patrickbland, jd, mba, llm

Intro to §367

Transfers of property By and To Foreign Corporations

1. A general rule of taxation is that a sale or exchange of property by a taxpayer is a taxable event. There are exceptions to IRC § 1001 for exchanges made when a corporation is formed (IRC § 351), reorganized (IRC § 354, IRC § 355, or IRC § 361), or liquidated (IRC § 332). However, if these provisions which provide for exceptions to IRC § 1001 were not modified, a U.S. person would gain U.S. tax advantages when the controlled foreign corporations is formed, reorganized, or liquidated.
   
   

Background

1. Section 367 was enacted to prevent use of the non-recognition provisions in sub-chapter C to avoid taxation on the transfer of property by and to controlled foreign corporations in transactions which would otherwise be covered by those non-recognition provisions. It does so by providing, in the situations that it covers, that the entity will not be considered to be a corporation for the purposes of IRC §§ 332, 351, 354, 356, and 361. Since the provisions of these sections are available only to corporations, the non-recognition provisions would not apply. IRC § 367 has two broad purposes:
   1. To prevent the tax free removal of appreciated stock, assets, or other property from U.S. tax jurisdiction, and
   2. To preserve the ability to impose U.S. income tax currently, or at a later time, on the accumulated E&P of certain foreign corporations.

Section 367(a)

1. IRC section 367(a) is intended to prevent U.S. persons from avoiding U.S. tax by transferring appreciated property to a foreign corporation in a tax-free organization or reorganization, and then selling the appreciated property outside the tax jurisdiction of the United States.
2. IRC section 367(a) generally treats a transfer of property (including stock) by a U.S. person to a foreign corporation (an "outbound transfer" ) in connection with an exchange described in sections 351, 354, 356 or 361 as a taxable exchange unless the transfer qualifies for an exception to this general rule. (An outbound transfer of an intangible asset is subject to the rules of IRC section 367(d) and not IRC section 367(a).)
3. Under IRC section 367(a)(3), an outbound transfer of assets (other than stock) qualifies for an exception from taxation if the assets are to be used in the active conduct of a trade or business outside the United States. Limitations on the IRC section 367(a)(3) exception are contained in Regs. 1.367(a) –4T through –6T.
4. Pursuant to IRC section 367(a)(2), Reg. 1.367(a)–3T(b) contains exceptions to the general rule of taxability for certain outbound transfers of stock or securities. Section 1.367(a)-3(b) deals with such exceptions where transfers of foreign stock are involved and section 1.367(a)-3(c) relates to transfers of domestic stock. Section 1.367(a)-3(d) deals with indirect transfers of either foreign or domestic stock.
5. If the outbound transfer is described in IRC section 361(a) or (b) (non-recognition for transfer by a corporation that is a party to a reorganization of property for stock or securities in another corporation a party to a reorganization), IRC section 367(a)(5) limits the exceptions to taxation that may otherwise be applicable under IRC section 367(a)(2) or (3).
6. A taxpayer that makes an outbound transfer that is subject to IRC section 367(a) may be required to report the transfer under IRC section 6038B. Failure to report the transfer may subject the taxpayer to penalties and an extended statute of limitations under IRC section 6501(c)(8). [See Reg. 1.6038B–1T.]

Section 367(b)

1. IRC section 367(b) is principally concerned with monitoring the earnings and profits of a controlled foreign corporation.
2. IRC section 367(b) provides that in the case of any exchange described in IRC sections 332, 351, 354, 355, 356 or 361 in connection with which there is no transfer of property described in IRC section 367(a)(1), a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes.
3. If a transaction described in IRC sections 332, 351, 354, 355, 356 or 361 affects the potential U.S. taxation of the earnings and profits of a controlled foreign corporation, consider whether the regulations and other authorities under IRC section 367(b) apply to require current taxation.
4. In addition to preserving section 1248 amounts, section 367(b) applies in situations in which the foreign corporation involved in the liquidation / reorganization is not a CFC. See e.g., 1.367(b)-3, specifically subparagraphs (b)(2) and (b)(3)(ii), Example 6. Also, see section 1.367(b)-5 for section 367(b) rules that apply to section 355 distributions. Finally, there are proposed regulations under section 367(b) addressing the carryover of earnings and profits and taxes.

Section 367(d)

1. If a U.S. person transfers intangible property to a foreign corporation in an exchange described in IRC section 351 or 361, the U.S. person is treated as transferring the intangible in exchange for contingent payments (for a period of no more than 20 years) that must be commensurate with the income attributable to the intangible. See 1.367(d)-1T.
2. Prior to the Taxpayer Relief Act of 1997, the contingent payment (royalty) income included by the U.S. transferrer was a U.S. source income under IRC section 367(d)(2)(C). A transfer of an intangible after August 5,1997 (the date of enactment of the Taxpayer Relief Act of 1997) is governed by the generally applicable sourcing rules.
3. For rules regarding the coordination of IRC section 367(d) and IRC section 482, see Reg. 1.376(d)–1T(g)(4).
4. A taxpayer that is subject to IRC section 367(d) with respect to a transfer of intangible property must report the transfer in accordance with IRC section 6038B, or be subject to penalties and an extended statute of limitations under IRC section 6501(c)(8).

Section 367(e)

1. If a domestic corporation distributes the stock of a foreign corporation to a foreign person in a distribution described in IRC section 355, the distribution is taxable under IRC section 367(e)(1).
2. If a domestic corporation distributes the stock of a domestic corporation to a foreign person in a distribution described in IRC section 355, the distribution is non-taxable. IRC section 1.367(e)-1(c).
3. If a U.S. corporation is liquidated into a foreign parent corporation under IRC section 332, IRC section 367(e)(2) provides in effect that, except as provided by regulations, the U.S. corporation will be treated as if it sold its assets in a taxable transaction (IRC section 337(a) and (b)(1) shall not apply). Reg. 1.367(e)–2(b)(2) contains exceptions to the general recognition rule contained in IRC section 367(e)(2).

Steps to Consider When you Analyze an IRC Section 367 Transaction

1. Step 1. Determine whether the transaction involves a:
   1. Corporate Formation pursuant to IRC § 351,
   2. Corporate Reorganization pursuant to IRC §§ 354, 355, 356, or 361,
   3. Corporate Liquidation pursuant to sections§§ 331 or 332, or
   4. Sale of stock.

Note:

If a U.S. person transferred property to a foreign partnership, estate or trust, then see IRC §§ 684, 721, and 1035(c).

1. Step 2. Analyze the above by listing the exchanges made in the corporate formations, reorganization, liquidation or sale.
   1. List the entity, classify the entity, characterize the transaction (exchange, distribution, etc.), and identify the applicable Code sections.
   2. DO NOT CONSIDER IRC §§ 367 OR 1248 AT THIS POINT.
   3. When you have a liquidation or reorganization prepare a before and an after organization chart.
2. . Classify each entity involved in each exchange in step 2 into the following:
   1. U.S. person, not a corporation,
   2. U.S. Corporation
   3. FC, not a CFC, or
   4. CFC

Note:

Use the status at the start of the exchange

1. Note the date of the transaction
2. Determine whether the exchanges listed in Step 2 and made by the entities in Step 3 are modified by IRC §§ 367 or 1248. Do the exchanges involve
   1. U.S. person transferring property to a foreign corporation?
   2. Foreign corporation transferring property to a foreign corporation?
   3. Foreign corporation transferring property to U.S. person? Or
   4. Sale of Stock?

If the answer to any of the above is yes, you will have to determine whether regulations under IRC §§ 367 and 1248 apply to the exchange(s) or sale. Also, note that when stock is transferred by a U.S. person, the taxpayer can elect to apply the final regulations prior to the normal effective date. [See Treas. Reg. § 1.367(a)-3(e)(2) Election.]

Special Rules for Stock or Securities of Corporations

• Example 1: DC1, a US corporation, owns 36% of the stock of FS, a foreign corporation, and DC2, another US corporation that is NOT related to DC1, owns 4% of the stock of FS; the other 60% of FS stock is owned by foreign persons unrelated to DC1 or DC2. As part of a plan of reorganization, DC1 exchanges its 36% stock interest in FS and DC2 exchanges its 4% stock interest in FS for stock of FC, another foreign corporation unrelated to DC1 or DC2. After the reorganization exchange, DC1 owns 9% of FC and DC2 owns 1% of FC. This reorganization transaction qualifies as a B reorganization. §367(a)(1) will not apply to override nonrecognition treatment for DC1 and DC2 if the requirements of §1.367(a)-3(b) are met. Thus, §367(a)(1) will not trigger gain recognition and DC1 will obtain nonrecognition treatment under §354 if it enters into a 5 year, gain recognition agreement with the IRS. Because DC2 owns less than 5% of both the total voting power and value of the stock of FC after the exchange, DC2 will obtain nonrecognition treatment under §354 without having to file a gain recognition agreement.
  
   
• Example 2: DC, a US corporation, owns all of the stock of DS, a US corporation. FC is a foreign corporation unrelated to DC. Pursuant to a plan of reorganization, DC transfers all of the DS stock to FC in exchange for FC stock. This exchange qualifies as a B reorganization.
  
  If, immediately after the exchange, DC owns more than 50% of the stock of FC, the exception in §1.367(a)-3(c) will not apply. Accordingly, §367(a)(1) will override §354 and require DC to recognize its gain on the transfer of the DS stock to FC.
  
  If, immediately after the exchange, DC owns 50% or less of the total voting power and value of the FC stock, the FMV of the FC is equal to or greater than the FMV of DS at the time of transfer and FC otherwise meets the active conduct of a trade or business requirements and the other requirements discussed above, the exception in §1.367(a)-3(c) will apply provided that DC enters into a 5 year gain-recognition agreement. If so, DC will be able to obtain nonrecognition treatment under §354 on the exchange.
  
  If DC owns less than 5% of both the total voting power and value of FC immediately after the exchange, the exception in §1.367(a)-3(c) will apply and DC will not recognize its gain on the transfer of the DS stock to FC without having to enter into a 5 year, gain-recognition agreement. 

Class Notes:

• 367 is all about Jurisdiction… when assets are in US corporation, US has taxing jurisdiction over the gain/income created by assets… when assets end up in FC, not taxable under 881 unless it’s ECI w/ a USTorB.
• 367 didn’t exist, and SubF doesn’t other wise reach income… Subchapter C effectively allows assets to move outside of US w/o recognition of gain… the international rules 881/882 don’t tax the gain, and SubC 332 allows gain to come back in free of US tax, never subjecting it to US tax
• Under specific sections, not all nonrecognition exchanges, certain tainted property automatically results in gain recognition.
• Basic rule, nonrecognition overridden, and if property used in active trade or business, then nonrecognition applies again
• 367(a) only applies to a US transferor
• Gain Recognition Agreement – agreement b/t US party and IRS to recognize gain… see 1.367(a)-3(b) regs
• REREAD THIS ASSIGNMENT ABOUT DISPOSITION OF SECURITIES, ETC.

Problems at Page 777

• Automatically Tainted Assets under §367—(1) FACTS: Analytical Equipment Company (“AEC”) is a US corporation engaged in the manufacture and sale of office automation systems. If AEC transfers the following assets to a wholly owned subsidiary organized under the laws of the Cayman Islands (“AEC Cayman”), in exchange for all of the subsidiary’s stock, which of the assets will be automatically tainted under §367(a)?

1. (a) 500,000 Cayman Island Dollars

• Tainted—but exception in §1.367(a)-5T(d)(2) for property denominated in a foreign currency of the country of the transferee foreign corporation that was acquired in the ordinary course of the transferor’s business which will be carried on by the transferee.
• Depreciated Cayman Currency? NO LOSS IS RECOGNIZED!
• What if bought currency in 2 different times – one time where basis is less than value and one case where basis is more than the value and they transferred it all… CAN NET LOSSES AGAINST GAINS! See 1.367(a)-5T(d)(3)

1. (b) Accounts Receivable from Cayman Customers Express in Cayman Dollars

• Tainted

1. (c) 10,000 Desktop Systems (for immediate sale)

• Tainted – inventory
  • Not tainted if the property, at the time of the transfer, it is reasonable to believe that, in the foreseeable future, the transferee will sell or otherwise dispose of any material portion of the transferred property other than in the ordinary course of business.

1. (d) 1,000 Copiers (to be leased to European Customers)

• Tainted – Transferor is the lessor at the time of the transfer, exception is the transferee is the lessee
  • §1.367(a)-4T(c)(1) treats tangible property transferred to a foreign corporation that the corporation will lease to others as an active conduct of a trade or business outside of the United States if the following 3 requirements met:

1. (1) The transferee’s leasing of the property constitutes the active conduct of a leasing business;
2. (2) The lessee of the property is not expected to, and does not, use the property in the United States; AND
3. (3) The transferee has need for substantial investment in assets of the type transferred.
4. Note: for the transferee’s leasing to constitute the active conduct of a leasing business, the FC’s employees must perform substantial marketing, customer service, repair and maintenance and other substantial operational activities with respect to the transferred property outside the United States.
5. (e) All of AEC’s interest in “Datamatitre,” a word processing program designed for European users; or

• Tainted – intellectual property w/ zero basis

1. (f) AEC’s just-purchased warehouse in the Cayman Islands.

• Not tainted – property not used in the United States
• Transfer of Intangibles and Disposition of Stock—(2) FACTS: Assume that Datamaitre generates revenue of $5m per year in the hands of the new Cayman subsidiary and $500k per year in an amount that reasonably reflects the amount AEC would have received as an arm’s length fair market royalty had AEC licensed Datamaitre to AEC Cayman rather than transferred it outright.

1. (a) How much must AEC include in income to reflect the transfer to Datamaitre to AEC Cayman?

• Cayman includes $500k in income each year pursuant to §367(d)(2)(A). This amount is subject to periodic adjustment to make sure it’s commensurate with income.
• §1.367(d)-1T(c)(3)—the transferor must continue to recognize the constructive royalties over the useful life of the intangible, but not in excess of 20 years.
• §1.367(d)-1T(c)(1)—deemed royalty payments are treated as ordinary income to the US transferor

1. (b) What if, after 3 years, AEC Cayman sells Datamaitre to an unrelated Jamaican Corporation?

• 1.367(d)-1T(f)—if, during the useful life of the intangible, the transferee foreign corporation disposes of the intangible to an unrelated person, the U.S. transferor is required to include in gross income the difference between the amount realized on the disposition of the intangible and the adjusted basis of the intangible at the time of original transfer.
• AEC is required to recognize gain (gain realized on disposition over AEC’s tax basis at time of original transfer). Reg. §1.367(d)-1T(f)(1).

1. (c) Alternatively, what if, after 3 years, AEC sells all of its stock in AEC Cayman to an unrelated Jamaican Corporation? What is the source of the income to AEC in each case?

• §1.367(d)-1T(d) – disposition by the U.S. transferor of the transferee foreign corporation’s stock to an unrelated person results in similar treatment as selling intangible itself (i.e., the US transferor includes in gross income the difference between the FMV of the intangible on date of sale of the stock and the transferor’s [AEC’s] original basis in the transferred intangible). Any amount of gain taxed on this deemed sale of the intangible reduces the amount of gain taxable to the US transferor on the sale of the stock. §1.367(d)-1T(d).
• AEC will be treated as simultaneously selling the intangible property.
• Source – foreign source (§865)
  • Constructive royalty payments will be foreign-source income to the extent that the intangible is used outside the US. §865(d)(1)(B).
  • (skipped) Foreign Branch Loss Recapture Rule—(3) FACTS: Suppose that AEC had operated in the Cayman Islands as a branch for 3 years before the incorporation of AEC Cayman with the following results:
    
    Year                        Branch Net Income
    1                        ($1,000)
    2                        ($2,000)
    3                        $500
    
    On December 31 of Year 3, AEC’s Cayman branch transferred to the new Cayman subsidiary assets used in the active conduct of a trade or business and not otherwise tainted under §367(a)(3), the FMV of which exceeded their basis by $2,000, and assets used in the active conduct of a trade or business but tainted under §367(a)(3)(B), the FMV of which exceeded their basis by $500. Assuming that AEC previously deducted the branch losses in years 1 and 2, what amount must AEC include in gross income under the branch loss recapture rule?

1. Cumulative Losses = $3,000 (1k year 1 + 2k year 2)
2. Year 3 Net Income = $500
3. Tentative Amount of Previously Deducted Branch Losses Subject to Recapture = $2,500 ($3,000 - $500)
4. $2,500 reduced by $500 taxable gain recognized on the tainted assets under §367(a)(1) and §367(a)(3)(B).
5. Thus, $2,000 branch loss recapture treated as foreign ordinary income. §367(a)(3)(C).

• (skipped) Foreign Branch Loss Recapture Rule—(4) FACTS: If the facts are the same as in Problem 3, except that the realized gain on the transfer of the untainted assets is only $1,000, what amount must AEC include in its gross income?

1. Branch loss recapture is limited to $1,000 rather than $2,0000 for untainted assets.
2. The $500 gain on the transferred tainted assets under §367(a)(3)(B).

• (skipped) §904(f)(3)—(5) FACTS: Assume that the facts are the same as in Problem 3, except that AEC establishes its branch in the Cayman Islands on 12/31 of Year 4, and that the branch breaks even that year. If AEC derives $1,000 of income from foreign sources other than through the Cayman branch and earns $2,000 in U.S. source income in year 4, how much of the branch loss is subject to recapture?

1. §904(f)(3) re transformation of foreign source income to domestic source income upon transfer of appreciated assets to the newly incorporated branch
2. $1,000 of year 4 foreign source income TREATED AS US SOURCE INCOME to recapture $1,000 of the overall foreign loss accumulated through year 3
3. Remaining amount to recapture is $1,000
4. Amount of branch loss to be recaptured would be $1,000 of the previously deducted branch loss, recaptured under §367(a)(3)(C).

• (skipped) Recapture Ordering Rules—(6) FACTS: Assume that AEC’s Branch in the Cayman has $2k in cumulative previously deducted losses at the time of its incorporation as a subsidiary. The branch transfers to the new subisidary assets with a FMV in excess of their basis of $2k. These assets include Datamaitre, the word processing program, which ahs a FMV value in excess of basis of $1k and which would give rise to constructive payments under §367(d) of $500 per year.

1. (a) How much branch loss recapture gain will be recognized? How much?

• The §904(f)(3) recapture is $1,000 – ½ the potential branch loss amount. Treated as US source income.

1. (b) How much income must AEC recognize under §367(d) during the first 2 years of the newly incorporated subsidiary’s operations?

• §904(f)(3) recapture amount is credited against payments that AEC-Cayman is deemed to make to AEC under §367(d) in the first 2 years of the newly incorporated subsidiary’s operations.

NEXT CLASS:

10125 – 10155, problems at 10155

Class Notes:

• Inverse of 367(a) – 367(b) says FC presumed to be FC, and therefore the nonrecognition rule will apply unless otherwise provided in the regulations

Generally

• General Rule w/r/t Nonoutbound Transfers—nonrecognition of gain, subject to the exceptions set forth in the regulations issued under §367(b).
• §367(b) Regulations—

1. The regs deal with the sale/exchange of stock or securities in a foreign corporation by a US person, including providing for recognition of gain or inclusion of amounts in gross income as a dividend, or both, or deferral of gain or other amounts for taxation at a later date. In addition, the regs are to provide for adjustments in E&P and basis of stock, securities, and assets.
2. Basic Thrust—implement taxation under §1248 in transactions that would otherwise be exempt from tax under a tax-free exchange provision.
3. The regs require current taxation as an ordinary income deemed dividend of amounts of earnings of a CFC that might otherwise escape US tax and permit deferral of US tax on amounts of income or gain associated w/ a CFC that remain w/in the taxing jurisdiction of the US.
4. Generally only impose tax when a CFC is involved in a transaction that would otherwise qualify as a tax-free exchange. If an exchange described in 332, 351, 354, 355, 356, or 361 involves only foreign corporations that ARE NOT CFCs, no gain would be recognized.

• Purpose of §367(b)—prevent the avoidance of US tax that can arise when SubC provisions apply to transactions involving foreign corporations. The potential for tax avoidance arises b/c of differences b/t the manner in which the US taxes foreign corporations and their shareholders and the manner in which the US taxes domestic corporations and their US shareholders.
• Purpose of §1248—Any gain on the subsequent sale of the foreign corporation stock is treated as dividend income to any U.S. shareholder who owns 10 percent or more of the stock at any time within five years before the sale of the stock. Gains from the sale of stock by shareholders who do not directly or indirectly own 10 percent of the company are eligible to be treated as a long-term capital gain rather than being taxed as ordinary income. For 10 percent or greater shareholders, it does not matter if the earnings of the foreign corporation are distributed as dividends or if the stock is sold at a gain.
• US SH of CFC exchanges stock for US SH CFC stock—In general, if a US SH of CFC exchanges, in a nonoutbound transaction, shares of that corporation for shares of another CFC as to which the SH is also a US SH, as defined in §1248(a)(2), no gain is recognized. §1.367(b)-4(b)

1. Recognition of gain and §1248 dividend income can be postponed until the US shareholder disposes of stock of the CFC received in the exchange.
2. Recognition of dividend income under §1248 is deferred through the mechanism of attributing appropriate amounts of the E&P of the CFC, the share sof which are transferred, to the stock the shareholder receives in the transferee CFC.

• US SH of CFC exchanges stock for NON US SH CFC stock—If the exchanging SH was a US SH of a CFC, the stock of which was exchanged, but is NOT a US SH of the transferee corporation(i.e., b/c the exchanging SH receives stock of a US corporation or stock of a foreign corp that is NOT a CFC or as to which it is not a US SH), it must pay its §1248 liability. This means that the exchanging SH must include in gross income, as a deemed dividend, the §1248 amount attributable to the stock exchanged TO THE EXTENT that the FMV of the stock exchanged EXCEEDS its adjusted basis. Any additional gain will be treated as gain from the sale or exchange of the stock. §1.367(b)-4(b).
• Liquidation of a FC controlled (w/in meaning of §1504(a)(2)) by a US corporation—the US corp must include in income as a deemed dividend the “all earnings and profits amount” attributable to its stock in the foreign sub. §1.367(b)-3(b)(3).
• “§1248 Shareholder”—

1. 2000 final regs changed the term in order to avoid confusion between it and US SH defined in §951(b).
2. “10% US Shareholder” refers to U.S. shareholder described in 951(b)

Concurrent Application of §367(a) and §367(b)

• May occur when:

1. US shareholder exchanges stock of a FC (foreign acquired corporation) for stock of another foreign corporation (foreign acquiring corporation). §1.367(a)-3(b)(1).
2. An acquiring corporation (foreign or domestic) acquires the assets of a foreign acquired corporation, and the US shareholder exchanges stock of the foreign acquired corporation for stock of the foreign parent of the acquiring corporation in a triangular merger.

• Subject to 367(a)—
  • The US persons’ exchange of stock of the foreign acquired corporation for stock of either the foreign acquiring corporation or the foreign parent is subject to 367(a). If the exchanging US SH owns 5% or more (vote or value) of the stock of the foreign acquiring corporation or the foreign parent immediately after the exchange, the shareholder recognizes gain, if any, under 367(a), unless the shareholder enters into a gain recognition agreement in §1.367(a)-8. If the exchange shareholder is NOT a 5% shareholder, then the exchanging shareholder DOES NOT recognize gain, if any, on the exchange.
  • Subject to 367(b)—
    • If the exchanging US shareholder is a §1248 shareholder of the foreign acquired corporation, and the stock of the foreign acquiring corporation (or its foreign parent corporation) is NOT stock in a corporation that is a CFC as to which the US shareholder is a §1248 shareholder immediately after the exchange, then exchanging shareholder must include in income the §1248 amount w/r/t the stock exchanged. §1.367(b)-4.
    • Alternatively, if a domestic acquiring corporation acquires the assets of a foreign acquired corporation, and the US shareholder exchanges stock of the foreign acquired corporation for stock of the foreign parent of the acquiring corporation in a triangular reorganization, then the exchanging shareholder must include in income the “all earnings and profits” amount with respect to the stock of the acquired corporation. §1.367(b)-3. Unlike the §1248 amount, the all earnings and profits amount is NOT limited by the shareholder’s gain inherent in the stock of the foreign acquired corporation.
    • See 2005 proposed regs that would modify concurrent application of 367(a) and (b) to transactions that require the inclusion in income of the “all earnings and profits amount” under §367(b).

Amounts of Attributed Earnings under §1248 and Treatment of Deemed Dividends

• 2 distinct amounts of attributed E&P that play a central role in the mechanisms adopted in the regulations under §367(b). They ensure that ordinary income, deemed dividend treatment will be imposed when a US shareholder disposes of stock in a CFC in a manner other than a tax-free exchange for stock of another CFC of which the shareholder is a US SH.
• 2 amounts:

1. 1) §1248 Amount = The §1248 amount is the previously untaxed post-1962 earnings that would be taxed as a dividend under §1248(a) if the stock had been sold. §1.367(b)-2(c)(1).
2. 2) “All Earnings and Profits Amount” = net positive E&P for all tax years which are attributable to the stock of the FC exchanged under §1248 and the underlying regs.

• The requirements of §1248 that are not relevant to determine a shareholder’s pro rata portion of E&P are ignored.
• The “all earnings and profits amount” is determined w/o regard to whether the exchanging shareholder owned a 10% or greater interest in the FC’s stock or whether the FC was a CFC at any time during the five prior years.
• The “all earnings and profits amount” is also determined w/o regard to whether the E&P of the FC were accumulated while the corporation was a CFC or in pre or post 1962 years. §1.367(b)-2(d).
• 367(b) Deemed Dividends vs. §1248 Deemed Dividends—

1. Amounts treated as dividends under §1.367(b)-2(e)(2) may constitute “qualified dividend income” for purposes of §1(h)(11) if the CFC is a “qualified foreign corporation” and other requirements of 1(h)(11) are met.
2. A §1248 deemed dividend is NOT treated as a dividend at the corporate level and DOES NOT reduce the corporation’s E&P. Instead, to prevent double taxation of the same amounts, §959 treats the shareholder-level inclusion under §1248 as previously taxed earnings and profits and, thus, not taxable on later distribution.

Rules for Nonoutbound Liquidations and Reorganizations

• Complete Liquidation of a Foreign Sub into US Parent under §332 OR US Corporation’s Acquisition of the Assets of a FC in a §368(a)(1) Transaction

1. The US corporation has to include in income as a deemed dividend the “all earnings and profits amount.” §1.367(b)-3(b)(3).
2. Under §334(b)(1), a domestic corporation’s basis in property distributed in a §332 liquidation of a foreign sub corporation is limited to the FMV value of the property distributed at the time of liquidation if the aggregate adjusted bases of such property distributed in liquidation would (but for this limitation) exceed the FMV of the property immediately after the liquidation.

• This was enacted b/c of concern that foreign-generated built-in losses were being imported in various corporation transactions and used to shelter US income from taxation.
• Complete Liquidation of Foreign Subsidiary into Foreign Parent

1. The distributee FC will be treated as a corporation for purposes of §332, 334(b)(1), and 381(a)(1). Thus, gain is NOT recognized. §1.367(b)-1(b)(1). See 10,105 for foreign subsidiary consequences.

• Acquisitive Reorganizations and §351 Exchanges

1. Policy considerations w/r/t inbound nonrec transactions is the appropriate carryover of attributes from foreign to domestic corporations.

• Shareholder level -- §367(b) regulations are concerned w/ the proper taxation of previously deferred E&P.
• Corporate level -- §367(b) regulations are concerned w/ both the extent and manner in which the tax attributes carry over in light of the variations b/t the Code’s taxation of foreign and domestic corporations.

1. §367(b) Exchange – encompasses the acquisition by a FC of the stock or assets of another foreign corporation in a reorg described in 368(a)(1)(A), (B), (C), (D), (E), (F), or (G) or a §351 exchange.
2. In general, exchanging shareholders in a 367(b) exchange have to include in income as a deemed dividend the §1248 amount w/r/t their stock if the transaction meets either of two tests. §1.367(b)-4(b).

• Test #1) met if a US person is a §1248 shareholder of the foreign acquired corporation immediately BEFORE the exchange, and DOES NOT receive stock in a CFC as to which the US person is a §1248 shareholder immediately AFTER the exchange
  • A “1248 Shareholder” is a US person who meets the ownership requirements of §1248(a)(2) or §1248(c)(2) w/r/t a foreign corporation. §1.367(b)-2(b).

1. §1248(a)(2) ownership requirements—such person owns 10% or more of the total combined voting power of ALL classes of stock entitled to vote of such foreign corporation at any time during the 5 year period ENDING on the date of the sale or exchange when such FC was a CFC within meaning of (1) 958(a) (direct and indirect ownership) or (2) 958(b) (constructive ownership)
2. §1248(c)(2) ownership requirements—

• Test #2) met if:
  • (1) the exchanging shareholder receives preferred stock in exchange for common stock;
  • (2) immediately after the exchange a US corporation owns a sufficient amount of the voting stock for the foreign acquiring corporation to qualify for the indirect foreign tax credit w/r/t a distribution from such corporation; and
  • (3) before the exchange the foreign acquired corporation and the foreign acquiring corporation were not members of the same affiliated group under §1504(a) (w/r regard to §1504(b)) based on more than 50%, rather than at least 80% ownership. §1.367(b)-4(b)(2).

1. If income is not required to be recognized under these rules, for purposes of applying §1248 or §367(b) to later exchanges, E&P to which the foreign acquiring corporation succeeds under §381 are deemed to have been accumulated by the acquiring corporation in the same years in which they were accumulated by the acquired corporation, and the exchanging shareholder is deemed to have owned stock in the acquiring corporation for the period during which it owned stock in the acquired corporation. §1.367(b)-4(d).

Problems age Page 786

1. (1) FACTS: American Holdings Inc, a US corporation, owns all of the outstanding stock of Pasta Spa, an Italian Corporation. Pasta has post-1986 undistributed earnings and profits of $1,000, has paid cumulative foreign taxes of $500 and has a basis of $200 in its assets. Pasta’s shares have unrealized appreciation (i.e., FMV in excess of basis) of $2,000 in American Holdings’ hands.
   1. a. If American liquidates Pasta into itself, what amount(s) must American include in its gross income?
      1. i. American must include in income as a deemed dividend the “all earnings and profits amount.” §1.367(b)-3(b)(3).
         1. 1. Would include $1,000 of income as a deemed dividend from Pasta.
         2. 2. DC takes a $200 basis in Pasta’s assets.
         3. 3. Pasta does not recognize gain or loss in the assets it distributes to American under 337(a)
         4. 4. American qualifies for a deemed paid foreign tax credit with respect to the deemed dividend that it receives from Pasta.
         5. 5. Deemed FTC Amount =
            1. a. $500 deemed tax credit…. When you get a dividend for FC, taxes flow up. So now US corp is deemed to pay $500 of Foreign Tax… and also gets §78 gross up, so US Corp has $1500 of dividend income and is deemed to pay $500 in foreign taxes
            2. ii. Class Notes:
               1. 1. This deals w/ 332/331/337—
               2. 2. This is a nonrecognition as far as Pasta is concerned, but might not be if 332 is overridden.
               3. 3. Does 367(b) apply to domestic corp – 1.367(b)-3(b)(3)(i) – liquidation of FC controlled by a US corporation.
               4. 4. Ownership requirements are satsifed here – trigger event under regulation – must have a CFC… and the assets that were in FC have to move to DC… if you don’t have this cross border transfer of assets, does this apply? NO. SO if assets of FC move to US corp in nonrecognition transaction, then in this circumstance, the DC would include in income a deemed dividend of All E&P Amount amount attributable to its stock in the foreign sub.
               5. 5. All E&P Amount -- §1.367(b)-2(d)
                  1. a. Not limited to post-62… it’s ALL earnings and profits… so if corporation is 60 years old you have to go back and recalculate all earnings for past 60 years under US accounting principles
                  2. b. Looking for term dividend… if treated as a dividend under the regulations, treated the same as a dividend under 902
                  3. 6. §1248 – has the stock of a CFC been sold or exchanged? If so, then 1248 applies.
                  4. 7. (1) says all E&P amount … if have 332 and all e&p? amount of gain doesn’t matter
      2. b. What amount(s) would American include if Pasta’s shares have unrealized appreciation of $200 in American’s hands?
         
         
      3. (2) FACTS: If the facts are the same as problem 1, except that American held its shares of Pasta indirectly, through Overseas SA, a first-tier wholly owned swiss CFC, and if Pasta were liquidated into Overseas, how much gain would Overseas recognize on the liquidation?
         1. a. Liquidation of foreign subsidiary into foreign parent.
         2. b. Class Notes:
            1. i. Exception in 3(b) – assets go back up to US corporation… the assets aren’t going up to a US corporation here, so therefore there is NO inclusion by US corporation… §381 applies and says that the E&P that was in Pasta is transferred to Overseas
               
               
            2. (3) FACTS: American exchanges its shares of Pasta, a first-tier CFC, for 5% of the outstanding stock of Ciel SA, a French corporation that is NOT a CFC after the exchange. At the time of the exchange, Pasta has E&P of $2,000 and has paid cumulative foreign taxes of $500. The Pasta shares have unrealized appreciation of $1,000 in American’s hands.
               1. a. What amount must American include in its gross income?
                  1. i. American must pay its §1248 liability. American must include in gross income, as a deemed dividend, the §1248 amount attributable to the stock exchanged TO THE EXTENT that the FMV of the stock exchanged EXCEEDS its adjusted basis. Additional gain will be treated as gain from the sale or exchange of stock.
                  2. ii. §1248 amount = previously untaxed post 1962 earnings that would be taxed as a dividend under §1248(a) if the stock had been sold.
                     1. 1. §1248 amount = Previously untaxed post 1962 earnings = 1500 (2000-500)
                     2. 2. Amt stock exchanged exceeds its basis = $1,000 ß limiter on amount of income included as a §1248 deemed dividend.
                     3. 3. In addition to dividend of $1000, going to pickup 250 to deem have paid that, and will gross up dividend of 78, so total gross up dividend of $250
                     4. iii. Class Notes:
                        1. 1. What kind of transaction is this? Need to know before we get to §367. Exchanged stock in Pasta for stock in French Corp
                        2. 2. Need 80% of vote and value for a B reorg… 368(a)(1)(B)… Acquring Corp needs control of the target/acquired corp and it has to have paid SOLELY voting stock… so in this example, this is a B reorg.
                        3. 3. This is analyzed under 354, which says the transferor (the US corp) doesn’t recognize any gain on the receipt of the voting stock of the French company for exchange of Pasta
                        4. 4. §367(b) tells us that Pasta is treated as a corporation for purposes of 354 unless the regs tell us otherwise… did a US person transfer anything to a foreign corporation? Yes. 367(a) applies, so BOTH 367(a) and 367(b) applies.
                        5. 5. Requirements for 367(a) – exception when US person transfers stock and securities of a FC to a foreign person… 1.367(a)-3(b)(2) says that 367(b) is transfer is taxable under 367(a).
                           1. a. 367(a) – US person transferring stock of a foreign corporation – §1.367(a)-3(b)(1) – shall not be subject to 367(a) if US person owns less than 5% of total voting and value of transferee corporation immediately after or US person enters into 5 year gain recognition agreement… (make sure I wrote this down right, check the reg)
                           2. 6. if 367(a) does not apply, does 367(b) apply? If overlap of 367(a) and (b)… so if didn’t make GRA in this case, 367(a) would apply, and the built in gain would be recognized, and 367(b) would not apply. But, if US corp is going to enter into GRA, 367(b) applies… 1.367(b)-4(b)… so 1248 amount inclusion
                           3. 7. When CFC and US Shareholder – potential for §1248 to apply… will continue to apply as long as US shareholders and owns stock in CFC… if no longer a US SH of CFC, 1248 no longer applies… 367(b) creates a triggering event… saying even though this is a good B reorg, if this US SH sold stock of Pasta in taxable exchange, it would have a built in gain of 1000k and convert that gain into dividend income and convert that into income b/c of undistributed earnings of 1000. When DC sells French stock, 1248 doesn’t apply because NOT a CFC NOR a US SH.
                              1. a.
      4. b. What amount is American entitled to as an indirect foreign tax credit?
         1. i. 902 calculation = $250
            1. 1. dividend of $1000 (b/c that’s 1248 amount that 367(b) causes US corp to include as deemed dividend)
            2. 2. $500 x 1000/2000 = $250.
               
               
            3. (4) FACTS: American owns all of the outstanding stock of Pasta, which in turn owns all of the stock of Milan, an Italian corporation. Pasta exchanges its shares of Milan for shares of Ciel, a French corporation, in which American has a 5% interest. The exchange results in Pasta having a 10% interest in Ciel, which is NOT a CFC after the exchange. Milan has E&P of $200 at the time of the exchange and has paid cumulative foreign taxes of $50. What are the federal income tax consequences of the foregoing exchange?
               1. a. Class Notes:
                  1. i. 367(b) – is something going to trigger recognition? Look at -4(b) – ap
                  2. ii. What happens to parent when Pasta has a deemed dividend of 200? What happens when Subsidiary receives dividend? What happens to a US SH when a CFC gets a Dividend… Subpart F! What happens under SubF – is this Foreign Personal Holding Company income? Look to the regs 1.367(b)-4(c) à SO NOTHING HAPPENS! Not SubF income under 1.367(b)-4(c) exception from personal holding company income.
                     
                     
                  3. (5) FACTS: Domestic, a US corporation, owns all of the stock of Foreign Sub, a CFC. Domestic has an adjusted basis of $100k in its stock in Foreign Sub, the value of which is $200k. The §1248 amount w/r/t the stock is $60k. Foreign Acquiring Corporation, a foreign corporation, is owned entirely by NRAs unrelated to either Domestic or Foreign Sub. Foreign Acquiring Corporation acquires all of the stock of Foreign Sub from Domestic in exchange for 10% of the stock of Foreign Acquiring in a reorganization meeting the requirements of §368(a)(1)(B). What are the federal income tax consequences of the exchange?
                     1. a. Class Notes:
                        1. i. Need a valid 351 or 368
                        2. ii. Income inclusion of deemed dividend of amount of 1248 if requirements of met
                        3. iii. Transfer what to whom in exchange for what? A DC has transferred property to a foreign person, 367(a). We have here an overlap b/t 367(a) and 367(b). How does 367(a) apply in this context? The DC is a 5% or more transferee shareholder, so it recognizes gain under 367(a) UNLESS it enters into gain recognition agreement. The gain is $100k. If NO GRA à it will have $100k of gain recognized which will be capital, and under 1248, 60k of that will be converted into dividend income, and 40 is long term capital gain. If it does enter into GRA à this 100k of gain doesn’t get recognized – it gets deferred. Under 367(b), the 1248 amount is triggered, because DC was a US person that was a 1248 shareholder of a FC that was a CFC before the exchange… after the exchange, DC is no longer a 1248 shareholder of a corporation that is a CFC, so it would get 60k of dividend income if entered into GRA.
                        4. iv. The choice – DC can say recognize total of 100 – 40 capital gain and 60 dividend; OR I’ll just pickup 60 of dividend. If you look at #3, the numbers were a little different. There was a built in gain of 1000 and E&P (1248 amount) of 2000. So what would D do in #3? If it doesn’t enter into GRA, it recognizes full 1000 of gain, and that full 1000 gets converted to dividend income. If it DOES enter into GRA à it still recognizes 1000 of gain as dividend under 1248, so either way it’s picking up the 1000, and either way that 1000 is a dividend. So what’s the point of the making the GRA? None.