On June 23, 2008, the IRS and the Treasury Department published Treasury Decision 9402 which includes new regulations under section 956. The government has stated that it is aware that certain taxpayers are engaging in certain nonrecognition transactions in which a controlled foreign corporation (CFC) acquires certain United States property (within the meaning of section 956(c)) without resulting in an income inclusion to the United States shareholders of the CFC under section 951(a)(1)(B).
In one such transaction, for example, USP, a domestic corporation and the common parent of an affiliated group that files a consolidated tax return, owns 100- percent of the outstanding stock of US1 and US2, both domestic corporations that join USP in the filing of a consolidated tax return. US1 owns 100 percent of the stock of CFC, a controlled foreign corporation. CFC holds cash that would be taxable as a dividend to US1 if it were to distribute the cash to US1.
In a transaction intended to bring the cash to the U.S., but to avoid dividend treatment, US2 issues $100x of its stock to CFC in exchange for $10x of CFC stock and $90x cash.
USP takes the position that :
- US2's transfer of its stock to CFC in exchange for $10x of CFC stock and $90x cash is an exchange to which section 351 applies;
- US2 recognizes no gain on the receipt of $10x of CFC stock and $90x cash in exchange for its stock pursuant to section 1032(a);
- CFC recognizes no gain on the issuance of its stock to US2 under section 1032(a);
- CFC's basis in the US2 stock is zero pursuant to section 362(a); and
- US1 and US2 do not and will not have an income inclusion under section 951(a)(1)(B) as a result of CFC holding the US2 stock (which constitutes United States property under section 956(c)).
At first blush, one would expect that CFC’s acquisition of US2 stock should trigger an inclusion because of the investment in U.S. property. However, inclusions under section 956 are keyed to the basis of the property. Because the US2 stock held by CFC has a zero basis, there would be no inclusion under section 951(a)(1)(B).
The government indicated these transactions raise significant policy concerns because the transactions may have the effect of repatriating earnings and profits of a CFC without a corresponding dividend inclusion, or an income inclusion under section 951(a)(1)(B) by reason of the CFC's investment in United States property.
As a result, the new regulations provide that when a CFC acquires stock or obligations of a domestic issuing corporation, that constitute United States property under section 956(c), from such corporation pursuant to an exchange in which the controlled foreign corporation's basis in such property is determined under section 362(a), the CFC's basis in such United States property (solely for purposes of section 956) shall be no less than the fair market value of the property transferred by the controlled foreign corporation in exchange for such property.