[Federal Register Volume 79, Number 12 (Friday, January 17, 2014)]
[Rules and Regulations]
[Pages 3094-3104]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-00899]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9654]
RIN 1545-BL01


Guidance for Determining Stock Ownership

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that identify 
certain stock of a foreign corporation that is disregarded in 
calculating ownership of the foreign corporation for purposes of 
determining whether it is a surrogate foreign corporation. These 
regulations also provide guidance with respect to the effect of 
transfers of stock of a foreign corporation after the foreign 
corporation has acquired substantially all of the properties of a 
domestic corporation or of a trade or business of a domestic 
partnership. These regulations affect certain domestic corporations and 
partnerships (and certain parties related thereto), and foreign 
corporations that acquire substantially all of the properties of such 
domestic corporations or of the trades or businesses of such domestic 
partnerships. The text of the temporary regulations serves as the text 
of the proposed regulations set forth in the Proposed Rules section in 
this issue of the Federal Register. This document also contains a final 
regulation that provides a cross-reference to the temporary 
regulations.

DATES: Effective Date: These regulations are effective on January 17, 
2014.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.7874-4T(k) and 1.7874-5T(c).

FOR FURTHER INFORMATION CONTACT: David A. Levine, (202) 317-6937 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

[[Page 3095]]

Background

A. Section 7874--In General

    A foreign corporation (foreign acquiring corporation) generally is 
treated as a surrogate foreign corporation under section 7874(a)(2)(B) 
of the Internal Revenue Code if pursuant to a plan (or a series of 
related transactions): (i) The foreign acquiring corporation completes 
after March 4, 2003, the direct or indirect acquisition of 
substantially all of the properties held directly or indirectly by a 
domestic corporation; (ii) after the acquisition, at least 60 percent 
of the stock (by vote or value) of the foreign acquiring corporation is 
held by former shareholders of the domestic corporation by reason of 
holding stock in the domestic corporation; and (iii) after the 
acquisition, the expanded affiliated group that includes the foreign 
acquiring corporation does not have substantial business activities in 
the foreign country in which, or under the law of which, the foreign 
acquiring corporation is created or organized, when compared to the 
total business activities of the expanded affiliated group. Similar 
provisions apply if a foreign acquiring corporation acquires 
substantially all of the properties constituting a trade or business of 
a domestic partnership.
    Under section 7874(c)(2)(B) (statutory public offering rule), stock 
of the foreign acquiring corporation that is sold in a public offering 
related to the acquisition described in section 7874(a)(2)(B)(i) 
(acquisition) is not taken into account for purposes of calculating the 
ownership percentage described in section 7874(a)(2)(B)(ii) (ownership 
fraction). The statutory public offering rule furthers the policy that 
section 7874 is intended to curtail inversion transactions that 
``permit corporations and other entities to continue to conduct 
business in the same manner as they did prior to the inversion.'' S. 
Rep. No. 192, 108th Cong., 1st. Sess. 142 (2003); Joint Committee on 
Taxation, General Explanation of Tax Legislation Enacted in the 108th 
Congress (JCS-5-05) (May 2005), at 343.
    Under section 7874(c)(4), a transfer of properties or liabilities 
(including by contribution or distribution) is disregarded if such 
transfer is part of a plan a principal purpose of which is to avoid the 
purposes of section 7874. Section 7874(c)(6) grants the Secretary 
authority to prescribe regulations as may be appropriate to determine 
whether a corporation is a surrogate foreign corporation, including 
regulations to treat stock as not stock. In addition, section 7874(g) 
grants the Secretary authority to provide regulations necessary to 
carry out section 7874, including regulations adjusting the application 
of section 7874 as necessary to prevent the avoidance of the purposes 
of section 7874.

B. Notice 2009-78

    On September 17, 2009, the IRS and the Department of the Treasury 
(Treasury Department) issued Notice 2009-78 (2009-40 IRB 452) (notice), 
which announced that regulations would be issued under section 7874 to 
identify certain stock of a foreign acquiring corporation that is not 
taken into account in determining the ownership fraction. See Sec.  
601.601(d)(2)(ii)(b) of this chapter.
    The notice states that regulations will provide that stock of the 
foreign acquiring corporation issued in exchange for ``nonqualified 
property'' in a transaction related to the acquisition is not taken 
into account for purposes of the ownership fraction, without regard to 
whether such stock is publicly traded on the date of issuance or 
otherwise. The notice further provides that the term nonqualified 
property generally will mean: (i) Cash or cash equivalents; (ii) 
marketable securities as defined in section 453(f)(2); and (iii) any 
other property acquired in a transaction with a principal purpose of 
avoiding the purposes of section 7874.
    The notice also states that regulations will clarify that certain 
stock of the foreign acquiring corporation, including certain stock 
otherwise described in the statutory public offering rule, nonetheless 
will be taken into account for purposes of the ownership fraction. 
Specifically, the notice states that marketable securities will not 
include stock of (or a partnership interest in) a member of the 
expanded affiliated group (as defined in section 7874(c)(1)) that, 
after the acquisition, includes the foreign acquiring corporation, 
unless a principal purpose of issuing the stock of the foreign 
acquiring corporation in exchange for such stock or partnership 
interest was the avoidance of the purposes of section 7874. 
Accordingly, even if issued in a public offering, stock of the foreign 
acquiring corporation issued in exchange for stock of (or a partnership 
interest in) a member of the expanded affiliated group that, after the 
acquisition, includes the foreign acquiring corporation, will be taken 
into account for purposes of the ownership fraction, unless a principal 
purpose of issuing the stock of the foreign acquiring corporation in 
exchange for such stock or partnership interest was the avoidance of 
the purposes of section 7874.
    The notice provides that the regulations will apply to acquisitions 
completed on or after September 17, 2009.
    The temporary regulations set forth the rules described in the 
notice, subject to certain modifications, in part, to address comments 
received.

Explanation of Provisions

A. New Exclusion Rule Modifies the Statutory Public Offering Rule

    Under the statutory public offering rule of section 7874(c)(2)(B), 
stock of the foreign acquiring corporation is not taken into account 
for purposes of the ownership fraction if the stock is sold in a public 
offering related to the acquisition. Absent the statutory public 
offering rule, the purposes of section 7874 could be avoided by having 
the foreign acquiring corporation issue stock to the public in exchange 
for cash in order to reduce the ownership fraction while not 
significantly altering the manner in which the domestic entity did 
business before the inversion transaction. Consistent with the notice, 
the IRS and the Treasury Department believe that stock of the foreign 
acquiring corporation transferred in exchange for certain property in a 
transaction related to the acquisition, but not through a public 
offering, presents the same opportunity to inappropriately reduce the 
ownership fraction. For example, a private placement of the stock of a 
foreign acquiring corporation in exchange for cash raises the same 
policy concern that the ownership fraction will be inappropriately 
reduced by increasing the net assets of the foreign acquiring 
corporation.
    Consistent with the notice, the IRS and the Treasury Department 
also believe that the statutory public offering rule can result in an 
over-inclusive application of section 7874 to certain business 
combinations. That is, the statutory public offering rule can apply to 
certain business combinations in which the unrelated shareholders of a 
foreign target corporation receive publicly traded stock of the foreign 
acquiring corporation in transactions that, while they do increase the 
net assets of the foreign acquiring corporation, generally are expected 
to meaningfully alter the way the expanded affiliated group that 
includes the foreign acquiring corporation does business and therefore 
such publicly traded stock should be taken into account in calculating 
the ownership fraction.
    To address these concerns, the temporary regulations modify the

[[Page 3096]]

statutory public offering rule (as modified, the exclusion rule). 
Specifically, the exclusion rule provides that, subject to a de minimis 
exception, disqualified stock (described in section B of this preamble) 
is excluded from the denominator of the ownership fraction. Because the 
determination of whether stock of the foreign acquiring corporation is 
disqualified stock is made without regard to whether it is publicly 
traded at the time of the transfer or at any other time, the exclusion 
rule under the temporary regulations addresses the potentially under-
inclusive application of section 7874 under the statutory public 
offering rule. Moreover, although the notice excluded stock of the 
foreign acquiring corporation from the denominator of the ownership 
fraction only when there was an issuance of such stock, the IRS and the 
Treasury Department do not believe the exclusion rule should be limited 
to stock of the foreign acquiring corporation that is issued in the 
transaction. Accordingly, under the temporary regulations, disqualified 
stock is stock of the foreign acquiring corporation that is transferred 
in a manner described in the temporary regulations, regardless of 
whether the transfer occurs by reason of an issuance, sale, 
distribution, exchange, or any other type of disposition and regardless 
of whether the stock is transferred by the foreign acquiring 
corporation or another person.
    The temporary regulations describe all situations in which stock 
will be excluded from the denominator of the ownership fraction under 
section 7874(c)(2)(B). Thus, even when a foreign acquiring corporation 
issues stock in a public offering, the statutory public offering rule 
will not exclude such stock from the denominator unless the stock is 
disqualified stock. Accordingly, the exclusion rule also addresses the 
potentially over-inclusive application of the statutory public offering 
rule.
    Because stock of the foreign acquiring corporation held by former 
shareholders or former partners by reason of holding stock or a 
partnership interest in the domestic entity will never be subject to 
the nonqualified property rule or the associated liability rule, the 
exclusion rule will never apply to such stock.

B. Identifying Stock of the Foreign Acquiring Corporation That Is 
Disqualified Stock

1. Stock Transferred in a Transaction That Does Not Increase the Net 
Assets of the Foreign Acquiring Corporation Is Not Disqualified Stock
    Comments questioned whether the rules described in the notice would 
exclude from the denominator of the ownership fraction stock of the 
foreign acquiring corporation that is transferred by persons that are 
not members of the expanded affiliated group that includes the foreign 
acquiring corporation in exchange for nonqualified property. Such a 
transfer may occur, for example, if an individual holds stock of the 
foreign acquiring corporation at the time of the acquisition and sells 
such stock to another individual for cash (which is nonqualified 
property) in a transaction related to the acquisition.
    The purpose of the exclusion rule is to prevent certain stock of 
the foreign acquiring corporation that is transferred in a transaction 
that increases the net assets of the foreign acquiring corporation from 
inappropriately increasing the denominator of the ownership fraction 
and thereby reducing the ownership fraction. Thus, provided that the 
stock of the foreign acquiring corporation that is transferred is not 
hook stock (that is, where the foreign acquiring corporation holds a 
direct or indirect interest in the selling shareholder), the IRS and 
the Treasury Department do not believe that the exclusion rule should 
apply to transfers of stock by a shareholder of the foreign acquiring 
corporation to another person because such transfers do not increase 
the net assets of the foreign acquiring corporation. Accordingly, the 
temporary regulations provide that stock of the foreign acquiring 
corporation is disqualified stock if the stock is transferred in 
exchange for certain property but only to the extent the exchange 
increases the net assets of the foreign acquiring corporation (that is, 
the exchange increases the fair market value of the assets of the 
foreign acquiring corporation or decreases the amount of its 
liabilities). The extent to which such an exchange increases the net 
assets of the foreign acquiring corporation is determined on a 
transfer-by-transfer basis. Therefore, a related transaction that might 
decrease the net assets of the foreign acquiring corporation, such as a 
related distribution by the foreign acquiring corporation with respect 
to its stock, is not taken into account for purposes of determining 
whether a specific transfer of stock in exchange for property increases 
the net assets of the foreign acquiring corporation.
2. Stock of the Foreign Acquiring Corporation That Generally Is 
Disqualified Stock
    Under the temporary regulations, stock of the foreign acquiring 
corporation that is transferred in any transaction described in section 
B.2.a. or B.2.b. of the preamble is treated as disqualified stock if 
the transaction is related to the acquisition, unless the exception 
described in section B.1. of the preamble applies.
(a) Transfers of Stock in Exchange for Nonqualified Property
    Disqualified stock includes stock of the foreign acquiring 
corporation that is transferred to a person other than the domestic 
entity in exchange for nonqualified property (nonqualified property 
rule). Transfers of stock of the foreign acquiring corporation to the 
domestic entity in exchange for nonqualified property are not subject 
to the nonqualified property rule because such transferred stock 
generally is treated as either: (i) Stock that is received by reason of 
holding stock or a partnership interest in the domestic entity (for 
example, if the domestic entity is a corporation that distributes the 
transferred stock to its shareholders in cancellation of their stock in 
the domestic entity), and, therefore, generally is included in the 
numerator and the denominator of the ownership fraction; or (ii) 
disqualified stock under the associated obligation rule described in 
paragraph (b) of this section B.2. of the preamble.
    The term nonqualified property means: (i) Cash or cash equivalents; 
(ii) marketable securities within the meaning of section 453(f)(2), as 
modified by the temporary regulations; (iii) a disqualified obligation; 
or (iv) any other property acquired in a transaction (or series of 
transactions) related to the acquisition with a principal purpose of 
avoiding the purposes of section 7874. A disqualified obligation is an 
obligation (as defined in Sec.  1.752-1(a)(4)(ii)) of any of the 
following persons: (i) A member of the expanded affiliated group that 
includes the foreign acquiring corporation; (ii) a former shareholder 
(within the meaning of Sec.  1.7874-2(b)(2)) or former partner (within 
the meaning of Sec.  1.7874-2(b)(3)) of the domestic entity; or (iii) a 
person that, before or after the acquisition, either owns stock of, or 
a partnership interest in, any person described in (i) or (ii) or is 
related (within the meaning of section 267 or 707(b)) to any such 
persons.
    In the notice, the definition of nonqualified property includes 
cash, cash equivalents, and marketable securities, but not a 
disqualified obligation. Nevertheless, based on further consideration, 
the IRS and the Treasury Department believe that, for purposes of the 
temporary regulations, a transfer of stock of the foreign acquiring 
corporation in exchange for a

[[Page 3097]]

disqualified obligation should be treated similarly to transfers of 
stock of the foreign acquiring corporation in exchange for cash, cash 
equivalents, and marketable securities because such transfers present 
similar opportunities to inappropriately reduce the ownership fraction 
by increasing the net assets of the foreign acquiring corporation.
    Consistent with the notice, the temporary regulations exclude from 
the definition of marketable securities (which constitute nonqualified 
property) stock of a corporation (or an interest in a partnership) that 
becomes a member of the expanded affiliated group that includes the 
foreign acquiring corporation in a transaction related to the 
acquisition, unless a principal purpose of the acquisition of such 
stock (or partnership interest) was the avoidance of the purposes of 
section 7874. Thus, for example, subject to an anti-abuse rule, 
publicly traded stock of a foreign target corporation does not 
constitute marketable securities for purposes of the temporary 
regulations and therefore is not nonqualified property.
    In addition, the IRS and the Treasury Department believe that a 
transfer of stock of the foreign acquiring corporation in exchange for 
the satisfaction or the assumption of an obligation of the transferor 
should be treated similarly to a transfer of stock of the foreign 
acquiring corporation in exchange for nonqualified property because 
such a transfer also presents opportunities to inappropriately reduce 
the ownership fraction by increasing the net assets of the foreign 
acquiring corporation. For example, if the foreign acquiring 
corporation is a debtor with respect to an obligation and satisfies the 
obligation with its stock, the transfer of the stock to the creditor in 
satisfaction of the obligation increases the net assets of the foreign 
acquiring corporation, and, absent a special rule, would increase the 
denominator of the ownership fraction. Accordingly, under the temporary 
regulations, disqualified stock includes stock of the foreign acquiring 
corporation that is transferred to a person other than the domestic 
entity in exchange for the satisfaction or the assumption of an 
obligation of the transferor. Solely for purposes of applying the 
temporary regulations, stock of the foreign acquiring corporation 
described in the preceding sentence is treated as if it were 
transferred to the transferee in exchange for an amount of cash (which 
is nonqualified property) equal to the fair market value of the stock 
of the foreign acquiring corporation that is transferred in exchange 
for the satisfaction or the assumption of the obligation.
    One comment suggested that the phrase ``related to the 
acquisition'' in section 7874(c)(2)(B) can be read to suggest that the 
statutory public offering rule should apply only if the proceeds of a 
public offering are used to acquire, or fund the business of, the 
domestic entity. Accordingly, the comment suggested that the statutory 
public offering rule should not apply if, for example, the proceeds are 
used to acquire business assets unrelated to those of the domestic 
entity. Another comment recommended an exception to the statutory 
public offering rule for offerings that further a significant business 
purpose, such as allowing an insolvent domestic entity to continue its 
operations. The IRS and the Treasury Department believe that the use of 
the offering proceeds is irrelevant to the application of the statutory 
public offering rule. Neither the statute nor the legislative history 
indicates that Congress intended for the statutory public offering rule 
to apply based on the use of the proceeds. Accordingly, the temporary 
regulations do not adopt these recommendations. Therefore, the 
determination of whether stock of the foreign acquiring corporation 
transferred in exchange for nonqualified property is disqualified stock 
is made without regard to the use of the nonqualified property.
(b) Subsequent Transfers of Stock in Exchange for the Satisfaction or 
the Assumption of an Obligation Associated With Property Exchanged
    The IRS and the Treasury Department believe that a transfer of 
stock of the foreign acquiring corporation in exchange for property 
when the transferee subsequently transfers the stock in exchange for 
the satisfaction or the assumption of the transferee's obligations 
associated with the property exchanged also presents opportunities to 
inappropriately decrease the ownership fraction. For example, assume 
that a domestic entity (DE) has $100x of assets employed in a trade or 
business and $25x of obligations that arose from conducting that trade 
or business. A foreign acquiring corporation (FA) wants to acquire all 
the assets of DE in a transaction in which DE will liquidate. FA could 
acquire the $100x of assets of DE by issuing $75x of stock and assuming 
the $25x of obligations, in which case DE would distribute the $75x of 
FA stock to its shareholders in liquidation. Alternatively, FA could 
acquire the $100x of assets of DE by issuing $100x of stock and not 
assuming the $25x of obligations, in which case DE would transfer $25x 
of FA stock to satisfy the $25x of obligations and distribute the 
remaining $75x of FA stock to its shareholders in liquidation. In 
either case, the shareholders of DE will receive $75x of FA stock by 
reason of holding stock in DE and FA will own the $100x of assets 
formerly owned by DE; however, absent a special rule, the denominator 
of the ownership fraction would not be the same in both cases. In the 
first case, the denominator would include only $75x of FA stock and FA 
would owe the $25x of obligations. In the second case, the denominator 
would include $100x of FA stock and FA would not owe the $25x of 
obligations. In the latter case, the ownership fraction would be 
inappropriately reduced.
    Accordingly, to address such transfers, the temporary regulations 
provide that disqualified stock includes stock of the foreign acquiring 
corporation transferred to a person (including the domestic entity) in 
exchange for property to the extent, pursuant to the same plan (or 
series of related transactions), the transferee subsequently transfers 
the stock in exchange for the satisfaction or the assumption of an 
obligation associated with the property exchanged (associated 
obligation rule). An obligation is associated with property exchanged 
if, for example, the obligation arose from the conduct of a trade or 
business in which the property exchanged has been used, regardless of 
whether the obligation is a non-recourse obligation. For an example of 
a rule that applies when liabilities associated with a trade or 
business are assumed by a corporate transferee of the trade or business 
in certain nonrecognition exchanges, see section 358(h)(2).
    In this case, the requirement that the transfer of stock of the 
foreign acquiring corporation increase the net assets of the foreign 
acquiring corporation applies only with respect to the transfer of the 
stock in exchange for property of the transferee, and not with respect 
to the subsequent transfer of the stock of the foreign acquiring 
corporation by the transferee in exchange for the satisfaction or the 
assumption of an obligation of the transferee.
    Unlike the nonqualified property rule, which does not apply to a 
transfer of stock of the foreign acquiring corporation to the domestic 
entity, the associated obligation rule may apply to a transfer of stock 
of the foreign acquiring corporation to the domestic entity to the 
extent the stock is subsequently transferred by the domestic entity in 
exchange for the satisfaction or the assumption of one or

[[Page 3098]]

more of the domestic entity's obligations associated with the property 
exchanged. This treatment is appropriate because, in such a case, the 
stock of the foreign acquiring corporation transferred will not be 
included in the numerator of the ownership fraction (because the 
creditor with respect to the obligation or the person that assumes the 
obligation, as the case may be, does not receive the stock of the 
foreign acquiring corporation by reason of holding stock or a 
partnership interest in the domestic entity).
    The temporary regulations limit the application of the associated 
obligation rule when the property exchanged (including cash deemed to 
be exchanged when stock of the foreign acquiring corporation is 
transferred in exchange for the satisfaction or the assumption of an 
obligation of the transferor) includes nonqualified property and the 
person exchanging the property is not the domestic entity. The 
limitation has the effect of treating a portion of the obligation as 
being satisfied with stock of the foreign acquiring corporation that is 
disqualified stock under the nonqualified property rule (with the 
result that such portion does not give rise to additional disqualified 
stock under the associated obligation rule) and the remaining portion 
of the obligation as being satisfied with stock of the foreign 
acquiring corporation that is not disqualified stock under the 
nonqualified property rule (with the result that satisfaction of this 
portion of the obligation with stock of the foreign acquiring 
corporation gives rise to additional disqualified stock under the 
associated obligation rule). The portions of an obligation described in 
the preceding sentence are determined based on the relative amount of 
nonqualified property and qualified property exchanged, respectively. 
This limitation does not apply when stock of the foreign acquiring 
corporation is transferred to the domestic entity because the 
nonqualified property rule does not apply to such transfers of stock.

C. Different Treatment for Stock and Asset Acquisitions

    One comment noted that under the notice the amount of nonqualified 
property exchanged for stock of the foreign acquiring corporation can 
differ depending on whether the stock or assets of a corporation are 
acquired. For example, if a foreign acquiring corporation issues stock 
in exchange for all of the stock of another foreign corporation in a 
transaction related to the acquisition, none of the stock of the 
foreign acquiring corporation is considered to be issued in exchange 
for nonqualified property, without regard to whether the acquired 
foreign corporation held nonqualified property, unless a principal 
purpose of the acquisition of the stock of such acquired foreign 
corporation is the avoidance of the purposes of section 7874. The 
comment further noted that, if the transaction instead is structured as 
the acquisition of all the assets of the acquired foreign corporation, 
the stock of the foreign acquiring corporation would not be taken into 
account to the extent it is treated as issued in exchange for 
nonqualified property held by the acquired foreign corporation. The 
comment suggested that the dissimilar treatment is not supported by 
policy and raises form-over-substance concerns.
    The structure of a transaction as an acquisition of stock or assets 
can often result in different U.S. tax consequences. In addition, the 
IRS and the Treasury Department believe that the complexity of adopting 
rules to harmonize the treatment of stock and asset acquisitions, such 
as by applying a look-through approach to stock acquisitions, would 
outweigh the benefits of consistent treatment. Moreover, the IRS and 
the Treasury Department believe that the treatment of property acquired 
in a transaction with a principal purpose of avoiding the purposes of 
section 7874 as nonqualified property addresses the concern that 
taxpayers may exploit this dissimilar treatment by engaging in 
transactions intended to convert nonqualified property into stock that 
is not nonqualified property. See Example 2 of Sec.  1.7874-4T(j) of 
the temporary regulations. Accordingly, the temporary regulations do 
not adopt this recommendation.

D. De Minimis Exception

    Comments asserted that both the statutory public offering rule and 
the rule set forth in the notice that disregards stock issued in 
exchange for nonqualified property can lead to inappropriate results 
when the former owners of the domestic entity own only a minimal equity 
interest in the foreign acquiring corporation after the acquisition. 
These comments recommended that, in such a case, the regulations 
provide exceptions from the application of those rules.
    First, comments recommended an exception for large cash public or 
private offerings where the cash remains in the foreign acquiring 
corporation and results in a change of ownership in the domestic entity 
of such a magnitude that the predominant effect of the transaction is 
that of a sale or joint venture. Because such offerings have 
independent economic significance, comments suggested that they should 
not be treated as ``related to'' the acquisition, so that they would be 
taken into account for purposes of the ownership fraction.
    Second, comments recommended an exception for transactions that in 
substance resemble a purchase by the foreign acquiring corporation of a 
substantial portion of the stock of the domestic entity from the former 
owners of the domestic entity. The comments asserted that this may 
occur, for example, when a significant amount of the consideration 
received by the former owners of the domestic entity is cash (or other 
nonqualified property) that, related to the acquisition, was received 
by the foreign acquiring corporation in exchange for its stock (which 
stock would not be taken into account in determining the ownership 
fraction under the notice). The comments stated that section 7874 
should not apply to such transactions because the former owners of the 
domestic entity sold the majority of their interests in the domestic 
entity. These comments recommended that the exclusion rule be limited 
to transactions in which the former owners of the domestic entity own 
at least a threshold percentage of the equity of the foreign acquiring 
corporation.
    The IRS and the Treasury Department agree that an exception from 
the exclusion rule is appropriate for certain transactions, but believe 
that any such exception should apply only when the former owners of the 
domestic entity own a de minimis equity interest in the foreign 
acquiring corporation after the acquisition. Accordingly, the temporary 
regulations provide that the exclusion rule will not apply to certain 
transactions involving unrelated parties if the ownership fraction, 
determined without regard to the exclusion rule, is less than five 
percent (by vote and value).

E. Effect of Subsequent Transfers of Stock of the Foreign Acquiring 
Corporation Related to the Acquisition

    Comments questioned the effect on the ownership fraction of certain 
subsequent transfers of stock of the foreign acquiring corporation in 
transactions related to the acquisition. This may occur, for example, 
when former shareholders of the domestic corporation receive stock of 
the foreign acquiring corporation by reason of holding stock in the 
domestic corporation and then transfer that stock to another person 
pursuant to the terms

[[Page 3099]]

of a binding commitment that was in effect at the time of the 
acquisition.
    The IRS and the Treasury Department believe that determining the 
ownership fraction by taking into account such subsequent transfers of 
stock of the foreign acquiring corporation could inappropriately reduce 
the numerator of the ownership fraction and thereby reduce the 
ownership fraction. For example, if such a subsequent transfer of stock 
of the foreign acquiring corporation were taken into account in 
determining the ownership fraction, the exclusion rule could be avoided 
by restructuring an inversion transaction so that an investor 
participates by purchasing stock of the foreign acquiring corporation 
received by a former owner of the domestic entity instead of purchasing 
newly issued stock of the foreign acquiring corporation. Accordingly, 
the temporary regulations clarify that stock of the foreign acquiring 
corporation that is described in section 7874(a)(2)(B)(ii) will not 
cease to be so described as a result of any subsequent transfer of the 
stock by the former shareholder or former partner of the domestic 
entity that received such stock, even if the subsequent transfer is 
related to the acquisition.
    In addition, the IRS and the Treasury Department continue to study 
the extent to which such subsequent transfers of stock of the foreign 
acquiring corporation should be taken into account in applying section 
7874(c)(2)(A) (which disregards stock held by members of the expanded 
affiliated group that includes the foreign acquiring corporation) and 
Sec.  1.7874-1 (which provides exceptions to the application of section 
7874(c)(2)(A)) (collectively, with the rule of section 7874(c)(2)(A), 
the expanded affiliated group rules). Section K of the preamble to 
temporary and final regulations published on June 12, 2009 (TD 9453, 
2009-28 IRB 114), describes certain divisive transactions described in 
section 355 that involve subsequent distributions by a corporation of 
the stock of the foreign acquiring corporation that is described in 
section 7874(a)(2)(B)(ii). These issues can also arise when there is a 
subsequent sale by a corporation of the stock of the foreign acquiring 
corporation, or in connection with an acquisitive asset reorganization 
described in section 368 in which the target corporation distributes 
such stock. In each of these cases, a corporation receives and only 
temporarily holds the stock of the foreign acquiring corporation, and, 
after the transfer of such stock, the corporation no longer is a member 
of the expanded affiliated group that includes the foreign acquiring 
corporation. The IRS and the Treasury Department request comments on 
whether different results may be appropriate depending on whether the 
corporation that receives the stock of the foreign acquiring 
corporation and only temporarily holds that stock is a foreign or 
domestic corporation.

F. Interaction of Exclusion Rule With Expanded Affiliated Group Rules

    One comment questioned the interaction of the rules set forth in 
the notice with the expanded affiliated group rules in cases other than 
those involving subsequent transfers of the stock of the foreign 
acquiring corporation (which are discussed in section E of this 
preamble). The comment suggested that stock of the foreign acquiring 
corporation that is disregarded under the rules set forth in the notice 
nonetheless should be taken into account for purposes of determining 
whether an entity is a member of an expanded affiliated group that 
includes the foreign acquiring corporation under section 7874(c)(2)(A), 
as well as for purposes of the ``internal group restructuring'' and 
``loss of control'' exceptions to section 7874(c)(2)(A) provided in 
Sec.  1.7874-1(c). The comment further suggested that the policy 
underlying the internal group restructuring and loss of control 
exceptions requires that stock that would be included in the 
denominator of the ownership fraction under those exceptions should 
continue to be so included even if such stock would otherwise be 
excluded under the exclusion rule.
    The IRS and the Treasury Department believe that the policies 
underlying the exclusion rule differ from those underlying the expanded 
affiliated group rules such that they should operate independently. 
Because the exclusion rule and the expanded affiliated group rules 
operate independently, the IRS and the Treasury Department do not 
believe that qualification for the internal group restructuring or loss 
of control exceptions should cause stock of the foreign acquiring 
corporation that would otherwise be excluded from the denominator of 
the ownership fraction under the exclusion rule to be included in the 
denominator of the ownership fraction. Instead, the IRS and the 
Treasury Department believe that the de minimis exception is the 
appropriate exception to the exclusion rule when the former owners own 
only a small equity interest in the foreign acquiring corporation after 
the acquisition. Accordingly, the temporary regulations provide that 
stock of the foreign acquiring corporation to which the exclusion rule 
applies is not included in the denominator of the ownership fraction 
regardless of whether it would otherwise be included in the denominator 
as a result of the acquisition being described in the internal group 
restructuring exception or loss of control exception. That is, stock of 
the foreign acquiring corporation will not be taken into account in the 
denominator of the ownership fraction if either the exclusion rule or 
the expanded affiliated group rule set forth in section 7874(c)(2)(A) 
and Sec.  1.7874-1(b) applies to such stock. However, consistent with 
the comment, the temporary regulations provide that the exclusion rule 
does not apply for purposes of applying the expanded affiliated group 
rules.

G. Certain Public Offerings

    The IRS and the Treasury Department are aware that the de minimis 
exception (described in section D of this preamble) may facilitate the 
acquisition of a domestic corporation by a foreign corporation in 
circumstances that implicate the policies underlying section 7874. This 
may occur, for example, in connection with the buyout of a publicly 
traded domestic corporation. In such a transaction, the buyer may 
contribute cash to a newly formed foreign acquiring corporation that 
uses such cash, along with the proceeds from borrowings and a small 
amount of its stock, to acquire all of the stock of a publicly traded 
domestic corporation. The small amount of stock of the foreign 
acquiring corporation often is issued to the management of the domestic 
corporation. After a period of time, the buyer may sell its stock of 
the foreign acquiring corporation pursuant to a public offering. The 
public offering of the stock of the foreign acquiring corporation may 
have been one of the intended exit strategies of the buyer when it 
organized the foreign acquiring corporation to acquire the stock of the 
domestic corporation.
    The IRS and the Treasury Department believe that these 
transactions, which have the effect of converting a publicly traded 
domestic corporation into a publicly traded foreign corporation over 
time, can be viewed as inconsistent with the policies underlying 
section 7874. The IRS and the Treasury Department are studying these 
transactions and request comments on the application of section 7874 to 
such transactions.

[[Page 3100]]

H. Effective/Applicability Date

    The rules described in the notice and set forth in the temporary 
regulations apply to acquisitions completed on or after September 17, 
2009. All other rules set forth in the temporary regulations apply to 
acquisitions completed on or after January 16, 2014. However, a 
taxpayer may elect to apply all the rules of the temporary regulations 
to acquisitions completed before January 16, 2014 if the taxpayer 
applies all of the rules consistently to all acquisitions completed 
before such date.
    Comments recommended an exception to the rules described in the 
notice for transactions that were subject to a binding commitment but 
not completed before September 17, 2009. Because the rules described in 
the notice address transactions that are intended to avoid the purposes 
of section 7874, the IRS and the Treasury Department do not believe 
that providing a binding commitment exception is appropriate. 
Therefore, the applicability date in the temporary regulations does not 
include a binding commitment exception.
    No inference is intended as to the treatment of transactions 
described in the temporary regulations under the law before the 
applicability date of these regulations. The IRS may, where 
appropriate, challenge such transactions under applicable provisions, 
including under section 7874(c)(4) or judicial doctrines such as the 
substance-over-form doctrine.

Effect on Other Documents

    Notice 2009-78 (2009-40 IRB 452) is obsolete as of January 16, 
2014.

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 also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the Special Analyses section of the preamble of the cross-
referenced notice of proposed rulemaking published in this issue of the 
Federal Register. Pursuant to section 7805(f), these regulations have 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of the temporary regulations are David A. 
Levine of the Office of Associate Chief Counsel (International) and 
Mary W. Lyons, formerly 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.

Amendments to the Regulations

    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 
entries in numerical order to read as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.7874-4T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
    Section 1.7874-5T also issued under 26 U.S.C. 7874(c)(6) and 
(g).


0
Par. 2. Section 1.7874-1 is amended by adding a sentence at the end of 
paragraph (c)(1) to read as follows:


Sec.  1.7874-1  Disregard of affiliate-owned stock.

* * * * *
    (c) * * * (1) * * * For rules addressing the interaction of this 
section and Sec.  1.7874-4T, see Sec.  1.7874-4T(h).
* * * * *


0
Par. 3. Section 1.7874-4T is added to read as follows:


Sec.  1.7874-4T  Disregard of certain stock related to the acquisition 
(temporary).

    (a) Scope. This section identifies certain stock of the foreign 
acquiring corporation that is disregarded in determining the ownership 
fraction (as defined in paragraph (i)(9) of this section) and modifies 
the scope of section 7874(c)(2)(B). Paragraph (b) of this section sets 
forth the general rule that certain stock of the foreign acquiring 
corporation, and only such stock, is treated as stock described in 
section 7874(c)(2)(B) and therefore is excluded from the denominator of 
the ownership fraction. Paragraph (c) of this section identifies the 
stock of the foreign acquiring corporation that is subject to paragraph 
(b) of this section. Paragraph (d) of this section provides a de 
minimis exception to the application of the general exclusion rule of 
paragraph (b) of this section. Paragraph (e) of this section addresses 
transfers of stock of the foreign acquiring corporation involving 
certain obligations. Paragraph (f) of this section provides rules for 
certain transfers of stock of the foreign acquiring corporation 
involving multiple properties or obligations. Paragraph (g) of this 
section provides rules for the treatment of partnerships, and paragraph 
(h) of this section provides rules addressing the interaction of this 
section with the expanded affiliated group rules of section 
7874(c)(2)(A) and Sec.  1.7874-1. Paragraph (i) of this section 
provides definitions. Paragraph (j) of this section provides examples 
illustrating the application of the rules of this section. Paragraph 
(k) of this section provides dates of applicability, and paragraph (l) 
of this section provides the date of expiration.
    (b) Exclusion of disqualified stock under section 7874(c)(2)(B). 
Except as provided in paragraph (d) of this section, disqualified stock 
(as determined under paragraph (c) of this section) is treated as stock 
described in section 7874(c)(2)(B) and therefore is not included in the 
denominator of the ownership fraction. Section 7874(c)(2)(B) shall not 
apply to exclude stock from the denominator of the ownership fraction 
that is not disqualified stock.
    (c) Disqualified stock--(1) General rule. Except as provided in 
paragraph (c)(2) of this section, disqualified stock is stock of the 
foreign acquiring corporation that is transferred in an exchange 
described in paragraph (c)(1)(i) or (c)(1)(ii) of this section that is 
related to the acquisition. This paragraph (c) applies without regard 
to whether the stock of the foreign acquiring corporation is publicly 
traded at the time of the transfer or at any other time.
    (i) Exchange for nonqualified property. The stock is transferred to 
a person other than the domestic entity in exchange for nonqualified 
property. See Example 1, Example 2, Example 5, Example 7, and Example 8 
of paragraph (j) of this section for illustrations of this paragraph 
(c)(1)(i).
    (ii) Certain obligations associated with property exchanged for 
stock. Except as otherwise provided in this paragraph (c)(1)(ii), the 
stock is transferred to a person in exchange for property and, pursuant 
to the same plan (or series of related transactions), the transferee 
subsequently transfers such stock in exchange for the satisfaction or 
the assumption of one or more obligations associated with the property 
exchanged. An obligation is associated with property exchanged if, for 
example, the obligation arose from the conduct of a trade or business 
in which the property exchanged has been used, regardless of whether 
the obligation is a non-recourse obligation. If any of the property 
exchanged constitutes

[[Page 3101]]

nonqualified property and the transferee is not the domestic entity, 
the amount of stock described in this paragraph (c)(1)(ii) is limited 
to the product of:
    (A) The fair market value of the stock subsequently transferred by 
the transferee in exchange for the satisfaction or the assumption of 
such obligations; and
    (B) A fraction, the numerator of which is the amount of qualified 
property exchanged by the transferee, and the denominator of which is 
the total amount of property exchanged by the transferee. See Example 5 
of paragraph (j) of this section for an illustration of this paragraph 
(c)(1)(ii).
    (2) Stock transferred in an exchange that does not increase the 
fair market value of the assets or decrease the amount of liabilities 
of the foreign acquiring corporation. Stock is disqualified stock only 
to the extent that the transfer of the stock in the exchange increases 
the fair market value of the assets of the foreign acquiring 
corporation or decreases the amount of its liabilities. This paragraph 
(c)(2) is applied to an exchange without regard to any other exchange 
described in paragraph (c)(1)(i) or (c)(1)(ii) of this section or any 
other transaction related to the acquisition. See Example 3 and Example 
6 of paragraph (j) of this section for illustrations of this paragraph 
(c)(2).
    (d) Exception to exclusion of disqualified stock--(1) De minimis 
ownership. Except as provided in paragraph (d)(2) of this section, 
paragraph (b) of this section does not apply if both:
    (i) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section, is less than five percent (by vote and 
value); and
    (ii) After the acquisition and all transactions related to the 
acquisition, if any, are completed, former shareholders (within the 
meaning of Sec.  1.7874-2(b)(2)) or former partners (within the meaning 
of Sec.  1.7874-2(b)(3)), as applicable, in the aggregate, own 
(applying the attribution rules of section 318(a) with the 
modifications described in section 304(c)(3)(B)) less than five percent 
(by vote and value) of the stock of (or a partnership interest in) any 
member of the expanded affiliated group that includes the foreign 
acquiring corporation. See Example 4 of paragraph (j) of this section 
for an illustration of this paragraph (d).
    (2) Stock issued to avoid the purposes of section 7874. The 
exception in paragraph (d)(1) of this section does not apply to 
disqualified stock that is transferred in a transaction (or series of 
transactions) related to the acquisition with a principal purpose of 
avoiding the purposes of section 7874.
    (e) Satisfaction or assumption of obligations. Except to the extent 
paragraph (c)(1)(ii) of this section applies, this paragraph (e) 
applies if, in a transaction related to the acquisition, stock of the 
foreign acquiring corporation is transferred to a person other than the 
domestic entity in exchange for the satisfaction or the assumption of 
one or more obligations of the transferor. In such a case, solely for 
purposes of this section, the stock of the foreign acquiring 
corporation is treated as if it is transferred in exchange for an 
amount of cash equal to the fair market value of such stock.
    (f) Transactions involving multiple properties. For purposes of 
this section, if stock and other property are exchanged for qualified 
property and nonqualified property, the stock is treated as transferred 
in exchange for the qualified property or nonqualified property, 
respectively, based on the relative value of the property. See also 
Sec.  1.7874-2(f)(2) (allocating stock of the foreign acquiring 
corporation between an interest in the domestic entity and other 
property).
    (g) Treatment of partnerships. For purposes of this section, if one 
or more members of the expanded affiliated group own, in the aggregate, 
more than 50 percent (by value) of the interests in a partnership, such 
partnership is treated as a corporation that is a member of the 
expanded affiliated group.
    (h) Interaction with expanded affiliated group rules. Disqualified 
stock that is excluded from the denominator of the ownership fraction 
pursuant to paragraph (b) of this section is taken into account for 
purposes of determining whether an entity is a member of the expanded 
affiliated group for purposes of applying section 7874(c)(2)(A) and 
determining whether an acquisition qualifies as an internal group 
restructuring or results in a loss of control, as described in Sec.  
1.7874-1(c)(2) and (c)(3), respectively. However, such disqualified 
stock is excluded from the denominator of the ownership fraction for 
purposes of section 7874(a)(2)(B)(ii) regardless of whether it would 
otherwise be included in the denominator of the ownership fraction as a 
result of the application of Sec.  1.7874-1(c). See Example 7 and 
Example 8 of paragraph (j) of this section for illustrations of this 
paragraph (h).
    (i) Definitions. The following definitions apply for purposes of 
this section:
    (1) An acquisition is an acquisition described in section 
7874(a)(2)(B)(i).
    (2) A domestic entity is a domestic corporation or domestic 
partnership described in section 7874(a)(2)(B)(i).
    (3) An expanded affiliated group is an affiliated group defined in 
section 7874(c)(1) determined as of the end of the day on which the 
acquisition is completed. A member of the expanded affiliated group is 
an entity included in the expanded affiliated group.
    (4) A foreign acquiring corporation is a foreign corporation 
described in section 7874(a)(2)(B).
    (5) An interest in a partnership has the meaning provided under 
Sec.  1.7874-2(b)(4), and therefore includes a capital or profits 
interest.
    (6) Marketable securities has the meaning set forth in section 
453(f)(2), except that the term marketable securities does not include 
stock of a corporation or an interest in a partnership that becomes a 
member of the expanded affiliated group that includes the foreign 
acquiring corporation in a transaction (or series of transactions) 
related to the acquisition, unless a principal purpose for acquiring 
such stock or partnership interest is to avoid the purposes of section 
7874. See Example 3 of paragraph (j) of this section for an 
illustration of this paragraph (i)(6).
    (7) Nonqualified property is property described in paragraphs 
(i)(7)(i) through (i)(7)(iv) of this section. Qualified property is 
property other than nonqualified property.
    (i) Cash or cash equivalents.
    (ii) Marketable securities, within the meaning of paragraph (i)(6) 
of this section.
    (iii) An obligation owed by any of the following:
    (A) A member of the expanded affiliated group that includes the 
foreign acquiring corporation;
    (B) A former shareholder (within the meaning of Sec.  1.7874-
2(b)(2)) or former partner (within the meaning of Sec.  1.7874-2(b)(3)) 
of the domestic entity; or
    (C) A person that, before or after the acquisition, either owns 
stock of, or a partnership interest in, a person described in paragraph 
(i)(7)(iii)(A) or (i)(7)(iii)(B) of this section or is related (within 
the meaning of section 267 or 707(b)) to such a person. See Example 5 
of paragraph (j) of this section for an illustration of this paragraph 
(i)(7)(iii).
    (iv) Any other property acquired in a transaction (or series of 
transactions) related to the acquisition with a principal purpose of 
avoiding the purposes of section 7874. See Example

[[Page 3102]]

2 of paragraph (j) of this section for an illustration of this 
paragraph (i)(7)(iv).
    (8) An obligation has the meaning set forth in Sec.  1.752-
1(a)(4)(ii), provided that the obligation is not otherwise treated as 
stock for purposes of section 7874 (see, for example, Sec.  1.7874-
2(i), which treats certain interests, including certain creditor 
claims, as stock).
    (9) The ownership fraction is the ownership percentage described in 
section 7874(a)(2)(B)(ii), expressed as a fraction.
    (10) A transfer is, with respect to stock of the foreign acquiring 
corporation, an issuance, sale, distribution, exchange, or any other 
disposition of such stock.
    (j) Examples. The following examples illustrate the rules of this 
section. For purposes of the examples, unless otherwise indicated, 
assume the following facts in addition to the facts stated in the 
examples:
    (1) FA, FMS, FS, and FT are foreign corporations, all of which have 
only one class of stock issued and outstanding;
    (2) DMS and DT are domestic corporations;
    (3) P and R are corporations that may be either domestic or 
foreign;
    (4) PRS is a partnership with individual partners;
    (5) The de minimis ownership exception in paragraph (d)(1) of this 
section does not apply;
    (6) None of the shareholders or partners in the entities described 
in the examples are related persons;
    (7) All transactions described in each example occur pursuant to 
the same plan; and
    (8) No property is acquired with a principal purpose of avoiding 
the purposes of section 7874.

    Example 1. Stock transferred in exchange for marketable 
securities. (i) Facts. Individual A wholly owns DT. PRS transfers 
marketable securities (within the meaning of paragraph (i)(6) of 
this section) to FA, a newly formed corporation, in exchange solely 
for 25 shares of FA stock. Then Individual A transfers all the DT 
stock to FA in exchange solely for 75 shares of FA stock.
    (ii) Analysis. Under paragraphs (i)(6) and (i)(7)(ii) of this 
section, the marketable securities constitute nonqualified property. 
Accordingly, the 25 shares of FA stock transferred by FA to PRS in 
exchange for the marketable securities constitute disqualified stock 
described in paragraph (c)(1) of this section by reason of paragraph 
(c)(1)(i) of this section. Paragraph (c)(2) of this section does not 
reduce the amount of disqualified stock described in paragraph 
(c)(1)(i) of this section because the transfer of FA stock in 
exchange for the marketable securities increases the fair market 
value of the assets of FA by the fair market value of the marketable 
securities transferred. Under paragraph (b) of this section, the 25 
shares of FA stock transferred to PRS are not included in the 
denominator of the ownership fraction. Accordingly, the only FA 
stock included in the ownership fraction is the FA stock transferred 
to Individual A in exchange for the DT stock, and that FA stock is 
included in both the numerator and the denominator of the ownership 
fraction. Thus, the ownership fraction is 75/75.
    Example 2. Stock transferred in exchange for property acquired 
with a principal purpose of avoiding the purposes of section 7874. 
(i) Facts. Individual A wholly owns DT. PRS transfers marketable 
securities (within the meaning of paragraph (i)(6) of this section) 
to FT, a newly formed corporation, in exchange solely for all the FT 
stock. Then PRS transfers the FT stock to FA, a newly formed 
corporation, in exchange solely for 25 shares of FA stock. Finally, 
Individual A transfers all the DT stock to FA in exchange solely for 
75 shares of FA stock. FA acquires the FT stock with a principal 
purpose of avoiding the purposes of section 7874.
    (ii) Analysis. Under paragraph (i)(7)(iv) of this section, the 
FT stock constitutes nonqualified property because a principal 
purpose of FA acquiring the FT stock is to avoid the purposes of 
section 7874. Accordingly, the 25 shares of FA stock transferred by 
FA to PRS in exchange for the FT stock constitute disqualified stock 
described in paragraph (c)(1) of this section by reason of paragraph 
(c)(1)(i) of this section. Paragraph (c)(2) of this section does not 
reduce the amount of disqualified stock described in paragraph 
(c)(1)(i) of this section because the transfer of FA stock in 
exchange for the FT stock increases the fair market value of FA's 
assets by the fair market value of the FT stock. Under paragraph (b) 
of this section, the 25 shares of FA stock transferred to PRS are 
not included in the denominator of the ownership fraction. 
Accordingly, the only FA stock included in the ownership fraction is 
FA stock transferred to Individual A in exchange for the DT stock, 
and that FA stock is included in both the numerator and the 
denominator of the ownership fraction. Thus, the ownership fraction 
is 75/75.
    Example 3. Stock transferred in exchange for stock of a foreign 
corporation that becomes a member of the expanded affiliated group. 
(i) Facts. FT, a publicly traded corporation, forms FA, and then FA 
forms DMS and FMS. FMS merges with and into FT, with FT surviving 
the merger (FMS-FT merger). Pursuant to the FMS-FT merger, the FT 
shareholders exchange their FT stock solely for 1,000 shares of FA 
stock and FT becomes a wholly owned subsidiary of FA. Following the 
FMS-FT merger, DMS merges with and into DT, also a publicly traded 
corporation, with DT surviving the merger (DMS-DT merger). Pursuant 
to the DMS-DT merger, the DT shareholders exchange their DT stock 
solely for the remaining 1,000 shares of FA stock, and DT becomes a 
wholly owned subsidiary of FA. After the completion of the plan, FA 
wholly owns FT and DT, DMS and FMS cease to exist, and the stock of 
FA is publicly traded.
    (ii) Analysis. Because FT becomes a member of the expanded 
affiliated group that includes FA in a transaction related to FA's 
acquisition of substantially all the properties of DT, the FT stock 
does not constitute marketable securities (within the meaning of 
paragraph (i)(6) of this section) and therefore does not constitute 
nonqualified property pursuant to paragraph (i)(7)(ii) of this 
section. Accordingly, no FA stock is disqualified stock described in 
paragraph (c)(1) of this section and therefore the FA stock 
transferred in exchange for the FT stock and DT stock is included in 
the denominator of the ownership fraction. Thus, the ownership 
fraction is 1,000/2,000.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 3, except that, instead of undertaking the FMS-
FT merger, FT merges with and into FA with FA surviving the merger 
(FT-FA merger). Pursuant to the FT-FA merger, the FT shareholders 
exchange their FT stock solely for 1,000 shares of FA stock. At the 
time of the FT-FA merger, FT does not hold nonqualified property and 
has no obligations. Accordingly, FA stock transferred by FA to FT in 
exchange for the property of FT is not disqualified stock described 
in paragraph (c)(1) of this section. Furthermore, the 1,000 shares 
of FA stock transferred by FT to the shareholders of FT in exchange 
for their FT stock do not constitute disqualified stock described in 
paragraph (c)(1) of this section. Although the FT stock is 
nonqualified property (the FT stock constitutes marketable 
securities within the meaning of paragraph (i)(7)(ii) of this 
section because the stock of FT is publicly traded and FT is not a 
member of the expanded affiliated group that includes FA after the 
acquisition), under paragraph (c)(2) of this section, the transfer 
of FA stock by FT to the shareholders of FT neither increases the 
fair market value of the assets of FA nor decreases the liabilities 
of FA. Accordingly, no FA stock is disqualified stock described in 
paragraph (c)(1) of this section and, therefore, the FA stock 
transferred in exchange for the assets of FT and the DT stock is 
included in the denominator of the ownership fraction. Thus, the 
ownership fraction is 1,000/2,000.
    Example 4. De minimis exception. (i) Facts. Individual A wholly 
owns DT. The fair market value of the DT stock is $100x. PRS 
transfers $96x of cash to FA, a newly formed corporation, in 
exchange solely for 96 shares of FA stock. Then Individual A 
transfers the DT stock to FA in exchange for $96x of cash and 4 
shares of FA stock.
    (ii) Analysis. Under paragraph (i)(7)(i) of this section, cash 
constitutes nonqualified property. Accordingly, the 96 shares of FA 
stock transferred by FA to PRS in exchange for $96x of cash 
constitute disqualified stock described in paragraph (c)(1) of this 
section by reason of paragraph (c)(1)(i) of this section. 
Furthermore, paragraph (c)(2) of this section does not reduce the 
amount of disqualified stock described in paragraph (c)(1)(i) of 
this section because the transfer of FA stock in exchange for $96x 
of cash increases the fair market value of the assets of FA by $96x. 
However, without regard to the application of paragraph (b) of this 
section, the ownership percentage described in section 
7874(a)(2)(B)(ii) would be less than 5% (by vote and value), or 4% 
(4/100, or 4 shares of FA stock held by Individual A by

[[Page 3103]]

reason of owning the DT stock, determined under Sec.  1.7874-
2(f)(2), over 100 shares of FA stock outstanding after the 
acquisition). Furthermore, after the acquisition and all 
transactions related to the acquisition, Individual A owns less than 
5% (by vote and value) of the stock of FA and DT (the members of the 
expanded affiliated group that includes FA). Accordingly, the de 
minimis exception in paragraph (d)(1) of this section applies and 
therefore paragraph (b) of this section does not apply to exclude 
the FA stock transferred to PRS from the denominator of the 
ownership fraction. Therefore, the FA stock transferred to 
Individual A and PRS is included in the denominator of the ownership 
fraction. Thus, the ownership fraction is 4/100.
    Example 5. Obligation of the expanded affiliated group satisfied 
with stock. (i) Facts. Individual A wholly owns DT. The stock of DT 
held by Individual A has a fair market value of $75x. Individual A 
also holds an obligation of DT with a value and face amount of $25x. 
DT holds property with a value of $100x, and the $25x obligation is 
associated with the property. FA, a newly formed corporation, 
transfers 100 shares of FA stock to Individual A in exchange for all 
the DT stock and the $25x obligation of DT.
    (ii) Analysis. Under paragraph (i)(7)(iii)(A) of this section, 
the $25x obligation of DT constitutes nonqualified property because 
DT is a member of the expanded affiliated group that includes FA. 
Thus, the shares of FA stock transferred by FA to Individual A in 
exchange for the obligation of DT constitute disqualified stock 
described in paragraph (c)(1)(i) of this section. Under Sec.  
1.7874-2(f)(2), Individual A is treated as receiving 75 shares of FA 
stock in exchange for the DT stock (100 x $75x/$100x) and 25 shares 
of FA stock in exchange for the obligation of DT (100 x $25x/$100x). 
Thus, 25 shares of FA stock constitute disqualified stock described 
in paragraph (c)(1) of this section by reason of paragraph (c)(1)(i) 
of this section. Paragraph (c)(2) of this section does not reduce 
the amount of disqualified stock described in paragraph (c)(1)(i) of 
this section because the transfer of FA stock for the $25x 
obligation increases the fair market value of FA's assets by $25x. 
Therefore, under paragraph (b) of this section, the 25 shares of FA 
stock transferred to Individual A in exchange for the obligation of 
DT are not included in the denominator of the ownership fraction. 
Accordingly, the only FA stock included in the ownership fraction is 
the 75 shares of FA stock transferred to Individual A in exchange 
for the DT stock, and that FA stock is included in both the 
numerator and the denominator of the ownership fraction. Thus, the 
ownership fraction is 75/75.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 5, except that instead of acquiring the stock of 
DT and the $25x obligation of DT, FA acquires the $100x of property 
from DT in exchange solely for 100 shares of FA stock. DT 
distributes 75 shares of FA stock to Individual A in exchange for 
Individual A's DT stock and transfers 25 shares of FA stock to 
Individual A in satisfaction of DT's obligation to Individual A, and 
liquidates. The 25 shares of FA stock used to satisfy DT's 
obligation to Individual A after being transferred by FA to DT in 
exchange for the property of DT constitute disqualified stock 
described in paragraph (c)(1) of this section by reason of paragraph 
(c)(1)(ii) of this section. Paragraph (c)(2) of this section does 
not reduce the amount of disqualified stock described in paragraph 
(c)(1)(ii) of this section because the transfer of FA stock in 
exchange for the property of DT increases the fair market value of 
FA's assets by $100x (although the amount of disqualified stock is 
limited to 25 shares of FA stock in this case). Therefore, under 
paragraph (b) of this section, the 25 shares of FA stock that 
constitute disqualified stock are not included in the denominator of 
the ownership fraction. Accordingly, only 75 shares of FA stock are 
included in the ownership fraction, and that FA stock is included in 
both the numerator and the denominator of the ownership fraction. 
Thus, the ownership fraction is 75/75.
    Example 6. ``Over-the-top'' stock transfer. (i) Facts. 
Individual A wholly owns DT. Individual B holds all 100 outstanding 
shares of FA stock. Individual C acquires 20 shares of FA stock from 
Individual B for cash, and then FA acquires all of the stock of DT 
from Individual A in exchange solely for 100 shares of FA stock.
    (ii) Analysis. Under paragraph (i)(7)(i) of this section, cash 
constitutes nonqualified property. Accordingly, absent the 
application of paragraph (c)(2) of this section, the 20 shares of FA 
stock transferred by Individual B to Individual C in exchange for 
cash would constitute disqualified stock described in paragraph 
(c)(1) of this section by reason of paragraph (c)(1)(i) of this 
section. Nevertheless, because Individual B's sale of FA stock 
neither increases the assets of FA nor decreases the liabilities of 
FA, such FA stock is not disqualified stock by reason of paragraph 
(c)(2) of this section. Accordingly, paragraph (b) of this section 
does not apply to Individual B's sale of the 20 shares of FA stock 
to Individual C, and that FA stock is included in the denominator of 
the ownership fraction. The 100 shares of FA stock received by 
Individual A are the only shares included in the numerator of the 
ownership fraction. Thus, the ownership fraction is 100/200.
    Example 7. Interaction with internal group restructuring rule. 
(i) Facts. P holds 85 shares of DT stock. The remaining 15 shares of 
DT stock are held by Individual A. P and Individual A transfer their 
shares of DT stock to FA, a newly formed corporation, in exchange 
for 85 and 15 shares of FA stock, respectively, and PRS transfers 
$75x of cash to FA in exchange for the remaining 75 shares of FA 
stock.
    (ii) Analysis. Under paragraph (i)(7)(i) of this section, cash 
constitutes nonqualified property. Accordingly, the 75 shares of FA 
stock transferred by FA to PRS in exchange for $75x of cash 
constitute disqualified stock described in paragraph (c)(1) of this 
section by reason of paragraph (c)(1)(i) of this section. 
Furthermore, paragraph (c)(2) of this section does not reduce the 
amount of disqualified stock described in paragraph (c)(1)(i) of 
this section because the transfer of FA stock in exchange for $75x 
of cash increases the fair market value of the assets of FA by $75x. 
Therefore, under paragraph (b) of this section, the 75 shares of FA 
stock transferred to PRS are not included in the denominator of the 
ownership fraction. Although PRS's shares of FA stock are excluded 
from the denominator of the ownership fraction under paragraph (b) 
of this section, such shares of FA stock nonetheless are taken into 
account for purposes of determining whether P is a member of the 
expanded affiliated group that includes FA under paragraph (h) of 
this section. Because P holds 48.6% of the FA stock (85/175) after 
the acquisition, it is not a member of the expanded affiliated group 
that includes FA. In addition, the acquisition does not qualify as 
an internal group restructuring described in Sec.  1.7874-1(c)(2) 
because P does not hold, directly or indirectly, 80% or more of the 
shares of FA stock (by vote and value) after the acquisition. 
Therefore, the FA stock held by P (along with the FA stock held by 
Individual A) is included in the numerator and the denominator of 
the ownership fraction. Thus, the ownership fraction is 100/100.
    Example 8. Interaction with loss of control rule. (i) Facts. P 
wholly owns DT. P transfers all of its shares of DT stock to FA, a 
newly formed corporation, in exchange for 49 shares of FA stock, and 
R transfers marketable securities (within the meaning of paragraph 
(i)(6) of this section) to FA in exchange for the remaining 51 
shares of FA stock.
    (ii) Analysis. Under paragraphs (i)(6) and (i)(7)(ii) of this 
section, the marketable securities constitute nonqualified property. 
Accordingly, the shares of FA stock transferred by FA to R in 
exchange for the marketable securities constitute disqualified stock 
described in paragraph (c)(1) of this section by reason of paragraph 
(c)(1)(i) of this section. Paragraph (c)(2) of this section does not 
reduce the amount of disqualified stock described in paragraph 
(c)(1)(i) of this section because the transfer of FA stock in 
exchange for the marketable securities increases the fair market 
value of the assets of FA by the fair market value of the marketable 
securities transferred. Therefore, under paragraph (b) of this 
section, the shares of FA stock transferred to R are not included in 
the denominator of the ownership fraction. Although under paragraph 
(b) of this section R's shares of FA stock are excluded from the 
denominator of the ownership fraction, under paragraph (h) of this 
section such stock is taken into account for purposes of determining 
whether P or R is a member of the expanded affiliated group that 
includes FA. Because P holds 49% of the shares of FA stock (49/100), 
P is not a member of the expanded affiliated group that includes FA, 
and P's FA stock is included in both the numerator and the 
denominator of the ownership fraction. Because R holds 51% of the 
shares of FA stock (51/100), R is a member of the expanded 
affiliated group that includes FA and, before taking into account 
Sec.  1.7874-1(c), R's FA stock would be excluded from the numerator 
and denominator of the ownership fraction under section 
7874(c)(2)(A) and Sec.  1.7874-1(b).

[[Page 3104]]

However, the acquisition results in a loss of control described in 
Sec.  1.7874-1(c)(2) because P does not hold, in the aggregate, 
directly or indirectly, more than 50% of the shares of FA stock (by 
vote or value) of R, FA, or DT after the acquisition. Accordingly, 
the FA stock held by R would be included in the denominator of the 
ownership fraction under Sec.  1.7874-1(c)(1). Nevertheless, the FA 
stock held by R is excluded from the denominator of the ownership 
fraction under paragraphs (b) and (h) of this section. Thus, the 
ownership fraction is 49/49.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 8, except that, in exchange for 51 shares of FA 
stock, R transfers marketable securities (within the meaning of 
paragraph (i)(6) of this section) with a value equal to that of 16 
shares of FA stock and qualified property (within the meaning of 
paragraph (i)(7) of this section) with a value equal to that of 35 
shares of FA stock. Accordingly, 16 of the 51 shares of FA stock 
transferred to R constitute disqualified stock described in 
paragraph (c)(1) of this section by reason of paragraph (c)(1)(i) of 
this section, and 35 of such shares do not constitute disqualified 
stock. Paragraph (c)(2) of this section does not reduce the amount 
of disqualified stock described in paragraph (c)(1)(i) of this 
section because the transfer of FA stock in exchange for the 
marketable securities increases the fair market value of the assets 
of FA by the fair market value of the marketable securities 
transferred. Therefore, under paragraph (b) of this section, 16 of 
the 51 shares of FA stock transferred to R are not included in the 
denominator of the ownership fraction. Although 16 of the 51 shares 
of FA stock that are transferred to R are excluded from the 
denominator of the ownership fraction, under paragraph (h) of this 
section, all 51 of R's shares of FA stock are taken into account for 
purposes of determining whether P or R is a member of the expanded 
affiliated group that includes FA. Because P holds 49% of the shares 
of FA stock (49/100), it is not a member of the expanded affiliated 
group that includes FA, and its FA stock is included in both the 
numerator and the denominator of the ownership fraction. Because R 
holds 51% of the shares of FA stock (51/100), it is a member of the 
expanded affiliated group that includes FA and, before taking into 
account Sec.  1.7874-1(c), its FA stock is excluded from the 
numerator and denominator of the ownership fraction under section 
7874(c)(2)(A) and Sec.  1.7874-1(b). However, the acquisition 
results in a loss of control described in Sec.  1.7874-1(c)(2) 
because P does not hold, in the aggregate, directly or indirectly, 
more than 50% of the shares of FA stock (by vote or value) of R, FA, 
or DT after the acquisition. Accordingly, the 51 shares of FA stock 
held by R would be included in the denominator of the ownership 
fraction under Sec.  1.7874-1(c)(1). Nevertheless, the 16 shares of 
FA stock that constitute disqualified stock are excluded from the 
denominator of the ownership fraction under paragraphs (b) and (h) 
of this section. In addition, the 35 shares of FA stock received by 
R that do not constitute disqualified stock are included in the 
denominator. Thus, the ownership fraction is 49/84.

    (k) Effective/applicability dates--(1) General rule. Except to the 
extent provided in paragraph (k)(2) of this section, this section 
applies to acquisitions completed on or after September 17, 2009.
    (2) Transitional rules. For acquisitions completed on or after 
September 17, 2009, but before January 16, 2014, except as provided in 
paragraph (k)(3) of this section, this section shall be applied with 
the following modifications:
    (i) Nonqualified property does not include property described in 
paragraph (i)(7)(iii) of this section.
    (ii) A transfer is limited to an issuance of stock of the foreign 
acquiring corporation.
    (iii) The determination of whether stock of the foreign acquiring 
corporation is described in paragraph (c)(1) of this section is made 
without regard to paragraphs (c)(1)(ii), (c)(2), and (e) of this 
section.
    (iv) Paragraphs (d) and (h) of this section do not apply.
    (3) Election. A taxpayer may elect to apply paragraphs (a) through 
(j) of this section to acquisitions completed on or after September 17, 
2009, but before January 16, 2014, if the taxpayer applies those 
paragraphs consistently to all acquisitions completed before such date. 
The election is made by applying paragraphs (a) through (j) of this 
section to all such acquisitions on a timely filed original return 
(including extensions) or an amended return filed no later than six 
months after January 16, 2014. A separate statement or form evidencing 
the election need not be filed.
    (l) Expiration date. The applicability of this section expires on 
January 13, 2017.

0
Par. 4. Section 1.7874-5T is added to read as follows:


Sec.  1.7874-5T  Effect of certain transfers of stock related to the 
acquisition (temporary).

    (a) General rule. Stock of a foreign corporation that is described 
in section 7874(a)(2)(B)(ii) shall not cease to be so described as a 
result of any subsequent transfer of the stock by the former 
shareholder (within the meaning of Sec.  1.7874-2(b)(2)) or former 
partner (within the meaning of Sec.  1.7874-2(b)(3)) that received such 
stock, even if the subsequent transfer is related to the acquisition 
described in section 7874(a)(2)(B)(i).
    (b) Example. The rule of this section is illustrated by the 
following example:

    Example.  (i) Facts. Individual A wholly owns DT, a domestic 
corporation. FA, a newly formed foreign corporation, acquires all of 
the stock of DT from Individual A in exchange solely for 100 shares 
of FA stock. Pursuant to a binding commitment that was entered into 
in connection with FA's acquisition of the DT stock, Individual A 
sells 25 shares of FA stock to B, an unrelated person, in exchange 
for cash. For federal income tax purposes, the form of the steps of 
the transaction is respected.
    (ii) Analysis. Under Sec.  1.7874-2(f)(1), the 100 shares of FA 
stock received by Individual A are stock of a foreign corporation 
(FA) that is held by reason of holding stock in a domestic 
corporation (DT). Accordingly, such stock is described in section 
7874(a)(2)(B)(ii). Under paragraph (a) of this section, all 100 
shares of FA stock retain their status as being described in section 
7874(a)(2)(B)(ii), even though Individual A sells 25 of the 100 
shares in connection with the acquisition described in section 
7874(a)(2)(B)(i) pursuant to the binding commitment. Therefore, all 
100 of the shares of FA stock are included in both the numerator and 
denominator of the ownership fraction (as defined in Sec.  1.7874-
4T(i)(9)).

    (c) Effective/applicability dates. This section applies to 
acquisitions that are completed on or after January 16, 2014.
    (d) Expiration date. The applicability of this section expires on 
January 13, 2017.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: December 30, 2013.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-00899 Filed 1-16-14; 8:45 am]
BILLING CODE 4830-01-P