n-09-78.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Section 7874: Treatment of Certain Stock of the Foreign Acquiring Corporation

Notice 2009-78

SECTION 1. OVERVIEW
The Internal Revenue Service (IRS) and the Treasury Department (Treasury)
intend to issue regulations under section 7874 of the Internal Revenue Code (Code)
incorporating the rules described in this notice that will identify certain stock of a foreign
corporation that is disregarded for determining ownership of the foreign corporation for
purposes of section 7874(a)(2)(B)(ii). In general, and as described below, the
regulations to be issued pursuant to this notice shall apply to acquisitions completed on
or after September 17, 2009.
SECTION 2. BACKGROUND
Section 7874 provides rules for expatriated entities and their surrogate foreign
corporations. An expatriated entity is a domestic corporation (or domestic partnership)
with respect to which a foreign corporation (which includes certain publicly traded
foreign partnerships) is a surrogate foreign corporation, and any United States person

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related to such domestic corporation (or domestic partnership) (within the meaning of
sections 267(b) or 707(b)(1)). Section 7874(a)(2)(A).
A foreign corporation constitutes a surrogate foreign corporation if three
conditions are satisfied. First, the foreign corporation completes, after March 4, 2003,
the direct or indirect acquisition of substantially all of the properties held directly or
indirectly by a domestic corporation. Section 7874(a)(2)(B)(i). Second, after the
acquisition at least 60 percent of the stock of the foreign corporation (by vote or value)
is held by former shareholders of the domestic corporation by reason of holding stock in
the domestic corporation (the Ownership Condition). Section 7874(a)(2)(B)(ii). Third,
after the acquisition the expanded affiliated group (defined in section 7874(c)(1)) that
includes the foreign corporation does not have substantial business activities in the
foreign country in which, or under the law of which, the foreign corporation is created or
organized, when compared to the total business activities of the expanded affiliated
group. Section 7874(a)(2)(B)(iii). Similar provisions apply if a foreign corporation
acquires substantially all of the properties constituting a trade or business of a domestic
partnership.
Under section 7874(c)(2), certain stock of the foreign corporation is not taken into
account in determining whether the Ownership Condition is satisfied: (1) stock of the
foreign corporation held by members of the expanded affiliated group that includes the
foreign corporation, and (2) stock of the foreign corporation sold in a public offering
related to the acquisition described in section 7874(a)(2)(B)(i).
Regulations addressing the Ownership Condition were published in the Federal

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Register on May 20, 2008, and June 12, 2009 (TD 9399, 73 FR 29054; TD 9453, 74 FR
27920).
Under section 7874(c)(4) a transfer of properties or liabilities (including by
contribution or distribution) shall be disregarded if such transfer is part of a plan a
principal purpose of which is to avoid the purposes of section 7874.
Section 7874(g) grants the Secretary broad authority to provide regulations
necessary to carry out section 7874, including regulations adjusting the application of
section 7874 as necessary to prevent the avoidance of the purposes of section 7874.
More specifically, section 7874(c)(6) grants the Secretary authority to prescribe
regulations as may be appropriate to determine whether a corporation is a surrogate
foreign corporation, including regulations to treat stock as not stock.
In TD 9453, the IRS and Treasury modified §1.7874-2T(e)(5), Example 3
, to
eliminate an unintended implication as to the scope or application of the public offering
rule of section 7874(c)(2)(B). The TD 9453 preamble states that the IRS and Treasury
are considering issuing guidance concerning the scope and application of the public
offering rule and request comments in this regard.
SECTION 3. TRANSACTIONS AT ISSUE
The IRS and Treasury have become aware of transactions intended to avoid the
application of section 7874 that involve a transfer of cash (or certain other assets) to the
foreign corporation in a transaction related to the acquisition described in section
7874(a)(2)(B)(i), thereby minimizing the former shareholders’ ownership in the foreign
corporation for purposes of the Ownership Condition. In one such transaction, for

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example, the shareholders of a domestic corporation (DC) transfer all their DC stock to
a newly-formed foreign corporation (New FCo) in exchange for 79 percent of the stock
of New FCo and, in a related transaction, an investor transfers cash to New FCo in
exchange for the remaining 21 percent of the New FCo stock. The parties to the
transaction take the position that the New FCo stock issued to the investor is not “sold
in a public offering” and thus not subject to section 7874(c)(2)(B). The parties also
assert that the transfer of cash from the investor to New FCo was not part of a plan a
principal purpose of which is to avoid the purposes of section 7874 such that section
7874(c)(4) does not apply to disregard the investor’s transfer of cash to New FCo in
exchange for New FCo stock.
Under these positions, the parties assert that the investor’s New FCo stock would
be taken into account for purposes of the Ownership Condition. Thus, the former
shareholders of DC would hold only 79 percent of the stock of New FCo by reason of
holding stock of DC, in which case section 7874(a)(1) would apply to DC (and any other
expatriated entity) but section 7874(b) would not apply to treat New FCo as a domestic
corporation for purposes of the Code. The IRS and Treasury understand that similar
transactions may be structured with respect to the acquisition of a domestic corporation
in a title 11 or similar case (as defined in section 368(a)(3)) or a domestic partnership.
These transactions are inconsistent with the purposes of section 7874.
The IRS and Treasury also understand that taxpayers are concerned the public
offering rule of section 7874(c)(2)(B) applies to all public issuances of stock by a foreign
corporation, regardless of the property exchanged for the stock. For example, assume

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that, pursuant to a business combination, the shareholders of a publicly-traded foreign
corporation (FT) and a publicly-traded domestic corporation (DT) intend to transfer their
FT and DT stock, respectively, to a newly-formed foreign corporation (FA) that will be
publicly-traded. To effectuate the transaction, as part of a plan FA acquires all of the FT
and the DT stock, respectively, from the FT and DT shareholders in exchange solely for
newly-issued FA stock. If the FA stock issued to the FT shareholders is considered
“sold in a public offering” and thus subject to section 7874(c)(2)(B), the former
shareholders of DT would be treated as owning 100 percent of the stock of FA for
purposes of the Ownership Condition, and FA would therefore be treated as a domestic
corporation for purposes of the Code under section 7874(b). A similar result would
occur if instead FT merged with and into FA and the FT shareholders exchanged their
FT stock for FA stock pursuant to the merger. The IRS and Treasury believe that such
a result could be inappropriate in certain cases.
SECTION 4. REGULATIONS TO BE ISSUED
To address certain transactions, including those described in Section 3 of this
notice, the IRS and Treasury intend to issue regulations identifying stock of the foreign
corporation that is not taken into account for purposes of the Ownership Condition. The
regulations will identify stock of the foreign corporation that shall not be taken into
account for purposes of the Ownership Condition, even if such stock may not otherwise
be described in section 7874(c)(2)(B). The regulations will also clarify that certain stock,
which may be described in section 7874(c)(2)(B), shall nonetheless be taken into
account for purposes of the Ownership Condition.

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The regulations issued pursuant to this notice shall provide that stock of the
foreign corporation issued in exchange for “nonqualified property” in a transaction
related to the acquisition described in section 7874(a)(2)(B)(i) is not taken into account
for purposes of the Ownership Condition, without regard to whether such stock is
publicly traded on the date of issuance or otherwise. Subject to certain exceptions, the
term “nonqualified property” shall generally mean: (1) cash or cash equivalents; (2)
marketable securities as defined in section 453(f)(2); and (3) any other property
acquired in a transaction with a principal purpose of avoiding the purposes of section
7874.
For this purpose, however, marketable securities generally shall not include stock
(or a partnership interest) issued by a member of the expanded affiliated group (as
defined in section 7874(c)(1)) that after the acquisition includes the foreign corporation,
unless a principal purpose of the issuance of the stock of the foreign corporation in
exchange for such property was the avoidance of the purposes of section 7874. For
this purpose, a partnership shall be treated as a member of an expanded affiliated
group if the partnership would be a member of the expanded affiliated group if it were a
corporation.
The regulations shall provide similar rules to address acquisitions of property by
one or more members of the expanded affiliated group (that includes the foreign
corporation after the acquisition) in exchange for stock of the foreign corporation,
including, for example, pursuant to a triangular reorganization. For this purpose, a
partnership shall be treated as a member of an expanded affiliated group if the

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partnership would be a member of the expanded affiliated group if it were a corporation.
The rules described in this notice are not intended to affect the application of
section 7874(c)(2)(A), §1.7874-1, or section 7874(c)(4).
The following examples illustrate the rules concerning the Ownership Condition
that are intended to be included in the regulations described in this notice. For
purposes of the examples, unless otherwise indicated, FA, FMS and FT are foreign
corporations, DMS and DT are domestic corporations, PRS is a partnership, all entities
are unrelated, and section 7874(c)(4) may apply to disregard certain transfers.
Example 1
. Stock issued in exchange for marketable securities. (i) Facts.
Individual A wholly owns DT. FA, a newly formed corporation, acquires all the DT stock
from individual A in exchange solely for FA stock. In a transaction related to FA’s
acquisition of the DT stock, PRS transfers marketable securities (within the meaning of
section 453(f)(2)) to FA solely in exchange for FA stock.

(ii) Analysis
. The FA stock issued to PRS in exchange for the marketable
securities is not taken into account for purposes of the Ownership Condition.

Example 2. Stock issued with a principal purpose of avoiding section 7874. (i)
Facts
. FA acquires all the DT stock in exchange solely for FA stock. In a transaction
related to FA’s acquisition of the DT stock, PRS transfers marketable securities (within
the meaning of section 453(f)(2)) to FT, a newly formed corporation, solely in exchange
for FT stock and then transfers the FT stock to FA in exchange solely for FA stock. The
shares of FT stock do not constitute marketable securities within the meaning of section
453(f)(2).

(ii) Analysis
. The FA stock issued to PRS in exchange for the FT stock is not
taken into account for purposes of the Ownership Condition because a principal
purpose of such issuance is the avoidance of the purposes of section 7874.

Example 3
. Stock issued or exchanged for stock of a foreign corporation. (i)
Facts. The stock of DT and FT is publicly traded. The following transactions are
completed pursuant to a plan: FT forms FA, and FA forms DMS and FMS. FMS
merges with and into FT, with FT surviving the merger. Pursuant to the FMS-FT
merger, the FT shareholders exchange their FT stock solely for FA stock. Following the
FMS-FT merger, DMS merges with and into DT, with DT surviving the merger.

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Pursuant to the DMS-DT merger, the DT shareholders exchange their DT stock solely
for FA stock. After completion of the plan, FA wholly owns FT and DT.

(ii) Analysis
. After the FMS-FT merger, FT is a member of the expanded
affiliated group that includes FA. Therefore, the shares of FT stock are not treated as
marketable securities and therefore do not constitute nonqualified property. Thus, the
FA stock issued or exchanged for the FT stock is taken into account for purposes of the
Ownership Condition.

(iii) Alternative facts
. Assume the same facts as in paragraph (i) of this example
except that, instead, FT merges with and into FA with FA surviving the merger. At the
time of the merger, FT does not hold nonqualified property. Pursuant to the FT-FA
merger, the FT shareholders exchange their FT stock solely for FA stock. Because the
properties transferred by FT to FA pursuant to the FT-FA merger do not constitute
nonqualified property, the FA stock issued in exchange for such properties pursuant to
the merger will be taken into account for purposes of the Ownership Condition.

SECTION 5. EFFECTIVE DATE
The regulations described in this notice shall apply to acquisitions completed on
or after September 17, 2009. Taxpayers may apply the rules described in this notice in
their entirety to acquisitions completed on or after September 17, 2009, and before
publication of the regulations described in this notice if the rules are applied consistently
to all such acquisitions.
No inference is intended as to the treatment of transactions described in this
notice under current law and the IRS may, where appropriate, challenge such
transactions under applicable provisions, including under section 7874(c)(4) or judicial
doctrines (such as the substance-over-form doctrine).
SECTION 6. DRAFTING INFORMATION
The principal author of this notice is S. James Hawes of the Office of Associate
Chief Counsel (International). However, other personnel from the IRS and the Treasury

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Department participated in its development. For further information regarding this
notice, contact Mr. Hawes or Milton M. Cahn at (202) 622-3860 (not a toll-free call).