Daily Tax Update - December 29, 2009


TREASURY AND IRS ISSUE TEMPORARY REGULATIONS ON THE USE OF CONTROLLED CORPORATIONS TO AVOID THE APPLICATION OF SECTION 304: Today, the Treasury and IRS issued temporary regulations (T.D. 9477), amending prior temporary regulations under Temp. Treas. Reg. § 1.304-4T, regarding the use of controlled corporations to “avoid the application of section 304.” T.D. 9477 also amends the final regulations under Treas. Reg. § 1.304-4 to refer to the temporary regulations.

  • In related party stock sales subject to section 304, the determination of the amount of the property distribution that is a dividend (and the source of such dividend) is made as if the property were distributed by the acquiring corporation to the extent of its earnings and profits, and then by the issuing corporation to the extent of its earnings and profits.
  • In the Preamble to T.D. 9477, the Treasury and IRS state that they have “become aware of certain transactions that are subject to section 304 but that are entered into with a principal purpose of avoiding the treatment of a corporation as the issuing corporation.” The Preamble provides an example in which a domestic corporation that wholly owns two foreign corporations, F1 (which has no earnings and profits) and F2 (which has earnings and profits) forms a new foreign corporation (F3), contributes the stock of F2 to F3 in exchange for F3 stock, and then, in a transaction subject to section 304(a)(1), transfers the stock of F3 to F1 for cash. Because neither F1 (the acquiring corporation) nor F3 (the newly-formed issuing corporation) has earnings and profits, the US parent reports the cash received as a return of basis under section 301(c)(2) rather than as a dividend.
  • Under prior Temp. Treas. Reg. § 1.304-4T, which was promulgated in 1988 in T.D. 8209, the District Director (now known as the Director of Field Operations) was permitted to consider a corporation (“deemed acquiring corporation”) as having acquired the stock of the issuing corporation that is in fact acquired by the acquiring corporation, if the deemed acquiring corporation controls the acquiring corporation and if one of the principal purposes for creating, organizing, or funding the acquiring corporation (through capital contributions or debt) is to avoid the application of section 304 to the deemed acquiring corporation.
  • New Temp. Treas. Reg. § 1.304-4T maintains the anti-avoidance rule for deemed acquiring corporations and adds a new anti-avoidance rule for deemed issuing corporations, under which the acquiring corporation shall be treated as acquiring for property the stock of a corporation (“deemed issuing corporation”) that is controlled by the issuing corporation, if, in connection with the acquisition of stock of the issuing corporation by the acquiring corporation, the issuing corporation acquired stock of the deemed issuing corporation with a principal purpose of avoiding the application of section 304 to the deemed issuing corporation.
  • New Temp. Treas. Reg. § 1.304-4T makes both anti-avoidance rules self-executing (unlike the anti-avoidance rule for deemed acquiring corporations, which was applicable at the discretion of the District Director). Further, the new temporary regulations provide that the anti-avoidance rule may apply when the funding of the acquiring corporation is from an unrelated party.
  • The Preamble also notes that “No inference is intended as to the potential applicability of other Code or regulatory provisions of judicial doctrines (including step transaction or substance over form) to transactions described in the regulations.”
  • The temporary regulations apply to acquisitions of stock occurring after December 28, 2009.
  • The regulations can be accessed here and here.
  • For additional information, contact Philip R. West - pwest@steptoe.com  

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.

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