Final Regs on Corporate Distributions to Foreign Corporations

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final Income Tax Regulations relating to the distribution of stock and securities under section 355 and section 367(e)(1) of the Internal Revenue Code of 1986 by a domestic corporation to a person who is not a United States person. These regulations are necessary to implement section 367(e)(1) as added by the Tax Reform Act of 1986. The regulations affect the taxability of the corporation making the distribution.

 DATE: These regulations are effective January 16, 1993.

 FOR FURTHER INFORMATION CONTACT: Leslie A. Cracraft or Willard W. Yates of the Office of Associate Chief Counsel (International), Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224 ((202) 622-3850 (Yates) or (202) 622-3860 (Cracraft)) (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)) under control number 1545-1124. The estimated annual burden per respondent varies from 2 hours to 10 hours, depending on individual circumstances, with an estimated average of 8 hours.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, D.C. 20224, and to the Office of Management and Budget, Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503.

BACKGROUND

On January 16, 1990, temporary regulations section 1.367(e)-1T were adopted (as part of T.D. 8280) [1990-1 C.B. 80] and published in the Federal Register at 55 FR 1406. A cross-referenced Notice of Proposed Rulemaking for section 1.367(e)-1 was published on that same date at 55 FR 1472. These amendments, in part, were proposed to implement section 367(e)(1) of the Internal Revenue Code of 1986, as revised by sections 631(d)(1) and 1810(g) of the Tax Reform Act of 1986 (100 Stat. 2085, 2272, Pub. L. 99-514). The regulations were issued under the authority contained in section 367(e)(1) and section 7805(a).

 Written comments responding to the notice were received. There were no requests for a public hearing. After consideration of all written comments relating to section 1.367(e)-1, this section of the proposed regulations is adopted as revised by this Treasury decision.

NEED FOR IMMEDIATE EFFECTIVE DATE FOR FINAL REGULATIONS

 The regulations under section 367(e)(1) will apply to the subject outbound distributions occurring on or after January 16, 1993. These regulations will clarify and simplify the law and provide taxpayers with immediate guidance needed to effectuate outbound distributions and will resolve uncertainty as to the tax consequences and reporting obligations with respect to such transactions. This effective date is also necessary to prevent avoidance of tax and to provide regulatory relief in certain instances. Accordingly, these regulations are not subject to the effective date limitation of 5 U.S.C. section 553(d).

EXPLANATION OF PROVISIONS

IN GENERAL

 The final regulations provide rules concerning the recognition of gain by a domestic corporation on a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic or foreign corporation to a person who is not a United States person. The regulations provide, as a general rule, that gain recognition is required on such a distribution. However, the final regulations follow the proposed regulations, with certain modifications, in providing three exceptions to this rule in the case of distributions of stock or securities of domestic controlled corporations: the U.S. real property holding corporation exception, the publicly traded exception, and the 5-year gain recognition agreement exception.

 In response to the proposed regulations, one commentator proposed that an exception to the general gain recognition rule be provided in cases where the foreign distributee agrees to subject to U.S. tax any gain realized on a disposition of the stock or securities of the distributing or controlled corporation within a 5 year period following the distribution. Such an exception was not included in the final regulations because of concerns about the administrative difficulties and complexities of collecting a shareholder-level tax, as well as concerns about the inconsistency of such an approach with the general principles of section 367. However, the Service intends to continue to study this alternative and solicits taxpayer comments on the proposal, including suggestions on how to administer such an election.

 Some commentators suggested that the exceptions to the general gain recognition rule be made applicable to distributions of stock or securities of foreign corporations. This suggestion was not adopted in the final regulations because the distribution of stock of a foreign corporation in a section 355 transaction will generally result in a complete loss of U.S. corporate taxing jurisdiction over the stock of the foreign corporation and its assets.

DISTRIBUTIONS TO PARTNERSHIPS, TRUSTS AND ESTATES

 Both foreign and domestic persons often hold interests in domestic corporations through pass-through entities. Accordingly, the final regulations apply aggregate principles to stock owned by a domestic or foreign partnership, trust or estate. The regulations generally apply the constructive ownership principles of section 318 in determining the ownership of stock or securities of the distributing or controlled corporation owned by a partnership, trust or estate (whether foreign or domestic). Thus, if under section 355 a domestic corporation distributes stock of a controlled corporation to a partnership that is owned by two equal partners, one domestic and one foreign, the distributing corporation must recognize gain under section 367(e)(1) with respect to one-half of the stock distributed to the partnership. The Service is studying the determination of a beneficiary's actuarial interest in a trust, and may issue further guidance on this subject at a future date.

 The final regulations generally do not permit a distributing corporation to qualify for nonrecognition under the 5-year gain recognition agreement exception on a distribution to a pass-through entity with respect to foreign persons holding interests in the pass- through entity. The Service is concerned that allowing foreign persons holding interests in pass-through entities to qualify for the exception would excessively complicate the exception and impose an undue administrative burden on the Service. The Service, however, recognizes that the denial of the exception to foreign persons holding interests in pass-through entities may be unduly harsh in certain circumstances. Therefore, the regulations permit a distributing corporation to obtain a ruling from the Service applying the exception to foreign persons holding interests in pass-through entities, and intends to publish a revenue procedure describing the conditions for obtaining such a ruling.

ANTI-ABUSE RULE

 The final regulations provide an anti-abuse rule to address situations in which a domestic corporation is formed or availed of by one or more foreign persons to hold the stock of a distributing corporation for a principal purpose of avoiding the requirements of section 367(e)(1) and these regulations. If the rule applies, the distribution will be treated as having been made to the foreign persons, who will then be treated as having transferred the distributed stock (and distributing stock, as the case may be) to the domestic corporation. If gain recognition on the distribution, as resequenced, can be avoided by filing a 5-year gain recognition agreement, gain recognition will not be required if the subsequent transfer to the domestic corporation qualifies under the successor- in-interest rules described below.

U.S. REAL PROPERTY HOLDING CORPORATION EXCEPTION

 The final regulations include the exception contained in the proposed regulations applicable to a distribution of the stock of a U.S. real property holding corporation by a corporation that continues to be a U.S. real property holding corporation after the distribution. Some commentators suggested that this exception be revised to provide for nonrecognition on any distribution of the stock of a U.S. real property holding corporation, even if the distributing corporation no longer qualifies as a U.S. real property holding corporation after the distribution. This approach was not adopted because the exception is premised on continuing U.S. taxing jurisdiction over shareholder-level gain on the stock of both the distributing and controlled corporation. Such a distribution could qualify for one of the other exceptions to the general gain recognition rule (assuming the requirements of the exception are satisfied).

PUBLICLY TRADED EXCEPTION

 The final regulations revise the publicly traded exception contained in the proposed regulations. The final regulations retain the requirement for nonrecognition on a distribution of stock or securities of a domestic controlled corporation that more than 80 percent of the stock (measured by value) of the controlled corporation be distributed with respect to one or more publicly traded classes of stock of the distributing corporation. The final regulations, however, eliminate the requirement in the proposed regulations that 80 percent or more of the stock of the distributing corporation be publicly traded.

 The final regulations also provide that a distributing corporation may obtain nonrecognition on the distribution of stock of a domestic controlled corporation to more-than-five-percent foreign shareholders of a publicly traded corporation under the U.S. real property holding corporation exception or the 5-year gain recognition agreement exception if all of the requirements of the relevant exception are satisfied. These exceptions may also apply to a distribution to non-publicly traded classes of stock of a publicly traded corporation.

5-YEAR GAIN RECOGNITION AGREEMENT EXCEPTION

 The final regulations liberalize and simplify the 5-year gain recognition agreement exception contained in the proposed regulations. In general, no gain is immediately recognized on the distribution of stock or securities of a domestic controlled corporation to a foreign distributee if the distributing corporation agrees to file an amended return and recognize such gain upon a disposition by the foreign distributee of the stock or securities of the distributing or controlled corporation within 60 months after the end of the taxable year of the distributing corporation in which the distribution was made. The foreign distributee must make annual certifications concerning its ownership of the stock during the 60- month period.

 Under the proposed regulations, this exception applied only if the distributing corporation was wholly-owned by five or fewer individual or corporate shareholders. The final regulations permit this exception to be claimed for a distribution to 10 or fewer foreign distributees, regardless of the number of shareholders of the corporation. The requirement that the foreign distributees be individuals or corporations generally has been retained because of the administrative difficulties of applying this exception to other types of taxpayers. Thus, except where the distributing corporation obtains a ruling from the Service to the contrary, distributions to partnerships, trusts or estates with foreign interest holders do not qualify for nonrecognition under this exception.

 Under the proposed regulations, this exception applied only if, immediately before the distribution, at least 90 percent of the stock of the distributing corporation had a holding period of at least two years in the hands of the shareholders. In light of the enactment of section 355(d), this requirement has not been included in the final regulations.

 Under the proposed regulations, to qualify for the exception in the case of a distribution to a foreign corporation, the fair market value of the stock of the distributing corporation owned by the foreign corporation immediately before the distribution could not equal or exceed 50 percent of the fair market value of all of the foreign corporation's stock immediately before the distribution. This anti-holding company provision has been replaced in the final regulations with a requirement that the foreign corporate distributee be engaged in the active conduct of a trade or business (determined without regard to the trade or business conducted by the distributing or controlled corporation) until the end of the 60-month period following the taxable year of the distribution. The determination of whether the distributee is engaged in an active trade or business generally is made in accordance with the provisions of section 355(b)(2)(A).

 In the case of a distribution of stock or securities of a controlled corporation that is not part of the distributing corporation's consolidated return group, the final regulations retain the rule in the proposed regulations that, immediately after the distribution, the stock of the distributing corporation must have a fair market value at least equal to the fair market value of the distributed stock and securities of the controlled corporation. The fair market value requirement ensures that the distributing corporation retains sufficient assets to meet potential tax liabilities if gain is subsequently recognized under the 5-year gain recognition agreement. However, the final regulations provide that, if a controlled corporation is part of the distributing corporation's consolidated return group for one or more taxable years in which all of the stock and securities of the controlled corporation are distributed, and thus is severally liable for any tax on gain recognized on the distribution, the fair market value requirement does not apply.

 The proposed regulations provided that, if a foreign distributee disposed of any of the stock or securities of the distributing or controlled corporation within the 60-month period covered by the gain recognition agreement, the entire amount of gain realized by the distributing corporation on the distribution to the foreign distributee would be recognized. The final regulations provide that only a proportionate amount of gain is recognized, determined by reference to the portion of stock and securities of the distributing corporation and controlled corporation disposed of by the foreign distributee.

 The final regulations permit the stock or securities of the distributing or controlled corporation to be disposed of by the foreign distributee in certain nonrecognition transactions without causing gain to be recognized under the gain recognition agreement. The rules have been designed to provide taxpayers with flexibility to restructure their operations, without imposing undue administrative burdens on the Service. The Service solicits taxpayer comments on the scope of these rules.

 The final regulations follow the proposed regulations in providing that the distributing corporation must amend its income tax return for the year of the distribution in the event gain is required to be recognized. Interest must be paid on any additional tax incurred.

REGULATIONS UNDER SECTION 367(e)(2)

 The temporary regulations under section 367(e)(2) that were proposed with the regulations under section 367(e)(1) will be promulgated as final regulations in a separate Treasury decision. The final regulations under section 367(e)(2) will be effective with respect to distributions occurring on or after January 16, 1993. However, taxpayers will be given the option to apply the provisions of the current temporary regulations to distributions occurring on or after January 16, 1993 but prior to the date that is 30 days after the date on which the final section 367(e)(2) regulations are published in the Federal Register.

EFFECTIVE DATE

 These regulations are effective with respect to distributions occurring on or after January 16, 1993. However, a corporation may elect to apply the regulations (subject to certain elective exceptions) to all distributions made by it after February 15, 1990 (the date the temporary regulations under section 367(e)(1) became effective), to which this section applies by timely filing an original or amended return for the year of distribution and otherwise complying with these regulations.

SPECIAL ANALYSES

 It has been determined that these regulations are not major rules as defined in Executive Order 12291. Therefore, a final Regulatory Impact Analysis is not required. It has also been determined that a prior notice of proposed rulemaking was required by the Administrative Procedure Act. It is hereby certified that these rules will not have a significant impact on a substantial number of small entities. Few small entities would be affected by these regulations. A Regulatory Flexibility Analysis, therefore, is not required under section 604 of the Regulatory Flexibility Act (5 U.S.C. chapter 6). Pursuant to section 7805(f) of the Internal Revenue Code, a copy of the notice of proposed rulemaking was submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 Various personnel from the Office of the Associate Chief Counsel (International), Internal Revenue Service, other offices of the Internal Revenue Service and the Treasury Department participated in developing these regulations.

LIST OF SUBJECTS

26 CFR 1.361-1 THROUGH 1.367(E)-2T

 Income taxes, Reporting and recordkeeping requirements.

26 CFR PART 602

 Reporting and recordkeeping requirements.

Treasury Decision 8472

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for part 1 is amended by adding a citation to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.367(e)-1 also issued under 26 U.S.C. 367 (e). * * *

Par. 2. Sections 1.367(e)-0T and 1.367(e)-1T are removed as of January 16, 1993.

Par. 3. Sections 1.367(e)-0 and 1.367(e)-1 are added to read as follows:

SECTION 1.367(e)-0 TREATMENT OF DISTRIBUTIONS OR LIQUIDATIONS UNDER SECTION 367(e); TABLE OF CONTENTS

This section lists captioned paragraphs contained in section 1.367(e)-1.

 SECTION 1.367(e)-1 DISTRIBUTIONS DESCRIBED IN SECTION 367(e)(1)

(a) PURPOSE AND SCOPE. This section provides rules concerning the recognition of gain by a domestic corporation on a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic or foreign corporation to a person who is not a United States person. Paragraph (b) of this section states as a general rule that gain recognition is required on the distribution. Paragraph (c) of this section provides exceptions to the gain recognition rule of paragraph (b) of this section for certain distributions of stock or securities of a domestic corporation. Paragraph (d) of this section refers to other consequences of distributions described in this section. Paragraph (e) of this section provides examples of the rules of paragraphs (b), (c) and (d) of this section. Finally, paragraph (f) of this section specifies the effective date of this section.

(b) RECOGNITION OF GAIN REQUIRED -- (1) IN GENERAL. If a domestic corporation (distributing corporation) makes a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic or foreign corporation (controlled corporation) to a person who is not a United States person, as defined in section 367(a) and the regulations thereunder (foreign distributee), then, except as provided in paragraph (c) of this section, the distributing corporation shall recognize gain (but not loss) on the distribution under section 367(e)(1).

(2) COMPUTATION OF GAIN OF THE DISTRIBUTING CORPORATION. The gain recognized by the distributing corporation under paragraph (b)(1) of this section shall be equal to the excess of the fair market value of the stock or securities distributed to the foreign distributee (determined as of the time of the distribution) over the distributing corporation's adjusted basis in the stock or securities distributed to the foreign distributee. For purposes of the preceding sentence, the distributing corporation's adjusted basis in each unit of each class of stock or securities distributed to a foreign distributee shall be equal to the distributing corporation's total adjusted basis in all of the units of the respective class of stock or securities owned immediately before the distribution, divided by the total number of units of the class of stock or securities owned immediately before the distribution.

(3) TREATMENT OF THE DISTRIBUTEE. If the distribution otherwise qualifies for nonrecognition under section 355, each distributee shall be considered to have received stock or securities in a distribution qualifying for nonrecognition under section 355, even though the distributing corporation recognizes gain on the distribution. Thus, the distributee shall not be considered to have received a distribution described in section 301 or a distribution in an exchange described in section 302(b) upon the receipt of the stock or securities of the controlled corporation.

(4) NONAPPLICATION OF SECTION 367(a) PRINCIPLES THAT PROVIDE FORE EXCEPTIONS TO GAIN RECOGNITION. Paragraph (b)(1) of this section requires recognition of gain notwithstanding the application of any principles contained in section 367(a) or the regulations thereunder. The only exceptions to paragraph (b)(1) of this section are contained in paragraph (c) of this section. None of these exceptions applies to a distribution of stock or securities of a foreign corporation.

(5) PARTNERSHIPS, TRUSTS AND ESTATES. (i) IN GENERAL. For purposes of this section, stock or securities owned by or for a partnership (whether foreign or domestic) shall be considered to be owned proportionately by its partners. In applying this principle, the proportionate share of the stock or securities of the distributing corporation considered to be owned by a partner of a partnership at the time of the distribution shall equal the partner's distributive share of gain that would be realized by the partnership from a sale of the stock of the distributing corporation immediately before the distribution (without regard to whether, under the particular facts, any gain would actually be realized on the sale for U.S. tax purposes), determined under the rules and principles of sections 701 through 761 and the regulations thereunder. For purposes of this section, stock or securities owned by or for a trust or estate (whether foreign or domestic) shall be considered to be owned proportionately by the persons who would be treated as owning such stock or securities under sections 318(a)(2)(A) and 318(a)(2)(B). In applying section 318(a)(2)(B), if a trust includes interests that are not actuarially ascertainable and a principal purpose of the inclusion of the interests is the avoidance of section 367(e)(1), all such interests shall be considered to be owned by foreign persons. In a case where an interest holder in a partnership, trust or estate that owns stock of the distributing corporation is itself a partnership, trust or estate, the rules of this paragraph (b)(5) apply to individuals or corporations that own (direct or indirect) interests in the upper-tier partnership, trust or estate.

(ii) WRITTEN STATEMENT. If prior to the date on which the distributing corporation must file its income tax return for the year of the distribution, the corporation obtains a written statement, signed under penalties of perjury by an interest holder in a partnership, trust, or estate, that certifies that the interest holder is a United States person who is an individual or corporation, no liability shall be imposed under paragraph (b)(1) of this section with respect to the distribution to the interest holder, unless the distributing corporation knows or has reason to know that the statement is false. The written statement must set forth the amount of the interest holder's proportionate interest in the distributing corporation, as well as the interest holder's name, taxpayer identification number, home address (in the case of an individual) or office address and place of incorporation (in the case of a corporation). The written statement must be retained by the distributing corporation with its books and records for a period of three calendar years following the close of the last calendar year in which the corporation relied upon the statement. If the distributing corporation instead relies upon other evidence of the interest holder's status as a United States person or of the amount of the interest holder's proportionate interest, liability shall be imposed under paragraph (b)(1) of this section if the interest holder, in fact, is not a United States person or the amount of its proportionate interest is not established.

(6) ANTI-ABUSE RULE. If a domestic corporation is directly or indirectly formed or availed of by one or more foreign persons to hold the stock of a second domestic corporation for a principal purpose of avoiding the application of section 367(e)(1) and the requirements of this section, any distribution of stock or securities to which section 355 applies by such second domestic corporation shall be treated for federal income tax purposes as a distribution to such foreign person or persons, followed by a transfer of the stock or securities to the domestic corporation. The qualification of the distribution to the foreign person for an exception to the general gain recognition rule of paragraph (b)(1) of this section, and the consequences of the transfer to the domestic corporation under this section, shall be determined in accordance with all of the facts and circumstances.

(c) NONRECOGNITION OF GAIN -- (1) DISTRIBUTION BY A U.S. REAL PROPERTY HOLDING CORPORATION OF STOCK IN A SECOND U.S. REAL PROPERTY HOLDING CORPORATION. U.S. REAL PROPERTY HOLDING CORPORATION. Gain shall not be recognized under paragraph (b) of this section by a domestic corporation making a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic controlled corporation to a foreign distributee if, immediately after the distribution, both the distributing and controlled corporations are U.S. real property holding corporations (as defined in section 897 (c)(2)). For the treatment of the distribution under section 897, see section 897(e)(1) and the regulations thereunder.

(2) DISTRIBUTION BY A PUBLICLY TRADED CORPORATION -- (i) CONDITIONS FOR NONRECOGNITION. Gain shall not be recognized under paragraph (b) of this section by a domestic corporation making a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic controlled corporation to a foreign distributee if both of the following conditions are satisfied:

(A) Stock of the domestic controlled corporation with a value of more than 80 percent of the outstanding stock of the corporation is distributed with respect to one or more classes of the outstanding stock of the distributing corporation that are regularly traded on an established securities market, as defined in section 1.897-1(m)(1) and (3), located in the United States. Stock is considered to be regularly traded if it is regularly quoted by brokers or dealers making a market in such interests. A broker or dealer is considered to make a market only if the broker or dealer holds himself out to buy or sell interests in the stock at the quoted price.

(B) At the time of the distribution, the distributing corporation does not know or have reason to know that the subject foreign distributee owns, directly or constructively, more than 5 percent (by value) of a class of stock of the distributing corporation with respect to which the stock of the controlled corporation is distributed. For purposes of determining whether a foreign distributee owns, directly or constructively, more than 5 percent (by value) of a class of stock of the distributing corporation, the rules of section 897(c)(3) and the regulations thereunder shall apply, except as otherwise provided herein.

(ii) RELATION TO OTHER NONRECOGNITION PROVISIONS. If the distribution of the stock and securities of the controlled corporation also qualifies for nonrecognition under paragraph (c)(1) of this section, the distributing corporation shall be entitled to nonrecognition under paragraph (c)(1) of this section and not this paragraph (c)(2). The distributing corporation may obtain nonrecognition treatment under paragraph (c)(1) or (c)(3) of this section with respect to a foreign distributee that owns more than 5 percent of a class of stock of the distributing corporation, if all of the requirements of either of those paragraphs is satisfied.

(3) DISTRIBUTION OF CERTAIN DOMESTIC STOCK TO 10 OR FEWER FOREIGN DISTRIBUTEES. -- (i) IN GENERAL. Gain shall not be recognized under paragraph (b) of this section by a domestic corporation making a distribution that qualifies for nonrecognition under section 355 of stock or securities of a domestic controlled corporation to a foreign distributee if each of the conditions of this paragraph (c)(3) is satisfied.

(ii) CONDITIONS FOR NONRECOGNITION. A distribution of stock or securities described in paragraph (c)(3)(i) of this section to a foreign distributee shall not result in the recognition of gain if each of the following conditions is satisfied:

(A)(1) There are 10 or fewer foreign distributees for which nonrecognition is claimed under this paragraph (c)(3), each of whom is either an individual or a corporation as defined in section 7701(a)(3) of the Internal Revenue Code.

(2) Unless the distributing corporation obtains a ruling from the Internal Revenue Service to the contrary, no foreign distributee shall be entitled to claim nonrecognition under this paragraph (c)(3) if it holds its interest in the distributing corporation through a partnership, trust or estate (whether foreign or domestic).

(3) If the distribution is made to more than 10 foreign distributees, the distributing corporation shall designate the 10 or fewer foreign distributees for which nonrecognition is claimed under this paragraph (c)(3).

(B) If the distributee for which nonrecognition is claimed under this paragraph (c)(3) is a foreign corporation, immediately after the distribution and at all times until the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributee is directly or indirectly engaged in the active conduct of a trade or business. To determine what constitutes an active conduct of a trade or business, see section 355(b)(2)(A) and the regulations thereunder. For purposes of this paragraph (c)(3)(ii)(B), a foreign distributee shall be considered to engage in the active conduct of a trade or business if it directly conducts the trade or business or if any corporation, 80% of the stock (measured by vote and value) of which it directly or indirectly owns, conducts the trade or business. However, for purposes of this paragraph (c)(3)(ii)(B), a foreign distributee will not be considered to engage in the active conduct of any trade or business engaged in, directly or indirectly, by the distributing corporation or controlled corporation. The requirements of this paragraph (c)(3)(ii)(B) will not be satisfied if, at any time until the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributee directly or indirectly engages in the active conduct of one or more trades or businesses that have a fair market value that is not substantial in relation to the fair market value of the stock of the foreign distributee for a principal purpose of complying with the requirements of this paragraph (a)(3)(ii)(B).

(C)(1) Immediately after the distribution, the stock of the distributing corporation has a fair market value that is at least equal to the fair market value of the distributed stock and securities of the controlled corporation immediately before the distribution.

(2) The requirements of paragraph (c)(3)(ii)(C)(1) of this section shall not apply if the distributing corporation distributes all of the stock and securities of the controlled corporation during one or more taxable years with respect to which the controlled corporation is severally liable under section 1.1502-6(a) for tax imposed on any gain required to be recognized by the distributing corporation pursuant to this paragraph (c)(3).

(D) Immediately after the distribution and at all times until the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributee is a resident of (if the foreign distributee is an individual), or is incorporated in (if the foreign distributee is a corporation), a foreign country that maintains a comprehensive income tax treaty with the United States that contains an information exchange provision to which the foreign distributee is subject. This requirement is satisfied during any period in which an individual foreign distributee is a resident of the United States.

(E) At all times until the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributee continues to own all of the stock and securities of the distributing and controlled corporations that the foreign distributee owned immediately after the distribution (including any stock and securities of the distributing or controlled corporation later acquired from the distributing or controlled corporation for which the distributee has a holding period determined under section 1223 by reference to such stock and securities).

(F) The distribution of stock or securities described in paragraph (c)(3)(i) of this section is not a distribution pursuant to which the distributing corporation goes out of existence.

(G) The distributing corporation files the agreement to recognize gain described in paragraph (c)(3)(iii) of this section with its income tax return for its taxable year in which the distribution is made. In addition, for each of the taxable years of the distributing corporation, beginning with the taxable year of the distribution and ending with the taxable year that includes the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the distributing corporation files with its income tax return the annual certifications described in paragraph (c)(3)(v) of this section.

(H) For each of the taxable years of the distributing corporation, beginning with the taxable year of the distribution and ending with the taxable year that includes the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributees for which nonrecognition is claimed under this paragraph (c)(3) provide to the distributing corporation the annual certifications described in paragraph (c)(3)(v) of this section.

(iii) AGREEMENT TO RECOGNIZE GAIN. The agreement to recognize gain required by this paragraph (c)(3)(iii) shall be prepared by or on behalf of the distributing corporation and signed under penalties of perjury by an authorized officer of the distributing corporation. The agreement provided by the distributing corporation shall set forth the following items, under the heading "GAIN RECOGNITION AGREEMENT UNDER SECTION 1.367(e)-1(c)(3)(iii)", with paragraphs labeled to correspond with such items:

(A) A declaration that the distribution is one to which section 1.367(e)-1(c)(3) applies.

(B) A description of each foreign distributee of the distributing corporation for which nonrecognition is claimed under this paragraph (c)(3), which shall include the distributee's --

(1) Name;

(2) Address;

(3) Taxpayer identification number (if any); and

(4) Residence and citizenship (in the case of an individual) or place of incorporation (in the case of a corporation).

(C) A description of the stock and securities of the distributing and controlled corporations owned immediately before and after the distribution by each distributee for which nonrecognition is claimed under this paragraph (c)(3), including --

(1) The number or amount of shares;

(2) The type of stock or securities;

(3) The fair market values of the stock and securities of the controlled corporation distributed to the foreign distributee, determined as of the date of the distribution;

(4) The fair market values of the stock and securities of the distributing corporation owned by the foreign distributee, determined immediately after the distribution;

(5) The total fair market values of the outstanding stock and securities of the distributing corporation, determined immediately after the distribution;

(6) The total fair market values of the distributed stock and securities of the controlled corporation, determined immediately before the distribution;

(7) The distributing corporation's adjusted basis in the distributed stock and securities immediately before the distribution (computed according to the provisions of paragraph (b)(2) of this section); and

(8) For each applicable valuation, a summary of the method (including appraisals, if any) used for determining the values required by this paragraph (c)(3)(iii).

(D) The distributing corporation's agreement to recognize gain in accordance with paragraph (c)(3)(vii) of this section.

(E) A waiver of the period of limitations as described in paragraph (c)(3)(iv) of this section.

(F) An attached statement from each foreign distributee for which nonrecognition is claimed under this paragraph (c)(3) declaring that the foreign distributee shall provide to the distributing corporation the annual certifications described in paragraph (c)(3)(v)(A) of this section for each of the taxable years of the distributing corporation, beginning with the taxable year of the distribution and ending with the taxable year that includes the close of the 60-month period following the taxable year of the distributing corporation in which the distribution was made.

(G) An agreement by the distributing corporation to attach to its income tax return the annual certification described in paragraph (c)(3)(v)(A) of this section and the statement described in paragraph (c)(3)(v)(B) of this section, in accordance with paragraph (c)(3)(v) of this section.

(H) A statement that arrangements have been made to ensure that the distributing corporation will be informed of any subsequent disposition by the foreign distributee of any stock or securities of the distributing or controlled corporation that are subject to the gain recognition agreement described in this paragraph (c)(3)(iii).

(iv) WAIVER OF PERIOD OF LIMITATION. The distributing corporation must file, with the gain recognition agreement described in paragraph (c)(3)(iii) of this section, a waiver of the period of limitation on the assessment of tax upon the gain realized on the distribution to the foreign distributee for which nonrecognition is claimed under this paragraph (c)(3). The waiver shall be executed on such forms as are prescribed therefor by the Commissioner and shall extend the period for assessment of such tax to a date not earlier than the close of the eighth full taxable year following the taxable year that includes the distribution. If the requirements of paragraph (c)(3)(ii)(C)(2) of this section are satisfied, a waiver of the period of limitation on the assessment of tax upon the gain realized on the distribution must be filed in accordance with the requirements of this paragraph (c)(3)(iv) by or on behalf of the controlled corporation.

(v) ANNUAL CERTIFICATIONS. For each of the taxable years of the distributing corporation, beginning with the taxable year of the distribution and ending with the taxable year that includes the close of the 60-month period following the end of the taxable year of the distributing corporation in which the distribution was made, the distributing corporation must file with its income tax return the annual certifications for that year described in this paragraph (c)(3)(v).

(A) Each foreign distributee for which nonrecognition is claimed under this paragraph (c)(3) must provide an annual certification, signed under penalties of perjury by an authorized officer of the foreign distributee corporation or by the individual foreign distributee (as the case may be). Each annual certification must identify the distribution with respect to which it is given by setting forth the date and a summary description of the distribution. In the annual certification, the foreign distributee must declare that --

(1) The foreign distributee continues to be, without interruption, a resident of (in the case of an individual foreign distributee) or incorporated in (in the case of a foreign distributee corporation) a country described in paragraph (c)(3)(ii)(D) of this section;

(2) The foreign distributee continues to own, without interruption, the stock and securities of the distributing and controlled corporations as described in paragraph (c)(3)(ii)(E) of this section (except to the extent the stock or securities have been disposed of in a transaction described in paragraph (c)(3)(vi) of this section); and

(3) If the foreign distributee is a corporation, the foreign distributee continues to meet the active trade or business requirement of paragraph (c)(3)(ii)(B) of this section.

(B) The distributing corporation must attach a statement to the annual certification described in paragraph (c)(3)(v)(A) of this section, signed under penalties of perjury by an authorized officer of the corporation, in which the corporation declares that, to the best of its knowledge, the annual certification is true.

(vi) SPECIAL RULE FOR NONRECOGNITION TRANSACTIONS.

(A) Gain shall not be recognized under paragraph (c)(3)(vii) of this section upon a disposition of stock or securities of the distributing or controlled corporation (or a successor in interest, as defined in this paragraph (c)(3)(vi)) that are subject to a gain recognition agreement described in paragraph (c)(3)(iii) of this section if the requirements of this paragraph (c)(3)(vi) are satisfied and the disposition consists of a transfer described in section 332, 337, 351, 354 or 356 or sections 361 and 381(a)(2).

(B) For purposes of this section, the term successor in interest refers to --

(1) Any corporation that acquires the assets of the distributing or controlled corporation (or a successor in interest) in a transaction described in section 381(a) to which this paragraph (c)(3)(vi) applies;

(2) Any corporation that acquires the stock or securities of the distributing or controlled corporation (or a successor in interest) in a transaction to which this paragraph (c)(3)(vi) applies;

(3) Any corporation whose stock or securities are exchanged for the stock or securities of the distributing or controlled corporation (or a successor in interest) in a transaction described in section 351, 354 or 356 to which this paragraph (c)(3)(vi) applies.

(C) Gain shall not be recognized under paragraph (c)(3)(vii) of this section upon a disposition of stock or securities of the distributing or controlled corporation (or a successor in interest) pursuant to a transaction described in paragraph (c)(3)(vi)(A) of this section if the following requirements are satisfied.

(1) Immediately after the transaction and at all times until the end of the 60-month period described in paragraph (c)(3)(vii)(A) of this section, the foreign distributee (or a successor in interest that acquires the assets of the foreign distributee in a transaction described in section 381(a) to which this paragraph (c)(3)(vi) applies) must continue to own directly or indirectly at least 80 percent of the vote and value of the stock and securities of the distributing corporation, and at least 80 percent of the vote and value of the stock and securities of the controlled corporation (or of a successor in interest that acquires the assets of the distributing or controlled corporation, as the case may be, in a transaction described in section 381(a) to which this paragraph (c)(3)(vi) applies), that it owned immediately after the distribution. The requirements of this paragraph (c)(3)(vi)(C)(1), however, will not be violated if such ownership drops below the 80 percent threshold by reason of a disposition of the stock or securities of the distributing or controlled corporation (or of a successor in interest that acquires the assets of the distributing or controlled corporation, as the case may be, in a transaction described in section 381(a) to which this paragraph (c)(3)(vi) applies) in a transaction subject to the gain recognition provisions of paragraph (c)(3)(vii) of this section.

(2) In a transaction involving a transfer of the assets of the distributing or controlled corporation described in section 381(a), the acquiring corporation must be a domestic corporation.

(3) The following information and agreements must be included with the first annual certification filed under paragraph (c)(3)(v) of this section after the transaction --

(i) A description of the transaction (including a statement of applicable Code provisions, and a description of stock or securities transferred, exchanged or received in the transaction);

(ii) A description of each successor in interest (including the name, address, taxpayer identification number (if any), and place of incorporation of the successor in interest);

(iii) Except in the case of a transaction described in section 381(a) pursuant to which the distributing corporation goes out of existence, an agreement of the distributing corporation (amending the agreement described in paragraph (c)(3)(iii) of this section), signed under penalties of perjury by an authorized officer of the corporation, to recognize gain in accordance with the provisions of this paragraph (c)(3) upon the occurrence of any of the following events (to the extent applicable): a disposition by the foreign distributee (or a successor in interest) of any stock or securities of a successor in interest that are subject to the provisions of this paragraph (c)(3)(vi) (other than a disposition that itself satisfies the requirements of this paragraph (c)(3)(vi)); a disposition by a successor in interest of any of the stock or securities of the distributing or controlled corporation (or a successor in interest) that are subject to the provisions of this paragraph (c)(3)(vi) (other than a disposition that itself satisfies the requirements of this paragraph (c)(3)(vi)); or any material failure to satisfy the requirements of this paragraph (c)(3) (or the terms of an agreement submitted pursuant hereto) with respect to the stock or securities of a successor in interest or the transferred stock or securities of the distributing or controlled corporation;

(iv) In the case of a transaction described in section 381(a) pursuant to which the distributing corporation goes out of existence, an agreement of the successor in interest that acquires the assets of the distributing corporation in the transaction, signed under penalties of perjury by an authorized officer of the successor in interest corporation, to succeed to all of the responsibilities and duties of the distributing corporation under this paragraph (c)(3);

(v) To the extent applicable, an agreement of each successor in interest, signed under penalties of perjury by an authorized officer of the corporation, to succeed to all of the responsibilities and duties of a foreign distributee under this paragraph (c)(3), as applied to the transferred stock and securities of the distributing or controlled corporation (or stock and securities of a successor in interest). The successor in interest, however, is required to comply with the provisions of paragraph (c)(3)(ii)(8) of this section only if the corporation acquires the assets of the foreign distributee in a transaction described in section 381(a). In the case of a successor in interest that is a domestic corporation, the successor in interest is not required to comply with the requirements of paragraph (c)(3)(ii)(D) of this section;

(vi) To the extent applicable, an agreement of the foreign distributee, signed under penalties of perjury by the individual or an authorized officer of the corporation (as the case may be), to comply with all responsibilities and duties of this paragraph (c)(3), as applied with respect to stock or securities of a successor in interest received in the transaction.

(D) Any property received (or treated as received) in a transaction described in this paragraph (c)(3)(vi) for which gain is required to be recognized under United States income tax principles shall be treated as an amount received in a disposition subject to the provisions of paragraph (c)(3)(vii) of this section.

(vii) RECOGNITION OF GAIN. (A) If, prior to the close of the 60- month period following the end of the taxable year of the distributing corporation in which the distribution was made, the foreign distributee disposes of the stock or securities of either the distributing or controlled corporation that the foreign distributee owned immediately after the distribution, as described in paragraph (c)(3)(ii)(E) of this section (other than pursuant to a transfer described in paragraph (c)(3)(vi) of this section), then by the 90th day thereafter the distributing corporation must file an amended return for the year of the distribution and recognize the gain realized but not recognized upon such distribution. For purposes of this paragraph (c)(3)(vii)(A), a disposition includes, but is not limited to, any disposition treated as a sale or exchange under this title.

(B) The gain shall be computed as if there had been a sale of the distributed stock or securities at fair market value at the time of the distribution. If the foreign distributee disposes of only a portion of the stock and securities of the distributing or controlled corporation, the distributing corporation shall be required to recognize only a proportionate amount of the gain realized but not recognized upon the initial distribution of the stock and securities of the controlled corporation to the foreign distributee. The proportion of the gain required to be recognized shall be equal to the same proportion that the value (determined immediately after the distribution) of the stock and securities of the distributing corporation or controlled corporation (as the case may be) disposed of by the foreign distributee bears to the total value (determined immediately after the distribution) of the stock and securities in such corporation owned by the foreign distributee immediately after the distribution (taking account of stock and securities of the distributing or controlled corporation later acquired from the distributing or controlled corporation for which the distributee has a holding period determined under section 1223 by reference to such stock or securities). However, gain recognized pursuant to this paragraph (c)(3)(vii)(B) on the disposition by the foreign distributee of stock or securities of either the distributing corporation or the controlled corporation (as the case may be) shall not exceed the excess of the gain required to be recognized by the distributing corporation under the gain recognition agreement solely by reason of such disposition and all prior dispositions of the stock and securities of such corporation over the gain already recognized by the distributing corporation under the gain recognition agreement solely by reason of dispositions by the foreign distributee of the stock and securities of the other corporation.

(C) For purposes of computing gain under this paragraph (c)(3)(vii), the following rules shall govern dispositions of stock or securities of the distributing or controlled corporation by a successor in interest, or dispositions of stock or securities of a successor in interest.

(1) A disposition by a successor in interest of stock or securities of the distributing or controlled corporation that were acquired in a transaction described in paragraph (c)(3)(vi) of this section shall be treated as a disposition of such stock or securities by a foreign distributee.

(2) A disposition by a foreign distributee of a portion of stock and securities of a successor in interest that were received in exchange for stock and securities of the distributing or controlled corporation (as the case may be) in a transaction described in paragraph (c)(3)(vi) of this section shall be treated as a disposition of a proportionate share of such stock and securities of the distributing or controlled corporation owned by the successor in interest at the time of the disposition. The proportionate share shall equal the same proportion that the amount of stock and securities of the successor in interest disposed of bears to the total amount of stock and securities of the successor in interest originally received in exchange for the stock and securities of the distributing or controlled corporation.

(3) Other dispositions of stock or securities of a successor in interest to which paragraph (c)(3)(vi) of this section applies shall result in gain recognition in a manner consistent with the principles of this paragraph (c)(3)(vii)(C).

(D) If additional tax is required to be paid by the distributing corporation for the year of the distribution, interest must be paid by the distributing corporation on that amount at the rates determined under section 6621 with respect to the period between the date that was prescribed for filing the distributing corporation's original income tax return for the year of the distribution and the date on which the additional tax for that year is paid.

(E) Net operating losses, capital losses, or credits against tax that were available in the year of the distribution and that are unused (whether or not they have expired since the distribution) at the time of gain recognition described in this paragraph (c)(vii) may be applied (respectively) against any gain recognized or tax owed by reason of this provision, but no other adjustments shall be made with respect to any other items of income or deduction in the year of distribution or other years.

(viii) FAILURE TO COMPLY. (A) Except as otherwise provided in paragraph (c)(3)(viii)(B) of this section, if the distributing corporation fails to comply in any material respect with the requirements of this paragraph (c)(3) or with the terms of an agreement submitted pursuant hereto, or if the distributing corporation knows or has reason to know of any failure of another person to so comply, the distributing corporation shall treat the initial distribution of the stock or securities of the controlled corporation as a taxable exchange in the year of the distribution. In such event, the period for assessment of tax shall be extended until three years after the date on which the Internal Revenue Service receives actual notice of such failure to comply.

(B) If a person fails to comply in any material respect with the requirements of this paragraph (c)(3) or with the terms of an agreement submitted pursuant hereto, the provisions of paragraph (c)(3)(viii)(A) of this section shall not apply if the person is able to show that such failure was due to reasonable cause and not willful neglect, provided that the person achieves compliance as soon as he becomes aware of the failure. Whether a failure to materially comply was due to reasonable cause shall be determined by the district director under all the facts and circumstances.

(d) OTHER CONSEQUENCES -- (1) DISTRIBUTEE BASIS IN STOCK. Except where section 897(e)(1) and the regulations thereunder cause gain to be recognized by the distributee, the basis of the distributed domestic or foreign corporation stock in the hands of the foreign distributee shall be the basis of the distributed stock determined under section 358 without any increase for any gain recognized by the domestic corporation on the distribution.

(2) EXCHANGE UNDER SECTION 897(e)(1). With respect to the treatment under section 897(e)(1) of a foreign distributee on the receipt of stock or securities of a domestic or foreign corporation where the foreign distributee's interest in the distributing domestic corporation is a United States real property interest, see section 897(e)(1) and the regulations thereunder.

(3) DIVIDEND TREATMENT UNDER SECTION 1248. With respect to the treatment as a dividend of a portion of the gain recognized by the domestic corporation on the distribution of the stock of certain foreign corporations, see section 1248(a) and (f) and the regulations thereunder.

(4) DISTRIBUTION OF STOCK OF A PASSIVE FOREIGN INVESTMENT COMPANY. [RESERVED]

(5) NO REPORTING UNDER SECTION 6038B. No notice shall be required under section 6038B with respect to a distribution described in this section.

(e) EXAMPLES. The rules of paragraphs (b), (c), and (d) of this section may be illustrated by the following examples:

EXAMPLE 1. (i) FC, a Country X corporation, owns a11 of the outstanding stock of DC1, a domestic corporation. DC1 owns all of the outstanding stock of DC2, another domestic corporation. The fair market value of the DC1 stock is 300x, and FC has a 100x basis in the DC1 stock. The fair market value of the DC2 stock is 180x, and DC1 has a 40x basis in the DC2 stock. Neither DC1 nor DC2 is a U.S. real property holding corporation. Country X does not maintain an income tax treaty with the United States.

(ii) In a transaction qualifying for nonrecognition under section 355(a), DC1 distributes all of the stock of DC2 to FC. After the distribution, the DC1 stock has a fair market value of 120x.

(iii) Under paragraphs (b)(1) and (2) of this section, DC1 recognizes gain of 140x, which is the difference between the fair market value (180x) and the basis (40x) of the stock distributed. Under paragraph (d)(1) of this section and section 358, FC takes a basis of 40x in the DC1 stock, and a basis of 60x in the DC2 stock.

EXAMPLE 2. (i) C, a citizen and resident of Country F, owns all of the stock of DC, a U.S. real property holding corporation. The fair market value of the DC stock is 500x, and C has a 100x basis in the DC stock.

(ii) In a transaction qualifying for nonrecognition under section 355(a), DC distributes to C all of the stock of DC2, a domestic corporation. DC and DC2 are U.S. real property holding corporations immediately after the distribution. The DC2 stock has a fair market value of 200x, and DC has a 180x basis in the DC2 stock. After the distribution, the DC stock has a fair market value of 300x.

(iii) Under paragraph (c)(1) of this section, DC does not recognize gain on the distribution of the DC2 stock because DC and DC2 are U.S. real property holding corporations immediately after the distribution.

(iv) Under section 897(e) and the regulations thereunder, C is considered to have exchanged DC stock with a fair market value of 200x and an adjusted basis of 40x for DC2 stock with a fair market value of 200x. Because DC2 is a U.S. real property holding corporation, and its stock is a U.S. real property interest, C does not recognize any gain under section 897(e) on the distribution. C takes a basis of 40x in the DC2 stock, and its basis in the DC stock is reduced to 60x pursuant to section 358.

EXAMPLE 3. (i) All of the outstanding common stock of DC, a domestic corporation, is regularly traded on an established securities market located in the United States. None of the foreign shareholders of DC directly or indirectly owns more than five percent of the common stock of DC.

(ii) In a transaction qualifying for nonrecognition under section 355(a), DC distributes all of the stock of DS, a domestic corporation, to the common shareholders of DC. The stock of DS has appreciated in the hands of DC.

(iii) Under paragraph (c)(2) of this section, DC does not recognize gain on the distribution of the DS stock to any foreign distributee. Each shareholder's basis in the DC and DS stock is determined pursuant to section 358.

EXAMPLE 4. (i) FC, a Country X corporation, owns all of the stock of DC1, a domestic corporation. The fair market value of the DC1 stock is 1,000x, and FC has a basis in the DC1 stock of 800x. Country X maintains an income tax treaty with the United States that includes an information exchange provision. In addition to owning stock in DC1, FC directly engages in an active trade or business in Country X.

(ii) In a transaction qualifying for nonrecognition under section 355(a), DC1 distributes to FC all of the stock of DC2, a domestic corporation. The DC2 stock has a fair market value of 500x at the time of the distribution, and DC1 has a 100x basis in the DC2 stock. Immediately after the distribution, the DC1 stock has a fair market value of 500x. Neither DC1 nor DC2 is a U.S. real property holding corporation.

(iii) Under paragraph (c)(3) of this section, DC1 will not recognize gain on the distribution of the DC2 stock if DC1 enters into a gain recognition agreement, as described in paragraph (c)(3)(iii), and DC1 and FC otherwise comply with all of the provisions of paragraph (c)(3) of this section. Pursuant to section 358, FC will take a 400x basis in the DC2 stock and FC's basis in the DC1 stock will be reduced to 400x.

EXAMPLE 5. (i) Assume the same facts as in EXAMPLE 4 and that DC1 enters into a gain recognition agreement pursuant to paragraph (c)(3) of this section. Two years after DC1's distribution of DC2 stock to FC, FC sells 25 percent of the DC2 stock to Y, an unrelated corporation. One year after the DC2 stock sale, FC sells 50 percent of its DC1 stock to Z, another unrelated corporation. In the next year, FC sells to Y an additional amount of DC2 stock representing 10% of the DC2 shares distributed to FC.

(ii) Under paragraph (c)(3)(vii) of this section, upon FC's sale of 25 percent of its DC2 stock, DC1 is required to file an amended return for the year in which the DC2 stock was distributed to FC, and recognize 100x of gain, which represents 25 percent of the gain realized but not recognized on the distribution.

(iii) Upon FC's subsequent sale of 50 percent of its DC1 stock, DC1 is required to file another amended return for the year of the distribution and recognize an additional 100x of gain. This represents the excess of the total amount of gain required to be recognized under the gain recognition agreement, determined solely by reference to FC's disposition of DC1 stock (200x), over the gain previously required to be recognized under the agreement, determined solely by reference to FC's disposition of DC2 stock (100x).

(iv) Upon FC's sale of additional DC2 stock representing 10 percent of the DC2 stock distributed to it, DC1 is not required to recognize additional gain. This is because the total amount of gain already recognized by DC1 under the gain recognition agreement solely by reason of FC's disposition of DC1 stock (200x) exceeds the amount of gain that would be required to be recognized under the agreement solely by reason of FC's total dispositions of DC2 stock (40x plus 100x).

EXAMPLE 6. (i) Assume the same facts as in EXAMPLE 4 and that DC1 enters into a gain recognition agreement pursuant to paragraph (c)(3) of this section. One year after DC1's distribution of DC2 stock to FC, FC transfers all of the DC2 stock to FS, a Country X corporation, in a transaction described in section 351. FC receives, in exchange for the DC2 stock, FS stock possessing 90 percent of the voting power and value of all of the outstanding stock of FS. The remaining 10 percent of the stock of FS is issued in the transaction to C, an unrelated corporation.

(ii) DC1 will not recognize gain under the gain recognition agreement upon FC's disposition of the stock of DC2 if DC1 enters into a new agreement to recognize gain on FC's disposition of the FS stock or FS's disposition of the DC2 stock, and DC1, FC and FS otherwise comply with the successor in interest provisions of paragraph (c)(3)(vi) of this section.

(iii) Assume that two years after DC1 enters into a new gain recognition agreement in accordance with paragraph (c)(3)(vi) of this section, FS sells one-half of its DC2 stock. One year later, FC sells one-half of its FS stock. Upon FS's sale of the DC2 stock, DC1 is required to file an amended return for the year in which the DC2 stock was distributed to FC, and recognize 200x (one-half of 400x) of the gain realized but not recognized on the distribution. Upon FC's subsequent sale of the FS stock, the entire remaining amount of gain realized on the distribution (200x) is required to be recognized pursuant to paragraph (c)(3)(vii) of this section because FC no longer complies with paragraph (c)(3)(vi)(C)(1) of this section. Therefore, paragraph (c)(3)(vii)(C)(2) of this section does not apply to determine the amount of gain required to be recognized upon FC's sale of the FS stock.

EXAMPLE 7. (i) P1, a partnership organized under the laws of Country X, owns all of the outstanding stock of DC1, a domestic corporation. DC1 owns all of the outstanding stock of DC2, another domestic corporation. The fair market value of the DC1 stock is 800x and P1 has an 800x basis in the DC1 stock. The fair market value of the DC2 stock is 600x and DC1 has a 400x basis in the DC2 stock. Neither DC1 nor DC2 is a U.S. real property holding corporation.

(ii) Y, a Country X corporation, and P2, another partnership organized under the laws of Country X, are the sole partners of P1. Under the rules and principles of sections 701 through 761, Y and P2 are each entitled to a 50 percent distributive share of each item of P1 income and loss. V, a domestic corporation, and Z, a Country X corporation, are the sole partners of P2. Under the rules and principles of sections 701 through 761, V and Z are each entitled to a 50 percent distributive share of each item of P2 income and loss.

(iii) In a distribution qualifying for nonrecognition under section 355(a), DC1 distributes all of the stock of DC2 to P1. Because the distribution is to a partnership, DC1 may not avoid recognition of gain on the distribution by entering into a gain recognition agreement pursuant to paragraph (c)(3) of this section (unless DC1 obtains a ruling from the Internal Revenue Service to the contrary).

(iv) Under paragraph (b)(5) of this section, if DC1 establishes that V is a domestic corporation that owns a 50 percent interest in P2, which owns a 50 percent interest in P1, DC1 will be required to recognize only 75 percent (150x) of the gain realized on the distribution. This gain must be recognized even though P1 would not realize any gain on a sale of the DC2 stock following the distribution because its basis in the stock (600x) equals the stock's fair market value (600x).

EXAMPLE 8. (i) DC1, a domestic corporation, owns all of the stock of DC2, also a domestic corporation. The stock of DC1 is owned equally by X, a domestic corporation, and FY, a Country Y corporation.

(ii) A short time before DC1 adopted a plan to distribute the stock of DC2 to its shareholders, but after the board of directors of DC1 began contemplating the distribution, FY formed Newco, a domestic corporation, and contributed its DC1 stock to Newco in a transaction qualifying for nonrecognition under section 351. A valid business purpose existed for FY's transfer of the DC1 stock to Newco, but this business purpose would have been fulfilled irrespective of whether FY transferred the stock to Newco before the distribution of DC2, or after the distribution of DC2 (in which case FY would have transferred the stock of DC1 and DC2 to Newco).

(iii) pursuant to paragraph (b)(6) of this section, the District Director may determine that FY formed Newco for a principal purpose of avoiding section 367(e)(1). In such case, for federal income tax purposes, FY will be treated as having received the stock of DC2 in a section 355 distribution, and then as having transferred the stock to Newco in a section 351 transaction.

(f) EFFECTIVE DATE. This section shall be effective with respect to distributions occurring on or after January 16, 1993. However, a corporation may elect to apply this section to all distributions made by it after February 15, 1990, and before January 16, 1993, to which section 367(e)(1) applies, by timely filing an original or amended return for the year of distribution, and otherwise complying with the provisions of this section. A corporation making such an election may choose to comply with section 1.367(e)-1T(c)(2)(i)(C) (as contained in the 26 CFR Part 1 edition revised as of April 1, 1992) instead of paragraph (c)(3)(ii)(B) of this section, and any annual certification submitted in compliance with section 1.367(e)-1T(c)(2)(ii)(F) (as contained in the 26 CFR part 1 edition revised as of April 1, 1992), prior to January 16, 1993 will be considered as complying with the annual certification requirements of paragraph (c)(3)(v) of this section.

Par. 4. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 5. Section 602.101(c) is amended by removing from the table "section 1.367(e)-1T . . . 1545-1124" and adding in its place "section 1.367(e)-1 . . . 1545-1124".