Significant recent corporate developments.

• Author: Hayes, Brandon L.

This article discusses selected developments in U.S. federal income taxation of corporations and consolidated groups during 2009. Not surprisingly, the arrival of a new administration was accompanied by the introduction of a variety of proposals for reform of the U.S. income tax system, with a principal focus for corporate taxpayers on the taxation of international activities. In addition to these legislative proposals, the IRS and Treasury issued several packages of final, temporary, and proposed regulations providing guidance on a variety of issues.

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Final and Temporary Regs.

Application of Sec. 367 to Outbound Sec. 304 Transactions

Sec. 304(a)(1) generally provides that if one or more persons are in control of each of two corporations and, in return for property, one corporation acquires stock in the other from the person(s) in control, the property is treated as a distribution in redemption of the acquiring corporation's stock. To the extent the distribution is treated as a dividend-equivalent redemption, the transferor and the acquiring corporation are treated as if:

* The transferor contributed the target corporation's stock to the acquiring corporation in exchange for its stock in a transaction to which Sec. 351(a) applies (the deemed 351 exchange); and

* The acquiring corporation then redeemed the stock it is treated as having issued (the deemed redemption).

Secs. 367(a) and (b) generally apply to certain outbound nonrecognition transactions, including Sec. 351 exchanges. However, final regulations adopted in 2006 provided that Secs. 367(a) and (b) would not apply to a deemed 351 exchange arising from a Sec. 304(a)(1) transaction. Treasury and the IRS initially adopted this position based on their views of permitted basis recovery in Sec. 304 transactions, which would generally require the current recognition of any gains that would be subject to Secs. 367(a) or (b). However, the law in the area of basis recovery in Sec. 304 transactions is unsettled, and the 2006 regulations have been revised accordingly.

On February 10, 2009, Treasury and the IRS issued temporary and final regulations (1) under Secs. 367, 304, and 1248. The new temporary regulations modify the general rule to provide for limited circumstances under which either Sec. 367(a) or (b) may apply to the deemed 351 exchange.

Sec. 367(a): Temp. Regs. Sec. 1.367(a)-9T(a) retains the general rule of the prior regulations that an outbound deemed 351 exchange is not subject to Sec. 367(a) (1). However, Temp. Regs. Sec. 1.367(a)-9T(b) provides a special rule under which Sec. 367(a) will apply to the deemed 351 exchange. Under this special rule, where the deemed redemption received by a U.S. transferor is a dividend-equivalent distribution, if such distribution is applied against and reduces (in whole or in part) the basis of the stock of the foreign acquiring corporation held by the U.S. transferor, other than the stock issued in the deemed 351 exchange, (2) the U.S. transferor recognizes gain. The amount of gain recognized is equal to the excess of the gain realized with respect to the transferred stock over the amount of the distribution that is treated as a dividend under Sec. 301(c)(1). It is important to note that this gain recognition rule operates independently of the other provisions of Sec. 367(a), such that a U.S. transferor may not avoid the gain by simply entering into a gain recognition agreement.

Effectively, this provision will cause the U.S. transferor to recognize the same amount of gain it would have recognized under Sec. 301(c)(3) had it not applied the distribution against its "old and cold" stock of the acquiring corporation. However, there is still an added benefit to taxpayers of taking such a position and falling into the special rule of Temp. Regs. Sec. 1.367(a)-9T(b). Because the special rule treats the gain as having been recognized in the deemed 351 exchange, the basis of the target corporation stock in the hands of the acquiring corporation will be increased by the amount of gain recognized under the special rule. A similar basis increase would not result if the gain were recognized under Sec. 301(c)(3).

Sec. 367(b): Temp. Regs. Secs. 1.367(b)-4T(e)(l) and (2) make similar changes to the 2006 regulations with respect to the potential application of Sec. 367(b) to the deemed 351 exchange. The special rule of Temp. Regs. Sec. 1.367(b)-4T(e)(2) provides that to the extent a deemed redemption distribution is applied against and reduces the U.S. transferor's basis in the stock of the acquiring corporation, other than the stock deemed issued in the deemed 351 exchange, the rules of Regs. Sec. 1.367(b)-4(b) shall apply to the deemed 351 exchange. Unlike the changes to the Sec. 367(a) regulations, this special rule does not automatically result in an income or gain inclusion to the transferor. Instead, it only defines a specific situation in which the current rules of Regs. Sec. 1.367(b)-4(b) must be applied to the deemed 351 exchange. Consequently, the transfer must still fall within one of the three designated transactions described in Regs. Sec. 1.367(b)-4(b) in order for the U.S. transferor to have a current income inclusion as a result of the transaction.

Sec. 1248: These final and temporary regulations also include a provision clarifying that any gain recognized under Sec. 301(c)(3) is treated as gain from the sale of stock for purposes of Sec. 1248(a).

Gain Recognition Agreements

The regulations under Sec. 367(a) provide that certain outbound stock transfers are not subject to the provisions of Sec. 367(a), but only if the U.S. transferor satisfies certain enumerated requirements, including the filing of a gain recognition agreement (GRA) under applicable regulations. In February 2007, the IRS and Treasury issued temporary regulations concerning the terms and conditions required for a GRA and addressed the impact of certain events on an existing GRA. These temporary regulations described a number of events that would cause the U.S. transferor to recognize gain under an existing GRA (each a triggering event), as well as certain events that would terminate the GRA, and also established exceptions to the triggering event rules for a number of specified transactions. However, these specific triggering event exceptions did not cover every situation in which the recognition of gain under an existing GRA seemed inappropriate from a policy perspective.

In response, on February 11, 2009, the IRS and Treasury issued final GRA regulations (T.D. 9446). These final regulations retain the general framework of the temporary regulations but include a number of significant changes, including the addition of new specific triggering event exceptions and a general triggering event exception that applies to certain nonrecognition transactions not otherwise covered by one of the specific exceptions.

Regs. Sec. 1.367(a)-8(k) outlines the various exceptions to the triggering event rules. These exceptions generally include only nonrecognition transactions. Notably, the exceptions apply only if:

* Immediately after the disposition or other triggering event, a U.S. transferor retains a direct or indirect interest in the transferred stock or securities (or in the assets of the transferred corporation); and

* A new GRA is entered into with respect to the initial transfer.

In addition to retaining the basic exceptions of the temporary regulations, these final regulations add exceptions for certain intercompany transactions (3) (as defined in Regs. Sec. 1.1502-13(b)(l)), certain divisive reorganizations under Sec. 355, (4) and the aforementioned general exception.

Regs. Sec. 1.367(a)-8(k)(14) provides the new general exception, which may be applied to triggering events that are not otherwise covered by one of the specific exceptions provided in Regs. Sees. 1.367(a)-8(k)(l) through (13). Under this general exception, a disposition or other event will not constitute a triggering event if:

1. The disposition qualifies as a nonrecognition transaction (as defined in Sec. 7701(a)(45));

2. Immediately after the disposition, a U.S. transferor retains a direct or indirect interest in the transferred stock or securities (or in substantially all the assets of the transferred corporation); and

3. A...