Proposed section 367 regulations.

On August 23, 1991, the Internal Revenue Service issued proposed regulations under section 367 of the Internal Revenue Code, relating to the transfers of stock or securities by U.S. persons to foreign corporations, and foreign liquidations and reorganizations. The regulations were published in the Federal Register on August 26, 1991 (56 Fed. Reg. 41993), and in the September 23, 1991, issue of the Internal Revenue Bulletin (1991-38 I.R.B. 6). The IRS held a public hearing on the regulations on November 22, 1991.

The proposed regulations would replace the current temporary regulations issued at various times from 1977 through 1990, some of which were reissued as final and temporary regulations. The proposed regulations would also incorporate changes announced in notices issued by the IRS during the last few years, particularly Notice 87-85, 1987-2 C.B. 395. For simplicity's sake, the temporary regulations are referred to collectively as the "temporary regulations"; the proposed regulations are referred to as the "proposed regulations." Specific provisions are cited as "Temp. Reg.[SECTION]" and "Prop. Reg. [section]." References to page numbers are to the proposed regulations (and preamble) as published in the Internal Revenue Bulletin.

BACKGROUND

Tax Executive Institute is the principal association of corporate tax executives in North America. Our 4,800 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations under section 367 relating to the transfers of stock or securities by U.S. persons to foreign corporations and foreign liquidations and reorganizations.

INTRODUCTION

Section 367 was enacted to prevent taxpayers from utilizing the nonrecognition provisions of the Internal Revenue Code to effect a tax-free transfer of appreciated property beyond the reach of the U.S. taxing authority and to preserve the taxation of the accumulated profits of controlled foreign corporations. H.R. Rep. No. 94-658, 94th Cong., 1st Sess. 242 (1975). Mechanically, the statute accomplishes these results by establishing separate rules for two types of transactions: (i) transfers of property from the United States (so-called outbound transfers); and (ii) other transfers, including transfers into the United States ("inbound transfers") and exclusively foreign transfers.

Section 367(a) reaches "outbound" transactions: If a U.S. person transfers property to a foreign corporation in an exchange described in section 332, 351, 356, or 361 of the Code, the transferee foreign corporation will not be considered a corporation "for purposes of determining the extent to which gain shall be recognized on such transfer." The denial of corporate status to the transferee effectively precludes the taxpayer from using the nonrecognition previsions of the Code and renders the transfer taxable. An exception is provided under section 367(a)(3) for outbound transfers of property to be used by the transferee in the "active conduct" of its trade or business outside the United States. In addition, section 367(a)(6) gives the Secretary of the Treasury broad authority to provide additional exceptions to recognition treatment.

Section 367(b) reaches "inbound" and foreign-to-foreign transactions: In the case of any exchange not described in section 367(a), the foreign corporation will be treated as a corporation "except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes."

The proposed regulations are a welcome simplification of many of the existing rules. For example, the elimination of the temporary regulations' unwieldy earnings and profits attribution rule and the requirement that the section 367(b) notice simply be attached to the return (rather than filed separately with the IRS District Director) will ease compliance burdens for taxpayers and the government alike. In addition, the Institute is particularly pleased that the penalty for failure to file the required notice will be determined under the general penalty provisions of the Code; this change represents a significant improvement over the facts and circumstances test in the temporary regulations which accord the IRS significant leeway in determining whether the foreign corporation will be treated as a corporation. We also welcome the confirmation that a taxpayer's failure to comply with the terms of a gain recognition agreement will be subject to a "reasonable cause" exception.

These helpful changes notwithstanding, there remain several areas in which the proposed regulations could be improved. In particular, we believe that the retention...