[Federal Register Volume 74, Number 249 (Wednesday, December 30, 2009)]
[Rules and Regulations]
[Pages 69021-69023]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-30861]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9477]
RIN 1545-BI14


Use of Controlled Corporations To Avoid the Application of 
Section 304

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations under 
section 304 of the Internal Revenue Code (Code). The regulations apply 
to certain transactions that are subject to section 304 but that are 
entered into with a principal purpose of avoiding the application of 
section 304 to a corporation that is controlled by the issuing 
corporation in the transaction, or with a principal purpose of avoiding 
the application of section 304 to a corporation that controls the 
acquiring corporation in the transaction. The regulations affect 
persons treated as receiving distributions in redemption of stock by 
reason of section 304. The text of the temporary regulations serves as 
the text of the proposed regulations in the notice of proposed 
rulemaking on this subject published in the Proposed Rules section of 
this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on December 30, 
2009.
    Applicability Date: These regulations apply to acquisitions of 
stock occurring on or after December 29, 2009.

FOR FURTHER INFORMATION CONTACT: Sean W. Mullaney, (202) 622-3860 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1 under section 
304 of the Code. Section 304(a)(1) provides generally that, for 
purposes of sections 302 and 303, if one or more persons are in control 
of each of two corporations and one such corporation (acquiring 
corporation) acquires in exchange for property stock of the other 
corporation (issuing corporation) from the person (or persons) so in 
control, then, unless section 304(a)(2) applies, the property shall be 
treated as received in redemption of the stock of the acquiring 
corporation. Section 304(a)(2) provides generally that, for purposes of 
sections 302 and 303, if in exchange for property the acquiring 
corporation acquires stock

[[Page 69022]]

of the issuing corporation from a shareholder of the issuing 
corporation and the issuing corporation controls the acquiring 
corporation, then the shareholder shall be treated as receiving the 
property in redemption of the stock of the issuing corporation. For 
purposes of section 304, control means the ownership of stock 
possessing at least 50 percent of the total combined voting power of 
all classes of voting stock or at least 50 percent of the total value 
of shares of all classes of stock. With certain modifications, the 
constructive ownership rules of section 318 apply for this purpose.
    Under section 304(b)(2), the determination of the amount of the 
property distribution that is a dividend (and the source thereof) is 
made as if the property were distributed by the acquiring corporation 
to the extent of its earnings and profits, and then by the issuing 
corporation to the extent of its earnings and profits. If the acquiring 
corporation is foreign, section 304(b)(5) limits the amount of earnings 
and profits of the acquiring corporation that are taken into account 
for this purpose.
    As part of a broad set of anti-avoidance rules published in the 
Federal Register on June 14, 1988 (TD 8209) the IRS and the Treasury 
Department promulgated Sec.  1.304-4T to address transactions that are 
subject to section 304 but that are entered into with a principal 
purpose of avoiding the application of section 304 to certain 
corporations. Specifically, for purposes of determining the amount of a 
property distribution constituting a dividend (and the source thereof) 
under section 304(b)(2), the District Director (now known as the 
Director of Field Operations) is permitted to consider a corporation 
(deemed acquiring corporation) as having acquired for property the 
stock of the issuing corporation that is in fact acquired for property 
by the acquiring corporation, if the deemed acquiring corporation 
controls the acquiring corporation and if one of the principal purposes 
for creating, organizing, or funding the acquiring corporation (through 
capital contributions or debt) is to avoid the application of section 
304 to the deemed acquiring corporation.

Explanation of the Provisions

A. Transactions at Issue

    The IRS and Treasury Department have become aware of certain 
transactions that are subject to section 304 but that are entered into 
with a principal purpose of avoiding the treatment of a corporation as 
the issuing corporation. In one such transaction, for example, a 
domestic corporation (USP) wholly owns two foreign corporations (F1 and 
F2). The basis and fair market value of the F1 stock is $100x. F1 does 
not have positive earnings and profits (or its earnings and profits for 
purposes of section 304(b)(2) are limited by section 304(b)(5)) but has 
at least $100x cash. The basis and fair market value of the F2 stock is 
$100x and F2 has earnings and profits of at least $100x. USP forms a 
new foreign corporation (F3) and contributes the stock of F2 to F3 in 
exchange for F3 stock. In a transaction subject to section 304(a)(1), 
USP then transfers the stock of F3 to F1 in exchange for $100x cash. 
Because neither F1 (the acquiring corporation) nor F3 (the issuing 
corporation) has positive earnings and profits, USP reports the $100x 
cash received in redemption of the shares deemed issued by F1 under 
section 304(a)(1) as a return of basis under section 301(c)(2).

B. Anti-Avoidance Rule Applicable to Deemed Issuing Corporations

    The IRS and Treasury Department believe that an anti-avoidance rule 
similar to Sec.  1.304-4T, but that applies in the case of a 
transaction entered into with a principal purpose of avoiding the 
treatment of a corporation as the issuing corporation is appropriate 
for transactions such as the one described above. Accordingly, the 
regulations amend Sec.  1.304-4T to provide that for purposes of 
determining the amount of a property distribution that is a dividend 
(and the source thereof) under section 304(b)(2), the acquiring 
corporation shall be treated as acquiring for property the stock of a 
corporation (deemed issuing corporation) that is controlled by the 
issuing corporation, if, in connection with the acquisition for 
property of stock of the issuing corporation by the acquiring 
corporation, the issuing corporation acquired stock of the deemed 
issuing corporation with a principal purpose of avoiding the 
application of section 304 to the deemed issuing corporation.

C. Modifications to Current Sec.  1.304-4T

    Current Sec.  1.304-4T applies at the discretion of the District 
Director. The IRS and the Treasury Department believe the anti-
avoidance rule of current Sec.  1.304-4T should be self-executing. 
Thus, current Sec.  1.304-4T is amended accordingly.
    Current Sec.  1.304-4T applies when ``one of the principal 
purposes'' for the transaction is to avoid the application of section 
304. The regulations included in this document apply when ``a principal 
purpose'' for the transaction is to avoid the application of section 
304. The IRS and the Treasury Department do not view this modification 
as a substantive change.
    Finally, and as noted above, current Sec.  1.304-4T applies if one 
of the principal purposes for creating, organizing, or funding the 
acquiring corporation, through capital contributions or debt, is to 
avoid the application of section 304 to the deemed acquiring 
corporation. The regulations included in this document clarify that 
this rule may apply in cases where the funding is from an unrelated 
party. For example, the regulations may apply when the deemed acquiring 
corporation facilitates the repayment of an obligation incurred by the 
acquiring corporation (even if such obligation is with respect to a 
borrowing from an unrelated party) to acquire the stock of the issuing 
corporation.

D. Effective/Applicability Dates

    The regulations apply to acquisitions occurring on or after 
December 29, 2009. No inference is intended as to the potential 
applicability of other Code or regulatory provisions or judicial 
doctrines (including step transaction or substance over form) to 
transactions described in the regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) and (d) of the Administrative Procedure 
Act (5 U.S.C. chapter 5) do not apply to these regulations. For 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the Special Analyses section of the preamble and to the cross-
referenced notice of proposed rulemaking published elsewhere in this 
issue of the Federal Register. Pursuant to section 7805(f) of the Code, 
these regulations have been submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of the regulations is Sean W. Mullaney of the 
Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 69023]]

Amendments to the Regulations

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read in part as follows:

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


0
Par. 2. Section 1.304-4 is added to read as follows:


Sec.  1.304-4  Special rule for the use of related corporations to 
avoid the application of section 304.

    [Reserved]. For further guidance, see Sec.  1.304-4T(a) through 
(d).

0
Par. 3. Section 1.304-4T is revised to read as follows:


Sec.  1.304-4T  Special rule for the use of related corporations to 
avoid the application of section 304 (temporary).

    (a) Scope and purpose. This section applies to determine the amount 
of a property distribution constituting a dividend (and the source 
thereof) under section 304(b)(2), for certain transactions involving 
controlled corporations. The purpose of this section is to prevent the 
avoidance of the application of section 304 to a controlled 
corporation.
    (b) Amount and source of dividend. For purposes of determining the 
amount constituting a dividend (and source thereof) under section 
304(b)(2), the following rules shall apply:
    (1) Deemed acquiring corporation. A corporation (deemed acquiring 
corporation) shall be treated as acquiring for property the stock of a 
corporation (issuing corporation) acquired for property by another 
corporation (acquiring corporation) that is controlled by the deemed 
acquiring corporation, if a principal purpose for creating, organizing, 
or funding the acquiring corporation by any means (including, through 
capital contributions or debt) is to avoid the application of section 
304 to the deemed acquiring corporation. See paragraph (c) Example 1 of 
this section for an illustration of this paragraph.
    (2) Deemed issuing corporation. The acquiring corporation shall be 
treated as acquiring for property the stock of a corporation (deemed 
issuing corporation) controlled by the issuing corporation if, in 
connection with the acquisition for property of stock of the issuing 
corporation by the acquiring corporation, the issuing corporation 
acquired stock of the deemed issuing corporation with a principal 
purpose of avoiding the application of section 304 to the deemed 
issuing corporation. See paragraph (c) Example 2 of this section for an 
illustration of this paragraph.
    (c) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1.  (i) Facts. P, a domestic corporation, wholly owns 
CFC1, a controlled foreign corporation with substantial accumulated 
earnings and profits. CFC1 is organized in Country X, which imposes 
a high rate of tax on the income of CFC1. P also wholly owns CFC2, a 
controlled foreign corporation with accumulated earnings and profits 
of $200x. CFC2 is organized in Country Y, which imposes a low rate 
of tax on the income of CFC2. P wishes to own all of its foreign 
corporations in a direct chain and to repatriate the cash of CFC2. 
In order to avoid having to obtain Country X approval for the 
acquisition of CFC1 (a Country X corporation) by CFC2 (a Country Y 
corporation) and to avoid the dividend distribution from CFC2 to P 
that would result if CFC2 were the acquiring corporation, P causes 
CFC2 to form CFC3 in Country X and to contribute $100x to CFC3. CFC3 
then acquires all of the stock of CFC1 from P for $100x.
    (ii) Result. Because a principal purpose for creating, 
organizing or funding CFC3 (acquiring corporation) is to avoid the 
application of section 304 to CFC2 (deemed acquiring corporation), 
under paragraph (b)(1) of this section, for purposes of determining 
the amount of the $100x distribution constituting a dividend (and 
source thereof) under section 304(b)(2), CFC2 shall be treated as 
acquiring the stock of CFC1 (issuing corporation) from P for $100x. 
As a result, P receives a $100x distribution, out of the earnings 
and profits of CFC2, to which section 301(c)(1) applies.
    Example 2.  (i) Facts. P, a domestic corporation, wholly owns 
CFC1, a controlled foreign corporation with substantial accumulated 
earnings and profits. The CFC1 stock has a basis of $100x. CFC1 is 
organized in Country X. P also wholly owns CFC2, a controlled 
foreign corporation with zero accumulated earnings and profits. CFC2 
is organized in Country Y. P wishes to own all of its foreign 
corporations in a direct chain and to repatriate the cash of CFC2. 
In order to avoid having to obtain Country X approval for the 
acquisition of CFC1 (a Country X corporation) by CFC2 (a Country Y 
corporation) and to avoid a dividend distribution from CFC1 to P, P 
forms a new corporation (CFC3) in Country X and transfers the stock 
of CFC1 to CFC3 in exchange for CFC3 stock. P then transfers the 
stock of CFC3 to CFC2 in exchange for $100x.
    (ii) Result. Because a principal purpose for the transfer of the 
stock of CFC1 (deemed issuing corporation) by P to CFC3 (issuing 
corporation) is to avoid the application of section 304 to CFC1, 
under paragraph (b)(2) of this section, for purposes of determining 
the amount of the $100x distribution constituting a dividend (and 
source thereof) under section 304(b)(2), CFC2 (acquiring 
corporation) shall be treated as acquiring the stock of CFC1 from P 
for $100x . As a result, P receives a $100x distribution, out of the 
earnings and profits of CFC1, to which section 301(c)(1) applies.

    (d) Effective/applicability date. This section applies to 
acquisitions of stock occurring on or after December 29, 2009. See 
Sec.  1.304-4T, as contained in 26 CFR part 1 revised as of April 1, 
2008, for acquisitions of stock occurring on or after June 14, 1988, 
and before December 29, 2009.
    (e) Expiration date. This section expires on or before December 31, 
2012.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
    Approved: December 18, 2009.
Michael F. Mundaca,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E9-30861 Filed 12-29-09; 8:45 am]
BILLING CODE 4830-01-P