Corporate Spinoffs, Split-Offs, and Split-Ups in the International Context

Corporate divisions involve the breaking of one corporation into multiple corporations. Such a transaction can be either taxable or tax-free. Corporate divisions tend to come in three basic flavors: spin-off, split-off, and split-up. Each variation involves a slightly different type of distribution of stock or securities. In general, if the transaction successfully runs the gauntlet of Internal Revenue Code Section 355, the tax treatment to the shareholders and the corporation will be the same regardless of whether the transaction is a spin-off, split-off, or split-up.

In a spin-off, the distributing corporation distributes stock of a controlled corporation (a subsidiary) to its shareholders. This subsidiary may be either a recently created subsidiary “spun off” through the parent corporation’s  transfer of assets in return for stock or an existing subsidiary. The shareholders in a spin-off generally receive a pro rata share of the controlled corporation’s stock and do not transfer anything in return for this stock. If the transaction fails to qualify for no recognition under Section 355 of the Internal Revenue Code, the distribution is treated as a dividend to the shareholder distributes to the extent of the corporation’s earnings and profits and any gain on the distribution of the appreciated assets is taxable to the distributing corporation. See IRC Section 301.

A split-off is very much like a spin-off except that the parent’s shareholders receive stock in the subsidiary in return for some of their stock in the parent corporation. In other words, the transaction is structured more like a redemption than a dividend. If the transaction fails to qualify for Section 355 non recognition treatment, the distribution will be subject to the redemption provisions of Internal Revenue Code Section 302. Consequently, the redemption distribution might be treated by the shareholders either as a dividend under Section 302 of the Internal Revenue Code or a sale or exchange redemption under Internal Revenue Code Section 302(a).

In a split-up, the corporation transfers all of its assets to two or more new corporations (controlled corporations) in return for stock, which is then distributed to the shareholders of the parent corporation in return for all of the parent stock. If the transaction fails to qualify for Section 355 non recognition, the distribution will be treated as a complete liquidation to the shareholders, who will report gain or loss based upon the difference between the fair market value of the stock received and their basis in the original corporation’s stock. In addition, the corporation would be taxable on any gain upon a distribution of assets in complete liquidation. See IRC Section 336.

In today’s global economy, corporations have operations all over the world. A corporate division through spin-offs, split-off, and split-up may trigger a number of negative tax consequences that are often overlooked by tax planners.

Basic Requirements of Internal Revenue Code Section 355 and Divisive Type D Reorganizations

A divisive Type D reorganization discussed in Internal Revenue Code Section 355 permits certain distributions by one corporation (the “distributing corporation”) to its shareholders of stock in another corporation (the “controlled corporation”) to be tax-free to its shareholders, and also to be tax-free to the distributing corporation.

A distribution of stock or securities in a controlled corporation will be eligible for Section 355 non recognition treatment only if it meets numerous statutory and non statutory requirements.

1. Control immediately before the distribution- the distributing corporation must distribute solely stock or securities of a corporation which it controls immediately before the distribution; See IRC Section 336.

2. Distribution requirement– the distributing corporation must distribute all of the stock and securities in the controlled corporation held immediately before the distribution. See IRC Section 355(a)(1)(D)(i). As an alternative, the distributing corporation may distribute an amount sufficient to constitute control. In such a case, however, the distributing corporation must also establish that any retention of stock was not in pursuance to a tax avoidance plan;

3. Trade or business requirement– both the distributing corporation and the controlled corporation must be engaged immediately after the distribution in the active conduct of a trade or business. The “trade or business” requirement actually incorporates both a post-distribution and a pre-distribution rule since the statutory definition of an “active trade or business” requires that the corporation’s trade or business have been “actively conducted throughout the five-year period ending on the date of the distribution. See IRC Section 355(b)(2)(B).

4. Non-device requirement– the transaction was not used principally as a device to distribute earnings and profits of the distributing corporation, the controlled corporation, or both. See IRC Section 355(a)(1)(B).

In addition to these statutory requirements, Internal Revenue Code Section 355 incorporates several judicially developed requirements paralleling those required for the reorganization provisions generally. These include business purpose, continuity of the business enterprise, and continuity of proprietary interest requirements. See Treas. Reg. Section 1.355-2(c).

Control “Immediately Before the Distribution”

Tax-free treatment under Internal Revenue Code Section 355 is limited to corporate distributions of stock or securities of a controlled corporation. Such distribution of stock or securities in a controlled subsidiary to shareholders of the parent arguably reflects a “mere change in form.”

Distribution of Control

A further requirement for an Internal Revenue Code Section 355 tax-free transaction involves the amount of stock or securities distributed. The distributing corporation must either distribute all of the stock or securities of the controlled corporation held immediately before the distribution or enough stock to constitute control. Although Section 355 requires distribution of all, or a controlling amount, of the controlled subsidiary stock, the distributing corporation has substantial flexibility regarding the structure of the distribution. This flexibility can be especially useful in structuring corporate separation to resolve conflicts among shareholders.

Active Trade or Business Requirement

Much of Section 355’s complexity enters through the “active trade or business” requirement of Internal Revenue Code Section 355(b). In addition to the requirements already mentioned, Section 355 requires that both the distributing corporation and the controlled corporation or corporations be “engaged immediately after the distribution in the active conduct of a trade or business.” In the case of a split-up, the distribution effectively is a liquidated distribution of stock in multiple controlled corporations after which the distributing corporation will cease to exist. In such cases, each of the controlled corporations must be “engaged immediately after the distribution in the active conduct of a trade or business.” See IRC Section 355(b)(1)(B). The post-distribution active trade or business requirement is designed to assure that the distributing corporation is actually breaking off in part, or parts, of the business that will continue to operate after the distribution rather than simply distributing assets to shareholders.

The “definition” subsection of Internal Revenue Code Section 355(b)(2) offers virtually no guidance on the meaning of words “active conduct of a trade or business.” However, the regulations define the definition of a corporation engaged in a “trade or business” as:

“a specific group of activities are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such a group includes every operation that forms a part of, or step in, the process of earning income or profit. Such a group of activities ordinarily must include the collection of income and the payment of expenses.” See Treas. Reg. Section 1.355-3(b)(2)(ii).

Whether or not the corporation is actively, as opposed to passively engaged in a trade or business will depend upon the facts and circumstances. To be considered an active trade or business, however, the corporation generally is “required itself to perform active and substantial management and operational functions.” See Treas. Reg. Section 1.355-3(b)(2)(iii). Activities performed by persons outside the corporation, such as independent contractors, do not count as activities performed by the corporation. Nevertheless, the corporation can meet the active trade or business requirement even though “some of its activities are performed by others.” If the corporation can establish that it provides significant operation and management services, the business will be considered an active trade or business. The regulations specifically eliminate from the active trade or business definition the holding of stock, securities, land or other property, for investment purposes as the stock or securities of the controlled corporation held immediately before the distribution or enough stock to constitute control. Although Section 355 requires distribution of all, or a controlling amount, of the controlled subsidiary stock, the distributing corporation has substantial flexibility regarding the structure of the distribution. This flexibility can be especially useful in structuring corporate separation to resolve conflicts among shareholders.

Active Trade or Business Requirement

Much of Section 355’s complexity enters through the “active trade or business” requirement of Internal Revenue Code Section 355(b). In addition to the requirements already mentioned, Section 355 requires that both the distributing corporation and the controlled corporation or corporations be “engaged immediately after the distribution in the active conduct of a trade or business.” In the case of a split-up, the distribution effectively is a liquidated distribution of stock in multiple controlled corporations after which the distributing corporation will cease to exist. In such cases, each of the controlled corporations must be “engaged immediately after the distribution in the active conduct of a trade or business.” See IRC Section 355(b)(1)(B). The post-distribution active trade or business requirement is designed to assure that the distributing corporation is actually breaking off in part, or parts, of the business that will continue to operate after the distribution rather than simply distributing assets to shareholders.

The “definition” section in Internal Revenue Code Section 355(b)(2) offers virtually no guidance on the meaning of words “active conduct of a trade or business.” However, the regulations define the definition of a corporation engaged in a “trade or business” as:

“a specific group of activities are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such a group include every operation that forms a part of, or step in, the process of earning income or profit. Such a group of activities ordinarily must include the collection of income and the payment of expenses.” See Treas. Reg. Section 1.355-3(b)(2)(ii).

Whether or not the corporation is actively, as opposed to passively engaged in a trade or business will depend upon the facts and circumstances. To be considered an active trade or business, however, the corporation generally is “required itself to perform active and substantial management and operational functions.” See Treas. Reg. Section 1.355-3(b)(2)(iii). Activities performed by persons outside the corporation, such as independent contractors, do not count as activities performed by the corporation. Nevertheless, the corporation can meet the active trade or business requirement even though “some of its activities are performed by others.” If the corporation can establish that it provides significant operation and management services, the business will be considered an active trade or business. The regulations specifically eliminate from the active trade or business definition the holding of stock, securities, lCorporations sometimes purchase stock in other corporations to hold for investment or purchase assets from other corporations to hold for investment or to use for business operations. The tax lawyer generally would not refer to these day-to-day corporate purchases of stock or assets as corporate acquisitions. A “corporate acquisition” generally refers to an acquisition of control by one corporation over another. (For purposes of this article, “control” refers to the 80 percent control requirement under Internal Revenue Code Section 1504). One corporation may acquire control over another through two different transaction types. First, a simple asset acquisition from the target corporation itself offers the purchaser direct control over the selling corporation’s assets. Second, a stock acquisition from the target corporation’s shareholders provides the purchaser with indirect control over the selling corporation’s assets through its ownership of the target corporation’s stock. 

In a stock purchase, the purchasing corporation (P) acquires a controlling interest in the target corporation (T) stock from the target’s shareholders, then becomes a parent to its newly acquired subsidiary (T). The parent may continue to operate T as a complete liquidation. In the case of a stock purchase followed immediately by a liquidation of T, the purchasing corporation acquires control over T’s assets upon the liquidation distribution.

Pre-Distribution Active Trade or business Requirement

The pre-distribution active trade or business requirement inelegantly in the statutory language. The language in Internal Revenue Code Section 355(b)(1) begins by including only a post-distribution trade or business requirement. The definition section that follows in Internal Revenue Code Section 355(b)(2) treats a corporation as engaged in the active conduct of a trade or business for purposes of paragraph (b)(1) only if the trade or business “has been actively conducted throughout the five-year period ending on the date of the distribution.” See IRC Section 355(b)(2)(B).  Thus, the particular trade or business relied upon to meet this requirement cannot be a new trade or business, but must have a five-year history. Finally, the distributing corporation must not have acquired the trade or business, or control over the corporation conducting the trade or business, in a taxable transaction within five years prior to the distribution. See IRC Section 355(b)(2)(C), (D).

Vertical and Horizontal Division of a Single Business

Corporations may wish to separate particular functions, such as research or sales, into separate corporate entities. The potential problem here is that a corporate entity created to engage in a single function of a larger business enterprise may not independently produce income. The Section 355 regulations envision a corporation as engaged in a “trade or business” “if a specific group of activities are carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation that forms a part, or a step, in the process of earning income or profit.” See Treas. Reg. Section 1.355-3(b)(2)(ii). In order to satisfy the “active trade or business” requirement, the activities separated in the new corporation must represent a separate and independent trade or business.

Device for the Distributions of Earnings and Profits

In addition to all the restrictions and requirements discussed above, Internal Revenue Code Section 355 explicitly demands that “the transaction was not used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation of both. See IRC Section 355(a)(1)(B). The regulations state

 that “Section 355 recognizes provisions of the Code through the subsequent sale or exchange of stock of one corporation and the retention of the stock of another corporation.” See Treas. Reg. Section 1.355-2(d)(1). All the restrictions and requirements found in Internal Revenue Code Section 355 are directed at the goal of preventing bailout of corporate earnings and profits without paying a “dividend” toll.

Tax Consequences to the Corporation

A corporation distributing stock or securities of a controlled subsidiary in a transaction meeting the requirements of Internal Revenue Code Section 355 will recognize no gain or loss upon the distribution. Section 355(c) provides such non-recognition for Section 355 distributions that are “not in pursuance of a plan or reorganization for purposes of Section 355 distributions are “not in pursuance of a plan or reorganization.” See IRC Section 355(c)(1).

Tax Consequences Under Section 368

Internal Revenue Code Section 368 provides for nonrecognition of gain or loss realized in connection with a considerable number of corporate organizational changes. These include divisive reorganizations under Section 355. They are permitted on a tax-free basis on the rationale that they are merely changes in the organizational forms for the conduct of business and that there should be no tax penalty imposed on formal organizational adjustments that are dictated by business considerations. A reorganization plan must occur pursuant to a plan in order to qualify as a tax-free reorganization under Section 368.

Section 367 Considerations

Anytime the stock or assets of a U.S. corporation or a controlled foreign corporation (“CFC”) are involved in a cross-border transaction, Internal Revenue Code Section 367 must be considered. Section 367 has two basic purposes. First, it stands sentinel to ensure that (with certain exceptions) a U.S. tax liability (sometimes called a “toll charge”) is imposed when property with untaxed appreciation is transferred beyond U.S. taxing jurisdiction. It generally accomplishes this objective by treating the foreign transferred corporation as not qualifying as a “corporation” for purposes of certain tax-free-exchange provisions. Because such provisions apply only to “corporations,” the U.S. transferor will recognize taxable gain on the transfer.

Second, Section 367 ensures that the earnings of a U.S. corporation do not avoid U.S. tax because they are shifted to an entity that is not a CFC as a result of some corporate reorganization or other transaction. In this respect, Section 367 is the mechanism that ensures the enforcement of the rules of Section 1248 of the Internal Revenue Code, which require dividend treatment when a U.S. shareholder sells or exchanges stock in CFC or the corporation is liquidated. The principal purpose of Section 1248 is to prevent a U.S. shareholder of a CFC from realizing gain on its undistributed earnings at the cost only of tax on long-term capital gains.

Any U.S. corporation or CFC involved in a Section 355 reorganization will likely be subject to the provisions of Section 367(b). Section 367(b) can require gain recognition, income, inclusion, or other adjustments in certain circumstances. The earnings and profits of the distributing corporation should be allocated between the distributing corporation and the controlled corporation in each divisive Type D reorganization transaction. Whether or not Section 367(b) will trigger a Section 1248 tax liability depends upon whether the distributing corporation is a domestic corporation or a CFC within the meaning of Section 957. For example, when a CFC makes a distribution in a Section 355 or divisive Type D reorganization, the tax results depend upon whether the CFC had certain types of earned that were not previously taxed under the global intangible low-tax income (“GILTI”) or Subpart F regimes of the Internal Revenue Code.

Another tax consideration in a cross border Section 355 reorganization is Section 356. In a Section 355 distribution, the shareholders of a distributing corporation do not recognize gain or loss or dividend income on the receipt of the stock of the controlled corporation, except to the extent of any boot received in the transaction. See IRC Sections 355(a)(1) and 356. Any stock of a controlled corporation distributed within five years prior to the distribution in a transaction in which gain or loss was recognized is treated as boot. See IRC Section 355(a)(2)(B).

Internal Revenue Code Section 356 applies if any property is received that is not permitted to be received under Section 355(a). Such property is referred to as “boot.” Specifically, cash that is distributed in connection with a divisive Type D reorganization is treated as boot. If boot is received in a Section 355 transaction in which the shareholders of the distributing corporation exchange shares in the distributing corporation for shares in the controlled corporation and boot (for example, split-offs or split-ups), its tax results are discussed under Internal Revenue Code Section 356(a). In the alternative, if boot is received in a Section 355 transaction in which the shareholders of the distributing corporation receive an interest in the controlled corporation and boot as a distribution from the distributing corporation (for example, a split-off), the tax consequences of the transaction is governed by Section 356(b) of the Internal Revenue Code. Section 356(b) requires that boot be treated as a distribution from the distributing corporation to which Section 301 applies. Section 301(c) provides that a distribution from a corporation to its shareholders be treated as a dividend, which means that the distribution is treated as a dividend to the extent of the distributing corporation’s accumulated earnings and profits.

A CFC is defined as a foreign corporation in which more than 50% of its total voting power or value is owned by U.S. Persons (U.S. individuals, U.S. trusts, U.S. corporations, or U.S. partnerships) who each own at least 10% of the combined voting power of all classes of the stock, or at least 10% of the total value of all classes of stock. See IRC Sections 957(a) and 951(b). For these purposes, certain attribution rules can apply to attribute stock ownership of a foreign corporation to U.S. persons. If a foreign distributing corporation were to be directly or indirectly owned by a U.S. person, it is possible that the foreign distributing corporation could be considered a CFC since the foreign distributing company’s stock would be attributed down to the U.S. person. Under these attribution rules, U.S. person directly, indirectly, or constructively holding shares in a distributing corporation could be subject to a surprise tax liability.

Gain Recognition Agreements

The Internal Revenue Code provides that some cross border reorganization are subject to gain recognition agreements. For example, a contributing U.S. parent of CFC stock to a second foreign corporation may require the U.S. parent corporation to enter into a gain recognition agreement. Thus, it is common for Type D reorganizations to file a gain recognition agreement with the Internal Revenue Service (“IRS”). A gain-recognition agreement requires the U.S. transferor to recognize any realized gain in the transferred stock or securities not recognized at the time of transfer if the transferee foreign corporation disposes of the transferred stock or securities during the five-year gain-recognition period. Gain recognition to the U.S. transferor is also triggered if the corporation (the “transferred corporation”) disposes of substantially all of its assets. If the transferee foreign corporation disposes of the transferred property (or the transferred corporation disposes of substantially all of its assets) during the five-year period in which the gain-recognition agreement is in effect, the U.S. transferor must recognize any previously unrecognized gain plus pay an interest charge. If gain is triggered under the gain-recognition agreement, the U.S. transferor files an amended federal income tax return for the year of the transfer, reporting the previously unrecognized gain and interest charge or the transferor may report the previously unrecognized gain and interest charge on the return in which the triggering event occurs.

A gain-recognition agreement is an agreement to which the U.S. transferor agrees to recognize gain if the transferred foreign corporation disposes of the transferred stock or securities during the term of the gain recognition and pay interest on any additional tax owing if a “triggering event” occurs. For purposes of Section 367(a), the term “United States transferor” includes: 1) a citizen or resident of the United States; 2) a domestic corporation; 3) a U.S. citizen, resident, or domestic corporation that is directly or indirectly a partner in a domestic or foreign partnership that transfers property to a foreign corporation; and 4) any estate or trust (other than a foreign estate or trust under Section 7701(a)(31). A “triggering event” typically takes place when a foreign corporation disposes of the untaxed U.S. property.  In most cases, a gain recognition agreement term is 60 months following the end of the taxable year in which the initial transfer is made.

Below, please see Illustration 1. and Illustration 2. which demonstrates typical situations where a gain recognition agreement would be required.

Illustration 1.

A U.S. parent corporation with two direct foreign subsidiaries (FS1 and FS2) transfers shares of FS1 to FS2 in a transaction that would otherwise qualify as a tax-free reorganization under Section 368 or a tax-free exchange under Section 351.

Illustration 2.

Foreign Acquirer acquires U.S. Target. U.S. Target’s shares are worth $10 million.

If a gain recognition agreement is not timely filed with the IRS or a U.S. transferor fails to comply with the terms of a gain recognition agreement (i.e., provide the IRS with an annual certification that a triggering event has taken place), the IRS could assess a penalty equal to 10 percent of the fair market value of the property transferred. However, the penalty does not apply if the U.S. person can show that the failure to comply was due to reasonable cause and not due to willful neglect. The total penalty cannot exceed $100,000 unless the failure is due to an intentional disregard of reporting requirements.

A United States transferor must file IRS Form 8838 if it enters into a gain recognition agreement with the IRS pursuant to Section 367(a) with respect to transferred property. A U.S. transferor must agree to extend the statute on transfers described in Section 367(a) for at least eight tax years following the tax year of the transfer on the Form 8938. In the case of domestic liquidating corporations and foreign distributee corporations described in Section 367(e)(2), the U.S. transferor must agree to extend the statute of limitations for at least three years after the date on which all items of property distributed to the foreign distributee are no longer used in a trade or business within the United States.

At a minimum a gain recognition agreement should include the following:

1) The identifying number of the U.S. transferor (i.e., social security number or employer identification number);

2) A list of controlling shareholders if any shares remain in existence after the transfer;

3) The name, address, identifying number or other identifying information, country code, and foreign law jurisdiction of the foreign transferred and the gain recognition agreement should state whether or not the foreign transferee is a controlled foreign corporation;

4) The date of transfer, description of property (i.e., currency, stocks, securities, inventory, intangible property, or property that was previously depreciated in the U.S.), fair market value of the property on the date of transfer, cost basis of the property transferred, and gain realized on the transfer;

5) A definition of a “triggering event.”

A gain recognition agreement provides the parameters under which a U.S. transferor will recognize gain if the foreign corporation sells or disposes transferred property during the 60 month term of the agreement. If a triggering event occurs, the U.S. transferor must: 1) report the taxable gain on an amended tax return on the year of transfer; 2) adjust the basis of the asset or assets for which the gain was realized; and 3) pay any applicable penalties and interest on the tax assessed as a result of the recognition.

Notice 2007-74

The IRS issued Notice 2005-74 to provide guidance regarding gain-recognition agreements. Under Notice 2005-74, a U.S. taxpayer can avoid realizing taxable gain in connection with a gain-recognition agreement if all the conditions are satisfied:

1. The U.S. transferor was a member of a consolidated group in the year in which the gain-recognition agreement was originally entered into (“original consolidated group”), and the common parent of the group (“U.S. parent corporation”) entered into the original gain recommendation agreement.

2. Immediately after the asset reorganization, the successor U.S. transferor is a member of the original consolidated group.

3. The U.S. parent corporation of the original consolidated group enters into a new gain-recognition agreement, modified by substituting the successor U.S. transferor in place of the original U.S. transferor.

4. The successor U.S. transferor includes the new gain-recognition agreement within its next tax return.

Below please see Illustration 3 which discusses how a taxpayer can avoid triggering a taxable gain through a gain recognition agreement by satisfying the above conditions.

Illustration 3.

USP, a domestic corporation, owns 100 percent of the stock of two foreign corporations, FC1 and FC2. In Year 1, USP transfers 100 percent of the stock of FC1 and FC2 in an exchange described in Section 351 and, pursuant to Treasury Regulation 1.367-3(b)(1)(ii) and 1.367(a)-8, enters into a gain recognition agreement with respect to such transfer. In Year 4, in a reorganization described in Section 368(a)(1)(C), FC1 transfers all of its assets to FC3, an unrelated foreign corporation, in exchange for FC3 stock. FC1 transfers the FC3 stock to FC2 in exchange for the FC1 stock held by FC2 and the FC1 stock is canceled.

Pursuant to condition three discussed above, the transfer of the FC1 assets to FC3 in exchange for FC3 stock and the exchange of the FC1 stock for FC3 stock will not trigger the gain-recognition agreement if, in addition to complying with the reporting requirements of the Internal Revenue Code, USP enters into a new gain-recognition agreement pursuant to which it agrees to recognize gain with respect to the transfer subject to the original gain-recognition agreement, substituting FC3 as the successor transferred corporation in place of FC1, treating FC3 as the original transferred corporation for purposes of Treasury Regulation Section 1.367(a)-8 and treating only the assets acquired by FC3 from FC1 pursuant to Section 368(a)(1)(C) reorganization as assets subject to the deemed disposition of stock rules under Treasury Regulation 1.367(a)-8(e)(3)(i). Thus, for purposes of the new gain-recognition agreement, Treasury Regulation Section 1.367(a)-8, USP continues to be the U.S. transferor, FC2 continues to be the transferee foreign corporation, and FC3 is the successor transferred corporation and is treated as the original transferred corporation. The new gain recognition agreement applies through the close of Year 3 (the remaining term of the original gain recognition agreement filed by USP).

For the most part, when a gain-recognition agreement is in effect, if the original transferee foreign corporation to another foreign corporation (“successor transferee foreign corporation”) in an asset reorganization, the exchange will trigger a taxable event. However, Notice 2005-74 provides that a taxable event will not take place if the following elements are satisfied:

1. The U.S. transferor enters into a new gain-recognition agreement in which it agrees to realize gain during the remaining term of the original gain-recognition agreement. In the new gain-recognition agreement, the successor transferee foreign corporation is substituted in place of the original transferee foreign corporation.

2. The successor U.S. transferor includes the new gain-recognition agreement with its new tax return.

Below please see Illustration 4 which discusses how a U.S. taxpayer can avoid triggering a taxable gain through a gain recognition agreement by satisfying the two above discussed conditions.

Illustration 4.

USP, a domestic corporation, owns 100 percent of the stock of two foreign corporations, FC1 and FC2. In Year 1, USP transfers 100 percent of the stock of FC1 to FC2 in an exchange described in Section 351 and, pursuant to Treasury Regulations 1.367(a)-3(b)(1)(ii) and 1.367(a)-8, enters into a gain-recognition agreement with respect to such transfer. In Year 2, FC2, FC2 transfers property to FC1 in exchange for newly issued FC1 stock. In Year 4, FC2 distributes all of its FC1 stock to USP in a liquidating distribution that qualifies under Sections 332 and 337.

In determining whether the gain-recognition agreement entered into by the USP is determined, or in the alternative triggered, only the stock of FC1 transferred by USP to FC2 in Year 1 is considered in determining whether immediately following the Section 332 liquidation, USP’s basis in the transferred stock is less than the equal to the basis that it had in such stock immediately prior to the initial transfer that necessitated the gain-recognition agreement. Thus, the basis in the FC1 stock issued to FC2 in Year 2, in exchange for property, is not taken into account. The result in this illustration would remain the same if, instead of FC1 actually issuing stock in FC2 in exchange for the transferred property FC1 was deemed to issue stock to FC2 in exchange for such property.  

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on providing tax planning domestic and international tax planning for multinational companies, closely held businesses, and individuals. In addition to providing tax planning advice, Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.