The Service and Treasury, in T.D. 9704, 2014-50 IRB 922 have published final regulations which clarify, as well as update, the rules on the consequences faced by U.S. and foreign persons for failing to file GRAs or other reporting obligations and resulting penalties under §6038B with respect to certain transfers of property made to foreign corporations in a non-recognition transaction. The Service had previously issued regulations in 2013 (proposed regulations) which required a U.S. person that transfers property to a foreign corporation to file a Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation,” regarding a transfer of stock or securities when a GRA is filed as well to avoid penalties under §6038B. The proposed regulations did not require the U.S. transferor to report any specific information regarding the transferred stock or securities. The final regulations modify Treas. Reg. §1.6038-1(b)(2)(iv) and require the U.S. transferor report the FMV, adjusted tax basis and gain recognized on the transferred stock or securities and other information.
The proposed regulations apply to requests for relief submitted on or after the date the final regulations become effective. The final regulations set forth a procedure whereby U.S. transferors can resubmit previously filed requests, including requests that were denied. Relief has been extended for non-willful failures with respect to other reporting obligations under §367(a) that were not covered in the proposed regulations. See Treas. Regs. §§1.367(a)-2 and 1.367(a)-7. The previously issued temporary regulations under Treas. Reg. § 1.367(a)-7T regarding reasonable cause relief has been removed.
The final regulations permit in certain instances, a U.S. transferor to attach a copy of a previously filed Form 8838, “Consent to Extend the Time to Assess Tax Under Section 367 — Gain Recognition Agreement,” to an amended return.
Preamble Summary to Final Regulations of Comments and Explanation of Revisions
A. Meeting the Requirements Under Section 6038B Where GRA is Filedatisfaction of Section
The proposed regulations (issued in January, 2013) under §6038B require a U.S. person that transfers property to file a Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, with respect to a transfer of stock or securities in all cases in which a GRA is filed in order to avoid penalties under section 6038B. The proposed regulations do not require that the U.S. transferor report on Form 926 any specific information regarding the transferred stock or securities.
The final regulations require that similar information that must be provided for other types of transferred property, the U.S. transferor should report on the Form 926 the fair market value, adjusted tax basis, and gain recognized with respect to the transferred stock or securities, as well as any other information that Form 926, its accompanying instructions, or other applicable guidance require be submitted with respect to the transfer of the stock or securities. See Treas. Reg. §1.6038B-1(b)(2)(iv)(as modified by the final regulations).
B. Previously Filed Requests
The proposed regulations (2013) in Treas. Reg.§ 1.367(a)-8(p) only apply to requests for relief submitted on or after the date the proposed regulations are adopted as final regulations. The final regulations provide relief for certain failures to file or otherwise comply with the GRA rules where such GRA failures that were not willful and that were the subject of requests for relief submitted under Treas. Reg.§ 1.367(a)-8(p) of the existing final regulations (or submitted under Treas. Reg. § 1.367(a)-8T(e)(10) or predecessor provision. Treas. Reg. § 1.367(a)-8(r)(3) of the finalized regulations sets forth a procedure under which U.S. transferors may resubmit certain previously filed requests (including requests that were denied). By submitting a previously filed request under this procedure, a U.S. transferor agrees that the newly issued final regulations under Treas. Reg. § 1.6038B-1 will apply to any transfer that is the subject of the request. This change is intended to provide equal treatment between similarly situated U.S. transferors and promote the policies underlying the proposed regulations by ensuring that a U.S. transferor that establishes its failure was not willful under Treas. Regs.§ 1.367(a)-8(p) is still subject to penalties under §6038B if its failure was not due to reasonable cause.
C. Amended Return Filing as a Requirement to Seeking Relief
A comment had been noted in the Preamble pertaining to § 1.367(a)-8(p)(2) of the proposed regulations for establishing that failures to file GRA documents, or failures to comply, were not willful. The comment requested that final regulations excuse Coordinated Industry Case (CIC) taxpayers from the requirement under § 1.367(a)-8(p)(2) of filing an amended return promptly after discovering a failure to file or a failure to comply. Such commentator suggested that the final regulations could be adopted to allow CIC taxpayers to submit the materials required under § 1.367(a)-8(p)(2) when the taxpayers effect a “qualified amended return” under Rev. Proc. 94-69, 1994-2 CB 804 (generally providing special procedures for certain taxpayers to show additional tax due or make adequate disclosure with respect to an item or position on a tax return prior to an audit). This suggestion was not adopted by in the final regulations cited that the same concerns exist in other international contexts thereby making this request inappropriate to create different procedures and exceptions for required information. The Preamble noted, however, that the issue was still under study.
D. Modifying the Reported Fair Market Value of Transferred Stock
Another comment received requested the final regulations provide a procedure under which taxpayers may modify the fair market value of transferred stock or securities reported on a previously filed GRA. In support, the commentator alleged that taxpayers often determine the fair market value of stock or securities before the date that the stock or securities are transferred to a foreign corporation; these determinations are based on projected financial information that may, in some cases, deviate from the actual financial information on the date of the transfer.
This recommendation was also declined based on the view that the proposed regulations had adequately addressed this issue. First, because a GRA is filed when a taxpayer files its tax return (rather than at the time of an outbound transfer of stock or securities), a taxpayer has, not including extensions, at least two and a half months following a transfer to reconcile projected financial information with actual financial information. Furthermore, a taxpayer may file an extension if it needs additional time to comply with the requirements of § 1.367(a)-8. Finally, a taxpayer that fails to materially comply with the requirements of § 1.367(a)-8, including the requirement to include the fair market value of the transferred stock or securities in the GRA pursuant to Treas. Reg. § 1.367(a)-8(c)(3)(i)(B), may be eligible to correct the GRA by seeking relief based on a claim that the failure was not willful.
E. Extension of Relief for Failures that are Not Willful to Other Section 367(a) Reporting Obligations
Treas. Reg. §1.367(a)-2 has been revised to provide an exception to gain recognition under §367(a)(1) for assets transferred outbound for use in the active conduct of a trade or business outside of the United States) and Treas. Reg. § 1.367(a)-7 (application of §367(a) to an outbound transfer of assets by a domestic target corporation in an exchange described in § 361) so that a taxpayer may, solely for purposes of §367(a), be deemed not to have failed to comply with reporting obligations under Treas. Regs. §§ 1.367(a)-2 and 1.367(a)-7 by demonstrating that the failure was not willful. Temp. Reg. § 1.367(a)-7 regarding reasonable cause relief is removed. Because the cases in which relief is sought under § 1.367(a)-2 and many of the cases in which relief is sought under Treas. § 1.367(a)-7 are also subject to reporting under §6038B and the regulations thereunder, the penalty imposed under § 6038B for failure to satisfy a reporting obligation has been determined to be sufficient to encourage proper reporting and compliance.
F. Withdrawal of Prior GRA Directive
On July 26, 2010, the Deputy Commissioner International (LMSB) issued directive LMSB-4-0510-017 (Directive). The Directive permits taxpayers to remedy, without having to demonstrate reasonable cause, unfiled or deficient GRA documents associated with a timely filed initial GRA or a timely filed document purporting to be an initial GRA. The Directive explained that the means to best ensure compliance with the GRA provisions was under study and that, pending the study, the Directive would be effective “until further notice.” Because this Treasury decision provides comprehensive guidance that is designed to ensure compliance with the GRA provisions, the Deputy Commissioner (International), Large Business & International will revoke the Directive effective on November 19, 2014.
G. Including an Original Form 8838 with a Request for Relief
The proposed regulations § 1.367(a)-8(p)(2)(i) provided that a U.S. transferor who seeks relief for a failure to file or failure to comply with the GRA rules must, among other requirements, file an original Form 8838, Consent to Extend the Time to Assess Tax Under Section 367 — Gain Recognition Agreement, with an amended return. The Form 8838 must, with respect to the gain realized but not recognized on the initial transfer, extend the period of limitations on the assessment of tax to the period specified in § 1.367(a)-8(p)(2)(i) of the proposed regulations.
The government stated in the Preamble it recognized that in certain cases (for example, certain cases in which a U.S. transferor seeks relief for an unfiled annual certification), the U.S. transferor will already have filed an original Form 8838 that extends the period of limitations through the required time period. The final regulations provide that, in these cases, a U.S. transferor need not file another Form 8838 with the amended return; rather, the U.S. transferor must attach a copy of the previously filed Form 8838 to the amended return. A similar modification is made to these final regulations under Treas. Reg. § 1.367(e)-2 concerning outbound liquidations and certain foreign-to-foreign liquidations described in §332.
H. Failure to Comply and Extension of Period of Limitations
Treas. Reg. §1.367(a)-8(j)(8) of the existing regulations provides that a failure to comply with the GRA provisions extends the statute of limitations until the close of the third full taxable year ending after the date on which the Director of Field Operations or Area Director receives actual notice of the failure to comply from the U.S. transferor. The same provision was included in the proposed regulations. Prop. Reg. §1.367(e)-2(e)(4)(ii)(B) contains a similar rule with respect to a liquidation document.
The government has now concluded that the extension of the statute of limitations under this regulations should be based on when the taxpayer furnishes to the Director of Field Operations International, Large Business & International (or any successor to the roles and responsibilities of such person) the information that should have been provided under the §§ 1.367(a)-8 or 1.367(e)-2 regulations, as applicable. The final regulations, in Treas.Regs. §§ 1.367(a)-8(j)(8) and 1.367(e)-2(e)(4)(ii)(B), have been modified accordingly.
The regulations in pertinent part have also been revised to clarify that when a taxpayer files a GRA under Treas. Reg. § 1.367(a)-8 or a liquidation document under Treas. Reg. § 1.367(e)-2, the taxpayer agrees to extend the period of limitations on assessment of tax, in the circumstances provided in §§ 1.367(a)-8(j)(8) and 1.367(e)-2(e)(4)(ii)(B), as applicable. This agreement is deemed consented to and signed by the Secretary for purposes of § 6501(c)(4).
I. Reporting Requirement Contained in Treas. Reg. § 1.367(a)-3(c)(6)(i)(F)(3)
Treas. Reg. §1.367(a)-3(a) of the existing final regulations provides, in general, that a U.S. person must recognize gain on certain transfers of stock or securities to a foreign corporation. In relevant part, Treas. Reg. § 1.367(a)-3(c) of the existing final regulations provides an exception for certain transfers of stock or securities of a domestic corporation. In particular, Treas. Reg. § 1.367(a)-3(c)(1) provides that, except as provided in Treas.Reg. § 1.367(a)-3(e) (providing rules for transfers of stock or securities by a domestic corporation to a foreign corporation pursuant to an exchange described in section 361), a transfer of stock or securities of a domestic corporation by a U.S. person to a foreign corporation that would otherwise be subject to gain recognition under §367(a)(1) pursuant to Treas. Reg. § 1.367(a)-3(a) will not be subject to gain under § 367(a)(1) if certain requirements are satisfied.
In particular, the domestic corporation the stock or securities of which are transferred (referred to as the U.S. target company) must comply with each of the reporting requirements in Treas. Reg. § 1.367(a)-3(c)(6) and each of the four conditions set forth in § 1.367(a)-3(c)(1)(i) through (iv) must be satisfied. The condition set forth in Treas. Reg. § 1.367(a)-3(c)(1)(iv) requires that the active trade or business test (as defined in Treas. Reg. § 1.367(a)-3(c)(3)) must be satisfied. To satisfy the active trade or business test, the substantiality test (as defined in § 1.367(a)-3(c)(3)(iii)) must be satisfied (among other requirements). The substantiality test is satisfied if, at the time of the transfer, the fair market value of the transferee foreign corporation is at least equal to the fair market value of the U.S. target company.
Under Treas. Reg. § 1.367(a)-3(c)(6)(i)(F)(3), the U.S. target company must submit a statement which confirms that the value of the transferee foreign corporation exceeds the value of the U.S. target company on the acquisition date. The standard that applies for purposes of the reporting requirement of Treas. Reg. § 1.367(a)-3(c)(6)(i)(F)(3) is intended to be the same as the standard that applies for purposes of the substantiality test. The final regulations modify Treas. Reg. § 1.367(a)-3(c)(6)(i)(F)(3) so that the U.S. target company must submit a statement demonstrating that the value of the transferee foreign corporation equals or exceeds the value of the U.S. target company on the acquisition date.