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IRS to revise final “Killer B” regs for triangular reorgs involving foreign corporations

April 28, 2014

IRS has issued a Notice outlining the ways that it intends to revise the Code Sec. 367(b) “Killer B” final regs that were released back in 2011. Among other things, the Notice eliminates the deemed contribution model under the existing regs, modifies the amount of income and gain taken into account for purposes of applying the priority rules of Code Sec. 367(a) and Code Sec. 367(b), and clarifies the application of the anti-abuse rule.

Background. A U.S. person’s transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354 , Code Sec. 356, or Code Sec. 361 exchanges generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent’s stock provided by it to its subsidiary—or provided directly to a target corporation or its shareholders on the subsidiary’s behalf—under a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent’s stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target’s stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent’s stock that it exchanges for the target’s stock in a reverse triangular merger. (Code Sec. 361)

A corporation’s distribution of property to its shareholder with respect to its stock is included in the shareholder’s gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation’s current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation’s stock, and any amount of the distribution in excess of the shareholder’s basis is treated as gain from the sale or exchange of the corporation’s stock. (Code Sec. 301(c)(2), Code Sec. 301(c)(3))

367(b) regs. In May of 2008, IRS issued temporary and proposed regs (the 2008 regs) that applied to triangular reorganizations where: (i) parent (P) or subsidiary (S), or both, are foreign; and (ii) in connection with the reorganization, S acquires, in exchange for property, all or a portion of the P stock that is used to acquire target’s (T’s) stock or assets. (See Weekly Alert ¶  17  05/29/2008 for more details.) The “in connection with” standard included any transaction related to the reorganization, even if not part of the plan of reorganization.

In 2011, IRS finalized the 2008 regs, with certain modifications. (See Weekly Alert ¶  26  05/19/2011 for more details.) The 2011 final regs including the following rules:

… Deemed distribution and contribution rules. In the case of a triangular reorganization subject to Reg. § 1.367(b)-10, adjustments had to be made in a manner consistent with those that would have been made if S had in fact distributed property to P under Code Sec. 301 (deemed distribution), with the amount of the deemed distribution generally equal to the amount of property that was transferred by S to acquire the P stock and securities in the P acquisition. (Reg. § 1.367(b)-10(b)(1)) In addition, adjustments had to be made consistent with those that would have been made if P had in fact contributed that same property to S (deemed contribution; Reg. § 1.367(b)-10(b)(2)), with the effect of increasing P’s basis in its S stock by the amount of the deemed distribution. (Reg. § 1.367(b)-10(c)(2))

… Triangular reorganizations exempt from the final regs. The 2011 final regs didn’t apply to a triangular reorganization if:


i. P and S were foreign corporations and neither was a controlled foreign corporation (under Reg. § 1.367(b)-2(a)) immediately before or after the triangular reorganization;
ii. S was a domestic corporation, P’s stock in S was not a U.S. real property interest (under Code Sec. 897(c)), and P would not be subject to U.S. tax on a dividend from S under either Code Sec. 881 (i.e., under a treaty) or Code Sec. 882 (the “no-U.S.-tax exception”); or
iii. in an exchange under Code Sec. 354 or Code Sec. 356, one or more U.S. persons exchanged stock or securities of T and the amount of gain in the T stock or securities recognized by such U.S. persons under Code Sec. 367(a)(1) was equal to or greater than the sum of the amount of the deemed distribution that would be treated by P as a dividend under Code Sec. 301(c)(1) and the amount of such deemed distribution that would be treated by P as gain from the sale or exchange of property under Code Sec. 301(c)(3) (together, “367(b) income”) if Reg. § 1.367(b)-10 would otherwise apply to the triangular reorganization (the “Code Sec. 367(a) priority rule”).
There was also a “Code Sec. 367(b) priority rule” that turned off the application of Code Sec. 367(a)(1) to an exchange under Code Sec. 354 or Code Sec. 356 that occurred in connection with a triangular reorganization described in Reg. § 1.367(b)-10 if the amount of gain that would otherwise be recognized under Code Sec. 367(a)(1) (without regard to any exceptions) was less than the amount of the 367(b) income recognized under Reg. § 1.367(b)-10. (Reg. § 1.367(a)-3(a)(2)(iv))


… Anti-abuse rule. The final regs provided that “appropriate adjustments” would be made if, in connection with a triangular reorganization, a transaction was engaged in with a view to avoid the purpose of Reg. § 1.367(b)-10. (Reg. § 1.367(b)-10(d))

Rules to be modified. In Notice 2014-32, IRS stated that it was aware that taxpayers are engaging in a number of transactions that are inconsistent with the policy concerns underlying the 2011 final regs. These perceived abuses including taxpayers engaging in transactions designed to avoid U.S. tax by exploiting the deemed contribution provided under the final regs, transactions facilitated by the 2011 final regs’ priority rule designed to avoid recognizing gain under Reg. § 1.367(a)-3(c), and overly narrow interpretations of the anti-abuse rule.

IRS stated that these transactions raise significant policy concerns and that it accordingly will revise the 2011 final regs. The regs that IRS intends to issue will make the following changes to the 2011 final regs:

… Deemed distribution and contribution rules. IRS will remove the rules in Reg. § 1.367(b)-10(b)(2) and Reg. § 1.367(b)-10(c)(2) regarding deemed contributions, and conforming changes will be made to other parts of the final regs.

… Triangular reorganizations exempt from the final regs. The Code Sec. 367(a) priority rule under Reg. § 1.367(b)-10 will be modified by adjusting the amount of income or gain that is considered 367(b) income for this purpose. The modified regs will provide that section 367(b) income includes a Code Sec. 301(c)(1) dividend or Code Sec. 301(c)(3) gain that would arise if Reg. § 1.367(b)-10 applied to the triangular reorganization only to the extent such dividend income or gain would be subject to U.S. tax or would give rise to an income inclusion under Code Sec. 951(a)(1)(A) that would be subject to U.S. tax. A conforming change will be made to the Code Sec. 367(b) priority rule under Reg. § 1.367(a)-3(a)(2)(iv).

In addition, the no-U.S.-tax exception will be modified to provide that the exception will not be available if P is a controlled foreign corporation. Furthermore, where P is not a controlled foreign corporation, S is a domestic corporation, and P’s stock in S is not a U.S. real property interest, the regs will be modified to clarify that the no-U.S.-tax exception will apply if the deemed distribution that would result from application of Reg. § 1.367(b)-10 to the triangular reorganization would not be treated as a dividend under Code Sec. 301(c)(1) that would be subject to U.S. tax (for example, by reason of an applicable treaty or by reason of an absence of earnings and profits).

… Anti-abuse rule. The anti-abuse rule in Reg. § 1.367(b)-10(d) will be clarified to provide that S’s acquisition of P stock or securities in exchange for a note may invoke the anti-abuse rule. In addition, Reg. § 1.367(b)-10(d) will be clarified to provide that the earnings and profits of a corporation (or a successor corporation) may be taken into account for purposes of determining the consequences of the adjustments provided in the revised final regs, regardless of whether such corporation is related to P or S before the triangular reorganization. Reg. § 1.367(b)-10(d) also will be clarified to provide that a funding of S may occur after the triangular reorganization and that a funding of S includes capital contributions, loans, and distributions.

Effective date. Except as otherwise provided, the modifications to the regs will apply to a triangular reorganization that is completed on or after Apr. 25, 2014. The revised final regs described in Notice 2014-32 will not apply if:


1. T was not related to P or S (within the meaning of Code Sec. 267(b)) immediately before the triangular reorganization;
2. the triangular reorganization was entered into either pursuant to a written agreement that was (subject to customary conditions) binding before Apr. 25, 2014 and all times afterward, or pursuant to a tender offer announced before Apr. 25, 2014 that is subject to section 14(d) of the Securities and Exchange Act of 1934 or that is subject to comparable foreign laws; and
3. to the extent the P acquisition that occurs pursuant to the plan of reorganization is not completed before Apr. 25, 2014, the P acquisition was included as part of the plan before Apr. 25, 2014.
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