Ch. 10 - International Tax-Free Exchanges P.814
Cross-border entity structuring options:
1) Corporation: domestic, foreign (destination
country) or other (intermediary) foreign country, including special purpose subsidiaries. Tax deferral (for U.S. shareholder) if foreign corporation (except for Subpart F income).
2) Partnerships (including LLCs) with flow-
through U.S. income tax status, including “check-the-box” entities.
International Tax-Free Corporate Exchanges
Alternative cross-border corporate structuring or restructuring situations:
1) Outbound – (a) incorporation of foreign corp. or (b) liquidation of U.S. sub into foreign parent.
2) Inbound – liquidation of foreign sub. into U.S.
3) Foreign to foreign restructuring.
U.S. income tax objective: maintain U.S. taxing jurisdiction over previously accrued U.S. value (income).
Maintaining U.S. Income Tax Jurisdiction
Objective is to maintain U.S. taxing jurisdiction
over previously accrued value (income).
How can value move from the U.S. tax area?
1) Organizing & funding a foreign corporation;
including a change from CFC to non-CFC.
2) Outbound corporate liquidation.
See §367 (corp. as “not a corporation”) & §1248.
Possible Corporate Structuring Transactions
Realization/Recognition Rules: §1001
Subchapter C rules for gain, & exceptions:
1) Corporate formation - §351 – corp. formation no gain or loss recognition.
2) Liquidations - §§331 (taxable) & 332 (tax-free) corp. liquidation proceeds to shareholder.
3) Tax-free reorganizations - §§354 & 368(a)(1)
4) Corporate divisions - §355 (spinoffs) & §368(a)(1)(D), aka, “de-mergers.”
Corporate Formation - §351 p.816
No gain or loss is recognized (unless §367 applies) in an incorporation transfer if:
1) property is transferred to a corporation solely in exchange for stock of the corporation, and
2) immediately after the exchange the transferors are in “control” of the corporation.
Similar treatment applies for a “contribution to the capital” of a corporation (i.e., no stock issuance). See §367(c)(2).
Taxable Corporate Liquidations- p.818
A. Shareholder (recipient) treatment:
1) §331(a) - complete corp. liquidation to shareholders treated as a distribution in exchange for the stock. §331(a).
2) If foreign corp. (CFC) liquidation proceeds are received by a greater than 10% U.S. shareholder, then gain may be treated as ordinary income under §1248 (to extent of E&P).
B. Corporate distributor: gain recognition on its distribution of appreciated property.
Tax-free Corporate Liquidations - §332 p.818
A. Liquidation of U.S. sub into U.S. parent:
1) no gain is recognized to the distributing corporation - §337(a); and,
2) no gain is recognized to the recipient parent corporation under §332.
B. Cross-border options: 1) Foreign sub is liquidated into U.S. parent (inbound) (§367(e)(2)).
2) U.S. sub is liquidated into its foreign parent corp. (outbound).
Corporate Tax-free Acquisitive Reorganizations p.819
Tax-free exchanges of corporate stock if a proprietary interest is maintained in the replacement corporate form. IRC §368 provides the definition of tax-free “reorganization” types.
U.S. tax common law requirements:
1) Business purpose;
2) Continued proprietary interest; and,
3) Continuity of business enterprise.
Types of Acquisitive Corporate Reorganizations
§368(a)(1)(A) - statutory merger or consolidation - the surviving corporation can be a U.S. or a foreign corporation.
B reorg. - “stock for stock” exchange.
C reorg. - stock for assets exchange.
Plus: triangular reorganizations – forward triangular merger (§368(a)(2)(D)) & reverse triangular merger (§368(a)(2)(E)) & triangular B & C reorgs.
1) Spin-off - distribution of stock of a controlled corporation - cf., dividend distribution.
2) Split-off - shareholders give up a portion of their stock in exchange for the stock of the controlled subsidiary - cf., redemption.
3) Split-up - stock of two or more subs distributed in liquidation of corporation - cf., corporate liquidation.
Code §355 Requirements
1) “Control” of stock of the subsidiary to be distributed to shareholders.
2) Both corps are to be engaged in business immediately after the distribution.
3) All (or most) of the stock of sub is to be distributed to shareholders.
4) Transaction is not used principally as a “device” for the distribution of earnings.
Anti-Importation of Loss Rules p.822
§362(e) limits tax basis upon the corporate acquisition of loss property. No duplication of loss potential by stuffing loss property into a corporation.
For this limitation to apply: Total adjusted bases of the transferred properties must exceed the FMV of transferred properties immediately after the transaction. §362(e)(2)(A)(ii).
Alternative taxing options
outbound transfers p.823
1) Tax appreciation when: (a) all or (b) certain assets are transferred. Income or excise tax?
2) No gain recognition when appreciated assets are transferred outbound.
3) Obtain an IRS ruling in advance – toll-charges are imposed on transfers of certain assets.
4) Ruling request within 183 days after the transaction - with anticipated toll-charges.
5) Selective gain recognition is specified.
Outbound exchange situations - §367(a) p.827
1) Transfer of appreciated assets to a foreign corp. in an incorporation transaction.
2) U.S. corporation is liquidated and assets are distributed to foreign parent coroporation.
3) Reorg. - Stock (or assets) of a U.S. corporation are acquired by a foreign corp. in exchange for foreign corp. stock; includes, triangular reorg. where foreign corp. stock received for U.S. corp stock.
§367(a) - Treatment for a §351 Transaction p.826
Code §351 eligibility is permitted based on the current inclusion in the U.S. income tax base of the accrued appreciation attributable to certain assets transferred to the foreign corporation.
Code §367(a)(1) – Query: is the recipient corporation to be treated as a “corporation” for federal tax purposes? Otherwise, Subchapter C nonrecognition treatment is not available.
§367(a) Requirements for Outbound Transfers p.826
A foreign corporation is not treated as a "corporation". §367(a)(1). What is the effect of this treatment for §351 purposes?
Possible income taxation of asset transfers: consider tax character and source. And, then, a tax basis adjustment for these assets.
Note: An exception is available for the property transferred for use in the “active conduct” of foreign trade or business. §367(a)(3)(A).
Outbound Triangular Reorganizations,etc. p.828
1) Forward triangular merger.
2) Reverse triangular merger.
3) “B” reorganizations - stock of a foreign corporation is received for domestic stock transferred (alternative: triangular B).
4) “C” reorganization - stock of a foreign corporation is received by domestic sub for domestic sub assets (alternative: triangular C).
Other §367(a) Outbound Transfers p.829
1) Transfer of a partnership interest to a foreign
corporation - §367(a)(4). Treated as the pro-rata
transfer of assets held by the partnership.
An exception applies for traded LP interests.
2) Partnership’s transfer of its assets to a foreign
corporation. Proportionate transfers by partners.
3) Change in the U.S. tax classification of the entity from (e.g., partnership) to a corporation. Treated as a transfer for §351 purposes.
“Active Trade or Business” Asset Exception p.830
1) What is the “trade or business”?
2) “Active conduct” of business is necessary to
enable nonrecognition exception to apply.
Substantial managerial and operational activities
are contemplated (not merely holding stock).
3) Conducted outside the United States.
4) Property is used in the trade or business (not
“listed” stocks and bonds).
Automatically “Tainted” Assets §367(a)(3)(B) p.833
2) Installment obligations and accounts receivable.
3) Foreign currency and property denominated in foreign currency (e.g., accounts receivable).
4) Where the transferor is a lessor, unless the transferee was the lessee (or, next slide).
5) Depreciable property - to the extent tax depreciation was claimed against U.S. income.
Property to be Leased by the Transferee p.834
When is leased property treated as the “active conduct” of trade or business property?
1) Leasing of property constitutes the active conduct of a leasing business;
2) Property is not used in the United States; &
3) Need exists for substantial investment in the assets of the type transferred.
Must be substantial marketing and customer service by foreign corp. employees. E.g., auto leasing operation?
Oil & Gas Working Interests p.835
Working interest in oil and gas properties treated as transferred for use in the active conduct of a trade or business.
But transferee must have no intention to “farm-out” the working interest. What is a “farm-out”?
Outbound Transfer of Corporate Stock p.836
Ordinarily stock is transferred for an outbound corporate reorganization, rather than a §351 incorporation.
General rule of taxability upon the transfer of stock or securities of foreign corporations. Possible gain recognition agreement (or “GRA”) alternative (for a five year post-transfer period).
“Limited interest in transferee” exceptions. (next slides)
Transfer of Foreign Corporation Stock p.837
Gain recognition on this transfer is required unless an exception applies:
1) The U.S. transferor owns less than 5 percent of the stock of the transferee - no current U.S. income tax effect (reorg).
2) U.S. transferor owns more than 5 percent, then a five year gain recognition agreement (GRA) to avoid gain recognition.
3) If foreign corporation moves from CFC to non-CFC status - §1248 pickup.
Transfer of U.S. Corporate Shares to Foreign Corp.
P.838 Usually taxable, but no gain recognition if:
1) All U.S. transferors own less than a total of 50% ownership of the transferee (next slide).
2) Transferee is engaged in active conduct of a trade or business for the 36 months prior to the transfer (and no sale is anticipated).
3) U.S. transferor (i) owns less than 5%, or (ii) if a 5% or greater interest, U.S. transferor has a gain recognition agreement (GRA).
U.S. Corp. - U.S. Shareholder Status? p.839
As relevant for the tax-free exception for U.S. transferors with less than 50% ownership of transferee (p. 839):
1. Presumption that all transferors to foreign corp. are U.S. persons (and, therefore, 50%+).
2. Therefore, to rebut presumption U.S. target corp. must obtain ownership statements from foreign shareholders of the U.S. corp. to show that the 50% U.S. ownership threshold is not exceeded.
Corporate Inversion Transactions p.840
U.S. corporation is transformed into a foreign corporation (i.e., corporate expatriation). Objective: Future avoidance of U.S. income tax.
Assume no CFC status, Subpart F avoided.
Treatment of the shareholders? Tax recognition on the transformation of the entity into foreign.
Transfer pricing/earnings stripping opportunities?
2004 JOBS Act Corporate Inversion Rules p.844
§7874 - two different types of inversion transactions:
1) 80%+ stock identity – former shareholders
own at least 80%. Foreign corp. is deemed to be domestic.
2) 60-80% stock identity – corporate level gain
recognized on stock & asset transfers.
Plus, §4985 excise tax on stock options.
Plus, §6043A IRS information reporting.
Outbound Transfers of Intangibles p.849
Prior tax objective: (1) incur and deduct cost (under §174) against U.S. source income, and then (2) transfer the (zero basis) asset to a foreign subsidiary (where intangible is exploited).
Subsequent foreign income from using the intangible is then immune from U.S. income tax (possibly subject to Subpart F rules). Under §367(d) – transferor is treated as selling the property in a licensing transaction. (next slide)
Outbound Transfers of Intangibles, continued
Amounts treated as income are to reflect a reasonable royalty( or disposition proceeds if a disposition by the foreign subsidiary occurs).
Over the useful life of the intangible – not in excess of 20 years.
See the “commensurate with income” requirement in §367(d) (& §482)).
I.e., a “super-royalty” requirement.
Outbound Transfers of Intangibles, continued
§367(d)(2)(C) – this royalty is treated ordinary income from sources without United States (assuming used outside the United States). Prior (U.S.) sourcing rule changed in 1997 to foreign.
§367(d)(2)(B) specifies a reduction of the E&P of the foreign corporation for the deemed royalty payments. P.851.
Outbound Transfer of Intangibles, continued
Exception for foreign based goodwill which is transferred. P.852.
Cf., Obama FY 2016 proposal to include workforce in place, goodwill & going concern value as intangible property for this rule.
Planning option: use a licensing agreement to transfer intangibles - then the pricing is determined under §482. But, is a foreign withholding tax then imposed at source? p.852
Outbound Transfer of Intangibles, continued
P. 853 - Disposition of the transferred intangible by the transferee accelerates transferor’s gain recognition. §367(d)(2)(A)(ii)(II). Similar treatment if disposition of the foreign corporation stock (holding the intangible).
P. 854 - Option to elect to treat the transfer of the intangible as a deemed sale at then fair market value – rather than periodic royalty treatment. Ordinary gross income in the year of transfer, but probably U.S. source.
Foreign Branch Loss Recapture Rules p.855
U.S. taxpayer operates a foreign branch at a loss. These losses reduce taxpayer’s U.S. taxable income (since branch losses flow through the branch to the U.S. owner).
Then, a transfer of these foreign branch assets to a foreign corporation is made. Foreign profits are thereafter immune from current U.S. income tax (assuming Subpart F is not applicable).
Branch loss recapture rules are applicable in this context (under §367(a)(3)(C)). (next slide)
Foreign Branch Loss Recapture, continued.
Recapture is required of the gain realized on the asset transfers - to the extent of previously unrecaptured losses of the branch.
The type of income recapture depends upon whether the previously deducted item was (1) an ordinary loss or (2) a capital loss.
Prior losses are offset by any subsequent gains.
Note: Foreign tax credit provision (§904(f)(3)) takes precedence in determining the recapture amount.
Liquidation of U.S. Corp. into Foreign Parent p.859
§367(e)(2) denies nonrecognition of gain to a U.S. corporation making a liquidating distribution to a foreign parent corporation (80 percent or more). Cf. §§332 & 337.
Exceptions (in regs): (1) when distributed assets are used in a U.S. trade or business; or, (2) if the property transferred is a U.S. real property interest. I.e., no removal from U.S. tax jurisdiction in these situations.
Liquidation of Foreign Corp into Foreign Parent p.862
No gain recognition on a “foreign to foreign” liquidation. §332.
But, gain recognition is required if U.S. trade or business assets are transferred, unless the ten year trade or business use rule is applicable. Why?
Further exception from gain recognition when U.S. real property distributed (because FIRPTA applies?).
Outbound Spinoffs p.862
Distribution of the stock of a sub by a U.S. corporation to a foreign person.
If the U.S. corporation distributes stock or securities of a U.S. or foreign subsidiary to a foreign person in a §355(a) transaction the distributing corporation recognizes gain under §367(e)(1).
(exceptions, next slide)
Outbound Spinoffs, cont.
Exceptions: 1) After distribution both distributing and distributed controlled corps are U.S. real property holding corps.
2) 80% or more of stock of the U.S. corp is to distributees holding 5% or less of the distributing corp's stock, i.e., publicly held.
3) Distributing corp agrees to file an amended return if foreign distributee of U.S. stock disposes of that stock.
Problem – Are AEC Transfers Tainted? p.864
a) Transfer of 500,000 Cayman dollars – tainted (& gain recognition is required).
b) Cayman dollars accounts receivable – tainted (& gain recognition is required).
c) Desktop systems for immediate sale - inventory and tainted (& gain required).
d) Copiers (as depreciable property held to be leased?) - likely to be treated as tainted inventory – particularly if not subject to current lease. cont.
e) Property interest in word processing program - intangible property specially treated under §367(d) (deemed periodic royalty).
f) Warehouse in Cayman Islands – not tainted; see the §367(a)(3)(B)(i) reference to §1221 which omits §1221(a)(2). (Also are the copiers under this exception?)
Problem 2 p.865
The word processing program generates $5 million gross revenue per year and $500,000 is an appropriate royalty.
The $500,000 is to be included in income each year under §367(d)(2)(A).
This amount is subject to periodic adjustments to assure that the payments are commensurate with income. continued
Problem 2, cont. p.865
Disposition - Ordinary income
1) After 3 years the word processing program is
sold by the Cayman sub. to an unrelated buyer. AEC is required to recognize gain (then the FMV over AEC’s tax basis). Reg. §1.367(d)-1T(f)(1).
2) AEC sells its stock in Cayman. AEC will be
treated as simultaneously selling the intangible property.
3) Source - used outside U.S. - foreign source (§865 rules) & ordinary income. §367(d)(2)(C).
Prob. 3 - Foreign Branch Loss Recapture Rule p.865
Tentative amount of previously deducted branch losses which is subject to recapture is $2,500 (the $3,000 of cumulative losses as reduced by AEC's net income of $500 in year 3).
A. This $2,500 amount is reduced by $500 taxable gain recognized on the tainted assets transfer under §367(a)(1) & (a)(3)(B).
B. The $2,000 branch loss recapture is treated as (foreign source) ordinary income. §367(a)(3)(C).
Prob. 4 - Foreign Branch Loss Recapture Rule
Realized gain on the transfer of untainted assets is only $1,000. What amount is to be included by AEC in its gross income?
The branch loss recapture is limited to the $1,000 amount (rather than the $2,000) for the untainted assets.
Plus, the $500 gain on the transferred tainted assets under §367(a)(3)(B).
Problem 5 p.865
FTC rule §904(f)(3)
§904(f)(3) concerns the transformation of foreign source income to domestic source income upon the transfer of appreciated assets to the newly incorporated branch.
A. $1,000 of year 4 foreign source income is to be treated as U.S. source income to enable the recapture of the $1,000 of the prior overall foreign loss (OFL) accumulated through year 3.
Problem 5, cont.
B. The remaining amount to recapture is $1,000.
The amount of the branch loss to be recaptured would be $1,000 of the previously deducted branch loss, recaptured under §367(a)(3)(C).
C. Note: This remaining $1,000 recapture is after the $500 gain to be recognized on the transfer of the tainted assets.
Problem 6 p.865
Recaptures - Ordering Rules
1) The §904(f)(3) recapture is $1,000 attributable to the $1,000 year four income. This recaptures 1/2 of the potential branch loss amount. This is treated as U.S. source income. This rule has priority over the §367(a)(3)(C) recapture rule.
2) The §904(f)(3) recapture amount is credited against payments that AEC-Cayman is deemed to make to AEC under §367(d) in the first two years of the newly incorporated subsidiary's operations.
Problem 7 p.866
DC, as a U.S. person owning five percent or more of the stock of FC3, the foreign corp. transferee of the FC1 stock, will have §354 nonrecognition if entering into a Reg. § 1.367(a)-8 gain recognition agreement (GRA).
C1 – owning less than 5 percent - is not required to enter into a gain recognition agreement.
Problem 8 p.866
Transfers to Other (Noncorp) Foreign Entities p.867
1) Prior §§1491-1494 excise tax provisions for outbound transfers to non-corporate entities. Repealed in 1997.
2) §367(d)(3) and §721(c) permit regulations on transfers to foreign partnerships. Cf., §704(c).
3) See §684 concerning required gain recognition on transfers of appreciated property to foreign trusts (or foreign estates).
1) Inbound liquidation of foreign corporation into U.S. corporation (inbound).
2) Stock of foreign corporation owned by U.S. shareholders is acquired in exchange for receiving stock of U.S. corporation (i.e., inbound).
3) U.S. shareholder of foreign corporation exchanges stock for stock of another foreign corporation (foreign to foreign).
§367(b) Objectives in Nonoutbound Transfers
1. Implement §1248 treatment
- require recognition where §1248 gain would slip out of U.S. tax base or retain §1248 treatment for the future if postponement is currently permitted.
2. E&P of foreign corporation moves up the ownership chain for corporations.
3. U.S. shareholder status – CFC?
§367(b) - Foreign Sub into U.S. Parent p.873
Complete liquidation of foreign sub into U.S. parent corporation (e.g., in §332 liquidation): Pickup of the “all earnings and profits amount” by the U.S. shareholder as a deemed dividend.
§367(b) - Foreign Sub into Foreign Parent p. 874
Liquidation of foreign subsidiary into foreign parent -
Not a gain recognition event.
E&P moves up.
1. CFC to non-CFC
Indirect FTC to corporate shareholder.
2. Exchange of second tier CFC stock by CFC for foreign corp. stock where not CFC status – §1248 move-up.