27920 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

the Center for Veterinary Medicine, 21 

CFR part 558 is amended as follows: 

PART 558—NEW ANIMAL DRUGS FOR 

USE IN ANIMAL FEEDS 

■ 1. The authority citation for 21 CFR 

part 558 continues to read as follows: 

Authority: 21 U.S.C. 360b, 371. 

■ 2. In § 558.128, in the table in 

paragraph (e)(2)(iii), in the ‘‘Indications 

for use’’ column, remove ‘‘meleagrides’’ 

and in its place add ‘‘meleagridis’’; and 

revise paragraphs (e)(4)(iv), (e)(4)(v), 

and (e)(4)(ix) to read as follows: 

§ 558.128 Chlortetracycline. 

* * * * * 

(e) * * * 

(4) * * * 

Chlortetracycline amount Indications for use Limitations Sponsor 

* * * * * * * 

(iv) 10 mg/lb of body weight daily ............. 1. Calves, beef and nonlactating dairy 

cattle; treatment of bacterial enteritis 

caused by E. coli and bacterial pneumonia caused by P. multocida organisms susceptible to chlortetracycline. 

Feed approximately 400 g/ton, varying 

with body weight and feed consumption 

to provide 10 mg/lb per day. Treat for 

not more than 5 d; in feed including 

milk replacers; withdraw 10 d prior to 

slaughter. To sponsor No. 048164: 

zero withdrawal time. See paragraph 

(d)(1) of this section. 

012286, 

048164, 

066104. 

2. Calves (up to 250 lb): For the treatment of bacterial enteritis caused by E. 

coli susceptible to chlortetracycline. 

See paragraph (d)(1) of this section. 012286, 

046573, 

048164, 

066104. 

(v) 500 to 4,000 g/ton ............................... Calves, beef and nonlactating dairy cattle; treatment of bacterial enteritis 

caused by E. coli and bacterial pneumonia caused by P. multocida organisms susceptible to chlortetracycline. 

Feed continuously for not more than 5 

days to provide 10 mg/lb body weight 

per day. To sponsor No. 046573 under 

NADA 046–699: 24-h withdrawal time. 

To sponsor No. 046573 under NADA 

048–761: zero withdrawal time. 

046573. 

* * * * * * * 

(ix) 350 mg/head/day ................................ 1. Beef cattle: For control of bacterial 

pneumonia associated with shipping 

fever complex caused by Pasteurella 

spp. susceptible to chlortetracycline. 

Withdraw 48 h prior to slaughter. To 

sponsor No. 046573 under NADA 046– 

699: 48-h withdrawal time. To sponsor 

No. 046573 under NADA 048–761 and 

No. 048164: zero withdrawal time. 

012286, 

046573, 

048164, 

066104. 

2. Beef cattle (under 700 lb): For control 

of active infection of anaplasmosis 

caused by A. marginale susceptible to 

chlortetracycline. 

Withdraw 48 h prior to slaughter. To 

sponsor No. 046573 under NADA 046– 

699: 48-h withdrawal time. To sponsor 

No. 046573 under NADA 048–761 and 

No. 048164: zero withdrawal time. 

012286, 

046573, 

048164, 

066104. 

* * * * * 

Dated: June 8, 2009. 

Bernadette Dunham, 

Director, Center for Veterinary Medicine. 

[FR Doc. E9–13849 Filed 6–11–09; 8:45 am] 

BILLING CODE 4160–01–S 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9453] 

RIN 1545–BI81 

Guidance Under Section 7874 

Regarding Surrogate Foreign 

Corporations 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final and temporary 

regulations. 

SUMMARY: This document contains final 

and temporary regulations under section 

7874 of the Internal Revenue Code 

(Code) concerning the determination of 

whether a foreign corporation shall be 

treated as a surrogate foreign 

corporation. The temporary regulations 

primarily affect domestic corporations 

or partnerships (and certain parties 

related thereto), and certain foreign 

corporations that acquire substantially 

all of the properties of such domestic 

corporations or partnerships. The text of 

these temporary regulations serves as 

the text of the proposed regulations set 

forth in the notice of proposed 

rulemaking on this subject also 

published in this issue of the Federal 

Register. 

DATES: Effective Dates: The regulations 

are effective on June 12, 2009. 

Applicability Date: For dates of 

applicability, see §§ 1.7874–1T(g) and 

1.7874–2T(o). 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27921 

FOR FURTHER INFORMATION CONTACT: S. 

James Hawes, (202) 622–3860 (not a tollfree number). 

SUPPLEMENTARY INFORMATION: 

Background 

A foreign corporation is generally 

treated as a surrogate foreign 

corporation under section 7874(a)(2)(B) 

if pursuant to a plan (or a series of 

related transactions) three conditions 

are satisfied. First, the foreign 

corporation completes after March 4, 

2003, the direct or indirect acquisition 

of substantially all of the properties held 

directly or indirectly by a domestic 

corporation. Second, after the 

acquisition at least 60 percent of the 

stock (by vote or value) of the foreign 

corporation is held by former 

shareholders of the domestic 

corporation by reason of holding stock 

in the domestic corporation. Third, after 

the acquisition the expanded affiliated 

group (defined in section 7874(c)(1)) 

that includes the foreign corporation 

does not have substantial business 

activities in the foreign country in 

which, or under the law of which, the 

foreign corporation is created or 

organized, when compared to the total 

business activities of the expanded 

affiliated group. Similar provisions 

apply to transactions involving the 

acquisition by a foreign corporation of 

substantially all of the properties 

constituting a trade or business of a 

domestic partnership. The level of 

ownership in the surrogate foreign 

corporation by former shareholders of 

the domestic corporation (or former 

partners in the domestic partnership) 

determines the treatment of the 

transaction. Compare sections 7874(a)(1) 

and 7874(b). 

Temporary regulations (TD 9265) 

were published in the Federal Register 

(71 FR 32437) on June 6, 2006, 

concerning the treatment of a foreign 

corporation as a surrogate foreign 

corporation (2006 temporary 

regulations). A notice of proposed 

rulemaking (REG–112994–06) crossreferencing the temporary regulations 

was published in the same issue of the 

Federal Register (71 FR 32495). On July 

28, 2006, Notice 2006–70 (2006–2 CB 

252), (see § 601.601(d)(2)(ii)(b)) was 

published, announcing that the effective 

date in § 1.7874–2T(j) would be 

amended for certain acquisitions 

initiated prior to December 28, 2005. No 

public hearing was requested or held; 

however, comments were received. 

After consideration of the comments, 

the 2006 temporary regulations and the 

related notice of proposed rulemaking 

are withdrawn and replaced with new 

temporary regulations and a new notice 

of proposed rulemaking. These new 

temporary regulations are discussed in 

this preamble. 

Summary of Temporary Regulations 

A. Stock Held by a Partnership 

Section 1.7874–1T(b), as contained in 

26 CFR part 1 revised as of April 1, 

2008, provided that, for purposes of 

section 7874(c)(2)(A), stock held by a 

partnership shall be considered as held 

proportionately by the partners of the 

partnership. Final regulations published 

in the Federal Register (73 FR 29054– 

29058) on May 20, 2008 (2008 final 

regulations) modified this provision to 

apply for all purposes of section 7874. 

See § 1.7874–1(e). By its terms, 

§ 1.7874–1(e) applies only to stock held 

by a partnership, not to all properties 

held by the partnership. 

Commentators have questioned the 

scope of § 1.7874–1(e). In response to 

these comments, the temporary 

regulations modify the rule to apply 

only for purposes of determining 

whether the ownership condition of 

section 7874(a)(2)(B)(ii) is satisfied. The 

temporary regulations provide other 

partnership look-through rules, as 

appropriate. See, for example, the 

discussion in section F.4. of this 

preamble concerning the partnership 

items that are taken into account for 

purposes of section 7874(a)(2)(B)(iii). 

B. Indirect Acquisition of Properties 

1. Clarification of Temporary 

Regulations 

The 2006 temporary regulations 

identify certain acquisitions that 

constitute indirect acquisitions of 

properties held by a domestic 

corporation. See § 1.7874–2T(b). The 

temporary regulations retain these rules 

and clarify that the identified 

transactions do not represent an 

exclusive list of transactions that 

constitute indirect acquisitions. The 

temporary regulations also clarify that 

the acquisition of an interest in a 

partnership is an indirect acquisition of 

a proportionate amount of the properties 

of the partnership for purposes of 

section 7874(a)(2)(B)(i). 

2. Certain Acquisitions by Members of 

the Expanded Affiliated Group 

The 2006 temporary regulations 

provide that if a corporation (acquiring 

corporation) acquires stock or assets of 

a domestic corporation in exchange for 

stock of a foreign corporation (foreign 

issuing corporation) that directly or 

indirectly owns more than 50 percent of 

the stock (by vote or value) of the 

acquiring corporation after the 

acquisition, the foreign issuing 

corporation shall be treated as acquiring 

a proportionate amount of the stock or 

assets of the domestic corporation. 

§ 1.7874–2T(b)(4). 

The temporary regulations retain this 

rule, with modifications. First, the rule 

is modified to apply if the acquiring 

corporation and the foreign issuing 

corporation are members of the same 

expanded affiliated group after the 

acquisition. Second, the rule is modified 

to apply to an acquisition of properties 

of a partnership. Finally, the rule is 

modified to apply if a partnership 

acquires properties of a domestic 

corporation (or partnership) in exchange 

for stock of a foreign issuing 

corporation, but only if the foreign 

issuing corporation and the partnership 

would be members of the same 

expanded affiliated group after the 

acquisition if the partnership were a 

corporation. 

C. Acquisitions by Multiple Foreign 

Corporations 

The IRS and the Treasury Department 

have become aware of transactions 

intended to avoid section 7874 that 

involve two or more foreign 

corporations completing, in the 

aggregate, an acquisition described in 

section 7874(a)(2)(B)(i). For example, 

pursuant to a plan (or a series of related 

transactions), two foreign corporations 

would collectively acquire substantially 

all of the properties held by a domestic 

corporation. Taxpayers may take the 

position that neither foreign corporation 

is a surrogate foreign corporation 

because no foreign corporation 

separately acquires substantially all of 

the properties held by the domestic 

corporation. Taxpayers may also take 

the position that section 7874(c)(4) does 

not apply to these transactions. 

Even if substantially all of the 

properties held by a domestic 

corporation (or constituting a trade or 

business of a domestic partnership) are 

not acquired by a single foreign 

corporation, this type of transaction 

presents the policy concerns that 

prompted the enactment of section 

7874. Accordingly, the temporary 

regulations provide that, if pursuant to 

a plan (or a series of related 

transactions) two or more foreign 

corporations complete, in the aggregate, 

an acquisition described in section 

7874(a)(2)(B)(i), then each foreign 

corporation shall be treated as 

completing the acquisition for purposes 

of determining whether such foreign 

corporation shall be treated as a 

surrogate foreign corporation. See also 

section 7874(c)(4). 

27922 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

D. Acquisition of Multiple Domestic 

Corporations (or Partnerships) 

The preamble to the 2008 final 

regulations identifies another 

transaction intended to avoid section 

7874 that involves a single foreign 

corporation completing more than one 

acquisition described in section 

7874(a)(2)(B)(i) as part of the same plan 

(or a series of related transactions). The 

preamble to the 2008 final regulations 

explains that the IRS and the Treasury 

Department disagree with the 

characterization of this type of 

transaction for purposes of section 7874 

under current law and are considering 

issuing regulations clarifying the 

application of section 7874 to such 

transactions. In particular, the IRS and 

the Treasury Department disagree with 

the position that in determining 

whether the foreign corporation is a 

surrogate foreign corporation the 

ownership percentage under section 

7874(a)(2)(B)(ii) is determined 

separately with respect to each domestic 

corporation (or partnership). 

The preamble to the 2008 final 

regulations explains that any regulations 

issued would clarify that references in 

section 7874(a)(2)(B) to ‘‘a domestic 

corporation’’ shall, as appropriate, mean 

‘‘one or more domestic corporations’’ 

where the properties of more than one 

domestic corporation are, directly or 

indirectly, acquired by a foreign 

corporation pursuant to the same plan. 

See § 1.368–2(h). The preamble 

indicates that similar clarifications 

would be made for transactions 

involving domestic partnerships. 

The temporary regulations clarify that 

if a foreign corporation completes more 

than one acquisition described in 

section 7874(a)(2)(B)(i) pursuant to a 

plan (or a series of related transactions), 

then, for purposes of section 

7874(a)(2)(B)(ii), the acquisitions shall 

be treated as a single acquisition and the 

domestic corporations (and/or domestic 

partnerships) shall be treated as a single 

entity. This rule shall apply equally to 

transactions involving multiple 

corporations, multiple partnerships, or 

multiple corporations and partnerships. 

The IRS and the Treasury Department 

determined that providing a specific 

operative rule was preferable to simply 

stating that, for purposes of section 

7874(a)(2)(B), any reference to a single 

domestic corporation (or partnership) 

includes one or more domestic 

corporations (or partnerships). However, 

the operative rule of the temporary 

regulations is not a change from current 

law. 

E. ‘‘By Reason of’’ Standard of Section 

7874(a)(2)(B)(ii) 

1. Distributions and Other Transactions 

The 2006 temporary regulations 

provide that stock of a foreign 

corporation received by a former 

shareholder of a domestic corporation in 

exchange for stock of the domestic 

corporation is held by reason of holding 

stock in the domestic corporation. 

§ 1.7874–2T(c)(1). Commentators have 

questioned whether an exchange is the 

exclusive means by which stock of a 

foreign corporation can be held by 

reason of holding stock in the domestic 

corporation. For example, one 

commentator questioned whether stock 

of a foreign corporation received by a 

former shareholder as a distribution 

with respect to the stock of the domestic 

corporation is held by reason of holding 

stock in the domestic corporation. 

Section 7874(a)(2)(B)(ii) does not 

require stock of the foreign corporation 

to be received in exchange for stock of 

the domestic corporation (or an interest 

in the domestic partnership). Therefore, 

the temporary regulations clarify that 

the ‘‘by reason of’’ condition of section 

7874(a)(2)(B)(ii) is satisfied if stock of a 

foreign corporation is received in 

exchange for, or with respect to, stock 

in a domestic corporation (or an interest 

in a domestic partnership). This 

includes a taxable or nontaxable 

distribution. The temporary regulations 

also clarify that the ‘‘by reason of’’ 

condition may be satisfied other than 

through exchanges or distributions. 

2. Acquisitions Involving Other 

Property 

One commentator questioned whether 

all the stock of a foreign corporation 

received by a former shareholder in 

exchange for stock of a domestic 

corporation and other property could be 

treated as held by reason of holding 

stock of the domestic corporation, if the 

other property bears some relationship 

to the stock of the domestic corporation. 

In response to this comment, the 

temporary regulations clarify that, 

subject to section 7874(c)(4) and general 

tax principles, the ‘‘by reason of’’ 

standard applies based on the amount of 

stock of the foreign corporation received 

in exchange for, or with respect to, the 

stock of the domestic corporation (or 

interest in the domestic partnership). 

This determination is based on the 

relative values of the stock of the 

domestic corporation (or interest in a 

domestic partnership) and any other 

property exchanged for the stock of the 

foreign corporation. Thus, subject to 

section 7874(c)(4) and general tax 

principles, the ‘‘by reason of’’ standard 

is not affected by a relationship between 

stock of the domestic corporation (or 

interest in the domestic partnership) 

and such other property. 

F. Substantial Business Activities 

Condition of Section 7874(a)(2)(B)(iii) 

1. Removal of Safe Harbor and Examples 

The third condition for the treatment 

of a foreign corporation as a surrogate 

foreign corporation is that, after the 

acquisition, the expanded affiliated 

group (defined in section 7874(c)(1)) 

that includes the foreign corporation 

does not have substantial business 

activities in the foreign country in 

which, or under the law of which, the 

foreign corporation is created or 

organized, when compared to the total 

business activities of the expanded 

affiliated group (the substantial business 

activities condition). Section 

7874(a)(2)(B)(iii). For purposes of 

determining whether the substantial 

business activities condition is satisfied, 

the 2006 temporary regulations provide 

a general rule that, with certain 

exceptions, is based on all the facts and 

circumstances, and a safe harbor. 

§ 1.7874–2T(d)(1) through (3). The 2006 

temporary regulations also provide 

examples illustrating the application of 

the general rule. § 1.7874–2T(d)(4). 

The IRS and the Treasury Department 

have concluded that the safe harbor 

provided by the 2006 temporary 

regulations may apply to certain 

transactions that are inconsistent with 

the purposes of section 7874, which is 

meant to prevent certain transactions 

that seek to avoid U.S. tax by merely 

shifting the place of organization of a 

domestic corporation (or partnership). 

The temporary regulations, therefore, do 

not retain the safe harbor provided by 

the 2006 temporary regulations. The 

temporary regulations also do not retain 

the examples illustrating the general 

rule contained in the 2006 temporary 

regulations. Thus, taxpayers can no 

longer rely on the safe harbor or the 

examples illustrating the general rule 

provided by the 2006 temporary 

regulations. Instead, taxpayers must 

apply the general rule to determine 

whether the substantial business 

activities condition is satisfied. In 

addition, the question of whether the 

substantial business activities condition 

is satisfied will continue to be on the 

list of provisions with respect to which 

the IRS will not ordinarily issue rulings 

or determination letters. See Rev. Proc. 

2009–7 (2009–1 IRB 226), Section 

4.01(30). Comments are requested with 

respect to these changes. 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27923 

2. Sales and Services Between 

Expanded Affiliated Group Members 

The 2006 temporary regulations 

identify sales made by the expanded 

affiliated group to customers located in 

the foreign country as an item to 

consider in determining whether the 

substantial business activities condition 

is satisfied. § 1.7874–2T(d)(1)(ii)(3 ). 

Commentators have asked whether sales 

(or the performance of services) between 

expanded affiliated group members may 

be taken into account for this purpose. 

The IRS and the Treasury Department 

are concerned that sales (and the 

performance of services) between 

expanded affiliated group members can 

be structured in a manner that does not 

represent actual business activities. 

However, subject to section 7874(c)(4) 

and general tax principles, the IRS and 

the Treasury Department believe that in 

appropriate circumstances sales (or the 

performance of services) between 

members of the expanded affiliated 

group may be taken into account under 

the general rule. 

3. Items Not To Be Considered 

The 2006 temporary regulations 

identify certain assets, activities, or 

income not to be taken into account in 

determining whether the substantial 

business activities condition is satisfied. 

See § 1.7874–2T(d)(1)(iii). See also 

section 7874(c)(4). The temporary 

regulations add to these items any 

assets, business activities, or employees 

located in the foreign country in which, 

or under the law of which, the foreign 

acquiring corporation is created or 

organized if such assets, business 

activities or employees are transferred to 

another country pursuant to a plan in 

existence at the time of the acquisition. 

4. Partnership Items 

The 2006 temporary regulations 

provide that if one or more members of 

the expanded affiliated group own 

capital or profits interests in a 

partnership, the proportionate amount 

of certain items of the partnership are 

considered to be items of the member 

(or members) of the expanded affiliated 

group. § 1.7874–2T(d)(3)(iv). 

The temporary regulations retain and 

modify this provision to provide that, 

for purposes of the substantial business 

activities condition, a member of the 

expanded affiliated group that holds at 

least a 10 percent capital and profits 

interest in a partnership shall take into 

account its proportionate share of the 

items of the partnership, including 

business activities, employees, assets, 

income, and sales. 

G. Publicly Traded Foreign Partnerships 

1. Scope 

For purposes of section 7874, the 

2006 temporary regulations treat as a 

foreign corporation any foreign 

partnership that would, but for section 

7704(c), be treated as a corporation 

under section 7704 at any time during 

the two-year period following the 

completion by the foreign partnership of 

an acquisition described in section 

7874(a)(2)(B)(i). The IRS and the 

Treasury Department are concerned that 

taxpayers may be taking the position 

that the rule does not apply to a foreign 

partnership whose interests become 

publicly traded outside this two-year 

period, even if the public trading occurs 

pursuant to a plan that existed at the 

time of the acquisition. 

To address these transactions, the 

temporary regulations modify the rule to 

apply to any foreign partnership that 

would, but for section 7704(c), be 

treated as a corporation under section 

7704(a) at the time of the acquisition 

described in section 7874(a)(2)(B)(i), or 

at any time after the acquisition 

pursuant to a plan that existed at the 

time of the acquisition. For this 

purpose, a plan shall be deemed to exist 

at the time of the acquisition if the 

foreign partnership would, but for 

section 7704(c), be treated as a 

corporation under section 7704(a) at any 

time during the two-year period 

following the acquisition. 

The temporary regulations also clarify 

that a publicly traded foreign 

partnership treated as foreign 

corporation under the rule is treated as 

a foreign corporation for all purposes of 

section 7874. 

2. Implication Regarding Scope of 

Public Offering Rule 

Section 1.7874–2T(e)(5), Example 3, 

involves a publicly traded foreign 

partnership that is treated as a surrogate 

foreign corporation under section 

7874(a)(2)(B), but not as a domestic 

corporation under section 7874(b). In 

the example, the publicly traded foreign 

partnership acquires the stock of a 

domestic corporation in exchange for 75 

percent of its outstanding interests. At 

the same time as the acquisition, an 

unrelated person acquires the remaining 

25 percent interest in exchange for stock 

of a foreign corporation. The example 

concludes that the former shareholders 

of the domestic corporation hold 75 

percent of the interests in the publicly 

traded foreign partnership by reason of 

holding stock of the domestic 

corporation. Implicit in this conclusion 

is that the 25 percent interest received 

by the unrelated person in exchange for 

the stock of the foreign corporation is 

not subject to the public offering rule of 

section 7874(c)(2)(B). 

The IRS and the Treasury Department 

did not intend for this example to 

address the scope or application of the 

public offering rule of section 

7874(c)(2)(B). The temporary regulations 

modify the example to eliminate the 

implication. The IRS and the Treasury 

Department are considering issuing 

guidance concerning the public offering 

rule of section 7874(c)(2)(B). Comments 

are requested in this regard. 

H. Options and Similar Interests 

The 2006 temporary regulations 

provide that, for purposes of section 

7874(a)(2)(B)(ii), options and interests 

that are similar to options held by 

reason of holding stock in a domestic 

corporation (or an interest in a domestic 

partnership) shall be treated as 

exercised. Not addressed by the 2006 

temporary regulations, however, is the 

treatment of options (or similar 

interests) or stock in a foreign 

corporation held by reason of holding 

options (or similar interests) in a 

domestic corporation (or a partnership, 

domestic or foreign). This issue may 

arise, for example, if the holder of a 

warrant to acquire stock of the domestic 

corporation exchanges the warrant for a 

warrant to acquire stock of the foreign 

acquiring corporation. The 2006 

regulations also do not address the 

treatment of options (or similar 

interests) in a foreign corporation not 

held by reason of holding stock in a 

domestic corporation (or an interest in 

a domestic partnership). Further, the 

IRS and the Treasury Department 

believe that treating options (or similar 

interests) as exercised may, in certain 

cases, lead to inappropriate results. For 

example, treating options (or similar 

interests) as exercised may distort the 

ownership of the foreign corporation for 

purposes of section 7874(a)(2)(B)(ii). For 

these reasons, the temporary regulations 

make the following changes to the rule 

provided by the 2006 temporary 

regulations. 

1. Domestic Corporations (or 

Partnerships) 

An option (or similar interest) 

represents a claim on equity to the 

extent the value of the stock (or 

partnership interest) that may be 

acquired pursuant to the option (or 

similar interest) exceeds the exercise 

price under the terms of the option (or 

similar interest). As a result, the 

temporary regulations provide that, for 

purposes of section 7874, an option (or 

similar interest) in a domestic 

corporation (or a partnership, domestic 

27924 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

or foreign) shall be treated as stock of 

the domestic corporation (or an interest 

in the partnership) with a value equal to 

the holder’s claim on the equity of the 

domestic corporation (or partnership) 

immediately before the acquisition 

described in section 7874(a)(2)(B)(i). For 

this purpose, the equity of the domestic 

corporation (or partnership) shall not 

include the value of any property the 

holder of the option (or similar interest) 

would be required to provide to the 

domestic corporation (or partnership) 

pursuant to the terms of the option (or 

similar interest) if such option (or 

similar interest) were exercised. 

Pursuant to these rules, for example, if 

the holder of an option in a domestic 

corporation receives stock of a foreign 

corporation by reason of holding the 

option, the holder shall be treated as 

holding the stock of the foreign 

corporation by reason of holding stock 

in the domestic corporation. 

2. Foreign Corporations 

The temporary regulations further 

provide that an option (or similar 

interest) in a foreign corporation shall 

generally be treated as stock of the 

foreign corporation with a value equal 

to the holder’s claim on the equity of the 

foreign corporation immediately after 

the acquisition described in section 

7874(a)(2)(B)(i). As is the case for 

options (and similar interests) with 

respect to domestic corporations (or 

partnerships), for this purpose the 

equity of the foreign corporation shall 

not include the value of any property 

the holder of the option (or similar 

interest) would be required to provide to 

the foreign corporation pursuant to the 

terms of the option (or similar interest) 

if such option (or similar interest) were 

exercised. This rule shall not apply, 

however, if a principal purpose of the 

issuance or acquisition of an option (or 

similar interest) is to avoid the foreign 

corporation being treated as a surrogate 

foreign corporation. 

3. Multiple Claims on Equity 

The rules of the temporary regulations 

concerning options (or similar interests) 

shall not apply to the extent treating an 

option (or similar interest) as stock of a 

corporation (or an interest in a 

partnership) would duplicate, in whole 

or in part, a shareholder’s (or partner’s) 

claim on the equity of the corporation 

(or partnership). However, except to the 

extent otherwise provided in section 

7874, stock of a corporation held by a 

shareholder, or an interest in a 

partnership held by a partner, shall in 

all cases be taken into account for 

purposes of section 7874. 

4. Comments 

The IRS and the Treasury Department 

request comments on the rules provided 

by the temporary regulations concerning 

options (or similar interests). For 

example, comments are requested as to 

whether the rules should not apply to 

certain options, such as publicly traded 

options or compensatory options. 

Comments are also requested on the 

general approach of the rules, which 

treats the option (or similar interest) as 

stock or a partnership interest to the 

extent of the holder’s claim on equity, 

as compared to an approach that would 

deem the options (or similar interests) 

as exercised. Any comments should 

consider the potential impact of treating 

options (or similar interests) as 

exercised on the determination of 

ownership in the foreign corporation 

under section 7874(a)(2)(B)(ii). 

I. Economically Equivalent Interests 

The IRS and the Treasury Department 

have become aware of transactions 

intended to avoid section 7874 by using 

interests (such as stock or partnership 

interests) that, although not in form 

exchangeable or convertible into stock 

of a foreign corporation, are structured 

to be substantially equivalent to an 

equity interest in the foreign 

corporation. In one such transaction, for 

example, a privately held domestic 

corporation (UST) intends to make an 

initial public offering of its stock for 

cash. The UST shareholders, however, 

would prefer a foreign corporation to be 

the publicly-traded corporation. 

To accomplish these objectives the 

following transactions are completed. A 

newly formed foreign corporation (FC) 

issues shares to the public in exchange 

for cash and then contributes all or part 

of the cash to a newly-formed domestic 

corporation (S) in exchange for all the 

stock of S. S then merges with and into 

UST. Pursuant to the merger agreement, 

the UST shareholders exchange their 

UST stock for a new class of UST stock 

(class B stock) and cash. FC exchanges 

its S stock for all of the remaining class 

of stock of UST (class A stock). FC holds 

few assets other than the class A stock. 

The class B stock entitles the UST 

shareholders to dividend distributions 

approximately equal to any dividend 

distributions made by FC with respect 

to its publicly traded stock. The class B 

stock also permits the UST 

shareholders, in certain cases, to require 

UST to redeem the class B stock at fair 

market value. The class B stock does not 

provide the holder voting rights with 

respect to FC. 

Because FC holds few assets other 

than the class A stock of UST, the value 

of the class B stock held by the former 

UST shareholders is approximately 

equal the value of a corresponding 

amount of FC stock. Further, the 

distribution and liquidity rights 

provided by the class B stock are 

intended to place the former UST 

shareholders in the same approximate 

economic position as if they had 

received publicly traded FC stock 

instead of the class B stock in the 

merger. Nonetheless, the former UST 

shareholders may take the position that 

they hold UST stock (and not FC stock) 

by reason of holding, in form, stock in 

UST and that the 2006 temporary 

regulations do not treat the class B stock 

as FC stock. For example, the former 

UST shareholders may take the position 

that the class B stock is not, in 

substance, an instrument other than 

debt that is convertible into stock of FC. 

See § 1.7874–2T(f)(2). The former UST 

shareholders may further take the 

position that section 7874(c)(4) does not 

apply to the transaction. If these 

positions are correct, FC would not be 

treated as a surrogate foreign 

corporation. The IRS and the Treasury 

Department understand that similar 

transactions may be structured using a 

partnership. 

The IRS and the Treasury Department 

believe these transactions are contrary 

to the policies underlying section 7874. 

Therefore, the temporary regulations 

provide that, for purposes of section 

7874, any interest (including stock or a 

partnership interest) that is not 

otherwise treated as stock of a foreign 

corporation (including under the rules 

concerning options (or similar 

interests)) shall be treated as stock of the 

foreign corporation if the following two 

conditions are satisfied: (1) The interest 

entitles the holder to distribution rights 

that are substantially similar in all 

material respects to the distribution 

rights entitled to a shareholder of the 

foreign corporation by reason of holding 

stock in the foreign corporation; and (2) 

treating the interest as stock of the 

foreign corporation has the effect of 

treating the foreign corporation as a 

surrogate foreign corporation. For 

purposes of the first condition, 

distribution rights include rights to 

dividend distributions (or partnership 

distributions), distributions in 

redemption of the interest (in whole or 

in part), distributions in liquidation, or 

other similar distributions that represent 

a return on, or of, the holder’s 

investment in the interest. 

J. Insolvent Entities 

The preamble to the 2008 final 

regulations describes a transaction 

involving an insolvent domestic 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27925 

corporation in which the creditors of the 

corporation claim not to be shareholders 

of the corporation for purposes of 

determining whether a foreign 

corporation that acquires substantially 

all of the properties held by the 

domestic corporation is treated as a 

surrogate foreign corporation. As further 

stated in the preamble, the IRS and the 

Treasury Department disagree with this 

interpretation under current law. See, 

for example, Helvering v. Alabama 

Asphaltic Limestone Co., 315 U.S. 179 

(1942), and § 1.368–1(e)(6). 

The temporary regulations clarify 

that, for purposes of section 7874, if 

immediately prior to the first date 

properties are acquired as part of an 

acquisition described in section 

7874(a)(2)(B)(i), a domestic corporation 

is in a title 11 or similar case (as defined 

in section 368(a)(3)), or the liabilities of 

the domestic corporation exceed the 

value of its assets, then any claim by a 

creditor against the domestic 

corporation shall be treated as stock of 

the domestic corporation. Therefore, 

any stock of a foreign corporation held 

by a creditor of the domestic 

corporation by reason of its claim 

against the domestic corporation would 

be considered held by a former 

shareholder of the domestic corporation 

by reason of holding stock in the 

domestic corporation. 

A similar rule applies with respect to 

a domestic or foreign partnership. 

Foreign partnerships are included in 

this rule because, for purposes of 

section 7874(a)(2)(B)(ii), the acquisition 

of an interest in a foreign partnership 

that owns stock of a domestic 

corporation is considered an acquisition 

of a proportionate amount of the stock 

of domestic corporation. Therefore, if a 

foreign corporation acquired a sufficient 

interest in that foreign partnership, the 

foreign corporation could be treated as 

a surrogate foreign corporation. 

One commentator requested the 

regulations clarifying the treatment of 

creditors for purposes of section 7874 

make clear that a creditor that is treated 

as a shareholder of a domestic 

corporation is treated as a shareholder 

for all purposes of section 7874. In 

particular, the commentator requested 

the regulations make clear that the 

provisions of the 2008 final regulations 

concerning the determination of the 

stock of a foreign corporation held by 

reason of holding stock of the domestic 

corporation apply equally to such a 

creditor. The IRS and the Treasury 

Department agree with this comment. 

Accordingly, the temporary regulations 

clarify that a creditor that is treated as 

a shareholder of a domestic corporation 

(or as a partner in a partnership) is 

treated as a shareholder (or partner) for 

all purposes of section 7874. Thus, for 

example, subject to section 7874(c)(4) 

and general tax principles, stock of the 

foreign corporation received by a 

creditor in exchange for other property 

would not be taken into account in 

determining former shareholder (or 

former partner) ownership under 

section 7874(a)(2)(B)(ii). 

K. Modification to Internal Restructuring 

Exception of 2008 Final Regulations 

The IRS and the Treasury Department 

have become aware of divisive 

transactions involving an acquisition 

described in section 7874(a)(2)(B)(i) in 

which the ownership condition of 

section 7874(a)(2)(B)(ii) may not be 

satisfied by reason of the internal group 

restructuring exception provided by 

§ 1.7874–1(c)(2). For example, assume 

that a publicly-traded domestic 

corporation (USP) wholly owns a 

domestic subsidiary (S1) that in turn 

wholly owns another domestic 

subsidiary (S2). The S2 stock does not 

represent substantially all of the 

properties of S1. Pursuant to a plan, S2 

transfers substantially all of its 

properties to a newly formed foreign 

corporation (F1) in exchange for F1 

stock and then distributes the F1 stock 

to S1. Pursuant to the same plan, S1 

distributes the F1 stock to USP, and 

USP then distributes the F1 stock to its 

shareholders. 

The acquisition by F1 of substantially 

all of the properties held by S2 is 

described in section 7874(a)(2)(B)(i). In 

addition, S1, the former shareholder of 

S2, holds all the F1 stock by reason of 

holding S2 stock. However, taxpayer 

may take the position that the condition 

of section 7874(a)(2)(B)(ii) is not 

satisfied by reason of the internal group 

restructuring exception under § 1.7874– 

1(c)(2). In relevant part, the internal 

group restructuring exception provides 

that, for purposes of section 

7874(a)(2)(B)(ii), stock of the foreign 

corporation held by a member of the 

expanded affiliated group shall be 

included in the denominator, but not in 

the numerator, of the ownership 

fraction, if: (i) Before the acquisition, at 

least 80 percent of the stock (by vote 

and value) of the domestic corporation 

was held directly or indirectly by the 

corporation that is the common parent 

of the expanded affiliated group after 

the acquisition; and (ii) after the 

acquisition, at least 80 percent of the 

stock (by vote and value) of the 

acquiring foreign corporation is held 

directly or indirectly by such common 

parent. Taxpayer may take the position 

that the internal restructuring exception 

applies because before the acquisition 

USP indirectly owned 100 percent of 

the stock of S2 and after the acquisition 

USP indirectly owned 100 percent of 

the stock of F1. Therefore, the F1 stock 

held by S1 would be included in the 

denominator but not the numerator of 

the ownership fraction, yielding zero 

percent former shareholder ownership 

and resulting in F1 not being treated as 

a surrogate foreign corporation. 

The IRS and the Treasury Department 

believe it is inappropriate for the 

internal restructuring exception to apply 

to divisive transactions such as the one 

described above. Accordingly, the IRS 

and the Treasury Department will issue 

regulations that determine former 

shareholder ownership under section 

7874(a)(2)(B)(ii) when pursuant to the 

same plan (or a series of related 

transactions) that includes the 

acquisition described in section 

7874(a)(2)(B)(i), all or part of the stock 

of the foreign corporation is transferred 

outside the expanded affiliated group 

that includes the foreign corporation 

after the acquisition. The regulations 

will provide that the internal group 

restructuring exception of § 1.7874– 

1(c)(2) does not apply to such 

transactions and will also modify the 

application of the general rule of 

§ 1.7874–1(b) to such transactions. The 

regulations may apply to acquisitions 

completed on or after June 9, 2009. 

L. Effective/Applicability Dates 

The temporary regulations included 

in this document generally apply to 

acquisitions completed on or after June 

9, 2009. However, taxpayers may apply 

the temporary regulations to 

acquisitions completed prior to June 9, 

2009, if the temporary regulations are 

applied consistently to all acquisitions 

completed prior to such date. 

The temporary regulations include the 

modifications announced by Notice 

2006–70 (2006–2 CB 252) to the 

effective date paragraph of § 1.7874–2T, 

as contained in 26 CFR part 1 revised as 

of April 1, 2009, for certain acquisitions 

initiated prior to December 28, 2005. 

No inference is intended as to the 

applicability of other Code or regulatory 

provisions, or judicial doctrines, to any 

transactions described in this preamble. 

These regulations will expire on or 

before June 8, 2012. 

Effect on Other Documents 

Notice 2006–70 (2006–2 CB 252) is 

obsolete as of June 9, 2009. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

27926 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

regulatory assessment 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 the temporary regulations. 

The temporary regulations do not 

impose a collection of information. 

Pursuant to the Regulatory Flexibility 

Act (5 U.S.C. Chapter 6), it is also 

hereby certified that the temporary 

regulations will not have a significant 

economic impact on a substantial 

number of small entities. Accordingly, a 

regulatory flexibility analysis is not 

required. The complexity and cost of a 

transaction to which section 7874 may 

apply makes it unlikely that a 

substantial number of small entities will 

engage in such a transaction. In 

addition, the economic impact to any 

entities affected by section 7874 is 

derived from the application of the 

statute, and not from the temporary 

regulations. Pursuant to section 7805(f) 

of the Code, the notice of proposed 

rulemaking preceding these regulations 

has been submitted to the Chief Counsel 

for Advocacy of the Small Business 

Administration for comments on its 

impact on small business. 

Drafting Information 

The principal author of the temporary 

regulations is S. James Hawes, Office of 

Associate Chief Counsel (International). 

However, other personnel from the IRS 

and the Treasury Department 

participated in their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Amendments to the Regulations 

■ Accordingly, 26 CFR part 1 is 

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 * * * 

Section 1.7874–1T also issued under 26 

U.S.C. 7874(g). * * * 

Section 1.7874–2T also issued under 26 

U.S.C. 7874(c)(6) and (g). * * * 

■ Par. 2. Section 1.7874–1(e) is revised 

to read as follows: 

§ 1.7874–1 Disregard of affiliate-owned 

stock. 

* * * * * 

(e) [Reserved]. For further guidance, 

see § 1.7874–1T(e). 

* * * * * 

■ Par. 3. Section 1.7874–1T is added to 

read as follows: 

§ 1.7874–1T Disregard of affiliate-owned 

stock (temporary). 

(a) through (d) [Reserved]. For further 

guidance, see § 1.7874–1(a) through (d). 

(e) Stock held by a partnership. For 

purposes of this section, each partner in 

a partnership shall be treated as holding 

its proportionate share of stock held by 

the partnership, as determined under 

the rules and principles of sections 701 

through 777. 

(f) [Reserved]. For further guidance, 

see § 1.7874–1(f). 

(g) Effective/applicability date. 

Paragraph (e) of this section shall apply 

to acquisitions completed on or after 

June 9, 2009. See § 1.7874–1(e), as 

contained in 26 CFR part 1 revised as of 

April 1, 2009, for transactions 

completed before June 9, 2009. 

(h) Expiration date. The applicability 

of this section expires on or before June 

8, 2012. 

■ Par. 4. Section 1.7874–2T is revised to 

read as follows: 

§ 1.7874–2T Surrogate foreign corporation 

(temporary). 

(a) Scope. This section provides rules 

for determining whether a foreign 

corporation shall be treated as a 

surrogate foreign corporation under 

section 7874(a)(2)(B). Paragraph (b) of 

this section provides definitions and 

special rules. Paragraph (c) of this 

section provides rules to determine 

whether a foreign corporation has 

indirectly acquired properties held by a 

domestic corporation (or of a 

partnership). Paragraph (d) of this 

section provides rules that apply when 

two or more foreign corporations 

complete, in the aggregate, an 

acquisition described in section 

7874(a)(2)(B)(i). Paragraph (e) of this 

section provides rules that apply when 

a single foreign corporation completes 

more than one acquisition described in 

section 7874(a)(2)(B)(i). Paragraph (f) of 

this section provides rules to identify 

the stock of a foreign corporation that is 

held by reason of holding stock in a 

domestic corporation (or an interest in 

a domestic partnership). Paragraph (g) of 

this section provides rules concerning 

the substantial business activities 

condition of section 7874(a)(2)(B)(iii). 

Paragraph (h) of this section provides 

rules that treat certain publicly traded 

foreign partnerships as foreign 

corporations for purposes of section 

7874. Paragraph (i) of this section is 

reserved. Paragraph (j) of this section 

provides rules concerning the treatment 

of certain options (or similar interests) 

for purposes of section 7874. Paragraph 

(k) of this section provides rules that 

treat certain interests (including debt, 

stock, or a partnership interest) as stock 

of a foreign corporation for purposes of 

section 7874. Paragraph (l) of this 

section is reserved. Paragraph (m) of this 

section provides rules concerning the 

conversion of a foreign corporation to a 

domestic corporation by reason of 

section 7874(b). Paragraph (n) of this 

section provides examples that illustrate 

the rules of this section. Paragraph (o) 

of this section provides the effective/ 

applicability dates of this section. 

Paragraph (p) of this section provides 

the expiration date of this section. 

(b) Definitions and special rules. 

Except as otherwise indicated, the 

following definitions and special rules 

apply for purposes of this section. 

(1) The rules of this section are 

subject to section 7874(c)(4). 

(2) An interest in a partnership 

includes a capital or profits interest. 

(3) A former shareholder of a 

domestic corporation is any person that 

held stock in the domestic corporation 

before the acquisition described in 

section 7874(a)(2)(B)(i), including any 

person that holds stock in the domestic 

corporation both before and after the 

acquisition. 

(4) A former partner of a domestic 

partnership is any person that held an 

interest in the domestic partnership 

before the acquisition described in 

section 7874(a)(2)(B)(i), including any 

person that holds an interest in the 

domestic partnership both before and 

after the acquisition. 

(5) References to properties held by a 

domestic corporation include properties 

held directly or indirectly by the 

domestic corporation. 

(6) The rules and principles of 

sections 701 through 777 shall be 

applied for purposes of determining a 

proportionate amount (or share) of items 

of a partnership (such as stock, 

properties, activities and employees). 

(7) Any reference to the acquisition of 

properties held by a domestic 

corporation (or of a partnership) 

includes a direct or indirect acquisition 

of such properties. 

(8) In the case of an acquisition of 

stock of a domestic corporation or an 

interest in a partnership, the 

proportionate amount of properties held 

by the domestic corporation (or of the 

partnership) that is treated as indirectly 

acquired shall, as applicable, be 

determined on the date of the 

acquisition based on the relative value 

of— 

(i) The stock acquired compared to all 

outstanding stock of the domestic 

corporation; or 

(ii) The interest acquired compared to 

all interests in the partnership. 

(9) The determination of whether a 

foreign corporation is a surrogate foreign 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27927 

corporation is made after the acquisition 

described in section 7874(a)(2)(B)(i). A 

foreign corporation that is treated as a 

surrogate foreign corporation (including 

a surrogate foreign corporation treated 

as a domestic corporation described in 

section 7874(b)) shall continue to be 

treated as a surrogate foreign 

corporation (or a domestic corporation), 

even if the conditions of section 

7874(a)(2)(B)(ii) and (iii) are not 

satisfied at a later date. 

(c) Acquisition of properties—(1) 

Indirect acquisition of properties. For 

purposes of section 7874(a)(2)(B)(i), an 

indirect acquisition of properties held 

by a domestic corporation (or of a 

partnership) includes the acquisitions 

described in paragraphs (c)(1)(i) through 

(iv) of this section. An acquisition of 

less than all of the stock of a domestic 

corporation (or interests in a 

partnership) shall constitute an indirect 

acquisition of a proportionate amount of 

the properties held by the domestic 

corporation or of the partnership. See 

paragraph (b)(8) of this section for rules 

determining the proportionate amount 

of properties indirectly acquired. 

(i) An acquisition of stock of a 

domestic corporation. See Example 1 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(ii) An acquisition of an interest in a 

partnership. See Example 2 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(iii) An acquisition by a corporation 

(acquiring corporation) of properties 

held by a domestic corporation (or of a 

partnership) in exchange for stock of a 

foreign corporation (foreign issuing 

corporation) that is part of the expanded 

affiliated group that includes the 

acquiring corporation after the 

acquisition shall be treated as an 

acquisition by the foreign issuing 

corporation. See Example 3 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(iv) An acquisition by a partnership 

(acquiring partnership) of properties 

held by a domestic corporation (or of a 

partnership) in exchange for stock of a 

foreign corporation that is part of the 

expanded affiliated group that would 

include the acquiring partnership after 

the acquisition (if the partnership were 

a corporation) shall be treated as an 

acquisition by the foreign issuing 

corporation. 

(2) Acquisition of stock of foreign 

corporation. An acquisition of stock of 

a foreign corporation that owns directly 

or indirectly stock of a domestic 

corporation (or an interest in a 

partnership) shall not constitute an 

indirect acquisition of any properties 

held by the domestic corporation (or the 

partnership). See Example 4 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(d) Acquisitions by multiple foreign 

corporations. If, pursuant to a plan (or 

a series of related transactions), two or 

more foreign corporations complete, in 

the aggregate, an acquisition described 

in section 7874(a)(2)(B)(i), then each 

foreign corporation shall be treated as 

completing the acquisition for purposes 

of determining whether such foreign 

corporation is treated as a surrogate 

foreign corporation. See Examples 5 and 

6 of paragraph (n) of this section for 

illustrations of the rules of this 

paragraph. 

(e) Acquisitions of multiple domestic 

entities. If, pursuant to a plan (or a 

series of related transactions), a foreign 

corporation completes two or more 

acquisitions described in section 

7874(a)(2)(B)(i) involving domestic 

corporations and/or domestic 

partnerships (domestic entities), then, 

for purposes of section 7874(a)(2)(B)(ii), 

the acquisitions shall be treated as a 

single acquisition and the domestic 

entities shall be treated as a single 

domestic entity. If the transaction 

involves one or more domestic 

corporations and one or more domestic 

partnerships, the stock of the foreign 

corporation held by former shareholders 

and former partners by reason of 

holding stock or a partnership interest 

in the domestic entities shall be 

aggregated for purposes of determining 

whether the ownership condition of 

section 7874(a)(2)(B)(ii) is satisfied. See 

Example 7 of paragraph (n) of this 

section for an illustration of the rules of 

this paragraph. 

(f) Stock held by reason of holding 

stock in a domestic corporation or an 

interest in a domestic partnership—(1) 

Specified transactions. For purposes of 

section 7874(a)(2)(B)(ii), stock of a 

foreign corporation that is held by 

reason of holding stock in a domestic 

corporation (or an interest in a domestic 

partnership) includes the stock 

described in paragraphs (f)(1)(i) through 

(iii) of this section. 

(i) Stock of a foreign corporation 

received in exchange for, or with respect 

to, stock of a domestic corporation. 

(ii) Stock of a foreign corporation 

received in exchange for, or with respect 

to, an interest in a domestic partnership. 

(iii) To the extent that paragraph 

(f)(1)(ii) of this section does not apply, 

stock of a foreign corporation received 

by a domestic partnership in exchange 

for all or part of its properties. In such 

a case, each partner in the domestic 

partnership shall be treated as holding 

its proportionate share of the stock of 

the foreign corporation by reason of 

holding an interest in the domestic 

partnership. 

(2) Transactions involving other 

property—(i) Stock of a domestic 

corporation. If, pursuant to the same 

transaction, stock of a foreign 

corporation is received in exchange for, 

or with respect to, stock of a domestic 

corporation and other property, the 

stock of the foreign corporation that was 

received in exchange for, or with respect 

to, the stock of the domestic corporation 

shall be determined based on the 

relative value of the stock of the 

domestic corporation compared to the 

aggregate value of such stock and the 

other property. 

(ii) Interest in a domestic partnership. 

If, pursuant to the same transaction, 

stock of a foreign corporation is received 

in exchange for, or with respect to, an 

interest in a domestic partnership and 

other property, the stock of the foreign 

corporation that was received in 

exchange for, or with respect to, the 

interest in the domestic partnership 

shall be determined based on the 

relative value of the interest in the 

domestic partnership compared to the 

aggregate value of such interest and the 

other property. 

(3) See Examples 8 through 10 of 

paragraph (n) of this section for 

illustrations of the rules of this 

paragraph (f). 

(g) Substantial business activities—(1) 

General rule. The determination of 

whether, after the acquisition, the 

expanded affiliated group that includes 

the foreign corporation has substantial 

business activities in the foreign country 

in which, or under the law of which, the 

foreign corporation is created or 

organized when compared to the total 

business activities of the expanded 

affiliated group, is (subject to paragraph 

(g)(5) of this section) based on all facts 

and circumstances. 

(2) Threshold of business activities. 

The determination of whether the 

expanded affiliated group has sufficient 

business activities in a foreign country 

is not solely based on the absolute 

amount of business activities in the 

foreign country. Rather the 

determination is based on a comparison 

of the amount of business activities in 

the foreign country to the total business 

activities of the expanded affiliated 

group. The determination must take into 

account the total business activities of 

the expanded affiliated group, including 

the relevant items identified in 

paragraph (g)(3) of this section. Thus, it 

is possible for the business activities of 

27928 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

one expanded affiliated group in a 

particular country to be substantial 

when compared to the total business 

activities of such expanded affiliated 

group, but for identical business 

activities of another expanded affiliated 

group in the same country not to be 

substantial when compared to the total 

business activities of that other 

expanded affiliated group. This may 

result, for example, because the total 

business activities of the second 

expanded affiliated group are more 

extensive than that of the first expanded 

affiliated group. 

(3) Items to be considered. Except as 

provided in paragraph (g)(5) of this 

section, relevant items to be considered 

for determining whether, after the 

acquisition, the expanded affiliated 

group has substantial business activities 

in a foreign country when compared to 

the total business activities of the 

expanded affiliated group include the 

items identified in paragraphs (g)(3)(i) 

through (v) of this section. The presence 

or absence of any item, or set of items, 

is not determinative and the weight 

given to any item, or set of items, 

depends on the facts and circumstances. 

(i) The historical conduct of 

continuous business activities in the 

foreign country by the expanded 

affiliated group. 

(ii) The conduct of continuous 

business activities in the foreign country 

by the expanded affiliated group in the 

ordinary course of one or more active 

trades or businesses, involving— 

(A) Property located in the foreign 

country that is owned by members of 

the expanded affiliated group; 

(B) The performance of services in the 

foreign country by employees of the 

expanded affiliated group; and 

(C) Sales of goods to customers. 

(iii) The performance in the foreign 

country of substantial managerial 

activities by officers and employees of 

the expanded affiliated group who are 

based in the foreign country. 

(iv) A substantial degree of ownership 

of the expanded affiliated group by 

investors resident in the foreign 

country. 

(v) Business activities in the foreign 

country that are material to the 

achievement of the overall business 

objectives of the expanded affiliated 

group. 

(4) Attribution from a partnership. For 

purposes of this paragraph (g), a 

member of the expanded affiliated 

group that holds at least a 10 percent 

capital and profits interest in a 

partnership shall take into account its 

proportionate share of all the items of 

the partnership, including business 

activities, employees, assets, income 

and sales. See paragraph (b)(6) of this 

section for determining a partner’s 

proportionate share of the items of a 

partnership. 

(5) Items not to be considered. The 

following items shall not be taken into 

account in determining whether, after 

the acquisition, the expanded affiliated 

group has substantial business activities 

in a foreign country when compared to 

the total business activities of the 

expanded affiliated group. 

(i) Any business activities or income 

attributable to properties or liabilities 

the transfer of which is disregarded 

under section 7874(c)(4). 

(ii) Any assets, business activities, or 

employees located in a foreign country 

at any time as part of a plan with a 

principal purpose of avoiding the 

purposes of section 7874. 

(iii) Any assets, business activities, or 

employees located in the foreign 

country in which, or under the law of 

which, the foreign corporation is created 

or organized if such assets, business 

activities or employees are transferred to 

another country pursuant to a plan that 

existed at the time of the acquisition 

described in section 7874(a)(2)(B)(i). 

(h) Publicly traded foreign 

partnerships—(1) Treatment as a foreign 

corporation. For purposes of section 

7874, a publicly traded foreign 

partnership described in paragraph 

(h)(2) of this section shall be treated as 

a foreign corporation that is organized 

in the foreign country in which, or 

under the law of which, the publicly 

traded foreign partnership was created 

or organized, and interests in the 

publicly traded foreign partnership shall 

be treated as stock of the foreign 

corporation. For purposes of 

determining whether the foreign 

corporation shall be treated as a 

surrogate foreign corporation, a deemed 

acquisition of assets and liabilities by 

reason of § 1.708–1(b)(4) shall not 

constitute an acquisition described in 

section 7874(a)(2)(B)(i). 

(2) Publicly traded foreign 

partnership. A publicly traded foreign 

partnership described in this paragraph 

(h)(2) is any foreign partnership that 

would, but for section 7704(c), be 

treated as a corporation under section 

7704(a): 

(i) At the time of the acquisition 

described in section 7874(a)(2)(B)(i); or 

(ii) At any time after the acquisition 

pursuant to a plan that existed at the 

time of the acquisition. For this 

purpose, a plan shall be deemed to exist 

at the time of the acquisition if the 

foreign partnership would, but for 

section 7704(c), be treated as a 

corporation under section 7704(a) at any 

time during the two-year period 

following the completion of the 

acquisition. 

(3) Surrogate foreign corporation to 

which section 7874(b) applies. If 

paragraph (h)(1) of this section applies 

to a publicly traded foreign partnership 

and the foreign corporation is a 

surrogate foreign corporation to which 

section 7874(b) applies, the publicly 

traded foreign partnership shall be 

treated as a domestic corporation for 

purposes of the Internal Revenue Code 

(Code). See paragraph (h)(6) of this 

section for the timing and treatment of 

the conversion of the publicly traded 

foreign partnership to a domestic 

corporation. See Example 11 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(4) Surrogate foreign corporation to 

which section 7874(b) does not apply. If 

paragraph (h)(1) of this section applies 

to a publicly traded foreign partnership 

and the foreign corporation is a 

surrogate foreign corporation to which 

section 7874(b) does not apply, the 

publicly traded foreign partnership shall 

continue to be treated as a foreign 

partnership for purposes of the Code, 

but section 7874(a)(1) shall apply to any 

expatriated entity (as defined in section 

7874(a)(2)(A)). See Example 13 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(5) Foreign corporation not treated as 

a surrogate foreign corporation. If 

paragraph (h)(1) of this section applies 

to a publicly traded foreign partnership 

and the foreign corporation is not 

treated as a surrogate foreign 

corporation, the status of the publicly 

traded foreign partnership as a foreign 

partnership shall not be affected by 

section 7874. See Example 12 of 

paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(6) Conversion to a domestic 

corporation. Except for purposes of 

determining whether the publicly 

traded foreign partnership is a surrogate 

foreign corporation, if paragraph (h)(1) 

of this section applies to a publicly 

traded foreign partnership and the 

foreign corporation is a surrogate foreign 

corporation to which section 7874(b) 

applies, then immediately before the 

first date properties are acquired as part 

of the acquisition described in section 

7874(a)(2)(B)(i) the publicly traded 

foreign partnership shall be treated as 

transferring all of its assets and 

liabilities to a newly formed domestic 

corporation in exchange solely for stock 

of the domestic corporation, and then 

distributing such stock to its partners in 

proportion to their partnership interests 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27929 

in liquidation of the partnership. The 

treatment of the transfer of assets and 

liabilities to the domestic corporation 

and the distribution of the stock of the 

domestic corporation to the partners in 

liquidation of the partnership shall be 

determined under all relevant 

provisions of the Code and general tax 

principles. 

(i) [Reserved]. 

(j) Options and similar interests—(1) 

Domestic corporation (or partnership). 

Except to the extent provided in this 

paragraph (j), for purposes of section 

7874, an option (or similar interest) with 

respect to a domestic corporation (or a 

partnership, domestic or foreign) shall 

be treated as stock of the domestic 

corporation (or an interest in the 

partnership) with a value equal to the 

holder’s claim on the equity of the 

domestic corporation (or partnership) 

immediately before the acquisition 

described in section 7874(a)(2)(B)(i). For 

this purpose, the equity of the domestic 

corporation (or partnership) shall not 

include the amount of any property the 

holder of the option (or similar interest) 

would be required to provide to the 

domestic corporation (or partnership) 

under the terms of the option (or similar 

interest) if such option (or similar 

interest) were exercised. See Example 

16 of paragraph (n) of this section for an 

illustration of the rules of this 

paragraph. 

(2) Foreign corporation—(i) General 

rule. Except to the extent provided in 

this paragraph (j), for purposes of 

section 7874 an option (or similar 

interest) with respect to a foreign 

corporation shall be treated as stock of 

the foreign corporation with a value 

equal to the holder’s claim on the equity 

of the foreign corporation after the 

acquisition described in section 

7874(a)(2)(B)(i). For this purpose, the 

equity of the foreign corporation shall 

not include the amount of any property 

the holder of the option (or similar 

interest) would be required to provide to 

the foreign corporation under the terms 

of the option (or similar interest) if such 

option (or similar interest) were 

exercised. See Examples 14 through 16 

of paragraph (n) of this section for 

illustrations of the rules of this 

paragraph (j)(2)(i). 

(ii) Certain options (or similar 

interests) disregarded. Paragraph (j)(2)(i) 

of this section shall not apply to an 

option (or similar interest) if a principal 

purpose of the issuance or acquisition of 

the option (or similar interest) is to 

avoid the foreign corporation being 

treated as a surrogate foreign 

corporation. 

(3) Similar interest. For purposes of 

this paragraph (j), an interest similar to 

an option (a similar interest) includes, 

but is not limited to, a warrant, a 

convertible debt instrument, an 

instrument other than debt that is 

convertible into stock or a partnership 

interest, a put, stock or a partnership 

interest subject to risk of forfeiture, a 

contract to acquire or sell stock or a 

partnership interest, and an 

exchangeable share or exchangeable 

partnership interest. 

(4) Multiple claims on equity. 

Paragraphs (j)(1) and (j)(2)(i) of this 

section shall not apply to an option (or 

similar interest) to the extent treating 

the option (or similar interest) as stock 

of a corporation (or interest in a 

partnership) would duplicate a 

shareholder’s (or partner’s) claim on the 

equity of the corporation (or 

partnership) by reason of holding stock 

in the corporation (or an interest in the 

partnership). However, except to the 

extent otherwise provided in section 

7874, in all cases stock of a corporation 

held by a shareholder or an interest in 

a partnership held by a partner (without 

regard to this paragraph (j)) shall be 

taken into account for purposes of 

section 7874. See Example 15 of 

paragraph (n) of this section for an 

illustration of the rules of this paragraph 

(j)(4). 

(k) Interests treated as stock of a 

foreign corporation—(1) Stock or other 

interests. If the conditions of paragraphs 

(k)(1)(i) and (ii) of this section are 

satisfied, then, for purposes of section 

7874, any interest (including stock or a 

partnership interest) that is not 

otherwise treated as stock of a foreign 

corporation (including under paragraph 

(j)(2)(i) of this section) shall be treated 

as stock of the foreign corporation. See 

Examples 17 and 18 of paragraph (n) of 

this section for illustrations of the rules 

of this paragraph (k)(1). 

(i) The interest provides the holder 

distribution rights that are substantially 

similar in all material respects to the 

distribution rights provided by stock in 

the foreign corporation. For this 

purpose, distribution rights include 

rights to dividends (or partnership 

distributions), distributions in 

redemption of the interest (in whole or 

in part), distributions in liquidation, or 

other similar distributions that represent 

a return on, or of, the holder’s 

investment in the interest. 

(ii) Treating the interest as stock of the 

foreign corporation has the effect of 

treating the foreign corporation as a 

surrogate foreign corporation. 

(2) Creditor claims—(i) Domestic 

corporation. For purposes of section 

7874, if, immediately prior to the first 

date properties are acquired as part of 

an acquisition described in section 

7874(a)(2)(B)(i), a domestic corporation 

is in a title 11 or similar case (as defined 

in section 368(a)(3)), or the liabilities of 

the domestic corporation exceed the 

value of its assets, then each creditor of 

the domestic corporation shall be 

treated as a shareholder of the domestic 

corporation and any claim of the 

creditor against the domestic 

corporation shall be treated as stock of 

the domestic corporation. See Example 

19 of paragraph (n) of this section for an 

illustration of the rules of this paragraph 

(k)(2)(i). 

(ii) Domestic or foreign partnership. 

For purposes of section 7874, if, 

immediately prior to the first date 

properties are acquired as part of an 

acquisition described in section 

7874(a)(2)(B)(i), a partnership (foreign or 

domestic) is in a title 11 or similar case 

(as defined in section 368(a)(3)), or the 

liabilities of the partnership exceed the 

value of its assets, then each creditor of 

the partnership shall be treated as a 

partner in the partnership and any claim 

of the creditor against the partnership 

shall be treated as an interest in the 

partnership. 

(iii) Treatment of creditor as 

shareholder or partner. A creditor that 

is treated as a shareholder or partner 

under paragraph (k)(2)(i) or (ii) of this 

section shall be treated as a shareholder 

or partner for all purposes of section 

7874. See, for example, § 1.7874–1(c) 

and paragraph (f) of this section. See 

Example 19 of paragraph (n) of this 

section for an illustration of the rules of 

this paragraph (k)(2)(iii). 

(l) [Reserved]. 

(m) Application of section 7874(b)— 

(1) Conversion to a domestic 

corporation. Except for purposes of 

determining whether a foreign 

corporation is treated as a surrogate 

foreign corporation, the conversion of a 

foreign corporation to a domestic 

corporation by reason of section 7874(b) 

shall constitute a reorganization 

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

occurs immediately before the first date 

properties are acquired as part of the 

acquisition described in section 

7874(a)(2)(B)(i). See, for example, 

§§ 1.367(b)–2 and 1.367(b)–3 for certain 

consequences of the reorganization. The 

treatment of all other aspects of the 

conversion shall be determined under 

the relevant provisions of the Code and 

general tax principles. See Example 20 

of paragraph (n) of this section for an 

illustration of the rules of this paragraph 

(m)(1). 

(2) Entity classification. A foreign 

corporation that is treated as a domestic 

corporation under section 7874(b) is not 

an eligible entity as defined in 

§ 301.7701–3(a) of this chapter and 

27930 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

therefore may not elect to be treated as 

other than an association for Federal tax 

purposes. 

(3) Application of section 367. If a 

foreign corporation is treated as a 

domestic corporation under section 

7874(b), section 367 shall not apply to 

any transfer of property by a United 

States person to such foreign 

corporation as part of the acquisition 

described in section 7874(a)(2)(B)(i). 

However, section 367 shall apply to the 

conversion of the foreign corporation to 

a domestic corporation. See paragraph 

(m)(1) of this section. See Example 20 of 

paragraph (n) of this section for an 

illustration of the rules of this paragraph 

(m)(3). 

(n) Examples—(1) Assumed facts. 

Except as otherwise stated, assume the 

following for purposes of the examples 

included in paragraph (n)(2) of this 

section. 

(i) DC1 and DC2 are domestic 

corporations. 

(ii) FA, FP, F1, F2, F3, and F4 are 

foreign corporations organized in 

Country A. 

(iii) DPS is a domestic partnership 

that conducts a trade or business. 

(iv) FPS is a foreign partnership that 

is not publicly traded. 

(v) A, B, and C are unrelated 

individuals. 

(vi) Each entity has a single class of 

equity outstanding and is unrelated to 

all other entities. 

(vii) All transactions are completed 

pursuant to a plan. 

(viii) All acquisitions of properties are 

completed after March 4, 2003. 

(ix) Neither section 7874(c)(4) nor 

paragraph (j)(2)(ii) of this section 

applies. 

(2) Examples. The following examples 

illustrate the rules of this section. 

Example 1. Acquisition of stock of a 

domestic corporation. (i) Facts. FA acquires 

25 percent of the outstanding stock of DC1. 

(ii) Analysis. Under paragraph (c)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring 25 

percent of the properties held by DC1 on the 

date of the stock acquisition. 

Example 2. Acquisition of a partnership 

interest. (i) Facts. DPS wholly owns DC1. FA 

acquires a 40 percent interest in DPS. 

(ii) Analysis. Under paragraph (c)(1)(ii) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring 40 

percent of the DC1 stock held by DPS on the 

date of the acquisition of the partnership 

interest. Further, under paragraph (c)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring 40 

percent of the properties held by DC1 on the 

date of the acquisition of the partnership 

interest. 

Example 3. Acquisition of stock by a 

subsidiary. (i) Facts. FP wholly owns FA. FA 

acquires all the outstanding stock of DC1 in 

exchange solely for FP stock. FP and FA are 

members of the same expanded affiliated 

group after the acquisition. 

(ii) Analysis. Under paragraph (c)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring 100 

percent of the properties held by DC1 on the 

date of the stock acquisition. Further, under 

paragraph (c)(1)(iii) of this section, for 

purposes of section 7874(a)(2)(B)(i) FP is also 

treated as acquiring 100 percent of the 

properties held by DC1 on the date of the 

stock acquisition. The result would be the 

same if instead FA had directly acquired all 

the properties held by DC1 in exchange for 

FP stock. 

Example 4. Acquisition of stock of a 

foreign corporation. (i) Facts. FP wholly 

owns DC1. FA acquires all of the outstanding 

stock of FP. 

(ii) Analysis. Under paragraph (c)(2) of this 

section, for purposes of section 

7874(a)(2)(B)(i) FA is not treated as acquiring 

any properties held by DC1 on the date of the 

acquisition of the FP stock. 

Example 5. Acquisition of stock by 

multiple foreign corporations. (i) Facts. 

Pursuant to the same plan, the shareholders 

of DC1 transfer all of their DC1 stock equally 

to F1, F2, F3, and F4 in exchange solely for 

stock of each foreign corporation. 

(ii) Analysis. Under paragraph (c)(1)(i) of 

this section, in the aggregate F1, F2, F3 and 

F4 are treated as acquiring substantially all 

of the properties held by DC1. Because the 

acquisition was pursuant to the same plan, 

under paragraph (d) of this section, F1, F2, 

F3, and F4 are each treated as acquiring 

substantially all of the properties held by 

DC1 for purposes of determining whether 

each foreign corporation shall be treated as 

a surrogate foreign corporation. 

Example 6. Acquisition of assets by 

multiple foreign corporations. (i) Facts. 

Individual A wholly owns DC1. DC1 forms 

F1, F2, F3, and F4, and transfers an equal 

portion of its properties to each corporation 

in exchange solely for stock of the 

corporation. Pursuant to the same plan DC1 

then distributes the stock of each foreign 

corporation to individual A. 

(ii) Analysis. Because pursuant to the same 

plan F1, F2, F3 and F4 acquired, in the 

aggregate, substantially all of the properties 

held by DC1, under paragraph (d) of this 

section, F1, F2, F3, and F4 are each treated 

as acquiring substantially all of the properties 

held by DC1 for purposes of determining 

whether each foreign corporation shall be 

treated as a surrogate foreign corporation. 

Example 7. Acquisition of multiple 

domestic corporations. (i) Facts. Individual A 

wholly owns DC1, and individual B wholly 

owns DC2. Pursuant to the same plan, A and 

B transfer all of their DC1 stock and DC2 

stock to FA, a newly formed corporation, in 

exchange solely for all 100 shares of FA stock 

outstanding. 

(ii) Analysis. Under paragraph (c)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring all 

of the properties held by DC1 and DC2 on the 

date of the stock acquisition. Under 

paragraph (e) of this section, because 

pursuant to the same plan FA acquired 

substantially all of the properties held by 

DC1 and DC2, for purposes of determining 

whether FA shall be treated as a surrogate 

foreign corporation, DC1 and DC2 shall be 

treated as a single domestic corporation, of 

which A and B are former shareholders. 

Thus, individuals A and B are treated as 

holding all 100 shares of the FA stock by 

reason of holding stock of such domestic 

corporation, and the ownership fraction 

under section 7874(a)(2)(B)(ii) is 100/100, or 

100 percent. 

Example 8. Exchange of stock and other 

property. (i) Facts. Individual A wholly owns 

DC1 and F1. DC1 has a $40x value and F1 

has a $60x value. Individual A transfers all 

of the DC1 stock and F1 stock to FA, a newlyformed corporation, in exchange solely for 

FA stock. 

(ii) Analysis. Under paragraphs (f)(1)(i) and 

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

7874(a)(2)(B)(ii) individual A is considered to 

hold 40 percent of the FA stock by reason of 

holding stock in DC1 ($100x FA stock 

multiplied by $40x/$100x, the relative value 

of the DC1 stock to all the property 

transferred by A to FA). 

Example 9. Stock received as a 

distribution. (i) Facts. Pursuant to a divisive 

reorganization described in section 

368(a)(1)(D), DC1 contributes substantially all 

of its properties to FA, a newly-formed 

corporation, in exchange solely for FA stock 

and then distributes the FA stock to its 

shareholders under section 355. 

(ii) Analysis. Under paragraph (f)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(ii) the FA stock received by the 

DC1 shareholders as a distribution with 

respect to the DC1 stock is considered held 

by reason of holding stock in DC1. The result 

would be the same if the transaction did not 

qualify as a reorganization (for example, if 

the distribution were subject to sections 301 

and 311(b)). 

Example 10. Incorporation of a partnership 

trade or business. (i) Facts. Individuals A and 

B equally own DPS. DPS transfers 

substantially all of its properties constituting 

a trade or business to FA, a newly-formed 

corporation, solely in exchange for FA stock. 

DPS retains the FA stock after the 

transaction. 

(ii) Analysis. Under paragraph (f)(1)(iii) of 

this section, for purposes of section 

7874(a)(2)(B)(ii) individuals A and B are 

treated as holding a proportionate amount 

(that is, an equal amount) of the FA stock 

held by DPS by reason of holding an interest 

in DPS. 

Example 11. Publicly traded foreign 

partnership treated as domestic corporation. 

(i) Facts. Pursuant to a plan, DC1 and 

individual B organize a limited liability 

company (HPS) under the law of Country A. 

DC1 owns 99.9 percent of the membership 

interests in HPS, and B owns 0.1 percent of 

the membership interests in HPS. HPS is a 

foreign eligible entity under § 301.7701–2 of 

this chapter, and DC1 and B make an election 

under § 301.7701–3 of this chapter to treat 

HPS as a partnership for Federal tax purposes 

as of the date of the formation of HPS. HPS 

forms DC2. DC2 merges with and into DC1. 

Pursuant to the merger agreement, the DC1 

shareholders exchange their DC1 stock solely 

for membership interests in HPS. After the 

Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 27931 

merger HPS wholly owns DC1, and the 

former shareholders of DC1 own a greater 

than 80 percent interest in HPS by reason of 

holding stock of DC1. Public trading of the 

HPS ownership interests begins the day after 

the date on which merger is completed. HPS 

is not treated as a corporation under section 

7704(a) by reason of section 7704(c). If HPS 

were a corporation, the condition of section 

7874(a)(2)(B)(iii) would be satisfied. 

(ii) Analysis. HPS is a publicly traded 

foreign partnership that is described in 

paragraph (h)(2) of this section. Therefore, 

under paragraph (h)(1) of this section, for 

purposes of section 7874 HPS is treated as a 

foreign corporation organized under the law 

of Country A and the membership interests 

in HPS are treated as stock of the foreign 

corporation. The foreign corporation is 

treated as a surrogate foreign corporation 

under section 7874(a)(2)(B) because, 

pursuant to the merger, HPS acquired 

substantially all of the properties held by 

DC1, the former shareholders of DC1 hold at 

least 60 percent of the stock of the foreign 

corporation by reason of holding stock of 

DC1, and the expanded affiliated group that 

includes the foreign corporation does not 

have substantial business activities in 

Country A when compared to the total 

business activities of the expanded affiliated 

group. Further, because the former 

shareholders of DC1 hold at least 80 percent 

of the stock of the foreign corporation by 

reason of holding stock of DC1, section 

7874(b) applies to the surrogate foreign 

corporation, and therefore HPS is treated as 

a domestic corporation for purposes of the 

Code. Under paragraph (h)(6) of this section, 

except for purposes of determining whether 

HPS is a surrogate foreign corporation, 

immediately before the merger of DC2 with 

and into DC1 HPS is treated as transferring 

all of its assets and liabilities to a new 

domestic corporation in exchange solely for 

stock of the domestic corporation. HPS is 

then treated as proportionately distributing 

such stock to its membership holders in 

liquidation of the partnership. In addition, as 

a result of the merger of DC2 with and into 

DC1, the former shareholders of DC1 shall be 

treated as receiving stock of a domestic 

corporation in exchange for their DC1 stock. 

Example 12. Publicly traded foreign 

partnership not treated as a surrogate foreign 

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

as in Example 11 of this section, except that, 

after the acquisition, the expanded affiliated 

group that includes HPS (treated as a foreign 

corporation for this purpose) has substantial 

business activities in Country A when 

compared to the total business activities of 

the expanded affiliated group. 

(ii) Analysis. Under paragraph (h)(1) of this 

section, for purposes of section 7874 HPS is 

treated as a foreign corporation and the 

membership interests in HPS are treated as 

stock of the foreign corporation. However, 

the foreign corporation is not treated as a 

surrogate foreign corporation under section 

7874(a)(2)(B) because, after the acquisition, 

the expanded affiliated group that includes 

HPS has substantial business activities in 

Country A when compared to the total 

business activities of the expanded affiliated 

group. Therefore, under paragraph (h)(5) of 

this section, section 7874 does not apply and 

the status of HPS as a foreign partnership is 

not affected. In addition, DC1 is not treated 

as an expatriated entity under section 7874(a) 

by reason of the acquisition. 

Example 13. Publicly traded foreign 

partnership treated as a surrogate foreign 

corporation but not as a domestic 

corporation. (i) Facts. FPS is a publicly 

traded foreign partnership organized in 

Country A that, by reason of section 7704(c), 

is not treated as a corporation under section 

7704(a). FPS acquires all the stock of DC1 in 

exchange for partnership interests in FPS. 

After the acquisition, the former shareholders 

of DC1 hold a 75 percent interest in FPS by 

reason of holding DC1 stock. After the 

acquisition, the expanded affiliated group 

that includes FPS (treated as a foreign 

corporation for this purpose) does not have 

substantial business activities in Country A 

when compared to the total business 

activities of the expanded affiliated group. 

(ii) Analysis. Under paragraph (h)(1) of this 

section, for purposes of section 7874 FPS is 

treated as a foreign corporation and the 

partnership interests in FPS are treated as 

stock of the foreign corporation. FPS is 

treated as a surrogate foreign corporation 

because the conditions of section 

7874(a)(2)(B) are satisfied. However, because 

the former shareholders of DC1 hold less 

than an 80 percent interest in FPS by reason 

of holding DC1 stock, section 7874(b) does 

not apply to FPS. Therefore, under paragraph 

(h)(4) of this section FPS continues to be 

treated as a foreign partnership for purposes 

of the Code, but section 7874(a)(1) applies to 

DC1 and any other expatriated entity. 

Example 14. Warrant to acquire stock from 

the foreign corporation. (i) Facts. Individual 

A wholly owns DC1. DC1 has a $200× value. 

Individual B wholly owns FA. Individual C 

holds a warrant to acquire FA stock from FA 

at an exercise price of $20×. Individual A 

transfers all of its DC1 stock to FA in 

exchange solely for FA stock. At the time of 

the transfer, the FA stock that individual C 

can acquire pursuant to the warrant has a 

$70× value. 

(ii) Analysis. Under paragraph (j)(2) of this 

section, for purposes of section 7874 

individual C is treated as owning FA stock 

with a $50× value. This amount represents 

individual C’s claim on the equity of FA after 

the acquisition ($70× value of FA stock that 

may be acquired pursuant to the warrant, less 

$20× exercise price), without taking into 

account the $20× individual C would be 

required to provide to FA upon the exercise 

of the warrant. 

Example 15. Option to acquire stock from 

another shareholder. (i) Facts. The facts are 

the same as in Example 14 except that, 

instead of holding a warrant issued by FA, 

individual C holds an option to acquire FA 

stock from individual B for an exercise price 

of $20×. At the time of the acquisition, the 

FA stock that individual C can acquire under 

the option has a $70× value. 

(ii) Analysis. Under paragraph (j)(4) of this 

section, for purposes of section 7874, 

individual C is not treated as owning FA 

stock by reason of holding the option because 

treating the option as FA stock would have 

the effect of partially duplicating individual 

B’s claim on the equity of FA at the time of 

the acquisition by reason of holding FA 

stock. However, all of the FA stock owned by 

individual B shall be taken into account for 

purposes of section 7874. 

Example 16. Warrant to acquire stock from 

the domestic corporation. (i) Facts. A DC1 

employee holds a warrant to acquire DC1 

stock from DC1. In connection with the 

acquisition by FA of substantially all of the 

properties held by DC1, the DC1 employee 

receives a warrant from FA to acquire 15 

shares of FA stock in exchange for the 

warrant to acquire DC1 stock. 

(ii) Analysis. Under paragraph (j)(1) of this 

section, for purposes of section 7874 the 

warrant held by the DC1 employee is treated 

as DC1 stock with a value equal to the 

employee’s claim on the equity of DC1 

immediately before the acquisition. Further, 

under paragraph (j)(2) of this section, for 

purposes of section 7874 the DC1 employee 

is treated as holding FA stock with a value 

equal to the employee’s claim on the equity 

of FA after the acquisition by reason of 

holding the warrant to acquire DC1 stock 

(treated as DC1 stock for this purpose). 

Example 17. Stock in a subsidiary treated 

as stock of a foreign parent corporation. (i) 

Facts. (A) Individuals A and B equally own 

DC1. FA, a newly formed corporation, issues 

stock in a public offering for cash. FA 

contributes part of the cash from the public 

offering to DC2, a newly-formed corporation, 

in exchange for all the stock of DC2. DC2 

merges with and into DC1 with DC1 

surviving. Pursuant to the merger agreement, 

individuals A and B exchange their DC1 

stock for cash and shares of class B stock of 

DC1. Following the merger FA owns all the 

class A stock of DC1. FA holds few assets 

other than the class A stock of DC1. 

Individuals A and B own all the class B stock 

of DC1. DC1 has no other class of stock 

outstanding. 

(B) The class B stock entitles individuals 

A and B to dividend distributions 

approximately equal to any dividend 

distributions made by FA with respect to its 

publicly traded stock. In certain 

circumstances, the class B stock also permits 

individuals A and B to require DC1 to 

redeem the stock at fair market value. The 

class B stock does not provide individuals A 

and B voting rights with respect to FA. 

(ii) Analysis. The dividend rights provided 

by the class B stock are substantially similar 

in all material respects to the dividend rights 

provided by the FA stock. In addition, 

because FA holds few assets other than the 

class A stock, the value of the class B stock 

held by individuals A and B is approximately 

equal to the value of a corresponding amount 

of publicly traded FA stock. The distribution 

rights on liquidation (or redemption) 

provided by the class B stock, therefore, are 

substantially similar in all material respects 

to the distribution rights on liquidation (or 

redemption) provided by the FA stock. As a 

result, the distribution rights provided by the 

class B stock are substantially similar in all 

material respects to the distribution rights 

provided by the publicly traded FA stock. 

Thus, if treating the class B stock as FA stock 

would have the effect of treating FA as a 

surrogate foreign corporation, under 

27932 Federal Register / Vol. 74, No. 112 / Friday, June 12, 2009 / Rules and Regulations 

paragraph (k)(1) of this section the class B 

stock shall be treated as FA stock for 

purposes of section 7874. 

Example 18. Partnership interest treated as 

stock of foreign acquiring corporation. (i) 

Facts. (A) Individuals A and B equally own 

DC1. FA, a newly-formed corporation, issues 

stock in a public offering for cash. 

Individuals A and B and FA organize FPS. 

FA transfers part of the cash from the public 

offering to FPS in exchange for a class A 

partnership interest. FA holds few assets 

other than the class A partnership interest. 

Individuals A and B transfer their DC1 stock 

to FPS in exchange for class B partnership 

interests. 

(B) The class B partnership interests entitle 

individuals A and B to cash distributions 

from FPS approximately equal to any 

dividend distributions made by FA with 

respect to its publicly traded stock. In certain 

circumstances, the class B partnership 

interests also permit individuals A and B to 

require FPS to redeem the interests in 

exchange for cash equal to the value of an 

amount of FA stock as determined on the 

redemption date. The class B partnership 

interests do not provide individuals A or B 

voting rights with respect to FA. 

(ii) Analysis. The non-liquidating 

distribution rights provided by the class B 

partnership interests are substantially similar 

in all material respects to the dividend rights 

provided by the FA stock. Because FA holds 

few assets other than the class A partnership 

interest, the value of the class B partnership 

interests held by individuals A and B is 

approximately equal to a corresponding 

amount of FA stock. The distribution rights 

on liquidation (or redemption) provided by 

the class B partnership interests, therefore, 

are substantially similar in all material 

respects to distribution rights on liquidation 

(or redemption) provided by the FA stock. 

Thus, the distribution rights provided by the 

class B partnership interests are substantially 

similar in all material respects to the 

distribution rights provided by the publicly 

traded FA stock. As a result, if treating the 

class B partnership interests as FA stock 

would have the effect of treating FA as a 

surrogate foreign corporation, under 

paragraph (k)(1) of this section the class B 

partnership interests shall be treated as FA 

stock for purposes of section 7874. 

Example 19. Creditor treated as a 

shareholder. (i) Facts. Individuals A and B 

equally own DC1. The liabilities of DC1 

exceed the value of its assets. Pursuant to a 

plan, FA, a newly-formed corporation, 

acquires substantially all of the properties 

held by DC1 in exchange solely for FA stock. 

Pursuant to the plan, the DC1 stock held by 

individuals A and B is cancelled, and the 

creditors of DC1 receive all the FA stock in 

exchange for their claims against DC1. 

(ii) Analysis. Because immediately before 

the first date on which properties are 

acquired as part of the acquisition described 

in section 7874(a)(2)(B)(i) the liabilities of 

DC1 exceed the value of its assets, under 

paragraph (k)(2)(i) of this section, for 

purposes of section 7874 the creditors of DC1 

are treated as shareholders of DC1 and the 

creditors’ claims against DC1 are treated as 

DC1 stock. Therefore, for purposes of section 

7874(a)(2)(B)(ii) the FA stock received by the 

creditors of DC1 by reason of their claims 

against DC1 is considered held by former 

shareholders of DC1 by reason of holding 

DC1 stock. 

Example 20. Conversion to a domestic 

corporation and application of section 367. 

(i) Facts. Individuals A and B are United 

States persons and equally own DC1. 

Pursuant to a plan, individuals A and B 

transfer their DC1 stock to FA in exchange 

solely for 80 percent of the outstanding FA 

stock. After the acquisition, the expanded 

affiliated group that includes FA does not 

have substantial business activities in 

Country A when compared to the total 

business activities of the expanded affiliated 

group. 

(ii) Analysis. Under paragraph (c)(1)(i) of 

this section, for purposes of section 

7874(a)(2)(B)(i) FA is treated as acquiring all 

of the properties held by DC1 on the date of 

the stock acquisition. After the acquisition, 

the former shareholders of DC1 own 80 

percent of the stock of FA by reason of 

holding DC1 stock. Therefore, FA is a 

surrogate foreign corporation that is treated 

as a domestic corporation under section 

7874(b). Under paragraph (m)(1) of this 

section, except for purposes of determining 

whether FA is treated as a surrogate foreign 

corporation, the conversion of FA to a 

domestic corporation shall constitute a 

reorganization described in section 

368(a)(1)(F) that occurs immediately before 

the stock acquisition. Section 367 applies to 

the conversion of FA to a domestic 

corporation. See, for example, §§ 1.367(b)–2 

and 1.367(b)–3 for the consequences of the 

conversion. Under paragraph (m)(3) of this 

section, section 367 does not apply to the 

transfers of DC1 stock by individuals A and 

B to FA. 

(o) Effective/applicability date—(1) 

Temporary regulations filed on June 9, 

2009. This section shall apply to 

acquisitions completed on or after June 

9, 2009. However, taxpayers may apply 

this section to acquisitions completed 

before June 9, 2009, if this section is 

applied consistently to all acquisitions 

completed before such date. 

(2) Application of prior temporary 

regulations to certain acquisitions 

completed on or after June 6, 2006. 

Section 1.7874–2T, as contained in 26 

CFR part 1 revised as of April 1, 2009, 

shall not apply to acquisitions 

completed on or after June 6, 2006, 

pursuant to a written agreement that 

was (subject to customary conditions) 

binding on December 28, 2005, and at 

all times thereafter (binding 

commitment). A binding commitment 

shall include options and similar 

interests entered into in connection 

with one or more written agreements 

described in the preceding sentence. 

Accordingly, § 1.7874–2T, as contained 

in 26 CFR part 1 revised as of April 1, 

2009, shall not apply to acquisitions 

that occur, in whole or in part, as a 

result of the exercise of such options or 

similar interests. 

(p) Expiration date. The applicability 

of this section expires on or before June 

8, 2012. 

Linda E. Stiff, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: June 8, 2009. 

Michael Mundaca, 

Acting Assistant Secretary of the Treasury 

(Tax Policy). 

[FR Doc. E9–13770 Filed 6–9–09; 11:15 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 165 

[Docket No. USCG–2008–1261] 

RIN 1625–AA00 

Safety Zone; AVI July Fireworks 

Display; Laughlin, NV 

AGENCY: Coast Guard, DHS. 

ACTION: Temporary final rule. 

SUMMARY: The Coast Guard is 

establishing a safety zone on the 

navigable waters of the lower Colorado 

River, Laughlin, NV, in support of a 

fireworks display near the AVI Resort 

and Casino. This safety zone is 

necessary to provide for the safety of the 

participants, crew, spectators, 

participating vessels, and other vessels 

and users of the waterway. Persons and 

vessels are prohibited from entering 

into, transiting through, or anchoring 

within this safety zone unless 

authorized by the Captain of the Port, or 

his designated representative. 

DATES: This rule is effective from 8:15 

p.m. to 9:15 p.m. on July 4, 2009. 

ADDRESSES: Comments and material 

received from the public, as well as 

documents mentioned in this preamble 

as being available in the docket, are part 

of docket USCG–2008–1261 and are 

available online by going to http:// 

www.regulations.gov, selecting the 

Advanced Docket Search option on the 

right side of the screen, inserting USCG– 

2008–1261 in the Docket ID box, 

pressing Enter, and then clicking on the 

item in the Docket ID column. This 

material is also available for inspection 

or copying at the Docket Management 

Facility (M–30), U.S. Department of 

Transportation, West Building Ground 

Floor, Room W12–140, 1200 New Jersey 

Avenue, SE., Washington, DC 20590,