The IRS said it plans to modify the regs relating to certain triangular reorganizations involving foreign corporations.
Specifically, in Notice 2016-73, the tax agency announced it will alter the rules affecting the treatment of property used to acquire parent stock or securities in triangular reorganizations involving one or more foreign corporations, as well as describe the consequences to persons that receive parent stock or securities in those reorganizations.
The IRS also said it will issue regs to modify the amount of an income inclusion required in certain inbound nonrecognition transactions.
Background on Taxable Transfers
A U.S. person’s transfer of appreciated property (including stock) to a foreign corporation in certain types of exchanges generally is treated as a taxable transaction, unless an exception applies. A section of the Internal Revenue Code (IRC) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, unless there are exceptions in the regs aimed at preventing tax avoidance.
No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. Stock that a parent provides to a subsidiary, or a target on behalf of the subsidiary, is treated as the parent’s disposition of its own shares in cases of forward triangular mergers, or either triangular C or triangular B reorganizations.
However, if the subsidiary didn’t receive the stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of the stock for the target’s stock or assets. The subsidiary doesn’t recognize gain or loss on the parent’s stock that it exchanges for the target’s stock in a reverse triangular merger.
A corporation’s distribution of stock to its shareholder is included in their gross income to the extent that it’s a dividend (out of the corporation’s current and accumulated earnings and profits). To the extent the distribution isn’t a dividend, the shareholder reduces basis in the corporation’s stock, and any amount of the distribution that exceeds the holder’s basis is treated as gain from the sale or exchange of the corporation’s stock.
Schemes to Avoid Taxes
The IRS said it’s aware that certain taxpayers are engaging in transactions that are designed to repatriate earnings and basis of foreign corporations without incurring U.S. tax by exploiting the IRC Section 367(a) priority rule. The agency added it believes that these transactions “raise significant policy concerns.”
Notice 2016-73 provides detailed descriptions of the specific transactions at issue.
The guidance notes that, among other things, the planned regs will modify the Sec. 367(a) priority rule so that it applies only when the target corporation is domestic. If it’s a foreign corporation, the regs generally will treat as a distribution any property the acquiring company provides to its domestic parent in exchange for stock used in the acquisition, regardless of what gain might otherwise be recognized in the reorganization.
Currently, under certain circumstances, the priority rule turns off the application of Sec. 367(a) to exchanging U.S. shareholders of the target corporation.
Down the Road
The IRS says the regulations will apply to transactions completed on or after December 2, 2016, and to any inbound transactions treated as completed before that date, as a result of an entity classification election that is filed on or after December 2, 2016.