Background

Under the Subpart F and Global Intangible Low-Taxed Income (GILTI) regimes, US shareholders holding stock in CFCs must include in income their pro rata share of Subpart F and GILTI income from such CFCs. Under section 961(a), a US shareholder's basis in the stock of a CFC is increased by the Subpart F and GILTI inclusions with respect to the stock of the CFC. Correspondingly, under section 961(b), when a CFC makes a distribution to a US shareholder, the US shareholder's basis in the CFC stock is decreased by the portion of the distribution representing PTEP that the US shareholder has previously included in income as Subpart F and GILTI inclusions.

For a lower-tier CFC that is owned by another CFC, section 961(c) provides that Treasury shall issue regulations under which basis adjustments similar to the basis adjustments provided by sections 961(a) and 961(b) shall be made to the basis of stock in the lower-tier CFC and the basis of stock in any other CFC the US shareholder is considered to own under section 958(a)(2), but only for the purposes of determining the US shareholder's Subpart F and GILTI inclusions under section 951. Section 961(c) effectively provides that a US shareholder is not subject to double taxation on undistributed PTEP of a lower-tier CFC when an upper-tier CFC sells the stock of the lower-tier CFC. Congress added section 961(c) to the Internal Revenue Code in 1997. To date, no regulations have been issued to implement section 961(c).

Prior to the Notice, it was unclear whether basis adjustments under section 961(c) would be inherited when a US shareholder ("Domestic Acquiring Corporation") acquires the stock of a CFC ("Acquired CFC") from another CFC ("Transferor CFC") pursuant to a liquidation described in section 332 or an asset reorganization described in section 368(a)(1) ("Inbound Nonrecognition Transaction"). Because section 961(c) provides that its basis adjustments only apply for the purposes of determining the US shareholder's Subpart F and GILTI inclusions under section 951, the statute could be interpreted to imply that a domestic acquiring corporation must recognize income from non-economic gains on subsequent PTEP distributions from the acquired CFC or on the subsequent sale of the acquired CFC stock (i.e., income not derived from Subpart F or GILTI inclusions).

Forthcoming proposed regulations

As discussed in the Notice, Treasury and the IRS believe that not allowing domestic acquiring corporations to inherit section 961(c) basis adjustments in certain inbound nonrecognition transactions would be inconsistent with one of the purposes of section 961, which is to prevent double taxation of the same CFC earnings. Treasury and the IRS plan to issue proposed regulations providing that, for certain "covered inbound transactions," the adjusted basis that a domestic acquiring corporation has in the stock of an acquired CFC determined under section 334(b) or 362(b) will be determined by using the transferor CFC's section 961(c) basis as the adjusted basis. The effect is to allow certain domestic acquiring corporations to inherit section 961(c) basis adjustments.

Covered inbound transactions

Subject to the exceptions discussed below, a transaction generally is a "covered inbound transaction" if it satisfies two requirements. First, in the transaction, a domestic acquiring corporation must acquire all of the stock of an acquired CFC from a transferor CFC that, immediately before the transaction and any related transactions, owned (directly or indirectly under section 958(a)(2)) all of the acquired CFC's stock. Second, the transaction must be one of the following:

• A section 332 liquidation
• A reorganization under section 368(a)(1)(A) (i.e., a statutory merger) that is not described in section 368(a)(2)(D) or 368(a)(2)(E)) ("Nontriangular A Reorganization") in which the domestic acquiring corporation directly owns all of the stock of the transferor CFC immediately before the transaction
• A nontriangular reorganization under section 368(a)(1)(C) ("Nontriangular C Reorganization") in which the domestic acquiring corporation directly owns all of the stock of the transferor CFC immediately before the transaction
• A nontriangular A reorganization, a nontriangular C reorganization, a reorganization described in section 368(a)(1)(D) (that satisfies the requirements of section 354(b)(1)(A) and (B)), or a reorganization under section 368(a)(1)(F), in which: (a) immediately before the transaction, a single domestic corporation (or members of the same consolidated group) directly owns all of the stock of the transferor CFC immediately before the transaction, and (b) immediately after the transaction and any related transactions, the same domestic corporation (or members of the same consolidated group) directly owns all of the stock of the domestic acquiring corporation.

De minimis exceptions

The Notice provides two narrow de minimis exceptions from the strict ownership requirements of the Notice's definition of covered inbound transactions. A transaction may still be a covered inbound transaction if, immediately before the transaction, one or more persons other than the acquiring domestic corporation (or consolidated group members) own, in aggregate, 1% or less of the total fair market value of the transferor CFC's stock. In addition, a transaction may still be a covered inbound transaction if, immediately before the transaction and any related transactions, stock of the acquired CFC owned by one or more persons other than the transferor CFC represent, in the aggregate, 1% or less of the fair market value of the outstanding stock of the acquired CFC and such persons continue to own the acquired CFC stock after the transaction and any related transactions if such persons are not related to the domestic acquiring corporation.

Disqualified transactions

The following characteristics generally disqualify a transaction from qualifying as a covered inbound transaction:

• Boot: the amount of money or other property received represents more than 1% of the total fair market value of the stock of the transferor CFC
• Built-in losses: immediately before the covered inbound transaction, the total amount of the transferor CFC's basis in the acquired CFC's stock (i.e., the aggregate amount of the adjusted basis and the section 961(c) basis) exceeds the total fair market value of that stock
• Transfers described in section 368(a)(2)(C) or Treas. Reg. § 1.368-2(k)(1): stock of the acquired CFC is transferred in a transaction described in section 368(a)(2)(C) or Treas. Reg. § 1.368-2(k)(1), unless the transferee is either: (a) a member of the same consolidated group as the domestic acquiring corporation and wholly owned by one or more members of the consolidated group; or (b) the common parent of the consolidated group.
• Subsequent transfers: pursuant to a plan or series of related transactions, in connection with a covered inbound transaction, stock of the acquired CFC is transferred to a partnership or foreign corporation. The Notice deems a plan to transfer the stock of the acquired CFC to exist if stock of the acquired CFC is subsequently transferred to a partnership or a foreign corporation within a two-year period after the covered inbound transaction.
• RIC, REIT, or S corporation as domestic acquiring corporation: the domestic acquiring corporation is a regulated investment company, a real estate investment trust, or an S corporation

Taxpayer reliance and comments requested

A taxpayer may rely on the Notice for transactions completed on or before the date the proposed regulations are published in the Federal Register, provided that the taxpayer and its related parties satisfy the requirements of the Notice in their entirety and in a consistent manner.

A taxpayer relying on the Notice that has maintained section 961(c) basis in a currency other than US dollars must translate section 961(c) basis into US dollars, under a reasonable method consistently applied to all acquired CFCs. To be considered reasonable, the taxpayer's method must use an exchange rate that reflects the original US dollar amounts of the US shareholder's income inclusions that gave rise to the section 961(c) basis, reduced as appropriate, taking into account any PTEP distributions. Basis reductions for PTEP distributions are similarly determined in US dollars.

Treasury and the IRS request comments on the Notice, including whether to extend the rules described in the Notice to other transactions and whether additional limitations might apply for such other transactions. Comments should be submitted by 26 February 2024.

Conclusion

We welcome Treasury's guidance on issues that have been left open since section 961(c) was enacted in 1997. The guidance confirms that taxpayers can take positions that many have already been taking, such as the belief that section 961(c) is self-executing. In some cases, the guidance may be too restrictive. Given the strict ownership requirements for covered inbound transactions (including the narrow de minimis exceptions), the Notice may fail to eliminate double taxation of the same CFC earnings in other internal reorganizations that do not satisfy the strict definitions for a "covered inbound reorganization."

Taxpayers have an early preview of the upcoming regulations and those taxpayers that may be adversely impacted by the restrictive rules in the Notice should speak out and explain their concerns to Treasury. We expect Treasury to be open to reasonable comments.