stock held by CFC1 pursuant to paragraph 
(b)(2)(ii) of this section. This amount consists of all of the $20 
of earnings and profits accumulated by CFC3 before the restructuring 
transaction and 40% of the $30 of earnings and profits accumulated 
by CFC3 after the restructuring transaction (.40 x $30 = $12).
    (2) DC1. The earnings and profits attributable to the CFC1 stock 
held by DC1 will also be reduced by $32, or the amount of earnings 
and profits that would have been attributable to the CFC1 stock held 
by DC1 as of December 31, year 5.
    (3) DC2. The earnings and profits attributable to the CFC2 stock 
held by DC2 will be reduced by $18, or the amount of earnings and 
profits that would have been attributable to the CFC2 stock held by 
DC2 as of December 31, year 5, under paragraph (b)(4) of this 
section. This amount consists of 60% of the $30 (.60 x $30 = $18) of 
earnings and profits accumulated by CFC3 after the restructuring 
transaction.
    (C) Partial sale by CFC2. If, instead of selling 100% of the 
CFC3 stock, on December 31, year 5, CFC2 sells only 50% of its CFC3 
stock, paragraph (b)(5) of this section requires CFC1 to reduce the 
earnings and profits of

[[Page 31996]]

CFC3 attributable to its CFC2 stock to $16. Similarly, DC1 would be 
required to reduce the earnings and profits of CFC3 attributable to 
its CFC1 stock by $16. Paragraph (b)(5) of this section also 
requires DC2 to reduce the CFC3 earnings and profits attributable to 
its CFC2 stock by $9. These reductions occur without regard to 
whether CFC2 recognizes gain on its sale of CFC3 stock.
    Example 8. Acquisition of the assets of a lower-tier controlled 
foreign corporation by an upper-tier controlled foreign corporation 
in a restructuring transaction described in section 368(a)(1)(C). 
(i) Facts. DC, a domestic corporation, has owned all the stock of 
CFC1, a controlled foreign corporation, since its formation on 
January 1, year 1. CFC1 is a holding company that has owned 79% of 
the stock of CFC2, a controlled foreign corporation, since its 
formation on January 1, year 1. The other 21% of CFC2 stock is owned 
by X, an unrelated party. On December 31, year 1, CFC2 has $200 of 
earnings and profits. On December 31, year 1, CFC1 has no 
accumulated earnings and profits. On December 31, year 1, pursuant 
to a restructuring transaction described in section 368(a)(1)(C), 
CFC2 transfers all its properties to CFC1. In exchange, CFC1 assumes 
the liabilities of CFC2 and transfers to CFC2 voting stock 
representing 21% of the stock of CFC1. CFC2 distributes the voting 
stock to X and liquidates. The liabilities assumed do not exceed 20% 
of the value of the properties of CFC2. From January 1, year 2, to 
December 31, year 3, CFC1 accumulates $100 of earnings and profits. 
On December 31, year 3, DC sells its CFC1 stock.
    (ii) Analysis. Pursuant to paragraphs (b)(4)(ii) of this 
section, there is $237 of earnings and profits attributable to DC's 
CFC1 stock. This amount consists of 79% of CFC2's $200 of earnings 
and profits accumulated before the restructuring transaction (see 
section 1248(c)(2)), and 79% of CFC1's $100 of earnings and profits 
accumulated after the restructuring transaction. Pursuant to 
paragraph (b)(6) of this section, none of CFC2's $200 of earnings 
and profits to which CFC1 succeeded under section 381 would be 
attributable to DC's CFC1 stock.

    (c) Earnings and profits attributable to stock of a foreign 
distributee corporation that is a foreign corporate shareholder with 
respect to a foreign liquidating corporation--(1) General rule. If a 
foreign corporation (liquidating corporation) makes a distribution of 
property in complete liquidation under section 332 to a foreign 
corporation (distributee), and immediately before the liquidation the 
distributee was a foreign corporate shareholder with respect to the 
liquidating foreign corporation, the amount of earnings and profits 
attributable to the distributee stock, upon its subsequent sale or 
exchange will be determined under this paragraph (c)(1). The earnings 
and profits attributable will be the sum of the earnings and profits 
attributable to the stock of the distributee immediately before the 
liquidation (including amounts attributed under section 1248(c)(2)) and 
the earnings and profits attributable to the stock of the distributee 
accumulated after the liquidation (including amounts attributed under 
section 1248(c)(2)).
    (2) Special rule regarding section 381. Solely for purposes of 
determining the earnings and profits (or deficit in earnings and 
profits) attributable to stock under this paragraph (c), the attributed 
earnings and profits of a corporation shall not include earnings and 
profits that are treated as received or incurred pursuant to section 
381(c)(2)(A) and Sec.  1.381(c)(2)-1(a).

    (3) Example. (i) Facts. DC, a domestic corporation, has owned 
all of the stock of CFC1, a foreign corporation, since its formation 
on January 1, year 1. CFC1 is an operating company that has owned 
all of the stock of CFC2, a foreign corporation, since its formation 
on January 1, year 1. On December 31, year 2, CFC1 has $200 of 
accumulated earnings and profits and CFC2 has a ($200) deficit in 
earnings and profits. On December 31, year 2, CFC2 distributes all 
of its assets and liabilities to CFC1 in a liquidation to which 
section 332 applies. From January 1, year 3, until December 31, year 
4, CFC1 accumulates no additional earnings and profits. On December 
31, year 4, DC sells its stock in CFC1.
    (ii) Analysis. Pursuant to paragraph (c)(1) of this section, 
there are no earnings and profits attributable to DC's CFC1 stock. 
This amount consists of the sum of the earnings and profits 
attributable to the CFC1 stock immediately before the liquidation 
(100% of the $200 accumulated earnings and profits of CFC1 and 100% 
of CFC2's ($200) deficit in earnings and profits) and the amount of 
earnings and profits accumulated after the section 332 liquidation 
(see also section 1248(c)(2)).

    (d) Effective date. This section applies to income inclusions that 
occur on or after the date these regulations are published as final 
regulations in the Federal Register.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E6-8551 Filed 6-1-06; 8:45 am]
BILLING CODE 4830-01-P