United States Tax Alert - 14 February 2012
IRS amends application of Section 367 to Section 304 transactions
By Tim Tuerff, Irwin Halpern, Chris Trump and Timothy Messenger
On 10 February 2012, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued Notice 2012-15, describing future amendments to the regulations under §367(a)1 and (b) of the U.S. Internal Revenue Code applicable to transfers of stock to foreign corporations in exchange for property under §304 (redemptions through use of related corporations). The amendments apply to transfers occurring on or after February 10, 2012.
The Notice provides that, contrary to the rules set forth in the 20062 and 2009 regulations,3 §367(a) and (b) shall apply to the outbound transfer of foreign or domestic stock in a §304 transaction.4
In particular, the Notice provides that, if a U.S. person is treated as transferring stock of a domestic or foreign corporation to a foreign corporation (the "foreign acquiring corporation") in a deemed §351 exchange (transfer to a corporation controlled by the transferor) in a §304 transaction, the transfer is subject to §367(a) and the regulations thereunder, including the exceptions described in Treas. Reg. §1.367(a)-3(b)(1) and (c)(1), as applicable (relating to entering into a gain recognition agreement (GRA) to avoid recognizing gain under §367(a)(1)). Thus, a transferor in a §304 transaction that is a U.S. person may, in certain cases, enter into a GRA pursuant to Treas. Reg. §1.367(a)-8 to avoid the recognition of gain under §367(a)(1). However, if the U.S. person enters into a GRA, the deemed redemption of the stock of the foreign acquiring corporation issued pursuant to §304(a)(1) constitutes a disposition of the transferee foreign corporation stock under Treas. Reg. §1.367(a)-8. Consistent with the redemption rules provided in Treas. Reg. §1.367(a)-8(n), the redemption will not be treated as a triggering event if the U.S. person that transfers the stock in the deemed §351 exchange in a §304 transaction enters into a new GRA that includes appropriate provisions to account for the redemption, provided the principles of Treas. Reg. §1.367(a)-8(k)(14)(ii) and (iii) are satisfied (relating to retention of ownership and entering into a new GRA).
Additionally, the Notice provides that, in applying §367(b) to a deemed §351 exchange occurring in a §304 transaction, the taxpayer must test to see if the §304 transaction results in the loss of status as a §1248 shareholder. If so, Treas. Reg. §1.367(b)-4(b)(1)(i) requires the exchanging shareholder to include in income as a deemed dividend the §1248 amount attributable to the foreign stock that is transferred.
1 Under the general rule of §367(a), a foreign corporation is deemed not to be a corporation in certain tax-free transactions requiring an exchange between corporations. Section 367(b) and regulations thereunder override certain tax-free transactions to the extent necessary to prevent the avoidance of U.S. Federal income tax by U.S. shareholders on certain inbound and foreign-to-foreign transactions.
2 Treas. Reg. §§1.367(a)-3, 1.367(b)-4T, 1.367(b)-6, T.D. 9250, 2006-1 C.B. 588.
3 Treas. Reg. §§1.367(a)-9T, 1.367(b)-4T(e), 1.1248-1T, T.D. 9444, 2009-1 C.B. 603.
4 As the Notice states: "the IRS and the Treasury Department believe that the amount of income taken into account as a result of a section 304 distribution generally should not affect the application of section 367 to the deemed section 351 exchange [in a section 304 transaction]. Furthermore, in the case of a transfer of stock by a U.S. person to a foreign corporation, the revised GRA regulations should substantially reduce the complexity and uncertainty resulting from the filing of a GRA in connection with a deemed section 351."