Application of Section 367 to a Section 351 Exchange Resulting From a Transaction Described in Section 304(a)(1); Treatment of Gain Recognized Under Section 301(c)(3) for Purposes of Section 1248, 6824-6828 [E9-2835]

Download as PDF 6824 Federal Register / Vol. 74, No. 27 / Wednesday, February 11, 2009 / Rules and Regulations proposed regulations set forth in the notice of proposed rulemaking on this subject published in the Proposed Rules section in this issue of the Federal Register. DATES: Effective Date: These regulations are effective on February 11, 2009. Applicability Date: These regulations apply to acquisitions of stock occurring on or after February 11, 2009. FOR FURTHER INFORMATION CONTACT: Sean W. Mullaney, (202) 622–3860 (not a toll-free number). SUPPLEMENTARY INFORMATION: gland of goats derived from lineage progenitor 155–92. (b) Sponsor. See No. 042976 in § 510.600 of this chapter. (c) Limitations. Food or feed from GTC–155–92 goats is not permitted in the food or feed supply. Dated: February 6, 2009. Bernadette Dunham, Director, Center for Veterinary Medicine. [FR Doc. E9–2881 Filed 2–6–09; 4:15 pm] BILLING CODE 4160–01–S DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9444] RIN 1545–BI42 Application of Section 367 to a Section 351 Exchange Resulting From a Transaction Described in Section 304(a)(1); Treatment of Gain Recognized Under Section 301(c)(3) for Purposes of Section 1248 dwashington3 on PRODPC68 with RULES AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final and temporary regulations. SUMMARY: This document contains final and temporary regulations under sections 367(a), 367(b) and 1248(a) of the Internal Revenue Code (Code). The final regulations under section 367 revise existing final regulations and add cross-references. The final regulations under section 1248 update an effective/ applicability date. The temporary regulations under section 367(a) and (b) revise existing final regulations concerning transfers of stock to a foreign corporation that are described in section 351 by reason of section 304(a)(1). The temporary regulations under section 1248(a) provide that, for purposes of section 1248(a), gain recognized by a shareholder under section 301(c)(3) in connection with the receipt of a distribution of property from a foreign corporation with respect to its stock shall be treated as gain from the sale or exchange of the stock of such foreign corporation. The temporary regulations affect certain persons that transfer stock to a foreign corporation in a transaction described in section 304(a)(1), or certain persons that recognize gain under section 301(c)(3) in connection with the receipt of a distribution of property from a foreign corporation with respect to its stock. The text of the temporary regulations serves as the text of the VerDate Nov<24>2008 14:15 Feb 10, 2009 Jkt 217001 Background Section 367(a)(1) generally provides that if a United States person transfers property to a foreign corporation in an exchange described in section 332, 351, 354, 356, or 361, the foreign corporation shall not be considered a corporation for purposes of determining the extent to which the United States person recognizes gain on such transfer. Exceptions to the general rule are provided by section 367(a)(2) and (3), and the Secretary has broad authority under section 367(a)(6) to promulgate regulations providing exceptions for other transactions. Section 367(b)(1) provides that in the case of an 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. Section 367(b)(2) provides that the regulations prescribed pursuant to section 367(b)(1) shall include (but shall not be limited to) regulations dealing with the sale or exchange of stock or securities in a foreign corporation by a United States person, including regulations providing the circumstances under which gain is recognized, amounts are included in gross income as a dividend, adjustments are made to earnings and profits, or adjustments are made to the basis of stock or securities. Regulations under section 367(b) generally provide that if the potential application of section 1248 cannot be preserved immediately following the acquisition of the stock or assets of a foreign corporation (foreign acquired corporation) by another foreign corporation in an exchange subject to section 367(b), then certain exchanging shareholders of the foreign acquired corporation must include in income as a dividend the section 1248 amount (as defined in § 1.367(b)–2(c)) attributable PO 00000 Frm 00002 Fmt 4700 Sfmt 4700 to the stock of the foreign acquired corporation. See § 1.367(b)–4(b). Section 304(a)(1) generally provides that, for purposes of sections 302 and 303, if one or more persons are in control of each of two corporations and in return for property one of the corporations (the acquiring corporation) acquires stock in the other corporation (the issuing corporation) from the person (or persons) so in control, then such property shall be treated as a distribution in redemption of the stock of the acquiring corporation. To the extent section 301 applies to the distribution, the transferor and the acquiring corporation are treated as if (1) the transferor transferred the stock of the issuing corporation to the acquiring corporation in exchange for stock of the acquiring corporation in a transaction to which section 351(a) applies, and (2) the acquiring corporation then redeemed the stock it is deemed to have issued. Under section 304(b)(2), the determination of the amount of the property distribution that is a dividend (and the source thereof) is made as if the property is distributed by the acquiring corporation to the extent of its earnings and profits, and then by the issuing corporation to the extent of its earnings and profits. On February 21, 2006, the IRS and Treasury Department issued final regulations (TD 9250) providing that section 367(a) and (b) shall not apply to certain transfers of stock of a foreign or domestic corporation to a foreign acquiring corporation to which section 351 applies (deemed section 351 exchange) by reason of section 304(a)(1) (final 2006 regulations). Specifically, § 1.367(a)–3(a) provides that if, pursuant to section 304(a)(1), a United States person is treated as transferring stock of a domestic or foreign corporation to a foreign corporation in exchange for stock of such foreign corporation in a deemed section 351 exchange, the deemed section 351 exchange is not a transfer to a foreign corporation subject to section 367(a). Similarly, § 1.367(b)– 4(a) provides that if, pursuant to section 304(a)(1), a foreign corporation is treated as acquiring the stock of another foreign corporation in a deemed section 351 exchange, the deemed section 351 exchange is not an acquisition subject to section 367(b). The preamble to the final 2006 regulations explained that the IRS and Treasury Department determined that the policies underlying section 367(a) and (b) are preserved even if a deemed section 351 exchange is not subject to section 367(a) and (b) because generally the income recognized by the transferor in the transaction (dividend income, E:\FR\FM\11FER1.SGM 11FER1 dwashington3 on PRODPC68 with RULES Federal Register / Vol. 74, No. 27 / Wednesday, February 11, 2009 / Rules and Regulations capital gain, or both) should equal or exceed the built-in gain in the transferred stock. Comments were received, however, stating that the transferor may not recognize income equal to or greater than the built-in gain in the transferred stock if, under section 301(c)(2), the transferor were permitted to recover the basis of shares of the foreign acquiring corporation held before (and after) the transaction. For example, assume a domestic corporation, P, wholly owns F1 and F2, both foreign corporations. The F1 stock has a $0x basis and $100x fair market value. The F2 stock has a $100x basis and $100x fair market value. Neither F1 nor F2 has current or accumulated earnings and profits. In a transaction subject to section 304(a)(1), P sells the F1 stock to F2 for $100x cash. Under section 304(a)(1), P and F2 are treated as if P transferred the F1 stock to F2 in exchange for F2 stock in a transaction to which section 351 applies, and then F2 redeemed its stock deemed issued to P. Because the redemption of the F2 stock would be described in section 302(d) and therefore subject to section 301, the commentators posited that P may not recognize gain under section 301(c)(3) on the receipt of the $100x cash in redemption of the F2 stock if the basis of both the F2 stock that is received by P in the deemed section 351 exchange ($0x), and of the F2 stock held by P prior to (and after) the transaction ($100x), is available for reduction under section 301(c)(2). If that were the case, P would recognize no gain in the transaction. The preamble to the final 2006 regulations stated, however, that the IRS and Treasury Department believe current law does not provide for the recovery of basis of any shares of the acquiring corporation other than the shares deemed issued to the transferor and redeemed by the acquiring corporation as provided under section 304(a)(1). Thus, in the example above, P would recognize $100x gain under section 301(c)(3) (the built-in gain on the F1 stock), and the basis of the F2 stock held by P after the transaction would continue to be $100x. The IRS and Treasury Department continue to study the basis recovery issue as part of a larger project and have determined that it is necessary to revise the final 2006 regulations prior to the completion of that project. VerDate Nov<24>2008 14:15 Feb 10, 2009 Jkt 217001 Explanation of Provisions A. Modified Application of Section 367(a) to Deemed Section 351 Exchanges Consistent with the final 2006 regulations, the temporary regulations under section 367(a) generally provide that if, pursuant to section 304(a)(1), a United States person is treated as transferring stock of a domestic or foreign corporation to a foreign corporation in exchange for stock of such foreign corporation in a deemed section 351 exchange, the deemed section 351 exchange is not a transfer to a foreign corporation subject to section 367(a). However, if the distribution received by the United States person in redemption of the foreign acquiring corporation stock received in the deemed section 351 exchange is subject to section 301 (by reason of section 302(d)), the temporary regulations provide an exception to the general rule if the distribution is applied against and reduces (in whole or in part), pursuant to section 301(c)(2), the basis of stock of the foreign acquiring corporation held by the United States person other than the stock deemed issued to the United States person in the deemed section 351 exchange. In such a case, the United States person shall recognize gain under section 367(a)(1) equal to the amount by which the gain realized by the United States person with respect to the transferred stock in the deemed section 351 exchange exceeds the amount of the distribution received by the United States person in redemption of the foreign acquiring corporation stock that is treated as a dividend under section 301(c)(1) and included in gross income by the United States person. Thus, in the hypothetical transaction described above, if any amount of the distribution received by P in redemption of the F2 stock was applied against the basis of the F2 stock held by P before (and after) the transaction, then under the temporary regulations P would recognized $100x gain under section 367(a)(1) in connection with its transfer of the F1 stock to F2 in the deemed section 351 exchange. The exceptions to the application of section 367(a)(1) for transfers of stock provided in § 1.367(a)–3 are not available to transfers covered by the temporary regulations. For example, a United States person cannot avoid gain recognition under the temporary regulations by entering into a gain recognition agreement under §§ 1.367(a)–3(b)(1)(ii) and 1.367(a)–8 with respect to the deemed section 351 exchange. PO 00000 Frm 00003 Fmt 4700 Sfmt 4700 6825 The temporary regulations provide rules to coordinate the recognition of gain under the temporary regulations and the corresponding increase to the basis of the stock of the foreign acquiring corporation received by the United States person in the transaction. Under such rules the increase to the basis of the stock of the foreign acquiring corporation by reason of gain recognized by the United States person under the temporary regulations would be taken into account before determining the consequences of the redemption of the shares of the foreign acquiring corporation. For example, in the hypothetical transaction described above, the basis of the F2 stock deemed received by P in exchange for the F1 stock would be increased to $100x under section 358 before determining the consequences of the redemption of such stock under section 301. The gain recognized by P will be treated as recognized with respect to the F1 stock transferred in the deemed section 351 exchange in proportion to the gain realized with respect to the F1 stock. B. Modified Application of Section 367(b) to Deemed Section 351 Exchanges The temporary regulations make similar revisions to the final 2006 regulations under section 367(b). Specifically, the temporary regulations provide that § 1.367(b)–4(b) shall apply to a deemed section 351 exchange to the extent the distribution received by the exchanging shareholder in redemption of the stock deemed issued by the foreign acquiring corporation is applied against and reduces, pursuant to section 301(c)(2), the adjusted basis of stock of the foreign acquiring corporation held by the exchanging shareholder before the transaction. The temporary regulations provide rules to determine the amount of an income inclusion that is attributable to the shares of stock of the foreign acquired corporation transferred in the deemed section 351 exchange when the income inclusion required under the regulations is less than the aggregate section 1248 amount attributable to all of the shares of stock transferred in the deemed section 351 exchange. C. Treatment of Gain Recognized Under Section 301(c)(3) for Purposes of Section 1248(a) The temporary regulations under section 1248(a) provide that gain recognized under section 301(c)(3) on the receipt of a distribution of property from a foreign corporation shall be treated, for purposes of section 1248(a), as gain from the sale or exchange of the E:\FR\FM\11FER1.SGM 11FER1 6826 Federal Register / Vol. 74, No. 27 / Wednesday, February 11, 2009 / Rules and Regulations stock of such corporation. The temporary regulations preserve the policies underlying section 367(b), are consistent with the premise of the final 2006 regulations, and ensure that the earnings and profits of lower-tier foreign subsidiaries described in section 1248(c)(2) are taken into account. D. Effective Dates The temporary regulations apply to transfers or distributions occurring on or after February 11, 2009. Availability of IRS Documents IRS notices cited in this preamble are made available by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. 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. These temporary and final regulations are necessary to ensure that the appropriate amount of income (dividend income, capital gain or both) is recognized currently in the transactions described in the explanation of provisions section in this preamble. Accordingly, good cause is found for dispensing with notice and public comment pursuant to 5 U.S.C. 553(b) and (c) and with a delayed effective date pursuant to 5 U.S.C. 553(d). For applicability of the Regulatory Flexibility Act, see the crossreferenced notice of proposed rulemaking published elsewhere in this Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information The principal author of these regulations is Sean W. Mullaney of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. dwashington3 on PRODPC68 with RULES Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows: ■ PART 1—INCOME TAXES ■ Paragraph. 1. The authority citation for part 1 is amended by adding new VerDate Nov<24>2008 14:15 Feb 10, 2009 Jkt 217001 entries in numerical order to read as follows: Authority: 26 U.S.C. 7805 * * * Section 1.367(a)–9T also issued under 26 U.S.C. 367(a) and (b). * * * Section 1.367(b)–4T also issued under 26 U.S.C. 367(b). * * * Par. 2. Section 1.367(a)–3 is amended by revising the third sentence in paragraph (a) to read as follows: ■ § 1.367(a)–3 Treatment of transfers of stock or securities to foreign corporations. (a) * * * For rules applicable when, pursuant to section 304(a)(1), a United States person is treated as transferring stock of a domestic or foreign corporation to a foreign corporation in exchange for stock of such foreign corporation in a transaction to which section 351(a) applies, see § 1.367(a)– 9T. * * * * * * * * ■ Par. 3. Section 1.367(a)–9T is added to read as follows: § 1.367(a)–9T Treatment of deemed section 351 exchanges pursuant to section 304(a)(1) (temporary). (a) Scope and general rule. This section applies to the extent that, pursuant to section 304(a)(1), a United States person is treated as transferring stock of a domestic or foreign corporation to a foreign corporation (foreign acquiring corporation) in exchange for stock of the foreign acquiring corporation in a transaction to which section 351(a) applies (deemed section 351 exchange). Except to the extent provided in paragraph (b) of this section, a transfer of stock by a United States person to a foreign acquiring corporation in a deemed section 351 exchange is not subject to section 367(a)(1). (b) Special rule. Notwithstanding paragraph (a) of this section, if the distribution received by the United States person in redemption of the stock of the foreign acquiring corporation deemed issued in the deemed section 351 exchange is applied against and reduces (in whole or in part), pursuant to section 301(c)(2), the basis of stock of the foreign acquiring corporation held by the United States person other than the stock deemed issued in the deemed section 351 exchange, the United States person shall recognize gain pursuant to this paragraph (b). The exceptions described in § 1.367(a)–3(b)(1) and (c)(1) shall not apply to a transfer of stock described in paragraph (a) of this section. The amount of gain recognized by a United States person pursuant to this paragraph (b) shall equal the amount, if any, by which— PO 00000 Frm 00004 Fmt 4700 Sfmt 4700 (1) The gain realized by the United States person with respect to the transferred stock in connection with the deemed section 351 exchange exceeds; and (2) The amount of the distribution received by the United States person in redemption of the stock of the foreign acquiring corporation deemed issued in the deemed section 351 exchange that is treated as a dividend under section 301(c)(1) and included in gross income by the United States person. (c) Ordering rule. For purposes of paragraph (b)(1) of this section, the amount of gain realized by the United States person in connection with the deemed section 351 exchange shall be determined without regard to the amount of gain recognized by the United States person under paragraph (b) of this section. (d) Allocation of recognized gain. Gain recognized by a United States person pursuant to paragraph (b) of this section shall be treated as recognized with respect to the stock transferred in the deemed section 351 exchange in proportion to the amount of gain realized by the United States person with respect to such stock. See § 1.367(a)–1T(b)(4) for additional rules on the character, source, and adjustments relating to gain recognized under section 367(a). (e) Example. The following example illustrates the rules of this section: Example. (i) Facts. (A) USP, a domestic corporation, wholly owns FC1 and FC2, each a foreign corporation. USP, FC1 and FC2 use a calendar taxable year. The FC1 stock has a $40x basis and $100x fair market value. The FC2 stock has a $100x basis and $100x fair market value. As of December 31, year 1, FC1 has zero earnings and profits, and FC2 has $20x earnings and profits. On December 31, year 1, in a transaction described in section 304(a)(1), USP sells the FC1 stock to FC2 for $100x cash. (B) Because USP wholly owns FC1 before the transactions and is treated, under section 318, as indirectly owning 100% of the FC1 stock after the transfer, under section 304(a)(1), USP and FC2 are treated in the same manner as if USP contributed the FC1 stock to FC2 in a deemed section 351 exchange in exchange solely for $100x of FC2 stock, and then FC2 redeemed for $100x cash its stock deemed issued to USP. Because USP wholly owns FC1 before the sale and is treated as owning 100% of FC1 after the sale, section 302(a) does not apply to the redemption. Instead, under section 302(d), the redemption is treated as a distribution to which section 301 applies. Pursuant to section 304(b)(2), $20x of the distribution is treated as a dividend from FC2. With respect to the remaining $80x, USP takes the position that $40x is applied against and reduces the basis of the FC2 stock issued in the deemed section 351 exchange, and $40x is applied against and reduces the basis of the FC2 stock E:\FR\FM\11FER1.SGM 11FER1 Federal Register / Vol. 74, No. 27 / Wednesday, February 11, 2009 / Rules and Regulations held by USP prior to (and after) the transaction. (ii) Analysis. Under paragraph (b) of this section, USP must recognize gain of $40x on its transfer of the FC1 stock to FC2 in the deemed section 351 exchange (the amount by which the $60x gain realized by USP on the deemed section 351 exchange with respect to the F1 stock exceeds the $20x dividend inclusion). Pursuant to paragraph (b) of this section, the exception under § 1.367(a)–3(b) is not available to the transfer of the FC1 stock by USP to FC2 in the deemed section 351 exchange. Thus, USP cannot avoid gain recognition under paragraph (b) of this section by entering into a gain recognition agreement with respect to its transfer of the FC1 stock to FC2 in the deemed section 351 exchange. Under paragraph (d) of this section, the $40x gain recognized is allocated among the shares of FC1 stock transferred to FC2 in the deemed section 351 exchange in proportion to the gain realized by USP on the transfer of such shares. Under paragraph (c) of this section, the application of paragraph (b) of this section is determined prior to taking into account the $40x increase to the basis of the FC1 stock transferred by USP. Under section 362, the basis of the FC1 stock in the hands of FC2 is increased by $40x, the amount of gain recognized by the USP on the transfer of the FC1 stock under paragraph (b) of this section. Under section 358, the basis of the FC2 stock received by USP in the deemed section 351 exchange is similarly increased by $40x. See § 1.367(a)–1T(b)(4). The $40x increase to the basis of the FC2 stock is taken into account before determining the consequences of the redemption of such stock under section 304(a)(1). (f) Effective/applicability date. This section applies to transfers occurring on or after February 10, 2009. See § 1.367(a)–3(a), as contained in 26 CFR part 1 revised as of April 1, 2008, for transfers occurring on or after February 21, 2006, and before February 10, 2009. (g) Expiration date. This section expires on or before February 10, 2012. ■ Par. 4. Section 1.367(b)–4 is amended by revising the second sentence in paragraph (a) and adding paragraphs (e), (f) and (g) to read as follows: dwashington3 on PRODPC68 with RULES § 1.367(b)–4 Acquisition of foreign corporate stock or assets by a foreign corporation in certain nonrecognition transactions. (a) * * * For rules applicable when, pursuant to section 304(a)(1), a foreign acquiring corporation is treated as acquiring the stock of a foreign acquired corporation in a transaction to which section 351(a) applies, see § 1.367(b)– 4T(e). * * * * * * * * (e) [Reserved]. For further guidance, see § 1.367(b)–4T(e). (f) [Reserved]. For further guidance, see § 1.367(b)–4T(f). (g) [Reserved]. For further guidance, see § 1.367(b)–4T(g). VerDate Nov<24>2008 14:15 Feb 10, 2009 Jkt 217001 6827 (a) through (d) [Reserved]. For further guidance, see § 1.367(b)–4(a) through (d). (e) Application of section 367(b) to transactions described in section 304(a)(1)—(1) Scope and general rule. This section applies to the extent that, pursuant to section 304(a)(1), an exchanging shareholder is treated as transferring the stock of a foreign acquired corporation to a foreign acquiring corporation in a transaction to which section 351(a) applies (deemed section 351 exchange). Except to the extent provided in paragraph (e)(2) of this section, a transfer of stock of a foreign acquired corporation by an exchanging shareholder in a deemed section 351 exchange shall not be subject to paragraph (b) of this section. (2) Special rule. Notwithstanding paragraph (e)(1) of this section, a transfer of stock of a foreign acquired corporation by an exchanging shareholder to a foreign acquiring corporation in a deemed section 351 exchange shall be subject to paragraph (b) of this section to the extent the distribution received by the exchanging shareholder in redemption of the stock of the foreign acquiring corporation is applied against and reduces, pursuant to section 301(c)(2), the basis of stock of the foreign acquiring corporation held by the exchanging shareholder other than the stock deemed issued by the foreign acquiring corporation in the deemed section 351 exchange. (3) Allocation of income inclusion. If the income inclusion resulting from the application of paragraph (e)(2) of this section is less than the section 1248 amount attributable to the shares of stock of the foreign acquired corporation transferred by the exchanging shareholder in the deemed section 351 exchange, the amount of the income inclusion attributable to each share of stock transferred in the deemed section 351 exchange shall be determined by multiplying the income inclusion by the percentage that the section 1248 amount attributable to such share of stock bears to the aggregate section 1248 amount attributable to all of the shares of stock transferred in the deemed section 351 exchange. (4) Example. The rules of this paragraph (e) are illustrated by the following example: corporation. USP wholly owns CFC1, and CFC1 wholly owns CFC2. CFC2 wholly owns CFC3. CFC1, CFC2 and CFC3 are controlled foreign corporations within the meaning of section 957(a). USP, CFC1, CFC2 and CFC3 use a calendar taxable year. CFC1 owns 30% of the outstanding stock of FS, a foreign corporation. FP owns the remaining 70% of the outstanding stock of FS. The CFC2 stock has a $40x basis and $100x fair market value. The FS stock held by CFC1 has a $60x basis and $100x fair market value. As of December 31, year 1, CFC2 has $20x of section 1248 earnings and profits, CFC3 has $40x of section 1248 earnings and profits, and FS has zero earnings and profits. On December 31, year 1, in a transaction described in section 304(a)(1), CFC1 sells the CFC2 stock to FS for $100x cash. FS is not a controlled foreign corporation (within the meaning section 957(a)) either before or after the sale of the CFC2 stock. (B) Because CFC1 wholly owns CFC2 before the transaction and is treated, under section 318, as indirectly owning 100% of the CFC2 stock after the transaction, under section 304(a)(1), CFC2 and FS are treated as if CFC1 contributed the CFC2 stock to FS in a deemed section 351 exchange in exchange solely for $100x of FS stock, and then FS redeemed for $100x cash its stock deemed issued to CFC1. Because CFC1 wholly owned CFC2 before the transaction and is treated, under section 318, as indirectly owning 100% of CFC2 after the transaction, section 302(a) does not apply to the redemption. Instead, under section 302(d), the redemption is treated as a distribution to which section 301 applies. Pursuant to section 304(b)(2), $20x of the distribution is treated as a dividend from the earnings and profits of CFC2. With respect to the remaining $80x, CFC1 takes the position that $40x is applied against and reduces the basis of the FS stock deemed issued in the transaction, and $40x is applied against and reduces the basis of the FS stock held by CFC1 prior to (and after) the transaction. (ii) Analysis. Under paragraph (e)(2) of this section, the transfer by CFC1 of the CFC2 stock to FS in the deemed section 351 exchange is subject to paragraph (b) of this section to the extent the distribution received by CFC1 in redemption of the FS stock issued in the deemed section 351 exchange is applied against and reduces, under section 301(c)(2), the basis of the FS stock held by CFC1 before (and after) the transaction. Thus, because $40x of the distribution received by CFC1 from FS in redemption of the FS stock issued in the deemed section 351 exchange is applied against and reduces, under section 301(c)(2), the basis of the FS stock held by CFC1 before (and after) the transaction, under paragraph (b) of this section, CFC1 must include $40x in income as a deemed dividend. See § 1.367(b)–2(e) for the treatment of the $40x income inclusion. In total, CFC1 recognizes dividend income of $60x, $20x from the application of section 304(a)(1) to the sale of the CFC2 stock to FS and $40x under paragraph (b) of this section by reason of the application of paragraph (e)(2) of this section. Example. (i) Facts. (A) FP, a foreign corporation, wholly owns USP, a domestic (f) Effective/applicability date. Paragraph (e) of this section applies to Par. 5. Section 1.367(b)–4T is added to read as follows: ■ § 1.367(b)–4T Acquisition of foreign corporate stock or assets by a foreign corporation in certain nonrecognition transactions (temporary). PO 00000 Frm 00005 Fmt 4700 Sfmt 4700 E:\FR\FM\11FER1.SGM 11FER1 6828 Federal Register / Vol. 74, No. 27 / Wednesday, February 11, 2009 / Rules and Regulations transfers occurring on or after February 10, 2009. See § 1.367(b)–4, as contained in 26 CFR part 1 revised as of April 1, 2008, for transfers occurring on or after February 21, 2006, and before February 10, 2009. (g) Expiration date. This section expires on or before February 10, 2012. ■ Par. 6. Section 1.1248–1 is amended by revising paragraphs (b) and (g) and adding paragraph (h) to read as follows: § 1.1248–1 Treatment of gain from certain sales or exchanges of stock in certain foreign corporations. * * * * * (b) [Reserved]. For further guidance, see § 1.1248–1T(b). * * * * * (g) Effective/applicability date. (1) The third sentence in paragraph (a)(1), paragraph (a)(4), and paragraph (a)(5), Example 4, of this section apply to income inclusions that occur on or after July 30, 2007. A taxpayer may elect to apply paragraph (a)(4) of this section to income inclusions in open taxable years provided that it consistently applies paragraph (a)(4) of this section for income inclusions in the first year for which the election is applicable and in all subsequent years. (2) [Reserved]. For further guidance, see § 1.1248–1T(g)(2). (h) [Reserved]. For further guidance, see § 1.1248–1T(h). ■ Par. 7. Section 1.1248–1T is added to read as follows: dwashington3 on PRODPC68 with RULES § 1.1248–1T Treatment of gain from certain sales or exchanges of stock in certain foreign corporations (temporary). (a) [Reserved]. For further guidance, see § 1.1248–1(a). (b) Sale or exchange. For purposes of section 1248(a), the term sale or exchange includes the receipt of a distribution which is treated as in exchange for stock under section 302(a) (relating to distributions in redemption of stock), section 331(a)(1) (relating to distributions in complete liquidation of a corporation), or section 331(a)(2) (relating to distributions in partial liquidation of a corporation). For purposes of section 1248(a), gain recognized by a shareholder under section 301(c)(3) in connection with a distribution of property by a corporation with respect to its stock shall be treated as gain from the sale or exchange of stock of such corporation. (c) through (f) [Reserved]. For further guidance, see § 1.1248–1(c) through (f). (g) Effective/applicability dates. (1) [Reserved]. For further guidance, see § 1.1248–1(g)(1). (2) Paragraph (b) of this section applies to distributions that occur on or after February 10, 2009. VerDate Nov<24>2008 14:15 Feb 10, 2009 Jkt 217001 (h) Expiration date. This section expires on or before February 10, 2012. Linda M. Kroening, Acting Deputy Commissioner for Services and Enforcement. Approved: January 13, 2009. Eric Solomon, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. E9–2835 Filed 2–10–09; 8:45 am] BILLING CODE 4830–01–P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9442] RIN 1545–BA11 Consolidated Returns; Intercompany Obligations; Correction AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Correction to final regulations. SUMMARY: This document contains corrections to final regulations (TD 9442) that were published in the Federal Register on Monday, December 29, 2008 (73 FR 79324) under section 1502 of the Internal Revenue Code providing guidance regarding the treatment of transactions involving obligations between members of a consolidated group. DATES: This correction is effective February 11, 2009, and is applicable on December 29, 2008. FOR FURTHER INFORMATION CONTACT: Frances Kelly, (202) 622–7770 (not a toll-free number). SUPPLEMENTARY INFORMATION: lines from the bottom of the paragraph, the language ‘‘from the deemed satisfaction and reissuance model, these final regulations also adopt more specific rules regarding such transfers (described in part C.3.a. of this Preamble).’’ is corrected to read ‘‘from the deemed satisfaction-reissuance model, these final regulations also adopt more specific rules regarding such transfers (described in part C.3.a. of this preamble).’’. ■ 2. On page 79325, column 3, in the preamble, under the paragraph heading ‘‘C. Exceptions and Related Provisions’’, third paragraph of the column, first line from the bottom of the paragraph, the language ‘‘satisfaction-reissuance.’’ is corrected to read ‘‘satisfaction and reissuance.’’. ■ 3. On page 79327, column 1, in the preamble, under the paragraph heading ‘‘5. Exceptions to the Application of Section 108(e)(4)’’, first paragraph of the column, fifth line from the bottom of the paragraph, the language ‘‘short term debt exceptions for both’’ is corrected to read ‘‘short-term debt exceptions for both’’. Guy Traynor, Acting Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel, (Procedure and Administration). [FR Doc. E9–2831 Filed 2–10–09; 8:45 am] BILLING CODE 4830–01–P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9442] Background RIN 1545–BA11 The final regulations that are the subject of this document are under section 1502 of the Internal Revenue Code. Consolidated Returns; Intercompany Obligations; Correction Need for Correction As published, final regulations (TD 9442) contains errors that may prove to be misleading and are in need of clarification. Correction of Publication Accordingly, the publication of the final regulations (TD 9442), which was the subject of FR Doc. E8–30718, is corrected as follows: ■ 1. On page 79325, column 2, in the preamble, under the paragraph heading ‘‘A. Anti-Abuse Rules’’, second paragraph of the column, first to fifth ■ PO 00000 Frm 00006 Fmt 4700 Sfmt 4700 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Correcting amendment. SUMMARY: This document contains corrections to final regulations (TD 9442) that were published in the Federal Register on Monday, December 29, 2008 (73 FR 79324) under section 1502 of the Internal Revenue Code providing guidance regarding the treatment of transactions involving obligations between members of a consolidated group. DATES: This correction is effective February 11, 2009, and is applicable on December 29, 2008. E:\FR\FM\11FER1.SGM 11FER1

Agencies

[Federal Register Volume 74, Number 27 (Wednesday, February 11, 2009)]
[Rules and Regulations]
[Pages 6824-6828]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-2835]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9444]
RIN 1545-BI42


Application of Section 367 to a Section 351 Exchange Resulting 
From a Transaction Described in Section 304(a)(1); Treatment of Gain 
Recognized Under Section 301(c)(3) for Purposes of Section 1248

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final and temporary regulations under 
sections 367(a), 367(b) and 1248(a) of the Internal Revenue Code 
(Code). The final regulations under section 367 revise existing final 
regulations and add cross-references. The final regulations under 
section 1248 update an effective/applicability date. The temporary 
regulations under section 367(a) and (b) revise existing final 
regulations concerning transfers of stock to a foreign corporation that 
are described in section 351 by reason of section 304(a)(1). The 
temporary regulations under section 1248(a) provide that, for purposes 
of section 1248(a), gain recognized by a shareholder under section 
301(c)(3) in connection with the receipt of a distribution of property 
from a foreign corporation with respect to its stock shall be treated 
as gain from the sale or exchange of the stock of such foreign 
corporation. The temporary regulations affect certain persons that 
transfer stock to a foreign corporation in a transaction described in 
section 304(a)(1), or certain persons that recognize gain under section 
301(c)(3) in connection with the receipt of a distribution of property 
from a foreign corporation with respect to its stock. The text of the 
temporary regulations serves as the text of the proposed regulations 
set forth in the notice of proposed rulemaking on this subject 
published in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective on February 11, 
2009.
    Applicability Date: These regulations apply to acquisitions of 
stock occurring on or after February 11, 2009.

FOR FURTHER INFORMATION CONTACT: Sean W. Mullaney, (202) 622-3860 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    Section 367(a)(1) generally provides that if a United States person 
transfers property to a foreign corporation in an exchange described in 
section 332, 351, 354, 356, or 361, the foreign corporation shall not 
be considered a corporation for purposes of determining the extent to 
which the United States person recognizes gain on such transfer. 
Exceptions to the general rule are provided by section 367(a)(2) and 
(3), and the Secretary has broad authority under section 367(a)(6) to 
promulgate regulations providing exceptions for other transactions.
    Section 367(b)(1) provides that in the case of an 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. Section 367(b)(2) provides that the regulations prescribed 
pursuant to section 367(b)(1) shall include (but shall not be limited 
to) regulations dealing with the sale or exchange of stock or 
securities in a foreign corporation by a United States person, 
including regulations providing the circumstances under which gain is 
recognized, amounts are included in gross income as a dividend, 
adjustments are made to earnings and profits, or adjustments are made 
to the basis of stock or securities.
    Regulations under section 367(b) generally provide that if the 
potential application of section 1248 cannot be preserved immediately 
following the acquisition of the stock or assets of a foreign 
corporation (foreign acquired corporation) by another foreign 
corporation in an exchange subject to section 367(b), then certain 
exchanging shareholders of the foreign acquired corporation must 
include in income as a dividend the section 1248 amount (as defined in 
Sec.  1.367(b)-2(c)) attributable to the stock of the foreign acquired 
corporation. See Sec.  1.367(b)-4(b).
    Section 304(a)(1) generally provides that, for purposes of sections 
302 and 303, if one or more persons are in control of each of two 
corporations and in return for property one of the corporations (the 
acquiring corporation) acquires stock in the other corporation (the 
issuing corporation) from the person (or persons) so in control, then 
such property shall be treated as a distribution in redemption of the 
stock of the acquiring corporation. To the extent section 301 applies 
to the distribution, the transferor and the acquiring corporation are 
treated as if (1) the transferor transferred the stock of the issuing 
corporation to the acquiring corporation in exchange for stock of the 
acquiring corporation in a transaction to which section 351(a) applies, 
and (2) the acquiring corporation then redeemed the stock it is deemed 
to have issued. Under section 304(b)(2), the determination of the 
amount of the property distribution that is a dividend (and the source 
thereof) is made as if the property is distributed by the acquiring 
corporation to the extent of its earnings and profits, and then by the 
issuing corporation to the extent of its earnings and profits.
    On February 21, 2006, the IRS and Treasury Department issued final 
regulations (TD 9250) providing that section 367(a) and (b) shall not 
apply to certain transfers of stock of a foreign or domestic 
corporation to a foreign acquiring corporation to which section 351 
applies (deemed section 351 exchange) by reason of section 304(a)(1) 
(final 2006 regulations). Specifically, Sec.  1.367(a)-3(a) provides 
that if, pursuant to section 304(a)(1), a United States person is 
treated as transferring stock of a domestic or foreign corporation to a 
foreign corporation in exchange for stock of such foreign corporation 
in a deemed section 351 exchange, the deemed section 351 exchange is 
not a transfer to a foreign corporation subject to section 367(a). 
Similarly, Sec.  1.367(b)-4(a) provides that if, pursuant to section 
304(a)(1), a foreign corporation is treated as acquiring the stock of 
another foreign corporation in a deemed section 351 exchange, the 
deemed section 351 exchange is not an acquisition subject to section 
367(b).
    The preamble to the final 2006 regulations explained that the IRS 
and Treasury Department determined that the policies underlying section 
367(a) and (b) are preserved even if a deemed section 351 exchange is 
not subject to section 367(a) and (b) because generally the income 
recognized by the transferor in the transaction (dividend income,

[[Page 6825]]

capital gain, or both) should equal or exceed the built-in gain in the 
transferred stock. Comments were received, however, stating that the 
transferor may not recognize income equal to or greater than the built-
in gain in the transferred stock if, under section 301(c)(2), the 
transferor were permitted to recover the basis of shares of the foreign 
acquiring corporation held before (and after) the transaction. For 
example, assume a domestic corporation, P, wholly owns F1 and F2, both 
foreign corporations. The F1 stock has a $0x basis and $100x fair 
market value. The F2 stock has a $100x basis and $100x fair market 
value. Neither F1 nor F2 has current or accumulated earnings and 
profits. In a transaction subject to section 304(a)(1), P sells the F1 
stock to F2 for $100x cash. Under section 304(a)(1), P and F2 are 
treated as if P transferred the F1 stock to F2 in exchange for F2 stock 
in a transaction to which section 351 applies, and then F2 redeemed its 
stock deemed issued to P. Because the redemption of the F2 stock would 
be described in section 302(d) and therefore subject to section 301, 
the commentators posited that P may not recognize gain under section 
301(c)(3) on the receipt of the $100x cash in redemption of the F2 
stock if the basis of both the F2 stock that is received by P in the 
deemed section 351 exchange ($0x), and of the F2 stock held by P prior 
to (and after) the transaction ($100x), is available for reduction 
under section 301(c)(2). If that were the case, P would recognize no 
gain in the transaction.
    The preamble to the final 2006 regulations stated, however, that 
the IRS and Treasury Department believe current law does not provide 
for the recovery of basis of any shares of the acquiring corporation 
other than the shares deemed issued to the transferor and redeemed by 
the acquiring corporation as provided under section 304(a)(1). Thus, in 
the example above, P would recognize $100x gain under section 301(c)(3) 
(the built-in gain on the F1 stock), and the basis of the F2 stock held 
by P after the transaction would continue to be $100x. The IRS and 
Treasury Department continue to study the basis recovery issue as part 
of a larger project and have determined that it is necessary to revise 
the final 2006 regulations prior to the completion of that project.

Explanation of Provisions

A. Modified Application of Section 367(a) to Deemed Section 351 
Exchanges

    Consistent with the final 2006 regulations, the temporary 
regulations under section 367(a) generally provide that if, pursuant to 
section 304(a)(1), a United States person is treated as transferring 
stock of a domestic or foreign corporation to a foreign corporation in 
exchange for stock of such foreign corporation in a deemed section 351 
exchange, the deemed section 351 exchange is not a transfer to a 
foreign corporation subject to section 367(a). However, if the 
distribution received by the United States person in redemption of the 
foreign acquiring corporation stock received in the deemed section 351 
exchange is subject to section 301 (by reason of section 302(d)), the 
temporary regulations provide an exception to the general rule if the 
distribution is applied against and reduces (in whole or in part), 
pursuant to section 301(c)(2), the basis of stock of the foreign 
acquiring corporation held by the United States person other than the 
stock deemed issued to the United States person in the deemed section 
351 exchange. In such a case, the United States person shall recognize 
gain under section 367(a)(1) equal to the amount by which the gain 
realized by the United States person with respect to the transferred 
stock in the deemed section 351 exchange exceeds the amount of the 
distribution received by the United States person in redemption of the 
foreign acquiring corporation stock that is treated as a dividend under 
section 301(c)(1) and included in gross income by the United States 
person. Thus, in the hypothetical transaction described above, if any 
amount of the distribution received by P in redemption of the F2 stock 
was applied against the basis of the F2 stock held by P before (and 
after) the transaction, then under the temporary regulations P would 
recognized $100x gain under section 367(a)(1) in connection with its 
transfer of the F1 stock to F2 in the deemed section 351 exchange.
    The exceptions to the application of section 367(a)(1) for 
transfers of stock provided in Sec.  1.367(a)-3 are not available to 
transfers covered by the temporary regulations. For example, a United 
States person cannot avoid gain recognition under the temporary 
regulations by entering into a gain recognition agreement under 
Sec. Sec.  1.367(a)-3(b)(1)(ii) and 1.367(a)-8 with respect to the 
deemed section 351 exchange.
    The temporary regulations provide rules to coordinate the 
recognition of gain under the temporary regulations and the 
corresponding increase to the basis of the stock of the foreign 
acquiring corporation received by the United States person in the 
transaction. Under such rules the increase to the basis of the stock of 
the foreign acquiring corporation by reason of gain recognized by the 
United States person under the temporary regulations would be taken 
into account before determining the consequences of the redemption of 
the shares of the foreign acquiring corporation. For example, in the 
hypothetical transaction described above, the basis of the F2 stock 
deemed received by P in exchange for the F1 stock would be increased to 
$100x under section 358 before determining the consequences of the 
redemption of such stock under section 301. The gain recognized by P 
will be treated as recognized with respect to the F1 stock transferred 
in the deemed section 351 exchange in proportion to the gain realized 
with respect to the F1 stock.

B. Modified Application of Section 367(b) to Deemed Section 351 
Exchanges

    The temporary regulations make similar revisions to the final 2006 
regulations under section 367(b). Specifically, the temporary 
regulations provide that Sec.  1.367(b)-4(b) shall apply to a deemed 
section 351 exchange to the extent the distribution received by the 
exchanging shareholder in redemption of the stock deemed issued by the 
foreign acquiring corporation is applied against and reduces, pursuant 
to section 301(c)(2), the adjusted basis of stock of the foreign 
acquiring corporation held by the exchanging shareholder before the 
transaction.
    The temporary regulations provide rules to determine the amount of 
an income inclusion that is attributable to the shares of stock of the 
foreign acquired corporation transferred in the deemed section 351 
exchange when the income inclusion required under the regulations is 
less than the aggregate section 1248 amount attributable to all of the 
shares of stock transferred in the deemed section 351 exchange.

C. Treatment of Gain Recognized Under Section 301(c)(3) for Purposes of 
Section 1248(a)

    The temporary regulations under section 1248(a) provide that gain 
recognized under section 301(c)(3) on the receipt of a distribution of 
property from a foreign corporation shall be treated, for purposes of 
section 1248(a), as gain from the sale or exchange of the

[[Page 6826]]

stock of such corporation. The temporary regulations preserve the 
policies underlying section 367(b), are consistent with the premise of 
the final 2006 regulations, and ensure that the earnings and profits of 
lower-tier foreign subsidiaries described in section 1248(c)(2) are 
taken into account.

D. Effective Dates

    The temporary regulations apply to transfers or distributions 
occurring on or after February 11, 2009.

Availability of IRS Documents

    IRS notices cited in this preamble are made available by the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402.

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. These temporary and 
final regulations are necessary to ensure that the appropriate amount 
of income (dividend income, capital gain or both) is recognized 
currently in the transactions described in the explanation of 
provisions section in this preamble. Accordingly, good cause is found 
for dispensing with notice and public comment pursuant to 5 U.S.C. 
553(b) and (c) and with a delayed effective date pursuant to 5 U.S.C. 
553(d). For applicability of the Regulatory Flexibility Act, see the 
cross-referenced notice of proposed rulemaking published elsewhere in 
this Federal Register. Pursuant to section 7805(f) of the Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Sean W. Mullaney of 
the Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and the Treasury Department participated in 
their 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 
new entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.367(a)-9T also issued under 26 U.S.C. 367(a) and (b). 
* * *
    Section 1.367(b)-4T also issued under 26 U.S.C. 367(b). * * *

0
Par. 2. Section 1.367(a)-3 is amended by revising the third sentence in 
paragraph (a) to read as follows:


Sec.  1.367(a)-3  Treatment of transfers of stock or securities to 
foreign corporations.

    (a) * * * For rules applicable when, pursuant to section 304(a)(1), 
a United States person is treated as transferring stock of a domestic 
or foreign corporation to a foreign corporation in exchange for stock 
of such foreign corporation in a transaction to which section 351(a) 
applies, see Sec.  1.367(a)-9T. * * *
* * * * *

0
Par. 3. Section 1.367(a)-9T is added to read as follows:


Sec.  1.367(a)-9T  Treatment of deemed section 351 exchanges pursuant 
to section 304(a)(1) (temporary).

    (a) Scope and general rule. This section applies to the extent 
that, pursuant to section 304(a)(1), a United States person is treated 
as transferring stock of a domestic or foreign corporation to a foreign 
corporation (foreign acquiring corporation) in exchange for stock of 
the foreign acquiring corporation in a transaction to which section 
351(a) applies (deemed section 351 exchange). Except to the extent 
provided in paragraph (b) of this section, a transfer of stock by a 
United States person to a foreign acquiring corporation in a deemed 
section 351 exchange is not subject to section 367(a)(1).
    (b) Special rule. Notwithstanding paragraph (a) of this section, if 
the distribution received by the United States person in redemption of 
the stock of the foreign acquiring corporation deemed issued in the 
deemed section 351 exchange is applied against and reduces (in whole or 
in part), pursuant to section 301(c)(2), the basis of stock of the 
foreign acquiring corporation held by the United States person other 
than the stock deemed issued in the deemed section 351 exchange, the 
United States person shall recognize gain pursuant to this paragraph 
(b). The exceptions described in Sec.  1.367(a)-3(b)(1) and (c)(1) 
shall not apply to a transfer of stock described in paragraph (a) of 
this section. The amount of gain recognized by a United States person 
pursuant to this paragraph (b) shall equal the amount, if any, by 
which--
    (1) The gain realized by the United States person with respect to 
the transferred stock in connection with the deemed section 351 
exchange exceeds; and
    (2) The amount of the distribution received by the United States 
person in redemption of the stock of the foreign acquiring corporation 
deemed issued in the deemed section 351 exchange that is treated as a 
dividend under section 301(c)(1) and included in gross income by the 
United States person.
    (c) Ordering rule. For purposes of paragraph (b)(1) of this 
section, the amount of gain realized by the United States person in 
connection with the deemed section 351 exchange shall be determined 
without regard to the amount of gain recognized by the United States 
person under paragraph (b) of this section.
    (d) Allocation of recognized gain. Gain recognized by a United 
States person pursuant to paragraph (b) of this section shall be 
treated as recognized with respect to the stock transferred in the 
deemed section 351 exchange in proportion to the amount of gain 
realized by the United States person with respect to such stock. See 
Sec.  1.367(a)-1T(b)(4) for additional rules on the character, source, 
and adjustments relating to gain recognized under section 367(a).
    (e) Example. The following example illustrates the rules of this 
section:

    Example. (i) Facts. (A) USP, a domestic corporation, wholly owns 
FC1 and FC2, each a foreign corporation. USP, FC1 and FC2 use a 
calendar taxable year. The FC1 stock has a $40x basis and $100x fair 
market value. The FC2 stock has a $100x basis and $100x fair market 
value. As of December 31, year 1, FC1 has zero earnings and profits, 
and FC2 has $20x earnings and profits. On December 31, year 1, in a 
transaction described in section 304(a)(1), USP sells the FC1 stock 
to FC2 for $100x cash.
    (B) Because USP wholly owns FC1 before the transactions and is 
treated, under section 318, as indirectly owning 100% of the FC1 
stock after the transfer, under section 304(a)(1), USP and FC2 are 
treated in the same manner as if USP contributed the FC1 stock to 
FC2 in a deemed section 351 exchange in exchange solely for $100x of 
FC2 stock, and then FC2 redeemed for $100x cash its stock deemed 
issued to USP. Because USP wholly owns FC1 before the sale and is 
treated as owning 100% of FC1 after the sale, section 302(a) does 
not apply to the redemption. Instead, under section 302(d), the 
redemption is treated as a distribution to which section 301 
applies. Pursuant to section 304(b)(2), $20x of the distribution is 
treated as a dividend from FC2. With respect to the remaining $80x, 
USP takes the position that $40x is applied against and reduces the 
basis of the FC2 stock issued in the deemed section 351 exchange, 
and $40x is applied against and reduces the basis of the FC2 stock

[[Page 6827]]

held by USP prior to (and after) the transaction.
    (ii) Analysis. Under paragraph (b) of this section, USP must 
recognize gain of $40x on its transfer of the FC1 stock to FC2 in 
the deemed section 351 exchange (the amount by which the $60x gain 
realized by USP on the deemed section 351 exchange with respect to 
the F1 stock exceeds the $20x dividend inclusion). Pursuant to 
paragraph (b) of this section, the exception under Sec.  1.367(a)-
3(b) is not available to the transfer of the FC1 stock by USP to FC2 
in the deemed section 351 exchange. Thus, USP cannot avoid gain 
recognition under paragraph (b) of this section by entering into a 
gain recognition agreement with respect to its transfer of the FC1 
stock to FC2 in the deemed section 351 exchange. Under paragraph (d) 
of this section, the $40x gain recognized is allocated among the 
shares of FC1 stock transferred to FC2 in the deemed section 351 
exchange in proportion to the gain realized by USP on the transfer 
of such shares. Under paragraph (c) of this section, the application 
of paragraph (b) of this section is determined prior to taking into 
account the $40x increase to the basis of the FC1 stock transferred 
by USP. Under section 362, the basis of the FC1 stock in the hands 
of FC2 is increased by $40x, the amount of gain recognized by the 
USP on the transfer of the FC1 stock under paragraph (b) of this 
section. Under section 358, the basis of the FC2 stock received by 
USP in the deemed section 351 exchange is similarly increased by 
$40x. See Sec.  1.367(a)-1T(b)(4). The $40x increase to the basis of 
the FC2 stock is taken into account before determining the 
consequences of the redemption of such stock under section 
304(a)(1).

    (f) Effective/applicability date. This section applies to transfers 
occurring on or after February 10, 2009. See Sec.  1.367(a)-3(a), as 
contained in 26 CFR part 1 revised as of April 1, 2008, for transfers 
occurring on or after February 21, 2006, and before February 10, 2009.
    (g) Expiration date. This section expires on or before February 10, 
2012.

0
Par. 4. Section 1.367(b)-4 is amended by revising the second sentence 
in paragraph (a) and adding paragraphs (e), (f) and (g) to read as 
follows:


Sec.  1.367(b)-4  Acquisition of foreign corporate stock or assets by a 
foreign corporation in certain nonrecognition transactions.

    (a) * * * For rules applicable when, pursuant to section 304(a)(1), 
a foreign acquiring corporation is treated as acquiring the stock of a 
foreign acquired corporation in a transaction to which section 351(a) 
applies, see Sec.  1.367(b)-4T(e). * * *
* * * * *
    (e) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(e).
    (f) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(f).
    (g) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(g).

0
Par. 5. Section 1.367(b)-4T is added to read as follows:


Sec.  1.367(b)-4T  Acquisition of foreign corporate stock or assets by 
a foreign corporation in certain nonrecognition transactions 
(temporary).

    (a) through (d) [Reserved]. For further guidance, see Sec.  
1.367(b)-4(a) through (d).
    (e) Application of section 367(b) to transactions described in 
section 304(a)(1)--(1) Scope and general rule. This section applies to 
the extent that, pursuant to section 304(a)(1), an exchanging 
shareholder is treated as transferring the stock of a foreign acquired 
corporation to a foreign acquiring corporation in a transaction to 
which section 351(a) applies (deemed section 351 exchange). Except to 
the extent provided in paragraph (e)(2) of this section, a transfer of 
stock of a foreign acquired corporation by an exchanging shareholder in 
a deemed section 351 exchange shall not be subject to paragraph (b) of 
this section.
    (2) Special rule. Notwithstanding paragraph (e)(1) of this section, 
a transfer of stock of a foreign acquired corporation by an exchanging 
shareholder to a foreign acquiring corporation in a deemed section 351 
exchange shall be subject to paragraph (b) of this section to the 
extent the distribution received by the exchanging shareholder in 
redemption of the stock of the foreign acquiring corporation is applied 
against and reduces, pursuant to section 301(c)(2), the basis of stock 
of the foreign acquiring corporation held by the exchanging shareholder 
other than the stock deemed issued by the foreign acquiring corporation 
in the deemed section 351 exchange.
    (3) Allocation of income inclusion. If the income inclusion 
resulting from the application of paragraph (e)(2) of this section is 
less than the section 1248 amount attributable to the shares of stock 
of the foreign acquired corporation transferred by the exchanging 
shareholder in the deemed section 351 exchange, the amount of the 
income inclusion attributable to each share of stock transferred in the 
deemed section 351 exchange shall be determined by multiplying the 
income inclusion by the percentage that the section 1248 amount 
attributable to such share of stock bears to the aggregate section 1248 
amount attributable to all of the shares of stock transferred in the 
deemed section 351 exchange.
    (4) Example. The rules of this paragraph (e) are illustrated by the 
following example:

    Example. (i) Facts. (A) FP, a foreign corporation, wholly owns 
USP, a domestic corporation. USP wholly owns CFC1, and CFC1 wholly 
owns CFC2. CFC2 wholly owns CFC3. CFC1, CFC2 and CFC3 are controlled 
foreign corporations within the meaning of section 957(a). USP, 
CFC1, CFC2 and CFC3 use a calendar taxable year. CFC1 owns 30% of 
the outstanding stock of FS, a foreign corporation. FP owns the 
remaining 70% of the outstanding stock of FS. The CFC2 stock has a 
$40x basis and $100x fair market value. The FS stock held by CFC1 
has a $60x basis and $100x fair market value. As of December 31, 
year 1, CFC2 has $20x of section 1248 earnings and profits, CFC3 has 
$40x of section 1248 earnings and profits, and FS has zero earnings 
and profits. On December 31, year 1, in a transaction described in 
section 304(a)(1), CFC1 sells the CFC2 stock to FS for $100x cash. 
FS is not a controlled foreign corporation (within the meaning 
section 957(a)) either before or after the sale of the CFC2 stock.
    (B) Because CFC1 wholly owns CFC2 before the transaction and is 
treated, under section 318, as indirectly owning 100% of the CFC2 
stock after the transaction, under section 304(a)(1), CFC2 and FS 
are treated as if CFC1 contributed the CFC2 stock to FS in a deemed 
section 351 exchange in exchange solely for $100x of FS stock, and 
then FS redeemed for $100x cash its stock deemed issued to CFC1. 
Because CFC1 wholly owned CFC2 before the transaction and is 
treated, under section 318, as indirectly owning 100% of CFC2 after 
the transaction, section 302(a) does not apply to the redemption. 
Instead, under section 302(d), the redemption is treated as a 
distribution to which section 301 applies. Pursuant to section 
304(b)(2), $20x of the distribution is treated as a dividend from 
the earnings and profits of CFC2. With respect to the remaining 
$80x, CFC1 takes the position that $40x is applied against and 
reduces the basis of the FS stock deemed issued in the transaction, 
and $40x is applied against and reduces the basis of the FS stock 
held by CFC1 prior to (and after) the transaction.
    (ii) Analysis. Under paragraph (e)(2) of this section, the 
transfer by CFC1 of the CFC2 stock to FS in the deemed section 351 
exchange is subject to paragraph (b) of this section to the extent 
the distribution received by CFC1 in redemption of the FS stock 
issued in the deemed section 351 exchange is applied against and 
reduces, under section 301(c)(2), the basis of the FS stock held by 
CFC1 before (and after) the transaction. Thus, because $40x of the 
distribution received by CFC1 from FS in redemption of the FS stock 
issued in the deemed section 351 exchange is applied against and 
reduces, under section 301(c)(2), the basis of the FS stock held by 
CFC1 before (and after) the transaction, under paragraph (b) of this 
section, CFC1 must include $40x in income as a deemed dividend. See 
Sec.  1.367(b)-2(e) for the treatment of the $40x income inclusion. 
In total, CFC1 recognizes dividend income of $60x, $20x from the 
application of section 304(a)(1) to the sale of the CFC2 stock to FS 
and $40x under paragraph (b) of this section by reason of the 
application of paragraph (e)(2) of this section.

    (f) Effective/applicability date. Paragraph (e) of this section 
applies to

[[Page 6828]]

transfers occurring on or after February 10, 2009. See Sec.  1.367(b)-
4, as contained in 26 CFR part 1 revised as of April 1, 2008, for 
transfers occurring on or after February 21, 2006, and before February 
10, 2009.
    (g) Expiration date. This section expires on or before February 10, 
2012.
0
Par. 6. Section 1.1248-1 is amended by revising paragraphs (b) and (g) 
and adding paragraph (h) to read as follows:


Sec.  1.1248-1  Treatment of gain from certain sales or exchanges of 
stock in certain foreign corporations.

* * * * *
    (b) [Reserved]. For further guidance, see Sec.  1.1248-1T(b).
* * * * *
    (g) Effective/applicability date. (1) The third sentence in 
paragraph (a)(1), paragraph (a)(4), and paragraph (a)(5), Example 4, of 
this section apply to income inclusions that occur on or after July 30, 
2007. A taxpayer may elect to apply paragraph (a)(4) of this section to 
income inclusions in open taxable years provided that it consistently 
applies paragraph (a)(4) of this section for income inclusions in the 
first year for which the election is applicable and in all subsequent 
years.
    (2) [Reserved]. For further guidance, see Sec.  1.1248-1T(g)(2).
    (h) [Reserved]. For further guidance, see Sec.  1.1248-1T(h).
0
Par. 7. Section 1.1248-1T is added to read as follows:


Sec.  1.1248-1T  Treatment of gain from certain sales or exchanges of 
stock in certain foreign corporations (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.1248-1(a).
    (b) Sale or exchange. For purposes of section 1248(a), the term 
sale or exchange includes the receipt of a distribution which is 
treated as in exchange for stock under section 302(a) (relating to 
distributions in redemption of stock), section 331(a)(1) (relating to 
distributions in complete liquidation of a corporation), or section 
331(a)(2) (relating to distributions in partial liquidation of a 
corporation). For purposes of section 1248(a), gain recognized by a 
shareholder under section 301(c)(3) in connection with a distribution 
of property by a corporation with respect to its stock shall be treated 
as gain from the sale or exchange of stock of such corporation.
    (c) through (f) [Reserved]. For further guidance, see Sec.  1.1248-
1(c) through (f).
    (g) Effective/applicability dates. (1) [Reserved]. For further 
guidance, see Sec.  1.1248-1(g)(1).
    (2) Paragraph (b) of this section applies to distributions that 
occur on or after February 10, 2009.
    (h) Expiration date. This section expires on or before February 10, 
2012.

Linda M. Kroening,
Acting Deputy Commissioner for Services and Enforcement.
    Approved: January 13, 2009.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E9-2835 Filed 2-10-09; 8:45 am]
BILLING CODE 4830-01-P