US IRS concludes gain recognition agreements and related filings not affected by short tax years

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1 30 November 2017 Global Tax Alert US IRS concludes gain recognition agreements and related filings not affected by short tax years EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary In a Chief Counsel legal advice memorandum (CCM) (AM ), the United States (US) Internal Revenue Service (IRS) has concluded that the term of a gain recognition agreement (GRA) becomes fixed as of the date of the initial transfer for which the GRA is filed. Subsequent events, such as a short tax year of the US transferor, do not affect the GRA term. Similarly, the period for which a taxpayer must agree to extend the statute of limitations for deferred gain that is the subject of a GRA is fixed as of the date of the initial transfer. Additionally, annual certifications must be filled for all tax years covering the GRA term, including short tax years, but only events within the GRA term are relevant for determining if gain must be recognized under the GRA. Detailed discussion Facts On 30 June of Year 0, a US corporation (UST) that is a calendar-year taxpayer transferred all of the stock of a foreign corporation (TFD) to another foreign corporation (TFC) in an exchange pursuant to Internal Revenue Code 1 Section 351. UST had built-in-gain with respect to the TFD stock and, therefore, entered into a GRA (GRA1) and filed Forms 8838 and 926 to defer recognizing the built-in-gain immediately.

2 2 Global Tax Alert On 30 June of Year 3, the common parent of a US consolidated group (USP) with a fiscal year ending on 30 April acquired all of the stock of UST (Acquisition). As a result of the Acquisition, UST became a member of USP s consolidated US group. UST filed a separate return for the short period from 1 January through 30 June of Year 3. After the Acquisition, UST entered into a new GRA (GRA2), which allowed for the continued deferral of the built-ingain in the TFD stock on the initial stock transfer under the triggering event exception in Reg. Section 1.367(a)-8(k)(11). USP filed GRA2 on behalf of UST with its consolidated US federal income tax return for the tax year that ended 30 April of Year 4. Law and analysis Determination of GRA term Unless an exception applies, Section 367(a)(1) requires a US person (US transferor) that transfers property, including stock or securities, to a foreign corporation in connection with an exchange described in Section 332, 351, 354, 356 or 361 (nonrecognition transaction) to recognize gain. The provisions of Reg. Section 1.367(a)-3 provides an exception to the general rule of gain recognition under Section 367(a)(1) for certain outbound transfers of stock or securities when the US transferor enters into a GRA under the provisions of Reg. Section 1.367(a)-8 (GRA regulations), and files certain other related documents. Absent an event terminating the GRA, under Reg. Section 1.367(a)-8(c)(1)(i), the GRA term is the period beginning on the date of the initial transfer and ending as of the close of the fifth full [tax] year (not less than 60 months) following the close of the [tax] year in which the initial transfer occurs. The CCM clarifies that the parenthetical language in Reg. Section 1.367(a)-8(c)(1)(i) not less than 60 months describes how the date on which the GRA term would end is a date that is between 60 and 72 months following the date of the initial transfer, depending on how early during the year of the initial transfer the initial transfer occurs. The CCM asserts that the date on which the GRA term would end is fixed as of the transfer date of the property subject to the GRA and is not affected by subsequent events, such as short tax years of the US transferor. The IRS considers this approach to be consistent with, and promoting the policy of, the GRA regulations, as well as increasing administrability and ensuring consistent treatment for US transferors. Under the CCM s facts, the term of GRA1 begins on 30 June of Year 0, and would end, absent any event that would otherwise terminate GRA1, on 31 December of Year 5 (the date that is 60 months after the date on which UST s tax year for the year of the initial stock transfer closes). As such, the term of GRA1 is set at 66 months. Under Reg. Section 1.367(a)-8(c)(5), USP s acquisition of UST terminates GRA1 on 30 June of Year 3 and is replaced by GRA2, which begins on 1 July of Year 3. The term of GRA2 is the remaining term of GRA1, which would have been 31 December of Year 5. Thus, absent an event that terminates GRA2, the GRA2 term ends on 31 December of Year 5. While this will be 60 months after the close of the tax year in which the initial transfer occurred, because the acquisition of UST by USP closed UST s Year 3 tax year on 30 June, it could be viewed that there has not been five full taxable years five 12-month tax years from the close of the tax year of the initial transfer. Nevertheless, the CCM concludes that the term of GRA2 ends on 31 December of Year 5. Annual certification Reg. Section 1.367(a)-8(g) requires a US transferor to include an annual certification, or a new GRA in a lieu of an annual certification, with its timely filed return for each of the five full tax years following the tax year of the initial transfer. Notwithstanding the reference to five full tax years, and consistent with the analysis above, the CCM takes the position that the annual certification, or a new GRA filed in lieu of such certification, must be filed for all tax years covering the term of the GRA, including short tax years. The IRS believes that this approach promotes compliance with the GRA regulations. By requiring US transferors to supply information regarding events affecting the GRA for all tax years during the GRA term, there will be no gaps in the certification period. Furthermore, a potentially indefinite certification period is avoided. Only events within the GRA term, however, must be reported and are relevant for determining if gain must be recognized under the GRA. Accordingly, the IRS determined that, with respect to GRA1 and GRA2, an annual certification or a new GRA must be submitted with UST s timely filed return or USP s group return for each tax year (other than Year 0) covering a period within the term for GRA1 and GRA2. For tax years 1 January through 31 December of Year 1, 1 January through 31 December of Year 2, and 1 January through 30 June of Year 3, UST must include an annual certification with its timely filed returns.

3 Global Tax Alert 3 On behalf of UST, USP must file GRA2 in lieu of the annual certification for the tax year 1 May of Year 3 through 30 April of Year 4. USP also must include, on behalf of UST, an annual certification with its timely filed returns for the tax years of 1 May of Year 4 through 30 April of Year 5 and 1 May of Year 5 through 30 April of Year 6. However, the annual certification filed with the return for the tax year ending on 30 April of Year 6 only needs to include information for events that occur through 31 December of Year 5 (the end of the GRA2 term). Period of limitations on assessments Reg. Section 1.367(a)-8(f)(1) requires a US transferor to file Form 8838 to extend the period of limitations on assessments of the tax for the deferred gain subject to a GRA through the close of the eighth full [tax] year following the [tax] year during which the initial transfer occurs. Similarly, when a new GRA is filed, Reg. Section 1.367(a)-8(f)(2) generally requires the US transferor to file a new Form 8838 to extend the period on assessments of tax on the initial transfer through the close of the eighth full [tax] year following the [tax] year during which the initial transfer occurs. Notwithstanding the reference to full [tax] years, and consistent with the prior analysis, the CCM concludes that the extension of the limitation period that is required when filing a GRA is fixed as of the time of the initial transfer that was subject to the initial GRA, and is not affected by subsequent years. Accordingly, the CCM concludes that UST must extend the period of limitations on assessments of tax for the deferred gain to 31 December of Year 8, which is 96 months after the close of the tax year of the initial transfer for which GRA1 was filed. Implications In the CCM, the IRS takes a pragmatic and helpful approach in determining the term of a GRA, the annual certification period and the extension of the period of limitations on assessments of tax. By treating these periods as fixed as of the date of the initial outbound transfer that results in the filing of a GRA, the concerns that some taxpayers and advisors may have had, due to the GRA regulations referring to full [tax] years, should be alleviated. Taxpayers and advisors should now feel more confident with the timing and periods for GRA filings (e.g., annual certifications) and the period during which they must monitor events for purposes of determining whether gain must be recognized under a GRA. Endnote 1. All Section references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.

4 4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, International Tax Services, Washington, DC John Morris Ernst & Young LLP, International Tax Services, New York Benjamin Orenstein International Tax Services Global ITS, Alex Postma, Tokyo ITS Director, Americas, Jeffrey Michalak, Detroit ITS Markets Leader, Americas, Stephen O Neil, New York Ernst & Young LLP, National Director of ITS Technical Services, Jose Murillo, Washington ITS Regional Contacts, Ernst & Young LLP (US) Northeast Johnny Lindroos, McLean, VA Financial Services Chris J Housman, New York Central Mark Mukhtar, Detroit Southeast Scott Shell, Charlotte, NC Southwest Amy Ritchie, Houston West Sadler Nelson, San Jose, CA Canada Ernst & Young LLP (Canada) Albert Anelli, Montreal

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