Section 367 regs issued.

International

SECTION 367 REGS ISSUED

New regulations under Internal Revenue Code section 367(e) require gain to be recognized on distributions by U.S. corporations to foreign persons in certain otherwise tax-free spin-offs, split-ups, split-offs and liquidations of controlled subsidiaries.

New section 367(e)(1) regulations affect distributions qualifying under IRC section 355. Generally, the distributing U.S. corporation will recognize gain (but not loss) on a distribution of a domestic or foreign subsidiary's stock or securities to non-U.S. shareholders. The tax liability of the foreign distributee is not affected.

There are three exceptions to this rule:

1. If both the distributed and distributing corporation are U.S. real-property holding corporations immediately after the distribution.

2. If a complicated set of requirements is met, including (a) no more than five individuals or corporations directly own 100% of the distributing corporation's stock immediately before the distribution, (b) the distributee directly owns the corporation distributed for five years after the distribution and (c) the foreign distributee is a resident of a U.S. treaty partner.

3. If, on distributions by a corporation publicly traded in the United States, 80% of the stock distributed is with respect to those publicly traded shares. Gain will be recognized, however, to the extent attributable to distributions to more than 5% foreign shareholders.

In addition, new section 367(e)(2) regulations affect liquidations under IRC section 332. Generally, on a liquidation of an 80%-owned U.S. subsidiary into its foreign parent, the U.S. distributing corporation recognizes gain on assets distributed.

There are also three exceptions to this rule:

1. For gain attributable to tangible property distributed in the liquidation if it is used in a U.S. trade or business for 10 years after the liquidation.

2. For gain attributable to U.S. real property interests distributed in the liquidation.

3. For gain attributable to property distributed on the liquidation of a foreign corporation into another foreign corporation, except to the extent the property was used in a U.S. trade or business. Non-recognition treatment is available, however, if that property will be used in a U.S. trade or business for the next 10 years.

Observation: These regulations indicate the overly complicated and overly restrictive approach the IRS has taken in its regulations recently. For example, under the second exception to the section 355 recognition rule, even an internal restructuring involving a drop-down of the distributed corporation into a wholly owned subsidiary would be prohibited.

The effective date of the section 355 regulations is February 16, 1990. However, the section 332 regulations are retroactive, applying to distributions after July 31, 1986.

Herbert M. Paul, CPA, senior partner of Mahoney, Cohen, Paul & Co., New York City; Robert Willens, CPA, senior vice-president-corporate finance at Shearson Lehman Hutton, New York City; and Marianne Burge, CPA, partner, international tax services, at Price Waterhouse, New York City.