The IRS has issued final regulations (TD 9759) under Sections 334(b)(1)(B) and 362(e)(1), which apply to certain corporate acquisitions of loss property in nonrecognition transactions resulting in an “importation” of a built-in loss property. The final regulations generally adopt, with a few changes, proposed regulations issued in 2013 (see Tax Alert 2013-1772). The final regulations also adopt without change proposed regulations issued in 2005 to reflect certain statutory changes under Sections 332 and 351 (see Tax Alert 2005-242).

Background

Sections 334(b)(1)(B) and 362(e)(1) were enacted as part of the American Jobs Creation Act of 2004 to prevent the erosion of the corporate tax base through the importation of loss in nonrecognition transfers. These provisions apply to corporate acquisitions of loss property in complete liquidations under Section 332, corporate reorganizations under Section 368, exchanges under Section 351, and capital contributions.

Final regulations

Adoption of 2013 proposed regulations

The final regulations adopt in large part the provisions of the 2013 proposed regulations. Under the final regulations, like the 2013 proposed regulations, property may be subject to the anti-loss importation provisions if any gain or loss recognized on the disposition of the property: (i) would not be subject to federal income tax in the hands of the transferor (Transferor) immediately before the transfer; and (ii) would be subject to federal income tax in the hands of the transferee (Acquiring) immediately after the transfer. Property meeting each of these requirements is referred to as “importation property.”

Loss importation property is identified under a hypothetical sale analysis. Under this approach, the actual tax treatment of any gain or loss that would be recognized by both the Transferor and Acquiring upon the sale of such property is analyzed to determine whether the property is importation property. This determination must take into account all relevant facts and circumstances, and the final regulations contain several examples illustrating this approach. Importantly, the final regulations, like the 2013 proposed regulations, expressly state that gain or loss recognized by a CFC is not considered subject to federal income tax solely by reason of such income affecting an inclusion under Section 951(a). The same is true for qualified electing fund (QEF) inclusions under Section 1293(a) for passive foreign investment companies (PFICs) under Section 1293(a). On the other hand, the regulations take into account gain that would be taxable to the foreign corporation transferor itself (for example, as income effectively connected with a US trade or business or under Section 897 rules for investments in US real property interests) on the transfer of the property. The preamble notes that, in this regard, the determination of whether the foreign corporation is subject to tax on the disposition would take into account whether the foreign corporation could eliminate US taxation under the provisions of an income tax treaty. In these circumstances, the property would be loss importation property.

In addition, the final regulations contain modified rules for applying the hypothetical sale analysis when the Transferor is a partnership, an S corporation or a grantor trust. In general, because of the flow-through nature of these entities, the determination of the tax treatment on a hypothetical sale is made at the partner, shareholder or owner level, and must take into account any special allocations that may be in place. Furthermore, the final regulations also contain an anti-avoidance rule applicable to Transferors that are entities that, although subject to US tax, may be able to effectively shift the consequences of gain or loss to its shareholders or owners through distributions (for example, certain domestic trusts, RICs, REITs and co-operatives). In this case, if property is transferred by such an entity and such property was acquired as part of a plan to avoid the anti-importation provisions, the entity is subject to a look-through rule. Under this look-through rule, the entity is presumed to distribute the proceeds of the hypothetical sale and, to the fullest extent possible, such distribution is deemed to be made to persons not subject to US federal income tax.

Once the importation property has been identified, Acquiring then determines the aggregate value and tax basis of all importation property acquired in the transaction without regard to the anti-loss importation provisions. This determination is made by reference to all importation property acquired from all Transferors (as opposed to a transferor-by-transferor approach found under Section 362(e)(2) for loss duplication transactions). If the aggregate basis of the importation property does not exceed such property's aggregate value, the transaction is not subject to the anti-loss importation provisions (but may still be subject to the loss duplication rules of Section 362(e)(2)). If the aggregate basis of the importation property exceeds such property's aggregate value, the transaction is a loss importation transaction and Acquiring’s basis in each importation property equals its value.

Generally, the “value” of property is its fair market value without regard to any liabilities assumed in the transaction. Because a partner’s share of partnership liabilities is generally included in its basis in its partnership interest, however, this may create the appearance of a built-in loss. Accordingly, the final regulations modify the definition of value for partnership interests to take liabilities into account.

The final regulations also modify the information statement filing requirements required for various corporate nonrecognition transactions. Specifically, information required to be disclosed in statements under Reg. Sections 1.332-6, 1.351-3, and 1.368-3 is expanded to include the aggregate value and basis of: (i) loss importation property; (ii) loss duplication property under Section 362(e)(2); (iii) property in which gain was recognized by the transferor (which is not loss importation property or loss duplication property); and (iv) property not described in (i), (ii) or (iii).

Changes in final regulations

In addition to adopting as final the prior provisions included in the 2013 proposed regulations, the final regulations include a few modifications and clarifications, as well as some non-substantive amendments. A few of the more substantive changes are described here.

Tax-exempt transferors of debt-financed property. Under the 2013 proposed regulations, if a tax-exempt entity transferred debt-financed property, the disposition of that property would be subject to federal income tax, so the property could not be importation property. In response to concerns about this rule applying even to a de minimis amount of indebtedness, the final regulations instead treat debt-financed property as subject to federal income tax in proportion to the amount of gain or loss that would be includible in the transferor’s unrelated business taxable income on a sale under Sections 511-514.

Transferred basis transaction. In response to requests for clarification of whether a transferee’s basis in property continued to be considered determined by reference to its transferor’s basis, notwithstanding the application of Section 334(b)(1)(B) or Section 362(e)(1), the final regulations expressly state that, notwithstanding the application of the anti-loss importation or anti-duplication provisions to a transaction, the transferee’s basis is generally considered determined by reference to the transferor’s basis for federal income tax purposes., The final regulations add, however, that, solely for purposes of applying Section 755, a determination of basis under the anti-loss importation provisions is treated as not made by reference to the transferor’s basis.

Partnership allocations. In determining to which partner an item should be allocated in a hypothetical sale, the final regulations clarify that the partnership agreement, as well as any applicable rules of law, should be taken into account.

Applicability date

The final regulations under Sections 334(b)(1)(B) and 362(e)(1) generally apply to transactions occurring on or after March 28, 2016, unless completed under a binding agreement that was in effect prior to that date. The final regulations also apply to transactions occurring before March 28, 2016, resulting from entity classification elections made under Treas. Reg. Section 301.7701-3 that are filed on or after March 28, 2016.

In addition, the final regulations provide that taxpayers may apply the rules to any transaction occurring after October 22, 2004.

Implications

As noted, the final regulations largely adopt the 2013 proposed regulations without significant change. The final regulations obviously affect many asset transfers from tax-exempt transferors or inbound cross-border transfers.  In this respect, it should be noted that the government rejected a suggestion of commentators to provide a “credit” against otherwise-required basis reduction to the extent of an all E&P inclusion.  See Reg. Section 1.334-1(b)(3)(iii)(C)(3), as revised by TD 9759. Thus, for example, notwithstanding an all E&P inclusion under Reg. Section 1.367(b)-3 from the inbound liquidation of a controlled foreign corporation (CFC), the final regulations generally apply to any property acquired by the domestic distributee corporation from the liquidating CFC in a loss importation transaction.

However, the final regulations will also affect—and add computational complexity to—a larger range of relatively straightforward transactions (e.g., complete liquidations under Section 332, transfers of property described in Section 351(a), and reorganizations under Section 368(a)) when any transferor is tax-exempt or when the transferor is a specified flow-through entity such as a partnership.  In such case, under the final regulations, Acquiring is obligated to segregate properties between importation property and non-importation property.  This task is refined further, when Acquiring also acquires loss duplication property (see Reg. Section 1.362-4).  Further complexity will arise, too, when there are multiple transferors (or the transferor is a flow-through entity such as a partnership with a mix of taxable and tax-exempt partners); in that case, each property must be “tentatively divided into separate portions” by Acquiring for purposes of applying the final regulations (e.g., to include such portions with all other importation property to determine whether the transaction is a loss importation transaction).

Indeed, essentially all transferred basis subchapter C nonrecognition transactions will feel the effect of these final regulations because of new information reporting requirements (see, e.g., Reg. Section 1.351-3) that are included with an acquiring corporation’s tax return for the year of the transaction.  Such statements obligate the acquiring corporation to distinguish among four categories of acquired properties:  (i) importation property; (ii) loss duplication property; (iii) property in which gain or loss was recognized; and (iv) all remaining property.

Finally, as noted above, while the final regulations are effective March 28, 2016, there is near-term interplay between the effective date and retroactive check-the-box elections filed on or after March 28, 2016.  For example, if a check-the-box election on Form 8832 is filed on April 10, 2016, to treat a partnership with tax-exempt partners as a corporation, and the effective date of the election is March 15, 2016, the deemed incorporation of the corporation occurs at the end of the day on March 14, 2016, and is subject to the final regulations. See Reg. Section 301.7701-3(g)(3)(i). Even though the deemed incorporation occurs prior to the effective date of the final regulations, because the check-the-box election is made on or after March 28, 2016, the deemed incorporation is subject to the final regulations, including the new reporting requirements.  See Reg. Section 1.351-3(f), as revised by TD 9759.

———————————————