Post by Foley on Apr 29, 2009 2:24:25 GMT 4
US Outbound: IRS modifies the application of section 367 to certain cross-border stock transfers
On February 10 2009, the Treasury department and IRS released temporary regulations (T.D. 9444) modifying the section 367 regulations by applying sections 367(a) and (b) to certain international section 304(a)(1) transactions, commonly referred to as cross-chain stock sales. The temporary regulations apply to transfers or distributions occurring on or after February 11 2009.
Section 304(a)(1) generally provides that property received in a cross-chain sale of stock is treated as a distribution in redemption of the acquiring corporation's stock. If the distribution is treated as a section 301 distribution, the transaction is treated as if (i) the transferor transferred the stock to the acquiring corporation in exchange for acquiring corporation stock (the fictional stock) in a section 351(a) transaction, and then (ii) the acquiring corporation distributed the property to the transferor in redemption of the fictional stock.
In February 2006, Treasury and the IRS released final section 367 regulations rendering sections 367(a) and (b) inapplicable to deemed section 351(a) exchanges occurring pursuant to cross-border section 304(a)(1) transactions. The preamble to the regulations explained that the policies underlying sections 367(a) and (b) were preserved even if a deemed section 351 exchange was not subject to section 367 because the income recognised by the transferor in such a transaction would generally equal or exceed the built-in gain in the transferred stock.
Commentators noted, however, that this may not be the case if the transferor can recover basis under section 301(c)(2) in acquiring corporation stock it held before the transaction (in other words, not the fictional stock). The following example illustrates this point:
* Domestic corporation (USP) wholly owns foreign corporations F1 and F2. The F1 stock has a basis of $0 and a fair market value of $100. The F2 stock has a basis of $100 and a fair market value of $100. Neither F1 nor F2 has current or accumulated earnings and profits.
* In a section 304(a)(1) transaction, USP sells the F1 stock to F2 for $100 cash. Under section 304(a)(1), USP and F2 are treated as if (i) USP transferred the F1 stock to F2 in exchange for fictional F2 stock in a section 351 transfer, and then (ii) F2 distributed the $100 cash to USP in redemption of the fictional stock.
* Because the redemption of the fictional stock would be described in section 302(d)—and therefore subject to section 301—the commentators asserted that USP may not recognise gain under section 301(c)(3) on the cash distribution if USP could reduce its basis under section 301(c)(2) in both the fictional stock and the actual F2 stock that it held prior to the transaction. In that case, USP would recognise no gain on the transaction.
The preamble to the 2006 regulations explained, however, that in this situation, the transferor can only recover its basis in the fictional stock of the acquiring corporation. Thus, since USP did not have any basis in the fictional F2 stock, it would recognise $100 gain under section 301(c)(3) (the built-in gain on the F1 stock).
In January 2009, however, the IRS issued proposed basis recovery regulations (REG-143686-07) that generally allow a transferor in a section 304(a)(1) transaction to recover basis in both fictional stock as well as the actual common shares that the transferor held before the transaction. Consequently, to prevent taxpayers from using this change to avoid recognising gain in cross-chain stock sales, Treasury and the IRS also issued new temporary section 367 regulations.
Under the temporary regulations, if, in the context of a section 304(a)(1) exchange, the deemed distribution reduces a transferor's basis in the acquiring corporation stock that it actually held before the section 304(a)(1) transaction, then sections 367(a) and (b) will turn back on, as appropriate, to potentially require the transferor to recognise gain or have a deemed dividend inclusion on the deemed section 351 exchange. Thus, the regulations preserve the result that Treasury and the IRS intended to achieve in the example discussed above.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
Sean Foley (sffoley@kpmg.com)
Washington, DC
On February 10 2009, the Treasury department and IRS released temporary regulations (T.D. 9444) modifying the section 367 regulations by applying sections 367(a) and (b) to certain international section 304(a)(1) transactions, commonly referred to as cross-chain stock sales. The temporary regulations apply to transfers or distributions occurring on or after February 11 2009.
Section 304(a)(1) generally provides that property received in a cross-chain sale of stock is treated as a distribution in redemption of the acquiring corporation's stock. If the distribution is treated as a section 301 distribution, the transaction is treated as if (i) the transferor transferred the stock to the acquiring corporation in exchange for acquiring corporation stock (the fictional stock) in a section 351(a) transaction, and then (ii) the acquiring corporation distributed the property to the transferor in redemption of the fictional stock.
In February 2006, Treasury and the IRS released final section 367 regulations rendering sections 367(a) and (b) inapplicable to deemed section 351(a) exchanges occurring pursuant to cross-border section 304(a)(1) transactions. The preamble to the regulations explained that the policies underlying sections 367(a) and (b) were preserved even if a deemed section 351 exchange was not subject to section 367 because the income recognised by the transferor in such a transaction would generally equal or exceed the built-in gain in the transferred stock.
Commentators noted, however, that this may not be the case if the transferor can recover basis under section 301(c)(2) in acquiring corporation stock it held before the transaction (in other words, not the fictional stock). The following example illustrates this point:
* Domestic corporation (USP) wholly owns foreign corporations F1 and F2. The F1 stock has a basis of $0 and a fair market value of $100. The F2 stock has a basis of $100 and a fair market value of $100. Neither F1 nor F2 has current or accumulated earnings and profits.
* In a section 304(a)(1) transaction, USP sells the F1 stock to F2 for $100 cash. Under section 304(a)(1), USP and F2 are treated as if (i) USP transferred the F1 stock to F2 in exchange for fictional F2 stock in a section 351 transfer, and then (ii) F2 distributed the $100 cash to USP in redemption of the fictional stock.
* Because the redemption of the fictional stock would be described in section 302(d)—and therefore subject to section 301—the commentators asserted that USP may not recognise gain under section 301(c)(3) on the cash distribution if USP could reduce its basis under section 301(c)(2) in both the fictional stock and the actual F2 stock that it held prior to the transaction. In that case, USP would recognise no gain on the transaction.
The preamble to the 2006 regulations explained, however, that in this situation, the transferor can only recover its basis in the fictional stock of the acquiring corporation. Thus, since USP did not have any basis in the fictional F2 stock, it would recognise $100 gain under section 301(c)(3) (the built-in gain on the F1 stock).
In January 2009, however, the IRS issued proposed basis recovery regulations (REG-143686-07) that generally allow a transferor in a section 304(a)(1) transaction to recover basis in both fictional stock as well as the actual common shares that the transferor held before the transaction. Consequently, to prevent taxpayers from using this change to avoid recognising gain in cross-chain stock sales, Treasury and the IRS also issued new temporary section 367 regulations.
Under the temporary regulations, if, in the context of a section 304(a)(1) exchange, the deemed distribution reduces a transferor's basis in the acquiring corporation stock that it actually held before the section 304(a)(1) transaction, then sections 367(a) and (b) will turn back on, as appropriate, to potentially require the transferor to recognise gain or have a deemed dividend inclusion on the deemed section 351 exchange. Thus, the regulations preserve the result that Treasury and the IRS intended to achieve in the example discussed above.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
Sean Foley (sffoley@kpmg.com)
Washington, DC