Treatment of Section 355 Distributions by U.S. Corporations to Foreign Persons

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8682]

RIN 1545-AU23

Treatment of Section 355 Distributions by U.S. Corporations to

Foreign Persons

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: These temporary regulations amend the Income Tax Regulations

relating to the distribution of stock and securities under section 355

of the Internal Revenue Code of 1986 by a domestic corporation to a

person that is not a United States person. These regulations are

necessary to implement section 367(e)(1) as added by the Tax Reform Act

of 1986. The text of these regulations also serves as the text of the

proposed regulations set forth in the notice of proposed rulemaking on

this subject in the Proposed Rules section of this issue of the Federal

Register.

EFFECTIVE DATE: These regulations are effective September 13, 1996.

FOR FURTHER INFORMATION CONTACT: Philip L. Tretiak at (202) 622-3860

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These regulations are being issued without prior notice and public

procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553).

For this reason, the collection of information contained in these

regulations has been reviewed and, pending receipt and evaluation of

public comments, approved by the Office of Management and Budget under

control number 1545-1487. Responses to this collection of information

are required in order for a U.S. corporation that distributes domestic

stock or securities to a foreign person to qualify for an exception to

the general rule of taxation provided by the regulations under section

367(e)(1).

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

For further information concerning this collection of information,

and where to submit comments on the collection of information and the

accuracy of the estimated burden, and suggestions for reducing this

burden, please refer to the preamble to the cross-referencing notice of

proposed rulemaking published in the Proposed Rules section of this

issue of the Federal Register.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

On January 16, 1990, temporary regulations under section 367(e)(1)

and 367(e)(2) were published in the Federal

[[Page 42166]]

Register (55 FR 1406). A cross-referenced Notice of Proposed Rulemaking

was published on that same date (55 FR 1472). These regulations were

proposed to implement section 367(e) of the Internal Revenue Code of

1986 (Code), as revised by sections 631(d)(1) and 1810(g) of the Tax

Reform Act of 1986 (100 Stat. 2085, 2272, Public Law 99-514 [1986-3

C.B. (Vol. 1) 1, 189, 745]). On January 15, 1993, final regulations

under section 367(e)(1) were published in the Federal Register.

Need for Temporary Regulations

Under the current regulations, in certain circumstances the gain

recognition exception may be dependent on the form rather than the

substance of a taxpayer's transaction. As a result, certain taxpayers

may be subject to strict restrictions under this exception, while other

taxpayers arguably may avoid the restrictions by structuring their

transactions in a different fashion (even though the substance of the

transactions is similar). Based on these considerations, it is

determined that immediate regulatory guidance will ensure the efficient

administration of the tax laws and that it would be impracticable and

contrary to the public interest to issue this Treasury decision with

prior notice under section 553(b).

Explanation of Provisions

Section 355 provides that, if certain requirements are met, a

distributing corporation (Distributing) does not recognize gain or loss

on the distribution of the stock or securities of a controlled

corporation (Controlled) to Distributing's shareholder or shareholders

(Distributee(s)). However, section 367(e)(1) provides that, in the case

of any distribution described in section 355 (or so much of section 356

as relates to section 355) by a domestic corporation to a Distributee

who is not a United States person (an outbound section 355

distribution), to the extent provided in regulations, gain shall be

recognized under principles similar to the principles of section 367.

The existing regulations under section 367(e)(1) provide different

tax treatment to Distributing in an outbound section 355 distribution

depending upon whether Controlled is a foreign corporation or a

domestic corporation. If Controlled is a foreign corporation, an

outbound section 355 distribution by Distributing is taxable, with no

exceptions. If Controlled is a domestic corporation, however, the

existing regulations provide that the distribution is taxable, but

permit three exceptions: (i) a FIRPTA exception in cases where both

Distributing and Controlled are U.S. real property holding corporations

(as defined in section 897(c)(2)) at the time of the distribution, (ii)

a publicly traded exception in certain cases where Distributing is

publicly traded in the United States at the time of the distribution,

and (iii) a gain recognition agreement (GRA) exception described in

detail below.

The new temporary regulations retain the general framework of the

existing regulations by permitting no exceptions in the case of an

outbound section 355 distribution of foreign stock and the same three

exceptions in the case of an outbound section 355 distribution of

domestic stock. However, the new temporary regulations substantially

modify the GRA exception.

The temporary regulations retain many of the provisions from the

existing regulations. However, the IRS and Treasury have decided to

reissue all of the regulations under section 367(e)(1) as temporary

regulations to obtain a uniform set of regulations.

GRA Exception Under the Existing Regulations

The GRA exception in the existing regulations contains a number of

specific requirements, all of which must be satisfied for the

distributing corporation to defer taxation under the exception.

In general, if Distributee is a resident of a country that has an

income tax treaty with the United States and meets certain other

requirements, Distributing can defer its gain by entering into a GRA.

Under the GRA, if a (foreign) Distributee sells all or a portion of the

stock of either Distributing or Controlled within 60 months after the

close of the taxable year in which the distribution occurs,

Distributing agrees to amend its return and include the deferred gain

in income based upon the proportion of the stock that is sold by

Distributee. Thus, for example, if Distributee sells 10 percent of its

stock of Distributing or Controlled, Distributing is required to amend

its return to include 10 percent of the deferred gain. There is no

special rule (i.e., no full trigger of the deferred gain) if

Distributee sells a substantial amount of its stock of either company.

In addition, there is no special rule that triggers gain in the case of

a nonrecognition transaction (such as the issuance of additional stock

by either Distributing or Controlled to third parties through a public

offering) that results in a substantial reduction of the percentage of

stock owned by Distributee(s).

The existing regulations generally provide that the GRA will not be

triggered if Distributee transfers the stock of either Distributing or

Controlled in certain nonrecognition transactions (permitted

transactions). The transfer of the stock of either company in a

(second) section 355 distribution, however, is not permitted.

In the case of a permitted transaction, the existing regulations

provide special successor-in-interest rules under which the deferred

gain generally will be taxable unless Distributee maintains a direct or

indirect 80 percent interest in the stock of Distributing and

Controlled that it owned immediately after the distribution. For

example, if Distributing distributed the stock of Controlled in an

outbound section 355 distribution that qualified for the GRA exception

and, within the term of the GRA, Distributee then contributed the stock

of Distributing to a new company (Newco) in a section 351 exchange and

received 100 percent of Newco, the successor-in-interest rules apply.

Thus, Distributee generally would be required to maintain an 80 percent

indirect interest in Distributing. Under these rules, (i) Distributee's

sale of up to 20 percent of the stock of Newco, or (ii) Newco's sale of

up to 20 percent of the stock of Distributing would result in a

corresponding trigger of the deferred gain. The issuance of new stock

by Newco or Distributing of up to 20 percent to unrelated persons,

however, would not result in any trigger of the GRA. If, however, Newco

(or Distributing) issued more than 20 percent of its stock to unrelated

persons (or any other nonrecognition transaction reduced Distributee's

indirect interest in Distributing to below 80 percent as a result of a

nonrecognition transaction), the entire gain would be triggered.

Reasons for Change/Overview of Temporary Regulations

The treatment of non pro rata outbound section 355 distributions is

not adequately addressed in the existing regulations. For example,

assume that a foreign parent (FP) owns all of the stock of

Distributing, a domestic corporation, which, in turn, owns all of the

stock of Controlled, also a domestic corporation. Assume that the

distribution of Controlled by Distributing to FP qualifies for the GRA

exception. If FP then contributes all of the stock of Distributing to a

newly formed foreign corporation (Newco), the successor rules would

apply, and FP would be required to maintain a direct or indirect 80

percent interest in Distributing.

The outcome under the existing regulations arguably is

substantially different, however, if the corporations structured the

distribution as a non pro

[[Page 42167]]

rata distribution. For example, assume that FP first forms Newco and

transfers to Newco a percentage of the Distributing stock (the

percentage equal to the value of Distributing (without the Controlled

stock) divided by the combined value of Distributing and Controlled) in

an exchange under section 351. Distributing then distributes the stock

of Controlled to FP in exchange for FP's stock of Distributing (a non

pro rata section 355 distribution). After the distribution, FP owns all

of the stock of Controlled and all of the stock of Newco; Newco owns

all of the stock of Distributing. Under the existing regulations, FP is

a Distributee. However, because FP has no direct interest in

Distributing after the distribution, the regulations effectively treat

FP as a Distributee only with respect to Controlled. Moreover, because

Newco does not actually receive stock of Controlled in the distribution

(even though its percentage ownership interest in Distributing

increases as a result of the distribution), it is arguably not a

Distributee with respect to the Distributing stock. As a result,

because the taxpayer structures the transaction in this manner (rather

than a section 355 distribution followed by a section 351 exchange as

in the first hypothetical), if the steps of the transaction are

respected and in the absence of the application of other sections of

the Code, Distributing could take the position that there are no

restrictions in the existing regulations with respect to (i) the sale

by FP of Newco stock, or (ii) the sale by Newco of Distributing stock.

To remedy this potential disparity in treatment between pro rata

and non pro rata distributions, the temporary regulations expand the

definition of Distributee in the GRA exception (referred to as Foreign

Distributee under such exception) to include all persons that were

shareholders of Distributing immediately prior to the distribution.

Thus, for example, in the second hypothetical above, Newco and FP would

both be Foreign Distributees. Provided that nonrecognition treatment is

claimed under the GRA exception with respect to Newco and FP (referred

to as Qualified Foreign Distributees in the case of Foreign

Distributees for which nonrecognition may be claimed), the GRA would be

triggered by either (i) the sale by FP of Newco stock, or (ii) the sale

by Newco of Distributing stock.

Second, even in the case of pro rata distributions, the IRS and

Treasury believe that the results obtained under the existing

regulations are too dependent upon the form of the transaction. This is

principally because taxpayers could be subject to the stricter

successor-in-interest rules if their transactions were structured in a

particular way, but might be subject to the more liberal distributee

rules if the order of the steps of the particular transaction are

reversed.

In the preamble to the existing regulations, the IRS and Treasury

stated that the successor-in-interest rules were ``designed to provide

taxpayers with flexibility to restructure their operations, without

imposing undue administrative burdens on the Service.'' The IRS

solicited taxpayer comments on the scope of these rules. A number of

commentators have stated that the rules are overly restrictive.

The temporary regulations harmonize the treatment of the

distributee and successor-in-interest rules in order to minimize the

importance of the form of a particular transaction. In addition, as

discussed below, the temporary regulations liberalize the strict

successor rules by replacing the 80-percent threshold (computed on an

individual Distributee basis) with a 50-percent threshold (computed

with reference to all Qualified Foreign Distributees as a group).

The temporary regulations follow the existing regulations by

providing that a sale by a Qualified Foreign Distributee of the stock

of either Controlled or Distributing triggers gain in the same

proportion as the percentage of stock that is sold. However, the

temporary regulations provide that a sale by Qualified Foreign

Distributee(s) of either Distributing or Controlled that results in a

substantial transformation results in a trigger of the full amount of

the deferred gain. A substantial transformation is defined as a greater

than 50-percent (direct or indirect) reduction, on an aggregate basis,

in either the total voting power or the total value of the stock of

Controlled or Distributing held by Qualified Foreign Distributee(s)

immediately after the distribution. The new temporary regulations also

provide that a nonrecognition transaction that results in a substantial

transformation (such as the issuance of stock by Distributing or

Controlled in a public offering) generally causes a trigger of the full

amount of the deferred gain. No gain will be triggered if a

nonrecognition transaction does not result in a substantial

transformation.

The temporary regulations also expand the types of post-

distribution nonrecognition transactions that are permitted

transactions to include section 355 distributions. A post-distribution

section 355 transaction may qualify for nonrecognition treatment if the

foreign distributee (referred to as a Substitute Distributee) that

receives stock of Distributing and/or Controlled qualifies as a

Qualified Foreign Distributee. In such case, the Substitute Distributee

will replace the initial Qualified Foreign Distributee as the person

whose ownership interest is considered for purposes of determining

whether a disposition or substantial transformation has occurred (on a

cumulative, aggregate basis) with respect to such stock.

In addition, the temporary regulations provide that foreign persons

that owned stock or securities of Distributing within two years prior

to the distribution and that own (directly, indirectly, or

constructively) 50 percent or more of the stock of Distributing or

Controlled immediately after the distribution will also be considered

Foreign Distributees. Thus, for example, if F1, a foreign corporation,

transfers the stock of US1 to F2 in exchange for all of the stock of F2

in a section 351 exchange and, within two years after the transfer, US1

distributes all of the stock of US2, its wholly owned subsidiary, to F2

in a section 355 exchange, F1 is also treated as a Foreign Distributee

under this rule. (F1 would have been treated as a Foreign Distributee

without the operation of this rule if the section 355 distribution

occurred prior to the section 351 exchange.)

The IRS and the Treasury also believe that certain procedural

aspects of the GRA exception need modification. The temporary

regulations enhance reporting and security requirements, extend the

term of the GRA from 5 to 10 years, and delete other requirements that

are believed to be unnecessary in light of the modifications herein.

To address the security concerns of the IRS resulting from the

liberalization of the successor-in-interest rules and the expansion of

permissible post-distribution nonrecognition transactions to include

section 355 distributions, the assets of Distributing are more closely

monitored to insure that such corporation has sufficient funds to pay a

potential tax on the deferred gain. In addition, Controlled must agree

to be secondarily liable (after Distributing) for the tax on the

deferred gain.

Moreover, the new temporary regulations extend the term of the GRA

from 5 to 10 years in order to conform the GRA term under section

367(e)(1) to the GRA term under section 367(a). Under section 367(a),

the GRA term in the case of outbound stock transfers is 10 years when

U.S. transferors own at least 50 percent of the stock of a foreign

transferee company. See Sec. 1.367(a)-3T(c)(3) and Notice 87-85 (1987-2

C.B. 395). The IRS and Treasury believe that

[[Page 42168]]

the GRA term under section 367(e)(1) should be no less than the term

under section 367(a) when U.S. transferors control the transferee

because, once the GRA under section 367(e)(1) expires, the sale of

Distributing or Controlled stock by a Qualified Foreign Distributee

likely will not be subject to Federal income taxation. In contrast,

under section 367(a), even if the GRA lapses, an amount approximating

the deferred gain likely will be subject to Federal income taxation if

the U.S. transferor later sells the stock of the transferee foreign

corporation.

Finally, the IRS and Treasury believe that section 367(e)(1)

distributions should be subject to some form of section 6038B

reporting, as are transfers described under sections 367(a) and 367(d).

Thus, the temporary regulations extend limited section 6038B reporting

to section 367(e)(1) transactions. The reporting requirements under

section 6038B will be deemed satisfied in the case of a taxpayer that

qualifies for one of the three exceptions to taxation under the

regulations if the taxpayer complies with the applicable reporting

requirements relating to the relevant exception. This change is also

intended to extend the statute of limitations under section 6501(c)(8)

in cases where distributing corporations do not properly report their

outbound section 355 distributions. Separately, the temporary

regulations provide new notice and reporting rules in cases where

Distributing qualifies for either the FIRPTA or publicly traded

exception.

Specific changes to GRA Exception in Temporary Regulations

The specific requirements of the GRA exception, as amended, are as

follows:

(A) Ten or Fewer Qualified Foreign Distributees

The existing regulations provide that Distributing is permitted to

claim nonrecognition with respect to 10 or fewer individual or

corporate foreign distributees. A ruling is required in the case of a

foreign distributee that holds its interest in Distributing through a

partnership, trust, or estate (whether foreign or domestic). This

requirement is unchanged in the temporary regulations.

(B) Active Trade or Business

The existing regulations provide that, if Distributee is a foreign

corporation, it must be engaged in an active trade or business. This

requirement is removed in the temporary regulations.

(C) Value of Distributing

The existing regulations provide that, immediately after the

distribution, the value of Distributing must be at least equal to the

value of the distributed stock and securities. This requirement is

waived by the existing regulations if Distributing and Controlled are

members of the same consolidated group at the time of the distribution.

This requirement is revised in the temporary regulations to provide

that the value of Distributing (the value of its assets less all of its

liabilities) must be at least equal to the amount of the deferred gain

on all testing dates during the GRA period. (Alternatively,

Distributing may satisfy this test using the adjusted basis of its

assets instead of fair market value.) A testing date is the last day of

each taxable year of Distributing and any day in which Distributing

distributes money or property to its shareholders (regardless of

whether such distribution is treated as a dividend). The waiver in the

existing regulations if Distributing and Controlled are members of the

same consolidated group is eliminated in the temporary regulations.

(D) Treaty Residence

The existing regulations provide that all Distributees are required

to be residents of a country that maintains a comprehensive income tax

treaty with the United States that contains an exchange of information

provision. This requirement is not changed in the temporary

regulations.

(E) Continuity of Interest Rule

The existing regulations provide that the Distributee is required

to continue to own, for a 60-month period, all of the stock of

Distributing and Controlled that it owns at the time of the

distribution. This requirement is maintained, but the period is

increased to 120 months.

(F) Distributing Must Remain in Existence

The existing regulations provide that Distributing cannot go out of

existence pursuant to the distribution. This requirement is maintained

in the temporary regulations.

(G) GRA

The existing regulations provide that Distributing is required to

enter into a 5-year GRA and receive annual certifications from

Distributees, stating that they continue to own the stock that they

held immediately after the distribution. The temporary regulations

increase the GRA term to 10 years.

(H) Annual Certifications

The existing regulations provide that Distributees must provide

their certifications directly to Distributing. Under the temporary

regulations, Controlled also must provide an annual statement to

Distributing, containing information regarding whether any of its

Qualified Foreign Distributees have disposed of their stock in

Controlled during the relevant taxable year.

Special Analyses

It has been determined that this temporary regulation is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It is hereby certified that this

regulation does not have a significant impact on a substantial number

of small entities. This certification is based on the fact that the

number of corporations that distribute stock or securities to foreign

persons in transactions that qualify under section 355, and thus become

subject to the collection of information contained in these

regulations, is estimated to be only 260 per year. Moreover, because

these regulations will primarily affect large multinational

corporations with foreign shareholders, it is estimated that out of the

260 annual transactions subject to reporting, very few, if any, will

involve small entities. Therefore, the regulations do not significantly

alter the reporting or recordkeeping duties of small entities. Thus, a

Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5

U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the

Internal Revenue Code, a copy of these temporary regulations will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Philip L. Tretiak of

the Office of Associate Chief Counsel (International), within the

Office of Chief Counsel, IRS. However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

[[Page 42169]]

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by

removing the entry for Sec. 1.367(e)-1 and adding an entry in numerical

order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.367(e)-1T also issued under 26 U.S.C. 367(e)(1) * * *

Sec. 1.367 [Amended]

Par. 2. Sections 1.367(e)-0 and 1.367(e)-1 are removed.

Par. 3. Sections 1.367(e)-0T and 1.367(e)-1T are added to read as

follows:

Sec. 1.367(e)-0T Treatment of section 355 distributions by U.S.

corporations to foreign persons; table of contents.

This section lists captioned paragraphs contained in Sec. 1.367(e)-

1T.

Sec. 1.367(e)-1T Treatment of section 355 distributions by U.S.

corporations to foreign persons.

(a) Purpose and scope.

(b) Recognition of gain required.

(1) In general.

(2) Computation of gain of the distributing corporation.

(3) Treatment of foreign distributee.

(4) Nonapplication of section 367(a) principles that provide for

exceptions to gain recognition.

(5) Partnerships, trusts, and estates.

(i) In general.

(ii) Written statement.

(6) Anti-abuse rule.

(c) Nonrecognition of gain.

(1) Distribution by a U.S. real property holding corporation of

stock in a second U.S. real property holding corporation.

(2) Distribution by a publicly traded corporation.

(i) Conditions for nonrecognition.

(ii) Recognition of gain if foreign distributee owns 5 percent of

distributing corporation.

(iii) Reporting requirements.

(iv) Timely filed return.

(v) Relation to other nonrecognition provisions.

(3) Distribution of certain domestic stock to 10 or fewer qualified

foreign distributees.

(i) In general.

(ii) Conditions for nonrecognition.

(iii) Agreement to recognize gain.

(iv) Waiver of period of limitation.

(v) Annual certifications and other reporting requirements.

(vi) Special rule for nonrecognition transactions.

(vii) Recognition of gain.

(viii) Failure to comply.

(d) Other consequences.

(1) Exchange under section 897(e)(1).

(2) Dividend treatment under section 1248.

(3) Distribution of stock of a passive foreign investment company.

[Reserved]

(4) Reporting under section 6038B.

(e) Examples.

(f) Effective date.

Sec. 1.367(e)-1T Treatment of section 355 distributions by U.S.

corporations to foreign persons (temporary).

(a) Purpose and scope. This section provides rules concerning the

recognition of gain by a domestic corporation on a distribution that

qualifies for nonrecognition under section 355 of stock or securities

of a domestic or foreign corporation to a person who is not a U.S.

person. Paragraph (b) of this section states as a general rule that

gain recognition is required on the distribution. Paragraph (c) of this

section provides exceptions to the gain recognition rule for certain

distributions of stock or securities of a domestic corporation.

Paragraph (d) of this section refers to other consequences of

distributions described in this section. Paragraph (e) of this section

provides examples of these rules. Finally, paragraph (f) of this

section specifies the effective date of this section.

(b) Recognition of gain required--(1) In general. (i) If a domestic

corporation (distributing corporation) makes a distribution that

qualifies for nonrecognition under section 355 of stock or securities

of a domestic or foreign corporation (controlled corporation) to a

person who is not a qualified U.S. person, then, except as provided in

paragraph (c) of this section, the distributing corporation shall

recognize gain (but not loss) on the distribution under section

367(e)(1). No gain is required to be recognized under this section with

respect to a distribution to a qualified U.S. person of stock or

securities that qualifies for nonrecognition under section 355. For

purposes of this section, a qualified U.S. person is--

(A) A citizen or resident of the United States; and

(B) A domestic corporation.

(ii) In the case of stock or securities owned through a

partnership, trust, or estate, see paragraph (b)(5) of this section.

(2) Computation of gain of the distributing corporation. The gain

recognized by the distributing corporation under paragraph (b)(1) of

this section shall be equal to the excess of the fair market value of

the stock or securities distributed to persons who are not qualified

U.S. persons (determined as of the time of the distribution) over the

distributing corporation's adjusted basis in the stock or securities

distributed to such distributees. For purposes of the preceding

sentence, the distributing corporation's adjusted basis in each unit of

each class of stock or securities distributed to a distributee shall be

equal to the distributing corporation's total adjusted basis in all of

the units of the respective class of stock or securities owned

immediately before the distribution, divided by the total number of

units of the class of stock or securities owned immediately before the

distribution.

(3) Treatment of distributee. If the distribution otherwise

qualifies for nonrecognition under section 355, each distributee shall

be considered to have received stock or securities in a distribution

qualifying for nonrecognition under section 355, even though the

distributing corporation may recognize gain on the distribution under

this section. Thus, the distributee shall not be considered to have

received a distribution described in section 301 or a distribution in

an exchange described in section 302(b) upon the receipt of the stock

or securities of the controlled corporation. Except where section

897(e)(1) and the regulations thereunder cause gain to be recognized by

the distributee, the basis of the distributed domestic or foreign

corporation stock in the hands of the foreign distributee shall be the

basis of the distributed stock determined under section 358 without any

increase for any gain recognized by the domestic corporation on the

distribution.

(4) Nonapplication of section 367(a) principles that provide for

exceptions to gain recognition. Paragraph (b)(1) of this section

requires recognition of gain notwithstanding the application of any

principles contained in section 367(a) or the regulations thereunder.

The only exceptions to paragraph (b)(1) of this section are contained

in paragraph (c) of this section. None of these exceptions applies to

distributions of stock or securities of a foreign corporation.

(5) Partnerships, trusts, and estates--(i) In general.

For purposes of this section, stock or securities owned by or for a

partnership (whether foreign or domestic) shall be considered to be

owned proportionately by its partners. In applying this principle, the

proportionate share of the stock or securities of the distributing

corporation considered to be owned by a partner of the partnership at

the time of the distribution shall equal the partner's distributive

share of gain that would be realized by the partnership from a sale of

stock of the distributing corporation immediately before the

distribution (without regard to whether, under the particular facts,

any gain would actually be realized on the sale

[[Page 42170]]

for U.S. tax purposes), determined under the rules and principles of

sections 701 through 761 and the regulations thereunder. For purposes

of this section, stock or securities owned by or for a trust or estate

(whether foreign or domestic) shall be considered to be owned

proportionately by the persons who would be treated as owning such

stock or securities under sections 318(a)(2)(A) and (B). In applying

section 318(a)(2)(B), if a trust includes interests that are not

actuarially ascertainable and a principal purpose of the inclusion of

the interests is the avoidance of section 367(e)(1), all such interests

shall be considered to be owned by foreign persons. In a case where an

interest holder in a partnership, trust, or estate that owns stock of

the distributing corporation is itself a partnership, trust, or estate,

the rules of this paragraph (b)(5) apply to individuals or corporations

that own (direct or indirect) interests in the upper-tier partnership,

trust or estate.

(ii) Written statement. If, prior to the date on which the

distributing corporation must file its income tax return for the year

of the distribution, the corporation obtains a written statement,

signed under penalties of perjury by an interest holder in a

partnership, trust, or estate that receives a distribution described in

paragraph (b)(1) of this section from the corporation, which statement

certifies that the interest holder is a qualified U.S. person (as

defined in paragraph (b)(1)(i) of this section), no liability shall be

imposed under paragraph (b)(1) of this section with respect to the

distribution to the partnership, trust, or estate to the extent of the

interest holder's interest in the partnership, trust, or estate, unless

the distributing corporation knows or has reason to know that the

statement is false, or it is subsequently determined that the interest

holder, in fact, was not a qualified U.S. person at the time of the

distribution. The written statement must set forth the amount of the

interest holder's proportionate interest in the partnership, trust, or

estate as determined under paragraph (b)(5)(i) of this section and must

set forth the amount of such entity's proportionate interest in the

distributing and controlled corporation, as well as the interest

holder's name, taxpayer identification number, home address (in the

case of an individual) or office address and place of incorporation (in

the case of a corporation). The written statement must be retained by

the distributing corporation with its books and records for a period of

three calendar years following the close of the last calendar year in

which the corporation relied upon the statement.

(6) Anti-abuse rule. If a domestic corporation is directly or

indirectly formed or availed of by one or more foreign persons to hold

the stock of a second domestic corporation for a principal purpose of

avoiding the application of section 367(e)(1) and the requirements of

this section, any distribution of stock or securities to which section

355 applies by such second domestic corporation shall be treated for

Federal income tax purposes as a distribution to such foreign person or

persons, followed by a transfer of the stock or securities to the first

domestic corporation. The qualification of the distribution to the

foreign person for an exception to the general gain recognition rule of

paragraph (b)(1) of this section, and the consequences of the transfer

to the first domestic corporation under this section, shall be

determined in accordance with all of the facts and circumstances.

(c) Nonrecognition of gain--(1) Distribution by a U.S. real

property holding corporation of stock in a second U.S. real property

holding corporation. Gain shall not be recognized under paragraph (b)

of this section by a domestic corporation making a distribution that

qualifies for nonrecognition under section 355 of stock or securities

of a domestic controlled corporation to a person who is not a qualified

U.S. person (as defined in paragraph (b)(1)(i) of this section) if the

conditions specified in paragraphs (c)(1) (i) and (ii) of this section

are both satisfied:

(i) Immediately after the distribution, both the distributing and

controlled corporations are U.S. real property holding corporations (as

defined in section 897(c)(2)). For the treatment of the distribution

under section 897, see section 897(e)(1) and the regulations

thereunder.

(ii) The distributing corporation attaches to its timely filed

Federal income tax return for the taxable year in which the

distribution occurs a statement titled ``Section 367(e)(1)--Reporting

of Section 355 Distribution by U.S. Real Property Holding

Corporation'', signed under penalties of perjury by an officer of the

corporation, disclosing the following information--

(A) A statement that the distribution is one to which paragraph

(c)(1) of this section applies; and

(B) A description of the transaction in which one U.S. real

property holding corporation distributes the stock of another U.S. real

property holding corporation in a transaction that is described under

section 355.

(iii) For purposes of this paragraph (c)(1), an income tax return

(including an amended return) will be considered a timely filed Federal

income tax return if it is filed prior to the time that the Internal

Revenue Service discovers that the reporting requirements of this

paragraph have not been satisfied.

(2) Distribution by a publicly traded corporation--(i) Conditions

for nonrecognition. Except as provided by paragraph (c)(2)(ii) of this

section, gain shall not be recognized under paragraph (b) of this

section by a domestic corporation making a distribution that qualifies

for nonrecognition under section 355 of stock or securities of a

domestic controlled corporation to a person who is not a qualified U.S.

person (as defined in paragraph (b)(1)(i) of this section) if both of

the following conditions are satisfied:

(A) Stock of the domestic controlled corporation with a value of

more than 80 percent of the outstanding stock of the corporation is

distributed with respect to one or more classes of the outstanding

stock of the distributing corporation that are regularly traded on an

established securities market, as defined in Sec. 1.897-1(m) (1) and

(3), located in the United States. Stock is considered to be regularly

traded if it is regularly quoted by brokers or dealers making a market

in such interests. A broker or dealer is considered to make a market

only if the broker or dealer holds himself out to buy or sell interests

in the stock at the quoted price.

(B) The distributing corporation satisfies the reporting

requirements contained in paragraph (c)(2)(iii) of this section.

(ii) Recognition of gain if distributee owns 5 percent of

distributing corporation. If, at the time of the distribution, the

distributing corporation knows or has reason to know that any

distributee who is not a qualified U.S. person (as defined in paragraph

(b)(1)(i) of this section) owns, directly, indirectly, or

constructively (using the rules of sections 897(c)(3) and (c)(6)(C),

but subject to the rules of paragraph (b)(5) of this section), more

than 5 percent (by value) of a class of stock or securities of the

distributing corporation with respect to which the stock or securities

of the controlled corporation is distributed (a 5-percent shareholder),

the distributing corporation will qualify for nonrecognition under

paragraph (c)(2)(i) of this section if, with respect to such 5-percent

shareholder, either--

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(A) The distribution qualifies for nonrecognition under paragraph

(c)(3) of this section; or

(B) The distributing corporation recognizes gain (but not loss) on

the distribution under paragraph (b) of this section.

(iii) Reporting Requirements. To qualify for nonrecognition

treatment under paragraph (c)(2)(i) of this section, the distributing

corporation must attach to its timely filed Federal income tax return,

for the taxable year in which the distribution occurs a statement

titled ``Section 367(e)(1)--Reporting of Section 355 Distribution by

U.S. Publicly Traded Corporation to Foreign Persons,'' signed under

penalties of perjury by an officer of the corporation, disclosing the

following information:

(A) A statement that the distribution is one to which paragraph

(c)(2) of this section applies.

(B) A description of the transaction in which the distributing

corporation that is publicly traded on a U.S. securities market

distributed stock or securities of a domestic controlled corporation.

(C) The U.S. securities market on which the stock of the

distributing corporation is publicly traded.

(D) A statement that, at the time of the distribution, either--

(1) The distributing corporation does not know or have reason to

know that any distributee who is not a qualified U.S. shareholder (as

defined in paragraph (b)(1)(i) of this section) is a 5-percent

shareholder; or

(2) The distributing corporation knows or has reason to know that

one or more distributees who are not qualified U.S. persons are 5-

percent shareholders, and, that with respect to each such 5-percent

shareholder, either--

(i) Gain will not be recognized because the requirements of

paragraph (c)(3) of this section are satisfied; or

(ii) Gain (but not loss) will be recognized in accordance with

paragraph (b) of this section.

(iv) Timely filed return. For purposes of this paragraph (c)(2), an

income tax return (including an amended return) will be considered a

timely filed Federal income tax return if it was received prior to the

time that the Internal Revenue Service discovers that the reporting

requirements of this paragraph (c)(2) have not been satisfied.

(v) Relation to other nonrecognition provisions. If the

distribution of the stock and securities of the controlled corporation

also qualifies for nonrecognition under paragraph (c)(1) of this

section, the distributing corporation shall be entitled to

nonrecognition under paragraph (c)(1) of this section and not this

paragraph (c)(2).

(3) Distribution of certain domestic stock to 10 or fewer qualified

foreign distributees--(i) In general. (A) Gain shall not be recognized

under paragraph (b) of this section by a domestic corporation making a

distribution that qualifies for nonrecognition under section 355 of

stock or securities of a domestic controlled corporation with respect

to a foreign distributee (defined in paragraph (c)(3)(i)(B) of this

section) that is a qualified foreign distributee (defined in paragraph

(c)(3)(i)(C) of this section), provided that each of the conditions

contained in paragraph (c)(3)(ii) of this section is satisfied. If one

or more foreign distributees are not treated as qualified foreign

distributees, the distributing corporation shall recognize a percentage

of the gain realized on the distribution, equal to the percentage of

its stock owned immediately before the distribution, directly or

indirectly, by foreign distributees who are not qualified foreign

distributees. See paragraph (b)(5) of this section for rules regarding

the ownership of stock held by a partnership, trust, or estate.

(B) For purposes of this paragraph (c)(3), the term foreign

distributee is any person who is not a qualified U.S. person (as

defined in paragraph (b)(1)(i) of this section) if such person--

(1) Owned stock or securities of the distributing corporation

immediately prior to the distribution;

(2) Owned stock or securities of the distributing corporation

within two years prior to the distribution and directly, indirectly, or

constructively (using the rules of section 318) owns 50 percent or more

of either the total voting power or the total value of the stock of the

distributing or controlled corporation immediately after the

distribution; or

(3) Is a transferee or substitute distributee, as defined in

paragraph (c)(3)(vi) (C) or (D) of this section.

(C) For purposes of this section, except as provided by paragraph

(c)(3)(i)(D) of this section, the term qualified foreign distributee is

a foreign distributee that, during the entire period for which the

agreement to recognize gain (described in paragraph (c)(3)(iii) of this

section) is in effect with respect to the distributee, is either an

individual or a corporation (as defined in section 7701(a)(3)),

resident of a foreign country that maintains a comprehensive income tax

treaty with the United States which contains an information exchange

provision. However, no more than ten foreign distributees in total may

be current or former qualified foreign distributees (including any

transferee or substitute distributees as defined in paragraph

(c)(3)(vi) (C) or (D) of this section) during the entire term of the

gain recognition agreement. See, however, paragraph (c)(3)(vi)(G) of

this section for special rules applicable to substitute distributees.

(D) Unless the distributing corporation obtains a ruling from the

Internal Revenue Service to the contrary, no foreign distributee shall

be treated as a qualified foreign distributee if it holds its interest

in the distributing corporation through a partnership, trust or estate,

characterized as such under the taxation laws of the United States or

any entity that is treated as fiscally transparent under the taxation

laws of the foreign country in which it is a resident if such country

maintains a comprehensive income tax treaty with the United States

which contains an information exchange provision.

(ii) Conditions for nonrecognition. A distribution of stock or

securities described in paragraph (c)(3)(i) of this section to a

qualified foreign distributee shall not result in the recognition of

gain if each of the following conditions is satisfied:

(A) If more than ten foreign distributees, at any time during the

entire term of the gain recognition agreement, are eligible to be

qualified foreign distributees, the distributing corporation shall

designate the foreign distributees to be considered qualified foreign

distributees for which nonrecognition is claimed under this paragraph

(c)(3).

(B) Immediately after the distribution and on each testing date

beginning after the distribution and during the period that the

agreement to recognize gain (described in paragraph (c)(3)(iii) of this

section) is in effect, the value of the distributing corporation (that

is, the fair market value of the assets of the distributing

corporation, less all liabilities of the distributing corporation) must

exceed the amount of gain that the distributing corporation realized,

but did not recognize (on or after the distribution) under this

paragraph (c)(3), as a consequence of the distribution with respect to

qualified foreign distributees. This requirement will be deemed

satisfied for any testing date upon which the adjusted basis of the

distributing corporation's assets, less all liabilities of the

distributing corporation, exceeds the amount of the deferred gain. A

testing date is--

(1) The last day of any taxable year of the distributing

corporation during which the agreement to recognize gain is in effect;

and

[[Page 42172]]

(2) Any date upon which the distributing corporation distributes

property to its shareholders under section 301(a).

(C) At all times until the close of the 120-month period following

the end of the taxable year of the distributing corporation in which

the distribution was made, except under the circumstances and subject

to the consequences prescribed in paragraphs (c)(3) (vi) and (vii) of

this section, all qualified foreign distributees must continue to own,

directly or indirectly, all of the stock and securities of the

distributing and controlled corporations that the qualified foreign

distributee owned, directly or indirectly, immediately after the

distribution (including any stock and securities of the distributing or

controlled corporation later acquired from the distributing or

controlled corporation for which the distributee has a holding period

determined under section 1223 by reference to the stock or securities).

(D) The distribution of stock or securities described in paragraph

(c)(3)(i) of this section must not be a distribution pursuant to which

the distributing corporation goes out of existence.

(E) The distributing corporation must file an agreement to

recognize gain, and the controlled corporation must agree to be

secondarily liable in the event that the distributing corporation does

not pay the tax due upon a recognition event described in paragraph

(c)(3)(vii) of this section. The agreement is described in paragraph

(c)(3)(iii) of this section and filed by the distributing corporation

with its Federal income tax return for its taxable year in which the

distribution is made.

(F) For each of the taxable years of the distributing corporation,

beginning with the taxable year of the distribution and ending with the

taxable year that includes the close of the 120-month period following

the end of the taxable year of the distributing corporation in which

the distribution was made, all qualified foreign distributees and the

controlled corporation must provide to the distributing corporation the

annual certifications described in paragraph (c)(3)(v) of this section,

and the distributing corporation must file the certifications with its

tax return.

(iii) Agreement to recognize gain. The agreement to recognize gain

required by this paragraph (c)(3)(iii) shall be prepared by or on

behalf of the distributing corporation and signed under penalties of

perjury by an authorized officer of the distributing corporation. An

authorized officer of the controlled corporation must also sign the

agreement under penalties of perjury, agreeing to extend the statute of

limitations and accept liability for the tax in the event that the

distributing corporation fails to pay the tax upon a recognition event.

The agreement provided by the distributing corporation shall set forth

the following items, under the heading ``GAIN RECOGNITION AGREEMENT

UNDER Sec. 1.367(e)-1T(c)(3)(iii)'', with paragraphs labeled to

correspond with such items:

(A) A declaration that the distribution is one to which paragraph

(c)(3) of this section applies.

(B) A description of each qualified foreign distributee, which

shall include the qualified foreign distributee's--

(1) Name;

(2) Address;

(3) Taxpayer identification number (if any); and

(4) Residence and citizenship (in the case of an individual) or

place of incorporation and country of residence (in the case of a

qualified foreign distributee that is a corporation for Federal income

tax purposes under section 7701(a)(3)).

(C) A description of the stock and securities of the distributing

and controlled corporations owned (directly or indirectly) by each

qualified foreign distributee, including--

(1) The number or amount of shares;

(2) The type of stock or securities;

(3) The fair market values of the stock and securities of the

controlled corporation owned (directly or indirectly) by the qualified

foreign distributee(s), determined immediately before and immediately

after the distribution;

(4) The distributing corporation's adjusted basis (immediately

before the distribution) in the stock and securities of the controlled

corporation distributed to the qualified foreign distributees;

(5) The fair market value of the distributing corporation (fair

market value of its assets, less all liabilities of the distributing

corporation) immediately after the distribution. Such amount must

exceed the amount of gain that the distributing corporation realized,

but did not recognize under this paragraph (c)(3), on the distribution

to qualified foreign distributees. Alternatively, the fair market value

standard will be deemed satisfied if the adjusted basis of the assets

of the distributing corporation, less all liabilities of the

distributing corporation, exceeds the amount of the deferred gain.

(6) For each applicable valuation, a summary of the method

(including appraisals, if any) used for determining the fair market

values required by this paragraph (c)(3)(iii).

(D) The distributing corporation's agreement to recognize gain in

accordance with paragraph (c)(3)(vii) of this section.

(E) The controlled corporation's agreement to be secondarily liable

for the distributing corporation's tax liability, pursuant to the gain

recognition agreement described in this paragraph (c)(3)(iii).

(F) A waiver of the period of limitations by both the distributing

and controlled corporation as described in paragraph (c)(3)(iv) of this

section.

(G) An attached statement from each qualified foreign distributee

declaring that the qualified foreign distributee will provide to the

distributing corporation the annual certifications described in

paragraph (c)(3)(v)(A) of this section for each of the taxable years of

the distributing corporation, beginning with the taxable year of the

distribution and ending with the taxable year that includes the close

of the 120-month period following the taxable year of the distributing

corporation in which the distribution was made. The attached statements

shall be signed under penalties of perjury by an authorized officer in

the case of any qualified foreign distributee that is a corporation for

Federal income tax purposes or by the individual in the case of a

qualified foreign distributee that is an individual.

(H) An attached statement from the controlled corporation declaring

that it will provide to the distributing corporation the annual

certifications described in paragraph (c)(3)(v)(B) of this section.

(I) An agreement by the distributing corporation to attach to its

tax returns the annual certifications of the qualified foreign

distributees and the controlled corporation described in paragraphs

(c)(3)(v)(A) and (B) of this section, respectively, and to meet any

other reporting requirement in accordance with paragraph (c)(3)(v) of

this section.

(iv) Waiver of period of limitation. The distributing corporation

and the controlled corporation must file, with the gain recognition

agreement described in paragraph (c)(3)(iii) of this section, a waiver

of the period of limitation on the assessment of tax upon the gain

realized on the distribution to the qualified foreign distributee(s).

The waiver shall be executed on Form 8838, substitute form, or such

other form as may be prescribed by the Commissioner for this purpose

and shall extend the period for assessment of such tax to a date not

earlier than the close of the thirteenth full year following the

taxable year that includes the distribution. A

[[Page 42173]]

properly executed Form 8838, substitute form, or such other form

authorized by this paragraph (c)(3)(iv) shall be deemed to be consented

to and signed by a Service Center Director or the Assistant

Commissioner (International) for purposes of Sec. 301.6501(c)-1(d) of

this chapter.

(v) Annual certifications and other reporting requirements. For

each of the taxable years of the distributing corporation, beginning

with the taxable year of the distribution and ending with the taxable

year that includes the close of the 120-month period following the end

of the taxable year of the distributing corporation in which the

distribution was made, the distributing corporation must file with its

Federal income tax return the annual certifications for that year

described in this paragraph (c)(3)(v).

(A) Each current qualified foreign distributee must provide to the

distributing corporation an annual certification, signed under

penalties of perjury by an authorized officer of the qualified foreign

distributee that is a corporation or by the qualified foreign

distributee that is an individual (as the case may be). Each annual

certification must identify the distribution with respect to which it

is given by setting forth the date and a summary description of the

distribution. In the annual certification, the qualified foreign

distributee must declare that--

(1) The qualified foreign distributee continues to satisfy

paragraph (c)(3)(i)(C) of this section; and

(2) The qualified foreign distributee continues to own, directly or

indirectly, without interruption, the stock and securities of the

distributing and controlled corporations (except to the extent the

stock or securities have been disposed of in a transfer described in

paragraph (c)(3)(vi) of this section).

(B) The controlled corporation must provide a certification to the

distributing corporation, signed under penalties of perjury by an

authorized officer of the corporation, that lists each current

qualified foreign distributee holding (directly or indirectly) stock of

the controlled corporation and its direct or indirect ownership

interest in the controlled corporation at both the first day and the

last day of the taxable year for which the distributing corporation

files its Federal income tax return, and certifies the accuracy of that

list.

(C) The distributing corporation must attach to the annual

certifications described in paragraphs (c)(3)(v)(A) and (B) of this

section, a statement signed under penalties of perjury by an authorized

officer of the corporation, in which the corporation declares that, to

the best of its knowledge, the annual certifications are true.

(D) The distributing corporation must also attach to the annual

certifications a separate statement indicating--

(1) The names and addresses of each current and each former

qualified foreign distributee;

(2) The percentage of direct or indirect ownership that the

qualified foreign distributees retain in the distributing corporation

at year-end; and

(3) A certification that the value of the distributing corporation

(or the adjusted basis of its assets), less all of the liabilities of

the distributing corporation on all testing dates, exceeded the amount

of the gain deferred as of the testing date.

(vi) Special rule for nonrecognition transactions. (A) Gain shall

not be recognized under paragraph (c)(3)(vii) of this section if the

distributing or controlled corporation is acquired by a successor-in-

interest (described in paragraph (c)(3)(vi)(B) of this section), or

upon a direct or indirect disposition by a qualified foreign

distributee of stock or securities of a distributing or controlled

corporation (or a successor-in-interest) that is subject to a gain

recognition agreement described in paragraph (c)(3)(iii) of this

section, if the requirements of this paragraph (c)(3)(vi) are satisfied

and the disposition consists of a transfer described in section 332,

337, 351, 354, 355, 356, or 361 that does not result in a substantial

transformation (as defined in paragraph (c)(3)(vii)(B) of this

section). For special rules regarding transfers described in section

355, see paragraph (c)(3)(vi)(G) of this section.

(B) For purposes of this section, the term successor-in-interest

refers to any domestic corporation that acquires the assets of the

distributing or controlled corporation in a transaction described in

section 381(a) to which this paragraph (c)(3)(vi) applies.

(C) For purposes of this section, the term transferee distributee

refers to:

(1) Any corporation whose stock or securities are exchanged for the

stock or securities of the distributing or controlled corporation (or a

successor-in-interest), or of another transferee distributee, in a

transaction described in section 351, 354, or sections 361 and

381(a)(2), to which this paragraph (c)(3)(vi) applies.

(2) Any corporation that acquires the assets of any qualified

foreign distributee, transferee distributee or substitute distributee

in a transaction described in section 381(a).

(D) For purposes of this section, the term substitute distributee

refers to any person that acquires the stock or securities of the

distributing or controlled corporation (or a successor-in-interest), or

of a qualified foreign distributee, in a section 355 distribution.

(E) Gain shall not be recognized under paragraph (c)(3)(vii) of

this section in a transaction involving a transfer of the assets of the

distributing or controlled corporation to a successor-in-interest, only

if the following information and agreements are included with the first

annual certification thereafter filed under paragraph (c)(3)(v) of this

section:

(1) A description of the transaction (including a statement of

applicable Internal Revenue Code provisions, and a description of stock

or securities transferred, exchanged, or received in the transaction).

(2) A description of the successor-in-interest (including the name,

address, taxpayer identification number, and place of incorporation of

the successor in interest).

(3) An agreement of the successor-in-interest, signed under

penalties of perjury by an authorized officer of the successor-in-

interest corporation, to succeed to all of the responsibilities and

duties of the distributing corporation or the controlled corporation

(as the case may be) under this paragraph (c)(3) as if the successor-

in-interest were the distributing or controlled corporation.

(F) Gain shall not be recognized under paragraph (c)(3)(vii) of

this section in a transaction described in paragraph (c)(3)(vi)(A) of

this section in which a qualified foreign distributee, directly or

indirectly, disposes of, and a transferee distributee acquires, stock

or securities of the distributing or controlled corporation (or a

successor-in-interest), or another transferee distributee, only if the

transferee distributee is either a qualified U.S. person or qualifies

as a qualified foreign distributee under this paragraph (c)(3) and the

following information and agreements are included with the first annual

certification thereafter filed under paragraph (c)(3)(v) of this

section:

(1) A description of the transaction (including a statement of

applicable Internal Revenue Code provisions, and a description of the

stock or securities of the distributing or controlled corporation (or a

successor-in-interest) owned, directly or indirectly, by qualified

foreign distributees immediately after the transaction).

(2) An agreement of the distributing corporation and the controlled

corporation (amending the agreement described in paragraph (c)(3)(iii)

of this section), signed under penalties of perjury by an authorized

officer of the corporation, to recognize gain (in the

[[Page 42174]]

case of the distributing corporation) and to be secondarily liable (in

the case of the controlled corporation) in accordance with the

provisions of this paragraph (c)(3) upon the occurrence of a

disposition, directly or indirectly, by the foreign transferee

distributee of any stock or securities of the distributing or

controlled corporation (or a successor-in-interest) (other than a

disposition that itself satisfies the requirements of this paragraph

(c)(3)(vi)).

(3) An agreement of each foreign transferee distributee, signed

under penalties of perjury by the individual or an authorized officer

of the corporation, to comply with all of the responsibilities,

qualifications and duties of a qualified foreign distributee under this

paragraph (c)(3), with respect to the stock or securities of the

distributing or controlled corporation (or a successor-in-interest)

owned, directly or indirectly, by the transferee distributee.

(G) Gain shall not be recognized under paragraph (c)(3)(vii) of

this section in the case of a section 355 distribution by a qualified

foreign distributee of stock or securities of the distributing or

controlled corporation (or a successor-in-interest), or of another

qualified foreign distributee. The qualified foreign distributee that

distributed the stock or securities is no longer required to comply

with the rules of this section applicable to qualified foreign

distributees, provided such person no longer has any interest, directly

or indirectly, in the distributing and controlled corporation. Thus,

for example, such person is not counted as a qualified foreign

distributee for purposes of limiting gain recognition to 10 or fewer

foreign distributees. In order for this provision to apply, the

substitute distributee must either be a qualified U.S. person or

satisfy the requirements applicable to qualified foreign distributees

contained in this paragraph (c)(3) and must include with the first

annual certification thereafter filed under paragraph (c)(3)(v) of this

section the following information and agreements:

(1) A description of the transaction (including a statement of

applicable Internal Revenue Code sections, and a description of the

stock or securities distributed in the transaction).

(2) An agreement of the distributing corporation and the controlled

corporation (amending the agreement described in paragraph (c)(3)(iii)

of this section), signed under penalties of perjury by an authorized

officer of the corporation, to recognize gain (in the case of the

distributing corporation) and to be secondarily liable (in the case of

the controlled corporation) in accordance with the provisions of this

paragraph (c)(3) upon the occurrence of a disposition, directly or

indirectly, by a foreign substitute distributee of any stock or

securities received by the substitute distributee in the transaction.

(3) An agreement of each foreign substitute distributee, signed

under penalties of perjury by the individual or authorized officer of

the corporation, to succeed to all of the responsibilities,

qualifications and duties of a qualified foreign distributee under this

paragraph (c)(3), with respect to the stock or securities of the

distributing or controlled corporation (or a successor-in-interest)

received by such substitute distributee.

(vii) Recognition of gain. (A) (1) The distributing corporation

must file, within 90 days of a transaction described in this paragraph

(c)(3)(vii)(A), an amended return for the year of the distribution and

recognize gain realized but not recognized upon such distribution, if,

prior to the close of the 120-month period following the end of the

taxable year of the distributing corporation in which the distribution

was made, either--

(i) A qualified foreign distributee sells (or otherwise disposes

of) the stock or securities of the distributing or controlled

corporation that the qualified foreign distributee owned (directly or

indirectly) (other than pursuant to a transfer described in paragraph

(c)(3)(vi) of this section); or

(ii) Any other transaction (e.g., a public offering or

reorganization) results in a substantial transformation (as defined in

paragraph (c)(3)(vii)(B) of this section) in either the distributing or

controlled corporation (or both).

(2) For purposes of this paragraph (c)(3)(vii)(A), a disposition

includes, but is not limited to, any disposition treated as a sale or

exchange under this subtitle (e.g., section 301(c)(3)(A), 302(a),

351(b) or 356(a)(1)). For the computation of gain in the case of a sale

(or similar disposition), see paragraph (c)(3)(vii)(C) of this section.

For the computation of gain in the case of other transactions, see

paragraphs (c)(3)(vii) (D) and (F) of this section. For special rules

regarding substitute distributees, see paragraph (c)(3)(vii)(E) of this

section.

(B) A transaction is treated as a substantial transformation if, as

a result of such transaction, the qualified foreign distributees,

transferee distributees and substitute distributees own, in the

aggregate, less than 50 percent of either the total voting power or the

total value of the stock of the distributing or the controlled

corporation, directly or indirectly, that the qualified foreign

distributees owned immediately after the distribution.

(C) In the case of a sale (or similar disposition), directly or

indirectly, by a qualified foreign distributee of the stock or

securities of the distributing or controlled corporation (or a

successor-in-interest) that does not result in a substantial

transformation, the distributing corporation shall be required to

recognize a proportionate amount of the gain realized but not

recognized under this paragraph (c)(3), equal to the percentage of

stock of the distributing or controlled corporation, as the case may

be, sold (or otherwise disposed of), directly or indirectly, by the

qualified foreign distributee. However, if the sale (or other

disposition) of stock or securities by a qualified foreign distributee

results in a substantial transformation, the distributing corporation

(or its successor-in-interest) must recognize the entire deferred gain

that has not already been recognized under paragraph (c)(3)(vii) of

this section.

(D) In the case of a nonrecognition transaction that results in a

substantial transformation, the distributing corporation must recognize

the entire deferred gain that has not already been recognized under

paragraph (c)(3)(vii) of this section. If a nonrecognition transaction

does not result in a substantial transformation, the distributing

corporation does not recognize any gain provided that the requirements

of paragraph (c)(3)(vi) of this section are satisfied.

(E) A sale (or other disposition), directly or indirectly, by a

substitute distributee, of all or a portion of the stock or securities

of the distributing or controlled corporation (or a successor-in-

interest) that the substitute distributee received in the section 355

distribution shall be treated as a disposition of such stock or

securities by a qualified foreign distributee (in accordance with

paragraph (c)(3)(vii)(C) of this section) for purposes of computing

gain under this paragraph (c)(3)(vii).

(F) Other transactions or events shall trigger gain under this

paragraph (c)(3)(vii) as follows:

(1) If a qualified foreign distributee ceases to satisfy the

requirements for a qualified foreign distributee contained in paragraph

(c)(3)(i)(C) of this section (or any other specified requirements in

paragraph (c)(3) of this section), the qualified foreign distributee

shall be treated as if it sold all of the stock and securities that it

owned, directly or indirectly, in the distributing and controlled

corporation (or a successor-

[[Page 42175]]

in-interest), on the date that such person ceased to meet the

requirements.

(2) If a substitute distributee ceases to satisfy the requirements

for a qualified foreign distributee contained in paragraph (c)(3)(i)(C)

of this section (or any other specified requirements in paragraph

(c)(3) of this section), the substitute distributee shall be treated as

if it sold all of the stock and securities of the distributing or

controlled corporation (or a successor-in-interest) that it received in

the distribution, on the date that it ceased to meet the requirements.

(3) If the distributing corporation (or a successor-in-interest)

fails to satisfy the requirement contained in paragraph (c)(3)(ii)(B)

of this section on any testing date during which the agreement to

recognize gain is in effect, such failure will be treated as if a

substantial transformation has occurred on such date.

(4) If either the distributing or controlled corporation (or a

successor-in-interest) is acquired in a section 381(a) exchange and the

acquirer is not a successor-in-interest that satisfies the requirements

of paragraph (c)(3)(vi)(E), such acquisition will be treated as if a

substantial transformation has occurred on the date of the acquisition.

(G) A qualified foreign distributee that sells (or otherwise

disposes of) all of its interest, directly or indirectly, in the

distributing and controlled corporation ceases thereafter to be a

qualified foreign distributee. In addition, where one qualified foreign

distributee owns all of the stock of another qualified foreign

distributee, and both persons have identical direct or indirect

interests in the distributing or controlled corporation, the direct or

indirect sale (or other disposition) by one qualified foreign

distributee of all of its interest in the distributing or controlled

corporation (under paragraph (c)(3)(vii) of this section) will

terminate the qualified foreign distributee status for the second

qualified foreign distributee. The principles of this paragraph

(c)(3)(vii) shall generally be applied so that any gain relating to the

same stock of the distributing or controlled corporation by more than

one person is not taxed more than once under this paragraph

(c)(3)(vii). In any event, gain recognized pursuant to this paragraph

(c)(3)(vii), on a cumulative basis, shall not exceed the amount of gain

that the distributing corporation would have recognized under section

367(e)(1) if its initial distribution of the stock or securities of the

controlled corporation was fully taxable under paragraph (b) of this

section.

(H) If additional tax is required to be paid by the distributing

corporation (or a successor-in-interest) for the year of the

distribution, interest must be paid by the distributing corporation (or

the controlled corporation if the distributing corporation fails to pay

the tax due) on that amount at the rates determined under section

6621(a)(2) with respect to the period between the date that was

prescribed for filing the distributing corporation's original income

tax return for the year of the distribution and the date on which the

additional tax for that year is paid.

(I) Net operating losses, capital losses, or credits against tax

that were available in the year of the distribution and that are unused

(whether or not they have expired since the distribution) at the time

of gain recognition described in this paragraph (c)(3)(vii) may be

applied (respectively) by the distributing corporation against any gain

recognized or tax owed by reason of this provision, but no other

adjustments shall be made with respect to any other items of income or

deduction in the year of distribution or other years.

(viii) Failure to comply. (A) Except as otherwise provided in

paragraph (c)(3)(viii)(B) of this section, if the distributing

corporation or the controlled corporation fails to comply in any

material respect with the requirements of this paragraph (c)(3) or with

the terms of an agreement submitted pursuant hereto, or if the

distributing corporation knows or has reason to know of any failure of

another person to so comply, the distributing corporation shall treat

the initial distribution of the stock or securities of the controlled

corporation as a taxable exchange in the year of the distribution. In

such event, the period for assessment of tax shall be extended until

three years after the date on which the Internal Revenue Service

receives actual notice of such failure to comply.

(B) If a person fails to comply in any material respect with the

requirements of this paragraph or with the terms of an agreement

submitted pursuant thereto, the provisions of paragraph (c)(3)(viii)(A)

of this section shall not apply if the person is able to show that such

failure was due to reasonable cause and not willful neglect, provided

that the person achieves compliance as soon as the person becomes aware

of the failure. Whether a failure to materially comply was due to

reasonable cause shall be determined by the district director under all

the facts and circumstances.

(d) Other consequences--(1) Exchange under section 897(e)(1). With

respect to the treatment under section 897(e)(1) of a foreign

distributee on the receipt of stock or securities of a domestic or

foreign corporation where the foreign distributee's interest in the

distributing domestic corporation is a United States real property

interest, see section 897(e)(1) and the regulations thereunder.

(2) Dividend treatment under section 1248. With respect to the

treatment as a dividend of a portion of the gain recognized by the

domestic corporation on the distribution of the stock of certain

foreign corporations, see sections 1248(a) and (f) and the regulations

thereunder.

(3) Distribution of stock of a passive foreign investment company.

[Reserved]

(4) Reporting under section 6038B. Notice shall be required under

section 6038B with respect to a distribution described in this section.

See Sec. 1.6038B-1T(e).

(e) Examples. The rules of paragraphs (b), (c), and (d) of this

section are illustrated by the examples below. In all examples, assume

that all foreign companies are treated as corporations for Federal

income tax purposes and are not treated as fiscally transparent under

the taxation laws of the relevant foreign country.

Example 1. (i) FC, a Country Z company, owns all of the

outstanding stock of DC1, a domestic corporation. DC1 owns all of

the outstanding stock of DC2, another domestic corporation. The fair

market value of the DC1 stock is 300x, and FC has a 100x basis in

the DC1 stock. The fair market value of the DC2 stock is 180x, and

DC1 has a 80x basis in the DC2 stock. Neither DC1 nor DC2 is a U.S.

real property holding corporation. Country Z does not maintain an

income tax treaty with the United States.

(ii) In a transaction qualifying for nonrecognition under

section 355, DC1 distributes all of the stock of DC2 to FC. After

the distribution, the DC1 stock has a fair market value of 120x.

(iii) Under paragraphs (b) (1) and (2) of this section, DC1

recognizes gain of 100x, which is the difference between the fair

market value (180x) and the adjusted basis (80x) of the stock

distributed. Under paragraph (d)(1) of this section and section 358,

FC takes a basis of 40x in the DC1 stock, and a basis of 60x in the

DC2 stock.

Example 2. (i) C, a citizen and resident of Country F, owns all

of the stock of DC1, a domestic corporation. DC1, in turn, owns all

of the stock of DC2, also a domestic corporation. The fair market

value of the DC1 stock is 500x, and C has a 100x basis in the DC1

stock. The DC2 stock has a fair market value of 200x, and DC1 has a

180x basis in the DC2 stock.

(ii) In a transaction qualifying for nonrecognition under

section 355, DC1 distributes to C all of the stock of DC2. DC1 and

DC2 are U.S. real property holding corporations immediately after

the distribution. After the distribution, the DC1 stock has a fair

market value of 300x.

[[Page 42176]]

(iii) Under paragraph (c)(1) of this section, provided that DC1

complies with the reporting requirements contained in paragraph

(c)(1)(ii) of this section, DC1 does not recognize gain on the

distribution of the DC2 stock because DC1 and DC2 are U.S. real

property holding corporations immediately after the distribution.

(iv) Under section 897(e) and the regulations thereunder, C is

considered to have exchanged DC1 stock with a fair market value of

200x and an adjusted basis of 40x for DC2 stock with a fair market

value of 200x. Because DC2 is a U.S. real property holding

corporation, and its stock is a U.S. real property interest, C does

not recognize any gain under section 897(e) on the distribution. C

takes a basis of 40x in the DC2 stock, and its basis in the DC1

stock is reduced to 60x pursuant to section 358.

Example 3. (i) All of the outstanding common stock of DC, a

domestic corporation that is not a U.S. real property holding

corporation, is regularly traded on an established securities market

located in the United States. None of the foreign shareholders of DC

(directly, indirectly, or constructively) owns more than five

percent of the common stock of DC. DC owns all of the stock of DS, a

domestic corporation. The stock of DS has appreciated in the hands

of DC.

(ii) In a transaction qualifying for nonrecognition under

section 355, DC distributes all of the stock of DS to the common

shareholders of DC.

(iii) Under paragraph (c)(2) of this section, DC does not

recognize gain on the distribution of the DS stock to any foreign

distributee, provided that DC complies with the reporting

requirements contained in paragraph (c)(2)(iii) of this section.

Each shareholder's basis in the DC and DS stock is determined

pursuant to section 358.

Example 4. (i) FC, a company resident in Country X, owns all of

the stock of DC1, a domestic corporation. DC1, in turn, owns all of

the stock of DC2, a domestic corporation. The fair market value of

the DC1 stock is 1,000x, and FC has a basis in the DC1 stock of

800x. The DC2 stock has a fair market value of 500x at the time of

the distribution, and DC1 has a 100x basis in the DC2 stock. Neither

DC1 nor DC2 is a U.S. real property holding corporation. Country X

maintains an income tax treaty with the United States that includes

an information exchange provision.

(ii) In a transaction qualifying for nonrecognition under

section 355, DC1 distributes to FC all of the stock of DC2.

Immediately after the distribution, the DC1 stock has a fair market

value of 500x. Thus, the value of DC1 exceeds 400x, the amount of

the deferred gain on the distribution.

(iii) Under paragraph (c)(3) of this section, DC1 will not

recognize gain on the distribution of the DC2 stock to (foreign

distributee) FC if FC is a qualified foreign distributee (as

described in paragraph (c)(3)(i)(C) of this section) and DC1 enters

into a gain recognition agreement (in which DC2 agrees to be

secondarily liable), as described in paragraph (c)(3)(iii) of this

section, and DC1, DC2 and FC otherwise comply with all of the

provisions of paragraph (c)(3) of this section. Pursuant to section

358, FC will take a 400x basis in the DC2 stock and FC's basis in

the DC1 stock will be reduced to 400x.

Example 5. (i) Assume the same facts as in Example 4. In

addition, two years after DC1's distribution of DC2 stock to FC, FC

sells 25 percent of the DC2 stock to Y, an unrelated corporation.

One year later, FC sells an additional 30 percent of its DC2 stock

to Z, another unrelated corporation.

(ii) Under paragraph (c)(3)(vii) of this section, upon FC's sale

of 25 percent of its DC2 stock, DC1 is required to file an amended

return for the year in which the DC2 stock was distributed to FC,

and recognize 100x of gain, which represents 25 percent of the gain

realized but not recognized on the distribution.

(iii) Upon FC's second sale of 30 percent of its DC1 stock, DC1

is required to file another amended return for the year of the

distribution and recognize the balance of the deferred gain, or

300x, because such sale results in a substantial transformation

(within the meaning of paragraph (c)(3)(vii)(B) of this section).

Example 6. (i) Assume the same facts as in Example 5, except

that FC did not sell an additional 30 percent of its DC2 stock.

Instead, DC2 issued additional stock in a public offering that

reduced FC's interest in DC2 to less than 50 percent.

(ii) The public offering caused a substantial transformation

because, as a result of the public offering, the interest of FC in

DC2 was reduced to less than 50 percent of the amount of stock that

FC owned in DC2 immediately after the distribution. Thus, the result

is the same as in Example 5.

Example 7. (i) Assume the same facts as in Example 4 In

addition, one year after DC1's distribution of DC2 stock to FC, FC

transfers all of the DC2 stock to FS, a company resident in Country

X, in exchange for all of the FS stock, in a transaction described

in section 351.

(ii) FS is described as a transferee distributee under paragraph

(c)(3)(vi)(C) of this section. The transfer by FC of DC2 stock to FS

is a nonrecognition transaction under paragraph (c)(3)(vi) of this

section provided all of the requirements in paragraph (c)(3)(vi)(F)

of this section are satisfied. (FS is counted, together with FC, for

purposes of limiting nonrecognition treatment to up to ten qualified

foreign distributees during the time that the gain recognition

agreement is in effect.) DC1 will not recognize gain under the gain

recognition agreement upon FC's transfer of the stock of DC2 to FS

if DC1 enters into a new agreement, agreeing to recognize gain if FS

sells DC2 stock, and the provisions of paragraph (c)(3)(vi) of this

section are satisfied. A sale by FC of FS stock would be treated as

a recognition event under paragraph (c)(3)(vii) because such sale

would constitute an indirect disposition by FC of the DC2 stock.

Example 8. (i) P1, an entity treated as a partnership for

Federal income tax purposes, owns all of the outstanding stock of

DC1, a domestic corporation. DC1 owns all of the outstanding stock

of DC2, another domestic corporation. The fair market value of the

DC1 stock is 900x and P1 has an 900x basis in the DC1 stock. The

fair market value of the DC2 stock is 600x and DC1 has a 400x basis

in the DC2 stock. Neither DC1 nor DC2 is a U.S. real property

holding corporation.

(ii) FC, a company resident in country X, and USP, a U.S.

corporation, are the sole partners of P1. Under the rules and

principles of sections 701 through 761, FC is entitled to a 60

percent, and USP is entitled to a 40 percent, distributive share of

each item of P1 income and loss. Country X maintains an income tax

treaty with the United States that includes an information exchange

provision.

(iii) In a distribution qualifying for nonrecognition under

section 355, DC1 distributes all of the stock of DC2 to P1.

Paragraph (b)(5)(i) of this section provides that stock owned by a

partnership is considered to be owned proportionately by its

partners. Under paragraph (b)(5)(ii) of this section, if USP

certifies to DC1 that it is a qualified U.S. person (and DC1 does

not know or have reason to know that the certification is false), no

Federal income tax shall be imposed with respect to the distribution

by DC1 of DC2 to P1, to the extent of USP's 40 percent interest in

P1.

(iv) Paragraph (c)(3)(i)(D) of this section provides that no

foreign distributee may be treated as a qualified foreign

distributee with respect to stock of the distributing corporation

owned through a partnership, unless the distributing corporation

receives a ruling from the Internal Revenue Service to the contrary.

Thus, DC1 may not avoid recognition of the remaining 60 percent of

the realized gain (relating to the interest of P1 owned by FC) by

entering into a gain recognition agreement pursuant to paragraph

(c)(3) of this section, unless DC1 obtains a ruling to the contrary.

Example 9. (i) DC1, a domestic corporation, owns all of the

stock of DC2, also a domestic corporation. The stock of DC1 is owned

equally by three shareholders: A, a domestic corporation, B, a U.S.

citizen, and FB, a Country Y company.

(ii) A short time before DC1 adopted a plan to distribute the

stock of DC2 to its shareholders, but after the board of directors

of DC1 began contemplating the distribution, FB formed Newco, a

domestic corporation, and contributed its DC1 stock to Newco in a

transaction qualifying for nonrecognition under section 351. A valid

business purpose existed for FB's transfer of the DC1 stock to

Newco, but this purpose would have been fulfilled irrespective of

whether FB transferred the DC1 stock to Newco before the

distribution of DC2, or after the distribution of DC2 (in which case

FB would have transferred the stock of DC1 and DC2 to Newco).

(iii) Pursuant to paragraph (b)(6) of this section, the District

Director may determine that FB formed Newco for a principal purpose

of avoiding section 367(e)(1). In such case, for Federal income tax

purposes, FB will be treated as having received the stock of DC2 in

a section 355 distribution, and then as having transferred the stock

to Newco in a section 351 transaction.

(iv) If B was not a shareholder of DC1 so that A and FB were

equal (50 percent) shareholders, FB would be treated as a foreign

distributee within the meaning of

[[Page 42177]]

paragraph (c)(3)(i)(B) of this section without the application of

paragraph (b)(6) of this section. In such case, DC1 would recognize

50 percent of the gain realized on the distribution of the DC2

stock, unless FB was a qualified foreign distributee within the

meaning of paragraph (c)(3)(i) of this section and the conditions

under paragraph (c)(3)(ii) of this section were satisfied.

Example 10. (i) DC1, a domestic corporation, owns all of the

stock of DC2, also a domestic corporation. The stock of DC1 is owned

by FP, a company resident in Country X. Country X maintains in

income tax treaty with the United States that includes an

information exchange provision. The DC2 stock has a fair market

value of 500x at the time of the distribution, and DC1 has a basis

of 100x in the DC2 stock. The stock of DC1 has a value of 500x

(excluding DC1's investment in DC2). Neither DC1 nor DC2 is a U.S.

real property holding corporation.

(ii) FP forms a holding company resident in Country X, Newco,

and transfers 50 percent of its DC1 stock to Newco in an exchange

described in section 351. Immediately after those transactions, DC1

distributes all of its DC2 stock to FP in exchange for FP's stock of

DC1 in a transaction described in section 355. Thus, after the non

pro rata distribution, FP owns all of the stock of DC2, and FP also

owns all of the stock of Newco, which, in turn, owns all of the

stock of DC1.

(iii) Newco and FP are foreign distributees (under paragraph

(c)(3)(i)(B)(1) of this section) because they owned stock of DC1

immediately prior to the distribution. Assuming that all of the

requirements of the gain recognition agreement exception under

paragraph (c)(3) of this section are satisfied (so that both FP and

Newco are qualified foreign distributees under paragraph

(c)(3)(i)(C) of this section), DC1 will not be immediately taxable

on the 400x gain realized on the distribution of the stock of DC2.

Gain will be triggered under the gain recognition agreement under

paragraph (c)(3)(vii) of this section if FP sells stock of Newco

(because such sale would be an indirect disposition by FP of the

stock of DC1), if Newco sells stock of DC1, or if FP sells stock of

DC2.

Example 11. (i) Assume the same facts as in Example 10, except

that Newco is a company resident of Country Z, and Country Z does

not maintain an income tax treaty with the United States that

includes an information exchange provision.

(ii) DC1 may still enter into a gain recognition agreement under

paragraph (c)(3) of this section. Both FP and Newco are foreign

distributees, but Newco is not a qualified foreign distributee.

Thus, DC1 must recognize 50 percent, or 200x, of the 400x deferred

gain on the distribution of DC2 stock. Such (50 percent) portion

equals the percentage of the DC1 stock owned by foreign distributees

that are not qualified foreign distributees (the 50 percent of the

stock owned by Newco). DC1 may defer 50 percent of the gain, with

respect to the portion of its stock owned by FP, a qualified foreign

distributee, provided that it meets the requirements of paragraph

(c)(3) of this section.

Example 12. (i) FC, a company resident in Country X, owns all of

the stock of DC1, a domestic corporation (and has owned DC1 for many

years). Country X maintains an income tax treaty with the United

States that includes an information exchange provision. DC1, in

turn, owns all of the stock of DC2, a domestic corporation. DC1 has

a basis of 200x in the DC2 stock, and the DC2 stock has a value of

500x. Immediately after the distribution of DC2 described below, DC1

has a value of more than 300x.

(ii) DC1 distributes all of the stock of DC2 to FC (a qualified

foreign distributee) in a transaction described under section 355,

and satisfies all of the requirements of paragraph (c)(3) of this

section to qualify for an exception to the general rule of taxation

under section 367(e)(1). Two years after the initial distribution,

FC distributes all of the stock of DC2 to its sole shareholder, FP,

a resident of Country X, in a transaction described under section

355.

(iii) Under paragraph (c)(3)(vi)(D) of this section, FP is a

substitute distributee with respect to the DC2 stock. Provided that

the requirements of paragraph (c)(3)(vi)(G) of this section are

satisfied, FP replaces FC as a qualified foreign distributee with

respect to the DC2 stock (although FC is still a qualified foreign

distributee with respect to the DC1 stock). FC is no longer required

to maintain an interest in DC2 for purposes of determining whether a

substantial transformation occurs. Thus, a sale by FP of the stock

of FC would not trigger gain under paragraph (c)(3)(vii) of this

section.

Example 13. (i) DC1, a domestic corporation, owns all of the

stock of DC2, also a domestic corporation. The stock of DC1 is owned

by two shareholders: FP and FX. FP, a company resident in Country Z,

owns 25 percent of the stock of DC1. FX, a company resident in

Country X, owns 75 percent of the stock of DC1. Country X maintains

an income tax treaty with the United States that includes an

information exchange provision; Country Z does not. The fair market

value of DC2 is 500x and DC1 has a basis of 100x in the DC2 stock.

Immediately after the distribution described below, DC1 has a value

in excess of 400x.

(ii) FP formed FS, a company resident in Country X, and

transferred its 25 percent interest in DC1 to FS in exchange for all

of the stock of FS in an exchange described in section 351. Within

two years of the exchange, DC1 distributed all of the stock of DC2

to its shareholders.

(iii) Under paragraph (c)(3) of this section, DC1 may defer a

portion of its gain realized on the distribution of DC2. DC1 must

immediately recognize 25 percent of the realized gain, or 100x,

because FP, a 25 percent (indirect) shareholder is a foreign

distributee (within the meaning of paragraph (c)(3)(i)(B) of this

section), but may not be treated as a qualified foreign distributee

(within the meaning of paragraph (c)(3)(i)(C) of this section). DC1

may defer 75 percent of its realized gain if FX is a qualified

foreign distributee and DC1 enters into a gain recognition agreement

(in which DC2 agrees to be secondarily liable), and the provisions

of paragraph (c)(3) of this section are otherwise met. DC1 need not

include FS as a qualified foreign distributee because FP and FS had

identical 25 percent ownership interests in DC1, and DC1 is taxable

with respect to such 25 percent interest. Thus, under paragraph

(c)(3)(vii)(G) of this section, a sale by FS of its DC1 or DC2 stock

will not result in an additional trigger of the gain recognition

agreement under paragraph (c)(3)(vii) of this section.

(iv) If FP was instead a resident of Country X, DC1 could defer

its entire realized gain if both FP and FS were qualified foreign

distributees. In such case, DC1 would have three qualified foreign

distributees. (DC1 is limited to ten qualified foreign distributees,

including transferee and substitute distributees during the term of

the gain recognition agreement.) If FS sold its entire interest in

either DC1 or DC2, DC1 would be required to amend its Federal income

tax return for the year of the transfer and include 100x in income.

In such case, neither FP nor FS would be considered a qualified

foreign distributee immediately after the sale (and, as a result,

FP's sale of its FS stock would not trigger additional gain under

paragraph (c)(3)(vii)(G) of this section). The result would be the

same if FP sold all of the stock of FS (as such sale is an indirect

disposition by FP of all its stock of DC1 and DC2). (In such case,

the sale by FS of its stock of DC1 or DC2 would not trigger

additional gain under paragraph (c)(3)(vii)(G) of this section.)

(f) Effective date. This section shall be effective with respect to

distributions occurring on or after September 13, 1996. However,

taxpayers may elect to apply the rules of this section with respect to

distributions occurring on or after December 31, 1995.

Par. 4. Section 1.6038B-1T is amended by revising the second

sentence of paragraph (b)(2)(i) and adding the text of paragraph (e) to

read as follows:

Sec. 1.6038B-1T Reporting of transfers described in section 367

(temporary).

* * * * *

(b) * * *

(2) * * * (i) * * * For special reporting rules applicable to

transfers described under section 367(e)(1), see paragraph (e) of this

section; no reporting is required for transfers described in section

367(e)(2). * * *

* * * * *

(e) * * * (1) In general. If a domestic corporation (distributing

corporation) makes a distribution described in section 367(e)(1), the

distributing corporation must comply with the reporting requirements

under this paragraph (e)(1). Form 926 and other requirements described

in this section need not be met by the distributing corporation in the

case of a distribution described in section 367(e)(1).

(2) Reporting requirements if transaction is taxable under section

367(e)(1). If the distribution is taxable to the distributing

corporation under

[[Page 42178]]

section 367(e)(1) and the regulations thereunder, the distributing

corporation must attach to its Federal income tax return for the

taxable year that includes the date of the transfer a statement titled

``Section 367(e)(1) Reporting--Compliance With Section 6038B'', signed

under penalties of perjury by an officer of the corporation, disclosing

the following information:

(i) A description of the transaction in which the U.S. distributing

corporation distributed stock or securities of a controlled corporation

(whether domestic or foreign) to one or more foreign distributees.

(ii) The basis and fair market value of the stock and securities

that were distributed by the distributing corporation in the

transaction.

(3) Reporting requirements if transaction qualifies for an

exception to section 367(e)(1). If the distributing corporation

qualifies for an exception under Sec. 1.367(e)-1T(c)(1), the

requirements of section 6038B are satisfied if the distributing

corporation complies with the reporting requirements contained in

Sec. 1.367(e)-1T(c)(1)(ii). If the distributing corporation qualifies

for an exception under Sec. 1.367(e)-1T(c)(2), the requirements of

section 6038B are satisfied if the distributing corporation complies

with the reporting requirements contained in Sec. 1.367(e)-

1T(c)(2)(iii). If the distributing corporation qualifies for an

exception under Sec. 1.367(e)-1T(c)(3), the requirements of section

6038B are satisfied if the distributing corporation complies with the

reporting requirements contained in Sec. 1.367(e)-1T(c)(3).

* * * * *

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 5. The authority for citation for part 602 continues to read

as follows:

Authority: 26 U.S.C. 7805.

Par. 6. In Sec. 602.101, paragraph (c) is amended by removing the

entry for ``1.367(e)-1'' and adding an entry in numerical order to read

as follows:

Sec. 602.101 OMB Control numbers.

* * * * *

(c) * * *

------------------------------------------------------------------------

Current OMB

CFR part or section where identified and described control

No.

------------------------------------------------------------------------

* * * * *

1.367(e)-1T................................................ 1545-1487

* * * * *

------------------------------------------------------------------------

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved:

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 96-20663 Filed 8-09-96; 12:19 pm]

BILLING CODE 4830-01-U