Don’t Forget Section 367(b) when Working with Foreign Corporations

September 13, 2024 in Controlled Foreign Corporations

Summary

I engineered a Section 368(a)(1)(D) reorganization in 2023 involving two CFCs. Form a new corporation, contribute the stock of OldCo to NewCo, liquidate OldCo into NewCo, and dissolve OldCo.

In thinking about the tax compliance for such a transaction, it’s easy to focus on Form 5471. Last Form 5471 ever for OldCo, first Form 5471 for NewCo, etc. Form 926 is fairly obvious, too.

Section 367(b)—and its notice requirements—are not always at the forefront of one’s mind (he admitted, sheepishly). I experienced this when writing up the reporting position memos for the CPA preparing the tax return that reports the 2023 reorganization.

Here’s a super brief overview of Section 367(b) for you.

Section 367(b)

Section 367 exists to make some otherwise tax-free corporate transactions taxable.

Section 367(a) looks at outbound transactions: transfers by U.S. persons to foreign corporations. We don’t care about that.

Section 367(b) looks at inbound transactions (transfers from foreign to domestic corporations) and foreign-to-foreign transactions. In some circumstances, it makes nonrecognition transactions taxable.

In the case of any exchange described in section 332, 351, 354, 355, 356, or 361 in connection with which there is no transfer of property described in subsection (a)(1), a foreign corporation shall be considered to be a corporation except to the extent provided in regulations prescribed by the Secretary which are necessary or appropriate to prevent the avoidance of Federal income taxes.

See how it works? The default nonrecognition rules apply unless the Regulations say otherwise.

The way it’s done is by pretending a foreign corporation is not a corporation.

Take the easy example of Section 351: a capital contribution to a corporation in exchange for stock. Section 351(a) says:

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

Well. If Section 367(b)’s regulations say that the foreign corporation receiving a purported Section 351 capital contribution is not a corporation, then property is not “transferred to a corporation and it isn’t a Section 351 capital contribution entitled to nonrecognition, is it?

That’s how Section 367(b) works. It applies not only to Section 351 transactions, but to any transaction in which one of several nonrecognition rules applies.

If you are working on a corporate transaction and you want to put an early alert on your research checklist, look for these elements in your facts:

  • A foreign corporation.
  • Application of Sections 332, 351, 354, 355, 356, or 361 in a transaction involving that corporation.
  • The transaction is from a foreign corporation to a domestic corporation, or from a foreign corporation to another foreign corporation.

Section 367(b) notice

Reporting requirements lurk everywhere in the Code and Regulations, and Section 367(b) is no exception. Notice requirements exist even if no gain is recognized in the transaction.

Who must file

Reg. Section 1.367(b)-1(c)(1) declares the notice requirement and who must file:

A notice under this paragraph (c) (section 367(b) notice) must be filed with regard to any person described in paragraph (c)(2) of this section. A section 367(b) notice must be filed in the time and manner described in paragraph (c)(3) of this section and must include the information described in paragraph (c)(4) of this section.

Short answer: you have a notice requirement if you are identified anywhere in Reg. Section 1.367(b)-1(c)(2), which identifies the following persons as having a notice requirement:

(i) A shareholder described in §1.367(b)-3(b)(1) that realizes income in a transaction described in §1.367(b)-3(a);(ii) A shareholder that makes the election described in §1.367(b)-3(c)(3);

(iii) A shareholder described in §1.367(b)-4(b)(1)(i)(A)(1) or (2) that realizes income in a transaction described in §1.367(b)-4(a);

(iv) A shareholder that realizes income in a transaction described in §1.367(b)-5(c) or 1.367(b)-5(d) and that is either—

(A) A section 1248 shareholder of the distributing or controlled corporation; or

(B) A foreign corporation with one or more shareholders that are described in paragraph (c)(2)(iv)(A) of this section;

(v) A foreign surviving corporation described in §1.367(b)-7(a); and

(vi) A domestic or foreign corporation (S) that acquires stock or securities of another corporation (P) in a transaction described in §1.367(b)-10(a)(1), without regard to the exceptions in §1.367(b)-10(a)(2).

“Realizes” vs. “recognizes”

Note two things. The first is the bolded word “realizes.” This is how you know that the notice is required even for a nonrecognition transaction, like a Section 351 capital contribution.

Income is realized when an exchange occurs. Contributing an asset to a corporation in return for stock is an exchange. You have realized income equal to the gain built into the asset.

Your realized gain is not included in gross income. It has to be “recognized.” This is the idea that your realized gain should be included in gross income. Realized gain may be excluded from gross income (e.g., gifts received or life insurance payouts). Realized gain that is not excluded from gross income is recognized, unless there is a special rule that says it is NOT recognized—a nonrecognition provision.

In almost every transaction covered by Section 367(b), there is going to be realized income. A liquidating distribution from a subsidiary into its parent is going to involve giving the parent more assets than its basis in the subsidiary stock, for instance. Income is realized. And therefore, the notice requirement is going to be triggered under Section 367(b). But that realized income is going to be given nonrecognition treatment under Section 332 (for the parent) and Section 337 (for the subsidiary).

So. No taxable income, but a notice requirement exists.

Proving no notice requirement? That’s a lot of work.

The second thing to note is that each of the six paragraphs requires you to go elsewhere to figure out the answer. You cannot look at the words, read them, and understand whether your facts fit in any one of them. You have to go look at other regulations.

This is a dreary and tedious process and you will need to disprove all six of these items if you want to escape the Section 367(b) notice requirements.

What the notice contains and who files it

Look at Reg. Section 1.367(b)-1(c)(3) and (4) to understand what the notice requirements are. That’s a whole tedious hour in itself. This type of knowledge fits in the “just in time” type of tax knowledge you need to pick up.

(As compared to the “realized” vs. “recognized” type of tax knowledge which is foundational since the beginning of the universe and you need to tattoo that type of knowledge on your brain.)

What if you don’t file the notice?

I’m not sure there is any impact. The Section 367(b) notice is not one of the listed items that extends the statute of limitations under Section 6501(c)(8).

Failure to file the notice does not render the nonrecognition transaction automatically taxable under Section 367(b)—indeed the old Section 367(b) Regulations had that as one of the consequences, and the Service removed this “too bad now you’re taxable” consequence in the 2000 amendment to the Regulations.

If any of you know what happens if you blow this notice requirement, I’d appreciate knowing.

Given the apparent lack of downside, the natural inclination is to skip it. ​I recommend doing things the hard way​.

Moral of the story

Many of you are doing tax compliance for clients with CFCs—for instance, Americans abroad who own businesses operated through a foreign corporation. From time to time your clients will do things with those corporations. These things might be simple (capital contributions) or they might be complicated (reorganizations).

If you are handling one of these projects your first concern is probably Form 5471, and fair enough. Form 5471 is a PITA. You probably think about Form 926 as well. But don’t forget Section 367.

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