Will the Liquidation of a Foreign Subsidiary into a Foreign Parent Trigger U.S. Taxable Gains?

The general rule established by the regulations promulgated by the Department of Treasury and the Internal Revenue Service (“IRS”) is that a foreign corporation does not recognize taxable gain in the U.S. with respect to property it distributes in a complete liquidation to a foreign parent corporation as long as the stock ownership tests of Section 332 are satisfied.

Section 332 of the Internal Revenue Code provides that a parent corporation recognizes no gain or loss on the receipt of property in complete liquidation of an 80 percent or more subsidiary if certain conditions are met. In that event, the parent corporation receives the distributed assets of the subsidiary with a transferred basis and takes the subsidiary’s earnings and profits. To qualify under Section 332, the subsidiary must distribute property to its parent in complete cancellation or redemption of its stock pursuant to a plan of liquidation, and the liquidation must satisfy the following two requirements

First, under Section 332(b)(1), the parent must own at least 80 percent of the total voting power of the stock of the subsidiary and 80 percent of the total value of all outstanding stock of the subsidiary from the date of adoption of the plan of complete liquidation and at all times thereafter until the parent corporation receives a final distribution. The stock ownership requirements are derived from Section 1504(a)(2) of the Internal Revenue Code, which sets forth rules for determining whether a corporation is a member of an “affiliated group.” Second, the parent corporation must satisfy one of two timing alternatives discussed in Section 332. Under Section 332, liquidations qualify for tax-free treatment if the subsidiary distributes all of its assets within one taxable year even if it is not the same year in which the liquidation plan is adopted. See Rev.Rul. 71-326, 1971-2 C.B. 177. Where the distributions span more than one year, the plan must provide that the subsidiary will transfer all of its property within three years after the close of the taxable year in which the first distribution is made. See IRC Section 332(b)(3); Treas. Reg. Section 1.332-4.

The nonrecognition rule contained in Section 337(a) is limited to distributions of property by a liquidating subsidiary to “the 80-percent distributee” or the parent corporation. Thus, U.S. minority shareholders will recognize taxable gain on the fair market value basis in the distributed property.

Consequently, if the aforementioned rules in Section 332 are satisfied, gain will not be recognized in connection with the liquidation of a foreign corporation into a foreign parent corporation for U.S. tax purposes. There are however exceptions to this general rule. Gain is realized on the distribution of any property (other than U.S. real property interests) used by the distributing foreign corporation in the conduct of a U.S. trade or business at the time of the liquidation. See Treas. Reg. Section 1.367(e)-2(c)(2)(i)(A). An exception to this recognition-of-gain rule applies if the distributing and distributee corporations file an appropriate statement with the IRS.

Conclusion

This article is intended to provide the reader with a basic understanding of the basic U.S. tax considerations in the context of a liquidation of a foreign corporation into a foreign parent corporation. It should be evident from this article that this is a relatively complex subject. In addition, it is important to note that this area is constantly subject to new developments and changes. As a result, it is crucial that any organization considering a cross-border reorganization consult with a qualified international tax attorney. We have advised a significant number of businesses, law firms, and accounting firms regarding the U.S. tax implications of cross-border corporate reorganizations.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.

He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.