PwC Seeks Guidance on Gain Recognition Agreements

I am writing to request that the Department of the Treasury and the Internal Revenue Service consider promulgating a proposed and temporary regulation or issuing a notice to address any ambiguity that may exist in Reg. § 1.367(a)-8T or Reg. § 1.367(a)-8 regarding the effect of certain non-recognition transfers on existing gain recognition agreements. I believe that it is important for the government to address these issues for purposes of clarifying its position in order to allay concerns that have arisen with respect to these issues.

This is an issue that, depending upon how the government interprets its regulations, does have and will have a most serious adverse impact on taxpayers' ability to enter into post-GRA restructuring transactions -- resulting in not only a trap for the unwary, but also a trap for the wary.

Before turning to these lingering issues I would like to applaud you and your respective staffs, plus, the recently departed Mr. Hicks, for a job well done with respect to the Treasury and the IRS addressing many of the outstanding issues and concerns that taxpayers had voiced respecting the final Reg. § 1.367(a)-8 GRA regulations. These important improvements and clarification include removing a "consolidation continuity" requirement where it served no apparent purpose, allowing for inbound § 361 transactions, providing for a basis "election" regarding "inbound" transactions, clarifying that "substantially all (within the meaning of § 368(a)(1)(C)" is a "facts and circumstances" test, and specifically identifying by Code section the transfers/exchanges subject to the various regulation provisions.

Unfortunately, an issue of serious import that has existed since the Reg. § 1.367(a)-8 GRA regulations initially became effective on July 20, 1998, still remains. Specifically, if an entity that has no nomenclature ("no nomenclature entity" [NNE]) under the regulations (a corporation that is not defined under the regulation as a party to the GRA -- the U.S. transferor, the transferee foreign corporation, or the transferred corporation) -- disposes of the stock or the assets of the transferred corporation, the GRA is triggered. This is because Reg. § 1.367(a)-8T(d), previously Reg. § 1.367(a)-8(e)(1)(i), provides that -- "Except to the extent provided in paragraph (e) [Exceptions] and (g) [Transactions that terminate the gain recognition agreement or reduce the amount of gain required to be recognized pursuant to a gain recognition agreement] of this section, if any of the following events occur during the term of the gain recognition agreement, it shall constitute a triggering event". Since a disposition by an NNE is not described in either Reg. § 1.367(a)-8T(e), previously Reg. § 1.367(a)-8(g), or Reg. § 1.367(a)-8T(g), previously Reg. § 1.367(a)-8(h), the transfer by an NNE of the stock, or in certain instances, of the assets of the transferred corporation would constitute a triggering event. Note, that if it was a disposition of assets of the transferred corporation by the NNE it would have to constitute a disposition of "substantially all" of the assets of the transferred corporation to constitute a triggering event.

With respect to identifying the parties to a GRA, both the Reg. § 1.367(a)-3 stock transfer rules and the Reg. § 1.367(a)-8T GRA provisions define in specific terms the parties to a GRA -- the U.S. transferor, the transferee foreign corporation, and the transferred corporation. See Reg. § 1.367(a)-8T(a)(1)(viii), (ix), and (xi). Note, that Reg. § 1.367(a)-3(d)(2) provides special rules regarding indirect stock transfers, such as, triangular "B" reorganizations (see Reg. § 1.367(a)-3(d)(1)(iii)) and triangular "C" reorganizations (see Reg. § 1.367(a)-3(d)(1)(iv)). Reg. § 1.367(a)-3(d)(2)(i) provides that "(t)he transferee foreign corporation shall be the foreign corporation that issues stock. . . to the U.S. person in the exchange". Reg. § 1.367(a)-3(d)(2)(ii) provides, in part, that in a triangular § 368(a)(1)(C) reorganization "(t)he transferred corporation shall be the acquiring corporation, (and) . . . in the case of a triangular section 368(a)(1)(B) reorganization . . . the transferred corporation shall be the acquired corporation".

I have attached several slides to this correspondence that illustrate my concerns regarding how post-GRA restructuring would prove to be highly problematic.

Notwithstanding the above discussion, there appears to be language in the regulations that possibly could provide relief from what appears to be a highly restrictive post-GRA restructuring regime. Reg. § 1.367(a)8T(e)(1)(ii)(C)(2), previously Reg. § 1.367(a)-8(g)(2)(iii)(B), provides in part that if an NNE disposes of the stock of the transferred corporation it shall constitute a triggering event "(other than in a disposition which itself qualifies under the rules of paragraph (e) of this section)" -- paragraph (e) sets forth certain nonrecognition dispositions that otherwise do not constitute triggering events as set forth in paragraph (d). The import and effect of this language is unclear. Either this parenthetical clause in the regulation is essentially superfluous, or this letter and my views are essentially superfluous. This parenthetical statement could be read to allow an NNE to dispose of the stock of a transferred corporation "in an exchange to which section 351, 354 (but only if in a reorganization described in section 368(a)(1)(B)), or 721", replicating transactions which may be entered into by the U.S. transferor, or the transferee foreign corporation that would not constitute a triggering event in accordance with Reg. § 1.367(a)-8T(e)(1)(i)(A)/U.S. transferor and Reg. § 1.367(a)-8T(e)(1)((ii)/foreign transferee corporation.

Furthermore, one could reinforce such a position by referring to the language in Reg. § 1.367(a)-3(d)(2)(iv) which is concerned with gain recognition agreements involving multiple parties. The regulation provides, in part, that the U.S. transferor's agreement to recognize gain shall include "appropriate provisions, consistent with the principles of these rules, requiring the transferor to recognize gain in the event of a direct or indirect disposition of the stock or assets of the transferred corporation". The regulation goes on to provide that in the event of a triangular section 368(a)(1)(B) reorganization "a disposition of the transferred stock shall include an indirect disposition of such stock by the transferee foreign corporation, such as a disposition of such stock by the acquiring corporation or a disposition of the stock of the acquiring corporation by the transferee foreign corporation". Note, the acquiring corporation in a triangular "B" reorganization described in Reg. § 1.367(a)-3(d)(iii)(A) is an NNE. One could read this provision to provide that a disposition by the NNE/acquiring corporation of the stock of the transferred corporation which is treated by the regulation as an indirect disposition by the transferee foreign corporation should be treated as a disposition within the purview of Reg. § 1.367(a)-8T(e)(1)(ii). More-than- likely I suspect that the government's intent regarding this provision was to impress upon taxpayers that even if the acquiring corporation was an NNE for purposes of the GRA, dispositions of the stock of the NNE by the foreign transferee corporation, or dispositions by the NNE of the stock of the transferred corporation could constitute a triggering event under the terms of the GRA. Also, note, this provision only applies to Reg. § 1.367(a)-3(d)(1)(i) through (vi) indirect stock transfers. Thus, you could have similar issues arising respecting a series of cascading § 351 transfers and the language set forth in Reg. § 1.367(a)-3(d)(2)(iv) would be inapplicable.

As I briefly noted above, if you believe that the parenthetical language in the regulation essentially empowers an NNE to be treated as a transferee foreign corporation for purposes of Reg. § 1.367(a)-8T(e) and Reg. § 1.367(a)-8(g)(1) then -- there is no problem, end of discussion. However, if you believe the parenthetical language in the regulation does not get you there -- then allow me to suggest language that could be part of a proposed and temporary regulation or the subject of a notice issued by the Treasury and the IRS:

If you have any questions, please do not hesitate to contact me directly at (202) 414-1661.