Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3589

2. Adding the following entry in

numerical order to the table to read as

follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where

identified and described

Current OMB

control No.

*****

1.367(b)–3T .......................... 1545–1666

*****

John M. Dalrymple,

Acting Deputy Commissioner of Internal

Revenue.

Approved: December 22, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

[FR Doc. 00–1379 Filed 1–21–00; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 7, and 602

[TD 8862]

RIN 1545–AI32

Stock Transfer Rules

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final and temporary

regulations.

SUMMARY: This document contains final

regulations addressing the application

of nonrecognition exchange provisions

in Subchapter C of the Internal Revenue

Code to transactions that involve one or

more foreign corporations. These

regulations provide guidance for

taxpayers engaging in those transactions

in order to determine the extent to

which income shall be included and

appropriate corresponding adjustments

shall be made.

DATES: Effective Date. These regulations

are effective as of February 23, 2000.

Applicability Dates. These regulations

apply to section 367(b) exchanges that

occur on or after February 23, 2000.

However, taxpayers may choose to

apply these regulations to section 367(b)

exchanges that occur before February

23, 2000, as specified in § 1.367(b)–

6(a)(2).

FOR FURTHER INFORMATION CONTACT:

Mark D. Harris, (202) 622–3860 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information

contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork

Reduction Act (44 U.S.C. 3507) under

control number 1545–1271. Responses

to these collections of information are

mandatory.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid control number.

The estimated average annual

reporting burden in these final

regulations is 4 hours.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and to the

Office of Management and Budget, Attn:

Desk Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503.

Books or records relating to these

collections of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law.

Generally, tax returns and tax return

information are confidential, as required

by 26 U.S.C. 6103.

Background

On December 27, 1977, the IRS and

Treasury issued proposed and

temporary regulations under section

367(b) of the Internal Revenue Code

(Code). Subsequent guidance updated

and amended the 1977 temporary

regulations (the 1977 regulations)

several times over the next 14 years. On

August 26, 1991, the IRS and Treasury

issued proposed regulations

§§ 1.367(b)–1 through 1.367(b)–6 (the

1991 proposed regulations). Comments

to the 1991 proposed regulations were

received, and a public hearing was held

on November 22, 1991. In June of 1998,

the IRS and Treasury issued final

regulations under sections 367(a) and

(b) (the 1998 regulations). The 1998

regulations addressed transactions

under section 367(b) only to the extent

the transactions are also subject to the

stock transfer rules of section 367(a).

Thus, the 1977 regulations have

remained in effect to the extent not

superseded by the 1998 regulations. The

preamble to the 1998 regulations stated

that the IRS and Treasury would issue

guidance at a later date to address the

portions of the 1991 proposed

regulations related to section 367(b) that

were not addressed in the 1998

regulations.

After consideration of the 1977

regulations and their updates and

amendments, the 1991 proposed

regulations and their updates and

amendments, the 1998 regulations, and

all comments received with respect to

such regulations, the IRS and Treasury

adopt §§ 1.367(b)–1 through 1.367(b)–6

as final regulations under section

367(b).

Overview

A. General Policies of Section 367(b)

Section 367(b) governs corporate

restructurings under sections 332, 351,

354, 355, 356, and 361 (except to the

extent described in section 367(a)(1)) in

which the status of a foreign corporation

as a ‘‘corporation’’ is necessary for

application of the relevant

nonrecognition provisions. Section

367(b) provides that a foreign

corporation that is a party to one of the

enumerated nonrecognition transactions

shall be respected as a corporation, and

thereby the parties involved in the

transaction shall obtain the benefits of

the applicable nonrecognition exchange

provisions and their related provisions

(such as section 381) (together, the

Subchapter C provisions), except to the

extent provided in regulations.

The principal purpose of section

367(b) is to prevent the avoidance of

U.S. tax that can arise when the

Subchapter C provisions apply to

transactions involving foreign

corporations. The potential for tax

avoidance arises because of differences

between the manner in which the

United States taxes foreign corporations

and their shareholders and the manner

in which the United States taxes

domestic corporations and their U.S.

shareholders.

The Subchapter C provisions

generally have been drafted to apply to

domestic corporations and U.S.

shareholders, and thus do not fully take

into account the cross-border aspects of

U.S. taxation (such as deferral, foreign

tax credits, and section 1248). Section

367(b) was enacted to help ensure that

international tax considerations in the

Code are adequately addressed when

the Subchapter C provisions apply to an

exchange involving a foreign

corporation. Because determining the

proper interaction of the Code’s

international and Subchapter C

provisions is ‘‘necessarily highly

technical,’’ Congress granted the

Secretary broad regulatory authority to

provide the ‘‘necessary or appropriate’’

rules, rather than enacting a complex

3590 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

statutory regime. H.R. Rep. No. 658,

94th Cong., 1st Sess. 241 (1975).

Accordingly, as the preamble to the

1991 proposed regulations stated, the

section 367(b) regulations require

adjustments or inclusions in order to

prevent the material distortion of

income that can occur when the

Subchapter C provisions apply to an

exchange involving a foreign

corporation. The 1991 proposed

regulations simplified the 1977

regulations and were generally favorably

received by taxpayers. The final

regulations adopt the 1991 proposed

regulations with modifications. The

modifications are based on further

considerations of fairness, simplicity,

and administrability.

The final regulations also incorporate

the section 367(b) rules contained in the

1998 regulations. The 1998 regulations

finalized portions of the 1991 proposed

regulations to the extent necessary to

address the overlap between section

367(b) and the section 367(a) stock

transfer rules. Because the scope of the

final regulations is broader than that

overlap, the final regulations adopt the

1998 section 367(b) provisions in a

manner appropriate to their

incorporation into the final regulations.

The IRS and Treasury are also issuing

other guidance under section 367(b).

Temporary and proposed regulations

(published elsewhere in this issue of the

Federal Register) address the

elimination of an election available to

certain taxpayers under the 1977

regulations and the 1991 proposed

regulations. In addition, the IRS and

Treasury intend to issue other proposed

regulations that provide rules regarding

the combination and separation of

corporate-level tax attributes in

applicable section 367(b) exchanges.

B. Specific Policies in Context of

Inbound Nonrecognition Transactions

Section 1.367(b)–3 addresses

transactions in which a foreign

corporation transfers assets to a

domestic corporation pursuant to a

Subchapter C provision. These

transactions include a section 332

liquidation of a foreign corporation into

a domestic parent corporation and an

asset reorganization, such as a C, D, or

F reorganization, of a foreign

corporation into a domestic corporation

(inbound nonrecognition transactions).

Section 381 generally provides rules

regarding the extent to which corporate

attributes carry over in such

transactions.

The principal policy consideration of

section 367(b) with respect to inbound

nonrecognition transactions is the

appropriate carryover of attributes from

foreign to domestic corporations. This

consideration has interrelated

shareholder-level and corporate-level

components. At the shareholder level,

the section 367(b) regulations are

concerned with the proper taxation of

previously deferred earnings and

profits. At the corporate level, the

section 367(b) regulations are concerned

with both the extent and manner in

which tax attributes carry over in light

of the variations between the Code’s

taxation of foreign and domestic

corporations.

The section 367(b) regulations have

historically focused on the carryover of

earnings and profits and bases of assets,

simultaneously addressing the

shareholder and corporate level

concerns by accounting for any

necessary adjustments through an

income inclusion by the U.S.

shareholders of the foreign acquired

corporation (and without limiting the

extent to which the domestic acquiring

corporation succeeds to the attributes).

The 1991 proposed regulations required

a U.S. shareholder of the foreign

acquired corporation (or, in certain

cases, a foreign subsidiary of the U.S.

shareholder) to currently include in

income the allocable portion of the

foreign acquired corporation’s earnings

and profits accumulated during the U.S.

shareholder’s holding period (all

earnings and profits amount). The

requirement to include in income the all

earnings and profits amount results in

the taxation of previously unrepatriated

earnings accumulated during a U.S.

shareholder’s (direct or indirect)

holding period. This income inclusion

prevents the conversion of a deferral of

tax into a forgiveness of tax and

generally ensures that the section 381

carryover basis reflects an after-tax

amount. However, the all earnings and

profits amount inclusion does not

consider tax attributes that accrue

during a non-U.S. person’s holding

period.

Commentators criticized the scope of

the 1991 proposed regulations, arguing

that the all earnings and profits amount

should be limited to the amount that a

shareholder would include in income as

a deemed dividend under section 1248.

The scope of the all earnings and profits

amount is broader than the section 1248

amount because, for example, the all

earnings and profits amount is

calculated without regard to whether

the foreign corporation is a CFC and

without regard to a shareholder’s gain in

the stock. However, this view too

narrowly construes the role of section

367(b) by focusing on potential

shareholder-level consequences without

adequately considering the section

367(b) policy of determining the

appropriate carryover of corporate-level

attributes in inbound nonrecognition

transactions. Thus, the final regulations

retain the 1991 proposed regulations’

definition of all earnings and profits

amount. The final regulations also

generally retain (subject to a new de

minimis exception) the taxation of all

exchanging U.S. shareholders in

inbound nonrecognition transactions.

In finalizing these regulations, the IRS

and Treasury considered whether future

section 367(b) regulations should limit

the extent to which tax attributes carry

over from foreign to domestic

corporations. Such a limitation would

more directly implement the section

367(b) policy related to the carryover of

attributes and, as a result, reduce the

class of U.S. persons required to have an

income inclusion in connection with an

inbound nonrecognition transaction.

Such a limitation would also enable the

section 367(b) regulations to address the

carryover of attributes attributable to a

non-U.S. person’s holding period. The

IRS and Treasury request comments as

to the merits of an attribute carryover

limitation, as well as other approaches

that could address the carryover of tax

attributes related to a non-U.S. person’s

holding period under section 367(b).

C. Specific Policies in Context of

Foreign-to-Foreign Nonrecognition

Transactions and Section 355

Distributions

Section 1.367(b)–4 addresses

transactions in which a foreign

corporation acquires the stock or assets

of another foreign corporation in an

exchange described in section 351 or a

section 368(a)(1)(B), (C), (D), (E), (F) or

(G) reorganization (foreign-to-foreign

nonrecognition transactions). Section

1.367(b)–5 provides rules regarding a

distribution by a foreign corporation of

the stock or securities of a domestic or

foreign corporation described in section

355. The historic policy objective of

section 367(b) in both of these contexts

has been to preserve the potential

application of section 1248. Thus, the

amount that would have been

recharacterized as a dividend under

section 1248 upon a disposition of the

stock (section 1248 amount) generally

must be included in income as a

dividend at the time of the section

367(b) exchange to the extent such

section 1248 amount would not be

preserved immediately following the

section 367(b) exchange.

The final regulations do not address

all of the policy considerations raised by

the application of the Subchapter C

provisions to transactions described in

§§ 1.367(b)–4 and 1.367(b)–5. For

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3591

example, current rules regarding the

carryover or separation of foreign

corporations’ earnings and profits do

not adequately consider the

international aspects of the Code, most

notably the foreign tax credit.

Forthcoming proposed regulations will

consider these issues. Until the IRS and

Treasury promulgate such regulations,

taxpayers should use a reasonable

method (consistent with existing law

and taking proper account of the

purposes of the foreign tax credit

regime) to determine the carryover and

separation of earnings and profits and

related foreign taxes.

Explanation of Provisions

The IRS received numerous

comments on the 1991 proposed

regulations. The following discussion

summarizes the comments and changes

to the 1991 proposed regulations.

A. § 1.367(b)–1(c): Notice Requirements

Section 1.367(b)–1(c) of the 1991

proposed regulations required any

person that realizes income in a section

367(b) exchange to file a notice with

respect to the exchange, regardless of

such person’s status as a U.S. person

and its percentage ownership in the

corporation that is a party to the section

367(b) exchange. Commentators

criticized this notice requirement as

overly broad. The 1998 regulations

limited the notice requirement to

shareholders that realize income and

file a tax return under section 6012. The

final regulations further revise the

notice requirement and generally

narrow its scope by requiring notice

only with respect to persons and

transactions that may be subject to an

inclusion under the final regulations’

operative provisions.

B. § 1.367(b)–2: Definitions and Special

Rules

1. § 1.367(b)–2(d): All Earnings and

Profits Amount

Section 1.367(b)–2(d) of the 1991

proposed regulations generally defined

‘‘all earnings and profits amount’’ as the

allocable share of net positive earnings

and profits accrued by a foreign

corporation during a shareholder’s

holding period. The 1991 proposed

regulations provided that the all

earnings and profits amount is

determined according to the attribution

principles of section 1248. Because the

section 1248 attribution rules

incorporate the section 1223 holding

period rules, commentators were

concerned that the definition of all

earnings and profits amount

inappropriately included earnings and

profits attributable to the holding period

of non-U.S. persons by virtue of the

rules of section 1223(2).

In response, the final regulations

amend the definition of all earnings and

profits amount to exclude amounts

attributable to the holding period of

non-U.S. persons. This modification

applies to the extent the non-U.S.

person was not directly or indirectly

owned by U.S. persons with a 10

percent or greater interest when the

earnings and profits accumulated. An

example in the final regulations

illustrates this new rule.

When applying the attribution

principles of section 1248 for purposes

of determining the all earnings and

profits amount, the requirements of

section 1248 unrelated to computing the

amount of earnings and profits

attributable to a shareholder’s block of

stock should not apply. The final

regulations explicitly state this

principle. The 1991 proposed

regulations applied this principle, for

example, when they provided that the

all earnings and profits amount is

calculated without regard to whether

the foreign corporation is a controlled

foreign corporation (CFC). The final

regulations further specify that the all

earnings and profits amount includes

earnings attributable to an exchanging

shareholder’s stock, without regard to

whether the exchanging shareholder

owned 10 percent of the stock of the

foreign acquired corporation. A new

example in the final regulations

illustrates these rules.

2. § 1.367(b)–2(e): Treatment of Deemed

Dividends

Section 1.367(b)–2(e) of the 1991

proposed regulations provided that a

deemed dividend shall be treated as an

actual dividend. Thus, a deemed

dividend was considered as paid out of

the earnings and profits of a foreign

corporation and was considered as

having been paid through intermediate

owners (when appropriate). One

commentator noted that an inclusion

under the 1991 proposed regulations

could yield a different result from an

inclusion under section 1248 because

section 1248 treats a corporation as

having paid the section 1248 amount

directly to an exchanging shareholder

despite any intermediate owners.

A deemed dividend under section

367(b) is distinguishable from a section

1248 inclusion because a section 1248

inclusion is not treated as a dividend at

the corporate level. Thus, a corporation

does not reduce its earnings and profits

with regard to an inclusion under

section 1248. Instead, the shareholderlevel inclusion is considered eligible to

be treated as previously taxed earnings

and profits (PTI) upon a subsequent

distribution. In light of this distinction

between section 367(b) and section

1248, the final regulations retain the

rule in § 1.367(b)–2(e) of the 1991

proposed regulations.

3. Final Regulation § 1.367(b)–2(j):

Sections 985 Through 989

Section 1.367(b)–2(k) of the 1991

proposed regulations provided rules

regarding currency exchange inclusions

or adjustments that result from a section

367(b) exchange. The final regulations

apply the principles of the 1991

proposed regulations, but provide the

following modifications.

The 1991 proposed regulations

required an acquired corporation that

participates in a transaction described

in section 381(a) to change its functional

currency if the acquiring corporation

has a different functional currency. The

rule was intended to ensure that

taxpayers use the correct functional

currency after a section 367(b)

exchange. However, functional currency

is determined separately for each

qualified business unit (QBU). In

addition, the functional currency of a

QBU of either the acquired or acquiring

corporation may change as a result of a

section 367(b) exchange. Accordingly,

the final regulations provide that a QBU

is deemed to have automatically

changed its functional currency when

its functional currency, as determined

after a section 367(b) exchange, is

different than before the exchange.

Thus, the QBU is required to make

appropriate adjustments under § 1.985–

5.

The 1991 proposed regulations

provided that, if an exchanging

shareholder is required to include in

income either the all earnings and

profits amount or the section 1248

amount, then immediately before the

exchange and solely for purposes of

computing exchange gain or loss under

section 986(c), the shareholder is treated

as receiving a distribution of PTI from

the appropriate foreign corporation. The

purpose of this provision was to ensure

that exchange gain or loss under section

986(c) is subject to current inclusion

when the earnings of the foreign

corporation are no longer deferred or to

the extent a taxpayer does not retain its

interest in PTI.

Section 1.367(b)–2(j)(2) of the final

regulations expands the rules regarding

the treatment of exchange gain or loss

on PTI under section 986(c). An

exchanging shareholder that is a U.S.

person is required to recognize its

section 986(c) gain or loss to the extent

that deferral has ended with respect to

3592 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

a foreign corporation’s earnings (as can

occur in the case of an inbound or

foreign-to-foreign nonrecognition

transaction) or the U.S. person has a

diminished interest in the PTI after the

exchange (as can occur in the case of a

section 355 distribution by a foreign

corporation). A different rule applies

when a U.S. person indirectly holds

(through a foreign exchanging

shareholder) its interest in the foreign

corporation with regard to which the

PTI inclusion is measured. In that case,

the indirect U.S. shareholder does not

recognize section 986(c) gain or loss at

the time of the section 367(b) exchange.

In order to preserve such section 986(c)

gain or loss for future inclusion by the

indirect U.S. shareholder, the foreign

exchanging shareholder is treated as

having received a distribution of the

PTI.

Other rules under sections 985

through 989, such as the branch

termination rules, may also apply to the

transaction.

C. § 1.367(b)–3: Repatriation of Foreign

Corporate Assets in Certain

Nonrecognition Transactions

Section 1.367(b)–3 provides rules

with respect to inbound nonrecognition

transactions.

1. § 1.367(b)–3(b): Exchanges of Stock

Section 1.367(b)–3(b) of the 1991

proposed regulations generally provided

that if an exchanging shareholder is

either (i) a 10 percent U.S. shareholder

of the foreign acquired corporation or

(ii) a foreign corporation with respect to

which a U.S. person is either a section

1248 shareholder or a domestic

corporation that meets the stock

ownership requirements of section 902,

the shareholder must include in income

as a deemed dividend the all earnings

and profits amount attributable to its

stock in the foreign acquired

corporation. The final regulations

generally retain this rule. However, in

order to provide greater consistency

among its various ownership thresholds,

the final regulations revise § 1.367(b)–

3(b)(ii) so that § 1.367(b)–3(b) applies to

a foreign corporation with respect to

which there is, in general, a 10 percent

U.S. shareholder.

The 1991 proposed regulations

provided that the same country

dividend exception in section

954(c)(3)(A)(i) does not apply to an

exchanging shareholder that is a CFC.

Commentators criticized this rule,

stating that a deemed dividend under

section 367(b) should not be treated

more harshly than an actual dividend

and that taxpayers can circumvent this

rule by having a lower-tier foreign

corporation distribute a dividend before

an asset transfer. However, unlike a

dividend distribution that qualifies for

the same country dividend exception,

an inbound asset transfer represents a

current repatriation of earnings into the

United States. Accordingly, the final

regulations retain the rule in the 1991

proposed regulations that the same

country dividend exception does not

apply to an exchanging shareholder that

is a CFC.

The 1991 proposed regulations

generally required the recognition of

exchange gain (or loss) to the extent that

an exchanging shareholder’s capital

account in a foreign acquired

corporation appreciated (or depreciated)

as a result of changes in currency

exchange rates. Such gain (or loss) is

reflected in the basis of assets when

translated at the spot rate. The preamble

to the 1991 proposed regulations invited

comments regarding the calculation of

such exchange gain (or loss),

particularly in cases when a shareholder

acquired the foreign corporate stock by

purchase rather than in connection with

the corporation’s formation. None of the

comments suggested a method for

determining and tracking shareholder

capital accounts. Most comments

focused on the potential complexity and

compliance burdens created by the rule.

After considering the administrability

issues associated with the exchange gain

(or loss) calculation, the final

regulations do not adopt the provision

requiring the recognition of exchange

gain (or loss) on a shareholder’s capital

account. However, the final regulations

reserve the issue for further

consideration.

Sections 7.367(b)–5(b) and 7.367(b)–

7(c)(2)(ii) of the 1977 regulations, and

§ 1.367(b)–3(b)(2)(iii) of the 1991

proposed regulations provided an

exchanging shareholder with an

opportunity to recognize the gain (but

not the loss) that it realizes in the

exchange (taxable exchange election),

rather than including the all earnings

and profits amount in income as a

deemed dividend. This taxable

exchange election, however, is

inconsistent with the policies of section

367(b) that apply to inbound

transactions. These policies, as

previously discussed, are unrelated to

an exchanging shareholder’s outside

gain on its stock.

Moreover, when the all earnings and

profits amount exceeds a shareholder’s

gain on its stock, merely limiting the

shareholder’s inclusion to its outside

stock gain creates the potential for the

duplication and importation of losses.

See TAM 9003005 (September 28, 1989)

(interpreting the 1977 regulations)

(available at IRS Freedom of Information

Act Reading Room, 1111 Constitution

Avenue, NW., Washington, DC 20224).

The 1991 proposed regulations

attempted to address this aspect of the

taxable exchange election by requiring

various attributes of the foreign acquired

corporation (such as basis in its assets)

to be reduced (attribute reduction

regime) to the extent the all earnings

and profits amount exceeds an

exchanging shareholder’s stock gain.

However, the taxable exchange

election in the 1991 proposed

regulations had other shortcomings. The

election added substantial complexity to

the regulations by requiring timely

coordination between electing

shareholders and the acquiring

corporation to carry out the required

attribute reductions. In addition, the

attribute reduction regime can be unfair

in situations involving more than one

exchanging U.S. shareholder. For

example, consider an inbound C, D, or

F reorganization involving two U.S.

shareholders of the foreign acquired

corporation, one that makes the taxable

exchange election (because its gain on

the stock is less than its all earnings and

profits amount) and one that does not.

In connection with the electing

shareholder’s taxable exchange election,

the 1991 proposed regulations required

a proportionate reduction in certain tax

attributes of the foreign acquired

corporation. This reduction effectively

allowed the electing shareholder to

transfer to the acquiring corporation the

burden created by its decision not to

include in income its full all earnings

and profits amount and, thereby, to

effectively shift a portion of this burden

to the non-electing shareholder (that has

already paid U.S. tax on its full share of

the foreign corporation’s earnings and

profits).

Finally, a taxable exchange election is

not required by the statute. Section

367(b) directs the Secretary to prescribe

regulations that provide the necessary or

appropriate tax consequences that

should accompany the application of

the Subchapter C provisions to

transactions involving foreign

corporations. Section 367(b)(2)

specifically provides that the section

367(b) regulations may include the

circumstances under which ‘‘gain shall

be recognized currently or amounts

included in gross income currently as a

dividend, or both * * *.’’ Thus, the

statute authorizes the IRS and Treasury

to require an inclusion of amounts, as

distinct from gain. As previously

discussed, the all earnings and profits

amount appropriately measures an

exchanging shareholder’s income

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3593

inclusion in connection with an

inbound nonrecognition transaction.

After balancing the above

considerations against the benefits of

the taxable exchange election, the final

regulations do not adopt the taxable

exchange election. However, in order to

provide taxpayers an opportunity to

comment on this change to the 1977

regulations and the 1991 proposed

regulations, the IRS and Treasury are

concurrently issuing temporary and

proposed regulations that provide the

taxable exchange election in modified

form. This election permits an

exchanging shareholder to elect to treat

a transaction as a taxable exchange, but

modifies the attribute reduction regime

by limiting its application to a section

332 liquidation or to an inbound asset

reorganization in which the foreign

acquired corporation is wholly owned

(directly or indirectly) by one U.S.

person. This limited application of the

attribute reduction regime eliminates

the potentially unfair results that can

arise when attributes are reduced in a

transaction involving multiple

exchanging shareholders. This also

reduces (although does not eliminate)

the potential for the duplication and

importation of losses that can arise in

the absence of attribute reduction. The

temporary regulation is effective for one

year from the effective date of the final

regulations.

2. § 1.367(b)–3(c): Exchanges of Stock by

Other U.S. Persons

Section 1.367(b)–3(c) of the 1991

proposed regulations provided a special

rule for U.S. persons that are not subject

to the § 1.367(b)–3(b) requirement to

include in income the all earnings and

profits amount (generally, shareholders

owning less than 10 percent of the

foreign acquired corporation, hereinafter

small shareholders). The 1991 proposed

regulations required these small

shareholders to recognize the gain on

their stock in the foreign acquired

corporation. This rule was included

because of administrative concerns,

since small shareholders may not have

sufficient information to calculate their

all earnings and profits amounts. In

addition, a foreign acquired corporation

may not have adequate information

about its small shareholders’ inclusions

to properly adjust its earnings and

profits for the deemed dividends that

would arise in these situations.

Commentators requested that the final

regulations provide small shareholders

the option of including in income the all

earnings and profits amount, rather than

recognizing the gain on their stock. In

response, the final regulations include

such an election, provided that a small

shareholder has sufficient information

to substantiate its all earnings and

profits amount and provided that the

small shareholder furnishes proper

certification to the foreign acquired

corporation (or its successor in interest)

so that the corporation can properly

reduce its earnings and profits. Electing

small shareholders must also comply

with the section 367(b) notice

requirement. A less extensive section

367(b) notice procedure is available if

the foreign acquired corporation has

never had earnings and profits that

would result in any shareholder having

an all earnings and profits amount.

Commentators also requested an

election that would permit a domestic

acquiring corporation to include in

income the all earnings and profits

amounts on behalf of the foreign

acquired corporation’s small

shareholders. The final regulations do

not adopt this suggestion because of its

substantial administrative difficulties.

For example, it is unlikely that a

publicly traded foreign corporation (or

its domestic acquirer) could ascertain

each small shareholder’s correct holding

period in the stock of the foreign

acquired corporation, which would be

necessary to properly determine such a

cumulative all earnings and profits

amount inclusion.

The final regulations also include a

new de minimis exception, which

applies to small shareholders whose

stock in the foreign acquired

corporation has a fair market value

below $50,000 on the date of the

exchange. These shareholders are not

required to include gain or a deemed

dividend under the section 367(b)

regulations.

3. § 1.367(b)–3(d): Carryover of Certain

Attributes

Section 1.367(b)–3(d) of the 1991

proposed regulations clarified that a

domestic acquiring corporation may

succeed to foreign taxes paid or accrued

by a foreign acquired corporation that

are eligible for credit under section 906.

A domestic acquiring corporation may

not succeed to any other foreign taxes

paid or accrued by a foreign acquired

corporation because the earnings that

carry over to a domestic acquiring

corporation (other than earnings related

to the taxes eligible for credit under

section 906) are not subject to double

taxation at the corporate level. This rule

is consistent with the general policy of

section 367(b) to permit the carryover of

corporate tax attributes only when

appropriate. The final regulations retain

the rules of § 1.367(b)–3(d), and add an

example that illustrates their

application.

D. § 1.367(b)–4: Acquisition of Foreign

Corporate Stock or Assets by a Foreign

Corporation in Certain Nonrecognition

Transactions

Section 1.367(b)–4 of the 1991

proposed regulations addressed foreignto-foreign nonrecognition transactions.

In general, if the exchange in such a

transaction results in a section 1248

shareholder of the foreign acquired

corporation losing its section 1248

shareholder status, § 1.367(b)–4(b)

required the exchanging shareholder to

currently include its section 1248

amount in income as a deemed

dividend. The 1991 proposed

regulations generally did not require an

income inclusion in circumstances

when a section 1248 shareholder retains

its status. In the case of a lower-tier

transaction (where the exchanging

shareholder is a foreign corporation),

the section 1248 amount was not

included as foreign personal holding

company income (FPHCI) under section

954(c). This provision permitted

deferral of the section 1248 amount by

preserving such earnings and profits as

earnings of the foreign corporation that

is the exchanging shareholder. The final

regulations retain these general rules.

1. § 1.367(b)–4(b): Recognition of

Income

Section 1.367(b)–4(b) of the 1991

proposed regulations provided an

exception to its general rule if an

exchanging shareholder receives stock

of a domestic corporation. This

provision, which the 1991 proposed

regulations included in response to a

criticism of the 1977 regulations, was

intended to provide relief in cases when

a domestic acquiring corporation issues

its own stock in exchange for CFC stock

and succeeds to the section 1248

amount allocable to the transferor U.S.

shareholder. Because § 1.367(b)–4(a) of

the 1991 proposed regulations already

limited the application of § 1.367(b)–4

to an acquisition by a foreign

corporation, such relief was

unnecessary.

Moreover, the provision inadvertently

did not require an inclusion of a section

1248 amount that may not be preserved

immediately after the exchange. This

could occur, for example, if a foreign

acquiring corporation uses the stock of

its domestic parent corporation to

acquire the stock or assets of a foreign

target corporation from a section 1248

shareholder. Accordingly, the final

regulations do not adopt the 1991

proposed regulations’ provision

regarding receipt of stock of a domestic

corporation in a transaction described in

§ 1.367(b)–4.

3594 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

2. § 1.367(b)–4(d): Special Rule for

Applying Section 1248 to Subsequent

Exchanges

The 1998 regulations revised the rules

of the 1991 proposed regulations

regarding the application of section

367(b) and section 1248 to exchanges

that follow a § 1.367(b)–4 exchange in

which an exchanging shareholder is not

required to include a section 1248

amount in income. Because of the

limited scope of the 1998 regulations, its

rule only addressed the application of

section 367(b) and section 1248

following a stock transfer by a direct

U.S. shareholder. The final regulations

incorporate the principles of the 1998

regulations and expand their

application to the class of transactions

subject to § 1.367(b)–4, including asset

transfers and transactions in which the

exchanging shareholder is a foreign

corporation. The final regulations also

address the interaction of these rules

with section 964(e), by providing the

extent to which they apply to

subsequent section 964(e) sales and

exchanges. Two new examples in the

final regulations, as well as an expanded

restatement of the example provided in

the 1998 regulations, illustrate the

application of these rules.

Commentators also requested that the

IRS and Treasury clarify the carryover of

earnings and profits and tax accounts in

transactions where an exchanging

shareholder is not required to include a

section 1248 amount, as well as the

application of section 902 to

distributions by a foreign acquiring

corporation after such a section 367(b)

exchange. The IRS and Treasury will

address these issues in forthcoming

proposed regulations.

E. § 1.367(b)–5: Distributions of Stock

Described in Section 355

1. § 1.367(b)–5(b): Distribution by a

Domestic Corporation

Section 1.367(b)–5(b) of the 1991

proposed regulations generally provided

that a domestic corporation must

recognize gain on a section 355

distribution of foreign stock to

individuals. The final regulations retain

this general rule, consistent with the

recently promulgated final regulations

under section 367(e) (governing a

section 355 distribution by a domestic

corporation of foreign stock to foreign

persons).

Commentators requested that the final

regulations clarify the proper method

for determining whether a distributee is

an individual. The same issue arises

under section 367(e), and the final

regulations adopt the approach of the

section 367(e) regulations. Thus, a

distributee is presumed to be an

individual except to the extent that the

distributing corporation certifies that

the distributee is not an individual.

However, a publicly traded distributing

corporation may use a reasonable

analysis with respect to distributees that

are not five percent shareholders of

publicly traded stock to demonstrate the

number of distributees that are not

individuals. A reasonable analysis

includes a determination of the actual

number of distributees that are not

individuals or a reasonable statistical

analysis of shareholder records and

other relevant information. Section

1.367(b)–2(k) (§ 1.367(b)–2(l) of the 1991

proposed regulations) has also been

amended to adopt the look-through

provisions provided in § 1.367(e)–

1(b)(2) for purposes of determining the

identity of distributees when the

domestic distributing corporation stock

is held by a partnership, trust or estate.

2. § 1.367(b)–5(c): Pro Rata Distribution

by a CFC

Section 1.367(b)–5(c) of the 1991

proposed regulations provided that,

when a CFC distributes stock of a

controlled corporation on a pro rata

basis in a section 355 transaction, a

distributee must reduce its postdistribution basis in either the

distributing or controlled corporation

stock to the extent its section 1248

amount attributable to such corporation

is reduced as a result of the distribution.

To the extent the reduction of the

section 1248 amount exceeds the stock

basis, the distributee must include the

difference in income as a deemed

dividend. The final regulations retain

this general rule, subject to the

following refinements.

The final regulations add new

§ 1.367(b)–5(c)(3), which provides that

the basis adjustment provided in

§ 1.367(b)–2(e)(3)(ii) shall not apply if a

deemed dividend is included in income

pursuant to § 1.367(b)–5(c). Under

§ 1.367(b)–2(e)(3)(ii), a shareholder’s

basis is increased by the amount of a

deemed dividend inclusion. In the

context of a § 1.367(b)–5(c) inclusion,

the § 1.367(b)–2(e)(3)(ii) basis increase

would undermine the purpose of the

section 367(b) regulations, because the

basis increase would correspondingly

decrease the shareholder’s built-in gain,

thereby reducing the section 1248

amount that is intended to be preserved

after the transaction.

Furthermore, some taxpayers

commented that the § 1.367(b)–5(c)(2)

basis reduction can lead to the creation

of phantom gain; that is, it can leave a

shareholder with a cumulative amount

of post-distribution built-in gain in the

stock of the distributing and controlled

corporations that exceeds its

predistribution built-in gain. As a result,

commentators requested that a

reduction in the basis in one of the

corporations give rise to a

corresponding increase in the basis of

the stock of the other corporation. In

response, § 1.367(b)–5(c)(4) of the final

regulations provides a basis

redistribution rule, under which the

basis of the stock of the distributing or

controlled corporation (as applicable) is

increased by the amount of the required

decrease in basis in the other stock

under § 1.367(b)–5(c)(2). However, basis

cannot be increased above the fair

market value of the stock and also

cannot be increased to the extent the

increase diminishes the postdistribution

section 1248 amount with respect to

such stock. This basis redistribution

rule also applies with regard to deemed

dividend inclusions under § 1.367(b)–

5(c)(2). An example in the final

regulations illustrates the application of

these new rules.

3. § 1.367(b)–5(d): Non-Pro Rata

Distribution by Controlled Foreign

Corporation

Section 1.367(b)–5(d) of the 1991

proposed regulations provided that, if a

CFC distributes controlled corporation

stock on a non-pro rata basis, each

distributee must include in income the

amount of any reduction in its section

1248 amount with regard to either the

distributing or controlled corporation.

For this purpose, the 1991 proposed

regulations treated a shareholder of the

distributing corporation that does not

exchange stock in the distributing

corporation for stock in the controlled

corporation (non-participating

shareholder) as a distributee.

The 1991 proposed regulations

provided that a non-participating

shareholder may make an election

(taxable distribution election), under

which the distributing and controlled

corporations are not treated as

corporations for purposes of gain (but

not loss) recognition by all persons

affected by the taxable status of the

transaction. The preamble to the 1991

proposed regulations invited comments

as to whether the benefits of the taxable

distribution election to nonparticipating shareholders are

outweighed by the potential adverse

effects on the other shareholders.

In response, commentators uniformly

criticized the taxable distribution

election. They argued that the election

was inequitable because it enabled a

non-participating shareholder (who may

be a small shareholder) to unilaterally

and retroactively invalidate the section

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3595

355 transaction for all parties involved.

Commentators also pointed out that the

taxable distribution election could

distort the economic incentives in crossborder restructurings by requiring

participating shareholders to consider

identifying and making contractual

arrangements (which could include

monetary arrangements) with each nonparticipating shareholder in order to

prevent them from electing to invalidate

the section 355 transaction.

Commentators thus argued in favor of

not adopting the taxable distribution

election in the final regulations.

The taxable distribution election is

also not required by the statute. Section

367(b) directs the Secretary to prescribe

regulations that provide the necessary or

appropriate tax consequences that

should accompany the application of

the Subchapter C provisions to

transactions involving foreign

corporations. Section 367(b)(2)

specifically provides that the section

367(b) regulations ‘‘shall include (but

shall not be limited to) regulations

dealing with the sale or exchange of

stock or securities in a foreign

corporation by a U.S. person. * * *’’

Accordingly, the section 367(b)

regulations may address the tax

consequences of a non-pro rata

distribution to both participating and

non-participating shareholders. In both

cases, the diminution in a shareholder’s

potential section 1248 amount following

a section 355 transaction appropriately

measures the shareholder’s inclusion

with regard to a section 355 transaction

involving a distributing corporation that

is a controlled foreign corporation.

Differing results depending on whether

a shareholder is a participating

shareholder or a non-participating

shareholder can also be viewed as

artificial, given that the distinction is

often merely a function of alternative

planning strategies.

In light of all of the above

considerations, the final regulations do

not adopt the taxable distribution

election. As a result, all shareholders of

a CFC that distributes stock on a nonpro rata basis must include in income

the amount of any reduction in their

section 1248 amount with respect to

either the distributing or controlled

corporation.

4. Final Regulation § 1.367(b)–5(f):

Exclusion of Deemed Dividend From

FPHCI

Commentators noted that the 1991

proposed regulations did not

automatically exclude a § 1.367(b)–5(c)

or (d) deemed dividend inclusion by an

exchanging foreign corporate

shareholder from FPHCI. Accordingly,

the deemed dividend generally would

be subpart F income and currently

includible in income by a U.S.

shareholder of the exchanging foreign

corporation. As in the case of a lowertier foreign-to-foreign transaction

described in § 1.367(b)–4, the potential

application of section 1248 can be

preserved by excluding the deemed

dividend from FPHCI. Thus, the final

regulations adopt the suggestion and

provide that a § 1.367(b)–5(c) or (d)

deemed dividend inclusion by a foreign

corporation is not included in FPHCI

under section 954(c).

5. 1991 Proposed Regulation § 1.367(b)–

5(f): Adjustments to Earnings and Profits

Section 1.367(b)–5(f) of the 1991

proposed regulations provided rules

regarding the allocation of earnings and

profits of a foreign transferor

corporation in connection with a section

355 distribution. After further

consideration, the IRS and Treasury

have not included § 1.367(b)–5(f) of the

1991 proposed regulations in the final

regulations. Forthcoming proposed

regulations will more fully consider the

allocation of earnings and profits in

section 355 distributions where either

(or both) the distributing or controlled

corporation is a foreign corporation.

F. § 1.367(b)–6: Effective Date

The final regulations apply to section

367(b) exchanges that occur on or after

February 23, 2000. The preamble to the

1991 proposed regulations solicited

comments on whether the final

regulations should provide an election

to apply the regulations retroactively to

exchanges that occur on or after August

26, 1991 (the date the 1991 proposed

regulations were published in the

Federal Register). Given the length of

time that has elapsed since the issuance

of the 1991 proposed regulations, the

IRS and Treasury do not believe that

such an election would be appropriate.

This determination is consistent with

the 1998 revision to § 1.367(b)–2(d) of

the 1991 proposed regulations, which

deleted the proposed special retroactive

effective date for the definition of the all

earnings and profits amount. A taxpayer

may, however, elect to apply the final

regulations to section 367(b) exchanges

that occur (or occurred) before February

23, 2000, if the due date for the

taxpayer’s timely filed Federal tax

return (including extensions) for the

taxable year in which the section 367(b)

exchange occurs (or occurred) is after

February 23, 2000.

Removed Provisions

These regulations finalize

substantially all of the 1991 proposed

regulations. In connection with the

finalization of these regulations, the

1977 regulations (other than § 7.367(b)–

12) and the section 367(b) provisions

contained in the 1998 regulations are

removed. Section 7.367(b)–12 is

retained to address distributions with

respect to (or a disposition of) stock that

was subject to certain provisions of the

1977 regulations in effect prior to

February 23, 2000.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in

Executive Order 12866. Therefore, a

regulatory assessment is not required. It

also has been determined that section

553(b) of the Administrative Procedure

Act (5 U.S.C. chapter 5) does not apply

to these regulations, and because the

notice of proposed rulemaking

preceding the regulations was issued

prior to March 29, 1996, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply.

Pursuant to section 7805(f) of the

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 the

impact of the proposed regulations on

small business.

Drafting Information. The principal

author of these regulations is Mark

Harris of the Office of Associate Chief

Counsel (International). However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects

26 CFR Parts 1 and 7

Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping

requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1, 7, and

602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by revising the

entry for § 1.367(b)–2 and by adding

entries in numerical order to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.367(b)–2 also issued under 26

U.S.C. 367(a) and (b).

Section 1.367(b)–3 also issued under 26

U.S.C. 367(a) and (b). * * *

3596 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

Section 1.367(b)–5 also issued under 26

U.S.C. 367(a) and (b).

Section 1.367(b)–6 also issued under 26

U.S.C. 367(a) and (b). * * *

Par. 2. Section 1.367(a)–3 is amended

as follows:

1. Paragraph (d)(3) Example 11,

paragraph (ii), the third sentence, the

reference ‘‘§ 7.367(b)–7(c)(1)(i) of this

chapter’’ is removed and ‘‘§ 1.367(b)–

4(b)’’ is added in its place.

2. Paragraph (d)(3) Example 11A,

paragraph (ii), the second, third and

fourth sentences are removed and a

sentence is added in their place.

3. Paragraph (e)(2), in the third,

fourth, and fifth sentences, the

parenthetical ‘‘(as in effect before

February 23, 2000; see 26 CFR part 1,

revised as of April 1, 1999)’’ is added

immediately after ‘‘§ 7.367(b)–7 of this

chapter’’ each place it appears.

4. Paragraph (g)(2)(iv), the

parenthetical ‘‘(as in effect before

February 23, 2000; see 26 CFR part 1,

revised April 1, 1999)’’ is added

immediately after ‘‘7.367(b)–2(b) of this

chapter.’’

The revisions read as follows:

§ 1.367(a)–3 Treatment of transfers of

stock or securities to foreign corporations.

* * * * *

(d) * * *

(3) * * *

Example 11A. * * *

(ii) Result. * * * Assuming

§ 1.367(b)–4(b) does not apply, there is

no income inclusion under section

367(b), and the amount of the gain

recognition agreement is $50.

Par. 3. Section 1.367(b)–0 is added to

read as follows:

§ 1.367(b)–0 Table of contents.

This section lists the paragraphs

contained in §§ 1.367(b)–0 through

1.367(b)–6.

§ 1.367(b)–1 Other transfers.

(a) Scope.

(b) General rules.

(1) Rules.

(2) Example.

(c) Notice required.

(1) In general.

(2) Persons subject to section 367(b) notice.

(3) Time and manner for filing notice.

(i) United States persons described in

§ 1.367(b)–1(c)(2).

(ii) Foreign corporations described in

§ 1.367(b)–1(c)(2).

(4) Information required.

(5) Abbreviated notice provision.

(6) Supplemental published guidance.

§ 1.367(b)–2 Definitions and special rules.

(a) Controlled foreign corporation.

(b) Section 1248 shareholder.

(c) Section 1248 amount.

(1) Rule.

(2) Examples.

(d) All earnings and profits amount.

(1) General rule.

(2) Rules for determining earnings and

profits.

(i) Domestic rules generally applicable.

(ii) Certain adjustments to earnings and

profits.

(iii) Effect of section 332 liquidating

distribution.

(3) Amount attributable to a block of stock.

(i) Application of section 1248 principles.

(A) In general.

(1) Rule.

(2) Example.

(B) Foreign shareholders.

(ii) Limitation on amounts attributable to

holding periods determined under

section 1223.

(A) Rule.

(B) Example.

(iii) Exclusion of lower-tier earnings.

(e) Treatment of deemed dividends.

(1) In general.

(2) Consequences of dividend

characterization.

(3) Ordering rules.

(4) Examples.

(f) Deemed asset transfer and closing of

taxable year in certain section

368(a)(1)(F) reorganizations.

(1) Scope.

(2) Deemed asset transfer.

(3) Other applicable rules.

(4) Closing of taxable year.

(g) Stapled stock under section 269B.

(h) Section 953(d) domestication elections.

(1) Effect of election.

(2) Post-election exchanges.

(i) Section 1504(d) elections.

(j) Sections 985 through 989.

(1) Change in functional currency of a

qualified business unit.

(i) Rule.

(ii) Example.

(2) Previously taxed earnings and profits.

(i) Exchanging shareholder that is a United

States person.

(ii) Exchanging shareholder that is a foreign

corporation.

(3) Other rules.

(k) Partnerships, trusts and estates.

§ 1.367(b)–3 Repatriation of foreign

corporate assets in certain nonrecognition

transactions.

(a) Scope.

(b) Exchange of stock owned directly by a

United States shareholder or by certain

foreign corporate shareholders.

(1) Scope.

(2) United States shareholder.

(3) Income inclusion.

(i) Inclusion of all earnings and profits

amount.

(ii) Examples.

(iii)Recognition of exchange gain or loss with

respect to capital [reserved].

(4) [Reserved].

(c) Exchange of stock owned by a United

States person that is not a United States

shareholder.

(1) Scope.

(2) Requirement to recognize gain.

(3) Election to include all earnings and

profits amount.

(4) De minimis exception.

(5) Examples.

(d) Carryover of certain foreign taxes.

(1) Rule.

(2) Example.

§ 1.367(b)–4 Acquisition of foreign

corporate stock or assets by a foreign

corporation in certain nonrecognition

transactions.

(a) Scope.

(b) Income inclusion.

(1) Exchange that results in loss of status as

section 1248 shareholder.

(i) Rule.

(ii) Examples.

(2) Receipt by exchanging shareholder of

preferred or other stock in certain

instances.

(i) Rule.

(ii) Examples.

(3) Certain recapitalizations.

(c) Exclusion of deemed dividend from

foreign personal holding company

income.

(1) Rule.

(2) Example.

(d) Rules for subsequent exchanges.

(1) In general.

(2) Subsequent dispositions by a foreign

acquiring corporation.

(3) Examples.

§ 1.367(b)–5 Distributions of stock described

in section 355.

(a) In general.

(1) Scope.

(2) Treatment of distributees as exchanging

shareholders.

(b) Distribution by a domestic corporation.

(1) General rule.

(2) Section 367(e) transactions.

(3) Determining whether distributees are

individuals.

(4) Applicable cross-references.

(c) Pro rata distribution by a controlled

foreign corporation.

(1) Scope.

(2) Adjustment to basis in stock and income

inclusion.

(3) Interaction with § 1.367(b)–2(e)(3)(ii).

(4) Basis redistribution.

(d) Non-pro rata distribution by a controlled

foreign corporation.

(1) Scope.

(2) Treatment of certain shareholders as

distributees.

(3) Inclusion of excess section 1248 amount

by exchanging shareholder.

(4) Interaction with § 1.367(b)–2(e)(3)(ii).

(i) Limited application.

(ii) Interaction with predistribution amount.

(e) Definitions.

(1) Predistribution amount.

(2) Postdistribution amount.

(f) Exclusion of deemed dividend from

foreign personal holding company

income.

(g) Examples.

§ 1.367(b)–6 Effective dates and

coordination rules.

(a) Effective date.

(1) In general.

(2) Exception.

(b) Certain recapitalizations described in

§ 1.367(b)–4(b)(3).

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3597

(c) Use of reasonable method to comply with

prior published guidance.

(1) Prior exchanges.

(2) Future exchanges.

(d) Effect of removal of attribution rules.

Par. 4. Sections 1.367(b)–1 and

1.367(b)–2 are revised to read as

follows:

§ 1.367(b)–1 Other transfers.

(a) Scope. The regulations

promulgated under section 367(b) (the

section 367(b) regulations) set forth

rules regarding the proper inclusions

and adjustments that must be made as

a result of an exchange described in

section 367(b) (a section 367(b)

exchange). A section 367(b) exchange is

any exchange described in section 332,

351, 354, 355, 356 or 361, with respect

to which the status of a foreign

corporation as a corporation is relevant

for determining the extent to which

income shall be recognized or for

determining the effect of the transaction

on earnings and profits, basis of stock or

securities, basis of assets, or other

relevant tax attributes. Notwithstanding

the preceding sentence, a section 367(b)

exchange does not include a transfer to

the extent the foreign corporation fails

to be treated as a corporation by reason

of section 367(a)(1). See § 1.367(a)–

3(b)(2)(ii) for an illustration of the

interaction of section 367(a) and (b).

(b) General rules—(1) Rules. The

following general rules apply under the

section 367(b) regulations—

(i) A foreign corporation in a section

367(b) exchange is considered to be a

corporation and, as a result, all of the

related provisions (e.g., section 381)

shall apply, except to the extent

provided in the section 367(b)

regulations; and

(ii) Nothing in the section 367(b)

regulations shall permit—

(A) The nonrecognition of income that

would otherwise be required to be

recognized under another provision of

the Internal Revenue Code or the

regulations thereunder; or

(B) The recognition of a loss or

deduction that would otherwise not be

recognized under another provision of

the Internal Revenue Code or the

regulations thereunder.

(2) Example. The following example

illustrates the rules of this paragraph (b):

Example—(i) Facts. DC, a domestic

corporation, owns 90 percent of P, a

partnership. The remaining 10 percent of P

is owned by a person unrelated to DC. P

owns all of the outstanding stock of FC, a

controlled foreign corporation. FC liquidates

into P.

(ii) Result. FC’s liquidation is not a

transaction described in section 332. Nothing

in the section 367(b) regulations, including

§ 1.367(b)–2(k), permits FC’s liquidation to

qualify as a liquidation described in section

332.

(c) Notice Required—(1) In general. A

notice under this paragraph (c) (section

367(b) notice) must be filed with regard

to any person described in paragraph

(c)(2) of this section. A section 367(b)

notice must be filed in the time and

manner described in paragraph (c)(3) of

this section and must include the

information described in paragraph

(c)(4) of this section.

(2) Persons subject to section 367(b)

notice. The following persons are

described in this paragraph (c)(2)—

(i) A shareholder described in

§ 1.367(b)–3(b)(1) that realizes income

in a transaction described in § 1.367(b)–

3(a);

(ii) A shareholder that makes the

election described in § 1.367(b)–3(c)(3);

(iii) A shareholder described in

§ 1.367(b)–4(b)(1)(i)(A)(1) or (2) that

realizes income in a transaction

described in § 1.367(b)–4(a); and

(iv) A shareholder that realizes

income in a transaction described in

§ 1.367(b)–5(c) or 1.367(b)–5(d) and that

is either—

(A) A section 1248 shareholder of the

distributing or controlled corporation;

or

(B) A foreign corporation with one or

more shareholders that are described in

paragraph (c)(2)(iv)(A) of this section.

(3) Time and manner for filing

notice—(i) United States persons

described in § 1.367(b)–1(c)(2). A United

States person described in paragraph

(c)(2) of this section must file a section

367(b) notice attached to a timely filed

Federal tax return (including

extensions) for the person’s taxable year

in which income is realized in the

section 367(b) exchange. In the case of

a shareholder that makes the election

described in § 1.367(b)–3(c)(3),

notification of such election must be

sent to the foreign acquired corporation

(or its successor in interest) on or before

the date the section 367(b) notice is

filed, so that appropriate corresponding

adjustments can be made in accordance

with the rules of § 1.367(b)–2(e).

(ii) Foreign corporations described in

§ 1.367(b)–1(c)(2). Each United States

person listed in this paragraph (c)(3)(ii)

must file a section 367(b) notice with

regard to a foreign corporation described

in paragraph (c)(2) of this section. Such

notice must be attached to a timely filed

Federal tax return (including

extensions) for the United States

person’s taxable year in which income

is realized in the section 367(b)

exchange and, if the United States

person is required to file a Form 5471

(Information Return of U.S. Persons

With Respect To Certain Foreign

Corporations), the section 367(b) notice

must be attached to the Form 5471. The

following persons are listed in this

paragraph (c)(3)(ii)—

(A) United States shareholders (as

defined in § 1.367(b)–3(b)(2)) of foreign

corporations described in paragraph

(c)(2)(i) of this section; and

(B) Section 1248 shareholders of

foreign corporations described in

paragraph (c)(2)(iii) or (iv) of this

section.

(4) Information required. Except as

provided in paragraph (c)(5) of this

section, a section 367(b) notice shall

include the following information—

(i) A statement that the exchange is a

section 367(b) exchange;

(ii) A complete description of the

exchange;

(iii) A description of any stock,

securities or other consideration

transferred or received in the exchange;

(iv) A statement that describes any

amount required, under the section

367(b) regulations, to be taken into

account as income or loss or as an

adjustment to basis, earnings and

profits, or other tax attributes as a result

of the exchange;

(v) Any information that is or would

be required to be furnished with a

Federal income tax return pursuant to

regulations under section 332, 351, 354,

355, 356, 361 or 368 (whether or not a

Federal income tax return is required to

be filed), if such information has not

otherwise been provided by the person

filing the section 367(b) notice;

(vi) Any information required to be

furnished with respect to the exchange

under sections 6038, 6038A, 6038B,

6038C or 6046, or the regulations under

those sections, if such information has

not otherwise been provided by the

person filing the section 367(b) notice;

and

(vii) If applicable, a statement that the

shareholder is making the election

described in § 1.367(b)–3(c)(3). This

statement must include—

(A) A copy of the information the

shareholder received from the foreign

acquired corporation (or its successor in

interest) establishing and substantiating

the shareholder’s all earnings and

profits amount with respect to the

shareholder’s stock in the foreign

acquired corporation; and

(B) A representation that the

shareholder has notified the foreign

acquired corporation (or its successor in

interest) that the shareholder is making

the election described in § 1.367(b)–

3(c)(3).

(5) Abbreviated notice provision. In

the case of a foreign acquired

corporation that has never had earnings

3598 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

and profits that would result in any

shareholder having an all earnings and

profits amount, a shareholder making

the election described in § 1.367(b)–

3(c)(3) may satisfy the information

requirements of paragraph (c)(4) of this

section by filing a section 367(b) notice

that includes—

(i) A statement from the foreign

acquired corporation (or its successor in

interest) that the foreign acquired

corporation has never had any earnings

and profits that would result in any

shareholder having an all earnings and

profits amount; and

(ii) The information described in

paragraphs (c)(4) (i) through (iii) of this

section.

(6) Supplemental published guidance.

The section 367(b) notice requirements

may be updated or amended by revenue

procedure or other published guidance.

§ 1.367(b)–2 Definitions and special rules.

(a) Controlled foreign corporation.

The term controlled foreign corporation

means a controlled foreign corporation

as defined in section 957 (taking into

account section 953(c)).

(b) Section 1248 shareholder. The

term section 1248 shareholder means

any United States person that satisfies

the ownership requirements of section

1248 (a)(2) or (c)(2) with respect to a

foreign corporation.

(c) Section 1248 amount—(1) Rule.

The term section 1248 amount with

respect to stock in a foreign corporation

means the net positive earnings and

profits (if any) that would have been

attributable to such stock and includible

in income as a dividend under section

1248 and the regulations thereunder if

the stock were sold by the shareholder.

In the case of a transaction in which the

shareholder is a foreign corporation

(foreign shareholder), the following

additional rules shall apply—

(i) The foreign shareholder shall be

deemed to be a United

States person for purposes of this

paragraph (c), except that the foreign

shareholder shall not be considered a

United States person for purposes of

determining whether the stock owned

by the foreign shareholder is stock of a

controlled foreign corporation, and

(ii) The foreign shareholder’s holding

period in the stock of the foreign

corporation shall be determined by

reference to the period that the foreign

shareholder’s section 1248 shareholders

held (directly or indirectly) an interest

in the foreign corporation. This

paragraph (c)(1)(ii) applies in addition

to the section 1248 regulations’

incorporation of section 1223 holding

periods, as modified by § 1.367(b)–4(d)

(as applicable).

(2) Examples. The following examples

illustrate the rules of this paragraph (c):

Example 1—(i) Facts. DC, a domestic

corporation, owns all of the outstanding

stock of FC1, a controlled foreign corporation

(CFC). FC1 owns all of the outstanding stock

of FC2, a CFC. DC has always owned all of

the stock of FC1, and FC1 has always owned

all of the stock of FC2.

(ii) Result. Under this paragraph (c), DC’s

section 1248 amount with respect to its FC1

stock is computed by reference to all of FC1’s

and FC2’s earnings and profits. See section

1248(c)(2). Because FC1’s section 1248

shareholder (DC) always indirectly held all of

the stock of FC2, FC1’s section 1248 amount

with respect to its FC2 stock is computed by

reference to all of FC2’s earnings and profits.

Example 2—(i) Facts. DC, a domestic

corporation, owns 40 percent of the

outstanding stock of FC1, a foreign

corporation. The other 60 percent of FC1

stock is owned (directly and indirectly) by

foreign persons that are unrelated to DC. FC1

owns all of the outstanding stock of FC2, a

foreign corporation. On January 1, 2001, DC

purchases the remaining 60 percent of FC1

stock.

(ii) Result. Under this paragraph (c), DC’s

section 1248 amount with respect to its FC1

stock is computed by reference to FC1’s and

FC2’s earnings and profits that accumulated

on or after January 1, 2001, the date FC1 and

FC2 became controlled foreign corporations

(CFCs). See section 1248(a). Because FC1 is

not considered a United States person for

purposes of determining whether FC2 is a

CFC, FC1’s section 1248 amount with respect

to its FC2 stock is computed by reference to

FC2’s earnings and profits that accumulated

on or after January 1, 2001, the date FC2

became an actual CFC.

Example 3—(i) Facts. FC1, a foreign

corporation, owns all of the outstanding

stock of FC2, a foreign corporation. DC is a

domestic corporation that is unrelated to

FC1, FC2, and their direct and indirect

owners. On January 1, 2001, DC purchases all

of the outstanding stock of FC1.

(ii) Result. Under this paragraph (c), DC’s

section 1248 amount with respect to its FC1

stock is computed by reference to FC1’s and

FC2’s earnings and profits that accumulated

on or after January 1, 2001, the first day DC

held the stock of FC1. See section 1248(a).

FC1’s section 1248 amount with respect to its

FC2 stock is computed by reference to FC2’s

earnings and profits that accumulated on or

after January 1, 2001, the first day FC1’s

section 1248 shareholder (DC) indirectly held

the stock of FC2.

Example 4—(i) Facts. DC, a domestic

corporation, directly owns all of the

outstanding stock of FC1 and FC2, controlled

foreign corporations. DC has always owned

all of the stock of FC1 and FC2. On January

1, 2001, DC contributes all of the stock of FC2

to FC1 in a nonrecognition exchange that

does not require an income inclusion under

the section 367(a) or 367(b) regulations. See

§§ 1.367(a)–8 and 1.367(b)–4.

(ii) Result. Under this paragraph (c), DC’s

section 1248 amount with respect to its FC1

stock is computed by reference to all of FC1’s

and FC2’s earnings and profits. See section

1248(c)(2). Because FC1’s section 1248

shareholder (DC) always held (directly or

indirectly) all of the stock of FC2, FC1’s

section 1248 amount with respect to its FC2

stock is computed by reference to all of FC2’s

earnings and profits.

(d) All earnings and profits amount—

(1) General rule. The term all earnings

and profits amount with respect to stock

in a foreign corporation means the net

positive earnings and profits (if any)

determined as provided under

paragraph (d)(2) of this section and

attributable to such stock as provided

under paragraph (d)(3) of this section.

The all earnings and profits amount

shall be determined without regard to

the amount of gain that would be

realized on a sale or exchange of the

stock of the foreign corporation.

(2) Rules for determining earnings

and profits—(i) Domestic rules generally

applicable. For purposes of this

paragraph (d), except as provided in

sections 312(k)(4) and (n)(8), 964 and

986, the earnings and profits of a foreign

corporation for any taxable year shall be

determined according to principles

substantially similar to those applicable

to domestic corporations.

(ii) Certain adjustments to earnings

and profits. Notwithstanding paragraph

(d)(2)(i) of this section, for purposes of

this paragraph (d), the earnings and

profits of a foreign corporation for any

taxable year shall not include the

amounts specified in section 1248(d). In

the case of amounts specified in section

1248(d)(4), the preceding sentence

requires that the earnings and profits for

any taxable year be decreased by the net

positive amount (if any) of earnings and

profits attributable to activities

described in section 1248(d)(4), and

increased by the net reduction (if any)

in earnings and profits attributable to

activities described in section

1248(d)(4).

(iii) Effect of section 332 liquidating

distribution. The all earnings and profits

amount with respect to stock of a

corporation that distributes all of its

property in a liquidation described in

section 332 shall be determined without

regard to the adjustments prescribed by

section 312(a) and (b) resulting from the

distribution of such property in

liquidation, except that gain or loss

realized by the corporation on the

distribution shall be taken into account

to the extent provided in section

312(f)(1). See § 1.367(b)–3(b)(3)(ii)

Example 3.

(3) Amount attributable to a block of

stock—(i) Application of section 1248

principles—(A) In general—(1) Rule.

The all earnings and profits amount

with respect to stock of a foreign

corporation is determined according to

the attribution principles of section

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3599

1248 and the regulations thereunder.

The attribution principles of section

1248 shall apply without regard to the

requirements of section 1248 that are

not relevant to the determination of a

shareholder’s pro rata portion of

earnings and profits. Thus, for example,

the all earnings and profits amount is

determined without regard to whether

the foreign corporation was a controlled

foreign corporation at any time during

the five years preceding the section

367(b) exchange in question, without

regard to whether the shareholder

owned a 10 percent or greater interest in

the stock, and without regard to whether

the earnings and profits of the foreign

corporation were accumulated in post1962 taxable years or while the

corporation was a controlled foreign

corporation.

(2) Example. The following example

illustrates the rules of this paragraph

(d)(3)(i)(A):

Example—(i) Facts. On January 1, 2001,

DC, a domestic corporation, purchases 9

percent of the outstanding stock of FC, a

foreign corporation. On January 1, 2002, DC

purchases an additional 1 percent of FC

stock. On January 1, 2003, DC exchanges its

stock in FC in a section 367(b) exchange in

which DC is required to include the all

earnings and profits amount in income. FC

was not a controlled foreign corporation

during the entire period DC held its FC stock.

(ii) Result. The all earnings and profits

amount with respect to DC’s stock in FC is

computed by reference to 9 percent of FC’s

earnings and profits from January 1, 2001,

through December 31, 2001, and by reference

to 10 percent of FC’s earnings and profits

from January 1, 2002, through January 1,

2003.

(B) Foreign shareholders. In the case

of a transaction in which the exchanging

shareholder is a foreign corporation

(foreign shareholder), the following

additional rules shall apply—

(1) The attribution principles of

section 1248 shall apply without regard

to whether the person directly owning

the stock is a United States person; and

(2) The foreign shareholder’s holding

period in the stock of the foreign

acquired corporation shall be

determined by reference to the period

that the foreign shareholder’s United

States shareholders (as defined in

§ 1.367(b)–3(b)(2)) held (directly or

indirectly) an interest in the foreign

acquired corporation. This paragraph

(d)(3)(i)(B)(2) applies in addition to the

section 1248 regulations’ incorporation

of section 1223 holding periods, as

modified by paragraph (d)(3)(ii) of this

section and § 1.367(b)–4(d) (as

applicable).

(ii) Limitation on amounts

attributable to holding periods

determined under section 1223—(A)

Rule. In applying the attribution

principles of section 1248 and the

regulations thereunder to determine the

all earnings and profits amount with

respect to the stock of a foreign

corporation, earnings and profits

attributable to a section 1223(2) holding

period that relates to a period of direct

ownership of the stock of the foreign

corporation by a non-United States

person shall not be included, except to

the extent of earnings and profits

attributable to a period when the stock

of the foreign corporation was indirectly

owned by United States shareholders (as

defined in § 1.367(b)–3(b)(2)).

(B) Example. The following example

illustrates the rules of this paragraph

(d)(3)(ii):

Example—(i) Facts. (A) FC1 is a foreign

corporation. The outstanding stock of FC1 is

directly owned by the following unrelated

persons: 20 percent by DP, a domestic

partnership; 20 percent by DC, a domestic

corporation; 20 percent by FC, a foreign

corporation that is directly and indirectly

owned by foreign persons; 20 percent by FP,

a foreign partnership that is equally owned

by 2 partners, DI, a United States citizen, and

FI, a nonresident alien; and 20 percent by a

variety of minority shareholders, none of

whom owns, applying the ownership rules of

section 958, 10 percent or more of the

outstanding stock of FC (the small

shareholders).

(B) FC1 owns all of the outstanding stock

of FC2, a foreign corporation that is not a

controlled foreign corporation subject to the

rules of section 953(c). FC2 has net positive

earnings and profits. In a reorganization

described in section 368(a)(1)(B), DA, a

domestic corporation, acquires all of the

stock of FC2 from FC1 in exchange for DA

voting stock.

(ii) Result. (A) Under section 1223(2), DA

holds the stock of FC2 with a holding period

that includes the period that FC2 was held

by FC1. As a result, the rules of this

paragraph (d)(3)(ii) apply for purposes of

computing DA’s all earnings and profits

amount.

(B) In applying the attribution principles of

section 1248, earnings and profits

attributable to a section 1223(2) holding

period that refers to a period of direct

ownership of the stock of a foreign

corporation by a non-United States person

are not included, except to the extent the

stock of the foreign corporation was

indirectly owned by United States

shareholders as defined in § 1.367(b)–3(b)(2).

Accordingly, DA’s all earnings and profits

amount does not include the FC2 earnings

and profits attributable to FC, FI, and the

small shareholders. DA’s all earnings and

profits amount does include the FC2 earnings

and profits attributable to DP, DC, and DI.

See § 1.367(b)–2(k) for rules concerning the

treatment of partnerships under the section

367(b) regulations.

(iii) Exclusion of lower-tier earnings.

In applying the attribution principles of

section 1248 and the regulations

thereunder to determine the all earnings

and profits amount with respect to stock

of a foreign corporation, the earnings

and profits of subsidiaries of the foreign

corporation shall not be taken into

account notwithstanding section

1248(c)(2).

(e) Treatment of deemed dividends—

(1) In general. In certain circumstances

these regulations provide that an

exchanging shareholder shall include an

amount in income as a deemed

dividend. This paragraph provides rules

for the treatment of the deemed

dividend.

(2) Consequences of dividend

characterization. A deemed dividend

described in paragraph (e)(1) of this

section shall be treated as a dividend for

purposes of the Internal Revenue Code.

The deemed dividend shall be

considered as paid out of the earnings

and profits with respect to which the

amount of the deemed dividend was

determined. Thus, for example, a

deemed dividend that is determined by

reference to the all earnings and profits

amount or the section 1248 amount will

never be considered as paid out of (and

therefore will never reduce) earnings

and profits specified in section 1248(d),

because such earnings and profits are

excluded in computing the all earnings

and profits amount (under paragraph

(d)(2)(ii) of this section) and the section

1248 amount (under section 1248(d) and

paragraph (c)(1) of this section). If the

deemed dividend is determined by

reference to the earnings and profits of

a foreign corporation that is owned

indirectly (i.e., through one or more

tiers of intermediate owners) by the

person that is required to include the

deemed dividend in income, the

deemed dividend shall be considered as

having been paid by such corporation to

such person through the intermediate

owners, rather than directly to such

person.

(3) Ordering rules. In the case of an

exchange of stock in which the

exchanging shareholder is treated as

receiving a deemed dividend from a

foreign corporation, the following

ordering rules concerning the timing,

treatment, and effect of such a deemed

dividend shall apply. See also

paragraph (j)(2) of this section.

(i) For purposes of the section 367(b)

regulations, the gain realized by an

exchanging shareholder shall be

determined before increasing (as

provided in paragraph (e)(3)(ii) of this

section) the basis in the stock of the

foreign corporation by the amount of the

deemed dividend.

(ii) Except as provided in paragraph

(e)(3)(i) of this section, the deemed

dividend shall be considered to be

3600 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

received immediately before the

exchanging shareholder’s receipt of

consideration for its stock in the foreign

corporation, and the shareholder’s basis

in the stock exchanged shall be

increased by the amount of the deemed

dividend. Such basis increase shall be

taken into account before determining

the gain otherwise recognized on the

exchange (for example, under section

356), the basis that the exchanging

shareholder takes in the property that it

receives in the exchange (under section

358(a)(1)), and the basis that the

transferee otherwise takes in the

transferred stock (under section 362).

(iii) Except as provided in paragraph

(e)(3)(i) of this section, the earnings and

profits of the appropriate foreign

corporation shall be reduced by the

deemed dividend amount before

determining the consequences of the

recognition of gain in excess of the

deemed dividend amount (for example,

under section 356(a)(2) or sections

356(a)(1) and 1248).

(4) Examples. The following examples

illustrate the rules of this paragraph (e):

Example 1. DC, a domestic corporation,

exchanges stock in FC, a foreign corporation,

in a section 367(b) exchange in which DC

includes the all earnings and profits amount

in income as a deemed dividend. Under

paragraph (e)(2) of this section, a deemed

dividend is treated as a dividend for

purposes of the Internal Revenue Code. As a

result, if the requirements of section 902 are

met, DC may qualify for a deemed paid

foreign tax credit with respect to the deemed

dividend that it receives from FC.

Example 2. DC, a domestic corporation,

exchanges stock in FC1, a foreign corporation

that is a controlled foreign corporation, in a

transaction in which DC is required to

include the section 1248 amount in income

as a deemed dividend. A portion of the

section 1248 amount is determined by

reference to the earnings and profits of FC1

(the upper-tier portion of the section 1248

amount), and the remainder of the section

1248 amount is determined by reference to

the earnings and profits of FC2, which is a

wholly owned foreign subsidiary of FC1 (the

lower-tier portion of the section 1248

amount). Under paragraph (e)(2) of this

section, DC computes its deemed paid

foreign tax credit as if the lower-tier portion

of the section 1248 amount were distributed

as a dividend by FC2 to FC1, and as if such

portion and the upper-tier portion of the

section 1248 amount were then distributed as

a dividend by FC1 to DC.

Example 3. DC, a domestic corporation,

exchanges stock in FC, a foreign corporation

that is a controlled foreign corporation, in a

transaction in which DC realizes gain of $100

(prior to the application of the section 367(b)

regulations). In connection with the

transaction, DC is required to include $40 in

income as a deemed dividend under the

section 367(b) regulations. In addition to

receiving property permitted to be received

under section 354 without the recognition of

gain, DC also receives cash in the amount of

$70. Under paragraph (e)(3) of this section,

the $40 deemed dividend increases DC’s

basis in its FC stock before determining the

gain to be recognized under section 56. Thus,

in applying section 356, DC is considered to

realize $60 of gain on the exchange, all of

which is recognized under section 356(a)(1).

(f) Deemed asset transfer and closing

of taxable year in certain section

368(a)(1)(F) reorganizations—(1) Scope.

This paragraph applies to a

reorganization described in section

368(a)(1)(F) in which the transferor

corporation is a foreign corporation.

(2) Deemed asset transfer. In a

reorganization described in paragraph

(f)(1) of this section, there is considered

to exist—

(i) A transfer of assets by the foreign

transferor corporation to the acquiring

corporation in exchange for stock (or

stock and securities) of the acquiring

corporation and the assumption by the

acquiring corporation of the foreign

transferor corporation’s liabilities;

(ii) A distribution of such stock (or

stock and securities) by the foreign

transferor corporation to its

shareholders (or shareholders and

security holders); and

(iii) An exchange by the foreign

transferor corporation’s shareholders (or

shareholders and security holders) of

their stock (or stock and securities) for

stock (or stock and securities) of the

acquiring corporation.

(3) Other applicable rules. For

purposes of this paragraph (f), it is

immaterial that the applicable foreign or

domestic law treats the acquiring

corporation as a continuation of the

foreign transferor corporation.

(4) Closing of taxable year. In a

reorganization described in paragraph

(f)(1) of this section, the taxable year of

the foreign transferor corporation shall

end with the close of the date of the

transfer and the taxable year of the

acquiring corporation shall end with the

close of the date on which the

transferor’s taxable year would have

ended but for the occurrence of the

reorganization if—

(i) The acquiring corporation is a

domestic corporation; or

(ii) The foreign transferor corporation

has effectively connected earnings and

profits (as defined in section 884(d)) or

accumulated effectively connected

earnings and profits (as defined in

section 884(b)(2)(B)(ii)).

(g) Stapled stock under section 269B.

For rules treating a foreign corporation

as a domestic corporation if it and a

domestic corporation are stapled

entities, see section 269B. The deemed

conversion of a foreign corporation to a

domestic corporation under section

269B is treated as a reorganization

under section 368(a)(1)(F).

(h) Section 953(d) domestication

elections—(1) Effect of election. A

foreign corporation that elects under

section 953(d) to be treated as a

domestic corporation shall be treated for

purposes of section 367(b) as

transferring, as of the first day of the

first taxable year for which the election

is effective, all of its assets to a domestic

corporation in a reorganization

described in section 368(a)(1)(F).

Notwithstanding paragraph (d) of this

section, for purposes of determining the

consequences of the reorganization

under § 1.367(b)–3, the all earnings and

profits amount shall not be considered

to include earnings and profits

accumulated in taxable years beginning

before January 1, 1988.

(2) Post-election exchanges. For

purposes of applying section 367(b) to

post-election exchanges with respect to

a corporation that has made a valid

election under section 953(d) to be

treated as a domestic corporation, such

corporation shall be treated as a

domestic corporation as to earnings and

profits that were taken into account at

the time of the section 953(d) election

or which accrue after such election, and

shall be treated as a foreign corporation

as to earnings and profits accumulated

in taxable years beginning before

January 1, 1988. Thus, for example, if

the section 953(d) corporation

subsequently transfers its assets to a

domestic corporation (other than

another section 953(d) corporation) in a

transaction described in section 381(a),

the rules of § 1.367(b)–3 shall apply to

such transaction to the extent of the

section 953(d) corporation’s earnings

and profits accumulated in taxable years

beginning before January 1, 1988.

(i) Section 1504(d) elections. An

election under section 1504(d), which

permits certain foreign corporations to

be treated as domestic corporations, is

treated as a transfer of property to a

domestic corporation and will generally

constitute a reorganization described in

section 368(a)(1)(F). However, if an

election under section 1504(d) is made

with respect to a foreign corporation

from the first day of the foreign

corporation’s existence, then the foreign

corporation shall be treated as a

domestic corporation, and the section

367(b) regulations will not apply.

(j) Sections 985 through 989—(1)

Change in functional currency of a

qualified business unit—(i) Rule. If, as a

result of a transaction described in

section 381(a), a qualified business unit

(as defined in section 989(a)) (QBU) has

a different functional currency

determined under the rules of section

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3601

985(b) than it used prior to the

transaction, then the QBU shall be

deemed to have automatically changed

its functional currency immediately

prior to the transaction. A QBU that is

deemed to change its functional

currency pursuant to this paragraph (j)

must make the adjustments described in

§ 1.985–5.

(ii) Example. The following example

illustrates the rule of this paragraph

(j)(1):

Example—(i) Facts. DC, a domestic

corporation, owns 100 percent of FC1, a

foreign corporation. FC1 owns and operates

a qualified business unit (QBU) (B1) in

France, whose functional currency is the

euro. FC2, an unrelated foreign corporation,

owns and operates a QBU (B2) in France,

whose functional currency is the dollar. FC2

acquires FC1’s assets (including B1) in a

reorganization described in section

368(a)(1)(C). As a part of the reorganization,

B1 and B2 combine their operations into one

QBU. Applying the rules of section 985(b),

the functional currency of the combined

operations of B1 and B2 is the euro.

(ii) Result. FC2’s acquisition of FC1’s assets

is a section 367(b) exchange that is described

in section 381(a). Because the functional

currency of the combined operations of B1

and B2 after the exchange is the euro, B2 is

deemed to have automatically changed its

functional currency to the euro immediately

prior to the section 367(b) exchange. B2 must

make the adjustments described in § 1.985–

5.

(2) Previously taxed earnings and

profits—(i) Exchanging shareholder that

is a United States person. If an

exchanging shareholder that is a United

States person is required to include in

income either the all earnings and

profits amount or the section 1248

amount under the provisions of

§ 1.367(b)–3 or 1.367(b)–4, then

immediately prior to the exchange, and

solely for the purpose of computing

exchange gain or loss under section

986(c), the exchanging shareholder shall

be treated as receiving a distribution of

previously taxed earnings and profits

from the appropriate foreign corporation

that is attributable (under the principles

of section 1248) to the exchanged stock.

If an exchanging shareholder that is a

United States person is a distributee in

an exchange described in § 1.367(b)–5(c)

or (d), then immediately prior to the

exchange, and solely for the purpose of

computing exchange gain or loss under

section 986(c), the exchanging

shareholder shall be treated as receiving

a distribution of previously taxed

earnings and profits from the

appropriate foreign corporation to the

extent such shareholder has a

diminished interest in such previously

taxed earnings and profits after the

exchange. The exchange gain or loss

recognized under this paragraph (j)(2)(i)

will increase or decrease the exchanging

shareholder’s adjusted basis in the stock

of the foreign corporation for purposes

of computing gain or loss realized with

respect to the stock on the transaction.

The exchanging shareholder’s dollar

basis with respect to each account of

previously taxed income shall be

increased or decreased by the exchange

gain or loss recognized.

(ii) Exchanging shareholder that is a

foreign corporation. If an exchanging

shareholder that is a foreign corporation

is required to include in income either

the all earnings and profits amount or

the section 1248 amount under the

provisions of § 1.367(b)–3 or 1.367(b)–4,

then, immediately prior to the exchange,

the exchanging shareholder shall be

treated as receiving a distribution of

previously taxed earnings and profits

from the appropriate foreign corporation

that is attributable (under the principles

of section 1248) to the exchanged stock.

If an exchanging shareholder that is a

foreign corporation is a distributee in an

exchange described in § 1.367(b)–5(c) or

(d), then the exchanging shareholder

shall be treated as receiving

(immediately prior to the exchange) a

distribution of previously taxed

earnings and profits from the

appropriate foreign corporation. Such

distribution shall be measured by the

extent to which the exchanging

shareholder’s direct or indirect United

States shareholders (as defined in

section 951(b)) have a diminished

interest in such previously taxed

earnings and profits after the exchange.

(3) Other rules. See sections 985

through 989 for other currency rules

that may apply in connection with a

section 367(b) exchange.

(k) Partnerships, trusts and estates. In

applying the section 367(b) regulations,

stock of a corporation that is owned by

a foreign partnership, trust or estate

shall be considered as owned

proportionately by its partners, owners,

or beneficiaries under the principles of

§ 1.367(e)–1(b)(2). Stock owned by an

entity that is disregarded as an entity

separate from its owner under

§ 301.7701–3 is owned directly by the

owner of such entity. In applying

§ 1.367(b)–5(b), the principles of

§ 1.367(e)–1(b)(2) shall also apply to a

domestic partnership, trust or estate.

Par. 5. Section 1.367(b)–3 is added to

read as follows:

§ 1.367(b)–3 Repatriation of foreign

corporate assets in certain nonrecognition

transactions.

(a) Scope. This section applies to an

acquisition by a domestic corporation

(the domestic acquiring corporation) of

the assets of a foreign corporation (the

foreign acquired corporation) in a

liquidation described in section 332 or

an asset acquisition described in section

368(a)(1).

(b) Exchange of stock owned directly

by a United States shareholder or by

certain foreign corporate shareholders—

(1) Scope. This paragraph (b) applies in

the case of an exchanging shareholder

that is either—

(i) A United States shareholder of the

foreign acquired corporation; or

(ii) A foreign corporation with respect

to which there are one or more United

States shareholders.

(2) United States shareholder. For

purposes of this section (and for

purposes of the other section 367(b)

regulation provisions that specifically

refer to this paragraph (b)(2)), the term

United States shareholder means any

shareholder described in section 951(b)

(without regard to whether the foreign

corporation is a controlled foreign

corporation), and also any shareholder

described in section 953(c)(1)(A) (but

only if the foreign corporation is a

controlled foreign corporation subject to

the rules of section 953(c)).

(3) Income inclusion—(i) Inclusion of

all earnings and profits amount. An

exchanging shareholder shall include in

income as a deemed dividend the all

earnings and profits amount with

respect to its stock in the foreign

acquired corporation. For the

consequences of the deemed dividend,

see § 1.367(b)–2(e). Notwithstanding

§ 1.367(b)–2(e), however, a deemed

dividend from the foreign acquired

corporation to an exchanging foreign

corporate shareholder shall not qualify

for the exception from foreign personal

holding company income provided by

section 954(c)(3)(A)(i), although it may

qualify for the look-through treatment

provided by section 904(d)(3) if the

requirements of that section are met

with respect to the deemed dividend.

(ii) Examples. The following

examples illustrate the rules of

paragraph (b)(3)(i) of this section:

Example 1—(i) Facts. DC, a domestic

corporation, owns all of the outstanding

stock of FC, a foreign corporation. The stock

of FC has a value of $100, and DC has a basis

of $30 in such stock. The all earnings and

profits amount attributable to the FC stock

owned by DC is $20, of which $15 is

described in section 1248(a) and the

remaining $5 is not (for example, because it

accumulated prior to 1963). FC has a basis of

$50 in its assets. In a liquidation described

in section 332, FC distributes all of its

property to DC, and the FC stock held by DC

is canceled.

(ii) Result. Under paragraph (b)(3)(i) of this

section, DC must include $20 in income as

a deemed dividend from FC. Under section

3602 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

337(a) FC does not recognize gain or loss in

the assets that it distributes to DC, and under

section 334(b), DC takes a basis of $50 in

such assets. Because the requirements of

section 902 are met, DC qualifies for a

deemed paid foreign tax credit with respect

to the deemed dividend that it receives from

FC.

Example 2—(i) Facts. DC, a domestic

corporation, owns all of the outstanding

stock of FC, a foreign corporation. The stock

of FC has a value of $100, and DC has a basis

of $30 in such stock. The all earnings and

profits amount attributable to the FC stock

owned by DC is $75. FC has a basis of $50

in its assets. In a liquidation described in

section 332, FC distributes all of its property

to DC, and the FC stock held by DC is

canceled.

(ii) Result. Under paragraph (b)(3)(i) of this

section, DC must include $75 in income as

a deemed dividend from FC. Under section

337(a) FC does not recognize gain or loss in

the assets that it distributes to DC, and under

section 334(b), DC takes a basis of $50 in

such assets. Because the requirements of

section 902 are met, DC qualifies for a

deemed paid foreign tax credit with respect

to the deemed dividend that it receives from

FC.

Example 3—(i) Facts. DC, a domestic

corporation, owns 80 percent of the

outstanding stock of FC, a foreign

corporation. DC has owned its 80 percent

interest in FC since FC was incorporated. The

remaining 20 percent of the outstanding

stock of FC is owned by a person unrelated

to DC (the minority shareholder). The stock

of FC owned by DC has a value of $80, and

DC has a basis of $24 in such stock. The stock

of FC owned by the minority shareholder has

a value of $20, and the minority shareholder

has a basis of $18 in such stock. FC’s only

asset is land having a value of $100, and FC

has a basis of $50 in the land. Gain on the

land would not generate earnings and profits

qualifying under section 1248(d) for an

exclusion from earnings and profits for

purposes of section 1248. FC has earnings

and profits of $20 (determined under the

rules of § 1.367(b)–2(d)(2) (i) and (ii)), $16 of

which is attributable to the stock owned by

DC under the rules of § 1.367(b)–2(d)(3). FC

subdivides the land and distributes to the

minority shareholder land with a value of

$20 and a basis of $10. As part of the same

transaction, in a liquidation described in

section 332, FC distributes the remainder of

its land to DC, and the FC stock held by DC

and the minority shareholder is canceled.

(ii) Result. Under section 336, FC must

recognize the $10 of gain it realizes in the

land it distributes to the minority

shareholder, and under section 331 the

minority shareholder recognizes its gain of $2

in the stock of FC. Such gain is included in

income by the minority shareholder as a

dividend to the extent provided in section

1248 if the minority shareholder is a United

States person that is described in section

1248(a)(2). Under § 1.367(b)–2(d)(2)(iii), the

$10 of gain recognized by FC increases its

earnings and profits for purposes of

computing the all earnings and profits

amount and, as a result, $8 of such increase

(80 percent of $10) is considered to be

attributable to the FC stock owned by DC

under § 1.367(b)–2(d)(3)(i)(A)(1). DC’s all

earnings and profits amount with respect to

its stock in FC is $24 (the $16 of initial all

earnings and profits amount with respect to

the FC stock held by DC, plus the $8 addition

to such amount that results from FC’s

recognition of gain on the distribution to the

minority shareholder). Under paragraph

(b)(3)(i) of this section, DC must include the

$24 all earnings and profits amount in

income as a deemed dividend from FC.

Example 4—(i) Facts. DC1, a domestic

corporation, owns all of the outstanding

stock of DC2, a domestic corporation. DC1

also owns all of the outstanding stock of FC,

a foreign corporation. The stock of FC has a

value of $100, and DC1 has a basis of $30 in

such stock. The assets of FC have a value of

$100. The all earnings and profits amount

with respect to the FC stock owned by DC1

is $20. In a reorganization described in

section 368(a)(1)(D), DC2 acquires all of the

assets of FC solely in exchange for DC2 stock.

FC distributes the DC2 stock to DC1, and the

FC stock held by DC1 is canceled.

(ii) Result. DC1 must include $20 in

income as a deemed dividend from FC under

paragraph (b)(3)(i) of this section. Under

section 361, FC does not recognize gain or

loss in the assets that it transfers to DC2 or

in the DC2 stock that it distributes to DC1,

and under section 362(b) DC2 takes a basis

in the assets that it acquires from FC equal

to the basis that FC had therein. Under

§ 1.367(b)–2(e)(3)(ii) and section 358(a)(1),

DC1 takes a basis of $50 (its $30 basis in the

stock of FC, plus the $20 that was treated as

a deemed dividend to DC1) in the stock of

DC2 that it receives in exchange for the stock

of FC. Under § 1.367(b)–2(e)(3)(iii) and

section 312(a), the earnings and profits of FC

are reduced by the $20 deemed dividend.

Example 5—(i) Facts. DC1, a domestic

corporation, owns all of the outstanding

stock of DC2, a domestic corporation. DC1

also owns all of the outstanding stock of FC1,

a foreign corporation. FC1 owns all of the

outstanding stock of FC2, a foreign

corporation. The all earnings and profits

amount with respect to the FC2 stock owned

by FC1 is $20. In a reorganization described

in section 368(a)(1)(D), DC2 acquires all of

the assets and liabilities of FC2 in exchange

for DC2 stock. FC2 distributes the DC2 stock

to FC1, and the FC2 stock held by FC1 is

canceled.

(ii) Result. FC1 must include $20 in

income as a deemed dividend from FC2

under paragraph (b)(3)(i) of this section. The

deemed dividend is treated as a dividend for

purposes of the Internal Revenue Code as

provided in § 1.367(b)–2(e)(2); however,

under paragraph (b)(3)(i) of this section the

deemed dividend cannot qualify for the

exception from foreign personal holding

company income provided by section

954(c)(3)(A)(i), even if the provisions of that

section would otherwise have been met in

the case of an actual dividend.

Example 6—(i) Facts. DC1, a domestic

corporation, owns 99 percent of USP, a

domestic partnership. The remaining 1

percent of USP is owned by a person

unrelated to DC1. DC1 and USP each directly

own 9 percent of the outstanding stock of FC,

a foreign corporation that is not a controlled

foreign corporation subject to the rule of

section 953(c). In a reorganization described

in section 368(a)(1)(C), DC2, a domestic

corporation, acquires all of the assets and

liabilities of FC in exchange for DC2 stock.

FC distributes to its shareholders DC2 stock,

and the FC stock held by its shareholders is

canceled.

(ii) Result. (A) DC1 and USP are United

States persons that are exchanging

shareholders in a transaction described in

paragraph (a) of this section. As a result, DC1

and USP are subject to the rules of paragraph

(b) of this section if they qualify as United

States shareholders as defined in paragraph

(b)(2) of this section. Alternatively, if they do

not qualify as United States shareholders as

defined in paragraph (b)(2) of this section,

DC1 and USP are subject to the rules of

paragraph (c) of this section. Paragraph (b)(2)

of this section defines the term United States

shareholder to include any shareholder

described in section 951(b) (without regard to

whether the foreign corporation is a

controlled foreign corporation). A

shareholder described in section 951(b) is a

United States person that is considered to

own, applying the rules of section 958(a) and

958(b), 10 percent or more of the total

combined voting power of all classes of stock

entitled to vote of a foreign corporation.

Under section 958(b), the rules of section

318(a), as modified by section 958(b) and the

regulations thereunder, apply so that, in

general, stock owned directly or indirectly by

a partnership is considered as owned

proportionately by its partners, and stock

owned directly or indirectly by a partner is

considered as owned by the partnership.

Thus, under section 958(b), DC1 is treated as

owning its proportionate share of FC stock

held by USP, and USP is treated as owning

all of the FC stock held by DC1.

(B) Accordingly, for purposes of

determining whether DC1 is a United States

shareholder under paragraph (b)(2) of this

section, DC1 is considered as owning 99

percent of the 9 percent of FC stock held by

USP. Because DC1 also owns 9 percent of FC

stock directly, DC1 is considered as owning

more than 10 percent of FC stock. DC1 is thus

a United States shareholder of FC under

paragraph (b)(2) of this section and, as a

result, is subject to the rules of paragraph (b)

of this section. However, for purposes of

determining DC1’s all earnings and profits

amount, DC1 is not treated as owning the FC

stock held by USP. Under § 1.367(b)–2(d)(3),

DC1’s all earnings and profits amount is

determined by reference to the 9 percent of

FC stock that it directly owns.

(C) For purposes of determining whether

USP is a United States shareholder under

paragraph (b)(2) of this section, USP is

considered as owning the 9 percent of FC

stock held by DC1. Because USP also owns

9 percent of FC stock directly, USP is

considered as owning more than 10 percent

of FC stock. USP is thus a United States

shareholder of FC under paragraph (b)(2) of

this section and, as a result, is subject to the

rules of paragraph (b) of this section.

However, for purposes of determining USP’s

all earnings and profits amount, USP is not

treated as owning the FC shares held by DC1.

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3603

Under § 1.367(b)–2(d)(3), USP’s all earnings

and profits amount is determined by

reference to the 9 percent of FC stock that it

directly owns.

(iii) Recognition of exchange gain or loss

with respect to capital. [Reserved]

(4) Reserved. For further guidance

concerning section 367(b) exchanges

occurring before February 23, 2001, see

§ 1.367(b)–3T(b)(4).

(c) Exchange of stock owned by a United

States person that is not a United States

shareholder—(1) Scope. This paragraph (c)

applies in the case of an exchanging

shareholder that is a United States person not

described in paragraph (b)(1)(i) of this section

(i.e., a United States person that is not a

United States shareholder of the foreign

acquired corporation).

(2) Requirement to recognize gain. An

exchanging shareholder described in

paragraph (c)(1) of this section shall

recognize realized gain (but not loss) with

respect to the stock of the foreign acquired

corporation.

(3) Election to include all earnings and

profits amount. In lieu of the treatment

prescribed by paragraph (c)(2) of this section,

an exchanging shareholder described in

paragraph (c)(1) of this section may instead

elect to include in income as a deemed

dividend the all earnings and profits amount

with respect to its stock in the foreign

acquired corporation. For the consequences

of a deemed dividend, see § 1.367(b)–2(e).

Such election may be made only if—

(i) The foreign acquired corporation (or its

successor in interest) has provided the

exchanging shareholder information to

substantiate the exchanging shareholder’s all

earnings and profits amount with respect to

its stock in the foreign acquired corporation;

and

(ii) The exchanging shareholder complies

with the section 367(b) notice requirement

described in § 1.367(b)–1(c), including the

specific rules contained therein concerning

the time and manner for electing to apply the

rules of this paragraph (c)(3).

(4) De minimis exception. This paragraph

(c) shall not apply in the case of an

exchanging shareholder whose stock in the

foreign acquired corporation has a fair market

value of less than $50,000 on the date of the

section 367(b) exchange.

(5) Examples. The following examples

illustrate the rules of this paragraph (c):

Example 1—(i) Facts. DC1, a domestic

corporation, owns 5 percent of the

outstanding stock of FC, a foreign corporation

that is not a controlled foreign corporation

subject to the rule of section 953(c). Persons

unrelated to DC1 own the remaining 95

percent of the outstanding stock of FC. DC1

has owned its 5 percent interest in FC since

FC was incorporated. DC1’s stock in FC has

a basis of $40,000 and a value of $100,000.

The all earnings and profits amount with

respect to DC1’s stock in FC is $50,000. In

a reorganization described in section

368(a)(1)(C), DC2, a domestic corporation,

acquires all of the assets and liabilities of FC

in exchange for DC2 stock. FC distributes

DC2 stock to its shareholders, and the FC

stock held by its shareholders is canceled.

(ii) Alternate result 1. If DC1 does not make

the election described in paragraph (c)(3) of

this section, then the general rule of

paragraph (c)(2) of this section applies and

DC1 must recognize its $60,000 gain in the

FC stock. Under section 358(a)(1), DC1 has a

$100,000 basis (its $40,000 basis in the FC

stock, plus the $60,000 recognized gain) in

the DC2 stock that it receives in exchange for

its FC stock. Because DC1 is not a

shareholder described in section 1248(a)(2),

section 1248 does not apply to recharacterize

any of DC1’s gain as a dividend.

(iii) Alternate result 2. If DC1 makes a valid

election under paragraph (c)(3) of this

section, then DC1 must include in income as

a deemed dividend the $50,000 all earnings

and profits amount with respect to its FC

stock. Under § 1.367(b)–2(e)(3) and section

358(a)(1), DC1 has a $90,000 basis (its

$40,000 basis in the FC stock, plus the

$50,000 that was treated as a deemed

dividend to DC1) in the DC2 stock that it

receives in exchange for its FC stock. Because

DC1 owns less than 10 percent of the voting

stock of FC, DC1 does not qualify for a

deemed paid foreign tax credit under section

902.

Example 2—(i) Facts. The facts are the

same as in Example 1, except that DC1’s

stock in FC has a fair market value of $48,000

on the date DC1 receives the DC2 stock.

(ii) Result. Because DC1’s stock in FC has

a fair market value of less than $50,000 on

the date of the section 367(b) exchange, the

de minimis exception of paragraph (c)(4) of

this section applies. As a result, DC1 is not

subject to the gain or income inclusion

requirements of this paragraph (c).

(d) Carryover of certain foreign

taxes—(1) Rule. Unused foreign tax

credits allowable to the foreign acquired

corporation under section 906 shall

carry over to the domestic acquiring

corporation and become allowable

under section 901, subject to the

limitations prescribed by the Internal

Revenue Code (for example, sections

383, 904 and 907). The domestic

acquiring corporation shall not succeed

to any other foreign taxes paid or

incurred by the foreign acquired

corporation.

(2) Example. The following example

illustrates the rules of this paragraph

(d):

Example—(i) Facts. DC, a domestic

corporation owns 100 percent of the

outstanding stock of FC, a foreign

corporation. FC has net positive earnings and

profits, none of which are attributable to DC’s

FC stock under § 1.367(b)–2(d)(3). FC has

paid foreign taxes that are not eligible for

credit under section 906. In a liquidation

described in section 332, FC distributes all of

its property to DC, and the FC stock held by

DC is canceled.

(ii) Result. The liquidation of FC into DC

is a section 367(b) exchange. Thus, DC is

subject to the section 367(b) regulations, and

must file a section 367(b) notice pursuant to

§ 1.367(b)–1(c). Pursuant to the provisions of

paragraph (d)(1) of this section, the foreign

taxes paid by FC do not carryover to DC

because FC’s foreign taxes are not eligible for

credit under section 906.

Par. 6. Section 1.367(b)–4 is revised 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 an

acquisition by a foreign corporation (the

foreign acquiring corporation) of the

stock or assets of another foreign

corporation (the foreign acquired

corporation) in an exchange described

in section 351 or a reorganization

described in section 368(a)(1)(B), (C),

(D), (E), (F) or (G). See § 1.367(a)–3(b)(2)

for additional rules that may apply.

(b) Income inclusion. If an exchange

is described in paragraph (b)(1)(i), (2)(i)

or (3) of this section, the exchanging

shareholder shall include in income as

a deemed dividend the section 1248

amount attributable to the stock that it

exchanges.

(1) Exchange that results in loss of

status as section 1248 shareholder—(i)

Rule. An exchange is described in this

paragraph (b)(1)(i) if—

(A) Immediately before the exchange,

the exchanging shareholder is—

(1) A United States person that is a

section 1248 shareholder with respect to

the foreign acquired corporation; or

( 2) A foreign corporation, and a

United States person is a section 1248

shareholder with respect to such foreign

corporation and with respect to the

foreign acquired corporation; and

(B) Either of the following conditions

is satisfied—

(1) Immediately after the exchange,

the stock received in the exchange is not

stock in a corporation that is a

controlled foreign corporation as to

which the United States person

described in paragraph (b)(1)(i)(A) of

this section is a section 1248

shareholder; or

(2) Immediately after the exchange,

the foreign acquiring corporation (or, in

the case of a reorganization described in

section 368(a)(1)(B), the foreign

acquired corporation) is not a controlled

foreign corporation as to which the

United States person described in

paragraph (b)(1)(i)(A) of this section is a

section 1248 shareholder.

(ii) Examples. The following

examples illustrate the rules of this

paragraph (b)(1):

Example 1—(i) Facts. FC1 is a foreign

corporation that is owned, directly and

indirectly (applying the ownership rules of

section 958), solely by foreign persons. DC is

a domestic corporation that is unrelated to

FC1. DC owns all of the outstanding stock of

3604 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

FC2, a foreign corporation. Thus, under

§ 1.367(b)–2(a) and (b), DC is a section 1248

shareholder with respect to FC2, and FC2 is

a controlled foreign corporation. Under

§ 1.367(b)–2(c)(1), the section 1248 amount

attributable to the stock of FC2 held by DC

is $20. In a reorganization described in

section 368(a)(1)(C), FC1 acquires all of the

assets and assumes all of the liabilities of FC2

in exchange for FC1 voting stock. The FC1

voting stock received does not represent

more than 50 percent of the voting power or

value of FC1’s stock. FC2 distributes the FC1

stock to DC, and the FC2 stock held by DC

is canceled.

(ii) Result. FC1 is not a controlled foreign

corporation immediately after the exchange.

As a result, the exchange is described in

paragraph (b)(1)(i) of this section. Under

paragraph (b) of this section, DC must

include in income, as a deemed dividend

from FC2, the section 1248 amount ($20)

attributable to the FC2 stock that DC

exchanged.

Example 2—(i) Facts. The facts are the

same as in Example 1, except that the voting

stock of FC1, which is received by FC2 in

exchange for its assets and distributed by FC2

to DC, represents more than 50 percent of the

voting power of FC1’s stock under the rules

of section 957(a).

(ii) Result. Paragraph (b)(1)(i) of this

section does not apply to require inclusion in

income of the section 1248 amount, because

FC1 is a controlled foreign corporation as to

which DC is a section 1248 shareholder

immediately after the exchange.

Example 3—(i) Facts. The facts are the

same as in Example 1, except that FC2

receives and distributes voting stock of FP, a

foreign corporation that is in control (within

the meaning of section 368(c)) of FC1, instead

of receiving and distributing voting stock of

FC1.

(ii) Result. For purposes of section 367(a),

the transfer is an indirect stock transfer

subject to section 367(a). See § 1.367(a)–

3(d)(1)(iv). Accordingly, DC’s exchange of

FC2 stock for FP stock under section 354 will

be taxable under section 367(a) (and section

1248 will be applicable) if DC fails to enter

into a gain recognition agreement in

accordance with § 1.367(a)–8. Under

§ 1.367(a)–3(b)(2), if DC enters into a gain

recognition agreement, the exchange will be

subject to the provisions of section 367(b)

and the regulations thereunder, as well as

section 367(a). If FP and FC1 are controlled

foreign corporations as to which DC is a

(direct or indirect) section 1248 shareholder

immediately after the reorganization, then

the section 367(b) result is the same as in

Example 2—that is, paragraph (b)(1)(i) of this

section does not apply to require inclusion in

income of the section 1248 amount. Under

these circumstances, the amount of the gain

recognition agreement would equal the

amount of the gain realized on the indirect

stock transfer. If FP or FC1 is not a controlled

foreign corporation as to which DC is a

(direct or indirect) section 1248 shareholder

immediately after the exchange, then the

section 367(b) result is the same as in

Example 1—that is, DC must include in

income, as a deemed dividend from FC2, the

section 1248 amount ($20) attributable to the

FC2 stock that DC exchanged. Under these

circumstances, the amount of the gain

recognition agreement would equal the

amount of the gain realized on the indirect

stock transfer, less the $20 section 1248

amount inclusion.

Example 4—(i) Facts. DC1, a domestic

corporation, owns all of the outstanding

stock of DC2, a domestic corporation. DC2

owns various assets including all of the

outstanding stock of FC2, a foreign

corporation. The stock of FC2 has a value of

$100, and DC2 has a basis of $30 in such

stock. The section 1248 amount attributable

to the FC2 stock held by DC2 is $20. DC2

does not own any other stock in a foreign

corporation. FC1 is a foreign corporation that

is unrelated to DC1, DC2 and FC2. In a

reorganization described in section

368(a)(1)(C), FC1 acquires all of the assets

and liabilities of DC2 in exchange for FC1

voting stock that represents 20 percent of the

outstanding voting stock of FC1. DC2

distributes the FC1 stock to DC1, and the DC2

stock held by DC1 is canceled. DC1 properly

files a gain recognition agreement under

§ 1.367(a)–8 to qualify for nonrecognition

treatment under section 367(a) with respect

to DC2’s transfer of the FC2 stock to FC1. See

§ 1.367(a)–8(f)(2).

(ii) Result. Pursuant to paragraph

(b)(1)(i)(A) of this section, DC2 is the

exchanging shareholder that is a section 1248

shareholder with respect to FC2, the foreign

acquired corporation. Immediately after the

exchange, DC2 is not a section 1248

shareholder with respect to FC1, the

corporation whose stock is received in the

exchange (because the DC2 stock is

canceled). Thus, paragraph (b)(1)(i)(B) of this

section is satisfied and, as a result, paragraph

(b)(1)(i) of this section applies to DC2’s

section 361 exchange of FC2 stock.

Accordingly, under paragraph (b) of this

section, DC2 must include in income, as a

deemed dividend from FC2, the section 1248

amount ($20) attributable to the FC2 stock

that DC2 exchanges. This result arises

without regard to whether FC1 and FC2 are

controlled foreign corporations immediately

after the exchange. For the tax treatment of

DC2’s transfer of assets (other than stock) to

FC1, see sections 367(a)(1) and (a)(3), and the

regulations thereunder. Because the exchange

is also described in section 361(a) or (b), see

section 367(a)(5) and any regulations

thereunder. If any of the assets transferred are

intangible assets, see section 367(d) and the

regulations thereunder.

(2) Receipt by exchanging shareholder

of preferred or other stock in certain

instances—(i) Rule. An exchange is

described in this paragraph (b)(2)(i) if—

(A) Immediately before the exchange,

the foreign acquired corporation and the

foreign acquiring corporations are not

members of the same affiliated group

(within the meaning of section 1504(a),

but without regard to the exceptions set

forth in section 1504(b), and

substituting the words ‘‘more than 50’’

in place of the words ‘‘at least 80’’ in

sections 1504(a)(2)(A) and (B));

(B) Immediately after the exchange, a

domestic corporation meets the

ownership threshold specified by

section 902(a) or (b) such that it may

qualify for a deemed paid foreign tax

credit if it receives a distribution from

the foreign acquiring corporation

(directly or through tiers); and

(C) The exchanging shareholder

receives preferred stock (other than

preferred stock that is fully participating

with respect to dividends, redemptions

and corporate growth) in consideration

for common stock or preferred stock that

is fully participating with respect to

dividends, redemptions and corporate

growth, or, in the discretion of the

Commissioner or the Commissioner’s

delegate (and without regard to whether

the stock exchanged is common stock or

preferred stock), receives stock that

entitles it to participate (through

dividends, redemption payments or

otherwise) disproportionately in the

earnings generated by particular assets

of the foreign acquired corporation or

foreign acquiring corporation.

(ii) Examples. The following

examples illustrate the rules of this

paragraph (b)(2):

Example 1—(i) Facts. FC1 is a foreign

corporation. DC is a domestic corporation

that is unrelated to FC1. DC owns all of the

outstanding stock of FC2, a foreign

corporation, and FC2 has no outstanding

preferred stock. The value of FC2 is $100 and

DC has a basis of $50 in the stock of FC2.

Under § 1.367(b)–2(c)(1), the section 1248

amount attributable to the stock of FC2 held

by DC is $20. In a reorganization described

in section 368(a)(1)(B), FC1 acquires all of the

stock of FC2 and, in exchange, DC receives

FC1 voting preferred stock that constitutes 10

percent of the voting stock of FC1 for

purposes of section 902(a). Immediately after

the exchange, FC1 and FC2 are controlled

foreign corporations and DC is a section 1248

shareholder of FC1 and FC2, so paragraph

(b)(1)(i) of this section does not require

inclusion in income of the section 1248

amount.

(ii) Result. Pursuant to § 1.367(a)–3(b)(2),

the transfer is subject to both section 367(a)

and section 367(b). Under § 1.367(a)–3(b)(1),

DC will not be subject to tax under section

367(a)(1) if it enters into a gain recognition

agreement in accordance with § 1.367(a)–8.

Even though paragraph (b)(1)(i) of this

section does not apply to require inclusion in

income by DC of the section 1248 amount,

DC must nevertheless include the $20 section

1248 amount in income as a deemed

dividend from FC2 under paragraph (b)(2)(i)

of this section. Thus, if DC enters into a gain

recognition agreement, the amount is $30

(the $50 gain realized less the $20 recognized

under section 367(b)). If DC fails to enter into

a gain recognition agreement, it must include

in income under section 367(a)(1) the $50 of

gain realized ($20 of which is treated as a

dividend under section 1248). Section 367(b)

does not apply in such case.

Example 2—(i) Facts. The facts are the

same as in Example 1, except that DC owns

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3605

all of the outstanding stock of FC1

immediately before the transaction.

(ii) Result. Both section 367(a) and section

367(b) apply to the transfer. Paragraph

(b)(2)(i) of this section does not apply to

require inclusion of the section 1248 amount.

Under paragraph (b)(2)(i)(A) of this section,

the transaction is outside the scope of

paragraph (b)(2)(i) of this section because

FC1 and FC2 are, immediately before the

transaction, members of the same affiliated

group (within the meaning of such

paragraph). Thus, if DC enters into a gain

recognition agreement in accordance with

§ 1.367(a)–8, the amount of such agreement is

$50. As in Example 1, if DC fails to enter into

a gain recognition agreement, it must include

in income $50, $20 of which will be treated

as a dividend under section 1248.

Example 3—(i) Facts. FC1 is a foreign

corporation. DC is a domestic corporation

that is unrelated to FC1. DC owns all of the

outstanding stock of FC2, a foreign

corporation. The section 1248 amount

attributable to the stock of FC2 held by DC

is $20. In a reorganization described in

section 368(a)(1)(B), FC1 acquires all of the

stock of FC2 in exchange for FC1 voting stock

that constitutes 10 percent of the voting stock

of FC1 for purposes of section 902(a). The

FC1 voting stock received by DC in the

exchange carries voting rights in FC1, but by

agreement of the parties the shares entitle the

holder to dividends, amounts to be paid on

redemption, and amounts to be paid on

liquidation, that are to be determined by

reference to the earnings or value of FC2 as

of the date of such event, and that are

affected by the earnings or value of FC1 only

if FC1 becomes insolvent or has insufficient

capital surplus to pay dividends.

(ii) Result. Under § 1.367(a)–3(b)(1), DC

will not be subject to tax under section

367(a)(1) if it enters into a gain recognition

agreement with respect to the transfer of FC2

stock to FC1. Under § 1.367(a)–3(b)(2), the

exchange will be subject to the provisions of

section 367(b) and the regulations thereunder

to the extent that it is not subject to tax under

section 367(a)(1). Furthermore, even if DC

would not otherwise be required to recognize

income under this section, the Commissioner

or the Commissioner’s delegate may

nevertheless require that DC include the $20

section 1248 amount in income as a deemed

dividend from FC2 under paragraph (b)(2)(i)

of this section.

(3) Certain recapitalizations. An

exchange pursuant to a recapitalization

under section 368(a)(1)(E) shall be

deemed to be an exchange described in

this paragraph (b)(3) if the following

conditions are satisfied—

(i) During the 24-month period

immediately preceding or following the

date of the recapitalization, the

corporation that undergoes the

recapitalization (or a predecessor of, or

successor to, such corporation) also

engages in a transaction that would be

described in paragraph (b)(2)(i) of this

section but for paragraph (b)(2)(i)(C) of

this section, either as the foreign

acquired corporation or the foreign

acquiring corporation; and

(ii) The exchange in the

recapitalization is described in

paragraph (b)(2)(i)(C) of this section.

(c) Exclusion of deemed dividend

from foreign personal holding company

income—(1) Rule. In the event the

section 1248 amount is included in

income as a deemed dividend by a

foreign corporation under paragraph (b)

of this section, such deemed dividend

shall not be included as foreign personal

holding company income under section

954(c).

(2) Example. The following example

illustrates the rule of this paragraph (c):

Example—(i) Facts. FC1 is a foreign

corporation that is owned, directly and

indirectly (applying the ownership rules of

section 958), solely by foreign persons. DC is

a domestic corporation that is unrelated to

FC1. DC owns all of the outstanding stock of

FC2, a foreign corporation. FC2 owns all of

the outstanding stock of FC3, a foreign

corporation. Under § 1.367(b)–2(c)(1), the

section 1248 amount attributable to the stock

of FC3 held by FC2 is $20. In a reorganization

described in section 368(a)(1)(B), FC1

acquires from FC2 all of the stock of FC3 in

exchange for FC1 voting stock. The FC1

voting stock received by FC2 does not

represent more than 50 percent of the voting

power or value of FC1’s stock.

(ii) Result. FC1 is not a controlled foreign

corporation immediately after the exchange.

Under paragraph (b)(1) of this section, FC2

must include in income, as a deemed

dividend from FC3, the section 1248 amount

($20) attributable to the FC3 stock that FC2

exchanged. The deemed dividend is treated

as a dividend for purposes of the Internal

Revenue Code as provided in § 1.367(b)–

2(e)(2); however, under this paragraph (c) the

deemed dividend is not foreign personal

holding company income to FC2.

(d) Rules for subsequent exchanges—

(1) In general. If income is not required

to be included under paragraph (b) of

this section in a section 367(b) exchange

described in paragraph (a) of this

section (non-inclusion exchange) then,

for purposes of applying section 367(b)

or 1248 to subsequent exchanges, the

determination of the earnings and

profits attributable to an exchanging

shareholder’s stock received in the noninclusion exchange shall include a

computation that refers to the

exchanging shareholder’s pro rata

interest in the earnings and profits of

the foreign acquiring corporation (and,

in the case of a stock transfer, the

foreign acquired corporation) that

accumulate after the non-inclusion

exchange, as well as its pro rata interest

in the earnings and profits of the foreign

acquired corporation that accumulated

before the non-inclusion exchange. See

also section 1248(c)(2)(D)(ii). The

earnings and profits attributable to the

stock received by an exchanging

shareholder in the non-inclusion

exchange shall not include any earnings

and profits of the foreign acquiring

corporation that accumulated before the

non-inclusion exchange. In the case of

a non-inclusion exchange in which the

exchanging shareholder is a foreign

corporation, this paragraph (d)(1) shall

also apply for purposes of determining

the earnings and profits attributable to

the exchanging foreign corporation’s

shareholders, as well as for purposes of

determining the earnings and profits

attributable to the exchanging foreign

corporation when applying section

964(e) to subsequent sales or exchanges

of the stock of the foreign acquiring

corporation.

(2) Subsequent dispositions by a

foreign acquiring corporation. In the

case of an exchange by a foreign

acquiring corporation that is subject to

section 367(b) or 964(e) and that follows

a non-inclusion exchange (as defined in

paragraph (d)(1) of this section), the

rules of paragraph (d)(1) of this section

shall not apply. However, as a result of

such a subsequent exchange,

proportionate reductions shall be made

to the earnings and profits that

accumulated before the non-inclusion

exchange and that were attributed under

paragraph (d)(1) of this section. Such

reductions shall be made without regard

to whether gain is recognized on the

subsequent sale or exchange.

(3) Examples. The following examples

illustrate the rules of this section:

Example 1—(i) Facts. DC1, a domestic

corporation, owns all of the outstanding

stock of FC1, a foreign corporation. DC1 has

owned all of the stock of FC1 since FC1’s

formation. FC1 has $20 of earnings and

profits, all of which is eligible for inclusion

in the section 1248 amount attributable to

DC1’s stock in FC1. DC2, a domestic

corporation, owns all of the outstanding

stock of FC2, a foreign corporation. DC2 has

owned all of the stock of FC2 since FC2’s

formation. FC2 has $40 of earnings and

profits, all of which is eligible for inclusion

in the section 1248 amount attributable to

DC2’s stock in FC2. DC1 and DC2 are

unrelated. In a reorganization described in

section 368(a)(1)(B), DC1 transfers all of the

stock of FC1 to FC2 in exchange for 40

percent of FC2 stock. DC1 enters into a fiveyear gain recognition agreement under the

provisions of §§ 1.367(a)–3(b) and 1.367(a)–8

with respect to its transfer of FC1 stock to

FC2.

(ii) Result. (A) DC1’s transfer of FC1 to FC2

is not described in paragraph (b)(1)(i), (2)(i),

or (3) of this section. As a result, DC1 is not

required to include in income the section

1248 amount attributable to its FC1 stock and

the rules of paragraph (d)(1) of this section

apply. Thus, for purposes of applying section

367(b) or 1248 to subsequent exchanges of

FC2 stock, the determination of the earnings

3606 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

and profits attributable to DC1’s stock in FC2

will include a computation that refers to 40

percent of the post-reorganization earnings

and profits of FC1 and FC2, and that refers

to 100 percent of the $20 of prereorganization earnings and profits of FC1.

The earnings and profits attributable to DC1’s

stock in FC2 will not include any of the $40

of earnings and profits accumulated by FC2

prior to the transaction. Those earnings and

profits are attributable to DC2 under section

1248. However, paragraph (d)(1) of this

section does not apply for purposes of

applying section 367(b) or 964(e) to

subsequent exchanges of FC1 stock by FC2.

For these purposes, the determination of the

earnings and profits attributable to FC2’s

stock in FC1 is made under the principles of

section 1248 and, as a result, includes a

computation that refers to the $20 of earnings

and profits attributable to FC2’s section

1223(2) holding period in the FC1 stock.

(B) In the event FC2 exchanges FC1 stock

in a transaction that is subject to section

367(b) or 964(e), a proportionate reduction

must be made to the $20 of earnings and

profits that was previously attributed under

paragraph (d)(1) of this section to DC1’s stock

in FC2. Thus, for example, if FC2 sells 50

percent of its FC1 stock (at a time when there

have been no other reductions that affect the

$20 of FC1 earnings and profits), paragraph

(d)(2) of this section requires DC1 to

proportionately reduce the $20 of earnings

and profits that was previously attributed to

its FC2 stock (to $10). This reduction occurs

without regard to whether FC2 recognizes

gain on its sale of FC1 stock.

Example 2—(i) Facts. The facts are the

same as in Example 1, except that in a

reorganization described in section

368(a)(1)(C), FC1 transfers all of its assets to

FC2 in exchange for 40 percent of FC2 stock.

FC1 then distributes the stock of FC2 to DC1,

and the FC1 stock held by DC1 is canceled.

None of FC1’s assets include stock.

(ii) Result. FC2’s acquisition of FC1 is not

described in paragraph (b)(1)(i), (2)(i), or (3)

of this section. As a result, DC1 is not

required to include in income the section

1248 amount attributable to its FC1 stock and

the rules of paragraph (d)(1) of this section

apply. Thus, for purposes of applying section

367(b) or 1248 to subsequent exchanges, the

determination of the earnings and profits

attributable to DC1’s stock in FC2 will

include a computation that refers to 40

percent of the post-reorganization earnings

and profits of FC2, and that refers to 100

percent of the pre-reorganization earnings

and profits of FC1. The earnings and profits

attributable to DC1’s stock in FC2 will not

include any of the $40 of earnings and profits

accumulated by FC2 prior to the transaction.

Those earnings and profits are attributable to

DC2 under section 1248.

Example 3—(i) Facts. DC1, a domestic

corporation, owns all of the outstanding

stock of FC1, a foreign corporation. FC1 owns

all of the outstanding stock of FC3, a foreign

corporation. DC1 has owned all of the stock

of FC1 since FC1’s formation, and FC1 has

owned all of the stock of FC3 since FC3’s

formation. FC3 has $20 of earnings and

profits, all of which is eligible for inclusion

in the section 1248 amount attributable to

DC1’s stock in FC1 and in the section 1248

amount attributable to FC1’s stock in FC3.

Such earnings and profits are similarly

eligible for inclusion as a dividend

attributable to FC1’s stock in FC3 under

section 964(e). DC2, a domestic corporation,

owns all of the outstanding stock of FC2, a

foreign corporation. DC2 has owned all of the

stock of FC2 since FC2’s formation. FC2 has

$40 of earnings and profits, all of which is

eligible for inclusion in the section 1248

amount attributable to DC2’s stock in FC2.

DC1 and DC2 are unrelated. In a

reorganization described in section

368(a)(1)(B), FC1 transfers all of the stock of

FC3 to FC2 in exchange for 40 percent of FC2

stock.

(ii) Result. (A) FC1’s transfer of FC3 to FC2

is not described in paragraph (b)(1)(i), (2)(i),

or (3) of this section. As a result, FC1 is not

required to include in income the section

1248 amount attributable to its FC3 stock and

the rules of paragraph (d)(1) of this section

apply. Thus, for purposes of applying section

367(b) or 1248 to subsequent exchanges of

FC1 stock, the determination of the earnings

and profits attributable to DC1’s stock in FC1

will include a computation that refers to 40

percent of the post-reorganization earnings

and profits of FC2 and FC3, and that refers

to 100 percent of the $20 of prereorganization earnings and profits of FC3.

The earnings and profits attributable to FC1’s

stock in FC2 will not include any of the $40

of earnings and profits accumulated by FC2

prior to the transaction. Those earnings and

profits are attributable to DC2 under section

1248. For purposes of applying section 367(b)

or 964(e) to subsequent exchanges of FC2

stock, the determination of the earnings and

profits attributable to FC1’s stock in FC2 will

include a computation that refers to 40

percent of the post-reorganization earnings

and profits of FC2 and FC3, and that refers

to 100 percent of the $20 of prereorganization earnings and profits of FC3.

The earnings and profits attributable to FC1’s

interest in FC2 do not include any of the $40

of earnings and profits accumulated by FC2

prior to the transaction. However, paragraph

(d)(1) of this section does not apply for

purposes of applying section 367(b) or 964(e)

to subsequent exchanges of FC3 stock by

FC2. For these purposes, the determination of

the earnings and profits attributable to FC2’s

stock in FC3 is made under the principles of

section 1248 and, as a result, includes a

computation that refers to the $20 of earnings

and profits attributable to FC2’s section

1223(2) holding period in the FC3 stock.

(B) In the event FC2 exchanges FC3 stock

in a transaction that is subject to section

367(b) or 964(e), a proportionate reduction

must be made to the $20 of earnings and

profits that was previously attributed under

paragraph (d)(1) of this section to DC1’s stock

in FC1 (for purposes of subsequent

application of section 367(b) or 1248) as well

as to FC1’s stock in FC2 (for purposes of

subsequent application of section 367(b) or

964(e)). Thus, for example, if FC2 sells 50

percent of its FC3 stock (at a time when there

have been no other reductions that affect the

$20 of FC3 earnings and profits), paragraph

(d)(2) of this section requires DC1 and FC1

to proportionately reduce the $20 of earnings

and profits that was previously attributed to

their FC1 and FC2 stock, respectively (to

$10). These reductions occur without regard

to whether FC2 recognizes gain on its sale of

FC3 stock.

Par. 7. Sections 1.367(b)–5 and

1.367(b)–6 are added to read as follows:

§ 1.367(b)–5 Distributions of stock

described in section 355.

(a) In general—(1) Scope. This section

provides rules relating to a distribution

described in section 355 and to which

section 367(b) applies. For purposes of

this section, the terms distributing

corporation, controlled corporation, and

distributee have the same meaning as

used in section 355 and the regulations

thereunder.

(2) Treatment of distributees as

exchanging shareholders. For purposes

of the section 367(b) regulations, all

distributees in a transaction described

in paragraph (b), (c), or (d) of this

section shall be treated as exchanging

shareholders that realize income in a

section 367(b) exchange.

(b) Distribution by a domestic

corporation—(1) General rule. In a

distribution described in section 355, if

the distributing corporation is a

domestic corporation and the controlled

corporation is a foreign corporation, the

following general rules shall apply—

(i) If the distributee is a corporation,

then the controlled corporation shall be

considered to be a corporation; and

(ii) If the distributee is an individual,

then, solely for purposes of determining

the gain recognized by the distributing

corporation, the controlled corporation

shall not be considered to be a

corporation, and the distributing

corporation shall recognize any gain

(but not loss) realized on the

distribution.

(2) Section 367(e) transactions. The

rules of paragraph (b)(1) of this section

shall not apply to a foreign distributee

to the extent gain is recognized under

section 367(e)(1) and the regulations

thereunder.

(3) Determining whether distributees

are individuals. All distributees in a

distribution described in paragraph

(b)(1) of this section are presumed to be

individuals. However, the shareholder

identification principles of § 1.367(e)–

1(d) (including the reporting procedures

in § 1.367(e)–1(d)(2) and (3)) shall apply

for purposes of rebutting this

presumption.

(4) Applicable cross-references. For

rules with respect to a distributee that

is a partnership, trust or estate, see

§ 1.367(b)–2(k). For additional rules

relating to a distribution of stock of a

foreign corporation by a domestic

corporation, see section 1248(f) and the

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3607

regulations thereunder. For additional

rules relating to a distribution described

in section 355 by a domestic corporation

to a foreign distributee, see section

367(e)(1) and the regulations

thereunder.

(c) Pro rata distribution by a

controlled foreign corporation—(1)

Scope. This paragraph (c) applies to a

distribution described in section 355 in

which the distributing corporation is a

controlled foreign corporation and in

which the stock of the controlled

corporation is distributed pro rata to

each of the distributing corporation’s

shareholders.

(2) Adjustment to basis in stock and

income inclusion. If the distributee’s

postdistribution amount (as defined in

paragraph (e)(2) of this section) with

respect to the distributing or controlled

corporation is less than the distributee’s

predistribution amount (as defined in

paragraph (e)(1) of this section) with

respect to such corporation, then the

distributee’s basis in such stock

immediately after the distribution

(determined under the normal

principles of section 358) shall be

reduced by the amount of the difference.

However, the distributee’s basis in such

stock shall not be reduced below zero,

and to the extent the foregoing

reduction would have reduced basis

below zero, the distributee shall instead

include such amount in income as a

deemed dividend from such

corporation.

(3) Interaction with § 1.367(b)–2(e)(3)(ii).

The basis increase provided in

§ 1.367(b)–2(e)(3)(ii) shall not apply to a

deemed dividend that is included in

income pursuant to paragraph (c)(2) of

this section.

(4) Basis redistribution. If a distributee

reduces the basis in the stock of the

distributing or controlled corporation

(or has an inclusion with respect to such

stock) under paragraph (c)(2) of this

section, the distributee shall increase its

basis in the stock of the other

corporation by the amount of the basis

decrease (or deemed dividend

inclusion) required by paragraph (c)(2)

of this section. However, the

distributee’s basis in such stock shall

not be increased above the fair market

value of such stock and shall not be

increased to the extent the increase

diminishes the distributee’s

postdistribution amount with respect to

such corporation.

(d) Non-pro rata distribution by a

controlled foreign corporation—(1)

Scope. This paragraph (d) applies to a

distribution described in section 355 in

which the distributing corporation is a

controlled foreign corporation and in

which the stock of the controlled

corporation is not distributed pro rata to

each of the distributing corporation’s

shareholders.

(2) Treatment of certain shareholders

as distributees. For purposes of the

section 367(b) regulations, all persons

owning stock of the distributing

corporation immediately after a

transaction described in paragraph

(d)(1) of this section shall be treated as

distributees of such stock. For other

applicable rules, see paragraph (a)(2) of

this section.

(3) Inclusion of excess section 1248

amount by exchanging shareholder. If

the distributee’s postdistribution

amount (as defined in paragraph (e)(2)

of this section) with respect to the

distributing or controlled corporation is

less than the distributee’s

predistribution amount (as defined in

paragraph (e)(1) of this section) with

respect to such corporation, then the

distributee shall include in income as a

deemed dividend the amount of the

difference. For purposes of this

paragraph (d)(3), if a distributee owns

no stock in the distributing or controlled

corporation immediately after the

distribution, the distributee’s

postdistribution amount with respect to

such corporation shall be zero.

(4) Interaction with § 1.367(b)—

2(e)(3)(ii)—(i) Limited application. The

basis increase provided in § 1.367(b)—

2(e)(3)(ii) shall apply to a deemed

dividend that is included in income

pursuant to paragraph (d)(3) of this

section only to the extent that such basis

increase does not increase the

distributee’s basis above the fair market

value of such stock and does not

diminish the distributee’s

postdistribution amount with respect to

such corporation.

(ii) Interaction with predistribution

amount. For purposes of this paragraph

(d), the distributee’s predistribution

amount (as defined in paragraph (e)(1)

of this section) shall be determined

without regard to any basis increase

permitted under paragraph (d)(4)(i) of

this section.

(e) Definitions—(1) Predistribution

amount. For purposes of this section,

the predistribution amount with respect

to a distributing or controlled

corporation is the distributee’s section

1248 amount (as defined in § 1.367(b)—

2(c)(1)) computed immediately before

the distribution (and after any section

368(a)(1)(D) transfer connected with the

section 355 distribution), but only to the

extent that such amount is attributable

to the distributing corporation and any

corporations controlled by it

immediately before the distribution (the

distributing group) or the controlled

corporation and any corporations

controlled by it immediately before the

distribution (the controlled group), as

the case may be, under the principles of

§§ 1.1248–1(d)(3), 1.1248–2 and 1.1248–

3. However, the predistribution amount

with regard to the distributing group

shall be computed without taking into

account the distributee’s predistribution

amount with respect to the controlled

group.

(2) Postdistribution amount. For

purposes of this section, the

postdistribution amount with respect to

a distributing or controlled corporation

is the distributee’s section 1248 amount

(as defined in § 1.367(b)–2(c)(1)) with

respect to such stock, computed

immediately after the distribution (but

without regard to paragraph (c) or (d) of

this section (whichever is applicable)).

The postdistribution amount under this

paragraph (e)(2) shall be computed

before taking into account the effect (if

any) of any inclusion under section

356(a) or (b).

(f) Exclusion of deemed dividend from

foreign personal holding company

income. In the event an amount is

included in income as a deemed

dividend by a foreign corporation under

paragraph (c) or (d) of this section, such

deemed dividend shall not be included

as foreign personal holding company

income under section 954(c).

(g) Examples. The following examples

illustrate the rules of this section:

Example 1—(i) Facts. USS, a domestic

corporation, owns 40 percent of the

outstanding stock of FD, a controlled foreign

corporation (CFC). USS has owned the stock

since FD was incorporated, and FD has

always been a CFC. USS has a basis of $80

in its FD stock, which has a fair market value

of $200. FD owns 100 percent of the

outstanding stock of FC, a foreign

corporation. FD has owned the stock since

FC was incorporated. Neither FD nor FC own

stock in any other corporation. FD has

earnings and profits of $0 and a fair market

value of $250 (not considering its ownership

of FC). FC has earnings and profits of $300,

none of which is described in section

1248(d), and a fair market value of $250. In

a pro rata distribution described in section

355, FD distributes to USS stock in FC worth

$100; thereafter, USS’s FD stock is worth

$100 as well.

(ii) Result—(A) FD’s distribution is a

transaction described in paragraph (c)(1) of

this section. Under paragraph (c)(2) of this

section, USS must compare its

predistribution amounts with respect to FD

and FC to its respective postdistribution

amounts. Under paragraph (e)(1) of this

section, USS’s predistribution amount with

respect to FD or FC is its section 1248

amount computed immediately before the

distribution, but only to the extent such

amount is attributable to FD or FC. Under

§ 1.367(b)–2(c)(1), USS’s section 1248

amount computed immediately before the

distribution is $120, all of which is

3608 Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations

attributable to FC. Thus, USS’s

predistribution amount with respect to FD is

$0, and its predistribution amount with

respect to FC is $120. These amounts are

computed as follows: If USS had sold its FD

stock immediately before the transaction, it

would have recognized $120 of gain ($200

fair market value $80 basis). All of the gain

would have been treated as a dividend under

section 1248, and all of the section 1248

amount would have been attributable to FC

(based on USS’s pro rata share of FC’s

earnings and profits (40 percent × $300)).

(B) Under paragraph (e)(2) of this section,

USS’s postdistribution amount with respect

to FD or FC is its section 1248 amount with

respect to such corporation, computed

immediately after the distribution (but

without regard to paragraph (c) of this

section). Under § 1.367(b)–2(c)(1), USS’s

section 1248 amounts computed immediately

after the distribution with respect to FD and

FC are $60 and $0, respectively. These

amounts, which are USS’s postdistribution

amounts, are computed as follows: Under the

normal principles of section 358, USS

allocates its $80 predistribution basis in FD

between FD and FC according to the stock

blocks’ relative values, yielding a $40 basis

in each block. If USS sold its FD stock

immediately after the distribution, none of

the resulting gain would be treated as a

dividend under section 1248. If USS sold its

FC stock immediately after the distribution,

it would have a $60 gain ($100 fair market

value—$40 basis), all of which would be

treated as a dividend under section 1248.

(C) The basis adjustment and income

inclusion rules of paragraph (c)(2) of this

section apply to the extent of any difference

between USS’s postdistribution and

predistribution amounts. In the case of FD,

there is no difference between the two

amounts and, as a result, no adjustment or

income inclusion is required. In the case of

FC, USS’s postdistribution amount is $60 less

than its predistribution amount. Accordingly,

under paragraph (c)(2) of this section, USS is

required to reduce its basis in its FC stock

from $40 to $0 and include $20 in income

as a deemed dividend from FC. Under

paragraph (c)(3) of this section, the basis

increase provided in § 1.367(b)–2(e)(3)(ii)

does not apply with regard to the $20

deemed dividend. Under the rules of

paragraph (c)(4) of this section, USS

increases its basis in FD by the amount by

which it decreased its basis in FC, as well as

by the amount of its deemed dividend

inclusion ($40 + $40 + $20 = $100).

Example 2—(i) Facts. USS1 and USS2,

domestic corporations, each own 50 percent

of the outstanding stock of FD, a controlled

foreign corporation (CFC). USS1 and USS2

have owned their FD stock since it was

incorporated, and FD has always been a CFC.

USS1 and USS2 each have a basis of $500 in

their FD stock, and the fair market value of

each block of FD stock is $750. FD owns 100

percent of the outstanding stock of FC, a

foreign corporation. FD owned the stock

since FC was incorporated. Neither FD nor

FC own stock in any other corporation. FD

has earnings and profits of $0 and a fair

market value of $750 (not considering its

ownership of FC). FC has earnings and

profits of $500, none of which is described

in section 1248(d), and a fair market value of

$750. In a non-pro rata distribution described

in section 355, FD distributes all of the stock

of FC to USS2 in exchange for USS2’s FD

stock.

(ii) Result—(A) FD’s distribution is a

transaction described in paragraph (d)(1) of

this section. Under paragraph (d)(2) of this

section, USS1 is considered a distributee of

FD stock. Under paragraph (d)(3) of this

section, USS1 and USS2 must compare their

predistribution amounts with respect to FD

and FC stock to their respective

postdistribution amounts. Under paragraph

(e)(1) of this section, USS1’s predistribution

amount with respect to FD or FC is USS1’s

section 1248 amount computed immediately

before the distribution, but only to the extent

such amount is attributable to FD or FC.

USS2’s predistribution amount is determined

in the same manner. Under § 1.367(b)–2(c)(1),

USS1 and USS2 each have a section 1248

amount computed immediately before the

distribution of $250, all of which is

attributable to FC. Thus, USS1 and USS2

each have a predistribution amount with

respect to FD of $0, and each have a

predistribution amount with respect to FC of

$250. These amounts are computed as

follows: If either USS1 or USS2 had sold its

FD stock immediately before the transaction,

it would have recognized $250 of gain ($750

fair market value—$500 basis). All of the gain

would have been treated as a dividend under

section 1248, and all of the section 1248

amount would have been attributable to FC

(based on USS1’s and USS2’s pro rata shares

of FC’s earnings and profits (50 percent x

$500)).

(B) Under paragraph (d)(3) of this section,

a distributee that owns no stock in the

distributing or controlled corporation

immediately after the distribution has a

postdistribution amount with regard to that

stock of zero. Accordingly, USS2 has a

postdistribution amount of $0 with respect to

FD and USS1 has a postdistribution amount

of $0 with respect to FC. Under paragraph

(e)(2) of this section, USS1’s postdistribution

amount with respect to FD is its section 1248

amount with respect to such corporation,

computed immediately after the distribution

(but without regard to paragraph (d) of this

section). USS2’s postdistribution amount

with respect to FC is determined in the same

manner. Under § 1.367(b)–2(c)(1), USS1’s

section 1248 amount computed immediately

after the distribution with respect to FD is $0

and USS2’s section 1248 amount computed

immediately after the distribution with

respect to FC is $250. These amounts, which

are USS1’s and USS2’s postdistribution

amounts, are computed as follows: After the

non-pro rata distribution, USS1 owns all the

stock of FD and USS2 owns all the stock of

FC. If USS1 sold its FD stock immediately

after the distribution, none of the resulting

$250 gain ($750 fair market value $500 basis)

would be treated as a dividend under section

1248. If USS2 sold its FC stock immediately

after the distribution, it would have a $250

gain ($750 fair market value—$500 basis), all

of which would be treated as a dividend

under section 1248.

(C) The income inclusion rule of paragraph

(d)(3) of this section applies to the extent of

any difference between USS1’s and USS2’s

postdistribution and predistribution

amounts. In the case of USS2, there is no

difference between the two amounts with

respect to either FD or FC and, as a result,

no income inclusion is required. In the case

of USS1, there is no difference between the

two amounts with respect to its FD stock.

However, USS1’s postdistribution amount

with respect to FC is $250 less than its

predistribution amount. Accordingly, under

paragraph (d)(3) of this section, USS1 is

required to include $250 in income as a

deemed dividend. Under § 1.367(b)–2(e)(2),

the $250 deemed dividend is considered as

having been paid by FC to FD, and by FD to

USS1, immediately prior to the distribution.

This deemed dividend increases USS1’s basis

in FD ($500 + $250 = $750).

§ 1.367(b)–6 Effective dates and

coordination rules.

(a) Effective date—(1) In general.

Sections 1.367(b)–1 through 1.367(b)–5,

and this section, apply to section 367(b)

exchanges that occur on or after

February 23, 2000.

(2) Exception. A taxpayer may,

however, elect to have §§ 1.367(b)–1

through 1.367(b)–5, and this section,

apply to section 367(b) exchanges that

occur (or occurred) before February 23,

2000, if the due date for the taxpayer’s

timely filed Federal tax return

(including extensions) for the taxable

year in which the section 367(b)

exchange occurs (or occurred) is after

February 23, 2000. The election under

this paragraph (a)(2) will be valid only

if—

(i) The electing taxpayer makes the

election on a timely filed section 367(b)

notice;

(ii) In the case of an exchanging

shareholder that is a foreign

corporation, the election is made on the

section 367(b) notice that is filed by

each of its shareholders listed in

§ 1.367(b)–1(c)(3)(ii); and

(iii) The electing taxpayer provides

notice of the election to all corporations

(or their successors in interest) whose

earnings and profits are affected by the

election on or before the date the section

367(b) notice is filed.

(b) Certain recapitalizations described

in § 1.367(b)–4(b)(3). In the case of a

recapitalization described in § 1.367(b)–

4(b)(3) that occurred prior to July 20,

1998, the exchanging shareholder shall

include the section 1248 amount on its

tax return for the taxable year that

includes the exchange described in

§ 1.367(b)–4(b)(3)(i) (and not in the

taxable year of the recapitalization),

except that no inclusion is required if

both the recapitalization and the

exchange described in § 1.367(b)–

4(b)(3)(i) occurred prior to July 20, 1998.

(c) Use of reasonable method to

comply with prior published guidance—

Federal Register / Vol. 65, No. 15 / Monday, January 24, 2000 / Rules and Regulations 3609

(1) Prior exchanges. The taxpayer may

use a reasonable method to comply with

the following prior published guidance

to the extent such guidance relates to

section 367(b): Notice 88–71 (1988–2

C.B. 374); Notice 89–30 (1989–1 C.B.

670); and Notice 89–79 (1989–2 C.B.

392) (see § 601.601(d)(2) of this chapter).

This rule applies to section 367(b)

exchanges that occur (or occurred)

before February 23, 2000, or, if a

taxpayer makes the election described

in paragraph (a)(2) of this section, for

section 367(b) exchanges that occur (or

occurred) before the date described in

paragraph (a)(2) of this section. This

rule also applies to section 367(b)

exchanges and distributions described

in paragraph (d) of this section.

(2) Future exchanges. Section 367(b)

exchanges that occur on or after

February 23, 2000, (or, if a taxpayer

makes the election described in

paragraph (a)(2) of this section, for

section 367(b) exchanges that occur on

or after the date described in paragraph

(a)(2) of this section) are governed by

the section 367(b) regulations and, as a

result, paragraph (c)(1) of this section

shall not apply.

(d) Effect of removal of attribution

rules. To the extent that the rules under

§§ 7.367(b)–9 and 7.367(b)–10(h) of this

chapter, as in effect prior to February

23, 2000 (see 26 CFR part 1, revised as

of April 1, 1999), attributed earnings

and profits to the stock of a foreign

corporation in connection with an

exchange described in section 351, 354,

355, or 356 before February 23, 2000,

the foreign corporation shall continue to

be subject to the rules of § 7.367(b)–12

of this chapter in the event of any

subsequent exchanges and distributions

with respect to such stock,

notwithstanding the fact that such

subsequent exchange or distribution

occurs on or after the effective date

described in paragraph (a) of this

section.

§§ 1.367(b)–7 through 1.367(b)–9

[Removed]

Par. 8. Sections 1.367(b)–7 through

1.367(b)–9 are removed.

Par. 9. Section 1.381(b)–1, paragraph

(a)(1), the second sentence is amended

by removing the reference ‘‘7.367(b)–

1(e)’’ and adding ‘‘1.367(b)–2(f)’’ in its

place.

PART 7—TEMPORARY INCOME TAX

REGULATIONS UNDER THE TAX

REFORM ACT OF 1976

Par. 10. The authority citation for part

7 is amended by removing the entries

for §§ 7.367(b)–1, 7.367(b)–2, 7.367(b)–

3, 7.367(b)–4, 7.367(b)–5, 7.367(b)–6,

7.367(b)–7, 7.367(b)–8, 7.367(b)–9,

7.367(b)–10, 7.367(b)–11, and 7.367(b)–

13; and continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 11. Sections 7.367(b)–1 through

7.367(b)–11 and 7.367(b)–13 are

removed as of February 23, 2000.

Par. 12. Section 7.367(b)–12 is

amended by revising paragraph (a) to

read as follows:

§ 7.367(b)–12 Subsequent treatment of

amounts attributed or included in income

(temporary).

(a) Application. This section applies

to distributions with respect to, or a

disposition of, stock—

(1) To which, in connection with an

exchange occurring before February 23,

2000, an amount has been attributed

pursuant to § 7.367(b)–9 or 7.367(b)–10

(as in effect prior to February 23, 2000;

see 26 CFR Part 1 revised as of April 1,

1999); or

(2) In respect of which, before

February 23, 2000, an amount has been

included in income or added to earnings

and profits pursuant to § 7.367(b)–7 or

7.367(b)–10 (as in effect prior to

February 23, 2000); see 26 CFR Part 1

revised as of April 1, 1999).

* * * * *

PART 602—OMB CONTROL NUMBERS

UNDER THE PAPERWORK

REDUCTION ACT

Par. 13. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 12. In § 602.101, paragraph (b) is

amended in the table by adding an entry

in numerical order to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section

where identified and

described

Current OMB control

No.

*****

1.367(b)–1 ................. 1545–1271

*****

John M. Dalrymple,

Acting Deputy Commissioner of Internal

Revenue.

Approved: December 22, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

[FR Doc. 00–1377 Filed 1–21–00; 8:45 am]

BILLING CODE 4830–01–U

POSTAL SERVICE

39 CFR Part 111

Barcode Requirements for Special

Services Labels

AGENCY: Postal Service.

ACTION: Final rule.

SUMMARY: The Postal Service has

redesigned the following special

services forms and labels: PS Form

3800, Receipt for Certified Mail; PS

Form 3813–P, Receipt for Insured

Mail—Domestic—International; PS

Form 8099, Receipt for Recorded

Delivery; Label 200, Registered Mail;

and PS Form 3804, Return Receipt for

Merchandise. In addition to the current

Optical Character Reader font on the

labels, the Postal Service is placing

formatted barcodes. The USS–128

Subset A format barcode will be used on

all USPS-printed retail labels for

insured mail, recorded delivery mail,

and registered mail. The USS Code 128

Subset C format will be used on all

USPS-printed retail labels for certified

mail and return receipt for merchandise.

Customer-generated labels for these

services will be either USS Code 128 or

USS I 2 of 5 barcode format. Vendors

and mailers preparing customergenerated labels will be required to

comply with these requirements for

special service labels by June 10, 2000.

This final rule sets forth the new

Domestic Mail Manual (DMM) and

International Mail Manual (IMM)

language.

DATES: Effective January 24, 2000. All

parties must comply with this final rule

by June 10, 2000.

FOR FURTHER INFORMATION CONTACT:

Mary Shriver, (202) 268–6554.

SUPPLEMENTARY INFORMATION: On

October 6, 1999, the Postal Service

published in the Federal Register a

proposed rule seeking public comment

on a proposal to require barcodes on

special services labels. The Postal

Service received responses from mailers

offering comments, but only on the

technical specifications in the proposed

rule. Five comments were submitted on

label dimensions and sizes, four

concerned printing specifics, two

expressed uncertainty about the

required label stock, nine inquired on

barcode specifics, and three sought

clarification of compliance procedures.

In order to address the highly specific

nature of comments received regarding

the technical specifications of barcodes

for the new special services labels, the

Postal Service is responding to each

respondent’s comments or concerns

individually by letter.