On December 29, 2023, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) published Notice 2024-16 (Notice) announcing their intent to issue proposed regulations relating to the determination of basis in the stock of a controlled foreign corporation (acquired CFC) that is acquired in a “covered inbound transaction,” which is generally a section 332 liquidation or an inbound section 368(a) reorganization of a CFC. The proposed regulations will provide that in the case of a covered inbound transaction, the domestic acquiring corporation’s adjusted basis in the stock of the acquired CFC generally will include the amount of any section 961(c) basis that the transferor CFC (first-tier CFC) had in the acquired CFC stock. Section 961(c) basis is basis in stock of a CFC held by another CFC that is created as a result of inclusions in income of a US shareholder under the subpart F rules (including section 951A) with respect to the subsidiary CFC (or a lower-tier CFC). Section 961(c) basis generally corresponds to the previously taxed earnings and profits (PTEP) of a CFC and lower-tier subsidiary CFCs that it owns. The Notice alleviates concerns regarding the potential elimination of section 961(c) basis in the stock of an acquired CFC resulting from the absence of specific guidance in the statute or existing regulations, considering that, under the literal language of the statute, section 961(c) basis is only taken into account for purposes of subpart F.
The Notice applies only to covered inbound transactions, as defined in the Notice. Covered inbound transactions are certain specified nonrecognition transactions in which a domestic acquiring corporation (or in certain cases, members of a single consolidated group) acquires all of the stock of the acquired CFC from a first-tier CFC that, immediately before the transaction, owns (directly or indirectly) all of the stock of the acquired CFC. Examples of covered inbound transactions include section 332 liquidations and certain asset reorganizations of wholly owned CFCs (specifically, reorganizations described in section 368(a)(1)(A), (C), (D) (acquisitive only), or (F), but excluding triangular reorganizations).
De minimis exceptions to the Notice’s 100% ownership requirements are contemplated by the Notice. Specifically, ownership by shareholders other than the domestic acquiring corporation (or members of a single consolidated group, as applicable) of one percent or less of the total fair market value of stock of the first-tier CFC will not prevent the transactions from qualifying as a covered inbound transaction. In addition, ownership of one percent or less (in the aggregate) of the total fair market value of the stock of an acquired CFC by shareholders other than the transferor CFC is disregarded, provided that any such shareholder that is unrelated to the acquiring domestic corporation continues to own its stock of the acquired CFC after the transaction. Thus, a transaction would not fail to be a covered inbound transaction solely because the transferor CFC or the acquired CFC has limited ownership by minority shareholders.
Generally, in order for a reorganization to be a covered inbound transaction, the first-tier CFC’s shareholder(s) must receive only assets that are permitted to be received tax-free. A de minimis exception applies, which allows boot worth up to one percent of the total fair market value of the stock in the first-tier CFC to be received in the transaction, and nonetheless qualify as a covered inbound transaction.
The Notice also contemplates certain limits on the scope of covered inbound transactions relating to the potential importation of losses. Under these rules, if the first-tier CFC’s basis in the stock of the acquired CFC (including section 961(c) basis) exceeds the total fair market value of such stock, then the transaction is not a covered inbound transaction. In addition, certain post-transaction transfers of stock of the acquired CFC preclude a transaction from qualifying as a covered inbound transaction. Finally, transactions where the domestic acquiring corporation is a RIC, REIT, or S corporation (under section 1361) are not covered inbound transactions.
Taxpayers relying on the Notice that have maintained section 961(c) basis in a currency other than the US dollar must translate that basis into US dollars using a “reasonable method” before applying the operative rules of the Notice. Under these rules, a reasonable method is an exchange rate reflecting the original US dollar inclusion amounts of the US shareholder that originally gave rise to the section 961(c) basis, reduced by the US dollar basis of PTEP distributed with respect to the stock.
Taxpayers are permitted to rely on the Notice until regulations are issued. Treasury and the IRS will be accepting comments on the Notice until February 26, 2024.
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