Ch. 10 - International Tax- Free Exchanges P · Ch. 10 - International Tax-Free Exchanges P.814...

4/24/2015 (c) William P. Streng 1

Ch. 10 - International Tax-

Free Exchanges P.814

Cross-border entity structuring options:

1) Corporation: domestic, foreign (destination

country) or other (intermediary) foreign country,

including special purpose subsidiaries. Tax

deferral if foreign corporation (except for Subpart

F income).

2) Partnerships (including LLCs) with flow-

through U.S. income tax status, including “check-

the-box” entities.


International Tax-Free

Corporate Exchanges

Alternative cross-border corporate structuring or

restructuring situations:

1) Outbound - incorporation of foreign corp. or

liquidation of U.S. sub into foreign corp. parent.

2) Inbound – liquidation of foreign sub. into U.S.

3) Foreign to foreign restructuring.

U.S. income tax objective: maintain U.S. taxing

jurisdiction over previously accrued U.S. value

(income).


Maintaining U.S. Income

Tax Jurisdiction

Objective is to maintain U.S. taxing jurisdiction

over previously accrued value (income).

How can value move from the U.S. tax area?

Examples:

1) Organizing & funding a foreign corporation;

including a change from CFC to non-CFC.

2) Outbound corporate liquidation.

See §367 (corp. as “not a corporation”) & §1248.


Possible Corporate

Structuring Transactions

Realization/Recognition Rules: §1001

Subchapter C rules for gain, & exceptions:

1) Corporate formation - §351 – corp. formation no gain or loss recognition.

2) Liquidations - §§331 (taxable) & 332 (tax-free) corp. liquidation proceeds to shareholder

3) Tax-free reorganizations - §§354 & 368(a)(1)

4) Corporate divisions - §355 & §368(a)(1)(D),

aka, “de-mergers.”


Corporate Formation -

§351 p.816

No gain or loss is recognized (unless §367 applies)

in an incorporation transfer if:

1) property is transferred to a corporation solely

in exchange for stock of the corporation, and

2) immediately after the exchange the transferors

are in “control” of the corporation.

Similar treatment for a “contribution to the

capital” of a corporation (i.e., no stock issuance).

See §367(c)(2).


Taxable Corporate

Liquidations- p.818

A. Shareholder treatment:

1) §331(a) - complete corp. liquidation to

shareholders treated as a distribution in

exchange for the stock. §331(a).

2) If foreign corp. (CFC) liquidation proceeds are

received by a greater than 10% U.S. shareholder,

then gain may be treated as ordinary income

under §1248 (to extent of E&P).

B. Corporate treatment: gain recognition on

distribution of appreciated property.


Tax-free Corporate

Liquidations - §332 p.818

A. Liquidation of U.S. sub into U.S. parent:

1) no gain is recognized to the distributing

corporation - §337(a); and,

2) no gain is recognized to the recipient parent

corporation under §332.

B. Cross-border options: 1) Foreign sub is

liquidated into U.S. parent (inbound) (§367(e)(2)).

2) U.S. sub is liquidated into its foreign parent

corp. (outbound).


Corporate Tax-free Acquisitive

Reorganizations p.819

Tax-free exchanges of corporate stock if a

proprietary interest is maintained in the

replacement corporate form. IRC §368 provides

the definition of tax-free “reorganization” types.

U.S. tax common law requirements:

1) Business purpose;

2) Continued proprietary interest; and,

3) Continuity of business enterprise.


Types of Acquisitive

Corporate Reorganizations

§368(a)(1)(A) - statutory merger or consolidation

- the surviving corporation can be a U.S. or a

foreign corporation.

B reorg. - “stock for stock” exchange.

C reorg. - stock for assets exchange.

Plus: triangular reorganizations – forward

triangular merger (§368(a)(2)(D)) & reverse

triangular merger (§368(a)(2)(E)).


Corporate Divisions

§355 p.821

1) Spin-off - distribution of stock of a controlled

corporation - cf., dividend distribution.

2) Split-off - shareholders give up a portion of

their stock in exchange for the stock of the

controlled subsidiary - cf., redemption.

3) Split-up - stock of two or more subs

distributed in liquidation of corporation - cf.,

corporate liquidation.


Code §355 Requirements

p.821

1) “Control” of stock of the subsidiary to be

distributed to shareholders.

2) Both corps are to be engaged in business

immediately after the distribution.

3) All (or most) of the stock of sub is to be

distributed to shareholders.

4) Transaction is not used principally as a

“device” for the distribution of earnings.


Anti-Importation of Loss

Rules p.822

§362(e) limits tax basis upon the corporate

acquisition of loss property. No duplication of

loss potential by stuffing loss property into a

corporation.

For this limitation to apply: Total adjusted bases

of the transferred properties must exceed the

FMV of transferred properties immediately after

the transaction. §362(e)(2)(A)(ii).


Alternative taxing options

outbound transfers p.823

1) Tax appreciation when (a) all, or (b) certain

assets are transferred. Income or excise tax?

2) No gain recognition when appreciated assets

are transferred outbound.

3) Obtain an IRS ruling in advance – toll-charges

are imposed on the transfers of certain assets.

4) Ruling request within 183 days after the

transaction - with anticipated toll-charges.

5) Selective gain recognition is specified.


Outbound exchange

situations - §367(a) p.827

1) Transfer of appreciated assets to a foreign

corp. in an incorporation transaction.

2) U.S. corporation is liquidated and assets are

distributed to foreign parent coroporation.

3) Reorg. - Stock (or assets) of a U.S. corporation

acquired by a foreign corp. in exchange for

foreign corp. stock; includes, triangular reorg.

where foreign corp. stock received for U.S. corp

stock.


§367(a) - Treatment for a

§351 Transaction p.826

Code §351 eligibility is permitted based on the

current inclusion in the U.S. income tax base of

the accrued appreciation attributable to certain

assets transferred to the foreign corporation.

Code §367(a)(1) – Query: is the recipient

corporation treated as a “corporation” for

federal tax purposes? Otherwise, Subchapter C

nonrecognition treatment is not available.


§367(a) Requirements for

Outbound Transfers p.826

A foreign corporation is not treated as a

"corporation". §367(a)(1). What is the effect of

this treatment for §351 purposes?

Possible income taxation of asset transfers:

consider tax character and source. And, then, a

tax basis adjustment for these assets.

An exception is available for the property

transferred for use in the “active conduct” of

foreign trade or business. §367(a)(3)(A).


Outbound Triangular

Reorganizations,etc. p.828

1) Forward triangular merger.

2) Reverse triangular merger.

3) “B” reorganizations - stock of a foreign

corporation is received for domestic stock

transferred (alternative: triangular B).

4) “C” reorganization - stock of a foreign

corporation is received by domestic sub for

domestic assets (alternative: triangular C).


Other §367(a) Outbound

Transfers p.829

1) Transfer of a partnership interest to a foreign

corporation - §367(a)(4). Treated as the pro-rata

transfer of assets held by the partnership.

An exception applies for traded LP interests.

2) Partnership’s transfer of its assets to a foreign

corporation. Proportionate transfers by partners.

3) Change in the U.S. tax classification of the

entity from (e.g., partnership) to a corporation.

Treated as a transfer for §351 purposes.


“Active Trade or Business”

Asset Exception p.830

§367(a)(3)(B) applicability.

1) What is the “trade or business”?

2) “Active conduct” of business is necessary to

enable nonrecognition exception to apply.

Substantial managerial and operational activities

are contemplated (not merely holding stock).

3) Conducted outside the United States.

4) Property is used in the trade or business (not

“listed” stocks and bonds).


Automatically “Tainted”

Assets §367(a)(3)(B) p.833

1) Inventory.

2) Installment obligations and accounts

receivable.

3) Foreign currency and property denominated

in foreign currency (e.g., accounts receivable).

4) Where the transferor is a lessor, unless the

transferee was the lessee (or, next slide).

5) Depreciable property - to the extent tax

depreciation was claimed against U.S. income.


Property to be Leased by

the Transferee p.834

When is leased property treated as the “active conduct” of trade or business property?

1) Leasing of property constitutes the active conduct of a leasing business;

2) Property is not used in the United States; &

3) Need exists for substantial investment in the assets of the type transferred.

Must be substantial marketing and customer service by foreign corp. employees. E.g., auto leasing operation?


Oil & Gas Working

Interests p.835

Working interest in oil and gas properties treated as transferred for use in the active conduct of a trade or business.

But transferee must have no intention to “farm-out” the working interest.

Reg. §1.367(a)-4T(e).


Outbound Transfer of

Corporate Stock p.836

Ordinarily stock is transferred for an outbound

corporate reorganization, rather than a §351

incorporation.

General rule of taxability upon the transfer of

stock or securities of foreign corporations.

Possible gain recognition agreement (or “GRA”)

alternative (for a five year post-transfer period).

“Limited interest in transferee” exceptions.

(next slides)


Transfer of Foreign

Corporation Stock p.837

Gain recognition on this transfer is required unless an exception applies:

1) The U.S. transferor owns less than 5 percent of the stock of the transferee - no current U.S. income tax effect (reorg).

2) U.S. transferor owns more than 5 percent, then a five year gain recognition agreement (GRA) to avoid gain recognition.

3) If foreign corporation moves from CFC to non-CFC status - §1248 pickup.


Transfer of U.S. Corporate

Shares to Foreign Corp.

P.838 Usually taxable, but no gain recognition if:

1) All U.S. transferors own less than a total of

50% ownership of the transferee (next slide).

2) Transferee is engaged in active conduct of a

trade or business for the 36 months prior to the

transfer (and no sale is anticipated).

3) U.S. transferor (i) owns less than 5%, or (ii) if a

5% or greater U.S. transferor, has a gain

recognition agreement (GRA).


U.S. Corp. - U.S.

Shareholder Status? p.839

As relevant for the tax-free exception for U.S.

transferors with less than 50% ownership of

transferee (p. 839):

1. Presumption that all transferors to foreign

corp. are U.S. persons (and, therefore, 50%+).

2. Therefore, to rebut presumption U.S. target

corp. must obtain ownership statements from

foreign shareholders of the U.S. corp. to show

that the 50% U.S. ownership threshold is not

exceeded.


Corporate Inversion

Transactions p.840

U.S. corporation is transformed into a foreign corporation (i.e., corporate expatriation). Objective: Future avoidance of U.S. income tax.

Assume no CFC status, Subpart F avoided.

Treatment of the shareholders? Tax recognition on the transformation of the entity into foreign.

Transfer pricing/earnings stripping opportunities?


2004 JOBS Act Corporate

Inversion Rules p.844

§7874 - two different types of inversion transactions:

1) 80%+ stock identity – former shareholders

own at least 80%. Foreign corp. is deemed to be domestic.

2) 60-80% stock identity – corporate level gain

recognized on stock & asset transfers.

Plus, §4985 excise tax on stock options.

Plus, §6043A IRS information reporting.


Outbound Transfers of

Intangibles p.849

Prior objective: (1) incur and deduct cost (under

§174) against U.S. source income, and then

(2) transfer the (zero basis) asset to a foreign

subsidiary.

Subsequent foreign income from using the

intangible is then immune from U.S. income tax

(possibly subject to Subpart F rules). Under

§367(d) – transferor treated as selling the

property in a licensing transaction. (next slide)



Intangibles, continued

Amounts are to reflect a reasonable royalty( or

disposition proceeds if a disposition by the

foreign subsidiary occurs).

Over the useful life of the intangible – not in

excess of 20 years.

See the “commensurate with income”

requirement in §367(d) (& §482)).

I.e., a “super-royalty” requirement.

(next slide)




§367(d)(2)(C) – this royalty is treated ordinary

income from sources without United States

(assuming used outside the United States). Prior

(U.S.) sourcing rule changed in 1997.

§367(d)(2)(B) specifies a reduction of the E&P of

the foreign corporation for the deemed royalty

payments. P.851.

(next slide)




Exception for foreign based goodwill which is

transferred. P.852.

Cf., Obama FY 2016 proposal to include

workforce in place, goodwill & going concern

value as intangible property for this rule.

Planning option: use a licensing agreement to

transfer intangibles - then the pricing is

determined under §482. But, is a foreign

withholding tax imposed at source? p.852




P. 853 - Disposition of the transferred intangible

by the transferee accelerates transferor’s gain

recognition. §367(d)(2)(A)(ii)(II). Similar

treatment if disposition of the foreign corporation

stock (holding the intangible).

P. 854 - Option to elect to treat the transfer of the

intangible as a deemed sale at then fair market

value – rather than periodic royalty treatment.

Ordinary gross income in the year of transfer,

but probably U.S. source.


Foreign Branch Loss

Recapture Rules p.855

U.S. taxpayer operates a foreign branch at a loss. These losses reduce taxpayer’s U.S. taxable income (since branch losses flow through the branch to the U.S. owner).

Then, a transfer of these foreign branch assets to a foreign corporation is made. Foreign profits are thereafter immune from current U.S. income tax (assuming Subpart F is not applicable).

Branch loss recapture rules are applicable in this context (under §367(a)(3)(C)). (next slide)


Foreign Branch Loss

Recapture, continued.

Recapture is required of the gain realized on the asset transfers - to the extent of previously unrecaptured losses of the branch.

The type of income recapture depends upon whether the previously deducted item was (1) an ordinary loss or (2) a capital loss.

Prior losses are offset by any subsequent gains.

Note: Foreign tax credit provision (§904(f)(3)) takes precedence in determining the recapture amount.


Liquidation of U.S. Corp.

into Foreign Parent p.859

§367(e)(2) denies nonrecognition of gain to a U.S.

corporation making a liquidating distribution to

a foreign parent corporation (80 percent or

more). Cf. §§332 & 337.

Exceptions (in regs): (1) when distributed assets

are used in a U.S. trade or business; or, (2) if the

property transferred is a U.S. real property

interest. I.e., no removal from U.S. tax

jurisdiction in these situations.


Liquidation of Foreign Corp

into Foreign Parent p.862

No gain recognition on a “foreign to foreign”

liquidation. §332.

But, gain recognition is required if U.S. trade or

business assets are transferred, unless the ten

year trade or business use rule is applicable.

Why?

Further exception from gain recognition when

U.S. real property (bause FIRPTA applies?).


Outbound Spinoffs p.862

§367(e)(1)

Distribution of the stock of a sub by a U.S.

corporation to a foreign person.

If the U.S. corporation distributes stock or

securities of a U.S. or foreign subsidiary to a

foreign person in a §355(a) transaction the

distributing corporation recognizes gain under

§367(e)(1).

(exceptions, next slide)


Outbound Spinoffs, cont.

Exceptions: 1) After distribution both

distributing and distributed controlled corps are

U.S. real property holding corps.

2) 80% or more of stock of the U.S. corp is to

distributees holding 5% or less of the distributing

corp's stock, i.e., publicly held.

3) Distributing corp agrees to file an amended

return if foreign distributee of U.S. stock

disposes of that stock.


Problem – Are AEC

Transfers Tainted? p.864

a) Transfer of 500,000 Cayman dollars – tainted

(& gain recognition is required).

b) Cayman dollars accounts receivable – tainted

(& gain recognition is required).

c) Desktop systems for immediate sale -

inventory and tainted (& gain required).

d) Copiers (as depreciable property held to be

leased?) - likely to be treated as tainted inventory

– particularly if not subject to current lease.

cont.


AEC, continued

e) Interest in word processing program -

intangible property specially treated under

§367(d) (deemed periodic royalty).

f) Warehouse in Cayman Islands – is not tainted;

see the §367(a)(3)(B)(i) reference to §1221 which

omits §1221(a)(2). (Also are the copiers under

this exception?)


Problem 2 p.865

Intangibles Transfer

The word processing program generates $5

million gross revenue per year and $500,000 is an

appropriate royalty.

The $500,000 is to be included in income each

year under §367(d)(2)(A).

This amount is subject to periodic adjustments to

assure that the payments are commensurate with

income. continued


Problem 2, cont. p.865

Disposition - Ordinary income

1) After 3 years the word processing program is

sold by the Cayman sub. to an unrelated buyer.

AEC is required to recognize gain (then the FMV

over AEC’s tax basis). Reg. §1.367(d)-1T(f)(1).

2) AEC sells its stock in Cayman. AEC will be

treated as simultaneously selling the intangible

property.

3) Source - used outside U.S. - foreign source

(§865 rules) & ordinary income. §367(d)(2)(C).


Prob. 3 - Foreign Branch

Loss Recapture Rule p.865

Tentative amount of previously deducted branch

losses which is subject to recapture is $2,500 (the

$3,000 of cumulative losses as reduced by AEC's

net income of $500 in year 3).

A. This $2,500 amount is reduced by $500

taxable gain recognized on the tainted assets

transfer under §367(a)(1) & (a)(3)(B).

B. The $2,000 branch loss recapture is treated as

(foreign) ordinary income. §367(a)(3)(C).


Prob. 4 - Foreign Branch

Loss Recapture Rule

Realized gain on the transfer of untainted assets

is only $1,000. What amount is to be included by

AEC in its gross income?

The branch loss recapture is limited to the $1,000

amount (rather than the $2,000) for the untainted

assets.

Plus, the $500 gain on the transferred tainted

assets under §367(a)(3)(B).


Problem 5 p.865

FTC rule §904(f)(3)

§904(f)(3) concerns the transformation of foreign source income to domestic source income upon the transfer of appreciated assets to the newly incorporated branch.

A. $1,000 of year 4 foreign source income is to be treated as U.S. source income to enable the recapture of the $1,000 of the prior overall foreign loss (OFL) accumulated through year 3.

continued


Problem 5, cont.

B. The remaining amount to recapture is $1,000.

The amount of the branch loss to be recaptured

would be $1,000 of the previously deducted

branch loss, recaptured under §367(a)(3)(C).

C. Note: This remaining $1,000 recapture is

after the $500 gain to be recognized on the

transfer of the tainted assets.


Problem 6 p.865

Recaptures - Ordering Rules

1) The §904(f)(3) recapture is $1,000 attributable

to the $1,000 year four income. This recaptures

1/2 of the potential branch loss amount. This is

treated as U.S. source income. This rule has

priority over the §367(a)(3)(C) recapture rule.

2) The §904(f)(3) recapture amount is credited

against payments that AEC-Cayman is deemed to

make to AEC under §367(d) in the first two years

of the newly incorporated subsidiary's operations.


Problem 7 p.866

Reorg Transfers

DC, as a U.S. person owning five percent or more

of the stock of FC3, the foreign corp. transferee of

the FC1 stock, will have §354 nonrecognition if

entering into a Reg. § 1.367(a)-8 gain recognition

agreement.

C1 – owning less than 5 percent- is not required

to enter into a gain recognition agreement.


Problem 8 p.866

[to come]


Transfers to Other Foreign

Entities p.867

1) Prior §§1491-1494 excise tax provisions for

outbound transfers to non-corporate entities.

Repealed in 1997.

2) §367(d)(3) and §721(c) permit regulations on

transfers to foreign partnerships. Cf., §704(c).

3) See §684 concerning required gain recognition

on transfers of appreciated property to foreign

trusts.


“Other” Transfers

§367(b) p.867

1) Inbound liquidation of foreign corporation into

U.S. corporation.

2) Stock of foreign corporation owned by U.S.

shareholders is acquired in exchange for receiving

stock of U.S. corporation (i.e., inbound).

3) U.S. shareholder of foreign corporation

exchanges stock for stock of another foreign

corporation (foreign to foreign).


§367(b) Objectives

Nonoutbound Transfers

1. Implement §1248 treatment

- require recognition where §1248 gain would slip

out of U.S. tax base or retain §1248 treatment for

the future if postponement currently permitted.

2. E&P of foreign corporation moves up the

ownership chain for corporations.

3. U.S. shareholder status – CFC?


§367(b) - Foreign Sub into

U.S. Parent p.873

Complete Liquidation of Foreign Sub into U.S.

Parent Corporation: Pickup of the “all earnings

and profits amount” by the U.S. shareholder.

Reg. §7.367(b)-5(b).


§367(b) - Foreign Sub into

Foreign Parent p. 874

Liquidation of Foreign Subsidiary into Foreign

Parent -

Not a gain recognition event.

E&P moves up.

Reg. §7.367(b)-5(c).


Share Exchanges

p. 874

1. CFC to non-CFC

§1248 pickup.

Indirect FTC to corporate shareholder.

2. Exchange of second tier CFC stock by CFC for

foreign corp. stock where not CFC status – §1248

move-up.


Problem

p. 875

[to come]


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