SECTION 4. REGULATIONS TO BE

ISSUED

.01 Priority Rules

The Treasury Department and the IRS intend to modify the section 367(a) priority rule to apply only when T is a domestic corporation. Accordingly, when T is a foreign corporation, the final regulations, as modified by the rules described in this notice, will apply to a triangular reorganization described in § 1.367(b)–10(a)(1), unless an exception in § 1.367(b)–10(a) (2)(i) or (ii) applies.

The Treasury Department and the IRS intend to modify the section 367(b) priority rule to provide that, in an exchange under section 354 or 356 that occurs in connection with a transaction described in the final regulations, to the extent one or more U.S. persons exchange stock or securities of a foreign corporation for P stock or securities acquired by S in exchange for property (as defined in § 1.367(b)–10(a)(3)(ii), as modified by the regulations described in this notice) in the P acquisition, section 367(a)(1) will not apply to such U.S. persons with respect to the exchange of the stock or securities of the foreign corporation. Instead, the exchange will be subject to §§ 1.367(b)–4 and 1.367(b)–4T, as modified by the regulations described in this notice. The section 367(b) priority rule, as modified by the regulations described in the 2014 notice, will continue to apply when T is a domestic corporation. In addition, section

367(a) will apply to the exchange of stock or securities of a foreign corporation to the extent such T stock or securities are exchanged for P stock or securities that are not acquired by S in exchange for property (as defined in § 1.367(b)– 10(a)(3)(ii), as modified by this notice) in connection with a transaction described in § 1.367(b)–10.

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

The Treasury Department and the IRS intend to modify §§ 1.367(b)–4 and 1.367(b)–4T to provide that, in an exchange under section 354 or 356 that occurs in connection with a transaction described in the final regulations, to the extent an exchanging shareholder exchanges stock or securities of a foreign acquired corporation for P stock or securities acquired by S in exchange for property (defined in § 1.367(b)–10(a)(3)(ii), as modified by the regulations described in this notice) in the P acquisition, then such shareholder must:

(i) Include in income as a deemed dividend the section 1248 amount attributable to the stock of the foreign acquired corporation that it exchanges; and

(ii) After taking into account the increase in basis provided in § 1.367(b)– 2(e)(3)(ii) resulting from the deemed dividend (if any), recognize all realized gain with respect to the stock or securities of the foreign acquired corporation exchanged that would not otherwise be recognized.

For purposes of the preceding paragraph, an exchanging shareholder is a U.S. person or foreign person that exchanges stock of a foreign acquired corporation in a prescribed exchange, regardless of whether such U.S. person is a section 1248 shareholder or such foreign person is a foreign corporation in which a U.S. person is a section 1248 shareholder.

.03 All Earnings and Profits Amount

(a) General Rule

The Treasury Department and the IRS intend to modify § 1.367(b)–2(d)(3)(ii) to provide that, if there is excess asset basis with respect to a foreign acquired corporation, then, in the case of an exchanging

shareholder to which § 1.367(b)–3(b)(3) applies, the all earnings and profits amount with respect to the stock in the foreign acquired corporation that it exchanges will be increased by the specified earnings with respect to such stock (if any).

(b) Excess Asset Basis

The term excess asset basis means, with respect to a foreign acquired corporation, the amount by which the inside asset basis of the foreign acquired corporation exceeds the sum of the following amounts:

(i) The earnings and profits of the foreign acquired corporation attributable to the outstanding stock of the foreign acquired corporation. For this purpose, the earnings and profits attributable to stock of the foreign acquired corporation is determined under the principles of § 1.367 (b)–2(d) but without regard to whether the exchanging shareholder is described in § 1.367(b)–3(b)(1) or is a U.S. person or a foreign person. Furthermore, the earnings and profits of the foreign acquired corporation will include amounts described in section 1248(d)(3) or 1248(d)(4).

(ii) The aggregate basis in the outstanding stock of the foreign acquired corporation determined immediately before the inbound transaction and without regard to any basis increase described in § 1.367(b)–2(e)(3)(ii) resulting from such inbound transaction.

(iii) The aggregate amount of liabilities of the foreign acquired corporation that are assumed by the domestic acquiring corporation in the inbound transaction determined under the principles of section 357(d).

(c) Inside Asset Basis

The term inside asset basis means, with respect to a foreign acquired corporation, the adjusted basis of the assets of the foreign acquired corporation in the hands of the domestic acquiring corporation determined immediately after the inbound transaction.

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(d) Specified Earnings

The term specified earnings means, with respect to the stock of a foreign acquired corporation that is exchanged by an exchanging shareholder, the lesser of the following amounts (but not below zero):

(i) The sum of the earnings and profits (including a deficit) with respect to each foreign subsidiary of the foreign acquired corporation that are attributable under section 1248(c)(2) to the stock of the foreign acquired corporation exchanged. For purposes of the preceding sentence, the modifications described in § 1.367(b)–2(d)(2) and (d)(3)(i) apply. Thus, for example, the amount of the earnings and profits of a foreign subsidiary that are attributable to stock of the foreign acquired corporation is determined without regard to whether the foreign subsidiary was a controlled foreign corporation at any time during the five years preceding the inbound transaction. The amount described in this Section 4.03(d)(i) is referred to in this notice as the “lower-tier earnings.”

(ii) The product of the excess asset basis of the foreign acquired corporation, multiplied by the exchanging shareholder’s specified percentage.

(iii) The amount of gain that would be realized by the exchanging shareholder if, immediately before the inbound transaction, the exchanging shareholder had sold the stock of the foreign acquired corporation for fair market value, reduced by the exchanging shareholder’s all earnings and profits amount (for this purpose, determined without regard to the modifications described in this notice). The amount described in this Section 4.03(d)(iii) is referred to in this notice as the “specified stock gain.”

(e) Specified Percentage

The term specified percentage means, with respect to an exchanging shareholder, a fraction (expressed as a percentage), the numerator of which is the amount of the exchanging shareholder’s specified stock gain, and the denominator of which is the sum of the aggregate of the specified stock gain with respect to all exchanging shareholders to which § 1.367 (b)–3(b)(3) applies and the aggregate of the gain realized (regardless of whether

such gain is recognized) with respect to the stock exchanged by all other exchanging shareholders.

(f) Source of Specified Earnings

If the specified earnings attributable to the stock of a foreign acquired corporation exchanged by an exchanging shareholder is less than the lower-tier earnings attributable to the stock exchanged, the specified earnings of the exchanging shareholder will be sourced from lower-tier earnings of foreign subsidiaries of the foreign acquired corporation under the principles of § 1.1248–1(d)(3).

(g) Adjustments to Excess Asset Basis

If there is excess asset basis with respect to a foreign acquired corporation, as determined under Section 4.03(b) of this notice, a taxpayer may reduce the excess asset basis to the extent that the excess asset basis is not attributable, directly or indirectly, to property provided by a foreign subsidiary of the foreign acquired corporation. For example, if there was a transfer of property to the foreign acquired corporation described in section 362(e)(2), and the election described in section 362(e)(2)(C) was made to limit the basis in the stock received in the foreign acquired corporation to its fair market value, then, for purposes of determining excess asset basis, the basis in the stock of the foreign acquiring corporation may be determined without regard to the application of section 362(e)(2).

For purposes of this Section 4.03(g), property used by a foreign subsidiary to purchase the stock of the foreign acquired corporation in connection with a triangular reorganization is treated as property provided by the foreign subsidiary. In addition, the term property has the meaning provided in § 1.367(b)–10(a)(3)(ii), as modified by this notice. Finally, a reference to a foreign acquired corporation or foreign subsidiary includes a predecessor of the foreign acquired corporation or foreign subsidiary. (h) Anti-Abuse Rule

The regulations to be issued under § 1.367(b)–3 will include an anti-abuse rule to address transactions engaged in with a view to avoid the purposes of the

rules described in this Section 4.03. Under the anti-abuse rule, adjustments must be made, including by disregarding the effects of transactions, to carry out the purposes of this section. Thus, as one example, if a transaction is engaged in with a view to reduce excess asset basis, including by increasing the basis in the stock of the foreign acquired corporation without a corresponding increase in the basis in the assets of the foreign acquired corporation, that increase in the basis in the stock of the foreign acquired corporation will be disregarded for purposes of computing excess asset basis.

.04 Nonqualified Preferred Stock

The definition of property provided in § 1.367(b)–10(a)(3)(ii) will be modified to include S stock that is nonqualified preferred stock (as defined in section 351 (g)(2)).

.05 Examples

The following examples illustrate certain modifications to the final regulations described in this Section 4:

Example 1 . (i) Facts . USP, a domestic corporation, wholly owns FP and USS. FP is a foreign corporation that wholly owns FS, a foreign corporation. USS is a domestic corporation that wholly owns FT, a foreign corporation. USS owns 100 shares of FT stock, which constitutes a single block of stock with a fair market value of $100x, an adjusted basis of $20x, and a section 1248 amount of $50x. FS has earnings and profits of $60x. A dividend from FS to FP would qualify for the exception to foreign personal holding company income under section 954(c)(6). FP issues 100 shares of voting stock with a fair market value of $100x to FS in exchange for $40x of common stock of FS and $60x cash. FS acquires all of the stock of FT held by USS solely in exchange for the $100x of FP voting stock in a triangular reorganization described in section 368(a)(1)(B). (ii) Analysis . The triangular reorganization is described in § 1.367(b)–10(a). Pursuant to § 1.367(b)– 10(b)(1), as modified by the rules announced in the 2014 notice, adjustments must be made that have the effect of a distribution of property in the amount of $60x from FS to FP under section 301. The $60x deemed distribution is treated as separate from, and occurring immediately before, FS’s acquisition of the $60x of FP stock used in the triangular reorganization. The $60x deemed distribution from FS to FP results in $60x dividend income to FP under section 301(c)(1) that is not subpart F income under section 954(c)(6). Pursuant to Section 4.01 of this notice, § 1.367(b)–4 (as modified by Section 4.02 of

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this notice), rather than section 367(a)(1), applies to the $60x of FT stock exchanged for the $60x of FP stock acquired by FS from FP in exchange for $60x cash. Thus, USS must include in income a $30x deemed dividend ($50x section 1248 amount x 60%) with respect to the FT stock exchanged for FP stock that was acquired by FS from FP for $60x cash. In addition, USS must recognize the remaining $18x gain ($48x gain (($80x gain x 60%) - $30x deemed dividend) realized with respect to such FT stock. If USS properly files a gain recognition agreement pursuant to §§ 1.367(a)– 3(b)(2) and 1.367(a)–8, USS does not recognize gain under section 367(a)(1) with respect to the $40x of FT stock exchanged for FP stock that was acquired by FS from FP in exchange for the $40x of FS common stock.

Example 2 . (i) Facts . USP, a domestic corporation, owns 90% of the stock of FP, a foreign corporation. The remaining 10% of the stock of FP is owned by FI, a nonresident alien individual unrelated to USP. FP is a foreign corporation that wholly owns FS1, a foreign corporation, which, in turn, wholly owns FS2, a foreign corporation. The FP stock owned by USP has a fair market value of $90x and an adjusted basis of $17x. The FP stock owned by FI has a fair market value of $10x and an adjusted basis of $6x. The all earnings and profits amount with respect to USP’s FP stock, determined without regard to this notice, is $27x. The assets of FP have an adjusted basis of $78x, FP has no liabilities, and the earnings and profits of FP attributable to the outstanding FP stock is $30x (in this case, as determined under the principles of § 1.367(b)–2(d) but without regard to whether USP and FI are exchanging shareholders described in § 1.367(b)–3(b)(1) or U.S. or foreign persons). The earnings and profits of FS1 and FS2 attributable to the FP stock owned by USP under section 1248(c)(2) (as determined under the principles of § 1.367(b)–2(d)(2) and (d)(3)(i)) are $80x and ($20x) respectively. In a reorganization described in section 368(a)(1)(F), US Newco, a newly-formed domestic corporation that is wholly owned by USP, acquires all of the assets of FP solely in exchange for stock of US Newco. No adjustment under Section 4.03(g) of this notice is appropriate.

(ii) Analysis —(A) All earnings and profits amount. Under § 1.367(b)–3(b)(3), USP must include in income as a deemed dividend the all earnings and profits amount with respect to its FP stock. Pursuant to Section 4.03 of this notice, the all earnings and profits amount of $27x, determined without regard to this notice, is increased by the specified earnings of FP, because there is excess asset basis with respect to FP determined as follows.

(B) Excess asset basis . The amount of the excess asset basis is $25x, the amount that the inside asset basis of FP ($78x) exceeds the sum of (i) the earnings and profits of FP ($30x), (ii) the aggregate basis in all of the FP stock ($23x), and (iii) the liabilities of FP assumed by US Newco ($0x).

(C) Specified earnings . The specified earnings with respect to the stock of FP exchanged by USP equals $23x, the lesser of the following amounts (but not below zero) (i) $60x, the sum of the earnings and profits (including deficits) with respect to FS1 and FS2 attributable under section 1248(c)(2) to the stock of FP exchanged by USP; (ii) $23x, the product of the excess asset basis with respect to FP ($25x), multiplied by USP’s specified percentage (92%), determined based on a fraction, the numerator of which is USP’s specified stock gain ($46x), and the denominator of which is the sum of the aggregate of the specified stock gain and gain realized with respect to FP stock ($50x), and (iii) $46x, USP’s specified stock gain, which is the amount of gain that would be realized by USP if immediately before the inbound transaction USP had sold the stock of FP for fair market value ($73x), reduced by USP’s all earnings and profits amount (determined without regard to the modifications described in this notice) ($27x).

(D) All earnings and profits amount, as modified by this notice . The all earnings and profits amount that USP must include in income as a deemed dividend is $50x ($27x - $23). Under § 1.367(b)– 2(e)(2), $23x of the deemed dividend is determined by reference to the earnings and profits of FS1 and is considered as having been paid by FS1 to USP through FP. Under § 1.367(b)–2(e)(3)(ii), immediately before the exchange, USP’s basis in the stock of FP is increased by the amount of the $50x deemed dividend for purposes of determining USP’s basis in its stock of US Newco. However, the basis increase under § 1.367(b)–2(e)(3)(ii) is not taken into account for purposes of calculating USP’s all earnings and profits amount, as modified by Section 4.03 of this notice.