On July 17, 2024, the Department of the Treasury and the IRS released final regulations under IRC sections 367(a) and (b) providing guidance on certain cross-border triangular reorganizations historically known as “Killer B” transactions. These transactions were coined this phrase because they were historically used by taxpayers to repatriate funds from a foreign subsidiary to its U.S. parent tax-free in transactions that were typically structured as triangular §368(a)(1)(B) reorganizations, i.e., “Type B reorganizations.” The regulations finalized, without substantive changes, the proposed regulations that were issued on October 6, 2023.
Background
Prior to the government’s rules and guidance addressing Killer B transactions, taxpayers would structure such transactions whereby a foreign subsidiary (“S”) would transfer funds to its direct U.S. parent (“P”) in return for newly issued parent stock. The taxpayer would take the position that such receipt of funds by P are not taxable under §1032. As part of the same plan, the S would exchange the recently acquired P stock in return for target corporation (“T”) stock. The taxpayer would take the position that such an exchange qualifies as a triangular reorganization under §368(a)(1)(B). These transactions were “killer” because they legitimately allowed cash to be repatriated back to the U.S. from foreign subsidiaries without the U.S. parent recognizing taxable dividend income.
Final regulations were issued in 2011 under §367(b) that addressed these transactions (in some instances, treating the repatriated funds as a distribution to the P under §301). Following these 2011 regulations, Notice 2014-32 and Notice 2016-73 were issued stating that further regulations would be issued to address certain transactions designed to exploit certain aspects of the 2011 final regulations. As part of the 2017 Tax Cuts and Jobs Act (“TCJA”), §245A was enacted that allowed U.S. C corporations to receive dividends from certain foreign corporations without incurring U.S. tax. In addition, §965 was modified to convert most or all untaxed earnings and profits (“E&P”) of certain foreign subsidiaries to previously taxed earnings and profits (“PTEP”). Thus, after the TCJA, one would think that issuing regulations under Notices 2014-32 and 2016-73 would be less important because TCJA gave U.S. multinational corporations several options of getting funds back to the U.S. without incurring tax.
However, proposed regulations were issued in October 2023 that would modify the existing rules to address the concerns in these notices. The preamble to the proposed regulations stated that guidance is still needed as incentives to avoid distribution treatment remains (because taxpayers might not qualify for §245A or taxpayers are seeking to preserve their PTEP). The regulations issued on July 17, 2024, finalized the 2023 proposed regulations with no substantive changes.
Anti-Abuse Provision
The 2023 proposed regulations contain an anti-abuse provision under which “appropriate adjustments” are made if, “in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose”1 of the regulations. The regulations contain an example showing that E&P of S may be deemed to include E&P of a related corporation. There were comments in response to the proposed regulations that argued that the only type of adjustments permitted here would be to increase S’s E&P but only if they bear on the P stock acquisition. In the preamble to the final regulations, the Treasury and IRS declined to adopt the recommendation that the anti-abuse should be applied in such narrow situations, stating that the anti-abuse rule is intended to serve as a backstop to the rule where taxpayers attempt to structure around the application of the rules. The preamble continues that such structuring may take many different forms and therefore the anti-abuse provisions should not be limited to a particular type of avoidance transaction. Similarly, the resulting adjustment under the anti-abuse provision should not be limited to a certain adjustment for the same reason the anti-abuse rule is not limited to a particular type of transaction. Such adjustments may have the effect of modifying the application of the technical rules (including the “priority rule”).
- Insight: The IRS and Treasury have intentionally left open the various types of transactions that might be considered to be “engaged in with a view to avoid the purpose” of the regulations. The examples are helpful, but the preamble to the final regulations make it clear that the examples are not the exclusive types of transactions that can be considered abusive. It is also left uncertain the types of adjustments (in addition to E&P adjustments) that the government can make if a transaction is considered abusive. Finally, the examples are not particularly helpful in determining when a transaction might be “engaged in with a view to avoid the purpose” of the regulations. Thus, the anti-abuse provisions are incredibly vague in 1) how it would be determined that a transaction was engaged in with a view to avoid the rules; 2) application to different types of transactions; and 3) the types of adjustments that can be made. This leaves a lot of unanswered questions for taxpayers.
Excess Asset Basis and Definition of “Foreign Subsidiary”
Under the proposed regulations, an excess asset basis (“EAB”) can be created in foreign P to the extent property was transferred from foreign S to foreign P as part of a triangular reorganization. To the extent an EAB exists, then foreign P is considered to have received a distribution of “specified earnings” pro rata from all “foreign subsidiaries.” A “foreign subsidiary” is defined by reference to §1248(c)(2)(B) which describes a 10% ownership threshold taking into consideration the constructive ownership rules of §958(b). The final regulations make a clarifying change from the proposed regulation by stating that “the distribution is treated as being made through any intermediate owners, or directly from any constructively owned foreign subsidiaries, where applicable.1
- Insight: By clarifying in the definition of “foreign subsidiaries” that such subsidiaries include any constructively owned foreign subsidiaries, taxpayers are going to have to determine specified earnings of all 10% owned foreign entities in the structure even if foreign P does not directly or indirectly own such subsidiaries. This can create particular challenges for the calculation of the pro rata amount of specified earnings to all foreign entities related to foreign P.
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