International Tax Alert

Transcription

1 30 April 2014 International Tax Alert EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date Notice announces amendments to recently finalized Section 367(b) regulations applying to certain cross-border triangular reorganizations Executive summary On 25 April 2014, the Treasury Department and Internal Revenue Service (the Service) issued Notice (the Notice), describing revisions to final regulations under Section 367(a) and 367(b) that apply to certain cross-border triangular reorganizations involving one or more foreign corporations where the acquiring subsidiary corporation uses property to acquire the stock of its parent corporation (issuing corporation) used in the reorganization (the Final Regulations). Specifically, the Notice announces that the deemed contribution provisions of the Final Regulations will be removed, potentially resulting in current taxation without a corresponding increase in the stock basis of the acquiring corporation. In addition, the Notice would modify the priority rule in Treas. Reg. Section 1.367(a)-3(a)(2)(iv) (the Priority Rule), which presently turns off the application of Section 367(a) to exchanging US shareholders of the target corporation if the issuing corporation recognizes a greater amount of dividend income or Section 301(c)(3) gain under Treas. Reg. Section 1.367(b)-10 than there is shareholder-level gain to be recognized under Section 367(a). For the purpose of comparing income under Treas. Reg. Section 1.367(b)-10 and gain under Section 367(a), the Final Regulations do not exclude dividend and/or gain created by Treas. Reg. Section 1.367(b)-10 that was not subject to US taxation. As modified, the Priority Rule would only take into account dividend income and/ or Section 301(c)(3) that would be subject to US tax directly or indirectly by reason

2 of an income inclusion under Section 951(a)(1)(A). Finally, the Notice purports to describe several clarifications to the anti-abuse rule of Treas. Reg. Section 1.367(b)-10 (the Anti-abuse Rule). Specifically, the Anti-abuse Rule of the Final Regulations will be amended (1) to provide that the rule may apply to the issuance of a note by the acquiring corporation to acquire stock of the issuing corporation used in the reorganization, (2) to take into account E&P of a corporation that is not related to the acquiring or issuing corporation before the reorganization; and (3) to clarify that a funding within the meaning of the Anti-abuse Rule can occur after the reorganization and can include debt, capital contributions or distributions. The amended regulations will apply to triangular reorganizations completed on or after 25 April 2014, with a limited exception applicable for transactions entered pursuant to certain binding commitments involving an unrelated target corporation. However, the Service indicates that no inference should be drawn regarding the treatment of transactions described in the Notice under current law. Background The Final Regulations apply to certain triangular reorganizations in which a subsidiary (S) purchases, in connection with a triangular reorganization, stock of its parent corporation (P) in exchange for property, and exchanges the P stock for the stock or property of a target corporation (T), but only if P or S (or both) is a foreign corporation. The Final Regulations require that adjustments be made to mirror the effects of a deemed distribution of property from S to P under Section 301(c) in the amount equal to the fair market value of the money and other property used to acquire the P stock (the Distribution Rule). Immediately following the deemed distribution, adjustments are to be made to mirror the effects of a deemed contribution by P to S of the property deemed distributed by S to P (the Contribution Rule). The deemed contribution increases P s basis in the S stock held by the amount deemed contributed. The Final Regulations state that both the Distribution Rule and the Contribution Rule are treated as occurring prior to, and apart from, the reorganization. There are several exceptions to the application of the Final Regulations to triangular reorganizations. One such exception is the Priority Rule, which operates to subject a transaction to either Section 367(a) or Section 367(b), but not to both. As such, the Final Regulations would not apply to a triangular reorganization if the amount of gain recognized by T shareholders or security holders under Section 367(a)(1) (Section 367(a) Income) equals or exceeds the sum of the amount of deemed dividend and Section 301(c)(3) gain under the Final Regulations (Section 367(b) Income). As noted above, Section 367(b) Income is determined without regard to whether there is any US tax liability with respect to such income. Notably, there is a similar provision in the Section 367(a) regulations that provides priority to the Final Regulations where the amount of gain recognized with respect to the T stock or securities under Section 367(a) (without regard to any exceptions thereto) would otherwise be less than the sum of the Section 367(b) Income. Another exception (the No US Tax Exception) applies if (a) P is a foreign corporation; (b) S is a domestic corporation; (c) P s receipt of a dividend from S would not be subject to US tax under either Section 881 or Section 882; and (d) P s stock in S is not a US real property interest (within the meaning of Section 897(c)). An exception also applies if P and S are foreign corporations and neither P nor S is a controlled foreign corporation immediately before or immediately after the triangular reorganization. Finally, the Anti-abuse Rule applies to a transaction that is engaged in with a view to avoid the purpose of the Final Regulations. If the Antiabuse Rule applies, appropriate adjustments will be made, including by taking into account E&P of a corporation that has funded the acquiring corporation. 2 International Tax Alert

3 Detailed discussion In accordance with Notice , the Service intends to amend the Final Regulations as follows: The Contribution Rule will be eliminated, resulting in no deemed contribution by P into S and no basis increase with respect to S stock held by P. However, under the amended regulations, the basis of the S stock held by P following the reorganization, will be determined as if the P stock used by S was provided by P pursuant to the plan of reorganization within the meaning of Treas. Reg. Section Thus, P will generally receive an increase in its S stock in an amount equal to T shareholder s basis in their T stock. The Priority Rule will be amended to provide that Section 367(b) Income (as compared to Section 367(a) Income) includes Section 301(c) dividend and gain only to the extent that such income would be subject to US tax directly or indirectly through a Subpart F income inclusion. The No US Tax Exception will be amended to not apply if P is a controlled foreign corporation. Furthermore, if P is not a controlled foreign corporation, S is a domestic corporation, and P s stock in S is not a real property interest, the exception will be amended to apply if the Distribution Rule would result in a dividend that would not be taxable in the United States (e.g., by reason of a tax treaty). The Anti-abuse Rule will be amended to apply in certain cases where S uses a note to acquire the P stock used in the reorganization, to provide that it may take into account E&P of corporations (e.g., T) not related to P and S before the reorganization, that a funding may occur after the reorganization, and that a funding may include debt, capital contributions, or distributions. Implications and observations The Notice would make fundamental changes to Final Regulations that were developed in a deliberate manner by the Service over an approximate five-year period. The elimination of the deemed contribution provisions under the Final Regulations represents a departure from other regulations promulgated under Section 367(b) (most notably Treas. Reg. Sections 1.367(b)-4 and -5), which permit positive basis adjustments upon a deemed distribution of unremitted E&P. The modified regulations would permit for a basis adjustment under Treas. Reg. Section ; however, it is unclear whether an adjustment under that regulation would be made pro rata with respect to the shares of the acquiring corporation, or rather result in the creation of additional basis blocks. In addition, the Notice s description of the forthcoming modifications to the Anti-abuse Rule as clarifications injects additional uncertainty into a rule whose scope is already unclear. An extreme interpretation of the Anti-abuse Rule, in light of the Notice, would suggest that the rule could apply in all cases, except in the limited scenario where S uses its own cash to acquire P stock and has sufficient E&P to treat the deemed distribution as a Section 301(c) dividend. Such an expansive interpretation of the Anti-abuse Rule, however, would convert an anti-abuse rule into the general rule, which would be inappropriate as a matter of regulatory interpretation. Moreover, such a broad reading of the Anti-abuse Rule would arguably override long-standing case law (e.g., Falkoff v. Commissioner) and the Internal Revenue Code (e.g., Section 316) regarding the determination of the amount and timing of dividends. Indeed, President Obama s FY 2015 Budget appears to acknowledge that legislation is required to make such a sweeping change to the law. Nonetheless, through the Notice, the Service has indicated that it may make such arguments in the case of triangular reorganizations subject to the modified regulations, perhaps signaling the arguments that the Service could make upon examination with respect to pre-notice transactions. Given the deliberate process by which the Final Regulations were created and the period between promulgation of the Final Regulations and issuance of the Notice, many taxpayers have reasonably relied on the Final Regulations to take positions that may now appear to be contrary to the Notice. Taxpayers who have relied on the Final Regulations could view the Notice s characterization of the changes as clarifications as inaccurate. International Tax Alert 3

4 For additional information with respect to this Alert, please contact the following: Ernst & Young, LLP, International Tax Services, United States Jose Murillo, Washington, DC David Waimon, Chicago Russell Carr, Chicago Greg Walker, Chicago Tom Bottomlee, Chicago Peg O Connor, Washington, DC margaret.oconnor@ey.com Stephen O Neil, New York stephen.oneil@ey.com Gary Scanlon, Chicago gary.scanlon@ey.com Mike Luke, New York michael.luke@ey.com Alon Kritzman, New York alon.kritzman@ey.com International Tax Services Global ITS, Alex Postma, London ITS Director, Americas, Jeffrey Michalak, Detroit National Director of ITS Technical Services, Jose Murillo, Washington Member Firm Contacts, Ernst & Young LLP (US) Northeast Johnny Lindroos, McLean, VA Financial Services Phil Green, New York Central Mark Muktar, Detroit Southeast Scott Shell, Charlotte, NC Southwest Amy Ritchie, Austin West Frederick Round, San Jose, CA Canada - Ernst & Young LLP (Canada) Albert Anelli, Montreal Kost Forer Gabbay & Kasierer (Israel) Sharon Shulman, Tel Aviv Mancera, S.C. (Mexico) Koen Van t Hek, Mexico City South America Alberto Lopez, New York 4 International Tax Alert

5 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. International Tax Services About Ernst & Young s International Tax Services practices Our dedicated international tax professionals assist our clients with their cross-border tax structuring, planning, reporting and risk management. We work with you to build proactive and truly integrated global tax strategies that address the tax risks of today s businesses and achieve sustainable growth. It s how Ernst & Young makes a difference EYGM Limited. All Rights Reserved. EYG No. CM4388 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com