[Federal Register Volume 73, Number 162 (Wednesday, August 20, 2008)]
[Proposed Rules]
[Pages 49278-49305]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-18885]



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Part III





Department of the Treasury





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26 CFR Part 1



Transfers by Domestic Corporations That Are Subject to Section 
367(a)(5); Distributions by Domestic Corporations That Are Subject to 
Section 1248(f); Proposed Rule

  Federal Register / Vol. 73, No. 162 / Wednesday, August 20, 2008 / 
Proposed Rules  

[[Page 49278]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209006-89]
RIN 1545-AM97


Transfers by Domestic Corporations That Are Subject to Section 
367(a)(5); Distributions by Domestic Corporations That Are Subject to 
Section 1248(f)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under sections 
367(a), 367(a)(5), 367(b), 1248(a), 1248(e), 1248(f), and 6038B of the 
Internal Revenue Code (Code). The proposed regulations under sections 
367(a)(5) and 367(b) apply when a domestic corporation transfers 
certain property to a foreign corporation in an exchange described in 
section 361(a) or (b). The proposed regulations under section 1248(e) 
suspend the application of section 1248(e) when capital gains are taxed 
at a rate equal to or greater than the rate at which ordinary income is 
taxed. The proposed regulations under section 1248(f) apply when a 
domestic corporation distributes stock of certain foreign corporations 
in a distribution to which section 337, 355, or 361 applies. The 
proposed regulations under section 1248(f) include regulations 
described in Notice 87-64 (1987-2 CB 375). The proposed regulations 
under section 6038B establish reporting requirements for certain 
transfers of property by a domestic corporation to a foreign 
corporation in certain exchanges described in section 361(a) or (b). 
Finally, the proposed regulations under section 367(a) include the 
regulations described in Notice 2008-10 (2008-3 IRB 277).
    The proposed regulations included in this document affect domestic 
corporations that transfer property to foreign corporations in certain 
transactions, or that distribute the stock of certain foreign 
corporations, and certain shareholders of such domestic corporations. 
The proposed regulations are necessary, in part, to provide guidance on 
changes to the law made by the Technical and Miscellaneous Revenue Act 
of 1988 (Pub. L. 100-647, 102 Stat. 3342).

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 18, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-209006-89), Room 
5203, Internal Revenue Service, P.O. 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-
209006-89), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC 20224, or sent electronically, via the 
Federal eRulemaking Portal at www.regulations.gov (IRS REG-209006-89).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Daniel 
McCall, (202) 622-3860; concerning submissions of comments, requests 
for a public hearing, and/or to be placed on the building access list 
to attend a hearing, Richard Hurst 
([email protected]), or (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 
20224. Comments on the collections of information should be received by 
October 20, 2008.
    Comments are requested concerning:
    Whether the proposed collections of information are necessary for 
the proper performance of the functions of the Internal Revenue 
Service, including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collections of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application or 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collections of information in these proposed regulations are in 
Sec. Sec.  1.367(a)-7(c)(4) and (5); 1.1248(f)-2(b)(1) and (c)(1); and 
1.6038B-1(c)(6). The collections of information are mandatory. The 
likely respondents are domestic corporations.
    Estimated total annual reporting burden: 3260.
    Estimated average annual burden hours per respondent: 10.69.
    Estimated number of respondents: 305.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains proposed amendments to 26 CFR part 1 under 
sections 367(a), 367(a)(5), 367(b), 1248(a), 1248(e), 1248(f), and 
6038B of the Code.
    Section 367(a)(1) generally provides that if a United States person 
transfers property to foreign corporation in connection with an 
exchange described in section 332, 351, 354, 356, or 361, then the 
foreign corporation shall not be considered a corporation for purposes 
of determining the extent to which the United States person recognizes 
gain on the transfer. Sections 367(a)(2) and 367(a)(3), respectively, 
provide exceptions to the general rule of section 367(a)(1) for 
transfers of stock or securities of a foreign corporation that is a 
party to the exchange or a party to the reorganization, and for certain 
property used in an active foreign trade or business. However, section 
367(a)(5) provides that, except to the extent provided in regulations, 
the exceptions to the general rule of section 367(a)(1) provided by 
section 367(a)(2) and (a)(3) do not apply to a transfer of property by 
a domestic corporation to a foreign corporation in an exchange 
described in section 361(a) or (b).
    Section 367(b)(1) provides that in the case of any exchange 
described in section 332, 351, 354, 355, 356, or 361 in connection with 
which there is no transfer of property described in section 367(a)(1), 
a foreign corporation shall be considered to be a corporation except to

[[Page 49279]]

the extent provided in regulations prescribed by the Secretary which 
are necessary or appropriate to prevent the avoidance of Federal income 
taxes. A fundamental policy of section 367(b) is to preserve the 
potential application of section 1248 following the acquisition of the 
stock or assets of a foreign corporation by another foreign 
corporation. H.R. Rep. No. 94-658, at 242 (1975).
    Section 367(c)(1) provides that for purposes of section 367, any 
distribution described in section 355 (or so much of section 356 as 
relates to section 355) shall be treated as an exchange whether or not 
it is an exchange.
    Section 1248(a) provides that a United States person shall include 
in gross income as a dividend any gain recognized on the sale or 
exchange of stock of a foreign corporation that was a controlled 
foreign corporation (CFC) (as defined in section 957(a)) at any time 
during the five-year period ending on the date of the sale or exchange 
but only if 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 (a section 1248 shareholder). The amount 
of the gain recognized by the United States person on the sale or 
exchange that is recharacterized as a dividend is limited to the 
earnings and profits of the foreign corporation, and of certain foreign 
subsidiaries of such corporation, attributable to the stock sold or 
exchanged that 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 CFC.
    Section 1248(e) provides that, except as provided in regulations, 
if a United States person sells or exchanges stock of a domestic 
corporation that was formed or availed of principally for the holding, 
directly or indirectly, of stock of one or more foreign corporations, 
such sale or exchange shall be treated for purposes of section 1248 as 
a sale or exchange of the stock of the foreign corporations held by the 
domestic corporation.
    Section 1248(f)(1) provides that, except as provided in 
regulations, a domestic corporation that distributes stock of a foreign 
corporation in a distribution to which section 311(a), 337, 355(c)(1), 
or 361(c)(1) applies, shall include in gross income as a dividend an 
amount equal to the excess of the fair market value of such stock over 
its adjusted basis, but only to the extent of the earnings and profits 
of the foreign corporation attributable (under regulations prescribed 
by the Secretary) to such stock which were accumulated in taxable years 
of such foreign corporation beginning after December 31, 1962, and 
during the period or periods the stock was held by the domestic 
corporation while the foreign corporation was a CFC.

Explanation of Provisions

A. Section 367(a)(5)

1. Overview
    As noted in the Background part of this preamble, section 367(a)(2) 
and (3) provide exceptions to the general rule of section 367(a)(1). 
Section 367(a)(2) provides that, except to the extent provided in 
regulations, section 367(a)(1) shall not apply to the transfer of stock 
or securities of a foreign corporation that is a party to the exchange 
or a party to the reorganization. Section 367(a)(3) provides that, 
except to the extent provided in regulations, section 367(a)(1) shall 
not apply to the transfer of property used in an active foreign trade 
or business. Sections 1.367(a)-2T and Sec.  1.367(a)-3, along with 
other related provisions, implement the exceptions in section 367(a)(2) 
and (a)(3). In addition, section 367(a)(6) grants the Secretary 
authority to promulgate regulations providing additional exceptions to 
the general rule of section 367(a)(1).
    Section 367(a)(5) provides that the exceptions to the general rule 
of section 367(a)(1) provided under section 367(a)(2) and (3) shall not 
apply in the case of a transfer of property by a domestic corporation 
(U.S. transferor) to a foreign corporation (foreign acquiring 
corporation) in an exchange described in section 361(a) or (b) (section 
361 exchange). The general rule under section 367(a)(5), therefore, is 
that a transfer of property by a U.S. transferor to a foreign acquiring 
corporation in a section 361 exchange is subject to the general rule of 
section 367(a)(1). In that case, the U.S. transferor recognizes gain 
with respect to the transfer of appreciated property in the section 361 
exchange. See section 367(a)(1) and the regulations under that section.
    Section 367(a)(5), however, further provides that subject to such 
basis adjustments and such other conditions as shall be provided in 
regulations the general rule of section 367(a)(5) shall not apply (and 
therefore the exceptions to the general rule of section 367(a)(1) may 
be available) if the U.S. transferor is controlled (within the meaning 
of section 368(c)), by five or fewer domestic corporations. For 
purposes of the control requirement, members of the same affiliated 
group (within the meaning of section 1504) are treated as a single 
corporation. The legislative history to section 367(a)(5) explains that 
regulations are expected to provide relief from the general rule only 
if the ``U.S. corporate shareholders in the transferor agree to take a 
basis in the stock they receive in a foreign corporation that is a 
party to the reorganization equal to the lesser of (a) the U.S. 
corporate shareholders' basis in such stock received pursuant to 
section 358, or (b) their proportionate share of the basis in the 
assets of the transferor corporation transferred to the foreign 
corporation.'' S. Rep. No. 100-445, at 62 (1988).
    The legislative history explains that ``the requirement that five 
or fewer domestic corporations own at least 80 percent of the U.S. 
transferor's stock assures that the bulk of the built-in gain [in the 
transferred property] remains subject to U.S. taxing jurisdiction.'' 
The legislative history further states that ``it is expected that 
regulations [issued under section 367(a)(5)] will require the U.S. 
corporate transferor to recognize immediately any built-in gain that 
does not remain subject to U.S. taxing jurisdiction by virtue of a 
substituted stock basis.'' For example, the U.S. transferor would 
recognize gain ``where 20 percent or less of the U.S. corporate 
transferor is owned by foreign shareholders who receive substituted 
basis stock in the transferee corporation, which stock would not be 
subject to U.S. taxing jurisdiction on disposition.'' The U.S. 
transferor would also recognize gain to the extent each controlling 
domestic corporate shareholder does not receive an amount of stock of 
the issuing corporation in the reorganization sufficient to preserve 
its share of the built-in gain in the property transferred by the U.S. 
transferor in the section 361 exchange.
2. Explanation of Proposed Regulations
    The proposed regulations confirm the general rule of section 
367(a)(5), but provide an elective exception to the general rule 
pursuant to which the exceptions provided by section 367(a) and the 
regulations under that section may be available.
(a) General Rule of Section 367(a)(5)
    Consistent with section 367(a)(5), the proposed regulations confirm 
that the exceptions to the general rule of section 367(a)(1) provided 
in section 367(a) generally are not available to a transfer of property 
by a U.S. transferor to a foreign acquiring corporation in a

[[Page 49280]]

section 361 exchange. As noted, under the general rule of section 
367(a)(5), section 367(a)(1) would require the U.S. transferor to 
recognize gain on the transfer of appreciated property to the foreign 
acquiring corporation in the section 361 exchange. This general rule 
applies even if the conditions and requirements for the application of 
such exceptions would otherwise be met. The proposed regulations 
clarify that the general rule of section 367(a)(5) applies to a 
transfer of property pursuant to an exchange described in section 351 
(section 351 exchange) that qualifies as both a section 351 exchange 
and a section 361 exchange. See Notice 2008-10, 2008-3 IRB 277.
(b) Elective Exception to the General Rule
    The proposed regulations provide an elective exception to the 
general rule of section 367(a)(5) if certain conditions and 
requirements are satisfied (discussed in parts A.2.b.i through v of 
this preamble). If the exception applies, then the exceptions to the 
general rule of section 367(a)(1) provided in section 367(a) and the 
regulations under that section are available to the transfer of 
property by the U.S. transferor to the foreign acquiring corporation in 
the section 361 exchange, subject to any conditions and requirements 
for the application of such exceptions. In addition, even if the 
exception provided by the proposed regulations applies, the U.S. 
transferor may still recognize gain on the section 361 exchange in 
certain circumstances (discussed in part A.2.b.ii of this preamble), 
including any gain otherwise required to be recognized under section 
367(a). See, for example, section 367(a)(3)(B) and (C).
    The conditions and requirements of the elective exception carry out 
the policy of section 367(a)(5) by ensuring that the exceptions to the 
general rule of section 367(a)(1) are available only to the extent the 
net built-in gain in certain property transferred by the U.S. 
transferor in the section 361 exchange remains subject to corporate-
level taxation in the hands of the controlling domestic corporate 
shareholders of the U.S. transferor through their ownership of stock 
received in the transaction. References to ``stock received'' in this 
preamble include stock deemed received in the transaction.
    The proposed regulations apply to all property transferred by the 
U.S. transferor in the section 361 exchange, other than property to 
which section 367(d) applies (section 367(d) property). But see part 
D.2 of this preamble regarding proposed regulations under section 
367(a) that require section 367(d) property to be treated as property 
to which section 367(a) applies (section 367(a) property) in 
transactions that may be eligible for the exception to the coordination 
rule of Sec.  1.367(a)-3(d)(2)(vi)(A) provided by Sec.  1.367(a)-
3(d)(2)(vi)(B)(1). For purposes of these proposed regulations, section 
367(a) property includes any property transferred by the U.S. 
transferor in the section 361 exchange (other than section 367(d) 
property), whether the property is appreciated (built-in gain property) 
or depreciated (built-in loss property) at the time of the section 361 
exchange. The proposed regulations preserve (or require the recognition 
of) the net built-in gain in the section 367(a) property transferred in 
the section 361 exchange (generally defined as ``inside gain'' by the 
proposed regulations). In this regard, a transfer of section 367(a) 
property pursuant to a section 361 exchange to which the elective 
exception applies is treated differently than a transfer of built-in 
gain property and built-in loss property by a U.S. person to a foreign 
corporation in a section 351 exchange that is not also a section 361 
exchange. In the latter transaction, only the built-in gain property 
would be subject to section 367(a)(1), and the U.S. transferor would be 
required to recognize gain with respect to such property without 
offsetting the gain with losses related to the built-in loss property.
    The proposed regulations contain an anti-stuffing rule pursuant to 
which any property that would otherwise constitute section 367(a) 
property shall not be considered section 367(a) property for purposes 
of any determination under the proposed regulations for which the 
amount of section 367(a) property is relevant, if the U.S. transferor 
acquires such property in connection with the section 361 exchange with 
a principle purpose of affecting any such determination (for example, 
inside gain and inside basis). This rule may apply, for example, if the 
U.S. transferor acquires built-in loss property or cash proceeds from 
indebtedness incurred in connection with the transaction.
    The conditions and requirements for the application of the 
exception provided by the proposed regulations ensure that, in the 
aggregate, the inside gain is recognized currently by the U.S. 
transferor or preserved for future taxation in the stock received in 
the transaction by the controlling domestic corporate shareholders of 
the U.S. transferor. If the entire inside gain is preserved in the 
stock received by the controlling domestic corporate shareholders, the 
basis adjustment required by the exception (discussed in part A.2.b.iii 
of this preamble) effectively results in the section 361 exchange being 
treated similarly to a transfer of the section 367(a) property in a 
section 351 exchange insofar as, in the aggregate, the controlling 
domestic corporate shareholders' adjusted basis in the stock received 
in the transaction generally would reflect the aggregate bases of the 
section 367(a) property and the net built-in gain in such property on 
the date of the section 361 exchange.
    The inside gain equals the amount by which the aggregate gross fair 
market value of the section 367(a) property transferred by the U.S. 
transferor in the section 361 exchange exceeds the sum of the aggregate 
bases of such property and a proportionate amount of any liabilities of 
the U.S. transferor assumed in the section 361 exchange or satisfied in 
the reorganization pursuant to section 361(c)(3), but only to the 
extent the payment of any such liability would give rise to a deduction 
(deductible liabilities). For this purpose, gross fair market value 
means fair market value determined without regard to mortgages, liens, 
pledges, or other liabilities. However, the fair market value of any 
property subject to nonrecourse indebtedness shall not be less than the 
amount of such indebtedness. In addition, the aggregate bases of the 
section 367(a) property is determined after taking into account any 
gain otherwise required to be recognized by the U.S. transferor under 
section 367(a). See, for example, section 367(a)(3)(B) and (C). The 
proposed regulations provide rules for determining the proportionate 
amount of any deductible liabilities taken into account in determining 
the inside gain. The IRS and Treasury Department believe that taking 
deductible liabilities into account in determining inside gain comports 
with the policy of section 367(a)(5) to protect the corporate tax base 
following the repeal of the ``General Utilities'' doctrine, insofar as 
the U.S. transferor would have received the benefit of any deductible 
liabilities if it had disposed of its assets in a taxable transaction 
in which the deductible liabilities were assumed by the acquirer.
    In determining the inside gain, the IRS and Treasury Department 
declined to consider attributes (for example, net operating losses and 
foreign tax credits) of the U.S. transferor other than the tax bases of 
the section 367(a) property and deductible liabilities allocable to 
section 367(a) property. These attributes are not considered for this 
purpose because of concerns regarding the complexity for determining 
how any limitations on the use of such attributes should be taken into 
account and the potential for

[[Page 49281]]

duplicating the benefit of such attributes. Comments are requested 
regarding whether and how other attributes of the U.S. transferor 
should be taken into account for determining inside gain.
    If the section 361 exchange is part of a divisive reorganization 
described in section 368(a)(1)(D) in which the U.S. transferor 
distributes the stock of the foreign acquiring corporation in a 
distribution to which section 355 applies (section 355 distribution) 
and, as part of a plan or series of related transactions, such stock is 
subsequently distributed in one or more section 355 distributions, in 
addition to the conditions discussed in parts A.2.b.i through v of this 
preamble, two additional conditions must be satisfied. First, each 
section 355 distribution must be to a member of the affiliated group 
(within the meaning of section 1504) that includes the U.S. transferor 
at the time of the 361 exchange. Second, each affiliated group member 
that receives stock of the foreign acquiring corporation in the final 
section 355 distribution must adjust the basis of the stock received 
(as determined under section 358 and the regulations under that 
section) as required by the proposed regulations (discussed in part 
A.2.b.iii of this preamble). These two additional conditions ensure 
that the amount of inside gain attributable to the U.S. transferor's 
controlling domestic corporate shareholders remains subject to 
corporate-level taxation following the final section 355 distribution 
and permit section 355 distributions of the stock of the foreign 
acquiring corporation within an affiliated group.
(i) Control Requirement
    At the time of the section 361 exchange, the U.S. transferor must 
be controlled (within the meaning of section 368(c)) by five or fewer, 
but at least one, domestic corporations (the control group). For this 
purpose, members of the same affiliated group (within the meaning of 
section 1504) are treated as one corporation. If the U.S. transferor is 
controlled (within the meaning of section 368(c)) by more than five 
domestic corporations, but some combination of five or fewer domestic 
corporations control the U.S. transferor within the meaning of section 
368(c), the U.S. transferor must designate the five or fewer domestic 
corporations that comprise the control group on Form 926, ``Return by a 
U.S. Transferor of Property to a Foreign Corporation.''
    Although a regulated investment company (as defined in section 
851(a)) (RIC), a real estate investment trust (as defined in section 
856(a)) (REIT), and a subchapter S corporation (as defined in section 
1361(a)) is each generally treated as a domestic corporation for 
purposes of the Code, such entities are not generally subject to 
corporate-level taxation. Therefore, the proposed regulations provide 
that these entities cannot be members of the control group.
    The proposed regulations confirm that because the stock ownership 
threshold for the control requirement is determined by reference to 
section 368(c), only direct ownership of the stock of the U.S. 
transferor is taken into account. The IRS and Treasury Department 
declined to exercise the authority under section 367(a)(6) to permit 
indirect ownership (through a partnership or other entity) to be taken 
into account for this purpose, in part, because of the complexity and 
administrative difficulties that would arise from the basis adjustments 
(discussed in part A.2.b.iii of this preamble) that would be needed to 
account for the intervening partnership or other entity. For example, 
in the case of indirect ownership through a partnership, basis 
adjustments would need to account for differences between a partner's 
basis in its partnership interest and the partnership's basis in the 
stock of the U.S. transferor. Comments are requested regarding the 
manner in which indirect ownership could be taken into account for this 
purpose without undue complexity.
(ii) Gain Recognition by U.S. Transferor
    Even if the exception provided by the proposed regulations applies, 
in two instances the U.S. transferor must recognize gain on the 
transfer of section 367(a) property in the section 361 exchange. This 
is the case even if an exception to the general rule of section 
367(a)(1) would otherwise apply to such transfer.
    First, the U.S. transferor must recognize gain equal to the 
aggregate amount of inside gain allocable to non-control group members. 
The inside gain is allocated among control group members and non-
control group members based on each shareholder's ownership interest 
(by value) in the U.S. transferor at the time of the section 361 
exchange. The U.S. transferor must recognize gain with respect to non-
control group members even if the entire inside gain could be preserved 
in the stock received by the control group members as a group.
    Second, the U.S. transferor must recognize gain to the extent any 
control group member cannot preserve its share of inside gain in the 
stock received that is allocable to the section 367(a) property 
transferred in the section 361 exchange. The amount of a control group 
member's share of inside gain that cannot be preserved in the stock 
received is the amount by which the control group member's share of 
inside gain exceeds the fair market value of the stock received by the 
control group member that is allocable to section 367(a) property. Gain 
is required to be recognized in such a case because the fair market 
value of the stock equals the maximum amount of the control group 
member's share of inside gain that can be preserved in such stock (if 
the basis of such stock were zero). Under this rule, stock received 
that is allocable to property other than section 367(a) property is not 
available to preserve any portion of the control group member's share 
of inside gain. The U.S. transferor may be required to recognize gain 
under this rule when, for example, non-qualifying property (property 
other than stock or securities permitted to be received under section 
361(a)) is received or when the foreign acquiring corporation assumes 
certain liabilities of the U.S. transferor in the section 361 exchange.
    The proposed regulations provide rules for determining the portion 
of the stock received by a control group member that is attributable to 
section 367(a) property that are consistent with general tax 
principles, including Rev. Rul. 68-55, 1968-1 CB 140, and the 
authorities cited therein. Under these rules, stock received by a 
control group member is allocated between the aggregate section 367(a) 
property and all other property transferred in the section 361 exchange 
based on relative gross fair market value.
    The U.S. transferor must recognize gain with respect to any control 
group member that cannot preserve its entire share of inside gain in 
the stock received in the transaction even if the control group 
members' aggregate share of inside gain can be preserved in the stock 
received by the control group members as a group. For example, assume 
that the U.S. transferor is wholly owned by two domestic corporations 
(US1 and US2) and that each control group member's share of inside gain 
is $40x. If in the transaction US1 received stock with a value of $30x 
and $20x of non-qualifying property, the U.S. transferor would 
recognize $10x gain with respect to US1, even if US2 received 
sufficient stock to preserve $50x gain (the sum of US2's $40x share of 
inside gain and the portion of US1's share of inside gain ($10x) that 
cannot be preserved in the stock received by US1).

[[Page 49282]]

(iii) Adjustments To Basis of Stock Received by Control Group Members
    Under the proposed regulations, each control group member's basis 
in the stock received in the transaction as determined under section 
358 and the regulations under that section (section 358 basis) that is 
allocable to the section 367(a) property transferred by the U.S. 
transferor in the section 361 exchange is reduced to the extent 
necessary to preserve the control group member's share of inside gain. 
As a general matter, if the U.S. transferor must recognize gain with 
respect to a control group member because the control group member's 
entire share of inside gain cannot be preserved in the stock received 
by the control group member in the transaction (see part A.2.b.ii of 
this preamble), the control group member's section 358 basis in the 
stock received that is attributable to section 367(a) property is 
reduced to zero.
    Only the basis of stock received by the control group member that 
is attributable to section 367(a) property transferred in the section 
361 exchange is reduced (for example, the basis of stock attributable 
to section 367(d) property is not reduced). The reduction to a control 
group member's section 358 basis in the stock received that is 
attributable to section 367(a) property equals the amount, if any, by 
which the control group member's share of inside gain (reduced by the 
amount of any gain recognized by the U.S. transferor with respect to 
the control group member (discussed in part A.2.b.ii of this preamble)) 
exceeds the built-in gain in such stock (outside gain). The outside 
gain is the amount by which the fair market value of such stock exceeds 
the section 358 basis of the stock (as determined before any required 
adjustment to such basis under the proposed regulations). The proposed 
regulations provide special rules that apply if the control group 
member holds more than one block of stock received in the transaction.
    If the section 361 exchange is part of a divisive reorganization 
described in section 368(a)(1)(D) that is eligible for the exception 
(see part A.2.b of this preamble for additional conditions that must be 
satisfied in such a case), each affiliated group member that receives 
stock of the foreign acquiring corporation in the final section 355 
distribution must reduce the section 358 basis of such stock to the 
same extent that the control group member that initially received the 
stock from the U.S. transferor would have reduced its section 358 basis 
in such stock. In such a case, the control group member that received 
the stock of the foreign acquiring corporation from the U.S. transferor 
is not required to reduce the section 358 basis of such stock.
    A section 361 exchange that is subject to section 367(a)(5) may be 
part of a triangular reorganization in which the control group members 
receive stock of the corporation that controls the foreign acquiring 
corporation (the controlling corporation). In such a case, the proposed 
regulations require the control group members to adjust (if necessary) 
the section 358 basis of the stock of the controlling corporation 
(whether foreign or domestic) received in the transaction. The IRS and 
Treasury Department believe adjusting the basis of such stock to be 
appropriate even if the controlling corporation is domestic because the 
control group members' aggregate share of inside gain may not be 
preserved in the stock of the foreign acquiring corporation held by the 
controlling corporation in all cases. For example, liabilities assumed 
or incurred by the foreign acquiring corporation in connection with the 
transaction could reduce the amount of inside gain preserved in such 
stock. Moreover, even if the control group members' aggregate share of 
inside gain could be preserved in such stock, such an approach would 
shift the inside gain to the domestic controlling corporation, rather 
than to the control group members as intended by section 367(a)(5).
(iv) Agreement To Recognize Gain and File Amended Tax Return
    The proposed regulations require the U.S. transferor to include a 
statement with its U.S. income tax return for the year of the section 
361 exchange certifying that if the foreign acquiring corporation 
disposes of a significant amount of the section 367(a) property 
transferred in the section 361 exchange in one or more related 
transactions entered into with a principal purpose of avoiding the U.S. 
tax that would have been imposed on a sale of such property by the U.S. 
transferor at the time of the section 361 exchange, then the U.S. 
transferor (or the foreign acquiring corporation on behalf of the U.S. 
transferor) shall file a U.S. income tax return (or amended U.S. income 
tax return, as the case may be) for the year of the section 361 
exchange reporting the gain realized but not recognized on the section 
361 exchange. This requirement is intended to prevent the potential use 
of reorganizations subject to section 367(a)(5) to avoid the repeal of 
the ``General Utilities'' doctrine. Interest must be paid (determined 
under section 6621) on the amount of any additional tax due on such 
return. For this purpose, a disposition of a significant amount of the 
section 367(a) property occurs if the foreign acquiring corporation 
disposes of an amount of the section 367(a) property transferred in the 
section 361 exchange that is greater than forty percent of the fair 
market value of the section 367(a) property at the time of the section 
361 exchange. Comments are requested regarding whether an exception 
from this rule should be provided for dispositions of section 367(a) 
property occurring in the ordinary course of business.
(v) Election and Reporting Requirements
    To elect to apply the exception, the proposed regulations require 
the U.S. transferor and the control group members to enter into a 
written agreement to make such election on or before the due date for 
the U.S. transferor's timely-filed return for the taxable year in which 
the section 361 exchange occurs. Each party to the written agreement 
must also include a statement with its timely-filed return for the year 
of the section 361 exchange reporting the election and other specified 
information. If the section 361 exchange is part of a divisive 
reorganization described in section 368(a)(1)(D) that is eligible for 
the exception (see part A.2.b of this preamble for additional 
conditions that must be satisfied in such a case), each affiliated 
group member that receives stock of the foreign acquiring corporation 
in the final section 355 distribution must enter into the written 
agreement and include the reporting statement with its timely-filed 
return (instead of the control group member that initially received the 
stock of the foreign acquiring corporation from the U.S. transferor.) 
Relief for reasonable cause may be available for the failure to comply 
with the election and reporting requirements.
3. Special Entities
    The proposed regulations apply to property transfers by U.S. 
transferors, including RICs, REITs, and subchapter S corporations. 
Comments are requested regarding whether and the extent to which the 
IRS and Treasury Department should exercise the authority under section 
367(a)(6) to provide an exception from the general rule of section 
367(a)(5) for a transfer of property by a RIC, a REIT, or a subchapter 
S corporation to a foreign corporation pursuant to a section 361 
exchange.

[[Page 49283]]

B. Section 367(b)

1. Overview
    Section 367(b)(1) provides that in the case of any exchange 
described in section 332, 351, 354, 355, 356, or 361 in connection with 
which there is no transfer of property described in section 367(a)(1), 
a foreign corporation shall be considered to be a corporation except to 
the extent provided in regulations prescribed by the Secretary which 
are necessary or appropriate to prevent the avoidance of Federal income 
taxes.
    A fundamental policy of section 367(b) is to preserve the potential 
application of section 1248 following certain section 367(b) exchanges. 
H.R. Rep. No. 94-658, at 242 (1975). Thus, if the potential application 
of section 1248 cannot be preserved immediately following the 
acquisition of the stock or assets of a foreign acquired corporation by 
a foreign acquiring corporation in a section 367(b) exchange, the final 
regulations (TD 8862) under section 367(b) issued on January 24, 2000 
(2000 final regulations) require certain shareholders of the foreign 
acquired corporation to include in income as a dividend the section 
1248 amount attributable to the stock of the foreign acquired 
corporation. See Sec.  1.367(b)-4(b). For example, the inclusion in 
income of the section 1248 amount is required if the section 367(b) 
exchange results in the loss of section 1248 shareholder status or if 
the foreign acquired corporation or foreign acquiring corporation is 
not a CFC immediately after the section 367(b) exchange. See Sec.  
1.367(b)-4(b)(1)(i).
2. Outbound Asset Reorganizations--In General
    The 2000 final regulations require a U.S. transferor that is a 
section 1248 shareholder of a foreign acquired corporation and that 
transfers the stock of such corporation to a foreign acquiring 
corporation in a section 361 exchange to include in income the section 
1248 amount attributable to the stock of the foreign acquired 
corporation. The U.S. transferor must include the section 1248 amount 
in income even if the foreign acquiring corporation and the foreign 
acquired corporation are CFCs with respect to which the U.S. transferor 
is a section 1248 shareholder immediately after the section 361 
exchange. See Sec.  1.367(b)-4(b)(1)(iii), Example 4. Moreover, under 
section 1248(f)(1) the U.S. transferor generally would be required to 
include in income the section 1248 amount attributable to the stock of 
the foreign acquiring corporation distributed under section 361(c)(1). 
The section 1248 amount attributable to the stock of the foreign 
acquiring corporation would generally include the section 1248 amount 
attributable to the stock of the foreign acquired corporation. See 
generally Sec.  1.1248-8.
    The final regulations (TD 9243) under section 367(b) issued on 
January 26, 2006 (2006 final regulations) provided an exception to the 
general rule of Sec.  1.367(b)-4(b)(1)(i) that applies in certain 
triangular reorganizations where the exchanging shareholder receives 
stock of a domestic corporation that controls the foreign acquiring 
corporation. This exception only applies, however, to a shareholder 
that exchanges stock of the foreign acquired corporation for stock of 
the domestic corporation in an exchange described under section 354 or 
356. Thus, the exception provided by the 2006 final regulations does 
not apply where the U.S. transferor receives stock of a domestic 
controlling corporation for stock of a foreign acquired corporation in 
a section 361 exchange.
    After studying the issue further and in response to comments 
received, the IRS and Treasury Department have determined that 
requiring the U.S. transferor to include the section 1248 amount in 
income may not be necessary in cases where the section 1248 amount 
attributable to the stock of the foreign acquired corporation can be 
preserved. Accordingly, the proposed regulations under section 367(b) 
included in this document provide an additional exception to the 
general rule of the 2000 final regulations that applies to certain 
transfers of stock of a foreign acquired corporation by a U.S. 
transferor to a foreign acquiring corporation in a section 361 
exchange.
    In such a case, the proposed regulations provide that the U.S. 
transferor must include in income the section 1248 amount attributable 
to the stock of the foreign acquired corporation only if immediately 
after the section 361 exchange the foreign acquiring corporation or the 
foreign acquired corporation is not a CFC with respect to which the 
U.S. transferor is a section 1248 shareholder. Example 4 in Sec.  
1.367(b)-4(b)(1)(iii) is modified accordingly. The proposed regulations 
under section 1248(f) included in this document supplement this 
exception to ensure that the section 1248 amount can be preserved in 
the hands of a corporate section 1248 shareholder following the 
distribution of the stock of the foreign acquiring corporation by the 
U.S. transferor. See part C of this preamble for discussion of the 
proposed regulations under section 1248(f).
3. Special Rules for Outbound Triangular Asset Reorganizations
    As noted, the 2000 final regulations also require the U.S. 
transferor to include in income the section 1248 amount attributable to 
stock of a foreign acquired corporation transferred to a foreign 
acquiring corporation in a section 361 exchange that is part of 
triangular asset reorganization, even if the corporation that controls 
the foreign acquiring corporation is domestic. The provisions of Sec.  
1.367(b)-13 (TD 9243) do not apply to preserve the section 1248 amount 
attributable to the stock of the foreign acquired corporation in such a 
case. The proposed regulations under section 367(b) included in this 
document, however, would provide an exception to the general rule of 
the final 2000 regulations in such triangular asset reorganizations.
    If the controlling corporation is foreign, the exception applies 
if, immediately after the section 361 exchange, the foreign controlling 
corporation, the foreign acquiring corporation, and the foreign 
acquired corporation are CFCs with respect to which the U.S. transferor 
is a section 1248 shareholder. If the controlling corporation is 
domestic, the exception applies if, immediately after the section 361 
exchange, the foreign acquired corporation is a CFC with respect to 
which the domestic controlling corporation is a section 1248 
shareholder. In addition, in either case, the controlling corporation 
(foreign or domestic) must apply the principles of Sec.  1.367(b)-13 to 
determine the adjustment to the basis of the stock of the foreign 
acquiring corporation (instead of the over-the-top basis adjustment 
rules of Sec.  1.358-6) to ensure that the section 1248 amount 
attributable to the stock of the foreign acquired corporation at the 
time of the section 361 exchange is preserved in the stock of the 
foreign acquiring corporation immediately after the section 361 
exchange. Under these principles, each share of stock of the foreign 
acquiring corporation would generally be divided into the portions 
necessary to preserve the pre-exchange section 1248 amounts 
attributable to the stock of the foreign acquired corporation and the 
foreign acquiring corporation, respectively. If the controlling 
corporation is foreign, the proposed regulations under section 1248(f) 
included in this document supplement this exception to ensure that the 
section 1248 amount can be preserved following the distribution of the 
stock of the foreign controlling corporation by the U.S. transferor to 
its shareholders.

[[Page 49284]]

C. Section 1248(f)

1. Overview
    Section 1248(f)(1) provides that, except as provided in 
regulations, if a domestic corporation (domestic distributing 
corporation) that is a section 1248 shareholder with respect to a 
foreign corporation distributes the stock of such foreign corporation 
in a distribution described in section 311(a), 337, 355(c)(1), or 
361(c)(1), then notwithstanding any other provisions of the Code, the 
domestic distributing corporation must include in income as a dividend 
the section 1248 amount attributable to such stock. Section 1248(f)(1) 
requires the inclusion of the section 1248 amount because the section 
1248 amount attributable to the stock distributed may not be preserved 
in the hands of the distributee shareholders following the 
distribution. Section 1248(f)(1) does not apply to the extent the 
domestic distributing corporation otherwise recognizes gain on the 
distribution, in which case the gain recognized would be 
recharacterized as a dividend under section 1248(a), as appropriate.
    Section 1248(f)(2), however, provides that section 1248(f)(1) shall 
not apply to a domestic distributing corporation's distribution of 
stock of a foreign corporation to a domestic corporation that is 
treated as holding the stock for the period during which the stock was 
held by the domestic distributing corporation and that, immediately 
after the distribution, is a section 1248 shareholder with respect to 
the foreign corporation. The legislative history explains that where 
``the corporate distribute[e] does not receive a stepped up basis as a 
result of the distribution and* * *the potential for the future 
application of section 1248 still exists, it is not necessary to [apply 
section 1248(f)(1) to] override the nonrecognition provisions which 
otherwise apply to a corporate distribution.'' S. Rep. No. 94-938, at 
270 (1976).
    The legislative history provides that the Treasury Department may 
exercise the regulatory authority granted under section 1248(f)(1) to 
provide that, where section 1248(f)(2) does not otherwise apply, ``the 
recipient corporation may be required to take a carryover basis in the 
stock received (rather than a substituted basis under section 358, for 
example, in the case of a section 355 or 361 distribution) and section 
1248(f)(1) will not apply to such distribution.'' S. Rep. No. 100-445, 
at 64 (1988).
    In Notice 87-64 (1987-2 CB 375), the IRS and Treasury Department 
announced that, in the case of section 355 distributions of CFC stock, 
regulations under section 1248(f) may limit the application of section 
1248(f)(1) to distributions in which the CFC is no longer a CFC after 
the distribution or in which one or more of the distributees are not 
United States shareholders (within the meaning of section 951(b)) of 
the CFC after the distribution. The notice further states that the 
regulations would ensure that, subsequent to a section 355 distribution 
of CFC stock that would not be subject to section 1248(f)(1) under the 
regulations, the amount of gain recognized from a disposition of the 
CFC stock that would be recharacterized as a dividend under section 
1248(a) would include the earnings and profits attributable to the CFC 
stock under section 1248 as of the date of the section 355 
distribution. To achieve this result, the notice provides that the 
regulations may require appropriate adjustments to the basis and 
holding period of the CFC stock received by one or more of the 
distributees.
2. General Rules
    The proposed regulations under section 1248(f) included in this 
document provide that a domestic distributing corporation that is a 
section 1248 shareholder of a foreign corporation and that distributes 
stock of such foreign corporation in a distribution to which section 
337 applies (section 337 distribution), shall generally include in 
income as a dividend the section 1248 amount attributable to the stock 
distributed.
    The proposed regulations further provide that a domestic 
distributing corporation that is a section 1248 shareholder of a 
foreign corporation and that distributes stock of such foreign 
corporation in a section 355 distribution, other than stock received by 
the domestic distributing corporation in a section 361 exchange, shall 
generally include in income as a dividend the section 1248 amount 
attributable to the stock distributed. This rule applies, however, only 
to the extent the domestic distributing corporation does not otherwise 
recognize gain on the section 355 distribution, in which case the gain 
recognized would be recharacterized as a dividend under section 
1248(a), as appropriate.
    Finally, the proposed regulations provide that a domestic 
distributing corporation that is a section 1248 shareholder of a 
foreign distributed corporation and that distributes stock of such 
corporation received in a section 361 exchange, in a section 355 
distribution or a distribution to which section 361 applies (section 
361 distribution), shall, notwithstanding any other provision of the 
Code, include in income as a dividend the ``section 1248(f) amount'' 
attributable to the stock distributed. The section 1248(f) amount 
equals the aggregate amount that would be included in income as a 
dividend by the foreign distributed corporation under section 964(e) 
if, immediately after the section 361 exchange that preceded the 
section 355 distribution or section 361 distribution, the foreign 
distributed corporation sold the stock of each foreign corporation 
received in the section 361 exchange. This rule supplements the 
proposed regulations under section 367(b) which provide an exception to 
the general rule of Sec.  1.367(b)-4(b)(1)(i) in certain cases where 
stock of a foreign acquired corporation is transferred by a U.S. 
transferor in a section 361 exchange.
3. Exceptions to the General Rules
    The proposed regulations incorporate the statutory exception 
provided by section 1248(f)(2) for distributions that meet certain 
conditions. The proposed regulations also provide elective exceptions 
for section 355 distributions and section 361 distributions. The 
exceptions for such distributions are elective because applying the 
exceptions may reduce a corporate distributee's section 358 basis in 
the stock received in the distribution. The conditions of the 
exceptions carry out the policy of section 1248(f) by limiting the 
exceptions to distributions where the potential application of section 
1248 and the relevant section 1248 amounts can be preserved following 
the distribution.
(a) Section 337 Distributions
    The general rule will not apply to a section 337 distribution of 
the stock of a foreign corporation if immediately after the 
distribution the 80-percent distributee (described in section 337(c)) 
is a section 1248 shareholder with respect to the foreign corporation, 
the 80-percent distributee's holding period in the stock received in 
the distribution is the same as the domestic distributing corporation's 
holding period in such stock at the time of the distribution, and the 
80-percent distributee's basis in the stock received in the 
distribution is not greater than the domestic distributing 
corporation's basis in such stock at the time of the distribution.
    The IRS and Treasury Department believe the conditions should be 
satisfied in most section 337 distributions because of the application 
of sections 334 and 1223. However, comments are requested regarding any

[[Page 49285]]

cases where these conditions may not be met and whether the 80-percent 
distributee should be permitted to adjust the basis or holding period 
of the stock received so that the conditions can be met.
(b) Certain Section 355 Distributions
    The proposed regulations provide an elective exception to the 
general rule for a section 355 distribution of stock of a foreign 
corporation not received by the domestic distributing corporation in a 
section 361 exchange to a domestic corporation that is a section 1248 
shareholder with respect to the foreign corporation immediately after 
the distribution. The election to apply the exception is irrevocable 
and must be made by the domestic distributing corporation and all such 
section 1248 shareholders. If the election is made, adjustments may be 
made to each section 1248 shareholder's section 358 basis and holding 
period in the stock received to preserve the section 1248 amount 
attributable to such stock at the time of the distribution.
    To apply the exception, the proposed regulations require the 
domestic distributing corporation and the section 1248 shareholders to 
enter into a written agreement on or before the due date (including 
extensions) of the domestic distributing corporation's tax return for 
the taxable year during which the section 355 distribution occurs. The 
proposed regulations also require the domestic distributing corporation 
and each section 1248 shareholder to include a statement with its tax 
return for the taxable year during which the distribution occurs 
reporting that the election to apply the exception has been made and 
any required adjustments to stock basis or holding period. Each party 
to the agreement must retain the original or a copy of the agreement as 
part of its records. The proposed regulations provide relief for 
reasonable cause for the failure to comply with the election and 
reporting requirement.
    If the exception applies, two adjustments may be required with 
respect to each section 1248 shareholder. First, solely for purposes of 
section 1248, immediately following the distribution the section 1248 
shareholder's holding period in the stock received in the distribution 
shall equal the domestic distributing corporation's holding period in 
such stock at the time of the distribution. Second, if the section 1248 
amount attributable to the stock of the foreign corporation at the time 
of the distribution exceeds the section 1248 shareholder's 
postdistribution amount attributable to such stock (excess amount), the 
section 1248 shareholder's section 358 basis in such stock is reduced 
by the excess amount. The postdistribution amount is the section 1248 
shareholder's section 1248 amount attributable to the stock received in 
the distribution, computed immediately after the distribution and 
taking into account the adjustment to the shareholder's holding period 
in such stock.
(c) Distributions Pursuant to a Plan of Reorganization
    The proposed regulations provide an elective exception to the 
general rule for a section 355 distribution or section 361 distribution 
of stock of a foreign corporation received by the domestic distributing 
corporation in the section 361 exchange that precedes such distribution 
to a domestic corporation that is a section 1248 shareholder with 
respect to the foreign corporation immediately after the distribution. 
The election to apply the exception is irrevocable and must be made by 
the domestic distributing corporation and all such section 1248 
shareholders. If the exception applies, adjustments may be made to each 
section 1248 shareholder's section 358 basis (as adjusted under the 
proposed regulations under section 367(a)(5)) and the amount of 
earnings and profits attributable to the stock received for purposes of 
section 1248 to preserve the section 1248(f) amount attributable to 
such stock at the time of the distribution.
    To apply the exception, the proposed regulations require the 
domestic distributing corporation and the section 1248 shareholders to 
enter into a written agreement on or before the due date (including 
extensions) of the domestic distributing corporation's tax return for 
the taxable year during which the distribution occurs. The proposed 
regulations also require the domestic distributing corporation and each 
section 1248 shareholder to include a statement with its tax return for 
the taxable year during which the distribution occurs reporting that 
the election to apply the exception has been made and any required 
adjustments to stock basis or the amount of earnings and profits 
attributable to the stock received for purposes of section 1248. Each 
party to the agreement must include the original or a copy of the 
agreement as part of its records. The proposed regulations provide 
relief for reasonable cause for the failure to comply with the election 
and reporting requirements.
    If the exception applies, two adjustments may be required with 
respect to each section 1248 shareholder. First, each share of stock of 
the foreign corporation received by the section 1248 shareholder is 
divided into portions attributable to each block of stock of a foreign 
acquired corporation transferred by the domestic distributing 
corporation in the section 361 exchange with respect to which the 
domestic distributing corporation was a section 1248 shareholder at the 
time of the section 361 exchange, and to all other property transferred 
by the domestic distributing corporation in the section 361 exchange. 
For example, if in the section 361 exchange the domestic distributing 
corporation transfers a block of stock in each of three foreign 
corporations with respect to which it is a section 1248 shareholder, 
then each share of stock of the foreign distributed corporation 
received by the section 1248 shareholder must be divided into three 
portions. Alternatively, if multiple blocks of stock in each of the 
three foreign corporations were transferred in the section 361 
exchange, then each share of the stock of the foreign distributed 
corporation would be divided into additional portions to account for 
the additional blocks of stock transferred. The proposed regulations 
further provide that, for purposes of section 1248, the earnings and 
profits attributable to each block of stock of a foreign acquired 
corporation transferred in the section 361 exchange that results in a 
divided portion of a share of stock of the foreign acquiring 
corporation (or whole share, if no division is required) are 
attributable to such portion (or whole share, if no division is 
required) based on the section 1248 shareholder's ownership interest 
(by value) in the domestic distributing corporation at the time of the 
section 361 exchange.
    Second, if the section 1248(f) amount attributable to a portion of 
a share (or whole share, if no division is required) of stock of the 
foreign distributed corporation received in the distribution exceeds 
the section 1248 shareholder's postdistribution amount attributable to 
such portion (or whole share) (excess amount), then the section 1248 
shareholder's section 358 basis in such portion (or whole share, if no 
division is required), as adjusted under the proposed regulations under 
section 367(a)(5) (discussed in part A.2.b.iii of this preamble), is 
reduced by such excess amount. This adjustment ensures that the section 
1248 shareholder's share of the section 1248 amount attributable to the 
stock of each foreign acquired corporation transferred in the section 
361 exchange is preserved in the stock of the foreign distributed

[[Page 49286]]

corporation received by such shareholder in the distribution.
    The IRS and Treasury Department declined to adopt rules that would 
not require the division of shares to preserve section 1248 amounts 
because such rules could inappropriately increase or decrease the 
section 1248 amount attributable to the stock of the foreign 
distributed corporation received by a section 1248 shareholder in the 
distribution. For example, if in the section 361 exchange the domestic 
distributing corporation transferred appreciated tangible property and 
stock of a CFC with earnings and profits for purposes of section 
1248(a) in excess of the built-in gain in such stock, then the 
appreciation in the tangible property could inappropriately increase 
the section 1248 amount attributable to the stock of the foreign 
distributed corporation received by a section 1248 shareholder in the 
distribution (to the extent the CFC's earnings and profits exceed the 
section 1248 amount attributable to the CFC stock at the time of the 
section 361 exchange). A similar inappropriate increase would result if 
the domestic distributing corporation transferred appreciated stock of 
two CFCs in the section 361 exchange, one CFC without a section 1248 
amount and the other CFC with a section 1248 amount but with earnings 
and profits for purposes of section 1248 in excess of such section 1248 
amount.
    The IRS and Treasury Department also declined to adopt rules that 
would preserve any reduction to a section 1248 shareholder's section 
358 basis in a portion of a share (or whole share, if no division is 
required) of stock of the foreign distributed corporation received in 
the distribution by increasing the basis of other portions of the share 
(or other whole shares, if no division is required) of stock or by 
establishing a suspended basis account equal to the basis reduction. 
Those rules were not adopted because a capital loss would be created 
that could economically offset the section 1248 amount, which would not 
be consistent with the policy underlying section 1248(f) and the 
regulations described in Notice 87-64. S. Rep. No. 94-938, at 270 
(1976).
    Comments are requested on how the rules of the proposed regulations 
can be simplified and how the rules should apply to different classes 
of stock.
4. Section 964(e) and Inclusions Under Section 367(b)
    Comments are requested regarding whether the IRS and Treasury 
Department should exercise the authority under section 367(b) to apply 
the principles of section 1248(f)(1) to section 355 distributions or 
section 361 distributions of stock of a foreign corporation by a CFC, 
to the extent the transaction does not otherwise result in an income 
inclusion to the exchanging shareholders of the CFC under section 
367(b) and the regulations under that section. Comments should consider 
the appropriate balance between the policy of sections 1248(a) and 
964(e) and the associated complexity and compliance burdens.

D. Changes to Exception to Coordination Rule of Sec.  1.367(a)-
3(d)(2)(vi)(A)

1. Overview
    Section 1.367(a)-3(d)(2)(vi)(A) (the coordination rule) provides 
that if, in connection with an indirect stock transfer, a U.S. person 
transfers assets to a foreign corporation (direct asset transfer) in an 
exchange described in section 351 or section 361, the rules of section 
367 and the regulations under that section shall first apply to the 
direct asset transfer and then to the indirect stock transfer. However, 
an exception to the coordination rule (coordination rule exception) 
provides that section 367(a) and (d) shall not apply to a direct asset 
transfer otherwise subject to the coordination rule to the extent that 
assets transferred by a domestic acquired corporation to a foreign 
acquiring corporation in an asset reorganization are re-transferred to 
a domestic corporation controlled by the foreign acquiring corporation 
(domestic controlled corporation), but only if the domestic controlled 
corporation's basis in the retransferred assets is not greater than the 
domestic acquired corporation's basis in such assets and other 
conditions are satisfied. See Sec.  1.367(a)-3(d)(2)(vi)(B)(1).
    The 2006 final regulations established the conditions for the 
application of the coordination rule exception. The preamble to the 
notice of proposed rulemaking that preceded the 2006 final regulations 
explained that the conditions were adopted to limit the use of asset 
reorganizations subject to the coordination rule that might facilitate 
inversion transactions and certain divisive transactions. See REG-
125628-01 (issued January 5, 2005).
2. Clarification of Conditions for Application of the Coordination Rule 
Exception
    In response to transactions intended to use the coordination rule 
exception inappropriately to repatriate earnings and profits of foreign 
corporations without the recognition of gain or a dividend inclusion, 
the IRS and Treasury Department issued Notice 2008-10 (2008-3 IRB 277). 
The notice announced that the conditions for the application of the 
coordination rule exception would be revised to clarify that any 
adjustment to basis required under section 367(a)(5) must be made to 
the basis of stock of the foreign acquiring corporation received by the 
control group members in the asset reorganization such that the 
appropriate amount of built-in gain in the property transferred by the 
domestic acquired corporation to the foreign acquiring corporation is 
reflected in such stock. The notice clarifies that the control group 
members cannot satisfy the basis adjustment requirement by adjusting 
the basis of stock of the foreign acquiring corporation held before the 
reorganization. The notice further states that the revised regulations 
would confirm that to the extent the appropriate amount of built-in 
gain in the property transferred by the domestic acquired corporation 
cannot be preserved in the stock received by the control group members 
in the reorganization, then the domestic acquired corporation's 
transfer of property to the foreign acquiring corporation shall be 
subject to section 367(a) and (d).
    The proposed regulations included in this document incorporate, 
with modifications, the clarifications to the conditions for the 
application of the coordination rule exception announced in the notice. 
The proposed regulations also provide that to the extent any of the re-
transferred assets constitutes section 367(d) property, the 
coordination rule exception shall apply only if the section 367(d) 
property is treated as section 367(a) property for purposes of 
satisfying the conditions and requirements of section 367(a)(5) and the 
regulations under that section. Thus, for example, any gain that the 
U.S. transferor must recognize on the direct asset transfer or any 
adjustment required to a control group member's section 358 basis in 
stock received in the transaction must take into account any inside 
gain attributable to section 367(d) property (treated as section 367(a) 
property for purposes of determining such inside gain) that is part of 
the re-transferred assets.
    The IRS and Treasury Department continue to study transactions that 
have the effect of repatriating earnings and profits of foreign 
corporations without the recognition of gain or a dividend inclusion. 
Temporary regulations were recently issued (TD 9400 and TD 9402) under 
sections 367(b) and 956(e) to address the inappropriate use of certain 
cross-border triangular reorganizations

[[Page 49287]]

and other nonrecognition transactions to repatriate earnings and 
profits of a foreign corporation without the recognition of gain or a 
dividend inclusion. The IRS and Treasury Department are evaluating 
other transactions that have a similar effect to determine whether 
guidance is appropriate. In particular, the IRS and Treasury Department 
are analyzing whether it is appropriate for the gain limitation rule of 
section 356(a)(1) to apply in an acquisitive asset reorganization 
involving a foreign acquiring corporation, considering that a policy of 
section 367(b) is ``to protect against tax avoidance in transfers to 
foreign corporations and upon the repatriation of previously untaxed 
foreign earnings.'' H.R. Rep. No. 94-658 (1975). Comments are requested 
in this regard, including whether the application of any such guidance 
should be limited to cases where section 356(a)(2) would otherwise 
apply to the shareholder's receipt of non-qualifying property.
    The IRS and Treasury Department also continue to study whether 
appropriate modifications should be made to the ``all earnings and 
profits'' inclusion requirement of Sec.  1.367(b)-3(b) when a domestic 
corporation acquires the assets of a foreign corporation pursuant to an 
acquisitive asset reorganization under section 368(a)(1) and then 
transfers all or part of the acquired assets to another foreign 
corporation in a transaction described in Sec.  1.368-2(k). Comments 
are requested in this regard, including regarding the appropriate 
adjustment to the domestic corporation's basis in the stock of the 
foreign corporation to which the acquired assets are transferred to 
ensure that the basis of such stock reflects an after-tax amount.

E. Other Proposed Regulations Under Section 367(a)

    The proposed regulations under section 367(a) would revise current 
Sec.  1.367(a)-1T(b)(4)(i)(B) to provide that an increase to basis for 
the amount of gain recognized by a U.S. person under section 367(a) in 
connection with a transfer of property to a foreign corporation is 
allocated among the transferred property with respect to which gain is 
recognized in proportion to the gain realized by the U.S. person on the 
transfer of such property. The IRS and Treasury Department believe the 
current temporary regulation may produce inappropriate results because 
it allocates the basis increase among the transferred property with 
respect to which gain is recognized in proportion to the amount 
realized by the U.S. person on the transfer of such property.
    The proposed regulations also clarify that a transfer of property 
by a U.S. person to a foreign corporation that is subject to section 
367(a) is not recharacterized for U.S. Federal tax purposes merely 
because the U.S. person is required to recognize gain in connection 
with such transfer under section 367(a). For example, if a U.S person 
transfers appreciated stock of a CFC to another CFC in a section 351 
exchange, the section 351 exchange is not recharacterized as other than 
a section 351 exchange for U.S. Federal tax purposes merely because the 
U.S. person recognizes gain in connection with the exchange under 
section 367(a).

F. Other Proposed Regulations Under Section 1248

    The proposed regulations under section 1248(a) remove as deadwood 
an exception from the application of section 1248(a) for gain 
recognized under section 356. In addition, consistent with Notice 87-
64, the proposed regulations under section 1248(e) suspend the 
application of section 1248(e) for periods when capital gains are taxed 
at a rate that equals or exceeds the rate of tax on ordinary income.

G. Effective/Applicability Dates

1. Sections 367(a)(5) and 6038B
    Section 1.367(a)-7 and the revisions to Sec.  1.6038B-1 apply to 
transfers occurring on or after the date that is 30 days after the date 
these regulations are published as final regulations in the Federal 
Register.
2. Section 1248(e)
    In accordance with Notice 87-64 (1987-2 CB 375), Sec.  1.1248-6(d) 
(suspending application of section 1248(e)) applies to sales, 
exchanges, or other dispositions of stock of a domestic corporation 
occurring on or after September 21, 1987.
3. Changes to Coordination Rule Exception
    The revisions to Sec.  1.367(a)-3(d)(2)(vi)(B)(1) and (2) described 
in Notice 2008-10 (2008-3 IRB 277) generally apply to transactions 
occurring on or after December 28, 2007. The requirement to treat 
section 367(d) property as section 367(a) property for purposes of the 
coordination rule exception (as discussed in part D.2 of this preamble) 
applies to transactions occurring on or after August 19, 2008.
4. Sections 1248(f) and 367(b)
    Section 1.1248-8(b)(2)(iv), Sec. Sec.  1.1248(f)-1 through 
1.1248(f)-3, and the modifications to Sec.  1.367(b)-4 apply to 
transfers or distributions occurring on or after the date that is 30 
days after the date these regulations are published as final 
regulations in the Federal Register.

H. Adjustments Under Section 367(a)(5) Before Final Regulations Are 
Published

    The general rule of section 367(a)(5) is that the exceptions to 
section 367(a)(1) provided by section 367(a)(2) and (a)(3) are not 
available for a transfer of property by a domestic corporation to a 
foreign corporation in a section 361 exchange, including a section 351 
exchange that also qualifies as a section 361 exchange. However, until 
the date that is 30 days after the date these regulations are published 
as final regulations, taxpayers may make reasonable adjustments, as 
described in the legislative history to section 367(a)(5), that are 
consistent with the policy of section 367(a)(5) so that the exceptions 
provided by section 367(a)(2) and (a)(3) may apply to the transfer of 
property by a U.S. transferor to a foreign corporation in a section 361 
exchange.
    Reasonable adjustments must include adjusting the basis of the 
stock received by the control group members in the transaction that is 
attributable to section 367(a) property so that each control group 
member's basis of such stock equals the lesser of (1) the control group 
member's section 358 basis in the stock or (2) the control group 
member's proportionate share of the basis of the section 367(a) 
property transferred by the U.S. transferor in the section 361 
exchange. Adjusting the basis of stock of the foreign acquiring 
corporation held by a control group member before the section 361 
exchange shall not be a reasonable adjustment.
    In addition, the U.S. transferor must recognize gain to the extent 
it has shareholders that are not control group members and to the 
extent any built-in gain in the section 367(a) property transferred in 
the section 361 exchange cannot be preserved in the hands of the 
control group members through their ownership of stock received in the 
transaction in exchange for the stock or securities of the U.S. 
transferor. For example, the U.S. transferor may recognize gain if the 
control group members receive non-qualifying property in the 
transaction, if the foreign acquiring corporation assumes liabilities 
of the U.S. transferor in the section 361 exchange, or if the U.S. 
transferor distributes the stock received in the section 361 exchange

[[Page 49288]]

disproportionately to its shareholders. For this purpose, the stock or 
other property received by the U.S. transferor in the section 361 
exchange must be allocated between the section 367(a) property and all 
other property transferred in the section 361 exchange consistent with 
general tax principles, including the principles of Rev. Rul. 68-55, 
1968-1 CB 140, and the authorities cited therein.
    Adjustments made in accordance with the proposed regulations under 
section 367(a)(5) included in this document shall be considered 
reasonable and in accordance with the policy of section 367(a)(5).

Availability of IRS Documents

    IRS notices cited in this preamble are made available by the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402.

Effect on Other Documents

    The following publications are proposed to be obsolete as of the 
date 30 days after the date these regulations are published as final 
regulations in the Federal Register:
    Notice 87-64 (1987-2 CB 375).
    Notice 2008-10 (2008-3 IRB 277).

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. Section 553(b) of 
the Administrative Procedure Act (5 U.S.C. chapter 5) and the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) apply to these 
regulations.
    It is hereby certified that the collection of information contained 
in this regulation will not have a significant economic impact on a 
substantial number of small entities. Accordingly, a regulatory 
flexibility analysis is not required. This regulation primarily will 
affect large domestic corporations engaged in cross-border corporate 
transactions. Thus, the number of affected small entities will not be 
substantial. A certain number of small domestic corporations may be 
shareholders of a larger domestic corporation the stock or assets of 
which are acquired by a foreign corporation in connection with an asset 
reorganization, and such shareholders may be required to make certain 
adjustments in the stock of the foreign acquiring corporation. 
Nonetheless, the IRS and Treasury Department do not anticipate the 
number of such shareholders to be substantial. Furthermore, the IRS and 
Treasury Department estimate that any small entities that are affected 
by the regulations will likely face a burden of approximately ten hours 
(at an hourly rate of $200) from the adjustments made to the basis of 
the stock received in the reorganization. Considering that the 
collections of information enable taxpayers to defer or avoid the 
recognition of potentially large amounts of gain, the IRS and Treasury 
Department believe that $2000 is not a significant economic impact. 
Comments about the accuracy of this certification may be submitted to 
the addresses provided in the preamble. Pursuant to section 7805(f) of 
the Internal Revenue Code, this regulation has been submitted to the 
Administrator of the Small Business Administration for comment on their 
impact on small business.

Comments and Request for a Public Hearing

    Before these regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any person that timely submits written 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 author of these regulations is Daniel McCall of the 
Office of Associate Chief Counsel (International), within the Office of 
Chief Counsel, Internal Revenue Service. Other personnel from offices 
of the IRS and Treasury Department participated in developing the 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Corporations, Corporate distributions, Corporate 
adjustments, Reorganizations.

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 * * *

    Section 1.367(a)-3(d)(2)(vi)(B)(1)(i) also issued under 26 
U.S.C. 367(d).
    Section 1.367(a)-7 also issued under 26 U.S.C. 367(a), (b), (c), 
and 337(d).
    Section 1.1248-6 also issued under 26 U.S.C. 1248(e).
    Section 1.1248-8(b)(2)(iv) also issued under 26 U.S.C. 1248(a), 
(c), and (f).
    Section 1.1248(f)-1 also issued under 26 U.S.C. 367(b) and 
1248(f).

    Section 1.1248(f)-2 also issued under 26 U.S.C. 367(b) and 
1248(f).
    Section 1.1248(f)-3 also issued under 26 U.S.C. 367(b) and 
1248(f).* * *
    Par. 2. Section 1.358-6 is amended by adding a new sentence at 
the end of paragraph (e) to read as follows:


Sec.  1.358-6  Stock basis in certain triangular reorganizations.

* * * * *
    (e) * * * For rules relating to certain triangular reorganizations 
involving transfers to which the exception provided in Sec.  1.367(a)-
7(c) applies, see Sec.  1.367(b)-4(b)(1)(ii)(B).
* * * * *
    Par. 3. Section 1.367(a)-1T is amended by:
    1. Revising the second sentence of paragraph (b)(4)(i)(B).
    2. Adding new paragraphs (b)(4)(i)(C) and (g)(4).
    The revision and additions to read as follows:


Sec.  1.367(a)-1T  Transfers to foreign corporations subject to section 
367(a): In general (temporary).

* * * * *
    (b) * * *
    (4) * * *
    (i) * * *
    (B) * * * Any increase in the basis of the property received by the 
foreign corporation under section 362(a) or (b) for gain recognized by 
a U.S. person due to the application of section 367(a) shall be 
allocated to the transferred property with respect to which gain is 
recognized in proportion to the gain realized by the U.S. person on the 
transfer of such property. * * *
    (C) A transfer of property by a U.S. person to a foreign 
corporation shall not be recharacterized for U.S. Federal tax purposes 
solely because the U.S. person recognizes gain in connection with the 
transfer under section 367(a)(1). For example, if a U.S. person 
transfers appreciated stock or securities to a foreign corporation in 
an exchange described in section 351, the transfer is not 
recharacterized as other than an exchange described in section 351 
solely because the U.S. person recognizes gain in connection with the 
transfer under section 367(a)(1).
* * * * *

[[Page 49289]]

    (g) * * *
    (4) The rules in paragraphs (b)(4)(i)(B) and (C) of this section 
apply to transfers occurring on or after the date 30 days after the 
date these regulations are published as final regulations in the 
Federal Register. For guidance with respect to paragraph (b)(4)(i)(B) 
of this section before the date 30 days after the date these 
regulations are published as final regulations in the Federal Register, 
see 26 CFR part 1 revised as of April 1 for the year before the date 
these regulations are published as final regulations in the Federal 
Register.
    Par. 4. Section 1.367(a)-3 is amended by:
    1. Revising the third to the last sentence of paragraph (a).
    2. Revising paragraphs (b)(1) and (c)(1).
    3. Revising paragraphs (d)(2)(vi)(B)(1) and (d)(2)(vi)(B)(1)(i).
    4. Adding two new sentences at the end of paragraph 
(d)(2)(vi)(B)(2).
    5. Revising the first and fourth sentences of paragraph (d)(3), 
Example 6A (ii).
    6. Revising the second and fifth sentences of paragraph (d)(3), 
Example 6B (ii), and add two new sentences after the fifth sentence.
    7. Revising the second and fourth sentences of paragraph (d)(3), 
Example 6C (ii).
    8. Adding a new sentence between the second and third sentences of 
paragraph (d)(3), Example 8 (ii).
    9. Revising the first sentence of paragraph (d)(3), Example 8B 
(ii).
    10. Revising the first sentence of paragraph (d)(3), Example 8C 
(ii).
    11. Revising the second sentence of paragraph (d)(3), Example 9 
(ii), and removing the third sentence.
    12. Revising the third sentence of paragraph (d)(3), Example 10 
(ii).
    13. Revising the second to last sentence of paragraph (d)(3), 
Example 11 (ii), and adding a new sentence after the second to last 
sentence.
    14. Revising the second sentence of paragraph (d)(3), Example 12 
(ii), and removing the last sentence.
    15. The heading for paragraph (g) is revised.
    16. Paragraph (g)(1)(E) is revised.
    The revisions and additions to read as follows:


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

    (a) * * * For additional rules regarding a transfer of stock or 
securities in an exchange described in section 361(a) or (b), see 
section 367(a)(5) and Sec.  1.367(a)-7. * * *
    (b) Transfers by U.S. persons of stock or securities of foreign 
corporations to foreign corporations--(1) General rule. Except as 
provided in Sec.  1.367(a)-7, a transfer of stock or securities of a 
foreign corporation by a U.S. person to a foreign corporation that 
would otherwise be subject to section 367(a)(1) under paragraph (a) of 
this section shall not be subject to section 367(a)(1) if either--
* * * * *
    (c) Transfers by U.S. persons of stock or securities of domestic 
corporations to foreign corporations--(1) In general. Except as 
provided in Sec.  1.367(a)-7, a transfer of stock or securities of a 
domestic corporation by a U.S. person to a foreign corporation that 
would otherwise be subject to section 367(a)(1) under paragraph (a) of 
this section shall not be subject to section 367(a)(1) if the domestic 
corporation the stock or securities of which are transferred (referred 
to as the U.S. target company) complies with the reporting requirements 
in paragraph (c)(6) of this section and if each of the following four 
conditions is met:
* * * * *
    (d) * * *
    (2) * * *
    (vi) * * *
    (B) Exceptions. (1) If a transaction is described in paragraph 
(d)(2)(vi)(A) of this section, section 367(a) and (d) shall not apply 
to the extent a domestic corporation (domestic acquired corporation) 
transfers assets to a foreign corporation (foreign acquiring 
corporation) in an asset reorganization, and such assets (re-
transferred assets) are transferred to a domestic corporation (domestic 
controlled corporation) in a controlled asset transfer, provided that 
the domestic controlled corporation's basis in the re-transferred 
assets is not greater than the domestic acquired corporation's basis in 
such assets and the conditions contained in paragraphs 
(d)(2)(vi)(B)(1)(i) or (d)(2)(vi)(B)(1)(ii) of this section are 
satisfied. For purposes of determining whether the domestic controlled 
corporation's basis in the re-transferred assets is not greater than 
the domestic acquired corporation's basis in such assets, the domestic 
acquired corporation's basis in the re-transferred assets shall reflect 
any increase in basis due to gain recognized by the domestic acquired 
corporation on the transfer of the re-transferred assets to the foreign 
acquiring corporation.
    (i) The conditions and requirements of section 367(a)(5) and Sec.  
1.367(a)-7(c) are satisfied with respect to the domestic acquired 
corporation's transfer of assets to the foreign acquiring corporation. 
To the extent any of the re-transferred assets constitutes property to 
which section 367(d) applies (section 367(d) property), however, the 
exception under paragraph (d)(2)(iv)(B)(1) shall apply only if such 
property is treated as property subject to section 367(a) for purposes 
of satisfying the conditions and requirements of section 367(a)(5) and 
Sec.  1.367(a)-7(c). The preceding sentences shall apply before the 
application of the exception under paragraph (d)(2)(vi)(B)(1) of this 
section. See paragraph (g)(1)(E)(3) of this section for rules under 
this paragraph (d)(2)(vi)(B)(1)(i) that apply to transactions that 
occur on or after December 28, 2007, and before the date 30 days after 
the date these regulations are published as final regulations in the 
Federal Register.
* * * * *
    (2) * * * This paragraph (d)(2)(vi)(B)(2) shall not, however, apply 
to an exchange described in section 351 that is also an exchange 
described in section 361(a) or (b). An exchange described in section 
351 that is also an exchange described in section 361(a) or (b) is only 
eligible for the exception in paragraph (d)(2)(vi)(B)(1) of this 
section.
* * * * *
    (3) * * *
    Example 6A. * * *
    (ii) * * * The transfer of the Business A assets by Z to F does not 
constitute an indirect stock transfer under paragraph (d) of this 
section, and, subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the Business A assets qualify for 
the section 367(a)(3) active trade or business exception and are not 
subject to section 367(a)(1). * * *
    * * * Subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the Business B assets qualify for 
the active trade or business exception under section 367(a)(3). * * *
    Example 6B. * * *
    (ii) * * * However, subject to the conditions and requirements of 
section 367(a)(5) and Sec.  1.367(a)-7(c), the Business A assets 
qualify for the section 367(a)(3) active trade or business exception 
and are not subject to section 367(a)(1). * * *
    * * * However, pursuant to paragraph (d)(2)(vi)(B)(1) of this 
section and subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the Business B and C assets are not 
subject to section 367(a) or (d), provided that the basis of the 
Business B and C assets in the hands of R is no greater than the basis 
of the assets in the hands of Z. If all or a portion of the Business B 
and C assets constituted section 367(d) property, as defined in Sec.  
1.367(a)-7(f)(10), then

[[Page 49290]]

paragraph (d)(2)(vi)(B)(1) of this section would apply to Z's transfer 
of such property only if such property is treated as property subject 
to section 367(a) for purposes of satisfying the conditions and 
requirements of section 367(a)(5) and Sec.  1.367(a)-7(c). Treating 
such section 367(d) property as property subject to section 367(a) for 
this purpose could further reduce V's basis in the F stock received in 
the reorganization, or result in the recognition of additional gain by 
Z, under section 367(a)(5) and Sec.  1.367(a)-7(c). * * *
    Example 6C. * * *
    (ii) * * * However, gain must be recognized on the transfer of such 
assets under section 367(a)(1) because the section 367(a)(3) active 
trade or business exception is inapplicable pursuant to section 
367(a)(5) and Sec.  1.367(a)-7(b). * * *
    * * * The transfer of the Business B assets (which otherwise would 
satisfy the section 367(a)(3) active trade or business exception) 
generally is subject to section 367(a)(1) pursuant to section 367(a)(5) 
and Sec.  1.367(a)-7(b). * * *
* * * * *
    Example 8. * * *
    (ii) * * * Subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the Business B assets qualify for 
the active trade or business exception under section 367(a)(3). * * *
    Example 8B. * * *
    (ii) * * * Under section 367(a)(5) and Sec.  1.367(a)-7(b), the 
active trade or business exception under section 367(a)(3) does not 
apply to Z's transfer of assets to R. * * *
    Example 8C. * * *
    (ii) * * * Under section 367(a)(5) and Sec.  1.367(a)-7(b), the 
active trade or business exception under section 367(a)(3) does not 
apply to Z's transfer of assets to R. * * *
    Example 9. * * *
    (ii) * * * Subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), Z's transfer of the Business B 
assets to R (which are not re-transferred to M) qualifies for the 
active trade or business exception under section 367(a)(3). * * *
    Example 10. * * *
    (ii) * * * Subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the Business B assets qualify for 
the active trade or business exception under section 367(a)(3). * * *
    Example 11. * * *
    (ii) * * * Because D is owned by F, a foreign corporation, the 
control requirement of section 367(a)(5) and Sec.  1.367(a)-7(c)(1) 
cannot be satisfied. Therefore, section 367(a)(5) and Sec.  1.367(a)-
7(b) preclude the application of the active trade or business exception 
under section 367(a)(3) from applying to any assets transferred by D to 
Z. * * *
    Example 12. * * *
    (ii) * * * Subject to the conditions and requirements of section 
367(a)(5) and Sec.  1.367(a)-7(c), the active trade or business 
exception under section 367(a)(3) applies to E's transfer of Business X 
assets. * * *
* * * * *
    (g) Effective/applicability dates.
    (1) * * *
    (E)(1) Except as provided in paragraphs (g)(1)(E)(2) through 
(g)(1)(E)(4) of this section, the rules of paragraph (d)(2)(vi) of this 
section apply only to transactions occurring on or after January 23, 
2006. See Sec.  1.367(a)-3(d)(2)(vi), as contained in 26 CFR part 1 
revised as of April 1, 2005, for transactions occurring on or after 
July 20, 1998 and before January 23, 2006.
    (2) Except to the extent provided in paragraph (g)(1)(E)(3) of this 
section, paragraph (d)(2)(vi)(B)(1)(i) of this section applies to 
transactions occurring on or after the date 30 days after the date 
these regulations are published as final regulations in the Federal 
Register.
    (3)(i) For purposes of paragraph (d)(2)(vi)(B)(1) of this section, 
except as provided in paragraph (g)(1)(E)(3)(iii) of this section, the 
conditions of paragraph (d)(2)(vi)(B)(1)(i) of this section shall be 
satisfied for transactions occurring on or after December 28, 2007, and 
before the date 30 days after the date these regulations are published 
as final regulations in the Federal Register, provided the conditions 
in paragraph (g)(1)(E)(3)(ii) are satisfied.
    (ii) The domestic acquired corporation is controlled (within the 
meaning of section 368(c)) by five or fewer (but at least one) domestic 
corporations (controlling domestic corporations) at the time of the 
section 361 exchange, appropriate basis adjustments under section 
367(a)(5) are made to the stock received (or deemed received) by the 
controlling domestic corporations in the reorganization, and any other 
conditions as provided in regulations under section 367(a)(5) are 
satisfied. For purposes of determining whether the domestic acquired 
corporation is controlled by five or fewer domestic corporations, all 
members of the same affiliated group within the meaning of section 1504 
shall be treated as one corporation. Any adjustments to stock basis 
required under section 367(a)(5) must be made to the stock received (or 
deemed received) by the controlling domestic corporations in the 
reorganization such that the appropriate amount of built-in gain in the 
property transferred by the domestic acquired corporation to the 
foreign acquiring corporation in the section 361 exchange is reflected 
in such stock. The basis adjustment requirement cannot be satisfied by 
adjusting the basis in stock of the foreign acquiring corporation held 
by the controlling domestic corporations before the reorganization. To 
the extent the appropriate amount of built-in gain in the property 
transferred by the domestic acquired corporation to the foreign 
acquiring corporation in the section 361 exchange cannot be preserved 
in the stock received (or deemed received) by the controlling domestic 
corporations in the reorganization, the domestic acquired corporation's 
transfer of property to the foreign acquiring corporation shall be 
subject to sections 367(a) and (d).
    (iii) The second sentence of paragraph (d)(2)(vi)(B)(1)(i) shall 
apply to transactions occurring on or after August 19, 2008 and before 
the date 30 days after the date these regulations are published as 
final regulations in the Federal Register.
    (4) The last two sentences of paragraph (d)(2)(vi)(B)(2) shall 
apply to transactions occurring on or after December 28, 2007.
* * * * *
    Par. 5. Section 1.367(a)-7 is added to read as follows:


Sec.  1.367(a)-7  Rules under section 367(a)(5) applicable to exchanges 
described in section 361(a) or (b).

    (a) Scope and purpose. This section provides rules under section 
367(a)(5) that apply to a transfer of certain property, including stock 
and securities, by a domestic corporation (U.S. transferor) to a 
foreign corporation (foreign acquiring corporation) in an exchange 
described in section 361(a) or (b), or in an exchange described in 
section 351 that is also described in section 361(a) or (b) 
(collectively, a section 361 exchange). The purpose of this section is 
to ensure that the net gain realized by the U.S. transferor in 
connection with the transfer of certain property to the foreign 
acquiring corporation in the section 361 exchange is, in the aggregate, 
recognized currently by the U.S. transferor or, to the extent permitted 
under the rules of this section, preserved in the stock received (or 
deemed received) in the reorganization by certain domestic corporate 
shareholders of the U.S. transferor in exchange for stock or securities 
of the U.S. transferor. This section applies only to the transfer of 
section 367(a) property in the section 361 exchange. See section 367(d) 
and

[[Page 49291]]

the regulations under that section for rules applicable to transfers of 
section 367(d) property.
    (b) General rule. Except as provided in paragraph (c) of this 
section, the exceptions to section 367(a)(1) provided in section 367(a) 
and the regulations under that section shall not apply to a transfer of 
section 367(a) property by a U.S. transferor to a foreign acquiring 
corporation in a section 361 exchange.
    (c) Exception. Except to the extent provided in paragraph (d) of 
this section, paragraph (b) of this section shall not apply to the 
transfer of section 367(a) property in a section 361 exchange if the 
conditions of paragraphs (c)(1) through (c)(4) of this section are 
satisfied and an election to apply the exception provided by this 
paragraph (c) is made in the manner provided by paragraph (c)(5) of 
this section. If paragraph (b) of this section does not apply to a 
section 361 exchange, see, for example, Sec. Sec.  1.367(a)-2T, 
1.367(a)-3, 1.367(a)-4T, or 1.367(a)-5T, as applicable, for additional 
requirements that must be satisfied to avoid the application of section 
367(a)(1) to the transfer of section 367(a) property in the section 361 
exchange. Nothing in this section shall permit the nonrecognition of 
gain not otherwise permitted under another provision of the Internal 
Revenue Code or the regulations under that section. See, for example, 
section 367(a)(3)(B) and Sec.  1.367(a)-5T.
    (1) Control. At the time of the section 361 exchange, the U.S. 
transferor is controlled (within the meaning of section 368(c)) by five 
or fewer, but at least one, control group members.
    (2) Gain recognition--(i) Gain recognition due to non-control group 
members. The U.S. transferor recognizes gain equal to the product of 
the inside gain and the aggregate ownership interest (by value) in the 
U.S. transferor by all shareholders of the U.S. transferor at the time 
of the section 361 exchange that are not control group members.
    (ii) Gain recognition where control group member is unable to 
preserve gain. With respect to each control group member, the U.S. 
transferor recognizes gain equal to the amount, if any, by which--
    (A) The product of the inside gain and the control group member's 
ownership interest (by value) in the U.S. transferor at the time of the 
section 361 exchange; exceeds
    (B) The product of the section 367(a) percentage and the fair 
market value of the stock received (or deemed received) by the control 
group member in exchange for stock or securities of the U.S. transferor 
under section 354, 355, or 356. For an illustration of gain recognition 
under this paragraph, see paragraph (g) of this section, Example 2.
    (3) Basis adjustments--(i) General rule. Except as provided in 
paragraphs (c)(3)(ii)(A) and (C) of this section, each control group 
member's aggregate basis in the stock received (or deemed received) in 
exchange for stock or securities of the U.S. transferor under section 
354, 355, or 356, as determined under section 358 and the regulations 
under that section (section 358 basis), is reduced by the amount, if 
any, by which--
    (A) The product of the inside gain and the control group member's 
ownership interest (by value) in the U.S. transferor at the time of the 
section 361 exchange, reduced by any gain recognized by the U.S. 
transferor with respect to such control group member under paragraph 
(c)(2)(ii) of this section; exceeds
    (B) The control group member's outside gain.
    (ii) Special rules--(A) General applicability. Paragraph (c)(3)(i) 
of this section shall apply only to stock that was received by the U.S. 
transferor in the section 361 exchange and distributed to the control 
group member.
    (B) Multiple blocks of stock. If a control group member holds 
multiple blocks of stock received (or deemed received) in the 
transaction, the section 358 basis of each block of stock must be 
reduced pro rata based on the relative section 358 basis of each block 
of stock.
    (C) Successive distributions to which section 355 applies. 
Paragraph (c)(3)(i) of this section shall not apply to a control group 
member that distributes the stock of a foreign acquiring corporation 
received from the U.S. transferor in a distribution to which section 
355 applies (section 355 distribution), that is in connection with a 
transaction described in paragraph (d) of this section. If paragraph 
(c)(3)(i) of this section does not apply to a control group member 
pursuant to the previous sentence, then paragraph (c)(3)(i) of this 
section shall apply to the final distributee (as defined in paragraph 
(d) of this section) that receives the stock of the foreign acquiring 
corporation in the final section 355 distribution described in 
paragraph (d) of this section. If the final distributee holds multiple 
blocks of stock of the foreign acquiring corporation after the final 
section 355 distribution, the rules of paragraph (c)(3)(ii)(B) of this 
section shall apply to reduce the section 358 basis of such blocks of 
stock.
    (iii) Applicable cross-references. For illustrations of the 
adjustment to stock basis under paragraph (c)(3)(i) of this section, 
see paragraph (g) of this section, Example 1 and Example 2, and Sec.  
1.1248(f)-2(d), Example 2. For an illustration of the adjustment to 
stock basis under paragraph (c)(3)(ii)(A) of this section, see Sec.  
1.1248(f)-2(d), Example 4. For an illustration of the adjustment to 
stock basis under paragraph (c)(3)(ii)(B) of this section, see 
paragraph (g) of this section, Example 3.
    (4) Agreement to amend or file a U.S. income tax return--(i) 
General rule. Except as provided in paragraph (c)(4)(ii) of this 
section, the U.S. transferor complies with the requirements of Sec.  
1.6038B-1(c)(6)(iii).
    (ii) Exception. Section 1.6038B-1(c)(6)(iii) shall not apply to the 
extent any section 367(a) property transferred in the section 361 
exchange is transferred in connection with a transaction described in 
Sec.  1.367(a)-3(e) and a gain recognition agreement is filed pursuant 
to Sec.  1.367(a)-8 with respect to the transfer of such property.
    (5) Election and reporting requirements--(i) General rule. The U.S. 
transferor and each control group member elect to apply the provisions 
of paragraph (c) of this section in the manner provided under paragraph 
(c)(5)(ii) or (iii) of this section, as applicable, and by entering 
into a written agreement described in paragraph (c)(5)(iv) of this 
section. If a control group member distributes the stock of the foreign 
acquiring corporation received from the U.S. transferor in a section 
355 distribution that is in connection with a transaction described in 
paragraph (d) of this section, the final distributee that receives such 
stock in the final section 355 distribution elects to apply the 
provisions of this paragraph (c) and enters into the written agreement 
instead of the control group member.
    (ii) Election and reporting by control group member or final 
distributee--(A) Time and manner of making election. Each control group 
member (or final distributee) elects to apply the provisions of 
paragraph (c) of this section by including a statement (in the form and 
with the content specified in paragraph (c)(5)(ii)(B) of this section) 
on or with its timely-filed return for the taxable year in which the 
section 361 exchange occurs. If the control group member (or final 
distributee) is a member of a consolidated group for the taxable year 
of the section 361 exchange, the common parent of the consolidated 
group makes the election on behalf of the control group member (or 
final distrubutee).
    (B) Form and content of election statement. The statement shall be 
entitled, STATEMENT TO ELECT TO

[[Page 49292]]

APPLY EXCEPTION UNDER Sec.  1.367(a)-7(c) and must set forth:
    (1) The name and taxpayer identification number of the control 
group member (or final distributee);
    (2) The name and taxpayer identification number of the common 
parent of the consolidated group, if any;
    (3) The amount of the adjustment (if any) to stock basis required 
under paragraph (c)(3)(i) of this section, the resulting adjusted basis 
in such stock, and the fair market value of such stock; and
    (4) The date on which the written agreement described in paragraph 
(c)(5)(iv) of this section was entered into.
    (iii) Statement by U.S. transferor. The U.S. transferor elects to 
apply the provisions of paragraph (c) of this section in the form and 
manner set forth in Sec.  1.6038B-1(c)(6)(ii).
    (iv) Written agreement. The U.S. transferor and each control group 
member (or final distributee) must enter into a written agreement on or 
before the due date (including extensions) for the U.S. transferor's 
tax return for the taxable year during which the section 361 exchange 
occurs. Each party to the agreement must retain the original or a copy 
of the agreement in the manner specified by Sec.  1.6001-1(e). Each 
party to the agreement must provide a copy of the agreement to the 
Internal Revenue Service within 30 days of the receipt of a request for 
the copy of the agreement in connection with an examination of the 
taxable year during which the section 361 exchange occurs. The written 
agreement must--
    (A) State the document constitutes an agreement entered into 
pursuant to paragraph (c)(5) of this section;
    (B) Identify the U.S. transferor and each control group member (or 
final distributee);
    (C) State the amount of gain (if any) recognized by the U.S. 
transferor under paragraph (c)(2) of this section; and
    (D) With respect to each control group member (or final 
distributee), state the amount of the adjustment (if any) to stock 
basis required under paragraph (c)(3)(i) of this section, the resulting 
adjusted basis in such stock, and the fair market value of such stock.
    (d) Section 361 exchange followed by successive distributions to 
which section 355 applies. If the U.S. transferor distributes stock of 
the foreign acquiring corporation received in the section 361 exchange 
to a control group member in a section 355 distribution and, as part of 
a plan or series of related transactions, such stock is further 
distributed in one or more successive section 355 distributions, 
paragraph (c) of this section shall apply to the section 361 exchange 
only to the extent each subsequent section 355 distribution is to a 
member of the affiliated group (within the meaning of section 1504) 
that includes the U.S. transferor at the time of the section 361 
exchange. In such a case, each affiliated group member that receives 
stock of the foreign acquiring corporation in the final section 355 
distribution (final distributee) shall be subject to the requirements 
of paragraphs (c)(3) and (c)(5) of this section.
    (e) Other rules--(1) Section 367(a) property on which gain is 
recognized. Gain recognized by the U.S. transferor pursuant to 
paragraph (c)(2) of this section shall be treated as recognized with 
respect to the section 367(a) property transferred in the section 361 
exchange in proportion to the amount of gain realized by the U.S. 
transferor on the transfer of each item of section 367(a) property. 
This paragraph (e)(1) shall be applied after taking into account any 
gain recognized by the U.S. transferor on the transfer of the section 
367(a) property in the section 361 exchange pursuant to all other 
provisions under section 367(a) and the regulations under that section. 
See, for example, section 367(a)(3)(B) and Sec.  1.367(a)-4T. See Sec.  
1.367(a)-1T(b)(4) for additional rules on the character, source, and 
adjustments relating to gain recognized under section 367(a).
    (2) Reasonable cause exception for failure to comply--(i) Request 
for relief. If a control group member (or final distributee) fails to 
comply with any requirement of this section, the control group member 
(or final distributee) shall be considered to have complied with such 
requirement if it submits a request for relief as provided under 
paragraph (e)(2)(ii) of this section and can demonstrate to the Area 
Director, Field Examination, Small Business/Self Employed or the 
Director of Field Operations, Large and Mid-Size Business (Director) 
having jurisdiction of the control group member's (or final 
distributee's) tax return for the taxable year, that such failure was 
due to reasonable cause and not willful neglect. Whether the failure to 
comply was due to reasonable cause and not willful neglect will be 
determined by the Director after considering all the facts and 
circumstances. The Director shall notify the control group member (or 
final distributee) in writing within 120 days if it is determined that 
the failure to comply was not due to reasonable cause, or if additional 
time will be needed to make such determination. For this purpose, the 
120-day period shall begin on the date the Internal Revenue Service 
notifies the control group member (or final distributee) in writing 
that the request for relief has been received and assigned for review. 
Once such period commences, if the control group member (or final 
distributee) is not again notified within 120 days, then the control 
group member (or final distributee) shall be deemed to have established 
reasonable cause.
    (ii) Requirements for reasonable cause relief--(A) Time of 
submission. Requests for reasonable cause relief under paragraph 
(e)(2)(i) of this section will be considered only if as soon as the 
control group member (or final distributee) becomes aware of the 
failure to comply with any requirement of this section, the control 
group member (or final distributee) attaches the statements or other 
documents that should have been filed, as well as a complete written 
statement setting forth the reasons for the failure to comply, to an 
amended return that amends the return to which the documents should 
have been attached pursuant to this section. The amended return and all 
required attachments must be filed with the applicable Internal Revenue 
Service Center with which the control group member (or final 
distributee) filed its original return to which the documents should 
have been attached.
    (B) Notice requirement. In addition to the requirement of paragraph 
(e)(2)(ii)(A) of this section, the control group member (or final 
distributee) must comply with the requirements of paragraph 
(e)(2)(ii)(B)(1) or (2) of this section, as applicable.
    (1) If the control group member (or final distributee) is under 
examination for any taxable year when the request for reasonable cause 
relief is filed, a copy of the amended return and attachments must be 
provided to the Internal Revenue Service personnel conducting the 
examination.
    (2) If the control group member (or final distributee) is not under 
examination for any taxable year when the request for reasonable cause 
relief is filed, a copy of the amended return and attachments must be 
provided to the Director having jurisdiction over the return.
    (iii) Cross-reference for reasonable cause relief requests by U.S. 
transferor. If the U.S. transferor fails to comply with any requirement 
of this section, the U.S. transferor shall be treated as having 
complied with such requirement if the U.S. transferor (or the foreign 
acquiring corporation on behalf of the U.S. transferor) complies with 
the reasonable cause exception procedures described in Sec.  1.6038B-
1(f)(3).

[[Page 49293]]

    (f) Definitions. The following definitions apply for purposes of 
this section:
    (1) Block of stock is a group of shares of the same class of stock 
and that have an identical basis.
    (2) Control group and control group member--(i) General rule. 
Except as provided in paragraph (f)(2)(ii) of this section, the control 
group is the five or fewer, but at least one, domestic corporations 
that control (within the meaning of section 368(c)) the U.S. transferor 
at the time of the section 361 exchange. If the U.S. transferor is 
controlled by more than five domestic corporations at the time of the 
section 361 exchange, but some combination of five or fewer domestic 
corporations control the U.S. transferor at such time, the U.S. 
transferor shall designate the five domestic corporations that comprise 
the control group on Form 926, ``Return by a U.S. Transferor of 
Property to a Foreign Corporation.'' For purposes of this paragraph, 
members of the same affiliated group (within the meaning of section 
1504) shall be treated as one corporation. Except as provided in 
paragraph (f)(2)(ii) of this section, a control group member is a 
domestic corporation that is part of the control group.
    (ii) Exception for certain entities. Neither a regulated investment 
company (as defined in section 851(a)), nor a real estate investment 
trust (as defined in section 856(a)), nor an S corporation (as defined 
in section 1361(a)) shall be a control group member.
    (3) Deductible liability is any liability of the U.S. transferor 
that is assumed in the section 361 exchange or satisfied in connection 
with the reorganization (within the meaning of section 361(c)(3)), but 
only if the payment of such liability would give rise to a deduction.
    (4) Gross fair market value means fair market value determined 
without regard to mortgages, liens, pledges, or other liabilities. The 
fair market value of any property subject to a nonrecourse indebtedness 
shall not be less than the amount of such indebtedness.
    (5) Inside basis is the amount equal to the aggregate bases of the 
section 367(a) property transferred by the U.S. transferor in the 
section 361 exchange, increased by any gain recognized by the U.S. 
transferor on the transfer of such property in the section 361 
exchange, including gain treated as a dividend under section 1248(a), 
but not including any gain recognized under paragraph (c)(2) of this 
section (including any such gain treated as a dividend under section 
1248(a)).
    (6) Inside gain is the amount by which the aggregate gross fair 
market value of the section 367(a) property transferred in the section 
361 exchange exceeds the sum of the inside basis and the product of the 
section 367(a) percentage and the aggregate deductible liabilities of 
the U.S. transferor.
    (7) Outside gain is the product of the section 367(a) percentage 
and the amount by which--
    (i) The aggregate fair market value of the stock received (or 
deemed received) by a control group member in exchange for stock or 
securities of the U.S. transferor under section 354, 355, or 356; 
exceeds
    (ii) The control group member's aggregate section 358 basis of such 
stock (as determined without regard to any adjustment to such basis 
required under paragraph (c)(3) of this section).
    (8) Section 367(a) percentage is the ratio of the aggregate gross 
fair market value of the section 367(a) property transferred by the 
U.S. transferor in the section 361 exchange to the aggregate gross fair 
market value of all property transferred by the U.S. transferor in the 
section 361 exchange.
    (9) Section 367(a) property--(i) General rule. Except as provided 
in paragraph (f)(9)(ii) of this section, section 367(a) property is any 
property other than section 367(d) property.
    (ii) Special rule. Any property that would otherwise constitute 
section 367(a) property under paragraph (f)(9)(i) of this section shall 
not constitute section 367(a) property for purposes of any 
determination under this section for which the amount of section 367(a) 
property transferred in the section 361 exchange is relevant, if such 
property is acquired by the U.S. transferor in connection with the 
section 361 exchange with a principal purpose of affecting any such 
determination, including, for example, the section 367(a) percentage, 
inside gain, and inside basis.
    (10) Section 367(d) property is property to which section 367(d) 
applies.
    (11) Timely-filed return is a U.S. income tax return filed on or 
before the due date set forth in section 6072(b), plus any extension of 
time to file such return granted under section 6081.
    (g) Examples. The rules of this section are illustrated by the 
following examples. The analysis of the following examples is limited 
to a discussion of issues under this section. Unless otherwise 
indicated, for purposes of the following examples assume: DP1, DP2, and 
DC are domestic corporations that do not join in the filing of a 
consolidated return; FP and FA are foreign corporations that are 
unrelated to DP1, DP2, and DC; each corporation has a single class of 
stock outstanding; each shareholder of DC owns one block of stock in 
DC; DC's Business A constitutes section 367(a) property that could 
qualify for the exception to section 367(a)(1) under Sec.  1.367(a)-2T; 
DC has no liabilities, and the requirements in paragraph (c)(5) of this 
section and Sec.  1.6038B-1(c)(6)(ii) are satisfied.

    Example 1. Tainted assets and non-control group ownership. (i) 
Facts. DP1, DP2, and FP own 50%, 30%, and 20%, respectively, of the 
outstanding stock of DC. DP1's DC stock has a $80x basis and $100x 
fair market value. DP2's DC stock has a $50x basis and $60x fair 
market value. DC owns inventory with a $40x basis and a $100x fair 
market value. DC also owns Business A with a $10x basis and $100x 
fair market value. In a reorganization described in section 
368(a)(1)(F), DC transfers the inventory and Business A to FA, a 
newly formed corporation, in exchange for all of the outstanding 
stock of FA. DC's transfer of the inventory and Business A to FA 
qualifies as a section 361 exchange. DP1, DP2, and FP exchange the 
DC stock for a proportionate amount of FA stock pursuant to section 
354.
    (ii) Result. (A) Under section 367(a)(3)(B), DC must recognize 
$60x gain on the transfer of the inventory to FA. Under Sec.  
1.367(a)-1T(b)(4)(i)(B), the section 362 basis increase is allocated 
to the inventory such that FA's basis in the inventory is $100x. 
Under section 367(a)(5) and paragraph (b) of this section, DC's 
transfer of Business A to FA is subject to the general rule of 
section 367(a)(1). As a result, DC must also generally recognize 
$90x gain on the transfer of Business A to FA notwithstanding the 
application of section 351 or section 361. However, if the 
conditions and requirements of paragraph (c) of this section are 
met, DC's transfer of Business A to FA may be partially eligible for 
the active foreign trade or business exception provided by section 
367(a)(3) and Sec.  1.367(a)-2T. See Sec.  1.367(a)-2T for the 
requirements of the active foreign trade or business exception.
    (B) The requirement of paragraph (c)(1) of this section is 
satisfied because DC is controlled (within the meaning of section 
368(c)) by DP1 and DP2 at the time of the section 361 exchange.
    (C) Under paragraph (c)(2)(i) of this section, DC must recognize 
$18x gain on the transfer of Business A with respect to FP, a non-
control group member. The $18x gain equals the product of the inside 
gain ($90x) and FP's 20% ownership interest (by value) in DC at the 
time of the section 361 exchange. Under paragraph (f)(6) of this 
section, the $90x inside gain is the amount by which the aggregate 
gross fair market value ($200x) of the section 367(a) property (the 
inventory and Business A) exceeds the $110x inside basis. Under 
paragraph (f)(5) of this section, the inside basis equals the $50x 
aggregate basis of the section 367(a) property transferred in the 
section 361 exchange, increased by the $60x gain recognized by DC on 
the transfer of the inventory to FA, but not

[[Page 49294]]

by the $18x gain recognized by DC under paragraph (c)(2)(i) of this 
section with respect to FP. Under paragraph (e)(1) of this section, 
the $18x gain recognized under paragraph (c)(2)(i) of this section 
is treated as recognized with respect to Business A.
    (D) DC is not required to recognize gain under paragraph 
(c)(2)(ii) of this section with respect to either DP1 or DP2. DP1's 
share of inside gain ($45x) does not exceed the product of the 
section 367(a) percentage (100%) and the fair market value of the FA 
stock ($100x) received in exchange for its DC stock. DP1's share of 
inside gain is determined based on its 50% ownership interest (by 
value) in DC at the time of the section 361 exchange. DP2's share of 
inside gain ($27x) does not exceed the product of the section 367(a) 
percentage (100%) and the fair market value of the FA stock ($60x) 
received in exchange for its DC stock. DP2's share of inside gain is 
determined based on its 30% ownership interest (by value) in DC at 
the time of the section 361 exchange.
    (E) Under paragraph (c)(3) of this section, DP1's section 358 
basis in the FA stock ($80x) received in exchange for its DC stock 
must be reduced by $25x, the amount by which DP1's share of inside 
gain ($45x) exceeds DP1's $20x outside gain. DP1's share of inside 
gain is determined based on its 50% ownership interest (by value) in 
DC at the time of the section 361 exchange. Because DC does not 
recognize gain on the section 361 exchange with respect to DP1, 
DP1's share of inside gain is not reduced under paragraph 
(c)(3)(i)(A) of this section. DP1's $20x outside gain equals the 
product of the section 367(a) percentage (100%) and the amount by 
which the fair market value ($100x) of the FA stock received by DP1 
in exchange for its DC stock exceeds the section 358 basis of such 
FA stock ($80x). As adjusted, DP1's basis in its FA stock is $55x. 
Similarly, under paragraph (c)(3) of this section, DP2's section 358 
basis in the FA stock ($50x) received in exchange for its DC stock 
must be reduced by $17x, the amount by which DP2's share of inside 
gain ($27x) exceeds DP1's $10x outside gain. DP2's share of inside 
gain is determined based on its 30% ownership interest (by value) in 
DC at the time of the section 361 exchange. Because DC does not 
recognize gain on the section 361 exchange with respect to DP2, 
DP2's share of inside gain is not reduced under paragraph 
(c)(3)(i)(A) of this section. DP2's $10x outside gain equals the 
product of the section 367(a) percentage (100%) and the amount by 
which the fair market value ($60x) of the FA stock received by DP2 
in exchange for its DC stock exceeds the section 358 basis of such 
stock ($50x). As adjusted, DP2's basis in its FA stock is $33x.
    (F) Under paragraph (c)(4) of this section, DC must comply with 
the requirements of Sec.  1.6038B-1(c)(6)(iii).
    Example 2. Triangular reorganization involving the exchange of 
section 367(d) property for stock and cash. (i) Facts. (A) DP1 
wholly owns DC. DP1 and DC file a consolidated return. DP1's DC 
stock has a $175x basis and $200x fair market value. DC owns 
Business A ($10x basis and $150x fair market value) and a patent 
($0x basis and $50x fair market value). The patent is section 367(d) 
property. FP wholly owns FA.
    (B) In a triangular reorganization described in section 
368(a)(1)(A) by reason of section 368(a)(2)(D), DC transfers 
Business A and the patent to FA in exchange for $180x of FP stock 
and $20x cash. DC's transfer of Business A and the patent to FA is a 
section 361 exchange. DP1 exchanges its DC stock for the $180x of FP 
stock and the $20x cash pursuant to section 356. The triangular 
reorganization constitutes an indirect stock transfer under Sec.  
1.367(a)-3(d)(1)(i), and DP1 files a gain recognition agreement 
under Sec.  1.367(a)-8 with respect to such transfer.
    (ii) Result. (A) Under section 367(a)(5) and paragraph (b) of 
this section, DC's transfer of Business A to FA is subject to the 
general rule of section 367(a)(1). As a result, DC must generally 
recognize $140x gain on the transfer of Business A to FA 
notwithstanding the application of section 361. However, if the 
requirements of paragraph (c) of this section are satisfied, DC's 
transfer of Business A to FA may be eligible for the active foreign 
trade or business exception provided by section 367(a)(3) and Sec.  
1.367(a)-2T. See Sec.  1.367(a)-2T for the requirements of the 
active foreign trade or business exception. For rules applicable to 
DC's transfer of the patent to FA, see section 367(d) and the 
regulations under that section.
    (B) The requirement of paragraph (c)(1) of this section is 
satisfied because DC is controlled (within the meaning of section 
368(c)) by DP1 at the time of the section 361 exchange.
    (C) DC is not required to recognize gain under paragraph 
(c)(2)(i) of this section because at the time of the section 361 
exchange DC is wholly owned by DP1, a control group member. Under 
paragraph (c)(2)(ii) of this section, DC must recognize $5x gain, 
the amount by which the product of the inside gain ($140x) and DP1's 
100% ownership interest (by value) in DC at the time of the section 
361 exchange exceeds the product of the section 367(a) percentage 
(75%) and the fair market value ($180x) of the FP stock received by 
DP1 in exchange for DC stock. The $140x inside gain equals the 
aggregate gross fair market value of Business A ($150x) less the 
inside basis ($10x). Under paragraph (e)(1) of this section, the $5x 
gain recognized is allocated to Business A. Under Sec.  1.1502-
32(b)(2), DP1 increases the basis of its DC stock by $5x.
    (D) Under paragraph (c)(3) of this section, DP1's section 358 
basis ($180x) in the FP stock ($180x basis of DC stock, decreased by 
$20x cash received, and increased by the $20x gain recognized under 
section 356) is reduced by $135x, the amount by which the product of 
the $140x inside gain, reduced by the $5x recognized by DC under 
paragraph (c)(2)(ii) ($135x) and DP1's 100% ownership interest (by 
value) in DC at the time of the exchange exceeds DP1's outside gain 
($0x). The $0x outside gain equals the product of the section 367(a) 
percentage (75%) and the amount by which the fair market value of 
the FP stock received by DP1 ($180x) exceeds the section 358 basis 
of such stock ($180x). As adjusted, DP1's basis in the FP stock is 
$45x.
    (E) Under paragraph (c)(4)(i) of this section, DC must comply 
with the requirements of Sec.  1.6038B-1(c)(6)(iii).
    Example 3. Adjustment to basis of multiple blocks of stock. (i) 
Facts.(A) DP1 wholly owns DC. DP1's DC stock is divided into two 
blocks of stock (Block 1 and Block 2). Block 1 has a $60x basis and 
$100x fair market value. Block 2 has a $120x basis and $100x fair 
market value. DC owns Business A ($15x basis and $150x fair market 
value) and a patent ($0x basis and $50x fair market value). The 
patent is section 367(d) property.
    (B) In a reorganization described in section 368(a)(1)(F), DC 
transfers Business A and the patent to FA, a newly-formed 
corporation, in exchange for 2 shares of FA stock. DC's transfer of 
Business A and the patent to FA qualifies as a section 361 exchange. 
DP1 exchanges Block 1 and Block 2 for the two shares of FA stock 
pursuant to section 354. Pursuant to Sec.  1.358-2(a)(2)(i), one 
share of the FA stock corresponds to Block 1 (Share 1) and the other 
share of FA stock corresponds to Block 2 (Share 2). The basis and 
holding period of Share 1 and Share 2 correspond to the basis and 
holding period of Block 1 and Block 2, respectively.
    (ii) Result. (A) Under section 367(a)(5) and paragraph (b) of 
this section, DC's transfer of Business A to FA is subject to the 
general rule of section 367(a)(1). As a result, DC must generally 
recognize $135x gain on the transfer of Business A to FA 
notwithstanding the application of section 351 or section 361. 
However, if the requirements of paragraph (c) of this section are 
met, DC's transfer of Business A to FA may be eligible for the 
active foreign trade or business exception provided in section 
367(a)(3). See Sec.  1.367(a)-2T for the requirements of the active 
foreign trade or business exception. For rules applicable to DC's 
transfer of the patent to FA, see section 367(d) and the regulations 
under that section.
    (B) The requirement of paragraph (c)(1) of this section is 
satisfied because DC is controlled (within the meaning of section 
368(c)) by DP1 at the time of the section 361 exchange.
    (C) DC is not required to recognize gain under paragraph 
(c)(2)(i) of this section because, at the time of the section 361 
exchange, DC is wholly owned by DP1. DC is not required to recognize 
gain under paragraph (c)(2)(ii) of this section because DP1's 100% 
share of inside gain ($135x) does not exceed the product of the 
section 367(a) percentage (75%) and the fair market value ($200x) of 
the FA stock received by DP1 in exchange for its DC stock ($150x). 
Under paragraph (f)(6) of this section, the $135x inside gain equals 
the aggregate gross fair market value of the section 367(a) property 
($150x) less the inside basis ($15x).
    (D) Under paragraph (c)(3) of this section, DP1's aggregate 
section 358 basis in Share 1 ($60x) and Share 2 ($120x) must be 
reduced by $120x, the amount by which DP1's 100% share of inside 
gain ($135x) exceeds DP1's $15x outside gain. The $15x outside gain 
equals the product of the section 367(a) percentage (75%) and the 
amount by which the fair market value of the FA stock received by 
DP1 ($200x) exceeds the section 358 basis of the FA stock ($180x) 
(75% of $20x).
    (E) Under paragraph (c)(3)(ii)(B) of this section, the $120x 
reduction to basis is allocated between Share 1 and Share 2 based on 
the relative section 358 basis of each share. Therefore, the basis 
in Share 1 is

[[Page 49295]]

reduced by $40x ($120x multiplied by $60x/$180x). As adjusted, DP1's 
basis in Share 1 is $20x. The basis in Share 2 is reduced by $80x 
($120x multiplied by $120x/$180x). As adjusted, DP1's basis in Share 
2 is $40x.
    (F) Under paragraph (c)(4)(i) of this section, DC must comply 
with the requirements of Sec.  1.6038B-1(c)(6)(iii).

    (h) Applicable cross-references. For rules relating to the 
character, source, and adjustments resulting from gain recognized by a 
U.S. transferor under section 367(a), see Sec.  1.367(a)-1T(b)(4). For 
rules relating to the acquisition of the stock or assets of a foreign 
corporation by another foreign corporation, see Sec.  1.367(b)-4. For 
rules relating to transfers of section 367(d) property by a U.S. 
transferor to a foreign corporation, see section 367(d) and the 
regulations under that section. For rules relating to distributions of 
stock of a foreign corporation by a domestic corporation under section 
355 or 361, see Sec. Sec.  1.1248(f)-1 through -3. For additional rules 
relating to certain reporting requirements of a U.S. transferor, see 
Sec.  1.6038B-1.
    (i) [Reserved.]
    (j) Effective/applicability date. This section shall apply to 
transfers occurring on or after the date 30 days after the date these 
regulations are published as final regulations in the Federal Register.
    Par. 6. Section 1.367(b)-4 is amended by:
    1. Revising paragraphs (b)(1)(i)(B)(2), (b)(1)(ii), and 
(b)(1)(iii), Example 4 (ii).
    2. Adding paragraph (b)(1)(iii), Example 5.
    The revisions and additions to read as follows:


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

* * * * *
    (b) * * *
    (1) * * *
    (i) * * *
    (B) * * *
    (2) Immediately after the exchange, the foreign acquiring 
corporation or the foreign acquired corporation (if any, such as in the 
case of the acquisition of the stock of a foreign acquired corporation) 
is not a controlled foreign corporation as to which the United States 
person described in paragraph (b)(1)(i)(A) of this section is a section 
1248 shareholder.
    (ii) Special rules for certain triangular reorganizations--(A) 
Exception for receipt of domestic stock. In the case of a triangular 
reorganization described in Sec.  1.358-6(b)(2), or a reorganization 
described in section 368(a)(1)(G) and (a)(2)(D), an exchange is not 
described in paragraph (b)(1)(i) of this section if--
    (1) The stock received in the exchange is stock of a domestic 
corporation that immediately after the exchange is a section 1248 
shareholder of--
    (i) The foreign acquired corporation, in the case of a triangular B 
reorganization or a reorganization in which stock of the foreign 
acquired corporation is acquired pursuant to a transfer to which the 
exception provided in Sec.  1.367(a)-7(c) applies; or
    (ii) The surviving corporation, in the case of a transaction that 
is not described in paragraph (b)(1)(ii)(A)(1)(i) of this section and 
that is a triangular C reorganization, a forward triangular merger, a 
reorganization described in section 368(a)(1)(G) and (a)(2)(D), or a 
reverse triangular merger; and
    (2) The foreign acquired corporation or surviving corporation is a 
controlled foreign corporation. See paragraph (b)(1)(iii) of this 
section, Example 3B for an illustration of this rule.
    (B) Adjustments to basis of stock of foreign acquiring 
corporation--(1) Transfers to which exception under Sec.  1.367(a)-7(c) 
applies. If the stock of the foreign acquired corporation is acquired 
by the foreign acquiring corporation pursuant to a triangular 
reorganization described in Sec.  1.358-6(b)(2)(i) through (iii), or a 
reorganization described in section 368(a)(1)(G) and (a)(2)(D), to 
which the exception provided in Sec.  1.367(a)-7(c) applies and that is 
not described in paragraph (b)(1)(i) of this section, the corporation 
(foreign or domestic) that controls the foreign acquiring corporation 
shall apply the principles of Sec.  1.367(b)-13 to adjust the basis of 
the stock of the foreign acquiring corporation so that the section 1248 
amount attributable to the stock of the foreign acquired corporation 
(determined when the foreign acquiring corporation acquires such stock) 
is reflected in the stock of the foreign acquiring corporation 
immediately after the exchange. See paragraph (b)(1)(iii) of this 
section, Example 5, for an illustration of this rule.
    (2) Other triangular reorganizations. See Sec.  1.367(b)-13(c) for 
rules regarding the adjustment to the basis of the stock of the foreign 
acquiring corporation in other triangular reorganizations described in 
paragraph (b)(1)(ii)(A)(1)(ii) of this section.
    (iii) * * *

    Example 4. * * *
    (ii) Result. DC2, the exchanging shareholder, is a U.S. person 
and a section 1248 shareholder with respect to FC2, the foreign 
acquired corporation. Whether DC2 is required to include in income 
the section 1248 amount attributable to the FC2 stock under 
paragraph (b)(1)(i) of this section depends on whether, immediately 
after DC2's exchange of the FC2 stock for FC1 stock (and before the 
distribution of the FC1 stock to DC1 under section 361(c)(1)), FC1 
and FC2 are controlled foreign corporations as to which DC2 is a 
section 1248 shareholder. If, immediately after the exchange, FC1 
and FC2 are both controlled foreign corporations as to which DC2 is 
a section 1248 shareholder, then DC2 is not required to include in 
income the section 1248 amount attributable to the FC2 stock under 
paragraph (b)(1)(i) because neither condition in paragraph 
(b)(1)(i)(B) is satisfied. Alternatively, if immediately after the 
exchange either FC1 or FC2 is not a controlled foreign corporation 
as to which DC2 is a section 1248 shareholder then, pursuant to 
paragraph (b)(1)(i) of this section, DC2 must include in income the 
section 1248 amount attributable to the FC2 stock exchanged. For the 
treatment of DC2's transfer of assets to FC1, see also section 
367(a)(1) and (a)(3) and the regulations under that section. Because 
DC2's transfer of assets to FC1 is described in section 361(a) or 
(b), see section 367(a)(5) and Sec.  1.367(a)-7. If any of the 
assets transferred are intangible assets, see section 367(d) and the 
regulations under that section. With respect to DC2's distribution 
of the FC1 stock to DC1 under section 361(c)(1), see section 
1248(f)(1), Sec.  1.1248(f)-1 and Sec.  1.1248(f)-2.
    Example 5. (i) Facts. DC1, a domestic corporation, wholly owns 
DC2, a domestic corporation. DC1's DC2 stock has a $30 basis and a 
$100 fair market value. DC2's only asset is all the outstanding 
stock of FC2, a foreign corporation. DC2's FC2 stock has a $30 
basis, $100 fair market value and a $20 section 1248 amount. USP, a 
domestic corporation unrelated to DC1, DC2 or FC2, wholly owns FC1, 
a foreign corporation. In a triangular reorganization described in 
section 368(a)(1)(C), DC2 transfers all the FC2 stock to FC1 in 
exchange solely for voting stock of USP and then distributes the USP 
stock to DC1 under section 361(c)(1). DC1 exchanges its DC2 stock 
for the USP stock under section 354. DC2's transfer of the FC2 stock 
to FC1 is described in section 361(a) and therefore, under section 
367(a)(5) and Sec.  1.367(a)-7, is generally subject to section 
367(a)(1). However, DC2's transfer of the FC2 stock to FC1 qualifies 
for the exception provided in Sec.  1.367(a)-7(c). DC1 and DC2 elect 
to apply the rules of Sec.  1.367(a)-7(c) in accordance with Sec.  
1.367(a)-7(c)(5). DC1 is not required to adjust the basis of its USP 
stock (determined under section 358) under section 367(a)(5) and 
Sec.  1.367(a)-7(c)(3).
    (ii) Result. Under paragraph (b)(1)(ii)(A) of this section, 
because the stock received by DC2 in exchange for its FC2 stock is 
stock of a domestic corporation (USP) and, immediately after the 
exchange, USP is a section 1248 shareholder of FC2 (the foreign 
acquired corporation) and FC2 is a controlled foreign corporation, 
DC2's exchange of its FC2 stock for USP stock is not described in 
paragraph (b)(1)(i) of this section. Therefore, DC2 is not required 
to include in income the section 1248 amount attributable to the FC2 
stock. Under paragraph (b)(1)(ii)(B)(1) of this section, USP must 
apply the principles of

[[Page 49296]]

Sec.  1.367(b)-13 to adjust the basis of its FC1 stock so that the 
$20 section 1248 amount attributable to the FC2 stock at the time of 
the exchange is reflected in the FC1 stock immediately after the 
exchange. Under the principles of Sec.  1.367(b)-13, each share of 
FC1 stock held by USP after the exchange must be divided into one 
portion attributable to the FC1 stock immediately before the 
exchange and one portion attributable to the FC2 stock acquired in 
the exchange. The $30 basis in the FC2 stock and the earnings and 
profits attributable to the FC2 stock before the exchange are 
attributable to the divided portions of the FC1 stock to which the 
FC2 stock relates.
* * * * *
    Par. 7. Section 1.367(b)-6 is amended by revising paragraph (a)(1) 
to read as follows:


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

    (a) Effective date--(1) In general--(A) Except as otherwise 
provided in this paragraph (a)(1) and paragraph (a)(2) of this section, 
Sec. Sec.  1.367(b)-1 through 1.367(b)-5, and this section, apply to 
section 367(b) exchanges that occur on or after February 23, 2000.
    (B) The rules of Sec. Sec.  1.367(b)-3 and 1.367(b)-4, as they 
apply to reorganizations described in section 368(a)(1)(A) (including 
reorganizations described in section 368(a)(2)(D) or (E)) involving a 
foreign acquiring or foreign acquired corporation, apply only to 
transfers occurring on or after January 23, 2006.
    (C) The second sentence of paragraph (a) in Sec.  1.367(b)-4 
applies to section 304(a)(1) transactions occurring on or after 
February 23, 2006; however, taxpayers may rely on this sentence for all 
section 304(a)(1) transactions occurring in open taxable years.
    (D) Section 1.367(b)-1(c)(2)(v), (c)(3)(ii)(A), (c)(4)(iv), 
(c)(4)(v), Sec.  1.367(b)-2(j)(1)(i), (l), and Sec.  1.367(b)-3(e) and 
(f), apply to section 367(b) exchanges that occur on or after November 
6, 2006. For guidance with respect to Sec.  1.367(b)-1(c)(3)(ii)(A) and 
(c)(4)(iv) and (v) and Sec.  1.367(b)-2(j)(1)(i) for exchanges that 
occur before November 6, 2006, see 26 CFR part 1 revised as of April 1, 
2006.
    (E) Section 1.367(b)-4(b)(1)(ii) and Sec.  1.367(b)-4(b)(1)(iii), 
Examples 4 and 5 apply to section 367(b) exchanges that occur on or 
after the date that is 30 days after the date these regulations are 
published as final regulations in the Federal Register. For guidance 
with respect to Sec.  1.367(b)-4(b)(1)(ii) and Sec.  1.367(b)-
4(b)(1)(iii), Example 4, for exchanges that occur before the date 30 
days after the date these regulations are published as final 
regulations in the Federal Register, see 26 CFR part 1 revised as of 
April 1 for the year before the date these regulations are published as 
final regulations in the Federal Register.
* * * * *
    Par. 8. For each entry in the table 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
------------------------------------------------------------------------
1.1248-1(a)(1), second to last      1248(f)            1248(g)
 sentence.
1.1248-1(a)(1), last sentence.....  1248(g)            1248(h)
1.1248-3(a)(6), first sentence....  1.1248-4           1.1248-2
1.1248-3(a)(6), first sentence....  1.1248-7           1.1248-8
1.1248-7(a)(1), second to last      1248(g)            1248(h)
 sentence.
------------------------------------------------------------------------

    Par. 9. Section 1.1248-1 is amended by:
    1. Revising paragraphs (b) and (e).
    2. Revising the second sentence of paragraph (c).
    The revisions to read as follows.


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

* * * * *
    (b) Sale or exchange. For purposes of this section and Sec. Sec.  
1.1248-2 through 1.1248-8, the term sale or exchange includes the 
receipt of a distribution that is treated as in exchange for stock 
under section 302(a) (relating to distributions in redemption of stock) 
or section 331(a) (relating to distributions in complete liquidation of 
a corporation).
    (c) * * * Thus, for example, if a United States person exchanges 
stock in a foreign corporation and no gain is recognized on such 
exchange under section 332, 351, 354, 355, or 361, taking into account 
the application of section 367, then no amount is includible in the 
gross income of such person as a dividend under section 1248(a).
* * * * *
    (e) Exceptions. Under section 1248(g), this section and Sec. Sec.  
1.1248-2 through 1.1248-8 shall not apply to:
    (1) Distributions to which section 303 (relating to distributions 
in redemption of stock to pay death taxes) applies; or
    (2) Any amount to the extent that such amount is, under any other 
provision of the Internal Revenue Code (Code), treated as (i) a 
dividend, (ii) gain from the sale of an asset which is not a capital 
asset, or (iii) gain from the sale of an asset held for not more than 1 
year.
* * * * *
    Par. 10. Section 1.1248-6 is amended by:
    1. Adding a new sentence at the end of paragraph (a).
    2. Adding paragraphs (d) and (e).
    The additions to read as follows:


1.1248-6  Sale or exchange of stock in certain domestic corporations.

    (a) * * * See paragraph (d) of this section for a rule suspending 
the application of this section in certain circumstances.
* * * * *
    (d) Temporary suspension of section 1248(e). Section 1248(e) and 
the rules of this section shall not apply to a sale, exchange, or other 
disposition of the stock of a domestic corporation during a period when 
capital gains are taxed at a rate that equals or exceeds the rate at 
which ordinary income is taxed.
    (e) Effective/applicability date. Paragraph (d) of this section 
shall apply to a sale, exchange, or other disposition of the stock of a 
domestic corporation on or after September 21, 1987.
    Par. 11. Section 1.1248-8 is amended by:
    1. Revising paragraphs (a)(3), (b)(1)(iv)(A), (b)(2)(i), and (d).
    2. Adding new paragraph (b)(2)(iv).
    The revisions and addition to read as follows:


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

    (a) * * *
    (3) Application of section 381. Stock of a foreign corporation that 
receives assets in a transfer to which section 361(a) or (b) 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
* * * * *
    (b) * * *
    (1) * * *
    (iv) * * *
    (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) or (b), 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
* * * * *

[[Page 49297]]

    (2) * * *
    (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. Except as provided in paragraph (b)(2)(iv) of this 
section, 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 before the 
restructuring transaction. See paragraph (b)(7) Example 1 of this 
section.
* * * * *
    (iv) Exchanging shareholder exchanges stock of a domestic acquired 
corporation for stock of a foreign corporation with respect to which 
the exchanging shareholder is a section 1248 shareholder after the 
exchange. If in a restructuring transaction described in Sec.  
1.1248(f)-2(c) and to which the exception provided by Sec.  1.1248(f)-
2(c)(1) applies, the earnings and profits attributable to a portion of 
a share of stock of a foreign corporation created pursuant to Sec.  
1.1248(f)-2(c)(2) (or a whole share, if no division is required) shall 
be determined pursuant to paragraphs (b)(2)(iv)(A) and (B) of this 
section.
    (A) The earnings and profits attributable to a portion of a share 
of stock created pursuant to Sec.  1.1248(f)-2(c)(2)(i) (or a whole 
share, if no division is required) shall be the earnings and profits 
attributable to the stock of the foreign corporation received by the 
section 1248 shareholder under section 354, 355, or 356 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 before the restructuring 
transaction.
    (B) The earnings and profits attributable to a portion of a share 
of stock created under Sec.  1.1248(f)-2(c)(2)(ii) (or whole share, if 
no division is required) shall be the sum of--
    (1) The earnings and profits attributable to the stock of the 
foreign corporation transferred in the section 361 exchange that 
relates to such portion (or share) multiplied by the section 1248 
shareholder's ownership interest (by value) in the domestic 
distributing corporation at the time of the restructuring transaction; 
and
    (2) The earnings and profits attributable to the stock of the 
foreign corporation received by the section 1248 shareholder under 
section 354, 355, or 356 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 
before the restructuring transaction. See Sec.  1.1248(f)-2(d), 
Examples 2 through 4.
* * * * *
    (d) Effective/applicability dates--(1) General rule. Except as 
provided in paragraph (d)(2) of this section, this section applies to 
income inclusions that occur on or after July 30, 2007.
    (2) Exception. Paragraph (b)(2)(iv) of this section applies to 
restructuring transactions occurring on or after the date 30 days after 
the date these regulations are published as final regulations in the 
Federal Register.
    Par. 12. Section 1.1248(f)-1 is added to read as follows:


Sec.  1.1248(f)-1  Certain nonrecognition distributions.

    (a) Scope and purpose. This section and Sec. Sec.  1.1248(f)-2 and 
1.1248(f)-3 provide rules that apply when a domestic corporation 
(domestic distributing corporation) distributes stock of a foreign 
corporation (foreign distributed corporation) in a distribution to 
which section 337, 355, or 361 applies. The purpose of this section is 
to confirm the general rule of section 1248(f)(1) that requires the 
domestic distributing corporation to include in gross income the 
section 1248 amount or section 1248(f) amount, as applicable, that is 
attributable to the stock of the foreign distributed corporation 
distributed under section 337, 355, or 361, and to provide exceptions 
to the general rule to the extent the section 1248 amount or section 
1248(f) amount, as applicable, can be preserved immediately following 
the distribution in the hands of a distributee that is a domestic 
corporation. This section provides the general rule and definitions. 
Section 1.1248(f)-2 provides the exceptions to the general rule. 
Section 1.1248(f)-3 provides a reasonable cause exception for a failure 
to comply with certain requirements of Sec.  1.1248(f)-2. Section 
1.1248(f)-3 also provides the effective dates of this section and Sec.  
1.1248(f)-2.
    (b) General rule--(1) Section 337 distributions. Except as provided 
in Sec.  1.1248(f)-2(a), a domestic distributing corporation that is a 
section 1248 shareholder of a foreign distributed corporation and that 
distributes stock of such corporation in a distribution to which 
section 337 applies (section 337 distribution), shall, notwithstanding 
any other provision of subtitle A, include in gross income as a 
dividend the section 1248 amount attributable to the distributed stock. 
This paragraph (b)(1) shall apply only to the extent the domestic 
distributing corporation does not recognize gain on the section 337 
distribution under any other provision of subtitle A.
    (2) Certain section 355 distributions. Except as provided in Sec.  
1.1248(f)-2(b), a domestic distributing corporation that is a section 
1248 shareholder of a foreign distributed corporation and that 
distributes stock of such corporation, other than stock received in a 
section 361 exchange, in a distribution to which section 355 applies 
(section 355 distribution), shall, notwithstanding any other provision 
of subtitle A, include in gross income as a dividend the section 1248 
amount attributable to the distributed stock. This paragraph (b)(2) 
shall apply only to the extent the domestic distributing corporation 
does not recognize gain on the section 355 distribution under any other 
provision of subtitle A.
    (3) Distributions pursuant to a plan of reorganization. Except as 
provided in Sec.  1.1248(f)-2(c), a domestic distributing corporation 
that is a section 1248 shareholder of a foreign distributed corporation 
and that distributes stock of such corporation received in a section 
361 exchange in a section 355 distribution or a distribution to which 
section 361 applies (section 361 distribution), shall, notwithstanding 
any other provision of subtitle A, include in gross income as a 
dividend the section 1248(f) amount attributable to the stock 
distributed. This paragraph (b)(3) shall apply without regard to the 
amount of gain realized by the domestic distributing corporation on the 
distribution.
    (c) Definitions. Except as otherwise provided, the following 
definitions apply for purposes of this section and Sec. Sec.  
1.1248(f)-2 and 1.1248(f)-3.
    (1) 80-percent distributee is a corporation described in section 
337(c).
    (2) Block of stock has the meaning set forth in Sec.  1.1248-2(b).
    (3) Distributee is a shareholder of the domestic distributing 
corporation that receives stock of a foreign distributed corporation in 
a section 355 distribution or section 361 distribution.
    (4) Postdistribution amount is the section 1248 amount attributable 
to the stock of a foreign distributed

[[Page 49298]]

corporation received (or deemed received) by a distributee, computed 
immediately after the distribution but without taking into account any 
adjustments to the basis of such stock under Sec.  1.1248(f)-2(b)(3) or 
(c)(3). The postdistribution amount attributable to stock of a foreign 
distributed corporation received in a section 355 distribution 
described in paragraph (b)(2) of this section shall be determined based 
on the distributee's holding period in such stock as adjusted under 
Sec.  1.1248(f)-2(b)(2). The postdistribution amount attributable to 
stock of a foreign distributed corporation received in a section 355 
distribution or section 361 distribution described in paragraph (b)(3) 
of this section shall be determined after applying the rules in 
Sec. Sec.  1.1248-8(b)(2)(iv) and 1.1248(f)-2(c)(2).
    (5) Section 358 basis is the basis of stock determined under 
section 358 and the regulations under that section.
    (6) Section 361 exchange is an exchange described in section 361(a) 
or (b).
    (7) Section 1248 amount is the net positive earnings and profits 
(if any) attributable to the stock of the foreign distributed 
corporation under Sec.  1.1248-2 or Sec.  1.1248-3 (as adjusted by 
Sec.  1.1248-8) and that would be included in gross income as a 
dividend under section 1248(a) if the stock were sold by the holder of 
such stock.
    (8) Section 1248(f) amount is the aggregate amount of the net 
positive earnings and profits (if any) attributable to the stock of 
each foreign corporation, under Sec.  1.1248-2 or Sec.  1.1248-3 (as 
adjusted by Sec.  1.1248-8), transferred by the domestic distributing 
corporation to the foreign distributed corporation in the section 361 
exchange that precedes the section 355 distribution or section 361 
distribution of the stock of the foreign distributed corporation, and 
that would be included in gross income as a dividend under section 
964(e) by the foreign distributed corporation if it sold such stock 
immediately after the section 361 exchange. The section 1248(f) amount 
is attributable to the stock of the foreign distributed corporation 
received in the section 361 exchange.
    (9) Section 1248 shareholder is a domestic corporation that 
satisfies the ownership requirements of section 1248(a)(2) with respect 
to a foreign corporation.
    (10) Timely-filed return is a U.S. income tax return filed on or 
before the due date set forth in section 6072(b), plus any extension of 
time to file such return granted under section 6081.
    Par. 13. Section 1.1248(f)-2 is added to read as follows:


Sec.  1.1248(f)-2  Exceptions for certain distributions.

    (a) Section 337 distributions. Section 1.1248(f)-1(b)(1) shall not 
apply to a section 337 distribution of stock of the foreign distributed 
corporation if the conditions of paragraphs (a)(1) through (a)(3) of 
this section are satisfied.
    (1) 80-percent distributee is a section 1248 shareholder. 
Immediately after the section 337 distribution, the 80-percent 
distributee is a section 1248 shareholder with respect to the foreign 
distributed corporation.
    (2) Holding period. The 80-percent distributee is treated as 
holding the stock of the foreign distributed corporation received in 
the section 337 distribution for the period during which the stock was 
held by the domestic distributing corporation.
    (3) Basis. The 80-percent distributee's basis in the stock of the 
foreign distributed corporation received in the section 337 
distribution does not exceed the domestic distributing corporation's 
basis in such stock at the time of the section 337 distribution.
    (b) Certain section 355 distributions. Section 1.1248(f)-1(b)(2) 
shall not apply to a section 355 distribution of stock of the foreign 
distributed corporation not received by the domestic distributing 
corporation in a section 361 exchange to a distributee that is a 
section 1248 shareholder with respect to the foreign distributed 
corporation immediately after the distribution, if the domestic 
distributing corporation and all such section 1248 shareholders elect 
to apply the provisions of this paragraph (b) in accordance with 
paragraph (b)(1) of this section. See paragraphs (b)(2) and (b)(3) of 
this section for adjustments that occur as a result of electing to 
apply the provisions of this paragraph (b).
    (1) Election and reporting--(i) Statement required by section 1248 
shareholders and domestic distributing corporation--(A) In general. The 
domestic distributing corporation and the section 1248 shareholders 
elect to apply the provisions of paragraph (b) of this section by each 
including a statement, described in paragraph (b)(1)(i)(B) of this 
section, with its timely-filed return for the taxable year during which 
the section 355 distribution occurs and by entering into a written 
agreement described in paragraph (b)(1)(ii) of this section. If the 
domestic distributing corporation or a section 1248 shareholder is a 
member of a consolidated group at the time of the section 355 
distribution, the common parent of the consolidated group makes the 
election on behalf of the domestic distributing corporation or section 
1248 shareholder. The election made under this paragraph (b)(1) is 
irrevocable.
    (B) Form and content. The statement of election must be entitled, 
STATEMENT TO ELECT TO APPLY EXCEPTION UNDER Sec.  1.1248(f)-2(b). The 
statement must state that the domestic distributing corporation and 
each section 1248 shareholder have entered into a written agreement 
described in paragraph (b)(1)(ii) of this section and must set forth 
the adjustment to each section 1248 shareholder's holding period or 
section 358 basis (if any) in the stock of the foreign distributed 
corporation received in the section 355 distribution required under 
paragraph (b)(2) or (b)(3) of this section.
    (ii) Written agreement. The domestic distributing corporation and 
the section 1248 shareholders must enter into a written agreement 
described in this paragraph (b)(1)(ii) on or before the due date 
(including extensions) of the domestic distributing corporation's U.S. 
income tax return for the taxable year during which the section 355 
distribution occurs. Each party to the agreement must retain the 
original or a copy of the agreement as part of its records in the 
manner specified by Sec.  1.6001-1(e). Each party to the agreement must 
provide a copy of the agreement to the Internal Revenue Service within 
30 days of the receipt of a request for the agreement in connection 
with an examination of the taxable year during which the section 355 
distribution occurs. The agreement must--
    (A) State the document is an agreement under paragraph (b)(1)(ii) 
of this section;
    (B) Identify the domestic distributing corporation and each section 
1248 shareholder;
    (C) With respect to each section 1248 shareholder, state the 
holding period in the stock of the foreign distributed corporation 
received in the section 355 distribution as adjusted under paragraph 
(b)(2) of this section; and
    (D) With respect to each section 1248 shareholder, identify the 
section 358 basis of the stock of the foreign distributed corporation 
received in the section 355 distribution and the adjustment (if any) to 
such basis under paragraph (b)(3) of this section.
    (2) Holding period adjustment. For purposes of section 1248, 
immediately after the section 355 distribution, each section 1248 
shareholder's holding period in the stock of the foreign distributed 
corporation received in the section 355 distribution shall equal the 
domestic distributing corporation's

[[Page 49299]]

holding period in such stock at the time of the distribution.
    (3) Basis adjustments. If the domestic distributing corporation's 
section 1248 amount attributable to the stock of the foreign 
distributed corporation received by a section 1248 shareholder in the 
section 355 distribution exceeds the section 1248 shareholder's 
postdistribution amount attributable to such stock (excess amount), the 
section 1248 shareholder's section 358 basis in such stock is reduced 
by such excess amount. For an illustration of the rule in this 
paragraph (b)(3), see paragraph (d) of this section, Examples 1 and 4.
    (c) Distributions pursuant to a plan of reorganization. Section 
1.1248(f)-1(b)(3) shall not apply to a section 355 distribution or 
section 361 distribution of stock of the foreign distributed 
corporation received by the domestic distributing corporation in the 
section 361 exchange that precedes the distribution, to a distributee 
that is a section 1248 shareholder with respect to the foreign 
distributed corporation immediately after the distribution, if the 
domestic distributing corporation and all such section 1248 
shareholders elect to apply the provisions of this paragraph (c) in 
accordance with paragraph (c)(1) of this section. See paragraphs (c)(2) 
and (c)(3) of this section for the adjustments that result from 
electing to apply the provisions of this paragraph (c). The adjustments 
provided in paragraphs (c)(2) and (c)(3) of this section shall apply 
after any adjustments required under section 367(a)(5) and Sec.  
1.367(a)-7(c). For illustrations of this exception, see paragraph (d) 
of this section, Examples 2 through 4.
    (1) Election and reporting--(i) Statement required by section 1248 
shareholders and domestic distributing corporation--(A) In general. The 
domestic distributing corporation and the section 1248 shareholders 
elect to apply the provisions of paragraph (c) of this section by each 
including a statement, in the form and with the content listed in 
paragraph (c)(1)(i)(B) of this section, with its timely-filed return 
for the taxable year during which the distribution occurs and by 
entering into a written agreement described in paragraph (c)(1)(ii) of 
this section. If the domestic distributing corporation or a section 
1248 shareholder is a member of a consolidated group at the time of the 
distribution, the common parent of the consolidated group makes the 
election on behalf of the domestic distributing corporation or section 
1248 shareholder. The election made under this paragraph (c)(1) is 
irrevocable.
    (B) Form and content. The statement of election must be entitled, 
STATEMENT TO APPLY EXCEPTION UNDER Sec.  1.1248(f)-2(c). The statement 
must state that the domestic distributing corporation and each section 
1248 shareholder have entered into a written agreement described in 
paragraph (c)(1)(ii) of this section and must describe, with respect to 
each section 1248 shareholder, the extent to which the shares of stock 
of the foreign distributed corporation received in the section 361 
distribution are divided into portions under paragraph (c)(2) of this 
section and any adjustments to the section 358 basis of such stock 
under paragraph (c)(3) of this section.
    (ii) Written agreement. The domestic distributing corporation and 
the section 1248 shareholders must enter into a written agreement 
described in this paragraph (c)(1)(ii) on or before the due date 
(including extensions) of the U.S. transferor's U.S. income tax return 
for the taxable year during which the distribution occurs. Each party 
to the agreement must retain the original or a copy of the agreement as 
part of its records in the manner specified by Sec.  1.6001-1(e). Each 
party to the agreement must provide a copy of the agreement to the 
Internal Revenue Service within 30 days of the receipt of a request for 
the agreement in connection with an examination of the taxable year 
during which the distribution occurs. The agreement must--
    (A) State the document is an agreement under paragraph (c)(1)(ii) 
of this section;
    (B) Identify the domestic distributing corporation and each section 
1248 shareholder;
    (C) With respect to each section 1248 shareholder, describe the 
extent to which the shares of stock of the foreign distributed 
corporation are divided into portions under paragraph (c)(2) of this 
section;
    (D) With respect to each section 1248 shareholder, state the amount 
of any adjustment to the section 358 basis of the stock of the foreign 
distributed corporation under paragraph (c)(3) of this section; and
    (E) With respect to each section 1248 shareholder, state the amount 
of earnings and profits attributable to the stock of the foreign 
distributed corporation received in the distribution. See Sec.  1.1248-
8(b)(2)(iv).
    (2) Portions. If the domestic distributing corporation transfers 
property to the foreign distributed corporation in the section 361 
exchange that precedes the section 355 distribution or section 361 
distribution, other than a single block of stock of a foreign 
corporation with respect to which the domestic distributing corporation 
is a section 1248 shareholder at the time of the section 361 exchange, 
then each share of stock of the foreign distributed corporation 
received by a section 1248 shareholder in the distribution must be 
divided into portions as follows:
    (i) One portion attributable to all property transferred in the 
section 361 exchange, other than stock of a foreign corporation with 
respect to which the domestic distributing corporation is a section 
1248 shareholder at the time of the section 361 exchange; and
    (ii) One portion attributable to each block of stock of a foreign 
corporation transferred in the section 361 exchange with respect to 
which the domestic distributing corporation is a section 1248 
shareholder at the time of the section 361 exchange. For the 
determination of the earnings and profits attributable to a portion of 
a share of stock of the foreign distributed corporation, see Sec.  
1.1248-8(b)(2)(iv).
    (3) Basis adjustments. If the section 1248(f) amount attributable 
to a portion of a share of stock (or whole share, if no division is 
required) of the foreign distributed corporation received (or deemed 
received) by a section 1248 shareholder in the distribution exceeds the 
section 1248 shareholder's postdistribution amount attributable to such 
portion (or whole share, if no division is required) (excess amount), 
then the section 1248 shareholder's section 358 basis in such portion 
(or whole share, if no division is required) as adjusted under Sec.  
1.367(a)-7(c)(3), is reduced by such excess amount. For an illustration 
of this rule, see paragraph (d) of this section, Example 3.
    (4) Rules applicable to divided shares of stock--(i) Basis. The 
basis of a portion of a share of stock of the foreign distributed 
corporation created under paragraph (c)(2) of this section is that 
amount of the section 1248 shareholder's section 358 basis (as adjusted 
under Sec.  1.367(a)-7(c)(3)) in the share of stock that bears the same 
ratio that the fair market value of the property received by the 
foreign distributed corporation in the section 361 exchange to which 
such portion relates bears to the aggregate fair market value of all 
property received by the foreign distributed corporation in the section 
361 exchange. For illustrations of this rule, see paragraph (d) of this 
section, Examples 2 and 3.
    (ii) Fair market value. The fair market value of a portion of a 
share of stock of the foreign distributed corporation created under 
paragraph (c)(2) of this section is that amount of the fair market 
value of the share of stock of the foreign

[[Page 49300]]

corporation that bears the same ratio that the fair market value of the 
property received by the foreign distributed corporation in the section 
361 exchange to which such portion relates bears to the aggregate fair 
market value of all property received by the foreign distributed 
corporation in the section 361 exchange. For illustrations of this 
rule, see paragraph (d) of this section, Examples 2 and 3.
    (iii) Rules for subsequent exchanges. For purposes of determining 
the gain realized on the sale or exchange of a share of stock of the 
foreign distributed corporation that has a divided portion pursuant to 
paragraph (c)(2) of this section, the amount realized on the sale or 
exchange of such share shall be allocated to each divided portion based 
on the relative fair market value of the property to which such portion 
relates as determined at the time of the section 361 exchange.
    (iv) Duration of divided shares. Shares of stock of the foreign 
distributed corporation that are divided into portions under paragraph 
(c)(2) of this section are not required to be divided as of the date on 
which section 1248(a) would not apply to a sale or exchange of such 
shares.
    (d) Examples. The rules of this section are illustrated by the 
following examples. The analysis of the examples is limited to a 
discussion of issues under this section. For purposes of the examples, 
unless otherwise indicated, assume: DP1, DP2, DP3, DC, and USD are 
domestic corporations; X is a United States resident individual; FP and 
FA are foreign corporations that are not, and have never been, 
controlled foreign corporations; CFC1, CFC2, and FC are controlled 
foreign corporations; each corporation has a single class of stock 
outstanding and uses the calendar year as its taxable year; each 
shareholder owns a single block of stock in each corporation; DC owns 
Business A, which consists solely of section 367(a) property that could 
satisfy the requirements of the active foreign trade or business 
exception under section 367(a)(3) and Sec.  1.367(a)-2T; and DC owns no 
other assets and has no liabilities. Further assume the requirements in 
Sec.  1.367(a)-7(c)(5) are satisfied, any requirement to file a gain 
recognition agreement is satisfied, and no earnings and profits of a 
foreign corporation are described in section 1248(d).

    Example 1. Section 355 distribution, gain recognition, and 
adjustment to stock basis--(i) Facts. DP1, FP, and X own 80%, 10%, 
and 10%, respectively, of the outstanding stock of USD. DP1's USD 
stock has a $140x basis, a $160x fair market value, and a 2 year 
holding period. USD wholly owns FC. USD's FC stock has a $50x basis, 
a $100x fair market value, a $25x section 1248 amount, and a 3 year 
holding period. On December 31, Year 3, USD distributes all of the 
FC stock to DP1, FP, and X on a pro-rata basis in a section 355 
distribution. The fair market value of the FC stock received by DP1, 
FP and X is $80x, $10x, and $10x, respectively. After the 
distribution, DP1's section 358 basis in its FC stock is $70x.
    (ii) Result. (A) Under Sec.  1.367(e)-1(b)(1), USD must 
recognize $5x gain on the distribution of FC stock to FP (10% of the 
$50x gain in the FC stock). Under Sec.  1.367(b)-5(b)(1)(ii), USD 
must recognize $5x gain on the distribution of FC stock to X (10% of 
the $50x gain in the FC stock). Of the aggregate $10x gain 
recognized by USD, $5x is recharacterized as a dividend under 
section 1248(a) (20% of the section 1248 amount ($25x) attributable 
to the FC stock). See Sec.  1.1248-1 for additional consequences.
    (B) USD's distribution of FC stock to DP1 is described in 
section 1248(f)(1) and Sec.  1.1248(f)-1(b)(2). As a result, USD 
must generally include in gross income as a dividend the section 
1248 amount attributable to such stock ($20x, or 80% of the $25x 
section 1248 amount). However, if DP1 and USD elect to apply the 
rules of paragraph (b) of this section (as provided in paragraph 
(b)(1) of this section), Sec.  1.1248(f)-1(b)(2) shall not apply to 
USD's distribution of FC stock to DP1. If DP1 and USD make that 
election, then:
    (1) Under paragraph (b)(2) of this section, for purposes of 
section 1248, immediately after the distribution DP1 will have a 3 
year holding period in the FC stock received in the section 355 
distribution, the same holding period USD had in such stock at the 
time of the distribution.
    (2) Under paragraph (b)(3) of this section, DP1's section 358 
basis in the FC stock ($70x) received in the distribution is reduced 
by $10x, the amount by which USD's section 1248 amount ($20x) 
attributable to such FC stock exceeds DP1's postdistribution amount 
($10x) attributable to such stock. As adjusted under paragraph 
(b)(3) of this section, DP1's basis in the FC stock is $60x. Under 
Sec.  1.1248(f)-1(c)(4), DP1's postdistribution amount ($10x) equals 
the amount that DP1 would include in gross income as a dividend 
under section 1248(a) if it sold the FC stock immediately after the 
distribution ($80x fair market value, $70x basis, and $20x earnings 
and profits attributable to the FC stock for purposes of section 
1248 taking into account DP1's 3-year holding period in such stock 
as required by paragraph (b)(2) of this section).
    Example 2. Section 361 distribution --(i) Facts. DP1, DP2, and 
FP own 50, 30, and 20, respectively, of the 100 outstanding shares 
of stock of DC. DP1's DC stock has a $180x basis and a $200x fair 
market value. DP2's DC stock has a $100x basis and $120x fair market 
value. DC owns Business A and wholly owns CFC1 and CFC2. DC's 
Business A has a $10x basis and a $200x fair market value. DC's CFC1 
stock has a $20x basis, a $40x fair market value, and $30x of 
earnings and profits attributable to it for purposes of section 
1248(a). DC's CFC2 stock has a $30x basis, a $160x fair market value 
and $150x of earnings and profits attributable to it for purposes of 
section 1248(a). On December 31, Year 3, in a reorganization 
described in section 368(a)(1)(D), DC transfers CFC1, CFC2 and 
Business A to FA in exchange for 60 shares of FA stock. DC's 
transfer of CFC1, CFC2 and Business A to FA in exchange for the 60 
shares of FA stock qualifies as a section 361 exchange. DC 
distributes the FA stock to DP1, DP2 and FP on a pro-rata basis in a 
section 361 distribution. DP1, DP2 and FP exchange their DC stock 
for 30, 18, and 12 shares, respectively, of FA stock pursuant to 
section 354. After the reorganization, FA has 100 shares of stock 
outstanding. DP3 owns the other 40 shares of FA stock.
    (ii) Result. (A) In general, under section 367(a)(5) and Sec.  
1.367(a)-7(b), DC's transfer of the stock of CFC1 and CFC2 and 
Business A to FA is subject to the general rule of section 
367(a)(1). As a result, DC must generally recognize gain on the 
transfer of such property to FA in the section 361 exchange. 
However, if the conditions and requirements of Sec.  1.367(a)-7(c) 
are met (which includes the making of the election under Sec.  
1.367(a)-7(c)(5)), DC's transfer of the stock of CFC1 and CFC2 and 
Business A to FA may, in part, be eligible for the exceptions to 
section 367(a)(1) provided by Sec. Sec.  1.367(a)-2T and -3. See 
Sec. Sec.  1.367(a)-2T and -3(b) for additional requirements. In 
addition, DC may not be required to include in income the section 
1248 amount attributable to the CFC1 and CFC2 stock under Sec.  
1.367(b)-4(b)(1). However, if the exception provided under paragraph 
(c) of this section does not apply, then under Sec.  1.1248(f)-
1(b)(3) DC must include in gross income as a dividend the section 
1248(f) amounts attributable to the FA stock distributed. DC must 
include in income as a dividend the section 1248(f) amount 
attributable to the FA stock distributed to FP even if the exception 
provided by Sec.  1.367(a)-7(c) applies.
    (B) The requirement of Sec.  1.367(a)-7(c)(1) is satisfied 
because DC is controlled (within the meaning of section 368(c)) by 
DP1 and DP2 at the time of the section 361 exchange.
    (C) Under Sec.  1.367(a)-7(c)(2)(i), DC must recognize $68x gain 
on the section 361 exchange with respect to FP. The $68x gain equals 
the product of FP's 20% ownership interest in DC (by value) at the 
time of the section 361 exchange and the $340x inside gain. The 
inside gain equals the excess of the aggregate gross fair market 
value of the section 367(a) property ($400x) over the $60x inside 
basis. Under Sec.  1.367(a)-7(e)(1), the $68x gain recognized is 
allocated among the CFC1 stock, the CFC2 stock and Business A in 
proportion to the amount of gain realized by DC on the transfer of 
such property. The amount allocated to the CFC1 stock is $4x ($68x 
gain multiplied by $20x/$340x). The amount allocated to the CFC2 
stock is $26x ($68x gain multiplied by $130x/$340x). The amount 
allocated to Business A is $38x ($68x gain multiplied by $190x/
$340x). Under Sec.  1.367(a)-1T(b)(4)(i)(B) and section 362(b), the 
basis of each asset is increased by the amount of gain allocated to 
such asset. Under section 1248(a), DC must include in gross income 
as a dividend the $4x gain recognized with respect to the CFC1 stock 
(20% of the $20x section 1248 amount attributable to

[[Page 49301]]

such stock) and the $26x gain recognized with respect to CFC2 stock 
(20% of the $130x section 1248 amount attributable to such stock). 
If the built-in gain in the CFC1 stock or CFC2 stock exceeded the 
section 1248 amount attributable to such stock, the amount of the 
gain recognized by DC on the transfer of such stock in the section 
361 exchange recharacterized as a dividend under section 1248(a) 
would be less.
    (D) DC is not required to recognize gain on the section 361 
exchange under Sec.  1.367(a)-7(c)(2)(ii) with respect to DP1 or 
DP2. With respect to DP1, the product of the inside gain ($340x) and 
DP1's 50% ownership interest (by value) in DC at the time of the 
section 361 exchange (or $170x) does not exceed the product of the 
section 367(a) percentage (100%) and the fair market value of the FA 
stock received by DP1 ($200x). With respect to DP2, the product of 
the inside gain ($340x) and DP2's 30% ownership percentage (by 
value) in DC at the time of the section 361 exchange (or $102x) does 
not exceed the product of the section 367(a) percentage (100%) and 
the fair market value of the FA stock received by DP2 ($120x).
    (E) Under Sec.  1.367(a)-7(c)(3), DP1's section 358 basis 
($180x) in the FA stock received in the section 361 distribution is 
reduced by $150x, the amount by which DP1's 50% share of inside gain 
($170x) exceeds DP1's $20x outside gain. DP1's share of inside gain 
is not reduced under Sec.  1.367(a)-7(c)(2)(ii) because DC did not 
recognize gain with respect to DP1. DP1's $20x outside gain equals 
the product of the section 367(a) percentage (100%) and the excess 
of the fair market value of the FA stock received by DP1 ($200x) 
over the section 358 basis of such stock ($180x). As adjusted, DP1's 
basis in the FA stock is $30x. Similarly, DP2's section 358 basis 
($100x) in the FA stock received in the section 361 distribution is 
reduced by $82x, the amount by which DP2's 30% share of inside gain 
($102x) exceeds DP1's $20x outside gain. DP2's share of inside gain 
is not reduced under Sec.  1.367(a)-7(c)(2)(ii) because DC did not 
recognize gain with respect to DP2. DP2's $20x outside gain equals 
the product of the section 367(a) percentage (100%) and the excess 
of the fair market value of the FA stock received by DP2 ($120x) 
over the section 358 basis of such stock ($100x). As adjusted, DP2's 
basis in the FA stock is $18x.
    (F) Under Sec.  1.367(a)-7(c)(4)(i), DC must comply with the 
requirements of Sec.  1.6038B-1(c)(6)(iii) with respect to Business 
A. Under Sec.  1.367(a)-7(c)(4)(ii), DC is not required to comply 
with the requirements of Sec.  1.6038B-1(c)(6)(iii) with respect to 
the stock of CFC1 or CFC2.
    (G) DC is not required to include in income as a dividend the 
remaining section 1248 amount attributable to the stock of CFC1 
($16x) or CFC2 ($104x) under Sec.  1.367(b)-4(b)(1)(i) because 
immediately after the section 361 exchange, FA, CFC1, and CFC2 are 
controlled foreign corporations with respect to which DC is a 
section 1248 shareholder.
    (H) Under Sec.  1.1248(f)-1(b)(3), DC must generally include in 
gross income as a dividend the section 1248(f) amount ($120x) 
attributable to the FA stock distributed to DP1, DP2 and FA in the 
section 361 distribution. The section 1248(f) amount equals the sum 
of the amounts that FA would include in income as a dividend under 
section 964(e) if it sold the CFC1 stock ($16x gain and $26x 
earnings and profits attributable to such stock--calculated in 
paragraph (K)(3) of this Example) and CFC2 stock ($104x gain and 
$124x earnings and profits attributable to such stock--calculated in 
paragraph (K)(3) of this Example) immediately after the section 361 
exchange.
    (I) [Reserved.]
    (J) However, if DP1, DP2, and DC elect to apply the provisions 
of paragraph (c) of this section (as provided in paragraph (c)(1) of 
this section), then Sec.  1.1248(f)-1(b)(3) shall not apply to DC's 
distribution of FA stock to DP1 and DP2. Even if such election is 
made, however, DC must include in gross income as a dividend the 
section 1248(f) amount ($24x) attributable to the 12 shares of FA 
stock distributed to FP (20% of the $120x section 1248(f) amount.)
    (K) If DP1, DP2, and DC elect to apply the provisions of 
paragraph (c) of this section, then under paragraph (c)(2) of this 
section each share of FA stock received by DP1 (30 shares) and DP2 
(18 shares) is divided into portions attributable to the CFC1 stock, 
the CFC2 stock and Business A. Under paragraphs (c)(4)(i) and (ii) 
of this section, the basis and fair market value of each portion of 
each share of FA stock is that amount of the total basis and fair 
market value of the FA stock that bears the same ratio that the fair 
market value of the property (exchanged for such FA stock) to which 
such portion relates bears to the aggregate fair market value of all 
property exchanged for the FA stock in the section 361 exchange.
    (1) With respect to DP1's 30 shares of FA stock, the portions 
attributable to the CFC1 stock have an aggregate basis of $3x ($30x 
multiplied by $40x/$400x) and a fair market value of $20x ($200x 
multiplied by $40x/$400x); the portions attributable to the CFC2 
stock have an aggregate basis of $12x ($30x multiplied by $160x/
$400x) and a fair market value of $80x ($200x multiplied by $160x/
$400x), and the portions attributable to Business A have an 
aggregate basis of $15x ($30x multiplied by $200x/$400x) and a fair 
market value of $100x (50% of $200x).
    (2) With respect to DP2's 18 shares of FA stock, the portions 
attributable to the CFC1 stock have an aggregate basis of $1.8x 
($18x multiplied by $40x/$400x) and a fair market value of $12x 
($120x multiplied by $40x/$400x); the portions attributable to the 
CFC2 stock have an aggregate basis of $7.2x ($18x multiplied by 
$160x/$400x) and a fair market value of $48x ($120x multiplied by 
$160x/$400x); and the portions attributable to Business A have an 
aggregate basis of $9x ($18x multiplied by $200x/$400x) and a fair 
market value of $60x ($120x multiplied by $200x/$400x).
    (3) Under Sec.  1.1248-8(b)(2)(iv), the earnings and profits of 
CFC1 attributable to the portions of DP1's 30 shares of FA stock 
attributable to the CFC1 stock is $13x ($26x earnings and profits 
amount multiplied by DP1's 50% ownership interest (by value) in DC 
at the time of the section 361 exchange), and the earnings and 
profits of CFC2 attributable to the portions of DP1's 30 shares of 
FA stock attributable to the CFC2 stock is $62x ($124x earnings and 
profits amount multiplied by DP1's 50% ownership interest in DC at 
the time of the section 361 exchange). Similarly, the earnings and 
profits of CFC1 attributable to the portions of DP2's 18 shares of 
FA stock attributable to the CFC1 stock is $7.8x ($26x earnings and 
profits amount multiplied by DP2's 30% ownership interest (by value) 
in DC at the time of the section 361 exchange), and the amount of 
earnings and profits of CFC2 attributable to the portions of DP2's 
18 shares of FA stock attributable to the CFC2 stock is $37.2x 
($124x earnings and profits amount multiplied by DP2's 30% ownership 
interest (by value) in DC at the time of the section 361 exchange). 
The $26x earnings and profits with respect to the CFC1 stock equals 
the $30x earnings and profits amount attributable to the CFC1 stock 
immediately before the section 361 exchange reduced by the $4x 
included in income by DC as a dividend under section 1248(a) on the 
transfer of the CFC1 stock to FA in the section 361 exchange. The 
$124x earnings and profits with respect to CFC2 equals the $150x 
earnings and profits attributable to the CFC2 stock immediately 
before the section 361 exchange reduced by the $26x amount included 
in income by DC as a dividend under section 1248(a) on the transfer 
of the CFC2 stock to FA in the section 361 exchange. See sections 
959(e) and 1248(d)(1).
    (L) Under paragraph (c)(3) of this section, DP1 is not required 
to reduce the aggregate section 358 basis of the portions of its 30 
shares of FA stock attributable to the CFC1 stock or CFC2 stock. 
DP1's postdistribution amount ($13x) attributable to the portions of 
its FA shares attributable to the CFC1 stock exceeds its allocable 
share of the section 1248(f) amount attributable to the CFC1 stock 
immediately after the section 361 exchange ($8x, or 50% of $16x). 
DP1's postdistribution amount ($62x) attributable to the portions of 
its FA shares attributable to the CFC2 stock exceeds its allocable 
share of the section 1248(f) amount attributable to the CFC2 stock 
immediately after the section 361 exchange ($52x, or 50% of $104x).
    (M) Similarly, DP2 is not required to reduce the aggregate 
section 358 basis of the portions of its 18 shares of FA stock 
attributable to the CFC1 stock or CFC2 stock. DP2's postdistribution 
amount ($7.8x) attributable to the portions of its FA shares 
attributable to the CFC1 stock exceeds its allocable share of the 
section 1248(f) amount attributable to the CFC1 stock immediately 
after the section 361 exchange ($4.8x, or 30% of $16x). DP2's 
postdistribution amount ($37.2x) attributable to the portions of its 
FA shares attributable to the CFC2 stock exceeds its allocable share 
of the section 1248(f) amount attributable to the CFC2 stock 
immediately after the section 361 exchange ($31.2x, or 30% of 
$104x).
    Example 3. Section 361 distribution and adjustment to stock 
basis. (i) Facts. DP1 wholly owns DC. DP1's DC stock has a $180x 
basis and a $200x fair market value. DC wholly owns CFC1 and CFC2. 
DC's CFC1 stock has a $70x basis, a $100x fair market

[[Page 49302]]

value, and $40x of earnings and profits attributable to it for 
purposes of section 1248. DC's CFC2 stock has a $130x basis, a $100x 
fair market value, and $80x of earnings and profits attributable to 
it for purposes of section 1248. On December 31, Year 1, in a 
reorganization described in section 368(a)(1)(F), DC transfers the 
CFC1 stock and the CFC2 stock to FA, a newly formed corporation, in 
exchange for 100 shares of FA stock. DC distributes the 100 shares 
of FA stock to DP1 in a section 361 distribution. DC's transfer of 
the stock of CFC1 and CFC2 to FA in exchange for FA stock qualifies 
as a section 361 exchange. DP1 exchanges its DC stock for the 100 
shares of FA stock pursuant to section 354. DP1 and DC elect to 
apply the rules of Sec.  1.367(a)-7(c) in accordance with Sec.  
1.367(a)-7(c)(5). DC is not required to recognize gain under Sec.  
1.367(a)-7(c)(2), and DP1 is not required to reduce its section 358 
basis in the FA shares under Sec.  1.367(a)-7(c)(3).
    (ii) Result. (A) DC is not required to include in income as a 
dividend the section 1248 amount attributable to the CFC1 stock 
under Sec.  1.367(b)-4(b)(1)(i) because, immediately after the 
section 361 exchange, FA and CFC1 are controlled foreign 
corporations with respect to which DC is a section 1248 shareholder. 
At the time of the section 361 exchange the section 1248 amount 
attributable to the CFC2 stock is zero.
    (B) Under Sec.  1.1248(f)-1(b)(3), DC must generally include in 
income as a dividend the section 1248(f) amount ($30x) attributable 
to the FA stock upon its distribution of such stock to DP1 in the 
section 361 distribution. The section 1248(f) amount is the amount 
that FA would include in income as a dividend under section 964(e) 
if it sold the CFC1 stock immediately after the section 361 
exchange. Immediately after the section 361 exchange, the section 
1248(f) amount attributable to the CFC2 stock is zero.
    (C) However, if DP1 and DC elect to apply the rules of paragraph 
(c) of this section (as provided in paragraph (c)(1) of this 
section), then Sec.  1.1248(f)-1(b)(3) shall not apply to DC's 
distribution of the FA stock to DP1. If that election is made then:
    (1) Under paragraph (c)(2)(ii) of this section each share of FA 
stock received by DP1 is divided into one portion attributable to 
the CFC1 stock and one portion attributable to the CFC2 stock. Under 
paragraphs (c)(4)(i) and (ii) of this section, the basis and fair 
market value of each portion is that amount of the total section 358 
basis and fair market value, respectively, of the FA stock that 
bears the same ratio that the fair market value of the property (the 
CFC1 stock and CFC2 stock) to which such portion relates bears to 
the aggregate fair market value of all property exchanged by DC for 
the FA stock in the section 361 exchange. Therefore, the portions 
attributable to the CFC1 stock have an aggregate basis of $90x 
($180x multiplied by $100x/$200x) and a fair market value of $100x 
($200x multiplied by $100x/$200x). The portions attributable to the 
CFC2 stock also have an aggregate basis of $90x ($180x multiplied by 
$100x/$200x) and a fair market value of $100x ($200x multiplied by 
$100x/$200x).
    (2) Under Sec.  1.1248-8(b)(2)(iv), the $40x earnings and 
profits attributable to the CFC1 stock at the time of the section 
361 exchange are attributed to the portions of the shares of FA 
stock that relate to the CFC1 stock. Similarly, the $80x of earnings 
and profits attributable to the CFC2 stock are attributed to the 
portions of the 100 shares of the FA stock that relate to the CFC2 
stock.
    (3) Under paragraph (c)(3) of this section, DP1's aggregate 
section 358 basis in the portions of the 100 shares of FA stock 
attributable to the CFC1 stock ($90x) is reduced by $20x, the amount 
by which the section 1248(f) amount attributable to the CFC1 stock 
($30x) exceeds DP1's postdistribution amount ($10x) with respect to 
the portions of the shares of FA stock attributable to the CFC1 
stock. The postdistribution amount is the section 1248 amount 
attributable to the portions of the FA stock attributable to the 
CFC1 stock immediately after the section 361 distribution ($100x 
fair market value less $90x basis, and $40x earnings and profits 
attributable to such portions). As adjusted, DP1's aggregate basis 
in the portions of the shares of FA stock attributable to the CFC1 
stock is $70x. No adjustment is required to DP1's aggregate basis in 
the portions of the FA stock attributable to the CFC2 stock because 
no portion of the $30x section 1248(f) amount is attributable to the 
CFC2 stock.
    Example 4. Section 361 exchange followed by distribution of 
stock pursuant to plan of reorganization. (i) Facts. DP1 owns all 
100 outstanding shares of stock of DC. DP1's DC stock has a $180x 
basis, $200x fair market value, and 2 year holding period. DC owns 
all 60 shares of the outstanding stock of CFC1. DC's CFC1 stock has 
a $50x basis, a $60x fair market value, $30x of earnings and profits 
attributable to it for purposes of section 1248, and a 3 year 
holding period. DC also owns all 40 shares of the outstanding stock 
of CFC2. DC's CFC2 stock has a $30x basis, a $40x fair market value, 
and $20x of earnings and profits attributable to it for purposes of 
section 1248. DC also owns Business A that has a fair market value 
of $100x. On December 31, Year 4, in a divisive reorganization 
described in section 368(a)(1)(D), DC transfers the CFC2 stock to 
CFC1 in exchange for 40 additional shares of CFC1 stock. DC then 
distributes the 100 shares of CFC1 stock to DP1. DC's transfer of 
the CFC2 stock to CFC1 qualifies as a section 361 exchange. DP1 and 
DC are eligible to and make the elections provided in Sec.  
1.367(a)-7(c)(5) and paragraphs (b) and (c) of this section.
    (ii) Result. (A) DC is not required to recognize gain under 
Sec.  1.367(a)-7(c)(2).
    (B) Under section 358, DP1 must allocate the $180x pre-
distribution section 358 basis in its DC stock between the shares of 
DC stock and the shares of CFC1 stock held after the distribution 
based on the relative fair market values of such shares. After the 
allocation of the pre-distribution basis, the basis of DP1's DC 
stock is $90x, and the basis of DP1's CFC1 stock is $90x. With 
respect to the $90x basis in the CFC1 stock, $36x is attributable to 
the 40 shares of CFC1 stock received by DC in the section 361 
exchange, and $54x is attributable to the 60 shares of CFC1 stock 
owned by DC before the section 361 exchange.
    (C) Pursuant to Sec.  1.367(a)-7(c)(3)(ii)(A), any adjustment to 
basis required under Sec.  1.367(a)-7(c)(3) applies only to the 40 
shares of CFC1 stock received by DC in the section 361 exchange. 
Under Sec.  1.367(a)-7(c)(3)(i), DP1 must reduce its section 358 
basis ($36x) in the 40 shares of CFC1 stock by $6x, the amount by 
which DP1's 100% share of the inside gain ($10x) exceeds DP2's 
outside gain ($4x). DP1's share of inside gain is not reduced under 
Sec.  1.367(a)-7(c)(2)(ii) because DC does not recognize gain on the 
transfer of the section 367(a) property in the section 361 exchange. 
The outside gain equals the product of the section 367(a) percentage 
(100%) and the amount by which the fair market value ($40x) of the 
40 shares of CFC1 stock exceeds DP1's section 358 basis of such 
stock ($36x). After the $6x reduction to stock basis required under 
Sec.  1.367(a)-7(c)(3), but before the application of Sec.  
1.1248(f)-2(c)(2), DP1's basis in such 40 shares of CFC1 stock is 
$30x.
    (D) DC is not required to include in income as a dividend the 
section 1248 amount attributable to the CFC2 stock under Sec.  
1.367(b)-4(b)(1)(i), because immediately after the section 361 
exchange CFC1 and CFC2 are both controlled foreign corporations with 
respect to which DC is a section 1248 shareholder.
    (E) Because DP1 and DC elect to apply the rules under paragraph 
(c) of this section, Sec.  1.1248(f)-1(b)(3) does not apply to DC's 
distribution to DP of the 40 shares of CFC1 stock received in the 
section 361 exchange.
    (1) Under paragraph (c)(2) of this section, the 40 shares of 
CFC1 stock received by DC in the section 361 exchange are 
attributable to the CFC2 stock. Thus, the 40 shares are not required 
to be divided into portions under paragraph (c)(2) of this section 
because DC exchanged a single block of stock of CFC2 for the 40 
shares of CFC1 stock in the section 361 exchange. The 40 shares of 
CFC1 stock have an aggregate basis of $30x (after the adjustment 
described in paragraph (C) of this Example) and fair market value of 
$40x.
    (2) Under Sec.  1.1248-8(b)(2)(iv), the $20x of earnings and 
profits attributable to the CFC2 stock at the time of the section 
361 exchange are attributable to the 40 shares of CFC1 stock.
    (3) DP1's basis ($30x) in the 40 shares of CFC1 stock 
attributable to the CFC2 stock is not required to be reduced under 
paragraph (c)(3) of this section because the section 1248(f) amount 
($10x) attributable to the 40 shares of CFC1 stock does not exceed 
DP1's postdistribution amount ($10x) attributable to such stock. The 
postdistribution amount equals the amount that DP1 would be required 
to include in income as a dividend under section 1248(a) if it sold 
the 40 shares of CFC1 stock immediately after the distribution ($40x 
fair market value, $30x basis, and $20x earnings and profits 
attributable to such stock for purposes of section 1248). The $10x 
section 1248(f) amount equals the amount CFC1 would include in 
income as a dividend under section 964(e) if it sold the CFC2 stock 
received from DC immediately after the section 361 exchange.
    (F) Because DP1 and DC make the election provided in paragraph 
(b)(1) of this section,

[[Page 49303]]

Sec.  1.1248(f)-1(b)(2) does not apply to DC's distribution to DP1 
of the 60 shares of CFC1 stock it owned before the section 361 
exchange.
    (1) Under paragraph (b)(2) of this section, for purposes of 
section 1248, DP1 has a 3-year holding period in the 60 shares of 
CFC1 stock immediately after the distribution, the same holding 
period that DC had in such shares at the time of the distribution.
    (2) Under paragraph (b)(3) of this section, DP1's section 358 
basis in the 60 shares of CFC1 stock ($54x) must be reduced by $4x, 
the amount by which DC's section 1248 amount ($10x) attributable to 
such shares immediately before the distribution exceeds DP1's 
postdistribution amount ($6x) attributable to such shares 
immediately after the distribution. The $6x postdistribution amount 
equals the amount that DP1 would be required to include in income as 
a dividend under section 1248(a) if it sold the 60 shares of CFC1 
stock immediately after the distribution ($60x fair market value, 
$54x basis, and $30x earnings and profits attributable to such stock 
for purposes of section 1248). After the reduction, DP1's basis in 
the 60 shares of CFC1 stock is $50x.

    (e) Applicable cross-references. For rules relating to the 
attribution of earnings and profits to the stock of a foreign 
corporation following certain nonrecognition transactions, see Sec.  
1.1248-8. For rules relating to a transfer of property by a domestic 
corporation to a foreign corporation in a section 361 exchange that 
precedes a section 355 distribution or section 361 distribution to 
which section 1248(f)(1) applies, see Sec.  1.367(a)-7. For rules 
relating to an acquisition of the stock of a foreign corporation by 
another foreign corporation in a section 361 exchange, see Sec.  
1.367(b)-4. For rules relating to a section 355 distribution of stock 
of a foreign corporation by a domestic corporation, see Sec. Sec.  
1.367(b)-5(b)(1) and 1.367(e)-1.
    Par. 14. Section 1.1248(f)-3 is added to read as follows:


Sec.  1.1248(f)-3  Reasonable cause exception and effective dates.

    (a) Reasonable cause exception for failure to comply--(1) General 
rule. If a section 1248 shareholder or the domestic distributing 
corporation fails to comply with any requirement under Sec.  1.1248(f)-
2, the section 1248 shareholder or the domestic distributing 
corporation shall be considered to have complied with such requirement 
if it submits a request for relief as provided under paragraph (a)(2) 
of this section and can demonstrate to the Area Director, Field 
Examination, Small Business/Self Employed or the Director of Field 
Operations, Large and Mid-Size Business (Director) having jurisdiction 
of the section 1248 shareholder's or domestic distributing 
corporation's tax return for the taxable year during which the 
distribution occurs, that such failure was due to reasonable cause and 
not willful neglect. Whether the failure to comply was due to 
reasonable cause and not willful neglect will be determined by the 
Director after considering all the facts and circumstances. The 
Director shall notify the section 1248 shareholder or domestic 
distributing corporation in writing within 120 days if it is determined 
that the failure to comply was not due to reasonable cause, or if 
additional time will be needed to make such determination. For this 
purpose, the 120-day period shall begin on the date the Internal 
Revenue Service notifies the section 1248 shareholder or domestic 
distributing corporation in writing that the request for relief has 
been received and assigned for review. Once such period commences, if 
the section 1248 shareholder or domestic distributing corporation is 
not again notified within 120 days, then the section 1248 shareholder 
or domestic distributing corporation shall be deemed to have 
established reasonable cause.
    (2) Requirements for reasonable cause relief--(i) Time of 
submission. Requests for reasonable cause relief will only be 
considered if as soon as the section 1248 shareholder or domestic 
distributing corporation becomes aware of the failure to comply with 
any requirement of Sec.  1.1248(f)-2, the section 1248 shareholder or 
domestic distributing corporation attaches the statements or other 
documents that should have been filed, as well as a complete written 
statement setting forth the reasons for the failure to comply, to an 
amended return that amends the return to which the documents should 
have been attached pursuant to Sec.  1.1248(f)-2. The amended return 
and all required attachments must be filed with the applicable Internal 
Revenue Service Center with which the section 1248 shareholder or 
domestic distributing corporation filed its original return to which 
the documents should have been attached.
    (ii) Notice requirement. In addition to the requirement of 
paragraph (a)(2)(i) of this section, the section 1248 shareholder or 
domestic distributing corporation must comply with the requirements of 
paragraph (a)(2)(ii)(A) or (B) of this section, as applicable.
    (A) If the section 1248 shareholder or domestic distributing 
corporation is under examination for any taxable year when the request 
for reasonable cause relief is filed, a copy of the amended return and 
attachments must be provided to the Internal Revenue Service personnel 
conducting the examination.
    (B) If the section 1248 shareholder or domestic distributing 
corporation is not under examination for any taxable year when the 
request for reasonable cause relief is filed, a copy of the amended 
return and attachments must be provided to the Director having 
jurisdiction over the return.
    (b) Effective/applicability date. Sections 1.1248(f)-1 and 
1.1248(f)-2 and this section shall apply to distributions occurring on 
or after the date 30 days after the date these regulations are 
published as final regulations in the Federal Register.
    Par. 15. Section 1.6038B-1 is amended by revising paragraphs 
(c)(6), (f)(3), and the heading and the first sentence of paragraph 
(g)(1), and adding paragraph (g)(5), to read as follows:


Sec.  1.6038B-1  Reporting of certain transfers to foreign 
corporations.

* * * * *
    (c) * * *
    (6) Transfers subject to section 367(a)(5)--(i) In general. This 
paragraph applies to a domestic corporation (U.S. transferor) that 
transfers section 367(a) property (as defined in Sec.  1.367(a)-
7(f)(9)) to a foreign corporation in an exchange described in section 
361(a) or (b) or in an exchange described in section 351 that is also 
described in section 361(a) or (b) (collectively, a section 361 
exchange) and to which the provisions of Sec.  1.367(a)-7(c) apply. 
Paragraph (c)(6)(ii) of this section establishes the time and manner 
for the U.S. transferor to elect to apply the provisions of Sec.  
1.367(a)-7(c). Paragraph (c)(6)(iii) of this section establishes the 
manner for the U.S. transferor to satisfy the requirement of Sec.  
1.367(a)-7(c)(4).
    (ii) Election. The U.S. transferor elects to apply the provisions 
of Sec.  1.367(a)-7(c) by including a statement entitled, STATEMENT TO 
ELECT TO APPLY EXCEPTION UNDER Sec.  1.367(a)-7(c) with its timely-
filed return (within the meaning of Sec.  1.367(a)-7(f)(11)) for the 
taxable year during which the section 361 exchange occurs, that 
includes the information described in paragraphs (c)(6)(ii)(A) through 
(c)(6)(ii)(C) of this section. See Sec.  1.367(a)-7(c)(5)(ii) for the 
statement required to be filed by a control group member, as defined in 
Sec.  1.367(a)-7(f)(2), or final distributee, as defined in Sec.  
1.367(a)-7(d).
    (A) The name and taxpayer identification number of each control 
group member and final distributee (if any), and the aggregate 
ownership interest (by value) in the U.S. transferor of each control 
group member or final distributee.

[[Page 49304]]

    (B) A calculation of the gain recognized (if any) by the U.S. 
transferor under Sec.  1.367(a)-7(c)(2)(i) and (ii).
    (C) The date on which the U.S. transferor and each control group 
member or final distributee entered into the written agreement 
described in Sec.  1.367(a)-7(c)(5)(iv).
    (iii) Agreement to amend U.S. transferor's tax return. The U.S. 
transferor complies with the requirement of Sec.  1.367(a)-7(c)(4)(i) 
by attaching a statement to its timely-filed return (within the meaning 
of Sec.  1.367(a)-7(f)(11)) for the taxable year in which the section 
361 exchange occurs, entitled STATEMENT UNDER Sec.  1.367(a)-7(c)(4) 
FOR TRANSFERS OF ASSETS TO A FOREIGN CORPORATION IN A SECTION 361 
EXCHANGE. The statement must certify that if the foreign acquiring 
corporation disposes of a significant amount (as defined in paragraph 
(c)(6)(iii)(A) of this section) of the section 367(a) property received 
from the U.S. transferor in the section 361 exchange in one or more 
related transactions described in paragraph (c)(6)(iii)(B) of this 
section, then the exception provided in Sec.  1.367(a)-7(c) shall not 
apply to the section 361 exchange and the U.S. transferor shall 
recognize the gain realized but not recognized in the section 361 
exchange. The U.S. transferor (or the foreign acquiring corporation on 
behalf of the U.S. transferor) shall file a U.S. income tax return (or 
amended U.S. income tax return, as the case may be) for the year of the 
section 361 exchange, reporting such gain.
    (A) Disposition of significant amount. For purposes of this 
paragraph (c)(6)(iii), a disposition of a significant amount occurs if, 
in one or more related transactions, the foreign acquiring corporation 
disposes of an amount of the section 367(a) property received from the 
U.S. transferor in the section 361 exchange that is greater than 40 
percent of the fair market value of all of the property transferred in 
the section 361 exchange.
    (B) Gain recognition transaction--(1) General rule. A transaction 
is described in this paragraph (c)(6)(iii)(B) if the transaction is 
entered into with a principal purpose of avoiding the U.S. tax that 
would have been imposed on the U.S. transferor on the disposition of 
the property transferred to the foreign acquiring corporation in the 
section 361 exchange. A disposition may have a principal purpose of tax 
avoidance even if the tax avoidance purpose is outweighed by other 
purposes when taken together.
    (2) Presumptive tax avoidance. For purposes of this paragraph 
(c)(6)(iii)(B), the principal purpose of the foreign acquiring 
corporation's disposition of a significant amount of the section 367(a) 
property within two years of the section 361 exchange (whether in a 
recognition or nonrecognition transaction) shall be presumed to be the 
avoidance of the U.S. tax that would have been imposed on the U.S. 
transferor on the disposition of the property transferred to the 
foreign acquiring corporation in the section 361 exchange. However, 
this presumption shall not apply if it is demonstrated to the 
satisfaction of the Area Director, Field Examination, Small Business/
Self Employed or the Director of Field Operations, Large and Mid-Size 
Business (Director) that the avoidance of U.S. tax was not a principal 
purpose of the disposition.
    (3) Interest. If additional tax is required to be paid as a result 
of a transaction described in paragraph (c)(6)(iii)(B) of this section, 
then interest must be paid on that amount at rates determined under 
section 6621 with respect to the period between the date prescribed for 
filing the U.S. transferor's income tax return for the year of the 
section 361 exchange and the date on which the additional tax for that 
year is paid.
* * * * *
    (f) * * *
    (3) Reasonable cause exception for failure to comply--(i) Request 
for relief. The provisions of paragraph (f)(1) of this section shall 
not apply if the U.S. transferor can demonstrate to the Area Director, 
Field Examination, Small Business/Self Employed or the Director of 
Field Operations, Large and Mid-Size Business (Director) having 
jurisdiction of the U.S. transferor's tax return for the taxable year, 
that a failure to comply was due to reasonable cause and not willful 
neglect. Whether the failure to comply was due to reasonable cause and 
not willful neglect will be determined by the Director after 
considering all the facts and circumstances. The Director shall notify 
the U.S. transferor in writing within 120 days if it is determined that 
the failure to comply was not due to reasonable cause, or if additional 
time will be needed to make such determination. For this purpose, the 
120-day period shall begin on the date the Internal Revenue Service 
notifies the U.S. transferor in writing that the request for relief has 
been received and assigned for review. Once such period commences, if 
the U.S. transferor is not again notified within 120 days, then the 
U.S. transferor shall be deemed to have established reasonable cause.
    (ii) Requirements for reasonable cause relief--(A) Time of 
submission. Requests for reasonable cause relief will only be 
considered if, as soon as the U.S. transferor becomes aware of the 
failure to comply, the U.S. transferor attaches all the documents that 
should have been filed, as well as a complete written statement setting 
forth the reasons for the failure to timely comply, to an amended 
return that amends the return to which the documents should have been 
attached pursuant to the rules of section 6038B and the regulations 
under that section. The amended return and all required attachments 
must be filed with the applicable Internal Revenue Service Center with 
which the U.S. transferor filed its original return to which the 
documents should have been attached.
    (B) Notice requirement. In addition to the requirement of paragraph 
(f)(3)(ii)(A) of this section, the U.S. transferor must comply with the 
requirements of paragraph (f)(3)(ii)(B)(1) or (2), as applicable.
    (1) If the U.S. transferor is under examination for any taxable 
year when it requests relief, the U.S. transferor must provide a copy 
of the amended return and attachments to the Internal Revenue Service 
personnel conducting the examination.
    (2) If the U.S. transferor is not under examination for any taxable 
year when it requests relief, the U.S. transferor must provide a copy 
of the amended return and attachments to the Director having 
jurisdiction over the U.S. transferor's return.
* * * * *
    (g) Effective/applicability dates. (1) Except as provided in 
paragraphs (g)(2) through (5) of this section, this section applies to 
transfers occurring on or after July 20, 1998, except for transfers of 
cash made in tax years beginning on or before February 5, 1999 (which 
are not required to be reported under section 6038B), and except for 
transfers described in paragraph (e) of this section, which applies to 
transfers that are subject to Sec. Sec.  1.367(e)-1(f) and 1.367(e)-
2(e). * * *
    (5) Paragraphs (c)(6) and (f)(3) of this section shall apply to 
transfers occurring on or after the date 30 days after the date these 
regulations are published as final regulations in the Federal Register. 
For guidance with respect to paragraphs (c)(6) and (f)(3) of this 
section before the date 30 days after the date these regulations are 
published as final regulations in the Federal Register, see 26 CFR part 
1 revised as of

[[Page 49305]]

April 1 for the year before the date these regulations are published as 
final regulations in the Federal Register.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E8-18885 Filed 8-19-08; 8:45 am]
BILLING CODE 4830-01-P