Temp. Treas. Reg. § 1.897-5T(c)(4) applies the rules of section 897(d) to certain distributions of stock of a USRPHC by a foreign corporation under section 361(c). Under the temporary regulations, a foreign corporation that transfers property to a domestic corporation (that is a USRPHC immediately after the transfer) in an exchange under section 361(a) or (b) pursuant to a reorganization under section 368(a)(1)(C), (D), or (F) must recognize gain under section 897(d)(1) and Temp. Treas. Reg. § 1.897-5T(c)(4)(i) when it distributes the stock of the USRPHC to its shareholders under section 361(c). Temp. Treas. Reg. § 1.897-5T(c)(4)(ii) and (iii) provide an exception and a limitation to this gain recognition.

In Notice 89-85, the IRS and Treasury announced that the exception and the limitation set forth in Temp. Treas. Reg. § 1.897-5T(c)(4)(ii) and (iii) would be replaced by a new exception. The new exception announced in Notice 89-85 provides that recognition of gain will not be required on the distribution under section 361(c)(1) of the stock of the USRPHC under Temp. Treas. Reg. § 1.897-5T(c)(4)(i) if the foreign corporation pays an amount equal to any taxes that section 897 would have imposed upon all persons who had disposed of interests in the transferor foreign corporation (or a corporation from which such assets were acquired in a transaction described in section 381) after June 18, 1980, as if it were a domestic corporation on the date of each such disposition, and if the conditions of Temp. Treas. Reg. § 1.897-5T(c)(4)(ii)(A) and (C) (relating to the distributee being subject to tax on a subsequent disposition and certain filing requirements) are met. Other requirements relating to the time and manner of payment of tax and interest are also set forth in the notice. The revisions announced in Notice 89-85 generally apply to all distributions of stock under Temp. Treas. Reg. § 1.897-5T(c)(4) occurring after July 31, 1989.

The IRS and Treasury have determined that when final regulations are issued, inbound statutory mergers and consolidations described in section 368(a)(1)(A) (including such reorganizations by reason of 368(a)(2)(D) or (E)) will be subject to the same rules set forth in Temp. Treas. Reg. § 1.897-5T(c)(4) and Notice 89-85 that apply to other inbound asset reorganizations. Further, as described in part 2, below, the period that a foreign corporation must consider with respect to prior stock dispositions under Temp. Treas. Reg. § 1.897-5T(c)(4) will be revised.

Section 1.897-5T(c)(2) of the temporary regulations applies the rules of section 897(d) to liquidating distributions of USRPIs by a foreign corporation to a domestic corporation pursuant to section 332(a). Under Temp. Treas. Reg. § 1.897-5T(c)(1), a foreign corporation that makes a liquidating distribution of a USRPI to a foreign or domestic shareholder must recognize gain on the distribution under section 897(d), unless the distribution comes within an exception described in Temp. Treas. Reg. § 1.897-5T(c)(2), (3), or (4). Temp. Treas. Reg. § 1.897-5T(c)(2)(i) and (ii) provide exceptions to this recognition rule that are applicable to liquidating distributions under section 332(a).

In Notice 89-85, the IRS and Treasury announced that the exceptions set forth in Temp. Treas. Reg. § 1.897-5T(c)(2)(i) and (ii) would be replaced by a new exception. The new exception announced in Notice 89-85 provides that recognition of gain shall not be required on the liquidating distribution of a USRPI by a foreign corporation to a domestic corporation meeting the stock ownership requirements of section 332(b) in a section 332(a) liquidation if the distributing foreign corporation pays the tax and interest on any prior disposition of its stock (or stock of a corporation from which such assets were acquired in a transaction described in section 381) after June 18, 1980, as if it were a domestic corporation on the date of such dispositions, and if the conditions of Temp. Treas. Reg. § 1.897-5T(c)(2)(i) are met (relating to the distributee being subject to tax on a subsequent disposition and certain basis carryover and filing requirements). The revisions announced in Notice 89-85 generally apply to all distributions of stock under Temp. Treas. Reg. § 1.897-5T(c)(2) occurring after July 31, 1989. Similarly, as described in part 1 of this notice, above, Notice 89-85 revised the look-back period applicable to inbound reorganizations under Temp. Treas. Reg. § 1.897-5T(c)(4) to encompass certain dispositions of the stock of the foreign corporation that occur after June 18, 1980. The rules of Notice 89-85 also require the payment of interest, as determined under section 6621, that would have accrued had tax actually been due with respect to the prior stock dispositions.

Further, section 897(i), which permits a foreign corporation to elect to be treated as a domestic corporation for purposes of section 897, requires as a condition to making the election that the electing foreign corporation verify that no interest in the corporation was disposed of during the shorter of: (1) the period from June 19, 1980 through the date of the election, (2) the period from the date on which the corporation first holds a USPRI through the date of the election, or (3) the five year period ending on the date of the election. See Treas. Reg. § 1.897-3(c)(5). If the foreign corporation cannot make such verification, then it must comply with the conditions of Treas. Reg. § 1.897-3(d) which, among other things, requires the payment of an amount equal to any taxes that section 897 would have imposed on all persons who had disposed of interests in the corporation during such period. The payment must also include any interest, as determined under section 6621, that would have accrued had the tax actually been due with respect to the dispositions. These rules were modified by Notice 89-85 to require the reporting and payment of tax and accrued interest on all dispositions of stock occurring after June 18, 1980 that would have been subject to taxation under section 897(a).

The IRS and Treasury have determined that when final regulations are issued, the look-back, tax, and interest payment periods applicable under Notice 89-85 to Temp. Treas. Reg. § 1.897-5T(c)(2) liquidating distributions, Temp. Treas. Reg. § 1.897-5T(c)(4) inbound asset reorganizations, and section 897(i) elections will be modified as described below.

Regarding distributions of USRPIs by a foreign corporation to a domestic corporation in a section 332 liquidation, the final regulations will amend the rules of Temp. Treas. Reg. § 1.897-5T(c)(2)(ii) and Notice 89-85 to provide that recognition of gain will not be required on the distribution of any USRPI by the distributing foreign corporation to the domestic corporation if the distributing foreign corporation pays an amount equal to the tax and interest that would have been imposed upon all persons who disposed of an interest in the foreign corporation (or a corporation from which such assets were acquired in a transaction described in section 381) during the period beginning on the date that is 10 years prior to the date on which the domestic corporation or any related person (within the meaning of section 267(b)) is in control (as determined under section 304(c)) of the liquidating foreign corporation, and ending on the date of the liquidation, as if the foreign corporation were a domestic corporation on the date of each such disposition and if the conditions of Temp. Treas. Reg. § 1.897-5T(c)(2)(i) are met.

Regarding inbound asset acquisitions described in Temp. Treas. Reg. § 1.897-5T(c)(4) as modified by this notice, the final regulations will amend the rules of Temp. Treas. Reg. § 1.897-5T(c)(4)(ii) and Notice 89-85 to provide that recognition of gain will not be required on the distribution of stock of a USRPHC if the foreign corporation pays an amount equal to any taxes and interest that would have been imposed upon all persons who disposed of an interest in the foreign corporation (or a corporation from which the assets were acquired in a transaction described in section 381) during the applicable period as if the foreign corporation were a domestic corporation on the date of each such disposition, and the conditions of Temp. Treas. § 1.897-5T(c)(4)(ii)(A) and (C) are met. The applicable period means the earliest of either:

Regarding the revisions to Treas. Reg. §1.897-3(c)(5), and (d) pertaining to a foreign corporation’s election under section 897(i), the final regulations will provide that the applicable period will be the earliest of either:

(a) Revision to the rules of Temp. Treas. Reg. § 1.897-6T(b)(1)(ii) to take into account statutory mergers and consolidations described in section 368(a)(1)(A)

As noted above, Temp. Treas. Reg. § 1.897-6T(a)(1) generally provides that any nonrecognition provision shall apply to a transfer by a foreign person of a USRPI only to the extent that the foreign person receives a USRPI in such exchange. Pursuant to the regulatory authority under section 897(e)(2) of the Code, Temp. Treas. Reg. § 1.897-6T(b)(1) and (2) provide exceptions to the rule of Temp. Treas. Reg. § 1.897-6T(a)(1) for certain foreign-to-foreign reorganizations and certain exchanges under section 351 where a foreign person transfers a USRPI for stock in a foreign corporation. These exceptions require that (1) the transferee’s subsequent disposition of the transferred USRPI be subject to U.S. income taxation in accordance with Temp. Treas. Reg. § 1.897-5T(d)(1); (2) the filing requirements of Temp. Treas. Reg. § 1.897-5T(d)(1)(iii) be satisfied; (3) one of the five conditions set forth in paragraph (b)(2) exists; and (4) the exchange takes one of the three forms of exchange described in paragraph (b)(1).

Temp. Treas. Reg. § 1.897-6T(b)(1)(ii) describes one of the three permissible forms of exchange referenced above. That paragraph describes an exchange by a foreign corporation pursuant to section 361(a) or (b) in a reorganization described in section 368(a)(1)(C), where there is an exchange of the transferor corporation stock for the transferee corporation stock (or stock of the transferee corporation’s parent in the case of a parenthetical C reorganization) under section 354(a), and the transferor corporation’s shareholders own more than fifty percent of the voting stock of the transferee corporation (or stock of the transferee corporation’s parent in the case of a parenthetical C reorganization) immediately after the reorganization. The fifty percent limitation restricts this exception to reorganizations described in section 368(a)(1)(C) that are restructurings where the transferor corporation shareholders control the transferee corporation after the transaction (e.g., internal restructurings).

The IRS and Treasury have determined that when final regulations are issued, foreign-to-foreign statutory mergers and consolidations described in section 368(a)(1)(A) (including such reorganizations by reason of section 368(a)(2)(D) or (E)) will be subject to the same rules set forth in Temp. Treas. Reg. § 1.897-6T(b)(1)(ii) that apply to foreign-to-foreign reorganizations described in section 368(a)(1)(C) (including parenthetical C reorganizations). The exception for statutory mergers and consolidations described in section 368(a)(1)(A) will be limited to restructurings where the 50 percent control requirement is satisfied after the transaction. Further, the final regulations will provide that in determining whether the fifty percent requirement set forth in Temp. Treas. Reg. § 1.897-6T(b)(1)(ii) is met where the transferee corporation owns more than fifty percent of the transferor corporation before a reorganization under section 368(a)(1)(A) or 368(a)(1)(C) (i.e., an upstream reorganization), the shareholders of the transferee corporation before the reorganization (that continue to be shareholders of the transferee corporation after the reorganization) will be treated as shareholders of the transferor corporation before the reorganization to the extent of their indirect interest in the stock of the transferor corporation (owned by the transferee corporation) before the reorganization.

Accordingly, when issued, the final regulations will provide that gain shall not be recognized where an exchange is made by a foreign corporation pursuant to section 361(a) or (b) in a reorganization described in section 368(a)(1)(A) (including such reorganization by reason of section 368(a)(2)(D) or (E)); there is an exchange of the transferor corporation stock for the transferee corporation stock (or the stock of the transferee corporation’s parent in the case of a reorganization by reason of section 368(a)(2)(D)) under section 354(a); immediately after the reorganization, the transferor corporation’s shareholders own more than fifty percent of the voting stock of the transferee corporation (or the transferee corporation’s parent in a reorganization by reason of section 368(a)(2)(D)), or in the case of a reorganization by reason of section 368(a)(2)(E), the shareholders of the corporation that controls the transferor corporation before the reorganization own more than fifty percent of the voting stock of that controlling corporation after the reorganization; and the other requirements of Temp. Treas. Reg. § 1.897-6T(b)(1) are satisfied.

(b) Additional exceptions to be added to the rules of Temp. Treas. Reg. § 1.897-6T(b)(1)

The IRS and Treasury have determined that when final regulations are issued, the rules of Temp. Treas. Reg. § 1.897-6T(b)(1) will be expanded to include two additional exceptions. Those exceptions will apply only in certain foreign-to-foreign statutory mergers and consolidations described in section 368(a)(1)(A) (including such reorganizations by reason of section 368(a)(2)(D) or (E)) and foreign-to-foreign reorganizations described in section 368(a)(1)(C) (including parenthetical C reorganizations). Accordingly, the new exceptions to be incorporated in the final regulations will revise the rules of Temp. Treas. Reg. § 1.897-6T(b)(1) to provide that such foreign-to-foreign reorganizations will be excepted from the general gain recognition rule of Temp. Treas. Reg. § 1.897-6T(a)(1) provided that the other requirements set forth in Temp. Treas. Reg. § 1.897-6T(b)(1) are met. The two additional exceptions apply where an exchange is made by a foreign corporation pursuant to section 361(a) or (b) in a reorganization described in section 368(a)(1)(A) (including a reorganization by reason of section 368(a)(2)(D) or (E)) or section 368(a)(1)(C) (including parenthetical C reorganizations); there is an exchange of the transferor corporation stock for the transferee corporation stock (or the transferee corporation’s parent in the case of a reorganization by reason of section 368(a)(2)(D) or a parenthetical C reorganization) under section 354(a); and either:

Regarding parenthetical C reorganizations and reorganizations under section 368(a)(1)(A) by reason of section 368(a)(2)(D): prior to the exchange the stock of the transferor corporation and the stock of the corporation in control of the transferee corporation, and after the exchange the stock of the corporation in control of the transferee corporation are regularly traded under Treas. Reg. § 1.897-1(n) and Temp. Treas. Reg. § 1.897-9T(d)(1) and (2) on an established securities market under § 1.897-1(m), and in the case where the transferor corporation would have been a USRPHC at any time within the five year period ending on the date of the reorganization if the transferor corporation had been a domestic corporation, no foreign shareholder of the transferor corporation owned a more than five percent interest in the transferor corporation at such time under the rules of Treas. Reg. § 1.897-1(c)(2)(iii) and Temp. Treas. Reg. § 1.897-9T.

Regarding reorganizations under section 368(a)(1)(A) by reason of section 368(a)(2)(E): prior to the exchange the stock of the transferee corporation and the stock of the corporation in control of the transferor corporation, and after the exchange the stock of the corporation that controls the transferee corporation are regularly traded under Treas. Reg. § 1.897-1(n) and Temp. Treas. Reg. § 1.897-9T(d)(1) and (2) on an established securities market under § 1.897-1(m), and in the case where the transferor corporation or the corporation in control of the transferor corporation would have been a USRPHC at any time within the five year period ending on the date of the reorganization if either corporation had been a domestic corporation, no foreign shareholder of the corporation in control of transferor corporation owned a more than five percent interest in the transferor corporation at such time under the rules of Treas. Reg. § 1.897-1(c)(2)(iii) and Temp. Treas. Reg. § 1.897-9T.

(c) Revision to the rules of Temp. Treas. Reg. § 1.897-6T(b)(1)(iii) relating to foreign-to-foreign section 351 transactions and section 368(a)(1)(B) reorganizations

As discussed above, Temp. Treas. Reg. § 1.897-6T(b)(1) contains exceptions to the general rule provided in Temp. Treas. Reg. § 1.897-6T(a)(1) if one of three forms of exchange occurs and certain other requirements are met. Specifically, Temp. Treas. Reg. § 1.897-6T(b)(1)(iii) provides a foreign person with nonrecognition treatment if the foreign person exchanges stock in a USRPHC under section 351(a) or section 354(a) in a reorganization described in section 368(a)(1)(B), and, immediately after the exchange, all of the outstanding stock of the transferee corporation (or the stock of the transferee corporation’s parent in the case of a parenthetical B reorganization) is owned in the same proportions by the same nonresident alien individuals and foreign corporations that immediately before the exchange owned the stock of the USRPHC. However, if any of the stock in the foreign corporation received by the individual or corporate transferor in the exchange is disposed of within three years from the date of its receipt, then the transferor must recognize that portion of the realized gain with respect to the stock of the USRPHC for which the foreign stock disposed of was received.

The IRS and Treasury have determined that the final regulations will revise Temp. Treas. Reg. § 1.897-6T(b)(1)(iii) in two respects. First, the exception will be revised so that “all of the stock of the transferee corporation” is removed and replaced with “substantially all of the outstanding stock of the transferee corporation” and the words “in the same proportions” will be removed. Second, the three year period will be revised to one year.

(d) Removal of the conditions set forth in Temp. Treas. Reg. § 1.897-6T(b)(2)

As discussed above, to come within an exception to Temp. Treas. Reg. § 1.897-6T(a)(1), not only must an exchange be described in Temp. Treas. Reg. § 1.897-6T(b)(1), but it must also satisfy one of the five conditions set forth in Temp. Treas. Reg. § 1.897-6T(b)(2). The IRS and Treasury have determined that the conditions of Temp. Treas. Reg. § 1.897-6T(b)(2) are no longer necessary. Accordingly, the final regulations will eliminate the conditions of Temp. Treas. Reg. § 1.897-6T(b)(2).