Service Issues Guidance to Examination Division On Deferred Gain Recognition Agreements Involving Outbound Transfers of Stocks and Securities to Foreign Corporations
In LMSB-4-0510-017 (7/26/2010), the Deputy Commissioner International (LMSB) of the IRS set forth guidance under IRM: 4.51.5 with respect to certain gain recognition agreements ("GRA"). Section 367(a) or §367(d) may require a U.S. person to recognize gain on the transfer of property, including intangibles, to a foreign corporation unless one of several statutory exemptions is applicable, several of which require the filing of a GRA. The Treasury Department and the IRS issued final regulations under section 367(a) and on GRAs in February, 2009 (T.D.9446), replacing temporary regulations (T.D. 9311) that were issued in 2007, which final regulations increased the list of exceptions to §367(a).
Brief Overview of Section 367(a)
Section 367(a) applies to appreciated property transferred to a controlled foreign corporation and §367(d) carves out as a special rule with respect to transfers "intangible property" to a foreign corporation. Section 367(a)(1) imposes a gain (but generally not loss) recognition requirement on the transfer of appreciated property to a foreign corporation that would otherwise be part of an exchange of property for stock as part of a tax-free exchange under §351. As far as contributions to capital, §367(c)(2) provides applicable rules. See Rev. Rul. 76-240, 1976-1 CB 101 . For transfers of intangible property, e.g., rights to a patent, to a controlled foreign corporation, §367(d) may tax the U.S. transferors on an imputed stream of "deemed royalty" payments for a period of up to twenty years. See, e.g., Du Pont de Nemours & Co. v. U.S., 471 F2d 1211 (Ct. Cl. 1973).
Section 367(a)(1) is subject to several exceptions. One applicable exception is a transfer of stock or securities of a foreign corporation by a U.S. person to a foreign corporation where: (i) the U.S. person, directly or indirectly, owns less than 5% of both the total voting power and value of stock of the transferee foreign corporation immediately after the transfer; or (ii) immediately after the transfer the U.S. person ends up owning at least 5% of either the total voting power or the total value of the stock of the transferee foreign corporation provided such U.S. person enters into a five year GRA. §367(a)(2); Treas. Reg. §1.367(a)-3(b)(1).
Another exception applies for transfers of stock or securities of a U.S. corporation by a U.S. person to a foreign corporation that would otherwise be taxable under §367(a)(1) unless four conditions are satisfied: (i) 50% or less of the total voting power and total value of the stock of the transferee foreign corporation is received in the exchange, in the aggregate, by U.S. transferors; (ii) 50% or less of each of the total voting power and the total value of the stock of the transferee foreign corporation is owned, in the aggregate, immediately after the transfer by U.S. persons that are either officers or directors of the U.S. target company or 5% target shareholders; (iii) either (a) the U.S. person is not a 5% transferee shareholder, or (b) the U.S. person is a 5% transferee shareholder and enters into a five-year GRA with respect to the U.S. target company stock or securities it exchanged; and (iv) the foreign corporation is actively engaged in a trade or business.
The preceding paragraphs represent two instances whereby the gain recognition requirement provision "turns off" so to speak gain recognition under section 367(a)(1) where the U.S. transferor properly and timely elects to enter into a five year GRA with the Service. Deferred gain under a GRA is required to be accelerated for certain events including a disposition of part or all of the stock or securities previously transferred by the foreign corporation, a disposition of substantially all of the assets of the transferred corporation, a complete or partial disposition of the stock of the transferee foreign corporation received by the U.S. transferor in the initial transfer, the U.S. transferor becomes a member of a consolidated group or ceases to be a member of a consolidated group in certain instances, where the U.S. transferor is an individual, the death, expatriation or termination of a resident’s "long term U.S. residence" and where the U.S. transferor materially breaches the terms of the GRA (or any requirement of §367), including the failure to file an annual certification, occurs within the five year period. See Treas. Regs. 1.367(a)-8(k)(1) through (k)(13) . But see, in general, §367(b), which must also be considered for transfers that may also fall within the purview of this section.
The new directive applies to any timely filed document that "purports" to be a GRA with respect to the original transfer, any new GRA required as a result of a triggering event, a waiver of the period of limitations on assessment, an annual certification statement and any other information required per Treas. Reg. §1.367(a)-8. For example, if in lieu of providing required information (such as the basis or FMV of the transferred stock or securities) taxpayer provides that such information is"available upon request." For example, if in lieu of providing required information (such as the basis or fair market value of the transferred stock or securities) taxpayer provides that such information is available upon request.This memorandum does not, however, apply to any original GRA required to be filed with respect to an initial transfer, where that original GRA (or document purporting to be an original GRA) was not timely filed. The Service, in setting forth its Directive, acknowledged that this subject was still under study.
Generally, where gain is required to be recognized under a GRA it must be reported (and the taxes paid) on an amended federal income tax return for the tax year of the initial transfer, which must be filed on or before the 90th day following the triggering event. An election is available, however, that allows the U.S. transferor to report any gain recognized under the GRA on its federal income tax return for the tax year during which the triggering event occurs. Interest must be paid under either filing option on any additional tax due, for the period between the due date of the initial federal income tax return for the year of the transfer and the date on which the additional tax due is paid
The Directive
Effective as of the date of this memorandum, July 26, 2010, until further notice is provided, IRS agents are directed to treat any failure to correctly or timely file a document subject to this memorandum as nevertheless satisfying the timeliness requirement under the regulations if, the taxpayer files an amended return for the taxable year to which the failure relates that includes: (i) the complete and accurate filing that should have been included with the original return for such taxable year; (ii) the statement "Filed pursuant to Directive of Examination Action with respect to Certain Gain Recognition Agreement" on the firstpage of the amended return and (iii) the amended return must be filed with the applicable Internal Revenue Service Center with which the U.S. transferor filed its original return for such taxable year; (iv) the taxpayer files with the amended return a Form 8838 "Consent to Extend the Time To Assess Tax Under Section 367- Gain Recognition Agreement" extending the period of limitations on assessment of tax with respect to the gain realized but not recognized on the initial transfer to the later of (1) the close of the eighth full taxable year followingthe taxable year during which the initial transfer occurs or (2) three years from the date the required information is provided to the IRS under this section II; and (v) the taxpayer complies with the notice requirements set forth in §1.367(a)-8(p)(2)(ii)(A) and (B).
Under the Directive, a taxpayer is not required to provide an explanation of the reasons for the failure to timely file or comply. Where the taxpayer submitted a request for reasonable cause relief under § 1.367(a)-8(p) prior to the issuance of this Directive that was denied, taxpayer will be subject to the procedures under this Directive provided that taxpayer meets all of the other requirements in this Directive. If, however, taxpayer submitted a request for reasonable cause relief under Treas. Reg. § 1.367(a)-8(p) prior to the issuance of this Directive that is pending, taxpayer must withdraw its request for reasonable cause to become subject to the procedures under this Directive. Under these circumstances, the amended return submitted by the taxpayer under § 1.367(a)-8(p) will be deemed to satisfy the requirement described in paragraph 1 above. Examples are provided in illustrating the applicable principles involved.
The Service cautions that the Directive is not an official pronouncement of the law or the position of the IRS and cannot be used or relied upon as such. More specifically, the memorandum recites that it sets forth no legal conclusion as to whether taxpayers have complied with the requirements in Treas. Reg. §1.367(a)-8 or other demonstrated that the failure to comply was due to reasonable cause and not willful neglect.
Caution to Reader. The foregoing description of LMSB-4-0510-017 and certain aspects of §367 and background material to aide in understanding the Directive are in no way intended to be construed or relied upon as advisory material for which any reliance may be given by anyone reading this entry. This area of the tax law is quite complex and reading the foregoing "current event" in no way is a substitute for seeking the advises of a competent tax advisor familiar with this area of the Internal Revenue Code.
