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Effect of certain asset reorgs. on gain recognition agreements.

According to Notice 2005-74, the Service will amend Regs. Sec. 1.367(a)-8, to address the effect of certain reorganizations on gain recognition agreements (GRAs). Under the current Sec. 367(a) regulations, certain nonrecognition transfers of stock, securities or assets are not triggering events with respect to outstanding GRAs, provided that the U.S. transferor complies with certain reporting requirements. Further, certain nonrecognition transactions will terminate a GILA (without triggering gain), provided that immediately after the transaction, the transferred stock's basis is not greater than the U.S. transferor's basis in the stock that, immediately prior to the initial transfer, necessitated the GRA. The current regulation's preamble (in TD 8770, 6/18/98) states that post-GRA nonrecognition transactions generally will not trigger a GRA, if the U.S. transferor reports the transaction properly.

Taxpayers and their advisers have recently expressed concern about the extent to which the regulations' existing exceptions apply to certain nonrecognition transactions involving asset transfers. In particular, the language of the exceptions to GRA triggers does not fit squarely with the exchanges in certain asset reorganizations. Notice 2005-74 is intended to clarify whether and how these exceptions apply to various asset reorganizations.

Generally, the regulations implementing Notice 2005-74 will apply to GRAs filed for exchanges of stock or securities occurring after Sept. 27, 2005. However, taxpayers may elect to apply these rules to exchanges occurring after July 19, 1998, the effective date of the current Sec. 367(a) regulations, as long as they apply the rules consistently to all transactions within the scope of the notice for all open years.

Background

Sec. 367(a)(1) provides that if, in connection with any exchange described in Sec. 332, 351, 354, 356 or 361, a U.S. person transfers property to a foreign corporation, the foreign corporation will not be considered to be a corporation when determining the extent to which gain will be recognized on the transfer, effectively denying nonrecognition treatment in such transactions to the extent it would otherwise apply under U.S. tax rules. Regs. Sec. 1.367(a)-3 provides exceptions to this general rule for certain transfers of stock or securities. Generally, to qualify, the U.S. transferor must enter into a GRA, under which it agrees to include in income any gain realized, but not recognized, on the initial transfer of the stock or securities (plus interest), if certain triggering events occur within five years following the transfer year; see Regs. Sec. 1.367(a)-8(b)(1)(iii) and (3)(i).

Under the current regulations, triggering events include:

* Dispositions of the transferred corporation's stock or securities; see Regs. Sec. 1.367(a)-8(e)(1) and (2);

* Dispositions of substantially all of the transferred corporation's assets, which are generally treated as deemed dispositions of the transferred corporation's stock or securities; see Kegs. Sec. 1.367(a)-8(e)(3); and

* Certain dispositions of the transferee foreign corporation's stock, such as when a U.S. corporate transferor is liquidated during a GRA's term; see, e.g., Regs. Sec. 1.367(a)-8(f) (2) (ii).

Under Regs. Sec. 1.367(a)-8(g), certain nonrecognition transfers of stock, securities or assets are not triggering events, as long as the U.S. transferor complies with certain reporting requirements.

According to the regulations, certain asset reorganizations involving the original U.S. transferor corporation, the transferee foreign corporation or the transferred corporation do not squarely fit within the triggering event exceptions. In response to taxpayer concerns, Notice 2005-74 clarifies whether and how these exceptions apply to various asset reorganizations of the (1) original U.S. transferor, (2) transferee foreign corporation and (3) transferred corporation. An "asset reorganization," for Notice 2005-74 purposes, is a reorganization (as described in Sec. 368(a)(1)) involving the transfer of assets by a corporation to another corporation under Sec. 361 .The term includes reorganizations described in Sec. 368(a)(1)(D) or (G), only if the Sec. 354(b)(1)(A) and (B) requirements are met. The notice also modifies other GPA provisions.

Asset Reorganizations of U.S. Transferor

Notice 2005-74 contains an exception for transfers of the transferee foreign corporation's stock by the U.S. transferor in an asset reorganization. If the original U.S. transferor transfers all or part of the transferee foreign corporation's stock to an acquiring corporation (successor U.S. transferor) in an asset reorganization while a GILA is in effect, the asset reorganization will trigger the GILA, unless:

1. In the year of the initial outbound transfer, the U.S. transferor was a member of a consolidated group (original consolidated group), and the U.S. parent of that group entered into the original GRA under Kegs. Sec. 1.367(a)-8(a)(3);

2. Immediately after the asset reorganization, the successor U.S. transferor is a member of the original consolidated group;

3. The U.S. parent of the original consolidated group (or new U.S. parent, if such corporation became the new common parent of the original consolidated group in a transaction in which the group remained in existence) enters into a new GILA (for the remainder of the original five-year term), in which it agrees to recognize the gain that is the subject of the original GILA and by substituting the successor U.S. transferor for the original U.S. transferor, and treats the successor U.S. transferor as the original U.S. transferor for purposes of Kegs. Sec. 1.367(a)-8 and Notice 2005-74; and

4. The successor U.S. transferor provides with its next annual certification the new GILA and a notice of the transfer, setting forth:

* A description of the transfer (including the date) and the successor U.S. transferor's name, address and taxpayer identification number; and

* A statement that arrangements have been made in connection with the asset reorganization, to ensure that the successor U.S. transferor will be informed of any subsequent disposition of property on which gain recognition would be required under the new GILA (notice of subsequent disposition statement).

This exception does not apply to the merger of the U.S. parent into an unrelated corporation in which the original consolidated group ceases to exist.

Asset Reorganizations of Transferee Foreign Corporation

Under Notice 2005-74, there is an exception for transfers of the transferred corporation's stock or securities by the transferee foreign corporation to a foreign acquiring corporation. If the original transferee foreign corporation transfers all or part of the transferred corporation's stock or securities to a foreign acquiring corporation in an asset reorganization while a GRA is in effect as to the stock of the transferred corporation, the GRA will be triggered, unless:

1. The U.S. transferor, U.S. parent or new U.S. parent enters into a new GRA (for the remainder of the original five-year term), in which it agrees to recognize the gain that is the subject of the original GRA, and substituting the successor transferee foreign corporation for the original transferee foreign corporation, and agreeing to treat the successor transferee corporation as the original transferee foreign corporation for purposes of Regs. Sec. 1.367(a)-8 and Notice 2005-74; and

2. The U.S. transferor provides with its next annual certification the new GRA and a notice that describes the transaction, identifies the successor transferee foreign corporation and provides a "notice of subsequent disposition" statement.

For purposes of this exception, an "asset reorganization" does not include: (1) a triangular asset reorganization described in Kegs. Sec. 1.358-6(b); and (2) an asset reorganization in which after the reorganization, the same corporation is both the transferee foreign corporation and the transferred corporation (downstream or upstream).

Asset Reorganization of the Transferred Corporation

As a third exception, a GRA triggering event does not occur on certain transfers of substantially all of the transferred corporation's assets. If the original transferred corporation transfers substantially all of its assets to an acquiring corporation in an asset reorganization while a GILA is in effect, the asset reorganization will trigger the GRA, unless:

1. The U.S. transferor, U.S. parent or new U.S. parent enters into a new GILA (for the remainder of the original five-year term), in which it agrees to recognize the gain in accordance with Regs. Sec. 1.367(a)-8(b) on the transfer subject to the original GRA, and

* Substitutes the successor transferred corporation for the original transferred corporation for purposes of Regs. Sec. 1.367(a)-8 and Notice 2005-74; and

* Treats only the assets acquired by the successor transferred corporation from the original transferred corporation in the asset reorganization as the assets subject to the deemed stock disposition rules under Kegs. Sec. 1.367(a)-8(e)(3)(i); and

2. The U.S. transferor provides with its next annual certification the new GILA and a notice that describes the transaction, identifies the successor transferred corporation and provides the notice of subsequent disposition statement described above.

For purposes of this exception, an "asset reorganization" does not include (1) a triangular asset reorganization described in Regs. Sec. 1.358-6(b); and (2) an asset reorganization in which after the reorganization, the same corporation is both the transferee foreign corporation and the transferred corporation.

Other Modifications

Regs. Sec. 1.367(a)-8(f)(2)(i) modifications: The regulations provide a special rule when the U.S. transferor goes out of existence as part of the original outbound transfer. Currently, if the transaction would have qualified for nonrecognition treatment under the Sec. 367(a) regulations had the U.S. transferor remained in existence, a GILA may be entered into only if the (1) U.S. transferor is owned by a single U.S. parent, (2) U.S. transferor and its parent file a consolidated Federal return for the tax year that includes the transfer and (3) consolidated group parent enters into the GILA. The notice modifies Regs. Sec. 1.367(a)-8(f)(2)(i) to provide that, for purposes of determining whether a U.S. transferor corporation is owned by a single U.S. parent, all members of the U.S. parent's consolidated group for the tax year that includes the transfer are treated as a single corporation.

Certain nonrecognition transfers of transferee foreign corporation's stock by the U.S. transferor under Regs. Sec. 1.367(a)-8(g)(1): The regulations provide rules on certain nonrecognition transfers of the transferee foreign corporation's stock or securities by the U.S. transferor. The regulations generally preserve a GRA, and will not trigger it, if the U.S. transferor complies with certain reporting requirements detailed in Regs. Sec. 1.367(a)-8(g)(2).

This rule, according to the notice, applies if a U.S. transferor disposes of any of the transferee foreign corporation's stock in a nonrecognition transfer, other than in an asset reorganization. Thus, only the notice's rules (requiring the continuation of the original consolidated group) apply to the U.S. transferor corporation's asset reorganizations.

Basis of transferred stock for purposes of Regs. Sec. 1.367(a)-8(h)(3): According to the regulations, a GRA will terminate and no longer apply, when the transferee foreign corporation distributes the transferred corporation's stock in a transaction that qualifies under Sec. 355 or 337. For the GRA to terminate immediately after the Sec. 355 distribution or the Sec. 332 liquidation, the U.S. transferor's basis in the transferred stock must be less than (or equal to) the basis that it had in the transferred stock immediately before the initial outbound transfer that necessitated the GRA.

Many practitioners were concerned that this was an impossible standard to meet if, at any time after the initial outbound transfer, the transferee foreign corporation made an additional property contribution to the transferred corporation. Accordingly, the notice clarifies that, for purposes of this provision, only the basis in the stock transferred by the U.S. transferor to the transferee foreign corporation is taken into account. Thus, the basis of additional stock issued by the transferred corporation to the transferee foreign corporation in connection with subsequent property transfers from the transferee foreign corporation to the transferred corporation, is not taken into account.

Effective Date

The regulations to be issued to implement Notice 2005-74 Hill apply to GRAs filed on exchanges of stock or securities occurring after Sept. 27, 2005. However, until they are issued, taxpayers may rely on Notice 2005-74, for transfers of stock or securities for all open years occurring after July 19, 1998 and before Sept. 28, 2005, assuming they apply the notice consistently to all transactions within its scope for all open years.

If an exchange addressed by Notice 2005-74 occurred after July 19, 1998 but before Sept. 28, 2005, and the taxpayer relies on the notice, it will be treated as having timely satisfied the requirements for filing new GRAs, as required by Regs. Sec. 1.367(a)-8 and the notice, as long as the U.S. person attaches the new GPA to its timely filed original return (including extensions) for the tax year that includes Sept. 28, 2005. The notice does not allow such a filing on an amended return.

Request for Comments

Treasury and the IRS are considering whether to issue further guidance under Regs. Sec. 1.367(a)-8, according to the notice. As such, it specifically requests comments on the following:

* Whether other transactions should be excepted from being treated as triggering events under rules similar to those in Notice 2005-74;

* Appropriate treatment of certain upstream and downstream reorganizations and divisive reorganizations under Sec. 368(a)(1)(D) or (G);

* Whether rules similar to those in Sections 3.03 and 3.04 of Notice 2005-74 should apply to triangular reorganizations and, if so, how they would apply; and

* Other transactions that should terminate a GILA under Regs. Sec. 1.367(a)-8(h)(3), when the transferred corporation's stock is transferred to the U.S. transferor (or other U.S. person).

Implications

The notice provides welcome clarification of the GiLA trigger rules in Regs. Sec. 1.367(a)-8 in several situations. In particular, it offers certainty for taxpayers who were concerned that certain internal restructurings could have potentially triggered a pre-existing GRA, even though the transaction did not result in the stock (or assets, as the case may be) leaving the indirect ownership of the original U.S. transferor group.

Although the notice provides welcome guidance, it does specifically provide that certain internal restructurings will trigger a pre-existing GILA. For example, in asset reorganizations involving two different consolidated groups, to the extent that the group going out of existence had entered into GRAs, they will be triggered if the U.S. transferor goes out of existence during the five-year GILA period in a nonrecognition transaction.

Note: The notice contains detailed filings that must be done timely, to avoid GRA triggering. Further, to benefit from the notice for prior years, a taxpayer must file the new GRA (as required by the notice) with its timely filed original tax return for the year that includes Sept. 28, 2005.

FROM KAREN GILBKEATH AND ANDREW DUBROFF, WASHINGTON, DC
COPYRIGHT 2006 American Institute of CPA's
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Author:Dubroff, Andrew
Publication:The Tax Adviser
Date:Jan 1, 2006
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