Ch. 10 - International TaxFree 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 if foreign corporation (except for Subpart
F income).
2) Partnerships (including LLCs) with flowthrough U.S. income tax status, including “checkthe-box” entities.
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International Tax-Free
Corporate Exchanges
Alternative cross-border corporate structuring or
restructuring situations:
1) Outbound - incorporation of foreign corp. or
liquidation of U.S. sub into foreign corp. 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).
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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?
Examples:
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.
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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 & §368(a)(1)(D),
aka, “de-mergers.”
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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 for a “contribution to the
capital” of a corporation (i.e., no stock issuance).
See §367(c)(2).
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Taxable Corporate
Liquidations-
p.818
A. Shareholder 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 treatment: gain recognition on
distribution of appreciated
property.
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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).
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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.
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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)).
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Corporate Divisions
§355
p.821
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.
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Code §355 Requirements
p.821
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.
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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).
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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 the transfers of certain assets.
4) Ruling request within 183 days after the
transaction - with anticipated toll-charges.
5) Selective gain recognition is specified.
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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
acquired by a foreign corp. in exchange for
foreign corp. stock; includes, triangular reorg.
where foreign corp. stock received for U.S. corp
stock.
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§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 treated as a “corporation” for
federal tax purposes? Otherwise, Subchapter C
nonrecognition treatment is not available.
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§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.
An exception is available for the property
transferred for use in the “active conduct” of
foreign trade or business. §367(a)(3)(A).
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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 assets (alternative: triangular C).
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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.
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“Active Trade or Business”
Asset Exception
p.830
§367(a)(3)(B) applicability.
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).
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Automatically “Tainted”
Assets §367(a)(3)(B) p.833
1) Inventory.
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.
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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?
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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 “farmout” the working interest.
Reg. §1.367(a)-4T(e).
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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)
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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 nonCFC status - §1248 pickup.
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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 U.S. transferor, has a gain
recognition agreement (GRA).
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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.
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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?
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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.
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Outbound Transfers of
Intangibles
p.849
Prior 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.
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 treated as selling the
property in a licensing transaction. (next slide)
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Outbound Transfers of
Intangibles, continued
Amounts 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.
(next slide)
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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.
§367(d)(2)(B) specifies a reduction of the E&P of
the foreign corporation for the deemed royalty
payments. P.851.
(next slide)
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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 imposed at source?
p.852
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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.
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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)
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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.
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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.
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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 (bause FIRPTA applies?).
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Outbound Spinoffs
§367(e)(1)
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)
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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.
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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.
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AEC, continued
e) Interest in word processing program intangible property specially treated under
§367(d) (deemed periodic royalty).
f) Warehouse in Cayman Islands – is not tainted;
see the §367(a)(3)(B)(i) reference to §1221 which
omits §1221(a)(2). (Also are the copiers under
this exception?)
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Problem 2
Intangibles Transfer
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
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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).
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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) ordinary income. §367(a)(3)(C).
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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).
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Problem 5
FTC rule
p.865
§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.
continued
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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.
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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.
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Problem 7
Reorg Transfers
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.
C1 – owning less than 5 percent- is not required
to enter into a gain recognition agreement.
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Problem 8
p.866
[to come]
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Transfers to Other 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.
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“Other” Transfers
§367(b)
p.867
1) Inbound liquidation of foreign corporation into
U.S. corporation.
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).
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§367(b) Objectives
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 currently permitted.
2. E&P of foreign corporation moves up the
ownership chain for corporations.
3. U.S. shareholder status – CFC?
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§367(b) - Foreign Sub into
U.S. Parent
p.873
Complete Liquidation of Foreign Sub into U.S.
Parent Corporation: Pickup of the “all earnings
and profits amount” by the U.S. shareholder.
Reg. §7.367(b)-5(b).
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§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.
Reg. §7.367(b)-5(c).
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Share Exchanges
p. 874
1. CFC to non-CFC
§1248 pickup.
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.
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Problem
p. 875
[to come]
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