Daily Tax Update - August 22, 2008


IRS, TREASURY ISSUE PROPOSED REGULATIONS UNDER SECTION 336(e):  The IRS and Treasury have issued proposed regulations in an effort to relieve taxpayers from potential multiple corporate level taxes resulting from the 1986 repeal of the General Utilities doctrine. The proposed regulations describe the circumstances under which a corporation (seller) can elect to treat the sale, exchange, or distribution of another corporation’s (target) stock as a sale of the target’s underlying assets. Where possible, the structure and principles of the proposed regulations are modeled after Code section 338(h)(10). 

  • The proposed regulations are narrower in scope than the authority granted to the IRS and Treasury pursuant to section 336(e). For example, the proposed regulations do not apply to (1) transactions between related persons, or (2) transactions where either the seller or the target is a foreign corporation. The preamble seeks comments regarding transactions that are beyond the scope of the proposed regulations.
  • The proposed regulations generally require that the seller be a domestic corporation that makes a “qualified stock disposition,” which is a sale, exchange, or distribution of 80% of the target stock over a 12-month period. However, unlike section 338 elections, the purchaser need not be a corporation.
  • The proposed regulations contain special rules to limit the losses that may be recognized on a qualified stock disposition that is a distribution, and to permit section 336(e) elections for section 355 distributions that are taxed at the corporate level under section 355(d)(2) or (e)(2). 
  • The regulations are proposed to apply to any qualified stock disposition on or after the date the regulations are published as final regulations.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com or Lisa M. Zarlenga - lzarlenga@steptoe.com  
  • The regulations can be accessed via: http://federalregister.gov/OFRUpload/OFRData/2008-19603_PI.pdf 

IRS ISSUES PROPOSED REGULATIONS REGARDING TREATMENT OF OUTBOUND ASSET TRANSFERS AND OTHER INTERNATIONAL TAX ISSUES:  On August 19, 2008, the IRS issued a comprehensive set of proposed regulations addressing the treatment of certain outbound asset transfers described in section 361, the application of section 1248(e) and (f) under certain circumstances, and other international tax issues. The proposed regulations are issued under section 367(a), section 367(a)(5), section 367(b), section 1248(a), section 1248(e), section 1248(f) and section 6038B. 

  • The proposed regulations issued under section 367(a)(5) address the manner in which that subsection modifies the exceptions under section 367(a)(2) and (3) to the general rule of section 367(a)(1). The section 367(a) tax on outbound transfers described in section 332, 351, 356 or 361 does not apply to certain transfers of stock or securities of a corporation that is a party to a reorganization or to certain property used in a foreign trade or business. Section 367(a)(5) provides that these general exceptions will not apply to transfers described in section 361 except to the extent provided in regulations. The IRS had not issued regulations on the scope of section 367(a)(5) prior to the proposed regulations. 
  • The proposed regulations effectuate the policy of section 367(a)(5) by ensuring that the general exceptions under section 367(a) are only available to the extent the net built-in gain otherwise recognized by the US transferor is preserved in the stock basis held by former corporate shareholders of the US transferor. The proposed regulations provide that taxpayers may apply the non-recognition rules of sections 367(a)(2) and (3) if they make the election described in the regulations. The election is available if the US transferor is controlled (within the meaning of section 368(c)) by five or fewer domestic corporations (the “control group”). Under the election: 
    1. the US transferor recognizes gain on an outbound asset reorganization described in section 361(a) to the extent of the aggregate amount of inside gain allocable to non-control group members and to the extent that the control group members cannot preserve their share of inside gain in the stock received allocable to property transferred in the exchange;
    2. each control group member reduces basis in the stock received in the transaction to the extent necessary to preserve the control group member's share of inside gain (i.e., basis is reduced by the member's proportionate share of the US transferor's inside gain less the member's outside gain); and
    3. the US transferor certifies that it will file an amended return to report unrecognized gain on the section 361 exchange if the foreign acquiring corporation disposes of a significant amount of the property received in the section 361 exchange with a principal purpose of avoiding US tax.
  • The proposed regulations clarify that section 368(c) control requires direct rather than indirect ownership, but that all domestic corporations that are members of an affiliated group (within the meaning of section 1504) will be treated as a single corporation for purposes of forming a control group. The Preamble to the proposed regulations requests comments regarding the manner in which indirect ownership could be taken into account for purposes of the control group requirement. The proposed regulations also provide that the election is not generally effective for property that is described in section 367(d). Moreover, in contrast to the treatment of section 351 exchanges under section 367(a), the proposed regulations calculate the amount of built-in gain associated with the transferred property in the section 367(a)(5) exchange on a net basis rather than considering only built-in gain property. The calculation of built-in gain does not account for any tax attributes of the US transferor, however, and the Preamble to the proposed regulations requests comments regarding whether and how certain attributes should be taken into account.
  • The proposed regulations issued under section 367(b) provide an additional exception to the general rule that applies to certain transfers of stock of a foreign corporation by a US transferor to a foreign acquiring corporation in a section 361 exchange. Under the general rule, if a US transferor that is a section 1248 shareholder transfers stock of a foreign corporation to a foreign acquiring corporation in a section 361 exchange, the US transferor must include the “section 1248 amount” attributable to the stock of the foreign acquired corporation. Existing rules provide an exception to the general rule for certain triangular reorganizations where the US transferor transfers stock of the foreign corporation in exchange for stock of a domestic corporation. The proposed regulations expand the exception to provide that the US transferor includes in income the section 1248 amount only if immediately after the section 361 exchange the foreign acquiring corporation or the foreign acquired corporation is not a CFC with respect to which the US transferor is a section 1248 shareholder. 
  • The proposed regulations also modify the exceptions to the “coordination rule” of Treas. Reg. § 1.367(a)-3(d)(2)(vi)(A) which provides that, in an outbound transfer described in section 351 or 361, section 367(a) and (d) will apply to the direct asset transfer prior to the application of the indirect stock transfer rules of §1.367(a)-3(d). The IRS had issued Notice 2008-10 to clarify the mechanics of the “coordination rule” in order to prevent taxpayers from repatriating earnings and profits of foreign corporations without the recognition of gain. The proposed regulations modify the exceptions to the “coordination rule” in a manner consistent with the approach set forth in Notice 2008-10. These modifications are generally applicable as of the effective date of Notice 2008-10 (December 28, 2007).
  • The proposed regulations issued under section 1248(f) establish the general rule that, if a domestic distributing corporation that is a section 1248 shareholder of a foreign corporation distributes the stock of such foreign corporation, the domestic distributing corporation must generally include as a dividend the “section 1248 amount” attributable to the stock distributed if the distribution is described in section 337 or described in section 355 (other than stock received by the domestic distributing corporation in a section 361 exchange). If the domestic distributing corporation received distributed stock in a section 361 exchange, a section 355 distribution, or a section 361 distribution, then the corporation shall include in income as a dividend the section 1248(f) amount attributable to the stock distributed. The proposed regulations provide for certain exceptions to the general rules described above for distributions described under section 337 or section 355, as well for distributions under certain plans of reorganization.
  • The proposed regulations issued under section 1248(e) are consistent with Notice 87-64, provide that section 1248(e) will not apply when capital gains are taxed at a rate equal to or greater than the ordinary income rate, and are effective for sales, exchanges, or other dispositions of stock of a domestic corporation occurring on or after September 21, 1987. 
  • The proposed regulations issued under section 367(a)(5), section 367(b), and section 1248(f) are generally effective for transfers or distributions, as the case may be, occurring on or after the date that is 30 days after the date that these regulations are published in final form. However, for purposes of section 367(a)(5), taxpayers may make reasonable adjustments, as described in the legislative history to section 367(a)(5) and the Preamble to the proposed regulations, provided that the US transferor recognizes gain in accordance with the proposed regulations.   
  • For additional information, contact Philip R. West - pwest@steptoe.com  
  • The regulations can be accessed via: http://federalregister.gov/OFRUpload/OFRData/2008-18885_PI.pdf

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving. Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them. Read more information on Steptoe's tax practice.