The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act (44 U.S.C. 3507(d)).  Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received no later than March 7, 2005. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information (see below);

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information can be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in §1.367(a)-3(d)(2)(vi)(B)(1)(ii). This information is required to inform the IRS of a domestic corporation that is claiming an exception from the application of section 367(a) and (d) to certain transfers of property to a foreign corporation that is re-transferred by the foreign corporation to a domestic corporation controlled by the foreign corporation. The information is in the form of a statement attached to the domestic corporation’s U.S. income tax return for the year of the transfer certifying that if the foreign corporation disposes of the stock of the domestic controlled corporation with a tax avoidance purpose, the domestic corporation will file an income tax return (or amended return, as the case may be) reporting gain. The collection of information is mandatory. The likely respondents are domestic corporations.

Estimated total annual reporting burden: 50 hours. 

Estimated average annual burden hours per respondent: 1 hour.  

Estimated number of respondents: 50.

Estimated annual frequency of responses:  on occasion.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Section 368(a)(1)(A) defines a reorganization to include a statutory merger or consolidation (A reorganization). For transactions completed before January 24, 2003, regulations under section 368(a)(1)(A) provided that a reorganization was a merger or consolidation effected pursuant to the corporation law of the United States or a State or Territory or the District of Columbia. See §1.368-2(b)(1), as in effect before January 24, 2003.

On January 24, 2003, the IRS and the Treasury Department issued proposed regulations (REG-126485-01, 2003-1 C.B. 542 [68 FR 3477]) and temporary regulations (T.D. 9038, 2003-1 C.B. 524 [68 FR 3384]), revising the definition of a statutory merger or consolidation. The proposed and temporary regulations define a statutory merger or consolidation in a manner intended to ensure that those transactions are not divisive in nature. Accordingly, the regulations generally require that all the assets and liabilities of the merged corporation (other than assets distributed or liabilities discharged in the transaction) are transferred to the acquiring corporation and that the separate legal identity of the merged corporation ceases to exist in the transaction.

Pursuant to a notice of proposed rulemaking (proposed section 368 regulations) published contemporaneously with this document, the IRS and Treasury are proposing further revisions to the definition of a statutory merger or consolidation to take into account those transactions effected pursuant to foreign law. The proposed section 368 regulations amend the 2003 proposed regulations and provide that an A reorganization may occur, if certain conditions are satisfied, pursuant to the laws of a foreign jurisdiction, including a U.S. possession.

In light of this change, this document contains proposed amendments to the regulations under certain international Code provisions (sections 367, 884, and 6038B) to account for statutory mergers and consolidations involving one or more foreign corporations. Current international tax regulations are premised on an A reorganization being limited to a statutory merger or consolidation involving domestic corporations effected pursuant to domestic law. See, e.g., Rev. Rul. 57-465, 1957-2 C.B. 250. As a result, conforming changes must be made to these international tax regulations to ensure that they apply appropriately to statutory mergers and consolidations effected pursuant to foreign law. The proposed regulations also modify the section 367(a) and (b) regulations to address several other related issues.

The proposed regulations provide basis and holding period rules for certain transactions involving foreign corporations with section 1248 shareholders in order to preserve relevant section 1248 amounts. A section 1248 shareholder is a U.S. person that satisfies the ownership requirements of section 1248(a) with respect to a foreign corporation. Section 1248(a) applies to a U.S. person that owns stock (directly, indirectly, or constructively) with 10 percent or more of the voting power in the foreign corporation at any time during the 5-year period ending on the sale or exchange of the stock when the foreign corporation was a controlled foreign corporation (CFC). Gain recognized by a section 1248 shareholder on the sale or exchange of stock of the foreign corporation is included in gross income as a dividend to the extent of the earnings and profits of the foreign corporation that are attributable to the stock sold or exchanged and that were accumulated while the stock was held by the U.S. person when the foreign corporation was a CFC (the section 1248 amount).

The IRS and Treasury believe that it is important to preserve section 1248 amounts in certain nonrecognition exchanges of foreign corporation stock. Preservation of section 1248 amounts is a function of the holding period and basis in the stock of the foreign corporation being exchanged. One of the underlying policies of section 367(b) is the preservation of the potential application of section 1248 in connection with certain nonrecognition exchanges. H. Rep. No. 94-658, 94^th Cong., 1^st Sess., at 242 (Nov. 12, 1975). These proposed regulations provide basis and holding period rules to preserve section 1248 amounts in the context of certain section 354 exchanges and certain triangular reorganizations.

The basis and holding period rules of the proposed regulations also apply to a foreign corporate shareholder of a foreign corporation that is a party to the reorganization, provided that the foreign corporate shareholder has at least one U.S. person that is a section 1248 shareholder with respect to the foreign corporate shareholder and to the foreign corporation. This rule is necessary to preserve application of section 964(e) to the foreign corporate shareholder with respect to lower-tier foreign corporations. Under section 964(e), if a CFC sells or exchanges stock in another foreign corporation, gain recognized on the sale or exchange is included in the income of the CFC as a dividend to the same extent that it would have been included under section 1248(a) if the CFC were a U.S. person. Such dividend income may be treated as subpart F income that is included in the income of U.S. shareholders of the CFC.

The proposed regulations apply to certain section 354 exchanges involving foreign corporations, including exchanges of multiple blocks of stock. The proposed regulations preserve the bases and holding periods in different blocks of stock in certain foreign target corporations by requiring the exchanging shareholder to establish the particular shares of stock that were received in exchange for shares of a particular block of target stock. If the exchanging shareholder cannot establish the particular shares of target stock that were received for shares of a particular block of stock, then the shareholder must designate which shares of stock were received in exchange for shares of a particular block of stock, provided that the designation is consistent with the terms of the exchange. These tracing methods are used to determine the resulting tax consequences when stock received in a nonrecognition exchange is subsequently sold or otherwise exchanged. If the exchanging shareholder cannot establish, and does not designate, the particular shares received, the shareholder is treated as selling or otherwise exchanging a share received in a nonrecognition exchange for a share that was purchased or acquired at the earliest time.

The IRS and Treasury recently published proposed section 358 regulations (REG-116564-03, 2004-20 I.R.B. 927) that determine the basis of stock or securities received in section 354 exchanges (proposed section 358 regulations). The proposed section 358 regulations generally provide that the basis of each share of stock or security received in an exchange to which section 354, 355, or 356 applies will be the same as the basis of the share of stock or security exchanged therefor. For these purposes, the determination of which share of stock or security is received in exchange for a particular share of stock or security is made in accordance with the terms of the exchange or distribution.

These proposed regulations apply the principles of the proposed section 358 regulations to certain exchanges of stock of a foreign corporation by either a section 1248 shareholder, or a foreign corporate shareholder where at least one U.S. person is a section 1248 shareholder with respect to such foreign corporate shareholder and to the foreign corporation whose shares are exchanged (collectively and individually, section 367(b) shareholder), to ensure the preservation of section 1248 amounts. The proposed regulations also include specific guidance on the shareholder’s holding period in the stock received in the section 354 exchange. The proposed regulations do not, however, apply to distributions described in section 355.

Consistent with the proposed section 358 regulations, the proposed regulations hereunder would not apply to section 351 exchanges or to exchanges to which both section 351 and section 354 (or section 356) apply, if, in addition to stock being received, other property is received or liabilities are assumed. This limitation is intended to prevent a conflict between the rules for determining basis in a section 351 exchange (including the application of section 357(c)) and the rules proposed in this document. The IRS and Treasury are considering approaches for the preservation of section 1248 amounts in section 351 transactions in which liabilities are assumed or other property is received, and comments are requested in this regard.

In addition, the IRS and Treasury are considering developing specific rules for situations in which stock of the foreign acquiring corporation is not issued in the exchange (for example, when the exchanging shareholder owns all the stock of the foreign acquiring corporation). One possible approach may be for each existing share of stock in that corporation to be divided into portions to account for the different basis and holding periods of the stock of the foreign acquiring corporation and the stock of the acquired corporation in order to preserve section 1248 amounts. Comments are requested regarding this approach or possible alternative approaches.

The proposed regulations provide special basis and holding period rules for triangular reorganizations where the merging or surviving corporation is a foreign corporation with a section 367(b) shareholder. These rules apply to reorganizations described in section 368(a)(1)(A) and (a)(2)(D) (forward triangular merger) and to parenthetical section 368(a)(1)(C) reorganizations. In these transactions, the surviving corporation (S) acquires substantially all the assets of the acquired corporation (T), and the T shareholders exchange their T stock for stock of the corporation (P) that is in control (within the meaning of section 368(c)) of S. These rules also apply to reorganizations described in section 368(a)(1)(A) and (a)(2)(E) (reverse triangular merger). In a reverse triangular merger, S, a controlled subsidiary of P, merges into T, the surviving corporation, and the T shareholders exchange their T stock for stock of P.

Under current regulations, in a forward triangular merger or a parenthetical C reorganization, P’s basis in its S stock is adjusted as if P had acquired the T assets directly from T in a section 362(b) exchange and then had transferred the T assets to S in a transaction in which P’s basis in S stock is determined under section 358. See §1.358-6(c)(1) (commonly referred to as the “over-the-top” basis rules). Under current regulations, in a reverse triangular merger, P’s basis in the T stock it receives immediately after the transaction is equal to its basis in its S stock immediately before the transaction adjusted as if T had merged into S in a forward triangular merger and the over-the-top basis rules had applied. See §1.358-6(c)(2). If a reverse triangular merger also qualifies as a section 351 transfer or a section 368(a)(1)(B) reorganization, P can determine its basis in its S stock either by using the over-the-top basis rules as described in the prior sentence or by treating P as if it had acquired the T stock from the former shareholders of T in a transaction in which basis is determined under section 362(b) (carryover stock basis).

The IRS and Treasury are concerned that, in certain exchanges involving foreign corporations, application of the over-the-top basis rules would not properly preserve the section 1248 or 964(e) amounts with respect to the stock of S or T. The proposed regulations provide that, in determining the stock basis of the surviving corporation in certain triangular reorganizations, outside stock basis will be used instead of inside asset basis pursuant to §1.358-6(c). For example, in the case of a forward triangular merger (or a parenthetical C reorganization), where P is a domestic corporation, S is a foreign corporation, T is a foreign corporation, and T has a section 1248 shareholder, the basis and holding period in the T stock, not the T assets, are used to determine P’s basis in the S stock. The same rules apply to certain reverse triangular mergers, where S merges into T with T surviving. In that case, P’s basis in the T stock immediately after the transaction would reflect the basis and holding period of the T stock instead of the T assets.

Under this stock basis approach for triangular reorganizations, the proposed regulations provide for a divided basis and holding period in each share of stock in the surviving corporation to reflect the relevant section 1248 amounts in the S stock and T stock. In particular, each share of S stock in a forward triangular merger, and each share of T stock in a reverse triangular merger, where P is a section 367(b) shareholder immediately after the transaction, is divided into portions reflecting the basis and holding period of the S stock and the T stock before the transaction. However, the proposed regulations contain a de minimis exception to this rule. Under this exception, if the value of the S stock immediately before the transaction is de minimis (for example, where S is a corporation formed to facilitate the transaction), then each share of the surviving corporation is not divided; instead, the basis of the S stock is added to the basis of the stock of the surviving corporation held by P. The value of the S stock would be de minimis for this purpose if it is less than 1 percent of the value of the surviving corporation (S or T) immediately after the transaction.

If there are two or more blocks of stock in T or S held by a section 367(b) shareholder immediately before the transaction, then each share of the surviving corporation (S or T) is further divided to account for each block of stock. If two or more blocks of stock are held by one or more shareholders that are not section 367(b) shareholders, then shares in these blocks are aggregated into one divided portion for basis purposes. If none of the S or T shareholders is a section 367(b) shareholder, then the over-the-top basis rules of §1.358-6 apply instead of the rules in these proposed regulations.

The proposed regulations provide special rules when stock of the surviving corporation has a divided basis and holding period. Earnings and profits accumulated prior to the reorganization are attributed to a divided portion of a share of stock based on the block of stock whose basis and holding period the divided portion reflects. Post-reorganization earnings and profits are attributed to each divided share of stock pursuant to section 1248 and the regulations thereunder. The amount of earnings and profits attributed to a divided share of stock pursuant to section 1248 are further attributed to a divided portion of such share of stock based on its fair market value in relation to the other divided portions. Finally, shares of stock are no longer divided into separate portions if section 1248 or 964(e) becomes inapplicable to a subsequent sale or exchange of the stock.

The special basis rules in these proposed regulations apply to all triangular reorganizations where T has at least one section 367(b) shareholder, even if such shareholders own less than a controlling interest in T. The IRS and Treasury are considering whether the current basis rules of §1.358-6 should apply in cases where section 367(b) shareholders do not own a substantial percentage of the stock of T, or whether taxpayers should be permitted to elect to apply the current basis rules under §1.358-6 to determine P’s basis in the stock of the surviving corporation (S or T), provided that all section 367(b) shareholders of T include in income the section 1248 amounts with respect to the stock exchanged. Comments are requested in this regard.

The use of stock basis to determine P’s basis in the surviving corporation also presents administrative concerns when a portion of the stock of T is widely held. In the case of a reorganization described in section 368(a)(1)(B), which presents similar issues, Rev. Proc. 81-70, 1981-2 C.B. 729, provides that statistical sampling techniques, if appropriate, are permitted to determine the basis of stock received by the acquiring corporation. In this regard, the IRS and Treasury recently have requested comments whether Rev. Proc. 81-70 should be revised to reflect changes in the marketplace since its publication. See Notice 2004-44, 2004-28 I.R.B. 32. Comments are requested on expanding this guidance to apply under the proposed regulations, for example in cases where blocks of T stock are held by persons that are not section 367(b) shareholders and such shares are aggregated into a single divided portion for basis and holding period purposes.

Under section 367(a), a U.S. person recognizes gain, but not loss, on the transfer of property to a foreign corporation in an exchange described in section 351, 354, 356, or 361, unless an exception applies. Section 367(a), however, does not apply to a section 354 exchange by a U.S. person of: (1) stock of a foreign corporation in a section 368(a)(1)(E) reorganization; or (2) stock of a domestic or foreign corporation for stock of a foreign corporation in an asset reorganization described in section 368(a)(1)(C), (D), or (F) that is not treated as an indirect stock transfer under §1.367(a)-3(a).

The proposed regulations amend §1.367(a)-3(a) so that this exception to the application of section 367(a) also applies to A reorganizations (including forward and reverse triangular mergers). In addition, the proposed regulations clarify that §1.367(a)-3(a) applies to exchanges described in section 356, as well as in section 354. Section 356 applies to an exchange that would qualify as a section 354 exchange except for the fact that money or other property is received in the exchange.

Taxpayers have questioned why the exception to the application of section 367(a) in §1.367(a)-3(a) includes exchanges of stock but not exchanges of securities in section 368(a)(1)(E) reorganizations and certain asset reorganizations. The IRS and Treasury believe that it is appropriate to provide comparable treatment for exchanges of securities in this context. Accordingly, Notice 2005-6, 2005-5 I.R.B. 448), published contemporaneously with these proposed regulations, announces that the IRS and Treasury intend to amend §1.367(a)-3(a) to apply the exception from section 367(a) to exchanges of stock or securities. Notice 2005-6 applies to transfers of securities after January 5, 2005. Taxpayers also may apply the provisions of the notice to transfers of securities occurring on or after July 20, 1998, and on or before January 5, 2005. In applying this notice, however, taxpayers must do so consistently to all transactions within its scope.

The proposed regulations also provide rules concerning the application of section 367(a) to reverse triangular mergers, where stock of P, a corporation that controls the merging corporation S, is treated as transferred (along with any other property of S) to the surviving corporation T in a section 361 transfer. If S is a domestic corporation and T is a foreign corporation, section 367(a) applies to the transfer by S of the P stock to T, unless an exception applies.

The IRS and Treasury believe that, if the stock of P is provided to S pursuant to the plan of reorganization, the section 361 transfer of the P stock from S to T should not be subject to section 367(a), and the proposed regulations so provide. If P does not provide its stock to S pursuant to the plan of reorganization, then the P stock will be treated as property of S and the transfer of such stock will be subject to section 367(a).

The IRS and Treasury intend to amend the regulations under section 6038B to conform with the changes made in these regulations.

The proposed regulations modify the current application of section 367(a) and (b) to transactions that require the inclusion in income of the all earnings and profits amount under section 367(b). Section 1.367(a)-3(b)(2) provides rules for the concurrent application of section 367(a) and (b) to transfers of stock of a foreign corporation. This may occur, for example, when a U.S. shareholder exchanges stock of a foreign corporation (foreign acquired corporation) for stock of another foreign corporation (foreign acquiring corporation). See §1.367(a)-3(b)(1). It may also occur when an acquiring corporation (foreign or domestic) acquires the assets of a foreign acquired corporation, and the U.S. shareholder exchanges stock of the foreign acquired corporation for stock of the foreign parent of the acquiring corporation in a triangular reorganization.

The U.S. person’s exchange of stock of the foreign acquired corporation for stock of either the foreign acquiring corporation or the foreign parent is subject to section 367(a). See §1.367(a)-3(b) and (d). If the exchanging U.S. shareholder owns 5 percent or more (by 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 section 367(a), unless the shareholder enters into a gain recognition agreement as provided in §1.367(a)-8. If the exchanging shareholder is not a 5-percent shareholder, then the exchanging shareholder does not recognize gain, if any, on the exchange.

The U.S. shareholder’s exchange described above also may be subject to section 367(b). If the exchanging U.S. shareholder is a section 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 U.S. shareholder is a section 1248 shareholder immediately after the exchange, then the exchanging shareholder must include in income the section 1248 amount with respect to the stock exchanged. See §1.367(b)-4. If, instead, a domestic acquiring corporation acquires the assets of a foreign acquired corporation, and the U.S. 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. See §1.367(b)-3. Unlike the section 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.

In cases where section 367(a) and (b) apply concurrently to a transaction, existing §1.367(a)-3(b)(2) provides that section 367(b) will not apply if the transfer is taxable under section 367(a). If the transfer is taxable under section 367(a), the exchanging U.S. shareholder will recognize gain inherent in the exchanged stock (subject to recharacterization as dividend income under section 1248). If the transfer is not taxable under section 367(a), because the exchanging U.S. shareholder either is not a 5-percent shareholder or enters into a gain recognition agreement, then section 367(b) applies and the exchange is subject to either §1.367(b)-3 or 1.367(b)-4 at the shareholder level.

Questions with respect to the concurrent application of section 367(a) and (b) have arisen in situations that otherwise would require inclusion of the all earnings and profits amount under §1.367(b)-3. If the all earnings and profits amount is greater than the section 367(a) gain with respect to the stock of the foreign acquired corporation, under current law the exchanging shareholder effectively may elect to be taxed on the lesser amount of gain under section 367(a) simply by failing to file a gain recognition agreement. In that case, section 367(b) would not apply and the shareholder would avoid inclusion in income of the greater all earnings and profits amount.

The ability to elect to recognize the lesser gain inherent in the stock exchanged in such cases is inconsistent with the policies of section 367(b) that apply to inbound transactions, including preventing conversion of tax deferral into tax forgiveness and ensuring that the domestic acquiring corporation’s section 381 carryover basis reflects an after-tax amount. Accordingly, the IRS and Treasury believe that the all earnings and profits amount provisions under §1.367(b)-3 should not operate electively in these cases. The proposed regulations require that, for exchanges subject to §1.367(b)-3 and section 367(a), section 367(b) would apply before section 367(a). In that case, inclusion of the all earnings and profits amount would increase the exchanging shareholder’s stock basis for purposes of computing the shareholder’s gain under section 367(a). Thus, if the all earnings and profits amount exceeds the inherent gain in the exchanged stock, gain is not recognized under section 367(a). If the transaction does not involve inclusion of the all earnings and profits amount (for example, if §1.367(b)-4 applies), the existing ordering rules continue to apply.

In a parenthetical reorganization under section 368(a)(1)(B), if a U.S. shareholder exchanges stock of an acquired corporation for voting stock of a foreign corporation that controls (within the meaning of section 368(c)) the acquiring corporation, the U.S. shareholder is treated as making an indirect transfer of stock of the acquired corporation to the foreign controlling corporation in a transfer subject to section 367(a). See §1.367(a)-3(d)(1)(iii). This result occurs even if the acquiring corporation is domestic. If the U.S. shareholder owns five percent or more (by vote or value) of the stock of the foreign controlling corporation, the shareholder must recognize gain inherent in the exchanged stock, unless a gain recognition agreement is filed. A gain recognition agreement filed with respect to the transfer may be triggered (and gain on the initial transfer of stock will be recognized) if the foreign controlling corporation disposes of the stock of the acquiring corporation, or the acquiring corporation disposes of the stock of the acquired corporation, within 5 years of the initial transfer. See §1.367(a)-3(d)(2)(ii).

The proposed regulations revise the indirect stock transfer rules to include triangular section 368(a)(1)(B) reorganizations in which a U.S. shareholder exchanges stock of the acquired corporation for voting stock of a domestic corporation that controls a foreign acquiring corporation. In such a case, the gain recognition agreement may be triggered if the domestic controlling corporation disposes of the stock of the foreign acquiring corporation, or the foreign acquiring corporation disposes of the stock of the acquired corporation, within 5 years of the initial transfer.

If a U.S. shareholder exchanges stock or securities of an acquired corporation for stock or securities of a foreign acquiring corporation in a reorganization described in section 368(a)(1)(C), and the foreign acquiring corporation transfers all or part of the assets of the acquired corporation to a subsidiary controlled (within the meaning of section 368(c)) by the foreign acquiring corporation in a transaction described in section 368(a)(2)(C), the U.S. shareholder is treated, for purposes of section 367(a), as transferring the stock of the acquired corporation to the foreign acquiring corporation to the extent of the assets transferred to the controlled subsidiary. §1.367(a)-3(d)(1)(v). Section 368(a)(2)(C) provides that a transaction otherwise qualifying as a reorganization under section 368(a)(1)(A), (B), (C), and (G) will not be disqualified because all or part of the assets or stock acquired in the transaction are transferred to a corporation controlled by the acquiring corporation.

On August 16, 2004, the IRS and Treasury issued proposed regulations under §1.368-2(k) that permit assets or stock acquired in any reorganization under section 368(a)(1) to be transferred to a corporation controlled by the acquiring corporation without disqualifying the reorganization. Prior to these proposed regulations, the IRS and Treasury issued Rev. Rul. 2002-85, 2002-2 C.B. 986, which extended this treatment to section 368(a)(1)(D) reorganizations. Notice 2002-77, 2002-2 C.B. 997, issued contemporaneously with Rev. Rul. 2002-85, provided that §1.367(a)-3(d)(1)(v) would be amended to treat transactions described in Rev. Rul. 2002-85 as indirect stock transfers, if the transfer of assets by the acquiring corporation to its controlled subsidiary occurred pursuant to the plan of reorganization.

The effect of the proposed regulations under §1.368-2(k) is to permit transfers of assets or stock to a controlled subsidiary in reorganizations not specifically identified or mentioned in section 368(a)(2)(C) (section 368(a)(1)(D) and (F) reorganizations). The proposed regulations amend the indirect stock transfer rules to conform to the changes in the section 368 regulations. As a result, the proposed regulations provide that the transfer of assets to a controlled subsidiary subsequent to an asset reorganization under section 368(a)(1) would constitute an indirect transfer of stock, provided the transfer of assets by the foreign acquiring corporation to its controlled subsidiary occurs as part of the same transaction.

As indicated above, under existing §1.367(a)-3(d)(1)(v), a U.S. shareholder of an acquired corporation is treated as transferring the stock of the acquired corporation to the foreign acquiring corporation to the extent of the assets transferred to the controlled subsidiary. Thus, if the acquired corporation is foreign, the U.S. shareholder is treated as transferring stock of a foreign corporation to the foreign acquiring corporation in a transaction that is subject to the §1.367(a)-3(b) stock transfer rules. If the acquired corporation is domestic, the U.S. shareholder is treated as transferring stock of a domestic corporation to the foreign acquiring corporation in a transaction that is subject to §1.367(a)-3(c). This deemed transfer of domestic stock prevails even if the controlled subsidiary is foreign. Similar rules apply to parenthetical C reorganizations.

Some commentators have suggested that the determination of whether domestic or foreign stock is deemed transferred should be based on the status of the controlled subsidiary, rather than the status of the acquired corporation. Under this approach, if the acquired corporation were domestic and the controlled subsidiary were foreign, the U.S. shareholders would be deemed to transfer foreign corporation stock subject to §1.367(a)-3(b), rather than domestic corporation stock subject to §1.367(a)-3(c). The IRS and Treasury believe that, consistent with the framework of the current regulations, it is appropriate for the rules to continue to apply based on the stock that is owned and exchanged by the U.S. person in the transaction (rather than on the stock of the controlled subsidiary). The IRS and Treasury are considering the application of §§1.367(a)-3(b), 1.367(a)-3(c), and 1.367(a)-8 to situations where the foreign acquiring corporation transfers assets of the acquired corporation to multiple controlled subsidiaries (including both domestic and foreign subsidiaries), comments are requested in this regard.

In the case of an indirect stock transfer that also involves a transfer of assets by a domestic corporation to a foreign corporation, §1.367(a)-3(d)(2)(vi) generally provides that section 367(a) and (d) apply to the transfer of assets prior to application of the indirect stock transfer rules. However, section 367(a) does not apply to such transfers to the extent that the foreign acquiring corporation transfers the assets received in the asset transfer to a domestic corporation controlled (within the meaning of section 368(c)) by the foreign acquiring corporation in a transfer described in section 368(a)(2)(C) or in a transfer described in section 351, provided the domestic transferee’s basis in the assets is no greater than the basis that the domestic acquired corporation had in such assets. The initial asset transfer to the foreign corporation is not subject to section 367(a) in such cases because the assets re-transferred to the domestic corporation remain subject to U.S. corporate tax.

The IRS and Treasury are concerned that asset reorganizations subject to this coordination rule may be used to facilitate corporate inversion transactions. An inversion generally involves a U.S. multinational corporation reincorporating outside the United States for tax purposes (either as a foreign corporation or as a subsidiary of a new foreign corporation). The IRS and Treasury also are concerned that the coordination rule might be used to facilitate divisive transactions. The proposed regulations address both of these concerns by modifying the scope of the coordination rule.

The revised coordination rule operates as follows. Section 367(a) and (d) generally apply to the transfer of assets to a foreign corporation even if the foreign corporation transfers all or part of the assets received to a controlled domestic corporation. This general rule, however, is subject to two exceptions which do not require income recognition under section 367(a) and (d) on the transfer of assets to the foreign corporation to the extent that assets are re-transferred to the domestic controlled corporation.

The first exception applies if the domestic acquired corporation is controlled (within the meaning of section 368(c)) by 5 or fewer domestic corporations, appropriate basis adjustments as provided in section 367(a)(5) are made to the stock of the foreign acquiring corporation, and any other conditions provided in regulations under section 367(a)(5) are satisfied. Although there currently are no regulations under section 367(a)(5), this exception will incorporate any conditions or limitations in future regulations once published.

In cases where the first exception does not apply, the second exception applies if the following two conditions are satisfied: (1) the indirect transfer of stock of the domestic acquired corporation satisfies the requirements of §1.367(a)-3(c)(1)(i), (ii), and (iv), and (c)(6); and (2) the domestic acquired corporation attaches a statement (described below) to its tax return for the taxable year of the transfer.

The statement that the domestic acquired corporation files must certify that, if the foreign acquiring corporation disposes of any stock of the domestic controlled corporation with a principal purpose of avoiding U.S. tax that would have been imposed on the domestic acquired corporation had it disposed of the re-transferred assets, the domestic acquired corporation will amend its return for the year of the initial transaction and recognize gain (described below). The disposition of stock is presumed to have a principal purpose of tax avoidance if the disposition occurs within 2 years of the transfer. The presumption may be rebutted, however, if the domestic acquired corporation (or the foreign acquiring corporation on its behalf) demonstrates to the satisfaction of the Commissioner that the transaction did not have a principal purpose of tax avoidance.

If the domestic acquired corporation recognizes gain pursuant to the statement, it is treated as if, immediately prior to the exchange, it had transferred the re-transferred assets, including any intangible assets, directly to a domestic corporation in exchange for stock of the corporation in a transaction that is treated as a section 351 exchange, and immediately sold the stock to an unrelated party at fair market value in a sale in which it recognizes gain, if any, but not loss. For purposes of this rule, the deemed transfer to a domestic corporation is treated as a section 351 exchange regardless of whether all the requirements for nonrecognition under section 351 are otherwise satisfied. Treating the domestic acquired corporation as recognizing gain on the disposition of stock, rather than assets, is intended to approximate the consequences that would have resulted had the domestic acquired corporation transferred the assets to a corporation and sold the stock received in such transfer prior to the outbound reorganization. In addition, this treatment is consistent with other provisions that address divisive transactions. See, e.g., section 355(e) and §1.367(e)-(2)(b)(2)(iii).

The basis that the foreign acquiring corporation has in the stock of the domestic controlled corporation is increased by the amount of gain recognized by the domestic acquired corporation under these rules immediately prior to its disposition; however, the basis of the re-transferred assets held by the domestic controlled corporation will not be increased by such gain. Finally, the anti-abuse provision under §1.367(d)-1T(g)(6) will not apply to intangible property included in the re-transferred assets.

Section 367(b) applies to exchanges under sections 332, 351, 354, 355, 356, and 361 (except to the extent described in section 367(a)(1)) in which the status of a foreign corporation as a corporation for tax purposes is necessary for application of the relevant nonrecognition provisions. Except as provided in regulations, under section 367(b) a foreign corporation that is a party to such an exchange is considered to be a corporation for tax purposes, and therefore the parties involved in the transaction are eligible for nonrecognition treatment.

Section 1.367(b)-4 applies to acquisitions by a foreign corporation (the foreign acquiring corporation) of the stock or assets of another foreign corporation (the foreign acquired corporation) in certain nonrecognition exchanges (a section 367(b) exchange). Consistent with section 1248, §1.367(b)-4(b)(1)(i) addresses exchanges by a section 1248 shareholder (or, in certain cases, a CFC shareholder that has a section 1248 shareholder), and generally requires such a shareholder to include in income its section 1248 amount as a result of a section 367(b) exchange, if immediately after the exchange (i) the stock received in the exchange is not stock in a corporation that is a controlled foreign corporation as to which the section 1248 shareholder described above is a section 1248 shareholder, or (ii) the foreign acquiring corporation or the foreign acquired corporation (if any, such as in a transaction described in section 368(a)(1)(B) or 351), is not a controlled foreign corporation as to which the section 1248 shareholder described above is a section 1248 shareholder.

Therefore, in a triangular reorganization (such as a triangular reorganization described in section 368(a)(1)(C)) that is within the scope of §1.367(b)-4, a section 367(b) shareholder must include in income the section 1248 amount if, for example, it receives stock of a domestic corporation in exchange for its stock in a controlled foreign corporation. This is the case because, immediately after the exchange, the section 367(b) shareholder does not hold stock in a corporation that is a controlled foreign corporation as to which such shareholder is a section 367(b) shareholder.

Pursuant to the basis rules contained in this proposed regulation under §1.367(b)-13, the section 1248 amount with respect to the stock of the foreign acquired corporation that is exchanged can be properly preserved in the stock of a foreign corporation owned by a domestic corporation when the section 367(b) shareholder receives stock of the domestic corporation in a triangular reorganization. Consequently, the proposed regulations provide that a section 367(b) shareholder receiving stock of a domestic corporation in a triangular reorganization is not required to include in income the section 1248 amount under §1.367(b)-4(b)(1)(i), provided that the domestic corporation, immediately after the exchange, is a section 1248 shareholder of the surviving corporation (or in the case of a parenthetical section 368(a)(1)(B) reorganization, of the acquired corporation) that is itself a controlled foreign corporation.

If a domestic corporation is a section 1248 shareholder with respect to a foreign corporation and transfers the stock in such foreign corporation to another foreign corporation in a section 361 transfer, the domestic corporation must include in income the section 1248 amount, if any, with respect to the stock of the transferred foreign corporation. See section 1248(f)(1) and §1.367(b)-4(b)(2)(ii), Example 4.

Taxpayers have commented that this rule may result in income inclusions in some cases where the section 1248 amount could be preserved, such that a current inclusion may not be necessary or appropriate. The IRS and Treasury are considering the application of section 367(a)(5) and section 1248(f)(1) to such transactions, in conjunction with §1.367(b)-13 of these regulations, to preserve section 1248 amounts, and comments are requested in this regard. The IRS and Treasury also are considering, and request comments, on situations in which there are multiple shareholders (including minority shareholders) of the domestic corporation; multiple assets (including appreciated and depreciated assets being transferred as part of the section 361 transfer); and liabilities being assumed in connection with the transaction.

Section 897(a) generally treats gain or loss from the disposition of a U.S. real property interest by a nonresident alien individual or a foreign corporation as gain or loss that is effectively connected with the conduct of a trade or business within the United States. Sections 897(d) and (e) provide rules that apply section 897 in the context of distributions and nonrecognition exchanges of U.S. real property interests. Temporary regulations were issued under sections 897(d) and (e) providing guidance on the application of section 897 to certain corporate transactions involving U.S. real property interests. See §1.897-5T, 1.897-6T, and Notice 89-85, 1989-2 C.B. 403. These rules do not specifically address A reorganizations because such regulations were based on A reorganizations being limited to statutory mergers between domestic corporations. The IRS and Treasury intend to revise these regulations to reflect A reorganizations and welcome comments on revisions that are necessary to apply these regulations to A reorganizations, as well as comments on other issues under the regulations.

Section 1291(f) provides authority to issue regulations concerning the exchange of stock in a passive foreign investment company (PFIC) in a nonrecognition transaction. Proposed regulations were published in the Federal Register (57 FR 11047) on April 1, 1992, providing rules for the disposition of PFIC stock by U.S. shareholders in nonrecognition exchanges. See §1.1291-6 of the proposed regulations. The application of these proposed regulations is based on A reorganizations being limited to statutory mergers between domestic corporations. The IRS and Treasury intend to revise these proposed regulations to reflect A reorganizations and welcome comments on revisions that are necessary in this regard, as well as comments on other issues under these regulations.

Except as otherwise specified, these regulations are proposed to apply to transactions occurring after the date these regulations are published as final regulations in the Federal Register.

The IRS and the Treasury Department have determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment pursuant to that Order is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and that because this regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this regulation will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and on how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for May 19, 2005, beginning at 10:00 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT portion of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments must submit written or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by April 28, 2005. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1.  The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2.  In section 1.358-1, paragraph (a) is amended by adding a sentence at the end of the paragraph to read as follows: