Global Tax Alert | 4 June 2013
IRS rules no gain or loss on domestication of parent company
In PLR 2013-21-007 (14 February 2013), the Service ruled that the domestication of a foreign parent corporation holding a United States real property holding corporation (USRPHC) will not result in the foreign corporation recognizing gain or loss under Section 897.
Parent is a foreign corporation that wholly owns Sub, a domestic corporation that owns significant United States real property interests (USRPIs) and is a USRPHC under Section 897(c)(2). Parent was traded on both domestic and international markets until delisting from the international market.
Parent plans to reincorporate into the United States for valid business reasons. In doing so, Parent will file a certificate of domestication and a certificate of incorporation, establishing New Parent in what Parent intends to qualify as a reorganization under Section 368(a)(1)(F) (the Domestication). As such, Parent does not expect to recognize any gain or loss on the constructive transfer of USRPIs to New Parent. As required by Treasury Regulation Section 1.367(b)-3, all domestic shareholders must include in income as a deemed dividend the all earnings and profits amounts regarding Parent stock or recognize gain with respect to its stock in Parent, or recognize gain with respect to their stock in Parent under Treasury Regulation Section 1.367(b)-3(c)(2).
Parent did not make an election to be treated as a domestic corporation under Section 897(i).
Law and analysis
An F reorganization of a foreign corporation that holds one or more USRPIs into a US corporation may be tax-free for US federal income tax purposes to the foreign corporation and its non-US shareholders if the requirements of Section 897(d), Section 897(e), Treasury regulations thereunder, as well as Notice 89-85, 1989-2 C.B. 403 (as modified by Notice 2006-46, 2006-1 C.B. 1044), are satisfied.
Because Parent transferred a USRPI in exchange for a USRPI (and no other consideration) pursuant to the Domestication (i.e., New Parent is a USRPHC immediately after the exchange), Section 897(e) accords tax-free treatment to Parent’s transfer of the USRPIs to New Parent (i.e., in Section 361(a) transfer). However, the ruling did not rule on whether the Domestication constituted a tax-free F reorganization.
Section 897(d)(1) generally requires a foreign corporation making a distribution (including a distribution in liquidation or redemption) of a USRPI to a shareholder to recognize any gain (but not loss) on the distribution. The gain recognized is the excess of the fair market value of the USRPI at the time of the distribution over its adjusted basis. However, pursuant to Notice 89-85, a foreign corporation that distributes a USRPI to a foreign shareholder does not have to recognize gain on the distribution of USRPHC stock to a foreign shareholder in a transaction that otherwise is part of a valid reorganization if: (i) the foreign corporation pays an amount equal to any taxes that Section 897 would have imposed on all foreign persons who had disposed of interests in the foreign corporation (or a corporation from which assets were acquired in a Section 381 transaction) in the 10-year period prior to the distribution date, as if the corporation were a domestic corporation on the date of each disposition (the Toll Charge) and (ii) the requirements of Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(A) and (C) are satisfied.
Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(A) requires that at the time of the distribution the foreign shareholder in a Section 354 exchange would be subject to US federal income tax on a subsequent disposition of the USRPHC stock. Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(C) requires that the distributing foreign corporation complies with the filing requirements of either Notice 89-57, 1989-1 C.B. 698, or Temporary Treasury Regulation Section 1.897-5T(d)(1)(iii).
While stock in a USRPHC is generally a USRPI, Section 897(c)(3) provides that if any class of stock of a corporation is regularly traded on an established securities market (as defined in Temporary Treasury Regulation Section 1.897-9T(d)), stock of such corporation shall be treated as a USRPI only in the case of a person who, at some time during the shorter or (i) the five-year period prior to its disposition of the stock or (ii) its holding period of the stock, held more than 5 percent of such class of stock (the regularly traded exception).
The Service ruled that Parent will not recognize gain or loss on the transfer of the Sub’s stock to New Parent in exchange for New Parent’s stock or on the distribution of New Parent’s stock to its foreign shareholders because it satisfied the requirements of Notice 89-85. While the Parent agreed to pay the Toll Charge, the Service ruled that Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(A) would be satisfied if all foreign persons that hold less than 5 percent of New Parent’s stock immediately after the Domestication (i.e., that qualified for the regularly traded exception) would have satisfied the regularly traded exception with respect to Parent’s stock immediately before the Domestication if the Parent had been a domestic corporation.
Interestingly, the Service indicated that it was not ruling on whether the Parent properly computed the Toll Charge, including whether it had correctly determined the extent to which foreign persons disposing of interests in Parent during the 10-year look back period would not have been subject to tax under Section 897 by reason of the Parent’s stock being regularly traded on an established securities market during this period. The IRS also ruled that the Parent did not have to satisfy certain information reporting requirements under Temporary Treasury Regulation Section 1.897-9T(d)(3) to US corporations that are publicly traded on non-US exchanges when it calculated the Toll Charge (i.e., because the Toll Charge treats the Parent as if it were a US corporation).
This is the second PLR that the Service has issued in connection with the domestication of a foreign corporation into the US in what is intended to be an reorganization under Section 368(a)(1)(F). The first ruling, PLR 2008-03-005 (19 October 2007), involved a corporation that had two foreign shareholders and was not publicly traded either before or after the reorganization. Therefore, the application of the regularly traded exception did not arise in the context of meeting the subject to tax requirement of Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(A) or the Toll Charge.
The instant ruling is the first guidance that the IRS has issued that applies the regularly traded exception in any Section 897 context. The Service’s rationale for allowing the Parent, for purposes of the subject-to-tax requirement of Temporary Treasury Regulation Section 1.897-5T(c)(4)(ii)(A), to ignore those foreign shareholders that would meet the regularly traded exception immediately after the Domestication if they would have met the same requirement had the Parent been a US corporation immediately prior to the Domestication is sensible and appears to adopt some of the rationale in Notice 99-43, 1999-2 C.B. 344. In Notice 99-43, the Service treated US corporations that undergo reorganizations under Section 368(a)(1)(E) and Section 368(a)(1)(F) as the same corporation in situations where a foreign shareholder gives up stock in a USRPHC but receives non-USRPHC stock in an E or F reorganization (i.e., the stock given up retained the USPRI taint but the stock received in the reorganization is not a USRPI as the corporation is no longer a USRPHC) .
In PLR 2013-21-007, the Service appears to be treating those foreign persons that meet the regularly traded exception immediately before and after the Domestication as in effect owning stock in the same corporation. However, this position requires that those foreign persons that can be ignored under this ruling must not have held more than 5 percent of the Parent’s stock during the shorter of the five-year period prior to the Domestication or their holding periods of the stock. Otherwise, while the ruling does not explicitly state it, it appears that the Parent may have to recognize gain on the distribution of New Parent stock to foreign persons that held more than 5 percent of the Parent’s stock at some time in the 5-year period before the Domestication (even though the Parent paid the Toll Charge).
Finally, while the Service did not affirmatively rule that the regularly traded exception applies in the context of the Toll Charge, its reservation on whether the Parent properly computed the Toll Charge by taking into consideration dispositions of its stock by persons that would have met the regularly traded exception when they disposed of the Parent’s stock strongly suggests that the regularly traded exception applies in the context of the Toll Charge. This makes perfect sense because the Toll Charge applies to dispositions of a foreign corporation’s stock that would have been subject to US federal income tax under Section 897 if it were a US corporation. In such circumstances, stock sold by persons that qualified for the regularly traded exception would not have been subject to tax under Section 897. However, the fact that the Service refused to rule on whether the foreign company properly computed the Toll Charge in connection with the application of the regularly traded exception suggests that the foreign corporation had devised some way of calculating the Toll Charge with respect to 5 percent shareholders’ dispositions of its stock over the prior 10 years that the Service found acceptable.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP, International Tax Services, Washington, DC
- • Peg O’Connor
+1 202 327 6229
Ernst & Young LLP, International Tax Services, New York
- • Harry Shannon
+1 212 773 7592
Ernst & Young LLP, Real Estate, New York
- • David Friedline
+1 212 773 1826
- • Josh W. McKniff
+1 212 773 7338
EYG no. CM3502