Tax

On October 5, 2023, the Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) issued long awaited proposed regulations under Section 367(b) of the Internal Revenue Code (the “Code”) providing guidance on the use of property to acquire parent stock or securities in connection with certain cross border triangular reorganizations, colloquially referred to as ‘Killer B’ transactions (the “Proposed Regulations”).  These ‘Killer B’ transactions generally had the effect of allowing a foreign subsidiary (“foreign acquirer”) to effectuate a tax-efficient repatriation of cash or other property to its corporate shareholder (“parent”) via the use of such cash or property to acquire parent stock which is then used by foreign acquirer to acquire another corporate entity (“foreign acquired corporation”) in a triangular reorganization.

The Proposed Regulations modify regulations previously announced and largely adopt the rules described in Notice 2014-32 (the “2014 Notice”) and Notice 2016-73 (the “2016 Notice”). The 2014 Notice contained rules to address aspects of these ‘Killer B’ transactions which Treasury identified as exploiting certain aspects of final regulations published on May 19, 2011 under Section 367(b) (the “2011 Final Regulations”). The 2016 Notice contained additional guidance to address subsequent variations on the ‘Killer B’ transactions that arose after the 2014 Notice which Treasury identified as exploiting the 2011 Final Regulations (as modified by the rules announced in the 2014 Notice), and announced that additional regulations would be issued under Section 367.

The Proposed Regulations generally adopt the rules set forth in the 2014 and 2016 Notices, with modifications.  The effect of these notices and the Proposed Regulations is to recharacterize in many situations the use of property by foreign acquirer to purchase parent stock as a distribution from foreign acquirer to parent.  Note that the potential tax benefits of these ‘Killer B’ transactions have been substantially impacted by the Tax Cuts and Jobs Act of 2017 (the “TCJA”).

Explanation of Proposed Regulations:

These modifications to the 2014 and 2016 Notices include but are not limited to: (i) narrowing the potential scope of the excess asset basis rules (described below); (ii) providing clarity on the definition of “specified earnings” that are included in the all earnings and profits (“E&P”) amount upon an inbound transaction; (iii) modifying the priority rules to take into account the extent to which a distribution would give rise to an inclusion under Section 951A(a) that would be subject to U.S. tax (even though it is unlikely that a distribution from the subsidiary to the parent corporation would give rise to a section 951A(a) inclusion); and (iv) certain other adjustments.   

Excess Asset Basis and Specified Earnings. Certain variations on the ‘Killer B’ transactions that arose after the 2014 Notice involved a triangular reorganization where parent was a foreign entity that was followed by a subsequent inbounding of parent (which had the effects of bringing foreign acquirer’s cash, but not E&P, into the U.S.).  To address these, the 2016 Notice proposed a number of rules (the “excess asset basis” rules) that would have the result of including foreign acquirer’s earnings in the all E&P amount that is potentially subject to tax upon the inbounding of foreign parent.

The Proposed Regulations would provide that an exchanging shareholder of the foreign acquired corporation, i.e., foreign parent, computes its amount of all E&P after accounting for the effects of a deemed distribution from the foreign subsidiaries of the foreign acquired corporation to the foreign acquired corporation. The deemed distribution, which occurs immediately before the inbound non-recognition transaction, would be equal to the amount of “specified earnings,” which would be defined under the Proposed Regulations as the lesser of (1) the aggregate E&P of foreign subsidiaries of the foreign acquired corporation (with no exclusion for those E&P characterized as previously taxed E&P), and (2) the excess asset basis of the foreign acquired corporation.

In response to comments urging for a narrowing of the excess asset basis rules because of the significant compliance burden that would otherwise be imposed on legitimate business transactions, the Proposed Regulations would also limit the application of those rules to inbound nonrecognition transactions in which (1) the subsidiary previously acquired stock or securities of the parent in exchange for property in connection with a triangular reorganization, and (2) adjustments were not made that have the effect of a distribution of property from the subsidiary to the parent under Section 301.  The IRS says this more limited application of the excess asset basis rules is expected to relieve taxpayers from the need to comply with the rules regarding transactions that are not tax-motivated, while still addressing the policy concerns identified in the 2016 Notice.

Note that the Proposed Regulations would also add an anti-avoidance rule that would provide that the excess asset basis rules apply to inbound non-recognition transactions in which excess asset basis was previously created in connection with a transaction other than a triangular reorganization if the principal purpose of the other transaction was to create excess asset basis.  

Priority Rule. Consistent with the 2016 Notice, the Proposed Regulations announce that Treasury and IRS intend to modify the priority rule under Treasury Regulations Section 1.367(b)-10(a)(2)(iii) so that it will continue to apply only when target is a domestic corporation. In light of the TCJA, the Proposed Regulations also would modify the priority rules to take into account the extent to which a distribution would give rise to an inclusion under Section 951A(a) that would be subject to U.S. tax (even though it is unlikely that a distribution from the subsidiary to the parent corporation would give rise to a section 951A(a) inclusion).

Other applications.

• The Proposed Regulations would modify the definition of “foreign subsidiary” to be based on the ownership rules in Section 1248(c)(2)(B).
• The Proposed Regulations would apply to the exchange of a foreign target corporation’s stock that occurs in connection with an applicable triangular reorganization. They would require all shareholders of the target corporation to both include in income as a deemed dividend the Section 1248 amount regarding the target stock exchanged and, after taking into account the increase in basis resulting from the deemed dividend, recognize all realized gain regarding the stock that would not otherwise be recognized. This treatment would be required only to the extent that the target shareholders exchanged target stock for the parent’s stock or securities that the subsidiary previously acquired for property in the parent’s acquisition.
• The 2014 and 2016 Notices build off the 2011 Final Regulations on the treatment of property used to acquire parent stock in triangular reorganizations with a foreign corporation. Those 2011 Final Regulations also contain an anti-abuse regulation that made adjustments if a transaction was completed to avoid the rules’ purpose, and they contain an example of such a transaction. The notices state that taxpayers have asserted that the anti-abuse rule did not apply if their transaction did not fit under the one example explicitly provided in the 2011 Final Regulations. The Proposed Regulations provide an example related to a downstream transfer of property and another involving a debt exchange. The preamble of the Proposed Regulations also states that the anti-abuse rule is not limited to facts described in the examples.
• The Proposed Regulations adopt the approach taken under the 2016 Notice to include nonqualified preferred stock as “property”.

Reporting. The Proposed Regulations also would modify the reporting requirements under Treasury Regulations Section 1.367(b)-1(c) to require corporations that acquire stock or securities of the parent corporation in a transaction described in the 2011 Final Regulations to disclose such acquisitions by attaching a Section 367(b) notice (within the meaning of Treasury Regulations Section 1.367(b)-1(c)) to the corporation’s tax return (or Form 5471, as applicable) for the year in which the stock or securities of the parent corporation are acquired. Under the Proposed Regulations, corporations would be required to describe the circumstances of the acquisition of stock or securities of the parent corporation, any related transactions involving the acquired stock or securities, and whether any adjustments were made pursuant to Treasury Regulations Section 1.367(b)-10. The information required to be disclosed would supplement (rather than replace) any information already required to be disclosed in the Section 367(b) notice.

Effective Dates. With respect to those rules described in the 2014 Notice, the Proposed Regulations generally would be applicable to transactions completed on or after April 25, 2014, subject to limited exceptions. With respect to those rules described in the 2016 Notice, the Proposed Regulations generally would be applicable to transactions completed on or after December 2, 2016. To the extent the Proposed Regulations contain rules not previously announced in either Notice, the Proposed Regulations would be applicable to transactions completed on or after the date the Proposed Regulations are filed in the Federal Register.