SERVICE STATES THAT U.S. TAXATION OF FOREIGN CORPORATIONS THAT LIQUIDATE U.S. SUBS DOES NOT VIOLATE TREATY NONDISCRIMINATION RULES.

Notice 87-66

The Internal Revenue Service today announced that, for the reasons set forth below, the last paragraph of Notice 87-5, 1987-3 I.R.B. 7, is being withdrawn as of the date of this Notice. The last paragraph of Notice 87-5 provided that section 367(c)(2) of the Internal Revenue Code of 1986 (the "Code") will be inapplicable to liquidation of domestic subsidiaries of foreign corporations in situation in which application of that section would violate a treaty nondiscrimination provision based on capital ownership similar to Article 24(5) of the 1981 draft of the U.S. Model Income Tax Convention (U.S. Model).

Section 337 of the Code generally provides that no gain or loss will be recognized on the distribution of property to an 80 percent corporate shareholder in a complete liquidation of the distributing corporation. The purpose of this non-recognition provision is to postpone collection of the U.S. corporate-level tax where the distributed property remains in U.S. corporate solution and thus is subject to U.S. corporate-level taxing jurisdiction. On the other hand, section 337 non-recognition is not available when the distributee of property is an individual or other person that is not a corporation. In each of these cases, recognition of gain or loss is required when the distributed property leaves U.S. corporate solution.

Except as provided in regulations, section 367(e)(2) denies section 337 nonrecognition treatment in the case of liquidations of controlled subsidiaries into foreign parent corporations. Property distributed to foreign corporations leaves U.S. corporate solution, and any appreciation inherent in such property at the time of the distribution will not generally be subject to U.S. corporate-level tax upon a subsequent disposition by the foreign corporation unless the disposition gives rise to gain which is effectively connected with the conduct of a trade or business within the United States by the foreign corporation.

Article 24(5) of the U.S. Model generally provides that enterprises of a Contracting State which are owned or controlled by residents of the other Contracting State shall not be subjected to any taxation or connected requirement which is other or more burdensome than the taxation or connected requirements to which other similar enterprises of the first-mentioned Contracting State are or may be subjected. This provision is identical to Article 24(6) of the OECD Model Double Taxation Convention On Income and On Capital.

The capital ownership nondiscrimination provision requires that a foreign-owned corporation be treated no worse than a similar domestically-owned corporation. This rule, like all nondiscrimination provisions, does not prohibit differing treatment of entities that are in differing circumstances. Rather, a protected enterprise is only required to be treated in the same manner as other enterprises that, from the point of view of the application of the tax law, are in substantially similar circumstances both in law and in fact.

Accordingly, section 367(e)(2)'s denial of section 337 nonrecognition treatment constitutes prohibited capital ownership discrimination only if a U.S. corporation owned by a foreign corporation is, in the context of a liquidation, similar to a U.S. corporation owned by another U.S. corporation. It is clear that such enterprises are not similar, since a liquidating distribution by the foreign-owned corporation may remove U.S. corporate assets from U.S. corporate-level taxing jurisdiction, while in the liquidation of the U.S.-owned corporation the assets will remain in U.S. corporate solution, assuring U.S. corporate-level taxation.

Thus, section 367(e)(2) or other domestic law provisions that ensure U.S. corporate-level taxation of income that could escape such taxation in the hands of a nonresident owner do not violate a treaty nondiscrimination provision based on capital ownership similar to Article 24(5) of the U.S. Model.

Consistent with the above, the last paragraph of Notice 87-5, 1987-3 I.R.B. 7, is hereby withdrawn; pursuant to authority granted by section 7805(b), this withdrawal applies to distributions made after the date of this Notice. Regulations will be issued under section 367(e)(2) consistent with the terms of this Notice; such regulations will generally be effective as of January 1, 1987, but will follow the last paragraph of Notice 87-5 with respect to the period between January 1, 1987, and the date of this notice. Regulations to be issued under section 367(e)(1) will be effective 30 days after their date of publication.

The Internal Revenue Service invites comments on how it might exercise its regulatory authority to allow section 337 nonrecognition for property used by an 80-percent foreign corporate distributee in the conduct of a U.S. trade or business. Comments may be directed to: Associate Chief Counsel (Technical and International), Internal Revenue Service, Washington DC 20224.