In May, 2008, temporary and proposed regulations were issued under §367(b) to address the Service’s concern about the tax impacts arising from certain triangular reorganizations involving foreign corporations, a/k/a “Killer B” transactions, in which a subsidiary purchases, in connection with the reorganization, stock of its parent corporation in exchange for property, and exchanges the parent corporation’s stock for the stock or property of a target corporation. This problem area had been on the Service’s radar screen for some time. See Notices 2006-85 and 2007-48. The reason for the concern was that the Service felt that such transactions involved the repatriation of earnings in the form of a tax-free reorganization that in many cases would escape U.S. income taxation on dividend repatriations.

The 2008 regulations contained in Temp. Reg.§ 1.367(b)-14, are now issued in final form in Treas. Reg. § 1.367(b)-10 and apply to transactions occurring after May 16, 2011. The final regulations require that adjustments be made as part of such a reorganization, i.e., subsidiary exchanges property for stock of its parent to acquire target stock (and/or securities) in a reorganization. The adjustments are deemed to be a dividend from the subsidiary  to the parent of the property transferred to the parent in exchange for its stock (and securities). Where the subsidiary purchases parent stock from another party, however, the parent is also treated as having contributed to the subsidiary the property deemed distributed to the parent.


Section 367(a)(1) provides in connection with a generally non-taxable liquidation of a controlled subsidiary, tax-free incorporation under §351 or non-taxable reorganization, involving a U.S. person’s transfer of appreciated property to a foreign corporation, such foreign corporation shall not be treated as a domestic corporation. This means that gain on the transfer of appreciated property will be recognized unless an exception to §367(a)(1) applies to the transfer. In addition, §367(b)(1) provides that in the case of any exchange that is entitled to non-recognition treatment, e.g., liquidation of a controlled subsidiary, non-taxable reorganization, etc., where there is no transfer of property described in §367(a)(1), such as in a  exhange of stock solely for voting stock in a Type B reorganization, a foreign corporation will be treated as a corporation except to the extent provided in regulations.  

Section 367(a)(1) (and the regulations under that section) and the 2008 regulations could each potentially apply to certain triangular reorganizations. For example, §367(a)(1) and the 2008 regulations could each potentially apply to a triangular reorganization described in  §368(a)(1)(B) if the subsidiary acquires parent corporation stock for property and each corporation involved in a triangular B reorganization, including the target corporation, are foreign corporations and the target corporation stock is held by a U.S. person who realizes gain on the exchange.  See Treas. Reg. § 1.367(a)-3(d)(1)(iii)(A) (providing that there is an indirect transfer by the U.S. person of the target stock to the subsidiary). Under a priority rule, §367(b)(1) will not apply to an exchange if gain is required to be recognized under §367(a)(1) unless an exception is provided by regulation.

Priority Rules

The 2008 regulations included a “priority rule” that provided, in general,  that if the amount of gain in the U.S. person’s disposition of target  stock that would otherwise be recognized under §367(a)(1) (absent an exception) is less than the adjustment treated as a dividend under the 2008 regulations, then the 2008 regulations, and not §367(a)(1), would apply to certain triangular reorganizations. See Treas. Reg. §1.367(a)-3(c). A comment received in response to the 2008 regulations was that the “priority rule” may not always yield the correct result at least from a tax policy standpoint, i.e., the “greater” dividend amount (over the gain amount) may be insulated from U.S. income taxation by a favorable tax treaty.  

While rejecting a full U.S. tax liability impact analysis as had been suggested by a commentator, the final regulations to Treas. Reg. §1.367(b)-10 will not apply (and therefore §367(a)(1) will apply) where the parent and subsidiary corporations in the triangular B reorganization are foreign corporations and neither corporation is a controlled foreign corporation (per Treas. Reg. §1.367(b)-2(a)) immediately before or immediately after the triangular reorganization. As a second exception to application of the  “priority rule”, the final regulations under Treas. Reg. §1.367(b)-10 do not apply if: (1) the parent is a foreign corporation; (2) the subsidiary is a domestic corporation; (3) the  parent’s receipt of a dividend from subsidiary  would not be subject to U.S. income tax under either §881 (for example, by reason of an applicable treaty) or  §882; and (4) the parent’s stock in the subsidiary is not a United States real property interest. See §897(c) .

The final regulations add a protective rule which includes the acquisition by the subsidiary, in exchange for property, of the parent corporation’s securities that are used to acquire the stock, securities, or property of the target corporation in the triangular reorganization, but only to the extent the parent’s securities are treated by the target’s shareholders or security holders as "other property" under §356(d).  Finally, the final regulations modify the “priority rule” by: (1) including exchanges of target securities as well as target corporation stock; (2) comparing the amount of gain that would be recognized under §367(a)(1) with not only the amount of the deemed dividend but also the amount of any gain (per §§301(c)(1) and (3), respectively); and (3) by providing  separate priority rules in  Treas. Regs. § 1.367(a)-3(a) and  Treas. Reg. § 1.367(b)-10.

Under Treas. Reg. § 1.367(a)-3(a)’s  priority rule, as modified, if the amount of gain in the target’s stock or securities that would otherwise be recognized by the target’s shareholders or security holders under §367(a)(1) (without regard to any exceptions to §367(a)(1)) is less than the sum of the amount of deemed dividend and the amount of gain (applying §§301(c)(1) and (3), respectively) under the final regulations, §367(a)(1) does not apply to the §§354 or 356 exchange by the target shareholders or security holders.  Stated in the opposite manner, under Treas. Reg. §1.367(b)-10’s priority rule, if the amount of gain recognized by the target shareholders or security holders under §367(a)(1) (taking into account any exception to §367(a)(1) that is applied) on the §354 or §356 exchange of target stock or securities exceeds the sum of the amount of deemed dividend and the amount of gain (applying §§ 301(c)(1) and (3), respectively) if the final regulations otherwise applied to the triangular reorganization, then the final regulations will not apply.

Priority Rules Apply Where Target is Unrelated to the Parent or Subsidiary Corporations

While commentators to the 2008 regulations posited that the 2008 regulations should not apply where the target is not related to either the parent or subsidiary, the final regulations did not adopt such proposal. The Treasury and IRS felt that even in such situation the potential for inequitable tax avoidance was still present.

Adjustments Having the Effect of a Distribution or Contribution

The final regulations clarify that adjustments are made based on a distribution or contribution of a notional amount, and therefore without the recognition of any built-in gain or loss on the distribution of such notional amount. The notional amount is equal to the amount of money transferred and liabilities assumed plus the fair market value of other property transferred, in connection with the triangular reorganization, by the subsidiary in exchange for the parent corporation’s stock or securities used to acquire the stock, securities or property of the target corporation.  The final regulations clarify that the adjustments that have the effect of a deemed distribution or deemed contribution do not affect the characterization of the actual transaction. For example, where the subsidiary corporation uses  property with a built-in gain to acquire parent corporation stock, its exchange of the property for parent stock is not affected by the regulations. Instead, the regulations require adjustments based on a deemed distribution and deemed contribution of the notional amount that occur apart from, and in addition to, the subsidiary corporation’s exchanging the built-in gain property for the  parent corporation stock. Under this example, the subsidiary would not recognize gain under §311(b) as to the notional amount and the subsidiary’s exchange of property would continue to be treated as an exchange subject to §1001 in which the subsidiary recognizes the built-in gain.

The final regulations apply to transactions occurring on or after May 17, 2011. For transactions that occur prior to May 17, 2011, see  Treas. Reg. § 1.367(b)-14T as contained in 26 CFR part 1 revised as of April 1, 2011.