[Code of Federal Regulations] [Title 26, Volume 4] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR1.367(a)-3] [Page 254-271] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) PART 1_INCOME TAXES--Table of Contents Sec. 1.367(a)-3 Treatment of transfers of stock or securities to foreign corporations. (a) In general. This section provides rules concerning the transfer of stock or securities by a U.S. person to a foreign corporation in an exchange described in section 367(a). In general, a transfer of stock or securities by a U.S. person to a foreign corporation that is described in section 351, 354 (including [[Page 255]] a reorganization described in section 368(a)(1)(B) and including an indirect stock transfer described in paragraph (d) of this section), 356 or section 361(a) or (b) is subject to section 367(a)(1) and, therefore, is treated as a taxable exchange, unless one of the exceptions set forth in paragraph (b) of this section (regarding transfers of foreign stock or securities) or paragraph (c) of this section (regarding transfers of domestic stock or securities) applies. However, if in an exchange described in section 354, a U.S. person exchanges stock of a foreign corporation in a reorganization described in section 368(a)(1)(E), or a U.S. person exchanges stock of a domestic or foreign corporation for stock of a foreign corporation pursuant to an asset reorganization described in section 368(a)(1)(C), (D) or (F) that is not treated as an indirect stock transfer under paragraph (d) of this section, such section 354 exchange is not a transfer to a foreign corporation subject to section 367(a). See, e.g., paragraph (d)(3) Example 12. For rules regarding other indirect or constructive transfers of stock or securities subject to section 367(a), see Sec. 1.367(a)-1T(c). For additional rules relating to an exchange involving a foreign corporation in connection with which there is a transfer of stock, see section 367(b) and the regulations under that section. For additional rules regarding a transfer of stock or securities in an exchange described in section 361(a) or (b), see section 367(a)(5) and any regulations under that section. For rules regarding reporting requirements with respect to transfers described under section 367(a), see section 6038B and the regulations thereunder. (b) Transfers by U.S. persons of stock or securities of foreign corporations to foreign corporations--(1) General rule. Except as provided in section 367(a)(5), a transfer of stock or securities of a foreign corporation by a U.S. person to a foreign corporation that would otherwise be subject to section 367(a)(1) under paragraph (a) of this section shall not be subject to section 367(a)(1) if either-- (i) Less than 5-percent shareholder. The U.S. person owns less than five percent (applying the attribution rules of section 318, as modified by section 958(b)) of both the total voting power and the total value of the stock of the transferee foreign corporation immediately after the transfer; or (ii) 5-percent shareholder. The U.S. person enters into a five-year gain recognition agreement with respect to the transferred stock or securities as provided in Sec. 1.367(a)-8. (2) Certain transfers subject to sections 367(a) and (b)--(i) In general. A transfer of foreign stock or securities described in section 367(a) or any regulations thereunder as well as in section 367(b) or any regulations thereunder shall be concurrently subject to sections 367(a) and (b) and the regulations thereunder, except to the extent that the transferee foreign corporation is not treated as a corporation under section 367(a)(1). The example in paragraph (b)(2)(ii) of this section illustrates the rules of this paragraph (b)(2). For an illustration of the interaction of the indirect stock transfer rules under section 367(a) (described under paragraph (d) of this section) and the rules of section 367(b), see paragraph (d)(3) Example 11 of this section. (ii) Example. The following example illustrates the provisions of this paragraph (b)(2): Example. (i) Facts. DC, a domestic corporation, owns all of the stock of FC1, a controlled foreign corporation within the meaning of section 957(a). DC's basis in the stock of FC1 is $50, and the value of such stock is $100. The section 1248 amount with respect to such stock is $30. FC2, also a foreign corporation, is owned entirely by foreign individuals who are not related to DC or FC1. In a reorganization described in section 368(a)(1)(B), FC2 acquires all of the stock of FC1 from DC in exchange for 20 percent of the voting stock of FC2. FC2 is not a controlled foreign corporation after the reorganization. (ii) Result without gain recognition agreement. Under the provisions of this paragraph (b), if DC fails to enter into a gain recognition agreement, DC is required to recognize in the year of the transfer the $50 of gain that it realized upon the transfer, $30 of which will be treated as a dividend under section 1248. (iii) Result with gain recognition agreement. If DC enters into a gain recognition agreement under Sec. 1.367(a)-8 with respect to the transfer of FC1 stock, the exchange will also be subject to the provisions of section 367(b) and the regulations thereunder to the extent that it is not subject to tax under section 367(a)(1). In such case, DC will be required to [[Page 256]] recognize the section 1248 amount of $30 on the exchange of FC1 for FC2 stock. See Sec. 1.367(b)-4(b). The deemed dividend of $30 recognized by DC will increase its basis in the FC1 stock exchanged in the transaction and, therefore, the basis of the FC2 stock received in the transaction. The remaining gain of $20 realized by DC (otherwise recognizable under section 367(a)) in the exchange of FC1 stock will not be recognized if DC enters into a gain recognition agreement with respect to the transfer. (The result would be unchanged if, for example, the exchange of FC1 stock for FC2 stock qualified as a section 351 exchange, or as an exchange described in both sections 351 and 368(a)(1)(B).) (c) Transfers by U.S. persons of stock or securities of domestic corporations to foreign corporations--(1) In general. Except as provided in section 367(a)(5), a transfer of stock or securities of a domestic corporation by a U.S. person to a foreign corporation that would otherwise be subject to section 367(a)(1) under paragraph (a) of this section shall not be subject to section 367(a)(1) if the domestic corporation the stock or securities of which are transferred (referred to as the U.S. target company) complies with the reporting requirements in paragraph (c)(6) of this section and if each of the following four conditions is met: (i) Fifty percent or less of both the total voting power and the total value of the stock of the transferee foreign corporation is received in the transaction, in the aggregate, by U.S. transferors (i.e., the amount of stock received does not exceed the 50-percent ownership threshold). (ii) Fifty percent or less of each of the total voting power and the total value of the stock of the transferee foreign corporation is owned, in the aggregate, immediately after the transfer by U.S. persons that are either officers or directors of the U.S. target company or that are five-percent target shareholders (as defined in paragraph (c)(5)(iii) of this section) (i.e., there is no control group). For purposes of this paragraph (c)(1)(ii), any stock of the transferee foreign corporation owned by U.S. persons immediately after the transfer will be taken into account, whether or not it was received in the exchange for stock or securities of the U.S. target company. (iii) Either-- (A) The U.S. person is not a five-percent transferee shareholder (as defined in paragraph (c)(5)(ii) of this section); or (B) The U.S. person is a five-percent transferee shareholder and enters into a five-year agreement to recognize gain with respect to the U.S. target company stock or securities it exchanged in the form provided in Sec. 1.367(a)-8; and (iv) The active trade or business test (as defined in paragraph (c)(3) of this section) is satisfied. (2) Ownership presumption. For purposes of paragraph (c)(1) of this section, persons who transfer stock or securities of the U.S. target company in exchange for stock of the transferee foreign corporation are presumed to be U.S. persons. This presumption may be rebutted in accordance with paragraph (c)(7) of this section. (3) Active trade or business test--(i) In general. The tests of this paragraph (c)(3), collectively referred to as the active trade or business test, are satisfied if: (A) The transferee foreign corporation or any qualified subsidiary (as defined in paragraph (c)(5)(vii) of this section) or any qualified partnership (as defined in paragraph (c)(5)(viii) of this section) is engaged in an active trade or business outside the United States, within the meaning of Sec. 1.367(a)-2T(b)(2) and (3), for the entire 36-month period immediately before the transfer; (B) At the time of the transfer, neither the transferors nor the transferee foreign corporation (and, if applicable, the qualified subsidiary or qualified partnership engaged in the active trade or business) have an intention to substantially dispose of or discontinue such trade or business; and (C) The substantiality test (as defined in paragraph (c)(3)(iii) of this section) is satisfied. (ii) Special rules. For purposes of paragraphs (c)(3)(i)(A) and (B) of this section, the following special rules apply: (A) The transferee foreign corporation, a qualified subsidiary, or a qualified partnership will be considered to be engaged in an active trade or business for the entire 36-month period preceding the exchange if it acquires at the time of, or any time prior to, the [[Page 257]] exchange a trade or business that has been active throughout the entire 36-month period preceding the exchange. This special rule shall not apply, however, if the acquired active trade or business assets were owned by the U.S. target company or any affiliate (within the meaning of section 1504(a) but excluding the exceptions contained in section 1504(b) and substituting ``50 percent'' for ``80 percent'' where it appears therein) at any time during the 36-month period prior to the acquisition. Nor will this special rule apply if the principal purpose of such acquisition is to satisfy the active trade or business test. (B) An active trade or business does not include the making or managing of investments for the account of the transferee foreign corporation or any affiliate (within the meaning of section 1504(a) but excluding the exceptions contained in section 1504(b) and substituting ``50 percent'' for ``80 percent'' where it appears therein). (This paragraph (c)(3)(ii)(B) shall not create any inference as to the scope of Sec. 1.367(a)-2T(b)(2) and (3) for other purposes.) (iii) Substantiality test--(A) General rule. A transferee foreign corporation will be deemed to satisfy the substantiality test if, at the time of the transfer, the fair market value of the transferee foreign corporation is at least equal to the fair market value of the U.S. target company. (B) Special rules. (1) For purposes of paragraph (c)(3)(iii)(A) of this section, the value of the transferee foreign corporation shall include assets acquired outside the ordinary course of business by the transferee foreign corporation within the 36-month period preceding the exchange only if either-- (i) Both-- (A) At the time of the exchange, such assets or, as applicable, the proceeds thereof, do not produce, and are not held for the production of, passive income as defined in section 1296(b); and (B) Such assets are not acquired for the principal purpose of satisfying the substantiality test; or (ii) Such assets consist of the stock of a qualified subsidiary or an interest in a qualified partnership. See paragraph (c)(3)(iii)(B)(2) of this section. (2) For purposes of paragraph (c)(3)(iii)(A) of this section, the value of the transferee foreign corporation shall not include the value of the stock of any qualified subsidiary or the value of any interest in a qualified partnership, held directly or indirectly, to the extent that such value is attributable to assets acquired by such qualified subsidiary or partnership outside the ordinary course of business and within the 36-month period preceding the exchange unless those assets satisfy the requirements in paragraph (c)(3)(iii)(B)(1) of this section. (3) For purposes of paragraph (c)(3)(iii)(A) of this section, the value of the transferee foreign corporation shall not include the value of assets received within the 36-month period prior to the acquisition, notwithstanding the special rule in paragraph (c)(3)(iii)(B)(1) of this section, if such assets were owned by the U.S. target company or an affiliate (within the meaning of section 1504(a) but without the exceptions under section 1504(b) and substituting ``50 percent'' for ``80 percent'' where it appears therein) at any time during the 36-month period prior to the transaction. (4) Special rules--(i) Treatment of partnerships. For purposes of this paragraph (c), if a partnership (whether domestic or foreign) owns stock or securities in the U.S. target company or the transferee foreign corporation, or transfers stock or securities in an exchange described in section 367(a), each partner in the partnership, and not the partnership itself, is treated as owning and as having transferred, or as owning, a proportionate share of the stock or securities. See Sec. 1.367(a)-1T(c)(3). (ii) Treatment of options. For purposes of this paragraph (c), one or more options (or an interest similar to an option) will be treated as exercised and thus will be counted as stock for purposes of determining whether the 50-percent threshold is exceeded or whether a control group exists if a principal purpose of the issuance or the acquisition of the option (or other interest) was the avoidance of the general rule contained in section 367(a)(1). (iii) U.S. target has a vestigial ownership interest in transferee foreign corporation. In cases where, immediately after [[Page 258]] the transfer, the U.S. target company owns, directly or indirectly (applying the attribution rules of sections 267(c)(1) and (5)), stock of the transferee foreign corporation, that stock will not in any way be taken into account (and, thus, will not be treated as outstanding) in determining whether the 50-percent threshold under paragraph (c)(1)(i) of this section is exceeded or whether a control group under paragraph (c)(1)(ii) of this section exists. (iv) Attribution rule. Except as otherwise provided in this section, the rules of section 318, as modified by the rules of section 958(b) shall apply for purposes of determining the ownership or receipt of stock, securities or other property under this paragraph (c). (5) Definitions--(i) Ownership statement. An ownership statement is a statement, signed under penalties of perjury, stating-- (A) The identity and taxpayer identification number, if any, of the person making the statement; (B) That the person making the statement is not a U.S. person (as defined in paragraph (c)(5)(iv) of this section); (C) That the person making the statement either-- (1) Owns less than 1 percent of the total voting power and total value of a U.S. target company the stock of which is described in Rule 13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or regulation to generally the same effect) promulgated by the Securities and Exchange Commission under the Securities and Exchange Act of 1934 (15 USC 78m), and such person did not acquire the stock with a principal purpose to enable the U.S. transferors to satisfy the requirement contained in paragraph (c)(1)(i) of this section; or (2) Is not related to any U.S. person to whom the stock or securities owned by the person making the statement are attributable under the rules of section 958(b), and did not acquire the stock with a principal purpose to enable the U.S. transferors to satisfy the requirement contained in paragraph (c)(1)(i) of this section; (D) The citizenship, permanent residence, home address, and U.S. address, if any, of the person making the statement; and (E) The ownership such person has (by voting power and by value) in the U.S. target company prior to the exchange and the amount of stock of the transferee foreign corporation (by voting power and value) received by such person in the exchange. (ii) Five-percent transferee shareholder. A five-percent transferee shareholder is a person that owns at least five percent of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer described in section 367(a)(1). For special rules involving cases in which stock is held by a partnership, see paragraph (c)(4)(i) of this section. (iii) Five-percent target shareholder and certain other 5-percent shareholders. A five-percent target shareholder is a person that owns at least five percent of either the total voting power or the total value of the stock of the U.S. target company immediately prior to the transfer described in section 367(a)(1). If the stock of the U.S. target company (or any company through which stock of the U.S. target company is owned indirectly or constructively) is described in Rule 13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or regulation to generally the same effect), promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934 (15 USC 78m), then, in the absence of actual knowledge to the contrary, the existence or absence of filings of Schedule 13-D or 13-G (or any similar schedules) may be relied upon for purposes of identifying five-percent target shareholders (or a five-percent shareholder of a corporation which itself is a five-percent shareholder of the U.S. target company). For special rules involving cases in which U.S. target company stock is held by a partnership, see paragraph (c)(4)(i) of this section. (iv) U.S. Person. For purposes of this section, a U.S. person is defined by reference to Sec. 1.367(a)-1T(d)(1). For application of the rules of this section to stock or securities owned or transferred by a partnership that is a U.S. person, however, see paragraph (c)(4)(i) of this section. [[Page 259]] (v) U.S. Transferor. A U.S. transferor is a U.S. person (as defined in paragraph (c)(5)(iv) of this section) that transfers stock or securities of one or more U.S. target companies in exchange for stock of the transferee foreign corporation in an exchange described in section 367. (vi) Transferee foreign corporation. A transferee foreign corporation is the foreign corporation whose stock is received in the exchange by U.S. persons. (vii) Qualified Subsidiary. A qualified subsidiary is a foreign corporation whose stock is at least 80-percent owned (by total voting power and total value), directly or indirectly, by the transferee foreign corporation. However, a corporation will not be treated as a qualified subsidiary if it was affiliated with the U.S. target company (within the meaning of section 1504(a) but without the exceptions under section 1504(b) and substituting ``50 percent'' for ``80 percent'' where it appears therein) at any time during the 36-month period prior to the transfer. Nor will a corporation be treated as a qualified subsidiary if it was acquired by the transferee foreign corporation at any time during the 36-month period prior to the transfer for the principal purpose of satisfying the active trade or business test, including the substantiality test. (viii) Qualified partnership. (A) Except as provided in paragraph (c)(5)(viii)(B) or (C) of this section, a qualified partnership is a partnership in which the transferee foreign corporation-- (1) Has active and substantial management functions as a partner with regard to the partnership business; or - (2) Has an interest representing a 25 percent or greater interest in the partnership's capital and profits. (B) A partnership is not a qualified partnership if the U.S. target company or any affiliate of the U.S. target company (within the meaning of section 1504(a) but without the exceptions under section 1504(b) and substituting ``50 percent'' for ``80 percent'' where it appears therein) held a 5 percent or greater interest in the partnership's capital and profits at any time during the 36-month period prior to the transfer. (C) A partnership is not a qualified partnership if the transferee foreign corporation's interest was acquired by that corporation at any time during the 36-month period prior to the transfer for the principal purpose of satisfying the active trade or business test, including the substantiality test. (6) Reporting requirements of U.S. target company. (i) In order for a U.S. person that transfers stock or securities of a domestic corporation to qualify for the exception provided by this paragraph (c) to the general rule under section 367(a)(1), in cases where 10 percent or more of the total voting power or the total value of the stock of the U.S. target company is transferred by U.S. persons in the transaction, the U.S. target company must comply with the reporting requirements contained in this paragraph (c)(6). The U.S. target company must attach to its timely filed U.S. income tax return for the taxable year in which the transfer occurs a statement titled ``Section 367(a)--Reporting of Cross-Border Transfer Under Reg. Sec. 1.367(a)-3(c)(6),'' signed under penalties of perjury by an officer of the corporation to the best of the officer's knowledge and belief, disclosing the following information-- (A) A description of the transaction in which a U.S. person or persons transferred stock or securities in the U.S. target company to the transferee foreign corporation in a transfer otherwise subject to section 367(a)(1); (B) The amount (specified as to the percentage of the total voting power and the total value) of stock of the transferee foreign corporation received in the transaction, in the aggregate, by persons who transferred stock or securities of the U.S. target company. For additional information that may be required to rebut the ownership presumption of paragraph (c)(2) of this section in cases where more than 50 percent of either the total voting power or the total value of the stock of the transferee foreign corporation is received in the transaction, in the aggregate, by persons who transferred stock or securities of the U.S. target company, see paragraph (c)(7) of this section; [[Page 260]] (C) The amount (if any) of transferee foreign corporation stock owned directly or indirectly (applying the attribution rules of sections 267(c)(1) and (5)) immediately after the exchange by the U.S. target company; (D) A statement that there is no control group within the meaning of paragraph (c)(1)(ii) of this section; (E) A list of U.S. persons who are officers, directors or five- percent target shareholders and the percentage of the total voting power and the total value of the stock of the transferee foreign corporation owned by such persons both immediately before and immediately after the transaction; and (F) A statement that includes the following-- (1) A statement that the active trade or business test described in paragraph (c)(3) of this section is satisfied by the transferee foreign corporation and a description of such business; (2) A statement that on the day of the transaction, there was no intent on the part of the transferee foreign corporation (or its qualified subsidiary, if relevant) or the transferors of the transferee foreign corporation (or qualified subsidiary, if relevant) to substantially discontinue its active trade or business; and (3) A statement that the substantiality test described in paragraph (c)(3)(iii) of this section is satisfied, and documentation that such test is satisfied, including the value of the transferee foreign corporation and the value of the U.S. target company on the day of the transfer, and either one of the following-- (i) A statement demonstrating that the value of the transferee foreign corporation 36 months prior to the acquisition, plus the value of any assets described in paragraph (c)(3)(iii)(B) of this section (including stock) acquired by the transferee foreign corporation within the 36-month period, less the amount of any liabilities acquired during that period, exceeds the value of the U.S. target company on the acquisition date; or (ii) A statement demonstrating that the value of the transferee foreign corporation on the date of the acquisition, reduced by the value of any assets not described in paragraph (c)(3)(iii)(B) of this section (including stock) acquired by the transferee foreign corporation within the 36-month period, exceeds the value of the U.S. target company on the date of the acquisition. (ii) For purposes of this paragraph (c)(6), an income tax return will be considered timely filed if such return is filed, together with the statement required by this paragraph (c)(6), on or before the last date for filing a Federal income tax return (taking into account any extensions of time therefor) for the taxable year in which the transfer occurs. If a return is not timely filed within the meaning of this paragraph (c)(6), the District Director may make a determination, based on all facts and circumstances, that the taxpayer had reasonable cause for its failure to file a timely filed return and, if such a determination is made, the requirement contained in this paragraph (c)(6) shall be waived. (7) Ownership statements. To rebut the ownership presumption of paragraph (c)(2) of this section, the U.S. target company must obtain ownership statements (described in paragraph (c)(5)(i) of this section) from a sufficient number of persons that transfer U.S. target company stock or securities in the transaction that are not U.S. persons to demonstrate that the 50-percent threshold of paragraph (c)(1)(i) of this section is not exceeded. In addition, the U.S. target company must attach to its timely filed U.S. income tax return (as described in paragraph (c)(6)(ii) of this section) for the taxable year in which the transfer occurs a statement, titled ``Section 367(a)--Compilation of Ownership Statements Under Reg. Sec. 1.367(a)-3(c),'' signed under penalties of perjury by an officer of the corporation, disclosing the following information: (i) The amount (specified as to the percentage of the total voting power and the total value) of stock of the transferee foreign corporation received, in the aggregate, by U.S. transferors; (ii) The amount (specified as to the percentage of total voting power and total value) of stock of the transferee foreign corporation received, in the aggregate, by foreign persons that filed ownership statements; [[Page 261]] (iii) A summary of the information tabulated from the ownership statements, including-- (A) The names of the persons that filed ownership statements stating that they are not U.S. persons; (B) The countries of residence and citizenship of such persons; and (C) Each of such person's ownership (by voting power and by value) in the U.S. target company prior to the exchange and the amount of stock of the transferee foreign corporation (by voting power and value) received by such persons in the exchange. (8) Certain transfers in connection with performance of services. Section 367(a)(1) shall not apply to a domestic corporation's transfer of its own stock or securities in connection with the performance of services, if the transfer is considered to be to a foreign corporation solely by reason of Sec. 1.83-6(d)(1). The transfer may still, however, be reportable under section 6038B. See Sec. 1.6038B-1(b)(2)(i)(A)(4) and (b)(2)(i)(B)(4). (9) Private letter ruling option. The Internal Revenue Service may, in limited circumstances, issue a private letter ruling to permit the taxpayer to qualify for an exception to the general rule under section 367(a)(1) if-- (i) A taxpayer is unable to satisfy all of the requirements of paragraph (c)(3) of this section relating to the active trade or business test of paragraph (c)(1)(iv) of this section, but such taxpayer meets all of the other requirements contained in paragraphs (c)(1)(i) through (c)(1)(iii) of this section, and such taxpayer is substantially in compliance with the rules set forth in paragraph (c)(3) of this section; or (ii) A taxpayer is unable to satisfy any requirement of paragraph (c)(1) of this section due to the application of paragraph (c)(4)(iv) of this section. Notwithstanding the preceding sentence, in no event will the Internal Revenue Service rule on the issue of whether the principal purpose of an acquisition was to satisfy the active trade or business test, including the substantiality test. (10) Examples. This paragraph (c) may be illustrated by the following examples: Example 1. Ownership presumption. (i) FC, a foreign corporation, issues 51 percent of its stock to the shareholders of S, a domestic corporation, in exchange for their S stock, in a transaction described in section 367(a)(1). (ii) Under paragraph (c)(2) of this section, all shareholders of S who receive stock of FC in the exchange are presumed to be U.S. persons. Unless this ownership presumption is rebutted, the condition set forth in paragraph (c)(1)(i) of this section will not be satisfied, and the exception in paragraph (c)(1) of this section will not be available. As a result, all U.S. persons that transferred S stock will recognize gain on the exchange. To rebut the ownership presumption, S must comply with the reporting requirements contained in paragraph (c)(6) of this section, obtaining ownership statements (described in paragraph (c)(5)(i) of this section) from a sufficient number of non-U.S. persons who received FC stock in the exchange to demonstrate that the amount of FC stock received by U.S. persons in the exchange does not exceed 50 percent. Example 2. Filing of Gain Recognition Agreement. (i) The facts are the same as in Example 1, except that FC issues only 40 percent of its stock to the shareholders of S in the exchange. FC satisfies the active trade or business test of paragraph (c)(1)(iv) of this section. A, a U.S. person, owns 10 percent of S's stock immediately before the transfer. All other shareholders of S own less than five percent of its stock. None of S's officers or directors owns any stock in FC immediately after the transfer. A will own 15 percent of the stock of FC immediately after the transfer, 4 percent received in the exchange, and the balance being stock in FC that A owned prior to and independent of the transaction. No S shareholder besides A owns five percent or more of FC immediately after the transfer. The reporting requirements under paragraph (c)(6) of this section are satisfied. (ii) The condition set forth in paragraph (c)(1)(i) of this section is satisfied because, even after application of the presumption in paragraph (c)(2) of this section, U.S. transferors could not receive more than 50 percent of FC's stock in the transaction. There is no control group because five-percent target shareholders and officers and directors of S do not, in the aggregate, own more than 50 percent of the stock of FC immediately after the transfer (A, the sole five-percent target shareholder, owns 15 percent of the stock of FC immediately after the transfer, and no officers or directors of S own any stock of FC immediately after the transfer). Therefore, the condition set forth in paragraph (c)(1)(ii) of this section is satisfied. The facts assume that the condition set forth in paragraph (c)(1)(iv) of this section is satisfied. Thus, U.S. persons that are not five-percent transferee shareholders will not recognize gain on the exchange of S shares for FC shares. A, a five-percent transferee shareholder, will not [[Page 262]] be required to include in income any gain realized on the exchange in the year of the transfer if he files a 5-year gain recognition agreement (GRA) and complies with section 6038B. Example 3. Control Group. (i) The facts are the same as in Example 2, except that B, another U.S. person, is a 5-percent target shareholder, owning 25 percent of S's stock immediately before the transfer. B owns 40 percent of the stock of FC immediately after the transfer, 10 percent received in the exchange, and the balance being stock in FC that B owned prior to and independent of the transaction. (ii) A control group exists because A and B, each a five-percent target shareholder within the meaning of paragraph (c)(5)(iii) of this section, together own more than 50 percent of FC immediately after the transfer (counting both stock received in the exchange and stock owned prior to and independent of the exchange). As a result, the condition set forth in paragraph (c)(1)(ii) of this section is not satisfied, and all U.S. persons (not merely A and B) who transferred S stock will recognize gain on the exchange. Example 4. Partnerships. (i) The facts are the same as in Example 3, except that B is a partnership (domestic or foreign) that has five equal partners, only two of whom, X and Y, are U.S. persons. Under paragraph (c)(4)(i) of this section, X and Y are treated as the owners and transferors of 5 percent each of the S stock owned and transferred by B and as owners of 8 percent each of the FC stock owned by B immediately after the transfer. U.S. persons that are five-percent target shareholders thus own a total of 31 percent of the stock of FC immediately after the transfer (A's 15 percent, plus X's 8 percent, plus Y's 8 percent). (ii) Because no control group exists, the condition in paragraph (c)(1)(ii) of this section is satisfied. The conditions in paragraphs (c)(1)(i) and (iv) of this section also are satisfied. Thus, U.S. persons that are not five-percent transferee shareholders will not recognize gain on the exchange of S shares for FC shares. A, X, and Y, each a five-percent transferee shareholder, will not be required to include in income in the year of the transfer any gain realized on the exchange if they file 5-year GRAs and comply with section 6038B. (11) Effective date. This paragraph (c) applies to transfers occurring after January 29, 1997. However, taxpayers may elect to apply this section in its entirety to all transfers occurring after April 17, 1994, provided that the statute of limitations of the affected tax year or years is open. (d) Indirect stock transfers in certain nonrecognition transfers-- (1) In general. For purposes of this section, a U.S. person who exchanges, under section 354 (or section 356) stock or securities in a domestic or foreign corporation for stock or securities in a foreign corporation in connection with one of the following transactions described in paragraphs (d)(1)(i) through (v) of this section (or who is deemed to make such an exchange under paragraph (d)(1)(vi) of this section) shall be treated as having made an indirect transfer of such stock or securities to a foreign corporation that is subject to the rules of this section, including, for example, the requirement, where applicable, that the U.S. transferor enter into a gain recognition agreement to preserve nonrecognition treatment under section 367(a). If the U.S. person exchanges stock or securities of a foreign corporation, see also section 367(b) and the regulations thereunder. For an example of the concurrent application of the indirect stock transfer rules under section 367(a) and the rules of section 367(b), see, e.g., paragraph (d)(3) Example 11 of this section. (i) Mergers described in sections 368(a)(1)(A) and (a)(2)(D). A U.S. person exchanges stock or securities of a corporation (the acquired corporation) for stock or securities of a foreign corporation that controls the acquiring corporation in a reorganization described in sections 368(a)(1)(A) and (a)(2)(D). See, e.g., paragraph (d)(3) Example 1 of this section. (ii) Mergers described in sections 368(a)(1)(A) and (a)(2)(E). A U.S. person exchanges stock or securities of a corporation (the acquiring corporation) for stock or securities in a foreign corporation that controls the acquired corporation in a reorganization described in sections 368(a)(1)(A) and (a)(2)(E). (iii) Triangular reorganizations described in section 368(a)(1)(B). A U.S. person exchanges stock of the acquired corporation for voting stock of a foreign corporation that is in control (as defined in section 368(c)) of the acquiring corporation in connection with a reorganization described in section 368(a)(1)(B). See, e.g., paragraph (d)(3) Example 4 of this section. [[Page 263]] (iv) Triangular reorganizations described in section 368(a)(1)(C). A U.S. person exchanges stock or securities of a corporation (the acquired corporation) for voting stock or securities of a foreign corporation that controls the acquiring corporation in a reorganization described in section 368(a)(1)(C). See, e.g., paragraph (d)(3) Example 5 of this section (for an example of a triangular section 368(a)(1)(C) reorganization involving domestic acquired and acquiring corporations), and paragraph (d)(3) Example 7 of this section (for an example involving a domestic acquired corporation and a foreign acquiring corporation). If the acquired corporation is a foreign corporation, see paragraph (d)(3) Example 11 of this section, and section 367(b) and the regulations thereunder. (v) Reorganizations described in sections 368(a)(1)(C) and (a)(2)(C). A U.S. person exchanges stock or securities of a corporation (the acquired corporation) for voting stock or securities of a foreign acquiring corporation in a reorganization described in sections 368(a)(1)(C) and (a)(2)(C) (other than a triangular section 368(a)(1)(C) reorganization described in paragraph (d)(1)(iv) of this section). In the case of a reorganization in which some but not all of the assets of the acquired corporation are transferred pursuant to section 368(a)(2)(C), the transaction shall be considered to be an indirect transfer of stock or securities subject to this paragraph (d) only to the extent of the assets so transferred. (Other assets shall be treated as having been transferred in an asset transfer rather than an indirect stock transfer, and such asset transfer would be subject to the other provisions of section 367, including sections 367(a)(1), (3), (5) and (d) if the acquired corporation is a domestic corporation). See, e.g., paragraph (d)(3) Example 5B of this section. (vi) Successive transfers of property to which section 351 applies. A U.S. person transfers property (other than stock or securities) to a foreign corporation in an exchange described in section 351, and all or a portion of such assets transferred to the foreign corporation by such person are, in connection with the same transaction, transferred to a second corporation that is controlled by the foreign corporation in one or more exchanges described in section 351. For purposes of this paragraph (d)(1) and Sec. 1.367(a)-8, the initial transfer by the U.S. person shall be deemed to be a transfer of stock described in section 354. (Any assets transferred to the foreign corporation that are not transferred by the foreign corporation to a second corporation shall be treated as a transfer of assets subject to the general rules of section 367, including sections 367(a)(1), (3), (5) and (d), and not as an indirect stock transfer under the rules of this paragraph (d).) See, e.g., paragraph (d)(3) Example 10 and Example 10A of this section. (2) Special rules for indirect transfers. If a U.S. person is considered to make an indirect transfer of stock or securities described in paragraph (d)(1) of this section, the rules of this section and Sec. 1.367(a)-8 shall apply to the transfer. For purposes of applying the rules of this section and Sec. 1.367(a)-8: (i) Transferee foreign corporation. The transferee foreign corporation shall be the foreign corporation that issues stock or securities to the U.S. person in the exchange. (ii) Transferred corporation. The transferred corporation shall be the acquiring corporation, except that in the case of a triangular section 368(a)(1)(B) reorganization described in paragraph (d)(1)(iii) of this section, the transferred corporation shall be the acquired corporation; in the case of a triangular section 368(a)(1)(C) reorganization described in paragraph (d)(1)(iv) of this section followed by a section 368(a)(2)(C) transfer or a section 368(a)(1)(C) reorganization followed by a section 368(a)(2)(C) transfer described in paragraph (d)(1)(v) of this section, the transferred corporation shall be the transferee corporation; and in the case of successive section 351 transfers described in paragraph (d)(1)(vi) of this section, the transferred corporation shall be the transferee corporation in the final section 351 transfer. The transferred property shall be the stock or securities of the transferred corporation, as appropriate in the circumstances. (iii) Amount of gain. The amount of gain that a U.S. person is required to [[Page 264]] include in income in the event of a disposition (or a deemed disposition) of some or all of the stock or securities of the transferred corporation shall be the proportionate share (as determined under Sec. 1.367(a)-8(e)) of the U.S. person's gain realized but not recognized in the initial exchange (or deemed exchange) of stock or securities under section 354. (iv) Gain recognition agreements involving multiple parties. The U.S. transferor's agreement to recognize gain, as provided in Sec. 1.367(a)-8, shall include appropriate provisions, consistent with the principles of these rules, requiring the transferor to recognize gain in the event of a direct or indirect disposition of the stock or assets of the transferred corporation. For example, in the case of a triangular section 368(a)(1)(B) reorganization described in paragraph (d)(1)(iii) of this section, a disposition of the transferred stock shall include an indirect disposition of such stock by the transferee foreign corporation, such as a disposition of such stock by the acquiring corporation or a disposition of the stock of the acquiring corporation by the transferee foreign corporation. See, e.g., paragraph (d)(3) Example 4 of this section. (v) Determination of whether the transferred corporation disposed of substantially all of its assets. For purposes of applying Sec. 1.367(a)-8(e)(3)(i) to determine whether the transferred corporation has disposed of substantially all of its assets, the following assets shall be taken into account (but only if such assets are not fully taxable under section 367 in the taxable year that includes the indirect transfer)-- (A) In the case of a sections 368(a)(1)(A) and (a)(2)(D) reorganization, and a triangular section 368(a)(1)(C) reorganization described in paragraph (d)(1)(i) or (iv) of this section, respectively, the assets of the acquired corporation; (B) In the case of a sections 368(a)(1)(A) and (a)(2)(E) reorganization described in paragraph (d)(1)(ii) of this section, the assets of the acquiring corporation immediately prior to the transaction; (C) In the case of a sections 368(a)(1)(C) and (a)(2)(C) reorganization described in paragraph (d)(1)(v) of this section, the assets of the acquired corporation that are subject to a transfer described in section 368(a)(2)(C); and (D) In the case of successive section 351 exchanges described in paragraph (d)(1)(vi) of this section, the assets that are both transferred initially to the foreign corporation, and transferred by the foreign corporation to a second corporation. (vi) Coordination between asset transfer rules and indirect stock transfer rules. If, pursuant to any of the transactions described in paragraph (d)(1) of this section, a domestic corporation transfers (or is deemed to transfer) assets to a foreign corporation (other than in an exchange described in section 354), the rules of section 367, including sections 367(a)(1), (a)(3) and (a)(5), as well as section 367(d), and the regulations thereunder shall apply prior to the application of the rules of this section. However, if a transaction is described in this paragraph (d), section 367(a) shall not apply in the case of a domestic acquired corporation that transfers its assets to a foreign acquiring corporation, to the extent that such assets are re-transferred to a domestic corporation in a transfer described in section 368(a)(2)(C) or paragraph (d)(1)(vi) of this section, but only if the domestic transferee's basis in the assets is no greater than the basis that the domestic acquired company had in such assets. See, e.g., paragraph (d)(3) Example 8 and Example 10A of this section. (3) Examples. The rules of this paragraph (d) and Sec. 1.367(a)-8 are illustrated by the following examples: Example 1. Section 368(a)(1)(A)/(a)(2)(D) reorganization--(i) Facts. F, a foreign corporation, owns all the stock of Newco, a domestic corporation. A, a domestic corporation, owns all of the stock of W, also a domestic corporation. A and W file a consolidated Federal income tax return. A does not own any stock in F (applying the attribution rules of section 318, as modified by section 958(b)). In a reorganization described in sections 368(a)(1)(A) and (a)(2)(D), Newco acquires all of the assets of W, and A receives 40% of the stock of F in an exchange described in section 354. (ii) Result. Pursuant to paragraph (d)(1)(i) of this section, the reorganization is subject to the indirect stock transfer rules. F is treated as the transferee foreign corporation, and Newco is treated as the transferred corporation. Provided that the requirements of [[Page 265]] paragraph (c)(1) of this section are satisfied, including the requirement that A enter into a five-year gain recognition agreement as described in Sec. 1.367(a)-8, A's exchange of W stock for F stock under section 354 will not be subject to section 367(a)(1). If F disposes (within the meaning of Sec. 1.367(a)-8(e)) of all (or a portion) of Newco's stock within the five-year term of the agreement (and A has not made a valid election under Sec. 1.367(a)-8(b)(1)(vii)), A is required to file an amended return for the year of the transfer and include in income, with interest, the gain realized but not recognized on the initial section 354 exchange. If A has made a valid election under Sec. 1.367(a)-8(b)(1)(vii) to include the amount subject to the gain recognition agreement in the year of the triggering event, A would instead include the gain on its tax return for the taxable year that includes the triggering event, together with interest. Example 1A. Transferor is a subsidiary in consolidated group--(i) Facts. The facts are the same as in Example 1, except that A is owned by P, a domestic corporation, and for the taxable year in which the transaction occurred, P, A and W filed a consolidated Federal income tax return. (ii) Result. Even though A is the U.S. transferor, P is required under Sec. 1.367(a)-8(a)(3) to enter into the gain recognition agreement and comply with the requirements under Sec. 1.367(a)-8. In the event that A leaves the P group, A would make the annual certifications required under Sec. 1.367(a)-8(b)(5)(ii). P would remain liable with A under the gain recognition agreement. Example 2. Taxable inversion pursuant to indirect stock transfer rules--(i) Facts. The facts are the same as in Example 1, except that A receives more than fifty percent of either the total voting power or the total value of the stock of F in the transaction. (ii) Result. A is required to include in income in the year of the exchange the amount of gain realized on such exchange. See paragraph (c)(1)(i) of this section. If A fails to include the income on its timely-filed return, A will also be liable for the penalty under section 6038B (together with interest and other applicable penalties) unless A's failure to include the income is due to reasonable cause and not willful neglect. See Sec. 1.6038B-1(f). Example 3. Disposition by U.S. transferred corporation of substantially all of its assets--(i) Facts. The facts are the same as in Example 1, except that, during the third year of the gain recognition agreement, Newco disposes of substantially all (as described in Sec. 1.367(a)-8(e)(3)(i)) of the assets described in paragraph (d)(2)(v)(A) of this section for cash and recognizes currently all of the gain realized on the disposition. (ii) Result. Under Sec. 1.367(a)-8(e)(3)(i), the gain recognition agreement is generally triggered when the transferred corporation disposes of substantially all of its assets. However, under the special rule contained in Sec. 1.367(a)-8(h)(2), because A and W filed a consolidated Federal income tax return prior to the transaction, and Newco, the transferred corporation, is a domestic corporation, the gain recognition agreement is terminated and has no further effect. Example 4. Triangular section 368(a)(1)(B) reorganization--(i) Facts. F, a foreign corporation, owns all the stock of S, a domestic corporation. U, a domestic corporation, owns all of the stock of Y, also a domestic corporation. U does not own any of the stock of F (applying the attribution rules of section 318, as modified by section 958(b)). In a triangular reorganization described in section 368(a)(1)(B) and paragraph (d)(1)(iii) of this section, S acquires all the stock of Y, and U receives 10% of the voting stock of F. (ii) Result. U's exchange of Y stock for F stock will not be subject to section 367(a)(1), provided that all of the requirements of paragraph (c)(1) are satisfied, including the requirement that U enter into a five-year gain recognition agreement. For purposes of this section, F is treated as the transferee foreign corporation and Y is treated as the transferred corporation. See paragraphs (d)(2)(i) and (ii) of this section. Under paragraph (d)(2)(iv) of this section, the gain recognition agreement would be triggered if F sold all or a portion of the stock of S, or if S sold all or a portion of the stock of Y. Example 5. Triangular section 368(a)(1)(C) reorganization--(i) Facts. F, a foreign corporation, owns all of the stock of R, a domestic corporation that operates an historical business. V, a domestic corporation, owns all of the stock of Z, also a domestic corporation. V does not own any of the stock of F (applying the attribution rules of section 318 as modified by section 958(b)). In a triangular reorganization described in section 368(a)(1)(C) (and paragraph (d)(1)(iv) of this section), R acquires all of the assets of Z, and V receives 30% of the voting stock of F. (ii) Result. The consequences of the transfer are similar to those described in Example 1; V is required to enter into a 5-year gain recognition agreement under Sec. 1.367(a)-8 to secure nonrecognition treatment under section 367(a). Under paragraphs (d)(2)(i) and (ii) of this section, F is treated as the transferee foreign corporation and R is treated as the transferred corporation. In determining whether, in a later transaction, R has disposed of substantially all of its assets under Sec. 1.367(a)-8(e)(3)(i), see paragraph (d)(2)(v)(A) of this section. Example 5A. Section 368(a)(1)(C) reorganization followed by section 368(a)(2)(C) exchange--(i) Facts. The facts are the same as in Example 5, except that the transaction is structured as a section 368(a)(1)(C) reorganization, followed by a section 368(a)(2)(C) [[Page 266]] exchange, and R is a foreign corporation. The following additional facts are present. Z has 3 businesses: Business A with a basis of $10 and a value of $50, Business B with a basis of $10 and a value of $40, and Business C with a basis of $10 and a value of $30. V and Z file a consolidated Federal income tax return and V has a basis of $30 in the Z stock, which has a value of $120. Assume that Businesses A and B consist solely of assets that will satisfy the section 367(a)(3) active trade or business exception; none of Business C's assets will satisfy the exception. Z transfers all 3 businesses to F in exchange for 30 percent of the F stock, which Z distributes to V pursuant to a section 368(a)(1)(C) reorganization. F then contributes Businesses B and C to R pursuant to section 368(a)(2)(C). (ii) Result. The transfer of the Business A assets by Z to F is subject to the general rules under section 367, as such transfer does not constitute an indirect stock transfer. The transfer by Z of the Business B and C assets to F must first be tested under sections 367(a)(1), (3) and (5). Z recognizes $20 of gain on the outbound transfer of the Business C assets, as such assets do not qualify for an exception to section 367(a)(1). The Business B assets, which will be used by R in an active trade or business outside the United States, qualify for the exception under section 367(a)(3) and Sec. 1.367(a)- 2T(c)(2). V is deemed to transfer the stock of Z to F in a section 354 exchange subject to the rules of paragraph (d). V must enter into the gain recognition agreement in the amount of $30 to preserve Z's nonrecognition treatment with respect to its transfer of Business B assets. Under paragraphs (d)(2)(i) and (ii) of this section, F is the transferee foreign corporation and R is the transferred corporation. Example 5B. Section 368(a)(1)(C) reorganization followed by section 368(a)(2)(C) exchange with U.S. transferee--(i) Facts. The facts are the same as in Example 5A, except that R is a U.S. corporation. (ii) Result. As in Example 5A, the outbound transfer of Business A assets to F is subject to section 367(a) and is not affected by the rules of this paragraph (d). The Business B assets qualified for nonrecognition treatment; the Business C assets did not. However, pursuant to paragraph (d)(2)(vi) of this section, the Business C assets are not subject to section 367(a)(1), provided that the basis of the assets in the hands of R is no greater than the basis of the assets in the hands of Z. V is deemed to make an indirect transfer under the rules of this paragraph (d). To preserve nonrecognition treatment under section 367(a), V must enter into a 5-year gain recognition agreement in the amount of $50, the amount of the appreciation in the Business B and C assets, as the transfer of such assets by Z were not taxable under section 367(a)(1) but were treated as an indirect stock transfer. Example 6. Triangular section 368(a)(1)(C) reorganization followed by 351 exchange--(i) Facts. The facts are the same as in Example 5, except that, during the fourth year of the gain recognition agreement, R transfers substantially all of the assets received from Z to K, a wholly-owned domestic subsidiary of R, in an exchange described in section 351. (ii) Result. The disposition by R, the transferred corporation, of substantially all of its assets would trigger the gain recognition agreement if the assets were disposed of in a taxable transaction. However, because the assets were transferred in a nonrecognition transaction, such transfer does not trigger the gain recognition agreement if V satisfies the reporting requirements contained in Sec. 1.367(a)-8(g)(3) (which includes the requirement that V amend its gain recognition agreement to reflect the transaction). See also paragraph (d)(2)(iv) of this section. To determine whether substantially all of the assets are disposed of, any assets of Z that were transferred by Z to R and then contributed by R to K are taken into account. Example 6A. Triangular section 368(a)(1)(C) reorganization followed by section 351 exchange with foreign transferee--(i) Facts. The facts are the same as in Example 6 except that K is a foreign corporation. (ii) Result. This transfer of assets by R to K must be analyzed to determine its effect upon the gain recognition agreement, and such transfer is also an outbound transfer of assets that is taxable under section 367(a)(1) unless the active trade or business exception under section 367(a)(3) applies. If the transfer is fully taxable under section 367(a)(1), the transfer is treated as if the transferred company, R, sold substantially all of its assets. Thus, the gain recognition agreement would be triggered (but see Sec. 1.367(a)- 8(b)(3)(ii) for potential offsets to the gain to be recognized). If each asset transferred qualifies for nonrecognition treatment under section 367(a)(3) and the regulations thereunder (which require, under Sec. 1.367(a)-2T(a)(2), the transferor to comply with the reporting requirements under section 6038B), the result is the same as in Example 6. If a portion of the assets transferred qualify for nonrecognition treatment under section 367(a)(3) and a portion are taxable under section 367(a)(1) (but such portion does not result in the disposition of substantially all of the assets), the gain recognition agreement will not be triggered if such information is reported as required under Sec. 1.367(a)-8(b)(5) and (e)(3)(i). Example 7. Concurrent application of asset transfer and indirect stock transfer rules in consolidated return setting--(i) Facts. Assume the same facts as in Example 5, except that R is a foreign corporation and V and Z file a consolidated return for Federal income tax purposes. The properties of Z consist of Business A assets, with an adjusted basis of [[Page 267]] $50 and fair market value of $90, and Business B assets, with an adjusted basis of $50 and a fair market value of $110. Assume that the Business A assets do not qualify for the active trade or business exception under section 367(a)(3), but that the Business B assets do qualify for the exception. V's basis in the Z stock is $100, and the value of such stock is $200. (ii) Result. Under paragraph (d)(2)(vi), the assets of Businesses A and B that are transferred to R must be tested under sections 367(a)(3) and (a)(5) prior to consideration of the indirect stock transfer rules of this paragraph (d). Thus, Z must recognize $40 of income under section 367(a)(1) on the outbound transfer of Business A assets. Under Sec. 1.1502-32, because V and Z file a consolidated return, V's basis in its Z stock increases from $100 to $140 as a result of Z's $40 gain. Provided that all of the other requirements under paragraph (c)(1) of this section are satisfied, to qualify for nonrecognition treatment with respect to V's indirect transfer of Z stock, V must enter into a gain recognition agreement in the amount of $60 (the gain realized but not recognized by V in the stock of Z after the $40 basis adjustment). If F sells a portion of its stock in R during the term of the agreement, V will be required to recognize a portion of the $60 gain subject to the agreement. To determine whether R disposes of substantially all of its assets (under Sec. 1.367(a)-8(e)(3)(i)), only the Business B assets will be considered (because the transfer of the Business A assets was taxable to Z under section 367). See paragraph (d)(2)(v)(A) of this section. Example 7A. Concurrent application without consolidated returns--(i) Facts. The facts are the same as in Example 7, except that V and Z do not file consolidated income tax returns. (ii) Result. Z would still recognize $40 of gain on the transfer of its Business A assets, and the Business B assets would still qualify for the active trade or business exception under section 367(a)(3). However, V's basis in its stock of Z would not be increased by the amount of Z's gain. V's indirect transfer of stock will be taxable unless V enters into a gain recognition agreement (as described in Sec. 1.367(a)-8) for the $100 of gain realized but not recognized with respect to the stock of Z. Example 7B. Concurrent application with individual U.S. shareholder--(i) Facts. The facts are the same as in Example 7, except that V is an individual U.S. citizen. (ii) Result. Section 367(a)(5) would prevent the application of the active trade or business exception under section 367(a)(3). Thus, Z's transfer of assets to R would be fully taxable under section 367(a)(1). Z would recognize $100 of income. V's basis in its stock of Z is not increased by this amount. V is taxable with respect to its indirect transfer of its Z stock unless V enters into a gain recognition agreement in the amount of the $100, the gain realized but not recognized with respect to its Z stock. Example 7C. Concurrent application with nonresident alien shareholder--(i) Facts. The facts are the same as in Example 7, except that V is a nonresident alien. (ii) Result. Pursuant to section 367(a)(5), the active trade or business exception under section 367(a)(3) is not available with respect to Z's transfer of assets to R. Thus, Z has $100 of gain with respect to the Business A and B assets. Because V is a nonresident alien, however, V is not subject to section 367(a) with respect to its indirect transfer of Z stock. Example 8. Concurrent application with section 368(a)(2)(C) Exchange--(i) Facts. The facts are the same as in Example 7, except that R transfers the Business A assets to M, a wholly-owned domestic subsidiary of R, in an exchange described in section 368(a)(2)(C). (ii) Result. Pursuant to paragraph (d)(2)(vi) of this section, section 367(a)(1) does not apply to Z's transfer of Business A assets to R, because such assets are transferred to M, a domestic corporation. Sections 367(a)(1), (3) and (5), as well as section 367(d), apply to Z's transfer of assets to R to the extent that such assets are not transferred to M. However, the Business B assets qualify for an exception to taxation under section 367(a)(3). Thus, if the requirements of paragraph (c)(1) of this section are satisfied, including the requirement that V enter into a 5-year gain recognition agreement and comply with the requirements of Sec. 1.367(a)-8 with respect to the gain realized on the Z stock, $100, the entire transaction qualifies for nonrecognition treatment under section 367(a)(1). See also section 367(a)(5) and any regulations issued thereunder. Under paragraphs (d)(2)(i) and (ii) of this section, the transferee foreign corporation is F and the transferred corporation is M. Pursuant to paragraph (d)(2)(iv) of this section, a disposition by F of the stock of R, or a disposition by R of the stock of M, will trigger the gain recognition agreement. To determine whether substantially all of the assets have been disposed of (as described under Sec. 1.367(a)-8(e)(3)(i)), the Business A assets in M and the Business B assets in R must both be considered. Example 9. Concurrent application of direct and indirect stock transfer rules--(i) Facts. F, a foreign corporation, owns all of the stock of O, also a foreign corporation. D, a domestic corporation, owns all of the stock of E, also a domestic corporation, which owns all of the stock of N, also a domestic corporation. Prior to the transactions described in this Example 9, D, E and N filed a consolidated income tax return. D has a basis of $100 in the stock of E, which has a fair market value of $160. The N stock has a fair market value of $100, and E has a basis [[Page 268]] of $60 in such stock. In addition to the stock of N, E owns the assets of Business X. The assets of Business X have a fair market value of $60, and E has a basis of $50 in such assets. Assume that the Business X assets qualify for nonrecognition treatment under section 367(a)(3). D does not own any stock in F (applying the attribution rules of section 318 as modified by section 958(b)). In a triangular reorganization described in section 368(a)(1)(C) and paragraph (d)(1)(iv) of this section, O acquires all of the assets of E, and D exchanges its stock in E for 40% of the voting stock of F. (ii) Result. E's transfer of its assets, including the N stock, must be tested under the general rules of section 367(a) before consideration of D's indirect transfer of the stock of E. E's transfer of the assets of Business X qualify for nonrecognition under section 367(a)(3). E could qualify for nonrecognition treatment with respect to its transfer of N stock if it enters into a gain recognition agreement (and all of the requirements of paragraph (c)(1)(i) of this section are satisfied); however under Sec. 1.367(a)-8(f)(2)(i), D, the parent of the consolidated group, must enter into the agreement. O is the transferee foreign corporation; N is the transferred corporation. D may also qualify for nonrecognition with respect to its indirect transfer of the stock of E if it enters into a separate gain recognition agreement with respect to the E stock (and all of the requirements of paragraph (c)(1)(i) of this section are satisfied). As to this transfer, F is the transferee foreign corporation; O is the transferred corporation. The amount of the gain recognition agreement is $60. See also section 367(a)(5) and any regulations issued thereunder. Example 10. Successive section 351 exchanges--(i) Facts. D, a domestic corporation, owns all the stock of X, a controlled foreign corporation that operates an historical business, which owns all the stock of Y, a controlled foreign corporation that also operates an historical business. The properties of D consist of Business A assets, with an adjusted basis of $50 and a fair market value of $90, and Business B assets, with an adjusted basis of $50 and a fair market value of $110. Assume that the Business B assets qualify for the exception under section 367(a)(3) and Sec. 1.367(a)-2T(c)(2), but that the Business A assets do not qualify for the exception. In an exchange described in section 351, D transfers the assets of Businesses A and B to X, and, in connection with the same transaction, X transfers the assets of Business B to Y in another exchange described in section 351. (ii) Result. Under paragraph (d)(1)(vi) of this section, this transaction is treated as an indirect stock transfer for purposes of section 367(a), but the transaction is not recharacterized for purposes of section 367(b). Moreover, under paragraph (d)(2)(vi) of this section, the assets of Businesses A and B that are transferred to X must be tested under section 367(a)(3). The Business A assets, which were not transferred to Y, are subject to the general rules of section 367(a), and not the indirect stock transfer rules described in this paragraph (d). D must recognize $40 of income on the outbound transfer of Business A assets. The transfer of the Business B assets is subject to both the asset transfer rules (under section 367(a)(3)) and the indirect stock transfer rules of this paragraph (d) and Sec. 1.367(a)-8. Thus, D's transfer of the Business B assets will not be subject to section 367(a)(1) if D enters into a five-year gain recognition agreement with respect to the stock of Y. Under paragraphs (d)(2)(i) and (ii) of this section, X will be treated as the transferee foreign corporation and Y will be treated as the transferred corporation for purposes of applying the terms of the agreement. If X sells all or a portion of the stock of Y during the term of the agreement, D will be required to recognize a proportionate amount of the $60 gain that was realized by D on the initial transfer of the Business B assets. Example 10A. Successive section 351 exchanges with ultimate domestic transferee--(i) Facts. The facts are the same as in Example 10, except that Y is a domestic corporation. (ii) Result. As in Example 10, D must recognize $40 of income on the outbound transfer of the Business A assets. Although the Business B assets qualify for the exception under section 367(a)(3) (and end up in U.S. corporate solution, in Y), the $60 of gain realized on the Business B assets is nevertheless taxable under paragraphs (c)(1) and (d)(1)(vi) of this section because the transaction is considered to be a transfer by D of stock of a domestic corporation, Y, in which D receives more than 50 percent of the stock of the transferee foreign corporation, X. A gain recognition agreement is not permitted. Example 11. Concurrent application of indirect stock transfer rules and section 367(b)--(i) Facts. F, a foreign corporation, owns all of the stock of Newco, which is also a foreign corporation. P, a domestic corporation, owns all of the stock of S, a foreign corporation that is a controlled foreign corporation within the meaning of section 957(a). P's basis in the stock of S is $50 and the value of S is $100. The section 1248 amount with respect to S stock is $30. In a reorganization described in section 368(a)(1)(C) (and paragraph (d)(1)(iv) of this section), Newco acquires all of the properties of S, and P exchanges its stock in S for 49 percent of the stock of F. (ii) Result. P's exchange of S stock for F stock under section 354 will be taxable under section 367(a) (and section 1248 will be applicable) if P fails to enter into a 5-year gain recognition agreement in accordance with [[Page 269]] Sec. 1.367(a)-8. Under paragraph (b)(2) of this section, if P enters into a gain recognition agreement, the exchange will be subject to the provisions of section 367(b) and the regulations thereunder as well as section 367(a). Under Sec. 1.367(b)-4(b), P must recognize the section 1248 amount of $30 because P exchanged stock of a controlled foreign corporation, S, for stock of a foreign corporation that is not a controlled foreign corporation, F. The indirect stock transfer rules do not apply with respect to section 367(b). The deemed dividend of $30 recognized by P will increase P's basis in the F stock received in the transaction, and F's basis in the Newco stock. Thus, the amount of the gain recognition agreement is $20 ($50 gain realized on the transfer less the $30 inclusion under section 367(b)). Under paragraphs (d)(2)(i) and (ii) of this section, F is treated as the transferee foreign corporation and Newco is the transferred corporation. Example 11A. Triangular section 368(a)(1)(C) reorganization involving foreign acquired corporation--(i) Facts. Assume the same facts as in Example 11, except that P receives 51 percent of the stock of F. (ii) Result. Assuming Sec. 1.367(b)-4(b) does not apply, there is no income inclusion under section 367(b), and the amount of the gain recognition agreement is $50. Example 12. Direct asset reorganization not subject to stock transfer rules--(i) Facts. D is a publicly traded domestic corporation. D's assets consist of tangible assets, including stock or securities. In a reorganization described in section 368(a)(1)(F), D becomes a foreign corporation, F. (ii) Result. The reorganization is characterized under Sec. 1.367(a)-1T(f). D's outbound transfer of assets is taxable under section 367(a)(1). Even if any of D's assets would have otherwise qualified for an exception to section 367(a)(1), section 367(a)(5) provides that no exception can apply. The section 368(a)(1)(F) reorganization is not an indirect stock transfer described in paragraph (d) of this section. Moreover, the exchange by D's shareholders of D stock for F stock in an exchange described under section 354 is not an exchange described under section 367(a). See paragraph (a) of this section. (e) Effective dates--(1) In general. The rules in paragraphs (a), (b) and (d) of this section apply to transfers occurring on or after July 20, 1998. The rules in paragraph (c) of this section with respect to transfers of domestic stock or securities are generally applicable for transfers occurring after January 29, 1997. See Sec. 1.367(a)- 3(c)(11). For rules regarding transfers of domestic stock or securities after December 16, 1987, and before January 30, 1997, and transfers of foreign stock or securities after December 16, 1987, and before July 20, 1998, see paragraph (g) of this section. (2) Election. Notwithstanding paragraphs (e)(1) and (g) of this section, taxpayers may, by timely filing an original or amended return, elect to apply paragraphs (b) and (d) of this section to all transfers of foreign stock or securities occurring after December 16, 1987, and before July 20, 1998, except to the extent that a gain recognition agreement has been triggered prior to July 20, 1998. If an election is made under this paragraph (e)(2), the provisions of Sec. 1.367(a)-3T(g) (see 26 CFR part 1, revised April 1, 1998) shall apply, and, for this purpose, the term substantial portion under Sec. 1.367(a)-3T(g)(3)(iii) (see 26 CFR part 1, revised April 1, 1998) shall be interpreted to mean substantially all as defined in section 368(a)(1)(C). In addition, if such an election is made, the taxpayer must apply the rules under section 367(b) and the regulations thereunder to any transfers occurring within that period as if the election to apply Sec. 1.367(a)-3(b) and (d) to transfers occurring within that period had not been made, except that in the case of an exchange described in section 351 the taxpayer must apply section 367(b) and the regulations thereunder as if the exchange was described in Sec. 7.367(b)-7 of this chapter (as in effect before February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999). For example, if a U.S. person, pursuant to a section 351 exchange, transfers stock of a controlled foreign corporation in which it is a United States shareholder but does not receive back stock of a controlled foreign corporation in which it is a United States shareholder, the U.S. person must include in income under Sec. 7.367(b)-7 of this chapter (as in effect before February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999) the section 1248 amount attributable to the stock exchanged (to the extent that the fair market value of the stock exchanged exceeds its adjusted basis). Such inclusion is required even though Sec. 7.367(b)-7 of this chapter (as in effect before February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999), by its terms, did not apply to section 351 exchanges. (f) Former 10-year gain recognition agreements. If a taxpayer elects to [[Page 270]] apply the rules of this section to all prior transfers occurring after December 16, 1987, any 10-year gain recognition agreement that remains in effect (has not been triggered in full) on July 20, 1998 will be considered by the Internal Revenue Service to be a 5-year gain recognition agreement with a duration of five full taxable years following the close of the taxable year of the initial transfer. (g) Transition rules regarding certain transfers of domestic or foreign stock or securities after December 16, 1987, and prior to July 20, 1998--(1) Scope. Transfers of domestic stock or securities described under section 367(a) that occurred after December 16, 1987, and prior to April 17, 1994, and transfers of foreign stock or securities described under section 367(a) that occur after December 16, 1987, and prior to July 20, 1998 are subject to the rules contained in section 367(a) and the regulations thereunder, as modified by the rules contained in paragraph (g)(2) of this section. For transfers of domestic stock or securities described under section 367(a) that occurred after April 17, 1994 and before January 30, 1997, see Temporary Income Regulations under section 367(a) in effect at the time of the transfer (Sec. 1.367(a)- 3T(a) and (c), 26 CFR part 1, revised April 1, 1996) and paragraph (c)(11) of this section. For transfers of domestic stock or securities described under section 367(a) that occur after January 29, 1997, see Sec. 1.367(a)-3(c). (2) Transfers of domestic or foreign stock or securities: Additional substantive rules--(i) Rule for less than 5-percent shareholders. Unless paragraph (g)(2)(iii) of this section applies (in the case of domestic stock or securities) or paragraph (g)(2)(iv) of this section applies (in the case of foreign stock or securities), a U.S. transferor that transfers stock or securities of a domestic or foreign corporation in an exchange described in section 367(a) and owns less than 5 percent of both the total voting power and the total value of the stock of the transferee foreign corporation immediately after the transfer (taking into account the attribution rules of section 958) is not subject to section 367(a)(1) and is not required to enter into a gain recognition agreement. (ii) Rule for 5-percent shareholders. Unless paragraph (g)(2)(iii) or (iv) of this section applies, a U.S. transferor that transfers domestic or foreign stock or securities in an exchange described in section 367(a) and owns at least 5 percent of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer (taking into account the attribution rules under section 958) may qualify for nonrecognition treatment by filing a gain recognition agreement in accordance with Sec. 1.367(a)-3T(g) in effect prior to July 20, 1998 (see 26 CFR part 1, revised April 1, 1998) for a duration of 5 or 10 years. The duration is 5 years if the U.S. transferor (5-percent shareholder) determines that all U.S. transferors, in the aggregate, own less than 50 percent of both the total voting power and the total value of the transferee foreign corporation immediately after the transfer. The duration is 10 years in all other cases. See, however, Sec. 1.367(a)-3(f). If a 5- percent shareholder fails to properly enter into a gain recognition agreement, the exchange is taxable to such shareholder under section 367(a)(1). (iii) Gain recognition agreement option not available to controlling U.S. transferor if U.S. stock or securities are transferred. Notwithstanding the provisions of paragraph (g)(2)(ii) of this section, in no event will any exception to section 367(a)(1) apply to the transfer of stock or securities of a domestic corporation where the U.S. transferor owns (applying the attribution rules of section 958) more than 50 percent of either the total voting power or the total value of the stock of the transferee foreign corporation immediately after the transfer (i.e., the use of a gain recognition agreement to qualify for nonrecognition treatment is unavailable in this case). (iv) Loss of United States shareholder status in the case of a transfer of foreign stock. Notwithstanding the provisions of paragraphs (g)(2)(i) and (ii) of this section, in no event will any exception to section 367(a)(1) apply to the transfer of stock of a foreign corporation in which the U.S. transferor is a United States shareholder (as defined in [[Page 271]] Sec. 7.367(b)-2(b) of this chapter (as in effect before February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999) or section 953(c)) unless the U.S. transferor receives back stock in a controlled foreign corporation (as defined in section 953(c), section 957(a) or section 957(b)) as to which the U.S. transferor is a United States shareholder immediately after the transfer. [T.D. 8702, 61 FR 68637, Dec. 30, 1996, as amended by T.D. 8770, 63 FR 33556, June 19, 1998; 64 FR 15687, Apr. 1, 1999; T.D. 8850, 64 FR 72550, Dec. 28, 1999; T.D. 8862, 65 FR 3596, Jan. 24, 2000]