The Advice Memorandum 2007-006 is “generic legal advice” from chief counsel to the IRS field, assuring the field that a domestic corporate purchaser of a foreign target “eligible entity” (treated as a default corporation) can make a section 338(g) election and step up the basis of the target’s assets, despite the fact that no U.S. tax will be paid, and whether or not the election is extended to a U.S. subsidiary of the target. The target was “irrelevant” for U.S. tax purposes prior to the purchase, meaning generally that it had no U.S. owners or business.
Wasn’t This Obvious?
One wonders why this advice was necessary, given the common understanding among commentators that section 338(g) elections are available for purchases of foreign targets and that this applies to default corporations as well as per se corporations, under the Reg. section 301.7701-3 regime. Perhaps the motivation for the memo was like that for Rev. Rul. 2003-125, 2003-2 CB 1243, and related guidance, in which the IRS made clear that a parent corporation can recognize a loss on a foreign sub that has performed a check-the-box liquidation; sometimes the results seem just too good to be true.
Is There Another Way?
What if a U.S. corporation buys the stock of a foreign eligible entity and checks the box to treat it as disregarded from its earliest moment of relevance for U.S. tax purposes? There is a strong argument that the entity is always unincorporated and the buyer bought assets (or partnership interest) and the section 338(g) election is unnecessary to achieve the asset purchase result and nothing happens insofar as a conversion event from corporation to partnership is concerned.
This way has not been tried because the regulations seem to state that the section 338 election is the only way to get to the cost basis asset purchase result and show how to combine such election with a check the box election. Reg. section 301.7701-3(g)(3)(ii) provides an ordering rule by which the section 338 events occur first and then the check-the-box events occur. In this case the target will make a one-day C corporation return, while owned by the stock purchaser. The regulation does not specifically address a foreign target, but covers such a case and would seem to mostly apply to such case. It states that a QSP of an eligible entity taxed as a corporation can support a section 338 election, even if the buyer checks the box to have the target disregarded at the earliest possible time.
There may be yet another way to obtain the results of an asset purchase in these cases: the foreign seller might be convinced to make the entity change election before the sale, so that the buyer could buy a disregarded entity or partnership interests and the seller, assuming no U.S. contacts, would not owe tax on the deemed liquidation of its subsidiary. But it may be difficult to persuade sellers to do this and the back-to-back 338 and entity change elections may be the best way to achieve the ownership of the foreign eligible entity’s assets in partnership or disregarded entity form, with a basis step up and no U.S. tax owning.