n-06-85.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Treatment Under Section 367(b) of Property Used to Purchase Parent Stock in Certain
Triangular Reorganizations

Notice 2006-85

SECTION 1. OVERVIEW
This notice announces that the Internal Revenue Service (IRS) and the Treasury
Department (Treasury) will issue regulations under section 367(b) of the Internal
Revenue Code that address certain triangular reorganizations under section 368(a)
involving one or more foreign corporations. This notice is issued in response to
comments and specific requests for guidance regarding certain transactions that are
designed to avoid U.S. income tax, including tax on the repatriation of a subsidiary's
earnings. The transactions generally involve a subsidiary purchasing its parent's stock
for property and then transferring the stock in exchange for the stock or assets of a
corporation in a triangular reorganization under section 368(a). In general, and as
described below, the regulations issued pursuant to this notice will apply to transactions
occurring on or after September 22, 2006.
The IRS and Treasury recently finalized §1.367(b)-4(b)(1)(ii), which may apply to
certain (but not all) of the triangular reorganizations described in this notice. That final
regulation under section 367(b) appropriately addressed the treatment of the majority of

relevant triangular reorganizations. While the IRS and Treasury were aware of the
transactions covered by this notice at that time, the decision was made to address these
transactions comprehensively in separate guidance.
The following definitions apply for purposes of this notice. A “triangular
reorganization” is a forward triangular merger, a triangular C reorganization, a reverse
triangular merger, or a triangular B reorganization, as those terms are defined in
§1.358-6(b)(2)(i) through (iv), respectively, or a reorganization described in section
368(a)(1)(G) and (a)(2)(D). In addition, P, S, and T are corporations described in
§1.358-6(b)(1)(i) through (iii), respectively. Finally, the term “property” means money,
securities, and any other property, except that the term does not include stock in S.
SECTION 2. TRANSACTIONS AT ISSUE
The IRS and Treasury are aware that certain taxpayers are engaging in
triangular reorganizations involving foreign corporations that result in a tax-advantaged
transfer of property from S to P. The transaction is often structured as a triangular B
reorganization, but could also be structured as a triangular C reorganization or another
type of triangular reorganization. For example, assume P, a domestic corporation,
owns 100 percent of S, a foreign corporation, and S1, a domestic corporation. S1 owns
100 percent of T, a foreign corporation. S purchases P stock for either cash or a note,
and provides the P stock to S1 in exchange for all the T stock in a triangular B
reorganization.
Taxpayers take the position that (i) when P sells its stock to S for cash or a note,
P recognizes no gain or loss on the sale under section 1032, (ii) S takes a cost basis in

the P shares under section 1012, and (iii) S recognizes no gain under §1.1032-2(c)
upon the transfer of the P shares immediately thereafter because the basis and fair
market value of the shares are equal. Thus, taxpayers take the position that the cash or
note used by S to acquire the P stock does not result in a distribution under section 301.
Furthermore, taxpayers do not include in income amounts under section 951(a)(1)(B)
because S acquires and disposes of the P stock before the close of a quarter of the
taxable year, which is the time at which to measure P’s share of the average amount of
United States property held by S. See section 956(a)(1)(A). Finally, under §1.367(b)-
4(b)(1)(ii), S1 does not include in income as a deemed dividend the section 1248
amount attributable to the T stock that S1 exchanges.
The IRS and Treasury believe that the taxpayers’ characterization of these
transactions raises significant policy concerns, particularly when either P or S (or both)
is a foreign corporation (regardless of whether T is related to P and S before the
transaction). For example, when P is domestic and S is foreign, as in the example
described above, the transaction could have the effect of repatriating foreign earnings of
S to P without a corresponding dividend to P that would be subject to U.S. income tax.
Similarly, where P is foreign and S is domestic, the transaction could have the effect of
repatriating S’s U.S. earnings to its foreign parent in a manner that is not subject to U.S.
withholding tax. This variation of the transaction also raises U.S. earnings stripping
issues where S uses a note to purchase all or a portion of the P stock. Moreover,
where both P and S are foreign, the transactions may have the effect of avoiding
income inclusions to certain U.S. shareholders of P that would be subject to U.S.

income tax under the subpart F provisions, absent the application of an exception, such
as under section 954(c)(6). In addition, foreign-to-foreign transactions of this type can
be used to facilitate the subsequent repatriation of foreign earnings to U.S. shareholders
without U.S. income tax.
SECTION 3. BACKGROUND
.01 Triangular reorganizations
Section 368 defines the term “reorganization.” Sections 368(a)(1)(B),
368(a)(1)(C), 368(a)(1)(G), 368(a)(2)(D), and 368(a)(2)(E) describe certain
reorganizations in which P stock may be used by S as the consideration issued in
exchange for T’s stock or assets, as applicable.
Section 1032 provides that no gain or loss will be recognized to a corporation on
the receipt of money or other property in exchange for stock of such corporation.
Section 1.1032-2(b) provides that in the case of a forward triangular merger, a triangular
C reorganization, or a triangular B reorganization, P stock provided by P to S, or directly
to T or T’s shareholders on behalf of S, pursuant to the plan of reorganization is treated
as a disposition by P of shares of its own stock. However, §1.1032-2(c) provides that S
must recognize gain or loss in the above transactions on its exchange of P stock for T
stock or assets if S did not receive the P stock from P pursuant to the plan of
reorganization. Section 361 provides that S does not recognize gain or loss on the P
stock that it exchanges for T stock in a reverse triangular merger.
Section 361(a) provides that no gain or loss shall be recognized by T if it
exchanges property in pursuance of the plan of reorganization solely for stock or

securities in P. Section 361(c) provides that no gain or loss shall be recognized to T on
the distribution to its shareholders of P stock received from P in pursuance of the plan of
reorganization.
Section 354 provides that no gain or loss shall be recognized by T shareholders
if stock or securities in T are, in pursuance of the plan of reorganization, exchanged
solely for stock or securities of P. Section 356 applies to T shareholders in cases where
they receive other property in addition to the property permitted to be received under
section 354.
Section 358 provides rules for determining the T shareholders’ bases in their P
stock following triangular reorganizations. Sections 1.358-6 and 1.367(b)-13 provide
rules for determining P’s basis in its S or T stock, as applicable. If P files a consolidated
return with S or T, other basis rules apply. See Treas. Reg. §1.1502-30 or 1.1502-31.
.02 Section 367
Section 367(a)(1) provides that if, in connection with any exchange described in
section 332, 351, 354, 356, or 361, a United States person transfers property to a
foreign corporation, such foreign corporation shall not, for purposes of determining the
extent to which gain shall be recognized on such transfer, be considered to be a
corporation. The Secretary has broad authority under section 367(a)(2), (3), and (6) to
provide that section 367(a)(1) will not apply to certain transfers described therein.
In the case of any exchange described in section 332, 351, 354, 355, 356, or 361
in connection with which there is no transfer of property described in section 367(a)(1),
section 367(b)(1) provides that a foreign corporation shall be considered to be 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.
Section 367(b)(2) provides that the regulations prescribed pursuant to section
367(b)(1) shall include (but shall not be limited to) regulations dealing with the sale or
exchange of stock or securities in a foreign corporation by a United States person,
including regulations providing, among other things, the circumstances under which gain
is recognized, amounts are included in gross income as a dividend, adjustments are
made to earnings and profits, or adjustments are made to basis of stock or securities.
.03 Distributions of property
Section 301(c)(1) provides that a distribution of property by a corporation to its
shareholder with respect to its stock is included in the shareholder’s gross income to the
extent the distribution constitutes a dividend under section 316. Section 316 defines a
dividend as a distribution out of a corporation’s current and accumulated earnings and
profits. To the extent the distribution is not a dividend, the shareholder reduces basis in
the distributing corporation’s stock, and any amount of the distribution in excess of the
shareholder’s basis is treated as gain from the sale or exchange of the corporation’s
stock. See section 301(c)(2) and (3).
Certain transactions that are exchanges in form can be treated as distributions
for tax purposes. Section 304 generally provides that when a shareholder transfers
stock of a controlled corporation to another controlled corporation in exchange for
property, the two legs of the exchange are bifurcated and the receipt of the property by
the shareholder is treated as a distribution. Section 304, by its terms, does not apply to

the transfer by a shareholder of its own stock to a controlled corporation in exchange for
property, even though the economic effect of that transaction is essentially identical.
Other transactions may result in deemed distribution treatment in certain
circumstances. For example, a shareholder that exchanges common stock of a
corporation for common stock and property pursuant to a recapitalization will be treated
as receiving a distribution of property with respect to its stock under section 301 if in
substance the distribution is a separate transaction. See Treas. Reg. §1.301-1(l); see
also, Bazley v. Comm’r, 331 U.S. 737 (1947).
.04 Distributions involving foreign corporations or foreign shareholders
The treatment of a distribution varies depending upon whether the corporation or
shareholder is domestic or foreign. A distribution from a foreign corporation to a
shareholder that is a U.S. person resulting in a dividend under sections 301(c)(1) and
316, or gain from the sale or exchange of property under section 301(c)(3), generally is
subject to U.S. income tax, with potential offset by foreign tax credits.
A distribution from a domestic corporation to a shareholder that is not a U.S.
person resulting in a dividend is generally taxable under section 871 or 881 at a rate of
30 percent, subject to reduction under an applicable treaty, and the domestic
corporation is responsible for withholding tax under section 1441 or 1442. To the extent
such a distribution results in gain from the sale or exchange of property to the foreign
shareholder under section 301(c)(3), such amounts are subject to U.S. income tax
under section 897(a) if the distributing corporation had been a United States real
property holding corporation (as defined in section 897(c)(2)) within the past five years.

In such a case, the gain is subject to U.S. income tax as income effectively connected
with the conduct of a trade or business within the United States.
Finally, a distribution from a foreign corporation to a shareholder that is a
controlled foreign corporation, within the meaning of section 957, resulting in a dividend
or gain from the sale or exchange of property to the foreign shareholder under section
301(c)(3) may also be subject to U.S. income tax. For example, such amounts may
constitute subpart F income and therefore result in an income inclusion under section
951(a)(1)(A) to U.S. shareholders, within the meaning of section 951(b), of the
controlled foreign corporation, subject to certain exceptions. See, e.g., section
954(c)(6).
SECTION 4. APPLICATION OF SECTION 367(b)
Congress enacted section 367(b) to ensure that international tax considerations
are adequately addressed when the subchapter C provisions apply to certain
nonrecognition exchanges involving foreign corporations. This provision was necessary
because the subchapter C provisions were enacted largely to address transactions
involving domestic corporations and shareholders that are United States persons. As a
result, the subchapter C provisions do not fully account for international tax concerns
that arise when the provisions apply to transactions involving foreign corporations or
shareholders that are not U.S. persons.
In enacting section 367(b), Congress noted that “it is essential to protect against
tax avoidance in transfers to foreign corporations and upon the repatriation of previously
untaxed foreign earnings....” H.R. Rep. No. 658, 94th Cong., 1
st
Sess. 241 (1975). In

addition, because determining the proper interaction of the Code’s international and
subchapter C provisions is “necessarily highly technical,” Congress granted the
Secretary broad regulatory authority to provide the “necessary or appropriate” rules to
prevent the avoidance of Federal income taxes, rather than enacting a more
comprehensive statutory regime. Id. This broad grant of authority has been exercised
on numerous occasions to address a wide range of international policy concerns. See,
e.g., Treas. Reg. §§1.367(b)-4(b)(1) (preserving section 1248 amounts), (b)(2)
(addressing trafficking in foreign tax credits by use of preferred stock), -5(b)(1)(ii)
(ensuring section 311(b) gain is recognized by a domestic corporation when it
distributes stock of a controlled foreign corporation to an individual distributee under
section 355), and -7 (addressing the carryover of tax attributes in a foreign-to-foreign
section 381 transaction).
In a triangular reorganization, the exchange by the T shareholders of their T
stock for P stock is described in section 354 or 356. As a result, a triangular
reorganization involving a foreign corporation is described in section 367(b) and,
therefore, may be subject to regulations issued under the broad regulatory authority
granted therein. It is on this basis that regulations will be issued to address the
triangular reorganizations covered by this notice.
SECTION 5. REGULATIONS TO BE ISSUED UNDER SECTION 367(b)

The IRS and Treasury will issue regulations under section 367(b) to address
certain triangular reorganizations involving foreign corporations. The regulations will
apply to triangular reorganizations where P or S (or both) is foreign and, pursuant to the

reorganization, S acquires from P, in exchange for property, all or a portion of the P
stock that is used to acquire the stock or assets of T (T could be either related or
unrelated to P and S before the transaction). In such a case, the regulations under
section 367(b) will make adjustments with respect to P and S such that the property
transferred from S to P in exchange for P stock will have the effect of a distribution of
property from S to P under section 301(c) that is treated as separate from the transfer
by P of the P stock to S pursuant to the reorganization. The adjustments will be made
notwithstanding the fact that section 1032 otherwise applies to the reorganization.
Therefore, the regulations will require, as appropriate, an inclusion in P’s gross income
as a dividend, a reduction in P’s basis in its S or T stock, and the recognition of gain by
P from the sale or exchange of property. The regulations will also provide for
appropriate corresponding adjustments to be made, such as a reduction of S’s earnings
and profits as a result of the distribution (consistent with the principles of section 312).
The regulations will also address similar transactions in which S acquires the P stock
used in the reorganization from a related party that purchased the P stock in a related
transaction.
SECTION 6. EFFECTIVE DATE
In general, the regulations to be issued under section 367(b) that are described
in section 5 of this notice will apply to transactions occurring on or after September 22,
2006. The regulations described in this notice will not, however, apply to a transaction
that was completed on or after September 22, 2006, provided the transaction was
entered into pursuant to a written agreement which was (subject to customary

conditions) binding before September 22, 2006 and all times thereafter.
No inference is intended as to the treatment of transactions described herein
under current law, and the IRS may, where appropriate, challenge such transactions
under applicable provisions or judicial doctrines.
SECTION 7. COMMENTS
The IRS and Treasury request comments on the regulations to be issued under
this notice. Specifically, comments are requested as to whether in certain cases it is
appropriate to provide an exception from the treatment described in this notice. In
addition, comments are requested as to the source and timing of the adjustments to be
made with respect to P and S under the regulations to be issued.
The IRS and Treasury also request comments regarding transactions that are not
described in section 5 of this notice. For example, comments are requested on
transactions where S or P is foreign and S purchases P stock from a person unrelated
to P (for example, from the public on the open market), or where S acquires the P stock
in a transaction that is unrelated to the triangular reorganization. Finally, the IRS and
Treasury request comments on the treatment of transactions similar to those described
in this notice that do not qualify as reorganizations (for example, because S issues
minimal consideration to T in a transaction that would otherwise qualify as a
reorganization under section 368(a)(1)(B)). Any regulations issued to address
transactions that are not described in section 5 of this notice will apply prospectively.
SECTION 8. DRAFTING INFORMATION
The principal authors of this notice are Daniel McCall of the Office of Associate

Chief Counsel (International) and Sean McKeever of the Office of Associate Chief
Counsel (Corporate). However, other personnel from the IRS and Treasury participated
in its development. For further information regarding this notice contact Mr. McCall
at (202) 622-3860 (not a toll-free call). For comments or questions regarding
subchapter C issues, contact Mr. McKeever at (202) 622-7750.