The U.S. tax consequences of an outbound transfer of property (including an outbound transfer of stock) are governed by section 367 of the U.S. Internal Revenue Code. section 6038B requires that U.S. persons satisfy various information reporting requirements when they transfer property outbound to a foreign corporation. Because the penalties for failure properly report outbound property transfers are substantial, a U.S. person that has completed (or is contemplating) a transfer to a foreign corporation will want to make sure to review all reporting requirements under both the substantive rules of section 367 and the information reporting rules of section 6038B.
Overview
Designed to moderate the application of subchapter C non-recognition transactions, section 367 generally imposes an exit tax on most outbound property transfers. Section 367(a)(1) generally provides that if a U.S. person transfers property to a foreign corporation in a transfer or exchange to which the corporate non-recognition rules (section 332, 351, 354, 356 or 361) would apply, the foreign corporation will not be considered a corporation for purposes of determining gain on the transfer.1 Generally, by disregarding the corporate status of the foreign corporation, section 367 has the effect of taxing the gain on the transfer of property by a U.S. person even though the transfer would typically be treated as a tax-free transfer. The application of the rule differs based on the type of assets transferred, and regulations provide some exceptions to the general rule. For example, if the U.S. transferor owns 5 percent or more of the stock in a foreign corporation receiving foreign stock or securities in a foreign entity (i.e., the transferred property) and enters into a gain recognition agreement (GRA) with the Internal Revenue Service (IRS), the taxpayer will be allowed to receive non-recognition treatment on the transfer of such stock.2
Gain recognition agreements
A GRA provides parameters under which the U.S. transferor, in a transaction to which section 367(a) applies, will recognize gain if the foreign corporation disposes of transferred property during the five-year term of the GRA. The terms of a GRA also outline certain "triggering events" that could cause the early termination of the GRA and trigger recognition of gain on the transfer. If a triggering event occurs, the U.S. transferor must: (1) report the gain on an amended return for the year of transfer; (2) adjust the basis of assets on which the gain was recognized; and (3) pay additional penalties and interest on the tax assessed from the recognition event.3 Failure to fully comply with the requirements of a GRA can create harsh tax results for the unwary taxpayer.
Common transactions triggering reporting requirements
There are a variety of cross-border transactions that may trigger a reporting obligation under section 367, including:
- Transfers of certain domestic target corporations to a foreign corporation
- Transfers of certain domestic and foreign securities
- Certain "indirect stock transfers"
- Distributions under a plan of reorganization to foreign corporations
- Transfers of property over a certain threshold to a foreign corporation
- Liquidations of domestic or foreign corporations into a foreign parent
The 2014 regulations
In November 2014, the IRS released final regulations (the 2014 regulations) revising the reporting rules applicable to stock and property transfers under sections 367 and 6038B, including the consequences to U.S. and foreign persons for failing to file GRAs or related documents or to satisfy other reporting obligations associated with such non-recognition exchanges.4
The most notable issues addressed by the new regulations are:
- New Form 926 filing requirements
The IRS and the Treasury Department have expanded the reporting requirements associated with Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Under the 2014 regulations, a U.S. transferor of property, in a transaction in which a GRA is required, must report the fair market value, adjusted tax basis, and gain recognized with respect to the transferred stock or securities on Form 926. In addition, the taxpayer must provide a notice along with the form that a GRA is being filed pursuant to Reg. section 1.367(a)-8.5
- Withdrawal of GRA directive
The 2014 regulations withdrew LMSB-4-0510-017, a taxpayer-friendly directive that provided guidance on how to remedy a defective GRA. The directive permitted taxpayers to remedy, without having to demonstrate reasonable cause, unfiled or deficient GRA documents that were associated with a timely filed GRA.6 Under the directive, the taxpayer was not required to furnish an explanatory statement outlining the reasons for the failure to file.
- Relief for failures to comply with section 367(a) reporting obligations
The IRS modified the standard applicable to untimely or incomplete filings. The 2014 regulations provide that the taxpayer can remedy untimely or incomplete GRA filings if the failure to comply was due to "reasonable cause and not willful neglect."7 If the taxpayer can demonstrate that the failure to file was not willful, the taxpayer can avoid gain recognition on the transaction. In order to avoid penalties under section 6038B regarding reporting requirements, the taxpayer must go a step further and demonstrate affirmatively that the failure was due to reasonable cause. The regulations provide four examples that are useful in making the "willful" determination:
- The taxpayer had filed numerous GRAs over the years and had never failed to file a timely GRA. In an isolated incident, the taxpayer failed to file a GRA due to an accidental oversight. The following year, the taxpayer discovered the defect and filed an amended return along with the GRA. In this scenario, the failure to file was not determined to be willful.8
- The taxpayer entered into a transaction that required the filing of a GRA. The taxpayer failed to file the GRA, had previously failed to file a GRA, and had an established history of failing to timely file other tax and information returns for which it was subject to penalties. The taxpayer reported non-recognition on the original return and subsequently amended the return to include the GRA. Because of the taxpayer's course of conduct regarding both prior GRAs and other unrelated returns, the taxpayer's behavior was determined to be willful.9
- The taxpayer filed a timely return reporting no gain in respect to a transaction that required a GRA. The taxpayer, aware that the GRA required reporting of the basis and fair market value of the stock, filed a GRA that did not contain such information. The taxpayer provided instead that the information was available on request. Because the taxpayer knowingly omitted the required information, the taxpayer's behavior was determined to be willful.10
- The taxpayer, after entering into a transaction requiring a GRA to avoid recognizing gain, anticipated selling a business in the following year that would produce a capital loss that could be carried back to offset the gain recognized on the transfer of the foreign stock. The taxpayer, instead of filing a GRA, chose to recognize the gain on a timely filed tax return. In the following year, the taxpayer was unable to sell the business to obtain the capital loss and sought to file a GRA to negate the gain recognized in the prior year. Because the taxpayer omitted the GRA as a planning mechanism, the failure to file was determined to be willful.11
Conclusion
Cross-border transfers and relevant subsequent events often may seem inconsequential. However, with any transfer of property to a foreign corporation, it is important to review both the substantive rules of section 367 and the information reporting rules of section 6038B. Failure to report such events can lead to significant adverse tax consequences. Adequate planning and a thorough review process should enable U.S. taxpayers to avoid these costly pitfalls.
[1] Section 367.
[2] Reg. section 1.367(a)-3(b). Former section 367(a)(3) had provided another exception for certain tangible property transferred to a foreign corporation for use in an active trade or business outside the U.S. The exception did not apply to a transfer of inventory, accounts receivable, or foreign currency. The 2017 Tax Cuts and Jobs Act (TCJA) eliminated this exception and so gain on a transfer of tangible property by a U.S. person to a foreign corporation is now subject to immediate taxation.
[3] Reg. section 1.367(a)-8
[4] T.D. 9704
[5] Reg. section 1.6038B-1(b)(2)(iv).
[6] I.R.B. 2014-50.
[7] Reg. section 1.1367(a)-8(p)(1).
[8] Reg. section 1.367(a)-8(p)(3), Example 1.
[9] Reg. section 1.367(a)-8(p)(3), Example 2.
[10] Reg. section 1.367(a)-8(p)(3), Example 3.
[11] Reg. section 1.367(a)-8(p)(3), Example 4.
