SECTION 3. TRANSACTIONS AT

ISSUE

The Treasury Department and the IRS are aware that taxpayers are engaging in transactions designed to repatriate earnings and basis of foreign corporations without incurring U.S. tax by exploiting the section 367(a) priority rule, as modified by the 2014 notice. In one such transaction, USP, a domestic corporation, wholly owns FP, a foreign corporation, which, in turn, wholly owns FS, another foreign corporation. FP has no earnings and profits, but FS has substantial earnings and profits. A dividend from FS to FP would qualify for the exception to foreign personal holding company income under section 954(c)(6). USP also wholly owns USS, a domestic corporation, which, in turn, wholly owns FT, a foreign corporation. Pursuant to a transaction undertaken for the purported business purpose of integrating FT into the FP-FS ownership chain, FS acquires FP stock from FP in exchange for cash, a note, or other property (the FP acquisition) and uses the FP stock to acquire all of the stock of FT from USS in a transaction intended to qualify as a reorganization described in section 368(a)(1)(B) (FT reorganization). On a later date, and purportedly unrelated to the FT reorganization, FP engages in an inbound transaction described in § 1.367 (b)–3, for example, a transfer of all of FP’s assets, including the cash, note, or other property received from FS, to USP or a domestic subsidiary of USP.

In this transaction, the transfer by USS of the FT stock to FS in exchange for stock of FP pursuant to the FT reorganization is an indirect stock transfer described in § 1.367(a)–3(d)(1)(iii)(A). Pursuant to § 1.367(a)–3(b), the taxpayer files a gain recognition agreement under § 1.367(a)–8 with respect to USS’s transfer of FT stock on all but a de minimis amount of FT stock, and, with respect to that de minimis amount of FT stock, recognizes a small amount of gain under section 367(a)(1). Furthermore, the taxpayer applies the priority rules by comparing the section 367(b) income to the de minimis amount of gain under section 367(a)(1) to determine whether the final regulations apply to the FP acquisition. In computing the amount of section 367(b) income for

purposes of the section 367(a) priority rule, the taxpayer takes the position that a deemed distribution from FS to FP would not result in section 367(b) income, as described in the 2014 notice, because any dividend income to FP would not be subject to U.S. tax and would not give rise to an income inclusion under section 951(a)(1)(A) by reason of section 954(c) (6). Accordingly, the taxpayer takes the position that the section 367(b) income (which, under this position, is zero) does not exceed the section 367(a) gain and, therefore, the final regulations do not apply to the FP acquisition by reason of the section 367(a) priority rule. Furthermore, the taxpayer takes the position that the subsequent inbound transaction with respect to FP results in no income inclusion to USP under § 1.367(b)–3 because FP’s earnings and profits are not increased under the final regulations and thus FP’s all earnings and profits amount is zero. Finally, the taxpayer takes the position that the anti-abuse rule does not apply in this case for various reasons that may include: (1) the FP acquisition is not engaged in with a view to avoid the purpose of the final regulations because it is engaged in for the purpose of integrating FT into the FP-FS chain; (2) the FP acquisition is not a transaction that occurs in connection with the FT reorganization because the acquisition is specifically contemplated by the final regulations; (3) the inbound transaction with respect to FP does not occur in connection with the FT reorganization because it does not occur pursuant to the same plan as the FT reorganization; or (4) the anti-abuse rule only applies to adjust the earnings and profits of FS to take into account the earnings and profits of another corporation and, in this regard, FS is not created, organized, or funded to avoid the purpose of the final regulations with respect to the earnings and profits of another corporation.

The Treasury Department and the IRS also are aware of a similar transaction in which taxpayers take advantage of the rule in section 951(a)(1)(A) that requires a U.S. shareholder to include in its gross income its pro rata share of the subpart F income of a foreign corporation only if the foreign corporation has been a controlled foreign corporation for an uninterrupted period of 30 days or more during the

taxable year (the 30-day rule). In this form of the transaction, FP is formed, and the FP acquisition occurs, during the final 29 days of FP’s taxable year. In computing the amount of section 367(b) income for purposes of the section 367(a) priority rule in this transaction, the taxpayer takes the position that a deemed distribution from FS to FP would not result in any section 367(b) income, as described in the 2014 notice, because any income recognized by FP (including capital gain under section 301(c)(3)) would not be subject to U.S. tax and would not give rise to an income inclusion under section 951(a)(1) (A) by reason of the 30-day rule.

The Treasury Department and the IRS also are aware of another variation of the transaction intended to repatriate earnings of a foreign corporation without U.S. tax through the use of nonqualified preferred stock. In one such transaction, USP, a domestic corporation, wholly owns both FP, a foreign corporation, and USS, a domestic corporation. USS wholly owns FT, a foreign corporation, which has substantial earnings and profits. FP has no earnings and profits. FP acquires newlyissued stock of USP from USP in exchange for nonqualified preferred stock of FP, and then FP uses the USP stock as consideration to acquire all of the stock of FT from USS in a transaction intended to qualify as a reorganization described in section 368(a)(1)(B). On a subsequent date, when FP still has no earnings and profits, FP redeems the FP nonqualified preferred stock held by USP in exchange for cash or a note.

The taxpayer takes the position that FP’s acquisition of USP stock is not subject to the final regulations because the FP nonqualified preferred stock is not “property” within the meaning of § 1.367(b)– 10(a)(3)(ii). Furthermore, the taxpayer takes the position that USP’s transfer of its own stock to FP in exchange for nonqualified preferred stock does not qualify as an exchange described in section 351 pursuant to section 351(g)(2) and, therefore, USP takes a basis in the FP nonqualified preferred stock equal to its fair market value under § 1.1032–1(d). In addition, the taxpayer takes the position that the redemption of the FP nonqualified preferred stock does not result in dividend income or capital gain to USP under sec

December 27, 2016 910 Bulletin No. 2016–52

tion 301(c) because FP does not have earnings and profits and the redemption is applied against and reduces USP’s basis in the FP stock under section 301(c)(2). Finally, the taxpayer takes the position that the anti-abuse rule does not apply in such a case for reasons similar to those discussed above in the context of the transaction involving section 954(c)(6).

The Treasury Department and the IRS have determined that these transactions raise significant policy concerns and that the revisions to the regulations described in Section 4 of this notice are necessary or appropriate to prevent the avoidance of U.S. federal income taxes. The Treasury Department and the IRS intend to revise the regulations under section 367 accordingly.