The Internal Revenue Service’s new private letter ruling (PLR) concerned a domestication of a Foreign Parent corporation under U.S. ownership—with a few notable twists. First, the PLR applied a substance-over-form analysis to treat a set of foreign law mechanics as a § 351 transaction. Second, following Revenue Rulings 2015-09 and 2015-10 on slightly different facts, the PLR ruled that a two-step transaction of a § 351 transaction of the Foreign Parent under the new U.S. holding company, followed by an “inbound F reorganization,” would be respected as two separate steps. Left unaddressed—in light of the taxpayer’s representations that Foreign Parent had no earnings and profits (E&P)—was how the § 367(b) pickup for inbound reorganizations works in this situation.
Facts of the Transaction
The Foreign Parent corporation had two classes of stock: high vote shares and low vote shares. The low vote shares were traded on a U.S. securities exchange. Foreign Parent owned Old U.S. Parent, one of several corporations making up a U.S. consolidated group.
Incidentally, some of the U.S. corporations were dual resident corporations—a rarer breed in this day of anti-hybrid rules and Pillar 2.
In the transaction addressed in the PLR, Foreign Parent was reorganized under a New U.S. Parent through a foreign law court procedure with a particular set of steps. The taxpayer requested a ruling that these steps could be seen as a tax-free exchange from a U.S. perspective, and also requested that the U.S. consolidated group would continue with New U.S. Parent stepping into the shoes of Old U.S. Parent. (The group continuation ruling is not further discussed here).
Pursuant to the foreign law court procedure, Foreign Parent first issued a single, Class C share to New U.S. Parent, a newly formed corporation. New U.S. Parent then acquired Foreign Parent for equivalent shares of New U.S. Parent, but through a roundabout way:
Thus, rather than a share-for-share exchange, Foreign Parent shares were canceled and reissued, with New U.S. Parent directly issuing shares to the exchanging shareholders.
Following these steps New U.S. Parent contributed its newly acquired shares of Foreign Parent to a New U.S. Sub, and Foreign Parent converted to a private limited company that elected to be treated as a disregarded entity.
Rulings & Observations
The PLR ruled that the cancellation and reissuance mechanic would be treated as an exchange for U.S. tax purposes. Although the Foreign Parent shares were canceled, seemingly for no consideration, the reissuance of those shares to New U.S. Parent effectively put Humpty Dumpty back together again. Thus, the net effect of the three steps was a bilateral exchange. Published IRS rulings have held that circular steps can be collapsed and analyzed according to their substance, particularly where the additional steps are taken to comply with non-tax legal restrictions. See Rev. Rul. 83-142 and Rev. Rul. 78-397.
After the exchange, as noted above, Foreign Parent was acquired by a newly formed U.S. Subsidiary of new Parent and then converted to a disregarded entity (DRE). This “drop and check” transaction standing alone would clearly be an F reorganization. See Reg. § 1.368-2(m). The PLR ruled that the fact that the F reorganization followed closely on the heels of a § 351 exchange wouldn’t affect F reorganization treatment. In doing so, the PLR followed Revenue Rulings 2015-09 and 2015-10, which ruled that a series of cascading § 351 transactions, followed by a “drop and check” D reorganization, would be respected according to their form. These 2015 rulings revoked Rev. Rul. 78-130, which had analyzed a § 351 drop-down, followed by an asset reorganization, as a direct transfer of assets to the Subsidiary to be tested as a triangular C reorganization.
Interestingly, the taxpayer provided representations that Foreign Parent had no E&P and that no holder of Foreign Parent’s stock had a positive “all earnings and profits” amount under Treas. Reg. § 1.367(b)-2.
This is important because, in an inbound asset reorganization such as the inbound F reorganization of Foreign Parent into U.S. Sub, U.S. shareholders of the exchanging corporation suffer a “toll charge” that takes one of two forms. U.S. shareholders that are “United States shareholders” under § 951(b) (generally 10% or greater) receive a deemed dividend of their share of untaxed E&P. U.S. persons who are not such United States shareholders generally recognize gain but may elect deemed dividend treatment. See Treas. Reg. § 1.367(b)-3(c).
The PLR’s transaction sequence involved a two-step reorganization under a U.S. Sub of Foreign Parent, rather than a domestication into Foreign Parent. Had Foreign Parent been reorganized into a DRE held directly by New U.S. Parent, Foreign Parent’s shareholders would have been exchanging shareholders under the § 367(b) regulations. In the PLR’s structure, by contrast, the inbound F reorganization happened after Foreign Parent’s public shareholders had already completed their § 351 exchange. Seemingly, in this situation, New U.S. Parent would be the exchanging shareholder for § 367(b) purposes. The PLR did not, however, rule on this issue and as noted above the taxpayer represented that Foreign Parent did not have positive E&P.