IRS ISSUES GUIDANCE ON OUTBOUND TRANSFERS UNDER SECTION 367(a)(1); TEN-YEAR CLOSING AGREEMENT IF MORE THAN 50 PERCENT STOCK TRANSFERRED.

Notice 87-85

The Internal Revenue Service today announced rules that will be incorporated in final regulations governing certain transfers of stock and securities under section 367(a) of the Internal Revenue Code of 1986.

Section 367(a)(1) of the Code generally provides that, for purposes of applying the corporate organization, reorganization, and liquidation provisions to a U.S. person's transfer of property to a foreign corporation, the foreign corporation will not be considered to be a corporation unless the transfer falls within one of the listed exceptions to the rule. Therefore, the transfer will generally be treated as a taxable exchange.

The current temporary regulations provide that a transfer of stock or securities by a U.S. person to a foreign corporation in connection with an exchange described in section 332, 351, 354, 356 (as it relates to section 354 exchanges), or 361 of the Code is subject to section 367(a)(1) unless one of several exceptions described in the regulations applies. To qualify for most of the exceptions, the U.S. transferor must enter into a gain recognition agreement with the Internal Revenue Service pursuant to section 1.367(a)-3T(g) of the temporary regulations. The gain recognition agreement provides that, if the transferee foreign corporation disposes of the transferred stock prior to the close of the fifth taxable year following the taxable year of the initial transfer, the transferor will file an amended return for the year of the initial transfer and recognize the gain realized but not recognized on the initial transfer.

Under the temporary regulations, two of the exceptions that apply to the transfer of both domestic and foreign stock and securities focus on the percentage of the transferee foreign corporation's stock owned immediately after the transfer by all U.S. persons that transferred any type of property (including stock) to the transferee foreign corporation. Transfers of domestic or foreign stock or securities by U.S. transferors who own in the aggregate fifty percent or more of the transferee foreign corporation's stock immediately after the transfer are excepted from section 367(a)(1) of the Code only in limited circumstances. These limited exceptions include transfers of domestic or foreign stock or securities that constitute an operating asset of the U.S. transferor, and certain transfers of foreign stock or securities where the transferred foreign corporation and the transferee foreign corporation either constitute an integrated business or are created or organized under the laws of the same foreign country.

The final regulations, when issued, will simplify the stock transfer rules by providing generally uniform exceptions to section 367(a)(1) of the Code for transfers of both domestic and foreign stock or securities. The exceptions under the final regulations will be based generally on the percentage of the transferee foreign corporation's stock that the U.S. transferors own immediately after the transfer. In response to public comments, the final regulations will be liberalized to permit an exception to section 367(a)(1) of the Code for certain transfers of domestic or foreign stock or securities where immediately after the transfer all U.S. transferors own fifty percent or more of the transferee foreign corporation's stock, provided that certain U.S. transferors enter into a ten-year gain recognition agreement.

In no event will any exception to section 367(a)(1) of the Code, including those described below, apply to the transfer of stock of a foreign corporation in which the U.S. transferor is a United States shareholder (as defined in section 7.367(b)-2(b) of the temporary regulations or section 953(c) of the Code) unless the U.S. transferor receives back stock in a controlled foreign corporation (as defined in section 953(c) or section 957(a) or section 957(b) of the Code) as to which the U.S. transferor is a United States shareholder immediately after the transfer. Furthermore, in no event will an exception to section 367(a)(1) of the Code apply to the transfer of stock or securities in a domestic corporation to a foreign corporation where the U.S. transferor owns (applying the attribution rules of section 958) more than fifty percent of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer.

Specifically, the exceptions will be as follows:

(1) Each U.S. transferor of stock or securities who owns less than 5 percent of both the total voting power and the total value of the stock of the transferee foreign corporation immediately after the transfer will not be subject to section 367(a)(1) of the Code and will not have to enter into a gain recognition agreement;

(2) If the U.S. transferors in the aggregate own less than fifty percent of both the total voting power and the total value of the stock of the transferee foreign corporation immediately after the transfer, the transfer by a U.S. transferor of stock or securities that owns five percent or more of the total voting power or the total value of the transferee foreign corporation's stock immediately after the transfer will not be subject to section 367(a)(1) of the Code if that U.S. transferor enters into a five-year gain recognition agreement as provided in section 1.367(a)-3T(g) of the temporary regulations; and

(3) If all U.S. transferors in the aggregate own fifty percent or more of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer, a transfer by a U.S. transferor of stock or securities owning five percent or more of the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer will not be subject to section 367(a)(1) of the Code if that U.S. transferor enters into a gain recognition agreement as provided in section 1.367(a)-3T(g) of the temporary regulations except that a ten-year period shall be substituted for the five-year term of agreement specified in the temporary regulations.

The term "U.S. transferor" shall include a U.S. person who transfers property other than stock or securities. In determining the ownership of stock for purposes of these exceptions the rules of section 958 shall apply.

If a U.S. transferor cannot determine whether all of the U.S. transferors own in the aggregate less than fifty percent of both the total voting power and the total value of the stock of the transferee foreign corporation immediately after the transfer, the U.S. transferors will be deemed to own in the aggregate fifty percent or more of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer.

Since the stock transfer rules under the final regulations will depend generally on the amount of stock the U.S. transferors own in the transferee foreign corporation after the transfer, the operating asset, consolidation of integrated business, and same-country stock transfer exceptions from 367(a)(1) of the Code under the temporary regulations will be omitted from the final regulations.

The rules described above, when incorporated in final regulations, will apply to transactions occurring after December 16, 1987. The final regulations will specify the extent to which these rules may be applied with respect to transactions occurring on or before December 16, 1987. This document serves as an "administrative pronouncement" as that term is used in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.