Guidance Under Section 7874 for Determining the Ownership Percentage in the Case of Expanded Affiliated Groups, 29054-29058 [E8-11285]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 98 (Tuesday, May 20, 2008)]
[Rules and Regulations]
[Pages 29054-29058]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-11285]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9399]
RIN 1545-BE93


Guidance Under Section 7874 for Determining the Ownership 
Percentage in the Case of Expanded Affiliated Groups

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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SUMMARY: This document contains final regulations under section 7874 of 
the Internal Revenue Code (Code) relating to the disregard of certain 
affiliate-owned stock in determining whether a corporation is a 
surrogate foreign corporation under section 7874(a)(2)(B) of the Code.

DATES: Effective Date: These regulations are effective on May 20, 2008.
    Applicability Date: For the date of applicability, see Sec.  
1.7874-1(g).

FOR FURTHER INFORMATION CONTACT: Milton Cahn, 202-622-3860 (not a toll-
free number).

SUPPLEMENTARY INFORMATION:

Background

    Section 7874 provides rules for expatriated entities and their 
surrogate foreign corporations. An expatriated entity is defined in 
section 7874(a)(2)(A) as a domestic corporation or partnership with 
respect to which a foreign corporation is a surrogate foreign 
corporation, and any U.S. person related (within the meaning of section 
267(b) or section 707(b)(1)) to such domestic corporation or 
partnership. Generally, a foreign corporation is a surrogate foreign 
corporation under section 7874(a)(2)(B) if, pursuant to a plan or a 
series of related transactions, certain conditions are met. One such 
condition depends on the percentage of owner continuity in the foreign 
corporation after the acquisition. This condition is satisfied if, 
after the acquisition, at least 60 percent of the stock (by vote or 
value) of the foreign corporation is held (in the case of an 
acquisition with respect to a domestic corporation) by former 
shareholders of the domestic corporation by reason of holding stock in 
the domestic corporation, or (in the case of an acquisition with 
respect to a domestic partnership) by former partners of the domestic 
partnership by reason of holding a capital or profits interest in the 
domestic partnership. See section 7874(a)(2)(B)(ii).
    The treatment of expatriated entities and surrogate foreign 
corporations varies depending on this percentage (ownership fraction). 
If the ownership fraction is 80 percent or more, the surrogate foreign 
corporation is treated as a domestic corporation for all purposes of 
the Code. If the ownership fraction is 60 percent or more (but less 
than 80 percent), the surrogate foreign corporation is treated as a 
foreign corporation, but certain income or gain recognized by the 
expatriated entity generally cannot be offset by net operating losses 
or credits from the first date properties are acquired pursuant to the 
plan through the end of the 10-year period following the completion of 
the acquisition.
    Section 7874(c)(2)(A) provides that stock held by members of the 
``expanded affiliated group'' which includes the foreign corporation is 
not taken into account for purposes of the ownership fraction 
(affiliate-owned stock rule). Section 7874(c)(1) defines the term 
expanded affiliated group (EAG) as an affiliated group defined in 
section 1504(a), but without regard to the exclusion of foreign 
corporations in section 1504(b)(3) and with a reduction of the 80 
percent ownership threshold of section 1504(a) to a more-than-50 
percent threshold.
    Section 7874(g) provides that ``[t]he Secretary shall provide such 
regulations as are necessary to carry out this section, including 
regulations providing for such adjustments to the application of this 
section as are necessary to prevent the avoidance of the purposes of 
this section, including the avoidance of such purposes through * * *. 
the use of related persons, pass-through or other noncorporate 
entities, or other intermediaries * * *.'' Section 7874(c)(6) provides 
that ``[t]he Secretary shall prescribe such regulations as may be 
appropriate to determine whether a corporation is a surrogate foreign 
corporation, including regulations * * * to treat stock as not stock.''
    On December 28, 2005, a temporary regulation (TD 9238) was 
published in the Federal Register (70 FR 76685) that related to the 
disregard of affiliate-owned stock under section 7874(c)(2)(A). A 
notice of proposed rulemaking (REG-143244-05) cross-referencing the 
temporary regulation was published in the Federal Register for the same 
day (70 FR 76732). No public hearing was requested or held. Written and 
electronic comments responding to the notice of proposed rulemaking 
were received. After consideration of all the comments, the proposed 
regulation is adopted, as amended by this Treasury decision, as final, 
and the corresponding temporary regulation is removed. The revisions 
are discussed below.

Summary of Comments and Revisions

A. Temporary and Proposed Regulations

    Treasury regulation Sec.  1.7874-1T provides guidance under the 
affiliated-owned stock rule. Generally, Sec.  1.7874-1T provides that 
stock owned by members of an EAG is excluded from both the numerator 
and denominator of the ownership fraction. However, affiliate-owned 
stock is excluded from the numerator of the ownership fraction, but is 
included in the denominator of the ownership fraction, in two 
instances: (1) Certain transactions occurring as part of an internal 
group restructuring involving a domestic entity; and (2) certain 
acquisitive business transactions between unrelated

[[Page 29055]]

parties where the former shareholders or partners of the domestic 
entity have a minority interest in the acquired properties after the 
acquisition.
    With respect to internal group restructurings, the special rule 
applies where the common parent of the EAG after the acquisition owns 
directly or indirectly at least 80 percent of the domestic entity 
before the acquisition, and non-members of the EAG hold, by reason of 
holding an interest in the domestic entity, no more than 20 percent of 
the stock (by vote or value) of the foreign corporation after the 
acquisition. With respect to transactions between unrelated parties, 
the special rule applies where, after the acquisition, the former 
owners of the domestic entity do not own, in the aggregate, directly or 
indirectly, more than 50 percent of the stock (by vote or value) of any 
member of the EAG.
    Section 1.7874-1T also provides guidance regarding the treatment of 
certain ``subsidiary-owned'' interests (which include so-called ``hook 
stock'') for purposes of the exceptions to the general application of 
the ownership fraction. These rules apply to stock or partnership 
interests owned by an entity in which at least 50 percent of the stock 
(by vote or value), or at least 50 percent of the capital or profits 
interest, is owned directly or indirectly by the issuer of such stock 
or by the partnership in question.
    These rules are included in the final regulations, with revisions 
as noted below.

B. Section 1504(a)(4) Preferred Stock

    Both the numerator and denominator of the ownership fraction take 
into account stock described in section 1504(a)(4) (so-called ``plain 
vanilla preferred stock''). For purposes of determining whether an 
affiliated group constitutes an EAG, however, such stock is not treated 
as stock because of the reference to the rules of section 1504(a). See 
section 7874(c)(1). Commentators have noted the inconsistent treatment 
of plain vanilla preferred stock in section 7874. In addition, they 
point out that, due to the debt-like nature of such stock, it should 
not be treated as stock for any purpose of section 7874, including the 
ownership fraction.
    The Treasury Department and the IRS note that Congress has 
expressly stated that section 1504(a)(4) preferred stock is not treated 
as stock in several Code provisions, including certain provisions of 
section 7874, as noted above. See, for example, sections 243(c)(1), 
246A(c)(4), and 355(g)(2)(B)(iv)(III). In contrast, Congress 
specifically chose not to exclude plain vanilla preferred stock from 
the ownership fraction. Although section 7874 grants the Treasury 
Department and the IRS the authority to treat stock as not stock when 
such treatment would further the purposes of section 7874, the 
legislative history to section 7874 does not suggest that the treatment 
of plain vanilla preferred stock in the ownership fraction is 
inconsistent with the purposes of section 7874. The Treasury Department 
and the IRS therefore decline to exercise the regulatory authority to 
exclude plain vanilla preferred stock in the calculation of the 
ownership fraction. Accordingly, all classes of stock, including plain 
vanilla preferred stock, are included in the ownership fraction and 
treated as stock for purposes of section 7874, other than for purposes 
of determining the EAG.
    The Treasury Department and the IRS considered whether the 
treatment of plain vanilla preferred stock in the EAG definition should 
be made consistent with the treatment of plain vanilla preferred stock 
in the ownership fraction. After studying the issue, the Treasury 
Department and the IRS believe that taking plain vanilla preferred 
stock into account for purposes of the definition of an EAG may 
facilitate the avoidance of the rules regarding EAGs. Consequently, the 
Treasury Department and the IRS also decline to exercise regulatory 
authority to amend the treatment of plain vanilla preferred stock for 
purposes of defining an EAG.
    The Treasury Department and the IRS will, however, continue to 
monitor the use of plain vanilla preferred stock and its treatment 
under section 7874.

C. Internal Restructuring Exception

    Treasury regulation Sec.  1.7874-1T(c)(1) provides that stock held 
by a member of an EAG is included in the denominator, but not the 
numerator, of the ownership fraction if two conditions are satisfied. 
First, the common parent of the EAG must own directly or indirectly at 
least 80 percent of the stock (by vote or value) or the capital or 
profits interest in the domestic entity prior to the acquisition. 
Second, following the acquisition non-members of the EAG, by reason of 
holding stock or a capital or profits interest in the domestic entity, 
must not own more than 20 percent of the stock (by vote or value) of 
the foreign corporation.
    One commentator suggested that the requirement should merely look 
to the stock ownership of the common parent of the EAG both before and 
after the acquisition. The Treasury Department and the IRS agree with 
this suggestion. In addition, the Treasury Department and the IRS have 
determined that the rule should be modified to consider the stock by 
vote and value held by the common parent of the EAG. Consequently, 
stock of a member of an EAG is included in the denominator, but not the 
numerator of the ownership fraction, if the common parent of the EAG 
held directly or indirectly at least 80 percent of the stock (by vote 
and value) or the capital and profits interest, as applicable, of the 
domestic entity before the acquisition, and holds at least 80 percent 
of the stock (by vote and value) of the foreign acquiring corporation 
after the acquisition. Corresponding revisions have been made to the 
examples.

D. Hook Stock

    One commentator requested clarification of the wording of Sec.  
1.7874-1T(d) regarding the treatment of hook stock. In response to this 
comment, the provision is clarified to exclude hook stock from both the 
numerator and denominator of the fractions that are used to determine 
whether the exceptions to the general rule apply (that is, the 
determination of whether the acquisition resulted in an internal group 
restructuring or a loss of control of the domestic entity).

Regulations Addressing Avoidance of the Purposes of Section 7874

    The Treasury Department and the IRS understand that taxpayers may 
be taking the position that a foreign corporation that acquires 
substantially all of the properties of a domestic corporation in a 
title 11 or similar case may not be a surrogate foreign corporation 
because it fails to satisfy the stock ownership requirement described 
in section 7874(a)(2)(B)(ii). These taxpayers maintain that creditors 
of the domestic corporation, which typically receive all of the stock 
of the acquiring foreign corporation issued in the title 11 or similar 
case, are not considered former shareholders of the domestic 
corporation for purposes of section 7874(a)(2)(B)(ii). Thus, they take 
the position that the creditors do not hold the stock of the foreign 
acquiring corporation received by reason of holding stock in the 
domestic corporation. Under this position, there often would be little 
or no continuity of ownership for purposes of section 7874(a)(2)(B)(ii) 
and, as a result, the foreign corporation would not be a surrogate 
foreign corporation. Taxpayers take this position even though the 
creditors, in substance, are the equity owners of the domestic 
corporation at the time of the title 11 or similar case and acquire the 
stock issued by the

[[Page 29056]]

acquiring foreign corporation by reason of their status as creditors of 
the domestic corporation. Helvering v. Alabama Asphaltic Limestone Co., 
315 U.S. 179 (1942).
    The Treasury Department and the IRS disagree with this 
characterization under current law and are considering issuing 
regulations to clarify the proper application of the rules to such 
transactions. Section 7874(c)(6) provides that the Secretary shall 
prescribe such regulations as may be appropriate to determine whether a 
corporation is a surrogate foreign corporation, including regulations: 
(i) To treat warrants, options, contracts to acquire stock, convertible 
debt interests, and other similar interests as stock, and (ii) to treat 
stock as not stock. These regulations would provide, as appropriate, 
that for purposes of section 7874(a)(2)(B)(ii), creditors of a domestic 
corporation emerging from a title 11 or similar case are treated as 
former shareholders of such corporation. The regulations would further 
provide, as appropriate, that for this purpose, stock issued by the 
foreign acquiring corporation to such creditors is held by reason of 
holding stock in the domestic corporation. Similar rules may apply to 
acquisitions of substantially all the properties constituting a trade 
or business of a domestic partnership.
    The Treasury Department and the IRS also understand that some 
taxpayers may be taking the position that, where two or more domestic 
entities described in section 7874(a)(2)(B)(i) are acquired pursuant to 
an overall plan, section 7874(a)(2)(B) is applied separately to each 
such domestic entity. For example, taxpayers may take this position 
where a foreign corporation is formed to acquire, in exchange for its 
stock, 100 percent of the stock of two domestic corporations that have 
approximately the same value. In such a case, after the acquisition the 
former shareholders of the two domestic corporations, in the aggregate, 
would hold 100 percent of the stock of the foreign acquiring 
corporation by reason of holding stock in the domestic corporations. 
However, the taxpayers may claim that the ownership fraction applies 
separately to each acquisition such that the ownership fraction would 
be approximately 50 percent, rather than 100 percent. Under this 
interpretation, the acquiring foreign corporation would not be a 
surrogate foreign corporation because the condition described in 
section 7874(a)(2)(B)(ii) would not be satisfied.
    The Treasury Department and the IRS disagree with this 
interpretation under current law and are considering issuing 
regulations to clarify the proper application of the rules. These 
regulations would clarify that the references in section 7874(a)(2)(B) 
to ``a domestic corporation'' shall, as appropriate, mean ``one or more 
domestic corporations'' where the properties of such corporations are, 
directly or indirectly, acquired pursuant to the same plan. Similar 
clarifications will be made with respect to acquisitions involving 
properties of domestic partnerships.
    Finally, the Treasury Department and the IRS understand that some 
taxpayers may be attempting to avoid the application of section 7874 by 
structuring acquisitions of domestic entities by foreign corporations 
through the use of intervening partnerships. For example, a foreign 
acquiring corporation may issue new shares to a newly formed domestic 
partnership in exchange for a 99 percent interest in the partnership. 
The shares transferred to the domestic partnership constitute 70 
percent of the outstanding stock of the foreign acquiring corporation. 
An affiliate of the foreign acquiring corporation would transfer cash 
or other property to the partnership for the remaining one percent 
interest. The foreign acquiring corporation then transfers its 99 
percent interest in the domestic partnership to the shareholders of a 
domestic corporation in exchange for 100 percent of the stock of the 
domestic corporation.
    The taxpayers take the position that this transaction is not 
subject to section 7874 even though, in substance, the foreign 
acquiring corporation acquired 100 percent of the stock of the domestic 
corporation and the former shareholders of the domestic corporation, 
through their 99 percent interest in the domestic partnership, hold 
more than 60 percent of the stock of the foreign acquiring corporation 
by reason of holding stock in the domestic corporation. Under this 
interpretation, which relies on treating the partnership as an entity 
(rather than as an aggregate of its partners), the ownership fraction 
would be zero because none of the foreign acquiring corporation stock 
held by the partnership was held by former shareholders of the domestic 
corporation. Thus, section 7874 would not apply to the transaction.
    The Treasury Department and the IRS disagree with this 
characterization under current law and are considering issuing 
regulations to clarify the proper application of the rules to these 
transactions. The regulations would provide, as appropriate, that for 
purposes of applying section 7874(a)(2)(B)(i) to these structures, the 
exchange of an interest in a domestic entity for an interest in a 
partnership shall be treated as an exchange of the interest in the 
domestic entity for a pro rata share of the assets of the partnership.
    The regulations described above, which may be issued in conjunction 
with the finalization of the Sec.  1.7874-2T regulations, may be 
effective as of May 20, 2008. However, no inference is intended as to 
the potential applicability of other Code or regulatory provisions, or 
judicial doctrines (including substance over form) to the transactions 
described above.

Effective/Applicability Date

    Section 1.7874-1 applies to acquisitions completed on or after May 
20, 2008, subject to transition relief for certain acquisitions entered 
into pursuant to binding commitments. In addition, taxpayers may elect 
to apply this section to prior acquisitions, but must apply it 
consistently to all acquisitions within its scope.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and because these 
regulations do not impose a collection of information on small 
entities, the provisions of the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) do not apply. Pursuant to section 7805(f) of the Internal 
Revenue Code, the notice of proposed rulemaking preceding this 
regulation has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comments on its impact on small 
business.

Drafting Information

    The principal author of this regulation is Milton Cahn, Office of 
Associate Chief Counsel (International). However, other personnel from 
the IRS and the Treasury Department participated in its development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry

[[Page 29057]]

in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.7874-1 also issued under 26 U.S.C. 7874(c)(6) and (g).


Sec.  1.7874-1T  [Removed]

0
Par. 2. Section 1.7874-1T is removed.

0
Par. 3. Section 1.7874-1 is added to read as follows:


Sec.  1.7874-1  Disregard of affiliate-owned stock.

    (a) Scope. Section 7874(c)(2)(A) provides that stock of the foreign 
corporation referred to in section 7874(a)(2)(B) held by members of the 
expanded affiliated group (EAG) that includes such foreign corporation 
shall not be taken into account in determining ownership for purposes 
of section 7874(a)(2)(B)(ii). This section provides rules under section 
7874(c)(2)(A). The rules provided in this section are also subject to 
section 7874(c)(4).
    (b) General rule. Except as provided in paragraph (c) of this 
section, for purposes of the ownership percentage determination 
required by section 7874(a)(2)(B)(ii), stock held by one or more 
members of the EAG is not included in either the numerator or the 
denominator of the fraction that determines such percentage (ownership 
fraction).
    (c) Exceptions to general rule--(1) Overview. Stock held by one or 
more members of the EAG shall be included in the denominator, but not 
in the numerator, of the ownership fraction, if the acquisition 
qualifies as an internal group restructuring or results in a loss of 
control, as described in paragraph (c)(2) and (c)(3) of this section.
    (2) Internal group restructuring. For purposes of paragraph (c)(1) 
of this section, an acquisition qualifies as an internal group 
restructuring if:
    (i) Before the acquisition, 80 percent or more of the stock (by 
vote and value) or the capital and profits interest, as applicable, of 
the domestic entity was held directly or indirectly by the corporation 
that is the common parent of the EAG after the acquisition; and
    (ii) After the acquisition, 80 percent or more of the stock (by 
vote and value) of the acquiring foreign corporation is held directly 
or indirectly by such common parent.
    (3) Loss of control. For purposes of paragraph (c)(1) of this 
section, the acquisition results in a loss of control if after the 
acquisition, the former shareholders or partners of the domestic entity 
do not hold, in the aggregate, directly or indirectly, more than 50 
percent of the stock (by vote or value) of any member of the EAG.
    (d) Treatment of certain hook stock. This paragraph applies to 
stock of a corporation that is held by an entity in which at least 50 
percent of the stock (by vote or value) or at least 50 percent of the 
capital or profits interest, as applicable, in such entity, is held 
directly or indirectly by the corporation. The stock to which this 
paragraph applies shall not be included in either the numerator or 
denominator of any fraction for the following purposes:
    (1) For applying paragraph (c)(1) of this section; and
    (2) For determining whether the acquisition qualifies as an 
internal group restructuring (described in paragraph (c)(2) of this 
section) or results in a loss of control (described in paragraph (c)(3) 
of this section).
    (e) Stock held by a partnership. For purposes of section 7874, 
stock held by a partnership shall be considered as held proportionately 
by its partners.
    (f) Examples. The application of this section is illustrated by the 
following examples. It is assumed that all transactions in the examples 
occur after March 4, 2003. In all the examples, if an entity or other 
person is not described as either domestic or foreign, it may be either 
domestic or foreign. In addition, each entity has only a single class 
of equity outstanding. Finally, the analysis of the following examples 
is limited to a discussion of issues under section 7874, even though 
the examples may raise other issues (for example, under section 367).

    Example 1. Disregard of hook stock--(i) Facts. USS, a domestic 
corporation, has 100 shares of stock outstanding. USS's stock is 
held by a group of individuals. Pursuant to a plan, USS forms FS, a 
foreign corporation, and transfers to FS the stock of several wholly 
owned foreign corporations, in exchange for 90 shares of FS stock. 
FS then forms Merger Sub, a domestic corporation. Under a merger 
agreement and state law, Merger Sub merges into USS, with USS 
surviving the merger. In exchange for their USS stock, the former 
shareholders of USS receive, in the aggregate, 100 shares of newly 
issued FS stock. As a result of the merger FS holds 100 percent of 
the USS stock. USS continues to hold 90 shares of FS stock.
    (ii) Analysis. FS has indirectly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
After the acquisition, the former shareholders of USS hold 100 
shares of FS stock by reason of holding stock in USS, and USS holds 
90 shares of FS stock. Under paragraph (b) of this section, the 90 
shares of FS stock held by USS, a member of the EAG, are not 
included in either the numerator or the denominator of the ownership 
fraction. Accordingly, the ownership fraction is 100/100. If the 
condition in section 7874(a)(2)(B)(iii) is satisfied, FS is a 
surrogate foreign corporation which is treated as a domestic 
corporation under section 7874(b).
    Example 2. Internal group restructuring; wholly owned 
corporation--(i) Facts. P, a corporation, owns all 100 outstanding 
shares of USS, a domestic corporation. USS forms FS, a foreign 
corporation, and transfers all its assets to FS in exchange for all 
100 shares of the stock of FS, in a reorganization described in 
section 368(a)(1). P exchanges its USS stock for FS stock under 
section 354.
    (ii) Analysis. FS has directly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
The acquisition is an internal group restructuring described in 
paragraph (c)(2) of this section because P, the common parent of the 
EAG after the acquisition, held directly or indirectly 80 percent or 
more of the stock (by vote and value) of USS before the acquisition, 
and after the acquisition, P holds directly or indirectly 80 percent 
or more of the stock (by vote and value) of FS. Accordingly, under 
paragraph (c)(1) of this section, the FS stock held by P is included 
in the denominator, but not in the numerator of the ownership 
fraction. Therefore, the ownership fraction is 0/100. FS is not a 
surrogate foreign corporation.
    Example 3. Internal group restructuring; wholly owned 
corporation--(i) Facts. The facts are the same as in Example 2, 
except that USS does not transfer any of its assets to FS. Instead, 
P transfers all 100 shares of USS stock to FS in exchange for all 
100 shares of FS stock.
    (ii) Analysis. FS has indirectly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
The acquisition is an internal group restructuring described in 
paragraph (c)(2) of this section because P, the common parent of the 
EAG after the acquisition, held directly or indirectly 80 percent or 
more of the stock (by vote and value) of USS before the acquisition, 
and after the acquisition, P holds directly or indirectly 80 percent 
or more of the stock (by vote and value) of FS. Accordingly, under 
paragraph (c)(1) of this section, the FS stock held by P is included 
in the denominator, but not in the numerator of the ownership 
fraction. Accordingly, the ownership fraction is 0/100. FS is not a 
surrogate foreign corporation.
    Example 4. Internal group restructuring; less than wholly owned 
corporation--(i) Facts. The facts are the same as in Example 3, 
except that P holds 85 shares of USS stock. The remaining 15 shares 
of USS stock are held by A, a person unrelated to P. P and A 
transfer their shares of USS stock to FS in exchange for 85 and 15 
shares of FS stock, respectively.
    (ii) Analysis. FS has indirectly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
The acquisition is an internal group restructuring described in 
paragraph (c)(2) of this section because P, the common parent of the 
EAG after the acquisition, held directly or indirectly 80 percent or 
more of the stock (by vote and value) of USS before the acquisition, 
and after the acquisition P holds directly or indirectly 80 percent 
or more of the stock (by vote and value) of FS. Therefore, under

[[Page 29058]]

paragraph (c)(1) of this section, the FS stock held by P is included 
in the denominator, but not in the numerator of the ownership 
fraction. Accordingly, the ownership fraction is 15/100. FS is not a 
surrogate foreign corporation.
    Example 5. Internal group restructuring exception not 
applicable; less than 80 percent owned corporation--(i) Facts. The 
facts are the same as in Example 2, except that P owns 55 shares of 
USS stock, and A, a person unrelated to P, holds 45 shares of USS 
stock. P and A exchange their shares of USS stock for 55 shares and 
45 shares of FS stock, respectively.
    (ii) Analysis. FS has acquired substantially all the properties 
held directly or indirectly by USS pursuant to a plan. P, the common 
parent of the EAG after the acquisition, did not hold directly or 
indirectly 80 percent or more of the stock (by vote and value) of 
USS before the acquisition, and after the acquisition P does not 
hold directly or indirectly 80 percent or more of the stock (by vote 
and value) of FS. Thus, the acquisition is not an internal group 
restructuring described in paragraph (c)(1) of this section, and the 
general rule of paragraph (b) of this section applies. Under 
paragraph (b) of this section, the FS stock held by P, a member of 
the EAG, is not included in either the numerator or the denominator 
of the ownership fraction. Accordingly, the ownership fraction is 
45/45. If the condition in section 7874(a)(2)(B)(iii) is satisfied, 
FS is a surrogate foreign corporation which is treated as a domestic 
corporation under section 7874(b).
    Example 6. Internal group restructuring; hook stock--(i) Facts. 
USS, a domestic corporation, has 100 shares of stock outstanding. P, 
a corporation, holds 80 shares of USS stock. The remaining 20 shares 
of USS stock are held by A, a person unrelated to P. USS owns all 30 
outstanding shares of FS, a foreign corporation. Pursuant to a plan, 
FS forms Merger Sub, a domestic corporation. Under a merger 
agreement and state law, Merger Sub merges into USS, with USS 
surviving the merger as a subsidiary of FS. In exchange for their 
USS stock, P and A, the former shareholders of USS, respectively 
receive 56 and 14 shares of FS stock. USS continues to hold 30 
shares of FS stock.
    (ii) Analysis. FS has indirectly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
Under paragraph (b) of this section, the shares of FS stock held by 
P and USS, both of which are members of the EAG, are not included in 
either the numerator or denominator of the ownership fraction, 
unless the acquisition results in an internal group restructuring or 
loss of control of USS such that the exception of paragraph (c)(1) 
of this section applies. In determining whether the acquisition of 
USS is an internal group restructuring, under paragraph (d)(2) of 
this section, the FS stock held by USS is disregarded. Because P 
held directly or indirectly 80 percent or more of the stock (by vote 
and value) of USS before the acquisition, and after the acquisition 
P holds directly or indirectly 80 percent or more of the stock (by 
vote and value) of FS (when disregarding the FS stock held by USS), 
the acquisition is an internal group restructuring and the exception 
of paragraph (c)(1) of this section applies. Accordingly, when 
determining whether FS is a surrogate foreign corporation, the FS 
stock held by P is included in the denominator, but not the 
numerator of the ownership fraction. However, under paragraph (b) of 
this section, the FS stock held by USS is not included in either the 
numerator or denominator of the ownership fraction. Accordingly, the 
ownership fraction is 14/70, or 20 percent, since only the stock 
held by A is included in the numerator, and the stock held by both P 
and A is included in the denominator. Accordingly, FS is not a 
surrogate foreign corporation.
    Example 7. Loss of control--(i) Facts. P, a corporation, holds 
all the outstanding stock of USS, a domestic corporation. B, a 
corporation unrelated to P, holds all 60 outstanding shares of FS, a 
foreign corporation. P transfers to FS all the outstanding stock of 
USS in exchange for 40 newly issued shares of FS.
    (ii) Analysis. FS has indirectly acquired substantially all the 
properties held directly or indirectly by USS pursuant to a plan. 
After the acquisition, B holds 60 percent of the outstanding shares 
of the FS stock. Accordingly, B, FS and USS are members of an EAG. 
After the acquisition, P does not hold directly or indirectly more 
than 50 percent of the stock (by vote or value) of any member of the 
EAG and, thus, the acquisition results in a loss of control 
described in paragraph (c)(3) of this section. Accordingly, under 
paragraph (c)(1) of this section, the FS stock owned by B is 
included in the denominator, but not in the numerator, of the 
ownership fraction. Therefore, the ownership fraction is 40/100. FS 
is not a surrogate foreign corporation.
    Example 8. Internal group restructuring; partnership--(i) Facts. 
LLC, a Delaware limited liability company, is engaged in the conduct 
of a trade or business. P, a corporation, holds 90 percent of the 
interests of LLC. A, a person unrelated to P, holds 10 percent of 
the interests of LLC. LLC has not elected to be treated as an 
association taxable as a corporation. P and A transfer their 
interests in LLC to FS, a newly formed foreign corporation, in 
exchange for 90 shares and 10 shares, respectively, of FS's stock, 
which are all of the outstanding shares of FS. Accordingly, LLC 
becomes a disregarded entity.
    (ii) Analysis. Prior to the FS's acquisition of the interests of 
LLC, LLC was a domestic partnership for Federal income tax purposes. 
FS has acquired substantially all the properties constituting a 
trade or business of LLC pursuant to a plan. After the acquisition, 
P holds 90 percent of FS's stock (by vote and value) by reason of 
holding a capital and profits interest in LLC, and A holds 10 
percent of FS's stock (by vote and value) by reason of holding a 
capital and profits interest in LLC. The internal group 
restructuring exception under paragraph (c)(2) of this section 
applies, because before the acquisition, P held 80 percent or more 
of the capital and profits interest in LLC, and after the 
acquisition, P holds 80 percent or more of the stock (by vote and 
value) of FS. Under paragraph (c)(1) of this section, the FS stock 
held by P is included in the denominator, but not the numerator, of 
the ownership fraction. Accordingly, the ownership fraction is 10/
100. FS is not a surrogate foreign corporation.

    (g) Effective/applicability date. Except as otherwise provided in 
this paragraph, this section shall apply to acquisitions completed on 
or after May 20, 2008. This section shall not, however, apply to an 
acquisition that was completed on or after May 20, 2008, provided such 
acquisition was entered into pursuant to a written agreement which was 
(subject to customary conditions) binding prior to May 20, 2008, and at 
all times thereafter (binding commitment). For purposes of the 
preceding sentence, a binding commitment shall include entering into 
options and similar interests in connection with one or more written 
agreements described in the preceding sentence. Notwithstanding the 
general application of this paragraph, taxpayers may elect to apply 
this section to prior acquisitions, but must apply it consistently to 
all acquisitions within its scope.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.

    Approved: May 8, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E8-11285 Filed 5-19-08; 8:45 am]
BILLING CODE 4830-01-P