On December 28, 2023, the IRS released Notice 2024-16, which announces that the U.S. Department of the Treasury and the IRS intend to issue proposed regulations addressing the treatment of basis adjustments provided under Section 961(c) in certain covered transactions in which a domestic corporation acquires stock of a lower-tier controlled foreign corporation (CFC).
Sections 959 and 961 together allow a U.S. shareholder to prevent double taxation of a CFC’s previously taxed earnings and profits (PTEP). Under §961(a), a U.S. shareholder’s tax basis in stock of a directly owed CFC is increased by the inclusion of its pro rata share of subpart in such U.S. shareholder’s gross income. In other words, §961(a) basis attributable to global intangible low-taxed income (GILTI) and Subpart F inclusions from lower-tier CFCs is considered as included in the U.S. shareholder’s outside tax basis in its directly-held CFC stock because it is the U.S. shareholder, not an upper-tier CFC, that recognizes GILTI or Subpart F income. In addition, §961(b)(1) requires the U.S. shareholder to decrease the stock basis when PTEP is distributed to a U.S. shareholder and excluded from its income under §959(a). To the extent that a PTEP distributed exceeds the U.S. shareholder’s basis in the CFC, gain is recognized under §961(b)(2).
Section 961(c) provides tax basis adjustments similarly to §961(a) and (b) for a CFC that owns stock in another CFC, in which the U.S. shareholder had a deemed inclusion with respect to the income of the lower-tier CFC. Section 961(c), however, essentially allows for a “push-down” to an upper-tier CFC of the U.S. shareholder’s §961(a) basis attributable to inclusions from a lower-tier CFC, but only for the limited purpose of determining Subpart F inclusion (and presumably GILTI inclusion as well under the coordinating provision of §951A(f)(1)). For example, an upper-tier CFC that sells lower-tier CFC stock must still recognize gain or loss for earnings and profits purposes based on the upper-tier CFC’s inside tax basis in lower-tier CFC stock. But under §961(c), any such gain to the extent of the U.S. shareholder’s §961(a) basis attributable to inclusions from the lower-tier CFC will not be considered as Subpart F income (or presumably as GILTI income) to the U.S. shareholder.
In the context of an inbound nonrecognition transaction involving an upper-tier CFC (such as an inbound §332 liquidation or §368(a)(1) asset reorganization of the upper-tier CFC), it was unclear prior to the issuance of Notice 2024-16 as to whether the U.S. shareholder’s tax basis in lower-tier CFC stock received in the nonrecognition transaction would include §961(c) basis, given the limited purpose of §961(c) and given that in a nonrecognition transaction, an acquiring corporation generally takes a carryover tax basis in assets received equal to the target corporation’s inside tax basis in those assets while the acquiring corporation’s outside tax basis in target corporation stock generally disappears. If not, the U.S. shareholder would have to recognize gain on PTEP distribution from the acquired CFC or upon subsequent sale of the stock of the acquired CFC.
To prevent double taxation of CFC earnings, the Notice announces that the forthcoming proposed regulations will provide that in the case of a covered inbound transaction, a domestic acquiring corporation’s adjusted basis of the stock of an acquired CFC is determined as if the transferor CFC’s §961(c) basis were adjusted tax basis.
Taxpayers may rely on the Notice for transactions completed on or before the date that the proposed regulations are published in the Federal Register.
The Notice defines “covered inbound transactions” as inbound nonrecognition transactions in which a domestic acquiring corporation acquires all the stock of the acquired CFC from a transferor CFC that—immediately before the transaction and any related transactions—owns (directly or indirectly) all of the stock of the acquired CFC. The covered inbound transactions include two sets of transactions.
The first set is upstream covered inbound transactions, which includes liquidations under Internal Revenue Code (IRC) §332 and nontriangular upstream asset reorganizations under IRC §368(a)(1)(A) and §368(a)(1)(C) in which all of the stock of the transferor CFC is owned directly by the domestic acquiring corporation immediately before the transaction.
The other covered inbound transactions include nontriangular reorganizations under IRC §368(a)(1)(A) and §368(a)(1)(C), non-divisive asset reorganizations under IRC §368(a)(1)(D) and reorganizations described under IRC §368(a)(1)(F) in which all of the stock of the transferor CFC is owned directly by a single domestic corporation (or by members of the same consolidated group) immediately before the transaction, and the same domestic corporation (or members of the same consolidated group) directly owns all of the stock of the domestic acquiring corporation immediately after the transaction and any related transactions.
The notice also establishes de minimis rules, provides scope limitations, and includes transition rules for taxpayers that maintained §961(c) basis in a currency that is not the U.S. dollar.
If you have questions about this Notice or other international tax topics, reach out to a professional at FORVIS.