SECTION 2. BACKGROUND

.01 Section 367(a)

Section 367(a)(1) provides that if, in connection with any exchange described in section 332, 351, 354, 356, or 361, a United States person (U.S. person) transfers property to a foreign corporation, the foreign corporation shall not, for purposes of determining the extent to which gain shall be recognized on such transfer, be considered to be a corporation. Sections 367(a)(2), (3), and (6) provide exceptions to the general rule of section 367(a)(1) and grant regulatory authority to the Secretary to provide additional exceptions and to limit the statutory exceptions.

.02 Section 367(b)

Section 367(b)(1) provides that, in the case of an exchange described in section 332, 351, 354, 355, 356, or 361 in con

nection with which there is no transfer of property described in section 367(a)(1), a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary that are necessary or appropriate to prevent the avoidance of U.S. 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 U.S. person, including regulations providing the circumstances under which gain is recognized or deferred, amounts are included in gross income as a dividend, adjustments are made to earnings and profits, or adjustments are made to the basis of stock or securities.

.03 Section 1.367(b)–10

(a) In General

Section 1.367(b)–10 (final regulations) applies to certain triangular reorganizations in which a subsidiary (S) acquires stock or securities of its parent corporation (P) in exchange for property (the P acquisition), and S exchanges the P stock or securities so acquired for stock, securities, or property of a target corporation (T). The final regulations do not apply unless P or S (or both) is a foreign corporation. The application of the final regulations is also subject to certain exceptions, including the section 367(a) priority rule discussed below.

When applicable to a triangular reorganization, the final regulations require that adjustments be made that have the effect of a distribution of property from S to P under section 301 (deemed distribution). § 1.367(b)–10(b)(1). For this purpose, the amount of the deemed distribution generally is the amount of property that was transferred by S to acquire the P stock and securities in the P acquisition. Id. For purposes of making the required adjustments, the final regulations treat the deemed distribution as a separate transaction that occurs before the P acquisition or, if P does not control S at the time of the P acquisition, immediately after P acquires control

of S, but before the triangular reorganization. § 1.367(b)–10(b)(3).

The term property for purposes of the final regulations has the meaning set forth in section 317(a) (that is, money, securities, and any other property, other than stock in the corporation making the distribution), as modified to take into account certain assumed liabilities and S stock or rights used by S to acquire P stock or securities from a person other than P. § 1.367(b)–10(a)(3)(ii).

(b) Priority Rules

Section 1.367(b)–10(a)(2)(iii) provides that the final regulations do not apply to a triangular reorganization if, in an exchange under section 354 or 356, one or more U.S. persons exchange stock or securities of T and the amount of gain in the T stock or securities recognized by such U.S. persons under section 367(a)(1) is equal to or greater than the sum of the amount of the deemed distribution that would be treated by P as a dividend under section 301(c)(1) and the amount of such deemed distribution that would be treated by P as gain from the sale or exchange of property under section 301(c)(3) (together, section 367(b) income) if the final regulations otherwise would apply to the triangular reorganization (section 367(a) priority rule).

Section 1.367(a)–3(a)(2)(iv) provides a similar priority rule that turns off the application of section 367(a)(1) to an exchange under section 354 or 356 that occurs in connection with a triangular reorganization described in the final regulations if the amount of gain that otherwise would be recognized under section 367(a)(1) (without regard to any exceptions thereto) is less than the amount of the section 367(b) income recognized under the final regulations (section 367(b) priority rule).

(c) Anti-Abuse Rule

The final regulations provide that appropriate adjustments shall be made if, in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of the final

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regulations (anti-abuse rule). § 1.367(b)– 10(d). The anti-abuse rule sets forth one example, which provides that the earnings and profits of S will be deemed to include the earnings and profits of a corporation related to P or S for purposes of determining the consequences of the adjustments provided in the final regulations, if S is created, organized, or funded to avoid the application of the final regulations with respect to the earnings and profits of that related corporation. Id.

(d) Notice 2014–32

On April 25, 2014, the Treasury Department and the IRS issued Notice 2014–32 (2014–20 IRB 1006) (2014 notice), which announced the intention to issue regulations modifying and clarifying the final regulations. The 2014 notice addressed, in part, certain inversion transactions that were structured to be subject to the final regulations in order to avoid shareholder-level gain recognition under section 367(a)(1) by reason of the section 367(b) priority rule, notwithstanding that only a minimal amount of income was subject to U.S. tax by reason of a deemed distribution under the final regulations. The 2014 notice announced that the final regulations would be modified to provide that section 367(b) income includes a section 301(c)(1) dividend or section 301(c)(3) gain that would arise if the final regulations applied to the triangular reorganization only to the extent such dividend income or gain would be subject to U.S. tax or would give rise to an income inclusion under section 951(a)(1)(A) that would be subject to U.S. tax.

The 2014 notice also announced that the anti-abuse rule would be clarified to provide that S’s acquisition of P stock or securities in exchange for a note may invoke the anti-abuse rule, and that the earnings and profits of a corporation (or a successor corporation) may be taken into account for purposes of determining the consequences of the adjustments provided in the final regulations, as modified by the rules announced in the notice, regardless of whether such corporation is related to P or S before the triangular reorganization.

Finally, the 2014 notice announced that the anti-abuse rule would be clarified to provide that a funding of S may occur

after the triangular reorganization and that a funding of S could include capital contributions, loans, and distributions.

.04 Sections 1.367(b)–4 and 1.367(b)– 4T

Sections 1.367(b)–4 and 1.367(b)–4T apply to certain acquisitions by a foreign corporation of the stock or assets of a foreign corporation (referred to in those regulations and this notice as the “foreign acquired corporation”) in an exchange described in section 351 or in a reorganization described in section 368(a)(1). Sections 1.367(b)–4T(b) and 1.367(b)–4(b) (1) provide that, if the potential application of section 1248 cannot be preserved following the acquisition of the stock or assets of a foreign corporation by another foreign corporation in an exchange subject to section 367(b), then certain exchanging shareholders of the foreign acquired corporation must include in income as a dividend the section 1248 amount attributable to the stock of the foreign acquired corporation exchanged. However, the scope and purpose of the grant of authority in section 367(b) are not limited to the preservation of section 1248 amounts, and the regulations thereunder are not limited to requiring an inclusion of the section 1248 amount with respect to the stock of a foreign acquired corporation exchanged. Section 367(b) provides the Treasury Department and the IRS broad authority to issue regulations applicable to nonrecognition transactions that are “necessary or appropriate to prevent the avoidance of Federal income taxes,” including regulations that prescribe “the circumstances under which gain shall be recognized currently, or amounts included in gross income currently as a dividend, or both.”

.05 Inbound Transactions and the All Earnings and Profits Amount

Section 1.367(b)–3 applies when a foreign corporation transfers assets to a domestic corporation pursuant to either a liquidation described in section 332 or an asset reorganization described in section 368 (in each case, an “inbound transaction”). Section 1.367(b)–3(a) and this notice refer to such foreign corporation as the “foreign acquired corporation” and

such domestic corporation as the “domestic acquiring corporation.” When there is an inbound transaction, in general, § 1.367(b)–3 requires certain shareholders (including certain foreign corporate shareholders) of the foreign acquired corporation to include in income as a deemed dividend the all earnings and profits amount with respect to their stock. Under § 1.367(b)–2(d), the all earnings and profits amount of a foreign acquired corporation is determined under the principles of section 1248 for computing the amount of earnings and profits attributable to stock, with certain modifications. For example, the all earnings and profits amount does not take into account earnings and profits of foreign subsidiaries of the foreign acquired corporation, notwithstanding section 1248(c)(2). § 1.367(b)–2(d)(3)(ii).

Section 1.367(b)–3 is intended to ensure that a domestic acquiring corporation does not succeed to the basis in the assets of the foreign acquired corporation except to the extent that a U.S. person that is a shareholder (including indirect ownership through certain foreign corporate shareholders) of the foreign acquired corporation has been subject to U.S. tax on its share of the earnings and profits that gave rise, in whole or in part, to the basis. See, for example, the discussion concerning inbound transactions in the preambles to TD 8862 (65 FR 3589–01, 2000–1 CB 466) and proposed regulations issued in 1991 (56 FR 41993, 1991–2 CB 1070). The definition of the all earnings and profits amount, in particular its limitation with respect to the earnings and profits of subsidiaries, is premised on an assumption that the basis in the assets of the foreign acquired corporation reflects solely the earnings and profits of the foreign acquired corporation, the liabilities of the foreign acquired corporation, and capital acquired from a shareholder.

.06 Nonqualified Preferred Stock

Section 351(g)(1) provides, in relevant part, that section 351(a) does not apply to a transfer of property in exchange for nonqualified preferred stock, as defined in section 351(g)(2).

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