Inversions and Related Transactions, 32524-32561 [2018-14693]

Download as PDF 32524 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9834] RIN 1545–BO20; 1545–BO22 Inversions and Related Transactions Internal Revenue Service (IRS), Treasury. ACTION: Final regulations, temporary regulations, and removal of temporary regulations. AGENCY: This document contains final regulations that address transactions that are structured to avoid the purposes of sections 7874 and 367 of the Internal Revenue Code (the Code) and certain post-inversion tax avoidance transactions. These regulations affect certain domestic corporations and domestic partnerships whose assets are directly or indirectly acquired by a foreign corporation and certain persons related to such domestic corporations and domestic partnerships. This document finalizes proposed regulations, and removes temporary regulations, published on April 8, 2016. DATES: Effective date: These regulations are effective on July 12, 2018. Applicability dates: For dates of applicability, see §§ 1.304–7(e), 1.367(a)–3(c)(11)(ii), 1.367(b)–4(h), 1.956–2(i), 1.7701(l)–4(h), 1.7874– 1(i)(2), 1.7874–2(l)(2), 1.7874–3(f)(2), 1.7874–6(h), 1.7874–7(g), 1.7874–8(i), 1.7874–9(g), 1.7874–10(l), 1.7874–11(f), and 1.7874–12(b). FOR FURTHER INFORMATION CONTACT: Regarding the regulations under sections 304, 367, and 7874, Shane M. McCarrick, (202) 317–6937; regarding the regulations under sections 956 and 7701(l), Rose E. Jenkins, (202) 317–6934 (not toll-free numbers). SUPPLEMENTARY INFORMATION: SUMMARY: Background amozie on DSK3GDR082PROD with RULES2 I. Overview On April 8, 2016, the Department of the Treasury (the Treasury Department) and the IRS published final and temporary regulations under sections 304, 367, 956, 7701(l), and 7874 (TD 9761) in the Federal Register (81 FR 20858, as corrected at 81 FR 40810 and 81 FR 46832). On the same date, the Treasury Department and the IRS published a notice of proposed rulemaking (REG–135734–14) in the Federal Register (81 FR 20588, as corrected at 81 FR 35275) by cross- VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 reference to the temporary regulations (the 2016 proposed regulations) (together with the final and temporary regulations described in the preceding sentence, the 2016 regulations). No public hearing was requested or held. Numerous written comments were received with respect to the proposed regulations and are available at www.regulations.gov or upon request. A comment was also received with respect to a notice that preceded the 2016 regulations (Notice 2015–79, 2015–49 I.R.B. 775) and, as explained in the preamble to those regulations, the comment has been included in the administrative record for the proposed regulations. The majority of the comments supported the 2016 regulations. On January 18, 2017, the Treasury Department and the IRS published final and temporary regulations under section 7874 (TD 9812) in the Federal Register (82 FR 5388, as corrected at 82 FR 42233), which adopted as final regulations the proposed regulations in § 1.7874–4 (including the portions included in the 2016 regulations) and modified certain portions of the 2016 regulations (see 82 FR 5476–01). This Treasury decision adopts the remaining 2016 proposed regulations, with the changes generally described in the Summary of Comments and Explanation of Revisions section of this preamble, as final regulations and removes the corresponding temporary regulations. II. Section 7874 Background A foreign corporation (foreign acquiring corporation) generally is treated as a surrogate foreign corporation under section 7874(a)(2)(B) if, pursuant to a plan (or a series of related transactions), three conditions are satisfied. First, the foreign acquiring corporation completes, after March 4, 2003, the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation (domestic entity acquisition). Second, after the domestic entity acquisition, at least 60 percent of the stock (by vote or value) of the foreign acquiring corporation is held by former shareholders of the domestic corporation (former domestic entity shareholders) by reason of holding stock in the domestic corporation (such percentage, the ownership percentage, and the fraction used to calculate the ownership percentage, the ownership fraction). And third, after the domestic entity acquisition, the expanded affiliated group (as defined in section 7874(c)(1)) that includes the foreign acquiring corporation (EAG) does not have substantial business activities in PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 the foreign country in which, or under the law of which, the foreign acquiring corporation is created or organized when compared to the total business activities of the EAG. Similar provisions apply if a foreign acquiring corporation acquires substantially all of the properties constituting a trade or business of a domestic partnership. The domestic corporation or the domestic partnership described in this paragraph is referred to at times in this preamble as the ‘‘domestic entity.’’ For other definitions used throughout this preamble but not defined in this preamble, see § 1.7874–12 (providing common definitions for purposes of certain regulations under sections 367(b), 956, 7701(l), and 7874). The tax treatment of a domestic entity acquisition in which the EAG does not have substantial business activities in the relevant foreign country varies depending on the level of owner continuity. If the ownership percentage is at least 80, the foreign acquiring corporation is treated as a domestic corporation for all purposes of the Code pursuant to section 7874(b). If, instead, the ownership percentage is at least 60 but less than 80 (in which case the domestic entity acquisition is referred to in this preamble as an ‘‘inversion transaction’’), the foreign acquiring corporation is respected as a foreign corporation but the domestic entity and certain other persons are subject to special rules that reduce the tax benefits of the inversion transaction. For example, section 7874(a)(1) prevents the use of certain tax attributes to reduce the U.S. federal income tax owed on certain income or gain (inversion gain) recognized in transactions intended to remove foreign operations from the U.S. taxing jurisdiction. ‘‘An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018’’ (the Act), Public Law 115–97, amended certain sections of the Code to further reduce the tax benefits of inversion transactions. See section 1(h)(11)(C)(iii) (shareholders of surrogate foreign corporations not eligible for reduced rate on dividends); section 59A (for inverted groups, generally treating costs of goods sold as a base erosion payment for purposes of the base erosion and anti-abuse tax); section 965 (upon certain inversions, recapturing the benefit of a deduction related to a transition tax); and section 4985 (increasing the rate of the excise tax imposed on certain holders of stock options and other stock-based compensation). Section 7874(c)(6) grants the Secretary authority to prescribe regulations as E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations may be appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations to treat stock as not stock. In addition, section 7874(g) grants the Secretary authority to provide regulations necessary to carry out section 7874, including regulations providing for such adjustments to the application of section 7874 as are necessary to prevent the avoidance of the purposes of section 7874. Summary of Comments and Explanation of Revisions I. Rules Addressing Certain Transactions That Are Structured To Avoid the Purposes of Section 7874 To address certain transactions that are structured to avoid the purposes of section 7874, the 2016 regulations provided rules for (i) identifying domestic entity acquisitions and foreign acquiring corporations in certain multiple-step transactions; (ii) calculating the ownership percentage and, more specifically, disregarding certain stock of the foreign acquiring corporation for purposes of computing the denominator of the ownership fraction and, in addition, taking into account certain non-ordinary course distributions (NOCDs) made by a domestic entity for purposes of computing the numerator of the ownership fraction; (iii) determining when certain stock of a foreign acquiring corporation is treated as held by a member of the EAG; and (iv) determining when an EAG has substantial business activities in a relevant foreign country. The comments and modifications with respect to these rules are discussed in this Part I. amozie on DSK3GDR082PROD with RULES2 A. Calculation of the Ownership Percentage 1. Passive Assets Rule Section 1.7874–7T of the 2016 regulations provides a rule (the passive assets rule) that excludes from the denominator of the ownership fraction stock of the foreign acquiring corporation attributable to certain passive assets. In general, the rule applies with respect to a domestic entity acquisition if, on the completion date, more than 50 percent of the gross value of all foreign group property constitutes foreign group nonqualified property. The amount of stock that is excluded is equal to the product of (i) the value of the stock of the foreign acquiring corporation, other than stock that is described in section 7874(a)(2)(B)(ii) and stock that is excluded from the denominator of the ownership fraction under either § 1.7874–1(b) or § 1.7874– VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 4(b) (the multiplicand), and (ii) the proportion of foreign group property that is foreign group nonqualified property, determined based on gross value (the foreign group nonqualified property fraction). For purposes of determining the foreign group nonqualified property fraction, property received by the EAG that gives rise to stock excluded from the ownership fraction under § 1.7874–4(b) is not taken into account. Under the 2016 regulations, the passive assets rule applies for purposes of determining the ownership percentage by vote and value. The Treasury Department and the IRS have determined that applying the rule for purposes of determining the ownership percentage by vote could give rise to administrative complexities, because the rule does not exclude particular shares of stock but instead excludes an amount of stock. In particular, when classes of stock of the foreign acquiring corporation have different voting power, a special rule would be needed to allocate the excluded amount among the shares. Consistent with other rules under section 7874, the Treasury Department and the IRS have concluded that the rule should apply only for purposes of determining the ownership percentage by value. See § 1.7874–8 (excluding an amount of stock for purposes of determining the ownership percentage by value); § 1.7874–10 (treating an amount as additional stock described in section 7874(a)(2)(B)(ii) for purposes of determining the ownership percentage by value). The final regulations therefore contain this modification. See § 1.7874–7(b). The Treasury Department and the IRS have also determined that the passive assets rule should be modified to take into account the other stock exclusion rules. For example, stock excluded under § 1.7874–8(b) (disregard of certain stock attributable to serial acquisitions) or § 1.7874–9(b) (disregard of certain stock in third-country transactions) should not be taken into account when determining the multiplicand. In addition, property of an entity the acquisition of which gives rise to stock excluded under § 1.7874–8(b) or § 1.7874–9(b) generally should not be taken into account when determining the foreign group nonqualified property fraction. The final regulations thus modify the multiplicand so that stock excluded under any of the stock exclusion rules is not taken into account. See § 1.7874–7(b)(1). Further, the final regulations modify the foreign group nonqualified property fraction so that, in general, property that gives rise to stock excluded under any of the stock PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 32525 exclusion rules is not taken into account. See § 1.7874–7(e)(3). The final regulations also include an example illustrating these rules. See § 1.7874–7(f) Example 4. Further, in response to a comment, the final regulations clarify that the passive assets rule is subject to section 7874(c)(4). See § 1.7874–7(a) (penultimate sentence). For example, section 7874(c)(4) can apply to the transfer of properties or liabilities as part of a plan a principal purpose of which is to prevent the more-than-50percent threshold of the passive assets rule from being satisfied with respect to a domestic entity acquisition. In these cases, section 7874(c)(4) would disregard the transaction and, as a result, the passive assets rule (including the more-than-50-percent threshold) would be applied as if the transfer did not occur. Lastly, and also in response to a comment, the Treasury Department and the IRS clarify § 1.7874–7(e)(1)(i)(C), which excludes property that gives rise to income described in section 1297(b)(2)(A) or (B) from the definition of foreign group nonqualified property. Under section 1297(b)(2)(A) and (B), for certain purposes of the passive foreign investment company rules, passive income does not include certain income derived in the active conduct of a banking or insurance business. The final regulations clarify that for purposes of determining whether property qualifies for the exclusion under § 1.7874– 7(e)(1)(i)(C), other passive foreign investment company rules do not apply. See § 1.7874–7(e)(1)(i)(C) (parenthetical language). Thus, for example, the rules in section 1298(b)(2) or (3) that except certain corporations from being treated as passive foreign investment companies during a start-up year or following a change in business do not apply for this purpose. 2. Serial Acquisitions of Domestic Entities Section 1.7874–8T of the 2016 regulations provides a rule (the serial acquisition rule) that, with respect to a domestic entity acquisition (a relevant domestic entity acquisition), excludes from the denominator of the ownership fraction stock of the foreign acquiring corporation attributable to certain domestic entity acquisitions previously completed by the foreign acquiring corporation (or a predecessor). Consistent with the explanation in the preamble to the 2016 regulations, this rule addresses a concern that domestic entity acquisitions previously completed by the foreign acquiring corporation serve as a platform for E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32526 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations additional and even larger domestic entity acquisitions. For administrability purposes, the serial acquisition rule under the 2016 regulations looks only to whether the foreign acquiring corporation completed a domestic entity acquisition within the 36-month period ending on the signing date of the relevant domestic entity acquisition (such acquisition, in general, a ‘‘prior domestic entity acquisition’’). Absent this 36-month look-back period, the rule could be difficult to administer, as all domestic entity acquisitions previously completed by the foreign acquiring corporation would need to be identified. In addition, as the period between a relevant domestic entity acquisition and a previous domestic entity acquisition increases, it may become more difficult to determine which stock of the foreign acquiring corporation is attributable to the previous domestic entity acquisition (for example, due to changes in the capital structure of the foreign acquiring corporation resulting from divisive or acquisitive transactions). The use of a 36-month look-back period provides an administrable standard and is consistent with other look-back periods under the Code and regulations. See, e.g., section 865(f) (sourcing rule for sales of stock in a foreign affiliate); section 2035 (transfers before death); section 7701(b)(3) (substantial presence test for residency); and § 1.7874–10 (NOCD rule). The final regulations therefore retain the 36-month look-back period. The majority of the comments received on the 2016 regulations involved the serial acquisition rule. Of those comments, nearly every one supported the rule. One comment, however, while generally supporting the prevention of inversions, asserted that the serial acquisition rule targets a specific transaction that was pending when the 2016 regulations were issued. The comment suggested that this would cause mistrust of federal agencies and could ultimately harm U.S. businesses. The Treasury Department and the IRS disagree with the comment. The serial acquisition rule does not target a specific transaction. Instead, and as explained in the preamble to the 2016 regulations, it addresses a particular practice occurring in the marketplace in which a foreign acquiring corporation completes multiple domestic entity acquisitions over a span of just a few years, with the corporation’s increased value serving as a platform to complete still larger domestic entity acquisitions that avoid the application of section 7874. The Treasury Department and the IRS have concluded that such serial VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 acquisitions, which in effect permit a single foreign acquiring corporation to facilitate the inversion of multiple domestic entities over time, are inconsistent with the policies underlying section 7874. As also explained in the preamble to the 2016 regulations, the Treasury Department and the IRS have determined that the rule appropriately addresses this practice. See Part I.B.3.a of the Explanation of Provisions of the preamble to the 2016 regulations; see also S. Rep. No. 192, at 142 (2003) (expressing concern that certain inversions ‘‘permit corporations and other entities to continue to conduct business in the same manner as they did prior to the inversion, but with the result that the inverted entity avoids U.S. tax on foreign operations and may engage in earnings-stripping techniques to avoid U.S. tax on domestic operations.’’). One other comment asserted that the serial acquisition rule exceeds statutory authority and lacks a reasoned explanation. Those same claims were subsequently asserted in Chamber of Commerce of the United States v. Internal Revenue Serv., No. 1:16–CV– 944–LY (W.D. Tex. Sept. 29, 2017), appeal docketed, No. 17–51063 (5th Cir. Dec. 1, 2017), in which the serial acquisition rule in the temporary regulations was challenged. While the district court invalidated the temporary regulation on procedural grounds because it was not subjected to prior notice and comment, the court found that the serial acquisition rule was substantively valid under sections 7874(c)(6) and (g) (the Code sections under which the Treasury Department and the IRS promulgated the rule). The court concluded that the rule did not exceed the statutory authority of the Treasury Department and the IRS because it was within their broad authority under section 7874 to ‘‘treat stock as not stock’’—the exercise of which, the court noted, could in certain cases ‘‘substantially alter a calculation under the statute’’—and to prevent the avoidance of the purposes of section 7874. The court also ‘‘reviewed the full analysis by which the Agencies determined the Rule is necessary’’ and concluded that the Treasury Department and the IRS provided a sufficient explanation in issuing the serial acquisition rule in the temporary regulation, and did not engage in arbitrary and capricious rulemaking. The final regulations adopt the rule with three technical clarifications or modifications, in response to comments. First, the final regulations clarify that the determination of stock of the foreign PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 acquiring corporation attributable to a prior domestic entity acquisition does not take into account stock of the foreign acquiring corporation deemed under § 1.7874–10(b) (the NOCD rule) or section 7874(c)(4) more broadly to have been received in the prior domestic entity acquisition. See § 1.7874–8(g)(3) (excluding such stock from the definition of total number of prior acquisition shares). Second, the final regulations provide an exception to the definition of the term prior domestic entity acquisition in addition to the one under the 2016 regulations (relating to certain de minimis acquisitions). Under this additional exception, the term does not include a domestic entity acquisition that occurs within a foreign-parented group and qualifies for the internal group restructuring exception of § 1.7874–1(c)(2). See § 1.7874– 8(g)(4)(ii)(B). In these cases, the Treasury Department and the IRS have determined that because the domestic entity remains (or is considered to remain) within the same foreignparented group, the acquisition should not be viewed as creating a platform to complete larger domestic entity acquisitions. As a result, the Treasury Department and the IRS have concluded that these acquisitions do not give rise to the policy concerns underlying the serial acquisition rule. Accordingly, like under the 2016 regulations, the term prior domestic entity acquisition under the final regulations means any domestic entity acquisition completed by the foreign acquiring corporation (or a predecessor) within a 36-month lookback period, except for those acquisitions that, for administrative or policy reasons, qualify for an exception. Third, the final regulations define a predecessor of a foreign acquiring corporation for purposes of the serial acquisition rule. See § 1.7874–8(b) (defining predecessor by cross-reference to the definition in the NOCD rule under § 1.7874–10(f)(1)). 3. Third-Country Rule Section 1.7874–9T of the 2016 regulations provides a rule (the thirdcountry rule) that excludes stock of the foreign acquiring corporation from the denominator of the ownership fraction when a domestic entity acquisition is a ‘‘third-country transaction,’’ which occurs when three requirements are satisfied. First, the foreign acquiring corporation must complete a ‘‘covered foreign acquisition’’ in a transaction related to the domestic entity acquisition. In general, a covered foreign acquisition is an acquisition by the foreign acquiring corporation of another E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 foreign corporation (such acquisition, a ‘‘foreign acquisition,’’ and such corporation, an ‘‘acquired foreign corporation’’), provided that an ownership continuity requirement is satisfied. Second, after all related transactions are complete, the foreign acquiring corporation must be a tax resident in a ‘‘third country’’—that is, a foreign country other than the foreign country in which, before the foreign acquisition and any related transaction, the acquired foreign corporation was a tax resident. (The 2016 regulations refer to the country in which a corporation is ‘‘subject to tax as a resident,’’ rather than the country in which a corporation is ‘‘tax resident.’’ However, similar to the reasons discussed in Part I.C. of this Summary of Comments and Explanation of Revisions section (concerning the substantial business activities test), the final regulations refer to ‘‘tax resident.’’) And third, the ownership percentage, determined without regard to the third country rule, must be at least 60 (by vote or value). As explained in Notice 2015–79, the Treasury Department and the IRS have determined that when a domestic entity acquisition is a third-country transaction, the decision to locate the tax residence of the foreign acquiring corporation in the third country generally is driven by tax planning, including the facilitation of U.S. tax avoidance following the acquisition, and, as a result, generally is contrary to the policies underlying section 7874. Accordingly, the third country rule provides that stock of the foreign acquiring corporation held by former shareholders of the acquired foreign corporation by reason of holding stock in the acquired foreign corporation is excluded from the denominator of the ownership fraction. a. Exceptions to Rule’s Application A comment suggested that the Treasury Department and the IRS consider adding one or more exceptions to the third-country rule, so as to better tailor the rule’s application to domestic entity acquisitions in which the use of a third country is likely driven by tax planning. The comment recommended against an exception based on the subjective criterion of whether a non-tax business purpose exists for the foreign acquiring corporation’s use of the third country. Instead, the comment suggested that any exception should be based on objective criteria. In particular, the comment proposed exceptions based on (i) the foreign group’s business activities in the third country, and (ii) a comparison of the treaty benefits (specifically, the withholding tax rate VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 with respect to dividends, interest, and royalties) available to the foreign acquiring corporation in the third country as compared to the benefits that would be available in the country in which the acquired foreign corporation is a tax resident. In response to the comment, the final regulations provide that the thirdcountry rule generally does not apply if the EAG has substantial business activities in the third country compared to the total business activities of the EAG. See § 1.7874–9(d)(4)(ii) (providing an exception to the definition of a covered foreign acquisition). For this purpose, the principles of § 1.7874–3 apply, and the determination of whether there are substantial business activities is made without regard to the domestic entity acquisition. The final regulations also generally provide that the third-country rule does not apply if (i) both the foreign acquiring corporation and the acquired foreign corporation are created or organized in, or under the law of, a foreign country that does not impose corporate income tax, and (ii) neither the foreign acquiring corporation nor the acquired foreign corporation is a tax resident of any other foreign country. See § 1.7874–9(d)(4)(iii) (providing an exception to the definition of a covered foreign acquisition). In these cases, the Treasury Department and the IRS have determined that the migration from one no-income-tax jurisdiction to another such jurisdiction is unlikely to be driven by tax planning, as the countries would generally be equally favorable from a tax perspective. The Treasury Department and the IRS decline, however, to provide an additional exception based on a comparison of treaty benefits. Even if the withholding rates with respect to certain categories of income are at least as high under the U.S. tax treaty with the third country as compared to the U.S. tax treaty with the country in which the acquired foreign corporation is a tax resident, the use of the third country may nevertheless be motivated by tax planning. For example, there could be tax-related features other than withholding rates that make the third country more advantageous; and, significant administrative difficulties could arise if the comparison were to include those features. Moreover, the third country might have a less restrictive regime for controlled foreign corporations, which could facilitate the use of low- or no-taxed entities to erode the U.S. tax base following the domestic entity acquisition. Consistent with the explanation in Notice 2015–79, the Treasury Department and the IRS have PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 32527 concluded that it is appropriate for the third-country rule to address this concern. b. Other Issues A comment observed that, in a transaction related to a domestic entity acquisition, the foreign acquiring corporation could change its tax residency by simply changing the country in which it is considered managed and controlled. The comment noted that, in such a case, the foreign acquiring corporation might not be viewed as having completed a foreign acquisition and, as a result, the thirdcountry rule could inappropriately be circumvented. The Treasury Department and the IRS agree with this comment and the final regulations are modified accordingly. See § 1.7874–9(e)(5). Finally, a comment recommended clarifying that the third-country rule compares only the tax residency of the foreign acquiring corporation and acquired foreign corporation, and thus does not consider the countries in which the corporations are created or organized. The Treasury Department and the IRS have determined that this is clear under the 2016 regulations; therefore the text of § 1.7874–9(c)(2) is unchanged from the corresponding provision in the 2016 regulations. 4. NOCD Rule Section 1.7874–10T of the 2016 regulations provides a rule (the NOCD rule) that, for purposes of determining the ownership percentage by value, deems former domestic entity shareholders or former domestic entity partners to receive, by reason of holding stock or an interest in the domestic entity, an amount of stock of the foreign acquiring corporation with a fair market value equal to the aggregate value of NOCDs made by the domestic entity (such stock, ‘‘NOCD stock’’). The rule provides mechanics for determining NOCDs. The final regulations include seven clarifications or modifications to the NOCD rule, in response to comments. First, the regulations clarify and refine the definition of distribution. The 2016 regulations define the term broadly but provide several exclusions, including, in general, an exclusion for a distribution that occurs pursuant to an asset reorganization. The final regulations clarify that the exclusion does not apply to a distribution to which section 355 applies, regardless of whether in connection with a reorganization described in section 368(a)(1)(D). See § 1.7874–10(k)(1)(i)(C). That is, a distribution of stock of a controlled corporation pursuant to a E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32528 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations divisive reorganization is a distribution for purposes of the NOCD rule, but a distribution of an acquiring corporation’s stock pursuant to an acquisitive reorganization (such as a merger described in section 368(a)(1)(A)) is not a distribution for this purpose. In addition, the final regulations refine the definition of distribution such that, in the case of a partnership, a distribution does not include a deemed distribution pursuant to section 752(b) to the extent that the transaction giving rise to the deemed distribution does not reduce the partnership’s value. Second, the final regulations modify a special rule that applies when a domestic corporation (distributing corporation) distributes stock of another domestic corporation (controlled corporation) pursuant to a transaction described in section 355 and, immediately before the distribution, the fair market value of the controlled corporation represents more than 50 percent of the fair market value of the stock of the distributing corporation. When the special rule applies, the controlled corporation is deemed for purposes of the NOCD rule to have distributed the stock of the distributing corporation. The final regulations modify the condition for the rule to apply: As modified, the rule considers the fair market value of the stock of the controlled corporation owned by the distributing corporation and any related person. See § 1.7874–10(g). Accordingly, the special rule would not apply, for example, if the fair market value of the stock of the distributing corporation were $100x (not taking into account the fair market value of the stock of the controlled corporation), the fair market value of the stock of the controlled corporation were $110x, and $100x or less of the stock of the controlled corporation were owned by the distributing corporation (with the balance owned by a person unrelated to the distributing corporation). Third, the final regulations clarify how the NOCD rule relates to the expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1 (the EAG rules). The preamble to the 2016 regulations indicates that the NOCD rule applies only for purposes of determining the ownership percentage by value and that it does not apply for any other purpose, including the loss of control exception of § 1.7874–1(c)(3) (one of the EAG rules). The final regulations clarify that NOCD stock is not taken into account for purposes of the EAG rules. See § 1.7874–1(d)(2) (providing that NOCD stock is not taken into account for purposes of VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 determining the members of an EAG or whether a domestic entity acquisition qualifies for the internal group restructuring or loss of control exception). As a result, the determination of the EAG and whether a domestic entity acquisition qualifies for the internal group restructuring or loss of control exception is based on the stock of the foreign acquiring corporation that actually exists. See also Part I.B of this Summary of Comments and Explanation of Revisions section (discussing the interaction of the stock exclusion rules and the EAG rules). Fourth, the final regulations provide guidance regarding how to allocate NOCD stock among the former domestic entity shareholders. Because the NOCD rule provides that NOCD stock is treated as stock described in section 7874(a)(2)(B)(ii), in most cases the NOCD stock will simply be included in both the numerator and denominator of the ownership fraction and, as a result, it will be irrelevant which former domestic entity shareholders or former domestic entity partners are considered to hold such stock. However, in certain cases involving the application of the EAG rules, the allocation of the NOCD stock among the former domestic entity shareholders or former domestic entity partners may affect whether the stock is included in the numerator and denominator of the ownership fraction. For example, assume two foreign corporations, F1 and F2, each own 50% of the stock of a domestic corporation, DT. During year y, DT makes a $10x distribution to each of F1 and F2 and, thereafter, distributes $40x to F2 in redemption of all of F2’s stock of DT. Then, on December 31 of year y, and in a transaction related to the redemption, F1 contributes all of the stock of DT to a newly-formed foreign corporation, FA, in exchange for all the stock of FA (DT acquisition). Assume that there are $36x of NOCDs with respect to the look-back year ending on December 31 of year y and that there are no NOCDs with respect to the other look-back years. An EAG exists (for this purpose, NOCD stock is not taken into account), composed of F1, FA, and DT, but the DT acquisition does not qualify for the internal group restructuring exception because F1 did not own 80 percent or more of the stock of DT before the DT acquisition and any related transaction. See § 1.7874–1(c)(2)(i) and (g). Moreover, the acquisition does not qualify for the loss of control exception because after the acquisition F1 (a former domestic entity shareholder) holds more than 50 percent of the stock of a member of the EAG. See § 1.7874– 1(c)(3). Thus, all FA stock held by F1, PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 including any NOCD stock considered held by F1, is excluded from the numerator and denominator of the ownership fraction. See § 1.7874–1(b). Any NOCD stock considered held by F2, however, is included in both the numerator and the denominator of the ownership fraction. To address this allocation issue, the final regulations provide that NOCD stock is allocated among the former domestic entity shareholders or former domestic entity partners based on the amount of NOCDs that the persons are treated as receiving. See § 1.7874–10(h). For this purpose, and for ease of administration, the regulations provide that a pro rata portion of each distribution during a look-back year is treated as comprising an NOCD with respect to the look-back year, based on the amount of NOCDs during the year relative to the total amount of distributions during the year. Thus, in the example above, because 60 percent of the distributions during year y constituted NOCDs ($36x/$60x), 60 percent of each of the $10x dividend distributions to F1 and F2, as well as 60 percent of the $40x distribution to F2 as part of the redemption, are treated as comprising the NOCD. Accordingly, under § 1.7874–10(h), F1 and F2 are treated as having received $6x and $30x of distributions comprising the NOCD, respectively. F1 and F2 are therefore treated as holding $6x and $30x of NOCD stock, respectively. As a result, the ownership percentage (by value) with respect to the DT acquisition is 100 ($30x/$30x). Fifth, the final regulations provide guidance when multiple foreign acquiring corporations complete a domestic entity acquisition, as to which corporation’s or corporations’ stock the NOCD stock is considered comprised. In general, the final regulations provide that the NOCD stock is considered comprised, on a pro rata basis, of stock of each foreign acquiring corporation that directly or indirectly provided consideration in the domestic entity acquisition. For this purpose, consideration is not considered directly provided by a foreign acquiring corporation if it was indirectly provided by another foreign acquiring corporation. See § 1.7874–10(i). For example, assume FP, a foreign corporation, owns all the stock of FS, also a foreign corporation, and FS acquires all the stock of DT, a domestic corporation, solely in exchange for FP stock. Pursuant to § 1.7874–2(c)(1)(i) and (iii), both FS and FP are treated as having completed a domestic entity acquisition. Under § 1.7874–10(i), because FP indirectly provided 100 E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 percent of the consideration in the domestic entity acquisition, stock of FP is considered to comprise 100 percent of any NOCD stock. Sixth, the final regulations address how the NOCD rule applies when, pursuant to § 1.7874–2(e), two or more domestic entities are treated as a single domestic entity. Specifically, the regulations provide that the NOCD rule is initially applied to each domestic entity on a separate basis, and then the amount of NOCDs treated as made by the single domestic entity is the sum of the separately computed NOCDs made by each domestic entity. See § 1.7874– 10(j). Finally, the final regulations confirm that NOCD stock is included in both the numerator and the denominator of the ownership fraction, except to the extent that the stock is treated as held by a member of the EAG and excluded from the numerator or both the numerator and denominator, as applicable, under the EAG rules. See § 1.7874–1(d)(2). 5. De Minimis Exceptions Certain stock exclusion rules under section 7874 contain a de minimis exception. See § 1.7874–4(b) (disqualified stock rule); § 1.7874–7T(b) (passive assets rule); and 1.7874–10T(b) (NOCD rule). As explained in the preamble to TD 9812 (final regulations regarding the disqualified stock rule), together the de minimis exceptions generally prevent one or more of the disqualified stock rule, the passive assets rule, and NOCD rule from causing section 7874 to apply to a domestic entity acquisition that, given minimal actual ownership continuity, largely resembles a cash purchase by the foreign acquiring corporation of the stock of (or interests in) the domestic entity. Each of the de minimis exceptions is satisfied when two requirements are met. First, the ownership percentage— determined without regard to the application of the disqualified stock rule, the passive assets rule, and the NOCD rule—must be less than five (by vote and value). Second, after the domestic entity acquisition and all related transactions, each former domestic entity shareholder or former domestic entity partner, as applicable, must own (applying the attribution rules of section 318(a) with the modifications described in section 304(c)(3)(B)) less than five percent (by vote and value) of the stock of (or a partnership interest in) each member of the EAG. Originally, this second requirement considered the ownership by the former domestic entity shareholders or former domestic entity partners collectively. However, in VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 response to a comment, TD 9812 modified the requirement so that it considers only the ownership by the former domestic entity shareholders or former domestic entity partners individually. Similar to a comment submitted with respect to the disqualified stock rule and addressed in TD 9812, a comment recommended additional modifications to the second requirement. The comment stated that, particularly in cases involving a publicly-traded domestic entity or a complex ownership structure, it could be difficult or burdensome to identify each former domestic entity shareholder or former domestic entity partner (including a de minimis former domestic entity shareholder or former domestic entity partner), as applicable, and then determine (taking into account the applicable attribution rules) the person’s ownership of the foreign acquiring corporation and each member of the EAG. The Treasury Department and the IRS agree that it is appropriate to modify the second requirement in order to make the de minimis exceptions easier for taxpayers to comply with and for the IRS to administer. Accordingly, under the final regulations, only former domestic entity shareholders or former domestic entity partners, as applicable, that own (taking into account the applicable attribution rules) at least five percent of the stock of (or a partnership interest in) the domestic entity need be identified. If none of those former domestic entity shareholders or former domestic entity partners owns (taking into account the applicable attribution rules) at least five percent of the foreign acquiring corporation or a member of the EAG, then the second requirement is satisfied. B. Coordination of Rules Affecting the Ownership Fraction With the EAG Rules Existing regulations under section 7874 coordinate the application of (i) rules that disregard certain stock of the foreign acquiring corporation for purposes of determining the ownership fraction, with (ii) the EAG rules. See § 1.7874–4(h) (regarding the interaction of the EAG rules with the rule that disregards disqualified stock) and § 1.7874–7T(e) (regarding the interaction of the EAG rules with the rule that disregards certain stock attributable to passive assets). The final regulations broaden this coordination to other rules that similarly disregard certain stock of the foreign acquiring corporation for purposes of determining the ownership fraction—namely, the serial acquisition rule and the third-country rule, as well PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 32529 as section 7874(c)(4) generally, the application of which in certain cases would similarly disregard stock of the foreign acquiring corporation. The final regulations provide a general coordination rule in § 1.7874–1(d)(1) to coordinate the stock exclusion rules and the EAG rules, and remove provisions of the existing regulations that are duplicative of this rule. See § 1.7874– 4(i), Example 8 and Example 9 for illustrations involving the general coordination rule. C. The Substantial Business Activities Test Section 1.7874–3T(b)(4) of the 2016 regulations provides that, for an EAG to be considered to have substantial business activities in the relevant foreign country, the foreign acquiring corporation must be subject to tax as a resident of the ‘‘relevant foreign country’’ (the tax residence requirement). The relevant foreign county means the foreign country in which, or under the law of which, the foreign acquiring corporation was created or organized (country of organization). The tax residence requirement is in addition to the three qualitative requirements relating to the percentage of employees, assets, and income in the relevant foreign country. See § 1.7874–3(b)(1) through (3). One comment made several recommendations with respect to the substantial business activities test. First, the comment recommended providing standards for determining when the tax residence requirement is considered satisfied, including in cases in which the relevant foreign country is a noincome-tax jurisdiction. The comment suggested that the standards be based on the definition of residence under the United States’ income tax treaties with foreign countries. It further suggested providing guidance on when a foreign acquiring corporation is considered to be fiscally-transparent in, and thus not a tax resident of, the relevant foreign country. The Treasury Department and the IRS generally agree with these recommendations. The final regulations thus define a tax resident of a country as a body corporate liable to tax under the laws of the country as a resident. See § 1.7874–3(d)(11). The Treasury Department and the IRS have concluded that defining tax resident in this manner obviates the need to provide specific guidance on when a foreign acquiring corporation is treated as fiscallytransparent under the laws of the relevant foreign country. In addition, the Treasury Department and the IRS have determined that when the relevant E:\FR\FM\12JYR2.SGM 12JYR2 32530 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations foreign country is a country that does not impose corporate income tax, the tax residency requirement should not apply. See § 1.7874–3(b)(4) (second sentence). The comment also suggested that the Treasury Department and the IRS consider changing the definition of relevant foreign country from the country of organization to the country in which the foreign acquiring corporation is a tax resident. Under this approach, the substantial business activities test would look to the percentage of the EAG’s employees, assets, and income in the foreign country where the foreign acquiring corporation is a tax resident, without regard to the corporation’s country of organization. The Treasury Department and the IRS have concluded that section 7874(a)(2)(B)(iii) requires substantial business activities in the country of organization, with tax residency in that country serving as a necessary component for establishing substantial business activities. Accordingly, the final regulations do not adopt this comment. II. Rules Addressing Certain PostInversion Tax Avoidance Transactions As described in the preamble to the 2016 regulations, as well as in Notice 2015–79 and Notice 2014–52 (2014–42 I.R.B. 712), certain inversion transactions are motivated in substantial part by the ability to engage in tax avoidance transactions after the inversion transaction that would not be possible in the absence of the inversion transaction. To reduce the tax benefits of certain post-inversion tax avoidance transactions, the 2016 regulations provided rules under sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874. The comments and modifications with respect to these rules are discussed in this Part II. amozie on DSK3GDR082PROD with RULES2 A. United States Property Rule Section 1.956–2T(a)(4)(i) of the 2016 regulations provides that, generally, for purposes of section 956 and § 1.956– 2(a), United States property includes an obligation of a foreign person and stock of a foreign corporation if (i) the obligation or stock is held by a CFC that is an expatriated foreign subsidiary (EFS), (ii) the foreign person or foreign corporation is a non-CFC foreign related person, and (iii) the obligation or stock was acquired either during the applicable period or in a transaction related to the inversion transaction. Similarly, § 1.956–2T(c)(5) extends the pledge and guarantee rule in § 1.956– 2(c) to apply to obligations of non-CFC foreign related persons. VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 Comments requested that the rules in § 1.956–2T of the 2016 regulations (the United States property rule) be extended to apply to all foreign-parented groups, and not only those that are foreignparented as a result of an inversion transaction. The Treasury Department and the IRS continue to study those comments, but do not adopt them in these final regulations. B. Nomenclature and Other Changes For clarity, the final regulations use the term ‘‘non-EFS foreign related person’’ instead of the term ‘‘non-CFC foreign related person.’’ In addition, the final regulations modify various examples involving foreign corporations that were not controlled foreign corporations before the effective date of section 14214 of the Act (amending section 958(b) so as to provide ‘‘downward attribution’’ of stock from foreign persons to United States persons). In general, the final regulations now refer to those foreign corporations as CFCs, as appropriate, and otherwise retain the regulations under sections 367(b), 956, and 7701(l). Although the recent amendment to section 958(b)(4) makes it more difficult for post-inversion planning to cause an EFS to cease to be a CFC, such planning could still substantially dilute a United States shareholder’s interest in the EFS. Accordingly, the recharacterization rules under § 1.7701(l)–4T concerning post-inversion dilution are finalized. The Treasury Department and the IRS decline at this time to extend the application of § 1.7701(l)–4 to all foreign-parented groups, in part, because other provisions may address such planning, including the fast-pay arrangement rules under § 1.7701(l)–3. Further, for purposes of determining whether an entity is an EFS, the final regulations provide that downward attribution from a non-United States person to a United States person does not apply. Absent this modification, in certain cases the term EFS would be over-inclusive and, as a result, the term non-EFS foreign related person would be under-inclusive; this could result in the regulations under sections 367(b), 956, and 7701(l) inappropriately not applying in certain cases. Similarly, the final regulations provide that, when determining if an entity is a CFC for purposes of § 1.304–7, downward attribution from a non-United States person to a United States person does not apply. The Treasury Department and the IRS have determined that these modifications—the effect of which is that the determination of whether an entity is an EFS, as well as whether an entity is a CFC for purposes of § 1.304– PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 7, is the same under pre- and post-Act law—are necessary to carry out the purposes of the provisions. III. Miscellaneous Rules A. New Definitions Section in Section 7874 Regulations Section 1.7874–12T of the 2016 regulations provides definitions for certain terms commonly used in §§ 1.367(b)–4, 1.956–2, 1.7701(l)–4, and certain of the section 7874 regulations. These final regulations adopt this definitions section. They also update other portions of the section 7874 regulations to conform those sections with the nomenclature used in § 1.7874–12. B. Rules Under Section 956 Relating to the Definition of Obligation Section 1.956–2T(d)(2)(iv) of the 2016 regulations provides the short-term obligation exception described in Notice 88–108, 1988–2 C.B. 446, and § 1.956– 2T(d)(2)(v) provides the alternative short-term obligation exception described in Notice 2008–91, 2008–43 I.R.B. 1001, as modified by Notice 2009– 10, 2009–5 I.R.B. 419, and Notice 2010– 12, 2010–4 I.R.B. 326. No comments were received on these rules; accordingly, § 1.956–2(d)(2)(iv) is adopted as proposed. However, these final regulations do not contain the rule contained in proposed § 1.956– 2(d)(2)(v), which applied only for certain taxable years beginning before 2011. C. Applicability Dates Section 7805(b)(1)(B) and (C) provide that a final regulation may apply to a taxable period ending on or after the date on which a proposed or temporary regulation to which the final regulation relates was filed with the Federal Register or the date on which a notice substantially describing the expected contents of the regulation was issued to the public. The applicability dates of the rules in the final regulations are generally the same as the applicability dates of the rules as set forth in the 2016 regulations, which were issued as temporary regulations to address transactions that are structured to avoid the purposes of sections 7874 and 367 and certain post-inversion tax avoidance transactions. Accordingly, the applicability date of some provisions in the final regulations corresponds to the date the 2016 regulations were filed with the Federal Register, and the applicability dates of other provisions in the final regulations predate the filing of the 2016 regulations and correspond to the issuance of Notice 2014–52, 2014– E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations 42 I.R.B. 712, which was issued on September 22, 2014, or Notice 2015–79, 2015–49 I.R.B. 775, which was issued on November 19, 2015. However, differences between the final regulations and the 2016 regulations generally apply on a prospective basis, with an option for taxpayers to apply the differences retroactively. Moreover, because taxpayers may have relied on the 2016 regulations, the modifications to the final regulations generally apply prospectively. However, domestic entity acquisitions completed before July 12, 2018 continue to be subject to those rules as set forth in the 2016 regulations (but generally with an option for taxpayers to apply the differences retroactively). Statement of Availability of IRS Documents IRS Revenue Procedures, Revenue Rulings, notices, and other guidance cited in this document are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov. Special Analyses Regulatory Planning and Review— Economic Analysis amozie on DSK3GDR082PROD with RULES2 Executive Orders 13563 and 12866 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. This rule has been designated a ‘‘significant regulatory action’’ although not economically significant, under section 3(f) of Executive Order 12866. Accordingly, the rule has been reviewed by the Office of Management and Budget. This final rule is considered an E.O. 13771 deregulatory action. For more detail on the economic analysis, please refer to the analysis below. Need for the Final Regulations These final regulations refine and clarify certain aspects of the proposed and temporary regulations published in 2016 (collectively referred to as the 2016 regulations, as explained in the preamble). The changes finalized in this VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 set of regulations help to ensure that the regulations do not impact mergers that provide market benefits independent of tax avoidance; for example, those that increase efficiencies within the corporation or provide other growth opportunities or that contribute to social welfare. These regulations still maintain the thresholds and substantiation requirements of the 2016 regulations aimed at discouraging tax-motivated inversions. Background Cross-border mergers can make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. In order for these benefits to be realized, these transactions should be driven by underlying economic considerations rather than by a desire to avoid U.S. taxes. One way for a U.S.-based multinational to avoid or reduce U.S. tax is for the company to expatriate by changing its tax residence from the U.S. to another country through an inversion transaction. Though there are some limitations, the transaction allows the inverted company to reduce future taxes on U.S.-source earnings, for example, by deducting interest paid on loans from the new foreign parent. In addition to potentially eroding the U.S. tax base, inversions may impose other costs on the U.S. economy. For instance, as a result of the inversion, a company’s headquarters may move overseas. This loss of a U.S. corporate identity or location of headquarters for the company may reduce employment in the United States. To limit inversions that are taxmotivated, section 7874 (enacted in 2004), in general, targets transactions in which a foreign corporation acquires a domestic corporation and, immediately after the transaction, the former shareholders of the domestic corporation make up a significant portion of the shareholders of the acquiring foreign corporation. If the former shareholders of the domestic corporation hold 80 percent or more of the stock of the foreign corporation after the transaction, the foreign corporation is treated as a domestic corporation for U.S. tax purposes. If the former shareholders hold at least 60 percent but less than 80 percent of the stock of the foreign acquiring corporation after the transaction, then the transaction is respected but use of tax attributes such as net operating losses and foreign tax credits is limited. Transactions where the former shareholders of the domestic corporation hold less than 60 percent of PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 32531 the stock of the foreign acquiring corporation are generally not limited. Since the enactment of section 7874, multiple sets of regulations have been issued interpreting the statute and restricting the ability of domestic corporations to undertake an inversion transaction. The Tax Cuts and Jobs Act of 2017 (TCJA) reduced, but did not completely eliminate, the tax-motivated incentives to invert. Particular TCJA provisions that reduced those incentives include the reduction in the maximum U.S. statutory corporate tax rate from 35 percent to 21 percent, the exemption from U.S. tax of dividends received from certain foreign corporations, the strengthening of Internal Revenue Code Section 163(j) on interest stripping, and the adoption of four punitive disincentives for new inversions in the 60 percent to 80 percent range. While the TCJA also included provisions that may increase incentives to invert, including the tax imposed on Global Intangible Low Tax Income (GILTI) of foreign subsidiaries, overall taxmotivated incentives to invert were reduced. The following qualitative analysis provides further detail regarding the anticipated impacts of this rulemaking. Baseline The 2016 regulations serve as the noaction baseline for our tax regulatory review. The 2016 regulations, which were issued pursuant to authority under sections 7874 and 7805 (as well as other sections), restrict the ability of U.S. companies to invert and reduce the incentives to invert. Alternatives As an alternative to these final regulations, Treasury considered retaining the 2016 regulations without amendment. Given public comment and the agency’s desire to provide transparency and clarity to the public, Treasury decided against this approach and moved forward with the final regulations as drafted. Anticipated Impacts These final regulations maintain the thresholds and substantiation requirements of the 2016 regulations aimed at discouraging tax-motivated inversions. In response to public comments, the final regulations make certain limited changes to the 2016 regulations that are designed to improve clarity, provide additional exceptions to their application, and reduce unnecessary burdens on taxpayers, including by providing guidance on how to apply particular mechanical E:\FR\FM\12JYR2.SGM 12JYR2 32532 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations rules. Specifically, clarifying changes were made to certain of the stock exclusion rules, and in particular, the passive assets rule, the serial acquisition rule, and the third country rule, as well as to the substantial business activities rule. Additional exceptions were added to the serial acquisition rule and the third country rule that narrowed their scope on the margins. Finally, changes to the passive assets rule, the NOCD rule, and the rules coordinating the application of the stock exclusion rules with the expanded affiliated group (EAG) rules were made to reduce complexity and ambiguity associated with these provisions. Given the limited nature of the changes made by these final regulations relative to the no-action baseline, Treasury estimates that collectively, these final regulations are not economically significant under Executive Order 12866. Revenue Impacts Due to the narrow scope of clarifications and refinements in the final regulations and the small number of taxpayers subject to these regulations, Treasury does not anticipate any meaningful change to revenues. amozie on DSK3GDR082PROD with RULES2 Anticipated Benefits At the margin, the final regulations may increase the incentive for crossborder mergers that are economically beneficial and not tax-motivated. The regulations are designed to help ensure that the regulations do not impact mergers that provide market benefits. Economically beneficial mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the U.S. Anticipated Costs The changes made by the final regulations are designed generally to reduce unnecessary burdens on taxpayers, an action that may lead to increased merger activity, and some of these additional mergers may potentially be tax-motivated at least in part. Due to the narrow scope of these changes, however, Treasury anticipates that any increase in tax-motivated crossborder merger activity will be relatively small relative to the no-action baseline and will not result in any meaningful adverse effects on economic activity relative to the no-action baseline. In particular, additional exceptions added to the serial acquisition rule and the third country rule are designed to narrow their role in defining crossborder mergers that are subject to targeted tax treatment. VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 Effects on Compliance Costs The final regulations narrow the scope of regulated activities and reduce compliance costs relative to the 2016 regulations. The regulations also aim to reduce required paperwork burden, complexity, and ambiguities that may unintentionally discourage legitimate merger activity. In particular, changes that reduce complexity and ambiguity were made to the passive assets rule, the NOCD rule, and the rules coordinating the application of the stock exclusion rules with the expanded affiliated group (EAG) rules. Clarifying changes were made to the passive assets rule, the serial acquisition rule, the third country rule, and the substantial business activities rule. Regulatory Flexibility Act The Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply because the regulations do not impose a collection of information on small entities. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. No comments were received. Drafting Information The principal authors of these regulations are Rose E. Jenkins and Shane M. McCarrick of the Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Adoption of the 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 removing the entries for §§ 1.304–7T, 1.367(b)–4T, 1.956–2T, 1.7701(l)–4T, 1.7874–2T, 1.7874–3T, 1.7874–6T, 1.7874–7T, 1.7874–8T, 1.7874–9T, 1.7874–10T, 1.7874–11T, 1.7874–12T and adding entries for §§ 1.304–7, 1.7701(l)–4, 1.7874–2, 1.7874–6, 1.7874–7, 1.7874–8, 1.7874–9, 1.7874–10, 1.7874–11, and 1.7874–12 in numerical order and revising the entry for § 1.367(b)–4 to read in part as follows: ■ PO 00000 Authority: 26 U.S.C. 7805 * * * Frm 00010 Fmt 4701 Sfmt 4700 Section 1.304–7 also issued under 26 U.S.C. 304(b)(5)(C). * * * * * Section 1.367(b)–4 also issued under 26 U.S.C. 367(a) and (b) and 954(c)(6)(A). * * * * * Section 1.7701(l)-4 also issued under 26 U.S.C. 7701(l) and 954(c)(6)(A). * * * * * Section 1.7874–2 also issued under 26 U.S.C. 7874(c)(6) and (g). * * * * * Section 1.7874–6 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874–7 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874–8 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874–9 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874–10 also issued under 26 U.S.C. 7874(c)(4) and (g). Section 1.7874–11 also issued under 26 U.S.C. 7874(g). Section 1.7874–12 also issued under 26 U.S.C. 7874(g). * * * * * Par. 2. Section 1.304–7 is added to read as follows: ■ § 1.304–7 Certain acquisitions by foreign acquiring corporations. (a) Scope. This section provides rules regarding the application of section 304(b)(5)(B) to an acquisition of stock described in section 304 by an acquiring corporation that is foreign (foreign acquiring corporation). Paragraph (b) of this section provides the rule for determining which earnings and profits are taken into account for purposes of applying section 304(b)(5)(B). Paragraph (c) of this section provides rules addressing the use of a partnership, option (or similar interest), or other arrangement. Paragraph (d) of this section provides examples that illustrate the rules of this section. Paragraph (e) of this section provides the applicability date. (b) Earnings and profits taken into account. For purposes of applying section 304(b)(5)(B), only the earnings and profits of the foreign acquiring corporation are taken into account in determining whether more than 50 percent of the dividends arising from the acquisition (determined without regard to section 304(b)(5)(B)) would neither be subject to tax under chapter 1 of subtitle A of the Internal Revenue Code for the taxable year in which the dividends arise (subject to tax) nor be includible in the earnings and profits of a controlled foreign corporation (includible by a controlled foreign corporation). For purposes of this section, a controlled foreign corporation has the meaning provided in section 957 and without regard to section 953(c), E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a United States person as owning stock which is owned by a person who is not a United States person. (c) Use of a partnership, option (or similar interest), or other arrangement. If a partnership, option (or similar interest), or other arrangement, is used with a principal purpose of avoiding the application of this section (for example, to treat a transferor as a controlled foreign corporation), then the partnership, option (or similar interest), or other arrangement will be disregarded for purposes of applying this section. (d) Examples. The following examples illustrate the rules of this section. For purposes of the examples, assume the following facts in addition to the facts stated in the examples: (1) FA is a foreign corporation that is not a controlled foreign corporation; (2) FA wholly owns DT, a domestic corporation; (3) DT wholly owns FS1, a controlled foreign corporation; and (4) No portion of a dividend from FS1 would be treated as from sources within the United States under section 861. recognition agreement that complies with the requirements set forth in section 4.01 of Notice 2012–15, 2012–9 I.R.B 424, with respect to the portion (60 percent) of the FS2 stock that DT is deemed to transfer to FS1 in an exchange described in section 367(a)(1). See § 1.367(a)–1T(c)(3)(i)(A). (ii) Analysis. Under section 304(a)(1), PRS and FS1 are treated as if PRS transferred its FS2 stock to FS1 in an exchange described in section 351(a) solely for FS1 stock, and, in turn, FS1 redeemed such FS1 stock in exchange for $100x of cash. The redemption of the FS1 stock is treated as a distribution to which section 301 applies pursuant to section 302(d). Without regard to the application of section 304(b)(5)(B), more than 50 percent of a dividend arising from the acquisition, taking into account only the earnings and profits of FS1 pursuant to paragraph (b) of this section, would be subject to tax. In particular, 60 percent of a dividend from FS1 would be included in DT’s distributive share of PRS’s partnership income and therefore would be subject to tax. Accordingly, section 304(b)(5)(B) does not apply, and the entire distribution of $100x is treated under section 301(c)(1) as a dividend out of the earnings and profits of FS1. Example 1—(i) Facts. DT has earnings and profits of $51x, and FS1 has earnings and profits of $49x. FA transfers DT stock with a fair market value of $100x to FS1 in exchange for $100x of cash. (ii) Analysis. Under section 304(a)(2), the $100x of cash is treated as a distribution in redemption of the stock of DT. The redemption of the DT stock is treated as a distribution to which section 301 applies pursuant to section 302(d), which ordinarily would be sourced first from FS1 under section 304(b)(2)(A). Without regard to the application of section 304(b)(5)(B), more than 50 percent of the dividend arising from the acquisition, taking into account only the earnings and profits of FS1 pursuant to paragraph (b) of this section, would neither be subject to tax nor includible by a controlled foreign corporation. In particular, no portion of a dividend from FS1 would be subject to tax or includible by a controlled foreign corporation. Accordingly, section 304(b)(5)(B) and paragraph (b) of this section apply to the transaction, and no portion of the distribution of $100x is treated under section 301(c)(1) as a dividend out of the earnings and profits of FS1. Furthermore, the $100x of cash is treated as a dividend to the extent of the earnings and profits of DT ($51x). Example 2—(i) Facts. FA and DT own 40 percent and 60 percent, respectively, of the capital and profits interests of PRS, a foreign partnership. PRS wholly owns FS2, a controlled foreign corporation. The FS2 stock has a fair market value of $100x. FS1 has earnings and profits of $150x. PRS transfers all of its FS2 stock to FS1 in exchange for $100x of cash. DT enters into a gain ■ VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 (e) Applicability date. This section applies to acquisitions that are completed on or after September 22, 2014. § 1.304–7T [Removed] Par. 3. Section 1.304–7T is removed. ■ Par. 4. Section 1.367(a)–3 is amended by revising paragraphs (c)(3)(iii)(C) and (c)(11)(ii) to read as follows: § 1.367(a)–3 Treatment of transfers of stock or securities to foreign corporations. * * * * * (c) * * * (3) * * * (iii) * * * (C) Special rule for U.S. target company value. For purposes of § 1.367(a)–3(c)(3)(iii)(A), the fair market value of the U.S. target company includes the aggregate amount of nonordinary course distributions (NOCDs) made by the U.S. target company. To calculate the aggregate value of NOCDs, the principles of § 1.7874–10, including the rule regarding predecessors in § 1.7874–10(e) and the rule regarding a deemed distribution of stock in certain cases in § 1.7874–10(g), apply. However, this paragraph (c)(3)(iii)(C) does not apply if the principles of the de minimis exception in § 1.7874–10(d) are satisfied. * * * * * (11) * * * (ii) Applicability date of certain provisions of this paragraph (c). The first and second sentence of paragraph (c)(3)(iii)(C) of this section apply to transfers completed on or after September 22, 2014. The third sentence PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 32533 of paragraph (c)(3)(iii)(C) of this section applies to transfers completed on or after November 19, 2015. Taxpayers may, however, elect to apply the third sentence of paragraph (c)(3)(iii)(C) of this section to transfers completed on or after September 22, 2014, and before November 19, 2015. * * * * * § 1.367(a)–3T [Removed] Par. 5. Section 1.367(a)–3T is removed. ■ Par. 6. Section 1.367(b)–4 is amended by revising paragraph (a), paragraph (b) introductory text, and paragraphs (b)(1)(i)(C), (d)(1), (e), (f), (g), and (h) to read as follows: ■ § 1.367(b)–4 Acquisition of foreign corporate stock or assets by a foreign corporation in certain nonrecognition transactions. (a) Scope. This section applies to certain acquisitions by a foreign corporation of the stock or assets of a foreign corporation in an exchange described in section 351 or in a reorganization described in section 368(a)(1). Paragraph (b) of this section provides a rule regarding when an exchanging shareholder is required to include in income as a deemed dividend the section 1248 amount attributable to the stock that it exchanges. Paragraph (c) of this section provides a rule excluding deemed dividends from foreign personal holding company income. Paragraph (d) of this section provides rules for subsequent sales or exchanges. Paragraphs (e) and (f) of this section provide rules regarding certain exchanges following inversion transactions. Paragraph (g) of this section provides definitions and special rules, including special rules regarding triangular reorganizations and recapitalizations. Paragraph (h) of this section provides the applicability dates for certain paragraphs of this section. See also § 1.367(a)–3(b)(2) for transactions subject to the concurrent application of sections 367(a) and (b) and § 1.367(b)–2 for additional definitions that apply. (b) Income inclusion. If a foreign corporation (the transferee foreign corporation) acquires the stock of a foreign corporation in an exchange described in section 351 or the stock or assets of a foreign corporation in a reorganization described in section 368(a)(1) (in either case, the foreign acquired corporation), then an exchanging shareholder must, if its exchange is described in paragraph (b)(1)(i), (b)(2)(i), or (b)(3) of this section, include in income as a deemed dividend the section 1248 amount E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32534 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations attributable to the stock that it exchanges. (1) * * * (i) * * * (C) The exchange is not a specified exchange to which paragraph (e)(1) of this section applies. * * * * * (d) * * * (1) Rule. If an exchanging shareholder (as defined in § 1.1248–8(b)(1)(iv)) is not required to include in income as a deemed dividend the section 1248 amount under paragraph (b) or paragraph (e)(1) of this section (noninclusion exchange), then, for purposes of applying section 367(b) or 1248 to subsequent sales or exchanges, and subject to the limitation of § 1.367(b)– 2(d)(3)(ii) (in the case of a transaction described in § 1.367(b)–3), the determination of the earnings and profits attributable to the stock an exchanging shareholder receives in the non-inclusion exchange is determined pursuant to the rules of section 1248 and the regulations under that section. * * * * * (e) Income inclusion and gain recognition in certain exchanges following an inversion transaction—(1) General rule. If a foreign corporation (the transferee foreign corporation) acquires stock of a foreign corporation in an exchange described in section 351 or stock or assets of a foreign corporation in a reorganization described in section 368(a)(1) (in either case, the foreign acquired corporation), then an exchanging shareholder must, if its exchange is a specified exchange and the exception in paragraph (e)(3) of this section does not apply— (i) Include in income as a deemed dividend the section 1248 amount attributable to the stock that it exchanges; and (ii) After taking into account the increase in basis provided in § 1.367(b)– 2(e)(3)(ii) resulting from the deemed dividend (if any), recognize all realized gain with respect to the stock that would not otherwise be recognized. (2) Specified exchanges. An exchange is a specified exchange if— (i) Immediately before the exchange, the foreign acquired corporation is an expatriated foreign subsidiary and the exchanging shareholder is either an expatriated entity described in paragraph (b)(1)(i)(A)(1) of this section or an expatriated foreign subsidiary described in paragraph (b)(1)(i)(A)(2) of this section; (ii) The stock received in the exchange is stock of a foreign corporation; and (iii) The exchange occurs during the applicable period. VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 (3) De minimis exception. The exception in this paragraph (e)(3) applies if— (i) Immediately after the exchange, the foreign acquired corporation (in the case of an acquisition of stock of the foreign acquired corporation) or the transferee foreign corporation (in the case of an acquisition of assets of the foreign acquired corporation) is a controlled foreign corporation; (ii) The post-exchange ownership percentage with respect to the foreign acquired corporation (in the case of an acquisition of stock of the foreign acquired corporation) or the transferee foreign corporation (in the case of an acquisition of assets of the foreign acquired corporation) is at least 90 percent of the pre-exchange ownership percentage with respect to the foreign acquired corporation; and (iii) The post-exchange ownership percentage with respect to each lowertier expatriated foreign subsidiary of the foreign acquired corporation is at least 90 percent of the pre-exchange ownership percentage with respect to the lower-tier expatriated foreign subsidiary. (4) Certain exceptions from foreign personal holding company not available. An income inclusion of a foreign corporation under paragraph (e)(1) of this section does not qualify for the exceptions from foreign personal holding company income provided by sections 954(c)(3)(A)(i) and 954(c)(6) (to the extent in effect). (5) Examples. The following examples illustrate the application of this paragraph (e). For purposes of all of the examples, unless otherwise indicated: FP, a foreign corporation, owns all of the stock of USP, a domestic corporation, and all 40 shares of stock of FS, a controlled foreign corporation for its taxable year beginning January 1, 2017, but not for prior taxable years, except as a result of a transaction described in the facts of an example. USP owns all 50 shares of stock of FT1, a controlled foreign corporation, which, in turn, owns all 50 shares of FT2, a controlled foreign corporation. FP acquired all of the stock of USP in an inversion transaction that was completed on July 1, 2016. Therefore, with respect to that inversion transaction, USP is an expatriated entity; FT1 and FT2 are expatriated foreign subsidiaries; and FP and FS are each a non-EFS foreign related person. All entities have a calendar year tax year for U.S. tax purposes. All shares of stock have a fair market value of $1x, and each corporation has a single class of stock outstanding. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 Example 1. Specified exchange to which general rule applies—(i) Facts. During the applicable period, and pursuant to a reorganization described in section 368(a)(1)(B), FT1 transfers all 50 shares of FT2 stock to FS in exchange solely for 50 newly issued voting shares of FS. Immediately before the exchange, USP is a section 1248 shareholder with respect to FT1 and FT2. At the time of the exchange, the FT2 stock owned by FT1 has a fair market value of $50x and an adjusted basis of $5x, such that the FT2 stock has a built-in gain of $45x. In addition, the earnings and profits of FT2 attributable to FT1’s stock in FT2 for purposes of section 1248 is $30x, taking into account the rules of § 1.367(b)–2(c)(1)(i) and (ii), and therefore the section 1248 amount with respect to the FT2 stock is $30x (the lesser of the $45x of built-in gain and the $30x of earnings and profits attributable to the stock). (ii) Analysis. FT1’s exchange is a specified exchange because the requirements set forth in paragraphs (e)(2)(i) through (iii) of this section are satisfied. The requirement set forth in paragraph (e)(2)(i) of this section is satisfied because, immediately before the exchange, FT2 (the foreign acquired corporation) is an expatriated foreign subsidiary and FT1 (the exchanging shareholder) is an expatriated foreign subsidiary that is described in paragraph (b)(1)(i)(A)(2) of this section. The requirement set forth in paragraph (e)(2)(ii) of this section is also satisfied because the stock received in the exchange (FS stock) is stock of a foreign corporation. The requirement set forth in paragraph (e)(2)(iii) of this section is satisfied because the exchange occurs during the applicable period. Accordingly, under paragraph (e)(1)(i) of this section, FT1 must include in income as a deemed dividend $30x, the section 1248 amount with respect to its FT2 stock. In addition, under paragraph (e)(1)(ii) of this section, FT1 must, after taking into account the increase in basis provided in § 1.367(b)–2(e)(3)(ii) resulting from the deemed dividend (which increases FT1’s basis in its FT2 stock from $5x to $35x), recognize $15x ($50x amount realized less $35x basis), the realized gain with respect to the FT2 stock that would not otherwise be recognized. Example 2. De minimis shift to non-EFS foreign related persons—(i) Facts. The facts are the same as in the introductory sentences of this paragraph (e)(5), except as follows. FT1 does not own any shares of FT2, and all 40 shares of FS are owned by DX, a domestic corporation wholly owned by individual A, and thus FS is not a non-EFS foreign related person. During the applicable period and pursuant to a reorganization described in section 368(a)(1)(D), FT1 transfers all of its assets to FS in exchange for 50 newly issued FS shares, FT1 distributes the 50 FS shares to USP in liquidation under section 361(c)(1), and USP exchanges its 50 shares of FT1 stock for the 50 FS shares under section 354. Further, immediately after the exchange, FS is a controlled foreign corporation. (ii) Analysis. Although USP’s exchange is a specified exchange, paragraph (e)(1) of this section does not apply to the exchange because, as described in paragraphs (ii)(A) E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 through (C) of this Example 2, the requirements of paragraph (e)(3) of this section are satisfied. (A) Because the assets, rather than the stock, of FT1 (the foreign acquired corporation) are acquired, the requirement set forth in paragraph (e)(3)(i) of this section is satisfied if FS (the transferee foreign corporation) is a controlled foreign corporation immediately after the exchange. As stated in the facts, FS is a controlled foreign corporation immediately after the exchange. (B) The requirement set forth in paragraph (e)(3)(ii) of this section is satisfied if the postexchange ownership percentage with respect to FS is at least 90% of the pre-exchange ownership percentage with respect to FT1. Because USP, a domestic corporation that is an expatriated entity, directly owns 50 shares of FT1 stock immediately before the exchange, none of those shares are treated as indirectly owned by FP (a non-EFS foreign related person) for purposes of calculating the pre-exchange ownership percentage with respect to FT1. See paragraph (g)(1) of this section. Thus, for purposes of calculating the pre-exchange ownership percentage with respect to FT1, FP is treated as directly or indirectly owning 0%, or 0 of 50 shares, of the stock of FT1. Accordingly, the preexchange ownership percentage with respect to FT1 is 100 (calculated as 100% less 0%, the percentage of FT1 stock that non-EFS foreign related persons are treated as directly or indirectly owning immediately before the exchange). Consequently, for the requirement set forth in paragraph (e)(3)(ii) of this section to be satisfied, the post-exchange ownership percentage with respect to FS must be at least 90. Because USP, a domestic corporation that is an expatriated entity, directly owns 50 shares of FS stock immediately after the exchange, none of those shares are treated as indirectly owned by FP (a non-EFS foreign related person) for purposes of calculating the post-exchange ownership percentage with respect to FS. See paragraph (g)(1) of this section. Thus, for purposes of calculating the post-exchange ownership percentage with respect to FS, FP is treated as directly or indirectly owning 0%, or 0 of 90 shares, of the stock of FS. As a result, the postexchange ownership percentage with respect to FS is 100 (calculated as 100% less 0%, the percentage of FS stock that non-EFS foreign related persons are treated as directly or indirectly owning immediately after the exchange). Therefore, because the postexchange ownership percentage with respect to FS (100) is at least 90, the requirement set forth in paragraph (e)(3)(ii) of this section is satisfied. (C) Because there is not a lower-tier expatriated foreign subsidiary of FT1, the requirement set forth in paragraph (e)(3)(iii) of this section does not apply. (f) Gain recognition upon certain transfers of property described in section 351 following an inversion transaction—(1) General rule. If, during the applicable period, an expatriated foreign subsidiary transfers specified property to a foreign corporation (the transferee foreign corporation) in an VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 exchange described in section 351, then the expatriated foreign subsidiary must recognize all realized gain with respect to the specified property transferred that would not otherwise be recognized, unless the exception in paragraph (f)(2) of this section applies. (2) De minimis exception. The exception in this paragraph (f)(2) applies if— (i) Immediately after the transfer, the transferee foreign corporation is a controlled foreign corporation; and (ii) The post-exchange ownership percentage with respect to the transferee foreign corporation is at least 90 percent of the pre-exchange ownership percentage with respect to the expatriated foreign subsidiary. (3) Examples. The following examples illustrate the application of this paragraph (f). For purposes of all of the examples, unless otherwise indicated: FP, a foreign corporation, owns all of the stock of USP, a domestic corporation, and all 10 shares of stock of FS, a controlled foreign corporation for its taxable year beginning January 1, 2017, but not for prior taxable years, except as a result of a transaction described in the facts of an example. USP owns all 50 shares of stock of FT, a controlled foreign corporation. FT owns Asset A, which is specified property with a fair market value of $50x and an adjusted basis of $10x. FP acquired all of the stock of USP in an inversion transaction that was completed on or after September 22, 2014. Accordingly, with respect to that inversion transaction, USP is an expatriated entity, FT is an expatriated foreign subsidiary, and FP and FS are each a non-EFS foreign related person. All entities have a calendar year tax year for U.S. tax purposes. All shares of stock have a fair market value of $1x, and each corporation has a single class of stock outstanding. Example 1. Transfer to which general rule applies—(i) Facts. In addition to the stock of USP and FS, FP owns Asset B, which has a fair market value of $40x. During the applicable period, and pursuant to an exchange described in section 351, FT transfers Asset A to FS in exchange for 50 newly issued shares of FS stock, and FP transfers Asset B to FS in exchange for 40 newly issued shares of FS stock. (ii) Analysis. Paragraph (f)(1) of this section applies to the transfer by FT (an expatriated foreign subsidiary) of Asset A, which is specified property, to FS (the transferee foreign corporation). Thus, FT must recognize gain of $40x under paragraph (f)(1) of this section, which is the realized gain with respect to Asset A that would not otherwise be recognized ($50x amount realized less $10x basis). For rules regarding whether the FS stock held by FT is treated PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 32535 as United States property for purposes of section 956, see § 1.956–2(a)(4)(i). Example 2. De minimis shift to non-EFS foreign related persons—(i) Facts. Individual, a United States person, owns Asset B, which has a fair market value of $40x. During the applicable period, and pursuant to an exchange described in section 351, FT transfers Asset A to FS in exchange for 50 newly issued shares of FS stock, and Individual transfers Asset B to FS in exchange for 40 newly issued shares of FS stock. (ii) Analysis. Paragraph (f)(1) of this section does not apply to the transfer by FT (an expatriated foreign subsidiary) of Asset A, which is specified property, to FS (the transferee foreign corporation)) because the requirements set forth in paragraph (f)(2) of this section are satisfied. The requirement set forth in paragraph (f)(2)(i) of this section is satisfied because FS is a controlled foreign corporation immediately after the transfer. The requirement set forth in paragraph (f)(2)(ii) of this section is satisfied if the postexchange ownership percentage with respect to FS is at least 90 percent of the preexchange ownership percentage with respect to FT. Because USP, a domestic corporation that is an expatriated entity, directly owns 50 shares of FT stock immediately before the transfer, none of those shares are treated as indirectly owned by FP (a non-EFS foreign related person) for purposes of calculating the pre-exchange ownership percentage with respect to FT. See paragraph (g)(1) of this section. Thus, for purposes of calculating the pre-exchange ownership percentage with respect to FT, FP is treated as directly or indirectly owning 0 percent, or 0 of 50 shares, of the stock of FT. Accordingly, the pre-exchange ownership percentage with respect to FT is 100 (calculated as 100 percent less 0 percent, the percentage of FT stock that non-EFS foreign related persons are treated as directly or indirectly owning immediately before the transfer). Consequently, for the requirement set forth in paragraph (f)(2)(ii) of this section to be satisfied, the post-exchange ownership percentage with respect to FS must be at least 90. Although FP directly owns 10 FS shares, none of the 50 FS shares that FP owns through USP (a domestic corporation that is an expatriated entity) are treated as indirectly owned by FP for purposes of calculating the post-exchange ownership percentage with respect to FS because USP directly owns them. See paragraph (g)(1) of this section. Thus, for purposes of calculating the postexchange ownership percentage with respect to FS, FP is treated as directly or indirectly owning 10 percent, or 10 of 100 shares, of the stock of FS. As a result, the post-exchange ownership percentage with respect to FS is 90 (calculated as 100 percent less 10 percent, the percentage of FS stock that non-EFS foreign related persons are treated as directly or indirectly owning immediately after the transfer). Therefore, because the postexchange ownership percentage with respect to FS (90) is at least 90, the requirement set forth in paragraph (f)(2)(ii) of this section is satisfied. (g) Definitions and special rules. In addition to the definitions and special E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32536 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations rules in §§ 1.367(b)–2 and 1.7874–12, the following definitions and special rules apply for purposes of this section. (1) Indirect ownership. To determine indirect ownership of the stock of a corporation for purposes of calculating a pre-exchange ownership percentage or post-exchange ownership percentage with respect to that corporation, the principles of section 958(a) apply without regard to whether an intermediate entity is foreign or domestic. For this purpose, stock of the corporation that is directly or indirectly (applying the principles of section 958(a) without regard to whether an intermediate entity is foreign or domestic) owned by a domestic corporation that is an expatriated entity is not treated as indirectly owned by a non-EFS foreign related person. (2) A lower-tier expatriated foreign subsidiary means an expatriated foreign subsidiary whose stock is directly or indirectly owned (under the principles of section 958(a)) by an expatriated foreign subsidiary. (3) Pre-exchange ownership percentage means, with respect to a corporation, 100 percent less the percentage of stock (by value) in the corporation that, immediately before an exchange, is owned, in the aggregate, directly or indirectly by non-EFS foreign related persons. (4) Post-exchange ownership percentage means, with respect to a corporation, 100 percent less the percentage of stock (by value) in the corporation that, immediately after the exchange, is owned, in the aggregate, directly or indirectly by non-EFS foreign related persons. (5) Specified property means any property other than stock of a lower-tier expatriated foreign subsidiary. (6) Recapitalizations. A foreign corporation that undergoes a reorganization described in section 368(a)(1)(E) is treated as both the foreign acquired corporation and the transferee foreign corporation. (7) Triangular reorganizations—(i) Definition. A triangular reorganization means a reorganization described in § 1.358–6(b)(2)(i) (forward triangular merger), (ii) (triangular C reorganization), (iii) (reverse triangular merger), (iv) (triangular B reorganization), and (v) (triangular G reorganization). (ii) Special rules—(A) Triangular reorganizations other than a reverse triangular merger. In the case of a triangular reorganization other than a reverse triangular merger, the surviving corporation is the transferee foreign corporation that acquires the assets or stock of the foreign acquired VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 corporation, and the reference to controlling corporation (foreign or domestic) is to the corporation that controls the surviving corporation. (B) Reverse triangular merger. In the case of a reverse triangular merger, the surviving corporation is the entity that survives the merger, and the controlling corporation (foreign or domestic) is the corporation that before the merger controls the merged corporation. In the case of a reverse triangular merger, this section applies only if stock of the foreign surviving corporation is exchanged for stock of a foreign corporation in control of the merging corporation; in such a case, the foreign surviving corporation is treated as a foreign acquired corporation. (h) Applicability date of certain paragraphs in this section. Except as otherwise provided in this paragraph (h), paragraphs (a), (b) introductory text, (b)(1)(i)(C), (d)(1), (e), (f), and (g) of this section apply to exchanges completed on or after September 22, 2014, but only if the inversion transaction was completed on or after September 22, 2014. Paragraph (e)(1)(ii) of this section applies to exchanges completed on or after November 19, 2015, but only if the inversion transaction was completed on or after September 22, 2014. The portion of paragraph (e)(2)(i) of this section that requires the exchanging shareholder to be an expatriated entity or an expatriated foreign subsidiary apply to exchanges completed on or after April 4, 2016, but only if the inversion transaction was completed on or after September 22, 2014. For inversion transactions completed on or after September 22, 2014, however, taxpayers may elect to apply the portion of paragraph (e)(2)(i) of this section that requires the exchanging shareholder to be an expatriated entity or an expatriated foreign subsidiary to exchanges completed on or after September 22, 2014, and before April 4, 2016. Paragraphs (f) and (g)(5) of this section apply to transfers completed on or after April 4, 2016, but only if the inversion transaction was completed or after September 22, 2014. See § 1.367(b)–4, as contained in 26 CFR part 1 revised as of April 1, 2016, for exchanges completed before September 22, 2014. § 1.367(b)–4T [Removed] Par. 7. Section 1.367(b)–4T is removed. ■ § 1.367(b)–6 [Amended] Par. 8. Section 1.367(b)–6 is amended by: ■ 1. Removing paragraph (a)(1)(iii). ■ PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 2. Redesignating paragraphs (a)(1)(iv) and (v) as (a)(1)(iii) and (iv), respectively. ■ 3. In newly redesignated paragraph (a)(1)(iv), removing the language ‘‘1.367(b)–4(a), §’’ in the first sentence and removing the language ‘‘§ 1.367(b)– 4(a)’’ in the second sentence. ■ Par. 9. Section 1.956–2 is amended by: ■ 1. Revising paragraphs (a)(4), (c)(5), and (d)(2). ■ 2. Adding paragraphs (f) and (h)(3) through (6). ■ 3. Removing paragraph (i). The revisions and additions read as follows: ■ § 1.956–2 property. Definition of United States (a) * * * (4) Certain foreign stock and obligations held by expatriated foreign subsidiaries following an inversion transaction—(i) General rule. Except as provided in paragraph (a)(4)(ii) of this section, for purposes of section 956 and paragraph (a) of this section, United States property includes an obligation of a foreign person and stock of a foreign corporation when the following conditions are satisfied— (A) The obligation or stock is held by a controlled foreign corporation that is an expatriated foreign subsidiary, regardless of whether, when the obligation or stock was acquired, the acquirer was a controlled foreign corporation or an expatriated foreign subsidiary; (B) The foreign person or foreign corporation is a non-EFS foreign related person, regardless of whether, when the obligation or stock was acquired, the foreign person or foreign corporation was a non-EFS foreign related person; and (C) The obligation or stock was acquired— (1) During the applicable period; or (2) In a transaction related to the inversion transaction. (ii) Exceptions. For purposes of section 956 and paragraph (a) of this section, United States property does not include— (A) Any obligation of a non-EFS foreign related person arising in connection with the sale or processing of property if the amount of the obligation at no time during the taxable year exceeds the amount that would be ordinary and necessary to carry on the trade or business of both the other party to the sale or processing transaction and the non-EFS foreign related person had the sale or processing transaction been made between unrelated persons; and (B) Any obligation of a non-EFS foreign related person to the extent the E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 principal amount of the obligation does not exceed the fair market value of readily marketable securities sold or purchased pursuant to a sale and repurchase agreement or otherwise posted or received as collateral for the obligation in the ordinary course of its business by a United States or foreign person which is a dealer in securities or commodities. (iii) Definitions. The definitions in § 1.7874–12 apply for the purposes of the application of paragraphs (a)(4), (c)(5), and (d)(2) of this section. (iv) Examples. The following examples illustrate the rules of this paragraph (a)(4). For purposes of the examples, FA, a foreign corporation, wholly owns DT, a domestic corporation, which, in turn, wholly owns FT, a foreign corporation that is a controlled foreign corporation. FA also wholly owns FS, a foreign corporation that is a controlled foreign corporation for its taxable year beginning January 1, 2017, but not for prior taxable years except as a result of a transaction described in the facts of an example. All entities have a calendar year tax year for U.S. tax purposes. FA acquired DT in an inversion transaction that was completed on January 1, 2015. Example 1. (A) Facts. FT acquired an obligation of FS on January 31, 2015. (B) Analysis. Pursuant to § 1.7874–12, DT is a domestic entity, FT is an expatriated foreign subsidiary, and FS is a non-EFS foreign related person. In addition, FT acquired the FS obligation during the applicable period. Thus, as of January 31, 2015, the obligation of FS is United States property with respect to FT for purposes of section 956(a) and this paragraph (a). Example 2. (A) Facts. The facts are the same as in Example 1 of this paragraph (a)(4)(iv), except that on February 15, 2015, FT contributed assets to FS in exchange for 60% of the stock of FS, by vote and value. (B) Analysis. As a result of the transaction on February 15, 2015, FS became a controlled foreign corporation with respect to which an expatriated entity, DT, is a United States shareholder. Accordingly, under § 1.7874– 12(a)(9), FS is an expatriated foreign subsidiary, and is therefore not a non-EFS foreign related person. Thus, as of February 15, 2015, the stock and obligation of FS are not United States property with respect to FT for purposes of section 956(a) and this paragraph (a). FS is not excluded from the definition of expatriated foreign subsidiary pursuant to § 1.7874–12(a)(9)(ii) because FS was not a CFC on the completion date. Example 3. (A) Facts. Before the inversion transaction, FA also wholly owns USP, a domestic corporation, which, in turn, wholly owns, LFS, a foreign corporation that is a controlled foreign corporation. DT was not a United States shareholder of LFS on or before the completion date. On January 31, 2015, FT contributed assets to LFS in exchange for 60% of the stock of LFS, by vote and value. VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 FT acquired an obligation of LFS on February 15, 2015. (B) Analysis. LFS is a foreign related person. Because LFS was a controlled foreign corporation and a member of the EAG with respect to the inversion transaction on the completion date, and DT was not a United States shareholder with respect to LFS on or before the completion date, LFS is excluded from the definition of expatriated foreign subsidiary pursuant to § 1.7874–12(a)(9)(ii). Thus, pursuant to § 1.7874–12(a)(16), LFS is a non-EFS foreign related person, and the stock and obligation of LFS are United States property with respect to FT for purposes of section 956(a) and this paragraph (a). The fact that FT contributed assets to LFS in exchange for 60% of the stock of LFS does not change this result. Example 4. (A) Facts. The facts are the same as in Example 3 of this paragraph (a)(4)(iv), except that on February 10, 2015, LFS organized a new foreign corporation (LFSS), transferred all of its assets to LFSS, and liquidated, in a transaction treated as a reorganization described in section 368(a)(1)(F), and FT acquired an obligation of LFSS, instead of LFS, on February 15, 2015. On March 1, 2015, LFSS acquired an obligation of FS. (B) Analysis. LFS is a controlled foreign corporation with respect to which USP, an expatriated entity, is a United States shareholder. USP is an expatriated entity because on the completion date, USP and DT became related to each other within the meaning of section 267(b). Because LFSS was not a member of the EAG with respect to the inversion transaction on the completion date, LFSS is not excluded from the definition of expatriated foreign subsidiary pursuant to § 1.7874–12(a)(9)(ii). Accordingly, under § 1.7874–12(a)(9)(i), LFFS is an expatriated foreign subsidiary and is therefore not a nonEFS foreign related person. Thus, the stock and obligation of LFSS are not United States property with respect to FT for purposes of section 956(a) and paragraph (a) of this section. However, because LFSS is an expatriated foreign subsidiary, pursuant to § 1.7874–12(a)(9), the obligation of FS, a nonEFS foreign related person, is United States property with respect to LFSS for purposes of section 956(a) and this paragraph (a). * * * * * (c) * * * (5) Special guarantee and pledge rule for expatriated foreign subsidiaries—(i) General rule. In applying paragraphs (c)(1) and (2) of this section to a controlled foreign corporation that is an expatriated foreign subsidiary, the phrase ‘‘of a United States person or a non-EFS foreign related person’’ is substituted for the phrase ‘‘of a United States person’’ each place it appears. (ii) Additional rules. The rule in paragraph (c)(5)(i) of this section— (A) Applies regardless of whether, when the pledge or guarantee was entered into or treated as entered into, the controlled foreign corporation was a controlled foreign corporation or an expatriated foreign subsidiary, or a PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 32537 foreign person whose obligation is subject to the pledge or guarantee, or deemed pledge or guarantee, was a nonEFS foreign related person; and (B) Applies to pledges or guarantees entered into, or treated pursuant to paragraph (c)(2) of this section as entered into— (1) During the applicable period; or (2) In a transaction related to the inversion transaction. (d) * * * (2) Obligation defined. For purposes of section 956 and this section, the term ‘‘obligation’’ includes any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other indebtedness, whether or not issued at a discount and whether or not bearing interest, except that the term does not include— (i) Any indebtedness arising out of the involuntary conversion of property which is not United States property within the meaning of paragraph (a) of this section; (ii) Any obligation of a United States person (as defined in section 957(c)) arising in connection with the provision of services by a controlled foreign corporation to the United States person if the amount of the obligation outstanding at any time during the taxable year of the controlled foreign corporation does not exceed an amount which would be ordinary and necessary to carry on the trade or business of the controlled foreign corporation and the United States person if they were unrelated. The amount of the obligations shall be considered to be ordinary and necessary to the extent of such receivables that are paid within 60 days; (iii) Any obligation of a non-EFS foreign related person arising in connection with the provision of services by an expatriated foreign subsidiary to the non-EFS foreign related person if the amount of the obligation outstanding at any time during the taxable year of the expatriated foreign subsidiary does not exceed an amount which would be ordinary and necessary to carry on the trade or business of the expatriated foreign subsidiary and the non-EFS foreign related person if they were unrelated. The amount of the obligations shall be considered to be ordinary and necessary to the extent of such receivables that are paid within 60 days; or (iv) Any obligation of a United States person (as defined in section 957(c)) that is collected within 30 days from the time it is incurred (a 30-day obligation), unless the controlled foreign corporation that holds the 30-day E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32538 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations obligation holds for 60 or more calendar days during the taxable year in which it holds the 30-day obligation any obligations which, without regard to the exclusion described in this paragraph (d)(2)(iv), would constitute United States property within the meaning of section 956 and paragraph (a) of this section. * * * * * (f) [Reserved]. For further guidance, see § 1.956–2T(f). * * * * * (h) * * * (3) Except as otherwise provided in this paragraph (h)(3), paragraphs (a)(4) and (c)(5) of this section apply to obligations or stock acquired or to pledges or guarantees entered into, or treated as entered into, on or after September 22, 2014, but only if the inversion transaction was completed on or after September 22, 2014. The phrase ‘‘, regardless of whether, when the obligation or stock was acquired, the acquirer was a controlled foreign corporation or an expatriated foreign subsidiary’’ in paragraph (a)(4)(i)(A) of this section, the phrase ‘‘regardless of whether, when the obligation or stock was acquired, the foreign person or foreign corporation was a non-EFS foreign related person’’ in paragraph (a)(4)(i)(B) of this section, and paragraphs (a)(4)(i)(C)(2), (c)(5)(ii)(A), and (c)(5)(ii)(B)(2) of this section apply to obligations or stock acquired or pledges or guarantees entered into or treated as entered into on or after April 4, 2016, but only if the inversion transaction was completed on or after September 22, 2014. Paragraph (a)(4)(ii) of this section applies to obligations acquired on or after April 4, 2016. For inversion transactions completed on or after September 22, 2014, however, taxpayers may elect to apply paragraph (a)(4)(ii) of this section to an obligation acquired before April 4, 2016. For purposes of paragraph (a)(4)(i) of this section and this paragraph (h)(3), a deemed exchange of an obligation or stock pursuant to section 1001 constitutes an acquisition of the obligation or stock. For purposes of paragraph (c)(5) of this section and this paragraph (h)(3), a pledgor or guarantor or deemed pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor or is treated as a pledgor or guarantor. (4) Paragraphs (d)(2)(i) and (ii) of this section are effective June 14, 1988, with VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 respect to investments made on or after June 14, 1988. (5) Paragraph (d)(2)(iii) of this section applies to obligations acquired on or after April 4, 2016, but only if the inversion transaction was completed on or after September 22, 2014. For inversion transactions completed on or after September 22, 2014, however, taxpayers may elect to apply paragraph (d)(2)(iii) of this section to an obligation acquired on or after September 22, 2014, and before April 4, 2016. For purposes of paragraph (d)(2)(iii) of this section and this paragraph (h)(5), a significant modification, within the meaning of § 1.1001–3(e), of an obligation on or after April 4, 2016, constitutes an acquisition of an obligation on or after April 4, 2016. (6) Paragraph (d)(2)(iv) of this section applies to obligations held on or after September 16, 1988. See § 1.956– 2T(d)(2)(v), as contained in 26 CFR part 1 revised as of April 1, 2017, for additional rules applicable to certain taxable years of a foreign corporation beginning before January 1, 2011. ■ Par. 10. Section 1.956–2T is amended by: ■ 1. Removing and reserving paragraph (a)(4). ■ 2. Revising paragraphs (b)(2) through (c)(4). ■ 3. Removing and reserving paragraphs (c)(5) and (d)(2). ■ 4. Removing paragraphs (i) and (j). The revisions read as follows: § 1.956–2T Definition of United States property (temporary). * * * * * (b)(2) through (c)(4). [Reserved] For further guidance, see § 1.956–2(b)(2) through (c)(4). * * * * * ■ Par. 11. Section 1.7701(l)–4 is added to read as follows: § 1.7701(l)–4 Rules regarding inversion transactions. (a) Overview. This section provides rules applicable to United States shareholders of controlled foreign corporations after certain inversion transactions. Paragraph (b) of this section defines specified transactions and provides the scope of the rules in this section. Paragraph (c) of this section provides rules recharacterizing certain specified transactions. Paragraph (d) of this section sets forth rules governing transactions that affect the stock of an expatriated foreign subsidiary following a recharacterized specified transaction. Paragraph (e) of this section sets forth a rule concerning the treatment of amounts included in income as a result of a specified transaction as foreign PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 personal holding company income. Paragraph (f) of this section sets forth definitions that apply for purposes of this section. Paragraph (g) of this section sets forth examples illustrating these rules. Paragraph (h) of this section provides applicability dates. See § 1.367(b)–4(e) and (f) for rules concerning certain other exchanges after an inversion transaction. See also § 1.956–2(a)(4), (c)(5), and (d)(2) for additional rules applicable to United States property held by controlled foreign corporations after an inversion transaction. (b) Specified transaction—(1) In general. Except as provided in paragraph (b)(2) of this section, paragraph (c) of this section applies to specified transactions. For purposes of this section, a specified transaction is, with respect to an expatriated foreign subsidiary, a transaction in which stock of the expatriated foreign subsidiary is issued or transferred to a person that immediately before the issuance or transfer is a specified related person, provided the transaction occurs during the applicable period. However, a specified transaction does not include a transaction in which stock of the expatriated foreign subsidiary is deemed issued pursuant to section 304. (2) Exceptions. Paragraph (c) of this section does not apply to a specified transaction— (i) That is a fast-pay arrangement that is recharacterized under § 1.7701(l)– 3(c)(2); (ii) In which the specified stock was transferred by a shareholder of the expatriated foreign subsidiary, and the shareholder either— (A) Pursuant to § 1.367(b)–4(e)(1), both— (1) Included in gross income as a deemed dividend the section 1248 amount attributable to the specified stock; and (2) After taking into account the increase in basis provided in § 1.367(b)– 2(e)(3)(ii) resulting from the deemed dividend (if any), recognized all realized gain with respect to the stock that otherwise would not have been recognized; or (B) Included in gross income all of the gain recognized on the transfer of the specified stock (including gain included in gross income as a dividend pursuant to section 964(e), section 1248(a), or section 356(a)(2)); or (iii) In which— (A) Immediately after the specified transaction and any related transaction, the expatriated foreign subsidiary is a controlled foreign corporation; (B) The post-transaction ownership percentage with respect to the E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations expatriated foreign subsidiary is at least 90 percent of the pre-transaction ownership percentage with respect to the expatriated foreign subsidiary; and (C) The post-transaction ownership percentage with respect to any lowertier expatriated foreign subsidiary is at least 90 percent of the pre-transaction ownership percentage with respect to the lower-tier expatriated foreign subsidiary. See Example 3 and Example 4 of paragraph (g) of this section. (c) Recharacterization of specified transactions—(1) In general. Except as otherwise provided, a specified transaction that is recharacterized under this paragraph (c) is recharacterized for all purposes of the Internal Revenue Code as of the date on which the specified transaction occurs, unless and until the rules of paragraph (d) of this section apply to alter or terminate the recharacterization. For purposes of paragraphs (c)(2) and (3) and (d) of this section, stock is considered owned by a section 958(a) U.S. shareholder if it is owned within the meaning of section 958(a) by the section 958(a) U.S. shareholder. (2) Specified transactions through stock issuance. A specified transaction in which the specified stock is issued by an expatriated foreign subsidiary to a specified related person is recharacterized as follows— (i) The transferred property is treated as having been transferred by the specified related person to the persons that were section 958(a) U.S. shareholders of the expatriated foreign subsidiary immediately before the specified transaction, in proportion to the stock of the expatriated foreign subsidiary owned by each section 958(a) U.S. shareholder, in exchange for deemed instruments in the section 958(a) U.S. shareholders; and (ii) The transferred property treated as transferred to the section 958(a) U.S. shareholders pursuant to paragraph (c)(2)(i) of this section is treated as having been contributed by the section 958(a) U.S. shareholders (through intermediate entities, if any, in exchange for equity in the intermediate entities) to the expatriated foreign subsidiary in exchange for deemed issued stock in the expatriated foreign subsidiary. See Example 1, Example 2, and Example 6 of paragraph (g) of this section. (3) Specified transactions through shareholder transfer. A specified transaction in which specified stock is transferred by shareholders of the expatriated foreign subsidiary to a specified related person is recharacterized as follows— VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 (i) The transferred property is treated as having been transferred by the specified related person to the persons that were section 958(a) U.S. shareholders of the expatriated foreign subsidiary immediately before the specified transaction, in proportion to the specified stock owned by each section 958(a) U.S. shareholder, in exchange for deemed instruments in the section 958(a) U.S. shareholders; and (ii) To the extent the section 958(a) U.S. shareholders are not the transferring shareholders, the transferred property treated as transferred to the section 958(a) U.S. shareholders pursuant to paragraph (c)(3)(i) of this section is treated as having been contributed by the section 958(a) U.S. shareholders (through intermediate entities, if any, in exchange for equity in the intermediate entities) to the transferring shareholder in exchange for equity in the transferring shareholder. See Example 5 of paragraph (g) of this section. (4) Treatment of deemed instruments following a recharacterized specified transaction—(i) Deemed instruments. The deemed instruments described in paragraphs (c)(2) and (3) of this section have the same terms as the specified stock issued or transferred pursuant to the specified transaction (that is, the disregarded specified stock), other than the issuer. When a distribution is made with respect to the disregarded specified stock, matching seriatim distributions with respect to the deemed issued stock are treated as made by the expatriated foreign subsidiary, through intermediate entities, if any, to the section 958(a) U.S. shareholders, which, in turn, then are treated as making corresponding payments with respect to the deemed instruments to the specified related person. (ii) Paying agent. The expatriated foreign subsidiary is treated as the paying agent of the section 958(a) U.S. shareholder with respect to the deemed instruments treated as issued by the section 958(a) U.S. shareholder to the specified related person. (d) Transactions affecting ownership of stock of an expatriated foreign subsidiary following a recharacterized specified transaction—(1) Transfers of stock other than specified stock. When, after a specified transaction with respect to an expatriated foreign subsidiary that is recharacterized under paragraph (c)(2) or (3) of this section, stock of the expatriated foreign subsidiary, other than disregarded specified stock, that is owned by a section 958(a) U.S. shareholder is transferred, the deemed issued stock treated as owned by the section 958(a) U.S. shareholder as a PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 32539 result of the specified transaction continues to be treated as directly owned by the holder, as are the deemed instruments treated as issued to the specified related person as a result of the specified transaction. (2) Transactions in which the expatriated foreign subsidiary ceases to be a foreign related person. When, after a specified transaction with respect to an expatriated foreign subsidiary that is recharacterized under paragraph (c)(2) or (3) of this section, there is a transaction that affects the ownership of the stock (including disregarded specified stock) of the expatriated foreign subsidiary, and, immediately after the transaction, the expatriated foreign subsidiary is not a foreign related person (determined without taking into account the recharacterization under paragraph (c)(2) or (3) of this section), then, immediately before the transaction— (i) Each section 958(a) U.S. shareholder that is treated as owning deemed issued stock in the expatriated foreign subsidiary under paragraph (c)(2) or (3) of this section is treated as transferring the deemed issued stock (after the deemed issued stock is deemed to be transferred to the section 958(a) U.S. shareholder through intermediate entities, if any, in redemption of equity deemed issued by the intermediate entities pursuant to paragraph (c)(2) or (3) of this section) to the specified related person that is treated as holding the deemed instruments issued by the section 958(a) U.S. shareholder under paragraph (c)(2) or (3) of this section, in redemption of the deemed instruments; and (ii) The deemed issued stock that is treated as transferred pursuant to paragraph (d)(2)(i) of this section is treated as recapitalized into the disregarded specified stock actually held by the specified related person, which immediately thereafter is treated as specified stock owned by the specified related person for all purposes of the Internal Revenue Code. See Example 8, Example 9, and Example 12 of paragraph (g) of this section. (3) Transfers in which disregarded specified stock ceases to be held by a foreign related person, specified related person, or expatriated entity. When, after a specified transaction with respect to an expatriated foreign subsidiary that is recharacterized under paragraph (c)(2) or (3) of this section, there is a direct or indirect transfer of the disregarded specified stock in the expatriated foreign subsidiary, and immediately after the transfer, the expatriated foreign subsidiary is a foreign related person, then, to the extent that, as a result of the E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32540 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations transfer, the disregarded specified stock is actually held (determined without taking into account the recharacterization under paragraph (c)(2) or (3) of this section) by a person that is not a foreign related person, a specified related person, or an expatriated entity, immediately before the transfer— (i) Each section 958(a) U.S. shareholder that is treated as owning all or a portion of the deemed issued stock in the expatriated foreign subsidiary is treated as transferring the deemed issued stock that is allocable to the transferred disregarded specified stock that is out-of-group transferred disregarded specified stock (after the deemed issued stock is deemed to be transferred to the section 958(a) U.S. shareholder through intermediate entities, if any, in redemption of equity deemed issued by the intermediate entities pursuant to paragraph (c)(2) or (3) of this section) to the specified related person that is treated as holding the deemed instruments allocable to the out-of-group transferred disregarded specified stock, in redemption of the deemed instruments that are allocable to the out-of-group transferred disregarded specified stock; and (ii) The deemed issued stock that is treated as transferred pursuant to paragraph (d)(3)(i) of this section is treated as recapitalized into the disregarded specified stock actually held by the specified related person, which immediately thereafter is treated as specified stock owned by the specified related person for all purposes of the Internal Revenue Code. See Example 7 and Example 11 of paragraph (g) of this section. (4) Certain direct transfers of disregarded specified stock to which unwind rules do not apply. When a specified related person directly transfers the disregarded specified stock of the expatriated foreign subsidiary and paragraphs (d)(2) and (3) of this section do not apply with respect to the transfer, the specified related person is deemed to transfer the deemed instruments allocable to the transferred disregarded specified stock, whether it is in-group transferred disregarded specified stock or out-of-group transferred disregarded specified stock, to the transferee of the specified stock, in lieu of the disregarded specified stock, in exchange for the consideration provided by the transferee for the disregarded specified stock. See Example 10 of paragraph (g) of this section. (5) Determination of deemed issued stock and deemed instruments allocable to transferred disregarded specified VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 stock—(i) Out-of-group transfers of disregarded specified stock. For purposes of paragraphs (d)(3) and (4) of this section, the portion of the deemed issued stock treated as owned, and of the deemed instruments treated as issued, by each section 958(a) U.S. shareholder as a result of the specified transaction that is allocable to out-ofgroup transferred disregarded specified stock is the amount that is proportionate to the ratio of the amount of the out-ofgroup transferred disregarded specified stock to the amount of disregarded specified stock of the expatriated foreign subsidiary that is actually held by the specified related person immediately before the transfer referred to in paragraph (d)(3) or (4) of this section as a result of the specified transaction. (ii) In-group direct transfers of disregarded specified stock. For purposes of paragraph (d)(4) of this section, the portion of the deemed issued stock treated as owned by each section 958(a) U.S. shareholder as a result of the specified transaction that is allocable to in-group transferred disregarded specified stock is the amount that is proportionate to the ratio of the amount of the in-group transferred disregarded specified stock to the amount of disregarded specified stock of the expatriated foreign subsidiary that is actually held by the specified related person immediately before the transfer described in paragraph (d)(4) of this section as a result of the specified transaction. (e) Certain exception from foreign personal holding company income not available. An amount included in the gross income of a controlled foreign corporation as a dividend with respect to stock transferred in a specified transaction does not qualify for the exception from foreign personal holding company income provided by section 954(c)(6) (to the extent in effect). (f) Definitions. In addition to the definitions in § 1.7874–12, the following definitions and special rules apply for purposes of this section: (1) Deemed instruments mean, with respect to a specified transaction, instruments deemed issued by a section 958(a) U.S. shareholder in exchange for transferred property in the specified transaction. (2) Deemed issued stock means, with respect to a specified transaction, stock of an expatriated foreign subsidiary deemed issued to a section 958(a) U.S. shareholder (or an intermediate entity) in the specified transaction. (3) Disregarded specified stock means, with respect to a specified transaction, specified stock that is actually held by a specified related person but that is PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 disregarded for all purposes of the Internal Revenue Code pursuant to paragraph (c)(2) or (3) of this section. (4) Indirect ownership. To determine indirect ownership of the stock of a corporation for purposes of calculating a pre-transaction ownership percentage or post-transaction ownership percentage with respect to that corporation, the principles of section 958(a) apply without regard to whether an intermediate entity is foreign or domestic. For this purpose, stock of the corporation that is directly or indirectly (applying the principles of section 958(a) without regard to whether an intermediate entity is foreign or domestic) owned by a domestic corporation that is an expatriated entity is not treated as indirectly owned by a non-EFS foreign related person. (5) In-group transferred disregarded specified stock means disregarded specified stock that is directly transferred to a foreign related person, a specified related person, or an expatriated entity. (6) A lower-tier expatriated foreign subsidiary means an expatriated foreign subsidiary, stock of which is directly or indirectly owned by an expatriated foreign subsidiary. (7) Out-of-group transferred disregarded specified stock means disregarded specified stock that, as a result of a transfer of disregarded specified stock, is actually held by a person that is not a foreign related person, a specified related person, or an expatriated entity. (8) Pre-transaction ownership percentage means, with respect to a corporation, 100 percent less the percentage of stock (by value) in the corporation that, immediately before a specified transaction and any related transaction, is owned, in the aggregate, directly or indirectly by non-EFS foreign related persons. (9) Post-transaction ownership percentage means, with respect to a corporation, 100 percent less the percentage of stock (by value) in the corporation that, immediately after the specified transaction and any related transaction, is owned, in the aggregate, directly or indirectly by non-EFS foreign related persons. (10) A section 958(a) U.S. shareholder means, with respect to an expatriated foreign subsidiary, a United States shareholder with respect to the expatriated foreign subsidiary that owns (within the meaning of section 958(a)) stock of the expatriated foreign subsidiary and that is an expatriated entity. (11) Specified stock means the stock of the expatriated foreign subsidiary that E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 is issued or transferred to a specified related person in a specified transaction. (12) Transferred property means the property transferred by the specified related person in exchange for specified stock in a specified transaction. (g) Examples. The following examples illustrate the regulations described in this section. Except as otherwise provided, FA, a foreign corporation, wholly owns DT, a domestic corporation, which, in turn, wholly owns FT, a foreign corporation that is a controlled foreign corporation. FA also wholly owns FS, a foreign corporation that is a controlled foreign corporation for its taxable year beginning January 1, 2017, but not for prior taxable years. FA acquired DT in an inversion transaction that was completed on January 1, 2015. Accordingly, DT is the domestic entity and a section 958(a) U.S. shareholder with respect to FT, FT is an expatriated foreign subsidiary, and FA and FS are non-EFS foreign related persons and specified related persons. All entities have a calendar year tax year for U.S. tax purposes. Example 1. (i) Facts. On February 1, 2015, FA acquires $6x of FT stock, representing 60% of the total voting power and value of the stock of FT, from FT in a stock issuance, in exchange for $6x of cash. (ii) Analysis. (A) Under paragraph (b) of this section, FA’s acquisition of the FT specified stock from FT is a specified transaction because stock of an expatriated foreign subsidiary was issued to a specified related person (FA) during the applicable period. Furthermore, the exceptions to recharacterization in paragraph (b)(2) of this section do not apply to the transaction. (B) FA’s acquisition of the FT specified stock is recharacterized under paragraphs (c)(1) and (2) of this section as follows, with the result that FT continues to be a CFC even before its taxable year beginning January 1, 2017: (1) DT is treated as having issued deemed instruments to FA in exchange for $6x of cash. (2) DT is treated as having contributed the $6x of cash to FT in exchange for deemed issued stock of FT. (C) Under paragraph (c)(4)(i) of this section, any distribution with respect to the FT specified stock issued to FA will be treated as a distribution to DT, which, in turn, will be treated as making a matching distribution with respect to the deemed instruments that DT is treated as having issued to FA. Under paragraph (c)(4)(ii) of this section, FT is treated as the paying agent of DT with respect to the deemed instruments issued by DT to FA. Example 2. (i) Facts. DT owns stock of FT representing 60% of the total voting power and value of the stock of FT, and the remaining stock of FT, representing 40% of the total voting power and value, is owned by USP, a domestic corporation that is not an expatriated entity. On February 1, 2015, FA acquires $6x of FT stock, representing 60% VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 of the total voting power and value of the stock of FT, from FT in a stock issuance, in exchange for $6x of cash. (ii) Analysis. (A) Under paragraph (b) of this section, FA’s acquisition of the FT specified stock from FT is a specified transaction because stock of an expatriated foreign subsidiary was issued to a specified related person (FA) during the applicable period. Furthermore, the exceptions to recharacterization in paragraph (b)(2) of this section do not apply to the transaction. (B) FA’s acquisition of the FT specified stock is recharacterized under paragraphs (c)(1) and (2) of this section as follows, with the result that FT continues to be a CFC even before its taxable year beginning January 1, 2017: (1) DT is treated as having issued deemed instruments to FA in exchange for $6x of cash. (2) DT is treated as having contributed the $6x of cash to FT in exchange for deemed issued stock of FT. (3) DT is treated as owning $8.40x of the stock of FT, representing 84% of the total voting power and value of the stock of FT. USP owns $1.60x of the stock of FT, representing 16% of the total voting power and value of the stock of FT. (C) Under paragraph (c)(4)(i) of this section, any distribution with respect to the FT specified stock issued to FA will be treated as a distribution to DT, which, in turn, will be treated as making a matching distribution with respect to the deemed instruments that DT is treated as having issued to FA. Under paragraph (c)(4)(ii) of this section, FT is treated as the paying agent of DT with respect to the deemed instruments issued by DT to FA. Example 3. (i) Facts. DT owns stock of FT representing 50% of the total voting power and value of the $8x of stock of FT outstanding, and the remaining stock of FT, representing 50% of the total voting power and value, is owned by USP, a domestic corporation that is not an expatriated entity. On April 30, 2016, FA and USP each simultaneously acquire $1x of FT stock from FT in a stock issuance, in exchange for $1x of cash each. (ii) Analysis. (A) Under paragraph (b) of this section, FA’s acquisition of the FT specified stock from FT is a specified transaction because stock of an expatriated foreign subsidiary was issued to a specified related person (FA) during the applicable period. (B) However, the specified transaction is not recharacterized under paragraphs (c)(1) and (2) of this section because the exception in paragraph (b)(2)(iii) of this section applies. The exception applies because FT remains a controlled foreign corporation immediately after the specified transaction and any related transaction, and the post-transaction ownership percentage with respect to FT is 90% (90%/100%), or at least 90%, of the pretransaction ownership percentage with respect to FT. The rule in paragraph (b)(2)(iii)(C) of this section does not apply because there is no lower-tier expatriated foreign subsidiary. Although FA (a non-EFS foreign related person) indirectly owns $4x of FT stock both immediately before and after PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 32541 the specified transaction and any related transaction, all of that stock is directly owned by DT (a domestic corporation), and as a result, under paragraph (f)(4) of this section, none of that stock is treated as directly or indirectly owned by FA for purposes of calculating the pre-transaction ownership percentage and the post-transaction ownership percentage with respect to FT. Accordingly, under paragraph (f)(8) of this section, the pre-transaction ownership percentage with respect to FT (100% less the percentage of stock (by value) in FT that, immediately before the specified transaction with respect to FT and any related transaction, is owned by non-EFS foreign related persons) is 100 (100%¥0%). Under paragraph (f)(9) of this section, the posttransaction ownership percentage with respect to FT (100% less the percentage of stock (by value) in FT that, immediately after the specified transaction with respect to FT and any related transaction, is owned by nonEFS foreign related persons) is 90 (100%¥10% ($1x/$10x)). Example 4. (i) Facts. On February 1, 2015, FA acquires 60% of the FT stock owned by DT in exchange for $2.40x of cash in a fully taxable transaction. DT recognizes and includes in income all of the gain (including any gain treated as a deemed dividend pursuant to section 1248(a)) with respect to the FT stock transferred to FA. (ii) Analysis. (A) Under paragraph (b) of this section, FA’s acquisition of the FT specified stock is a specified transaction because stock of an expatriated foreign subsidiary was transferred to a specified related person (FA) during the applicable period. (B) However, the specified transaction is not recharacterized under paragraphs (c)(1) and (c)(3) of this section because the exception in paragraph (b)(2)(ii) of this section applies. The exception applies because DT recognizes and includes in income all of the gain (including any gain treated as a deemed dividend pursuant to section 1248(a)) with respect to the FT specified stock transferred to FA. Example 5. (i) Facts. On February 1, 2015, DT and FA organize FPRS, a foreign partnership, with nominal capital. DT transfers all of the stock of FT to FPRS in exchange for 40% of the capital and profits interests in the partnership. Furthermore, FA contributes property to FPRS in exchange for the other 60% of the capital and profits interests. (ii) Analysis. (A) Under paragraph (b) of this section, DT’s transfer of the FT specified stock is a specified transaction, because stock of an expatriated foreign subsidiary was transferred to a specified related person (FPRS) during the applicable period. The exceptions to recharacterization in paragraph (b)(2) of this section do not apply to the transaction. (B) DT’s transfer of the FT specified stock is recharacterized under paragraphs (c)(1) and (c)(3) of this section as follows, with the result that FT continues to be a CFC even before its taxable year beginning January 1, 2017: (1) FPRS is treated as having issued 40% of its capital and profits interests to DT in E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32542 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations exchange for deemed instruments treated as having been issued by DT. (2) DT is treated as continuing to own all of the stock of FT, as well as the FPRS interests. (C) Under paragraph (c)(4)(i) of this section, any distribution with respect to the FT specified stock transferred to FPRS will be treated as a distribution to DT, which, in turn, will be treated as making a matching distribution with respect to the deemed instruments that DT is treated as having issued to FPRS. Under paragraph (c)(4)(ii) of this section, FT is treated as the paying agent of DT with respect to the deemed instruments issued by DT to FPRS. Example 6. (i) Facts. DT wholly owns FT2, a foreign corporation that is a controlled foreign corporation. FT and FT2 each own 50% of the capital and profits interests in DPRS, a domestic partnership. DPRS wholly owns FT3, a foreign corporation that is a controlled foreign corporation. FT2 and FT3 are expatriated foreign subsidiaries. On April 30, 2016, FS acquires $9x of the stock of each of FT and FT2, representing 9% of the total voting power and value of the stock of FT and FT2, from FT and FT2, respectively, in a stock issuance, in exchange for cash of $9x each. Also on April 30, 2016, in a related transaction, FS acquires $9x of the stock of FT3, representing 9% of the total voting power and value of the stock of FT3, from FT3 in a stock issuance, in exchange for cash of $9x. (ii) Analysis. (A) Under paragraph (b) of this section, the acquisitions by FS of the specified stock of each of FT, FT2, and FT3 from FT, FT2, and FT3 are specified transactions with respect to each of FT, FT2, and FT3, respectively, because stock of an expatriated foreign subsidiary was issued to a specified related person (FS) during the applicable period. (B) If FS had acquired only stock of FT and FT2, and had not acquired stock of FT3 in a related transaction, the specified transactions resulting from the acquisitions with respect to FT and FT2 would not have been recharacterized under paragraphs (c)(1) and (2) of this section, because the exception from recharacterization in paragraph (b)(2)(iii) of this section would have applied. FT and FT2 remain controlled foreign corporations immediately after each specified transaction and any related transaction. Under paragraph (f)(9) of this section, the post-transaction ownership percentage with respect to each of FT, FT2, and FT3 (a lowertier expatriated foreign subsidiary of FT and FT2) would have been 91% ((100%¥9%)/ (100%¥0%)), or at least 90%, of the pretransaction ownership percentage determined under paragraph (f)(8) of this section with respect to each of FT, FT2, and FT3 (100%). (C) However, for the specified transactions with respect to FT, FT2, and FT3, the posttransaction ownership percentage determined under paragraph (f)(9) of this section with respect to FT3 (the lower-tier expatriated foreign subsidiary of FT and FT2), 100% less the percentage of stock (by value) in FT3 that, immediately after each of the specified transactions with respect to each of FT and FT2 and any related VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 transaction, is owned by the non-EFS foreign related persons, is 82.81 (100% ¥ (9% × 50% × 91%)¥(9% × 50% × 91%)¥9%). Accordingly, the post-transaction ownership percentage with respect to FT3 is 82.81% (82.81/(100%¥0%)), which is less than 90%, of the pre-transaction ownership percentage determined under paragraph (f)(8) of this section with respect to FT3. Thus, the exception from recharacterization in paragraph (b)(2)(iii) of this section does not apply with respect to the specified transactions with respect to FT, FT2, or FT3. (D) The specified transactions with respect to FT and FT2 are recharacterized under paragraphs (c)(1) and (2) of this section as follows: (1) DT is treated as having issued 2 deemed instruments worth $9x each to FA in exchange for $18x ($9x + $9x) of cash. (2) DT is treated as having contributed $9x of cash to each of FT and FT2 in exchange for deemed issued stock of FT and FT2. (3) DT is treated as continuing to own all of the stock of FT and FT2. (E) Under paragraph (c)(4)(i) of this section, any distribution with respect to the FT and FT2 specified stock issued to FS will be treated as a distribution to DT, which, in turn, will be treated as making a matching distribution with respect to the deemed instruments that DT is treated as having issued to FS. Under paragraph (c)(4)(ii) of this section, FT and FT2 are treated as the paying agents of DT with respect to the deemed instruments issued by DT to FS. (F) The specified transaction with respect to FT3 is recharacterized under paragraphs (c)(1) and (2) of this section as follows: (1) DPRS is treated as having issued a deemed instrument worth $9x to FA in exchange for $9x of cash. (2) DPRS is treated as having contributed $9x of cash to FT3 in exchange for deemed issued stock of FT3. (3) DPRS is treated as continuing to own all of the stock of FT3. (G) Under paragraph (c)(4)(i) of this section, any distribution with respect to the FT3 specified stock issued to FS will be treated as a distribution to DPRS, which, in turn, will be treated as making a matching distribution with respect to the deemed instruments that DPRS is treated as having issued to FS. Under paragraph (c)(4)(ii) of this section, FT3 is treated as the paying agent of DPRS with respect to the deemed instrument issued by DPRS to FS. Example 7. (i) Facts. The facts are the same as in Example 1 of this paragraph (g). On April 30, 2016, FA transfers $4x of the FT disregarded specified stock that it acquired on February 1, 2015 to USP, a domestic corporation that is not an expatriated entity, in exchange for $4x of cash. (ii) Results. After the transfer, FT remains a foreign related person. Therefore, paragraph (d)(2) of this section does not apply. However, the $4x of FT disregarded specified stock transferred to USP ceases to be held by a foreign related person, a specified related person, or an expatriated entity (determined without taking into account paragraph (c)(2) or (3) of this section). Therefore, under paragraph (d)(3) of this section, immediately before the transfer of the disregarded PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 specified stock, DT is deemed to transfer $4x ($6x × ($4x/$6x)) of the FT deemed issued stock that it is treated as owning to FA, the specified related person, in redemption of $4x ($6x × ($4x/$6x)) of the DT deemed instruments that FA is treated as owning, and the $4x of FT deemed issued stock deemed transferred to FA is deemed recapitalized into disregarded specified stock actually held by FA, which is thereafter treated as owned by FA for all purposes of the Code until the transfer to USP. Example 8. (i) Facts. The facts are the same as in Example 7 of this paragraph (g), except that on April 30, 2016, FA transfers all $6x of the FT disregarded specified stock to USP in exchange for $6x of cash. (ii) Results. After the transfer, FT ceases to be a foreign related person (determined without taking into account paragraph (c)(2) or (3) of this section). Therefore, under paragraph (d)(2) of this section, immediately before the transfer of the disregarded specified stock, DT is deemed to transfer the $6x of FT deemed issued stock that it is treated as owning to FA, the specified related person, in redemption of the $6x of DT deemed instruments that FA is treated as owning, and the $6x of FT deemed issued stock deemed transferred to FA is deemed recapitalized into disregarded specified stock actually held by FA, which is thereafter treated as owned by FA for all purposes of the Code until the transfer to USP. Example 9. (i) Facts. The facts are the same as in Example 7 of this paragraph (g), except that on April 30, 2016, FA transfers $5.5x of the FT disregarded specified stock to USP in exchange for $5.5x of cash. (ii) Results. After the transfer, FT ceases to be a foreign related person (determined without taking into account paragraph (c)(2) or (3) of this section). Therefore, under paragraph (d)(2) of this section, immediately before the transfer of the disregarded specified stock, DT is deemed to transfer the $6x of FT deemed issued stock that it is treated as owning to FA, the specified related person, in redemption of the $6x of DT deemed instruments that FA is treated as owning, and the $6x of FT deemed issued stock deemed transferred to FA is deemed recapitalized into disregarded specified stock actually held by FA, which is thereafter treated as owned by FA for all purposes of the Code and $5.5x of which is transferred to USP. The remaining $0.5x of the specified stock continues to be treated as owned by FA for all purposes of the Code. Example 10. (i) Facts. The facts are the same as in Example 1 of this paragraph (g). On April 30, 2016, FA transfers $5x of the FT disregarded specified stock that it acquired on February 1, 2015 to DS, a domestic corporation wholly owned by DT, in exchange for $5x of cash. (ii) Results. After the transfer, FT remains a foreign related person because DS is wholly owned by DT. Therefore, paragraph (d)(2) of this section does not apply. Furthermore, the $5x of FT disregarded specified stock is not, as a result of the transfer, held by a person that is not a foreign related person, a specified related person, or an expatriated entity. Therefore, paragraph (d)(3) of this section does not apply. Because FA, a E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations specified related person, directly transferred disregarded specified stock of FT in a transaction to which paragraphs (d)(2) and (3) of this section do not apply, under paragraph (d)(4) of this section, FA is treated as transferring the $5x of deemed instruments of DT allocable to the $5x of ingroup transferred disregarded specified stock ($6x × ($5x/$6x)) to DS. Example 11. (i) Facts. On February 1, 2015, FS acquires $6x of FT stock, representing 60% of the total voting power and value of the stock of FT, from FT in a stock issuance, in exchange for $6x of cash. The $6x of FT stock is specified stock, and the transaction is recharacterized under paragraph (c)(2) of this section. See Example 1 of this paragraph (g). On April 30, 2016, FA transfers stock of FS representing 60% of the total voting power and value of the stock of FS to USP, a domestic corporation that is not an expatriated entity. As a result of the transfer, FS ceases to be a foreign related person. (ii) Results. After the February 1, 2015 transfer, FT remains a foreign related person because the FT stock is acquired by FS, a foreign related person with respect to DT at that time. Therefore, paragraph (d)(2) of this section does not apply. However, after the April 30, 2016 transfer, because FS ceases to be a foreign related person, it ceases to be a specified related person. Furthermore, the $6x of disregarded specified stock held before the transaction continues to be held by FS after the transaction, and therefore is not held by a foreign related person, a specified related person, or an expatriated entity after the transaction. Accordingly, under paragraph (d)(3) of this section, immediately before the transfer of FS disregarded specified stock, DT is deemed to transfer $6x ($6x × ($6x/$6x)) of the FT deemed issued stock that it is treated as owning to FS, the specified related person, in redemption of $6x ($6x × ($6x/$6x)) of the DT deemed instruments that FS is treated as owning, and the $6x of FT deemed issued stock deemed transferred to FS is deemed recapitalized into disregarded specified stock actually held by FS, which thereafter is treated as owned by FS for all purposes of the Code, including after the transfer of 60% of the FS stock to USP. Example 12. (i) Facts. The facts are the same as in Example 1 of this paragraph (g). On April 30, 2016, FP, a foreign corporation that is not a foreign related person acquires $15x of FT stock, representing 60% of the total voting power and value of the stock of FT, from FT in a stock issuance, in exchange for $15x of cash. (ii) Results. After the transaction, FT ceases to be a foreign related person. Therefore, under paragraph (d)(2) of this section, immediately before the issuance of FT stock to FP, DT is deemed to transfer the $6x of FT deemed issued stock that it is treated as owning to FA, the specified related person, in redemption of the $6x of DT deemed instruments that FA is treated as owning, and the $6x of FT deemed issued stock deemed transferred to FA is deemed recapitalized into disregarded specified stock actually held by FA, which thereafter is treated as owned by FA for all purposes of the Code. Example 13. (i) Facts. The facts are the same as in Example 1 of this paragraph (g). On April 30, 2016, FS acquires $4x of the FT stock owned by DT in exchange for $4x of cash in a fully taxable transaction. DT recognizes and includes in income all of the gain (including any gain treated as a deemed dividend pursuant to section 1248(a)) with respect to the FT stock transferred to FS. (ii) Results. (A) The transfer of FT stock by DT to FS is a specified transaction, but it is not recharacterized under paragraphs (c)(1) and (3) of this section because the exception in paragraph (b)(2)(ii) of this section applies. See Example 4 of this paragraph (g). (B) After the transfer, FT remains a foreign related person. Therefore, paragraph (d)(2) of this section does not apply. The disregarded specified stock of FT is not, as a result of the transfer, held by a person that is not a foreign related person, a specified related person, or an expatriated entity. Therefore, paragraph (d)(3) of this section does not apply. There has been no direct transfer of specified stock. Therefore, paragraph (d)(4) of this section also does not apply. (C) Under paragraph (d)(1) of this section, the $6x of deemed issued stock treated as owned by DT as a result of the specified transaction in which FA acquired FT stock continues to be treated as owned by DT, and the $6x of deemed instruments treated as issued by DT to FA continue to be treated as owned by FA. (h) Applicability date. Except as otherwise provided in this paragraph (h), this section applies to specified transactions completed on or after September 22, 2014, but only if the inversion transaction was completed on or after September 22, 2014. Paragraph (b)(2)(ii)(A)(2) of this section applies to specified transactions completed on or after November 19, 2015, but only if the inversion transaction was completed on or after September 22, 2014. Paragraphs (d) and (f)(5), (7), and (10) of this section apply to specified transactions completed on or after April 4, 2016, but only if the inversion transaction was foreign corporation referred to in section 7874(a)(2)(B). expanded affiliated group (EAG) that includes such foreign corporation. the ownership percentage determination required by section 7874(a)(2)(B)(ii). fraction that determines such percentage (ownership fraction). acquisition ........................................................ completed on or after September 22, 2014. For inversion transactions completed on or after September 22, 2014, however, taxpayers may elect to apply paragraphs (d) and (f)(5), (7), and (10) of this section to specified transactions completed before April 4, 2016. In addition, for inversion transactions completed on or after September 22, 2014, in lieu of applying paragraphs (d) and (f)(5) and (7) of this section to specified transactions completed on or after September 22, 2014, and before April 4, 2016, taxpayers may elect to apply the principles of § 1.7701(l)–3(c)(3)(iii). Furthermore, for inversion transactions completed on or after September 22, 2014, in lieu of applying paragraph (f)(10) of this section to specified transactions completed on or after September 22, 2014, and before April 4, 2016, taxpayers may elect to define a section 958(a) U.S. shareholder as a United States shareholder with respect to the expatriated foreign subsidiary that owns (within the meaning of section 958(a)) stock in the expatriated foreign subsidiary, but only if such United States shareholder is related (within the meaning of section 267(b) or 707(b)(1)) to the specified related person or is under the same common control (within the meaning of section 482) as the specified related person. § 1.7701(l)–4T (a), first sentence ............................................... (b) ....................................................................... (b) ....................................................................... (c)(1), first sentence ........................................... VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 [Removed] Par. 12. Section 1.7701(l)–4T is removed. ■ Par. 13. Section 1.7874–1 is amended by: ■ 1. Adding a sentence at the end of paragraph (a). ■ 2. Revising paragraph (c)(2)(iii). ■ 2. Redesignating paragraphs (d) through (h) as paragraphs (e) through (i), respectively. ■ 3. Adding a new paragraph (d). ■ 4. Revising newly redesignated paragraphs (g) and (i)(2). ■ 5. For each paragraph listed in the following table, removing the language in the ‘‘Remove’’ column and adding in its place the language in the ‘‘Add’’ column. ■ Remove (a), first sentence ............................................... amozie on DSK3GDR082PROD with RULES2 Paragraph 32543 Add foreign acquiring corporation. expanded affiliated group. determining the ownership percentage described in section 7874(a)(2)(B)(ii). ownership fraction. domestic entity acquisition. E:\FR\FM\12JYR2.SGM 12JYR2 32544 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations Paragraph Remove Add (c)(1), second sentence ..................................... (c)(2), introductory text ....................................... (c)(2)(i) ................................................................ (c)(2)(ii) ............................................................... (c)(2)(ii) ............................................................... (c)(3) ................................................................... (c)(3) ................................................................... § 1.7874–4, see § 1.7874–4(h) ........................ an acquisition ................................................... Before the acquisition ...................................... acquisition ........................................................ acquiring foreign corporation ........................... acquisition results in ........................................ former shareholders or partners of the domestic entity. acquisition ........................................................ (d)(2) ................................................................ other rules, see paragraph (d) of this section. a domestic entity acquisition. Before the domestic entity acquisition. domestic entity acquisition. foreign acquiring corporation. domestic entity acquisition results in. former domestic entity shareholders or former domestic entity partners. domestic entity acquisition. (e)(2). acquisitions ...................................................... an acquisition ................................................... prior acquisitions .............................................. domestic entity acquisitions. a domestic entity acquisition. domestic entity acquisitions completed before May 20, 2008. (f). domestic entity acquisitions. newly redesignated (e)(2) ................................... newly redesignated (h), Example 6 (ii), third sentence. newly redesignated (i)(1), first sentence ............ newly redesignated (i)(1), second sentence ...... newly redesignated (i)(1), fourth sentence ......... newly redesignated (i)(1), fifth sentence ............ newly redesignated (i)(1), last sentence ............ The revisions and additions read as follows: amozie on DSK3GDR082PROD with RULES2 § 1.7874–1 stock. Disregard of affiliate-owned (a) * * * For definitions that apply for purposes of this section, see 1.7874– 12. * * * * * (c) * * * (2) * * * (iii) Special rule. If § 1.7874–6(c)(2) applies for purposes of applying section 7874(c)(2)(A) and this section, then, for purposes of paragraph (c)(2) of this section (and so much of paragraph (c)(1) of this section as relates to paragraph (c)(2) of this section), the determination of the EAG after the domestic entity acquisition, as well as the determination of stock held by one or more members of the EAG after the domestic entity acquisition, is made without regard to one or more transfers (other than by issuance), in a transaction (or series of transactions) after and related to the acquisition, of stock of the acquiring foreign corporation by one or more members of the foreign-parented group described in § 1.7874–6(c)(2)(i). * * * * * (d) Interaction of expanded affiliated group rules with other rules—(1) Exclusion rules. Stock that is excluded from the denominator of the ownership fraction pursuant to § 1.7874–4(b), 1.7874–7(b), 1.7874–8(b), 1.7874–9(b), or section 7874(c)(4) is taken into account for purposes of determining whether an entity is a member of the expanded affiliated group for purposes of applying section 7874(c)(2)(A) and paragraph (b) of this section and determining whether a domestic entity acquisition qualifies as an internal group restructuring or results in a loss of control, as described in paragraphs (c)(2) and (3) of this section, respectively. However, such stock is VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 (e) ..................................................................... acquisitions ...................................................... excluded from the denominator of the ownership fraction regardless of whether it otherwise would be included in the denominator of the ownership fraction as a result of the application of paragraph (c) of this section. See Example 8 and Example 9 of § 1.7874– 4(i) for illustrations of the application of this paragraph (d)(1). (2) NOCD rule. Stock of the foreign acquiring corporation treated as received by former domestic entity shareholders or former domestic entity partners, as applicable, under § 1.7874– 10(b) is not taken into account for purposes of determining whether an entity is a member of the expanded affiliated group for purposes of applying section 7874(c)(2)(A) and paragraph (b) of this section and determining whether a domestic entity acquisition qualifies as an internal group restructuring or results in a loss of control, as described in paragraphs (c)(2) and (3) of this section, respectively. However, such stock is included in the numerator and denominator of the ownership fraction, except to the extent that it is treated as held by a member of the EAG and is excluded from the numerator or both the numerator and the denominator, as applicable, under section 7874(c)(2)(A) or paragraphs (b) or (c) of this section. * * * * * (g) Treatment of transactions related to the acquisition. Except as provided in paragraph (c)(2)(iii) of this section, all transactions that are related to an acquisition are taken into account in applying this section. * * * * * (i) * * * (2) Applicability date of certain provisions of this section. Except as provided in this paragraph (i)(2), paragraph (c)(2)(iii) of this section applies to domestic entity acquisitions completed on or after April 4, 2016. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 Except as provided in this paragraph (i)(2), paragraph (d) of this section (interaction of EAG rules with other rules) applies to domestic entity acquisitions completed on or after July 12, 2018. See §§ 1.7874–4(h) and 1.7874–7T(e), as contained in 26 CFR part 1 revised as of April 1, 2017, for certain coordination rules for domestic entity acquisitions completed before July 12, 2018. Except as provided in this paragraph (i)(2), paragraph (g) of this section applies to domestic entity acquisitions completed on or after September 22, 2014. For domestic entity acquisitions completed before April 4, 2016, however, taxpayers may elect to consistently apply paragraphs (c)(2)(iii) and (g) of this section, and § 1.7874– 6(c)(2), (d)(2), and (f)(2)(ii). In addition, for domestic entity acquisitions completed before July 12, 2018, taxpayers may elect to consistently apply paragraph (d) of this section. § 1.7874–1T [Removed] Par. 14. Section 1.7874–1T is removed. ■ Par. 15. Section 1.7874–2 is amended by: ■ 1. Revising paragraph (a). ■ 2. Removing the language ‘‘§ 1.7874– 12T’’ in paragraph (b) introductory text, and adding the language ‘‘§ 1.7874–12’’ in its place. ■ 3. Revising paragraphs (b)(7) through (13), (c)(2) and (4), (f)(1) introductory text, (f)(1)(iv), Example 21 of paragraph (k)(2), and paragraph (l)(2). The revisions read as follows: ■ § 1.7874–2 Surrogate foreign corporation. (a) Scope. This section provides rules for determining whether a foreign corporation is treated as a surrogate foreign corporation under section 7874(a)(2)(B). Paragraph (b) of this section provides definitions and special rules. Paragraph (c) of this section E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations provides rules to determine whether a foreign corporation has acquired properties held by a domestic corporation (or a partnership). Paragraph (d) of this section provides rules that apply when two or more foreign corporations complete, in the aggregate, a domestic entity acquisition. Paragraph (e) of this section provides rules that apply when, pursuant to a plan, a single foreign corporation completes more than one domestic entity acquisition. Paragraph (f) of this section provides rules to identify the stock of a foreign corporation that is held by reason of holding stock in a domestic corporation (or an interest in a domestic partnership). Paragraph (g) of this section provides rules that treat certain publicly traded foreign partnerships as foreign corporations for purposes of section 7874. Paragraph (h) of this section provides rules concerning the treatment of certain options (or similar interests) for purposes of section 7874. Paragraph (i) of this section provides rules that treat certain interests (including debt, stock, or a partnership interest) as stock of a foreign corporation for purposes of section 7874. Paragraph (j) of this section provides rules concerning the conversion of a foreign corporation to a domestic corporation by reason of section 7874(b). Paragraph (k) of this section provides examples that illustrate the rules of this section. Paragraph (l) of this section provides the applicability dates of this section. For additional definitions that apply for purposes of this section, see § 1.7874–12. (b) * * * (7) A former initial acquiring corporation shareholder of an initial acquiring corporation means any person that held stock in the initial acquiring corporation before the subsequent acquisition, including any person that holds stock in the initial acquiring corporation both before and after the subsequent acquisition. (8) An initial acquisition means, with respect to a subsequent acquisition, a domestic entity acquisition occurring, pursuant to a plan that includes the subsequent acquisition (or a series of related transactions), before the subsequent acquisition. (9) An initial acquiring corporation means, with respect to an initial acquisition, the foreign acquiring corporation. (10) A subsequent acquisition means, with respect to an initial acquisition, a transaction occurring, pursuant to a plan that includes the initial acquisition (or a series of related transactions), after the initial acquisition in which a foreign corporation directly or indirectly VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 acquires (within the meaning of paragraph (c)(4)(ii) of this section) substantially all of the properties held directly or indirectly by the initial acquiring corporation. (11) A subsequent acquiring corporation means, with respect to a subsequent acquisition, the foreign corporation that directly or indirectly acquires substantially all of the properties held directly or indirectly by the initial acquiring corporation. (12) Special rule regarding initial acquisitions. With respect to an initial acquisition, the determination of the ownership percentage described in section 7874(a)(2)(B)(ii) is made without regard to the subsequent acquisition and all related transactions occurring after the subsequent acquisition. (13) Special rule regarding subsequent acquisitions. With respect to a subsequent acquisition (or a similar acquisition under the principles of paragraph (c)(4)(i) of this section) that is an inversion transaction, the applicable period begins on the first date that properties are acquired as part of the initial acquisition. (c) * * * (2) Acquisition of stock of a foreign corporation. Except as provided in paragraph (c)(4) of this section, an acquisition of stock of a foreign corporation that owns directly or indirectly stock of a domestic corporation (or an interest in a partnership) shall not constitute an indirect acquisition of any properties held by the domestic corporation (or the partnership). See Example 4 of paragraph (k) of this section for an illustration of the rules of this paragraph (c)(2). * * * * * (4) Multiple-step acquisitions—(i) Rule. A subsequent acquisition is treated as a domestic entity acquisition, and the subsequent acquiring corporation is treated as a foreign acquiring corporation. See Example 21 of paragraph (k) of this section for an illustration of this rule. See also paragraph (f)(1)(iv) of this section (treating certain stock of the subsequent acquiring corporation as stock of a foreign corporation that is held by reason of holding stock of, or a partnership interest in, the domestic entity). (ii) Acquisition of property pursuant to a subsequent acquisition. In determining whether a foreign corporation directly or indirectly acquires substantially all of the properties held directly or indirectly by an initial acquiring corporation, the principles of section 7874(a)(2)(B)(i) PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 32545 apply, including paragraph (c) of this section other than paragraph (c)(2) of this section. For this purpose, the principles of paragraph (c)(1) of this section, including paragraph (b)(5) of this section, apply by substituting the term ‘‘foreign’’ for ‘‘domestic’’ wherever it appears. (iii) Additional related transactions. If, pursuant to the same plan (or a series of related transactions), a foreign corporation directly or indirectly acquires (under the principles of paragraph (c)(4)(ii) of this section) substantially all of the properties directly or indirectly held by a subsequent acquiring corporation in a transaction occurring after the subsequent acquisition, then the principles of paragraph (c)(4)(i) of this section apply to such transaction (and any subsequent transaction or transactions occurring pursuant to the plan (or the series of related transactions)). * * * * * (f) * * * (1) Certain transactions. For purposes of section 7874(a)(2)(B)(ii), stock of a foreign corporation that is held by reason of holding stock in a domestic corporation (or an interest in a domestic partnership) includes, but is not limited to, the stock described in paragraphs (f)(1)(i) through (iv) of this section. * * * * * (iv) Stock of a subsequent acquiring corporation received by a former initial acquiring corporation shareholder pursuant to a subsequent acquisition in exchange for, or with respect to, stock of an initial acquiring corporation that is held by reason of holding stock of, or a partnership interest in, a domestic entity. * * * * * (k) * * * (2) * * * Example 21. Application of multiple-step acquisition rule—(i) Facts. Individual A owns all 70 shares of stock of DC1, a domestic corporation. Individual B owns all 30 shares of stock of F1, a foreign corporation that is a tax resident (as described in § 1.7874–3(d)(11)) of Country X. Pursuant to a reorganization described in section 368(a)(1)(D), DC1 transfers all of its properties to F1 solely in exchange for 70 newly issued voting shares of F1 stock (DC1 acquisition) and distributes the F1 stock to Individual A in liquidation pursuant to section 361(c)(1). Pursuant to a plan that includes the DC1 acquisition, F2, a newly formed foreign corporation that is also a tax resident of Country X, acquires 100 percent of the stock of F1 solely in exchange for 100 newly issued shares of F2 stock (F1 acquisition). After the F1 acquisition, Individual A owns 70 shares of F2 stock, Individual B owns 30 shares of F2 stock, F2 E:\FR\FM\12JYR2.SGM 12JYR2 32546 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations owns all 100 shares of F1 stock, and F1 owns all the properties held by DC1 immediately before the DC1 acquisition. In addition, the form of the transaction is respected for U.S. federal income tax purposes. (ii) Analysis—(A) The DC1 acquisition is a domestic entity acquisition, and F1 is a foreign acquiring corporation, because F1 directly acquires 100 percent of the properties of DC1. In addition, the 70 shares of F1 stock received by A pursuant to the DC1 acquisition in exchange for Individual A’s DC1 stock are stock of a foreign corporation that is held by reason of holding stock in DC1. As a result, those 70 shares are included in both the numerator and the denominator of the ownership fraction when applying section 7874 to the DC1 acquisition. (B) The DC1 acquisition is also an initial acquisition because it is a domestic entity acquisition that, pursuant to a plan that includes the F1 acquisition, occurs before the F1 acquisition (which, as described in paragraph (ii)(C) of this Example 21, is a subsequent acquisition). Thus, F1 is the initial acquiring corporation. (C) The F1 acquisition is a subsequent acquisition because it occurs, pursuant to a plan that includes the DC1 acquisition, after the DC1 acquisition and, pursuant to the F1 acquisition, F2 acquires 100 percent of the stock of F1 and therefore is treated under paragraph (c)(4)(ii) of this section (which applies the principles of section 7874(a)(2)(B)(i) with certain modifications) as indirectly acquiring substantially all of the properties held directly or indirectly by F1. Thus, F2 is the subsequent acquiring corporation. (D) Under paragraph (c)(4)(i) of this section, the F1 acquisition is treated as a domestic entity acquisition, and F2 is treated as a foreign acquiring corporation. In addition, under paragraph (f)(1)(iv) of this section, the 70 shares of F2 stock received by Individual A (a former initial acquiring corporation shareholder) pursuant to the F1 acquisition in exchange for Individual A’s F1 stock are stock of a foreign corporation that is held by reason of holding stock in DC1. As a result, those 70 shares are included in both the numerator and the denominator of the ownership fraction when applying section 7874 to the F1 acquisition. (l) * * * (2) Applicability date of certain provisions of this section. Paragraphs (a), (b)(7) through (13), (c)(2) and (4), and (f)(1)(iv) of this section, as well as the introductory text of paragraph (f)(1) Paragraph after an acquisition described in section 7874(a)(2)(B)(i). acquisition described in section 7874(a)(2)(B)(i). acquisition date ................................................ acquisition date ................................................ acquisition date ................................................ (c)(1)(iii) .............................................................. newly redesignated (d)(1)(i) ............................... newly redesignated (d)(1)(ii) ............................... newly redesignated (d)(3), first, second, third, and fifth sentences. newly redesignated (d)(9) ................................... (f)(1) .................................................................... The revisions and addition read as follows: § 1.7874–3 Substantial business activities. * amozie on DSK3GDR082PROD with RULES2 § 1.7874–2T [Removed] Par. 16. Section 1.7874–2T is removed. ■ Par. 17. Section 1.7874–3 is amended by: ■ 1. Revising paragraph (b)(4). ■ 2. Revising the introductory text of paragraph (d). ■ 3. Removing paragraphs (d)(1) and (d)(4). ■ 4. Redesignating paragraphs (d)(2), (d)(3), (d)(5) through (12), and (d)(13) as paragraphs (d)(1), (d)(2), (d)(3) through (10), and (d)(12), respectively. ■ 5. Revising newly redesignated paragraph (d)(8). ■ 6. Adding paragraph (d)(11). ■ 7. Revising paragraph (f)(2). ■ 8. For each paragraph listed in the following table, removing the language in the ‘‘Remove’’ column and adding in its place the language in the ‘‘Add’’ column. ■ Remove (b), introductory text ........................................... and Example 21 of paragraph (k)(2), apply to domestic entity acquisitions completed on or after April 4, 2016. * * * * (b) * * * (4) Tax residence of foreign acquiring corporation. The foreign acquiring corporation is a tax resident of the relevant foreign country. However, this paragraph (b)(4) does not apply if the relevant foreign country does not impose corporate income tax. * * * * * (d) Definitions and special rules. In addition to the definitions in § 1.7874– 12, the following definitions and special rules apply for purposes of this section. * * * * * (8) The term relevant financial statements means financial statements prepared consistently for all members of the expanded affiliated group in accordance with either U.S. Generally Accepted Accounting Principles (U.S. GAAP) or the International Financial VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 Add foreign corporation described in section 7874(a)(2)(B). acquisitions ...................................................... Reporting Standards (IFRS) used for the expanded affiliated group’s consolidated financial statements, but, if, after the domestic entity acquisition, financial statements will not be prepared consistently for all members of the expanded affiliated group in accordance with either U.S. GAAP or IFRS, then, for each member, financial statements prepared in accordance with either U.S. GAAP or IFRS. The relevant financial statements must take into account all items of income generated by all members of the expanded affiliated group for the entire testing period. * * * * * (11) The term tax resident means, with respect to a foreign country, a body corporate liable to tax under the laws of the country as a resident. * * * * * (f) * * * (2) Paragraphs (b)(4), (d)(8), and (d)(11) of this section. The first sentence PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 on the completion date. domestic entity acquisition. completion date. completion date. completion date. foreign acquiring corporation. domestic entity acquisitions. of paragraph (b)(4) of this section applies to domestic entity acquisitions completed on or after November 19, 2015, and the second sentence applies to domestic entity acquisitions completed on or after July 12, 2018. Paragraph (d)(8) of this section applies to domestic entity acquisitions completed on or after April 4, 2016. Paragraph (d)(11) of this section applies to domestic entity acquisitions completed on or after July 12, 2018. For domestic entity acquisitions completed on or after June 3, 2015, and before April 4, 2016, however, taxpayers may elect to apply paragraph (d)(8) of this section. For domestic entity acquisitions completed on or after November 19, 2015, and before July 12, 2018, taxpayers may elect to apply the second sentence of paragraph (b)(4) and paragraph (d)(11) of this section. § 1.7874–3T [Removed] Par. 18. Section 1.7874–3T is removed. ■ E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations Par. 19. Section 1.7874–4 is amended by: ■ 1. Revising the seventh sentence of paragraph (a), and adding a sentence at the end of paragraph (a). ■ 2. Revising paragraph (d)(1)(ii). ■ 3. Removing paragraph (h). ■ 4. Redesignating paragraphs (i), (j), and (k) as paragraphs (h), (i), and (j), respectively. ■ 5. In newly redesignated paragraph (j)(1), removing the language ‘‘(d)(1)(ii),’’ from the fourth and seventh sentences ■ 32547 and adding two sentences at the end of the paragraph. ■ 6. For each paragraph listed in the following table, removing the language in the ‘‘Remove’’ column and adding in its place the language in the ‘‘Add’’ column. amozie on DSK3GDR082PROD with RULES2 Paragraph Remove (a), eighth sentence ........................................... (a), ninth sentence ............................................. (a), tenth sentence ............................................. (c)(1)(i), second sentence .................................. (c)(1)(ii)(A), last sentence ................................... (c)(2), last sentence ........................................... (d)(1)(i) ................................................................ (d)(1)(ii), last sentence ....................................... newly redesignated (h), introductory text ........... newly redesignated (h)(1), last sentence ........... newly redesignated (h)(1), last sentence ........... newly redesignated (h)(2), introductory text, first sentence. newly redesignated (h)(2), introductory text, second sentence. newly redesignated (h)(2)(ii) ............................... newly redesignated (h)(2)(iii)(A), last sentence newly redesignated (h)(2)(iii)(A), last sentence newly redesignated (h)(2)(iii)(C)(2) .................... newly redesignated (h)(2)(iv), first sentence ...... newly redesignated (h)(2)(iv), last sentence ...... newly redesignated (h)(2)(iv), last sentence ...... newly redesignated (i)(10) .................................. newly redesignated (i)(11) .................................. newly redesignated (i), Example 1 (i), second sentence. newly redesignated (i), Example 1 (ii), first sentence. newly redesignated (i), Example 2 (i), second sentence. newly redesignated (i), Example 2 (ii), first and fifth sentences. newly redesignated (i), Example 3 (i), last sentence. newly redesignated (i), Example 3 (ii), first and fifth sentences. newly redesignated (i), Example 4 (ii), first sentence. newly redesignated (i), Example 4 (ii), first sentence. newly redesignated (i), Example 4 (iii), sixth sentence. newly redesignated (i), Example 5 (ii), first sentence. newly redesignated (i), Example 5 (ii), fourth sentence. newly redesignated (i), Example 6 (ii), first sentence. newly redesignated (i), Example 7 (ii), first sentence. newly redesignated (i), Example 8 (ii), first sentence. newly redesignated (i), Example 8 (ii), fifth sentence. newly redesignated (i), Example 9 (i), last sentence. newly redesignated (i), Example 9 (ii), first sentence. newly redesignated (i), Example 9 (ii), fifth sentence. newly redesignated (i), Example 9 (ii), penultimate sentence. newly redesignated (i), Example 9 (iii), first sentence. (i) ...................................................................... (j) ...................................................................... (k) ..................................................................... (j) ...................................................................... (j) ...................................................................... (j) ...................................................................... §§ 1.7874–7T(b) and 1.7874–10T(b) ............... (j) ...................................................................... § 1.7874–12T ................................................... (j) ...................................................................... (i)(1) .................................................................. (i)(2)(i) .............................................................. (h). (i). (j). (i). (i). (i). §§ 1.7874–7(b) and 1.7874–10(b). (i). § 1.7874–12. (i). (h)(1). (h)(2)(i). (i)(2)(ii) .............................................................. (h)(2)(ii). (i)(1) .................................................................. (j) ...................................................................... (i)(2)(iii)(A) ........................................................ (i)(2)(iii)(B) ........................................................ (i)(2)(i) .............................................................. (j) ...................................................................... (i)(2)(iv) ............................................................. § 1.7874–7T(b) ................................................. § 1.7874–10T(b) ............................................... (i)(1) .................................................................. (h)(1). (i). (h)(2)(iii)(A). (h)(2)(iii)(B). (h)(2)(i). (i). (h)(2)(iv). § 1.7874–7(b). § 1.7874–10(b). (h)(1). (i)(2)(ii) .............................................................. (h)(2)(ii). (i)(1) .................................................................. (h)(1). (i)(2)(iv) ............................................................. (h)(2)(iv). (i)(2)(i) .............................................................. (h)(2)(i). (i)(2)(iv) ............................................................. (h)(2)(iv). (i)(1) .................................................................. (h)(1). (i)(2)(ii) .............................................................. (h)(2)(ii). (i)(2)(ii) .............................................................. (h)(2)(ii). (i)(2)(i) .............................................................. (h)(2)(i). §§ 1.7874–7T(b) and 1.7874–10T(b) ............... §§ 1.7874–7(b) and 1.7874–10(b). (i)(2)(iii)(A) ........................................................ (h)(2)(iii)(A). (i)(2)(i) .............................................................. (h)(2)(i). (i)(2)(i) .............................................................. (h)(2)(i). paragraph (h) of this section ............................ § 1.7874–1(d)(1). (i)(1) .................................................................. (h)(1). (i)(2)(ii) .............................................................. (h)(2)(ii). paragraph (h) of this section ............................ § 1.7874–1(d)(1). paragraphs (b) and (h) of this section ............. paragraph (b) of this section and § 1.7874– 1(d)(1). (h)(1). VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 Add (i)(1) .................................................................. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 E:\FR\FM\12JYR2.SGM 12JYR2 32548 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations Paragraph Remove newly redesignated (i), Example 9 (iii), first sentence. newly redesignated (i), Example 9 (iii), fifth sentence. newly redesignated (i), Example 9 (iii), tenth sentence. newly redesignated (j)(1), first sentence ............ newly redesignated (j)(1), second sentence ...... newly redesignated (j)(1), fourth sentence ......... newly redesignated (j)(1), fifth sentence ............ newly redesignated (j)(1), last sentence ............ newly redesignated (j)(1), last sentence ............ newly redesignated (j)(2), introductory text ........ newly redesignated (j)(2)(i) ................................. newly redesignated (j)(2)(iv) ............................... (i)(2) .................................................................. (h)(2). paragraph (h) of this section ............................ § 1.7874–1(d)(1). paragraphs (b) and (h) of this section ............. (k) ..................................................................... (i)(1) and (i)(2)(iv) ............................................. (i)(2)(iii), and (i)(3) ............................................ (i)(1) and (i)(2)(iv) ............................................. (i)(2)(iii) ............................................................. (i)(3) .................................................................. (k)(3) ................................................................. (i)(2)(iii) ............................................................. paragraphs (d) and (h) of this section ............. newly redesignated (j)(3), first sentence ............ (k)(1) ................................................................. paragraph (b) of this section and § 1.7874– 1(d)(1). (j). (h)(1) and (h)(2)(iv). (h)(2)(iii), and (h)(3). (h)(1) and (h)(2)(iv). (h)(2)(iii). (h)(3). (j)(3). (h)(2)(iii). Paragraph (d) of this section and § 1.7874– 1(d)(1). (j)(1). The revisions and addition read as follows: § 1.7874–4 Disregard of certain stock related to the domestic entity acquisition. (a) * * * Paragraph (g) of this section provides rules for the treatment of partnerships, and paragraph (h) of this section provides definitions. * * * See § 1.7874–1(d)(1) for rules addressing the interaction of this section with the expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1. * * * * * (d) * * * (1) * * * (ii) On the completion date, each five percent former domestic entity shareholder or five percent former domestic entity partner, as applicable, owns (applying the attribution rules of Add section 318(a) with the modifications described in section 304(c)(3)(B)) less than five percent (by vote and value) of the stock of (or a partnership interest in) each member of the expanded affiliated group. For this purpose, a five percent former domestic entity shareholder (or five percent former domestic entity partner) is a former domestic entity shareholder (or former domestic entity partner) that, before the domestic entity acquisition, owned (applying the attribution rules of section 318(a) with the modifications described in section 304(c)(3)(B)) at least five percent (by vote and value) of the stock of (or a partnership interest in) the domestic entity. See Example 5 of this paragraph (i) for an illustration of this paragraph (d). * * * * * Paragraph § 1.7874–6T ..................................................... § 1.7874–12T ................................................... Par. 21. Section 1.7874–6 is added to read as follows: ■ § 1.7874–6 Stock transferred by members of the EAG. amozie on DSK3GDR082PROD with RULES2 § 1.7874–5 [Amended] Par. 20. For each paragraph listed in the following table, removing the language in the ‘‘Remove’’ column and adding in its place the language in the ‘‘Add’’ column. ■ Remove (c) ....................................................................... (d) ....................................................................... (j) * * * (1) * * * Paragraph (d)(1)(ii) of this section applies to domestic entity acquisitions completed on or after July 12, 2018, though taxpayers may elect to consistently apply paragraph (d)(1)(ii) of this section to domestic entity acquisitions completed before July 12, 2018. For domestic entity acquisitions completed before July 12, 2018, see § 1.7874–4(d)(1)(ii) as contained in 26 CFR part 1 revised as of April 1, 2017. * * * * * (a) Scope. This section provides rules regarding whether transferred stock is treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1. Paragraph (b) of this section sets forth the general rule under which transferred stock is not treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1. Paragraph (c) of this section provides exceptions to the general rule. Paragraph (d) of this section provides rules regarding the treatment of partnerships, and paragraph (e) of this section provides rules regarding transactions related to VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 Add the acquisition. Paragraph (f) of this section provides definitions. Paragraph (g) of this section provides examples illustrating the application of the rules of this section. Paragraph (h) of this section provides dates of applicability. (b) General rule. Except as provided in paragraph (c) of this section, transferred stock is not treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1. Transferred stock that is not treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1 is included in the numerator and the denominator of the ownership fraction. See § 1.7874– 5(a). (c) Exceptions. Transferred stock is treated as held by members of the EAG for purposes of applying section PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 § 1.7874–6. § 1.7874–12. 7874(c)(2)(A) and § 1.7874–1 if paragraph (c)(1) or (2) of this section applies. Transferred stock that is treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1 is excluded from the numerator of the ownership fraction and, depending upon the application of § 1.7874–1(c), may be excluded from the denominator of the ownership fraction. See § 1.7874– 1(b) and (c). (1) Transfers involving a U.S.parented group. This paragraph (c)(1) applies if the following conditions are satisfied: (i) Before the domestic entity acquisition, the transferring corporation is a member of a U.S.-parented group. (ii) After the domestic entity acquisition, each of the transferring E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations corporation (or its successor), any person that holds transferred stock, and the foreign acquiring corporation are members of a U.S.-parented group the common parent of which— (A) Before the domestic entity acquisition, was a member of the U.S.parented group described in paragraph (c)(1)(i) of this section; or (B) Is a corporation that was formed in a transaction related to the domestic entity acquisition, provided that, immediately after the corporation was formed (and without regard to any related transactions), the corporation was a member of the U.S.-parented group described in paragraph (c)(1)(i) of this section. (2) Transfers involving a foreignparented group. This paragraph (c)(2) applies if the following conditions are satisfied: (i) Before the domestic entity acquisition, the transferring corporation and the domestic entity are members of the same foreign-parented group. (ii) After the domestic entity acquisition, the transferring corporation— (A) Is a member of the EAG; or (B) Would be a member of the EAG absent one or more transfers (other than by issuance), in a transaction (or series of transactions) after and related to the domestic entity acquisition, of stock of the foreign acquiring corporation by one or more members of the foreignparented group described in paragraph (c)(2)(i) of this section. (d) Treatment of partnerships—(1) Stock held by a partnership. For purposes of this section, each partner in a partnership, as determined without regard to the application of paragraph (d)(2) of this section, is treated as holding its proportionate share of the stock held by the partnership, as determined under the rules and principles of sections 701 through 777. (2) Partnership treated as corporation. For purposes of this section, if one or more members of an affiliated group, as determined after the application of paragraph (d)(1) of this section, own, in the aggregate, more than 50 percent (by value) of the interests in a partnership, the partnership will be treated as a corporation that is a member of the affiliated group. (e) Treatment of transactions related to the acquisition. Except as provided in paragraphs (c)(1)(ii)(B) and (c)(2)(ii)(B) of this section, all transactions that are related to a domestic entity acquisition are taken into account in applying this section. (f) Definitions. In addition to the definitions provided in § 1.7874–12, the VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 following definitions apply for purposes of this section. (1) A foreign-parented group means an affiliated group that has a foreign corporation as the common parent corporation. A member of the foreignparented group is an entity included in the foreign-parented group. (2) Transferred stock—(i) In general. Transferred stock means stock of the foreign acquiring corporation described in section 7874(a)(2)(B)(ii) that is received by a transferring corporation and, in a transaction (or series of transactions) related to the domestic entity acquisition, is subsequently transferred. (ii) Special rule. This paragraph (f)(2)(ii) applies in certain cases in which a transferring corporation receives stock of the foreign acquiring corporation described in section 7874(a)(2)(B)(ii) that has the same terms as other stock of the foreign acquiring corporation that is received by the transferring corporation in a transaction (or series of transactions) related to the domestic entity acquisition or that is owned by the transferring corporation prior to the domestic entity acquisition (the stock described in this sentence, collectively, fungible stock). Pursuant to this paragraph (f)(2)(ii), if, in a transaction (or series of transactions) related to the domestic entity acquisition, the transferring corporation subsequently transfers less than all of the fungible stock, a pro rata portion of the stock subsequently transferred is treated as consisting of stock of the foreign acquiring corporation described in section 7874(a)(2)(B)(ii). The pro rata portion is based, at the time of the subsequent transfer, on the relative fair market value of the fungible stock that is stock of the foreign acquiring corporation described in section 7874(a)(2)(B)(ii) to the fair market value of all the fungible stock. (3) A transferring corporation means a corporation that is a former domestic entity shareholder or former domestic entity partner. (4) A U.S.-parented group means an affiliated group that has a domestic corporation as the common parent corporation. A member of the U.S.parented group is an entity included in the U.S.-parented group, including the common parent corporation. (g) Examples. The following examples illustrate the application of this section. Example 1. U.S.-parented group exception not available—(i) Facts. USP, a domestic corporation wholly owned by Individual A, owns all the stock of DT, a domestic corporation, as well as other property. The DT stock does not represent substantially all of the property of USP for purposes of section PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 32549 7874. Pursuant to a reorganization described in section 368(a)(1)(D), USP transfers all the DT stock to FA, a newly formed foreign corporation, in exchange for 100 shares of FA stock (DT acquisition) and distributes the FA stock to Individual A pursuant to section 361(c)(1). (ii) Analysis. The 100 FA shares received by USP are stock of a foreign acquiring corporation described in section 7874(a)(2)(B)(ii) and, under § 1.7874–5(a), the shares retain their status as such even though USP subsequently distributes the shares to Individual A pursuant to section 361(c)(1). Thus, the 100 FA shares are included in the ownership fraction, unless the shares are treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1 and are excluded from the ownership fraction under those rules. For purposes of applying section 7874(c)(2)(A) and § 1.7874–1, the 100 FA shares, which constitute transferred stock under paragraph (f)(2) of this section, are treated as held by members of the EAG only if an exception in paragraph (c) of this section applies. See paragraph (b) of this section. The U.S.parented group exception described in paragraph (c)(1) of this section does not apply. Although before the DT acquisition, USP (the transferring corporation) is a member of a U.S.-parented group of which USP is the common parent, after the DT acquisition, and taking into account all transactions related to the acquisition, each of USP, Individual A (the person that holds the transferred stock), and FA (the foreign acquiring corporation) are not members of a U.S.-parented group described in paragraph (c)(1)(ii)(A) or (B) of this section. Accordingly, because the 100 FA shares are not treated as held by members of the EAG, those shares are included in the numerator and the denominator of the ownership fraction. Therefore, the ownership fraction is 100/100. Example 2. U.S.-parented group exception available—(i) Facts. USP, a domestic corporation wholly owned by Individual A, owns all the stock of USS, a domestic corporation, and USS owns all the stock of FT, a foreign corporation. FT owns all the stock of DT, a domestic corporation. FT does not own any other property and has no liabilities. Pursuant to a reorganization described in section 368(a)(1)(F), FT transfers all of its DT stock to FA, a newly formed foreign corporation, in exchange for 100 shares of FA stock (DT acquisition) and distributes the FA stock to USS in liquidation pursuant to section 361(c)(1). In a transaction after and related to the DT acquisition, USP sells 60 percent of the stock of USS (by vote and value) to Individual B. (ii) Analysis. The 100 FA shares received by FT are stock of a foreign acquiring corporation described in section 7874(a)(2)(B)(ii) and, under § 1.7874–5(a), the shares retain their status as such even though FT subsequently distributes the shares to USS pursuant to section 361(c)(1). Thus, the 100 FA shares are included in the ownership fraction, unless the shares are treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874– 1 and are excluded from the ownership E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32550 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations fraction under those rules. For purposes of applying section 7874(c)(2)(A) and § 1.7874– 1, the 100 FA shares, which constitute transferred stock under paragraph (f)(2) of this section, are treated as held by members of the EAG only if an exception in paragraph (c) of this section applies. See paragraph (b) of this section. The U.S.-parented group exception described in paragraph (c)(1) of this section applies. The requirement set forth in paragraph (c)(1)(i) of this section is satisfied because before the DT acquisition, FT (the transferring corporation) is a member of a U.S.-parented group of which USP is the common parent (the USP group). The requirement set forth in paragraph (c)(1)(ii) of this section is satisfied because after the DT acquisition, and taking into account all transactions related to the acquisition, each of FA (which is both the successor to FT, the transferring corporation, and the foreign acquiring corporation) and USS (the person that holds the transferred stock) are members of a U.S.-parented group of which USS (a member of the USP group before the DT acquisition) is the common parent. Moreover, the DT acquisition qualifies as an internal group restructuring under § 1.7874–1(c)(2). The requirement set forth in § 1.7874– 1(c)(2)(i) is satisfied because before the DT acquisition, 80 percent or more of the stock (by vote and value) of DT was held directly or indirectly by USS (the corporation that after the acquisition, and taking into account all transactions related to the acquisition, is the common parent of the EAG). The requirement set forth in § 1.7874–1(c)(2)(ii) is satisfied because after the acquisition, and taking into account all transactions related to the acquisition, 80 percent or more of the stock (by vote and value) of FA (the foreign acquiring corporation) is held directly or indirectly by USS. Therefore, the 100 FA shares are excluded from the numerator, but included in the denominator, of the ownership fraction. Accordingly, the ownership fraction is 0/100. Example 3. U.S.-parented group exception available—(i) Facts. USP, a domestic corporation wholly owned by Individual A, owns all the stock of USS, a domestic corporation, and USS owns all the stock of DT, also a domestic corporation. DT owns all the stock of FT, a foreign corporation. The FT stock represents substantially all of the property of DT for purposes of section 7874. Pursuant to a reorganization described in section 368(a)(1)(D), DT transfers all the FT stock to FA, a newly formed foreign corporation, in exchange for 100 shares of FA stock (DT acquisition) and distributes the FA stock to USS pursuant to section 361(c)(1). In a related transaction, USS distributes all the FA stock to USP under section 355(c)(1). Lastly, in another related transaction and pursuant to a divisive reorganization described in section 368(a)(1)(D), USP transfers all the stock of USS and FA to DP, a newly formed domestic corporation, in exchange for all the stock of DP and distributes the DP stock to Individual A pursuant to section 361(c)(1). (ii) Analysis. The 100 FA shares received by USS are stock of a foreign acquiring corporation described in section 7874(a)(2)(B)(ii) and, under § 1.7874–5(a), the VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 shares retain their status as such even though USS subsequently transfers the shares to USP. Thus, the 100 FA shares are included in the ownership fraction, unless the shares are treated as held by members of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1 and are excluded from the ownership fraction under those rules. For purposes of applying section 7874(c)(2)(A) and § 1.7874–1, the 100 FA shares, which constitute transferred stock under paragraph (f)(2) of this section, are treated as held by members of the EAG only if an exception in paragraph (c) of this section applies. See paragraph (b) of this section. The U.S.-parented group exception described in paragraph (c)(1) of this section applies. The requirement set forth in paragraph (c)(1)(i) of this section is satisfied because before the DT acquisition, USS (the transferring corporation) is a member of a U.S.-parented group of which USP is the common parent (the USP group). The requirement set forth in paragraph (c)(1)(ii) of this section is satisfied because after the DT acquisition, and taking into account all transactions related to the acquisition, each of USS, DP (the person that holds the transferred stock), and FA (the foreign acquiring corporation) are members of a U.S.parented group of which DP (a corporation that was formed in a transaction related to the DT acquisition and that, immediately after it was formed (but without regard to any related transactions) was a member of the USP group) is the common parent. Therefore, the 100 FA shares are excluded from the numerator and the denominator of the ownership fraction. Accordingly, the ownership fraction is 0/0. Example 4. Foreign-parented group exception—(i) Facts. Individual A owns all the stock of FT, a foreign corporation, and FT owns all the stock of DT, a domestic corporation. FT does not own any other property and has no liabilities. Pursuant to a reorganization described in section 368(a)(1)(F), FT transfers all the stock of DT to FA, a newly formed foreign corporation, in exchange for 100 shares of FA stock (DT acquisition) and distributes the FA stock to Individual A in liquidation pursuant to section 361(c)(1). (ii) Analysis. The 100 FA shares received by FT are stock of a foreign acquiring corporation described in section 7874(a)(2)(B)(ii) and, under § 1.7874–5(a), the shares retain their status as such even though FT subsequently distributes the shares to Individual A pursuant to section 361(c)(1). Thus, the 100 FA shares are included in the ownership fraction, unless the shares are treated as held by members of the EAG of purposes of applying section 7874(a)(2)(A) and § 1.7874–1 and are excluded from the ownership fraction under those rules. For purposes of applying section 7874(c)(2)(A) and § 1.7874–1, the 100 FA shares, which constitute transferred stock under paragraph (f)(2) of this section, are treated as held by members of the EAG only if an exception in paragraph (c) of this section applies. See paragraph (b) of this section. The foreignparented group exception described in paragraph (c)(2) of this section applies. The requirement set forth in paragraph (c)(2)(i) of PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 this section is satisfied because before the DT acquisition, FT (the transferring corporation) and DT are members of the foreign-parented group of which FT is the common parent. The requirement set forth in paragraph (c)(2)(ii) of this section is satisfied because after the acquisition, and taking into account all transactions related to the acquisition, FT would be a member of the EAG absent the distribution of the FA shares pursuant to section 361(c)(1). Moreover, the DT acquisition qualifies as an internal group restructuring under § 1.7874–1(c)(2). The requirement set forth in § 1.7874–1(c)(2)(i) is satisfied because before the acquisition, 80 percent or more of the stock (by vote and value) of DT was held directly or indirectly by FT, the corporation that, without regard to the distribution of the FA shares pursuant to section 361(c)(1), would be common parent of the EAG after the acquisition. See § 1.7874–1(c)(2)(iii). The requirement set forth in § 1.7874–1(c)(2)(ii) is satisfied because after the acquisition, but without regard to the distribution of the FA shares pursuant to the section 361(c)(1) distribution, FT would directly or indirectly hold 80 percent or more of the stock (by vote and value) of FA (the foreign acquiring corporation). See § 1.7874–1(c)(2)(iii). Therefore, the 100 FA shares are excluded from the numerator, but included in the denominator, of the ownership fraction. Accordingly, the ownership fraction is 0/100. (iii) Alternative facts. The facts are the same as in paragraph (i) of this Example 4, except that in a transaction after and related to the DT acquisition, FA issues 200 shares of FA stock to Individual B in exchange for qualified property (within the meaning of § 1.7874–4(h)(2)). The foreign-parented group exception does not apply because after the acquisition, and taking into account FA’s issuance of the 200 FA shares to Individual B, FT would not be a member of the EAG absent FT’s distribution of the 100 FA shares pursuant to section 361(c)(1). Accordingly, the 100 FA shares received by FT are not treated as held by a member of the EAG for purposes of applying section 7874(c)(2)(A) and § 1.7874–1. As a result, the ownership fraction is 100/300. (h) Applicability dates. Except as otherwise provided in this paragraph (h), this section applies to domestic entity acquisitions completed on or after September 22, 2014. Paragraphs (d)(2) and (f)(2)(ii) of this section apply to domestic entity acquisitions completed on or after April 4, 2016. Taxpayers, however, may elect either to apply paragraph (c)(2) of this section to domestic entity acquisitions completed before September 22, 2014, or to consistently apply paragraphs (c)(2), (d)(2), and (f)(2)(ii) of this section and § 1.7874–1(c)(2)(iii) and (g) to domestic entity acquisitions completed before April 4, 2016. § 1.7874–6T [Removed] Par. 22. Section 1.7874–6T is removed. ■ E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations Par. 23. Section 1.7874–7 is added to read as follows: ■ amozie on DSK3GDR082PROD with RULES2 § 1.7874–7 Disregard of certain stock attributable to passive assets. (a) Scope. This section identifies certain stock of a foreign acquiring corporation that is attributable to passive assets and that is disregarded in determining the ownership fraction by value. Paragraph (b) of this section sets forth the general rule regarding when stock of a foreign acquiring corporation is excluded from the denominator of the ownership fraction under this section. Paragraph (c) of this section provides a de minimis exception to the application of the general rule of paragraph (b) of this section. Paragraph (d) of this section provides rules for the treatment of partnerships, and paragraph (e) of this section provides definitions. Paragraph (f) of this section provides examples illustrating the application of the rules of this section. Paragraph (g) of this section provides dates of applicability. The rules provided in this section are also subject to section 7874(c)(4). See § 1.7874–1(d)(1) for rules addressing the interaction of this section with the expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1. (b) General rule. If, on the completion date, more than fifty percent of the gross value of all foreign group property constitutes foreign group nonqualified property, then, for purposes of determining the ownership percentage by value (but not vote) described in section 7874(a)(2)(B)(ii), stock of the foreign acquiring corporation is excluded from the denominator of the ownership fraction in an amount equal to the product of— (1) The value of the stock of the foreign acquiring corporation, other than stock that is described in section 7874(a)(2)(B)(ii) and stock that is excluded from the denominator of the ownership fraction under § 1.7874–1(b), § 1.7874–4(b), § 1.7874–8(b), § 1.7874– 9(b), or section § 7874(c)(4); and (2) The foreign group nonqualified property fraction. (c) De minimis ownership. Paragraph (b) of this section does not apply if— (1) The ownership percentage described in section 7874(a)(2)(B)(ii), determined without regard to the application of paragraph (b) of this section and §§ 1.7874–4(b) and 1.7874– 10(b), is less than five (by vote and value); and (2) On the completion date, each five percent former domestic entity shareholder or five percent former domestic entity partner, as applicable, owns (applying the attribution rules of section 318(a) with the modifications VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 described in section 304(c)(3)(B)) less than five percent (by vote and value) of the stock of (or a partnership interest in) each member of the expanded affiliated group. For this purpose, a five percent former domestic entity shareholder (or five percent former domestic entity partner) is a former domestic entity shareholder (or former domestic entity partner) that, before the domestic entity acquisition, owned (applying the attribution rules of section 318(a) with the modifications described in section 304(c)(3)(B)) at least five percent (by vote and value) of the stock of (or a partnership interest in) the domestic entity. (d) Treatment of partnerships. For purposes of this section, if one or more members of the modified expanded affiliated group own, in the aggregate, more than 50 percent (by value) of the interests in a partnership, the partnership is treated as a corporation that is a member of the modified expanded affiliated group. (e) Definitions. In addition to the definitions provided in § 1.7874–12, the following definitions apply for purposes of this section. (1) Foreign group nonqualified property—(i) General rule. Foreign group nonqualified property means foreign group property described in § 1.7874–4(h)(2), other than the following: (A) Property that gives rise to income described in section 954(h), determined— (1) In the case of property held by a foreign corporation, by substituting the term ‘‘foreign corporation’’ for the term ‘‘controlled foreign corporation;’’ and (2) In the case of property held by a domestic corporation, by substituting the term ‘‘domestic corporation’’ for the term ‘‘controlled foreign corporation,’’ without regard to the phrase ‘‘other than the United States’’ in section 954(h)(3)(A)(ii)(I), and without regard to any inference that the tests in section 954(h) should be calculated or determined without taking transactions with customers located in the United States into account. (B) Property that gives rise to income described in section 954(i), determined by substituting the term ‘‘foreign corporation’’ for the term ‘‘controlled foreign corporation.’’ (C) Property that gives rise to income described in section 1297(b)(2)(A) or (B) (determined without regard to other passive foreign investment company rules). (D) Property held by a domestic corporation that is subject to tax as an insurance company under subchapter L of chapter 1 of subtitle A of the Internal PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 32551 Revenue Code, provided that the property is required to support, or is substantially related to, the active conduct of an insurance business. (ii) Special rule. Foreign group nonqualified property also means any foreign group property that, in a transaction related to the domestic entity acquisition, is acquired in exchange for other property, including cash, if such other property would be described in paragraph (e)(1)(i) of this section had the transaction not occurred. (2) Foreign group property means any property (including excluded property, as described in paragraph (e)(3)(ii) of this section)) held on the completion date by the modified expanded affiliated group, other than— (i) Property that is directly or indirectly acquired in the domestic entity acquisition; (ii) Stock or a partnership interest in a member of the modified expanded affiliated group; and (iii) An obligation of a member of the modified expanded affiliated group. (3) Foreign group nonqualified property fraction—(i) In general. Foreign group nonqualified property fraction means a fraction calculated with the following numerator and denominator: (A) The numerator of the fraction is the gross value of all foreign group nonqualified property, other than excluded property (as described in paragraph (e)(3)(ii) of this section). (B) The denominator of the fraction is the gross value of all foreign group property, other than excluded property (as described in paragraph (e)(3)(ii) of this section) (ii) Excluded property. For purposes of paragraph (e)(3) of this section, excluded property means property that gives rise to stock that is excluded from the ownership fraction with respect to the domestic entity acquisition under § 1.7874–4(b), § 1.7874–8(b), § 1.7874– 9(b), or section 7874(c)(4). For this purpose, only property that was directly or indirectly acquired in a prior domestic entity acquisition (as described in § 1.7874–8(g)(4)) or covered foreign acquisition (as described in § 1.7874–9(d)(4)) with respect to the domestic entity acquisition may be considered to give rise to stock that is excluded from the ownership fraction with respect to the domestic entity acquisition under § 1.7874–8(b) or § 1.7874–9(b). If only a portion of the consideration provided in a prior domestic entity acquisition or covered foreign acquisition consisted of stock of the foreign acquiring corporation, then only a pro rata portion of a property E:\FR\FM\12JYR2.SGM 12JYR2 32552 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 directly or indirectly acquired in the prior domestic entity acquisition or covered foreign acquisition may be considered excluded property, based on a fraction the numerator of which is the amount of the consideration that consisted of stock of the foreign acquiring corporation and the denominator of which is the total amount of consideration. (4) Modified expanded affiliated group means, with respect to a domestic entity acquisition, the group described in either paragraph (e)(4)(i) of this section or paragraph (e)(4)(ii) of this section. A member of the modified expanded affiliated group is an entity included in the modified expanded affiliated group. (i) When the foreign acquiring corporation is not the common parent corporation of the expanded affiliated group, the expanded affiliated group determined as if the foreign acquiring corporation was the common parent corporation. (ii) When the foreign acquiring corporation is the common parent corporation of the expanded affiliated group, the expanded affiliated group. (f) Examples. The following examples illustrate the rules of this section. Example 1. Application of general rule—(i) Facts. Individual A owns all 20 shares of the sole class of stock of FA, a foreign corporation. FA acquires all the stock of DT, a domestic corporation, solely in exchange for 76 shares of newly issued FA stock (DT acquisition). In a transaction related to the DT acquisition, FA issues 4 shares of stock to Individual A in exchange for Asset A, which has a gross value of $50x. On the completion date, in addition to the DT stock and Asset A, FA holds Asset B, which has a gross value of $150x, and Asset C, which has a gross value of $100x. Assets A and B, but not Asset C, are nonqualified property (within the meaning of § 1.7874–4(h)(2)). Further, Asset C was not acquired in a transaction related to the DT acquisition. (ii) Analysis. The 4 shares of FA stock issued to Individual A in exchange for Asset A are disqualified stock under § 1.7874–4(c) and are excluded from the denominator of the ownership fraction pursuant to § 1.7874– 4(b). Furthermore, additional shares of FA stock are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section. This is because on the completion date, the gross value of all foreign group property is $300x (the sum of the gross values of Assets A, B, and C), the gross value of all foreign group nonqualified property is $200x (the sum of the gross values of Assets A and B), and thus 66.67% of the gross value of all foreign group property constitutes foreign group nonqualified property ($200x/ $300x). Because FA has only one class of stock outstanding, the shares of FA stock that are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section are calculated by multiplying VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 20 shares of FA stock (100 shares less the 76 shares described in section 7874(a)(2)(B)(ii) and the 4 shares of disqualified stock) by the foreign group nonqualified property fraction. The numerator of the foreign group nonqualified property fraction is $150x (the gross value of Asset B) and the denominator is $250x (the sum of the gross values of Assets B and C). Asset A is not taken into account for purposes of the foreign group nonqualified property fraction because it gives rise to FA stock that is excluded under § 1.7874–4(b) (4 shares) and, as a result, is excluded property. Accordingly, 12 shares of FA stock are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section (20 shares multiplied by $150x/$250x). Thus, a total of 16 shares are excluded from the denominator of the ownership fraction (4 + 12). As a result, the ownership fraction by value is 76/84. Example 2. Application of de minimis exception—(i) Facts. Individual A owns all 96 shares of the sole class of stock of FA, a foreign corporation. Individual B wholly owns DT, a domestic corporation. Individuals A and B are not related. FA acquires all the stock of DT solely in exchange for 4 shares of newly issued FA stock (DT acquisition). On the completion date, in addition to all of the stock of DT, FA holds Asset A, which is nonqualified property (within the meaning of § 1.7874– 4(h)(2)). (ii) Analysis. Without regard to the application of §§ 1.7874–4(b) and 1.7874– 10(b) as well as paragraph (b) of this section, the ownership percentage described in section 7874(a)(2)(B)(ii) would be less than 5 (by vote and value), or 4 (4/100, or 4 shares of FA stock held by Individual B by reason of owning the DT stock, determined under § 1.7874–2(f)(2), over 100 shares of FA stock outstanding after the DT acquisition). Furthermore, on the completion date, Individual B owns less than 5% (by vote and value) of the stock of FA and DT (the members of the expanded affiliated group). Accordingly, the de minimis exception in paragraph (c) of this section applies. Therefore, paragraph (b) of this section does not apply and the ownership fraction is 4/100. Example 3. Foreign acquiring corporation not common parent of EAG—(i) Facts. FP, a foreign corporation, owns all 85 shares of the sole class of stock of FA, a foreign corporation. FA acquires all the stock of DT, a domestic corporation, solely in exchange for 65 shares of newly issued FA stock (DT acquisition). On the completion date, FA, in addition to all of the stock of DT, owns Asset A, which has a gross value of $40x, and Asset B, which has a gross value of $45x. Moreover, on the completion date, in addition to the 85 shares of FA stock, FP owns Asset C, which has a gross value of $10x. Assets A and C, but not Asset B, are nonqualified property (within the meaning of § 1.7874–4(h)(2)). Further, Asset B was not acquired in a transaction related to the DT acquisition in exchange for nonqualified property. (ii) Analysis. Under paragraph (e)(2) of this section, Assets A and B, but not Asset C, are foreign group property. Although Asset C is PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 held on the completion date by FP, a member of the expanded affiliated group, Asset C is not foreign group property because FP is not a member of the modified expanded affiliated group. This is the case because if the expanded affiliated group were determined based on FA as the common parent corporation, FP would not be a member of such expanded affiliated group (see paragraph (e)(4)(i) of this section). Under paragraph (e)(1) of this section, Asset A, but not Asset B, is foreign group nonqualified property. Therefore, on the completion date, the gross value of all foreign group property is $85x (the sum of the gross values of Assets A and B), and the gross value of all foreign group nonqualified property is $40x (the gross value of Asset A). Accordingly, on the completion date, only 47.06% of the gross value of all foreign group property constitutes foreign group nonqualified property ($40x/$85x). Consequently, paragraph (b) of this section does not apply to exclude any FA stock from the denominator of the ownership fraction. Example 4. Coordination with serial acquisition rule—(i) Facts. Individual A owns all 30 shares of the sole class of stock of FA, a foreign corporation. In Year 1, FA acquires all the stock of DT1, a domestic corporation, solely in exchange for 40 shares of newly issued FA stock (DT1 acquisition). In Year 2, FA acquires all the stock of DT2, a domestic corporation, solely in exchange for 50 shares of newly issued FA stock (DT2 acquisition). On the completion date for the DT2 acquisition, in addition to the DT2 stock, FA holds Asset A, which has a gross value of $15x, Asset B, which has a gross value of $15x, and all the stock of DT1, which has a gross value of $40x. At all times, DT1 holds only Asset C, which has a gross value of $30x, and Asset D, which has a gross value of $10x. Assets A and C, but not Assets B and D, are nonqualified property (within the meaning of § 1.7874–4(h)(2)). In addition, at all times, the fair market value of each share of FA stock is $1x. Further, there have been no redemptions of FA stock subsequent to the DT1 acquisition. Lastly, under § 1.7874–8, the DT1 acquisition is a prior domestic entity acquisition with respect to the DT2 acquisition and $40x of FA stock is excluded from the denominator of the ownership fraction with respect to the DT2 acquisition. (ii) Analysis. Shares of FA stock are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section. This is because on the completion date, the gross value of all foreign group property is $70x (the sum of the gross values of Assets A, B, C, and D), the gross value of all foreign group nonqualified property is $45x (the sum of the gross values of Assets A and C), and thus 64.29% of the gross value of all foreign group property constitutes foreign group nonqualified property ($45x/$70x). The shares of FA stock that are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section are calculated by multiplying $30x ($120x, the value of all the shares of FA stock, less $50x, the value of the stock described in section 7874(a)(2)(B)(ii), less $40x, the value of the stock excluded E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations under § 1.7874–8(b)) by the foreign group nonqualified property fraction. The property taken into account for purposes of determining the foreign group nonqualified property fraction is Asset A and Asset B. Asset C and Asset D are not taken into account for purposes of the foreign group nonqualified property fraction because they are excluded property. This is because FA indirectly acquired the Assets in the DT1 acquisition (a prior domestic entity acquisition with respect to the DT2 acquisition) and, as a result of that acquisition, $40x of FA stock is excluded from the denominator of the ownership fraction with respect to the DT2 acquisition under § 1.7874–8(b). Thus, the numerator of the foreign group nonqualified property fraction is $15x (the gross value of Asset A) and the denominator is $30x (the sum of the gross values of Asset A, $15x, and Asset B, $15x). Accordingly, $15x of FA stock is excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section ($30x multiplied by $15x/ $30x). Thus, a total of $55x of FA stock is excluded from the denominator of the ownership fraction ($40x + $15x), making the denominator $65x ($120x ¥ $55x). As a result, the ownership percentage with respect to the DT2 acquisition by value is 76.92 ($50x/$65x). (ii) Alternative facts. The facts are the same as in paragraph (i) of this Example 4, except as follows. Initially, there are 40 shares of FA stock outstanding, all of which are owned by Individual A. At all times, the gross value of asset D is $20x. In the DT1 acquisition, FA acquires all the stock of DT1 ($50x fair market value) solely in exchange for 40 shares of newly issued FA stock and $10x of other property. As in paragraph (i) of this Example 4, shares of FA stock are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section. This is because on the completion date, the gross value of all foreign group property is $80x (the sum of the gross values of Assets A, B, C, and D), the gross value of all foreign group nonqualified property is $45x (the sum of the gross values of Assets A and C), and thus 56.25% of the gross value of all foreign group property constitutes foreign group nonqualified property ($45x/ $80x). The shares of FA stock that are excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section are calculated by multiplying $40x ($130x, the value of all the shares of FA stock, less $50x, the value of the stock described in section 7874(a)(2)(B)(ii), less $40x, the value of the stock excluded under § 1.7874–8(b)) by the foreign group nonqualified property fraction. The property taken into account for purposes of determining the foreign group nonqualified property fraction is Asset A, Asset B, and the portion of Asset C and Asset D that is not excluded property. Eighty percent of each of Asset C and Asset D are considered excluded property because FA indirectly acquired Asset C and Asset D in the DT1 acquisition (a prior domestic entity acquisition with respect to the DT2 acquisition); as a result of that acquisition, $40x of FA stock is excluded from the denominator of the ownership VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 fraction with respect to the DT2 acquisition under § 1.7874–8(b); and 80% of the consideration provided in the DT1 acquisition consisted of stock of FA ($40x/ $50x). Thus, the numerator of the foreign group nonqualified property fraction is $21x (the sum of the gross values of Asset A, $15x, and the portion of Asset C that is not excluded property, $6x) and the denominator is $40x (the sum of the gross values of Asset A, $15x, Asset B, $15x, and the portion of Asset C and Asset D that is not excluded property, $6x and $4x, respectively). Accordingly, $21x of FA stock is excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section ($40x multiplied by $21x/$40x). Thus, a total of $61x of FA stock is excluded from the denominator of the ownership fraction pursuant to paragraph (b) of this section ($40x + $21x), making the denominator $69x ($130x ¥ $61x). As a result, the ownership percentage with respect to D2 acquisition by value is 72.46 ($50x/ $69x). (g) Applicability dates. This section applies to domestic entity acquisitions completed on or after July 12, 2018. For domestic entity acquisitions completed before July 12, 2018, see § 1.7874–7T, as contained in 26 CFR part 1 revised as of April 1, 2017. However, to the extent this section differs from § 1.7874–7T, as contained in 26 CFR part 1 revised as of April 1, 2017, taxpayers may elect to consistently apply the differences to domestic entity acquisitions completed before July 12, 2018. § 1.7874–7T [Removed] Par. 24. Section 1.7874–7T is removed. ■ Par. 25. Section 1.7874–8 is added to read as follows: ■ § 1.7874–8 Disregard of certain stock attributable to serial acquisitions. (a) Scope. This section identifies stock of a foreign acquiring corporation that is disregarded in determining an ownership fraction by value because it is attributable to certain prior domestic entity acquisitions. Paragraph (b) of this section sets forth the general rule regarding the amount of stock of a foreign acquiring corporation that is excluded from the denominator of the ownership fraction by value under this section, and paragraphs (c) through (f) of this section provide rules for determining this amount. Paragraph (g) provides definitions. Paragraph (h) of this section provides examples illustrating the application of the rules of this section. Paragraph (i) of this section provides dates of applicability. This section applies after taking into account § 1.7874–2(e). See § 1.7874– 1(d)(1) for rules addressing the interaction of this section with the PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 32553 expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1. (b) General rule. This paragraph (b) applies to a domestic entity acquisition (relevant domestic entity acquisition) when the foreign acquiring corporation (including a predecessor, as defined in § 1.7874–10(f)(1)) has completed one or more prior domestic entity acquisitions. When this paragraph (b) applies, then, for purposes of determining the ownership percentage by value (but not vote) described in section 7874(a)(2)(B)(ii), stock of the foreign acquiring corporation is excluded from the denominator of the ownership fraction in an amount equal to the sum of the excluded amounts computed separately with respect to each prior domestic entity acquisition and each relevant share class. (c) Computation of excluded amounts. With respect to each prior domestic entity acquisition and each relevant share class, the excluded amount is the product of— (1) The total number of prior acquisition shares, reduced by the sum of the number of allocable redeemed shares for all redemption testing periods; and (2) The fair market value of a single share of stock of the relevant share class on the completion date of the relevant domestic entity acquisition. (d) Computation of allocable redeemed shares—(1) In general. With respect to each prior domestic entity acquisition and each relevant share class, the allocable redeemed shares, determined separately for each redemption testing period, is the product of the number of redeemed shares during the redemption testing period and the redemption fraction. (2) Redemption fraction. The redemption fraction is determined separately with respect to each prior domestic entity acquisition, each relevant share class, and each redemption testing period, as follows: (i) The numerator is the total number of prior acquisition shares, reduced by the sum of the number of allocable redeemed shares for all prior redemption testing periods. (ii) The denominator is the sum of— (A) The number of outstanding shares of the foreign acquiring corporation stock as of the end of the last day of the redemption testing period; and (B) The number of redeemed shares during the redemption testing period. (e) Rules for determining redemption testing periods—(1) In general. Except as provided in paragraph (e)(2) of this section, a redemption testing period with respect to a prior domestic entity acquisition is the period beginning on E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32554 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations the day after the completion date of the prior domestic entity acquisition and ending on the day prior to the completion date of the relevant domestic entity acquisition. (2) Election to use multiple redemption testing periods. A foreign acquiring corporation may establish a reasonable method for dividing the period described in paragraph (e)(1) of this section into shorter periods (each such shorter period, a redemption testing period). A reasonable method would include a method based on a calendar convention (for example, daily, monthly, quarterly, or yearly), or on a convention that triggers the start of a new redemption testing period whenever a share issuance occurs that exceeds a certain threshold. In order to be reasonable, the method must be consistently applied with respect to all prior domestic entity acquisitions and all relevant share classes. (f) Appropriate adjustments required to take into account share splits and similar transactions. For purposes of this section, appropriate adjustments must be made to take into account changes in a foreign acquiring corporation’s capital structure, including, for example, stock splits, reverse stock splits, stock distributions, recapitalizations, and similar transactions. Thus, for example, in determining the total number of prior acquisition shares with respect to a relevant share class, appropriate adjustments must be made to take into account a stock split with respect to that relevant share class that occurs after the completion date with respect to a prior domestic entity acquisition. (g) Definitions. In addition to the definitions provided in § 1.7874–12, the following definitions apply for purposes of this section. (1) A binding contract means an instrument enforceable under applicable law against the parties to the instrument. The presence of a condition outside the control of the parties (including, for example, regulatory agency approval) does not prevent an instrument from being a binding contract. Further, the fact that insubstantial terms remain to be negotiated by the parties to the contract, or that customary conditions remain to be satisfied, does not prevent an instrument from being a binding contract. A tender offer that is subject to section 14(d) of the Securities and Exchange Act of 1934, (15 U.S.C. 78n(d)(1)), and Regulation 14D (17 CFR 240.14d–1 through 240.14d–103) and that is not pursuant to a binding contract, is treated as a binding contract made on the date of its announcement, VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 notwithstanding that it may be modified by the offeror or that it is not enforceable against the offerees. (2) A relevant share class means, with respect to a prior domestic entity acquisition, each separate legal class of shares in the foreign acquiring corporation from which prior acquisition shares were issued. See also paragraph (f) of this section (requiring appropriate adjustments in certain cases). (3) Total number of prior acquisition shares means, with respect to a prior domestic entity acquisition and each relevant share class, the total number of shares of stock of the foreign acquiring corporation that were described in section 7874(a)(2)(B)(ii) as a result of that acquisition (without regard to whether the 60 percent test of section 7874(a)(2)(B)(ii) was satisfied), other than stock treated as received by former domestic entity shareholders or former domestic entity partners under § 1.7874–10(b) or section 7874(c)(4), adjusted as appropriate under paragraph (f) of this section. (4) A prior domestic entity acquisition—(i) General rule. Except as provided in this paragraph (g)(4), a prior domestic entity acquisition means, with respect to a relevant domestic entity acquisition, a domestic entity acquisition that occurred within the 36month period ending on the signing date of the relevant domestic entity acquisition. (ii) Exception. A domestic entity acquisition is not a prior domestic entity acquisition if it is described in paragraph (g)(4)(ii)(A) or (B) of this section. (A) De minimis. A domestic entity acquisition is described in this paragraph (g)(4)(ii)(A) if— (1) The ownership percentage described in section 7874(a)(2)(B)(ii) with respect to the domestic entity acquisition was less than five (by vote and value); and (2) The fair market value of the stock of the foreign acquiring corporation described in section 7874(a)(2)(B)(ii) as a result of the domestic entity acquisition (without regard to whether the 60 percent test of section 7874(a)(2)(B)(ii) was satisfied) did not exceed $50 million, as determined on the completion date with respect to the domestic entity acquisition. (B) Foreign-parented group. A domestic entity acquisition is described in this paragraph (g)(4)(ii)(B) if— (1) Before the domestic entity acquisition and any related transaction, the domestic entity was a member of a foreign-parented group (as described in § 1.7874–6(f)(1)); and PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 (2) The domestic entity acquisition qualified for the internal group restructuring exception under § 1.7874– 1(c)(2). (5) A redeemed share means a share of stock in a relevant share class that was redeemed (within the meaning of section 317(b)). (6) A signing date means the first date on which the contract to effect the relevant domestic entity acquisition is a binding contract, or if another binding contract to effect a substantially similar acquisition was terminated with a principal purpose of avoiding section 7874, the first date on which such other contract was a binding contract. (h) Examples. The following examples illustrate the rules of this section. Example 1. Application of general rule—(i) Facts. Individual A wholly owns DT1, a domestic corporation. Individual B owns all 100 shares of the sole class of stock of FA, a foreign corporation. In Year 1, FA acquires all the stock of DT1 solely in exchange for 100 shares of newly issued FA stock (DT1 acquisition). On the completion date with respect to the DT1 acquisition, the fair market value of each share of FA stock is $1x. In Year 3, FA enters into a binding contract to acquire all the stock of DT2, a domestic corporation wholly owned by Individual C. Thereafter, FA acquires all the stock of DT2 solely in exchange for 150 shares of newly issued FA stock (DT2 acquisition). On the completion date with respect to the DT2 acquisition, the fair market value of each share of FA stock is $1.50x. FA did not complete the DT1 acquisition and DT2 acquisition pursuant to a plan (or series of related transactions) for purposes of applying § 1.7874–2(e). In addition, there have been no redemptions of FA stock subsequent to the DT1 acquisition. (ii) Analysis. The DT1 acquisition is a prior domestic entity acquisition with respect to the DT2 acquisition (the relevant domestic entity acquisition) because the DT1 acquisition occurred within the 36-month period ending on the signing date with respect to the DT2 acquisition. Accordingly, paragraph (b) of this section applies to the DT2 acquisition. As a result, and because there were no redemptions of FA stock, the excluded amount is $150x, calculated as 100 (the total number of prior acquisition shares) multiplied by $1.50x (the fair market value of a single share of FA stock on the completion date with respect to the DT2 acquisition). Accordingly, the numerator of the ownership fraction by value is $225x (the fair market value of the stock of FA that, with respect to the DT2 acquisition, is described in section 7874(a)(2)(B)(ii)) (150 shares x $1.50x per share). In addition, the denominator of the ownership fraction is $375x (calculated as $525x, the fair market value of all 350 shares of FA stock as of the completion date with respect to the DT2 acquisition, less $150x, the excluded amount). Therefore, the ownership percentage by value is 60 ($225x divided by $375x). E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations Example 2. Effect of certain redemptions— (i) Facts. The facts are the same as in paragraph (i) of Example 1 of this paragraph (h), except that in Year 2 FA redeems 50 shares of its stock (the Year 2 redemption). (ii) Analysis. As is the case in paragraph (ii) of Example 1 of this paragraph (h), the DT1 acquisition is a prior domestic entity acquisition with respect to the DT2 acquisition (the relevant domestic entity acquisition), and paragraph (b) of this section thus applies to the DT2 acquisition. Because of the Year 2 redemption, the allocable redeemed shares, and thus the redemption fraction, must be calculated. For this purpose, the redemption testing period is the period beginning on the day after the completion date with respect to the DT1 acquisition and ending on the day prior to the completion date with respect to the DT2 acquisition. The redemption fraction for the redemption testing period is thus 100/200, calculated as 100 (the total number of prior acquisition shares) divided by 200 (150, the number of outstanding shares of FA stock on the last day of the redemption testing period, plus 50, the number of redeemed shares during the redemption testing period), and the allocable redeemed shares for the redemption testing period is 25, calculated as 50 (the number of redeemed shares during the redemption testing period) multiplied by 100/200 (the redemption fraction for the redemption testing period). As a result, the excluded amount is $112.50x, calculated as 75 (100, the total number of prior acquisition shares, less 25, the allocable redeemed shares) multiplied by $1.50x (the fair market value of a single share of FA stock on the completion date with respect to the DT2 acquisition). Accordingly, the numerator of the ownership fraction by value is $225x (the fair market value of the stock of FA that, with respect to the DT2 acquisition, is described in section 7874(a)(2)(B)(ii)) (150 shares × $1.50x per share), and the denominator of the ownership fraction is $337.50x (calculated as $450x, the fair market value of all 300 shares of FA stock as of the completion date with respect to the DT2 acquisition, less $112.50x, the excluded amount). Therefore, the ownership percentage by value is 66.67 ($225x divided by $337.50x). Example 3. Stock split—(i) Facts. The facts are the same as in paragraph (i) of Example 2 of this paragraph (h), except as follows. After the Year 2 redemption, but before the DT2 acquisition, FA undergoes a stock split and, as a result, each of the 150 shares of FA stock outstanding are converted into two shares (Year 2 stock split). Further, pursuant to the DT2 acquisition, FA acquires all the stock of DT2 solely in exchange for 300 shares of newly issued FA stock. Moreover, on the completion date with respect to the DT2 acquisition, the fair market value of each share of FA stock is $0.75x. (ii) Analysis. As is the case in paragraph (ii) of Example 1 of this paragraph (h), the DT1 acquisition is a prior domestic entity acquisition with respect to the DT2 acquisition (the relevant domestic entity acquisition), and paragraph (b) of this section thus applies to the DT2 acquisition. In addition, as is the case in paragraph (ii) of Example 2 of this paragraph (h), the VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 redemption testing period is the period beginning on the day after the completion date with respect to the DT1 acquisition and ending on the day prior to the completion date with respect to the DT2 acquisition. To calculate the redemption fraction, the total number of prior acquisition shares and the number of redeemed shares during the redemption testing period must be appropriately adjusted to take into account the Year 2 stock split. See paragraph (f) of this section. In this case, the appropriate adjustment is to increase the total number of prior acquisition shares from 100 to 200 and to increase the number of redeemed shares during the redemption testing period from 50 to 100. Thus, the redemption fraction for the redemption testing period is 200/400, calculated as 200 (the total number of prior acquisition shares) divided by 400 (300, the number of outstanding shares of FA stock on the last day of the redemption testing period, plus 100, the number of redeemed shares during the redemption testing period), and the allocable redeemed shares for the redemption testing period is 50, calculated as 100 (the number of redeemed shares during the redemption testing period) multiplied by 200/400 (the redemption fraction for the redemption testing period). In addition, for purposes of calculating the excluded amount, the total number of prior acquisition shares must be adjusted from 100 to 200. See paragraph (f) of this section. Accordingly, the excluded amount is $112.50x, calculated as 150 (200, the total number of prior acquisition shares, less 50, the allocable redeemed shares) multiplied by $0.75x (the fair market value of a single share of FA stock on the completion date with respect to the DT2 acquisition). Consequently, the numerator of the ownership fraction by value is $225x (the fair market value of the stock of FA that, with respect to the DT2 acquisition, is described in section 7874(a)(2)(B)(ii)) (300 shares × $0.75x per share), and the denominator of the ownership fraction is $337.50x (calculated as $450x, the fair market value of all 600 shares of FA stock as of the completion date with respect to the DT2 acquisition, less $112.50x, the excluded amount). Therefore, the ownership percentage by value is 66.67 ($225 divided by $337.50x). (i) Applicability dates. Except as provided in this paragraph (i), this section applies to domestic entity acquisitions completed on or after April 4, 2016, regardless of when a prior domestic entity acquisition was completed. Paragraphs (g)(3) and (g)(4)(ii) of this section apply to domestic entity acquisitions completed on or after July 12, 2018. However, taxpayers may elect to consistently apply paragraphs (g)(3) and (g)(4)(ii) of this section to domestic entity acquisitions completed on or after April 4, 2016, and before July 12, 2018. For domestic entity acquisitions completed on or after April 4, 2016, and before July 12, 2018, see § 1.7874–8T(g)(3) and (g)(4)(ii) as contained in 26 CFR part 1 revised as of April 1, 2017. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 § 1.7874–8T 32555 [Removed] Par. 26. Section 1.7874–8T is removed. ■ Par. 27. Section 1.7874–9 is added to read as follows: ■ § 1.7874–9 Disregard of certain stock in third-country transactions. (a) Scope. This section identifies certain stock of a foreign acquiring corporation that is disregarded in determining the ownership fraction. Paragraph (b) of this section provides a rule that, in a third-country transaction, excludes from the denominator of the ownership fraction stock in the foreign acquiring corporation held by former shareholders of an acquired foreign corporation by reason of holding certain stock in that foreign corporation. Paragraph (c) of this section defines a third-country transaction, and paragraph (d) of this section provides other definitions. Paragraph (e) of this section provides operating rules. Paragraph (f) of this section provides an example illustrating the application of the rules of this section. Paragraph (g) of this section provides the dates of applicability. See § 1.7874–1(d)(1) for rules addressing the interaction of this section with the expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1. (b) Exclusion of certain stock of a foreign acquiring corporation from the ownership fraction. When a domestic entity acquisition is a third-country transaction, stock of the foreign acquiring corporation held by reason of holding stock in the acquired foreign corporation (within the meaning of paragraph (e)(4) of this section) is, to the extent the stock otherwise would be included in the denominator of the ownership fraction, excluded from the denominator of the ownership fraction pursuant to this paragraph. (c) Third-country transaction. A domestic entity acquisition is a thirdcountry transaction if the following requirements are satisfied: (1) The foreign acquiring corporation completes a covered foreign acquisition pursuant to a plan (or series of related transactions) that includes the domestic entity acquisition. (2) After the covered foreign acquisition and all related transactions are complete, the foreign acquiring corporation is not a tax resident of the foreign country in which the acquired foreign corporation was a tax resident before the covered foreign acquisition and all related transactions. (3) The ownership percentage described in section 7874(a)(2)(B)(ii), determined without regard to the E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32556 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations application of paragraph (b) of this section, is at least 60. (d) Definitions. In addition to the definitions provided in § 1.7874–12, the following definitions apply for purposes of this section. (1) A foreign acquisition means a transaction in which a foreign acquiring corporation directly or indirectly acquires substantially all of the properties held directly or indirectly by an acquired foreign corporation (within the meaning of paragraph (e)(2) of this section). (2) An acquired foreign corporation means a foreign corporation whose properties are acquired in a foreign acquisition. (3) Foreign ownership percentage means, with respect to a foreign acquisition, the percentage of stock (by vote or value) of the foreign acquiring corporation held by reason of holding stock in the acquired foreign corporation (within the meaning of paragraph (e)(3) of this section). (4) Covered foreign acquisition—(i) In general. Except as provided in paragraphs (d)(4)(ii) and (iii) of this section, a covered foreign acquisition means a foreign acquisition in which, after the acquisition and all related transactions are complete, the foreign ownership percentage is at least 60. (ii) Substantial business activities exception. A foreign acquisition is not a covered foreign acquisition if, on the completion date, the following requirements are satisfied: (A) The foreign acquiring corporation is a tax resident of a foreign country. (B) The expanded affiliated group has substantial business activities in the country in which the foreign acquiring corporation is a tax resident when compared to the total business activities of the expanded affiliated group. For this purpose, the principles of § 1.7874– 3 apply and the determination of whether there are substantial business activities is made without regard to the domestic entity acquisition. (iii) No income tax exception. A foreign acquisition is not a covered foreign acquisition if— (A) Before the acquisition and all related transactions, the acquired foreign corporation was created or organized in, or under the law of, a foreign country that does not impose corporate income tax and was not a tax resident of any other foreign country; and (B) After the acquisition and all related transactions are complete, the foreign acquiring corporation is created or organized in, or under the law of, a foreign country that does not impose VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 corporate income tax and is not a tax resident of any other foreign country. (5) A tax resident of a foreign country has the meaning set forth in § 1.7874– 3(d)(11). (e) Operating rules. The following rules apply for purposes of this section. (1) Acquisition of multiple foreign corporations that are tax residents of the same foreign country. When multiple foreign acquisitions occur pursuant to the same plan (or a series of related transactions) and two or more of the acquired foreign corporations were tax residents of the same foreign country before the foreign acquisitions and all related transactions, then those foreign acquisitions are treated as a single foreign acquisition and those acquired foreign corporations are treated as a single acquired foreign corporation for purposes of this section. (2) Acquisition of properties of an acquired foreign corporation. For purposes of determining whether a foreign acquisition occurs, the principles of section 7874(a)(2)(B)(i) and § 1.7874–2(c) and (d) (regarding acquisitions of properties of a domestic entity and acquisitions by multiple foreign corporations) apply with the following modifications: (i) The principles of § 1.7874–2(c)(1) (providing rules for determining whether there is an indirect acquisition of properties of a domestic entity), including § 1.7874–2(b)(5) (providing rules for determining the proportionate amount of properties indirectly acquired), apply by substituting the term ‘‘foreign’’ for ‘‘domestic’’ wherever it appears. (ii) The principles of § 1.7874–2(c)(2) (regarding acquisitions of stock of a foreign corporation that owns a domestic entity) apply by substituting the term ‘‘domestic’’ for ‘‘foreign’’ wherever it appears. (3) Computation of foreign ownership percentage. For purposes of determining a foreign ownership percentage, the principles of all rules applicable to calculating an ownership percentage apply (including §§ 1.7874–2, 1.7874–4, 1.7874–5, 1.7874–7, and section 7874(c)(4)) with the following modifications: (i) Stock of a foreign acquiring corporation described in section 7874(a)(2)(B)(ii) is not taken into account. (ii) The principles of this section, section 7874(c)(2)(A), and §§ 1.7874–1, 1.7874–6, 1.7874–8, and 1.7874–10 do not apply. (iii) The principles of § 1.7874–7 apply by, in addition to the exclusions listed in § 1.7874–7(e)(2)(i) through (iii), also excluding from the definition of PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 foreign group property any property held directly or indirectly by the acquired foreign corporation immediately before the foreign acquisition and directly or indirectly acquired in the foreign acquisition. (4) Stock held by reason of holding stock in an acquired foreign corporation. For purposes of determining stock of a foreign acquiring corporation held by reason of holding stock in an acquired foreign corporation, the principles of section 7874(a)(2)(B)(ii) and §§ 1.7874–2(f) and 1.7874–5 apply. (5) Change in the tax residency of a foreign corporation. For purposes of this section, a change in a country in which a foreign corporation is a tax resident is treated as a transaction. Further, for purposes of this section, if a foreign acquiring corporation changes the country in which it is a tax resident in a manner that would not otherwise be considered to result in a foreign acquisition (for example, by changing where it is managed and controlled), then the foreign acquiring corporation is treated as— (i) Both an acquired foreign corporation and a foreign acquiring corporation; and (ii) Directly or indirectly acquiring all of the properties held directly or indirectly by the acquired foreign corporation solely in exchange for stock of the foreign acquiring corporation. (f) Example. The following example illustrates the rules of this section. Example. Third-country transaction—(i) Facts. FA, a newly formed foreign corporation that is a tax resident of Country Y, acquires all the stock of DT, a domestic corporation that is wholly owned by Individual A, solely in exchange for 65 shares of newly issued FA stock (DT acquisition). Pursuant to a plan that includes the DT acquisition, FA acquires all the stock of FT, a foreign corporation that is a tax resident of Country X and wholly owned by Individual B, solely in exchange for the remaining 35 shares of newly issued FA stock (FT acquisition). After the FT acquisition and all related transactions, the expanded affiliated group does not have substantial business activities in Country Y when compared to the total business activities of the expanded affiliated group, as determined under the principles of § 1.7874– 3 and without regard to the DT acquisition. (ii) Analysis. As described in paragraphs (A) through (C) of this Example, the requirements set forth in paragraphs (c)(1) through (3) of this section are satisfied and, as result, the DT acquisition is a thirdcountry transaction. (A) The FT acquisition is a foreign acquisition because, pursuant to the FT acquisition, FA (a foreign acquiring corporation) acquires 100 percent of the stock of FT and is thus treated as indirectly acquiring 100 percent of the properties held by FT (an acquired foreign corporation). See E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations § 1.7874–2(c)(1) and paragraph (e)(2) of this section. Moreover, Individual B is treated as receiving 35 shares of FA stock by reason of holding stock in FT. See § 1.7874–2(f)(1)(i) and paragraph (e)(4) of this section. As a result, not taking into account the 65 shares of FA stock held by Individual A (a former domestic entity shareholder), 100 percent (35/35) of the stock of FA is held by reason of holding stock in FT and, thus, the foreign ownership percentage is 100. See paragraph (e)(3) of this section. Accordingly, the FT acquisition is a covered foreign acquisition. Therefore, because the FT acquisition occurs pursuant to a plan that includes the DT acquisition, the requirement set forth in paragraph (c)(1) of this section is satisfied. (B) The requirement set forth in paragraph (c)(2) of this section is satisfied because, after the FT acquisition and all related transactions, the foreign country in which FA is a tax resident (Country Y) is different than the foreign country in which FT was a resident (Country X) before the FT acquisition and all related transactions. (C) The requirement set forth in paragraph (c)(3) of this section is satisfied because, not taking into account paragraph (b) of this section, the ownership fraction is 65/100 and the ownership percentage is 65. (D) Because the DT acquisition is a thirdcountry transaction, the 35 shares of FA stock held by reason of holding stock in FT are excluded from the denominator of the ownership fraction. See paragraph (b) of this section. As a result, the ownership fraction is 65/65 and the ownership percentage is 100. The result would be the same if instead FA had directly acquired all of the properties held by FT in exchange for FA stock, for example, in a transaction that would qualify for U.S. federal income tax purposes as an asset reorganization under section 368. (iii) Alternative facts. The facts are the same as in paragraph (i) of this example, except that before the FT acquisition, but in a transaction related to the FT acquisition, FT becomes a tax resident of Country Y by reincorporating in Country Y. As is the case in paragraph (ii) of this Example, the requirements set forth in paragraphs (c)(1) and (3) of this section are satisfied. The requirement set forth in paragraph (c)(2) of this section is satisfied because, after the FT acquisition and any related transactions, the foreign country of which FA is a tax resident (Country Y) is different than the foreign country of which FT was a tax resident (Country X) before the FT acquisition and the reincorporation. See paragraph (e)(5) of this section. Accordingly, the DT acquisition is a third-country transaction and the consequences are the same as in paragraph (ii)(D) of this Example. (iv) Alternative facts. The facts are the same as in paragraph (i) of this Example, except that, instead of FA acquiring all of the stock of FT, FS, a newly formed foreign corporation that is wholly owned by FA and that is a tax resident of Country X, acquires all the stock of FT solely in exchange for 35 shares of newly issued FA stock (FT acquisition). As a result of the FT acquisition, FS and FA are each treated as indirectly acquiring 100 percent of the properties held by FT. See § 1.7874–2(c)(1)(i) and (iii) and VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 paragraph (e)(2) of this section. Accordingly, each of FS’s and FA’s indirect acquisition of properties of FT (an acquired foreign corporation) is a foreign acquisition. However, FS’s indirect acquisition of FT’s properties is not a covered foreign acquisition because no shares of FS stock are held by reason of holding stock in FT; thus, with respect to this foreign acquisition, the foreign ownership percentage is zero. See § 1.7874–2(f) and paragraphs (e)(3) and (4) of this section. FA’s indirect acquisition of FT’s properties is a covered foreign acquisition because 35 shares of FA stock (the shares received by Individual B) are held by reason of holding stock in FT; thus, the foreign ownership percentage is 100 percent (35/35). See § 1.7874–2(f)(1)(i) and paragraphs (e)(3) and (4) of this section. Accordingly, because the FT acquisition occurs pursuant to a plan that includes the DT acquisition, the requirement set forth in paragraph (c)(1) of this section is satisfied. Further, as is the case in paragraphs (ii)(B) through (C) of this Example, the requirements set forth in paragraphs (c)(2) and (3) of this section are satisfied. Therefore, the DT acquisition is a third-country transaction and the consequences are the same as in paragraph (ii)(D) of this Example. (g) Applicability dates. This section applies to domestic entity acquisitions completed on or after July 12, 2018. For domestic entity acquisitions completed before July 12, 2018, see § 1.7874–9T, as contained in 26 CFR part 1 revised as of April 1, 2017. However, to the extent this section differs from § 1.7874–9T, as contained in 26 CFR part 1 revised as of April 1, 2017, taxpayers may elect to consistently apply the differences to domestic entity acquisitions completed before July 12, 2018. § 1.7874–9T [Removed] Par. 28. Section 1.7874–9T is removed. ■ Par. 29. Section 1.7874–10 is added to read as follows: ■ § 1.7874–10 Disregard of certain distributions. (a) Scope. This section identifies distributions made by a domestic entity that are disregarded in determining an ownership fraction. Paragraph (b) of this section provides the general rule that former domestic entity shareholders or former domestic entity partners are treated as receiving additional stock of the foreign acquiring corporation when the domestic entity has made nonordinary course distributions (NOCDs). Paragraph (c) of this section identifies distributions that, in whole or in part, are outside the scope of this section. Paragraph (d) of this section provides a de minimis exception to the application of the general rule in paragraph (b) of this section. Paragraph (e) of this section provides rules concerning the treatment PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 32557 of distributions made by a predecessor, and paragraph (f) of this section provides rules for identifying a predecessor. Paragraph (g) of this section provides a special rule for certain distributions described in section 355. Paragraph (h) of this section provides rules regarding the allocation of NOCD stock. Paragraph (i) of this section addresses cases in which there are multiple foreign acquiring corporations, and paragraph (j) of this section addresses cases in which multiple domestic entities are treated as a single domestic entity. Paragraph (k) of this section provides definitions. Paragraph (l) of this section provides dates of applicability. See § 1.7874– 1(d)(2) for rules addressing the interaction of this section with the expanded affiliated group rules of section 7874(c)(2)(A) and § 1.7874–1. (b) General rule regarding NOCDs. Except as provided in paragraph (d) of this section, for purposes of determining the ownership percentage by value (but not vote) described in section 7874(a)(2)(B)(ii), former domestic entity shareholders or former domestic entity partners, as applicable, are treated as receiving, by reason of holding stock or partnership interests in a domestic entity, stock of the foreign acquiring corporation with a fair market value equal to the amount of the non-ordinary course distributions (NOCDs), determined as of the date of the distributions, made by the domestic entity during the look-back period. The stock of the foreign acquiring corporation treated as received under this paragraph (b) (NOCD stock) is in addition to stock of the foreign acquiring corporation otherwise treated as received by the former domestic entity shareholders or former domestic entity partners by reason of holding stock or partnership interests in the domestic entity. (c) Distributions that are not NOCDs. If only a portion of a distribution is an NOCD, section 7874(c)(4) may apply to the remainder of the distribution. This section does not, however, create a presumption that section 7874(c)(4) applies to the remainder of the distribution. (d) De minimis exception to the general rule. Paragraph (b) of this section does not apply if— (1) The ownership percentage described in section 7874(a)(2)(B)(ii), determined without regard to the application of paragraph (b) of this section and §§ 1.7874–4(b) and 1.7874– 7(b), is less than five (by vote and value); and (2) On the completion date, each five percent former domestic entity E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 32558 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations shareholder or five percent former domestic entity partner, as applicable, owns (applying the attribution rules of section 318(a) with the modifications described in section 304(c)(3)(B)) less than five percent (by vote and value) of the stock of (or a partnership interest in) each member of the expanded affiliated group. For this purpose, a five percent former domestic entity shareholder (or five percent former domestic entity partner) is a former domestic entity shareholder (or former domestic entity partner) that, before the domestic entity acquisition, owned (applying the attribution rules of section 318(a) with the modifications described in section 304(c)(3)(B)) at least five percent (by vote and value) of the stock of (or a partnership interest in) the domestic entity. (e) Treatment of distributions made by a predecessor. For purposes of this section, a corporation or a partnership (relevant entity), including a domestic entity, is treated as making the following distributions made by a predecessor with respect to the relevant entity: (1) A distribution made before the predecessor acquisition with respect to the predecessor; and (2) A distribution made in connection with the predecessor acquisition to the extent the property distributed is directly or indirectly provided by the predecessor. See paragraph (k)(1)(iv) of this section. (f) Rules for identifying a predecessor—(1) Definition of predecessor. A corporation or a partnership (tentative predecessor) is a predecessor with respect to a relevant entity if— (i) The relevant entity completes a predecessor acquisition; and (ii) After the predecessor acquisition and all related transactions are complete, the tentative predecessor ownership percentage is at least 10. (2) Definition of predecessor acquisition—(i) In general. Predecessor acquisition means a transaction in which a relevant entity directly or indirectly acquires substantially all of the properties held directly or indirectly by a tentative predecessor. (ii) Acquisition of properties of a tentative predecessor. For purposes of determining whether a predecessor acquisition occurs, the principles of section 7874(a)(2)(B)(i) apply, including § 1.7874–2(c) other than § 1.7874–2(c)(2) and (4) (regarding acquisitions of properties of a domestic entity), without regard to whether the tentative predecessor is domestic or foreign. (iii) Lower-tier entities of a predecessor. If, before a predecessor VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 acquisition and all related transactions, the predecessor held directly or indirectly stock in a corporation or an interest in a partnership, then, for purposes of this section, the relevant entity is not considered to directly or indirectly acquire the properties held directly or indirectly by the corporation or partnership. (3) Definition of tentative predecessor ownership percentage. Tentative predecessor ownership percentage means, with respect to a predecessor acquisition, the percentage of stock or partnership interests (by value) in a relevant entity held by reason of holding stock or partnership interests in the tentative predecessor. For purposes of computing the tentative predecessor ownership percentage, the following rules apply: (i) For purposes of determining the stock or partnership interests in a relevant entity held by reason of holding stock or partnership interests in the tentative predecessor, the principles of section 7874(a)(2)(B)(ii) and §§ 1.7874– 2(f)(1)(i) through (iii) and 1.7874–5 apply. (ii) For purposes of determining the stock or partnership interests in a relevant entity included in the numerator of the fraction used to compute the tentative predecessor ownership percentage, the rules of paragraph (f)(3)(i) of this section apply, and all the rules applicable to calculating the numerator of an ownership fraction with respect to a domestic entity acquisition apply, except that— (A) The principles of section 7874(c)(2)(A) and §§ 1.7874–1 and 1.7874–6 do not apply; and (B) The principles of paragraph (b) of this section do not apply. (iii) For purposes of determining stock or partnership interests in a relevant entity included in the denominator of the fraction used to compute the tentative predecessor ownership percentage, the principles of section 7874(a)(2)(B)(ii) and all rules applicable to calculating the denominator of an ownership fraction with respect to a domestic entity acquisition apply, except that— (A) The principles of section 7874(c)(2)(A) and §§ 1.7874–1 and 1.7874–6 do not apply; and (B) The principles of §§ 1.7874–4 and 1.7874–7 through 1.7874–9 do not apply. (g) Rule regarding direction of a section 355 distribution. For purposes of this section, if a domestic corporation (distributing corporation) distributes the stock of another domestic corporation (controlled corporation) pursuant to a PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 transaction described in section 355, and, immediately before the distribution, the fair market value of the stock of the controlled corporation owned by the distributing corporation and any related person (determined under section 7874(d)(3), without regard to whether the person is foreign) represents more than 50 percent of the fair market value of the stock of the distributing corporation, then, the controlled corporation is deemed, on the date of the distribution, to have distributed the stock of the distributing corporation. The deemed distribution is equal to the fair market value of the stock of the distributing corporation (but not taking into account the fair market value of the stock of the controlled corporation) on the date of the distribution. (h) Allocation of NOCD stock. NOCD stock is allocated among the former domestic entity shareholders or former domestic entity partners, as applicable, based on the amount of NOCDs that the former domestic entity shareholders or former domestic entity partners, as applicable, are treated as having received under this paragraph (h). Under this paragraph (h), a pro rata portion of each distribution during a look-back year is treated as comprising an NOCD with respect to the look-back year, based on a fraction the numerator of which is the amount of NOCDs during the look-back year and the denominator of which is the amount of distributions during the look-back year. Thus, each former domestic entity shareholder or former domestic entity partner, as applicable, is treated as receiving an amount of NOCD stock equal to the amount of NOCDs treated as received by the former domestic entity shareholder or former domestic entity partner, as applicable. (i) Multiple foreign acquiring corporations. If there are multiple foreign acquiring corporations with respect to a domestic entity acquisition, then the foreign acquiring corporation or corporations as to which NOCD stock is considered comprised is based on the proportion of consideration directly or indirectly provided by a foreign acquiring corporation in the domestic entity acquisition relative to the total amount of consideration directly or indirectly provided by the foreign acquiring corporations in the domestic entity acquisition. For purposes of this paragraph (i), consideration is not considered directly provided by a foreign acquiring corporation if it was indirectly provided by another foreign acquiring corporation. In addition, for purposes of this paragraph (i), consideration provided in the domestic E:\FR\FM\12JYR2.SGM 12JYR2 amozie on DSK3GDR082PROD with RULES2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations entity acquisition does not include money or other property described in paragraph (k)(1)(iii) of this section. (j) Multiple domestic entities. If pursuant to § 1.7874–2(e) two or more domestic entities are treated as a single domestic entity, then the determination of the amount of NOCDs made by the single domestic entity is made by— (1) Applying the rules of this section to each domestic entity on a separate basis, with the result that the amount of NOCDs made by each domestic entity is separately computed; and (2) Treating the amount of NOCDs made by the single domestic entity as the sum of the separately computed NOCDs made by each domestic entity. (k) Definitions. In addition to the definitions provided in § 1.7874–12, the following definitions apply for purposes of this section. (1) A distribution means the following: (i) Any distribution made by a corporation with respect to its stock other than— (A) A distribution to which section 305 applies; (B) A distribution to which section 304(a)(1) applies; and (C) Except as provided in paragraphs (k)(1)(iii) and (iv) of this section, a distribution pursuant to section 361(c)(1) (other than a distribution to which section 355 applies). (ii) Any distribution by a partnership (other than a distribution pursuant to section 752(b) to the extent that the transaction giving rise to such distribution does not reduce the partnership’s value). (iii) In the case of a domestic entity, a transfer of money or other property to the former domestic entity shareholders or former domestic entity partners that is made in connection with the domestic entity acquisition to the extent the money or other property is directly or indirectly provided by the domestic entity. (iv) In the case of a predecessor, a transfer of money or other property to the former owners of the predecessor that is made in connection with the predecessor acquisition to the extent the money or other property is directly or indirectly provided by the predecessor. (2) Distribution history period—(i) In general. Except as provided in paragraph (k)(2)(ii) or (iii) of this section, a distribution history period means, with respect to a look-back year, the 36-month period preceding the start of the look-back year. (ii) Formation date less than 36 months but at least 12 months before look-back year. If the formation date is less than 36 months, but at least 12 VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 months, before the start of a look-back year, then the distribution history period with respect to that look-back year means the entire period, starting with the formation date, that precedes the start of the look-back year. (iii) Formation date less than 12 months before look-back year. If the formation date is less than 12 months before the start of a look-back year, then there is no distribution history period with respect to that look-back year. (3) Formation date means, with respect to a domestic entity, the date that the domestic entity was created or organized, or, if earlier, the earliest date that any predecessor of the domestic entity was created or organized. (4) Look-back period means, with respect to a domestic acquisition, the 36-month period ending on the completion date or, if shorter, the entire period, starting with the formation date, that ends on the completion date. (5) Look-back year means, with respect to a look-back period, the following: (i) If the look-back period is 36 months, the three consecutive 12-month periods that comprise the look-back period. (ii) If the look-back period is less than 36 months, but at least 24 months— (A) The 12-month period that ends on the completion date; (B) The 12-month period that immediately precedes the period described in paragraph (k)(5)(ii)(A) of this section; and (C) The period, if any, that immediately precedes the period described in paragraph (k)(5)(ii)(B) of this section. (iii) If the look-back period is less than 24 months, but at least 12 months— (A) The 12-month period that ends on the completion date; and (B) The period, if any, that immediately precedes the period described in paragraph (k)(5)(iii)(A) of this section. (iv) If the look-back period is less than 12 months, the entire period, starting with the formation date, that ends on the completion date. (6) NOCDs mean, with respect to a look-back year, the excess of all distributions made during the look-back year over the NOCD threshold for the look-back year. (7) NOCD threshold means, with respect to a look-back year, the following: (i) If the look-back year has at least a 12-month distribution history period, 110 percent of the sum of all distributions made during the distribution history period multiplied PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 32559 by a fraction. The numerator of the fraction is the number of days in the look-back year and the denominator is the number of days in the distribution history period with respect to the lookback year. (ii) If the look-back year has no distribution history period, zero. (l) Applicability date. This section applies to domestic entity acquisitions completed on or after July 12, 2018. For domestic entity acquisitions completed before July 12, 2018, see § 1.7874–10T, as contained in 26 CFR part 1 revised as of April 1, 2017. However, to the extent this section differs from § 1.7874–10T, as contained in 26 CFR part 1 revised as of April 1, 2017, taxpayers may elect to consistently apply the differences to domestic entity acquisitions completed before July 12, 2018. § 1.7874–10T [Removed] Par. 30. Section 1.7874–10T is removed. ■ Par. 31. Section 1.7874–11 is added to read as follows: ■ § 1.7874–11 gain. Rules regarding inversion (a) Scope. This section provides rules for determining the inversion gain of an expatriated entity for purposes of section 7874. Paragraph (b) of this section provides rules for determining the inversion gain of an expatriated entity. Paragraph (c) of this section provides special rules with respect to certain foreign partnerships in which an expatriated entity owns an interest. Paragraph (d) of this section provides additional definitions. Paragraph (e) of this section provides an example that illustrates the rules of this section. Paragraph (f) of this section provides the applicability dates. (b) Inversion gain—(1) General rule. Except as provided in paragraphs (b)(2) and (3) of this section, inversion gain includes income (including an amount treated as a dividend under section 78) or gain recognized by an expatriated entity for any taxable year that includes any portion of the applicable period by reason of a direct or indirect transfer of stock or other properties or license of any property either as part of the domestic entity acquisition, or after such acquisition if the transfer or license is to a specified related person. (2) Exception for property described in section 1221(a)(1). Inversion gain does not include income or gain recognized by reason of the transfer or license, after the domestic entity acquisition, of property that is described in section 1221(a)(1) in the hands of the transferor or licensor. E:\FR\FM\12JYR2.SGM 12JYR2 32560 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 (3) Treatment of partnerships. Except to the extent provided in paragraph (c) of this section and section 7874(e)(2), inversion gain does not include income or gain recognized by reason of the transfer or license of property by a partnership. (c) Transfers and licenses by partnerships. If a partnership that is a foreign related person transfers or licenses property, a partner of the partnership shall be treated as having transferred or licensed its proportionate share of that property, as determined under the rules and principles of sections 701 through 777, for purposes of determining the inversion gain of an expatriated entity. See section 7874(e)(2) for rules regarding the treatment of transfers and licenses by domestic partnerships and transfers of interests in certain domestic partnerships. (d) Definitions. The definitions provided in § 1.7874–12 apply for purposes of this section. (e) Example. The following example illustrates the rules of this section. Example —(i) Facts. On July 1, 2016, FA, a foreign corporation, acquires all the stock of DT, a domestic corporation, in an inversion transaction. When the inversion transaction occurred, DT wholly owned FS, a foreign corporation that is a controlled foreign corporation (within the meaning of section 957(a)). During the applicable period, FS sells to FA property that is not described in section 1221(a)(1) in the hands of FS. Under section 951(a)(1)(A), DT has a $80x gross income inclusion that is attributable to FS’s gain from the sale of the property. Under section 960(a)(1), DT is deemed to have paid $20x of the post-1986 foreign income taxes of FS by reason of this income inclusion and includes $20x in gross income as a deemed dividend under section 78. Accordingly, DT recognizes $100x ($80x + $20x) of gross income because of FS’s sale of property to FA. (ii) Analysis. Pursuant to section 7874(a)(2)(A), DT is an expatriated entity. Under paragraph (b)(1) of this section, DT’s $100x gross income recognized under sections 951(a)(1)(A) and 78 is inversion gain, because it is income recognized by an expatriated entity during the applicable period by reason of an indirect transfer of property by DT (through its wholly-owned CFC, FS) after the inversion transaction to a specified related person (FA). Sections 7874(a)(1) and (e) therefore prevent the use of certain tax attributes (such as net operating losses) to reduce the U.S. tax owed with respect to DT’s $100x gross income recognized under sections 951(a)(1)(A) and 78. (f) Applicability dates. Except as otherwise provided in this paragraph (f), this section applies to transfers and licenses of property completed on or after November 19, 2015, but only if the inversion transaction was completed on VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 or after September 22, 2014. For inversion transactions completed on or after September 22, 2014, however, taxpayers may elect to apply paragraph (b) of this section by excluding the phrase ‘‘(including an amount treated as a dividend under section 78)’’ for transfers and licenses of property completed on or after November 19, 2015, and before April 4, 2016. § 1.7874–11T [Removed] Par. 32. Section 1.7874–11T is removed. ■ Par. 33. Section 1.7874–12 is added to read as follows: ■ § 1.7874–12 Definitions. (a) Definitions. Except as otherwise provided, the following definitions apply for purposes of this section and §§ 1.367(b)–4, 1.956–2, 1.7701(l)–4, and 1.7874–1 through 1.7874–11. (1) An affiliated group has the meaning set forth in section 1504(a) but without regard to section 1504(b)(3), except that section 1504(a) is applied by substituting ‘‘more than 50 percent’’ for ‘‘at least 80 percent’’ each place it appears. A member of the affiliated group is an entity included in the affiliated group. (2) The applicable period means, with respect to an inversion transaction, the period described in section 7874(d)(1). However, see also § 1.7874–2(b)(13) in the case of a subsequent acquisition (or a similar acquisition under the principles of § 1.7874–2(c)(4)(i)) that is an inversion transaction. (3) The completion date means, with respect to a domestic entity acquisition, the date that the domestic entity acquisition and all transactions related to the domestic entity acquisition are complete. (4) A controlled foreign corporation (or CFC) has the meaning provided in section 957. (5) A domestic entity acquisition means an acquisition described in section 7874(a)(2)(B)(i). (6) A domestic entity means, with respect to a domestic entity acquisition, a domestic corporation or domestic partnership described in section 7874(a)(2)(B)(i). A reference to a domestic entity includes a successor to such domestic corporation or domestic partnership, including a corporation that succeeds to and takes into account amounts with respect to the domestic entity pursuant to section 381. (7) An expanded affiliated group (or EAG) means, with respect to a domestic entity acquisition, an affiliated group that includes the foreign acquiring corporation, determined as of the completion date. A member of the EAG PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 is an entity included in the EAG, and a reference to a member of the EAG includes a predecessor with respect to such member. (8) An expatriated entity means, with respect to an inversion transaction— (i) The domestic entity; and (ii) A United States person that, on any date on or after the completion date, is or was related (within the meaning of section 267(b) or 707(b)(1)) to the domestic entity. (9) Expatriated foreign subsidiary—(i) General rule. Except as provided in paragraph (a)(9)(ii) of this section, an expatriated foreign subsidiary means a foreign corporation that is a CFC (determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a United States person as owning stock which is owned by a person who is not a United States person) and in which an expatriated entity is a United States shareholder (determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a United States person as owning stock which is owned by a person who is not a United States person). (ii) Exception to the general rule. A foreign corporation is not an expatriated foreign subsidiary if, with respect to the inversion transaction as a result of which the foreign corporation otherwise would be an expatriated foreign subsidiary— (A) On the completion date, the foreign corporation was both a CFC (determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a United States person as owning stock which is owned by a person who is not a United States person) and a member of the EAG; and (B) On or before the completion date, the domestic entity was not a United States shareholder (determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) so as to consider a United States person as owning stock which is owned by a person who is not a United States person) with respect to the foreign corporation. (10) A foreign acquiring corporation means, with respect to a domestic entity acquisition, the foreign corporation described in section 7874(a)(2)(B). A reference to a foreign acquiring corporation includes a successor to the foreign acquiring corporation, including a corporation that succeeds to and takes into account amounts with respect to the foreign acquiring corporation pursuant to section 381. (11) A foreign related person means, with respect to an inversion transaction, a foreign person that is related (within E:\FR\FM\12JYR2.SGM 12JYR2 Federal Register / Vol. 83, No. 134 / Thursday, July 12, 2018 / Rules and Regulations amozie on DSK3GDR082PROD with RULES2 the meaning of section 267(b) or 707(b)(1)) to, or under the same common control as (within the meaning of section 482), a person that is an expatriated entity with respect to the inversion transaction. (12) A former domestic entity partner of a domestic entity that is a domestic partnership is any person that held an interest in the partnership before the domestic entity acquisition, including any person that holds an interest in the partnership both before and after the domestic entity acquisition. (13) A former domestic entity shareholder of a domestic entity that is a domestic corporation is any person that held stock in the domestic corporation before the domestic entity acquisition, including any person that holds stock in the domestic corporation both before and after the domestic entity acquisition. (14) An interest in a partnership includes a capital or profits interest. (15) An inversion transaction means a domestic entity acquisition in which the foreign acquiring corporation is treated as a surrogate foreign corporation under VerDate Sep<11>2014 18:00 Jul 11, 2018 Jkt 244001 section 7874(a)(2)(B), taking into account section 7874(a)(3). (16) A non-EFS foreign related person means, with respect to an inversion transaction, a foreign related person that is not an expatriated foreign subsidiary. (17) The ownership fraction means, with respect to a domestic entity acquisition, the ownership percentage described in section 7874(a)(2)(B)(ii), expressed as a fraction. (18) A specified related person means, with respect to an inversion transaction— (i) A non-EFS foreign related person; (ii) A domestic partnership in which a non-EFS foreign related person is a partner; and (iii) A domestic trust of which a nonEFS foreign related person is a beneficiary. (19) A United States person means a person described in section 7701(a)(30). (20) A United States shareholder has the meaning provided in section 951(b). (b) Applicability dates. Except as otherwise provided in this paragraph (b), this section applies to domestic entity acquisitions completed on or after September 22, 2014. The following PO 00000 Frm 00039 Fmt 4701 Sfmt 9990 32561 apply to domestic entity acquisitions completed on or after April 4, 2016: paragraph (a)(8) of this section; in paragraph (a)(6) of this section, the phrase ‘‘, including a corporation that succeeds to and takes into account amounts with respect to the domestic entity pursuant to section 381’’; and the second sentence of paragraph (a)(10) of this section. For domestic entity acquisitions completed on or after September 22, 2014, and before April 4, 2016, however, taxpayers, may elect to apply the provisions in the immediately prior sentence. § 1.7874–12T [Removed] Par. 34. Section 1.7874–12T is removed. Kirsten Wielobob, Deputy Commissioner for Services and Enforcement. Approved: June 22, 2018. David J. Kautter, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2018–14693 Filed 7–11–18; 8:45 am] BILLING CODE 4830–01–P E:\FR\FM\12JYR2.SGM 12JYR2

Agencies

[Federal Register Volume 83, Number 134 (Thursday, July 12, 2018)]
[Rules and Regulations]
[Pages 32524-32561]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-14693]



[[Page 32523]]

Vol. 83

Thursday,

No. 134

July 12, 2018

Part III





Department of the Treasury





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





Internal Revenue Service





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





26 CFR Part 1





Inversions and Related Transactions; Rule

Federal Register / Vol. 83 , No. 134 / Thursday, July 12, 2018 / 
Rules and Regulations

[[Page 32524]]


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

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9834]
RIN 1545-BO20; 1545-BO22


Inversions and Related Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations, temporary regulations, and removal of 
temporary regulations.

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

SUMMARY: This document contains final regulations that address 
transactions that are structured to avoid the purposes of sections 7874 
and 367 of the Internal Revenue Code (the Code) and certain post-
inversion tax avoidance transactions. These regulations affect certain 
domestic corporations and domestic partnerships whose assets are 
directly or indirectly acquired by a foreign corporation and certain 
persons related to such domestic corporations and domestic 
partnerships. This document finalizes proposed regulations, and removes 
temporary regulations, published on April 8, 2016.

DATES: 
    Effective date: These regulations are effective on July 12, 2018.
    Applicability dates: For dates of applicability, see Sec. Sec.  
1.304-7(e), 1.367(a)-3(c)(11)(ii), 1.367(b)-4(h), 1.956-2(i), 
1.7701(l)-4(h), 1.7874-1(i)(2), 1.7874-2(l)(2), 1.7874-3(f)(2), 1.7874-
6(h), 1.7874-7(g), 1.7874-8(i), 1.7874-9(g), 1.7874-10(l), 1.7874-
11(f), and 1.7874-12(b).

FOR FURTHER INFORMATION CONTACT: Regarding the regulations under 
sections 304, 367, and 7874, Shane M. McCarrick, (202) 317-6937; 
regarding the regulations under sections 956 and 7701(l), Rose E. 
Jenkins, (202) 317-6934 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

    On April 8, 2016, the Department of the Treasury (the Treasury 
Department) and the IRS published final and temporary regulations under 
sections 304, 367, 956, 7701(l), and 7874 (TD 9761) in the Federal 
Register (81 FR 20858, as corrected at 81 FR 40810 and 81 FR 46832). On 
the same date, the Treasury Department and the IRS published a notice 
of proposed rulemaking (REG-135734-14) in the Federal Register (81 FR 
20588, as corrected at 81 FR 35275) by cross-reference to the temporary 
regulations (the 2016 proposed regulations) (together with the final 
and temporary regulations described in the preceding sentence, the 2016 
regulations). No public hearing was requested or held. Numerous written 
comments were received with respect to the proposed regulations and are 
available at www.regulations.gov or upon request. A comment was also 
received with respect to a notice that preceded the 2016 regulations 
(Notice 2015-79, 2015-49 I.R.B. 775) and, as explained in the preamble 
to those regulations, the comment has been included in the 
administrative record for the proposed regulations. The majority of the 
comments supported the 2016 regulations.
    On January 18, 2017, the Treasury Department and the IRS published 
final and temporary regulations under section 7874 (TD 9812) in the 
Federal Register (82 FR 5388, as corrected at 82 FR 42233), which 
adopted as final regulations the proposed regulations in Sec.  1.7874-4 
(including the portions included in the 2016 regulations) and modified 
certain portions of the 2016 regulations (see 82 FR 5476-01). This 
Treasury decision adopts the remaining 2016 proposed regulations, with 
the changes generally described in the Summary of Comments and 
Explanation of Revisions section of this preamble, as final regulations 
and removes the corresponding temporary regulations.

II. Section 7874 Background

    A foreign corporation (foreign acquiring corporation) generally is 
treated as a surrogate foreign corporation under section 7874(a)(2)(B) 
if, pursuant to a plan (or a series of related transactions), three 
conditions are satisfied. First, the foreign acquiring corporation 
completes, after March 4, 2003, the direct or indirect acquisition of 
substantially all of the properties held directly or indirectly by a 
domestic corporation (domestic entity acquisition). Second, after the 
domestic entity acquisition, at least 60 percent of the stock (by vote 
or value) of the foreign acquiring corporation is held by former 
shareholders of the domestic corporation (former domestic entity 
shareholders) by reason of holding stock in the domestic corporation 
(such percentage, the ownership percentage, and the fraction used to 
calculate the ownership percentage, the ownership fraction). And third, 
after the domestic entity acquisition, the expanded affiliated group 
(as defined in section 7874(c)(1)) that includes the foreign acquiring 
corporation (EAG) does not have substantial business activities in the 
foreign country in which, or under the law of which, the foreign 
acquiring corporation is created or organized when compared to the 
total business activities of the EAG. Similar provisions apply if a 
foreign acquiring corporation acquires substantially all of the 
properties constituting a trade or business of a domestic partnership. 
The domestic corporation or the domestic partnership described in this 
paragraph is referred to at times in this preamble as the ``domestic 
entity.'' For other definitions used throughout this preamble but not 
defined in this preamble, see Sec.  1.7874-12 (providing common 
definitions for purposes of certain regulations under sections 367(b), 
956, 7701(l), and 7874).
    The tax treatment of a domestic entity acquisition in which the EAG 
does not have substantial business activities in the relevant foreign 
country varies depending on the level of owner continuity. If the 
ownership percentage is at least 80, the foreign acquiring corporation 
is treated as a domestic corporation for all purposes of the Code 
pursuant to section 7874(b).
    If, instead, the ownership percentage is at least 60 but less than 
80 (in which case the domestic entity acquisition is referred to in 
this preamble as an ``inversion transaction''), the foreign acquiring 
corporation is respected as a foreign corporation but the domestic 
entity and certain other persons are subject to special rules that 
reduce the tax benefits of the inversion transaction. For example, 
section 7874(a)(1) prevents the use of certain tax attributes to reduce 
the U.S. federal income tax owed on certain income or gain (inversion 
gain) recognized in transactions intended to remove foreign operations 
from the U.S. taxing jurisdiction. ``An Act to provide for 
reconciliation pursuant to titles II and V of the concurrent resolution 
on the budget for fiscal year 2018'' (the Act), Public Law 115-97, 
amended certain sections of the Code to further reduce the tax benefits 
of inversion transactions. See section 1(h)(11)(C)(iii) (shareholders 
of surrogate foreign corporations not eligible for reduced rate on 
dividends); section 59A (for inverted groups, generally treating costs 
of goods sold as a base erosion payment for purposes of the base 
erosion and anti-abuse tax); section 965 (upon certain inversions, 
recapturing the benefit of a deduction related to a transition tax); 
and section 4985 (increasing the rate of the excise tax imposed on 
certain holders of stock options and other stock-based compensation).
    Section 7874(c)(6) grants the Secretary authority to prescribe 
regulations as

[[Page 32525]]

may be appropriate to determine whether a corporation is a surrogate 
foreign corporation, including regulations to treat stock as not stock. 
In addition, section 7874(g) grants the Secretary authority to provide 
regulations necessary to carry out section 7874, including regulations 
providing for such adjustments to the application of section 7874 as 
are necessary to prevent the avoidance of the purposes of section 7874.

Summary of Comments and Explanation of Revisions

I. Rules Addressing Certain Transactions That Are Structured To Avoid 
the Purposes of Section 7874

    To address certain transactions that are structured to avoid the 
purposes of section 7874, the 2016 regulations provided rules for (i) 
identifying domestic entity acquisitions and foreign acquiring 
corporations in certain multiple-step transactions; (ii) calculating 
the ownership percentage and, more specifically, disregarding certain 
stock of the foreign acquiring corporation for purposes of computing 
the denominator of the ownership fraction and, in addition, taking into 
account certain non-ordinary course distributions (NOCDs) made by a 
domestic entity for purposes of computing the numerator of the 
ownership fraction; (iii) determining when certain stock of a foreign 
acquiring corporation is treated as held by a member of the EAG; and 
(iv) determining when an EAG has substantial business activities in a 
relevant foreign country. The comments and modifications with respect 
to these rules are discussed in this Part I.

A. Calculation of the Ownership Percentage

1. Passive Assets Rule
    Section 1.7874-7T of the 2016 regulations provides a rule (the 
passive assets rule) that excludes from the denominator of the 
ownership fraction stock of the foreign acquiring corporation 
attributable to certain passive assets. In general, the rule applies 
with respect to a domestic entity acquisition if, on the completion 
date, more than 50 percent of the gross value of all foreign group 
property constitutes foreign group nonqualified property. The amount of 
stock that is excluded is equal to the product of (i) the value of the 
stock of the foreign acquiring corporation, other than stock that is 
described in section 7874(a)(2)(B)(ii) and stock that is excluded from 
the denominator of the ownership fraction under either Sec.  1.7874-
1(b) or Sec.  1.7874-4(b) (the multiplicand), and (ii) the proportion 
of foreign group property that is foreign group nonqualified property, 
determined based on gross value (the foreign group nonqualified 
property fraction). For purposes of determining the foreign group 
nonqualified property fraction, property received by the EAG that gives 
rise to stock excluded from the ownership fraction under Sec.  1.7874-
4(b) is not taken into account.
    Under the 2016 regulations, the passive assets rule applies for 
purposes of determining the ownership percentage by vote and value. The 
Treasury Department and the IRS have determined that applying the rule 
for purposes of determining the ownership percentage by vote could give 
rise to administrative complexities, because the rule does not exclude 
particular shares of stock but instead excludes an amount of stock. In 
particular, when classes of stock of the foreign acquiring corporation 
have different voting power, a special rule would be needed to allocate 
the excluded amount among the shares. Consistent with other rules under 
section 7874, the Treasury Department and the IRS have concluded that 
the rule should apply only for purposes of determining the ownership 
percentage by value. See Sec.  1.7874-8 (excluding an amount of stock 
for purposes of determining the ownership percentage by value); Sec.  
1.7874-10 (treating an amount as additional stock described in section 
7874(a)(2)(B)(ii) for purposes of determining the ownership percentage 
by value). The final regulations therefore contain this modification. 
See Sec.  1.7874-7(b).
    The Treasury Department and the IRS have also determined that the 
passive assets rule should be modified to take into account the other 
stock exclusion rules. For example, stock excluded under Sec.  1.7874-
8(b) (disregard of certain stock attributable to serial acquisitions) 
or Sec.  1.7874-9(b) (disregard of certain stock in third-country 
transactions) should not be taken into account when determining the 
multiplicand. In addition, property of an entity the acquisition of 
which gives rise to stock excluded under Sec.  1.7874-8(b) or Sec.  
1.7874-9(b) generally should not be taken into account when determining 
the foreign group nonqualified property fraction. The final regulations 
thus modify the multiplicand so that stock excluded under any of the 
stock exclusion rules is not taken into account. See Sec.  1.7874-
7(b)(1). Further, the final regulations modify the foreign group 
nonqualified property fraction so that, in general, property that gives 
rise to stock excluded under any of the stock exclusion rules is not 
taken into account. See Sec.  1.7874-7(e)(3). The final regulations 
also include an example illustrating these rules. See Sec.  1.7874-7(f) 
Example 4.
    Further, in response to a comment, the final regulations clarify 
that the passive assets rule is subject to section 7874(c)(4). See 
Sec.  1.7874-7(a) (penultimate sentence). For example, section 
7874(c)(4) can apply to the transfer of properties or liabilities as 
part of a plan a principal purpose of which is to prevent the more-
than-50-percent threshold of the passive assets rule from being 
satisfied with respect to a domestic entity acquisition. In these 
cases, section 7874(c)(4) would disregard the transaction and, as a 
result, the passive assets rule (including the more-than-50-percent 
threshold) would be applied as if the transfer did not occur.
    Lastly, and also in response to a comment, the Treasury Department 
and the IRS clarify Sec.  1.7874-7(e)(1)(i)(C), which excludes property 
that gives rise to income described in section 1297(b)(2)(A) or (B) 
from the definition of foreign group nonqualified property. Under 
section 1297(b)(2)(A) and (B), for certain purposes of the passive 
foreign investment company rules, passive income does not include 
certain income derived in the active conduct of a banking or insurance 
business. The final regulations clarify that for purposes of 
determining whether property qualifies for the exclusion under Sec.  
1.7874-7(e)(1)(i)(C), other passive foreign investment company rules do 
not apply. See Sec.  1.7874-7(e)(1)(i)(C) (parenthetical language). 
Thus, for example, the rules in section 1298(b)(2) or (3) that except 
certain corporations from being treated as passive foreign investment 
companies during a start-up year or following a change in business do 
not apply for this purpose.
2. Serial Acquisitions of Domestic Entities
    Section 1.7874-8T of the 2016 regulations provides a rule (the 
serial acquisition rule) that, with respect to a domestic entity 
acquisition (a relevant domestic entity acquisition), excludes from the 
denominator of the ownership fraction stock of the foreign acquiring 
corporation attributable to certain domestic entity acquisitions 
previously completed by the foreign acquiring corporation (or a 
predecessor). Consistent with the explanation in the preamble to the 
2016 regulations, this rule addresses a concern that domestic entity 
acquisitions previously completed by the foreign acquiring corporation 
serve as a platform for

[[Page 32526]]

additional and even larger domestic entity acquisitions.
    For administrability purposes, the serial acquisition rule under 
the 2016 regulations looks only to whether the foreign acquiring 
corporation completed a domestic entity acquisition within the 36-month 
period ending on the signing date of the relevant domestic entity 
acquisition (such acquisition, in general, a ``prior domestic entity 
acquisition''). Absent this 36-month look-back period, the rule could 
be difficult to administer, as all domestic entity acquisitions 
previously completed by the foreign acquiring corporation would need to 
be identified. In addition, as the period between a relevant domestic 
entity acquisition and a previous domestic entity acquisition 
increases, it may become more difficult to determine which stock of the 
foreign acquiring corporation is attributable to the previous domestic 
entity acquisition (for example, due to changes in the capital 
structure of the foreign acquiring corporation resulting from divisive 
or acquisitive transactions). The use of a 36-month look-back period 
provides an administrable standard and is consistent with other look-
back periods under the Code and regulations. See, e.g., section 865(f) 
(sourcing rule for sales of stock in a foreign affiliate); section 2035 
(transfers before death); section 7701(b)(3) (substantial presence test 
for residency); and Sec.  1.7874-10 (NOCD rule). The final regulations 
therefore retain the 36-month look-back period.
    The majority of the comments received on the 2016 regulations 
involved the serial acquisition rule. Of those comments, nearly every 
one supported the rule.
    One comment, however, while generally supporting the prevention of 
inversions, asserted that the serial acquisition rule targets a 
specific transaction that was pending when the 2016 regulations were 
issued. The comment suggested that this would cause mistrust of federal 
agencies and could ultimately harm U.S. businesses. The Treasury 
Department and the IRS disagree with the comment. The serial 
acquisition rule does not target a specific transaction. Instead, and 
as explained in the preamble to the 2016 regulations, it addresses a 
particular practice occurring in the marketplace in which a foreign 
acquiring corporation completes multiple domestic entity acquisitions 
over a span of just a few years, with the corporation's increased value 
serving as a platform to complete still larger domestic entity 
acquisitions that avoid the application of section 7874. The Treasury 
Department and the IRS have concluded that such serial acquisitions, 
which in effect permit a single foreign acquiring corporation to 
facilitate the inversion of multiple domestic entities over time, are 
inconsistent with the policies underlying section 7874. As also 
explained in the preamble to the 2016 regulations, the Treasury 
Department and the IRS have determined that the rule appropriately 
addresses this practice. See Part I.B.3.a of the Explanation of 
Provisions of the preamble to the 2016 regulations; see also S. Rep. 
No. 192, at 142 (2003) (expressing concern that certain inversions 
``permit corporations and other entities to continue to conduct 
business in the same manner as they did prior to the inversion, but 
with the result that the inverted entity avoids U.S. tax on foreign 
operations and may engage in earnings-stripping techniques to avoid 
U.S. tax on domestic operations.'').
    One other comment asserted that the serial acquisition rule exceeds 
statutory authority and lacks a reasoned explanation. Those same claims 
were subsequently asserted in Chamber of Commerce of the United States 
v. Internal Revenue Serv., No. 1:16-CV-944-LY (W.D. Tex. Sept. 29, 
2017), appeal docketed, No. 17-51063 (5th Cir. Dec. 1, 2017), in which 
the serial acquisition rule in the temporary regulations was 
challenged. While the district court invalidated the temporary 
regulation on procedural grounds because it was not subjected to prior 
notice and comment, the court found that the serial acquisition rule 
was substantively valid under sections 7874(c)(6) and (g) (the Code 
sections under which the Treasury Department and the IRS promulgated 
the rule). The court concluded that the rule did not exceed the 
statutory authority of the Treasury Department and the IRS because it 
was within their broad authority under section 7874 to ``treat stock as 
not stock''--the exercise of which, the court noted, could in certain 
cases ``substantially alter a calculation under the statute''--and to 
prevent the avoidance of the purposes of section 7874. The court also 
``reviewed the full analysis by which the Agencies determined the Rule 
is necessary'' and concluded that the Treasury Department and the IRS 
provided a sufficient explanation in issuing the serial acquisition 
rule in the temporary regulation, and did not engage in arbitrary and 
capricious rulemaking.
    The final regulations adopt the rule with three technical 
clarifications or modifications, in response to comments.
    First, the final regulations clarify that the determination of 
stock of the foreign acquiring corporation attributable to a prior 
domestic entity acquisition does not take into account stock of the 
foreign acquiring corporation deemed under Sec.  1.7874-10(b) (the NOCD 
rule) or section 7874(c)(4) more broadly to have been received in the 
prior domestic entity acquisition. See Sec.  1.7874-8(g)(3) (excluding 
such stock from the definition of total number of prior acquisition 
shares).
    Second, the final regulations provide an exception to the 
definition of the term prior domestic entity acquisition in addition to 
the one under the 2016 regulations (relating to certain de minimis 
acquisitions). Under this additional exception, the term does not 
include a domestic entity acquisition that occurs within a foreign-
parented group and qualifies for the internal group restructuring 
exception of Sec.  1.7874-1(c)(2). See Sec.  1.7874-8(g)(4)(ii)(B). In 
these cases, the Treasury Department and the IRS have determined that 
because the domestic entity remains (or is considered to remain) within 
the same foreign-parented group, the acquisition should not be viewed 
as creating a platform to complete larger domestic entity acquisitions. 
As a result, the Treasury Department and the IRS have concluded that 
these acquisitions do not give rise to the policy concerns underlying 
the serial acquisition rule. Accordingly, like under the 2016 
regulations, the term prior domestic entity acquisition under the final 
regulations means any domestic entity acquisition completed by the 
foreign acquiring corporation (or a predecessor) within a 36-month 
look-back period, except for those acquisitions that, for 
administrative or policy reasons, qualify for an exception.
    Third, the final regulations define a predecessor of a foreign 
acquiring corporation for purposes of the serial acquisition rule. See 
Sec.  1.7874-8(b) (defining predecessor by cross-reference to the 
definition in the NOCD rule under Sec.  1.7874-10(f)(1)).
3. Third-Country Rule
    Section 1.7874-9T of the 2016 regulations provides a rule (the 
third-country rule) that excludes stock of the foreign acquiring 
corporation from the denominator of the ownership fraction when a 
domestic entity acquisition is a ``third-country transaction,'' which 
occurs when three requirements are satisfied. First, the foreign 
acquiring corporation must complete a ``covered foreign acquisition'' 
in a transaction related to the domestic entity acquisition. In 
general, a covered foreign acquisition is an acquisition by the foreign 
acquiring corporation of another

[[Page 32527]]

foreign corporation (such acquisition, a ``foreign acquisition,'' and 
such corporation, an ``acquired foreign corporation''), provided that 
an ownership continuity requirement is satisfied. Second, after all 
related transactions are complete, the foreign acquiring corporation 
must be a tax resident in a ``third country''--that is, a foreign 
country other than the foreign country in which, before the foreign 
acquisition and any related transaction, the acquired foreign 
corporation was a tax resident. (The 2016 regulations refer to the 
country in which a corporation is ``subject to tax as a resident,'' 
rather than the country in which a corporation is ``tax resident.'' 
However, similar to the reasons discussed in Part I.C. of this Summary 
of Comments and Explanation of Revisions section (concerning the 
substantial business activities test), the final regulations refer to 
``tax resident.'') And third, the ownership percentage, determined 
without regard to the third country rule, must be at least 60 (by vote 
or value).
    As explained in Notice 2015-79, the Treasury Department and the IRS 
have determined that when a domestic entity acquisition is a third-
country transaction, the decision to locate the tax residence of the 
foreign acquiring corporation in the third country generally is driven 
by tax planning, including the facilitation of U.S. tax avoidance 
following the acquisition, and, as a result, generally is contrary to 
the policies underlying section 7874. Accordingly, the third country 
rule provides that stock of the foreign acquiring corporation held by 
former shareholders of the acquired foreign corporation by reason of 
holding stock in the acquired foreign corporation is excluded from the 
denominator of the ownership fraction.
a. Exceptions to Rule's Application
    A comment suggested that the Treasury Department and the IRS 
consider adding one or more exceptions to the third-country rule, so as 
to better tailor the rule's application to domestic entity acquisitions 
in which the use of a third country is likely driven by tax planning. 
The comment recommended against an exception based on the subjective 
criterion of whether a non-tax business purpose exists for the foreign 
acquiring corporation's use of the third country. Instead, the comment 
suggested that any exception should be based on objective criteria. In 
particular, the comment proposed exceptions based on (i) the foreign 
group's business activities in the third country, and (ii) a comparison 
of the treaty benefits (specifically, the withholding tax rate with 
respect to dividends, interest, and royalties) available to the foreign 
acquiring corporation in the third country as compared to the benefits 
that would be available in the country in which the acquired foreign 
corporation is a tax resident.
    In response to the comment, the final regulations provide that the 
third-country rule generally does not apply if the EAG has substantial 
business activities in the third country compared to the total business 
activities of the EAG. See Sec.  1.7874-9(d)(4)(ii) (providing an 
exception to the definition of a covered foreign acquisition). For this 
purpose, the principles of Sec.  1.7874-3 apply, and the determination 
of whether there are substantial business activities is made without 
regard to the domestic entity acquisition.
    The final regulations also generally provide that the third-country 
rule does not apply if (i) both the foreign acquiring corporation and 
the acquired foreign corporation are created or organized in, or under 
the law of, a foreign country that does not impose corporate income 
tax, and (ii) neither the foreign acquiring corporation nor the 
acquired foreign corporation is a tax resident of any other foreign 
country. See Sec.  1.7874-9(d)(4)(iii) (providing an exception to the 
definition of a covered foreign acquisition). In these cases, the 
Treasury Department and the IRS have determined that the migration from 
one no-income-tax jurisdiction to another such jurisdiction is unlikely 
to be driven by tax planning, as the countries would generally be 
equally favorable from a tax perspective.
    The Treasury Department and the IRS decline, however, to provide an 
additional exception based on a comparison of treaty benefits. Even if 
the withholding rates with respect to certain categories of income are 
at least as high under the U.S. tax treaty with the third country as 
compared to the U.S. tax treaty with the country in which the acquired 
foreign corporation is a tax resident, the use of the third country may 
nevertheless be motivated by tax planning. For example, there could be 
tax-related features other than withholding rates that make the third 
country more advantageous; and, significant administrative difficulties 
could arise if the comparison were to include those features. Moreover, 
the third country might have a less restrictive regime for controlled 
foreign corporations, which could facilitate the use of low- or no-
taxed entities to erode the U.S. tax base following the domestic entity 
acquisition. Consistent with the explanation in Notice 2015-79, the 
Treasury Department and the IRS have concluded that it is appropriate 
for the third-country rule to address this concern.
b. Other Issues
    A comment observed that, in a transaction related to a domestic 
entity acquisition, the foreign acquiring corporation could change its 
tax residency by simply changing the country in which it is considered 
managed and controlled. The comment noted that, in such a case, the 
foreign acquiring corporation might not be viewed as having completed a 
foreign acquisition and, as a result, the third-country rule could 
inappropriately be circumvented. The Treasury Department and the IRS 
agree with this comment and the final regulations are modified 
accordingly. See Sec.  1.7874-9(e)(5).
    Finally, a comment recommended clarifying that the third-country 
rule compares only the tax residency of the foreign acquiring 
corporation and acquired foreign corporation, and thus does not 
consider the countries in which the corporations are created or 
organized. The Treasury Department and the IRS have determined that 
this is clear under the 2016 regulations; therefore the text of Sec.  
1.7874-9(c)(2) is unchanged from the corresponding provision in the 
2016 regulations.
4. NOCD Rule
    Section 1.7874-10T of the 2016 regulations provides a rule (the 
NOCD rule) that, for purposes of determining the ownership percentage 
by value, deems former domestic entity shareholders or former domestic 
entity partners to receive, by reason of holding stock or an interest 
in the domestic entity, an amount of stock of the foreign acquiring 
corporation with a fair market value equal to the aggregate value of 
NOCDs made by the domestic entity (such stock, ``NOCD stock''). The 
rule provides mechanics for determining NOCDs.
    The final regulations include seven clarifications or modifications 
to the NOCD rule, in response to comments. First, the regulations 
clarify and refine the definition of distribution. The 2016 regulations 
define the term broadly but provide several exclusions, including, in 
general, an exclusion for a distribution that occurs pursuant to an 
asset reorganization. The final regulations clarify that the exclusion 
does not apply to a distribution to which section 355 applies, 
regardless of whether in connection with a reorganization described in 
section 368(a)(1)(D). See Sec.  1.7874-10(k)(1)(i)(C). That is, a 
distribution of stock of a controlled corporation pursuant to a

[[Page 32528]]

divisive reorganization is a distribution for purposes of the NOCD 
rule, but a distribution of an acquiring corporation's stock pursuant 
to an acquisitive reorganization (such as a merger described in section 
368(a)(1)(A)) is not a distribution for this purpose. In addition, the 
final regulations refine the definition of distribution such that, in 
the case of a partnership, a distribution does not include a deemed 
distribution pursuant to section 752(b) to the extent that the 
transaction giving rise to the deemed distribution does not reduce the 
partnership's value.
    Second, the final regulations modify a special rule that applies 
when a domestic corporation (distributing corporation) distributes 
stock of another domestic corporation (controlled corporation) pursuant 
to a transaction described in section 355 and, immediately before the 
distribution, the fair market value of the controlled corporation 
represents more than 50 percent of the fair market value of the stock 
of the distributing corporation. When the special rule applies, the 
controlled corporation is deemed for purposes of the NOCD rule to have 
distributed the stock of the distributing corporation. The final 
regulations modify the condition for the rule to apply: As modified, 
the rule considers the fair market value of the stock of the controlled 
corporation owned by the distributing corporation and any related 
person. See Sec.  1.7874-10(g). Accordingly, the special rule would not 
apply, for example, if the fair market value of the stock of the 
distributing corporation were $100x (not taking into account the fair 
market value of the stock of the controlled corporation), the fair 
market value of the stock of the controlled corporation were $110x, and 
$100x or less of the stock of the controlled corporation were owned by 
the distributing corporation (with the balance owned by a person 
unrelated to the distributing corporation).
    Third, the final regulations clarify how the NOCD rule relates to 
the expanded affiliated group rules of section 7874(c)(2)(A) and Sec.  
1.7874-1 (the EAG rules). The preamble to the 2016 regulations 
indicates that the NOCD rule applies only for purposes of determining 
the ownership percentage by value and that it does not apply for any 
other purpose, including the loss of control exception of Sec.  1.7874-
1(c)(3) (one of the EAG rules). The final regulations clarify that NOCD 
stock is not taken into account for purposes of the EAG rules. See 
Sec.  1.7874-1(d)(2) (providing that NOCD stock is not taken into 
account for purposes of determining the members of an EAG or whether a 
domestic entity acquisition qualifies for the internal group 
restructuring or loss of control exception). As a result, the 
determination of the EAG and whether a domestic entity acquisition 
qualifies for the internal group restructuring or loss of control 
exception is based on the stock of the foreign acquiring corporation 
that actually exists. See also Part I.B of this Summary of Comments and 
Explanation of Revisions section (discussing the interaction of the 
stock exclusion rules and the EAG rules).
    Fourth, the final regulations provide guidance regarding how to 
allocate NOCD stock among the former domestic entity shareholders. 
Because the NOCD rule provides that NOCD stock is treated as stock 
described in section 7874(a)(2)(B)(ii), in most cases the NOCD stock 
will simply be included in both the numerator and denominator of the 
ownership fraction and, as a result, it will be irrelevant which former 
domestic entity shareholders or former domestic entity partners are 
considered to hold such stock. However, in certain cases involving the 
application of the EAG rules, the allocation of the NOCD stock among 
the former domestic entity shareholders or former domestic entity 
partners may affect whether the stock is included in the numerator and 
denominator of the ownership fraction.
    For example, assume two foreign corporations, F1 and F2, each own 
50% of the stock of a domestic corporation, DT. During year y, DT makes 
a $10x distribution to each of F1 and F2 and, thereafter, distributes 
$40x to F2 in redemption of all of F2's stock of DT. Then, on December 
31 of year y, and in a transaction related to the redemption, F1 
contributes all of the stock of DT to a newly-formed foreign 
corporation, FA, in exchange for all the stock of FA (DT acquisition). 
Assume that there are $36x of NOCDs with respect to the look-back year 
ending on December 31 of year y and that there are no NOCDs with 
respect to the other look-back years. An EAG exists (for this purpose, 
NOCD stock is not taken into account), composed of F1, FA, and DT, but 
the DT acquisition does not qualify for the internal group 
restructuring exception because F1 did not own 80 percent or more of 
the stock of DT before the DT acquisition and any related transaction. 
See Sec.  1.7874-1(c)(2)(i) and (g). Moreover, the acquisition does not 
qualify for the loss of control exception because after the acquisition 
F1 (a former domestic entity shareholder) holds more than 50 percent of 
the stock of a member of the EAG. See Sec.  1.7874-1(c)(3). Thus, all 
FA stock held by F1, including any NOCD stock considered held by F1, is 
excluded from the numerator and denominator of the ownership fraction. 
See Sec.  1.7874-1(b). Any NOCD stock considered held by F2, however, 
is included in both the numerator and the denominator of the ownership 
fraction.
    To address this allocation issue, the final regulations provide 
that NOCD stock is allocated among the former domestic entity 
shareholders or former domestic entity partners based on the amount of 
NOCDs that the persons are treated as receiving. See Sec.  1.7874-
10(h). For this purpose, and for ease of administration, the 
regulations provide that a pro rata portion of each distribution during 
a look-back year is treated as comprising an NOCD with respect to the 
look-back year, based on the amount of NOCDs during the year relative 
to the total amount of distributions during the year. Thus, in the 
example above, because 60 percent of the distributions during year y 
constituted NOCDs ($36x/$60x), 60 percent of each of the $10x dividend 
distributions to F1 and F2, as well as 60 percent of the $40x 
distribution to F2 as part of the redemption, are treated as comprising 
the NOCD. Accordingly, under Sec.  1.7874-10(h), F1 and F2 are treated 
as having received $6x and $30x of distributions comprising the NOCD, 
respectively. F1 and F2 are therefore treated as holding $6x and $30x 
of NOCD stock, respectively. As a result, the ownership percentage (by 
value) with respect to the DT acquisition is 100 ($30x/$30x).
    Fifth, the final regulations provide guidance when multiple foreign 
acquiring corporations complete a domestic entity acquisition, as to 
which corporation's or corporations' stock the NOCD stock is considered 
comprised. In general, the final regulations provide that the NOCD 
stock is considered comprised, on a pro rata basis, of stock of each 
foreign acquiring corporation that directly or indirectly provided 
consideration in the domestic entity acquisition. For this purpose, 
consideration is not considered directly provided by a foreign 
acquiring corporation if it was indirectly provided by another foreign 
acquiring corporation. See Sec.  1.7874-10(i). For example, assume FP, 
a foreign corporation, owns all the stock of FS, also a foreign 
corporation, and FS acquires all the stock of DT, a domestic 
corporation, solely in exchange for FP stock. Pursuant to Sec.  1.7874-
2(c)(1)(i) and (iii), both FS and FP are treated as having completed a 
domestic entity acquisition. Under Sec.  1.7874-10(i), because FP 
indirectly provided 100

[[Page 32529]]

percent of the consideration in the domestic entity acquisition, stock 
of FP is considered to comprise 100 percent of any NOCD stock.
    Sixth, the final regulations address how the NOCD rule applies 
when, pursuant to Sec.  1.7874-2(e), two or more domestic entities are 
treated as a single domestic entity. Specifically, the regulations 
provide that the NOCD rule is initially applied to each domestic entity 
on a separate basis, and then the amount of NOCDs treated as made by 
the single domestic entity is the sum of the separately computed NOCDs 
made by each domestic entity. See Sec.  1.7874-10(j).
    Finally, the final regulations confirm that NOCD stock is included 
in both the numerator and the denominator of the ownership fraction, 
except to the extent that the stock is treated as held by a member of 
the EAG and excluded from the numerator or both the numerator and 
denominator, as applicable, under the EAG rules. See Sec.  1.7874-
1(d)(2).
5. De Minimis Exceptions
    Certain stock exclusion rules under section 7874 contain a de 
minimis exception. See Sec.  1.7874-4(b) (disqualified stock rule); 
Sec.  1.7874-7T(b) (passive assets rule); and 1.7874-10T(b) (NOCD 
rule). As explained in the preamble to TD 9812 (final regulations 
regarding the disqualified stock rule), together the de minimis 
exceptions generally prevent one or more of the disqualified stock 
rule, the passive assets rule, and NOCD rule from causing section 7874 
to apply to a domestic entity acquisition that, given minimal actual 
ownership continuity, largely resembles a cash purchase by the foreign 
acquiring corporation of the stock of (or interests in) the domestic 
entity.
    Each of the de minimis exceptions is satisfied when two 
requirements are met. First, the ownership percentage--determined 
without regard to the application of the disqualified stock rule, the 
passive assets rule, and the NOCD rule--must be less than five (by vote 
and value). Second, after the domestic entity acquisition and all 
related transactions, each former domestic entity shareholder or former 
domestic entity partner, as applicable, must own (applying the 
attribution rules of section 318(a) with the modifications described in 
section 304(c)(3)(B)) less than five percent (by vote and value) of the 
stock of (or a partnership interest in) each member of the EAG. 
Originally, this second requirement considered the ownership by the 
former domestic entity shareholders or former domestic entity partners 
collectively. However, in response to a comment, TD 9812 modified the 
requirement so that it considers only the ownership by the former 
domestic entity shareholders or former domestic entity partners 
individually.
    Similar to a comment submitted with respect to the disqualified 
stock rule and addressed in TD 9812, a comment recommended additional 
modifications to the second requirement. The comment stated that, 
particularly in cases involving a publicly-traded domestic entity or a 
complex ownership structure, it could be difficult or burdensome to 
identify each former domestic entity shareholder or former domestic 
entity partner (including a de minimis former domestic entity 
shareholder or former domestic entity partner), as applicable, and then 
determine (taking into account the applicable attribution rules) the 
person's ownership of the foreign acquiring corporation and each member 
of the EAG.
    The Treasury Department and the IRS agree that it is appropriate to 
modify the second requirement in order to make the de minimis 
exceptions easier for taxpayers to comply with and for the IRS to 
administer. Accordingly, under the final regulations, only former 
domestic entity shareholders or former domestic entity partners, as 
applicable, that own (taking into account the applicable attribution 
rules) at least five percent of the stock of (or a partnership interest 
in) the domestic entity need be identified. If none of those former 
domestic entity shareholders or former domestic entity partners owns 
(taking into account the applicable attribution rules) at least five 
percent of the foreign acquiring corporation or a member of the EAG, 
then the second requirement is satisfied.

B. Coordination of Rules Affecting the Ownership Fraction With the EAG 
Rules

    Existing regulations under section 7874 coordinate the application 
of (i) rules that disregard certain stock of the foreign acquiring 
corporation for purposes of determining the ownership fraction, with 
(ii) the EAG rules. See Sec.  1.7874-4(h) (regarding the interaction of 
the EAG rules with the rule that disregards disqualified stock) and 
Sec.  1.7874-7T(e) (regarding the interaction of the EAG rules with the 
rule that disregards certain stock attributable to passive assets). The 
final regulations broaden this coordination to other rules that 
similarly disregard certain stock of the foreign acquiring corporation 
for purposes of determining the ownership fraction--namely, the serial 
acquisition rule and the third-country rule, as well as section 
7874(c)(4) generally, the application of which in certain cases would 
similarly disregard stock of the foreign acquiring corporation. The 
final regulations provide a general coordination rule in Sec.  1.7874-
1(d)(1) to coordinate the stock exclusion rules and the EAG rules, and 
remove provisions of the existing regulations that are duplicative of 
this rule. See Sec.  1.7874-4(i), Example 8 and Example 9 for 
illustrations involving the general coordination rule.

C. The Substantial Business Activities Test

    Section 1.7874-3T(b)(4) of the 2016 regulations provides that, for 
an EAG to be considered to have substantial business activities in the 
relevant foreign country, the foreign acquiring corporation must be 
subject to tax as a resident of the ``relevant foreign country'' (the 
tax residence requirement). The relevant foreign county means the 
foreign country in which, or under the law of which, the foreign 
acquiring corporation was created or organized (country of 
organization). The tax residence requirement is in addition to the 
three qualitative requirements relating to the percentage of employees, 
assets, and income in the relevant foreign country. See Sec.  1.7874-
3(b)(1) through (3).
    One comment made several recommendations with respect to the 
substantial business activities test. First, the comment recommended 
providing standards for determining when the tax residence requirement 
is considered satisfied, including in cases in which the relevant 
foreign country is a no-income-tax jurisdiction. The comment suggested 
that the standards be based on the definition of residence under the 
United States' income tax treaties with foreign countries. It further 
suggested providing guidance on when a foreign acquiring corporation is 
considered to be fiscally-transparent in, and thus not a tax resident 
of, the relevant foreign country.
    The Treasury Department and the IRS generally agree with these 
recommendations. The final regulations thus define a tax resident of a 
country as a body corporate liable to tax under the laws of the country 
as a resident. See Sec.  1.7874-3(d)(11). The Treasury Department and 
the IRS have concluded that defining tax resident in this manner 
obviates the need to provide specific guidance on when a foreign 
acquiring corporation is treated as fiscally-transparent under the laws 
of the relevant foreign country. In addition, the Treasury Department 
and the IRS have determined that when the relevant

[[Page 32530]]

foreign country is a country that does not impose corporate income tax, 
the tax residency requirement should not apply. See Sec.  1.7874-
3(b)(4) (second sentence).
    The comment also suggested that the Treasury Department and the IRS 
consider changing the definition of relevant foreign country from the 
country of organization to the country in which the foreign acquiring 
corporation is a tax resident. Under this approach, the substantial 
business activities test would look to the percentage of the EAG's 
employees, assets, and income in the foreign country where the foreign 
acquiring corporation is a tax resident, without regard to the 
corporation's country of organization. The Treasury Department and the 
IRS have concluded that section 7874(a)(2)(B)(iii) requires substantial 
business activities in the country of organization, with tax residency 
in that country serving as a necessary component for establishing 
substantial business activities. Accordingly, the final regulations do 
not adopt this comment.

II. Rules Addressing Certain Post-Inversion Tax Avoidance Transactions

    As described in the preamble to the 2016 regulations, as well as in 
Notice 2015-79 and Notice 2014-52 (2014-42 I.R.B. 712), certain 
inversion transactions are motivated in substantial part by the ability 
to engage in tax avoidance transactions after the inversion transaction 
that would not be possible in the absence of the inversion transaction. 
To reduce the tax benefits of certain post-inversion tax avoidance 
transactions, the 2016 regulations provided rules under sections 
304(b)(5)(B), 367, 956(e), 7701(l), and 7874. The comments and 
modifications with respect to these rules are discussed in this Part 
II.

A. United States Property Rule

    Section 1.956-2T(a)(4)(i) of the 2016 regulations provides that, 
generally, for purposes of section 956 and Sec.  1.956-2(a), United 
States property includes an obligation of a foreign person and stock of 
a foreign corporation if (i) the obligation or stock is held by a CFC 
that is an expatriated foreign subsidiary (EFS), (ii) the foreign 
person or foreign corporation is a non-CFC foreign related person, and 
(iii) the obligation or stock was acquired either during the applicable 
period or in a transaction related to the inversion transaction. 
Similarly, Sec.  1.956-2T(c)(5) extends the pledge and guarantee rule 
in Sec.  1.956-2(c) to apply to obligations of non-CFC foreign related 
persons.
    Comments requested that the rules in Sec.  1.956-2T of the 2016 
regulations (the United States property rule) be extended to apply to 
all foreign-parented groups, and not only those that are foreign-
parented as a result of an inversion transaction. The Treasury 
Department and the IRS continue to study those comments, but do not 
adopt them in these final regulations.

B. Nomenclature and Other Changes

    For clarity, the final regulations use the term ``non-EFS foreign 
related person'' instead of the term ``non-CFC foreign related 
person.''
    In addition, the final regulations modify various examples 
involving foreign corporations that were not controlled foreign 
corporations before the effective date of section 14214 of the Act 
(amending section 958(b) so as to provide ``downward attribution'' of 
stock from foreign persons to United States persons). In general, the 
final regulations now refer to those foreign corporations as CFCs, as 
appropriate, and otherwise retain the regulations under sections 
367(b), 956, and 7701(l). Although the recent amendment to section 
958(b)(4) makes it more difficult for post-inversion planning to cause 
an EFS to cease to be a CFC, such planning could still substantially 
dilute a United States shareholder's interest in the EFS. Accordingly, 
the recharacterization rules under Sec.  1.7701(l)-4T concerning post-
inversion dilution are finalized. The Treasury Department and the IRS 
decline at this time to extend the application of Sec.  1.7701(l)-4 to 
all foreign-parented groups, in part, because other provisions may 
address such planning, including the fast-pay arrangement rules under 
Sec.  1.7701(l)-3.
    Further, for purposes of determining whether an entity is an EFS, 
the final regulations provide that downward attribution from a non-
United States person to a United States person does not apply. Absent 
this modification, in certain cases the term EFS would be over-
inclusive and, as a result, the term non-EFS foreign related person 
would be under-inclusive; this could result in the regulations under 
sections 367(b), 956, and 7701(l) inappropriately not applying in 
certain cases. Similarly, the final regulations provide that, when 
determining if an entity is a CFC for purposes of Sec.  1.304-7, 
downward attribution from a non-United States person to a United States 
person does not apply. The Treasury Department and the IRS have 
determined that these modifications--the effect of which is that the 
determination of whether an entity is an EFS, as well as whether an 
entity is a CFC for purposes of Sec.  1.304-7, is the same under pre- 
and post-Act law--are necessary to carry out the purposes of the 
provisions.

III. Miscellaneous Rules

A. New Definitions Section in Section 7874 Regulations

    Section 1.7874-12T of the 2016 regulations provides definitions for 
certain terms commonly used in Sec. Sec.  1.367(b)-4, 1.956-2, 
1.7701(l)-4, and certain of the section 7874 regulations. These final 
regulations adopt this definitions section. They also update other 
portions of the section 7874 regulations to conform those sections with 
the nomenclature used in Sec.  1.7874-12.

B. Rules Under Section 956 Relating to the Definition of Obligation

    Section 1.956-2T(d)(2)(iv) of the 2016 regulations provides the 
short-term obligation exception described in Notice 88-108, 1988-2 C.B. 
446, and Sec.  1.956-2T(d)(2)(v) provides the alternative short-term 
obligation exception described in Notice 2008-91, 2008-43 I.R.B. 1001, 
as modified by Notice 2009-10, 2009-5 I.R.B. 419, and Notice 2010-12, 
2010-4 I.R.B. 326. No comments were received on these rules; 
accordingly, Sec.  1.956-2(d)(2)(iv) is adopted as proposed. However, 
these final regulations do not contain the rule contained in proposed 
Sec.  1.956-2(d)(2)(v), which applied only for certain taxable years 
beginning before 2011.

C. Applicability Dates

    Section 7805(b)(1)(B) and (C) provide that a final regulation may 
apply to a taxable period ending on or after the date on which a 
proposed or temporary regulation to which the final regulation relates 
was filed with the Federal Register or the date on which a notice 
substantially describing the expected contents of the regulation was 
issued to the public. The applicability dates of the rules in the final 
regulations are generally the same as the applicability dates of the 
rules as set forth in the 2016 regulations, which were issued as 
temporary regulations to address transactions that are structured to 
avoid the purposes of sections 7874 and 367 and certain post-inversion 
tax avoidance transactions. Accordingly, the applicability date of some 
provisions in the final regulations corresponds to the date the 2016 
regulations were filed with the Federal Register, and the applicability 
dates of other provisions in the final regulations predate the filing 
of the 2016 regulations and correspond to the issuance of Notice 2014-
52, 2014-

[[Page 32531]]

42 I.R.B. 712, which was issued on September 22, 2014, or Notice 2015-
79, 2015-49 I.R.B. 775, which was issued on November 19, 2015.
    However, differences between the final regulations and the 2016 
regulations generally apply on a prospective basis, with an option for 
taxpayers to apply the differences retroactively. Moreover, because 
taxpayers may have relied on the 2016 regulations, the modifications to 
the final regulations generally apply prospectively. However, domestic 
entity acquisitions completed before July 12, 2018 continue to be 
subject to those rules as set forth in the 2016 regulations (but 
generally with an option for taxpayers to apply the differences 
retroactively).

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

Special Analyses

Regulatory Planning and Review--Economic Analysis

    Executive Orders 13563 and 12866 direct agencies to assess costs 
and benefits of available regulatory alternatives and, if regulation is 
necessary, to select regulatory approaches that maximize net benefits 
(including potential economic, environmental, public health and safety 
effects, distributive impacts, and equity). Executive Order 13563 
emphasizes the importance of quantifying both costs and benefits, of 
reducing costs, of harmonizing rules, and of promoting flexibility. 
This rule has been designated a ``significant regulatory action'' 
although not economically significant, under section 3(f) of Executive 
Order 12866. Accordingly, the rule has been reviewed by the Office of 
Management and Budget. This final rule is considered an E.O. 13771 
deregulatory action. For more detail on the economic analysis, please 
refer to the analysis below.
Need for the Final Regulations
    These final regulations refine and clarify certain aspects of the 
proposed and temporary regulations published in 2016 (collectively 
referred to as the 2016 regulations, as explained in the preamble). The 
changes finalized in this set of regulations help to ensure that the 
regulations do not impact mergers that provide market benefits 
independent of tax avoidance; for example, those that increase 
efficiencies within the corporation or provide other growth 
opportunities or that contribute to social welfare. These regulations 
still maintain the thresholds and substantiation requirements of the 
2016 regulations aimed at discouraging tax-motivated inversions.
Background
    Cross-border mergers can make the U.S. economy stronger by enabling 
U.S. companies to invest overseas and encouraging foreign investment to 
flow into the United States. In order for these benefits to be 
realized, these transactions should be driven by underlying economic 
considerations rather than by a desire to avoid U.S. taxes. One way for 
a U.S.-based multinational to avoid or reduce U.S. tax is for the 
company to expatriate by changing its tax residence from the U.S. to 
another country through an inversion transaction. Though there are some 
limitations, the transaction allows the inverted company to reduce 
future taxes on U.S.-source earnings, for example, by deducting 
interest paid on loans from the new foreign parent. In addition to 
potentially eroding the U.S. tax base, inversions may impose other 
costs on the U.S. economy. For instance, as a result of the inversion, 
a company's headquarters may move overseas. This loss of a U.S. 
corporate identity or location of headquarters for the company may 
reduce employment in the United States.
    To limit inversions that are tax-motivated, section 7874 (enacted 
in 2004), in general, targets transactions in which a foreign 
corporation acquires a domestic corporation and, immediately after the 
transaction, the former shareholders of the domestic corporation make 
up a significant portion of the shareholders of the acquiring foreign 
corporation. If the former shareholders of the domestic corporation 
hold 80 percent or more of the stock of the foreign corporation after 
the transaction, the foreign corporation is treated as a domestic 
corporation for U.S. tax purposes. If the former shareholders hold at 
least 60 percent but less than 80 percent of the stock of the foreign 
acquiring corporation after the transaction, then the transaction is 
respected but use of tax attributes such as net operating losses and 
foreign tax credits is limited. Transactions where the former 
shareholders of the domestic corporation hold less than 60 percent of 
the stock of the foreign acquiring corporation are generally not 
limited.
    Since the enactment of section 7874, multiple sets of regulations 
have been issued interpreting the statute and restricting the ability 
of domestic corporations to undertake an inversion transaction.
    The Tax Cuts and Jobs Act of 2017 (TCJA) reduced, but did not 
completely eliminate, the tax-motivated incentives to invert. 
Particular TCJA provisions that reduced those incentives include the 
reduction in the maximum U.S. statutory corporate tax rate from 35 
percent to 21 percent, the exemption from U.S. tax of dividends 
received from certain foreign corporations, the strengthening of 
Internal Revenue Code Section 163(j) on interest stripping, and the 
adoption of four punitive disincentives for new inversions in the 60 
percent to 80 percent range. While the TCJA also included provisions 
that may increase incentives to invert, including the tax imposed on 
Global Intangible Low Tax Income (GILTI) of foreign subsidiaries, 
overall tax-motivated incentives to invert were reduced.
    The following qualitative analysis provides further detail 
regarding the anticipated impacts of this rulemaking.
Baseline
    The 2016 regulations serve as the no-action baseline for our tax 
regulatory review. The 2016 regulations, which were issued pursuant to 
authority under sections 7874 and 7805 (as well as other sections), 
restrict the ability of U.S. companies to invert and reduce the 
incentives to invert.
Alternatives
    As an alternative to these final regulations, Treasury considered 
retaining the 2016 regulations without amendment. Given public comment 
and the agency's desire to provide transparency and clarity to the 
public, Treasury decided against this approach and moved forward with 
the final regulations as drafted.
Anticipated Impacts
    These final regulations maintain the thresholds and substantiation 
requirements of the 2016 regulations aimed at discouraging tax-
motivated inversions. In response to public comments, the final 
regulations make certain limited changes to the 2016 regulations that 
are designed to improve clarity, provide additional exceptions to their 
application, and reduce unnecessary burdens on taxpayers, including by 
providing guidance on how to apply particular mechanical

[[Page 32532]]

rules. Specifically, clarifying changes were made to certain of the 
stock exclusion rules, and in particular, the passive assets rule, the 
serial acquisition rule, and the third country rule, as well as to the 
substantial business activities rule. Additional exceptions were added 
to the serial acquisition rule and the third country rule that narrowed 
their scope on the margins. Finally, changes to the passive assets 
rule, the NOCD rule, and the rules coordinating the application of the 
stock exclusion rules with the expanded affiliated group (EAG) rules 
were made to reduce complexity and ambiguity associated with these 
provisions.
    Given the limited nature of the changes made by these final 
regulations relative to the no-action baseline, Treasury estimates that 
collectively, these final regulations are not economically significant 
under Executive Order 12866.
Revenue Impacts
    Due to the narrow scope of clarifications and refinements in the 
final regulations and the small number of taxpayers subject to these 
regulations, Treasury does not anticipate any meaningful change to 
revenues.
Anticipated Benefits
    At the margin, the final regulations may increase the incentive for 
cross-border mergers that are economically beneficial and not tax-
motivated. The regulations are designed to help ensure that the 
regulations do not impact mergers that provide market benefits. 
Economically beneficial mergers make the U.S. economy stronger by 
enabling U.S. companies to invest overseas and encouraging foreign 
investment to flow into the U.S.
Anticipated Costs
    The changes made by the final regulations are designed generally to 
reduce unnecessary burdens on taxpayers, an action that may lead to 
increased merger activity, and some of these additional mergers may 
potentially be tax-motivated at least in part. Due to the narrow scope 
of these changes, however, Treasury anticipates that any increase in 
tax-motivated cross-border merger activity will be relatively small 
relative to the no-action baseline and will not result in any 
meaningful adverse effects on economic activity relative to the no-
action baseline. In particular, additional exceptions added to the 
serial acquisition rule and the third country rule are designed to 
narrow their role in defining cross-border mergers that are subject to 
targeted tax treatment.
Effects on Compliance Costs
    The final regulations narrow the scope of regulated activities and 
reduce compliance costs relative to the 2016 regulations. The 
regulations also aim to reduce required paperwork burden, complexity, 
and ambiguities that may unintentionally discourage legitimate merger 
activity. In particular, changes that reduce complexity and ambiguity 
were made to the passive assets rule, the NOCD rule, and the rules 
coordinating the application of the stock exclusion rules with the 
expanded affiliated group (EAG) rules. Clarifying changes were made to 
the passive assets rule, the serial acquisition rule, the third country 
rule, and the substantial business activities rule.

Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply 
because the regulations do not impose a collection of information on 
small entities. Pursuant to section 7805(f) of the Internal Revenue 
Code, the notice of proposed rulemaking preceding these regulations was 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business. No comments 
were received.

Drafting Information

    The principal authors of these regulations are Rose E. Jenkins and 
Shane M. McCarrick of the Office of Associate Chief Counsel 
(International). However, other personnel from the Treasury Department 
and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of the Amendments to the Regulations

    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 removing 
the entries for Sec. Sec.  1.304-7T, 1.367(b)-4T, 1.956-2T, 1.7701(l)-
4T, 1.7874-2T, 1.7874-3T, 1.7874-6T, 1.7874-7T, 1.7874-8T, 1.7874-9T, 
1.7874-10T, 1.7874-11T, 1.7874-12T and adding entries for Sec. Sec.  
1.304-7, 1.7701(l)-4, 1.7874-2, 1.7874-6, 1.7874-7, 1.7874-8, 1.7874-9, 
1.7874-10, 1.7874-11, and 1.7874-12 in numerical order and revising the 
entry for Sec.  1.367(b)-4 to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.304-7 also issued under 26 U.S.C. 304(b)(5)(C).
* * * * *
    Section 1.367(b)-4 also issued under 26 U.S.C. 367(a) and (b) 
and 954(c)(6)(A).
* * * * *
    Section 1.7701(l)-4 also issued under 26 U.S.C. 7701(l) and 
954(c)(6)(A).
* * * * *
    Section 1.7874-2 also issued under 26 U.S.C. 7874(c)(6) and (g).
* * * * *
    Section 1.7874-6 also issued under 26 U.S.C. 7874(c)(6) and (g).
    Section 1.7874-7 also issued under 26 U.S.C. 7874(c)(6) and (g).
    Section 1.7874-8 also issued under 26 U.S.C. 7874(c)(6) and (g).
    Section 1.7874-9 also issued under 26 U.S.C. 7874(c)(6) and (g).
    Section 1.7874-10 also issued under 26 U.S.C. 7874(c)(4) and 
(g).
    Section 1.7874-11 also issued under 26 U.S.C. 7874(g).
    Section 1.7874-12 also issued under 26 U.S.C. 7874(g).
* * * * *

0
Par. 2. Section 1.304-7 is added to read as follows:


Sec.  1.304-7  Certain acquisitions by foreign acquiring corporations.

    (a) Scope. This section provides rules regarding the application of 
section 304(b)(5)(B) to an acquisition of stock described in section 
304 by an acquiring corporation that is foreign (foreign acquiring 
corporation). Paragraph (b) of this section provides the rule for 
determining which earnings and profits are taken into account for 
purposes of applying section 304(b)(5)(B). Paragraph (c) of this 
section provides rules addressing the use of a partnership, option (or 
similar interest), or other arrangement. Paragraph (d) of this section 
provides examples that illustrate the rules of this section. Paragraph 
(e) of this section provides the applicability date.
    (b) Earnings and profits taken into account. For purposes of 
applying section 304(b)(5)(B), only the earnings and profits of the 
foreign acquiring corporation are taken into account in determining 
whether more than 50 percent of the dividends arising from the 
acquisition (determined without regard to section 304(b)(5)(B)) would 
neither be subject to tax under chapter 1 of subtitle A of the Internal 
Revenue Code for the taxable year in which the dividends arise (subject 
to tax) nor be includible in the earnings and profits of a controlled 
foreign corporation (includible by a controlled foreign corporation). 
For purposes of this section, a controlled foreign corporation has the 
meaning provided in section 957 and without regard to section 953(c),

[[Page 32533]]

determined without applying subparagraphs (A), (B), and (C) of section 
318(a)(3) so as to consider a United States person as owning stock 
which is owned by a person who is not a United States person.
    (c) Use of a partnership, option (or similar interest), or other 
arrangement. If a partnership, option (or similar interest), or other 
arrangement, is used with a principal purpose of avoiding the 
application of this section (for example, to treat a transferor as a 
controlled foreign corporation), then the partnership, option (or 
similar interest), or other arrangement will be disregarded for 
purposes of applying this section.
    (d) Examples. The following examples illustrate the rules of this 
section. For purposes of the examples, assume the following facts in 
addition to the facts stated in the examples:
    (1) FA is a foreign corporation that is not a controlled foreign 
corporation;
    (2) FA wholly owns DT, a domestic corporation;
    (3) DT wholly owns FS1, a controlled foreign corporation; and
    (4) No portion of a dividend from FS1 would be treated as from 
sources within the United States under section 861.

    Example 1--(i) Facts.  DT has earnings and profits of $51x, and 
FS1 has earnings and profits of $49x. FA transfers DT stock with a 
fair market value of $100x to FS1 in exchange for $100x of cash.
    (ii) Analysis. Under section 304(a)(2), the $100x of cash is 
treated as a distribution in redemption of the stock of DT. The 
redemption of the DT stock is treated as a distribution to which 
section 301 applies pursuant to section 302(d), which ordinarily 
would be sourced first from FS1 under section 304(b)(2)(A). Without 
regard to the application of section 304(b)(5)(B), more than 50 
percent of the dividend arising from the acquisition, taking into 
account only the earnings and profits of FS1 pursuant to paragraph 
(b) of this section, would neither be subject to tax nor includible 
by a controlled foreign corporation. In particular, no portion of a 
dividend from FS1 would be subject to tax or includible by a 
controlled foreign corporation. Accordingly, section 304(b)(5)(B) 
and paragraph (b) of this section apply to the transaction, and no 
portion of the distribution of $100x is treated under section 
301(c)(1) as a dividend out of the earnings and profits of FS1. 
Furthermore, the $100x of cash is treated as a dividend to the 
extent of the earnings and profits of DT ($51x).
    Example 2--(i) Facts.  FA and DT own 40 percent and 60 percent, 
respectively, of the capital and profits interests of PRS, a foreign 
partnership. PRS wholly owns FS2, a controlled foreign corporation. 
The FS2 stock has a fair market value of $100x. FS1 has earnings and 
profits of $150x. PRS transfers all of its FS2 stock to FS1 in 
exchange for $100x of cash. DT enters into a gain recognition 
agreement that complies with the requirements set forth in section 
4.01 of Notice 2012-15, 2012-9 I.R.B 424, with respect to the 
portion (60 percent) of the FS2 stock that DT is deemed to transfer 
to FS1 in an exchange described in section 367(a)(1). See Sec.  
1.367(a)-1T(c)(3)(i)(A).
    (ii) Analysis. Under section 304(a)(1), PRS and FS1 are treated 
as if PRS transferred its FS2 stock to FS1 in an exchange described 
in section 351(a) solely for FS1 stock, and, in turn, FS1 redeemed 
such FS1 stock in exchange for $100x of cash. The redemption of the 
FS1 stock is treated as a distribution to which section 301 applies 
pursuant to section 302(d). Without regard to the application of 
section 304(b)(5)(B), more than 50 percent of a dividend arising 
from the acquisition, taking into account only the earnings and 
profits of FS1 pursuant to paragraph (b) of this section, would be 
subject to tax. In particular, 60 percent of a dividend from FS1 
would be included in DT's distributive share of PRS's partnership 
income and therefore would be subject to tax. Accordingly, section 
304(b)(5)(B) does not apply, and the entire distribution of $100x is 
treated under section 301(c)(1) as a dividend out of the earnings 
and profits of FS1.

    (e) Applicability date. This section applies to acquisitions that 
are completed on or after September 22, 2014.


Sec.  1.304-7T   [Removed]

0
Par. 3. Section 1.304-7T is removed.

0
Par. 4. Section 1.367(a)-3 is amended by revising paragraphs 
(c)(3)(iii)(C) and (c)(11)(ii) to read as follows:


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

* * * * *
    (c) * * *
    (3) * * *
    (iii) * * *
    (C) Special rule for U.S. target company value. For purposes of 
Sec.  1.367(a)-3(c)(3)(iii)(A), the fair market value of the U.S. 
target company includes the aggregate amount of non-ordinary course 
distributions (NOCDs) made by the U.S. target company. To calculate the 
aggregate value of NOCDs, the principles of Sec.  1.7874-10, including 
the rule regarding predecessors in Sec.  1.7874-10(e) and the rule 
regarding a deemed distribution of stock in certain cases in Sec.  
1.7874-10(g), apply. However, this paragraph (c)(3)(iii)(C) does not 
apply if the principles of the de minimis exception in Sec.  1.7874-
10(d) are satisfied.
* * * * *
    (11) * * *
    (ii) Applicability date of certain provisions of this paragraph 
(c). The first and second sentence of paragraph (c)(3)(iii)(C) of this 
section apply to transfers completed on or after September 22, 2014. 
The third sentence of paragraph (c)(3)(iii)(C) of this section applies 
to transfers completed on or after November 19, 2015. Taxpayers may, 
however, elect to apply the third sentence of paragraph (c)(3)(iii)(C) 
of this section to transfers completed on or after September 22, 2014, 
and before November 19, 2015.
* * * * *


Sec.  1.367(a)-3T   [Removed]

0
Par. 5. Section 1.367(a)-3T is removed.

0
Par. 6. Section 1.367(b)-4 is amended by revising paragraph (a), 
paragraph (b) introductory text, and paragraphs (b)(1)(i)(C), (d)(1), 
(e), (f), (g), and (h) 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) Scope. This section applies to certain acquisitions by a 
foreign corporation of the stock or assets of a foreign corporation in 
an exchange described in section 351 or in a reorganization described 
in section 368(a)(1). Paragraph (b) of this section provides a rule 
regarding when an exchanging shareholder is required to include in 
income as a deemed dividend the section 1248 amount attributable to the 
stock that it exchanges. Paragraph (c) of this section provides a rule 
excluding deemed dividends from foreign personal holding company 
income. Paragraph (d) of this section provides rules for subsequent 
sales or exchanges. Paragraphs (e) and (f) of this section provide 
rules regarding certain exchanges following inversion transactions. 
Paragraph (g) of this section provides definitions and special rules, 
including special rules regarding triangular reorganizations and 
recapitalizations. Paragraph (h) of this section provides the 
applicability dates for certain paragraphs of this section. See also 
Sec.  1.367(a)-3(b)(2) for transactions subject to the concurrent 
application of sections 367(a) and (b) and Sec.  1.367(b)-2 for 
additional definitions that apply.
    (b) Income inclusion. If a foreign corporation (the transferee 
foreign corporation) acquires the stock of a foreign corporation in an 
exchange described in section 351 or the stock or assets of a foreign 
corporation in a reorganization described in section 368(a)(1) (in 
either case, the foreign acquired corporation), then an exchanging 
shareholder must, if its exchange is described in paragraph (b)(1)(i), 
(b)(2)(i), or (b)(3) of this section, include in income as a deemed 
dividend the section 1248 amount

[[Page 32534]]

attributable to the stock that it exchanges.
    (1) * * *
    (i) * * *
    (C) The exchange is not a specified exchange to which paragraph 
(e)(1) of this section applies.
* * * * *
    (d) * * *
    (1) Rule. If an exchanging shareholder (as defined in Sec.  1.1248-
8(b)(1)(iv)) is not required to include in income as a deemed dividend 
the section 1248 amount under paragraph (b) or paragraph (e)(1) of this 
section (non-inclusion exchange), then, for purposes of applying 
section 367(b) or 1248 to subsequent sales or exchanges, and subject to 
the limitation of Sec.  1.367(b)-2(d)(3)(ii) (in the case of a 
transaction described in Sec.  1.367(b)-3), the determination of the 
earnings and profits attributable to the stock an exchanging 
shareholder receives in the non-inclusion exchange is determined 
pursuant to the rules of section 1248 and the regulations under that 
section.
* * * * *
    (e) Income inclusion and gain recognition in certain exchanges 
following an inversion transaction--(1) General rule. If a foreign 
corporation (the transferee foreign corporation) acquires stock of a 
foreign corporation in an exchange described in section 351 or stock or 
assets of a foreign corporation in a reorganization described in 
section 368(a)(1) (in either case, the foreign acquired corporation), 
then an exchanging shareholder must, if its exchange is a specified 
exchange and the exception in paragraph (e)(3) of this section does not 
apply--
    (i) Include in income as a deemed dividend the section 1248 amount 
attributable to the stock that it exchanges; and
    (ii) After taking into account the increase in basis provided in 
Sec.  1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), 
recognize all realized gain with respect to the stock that would not 
otherwise be recognized.
    (2) Specified exchanges. An exchange is a specified exchange if--
    (i) Immediately before the exchange, the foreign acquired 
corporation is an expatriated foreign subsidiary and the exchanging 
shareholder is either an expatriated entity described in paragraph 
(b)(1)(i)(A)(1) of this section or an expatriated foreign subsidiary 
described in paragraph (b)(1)(i)(A)(2) of this section;
    (ii) The stock received in the exchange is stock of a foreign 
corporation; and
    (iii) The exchange occurs during the applicable period.
    (3) De minimis exception. The exception in this paragraph (e)(3) 
applies if--
    (i) Immediately after the exchange, the foreign acquired 
corporation (in the case of an acquisition of stock of the foreign 
acquired corporation) or the transferee foreign corporation (in the 
case of an acquisition of assets of the foreign acquired corporation) 
is a controlled foreign corporation;
    (ii) The post-exchange ownership percentage with respect to the 
foreign acquired corporation (in the case of an acquisition of stock of 
the foreign acquired corporation) or the transferee foreign corporation 
(in the case of an acquisition of assets of the foreign acquired 
corporation) is at least 90 percent of the pre-exchange ownership 
percentage with respect to the foreign acquired corporation; and
    (iii) The post-exchange ownership percentage with respect to each 
lower-tier expatriated foreign subsidiary of the foreign acquired 
corporation is at least 90 percent of the pre-exchange ownership 
percentage with respect to the lower-tier expatriated foreign 
subsidiary.
    (4) Certain exceptions from foreign personal holding company not 
available. An income inclusion of a foreign corporation under paragraph 
(e)(1) of this section does not qualify for the exceptions from foreign 
personal holding company income provided by sections 954(c)(3)(A)(i) 
and 954(c)(6) (to the extent in effect).
    (5) Examples. The following examples illustrate the application of 
this paragraph (e). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock 
of USP, a domestic corporation, and all 40 shares of stock of FS, a 
controlled foreign corporation for its taxable year beginning January 
1, 2017, but not for prior taxable years, except as a result of a 
transaction described in the facts of an example. USP owns all 50 
shares of stock of FT1, a controlled foreign corporation, which, in 
turn, owns all 50 shares of FT2, a controlled foreign corporation. FP 
acquired all of the stock of USP in an inversion transaction that was 
completed on July 1, 2016. Therefore, with respect to that inversion 
transaction, USP is an expatriated entity; FT1 and FT2 are expatriated 
foreign subsidiaries; and FP and FS are each a non-EFS foreign related 
person. All entities have a calendar year tax year for U.S. tax 
purposes. All shares of stock have a fair market value of $1x, and each 
corporation has a single class of stock outstanding.

    Example 1.  Specified exchange to which general rule applies--
(i) Facts. During the applicable period, and pursuant to a 
reorganization described in section 368(a)(1)(B), FT1 transfers all 
50 shares of FT2 stock to FS in exchange solely for 50 newly issued 
voting shares of FS. Immediately before the exchange, USP is a 
section 1248 shareholder with respect to FT1 and FT2. At the time of 
the exchange, the FT2 stock owned by FT1 has a fair market value of 
$50x and an adjusted basis of $5x, such that the FT2 stock has a 
built-in gain of $45x. In addition, the earnings and profits of FT2 
attributable to FT1's stock in FT2 for purposes of section 1248 is 
$30x, taking into account the rules of Sec.  1.367(b)-2(c)(1)(i) and 
(ii), and therefore the section 1248 amount with respect to the FT2 
stock is $30x (the lesser of the $45x of built-in gain and the $30x 
of earnings and profits attributable to the stock).
    (ii) Analysis. FT1's exchange is a specified exchange because 
the requirements set forth in paragraphs (e)(2)(i) through (iii) of 
this section are satisfied. The requirement set forth in paragraph 
(e)(2)(i) of this section is satisfied because, immediately before 
the exchange, FT2 (the foreign acquired corporation) is an 
expatriated foreign subsidiary and FT1 (the exchanging shareholder) 
is an expatriated foreign subsidiary that is described in paragraph 
(b)(1)(i)(A)(2) of this section. The requirement set forth in 
paragraph (e)(2)(ii) of this section is also satisfied because the 
stock received in the exchange (FS stock) is stock of a foreign 
corporation. The requirement set forth in paragraph (e)(2)(iii) of 
this section is satisfied because the exchange occurs during the 
applicable period. Accordingly, under paragraph (e)(1)(i) of this 
section, FT1 must include in income as a deemed dividend $30x, the 
section 1248 amount with respect to its FT2 stock. In addition, 
under paragraph (e)(1)(ii) of this section, FT1 must, after taking 
into account the increase in basis provided in Sec.  1.367(b)-
2(e)(3)(ii) resulting from the deemed dividend (which increases 
FT1's basis in its FT2 stock from $5x to $35x), recognize $15x ($50x 
amount realized less $35x basis), the realized gain with respect to 
the FT2 stock that would not otherwise be recognized.
    Example 2.  De minimis shift to non-EFS foreign related 
persons--(i) Facts. The facts are the same as in the introductory 
sentences of this paragraph (e)(5), except as follows. FT1 does not 
own any shares of FT2, and all 40 shares of FS are owned by DX, a 
domestic corporation wholly owned by individual A, and thus FS is 
not a non-EFS foreign related person. During the applicable period 
and pursuant to a reorganization described in section 368(a)(1)(D), 
FT1 transfers all of its assets to FS in exchange for 50 newly 
issued FS shares, FT1 distributes the 50 FS shares to USP in 
liquidation under section 361(c)(1), and USP exchanges its 50 shares 
of FT1 stock for the 50 FS shares under section 354. Further, 
immediately after the exchange, FS is a controlled foreign 
corporation.
    (ii) Analysis. Although USP's exchange is a specified exchange, 
paragraph (e)(1) of this section does not apply to the exchange 
because, as described in paragraphs (ii)(A)

[[Page 32535]]

through (C) of this Example 2, the requirements of paragraph (e)(3) 
of this section are satisfied.
    (A) Because the assets, rather than the stock, of FT1 (the 
foreign acquired corporation) are acquired, the requirement set 
forth in paragraph (e)(3)(i) of this section is satisfied if FS (the 
transferee foreign corporation) is a controlled foreign corporation 
immediately after the exchange. As stated in the facts, FS is a 
controlled foreign corporation immediately after the exchange.
    (B) The requirement set forth in paragraph (e)(3)(ii) of this 
section is satisfied if the post-exchange ownership percentage with 
respect to FS is at least 90% of the pre-exchange ownership 
percentage with respect to FT1. Because USP, a domestic corporation 
that is an expatriated entity, directly owns 50 shares of FT1 stock 
immediately before the exchange, none of those shares are treated as 
indirectly owned by FP (a non-EFS foreign related person) for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT1. See paragraph (g)(1) of this section. Thus, for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT1, FP is treated as directly or indirectly owning 0%, 
or 0 of 50 shares, of the stock of FT1. Accordingly, the pre-
exchange ownership percentage with respect to FT1 is 100 (calculated 
as 100% less 0%, the percentage of FT1 stock that non-EFS foreign 
related persons are treated as directly or indirectly owning 
immediately before the exchange). Consequently, for the requirement 
set forth in paragraph (e)(3)(ii) of this section to be satisfied, 
the post-exchange ownership percentage with respect to FS must be at 
least 90. Because USP, a domestic corporation that is an expatriated 
entity, directly owns 50 shares of FS stock immediately after the 
exchange, none of those shares are treated as indirectly owned by FP 
(a non-EFS foreign related person) for purposes of calculating the 
post-exchange ownership percentage with respect to FS. See paragraph 
(g)(1) of this section. Thus, for purposes of calculating the post-
exchange ownership percentage with respect to FS, FP is treated as 
directly or indirectly owning 0%, or 0 of 90 shares, of the stock of 
FS. As a result, the post-exchange ownership percentage with respect 
to FS is 100 (calculated as 100% less 0%, the percentage of FS stock 
that non-EFS foreign related persons are treated as directly or 
indirectly owning immediately after the exchange). Therefore, 
because the post-exchange ownership percentage with respect to FS 
(100) is at least 90, the requirement set forth in paragraph 
(e)(3)(ii) of this section is satisfied.
    (C) Because there is not a lower-tier expatriated foreign 
subsidiary of FT1, the requirement set forth in paragraph 
(e)(3)(iii) of this section does not apply.

    (f) Gain recognition upon certain transfers of property described 
in section 351 following an inversion transaction--(1) General rule. 
If, during the applicable period, an expatriated foreign subsidiary 
transfers specified property to a foreign corporation (the transferee 
foreign corporation) in an exchange described in section 351, then the 
expatriated foreign subsidiary must recognize all realized gain with 
respect to the specified property transferred that would not otherwise 
be recognized, unless the exception in paragraph (f)(2) of this section 
applies.
    (2) De minimis exception. The exception in this paragraph (f)(2) 
applies if--
    (i) Immediately after the transfer, the transferee foreign 
corporation is a controlled foreign corporation; and
    (ii) The post-exchange ownership percentage with respect to the 
transferee foreign corporation is at least 90 percent of the pre-
exchange ownership percentage with respect to the expatriated foreign 
subsidiary.
    (3) Examples. The following examples illustrate the application of 
this paragraph (f). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock 
of USP, a domestic corporation, and all 10 shares of stock of FS, a 
controlled foreign corporation for its taxable year beginning January 
1, 2017, but not for prior taxable years, except as a result of a 
transaction described in the facts of an example. USP owns all 50 
shares of stock of FT, a controlled foreign corporation. FT owns Asset 
A, which is specified property with a fair market value of $50x and an 
adjusted basis of $10x. FP acquired all of the stock of USP in an 
inversion transaction that was completed on or after September 22, 
2014. Accordingly, with respect to that inversion transaction, USP is 
an expatriated entity, FT is an expatriated foreign subsidiary, and FP 
and FS are each a non-EFS foreign related person. All entities have a 
calendar year tax year for U.S. tax purposes. All shares of stock have 
a fair market value of $1x, and each corporation has a single class of 
stock outstanding.

    Example 1.  Transfer to which general rule applies--(i) Facts. 
In addition to the stock of USP and FS, FP owns Asset B, which has a 
fair market value of $40x. During the applicable period, and 
pursuant to an exchange described in section 351, FT transfers Asset 
A to FS in exchange for 50 newly issued shares of FS stock, and FP 
transfers Asset B to FS in exchange for 40 newly issued shares of FS 
stock.
    (ii) Analysis. Paragraph (f)(1) of this section applies to the 
transfer by FT (an expatriated foreign subsidiary) of Asset A, which 
is specified property, to FS (the transferee foreign corporation). 
Thus, FT must recognize gain of $40x under paragraph (f)(1) of this 
section, which is the realized gain with respect to Asset A that 
would not otherwise be recognized ($50x amount realized less $10x 
basis). For rules regarding whether the FS stock held by FT is 
treated as United States property for purposes of section 956, see 
Sec.  1.956-2(a)(4)(i).
    Example 2.  De minimis shift to non-EFS foreign related 
persons--(i) Facts. Individual, a United States person, owns Asset 
B, which has a fair market value of $40x. During the applicable 
period, and pursuant to an exchange described in section 351, FT 
transfers Asset A to FS in exchange for 50 newly issued shares of FS 
stock, and Individual transfers Asset B to FS in exchange for 40 
newly issued shares of FS stock.
    (ii) Analysis. Paragraph (f)(1) of this section does not apply 
to the transfer by FT (an expatriated foreign subsidiary) of Asset 
A, which is specified property, to FS (the transferee foreign 
corporation)) because the requirements set forth in paragraph (f)(2) 
of this section are satisfied. The requirement set forth in 
paragraph (f)(2)(i) of this section is satisfied because FS is a 
controlled foreign corporation immediately after the transfer. The 
requirement set forth in paragraph (f)(2)(ii) of this section is 
satisfied if the post-exchange ownership percentage with respect to 
FS is at least 90 percent of the pre-exchange ownership percentage 
with respect to FT. Because USP, a domestic corporation that is an 
expatriated entity, directly owns 50 shares of FT stock immediately 
before the transfer, none of those shares are treated as indirectly 
owned by FP (a non-EFS foreign related person) for purposes of 
calculating the pre-exchange ownership percentage with respect to 
FT. See paragraph (g)(1) of this section. Thus, for purposes of 
calculating the pre-exchange ownership percentage with respect to 
FT, FP is treated as directly or indirectly owning 0 percent, or 0 
of 50 shares, of the stock of FT. Accordingly, the pre-exchange 
ownership percentage with respect to FT is 100 (calculated as 100 
percent less 0 percent, the percentage of FT stock that non-EFS 
foreign related persons are treated as directly or indirectly owning 
immediately before the transfer). Consequently, for the requirement 
set forth in paragraph (f)(2)(ii) of this section to be satisfied, 
the post-exchange ownership percentage with respect to FS must be at 
least 90. Although FP directly owns 10 FS shares, none of the 50 FS 
shares that FP owns through USP (a domestic corporation that is an 
expatriated entity) are treated as indirectly owned by FP for 
purposes of calculating the post-exchange ownership percentage with 
respect to FS because USP directly owns them. See paragraph (g)(1) 
of this section. Thus, for purposes of calculating the post-exchange 
ownership percentage with respect to FS, FP is treated as directly 
or indirectly owning 10 percent, or 10 of 100 shares, of the stock 
of FS. As a result, the post-exchange ownership percentage with 
respect to FS is 90 (calculated as 100 percent less 10 percent, the 
percentage of FS stock that non-EFS foreign related persons are 
treated as directly or indirectly owning immediately after the 
transfer). Therefore, because the post-exchange ownership percentage 
with respect to FS (90) is at least 90, the requirement set forth in 
paragraph (f)(2)(ii) of this section is satisfied.

    (g) Definitions and special rules. In addition to the definitions 
and special

[[Page 32536]]

rules in Sec. Sec.  1.367(b)-2 and 1.7874-12, the following definitions 
and special rules apply for purposes of this section.
    (1) Indirect ownership. To determine indirect ownership of the 
stock of a corporation for purposes of calculating a pre-exchange 
ownership percentage or post-exchange ownership percentage with respect 
to that corporation, the principles of section 958(a) apply without 
regard to whether an intermediate entity is foreign or domestic. For 
this purpose, stock of the corporation that is directly or indirectly 
(applying the principles of section 958(a) without regard to whether an 
intermediate entity is foreign or domestic) owned by a domestic 
corporation that is an expatriated entity is not treated as indirectly 
owned by a non-EFS foreign related person.
    (2) A lower-tier expatriated foreign subsidiary means an 
expatriated foreign subsidiary whose stock is directly or indirectly 
owned (under the principles of section 958(a)) by an expatriated 
foreign subsidiary.
    (3) Pre-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately before an exchange, is owned, in the 
aggregate, directly or indirectly by non-EFS foreign related persons.
    (4) Post-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately after the exchange, is owned, in the 
aggregate, directly or indirectly by non-EFS foreign related persons.
    (5) Specified property means any property other than stock of a 
lower-tier expatriated foreign subsidiary.
    (6) Recapitalizations. A foreign corporation that undergoes a 
reorganization described in section 368(a)(1)(E) is treated as both the 
foreign acquired corporation and the transferee foreign corporation.
    (7) Triangular reorganizations--(i) Definition. A triangular 
reorganization means a reorganization described in Sec.  1.358-
6(b)(2)(i) (forward triangular merger), (ii) (triangular C 
reorganization), (iii) (reverse triangular merger), (iv) (triangular B 
reorganization), and (v) (triangular G reorganization).
    (ii) Special rules--(A) Triangular reorganizations other than a 
reverse triangular merger. In the case of a triangular reorganization 
other than a reverse triangular merger, the surviving corporation is 
the transferee foreign corporation that acquires the assets or stock of 
the foreign acquired corporation, and the reference to controlling 
corporation (foreign or domestic) is to the corporation that controls 
the surviving corporation.
    (B) Reverse triangular merger. In the case of a reverse triangular 
merger, the surviving corporation is the entity that survives the 
merger, and the controlling corporation (foreign or domestic) is the 
corporation that before the merger controls the merged corporation. In 
the case of a reverse triangular merger, this section applies only if 
stock of the foreign surviving corporation is exchanged for stock of a 
foreign corporation in control of the merging corporation; in such a 
case, the foreign surviving corporation is treated as a foreign 
acquired corporation.
    (h) Applicability date of certain paragraphs in this section. 
Except as otherwise provided in this paragraph (h), paragraphs (a), (b) 
introductory text, (b)(1)(i)(C), (d)(1), (e), (f), and (g) of this 
section apply to exchanges completed on or after September 22, 2014, 
but only if the inversion transaction was completed on or after 
September 22, 2014. Paragraph (e)(1)(ii) of this section applies to 
exchanges completed on or after November 19, 2015, but only if the 
inversion transaction was completed on or after September 22, 2014. The 
portion of paragraph (e)(2)(i) of this section that requires the 
exchanging shareholder to be an expatriated entity or an expatriated 
foreign subsidiary apply to exchanges completed on or after April 4, 
2016, but only if the inversion transaction was completed on or after 
September 22, 2014. For inversion transactions completed on or after 
September 22, 2014, however, taxpayers may elect to apply the portion 
of paragraph (e)(2)(i) of this section that requires the exchanging 
shareholder to be an expatriated entity or an expatriated foreign 
subsidiary to exchanges completed on or after September 22, 2014, and 
before April 4, 2016. Paragraphs (f) and (g)(5) of this section apply 
to transfers completed on or after April 4, 2016, but only if the 
inversion transaction was completed or after September 22, 2014. See 
Sec.  1.367(b)-4, as contained in 26 CFR part 1 revised as of April 1, 
2016, for exchanges completed before September 22, 2014.


Sec.  1.367(b)-4T   [Removed]

0
Par. 7. Section 1.367(b)-4T is removed.


Sec.  1.367(b)-6   [Amended]

0
Par. 8. Section 1.367(b)-6 is amended by:
0
1. Removing paragraph (a)(1)(iii).
0
2. Redesignating paragraphs (a)(1)(iv) and (v) as (a)(1)(iii) and (iv), 
respectively.
0
3. In newly redesignated paragraph (a)(1)(iv), removing the language 
``1.367(b)-4(a), Sec. '' in the first sentence and removing the 
language ``Sec.  1.367(b)-4(a)'' in the second sentence.

0
Par. 9. Section 1.956-2 is amended by:
0
1. Revising paragraphs (a)(4), (c)(5), and (d)(2).
0
2. Adding paragraphs (f) and (h)(3) through (6).
0
3. Removing paragraph (i).
    The revisions and additions read as follows:


Sec.  1.956-2  Definition of United States property.

    (a) * * *
    (4) Certain foreign stock and obligations held by expatriated 
foreign subsidiaries following an inversion transaction--(i) General 
rule. Except as provided in paragraph (a)(4)(ii) of this section, for 
purposes of section 956 and paragraph (a) of this section, United 
States property includes an obligation of a foreign person and stock of 
a foreign corporation when the following conditions are satisfied--
    (A) The obligation or stock is held by a controlled foreign 
corporation that is an expatriated foreign subsidiary, regardless of 
whether, when the obligation or stock was acquired, the acquirer was a 
controlled foreign corporation or an expatriated foreign subsidiary;
    (B) The foreign person or foreign corporation is a non-EFS foreign 
related person, regardless of whether, when the obligation or stock was 
acquired, the foreign person or foreign corporation was a non-EFS 
foreign related person; and
    (C) The obligation or stock was acquired--
    (1) During the applicable period; or
    (2) In a transaction related to the inversion transaction.
    (ii) Exceptions. For purposes of section 956 and paragraph (a) of 
this section, United States property does not include--
    (A) Any obligation of a non-EFS foreign related person arising in 
connection with the sale or processing of property if the amount of the 
obligation at no time during the taxable year exceeds the amount that 
would be ordinary and necessary to carry on the trade or business of 
both the other party to the sale or processing transaction and the non-
EFS foreign related person had the sale or processing transaction been 
made between unrelated persons; and
    (B) Any obligation of a non-EFS foreign related person to the 
extent the

[[Page 32537]]

principal amount of the obligation does not exceed the fair market 
value of readily marketable securities sold or purchased pursuant to a 
sale and repurchase agreement or otherwise posted or received as 
collateral for the obligation in the ordinary course of its business by 
a United States or foreign person which is a dealer in securities or 
commodities.
    (iii) Definitions. The definitions in Sec.  1.7874-12 apply for the 
purposes of the application of paragraphs (a)(4), (c)(5), and (d)(2) of 
this section.
    (iv) Examples. The following examples illustrate the rules of this 
paragraph (a)(4). For purposes of the examples, FA, a foreign 
corporation, wholly owns DT, a domestic corporation, which, in turn, 
wholly owns FT, a foreign corporation that is a controlled foreign 
corporation. FA also wholly owns FS, a foreign corporation that is a 
controlled foreign corporation for its taxable year beginning January 
1, 2017, but not for prior taxable years except as a result of a 
transaction described in the facts of an example. All entities have a 
calendar year tax year for U.S. tax purposes. FA acquired DT in an 
inversion transaction that was completed on January 1, 2015.

    Example 1.  (A) Facts. FT acquired an obligation of FS on 
January 31, 2015.
    (B) Analysis. Pursuant to Sec.  1.7874-12, DT is a domestic 
entity, FT is an expatriated foreign subsidiary, and FS is a non-EFS 
foreign related person. In addition, FT acquired the FS obligation 
during the applicable period. Thus, as of January 31, 2015, the 
obligation of FS is United States property with respect to FT for 
purposes of section 956(a) and this paragraph (a).
    Example 2.  (A) Facts. The facts are the same as in Example 1 of 
this paragraph (a)(4)(iv), except that on February 15, 2015, FT 
contributed assets to FS in exchange for 60% of the stock of FS, by 
vote and value.
    (B) Analysis. As a result of the transaction on February 15, 
2015, FS became a controlled foreign corporation with respect to 
which an expatriated entity, DT, is a United States shareholder. 
Accordingly, under Sec.  1.7874-12(a)(9), FS is an expatriated 
foreign subsidiary, and is therefore not a non-EFS foreign related 
person. Thus, as of February 15, 2015, the stock and obligation of 
FS are not United States property with respect to FT for purposes of 
section 956(a) and this paragraph (a). FS is not excluded from the 
definition of expatriated foreign subsidiary pursuant to Sec.  
1.7874-12(a)(9)(ii) because FS was not a CFC on the completion date.
    Example 3.  (A) Facts. Before the inversion transaction, FA also 
wholly owns USP, a domestic corporation, which, in turn, wholly 
owns, LFS, a foreign corporation that is a controlled foreign 
corporation. DT was not a United States shareholder of LFS on or 
before the completion date. On January 31, 2015, FT contributed 
assets to LFS in exchange for 60% of the stock of LFS, by vote and 
value. FT acquired an obligation of LFS on February 15, 2015.
    (B) Analysis. LFS is a foreign related person. Because LFS was a 
controlled foreign corporation and a member of the EAG with respect 
to the inversion transaction on the completion date, and DT was not 
a United States shareholder with respect to LFS on or before the 
completion date, LFS is excluded from the definition of expatriated 
foreign subsidiary pursuant to Sec.  1.7874-12(a)(9)(ii). Thus, 
pursuant to Sec.  1.7874-12(a)(16), LFS is a non-EFS foreign related 
person, and the stock and obligation of LFS are United States 
property with respect to FT for purposes of section 956(a) and this 
paragraph (a). The fact that FT contributed assets to LFS in 
exchange for 60% of the stock of LFS does not change this result.
    Example 4.  (A) Facts. The facts are the same as in Example 3 of 
this paragraph (a)(4)(iv), except that on February 10, 2015, LFS 
organized a new foreign corporation (LFSS), transferred all of its 
assets to LFSS, and liquidated, in a transaction treated as a 
reorganization described in section 368(a)(1)(F), and FT acquired an 
obligation of LFSS, instead of LFS, on February 15, 2015. On March 
1, 2015, LFSS acquired an obligation of FS.
    (B) Analysis. LFS is a controlled foreign corporation with 
respect to which USP, an expatriated entity, is a United States 
shareholder. USP is an expatriated entity because on the completion 
date, USP and DT became related to each other within the meaning of 
section 267(b). Because LFSS was not a member of the EAG with 
respect to the inversion transaction on the completion date, LFSS is 
not excluded from the definition of expatriated foreign subsidiary 
pursuant to Sec.  1.7874-12(a)(9)(ii). Accordingly, under Sec.  
1.7874-12(a)(9)(i), LFFS is an expatriated foreign subsidiary and is 
therefore not a non-EFS foreign related person. Thus, the stock and 
obligation of LFSS are not United States property with respect to FT 
for purposes of section 956(a) and paragraph (a) of this section. 
However, because LFSS is an expatriated foreign subsidiary, pursuant 
to Sec.  1.7874-12(a)(9), the obligation of FS, a non-EFS foreign 
related person, is United States property with respect to LFSS for 
purposes of section 956(a) and this paragraph (a).
* * * * *
    (c) * * *
    (5) Special guarantee and pledge rule for expatriated foreign 
subsidiaries--(i) General rule. In applying paragraphs (c)(1) and (2) 
of this section to a controlled foreign corporation that is an 
expatriated foreign subsidiary, the phrase ``of a United States person 
or a non-EFS foreign related person'' is substituted for the phrase 
``of a United States person'' each place it appears.
    (ii) Additional rules. The rule in paragraph (c)(5)(i) of this 
section--
    (A) Applies regardless of whether, when the pledge or guarantee was 
entered into or treated as entered into, the controlled foreign 
corporation was a controlled foreign corporation or an expatriated 
foreign subsidiary, or a foreign person whose obligation is subject to 
the pledge or guarantee, or deemed pledge or guarantee, was a non-EFS 
foreign related person; and
    (B) Applies to pledges or guarantees entered into, or treated 
pursuant to paragraph (c)(2) of this section as entered into--
    (1) During the applicable period; or
    (2) In a transaction related to the inversion transaction.
    (d) * * *
    (2) Obligation defined. For purposes of section 956 and this 
section, the term ``obligation'' includes any bond, note, debenture, 
certificate, bill receivable, account receivable, note receivable, open 
account, or other indebtedness, whether or not issued at a discount and 
whether or not bearing interest, except that the term does not 
include--
    (i) Any indebtedness arising out of the involuntary conversion of 
property which is not United States property within the meaning of 
paragraph (a) of this section;
    (ii) Any obligation of a United States person (as defined in 
section 957(c)) arising in connection with the provision of services by 
a controlled foreign corporation to the United States person if the 
amount of the obligation outstanding at any time during the taxable 
year of the controlled foreign corporation does not exceed an amount 
which would be ordinary and necessary to carry on the trade or business 
of the controlled foreign corporation and the United States person if 
they were unrelated. The amount of the obligations shall be considered 
to be ordinary and necessary to the extent of such receivables that are 
paid within 60 days;
    (iii) Any obligation of a non-EFS foreign related person arising in 
connection with the provision of services by an expatriated foreign 
subsidiary to the non-EFS foreign related person if the amount of the 
obligation outstanding at any time during the taxable year of the 
expatriated foreign subsidiary does not exceed an amount which would be 
ordinary and necessary to carry on the trade or business of the 
expatriated foreign subsidiary and the non-EFS foreign related person 
if they were unrelated. The amount of the obligations shall be 
considered to be ordinary and necessary to the extent of such 
receivables that are paid within 60 days; or
    (iv) Any obligation of a United States person (as defined in 
section 957(c)) that is collected within 30 days from the time it is 
incurred (a 30-day obligation), unless the controlled foreign 
corporation that holds the 30-day

[[Page 32538]]

obligation holds for 60 or more calendar days during the taxable year 
in which it holds the 30-day obligation any obligations which, without 
regard to the exclusion described in this paragraph (d)(2)(iv), would 
constitute United States property within the meaning of section 956 and 
paragraph (a) of this section.
* * * * *
    (f) [Reserved]. For further guidance, see Sec.  1.956-2T(f).
* * * * *
    (h) * * *
    (3) Except as otherwise provided in this paragraph (h)(3), 
paragraphs (a)(4) and (c)(5) of this section apply to obligations or 
stock acquired or to pledges or guarantees entered into, or treated as 
entered into, on or after September 22, 2014, but only if the inversion 
transaction was completed on or after September 22, 2014. The phrase 
``, regardless of whether, when the obligation or stock was acquired, 
the acquirer was a controlled foreign corporation or an expatriated 
foreign subsidiary'' in paragraph (a)(4)(i)(A) of this section, the 
phrase ``regardless of whether, when the obligation or stock was 
acquired, the foreign person or foreign corporation was a non-EFS 
foreign related person'' in paragraph (a)(4)(i)(B) of this section, and 
paragraphs (a)(4)(i)(C)(2), (c)(5)(ii)(A), and (c)(5)(ii)(B)(2) of this 
section apply to obligations or stock acquired or pledges or guarantees 
entered into or treated as entered into on or after April 4, 2016, but 
only if the inversion transaction was completed on or after September 
22, 2014. Paragraph (a)(4)(ii) of this section applies to obligations 
acquired on or after April 4, 2016. For inversion transactions 
completed on or after September 22, 2014, however, taxpayers may elect 
to apply paragraph (a)(4)(ii) of this section to an obligation acquired 
before April 4, 2016. For purposes of paragraph (a)(4)(i) of this 
section and this paragraph (h)(3), a deemed exchange of an obligation 
or stock pursuant to section 1001 constitutes an acquisition of the 
obligation or stock. For purposes of paragraph (c)(5) of this section 
and this paragraph (h)(3), a pledgor or guarantor or deemed pledgor or 
guarantor is treated as entering into a pledge or guarantee when there 
is a significant modification, within the meaning of Sec.  1.1001-3(e), 
of an obligation with respect to which it is a pledgor or guarantor or 
is treated as a pledgor or guarantor.
    (4) Paragraphs (d)(2)(i) and (ii) of this section are effective 
June 14, 1988, with respect to investments made on or after June 14, 
1988.
    (5) Paragraph (d)(2)(iii) of this section applies to obligations 
acquired on or after April 4, 2016, but only if the inversion 
transaction was completed on or after September 22, 2014. For inversion 
transactions completed on or after September 22, 2014, however, 
taxpayers may elect to apply paragraph (d)(2)(iii) of this section to 
an obligation acquired on or after September 22, 2014, and before April 
4, 2016. For purposes of paragraph (d)(2)(iii) of this section and this 
paragraph (h)(5), a significant modification, within the meaning of 
Sec.  1.1001-3(e), of an obligation on or after April 4, 2016, 
constitutes an acquisition of an obligation on or after April 4, 2016.
    (6) Paragraph (d)(2)(iv) of this section applies to obligations 
held on or after September 16, 1988. See Sec.  1.956-2T(d)(2)(v), as 
contained in 26 CFR part 1 revised as of April 1, 2017, for additional 
rules applicable to certain taxable years of a foreign corporation 
beginning before January 1, 2011.

0
Par. 10. Section 1.956-2T is amended by:
0
1. Removing and reserving paragraph (a)(4).
0
2. Revising paragraphs (b)(2) through (c)(4).
0
3. Removing and reserving paragraphs (c)(5) and (d)(2).
0
4. Removing paragraphs (i) and (j).
    The revisions read as follows:


Sec.  1.956-2T  Definition of United States property (temporary).

* * * * *
    (b)(2) through (c)(4). [Reserved] For further guidance, see Sec.  
1.956-2(b)(2) through (c)(4).
* * * * *

0
Par. 11. Section 1.7701(l)-4 is added to read as follows:


Sec.  1.7701(l)-4  Rules regarding inversion transactions.

    (a) Overview. This section provides rules applicable to United 
States shareholders of controlled foreign corporations after certain 
inversion transactions. Paragraph (b) of this section defines specified 
transactions and provides the scope of the rules in this section. 
Paragraph (c) of this section provides rules recharacterizing certain 
specified transactions. Paragraph (d) of this section sets forth rules 
governing transactions that affect the stock of an expatriated foreign 
subsidiary following a recharacterized specified transaction. Paragraph 
(e) of this section sets forth a rule concerning the treatment of 
amounts included in income as a result of a specified transaction as 
foreign personal holding company income. Paragraph (f) of this section 
sets forth definitions that apply for purposes of this section. 
Paragraph (g) of this section sets forth examples illustrating these 
rules. Paragraph (h) of this section provides applicability dates. See 
Sec.  1.367(b)-4(e) and (f) for rules concerning certain other 
exchanges after an inversion transaction. See also Sec.  1.956-2(a)(4), 
(c)(5), and (d)(2) for additional rules applicable to United States 
property held by controlled foreign corporations after an inversion 
transaction.
    (b) Specified transaction--(1) In general. Except as provided in 
paragraph (b)(2) of this section, paragraph (c) of this section applies 
to specified transactions. For purposes of this section, a specified 
transaction is, with respect to an expatriated foreign subsidiary, a 
transaction in which stock of the expatriated foreign subsidiary is 
issued or transferred to a person that immediately before the issuance 
or transfer is a specified related person, provided the transaction 
occurs during the applicable period. However, a specified transaction 
does not include a transaction in which stock of the expatriated 
foreign subsidiary is deemed issued pursuant to section 304.
    (2) Exceptions. Paragraph (c) of this section does not apply to a 
specified transaction--
    (i) That is a fast-pay arrangement that is recharacterized under 
Sec.  1.7701(l)-3(c)(2);
    (ii) In which the specified stock was transferred by a shareholder 
of the expatriated foreign subsidiary, and the shareholder either--
    (A) Pursuant to Sec.  1.367(b)-4(e)(1), both--
    (1) Included in gross income as a deemed dividend the section 1248 
amount attributable to the specified stock; and
    (2) After taking into account the increase in basis provided in 
Sec.  1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), 
recognized all realized gain with respect to the stock that otherwise 
would not have been recognized; or
    (B) Included in gross income all of the gain recognized on the 
transfer of the specified stock (including gain included in gross 
income as a dividend pursuant to section 964(e), section 1248(a), or 
section 356(a)(2)); or
    (iii) In which--
    (A) Immediately after the specified transaction and any related 
transaction, the expatriated foreign subsidiary is a controlled foreign 
corporation;
    (B) The post-transaction ownership percentage with respect to the

[[Page 32539]]

expatriated foreign subsidiary is at least 90 percent of the pre-
transaction ownership percentage with respect to the expatriated 
foreign subsidiary; and
    (C) The post-transaction ownership percentage with respect to any 
lower-tier expatriated foreign subsidiary is at least 90 percent of the 
pre-transaction ownership percentage with respect to the lower-tier 
expatriated foreign subsidiary. See Example 3 and Example 4 of 
paragraph (g) of this section.
    (c) Recharacterization of specified transactions--(1) In general. 
Except as otherwise provided, a specified transaction that is 
recharacterized under this paragraph (c) is recharacterized for all 
purposes of the Internal Revenue Code as of the date on which the 
specified transaction occurs, unless and until the rules of paragraph 
(d) of this section apply to alter or terminate the recharacterization. 
For purposes of paragraphs (c)(2) and (3) and (d) of this section, 
stock is considered owned by a section 958(a) U.S. shareholder if it is 
owned within the meaning of section 958(a) by the section 958(a) U.S. 
shareholder.
    (2) Specified transactions through stock issuance. A specified 
transaction in which the specified stock is issued by an expatriated 
foreign subsidiary to a specified related person is recharacterized as 
follows--
    (i) The transferred property is treated as having been transferred 
by the specified related person to the persons that were section 958(a) 
U.S. shareholders of the expatriated foreign subsidiary immediately 
before the specified transaction, in proportion to the stock of the 
expatriated foreign subsidiary owned by each section 958(a) U.S. 
shareholder, in exchange for deemed instruments in the section 958(a) 
U.S. shareholders; and
    (ii) The transferred property treated as transferred to the section 
958(a) U.S. shareholders pursuant to paragraph (c)(2)(i) of this 
section is treated as having been contributed by the section 958(a) 
U.S. shareholders (through intermediate entities, if any, in exchange 
for equity in the intermediate entities) to the expatriated foreign 
subsidiary in exchange for deemed issued stock in the expatriated 
foreign subsidiary. See Example 1, Example 2, and Example 6 of 
paragraph (g) of this section.
    (3) Specified transactions through shareholder transfer. A 
specified transaction in which specified stock is transferred by 
shareholders of the expatriated foreign subsidiary to a specified 
related person is recharacterized as follows--
    (i) The transferred property is treated as having been transferred 
by the specified related person to the persons that were section 958(a) 
U.S. shareholders of the expatriated foreign subsidiary immediately 
before the specified transaction, in proportion to the specified stock 
owned by each section 958(a) U.S. shareholder, in exchange for deemed 
instruments in the section 958(a) U.S. shareholders; and
    (ii) To the extent the section 958(a) U.S. shareholders are not the 
transferring shareholders, the transferred property treated as 
transferred to the section 958(a) U.S. shareholders pursuant to 
paragraph (c)(3)(i) of this section is treated as having been 
contributed by the section 958(a) U.S. shareholders (through 
intermediate entities, if any, in exchange for equity in the 
intermediate entities) to the transferring shareholder in exchange for 
equity in the transferring shareholder. See Example 5 of paragraph (g) 
of this section.
    (4) Treatment of deemed instruments following a recharacterized 
specified transaction--(i) Deemed instruments. The deemed instruments 
described in paragraphs (c)(2) and (3) of this section have the same 
terms as the specified stock issued or transferred pursuant to the 
specified transaction (that is, the disregarded specified stock), other 
than the issuer. When a distribution is made with respect to the 
disregarded specified stock, matching seriatim distributions with 
respect to the deemed issued stock are treated as made by the 
expatriated foreign subsidiary, through intermediate entities, if any, 
to the section 958(a) U.S. shareholders, which, in turn, then are 
treated as making corresponding payments with respect to the deemed 
instruments to the specified related person.
    (ii) Paying agent. The expatriated foreign subsidiary is treated as 
the paying agent of the section 958(a) U.S. shareholder with respect to 
the deemed instruments treated as issued by the section 958(a) U.S. 
shareholder to the specified related person.
    (d) Transactions affecting ownership of stock of an expatriated 
foreign subsidiary following a recharacterized specified transaction--
(1) Transfers of stock other than specified stock. When, after a 
specified transaction with respect to an expatriated foreign subsidiary 
that is recharacterized under paragraph (c)(2) or (3) of this section, 
stock of the expatriated foreign subsidiary, other than disregarded 
specified stock, that is owned by a section 958(a) U.S. shareholder is 
transferred, the deemed issued stock treated as owned by the section 
958(a) U.S. shareholder as a result of the specified transaction 
continues to be treated as directly owned by the holder, as are the 
deemed instruments treated as issued to the specified related person as 
a result of the specified transaction.
    (2) Transactions in which the expatriated foreign subsidiary ceases 
to be a foreign related person. When, after a specified transaction 
with respect to an expatriated foreign subsidiary that is 
recharacterized under paragraph (c)(2) or (3) of this section, there is 
a transaction that affects the ownership of the stock (including 
disregarded specified stock) of the expatriated foreign subsidiary, 
and, immediately after the transaction, the expatriated foreign 
subsidiary is not a foreign related person (determined without taking 
into account the recharacterization under paragraph (c)(2) or (3) of 
this section), then, immediately before the transaction--
    (i) Each section 958(a) U.S. shareholder that is treated as owning 
deemed issued stock in the expatriated foreign subsidiary under 
paragraph (c)(2) or (3) of this section is treated as transferring the 
deemed issued stock (after the deemed issued stock is deemed to be 
transferred to the section 958(a) U.S. shareholder through intermediate 
entities, if any, in redemption of equity deemed issued by the 
intermediate entities pursuant to paragraph (c)(2) or (3) of this 
section) to the specified related person that is treated as holding the 
deemed instruments issued by the section 958(a) U.S. shareholder under 
paragraph (c)(2) or (3) of this section, in redemption of the deemed 
instruments; and
    (ii) The deemed issued stock that is treated as transferred 
pursuant to paragraph (d)(2)(i) of this section is treated as 
recapitalized into the disregarded specified stock actually held by the 
specified related person, which immediately thereafter is treated as 
specified stock owned by the specified related person for all purposes 
of the Internal Revenue Code. See Example 8, Example 9, and Example 12 
of paragraph (g) of this section.
    (3) Transfers in which disregarded specified stock ceases to be 
held by a foreign related person, specified related person, or 
expatriated entity. When, after a specified transaction with respect to 
an expatriated foreign subsidiary that is recharacterized under 
paragraph (c)(2) or (3) of this section, there is a direct or indirect 
transfer of the disregarded specified stock in the expatriated foreign 
subsidiary, and immediately after the transfer, the expatriated foreign 
subsidiary is a foreign related person, then, to the extent that, as a 
result of the

[[Page 32540]]

transfer, the disregarded specified stock is actually held (determined 
without taking into account the recharacterization under paragraph 
(c)(2) or (3) of this section) by a person that is not a foreign 
related person, a specified related person, or an expatriated entity, 
immediately before the transfer--
    (i) Each section 958(a) U.S. shareholder that is treated as owning 
all or a portion of the deemed issued stock in the expatriated foreign 
subsidiary is treated as transferring the deemed issued stock that is 
allocable to the transferred disregarded specified stock that is out-
of-group transferred disregarded specified stock (after the deemed 
issued stock is deemed to be transferred to the section 958(a) U.S. 
shareholder through intermediate entities, if any, in redemption of 
equity deemed issued by the intermediate entities pursuant to paragraph 
(c)(2) or (3) of this section) to the specified related person that is 
treated as holding the deemed instruments allocable to the out-of-group 
transferred disregarded specified stock, in redemption of the deemed 
instruments that are allocable to the out-of-group transferred 
disregarded specified stock; and
    (ii) The deemed issued stock that is treated as transferred 
pursuant to paragraph (d)(3)(i) of this section is treated as 
recapitalized into the disregarded specified stock actually held by the 
specified related person, which immediately thereafter is treated as 
specified stock owned by the specified related person for all purposes 
of the Internal Revenue Code. See Example 7 and Example 11 of paragraph 
(g) of this section.
    (4) Certain direct transfers of disregarded specified stock to 
which unwind rules do not apply. When a specified related person 
directly transfers the disregarded specified stock of the expatriated 
foreign subsidiary and paragraphs (d)(2) and (3) of this section do not 
apply with respect to the transfer, the specified related person is 
deemed to transfer the deemed instruments allocable to the transferred 
disregarded specified stock, whether it is in-group transferred 
disregarded specified stock or out-of-group transferred disregarded 
specified stock, to the transferee of the specified stock, in lieu of 
the disregarded specified stock, in exchange for the consideration 
provided by the transferee for the disregarded specified stock. See 
Example 10 of paragraph (g) of this section.
    (5) Determination of deemed issued stock and deemed instruments 
allocable to transferred disregarded specified stock--(i) Out-of-group 
transfers of disregarded specified stock. For purposes of paragraphs 
(d)(3) and (4) of this section, the portion of the deemed issued stock 
treated as owned, and of the deemed instruments treated as issued, by 
each section 958(a) U.S. shareholder as a result of the specified 
transaction that is allocable to out-of-group transferred disregarded 
specified stock is the amount that is proportionate to the ratio of the 
amount of the out-of-group transferred disregarded specified stock to 
the amount of disregarded specified stock of the expatriated foreign 
subsidiary that is actually held by the specified related person 
immediately before the transfer referred to in paragraph (d)(3) or (4) 
of this section as a result of the specified transaction.
    (ii) In-group direct transfers of disregarded specified stock. For 
purposes of paragraph (d)(4) of this section, the portion of the deemed 
issued stock treated as owned by each section 958(a) U.S. shareholder 
as a result of the specified transaction that is allocable to in-group 
transferred disregarded specified stock is the amount that is 
proportionate to the ratio of the amount of the in-group transferred 
disregarded specified stock to the amount of disregarded specified 
stock of the expatriated foreign subsidiary that is actually held by 
the specified related person immediately before the transfer described 
in paragraph (d)(4) of this section as a result of the specified 
transaction.
    (e) Certain exception from foreign personal holding company income 
not available. An amount included in the gross income of a controlled 
foreign corporation as a dividend with respect to stock transferred in 
a specified transaction does not qualify for the exception from foreign 
personal holding company income provided by section 954(c)(6) (to the 
extent in effect).
    (f) Definitions. In addition to the definitions in Sec.  1.7874-12, 
the following definitions and special rules apply for purposes of this 
section:
    (1) Deemed instruments mean, with respect to a specified 
transaction, instruments deemed issued by a section 958(a) U.S. 
shareholder in exchange for transferred property in the specified 
transaction.
    (2) Deemed issued stock means, with respect to a specified 
transaction, stock of an expatriated foreign subsidiary deemed issued 
to a section 958(a) U.S. shareholder (or an intermediate entity) in the 
specified transaction.
    (3) Disregarded specified stock means, with respect to a specified 
transaction, specified stock that is actually held by a specified 
related person but that is disregarded for all purposes of the Internal 
Revenue Code pursuant to paragraph (c)(2) or (3) of this section.
    (4) Indirect ownership. To determine indirect ownership of the 
stock of a corporation for purposes of calculating a pre-transaction 
ownership percentage or post-transaction ownership percentage with 
respect to that corporation, the principles of section 958(a) apply 
without regard to whether an intermediate entity is foreign or 
domestic. For this purpose, stock of the corporation that is directly 
or indirectly (applying the principles of section 958(a) without regard 
to whether an intermediate entity is foreign or domestic) owned by a 
domestic corporation that is an expatriated entity is not treated as 
indirectly owned by a non-EFS foreign related person.
    (5) In-group transferred disregarded specified stock means 
disregarded specified stock that is directly transferred to a foreign 
related person, a specified related person, or an expatriated entity.
    (6) A lower-tier expatriated foreign subsidiary means an 
expatriated foreign subsidiary, stock of which is directly or 
indirectly owned by an expatriated foreign subsidiary.
    (7) Out-of-group transferred disregarded specified stock means 
disregarded specified stock that, as a result of a transfer of 
disregarded specified stock, is actually held by a person that is not a 
foreign related person, a specified related person, or an expatriated 
entity.
    (8) Pre-transaction ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately before a specified transaction and any 
related transaction, is owned, in the aggregate, directly or indirectly 
by non-EFS foreign related persons.
    (9) Post-transaction ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately after the specified transaction and any 
related transaction, is owned, in the aggregate, directly or indirectly 
by non-EFS foreign related persons.
    (10) A section 958(a) U.S. shareholder means, with respect to an 
expatriated foreign subsidiary, a United States shareholder with 
respect to the expatriated foreign subsidiary that owns (within the 
meaning of section 958(a)) stock of the expatriated foreign subsidiary 
and that is an expatriated entity.
    (11) Specified stock means the stock of the expatriated foreign 
subsidiary that

[[Page 32541]]

is issued or transferred to a specified related person in a specified 
transaction.
    (12) Transferred property means the property transferred by the 
specified related person in exchange for specified stock in a specified 
transaction.
    (g) Examples. The following examples illustrate the regulations 
described in this section. Except as otherwise provided, FA, a foreign 
corporation, wholly owns DT, a domestic corporation, which, in turn, 
wholly owns FT, a foreign corporation that is a controlled foreign 
corporation. FA also wholly owns FS, a foreign corporation that is a 
controlled foreign corporation for its taxable year beginning January 
1, 2017, but not for prior taxable years. FA acquired DT in an 
inversion transaction that was completed on January 1, 2015. 
Accordingly, DT is the domestic entity and a section 958(a) U.S. 
shareholder with respect to FT, FT is an expatriated foreign 
subsidiary, and FA and FS are non-EFS foreign related persons and 
specified related persons. All entities have a calendar year tax year 
for U.S. tax purposes.

    Example 1.  (i) Facts. On February 1, 2015, FA acquires $6x of 
FT stock, representing 60% of the total voting power and value of 
the stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period. Furthermore, the exceptions to recharacterization in 
paragraph (b)(2) of this section do not apply to the transaction.
    (B) FA's acquisition of the FT specified stock is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows, with the result that FT continues to be a CFC even before 
its taxable year beginning January 1, 2017:
    (1) DT is treated as having issued deemed instruments to FA in 
exchange for $6x of cash.
    (2) DT is treated as having contributed the $6x of cash to FT in 
exchange for deemed issued stock of FT.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock issued to FA will be treated 
as a distribution to DT, which, in turn, will be treated as making a 
matching distribution with respect to the deemed instruments that DT 
is treated as having issued to FA. Under paragraph (c)(4)(ii) of 
this section, FT is treated as the paying agent of DT with respect 
to the deemed instruments issued by DT to FA.
    Example 2. (i) Facts. DT owns stock of FT representing 60% of 
the total voting power and value of the stock of FT, and the 
remaining stock of FT, representing 40% of the total voting power 
and value, is owned by USP, a domestic corporation that is not an 
expatriated entity. On February 1, 2015, FA acquires $6x of FT 
stock, representing 60% of the total voting power and value of the 
stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period. Furthermore, the exceptions to recharacterization in 
paragraph (b)(2) of this section do not apply to the transaction.
    (B) FA's acquisition of the FT specified stock is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows, with the result that FT continues to be a CFC even before 
its taxable year beginning January 1, 2017:
    (1) DT is treated as having issued deemed instruments to FA in 
exchange for $6x of cash.
    (2) DT is treated as having contributed the $6x of cash to FT in 
exchange for deemed issued stock of FT.
    (3) DT is treated as owning $8.40x of the stock of FT, 
representing 84% of the total voting power and value of the stock of 
FT. USP owns $1.60x of the stock of FT, representing 16% of the 
total voting power and value of the stock of FT.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock issued to FA will be treated 
as a distribution to DT, which, in turn, will be treated as making a 
matching distribution with respect to the deemed instruments that DT 
is treated as having issued to FA. Under paragraph (c)(4)(ii) of 
this section, FT is treated as the paying agent of DT with respect 
to the deemed instruments issued by DT to FA.
    Example 3. (i) Facts. DT owns stock of FT representing 50% of 
the total voting power and value of the $8x of stock of FT 
outstanding, and the remaining stock of FT, representing 50% of the 
total voting power and value, is owned by USP, a domestic 
corporation that is not an expatriated entity. On April 30, 2016, FA 
and USP each simultaneously acquire $1x of FT stock from FT in a 
stock issuance, in exchange for $1x of cash each.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period.
    (B) However, the specified transaction is not recharacterized 
under paragraphs (c)(1) and (2) of this section because the 
exception in paragraph (b)(2)(iii) of this section applies. The 
exception applies because FT remains a controlled foreign 
corporation immediately after the specified transaction and any 
related transaction, and the post-transaction ownership percentage 
with respect to FT is 90% (90%/100%), or at least 90%, of the pre-
transaction ownership percentage with respect to FT. The rule in 
paragraph (b)(2)(iii)(C) of this section does not apply because 
there is no lower-tier expatriated foreign subsidiary. Although FA 
(a non-EFS foreign related person) indirectly owns $4x of FT stock 
both immediately before and after the specified transaction and any 
related transaction, all of that stock is directly owned by DT (a 
domestic corporation), and as a result, under paragraph (f)(4) of 
this section, none of that stock is treated as directly or 
indirectly owned by FA for purposes of calculating the pre-
transaction ownership percentage and the post-transaction ownership 
percentage with respect to FT. Accordingly, under paragraph (f)(8) 
of this section, the pre-transaction ownership percentage with 
respect to FT (100% less the percentage of stock (by value) in FT 
that, immediately before the specified transaction with respect to 
FT and any related transaction, is owned by non-EFS foreign related 
persons) is 100 (100%-0%). Under paragraph (f)(9) of this section, 
the post-transaction ownership percentage with respect to FT (100% 
less the percentage of stock (by value) in FT that, immediately 
after the specified transaction with respect to FT and any related 
transaction, is owned by non-EFS foreign related persons) is 90 
(100%-10% ($1x/$10x)).
    Example 4. (i) Facts. On February 1, 2015, FA acquires 60% of 
the FT stock owned by DT in exchange for $2.40x of cash in a fully 
taxable transaction. DT recognizes and includes in income all of the 
gain (including any gain treated as a deemed dividend pursuant to 
section 1248(a)) with respect to the FT stock transferred to FA.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock is a specified transaction 
because stock of an expatriated foreign subsidiary was transferred 
to a specified related person (FA) during the applicable period.
    (B) However, the specified transaction is not recharacterized 
under paragraphs (c)(1) and (c)(3) of this section because the 
exception in paragraph (b)(2)(ii) of this section applies. The 
exception applies because DT recognizes and includes in income all 
of the gain (including any gain treated as a deemed dividend 
pursuant to section 1248(a)) with respect to the FT specified stock 
transferred to FA.
    Example 5. (i) Facts. On February 1, 2015, DT and FA organize 
FPRS, a foreign partnership, with nominal capital. DT transfers all 
of the stock of FT to FPRS in exchange for 40% of the capital and 
profits interests in the partnership. Furthermore, FA contributes 
property to FPRS in exchange for the other 60% of the capital and 
profits interests.
    (ii) Analysis. (A) Under paragraph (b) of this section, DT's 
transfer of the FT specified stock is a specified transaction, 
because stock of an expatriated foreign subsidiary was transferred 
to a specified related person (FPRS) during the applicable period. 
The exceptions to recharacterization in paragraph (b)(2) of this 
section do not apply to the transaction.
    (B) DT's transfer of the FT specified stock is recharacterized 
under paragraphs (c)(1) and (c)(3) of this section as follows, with 
the result that FT continues to be a CFC even before its taxable 
year beginning January 1, 2017:
    (1) FPRS is treated as having issued 40% of its capital and 
profits interests to DT in

[[Page 32542]]

exchange for deemed instruments treated as having been issued by DT.
    (2) DT is treated as continuing to own all of the stock of FT, 
as well as the FPRS interests.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock transferred to FPRS will be 
treated as a distribution to DT, which, in turn, will be treated as 
making a matching distribution with respect to the deemed 
instruments that DT is treated as having issued to FPRS. Under 
paragraph (c)(4)(ii) of this section, FT is treated as the paying 
agent of DT with respect to the deemed instruments issued by DT to 
FPRS.
    Example 6. (i) Facts. DT wholly owns FT2, a foreign corporation 
that is a controlled foreign corporation. FT and FT2 each own 50% of 
the capital and profits interests in DPRS, a domestic partnership. 
DPRS wholly owns FT3, a foreign corporation that is a controlled 
foreign corporation. FT2 and FT3 are expatriated foreign 
subsidiaries. On April 30, 2016, FS acquires $9x of the stock of 
each of FT and FT2, representing 9% of the total voting power and 
value of the stock of FT and FT2, from FT and FT2, respectively, in 
a stock issuance, in exchange for cash of $9x each. Also on April 
30, 2016, in a related transaction, FS acquires $9x of the stock of 
FT3, representing 9% of the total voting power and value of the 
stock of FT3, from FT3 in a stock issuance, in exchange for cash of 
$9x.
    (ii) Analysis. (A) Under paragraph (b) of this section, the 
acquisitions by FS of the specified stock of each of FT, FT2, and 
FT3 from FT, FT2, and FT3 are specified transactions with respect to 
each of FT, FT2, and FT3, respectively, because stock of an 
expatriated foreign subsidiary was issued to a specified related 
person (FS) during the applicable period.
    (B) If FS had acquired only stock of FT and FT2, and had not 
acquired stock of FT3 in a related transaction, the specified 
transactions resulting from the acquisitions with respect to FT and 
FT2 would not have been recharacterized under paragraphs (c)(1) and 
(2) of this section, because the exception from recharacterization 
in paragraph (b)(2)(iii) of this section would have applied. FT and 
FT2 remain controlled foreign corporations immediately after each 
specified transaction and any related transaction. Under paragraph 
(f)(9) of this section, the post-transaction ownership percentage 
with respect to each of FT, FT2, and FT3 (a lower-tier expatriated 
foreign subsidiary of FT and FT2) would have been 91% ((100%-9%)/
(100%-0%)), or at least 90%, of the pre-transaction ownership 
percentage determined under paragraph (f)(8) of this section with 
respect to each of FT, FT2, and FT3 (100%).
    (C) However, for the specified transactions with respect to FT, 
FT2, and FT3, the post-transaction ownership percentage determined 
under paragraph (f)(9) of this section with respect to FT3 (the 
lower-tier expatriated foreign subsidiary of FT and FT2), 100% less 
the percentage of stock (by value) in FT3 that, immediately after 
each of the specified transactions with respect to each of FT and 
FT2 and any related transaction, is owned by the non-EFS foreign 
related persons, is 82.81 (100% - (9% x 50% x 91%)-(9% x 50% x 91%)-
9%). Accordingly, the post-transaction ownership percentage with 
respect to FT3 is 82.81% (82.81/(100%-0%)), which is less than 90%, 
of the pre-transaction ownership percentage determined under 
paragraph (f)(8) of this section with respect to FT3. Thus, the 
exception from recharacterization in paragraph (b)(2)(iii) of this 
section does not apply with respect to the specified transactions 
with respect to FT, FT2, or FT3.
    (D) The specified transactions with respect to FT and FT2 are 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows:
    (1) DT is treated as having issued 2 deemed instruments worth 
$9x each to FA in exchange for $18x ($9x + $9x) of cash.
    (2) DT is treated as having contributed $9x of cash to each of 
FT and FT2 in exchange for deemed issued stock of FT and FT2.
    (3) DT is treated as continuing to own all of the stock of FT 
and FT2.
    (E) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT and FT2 specified stock issued to FS will be 
treated as a distribution to DT, which, in turn, will be treated as 
making a matching distribution with respect to the deemed 
instruments that DT is treated as having issued to FS. Under 
paragraph (c)(4)(ii) of this section, FT and FT2 are treated as the 
paying agents of DT with respect to the deemed instruments issued by 
DT to FS.
    (F) The specified transaction with respect to FT3 is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows:
    (1) DPRS is treated as having issued a deemed instrument worth 
$9x to FA in exchange for $9x of cash.
    (2) DPRS is treated as having contributed $9x of cash to FT3 in 
exchange for deemed issued stock of FT3.
    (3) DPRS is treated as continuing to own all of the stock of 
FT3.
    (G) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT3 specified stock issued to FS will be treated 
as a distribution to DPRS, which, in turn, will be treated as making 
a matching distribution with respect to the deemed instruments that 
DPRS is treated as having issued to FS. Under paragraph (c)(4)(ii) 
of this section, FT3 is treated as the paying agent of DPRS with 
respect to the deemed instrument issued by DPRS to FS.
    Example 7. (i) Facts. The facts are the same as in Example 1 of 
this paragraph (g). On April 30, 2016, FA transfers $4x of the FT 
disregarded specified stock that it acquired on February 1, 2015 to 
USP, a domestic corporation that is not an expatriated entity, in 
exchange for $4x of cash.
    (ii) Results. After the transfer, FT remains a foreign related 
person. Therefore, paragraph (d)(2) of this section does not apply. 
However, the $4x of FT disregarded specified stock transferred to 
USP ceases to be held by a foreign related person, a specified 
related person, or an expatriated entity (determined without taking 
into account paragraph (c)(2) or (3) of this section). Therefore, 
under paragraph (d)(3) of this section, immediately before the 
transfer of the disregarded specified stock, DT is deemed to 
transfer $4x ($6x x ($4x/$6x)) of the FT deemed issued stock that it 
is treated as owning to FA, the specified related person, in 
redemption of $4x ($6x x ($4x/$6x)) of the DT deemed instruments 
that FA is treated as owning, and the $4x of FT deemed issued stock 
deemed transferred to FA is deemed recapitalized into disregarded 
specified stock actually held by FA, which is thereafter treated as 
owned by FA for all purposes of the Code until the transfer to USP.
    Example 8.  (i) Facts. The facts are the same as in Example 7 of 
this paragraph (g), except that on April 30, 2016, FA transfers all 
$6x of the FT disregarded specified stock to USP in exchange for $6x 
of cash.
    (ii) Results. After the transfer, FT ceases to be a foreign 
related person (determined without taking into account paragraph 
(c)(2) or (3) of this section). Therefore, under paragraph (d)(2) of 
this section, immediately before the transfer of the disregarded 
specified stock, DT is deemed to transfer the $6x of FT deemed 
issued stock that it is treated as owning to FA, the specified 
related person, in redemption of the $6x of DT deemed instruments 
that FA is treated as owning, and the $6x of FT deemed issued stock 
deemed transferred to FA is deemed recapitalized into disregarded 
specified stock actually held by FA, which is thereafter treated as 
owned by FA for all purposes of the Code until the transfer to USP.
    Example 9.  (i) Facts. The facts are the same as in Example 7 of 
this paragraph (g), except that on April 30, 2016, FA transfers 
$5.5x of the FT disregarded specified stock to USP in exchange for 
$5.5x of cash.
    (ii) Results. After the transfer, FT ceases to be a foreign 
related person (determined without taking into account paragraph 
(c)(2) or (3) of this section). Therefore, under paragraph (d)(2) of 
this section, immediately before the transfer of the disregarded 
specified stock, DT is deemed to transfer the $6x of FT deemed 
issued stock that it is treated as owning to FA, the specified 
related person, in redemption of the $6x of DT deemed instruments 
that FA is treated as owning, and the $6x of FT deemed issued stock 
deemed transferred to FA is deemed recapitalized into disregarded 
specified stock actually held by FA, which is thereafter treated as 
owned by FA for all purposes of the Code and $5.5x of which is 
transferred to USP. The remaining $0.5x of the specified stock 
continues to be treated as owned by FA for all purposes of the Code.
    Example 10.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FA transfers $5x of the FT 
disregarded specified stock that it acquired on February 1, 2015 to 
DS, a domestic corporation wholly owned by DT, in exchange for $5x 
of cash.
    (ii) Results. After the transfer, FT remains a foreign related 
person because DS is wholly owned by DT. Therefore, paragraph (d)(2) 
of this section does not apply. Furthermore, the $5x of FT 
disregarded specified stock is not, as a result of the transfer, 
held by a person that is not a foreign related person, a specified 
related person, or an expatriated entity. Therefore, paragraph 
(d)(3) of this section does not apply. Because FA, a

[[Page 32543]]

specified related person, directly transferred disregarded specified 
stock of FT in a transaction to which paragraphs (d)(2) and (3) of 
this section do not apply, under paragraph (d)(4) of this section, 
FA is treated as transferring the $5x of deemed instruments of DT 
allocable to the $5x of in-group transferred disregarded specified 
stock ($6x x ($5x/$6x)) to DS.
    Example 11.  (i) Facts. On February 1, 2015, FS acquires $6x of 
FT stock, representing 60% of the total voting power and value of 
the stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash. The $6x of FT stock is specified stock, and the transaction is 
recharacterized under paragraph (c)(2) of this section. See Example 
1 of this paragraph (g). On April 30, 2016, FA transfers stock of FS 
representing 60% of the total voting power and value of the stock of 
FS to USP, a domestic corporation that is not an expatriated entity. 
As a result of the transfer, FS ceases to be a foreign related 
person.
    (ii) Results. After the February 1, 2015 transfer, FT remains a 
foreign related person because the FT stock is acquired by FS, a 
foreign related person with respect to DT at that time. Therefore, 
paragraph (d)(2) of this section does not apply. However, after the 
April 30, 2016 transfer, because FS ceases to be a foreign related 
person, it ceases to be a specified related person. Furthermore, the 
$6x of disregarded specified stock held before the transaction 
continues to be held by FS after the transaction, and therefore is 
not held by a foreign related person, a specified related person, or 
an expatriated entity after the transaction. Accordingly, under 
paragraph (d)(3) of this section, immediately before the transfer of 
FS disregarded specified stock, DT is deemed to transfer $6x ($6x x 
($6x/$6x)) of the FT deemed issued stock that it is treated as 
owning to FS, the specified related person, in redemption of $6x 
($6x x ($6x/$6x)) of the DT deemed instruments that FS is treated as 
owning, and the $6x of FT deemed issued stock deemed transferred to 
FS is deemed recapitalized into disregarded specified stock actually 
held by FS, which thereafter is treated as owned by FS for all 
purposes of the Code, including after the transfer of 60% of the FS 
stock to USP.
    Example 12.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FP, a foreign corporation 
that is not a foreign related person acquires $15x of FT stock, 
representing 60% of the total voting power and value of the stock of 
FT, from FT in a stock issuance, in exchange for $15x of cash.
    (ii) Results. After the transaction, FT ceases to be a foreign 
related person. Therefore, under paragraph (d)(2) of this section, 
immediately before the issuance of FT stock to FP, DT is deemed to 
transfer the $6x of FT deemed issued stock that it is treated as 
owning to FA, the specified related person, in redemption of the $6x 
of DT deemed instruments that FA is treated as owning, and the $6x 
of FT deemed issued stock deemed transferred to FA is deemed 
recapitalized into disregarded specified stock actually held by FA, 
which thereafter is treated as owned by FA for all purposes of the 
Code.
    Example 13.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FS acquires $4x of the FT 
stock owned by DT in exchange for $4x of cash in a fully taxable 
transaction. DT recognizes and includes in income all of the gain 
(including any gain treated as a deemed dividend pursuant to section 
1248(a)) with respect to the FT stock transferred to FS.
    (ii) Results. (A) The transfer of FT stock by DT to FS is a 
specified transaction, but it is not recharacterized under 
paragraphs (c)(1) and (3) of this section because the exception in 
paragraph (b)(2)(ii) of this section applies. See Example 4 of this 
paragraph (g).
    (B) After the transfer, FT remains a foreign related person. 
Therefore, paragraph (d)(2) of this section does not apply. The 
disregarded specified stock of FT is not, as a result of the 
transfer, held by a person that is not a foreign related person, a 
specified related person, or an expatriated entity. Therefore, 
paragraph (d)(3) of this section does not apply. There has been no 
direct transfer of specified stock. Therefore, paragraph (d)(4) of 
this section also does not apply.
    (C) Under paragraph (d)(1) of this section, the $6x of deemed 
issued stock treated as owned by DT as a result of the specified 
transaction in which FA acquired FT stock continues to be treated as 
owned by DT, and the $6x of deemed instruments treated as issued by 
DT to FA continue to be treated as owned by FA.

    (h) Applicability date. Except as otherwise provided in this 
paragraph (h), this section applies to specified transactions completed 
on or after September 22, 2014, but only if the inversion transaction 
was completed on or after September 22, 2014. Paragraph 
(b)(2)(ii)(A)(2) of this section applies to specified transactions 
completed on or after November 19, 2015, but only if the inversion 
transaction was completed on or after September 22, 2014. Paragraphs 
(d) and (f)(5), (7), and (10) of this section apply to specified 
transactions completed on or after April 4, 2016, but only if the 
inversion transaction was completed on or after September 22, 2014. For 
inversion transactions completed on or after September 22, 2014, 
however, taxpayers may elect to apply paragraphs (d) and (f)(5), (7), 
and (10) of this section to specified transactions completed before 
April 4, 2016. In addition, for inversion transactions completed on or 
after September 22, 2014, in lieu of applying paragraphs (d) and (f)(5) 
and (7) of this section to specified transactions completed on or after 
September 22, 2014, and before April 4, 2016, taxpayers may elect to 
apply the principles of Sec.  1.7701(l)-3(c)(3)(iii). Furthermore, for 
inversion transactions completed on or after September 22, 2014, in 
lieu of applying paragraph (f)(10) of this section to specified 
transactions completed on or after September 22, 2014, and before April 
4, 2016, taxpayers may elect to define a section 958(a) U.S. 
shareholder as a United States shareholder with respect to the 
expatriated foreign subsidiary that owns (within the meaning of section 
958(a)) stock in the expatriated foreign subsidiary, but only if such 
United States shareholder is related (within the meaning of section 
267(b) or 707(b)(1)) to the specified related person or is under the 
same common control (within the meaning of section 482) as the 
specified related person.


Sec.  1.7701(l)-4T   [Removed]

0
Par. 12. Section 1.7701(l)-4T is removed.

0
Par. 13. Section 1.7874-1 is amended by:
0
1. Adding a sentence at the end of paragraph (a).
0
2. Revising paragraph (c)(2)(iii).
0
2. Redesignating paragraphs (d) through (h) as paragraphs (e) through 
(i), respectively.
0
3. Adding a new paragraph (d).
0
4. Revising newly redesignated paragraphs (g) and (i)(2).
0
5. For each paragraph listed in the following table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column.

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(a), first sentence.........  foreign corporation   foreign acquiring
                               referred to in        corporation.
                               section
                               7874(a)(2)(B).
(a), first sentence.........  expanded affiliated   expanded affiliated
                               group (EAG) that      group.
                               includes such
                               foreign corporation.
(b).........................  the ownership         determining the
                               percentage            ownership
                               determination         percentage
                               required by section   described in
                               7874(a)(2)(B)(ii).    section
                                                     7874(a)(2)(B)(ii).
(b).........................  fraction that         ownership fraction.
                               determines such
                               percentage
                               (ownership
                               fraction).
(c)(1), first sentence......  acquisition.........  domestic entity
                                                     acquisition.

[[Page 32544]]

 
(c)(1), second sentence.....  Sec.   1.7874-4, see  other rules, see
                               Sec.   1.7874-4(h).   paragraph (d) of
                                                     this section.
(c)(2), introductory text...  an acquisition......  a domestic entity
                                                     acquisition.
(c)(2)(i)...................  Before the            Before the domestic
                               acquisition.          entity acquisition.
(c)(2)(ii)..................  acquisition.........  domestic entity
                                                     acquisition.
(c)(2)(ii)..................  acquiring foreign     foreign acquiring
                               corporation.          corporation.
(c)(3)......................  acquisition results   domestic entity
                               in.                   acquisition results
                                                     in.
(c)(3)......................  former shareholders   former domestic
                               or partners of the    entity shareholders
                               domestic entity.      or former domestic
                                                     entity partners.
newly redesignated (e)(2)...  acquisition.........  domestic entity
                                                     acquisition.
newly redesignated (h),       (d)(2)..............  (e)(2).
 Example 6 (ii), third
 sentence.
newly redesignated (i)(1),    acquisitions........  domestic entity
 first sentence.                                     acquisitions.
newly redesignated (i)(1),    an acquisition......  a domestic entity
 second sentence.                                    acquisition.
newly redesignated (i)(1),    prior acquisitions..  domestic entity
 fourth sentence.                                    acquisitions
                                                     completed before
                                                     May 20, 2008.
newly redesignated (i)(1),    (e).................  (f).
 fifth sentence.
newly redesignated (i)(1),    acquisitions........  domestic entity
 last sentence.                                      acquisitions.
------------------------------------------------------------------------

    The revisions and additions read as follows:


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

    (a) * * * For definitions that apply for purposes of this section, 
see 1.7874-12.
* * * * *
    (c) * * *
    (2) * * *
    (iii) Special rule. If Sec.  1.7874-6(c)(2) applies for purposes of 
applying section 7874(c)(2)(A) and this section, then, for purposes of 
paragraph (c)(2) of this section (and so much of paragraph (c)(1) of 
this section as relates to paragraph (c)(2) of this section), the 
determination of the EAG after the domestic entity acquisition, as well 
as the determination of stock held by one or more members of the EAG 
after the domestic entity acquisition, is made without regard to one or 
more transfers (other than by issuance), in a transaction (or series of 
transactions) after and related to the acquisition, of stock of the 
acquiring foreign corporation by one or more members of the foreign-
parented group described in Sec.  1.7874-6(c)(2)(i).
* * * * *
    (d) Interaction of expanded affiliated group rules with other 
rules--(1) Exclusion rules. Stock that is excluded from the denominator 
of the ownership fraction pursuant to Sec.  1.7874-4(b), 1.7874-7(b), 
1.7874-8(b), 1.7874-9(b), or section 7874(c)(4) is taken into account 
for purposes of determining whether an entity is a member of the 
expanded affiliated group for purposes of applying section 
7874(c)(2)(A) and paragraph (b) of this section and determining whether 
a domestic entity acquisition qualifies as an internal group 
restructuring or results in a loss of control, as described in 
paragraphs (c)(2) and (3) of this section, respectively. However, such 
stock is excluded from the denominator of the ownership fraction 
regardless of whether it otherwise would be included in the denominator 
of the ownership fraction as a result of the application of paragraph 
(c) of this section. See Example 8 and Example 9 of Sec.  1.7874-4(i) 
for illustrations of the application of this paragraph (d)(1).
    (2) NOCD rule. Stock of the foreign acquiring corporation treated 
as received by former domestic entity shareholders or former domestic 
entity partners, as applicable, under Sec.  1.7874-10(b) is not taken 
into account for purposes of determining whether an entity is a member 
of the expanded affiliated group for purposes of applying section 
7874(c)(2)(A) and paragraph (b) of this section and determining whether 
a domestic entity acquisition qualifies as an internal group 
restructuring or results in a loss of control, as described in 
paragraphs (c)(2) and (3) of this section, respectively. However, such 
stock is included in the numerator and denominator of the ownership 
fraction, except to the extent that it is treated as held by a member 
of the EAG and is excluded from the numerator or both the numerator and 
the denominator, as applicable, under section 7874(c)(2)(A) or 
paragraphs (b) or (c) of this section.
* * * * *
    (g) Treatment of transactions related to the acquisition. Except as 
provided in paragraph (c)(2)(iii) of this section, all transactions 
that are related to an acquisition are taken into account in applying 
this section.
* * * * *
    (i) * * *
    (2) Applicability date of certain provisions of this section. 
Except as provided in this paragraph (i)(2), paragraph (c)(2)(iii) of 
this section applies to domestic entity acquisitions completed on or 
after April 4, 2016. Except as provided in this paragraph (i)(2), 
paragraph (d) of this section (interaction of EAG rules with other 
rules) applies to domestic entity acquisitions completed on or after 
July 12, 2018. See Sec. Sec.  1.7874-4(h) and 1.7874-7T(e), as 
contained in 26 CFR part 1 revised as of April 1, 2017, for certain 
coordination rules for domestic entity acquisitions completed before 
July 12, 2018. Except as provided in this paragraph (i)(2), paragraph 
(g) of this section applies to domestic entity acquisitions completed 
on or after September 22, 2014. For domestic entity acquisitions 
completed before April 4, 2016, however, taxpayers may elect to 
consistently apply paragraphs (c)(2)(iii) and (g) of this section, and 
Sec.  1.7874-6(c)(2), (d)(2), and (f)(2)(ii). In addition, for domestic 
entity acquisitions completed before July 12, 2018, taxpayers may elect 
to consistently apply paragraph (d) of this section.


Sec.  1.7874-1T  [Removed]

0
Par. 14. Section 1.7874-1T is removed.

0
Par. 15. Section 1.7874-2 is amended by:
0
1. Revising paragraph (a).
0
2. Removing the language ``Sec.  1.7874-12T'' in paragraph (b) 
introductory text, and adding the language ``Sec.  1.7874-12'' in its 
place.
0
3. Revising paragraphs (b)(7) through (13), (c)(2) and (4), (f)(1) 
introductory text, (f)(1)(iv), Example 21 of paragraph (k)(2), and 
paragraph (l)(2).
    The revisions read as follows:


Sec.  1.7874-2  Surrogate foreign corporation.

    (a) Scope. This section provides rules for determining whether a 
foreign corporation is treated as a surrogate foreign corporation under 
section 7874(a)(2)(B). Paragraph (b) of this section provides 
definitions and special rules. Paragraph (c) of this section

[[Page 32545]]

provides rules to determine whether a foreign corporation has acquired 
properties held by a domestic corporation (or a partnership). Paragraph 
(d) of this section provides rules that apply when two or more foreign 
corporations complete, in the aggregate, a domestic entity acquisition. 
Paragraph (e) of this section provides rules that apply when, pursuant 
to a plan, a single foreign corporation completes more than one 
domestic entity acquisition. Paragraph (f) of this section provides 
rules to identify the stock of a foreign corporation that is held by 
reason of holding stock in a domestic corporation (or an interest in a 
domestic partnership). Paragraph (g) of this section provides rules 
that treat certain publicly traded foreign partnerships as foreign 
corporations for purposes of section 7874. Paragraph (h) of this 
section provides rules concerning the treatment of certain options (or 
similar interests) for purposes of section 7874. Paragraph (i) of this 
section provides rules that treat certain interests (including debt, 
stock, or a partnership interest) as stock of a foreign corporation for 
purposes of section 7874. Paragraph (j) of this section provides rules 
concerning the conversion of a foreign corporation to a domestic 
corporation by reason of section 7874(b). Paragraph (k) of this section 
provides examples that illustrate the rules of this section. Paragraph 
(l) of this section provides the applicability dates of this section. 
For additional definitions that apply for purposes of this section, see 
Sec.  1.7874-12.
    (b) * * *
    (7) A former initial acquiring corporation shareholder of an 
initial acquiring corporation means any person that held stock in the 
initial acquiring corporation before the subsequent acquisition, 
including any person that holds stock in the initial acquiring 
corporation both before and after the subsequent acquisition.
    (8) An initial acquisition means, with respect to a subsequent 
acquisition, a domestic entity acquisition occurring, pursuant to a 
plan that includes the subsequent acquisition (or a series of related 
transactions), before the subsequent acquisition.
    (9) An initial acquiring corporation means, with respect to an 
initial acquisition, the foreign acquiring corporation.
    (10) A subsequent acquisition means, with respect to an initial 
acquisition, a transaction occurring, pursuant to a plan that includes 
the initial acquisition (or a series of related transactions), after 
the initial acquisition in which a foreign corporation directly or 
indirectly acquires (within the meaning of paragraph (c)(4)(ii) of this 
section) substantially all of the properties held directly or 
indirectly by the initial acquiring corporation.
    (11) A subsequent acquiring corporation means, with respect to a 
subsequent acquisition, the foreign corporation that directly or 
indirectly acquires substantially all of the properties held directly 
or indirectly by the initial acquiring corporation.
    (12) Special rule regarding initial acquisitions. With respect to 
an initial acquisition, the determination of the ownership percentage 
described in section 7874(a)(2)(B)(ii) is made without regard to the 
subsequent acquisition and all related transactions occurring after the 
subsequent acquisition.
    (13) Special rule regarding subsequent acquisitions. With respect 
to a subsequent acquisition (or a similar acquisition under the 
principles of paragraph (c)(4)(i) of this section) that is an inversion 
transaction, the applicable period begins on the first date that 
properties are acquired as part of the initial acquisition.
    (c) * * *
    (2) Acquisition of stock of a foreign corporation. Except as 
provided in paragraph (c)(4) of this section, an acquisition of stock 
of a foreign corporation that owns directly or indirectly stock of a 
domestic corporation (or an interest in a partnership) shall not 
constitute an indirect acquisition of any properties held by the 
domestic corporation (or the partnership). See Example 4 of paragraph 
(k) of this section for an illustration of the rules of this paragraph 
(c)(2).
* * * * *
    (4) Multiple-step acquisitions--(i) Rule. A subsequent acquisition 
is treated as a domestic entity acquisition, and the subsequent 
acquiring corporation is treated as a foreign acquiring corporation. 
See Example 21 of paragraph (k) of this section for an illustration of 
this rule. See also paragraph (f)(1)(iv) of this section (treating 
certain stock of the subsequent acquiring corporation as stock of a 
foreign corporation that is held by reason of holding stock of, or a 
partnership interest in, the domestic entity).
    (ii) Acquisition of property pursuant to a subsequent acquisition. 
In determining whether a foreign corporation directly or indirectly 
acquires substantially all of the properties held directly or 
indirectly by an initial acquiring corporation, the principles of 
section 7874(a)(2)(B)(i) apply, including paragraph (c) of this section 
other than paragraph (c)(2) of this section. For this purpose, the 
principles of paragraph (c)(1) of this section, including paragraph 
(b)(5) of this section, apply by substituting the term ``foreign'' for 
``domestic'' wherever it appears.
    (iii) Additional related transactions. If, pursuant to the same 
plan (or a series of related transactions), a foreign corporation 
directly or indirectly acquires (under the principles of paragraph 
(c)(4)(ii) of this section) substantially all of the properties 
directly or indirectly held by a subsequent acquiring corporation in a 
transaction occurring after the subsequent acquisition, then the 
principles of paragraph (c)(4)(i) of this section apply to such 
transaction (and any subsequent transaction or transactions occurring 
pursuant to the plan (or the series of related transactions)).
* * * * *
    (f) * * *
    (1) Certain transactions. For purposes of section 
7874(a)(2)(B)(ii), stock of a foreign corporation that is held by 
reason of holding stock in a domestic corporation (or an interest in a 
domestic partnership) includes, but is not limited to, the stock 
described in paragraphs (f)(1)(i) through (iv) of this section.
* * * * *
    (iv) Stock of a subsequent acquiring corporation received by a 
former initial acquiring corporation shareholder pursuant to a 
subsequent acquisition in exchange for, or with respect to, stock of an 
initial acquiring corporation that is held by reason of holding stock 
of, or a partnership interest in, a domestic entity.
* * * * *
    (k) * * *
    (2) * * *

    Example 21. Application of multiple-step acquisition rule--(i) 
Facts. Individual A owns all 70 shares of stock of DC1, a domestic 
corporation. Individual B owns all 30 shares of stock of F1, a 
foreign corporation that is a tax resident (as described in Sec.  
1.7874-3(d)(11)) of Country X. Pursuant to a reorganization 
described in section 368(a)(1)(D), DC1 transfers all of its 
properties to F1 solely in exchange for 70 newly issued voting 
shares of F1 stock (DC1 acquisition) and distributes the F1 stock to 
Individual A in liquidation pursuant to section 361(c)(1). Pursuant 
to a plan that includes the DC1 acquisition, F2, a newly formed 
foreign corporation that is also a tax resident of Country X, 
acquires 100 percent of the stock of F1 solely in exchange for 100 
newly issued shares of F2 stock (F1 acquisition). After the F1 
acquisition, Individual A owns 70 shares of F2 stock, Individual B 
owns 30 shares of F2 stock, F2

[[Page 32546]]

owns all 100 shares of F1 stock, and F1 owns all the properties held 
by DC1 immediately before the DC1 acquisition. In addition, the form 
of the transaction is respected for U.S. federal income tax 
purposes.
    (ii) Analysis--(A) The DC1 acquisition is a domestic entity 
acquisition, and F1 is a foreign acquiring corporation, because F1 
directly acquires 100 percent of the properties of DC1. In addition, 
the 70 shares of F1 stock received by A pursuant to the DC1 
acquisition in exchange for Individual A's DC1 stock are stock of a 
foreign corporation that is held by reason of holding stock in DC1. 
As a result, those 70 shares are included in both the numerator and 
the denominator of the ownership fraction when applying section 7874 
to the DC1 acquisition.
    (B) The DC1 acquisition is also an initial acquisition because 
it is a domestic entity acquisition that, pursuant to a plan that 
includes the F1 acquisition, occurs before the F1 acquisition 
(which, as described in paragraph (ii)(C) of this Example 21, is a 
subsequent acquisition). Thus, F1 is the initial acquiring 
corporation.
    (C) The F1 acquisition is a subsequent acquisition because it 
occurs, pursuant to a plan that includes the DC1 acquisition, after 
the DC1 acquisition and, pursuant to the F1 acquisition, F2 acquires 
100 percent of the stock of F1 and therefore is treated under 
paragraph (c)(4)(ii) of this section (which applies the principles 
of section 7874(a)(2)(B)(i) with certain modifications) as 
indirectly acquiring substantially all of the properties held 
directly or indirectly by F1. Thus, F2 is the subsequent acquiring 
corporation.
    (D) Under paragraph (c)(4)(i) of this section, the F1 
acquisition is treated as a domestic entity acquisition, and F2 is 
treated as a foreign acquiring corporation. In addition, under 
paragraph (f)(1)(iv) of this section, the 70 shares of F2 stock 
received by Individual A (a former initial acquiring corporation 
shareholder) pursuant to the F1 acquisition in exchange for 
Individual A's F1 stock are stock of a foreign corporation that is 
held by reason of holding stock in DC1. As a result, those 70 shares 
are included in both the numerator and the denominator of the 
ownership fraction when applying section 7874 to the F1 acquisition.

    (l) * * *
    (2) Applicability date of certain provisions of this section. 
Paragraphs (a), (b)(7) through (13), (c)(2) and (4), and (f)(1)(iv) of 
this section, as well as the introductory text of paragraph (f)(1) and 
Example 21 of paragraph (k)(2), apply to domestic entity acquisitions 
completed on or after April 4, 2016.


Sec.  1.7874-2T  [Removed]

0
Par. 16. Section 1.7874-2T is removed.

0
Par. 17. Section 1.7874-3 is amended by:
0
1. Revising paragraph (b)(4).
0
2. Revising the introductory text of paragraph (d).
0
3. Removing paragraphs (d)(1) and (d)(4).
0
4. Redesignating paragraphs (d)(2), (d)(3), (d)(5) through (12), and 
(d)(13) as paragraphs (d)(1), (d)(2), (d)(3) through (10), and (d)(12), 
respectively.
0
5. Revising newly redesignated paragraph (d)(8).
0
6. Adding paragraph (d)(11).
0
7. Revising paragraph (f)(2).
0
8. For each paragraph listed in the following table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column.

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(b), introductory text......  after an acquisition  on the completion
                               described in          date.
                               section
                               7874(a)(2)(B)(i).
(c)(1)(iii).................  acquisition           domestic entity
                               described in          acquisition.
                               section
                               7874(a)(2)(B)(i).
newly redesignated (d)(1)(i)  acquisition date....  completion date.
newly redesignated            acquisition date....  completion date.
 (d)(1)(ii).
newly redesignated (d)(3),    acquisition date....  completion date.
 first, second, third, and
 fifth sentences.
newly redesignated (d)(9)...  foreign corporation   foreign acquiring
                               described in          corporation.
                               section
                               7874(a)(2)(B).
(f)(1)......................  acquisitions........  domestic entity
                                                     acquisitions.
------------------------------------------------------------------------

    The revisions and addition read as follows:


Sec.  1.7874-3  Substantial business activities.

* * * * *
    (b) * * *
    (4) Tax residence of foreign acquiring corporation. The foreign 
acquiring corporation is a tax resident of the relevant foreign 
country. However, this paragraph (b)(4) does not apply if the relevant 
foreign country does not impose corporate income tax.
* * * * *
    (d) Definitions and special rules. In addition to the definitions 
in Sec.  1.7874-12, the following definitions and special rules apply 
for purposes of this section.
* * * * *
    (8) The term relevant financial statements means financial 
statements prepared consistently for all members of the expanded 
affiliated group in accordance with either U.S. Generally Accepted 
Accounting Principles (U.S. GAAP) or the International Financial 
Reporting Standards (IFRS) used for the expanded affiliated group's 
consolidated financial statements, but, if, after the domestic entity 
acquisition, financial statements will not be prepared consistently for 
all members of the expanded affiliated group in accordance with either 
U.S. GAAP or IFRS, then, for each member, financial statements prepared 
in accordance with either U.S. GAAP or IFRS. The relevant financial 
statements must take into account all items of income generated by all 
members of the expanded affiliated group for the entire testing period.
* * * * *
    (11) The term tax resident means, with respect to a foreign 
country, a body corporate liable to tax under the laws of the country 
as a resident.
* * * * *
    (f) * * *
    (2) Paragraphs (b)(4), (d)(8), and (d)(11) of this section. The 
first sentence of paragraph (b)(4) of this section applies to domestic 
entity acquisitions completed on or after November 19, 2015, and the 
second sentence applies to domestic entity acquisitions completed on or 
after July 12, 2018. Paragraph (d)(8) of this section applies to 
domestic entity acquisitions completed on or after April 4, 2016. 
Paragraph (d)(11) of this section applies to domestic entity 
acquisitions completed on or after July 12, 2018. For domestic entity 
acquisitions completed on or after June 3, 2015, and before April 4, 
2016, however, taxpayers may elect to apply paragraph (d)(8) of this 
section. For domestic entity acquisitions completed on or after 
November 19, 2015, and before July 12, 2018, taxpayers may elect to 
apply the second sentence of paragraph (b)(4) and paragraph (d)(11) of 
this section.


Sec.  1.7874-3T  [Removed]

0
Par. 18. Section 1.7874-3T is removed.

[[Page 32547]]


0
Par. 19. Section 1.7874-4 is amended by:
0
1. Revising the seventh sentence of paragraph (a), and adding a 
sentence at the end of paragraph (a).
0
2. Revising paragraph (d)(1)(ii).
0
3. Removing paragraph (h).
0
4. Redesignating paragraphs (i), (j), and (k) as paragraphs (h), (i), 
and (j), respectively.
0
5. In newly redesignated paragraph (j)(1), removing the language 
``(d)(1)(ii),'' from the fourth and seventh sentences and adding two 
sentences at the end of the paragraph.
0
6. For each paragraph listed in the following table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column.

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(a), eighth sentence........  (i).................  (h).
(a), ninth sentence.........  (j).................  (i).
(a), tenth sentence.........  (k).................  (j).
(c)(1)(i), second sentence..  (j).................  (i).
(c)(1)(ii)(A), last sentence  (j).................  (i).
(c)(2), last sentence.......  (j).................  (i).
(d)(1)(i)...................  Sec.  Sec.   1.7874-  Sec.  Sec.   1.7874-
                               7T(b) and 1.7874-     7(b) and 1.7874-
                               10T(b).               10(b).
(d)(1)(ii), last sentence...  (j).................  (i).
newly redesignated (h),       Sec.   1.7874-12T...  Sec.   1.7874-12.
 introductory text.
newly redesignated (h)(1),    (j).................  (i).
 last sentence.
newly redesignated (h)(1),    (i)(1)..............  (h)(1).
 last sentence.
newly redesignated (h)(2),    (i)(2)(i)...........  (h)(2)(i).
 introductory text, first
 sentence.
newly redesignated (h)(2),    (i)(2)(ii)..........  (h)(2)(ii).
 introductory text, second
 sentence.
newly redesignated            (i)(1)..............  (h)(1).
 (h)(2)(ii).
newly redesignated            (j).................  (i).
 (h)(2)(iii)(A), last
 sentence.
newly redesignated            (i)(2)(iii)(A)......  (h)(2)(iii)(A).
 (h)(2)(iii)(A), last
 sentence.
newly redesignated            (i)(2)(iii)(B)......  (h)(2)(iii)(B).
 (h)(2)(iii)(C)(2).
newly redesignated            (i)(2)(i)...........  (h)(2)(i).
 (h)(2)(iv), first sentence.
newly redesignated            (j).................  (i).
 (h)(2)(iv), last sentence.
newly redesignated            (i)(2)(iv)..........  (h)(2)(iv).
 (h)(2)(iv), last sentence.
newly redesignated (i)(10)..  Sec.   1.7874-7T(b).  Sec.   1.7874-7(b).
newly redesignated (i)(11)..  Sec.   1.7874-10T(b)  Sec.   1.7874-10(b).
newly redesignated (i),       (i)(1)..............  (h)(1).
 Example 1 (i), second
 sentence.
newly redesignated (i),       (i)(2)(ii)..........  (h)(2)(ii).
 Example 1 (ii), first
 sentence.
newly redesignated (i),       (i)(1)..............  (h)(1).
 Example 2 (i), second
 sentence.
newly redesignated (i),       (i)(2)(iv)..........  (h)(2)(iv).
 Example 2 (ii), first and
 fifth sentences.
newly redesignated (i),       (i)(2)(i)...........  (h)(2)(i).
 Example 3 (i), last
 sentence.
newly redesignated (i),       (i)(2)(iv)..........  (h)(2)(iv).
 Example 3 (ii), first and
 fifth sentences.
newly redesignated (i),       (i)(1)..............  (h)(1).
 Example 4 (ii), first
 sentence.
newly redesignated (i),       (i)(2)(ii)..........  (h)(2)(ii).
 Example 4 (ii), first
 sentence.
newly redesignated (i),       (i)(2)(ii)..........  (h)(2)(ii).
 Example 4 (iii), sixth
 sentence.
newly redesignated (i),       (i)(2)(i)...........  (h)(2)(i).
 Example 5 (ii), first
 sentence.
newly redesignated (i),       Sec.  Sec.   1.7874-  Sec.  Sec.   1.7874-
 Example 5 (ii), fourth        7T(b) and 1.7874-     7(b) and 1.7874-
 sentence.                     10T(b).               10(b).
newly redesignated (i),       (i)(2)(iii)(A)......  (h)(2)(iii)(A).
 Example 6 (ii), first
 sentence.
newly redesignated (i),       (i)(2)(i)...........  (h)(2)(i).
 Example 7 (ii), first
 sentence.
newly redesignated (i),       (i)(2)(i)...........  (h)(2)(i).
 Example 8 (ii), first
 sentence.
newly redesignated (i),       paragraph (h) of      Sec.   1.7874-
 Example 8 (ii), fifth         this section.         1(d)(1).
 sentence.
newly redesignated (i),       (i)(1)..............  (h)(1).
 Example 9 (i), last
 sentence.
newly redesignated (i),       (i)(2)(ii)..........  (h)(2)(ii).
 Example 9 (ii), first
 sentence.
newly redesignated (i),       paragraph (h) of      Sec.   1.7874-
 Example 9 (ii), fifth         this section.         1(d)(1).
 sentence.
newly redesignated (i),       paragraphs (b) and    paragraph (b) of
 Example 9 (ii), penultimate   (h) of this section.  this section and
 sentence.                                           Sec.   1.7874-
                                                     1(d)(1).
newly redesignated (i),       (i)(1)..............  (h)(1).
 Example 9 (iii), first
 sentence.

[[Page 32548]]

 
newly redesignated (i),       (i)(2)..............  (h)(2).
 Example 9 (iii), first
 sentence.
newly redesignated (i),       paragraph (h) of      Sec.   1.7874-
 Example 9 (iii), fifth        this section.         1(d)(1).
 sentence.
newly redesignated (i),       paragraphs (b) and    paragraph (b) of
 Example 9 (iii), tenth        (h) of this section.  this section and
 sentence.                                           Sec.   1.7874-
                                                     1(d)(1).
newly redesignated (j)(1),    (k).................  (j).
 first sentence.
newly redesignated (j)(1),    (i)(1) and            (h)(1) and
 second sentence.              (i)(2)(iv).           (h)(2)(iv).
newly redesignated (j)(1),    (i)(2)(iii), and      (h)(2)(iii), and
 fourth sentence.              (i)(3).               (h)(3).
newly redesignated (j)(1),    (i)(1) and            (h)(1) and
 fifth sentence.               (i)(2)(iv).           (h)(2)(iv).
newly redesignated (j)(1),    (i)(2)(iii).........  (h)(2)(iii).
 last sentence.
newly redesignated (j)(1),    (i)(3)..............  (h)(3).
 last sentence.
newly redesignated (j)(2),    (k)(3)..............  (j)(3).
 introductory text.
newly redesignated (j)(2)(i)  (i)(2)(iii).........  (h)(2)(iii).
newly redesignated            paragraphs (d) and    Paragraph (d) of
 (j)(2)(iv).                   (h) of this section.  this section and
                                                     Sec.   1.7874-
                                                     1(d)(1).
newly redesignated (j)(3),    (k)(1)..............  (j)(1).
 first sentence.
------------------------------------------------------------------------

    The revisions and addition read as follows:


Sec.  1.7874-4  Disregard of certain stock related to the domestic 
entity acquisition.

    (a) * * * Paragraph (g) of this section provides rules for the 
treatment of partnerships, and paragraph (h) of this section provides 
definitions. * * * See Sec.  1.7874-1(d)(1) for rules addressing the 
interaction of this section with the expanded affiliated group rules of 
section 7874(c)(2)(A) and Sec.  1.7874-1.
* * * * *
    (d) * * *
    (1) * * *
    (ii) On the completion date, each five percent former domestic 
entity shareholder or five percent former domestic entity partner, as 
applicable, owns (applying the attribution rules of section 318(a) with 
the modifications described in section 304(c)(3)(B)) less than five 
percent (by vote and value) of the stock of (or a partnership interest 
in) each member of the expanded affiliated group. For this purpose, a 
five percent former domestic entity shareholder (or five percent former 
domestic entity partner) is a former domestic entity shareholder (or 
former domestic entity partner) that, before the domestic entity 
acquisition, owned (applying the attribution rules of section 318(a) 
with the modifications described in section 304(c)(3)(B)) at least five 
percent (by vote and value) of the stock of (or a partnership interest 
in) the domestic entity. See Example 5 of this paragraph (i) for an 
illustration of this paragraph (d).
* * * * *
    (j) * * *
    (1) * * * Paragraph (d)(1)(ii) of this section applies to domestic 
entity acquisitions completed on or after July 12, 2018, though 
taxpayers may elect to consistently apply paragraph (d)(1)(ii) of this 
section to domestic entity acquisitions completed before July 12, 2018. 
For domestic entity acquisitions completed before July 12, 2018, see 
Sec.  1.7874-4(d)(1)(ii) as contained in 26 CFR part 1 revised as of 
April 1, 2017.
* * * * *


Sec.  1.7874-5  [Amended]

0
Par. 20. For each paragraph listed in the following table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column.

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(c).........................  Sec.   1.7874-6T....  Sec.   1.7874-6.
(d).........................  Sec.   1.7874-12T...  Sec.   1.7874-12.
------------------------------------------------------------------------


0
Par. 21. Section 1.7874-6 is added to read as follows:


Sec.  1.7874-6  Stock transferred by members of the EAG.

    (a) Scope. This section provides rules regarding whether 
transferred stock is treated as held by members of the EAG for purposes 
of applying section 7874(c)(2)(A) and Sec.  1.7874-1. Paragraph (b) of 
this section sets forth the general rule under which transferred stock 
is not treated as held by members of the EAG for purposes of applying 
section 7874(c)(2)(A) and Sec.  1.7874-1. Paragraph (c) of this section 
provides exceptions to the general rule. Paragraph (d) of this section 
provides rules regarding the treatment of partnerships, and paragraph 
(e) of this section provides rules regarding transactions related to 
the acquisition. Paragraph (f) of this section provides definitions. 
Paragraph (g) of this section provides examples illustrating the 
application of the rules of this section. Paragraph (h) of this section 
provides dates of applicability.
    (b) General rule. Except as provided in paragraph (c) of this 
section, transferred stock is not treated as held by members of the EAG 
for purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1. 
Transferred stock that is not treated as held by members of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1 is 
included in the numerator and the denominator of the ownership 
fraction. See Sec.  1.7874-5(a).
    (c) Exceptions. Transferred stock is treated as held by members of 
the EAG for purposes of applying section 7874(c)(2)(A) and Sec.  
1.7874-1 if paragraph (c)(1) or (2) of this section applies. 
Transferred stock that is treated as held by members of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1 is 
excluded from the numerator of the ownership fraction and, depending 
upon the application of Sec.  1.7874-1(c), may be excluded from the 
denominator of the ownership fraction. See Sec.  1.7874-1(b) and (c).
    (1) Transfers involving a U.S.-parented group. This paragraph 
(c)(1) applies if the following conditions are satisfied:
    (i) Before the domestic entity acquisition, the transferring 
corporation is a member of a U.S.-parented group.
    (ii) After the domestic entity acquisition, each of the 
transferring

[[Page 32549]]

corporation (or its successor), any person that holds transferred 
stock, and the foreign acquiring corporation are members of a U.S.-
parented group the common parent of which--
    (A) Before the domestic entity acquisition, was a member of the 
U.S.-parented group described in paragraph (c)(1)(i) of this section; 
or
    (B) Is a corporation that was formed in a transaction related to 
the domestic entity acquisition, provided that, immediately after the 
corporation was formed (and without regard to any related 
transactions), the corporation was a member of the U.S.-parented group 
described in paragraph (c)(1)(i) of this section.
    (2) Transfers involving a foreign-parented group. This paragraph 
(c)(2) applies if the following conditions are satisfied:
    (i) Before the domestic entity acquisition, the transferring 
corporation and the domestic entity are members of the same foreign-
parented group.
    (ii) After the domestic entity acquisition, the transferring 
corporation--
    (A) Is a member of the EAG; or
    (B) Would be a member of the EAG absent one or more transfers 
(other than by issuance), in a transaction (or series of transactions) 
after and related to the domestic entity acquisition, of stock of the 
foreign acquiring corporation by one or more members of the foreign-
parented group described in paragraph (c)(2)(i) of this section.
    (d) Treatment of partnerships--(1) Stock held by a partnership. For 
purposes of this section, each partner in a partnership, as determined 
without regard to the application of paragraph (d)(2) of this section, 
is treated as holding its proportionate share of the stock held by the 
partnership, as determined under the rules and principles of sections 
701 through 777.
    (2) Partnership treated as corporation. For purposes of this 
section, if one or more members of an affiliated group, as determined 
after the application of paragraph (d)(1) of this section, own, in the 
aggregate, more than 50 percent (by value) of the interests in a 
partnership, the partnership will be treated as a corporation that is a 
member of the affiliated group.
    (e) Treatment of transactions related to the acquisition. Except as 
provided in paragraphs (c)(1)(ii)(B) and (c)(2)(ii)(B) of this section, 
all transactions that are related to a domestic entity acquisition are 
taken into account in applying this section.
    (f) Definitions. In addition to the definitions provided in Sec.  
1.7874-12, the following definitions apply for purposes of this 
section.
    (1) A foreign-parented group means an affiliated group that has a 
foreign corporation as the common parent corporation. A member of the 
foreign-parented group is an entity included in the foreign-parented 
group.
    (2) Transferred stock--(i) In general. Transferred stock means 
stock of the foreign acquiring corporation described in section 
7874(a)(2)(B)(ii) that is received by a transferring corporation and, 
in a transaction (or series of transactions) related to the domestic 
entity acquisition, is subsequently transferred.
    (ii) Special rule. This paragraph (f)(2)(ii) applies in certain 
cases in which a transferring corporation receives stock of the foreign 
acquiring corporation described in section 7874(a)(2)(B)(ii) that has 
the same terms as other stock of the foreign acquiring corporation that 
is received by the transferring corporation in a transaction (or series 
of transactions) related to the domestic entity acquisition or that is 
owned by the transferring corporation prior to the domestic entity 
acquisition (the stock described in this sentence, collectively, 
fungible stock). Pursuant to this paragraph (f)(2)(ii), if, in a 
transaction (or series of transactions) related to the domestic entity 
acquisition, the transferring corporation subsequently transfers less 
than all of the fungible stock, a pro rata portion of the stock 
subsequently transferred is treated as consisting of stock of the 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii). 
The pro rata portion is based, at the time of the subsequent transfer, 
on the relative fair market value of the fungible stock that is stock 
of the foreign acquiring corporation described in section 
7874(a)(2)(B)(ii) to the fair market value of all the fungible stock.
    (3) A transferring corporation means a corporation that is a former 
domestic entity shareholder or former domestic entity partner.
    (4) A U.S.-parented group means an affiliated group that has a 
domestic corporation as the common parent corporation. A member of the 
U.S.-parented group is an entity included in the U.S.-parented group, 
including the common parent corporation.
    (g) Examples. The following examples illustrate the application of 
this section.

    Example 1. U.S.-parented group exception not available--(i) 
Facts. USP, a domestic corporation wholly owned by Individual A, 
owns all the stock of DT, a domestic corporation, as well as other 
property. The DT stock does not represent substantially all of the 
property of USP for purposes of section 7874. Pursuant to a 
reorganization described in section 368(a)(1)(D), USP transfers all 
the DT stock to FA, a newly formed foreign corporation, in exchange 
for 100 shares of FA stock (DT acquisition) and distributes the FA 
stock to Individual A pursuant to section 361(c)(1).
    (ii) Analysis. The 100 FA shares received by USP are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5(a), the shares retain their status as such 
even though USP subsequently distributes the shares to Individual A 
pursuant to section 361(c)(1). Thus, the 100 FA shares are included 
in the ownership fraction, unless the shares are treated as held by 
members of the EAG for purposes of applying section 7874(c)(2)(A) 
and Sec.  1.7874-1 and are excluded from the ownership fraction 
under those rules. For purposes of applying section 7874(c)(2)(A) 
and Sec.  1.7874-1, the 100 FA shares, which constitute transferred 
stock under paragraph (f)(2) of this section, are treated as held by 
members of the EAG only if an exception in paragraph (c) of this 
section applies. See paragraph (b) of this section. The U.S.-
parented group exception described in paragraph (c)(1) of this 
section does not apply. Although before the DT acquisition, USP (the 
transferring corporation) is a member of a U.S.-parented group of 
which USP is the common parent, after the DT acquisition, and taking 
into account all transactions related to the acquisition, each of 
USP, Individual A (the person that holds the transferred stock), and 
FA (the foreign acquiring corporation) are not members of a U.S.-
parented group described in paragraph (c)(1)(ii)(A) or (B) of this 
section. Accordingly, because the 100 FA shares are not treated as 
held by members of the EAG, those shares are included in the 
numerator and the denominator of the ownership fraction. Therefore, 
the ownership fraction is 100/100.
    Example 2. U.S.-parented group exception available--(i) Facts. 
USP, a domestic corporation wholly owned by Individual A, owns all 
the stock of USS, a domestic corporation, and USS owns all the stock 
of FT, a foreign corporation. FT owns all the stock of DT, a 
domestic corporation. FT does not own any other property and has no 
liabilities. Pursuant to a reorganization described in section 
368(a)(1)(F), FT transfers all of its DT stock to FA, a newly formed 
foreign corporation, in exchange for 100 shares of FA stock (DT 
acquisition) and distributes the FA stock to USS in liquidation 
pursuant to section 361(c)(1). In a transaction after and related to 
the DT acquisition, USP sells 60 percent of the stock of USS (by 
vote and value) to Individual B.
    (ii) Analysis. The 100 FA shares received by FT are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5(a), the shares retain their status as such 
even though FT subsequently distributes the shares to USS pursuant 
to section 361(c)(1). Thus, the 100 FA shares are included in the 
ownership fraction, unless the shares are treated as held by members 
of the EAG for purposes of applying section 7874(c)(2)(A) and Sec.  
1.7874-1 and are excluded from the ownership

[[Page 32550]]

fraction under those rules. For purposes of applying section 
7874(c)(2)(A) and Sec.  1.7874-1, the 100 FA shares, which 
constitute transferred stock under paragraph (f)(2) of this section, 
are treated as held by members of the EAG only if an exception in 
paragraph (c) of this section applies. See paragraph (b) of this 
section. The U.S.-parented group exception described in paragraph 
(c)(1) of this section applies. The requirement set forth in 
paragraph (c)(1)(i) of this section is satisfied because before the 
DT acquisition, FT (the transferring corporation) is a member of a 
U.S.-parented group of which USP is the common parent (the USP 
group). The requirement set forth in paragraph (c)(1)(ii) of this 
section is satisfied because after the DT acquisition, and taking 
into account all transactions related to the acquisition, each of FA 
(which is both the successor to FT, the transferring corporation, 
and the foreign acquiring corporation) and USS (the person that 
holds the transferred stock) are members of a U.S.-parented group of 
which USS (a member of the USP group before the DT acquisition) is 
the common parent. Moreover, the DT acquisition qualifies as an 
internal group restructuring under Sec.  1.7874-1(c)(2). The 
requirement set forth in Sec.  1.7874-1(c)(2)(i) is satisfied 
because before the DT acquisition, 80 percent or more of the stock 
(by vote and value) of DT was held directly or indirectly by USS 
(the corporation that after the acquisition, and taking into account 
all transactions related to the acquisition, is the common parent of 
the EAG). The requirement set forth in Sec.  1.7874-1(c)(2)(ii) is 
satisfied because after the acquisition, and taking into account all 
transactions related to the acquisition, 80 percent or more of the 
stock (by vote and value) of FA (the foreign acquiring corporation) 
is held directly or indirectly by USS. Therefore, the 100 FA shares 
are excluded from the numerator, but included in the denominator, of 
the ownership fraction. Accordingly, the ownership fraction is 0/
100.
    Example 3. U.S.-parented group exception available--(i) Facts. 
USP, a domestic corporation wholly owned by Individual A, owns all 
the stock of USS, a domestic corporation, and USS owns all the stock 
of DT, also a domestic corporation. DT owns all the stock of FT, a 
foreign corporation. The FT stock represents substantially all of 
the property of DT for purposes of section 7874. Pursuant to a 
reorganization described in section 368(a)(1)(D), DT transfers all 
the FT stock to FA, a newly formed foreign corporation, in exchange 
for 100 shares of FA stock (DT acquisition) and distributes the FA 
stock to USS pursuant to section 361(c)(1). In a related 
transaction, USS distributes all the FA stock to USP under section 
355(c)(1). Lastly, in another related transaction and pursuant to a 
divisive reorganization described in section 368(a)(1)(D), USP 
transfers all the stock of USS and FA to DP, a newly formed domestic 
corporation, in exchange for all the stock of DP and distributes the 
DP stock to Individual A pursuant to section 361(c)(1).
    (ii) Analysis. The 100 FA shares received by USS are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5(a), the shares retain their status as such 
even though USS subsequently transfers the shares to USP. Thus, the 
100 FA shares are included in the ownership fraction, unless the 
shares are treated as held by members of the EAG for purposes of 
applying section 7874(c)(2)(A) and Sec.  1.7874-1 and are excluded 
from the ownership fraction under those rules. For purposes of 
applying section 7874(c)(2)(A) and Sec.  1.7874-1, the 100 FA 
shares, which constitute transferred stock under paragraph (f)(2) of 
this section, are treated as held by members of the EAG only if an 
exception in paragraph (c) of this section applies. See paragraph 
(b) of this section. The U.S.-parented group exception described in 
paragraph (c)(1) of this section applies. The requirement set forth 
in paragraph (c)(1)(i) of this section is satisfied because before 
the DT acquisition, USS (the transferring corporation) is a member 
of a U.S.-parented group of which USP is the common parent (the USP 
group). The requirement set forth in paragraph (c)(1)(ii) of this 
section is satisfied because after the DT acquisition, and taking 
into account all transactions related to the acquisition, each of 
USS, DP (the person that holds the transferred stock), and FA (the 
foreign acquiring corporation) are members of a U.S.-parented group 
of which DP (a corporation that was formed in a transaction related 
to the DT acquisition and that, immediately after it was formed (but 
without regard to any related transactions) was a member of the USP 
group) is the common parent. Therefore, the 100 FA shares are 
excluded from the numerator and the denominator of the ownership 
fraction. Accordingly, the ownership fraction is 0/0.
    Example 4. Foreign-parented group exception--(i) Facts. 
Individual A owns all the stock of FT, a foreign corporation, and FT 
owns all the stock of DT, a domestic corporation. FT does not own 
any other property and has no liabilities. Pursuant to a 
reorganization described in section 368(a)(1)(F), FT transfers all 
the stock of DT to FA, a newly formed foreign corporation, in 
exchange for 100 shares of FA stock (DT acquisition) and distributes 
the FA stock to Individual A in liquidation pursuant to section 
361(c)(1).
    (ii) Analysis. The 100 FA shares received by FT are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5(a), the shares retain their status as such 
even though FT subsequently distributes the shares to Individual A 
pursuant to section 361(c)(1). Thus, the 100 FA shares are included 
in the ownership fraction, unless the shares are treated as held by 
members of the EAG of purposes of applying section 7874(a)(2)(A) and 
Sec.  1.7874-1 and are excluded from the ownership fraction under 
those rules. For purposes of applying section 7874(c)(2)(A) and 
Sec.  1.7874-1, the 100 FA shares, which constitute transferred 
stock under paragraph (f)(2) of this section, are treated as held by 
members of the EAG only if an exception in paragraph (c) of this 
section applies. See paragraph (b) of this section. The foreign-
parented group exception described in paragraph (c)(2) of this 
section applies. The requirement set forth in paragraph (c)(2)(i) of 
this section is satisfied because before the DT acquisition, FT (the 
transferring corporation) and DT are members of the foreign-parented 
group of which FT is the common parent. The requirement set forth in 
paragraph (c)(2)(ii) of this section is satisfied because after the 
acquisition, and taking into account all transactions related to the 
acquisition, FT would be a member of the EAG absent the distribution 
of the FA shares pursuant to section 361(c)(1). Moreover, the DT 
acquisition qualifies as an internal group restructuring under Sec.  
1.7874-1(c)(2). The requirement set forth in Sec.  1.7874-1(c)(2)(i) 
is satisfied because before the acquisition, 80 percent or more of 
the stock (by vote and value) of DT was held directly or indirectly 
by FT, the corporation that, without regard to the distribution of 
the FA shares pursuant to section 361(c)(1), would be common parent 
of the EAG after the acquisition. See Sec.  1.7874-1(c)(2)(iii). The 
requirement set forth in Sec.  1.7874-1(c)(2)(ii) is satisfied 
because after the acquisition, but without regard to the 
distribution of the FA shares pursuant to the section 361(c)(1) 
distribution, FT would directly or indirectly hold 80 percent or 
more of the stock (by vote and value) of FA (the foreign acquiring 
corporation). See Sec.  1.7874-1(c)(2)(iii). Therefore, the 100 FA 
shares are excluded from the numerator, but included in the 
denominator, of the ownership fraction. Accordingly, the ownership 
fraction is 0/100.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 4, except that in a transaction after and 
related to the DT acquisition, FA issues 200 shares of FA stock to 
Individual B in exchange for qualified property (within the meaning 
of Sec.  1.7874-4(h)(2)). The foreign-parented group exception does 
not apply because after the acquisition, and taking into account 
FA's issuance of the 200 FA shares to Individual B, FT would not be 
a member of the EAG absent FT's distribution of the 100 FA shares 
pursuant to section 361(c)(1). Accordingly, the 100 FA shares 
received by FT are not treated as held by a member of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1. As a 
result, the ownership fraction is 100/300.

    (h) Applicability dates. Except as otherwise provided in this 
paragraph (h), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. Paragraphs (d)(2) and 
(f)(2)(ii) of this section apply to domestic entity acquisitions 
completed on or after April 4, 2016. Taxpayers, however, may elect 
either to apply paragraph (c)(2) of this section to domestic entity 
acquisitions completed before September 22, 2014, or to consistently 
apply paragraphs (c)(2), (d)(2), and (f)(2)(ii) of this section and 
Sec.  1.7874-1(c)(2)(iii) and (g) to domestic entity acquisitions 
completed before April 4, 2016.


Sec.  1.7874-6T   [Removed]

0
Par. 22. Section 1.7874-6T is removed.

[[Page 32551]]


0
Par. 23. Section 1.7874-7 is added to read as follows:


Sec.  1.7874-7  Disregard of certain stock attributable to passive 
assets.

    (a) Scope. This section identifies certain stock of a foreign 
acquiring corporation that is attributable to passive assets and that 
is disregarded in determining the ownership fraction by value. 
Paragraph (b) of this section sets forth the general rule regarding 
when stock of a foreign acquiring corporation is excluded from the 
denominator of the ownership fraction under this section. Paragraph (c) 
of this section provides a de minimis exception to the application of 
the general rule of paragraph (b) of this section. Paragraph (d) of 
this section provides rules for the treatment of partnerships, and 
paragraph (e) of this section provides definitions. Paragraph (f) of 
this section provides examples illustrating the application of the 
rules of this section. Paragraph (g) of this section provides dates of 
applicability. The rules provided in this section are also subject to 
section 7874(c)(4). See Sec.  1.7874-1(d)(1) for rules addressing the 
interaction of this section with the expanded affiliated group rules of 
section 7874(c)(2)(A) and Sec.  1.7874-1.
    (b) General rule. If, on the completion date, more than fifty 
percent of the gross value of all foreign group property constitutes 
foreign group nonqualified property, then, for purposes of determining 
the ownership percentage by value (but not vote) described in section 
7874(a)(2)(B)(ii), stock of the foreign acquiring corporation is 
excluded from the denominator of the ownership fraction in an amount 
equal to the product of--
    (1) The value of the stock of the foreign acquiring corporation, 
other than stock that is described in section 7874(a)(2)(B)(ii) and 
stock that is excluded from the denominator of the ownership fraction 
under Sec.  1.7874-1(b), Sec.  1.7874-4(b), Sec.  1.7874-8(b), Sec.  
1.7874-9(b), or section Sec.  7874(c)(4); and
    (2) The foreign group nonqualified property fraction.
    (c) De minimis ownership. Paragraph (b) of this section does not 
apply if--
    (1) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-4(b) and 1.7874-
10(b), is less than five (by vote and value); and
    (2) On the completion date, each five percent former domestic 
entity shareholder or five percent former domestic entity partner, as 
applicable, owns (applying the attribution rules of section 318(a) with 
the modifications described in section 304(c)(3)(B)) less than five 
percent (by vote and value) of the stock of (or a partnership interest 
in) each member of the expanded affiliated group. For this purpose, a 
five percent former domestic entity shareholder (or five percent former 
domestic entity partner) is a former domestic entity shareholder (or 
former domestic entity partner) that, before the domestic entity 
acquisition, owned (applying the attribution rules of section 318(a) 
with the modifications described in section 304(c)(3)(B)) at least five 
percent (by vote and value) of the stock of (or a partnership interest 
in) the domestic entity.
    (d) Treatment of partnerships. For purposes of this section, if one 
or more members of the modified expanded affiliated group own, in the 
aggregate, more than 50 percent (by value) of the interests in a 
partnership, the partnership is treated as a corporation that is a 
member of the modified expanded affiliated group.
    (e) Definitions. In addition to the definitions provided in Sec.  
1.7874-12, the following definitions apply for purposes of this 
section.
    (1) Foreign group nonqualified property--(i) General rule. Foreign 
group nonqualified property means foreign group property described in 
Sec.  1.7874-4(h)(2), other than the following:
    (A) Property that gives rise to income described in section 954(h), 
determined--
    (1) In the case of property held by a foreign corporation, by 
substituting the term ``foreign corporation'' for the term ``controlled 
foreign corporation;'' and
    (2) In the case of property held by a domestic corporation, by 
substituting the term ``domestic corporation'' for the term 
``controlled foreign corporation,'' without regard to the phrase 
``other than the United States'' in section 954(h)(3)(A)(ii)(I), and 
without regard to any inference that the tests in section 954(h) should 
be calculated or determined without taking transactions with customers 
located in the United States into account.
    (B) Property that gives rise to income described in section 954(i), 
determined by substituting the term ``foreign corporation'' for the 
term ``controlled foreign corporation.''
    (C) Property that gives rise to income described in section 
1297(b)(2)(A) or (B) (determined without regard to other passive 
foreign investment company rules).
    (D) Property held by a domestic corporation that is subject to tax 
as an insurance company under subchapter L of chapter 1 of subtitle A 
of the Internal Revenue Code, provided that the property is required to 
support, or is substantially related to, the active conduct of an 
insurance business.
    (ii) Special rule. Foreign group nonqualified property also means 
any foreign group property that, in a transaction related to the 
domestic entity acquisition, is acquired in exchange for other 
property, including cash, if such other property would be described in 
paragraph (e)(1)(i) of this section had the transaction not occurred.
    (2) Foreign group property means any property (including excluded 
property, as described in paragraph (e)(3)(ii) of this section)) held 
on the completion date by the modified expanded affiliated group, other 
than--
    (i) Property that is directly or indirectly acquired in the 
domestic entity acquisition;
    (ii) Stock or a partnership interest in a member of the modified 
expanded affiliated group; and
    (iii) An obligation of a member of the modified expanded affiliated 
group.
    (3) Foreign group nonqualified property fraction--(i) In general. 
Foreign group nonqualified property fraction means a fraction 
calculated with the following numerator and denominator:
    (A) The numerator of the fraction is the gross value of all foreign 
group nonqualified property, other than excluded property (as described 
in paragraph (e)(3)(ii) of this section).
    (B) The denominator of the fraction is the gross value of all 
foreign group property, other than excluded property (as described in 
paragraph (e)(3)(ii) of this section)
    (ii) Excluded property. For purposes of paragraph (e)(3) of this 
section, excluded property means property that gives rise to stock that 
is excluded from the ownership fraction with respect to the domestic 
entity acquisition under Sec.  1.7874-4(b), Sec.  1.7874-8(b), Sec.  
1.7874-9(b), or section 7874(c)(4). For this purpose, only property 
that was directly or indirectly acquired in a prior domestic entity 
acquisition (as described in Sec.  1.7874-8(g)(4)) or covered foreign 
acquisition (as described in Sec.  1.7874-9(d)(4)) with respect to the 
domestic entity acquisition may be considered to give rise to stock 
that is excluded from the ownership fraction with respect to the 
domestic entity acquisition under Sec.  1.7874-8(b) or Sec.  1.7874-
9(b). If only a portion of the consideration provided in a prior 
domestic entity acquisition or covered foreign acquisition consisted of 
stock of the foreign acquiring corporation, then only a pro rata 
portion of a property

[[Page 32552]]

directly or indirectly acquired in the prior domestic entity 
acquisition or covered foreign acquisition may be considered excluded 
property, based on a fraction the numerator of which is the amount of 
the consideration that consisted of stock of the foreign acquiring 
corporation and the denominator of which is the total amount of 
consideration.
    (4) Modified expanded affiliated group means, with respect to a 
domestic entity acquisition, the group described in either paragraph 
(e)(4)(i) of this section or paragraph (e)(4)(ii) of this section. A 
member of the modified expanded affiliated group is an entity included 
in the modified expanded affiliated group.
    (i) When the foreign acquiring corporation is not the common parent 
corporation of the expanded affiliated group, the expanded affiliated 
group determined as if the foreign acquiring corporation was the common 
parent corporation.
    (ii) When the foreign acquiring corporation is the common parent 
corporation of the expanded affiliated group, the expanded affiliated 
group.
    (f) Examples. The following examples illustrate the rules of this 
section.

    Example 1.  Application of general rule--(i) Facts. Individual A 
owns all 20 shares of the sole class of stock of FA, a foreign 
corporation. FA acquires all the stock of DT, a domestic 
corporation, solely in exchange for 76 shares of newly issued FA 
stock (DT acquisition). In a transaction related to the DT 
acquisition, FA issues 4 shares of stock to Individual A in exchange 
for Asset A, which has a gross value of $50x. On the completion 
date, in addition to the DT stock and Asset A, FA holds Asset B, 
which has a gross value of $150x, and Asset C, which has a gross 
value of $100x. Assets A and B, but not Asset C, are nonqualified 
property (within the meaning of Sec.  1.7874-4(h)(2)). Further, 
Asset C was not acquired in a transaction related to the DT 
acquisition.
    (ii) Analysis. The 4 shares of FA stock issued to Individual A 
in exchange for Asset A are disqualified stock under Sec.  1.7874-
4(c) and are excluded from the denominator of the ownership fraction 
pursuant to Sec.  1.7874-4(b). Furthermore, additional shares of FA 
stock are excluded from the denominator of the ownership fraction 
pursuant to paragraph (b) of this section. This is because on the 
completion date, the gross value of all foreign group property is 
$300x (the sum of the gross values of Assets A, B, and C), the gross 
value of all foreign group nonqualified property is $200x (the sum 
of the gross values of Assets A and B), and thus 66.67% of the gross 
value of all foreign group property constitutes foreign group 
nonqualified property ($200x/$300x). Because FA has only one class 
of stock outstanding, the shares of FA stock that are excluded from 
the denominator of the ownership fraction pursuant to paragraph (b) 
of this section are calculated by multiplying 20 shares of FA stock 
(100 shares less the 76 shares described in section 
7874(a)(2)(B)(ii) and the 4 shares of disqualified stock) by the 
foreign group nonqualified property fraction. The numerator of the 
foreign group nonqualified property fraction is $150x (the gross 
value of Asset B) and the denominator is $250x (the sum of the gross 
values of Assets B and C). Asset A is not taken into account for 
purposes of the foreign group nonqualified property fraction because 
it gives rise to FA stock that is excluded under Sec.  1.7874-4(b) 
(4 shares) and, as a result, is excluded property. Accordingly, 12 
shares of FA stock are excluded from the denominator of the 
ownership fraction pursuant to paragraph (b) of this section (20 
shares multiplied by $150x/$250x). Thus, a total of 16 shares are 
excluded from the denominator of the ownership fraction (4 + 12). As 
a result, the ownership fraction by value is 76/84.
    Example 2.  Application of de minimis exception--(i) Facts. 
Individual A owns all 96 shares of the sole class of stock of FA, a 
foreign corporation. Individual B wholly owns DT, a domestic 
corporation. Individuals A and B are not related. FA acquires all 
the stock of DT solely in exchange for 4 shares of newly issued FA 
stock (DT acquisition). On the completion date, in addition to all 
of the stock of DT, FA holds Asset A, which is nonqualified property 
(within the meaning of Sec.  1.7874-4(h)(2)).
    (ii) Analysis. Without regard to the application of Sec. Sec.  
1.7874-4(b) and 1.7874-10(b) as well as paragraph (b) of this 
section, the ownership percentage described in section 
7874(a)(2)(B)(ii) would be less than 5 (by vote and value), or 4 (4/
100, or 4 shares of FA stock held by Individual B by reason of 
owning the DT stock, determined under Sec.  1.7874-2(f)(2), over 100 
shares of FA stock outstanding after the DT acquisition). 
Furthermore, on the completion date, Individual B owns less than 5% 
(by vote and value) of the stock of FA and DT (the members of the 
expanded affiliated group). Accordingly, the de minimis exception in 
paragraph (c) of this section applies. Therefore, paragraph (b) of 
this section does not apply and the ownership fraction is 4/100.
    Example 3.  Foreign acquiring corporation not common parent of 
EAG--(i) Facts. FP, a foreign corporation, owns all 85 shares of the 
sole class of stock of FA, a foreign corporation. FA acquires all 
the stock of DT, a domestic corporation, solely in exchange for 65 
shares of newly issued FA stock (DT acquisition). On the completion 
date, FA, in addition to all of the stock of DT, owns Asset A, which 
has a gross value of $40x, and Asset B, which has a gross value of 
$45x. Moreover, on the completion date, in addition to the 85 shares 
of FA stock, FP owns Asset C, which has a gross value of $10x. 
Assets A and C, but not Asset B, are nonqualified property (within 
the meaning of Sec.  1.7874-4(h)(2)). Further, Asset B was not 
acquired in a transaction related to the DT acquisition in exchange 
for nonqualified property.
    (ii) Analysis. Under paragraph (e)(2) of this section, Assets A 
and B, but not Asset C, are foreign group property. Although Asset C 
is held on the completion date by FP, a member of the expanded 
affiliated group, Asset C is not foreign group property because FP 
is not a member of the modified expanded affiliated group. This is 
the case because if the expanded affiliated group were determined 
based on FA as the common parent corporation, FP would not be a 
member of such expanded affiliated group (see paragraph (e)(4)(i) of 
this section). Under paragraph (e)(1) of this section, Asset A, but 
not Asset B, is foreign group nonqualified property. Therefore, on 
the completion date, the gross value of all foreign group property 
is $85x (the sum of the gross values of Assets A and B), and the 
gross value of all foreign group nonqualified property is $40x (the 
gross value of Asset A). Accordingly, on the completion date, only 
47.06% of the gross value of all foreign group property constitutes 
foreign group nonqualified property ($40x/$85x). Consequently, 
paragraph (b) of this section does not apply to exclude any FA stock 
from the denominator of the ownership fraction.
    Example 4.  Coordination with serial acquisition rule--(i) 
Facts. Individual A owns all 30 shares of the sole class of stock of 
FA, a foreign corporation. In Year 1, FA acquires all the stock of 
DT1, a domestic corporation, solely in exchange for 40 shares of 
newly issued FA stock (DT1 acquisition). In Year 2, FA acquires all 
the stock of DT2, a domestic corporation, solely in exchange for 50 
shares of newly issued FA stock (DT2 acquisition). On the completion 
date for the DT2 acquisition, in addition to the DT2 stock, FA holds 
Asset A, which has a gross value of $15x, Asset B, which has a gross 
value of $15x, and all the stock of DT1, which has a gross value of 
$40x. At all times, DT1 holds only Asset C, which has a gross value 
of $30x, and Asset D, which has a gross value of $10x. Assets A and 
C, but not Assets B and D, are nonqualified property (within the 
meaning of Sec.  1.7874-4(h)(2)). In addition, at all times, the 
fair market value of each share of FA stock is $1x. Further, there 
have been no redemptions of FA stock subsequent to the DT1 
acquisition. Lastly, under Sec.  1.7874-8, the DT1 acquisition is a 
prior domestic entity acquisition with respect to the DT2 
acquisition and $40x of FA stock is excluded from the denominator of 
the ownership fraction with respect to the DT2 acquisition.
    (ii) Analysis. Shares of FA stock are excluded from the 
denominator of the ownership fraction pursuant to paragraph (b) of 
this section. This is because on the completion date, the gross 
value of all foreign group property is $70x (the sum of the gross 
values of Assets A, B, C, and D), the gross value of all foreign 
group nonqualified property is $45x (the sum of the gross values of 
Assets A and C), and thus 64.29% of the gross value of all foreign 
group property constitutes foreign group nonqualified property 
($45x/$70x). The shares of FA stock that are excluded from the 
denominator of the ownership fraction pursuant to paragraph (b) of 
this section are calculated by multiplying $30x ($120x, the value of 
all the shares of FA stock, less $50x, the value of the stock 
described in section 7874(a)(2)(B)(ii), less $40x, the value of the 
stock excluded

[[Page 32553]]

under Sec.  1.7874-8(b)) by the foreign group nonqualified property 
fraction. The property taken into account for purposes of 
determining the foreign group nonqualified property fraction is 
Asset A and Asset B. Asset C and Asset D are not taken into account 
for purposes of the foreign group nonqualified property fraction 
because they are excluded property. This is because FA indirectly 
acquired the Assets in the DT1 acquisition (a prior domestic entity 
acquisition with respect to the DT2 acquisition) and, as a result of 
that acquisition, $40x of FA stock is excluded from the denominator 
of the ownership fraction with respect to the DT2 acquisition under 
Sec.  1.7874-8(b). Thus, the numerator of the foreign group 
nonqualified property fraction is $15x (the gross value of Asset A) 
and the denominator is $30x (the sum of the gross values of Asset A, 
$15x, and Asset B, $15x). Accordingly, $15x of FA stock is excluded 
from the denominator of the ownership fraction pursuant to paragraph 
(b) of this section ($30x multiplied by $15x/$30x). Thus, a total of 
$55x of FA stock is excluded from the denominator of the ownership 
fraction ($40x + $15x), making the denominator $65x ($120x - $55x). 
As a result, the ownership percentage with respect to the DT2 
acquisition by value is 76.92 ($50x/$65x).
    (ii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 4, except as follows. Initially, there are 40 
shares of FA stock outstanding, all of which are owned by Individual 
A. At all times, the gross value of asset D is $20x. In the DT1 
acquisition, FA acquires all the stock of DT1 ($50x fair market 
value) solely in exchange for 40 shares of newly issued FA stock and 
$10x of other property. As in paragraph (i) of this Example 4, 
shares of FA stock are excluded from the denominator of the 
ownership fraction pursuant to paragraph (b) of this section. This 
is because on the completion date, the gross value of all foreign 
group property is $80x (the sum of the gross values of Assets A, B, 
C, and D), the gross value of all foreign group nonqualified 
property is $45x (the sum of the gross values of Assets A and C), 
and thus 56.25% of the gross value of all foreign group property 
constitutes foreign group nonqualified property ($45x/$80x). The 
shares of FA stock that are excluded from the denominator of the 
ownership fraction pursuant to paragraph (b) of this section are 
calculated by multiplying $40x ($130x, the value of all the shares 
of FA stock, less $50x, the value of the stock described in section 
7874(a)(2)(B)(ii), less $40x, the value of the stock excluded under 
Sec.  1.7874-8(b)) by the foreign group nonqualified property 
fraction. The property taken into account for purposes of 
determining the foreign group nonqualified property fraction is 
Asset A, Asset B, and the portion of Asset C and Asset D that is not 
excluded property. Eighty percent of each of Asset C and Asset D are 
considered excluded property because FA indirectly acquired Asset C 
and Asset D in the DT1 acquisition (a prior domestic entity 
acquisition with respect to the DT2 acquisition); as a result of 
that acquisition, $40x of FA stock is excluded from the denominator 
of the ownership fraction with respect to the DT2 acquisition under 
Sec.  1.7874-8(b); and 80% of the consideration provided in the DT1 
acquisition consisted of stock of FA ($40x/$50x). Thus, the 
numerator of the foreign group nonqualified property fraction is 
$21x (the sum of the gross values of Asset A, $15x, and the portion 
of Asset C that is not excluded property, $6x) and the denominator 
is $40x (the sum of the gross values of Asset A, $15x, Asset B, 
$15x, and the portion of Asset C and Asset D that is not excluded 
property, $6x and $4x, respectively). Accordingly, $21x of FA stock 
is excluded from the denominator of the ownership fraction pursuant 
to paragraph (b) of this section ($40x multiplied by $21x/$40x). 
Thus, a total of $61x of FA stock is excluded from the denominator 
of the ownership fraction pursuant to paragraph (b) of this section 
($40x + $21x), making the denominator $69x ($130x - $61x). As a 
result, the ownership percentage with respect to D2 acquisition by 
value is 72.46 ($50x/$69x).

    (g) Applicability dates. This section applies to domestic entity 
acquisitions completed on or after July 12, 2018. For domestic entity 
acquisitions completed before July 12, 2018, see Sec.  1.7874-7T, as 
contained in 26 CFR part 1 revised as of April 1, 2017. However, to the 
extent this section differs from Sec.  1.7874-7T, as contained in 26 
CFR part 1 revised as of April 1, 2017, taxpayers may elect to 
consistently apply the differences to domestic entity acquisitions 
completed before July 12, 2018.


Sec.  1.7874-7T  [Removed]

0
Par. 24. Section 1.7874-7T is removed.

0
Par. 25. Section 1.7874-8 is added to read as follows:


Sec.  1.7874-8  Disregard of certain stock attributable to serial 
acquisitions.

    (a) Scope. This section identifies stock of a foreign acquiring 
corporation that is disregarded in determining an ownership fraction by 
value because it is attributable to certain prior domestic entity 
acquisitions. Paragraph (b) of this section sets forth the general rule 
regarding the amount of stock of a foreign acquiring corporation that 
is excluded from the denominator of the ownership fraction by value 
under this section, and paragraphs (c) through (f) of this section 
provide rules for determining this amount. Paragraph (g) provides 
definitions. Paragraph (h) of this section provides examples 
illustrating the application of the rules of this section. Paragraph 
(i) of this section provides dates of applicability. This section 
applies after taking into account Sec.  1.7874-2(e). See Sec.  1.7874-
1(d)(1) for rules addressing the interaction of this section with the 
expanded affiliated group rules of section 7874(c)(2)(A) and Sec.  
1.7874-1.
    (b) General rule. This paragraph (b) applies to a domestic entity 
acquisition (relevant domestic entity acquisition) when the foreign 
acquiring corporation (including a predecessor, as defined in Sec.  
1.7874-10(f)(1)) has completed one or more prior domestic entity 
acquisitions. When this paragraph (b) applies, then, for purposes of 
determining the ownership percentage by value (but not vote) described 
in section 7874(a)(2)(B)(ii), stock of the foreign acquiring 
corporation is excluded from the denominator of the ownership fraction 
in an amount equal to the sum of the excluded amounts computed 
separately with respect to each prior domestic entity acquisition and 
each relevant share class.
    (c) Computation of excluded amounts. With respect to each prior 
domestic entity acquisition and each relevant share class, the excluded 
amount is the product of--
    (1) The total number of prior acquisition shares, reduced by the 
sum of the number of allocable redeemed shares for all redemption 
testing periods; and
    (2) The fair market value of a single share of stock of the 
relevant share class on the completion date of the relevant domestic 
entity acquisition.
    (d) Computation of allocable redeemed shares--(1) In general. With 
respect to each prior domestic entity acquisition and each relevant 
share class, the allocable redeemed shares, determined separately for 
each redemption testing period, is the product of the number of 
redeemed shares during the redemption testing period and the redemption 
fraction.
    (2) Redemption fraction. The redemption fraction is determined 
separately with respect to each prior domestic entity acquisition, each 
relevant share class, and each redemption testing period, as follows:
    (i) The numerator is the total number of prior acquisition shares, 
reduced by the sum of the number of allocable redeemed shares for all 
prior redemption testing periods.
    (ii) The denominator is the sum of--
    (A) The number of outstanding shares of the foreign acquiring 
corporation stock as of the end of the last day of the redemption 
testing period; and
    (B) The number of redeemed shares during the redemption testing 
period.
    (e) Rules for determining redemption testing periods--(1) In 
general. Except as provided in paragraph (e)(2) of this section, a 
redemption testing period with respect to a prior domestic entity 
acquisition is the period beginning on

[[Page 32554]]

the day after the completion date of the prior domestic entity 
acquisition and ending on the day prior to the completion date of the 
relevant domestic entity acquisition.
    (2) Election to use multiple redemption testing periods. A foreign 
acquiring corporation may establish a reasonable method for dividing 
the period described in paragraph (e)(1) of this section into shorter 
periods (each such shorter period, a redemption testing period). A 
reasonable method would include a method based on a calendar convention 
(for example, daily, monthly, quarterly, or yearly), or on a convention 
that triggers the start of a new redemption testing period whenever a 
share issuance occurs that exceeds a certain threshold. In order to be 
reasonable, the method must be consistently applied with respect to all 
prior domestic entity acquisitions and all relevant share classes.
    (f) Appropriate adjustments required to take into account share 
splits and similar transactions. For purposes of this section, 
appropriate adjustments must be made to take into account changes in a 
foreign acquiring corporation's capital structure, including, for 
example, stock splits, reverse stock splits, stock distributions, 
recapitalizations, and similar transactions. Thus, for example, in 
determining the total number of prior acquisition shares with respect 
to a relevant share class, appropriate adjustments must be made to take 
into account a stock split with respect to that relevant share class 
that occurs after the completion date with respect to a prior domestic 
entity acquisition.
    (g) Definitions. In addition to the definitions provided in Sec.  
1.7874-12, the following definitions apply for purposes of this 
section.
    (1) A binding contract means an instrument enforceable under 
applicable law against the parties to the instrument. The presence of a 
condition outside the control of the parties (including, for example, 
regulatory agency approval) does not prevent an instrument from being a 
binding contract. Further, the fact that insubstantial terms remain to 
be negotiated by the parties to the contract, or that customary 
conditions remain to be satisfied, does not prevent an instrument from 
being a binding contract. A tender offer that is subject to section 
14(d) of the Securities and Exchange Act of 1934, (15 U.S.C. 
78n(d)(1)), and Regulation 14D (17 CFR 240.14d-1 through 240.14d-103) 
and that is not pursuant to a binding contract, is treated as a binding 
contract made on the date of its announcement, notwithstanding that it 
may be modified by the offeror or that it is not enforceable against 
the offerees.
    (2) A relevant share class means, with respect to a prior domestic 
entity acquisition, each separate legal class of shares in the foreign 
acquiring corporation from which prior acquisition shares were issued. 
See also paragraph (f) of this section (requiring appropriate 
adjustments in certain cases).
    (3) Total number of prior acquisition shares means, with respect to 
a prior domestic entity acquisition and each relevant share class, the 
total number of shares of stock of the foreign acquiring corporation 
that were described in section 7874(a)(2)(B)(ii) as a result of that 
acquisition (without regard to whether the 60 percent test of section 
7874(a)(2)(B)(ii) was satisfied), other than stock treated as received 
by former domestic entity shareholders or former domestic entity 
partners under Sec.  1.7874-10(b) or section 7874(c)(4), adjusted as 
appropriate under paragraph (f) of this section.
    (4) A prior domestic entity acquisition--(i) General rule. Except 
as provided in this paragraph (g)(4), a prior domestic entity 
acquisition means, with respect to a relevant domestic entity 
acquisition, a domestic entity acquisition that occurred within the 36-
month period ending on the signing date of the relevant domestic entity 
acquisition.
    (ii) Exception. A domestic entity acquisition is not a prior 
domestic entity acquisition if it is described in paragraph 
(g)(4)(ii)(A) or (B) of this section.
    (A) De minimis. A domestic entity acquisition is described in this 
paragraph (g)(4)(ii)(A) if--
    (1) The ownership percentage described in section 7874(a)(2)(B)(ii) 
with respect to the domestic entity acquisition was less than five (by 
vote and value); and
    (2) The fair market value of the stock of the foreign acquiring 
corporation described in section 7874(a)(2)(B)(ii) as a result of the 
domestic entity acquisition (without regard to whether the 60 percent 
test of section 7874(a)(2)(B)(ii) was satisfied) did not exceed $50 
million, as determined on the completion date with respect to the 
domestic entity acquisition.
    (B) Foreign-parented group. A domestic entity acquisition is 
described in this paragraph (g)(4)(ii)(B) if--
    (1) Before the domestic entity acquisition and any related 
transaction, the domestic entity was a member of a foreign-parented 
group (as described in Sec.  1.7874-6(f)(1)); and
    (2) The domestic entity acquisition qualified for the internal 
group restructuring exception under Sec.  1.7874-1(c)(2).
    (5) A redeemed share means a share of stock in a relevant share 
class that was redeemed (within the meaning of section 317(b)).
    (6) A signing date means the first date on which the contract to 
effect the relevant domestic entity acquisition is a binding contract, 
or if another binding contract to effect a substantially similar 
acquisition was terminated with a principal purpose of avoiding section 
7874, the first date on which such other contract was a binding 
contract.
    (h) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Application of general rule--(i) Facts. Individual A 
wholly owns DT1, a domestic corporation. Individual B owns all 100 
shares of the sole class of stock of FA, a foreign corporation. In 
Year 1, FA acquires all the stock of DT1 solely in exchange for 100 
shares of newly issued FA stock (DT1 acquisition). On the completion 
date with respect to the DT1 acquisition, the fair market value of 
each share of FA stock is $1x. In Year 3, FA enters into a binding 
contract to acquire all the stock of DT2, a domestic corporation 
wholly owned by Individual C. Thereafter, FA acquires all the stock 
of DT2 solely in exchange for 150 shares of newly issued FA stock 
(DT2 acquisition). On the completion date with respect to the DT2 
acquisition, the fair market value of each share of FA stock is 
$1.50x. FA did not complete the DT1 acquisition and DT2 acquisition 
pursuant to a plan (or series of related transactions) for purposes 
of applying Sec.  1.7874-2(e). In addition, there have been no 
redemptions of FA stock subsequent to the DT1 acquisition.
    (ii) Analysis. The DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition) because the DT1 acquisition occurred 
within the 36-month period ending on the signing date with respect 
to the DT2 acquisition. Accordingly, paragraph (b) of this section 
applies to the DT2 acquisition. As a result, and because there were 
no redemptions of FA stock, the excluded amount is $150x, calculated 
as 100 (the total number of prior acquisition shares) multiplied by 
$1.50x (the fair market value of a single share of FA stock on the 
completion date with respect to the DT2 acquisition). Accordingly, 
the numerator of the ownership fraction by value is $225x (the fair 
market value of the stock of FA that, with respect to the DT2 
acquisition, is described in section 7874(a)(2)(B)(ii)) (150 shares 
x $1.50x per share). In addition, the denominator of the ownership 
fraction is $375x (calculated as $525x, the fair market value of all 
350 shares of FA stock as of the completion date with respect to the 
DT2 acquisition, less $150x, the excluded amount). Therefore, the 
ownership percentage by value is 60 ($225x divided by $375x).

[[Page 32555]]

    Example 2.  Effect of certain redemptions--(i) Facts. The facts 
are the same as in paragraph (i) of Example 1 of this paragraph (h), 
except that in Year 2 FA redeems 50 shares of its stock (the Year 2 
redemption).
    (ii) Analysis. As is the case in paragraph (ii) of Example 1 of 
this paragraph (h), the DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition), and paragraph (b) of this section thus 
applies to the DT2 acquisition. Because of the Year 2 redemption, 
the allocable redeemed shares, and thus the redemption fraction, 
must be calculated. For this purpose, the redemption testing period 
is the period beginning on the day after the completion date with 
respect to the DT1 acquisition and ending on the day prior to the 
completion date with respect to the DT2 acquisition. The redemption 
fraction for the redemption testing period is thus 100/200, 
calculated as 100 (the total number of prior acquisition shares) 
divided by 200 (150, the number of outstanding shares of FA stock on 
the last day of the redemption testing period, plus 50, the number 
of redeemed shares during the redemption testing period), and the 
allocable redeemed shares for the redemption testing period is 25, 
calculated as 50 (the number of redeemed shares during the 
redemption testing period) multiplied by 100/200 (the redemption 
fraction for the redemption testing period). As a result, the 
excluded amount is $112.50x, calculated as 75 (100, the total number 
of prior acquisition shares, less 25, the allocable redeemed shares) 
multiplied by $1.50x (the fair market value of a single share of FA 
stock on the completion date with respect to the DT2 acquisition). 
Accordingly, the numerator of the ownership fraction by value is 
$225x (the fair market value of the stock of FA that, with respect 
to the DT2 acquisition, is described in section 7874(a)(2)(B)(ii)) 
(150 shares x $1.50x per share), and the denominator of the 
ownership fraction is $337.50x (calculated as $450x, the fair market 
value of all 300 shares of FA stock as of the completion date with 
respect to the DT2 acquisition, less $112.50x, the excluded amount). 
Therefore, the ownership percentage by value is 66.67 ($225x divided 
by $337.50x).
    Example 3.  Stock split--(i) Facts. The facts are the same as in 
paragraph (i) of Example 2 of this paragraph (h), except as follows. 
After the Year 2 redemption, but before the DT2 acquisition, FA 
undergoes a stock split and, as a result, each of the 150 shares of 
FA stock outstanding are converted into two shares (Year 2 stock 
split). Further, pursuant to the DT2 acquisition, FA acquires all 
the stock of DT2 solely in exchange for 300 shares of newly issued 
FA stock. Moreover, on the completion date with respect to the DT2 
acquisition, the fair market value of each share of FA stock is 
$0.75x.
    (ii) Analysis. As is the case in paragraph (ii) of Example 1 of 
this paragraph (h), the DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition), and paragraph (b) of this section thus 
applies to the DT2 acquisition. In addition, as is the case in 
paragraph (ii) of Example 2 of this paragraph (h), the redemption 
testing period is the period beginning on the day after the 
completion date with respect to the DT1 acquisition and ending on 
the day prior to the completion date with respect to the DT2 
acquisition. To calculate the redemption fraction, the total number 
of prior acquisition shares and the number of redeemed shares during 
the redemption testing period must be appropriately adjusted to take 
into account the Year 2 stock split. See paragraph (f) of this 
section. In this case, the appropriate adjustment is to increase the 
total number of prior acquisition shares from 100 to 200 and to 
increase the number of redeemed shares during the redemption testing 
period from 50 to 100. Thus, the redemption fraction for the 
redemption testing period is 200/400, calculated as 200 (the total 
number of prior acquisition shares) divided by 400 (300, the number 
of outstanding shares of FA stock on the last day of the redemption 
testing period, plus 100, the number of redeemed shares during the 
redemption testing period), and the allocable redeemed shares for 
the redemption testing period is 50, calculated as 100 (the number 
of redeemed shares during the redemption testing period) multiplied 
by 200/400 (the redemption fraction for the redemption testing 
period). In addition, for purposes of calculating the excluded 
amount, the total number of prior acquisition shares must be 
adjusted from 100 to 200. See paragraph (f) of this section. 
Accordingly, the excluded amount is $112.50x, calculated as 150 
(200, the total number of prior acquisition shares, less 50, the 
allocable redeemed shares) multiplied by $0.75x (the fair market 
value of a single share of FA stock on the completion date with 
respect to the DT2 acquisition). Consequently, the numerator of the 
ownership fraction by value is $225x (the fair market value of the 
stock of FA that, with respect to the DT2 acquisition, is described 
in section 7874(a)(2)(B)(ii)) (300 shares x $0.75x per share), and 
the denominator of the ownership fraction is $337.50x (calculated as 
$450x, the fair market value of all 600 shares of FA stock as of the 
completion date with respect to the DT2 acquisition, less $112.50x, 
the excluded amount). Therefore, the ownership percentage by value 
is 66.67 ($225 divided by $337.50x).

    (i) Applicability dates. Except as provided in this paragraph (i), 
this section applies to domestic entity acquisitions completed on or 
after April 4, 2016, regardless of when a prior domestic entity 
acquisition was completed. Paragraphs (g)(3) and (g)(4)(ii) of this 
section apply to domestic entity acquisitions completed on or after 
July 12, 2018. However, taxpayers may elect to consistently apply 
paragraphs (g)(3) and (g)(4)(ii) of this section to domestic entity 
acquisitions completed on or after April 4, 2016, and before July 12, 
2018. For domestic entity acquisitions completed on or after April 4, 
2016, and before July 12, 2018, see Sec.  1.7874-8T(g)(3) and 
(g)(4)(ii) as contained in 26 CFR part 1 revised as of April 1, 2017.


Sec.  1.7874-8T   [Removed]

0
Par. 26. Section 1.7874-8T is removed.

0
Par. 27. Section 1.7874-9 is added to read as follows:


Sec.  1.7874-9  Disregard of certain stock in third-country 
transactions.

    (a) Scope. This section identifies certain stock of a foreign 
acquiring corporation that is disregarded in determining the ownership 
fraction. Paragraph (b) of this section provides a rule that, in a 
third-country transaction, excludes from the denominator of the 
ownership fraction stock in the foreign acquiring corporation held by 
former shareholders of an acquired foreign corporation by reason of 
holding certain stock in that foreign corporation. Paragraph (c) of 
this section defines a third-country transaction, and paragraph (d) of 
this section provides other definitions. Paragraph (e) of this section 
provides operating rules. Paragraph (f) of this section provides an 
example illustrating the application of the rules of this section. 
Paragraph (g) of this section provides the dates of applicability. See 
Sec.  1.7874-1(d)(1) for rules addressing the interaction of this 
section with the expanded affiliated group rules of section 
7874(c)(2)(A) and Sec.  1.7874-1.
    (b) Exclusion of certain stock of a foreign acquiring corporation 
from the ownership fraction. When a domestic entity acquisition is a 
third-country transaction, stock of the foreign acquiring corporation 
held by reason of holding stock in the acquired foreign corporation 
(within the meaning of paragraph (e)(4) of this section) is, to the 
extent the stock otherwise would be included in the denominator of the 
ownership fraction, excluded from the denominator of the ownership 
fraction pursuant to this paragraph.
    (c) Third-country transaction. A domestic entity acquisition is a 
third-country transaction if the following requirements are satisfied:
    (1) The foreign acquiring corporation completes a covered foreign 
acquisition pursuant to a plan (or series of related transactions) that 
includes the domestic entity acquisition.
    (2) After the covered foreign acquisition and all related 
transactions are complete, the foreign acquiring corporation is not a 
tax resident of the foreign country in which the acquired foreign 
corporation was a tax resident before the covered foreign acquisition 
and all related transactions.
    (3) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the

[[Page 32556]]

application of paragraph (b) of this section, is at least 60.
    (d) Definitions. In addition to the definitions provided in Sec.  
1.7874-12, the following definitions apply for purposes of this 
section.
    (1) A foreign acquisition means a transaction in which a foreign 
acquiring corporation directly or indirectly acquires substantially all 
of the properties held directly or indirectly by an acquired foreign 
corporation (within the meaning of paragraph (e)(2) of this section).
    (2) An acquired foreign corporation means a foreign corporation 
whose properties are acquired in a foreign acquisition.
    (3) Foreign ownership percentage means, with respect to a foreign 
acquisition, the percentage of stock (by vote or value) of the foreign 
acquiring corporation held by reason of holding stock in the acquired 
foreign corporation (within the meaning of paragraph (e)(3) of this 
section).
    (4) Covered foreign acquisition--(i) In general. Except as provided 
in paragraphs (d)(4)(ii) and (iii) of this section, a covered foreign 
acquisition means a foreign acquisition in which, after the acquisition 
and all related transactions are complete, the foreign ownership 
percentage is at least 60.
    (ii) Substantial business activities exception. A foreign 
acquisition is not a covered foreign acquisition if, on the completion 
date, the following requirements are satisfied:
    (A) The foreign acquiring corporation is a tax resident of a 
foreign country.
    (B) The expanded affiliated group has substantial business 
activities in the country in which the foreign acquiring corporation is 
a tax resident when compared to the total business activities of the 
expanded affiliated group. For this purpose, the principles of Sec.  
1.7874-3 apply and the determination of whether there are substantial 
business activities is made without regard to the domestic entity 
acquisition.
    (iii) No income tax exception. A foreign acquisition is not a 
covered foreign acquisition if--
    (A) Before the acquisition and all related transactions, the 
acquired foreign corporation was created or organized in, or under the 
law of, a foreign country that does not impose corporate income tax and 
was not a tax resident of any other foreign country; and
    (B) After the acquisition and all related transactions are 
complete, the foreign acquiring corporation is created or organized in, 
or under the law of, a foreign country that does not impose corporate 
income tax and is not a tax resident of any other foreign country.
    (5) A tax resident of a foreign country has the meaning set forth 
in Sec.  1.7874-3(d)(11).
    (e) Operating rules. The following rules apply for purposes of this 
section.
    (1) Acquisition of multiple foreign corporations that are tax 
residents of the same foreign country. When multiple foreign 
acquisitions occur pursuant to the same plan (or a series of related 
transactions) and two or more of the acquired foreign corporations were 
tax residents of the same foreign country before the foreign 
acquisitions and all related transactions, then those foreign 
acquisitions are treated as a single foreign acquisition and those 
acquired foreign corporations are treated as a single acquired foreign 
corporation for purposes of this section.
    (2) Acquisition of properties of an acquired foreign corporation. 
For purposes of determining whether a foreign acquisition occurs, the 
principles of section 7874(a)(2)(B)(i) and Sec.  1.7874-2(c) and (d) 
(regarding acquisitions of properties of a domestic entity and 
acquisitions by multiple foreign corporations) apply with the following 
modifications:
    (i) The principles of Sec.  1.7874-2(c)(1) (providing rules for 
determining whether there is an indirect acquisition of properties of a 
domestic entity), including Sec.  1.7874-2(b)(5) (providing rules for 
determining the proportionate amount of properties indirectly 
acquired), apply by substituting the term ``foreign'' for ``domestic'' 
wherever it appears.
    (ii) The principles of Sec.  1.7874-2(c)(2) (regarding acquisitions 
of stock of a foreign corporation that owns a domestic entity) apply by 
substituting the term ``domestic'' for ``foreign'' wherever it appears.
    (3) Computation of foreign ownership percentage. For purposes of 
determining a foreign ownership percentage, the principles of all rules 
applicable to calculating an ownership percentage apply (including 
Sec. Sec.  1.7874-2, 1.7874-4, 1.7874-5, 1.7874-7, and section 
7874(c)(4)) with the following modifications:
    (i) Stock of a foreign acquiring corporation described in section 
7874(a)(2)(B)(ii) is not taken into account.
    (ii) The principles of this section, section 7874(c)(2)(A), and 
Sec. Sec.  1.7874-1, 1.7874-6, 1.7874-8, and 1.7874-10 do not apply.
    (iii) The principles of Sec.  1.7874-7 apply by, in addition to the 
exclusions listed in Sec.  1.7874-7(e)(2)(i) through (iii), also 
excluding from the definition of foreign group property any property 
held directly or indirectly by the acquired foreign corporation 
immediately before the foreign acquisition and directly or indirectly 
acquired in the foreign acquisition.
    (4) Stock held by reason of holding stock in an acquired foreign 
corporation. For purposes of determining stock of a foreign acquiring 
corporation held by reason of holding stock in an acquired foreign 
corporation, the principles of section 7874(a)(2)(B)(ii) and Sec. Sec.  
1.7874-2(f) and 1.7874-5 apply.
    (5) Change in the tax residency of a foreign corporation. For 
purposes of this section, a change in a country in which a foreign 
corporation is a tax resident is treated as a transaction. Further, for 
purposes of this section, if a foreign acquiring corporation changes 
the country in which it is a tax resident in a manner that would not 
otherwise be considered to result in a foreign acquisition (for 
example, by changing where it is managed and controlled), then the 
foreign acquiring corporation is treated as--
    (i) Both an acquired foreign corporation and a foreign acquiring 
corporation; and
    (ii) Directly or indirectly acquiring all of the properties held 
directly or indirectly by the acquired foreign corporation solely in 
exchange for stock of the foreign acquiring corporation.
    (f) Example. The following example illustrates the rules of this 
section.

    Example. Third-country transaction--(i) Facts. FA, a newly 
formed foreign corporation that is a tax resident of Country Y, 
acquires all the stock of DT, a domestic corporation that is wholly 
owned by Individual A, solely in exchange for 65 shares of newly 
issued FA stock (DT acquisition). Pursuant to a plan that includes 
the DT acquisition, FA acquires all the stock of FT, a foreign 
corporation that is a tax resident of Country X and wholly owned by 
Individual B, solely in exchange for the remaining 35 shares of 
newly issued FA stock (FT acquisition). After the FT acquisition and 
all related transactions, the expanded affiliated group does not 
have substantial business activities in Country Y when compared to 
the total business activities of the expanded affiliated group, as 
determined under the principles of Sec.  1.7874-3 and without regard 
to the DT acquisition.
    (ii) Analysis. As described in paragraphs (A) through (C) of 
this Example, the requirements set forth in paragraphs (c)(1) 
through (3) of this section are satisfied and, as result, the DT 
acquisition is a third-country transaction.
    (A) The FT acquisition is a foreign acquisition because, 
pursuant to the FT acquisition, FA (a foreign acquiring corporation) 
acquires 100 percent of the stock of FT and is thus treated as 
indirectly acquiring 100 percent of the properties held by FT (an 
acquired foreign corporation). See

[[Page 32557]]

Sec.  1.7874-2(c)(1) and paragraph (e)(2) of this section. Moreover, 
Individual B is treated as receiving 35 shares of FA stock by reason 
of holding stock in FT. See Sec.  1.7874-2(f)(1)(i) and paragraph 
(e)(4) of this section. As a result, not taking into account the 65 
shares of FA stock held by Individual A (a former domestic entity 
shareholder), 100 percent (35/35) of the stock of FA is held by 
reason of holding stock in FT and, thus, the foreign ownership 
percentage is 100. See paragraph (e)(3) of this section. 
Accordingly, the FT acquisition is a covered foreign acquisition. 
Therefore, because the FT acquisition occurs pursuant to a plan that 
includes the DT acquisition, the requirement set forth in paragraph 
(c)(1) of this section is satisfied.
    (B) The requirement set forth in paragraph (c)(2) of this 
section is satisfied because, after the FT acquisition and all 
related transactions, the foreign country in which FA is a tax 
resident (Country Y) is different than the foreign country in which 
FT was a resident (Country X) before the FT acquisition and all 
related transactions.
    (C) The requirement set forth in paragraph (c)(3) of this 
section is satisfied because, not taking into account paragraph (b) 
of this section, the ownership fraction is 65/100 and the ownership 
percentage is 65.
    (D) Because the DT acquisition is a third-country transaction, 
the 35 shares of FA stock held by reason of holding stock in FT are 
excluded from the denominator of the ownership fraction. See 
paragraph (b) of this section. As a result, the ownership fraction 
is 65/65 and the ownership percentage is 100. The result would be 
the same if instead FA had directly acquired all of the properties 
held by FT in exchange for FA stock, for example, in a transaction 
that would qualify for U.S. federal income tax purposes as an asset 
reorganization under section 368.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this example, except that before the FT acquisition, but in a 
transaction related to the FT acquisition, FT becomes a tax resident 
of Country Y by reincorporating in Country Y. As is the case in 
paragraph (ii) of this Example, the requirements set forth in 
paragraphs (c)(1) and (3) of this section are satisfied. The 
requirement set forth in paragraph (c)(2) of this section is 
satisfied because, after the FT acquisition and any related 
transactions, the foreign country of which FA is a tax resident 
(Country Y) is different than the foreign country of which FT was a 
tax resident (Country X) before the FT acquisition and the 
reincorporation. See paragraph (e)(5) of this section. Accordingly, 
the DT acquisition is a third-country transaction and the 
consequences are the same as in paragraph (ii)(D) of this Example.
    (iv) Alternative facts. The facts are the same as in paragraph 
(i) of this Example, except that, instead of FA acquiring all of the 
stock of FT, FS, a newly formed foreign corporation that is wholly 
owned by FA and that is a tax resident of Country X, acquires all 
the stock of FT solely in exchange for 35 shares of newly issued FA 
stock (FT acquisition). As a result of the FT acquisition, FS and FA 
are each treated as indirectly acquiring 100 percent of the 
properties held by FT. See Sec.  1.7874-2(c)(1)(i) and (iii) and 
paragraph (e)(2) of this section. Accordingly, each of FS's and FA's 
indirect acquisition of properties of FT (an acquired foreign 
corporation) is a foreign acquisition. However, FS's indirect 
acquisition of FT's properties is not a covered foreign acquisition 
because no shares of FS stock are held by reason of holding stock in 
FT; thus, with respect to this foreign acquisition, the foreign 
ownership percentage is zero. See Sec.  1.7874-2(f) and paragraphs 
(e)(3) and (4) of this section. FA's indirect acquisition of FT's 
properties is a covered foreign acquisition because 35 shares of FA 
stock (the shares received by Individual B) are held by reason of 
holding stock in FT; thus, the foreign ownership percentage is 100 
percent (35/35). See Sec.  1.7874-2(f)(1)(i) and paragraphs (e)(3) 
and (4) of this section. Accordingly, because the FT acquisition 
occurs pursuant to a plan that includes the DT acquisition, the 
requirement set forth in paragraph (c)(1) of this section is 
satisfied. Further, as is the case in paragraphs (ii)(B) through (C) 
of this Example, the requirements set forth in paragraphs (c)(2) and 
(3) of this section are satisfied. Therefore, the DT acquisition is 
a third-country transaction and the consequences are the same as in 
paragraph (ii)(D) of this Example.

    (g) Applicability dates. This section applies to domestic entity 
acquisitions completed on or after July 12, 2018. For domestic entity 
acquisitions completed before July 12, 2018, see Sec.  1.7874-9T, as 
contained in 26 CFR part 1 revised as of April 1, 2017. However, to the 
extent this section differs from Sec.  1.7874-9T, as contained in 26 
CFR part 1 revised as of April 1, 2017, taxpayers may elect to 
consistently apply the differences to domestic entity acquisitions 
completed before July 12, 2018.


Sec.  1.7874-9T   [Removed]

0
Par. 28. Section 1.7874-9T is removed.

0
Par. 29. Section 1.7874-10 is added to read as follows:


Sec.  1.7874-10  Disregard of certain distributions.

    (a) Scope. This section identifies distributions made by a domestic 
entity that are disregarded in determining an ownership fraction. 
Paragraph (b) of this section provides the general rule that former 
domestic entity shareholders or former domestic entity partners are 
treated as receiving additional stock of the foreign acquiring 
corporation when the domestic entity has made non-ordinary course 
distributions (NOCDs). Paragraph (c) of this section identifies 
distributions that, in whole or in part, are outside the scope of this 
section. Paragraph (d) of this section provides a de minimis exception 
to the application of the general rule in paragraph (b) of this 
section. Paragraph (e) of this section provides rules concerning the 
treatment of distributions made by a predecessor, and paragraph (f) of 
this section provides rules for identifying a predecessor. Paragraph 
(g) of this section provides a special rule for certain distributions 
described in section 355. Paragraph (h) of this section provides rules 
regarding the allocation of NOCD stock. Paragraph (i) of this section 
addresses cases in which there are multiple foreign acquiring 
corporations, and paragraph (j) of this section addresses cases in 
which multiple domestic entities are treated as a single domestic 
entity. Paragraph (k) of this section provides definitions. Paragraph 
(l) of this section provides dates of applicability. See Sec.  1.7874-
1(d)(2) for rules addressing the interaction of this section with the 
expanded affiliated group rules of section 7874(c)(2)(A) and Sec.  
1.7874-1.
    (b) General rule regarding NOCDs. Except as provided in paragraph 
(d) of this section, for purposes of determining the ownership 
percentage by value (but not vote) described in section 
7874(a)(2)(B)(ii), former domestic entity shareholders or former 
domestic entity partners, as applicable, are treated as receiving, by 
reason of holding stock or partnership interests in a domestic entity, 
stock of the foreign acquiring corporation with a fair market value 
equal to the amount of the non-ordinary course distributions (NOCDs), 
determined as of the date of the distributions, made by the domestic 
entity during the look-back period. The stock of the foreign acquiring 
corporation treated as received under this paragraph (b) (NOCD stock) 
is in addition to stock of the foreign acquiring corporation otherwise 
treated as received by the former domestic entity shareholders or 
former domestic entity partners by reason of holding stock or 
partnership interests in the domestic entity.
    (c) Distributions that are not NOCDs. If only a portion of a 
distribution is an NOCD, section 7874(c)(4) may apply to the remainder 
of the distribution. This section does not, however, create a 
presumption that section 7874(c)(4) applies to the remainder of the 
distribution.
    (d) De minimis exception to the general rule. Paragraph (b) of this 
section does not apply if--
    (1) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-4(b) and 1.7874-
7(b), is less than five (by vote and value); and
    (2) On the completion date, each five percent former domestic 
entity

[[Page 32558]]

shareholder or five percent former domestic entity partner, as 
applicable, owns (applying the attribution rules of section 318(a) with 
the modifications described in section 304(c)(3)(B)) less than five 
percent (by vote and value) of the stock of (or a partnership interest 
in) each member of the expanded affiliated group. For this purpose, a 
five percent former domestic entity shareholder (or five percent former 
domestic entity partner) is a former domestic entity shareholder (or 
former domestic entity partner) that, before the domestic entity 
acquisition, owned (applying the attribution rules of section 318(a) 
with the modifications described in section 304(c)(3)(B)) at least five 
percent (by vote and value) of the stock of (or a partnership interest 
in) the domestic entity.
    (e) Treatment of distributions made by a predecessor. For purposes 
of this section, a corporation or a partnership (relevant entity), 
including a domestic entity, is treated as making the following 
distributions made by a predecessor with respect to the relevant 
entity:
    (1) A distribution made before the predecessor acquisition with 
respect to the predecessor; and
    (2) A distribution made in connection with the predecessor 
acquisition to the extent the property distributed is directly or 
indirectly provided by the predecessor. See paragraph (k)(1)(iv) of 
this section.
    (f) Rules for identifying a predecessor--(1) Definition of 
predecessor. A corporation or a partnership (tentative predecessor) is 
a predecessor with respect to a relevant entity if--
    (i) The relevant entity completes a predecessor acquisition; and
    (ii) After the predecessor acquisition and all related transactions 
are complete, the tentative predecessor ownership percentage is at 
least 10.
    (2) Definition of predecessor acquisition--(i) In general. 
Predecessor acquisition means a transaction in which a relevant entity 
directly or indirectly acquires substantially all of the properties 
held directly or indirectly by a tentative predecessor.
    (ii) Acquisition of properties of a tentative predecessor. For 
purposes of determining whether a predecessor acquisition occurs, the 
principles of section 7874(a)(2)(B)(i) apply, including Sec.  1.7874-
2(c) other than Sec.  1.7874-2(c)(2) and (4) (regarding acquisitions of 
properties of a domestic entity), without regard to whether the 
tentative predecessor is domestic or foreign.
    (iii) Lower-tier entities of a predecessor. If, before a 
predecessor acquisition and all related transactions, the predecessor 
held directly or indirectly stock in a corporation or an interest in a 
partnership, then, for purposes of this section, the relevant entity is 
not considered to directly or indirectly acquire the properties held 
directly or indirectly by the corporation or partnership.
    (3) Definition of tentative predecessor ownership percentage. 
Tentative predecessor ownership percentage means, with respect to a 
predecessor acquisition, the percentage of stock or partnership 
interests (by value) in a relevant entity held by reason of holding 
stock or partnership interests in the tentative predecessor. For 
purposes of computing the tentative predecessor ownership percentage, 
the following rules apply:
    (i) For purposes of determining the stock or partnership interests 
in a relevant entity held by reason of holding stock or partnership 
interests in the tentative predecessor, the principles of section 
7874(a)(2)(B)(ii) and Sec. Sec.  1.7874-2(f)(1)(i) through (iii) and 
1.7874-5 apply.
    (ii) For purposes of determining the stock or partnership interests 
in a relevant entity included in the numerator of the fraction used to 
compute the tentative predecessor ownership percentage, the rules of 
paragraph (f)(3)(i) of this section apply, and all the rules applicable 
to calculating the numerator of an ownership fraction with respect to a 
domestic entity acquisition apply, except that--
    (A) The principles of section 7874(c)(2)(A) and Sec. Sec.  1.7874-1 
and 1.7874-6 do not apply; and
    (B) The principles of paragraph (b) of this section do not apply.
    (iii) For purposes of determining stock or partnership interests in 
a relevant entity included in the denominator of the fraction used to 
compute the tentative predecessor ownership percentage, the principles 
of section 7874(a)(2)(B)(ii) and all rules applicable to calculating 
the denominator of an ownership fraction with respect to a domestic 
entity acquisition apply, except that--
    (A) The principles of section 7874(c)(2)(A) and Sec. Sec.  1.7874-1 
and 1.7874-6 do not apply; and
    (B) The principles of Sec. Sec.  1.7874-4 and 1.7874-7 through 
1.7874-9 do not apply.
    (g) Rule regarding direction of a section 355 distribution. For 
purposes of this section, if a domestic corporation (distributing 
corporation) distributes the stock of another domestic corporation 
(controlled corporation) pursuant to a transaction described in section 
355, and, immediately before the distribution, the fair market value of 
the stock of the controlled corporation owned by the distributing 
corporation and any related person (determined under section 
7874(d)(3), without regard to whether the person is foreign) represents 
more than 50 percent of the fair market value of the stock of the 
distributing corporation, then, the controlled corporation is deemed, 
on the date of the distribution, to have distributed the stock of the 
distributing corporation. The deemed distribution is equal to the fair 
market value of the stock of the distributing corporation (but not 
taking into account the fair market value of the stock of the 
controlled corporation) on the date of the distribution.
    (h) Allocation of NOCD stock. NOCD stock is allocated among the 
former domestic entity shareholders or former domestic entity partners, 
as applicable, based on the amount of NOCDs that the former domestic 
entity shareholders or former domestic entity partners, as applicable, 
are treated as having received under this paragraph (h). Under this 
paragraph (h), a pro rata portion of each distribution during a look-
back year is treated as comprising an NOCD with respect to the look-
back year, based on a fraction the numerator of which is the amount of 
NOCDs during the look-back year and the denominator of which is the 
amount of distributions during the look-back year. Thus, each former 
domestic entity shareholder or former domestic entity partner, as 
applicable, is treated as receiving an amount of NOCD stock equal to 
the amount of NOCDs treated as received by the former domestic entity 
shareholder or former domestic entity partner, as applicable.
    (i) Multiple foreign acquiring corporations. If there are multiple 
foreign acquiring corporations with respect to a domestic entity 
acquisition, then the foreign acquiring corporation or corporations as 
to which NOCD stock is considered comprised is based on the proportion 
of consideration directly or indirectly provided by a foreign acquiring 
corporation in the domestic entity acquisition relative to the total 
amount of consideration directly or indirectly provided by the foreign 
acquiring corporations in the domestic entity acquisition. For purposes 
of this paragraph (i), consideration is not considered directly 
provided by a foreign acquiring corporation if it was indirectly 
provided by another foreign acquiring corporation. In addition, for 
purposes of this paragraph (i), consideration provided in the domestic

[[Page 32559]]

entity acquisition does not include money or other property described 
in paragraph (k)(1)(iii) of this section.
    (j) Multiple domestic entities. If pursuant to Sec.  1.7874-2(e) 
two or more domestic entities are treated as a single domestic entity, 
then the determination of the amount of NOCDs made by the single 
domestic entity is made by--
    (1) Applying the rules of this section to each domestic entity on a 
separate basis, with the result that the amount of NOCDs made by each 
domestic entity is separately computed; and
    (2) Treating the amount of NOCDs made by the single domestic entity 
as the sum of the separately computed NOCDs made by each domestic 
entity.
    (k) Definitions. In addition to the definitions provided in Sec.  
1.7874-12, the following definitions apply for purposes of this 
section.
    (1) A distribution means the following:
    (i) Any distribution made by a corporation with respect to its 
stock other than--
    (A) A distribution to which section 305 applies;
    (B) A distribution to which section 304(a)(1) applies; and
    (C) Except as provided in paragraphs (k)(1)(iii) and (iv) of this 
section, a distribution pursuant to section 361(c)(1) (other than a 
distribution to which section 355 applies).
    (ii) Any distribution by a partnership (other than a distribution 
pursuant to section 752(b) to the extent that the transaction giving 
rise to such distribution does not reduce the partnership's value).
    (iii) In the case of a domestic entity, a transfer of money or 
other property to the former domestic entity shareholders or former 
domestic entity partners that is made in connection with the domestic 
entity acquisition to the extent the money or other property is 
directly or indirectly provided by the domestic entity.
    (iv) In the case of a predecessor, a transfer of money or other 
property to the former owners of the predecessor that is made in 
connection with the predecessor acquisition to the extent the money or 
other property is directly or indirectly provided by the predecessor.
    (2) Distribution history period--(i) In general. Except as provided 
in paragraph (k)(2)(ii) or (iii) of this section, a distribution 
history period means, with respect to a look-back year, the 36-month 
period preceding the start of the look-back year.
    (ii) Formation date less than 36 months but at least 12 months 
before look-back year. If the formation date is less than 36 months, 
but at least 12 months, before the start of a look-back year, then the 
distribution history period with respect to that look-back year means 
the entire period, starting with the formation date, that precedes the 
start of the look-back year.
    (iii) Formation date less than 12 months before look-back year. If 
the formation date is less than 12 months before the start of a look-
back year, then there is no distribution history period with respect to 
that look-back year.
    (3) Formation date means, with respect to a domestic entity, the 
date that the domestic entity was created or organized, or, if earlier, 
the earliest date that any predecessor of the domestic entity was 
created or organized.
    (4) Look-back period means, with respect to a domestic acquisition, 
the 36-month period ending on the completion date or, if shorter, the 
entire period, starting with the formation date, that ends on the 
completion date.
    (5) Look-back year means, with respect to a look-back period, the 
following:
    (i) If the look-back period is 36 months, the three consecutive 12-
month periods that comprise the look-back period.
    (ii) If the look-back period is less than 36 months, but at least 
24 months--
    (A) The 12-month period that ends on the completion date;
    (B) The 12-month period that immediately precedes the period 
described in paragraph (k)(5)(ii)(A) of this section; and
    (C) The period, if any, that immediately precedes the period 
described in paragraph (k)(5)(ii)(B) of this section.
    (iii) If the look-back period is less than 24 months, but at least 
12 months--
    (A) The 12-month period that ends on the completion date; and
    (B) The period, if any, that immediately precedes the period 
described in paragraph (k)(5)(iii)(A) of this section.
    (iv) If the look-back period is less than 12 months, the entire 
period, starting with the formation date, that ends on the completion 
date.
    (6) NOCDs mean, with respect to a look-back year, the excess of all 
distributions made during the look-back year over the NOCD threshold 
for the look-back year.
    (7) NOCD threshold means, with respect to a look-back year, the 
following:
    (i) If the look-back year has at least a 12-month distribution 
history period, 110 percent of the sum of all distributions made during 
the distribution history period multiplied by a fraction. The numerator 
of the fraction is the number of days in the look-back year and the 
denominator is the number of days in the distribution history period 
with respect to the look-back year.
    (ii) If the look-back year has no distribution history period, 
zero.
    (l) Applicability date. This section applies to domestic entity 
acquisitions completed on or after July 12, 2018. For domestic entity 
acquisitions completed before July 12, 2018, see Sec.  1.7874-10T, as 
contained in 26 CFR part 1 revised as of April 1, 2017. However, to the 
extent this section differs from Sec.  1.7874-10T, as contained in 26 
CFR part 1 revised as of April 1, 2017, taxpayers may elect to 
consistently apply the differences to domestic entity acquisitions 
completed before July 12, 2018.


Sec.  1.7874-10T   [Removed]

0
Par. 30. Section 1.7874-10T is removed.

0
Par. 31. Section 1.7874-11 is added to read as follows:


Sec.  1.7874-11  Rules regarding inversion gain.

    (a) Scope. This section provides rules for determining the 
inversion gain of an expatriated entity for purposes of section 7874. 
Paragraph (b) of this section provides rules for determining the 
inversion gain of an expatriated entity. Paragraph (c) of this section 
provides special rules with respect to certain foreign partnerships in 
which an expatriated entity owns an interest. Paragraph (d) of this 
section provides additional definitions. Paragraph (e) of this section 
provides an example that illustrates the rules of this section. 
Paragraph (f) of this section provides the applicability dates.
    (b) Inversion gain--(1) General rule. Except as provided in 
paragraphs (b)(2) and (3) of this section, inversion gain includes 
income (including an amount treated as a dividend under section 78) or 
gain recognized by an expatriated entity for any taxable year that 
includes any portion of the applicable period by reason of a direct or 
indirect transfer of stock or other properties or license of any 
property either as part of the domestic entity acquisition, or after 
such acquisition if the transfer or license is to a specified related 
person.
    (2) Exception for property described in section 1221(a)(1). 
Inversion gain does not include income or gain recognized by reason of 
the transfer or license, after the domestic entity acquisition, of 
property that is described in section 1221(a)(1) in the hands of the 
transferor or licensor.

[[Page 32560]]

    (3) Treatment of partnerships. Except to the extent provided in 
paragraph (c) of this section and section 7874(e)(2), inversion gain 
does not include income or gain recognized by reason of the transfer or 
license of property by a partnership.
    (c) Transfers and licenses by partnerships. If a partnership that 
is a foreign related person transfers or licenses property, a partner 
of the partnership shall be treated as having transferred or licensed 
its proportionate share of that property, as determined under the rules 
and principles of sections 701 through 777, for purposes of determining 
the inversion gain of an expatriated entity. See section 7874(e)(2) for 
rules regarding the treatment of transfers and licenses by domestic 
partnerships and transfers of interests in certain domestic 
partnerships.
    (d) Definitions. The definitions provided in Sec.  1.7874-12 apply 
for purposes of this section.
    (e) Example. The following example illustrates the rules of this 
section.

    Example --(i) Facts. On July 1, 2016, FA, a foreign corporation, 
acquires all the stock of DT, a domestic corporation, in an 
inversion transaction. When the inversion transaction occurred, DT 
wholly owned FS, a foreign corporation that is a controlled foreign 
corporation (within the meaning of section 957(a)). During the 
applicable period, FS sells to FA property that is not described in 
section 1221(a)(1) in the hands of FS. Under section 951(a)(1)(A), 
DT has a $80x gross income inclusion that is attributable to FS's 
gain from the sale of the property. Under section 960(a)(1), DT is 
deemed to have paid $20x of the post-1986 foreign income taxes of FS 
by reason of this income inclusion and includes $20x in gross income 
as a deemed dividend under section 78. Accordingly, DT recognizes 
$100x ($80x + $20x) of gross income because of FS's sale of property 
to FA.
    (ii) Analysis. Pursuant to section 7874(a)(2)(A), DT is an 
expatriated entity. Under paragraph (b)(1) of this section, DT's 
$100x gross income recognized under sections 951(a)(1)(A) and 78 is 
inversion gain, because it is income recognized by an expatriated 
entity during the applicable period by reason of an indirect 
transfer of property by DT (through its wholly-owned CFC, FS) after 
the inversion transaction to a specified related person (FA). 
Sections 7874(a)(1) and (e) therefore prevent the use of certain tax 
attributes (such as net operating losses) to reduce the U.S. tax 
owed with respect to DT's $100x gross income recognized under 
sections 951(a)(1)(A) and 78.

    (f) Applicability dates. Except as otherwise provided in this 
paragraph (f), this section applies to transfers and licenses of 
property completed on or after November 19, 2015, but only if the 
inversion transaction was completed on or after September 22, 2014. For 
inversion transactions completed on or after September 22, 2014, 
however, taxpayers may elect to apply paragraph (b) of this section by 
excluding the phrase ``(including an amount treated as a dividend under 
section 78)'' for transfers and licenses of property completed on or 
after November 19, 2015, and before April 4, 2016.


Sec.  1.7874-11T   [Removed]

0
Par. 32. Section 1.7874-11T is removed.

0
Par. 33. Section 1.7874-12 is added to read as follows:


Sec.  1.7874-12  Definitions.

    (a) Definitions. Except as otherwise provided, the following 
definitions apply for purposes of this section and Sec. Sec.  1.367(b)-
4, 1.956-2, 1.7701(l)-4, and 1.7874-1 through 1.7874-11.
    (1) An affiliated group has the meaning set forth in section 
1504(a) but without regard to section 1504(b)(3), except that section 
1504(a) is applied by substituting ``more than 50 percent'' for ``at 
least 80 percent'' each place it appears. A member of the affiliated 
group is an entity included in the affiliated group.
    (2) The applicable period means, with respect to an inversion 
transaction, the period described in section 7874(d)(1). However, see 
also Sec.  1.7874-2(b)(13) in the case of a subsequent acquisition (or 
a similar acquisition under the principles of Sec.  1.7874-2(c)(4)(i)) 
that is an inversion transaction.
    (3) The completion date means, with respect to a domestic entity 
acquisition, the date that the domestic entity acquisition and all 
transactions related to the domestic entity acquisition are complete.
    (4) A controlled foreign corporation (or CFC) has the meaning 
provided in section 957.
    (5) A domestic entity acquisition means an acquisition described in 
section 7874(a)(2)(B)(i).
    (6) A domestic entity means, with respect to a domestic entity 
acquisition, a domestic corporation or domestic partnership described 
in section 7874(a)(2)(B)(i). A reference to a domestic entity includes 
a successor to such domestic corporation or domestic partnership, 
including a corporation that succeeds to and takes into account amounts 
with respect to the domestic entity pursuant to section 381.
    (7) An expanded affiliated group (or EAG) means, with respect to a 
domestic entity acquisition, an affiliated group that includes the 
foreign acquiring corporation, determined as of the completion date. A 
member of the EAG is an entity included in the EAG, and a reference to 
a member of the EAG includes a predecessor with respect to such member.
    (8) An expatriated entity means, with respect to an inversion 
transaction--
    (i) The domestic entity; and
    (ii) A United States person that, on any date on or after the 
completion date, is or was related (within the meaning of section 
267(b) or 707(b)(1)) to the domestic entity.
    (9) Expatriated foreign subsidiary--(i) General rule. Except as 
provided in paragraph (a)(9)(ii) of this section, an expatriated 
foreign subsidiary means a foreign corporation that is a CFC 
(determined without applying subparagraphs (A), (B), and (C) of section 
318(a)(3) so as to consider a United States person as owning stock 
which is owned by a person who is not a United States person) and in 
which an expatriated entity is a United States shareholder (determined 
without applying subparagraphs (A), (B), and (C) of section 318(a)(3) 
so as to consider a United States person as owning stock which is owned 
by a person who is not a United States person).
    (ii) Exception to the general rule. A foreign corporation is not an 
expatriated foreign subsidiary if, with respect to the inversion 
transaction as a result of which the foreign corporation otherwise 
would be an expatriated foreign subsidiary--
    (A) On the completion date, the foreign corporation was both a CFC 
(determined without applying subparagraphs (A), (B), and (C) of section 
318(a)(3) so as to consider a United States person as owning stock 
which is owned by a person who is not a United States person) and a 
member of the EAG; and
    (B) On or before the completion date, the domestic entity was not a 
United States shareholder (determined without applying subparagraphs 
(A), (B), and (C) of section 318(a)(3) so as to consider a United 
States person as owning stock which is owned by a person who is not a 
United States person) with respect to the foreign corporation.
    (10) A foreign acquiring corporation means, with respect to a 
domestic entity acquisition, the foreign corporation described in 
section 7874(a)(2)(B). A reference to a foreign acquiring corporation 
includes a successor to the foreign acquiring corporation, including a 
corporation that succeeds to and takes into account amounts with 
respect to the foreign acquiring corporation pursuant to section 381.
    (11) A foreign related person means, with respect to an inversion 
transaction, a foreign person that is related (within

[[Page 32561]]

the meaning of section 267(b) or 707(b)(1)) to, or under the same 
common control as (within the meaning of section 482), a person that is 
an expatriated entity with respect to the inversion transaction.
    (12) A former domestic entity partner of a domestic entity that is 
a domestic partnership is any person that held an interest in the 
partnership before the domestic entity acquisition, including any 
person that holds an interest in the partnership both before and after 
the domestic entity acquisition.
    (13) A former domestic entity shareholder of a domestic entity that 
is a domestic corporation is any person that held stock in the domestic 
corporation before the domestic entity acquisition, including any 
person that holds stock in the domestic corporation both before and 
after the domestic entity acquisition.
    (14) An interest in a partnership includes a capital or profits 
interest.
    (15) An inversion transaction means a domestic entity acquisition 
in which the foreign acquiring corporation is treated as a surrogate 
foreign corporation under section 7874(a)(2)(B), taking into account 
section 7874(a)(3).
    (16) A non-EFS foreign related person means, with respect to an 
inversion transaction, a foreign related person that is not an 
expatriated foreign subsidiary.
    (17) The ownership fraction means, with respect to a domestic 
entity acquisition, the ownership percentage described in section 
7874(a)(2)(B)(ii), expressed as a fraction.
    (18) A specified related person means, with respect to an inversion 
transaction--
    (i) A non-EFS foreign related person;
    (ii) A domestic partnership in which a non-EFS foreign related 
person is a partner; and
    (iii) A domestic trust of which a non-EFS foreign related person is 
a beneficiary.
    (19) A United States person means a person described in section 
7701(a)(30).
    (20) A United States shareholder has the meaning provided in 
section 951(b).
    (b) Applicability dates. Except as otherwise provided in this 
paragraph (b), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. The following apply to 
domestic entity acquisitions completed on or after April 4, 2016: 
paragraph (a)(8) of this section; in paragraph (a)(6) of this section, 
the phrase ``, including a corporation that succeeds to and takes into 
account amounts with respect to the domestic entity pursuant to section 
381''; and the second sentence of paragraph (a)(10) of this section. 
For domestic entity acquisitions completed on or after September 22, 
2014, and before April 4, 2016, however, taxpayers, may elect to apply 
the provisions in the immediately prior sentence.


Sec.  1.7874-12T   [Removed]

    Par. 34. Section 1.7874-12T is removed.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
    Approved: June 22, 2018.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2018-14693 Filed 7-11-18; 8:45 am]
 BILLING CODE 4830-01-P