This November the IRS has given some taxpayers subject to reporting on outbound property transfers to foreign corporations something to be thankful for.
Under Section 367(a) of the Code, if a US person transfers property to a foreign corporation in a Section 332, 351, 354, 356, or 361 transfer or exchange, the foreign corporation generally is not treated as a corporation for purposes of determining the US transferor’s gain on the transfer. This rule typically means that the US person will recognize gain on what would otherwise be a non-taxable transfer.
The regulations offer exceptions to the general rule of Section 367(a) for certain transfers of stock or securities to a foreign corporation. If a US person transfers foreign stock or securities and owns 5% or more of the transferee foreign corporation after the transfer, the general rule will not apply if the transferor enters a gain recognition agreement (GRA). Section 1.367(a)-8 describes the terms of a GRA, which generally require the US transferor to agree to recognize some or all of the gain realized on the transfer if certain “gain recognition events” occur during a 5-year period following the taxable year of the transfer. One gain recognition event is the failure to comply “in any material respect” with any requirements of the GRA regulations or the terms of an existing GRA. Such a failure could trigger full gain recognition unless the US transferor rectified the situation and showed reasonable cause for the failure.
Regulations under Section 367(e) apply rules analogous to the GRA provisions to the liquidation of US subsidiary into its foreign parent corporation, although those regulations do not state the consequences of failures to comply. Additional reporting obligations for property transfers to foreign corporations arise under Section 6038B (i.e., Form 926) and other Section 367(a) regulations.
In 2013, the IRS issued proposed regulations under Sections 367(a) and 6038B that would generally relax the consequences of failures to file GRAs or to meet other reporting obligations in connection with outbound transfers to foreign corporations. Those proposed rules provided that a US transferor must show that a failure to file a GRA or comply with an existing GRA’s terms was not willful to avoid consequent gain recognition. Moreover, the proposals included procedural rules to clarify and harmonize the reporting requirements and consequences for non-compliance under Sections 367(a) (including GRAs), 367(e)(2), and 6038B. Shortly after the release of the proposed regulations, the IRS issued temporary regulations that changed the rules for when gain is recognized in certain outbound stock transfers and altered the procedures to obtain reasonable cause relief.
Final regulations issued this month generally incorporate the 2013 proposed regulations, with some modifications, and amend and delete parts of the 2013 temporary regulations. Significantly, the non-willful relief provisions under the proposed regulations have been retained and extended to certain previously filed requests (including those that were denied under the harsher “reasonable cause” standard) and failures to comply with other non-GRA-related Section 367(a) reporting. There are also relaxed procedural rules for consents to extend the assessment period that must be filed to request relief under the GRA rules or in connection with outbound liquidations.
While taxpayers may be eager to gobble up the relief afforded by the recent regulations, the new rules are not all gravy. The final regulations revoke a 2010 directive that had allowed taxpayers to correct, without showing reasonable cause, failures with respect to GRA-related documents associated with a timely filed GRA. Additionally, the Section 6038B regulations now require more specific information to be reported on Form 926 – including fair market value, basis, and gain recognized – whenever a GRA is filed with respect to an outbound transfer of stock or securities. The new rules also implement a new limitations period relating to failure to comply with GRA provisions: the period is now based on when the taxpayer furnishes missing information to the IRS (rather than on when the IRS receives notice of the failure).
