The new 367(a) regulations amend the 1997 rules and are generally favorable for taxpayers.
On February 11, 2009, the Internal Revenue Service (IRS) issued final regulations under section 367(a) addressing gain recognition agreements (GRAs) filed by U.S. persons with respect to transfers of stock or securities to foreign corporations. The final regulations revise and broaden temporary regulations issued in 2007 and amend the 1997 regulations.
The final regulations are generally taxpayer favorable, expanding the types of transactions that will not be treated as “triggering” existing GRAs. Additionally, the final regulations provide taxpayers with an opportunity to retroactively apply the more liberal rules to all open taxable years. However, this is a limited opportunity that in some cases requires amended returns to be filed by August 10, 2009.
Section 367(a)(1) and GRAs in General
Pursuant to section 367(a)(1), if a U.S. person (U.S. transferor) transfers stock or securities to a foreign corporation in connection with any exchange described in sections 332, 351, 354, 356 or 361, the transfer is taxable unless an exception applies. The purpose of this rule is to limit the circumstances under which a U.S. person is able to transfer appreciated property including stock or securities to a foreign corporation in what otherwise would be a nonrecognition exchange.
The existing regulations provide that a U.S. transferor may defer recognizing gain immediately on a transfer of stock or securities to a foreign corporation if it files a GRA and meets certain other requirements. Pursuant to the GRA, the U.S. transferor agrees to include in income the gain realized, but not recognized, on the initial transfer of the stock and securities, and to pay any applicable interest, upon certain events referred to as “triggering events” that occur before the close of the fifth taxable year following the year of the initial transfer.
The 1997 regulations provided that various nonrecognition transactions were not triggering events if certain requirements were satisfied. Although the exceptions clearly contemplated some nonrecognition transactions, they were unclear whether and, if so, how the exceptions applied to various asset reorganizations.
2007 Temporary Regulations
The principal purpose of the 2007 temporary regulations was to provide additional circumstances in which nonrecognition could be continued because the ability to collect the tax would remain sufficiently preserved. They followed an announcement made by the IRS in Notice 2005-74. The 2007 temporary regulations provided guidance on certain asset reorganizations that were insufficiently addressed in the prior regulations by providing specific triggering event exceptions.
2009 Final Regulations
The 2009 final regulations retain the exceptions of the 2007 temporary regulations with certain modifications and additions. Highlights of the 2009 final regulations are set out below.
Expanded Specific Triggering Event Exceptions
The 2009 final regulations retain the triggering event exceptions in the 2007 temporary regulations with, in certain cases, modifications to clarify and expand such exceptions. In addition, the 2009 final regulations add new triggering event exceptions to address intercompany transactions, divisive reorganizations and the deemed transactions that take place pursuant to an election under section 338(g).
General Triggering Event Exception
In a marked improvement over the 2007 temporary regulations, the 2009 final regulations provide a general exception described by the preamble as being “for certain transactions that cannot be adequately covered by a specific exception because of the myriad factual permutations.” The preamble states that the IRS and the U.S. Department of Treasury expect that this general exception will apply, for example, to an outbound transfer of stock of a transferee foreign corporation pursuant to a section 368(a)(1) asset reorganization. In addition, this general exception should apply to most, if not all, purely internal restructuring transactions.
In general, this exception applies to a disposition that would otherwise be a triggering event if the disposition is a nonrecognition transaction, a U.S. transferor retains a direct or indirect interest in the transferred stock or securities (or the assets of the transferred corporation), and the U.S. transferor enters into a new GRA with respect to the initial transfer. Additionally, if as a result of the disposition, a foreign corporation acquires all or part of the transferred stock or securities (or the assets of the transferred corporation), the general exception applies only if the U.S. transferor owns at least 5 percent of the vote and value of the stock of the foreign corporation immediately after the disposition.
The final regulations generally apply to GRAs filed with respect to transfers of stock or securities on or after March 13, 2009. However, taxpayers can elect to apply the final regulations to GRAs filed with respect to transfers of stock or securities for all open taxable years, subject to a consistency requirement. This retroactivity can be elected to reverse the effect of a disposition that was a triggering event under the 2007 temporary regulations but would not be a triggering event under the 2009 final regulations.
In order to apply the 2009 final regulations to a taxable year ending before March 13, 2009, the GRA or other filings required under the particular facts must be attached to an original or amended return for that year. If an amended return is required to elect retroactive application of these regulations, the amended return must be filed no later than August 10, 2009.
Information Required by GRA Must Be Provided with the Tax Return
The 2009 final regulations and the preamble confirm that the information required by the regulations must be provided with the GRA as filed with the tax return of the U.S. transferor. It is insufficient for a U.S. transferor to make such information available “upon request.” The information required includes a calculation of the built-in gain in the transferred stock or securities on the date of the initial transfer. Consequently, a valuation of the transferred stock or securities will need to be performed to determine their fair market value. This is the case even in an internal restructuring where a valuation may not otherwise be undertaken.