The Internal Revenue Service has issued new guidance on so-called Killer B transactions, the triangular reorganizations that involve foreign controlled corporations. For the second time since early June, the IRS has taken decisive steps to prevent what it obviously considers one of the most objectionable tax outcomes in the tax adviser’s arsenal. That is, the effective repatriation of a controlled foreign corporation’s earnings and profits without the U.S. corporation reporting related income. (See, The Willens Report, Volume 2 Issue 166, June 2, 2008, subscription needed, “I.R.S. Eliminates the Utility of Killer ‘B’s”.)
The transaction the IRS is seeking to ban involves, for example, a United States corporation which owns 100 percent of the stock of each of two United States corporations (AmericaOne and AmericaTwo). AmericaOne, in turn, owns 100 percent of the stock of a foreign corporation (OverseasCorp.) In the transaction, AmericaTwo issues $10 million worth of its stock to OverseasCorp. In exchange, OverseasCorp hands over to AmericaTwo $1 million in stock and $9 million in cash. The transaction gives rise to the following tax consequences:
AmericaTwo, immediately after the exchange, is in control of OverseasCorp. within the meaning of the IRS code’s Section 368(c). That’s because AmericaTwo’s transfer to OverseasCorp is governed by Section 351 of the code, the section that applies when one company transfers property to another using stock. In the case of AmericaTwo, the requisite control was present because under the consolidated tax return’s “aggregation rules” (See Regulation Section 1.1502-34) the stock in OverseasCorp that was owned by AmericaOne is attributed to AmericaTwo under Section 351.
AmericaTwo recognizes no gain on the receipt of stock and cash in exchange for its stock because under another section of the law — (Section 1032) — no gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for its stock.
OverseasCorp recognizes no gain on the issuance of its stock under Section 1032.
OverseasCorp’s basis in the AmericaTwo stock is zero under Section 362(a). That section says that if property is acquired by a corporation in connection with a Section 351 transaction, the basis of the property when it is in the hands of the transferee should be the same as if it was in the hands of the transferor — plus the amount of gain recognized by the transferor. (See Revenue Ruling 74-503, 1974-2 C.B. 117. )
In its example, the IRS notes that AmericaOne and AmericaTwo have no “income inclusion” as defined by the tax code ( See Section 951(a)(1)(B), despite the fact that OverseasCorp holds AmericaTwo stock. As a result, the agency went to work to tighten the rules around “effective” repatriation that allowed companies to sidestep reporting related income.