NEW RULES CLOSE LOOPHOLE FOR CERTAIN WIDELY HELD CORPORATIONS.

Notice 94-46

The purpose of this notice is to announce certain rules that will be incorporated into regulations under section 367(a) of the Internal Revenue Code.

BACKGROUND

Section 367(a)(1) provides that if a U.S. person transfers property to a foreign corporation in an exchange described in section 332, 351, 354, 356, or 361, the foreign corporation will not be considered a corporation for purposes of determining whether gain is recognized on the transaction, unless an enumerated exception to this rule applies. Thus, in the absence of an applicable exception to this rule, the transfer will be treated as a taxable exchange.

Temporary regulations issued under section 367(a) set forth certain exceptions to the general gain recognition rule of section 367(a)(1) in the case of transfers of stock or securities of a domestic or foreign corporation by a U.S. person to a foreign corporation. See Reg. section 1.367(a)-3T. Notice 87-85, 1987-2 C.B. 395, substantially modified these rules.

Notice 87-85 provides that section 367(a)(1) will not apply to a U.S. person who transfers stock or securities to a foreign corporation if the U.S. person owns less than 5 percent of both the total voting power and the total value of the stock of the transferee corporation immediately after the exchange. If the U.S. person owns 5 percent or more of either the total voting power or the total value of the stock of the transferee corporation, the transfer of stock or securities generally will not be subject to section 367(a)(1) if the U.S. person enters into a gain recognition agreement. Pursuant to the agreement, the U.S. person must file an amended return and recognize the gain realized on the exchange if the transferee corporation disposes of the transferred stock within a specified period of time (i.e., 5 or 10 years, depending on the facts) following the transaction. However, a transaction will be taxable under section 367(a)(1) if a U.S. person transfers the stock or securities of a domestic corporation to a foreign corporation and the U.S. person owns more than 50 percent of the total voting power or total value of the transferee corporation's stock immediately after the exchange.

For purposes of determining the ownership of the transferee corporation, the attribution rules of section 958 apply. In cases where a taxpayer cannot determine the ownership of the transferee corporation, it will be presumed that U.S. transferors own 50 percent or more of the total voting power or total value of the transferee corporation's stock immediately after the exchange.

Similar rules have been included in proposed regulations under section 367(a). See Prop. Reg. section 1.367(a)-3(b).

MODIFICATION OF RULES UNDER SECTION 367(a)

The Internal Revenue Service and Treasury Department are concerned that widely-held U.S. companies with foreign subsidiaries recently have undertaken certain restructurings for tax-motivated purposes. These restructurings typically involve a transfer of the stock of the domestic parent corporation to an existing foreign subsidiary or a newly-formed foreign corporation in exchange for shares of the foreign corporation in a transaction intended to qualify for nonrecognition treatment under the Code. Following the transaction, the former shareholders of the domestic corporation own stock of a foreign corporation that typically is not a controlled foreign corporation ("CFC") within the meaning of section 957 of the Code.

The Internal Revenue Service and Treasury Department are concerned that these transactions, or related transactions undertaken pursuant to the restructurings, present opportunities for avoidance of U.S. tax. The regulations under section 367(a), therefore, will be modified to provide that the transfer of stock or securities of a domestic corporation by a U.S. person to a foreign corporation is taxable under section 367(a)(1) if all U.S. transferors own in the aggregate 50 percent or more of either the total voting power or the total value of the stock of the transferee corporation immediately after the exchange. In cases where, immediately after the exchange, the domestic corporation owns, directly or indirectly (applying the attribution rules of section 267(c)(1) and (5)), stock of the transferee corporation, that stock will not be taken into account in determining whether the U.S. transferors own in the aggregate 50 percent or more of the total voting power or total value of the stock of the transferee corporation immediately after the exchange.

These provisions will apply to transfers occurring on or after April 18, 1994. The Internal Revenue Service and Treasury Department invite comments on possible exceptions to the provisions. Such exceptions could include cases where a domestic corporation is acquired by a foreign corporation that is engaged in an active trade or business and is unrelated to the domestic corporation or its shareholders, or where the transferee corporation is a CFC following the exchange (including cases where a single U.S. transferor owns more than 50 percent of the stock of the transferee corporation following the transaction). The Internal Revenue Service and Treasury Department also solicit comments on whether special rules should be provided for determining the ownership of the transferee corporation in cases where the corporation is publicly traded.

This notice addresses the tax treatment of certain transfers of stock or securities only under section 367 of the Code. No inference should be drawn from this notice regarding the taxation of affected transactions under other provisions of the Code.

For further information regarding this notice contact Bernard T. Bress of the Office of Associate Chief Counsel (International) on (202) 622-3850 (not a toll-free call).