International Tax Alert - December 2016

December 2016

New Guidance on Triangular Reorganizations Involving Foreign Corporations 


Summary

In Notice 2016-73 (the “Notice”), the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) announced their intention to issue regulations under Internal Revenue Code (“IRC”) Section 367 to modify the rules relating to the treatment of property used to acquire parent stock or securities in certain triangular reorganizations involving one or more foreign corporations, and the consequences to persons that receive parent stock or securities pursuant to such triangular reorganizations. The Notice also announced the intention to issue regulations under IRC Section 367 to modify the amount of income inclusion required in certain inbound non-recognition transactions.


Details

Treasury Regulation Section 1.367(b)-10 (the “Killer B regulations”) applies to certain triangular reorganizations in which a subsidiary corporation acquires stock or securities of its parent corporation in exchange for property and then exchanges the acquired parent stock or securities for stock, securities or property of a target corporation. Assuming no exception applies and the Killer B regulations apply to the transaction, the parent corporation is generally treated as receiving a distribution from the subsidiary corporation typically equal to the amount of the property transferred by the subsidiary corporation to the parent corporation to acquire the parent corporation stock and securities. This deemed distribution generally is treated as a separate transaction that occurs before the acquisition of parent corporation stock (special rules apply if the parent corporation does not control the subsidiary corporation at the time of the transfer).
 
  1. General Rules
The “367(a) priority rule” in Treasury Regulation Section 1.367(b)-10(a)(2)(iii) provides that the Killer B regulations generally do not apply to the transaction if, in an exchange under IRC Section 354 or 356, one or more U.S. persons exchange stock or securities of the target corporation and the amount of gain in the target corporation stock or securities recognized by such U.S. persons under IRC Section 367(a)(1) is equal to or greater than the sum of the amount of the deemed distribution that would be treated by the parent corporation as a dividend under IRC Section 301(c)(1) and the amount of such deemed distribution that would be treated by the parent corporation as gain from the sale or exchange of property under IRC Section 301(c)(3) (together, referred to as “Section 367(b) income”) if the Killer B regulations otherwise would apply to the transaction.

The “367(b) priority rule” in Treasury Regulation Section 1.367(a)-3(a)(2)(iv) provides a similar priority rule that turns off the application of IRC Section 367(a) to an exchange under IRC Section 354 or 356 that occurs in connection with a transaction if the amount of gain that would otherwise be recognized under IRC Section 367(a)(1) (without regards to any exceptions thereto) is less than the amount of the Section 367(b) income recognized under the Killer B regulations.

The Killer B regulations also include an anti-abuse rule that applies if a transaction is engaged in with a view to avoid the purpose of the Killer B regulations.

Treasury and the Service also issued Notice 2014-32 (2014-20 IRB 1006) on April 25, 2014, which announced the intention to issues regulations modifying and clarifying the Killer B regulations. Notice 2014-32 provided, among other items, that Section 367(b) income only includes a IRC Section 301(c)(1) dividend or IRC Section 301(c)(3) gain that would arise if the Killer B regulations applied to the transaction only to the extent such dividend income or gain would be subject to U.S. tax or would give rise to an income inclusion as Subpart F income that would be subject to U.S. tax. In addition, Notice 2014-32 also addressed certain aspects of the anti-abuse rule in the Killer B regulations.
 
  1. Changes Made by the Notice
The Notice states that Treasury and the Service are aware that certain taxpayers are engaging in transactions to repatriate earnings and basis of foreign corporations without incurring U.S. income tax by exploiting the 367(a) priority rule. The Notice provides examples of the transactions at issue.

To address these concerns, the Notice provides that the regulations will modify the 367(a) priority rule to apply only when the target corporation is a domestic corporation. Accordingly, when the target corporation is a foreign corporation, the Killer B regulations, as modified by the rules described in the Notice, will apply to the transaction assuming no other exception applies.

The Notice also provides that the regulations will modify the 367(b) priority rule to provide that, in an exchange under IRC Section 354 or 356 that occurs in connection with a transaction described in the Killer B regulations, to the extent one or more U.S. persons exchange stock or securities of a foreign corporation for stock or securities of the parent corporation acquired by the subsidiary corporation in exchange for property (as defined in Treasury Regulation Section 1.367(b)-10(a)(3)(ii), as modified by the regulations described in the Notice), IRC Section 367(a)(1) will not apply to such U.S. persons with respect to the exchange of the stock or securities of the foreign corporation.[1] Rather, the exchange will be subject to Treasury Regulation Sections 1.367(b)-4 and 1.367(b)-4T, as modified by the regulations described in the Notice.

The Section 367(b) priority rule, as modified by Notice 2014-32, will continue to apply when the target corporation is a domestic corporation. In addition, IRC Section 367(a) will apply to the exchange of stock or securities of a foreign corporation to the extent such target stock or securities are exchanged for parent corporation stock or securities that are not acquired by the subsidiary corporation for property (as defined in Treasury Regulation Section 1.367(b)-10(a)(3)(ii), as modified by the Notice) in the transaction.

In addition, Treasury and the Service announced in the Notice their intention to modify Treasury Regulation Sections 1.367(b)-4 and 1.367(b)-4T to provide that, in an exchange under Section 354 or 356 that occurs in connection with a transaction described in the Killer B regulations, to the extent an exchanging shareholder exchanges stock or securities of a foreign acquired corporation for parent corporation stock acquired by the subsidiary corporation in exchange for property (as defined in Treasury Regulation Section 1.367(b)-10(a)(3)(ii), as modified by the regulations described in the Notice) in the transaction, then such shareholder must (1) include in income as a deemed dividend the section 1248 amount attributable to the stock of the foreign acquired corporation that it exchanges and (2) after taking into account the increase in basis provided in Treasury Regulation Section 1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), recognize all realized gain with respect to the stock or securities of the foreign acquired corporation exchanged that would not otherwise be recognized.[2]

For purposes of the preceding paragraphs, an exchanging shareholder is a U.S. person or a foreign person that exchanges stock of a foreign acquired corporation in a prescribed exchange, regardless of whether such U.S. person is a Section 1248 shareholder or such foreign person is a foreign corporation in which a U.S. person is a Section 1248 shareholder.
 
  1. All Earnings and Profits Amount
The Notice also provides that Treasury and the Service intend to modify how the “all earnings and profits amount” in Treasury Regulation Section 1.367(b)-2(d) which requires certain U.S. shareholders to recognize taxable income in certain inbound transactions (e.g., a IRC Section 332 liquidation or a IRC Section 368 asset reorganization), is calculated. These complex rules will generally apply if there is “excess asset basis” with respect to a foreign acquired corporation.[3]

In addition, the regulations to be issued under Treasury Regulation Section 1.367(b)-3 will include an anti-abuse rule to address transactions engaged in with a view to avoid the purposes of the new rules regarding the all earnings and profits amount described in the Notice.

The regulations detailed in the Notice are intended to apply to transactions completed on or after December 2, 2016, and to any inbound transaction treated as completed before December 2, 2016, as a result of an entity classification election that is filed on or after December 2, 2016. No inference is intended regarding the treatment of the repatriation transactions at issue detailed in the Notice under current law (e.g., these transactions are currently subject to challenge under the anti-abuse rule in Treasury Regulation Section 1.367(b)-10).


BDO Insights

BDO can assist our clients with understanding the complexities of the Killer B regulations and also advise on how the rules described in the Notice may impact certain repatriation transactions.

 

For more information, please contact one of the following practice leaders:
 
Robert Pedersen
Partner and International Tax Practice Leader
         Chip Morgan        Partner 

 
Joe Calianno
Partner and International Tax Technical Practice Leader 
  Brad Rode
Partner 
 

 
William F. Roth III
Partner, National Tax Office
  Jerry Seade
Principal 

 
Scott Hendon
Partner 
  Monika Loving
Partner 

 
Annie Lee
Partner
  Sean Dokko
Senior Manager 
 
[1] The Notice provides that the definition of property provided in Treasury Regulation Section 1.367(b)-10(a)(3)(ii) will be modified to include subsidiary stock that is non-qualified preferred stock (as defined in IRC Section 351(g)(2)),
[2] For this purpose, a “foreign acquired corporation” refers to a foreign corporation whose stock or assets are acquired by another foreign corporation in a IRC Section 351 transaction or a IRC Section 368(a)(1) reorganization.
[3] The term “excess asset basis” means, with respect to a foreign acquired corporation, the amount of which the inside asset basis of the foreign acquired corporation exceeds the sum of (1) the earnings and profits of the foreign acquired corporation attributable to the outstanding stock of the foreign acquired corporation, (2) the aggregate basis in the outstanding stock of the foreign acquired corporation determined immediately before the inbound transaction and without regard to any basis increase described in Treasury Regulation Section 1.367(b)-2(e)(3)(ii) resulting from such inbound transaction, and (3) the aggregate amount of liabilities of the foreign acquired corporation that are assumed by the domestic acquiring corporation in the inbound transaction determined under the principles of IRC Section 357(d). The amount of such increase will be equal to the specified earnings with regards to such stock (if any). The Notice provides details on the calculation of specified earnings.