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By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
One of the lighter fixes to an otherwise complex §304 world was promulgated in late 2009 when the IRS issued final and temporary anti-abuse regulations. At the same time, the regulations reflect yet one more attack on the steady stream of taxpayer-inspired repatriation techniques.
Section 304 applies in two different situations. In the first (brother-sister acquisition), if one or more persons control each of two corporations and, in return for property, one of the corporations acquires stock of the other corporation from the person in control, then the property is treated as a distribution in redemption of the acquiring corporation's stock in a fictional §351 setting.
In the second (subsidiary acquisition), if, in return for property, one corporation acquires from a shareholder of another corporation stock in such other corporation, and the issuing corporation controls the acquiring corporation, then the property is treated as a distribution in redemption of the issuing corporation's stock.
Section 304 is essentially designed to prevent the classic bailout of earnings and profits at capital gain rates by deeming "distribution" treatment rather than sale or exchange treatment. It does so by forcing sales proceeds to be tested under the ordering rules of §301(c)(1), (2), and (3), i.e., dividend characterization to the extent of earnings and profits, return of capital (basis) to the extent thereof, and, finally, sale or exchange treatment.
Section 304 has its more interesting applicability in the international context, given its sourcing rules, its rules governing the extent to which earnings and profits are (or are not) counted in the dividend determination, and its rules relating to stock basis. For example, in determining the amount and source of the dividend, the property is deemed distributed first by the acquiring corporation to the extent of its earnings and profits and, then, by the issuing (target) corporation to the extent of its earnings and profits. Moreover, earnings and profits of a foreign acquiring corporation are counted only to the extent attributable to certain U.S. shareholders, as defined, of the foreign acquiring corporation.
The aggregate of these rules has made for interesting cash repatriation techniques from foreign subsidiaries to U.S. parents, the subject of this particular anti-abuse regulation, which was issued on December 29, 2009.1
Regs. §1.304-4T was originally promulgated back in 1988 and it dealt with an abusive technique involving the "acquiring" corporation side of the transaction, which the IRS deemed to have a §304 tax avoidance purpose. That temporary regulation has now been amended to deal with an abusive technique involving the "issuing" corporation side of the transaction, also deemed to have a §304 tax avoidance purpose. You might say that the IRS has brought a little symmetry into our §304 lives, no doubt inspired by fairly recent taxpayer attempts to bring back cash to the United States on a tax-free basis.
In the first case (deemed acquiring corporation), for purposes of determining the amount and source of a dividend, a "deemed acquiring corporation" will be treated as the acquiring corporation of stock of the issuing (target) corporation actually acquired by a corporation controlled by the deemed acquiring corporation, if a principal purpose for establishing the acquiring corporation is to avoid the applicability of §304.
That's a mouthful but here's the example: P, a domestic corporation, owns each of CFC1 and CFC2. CFC1 is organized in one country and has no E&P. CFC2, located in another country, has E&P of $200. Amongst good and valid business reasons, including wanting to have all CFCs in a direct chain, P also wants to receive cash of $100 from CFC2 but avoid dividend treatment (which would be the result under §304 if CFC2 itself acquired CFC1). So, P causes CFC2 to form CFC3 and CFC2 contributes $100 to CFC3 to fund an acquisition by CFC3 of the stock of CFC1. (CFC3 obviously has no E&P.)
Because the structure has a principal purpose of avoiding the applicability of §304, the regulation provides that, for purposes of determining the amount and source of the dividend, CFC2 (which controls CFC3) is the deemed acquiring corporation of CFC1 and P is deemed to receive a $100 dividend distribution from CFC2.
In the second case (deemed issuing corporation), for purposes of determining the amount and source of a dividend, an acquiring corporation will be treated as acquiring the stock of a corporation (the deemed issuing corporation) controlled by the issuing corporation if, in connection with the acquisition of the issuing corporation, the issuing corporation acquired stock of the deemed issuing corporation with a principal purpose of avoiding the applicability of §304.
Here's the example: P owns CFC1 with E&P of $200. P also owns CFC2 with no E&P. In addition to good business reasons, P wants to receive cash of $100 from CFC2 but avoid dividend treatment (which would be the result under §304 if CFC2 acquired CFC1 directly). So, P forms CFC3 to which it contributes CFC1, and CFC2 acquires CFC3 (which has no E&P).
Because the structure has a principal purpose of avoiding the applicability of §304, the regulation provides that, for purposes of determining the amount and source of the dividend, CFC2 is treated as acquiring the stock of CFC1 (not CFC3), resulting in a $100 dividend because of the E&P of CFC1.
So, we now have some more contours built around §304 transactions in the international arena designed to avoid tax-free repatriations to the United States. It would seem, however, that these are appropriate anti-abuse regulations and it's hard to argue to the contrary.
This commentary also will appear in the March 2010 issue of theTax Management International Journal. For more information, in the Tax Management Portfolios, see Gross, Doloboff, Koutouras and Tizabgar, 768 T.M., Stock Sales Subject to Section 304, and in Tax Practice Series, see ¶7150, U.S. Persons — Worldwide Taxation.
1 T.D. 9477, 74 Fed. Reg. 69021 (12/30/09).
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