"Check-the-box" prop., regs. - extraordinary transactions could cause extraordinary results.

• Author: Venigalla, Arvind
• Position: IRS regulations

Recently issued proposed regulation contain amendments to the check-the-box regulations. Regs. Secs. 301.7701-2 and -3 could alter the tax treatment of a common transaction involving the transfer of the stock of a U.S. corporation's foreign subsidiary to another foreign subsidiary controlled by the same U.S. corporation, followed by a liquidation of the transferred foreign subsidiary.

Common Transaction and Existing Tax Treatment

If a U.S. parent transfers all the stock of one of its foreign subsidiaries to another of its foreign subsidiaries in a transaction that qualifies as a B reorganization or a Sec. 351 transfer, the transfer will be treated as an outbound transfer of stock subject to Sec. 367. The U.S. parent will, therefore, be required to file a five-year gain recognition agreement (GRA), generally binding the U.S. parent to recognize gain if the transferee foreign corporation disposes (in full or in part) of the stock of the transferred foreign corporation within the five-year period following the close of the tax year of the initial transfer. If, however, the B reorganization or Sec. 351 transfer is followed, as part of the plan, by a liquidation of the transferred corporation, applicable Federal tax principles convert the stock transfer to an asset reorganization. That is, the integrated transaction is treated as if the transferred foreign corporation transferred all of its assets to the transferree foreign corporation in what typically qualifies as a C, D or F asset reorganization; see, e.g., Rev. Rul. 67-274 (B reorganization followed by a liquidation of the transferred corporation tested as a C reorganization) and Rev. Rul. 76-123 (Sec. 351 transfer of a corporation's stock followed by a liquidation of that corporation tested as a C reorganization). Under this recast, the transfer of the assets from one foreign subsidiary to another in an asset reorganization is generally not considered an outbound stock transfer by the U.S. parent (unless the indirect stock transfer rules of Sec. 367(a) apply), and the U.S. parent is not required to file a GRA.

The existing check-the-box regulations provide that the tax treatment of a change-in-entity classification is to be determined based on all applicable Federal income tax principles, including the step-transaction doctrine (Regs. Sec. 301.7701-3(g)(2)). Relying on that language, taxpayers have taken the position that the recast from an outbound stock transfer to a foreign-to-foreign...