Transfers by Domestic Corporations That Are Subject to Section 367(a)(5); Distributions by Domestic Corporations That Are Subject to Section 1248(f), 49278-49305 [E8-18885]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 162 (Wednesday, August 20, 2008)]
[Proposed Rules]
[Pages 49278-49305]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-18885]



[[Page 49277]]

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Part III





Department of the Treasury





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26 CFR Part 1



Transfers by Domestic Corporations That Are Subject to Section 
367(a)(5); Distributions by Domestic Corporations That Are Subject to 
Section 1248(f); Proposed Rule

Federal Register / Vol. 73, No. 162 / Wednesday, August 20, 2008 / 
Proposed Rules

[[Page 49278]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209006-89]
RIN 1545-AM97


Transfers by Domestic Corporations That Are Subject to Section 
367(a)(5); Distributions by Domestic Corporations That Are Subject to 
Section 1248(f)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under sections 
367(a), 367(a)(5), 367(b), 1248(a), 1248(e), 1248(f), and 6038B of the 
Internal Revenue Code (Code). The proposed regulations under sections 
367(a)(5) and 367(b) apply when a domestic corporation transfers 
certain property to a foreign corporation in an exchange described in 
section 361(a) or (b). The proposed regulations under section 1248(e) 
suspend the application of section 1248(e) when capital gains are taxed 
at a rate equal to or greater than the rate at which ordinary income is 
taxed. The proposed regulations under section 1248(f) apply when a 
domestic corporation distributes stock of certain foreign corporations 
in a distribution to which section 337, 355, or 361 applies. The 
proposed regulations under section 1248(f) include regulations 
described in Notice 87-64 (1987-2 CB 375). The proposed regulations 
under section 6038B establish reporting requirements for certain 
transfers of property by a domestic corporation to a foreign 
corporation in certain exchanges described in section 361(a) or (b). 
Finally, the proposed regulations under section 367(a) include the 
regulations described in Notice 2008-10 (2008-3 IRB 277).
    The proposed regulations included in this document affect domestic 
corporations that transfer property to foreign corporations in certain 
transactions, or that distribute the stock of certain foreign 
corporations, and certain shareholders of such domestic corporations. 
The proposed regulations are necessary, in part, to provide guidance on 
changes to the law made by the Technical and Miscellaneous Revenue Act 
of 1988 (Pub. L. 100-647, 102 Stat. 3342).

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 18, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-209006-89), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
209006-89), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC 20224, or sent electronically, via the 
Federal eRulemaking Portal at www.regulations.gov (IRS REG-209006-89).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Daniel 
McCall, (202) 622-3860; concerning submissions of comments, requests 
for a public hearing, and/or to be placed on the building access list 
to attend a hearing, Richard Hurst 
(Richard.A.Hurst@irscounsel.treas.gov), or (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 
20224. Comments on the collections of information should be received by 
October 20, 2008.
    Comments are requested concerning:
    Whether the proposed collections of information are necessary for 
the proper performance of the functions of the Internal Revenue 
Service, including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collections of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application or 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collections of information in these proposed regulations are in 
Sec. Sec.  1.367(a)-7(c)(4) and (5); 1.1248(f)-2(b)(1) and (c)(1); and 
1.6038B-1(c)(6). The collections of information are mandatory. The 
likely respondents are domestic corporations.
    Estimated total annual reporting burden: 3260.
    Estimated average annual burden hours per respondent: 10.69.
    Estimated number of respondents: 305.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains proposed amendments to 26 CFR part 1 under 
sections 367(a), 367(a)(5), 367(b), 1248(a), 1248(e), 1248(f), and 
6038B of the Code.
    Section 367(a)(1) generally provides that if a United States person 
transfers property to foreign corporation in connection with an 
exchange described in section 332, 351, 354, 356, or 361, then the 
foreign corporation shall not be considered a corporation for purposes 
of determining the extent to which the United States person recognizes 
gain on the transfer. Sections 367(a)(2) and 367(a)(3), respectively, 
provide exceptions to the general rule of section 367(a)(1) for 
transfers of stock or securities of a foreign corporation that is a 
party to the exchange or a party to the reorganization, and for certain 
property used in an active foreign trade or business. However, section 
367(a)(5) provides that, except to the extent provided in regulations, 
the exceptions to the general rule of section 367(a)(1) provided by 
section 367(a)(2) and (a)(3) do not apply to a transfer of property by 
a domestic corporation to a foreign corporation in an exchange 
described in section 361(a) or (b).
    Section 367(b)(1) provides that in the case of any exchange 
described in section 332, 351, 354, 355, 356, or 361 in connection 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

[[Page 49279]]

the extent provided in regulations prescribed by the Secretary which 
are necessary or appropriate to prevent the avoidance of Federal income 
taxes. A fundamental policy of section 367(b) is to preserve the 
potential application of section 1248 following the acquisition of the 
stock or assets of a foreign corporation by another foreign 
corporation. H.R. Rep. No. 94-658, at 242 (1975).
    Section 367(c)(1) provides that for purposes of section 367, any 
distribution described in section 355 (or so much of section 356 as 
relates to section 355) shall be treated as an exchange whether or not 
it is an exchange.
    Section 1248(a) provides that a United States person shall include 
in gross income as a dividend any gain recognized on the sale or 
exchange of stock of a foreign corporation that was a controlled 
foreign corporation (CFC) (as defined in section 957(a)) at any time 
during the five-year period ending on the date of the sale or exchange 
but only if the United States person owned (or is considered to have 
owned, within the meaning of section 958) 10 percent or more of the 
total combined voting power of the foreign corporation at any time 
during that five-year period (a section 1248 shareholder). The amount 
of the gain recognized by the United States person on the sale or 
exchange that is recharacterized as a dividend is limited to the 
earnings and profits of the foreign corporation, and of certain foreign 
subsidiaries of such corporation, attributable to the stock sold or 
exchanged that were accumulated in taxable years of the foreign 
corporation beginning after December 31, 1962, and during the period or 
periods the stock was held by the United States person while the 
foreign corporation was a CFC.
    Section 1248(e) provides that, except as provided in regulations, 
if a United States person sells or exchanges stock of a domestic 
corporation that was formed or availed of principally for the holding, 
directly or indirectly, of stock of one or more foreign corporations, 
such sale or exchange shall be treated for purposes of section 1248 as 
a sale or exchange of the stock of the foreign corporations held by the 
domestic corporation.
    Section 1248(f)(1) provides that, except as provided in 
regulations, a domestic corporation that distributes stock of a foreign 
corporation in a distribution to which section 311(a), 337, 355(c)(1), 
or 361(c)(1) applies, shall include in gross income as a dividend an 
amount equal to the excess of the fair market value of such stock over 
its adjusted basis, but only to the extent of the earnings and profits 
of the foreign corporation attributable (under regulations prescribed 
by the Secretary) to such stock which were accumulated in taxable years 
of such foreign corporation beginning after December 31, 1962, and 
during the period or periods the stock was held by the domestic 
corporation while the foreign corporation was a CFC.

Explanation of Provisions

A. Section 367(a)(5)

1. Overview
    As noted in the Background part of this preamble, section 367(a)(2) 
and (3) provide exceptions to the general rule of section 367(a)(1). 
Section 367(a)(2) provides that, except to the extent provided in 
regulations, section 367(a)(1) shall not apply to the transfer of stock 
or securities of a foreign corporation that is a party to the exchange 
or a party to the reorganization. Section 367(a)(3) provides that, 
except to the extent provided in regulations, section 367(a)(1) shall 
not apply to the transfer of property used in an active foreign trade 
or business. Sections 1.367(a)-2T and Sec.  1.367(a)-3, along with 
other related provisions, implement the exceptions in section 367(a)(2) 
and (a)(3). In addition, section 367(a)(6) grants the Secretary 
authority to promulgate regulations providing additional exceptions to 
the general rule of section 367(a)(1).
    Section 367(a)(5) provides that the exceptions to the general rule 
of section 367(a)(1) provided under section 367(a)(2) and (3) shall not 
apply in the case of a transfer of property by a domestic corporation 
(U.S. transferor) to a foreign corporation (foreign acquiring 
corporation) in an exchange described in section 361(a) or (b) (section 
361 exchange). The general rule under section 367(a)(5), therefore, is 
that a transfer of property by a U.S. transferor to a foreign acquiring 
corporation in a section 361 exchange is subject to the general rule of 
section 367(a)(1). In that case, the U.S. transferor recognizes gain 
with respect to the transfer of appreciated property in the section 361 
exchange. See section 367(a)(1) and the regulations under that section.
    Section 367(a)(5), however, further provides that subject to such 
basis adjustments and such other conditions as shall be provided in 
regulations the general rule of section 367(a)(5) shall not apply (and 
therefore the exceptions to the general rule of section 367(a)(1) may 
be available) if the U.S. transferor is controlled (within the meaning 
of section 368(c)), by five or fewer domestic corporations. For 
purposes of the control requirement, members of the same affiliated 
group (within the meaning of section 1504) are treated as a single 
corporation. The legislative history to section 367(a)(5) explains that 
regulations are expected to provide relief from the general rule only 
if the ``U.S. corporate shareholders in the transferor agree to take a 
basis in the stock they receive in a foreign corporation that is a 
party to the reorganization equal to the lesser of (a) the U.S. 
corporate shareholders' basis in such stock received pursuant to 
section 358, or (b) their proportionate share of the basis in the 
assets of the transferor corporation transferred to the foreign 
corporation.'' S. Rep. No. 100-445, at 62 (1988).
    The legislative history explains that ``the requirement that five 
or fewer domestic corporations own at least 80 percent of the U.S. 
transferor's stock assures that the bulk of the built-in gain [in the 
transferred property] remains subject to U.S. taxing jurisdiction.'' 
The legislative history further states that ``it is expected that 
regulations [issued under section 367(a)(5)] will require the U.S. 
corporate transferor to recognize immediately any built-in gain that 
does not remain subject to U.S. taxing jurisdiction by virtue of a 
substituted stock basis.'' For example, the U.S. transferor would 
recognize gain ``where 20 percent or less of the U.S. corporate 
transferor is owned by foreign shareholders who receive substituted 
basis stock in the transferee corporation, which stock would not be 
subject to U.S. taxing jurisdiction on disposition.'' The U.S. 
transferor would also recognize gain to the extent each controlling 
domestic corporate shareholder does not receive an amount of stock of 
the issuing corporation in the reorganization sufficient to preserve 
its share of the built-in gain in the property transferred by the U.S. 
transferor in the section 361 exchange.
2. Explanation of Proposed Regulations
    The proposed regulations confirm the general rule of section 
367(a)(5), but provide an elective exception to the general rule 
pursuant to which the exceptions provided by section 367(a) and the 
regulations under that section may be available.
(a) General Rule of Section 367(a)(5)
    Consistent with section 367(a)(5), the proposed regulations confirm 
that the exceptions to the general rule of section 367(a)(1) provided 
in section 367(a) generally are not available to a transfer of property 
by a U.S. transferor to a foreign acquiring corporation in a

[[Page 49280]]

section 361 exchange. As noted, under the general rule of section 
367(a)(5), section 367(a)(1) would require the U.S. transferor to 
recognize gain on the transfer of appreciated property to the foreign 
acquiring corporation in the section 361 exchange. This general rule 
applies even if the conditions and requirements for the application of 
such exceptions would otherwise be met. The proposed regulations 
clarify that the general rule of section 367(a)(5) applies to a 
transfer of property pursuant to an exchange described in section 351 
(section 351 exchange) that qualifies as both a section 351 exchange 
and a section 361 exchange. See Notice 2008-10, 2008-3 IRB 277.
(b) Elective Exception to the General Rule
    The proposed regulations provide an elective exception to the 
general rule of section 367(a)(5) if certain conditions and 
requirements are satisfied (discussed in parts A.2.b.i through v of 
this preamble). If the exception applies, then the exceptions to the 
general rule of section 367(a)(1) provided in section 367(a) and the 
regulations under that section are available to the transfer of 
property by the U.S. transferor to the foreign acquiring corporation in 
the section 361 exchange, subject to any conditions and requirements 
for the application of such exceptions. In addition, even if the 
exception provided by the proposed regulations applies, the U.S. 
transferor may still recognize gain on the section 361 exchange in 
certain circumstances (discussed in part A.2.b.ii of this preamble), 
including any gain otherwise required to be recognized under section 
367(a). See, for example, section 367(a)(3)(B) and (C).
    The conditions and requirements of the elective exception carry out 
the policy of section 367(a)(5) by ensuring that the exceptions to the 
general rule of section 367(a)(1) are available only to the extent the 
net built-in gain in certain property transferred by the U.S. 
transferor in the section 361 exchange remains subject to corporate-
level taxation in the hands of the controlling domestic corporate 
shareholders of the U.S. transferor through their ownership of stock 
received in the transaction. References to ``stock received'' in this 
preamble include stock deemed received in the transaction.
    The proposed regulations apply to all property transferred by the 
U.S. transferor in the section 361 exchange, other than property to 
which section 367(d) applies (section 367(d) property). But see part 
D.2 of this preamble regarding proposed regulations under section 
367(a) that require section 367(d) property to be treated as property 
to which section 367(a) applies (section 367(a) property) in 
transactions that may be eligible for the exception to the coordination 
rule of Sec.  1.367(a)-3(d)(2)(vi)(A) provided by Sec.  1.367(a)-
3(d)(2)(vi)(B)(1). For purposes of these proposed regulations, section 
367(a) property includes any property transferred by the U.S. 
transferor in the section 361 exchange (other than section 367(d) 
property), whether the property is appreciated (built-in gain property) 
or depreciated (built-in loss property) at the time of the section 361 
exchange. The proposed regulations preserve (or require the recognition 
of) the net built-in gain in the section 367(a) property transferred in 
the section 361 exchange (generally defined as ``inside gain'' by the 
proposed regulations). In this regard, a transfer of section 367(a) 
property pursuant to a section 361 exchange to which the elective 
exception applies is treated differently than a transfer of built-in 
gain property and built-in loss property by a U.S. person to a foreign 
corporation in a section 351 exchange that is not also a section 361 
exchange. In the latter transaction, only the built-in gain property 
would be subject to section 367(a)(1), and the U.S. transferor would be 
required to recognize gain with respect to such property without 
offsetting the gain with losses related to the built-in loss property.
    The proposed regulations contain an anti-stuffing rule pursuant to 
which any property that would otherwise constitute section 367(a) 
property shall not be considered section 367(a) property for purposes 
of any determination under the proposed regulations for which the 
amount of section 367(a) property is relevant, if the U.S. transferor 
acquires such property in connection with the section 361 exchange with 
a principle purpose of affecting any such determination (for example, 
inside gain and inside basis). This rule may apply, for example, if the 
U.S. transferor acquires built-in loss property or cash proceeds from 
indebtedness incurred in connection with the transaction.
    The conditions and requirements for the application of the 
exception provided by the proposed regulations ensure that, in the 
aggregate, the inside gain is recognized currently by the U.S. 
transferor or preserved for future taxation in the stock received in 
the transaction by the controlling domestic corporate shareholders of 
the U.S. transferor. If the entire inside gain is preserved in the 
stock received by the controlling domestic corporate shareholders, the 
basis adjustment required by the exception (discussed in part A.2.b.iii 
of this preamble) effectively results in the section 361 exchange being 
treated similarly to a transfer of the section 367(a) property in a 
section 351 exchange insofar as, in the aggregate, the controlling 
domestic corporate shareholders' adjusted basis in the stock received 
in the transaction generally would reflect the aggregate bases of the 
section 367(a) property and the net built-in gain in such property on 
the date of the section 361 exchange.
    The inside gain equals the amount by which the aggregate gross fair 
market value of the section 367(a) property transferred by the U.S. 
transferor in the section 361 exchange exceeds the sum of the aggregate 
bases of such property and a proportionate amount of any liabilities of 
the U.S. transferor assumed in the section 361 exchange or satisfied in 
the reorganization pursuant to section 361(c)(3), but only to the 
extent the payment of any such liability would give rise to a deduction 
(deductible liabilities). For this purpose, gross fair market value 
means fair market value determined without regard to mortgages, liens, 
pledges, or other liabilities. However, the fair market value of any 
property subject to nonrecourse indebtedness shall not be less than the 
amount of such indebtedness. In addition, the aggregate bases of the 
section 367(a) property is determined after taking into account any 
gain otherwise required to be recognized by the U.S. transferor under 
section 367(a). See, for example, section 367(a)(3)(B) and (C). The 
proposed regulations provide rules for determining the proportionate 
amount of any deductible liabilities taken into account in determining 
the inside gain. The IRS and Treasury Department believe that taking 
deductible liabilities into account in determining inside gain comports 
with the policy of section 367(a)(5) to protect the corporate tax base 
following the repeal of the ``General Utilities'' doctrine, insofar as 
the U.S. transferor would have received the benefit of any deductible 
liabilities if it had disposed of its assets in a taxable transaction 
in which the deductible liabilities were assumed by the acquirer.
    In determining the inside gain, the IRS and Treasury Department 
declined to consider attributes (for example, net operating losses and 
foreign tax credits) of the U.S. transferor other than the tax bases of 
the section 367(a) property and deductible liabilities allocable to 
section 367(a) property. These attributes are not considered for this 
purpose because of concerns regarding the complexity for determining 
how any limitations on the use of such attributes should be taken into 
account and the potential for

[[Page 49281]]

duplicating the benefit of such attributes. Comments are requested 
regarding whether and how other attributes of the U.S. transferor 
should be taken into account for determining inside gain.
    If the section 361 exchange is part of a divisive reorganization 
described in section 368(a)(1)(D) in which the U.S. transferor 
distributes the stock of the foreign acquiring corporation in a 
distribution to which section 355 applies (section 355 distribution) 
and, as part of a plan or series of related transactions, such stock is 
subsequently distributed in one or more section 355 distributions, in 
addition to the conditions discussed in parts A.2.b.i through v of this 
preamble, two additional conditions must be satisfied. First, each 
section 355 distribution must be to a member of the affiliated group 
(within the meaning of section 1504) that includes the U.S. transferor 
at the time of the 361 exchange. Second, each affiliated group member 
that receives stock of the foreign acquiring corporation in the final 
section 355 distribution must adjust the basis of the stock received 
(as determined under section 358 and the regulations under that 
section) as required by the proposed regulations (discussed in part 
A.2.b.iii of this preamble). These two additional conditions ensure 
that the amount of inside gain attributable to the U.S. transferor's 
controlling domestic corporate shareholders remains subject to 
corporate-level taxation following the final section 355 distribution 
and permit section 355 distributions of the stock of the foreign 
acquiring corporation within an affiliated group.
(i) Control Requirement
    At the time of the section 361 exchange, the U.S. transferor must 
be controlled (within the meaning of section 368(c)) by five or fewer, 
but at least one, domestic corporations (the control group). For this 
purpose, members of the same affiliated group (within the meaning of 
section 1504) are treated as one corporation. If the U.S. transferor is 
controlled (within the meaning of section 368(c)) by more than five 
domestic corporations, but some combination of five or fewer domestic 
corporations control the U.S. transferor within the meaning of section 
368(c), the U.S. transferor must designate the five or fewer domestic 
corporations that comprise the control group on Form 926, ``Return by a 
U.S. Transferor of Property to a Foreign Corporation.''
    Although a regulated investment company (as defined in section 
851(a)) (RIC), a real estate investment trust (as defined in section 
856(a)) (REIT), and a subchapter S corporation (as defined in section 
1361(a)) is each generally treated as a domestic corporation for 
purposes of the Code, such entities are not generally subject to 
corporate-level taxation. Therefore, the proposed regulations provide 
that these entities cannot be members of the control group.
    The proposed regulations confirm that because the stock ownership 
threshold for the control requirement is determined by reference to 
section 368(c), only direct ownership of the stock of the U.S. 
transferor is taken into account. The IRS and Treasury Department 
declined to exercise the authority under section 367(a)(6) to permit 
indirect ownership (through a partnership or other entity) to be taken 
into account for this purpose, in part, because of the complexity and 
administrative difficulties that would arise from the basis adjustments 
(discussed in part A.2.b.iii of this preamble) that would be needed to 
account for the intervening partnership or other entity. For example, 
in the case of indirect ownership through a partnership, basis 
adjustments would need to account for differences between a partner's 
basis in its partnership interest and the partnership's basis in the 
stock of the U.S. transferor. Comments are requested regarding the 
manner in which indirect ownership could be taken into account for this 
purpose without undue complexity.
(ii) Gain Recognition by U.S. Transferor
    Even if the exception provided by the proposed regulations applies, 
in two instances the U.S. transferor must recognize gain on the 
transfer of section 367(a) property in the section 361 exchange. This 
is the case even if an exception to the general rule of section 
367(a)(1) would otherwise apply to such transfer.
    First, the U.S. transferor must recognize gain equal to the 
aggregate amount of inside gain allocable to non-control group members. 
The inside gain is allocated among control group members and non-
control group members based on each shareholder's ownership interest 
(by value) in the U.S. transferor at the time of the section 361 
exchange. The U.S. transferor must recognize gain with respect to non-
control group members even if the entire inside gain could be preserved 
in the stock received by the control group members as a group.
    Second, the U.S. transferor must recognize gain to the extent any 
control group member cannot preserve its share of inside gain in the 
stock received that is allocable to the section 367(a) property 
transferred in the section 361 exchange. The amount of a control group 
member's share of inside gain that cannot be preserved in the stock 
received is the amount by which the control group member's share of 
inside gain exceeds the fair market value of the stock received by the 
control group member that is allocable to section 367(a) property. Gain 
is required to be recognized in such a case because the fair market 
value of the stock equals the maximum amount of the control group 
member's share of inside gain that can be preserved in such stock (if 
the basis of such stock were zero). Under this rule, stock received 
that is allocable to property other than section 367(a) property is not 
available to preserve any portion of the control group member's share 
of inside gain. The U.S. transferor may be required to recognize gain 
under this rule when, for example, non-qualifying property (property 
other than stock or securities permitted to be received under section 
361(a)) is received or when the foreign acquiring corporation assumes 
certain liabilities of the U.S. transferor in the section 361 exchange.
    The proposed regulations provide rules for determining the portion 
of the stock received by a control group member that is attributable to 
section 367(a) property that are consistent with general tax 
principles, including Rev. Rul. 68-55, 1968-1 CB 140, and the 
authorities cited therein. Under these rules, stock received by a 
control group member is allocated between the aggregate section 367(a) 
property and all other property transferred in the section 361 exchange 
based on relative gross fair market value.
    The U.S. transferor must recognize gain with respect to any control 
group member that cannot preserve its entire share of inside gain in 
the stock received in the transaction even if the control group 
members' aggregate share of inside gain can be preserved in the stock 
received by the control group members as a group. For example, assume 
that the U.S. transferor is wholly owned by two domestic corporations 
(US1 and US2) and that each control group member's share of inside gain 
is $40x. If in the transaction US1 received stock with a value of $30x 
and $20x of non-qualifying property, the U.S. transferor would 
recognize $10x gain with respect to US1, even if US2 received 
sufficient stock to preserve $50x gain (the sum of US2's $40x share of 
inside gain and the portion of US1's share of inside gain ($10x) that 
cannot be preserved in the stock received by US1).

[[Page 49282]]

(iii) Adjustments To Basis of Stock Received by Control Group Members
    Under the proposed regulations, each control group member's basis 
in the stock received in the transaction as determined under section 
358 and the regulations under that section (section 358 basis) that is 
allocable to the section 367(a) property transferred by the U.S. 
transferor in the section 361 exchange is reduced to the extent 
necessary to preserve the control group member's share of inside gain. 
As a general matter, if the U.S. transferor must recognize gain with 
respect to a control group member because the control group member's 
entire share of inside gain cannot be preserved in the stock received 
by the control group member in the transaction (see part A.2.b.ii of 
this preamble), the control group member's section 358 basis in the 
stock received that is attributable to section 367(a) property is 
reduced to zero.
    Only the basis of stock received by the control group member that 
is attributable to section 367(a) property transferred in the section 
361 exchange is reduced (for example, the basis of stock attributable 
to section 367(d) property is not reduced). The reduction to a control 
group member's section 358 basis in the stock received that is 
attributable to section 367(a) property equals the amount, if any, by 
which the control group member's share of inside gain (reduced by the 
amount of any gain recognized by the U.S. transferor with respect to 
the control group member (discussed in part A.2.b.ii of this preamble)) 
exceeds the built-in gain in such stock (outside gain). The outside 
gain is the amount by which the fair market value of such stock exceeds 
the section 358 basis of the stock (as determined before any required 
adjustment to such basis under the proposed regulations). The proposed 
regulations provide special rules that apply if the control group 
member holds more than one block of stock received in the transaction.
    If the section 361 exchange is part of a divisive reorganization 
described in section 368(a)(1)(D) that is eligible for the exception 
(see part A.2.b of this preamble for additional conditions that must be 
satisfied in such a case), each affiliated group member that receives 
stock of the foreign acquiring corporation in the final section 355 
distribution must reduce the section 358 basis of such stock to the 
same extent that the control group member that initially received the 
stock from the U.S. transferor would have reduced its section 358 basis 
in such stock. In such a case, the control group member that received 
the stock of the foreign acquiring corporation from the U.S. transferor 
is not required to reduce the section 358 basis of such stock.
    A section 361 exchange that is subject to section 367(a)(5) may be 
part of a triangular reorganization in which the control group members 
receive stock of the corporation that controls the foreign acquiring 
corporation (the controlling corporation). In such a case, the proposed 
regulations require the control group members to adjust (if necessary) 
the section 358 basis of the stock of the controlling corporation 
(whether foreign or domestic) received in the transaction. The IRS and 
Treasury Department believe adjusting the basis of such stock to be 
appropriate even if the controlling corporation is domestic because the 
control group members' aggregate share of inside gain may not be 
preserved in the stock of the foreign acquiring corporation held by the 
controlling corporation in all cases. For example, liabilities assumed 
or incurred by the foreign acquiring corporation in connection with the 
transaction could reduce the amount of inside gain preserved in such 
stock. Moreover, even if the control group members' aggregate share of 
inside gain could be preserved in such stock, such an approach would 
shift the inside gain to the domestic controlling corporation, rather 
than to the control group members as intended by section 367(a)(5).
(iv) Agreement To Recognize Gain and File Amended Tax Return
    The proposed regulations require the U.S. transferor to include a 
statement with its U.S. income tax return for the year of the section 
361 exchange certifying that if the foreign acquiring corporation 
disposes of a significant amount of the section 367(a) property 
transferred in the section 361 exchange in one or more related 
transactions entered into with a principal purpose of avoiding the U.S. 
tax that would have been imposed on a sale of such property by the U.S. 
transferor at the time of the section 361 exchange, then the U.S. 
transferor (or the foreign acquiring corporation on behalf of the U.S. 
transferor) shall file a U.S. income tax return (or amended U.S. income 
tax return, as the case may be) for the year of the section 361 
exchange reporting the gain realized but not recognized on the section 
361 exchange. This requirement is intended to prevent the potential use 
of reorganizations subject to section 367(a)(5) to avoid the repeal of 
the ``General Utilities'' doctrine. Interest must be paid (determined 
under section 6621) on the amount of any additional tax due on such 
return. For this purpose, a disposition of a significant amount of the 
section 367(a) property occurs if the foreign acquiring corporation 
disposes of an amount of the section 367(a) property transferred in the 
section 361 exchange that is greater than forty percent of the fair 
market value of the section 367(a) property at the time of the section 
361 exchange. Comments are requested regarding whether an exception 
from this rule should be provided for dispositions of section 367(a) 
property occurring in the ordinary course of business.
(v) Election and Reporting Requirements
    To elect to apply the exception, the proposed regulations require 
the U.S. transferor and the control group members to enter into a 
written agreement to make such election on or before the due date for 
the U.S. transferor's timely-filed return for the taxable year in which 
the section 361 exchange occurs. Each party to the written agreement 
must also include a statement with its timely-filed return for the year 
of the section 361 exchange reporting the election and other specified 
information. If the section 361 exchange is part of a divisive 
reorganization described in section 368(a)(1)(D) that is eligible for 
the exception (see part A.2.b of this preamble for additional 
conditions that must be satisfied in such a case), each affiliated 
group member that receives stock of the foreign acquiring corporation 
in the final section 355 distribution must enter into the written 
agreement and include the reporting statement with its timely-filed 
return (instead of the control group member that initially received the 
stock of the foreign acquiring corporation from the U.S. transferor.) 
Relief for reasonable cause may be available for the failure to comply 
with the election and reporting requirements.
3. Special Entities
    The proposed regulations apply to property transfers by U.S. 
transferors, including RICs, REITs, and subchapter S corporations. 
Comments are requested regarding whether and the extent to which the 
IRS and Treasury Department should exercise the authority under section 
367(a)(6) to provide an exception from the general rule of section 
367(a)(5) for a transfer of property by a RIC, a REIT, or a subchapter 
S corporation to a foreign corporation pursuant to a section 361 
exchange.

[[Page 49283]]

B. Section 367(b)

1. Overview
    Section 367(b)(1) provides that in the case of any exchange 
described in section 332, 351, 354, 355, 356, or 361 in connection 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 which 
are necessary or appropriate to prevent the avoidance of Federal income 
taxes.
    A fundamental policy of section 367(b) is to preserve the potential 
application of section 1248 following certain section 367(b) exchanges. 
H.R. Rep. No. 94-658, at 242 (1975). Thus, if the potential application 
of section 1248 cannot be preserved immediately following the 
acquisition of the stock or assets of a foreign acquired corporation by 
a foreign acquiring corporation in a section 367(b) exchange, the final 
regulations (TD 8862) under section 367(b) issued on January 24, 2000 
(2000 final regulations) require certain shareholders of the foreign 
acquired corporation to include in income as a dividend the section 
1248 amount attributable to the stock of the foreign acquired 
corporation. See Sec.  1.367(b)-4(b). For example, the inclusion in 
income of the section 1248 amount is required if the section 367(b) 
exchange results in the loss of section 1248 shareholder status or if 
the foreign acquired corporation or foreign acquiring corporation is 
not a CFC immediately after the section 367(b) exchange. See Sec.  
1.367(b)-4(b)(1)(i).
2. Outbound Asset Reorganizations--In General
    The 2000 final regulations require a U.S. transferor that is a 
section 1248 shareholder of a foreign acquired corporation and that 
transfers the stock of such corporation to a foreign acquiring 
corporation in a section 361 exchange to include in income the section 
1248 amount attributable to the stock of the foreign acquired 
corporation. The U.S. transferor must include the section 1248 amount 
in income even if the foreign acquiring corporation and the foreign 
acquired corporation are CFCs with respect to which the U.S. transferor 
is a section 1248 shareholder immediately after the section 361 
exchange. See Sec.  1.367(b)-4(b)(1)(iii), Example 4. Moreover, under 
section 1248(f)(1) the U.S. transferor generally would be required to 
include in income the section 1248 amount attributable to the stock of 
the foreign acquiring corporation distributed under section 361(c)(1). 
The section 1248 amount attributable to the stock of the foreign 
acquiring corporation would generally include the section 1248 amount 
attributable to the stock of the foreign acquired corporation. See 
generally Sec.  1.1248-8.
    The final regulations (TD 9243) under section 367(b) issued on 
January 26, 2006 (2006 final regulations) provided an exception to the 
general rule of Sec.  1.367(b)-4(b)(1)(i) that applies in certain 
triangular reorganizations where the exchanging shareholder receives 
stock of a domestic corporation that controls the foreign acquiring 
corporation. This exception only applies, however, to a shareholder 
that exchanges stock of the foreign acquired corporation for stock of 
the domestic corporation in an exchange described under section 354 or 
356. Thus, the exception provided by the 2006 final regulations does 
not apply where the U.S. transferor receives stock of a domestic 
controlling corporation for stock of a foreign acquired corporation in 
a section 361 exchange.
    After studying the issue further and in response to comments 
received, the IRS and Treasury Department have determined that 
requiring the U.S. transferor to include the section 1248 amount in 
income may not be necessary in cases where the section 1248 amount 
attributable to the stock of the foreign acquired corporation can be 
preserved. Accordingly, the proposed regulations under section 367(b) 
included in this document provide an additional exception to the 
general rule of the 2000 final regulations that applies to certain 
transfers of stock of a foreign acquired corporation by a U.S. 
transferor to a foreign acquiring corporation in a section 361 
exchange.
    In such a case, the proposed regulations provide that the U.S. 
transferor must include in income the section 1248 amount attributable 
to the stock of the foreign acquired corporation only if immediately 
after the section 361 exchange the foreign acquiring corporation or the 
foreign acquired corporation is not a CFC with respect to which the 
U.S. transferor is a section 1248 shareholder. Example 4 in Sec.  
1.367(b)-4(b)(1)(iii) is modified accordingly. The proposed regulations 
under section 1248(f) included in this document supplement this 
exception to ensure that the section 1248 amount can be preserved in 
the hands of a corporate section 1248 shareholder following the 
distribution of the stock of the foreign acquiring corporation by the 
U.S. transferor. See part C of this preamble for discussion of the 
proposed regulations under section 1248(f).
3. Special Rules for Outbound Triangular Asset Reorganizations
    As noted, the 2000 final regulations also require the U.S. 
transferor to include in income the section 1248 amount attributable to 
stock of a foreign acquired corporation transferred to a foreign 
acquiring corporation in a section 361 exchange that is part of 
triangular asset reorganization, even if the corporation that controls 
the foreign acquiring corporation is domestic. The provisions of Sec.  
1.367(b)-13 (TD 9243) do not apply to preserve the section 1248 amount 
attributable to the stock of the foreign acquired corporation in such a 
case. The proposed regulations under section 367(b) included in this 
document, however, would provide an exception to the general rule of 
the final 2000 regulations in such triangular asset reorganizations.
    If the controlling corporation is foreign, the exception applies 
if, immediately after the section 361 exchange, the foreign controlling 
corporation, the foreign acquiring corporation, and the foreign 
acquired corporation are CFCs with respect to which the U.S. transferor 
is a section 1248 shareholder. If the controlling corporation is 
domestic, the exception applies if, immediately after the section 361 
exchange, the foreign acquired corporation is a CFC with respect to 
which the domestic controlling corporation is a section 1248 
shareholder. In addition, in either case, the controlling corporation 
(foreign or domestic) must apply the principles of Sec.  1.367(b)-13 to 
determine the adjustment to the basis of the stock of the foreign 
acquiring corporation (instead of the over-the-top basis adjustment 
rules of Sec.  1.358-6) to ensure that the section 1248 amount 
attributable to the stock of the foreign acquired corporation at the 
time of the section 361 exchange is preserved in the stock of the 
foreign acquiring corporation immediately after the section 361 
exchange. Under these principles, each share of stock of the foreign 
acquiring corporation would generally be divided into the portions 
necessary to preserve the pre-exchange section 1248 amounts 
attributable to the stock of the foreign acquired corporation and the 
foreign acquiring corporation, respectively. If the controlling 
corporation is foreign, the proposed regulations under section 1248(f) 
included in this document supplement this exception to ensure that the 
section 1248 amount can be preserved following the distribution of the 
stock of the foreign controlling corporation by the U.S. transferor to 
its shareholders.

[[Page 49284]]

C. Section 1248(f)

1. Overview
    Section 1248(f)(1) provides that, except as provided in 
regulations, if a domestic corporation (domestic distributing 
corporation) that is a section 1248 shareholder with respect to a 
foreign corporation distributes the stock of such foreign corporation 
in a distribution described in section 311(a), 337, 355(c)(1), or 
361(c)(1), then notwithstanding any other provisions of the Code, the 
domestic distributing corporation must include in income as a dividend 
the section 1248 amount attributable to such stock. Section 1248(f)(1) 
requires the inclusion of the section 1248 amount because the section 
1248 amount attributable to the stock distributed may not be preserved 
in the hands of the distributee shareholders following the 
distribution. Section 1248(f)(1) does not apply to the extent the 
domestic distributing corporation otherwise recognizes gain on the 
distribution, in which case the gain recognized would be 
recharacterized as a dividend under section 1248(a), as appropriate.
    Section 1248(f)(2), however, provides that section 1248(f)(1) shall 
not apply to a domestic distributing corporation's distribution of 
stock of a foreign corporation to a domestic corporation that is 
treated as holding the stock for the period during which the stock was 
held by the domestic distributing corporation and that, immediately 
after the distribution, is a section 1248 shareholder with respect to 
the foreign corporation. The legislative history explains that where 
``the corporate distribute[e] does not receive a stepped up basis as a 
result of the distribution and* * *the potential for the future 
application of section 1248 still exists, it is not necessary to [apply 
section 1248(f)(1) to] override the nonrecognition provisions which 
otherwise apply to a corporate distribution.'' S. Rep. No. 94-938, at 
270 (1976).
    The legislative history provides that the Treasury Department may 
exercise the regulatory authority granted under section 1248(f)(1) to 
provide that, where section 1248(f)(2) does not otherwise apply, ``the 
recipient corporation may be required to take a carryover basis in the 
stock received (rather than a substituted basis under section 358, for 
example, in the case of a section 355 or 361 distribution) and section 
1248(f)(1) will not apply to such distribution.'' S. Rep. No. 100-445, 
at 64 (1988).
    In Notice 87-64 (1987-2 CB 375), the IRS and Treasury Department 
announced that, in the case of section 355 distributions of CFC stock, 
regulations under section 1248(f) may limit the application of section 
1248(f)(1) to distributions in which the CFC is no longer a CFC after 
the distribution or in which one or more of the distributees are not 
United States shareholders (within the meaning of section 951(b)) of 
the CFC after the distribution. The notice further states that the 
regulations would ensure that, subsequent to a section 355 distribution 
of CFC stock that would not be subject to section 1248(f)(1) under the 
regulations, the amount of gain recognized from a disposition of the 
CFC stock that would be recharacterized as a dividend under section 
1248(a) would include the earnings and profits attributable to the CFC 
stock under section 1248 as of the date of the section 355 
distribution. To achieve this result, the notice provides that the 
regulations may require appropriate adjustments to the basis and 
holding period of the CFC stock received by one or more of the 
distributees.
2. General Rules
    The proposed regulations under section 1248(f) included in this 
document provide that a domestic distributing corporation that is a 
section 1248 shareholder of a foreign corporation and that distributes 
stock of such foreign corporation in a distribution to which section 
337 applies (section 337 distribution), shall generally include in 
income as a dividend the section 1248 amount attributable to the stock 
distributed.
    The proposed regulations further provide that a domestic 
distributing corporation that is a section 1248 shareholder of a 
foreign corporation and that distributes stock of such foreign 
corporation in a section 355 distribution, other than stock received by 
the domestic distributing corporation in a section 361 exchange, shall 
generally include in income as a dividend the section 1248 amount 
attributable to the stock distributed. This rule applies, however, only 
to the extent the domestic distributing corporation does not otherwise 
recognize gain on the section 355 distribution, in which case the gain 
recognized would be recharacterized as a dividend under section 
1248(a), as appropriate.
    Finally, the proposed regulations provide that a domestic 
distributing corporation that is a section 1248 shareholder of a 
foreign distributed corporation and that distributes stock of such 
corporation received in a section 361 exchange, in a section 355 
distribution or a distribution to which section 361 applies (section 
361 distribution), shall, notwithstanding any other provision of the 
Code, include in income as a dividend the ``section 1248(f) amount'' 
attributable to the stock distributed. The section 1248(f) amount 
equals the aggregate amount that would be included in income as a 
dividend by the foreign distributed corporation under section 964(e) 
if, immediately after the section 361 exchange that preceded the 
section 355 distribution or section 361 distribution, the foreign 
distributed corporation sold the stock of each foreign corporation 
received in the section 361 exchange. This rule supplements the 
proposed regulations under section 367(b) which provide an exception to 
the general rule of Sec.  1.367(b)-4(b)(1)(i) in certain cases where 
stock of a foreign acquired corporation is transferred by a U.S. 
transferor in a section 361 exchange.
3. Exceptions to the General Rules
    The proposed regulations incorporate the statutory exception 
provided by section 1248(f)(2) for distributions that meet certain 
conditions. The proposed regulations also provide elective exceptions 
for section 355 distributions and section 361 distributions. The 
exceptions for such distributions are elective because applying the 
exceptions may reduce a corporate distributee's section 358 basis in 
the stock received in the distribution. The conditions of the 
exceptions carry out the policy of section 1248(f) by limiting the 
exceptions to distributions where the potential application of section 
1248 and the relevant section 1248 amounts can be preserved following 
the distribution.
(a) Section 337 Distributions
    The general rule will not apply to a section 337 distribution of 
the stock of a foreign corporation if immediately after the 
distribution the 80-percent distributee (described in section 337(c)) 
is a section 1248 shareholder with respect to the foreign corporation, 
the 80-percent distributee's holding period in the stock received in 
the distribution is the same as the domestic distributing corporation's 
holding period in such stock at the time of the distribution, and the 
80-percent distributee's basis in the stock received in the 
distribution is not greater than the domestic distributing 
corporation's basis in such stock at the time of the distribution.
    The IRS and Treasury Department believe the conditions should be 
satisfied in most section 337 distributions because of the application 
of sections 334 and 1223. However, comments are requested regarding any

[[Page 49285]]

cases where these conditions may not be met and whether the 80-percent 
distributee should be permitted to adjust the basis or holding period 
of the stock received so that the conditions can be met.
(b) Certain Section 355 Distributions
    The proposed regulations provide an elective exception to the 
general rule for a section 355 distribution of stock of a foreign 
corporation not received by the domestic distributing corporation in a 
section 361 exchange to a domestic corporation that is a section 1248 
shareholder with respect to the foreign corporation immediately after 
the distribution. The election to apply the exception is irrevocable 
and must be made by the domestic distributing corporation and all such 
section 1248 shareholders. If the election is made, adjustments may be 
made to each section 1248 shareholder's section 358 basis and holding 
period in the stock received to preserve the section 1248 amount 
attributable to such stock at the time of the distribution.
    To apply the exception, the proposed regulations require the 
domestic distributing corporation and the section 1248 shareholders to 
enter into a written agreement on or before the due date (including 
extensions) of the domestic distributing corporation's tax return for 
the taxable year during which the section 355 distribution occurs. The 
proposed regulations also require the domestic distributing corporation 
and each section 1248 shareholder to include a statement with its tax 
return for the taxable year during which the distribution occurs 
reporting that the election to apply the exception has been made and 
any required adjustments to stock basis or holding period. Each party 
to the agreement must retain the original or a copy of the agreement as 
part of its records. The proposed regulations provide relief for 
reasonable cause for the failure to comply with the election and 
reporting requirement.
    If the exception applies, two adjustments may be required with 
respect to each section 1248 shareholder. First, solely for purposes of 
section 1248, immediately following the distribution the section 1248 
shareholder's holding period in the stock received in the distribution 
shall equal the domestic distributing corporation's holding period in 
such stock at the time of the distribution. Second, if the section 1248 
amount attributable to the stock of the foreign corporation at the time 
of the distribution exceeds the section 1248 shareholder's 
postdistribution amount attributable to such stock (excess amount), the 
section 1248 shareholder's section 358 basis in such stock is reduced 
by the excess amount. The postdistribution amount is the section 1248 
shareholder's section 1248 amount attributable to the stock received in 
the distribution, computed immediately after the distribution and 
taking into account the adjustment to the shareholder's holding period 
in such stock.
(c) Distributions Pursuant to a Plan of Reorganization
    The proposed regulations provide an elective exception to the 
general rule for a section 355 distribution or section 361 distribution 
of stock of a foreign corporation received by the domestic distributing 
corporation in the section 361 exchange that precedes such distribution 
to a domestic corporation that is a section 1248 shareholder with 
respect to the foreign corporation immediately after the distribution. 
The election to apply the exception is irrevocable and must be made by 
the domestic distributing corporation and all such section 1248 
shareholders. If the exception applies, adjustments may be made to each 
section 1248 shareholder's section 358 basis (as adjusted under the 
proposed regulations under section 367(a)(5)) and the amount of 
earnings and profits attributable to the stock received for purposes of 
section 1248 to preserve the section 1248(f) amount attributable to 
such stock at the time of the distribution.
    To apply the exception, the proposed regulations require the 
domestic distributing corporation and the section 1248 shareholders to 
enter into a written agreement on or before the due date (including 
extensions) of the domestic distributing corporation's tax return for 
the taxable year during which the distribution occurs. The proposed 
regulations also require the domestic distributing corporation and each 
section 1248 shareholder to include a statement with its tax return for 
the taxable year during which the distribution occurs reporting that 
the election to apply the exception has been made and any required 
adjustments to stock basis or the amount of earnings and profits 
attributable to the stock received for purposes of section 1248. Each 
party to the agreement must include the original or a copy of the 
agreement as part of its records. The proposed regulations provide 
relief for reasonable cause for the failure to comply with the election 
and reporting requirements.
    If the exception applies, two adjustments may be required with 
respect to each section 1248 shareholder. First, each share of stock of 
the foreign corporation received by the section 1248 shareholder is 
divided into portions attributable to each block of stock of a foreign 
acquired corporation transferred by the domestic distributing 
corporation in the section 361 exchange with respect to which the 
domestic distributing corporation was a section 1248 shareholder at the 
time of the section 361 exchange, and to all other property transferred 
by the domestic distributing corporation in the section 361 exchange. 
For example, if in the section 361 exchange the domestic distributing 
corporation transfers a block of stock in each of three foreign 
corporations with respect to which it is a section 1248 shareholder, 
then each share of stock of the foreign distributed corporation 
received by the section 1248 shareholder must be divided into three 
portions. Alternatively, if multiple blocks of stock in each of the 
three foreign corporations were transferred in the section 361 
exchange, then each share of the stock of the foreign distributed 
corporation would be divided into additional portions to account for 
the additional blocks of stock transferred. The proposed regulations 
further provide that, for purposes of section 1248, the earnings and 
profits attributable to each block of stock of a foreign acquired 
corporation transferred in the section 361 exchange that results in a 
divided portion of a share of stock of the foreign acquiring 
corporation (or whole share, if no division is required) are 
attributable to such portion (or whole share, if no division is 
required) based on the section 1248 shareholder's ownership interest 
(by value) in the domestic distributing corporation at the time of the 
section 361 exchange.
    Second, if the section 1248(f) amount attributable to a portion of 
a share (or whole share, if no division is required) of stock of the 
foreign distributed corporation received in the distribution exceeds 
the section 1248 shareholder's postdistribution amount attributable to 
such portion (or whole share) (excess amount), then the section 1248 
shareholder's section 358 basis in such portion (or whole share, if no 
division is required), as adjusted under the proposed regulations under 
section 367(a)(5) (discussed in part A.2.b.iii of this preamble), is 
reduced by such excess amount. This adjustment ensures that the section 
1248 shareholder's share of the section 1248 amount attributable to the 
stock of each foreign acquired corporation transferred in the section 
361 exchange is preserved in the stock of the foreign distributed

[[Page 49286]]

corporation received by such shareholder in the distribution.
    The IRS and Treasury Department declined to adopt rules that would 
not require the division of shares to preserve section 1248 amounts 
because such rules could inappropriately increase or decrease the 
section 1248 amount attributable to the stock of the foreign 
distributed corporation received by a section 1248 shareholder in the 
distribution. For example, if in the section 361 exchange the domestic 
distributing corporation transferred appreciated tangible property and 
stock of a CFC with earnings and profits for purposes of section 
1248(a) in excess of the built-in gain in such stock, then the 
appreciation in the tangible property could inappropriately increase 
the section 1248 amount attributable to the stock of the foreign 
distributed corporation received by a section 1248 shareholder in the 
distribution (to the extent the CFC's earnings and profits exceed the 
section 1248 amount attributable to the CFC stock at the time of the 
section 361 exchange). A similar inappropriate increase would result if 
the domestic distributing corporation transferred appreciated stock of 
two CFCs in the section 361 exchange, one CFC without a section 1248 
amount and the other CFC with a section 1248 amount but with earnings 
and profits for purposes of section 1248 in excess of such section 1248 
amount.
    The IRS and Treasury Department also declined to adopt rules that 
would preserve any reduction to a section 1248 shareholder's section 
358 basis in a portion of a share (or whole share, if no division is 
required) of stock of the foreign distributed corporation received in 
the distribution by increasing the basis of other portions of the share 
(or other whole shares, if no division is required) of stock or by 
establishing a suspended basis account equal to the basis reduction. 
Those rules were not adopted because a capital loss would be created 
that could economically offset the section 1248 amount, which would not 
be consistent with the policy underlying section 1248(f) and the 
regulations described in Notice 87-64. S. Rep. No. 94-938, at 270 
(1976).
    Comments are requested on how the rules of the proposed regulations 
can be simplified and how the rules should apply to different classes 
of stock.
4. Section 964(e) and Inclusions Under Section 367(b)
    Comments are requested regarding whether the IRS and Treasury 
Department should exercise the authority under section 367(b) to apply 
the principles of section 1248(f)(1) to section 355 distributions or 
section 361 distributions of stock of a foreign corporation by a CFC, 
to the extent the transaction does not otherwise result in an income 
inclusion to the exchanging shareholders of the CFC under section 
367(b) and the regulations under that section. Comments should consider 
the appropriate balance between the policy of sections 1248(a) and 
964(e) and the associated complexity and compliance burdens.

D. Changes to Exception to Coordination Rule of Sec.  1.367(a)-
3(d)(2)(vi)(A)

1. Overview
    Section 1.367(a)-3(d)(2)(vi)(A) (the coordination rule) provides 
that if, in connection with an indirect stock transfer, a U.S. person 
transfers assets to a foreign corporation (direct asset transfer) in an 
exchange described in section 351 or section 361, the rules of section 
367 and the regulations under that section shall first apply to the 
direct asset transfer and then to the indirect stock transfer. However, 
an exception to the coordination rule (coordination rule exception) 
provides that section 367(a) and (d) shall not apply to a direct asset 
transfer otherwise subject to the coordination rule to the extent that 
assets transferred by a domestic acquired corporation to a foreign 
acquiring corporation in an asset reorganization are re-transferred