The temporary regulations adopt the rules announced in Notice 2005-74, with a number of modifications discussed below. Notice 2005-74 only provided guidance on a particular range of transactions, namely certain asset reorganizations, that are insufficiently addressed in the current regulations. The temporary regulations respond to comments and provide guidance on the effect on GRAs of transactions that are not addressed in the current regulation or Notice 2005-74. The temporary regulations also make additional changes to the existing regulations. For example, the temporary regulations modify and clarify procedural requirements attendant to entering into GRAs. Finally, the temporary regulations reorganize the current regulation so that distinct paragraphs address triggering events, exceptions to triggering events, and events that terminate a GRA. The IRS and Treasury Department continue to consider issuing additional public guidance that further revises §1.367(a)-8.

Notice 2005-74 provided that if, in a section 361 transaction, a U.S. transferor transfers all or a portion of the stock or securities of the transferee foreign corporation to an acquiring domestic corporation (successor U.S. transferor) pursuant to certain asset reorganizations, the exchanges made pursuant to the asset reorganization will trigger the gain recognition agreement, unless various conditions are satisfied. These conditions are: (1) the U.S. transferor must have been a member of a consolidated group (original consolidated group) at the time of the initial transfer and the common parent of such group (original common parent) entered into the original GRA; (2) immediately after the asset reorganization, the successor U.S. transferor is a member of the original consolidated group (consolidation continuity requirement); and (3) the original common parent enters into a new GRA with respect to the transfer subject to the original GRA, modified by substituting the successor U.S. transferor for the original U.S. transferor. A notice of the asset reorganization also must be provided with the successor U.S. transferor’s next annual certification.

For this purpose, an asset reorganization is defined as a reorganization described in section 368(a)(1) involving the transfer of assets by a corporation to another corporation pursuant to section 361, except that such term shall include reorganizations described in section 368(a)(1)(D) or (G) only if the requirements of section 354(b)(1)(A) and (B) are met.

The IRS and Treasury Department received several comments that the consolidation continuity requirement was unduly restrictive because it focused on maintaining the same obligor for a GRA following the asset reorganization. Commentators asserted that an equal or better ability to collect the tax due as a result of a triggering event subsequent to such a reorganization may be preserved in certain instances where the consolidation continuity requirement would not be satisfied. However, these same commentators noted that if there were no consolidation continuity requirement, such that a U.S. transferor that is a member of a consolidated group at the time of the initial transfer could be acquired in a later asset reorganization by a corporation (successor corporation) that is not a member of such group without triggering the GRA, the actions of the successor corporation could inappropriately affect the liability of the original consolidated group under the GRA. As a result, the commentators requested that the consolidation continuity requirement be curtailed or eliminated, while at the same time not inappropriately exposing the original consolidated group to the liabilities arising from the actions of the successor corporation.

The IRS and Treasury Department generally agree with these views. Therefore, the temporary regulations eliminate the consolidation continuity requirement and address concerns about the liability of a consolidated group that disposes of a U.S. transferor subject to a GRA.

Specifically, the temporary regulations provide that when a U.S. transferor transfers all or a portion of the stock of the transferee foreign corporation to an acquiring corporation in an asset reorganization, the exchanges made pursuant to the reorganization will not be triggering events and the GRA will terminate without further effect, but only if certain requirements are satisfied. These requirements ensure that the ability to collect tax is sufficiently preserved and that the terms of the GRA are administrable.

First, the acquiring corporation (successor U.S. transferor) must be a domestic corporation, and the successor U.S. transferor or the common parent of the consolidated group of which the successor U.S. transferor is a member (as applicable) must enter into a new GRA to recognize gain with respect to the initial transfer during the remaining term of the original GRA (with certain modifications).

Second, with its next certification, the successor U.S. transferor must provide to the IRS the new GRA, notice of the transaction, and Form 8838 (Consent To Extend the Time To Assess Tax Under Section 367 - Gain Recognition Agreement) to extend the period of assessment of tax on the initial transfer.

Third, unless the successor U.S. transferor is a member of the same consolidated group of which the U.S. transferor was a member immediately before the asset reorganization, the person entering into the new GRA must elect that, if the new GRA is triggered in whole or in part, the person will include the required amount in the year of the triggering event (as opposed to the year of the initial transfer). Requiring an inclusion in these circumstances only in the year of a subsequent triggering event when the U.S. transferor is no longer owned by the same consolidated group is necessary, among other reasons, because the successor U.S. transferor may not have existed in the year of the initial transfer. In such a case, the successor U.S. transferor would not be able to amend a return for the year of the initial transfer to include any tax due as a result of a subsequent triggering event. Moreover, the requirement is appropriate even if the successor U.S. transferor did exist in the year of the initial transfer because its tax year for the year of the initial transfer may be closed. In sum, this requirement assures the GRA rules are administrable and that the ability to collect tax is sufficiently preserved. If these requirements are met, the original GRA will terminate without further effect.

The IRS and Treasury Department have decided to eliminate the consolidation continuity requirement because these three requirements adequately address the government’s concern in this area by, among other things, preserving the ability to collect the tax due as a result of a triggering event subsequent to a covered asset reorganization. In many asset reorganizations, the successor U.S. transferor will have an equal or greater ability to pay the tax due in the case of a subsequent triggering event than would the original U.S. transferor. Furthermore, the current regulations generally do not impose any financial or other requirements on the ability of a U.S. transferor to enter into a GRA. But see §1.367(a)-8(d) (imposing a security requirement in certain situations). Consequently, the IRS and Treasury Department believe that even if in some circumstances an acquisition of a U.S. transferor may affect the ability to collect the tax due as a result of a subsequent triggering event (for example, the U.S. transferor is acquired from a consolidated group by another consolidated group whose value is less than that of the original consolidated group), the requirements above nonetheless sufficiently preserve the ability to collect the tax that would be due if the new GRA were triggered and ensure that the terms of the GRA are administrable.

As described in this section, the temporary regulations require that the acquirer be a domestic corporation because, among other reasons, the IRS and Treasury Department are concerned that if a foreign acquirer is allowed to enter into a new GRA, it may be difficult for the IRS to collect any tax due in the event of a subsequent trigger of the GRA. However, the IRS and Treasury Department continue to study whether it would be appropriate to allow a domestic corporate shareholder of the U.S. transferor to enter into a new GRA when a U.S. transferor is acquired by a foreign corporation in an asset reorganization under conditions similar to those provided in §1.367(a)-3T(e). The IRS and Treasury Department welcome more detailed comments on specific approaches that could extend these rules to foreign acquisitions of the U.S. transferor.

The current regulations provide that, if a corporate U.S. transferor liquidates in a transaction that qualifies under sections 332 and 337, the GRA is triggered unless (1) the U.S. transferor filed a consolidated income tax return with a U.S. parent corporation both in the year of the initial transfer and the year of the liquidation, and (2) the common parent enters into a new GRA, with certain modifications. Section 1.367(a)-8(f)(2)(ii).

The temporary regulations provide a similar rule. However, the temporary regulations eliminate the consolidation continuity requirement, so the U.S. transferor is no longer required to be a member of the same consolidated group in the year of the initial transfer and the year of the liquidation. Consequently, the temporary regulations provide that where a U.S. transferor disposes of the stock of the foreign transferee corporation in a liquidation that qualifies under sections 332 and 337, the disposition will not constitute a triggering event provided that: (1) the distributee (successor U.S. transferor) is a domestic corporation described in section 332(b)(1); (2) the successor U.S. transferor or, if the successor U.S. transferor is a member of a consolidated group, the common parent of the successor U.S. transferor’s group, enters into a new GRA covering the remaining term of the original GRA (with certain modifications); (3) where the successor U.S. transferor is not a member of the original consolidated group immediately after the liquidation, the person entering into the GRA agrees that if there is a subsequent triggering event, the taxpayer will recognize the gain in the year of the triggering event (as opposed to the year of the initial transfer); and (4) the successor U.S. transferor provides, with its next annual certification, Form 8838 to extend the period of assessment of the tax on the initial transfer. If these conditions are satisfied, the original GRA will terminate without further effect.

For reasons similar to those discussed above in the context of asset reorganizations involving the U.S. transferor, the IRS and Treasury Department believe that the temporary regulations sufficiently address the government’s concerns in this area, including preserving the ability to collect tax due as a result of a subsequent triggering event. As a result, it is not necessary for the U.S. transferor to be a member of the same consolidated group in the year of the transfer and the year of the liquidation. In addition, the IRS and Treasury Department believe that it is appropriate to require an inclusion in the year of a subsequent triggering event if the successor U.S. transferor was not a member of a consolidated group with the U.S. transferor immediately before the liquidation for reasons similar to those discussed regarding asset reorganizations involving the U.S. transferor.

Notice 2005-74 provided that if, in a section 361 transaction, a transferee foreign corporation transfers stock or securities of a transferred corporation to a foreign acquiring corporation in an asset reorganization, the exchanges made pursuant to the reorganization will be a triggering event, unless certain conditions are met. These conditions require that the U.S. transferor, common parent, or new common parent corporation, as applicable, enter into a new GRA, with certain modifications. In addition, the U.S. transferor also is required to provide the new GRA and a notice of the asset reorganization with its next annual certification.

For purposes of this rule, Notice 2005-74 retained the same definition of asset reorganization as used for the provision dealing with transfers of transferee corporation stock, with certain modifications. Specifically, Notice 2005-74 excludes the following asset reorganizations: (1) triangular asset reorganizations described in §1.358-6(b); and (2) asset reorganizations where, after the reorganization, the same corporation is both the transferee foreign corporation (or successor transferee foreign corporation, as applicable) and the transferred corporation (or the successor transferred corporation, as applicable).

The temporary regulations generally incorporate these rules and provide that if the above conditions are satisfied the original GRA will terminate without further effect. However, even if these conditions are satisfied, the temporary regulations provide specific gain recognition rules if the transferee foreign corporation transfers stock or securities of the transferred corporation in an asset reorganization and the U.S. transferor recognizes gain under section 356(a)(1). See section C of this preamble.

As noted in this preamble, Notice 2005-74 excluded from the definition of the term asset reorganization any triangular asset reorganizations of the transferee foreign corporation and transferred corporation and certain upstream and downstream reorganizations. In response to comments and upon further study by the IRS and Treasury Department, the temporary regulations address the treatment of triangular asset reorganizations of the transferee foreign corporation and certain upstream and downstream reorganizations. See sections G and H of this preamble.

Notice 2005-74 provides that if a transferred corporation transfers substantially all its assets in an asset reorganization, the exchanges made pursuant to the reorganization will be a triggering event, unless certain conditions are met. These conditions require that the U.S. transferor, U.S. parent corporation or new U.S. parent corporation, as applicable, enters into a new GRA, with certain modifications. The U.S. transferor also is required to provide the new GRA and the notice of the asset reorganization with its next annual certification. The definition of asset reorganization is the same as that used in asset reorganizations involving the transferee foreign corporation.

The temporary regulations generally incorporate these rules and provide that if these conditions are met, the original GRA will terminate without further effect. However, even if these conditions are satisfied, the temporary regulations provide specific gain recognition rules (described in section C of this preamble) if the transferred corporation transfers substantially all of its assets in an asset reorganization and the transferee foreign corporation recognizes gain under section 356(a)(1). In addition, although the definition of asset reorganization excludes triangular asset reorganizations and downstream mergers of the transferee foreign corporation, the temporary regulations address the tax treatment of these transactions. See sections G and H of this preamble.

The current regulations provide that certain nonrecognition transactions are not triggering events if particular requirements are satisfied. However, commentators have stated that the current regulations provide that certain nonrecognition transactions at the transferee foreign corporation or transferred corporation level in which any money or other property (as described in sections 351(b) or 356(a)) is received in exchange are triggering events without exception. These commentators assert that it is not appropriate to trigger an entire GRA as a result of receiving a relatively minor amount of “boot” in the nonrecognition transaction. These commentators also note that the current regulations do not address clearly the treatment of transfers of transferee foreign corporation stock by a U.S. transferor in a nonrecognition transaction in which the U.S. transferor receives boot.

The IRS and Treasury Department agree that the receipt of boot under section 351(b) or 356(a)(1) in connection with the disposition of transferred corporation stock or securities, or substantially all of a transferred corporation’s assets, should not automatically trigger all the gain under a GRA. Accordingly, the temporary regulations provide that if certain conditions are met, the entire GRA will not be triggered when a transferee foreign corporation disposes of transferred corporation stock or securities in a nonrecognition transaction simply because the transferee foreign corporation receives boot.

However, the IRS and Treasury Department believe that the GRA should be triggered to the extent that gain would be recognized in such a transaction by a transferee foreign corporation or a transferred corporation, before taking into account basis increases that may apply to the stock or securities disposed of as a result of triggering the GRA. The current, as well as the temporary regulations, provide that if a U.S. transferor is required to recognize gain because of a triggering event, then certain basis increases are allowed as of the date of the initial transfer. Therefore, in determining the amount of gain that is recognized under the GRA in such a transaction, the temporary regulations provide that the U.S. transferor first must recognize that amount of gain that the transferee foreign corporation or transferred corporation would have recognized under 351(b) or 356(a)(1), before taking into account the basis increases that are allowed under the regulations as of the date of the initial transfer. Second, if the U.S. transferor has not recognized all the gain realized, but not recognized, on the initial transfer, then its new GRA will reflect any remaining unrecognized gain on the initial transfer. Third, after the consequences of the transaction are determined under the temporary regulations, then the taxpayer must determine the amount of gain, if any, that the transferee foreign corporation or transferred corporation must recognize under 351(b) or 356(a)(1). In determining the amount to be recognized, the basis of the stock disposed of shall reflect the basis increase allowed as a result of the gain recognized under the GRA by the U.S. transferor.

This special rule limiting recognition of gain in otherwise nonrecognition transactions involving boot applies only if the U.S. transferor complies with the otherwise applicable requirements of the exception to recognizing all of the gain subject to the GRA when there is a triggering event. This special rule is intended to require the U.S. transferor to recognize only an appropriate amount of income, without automatically triggering the entire GRA.

The IRS and Treasury Department also believe that additional guidance is needed on the treatment of transfers of transferee foreign corporation stock by a U.S. transferor in a nonrecognition exchange in which the U.S. transferor receives boot. Therefore, the temporary regulations treat the disposition of transferee foreign corporation stock in a nonrecognition transaction by the U.S. transferor when the U.S. transferor receives money or other property as described in section 351(b) or 356(a) as a termination of the GRA in whole or in part. Consequently, if a new GRA is filed, then the U.S. transferor will recognize gain under the new GRA in the event of a subsequent triggering event in the amount of the gain realized, but not recognized, in the initial transfer less any gain recognized by the U.S. transferor under section 351(b) and 356(a)(1) in connection with the nonrecognition transaction. If, however, a new GRA is not filed in connection with the nonrecognition transaction, then the original GRA is triggered, and the U.S. transferor must recognize the gain that was realized, but not recognized, on the initial transfer less any gain recognized by the U.S. transferor under section 351(b) or 356(a)(1) in connection with the nonrecognition transaction.

Commentators noted that the current regulation does not adequately address the effect on GRAs of certain transactions involving consolidated groups. For example, the commentators noted that it is not clear what effect a U.S. transferor becoming a member of a consolidated group has on an existing GRA. The current regulations do provide, however, that if a U.S. transferor is a member of a consolidated group at the time of the initial transfer and ceases to be a member of the group during the term of the GRA, the common parent of such group that entered into the GRA continues to be liable under the original GRA. Section 1.367(a)-8(b)(5)(ii). Several commentators have raised concerns that such a result is not appropriate because the actions of an acquirer could unilaterally affect the liability of the original consolidated group under the GRA.

The IRS and Treasury Department agree that the effect of these transactions needs to be clarified and rationalized. Accordingly, in response to these concerns, the temporary regulations provide specific rules addressing these transactions. In particular, the IRS and Treasury Department believe that the U.S. parent corporation of a consolidated group should not continue to be liable under a GRA with respect to a U.S. transferor that is no longer a member of such group.

The temporary regulations provide that when a U.S. transferor becomes a member of a consolidated group (including a transaction where it joins such a group after being a member of another consolidated group) the transaction is a triggering event unless certain conditions are met. If these conditions are satisfied, the original GRA is terminated without further effect. These conditions require the U.S. parent corporation of the consolidated group that the U.S. transferor joins (1) to enter into a new GRA for the remaining term of the original GRA and (2) to elect to recognize gain in the taxable year of any subsequent triggering event (as opposed to the year of the initial transfer). A notice of the consolidation transaction must also be filed with the next annual certification. The IRS and Treasury Department believe that these requirements ensure that a GRA remains in effect after a U.S. transferor joins a consolidated group. These requirements are also consistent with §1.1502-77(a), which provides that the common parent is the sole agent for each member of the consolidated group.

In addition, the temporary regulations also cover situations in which a U.S. transferor ceases to be a member of a consolidated group and does not become a member of a new consolidated group. In these cases, the transaction is a triggering event, unless certain conditions are met. If these conditions are satisfied, the original GRA is terminated without further effect. These conditions require the U.S. transferor (1) to enter into a new GRA for the remaining term of the original gain recognition agreement and (2) to elect that in the event of a subsequent triggering event the U.S. transferor will recognize gain in the year of the triggering event. The U.S. transferor must also provide notice of the deconsolidation with the next annual certification.

The current regulation provides that when a U.S. transferor goes out of existence in a transaction giving rise to a GRA, gain generally qualifies for nonrecognition treatment only if the U.S. transferor is owned by a single U.S. parent corporation, the U.S. transferor and its parent corporation file a consolidated Federal income tax return for the taxable year that includes the transfer, and the parent of the consolidated group enters into a GRA. Section 1.367(a)-8(f)(2)(i). The current regulation provides that a U.S. transferor that is controlled by five or fewer domestic corporations may request a ruling that the transaction qualifies for nonrecognition treatment. Section 1.367(a)-8(f)(2)(i).

Notice 2005-74, in turn, provides a rule that treats all members of the U.S. parent’s consolidated group for the taxable year that includes the transfer as a single corporation for purposes of §1.367(a)-8(f)(2)(i). Thus, a U.S. transferor that is not directly owned by a single U.S. parent corporation may still qualify for nonrecognition, without requesting a ruling, when the U.S. transferor goes out of existence in a transaction giving rise to a GRA, if it is indirectly wholly owned by members of a consolidated group.

The IRS and Treasury Department believe it is necessary to provide additional guidance on how GRAs are entered into when a U.S. transferor is controlled by multiple corporate shareholders with which the U.S. transferor does not join in filing a consolidated return. Moreover, the IRS and Treasury Department believe that in this area a single rule should apply both in consolidated and nonconsolidated situations. As a result, the temporary regulations provide unified rules, replacing both the current regulations and Notice 2005-74, in situations in which a U.S. transferor goes out of existence in a transaction giving rise to a GRA.

The temporary regulations generally provide that when a U.S. transferor goes out of existence in a transaction giving rise to a GRA, the gain may qualify for nonrecognition treatment if (1) the requirements of section 367(a)(5) and any regulations under that paragraph are satisfied such that five or fewer domestic corporations control the U.S. transferor and appropriate basis adjustments are made, (2) the requirements of §1.367(a)-3(c)(1) are satisfied if the transferred corporation is domestic, (3) all domestic corporate shareholders of the U.S. transferor that own at least five percent of either the total voting power or the total fair market value of the stock of the transferee foreign corporation immediately after the transaction enter into GRAs with respect to their pro rata share of the gain in the transferred stock or securities that designate such domestic corporate shareholders as U.S. transferors for purposes of §§1.367(a)-3(b) and (c) and 1.367(a)-8T, and (4) all domestic corporate shareholders that enter into GRAs elect to recognize any gain upon a subsequent trigger of the GRA in the year of the triggering event.

The temporary regulations eliminate the current regulation’s option to request a private letter ruling because guidance is now provided on how GRAs are entered into by five or fewer domestic corporations that control a U.S. transferor satisfying section 367(a)(5). In addition, the temporary regulations clarify that the terms of section 367(a)(5) must be satisfied (along with other requirements) to avoid gain recognition on the U.S. transferor’s section 361 transfer of stock or securities to a foreign acquiring corporation. Therefore, the rule in Notice 2005-74 treating consolidated group members as a single corporation is incorporated by reference to section 367(a)(5), which provides that all members of the same affiliated group are treated as one corporation. Lastly, because these rules address how gain recognition may be avoided under section 367(a)(1) on the initial transfer itself, rather than the effect of subsequent transactions on existing GRAs, these rules have been removed from §1.367(a)-8 and included instead in §1.367(a)-3T(e).

Under the current regulations, dispositions of substantially all of the assets of the transferred corporation (within the meaning of section 368(a)(1)(C)) are generally treated as deemed dispositions of the stock or securities of the transferred corporation and therefore are triggering events. Section 1.367(a)-8(e)(3). In Revenue Ruling 57-518, 1957-2 C.B. 253, see §601.601(d)(2), the IRS stated that what constitutes “substantially all of the properties” as the term is used in section 368(a)(1)(C) “will depend upon the facts and circumstances in each case rather than upon any particular percentage.” However, Revenue Procedure 77-37, 1977-2 C.B. 568, see §601.601(d)(2), provides that for ruling purposes, the transfer by a corporation of 70 percent of its gross assets or 90 percent of its assets net of liabilities will generally be deemed to be a transfer of substantially all of the assets of a corporation.

Commentators have noted that defining substantially all by reference to section 368(a)(1)(C) may not be appropriate in the context of the GRA rules. The IRS and Treasury Department, however, generally believe that defining “substantially all” for these purposes by reference to the definition of the term under section 368(a)(1)(C) is appropriate. Nonetheless, the IRS and Treasury Department believe that it is important to clarify the scope of the term “substantially all,” as used in the current regulation and the temporary regulations. One commentator suggested that if a transferred corporation disposes of less than 70 percent of its gross assets or 90 percent of its assets net of liabilities, the transfer will not be treated as a disposition of substantially all of the assets of the transferred corporation for purposes of §1.367(a)-8(e)(3), and thus, such a disposition would not trigger a GRA. This suggestion is not correct. If, upon considering the facts and circumstances, a transferred corporation has disposed of substantially all its assets, such a transaction is a triggering event, even if the transferred corporation disposes of less than 70 percent of a corporation’s gross assets or 90 percent of its assets net of liabilities. The “substantially all” safe harbor provided in Revenue Procedure 77-37 is intentionally high so that the IRS does not need to engage in a factually detailed analysis before issuing a letter ruling. As a result, in the context of GRAs, the Revenue Procedure’s threshold does not mean that a disposition of substantially all the assets does not occur upon the disposition of a lesser amount of assets. Therefore, the temporary regulations provide that whether a transferred corporation has disposed of substantially all of its assets is determined under all the facts and circumstances.

Section 1.367(a)-8(h)(1) provides that a GRA will terminate, in whole or in part, as a result of certain taxable dispositions of the transferee foreign corporation stock by the U.S. transferor. A key premise for this termination rule is that the basis in the transferee foreign corporation stock received by the U.S. transferor in the initial transfer is assumed to reflect the basis in the transferred stock or securities.

The IRS and Treasury Department continue to believe this termination rule is appropriate. As a result, the temporary regulations generally retain this rule. However, the temporary regulations modify the termination rule to ensure that a GRA terminates only when the transferee foreign corporation stock disposed of in fact reflects the basis of the transferred stock or securities. This termination rule only applies to transferee foreign corporation stock that is received (or deemed received) in the initial transfer. The IRS and Treasury Department understand that in some cases, taxpayers may take the position that the basis in the transferee foreign corporation stock does not reflect the basis of the transferred stock or securities. For example, taxpayers may take the position that the basis in such transferee foreign corporation stock received also reflects the basis of other property that had a built-in loss when it was transferred to the transferee foreign corporation. Thus, the termination rule in the temporary regulations will apply only when the basis of the transferee foreign corporation stock received (or deemed received) in the initial transfer properly reflects the sum of the aggregate basis of the transferred stock or securities immediately before the initial transfer, plus any increase in the basis of such stock or securities as a result of recognizing gain on the transfer. In addition, for purposes of this basis determination, basis increases to the transferee foreign corporation stock as a result of income inclusions (for example, pursuant to section 961) shall not be taken into account.

In cases where the basis of the relevant transferee foreign corporation stock exceeds the basis of the transferred stock or securities, however, the temporary regulations allow the U.S. transferor to take advantage of this termination rule if it elects to reduce its basis in the transferee foreign corporation stock such that it does not exceed the basis it had in the transferred stock or securities. If the U.S. transferor makes this election, the basis reduction will be effective immediately before the taxable disposition that terminates the GRA. In addition, if the U.S. transferor makes this election, it may increase its basis in other stock of the transferee foreign corporation it holds, if any, by a corresponding amount but not above the fair market value of such stock.

Similar rules apply in the case of partial dispositions of transferee foreign corporation stock and dispositions of transferee foreign corporation stock in nonrecognition transactions in which a portion of the realized gain is recognized.

Section 1.367(a)-8(h)(3) provides that a distribution of the transferred stock in a transaction qualifying under section 355 or sections 332 and 337 will terminate the GRA if the U.S. transferor’s basis in the transferred stock or securities that it receives in the section 355 or 332 and 337 transaction does not exceed the basis the U.S. transferor had in the transferred stock or securities immediately before the initial transfer. In response to comments, however, the temporary regulations allow the U.S. transferor to take advantage of this termination rule if it elects to reduce the basis of the transferred stock or securities if the basis exceeds the basis the U.S. transferor had in the transferred stock or securities immediately before the initial transfer. For purposes of this basis determination, basis increases to the transferred stock as a result of income inclusions (for example, pursuant to section 961) shall not be taken into account. If the U.S. transferor elects to reduce basis in the transferred stock or securities it receives, the U.S. transferor shall increase its basis in other transferee foreign corporation stock (if any) by a corresponding amount but not above the fair market value of such stock.

Although the temporary regulations generally provide that a GRA terminates in certain section 332 liquidations of the transferee foreign corporation, the IRS and Treasury Department are studying to what extent this rule should apply when the transferee foreign corporation has a minority shareholder and therefore recognizes gain under section 336 in connection with the section 332 liquidation. As noted in the request for comments, although the IRS and Treasury Department generally believe it is appropriate to terminate entirely the GRA in a section 332 liquidation, in other circumstances it may not be appropriate. For example, if after an initial transfer, a wholly-owned transferee foreign corporation issues a minority interest to a foreign shareholder, completely terminating the GRA upon a section 332 liquidation of the transferee foreign corporation does not account for the fact that the U.S. transferor has indirectly disposed of up to 20 percent of its interest in the transferred stock or securities. Therefore, when the temporary regulations are finalized, the IRS and Treasury Department may address the effect that section 336 gain has on a gain recognition agreement when a transferee foreign corporation with a minority shareholder liquidates under section 332.

The temporary regulations expand the current rule to terminate GRAs when certain U.S. persons other than the original U.S. transferor receive the stock or securities that was transferred in the initial transfer. For example, if the transferred corporation is distributed to a domestic corporation or U.S. individual other than the U.S. transferor in a section 355 “split off,” the GRA would terminate if the domestic corporation or U.S. individual receives the transferred stock or securities with a basis that is not greater than the basis the U.S. transferor had in the transferred stock or securities immediately before the initial transfer.

Finally, and in response to comments requested in Notice 2005-74, the temporary regulations also expand the current rule to provide that the GRA will terminate in additional transactions where the U.S. transferor or a domestic corporation receives the transferred stock or securities with a basis that is not greater than the basis the U.S. transferor had in the transferred stock or securities immediately before the initial transfer. These transactions are upstream asset reorganizations where the U.S. transferor acquires the assets of the transferee foreign corporation, downstream asset reorganizations where the transferred corporation acquires the assets of the transferee foreign corporation, and certain other asset reorganizations where a domestic corporation acquires the assets of the transferee foreign corporation. Consequently, the temporary regulations generally provide that the GRA terminates in particular circumstances when the transferred stock or securities are held with the correct basis by certain U.S. persons, even if the U.S. person is not the original U.S. transferor.

However, the IRS and Treasury Department believe that it is not appropriate for the GRA to terminate when the transferred stock or securities may then be disposed of, directly or indirectly, by a foreign shareholder without being subject to U.S. tax. Therefore, this termination rule is limited to section 332 liquidations, section 355 distributions, and asset reorganizations where the domestic corporation that holds the transferred stock or securities after the transaction is either the U.S. transferor or a member of the same consolidated group of which the U.S. transferor is then a member. The IRS and Treasury Department continue to study whether it would be appropriate to expand the scope of the rule to transactions where the acquirer is not a member of the same consolidated group of which the U.S. transferor is then a member and request comments regarding such a rule.

Notice 2005-74 provides rules that allow a U.S. transferor to avoid gain recognition on certain asset reorganizations of the transferee foreign corporation and transferred corporation. However, Notice 2005-74 restricts the definition of “asset reorganization” to exclude triangular asset reorganizations of the transferee foreign corporation and transferred corporation.

In response to comments and after further study, the temporary regulations address the treatment of certain triangular asset reorganizations. Specifically, they provide that if the transferee foreign corporation or transferred corporation is acquired in a triangular asset reorganization, the exchanges made pursuant to the reorganization will not be triggering events if certain requirements are satisfied. For purposes of this rule, a triangular asset reorganization is limited to a transaction in which the acquiring subsidiary is foreign. The additional requirements are as follows. First, the U.S. transferor or common parent must enter into a new GRA to recognize gain with respect to the initial transfer during the remaining term of the original GRA, with certain modifications. In the case of a triangular asset reorganization of the transferee foreign corporation, the U.S. transferor also must make certain designations depending on whether the parent corporation of the foreign acquiring subsidiary is foreign or domestic and depending on the type of triangular asset reorganization. Finally, the U.S. transferor must provide notice of the transaction with its next annual certification.

The current regulations refer to “stock of the transferred corporation” in some paragraphs but refer to “stock or securities of the transferred corporation” in other paragraphs. The temporary regulations refer to “stock or securities of the transferred corporation” because either stock or securities, or both, may be subject to a GRA when transferred to a transferee foreign corporation by a U.S. person. In contrast, the temporary regulations generally refer only to stock, and not securities, of the transferee foreign corporation. The rules applying to a disposition of the transferee foreign corporation are concerned primarily with transactions in which the U.S. transferor loses or decreases its control of the transferee foreign corporation, which does not occur when a U.S. transferor disposes of securities of the transferee foreign corporation.

The current regulation provides a reasonable cause exception to triggering a GRA when the person required to file the GRA fails to comply in any material respect with the terms of a GRA, or when the person fails to meet the timeliness requirement for submitting a GRA. The temporary regulations retain this reasonable cause exception but provide additional guidance on how the person should submit a request for reasonable cause relief. The temporary regulations also provide that the Area Director or Director of Field Operations, as applicable, shall notify the person in writing within 120 days of the filing if the person will be granted reasonable cause relief or if additional time is required to make the determination. The 120-day period runs from the date that the IRS notifies the person that its request has been received. Once this period begins, the person shall be deemed to have established reasonable cause if it is not again notified within 120 days.

(a) * * * In general, a transfer of stock or securities by a U.S. person to a foreign corporation that is described in section 351, 354 (including a reorganization described in section 368(a)(1)(B) and including an indirect stock transfer described in paragraph (d) of this section), 356 or section 361(a) or (b) is subject to section 367(a)(1) and, therefore, is treated as a taxable exchange, unless one of the exceptions set forth in paragraph (b) of this section (regarding transfers of foreign stock or securities), paragraph (c) of this section (regarding transfers of domestic stock or securities), or paragraph (e) of this section (regarding transfers of stock or securities in a section 361 exchange) applies. * * *

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(d) * * *

(2)(iii) * * * For purposes of determining the amount of gain that a U.S. person is required to include in income as a result of a triggering event, see §1.367(a)-8T(b)(3)(i) and (d).

(iv) * * * The U.S. transferor’s agreement to recognize gain, as provided in §1.367(a)-8, shall include appropriate provisions consistent with the principles of §1.367(a)-3 and §1.367(a)-8, including, for example, as an additional triggering event an indirect disposition of the transferred stock or securities. For example, in the case of a triangular section 368(a)(1)(B) reorganization described in paragraph (d)(1)(iii)(A) of this section, a triggering event shall include an indirect disposition of the transferred stock or securities by the transferee foreign corporation, such as a disposition of the stock of the acquiring corporation (either foreign or domestic) by the transferee foreign corporation. In the case of a triangular section 368(a)(1)(B) reorganization described in paragraph (d)(1)(iii)(B) of this section, a disposition of the stock of the acquiring corporation by the domestic issuing corporation in a taxable transaction shall, for example, terminate the gain recognition agreement if the principles of §1.367(a)-8T(g)(1)(i)(A) and (B) are satisfied. See Examples 5 and 5A of this section.

(v) Determination of whether substantially all of the transferred corporation’s assets are disposed of. For purposes of applying §1.367(a)-8T(d)(2) to determine whether substantially all of the assets of the transferred corporation have been disposed of, the following assets shall be taken into account (but only if such assets are not fully taxable under section 367 in the taxable year that includes the indirect transfer)—

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(3) * * *

Example 1A. * * *

(ii) * * * If A leaves the P group, the gain recognition agreement would be triggered pursuant to §1.367(a)-8T(d)(4), unless the exception provided under §1.367(a)-8T(e)(8) applies.

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Example 5A * * *

(ii) * * * If Y sold substantially all of its assets (within the meaning of section 368(a)(1)(C)), the gain recognition agreement would be terminated because U owned an amount of stock in Y described in section 1504(a)(2) immediately before the transaction and Y is a domestic corporation. See §1.367(a)-8T(g)(2). In addition, if F disposed of the stock of S in a taxable transaction the gain recognition agreement would be terminated if the principles of §1.367(a)-8T(g)(1)(i)(A) and (B) are satisfied.

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Example 7. * * *