Final Regulations Address Gain Recognition Agreements and Other Cross-Border Transfer Reporting

By Irwin Halpern, J.D., LL.M., and Meyer Jacobson, J.D., LL.M., Washington

Editor: Jon Almeras, J.D., LL.M.

Foreign Income & Taxpayers

In November, the IRS and Treasury issued final regulations revising the reporting rules applicable to stock and property transfers under Secs. 367 and 6038B, including Sec. 367(a) gain recognition agreements (GRAs) (T.D. 9704). Most notably, the regulations provide common standards to address untimely and incomplete filings, including revised coordination of the Secs. 367 and 6038B rules. The regulations adopt, with amendments, proposed regulations issued on Jan. 31, 2013 (REG-140649-11).

New Provisions in the Final Regulations

While the final regulations are generally consistent with the proposed regulations, they include several revisions and additions. Most notably:

  • The final regulations expand the scope of the proposed regulations to include the filings under Regs. Secs. 1.367(a)-2 and 1.367(a)-7 (Regs. Secs. 1.367(a)-2(f) and 1.367(a)-7(e)(2)).
  • The final regulations revise the extension of statute-of-limitation rules applicable in the event a taxpayer fails to comply in any material respect with the GRA or Regs. Sec. 1.367(e)-2 reporting requirements (Regs. Secs. 1.367(a)-8(j)(8) and 1.367(e)-2(e)(4)(ii)(B)).
  • The final regulations expand the Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, information reporting required when a taxpayer files a GRA (Regs. Sec. 1.6038B-1(b)(2)(iv)).
  • In certain circumstances, taxpayers may resubmit previously filed requests for relief (including requests that were denied) and thereby apply the regulations' new standards and procedures retroactively (Regs. Secs. 1.367(a)-7(j) and 1.367(a)-8(r)(3)).
  • As anticipated, and in tandem with the issuance of the final regulations, the IRS withdrew, effective Nov. 19, 2014, the memorandum LMSB-4-0510-017, Directive on Examination Action With Respect to Certain Gain Recognition Agreements (July 26, 2010).
Background

Sec. 367 modifies the application of the subchapter C nonrecognition rules to cross-border transactions. Secs. 367(a) and (e) address transfers of stock and other property by U.S. persons to foreign corporations (outbound transfers); Sec. 6038B contains notification requirements that apply to these transfers. Sec. 367(e) also addresses certain transfers between foreign corporations (see Regs. Sec. 1.367(e)-2(c) (addressing distributions of property in "foreign to foreign" Sec. 332 liquidations).)

Together, Secs. 367 and 6038B provide a regime of substantive and procedural requirements that must be met to apply the subchapter C rules to avoid current gain recognition in connection with an outbound transfer.

Filings Addressed

The final regulations address the following filing requirements under Secs. 367(a), 367(e), and 6038B:

  • The reporting requirements under Temp. Regs. Sec. 1.367(a)-2T(a) for when a U.S. person subject to Sec. 367(a) transfers property to a foreign corporation for use in the active conduct of a foreign trade or business. The 2013 proposed regulations did not address this reporting;
  • The reporting requirements under Regs. Secs. 1.367(a)-3(c)(6) and (7), for certain domestic target corporations in connection with a transfer of stock or securities of such corporation to a foreign corporation;
  • The reporting requirements under Temp. Regs. Secs. 1.367(a)-3T(d)(2)(vi)(B)(1)(ii) and (d)(2)(vi)(C) for a domestic target corporation that is a party to certain indirect stock transfers under Regs. Sec. 1.367(a)-3(d)(1);
  • The reporting requirements under Regs. Sec. 1.367(a)-7(c) for when a domestic corporation transfers property to a foreign corporation in a Sec. 361 exchange. The proposed regulations did not address this reporting;
  • Gain recognition agreements and associated filings under Regs. Sec. 1.367(a)-8, which are required in connection with certain U.S. persons' transfers of stock or securities to a foreign corporation;
  • The reporting requirements under Regs. Sec. 1.367(e)-2 for when a domestic or foreign corporation liquidates into a foreign parent corporation under Sec. 367(e); and
  • Form 926, which generally implements the Sec. 6038B requirement for a U.S. person to report the transfer of property to a foreign corporation in a nonrecognition transaction.

Before the final regulations were issued, a variety of rules applied to late or incomplete filings under Secs. 367(a), 367(e), and 6038B, and to taxpayers' attempts to correct these filings. As described below, the final regulations institute a more cohesive regime for both the IRS and taxpayers to address these issues.

If the Sec. 367 filing requirements are not satisfied, the property transfer may be subject to current gain recognition. Sec. 6038B supplements this consequence with a penalty equal to 10% of the fair market value (FMV) of the transferred property, up to $100,000. (The $100,000 limit does not apply if the failure to comply was due to intentional disregard.) The Sec. 6038B penalty does not apply if the U.S. transferor demonstrates that the failure to comply was due to reasonable cause and not willful neglect.

Sec. 367 Revisions

The final regulations revise the Treasury regulations under Secs. 367(a) and (e) to state common standards that apply to untimely or incomplete filings, and to make other changes. The most significant revisions follow.

The standard applicable to taxpayers seeking to avoid gain recognition by remedying untimely or incomplete GRA filings is revised from proof that the failure to comply was "due to reasonable cause and not willful neglect" to proof that the failure "was not willful" (Regs. Sec. 1.367(a)-8(p)(1)). The preamble to the proposed regulations explains this change by stating that

[t]he existing reasonable cause standard, given its interpretation under the case law, may not be satisfied by U.S. transferors in many common situations even though the failure was not intentional and not due to willful neglect. Based on the current operation of the section 367(a) GRA regulation the [IRS and Treasury] believe that full gain recognition under section 367(a)(1) should apply only if a failure to timely file an initial GRA or a failure to comply with the section 367(a) GRA regulations with respect to an existing GRA is willful. [REG-140649-11]

"Willful" is to be interpreted consistently with its meaning in the context of other civil penalties (the preamble to REG-140649-11 cites Sec. 6672, penalty for failure to collect or pay over tax, or attempt to defeat or evade tax, as an example), and includes a failure due to gross negligence, reckless disregard, or willful neglect, determined based on all the facts and circumstances (Regs. Sec. 1.367(a)-8(p)(1)). The regulations contain specific examples applying the willful standard to GRAs, illustrating:

  • An isolated, accidental oversight that is not willful (Regs. Sec. 1.367(a)-8(p)(3), Example (1));
  • A taxpayer's course of conduct that is relevant to the willfulness determination (Regs. Sec. 1.367(a)-8(p)(3), Example (2));
  • A knowing omission of material information that is willful (Regs. Sec. 1.367(a)-8(p)(3), Example (3)); and
  • A knowing, willful decision to not file a GRA (Regs. Sec. 1.367(a)-8(p)(3), Example (4)).

The final regulations revise the IRS procedures for processing requests for late-filing relief by removing the current 120-day deadline for the IRS to process a request for relief (see Regs. Sec. 1.367(a)-8(p)(1), as in effect prior to T.D. 9704). The preamble to the proposed regulations explains that "the IRS and the Treasury Department do not believe that the IRS's processing time with respect to a relief request should be determinative of whether a U.S. transferor has satisfied its obligations under the section 367(a) GRA regulations" (REG-140649-11). In addition, the final regulations revise the language describing the requirement that taxpayers request relief shortly after discovering a missed or incomplete filing. The prior regulations refer to a U.S. transferor requesting relief "as soon as" becoming aware of the omission; the final regulations replace "as soon as" with "promptly after."

The final regulations provide guidance addressing when a GRA is considered timely filed and what gives rise to a failure to comply with the GRA requirements in a material respect. A GRA is timely filed only when every document that is required to be filed as part of the GRA is timely filed and completed in all material respects (Regs. Sec. 1.367(a)-8(d)(1)). An example illustrates the "completed in all material respects" requirement, providing that the standard is not met where a taxpayer omits the FMV or the tax basis of the transferred stock (Regs. Sec. 1.367(a)-8(p)(3), Example (3)).

Consistent with the proposed regulations, the final regulations apply the "not willful" and "completed in all material respects" standards and the new procedures for requesting late-filing relief to the filings under Regs. Secs. 1.367(a)-3(c), 1.367(a)-3(d), and 1.367(e)-2 (Regs. Secs. 1.367(a)-3(f) and 1.367(e)-2(f)). The final regulations extend the scope of the proposed regulations to also apply the "not willful" standard and new procedures for requesting late-filing relief to filings under Regs. Secs. 1.367(a)-2 and 1.367(a)-7 (Regs. Secs. 1.367(a)-2(f) and 1.367(a)-7(e)(2)). (Previously, Temp. Regs. Sec. 1.367(a)-7T(e) provided late-filing relief under the reasonable-cause standard (T.D. 9615).) In conjunction with issuing Regs. Sec. 1.367(a)-7(e)(2), T.D. 9704 removes Temp. Regs. Sec. 1.367(a)-7T.

GRAs must now contain language agreeing that a failure to comply in any material respect with the GRA rules extends the statute of limitation on assessment for the year when gain is required to be reported until the close of the third full tax year ending after the date the taxpayer furnishes the omitted information (Regs. Secs. 1.367(a)-8(c)(2)(iii) and (j)(8)). (The prior regulations, as well as the proposed regulations, extended the statute of limitation until the close of the third full tax year after the IRS "receives actual notice of the failure to comply from the U.S. transferor" (Regs. Sec. 1.367(a)-8(j)(8), as in effect before T.D. 9704; Prop. Regs. Sec. 1.367(a)-8(j)(8)). The final regulations state similar statute-of-limitation rules that apply to the Regs. Sec. 1.367(e)-2 disclosures (Regs. Secs. 1.367(e)-2(b)(2)(i)(C)(1), 1.367(e)-2(b)(2)(iii)(D), and 1.367(e)-2(e)(4)(ii)(B)).

Sec. 6038B Revisions

The final regulations revise the integration and coordination of the Sec. 6038B filings and penalty provisions with the Sec. 367 regulations.

The Sec. 6038B penalty applies to a failure to comply in any material respect with the GRA, Sec. 367(a), or the Sec. 367(e) outbound transfer reporting rules (Regs. Sec. 1.6038B-1(b)(1)(i)). (In the context of GRA filings, the preamble to the proposed regulations refers to this provision as a clarification.) While the "completed in all material respects" standard follows the final Sec. 367 regulations, the new "not willful" standard is not extended to Sec. 6038B reporting. Instead, the current "reasonable cause and not willful neglect" standard remains in place (Temp. Regs. Sec. 1.6038B-1T(f)(3); see also Sec. 6038B(c)(2)). As a result, the final regulations contemplate a class of noncompliance that falls between the two standards: missed or incomplete filings that satisfy the not-willful test, but fail the reasonable-cause test and are thus subject to the Sec. 6038B penalty (but not Sec. 367 gain recognition). In this regard, the preamble to the proposed regulations states that "[t]he IRS and Treasury Department believe that the penalty imposed by section 6038B generally should be sufficient to encourage proper reporting and compliance" (REG-140649-11).

The final regulations revise the coordination of Form 926 and GRA filings. Regs. Sec. 1.6038B-1(b)(2) formerly provided that a U.S. transferor that properly filed a GRA did not have to file Form 926. Consistent with the proposed regulations, the final regulations eliminate this exemption and require that a U.S. transferor that executes a GRA also complete a Form 926. The final regulations augment this provision in the proposed regulations, adding that this Form 926 must, inter alia , state the FMV, adjusted tax basis, and gain recognized with respect to the transferred stock or securities (Regs. Sec. 1.6038B-1(b)(2)(iv)). (The final regulations also modify the information that must be reported in connection with a transfer under Sec. 367(e)(2) (Regs. Sec. 1.6038B-1(e)(4)).)

Effective Dates

The final regulations are effective for filings that are due on or after Nov. 19, 2014, and for requests for relief for late or incomplete filings that are submitted on or after Nov. 19, 2014 (Regs. Secs. 1.367(a)-2(f)(4), 1.367(a)-3(g)(1)(x), 1.367(a)-7(j), 1.367(a)-8(r)(1)(i), 1.367(e)-2(g), and 1.6038B-1(g)(6)).

In two instances, including under the GRA rules, the final regulations specifically provide that taxpayers may resubmit under the final regulations a request for relief that was submitted before Nov. 19, 2014, provided that the statute of limitation on assessment has not expired for any tax year to which the request relates (Regs. Secs. 1.367(a)-7(j) and 1.367(a)-8(r)(3)). As the preamble to the final regulations describes, "§1.367(a)-8(r)(3) of these final regulations provides a procedure under which U.S. transferors may resubmit certain previously filed requests (including requests that were denied)" (T.D. 9704). Where a taxpayer submits or resubmits a request for relief regarding a filing that was due before Nov. 19, 2014, other applicable provisions of the final regulations apply (e.g., the requirement to submit a Form 926 with a GRA) (Regs. Sec. 1.6038B-1(g)(6)).

Finally, in tandem with the issuance of the final regulations, on Nov. 21, 2014, the IRS withdrew LMSB-4-0510-017, effective on Nov. 19, 2014. The preamble to the final regulations explains that LMSB-4-0510-017 was a temporary measure and that T.D. 9704 "provides comprehensive guidance that is intended to ensure compliance with the GRA provisions" (T.D. 9704).

A version of this item appeared as a Deloitte United States Tax Alert.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte, its affiliates and related entities, shall not be responsible for any loss sustained by any person who relies on this publication.


EditorNotes

Jon Almeras is a tax manager with Deloitte Tax LLP in Washington.

For additional information about these items, contact Mr. Almeras at 202-758-1437 or jalmeras@deloitte.com.

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

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