SECTION 4. APPLICATION OF

SECTION 367(b)

Congress enacted section 367(b) to ensure that international tax considerations are adequately addressed when the subchapter C provisions apply to certain nonrecognition exchanges involving foreign corporations. This provision was necessary because the subchapter C provisions were enacted largely to address transactions involving domestic corporations and shareholders that are United States persons. As a result, the subchapter C provisions do not fully account for international tax concerns that arise when the provisions apply to transactions involving foreign corporations or shareholders that are not U.S. persons.

In enacting section 367(b), Congress noted that “it is essential to protect against tax avoidance in transfers to foreign corporations and upon the repatriation of previously untaxed foreign earnings....” H.R. Rep. No. 658, 94th Cong., 1 ^st Sess. 241 (1975). In addition, because determining the proper interaction of the Code’s international and subchapter C provisions is “necessarily highly technical,” Congress granted the Secretary broad regulatory authority to provide the “necessary or appropriate” rules to prevent the avoidance of Federal income taxes, rather than enacting a more comprehensive statutory regime. Id. This broad grant of authority has been exercised on numerous occasions to address a wide range of international policy concerns. See, e.g., Treas. Reg. §§1.367(b)–4(b)(1) (preserving section 1248 amounts), (b)(2) (addressing trafficking in foreign tax credits by use of preferred stock), –5(b)(1)(ii) (ensuring section 311(b) gain is recognized by a domestic corporation when it distributes stock of a controlled foreign corporation to an individual distributee under section 355), and –7 (addressing the carryover of tax attributes in a foreign-to-foreign section 381 transaction).

a corporation. The Secretary has broad authority under section 367(a)(2), (3), and (6) to provide that section 367(a)(1) will not apply to certain transfers described therein.

In the case of any exchange described in section 332, 351, 354, 355, 356, or 361 in connection with which there is no transfer of property described in section 367(a)(1), section 367(b)(1) provides that a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes.

Section 367(b)(2) provides that the regulations prescribed pursuant to section 367(b)(1) shall include (but shall not be limited to) regulations dealing with the sale or exchange of stock or securities in a foreign corporation by a United States person, including regulations providing, among other things, the circumstances under which gain is recognized, amounts are included in gross income as a dividend, adjustments are made to earnings and profits, or adjustments are made to basis of stock or securities.

.03 Distributions of property

Section 301(c)(1) provides that a distribution of property by a corporation to its shareholder with respect to its stock is included in the shareholder’s gross income to the extent the distribution constitutes a dividend under section 316. Section 316 defines a dividend as a distribution out of a corporation’s current and accumulated earnings and profits. To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation’s stock, and any amount of the distribution in excess of the shareholder’s basis is treated as gain from the sale or exchange of the corporation’s stock. See section 301(c)(2) and (3).

Certain transactions that are exchanges in form can be treated as distributions for tax purposes. Section 304 generally provides that when a shareholder transfers stock of a controlled corporation to another controlled corporation in exchange for property, the two legs of the exchange are bifurcated and the receipt of the property by the shareholder is treated as a distribution. Section 304, by its terms, does not apply to the transfer by a shareholder

of its own stock to a controlled corporation in exchange for property, even though the economic effect of that transaction is essentially identical.

Other transactions may result in deemed distribution treatment in certain circumstances. For example, a shareholder that exchanges common stock of a corporation for common stock and property pursuant to a recapitalization will be treated as receiving a distribution of property with respect to its stock under section 301 if in substance the distribution is a separate transaction. See Treas. Reg. §1.301–1(l); see also, Bazley v. Comm’r, 331 U.S. 737 (1947).

.04 Distributions involving foreign corporations or foreign shareholders

The treatment of a distribution varies depending upon whether the corporation or shareholder is domestic or foreign. A distribution from a foreign corporation to a shareholder that is a U.S. person resulting in a dividend under sections 301(c)(1) and 316, or gain from the sale or exchange of property under section 301(c)(3), generally is subject to U.S. income tax, with potential offset by foreign tax credits.

A distribution from a domestic corporation to a shareholder that is not a U.S. person resulting in a dividend is generally taxable under section 871 or 881 at a rate of 30 percent, subject to reduction under an applicable treaty, and the domestic corporation is responsible for withholding tax under section 1441 or 1442. To the extent such a distribution results in gain from the sale or exchange of property to the foreign shareholder under section 301(c)(3), such amounts are subject to U.S. income tax under section 897(a) if the distributing corporation had been a United States real property holding corporation (as defined in section 897(c)(2)) within the past five years. In such a case, the gain is subject to U.S. income tax as income effectively connected with the conduct of a trade or business within the United States.

Finally, a distribution from a foreign corporation to a shareholder that is a controlled foreign corporation, within the meaning of section 957, resulting in a dividend or gain from the sale or exchange of property to the foreign shareholder under section 301(c)(3) may also be subject to U.S. income tax. For example, such

October 10, 2006 679 2006–41 I.R.B.

Chief Counsel (Corporate). However, other personnel from the IRS and Treasury participated in its development. For further information regarding this notice, contact Mr. McCall at (202) 622–3860 (not a toll-free call). For comments or questions regarding subchapter C issues, contact Mr. McKeever at (202) 622–7750.

“Tie-breaking” Rule for Two or More Taxpayers Claiming a Child as a Qualifying Child

Notice 2006–86

PURPOSE

This notice provides interim guidance under § 152(c)(4) of the Internal Revenue Code, the rule for determining which taxpayer may claim a qualifying child when two or more taxpayers claim the same child under any of the following provisions: (1) head of household filing status under § 2(b), (2) the child and dependent care credit under § 21, (3) the child tax credit under § 24, (4) the earned income credit under § 32, (5) the exclusion for dependent care assistance under § 129 (which incorporates by reference the definition of qualifying child or other qualifying individual under § 21), and (6) the dependency deduction under § 151. This notice clarifies that, unless the special rule in § 152(e) applies, the tie-breaking rule in § 152(c)(4) applies to these provisions as a group, rather than on a section-by-section basis.

Section 152 was amended by § 201 of the Working Families Tax Relief Act of 2004 (WFTRA), Pub. L. No. 108–311, 118 Stat. 1169, effective for taxable years beginning after December 31, 2004. The Internal Revenue Service and Treasury Department intend to issue regulations consistent with the guidance contained in this notice. The guidance in this notice applies until those regulations are effective.

BACKGROUND

Definition of a qualifying child

Section 151 allows a taxpayer a deduction of the exemption amount for each individual who is a dependent (as defined in § 152) of the taxpayer for the taxable year.

In a triangular reorganization, the exchange by the T shareholders of their T stock for P stock is described in section 354 or 356. As a result, a triangular reorganization involving a foreign corporation is described in section 367(b) and, therefore, may be subject to regulations issued under the broad regulatory authority granted therein. It is on this basis that regulations will be issued to address the triangular reorganizations covered by this notice.