Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 749

following events occur simultaneously at the 

effective time of the transaction: All of the 

assets and liabilities of Z, the combining 

entity and sole member of the transferor unit, 

become the assets and liabilities of Y, the 

combining entity and sole member of the 

transferee unit, and Z ceases its separate legal 

existence for all purposes. Accordingly, the 

transaction qualifies as a statutory merger or 

consolidation for purposes of section 

368(a)(1)(A).

Example 9. Transaction effected pursuant 

to foreign statutes. (i) Z and Y are entities 

organized under the laws of Country Q and 

classified as corporations for Federal tax 

purposes. Z and Y combine. Pursuant to 

statutes of Country Q the following events 

occur simultaneously: All of the assets and 

liabilities of Z become the assets and 

liabilities of Y and Z’s separate legal 

existence ceases for all purposes. 

(ii) The transaction satisfies the 

requirements of paragraphs (b)(1)(ii) of this 

section because the transaction is effected 

pursuant to statutes of Country Q and the 

following events occur simultaneously at the 

effective time of the transaction: All of the 

assets and liabilities of Z, the combining 

entity of the transferor unit, become the 

assets and liabilities of Y, the combining 

entity and sole member of the transferee unit, 

and Z ceases its separate legal existence for 

all purposes. Accordingly, the transaction 

qualifies as a statutory merger or 

consolidation for purposes of section 

368(a)(1)(A).

(iv) Effective dates. This paragraph 

(b)(1) applies to transactions occurring 

after the date these regulations are 

published as final regulations in the 

Federal Register. For rules regarding 

statutory mergers or consolidations on 

or after January 24, 2003, and before 

these regulations are published as final 

regulations in the Federal Register, see 

§ 1.368–2T(b)(1). For rules regarding 

statutory mergers or consolidations 

before January 24, 2003, see § 1.368–

2(b)(1) as it applies before January 24, 

2003 (see 26 CFR part 1, revised April 

1, 2002).

* * * * *

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement.

[FR Doc. 05–202 Filed 1–4–05; 8:45 am] 

BILLING CODE 4830–01–M

DEPARTMENT OF THE TREASURY

Internal Revenue Service 

26 CFR Part 1 

[REG–125628–01] 

RIN 1545–BA65 

Revision of Income Tax Regulations 

Under Sections 358, 367, 884, and 

6038B Dealing With Statutory Mergers 

or Consolidations Under Section 

368(a)(1)(A) Involving One or More 

Foreign Corporations

AGENCY: Internal Revenue Service (IRS), 

Treasury.

ACTION: Notice of proposed rulemaking 

and notice of public hearing. 

SUMMARY: This document contains 

proposed regulations amending the 

income tax regulations under various 

provisions of the Internal Revenue Code 

(Code) to account for statutory mergers 

and consolidations under section 

368(a)(1)(A) (including reorganizations 

described in section 368(a)(2)(D) and 

(E)) involving one or more foreign 

corporations. These proposed 

regulations are issued concurrently with 

proposed regulations (REG–117969–00) 

that would amend the definition of a 

reorganization under section 

368(a)(1)(A) to include certain statutory 

mergers or consolidations effected 

pursuant to foreign law.

DATES: Written and electronic comments 

and requests to speak and outlines of 

topics to be discussed at the public 

hearing scheduled for May 19, 2005, at 

10 a.m. must be received by April 28, 

2005.

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–125628–01), room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. Submissions 

may be hand delivered Monday through 

Friday between the hours of 8 a.m. and 

4 p.m. to: CC:PA:LPD:PR (REG–125628–

01), Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically, via the IRS Internet site 

at: http://www.irs.gov/regs or via the 

Federal eRulemaking Portal at http://

www.regulations.gov (IRS and REG–

125628–01). The public hearing will be 

held in the Auditorium, Internal 

Revenue Building, 1111 Constitution 

Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations, 

Robert W. Lorence, Jr., (202) 622–3860; 

concerning submissions, the hearing, or 

placement on the building access list to 

attend the hearing, Guy Traynor, (202) 

622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collection of information 

contained in this notice of proposed 

rulemaking has been submitted to the 

Office of Management and Budget for 

review in accordance with the 

Paperwork Reduction Act (44 U.S.C. 

3507(d)). Comments on the collection of 

information should be sent 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, with copies to the Internal 

Revenue Service, Attn: IRS Reports 

Clearance Officer, SE:W:CAR:MP:T:T:SP 

Washington, DC 20224. Comments on 

the collection of information should be 

received no later than March 7, 2005. 

Comments are specifically requested 

concerning: 

Whether the proposed collection of 

information is necessary for the proper 

performance of the functions of the IRS, 

including whether the information will 

have practical utility; 

The accuracy of the estimated burden 

associated with the proposed collection 

of information (see below); 

How the quality, utility, and clarity of 

the information to be collected may be 

enhanced; 

How the burden of complying with 

the proposed collection of information 

can be minimized, including through 

the application of automated collection 

techniques or other forms of information 

technology; and 

Estimates of capital or start-up costs 

and costs of operation, maintenance, 

and purchase of services to provide 

information. 

The collection of information in this 

proposed regulation is in § 1.367(a)–

3(d)(2)(vi)(B)(1)(ii). This information is 

required to inform the IRS of a domestic 

corporation that is claiming an 

exception from the application of 

section 367(a) and (d) to certain 

transfers of property to a foreign 

corporation that is re-transferred by the 

foreign corporation to a domestic 

corporation controlled by the foreign 

corporation. The information is in the 

form of a statement attached to the 

domestic corporation’s U.S. income tax 

return for the year of the transfer 

certifying that if the foreign corporation 

disposes of the stock of the domestic 

controlled corporation with a tax 

avoidance purpose, the domestic 

corporation will file an income tax 

return (or amended return, as the case 

may be) reporting gain. The collection of

750 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

information is mandatory. The likely 

respondents are domestic corporations. 

Estimated total annual reporting 

burden: 50 hours. 

Estimated average annual burden 

hours per respondent: 1 hour. 

Estimated number of respondents: 50. 

Estimated annual frequency of 

responses: on occasion. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number assigned by the Office of 

Management and Budget.

Books or records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

Section 368(a)(1)(A) defines a 

reorganization to include a statutory 

merger or consolidation (A 

reorganization). For transactions 

completed before January 24, 2003, 

regulations under section 368(a)(1)(A) 

provided that a reorganization was a 

merger or consolidation effected 

pursuant to the corporation law of the 

United States or a State or Territory or 

the District of Columbia. See 1.368–

2(b)(1), as in effect before January 24, 

2003. 

On January 24, 2003, the IRS and the 

Treasury Department issued proposed 

regulations (REG–126485–01, 2003–9 

I.R.B. 542, 66 FR 57400) and temporary 

regulations (TD 9038, 2003–9 I.R.B. 524, 

68 FR 3384), revising the definition of 

a statutory merger or consolidation. The 

proposed and temporary regulations 

define a statutory merger or 

consolidation in a manner intended to 

ensure that those transactions are not 

divisive in nature. Accordingly, the 

regulations generally require that all the 

assets and liabilities of the merged 

corporation (other than assets 

distributed or liabilities discharged in 

the transaction) are transferred to the 

acquiring corporation and that the 

separate legal identity of the merged 

corporation ceases to exist in the 

transaction. 

Pursuant to a notice of proposed 

rulemaking (proposed section 368 

regulations) published 

contemporaneously with this document, 

the IRS and Treasury are proposing 

further revisions to the definition of a 

statutory merger or consolidation to take 

into account those transactions effected 

pursuant to foreign law. The proposed 

section 368 regulations amend the 2003 

proposed regulations and provide that 

an A reorganization may occur, if 

certain conditions are satisfied, 

pursuant to the laws of a foreign 

jurisdiction, including a U.S. 

possession. 

In light of this change, this document 

contains proposed amendments to the 

regulations under certain international 

Code provisions (sections 367, 884, and 

6038B) to account for statutory mergers 

and consolidations involving one or 

more foreign corporations. Current 

international tax regulations are 

premised on an A reorganization being 

limited to a statutory merger or 

consolidation involving domestic 

corporations effected pursuant to 

domestic law. See, e.g., Rev. Rul. 57–

465 (1957–2 C.B. 250). As a result, 

conforming changes must be made to 

these international tax regulations to 

ensure that they apply appropriately to 

statutory mergers and consolidations 

effected pursuant to foreign law. The 

proposed regulations also modify the 

section 367(a) and (b) regulations to 

address several other related issues. 

Explanation of Provisions 

A. Basis and Holding Period Rules 

The proposed regulations provide 

basis and holding period rules for 

certain transactions involving foreign 

corporations with section 1248 

shareholders in order to preserve 

relevant section 1248 amounts. A 

section 1248 shareholder is a U.S. 

person that satisfies the ownership 

requirements of section 1248(a) with 

respect to a foreign corporation. Section 

1248(a) applies to a U.S. person that 

owns stock (directly, indirectly, or 

constructively) with 10 percent or more 

of the voting power in the foreign 

corporation at any time during the 5-

year period ending on the sale or 

exchange of the stock when the foreign 

corporation was a controlled foreign 

corporation (CFC). Gain recognized by a 

section 1248 shareholder on the sale or 

exchange of stock of the foreign 

corporation is included in gross income 

as a dividend to the extent of the 

earnings and profits of the foreign 

corporation that are attributable to the 

stock sold or exchanged and that were 

accumulated while the stock was held 

by the U.S. person when the foreign 

corporation was a CFC (the section 1248 

amount).

The IRS and Treasury believe that it 

is important to preserve section 1248 

amounts in certain nonrecognition 

exchanges of foreign corporation stock. 

Preservation of section 1248 amounts is 

a function of the holding period and 

basis in the stock of the foreign 

corporation being exchanged. One of the 

underlying policies of section 367(b) is 

the preservation of the potential 

application of section 1248 in 

connection with certain nonrecognition 

exchanges. H. Rep. No. 94–658, 94th 

Cong., 1st Sess., at 242 (Nov. 12, 1975). 

These proposed regulations provide 

basis and holding period rules to 

preserve section 1248 amounts in the 

context of certain section 354 exchanges 

and certain triangular reorganizations. 

The basis and holding period rules of 

the proposed regulations also apply to a 

foreign corporate shareholder of a 

foreign corporation that is a party to the 

reorganization, provided that the foreign 

corporate shareholder has at least one 

U.S. person that is a section 1248 

shareholder with respect to the foreign 

corporate shareholder and to the foreign 

corporation. This rule is necessary to 

preserve application of section 964(e) to 

the foreign corporate shareholder with 

respect to lower-tier foreign 

corporations. Under section 964(e), if a 

CFC sells or exchanges stock in another 

foreign corporation, gain recognized on 

the sale or exchange is included in the 

income of the CFC as a dividend to the 

same extent that it would have been 

included under section 1248(a) if the 

CFC were a U.S. person. Such dividend 

income may be treated as subpart F 

income that is included in the income 

of U.S. shareholders of the CFC. 

1. Section 354 Exchanges 

The proposed regulations apply to 

certain section 354 exchanges involving 

foreign corporations, including 

exchanges of multiple blocks of stock. 

The proposed regulations preserve the 

bases and holding periods in different 

blocks of stock in certain foreign target 

corporations by requiring the 

exchanging shareholder to establish the 

particular shares of stock that were 

received in exchange for shares of a 

particular block of target stock. If the 

exchanging shareholder cannot establish 

the particular shares of target stock that 

were received for shares of a particular 

block of stock, then the shareholder 

must designate which shares of stock 

were received in exchange for shares of 

a particular block of stock, provided that 

the designation is consistent with the 

terms of the exchange. These tracing 

methods are used to determine the 

resulting tax consequences when stock 

received in a nonrecognition exchange 

is subsequently sold or otherwise 

exchanged. If the exchanging 

shareholder cannot establish, and does 

not designate, the particular shares 

received, the shareholder is treated as 

selling or otherwise exchanging a share 

received in a nonrecognition exchange

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 751

for a share that was purchased or 

acquired at the earliest time. 

The IRS and Treasury recently 

published proposed section 358 

regulations (REG–116564–03) that 

determine the basis of stock or securities 

received in section 354 exchanges 

(proposed section 358 regulations). The 

proposed section 358 regulations 

generally provide that the basis of each 

share of stock or security received in an 

exchange to which section 354, 355, or 

356 applies will be the same as the basis 

of the share of stock or security 

exchanged therefor. For these purposes, 

the determination of which share of 

stock or security is received in exchange 

for a particular share of stock or security 

is made in accordance with the terms of 

the exchange or distribution. 

These proposed regulations apply the 

principles of the proposed section 358 

regulations to certain exchanges of stock 

of a foreign corporation by either a 

section 1248 shareholder, or a foreign 

corporate shareholder where at least one 

U.S. person is a section 1248 

shareholder with respect to such foreign 

corporate shareholder and to the foreign 

corporation whose shares are exchanged 

(collectively and individually, section 

367(b) shareholder), to ensure the 

preservation of section 1248 amounts. 

The proposed regulations also include 

specific guidance on the shareholder’s 

holding period in the stock received in 

the section 354 exchange. The proposed 

regulations do not, however, apply to 

distributions described in section 355. 

Consistent with the proposed section 

358 regulations, the proposed 

regulations hereunder would not apply 

to section 351 exchanges or to 

exchanges to which both section 351 

and section 354 (or section 356) apply, 

if, in addition to stock being received, 

other property is received or liabilities 

are assumed. This limitation is intended 

to prevent a conflict between the rules 

for determining basis in a section 351 

exchange (including the application of 

section 357(c)) and the rules proposed 

in this document. The IRS and Treasury 

are considering approaches for the 

preservation of section 1248 amounts in 

section 351 transactions in which 

liabilities are assumed or other property 

is received, and comments are requested 

in this regard. 

In addition, the IRS and Treasury are 

considering developing specific rules 

for situations in which stock of the 

foreign acquiring corporation is not 

issued in the exchange (for example, 

when the exchanging shareholder owns 

all the stock of the foreign acquiring 

corporation). One possible approach 

may be for each existing share of stock 

in that corporation to be divided into 

portions to account for the different 

basis and holding periods of the stock 

of the foreign acquiring corporation and 

the stock of the acquired corporation in 

order to preserve section 1248 amounts. 

Comments are requested regarding this 

approach or possible alternative 

approaches. 

2. Triangular Reorganizations 

The proposed regulations provide 

special basis and holding period rules 

for triangular reorganizations where the 

merging or surviving corporation is a 

foreign corporation with a section 

367(b) shareholder. These rules apply to 

reorganizations described in section 

368(a)(1)(A) and (a)(2)(D) (forward 

triangular merger) and to parenthetical 

section 368(a)(1)(C) reorganizations. In 

these transactions, the surviving 

corporation (S) acquires substantially all 

the assets of the acquired corporation 

(T), and the T shareholders exchange 

their T stock for stock of the corporation 

(P) that is in control (within the 

meaning of section 368(c)) of S. These 

rules also apply to reorganizations 

described in section 368(a)(1)(A) and 

(a)(2)(E) (reverse triangular merger). In a 

reverse triangular merger, S, a 

controlled subsidiary of P, merges into 

T, the surviving corporation, and the T 

shareholders exchange their T stock for 

stock of P.

Under current regulations, in a 

forward triangular merger or a 

parenthetical C reorganization, P’s basis 

in its S stock is adjusted as if P had 

acquired the T assets directly from T in 

a section 362(b) exchange and then had 

transferred the T assets to S in a 

transaction in which P’s basis in S stock 

is determined under section 358. See 

§ 1.358–6(c)(1) (commonly referred to as 

the ‘‘over-the-top’’ basis rules). Under 

current regulations, in a reverse 

triangular merger, P’s basis in the T 

stock it receives immediately after the 

transaction is equal to its basis in its S 

stock immediately before the transaction 

adjusted as if T had merged into S in a 

forward triangular merger and the overthe-top basis rules had applied. See 

§ 1.358–6(c)(2). If a reverse triangular 

merger also qualifies as a section 351 

transfer or a section 368(a)(1)(B) 

reorganization, P can determine its basis 

in its S stock either by using the overthe-top basis rules as described in the 

prior sentence or by treating P as if it 

had acquired the T stock from the 

former shareholders of T in a 

transaction in which basis is determined 

under section 362(b) (carryover stock 

basis). 

The IRS and Treasury are concerned 

that, in certain exchanges involving 

foreign corporations, application of the 

over-the-top basis rules would not 

properly preserve the section 1248 or 

964(e) amounts with respect to the stock 

of S or T. The proposed regulations 

provide that, in determining the stock 

basis of the surviving corporation in 

certain triangular reorganizations, 

outside stock basis will be used instead 

of inside asset basis pursuant to § 1.358–

6(c). For example, in the case of a 

forward triangular merger (or a 

parenthetical C reorganization), where P 

is a domestic corporation, S is a foreign 

corporation, T is a foreign corporation, 

and T has a section 1248 shareholder, 

the basis and holding period in the T 

stock, not the T assets, are used to 

determine P’s basis in the S stock. The 

same rules apply to certain reverse 

triangular mergers, where S merges into 

T with T surviving. In that case, P’s 

basis in the T stock immediately after 

the transaction would reflect the basis 

and holding period of the T stock 

instead of the T assets. 

Under this stock basis approach for 

triangular reorganizations, the proposed 

regulations provide for a divided basis 

and holding period in each share of 

stock in the surviving corporation to 

reflect the relevant section 1248 

amounts in the S stock and T stock. In 

particular, each share of S stock in a 

forward triangular merger, and each 

share of T stock in a reverse triangular 

merger, where P is a section 367(b) 

shareholder immediately after the 

transaction, is divided into portions 

reflecting the basis and holding period 

of the S stock and the T stock before the 

transaction. However, the proposed 

regulations contain a de minimis

exception to this rule. Under this 

exception, if the value of the S stock 

immediately before the transaction is de 

minimis (for example, where S is a 

corporation formed to facilitate the 

transaction), then each share of the 

surviving corporation is not divided; 

instead, the basis of the S stock is added 

to the basis of the stock of the surviving 

corporation held by P. The value of the 

S stock would be de minimis for this 

purpose if it is less than 1 percent of the 

value of the surviving corporation (S or 

T) immediately after the transaction. 

If there are two or more blocks of 

stock in T or S held by a section 367(b) 

shareholder immediately before the 

transaction, then each share of the 

surviving corporation (S or T) is further 

divided to account for each block of 

stock. If two or more blocks of stock are 

held by one or more shareholders that 

are not section 367(b) shareholders, then 

shares in these blocks are aggregated 

into one divided portion for basis 

purposes. If none of the S or T 

shareholders is a section 367(b)

752 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

shareholder, then the over-the-top basis 

rules of § 1.358–6 apply instead of the 

rules in these proposed regulations. 

The proposed regulations provide 

special rules when stock of the 

surviving corporation has a divided 

basis and holding period. Earnings and 

profits accumulated prior to the 

reorganization are attributed to a 

divided portion of a share of stock based 

on the block of stock whose basis and 

holding period the divided portion 

reflects. Post-reorganization earnings 

and profits are attributed to each 

divided share of stock pursuant to 

section 1248 and the regulations 

thereunder. The amount of earnings and 

profits attributed to a divided share of 

stock pursuant to section 1248 are 

further attributed to a divided portion of 

such share of stock based on its fair 

market value in relation to the other 

divided portions. Finally, shares of 

stock are no longer divided into separate 

portions if section 1248 or 964(e) 

becomes inapplicable to a subsequent 

sale or exchange of the stock. 

The special basis rules in these 

proposed regulations apply to all 

triangular reorganizations where T has 

at least one section 367(b) shareholder, 

even if such shareholders own less than 

a controlling interest in T. The IRS and 

Treasury are considering whether the 

current basis rules of § 1.358–6 should 

apply in cases where section 367(b) 

shareholders do not own a substantial 

percentage of the stock of T, or whether 

taxpayers should be permitted to elect 

to apply the current basis rules under 

§ 1.358–6 to determine P’s basis in the 

stock of the surviving corporation (S or 

T), provided that all section 367(b) 

shareholders of T include in income the 

section 1248 amounts with respect to 

the stock exchanged. Comments are 

requested in this regard.

The use of stock basis to determine 

P’s basis in the surviving corporation 

also presents administrative concerns 

when a portion of the stock of T is 

widely held. In the case of a 

reorganization described in section 

368(a)(1)(B), which presents similar 

issues, Rev. Proc. 81–70 (1980–2 C.B. 

729) provides that statistical sampling 

techniques, if appropriate, are permitted 

to determine the basis of stock received 

by the acquiring corporation. In this 

regard, the IRS and Treasury recently 

have requested comments whether Rev. 

Proc. 81–70 should be revised to reflect 

changes in the marketplace since its 

publication. See Notice 2004–44 (2004–

28 I.R.B. 32). Comments are requested 

on expanding this guidance to apply 

under the proposed regulations, for 

example in cases where blocks of T 

stock are held by persons that are not 

section 367(b) shareholders and such 

shares are aggregated into a single 

divided portion for basis and holding 

period purposes. 

B. Exceptions to the Application of 

Section 367(a) 

Under section 367(a), a U.S. person 

recognizes gain, but not loss, on the 

transfer of property to a foreign 

corporation in an exchange described in 

section 351, 354, 356, or 361, unless an 

exception applies. Section 367(a), 

however, does not apply to a section 

354 exchange by a U.S. person of: (1) 

Stock of a foreign corporation in a 

section 368(a)(1)(E) reorganization; or 

(2) stock of a domestic or foreign 

corporation for stock of a foreign 

corporation in an asset reorganization 

described in section 368(a)(1)(C), (D), or 

(F) that is not treated as an indirect 

stock transfer under § 1.367(a)–3(a). 

The proposed regulations amend 

§ 1.367(a)-3(a) so that this exception to 

the application of section 367(a) also 

applies to A reorganizations (including 

forward and reverse triangular mergers). 

In addition, the proposed regulations 

clarify that § 1.367(a)-3(a) applies to 

exchanges described in section 356, as 

well as in section 354. Section 356 

applies to an exchange that would 

qualify as a section 354 exchange except 

for the fact that money or other property 

is received in the exchange. 

Taxpayers have questioned why the 

exception to the application of section 

367(a) in § 1.367(a)-3(a) includes 

exchanges of stock but not exchanges of 

securities in section 368(a)(1)(E) 

reorganizations and certain asset 

reorganizations. The IRS and Treasury 

believe that it is appropriate to provide 

comparable treatment for exchanges of 

securities in this context. Accordingly, 

Notice 2005–6 (2005–5 IRB), published 

contemporaneously with these proposed 

regulations, announces that the IRS and 

Treasury intend to amend § 1.367(a)-3(a) 

to apply the exception from section 

367(a) to exchanges of stock or 

securities. Notice 2005–6 provides that 

the applicable date of the amendment 

will be January 5, 2005. 

The proposed regulations also provide 

rules concerning the application of 

section 367(a) to reverse triangular 

mergers, where stock of P, a corporation 

that controls the merging corporation S, 

is treated as transferred (along with any 

other property of S) to the surviving 

corporation T in a section 361 transfer. 

If S is a domestic corporation and T is 

a foreign corporation, section 367(a) 

applies to the transfer by S of the P 

stock to T, unless an exception applies. 

The IRS and Treasury believe that, if 

the stock of P is provided to S pursuant 

to the plan of reorganization, the section 

361 transfer of the P stock from S to T 

should not be subject to section 367(a), 

and the proposed regulations so 

provide. If P does not provide its stock 

to S pursuant to the plan of 

reorganization, then the P stock will be 

treated as property of S and the transfer 

of such stock will be subject to section 

367(a). 

The IRS and Treasury intend to 

amend the regulations under section 

6038B to conform with the changes 

made in these regulations. 

C. Concurrent Application of Section 

367(a) and (b) 

The proposed regulations modify the 

current application of section 367(a) and 

(b) to transactions that require the 

inclusion in income of the all earnings 

and profits amount under section 

367(b). Section 1.367(a)-3(b)(2) provides 

rules for the concurrent application of 

section 367(a) and (b) to transfers of 

stock of a foreign corporation. This may 

occur, for example, when a U.S. 

shareholder exchanges stock of a foreign 

corporation (foreign acquired 

corporation) for stock of another foreign 

corporation (foreign acquiring 

corporation). See § 1.367(a)-3(b)(1). It 

may also occur when an acquiring 

corporation (foreign or domestic) 

acquires the assets of a foreign acquired 

corporation, and the U.S. shareholder 

exchanges stock of the foreign acquired 

corporation for stock of the foreign 

parent of the acquiring corporation in a 

triangular reorganization. 

The U.S. person’s exchange of stock of 

the foreign acquired corporation for 

stock of either the foreign acquiring 

corporation or the foreign parent is 

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

3(b) and (d). If the exchanging U.S. 

shareholder owns 5 percent or more (by 

vote or value) of the stock of the foreign 

acquiring corporation or the foreign 

parent immediately after the exchange, 

the shareholder recognizes gain, if any, 

under section 367(a), unless the 

shareholder enters into a gain 

recognition agreement as provided in 

§ 1.367(a)-8. If the exchanging 

shareholder is not a 5-percent 

shareholder, then the exchanging 

shareholder does not recognize gain, if 

any, on the exchange.

The U.S. shareholder’s exchange 

described above also may be subject to 

section 367(b). If the exchanging U.S. 

shareholder is a section 1248 

shareholder of the foreign acquired 

corporation, and the stock of the foreign 

acquiring corporation (or its foreign 

parent corporation) is not stock in a 

corporation that is a CFC as to which 

the U.S. shareholder is a section 1248

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 753

shareholder immediately after the 

exchange, then the exchanging 

shareholder must include in income the 

section 1248 amount with respect to the 

stock exchanged. See § 1.367(b)–4. If, 

instead, a domestic acquiring 

corporation acquires the assets of a 

foreign acquired corporation, and the 

U.S. shareholder exchanges stock of the 

foreign acquired corporation for stock of 

the foreign parent of the acquiring 

corporation in a triangular 

reorganization, then the exchanging 

shareholder must include in income the 

all earnings and profits amount with 

respect to the stock of the acquired 

corporation. See § 1.367(b)–3. Unlike 

the section 1248 amount, the all 

earnings and profits amount is not 

limited by the shareholder’s gain 

inherent in the stock of the foreign 

acquired corporation. 

In cases where section 367(a) and (b) 

apply concurrently to a transaction, 

existing § 1.367(a)–3(b)(2) provides that 

section 367(b) will not apply if the 

transfer is taxable under section 367(a). 

If the transfer is taxable under section 

367(a), the exchanging U.S. shareholder 

will recognize gain inherent in the 

exchanged stock (subject to 

recharacterization as dividend income 

under section 1248). If the transfer is not 

taxable under section 367(a), because 

the exchanging U.S. shareholder either 

is not a 5-percent shareholder or enters 

into a gain recognition agreement, then 

section 367(b) applies and the exchange 

is subject to either § 1.367(b)–3 or 

1.367(b)–4 at the shareholder level. 

Questions with respect to the 

concurrent application of section 367(a) 

and (b) have arisen in situations that 

otherwise would require inclusion of 

the all earnings and profits amount 

under § 1.367(b)–3. If the all earnings 

and profits amount is greater than the 

section 367(a) gain with respect to the 

stock of the foreign acquired 

corporation, under current law the 

exchanging shareholder effectively may 

elect to be taxed on the lesser amount 

of gain under section 367(a) simply by 

failing to file a gain recognition 

agreement. In that case, section 367(b) 

would not apply and the shareholder 

would avoid inclusion in income of the 

greater all earnings and profits amount. 

The ability to elect to recognize the 

lesser gain inherent in the stock 

exchanged in such cases is inconsistent 

with the policies of section 367(b) that 

apply to inbound transactions, 

including preventing conversion of tax 

deferral into tax forgiveness and 

ensuring that the domestic acquiring 

corporation’s section 381 carryover 

basis reflects an after-tax amount. 

Accordingly, the IRS and Treasury 

believe that the all earnings and profits 

amount provisions under § 1.367(b)–3 

should not operate electively in these 

cases. The proposed regulations require 

that, for exchanges subject to § 1.367(b)–

3 and section 367(a), section 367(b) 

would apply before section 367(a). In 

that case, inclusion of the all earnings 

and profits amount would increase the 

exchanging shareholder’s stock basis for 

purposes of computing the 

shareholder’s gain under section 367(a). 

Thus, if the all earnings and profits 

amount exceeds the inherent gain in the 

exchanged stock, gain is not recognized 

under section 367(a). If the transaction 

does not involve inclusion of the all 

earnings and profits amount (for 

example, if § 1.367(b)–4 applies), the 

existing ordering rules continue to 

apply. 

D. Parenthetical Section 368(a)(1)(B) 

Reorganizations 

In a parenthetical reorganization 

under section 368(a)(1)(B), if a U.S. 

shareholder exchanges stock of an 

acquired corporation for voting stock of 

a foreign corporation that controls 

(within the meaning of section 368(c)) 

the acquiring corporation, the U.S. 

shareholder is treated as making an 

indirect transfer of stock of the acquired 

corporation to the foreign controlling 

corporation in a transfer subject to 

section 367(a). See § 1.367(a)–

3(d)(1)(iii). This result occurs even if the 

acquiring corporation is domestic. If the 

U.S. shareholder owns five percent or 

more (by vote or value) of the stock of 

the foreign controlling corporation, the 

shareholder must recognize gain 

inherent in the exchanged stock, unless 

a gain recognition agreement is filed. A 

gain recognition agreement filed with 

respect to the transfer may be triggered 

(and gain on the initial transfer of stock 

will be recognized) if the foreign 

controlling corporation disposes of the 

stock of the acquiring corporation, or 

the acquiring corporation disposes of 

the stock of the acquired corporation, 

within 5 years of the initial transfer. See 

§ 1.367(a)–3(d)(2)(ii). 

The proposed regulations revise the 

indirect stock transfer rules to include 

triangular section 368(a)(1)(B) 

reorganizations in which a U.S. 

shareholder exchanges stock of the 

acquired corporation for voting stock of 

a domestic corporation that controls a 

foreign acquiring corporation. In such a 

case, the gain recognition agreement 

may be triggered if the domestic 

controlling corporation disposes of the 

stock of the foreign acquiring 

corporation, or the foreign acquiring 

corporation disposes of the stock of the 

acquired corporation, within 5 years of 

the initial transfer. 

E. Transfers of Assets Following Certain 

Asset Reorganizations 

If a U.S. shareholder exchanges stock 

or securities of an acquired corporation 

for stock or securities of a foreign 

acquiring corporation in a 

reorganization described in section 

368(a)(1)(C), and the foreign acquiring 

corporation transfers all or part of the 

assets of the acquired corporation to a 

subsidiary controlled (within the 

meaning of section 368(c)) by the 

foreign acquiring corporation in a 

transaction described in section 

368(a)(2)(C), the U.S. shareholder is 

treated, for purposes of section 367(a), 

as transferring the stock of the acquired 

corporation to the foreign acquiring 

corporation to the extent of the assets 

transferred to the controlled subsidiary. 

§ 1.367(a)–3(d)(1)(v). Section 

368(a)(2)(C) provides that a transaction 

otherwise qualifying as a reorganization 

under section 368(a)(1)(A), (B), (C), and 

(G) will not be disqualified because all 

or part of the assets or stock acquired in 

the transaction are transferred to a 

corporation controlled by the acquiring 

corporation. 

On August 16, 2004, the IRS and 

Treasury issued proposed regulations 

under § 1.368–2(k) that permit assets or 

stock acquired in any reorganization 

under section 368(a)(1) to be transferred 

to a corporation controlled by the 

acquiring corporation without 

disqualifying the reorganization. Prior to 

these proposed regulations, the IRS and 

Treasury issued Rev. Rul. 2002–85 

(2002–2 C.B. 986) which extended this 

treatment to section 368(a)(1)(D) 

reorganizations. Notice 2002–77 (2002–

2 C.B. 997) issued contemporaneously 

with Rev. Rul. 2002–85, provided that 

§ 1.367(a)–3(d)(1)(v) would be amended 

to treat transactions described in Rev. 

Rul. 2002–85 as indirect stock transfers, 

if the transfer of assets by the acquiring 

corporation to its controlled subsidiary 

occurred pursuant to the plan of 

reorganization. 

The effect of the proposed regulations 

under § 1.368–2(k) is to permit transfers 

of assets or stock to a controlled 

subsidiary in reorganizations not 

specifically identified or mentioned in 

section 368(a)(2)(C) (section 368(a)(1)(D) 

and (F) reorganizations). The proposed 

regulations amend the indirect stock 

transfer rules to conform to the changes 

in the section 368 regulations. As a 

result, the proposed regulations provide 

that the transfer of assets to a controlled 

subsidiary subsequent to an asset 

reorganization under section 368(a)(1) 

would constitute an indirect transfer of

754 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

stock, provided the transfer of assets by 

the foreign acquiring corporation to its 

controlled subsidiary occurs as part of 

the same transaction. 

F. Indirect Transfers Involving a Change 

in Domestic or Foreign Status of 

Acquired Corporation

As indicated above, under existing 

§ 1.367(a)–3(d)(1)(v), a U.S. shareholder 

of an acquired corporation is treated as 

transferring the stock of the acquired 

corporation to the foreign acquiring 

corporation to the extent of the assets 

transferred to the controlled subsidiary. 

Thus, if the acquired corporation is 

foreign, the U.S. shareholder is treated 

as transferring stock of a foreign 

corporation to the foreign acquiring 

corporation in a transaction that is 

subject to the § 1.367(a)–3(b) stock 

transfer rules. If the acquired 

corporation is domestic, the U.S. 

shareholder is treated as transferring 

stock of a domestic corporation to the 

foreign acquiring corporation in a 

transaction that is subject to § 1.367(a)–

3(c). This deemed transfer of domestic 

stock prevails even if the controlled 

subsidiary is foreign. Similar rules 

apply to parenthetical C reorganizations. 

Some commentators have suggested 

that the determination of whether 

domestic or foreign stock is deemed 

transferred should be based on the 

status of the controlled subsidiary, 

rather than the status of the acquired 

corporation. Under this approach, if the 

acquired corporation were domestic and 

the controlled subsidiary were foreign, 

the U.S. shareholders would be deemed 

to transfer foreign corporation stock 

subject to § 1.367(a)–3(b), rather than 

domestic corporation stock subject to 

§ 1.367(a)–3(c). The IRS and Treasury 

believe that, consistent with the 

framework of the current regulations, it 

is appropriate for the rules to continue 

to apply based on the stock that is 

owned and exchanged by the U.S. 

person in the transaction (rather than on 

the stock of the controlled subsidiary). 

The IRS and Treasury are considering 

the application of §§ 1.367(a)–3(b), 

1.367(a)–3(c), and 1.367(a)–8 to 

situations where the foreign acquiring 

corporation transfers assets of the 

acquired corporation to multiple 

controlled subsidiaries (including both 

domestic and foreign subsidiaries), 

comments are requested in this regard. 

G. Coordination of the Indirect Stock 

Transfer Rules and the Asset Transfer 

Rules 

In the case of an indirect stock 

transfer that also involves a transfer of 

assets by a domestic corporation to a 

foreign corporation, § 1.367(a)–

3(d)(2)(vi) generally provides that 

section 367(a) and (d) apply to the 

transfer of assets prior to application of 

the indirect stock transfer rules. 

However, section 367(a) does not apply 

to such transfers to the extent that the 

foreign acquiring corporation transfers 

the assets received in the asset transfer 

to a domestic corporation controlled 

(within the meaning of section 368(c)) 

by the foreign acquiring corporation in 

a transfer described in section 

368(a)(2)(C) or in a transfer described in 

section 351, provided the domestic 

transferee’s basis in the assets is no 

greater than the basis that the domestic 

acquired corporation had in such assets. 

The initial asset transfer to the foreign 

corporation is not subject to section 

367(a) in such cases because the assets 

re-transferred to the domestic 

corporation remain subject to U.S. 

corporate tax. 

The IRS and Treasury are concerned 

that asset reorganizations subject to this 

coordination rule may be used to 

facilitate corporate inversion 

transactions. An inversion generally 

involves a U.S. multinational 

corporation reincorporating outside the 

United States for tax purposes (either as 

a foreign corporation or as a subsidiary 

of a new foreign corporation). The IRS 

and Treasury also are concerned that the 

coordination rule might be used to 

facilitate divisive transactions. The 

proposed regulations address both of 

these concerns by modifying the scope 

of the coordination rule. 

The revised coordination rule 

operates as follows. Section 367(a) and 

(d) generally apply to the transfer of 

assets to a foreign corporation even if 

the foreign corporation transfers all or 

part of the assets received to a 

controlled domestic corporation. This 

general rule, however, is subject to two 

exceptions which do not require income 

recognition under section 367(a) and (d) 

on the transfer of assets to the foreign 

corporation to the extent that assets are 

re-transferred to the domestic controlled 

corporation. 

The first exception applies if the 

domestic acquired corporation is 

controlled (within the meaning of 

section 368(c)) by 5 or fewer domestic 

corporations, appropriate basis 

adjustments as provided in section 

367(a)(5) are made to the stock of the 

foreign acquiring corporation, and any 

other conditions provided in regulations 

under section 367(a)(5) are satisfied. 

Although there currently are no 

regulations under section 367(a)(5), this 

exception will incorporate any 

conditions or limitations in future 

regulations once published. 

In cases where the first exception 

does not apply, the second exception 

applies if the following two conditions 

are satisfied: (1) The indirect transfer of 

stock of the domestic acquired 

corporation satisfies the requirements of 

§ 1.367(a)–3(c)(1)(i), (ii), and (iv), and 

(c)(6); and (2) the domestic acquired 

corporation attaches a statement 

(described below) to its tax return for 

the taxable year of the transfer. 

The statement that the domestic 

acquired corporation files must certify 

that, if the foreign acquiring corporation 

disposes of any stock of the domestic 

controlled corporation with a principal 

purpose of avoiding U.S. tax that would 

have been imposed on the domestic 

acquired corporation had it disposed of 

the re-transferred assets, the domestic 

acquired corporation will amend its 

return for the year of the initial 

transaction and recognize gain 

(described below). The disposition of 

stock is presumed to have a principal 

purpose of tax avoidance if the 

disposition occurs within 2 years of the 

transfer. The presumption may be 

rebutted, however, if the domestic 

acquired corporation (or the foreign 

acquiring corporation on its behalf) 

demonstrates to the satisfaction of the 

Commissioner that the transaction did 

not have a principal purpose of tax 

avoidance.

If the domestic acquired corporation 

recognizes gain pursuant to the 

statement, it is treated as if, immediately 

prior to the exchange, it had transferred 

the re-transferred assets, including any 

intangible assets, directly to a domestic 

corporation in exchange for stock of the 

corporation in a transaction that is 

treated as a section 351 exchange, and 

immediately sold the stock to an 

unrelated party at fair market value in 

a sale in which it recognizes gain, if any, 

but not loss. For purposes of this rule, 

the deemed transfer to a domestic 

corporation is treated as a section 351 

exchange regardless of whether all the 

requirements for nonrecognition under 

section 351 are otherwise satisfied. 

Treating the domestic acquired 

corporation as recognizing gain on the 

disposition of stock, rather than assets, 

is intended to approximate the 

consequences that would have resulted 

had the domestic acquired corporation 

transferred the assets to a corporation 

and sold the stock received in such 

transfer prior to the outbound 

reorganization. In addition, this 

treatment is consistent with other 

provisions that address divisive 

transactions. See, e.g., section 355(e) 

and § 1.367(e)–(2)(b)(2)(iii). 

The basis that the foreign acquiring 

corporation has in the stock of the

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 755

domestic controlled corporation is 

increased by the amount of gain 

recognized by the domestic acquired 

corporation under these rules 

immediately prior to its disposition; 

however, the basis of the re-transferred 

assets held by the domestic controlled 

corporation will not be increased by 

such gain. Finally, the anti-abuse 

provision under § 1.367(d)–1T(g)(6) will 

not apply to intangible property 

included in the re-transferred assets. 

H. Application of Section 367(b) 

Regulations to Certain Triangular 

Reorganizations 

Section 367(b) applies to exchanges 

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 

for tax purposes is necessary for 

application of the relevant 

nonrecognition provisions. Except as 

provided in regulations, under section 

367(b) a foreign corporation that is a 

party to such an exchange is considered 

to be a corporation for tax purposes, and 

therefore the parties involved in the 

transaction are eligible for 

nonrecognition treatment. 

Section 1.367(b)–4 applies to 

acquisitions by a foreign corporation 

(the foreign acquiring corporation) of 

the stock or assets of another foreign 

corporation (the foreign acquired 

corporation) in certain nonrecognition 

exchanges (a section 367(b) exchange). 

Consistent with section 1248, 

§ 1.367(b)–4(b)(1)(i) addresses 

exchanges by a section 1248 shareholder 

(or, in certain cases, a CFC shareholder 

that has a section 1248 shareholder), 

and generally requires such a 

shareholder to include in income its 

section 1248 amount as a result of a 

section 367(b) exchange, if immediately 

after the exchange (i) the stock received 

in the exchange is not stock in a 

corporation that is a controlled foreign 

corporation as to which the section 1248 

shareholder described above is a section 

1248 shareholder, or (ii) the foreign 

acquiring corporation or the foreign 

acquired corporation (if any, such as in 

a transaction described in section 

368(a)(1)(B) or 351), is not a controlled 

foreign corporation as to which the 

section 1248 shareholder described 

above is a section 1248 shareholder. 

Therefore, in a triangular 

reorganization (such as a triangular 

reorganization described in section 

368(a)(1)(C)) that is within the scope of 

§ 1.367(b)–4, a section 367(b) 

shareholder must include in income the 

section 1248 amount if, for example, it 

receives stock of a domestic corporation 

in exchange for its stock in a controlled 

foreign corporation. This is the case 

because, immediately after the 

exchange, the section 367(b) 

shareholder does not hold stock in a 

corporation that is a controlled foreign 

corporation as to which such 

shareholder is a section 367(b) 

shareholder. 

Pursuant to the basis rules contained 

in this proposed regulation under 

§ 1.367(b)–13, the section 1248 amount 

with respect to the stock of the foreign 

acquired corporation that is exchanged 

can be properly preserved in the stock 

of a foreign corporation owned by a 

domestic corporation when the section 

367(b) shareholder receives stock of the 

domestic corporation in a triangular 

reorganization. Consequently, the 

proposed regulations provide that a 

section 367(b) shareholder receiving 

stock of a domestic corporation in a 

triangular reorganization is not required 

to include in income the section 1248 

amount under § 1.367(b)–4(b)(1)(i), 

provided that the domestic corporation, 

immediately after the exchange, is a 

section 1248 shareholder of the 

surviving corporation (or in the case of 

a parenthetical section 368(a)(1)(B) 

reorganization, of the acquired 

corporation) that is itself a controlled 

foreign corporation. 

I. Application of Section 367(b) 

Regulations to Certain Outbound 

Reorganizations 

If a domestic corporation is a section 

1248 shareholder with respect to a 

foreign corporation and transfers the 

stock in such foreign corporation to 

another foreign corporation in a section 

361 transfer, the domestic corporation 

must include in income the section 

1248 amount, if any, with respect to the 

stock of the transferred foreign 

corporation. See section 1248(f)(1) and 

§ 1.367(b)–4(b)(2)(ii), Example 4.

Taxpayers have commented that this 

rule may result in income inclusions in 

some cases where the section 1248 

amount could be preserved, such that a 

current inclusion may not be necessary 

or appropriate. The IRS and Treasury 

are considering the application of 

section 367(a)(5) and section 1248(f)(1) 

to such transactions, in conjunction 

with § 1.367(b)–13 of these regulations, 

to preserve section 1248 amounts, and 

comments are requested in this regard. 

The IRS and Treasury also are 

considering, and request comments, on 

situations in which there are multiple 

shareholders (including minority 

shareholders) of the domestic 

corporation; multiple assets (including 

appreciated and depreciated assets 

being transferred as part of the section 

361 transfer); and liabilities being 

assumed in connection with the 

transaction. 

J. Nonrecognition Transactions Under 

the FIRPTA and PFIC Provisions 

Section 897(a) generally treats gain or 

loss from the disposition of a U.S. real 

property interest by a nonresident alien 

individual or a foreign corporation as 

gain or loss that is effectively connected 

with the conduct of a trade or business 

within the United States. Sections 

897(d) and (e) provide rules that apply 

section 897 in the context of 

distributions and nonrecognition 

exchanges of U.S. real property 

interests. Temporary regulations were 

issued under sections 897(d) and (e) 

providing guidance on the application 

of section 897 to certain corporate 

transactions involving U.S. real property 

interests. See § 1.897–5T, 1.897–6T, and 

Notice 89–85 (1989–2 C.B. 403). These 

rules do not specifically address A 

reorganizations because such 

regulations were based on A 

reorganizations being limited to 

statutory mergers between domestic 

corporations. The IRS and Treasury 

intend to revise these regulations to 

reflect A reorganizations and welcome 

comments on revisions that are 

necessary to apply these regulations to 

A reorganizations, as well as comments 

on other issues under the regulations. 

Section 1291(f) provides authority to 

issue regulations concerning the 

exchange of stock in a passive foreign 

investment company (PFIC) in a 

nonrecognition transaction. Proposed 

regulations were published in the 

Federal Register (57 FR 11047) on April 

1, 1992, providing rules for the 

disposition of PFIC stock by U.S. 

shareholders in nonrecognition 

exchanges. See § 1.1291–6 of the 

proposed regulations. The application of 

these proposed regulations is based on 

A reorganizations being limited to 

statutory mergers between domestic 

corporations. The IRS and Treasury 

intend to revise these proposed 

regulations to reflect A reorganizations 

and welcome comments on revisions 

that are necessary in this regard, as well 

as comments on other issues under 

these regulations.

Proposed Effective Date 

Except as otherwise specified, these 

regulations are proposed to apply to 

transactions occurring after the date 

these regulations are published as final 

regulations in the Federal Register. 

Special Analyses 

The IRS and the Treasury Department 

have determined that this notice of 

proposed rulemaking is not a significant

756 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment pursuant to that 

Order is not required. It has also been 

determined that section 553(b) of the 

Administrative Procedure Act (5 U.S.C. 

chapter 5) does not apply to these 

regulations, and that because this 

regulation does not impose a collection 

of information on small entities, the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) does not apply. Pursuant to 

section 7805(f) of the Code, this 

regulation will be submitted to the Chief 

Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

Comments and Public Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written comments (a signed original and 

eight (8) copies) or electronic comments 

that are submitted timely to the IRS. The 

IRS and Treasury Department 

specifically request comments on the 

clarity of the proposed regulations and 

on how they can be made easier to 

understand. All comments will be 

available for public inspection and 

copying. 

A public hearing has been scheduled 

for May 19, 2005, beginning at 10 a.m. 

in the Auditorium, Internal Revenue 

Building, 1111 Constitution Avenue, 

NW., Washington, DC. Due to building 

security procedures, visitors must enter 

at the Constitution Avenue entrance. In 

addition, all visitors must present photo 

identification to enter the building. 

Because of access restrictions, visitors 

will not be admitted beyond the 

immediate entrance area more than 30 

minutes before the hearing starts. For 

information about having your name 

placed on the building access list to 

attend the hearing, see the FOR FURTHER

INFORMATION CONTACT portion of this 

preamble. 

The rules of 26 CFR 601.601(a)(3) 

apply to the hearing. Persons who wish 

to present oral comments must submit 

written or electronic comments and an 

outline of the topics to be discussed and 

the time to be devoted to each topic (a 

signed original and eight (8) copies) by 

April 28, 2005. A period of 10 minutes 

will be allotted to each person for 

making comments. An agenda showing 

the scheduling of the speakers will be 

prepared after the deadline for receiving 

outlines has passed. Copies of the 

agenda will be available free of charge 

at the hearing. 

Drafting Information 

The principal author of these 

regulations is Robert W. Lorence, Jr., of 

the Office of Associate Chief Counsel 

(International). However, other 

personnel from the IRS and Treasury 

Department participated in their 

development.

List of Subjects in 26 CFR Part 1 

Income taxes. Reporting and 

recordkeeping requirements.

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows:

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 continues to read, in part, as 

follows:

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

Par. 2. In section 1.358–1, paragraph 

(a) is amended by adding a sentence at 

the end of the paragraph to read as 

follows:

§ 1.358–1 Basis to distributes. 

(a) * * * In the case of certain section 

354 or 356 exchanges of stock in a 

foreign corporation, § 1.367(b)–13 

applies instead of the rules of § 1.358–

2.

* * * * *

Par. 3. In § 1.358–6, paragraph (e) is 

amended by adding a sentence at the 

end of the paragraph to read as follows:

§ 1.358–6 Stock basis in certain triangular 

reorganizations.

* * * * *

(e) * * * For certain triangular 

reorganizations where the surviving 

corporation (S or T) is foreign, see 

§ 1.367(b)–13.

* * * * *

Par. 4. Section 1.367(a)–3 is amended 

as follows: 

1. In paragraph (a), remove the third 

and fourth sentences, and add five 

sentences in their place. 

2. Revise paragraph (b)(2)(i). 

3. Revise paragraph (c)(5)(vi). 

4. In paragraph (d)(1), introductory 

text, first sentence, add the 

parenthetical ‘‘(or in a domestic 

corporation in control of a foreign 

acquiring corporation in a triangular 

section 368(a)(1)(B) reorganization)’’

after the words ‘‘for stock or securities 

in a foreign corporation’’. 

5. In paragraph (d)(1), introductory 

text, remove the last sentence and add 

three sentences in its place.

6. In paragraph (d)(1)(i), remove the 

last sentence and add a sentence in its 

place. 

7. In paragraph (d)(1)(ii), add a 

sentence at the end of the paragraph. 

8. Paragraph (d)(1)(iii) is revised. 

9. In paragraph (d)(1)(iv), remove the 

language ‘‘Example 7’’ and add 

‘‘Example 8’’ in its place, and remove 

‘‘Example 11’’ and add ‘‘Example 14’’ in 

its place. 

10. Revise paragraph (d)(1)(v). 

11. Revise paragraphs (d)(2)(i) and (ii). 

12. In paragraph (d)(2)(iv), last 

sentence, remove the language 

‘‘Example 4’’ and add ‘‘Examples 5 and 

5A’’ in its place. 

13. Revise paragraph (d)(2)(v)(C). 

14. Redesignate paragraph (d)(2)(v)(D) 

as paragraph (d)(2)(v)(F). 

15. Add new paragraphs (d)(2)(v)(D) 

and (E). 

16. Revise paragraph (d)(2)(vi). 

17. In paragraph (d)(3), redesignate 

the examples as follows and add the 

following new examples:

Redesignate As Add 

Example 12 ......................................................................... Example 16 ........................................................................

Example 15.

Examples 11 and 11A ........................................................ Examples 14 and 14A .......................................................

Examples 10 and 10A ........................................................ Examples 13 and 13A .......................................................

Example 9 ........................................................................... Example 12 ........................................................................

Examples 10 and 11.

Example 8 ........................................................................... Example 9 ..........................................................................

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 757

Redesignate As Add 

Examples 7, 7A, 7B, and 7C .............................................. Examples 8, 8A, 8B, and 8C .............................................

Examples 6 and 6A ............................................................ Examples 7 and 7A ...........................................................

Examples 5, 5A, and 5B .................................................... Examples 6, 6A, and 6B ....................................................

Examples 6C and 6D.

Example 4 ........................................................................... Example 5 ..........................................................................

Example 5A.

Example 3 ........................................................................... Example 4 ..........................................................................

Example 2 ........................................................................... Example 3 ..........................................................................

Example 2.

18. In paragraph (d)(3), newly 

designated Example 6A, paragraph (i), 

the first and last sentences are revised. 

19. In paragraph (d)(3), newly 

designated Example 6B and Example 9

are revised. 

20. In paragraph (d)(3), for each of the 

newly designated Examples listed in the 

first column, replace the language in the 

second column with the language in the 

third column:

Redesignated examples Remove Add 

Example 6A, paragraph (i), first sentence ........................................................................ Example 5 ............................................ Example 6.

Example 7, paragraph (i) .................................................................................................. Example 5 ............................................ Example 6.

Example 7A, paragraph (i) and paragraph (ii), penultimate sentence ............................. Example 6 ............................................ Example 7.

Example 8, paragraph (i) .................................................................................................. Example 5 ............................................ Example 6.

Example 8A, paragraph (i) ............................................................................................... Example 7 ............................................ Example 8.

Example 8B, paragraph (i) ............................................................................................... Example 7 ............................................ Example 8.

Example 8C, paragraph (i) ............................................................................................... Example 7 ............................................ Example 8.

Example 12, paragraph (i), third sentence ....................................................................... Example 9 ............................................ Example 12.

Example 13A, paragraph (i) and paragraph (ii), first sentence ........................................ Example 10 .......................................... Example 13.

Example 14A, paragraph (i) ............................................................................................. Example 11 .......................................... Example 14.

22. In paragraph (e)(1), remove the 

first sentence and add two sentences in 

its place. 

The revisions and additions are as 

follows:

§ 1.367(a)–3 Treatment of transfers of 

stock or securities to foreign corporations.

* * * * *

(a) * * * However, if, in an exchange 

described in section 354 or 356, a U.S. 

person exchanges stock of a foreign 

corporation in a reorganization 

described in section 368(a)(1)(E), or a 

U.S. person exchanges stock of a 

domestic or foreign corporation for 

stock of a foreign corporation pursuant 

to an asset reorganization that is not 

treated as an indirect stock transfer 

under paragraph (d) of this section, such 

section 354 or 356 exchange is not a 

transfer to a foreign corporation subject 

to section 367(a). See paragraph (d)(3), 

Example 16, of this section. For 

purposes of this section, an asset 

reorganization is defined as a 

reorganization described in section 

368(a)(1) involving a transfer of assets 

under section 361. If, in a transfer 

described in section 361, a domestic 

merging corporation transfers stock of a 

controlling corporation to a foreign 

surviving corporation in a 

reorganization described in sections 

368(a)(1)(A) and (a)(2)(E), such section 

361 transfer is not subject to section 

367(a) if the stock of the controlling 

corporation is provided to the merging 

corporation by the controlling 

corporation pursuant to the plan of 

reorganization; a section 361 transfer of 

other property, including stock of the 

controlling corporation not provided by 

the controlling corporation pursuant to 

the plan of reorganization, by the 

domestic merging corporation to the 

foreign surviving corporation pursuant 

to such a reorganization is subject to 

section 367(a). For special basis and 

holding period rules involving foreign 

corporations that are parties to certain 

reorganizations under section 368(a)(1), 

see § 1.367(b)–13. * * * 

(b) * * * 

(2) * * * 

(i) In general. A transfer of foreign 

stock or securities described in section 

367(a) and the regulations thereunder as 

well as in section 367(b) and the 

regulations thereunder shall be subject 

concurrently to sections 367(a) and (b) 

and the regulations thereunder, except 

as provided in paragraph (b)(2)(i)(A) or 

(B) of this section. See paragraph (d)(3), 

Example 11, of this section. 

(A) If a foreign corporation transfers 

assets to a domestic corporation in a 

transaction to which § 1.367(b)–3(a) and

758 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

(b) and the indirect stock transfer rules 

of paragraph (d) of this section apply, 

then the section 367(b) rules shall apply 

prior to the section 367(a) rules. See 

paragraph (d)(3), Example 15, of this 

section. This paragraph (b)(2)(i)(A) 

applies only to transactions occurring 

after the date these regulations are 

published as final regulations in the 

Federal Register. 

(B) Except as provided in paragraph 

(b)(2)(i)(A) of this section, section 367(b) 

and the regulations thereunder shall not 

apply if the foreign corporation is not 

treated as a corporation under section 

367(a)(1). See paragraph (d)(3), Example 

14, of this section.

* * * * *

(c) * * * 

(5) * * * 

(vi) Transferee foreign corporation.

Except as provided in paragraph 

(d)(1)(iii)(B) of this section, the 

transferee foreign corporation shall be 

the foreign corporation that issues stock 

or securities to the U.S. person in the 

exchange.

* * * * *

(d) * * * 

(1) * * * For examples of the 

concurrent application of the indirect 

stock transfer rules under section 367(a) 

and the rules of section 367(b), see 

paragraph (d)(3), Examples 14 and 15 of 

this section. For purposes of this 

paragraph (d), if a corporation acquiring 

assets in a reorganization described in 

section 368(a)(1) transfers all or a 

portion of such assets to a corporation 

controlled (within the meaning of 

section 368(c)) by the acquiring 

corporation as part of the same 

transaction, the subsequent transfer of 

assets to the controlled corporation will 

be referred to as a controlled asset 

transfer. See section 368(a)(2)(C). 

(i) * * * See paragraph (d)(3), 

Example 1 of this section for an example 

of a reorganization described in sections 

368(a)(1)(A) and (a)(2)(D) involving 

domestic acquired and acquiring 

corporations, and see paragraph (d)(3), 

Example 10 of this section for an 

example involving a domestic acquired 

corporation and a foreign acquiring 

corporation. 

(ii) * * * See paragraph (d)(3), 

Example 2 of this section for an example 

of a reorganization described in sections 

368(a)(1)(A) and (a)(2)(E) involving 

domestic acquired and acquiring 

corporations, and see paragraph (d)(3), 

Example 11 of this section for an 

example involving a domestic acquired 

corporation and a foreign acquiring 

corporation.

(iii) Triangular reorganizations 

described in section 368(a)(1)(B)—(A) A 

U.S. person exchanges stock of the 

acquired corporation for voting stock of 

a foreign corporation that is in control 

(as defined in section 368(c)) of the 

acquiring corporation in a 

reorganization described in section 

368(a)(1)(B). See paragraph (d)(3), 

Example 5 of this section. 

(B) A U.S. person exchanges stock of 

the acquired corporation for voting 

stock of a domestic corporation that is 

in control (as defined in section 368(c)) 

of a foreign acquiring corporation in a 

reorganization described in section 

368(a)(1)(B). 

(1) For purposes of paragraphs (b) and 

(c) of this section, the foreign acquiring 

corporation is considered to be the 

transferee foreign corporation even 

though the U.S. transferor receives stock 

of the domestic controlling corporation 

in the exchange. 

(2) If stock of a foreign acquired 

corporation is exchanged for the voting 

stock of a domestic corporation in 

control of a foreign acquiring 

corporation, then the exchange will be 

subject to the rules of paragraph (b) of 

this section. If the exchanging 

shareholder is a section 1248 

shareholder with respect to the foreign 

acquired corporation, the indirect 

transfer will be subject to sections 

367(a) and (b) concurrently. For the 

application of section 367(b) to the 

exchange, see §§ 1.367(b)–4 and 

1.367(b)–13(c). 

(3) If stock of a domestic acquired 

corporation is exchanged for the voting 

stock of a domestic corporation in 

control of a foreign acquiring 

corporation, then the exchange will be 

subject to the rules of paragraph (c) of 

this section. 

(4) For purposes of applying the gain 

recognition agreement provisions of 

paragraph (d)(2) of this section and 

§ 1.367(a)–8, the domestic controlling 

corporation will be treated as the 

transferee foreign corporation. Thus, a 

disposition of foreign acquiring 

corporation stock by the domestic 

controlling corporation, or a disposition 

of acquired corporation stock by the 

foreign acquiring corporation, will 

trigger the gain recognition agreement. 

See paragraph (d)(3), Example 5A of this 

section. 

(5) This paragraph (d)(1)(iii)(B) 

applies only to transactions occurring 

after the date these regulations are 

published as final regulations in the 

Federal Register.

* * * * *

(v) Transfers of assets to subsidiaries 

in certain section 368(a)(1) 

reorganizations. A U.S. person 

exchanges stock or securities of a 

corporation (the acquired corporation) 

for stock or securities of a foreign 

acquiring corporation in an asset 

reorganization (other than a triangular 

section 368(a)(1)(C) reorganization 

described in paragraph (d)(1)(iv) of this 

section or a reorganization described in 

sections 368(a)(1)(A) and (a)(2)(D) or 

(a)(2)(E) described in paragraphs 

(d)(1)(i) or (ii) of this section) that is 

followed by a controlled asset transfer. 

In the case of a transaction described in 

this paragraph (d)(1)(v) in which some 

but not all of the assets of the acquired 

corporation are transferred in a 

controlled asset transfer, the transaction 

shall be considered to be an indirect 

transfer of stock or securities subject to 

this paragraph (d) only to the extent of 

the assets so transferred. The remaining 

assets shall be treated as having been 

transferred in an asset transfer rather 

than an indirect stock transfer, and such 

asset transfer shall be subject to the 

other provisions of section 367, 

including sections 367(a)(1), (3), and (5), 

and (d) if the acquired corporation is a 

domestic corporation. See paragraph 

(d)(3), Examples 6A and 6B of this 

section.

* * * * *

(2) * * *

(i) Transferee foreign corporation.

Except as provided in paragraph 

(d)(1)(iii)(B) of this section, the 

transferee foreign corporation shall be 

the foreign corporation that issues stock 

or securities to the U.S. person in the 

exchange. 

(ii) Transferred corporation. The 

transferred corporation shall be the 

acquiring corporation, except as 

provided in this paragraph (d)(2)(ii). In 

the case of a triangular section 

368(a)(1)(B) reorganization described in 

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

transferred corporation shall be the 

acquired corporation. In the case of an 

indirect stock transfer described in 

paragraph (d)(1)(i), (ii), or (iv) of this 

section followed by a controlled asset 

transfer, or an indirect stock transfer 

described in paragraph (d)(1)(v) of this 

section, the transferred corporation shall 

be the controlled corporation to which 

the assets are transferred. In the case of 

successive section 351 transfers 

described in paragraph (d)(1)(vi) of this 

section, the transferred corporation shall 

be the corporation to which the assets 

are transferred in the final section 351 

transfer. The transferred property shall 

be the stock or securities of the 

transferred corporation, as appropriate 

under the circumstances.

* * * * *

(v) * * *

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(C) In the case of an asset 

reorganization followed by a controlled 

asset transfer, as described in paragraph 

(d)(1)(v) of this section, the assets of the 

acquired corporation that are transferred 

to the corporation controlled by the 

acquiring corporation; 

(D) In the case of a triangular 

reorganization described in section 

368(a)(1)(C) followed by a controlled 

asset transfer, or a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(D) followed by a controlled asset 

transfer, the assets of the acquired 

corporation including those transferred 

to the corporation controlled by the 

acquiring corporation; 

(E) In the case of a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(E) followed by a controlled asset 

transfer, the assets of the acquiring 

corporation including those transferred 

to the corporation controlled by the 

acquiring corporation; and

* * * * *

(vi) Coordination between asset 

transfer rules and indirect stock transfer 

rules— (A) General rule. If, pursuant to 

any of the transactions described in 

paragraph (d)(1) of this section, a U.S. 

person transfers (or is deemed to 

transfer) assets to a foreign corporation 

in an exchange described in section 351 

or 361, the rules of section 367, 

including sections 367(a)(1), (a)(3), and 

(a)(5), as well as section 367(d), and the 

regulations thereunder shall apply prior 

to the application of the rules of this 

section. 

(B) Exceptions. (1) If a transaction is 

described in paragraph (d)(2)(vi)(A) of 

this section, sections 367(a) and (d) 

shall not apply to the extent a domestic 

corporation (domestic acquired 

corporation) transfers its assets to a 

foreign corporation (foreign acquiring 

corporation) in an asset reorganization, 

and such assets (re-transferred assets) 

are transferred to a domestic corporation 

(domestic controlled corporation) 

controlled (within the meaning of 

section 368(c)) by the foreign acquiring 

corporation as part of the same 

transaction, provided that the domestic 

controlled corporation’s basis in such 

assets is no greater than the basis that 

the domestic acquired corporation had 

in such assets and the conditions 

contained in either of the following 

paragraphs are satisfied: 

(i) The domestic acquired corporation 

is controlled (within the meaning of 

section 368(c)) by 5 or fewer domestic 

corporations, appropriate basis 

adjustments as provided in section 

367(a)(5) are made to the stock of the 

foreign acquiring corporation, and any 

other conditions as provided in 

regulations under section 367(a)(5) are 

satisfied. For purposes of determining 

whether the domestic acquired 

corporation is controlled by 5 or fewer 

domestic corporations, all members of 

the same affiliated group within the 

meaning of section 1504 shall be treated 

as 1 corporation. 

(ii) The requirements of paragraphs 

(c)(1)(i), (ii), and (iv), and (c)(6) of this 

section are satisfied with respect to the 

indirect transfer of stock in the domestic 

acquired corporation, and the domestic 

acquired corporation attaches a 

statement described in paragraph 

(d)(2)(vi)(C) of this section to its U.S. 

income tax return for the taxable year of 

the transfer. 

(2) Sections 367(a) and (d) shall not 

apply to transfers described in 

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

where a U.S. person transfers assets to 

a foreign corporation in a section 351 

exchange, to the extent that such assets 

are transferred by such foreign 

corporation to a domestic corporation in 

another section 351 exchange, but only 

if the domestic transferee’s basis in the 

assets is no greater than the basis that 

the U.S. transferor had in such assets. 

(C) Required statement. The statement 

required by paragraph (d)(2)(vi)(B)(1)(ii) 

of this section shall be entitled 

‘‘Required Statement under § 1.367(a)–

3(d) for Assets Transferred to a 

Domestic Corporation’’ and shall be 

signed under penalties of perjury by an 

authorized officer of the domestic 

acquired corporation and by an 

authorized officer of the foreign 

acquiring corporation. The required 

statement shall contain a certification 

that, if the foreign acquiring corporation 

disposes of any stock of the domestic 

controlled corporation in a transaction 

described in paragraph (d)(2)(vi)(D) of 

this section, the domestic acquired 

corporation shall recognize gain as 

described in paragraph (d)(2)(vi)(E)(1) of 

this section. The domestic acquired 

corporation (or the foreign acquiring 

corporation on behalf of the domestic 

acquired corporation) shall file a U.S. 

income tax return (or an amended U.S. 

tax return, as the case may be) for the 

year of the transfer reporting such gain.

(D) Gain recognition transaction. (1) A 

transaction described in this paragraph 

(d)(2)(vi)(D) is one where a principal 

purpose of the transfer by the domestic 

acquired corporation is the avoidance of 

U.S. tax that would have been imposed 

on the domestic acquired corporation on 

the disposition of the re-transferred 

assets. A transfer may have a principal 

purpose of tax avoidance even though 

the tax avoidance purpose is 

outweighed by other purposes when 

taken together. 

(2) For purposes of paragraph 

(d)(2)(vi)(D)(1) of this section, a 

transaction is deemed to have a 

principal purpose of tax avoidance if the 

foreign acquiring corporation disposes 

of any stock of the domestic controlled 

corporation (whether in a recognition or 

non-recognition transaction) within 2 

years of the transfer. The rule in this 

paragraph (d)(2)(vi)(D)(2) shall not 

apply if the domestic acquired 

corporation (or the foreign acquiring 

corporation on behalf of the domestic 

acquired corporation) demonstrates to 

the satisfaction of the Commissioner 

that the avoidance of U.S. tax was not 

a principal purpose of the transaction. 

(E) Amount of gain recognized and 

other matters. (1) In the case of a 

transaction described in paragraph 

(d)(2)(vi)(D) of this section, solely for 

purposes of this paragraph (d)(2)(vi)(E), 

the domestic acquired corporation shall 

be treated as if, immediately prior to the 

transfer, it transferred the re-transferred 

assets, including any intangible assets, 

directly to a domestic corporation in 

exchange for stock of such domestic 

corporation in a transaction that is 

treated as a section 351 exchange, and 

immediately sold such stock to an 

unrelated party for its fair market value 

in a sale in which it shall recognize 

gain, if any (but not loss). Any gain 

recognized by the domestic acquired 

corporation pursuant to this paragraph 

(d)(2)(vi)(E) will increase the basis that 

the foreign acquiring corporation has in 

the stock of the domestic controlled 

corporation immediately before the 

transaction described in paragraph 

(d)(2)(vi)(D) of this section, but will not 

increase the basis of the re-transferred 

assets held by the domestic controlled 

corporation. Section 1.367(d)–1T(g)(6) 

shall not apply with respect to any 

intangible property included in the retransferred assets described in the 

preceding sentence. 

(2) If additional tax is required to be 

paid as a result of a transaction 

described in paragraph (d)(2)(vi)(D) of 

this section, then interest must be paid 

on that amount at rates determined 

under section 6621 with respect to the 

period between the date prescribed for 

filing the domestic acquired 

corporation’s income tax return for the 

year of the transfer and the date on 

which the additional tax for that year is 

paid. 

(F) Examples. For illustrations of the 

rules in paragraph (d)(2)(vi) of this 

section, see paragraph (d)(3), Examples 

6B, 6C, 6D, 9, and 13A of this section. 

(G) Effective dates. Paragraph 

(d)(2)(vi) of this section applies only to 

transactions occurring after the date 

these regulations are published as final

760 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

regulations in the Federal Register. See 

§ 1.367(a)–3(d)(2)(vi), as contained in 26 

CFR part 1 revised as of April 1, 2004, 

for transactions occurring on or after 

July 20, 1998, until the date these 

regulations are published as final 

regulations in the Federal Register. 

(3) * * *

Example 2. Section 368(a)(1)(A)/(a)(2)(E) 

reorganization—(i) Facts. The facts are the 

same as in Example 1, except that Newco 

merges into W and Newco receives stock of 

W which it distributes to F in a 

reorganization described in sections 

368(a)(1)(A) and (a)(2)(E). Pursuant to the 

reorganization, A receives 40 percent of the 

stock of F in an exchange described in 

section 354. 

(ii) Result. The consequences of the 

transfer are similar to those described in 

Example 1. Pursuant to paragraph (d)(1)(ii) of 

this section, the reorganization is subject to 

the indirect stock transfer rules. F is treated 

as the transferee foreign corporation, and W 

is treated as the transferred corporation. 

Provided that the requirements of paragraph 

(c)(1) of this section are satisfied, including 

the requirement that A enter into a five-year 

gain recognition agreement as described in 

§ 1.367(a)–8, A’s exchange of W stock for F 

stock under section 354 will not be subject 

to section 367(a)(1).

* * * * *

Example 5A. Triangular section 

368(a)(1)(B) reorganization—(i) Facts. The 

facts are the same as in Example 5, except 

that F is a domestic corporation and S is a 

foreign corporation. 

(ii) Result. U’s exchange of Y stock for 

stock of F, a domestic corporation in control 

of S, the foreign acquiring corporation, is 

treated as an indirect transfer of Y stock to 

a foreign corporation under paragraph 

(d)(1)(iii) of this section. U’s exchange of Y 

stock for F stock will not be subject to section 

367(a)(1) provided that all of the 

requirements of paragraph (c)(1) are satisfied, 

including the requirement that U enter in a 

five-year gain recognition agreement. In 

satisfying the 50 percent or less ownership 

requirements of paragraph (c)(1)(i) and (ii) of 

this section, U’s indirect ownership of S 

stock (through its direct ownership of F 

stock) will determine whether the 

requirement of paragraph (c)(1)(i) is satisfied 

and will be taken into account in 

determining whether the requirement of 

paragraph (c)(1)(ii) is satisfied. (See 

paragraph (c)(4)(iv)). For purposes of 

applying the gain recognition agreement 

provisions of paragraph (d)(2) of this section 

and § 1.367(a)–8, F is treated as the transferee 

foreign corporation. The gain recognition 

agreement would be triggered if F sold all or 

a portion of the stock of S, or if S sold all 

or a portion of the stock of Y.

* * * * *

Example 6A. Section 368(a)(1)(C) 

reorganization followed by a controlled asset 

transfer—(i) Facts. The facts are the same as 

in Example 6, except that the transaction is 

structured as a section 368(a)(1)(C) 

reorganization, followed by a controlled asset 

transfer, and R is a foreign corporation. * * * 

F then contributes Businesses B and C to R 

in a controlled asset transfer. * * *

* * * * *

Example 6B. Section 368(a)(1)(C) 

reorganization followed by a controlled asset 

transfer to a domestic controlled 

corporation—(i) Facts. The facts are the same 

as in Example 6A, except that R is a domestic 

corporation. 

(ii) Result. As in Example 6A, the 

outbound transfer of the Business A assets to 

F is not affected by the rules of this 

paragraph (d) and is subject to the general 

rules under section 367. However, the 

Business A assets qualify for the section 

367(a)(3) active trade or business exception. 

The Business B and C assets are part of an 

indirect stock transfer under this paragraph 

(d) but must first be tested under sections 

367(a) and (d). The Business B assets qualify 

for the active trade or business exception 

under section 367(a)(3); the Business C assets 

do not. However, pursuant to paragraph 

(d)(2)(vi)(B) of this section, the Business C 

assets are not subject to section 367(a) or (d), 

provided that the basis of the Business C 

assets in the hands of R is no greater than the 

basis of the assets in the hands of Z, and 

appropriate basis adjustments are made 

pursuant to section 367(a)(5) to the stock of 

F held by V. (In this case, no adjustments are 

required because, pursuant to section 358, V 

takes a basis of $30 in the stock of F, which 

is equal to V’s proportionate share of the 

basis in the assets of Z ($30) transferred to 

F.) V also is deemed to make an indirect 

transfer of stock under the rules of paragraph 

(d). To preserve non-recognition treatment 

under section 367(a), V must enter into a 5-

year gain recognition agreement in the 

amount of $50, the amount of the 

appreciation in the Business B and C assets, 

as the transfer of such assets by Z was not 

taxable under section 367(a)(1) and 

constituted an indirect stock transfer. 

Example 6C. Section 368(a)(1)(C) 

reorganization followed by a controlled asset 

transfer to a domestic controlled 

corporation—(i) Facts. The facts are the same 

as in Example 6B, except that Z is owned by 

individuals, none of whom qualify as fivepercent target shareholders with respect to Z 

within the meaning of paragraph (c)(5)(iii) of 

this section. The following additional facts 

are present. No U.S. persons that are either 

officers or directors of Z own any stock of F 

immediately after the transfer. F is engaged 

in an active trade or business outside the 

United States that satisfies the test set forth 

in paragraph (c)(3) of this section. 

(ii) Result. The transfer of the Business A 

assets is not affected by the rules of this 

paragraph (d). However, the transfer of such 

assets is subject to gain recognition under 

section 367(a)(1), because the section 

367(a)(3) active trade or business exception is 

inapplicable pursuant to section 367(a)(5). 

The Business B and C assets are part of an 

indirect stock transfer under this paragraph 

(d) but must first be tested under sections 

367(a) and (d). The transfer of the Business 

B assets (which otherwise would satisfy the 

section 367(a)(3) active trade or business 

exception) generally is subject to section 

367(a)(1) pursuant to section 367(a)(5). The 

transfer of the Business C assets generally is 

subject to sections 367(a)(1) and (d). 

However, pursuant to paragraph (d)(2)(vi)(B) 

of this section, the transfer of the Business B 

and C assets is not subject to sections 

367(a)(1) and (d), provided the basis of the 

Business B and C assets in the hands of R is 

no greater than the basis in the hands of Z 

and certain other requirements are satisfied. 

Since Z is not controlled within the meaning 

of section 368(c) by 5 or fewer domestic 

corporations, the indirect transfer of Z stock 

must satisfy the requirements of paragraphs 

(c)(1)(i), (ii), and (iv), and (c)(6) of this 

section, and Z must attach a statement 

described in paragraph (d)(2)(vi)(C) of this 

section to its U.S. income tax return for the 

taxable year of the transfer. In general, the 

statement must contain a certification that, if 

F disposes of the stock of R (in a recognition 

or nonrecognition transaction) and a 

principal purpose of the transfer is the 

avoidance of U.S. tax that would have been 

imposed on Z on the disposition of the 

Business B and C assets transferred to R, then 

Z (or F on behalf of Z) will file a return (or 

amended return as the case may be) 

recognizing gain ($50), as if, immediately 

prior to the reorganization, Z transferred the 

Business B and C assets to a domestic 

corporation in exchange for stock in a 

transaction treated as a section 351 exchange 

and immediately sold such stock to an 

unrelated party for its fair market value. A 

transaction is deemed to have a principal 

purpose of U.S. tax avoidance if F disposes 

of R stock within two years of the transfer, 

unless Z (or F on behalf of Z) can rebut the 

presumption to the satisfaction of the 

Commissioner. See paragraph (d)(2)(vi)(D)(2) 

of this section. With respect to the indirect 

transfer of Z stock, the requirements of 

paragraphs (c)(1)(i), (ii), and (iv) of this 

section are satisfied. Thus, assuming Z 

attaches the statement described in paragraph 

(d)(2)(vi)(C) of this section to its U.S. income 

tax return and satisfies the reporting 

requirements of (c)(6) of this section, the 

transfer of Business B and C assets is not 

subject to section 367(a) or (d). 

Example 6D. Section 368(a)(1)(C) 

reorganization followed by a controlled asset 

transfer to a domestic controlled 

corporation—(i) Facts. The facts are the same 

as in Example 6C, except that the Z 

shareholders receive 60 percent of the F stock 

in exchange for their Z stock in the 

reorganization. 

(ii) Result. The requirement of paragraph 

(c)(1)(i) of this section is not satisfied because 

the Z shareholders that are U.S. persons do 

not receive 50 percent or less of the total 

voting power and the total value of the stock 

of F in the transaction. Accordingly, Z 

shareholders that are U.S. persons are subject 

to section 367(a)(1) on their exchange of Z 

stock for F stock pursuant to the 

reorganization. For the same reason, the 

conditions of paragraph (d)(2)(vi)(B)(1)(ii) of 

this section are not met. Accordingly, the 

transfer of Business B and C assets is subject 

to sections 367(a)(1) and (d), even though 

such assets are re-transferred to R, a domestic 

corporation. As in Example 6C, the transfer 

of Business A assets, which is not affected by 

the rules of paragraph (d) of this section, is

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 761

subject to gain recognition under sections 

367(a)(1) and (5).

* * * * *

Example 9. Concurrent application with a 

controlled asset transfer—(i) Facts. The facts 

are the same as in Example 8, except that R 

transfers the Business A assets to M, a wholly 

owned domestic subsidiary of R, in a 

controlled asset transfer. In addition, V’s 

basis in its Z stock is $90. 

(ii) Result. Pursuant to paragraph 

(d)(2)(vi)(B) of this section, sections 367(a) 

and (d) do not apply to Z’s transfer of the 

Business A assets to R, because such assets 

are re-transferred to M, a domestic 

corporation, provided that the basis of the 

Business A assets in the hands of M is no 

greater than the basis of the assets in the 

hands of Z, and certain other requirements 

are satisfied. Because Z is controlled (within 

the meaning of section 368(c)) by V, a 

domestic corporation, appropriate basis 

adjustments must be made pursuant to 

section 367(a)(5) to the stock of F held by V. 

(In this case, no adjustments are required 

because, pursuant to section 358, V takes a 

basis of $90 in the stock of F, which is less 

than V’s proportionate share of the basis in 

the assets of Z ($100) transferred to R.) 

Section 367(a)(1) does not apply to Z’s 

transfer of its Business B assets to R (which 

are not re-transferred to M) because such 

assets qualify for an exception to gain 

recognition under section 367(a)(3). With 

respect to the indirect transfer of Z stock, 

such transfer is not subject to gain 

recognition under section 367(a)(1) if the 

requirements of paragraph (c) of this section 

are satisfied, including the requirement that 

V enter into a 5-year gain recognition 

agreement and comply with the requirements 

of § 1.367(a)–8 with respect to the gain ($100) 

realized on the Z stock. Under paragraphs 

(d)(2)(i) and (ii) of this section, the transferee 

foreign corporation is F and the transferred 

corporation is M. Pursuant to paragraph 

(d)(2)(iv) of this section, a disposition by F 

of the stock of R, or a disposition by R of the 

stock of M, will trigger the gain recognition 

agreement. To determine whether an asset 

disposition constitutes a deemed disposition 

of the transferred corporation’s stock under 

the rules of § 1.367(a)–8(e)(3)(i), both the 

Business A assets in M and the Business B 

assets in R must be considered.

Example 10. Concurrent application in 

section 368(a)(1)(A)/(a)(2)(D) 

reorganization—(i) Facts. The facts are the 

same as in Example 8, except that R acquires 

all of the assets of Z in a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(D). Pursuant to the reorganization, V 

receives 30 percent of the stock of F in a 

section 354 exchange. 

(ii) Result. The consequences of the 

transaction are similar to those in Example 8.

The assets of Businesses A and B that are 

transferred to R must be tested under section 

367(a) prior to the consideration of the 

indirect stock transfer rules of this paragraph 

(d). The Business B assets qualify for the 

active trade or business exception under 

section 367(a)(3). Because the Business A 

assets do not qualify for the exception, Z 

must recognize $40 of gain under section 

367(a) on the transfer of Business A assets to 

R. Because V and Z file a consolidated return, 

V’s basis in the stock of Z is increased from 

$100 to $140 as a result of Z’s $40 gain. V’s 

indirect transfer of Z stock will be taxable 

under section 367(a) unless V enters into a 

gain recognition agreement in the amount of 

$60 ($200 value of Z stock less $140 adjusted 

basis) and the other requirements of 

paragraph (c)(1) of this section are satisfied. 

Example 11. Section 368(a)(1)(A)/(a)(2)(E) 

reorganization—(i) Facts. F, a foreign 

corporation, owns all the stock of D, a 

domestic corporation. V, a domestic 

corporation, owns all the stock of Z, a foreign 

corporation. V has a basis of $100 in the 

stock of Z which has a fair market value of 

$200. D is an operating corporation with 

assets valued at $100 with a basis of $60. In 

a reorganization described in sections 

368(a)(1)(A) and (a)(2)(E), D merges into Z, 

and V exchanges its Z stock for 55 percent 

of the outstanding F stock. 

(ii) Result. Under paragraph (d)(1)(ii) of 

this section, V is treated as making an 

indirect transfer of Z stock to F. V’s exchange 

of Z stock for F stock will be taxable under 

section 367(a) (and section 1248 will be 

applicable) if V fails to enter into a 5-year 

gain recognition agreement in accordance 

with the requirements of § 1.367(a)–8. Under 

paragraph (b)(2) of this section, if V 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). Under § 1.367(b)–

4(b) of this chapter, however, no income 

inclusion is required because both F and Z 

are controlled foreign corporations with 

respect to which V is a section 1248 

shareholder immediately after the exchange. 

Under paragraphs (d)(2)(i) and (ii) of this 

section, the transferee foreign corporation is 

F, and the transferred corporation is Z (the 

acquiring corporation). If F disposes (within 

the meaning of § 1.367(a)–8(e)) of all (or a 

portion) of Z stock within the 5-year term of 

the agreement (and V has not made a valid 

election under § 1.367(a)–8(b)(1)(vii)), V is 

required to file an amended return for the 

year of the transfer and include in income, 

with interest, the gain realized but not 

recognized on the initial section 354 

exchange. To determine whether Z (the 

transferred corporation) disposes of 

substantially all of its assets, the assets of Z 

immediately prior to the transaction are 

taken into account, pursuant to paragraph 

(d)(2)(v)(B) of this section. Because D is 

owned by F, a foreign corporation, section 

367(a)(5) precludes any assets of D from 

qualifying for nonrecognition under section 

367(a)(3). Thus, D recognizes $40 of gain on 

the transfer of its assets to Z under section 

367(a)(1).

* * * * *

Example 15. Concurrent application of 

indirect stock transfer rules and section 

367(b)— (i) Facts. F, a foreign corporation, 

owns all of the stock of Newco, a domestic 

corporation. P, a domestic corporation, owns 

all of the stock of FC, a foreign corporation. 

P’s basis in the stock of FC is $50 and the 

value of FC stock is $100. The all earnings 

and profits amount with respect to the FC 

stock held by P is $60. See § 1.367(b)–2(d). 

In a reorganization described in sections 

368(a)(1)(A) and (a)(2)(D) (and paragraph 

(d)(1)(i) of this section), Newco acquires all 

of the properties of FC, and P exchanges its 

stock in FC for 20 percent of the stock in F. 

(ii) Result. Because a domestic corporation, 

Newco, acquires the assets of a foreign 

corporation, FC, in an asset reorganization to 

which § 1.367(b)–3(a) and (b) and the indirect 

stock rules of paragraph (d) of this section 

apply, the section 367(b) rules apply before 

the section 367(a) rules apply. See § 1.367(a)–

3(b)(2)(i)(A). Under the rules of section 

367(b), P must include in income the all 

earnings and profits amount of $60 with 

respect to its FC stock. See § 1.367(b)–3. 

Although P’s exchange of FC stock for F stock 

under section 354 is an indirect stock 

transfer, no gain is recognized under section 

367(a), because P’s basis in the FC stock is 

increased by the amount ($60) included in 

income under the rules of section 367(b). See 

§ 1.367(b)–2(e)(3)(ii). Alternatively, if P’s all 

earnings and profits amount were $30, then 

the amount of the income inclusion and basis 

adjustment under the rules of section 367(b) 

would be $30, and the amount of gain subject 

to section 367(a)(1) would be $20 unless P 

entered into a 5-year gain recognition 

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

* * * * *

(e) * * * 

(1) In general. Except as provided in 

paragraphs (b)(2)(i)(A), (d)(1)(iii)(B), and 

(d)(2)(vi)(G), or in this paragraph (e), the 

rules in paragraphs (a), (b), and (d) of 

this section apply to transfers occurring 

on or after July 20, 1998. The rules in 

paragraphs (a) and (d) of this section, as 

they apply to section 368(a)(1)(A) 

reorganizations (including 

reorganizations described in section 

368(a)(2)(D) or (E)) involving a foreign 

acquiring or acquired corporation, apply 

only to transfers occurring after the date 

these regulations are published as final 

regulations in the Federal Register. 

***

* * * * *

Par. 5. Section 1.367(a)–8 is amended 

as follows: 

1. In paragraphs (c)(2) and (d), remove 

the words ‘‘district director’’ and add 

‘‘Director of Field Operations’’ in their 

place. 

2. In paragraph (e)(1)(i), a sentence is 

added after the first sentence.

The addition reads as follows:

§ 1.367(a)–8 Gain recognition agreement 

requirements.

* * * * *

(e) * * * 

(1) * * * 

(i) * * * It also includes an indirect 

disposition of the stock of the 

transferred corporation as described in 

§ 1.367(a)–3(d)(2)(iv). * * *

* * * * *

Par. 6. In § 1.367(b)–1(a), remove the 

third and fourth sentences and add a 

sentence in their place to read as 

follows:

762 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

§ 1.367(b)–1 Other transfers. 

(a) * * * For rules coordinating the 

concurrent application of sections 

367(a) and (b), including the extent to 

which section 367(b) does not apply if 

the foreign corporation is not treated as 

a corporation under section 367(a), see 

§ 1.367(a)–3(b)(2)(i). * * *

* * * * *

Par. 7. In § 1.367(b)–3(b)(3)(ii), revise 

paragraph (i) of Example 5 to read as 

follows:

§ 1.367(b)–3 Repatriation of foreign 

corporate assets in certain nonrecognition 

transactions.

* * * * *

(b) * * * 

(3) * * * 

(ii) * * *

Example 5—(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 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)(A), DC2, a domestic 

corporation unrelated to FC1 or FC2, acquires 

all of the assets and liabilities of FC2 

pursuant to a State W merger. FC2 receives 

DC2 stock and distributes such stock to FC1. 

The FC2 stock held by FC1 is canceled, and 

FC2 ceases its separate legal existence.

* * * * *

Par. 8. Section 1.367(b)–4 is amended 

as follows. 

1. Paragraph (a) is revised. 

2. Redesignate paragraph (b)(1)(ii) as 

paragraph (b)(1)(iii), and add new 

paragraph (b)(1)(ii). 

3. In newly designated paragraph 

(b)(1)(iii), after Example 3, add 

Examples 3A and 3B. 

The revisions and additions 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 a foreign corporation 

(the foreign acquired corporation) in an 

exchange described in section 351 or a 

reorganization described in section 

368(a)(1). In the case of a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(E), this section applies if stock of 

the foreign surviving corporation is 

exchanged for stock of a foreign 

corporation in control of the merging 

corporation; in such a case, the foreign 

surviving corporation is treated as a 

foreign acquired corporation for 

purposes of this section. A foreign 

corporation that undergoes a 

reorganization described in section 

368(a)(1)(E) is treated as both the foreign 

acquired corporation and foreign 

acquiring corporation for purposes of 

this section. See § 1.367(a)–3(b)(2) for 

transactions subject to the concurrent 

application of this section and section 

367(a). 

(b) * * *

(1) * * * 

(ii) Exception. In the case of a 

triangular reorganization described in 

section 368(a)(1)(B) or (C), or a 

reorganization described in sections 

368(a)(1)(A) and (a)(2)(D) or (E), an 

exchange is not described in paragraph 

(b)(1)(i) of this section if the stock 

received in the exchange is stock of a 

domestic corporation and, immediately 

after the exchange, such domestic 

corporation is a section 1248 

shareholder of the acquired corporation 

(in the case of a triangular section 

368(a)(1)(B) reorganization) or the 

surviving corporation (in the case of a 

reorganization described in sections 

368(a)(1)(A) and (a)(2)(D) or (E)) and 

such acquired or surviving corporation 

is a controlled foreign corporation. See 

paragraph (b)(1)(iii) of this section, 

Example 3B for an illustration of this 

rule. 

(iii) * * *

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

same as in Example 3, except that FC1 

merges into FC2 in a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(E). Pursuant to the reorganization, DC 

exchanges its FC2 stock for stock of FP. 

(ii) Result. The result is similar to the result 

in Example 3. The transfer is an indirect 

stock transfer subject to section 367(a). See 

§ 1.367(a)–3(d)(1)(ii). Accordingly, DC’s 

exchange of FC2 stock for FP stock will be 

taxable under section 367(a) (and section 

1248 will be applicable) if DC fails to enter 

into a gain recognition agreement. 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 FC2 are controlled foreign corporations 

as to which DC is a (direct or indirect) 

section 1248 shareholder immediately after 

the reorganization, then paragraph (b)(1)(i) of 

this section does not apply to require 

inclusion in income of the section 1248 

amount and the amount of the gain 

recognition agreement is the amount of gain 

realized on the indirect stock transfer. If FP 

or FC2 is not a controlled foreign corporation 

as to which DC is a (direct or indirect) 

section 1248 shareholder immediately after 

the exchange, then DC must include in 

income the section 1248 amount ($20) 

attributable to the FC2 stock that DC 

exchanged. Under these circumstances, the 

gain recognition agreement would be the 

amount of gain realized on the indirect 

transfer, less the $20 section 1248 income 

inclusion. 

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

same as Example 3, except that USP, a 

domestic corporation, owns the controlling 

interest (within the meaning of section 

368(c)) in FC1 stock. FC2 merges into FC1 in 

a reorganization described in sections 

368(a)(1)(A) and (a)(2)(D). Pursuant to the 

reorganization, DC exchanges its FC2 stock 

for USP stock. 

(ii) Result. Because DC receives stock of a 

domestic corporation, USP, in the section 

354 exchange, the transfer is not an indirect 

stock transfer subject to section 367(a). 

Accordingly, the exchange will be subject 

only to the provisions of section 367(b) and 

the regulations thereunder. Under paragraph 

(b)(1)(ii)(A) of this section, because the stock 

received is stock of a domestic corporation 

(USP) and, immediately after the exchange, 

USP is a section 1248 shareholder of FC1 (the 

acquiring corporation) and FC1 is a 

controlled foreign corporation, the exchange 

is not described in paragraph (b)(1)(i) of this 

section and DC includes no amount in its 

gross income. See § 1.367(b)–13(b) and (c) for 

the basis and holding period rules applicable 

to this transaction, which cause USP’s 

adjusted basis and holding period in the 

stock of FC1 after the transaction to reflect 

the basis and holding period that DC had in 

its FC2 stock.

* * * * *

Par. 9. In § 1.367(b)–6, paragraph 

(a)(1), add a sentence to the end to read 

as follows:

§ 1.367(b)–6 Effective dates and 

coordination rules. 

(a) * * * 

(1) * * * The rules of §§ 1.367(b)–3 

and 1.367(b)–4, as they apply to 

reorganizations described in section 

368(a)(1)(A) (including reorganizations 

described in section 368(a)(2)(D) or (E)) 

involving a foreign acquiring or foreign 

acquired corporation, apply only to 

transfers occurring after the date these 

regulations are published as final 

regulations in the Federal Register.

* * * * *

Par. 10. Section 1.367(b)–13 is added 

to read as follows:

§ 1.367(b)–13 Special rules for determining 

basis and holding period. 

(a) Scope and definitions—(1) Scope. 

This section provides special basis and 

holding period rules for certain 

transactions involving the acquisition of 

property by a foreign acquiring 

corporation in nonrecognition 

exchanges. Special rules apply to 

determine the basis and holding period 

of stock in a foreign corporation 

received by certain shareholders in a 

section 354 or 356 exchange. In 

addition, special rules apply to 

determine the basis and holding period 

of stock of certain foreign surviving 

corporations held by a controlling 

corporation whose stock is issued in an 

exchange under section 354 or 356 in a 

triangular reorganization. This section

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 763

applies to transactions that are subject 

to section 367(b) as well as section 

367(a), including transactions 

concurrently subject to sections 367(a) 

and (b). 

(2) Definitions. For purposes of this 

section, the following definitions apply: 

(i) A foreign acquired corporation is a 

foreign corporation whose stock or 

assets are acquired by a foreign 

corporation in a reorganization 

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

reverse triangular merger, where T is a 

foreign corporation, T is treated as a 

foreign acquired corporation. A foreign 

corporation that undergoes a 

reorganization described in section 

368(a)(1)(E) is treated as a foreign 

acquired corporation. 

(ii) A block of stock has the meaning 

provided in § 1.1248–2(b). 

(iii) A triangular reorganization is a 

reorganization described in § 1.358–

6(b)(2)(i), (ii), or (iii) (but not a 

reorganization described in § 1.358–

6(b)(2)(iv)). A triangular C 

reorganization, a forward triangular 

merger, and a reverse triangular merger 

each is a reorganization described in 

§ 1.358–6(b)(2)(i), (ii), or (iii), 

respectively. For purposes of triangular 

reorganizations—

(A) P is a corporation that is a party 

to a reorganization that is in control 

(within the meaning of section 368(c)) of 

another party to the reorganization and 

whose stock is transferred pursuant to 

the reorganization; 

(B) S is a corporation that is a party 

to the reorganization and that is 

controlled by P; and 

(C) T is a corporation that is another 

party to the reorganization. 

(b) Determination of basis and 

holding period for exchanges of foreign 

stock—(1) Application. Except as 

provided in paragraph (b)(4) of this 

section, this paragraph (b) applies to a 

shareholder that exchanges stock of a 

foreign acquired corporation in an 

exchange under section 354 or 356 for 

stock of a controlled foreign 

corporation, if—

(i) Immediately before the exchange 

either such shareholder is a section 

1248 shareholder with respect to the 

foreign acquired corporation, or such 

shareholder is a foreign corporation and 

a United States person is a section 1248 

shareholder with respect to both such 

foreign corporation and the foreign 

acquired corporation; and 

(ii) The exchange is not described in 

§ 1.367(b)–4(b)(1)(i), (2)(i), or (3). 

(2) Basis and holding period rules—(i) 

If a shareholder surrenders a share of 

stock in an exchange under the terms of 

section 354 or 356, the basis and 

holding period of each share of stock 

received in the exchange shall be the 

same as the basis and holding period of 

the allocable portion of the share or 

shares of stock exchanged therefor, as 

adjusted under § 1.358–1 (such that the 

section 1248 amount of each share of 

stock exchanged is preserved in the 

share or shares of stock received). If 

more than one share of stock is received 

in exchange for one share of stock, the 

basis of the share of stock surrendered 

shall be allocated to the shares of stock 

received in the exchange in proportion 

to the fair market value of the shares of 

stock received. If one share of stock is 

received in respect of more than one 

share of stock or a fraction of a share of 

stock is received, the basis of the shares 

of stock surrendered must be allocated 

to the share of stock received, or a 

fraction thereof received, in a manner 

that reflects, to the greatest extent 

possible, that a share of stock is received 

in respect of shares of stock acquired on 

the same date and at the same price. The 

provisions of this paragraph may be 

applied, to the extent possible, on the 

basis of blocks of stock. 

(ii) If a shareholder that purchased or 

acquired shares of stock in a corporation 

on different dates or at different prices 

exchanges such shares of stock under 

the terms of section 354 or 356, and the 

shareholder is not able to identify which 

particular share or shares of stock (or 

portion of a share of stock) is received 

in exchange for a particular share or 

shares of stock, the shareholder may 

designate which share or shares of stock 

is received in exchange for a particular 

share or shares of stock, provided that 

such designation is consistent with the 

terms of the exchange or distribution. 

The designation must be made on or 

before the first date on which the basis 

of a share of stock received is relevant. 

The basis of a share received, for 

example, is relevant when such share is 

sold or otherwise transferred. The 

designation will be binding for purposes 

of determining the Federal tax 

consequences of any sale or transfer of 

a share received. If the shareholder fails 

to make a designation, then the 

shareholder will not be able to identify 

which share is sold or transferred for 

purposes of determining the basis of 

property sold or transferred under 

section 1012 and § 1.1012–1(c) and, 

instead, will be treated as selling or 

transferring the share received in 

respect of the earliest share purchased 

or acquired. See paragraph (e), Example 

1 of this section for an illustration of 

this paragraph (b). 

(3) In the case of a triangular 

reorganization, this paragraph (b) 

applies only to the exchange of T stock 

for P stock by T shareholders. See 

paragraph (c) of this section to 

determine the basis and holding period 

of stock of the surviving corporation (S 

or T) held by P immediately after a 

triangular reorganization. 

(4) Paragraphs (b)(1) through (3) of 

this section shall not apply to determine 

the basis of a share of stock received by 

a shareholder in an exchange described 

in both section 351 and section 354 or 

356, if, in connection with the 

exchange, the shareholder exchanges 

property for stock in an exchange to 

which neither section 354 nor 356 

applies or liabilities of the shareholder 

are assumed. 

(c) Determination of basis and holding 

period for triangular reorganizations—

(1) Application. In the case of a 

triangular reorganization, this paragraph 

(c) applies, if—

(i) In the case of a reverse triangular 

merger—

(A) Immediately before the 

transaction, either P is a section 1248 

shareholder with respect to S, or P is a 

foreign corporation and a United States 

person is a section 1248 shareholder 

with respect to both P and S; and 

(B) P’s exchange of S stock is not 

described in § 1.367(b)–3(a) and (b) or in 

§ 1.367(b)–4(b)(1)(i), (2)(i), or (3); or 

(ii)(A) Immediately before the 

transaction, a shareholder of T is either 

a section 1248 shareholder with respect 

to T or a foreign corporation and a 

United States person is a section 1248 

shareholder with respect to both such 

foreign corporation and T; and 

(B) With respect to at least one of the 

exchanging shareholders described in 

paragraph (c)(1)(ii)(A) of this section, 

the exchange of T stock is not described 

in § 1.367(b)–3(a) and (b) or in 

§ 1.367(b)–4(b)(1)(i), (2)(i), or (3). 

(2) Basis and holding period rules. In 

the case of a triangular reorganization 

described in this paragraph (c), each 

share of stock of the surviving 

corporation (S or T) held by P must be 

divided into portions attributable to the 

S stock and the T stock immediately 

before the exchange. See paragraph (e) 

of this section, Examples 2 through 5 for 

illustrations of this rule. 

(i) Portions attributable to S stock—

(A) In the case of a forward triangular 

merger or a triangular C reorganization, 

the basis and holding period of the 

portion of each share of surviving 

corporation stock attributable to the S 

stock is the basis and holding period of 

such share of stock immediately before 

the exchange.

(B) In the case of a reverse triangular 

merger, the basis and holding period of 

the portion of each share of surviving 

corporation stock attributable to the S 

stock is the basis and the holding period

764 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

immediately before the exchange of a 

proportionate amount of the S stock to 

which the portion relates. If P is a 

shareholder described in paragraph 

(c)(1)(i)(A) of this section with respect to 

S, and P exchanges two or more blocks 

of S stock pursuant to the transaction, 

then each share of the surviving 

corporation (T) attributable to the S 

stock must be further divided into 

separate portions to account for the 

separate blocks of stock in S. 

(C) If the value of S stock immediately 

before the triangular reorganization is 

less than one percent of the value of the 

surviving corporation stock immediately 

after the triangular reorganization, then 

P may determine its basis in the 

surviving corporation stock by applying 

the rules of paragraph (c)(2)(ii) of this 

section to determine the basis and 

holding period of the surviving 

corporation stock attributable to the T 

stock, and then increasing the basis of 

each share of surviving corporation 

stock by the proportionate amount of P’s 

aggregate basis in the S stock 

immediately before the exchange 

(without dividing the stock of the 

surviving corporation into separate 

portions attributable to the S stock). 

(ii) Portions attributable to T stock—

(A) If any exchanging shareholder of T 

stock is described in paragraph (c)(1)(ii) 

of this section, the basis and holding 

period of the portion of each share of 

stock in the surviving corporation 

attributable to the T stock is the basis 

and holding period immediately before 

the exchange of a proportionate amount 

of the T stock to which such portion 

relates. If any exchanging shareholder of 

T stock is described in paragraph 

(c)(1)(ii) of this section, and such 

shareholder exchanges two or more 

blocks of T stock pursuant to the 

transaction, then each share of surviving 

corporation stock attributable to the T 

stock must be further divided into 

separate portions to account for the 

separate blocks of T stock. 

(B) If no exchanging shareholder of T 

stock is described in paragraph (c)(1)(ii) 

of this section, the rules of § 1.358–6(c) 

apply to determine the basis of the 

portion of each share of the surviving 

corporation attributable to T 

immediately before the exchange. 

(d) Special rules applicable to divided 

shares of stock —(1) In general—(i) 

Shares of stock in different blocks can 

be aggregated into one divided portion 

for basis purposes, if such shares 

immediately before the exchange are 

owned by one or more shareholders that 

are—

(A) Neither section 1248 shareholders 

with respect to the corporation nor 

foreign corporate shareholders; or 

(B) Foreign corporate shareholders, 

provided that no United States persons 

are section 1248 shareholders with 

respect to both such foreign corporate 

shareholders and the corporation. 

(ii) For purposes of determining the 

amount of gain realized on the sale or 

exchange of stock that has a divided 

portion pursuant to paragraph (c) of this 

section, any amount realized on such 

sale or exchange will be allocated to 

each divided portion of the stock based 

on the relative fair market value of the 

stock to which the portion is 

attributable at the time the portions 

were created. 

(iii) Shares of stock will no longer be 

required to be divided if section 1248 or 

section 964(e) would not apply to a 

disposition or exchange of such stock. 

(2) Pre-exchange earnings and profits. 

All earnings and profits (or deficits) 

accumulated by a foreign corporation 

before the reorganization and 

attributable to a share (or block) of stock 

for purposes of section 1248 are 

attributable to the divided portion of 

stock with the basis and holding period 

of that share (or block). See § 1.367(b)–

4(d). 

(3) Post-exchange earnings and 

profits. Any earnings and profits (or 

deficits) accumulated by the surviving 

corporation subsequent to the 

reorganization are attributed to each 

divided share of stock pursuant to 

section 1248 and the regulations 

thereunder. The amount of earnings and 

profits (or deficits) attributable to a 

divided share of stock is further 

attributed to the divided portions of 

such share of stock based on the relative 

fair market value of each divided 

portion of stock. 

(e) Examples. The rules of this section 

are illustrated by the following 

examples:

Example 1. (i) Facts. US1 is a domestic 

corporation that owns all the stock of FT, a 

foreign corporation with 100 shares of stock 

outstanding. Each share of FT stock is valued 

at $10x. Because US1 acquired the stock of 

FT at two different dates, US1 owns two 

blocks of FT stock for purposes of section 

1248. The first block consists of 60 shares. 

The shares in the first block have a basis of 

$300x ($5x per share), a holding period of 10 

years, and $240x ($4x per share) of earnings 

and profits attributable to the shares for 

purposes of section 1248. The second block 

consists of 40 shares. The shares in the 

second block have a basis of $600x ($15x per 

share), a holding period of 2 years, and $80x 

($2x per share) of earnings and profits 

attributable to the shares for purposes of 

section 1248. US2, a domestic corporation, 

owns all of the stock of FP, a foreign 

corporation, which owns all of the stock of 

FS, a foreign corporation. FT merges into FS 

with FS surviving in a reorganization 

described in section 368(a)(1)(A). Pursuant to 

the reorganization, US1 receives 50 shares of 

FS stock with a value of $1,000x for its FT 

stock in an exchange that qualifies for 

nonrecognition under section 354. 

(ii) Basis and holding period 

determination—(A) US1 is a section 1248 

shareholder of FT immediately before the 

exchange and exchanges its FT stock for 

stock of a controlled foreign corporation (FS) 

as to which US1 is a section 1248 

shareholder immediately after the exchange. 

US1 is not required to include income under 

§ 1.367(b)-4(b) with respect to the exchange. 

Accordingly, the basis and holding period of 

the FS stock received by US1 is determined 

pursuant to paragraph (b) of this section. 

(B) Pursuant to paragraph (b) of this 

section, 30 shares of the FS stock received by 

US1 in the reorganization (valued at $20x per 

share and exchanged for US1’s first block of 

60 shares of FT stock) have a basis of $300x 

($10x per share), a holding period of 10 

years, and $240x of earnings and profits ($8x 

per share) attributable to such shares for 

purposes of section 1248. In addition, 20 

shares of the FS stock (valued at $20 per 

share and exchanged for US1’s second block 

of 40 shares of FT stock) have a basis of 

$600x ($30x per share), a holding period of 

2 years, and $80x of earnings and profits ($4x 

per share) attributable to such shares for 

purposes of section 1248. 

(iii) Subsequent Disposition. Assume, 

subsequent to the exchange, US1 disposes of 

20 shares of FS stock. On or before the date 

of the disposition when the basis of the F1 

shares received by US1 becomes relevant, 

US1 can designate the 20 shares from the first 

block, the second block, or from any 

combination of shares in both blocks.

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

as in Example 1, except that US1 receives 50 

shares of FP stock (instead of FS stock) with 

a value of $1,000x in exchange for its FT 

stock. Accordingly, the merger of FT into FS 

qualifies as forward triangular merger, and 

immediately after the exchange US1 is a 

section 1248 shareholder with respect to FP 

and FS. Additionally, prior to the 

transaction, FP owned two blocks of FS 

stock. Each block consisted of 10 shares with 

a value of $200x ($20x per share). The shares 

in the first block had a basis of $50x ($5x per 

share), a holding period of 10 years, and $50x 

($5x per share) of earnings and profits 

attributable to such shares for purposes of 

section 1248. The shares in the second block 

had a basis of $100x ($10x per share), a 

holding period of 5 years, and $20x ($2x per 

share) of earnings and profits attributable to 

such shares for purposes of section 1248. 

(ii) Basis and holding period 

determination. (A) The basis and holding 

period of the FP shares received by US1 in 

the exchange are determined pursuant to 

paragraph (b) of this section and are identical 

to the results in Example 1. 

(B)(1) US1 is a section 1248 shareholder of 

FT immediately before the transaction. 

Moreover, US1 is not required to include 

income under § 1.367(b)–3(b) or 1.367(b)–4(b) 

as described in paragraph (c)(2) of this 

section. Accordingly, the basis and holding 

period of the FS stock held by FP 

immediately after the triangular 

reorganization is determined pursuant to 

paragraph (c) of this section.

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 765

(2) Pursuant to paragraph (c) of this 

section, each share of FS stock is divided into 

portions attributable to the basis and holding 

period of the FS stock held by FP 

immediately before the exchange (the FS 

portion) and the FT stock held by US1 

immediately before the exchange (the FT 

portion). The basis and holding period of the 

FS portion is the basis and holding period of 

the FS stock held by FP immediately before 

the exchange. Thus, each share of FS stock 

in the first block has a portion with a basis 

of $5x, a value of $20x, a holding period of 

10 years, and $5x of earnings and profits 

attributable to such portion for purposes of 

section 1248. Each share of FS stock in the 

second block has a portion with a basis of 

$10x, a value of $20x, a holding period of 5 

years, and $2x of earnings and profits 

attributable to such portion for purposes of 

section 1248. 

(3) Because the exchanging shareholder of 

FT stock (US1) is a section 1248 shareholder, 

the holding period and basis of the FT 

portion is the holding period and the 

proportionate amount of the basis of the FT 

stock immediately before the exchange to 

which such portion relates. Further, because 

US1 exchanged two blocks of FT stock, the 

FT portion must be divided into two separate 

portions attributable to the two blocks of FT 

stock. Thus, each share of FS stock will have 

a second portion with a basis of $15x ($300x 

basis / 20 shares), a value of $30x ($600x 

value / 20 shares), a holding period of 10 

years, and $12x of earnings and profits 

($240x / 20 shares) attributable to such 

portion for purposes of section 1248. Each 

share of FS stock will have a third portion 

with a basis of $30x ($600x basis / 20 shares), 

a value of $20x ($400x value / 20 shares), a 

holding period of 2 years, and $4x of 

earnings and profits ($80x / 20 shares) 

attributable to such portion for purposes of 

section 1248. 

(iii) Assume, immediately after the 

transaction, FP disposes of a share of FS 

stock from the first block. When FP disposes 

of any share of its FS stock, it is treated as 

disposing of each divided portion of such 

share. With respect to the first portion 

(attributable to the FS stock), FP recognizes 

a gain of $15x ($20x value¥$5x basis), $5x 

of which is treated as a dividend under 

section 1248. With respect to the second 

portion (attributable to the first block of FT 

stock), FP recognizes a gain of $15x ($30x 

value¥$15x basis), $12x of which is treated 

as a dividend under section 1248. With 

respect to the third portion (attributable to 

the second block of FT stock), FP recognizes 

a capital loss of $10x ($20x value¥$30x 

basis). 

(iv) Assume further, immediately after the 

transaction, FP also disposes of a share of 

stock from the second block of FS stock. With 

respect to the first portion (attributable to the 

FS stock), FP recognizes a gain of $10x ($20x 

value¥$10x basis), $2x of which is treated as 

a dividend under section 1248. With respect 

to the second portion (attributable to the first 

block of FT stock), FP recognizes a gain of 

$15x ($30x value¥$15x basis), $12x of 

which is treated as a dividend under section 

1248. With respect to the third portion 

(attributable to the second block of FT stock), 

FP recognizes a capital loss of $10x ($20x 

value¥$30x basis). 

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

same as in Example 2, except that FS merges 

into FT with FT surviving in a reverse 

triangular merger. Pursuant to the merger, 

US1 receives FP stock with a value of 

$1,000x in exchange for its FT stock, and FP 

receives 10 shares of FT stock with a value 

of $1,400x in exchange for its FS stock. 

Immediately after the exchange, US1 is a 

section 1248 shareholder with respect to FP 

and FT. 

(ii) Basis and holding period 

determination—(A) The basis and holding 

period of the FP shares received by US1 and 

the stock of the surviving corporation held by 

FP are the same as in Example 2, except that 

each share of the surviving corporation (FT, 

instead of FS) will be divided into four 

portions instead of three portions. Because 

FP exchanges two blocks of FS stock, the FS 

portion must be divided into two separate 

portions attributable to the two blocks of FS 

stock. Because US1 exchanges two blocks of 

FT stock, the FT portion must be divided into 

two separate portions attributable to the two 

blocks of FT stock. 

(B) Thus, each share of the surviving 

corporation (FT) will have a first portion 

(attributable to the first block of FS stock) 

with a basis of $5x ($50x / 10 shares), a value 

of $20x ($200x / 10 shares), a holding period 

of 10 years, and $5x of earnings and profits 

($50x / 10 shares) attributable to such portion 

for purposes of section 1248. Each share of 

FT stock will have a second portion 

(attributable to the second block of FS stock) 

with a basis of $10x ($100x / 10 shares), a 

value of $20x ($200x / 10 shares), a holding 

period of 5 years, and $2x of earnings and 

profits ($20x / 10 shares) attributable to such 

portion for purposes of section 1248. 

Moreover, each share of FT stock will have 

a third portion (attributable to the first block 

of FT stock) with a basis of $30x ($300x basis 

/ 10 shares), a value of $60x ($600x value / 

10 shares), a holding period of 10 years, and 

$24x of earnings and profits ($240x / 10 

shares) attributable to such portion for 

purposes of section 1248. Lastly, each share 

of FT stock will have a fourth portion 

(attributable to the second block of FT stock) 

with a basis of $60x ($600x basis / 10 shares), 

a value of $40x ($400x value / 10 shares), a 

holding period of 2 years, and $8x of 

earnings and profits ($80x / 10 shares) 

attributable to such portion for purposes of 

section 1248. 

Example 3. (i) Facts. USP, a domestic 

corporation, owns all the stock of FS, a 

foreign corporation with 10 shares of stock 

outstanding. Each share of FS stock has a 

value of $10x, a basis of $5x, a holding 

period of 10 years, and $7x of earnings and 

profits attributable to such share for purposes 

of section 1248. FP, a foreign corporation, 

owns the stock of FT, another foreign 

corporation. FP and FT do not have any 

section 1248 shareholders. FT has assets with 

a value of $100x, a basis of $50x, and no 

liabilities. The FT stock held by FP has a 

value of $100x and a basis of $75x. FT 

merges into FS with FS surviving in a 

forward triangular merger. Pursuant to the 

reorganization, FP receives USP stock with a 

value of $100x in exchange for its FT stock. 

(ii) Basis and holding period 

determination—(A) Because USP is a section 

1248 shareholder of FS immediately before 

the transaction, the basis and holding period 

of the FS stock held by USP immediately 

after the triangular reorganization is 

determined pursuant to paragraph (c) of this 

section. 

(B) Pursuant to paragraph (c) of this 

section, each share of FS stock is divided into 

portions attributable to the basis and holding 

period of the FS stock held by USP 

immediately before the exchange (the FS 

portion) and the basis of FT’s net assets (the 

FT portion) immediately before the exchange. 

The basis of FT’s net assets (and not FT 

stock) is used to determine the FT portion 

because FT does not have a section 1248 

shareholder immediately before the 

transaction. As a result, the rules of § 1.358–

6(c) apply to determine the basis of the FT 

portion of each share of FS stock. The basis 

and holding period of the FS portion is the 

basis and holding period of the FS stock held 

by USP immediately before the exchange. 

Thus, each share of FS stock has a portion 

with a basis of $5x, a value of $10x, and a 

holding period of 10 years. The basis of the 

FT portion is the basis of the FT assets to 

which such portion relates. Thus, each share 

of FS stock has a second portion with a basis 

of $5x ($50x basis in FT’s assets / 10 shares) 

and a value of $10x ($100x value of FT’s 

assets / 10 shares). All of FS’s earnings and 

profits prior to the transaction ($70x) is 

attributed solely to the FS portion in each 

share of FS stock. The FS portion of each 

share of FS stock has earnings and profits of 

$7x ($70x / 10 shares) attributable to such 

portion for purposes of section 1248. As a 

result of each share of stock being divided 

into portions, the basis of the FS stock is not 

averaged with the basis of the FT assets to 

increase the section 1248 amount with 

respect to the stock of the surviving 

corporation (FS). 

Example 4. (i) Facts. US, a domestic 

corporation, owns all of the stock of FT, a 

foreign corporation. The FT stock held by US 

constitutes a single block of stock with a 

value of $1,000x, a basis of $600x, and 

holding period of 5 years. USP, a domestic 

corporation, forms FS, a foreign corporation, 

pursuant to the plan of reorganization and 

capitalizes it with $10x of cash. FS merges 

into FT with FT surviving in a reverse 

triangular merger and a reorganization 

described in section 368(a)(1)(B). Pursuant to 

the reorganization, US receives USP stock 

with a value of $1,000x in exchange for its 

FT stock, and USP receives 10 shares of FT 

stock with a value of $1,010x in exchange for 

its FS stock. 

(ii) Basis and holding period 

determination. (A) U.S. and USP are section 

1248 shareholders of FT and FS, respectively, 

immediately before the transaction. Neither 

US nor USP is required to include income 

under § 1.367(b)–3(b) or 1.367(b)–4(b) as 

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

The basis and holding period of the FT stock 

held by USP is determined pursuant to 

paragraph (c) of this section.

(B) Pursuant to paragraph (c) of this 

section, because the exchanging shareholder 

of FT stock (US) is a section 1248

766 Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 

shareholder of FT, each share of the 

surviving corporation (FT) has a 

proportionate amount of the basis and 

holding period of the FT stock immediately 

before the exchange to which such share 

relates. Thus, the portion of each share of FT 

stock attributable to the FT stock has a basis 

of $60x ($600x basis / 10 shares), a value of 

$100x ($1,000x value / 10 shares), and a 

holding period of 5 years. Because the value 

of FS stock immediately before the triangular 

reorganization ($10x) is less than one percent 

of the value of the surviving corporation (FT) 

immediately after the triangular 

reorganization ($1,010x), USP may determine 

its basis in the stock of the surviving 

corporation (FT) by increasing the basis of 

each share of FT stock by the proportionate 

amount of USP’s aggregate basis in the FS 

stock immediately before the exchange 

(without dividing each share of FT stock into 

separate portions to account for FS and FT). 

If USP so elects, USP’s basis in each share 

of FT stock is increased by $1x ($10x basis 

in FS stock / 10 shares). As a result, each 

share of FT stock has a basis of $61x, a value 

of $101x, and a holding period of 5 years. 

Example 5. (i) Facts. U.S., a domestic 

corporation, owns all of the stock of FT, a 

foreign corporation. The FT stock held by 

U.S. constitutes one block of stock with a 

basis of $170x, a value of $200x, a holding 

period of 5 years, and $10x of earnings and 

profits attributable to such stock for purposes 

of section 1248. FP, a foreign corporation, 

owns all the stock of FS, a foreign 

corporation. FS has 10 shares of stock 

outstanding. No United States person is a 

section 1248 shareholder with respect to FP 

or FS. The FS stock held by FP has a value 

of $100x and a basis of $50x ($5x per share). 

FT merges into FS with FS surviving in a 

forward triangular merger. Pursuant to the 

merger, U.S. receives FP stock with a value 

of $200x for its FT stock in an exchange that 

qualifies for non-recognition under section 

354. FP is a controlled foreign corporation 

and U.S. is a section 1248 shareholder with 

respect to FP and FS immediately after the 

exchange. 

(ii) Basis and holding period 

determination. (A) Because U.S. is a section 

1248 shareholder of FT immediately before 

the transaction, and U.S. is not required to 

include income under §§ 1.367(b)–3(b) and 

1.367(b)–4(b) as described in paragraph (c)(2) 

of this section, the basis and holding period 

of the FS stock held by FP immediately after 

the triangular reorganization is determined 

pursuant to paragraph (c) of this section. 

(B) Pursuant to paragraph (c) of this 

section, each share of FS stock is divided into 

portions attributable to the basis and holding 

period of the FS stock held by FP 

immediately before the exchange (the FS 

portion) and the FT stock held by U.S. 

immediately before the exchange (the FT 

portion). The basis and holding period of the 

FS portion is the basis and holding period of 

the FS stock held by FP immediately before 

the exchange. Thus, each share of FS stock 

has a portion with a basis of $5x and a value 

of $10x. Because the exchanging shareholder 

of FT stock (U.S.) is a section 1248 

shareholder of FT, the basis and holding 

period of the FT portion is the proportionate 

amount of the basis and the holding period 

of the FT stock immediately before the 

exchange to which such portion relates. 

Thus, each share of FS stock will have a 

second portion with a basis of $17x ($170x 

basis/10 shares), a value of $20x ($200x 

value/10 shares), a holding period of 5 years, 

and $1x of earnings and profits ($10x 

earnings and profits/10 shares) attributable to 

such portion for purposes of section 1248. 

(iii) Subsequent disposition. (A) Several 

years after the merger, FP disposes of all of 

its FS stock in a transaction governed by 

section 964(e). At the time of the disposition, 

FS stock has decreased in value to $210x (a 

post-merger reduction in value of $90x), and 

FS has incurred a post-merger deficit in 

earnings and profits of $30x. 

(B) Pursuant to paragraph (d)(1)(ii) of this 

section, for purposes of determining the 

amount of gain realized on the sale or 

exchange of stock that has a divided portion, 

any amount realized on such sale or 

exchange is allocated to each divided portion 

of the stock based on the relative fair market 

value of the stock to which the portion is 

attributable at the time the portions were 

created. Immediately before the merger, the 

value of the FS stock in relation to the value 

of both the FS stock and the FT stock was 

one-third ($100x/($100x plus $200x)). 

Likewise, immediately before the merger, the 

value of the FT stock in relation to the value 

of both the FT stock and the FS stock was 

two-thirds ($200x/$100x plus $200x). 

Accordingly, one-third of the $210x amount 

realized is allocated to the FS portion of each 

share and two-thirds to the FT portion of 

each share. Thus, the amount realized 

allocated to the FS portion of each share is 

$7x (one-third of $210x divided by 10 

shares). The amount realized allocated to the 

FT portion of each share is $14x (two-thirds 

of $210x divided by 10 shares). 

(C) Pursuant to paragraph (d)(3) of this 

section, any earnings and profits (or deficits) 

accumulated by the surviving corporation 

subsequent to the reorganization are 

attributed to the divided portions of shares of 

stock based on the relative fair market value 

of each divided portion of stock. 

Accordingly, one-third of the post-merger 

earnings and profits deficit of $30x is 

allocated to the FS portion of each share and 

two-thirds to the FT portion of each share. 

Thus, the deficit in earnings and profits 

allocated to the FS portion of each share is 

$1x (one-third of $30x divided by 10 shares). 

The deficit in earnings and profits allocated 

to the FT portion of each share is $2x (twothirds of $30x divided by 10 shares). 

(D) When FP disposes of its FS stock, FP 

is treated as disposing of each divided 

portion of a share of stock. With respect to 

the FS portion of each share of stock, FP 

recognizes a gain of $2x ($7x value¥$5x 

basis), which is not recharacterized as a 

dividend because a deficit in earnings and 

profits of $1x is attributable to such portion 

for purposes of section 1248. With respect to 

the FT portion of each share of stock, FP 

recognizes a loss of $3x ($14x value¥$17x 

basis).

(e) Effective date. This section applies 

to exchanges occurring after the date 

these regulations are published as final 

regulations in the Federal Register. 

Par. 11. Section 1.884–2 is amended 

as follows: 

1. Paragraphs (c)(3) through 

(c)(6)(i)(A) are revised. 

2. Paragraphs (c)(6)(i)(B), (C), and (D) 

are added. 

3. Paragraphs (c)(6)(ii) through (f) are 

revised.

4. Paragraph (g) is amended by adding 

a sentence at the end. 

The revisions and additions read as 

follows:

§ 1.884–2 Special rules for termination or 

incorporation of a U.S. trade or business or 

liquidation or reorganization of a foreign 

corporation or its domestic subsidiary.

* * * * *

(c)(3) through (c)(6)(i)(A) [Reserved]. 

For further guidance, see § 1.884–

2T(c)(3) through (c)(6)(i)(A). 

(c)(6)(i)(B) Shareholders of the 

transferee (or of the transferee’s parent 

in the case of a triangular reorganization 

described in section 368(a)(1)(C) or a 

reorganization described in sections 

368(a)(1)(A) and 368(a)(2)(D) or (E)) who 

in the aggregate owned more than 25 

percent of the value of the stock of the 

transferor at any time within the 12-

month period preceding the close of the 

year in which the section 381(a) 

transaction occurs sell, exchange or 

otherwise dispose of their stock or 

securities in the transferee at any time 

during a period of three years from the 

close of the taxable year in which the 

section 381(a) transaction occurs. 

(c)(6)(i)(C) In the case of a triangular 

reorganization described in section 

368(a)(1)(C) or a reorganization 

described in sections 368(a)(1)(A) and 

368(a)(2)(D) or (E), the transferee’s 

parent sells, exchanges, or otherwise 

disposes of its stock or securities in the 

transferee at any time during a period of 

three years from the close of the taxable 

year in which the section 381(a) 

transaction occurs. 

(c)(6)(i)(D) A corporation related to 

any such shareholder or the shareholder 

itself if it is a corporation (subsequent 

to an event described in paragraph 

(c)(6)(i)(A) or (B) of this section) or the 

transferee’s parent (subsequent to an 

event described in paragraph (c)(6)(i)(C) 

of this section), uses, directly or 

indirectly, the proceeds or property 

received in such sale, exchange or 

disposition, or property attributable 

thereto, in the conduct of a trade or 

business in the United States at any 

time during a period of three years from 

the date of sale in the case of a 

disposition of stock in the transferor, or 

from the close of the taxable year in 

which the section 381(a) transaction

Federal Register / Vol. 70, No. 3 / Wednesday, January 5, 2005 / Proposed Rules 767

occurs in the case of a disposition of the 

stock or securities in the transferee (or 

the transferee’s parent in the case of a 

triangular reorganization described in 

section 368(a)(1)(C) or a reorganization 

described in sections 368(a)(1)(A) and 

(a)(2)(D) or (E)). Where this paragraph 

(c)(6)(i) applies, the transferor’s branch 

profits tax liability for the taxable year 

in which the section 381(a) transaction 

occurs shall be determined under 

§ 1.884–1, taking into account all the 

adjustments in U.S. net equity that 

result from the transfer of U.S. assets 

and liabilities to the transferee pursuant 

to the section 381(a) transaction, 

without regard to any provisions in this 

paragraph (c). If an event described in 

paragraph (c)(6)(i)(A), (B), or (C) of this 

section occurs after the close of the 

taxable year in which the section 381(a) 

transaction occurs, and if additional 

branch profits tax is required to be paid 

by reason of the application of this 

paragraph (c)(6)(i), then interest must be 

paid on that amount at the 

underpayment rates determined under 

section 6621(a)(2), with respect to the 

period between the date that was 

prescribed for filing the transferor’s 

income tax return for the year in which 

the section 381(a) transaction occurs 

and the date on which the additional tax 

for that year is paid. Any such 

additional tax liability together with 

interest thereon shall be the liability of 

the transferee within the meaning of 

section 6901 pursuant to section 6901 

and the regulations thereunder. 

(c)(6)(ii) through (f) [Reserved]. For 

further guidance, see § 1.884–2T(c)(6)(ii) 

through (f). 

(g) * * * Paragraphs (c)(6)(i)(B), (C), 

and (D), are applicable for tax years 

beginning after December 31, 1986, 

except that such paragraphs are 

applicable to transactions occurring 

after the date these regulations are 

published as final regulations in the 

Federal Register in the case of 

reorganizations described in sections 

368(a)(1)(A) and 368(a)(2)(D) or (E). 

Par. 12. In § 1.884–2T, paragraphs 

(c)(6)(i)(B), (C), and (D) are revised to 

read as follows:

§ 1.884–2T Special rules for termination or 

incorporation of a U.S. trade or business or 

liquidation or reorganization of a foreign 

corporation or its domestic subsidiary 

(Temporary).

* * * * *

(c) * * *

(6) * * *

(i) * * *

(B), (C), and (D) [Reserved]. For 

further guidance, see § 1.884–

2(c)(6)(i)(B), (C), and (D).

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement.

[FR Doc. 05–201 Filed 1–4–05; 8:45 am] 

BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service 

26 CFR Part 31

[REG–152945–04] 

RIN 1545–BD96

Flat Rate Supplemental Wage 

Withholding

AGENCY: Internal Revenue Service (IRS), 

Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains 

proposed regulations amending the 

regulations that provide for the flat rate 

of withholding applicable to calculating 

the amount of income tax withholding 

on supplemental wages. The proposed 

amendment to the regulations reflects 

changes in the law made by the Revenue 

Reconciliation Act of 1993, the 

Economic Growth and Tax Relief 

Reconciliation Act of 2001, the Jobs and 

Growth Tax Relief Reconciliation Act of 

2003, and the American Jobs Creation 

Act of 2004. Under the American Jobs 

Creation Act of 2004, the optional flat 

rate for withholding on supplemental 

wages will generally remain at 25 

percent for payments made after 

December 31, 2004, but may change if 

income tax rates change. However, the 

2004 Act also provides that, after 2004, 

if an employee receives supplemental 

wages in excess of one million dollars 

from an employer in a calendar year, the 

excess of the supplemental wages over 

one million dollars is subject to 

mandatory income tax withholding at 

the highest income tax rate. The highest 

income tax rate is currently 35 percent. 

In determining whether an employer 

has reached the one million dollar 

threshold for an employee, 

supplemental wage payments from all 

businesses under common control and 

from agents will be taken into account.

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by April 5, 2005.

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–152945–04), room 

5203, Internal Revenue Service, PO Box 

7604, Ben Franklin Station, Washington, 

DC 20044. Submission may be handdelivered Monday through Friday 

between the hours of 8 a.m. and 4 p.m. 

to CC:PA:LPD:PR (REG–152945–04), 

Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC or sent 

electronically, via the IRS Internet site 

at http://www.irs.gov/regs or via the 

Federal eRulemaking Portal at http://

www.regulations.gov (IRS and REG–

152945–04).

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations, A. 

G. Kelley, (202) 622–6040; concerning 

submission of comments, Treena 

Garrett, (202) 622–3401 (not toll-free 

numbers).

SUPPLEMENTARY INFORMATION: 

Background 

The Employment Tax Regulations 

distinguish between regular wages paid 

for a payroll period and supplemental 

wages for purposes of income tax 

withholding. Although the regulations 

do not give a comprehensive definition 

of the term ‘‘supplemental wages,’’ the 

regulations provide that supplemental 

wages include ‘‘* * * bonuses, 

commissions, and overtime pay, paid 

for the same or a different period, or 

without regard to a particular period.’’

Regulations and revenue rulings have 

provided other examples. See 

§ 31.3401(a)–1(b)(8)(i)(b)(2) of the 

regulations (sick pay paid by an agent of 

the employer); § 31.3401(a)–4(c) of the 

regulations (wages paid under 

reimbursement and other expense 

allowance arrangements); Rev. Rul. 67–

257)1967–2 C.B. 359) (income 

recognized on exercise of nonqualified 

stock option); Rev. Rul. 67–131 (1967–

1 C.B. 291) (lump sum payment of 

accumulated annual leave); and Rev. 

Rul. 66–294 (1966–2 C.B. 459) (lump 

sum vacation payment, overtime pay, 

lump sum retroactive pay, sick pay paid 

separately from regular pay). 

Section 31.3402(g)–1 of the 

regulations provides the current rules 

for withholding income tax from a 

payment of supplemental wages. Two 

procedures have been generally 

available to the employer with respect 

to such supplemental wage payments. 

Under the first procedure (the aggregate 

procedure), employers calculate the 

amount of withholding due by 

aggregating the amount of supplemental 

wages with the regular wages paid for 

the current payroll period or for the 

most recent payroll period this year, and 

treating the aggregate as if it were a 

single wage payment for the regular 

payroll period.