January 8, 2024
United States | Notice 2024-16 provides that Section 961(c) basis of acquired CFCs carries over to domestic acquiring corporations in certain covered inbound transactions
In Notice 2024-16 (Notice), issued December 28, 2023, the United States (US) Treasury Department (Treasury) and the Internal Revenue Service (IRS) allow domestic acquiring corporations in certain inbound liquidations and asset reorganizations (covered inbound transactions) to determine under IRC Sections 334(b) and 362(b) their basis in the stock of a controlled foreign corporation (CFC) acquired in the transaction (an acquired CFC) as if the transferor CFC's basis from subpart F income and global intangible low-taxed income (GILTI) inclusions (Section 961(c) basis) were adjusted basis.
Under IRC Section 961(a), a US shareholder's basis in CFC stock or in property causing the US shareholder to be treated as owning CFC stock under IRC Section 958(a)(2) (applicable property) increases by the US shareholder's subpart F income inclusion with respect to such CFC. The increase, however, only occurs to the extent to which the amount was included in the US shareholder's gross income.
IRC Section 951A(f)(1) and Treas. Reg Section 1.951A-5(b)(1) treat a US shareholder's GILTI inclusion the same way as a subpart F income inclusion for purposes of IRC Section 961.
Under IRC Section 961(b)(1), a US shareholder's basis in CFC stock or applicable property is reduced by amounts received from the CFC that are excluded from gross income under IRC Section 959(a) (i.e., distributions of previously taxed earnings and profits (PTEP)). To the extent that a distribution of PTEP exceeds the basis of the CFC stock or applicable property for which it is received, the excess is treated as a gain from the sale or exchange of property (IRC Section 961(b)(2)).
When a US shareholder is treated as owning stock of a lower-tier CFC that is directly owned by an upper-tier CFC, IRC Section 961(c) requires adjustments similar to those required under IRC Section 961(a) and (b) to the basis in the stock of the lower-tier CFC. Adjustments are also required to the basis of stock in any other CFC by reason of which the US shareholder owns the lower-tier CFC, but only for purposes of determining the US shareholder's subpart F and GILTI inclusions under IRC Section 951(a). IRC Section 961(c) does not apply these adjustments to any stock to which a basis adjustment under IRC Sections 961(a) and (b) applies.
Although IRC Section 961(c) was added to the Code in 1997, no final regulations have been issued to implement the statute. Moreover, preexisting regulations implementing IRC Sections 961(a) and (b) have not been updated to incorporate IRC Section 961(c).
Because Section 961(c) basis applies solely for purposes of IRC Section 951(a), it was unclear whether Section 961(c) basis in a CFC could convert into adjusted basis when the stock of the CFC was acquired by a domestic acquiring corporation. If Section 961(c) basis did not convert to adjusted basis, taxpayers would often have to recognize non-economic gains on PTEP distributions from the acquired CFC or upon a subsequent sale of the stock of the acquired CFC. As discussed in the Notice, Treasury and the IRS determined that these results were inconsistent with one of the primary purposes of IRC Section 961, to prevent double taxation of CFC earnings. To prevent that, the Notice announced plans to issue regulations consistent with the guidance described next.
Definition of covered inbound transaction
Under Notice 2024-16, covered inbound transactions include two sets of transactions (collectively, inbound nonrecognition transactions) in which a domestic acquiring corporation acquires all the stock of the acquired CFC from a transferor CFC that, immediately before the transaction and any related transactions, directly or indirectly owns all of the stock of the acquired CFC. The first set of covered inbound transactions (upstream covered inbound transactions) includes liquidations under IRC Section 332 and nontriangular upstream asset reorganizations under IRC Section 368(a)(1)(A) and 368(a)(1)(C). The second set of transactions (other covered inbound transactions) includes nontriangular reorganizations under IRC Section 368(a)(1)(A) and 368(a)(1)(C), nondivisive asset reorganizations under IRC Section 368(a)(1)(D) and reorganizations described under IRC Section 368(a)(1)(F), provided that:
Subject to the limited de minimis exception discussed later, the Notice's strict stock ownership thresholds may lead to surprising results. For example, assume that USP owns all the stock of CFC1, which owns all the stock of CFC2. A liquidation of CFC1 may qualify as an upstream covered inbound transaction. By contrast, if USP owned all the stock of CFC1 and 5% of the stock of CFC2, with CFC1 owning the remaining 95% of CFC2 stock, the transaction would not qualify as an upstream covered inbound transaction. Similarly, if USP owned 95% of CFC1 stock, a liquidation of CFC1 would not qualify as an upstream covered inbound transaction whether or not CFC1 owned all the stock in CFC2, and whether or not a person related to USP owned the remaining 5% of CFC1's stock.
De minimis rules for stock ownership
The strict stock ownership requirements are subject to limited de minimis exceptions. First, a transaction would not fail to qualify as a covered inbound transaction solely because, immediately before the transaction, one or more persons other than the acquiring domestic corporation own, in aggregate, 1% or less of the total fair market value of the stock of the transferor CFC. Second, stock of the acquired CFC owned by a person(s) other than the transferor CFC is disregarded to the extent it represents 1% or less of the fair market value of the outstanding stock of the acquired CFC and such person(s) continue to own the acquired CFC stock after the transaction and any related transactions if they are not related to the domestic acquiring corporation.
For example, if USP owned 99.1% of the stock of CFC1, which owned 99.1% of the stock of CFC2, a liquidation of CFC1 could qualify as a covered nonrecognition transaction by reason of the de minimis exception. If, however, USP held less than 99% of the CFC1, or CFC1 held less than 99% of the stock CFC2, the transaction could not qualify for the de minimis exception, and thus could not be treated as a covered nonrecognition transaction.
Limitations on the scope of covered inbound transactions
A transaction would not qualify as a covered inbound transaction under the following scenarios:
If the stock of multiple acquired CFCs is transferred by a single transferor CFC in a covered inbound transaction, these limitations apply separately to each acquired CFC.
The limitation on the importation of built-in loss stock is an all-or-nothing rule. That is, if the basis of acquired CFC stock is equal to or less than its fair market value, all Section 961(c) basis may be converted into adjusted basis; if the basis exceeds fair market value by any amount, none of the Section 961(c) basis is eligible to convert into adjusted basis under the Notice.
The Notice indicates that taxpayers should not draw inferences about the treatment of Section 961(c) basis in transactions other than covered inbound transactions. Treasury and the IRS will consider the impact of Section 961(c) basis on other transactions in future guidance.
Taxpayers may rely on the guidance in the Notice for transactions completed before the date of the forthcoming proposed regulations, provided the taxpayer and all related parties consistently apply all the rules in the Notice. The Notice provides no guidance on the scope of this consistency requirement, including whether it applies solely to transactions or periods following the Notice's issuance.
Taxpayers that maintain Section 961(c) basis in a currency other than the US dollar (USD) must translate the Section 961(c) basis to USD under a reasonable method applied consistently to all acquired CFCs in any covered inbound transaction. A reasonable method uses an exchange rate that reflects the original USD amounts of the Section 961(c) basis reduced, as applicable, to take into consideration distributions of PTEP (translated to the USD basis of the PTEP).
The guidance in Notice 2024-16 is a welcome development, offering much-needed clarity for domestic acquiring corporations acquiring lower-tier CFC stock in nonrecognition transactions. The Notice's limitations and exclusions are key considerations in planning and executing such transactions. Furthermore, taxpayers seeking to rely on the Notice should carefully consider the possible scope of the reliance provision's consistency requirement, including whether the taxpayer previously took any positions contrary to the guidance in the Notice.
Finally, the Notice does not offer guidance on other pressing questions on the scope and effect of IRC Section 961(c), including whether and how Section 961(c) basis reduces tested income for purposes of determining a US shareholder's GILTI inclusion.