[Federal Register Volume 81, Number 68 (Friday, April 8, 2016)]
[Rules and Regulations]
[Pages 20857-20909]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-07300]



[[Page 20857]]

Vol. 81

Friday,

No. 68

April 8, 2016

Part III

Book 2 of 2 Books

Pages 20857-21222





Department of the Treasury





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Internal Revenue Service



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26 CFR Part 1



Inversions and Related Transactions; Final and Temporary Regulations

Federal Register / Vol. 81 , No. 68 / Friday, April 8, 2016 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9761]
RIN 1545-BM88


Inversions and Related Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations that address 
transactions that are structured to avoid the purposes of sections 7874 
and 367 of the Internal Revenue Code (the Code) and certain post-
inversion tax avoidance transactions. These regulations affect certain 
domestic corporations and domestic partnerships whose assets are 
directly or indirectly acquired by a foreign corporation and certain 
persons related to such domestic corporations and domestic 
partnerships. The text of the temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section of this issue 
of the Federal Register. The final regulations revise and add cross-
references to coordinate the application of the temporary regulations.

DATES: Effective Date: These regulations are effective on April 8, 
2016.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.304-7T(e), 1.367(a)-3T(c)(11)(ii), 1.367(b)-4T(h), 1.956-2T(i), 
1.7701(l)-4T(h), 1.7874-1T(h)(2), 1.7874-2T(l)(2), 1.7874-3T(f)(2), 
1.7874-4T(k)(1), 1.7874-6T(h), 1.7874-7T(h), 1.7874-8T(i), 1.7874-
9T(g), 1.7874-10T(i), 1.7874-11T(f), and 1.7874-12T(b).

FOR FURTHER INFORMATION CONTACT: Regarding the regulations under 
sections 304, 367, and 7874, Shane M. McCarrick or David A. Levine, 
(202) 317-6937; regarding the regulations under sections 956 and 
7701(l), Rose E. Jenkins, (202) 317-6934 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

    This document contains regulations to address transactions commonly 
referred to as inversions and certain tax avoidance transactions 
related to inversions. An inversion may take many forms but has been 
generally described as a transaction that results in a domestic parent 
corporation of a multinational group being replaced with a foreign 
parent corporation. Staff of the Joint Committee on Taxation, General 
Explanation of Tax Legislation Enacted in the 108th Congress (JCS-5-05) 
(May 31, 2005) (the JCT Explanation), at 342. An inversion is typically 
accompanied or followed by certain transactions that are intended ``to 
remove income from foreign operations from the U.S. taxing 
jurisdiction.'' Id. In addition, the ``corporate group may derive 
further advantage from the inverted structure by reducing U.S. tax on 
U.S.-source income through various earnings stripping or other 
transactions.'' Id.
    Section 7874 and the regulations thereunder and Sec.  1.367(a)-3(c) 
(concerning outbound transfers of domestic stock) are intended to 
address inversions. As described in Part II.F of this Background 
section, section 7874 generally applies to a transaction if three 
conditions are satisfied. When these conditions are satisfied, section 
7874 either prevents the use of certain tax attributes to reduce the 
U.S. federal income tax owed on certain income or gain (inversion gain) 
recognized in transactions intended to remove foreign operations from 
the U.S. taxing jurisdiction, or treats the new foreign parent 
corporation as a domestic corporation for all purposes of the Code. As 
described in Part II.B.1 of this Background section, in certain 
inversions, Sec.  1.367(a)-3(c) causes a United States person that is a 
shareholder of the domestic parent corporation to recognize gain (but 
not loss) on the exchange of its stock in the domestic corporation.
    On September 22, 2014, the Department of the Treasury (Treasury 
Department) and the IRS issued Notice 2014-52, 2014-42 I.R.B. 712 (the 
2014 notice), which announced the intention to issue regulations 
described therein to address certain transactions structured to avoid 
the purposes of section 7874 and Sec.  1.367(a)-3(c) and certain post-
inversion tax avoidance transactions. On November 19, 2015, the 
Treasury Department and the IRS issued Notice 2015-79, 2015-49 I.R.B. 
775 (the 2015 notice), which announced the intention to issue 
regulations described therein to address certain additional 
transactions structured to avoid the purposes of section 7874 and Sec.  
1.367(a)-3(c) and certain additional post-inversion tax avoidance 
transactions. This document contains temporary regulations under 
sections 304, 367, 956, 7701(l), and 7874 of the Code.
    The temporary regulations include the rules described in the two 
notices. Part I of the Explanation of Provisions section of this 
preamble explains the regulations addressing certain transactions 
structured to avoid the purposes of section 7874. Part II of the 
Explanation of Provisions section of this preamble explains the 
regulations addressing certain post-inversion tax avoidance 
transactions. In addition, the temporary regulations set forth new 
rules that address issues that were not discussed in either notice: (i) 
Rules for identifying a foreign acquiring corporation when a domestic 
entity acquisition involves multiple steps (described in Part I.A of 
the Explanation of Provisions section of this preamble); (ii) rules 
that disregard stock of the foreign acquiring corporation that is 
attributable to certain prior domestic entity acquisitions (described 
in Part I.B.3 of the Explanation of Provisions section of this 
preamble); (iii) rules that require a controlled foreign corporation 
(CFC) to recognize all realized gain upon certain transfers of assets 
described in section 351 that shift the ownership of those assets to a 
related foreign person that is not a CFC (described in Part II.B.3 of 
the Explanation of Provisions section of this preamble); and (iv) rules 
clarifying the definition of group income for purposes of the 
substantial business activities test (described in Part I.D.2 of the 
Explanation of Provisions section of this preamble). The temporary 
regulations also contain the rules described in Notice 88-108, 1988-2 
C.B. 445; Notice 2008-91, 2008-43 I.R.B. 1001; Notice 2009-10, 2009-5 
I.R.B. 419; and Notice 2010-12, 2010-4 I.R.B. 326, concerning the 
short-term obligation exception from United States property for 
purposes of section 956.
    In addition, the temporary regulations provide a new definitions 
section under Sec.  1.7874-12T that defines terms commonly used in 
certain of the regulations under sections 367(b), 956, 7701(l), and 
7874. It is expected that future guidance projects will conform the 
nomenclature used in other portions of the existing section 7874 
regulations with the nomenclature used in Sec.  1.7874-12T.
    The applicability dates for the rules that previously were 
announced in the 2014 notice and the 2015 notice are consistent with 
the dates previously announced. Thus, the rules described in the 2014 
notice that address transactions that are structured to avoid the 
purposes of section 7874 apply to acquisitions completed on or after 
September 22, 2014, and the rules described in the 2015 notice that 
address transactions that are structured to avoid the purposes of 
section 7874 apply to acquisitions completed on or

[[Page 20859]]

after November 19, 2015. Furthermore, the rules described in the 2014 
notice that reduce the tax benefits of inversion transactions apply to 
post-inversion tax avoidance transactions completed on or after 
September 22, 2014, and the rules described in the 2015 notice that 
reduce the tax benefits of inversion transactions apply to post-
inversion tax avoidance transactions completed on or after November 19, 
2015. In both cases described in the preceding sentence, subject to one 
exception, the rules apply only if the inversion transaction was 
completed on or after September 22, 2014. The one exception is that, 
consistent with the 2014 notice, the rule described in Part II.B.4 of 
the Explanation of Provisions section of this preamble regarding the 
application of section 304(b)(5) is a generally applicable rule that 
applies without regard to whether there was an inversion transaction.
    The new rules included in the temporary regulations, including any 
changes to rules described in the 2014 notice and the 2015 notice, 
generally apply to acquisitions or post-inversion tax avoidance 
transactions completed on or after April 4, 2016. In addition, and 
consistent with the announcement in the 2014 notice, the new rule 
described in Part II.B.3 of the Explanation of Provisions section of 
this preamble that reduces post-inversion tax benefits (by requiring a 
CFC to recognize all realized gain upon certain section 351 transfers) 
applies only if the inversion transaction was completed on or after 
September 22, 2014. However, no inference is intended as to the 
treatment of transactions described in the temporary regulations and 
this preamble under the law that applied before the applicability date 
of these regulations. The IRS may, where appropriate, challenge 
transactions, including those described in the temporary regulations 
and this preamble, under applicable Code or regulatory provisions or 
judicial doctrines.
    Comments were received on the 2014 notice. One comment was received 
on the 2015 notice, but the comment was received after these temporary 
regulations had been substantially developed such that the Treasury 
Department and the IRS did not have time to fully consider the comment. 
The Treasury Department and the IRS will include this comment in the 
administrative record for the notice of proposed rulemaking on this 
subject in the Proposed Rules section of this issue of the Federal 
Register (REG-135734-14) and fully consider the comment in connection 
with finalization of the proposed regulations.

II. Statutory and Regulatory Background

A. Section 304

    Section 304(a)(1) generally provides that, for purposes of sections 
302 and 303, if one or more persons are in control of each of two 
corporations and, in return for property, one of the corporations 
(acquiring corporation) acquires stock in the other corporation 
(issuing corporation) from the person (or persons) so in control, then 
(unless section 304(a)(2) applies) the property shall be treated as a 
distribution in redemption of the stock of the acquiring corporation.
    Section 304(a)(2) provides that, for purposes of sections 302 and 
303, if in return for property, one corporation acquires from a 
shareholder of another corporation stock in such other corporation, and 
the issuing corporation controls the acquiring corporation, then the 
property shall be treated as a distribution in redemption of the stock 
of the issuing corporation.
    Section 304(b)(2) provides that, in the case of any acquisition to 
which section 304(a) applies, the determination of the amount that is a 
dividend (and the source thereof) shall be made as if the property were 
distributed by the acquiring corporation to the extent of its earnings 
and profits, and then by the issuing corporation to the extent of its 
earnings and profits.
    Section 304(b)(5)(B) limits the earnings and profits taken into 
account under section 304(b)(2) when the acquiring corporation is 
foreign. Specifically, section 304(b)(5)(B) provides that no earnings 
and profits are taken into account for purposes of section 304(b)(2)(A) 
(and section 304(b)(2)(A) shall not apply) if more than 50 percent of 
the dividends arising from such acquisition (determined without regard 
to section 304(b)(5)(B)) would neither be subject to U.S. federal 
income tax for the taxable year in which the dividends arise, nor be 
included in the earnings and profits of a CFC.
    The Staff of the Joint Committee on Taxation's technical 
explanation of section 304(b)(5)(B) provides:

    The provision prevents the foreign acquiring corporation's E&P 
from permanently escaping U.S. taxation by being deemed to be 
distributed directly to a foreign person (i.e., the transferor) 
without an intermediate distribution to a domestic corporation in 
the chain of ownership between the acquiring corporation and the 
transferor corporation.

    Staff of the Joint Committee on Taxation, Technical Explanation of 
the Revenue Provisions of the Senate Amendment to the House Amendment 
to the Senate Amendment to H.R. 1586, Scheduled for Consideration by 
the House of Representatives on August 10, 2010 (JCX-46-10) (August 10, 
2010), at 28.
    Section 304(b)(5)(C) provides that the Secretary shall prescribe 
such regulations as are necessary to carry out the purposes of section 
304(b)(5).

B. Section 367

1. Section 367(a)
    Subject to certain exceptions, section 367(a)(1) generally provides 
that if a United States person transfers property to a foreign 
corporation in an exchange described in section 332, 351, 354, 356, or 
361, the foreign corporation shall not be considered a corporation for 
purposes of determining the extent to which the United States person 
recognizes gain on the transfer. Section 1.367(a)-3(c) provides an 
exception to the general rule of section 367(a)(1) for certain 
transfers by a United States person of stock or securities of a 
domestic corporation (the U.S. target company) to a foreign 
corporation. This exception only applies, however, if the U.S. target 
company complies with the reporting requirements in Sec.  1.367(a)-
3(c)(6) and if the four conditions set forth in Sec.  1.367(a)-
3(c)(1)(i) through (iv) are satisfied. The condition set forth in Sec.  
1.367(a)-3(c)(1)(iv) requires the active trade or business test (as 
defined in Sec.  1.367(a)-3(c)(3)) to be satisfied, the requirements of 
which include the substantiality test (as defined in Sec.  1.367(a)-
3(c)(3)(iii)). 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. For this purpose, the fair market value of the 
transferee foreign corporation generally does not include assets 
acquired outside the ordinary course of business within the 36-month 
period preceding the exchange if they produce, or are held for the 
production of, passive income or are acquired for the principal purpose 
of satisfying the substantiality test.
2. Section 367(b)
    Section 367(b)(1) provides that, in the case of an exchange 
described in section 332, 351, 354, 355, 356, or 361 in connection with 
which there is no transfer of property described in section 367(a)(1), 
a foreign corporation shall be considered to be a corporation except to 
the extent provided in regulations prescribed by the Secretary that are

[[Page 20860]]

necessary or appropriate to prevent the avoidance of U.S. federal 
income taxes. Section 367(b)(2) provides that the regulations 
prescribed pursuant to section 367(b)(1) shall include (but shall not 
be limited to) regulations dealing with the sale or exchange of stock 
or securities in a foreign corporation by a United States person, 
including regulations providing the circumstances under which gain is 
recognized or deferred, amounts are included in gross income as a 
dividend, adjustments are made to earnings and profits, or adjustments 
are made to the basis of stock or securities.
    Regulations under section 367(b) generally provide that, if the 
potential application of section 1248 cannot be preserved following the 
acquisition of the stock or assets of a foreign corporation (foreign 
acquired corporation) by another foreign corporation in an exchange 
subject to section 367(b), then certain exchanging shareholders of the 
foreign acquired corporation must include in income as a dividend the 
section 1248 amount attributable to the stock of the foreign acquired 
corporation exchanged. See Sec.  1.367(b)-4(b). Under Sec.  1.367(b)-
2(c)(1), the section 1248 amount attributable to the stock of a foreign 
acquired corporation means the net positive earnings and profits (if 
any) that would have been attributable to such stock and includible in 
income as a dividend under section 1248 if the stock were sold by the 
exchanging shareholder.
    Specifically, subject to certain exceptions, Sec.  1.367(b)-
4(b)(1)(i) requires a deemed dividend inclusion if the exchange 
satisfies two conditions. First, immediately before the exchange, the 
exchanging shareholder is either (i) a United States person that is a 
section 1248 shareholder with respect to the foreign acquired 
corporation, or (ii) a foreign corporation, and a United States person 
is a section 1248 shareholder with respect to such foreign corporation 
and the foreign acquired corporation. See Sec.  1.367(b)-4(b)(1)(i)(A). 
Second, immediately after the exchange, either (i) the stock received 
by the exchanging shareholder is not stock in a CFC as to which the 
United States person described in the preceding sentence is a section 
1248 shareholder, or (ii) the foreign acquiring corporation (for this 
purpose, as defined in Sec.  1.367(b)-4(a)) or the foreign acquired 
corporation (in the case of an acquisition of the stock of the foreign 
acquired corporation) is not a CFC as to which the United States person 
is a section 1248 shareholder. See Sec.  1.367(b)-4(b)(1)(i)(B).
    Section 1.367(b)-4(c)(1) provides that a section 1248 amount 
included in income as a deemed dividend under Sec.  1.367(b)-4(b) is 
not included as foreign personal holding company income (FPHCI) under 
section 954(c).

C. Section 954

    Section 954 defines foreign base company income (FBCI), which 
generally is income earned by a CFC that is taken into account in 
computing the amount that a United States shareholder (within the 
meaning of section 951(b)) of the CFC must include in income under 
section 951(a)(1)(A). FBCI includes FPHCI, as defined in section 
954(c), which, in turn, generally includes dividends. Section 
954(c)(1)(A). However, dividends generally are excluded from FPHCI if 
they are received from a related person that (i) is a corporation 
created or organized under the laws of the same foreign country under 
the laws of which the CFC is created or organized, and (ii) has a 
substantial part of its assets used in its trade or business located in 
that foreign country. Section 954(c)(3).
    In addition, for certain taxable years, dividends received or 
accrued from another CFC that is a related person generally are 
excluded from the FPHCI of a CFC to the extent the dividends are 
attributable or properly allocable to income of the related person that 
is neither subpart F income nor income treated as effectively connected 
with the conduct of a trade or business in the United States. Section 
954(c)(6). Section 103(b)(1) of the Tax Increase Prevention and 
Reconciliation Act of 2005 (Pub. L. 109-222, 120 Stat. 345) added 
section 954(c)(6), which applied to taxable years of foreign 
corporations beginning after December 31, 2005, and before January 1, 
2009, and to taxable years of United States shareholders with or within 
which these taxable years of the foreign corporation ended. 
Subsequently, section 954(c)(6) was amended five times to extend its 
applicability. Section 304(a) of the Tax Extenders and Alternative 
Minimum Tax Relief Act of 2008 (Pub. L. 110-343, 122 Stat. 3765); 
section 751(a) of the Tax Relief, Unemployment Insurance 
Reauthorization, and Job Creation Act of 2010 (Pub. L. 111-312, 124 
Stat. 3296); section 323(a) of the American Taxpayer Relief Act of 2012 
(Pub. L. 112-240, 126 Stat. 2313); section 135(a) of Tax Increase 
Prevention Act of 2014 (Pub. L. 113-295, 128 Stat. 4010); and section 
144 of the Protecting Americans from Tax Hikes Act of 2015 (Pub. L. 
114-113, 129 Stat. 2242). Currently, section 954(c)(6) applies to 
taxable years of foreign corporations beginning after December 31, 
2005, and before January 1, 2020, and to taxable years of United States 
shareholders with or within which such taxable years of the foreign 
corporations end. Section 954(c)(6)(A) provides the Secretary with the 
authority to prescribe regulations as may be necessary or appropriate 
to carry out section 954(c)(6), including regulations as may be 
necessary or appropriate to prevent the abuse of its purposes.

D. Section 956

    Section 956 determines the amount that a United States shareholder 
of a CFC must include in gross income with respect to the CFC under 
section 951(a)(1)(B). This amount is determined, in part, based on the 
average amount of United States property held, directly or indirectly, 
by the CFC at the close of each quarter during its taxable year. 
Subject to certain exceptions, section 956(c) generally defines United 
States property to include stock and obligations of United States 
persons that are related to the CFC. Sections 956(c)(1)(B) and (C) and 
956(c)(2)(F) and (L). The term ``obligation'' is defined in Sec.  
1.956-2T(d). Section 956(e) grants the Secretary authority to prescribe 
such regulations as may be necessary to carry out the purposes of 
section 956, including regulations to prevent the avoidance of section 
956 through reorganizations or otherwise. In addition, section 956(d) 
grants the Secretary authority to prescribe regulations pursuant to 
which a CFC that is a pledgor or guarantor of an obligation of a United 
States person is considered to hold the obligation. Section 1.956-2(c) 
provides that a CFC that is a direct or indirect pledgor or guarantor 
of an obligation of a United States person is treated as holding the 
obligation. Section 3.01(a) of the 2014 notice discusses relevant 
legislative history of section 956.

E. Section 7701

    Section 7701(l) grants the Secretary authority to issue regulations 
re-characterizing any multiple-party financing transaction as a 
transaction directly among any two or more of such parties where the 
Secretary determines that such re-characterization is appropriate to 
prevent avoidance of any tax imposed under the Code. Section 3.02(a) of 
the 2014 notice discusses relevant legislative history of section 
7701(l).

F. Section 7874

    Under section 7874, a foreign corporation (foreign acquiring 
corporation) generally is treated as a

[[Page 20861]]

surrogate foreign corporation under section 7874(a)(2)(B) if pursuant 
to a plan (or a series of related transactions) three conditions are 
satisfied. First, the foreign acquiring corporation completes, after 
March 4, 2003, the direct or indirect acquisition of substantially all 
of the properties held directly or indirectly by a domestic corporation 
(domestic entity acquisition). Second, after the domestic entity 
acquisition, at least 60 percent of the stock (by vote or value) of the 
foreign acquiring corporation is held by former shareholders of the 
domestic corporation (former domestic entity shareholders) by reason of 
holding stock in the domestic corporation (such percentage is referred 
to at times in this preamble as the ``ownership percentage,'' and, the 
fraction used to calculate the ownership percentage is referred to at 
times in this preamble as the ``ownership fraction''). And third, after 
the domestic entity acquisition, the expanded affiliated group (as 
defined in section 7874(c)(1)) that includes the foreign acquiring 
corporation (EAG) does not have substantial business activities in the 
foreign country in which, or under the law of which, the foreign 
acquiring corporation is created or organized (relevant foreign 
country), when compared to the total business activities of the EAG. 
Pursuant to section 7874(c)(1), an EAG is an affiliated group defined 
in section 1504(a), but without regard to the exclusion of foreign 
corporations in section 1504(b)(3) and using a more-than-50-percent 
ownership threshold in lieu of the 80-percent ownership threshold in 
section 1504(a). Similar provisions apply if a foreign acquiring 
corporation acquires substantially all of the properties constituting a 
trade or business of a domestic partnership. The domestic corporation 
or the domestic partnership described in this paragraph is referred to 
at times in this preamble as the ``domestic entity.''
    The tax treatment of a domestic entity acquisition in which the EAG 
does not have substantial business activities in the relevant foreign 
country varies depending on the level of owner continuity. If the 
ownership percentage is at least 80, the foreign acquiring corporation 
is treated as a domestic corporation for all purposes of the Code 
pursuant to section 7874(b). If, instead, the ownership percentage is 
at least 60 but less than 80 (in which case the domestic entity 
acquisition is referred to in this preamble as an ``inversion 
transaction''), the foreign acquiring corporation is respected as a 
foreign corporation, but, under section 7874(a)(1), the taxable income 
of the domestic entity and certain related United States persons 
(referred to as ``expatriated entities'' and defined in section 
7874(a)(2)(A)) for any year that includes any portion of the applicable 
period shall in no event be less than the inversion gain of the entity 
for the taxable year. Section 7874(d)(1) defines the term ``applicable 
period'' as the period beginning on the first date properties are 
acquired as part of the domestic entity acquisition, and ending on the 
date that is 10 years after the last date properties are acquired as 
part of the domestic entity acquisition. In addition, section 
7874(d)(2) generally provides that the term ``inversion gain'' means 
the income or gain recognized by reason of the transfer during the 
applicable period of stock or other properties by an expatriated 
entity, and any income received or accrued during the applicable period 
by reason of a license of any property by an expatriated entity, 
provided the transfer or license takes place as part of the domestic 
entity acquisition or, under subparagraph (B), after the domestic 
entity acquisition if the transfer or license is to a foreign related 
person. Section 7874(d)(2) provides that subparagraph (B) does not 
apply to property described in section 1221(a)(1) (generally, property 
that is inventory) in the hands of the expatriated entity.
    Section 7874(d)(3) provides that the term ``foreign related 
person'' means, with respect to any expatriated entity, a foreign 
person that is (i) related (within the meaning of section 267(b) or 
707(b)(1)) to the entity, or (ii) under the same common control (within 
the meaning of section 482) as the entity.
    Section 7874(e)(2)(A) provides that, in the case of an expatriated 
entity that is a partnership, section 7874(a)(1) shall apply at the 
partner rather than the partnership level.
    Under section 7874(c)(4), a transfer of properties or liabilities 
(including by contribution or distribution) is disregarded if the 
transfer is part of a plan a principal purpose of which is to avoid the 
purposes of section 7874. In addition, section 7874(c)(6) grants the 
Secretary authority to prescribe regulations as may be appropriate to 
determine whether a corporation is a surrogate foreign corporation, 
including regulations to treat stock as not stock. Finally, section 
7874(g) grants the Secretary authority to provide regulations necessary 
to carry out section 7874, including regulations providing for such 
adjustments to the application of section 7874 as are necessary to 
prevent the avoidance of the purposes of section 7874, including the 
avoidance of such purposes through (i) the use of related persons, 
pass-through or other non-corporate entities, or other intermediaries, 
or (ii) transactions designed to have persons cease to be (or not 
become) members of expanded affiliated groups or related persons.

Explanation of Provisions

I. Regulations Addressing Certain Transactions That Are Structured To 
Avoid the Purposes of Section 7874

    This Part I describes rules for (i) identifying domestic entity 
acquisitions and foreign acquiring corporations in certain multiple-
step transactions; (ii) calculating the ownership percentage and, more 
specifically, disregarding certain stock of the foreign acquiring 
corporation for purposes of computing the denominator of the ownership 
fraction and, in addition, taking into account certain non-ordinary 
course distributions (NOCDs) made by a domestic entity for purposes of 
computing the numerator of the ownership fraction; (iii) determining 
when certain stock of a foreign acquiring corporation is treated as 
held by a member of the EAG; and (iv) determining when an EAG has 
substantial business activities in a relevant foreign country.

A. Multiple-Step Acquisition of Property of a Domestic Entity

1. Background
    Section 1.7874-2(c) provides guidance on the types of transactions 
that constitute a direct or indirect acquisition by a foreign 
corporation of properties held directly or indirectly by a domestic 
entity and that therefore potentially result in a domestic entity 
acquisition. Section 1.7874-2(c)(1) sets forth a non-exclusive list of 
the types of transactions that generally result in an indirect 
acquisition of properties of a domestic entity. In addition, Sec.  
1.7874-2(c)(2) provides that when a foreign corporation acquires stock 
of another foreign corporation, which, in turn, directly or indirectly 
owns stock or a partnership interest in a domestic entity, the 
acquisition by the foreign corporation does not constitute an indirect 
acquisition of any properties held by the domestic entity. Absent Sec.  
1.7874-2(c)(2), the foreign corporation's acquisition of the stock of 
the other foreign corporation would be an indirect acquisition of 
properties of the domestic entity. However, because the domestic entity 
had a foreign parent before the acquisition, these types of 
transactions typically do not give rise to the policy concerns that 
motivated

[[Page 20862]]

Congress to enact section 7874, and therefore they generally are not 
treated as indirect acquisitions of properties of a domestic entity. 
This rule does not, however, address multiple related acquisitions of 
the properties of a domestic entity.
    Section 1.7874-2(f) provides a non-exclusive list of stock of a 
foreign corporation that is described in section 7874(a)(2)(B)(ii) 
(that is, stock of the foreign acquiring corporation held by former 
domestic entity shareholders or former domestic entity partners by 
reason of holding stock or partnership interests in the domestic 
entity; at times, referred to in this preamble as ``by-reason-of 
stock'').
2. Transactions at Issue
    The Treasury Department and the IRS are concerned that taxpayers 
may take the position that certain transactions are not domestic entity 
acquisitions even though the transactions give rise to the policy 
concerns that motivated Congress to enact section 7874. This could 
occur, for example, when a foreign corporation (initial acquiring 
corporation) acquires substantially all of the properties held by a 
domestic entity (the initial acquisition) in a transaction that does 
not result in the initial acquiring corporation being treated as a 
domestic corporation under section 7874(b) (for example, because the 
ownership percentage is less than 80 or because the EAG purports to 
meet the substantial business activities exception in Sec.  1.7874-3), 
and, pursuant to a plan that includes the initial acquisition (or a 
series of related transactions), another foreign corporation 
(subsequent acquiring corporation) acquires substantially all of the 
properties of the initial acquiring corporation (the subsequent 
acquisition). In these cases, a taxpayer may take the position that the 
form of the transactions is respected for U.S. federal income tax 
purposes and that Sec.  1.7874-2(c)(2) prevents the subsequent 
acquiring corporation from being considered to have indirectly acquired 
the properties of the domestic entity pursuant to the subsequent 
acquisition. Under this position, although the initial acquisition 
would be a domestic entity acquisition and the initial acquiring 
corporation would be a foreign acquiring corporation, the subsequent 
acquisition would not be a domestic entity acquisition, and the 
subsequent acquiring corporation would not be a foreign acquiring 
corporation. Moreover, for purposes of computing the ownership 
percentage, a taxpayer may assert that former domestic entity 
shareholders do not hold stock of the subsequent acquiring corporation 
by reason of holding stock in the domestic entity and, instead, hold 
stock of the subsequent acquiring corporation only by reason of holding 
stock in the initial acquiring corporation.
    In certain cases, these positions are contrary to the purposes of 
section 7874, including the purposes of (i) the third-country rule set 
forth in Sec.  1.7874-9T (and described in Section B.4 of this Part I), 
if the subsequent acquiring corporation and the initial acquiring 
corporation are subject to tax as residents of different foreign 
countries, or (ii) the substantial business activities exception in 
Sec.  1.7874-3 if the EAG has substantial business activities in the 
foreign country in which, or under the laws of which, the initial 
acquiring corporation is created or organized but does not have 
substantial business activities in the foreign country in which, or 
under the laws of which, the subsequent acquiring corporation is 
created or organized.
3. Multiple-Step Acquisition Rule
    To address the concerns described in Section 2 of this Part I.A, 
the temporary regulations provide a rule (the multiple-step acquisition 
rule) that treats the subsequent acquisition as a domestic entity 
acquisition and the subsequent acquiring corporation as a foreign 
acquiring corporation. Sec.  1.7874-2T(c)(4)(i). When the multiple-step 
acquisition rule applies, the temporary regulations treat stock of the 
subsequent acquiring corporation received, pursuant to the subsequent 
acquisition, in exchange for stock of the initial acquiring corporation 
described in section 7874(a)(2)(B)(ii) (that is, stock of the initial 
acquiring corporation that, as a result of the initial acquisition, is 
by-reason-of stock) as stock of the subsequent acquiring corporation 
held by reason of holding stock in the domestic entity. Sec.  1.7874-
2T(f)(1)(iv).
    Further, if, pursuant to the same plan (or a series of related 
transactions), a foreign corporation directly or indirectly acquires 
substantially all of the properties held by a subsequent acquiring 
corporation in a transaction that occurs after the subsequent 
acquisition, the principles of the multiple-step acquisition rule apply 
to also treat the further acquisition as a domestic entity acquisition 
and the foreign corporation that made such acquisition as a foreign 
acquiring corporation. Sec.  1.7874-2T(c)(4)(iii). For example, if, 
pursuant to a plan, a foreign corporation (F1) acquires substantially 
all of the properties held by a domestic corporation, followed by 
another foreign corporation (F2) acquiring substantially all of the 
properties held by F1, followed, in turn, by another foreign 
corporation (F3) acquiring substantially all of the properties held by 
F2, then the multiple-step acquisition rule also would treat F3's 
acquisition of F2's properties as a domestic entity acquisition and F3 
as a foreign acquiring corporation. In such a case, the principles of 
the multiple-step acquisition rule would apply in a similar manner to 
treat stock of F3 as by-reason-of stock to the extent the F3 stock is 
received in exchange for F2 stock that is itself treated as by-reason-
of stock under the multiple-step acquisition rule.
    The multiple-step acquisition rule applies in a similar manner when 
the domestic entity is a domestic partnership.
    These rules do not affect the application of section 7874 to the 
initial acquisition. As a result, section 7874 may apply to both the 
initial acquisition and the subsequent acquisition. In addition, and 
like other guidance under Sec.  1.7874-2, the multiple-step acquisition 
rule applies solely for section 7874 purposes. Accordingly, this rule 
does not modify general tax principles (such as the step-transaction 
doctrine) or other rules or guidance that may apply to related 
transactions.

B. Calculation of the Ownership Percentage

1. Clarification of Sec.  1.7874-4T
a. Sec.  1.7874-4T, In General
    Under section 7874(c)(2)(B) (statutory public offering rule), stock 
of a foreign acquiring corporation that is sold in a public offering 
related to a domestic entity acquisition described in section 
7874(a)(2)(B)(i) is excluded from the denominator of the ownership 
fraction. The statutory public offering rule furthers the policy that 
section 7874 is intended to curtail domestic entity acquisitions that 
``permit corporations and other entities to continue to conduct 
business in the same manner as they did prior to the inversion.'' S. 
Rep. No. 192, 108th Cong., 1st. Sess., at 142 (2003); JCT Explanation, 
at 343.
    Section 1.7874-4T modifies the statutory public offering rule. The 
preamble to Sec.  1.7874-4T provides that ``the IRS and the Treasury 
Department believe that stock of the foreign acquiring corporation 
transferred in exchange for certain property in a transaction related 
to the acquisition, but not through a public offering, presents the 
same opportunity to inappropriately reduce the ownership fraction.'' TD 
9654, published on January 17, 2014, in the Federal Register (79 FR 
3094, at 3095).

[[Page 20863]]

Accordingly, Sec.  1.7874-4T(b) provides that, subject to a de minimis 
exception, ``disqualified stock'' is not included in the denominator of 
the ownership fraction. Disqualified stock generally includes stock of 
the foreign acquiring corporation that is transferred to a person 
(other than the domestic entity) in exchange for ``nonqualified 
property.'' The term ``nonqualified property'' means (i) cash or cash 
equivalents, (ii) marketable securities, (iii) certain obligations (for 
example, obligations owed by members of the EAG), or (iv) any other 
property acquired in a transaction (or series of transactions) related 
to the domestic entity acquisition with a principal purpose of avoiding 
the purposes of section 7874. This preamble refers at times to the 
property described in clauses (i), (ii), and (iii) of the preceding 
sentence collectively as ``specified nonqualified property'' and to the 
property described in clause (iv) as ``avoidance property.'' For this 
purpose, the term ``marketable securities'' has the meaning set forth 
in section 453(f)(2), except that the term does not include stock of a 
corporation or an interest in a partnership that becomes a member of 
the EAG in a transaction (or series of transactions) related to the 
domestic entity acquisition, unless a principal purpose for acquiring 
such stock or partnership interest is to avoid the purposes of section 
7874.
b. Clarification
    Section 2.03(b) of the 2015 notice provides that Sec.  1.7874-4T 
will be clarified in certain respects. The temporary regulations 
implement these clarifications. Accordingly, with respect to the 
definition of nonqualified property, the temporary regulations clarify 
that avoidance property means any property (other than specified 
nonqualified property) acquired with a principal purpose of avoiding 
the purposes of section 7874, regardless of whether the transaction 
involves an indirect transfer of specified nonqualified property. See 
Sec.  1.7874-4T(j), Example 3. Second, the temporary regulations remove 
the phrase ``in a transaction (or series of transactions) related to 
the acquisition'' from the definition of avoidance property. See Sec.  
1.7874-4T(i)(7)(iv). Third, the temporary regulations remove the phrase 
``unless a principal purpose for acquiring such stock or partnership 
interest is to avoid the purposes of section 7874'' from the definition 
of ``marketable securities.'' See Sec.  1.7874-4T(i)(6). Finally, the 
temporary regulations clarify Example 1 and Example 2 of Sec.  1.7874-
4T(j) by including a reference to section 7874(c)(4).
    In addition, the temporary regulations update the de minimis 
exception in Sec.  1.7874-4T(d)(1) to reflect the passive assets rule 
(described in Section 2 of this Part I.B) and the NOCD rule (described 
in Section 5 of this Part I.B), and to also conform the exception to 
the de minimis exceptions in Sec. Sec.  1.7874-7T(c) and 1.7874-10T(d).
2. Passive Assets Rule
a. Overview of the 2014 Notice
    Section 2.01(b) of the 2014 notice announced that future 
regulations would include a rule (the passive assets rule) that would 
exclude from the denominator of the ownership fraction stock of a 
foreign acquiring corporation that is attributable to certain passive 
assets, but only if, after the domestic entity acquisition and all 
related transactions are complete, more than 50 percent of the gross 
value of all foreign group property constitutes certain passive assets 
(referred to in the notice and temporary regulations as ``foreign group 
nonqualified property''). See Section b of this Part I.B.2 for the 
definition of foreign group property and foreign group nonqualified 
property. The temporary regulations implement the passive assets rule 
described in the 2014 notice, subject to the modifications described in 
Section c of this Part I.B.2.
    The 2014 notice provides that the amount of stock that will be 
excluded under the passive assets rule is equal to the product of (i) 
the value of the stock of the foreign acquiring corporation, other than 
stock that is described in section 7874(a)(2)(B)(ii) (that is, by-
reason-of stock) and stock that is excluded from the denominator of the 
ownership fraction under either Sec.  1.7874-1(b) (because it is held 
by a member of the EAG) or Sec.  1.7874-4T(b) (because it is 
disqualified stock); and (ii) the foreign group nonqualified property 
fraction. The numerator of the foreign group nonqualified property 
fraction is the gross value of all foreign group nonqualified property, 
and the denominator is the gross value of all foreign group property. 
However, property received by the foreign acquiring corporation that 
gives rise to stock that is excluded from the ownership fraction under 
Sec.  1.7874-4T(b) is excluded from both the numerator and the 
denominator of the foreign group nonqualified property fraction, as 
applicable.
    In addition, the 2014 notice provides that the passive assets rule 
will incorporate the principles of Sec.  1.7874-4T(h) (regarding the 
interaction of the EAG rules with the rule that excludes disqualified 
stock from the denominator of the ownership fraction) with respect to 
stock of the foreign acquiring corporation that is excluded under the 
passive assets rule.
b. Foreign Group Property and Foreign Group Nonqualified Property
    The 2014 notice provides that foreign group property means any 
property (including property that gives rise to disqualified stock upon 
application of Sec.  1.7874-4T) held by the EAG after the domestic 
entity acquisition and all transactions related to that acquisition are 
complete, other than the following property: (i) Property that is 
directly or indirectly acquired in the domestic entity acquisition and 
that, at the time of the domestic entity acquisition, was held directly 
or indirectly by the domestic entity; and (ii) to avoid double 
counting, stock or a partnership interest in a member of the EAG and an 
obligation described in Sec.  1.7874-4T(i)(7)(iii)(A) (that is, an 
obligation of a member of the EAG).
    With respect to foreign group nonqualified property, the 2014 
notice provides that the term generally means foreign group property 
that is described in Sec.  1.7874-4T(i)(7) other than property that 
gives rise to income described in section 1297(b)(2)(A) (the banking 
exception under the passive foreign investment company (PFIC) rules) or 
section 954(h) or (i) (subpart F exceptions for qualified banking or 
financing income and for qualified insurance income, respectively), 
determined by substituting the term ``foreign corporation'' for the 
term ``controlled foreign corporation.'' In addition, a special rule 
treats certain property (referred to as ``substitute property'') that 
would not be foreign group nonqualified property under the general rule 
as foreign group nonqualified property if, in a transaction related to 
the acquisition, such property is acquired in exchange for other 
property that would be foreign group nonqualified property under the 
general rule.
    Section 4.01(b)(i) of the 2015 notice modifies the general 
definition of foreign group nonqualified property to also exclude from 
that definition property that gives rise to income described in section 
1297(b)(2)(B) (the PFIC insurance exception). Further, section 
4.01(b)(ii) of the 2015 notice provides that the general definition of 
foreign group nonqualified property does not include property (i) held 
by a domestic corporation that is subject to tax as an insurance 
company under subchapter L, provided that the property

[[Page 20864]]

is required to support, or is substantially related to, the active 
conduct of an insurance business; or (ii) that gives rise to income 
described in section 954(h), determined by substituting the term 
``domestic corporation'' for the term ``controlled foreign 
corporation,'' and without regard to the phrase ``located in a country 
other than the United States'' in section 954(h)(3)(A)(ii)(I) and 
without regard to any inference that the tests in section 954(h) should 
be calculated or determined without taking into account transactions 
with customers located in the United States. In all three of these 
cases, however, the special rule for substitute property could still 
apply.
c. Regulations Implementing the Passive Assets Rule
    Section 1.7874-7T sets forth the passive assets rule as described 
in the 2014 notice and the 2015 notice, subject to certain 
modifications, in part, to address comments received.
i. De Minimis Exception
    A comment noted that certain rules described in the 2014 notice 
could cause section 7874 to apply to a domestic entity acquisition even 
though the former domestic entity shareholders or former domestic 
entity partners, as applicable, actually own no, or only a de minimis 
amount of, stock in the foreign acquiring corporation after the 
domestic entity acquisition. In the context of the passive assets rule 
this could occur, for example, if a foreign acquiring corporation, 
which holds only cash that does not give rise to disqualified stock 
under Sec.  1.7874-4T, acquires the stock of the domestic entity in 
exchange for a portion of the cash and a small amount of stock of the 
foreign acquiring corporation. Because the foreign group property would 
be comprised entirely of the remaining cash held by the foreign 
acquiring corporation, 100 percent of the gross value of all foreign 
group property would constitute foreign group nonqualified property. 
Accordingly, absent a de minimis exception, all of the stock of the 
foreign acquiring corporation, other than stock described in section 
7874(a)(2)(B)(ii) (that is, by-reason-of stock), would be excluded from 
the denominator of the ownership fraction pursuant to the passive 
assets rule, resulting in an ownership fraction of 100 percent. In 
response to the comment, and for reasons similar to the reasons for the 
de minimis exceptions in Sec.  1.7874-4T and the NOCD rule (described 
in Section 5 of this Part I.B), the Treasury Department and the IRS 
have determined that there should be a de minimis exception to the 
passive assets rule.
    Accordingly, Sec.  1.7874-7T(c) provides a de minimis exception 
when two requirements are satisfied: (i) First, the ownership 
percentage--determined without regard to the application of the passive 
assets rule, Sec.  1.7874-4T(b), and the NOCD rule (described in 
Section 5 of this Part I.B)--is less than five (by vote and value); and 
(ii) second, on the date that the domestic entity acquisition and all 
transactions related to the domestic entity acquisition are complete 
(the completion date), former domestic entity shareholders or former 
domestic entity partners, as applicable, in the aggregate, own 
(applying the attribution rules of section 318(a) with the 
modifications described in section 304(c)(3)(B)) less than five percent 
(by vote and value) of the stock of (or a partnership interest in) each 
member of the EAG.
ii. Assets Upstream of the Foreign Acquiring Corporation
    The 2014 notice would treat property held by an EAG member as 
foreign group property regardless of whether the foreign acquiring 
corporation directly or indirectly owned an interest in the property. 
Thus, in cases in which the foreign acquiring corporation is not the 
common parent of the EAG, the 2014 notice could treat property as 
foreign group property even though the value of the property is not 
reflected in the value of the stock of the foreign acquiring 
corporation.
    The Treasury Department and the IRS have concluded that foreign 
group property should not include property held by EAG members if the 
value of such property is not reflected in the value of the stock of 
the foreign acquiring corporation. In order to effectuate this policy, 
the temporary regulations limit foreign group property to property held 
by members of the ``modified expanded affiliated group.'' See Sec.  
1.7874-7T(f)(2) (defining foreign group property). When the foreign 
acquiring corporation is not the common parent corporation, the 
modified EAG is the EAG redetermined as if the foreign acquiring 
corporation were the common parent corporation. See Sec.  1.7874-
7T(f)(4) (defining modified expanded affiliated group).
    In connection with this change, the temporary regulations also 
modify the definition of foreign group property provided in the 2014 
notice to exclude only stock or partnership interests in members of the 
modified EAG and obligations of such members, since the issue of 
double-counting only arises with respect to those interests.
iii. Certain Nonqualified Property That Gives Rise to Disqualified 
Stock
    A comment questioned whether, for purposes of the more-than-50-
percent threshold test, foreign group property should include certain 
nonqualified property (within the meaning of Sec.  1.7874-4T(i)(7)) 
received by the EAG in a transaction related to the domestic entity 
acquisition. In particular, the comment noted that nonqualified 
property received by the EAG in such a transaction may (i) if received 
in exchange for stock of the foreign acquiring corporation, give rise 
to disqualified stock (within the meaning of Sec.  1.7874-4T(c)) that 
is excluded from the denominator of the ownership fraction under Sec.  
1.7874-4T(b), and (ii) because such property is foreign group 
nonqualified property, increase the likelihood that the more-than-50-
percent threshold will be exceeded and thus that additional stock of 
the foreign acquiring corporation will be excluded from the denominator 
of the ownership fraction under the passive assets rule.
    The Treasury Department and the IRS have determined that the more-
than-50-percent threshold test should apply without regard to whether 
all or a portion of the foreign group nonqualified property was 
received in a transaction related to the domestic entity acquisition. 
The more-than-50-percent threshold test is an on-off switch that is 
intended to determine whether, after the domestic entity acquisition 
and all related transactions are complete, a majority of the value of 
the stock of the foreign acquiring corporation is attributable to 
nonqualified property; other aspects of the passive assets rule 
coordinate its operation with the other anti-abuse rules under section 
7874. Accordingly, the temporary regulations confirm that, for purposes 
of the more-than-50-percent threshold test, foreign group property 
includes nonqualified property that gives rise to disqualified stock 
that is excluded from the denominator of the ownership fraction 
pursuant to Sec.  1.7874-4T(b). See Sec.  1.7874-7T(f)(2). However, as 
is the case under the 2014 notice, Sec.  1.7874-7T(b) does not exclude 
from the denominator of the ownership fraction any stock of the foreign 
acquiring corporation that is attributable to such property. See Sec.  
1.7874-7T(f)(3). Stock attributable to such property is instead 
excluded from the denominator of the ownership fraction under Sec.  
1.7874-4T(b).
iv. Valuing Foreign Group Property
    A comment recommended providing a safe harbor to facilitate the 
valuation

[[Page 20865]]

of foreign group property. The comment noted that the value of certain 
property, particularly illiquid property, may be difficult or costly to 
determine, especially in the case of a foreign acquiring corporation 
that is not publicly traded.
    After considering this comment, the Treasury Department and the IRS 
decline to provide such a safe harbor. A domestic entity acquisition is 
likely to be an infrequent occurrence for a foreign acquiring 
corporation. Furthermore, as a general matter, the value of foreign 
group property must be established in order to determine the amount of 
stock of the foreign acquiring corporation that must be provided in the 
domestic entity acquisition. Therefore, it should not be unduly 
burdensome to determine the aggregate gross value of foreign group 
property and foreign group nonqualified property.
v. Exclusions From General Definition of Foreign Group Nonqualified 
Property
    A comment requested that the regulations clarify that the 
exclusions from the general definition of foreign group nonqualified 
property for certain property that gives rise to income described in 
section 954(h) or (i) apply regardless of whether section 954(h) or (i) 
sunset. However, section 128 of the Protecting Americans from Tax Hikes 
Act of 2015 (Pub. L. 114-113, 129 Stat. 2242) made sections 954(h) and 
(i) permanent. Therefore, this comment is no longer relevant and is not 
adopted.
    Another comment requested that the Treasury Department and the IRS 
clarify that references in the regulations to section 954(h) or (i) or 
section 1297(b)(2)(A) or (B) incorporate the principles of any 
regulations or other guidance issued pursuant to those Code sections. 
In this regard, the Treasury Department and the IRS note that as a 
general matter, unless otherwise indicated, a reference in a regulation 
to a Code section implicitly includes any regulations or other guidance 
issued pursuant to that Code section. Accordingly, the comment is not 
adopted.
vi. Treatment of Partnerships
    The 2014 notice did not explicitly address the treatment of 
partnerships under the passive assets rule. Similar to Sec.  1.7874-
4T(g), the temporary regulations provide that, if one or more members 
of an EAG (for this purpose, taking into account only members of the 
modified EAG as described in Section ii of this Part I.B.2.c) own, in 
the aggregate, more than 50 percent (by value) of the interests in a 
partnership, then, for purposes of the passive assets rule, the 
partnership is treated as a corporation that is a member of the EAG 
(deemed corporation rule). See Sec.  1.7874-7T(d).
    The temporary regulations implementing the passive assets rule do 
not include a rule analogous to that provided in Sec.  1.7874-3(e)(1), 
which treats certain corporate partners of a partnership that owns 
stock of a foreign acquiring corporation as members of the EAG for 
purposes of applying the substantial business activities test. Such a 
rule is not necessary because, as described in Section ii of this Part 
I.B.2.c, assets that are upstream of the foreign acquiring corporation 
are not taken into account as foreign group property for purposes of 
applying the passive assets rule.
3. Acquisitions of Multiple Domestic Entities
a. Transactions at Issue
    The Treasury Department and the IRS are concerned that a single 
foreign acquiring corporation may avoid the application of section 7874 
by completing multiple domestic entity acquisitions over a relatively 
short period of time, in circumstances where section 7874 would 
otherwise have applied if the acquisitions had been made at the same 
time or pursuant to a plan (or series of related transactions). In 
these situations, the value of the foreign acquiring corporation 
increases to the extent it issues stock in connection with each 
successive domestic entity acquisition, thereby enabling the foreign 
acquiring corporation to complete another, potentially larger, domestic 
entity acquisition to which section 7874 will not apply. In some cases, 
a substantial portion of the value of a foreign acquiring corporation 
may be attributable to its completion of multiple domestic entity 
acquisitions over the span of just a few years, with that value serving 
as a platform to complete still larger subsequent domestic entity 
acquisitions that avoid the application of section 7874. That is, the 
ownership percentage determined with respect to a subsequent domestic 
entity acquisition may be less than 60, or less than 80, if the shares 
of the foreign acquiring corporation issued in prior domestic entity 
acquisitions are respected as outstanding (thus, included in the 
denominator but not the numerator) when determining the ownership 
fraction.
    Section 7874 is intended to address transactions in which a 
domestic parent corporation of a multinational group is replaced with a 
foreign parent corporation while ``permit[ting] corporations and other 
entities to continue to conduct business in the same manner as they did 
prior to the inversion.'' S. Rep. No. 192, at 142 (2003); JCT 
Explanation, at 343. To further this policy, various rules under 
section 7874 exclude from the denominator of the ownership fraction 
stock of the foreign acquiring corporation that otherwise would 
inappropriately reduce the ownership fraction. For example, the 
statutory public offering rule of section 7874(a)(2)(B) excludes from 
the denominator of the ownership fraction stock of the foreign 
acquiring corporation that is sold for cash in a public offering 
related to the domestic entity acquisition. For the same reason, rules 
under Sec. Sec.  1.7874-4T and 1.7874-7T exclude from the denominator 
of the ownership fraction certain stock of the foreign acquiring 
corporation that is transferred in exchange for, or otherwise 
attributable to, passive assets or other nonqualified property.
    The Treasury Department and the IRS have concluded that it is not 
consistent with the purposes of section 7874 to permit a foreign 
acquiring corporation to reduce the ownership fraction for a domestic 
entity acquisition by including stock issued in connection with other 
recent domestic entity acquisitions. Moreover, the Treasury Department 
and the IRS do not believe that the application of section 7874 in 
these circumstances should depend on whether there was a demonstrable 
plan to undertake the subsequent domestic entity acquisition at the 
time of the prior domestic entity acquisitions. Therefore, and 
consistent with the policies underlying the other stock exclusion rules 
under section 7874, the Treasury Department and the IRS have determined 
that stock of the foreign acquiring corporation that was issued in 
connection with certain prior domestic entity acquisitions occurring 
within a 36-month look-back period should be excluded from the 
denominator of the ownership fraction.
b. Disregard of Stock Attributable to Certain Domestic Entity 
Acquisitions
    To address these concerns, the temporary regulations provide a rule 
under section 7874(c)(6) and (g) that, for purposes of calculating the 
ownership percentage by value with respect to a domestic entity 
acquisition (the relevant domestic entity acquisition), excludes from 
the denominator of the ownership fraction stock of the foreign 
acquiring corporation attributable to certain prior domestic entity 
acquisitions. This rule (the multiple domestic entity

[[Page 20866]]

acquisition rule) applies if, within the 36-month period ending on the 
signing date with respect to the relevant domestic entity acquisition, 
the foreign acquiring corporation (or a predecessor) completed one or 
more other domestic entity acquisitions that are not excluded under an 
exception (each such other domestic entity acquisition, a prior 
domestic entity acquisition). For this purpose, the signing date is the 
first date on which the contract to effect the relevant domestic entity 
acquisition is binding, or if another binding contract to effect a 
substantially similar acquisition was terminated with a principal 
purpose of avoiding section 7874, the first date on which such other 
contract was binding. In general, a domestic entity acquisition is 
excluded from the definition of a prior domestic entity acquisition if 
(i) the ownership percentage with respect to such domestic entity 
acquisition was less than five, and (ii) the fair market value of the 
by-reason-of stock received by the former domestic entity shareholders 
or former domestic entity partners did not exceed $50 million.
    In general, the amount of foreign acquiring corporation stock that 
is excluded under the multiple domestic entity acquisition rule is 
based on the current value of the shares of foreign acquiring 
corporation stock that were issued in the prior domestic entity 
acquisition, adjusted to reflect intervening redemptions of stock as 
well as certain other changes in the capital structure of the foreign 
acquiring corporation. The Treasury Department and the IRS have 
determined that this approach, which takes into account subsequent 
fluctuations in value attributable to the prior domestic entity 
acquisition, best reflects the policies underlying section 7874, 
including the ownership fraction.
    The temporary regulations provide a three-step process to determine 
the excluded amount for each prior domestic entity acquisition. First, 
the total number of shares of stock of the foreign acquiring 
corporation, within each separate share class (relevant share class), 
that was described in section 7874(a)(2)(B)(ii) as a result of the 
prior domestic entity acquisition (without regard to whether the 60 
percent test of section 7874(a)(2)(B)(ii) was satisfied) must be 
calculated (total number of prior acquisition shares). For this 
purpose, it is not relevant whether a share is outstanding at the time 
of the relevant domestic entity acquisition.
    Second, for each relevant share class, the total number of prior 
acquisition shares must be adjusted to account for redemptions (within 
the meaning of section 317(b)) of shares that occur during the 
redemption testing period (each such share, a redeemed share) and that 
are attributed, on a pro rata basis, to the prior acquisition shares. 
In general, the redemption testing period is the period beginning on 
the day after the completion date of the prior domestic entity 
acquisition and ending on the day prior to the completion date of the 
relevant domestic entity acquisition (the general redemption testing 
period). Sec.  1.7874-8T(e)(1). The number of redeemed shares is then 
multiplied by the redemption fraction (such product, the allocable 
redeemed shares). Sec.  1.7874-8T(d)(1). The numerator of the 
redemption fraction is generally the total number of prior acquisition 
shares, and the denominator is the sum of: (i) The number of 
outstanding shares of the foreign acquiring corporation stock as of the 
end of the last day of the redemption testing period, and (ii) the 
number of redeemed shares during the redemption testing period.
    By ending the redemption testing period on the day prior to the 
completion date of the relevant domestic entity acquisition, shares 
issued on such completion date would not dilute the portion of a prior 
redemption that is allocated to the prior acquisition shares. However, 
to prevent other stock issuances that occur after a particular 
redemption from diluting the amount of allocable redeemed shares, a 
foreign acquiring corporation may establish a reasonable method for 
dividing the general redemption testing period into shorter periods 
(each such shorter period, a redemption testing period). Sec.  1.7874-
8T(e)(2). In these cases, to account for the fact that the total number 
of prior acquisition shares is reduced by the allocable redeemed shares 
for each redemption testing period, the numerator of the redemption 
fraction for a redemption testing period is the total number of prior 
acquisition shares less the sum of the number of allocable redeemed 
shares for prior redemption testing periods. Sec.  1.7874-8T(d)(2)(i).
    Finally, for each relevant share class, the total number of prior 
acquisition shares, reduced to take into account redemptions, is 
multiplied by the fair market value of a single share of stock of the 
relevant share class, as of the completion date of the relevant 
domestic entity acquisition (such product, an excluded amount). Sec.  
1.7874-8T(c). The total amount of stock of the foreign acquiring 
corporation excluded from the denominator of the ownership fraction is 
the sum of the excluded amounts computed separately with respect to 
each prior domestic entity acquisition and each relevant share class. 
Sec.  1.7874-8T(b).
    The temporary regulations also require appropriate adjustments to 
be made to take into account changes in a foreign acquiring 
corporation's capital structure to ensure that the amount of stock 
excluded under the multiple domestic entity acquisition rule properly 
reflects the value attributable to prior domestic entity acquisitions. 
See Sec.  1.7874-8T(f).
    The multiple domestic entity acquisition rule applies after taking 
into account the rule in Sec.  1.7874-2(e). The rule in Sec.  1.7874-
2(e) applies when a foreign acquiring corporation completes two or more 
domestic entity acquisitions pursuant to a plan (or series of related 
transactions). In such a case, for purposes of section 
7874(a)(2)(B)(ii), the acquisitions are treated as a single 
acquisition, and the domestic entities are treated as a single domestic 
entity. Thus, for example, if two acquisitions that would separately 
qualify as a relevant domestic entity acquisition and a prior domestic 
entity acquisition are subject to Sec.  1.7874-2(e), they are treated 
as a single acquisition and, as a result, would not be subject to the 
multiple domestic entity acquisition rule. Similarly, if two 
acquisitions that would separately be treated as two prior domestic 
entity acquisitions are subject to Sec.  1.7874-2(e), they are treated 
as a single prior domestic entity acquisition for purposes of applying 
the multiple domestic entity acquisition rule.
4. Third-Country Rule
a. Background
    Section 2.02(b) of the 2015 notice announces that the Treasury 
Department and the IRS intend to issue regulations providing a rule 
(the third-country rule) that will apply to certain domestic entity 
acquisitions in which a domestic entity combines with an existing 
foreign corporation under a foreign parent corporation that is a tax 
resident of a ``third country'' (that is, a foreign country other than 
the foreign country of which the existing foreign corporation is 
subject to tax as a resident). The 2015 notice provides that the third-
country rule will apply when four requirements are satisfied. First, in 
a transaction (referred to in the 2015 notice as a ``foreign target 
acquisition'' but in this preamble and the temporary regulations as a 
``foreign acquisition'') related to the domestic entity acquisition, 
the foreign acquiring corporation directly or indirectly acquires 
substantially all of the

[[Page 20867]]

properties held directly or indirectly by another foreign corporation 
(the acquired foreign corporation). Second, the gross value of all 
property directly or indirectly acquired by the foreign acquiring 
corporation in the foreign acquisition exceeds 60 percent of the gross 
value of all foreign group property, other than foreign group 
nonqualified property, held by the EAG on the completion date (the 
gross value requirement). Third, the tax residence of the foreign 
acquiring corporation is not the same as that of the acquired foreign 
corporation, as determined before the foreign acquisition and any 
related transaction (the tax residency requirement). And fourth, the 
ownership percentage, determined without regard to the third-country 
rule, must be at least 60 but less than 80 (the domestic entity 
ownership requirement). As explained in Section b of this Part II.B.4, 
the temporary regulations retain the first, third, and fourth 
requirements described in the 2015 notice but replace the second 
requirement with a new requirement.
    When these requirements are satisfied, the 2015 notice provides 
that the third-country rule will exclude from the denominator of the 
ownership fraction stock of the foreign acquiring corporation held by 
former shareholders of the acquired foreign corporation by reason of 
holding stock in the acquired foreign corporation (based on the 
principles of section 7874(a)(2)(B)(ii), which describes by-reason-of 
stock).
b. Regulations Implementing the Third-Country Rule
    Section 1.7874-9T sets forth the third-country rule as described in 
the 2015 notice, subject to certain modifications.
    The temporary regulations replace the gross value requirement 
contained in the 2015 notice with a continuity of interest requirement 
(referred to as the ``foreign ownership percentage''). See Sec.  
1.7874-9T(d)(3) and (4). In general, this requirement is satisfied if 
at least 60 percent of the stock (by vote or value) of the foreign 
acquiring corporation is held by former shareholders of the acquired 
foreign corporation by reason of holding stock in the acquired foreign 
corporation, as determined under the principles of section 
7874(a)(2)(B)(ii), with certain modifications. Sec.  1.7874-9T(e)(3) 
and (4). For this purpose, stock of the foreign acquiring corporation 
held by former domestic entity shareholders (or former domestic entity 
partners) is not taken into account. See Sec.  1.7874-9T(e)(3)(i). 
Because a domestic entity acquisition is disregarded for this purpose, 
it does not dilute the foreign ownership percentage. The temporary 
regulations implement this modification by requiring that there be a 
covered foreign acquisition, generally defined as a transaction in 
which there is an acquisition of substantially all of the properties of 
a foreign corporation (that is, a foreign acquisition) and in which the 
foreign ownership percentage is at least 60. This modification aligns 
the requirements for the third-country rule with the principles of 
section 7874.
    The temporary regulations generally retain the domestic entity 
ownership and tax residency requirements as described in the 2015 
notice. However, the temporary regulations clarify the application of 
the tax residency requirement by providing that the tax residency of 
the foreign acquiring corporation is determined after the covered 
foreign acquisition and all related transactions, and that the tax 
residency of the acquired foreign corporation is determined before the 
covered foreign acquisition and all related transactions.
5. Non-Ordinary Course Distributions (NOCD) Rule
a. Overview
    The 2014 notice announced that the Treasury Department and the IRS 
intend to include in future regulations under section 7874 a rule (the 
NOCD rule) that disregards certain distributions made by a domestic 
entity before being acquired by a foreign acquiring corporation that 
otherwise would reduce the numerator of the ownership fraction. 
Specifically, section 2.02(b) of the 2014 notice provides that, for 
purposes of applying section 7874(c)(4), NOCDs made by the domestic 
entity (including a predecessor) during the 36-month period ending on 
the completion date will be treated as part of a plan a principal 
purpose of which is to avoid the purposes of section 7874.
    The 2014 notice defines NOCDs as the excess of all distributions 
made during a taxable year by the domestic entity with respect to its 
stock or partnership interests, as applicable, over 110 percent of the 
average of such distributions during the thirty-six month period 
immediately preceding such taxable year. The 2014 notice defines 
distribution, in relevant part, to mean any distribution, regardless of 
whether it is treated as a dividend or whether, for example, it 
qualifies under section 355.
    Section 4.02(b) of the 2015 notice provides that the future 
regulations incorporating the NOCD rule will include a de minimis 
exception. The 2015 notice provides that this exception, similar to the 
de minimis exception in Sec.  1.7874-4T(d)(1), will apply to an 
acquisition that satisfies two requirements. First, the ownership 
percentage--determined without regard to Sec.  1.7874-4T(b) (which 
disregards certain stock of the foreign acquiring corporation received 
in exchange for nonqualified property), the passive assets rule, and 
the NOCD rule--must be less than five (by vote and value). Second, 
after the domestic entity acquisition and all transactions related to 
the acquisition are complete, former domestic entity shareholders or 
former domestic entity partners, as applicable, of the domestic entity, 
in the aggregate, must own (applying the attribution rules of section 
318(a) with the modifications described in section 304(c)(3)(B)) less 
than five percent (by vote and value) of the stock of (or a partnership 
interest in) any member of the EAG.
    The 2015 notice provides that, when a domestic entity acquisition 
satisfies the requirements of the de minimis exception, no 
distributions will be treated as NOCDs that are disregarded under the 
NOCD rule. The 2015 notice further provides, however, that even when a 
domestic entity acquisition satisfies the requirements of the de 
minimis exception, distributions that are part of a plan a principal 
purpose of which is to avoid the purposes of section 7874, determined 
without regard to the NOCD rule, will nevertheless be disregarded under 
section 7874(c)(4).
    Further, the 2014 notice provides that Sec.  1.367(a)-3(c) 
(concerning outbound transfers of stock or securities of a domestic 
corporation) will be modified to include a rule that incorporates the 
principles of the NOCD rule for purposes of the substantiality test, 
which, in general, requires that the value of the foreign acquiring 
corporation be equal to or greater than the value of the domestic 
target corporation.
b. Regulations Implementing the NOCD Rule
    Section 1.7874-10T sets forth the NOCD rule as described in the 
2014 notice and the 2015 notice, subject to certain modifications, in 
part, to address comments received. Section 1.367(a)-3T(c)(3)(iii)(C) 
sets forth a similar rule for purposes of the substantiality test under 
Sec.  1.367(a)-3(c).
    i. In General
    Section 1.7874-10T(b) generally provides that, for purposes of 
determining the ownership percentage by value, former domestic entity 
shareholders or former domestic entity partners, as applicable, are 
deemed to receive, by reason of holding stock or an interest in the 
domestic entity, an

[[Page 20868]]

amount of stock of the foreign acquiring corporation with a fair market 
value equal to the aggregate value of NOCDs made by the domestic entity 
(NOCD stock). Thus, similar to the rule under Sec.  1.7874-2(h)(1) 
(regarding the treatment of options for purposes of determining the 
ownership percentage), the NOCD rule does not apply for purposes of 
determining the ownership percentage by vote. Similar to the rule 
addressing voting power in Sec.  1.7874-2(h)(2), however, section 
7874(c)(4) will nonetheless disregard distributions for purposes of 
determining the ownership percentage by vote that, without regard to 
the NOCD rule, are part of a plan a principal purpose of which is to 
avoid the purposes of section 7874.
    The temporary regulations provide, consistent with the approach 
recommended in comments received, that the amount of a distribution 
(including with respect to property distributed in redemption of stock) 
is determined based on the value of the property distributed at the 
time of the distribution. See Sec.  1.7874-10T(b). Accordingly, post-
distribution fluctuations in the value of the stock or interests of the 
domestic entity, as applicable, or the value of the distributed 
property (for example, in the case of a spin-off), do not affect the 
amount of NOCD stock that is deemed received. A comment suggested 
additional guidance on valuing the stock of controlled corporations in 
spin-off transactions. The temporary regulations do not provide new 
guidance on this issue, which extends beyond the scope of the NOCD 
rule.
    A comment generally recommended that, for purposes of determining 
the extent to which NOCD stock is deemed received, the NOCD rule should 
take into account the mix of stock and non-stock consideration provided 
by a foreign acquiring corporation. For example, if the foreign 
acquiring corporation acquires a domestic entity in exchange for 60 
percent stock and 40 percent cash, the comment recommended that only 60 
percent of the additional consideration deemed received under the NOCD 
rule would be treated as consisting of NOCD stock (with the remaining 
40 percent of the additional consideration treated as consisting of 
cash and, to this extent, not increasing the ownership percentage). The 
same comment indicated that, under such an approach, additional 
guidance would be needed in certain cases in which a domestic entity 
had multiple classes of stock outstanding, particularly where the 
foreign acquiring corporation does not have a similar capital 
structure.
    The NOCD rule is intended to address transactions in which a 
taxpayer elects to reduce its size by making distributions outside of 
the ordinary course to shareholders in order to reduce the amount of 
foreign acquiring stock that would have to be provided to such 
shareholders in a subsequent domestic entity acquisition. The Treasury 
Department and the IRS have determined that the mix of additional 
consideration that would have been provided in the subsequent domestic 
entity acquisition but for the NOCDs could differ from the mix of 
consideration that was actually provided in the domestic entity 
acquisition. This could occur, for example, due to limitations on the 
amount of cash that the foreign acquiring corporation was financially 
capable of providing. It is in fact this type of limitation that could 
motivate a domestic entity to make NOCDs in order to reduce the 
ownership percentage, rather than relying on cash consideration 
provided by the foreign acquiring corporation. In addition, the 
Treasury Department and the IRS have concluded that determining the 
hypothetical mix of consideration that would have been provided in the 
absence of NOCDs would give rise to significant administrative 
complexities. Accordingly, the temporary regulations do not adopt this 
comment, and, therefore, also do not provide guidance specific to cases 
where a domestic entity has, or had, multiple classes of stock 
outstanding.
    A comment also requested clarification that the NOCD rule does not 
establish a safe harbor with respect to the application of section 
7874(c)(4). Specifically, the comment requested clarification that, 
when a distribution is not disregarded under the NOCD rule, the 
distribution may nevertheless be disregarded under section 7874(c)(4) 
if, without regard to the NOCD rule, it was made with a principal 
purpose of avoiding the purposes of section 7874. The temporary 
regulations confirm that this is the case. See Sec.  1.7874-10T(c). In 
addition, and also in response to a comment, the temporary regulations 
clarify that, when only a portion of a distribution is treated as an 
NOCD, the NOCD rule does not create a presumption that the remaining 
portion of the distribution was made with a principal purpose of 
avoiding the purposes of section 7874. See id. The remaining portion 
must be analyzed under section 7874(c)(4) in the same manner as any 
other distribution that is not treated as an NOCD.
    Comments requested clarification regarding whether the NOCD rule 
could apply for purposes other than the ownership fraction. For 
example, the comments questioned whether property distributed as part 
of an NOCD could be considered held by the EAG for purposes of 
determining whether the EAG has substantial business activities in the 
relevant foreign country. The temporary regulations confirm that the 
NOCD rule applies only for purposes of determining the ownership 
percentage by value; it therefore does not apply for any other purpose, 
including, for example, the substantial business activities 
determination under Sec.  1.7874-3 or the loss of control exception 
under Sec.  1.7874-1(c)(3). Nevertheless, the scope of section 
7874(c)(4), by its terms, is not limited to the ownership fraction and 
therefore may apply for other purposes under section 7874. See also, 
for example, Sec.  1.7874-3(c), which provides anti-abuse rules 
pursuant to which certain items are not taken into account for purposes 
of the substantial business activities test, including items associated 
with properties or liabilities the transfer of which is disregarded 
under section 7874(c)(4).
ii. Scope of the NOCD Rule
    Comments recommended narrowing the NOCD rule. For example, comments 
suggested that the NOCD rule should only create, either in all cases or 
at least with respect to section 355 distributions, a rebuttable 
presumption that a distribution identified as an NOCD under the rule is 
made with a principal purpose of avoiding the purposes of section 7874. 
Under this approach, if a taxpayer demonstrated that a distribution 
presumptively identified as an NOCD was not in fact made with a 
principal purpose of avoiding the purposes of section 7874, then the 
distribution would not be disregarded. A comment did note, though, that 
difficulties, uncertainties, and administrative burdens could arise 
under a rebuttable presumption approach. After considering the comments 
received, the Treasury Department and the IRS have determined that 
replacing the per se NOCD rule with a rebuttable presumption would give 
rise to significant uncertainty and administrative burden because the 
IRS would face significant challenges in ascertaining the purpose 
underlying each distribution. Accordingly, the temporary regulations do 
not adopt this approach.
    A comment suggested that, if a non-rebuttable presumption is 
retained, the NOCD rule should be narrowed by other means, such as by 
(i) replacing the 36-month period during which

[[Page 20869]]

distributions are subject to being disregarded under the NOCD rule with 
a 24-month period, (ii) increasing the 110% threshold, or (iii) 
excluding certain distributions (such as section 355 distributions, as 
well as certain other distributions) from the definition of 
distribution provided in the 2014 notice. This comment acknowledges 
that the adoption of many or all of these proposals, at the margins, 
could exempt certain tax-motivated distributions from the mechanical 
NOCD rules, but suggests that the IRS could nonetheless use its 
authority to disregard such distributions under the general anti-
avoidance rule of section 7874(c)(4). After considering these comments, 
the Treasury Department and the IRS have concluded that these changes 
could inappropriately facilitate the use of distributions made with a 
principal purpose of avoiding the purposes of section 7874. For 
example, excluding section 355 distributions from the definition of 
distribution would undermine one of the purposes of the NOCD rule, 
which is to address certain section 355 distributions in which a 
domestic distributing corporation distributes one or more lines of 
business in order to facilitate a future inversion by either the 
controlled corporation or itself based on a business combination with a 
foreign corporation that may or may not have been definitively 
identified. Similarly, with respect to the 36-month period, a comment 
suggests that it is unlikely that a taxpayer would be able to determine 
36 months before a particular transaction the amount of distributions 
that would be required to reduce the ownership percentage below 60% or 
80% on the completion date. Large transactions, however, can take many 
months to close. Moreover, some companies that wish to pursue an 
inversion but have not yet definitively identified a foreign target may 
use NOCDs to reduce their size in order to expand the pool of 
appropriately-sized target companies. Accordingly, the Treasury 
Department and the IRS have determined that the parameters described in 
the 2014 notice and the 2015 notice strike the right balance between 
exempting non-abusive transactions from the NOCD rule and providing an 
administrable rule to address tax-motivated transactions. In 
particular, for the reasons described previously for not converting the 
NOCD rule into a rebuttable presumption, the Treasury Department and 
the IRS have concluded that the general anti-avoidance rule under 
section 7874(c)(4) would not be an effective backstop to looser 
objective tests. Accordingly, the temporary regulations do not adopt 
these recommendations.
    Other comments suggested that the regulations should exclude the 
following distributions from the NOCD rule because they ordinarily 
would not give rise to avoidance concerns: (i) Dividends or redemptions 
made pursuant to a policy that is carried out consistently for the 36-
month period preceding the completion date; (ii) intercompany 
distributions by a controlled corporation to its corporate shareholder, 
before the latter distributes the former in a spin-off transaction; 
(iii) certain redemptions of preferred stock; and (iv) in the case of a 
domestic entity that is a domestic partnership, certain partnership 
distributions. These changes are not adopted in the temporary 
regulations because each type of distribution implicates the 
fundamental concern that it reduces the value of the domestic entity. 
Furthermore, the Treasury Department and the IRS have concluded that 
crafting an ``angel list'' of categories of distributions would make 
the NOCD rule more complex and in some cases could lead to 
inappropriate results. As an example of additional complexity, to 
produce symmetrical results, it would be necessary to distinguish these 
types of distributions from other distributions and exclude them not 
only from the look-back period, but also from the distribution history 
period (as described in Section iii of this Part I.B.5.b). Another 
comment suggested that aggregate distributions during a period be 
calculated by netting distributions against certain capital 
contributions. Although netting distributions against contributions 
could more accurately reflect any reduction in the value of the 
domestic entity, it would require additional rules to identify which 
contributions and distributions are appropriate to net, raising the 
same complexity concerns as the other comments. The Treasury Department 
and IRS also note that netting is not allowed in other settings, for 
example, in the excess distribution regime under section 1291 (which 
applies to passive foreign investment companies) and in Sec.  1.7874-4T 
(which applies to domestic entity acquisitions). In particular, Sec.  
1.7874-4T does not allow for a foreign acquiring corporation to net the 
amount of disqualified stock, the issuance of which increases its 
value, against distributions it makes. In sum, the Treasury Department 
and the IRS have determined that the NOCD rule should operate as a 
bright-line rule, testing whether a domestic entity's value-decreasing 
distributions exceed a threshold amount. For this reason, and in 
response to a comment, the temporary regulations exclude from the 
definition of a distribution certain distributions described in 
sections 304 and 305 because they do not reduce the domestic entity's 
value. See Sec.  1.7874-10T(h)(1)(i)(A) and (B).
iii. Determining NOCDs
    The temporary regulations set forth five steps for determining the 
amount of NOCDs. The first step is to identify the look-back period, 
that is, the period during which distributions are subject to being 
disregarded under the NOCD rule. Under Sec.  1.7874-10T(h)(4), the 
look-back period means the 36-month period ending on the completion 
date or, if shorter, the entire period starting with the formation date 
(described in Sec.  1.7874-10T(h)(3) as the earliest of the dates that 
the domestic entity and any predecessor were created or organized) and 
ending on the completion date.
    The next step is to divide the look-back period into look-back 
years. Although the 2014 notice contemplated using a taxable-year 
convention to determine a look-back year, a taxable-year convention may 
create undue complexity or uncertainty when--as noted in a comment--the 
completion date is not the last day of the domestic entity's taxable 
year, or when the domestic entity (or any predecessor) has a short 
taxable year. Because a 12-month convention more simply addresses these 
situations and thus provides for a more administrable NOCD rule, the 
Treasury Department and the IRS have determined that a 12-month 
convention should be used to determine a look-back year. Accordingly, 
the temporary regulations provide that a look-back year generally means 
any of the three consecutive 12-month periods that comprise the look-
back period. See Sec.  1.7874-10T(h)(5)(i). The temporary regulations 
also provide special rules for determining look-back years when the 
look-back period is less than 36 months. See Sec.  1.7874-10T(h)(5)(ii) 
through (iv).
    Once the look-back years have been determined, the distribution 
history period for each look-back year must be identified. The 
distribution history period for a look-back year generally means the 
36-month period preceding the start of the look-back year. Sec.  
1.7874-10T(h)(2)(i). In response to a comment, the temporary 
regulations provide special rules for determining the distribution 
history period for a look-back year that is not preceded by 36 months 
of history. In particular, Sec.  1.7874-10T(h)(2)(ii) provides that 
when the formation date is less than 36 months, but at least 12 months, 
before

[[Page 20870]]

the start of a look-back year, then the distribution history period for 
that look-back year means the entire period, starting with the 
formation date, that precedes the start of the look-back year. Section 
1.7874-10T(h)(2)(iii) provides that, when a look-back year is preceded 
by less than 12 months of history, then the look-back year is 
considered to not have a distribution history period.
    Next, the NOCD threshold for each look-back year must be 
calculated. Except for a look-back year that does not have a 
distribution history period, the NOCD threshold for a look-back year 
means 110 percent of the sum of the distributions made during the 
distribution history period for that look-back year multiplied by a 
fraction. Sec.  1.7874-10T(h)(7)(i). The numerator of the fraction is 
the number of days in the look-back year at issue, and the denominator 
of the fraction is the number of days in the distribution history 
period for that look-back year. Id. Thus, if a look-back year has a 36-
month distribution history period, the NOCD threshold for that look-
back year would be 110 percent of the distributions in the 36-month 
distribution history period, multiplied by 1/3 (simplified from 365/
1095). Similarly, if a look-back year has only a 12-month distribution 
history period, then the NOCD threshold for that look-back year 
generally would be 110 percent of the distributions in the 12-month 
distribution history period, multiplied by 1 (simplified from 365/365). 
For a look-back year that does not have a distribution history period, 
the NOCD threshold is zero. Sec.  1.7874-10T(h)(7)(ii).
    The last step for determining the amount of NOCDs is to calculate, 
for each look-back year, the excess, if any, of all distributions made 
during the look-back year over the NOCD threshold for the look-back 
year. Under Sec.  1.7874-10T(h)(6), the excess amounts constitute 
NOCDs.
    One comment suggested an aggregate approach to determining NOCDs 
under which NOCDs would mean the excess of all distributions during the 
look-back period over 110 percent of the aggregate distributions made 
during the 36-month period preceding the look-back period. The approach 
described in the preceding paragraphs is generally consistent with the 
approach used in other areas of the Code. See, for example, sections 
172(g)(3)(C) and 1291(b)(1). Moreover, for a domestic entity that has 
otherwise had a consistent distribution practice during the look-back 
period, the approach suggested by the comment would facilitate larger 
distributions than are intended to be permitted under the NOCD rule in 
the year preceding the domestic entity acquisition, the year in which 
abusive distributions are most likely. As a result, the Treasury 
Department and the IRS decline to adopt the recommendation.
iv. Predecessors
    In response to a comment, the temporary regulations provide that a 
corporation or partnership (relevant entity) is treated for all 
purposes of the NOCD rule--including for purposes of look-back year 
calculations, distribution history period calculations, and NOCD 
threshold calculations--as having made distributions that were made by 
a predecessor of the relevant entity (the predecessor rule). Sec.  
1.7874-10T(e). Under the predecessor rule, a domestic entity 
``inherits'' distributions made by a predecessor (and, such a 
predecessor could also be a relevant entity that inherits distributions 
made by a predecessor with respect to it).
(a) Purposes of the Predecessor Rule
    The predecessor rule serves two purposes. First, the predecessor 
rule prevents potential avoidance of the NOCD rule. For example, absent 
the predecessor rule, a domestic corporation that would be treated as 
having NOCDs under the NOCD rule might, in anticipation of a domestic 
entity acquisition, undergo a reorganization into a newly formed 
domestic corporation and take the position that the newly formed 
domestic corporation has no distributions to which the NOCD rule 
applies. In addition, upon the combination of two domestic corporations 
in a transaction before a domestic entity acquisition, the domestic 
corporations might, absent the predecessor rule, structure the 
combination such that the corporation with the more favorable 
distribution history serves as the surviving corporation. Although 
section 7874(c)(4) could apply to address these types of transactions 
even absent the predecessor rule, the Treasury Department and the IRS 
have determined that it is appropriate to specifically address these 
transactions through the predecessor rule.
    Second, the predecessor rule increases the accuracy of NOCD 
calculations. That is, when two entities combine in a transaction that 
increases the value of the combined group (for example, in a 
transaction in which a substantial portion of the consideration issued 
by the acquiring entity consists of equity interests in the entity), 
the distribution-paying capacity of the combined group increases. As a 
result, the separate distribution histories of the entities should be 
combined pursuant to the predecessor rule because, otherwise, post-
combination distributions (which are funded by the earnings of both 
entities) might be compared to an NOCD threshold that is 
inappropriately low (that is, an NOCD threshold that takes into account 
the distribution history of only the acquiring entity).
(b) Definition of Predecessor
    In response to comments, the temporary regulations provide guidance 
on the meaning of predecessor. In particular, the temporary regulations 
provide that an entity (tentative predecessor) is a predecessor of 
another entity (relevant entity) when two requirements are satisfied. 
First, the relevant entity must complete a predecessor acquisition, 
which occurs when a relevant entity directly or indirectly acquires 
substantially all of the properties held directly or indirectly by the 
tentative predecessor. See Sec.  1.7874-10T(f)(1)(i) and (f)(2)(i). 
Second, after the predecessor acquisition and all related transactions 
are complete, at least 10 percent of the stock (or interests) in the 
relevant entity must be held by reason of holding stock (or interests) 
in the tentative predecessor. See Sec.  1.7874-10T(f)(1)(ii) and 
(f)(3).
    The second requirement generally ensures that only transactions 
that result in a meaningful increase in the value of the relevant 
entity result in the predecessor's history being inherited by the 
relevant entity. The second requirement also generally ensures that, 
before the predecessor acquisition, the fair market value of the 
tentative predecessor is greater than a de minimis portion of the fair 
market value of the relevant entity. Accordingly, and in response to a 
comment, the second requirement generally prevents a tentative 
predecessor from being a predecessor in cases in which the utility of 
the relevant entity inheriting the historic distributions of the 
tentative predecessor could be outweighed by the potentially 
complicated due diligence required to determine those historic 
distributions. On the other hand, the Treasury Department and the IRS 
determined that it is not appropriate to condition predecessor status 
on a tentative predecessor being larger in value than the relevant 
entity at the time of the predecessor acquisition, as was suggested by 
a comment. Such a narrow definition of predecessor would not 
appropriately reflect the second, accuracy-related purpose of the 
predecessor rule, which requires taking into account the increase in 
the

[[Page 20871]]

dividend-paying capacity of the combined entity.
(c) Distributions Inherited by the Domestic Entity
    Under the temporary regulations, when there is a predecessor of a 
relevant entity, the relevant entity inherits the full amount of any 
distributions made by the predecessor before the predecessor 
acquisition. Sec.  1.7874-10T(e)(1). The relevant entity also inherits 
the full amount of any transfer of money or other property to the 
former owners of the predecessor that is made in connection with the 
predecessor acquisition, to the extent the money or other property was 
directly or indirectly provided by the predecessor. See Sec.  1.7874-
10T(e)(2); see also Sec.  1.7874-10T(h)(1)(iv).
v. Domestic Entity Deemed To Have Distributed Stock of a Distributing 
Corporation in Certain Cases
    A comment noted that, in cases in which a foreign corporation 
wishes to acquire only a portion of a domestic corporation's 
properties, different results may arise under the NOCD rule depending 
on how the parties structure the acquisition and related transactions. 
Consider, for example, a situation in which a domestic parent 
corporation (DP) owns two businesses, Business A ($600 fair market 
value) and Business B ($400 fair market value), and a foreign 
corporation (FA) wishes to acquire Business A in exchange for FA stock. 
Under one structure, DP could contribute Business B to a newly formed 
domestic corporation (DC) and then distribute the stock of DC to its 
shareholders, followed by FA acquiring all the stock of DP in exchange 
for $600 of FA stock. Under another structure, DP could contribute 
Business A to DC and then distribute the stock of DC to its 
shareholders, followed by FA acquiring all the stock of DC in exchange 
for $600 of FA stock. In the first scenario, because the $400 of value 
attributable to Business B was distributed by the domestic entity (DP), 
the NOCD rule would take into account the value of Business B. In the 
second scenario, however, the NOCD rule would not take into account the 
$400 of value of Business B, because the value of Business B was not 
distributed by the domestic entity (DC) and, moreover, DC would not 
inherit any portion of the distribution by DP of the DC stock. See 
Sec.  1.7874-10T(f)(1) (defining a predecessor).
    The comment explained that examples like the one in the preceding 
paragraph demonstrate that, if in certain cases the direction of a 
spin-off is respected for purposes of the NOCD rule, then transactions 
that are substantively the same could give rise to vastly different 
results under the NOCD rule depending on the direction of the spin-off. 
The comment noted that this could lead to abuse of the NOCD rule. The 
Treasury Department and the IRS agree with the concerns raised by the 
comment. As a result, the temporary regulations provide a special rule 
pursuant to section 7874(g) that, for purposes of the NOCD rule, 
creates parity between certain transactions regardless of the direction 
of a spin-off. See Sec.  1.7874-10T(g).
    The special rule in Sec.  1.7874-10T(g) applies when a domestic 
corporation (domestic distributing corporation) distributes stock of 
another domestic corporation (controlled corporation) pursuant to a 
transaction described in section 355 and, immediately before the 
distribution, the value of the distributed stock represents more than 
50 percent of the value of the domestic distributing corporation. When 
the special rule applies, the controlled corporation is deemed for 
purposes of the NOCD rule to have distributed the stock of the 
distributing corporation. The value of the deemed distribution is equal 
to the fair market value of the distributing corporation (but not 
taking into account the fair market value of the stock of the 
controlled corporation) on the date of the distribution.
vi. NOCD Rule for Purposes of Section 367(a) Substantiality Test
    The temporary regulations generally provide that, for purposes of 
the substantiality test in Sec.  1.367(a)-3(c)(3)(iii)(A), the fair 
market value of the U.S. target company includes the aggregate value of 
NOCDs made by the U.S. target company. Sec.  1.367(a)-3T(c)(3)(iii)(C). 
In this regard, NOCDs are calculated in the same manner as provided 
under Sec.  1.7874-10T. See id. Thus, regardless of whether the 
transfer of stock of the U.S. target company is part of a domestic 
entity acquisition, the amount of NOCDs under Sec.  1.367(a)-
3T(c)(3)(iii)(C) is the same as the amount of NOCDs that would exist 
under Sec.  1.7874-10T.
    One comment recommended a de minimis exception should apply to the 
NOCD rule as applied for purposes of the section 367(a) substantiality 
test. The comment suggested that the exception could be based on a 
fixed dollar amount or percentage of the U.S. target company, perhaps 
conditioned on a requirement that the distribution not have been 
motivated by the substantiality test. The temporary regulations adopt 
the comment's recommendation to provide a de minimis exception, but do 
not adopt the comment's recommended formulation of the exception. 
Rather, because the Treasury Department and IRS have concluded that the 
NOCD rule should apply consistently under sections 367 and 7874, the 
temporary regulations provide that the NOCD rule under section 367 does 
not apply if the de minimis exception in Sec.  1.7874-10T(d) would 
apply. See Sec.  1.367(a)-3T(c)(3)(iii)(C).

C. Subsequent Transfers of Stock of the Foreign Acquiring Corporation 
and the EAG Rules

1. In General
    In general, section 7874 is intended to apply to transactions in 
which a U.S. parent corporation of a multinational corporate group is 
replaced by a foreign parent corporation without a significant change 
in the ultimate ownership of the group. See H.R. Conf. Rep. No. 755, 
108th Cong., 2d Sess., at 568 (2004). Congress intended the statutory 
EAG rule in section 7874(c)(2)(A) to prevent section 7874 from applying 
to certain transactions that do not give rise to inversion policy 
concerns. For example, section 7874 should not apply to transactions 
occurring within a group of corporations owned by the same common 
parent corporation before and after the transaction, such as the 
conversion of a wholly-owned domestic subsidiary into a new wholly-
owned CFC. See JCT Explanation, at 344. In this regard, section 
7874(c)(2)(A) provides that stock of a foreign acquiring corporation 
that is held by members of the EAG is not included in the numerator or 
the denominator of the ownership fraction (statutory EAG rule).
    The application of the statutory EAG rule may not always lead to 
appropriate results, including when the domestic entity has minority 
shareholders. To address these cases, Sec.  1.7874-1 provides two 
exceptions to the statutory EAG rule: The internal group restructuring 
exception and the loss-of-control exception (together with the 
statutory EAG rule, the EAG rules). See Sec.  1.7874-1(c)(2) and (3), 
respectively. When either of these exceptions applies, stock of the 
foreign acquiring corporation held by members of the EAG is excluded 
from the numerator, but not the denominator, of the ownership fraction. 
In general, the internal group restructuring exception applies when the 
domestic entity and the foreign acquiring corporation are members of an 
affiliated group (generally based on an 80-percent vote-and-value 
requirement) with the same common parent both

[[Page 20872]]

before and after the acquisition. The loss-of-control exception applies 
when the former domestic entity shareholders or former domestic entity 
partners do not hold more than 50 percent of the stock of any member of 
the EAG after the acquisition. For additional background on these 
exceptions, see the preamble to TD 9238, published on December 28, 
2005, in the Federal Register (70 FR 76685).
    Section 1.7874-5T addresses the effect on the numerator of the 
ownership fraction when former domestic entity shareholders or former 
domestic entity partners receive stock of the foreign acquiring 
corporation by reason of holding stock or a partnership interest in the 
domestic entity and then transfer that stock to another person. 
Specifically, Sec.  1.7874-5T(a) provides that stock of the foreign 
acquiring corporation that is described in section 7874(a)(2)(B)(ii) 
(that is, by-reason-of stock) shall not cease to be so described as a 
result of any subsequent transfer of the stock by the former domestic 
entity shareholder or former domestic entity partner that received the 
stock, even if the subsequent transfer is related to the domestic 
entity acquisition described in section 7874(a)(2)(B)(i). The preamble 
to that regulation notes that the Treasury Department and the IRS 
continue to study the extent to which subsequent transfers of stock of 
the foreign acquiring corporation should be taken into account in 
applying the EAG rules. See TD 9654, published on January 17, 2014, in 
the Federal Register (79 FR 3094, at 3099).
2. Rule Addressing Application of EAG Rules When There Is a Related 
Transfer of Stock of the Foreign Acquiring Corporation
    Section 2.03(b) of the 2014 notice provides a rule concerning the 
interaction of Sec.  1.7874-5T and the EAG rules. Subject to two 
exceptions, the 2014 notice provides that certain stock, referred to as 
``transferred stock,'' is not treated as held by a member of the EAG 
for purposes of applying the EAG rules. As a result, transferred stock 
generally is included in both the numerator and the denominator of the 
ownership fraction. See Sec.  1.7874-5T(a). For this purpose, 
transferred stock is stock of a foreign acquiring corporation described 
in section 7874(a)(2)(B)(ii) (that is, by-reason-of stock) that is 
received by a former domestic entity shareholder or former domestic 
entity partner that is a corporation (transferring corporation), and, 
in a transaction (or series of transactions) related to the domestic 
entity acquisition, is subsequently transferred.
    The 2014 notice also described two exceptions to this rule: The 
U.S.-parented group exception and the foreign-parented group exception. 
When either of these exceptions applies, transferred stock is treated 
as held by members of the EAG for purposes of applying the EAG rules. 
In these cases, transferred stock is excluded from the numerator of the 
ownership fraction and, depending on the application of Sec.  1.7874-
1(c), may be excluded from the denominator of the ownership fraction. 
See Sec.  1.7874-1(b) and (c).
    The U.S.-parented group exception applies if: (i) Before and after 
the domestic entity acquisition, the transferring corporation (or its 
successor) is a member of a U.S.-parented group, and (ii) after the 
domestic entity acquisition, both the person that holds the transferred 
stock after all related transfers of the transferred stock are complete 
and the foreign acquiring corporation are members of the U.S.-parented 
group referred to in (i).
    The foreign-parented group exception applies if: (i) Before the 
domestic entity acquisition, the transferring corporation and the 
domestic entity are members of the same foreign-parented group, and 
(ii) after the domestic entity acquisition, the transferring 
corporation is a member of the EAG, or would be a member of the EAG 
absent the subsequent transfer of any stock of the foreign acquiring 
corporation by a member of the foreign-parented group in a transaction 
related to the domestic entity acquisition (but taking into account all 
other transactions related to such acquisition).
    The 2014 notice defines a U.S.-parented group as an affiliated 
group that has a domestic corporation as the common parent corporation, 
and a foreign-parented group as an affiliated group that has a foreign 
corporation as the common parent corporation. For this purpose, the 
term ``affiliated group'' means an affiliated group as defined in 
section 1504(a) but without regard to section 1504(b)(3), except that 
section 1504(a) is applied by substituting the term ``more than 50 
percent'' for the term ``at least 80 percent'' each place it appears. 
Finally, the 2014 notice provides that, except as provided in the 
foreign-parented group exception, all transactions related to the 
domestic entity acquisition must be taken into account for purposes of 
determining an EAG, a U.S.-parented group, and a foreign-parented 
group.
3. Regulations Implementing the Rule
    Section 1.7874-6T sets forth the rule concerning the interaction of 
Sec.  1.7874-5T and the EAG rules, as described in the 2014 notice, 
subject to the modifications described in this Part I.C.3, in part, to 
address comments received.
a. Loosening of the Restrictions for the U.S.-Parented Group Exception
    In response to a comment, the Treasury Department and the IRS have 
determined that it is not necessary to limit the U.S.-parented group 
exception to cases in which the common parent after the domestic entity 
acquisition is the same as the common parent before the acquisition. 
Accordingly, under Sec.  1.7874-6T, the U.S.-parented group exception 
applies if two requirements are satisfied. First, before the domestic 
entity acquisition, the transferring corporation must be a member of a 
U.S.-parented group. Sec.  1.7874-6T(c)(1)(i). Second, after the 
domestic entity acquisition, each of the transferring corporation (or 
its successor), any person that holds transferred stock, and the 
foreign acquiring corporation must be members of a U.S.-parented group 
the common parent of which: (i) Before the domestic entity acquisition, 
was a member (including the parent) of the U.S.-parented group 
described in the first requirement; or (ii) is a corporation that was 
formed in a transaction related to the domestic entity acquisition, 
provided that, immediately after the corporation was formed (and 
without regard to any related transactions), the corporation was a 
member of the U.S.-parented group described in the first requirement. 
Sec.  1.7874-6T(c)(1)(ii).
    A comment asserted that certain restructurings undertaken by 
foreign-parented groups could inappropriately be subject to section 
7874. The comment posited a circumstance that is a variation of Example 
2 of section 2.03(b)(iv) of the 2014 notice, where FA, the foreign 
acquiring corporation, acquired all the stock of a domestic corporation 
(DT) from a foreign corporation (FT) pursuant to a reorganization 
described in section 368(a)(1)(F). Related to the reorganization, FA 
subsequently issued shares to an individual in exchange for 
nonqualified property (as defined in Sec.  1.7874-4T(i)(7)), which 
prevented FA and FT from being members of the same expanded affiliated 
group, therefore resulting in an ownership fraction of 100 percent. The 
comment asserted that there was no policy reason for section 7874 to 
apply to this transaction and requested that all ``foreign-to-foreign'' 
reorganizations described in section 368(a)(1)(F) be excluded from the 
application of section 7874.
    The Treasury Department and the IRS decline to adopt the comment at 
this

[[Page 20873]]

time. Section 1.7874-6T addresses the interaction of Sec.  1.7874-5T 
and the EAG rules and, in particular, when transferred stock is treated 
as held by members of the EAG. In the example set forth in the comment, 
the stock that caused FA and FT to cease being members of the same EAG 
is not transferred stock. Thus, the comment is beyond the scope of the 
temporary regulations. Nevertheless, the Treasury Department and the 
IRS will continue to study the scope of section 7874 and its 
application to various transactions, including cases similar to the 
example set forth in the comment.
b. Identifying Transferred Stock
    A comment noted that it is unclear how to identify transferred 
stock in certain cases. This may occur, for example, when a 
transferring corporation that receives stock of a foreign acquiring 
corporation described in section 7874(a)(2)(B)(ii) (that is, by-reason-
of stock) also holds other stock of the foreign acquiring corporation 
that has the same terms as the by-reason-of stock (other stock) (by-
reason-of stock and other stock, collectively, fungible stock), and in 
a transaction related to the domestic entity acquisition, subsequently 
transfers less than all of the fungible stock. Different results would 
arise in these cases depending on the extent to which the subsequently 
transferred stock is considered to consist of by-reason-of stock or 
other stock.
    To address this concern, the temporary regulations provide that a 
pro rata portion of the subsequently transferred stock is treated as 
consisting of by-reason-of stock. See Sec.  1.7874-6T(f)(2)(ii).
c. Modifications to the Affiliate-Owned Stock Rules in Sec.  1.7874-1
    The temporary regulations modify the affiliate-owned stock rules in 
Sec.  1.7874-1 to take into account the rules described in the 2014 
notice. First, the temporary regulations provide that, subject to an 
exception, for purposes of Sec. Sec.  1.7874-1 and 1.7874-1T, all 
transactions related to an acquisition are taken into account. See 
Sec.  1.7874-1T(f). This rule is consistent with the general rule 
provided in Sec.  1.7874-6T(e) and the general rule described in 
section 2.03(b)(i) of the 2014 notice.
    Second, the temporary regulations modify the internal group 
restructuring exception to take into account Sec.  1.7874-6T(c)(2). See 
Sec.  1.7874-1T(c)(2)(iii).

D. The Substantial Business Activities Test

1. The Subject-to-Tax Rule
    Section 2.02(a) of the 2015 notice provides a rule (the subject-to-
tax rule) that addresses domestic entity acquisitions in which a 
taxpayer asserts that its EAG has substantial business activities in 
the relevant foreign country when compared to the EAG's total business 
activities even though the foreign acquiring corporation is not subject 
to tax as a resident of the relevant foreign country. Under the 
subject-to-tax rule, an EAG cannot have substantial business activities 
in the relevant foreign country when compared to the EAG's total 
business activities unless the foreign acquiring corporation is subject 
to tax as a resident of the relevant foreign country.
    The temporary regulations implement the subject-to-tax rule 
described in the 2015 notice without making any substantive changes. 
See Sec.  1.7874-3T(b)(4). The requirement set forth in Sec.  1.7874-
3T(b)(4) is in addition to the three quantitative tests for group 
employees, group assets, and group income set forth in Sec.  1.7874-
3(b)(1) through (3).
2. Clarification of ``Group Income''
    Under Sec.  1.7874-3, an EAG is considered to have substantial 
business activities in the relevant foreign country only if at least 25 
percent of its group employees, group assets, and group income are 
located or derived in the relevant foreign country. In general, group 
income is gross income from transactions occurring in the ordinary 
course of business with unrelated customers, as determined consistently 
under either federal tax principles or as reflected in the EAG's 
financial statements. With respect to group income determined using the 
EAG's financial statements, a comment in response to final regulations 
issued under Sec.  1.7874-3 (see TD 9720, published on June 4, 2015, in 
the Federal Register (80 FR 31837)), questioned whether financial 
reporting principles apply only to determine the amount of items of 
income that is taken into account (such as where there is a book-tax 
difference) or also to determine which EAG members are to be taken into 
account during the testing period. The question arose because the 
regulations refer to the ``International Financial Reporting Standards 
(IFRS) used for consolidated financial statement purposes.'' Sec.  
1.7874-3(d)(10). The reference in Sec.  1.7874-3(d)(10) to the IFRS 
used for consolidated financial statement purposes is intended to 
ensure only that the EAG uses a single set of IFRS in preparing 
financial statements for this purpose, as there may be certain 
variations in the IFRS used in different countries. The temporary 
regulations clarify that financial reporting principles are only 
relevant for determining the amount of items of income that are taken 
into account, as an EAG must take into account all items that its 
members (as determined based on the definition of EAG set forth in 
Sec.  1.7874-3(d)(4)) recognized for financial accounting purposes 
during the testing period.

II. Rules Addressing Certain Post-Inversion Tax Avoidance Transactions

    As stated in Section 1 of the 2014 notice, the Treasury Department 
and the IRS understand that certain inversion transactions are 
motivated in substantial part by the ability to engage in tax avoidance 
transactions after the inversion transaction that would not be possible 
in the absence of the inversion transaction. In order to reduce the tax 
benefits of certain post-inversion tax avoidance transactions, the 2014 
notice announced that the Treasury Department and the IRS would issue 
regulations under sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874 
of the Code. Furthermore, the 2015 notice announced additional rules to 
reduce the tax benefits of certain post-inversion tax avoidance 
transactions.

A. United States Property Rule

1. Overview
    As described in section 3.01(a) of the 2014 notice, an inversion 
transaction may permit the new foreign parent of the inverted group, a 
group still principally comprised of United States shareholders and 
their CFCs, to avoid section 956 by accessing the untaxed earnings and 
profits of the CFCs without a current U.S. federal income tax to the 
United States shareholders. This is a result that the United States 
shareholders could not achieve before the inversion transaction. The 
ability of the new foreign parent to access deferred CFC earnings and 
profits would in many cases eliminate the need for the CFCs to pay 
dividends to the United States shareholders, thereby circumventing the 
purposes of section 956.
    In order to prevent this avoidance of section 956, section 3.01(b) 
of the 2014 notice announces that future regulations will include a 
rule (the United States property rule) providing that, solely for 
purposes of section 956, any obligation or stock of a non-CFC foreign 
related person (generally, either the foreign

[[Page 20874]]

acquiring corporation or a foreign affiliate of the foreign acquiring 
corporation that is not an expatriated foreign subsidiary) is United 
States property within the meaning of section 956(c)(1) to the extent 
such obligation or stock is acquired by an expatriated foreign 
subsidiary during the applicable period. The 2014 notice defines an 
expatriated foreign subsidiary as a CFC with respect to which an 
expatriated entity is a United States shareholder, but provides that an 
expatriated foreign subsidiary does not include a CFC that is a member 
of the EAG on the completion date if the domestic entity is not a 
United States shareholder with respect to the CFC on or before the 
completion date. For example, a CFC owned by a U.S. corporation or U.S. 
partnership historically owned by the foreign parent generally would 
not be an expatriated foreign subsidiary because the domestic entity 
was not a United States shareholder with respect to such CFC on or 
before the completion date. See section 958(b)(4).
2. Regulations Implementing the United States Property Rule
    These temporary regulations include the rules described in the 2014 
notice, with certain modifications, in part, to address comments 
received.
a. General Section 956 Rule
    Section 1.956-2T(a)(4)(i) provides that, generally, for purposes of 
section 956 and Sec.  1.956-2(a), United States property includes an 
obligation of a foreign person and stock of a foreign corporation if 
(A) the obligation or stock is held by a CFC that is an expatriated 
foreign subsidiary, (B) the foreign person or foreign corporation is a 
non-CFC foreign related person, and (C) the obligation or stock was 
acquired either during the applicable period or in a transaction 
related to the inversion transaction. A non-CFC foreign related person 
is defined as a foreign related person that is not itself an 
expatriated foreign subsidiary. See Sec.  1.7874-12T(a)(16). The rule 
applies to obligations and stock acquired during the applicable period 
or in a transaction related to the inversion transaction, regardless of 
whether at the time of acquisition the obligation or stock would 
constitute United States property--that is, regardless of whether, at 
the time of acquisition, the expatriated foreign subsidiary was a CFC 
or an expatriated foreign subsidiary, and the non-CFC foreign related 
person was a non-CFC foreign related person. Rather, the rules apply 
when the requirements set forth in Sec.  1.956-2T(a)(4)(i) are 
satisfied on the expatriated foreign subsidiary's relevant quarterly 
measuring date.
    The Treasury Department and the IRS have determined that CFC 
acquisitions of stock or obligations of a prospective foreign acquiring 
corporation or its foreign affiliates in contemplation of an inversion 
transaction present the same repatriation concerns as such acquisitions 
undertaken after an inversion transaction. Accordingly, Sec.  1.956-
2T(a)(4)(i)(C)(2) clarifies that stock or obligations that otherwise 
meet the requirements of the United States property rule described in 
the 2014 notice but that were issued prior to the applicable period, in 
a transaction related to the inversion transaction, constitute United 
States property, provided they are acquired on or after April 4, 2016.
    An expatriated foreign subsidiary generally is defined as a CFC 
with respect to which an expatriated entity is a United States 
shareholder. See Sec.  1.7874-12T(a)(9)(i). However, consistent with 
the 2014 notice, the Treasury Department and the IRS have determined 
that the CFCs of a domestic subsidiary owned by a foreign acquiring 
corporation before an inversion transaction should not be subject to 
the section 956 rules described in this Part II.A, or the rules under 
sections 7701(l) and 367(b) described in Sections B.1, B.2, and B.3 of 
this Part II. Accordingly, consistent with the 2014 notice, Sec.  
1.7874-12T(a)(9)(ii) excludes from the definition of expatriated 
foreign subsidiary a CFC that was a member of the EAG on the completion 
date if the domestic entity was not a United States shareholder with 
respect to the CFC on or before the completion date. As a result of not 
being treated as expatriated foreign subsidiaries, these CFCs are not 
subject to the new rules described in this Part II.A. However, the 
stock and obligations of these CFCs generally are United States 
property when acquired by an expatriated foreign subsidiary during the 
applicable period because these CFCs constitute non-CFC foreign related 
persons within the meaning of these temporary regulations. In addition, 
the exclusion from the definition of expatriated foreign subsidiary 
does not apply to CFCs of the foreign acquiring corporation's legacy 
domestic group that are formed or acquired after the inversion 
transaction. See Sec.  1.956-2T(a)(4)(iv), Example 4.
    The 2014 notice indicates that the term ``expatriated entity'' has 
the meaning provided in section 7874(a)(2)(A). Section 7874(a)(2)(A) 
defines an expatriated entity to include both the domestic entity and 
any United States person who is related (within the meaning of section 
267(b) or 707(b)(1)) to the domestic entity. Comments questioned which 
entities are expatriated entities in certain cases, for example, when a 
domestic entity described in section 7874(a)(2)(B)(i) is transferred or 
ceases to exist. In response to these comments, these temporary 
regulations clarify that an expatriated entity means a domestic entity 
(which includes a successor to a domestic entity, whether domestic or 
foreign) and any United States person that, on any date on or after the 
completion date, is or was related (within the meaning of section 
267(b) or 707(b)(1)) to the domestic entity. See Sec.  1.7874-12T(a)(6) 
and (8). Thus, for example, an entity that is a domestic subsidiary of 
a foreign acquiring corporation on (and before) the completion date, is 
treated as an expatriated entity, while any CFCs owned by that domestic 
subsidiary on or before the completion date are not treated as 
expatriated foreign subsidiaries.
    The 2014 notice also provides that an expatriated foreign 
subsidiary that is a pledgor or guarantor with respect to an obligation 
of a non-CFC foreign related person will be treated as holding the 
obligation, which would be United States property under the general 
rule of Sec.  1.956-2T(a)(4)(i), to the same extent that it would be 
treated as holding the obligation if it were a pledgor or guarantor 
with respect to an obligation of a United States person under the 
principles of section 956(d) and Sec.  1.956-2(c). Accordingly, these 
temporary regulations add Sec.  1.956-2T(c)(5) to extend the pledge and 
guarantee rule in Sec.  1.956-2(c) to apply to obligations of non-CFC 
foreign related persons. Under this rule, an expatriated foreign 
subsidiary that is (or is treated as) a pledgor or guarantor of an 
obligation of a non-CFC foreign related person is considered to hold 
the obligation for purposes of section 956. In addition to pledges or 
guarantees entered into or treated as entered into during the 
applicable period, the rule applies to pledges or guarantees entered 
into or treated as entered into in a transaction related to an 
inversion transaction provided they are entered into or treated as 
entered into on or after April 4, 2016.
b. Exceptions From United States Property
    In the description of the United States property rule in section 
3.01(b) of the 2014 notice, the Treasury Department and the IRS 
requested comments on whether any exceptions under section 956(c)(2) or 
Sec.  1.956-2 should apply to an obligation or stock of a non-CFC

[[Page 20875]]

foreign related person that is United States property pursuant to the 
general rule in Sec.  1.956-2T(a)(4)(i). A comment suggested that the 
following exceptions from United States property should apply to 
obligations of non-CFC foreign related persons: (i) The exception for 
obligations arising out of the sale or processing of property described 
in section 956(c)(2)(C); (ii) the exception for assets equal to the 
earnings of the CFC that have been taxed as effectively connected with 
the conduct of a U.S. trade or business included in section 
956(c)(2)(H); (iii) the exception for certain deposits made in the 
ordinary course of a person's business as a dealer in securities or 
commodities described in section 956(c)(2)(I); and (iv) the exception 
in section 956(c)(2)(J) for obligations, to the extent the principal 
amount thereof does not exceed the fair market value of readily 
marketable securities sold or repurchased pursuant to a sale and 
repurchase agreement or otherwise posted or received as collateral for 
the obligation in the ordinary course of its business by a person that 
is a securities or commodities dealer.
    The Treasury Department and the IRS have concluded that it is 
appropriate for these exceptions to apply to obligations of non-CFC 
foreign related persons as well as United States persons because they 
relate to ordinary business transactions. The exceptions in section 
956(c)(2)(H) and (I) apply by their terms to obligations of non-CFC 
foreign related persons, and thus no rules need to be added to the 
regulations to extend their application. On the other hand, the 
exceptions in current section 956(c)(2)(C) and (J) apply only to 
obligations of United States persons. Accordingly, these temporary 
regulations add rules in Sec.  1.956-2T(a)(4)(ii)(A) and (B), pursuant 
to which obligations of non-CFC foreign related persons are excluded 
from the definition of United States property to the same extent that 
obligations of United States persons are excluded from the definition 
of United States property under section 956(c)(2)(C) and (J). In 
addition, new Sec.  1.956-2T(d)(2)(iii) excludes from the definition of 
United States property obligations of non-CFC foreign related persons 
that arise in connection with the provision of services by a CFC, based 
on the principles of the exception in Sec.  1.956-2T(d)(2)(ii) 
(previously Sec.  1.956-2T(d)(2)(i)(B)), which sets forth a similar 
exclusion for obligations of United States persons.
    A comment also advocated for an additional exception for CFCs that 
are regularly engaged in a third-party lending business. Specifically, 
the comment suggested that loans made by a CFC to related parties in 
the ordinary course of the CFC's business should not be treated as 
United States property when the CFC is regularly engaged in the 
business of making loans to unrelated parties. Alternatively, the 
comment suggested a more limited exclusion for loans made pursuant to a 
binding commitment that predated the inversion transaction, or 
negotiations leading to it, such as loans made under a revolving line 
of credit that was established several years before the first 
negotiations leading to the inversion transaction. An exception akin to 
the exception suggested by the comment does not currently exist with 
respect to obligations of United States persons. The consideration of 
new exceptions to the definition of United States property is beyond 
the scope of this regulation. Furthermore, the exception from the 
definition of non-CFC foreign related person for other expatriated 
foreign subsidiaries ensures that CFCs of a newly inverted group that 
are in the business of lending to other CFCs of the group will not be 
subject to section 956 with respect to the loans.
    The 2014 notice provides that the exception to the definition of 
obligation for certain short-term obligations announced in Notice 88-
108 (the short-term obligation exception) would not apply to 
obligations of non-CFC foreign related persons. As discussed in more 
detail in Part III.B of this Explanation of Provisions section, Notice 
88-108 announced an exception for obligations that are collected within 
30 days, as long as the CFC does not have loans to related United 
States persons that would constitute United States property outstanding 
during the year for 60 or more days. A comment requested that the 
Treasury Department and the IRS reconsider this position because the 
concerns underlying the exception exist with respect to foreign-
parented groups as well as U.S.-parented groups, and questioned the 
rationale for eliminating this exception in the context of an inversion 
transaction. The Treasury Department and the IRS are concerned that 
there is a heightened risk that taxpayers would take abusive positions 
in reliance on the short-term obligation exception announced in Notice 
88-108 in post-inversion transaction structures, due to the fact that 
gaining access to the deferred foreign earnings of CFCs without paying 
U.S. federal income tax is often a stated goal of inversion 
transactions. Accordingly, these temporary regulations provide that the 
exception announced in Notice 88-108 applies only to obligations of 
United States persons. Therefore, this exception does not apply to an 
obligation of a non-CFC foreign related person that is treated as 
United States property pursuant to Sec.  1.956-2T(a)(4)(i).

B. Rules Addressing Avoidance of U.S. Federal Income Tax on Certain 
Earnings and Profits of a CFC or Certain Appreciation in a CFC's Assets

1. Section 7701(l) Recharacterization Rule
a. Overview
    As described in the 2014 notice, after an inversion transaction, 
the inverted group may cause an expatriated foreign subsidiary to cease 
to be a CFC using certain transactions that do not give rise to U.S. 
federal income tax, so as to avoid U.S. federal income tax on the CFC's 
pre-inversion transaction earnings and profits. Additionally, even if 
the foreign acquiring corporation were to acquire less stock of an 
expatriated foreign subsidiary, such that the expatriated foreign 
subsidiary remained a CFC, it could nevertheless substantially dilute a 
United States shareholder's ownership of the CFC. As a result, the 
United States shareholder could avoid U.S. federal income tax on the 
CFC's pre-inversion transaction earnings and profits if, for example, 
the CFC later redeemed, on a non pro rata basis, its stock held by the 
foreign acquiring corporation.
    In order to prevent the use of these transactions to avoid U.S. 
federal income tax, the 2014 notice announces that the Treasury 
Department and the IRS intend to issue regulations under section 
7701(l) that will recharacterize specified transactions completed 
during the applicable period (the section 7701(l) recharacterization 
rule). A specified transaction is defined in section 3.02(e)(i) of the 
2014 notice as a transaction in which stock in an expatriated foreign 
subsidiary (specified stock) is transferred (including by issuance) to 
a specified related person. A specified related person means a non-CFC 
foreign related person, a U.S. partnership that has one or more 
partners that is a non-CFC foreign related person, or a U.S. trust that 
has one or more beneficiaries that is a non-CFC foreign related person.
    Section 3.02(e)(i)(A) of the 2014 notice provides that a specified 
transaction is recharacterized for all purposes of the Code, as of the 
date on which the specified transaction occurs, as an arrangement 
directly between the specified related person and one or more section 
958(a) U.S. shareholders of the expatriated foreign subsidiary. A

[[Page 20876]]

section 958(a) U.S. shareholder of an expatriated foreign subsidiary is 
defined in the 2014 notice as a United States shareholder with respect 
to the expatriated foreign subsidiary that owns (within the meaning of 
section 958(a)) stock in the expatriated foreign subsidiary, but only 
if the United States shareholder is related (within the meaning of 
section 267(b) or 707(b)(1)) to the specified related person or is 
under the same common control (within the meaning of section 482) as 
the specified related person.
    The 2014 notice states that regulations will provide that, if an 
expatriated foreign subsidiary issues specified stock to a specified 
related person, the specified transaction will be recharacterized as 
follows: (i) The property transferred by the specified related person 
to acquire the specified stock (transferred property) will be treated 
as having been transferred by the specified related person to the 
section 958(a) U.S. shareholder(s) of the expatriated foreign 
subsidiary in exchange for instruments deemed issued by the section 
958(a) U.S. shareholder(s) (deemed instrument(s)); and (ii) the 
transferred property or proportionate share thereof will be treated as 
having been contributed by the section 958(a) U.S. shareholder(s) 
(through intervening entities, if any, in exchange for equity in such 
entities) to the expatriated foreign subsidiary in exchange for stock 
in the expatriated foreign subsidiary. The 2014 notice states that 
similar principles will apply to recharacterize a specified transaction 
in which a shareholder transfers specified stock of the expatriated 
foreign subsidiary to a specified related person (such as a partnership 
in which a non-CFC foreign related person is a partner).
    Section 3.02(e)(i)(B) of the 2014 notice explains that regulations 
will provide that a deemed instrument treated as issued in a specified 
transaction will have the same terms as the specified stock (other than 
the issuer). Accordingly, if a distribution is made with respect to 
specified stock of the expatriated foreign subsidiary, matching 
seriatim distributions with respect to stock will be treated as made by 
the expatriated foreign subsidiary (through intervening entities, if 
any) to the section 958(a) U.S. shareholder(s). The section 958(a) U.S. 
shareholder(s), in turn, will be treated as making payments with 
respect to the deemed instrument(s) to the specified related person(s). 
An expatriated foreign subsidiary will be treated as the paying agent 
of a section 958(a) U.S. shareholder of the expatriated foreign 
subsidiary with respect to the deemed instrument treated as issued by 
the section 958(a) U.S. shareholder to a specified related person.
    The 2014 notice states that the regulations will not recharacterize 
a specified transaction in certain situations. If the specified 
transaction is a fast-pay arrangement that is recharacterized under 
Sec.  1.7701(l)-3(c)(2), section 3.02(e)(i)(A) of the 2014 notice 
provides that the rules of Sec.  1.7701(l)-3 will apply instead of the 
recharacterization provided in the 2014 notice. Furthermore, section 
3.02(e)(i)(C) of the 2014 notice provides that a specified transaction 
will not be recharacterized if the specified stock was transferred by a 
shareholder of the expatriated foreign subsidiary and, under applicable 
U.S. federal income tax rules, the shareholder either is required to 
recognize and include in income all of the gain in the specified stock 
(including gain treated as a deemed dividend pursuant to section 964(e) 
or 1248(a) or characterized as a dividend pursuant to section 
356(a)(2)) or has a deemed dividend included in income with respect to 
the specified stock under Sec.  1.367(b)-4 (including by reason of the 
regulations described in the 2014 notice that apply to specified 
exchanges, described in Section 2.c.i of this Part II.B). The last 
exception described in the 2014 notice applies if (i) the expatriated 
foreign subsidiary is a CFC immediately after the specified transaction 
and all related transactions, and (ii) the amount of stock (by value) 
in the expatriated foreign subsidiary (and any lower-tier expatriated 
foreign subsidiary) that is owned, in the aggregate, directly or 
indirectly by the section 958(a) U.S. shareholders of the expatriated 
foreign subsidiary immediately before the specified transaction and any 
transactions related to the specified transaction does not decrease by 
more than 10 percent as a result of the specified transaction and any 
related transactions. The 2015 notice clarifies that the second prong 
of the exception is satisfied only if the percentage of stock (by 
value) (rather than the amount of stock (by value)) does not decrease 
by more than 10 percent.
    Further, the 2014 notice states that regulations will provide that 
if a deemed dividend is included in a CFC's income under section 964(e) 
as a result of a specified transaction that is completed during the 
applicable period, the deemed dividend will not be excluded from 
foreign personal holding company income under section 954(c)(6) (to the 
extent in effect, and notwithstanding the rule described in Notice 
2007-9, 2007-1 C.B. 401).
b. Regulations Implementing the Section 7701(l) Recharacterization Rule
    These temporary regulations implement the section 7701(l) 
recharacterization rule described in the 2014 notice, subject to 
certain modifications, in part, to address comments received. Under 
Sec.  1.7701(l)-4T(b)(1), a specified transaction completed during the 
applicable period will be recharacterized in the manner described in 
Sec.  1.7701(l)-4T(c), subject to the exceptions described in Sec.  
1.7701(l)-4T(b)(2).
i. General Recharacterization Rule
    The description of the specified transaction rules in section 
3.02(e) of the 2014 notice provides that a ``section 958(a) U.S. 
shareholder'' means any United States shareholder of an expatriated 
foreign subsidiary that is related (within the meaning of section 
267(b) or 707(b)(1)) to the specified related person or is under the 
same common control (within the meaning of section 482) as the 
specified related person. In order to more appropriately tailor the 
rules, these temporary regulations narrow the definition of the term 
``section 958(a) U.S. shareholder'' to include only United States 
shareholders that are expatriated entities. See Sec.  1.7701(l)-
4T(f)(10).
    If an expatriated foreign subsidiary issues specified stock to a 
specified related person, the specified transaction is recharacterized 
under Sec.  1.7701(l)-4T(c)(2) in the manner described in the 2014 
notice. Similar rules are provided in Sec.  1.7701(l)-4T(c)(3) for a 
specified transaction arising from a transfer of specified stock by 
shareholders of the expatriated foreign subsidiary. In the 2014 notice, 
the Treasury Department and the IRS requested comments about the 
application of the recharacterization rules to transfers to 
partnerships that are specified related persons, as illustrated in 
Example 2 in section 3.02(e)(iii) of the notice. A comment suggested 
that the recharacterization described in the 2014 notice should not 
apply to transfers of specified stock to partnerships, and that, 
instead, a transferee partnership should be treated as a conduit, to 
the extent of its ownership of specified stock and any corresponding 
property contributed to the partnership. The comment suggested that the 
section 958(a) U.S. shareholder could be treated as directly owning the 
specified stock, or, alternatively, the items attributable to the 
specified stock could be tracked solely to the section 958(a) U.S. 
shareholder. Thus, under the proposed recast, each transferor to the 
partnership would be treated as

[[Page 20877]]

retaining its economic interest in the property transferred to the 
partnership.
    The Treasury Department and the IRS appreciate the complexity of 
the recharacterization described in the 2014 notice, as highlighted by 
the comment, but are concerned that the comment does not fully account 
for the treatment of distributions by the expatriated foreign 
subsidiary as received by its section 958(a) U.S. shareholder rather 
than the transferee partnership. After consideration of the comment's 
proposal, the Treasury Department and the IRS have determined that the 
recharacterization described in the 2014 notice better ensures that an 
expatriated foreign subsidiary that is transferred to a partnership 
that is a specified related person continues to be a CFC, while 
addressing the ancillary consequences of recharacterizing the transfer.
    The expatriated foreign subsidiary stock that is deemed issued 
pursuant to the recharacterization is referred to in the regulations as 
``deemed issued stock,'' and the specified stock actually issued 
pursuant to the specified transaction but disregarded pursuant to the 
recharacterization is referred to as ``disregarded specified stock.'' 
Because the instruments deemed issued by a section 958(a) U.S. 
shareholder have the same terms as the disregarded specified stock 
(other than the issuer), the Treasury Department and the IRS believe 
that the deemed instruments generally will be treated as equity for all 
purposes of the Code.
ii. Exceptions From Recharacterization
    Section 1.7701(l)-4T(b)(2) sets forth three exceptions to the 
application of the rules in Sec.  1.7701(l)-4T(c) to recharacterize a 
specified transaction. The first two exceptions are consistent with the 
exceptions described in the 2014 notice and the 2015 notice for fast-
pay arrangements described in Sec.  1.7701(l)-3(b) and transactions 
(including specified exchanges) in which an appropriate amount of gain 
is recognized. See Section 2.C of this Part II.B for a description of 
the rules applicable to specified exchanges.
    The final exception applies when the expatriated foreign subsidiary 
is a CFC immediately after the specified transaction and any related 
transaction and there is only a de minimis shift of ownership of the 
stock of the expatriated foreign subsidiary or any lower-tier 
expatriated foreign subsidiary to non-CFC foreign related persons. See 
Sec.  1.7701(l)-4T(b)(2)(iii). This exception (referred to in this Part 
II.B.1.b.ii as the ``de minimis exception'') replaces the exception 
described in the 2014 notice for specified transactions in which the 
ownership of section 958(a) U.S. shareholders did not decrease by more 
than 10 percent as a result of the specified transaction and any 
related transactions. The new de minimis exception better reflects the 
policy behind the section 7701(l) recharacterization rule by ensuring 
that dilution of the ownership interests of section 958(a) U.S. 
shareholders in an expatriated foreign subsidiary that is attributable 
to unrelated persons is not taken into account in determining whether 
the exception from recharacterization applies. See Sec.  1.7701(l)-
4T(g), Example 3.
    The de minimis exception generally determines whether a specified 
transaction shifts ownership of stock of an expatriated foreign 
subsidiary (or any lower-tier expatriated foreign subsidiary) to non-
CFC foreign related persons by comparing the percentage of the stock 
(by value) of the expatriated foreign subsidiary (or any lower-tier 
expatriated foreign subsidiary) owned immediately before and 
immediately after the transaction by persons other than non-CFC foreign 
related persons. For this purpose, to determine direct or indirect 
ownership, the principles of section 958(a) apply without regard to 
whether an intermediate entity is foreign or domestic. Sec.  1.7701(l)-
4T(f)(4). The de minimis exception applies if the post-transaction 
ownership percentage (defined in Sec.  1.7701(l)-4T(f)(9)) is at least 
90 percent of the pre-transaction ownership percentage (defined in 
Sec.  1.7701(l)-4T(f)(8)).
    The temporary regulations provide a special rule to ensure that 
stock of a corporation that is directly or indirectly owned by a 
domestic corporation that is an expatriated entity is considered for 
purposes of the de minimis exception as not owned by a non-CFC foreign 
related person. See Sec.  1.7701(l)-4T(f)(4). Absent this special rule, 
such stock would not, to the extent such stock is indirectly owned by a 
non-CFC foreign related person through the domestic corporation, be 
treated as owned by a person other than a non-CFC foreign related 
person for purposes of the de minimis exception.
    Because the de minimis exception measures the shift in ownership of 
lower-tier expatriated foreign subsidiaries as well as the expatriated 
foreign subsidiary whose stock is transferred or issued in the 
specified transaction, dilution of a United States person's indirect 
interest in a lower-tier expatriated foreign subsidiary can prevent the 
exception from applying, even if the United States person is not a 
section 958(a) U.S. shareholder with respect to that lower-tier 
expatriated foreign subsidiary. See Sec.  1.7701(l)-4T(g), Example 6.
    The 2014 notice requested comments on whether an exception to the 
section 7701(l) recharacterization rule and the section 367(b) stock 
dilution rule (described in Section 2 of this Part II.B) is warranted 
where (i) a specified transaction is undertaken in order to integrate 
similar or complementary businesses and (ii) after the inversion 
transaction, the inverted group in fact does not exploit that form in 
order to avoid U.S. taxation on the expatriated foreign subsidiary's 
pre-inversion earnings and profits. In addition, the 2014 notice 
requested comments on the provisions that would be necessary to 
administer such an exception and on the types of transactions that 
would need to serve as ``triggers'' for denying the exception because 
taxpayers could use them to avoid tax on a CFC's pre-inversion earnings 
after a specified transaction. One comment recommended providing a 
business integration exception because foreign-parented multinational 
groups of corporations often engage in internal restructurings for 
business reasons. After consideration of the comment, the Treasury 
Department and the IRS have determined that a business integration 
exception would be very difficult to administer given the subjective 
nature of the determination, the difficulty of determining whether the 
taxpayer takes ``exploitative'' actions in subsequent taxable years, 
and the complexity of potentially having to apply the section 7701(l) 
recharacterization rule retroactively depending on these subsequent 
actions. Accordingly, the temporary regulations do not provide a 
business integration exception.
iii. Transactions Affecting Ownership of Stock of an Expatriated 
Foreign Subsidiary Following a Recharacterized Specified Transaction
    The rules in Sec.  1.7701(l)-4T(d) address transactions that affect 
the ownership of stock of an expatriated foreign subsidiary after a 
specified transaction with respect to the expatriated foreign 
subsidiary has been recharacterized under Sec.  1.7701(l)-4T(c)(2) or 
(3). As discussed in Section i of this Part II.B.1.b, a specified 
transaction that is recharacterized under the rules of Sec.  1.7701(l)-
4T(c) is recharacterized for all purposes of the Code as of the date 
that the specified transaction occurs. Although the recharacterization 
described in the 2014 notice generally applies for all purposes for all 
future tax years, the Treasury Department and the IRS considered 
whether to unwind the recharacterization when stock,

[[Page 20878]]

including disregarded specified stock, in the expatriated foreign 
subsidiary is transferred (directly or indirectly) after the specified 
transaction, and considered adding other special rules concerning the 
results of a subsequent transfer of expatriated foreign subsidiary 
stock.
    The specified transaction rules in Sec.  1.7701(l)-4T are issued 
under the Secretary's regulatory authority in section 7701(l) to 
recharacterize multi-party financing arrangements to prevent the 
avoidance of tax, which is the same authority underlying the fast-pay 
arrangement rules in Sec.  1.7701(l)-3. Although the two regulations 
serve a similar purpose, the technical rules that effectuate that 
purpose deviate due to differences in the underlying financing 
arrangements. The specified transaction rules set forth herein 
generally are concerned with the relationship of the expatriated 
foreign subsidiary to the expatriated entity, as well as the 
expatriated foreign subsidiary's status as a controlled foreign 
corporation, and thus generally are focused on abusive transactions 
that affect the direct and indirect ownership of the expatriated 
foreign subsidiary.
    The 2014 notice states that rules similar to those described in 
Sec.  1.7701(l)-3(c)(3)(iii) (concerning transfers of benefited stock) 
under the fast-pay regulations will apply to transactions affecting 
specified stock. In general, pursuant to Sec.  1.7701(l)-
3(c)(3)(iii)(A), the designation of stock as benefited stock continues 
upon transfer of the stock. Upon further consideration, the Treasury 
Department and the IRS have determined that it is not necessary for the 
specified transaction rules to maintain the connection between the 
instruments that are deemed issued pursuant to the recharacterization 
and the stock (specifically, the non-specified stock) that led to the 
application of the recharacterization rules, as occurs when Sec.  
1.7701(l)-3(c)(3)(iii) is applied to fast-pay stock, due to the 
differences in policy underlying the fast-pay regulations and these 
temporary regulations. Accordingly, a transfer of non-specified stock 
does not require an associated transfer of the deemed instruments as 
would be required under the rules in Sec.  1.7701(l)-3(c)(3)(iii) for a 
transfer of benefited stock. See Sec.  1.7701(l)-4T(d)(1).
    However, the Treasury Department and the IRS determined that 
special rules are necessary to address direct and indirect transfers of 
stock of an expatriated foreign subsidiary (both disregarded specified 
stock and non-specified stock), including rules that generally 
terminate the recharacterization provided for in these temporary 
regulations. Transactions that occur after the specified transaction 
can affect the underlying ownership of the expatriated foreign 
subsidiary stock in such a way that the underlying need for the 
recharacterization rules ceases to exist. That is, there is no reason 
for the recharacterization rules to continue to apply when the reason 
for the rule ceases to apply; the rules need to apply only to the 
extent the relatedness that gave rise to the application of the rules 
continues to be present. In addition, transactions in which the 
inverted group no longer holds the expatriated foreign subsidiary 
create concerns about whether the taxpayer will have access to the 
information necessary to comply with the rules in these temporary 
regulations. In this circumstance, the administrative burden of 
maintaining the recharacterization is not justified.
    Thus, the Treasury Department and the IRS have determined that it 
is appropriate, in certain circumstances, to unwind the 
recharacterization as a result of certain subsequent transactions that 
affect the ownership of the expatriated foreign subsidiary. The 
regulations provide that the recharacterization generally is fully 
unwound when an expatriated foreign subsidiary ceases to be a foreign 
related person. Specifically, Sec.  1.7701(l)-4T(d)(2) provides that 
when a transaction causes an expatriated foreign subsidiary to cease to 
be a foreign related person, the recharacterization is fully unwound 
immediately before the transaction as follows: the section 958(a) U.S. 
shareholders are treated as redeeming their respective deemed 
instruments with the deemed issued stock in the expatriated foreign 
subsidiary, which, in turn, is ``recapitalized'' into the disregarded 
specified stock (which is the specified stock that was transferred in 
the specified transaction that gave rise to the application of Sec.  
1.7701-4T) in the hands of the specified related person.
    In addition, the regulations provide for a similar pro-rata unwind 
when the expatriated foreign subsidiary continues to be a foreign 
related person after a direct or indirect transfer of disregarded 
specified stock of the expatriated foreign subsidiary, and, after the 
transfer, no portion of the disregarded specified stock is held by a 
foreign related person, a specified related person, or an expatriated 
entity. In such circumstances, Sec.  1.7701(l)-4T(d)(3) provides that 
the recharacterization under Sec.  1.7701(l)-4T(c)(2) or (3) is 
partially unwound as follows: The section 958(a) U.S. shareholders are 
treated as redeeming a proportionate amount of their respective deemed 
instruments with the deemed issued stock in the expatriated foreign 
subsidiary, which, in turn, is ``recapitalized'' into the disregarded 
specified stock (which is the specified stock that was transferred in 
the specified transaction that gave rise to the application of Sec.  
1.7701-4T) in the hands of the specified related person.
    The regulations also provide a rule that applies when there is a 
direct transfer of disregarded specified stock, but the 
recharacterization is not unwound, because the transaction does not 
result in an unwind under the rules described earlier in this Part 
II.B.1.b.iii. In those circumstances, the transferor is treated as 
transferring the deemed instruments, in lieu of the disregarded 
specified stock, in exchange for the consideration that was received in 
exchange for the disregarded specified stock. See Sec.  1.7701(l)-
4T(d)(4).
    Even if the rules described in this Part II.B.1.b.iii do not apply 
to unwind a recharacterization under the rules of Sec.  1.7701(l)-
4T(c)(2) or (3), an inverted group may choose to unwind the 
recharacterization by causing the expatriated foreign subsidiary to 
actually redeem all of its disregarded specified stock.
iv. Treatment of Deemed Dividends Included in Income Under Section 
964(e)
    Under Sec.  1.7701(l)-4T(e), and consistent with section 3.02(e)(i) 
of the 2014 notice, a deemed dividend that is included in a CFC's 
income under section 964(e) as a result of a specified transaction that 
is completed during the applicable period is not excluded from FPHCI 
under section 954(c)(6) (to the extent in effect and notwithstanding 
the rule described in Notice 2007-9). See Part III.C of this 
Explanation of Provisions section for a discussion of Notice 2007-9.
2. Section 367(b) Stock Dilution Rule
a. Overview
    Section 3.02(e)(ii) of the 2014 notice provides a rule (the section 
367(b) stock dilution rule) that addresses certain post-inversion 
transaction exchanges that dilute the interest of a United States 
shareholder in a CFC and, absent the rule, could allow the United 
States shareholder to avoid U.S. federal income tax on earnings and 
profits of the CFC that exist at the time of the exchange. 
Specifically, the section 367(b) stock dilution rule, as described in 
the 2014 notice, provides that when certain requirements are satisfied 
with

[[Page 20879]]

respect to an exchange (see Section c.i of this Part II.B.2), the 
exchanging shareholder is generally required to include in income as a 
deemed dividend the section 1248 amount with respect to the stock 
exchanged.
    As explained in the 2014 notice, the section 367(b) stock dilution 
rule is subject to an exception. The exception applies to exchanges 
that satisfy the principles of the second exception described in 
section 3.02(e)(i)(C) of the 2014 notice (regarding specified 
transactions that do not decrease, in the aggregate, the section 958(a) 
U.S. shareholders' ownership of stock in an expatriated foreign 
subsidiary (or lower-tier expatriated foreign subsidiary) by more than 
10 percent).
    The 2014 notice also provides that Sec.  1.367(b)-4(c)(1) 
(regarding the exclusion of a deemed dividend from foreign personal 
holding company income) does not apply to a deemed dividend that 
results from an exchange to which the section 367(b) stock dilution 
rule applies. Further, the 2014 notice provides that such a deemed 
dividend does not qualify for the exceptions from foreign personal 
holding company income provided by section 954(c)(3)(A)(i) or (6) (to 
the extent in effect).
b. Application of the Section 367(b) Stock Dilution Rule to Unrealized 
Appreciation
    The 2015 notice expands the consequences of being subject to the 
section 367(b) stock dilution rule. The 2015 notice provides that, when 
an exchanging shareholder is required under the section 367(b) stock 
dilution rule to include in income as a deemed dividend the section 
1248 amount (if any) with respect to the stock exchanged, the 
exchanging shareholder must also, after taking into account any 
increase in basis provided in Sec.  1.367(b)-2(e)(3)(ii) resulting from 
the deemed dividend, recognize all realized gain with respect to the 
stock that is not otherwise recognized. The 2015 notice explains that 
this result is necessary to prevent a United States shareholder of a 
CFC from potentially avoiding U.S. federal income tax on net unrealized 
built-in-gain in property held by the CFC at the time of the exchange 
of the stock of the CFC. See section 3.02(b) of the 2015 notice.
    The 2015 notice also states that a conforming change will be made 
to the regulations described in section 3.02(e)(i) of the 2014 notice. 
Thus, as noted in Section 1.b.ii of this Part II.B, the first exception 
described in section 3.02(e)(i)(C) of the 2014 notice applies with 
respect to a transfer of specified stock only if, as a result of the 
transfer, all the gain in the specified stock is recognized.
c. Regulations Implementing the Section 367(b) Stock Dilution Rule
    The temporary regulations implement the section 367(b) stock 
dilution rule as described in the 2014 notice and the 2015 notice, 
subject to certain modifications. See Sec.  1.367(b)-4T(e).
i. Requirements for the Section 367(b) Stock Dilution Rule to Apply
    The section 367(b) stock dilution rule, as described in the 2014 
notice, generally applies to an exchange when three requirements are 
satisfied. First, the exchanging shareholder must be described in Sec.  
1.367(b)-4(b)(1)(i)(A). Second, the exchange must occur pursuant to a 
transaction described in Sec.  1.367(b)-4(a) in which the exchanging 
shareholder exchanges stock of an expatriated foreign subsidiary for 
stock in another foreign corporation. And third, the exchange must 
occur within the applicable period. The temporary regulations, as well 
as the remainder of this preamble, use the term ``specified exchange'' 
to describe any exchange that meets all three requirements and with 
respect to which the section 367(b) stock dilution rule thus generally 
applies. See Sec.  1.367(b)-4T(e)(1) and (2).
ii. Exceptions to Section 367(b) Stock Dilution Rule
    The Treasury Department and the IRS have determined that it is 
appropriate to provide two new exceptions to the section 367(b) stock 
dilution rule. The first exception applies to specified exchanges in 
which the exchanging shareholder is neither an expatriated entity nor 
an expatriated foreign subsidiary. The temporary regulations 
incorporate this exception into the first requirement for an exchange 
to be a specified exchange. See Sec.  1.367(b)-4T(e)(2)(i) (requiring, 
among other things, that the exchanging shareholder be an expatriated 
entity or an expatriated foreign subsidiary).
    The second exception replaces the exception described in the 2014 
notice, and is consistent with the exception for de minimis shifts in 
ownership provided in Sec.  1.7701(l)-4T(b)(2)(iii) and discussed in 
Section 1.b.ii of this Part II.B. Accordingly, the second exception 
applies to specified exchanges when the expatriated foreign subsidiary 
is a CFC immediately after the specified exchange and there is only a 
de minimis shift of ownership of the stock of the acquired expatriated 
foreign subsidiary (and any lower-tier expatriated foreign subsidiary) 
to non-CFC foreign related persons. See Sec.  1.367(b)-4T(e)(3).
    Under the second exception, as in the de minimis exception with 
respect to the section 7701(l) recharacterization rule provided in 
Sec.  1.7701(l)-4T(b)(2)(iii), to determine whether a specified 
exchange shifts ownership of stock of an acquired expatriated foreign 
subsidiary (or any lower-tier expatriated foreign subsidiary) to non-
CFC foreign related persons, the temporary regulations generally 
compare the percentage of the stock (by value) of the corporation owned 
immediately before and immediately after the exchange by persons other 
than non-CFC foreign related persons. In the case of asset 
acquisitions, however, because the acquired expatriated foreign 
subsidiary does not exist after the exchange, the temporary regulations 
compare (i) the percentage of the stock (by value) of the transferee 
foreign corporation--which may be viewed as a successor of the acquired 
expatriated foreign subsidiary for purposes of the exception--owned 
immediately after the exchange by persons other than non-CFC foreign 
related persons to (ii) the percentage of the stock (by value) of the 
acquired expatriated foreign subsidiary owned immediately before the 
exchange by persons other than non-CFC foreign related persons. The 
rules concerning the determination of indirect ownership for this 
purpose are identical to those applicable for purposes of the de 
minimis exception from the section 7701(l) recharacterization rule, 
described in Section 1.b.ii of this Part II.B.
    Further, as is generally the case throughout Sec.  1.367(b)-4, 
judicial doctrines and principles, such as substance-over-form and the 
step-transaction doctrine, apply in determining whether the 
requirements of a specified exchange or the de minimis exception are 
satisfied. See also Rev. Rul. 83-23, 1983-1 C.B. 82.
    As noted in Section 1.b.ii of this Part II.B, the 2014 notice 
requested comments on whether an exception to the section 7701(l) 
recharacterization rule discussed therein and the section 367(b) stock 
dilution rule is warranted for certain business integration 
transactions. For the reasons discussed with respect to the section 
7701(l) recharacterization rule, the temporary regulations do not 
provide a business integration exception with respect to the section 
367(b) stock dilution rule.
iii. Treatment of Income Inclusions Under Section 367(b)
    Consistent with section 3.02(e)(ii) of the 2014 notice, Sec.  
1.367(b)-4T(e)(4)

[[Page 20880]]

provides that an income inclusion of a foreign corporation under Sec.  
1.367(b)-4T(e)(1) does not qualify for the exceptions from foreign 
personal holding company income provided by sections 954(c)(3)(A)(i) 
and 954(c)(6) (to the extent in effect and notwithstanding the rule 
described in Notice 2007-9). See Part III.C of this Explanation of 
Provisions section for a discussion of Notice 2007-9.
3. Section 367(b) Asset Dilution Rule
a. Transactions at Issue
    For reasons similar to those discussed in section 3.02(d) of the 
2014 notice and section 3.02(b) of the 2015 notice, the Treasury 
Department and the IRS have determined that, upon a transfer by an 
expatriated foreign subsidiary of property (other than stock of another 
expatriated foreign subsidiary) to a transferee foreign corporation in 
certain section 351 exchanges, the expatriated foreign subsidiary 
should be required to recognize all realized gain in the property that 
is not otherwise recognized. Absent such a rule, the transfer could 
dilute a United States shareholder's indirect interest in the property 
and, as a result, could allow the United States shareholder to avoid 
U.S. federal income tax on realized gain that is not recognized at the 
time of the transfer. For example, under section 351, an expatriated 
foreign subsidiary could transfer appreciated intangible property to a 
transferee foreign corporation in connection with a transfer by a non-
CFC foreign related person to the transferee foreign corporation. 
Realized gain in the transferred property that is not recognized at the 
time of the transfer would, when recognized by the transferee foreign 
corporation after the transfer, create earnings and profits that are 
attributable to gain that economically had accrued within the U.S. 
federal income tax system at the time of the transfer. Because the 
United States shareholder would own less than all the stock of the 
transferee foreign corporation, the United States shareholder could 
avoid U.S. federal income tax on such earnings and profits, 
particularly if the transferee foreign corporation is not a CFC.
b. Regulations Implementing the Section 367(b) Asset Dilution Rule
    The temporary regulations provide a rule (the section 367(b) asset 
dilution rule) that applies when an expatriated foreign subsidiary 
transfers specified property to a foreign transferee corporation in an 
exchange described in section 351 that occurs within the applicable 
period. Sec.  1.367(b)-4T(f)(1). When the section 367(b) asset dilution 
rule applies, the expatriated foreign subsidiary must recognize all 
realized gain (but not loss) with respect to the specified property 
that is not otherwise recognized, unless an exception applies. Sec.  
1.367(b)-4T(f)(1). For this purpose, specified property means any 
property other than stock of a lower-tier expatriated foreign 
subsidiary. Sec.  1.367(b)-4T(g)(5).
    Similar to the section 367(b) stock dilution rule, the section 
367(b) asset dilution rule contains an exception that applies to 
transfers in which there is only a de minimis shift of ownership of the 
specified property to non-CFC foreign related persons. See Sec.  
1.367(b)-4T(f)(2). For purposes of the exception, the temporary 
regulations use ownership of stock of the expatriated foreign 
subsidiary immediately before the exchange as a proxy for ownership of 
specified property immediately before the exchange, and, similarly, use 
ownership of stock of the transferee foreign corporation immediately 
after the exchange as a proxy for ownership of specified property 
immediately after the exchange.
4. The Section 304 Rules
a. Transactions at Issue
    Section 3.03(b) of the 2014 notice explains how taxpayers may be 
engaging in certain transactions following an inversion transaction 
that reduce the earnings and profits of a CFC to facilitate 
repatriation of cash and other property of the CFC. The Treasury 
Department and the IRS understand that taxpayers may interpret section 
304(b)(5)(B) to not apply when more than 50 percent of the dividend 
arising upon application of section 304 is sourced from the domestic 
corporation, even though, for example, pursuant to an income tax treaty 
there may be no (or a reduced rate of) U.S. withholding tax imposed on 
a dividend sourced from the domestic corporation. Under this position, 
the dividend sourced from earnings and profits of the CFC would never 
be subject to U.S. federal income tax.
b. Overview
    To address the concerns described in Section a of this Part II.B.4, 
section 3.03(b) of the 2014 notice provides rules (the section 304 
rules) that apply for purposes of section 304(b)(5)(B). In particular, 
the section 304 rules provide that the determination of whether more 
than 50 percent of the dividends that arise under section 304(b)(2) is 
subject to tax or includible in the earnings and profits of a CFC is 
made by taking into account only the earnings and profits of the 
acquiring corporation (and therefore excluding the earnings and profits 
of the issuing corporation). The section 304 rules also provide that if 
a partnership, option (or similar interest), or other arrangement, is 
used with a principal purpose of avoiding the application of the rule 
described in section 3.03(b) of the 2014 notice (for example, to treat 
a transferor as a CFC), then the partnership, option (or similar 
interest), or other arrangement will be disregarded for purposes of 
applying the rule. Further, the section 304 rules provide that these 
rules apply without regard to whether an inversion transaction has 
occurred.
c. Regulations Implementing the Section 304 Rules
    Section 1.304-7T sets forth regulations implementing the section 
304 rules as described in the 2014 notice.
    A comment requested that the regulations clarify that a dividend is 
``subject to tax'' if it is reportable in the income of a U.S. person, 
even if that income is not currently burdened with tax because of the 
U.S. person's tax attributes. The Treasury Department and the IRS 
decline to adopt the comment at this time because the narrow scope of 
Sec.  1.304-7T concerns taking into account only the earnings and 
profits of the acquiring corporation, for purposes of making the 50 
percent determination discussed in Section b of this Part II.B.4.

C. Inversion Gain Rule

1. In General
    Section 7874(a)(1), together with section 7874(e)(1) (which 
prevents the use of certain credits to offset U.S. federal income tax 
on inversion gain), ensures that an expatriated entity generally pays 
current U.S. federal income tax with respect to inversion gain. These 
rules are intended to ensure that an appropriate ``toll charge'' is 
paid on transactions that accompany or follow an inversion transaction 
and are designed to ``remove income from foreign operations from the 
U.S. taxing jurisdiction.'' See H.R. Conf. Rep. No. 755, at 568, 574 
(2004); JCT Explanation, at 342, 345.
    Section 3.01(b) of the 2015 notice announces that the Treasury 
Department and the IRS intend to issue regulations that will provide a 
rule (the inversion gain rule) to address certain indirect transfers by 
an expatriated entity that, absent the rule, could have the effect of 
removing foreign earnings from the U.S. taxing jurisdiction while

[[Page 20881]]

avoiding current U.S. federal income tax. As described in the 2015 
notice, the inversion gain rule provides that inversion gain includes 
income or gain recognized by an expatriated entity from an indirect 
transfer or license of property, such as an expatriated entity's 
section 951(a)(1)(A) gross income inclusions taken into account during 
the applicable period that are attributable to a transfer of stock or 
other properties or a license of property, either: (i) As part of the 
acquisition, or (ii) after such acquisition if the transfer or license 
is to a specified related person. However, clause (ii) of the preceding 
sentence generally does not apply to transfers or licenses of property 
that is inventory in the hands of the transferor or licensor.
    The inversion gain rule also provides that, if a partnership that 
is a foreign related person transfers or licenses property, a partner 
of the partnership is treated as having transferred or licensed its 
proportionate share of that property, as determined under the rules and 
principles of sections 701 through 777, for purposes of determining 
inversion gain.
2. Regulations Implementing the Inversion Gain Rule
    Section 1.7874-11T sets forth the inversion gain rule as described 
in the 2015 notice, subject to the following modification. In response 
to a comment, Sec.  1.7874-11T(b)(1) provides that inversion gain 
includes amounts treated as a dividend under section 78 with respect to 
foreign taxes deemed to be paid by an expatriated entity under section 
902(a) or 960(a)(1).

III. Miscellaneous Rules and Comment Request

A. New Definitions Section in Section 7874 Regulations

    As noted in Part I of the Background section of this preamble, the 
temporary regulations provide a new definitions section, Sec.  1.7874-
12T, that defines certain terms commonly used in Sec. Sec.  1.367(b)-
4T, 1.956-2T, 1.7701(l)-4T, 1.7874-2, 1.7874-2T, and 1.7874-6T through 
1.7874-11T. The Treasury Department and the IRS anticipate, in the 
future, updating other portions of the section 7874 regulations to 
conform those sections with the nomenclature used in Sec.  1.7874-12T.
    A comment noted that certain rules in the 2014 notice apply to 
inversion transactions, defined as acquisitions in which the foreign 
acquiring corporation is treated as a surrogate foreign corporation 
under section 7874(a)(2). The comment further noted that a transaction 
is not an inversion transaction if the substantial business activities 
requirement in section 7874(a)(2)(B)(iii) is not satisfied, but 
requested that this point be clarified in regulations.
    The Treasury Department and the IRS believe that the definition of 
an inversion transaction, defined in the temporary regulations as a 
domestic entity acquisition in which the foreign acquiring corporation 
is treated as a surrogate foreign corporation under section 
7874(a)(2)(B), taking into account section 7874(a)(3), is clear. If the 
substantial business activities requirement in section 
7874(a)(2)(B)(iii) is not satisfied, the foreign acquiring corporation 
is not a surrogate foreign corporation, and the acquisition therefore 
is not an inversion transaction. Accordingly, this comment is not 
adopted.

B. Rules Under Section 956 Relating to the Definition of Obligation 
Announced in Notice 88-108, Notice 2008-91, Notice 2009-10, and Notice 
2010-12

    On September 16, 1988, the Treasury Department and the IRS issued 
Notice 88-108, which announced that regulations would be issued under 
section 956 that would exclude from the definition of the term 
``obligation'' for purposes of section 956 obligations that are 
collected within 30 days, as long as the CFC does not have loans to 
related United States persons that would constitute United States 
property outstanding during the year for 60 or more days (the 30/60 day 
exception). Due to circumstances affecting liquidity in the United 
States during 2008, on October 4, 2008, the Treasury Department and the 
IRS issued Notice 2008-91, which announced that the 30/60 day exception 
would be expanded to exclude obligations that are collected within 60 
days, as long as the CFC does not have loans outstanding to related 
United States persons that would constitute United States property 
during the year for 180 or more days (the 60/180 day exception). A CFC 
could choose to apply either the 30/60 day exception or the 60/180 day 
exception in years in which the 60/180 day exception is applicable. 
Notice 2008-91 applies for the first two taxable years of a foreign 
corporation ending after October 3, 2008, but does not apply to taxable 
years of a foreign corporation beginning after December 31, 2009. On 
January 14, 2009, the Treasury Department and the IRS issued Notice 
2009-10, which extends the application of the regulations described in 
Notice 2008-91 to a third taxable year in certain cases. On December 
28, 2009, the Treasury Department and the IRS issued Notice 2010-12, 
which extends the application of Notice 2008-91 to the taxable year of 
the CFC that immediately follows the last taxable year of the CFC to 
which the regulations described in Notice 2008-91 otherwise could 
apply.
    These temporary regulations set forth the exceptions to the 
definition of obligation that were announced in Notice 88-108 and 
Notice 2008-91, as modified by Notice 2009-10 and Notice 2010-12. 
Section 1.956-2T(d)(2)(iv) provides the short-term obligation exception 
described in Notice 88-108, and Sec.  1.956-2T(d)(2)(v) provides the 
alternative short-term obligation exception described in Notice 2008-
91, Notice 2009-10 and Notice 2010-12. For the years in which Sec.  
1.956-2T(d)(2)(v) is applicable, CFCs can choose to apply either 
paragraph (iv) or paragraph (v) of Sec.  1.956-2T(d)(2).
    As noted in Part II.A.2.b of this Explanation of Provisions 
section, the exceptions in Sec.  1.956-2T(d)(2)(iv) and (v) apply only 
to obligations of United States persons, and thus do not apply to an 
obligation of a non-CFC foreign related person that is treated as 
United States property pursuant to Sec.  1.956-2T(a)(4)(i).
    The rules in Sec.  1.956-2T(d)(2)(iv) described in this Part III.B 
that were described in Notice 88-108 apply to obligations held on or 
after September 16, 1988, and the rules in Sec.  1.956-2T(d)(2)(v) 
apply to the first three taxable years of a foreign corporation ending 
after October 3, 2008, other than taxable years of a foreign 
corporation beginning on or after January 1, 2011, as well as the 
fourth taxable year of a foreign corporation, if any, when the foreign 
corporation's third taxable year (including any short taxable year) 
ended after October 3, 2008, and on or before December 31, 2009.

C. Request for Comments With Respect to Rules Under Section 954(c)(6) 
Announced in Notice 2007-9 Affected by the 2014 Notice

    On January 11, 2007, the Treasury Department and the IRS issued 
Notice 2007-9, which provided guidance under section 954(c)(6) and 
announced that regulations under section 954(c)(6) that incorporated 
the guidance provided in the notice would be issued. In particular, 
Notice 2007-9 announced that gains treated as dividends under section 
964(e) would be included among dividends eligible for the exclusion 
from FPHCI in section 954(c)(6). In the 2014 notice, the Treasury 
Department and the IRS announced that, notwithstanding Notice 2007-9, a 
deemed dividend included in a CFC's income under section 964(e) as a 
result

[[Page 20882]]

of a specified exchange or a specified transaction that is completed 
during the applicable period would not be excluded from FPHCI under 
section 954(c)(6). As noted in Parts II.B.1.b.iv and II.B.2.c.iii of 
this Explanation of Provisions section, Sec. Sec.  1.367(b)-4T(e)(4) 
and 1.7701(l)-4T(e) set forth the limitations on the applicability of 
section 954(c)(6) described in the 2014 notice. The Treasury Department 
and the IRS request comments as to whether it is appropriate to treat 
other amounts included by a CFC in gross income as a dividend under 
section 964(e) as dividends from a related person to which section 
954(c)(6) may apply.

Effect on Other Documents

    Notice 88-108, 1988-2 C.B. 446 is obsolete as of April 4, 2016.
    Notice 2008-91, 2008-43 I.R.B. 1001 is obsolete as of April 4, 
2016.
    Notice 2009-10, 2009-5 I.R.B. 419 is obsolete as of April 4, 2016.
    Notice 2010-12, 2010-4 I.R.B. 326 is obsolete as of April 4, 2016.
    Notice 2014-52, 2014-42 I.R.B. 712 is obsolete as of April 4, 2016.
    Notice 2015-79, 2015-49 I.R.B. 775 is obsolete as of April 4, 2016.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin (or Cumulative Bulletin) and are available from the 
Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402, or by visiting the IRS Web site at http://www.irs.gov.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory assessment is not 
required. It has been determined that sections 553(b) and (d) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) do not apply to these 
regulations. For applicability of the Regulatory Flexibility Act (5 
U.S.C. chapter 6), refer to the cross-referenced notice of proposed 
rulemaking published elsewhere in this issue of the Federal Register. 
Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal authors of these regulations are Rose E. Jenkins, 
David A. Levine, and Shane M. McCarrick of the Office of Associate 
Chief Counsel (International). However, other personnel from the 
Treasury Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by revising 
the entry for Sec.  1.367(b)-4T and adding the following entries in 
numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.304-7T also issued under 26 U.S.C. 304(b)(5)(C).
* * * * *
    Section 1.367(b)-4T also issued under 26 U.S.C. 367(b) and 
954(c)(6)(A).
* * * * *
    Section 1.956-2T also issued under 26 U.S.C. 956(d) and 956(e).
* * * * *
    Section 1.7701(l)-4T also issued under 26 U.S.C. 7701(l) and 
954(c)(6)(A).
* * * * *
    Section 1.7874-2T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
* * * * *
    Section 1.7874-3T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
* * * * *
    Section 1.7874-6T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
    Section 1.7874-7T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
    Section 1.7874-8T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
    Section 1.7874-9T also issued under 26 U.S.C. 7874(c)(6) and 
(g).
    Section 1.7874-10T also issued under 26 U.S.C. 7874(c)(4) and 
(g).
    Section 1.7874-11T also issued under 26 U.S.C. 7874(g).
    Section 1.7874-12T also issued under 26 U.S.C. 7874(g).


0
Par. 2. Section 1.304-6 is added to read as follows:


Sec.  1.304-6  Amount constituting a dividend. [Reserved]

0
Par. 3. Section 1.304-7T is added to read as follows:


Sec.  1.304-7T  Certain acquisitions by foreign acquiring corporations 
(temporary).

    (a) Scope. This section provides rules regarding the application of 
section 304(b)(5)(B) to an acquisition of stock described in section 
304 by an acquiring corporation that is foreign (foreign acquiring 
corporation). Paragraph (b) of this section provides the rule for 
determining which earnings and profits are taken into account for 
purposes of applying section 304(b)(5)(B). Paragraph (c) of this 
section provides rules addressing the use of a partnership, option (or 
similar interest), or other arrangement. Paragraph (d) of this section 
provides examples that illustrate the rules of this section. Paragraph 
(e) of this section provides the applicability date, and paragraph (f) 
of this section provides the date of expiration.
    (b) Earnings and profits taken into account. For purposes of 
applying section 304(b)(5)(B), only the earnings and profits of the 
foreign acquiring corporation are taken into account in determining 
whether more than 50 percent of the dividends arising from the 
acquisition (determined without regard to section 304(b)(5)(B)) would 
neither be subject to tax under chapter 1 of subtitle A of the Internal 
Revenue Code for the taxable year in which the dividends arise (subject 
to tax) nor be includible in the earnings and profits of a controlled 
foreign corporation, as defined in section 957 and without regard to 
section 953(c) (includible by a controlled foreign corporation).
    (c) Use of a partnership, option (or similar interest), or other 
arrangement. If a partnership, option (or similar interest), or other 
arrangement, is used with a principal purpose of avoiding the 
application of this section (for example, to treat a transferor as a 
controlled foreign corporation), then the partnership, option (or 
similar interest), or other arrangement will be disregarded for 
purposes of applying this section.
    (d) Examples. The following examples illustrate the rules of this 
section. For purposes of the examples, assume the following facts in 
addition to the facts stated in the examples:
    (1) FA is a foreign corporation that is not a controlled foreign 
corporation;
    (2) FA wholly owns DT, a domestic corporation;
    (3) DT wholly owns FS1, a controlled foreign corporation; and
    (4) No portion of a dividend from FS1 would be treated as from 
sources within the United States under section 861.

    Example 1-- (i) Facts. DT has earnings and profits of $51x, and 
FS1 has earnings and profits of $49x. FA transfers DT stock with a 
fair market value of $100x to FS1 in exchange for $100x of cash.
    (ii) Analysis. Under section 304(a)(2), the $100x of cash is 
treated as a distribution in redemption of the stock of DT. The

[[Page 20883]]

redemption of the DT stock is treated as a distribution to which 
section 301 applies pursuant to section 302(d), which ordinarily 
would be sourced first from FS1 under section 304(b)(2)(A). Without 
regard to the application of section 304(b)(5)(B), more than 50 
percent of the dividend arising from the acquisition, taking into 
account only the earnings and profits of FS1 pursuant to paragraph 
(b) of this section, would neither be subject to tax nor includible 
by a controlled foreign corporation. In particular, no portion of a 
dividend from FS1 would be subject to tax or includible by a 
controlled foreign corporation. Accordingly, section 304(b)(5)(B) 
and paragraph (b) of this section apply to the transaction, and no 
portion of the distribution of $100x is treated under section 
301(c)(1) as a dividend out of the earnings and profits of FS1. 
Furthermore, the $100x of cash is treated as a dividend to the 
extent of the earnings and profits of DT ($51x).
    Example 2-- (i) Facts. FA and DT own 40 percent and 60 percent, 
respectively, of the capital and profits interests of PRS, a foreign 
partnership. PRS wholly owns FS2, a controlled foreign corporation. 
The FS2 stock has a fair market value of $100x. FS1 has earnings and 
profits of $150x. PRS transfers all of its FS2 stock to FS1 in 
exchange for $100x of cash. DT enters into a gain recognition 
agreement that complies with the requirements set forth in section 
4.01 of Notice 2012-15, 2012-9 I.R.B 424, with respect to the 
portion (60 percent) of the FS2 stock that DT is deemed to transfer 
to FS1 in an exchange described in section 367(a)(1). See Sec.  
1.367(a)-1T(c)(3)(i)(A).
    (ii) Analysis. Under section 304(a)(1), PRS and FS1 are treated 
as if PRS transferred its FS2 stock to FS1 in an exchange described 
in section 351(a) solely for FS1 stock, and, in turn, FS1 redeemed 
such FS1 stock in exchange for $100x of cash. The redemption of the 
FS1 stock is treated as a distribution to which section 301 applies 
pursuant to section 302(d). Without regard to the application of 
section 304(b)(5)(B), more than 50 percent of a dividend arising 
from the acquisition, taking into account only the earnings and 
profits of FS1 pursuant to paragraph (b) of this section, would be 
subject to tax. In particular, 60 percent of a dividend from FS1 
would be included in DT's distributive share of PRS's partnership 
income and therefore would be subject to tax. Accordingly, section 
304(b)(5)(B) does not apply, and the entire distribution of $100x is 
treated under section 301(c)(1) as a dividend out of the earnings 
and profits of FS1.

    (e) Applicability date. This section applies to acquisitions that 
are completed on or after September 22, 2014.
    (f) Expiration date. This section expires on April 4, 2019.

0
Par. 4. Section 1.367(a)-3 is amended by:
0
1. Revising the paragraph heading of paragraph (c)(3)(iii)(B).
0
2. Adding paragraph (c)(3)(iii)(C).
0
3. Redesignating paragraph (c)(11) as paragraph (c)(11)(i).
0
4. Adding a paragraph heading for paragraph (c)(11) and revising the 
paragraph heading of newly redesignated paragraph (c)(11)(i).
0
5. Revising the first sentence of newly redesignated paragraph 
(c)(11)(i).
0
6. Adding paragraph (c)(11)(ii).
    The additions and revisions read as follows:


Sec.  1.367(a)-3  Treatment of transfers of stock or securities to 
foreign corporations.

* * * * *
    (c) * * *
    (3) * * *
    (iii) * * *
    (B) Special rules for transferee foreign corporation value. * * *
* * * * *
    (C) [Reserved]. For further guidance, see Sec.  1.367(a)-
3T(c)(3)(iii)(C).
* * * * *
    (11) Applicability date of this paragraph (c)--(i) In general. 
Except as otherwise provided, this paragraph (c) applies to transfers 
occurring after January 29, 1997. * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.367(a)-
3T(c)(11)(ii).
* * * * *

0
Par. 5. Section 1.367(a)-3T is added to read as follows:


Sec.  1.367(a)-3T  Treatment of transfers of stock or securities to 
foreign corporations. (temporary).

    (a) through (c)(3)(iii)(B) [Reserved]. For further guidance, see 
Sec.  1.367(a)-3(a) through (c)(3)(iii)(B).
    (C) Special rule for U.S. target company value. For purposes of 
Sec.  1.367(a)-3(c)(3)(iii)(A), the fair market value of the U.S. 
target company includes the aggregate amount of non-ordinary course 
distributions (NOCDs) made by the U.S. target company. To calculate the 
aggregate value of NOCDs, the principles of Sec.  1.7874-10T, including 
the rule regarding predecessors in Sec.  1.7874-10T(e) and the rule 
regarding a deemed distribution of stock in certain cases in Sec.  
1.7874-10T(g), apply. However, this paragraph (c)(3)(iii)(C) does not 
apply if the principles of the de minimis exception in Sec.  1.7874-
10T(d) are satisfied.
    (4) through (11)(i) [Reserved]. For further guidance, see Sec.  
1.367(a)-3(c)(4) through (c)(11)(i).
    (ii) Applicability date of certain provisions of this paragraph 
(c). The first and second sentence of paragraph (c)(3)(iii)(C) of this 
section apply to transfers completed on or after September 22, 2014. 
The third sentence of paragraph (c)(3)(iii)(C) of this section applies 
to transfers completed on or after November 19, 2015. Taxpayers may, 
however, elect to apply the third sentence of paragraph (c)(3)(iii)(C) 
of this section to transfers completed on or after September 22, 2014, 
and before November 19, 2015.
    (d) through (j) [Reserved]. For further guidance, see Sec.  
1.367(a)-3(d) through (j).
    (k) Expiration date. Paragraph (c)(3)(iii)(C) of this section 
expires on April 4, 2019.

0
Par. 6. Section 1.367(b)-4 is amended by:
0
1. Revising paragraph (a).
0
2. Revising the introductory text of paragraph (b).
0
3. In paragraph (b)(1)(i)(A)(2), removing the word ``and'' at the end 
of the paragraph.
0
4. In paragraph (b)(1)(i)(B)(2), removing the period at the end of the 
paragraph and adding ``; and'' in its place.
0
5. Adding paragraph (b)(1)(i)(C).
0
6. Revising paragraph (d)(1).
0
7. Adding paragraph (h).
    The additions and revisions read as follows:


Sec.  1.367(b)-4  Acquisition of foreign corporate stock or assets by a 
foreign corporation in certain nonrecognition transactions.

    (a) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(a).
    (b) introductory text [Reserved]. For further guidance, see Sec.  
1.367(b)-4T(b) introductory text.
    (1) * * *
    (i) * * *
    (C) [Reserved]. For further guidance, see Sec.  1.367(b)-
4T(b)(1)(i)(C).
* * * * *
    (d) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(d)(1).
* * * * *
    (h) [Reserved]. For further guidance, see Sec.  1.367(b)-4T(h).

0
Par. 7. Section 1.367(b)-4T is revised to read as follows:


Sec.  1.367(b)-4T  Acquisition of foreign corporate stock or assets by 
a foreign corporation in certain nonrecognition transactions 
(temporary).

    (a) Scope. This section applies to certain acquisitions by a 
foreign corporation of the stock or assets of a foreign corporation in 
an exchange described in section 351 or in a reorganization described 
in section 368(a)(1). Paragraph (b) of this section provides a rule 
regarding when an exchanging shareholder is required to include in 
income as a deemed dividend the section 1248 amount attributable to the 
stock that it exchanges. Paragraph (c) of this section provides a rule 
excluding deemed dividends from foreign personal holding

[[Page 20884]]

company income. Paragraph (d) of this section provides rules for 
subsequent sales or exchanges. Paragraphs (e) and (f) of this section 
provide rules regarding certain exchanges following inversion 
transactions. Paragraph (g) of this section provides definitions and 
special rules, including special rules regarding triangular 
reorganizations and recapitalizations. Paragraph (h) of this section 
provides the applicability dates, and paragraph (i) of this section 
provides the date of expiration. See also Sec.  1.367(a)-3(b)(2) for 
transactions subject to the concurrent application of sections 367(a) 
and (b) and Sec.  1.367(b)-2 for additional definitions that apply.
    (b) Income inclusion. If a foreign corporation (the transferee 
foreign corporation) acquires the stock of a foreign corporation in an 
exchange described in section 351 or the stock or assets of a foreign 
corporation in a reorganization described in section 368(a)(1) (in 
either case, the foreign acquired corporation), then an exchanging 
shareholder must, if its exchange is described in paragraph (b)(1)(i), 
(b)(2)(i), or (b)(3) of this section, include in income as a deemed 
dividend the section 1248 amount attributable to the stock that it 
exchanges.
    (b)(1) through (b)(1)(i)(B) [Reserved]. For further guidance, see 
Sec.  1.367(b)-4(b)(1) through (b)(1)(i)(B).
    (C) The exchange is not a specified exchange to which paragraph 
(e)(1) of this section applies.
    (b)(1)(ii) through (d) introductory text [Reserved]. For further 
guidance, see Sec.  1.367(b)-4(b)(1)(ii) through (d) introductory text.
    (1) Rule. If an exchanging shareholder (as defined in Sec.  1.1248-
8(b)(1)(iv)) is not required to include in income as a deemed dividend 
the section 1248 amount under Sec.  1.367(b)-4(b) or paragraph (e)(1) 
of this section (non-inclusion exchange), then, for purposes of 
applying section 367(b) or 1248 to subsequent sales or exchanges, and 
subject to the limitation of Sec.  1.367(b)-2(d)(3)(ii) (in the case of 
a transaction described in Sec.  1.367(b)-(3), the determination of the 
earnings and profits attributable to the stock an exchanging 
shareholder receives in the non-inclusion exchange is determined 
pursuant to the rules of section 1248 and the regulations under that 
section.
    (2) [Reserved]. For further guidance, see Sec.  1.367(b)-4(d)(2).
    (e) Income inclusion and gain recognition in certain exchanges 
following an inversion transaction--(1) General rule. If a foreign 
corporation (the transferee foreign corporation) acquires stock of a 
foreign corporation in an exchange described in section 351 or stock or 
assets of a foreign corporation in a reorganization described in 
section 368(a)(1) (in either case, the foreign acquired corporation), 
then an exchanging shareholder must, if its exchange is a specified 
exchange and the exception in paragraph (e)(3) of this section does not 
apply--
    (i) Include in income as a deemed dividend the section 1248 amount 
attributable to the stock that it exchanges; and
    (ii) After taking into account the increase in basis provided in 
Sec.  1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), 
recognize all realized gain with respect to the stock that would not 
otherwise be recognized.
    (2) Specified exchanges. An exchange is a specified exchange if--
    (i) Immediately before the exchange, the foreign acquired 
corporation is an expatriated foreign subsidiary and the exchanging 
shareholder is either an expatriated entity described in Sec.  
1.367(b)-4(b)(1)(i)(A)(1) or an expatriated foreign subsidiary 
described in Sec.  1.367(b)-4(b)(1)(i)(A)(2);
    (ii) The stock received in the exchange is stock of a foreign 
corporation; and
    (iii) The exchange occurs during the applicable period.
    (3) De minimis exception. The exception in this paragraph (e)(3) 
applies if--
    (i) Immediately after the exchange, the foreign acquired 
corporation (in the case of an acquisition of stock of the foreign 
acquired corporation) or the transferee foreign corporation (in the 
case of an acquisition of assets of the foreign acquired corporation) 
is a controlled foreign corporation;
    (ii) The post-exchange ownership percentage with respect to the 
foreign acquired corporation (in the case of an acquisition of stock of 
the foreign acquired corporation) or the transferee foreign corporation 
(in the case of an acquisition of assets of the foreign acquired 
corporation) is at least 90 percent of the pre-exchange ownership 
percentage with respect to the foreign acquired corporation; and
    (iii) The post-exchange ownership percentage with respect to each 
lower-tier expatriated foreign subsidiary of the foreign acquired 
corporation is at least 90 percent of the pre-exchange ownership 
percentage with respect to the lower-tier expatriated foreign 
subsidiary.
    (4) Certain exceptions from foreign personal holding company not 
available. An income inclusion of a foreign corporation under paragraph 
(e)(1) of this section does not qualify for the exceptions from foreign 
personal holding company income provided by sections 954(c)(3)(A)(i) 
and 954(c)(6) (to the extent in effect).
    (5) Examples. The following examples illustrate the application of 
this paragraph (e). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock 
of USP, a domestic corporation, and all 40 shares of stock of FS, a 
foreign corporation. USP owns all 50 shares of stock of FT1, a 
controlled foreign corporation, which, in turn, owns all 50 shares of 
FT2, a controlled foreign corporation. FP acquired all of the stock of 
USP in an inversion transaction that was completed on July 1, 2016. 
Therefore, with respect to that inversion transaction, USP is an 
expatriated entity; FT1 and FT2 are expatriated foreign subsidiaries; 
and FP and FS are each a non-CFC foreign related person. All shares of 
stock have a fair market value of $1x, and each corporation has a 
single class of stock outstanding.

    Example 1. Specified exchange to which general rule applies--(i) 
Facts. During the applicable period, and pursuant to a 
reorganization described in section 368(a)(1)(B), FT1 transfers all 
50 shares of FT2 stock to FS in exchange solely for 50 newly issued 
voting shares of FS. Immediately before the exchange, USP is a 
section 1248 shareholder with respect to FT1 and FT2. At the time of 
the exchange, the FT2 stock owned by FT1 has a fair market value of 
$50x and an adjusted basis of $5x, such that the FT2 stock has a 
built-in gain of $45x. In addition, the earnings and profits of FT2 
attributable to FT1's stock in FT2 for purposes of section 1248 is 
$30x, taking into account the rules of Sec.  1.367(b)-2(c)(1)(i) and 
(ii), and therefore the section 1248 amount with respect to the FT2 
stock is $30x (the lesser of the $45x of built-in gain and the $30x 
of earnings and profits attributable to the stock).
    (ii) Analysis. FT1's exchange is a specified exchange because 
the requirements set forth in paragraphs (e)(2)(i) through (iii) of 
this section are satisfied. The requirement set forth in paragraph 
(e)(2)(i) of this section is satisfied because, immediately before 
the exchange, FT2 (the foreign acquired corporation) is an 
expatriated foreign subsidiary and FT1 (the exchanging shareholder) 
is an expatriated foreign subsidiary that is described in Sec.  
1.367(b)-4(b)(1)(i)(A)(2). The requirement set forth in paragraph 
(e)(2)(ii) of this section is also satisfied because the stock 
received in the exchange (FS stock) is stock of a foreign 
corporation. The requirement set forth in paragraph (e)(2)(iii) of 
this section is satisfied because the exchange occurs during the 
applicable period. Accordingly, under paragraph (e)(1)(i) of this 
section, FT1 must include in income as a deemed dividend $30x, the 
section 1248 amount with respect to its FT2 stock. In addition, 
under paragraph (e)(1)(ii) of this section, FT1 must, after

[[Page 20885]]

taking into account the increase in basis provided in Sec.  
1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (which 
increases FT1's basis in its FT2 stock from $5x to $35x), recognize 
$15x ($50x amount realized less $35x basis), the realized gain with 
respect to the FT2 stock that would not otherwise be recognized.
    Example 2. De minimis shift to non-CFC foreign related persons--
(i) Facts. The facts are the same as in the introductory sentences 
of this paragraph (e)(5) that precede Example 1 of this paragraph 
(e)(5), except as follows. FT1 does not own any shares of FT2, and 
all 40 shares of FS are owned by DX, a domestic corporation wholly 
owned by individual A, and thus FS is not a non-CFC foreign related 
person. During the applicable period and pursuant to a 
reorganization described in section 368(a)(1)(D), FT1 transfers all 
of its assets to FS in exchange for 50 newly issued FS shares, FT1 
distributes the 50 FS shares to USP in liquidation under section 
361(c)(1), and USP exchanges its 50 shares of FT1 stock for the 50 
FS shares under section 354. Further, immediately after the 
exchange, FS is a controlled foreign corporation.
    (ii) Analysis. Although USP's exchange is a specified exchange, 
paragraph (e)(1) of this section does not apply to the exchange 
because, as described in paragraphs (ii)(A) through (C) of this 
Example 2, the requirements of paragraph (e)(3) of this section are 
satisfied.
    (A) Because the assets, rather than the stock, of FT1 (the 
foreign acquired corporation) are acquired, the requirement set 
forth in paragraph (e)(3)(i) of this section is satisfied if FS (the 
transferee foreign corporation) is a controlled foreign corporation 
immediately after the exchange. As stated in the facts, FS is a 
controlled foreign corporation immediately after the exchange.
    (B) The requirement set forth in paragraph (e)(3)(ii) of this 
section is satisfied if the post-exchange ownership percentage with 
respect to FS is at least 90% of the pre-exchange ownership 
percentage with respect to FT1. Because USP, a domestic corporation 
that is an expatriated entity, directly owns 50 shares of FT stock 
immediately before the exchange, none of those shares are treated as 
indirectly owned by FP (a non-CFC foreign related person) for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT1. See paragraph (g)(1) of this section. Thus, for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT1, FP is treated as directly or indirectly owning 0%, 
or 0 of 50 shares, of the stock of FT1. Accordingly, the pre-
exchange ownership percentage with respect to FT1 is 100 (calculated 
as 100% less 0%, the percentage of FT1 stock that non-CFC foreign 
related persons are treated as directly or indirectly owning 
immediately before the exchange). Consequently, for the requirement 
set forth in paragraph (e)(3)(ii) of this section to be satisfied, 
the post-exchange ownership percentage with respect to FS must be at 
least 90. Because USP, a domestic corporation that is an expatriated 
entity, directly owns 50 shares of FS stock immediately after the 
exchange, none of those shares are treated as indirectly owned by FP 
(a non-CFC foreign related person) for purposes of calculating the 
post-exchange ownership percentage with respect to FS. See paragraph 
(g)(1) of this section. Thus, for purposes of calculating the post-
exchange ownership percentage with respect to FS, FP is treated as 
directly or indirectly owning 0%, or 0 of 90 shares, of the stock of 
FS. As a result, the post-exchange ownership percentage with respect 
to FS is 100 (calculated as 100% less 0%, the percentage of FS stock 
that non-CFC foreign related persons are treated as directly or 
indirectly owning immediately after the exchange). Therefore, 
because the post-exchange ownership percentage with respect to FS 
(100) is at least 90, the requirement set forth in paragraph 
(e)(3)(ii) of this section is satisfied.
    (C) Because there is not a lower-tier expatriated foreign 
subsidiary of FT1, the requirement set forth in paragraph 
(e)(3)(iii) of this section does not apply.

    (f) Gain recognition upon certain transfers of property described 
in section 351 following an inversion transaction--(1) General rule. 
If, during the applicable period, an expatriated foreign subsidiary 
transfers specified property to a foreign corporation (the transferee 
foreign corporation) in an exchange described in section 351, then the 
expatriated foreign subsidiary must recognize all realized gain with 
respect to the specified property transferred that would not otherwise 
be recognized, unless the exception in paragraph (f)(2) of this section 
applies.
    (2) De minimis exception. The exception in this paragraph (f)(2) 
applies if--
    (i) Immediately after the transfer, the transferee foreign 
corporation is a controlled foreign corporation; and
    (ii) The post-exchange ownership percentage with respect to the 
transferee foreign corporation is at least 90 percent of the pre-
exchange ownership percentage with respect to the expatriated foreign 
subsidiary.
    (3) Examples. The following examples illustrate the application of 
this paragraph (f). For purposes of all of the examples, unless 
otherwise indicated: FP, a foreign corporation, owns all of the stock 
of USP, a domestic corporation, and all 10 shares of stock of FS, a 
foreign corporation. USP owns all 50 shares of stock of FT, a 
controlled foreign corporation. FT owns Asset A, which is specified 
property with a fair market value of $50x and an adjusted basis of 
$10x. FP acquired all of the stock of USP in an inversion transaction 
that was completed on or after September 22, 2014. Accordingly, with 
respect to that inversion transaction, USP is an expatriated entity, FT 
is an expatriated foreign subsidiary, and FP and FS are each a non-CFC 
foreign related person. All shares of stock have a fair market value of 
$1x, and each corporation has a single class of stock outstanding.

    Example 1. Transfer to which general rule applies--(i) Facts. In 
addition to the stock of USP and FS, FP owns Asset B, which has a 
fair market value of $40x. During the applicable period, and 
pursuant to an exchange described in section 351, FT transfers Asset 
A to FS in exchange for 50 newly issued shares of FS stock, and FP 
transfers Asset B to FS in exchange for 40 newly issued shares of FS 
stock. Immediately after the transfer, FS is not a controlled 
foreign corporation.
    (ii) Analysis. Paragraph (f)(1) of this section applies to the 
transfer by FT (an expatriated foreign subsidiary) of Asset A, which 
is specified property, to FS (the transferee foreign corporation). 
Thus, FT must recognize gain of $40x under paragraph (f)(1) of this 
section, which is the realized gain with respect to Asset A that 
would not otherwise be recognized ($50x amount realized less $10x 
basis). For rules regarding whether the FS stock held by FT is 
treated as United States property for purposes of section 956, see 
Sec.  1.956-2T(a)(4)(i).
    Example 2. De minimis shift to non-CFC foreign related persons--
(i) Facts. Individual, a United States person, owns Asset B, which 
has a fair market value of $40x. During the applicable period, and 
pursuant to an exchange described in section 351, FT transfers Asset 
A to FS in exchange for 50 newly issued shares of FS stock, and 
Individual transfers Asset B to FS in exchange for 40 newly issued 
shares of FS stock.
    (ii) Analysis. Paragraph (f)(1) of this section does not apply 
to the transfer by FT (an expatriated foreign subsidiary) of Asset 
A, which is specified property, to FS (the transferee foreign 
corporation)) because the requirements set forth in paragraph (f)(2) 
of this section are satisfied. FS is a controlled foreign 
corporation immediately after the transfer because 90 out of FS's 
100 outstanding shares are owned (within the meaning of section 
958(a)) by Individual and USP, who are both United States 
shareholders (within the meaning of section 951(b)). Accordingly, 
the requirement set forth in paragraph (f)(2)(i) of this section is 
satisfied. The requirement set forth in paragraph (f)(2)(ii) of this 
section is satisfied if the post-exchange ownership percentage with 
respect to FS is at least 90 percent of the pre-exchange ownership 
percentage with respect to FT. Because USP, a domestic corporation 
that is an expatriated entity, directly owns 50 shares of FT stock 
immediately before the transfer, none of those shares are treated as 
indirectly owned by FP (a non-CFC foreign related person) for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT. See paragraph (g)(1) of this section. Thus, for 
purposes of calculating the pre-exchange ownership percentage with 
respect to FT, FP is treated as directly or indirectly owning 0 
percent, or 0 of 50 shares, of the stock of FT. Accordingly, the 
pre-exchange ownership percentage with respect to FT is 100 
(calculated as 100 percent less 0 percent, the

[[Page 20886]]

percentage of FT stock that non-CFC foreign related persons are 
treated as directly or indirectly owning immediately before the 
transfer). Consequently, for the requirement set forth in paragraph 
(f)(2)(ii) of this section to be satisfied, the post-exchange 
ownership percentage with respect to FS must be at least 90. 
Although FP directly owns 10 FS shares, none of the 50 FS shares 
that FP owns through USP (a domestic corporation that is an 
expatriated entity) are treated as indirectly owned by FP for 
purposes of calculating the post-exchange ownership percentage with 
respect to FS because USP directly owns them. See paragraph (g)(1) 
of this section. Thus, for purposes of calculating the post-exchange 
ownership percentage with respect to FS, FP is treated as directly 
or indirectly owning 10 percent, or 10 of 100 shares, of the stock 
of FS. As a result, the post-exchange ownership percentage with 
respect to FS is 90 (calculated as 100 percent less 10 percent, the 
percentage of FS stock that non-CFC foreign related persons are 
treated as directly or indirectly owning immediately after the 
transfer). Therefore, because the post-exchange ownership percentage 
with respect to FS (90) is at least 90, the requirement set forth in 
paragraph (f)(2)(ii) of this section is satisfied.

    (g) Definitions and special rules. In addition to the definitions 
and special rules in Sec. Sec.  1.367(b)-2 and 1.7874-12T, the 
following definitions and special rules apply for purposes of this 
section and Sec.  1.367(b)-4.
    (1) Indirect ownership. To determine indirect ownership of the 
stock of a corporation for purposes of calculating a pre-exchange 
ownership percentage or post-exchange ownership percentage with respect 
to that corporation, the principles of section 958(a) apply without 
regard to whether an intermediate entity is foreign or domestic. For 
this purpose, stock of the corporation that is directly or indirectly 
(applying the principles of section 958(a) without regard to whether an 
intermediate entity is foreign or domestic) owned by a domestic 
corporation that is an expatriated entity is not treated as indirectly 
owned by a non-CFC foreign related person.
    (2) A lower-tier expatriated foreign subsidiary means an 
expatriated foreign subsidiary whose stock is directly or indirectly 
owned (under the principles of section 958(a)) by an expatriated 
foreign subsidiary.
    (3) Pre-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately before an exchange, is owned, in the 
aggregate, directly or indirectly by non-CFC foreign related persons.
    (4) Post-exchange ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately after the exchange, is owned, in the 
aggregate, directly or indirectly by non-CFC foreign related persons.
    (5) Specified property means any property other than stock of a 
lower-tier expatriated foreign subsidiary.
    (6) Recapitalizations. A foreign corporation that undergoes a 
reorganization described in section 368(a)(1)(E) is treated as both the 
foreign acquired corporation and the transferee foreign corporation.
    (7) Triangular reorganizations--(i) Definition. A triangular 
reorganization means a reorganization described in Sec.  1.358-
6(b)(2)(i) (forward triangular merger), (ii) (triangular C 
reorganization), (iii) (reverse triangular merger), (iv) (triangular B 
reorganization), and (v) (triangular G reorganization).
    (ii) Special rules--(A) Triangular reorganizations other than a 
reverse triangular merger. In the case of a triangular reorganization 
other than a reverse triangular merger, the surviving corporation is 
the transferee foreign corporation that acquires the assets or stock of 
the foreign acquired corporation, and the reference to controlling 
corporation (foreign or domestic) is to the corporation that controls 
the surviving corporation.
    (B) Reverse triangular merger. In the case of a reverse triangular 
merger, the surviving corporation is the entity that survives the 
merger, and the controlling corporation (foreign or domestic) is the 
corporation that before the merger controls the merged corporation. In 
the case of a reverse triangular merger, Sec.  1.367(b)-4 and this 
section apply only if stock of the foreign surviving corporation is 
exchanged for stock of a foreign corporation in control of the merging 
corporation; in such a case, the foreign surviving corporation is 
treated as a foreign acquired corporation.
    (h) Applicability date of certain paragraphs in this section. 
Except as otherwise provided in this paragraph (h), this section 
applies to exchanges completed on or after September 22, 2014, but only 
if the inversion transaction was completed on or after September 22, 
2014. Paragraph (e)(1)(ii) of this section applies to exchanges 
completed on or after November 19, 2015, but only if the inversion 
transaction was completed on or after September 22, 2014. The portion 
of paragraph (e)(2)(i) of this section that requires the exchanging 
shareholder to be an expatriated entity or an expatriated foreign 
subsidiary apply to exchanges completed on or after April 4, 2016, but 
only if the inversion transaction was completed on or after September 
22, 2014. For inversion transactions completed on or after September 
22, 2014, however, taxpayers may elect to apply the portion of 
paragraph (e)(2)(i) of this section that requires the exchanging 
shareholder to be an expatriated entity or an expatriated foreign 
subsidiary to exchanges completed on or after September 22, 2014, and 
before April 4, 2016. Paragraphs (f) and (g)(5) of this section apply 
to transfers completed on or after April 4, 2016, but only if the 
inversion transaction was completed or after September 22, 2014. See 
Sec.  1.367(b)-4, as contained in 26 CFR part 1 revised as of April 1, 
2016, for exchanges completed before September 22, 2014.
    (i) Expiration date. This section expires on or before April 4, 
2019.

0
Par. 8. Section 1.956-2 is amended by:
0
1. Adding paragraphs (a)(4) and (c)(5).
0
2. Revising paragraph (d)(2).
0
3. Adding reserved paragraphs (f), (g), and (h).
0
4. Adding paragraph (i).
    The additions and revision read as follows:


Sec.  1.956-2  Definition of United States property.

    (a) * * *
    (4) [Reserved]. For further guidance, see Sec.  1.956-2T(a)(4).
* * * * *
    (c) * * *
    (5) [Reserved]. For further guidance, see Sec.  1.956-2T(c)(5).
    (d) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.956-2T(d)(2).
* * * * *
    (f) [Reserved]
    (g) [Reserved]
    (h) [Reserved]
    (i) [Reserved]. For further guidance, see Sec.  1.956-2T(i).

0
Par. 9. Section 1.956-2T is amended by:
0
1. Adding paragraphs (a)(4) and (c)(5).
0
2. Revising paragraph (d)(2).
0
3. Adding reserved paragraph (h).
0
4. Adding paragraphs (i) and (j).
    The additions and revision read as follows:


Sec.  1.956-2T  Definition of United States property (temporary).

    (a)(1) through (3) [Reserved]. For further guidance, see Sec.  
1.956-2(a)(1) through (3).
    (4) Certain foreign stock and obligations held by expatriated 
foreign subsidiaries following an inversion transaction--(i) General 
rule. Except as

[[Page 20887]]

provided in paragraph (a)(4)(ii) of this section, for purposes of 
section 956 and Sec.  1.956-2(a), United States property includes an 
obligation of a foreign person and stock of a foreign corporation when 
the following conditions are satisfied--
    (A) The obligation or stock is held by a controlled foreign 
corporation that is an expatriated foreign subsidiary, regardless of 
whether, when the obligation or stock was acquired, the acquirer was a 
controlled foreign corporation or an expatriated foreign subsidiary;
    (B) The foreign person or foreign corporation is a non-CFC foreign 
related person, regardless of whether, when the obligation or stock was 
acquired, the foreign person or foreign corporation was a non-CFC 
foreign related person; and
    (C) The obligation or stock was acquired--
    (1) During the applicable period; or
    (2) In a transaction related to the inversion transaction.
    (ii) Exceptions. For purposes of section 956 and Sec.  1.956-2(a), 
United States property does not include--
    (A) Any obligation of a non-CFC foreign related person arising in 
connection with the sale or processing of property if the amount of the 
obligation at no time during the taxable year exceeds the amount that 
would be ordinary and necessary to carry on the trade or business of 
both the other party to the sale or processing transaction and the non-
CFC foreign related person had the sale or processing transaction been 
made between unrelated persons; and
    (B) Any obligation of a non-CFC foreign related person to the 
extent the principal amount of the obligation does not exceed the fair 
market value of readily marketable securities sold or purchased 
pursuant to a sale and repurchase agreement or otherwise posted or 
received as collateral for the obligation in the ordinary course of its 
business by a United States or foreign person which is a dealer in 
securities or commodities.
    (iii) Definitions. The definitions in Sec.  1.7874-12T apply for 
the purposes of the application of paragraphs (a)(4), (c)(5), and 
(d)(2) of this section.
    (iv) Examples. The following examples illustrate the rules of this 
paragraph (a)(4). For purposes of the examples, FA, a foreign 
corporation, wholly owns DT, a domestic corporation, which, in turn, 
wholly owns FT, a foreign corporation that is a controlled foreign 
corporation. FA also wholly owns FS, a foreign corporation. FA acquired 
DT in an inversion transaction that was completed on January 1, 2015.

    Example 1. (A) Facts. FT acquired an obligation of FS on January 
31, 2015.
    (B) Analysis. Pursuant to Sec.  1.7874-12T, DT is a domestic 
entity, FT is an expatriated foreign subsidiary, and FS is a non-CFC 
foreign related person. In addition, FT acquired the FS obligation 
during the applicable period. Thus, as of January 31, 2015, the 
obligation of FS is United States property with respect to FT for 
purposes of section 956(a) and Sec.  1.956-2(a).
    Example 2. (A) Facts. The facts are the same as in Example 1 of 
this paragraph (a)(4)(iv), except that on February 15, 2015, FT 
contributed assets to FS in exchange for 60% of the stock of FS, by 
vote and value.
    (B) Analysis. As a result of the transaction on February 15, 
2015, FS becomes a controlled foreign corporation with respect to 
which an expatriated entity, DT, is a United States shareholder. 
Accordingly, under Sec.  1.7874-12T(a)(9), FS is an expatriated 
foreign subsidiary, and is therefore not a non-CFC foreign related 
person. Thus, as of February 15, 2015, the stock and obligation of 
FS are not United States property with respect to FT for purposes of 
section 956(a) and Sec.  1.956-2(a). FS is not excluded from the 
definition of expatriated foreign subsidiary pursuant to Sec.  
1.7874-12T(a)(9)(ii) because FS was not a CFC on the completion 
date.
    Example 3. (A) Facts. Before the acquisition, FA also wholly 
owns USP, a domestic corporation, which, in turn, wholly owns, LFS, 
a foreign corporation that is a controlled foreign corporation. DT 
was not a United States shareholder of LFS on or before the 
completion date. On January 31, 2015, FT contributed assets to LFS 
in exchange for 60% of the stock of LFS, by vote and value. FT 
acquired an obligation of LFS on February 15, 2015.
    (B) Analysis. LFS is a foreign related person. Because LFS was a 
controlled foreign corporation and a member of the expanded 
affiliated group with respect to the inversion transaction on the 
completion date, and DT was not a United States shareholder with 
respect to LFS on or before the completion date, LFS is excluded 
from the definition of expatriated foreign subsidiary pursuant to 
Sec.  1.7874-12T(a)(9)(ii). Thus, pursuant to Sec.  1.7874-
12T(a)(16), LFS is a non-CFC foreign related person, and the stock 
and obligation of LFS are United States property with respect to FT 
for purposes of section 956(a) and Sec.  1.956-2(a). The fact that 
FT contributed assets to LFS in exchange for 60% of the stock of LFS 
does not change this result.
    Example 4.  (A) Facts. The facts are the same as in Example 3 of 
this paragraph (a)(4)(iv), except that on February 10, 2015, LFS 
organized a new foreign corporation (LFSS), transferred all of its 
assets to LFSS, and liquidated, in a transaction treated as a 
reorganization described in section 368(a)(1)(F), and FT acquired an 
obligation of LFSS, instead of LFS, on February 15, 2015. On March 
1, 2015, LFSS acquired an obligation of FS.
    (B) Analysis. LFS is a controlled foreign corporation with 
respect to which USP, an expatriated entity, is a United States 
shareholder. USP is an expatriated entity because on the completion 
date, USP and DT became related to each other within the meaning of 
section 267(b). Because LFSS was not a member of the expanded 
affiliated group with respect to the inversion transaction on the 
completion date, LFSS is not excluded from the definition of 
expatriated foreign subsidiary pursuant to Sec.  1.7874-
12T(a)(9)(ii). Accordingly, under Sec.  1.7874-12T(a)(9)(i), LFFS is 
an expatriated foreign subsidiary and is therefore not a non-CFC 
foreign related person. Thus, the stock and obligation of LFSS are 
not United States property with respect to FT for purposes of 
section 956(a) and Sec.  1.956-2(a). However, because LFSS is an 
expatriated foreign subsidiary, pursuant to Sec.  1.7874-12T(a)(9), 
the obligation of FS, a non-CFC foreign related person, is United 
States property with respect to LFSS for purposes of section 956(a) 
and Sec.  1.956-2(a).

    (b)(1) through (b)(1)(x) [Reserved]. For further guidance, see 
Sec.  1.956-2(b)(1) through (b)(1)(x).
* * * * *
    (b)(2) through (c)(4) [Reserved]. For further guidance, see Sec.  
1.956-2(b)(2) through (c)(4).
    (5) Special guarantee and pledge rule for expatriated foreign 
subsidiaries--(i) General rule. In applying Sec.  1.956-2(c)(1) and (2) 
to a controlled foreign corporation that is an expatriated foreign 
subsidiary, the phrase ``of a United States person or a non-CFC foreign 
related person'' is substituted for the phrase ``of a United States 
person'' each place it appears.
    (ii) Additional rules. The rule in paragraph (c)(5)(i) of this 
section--
    (A) Applies regardless of whether, when the pledge or guarantee was 
entered into or treated as entered into, the controlled foreign 
corporation was a controlled foreign corporation or an expatriated 
foreign subsidiary, or a foreign person whose obligation is subject to 
the pledge or guarantee, or deemed pledge or guarantee, was a non-CFC 
foreign related person; and
    (B) Applies to pledges or guarantees entered into, or treated 
pursuant to Sec.  1.956-2(c)(2) as entered into--
    (1) During the applicable period; or
    (2) In a transaction related to the inversion transaction.
    (d)(1) [Reserved]. For further guidance, see Sec.  1.956-2(d)(1).
    (2) Obligation defined. For purposes of section 956 and Sec.  
1.956-2, the term ``obligation'' includes any bond, note, debenture, 
certificate, bill receivable, account receivable, note receivable, open 
account, or other indebtedness, whether or not issued at a discount and 
whether or not bearing interest, except that the term does not 
include--
    (i) Any indebtedness arising out of the involuntary conversion of 
property

[[Page 20888]]

which is not United States property within the meaning of Sec.  1.956-
2(a)(1) or Sec.  1.956-2T(a);
    (ii) Any obligation of a United States person (as defined in 
section 957(c)) arising in connection with the provision of services by 
a controlled foreign corporation to the United States person if the 
amount of the obligation outstanding at any time during the taxable 
year of the controlled foreign corporation does not exceed an amount 
which would be ordinary and necessary to carry on the trade or business 
of the controlled foreign corporation and the United States person if 
they were unrelated. The amount of the obligations shall be considered 
to be ordinary and necessary to the extent of such receivables that are 
paid within 60 days;
    (iii) Any obligation of a non-CFC foreign related person arising in 
connection with the provision of services by an expatriated foreign 
subsidiary to the non-CFC foreign related person if the amount of the 
obligation outstanding at any time during the taxable year of the 
expatriated foreign subsidiary does not exceed an amount which would be 
ordinary and necessary to carry on the trade or business of the 
expatriated foreign subsidiary and the non-CFC foreign related person 
if they were unrelated. The amount of the obligations shall be 
considered to be ordinary and necessary to the extent of such 
receivables that are paid within 60 days;
    (iv) Unless a controlled foreign corporation applies the exception 
provided in paragraph (d)(2)(v) of this section with respect to the 
obligation, any obligation of a United States person (as defined in 
section 957(c)) that is collected within 30 days from the time it is 
incurred (a 30-day obligation), unless the controlled foreign 
corporation that holds the 30-day obligation holds for 60 or more 
calendar days during the taxable year in which it holds the 30-day 
obligation any obligations which, without regard to the exclusion 
described in this paragraph (d)(2)(iv), would constitute United States 
property within the meaning of section 956 and Sec.  1.956-2(a); or
    (v) Unless a controlled foreign corporation applies the exception 
provided in paragraph (d)(2)(iv) of this section with respect to the 
obligation, any obligation of a United States person (as defined in 
section 957(c)) that is collected within 60 days from the time it is 
incurred (a 60-day obligation), unless the controlled foreign 
corporation that holds the 60-day obligation holds for 180 or more 
calendar days during the taxable year in which it holds the 60-day 
obligation any obligations which, without regard to the exclusion 
described in this paragraph (d)(2)(v), would constitute United States 
property within the meaning of section 956 and Sec.  1.956-2(a).
* * * * *
    (h) [Reserved]
    (i) Effective/applicability date. (1) Except as otherwise provided 
in this paragraph (i)(1), paragraphs (a)(4) and (c)(5) of this section 
apply to obligations or stock acquired or to pledges or guarantees 
entered into, or treated as entered into, on or after September 22, 
2014, but only if the inversion transaction was completed on or after 
September 22, 2014. The phrase ``, regardless of whether, when the 
obligation or stock was acquired, the acquirer was a controlled foreign 
corporation or an expatriated foreign subsidiary'' in paragraph 
(a)(4)(i)(A) of this section, the phrase ``regardless of whether, when 
the obligation or stock was acquired, the foreign person or foreign 
corporation was a non-CFC foreign related person'' in paragraph 
(a)(4)(i)(B) of this section, and paragraphs (a)(4)(i)(C)(2), 
(c)(5)(ii)(A), and (c)(5)(ii)(B)(2) of this section apply to 
obligations or stock acquired or pledges or guarantees entered into or 
treated as entered into on or after April 4, 2016, but only if the 
inversion transaction was completed on or after September 22, 2014. 
Paragraph (a)(4)(ii) of this section applies to obligations acquired on 
or after April 4, 2016. For inversion transactions completed on or 
after September 22, 2014, however, taxpayers may elect to apply 
paragraph (a)(4)(ii) of this section to an obligation acquired before 
April 4, 2016. For purposes of paragraph (a)(4)(i) of this section and 
this paragraph (i)(1), a deemed exchange of an obligation or stock 
pursuant to section 1001 constitutes an acquisition of the obligation 
or stock. For purposes of paragraph (c)(5) of this section and this 
paragraph (i)(1), a pledgor or guarantor or deemed pledgor or guarantor 
is treated as entering into a pledge or guarantee when there is a 
significant modification, within the meaning of Sec.  1.1001-3(e), of 
an obligation with respect to which it is a pledgor or guarantor or is 
treated as a pledgor or guarantor.
    (2) Paragraphs (d)(2)(i) and (ii) of this section are effective 
June 14, 1988, with respect to investments made on or after June 14, 
1988.
    (3) Paragraph (d)(2)(iii) of this section applies to obligations 
acquired on or after April 4, 2016, but only if the inversion 
transaction was completed on or after September 22, 2014. For inversion 
transactions completed on or after September 22, 2014, however, 
taxpayers may elect to apply paragraph (d)(2)(iii) of this section to 
an obligation acquired on or after September 22, 2014, and before April 
4, 2016. For purposes of paragraph (d)(2)(iii) of this section and this 
paragraph (i)(3), a significant modification, within the meaning of 
Sec.  1.1001-3(e), of an obligation on or after April 4, 2016, 
constitutes an acquisition of an obligation on or after April 4, 2016.
    (4) Paragraph (d)(2)(iv) of this section applies to obligations 
held on or after September 16, 1988.
    (5) Paragraph (d)(2)(v) of this section applies to the first three 
taxable years of a foreign corporation ending after October 3, 2008, 
other than taxable years of a foreign corporation beginning on or after 
January 1, 2011, as well as the fourth taxable year of a foreign 
corporation, if any, when the foreign corporation's third taxable year 
(including any short taxable year) ended after October 3, 2008, and on 
or before December 31, 2009.
    (j) Expiration date. The applicability of paragraphs (a)(4), 
(c)(5), and (d)(2) of this section expires on or before April 4, 2019.

0
Par. 10. Section 1.7701(l)-4T is added to read as follows:


Sec.  1.7701(l)-4T  Rules regarding inversion transactions (temporary).

    (a) Overview. This section provides rules applicable to United 
States shareholders of controlled foreign corporations after certain 
inversion transactions. Paragraph (b) of this section defines specified 
transactions and provides the scope of the rules in this section. 
Paragraph (c) of this section provides rules recharacterizing certain 
specified transactions. Paragraph (d) of this section sets forth rules 
governing transactions that affect the stock of an expatriated foreign 
subsidiary following a recharacterized specified transaction. Paragraph 
(e) of this section sets forth a rule concerning the treatment of 
amounts included in income as a result of a specified transaction as 
foreign personal holding company income. Paragraph (f) of this section 
sets forth definitions that apply for purposes of this section. 
Paragraph (g) of this section sets forth examples illustrating these 
rules. Paragraph (h) of this section provides applicability dates, and 
paragraph (i) of this section provides the date of expiration. See 
Sec.  1.367(b)-4T(e) for rules concerning certain other exchanges after 
an inversion transaction. See also Sec.  1.956-2T(a)(4),

[[Page 20889]]

(c)(5), and (d)(2) for additional rules applicable to United States 
property held by controlled foreign corporations after an inversion 
transaction.
    (b) Specified transaction--(1) In general. Except as provided in 
paragraph (b)(2) of this section, paragraph (c) of this section applies 
to specified transactions. For purposes of this section, a specified 
transaction is, with respect to an expatriated foreign subsidiary, a 
transaction in which stock of the expatriated foreign subsidiary is 
issued or transferred to a person that immediately before the issuance 
or transfer is a specified related person, provided the transaction 
occurs during the applicable period. However, a specified transaction 
does not include a transaction in which stock of the expatriated 
foreign subsidiary is deemed issued pursuant to section 304.
    (2) Exceptions. Paragraph (c) of this section does not apply to a 
specified transaction--
    (i) That is a fast-pay arrangement that is recharacterized under 
Sec.  1.7701(l)-3(c)(2);
    (ii) In which the specified stock was transferred by a shareholder 
of the expatriated foreign subsidiary, and the shareholder either--
    (A) Pursuant to Sec.  1.367(b)-4T(e)(1), both--
    (1) Included in gross income as a deemed dividend the section 1248 
amount attributable to the specified stock; and
    (2) After taking into account the increase in basis provided in 
Sec.  1.367(b)-2(e)(3)(ii) resulting from the deemed dividend (if any), 
recognized all realized gain with respect to the stock that otherwise 
would not have been recognized; or
    (B) Included in gross income all of the gain recognized on the 
transfer of the specified stock (including gain included in gross 
income as a dividend pursuant to section 964(e), section 1248(a), or 
section 356(a)(2)); or
    (iii) In which--
    (A) Immediately after the specified transaction and any related 
transaction, the expatriated foreign subsidiary is a controlled foreign 
corporation;
    (B) The post-transaction ownership percentage with respect to the 
expatriated foreign subsidiary is at least 90 percent of the pre-
transaction ownership percentage with respect to the expatriated 
foreign subsidiary; and
    (C) The post-transaction ownership percentage with respect to any 
lower-tier expatriated foreign subsidiary is at least 90 percent of the 
pre-transaction ownership percentage with respect to the lower-tier 
expatriated foreign subsidiary. See Example 3 and Example 4 of 
paragraph (g) of this section.
    (c) Recharacterization of specified transactions--(1) In general. 
Except as otherwise provided, a specified transaction that is 
recharacterized under this paragraph (c) is recharacterized for all 
purposes of the Internal Revenue Code as of the date on which the 
specified transaction occurs, unless and until the rules of paragraph 
(d) of this section apply to alter or terminate the recharacterization. 
For purposes of paragraphs (c)(2) and (3) and (d) of this section, 
stock is considered owned by a section 958(a) U.S. shareholder if it is 
owned within the meaning of section 958(a) by the section 958(a) U.S. 
shareholder.
    (2) Specified transactions through stock issuance. A specified 
transaction in which the specified stock is issued by an expatriated 
foreign subsidiary to a specified related person is recharacterized as 
follows--
    (i) The transferred property is treated as having been transferred 
by the specified related person to the persons that were section 958(a) 
U.S. shareholders of the expatriated foreign subsidiary immediately 
before the specified transaction, in proportion to the stock of the 
expatriated foreign subsidiary owned by each section 958(a) U.S. 
shareholder, in exchange for deemed instruments in the section 958(a) 
U.S. shareholders; and
    (ii) The transferred property treated as transferred to the section 
958(a) U.S. shareholders pursuant to paragraph (c)(2)(i) of this 
section is treated as having been contributed by the section 958(a) 
U.S. shareholders (through intermediate entities, if any, in exchange 
for equity in the intermediate entities) to the expatriated foreign 
subsidiary in exchange for deemed issued stock in the expatriated 
foreign subsidiary. See Example 1, Example 2, and Example 6 of 
paragraph (g) of this section.
    (3) Specified transactions through shareholder transfer. A 
specified transaction in which specified stock is transferred by 
shareholders of the expatriated foreign subsidiary to a specified 
related person is recharacterized as follows--
    (i) The transferred property is treated as having been transferred 
by the specified related person to the persons that were section 958(a) 
U.S. shareholders of the expatriated foreign subsidiary immediately 
before the specified transaction, in proportion to the specified stock 
owned by each section 958(a) U.S. shareholder, in exchange for deemed 
instruments in the section 958(a) U.S. shareholders; and
    (ii) To the extent the section 958(a) U.S. shareholders are not the 
transferring shareholders, the transferred property treated as 
transferred to the section 958(a) U.S. shareholders pursuant to 
paragraph (c)(3)(i) of this section is treated as having been 
contributed by the section 958(a) U.S. shareholders (through 
intermediate entities, if any, in exchange for equity in the 
intermediate entities) to the transferring shareholder in exchange for 
equity in the transferring shareholder. See Example 5 of paragraph (g) 
of this section.
    (4) Treatment of deemed instruments following a recharacterized 
specified transaction--(i) Deemed instruments. The deemed instruments 
described in paragraphs (c)(2) and (3) of this section have the same 
terms as the specified stock issued or transferred pursuant to the 
specified transaction (that is, the disregarded specified stock), other 
than the issuer. When a distribution is made with respect to the 
disregarded specified stock, matching seriatim distributions with 
respect to the deemed issued stock are treated as made by the 
expatriated foreign subsidiary, through intermediate entities, if any, 
to the section 958(a) U.S. shareholders, which, in turn, then are 
treated as making corresponding payments with respect to the deemed 
instruments to the specified related person.
    (ii) Paying agent. The expatriated foreign subsidiary is treated as 
the paying agent of the section 958(a) U.S. shareholder with respect to 
the deemed instruments treated as issued by the section 958(a) U.S. 
shareholder to the specified related person.
    (d) Transactions affecting ownership of stock of an expatriated 
foreign subsidiary following a recharacterized specified transaction--
(1) Transfers of stock other than specified stock. When, after a 
specified transaction with respect to an expatriated foreign subsidiary 
that is recharacterized under paragraph (c)(2) or (3) of this section, 
stock of the expatriated foreign subsidiary, other than disregarded 
specified stock, that is owned by a section 958(a) U.S. shareholder is 
transferred, the deemed issued stock treated as owned by the section 
958(a) U.S. shareholder as a result of the specified transaction 
continues to be treated as directly owned by the holder, as are the 
deemed instruments treated as issued to the specified related person as 
a result of the specified transaction.
    (2) Transactions in which the expatriated foreign subsidiary ceases 
to be a foreign related person. When, after a specified transaction 
with respect to an expatriated foreign subsidiary that is

[[Page 20890]]

recharacterized under paragraph (c)(2) or (3) of this section, there is 
a transaction that affects the ownership of the stock (including 
disregarded specified stock) of the expatriated foreign subsidiary, 
and, immediately after the transaction, the expatriated foreign 
subsidiary is not a foreign related person (determined without taking 
into account the recharacterization under paragraph (c)(2) or (3) of 
this section), then, immediately before the transaction--
    (i) Each section 958(a) U.S. shareholder that is treated as owning 
deemed issued stock in the expatriated foreign subsidiary under 
paragraph (c)(2) or (3) of this section is treated as transferring the 
deemed issued stock (after the deemed issued stock is deemed to be 
transferred to the section 958(a) U.S. shareholder through intermediate 
entities, if any, in redemption of equity deemed issued by the 
intermediate entities pursuant to paragraph (c)(2) or (3) of this 
section) to the specified related person that is treated as holding the 
deemed instruments issued by the section 958(a) U.S. shareholder under 
paragraph (c)(2) or (3) of this section, in redemption of the deemed 
instruments; and
    (ii) The deemed issued stock that is treated as transferred 
pursuant to paragraph (d)(2)(i) of this section is treated as 
recapitalized into the disregarded specified stock actually held by the 
specified related person, which immediately thereafter is treated as 
specified stock owned by the specified related person for all purposes 
of the Internal Revenue Code. See Example 8, Example 9, and Example 12 
of paragraph (g) of this section.
    (3) Transfers in which disregarded specified stock ceases to be 
held by a foreign related person, specified related person, or 
expatriated entity. When, after a specified transaction with respect to 
an expatriated foreign subsidiary that is recharacterized under 
paragraph (c)(2) or (3) of this section, there is a direct or indirect 
transfer of the disregarded specified stock in the expatriated foreign 
subsidiary, and immediately after the transfer, the expatriated foreign 
subsidiary is a foreign related person, then, to the extent that, as a 
result of the transfer, the disregarded specified stock is actually 
held (determined without taking into account the recharacterization 
under paragraph (c)(2) or (3) of this section) by a person that is not 
a foreign related person, a specified related person, or an expatriated 
entity, immediately before the transfer--
    (i) Each section 958(a) U.S. shareholder that is treated as owning 
all or a portion of the deemed issued stock in the expatriated foreign 
subsidiary is treated as transferring the deemed issued stock that is 
allocable to the transferred disregarded specified stock that is out-
of-group transferred disregarded specified stock (after the deemed 
issued stock is deemed to be transferred to the section 958(a) U.S. 
shareholder through intermediate entities, if any, in redemption of 
equity deemed issued by the intermediate entities pursuant to paragraph 
(c)(2) or (3) of this section) to the specified related person that is 
treated as holding the deemed instruments allocable to the out-of-group 
transferred disregarded specified stock, in redemption of the deemed 
instruments that are allocable to the out-of-group transferred 
disregarded specified stock; and
    (ii) The deemed issued stock that is treated as transferred 
pursuant to paragraph (d)(3)(i) of this section is treated as 
recapitalized into the disregarded specified stock actually held by the 
specified related person, which immediately thereafter is treated as 
specified stock owned by the specified related person for all purposes 
of the Internal Revenue Code. See Example 7 and Example 11 of paragraph 
(g) of this section.
    (4) Certain direct transfers of disregarded specified stock to 
which unwind rules do not apply. When a specified related person 
directly transfers the disregarded specified stock of the expatriated 
foreign subsidiary and paragraphs (d)(2) and (3) of this section do not 
apply with respect to the transfer, the specified related person is 
deemed to transfer the deemed instruments allocable to the transferred 
disregarded specified stock, whether it is in-group transferred 
disregarded specified stock or out-of-group transferred disregarded 
specified stock, to the transferee of the specified stock, in lieu of 
the disregarded specified stock, in exchange for the consideration 
provided by the transferee for the disregarded specified stock. See 
Example 10 of paragraph (g) of this section.
    (5) Determination of deemed issued stock and deemed instruments 
allocable to transferred disregarded specified stock--(i) Out-of-group 
transfers of disregarded specified stock. For purposes of paragraphs 
(d)(3) and (4) of this section, the portion of the deemed issued stock 
treated as owned, and of the deemed instruments treated as issued, by 
each section 958(a) U.S. shareholder as a result of the specified 
transaction that is allocable to out-of-group transferred disregarded 
specified stock is the amount that is proportionate to the ratio of the 
amount of the out-of-group transferred disregarded specified stock to 
the amount of disregarded specified stock of the expatriated foreign 
subsidiary that is actually held by the specified related person 
immediately before the transfer referred to in paragraph (d)(3) or (4) 
of this section as a result of the specified transaction.
    (ii) In-group direct transfers of disregarded specified stock. For 
purposes of paragraph (d)(4) of this section, the portion of the deemed 
issued stock treated as owned by each section 958(a) U.S. shareholder 
as a result of the specified transaction that is allocable to in-group 
transferred disregarded specified stock is the amount that is 
proportionate to the ratio of the amount of the in-group transferred 
disregarded specified stock to the amount of disregarded specified 
stock of the expatriated foreign subsidiary that is actually held by 
the specified related person immediately before the transfer described 
in paragraph (d)(4) of this section as a result of the specified 
transaction.
    (e) Certain exception from foreign personal holding company income 
not available. An amount included in the gross income of a controlled 
foreign corporation as a dividend with respect to stock transferred in 
a specified transaction does not qualify for the exception from foreign 
personal holding company income provided by section 954(c)(6) (to the 
extent in effect).
    (f) Definitions. In addition to the definitions in Sec.  1.7874-
12T, the following definitions and special rules apply for purposes of 
this section:
    (1) Deemed instruments mean, with respect to a specified 
transaction, instruments deemed issued by a section 958(a) U.S. 
shareholder in exchange for transferred property in the specified 
transaction.
    (2) Deemed issued stock means, with respect to a specified 
transaction, stock of an expatriated foreign subsidiary deemed issued 
to a section 958(a) U.S. shareholder (or an intermediate entity) in the 
specified transaction.
    (3) Disregarded specified stock means, with respect to a specified 
transaction, specified stock that is actually held by a specified 
related person but that is disregarded for all purposes of the Internal 
Revenue Code pursuant to paragraph (c)(2) or (3) of this section.
    (4) Indirect ownership. To determine indirect ownership of the 
stock of a corporation for purposes of calculating a pre-transaction 
ownership percentage or post-transaction ownership percentage with 
respect to that corporation, the principles of section 958(a) apply 
without regard to whether

[[Page 20891]]

an intermediate entity is foreign or domestic. For this purpose, stock 
of the corporation that is directly or indirectly (applying the 
principles of section 958(a) without regard to whether an intermediate 
entity is foreign or domestic) owned by a domestic corporation that is 
an expatriated entity is not treated as indirectly owned by a non-CFC 
foreign related person.
    (5) In-group transferred disregarded specified stock means 
disregarded specified stock that is directly transferred to a foreign 
related person, a specified related person, or an expatriated entity.
    (6) A lower-tier expatriated foreign subsidiary means an 
expatriated foreign subsidiary, stock of which is directly or 
indirectly owned by an expatriated foreign subsidiary.
    (7) Out-of-group transferred disregarded specified stock means 
disregarded specified stock that, as a result of a transfer of 
disregarded specified stock, is actually held by a person that is not a 
foreign related person, a specified related person, or an expatriated 
entity.
    (8) Pre-transaction ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately before a specified transaction and any 
related transaction, is owned, in the aggregate, directly or indirectly 
by non-CFC foreign related persons.
    (9) Post-transaction ownership percentage means, with respect to a 
corporation, 100 percent less the percentage of stock (by value) in the 
corporation that, immediately after the specified transaction and any 
related transaction, is owned, in the aggregate, directly or indirectly 
by non-CFC foreign related persons.
    (10) A section 958(a) U.S. shareholder means, with respect to an 
expatriated foreign subsidiary, a United States shareholder with 
respect to the expatriated foreign subsidiary that owns (within the 
meaning of section 958(a)) stock of the expatriated foreign subsidiary 
and that is an expatriated entity.
    (11) Specified stock means the stock of the expatriated foreign 
subsidiary that is issued or transferred to a specified related person 
in a specified transaction.
    (12) Transferred property means the property transferred by the 
specified related person in exchange for specified stock in a specified 
transaction.
    (g) Examples. The following examples illustrate the regulations 
described in this section. Except as otherwise provided, FA, a foreign 
corporation, wholly owns DT, a domestic corporation, which, in turn, 
wholly owns FT, a foreign corporation that is a controlled foreign 
corporation. FA also wholly owns FS, a foreign corporation. FA acquired 
DT in an inversion transaction that was completed on January 1, 2015. 
Accordingly, DT is the domestic entity and a section 958(a) U.S. 
shareholder with respect to FT, FT is an expatriated foreign 
subsidiary, and FA and FS are non-CFC foreign related persons and 
specified related persons.

    Example 1. (i) Facts. On February 1, 2015, FA acquires $6x of FT 
stock, representing 60% of the total voting power and value of the 
stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period. Furthermore, the exceptions to recharacterization in 
paragraph (b)(2) of this section do not apply to the transaction.
    (B) FA's acquisition of the FT specified stock is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows, with the result that FT continues to be a CFC:
    (1) DT is treated as having issued deemed instruments to FA in 
exchange for $6x of cash.
    (2) DT is treated as having contributed the $6x of cash to FT in 
exchange for deemed issued stock of FT.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock issued to FA will be treated 
as a distribution to DT, which, in turn, will be treated as making a 
matching distribution with respect to the deemed instruments that DT 
is treated as having issued to FA. Under paragraph (c)(4)(ii) of 
this section, FT is treated as the paying agent of DT with respect 
to the deemed instruments issued by DT to FA.
    Example 2. (i) Facts. DT owns stock of FT representing 60% of 
the total voting power and value of the stock of FT, and the 
remaining stock of FT, representing 40% of the total voting power 
and value, is owned by USP, a domestic corporation that is not an 
expatriated entity. On February 1, 2015, FA acquires $6x of FT 
stock, representing 60% of the total voting power and value of the 
stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period. Furthermore, the exceptions to recharacterization in 
paragraph (b)(2) of this section do not apply to the transaction.
    (B) FA's acquisition of the FT specified stock is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows, with the result that FT continues to be a CFC:
    (1) DT is treated as having issued deemed instruments to FA in 
exchange for $6x of cash.
    (2) DT is treated as having contributed the $6x of cash to FT in 
exchange for deemed issued stock of FT.
    (3) DT is treated as owning $8.40x of the stock of FT, 
representing 84% of the total voting power and value of the stock of 
FT. USP owns $1.60x of the stock of FT, representing 16% of the 
total voting power and value of the stock of FT.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock issued to FA will be treated 
as a distribution to DT, which, in turn, will be treated as making a 
matching distribution with respect to the deemed instruments that DT 
is treated as having issued to FA. Under paragraph (c)(4)(ii) of 
this section, FT is treated as the paying agent of DT with respect 
to the deemed instruments issued by DT to FA.
    Example 3.  (i) Facts. DT owns stock of FT representing 50% of 
the total voting power and value of the $8x of stock of FT 
outstanding, and the remaining stock of FT, representing 50% of the 
total voting power and value, is owned by USP, a domestic 
corporation that is not an expatriated entity. On April 30, 2016, FA 
and USP each simultaneously acquire $1x of FT stock from FT in a 
stock issuance, in exchange for $1x of cash each.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock from FT is a specified 
transaction because stock of an expatriated foreign subsidiary was 
issued to a specified related person (FA) during the applicable 
period.
    (B) However, the specified transaction is not recharacterized 
under paragraphs (c)(1) and (2) of this section because the 
exception in paragraph (b)(2)(iii) of this section applies. The 
exception applies because FT remains a controlled foreign 
corporation immediately after the specified transaction and any 
related transaction, and the post-transaction ownership percentage 
with respect to FT is 90% (90%/100%), or at least 90%, of the pre-
transaction ownership percentage with respect to FT. The rule in 
paragraph (b)(2)(iii)(C) of this section does not apply because 
there is no lower-tier expatriated foreign subsidiary. Although FA 
(a non-CFC foreign related person) indirectly owns $4x of FT stock 
both immediately before and after the specified transaction and any 
related transaction, all of that stock is directly owned by DT (a 
domestic corporation that is a section 958(a) U.S. shareholder of 
FT), and as a result, under paragraph (f)(4) of this section, none 
of that stock is treated as directly or indirectly owned by FP for 
purposes of calculating the pre-transaction ownership percentage and 
the post-transaction ownership percentage with respect to FT. 
Accordingly, under paragraph (f)(8) of this section, the pre-
transaction ownership percentage with respect to FT (100% less the 
percentage of stock (by value) in FT that, immediately before the 
specified transaction with respect to FT and any related 
transaction, is owned by non-CFC foreign related persons) is 100 
(100% - 0%). Under paragraph (f)(9) of this section, the post-
transaction ownership percentage with respect to FT (100% less the 
percentage of

[[Page 20892]]

stock (by value) in FT that, immediately after the specified 
transaction with respect to FT and any related transaction, is owned 
by non-CFC foreign related persons) is 90 (100% - 10% ($1x/$10x)).
    Example 4.  (i) Facts. On February 1, 2015, FA acquires 60% of 
the FT stock owned by DT in exchange for $2.40x of cash in a fully 
taxable transaction. DT recognizes and includes in income all of the 
gain (including any gain treated as a deemed dividend pursuant to 
section 1248(a)) with respect to the FT stock transferred to FA.
    (ii) Analysis. (A) Under paragraph (b) of this section, FA's 
acquisition of the FT specified stock is a specified transaction 
because stock of an expatriated foreign subsidiary was transferred 
to a specified related person (FA) during the applicable period.
    (B) However, the specified transaction is not recharacterized 
under paragraphs (c)(1) and (c)(3) of this section because the 
exception in paragraph (b)(2)(ii) of this section applies. The 
exception applies because DT recognizes and includes in income all 
of the gain (including any gain treated as a deemed dividend 
pursuant to section 1248(a)) with respect to the FT specified stock 
transferred to FA.
    Example 5. (i) Facts. On February 1, 2015, DT and FA organize 
FPRS, a foreign partnership, with nominal capital. DT transfers all 
of the stock of FT to FPRS in exchange for 40% of the capital and 
profits interests in the partnership. Furthermore, FA contributes 
property to FPRS in exchange for the other 60% of the capital and 
profits interests.
    (ii) Analysis. (A) Under paragraph (b) of this section, DT's 
transfer of the FT specified stock is a specified transaction, 
because stock of an expatriated foreign subsidiary was transferred 
to a specified related person (FPRS) during the applicable period. 
The exceptions to recharacterization in paragraph (b)(2) of this 
section do not apply to the transaction.
    (B) DT's transfer of the FT specified stock is recharacterized 
under paragraphs (c)(1) and (c)(3) of this section as follows, with 
the result that FT continues to be a CFC:
    (1) FPRS is treated as having issued 40% of its capital and 
profits interests to DT in exchange for deemed instruments treated 
as having been issued by DT.
    (2) DT is treated as continuing to own all of the stock of FT, 
as well as the FPRS interests.
    (C) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT specified stock transferred to FPRS will be 
treated as a distribution to DT, which, in turn, will be treated as 
making a matching distribution with respect to the deemed 
instruments that DT is treated as having issued to FPRS. Under 
paragraph (c)(4)(ii) of this section, FT is treated as the paying 
agent of DT with respect to the deemed instruments issued by DT to 
FPRS.
    Example 6.  (i) Facts. DT wholly owns FT2, a foreign corporation 
that is a controlled foreign corporation. FT and FT2 each own 50% of 
the capital and profits interests in DPRS, a domestic partnership. 
DPRS wholly owns FT3, a foreign corporation that is a controlled 
foreign corporation. FT2 and FT3 are expatriated foreign 
subsidiaries. On April 30, 2016, FS acquires $9x of the stock of 
each of FT and FT2, representing 9% of the total voting power and 
value of the stock of FT and FT2, from FT and FT2, respectively, in 
a stock issuance, in exchange for cash of $9x each. Also on April 
30, 2016, in a related transaction, FS acquires $9x of the stock of 
FT3, representing 9% of the total voting power and value of the 
stock of FT3, from FT3 in a stock issuance, in exchange for cash of 
$9x.
    (ii) Analysis. (A) Under paragraph (b) of this section, the 
acquisitions by FS of the specified stock of each of FT, FT2, and 
FT3 from FT, FT2, and FT3 are specified transactions with respect to 
each of FT, FT2, and FT3, respectively, because stock of an 
expatriated foreign subsidiary was issued to a specified related 
person (FS) during the applicable period.
    (B) If FS had acquired only stock of FT and FT2, and had not 
acquired stock of FT3 in a related transaction, the specified 
transactions resulting from the acquisitions with respect to FT and 
FT2 would not have been recharacterized under paragraphs (c)(1) and 
(2) of this section, because the exception from recharacterization 
in paragraph (b)(2)(iii) of this section would have applied. FT and 
FT2 remain controlled foreign corporations (within the meaning of 
section 957) immediately after each specified transaction and any 
related transaction. Under paragraph (f)(9) of this section, the 
post-transaction ownership percentage with respect to each of FT, 
FT2, and FT3 (a lower-tier expatriated foreign subsidiary of FT and 
FT2) would have been 91% ((100% - 9%)/(100% - 0%)), or at least 90%, 
of the pre-transaction ownership percentage determined under 
paragraph (f)(8) of this section with respect to each of FT, FT2, 
and FT3 (100%).
    (C) However, for the specified transactions with respect to FT, 
FT2, and FT3, the post-transaction ownership percentage determined 
under paragraph (f)(9) of this section with respect to FT3 (the 
lower-tier expatriated foreign subsidiary of FT and FT2), 100% less 
the percentage of stock (by value) in FT3 that, immediately after 
each of the specified transactions with respect to each of FT and 
FT2 and any related transaction, is owned by the non-CFC foreign 
related persons, is 82.81 (100%-(9%x50%x91%)-(9%x50%x91%)-9%). 
Accordingly, the post-transaction ownership percentage with respect 
to FT3 is 82.81% (82.81/(100%-0%)), which is less than 90%, of the 
pre-transaction ownership percentage determined under paragraph 
(f)(8) of this section with respect to FT3. Thus, the exception from 
recharacterization in paragraph (b)(2)(iii) of this section does not 
apply with respect to the specified transactions with respect to FT, 
FT2, or FT3.
    (D) The specified transactions with respect to FT and FT2 are 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows:
    (1) DT is treated as having issued 2 deemed instruments worth 
$9x each to FA in exchange for $18x ($9x + $9x) of cash.
    (2) DT is treated as having contributed $9x of cash to each of 
FT and FT2 in exchange for deemed issued stock of FT and FT2.
    (3) DT is treated as continuing to own all of the stock of FT 
and FT2.
    (E) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT and FT2 specified stock issued to FS will be 
treated as a distribution to DT, which, in turn, will be treated as 
making a matching distribution with respect to the deemed 
instruments that DT is treated as having issued to FS. Under 
paragraph (c)(4)(ii) of this section, FT and FT2 are treated as the 
paying agents of DT with respect to the deemed instruments issued by 
DT to FS.
    (F) The specified transaction with respect to FT3 is 
recharacterized under paragraphs (c)(1) and (2) of this section as 
follows:
    (1) DPRS is treated as having issued a deemed instrument worth 
$9x to FA in exchange for $9x of cash.
    (2) DPRS is treated as having contributed $9x of cash to FT3 in 
exchange for deemed issued stock of FT3.
    (3) DPRS is treated as continuing to own all of the stock of 
FT3.
    (G) Under paragraph (c)(4)(i) of this section, any distribution 
with respect to the FT3 specified stock issued to FS will be treated 
as a distribution to DPRS, which, in turn, will be treated as making 
a matching distribution with respect to the deemed instruments that 
DPRS is treated as having issued to FS. Under paragraph (c)(4)(ii) 
of this section, FT3 is treated as the paying agent of DPRS with 
respect to the deemed instrument issued by DPRS to FS.
    Example 7.  (i) Facts. The facts are the same as in Example1 of 
this paragraph (g). On April 30, 2016, FA transfers $4x of the FT 
disregarded specified stock that it acquires on February 1, 2015 to 
USP, a domestic corporation that is not an expatriated entity, in 
exchange for $4x of cash.
    (ii) Results. After the transfer, FT remains a foreign related 
person, Therefore, paragraph (d)(2) of this section does into apply. 
However, the $4x of FT disregarded specified stock transferred to 
USP ceases to be held by a foreign related person, a specified 
related person, or an expatriated entity (determined without taking 
into account paragraph (c)(2) or (3) of this section). Therefore, 
under paragraph (d)(3) of this section, immediately before the 
transfer of the disregarded specified stock, DT is deemed to 
transfer $4x ($6x x ($4x/$6x)) of the FT deemed issued stock that it 
is treated as owning to FA, the specified related person, in 
redemption of $4x ($6x x ($4x/$6x)) of the DT deemed instruments 
that FA is treated as owning, and the $4x of FT deemed issued stock 
deemed transferred to FA is deemed recapitalized into disregarded 
specified stock actually held by FA, which is thereafter treated as 
owned by FA for all purposes of the Code until the transfer to USP.
     Example 8. (i) Facts. The facts are the same as in Example 7 of 
this paragraph (g), except that on April 30, 2016, FA transfers all 
$6x of the FT disregarded specified stock to USP in exchange for $6x 
of cash.
    (ii) Results. After the transfer, FT ceases to be a foreign 
related person (determined

[[Page 20893]]

without taking into account paragraph (c)(2) or (3) of this 
section). Therefore, under paragraph (d)(2) of this section, 
immediately before the transfer of the disregarded specified stock, 
DT is deemed to transfer the $6x of FT deemed issued stock that it 
is treated as owning to FA the specified related person, in 
redemption of the $6x of DT deemed instruments that FA is treated as 
owning, and the $6x of FT deemed issued stock deemed transferred to 
FA is deemed recapitalized into disregarded specified stock actually 
held by FA, which is thereafter treated as owned by FA for all 
purposes of the Code until the transfer to USP.
    Example 9. (i) Facts. The facts are the same as in Example 7 of 
this paragraph (g), except that on April 30, 2016, FA transfers 
$5.5x of the FT disregarded specified stock to USP in exchange for 
$5.5x of cash.
    (ii) Results. After the transfer, FT ceases to be a foreign 
related person (determined without taking into account paragraph 
(c)(2) or (3) of this section). Therefore, under paragraph (d)(2) of 
this section, immediately before the transfer of the disregarded 
specified stock, DT is deemed to transfer the $6x of FT deemed 
issued stock that it is treated as owning to FA, the specified 
related person, in redemption of the $6x of DT deemed instruments 
that FA is treated as owning, and the $6x of FT deemed issued stock 
deemed transferred to FA is deemed recapitalized into disregarded 
specified stock actually held by FA, which is thereafter treated as 
owned by FA for all purposes of the Code and $5.5x of which is 
transferred to USP. The remaining $0.5x of the specified stock 
continues to be treated as owned by FA for all purposes of the Code.
    Example 10.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FA transfers $5x of the FT 
disregarded specified stock that it acquired on February 1, 2015 to 
DS, a domestic corporation wholly owned by DT, in exchange for $5x 
of cash.
    (ii) Results. After the transfer, FT remains a foreign related 
person because DS is wholly owned by DT. Therefore, paragraph (d)(2) 
of this section does not apply. Furthermore, the $5x of FT 
disregarded specified stock is not, as a result of the transfer, 
held by a person that is not a foreign related person, a specified 
related person, or an expatriated entity. Therefore, paragraph 
(d)(3) of this section does not apply. Because FA, a specified 
related person, directly transferred disregarded specified stock of 
FT in a transaction to which paragraphs (d)(2) and (3) of this 
section do not apply, under paragraph (d)(4) of this section, FA is 
treated as transferring the $5x of deemed instruments of DT 
allocable to the $5x of in-group transferred disregarded specified 
stock ($6x x ($5x/$6x)) to DS.
    Example 11.  (i) Facts. On February 1, 2015, FS acquires $6x of 
FT stock, representing 60% of the total voting power and value of 
the stock of FT, from FT in a stock issuance, in exchange for $6x of 
cash. The $6x of FT stock is specified stock, and the transaction is 
recharacterized under paragraph (c)(2) of this section. See Example 
1 of this paragraph (g). On April 30, 2016, FA transfers stock of FS 
representing 60% of the total voting power and value of the stock of 
FS to USP, a domestic corporation that is not an expatriated entity. 
As a result of the transfer, FS ceases to be a foreign related 
person.
    (ii) Results. After the February 1, 2015 transfer, FT remains a 
foreign related person because the FT stock is acquired by FS, a 
foreign related person with respect to DT at that time. Therefore, 
paragraph (d)(2) of this section does not apply. However, after the 
March 1, 2015 transfer, because FS ceases to be a foreign related 
person, it ceases to be a specified related person. Furthermore, the 
$6x of disregarded specified stock held before the transaction 
continues to be held by FS after the transaction, and therefore is 
not held by a foreign related person, a specified related person, or 
an expatriated entity after the transaction. Accordingly, under 
paragraph (d)(3) of this section, immediately before the transfer of 
FS disregarded specified stock, DT is deemed to transfer $6x ($6x x 
($6x/$6x)) of the FT deemed issued stock that it is treated as 
owning to FS, the specified related person, in redemption of $6x 
($6x x ($6x/$6x)) of the DT deemed instruments that FS is treated as 
owning, and the $6x of FT deemed issued stock deemed transferred to 
FS is deemed recapitalized into disregarded specified stock actually 
held by FS, which thereafter is treated as owned by FS for all 
purposes of the Code, including after the transfer of 60% of the FS 
stock to USP.
    Example 12.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FP, a foreign corporation 
that is not a foreign related person acquires $15x of FT stock, 
representing 60% of the total voting power and value of the stock of 
FT, from FT in a stock issuance, in exchange for $15x of cash.
    (ii) Results. After the transaction, FT ceases to be a foreign 
related person. Therefore, under paragraph (d)(2) of this section, 
immediately before the issuance of FT stock to FP, DT is deemed to 
transfer the $6x of FT deemed issued stock that it is treated as 
owning to FA, the specified related person, in redemption of the $6x 
of DT deemed instruments that FA is treated as owning, and the $6x 
of FT deemed issued stock deemed transferred to FA is deemed 
recapitalized into disregarded specified stock actually held by FA, 
which thereafter is treated as owned by FA for all purposes of the 
Code.
    Example 13.  (i) Facts. The facts are the same as in Example 1 
of this paragraph (g). On April 30, 2016, FS acquires $4x of the FT 
stock owned by DT in exchange for $4x of cash in a fully taxable 
transaction. DT recognizes and includes in income all of the gain 
(including any gain treated as a deemed dividend pursuant to section 
1248(a)) with respect to the FT stock transferred to FS.
    (ii) Results. (A) The transfer of FT stock by DT to FS is a 
specified transaction, but it is not recharacterized under 
paragraphs (c)(1) and (3) of this section because the exception in 
paragraph (b)(2)(ii) of this section applies. See Example 4 of this 
paragraph (g).
    (B) After the transfer, FT remains a foreign related person. 
Therefore, paragraph (d)(2) of this section does not apply. The 
disregarded specified stock of FT is not, as a result of the 
transfer, held by a person that is not a foreign related person, a 
specified related person, or an expatriated entity. Therefore, 
paragraph (d)(3) of this section does not apply. There has been no 
direct transfer of specified stock. Therefore, paragraph (d)(4) of 
this section also does not apply.
    (C) Under paragraph (d)(1) of this section, the $6x of deemed 
issued stock treated as owned by DT as a result of the specified 
transaction in which FA acquired FT stock continues to be treated as 
owned by DT, and the $6x of deemed instruments treated as issued by 
DT to FA continue to be treated as owned by FA.

    (h) Applicability date. Except as otherwise provided in this 
paragraph (h), this section applies to specified transactions completed 
on or after September 22, 2014, but only if the inversion transaction 
was completed on or after September 22, 2014. Paragraph 
(b)(2)(ii)(A)(2) of this section applies to specified transactions 
completed on or after November 19, 2015, but only if the inversion 
transaction was completed on or after September 22, 2014. Paragraphs 
(d) and (f)(5), (7), and (10) of this section apply to specified 
transactions completed on or after April 4, 2016, but only if the 
inversion transaction was completed on or after September 22, 2014. For 
inversion transactions completed on or after September 22, 2014, 
however, taxpayers may elect to apply paragraphs (d) and (f)(5), (7), 
and (10) of this section to specified transactions completed before 
April 4, 2016. In addition, for inversion transactions completed on or 
after September 22, 2014, in lieu of applying paragraphs (d) and (f)(5) 
and (7) of this section to specified transactions completed on or after 
September 22, 2014, and before April 4, 2016, taxpayers may elect to 
apply the principles of Sec.  1.7701(l)-3(c)(3)(iii). Furthermore, for 
inversion transactions completed on or after September 22, 2014, in 
lieu of applying paragraph (f)(10) of this section to specified 
transactions completed on or after September 22, 2014, and before April 
4, 2016, taxpayers may elect to define a section 958(a) U.S. 
shareholder as a United States shareholder with respect to the 
expatriated foreign subsidiary that owns (within the meaning of section 
958(a)) stock in the expatriated foreign subsidiary, but only if such 
United States shareholder is related (within the meaning of section 
267(b) or 707(b)(1)) to the specified related person or is under the 
same common control (within the meaning of section 482) as the 
specified related person.
    (i) Expiration date. The applicability of this section expires on 
or before April 4, 2019.

[[Page 20894]]


0
Par. 11. Section 1.7874-1 is amended by:
0
1. Adding paragraph (c)(2)(iii).
0
2. Redesignating paragraphs (f) and (g) as paragraph (g) and (h).
0
3. Adding paragraph (f).
0
4. Further redesignating newly redesignated paragraph (h) as paragraph 
(h)(1).
0
5. Adding a paragraph heading for newly redesignated paragraph (h) and 
revising the paragraph heading of newly redesignated paragraph (h)(1).
0
6. Removing the language ``in this paragraph'' in the first sentence of 
newly redesignated paragraph (h)(1).
0
7. Adding paragraph (h)(2).
    The additions and revision read as follows:


Sec.  1.7874-1  Disregard of affiliate-owned stock.

* * * * *
    (c) * * *
    (2) * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.7874-
1T(c)(2)(iii).
* * * * *
    (f) [Reserved]. For further guidance, see Sec.  1.7874-1T(f).
* * * * *
    (h) Applicability dates--(1) In general. * * *
    (2) [Reserved]. For further guidance, see Sec.  1.7874-1T(h)(2).

0
Par. 12. Section 1.7874-1T is added to read as follows:


Sec.  1.7874-1T  Disregard of affiliate-owned stock (temporary).

    (a) through (c)(2)(ii) [Reserved]. For further guidance, see Sec.  
1.7874-1(a) through (c)(2)(ii).
    (iii) Special rule. If Sec.  1.7874-6T(c)(2) applies for purposes 
of applying section 7874(c)(2)(A) and Sec.  1.7874-1, then, for 
purposes of Sec.  1.7874-1(c)(2) (and so much of Sec.  1.7874-1(c)(1) 
as relates to Sec.  1.7874-1(c)(2)), the determination of the EAG after 
the acquisition, as well as the determination of stock held by one or 
more members of the EAG after the acquisition, is made without regard 
to one or more transfers (other than by issuance), in a transaction (or 
series of transactions) after and related to the acquisition, of stock 
of the acquiring foreign corporation by one or more members of the 
foreign-parented group described in Sec.  1.7874-6T(c)(2)(i).
    (c)(3) through (e) [Reserved]. For further guidance, see Sec.  
1.7874-1(c)(3) through (e).
    (f) Treatment of transactions related to the acquisition. Except as 
provided in paragraph (c)(2)(iii) of this section, all transactions 
that are related to an acquisition are taken into account in applying 
this section and Sec.  1.7874-1.
    (g) through (h)(1) [Reserved]. For further guidance, see Sec.  
1.7874-1(g) through (h)(1).
    (2) Applicability date of certain provisions of this section. 
Except as provided in this paragraph (h)(2), paragraph (c)(2)(iii) of 
this section applies to domestic entity acquisitions completed on or 
after April 4, 2016. Except as provided in this paragraph (h)(2), 
paragraph (f) of this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. For domestic entity 
acquisitions completed before April 4, 2016, however, taxpayers may 
elect to consistently apply paragraphs (c)(2)(iii) and (f) of this 
section, and Sec.  1.7874-6T(c)(2), (d)(2), and (f)(2)(ii).
    (i) Expiration date. This section expires on April 4, 2019.

0
Par. 13. Section 1.7874-2 is amended by:
0
1. Revising paragraph (a).
0
2. Revising the introductory text of paragraph (b).
0
3. Removing paragraphs (b)(2) through (4).
0
4. Redesignating paragraphs (b)(5) through (9) as paragraphs (b)(2) 
through (6), respectively.
0
5. Adding paragraphs (b)(7) through (13).
0
6. Revising paragraph (c)(2).
0
7. Adding paragraph (c)(4).
0
8. Revising the introductory text of paragraph (f)(1).
0
9. Adding paragraph (f)(1)(iv).
0
10. Adding Example 21 to paragraph (k)(2).
0
11. Redesignating paragraph (l) as paragraph (l)(1).
0
12. Adding a paragraph heading for paragraph (l) and revising the 
heading of newly redesignated paragraph (l)(1).
0
13. Adding paragraph (l)(2).
0
14. For each paragraph listed in the following table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column:

------------------------------------------------------------------------
            Paragraph                   Remove                Add
------------------------------------------------------------------------
Newly redesignated (b)(6).......  acquisition         domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(d).............................  an acquisition      a domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(e).............................  acquisitions        domestic entity
                                   described in        acquisitions.
                                   section
                                   7874(a)(2)(B)(i).
(e).............................  former              former domestic
                                   shareholders.       entity
                                                       shareholders.
(e).............................  former partners...  former domestic
                                                       entity partners.
(g)(2)(i).......................  acquisition         domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(g)(2)(ii)......................  acquisition.......  domestic entity
                                                       acquisition.
(g)(6)..........................  acquisition         domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(h)(3)(i) and (ii) and            acquisition         domestic entity
 (h)(4)(ii).                       described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(i)(2)(i) and (ii)..............  an acquisition      a domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(j)(1) and (3)..................  acquisition         domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(k)(2), Examples 7, 11, 13, 19,   former              former domestic
 20.                               shareholders.       entity
                                                       shareholders.
(k)(2), Examples 12, 14, 15, and  acquisition.......  domestic entity
 16.                                                   acquisition.
(k)(2), Example 19..............  acquisition         domestic entity
                                   described in        acquisition.
                                   section
                                   7874(a)(2)(B)(i).
(l).............................  acquisitions......  domestic entity
                                                       acquisitions.
------------------------------------------------------------------------

    The revisions and additions read as follows:


Sec.  1.7874-2  Surrogate foreign corporation.

    (a) [Reserved]. For further guidance, see Sec.  1.7874-2T(a).
    (b) Definitions and special rules. In addition to the definitions 
in Sec.  1.7874-12T, the following definitions and special rules apply 
for purposes of this section.
* * * * *
    (b)(7) through (13) [Reserved]. For further guidance, see Sec.  
1.7874-2T(b)(7) through (13).
    (c) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.7874-2T(c)(2).
* * * * *
    (4) [Reserved]. For further guidance, see Sec.  1.7874-2T(c)(4).
* * * * *
    (f) * * *

[[Page 20895]]

    (1) introductory text [Reserved]. For further guidance, see Sec.  
1.7874-2T(f)(1) introductory text.
* * * * *
    (iv) [Reserved]. For further guidance, see Sec.  1.7874-
2T(f)(1)(iv).
* * * * *
    (k) * * *
    (2) * * *
    Example 21 [Reserved]. For further guidance, see Sec.  1.7874-
2T(k)(2), Example 21.
    (l) Applicability date--(1) In general. * * *
    (2) [Reserved]. For further guidance, see Sec.  1.7874-2T(l)(2).
    Par. 14. Section 1.7874-2T is added to read as follows:


Sec.  1.7874-2T  Surrogate foreign corporation (temporary).

    (a) Scope. This section provides rules for determining whether a 
foreign corporation is treated as a surrogate foreign corporation under 
section 7874(a)(2)(B). Paragraph (b) of this section provides 
definitions and special rules. Paragraph (c) of this section provides 
rules to determine whether a foreign corporation has acquired 
properties held by a domestic corporation (or a partnership). Paragraph 
(d) of this section provides rules that apply when two or more foreign 
corporations complete, in the aggregate, a domestic entity acquisition. 
Paragraph (e) of this section provides rules that apply when, pursuant 
to a plan, a single foreign corporation completes more than one 
domestic entity acquisition. Paragraph (f) of this section provides 
rules to identify the stock of a foreign corporation that is held by 
reason of holding stock in a domestic corporation (or an interest in a 
domestic partnership). Paragraph (g) of this section provides rules 
that treat certain publicly traded foreign partnerships as foreign 
corporations for purposes of section 7874. Paragraph (h) of this 
section provides rules concerning the treatment of certain options (or 
similar interests) for purposes of section 7874. Paragraph (i) of this 
section provides rules that treat certain interests (including debt, 
stock, or a partnership interest) as stock of a foreign corporation for 
purposes of section 7874. Paragraph (j) of this section provides rules 
concerning the conversion of a foreign corporation to a domestic 
corporation by reason of section 7874(b). Paragraph (k) of this section 
provides examples that illustrate the rules of this section. Paragraph 
(l) of this section provides the applicability dates of this section, 
and paragraph (m) provides the date of expiration. For additional 
definitions that apply for purposes of this section, see Sec.  1.7874-
12T.
    (b) through (b)(6) [Reserved]. For further guidance, see Sec.  
1.7874-2(b) through (b)(6).
    (7) A former initial acquiring corporation shareholder of an 
initial acquiring corporation means any person that held stock in the 
initial acquiring corporation before the subsequent acquisition, 
including any person that holds stock in the initial acquiring 
corporation both before and after the subsequent acquisition.
    (8) An initial acquisition means, with respect to a subsequent 
acquisition, a domestic entity acquisition occurring, pursuant to a 
plan that includes the subsequent acquisition (or a series of related 
transactions), before the subsequent acquisition.
    (9) An initial acquiring corporation means, with respect to an 
initial acquisition, the foreign acquiring corporation.
    (10) A subsequent acquisition means, with respect to an initial 
acquisition, a transaction occurring, pursuant to a plan that includes 
the initial acquisition (or a series of related transactions), after 
the initial acquisition in which a foreign corporation directly or 
indirectly acquires (within the meaning of paragraph (c)(4)(ii) of this 
section) substantially all of the properties held directly or 
indirectly by the initial acquiring corporation.
    (11) A subsequent acquiring corporation means, with respect to a 
subsequent acquisition, the foreign corporation that directly or 
indirectly acquires substantially all of the properties held directly 
or indirectly by the initial acquiring corporation.
    (12) Special rule regarding initial acquisitions. With respect to 
an initial acquisition, the determination of the ownership percentage 
described in section 7874(a)(2)(B)(ii) is made without regard to the 
subsequent acquisition and all related transactions occurring after the 
subsequent acquisition.
    (13) Special rule regarding subsequent acquisitions. With respect 
to a subsequent acquisition (or a similar acquisition under the 
principles of paragraph (c)(4)(i) of this section) that is an inversion 
transaction, the applicable period begins on the first date that 
properties are acquired as part of the initial acquisition.
    (c) through (c)(1) [Reserved]. For further guidance, see Sec.  
1.7874-2(c) through (c)(1).
    (2) Acquisition of stock of a foreign corporation. Except as 
provided in paragraph (c)(4) of this section, an acquisition of stock 
of a foreign corporation that owns directly or indirectly stock of a 
domestic corporation (or an interest in a partnership) shall not 
constitute an indirect acquisition of any properties held by the 
domestic corporation (or the partnership). See Example 4 of paragraph 
(k) of this section for an illustration of the rules of this paragraph 
(c)(2).
    (3) [Reserved]. For further guidance, see Sec.  1.7874-2(c)(3).
    (4) Multiple-step acquisitions--(i) Rule. A subsequent acquisition 
is treated as a domestic entity acquisition, and the subsequent 
acquiring corporation is treated as a foreign acquiring corporation. 
See Example 21 of paragraph (k) of this section for an illustration of 
this rule. See also paragraph (f)(1)(iv) of this section (treating 
certain stock of the subsequent acquiring corporation as stock of a 
foreign corporation that is held by reason of holding stock of, or a 
partnership interest in, the domestic entity).
    (ii) Acquisition of property pursuant to a subsequent acquisition. 
In determining whether a foreign corporation directly or indirectly 
acquires substantially all of the properties held directly or 
indirectly by an initial acquiring corporation, the principles of 
section 7874(a)(2)(B)(i) apply, including Sec.  1.7874-2(c) other than 
Sec.  1.7874-2(c)(2). For this purpose, the principles of Sec.  1.7874-
2(c)(1), including Sec.  1.7874-2(b)(5), apply by substituting the term 
``foreign'' for ``domestic'' wherever it appears.
    (iii) Additional related transactions. If, pursuant to the same 
plan (or a series of related transactions), a foreign corporation 
directly or indirectly acquires (under the principles of paragraph 
(c)(4)(ii) of this section) substantially all of the properties 
directly or indirectly held by a subsequent acquiring corporation in a 
transaction occurring after the subsequent acquisition, then the 
principles of paragraph (c)(4)(i) of this section apply to such 
transaction (and any subsequent transaction or transactions occurring, 
pursuant to the plan (or the series of related transactions)).
    (d) through (f) introductory text [Reserved]. For further guidance, 
see Sec.  1.7874-2(d) through (f) introductory text.
    (1) Certain transactions. For purposes of section 
7874(a)(2)(B)(ii), stock of a foreign corporation that is held by 
reason of holding stock in a domestic corporation (or an interest in a 
domestic partnership) includes, but is not limited to, the stock 
described in paragraphs (f)(1)(i) through (iv) of this section.

[[Page 20896]]

    (f)(1)(i) through (f)(1)(iii) [Reserved]. For further guidance, see 
Sec.  1.7874-2(f)(1)(i) through (iii).
    (iv) Stock of a subsequent acquiring corporation received by a 
former initial acquiring corporation shareholder pursuant to a 
subsequent acquisition in exchange for, or with respect to, stock of an 
initial acquiring corporation that is held by reason of holding stock 
of, or a partnership interest in, a domestic entity.
    (g) through (k)(2), Example 20 [Reserved]. For further guidance, 
see Sec.  1.7874-2(g) through (k)(2), Example 20.

    Example 21. Application of multiple-step acquisition rule--(i) 
Facts. Individual A owns all 70 shares of stock of DC1, a domestic 
corporation. Individual B owns all 30 shares of stock of F1, a 
foreign corporation that is subject to tax as a resident of Country 
X. Pursuant to a reorganization described in section 368(a)(1)(D), 
DC1 transfers all of its properties to F1 solely in exchange for 70 
newly issued voting shares of F1 stock (DC1 acquisition) and 
distributes the F1 stock to Individual A in liquidation pursuant to 
section 361(c)(1). Pursuant to a plan that includes the DC1 
acquisition, F2, a newly formed foreign corporation that is also 
subject to tax as a resident of Country X, acquires 100 percent of 
the stock of F1 solely in exchange for 100 newly issued shares of F2 
stock (F1 acquisition). After the F1 acquisition, Individual A owns 
70 shares of F2 stock, Individual B owns 30 shares of F2 stock, F2 
owns all 100 shares of F1 stock, and F1 owns all the properties held 
by DC1 immediately before the DC1 acquisition. In addition, the form 
of the transaction is respected for U.S. federal income tax 
purposes.
    (ii) Analysis--(A) The DC1 acquisition is a domestic entity 
acquisition, and F1 is a foreign acquiring corporation, because F1 
directly acquires 100 percent of the properties of DC1. In addition, 
the 70 shares of F1 stock received by A pursuant to the DC1 
acquisition in exchange for Individual A's DC1 stock are stock of a 
foreign corporation that is held by reason of holding stock in DC1. 
As a result, those 70 shares are included in both the numerator and 
the denominator of the ownership fraction when applying section 7874 
to the DC1 acquisition.
    (B) The DC1 acquisition is also an initial acquisition because 
it is a domestic entity acquisition that, pursuant to a plan that 
includes the F1 acquisition, occurs before the F1 acquisition 
(which, as described in paragraph (ii)(C) of this Example 21, is a 
subsequent acquisition). Thus, F1 is the initial acquiring 
corporation.
    (C) The F1 acquisition is a subsequent acquisition because it 
occurs, pursuant to a plan that includes the DC1 acquisition, after 
the DC1 acquisition and, pursuant to the F1 acquisition, F2 acquires 
100 percent of the stock of F1 and therefore is treated under 
paragraph (c)(4)(ii) of this section (which applies the principles 
of section 7874(a)(2)(B)(i) with certain modifications) as 
indirectly acquiring substantially all of the properties held 
directly or indirectly by F1. Thus, F2 is the subsequent acquiring 
corporation.
    (D) Under paragraph (c)(4)(i) of this section, the F1 
acquisition is treated as a domestic entity acquisition, and F2 is 
treated as a foreign acquiring corporation. In addition, under 
paragraph (f)(1)(iv) of this section, the 70 shares of F2 stock 
received by Individual A (a former initial acquiring corporation 
shareholder) pursuant to the F1 acquisition in exchange for 
Individual A's F1 stock are stock of a foreign corporation that is 
held by reason of holding stock in DC1. As a result, those 70 shares 
are included in both the numerator and the denominator of the 
ownership fraction when applying section 7874 to the F1 acquisition.

    (l) through (l)(1) [Reserved]. For further guidance, see Sec.  
1.7874-2(l) through (l)(1).
    (2) Applicability date of certain provisions of this section. 
Paragraphs (a), (b)(7) through (13), (c)(2) and (4), and (f)(1)(iv) of 
this section, as well as the introductory text of paragraph (f)(1) and 
Example 21 of paragraph (k)(2), apply to domestic entity acquisitions 
completed on or after April 4, 2016.
    (m) Expiration date. This section expires on April 4, 2019.

0
Par. 15. Section 1.7874-3 is amended by:
0
1. Revising the second sentence of paragraph (a).
0
2. Revising the introductory text of paragraph (b).
0
3. Adding paragraph (b)(4).
0
4. Revising paragraph (d)(10).
0
5. Redesignating paragraph (f) as paragraph (f)(1).
0
6. Adding a paragraph heading for paragraph (f) and revising newly 
redesignated paragraph (f)(1).
0
7. Adding paragraph (f)(2).
    The revisions and additions read as follows:


Sec.  1.7874-3  Substantial business activities.

    (a) * * * Paragraph (b) of this section describes the general rule 
for determining whether the expanded affiliated group has substantial 
business activities in the relevant foreign country when compared to 
its total business activities.* * *
    (b) General rule. The expanded affiliated group will be considered 
to have substantial business activities in the relevant foreign country 
after an acquisition described in section 7874(a)(2)(B)(i) when 
compared to the total business activities of the expanded affiliated 
group only if, subject to paragraph (c) of this section, each of the 
requirements of this paragraph (b) are satisfied.
* * * * *
    (4) [Reserved]. For further guidance, see Sec.  1.7874-3T(b)(4).
* * * * *
    (d) * * *
* * * * *
    (10) [Reserved]. For further guidance, see Sec.  1.7874-3T(d)(10).
* * * * *
    (f) Applicability dates--(1) General rule. Except as otherwise 
provided in paragraph (f)(2) of this section, this section applies to 
acquisitions that are completed on or after June 3, 2015. For 
acquisitions completed before June 3, 2015, see Sec.  1.7874-3T as 
contained in 26 CFR part 1 revised as of April 1, 2016.
    (2) [Reserved]. For further guidance, see Sec.  1.7874-3T(f)(2).

0
Par. 16. Section 1.7874-3T is added to read as follows:


Sec.  1.7874-3T  Substantial business activities (temporary).

    (a) through (b)(3) [Reserved]. For further guidance, see Sec.  
1.7874-3(a) through 1.7874-3(b)(3).
    (4) Tax residence of foreign acquiring corporation. The foreign 
acquiring corporation is subject to tax as a resident of the relevant 
foreign country.
    (c) through (d)(9) [Reserved]. For further guidance, see Sec.  
1.7874-3(c) through (d)(9).
    (10) The term relevant financial statements means financial 
statements prepared consistently for all members of the expanded 
affiliated group in accordance with either U.S. Generally Accepted 
Accounting Principles (U.S. GAAP) or the International Financial 
Reporting Standards (IFRS) used for the expanded affiliated group's 
consolidated financial statements, but, if, after the acquisition 
described in section 7874(a)(2)(B)(i), financial statements will not be 
prepared consistently for all members of the expanded affiliated group 
in accordance with either U.S. GAAP or IFRS, then, for each member, 
financial statements prepared in accordance with either U.S. GAAP or 
IFRS. The relevant financial statements must take into account all 
items of income generated by all members of the expanded affiliated 
group for the entire testing period.
    (d)(11) through (f)(1) [Reserved]. For further guidance, see Sec.  
1.7874-3(d)(11) through (f)(1).
    (2) Paragraphs (b)(4) and (d)(10) of this section. Paragraph (b)(4) 
of this section applies to domestic entity acquisitions completed on or 
after November 19, 2015. Paragraph (d)(10) of this section applies to 
domestic entity acquisitions completed on or after April 4, 2016. For 
domestic entity acquisitions completed on or after June 3, 2015, and 
before April 4, 2016, however, taxpayers may elect to apply paragraph 
(d)(10) of this section.

[[Page 20897]]

    (g) Expiration date. The applicability of paragraphs (b)(4) and 
(d)(10) of this section expires on April 4, 2019.

0
Par. 17. Section 1.7874-4T is amended by:
0
1. Revising paragraph (d)(1)(i).
0
2. Revising paragraphs (i)(6) and (i)(7)(iv).
0
3. In paragraph (j)(7), removing the word ``and'' at the end of the 
paragraph.
0
4. In paragraph (j)(8), removing the period at the end of the paragraph 
and adding a semicolon in its place.
0
5. Adding paragraphs (j)(9), (10), and (11) before Example 1 of 
paragraph (j).
0
6. In paragraph (ii) of Example 1 of paragraph (j), adding a sentence 
after the fourth sentence.
0
7. In paragraph (ii) of Example 2 of paragraph (j), adding a sentence 
after the fourth sentence.
0
8. In paragraph (j), redesignating Example 3 through Example 8 as 
Example 4 through Example 9, respectively.
0
9. Adding Example 3 to paragraph (j).
0
10. In paragraph (ii) of newly redesignated Example 5 of paragraph (j), 
revising the fourth sentence.
0
11. For each paragraph listed in following the table, removing the 
language in the ``Remove'' column and adding in its place the language 
in the ``Add'' column:

------------------------------------------------------------------------
            Paragraph                   Remove                Add
------------------------------------------------------------------------
(c)(1)(i), last sentence........  Example 5.........  Example 6.
(c)(1)(i), last sentence........  Example 7.........  Example 8.
(c)(1)(i), last sentence........  Example 8.........  Example 9.
(c)(1)(ii)(B), second sentence..  Example 5.........  Example 6.
(c)(2), last sentence...........  Example 3.........  Example 4.
(c)(2), last sentence...........  Example 6.........  Example 7.
(d)(1)(ii), last sentence.......  Example 4.........  Example 5.
(h), last sentence..............  Example 7.........  Example 8.
(h), last sentence..............  Example 8.........  Example 9.
(i)(7)(iii)(C), last sentence...  Example 5.........  Example 6.
(j), newly redesignated Example   Example 3.........  Example 4.
 4 (iii), first sentence.
(j), newly redesignated Example   Example 5.........  Example 6.
 6 (iii), first sentence.
(j), newly redesignated Example   Example 8.........  Example 9.
 9 (iii), first sentence.
------------------------------------------------------------------------

0
12. Revising paragraph (k)(1).
    The revisions and additions read as follows:


Sec.  1.7874-4T  Disregard of certain stock related to the acquisition 
(temporary).

* * * * *
    (d) * * *
    (1) * * *
    (i) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-7T(b) and 1.7874-
10T(b), is less than five (by vote and value); and
* * * * *
    (i) * * *
    (6) Marketable securities has the meaning set forth in section 
453(f)(2), except that the term ``marketable securities'' does not 
include stock of a corporation or an interest in a partnership that 
becomes a member of the expanded affiliated group that includes the 
foreign acquiring corporation in a transaction (or series of 
transactions) related to the acquisition. See Example 4 of paragraph 
(j) of this section for an illustration of this paragraph (i)(6).
    (7) * * *
    (iv) Any other property acquired with a principal purpose of 
avoiding the purposes of section 7874, regardless of whether the 
transaction involves an indirect transfer of property described in 
paragraph (i)(7)(i), (ii), or (iii) of this section. See Example 2 and 
Example 3 of paragraph (j) of this section for illustrations of this 
paragraph (i)(7)(iv).
* * * * *
    (j) * * *
    (9) FA, FMS, FS, and FT are tax residents in the same foreign 
country;
    (10) For purposes of determining the ownership fraction, no shares 
of FA stock are excluded from the denominator pursuant to Sec.  1.7874-
7T(b); and
    (11) For purposes of determining the ownership fraction, no shares 
of FA stock are received by former shareholders of DT pursuant to Sec.  
1.7874-10T(b).

    Example 1.  * * *
    (ii) * * * See also section 7874(c)(4). * * *

    Example 2.  * * *
    (ii) * * * Furthermore, even in the absence of paragraph 
(i)(7)(iv) of this section, the transfer of marketable securities to 
FT would be disregarded pursuant to section 7874(c)(4). * * *
    Example 3. Stock transferred in exchange for property acquired 
with a principal purpose of avoiding the purposes of section 7874. 
(i) Facts. DT is a publicly traded corporation. PRS is a foreign 
partnership that is unrelated to DT. PRS transfers certain business 
assets (PRS properties) to FA, a newly formed foreign corporation, 
in exchange solely for 25 shares of FA stock. The shareholders of DT 
transfer all of their DT stock to FA in exchange solely for the 
remaining 75 shares of FA stock. None of the PRS properties is 
property described in paragraph (i)(7)(i) through (iii) of this 
section, but FA acquires the PRS properties with a principal purpose 
of avoiding the purposes of section 7874.
    (ii) Analysis. Under paragraph (i)(7)(iv) of this section, the 
PRS properties transferred to FA constitute nonqualified property, 
because FA acquires the PRS properties in a transaction related to 
the acquisition of the DT stock with a principal purpose of avoiding 
the purposes of section 7874. Accordingly, the 25 shares of FA stock 
transferred by FA to PRS in exchange for the PRS properties 
constitute disqualified stock described in paragraph (c)(1)(i) of 
this section. Paragraph (c)(2) of this section does not apply to 
reduce the amount of disqualified stock described in paragraph 
(c)(1)(i) of this section because the transfer of FA stock in 
exchange for the PRS properties increases the fair market value of 
FA's assets by the fair market value of the PRS properties. 
Accordingly, pursuant to paragraph (b) of this section, the 25 
shares of FA stock transferred to PRS in exchange for the PRS 
properties are not included in the denominator of the ownership 
fraction. Furthermore, even in the absence of paragraph (i)(7)(iv) 
of this section, the transfer of the PRS properties to FA would be 
disregarded pursuant to section 7874(c)(4). Therefore, the only FA 
stock included in the ownership fraction is the FA stock transferred 
to DT's former shareholders in exchange for their DT stock, and that 
FA stock is included in both the numerator and the denominator of 
the ownership fraction. Thus, the ownership fraction is 75/75.
* * * * *
    Example 5.  * * *
    (ii) * * * However, without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-7T(b) and 
1.7874-10T(b), the ownership percentage described in section

[[Page 20898]]

7874(a)(2)(B)(ii) would be less than 5 (by vote and value), or 4 (4/
100, or 4 shares of FA stock held by Individual A by reason of 
owning the DT stock, determined under Sec.  1.7874-2(f)(2), over 100 
shares of FA stock outstanding after the acquisition). * * *
* * * * *

    (k) * * *
    (1) Except to the extent provided in this paragraph (k)(1) and 
paragraph (k)(2) of this section, this section applies to domestic 
entity acquisitions completed on or after September 17, 2009. 
Paragraphs (i)(6) and (i)(7)(iv) of this section apply to domestic 
entity acquisitions completed on or after November 19, 2015. Paragraph 
(d)(1)(i) of this section applies to domestic entity acquisitions 
completed on or after April 4, 2016. For domestic entity acquisitions 
completed on or after September 22, 2014, and before April 4, 2016, 
however, taxpayers may elect to apply paragraph (d)(1)(i) of this 
section. For domestic entity acquisitions completed before November 19, 
2015, see paragraphs (i)(6) and (i)(7)(iv) of this section as contained 
in 26 CFR part 1 revised as of April 1, 2016.
* * * * *

0
Par. 18. Section 1.7874-6T is added to read as follows:


Sec.  1.7874-6T  Stock transferred by members of the EAG (temporary).

    (a) Scope. This section provides rules regarding whether 
transferred stock is treated as held by members of the EAG for purposes 
of applying section 7874(c)(2)(A) and Sec.  1.7874-1. Paragraph (b) of 
this section sets forth the general rule under which transferred stock 
is not treated as held by members of the EAG for purposes of applying 
section 7874(c)(2)(A) and Sec.  1.7874-1. Paragraph (c) of this section 
provides exceptions to the general rule. Paragraph (d) of this section 
provides rules regarding the treatment of partnerships, and paragraph 
(e) of this section provides rules regarding transactions related to 
the acquisition. Paragraph (f) of this section provides definitions. 
Paragraph (g) of this section provides examples illustrating the 
application of the rules of this section. Paragraph (h) of this section 
provides dates of applicability, and paragraph (i) of this section 
provides the date of expiration.
    (b) General rule. Except as provided in paragraph (c) of this 
section, transferred stock is not treated as held by members of the EAG 
for purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1. 
Transferred stock that is not treated as held by members of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1 is 
included in the numerator and the denominator of the ownership 
fraction. See Sec.  1.7874-5T(a).
    (c) Exceptions. Transferred stock is treated as held by members of 
the EAG for purposes of applying section 7874(c)(2)(A) and Sec.  
1.7874-1 if paragraph (c)(1) or (2) of this section applies. 
Transferred stock that is treated as held by members of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1 is 
excluded from the numerator of the ownership fraction and, depending 
upon the application of Sec.  1.7874-1(c), may be excluded from the 
denominator of the ownership fraction. See Sec.  1.7874-1(b) and (c).
    (1) Transfers involving a U.S.-parented group. This paragraph 
(c)(1) applies if the following conditions are satisfied:
    (i) Before the domestic entity acquisition, the transferring 
corporation is a member of a U.S.-parented group.
    (ii) After the domestic entity acquisition, each of the 
transferring corporation (or its successor), any person that holds 
transferred stock, and the foreign acquiring corporation are members of 
a U.S.-parented group the common parent of which--
    (A) Before the domestic entity acquisition, was a member of the 
U.S.-parented group described in paragraph (c)(1)(i) of this section; 
or
    (B) Is a corporation that was formed in a transaction related to 
the domestic entity acquisition, provided that, immediately after the 
corporation was formed (and without regard to any related 
transactions), the corporation was a member of the U.S.-parented group 
described in paragraph (c)(1)(i) of this section.
    (2) Transfers involving a foreign-parented group. This paragraph 
(c)(2) applies if the following conditions are satisfied:
    (i) Before the domestic entity acquisition, the transferring 
corporation and the domestic entity are members of the same foreign-
parented group.
    (ii) After the domestic entity acquisition, the transferring 
corporation--
    (A) Is a member of the EAG; or
    (B) Would be a member of the EAG absent one or more transfers 
(other than by issuance), in a transaction (or series of transactions) 
after and related to the domestic entity acquisition, of stock of the 
foreign acquiring corporation by one or more members of the foreign-
parented group described in paragraph (c)(2)(i) of this section.
    (d) Treatment of partnerships--(1) Stock held by a partnership. For 
purposes of this section, each partner in a partnership, as determined 
without regard to the application of paragraph (d)(2) of this section, 
is treated as holding its proportionate share of the stock held by the 
partnership, as determined under the rules and principles of sections 
701 through 777.
    (2) Partnership treated as corporation. For purposes of this 
section, if one or more members of an affiliated group, as determined 
after the application of paragraph (d)(1) of this section, own, in the 
aggregate, more than 50 percent (by value) of the interests in a 
partnership, the partnership will be treated as a corporation that is a 
member of the affiliated group.
    (e) Treatment of transactions related to the acquisition. Except as 
provided in paragraphs (c)(1)(ii)(B) and (c)(2)(ii)(B) of this section, 
all transactions that are related to a domestic entity acquisition are 
taken into account in applying this section.
    (f) Definitions. In addition to the definitions provided in Sec.  
1.7874-12T, the following definitions apply for purposes of this 
section.
    (1) A foreign-parented group means an affiliated group that has a 
foreign corporation as the common parent corporation. A member of the 
foreign-parented group is an entity included in the foreign-parented 
group.
    (2) Transferred stock--(i) In general. Transferred stock means 
stock of the foreign acquiring corporation described in section 
7874(a)(2)(B)(ii) that is received by a transferring corporation and, 
in a transaction (or series of transactions) related to the domestic 
entity acquisition, is subsequently transferred.
    (ii) Special rule. This paragraph (f)(2)(ii) applies in certain 
cases in which a transferring corporation receives stock of the foreign 
acquiring corporation described in section 7874(a)(2)(B)(ii) that has 
the same terms as other stock of the foreign acquiring corporation that 
is received by the transferring corporation in a transaction (or series 
of transactions) related to the domestic entity acquisition or that is 
owned by the transferring corporation prior to the domestic entity 
acquisition (the stock described in this sentence, collectively, 
fungible stock). Pursuant to this paragraph (f)(2)(ii), if, in a 
transaction (or series of transactions) related to the domestic entity 
acquisition, the transferring corporation subsequently transfers less 
than all of the fungible stock, a pro rata portion of the stock 
subsequently transferred is treated as consisting of stock of the 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii). 
The pro rata portion is based, at the time of the subsequent transfer, 
on the relative fair

[[Page 20899]]

market value of the fungible stock that is stock of the foreign 
acquiring corporation described in section 7874(a)(2)(B)(ii) to the 
fair market value of all the fungible stock.
    (3) A transferring corporation means a corporation that is a former 
shareholder or former partner.
    (4) A U.S.-parented group means an affiliated group that has a 
domestic corporation as the common parent corporation. A member of the 
U.S.-parented group is an entity included in the U.S.-parented group, 
including the common parent corporation.
    (g) Examples. The following examples illustrate the application of 
this section.

    Example 1. U.S.-parented group exception not available--(i) 
Facts. USP, a domestic corporation wholly owned by Individual A, 
owns all the stock of DT, a domestic corporation, as well as other 
property. The DT stock does not represent substantially all of the 
property of USP for purposes of section 7874. Pursuant to a 
reorganization described in section 368(a)(1)(D), USP transfers all 
the DT stock to FA, a newly formed foreign corporation, in exchange 
for 100 shares of FA stock (DT acquisition) and distributes the FA 
stock to Individual A pursuant to section 361(c)(1).
    (ii) Analysis. The 100 FA shares received by USP are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5T(a), the shares retain their status as 
such even though USP subsequently distributes the shares to 
Individual A pursuant to section 361(c)(1). Thus, the 100 FA shares 
are included in the ownership fraction, unless the shares are 
treated as held by members of the EAG for purposes of applying 
section 7874(c)(2)(A) and Sec.  1.7874-1 and are excluded from the 
ownership fraction under those rules. For purposes of applying 
section 7874(c)(2)(A) and Sec.  1.7874-1, the 100 FA shares, which 
constitute transferred stock under paragraph (f)(2) of this section, 
are treated as held by members of the EAG only if an exception in 
paragraph (c) of this section applies. See paragraph (b) of this 
section. The U.S.-parented group exception described in paragraph 
(c)(1) of this section does not apply. Although before the DT 
acquisition, USP (the transferring corporation) is a member of a 
U.S.-parented group of which USP is the common parent, after the DT 
acquisition, and taking into account all transactions related to the 
acquisition, each of USP, Individual A (the person that holds the 
transferred stock), and FA (the foreign acquiring corporation) are 
not members of a U.S.-parented group described in paragraph 
(c)(1)(ii)(A) or (B) of this section. Accordingly, because the 100 
FA shares are not treated as held by members of the EAG, those 
shares are included in the numerator and the denominator of the 
ownership fraction. Therefore, the ownership fraction is 100/100.
    Example 2. U.S.-parented group exception available--(i) Facts. 
USP, a domestic corporation wholly owned by Individual A, owns all 
the stock of USS, a domestic corporation, and USS owns all the stock 
of FT, a foreign corporation. FT owns all the stock of DT, a 
domestic corporation. FT does not own any other property and has no 
liabilities. Pursuant to a reorganization described in section 
368(a)(1)(F), FT transfers all of its DT stock to FA, a newly formed 
foreign corporation, in exchange for 100 shares of FA stock (DT 
acquisition) and distributes the FA stock to USS in liquidation 
pursuant to section 361(c)(1). In a transaction after and related to 
the DT acquisition, USP sells 60 percent of the stock of USS (by 
vote and value) to Individual B.
    (ii) Analysis. The 100 FA shares received by FT are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5T(a), the shares retain their status as 
such even though FT subsequently distributes the shares to USS 
pursuant to section 361(c)(1). Thus, the 100 FA shares are included 
in the ownership fraction, unless the shares are treated as held by 
members of the EAG for purposes of applying section 7874(c)(2)(A) 
and Sec.  1.7874-1 and are excluded from the ownership fraction 
under those rules. For purposes of applying section 7874(c)(2)(A) 
and Sec.  1.7874-1, the 100 FA shares, which constitute transferred 
stock under paragraph (f)(2) of this section, are treated as held by 
members of the EAG only if an exception in paragraph (c) of this 
section applies. See paragraph (b) of this section. The U.S.-
parented group exception described in paragraph (c)(1) of this 
section applies. The requirement set forth in paragraph (c)(1)(i) of 
this section is satisfied because before the DT acquisition, FT (the 
transferring corporation) is a member of a U.S.-parented group of 
which USP is the common parent (the USP group). The requirement set 
forth in paragraph (c)(1)(ii) of this section is satisfied because 
after the DT acquisition, and taking into account all transactions 
related to the acquisition, each of FA (which is both the successor 
to FT, the transferring corporation, and the foreign acquiring 
corporation) and USS (the person that holds the transferred stock) 
are members of a U.S.-parented group of which USS (a member of the 
USP group before the DT acquisition) is the common parent. Moreover, 
the DT acquisition qualifies as an internal group restructuring 
under Sec.  1.7874-1(c)(2). The requirement set forth in Sec.  
1.7874-1(c)(2)(i) is satisfied because before the DT acquisition, 80 
percent or more of the stock (by vote and value) of DT was held 
directly or indirectly by USS (the corporation that after the 
acquisition, and taking into account all transactions related to the 
acquisition, is the common parent of the EAG). The requirement set 
forth in Sec.  1.7874-1(c)(2)(ii) is satisfied because after the 
acquisition, and taking into account all transactions related to the 
acquisition, 80 percent or more of the stock (by vote and value) of 
FA (the foreign acquiring corporation) is held directly or 
indirectly by USS. Therefore, the 100 FA shares are excluded from 
the numerator, but included in the denominator, of the ownership 
fraction. Accordingly, the ownership fraction is 0/100.
    Example 3. U.S.-parented group exception available--(i) Facts. 
USP, a domestic corporation wholly owned by Individual A, owns all 
the stock of USS, a domestic corporation, and USS owns all the stock 
of DT, also a domestic corporation. DT owns all the stock of FT, a 
foreign corporation. The FT stock represents substantially all of 
the property of DT for purposes of section 7874. Pursuant to a 
divisive reorganization described in section 368(a)(1)(D), DT 
transfers all the FT stock to FA, a newly formed foreign 
corporation, in exchange for 100 shares of FA stock (DT acquisition) 
and distributes the FA stock to USS pursuant to section 361(c)(1). 
In a related transaction, USS distributes all the FA stock to USP 
under section 355(c)(1). Lastly, in another related transaction and 
pursuant to a divisive reorganization described in section 
368(a)(1)(D), USP transfers all the stock of USS and FA to DP, a 
newly formed domestic corporation, in exchange for all the stock of 
DP and distributes the DP stock to Individual A pursuant to section 
361(c)(1).
    (ii) Analysis. The 100 FA shares received by USS are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5T(a), the shares retain their status as 
such even though USS subsequently transfers the shares to USP. Thus, 
the 100 FA shares are included in the ownership fraction, unless the 
shares are treated as held by members of the EAG for purposes of 
applying section 7874(c)(2)(A) and Sec.  1.7874-1 and are excluded 
from the ownership fraction under those rules. For purposes of 
applying section 7874(c)(2)(A) and Sec.  1.7874-1, the 100 FA 
shares, which constitute transferred stock under paragraph (f)(2) of 
this section, are treated as held by members of the EAG only if an 
exception in paragraph (c) of this section applies. See paragraph 
(b) of this section. The U.S.-parented group exception described in 
paragraph (c)(1) of this section applies. The requirement set forth 
in paragraph (c)(1)(i) of this section is satisfied because before 
the DT acquisition, USS (the transferring corporation) is a member 
of a U.S.-parented group of which USP is the common parent (the USP 
group). The requirement set forth in paragraph (c)(1)(ii) of this 
section is satisfied because after the DT acquisition, and taking 
into account all transactions related to the acquisition, each of 
USS, DP (the person that holds the transferred stock), and FA (the 
foreign acquiring corporation) are members of a U.S.-parented group 
of which DP (a corporation that was formed in a transaction related 
to the DT acquisition and that, immediately after it was formed (but 
without regard to any related transactions) was a member of the USP 
group) is the common parent. Therefore, the 100 FA shares are 
excluded from the numerator and the denominator of the ownership 
fraction. Accordingly, the ownership fraction is 0/0.
    Example 4. Foreign-parented group exception--(i) Facts. 
Individual A owns all the stock of FT, a foreign corporation, and FT 
owns all the stock of DT, a domestic corporation. FT does not own 
any other property and has no liabilities. Pursuant to a 
reorganization described in section 368(a)(1)(F), FT transfers all 
the stock of DT to FA, a newly formed foreign corporation, in

[[Page 20900]]

exchange for 100 shares of FA stock (DT acquisition) and distributes 
the FA stock to Individual A in liquidation pursuant to section 
361(c)(1).
    (ii) Analysis. The 100 FA shares received by FT are stock of a 
foreign acquiring corporation described in section 7874(a)(2)(B)(ii) 
and, under Sec.  1.7874-5T(a), the shares retain their status as 
such even though FT subsequently distributes the shares to 
Individual A pursuant to section 361(c)(1). Thus, the 100 FA shares 
are included in the ownership fraction, unless the shares are 
treated as held by members of the EAG of purposes of applying 
section 7874(a)(2)(A) and Sec.  1.7874-1 and are excluded from the 
ownership fraction under those rules. For purposes of applying 
section 7874(c)(2)(A) and Sec.  1.7874-1, the 100 FA shares, which 
constitute transferred stock under paragraph (f)(2) of this section, 
are treated as held by members of the EAG only if an exception in 
paragraph (c) of this section applies. See paragraph (b) of this 
section. The foreign-parented group exception described in paragraph 
(c)(2) of this section applies. The requirement set forth in 
paragraph (c)(2)(i) of this section is satisfied because before the 
DT acquisition, FT (the transferring corporation) and DT are members 
of the foreign-parented group of which FT is the common parent. The 
requirement set forth in paragraph (c)(2)(ii) of this section is 
satisfied because after the acquisition, and taking into account all 
transactions related to the acquisition, FT would be a member of the 
EAG absent the distribution of the FA shares pursuant to section 
361(c)(1). Moreover, the DT acquisition qualifies as an internal 
group restructuring under Sec.  1.7874-1(c)(2). The requirement set 
forth in Sec.  1.7874-1(c)(2)(i) is satisfied because before the 
acquisition, 80 percent or more of the stock (by vote and value) of 
DT was held directly or indirectly by FT, the corporation that, 
without regard to the distribution of the FA shares pursuant to 
section 361(c)(1), would be common parent of the EAG after the 
acquisition. See Sec.  1.7874-1T(c)(2)(iii). The requirement set 
forth in Sec.  1.7874-1(c)(2)(ii) is satisfied because after the 
acquisition, but without regard to the distribution of the FA shares 
pursuant to the section 361(c)(1) distribution, FT would directly or 
indirectly hold 80 percent or more of the stock (by vote and value) 
of FA (the foreign acquiring corporation). See Sec.  1.7874-
1T(c)(2)(iii). Therefore, the 100 FA shares are excluded from the 
numerator, but included in the denominator, of the ownership 
fraction. Accordingly, the ownership fraction is 0/100.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this Example 4, except that in a transaction after and 
related to the DT acquisition, FA issues 200 shares of FA stock to 
Individual B in exchange for qualified property (within the meaning 
of Sec.  1.7874-4T(i)(7)). The foreign-parented group exception does 
not apply because after the acquisition, and taking into account 
FA's issuance of the 200 FA shares to Individual B, FT would not be 
a member of the EAG absent FT's distribution of the 100 FA shares 
pursuant to section 361(c)(1). Accordingly, the 100 FA shares 
received by FT are not treated as held by a member of the EAG for 
purposes of applying section 7874(c)(2)(A) and Sec.  1.7874-1. As a 
result, the ownership fraction is 100/300.

    (h) Applicability dates. Except as otherwise provided in this 
paragraph (h), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. Paragraphs (d)(2) and 
(f)(2)(ii) of this section apply to domestic entity acquisitions 
completed on or after April 4, 2016. Taxpayers, however, may elect 
either to apply paragraph (c)(2) of this section to domestic entity 
acquisitions completed before September 22, 2014, or to consistently 
apply paragraphs (c)(2), (d)(2), and (f)(2)(ii) of this section and 
Sec.  1.7874-1(c)(2)(iii) and (f) to domestic entity acquisitions 
completed before April 4, 2016.
    (i) Expiration date. This section expires on April 4, 2019.

0
Par. 19. Section 1.7874-7T is added to read as follows:


Sec.  1.7874-7T  Disregard of certain stock attributable to passive 
assets (temporary).

    (a) Scope. This section identifies certain stock of a foreign 
acquiring corporation that is attributable to passive assets and that 
is disregarded in determining the ownership fraction. Paragraph (b) of 
this section sets forth the general rule regarding when stock of a 
foreign acquiring corporation is excluded from the denominator of the 
ownership fraction under this section. Paragraph (c) of this section 
provides a de minimis exception to the application of the general rule 
of paragraph (b) of this section. Paragraph (d) of this section 
provides rules for the treatment of partnerships, and paragraph (e) of 
this section provides rules addressing the interaction of this section 
with the expanded affiliated group rules of section 7874(c)(2)(A) and 
Sec.  1.7874-1. Paragraph (f) of this section provides definitions. 
Paragraph (g) of this section provides examples illustrating the 
application of the rules of this section. Paragraph (h) of this section 
provides dates of applicability, and paragraph (i) of this section 
provides the date of expiration.
    (b) General rule. If, on the completion date, more than fifty 
percent of the gross value of all foreign group property constitutes 
foreign group nonqualified property, then stock of the foreign 
acquiring corporation is excluded from the denominator of the ownership 
fraction in an amount equal to the product of--
    (1) The value of the stock of the foreign acquiring corporation, 
other than stock that is described in section 7874(a)(2)(B)(ii) and 
stock that is excluded from the denominator of the ownership fraction 
under either Sec.  1.7874-1(b) or Sec.  1.7874-4T(b); and
    (2) The foreign group nonqualified property fraction.
    (c) De minimis ownership. Paragraph (b) of this section does not 
apply if--
    (1) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-4T(b) and 1.7874-
10T(b), is less than five (by vote and value); and
    (2) On the completion date, former domestic entity shareholders or 
former domestic entity partners, as applicable, in the aggregate, own 
(applying the attribution rules of section 318(a) with the 
modifications described in section 304(c)(3)(B)) less than five percent 
(by vote and value) of the stock of (or a partnership interest in) each 
member of the expanded affiliated group.
    (d) Treatment of partnerships. For purposes of this section, if one 
or more members of the modified expanded affiliated group own, in the 
aggregate, more than 50 percent (by value) of the interests in a 
partnership, the partnership is treated as a corporation that is a 
member of the modified expanded affiliated group.
    (e) Interaction with expanded affiliated group rules. Stock that is 
excluded from the denominator of the ownership fraction pursuant to 
paragraph (b) of this section is taken into account for purposes of 
determining whether an entity is a member of the expanded affiliated 
group for purposes of applying section 7874(c)(2)(A) and determining 
whether an acquisition qualifies as an internal group restructuring or 
results in a loss of control, as described in Sec.  1.7874-1(c)(2) and 
(3), respectively. However, such stock is excluded from the denominator 
of the ownership fraction for purposes of section 7874(a)(2)(B)(ii) 
regardless of whether it would otherwise be included in the denominator 
of the ownership fraction as a result of the application of Sec.  
1.7874-1(c).
    (f) Definitions. In addition to the definitions provided in Sec.  
1.7874-12T, the following definitions apply for purposes of this 
section.
    (1) Foreign group nonqualified property--(i) General rule. Foreign 
group nonqualified property means foreign group property described in 
Sec.  1.7874-4T(i)(7), other than the following:
    (A) Property that gives rise to income described in section 954(h), 
determined--

[[Page 20901]]

    (1) In the case of property held by a foreign corporation, by 
substituting the term ``foreign corporation'' for the term ``controlled 
foreign corporation;'' and
    (2) In the case of property held by a domestic corporation, by 
substituting the term ``domestic corporation'' for the term 
``controlled foreign corporation,'' without regard to the phrase 
``other than the United States'' in section 954(h)(3)(A)(ii)(I), and 
without regard to any inference that the tests in section 954(h) should 
be calculated or determined without taking transactions with customers 
located in the United States into account.
    (B) Property that gives rise to income described in section 954(i), 
determined by substituting the term ``foreign corporation'' for the 
term ``controlled foreign corporation.''
    (C) Property that gives rise to income described in section 
1297(b)(2)(A) or (B).
    (D) Property held by a domestic corporation that is subject to tax 
as an insurance company under subchapter L of chapter 1 of subtitle A 
of the Internal Revenue Code, provided that the property is required to 
support, or is substantially related to, the active conduct of an 
insurance business.
    (ii) Special rule. Foreign group nonqualified property also means 
any foreign group property that, in a transaction related to the 
acquisition, is acquired in exchange for other property, including 
cash, if such other property would be described in paragraph (f)(1)(i) 
of this section had the transaction not occurred.
    (2) Foreign group property means any property (including property 
that gives rise to stock that is excluded from the ownership fraction 
under Sec.  1.7874-4T(b)) held on the completion date by the modified 
expanded affiliated group, other than--
    (i) Property that is directly or indirectly acquired in the 
domestic entity acquisition;
    (ii) Stock or a partnership interest in a member of the modified 
expanded affiliated group; and
    (iii) An obligation of a member of the modified expanded affiliated 
group.
    (3) Foreign group nonqualified property fraction means a fraction 
calculated with the following numerator and denominator:
    (i) The numerator of the fraction is the gross value of all foreign 
group nonqualified property, other than property received by the 
expanded affiliated group that gives rise to stock that is excluded 
from the ownership fraction under Sec.  1.7874-4T(b).
    (ii) The denominator of the fraction is the gross value of all 
foreign group property, other than property received by the expanded 
affiliated group that gives rise to stock that is excluded from the 
ownership fraction under Sec.  1.7874-4T(b).
    (4) Modified expanded affiliated group means, with respect to a 
domestic entity acquisition, the group described in either paragraph 
(f)(4)(i) of this section or paragraph (f)(4)(ii) of this section. A 
member of the modified expanded affiliated group is an entity included 
in the modified expanded affiliated group.
    (i) When the foreign acquiring corporation is not the common parent 
corporation of the expanded affiliated group, the expanded affiliated 
group determined as if the foreign acquiring corporation was the common 
parent corporation.
    (ii) When the foreign acquiring corporation is the common parent 
corporation of the expanded affiliated group, the expanded affiliated 
group.
    (g) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Application of general rule--(i) Facts. Individual A 
owns all 20 shares of the sole class of stock of FA, a foreign 
corporation. FA acquires all the stock of DT, a domestic 
corporation, solely in exchange for 76 shares of newly issued FA 
stock (DT acquisition). In a transaction related to the DT 
acquisition, FA issues 4 shares of stock to Individual A in exchange 
for Asset A, which has a gross value of $50x. On the completion 
date, in addition to the DT stock and Asset A, FA holds Asset B, 
which has a gross value of $150x, and Asset C, which has a gross 
value of $100x. Assets A and B, but not Asset C, are nonqualified 
property (within the meaning of Sec.  1.7874-4T(i)(7)). Further, 
Asset C was not acquired in a transaction related to the DT 
acquisition.
    (ii) Analysis. The 4 shares of FA stock issued to Individual A 
in exchange for Asset A are disqualified stock under Sec.  1.7874-
4T(c) and are excluded from the denominator of the ownership 
fraction pursuant to Sec.  1.7874-4T(b). Furthermore, additional 
shares of FA stock are excluded from the denominator of the 
ownership fraction pursuant to paragraph (b) of this section. This 
is because on the completion date, the gross value of all foreign 
group property is $300x (the sum of the gross values of Assets A, B, 
and C), the gross value of all foreign group nonqualified property 
is $200x (the sum of the gross values of Assets A and B), and thus 
66.67% of the gross value of all foreign group property constitutes 
foreign group nonqualified property ($200x/$300x). Because FA has 
only one class of stock outstanding, the shares of FA stock that are 
excluded from the denominator of the ownership fraction pursuant to 
paragraph (b) of this section are calculated by multiplying 20 
shares of FA stock (100 shares less the 76 shares described in 
section 7874(a)(2)(B)(ii) and the 4 shares of disqualified stock) by 
the foreign group nonqualified property fraction. The numerator of 
the foreign group nonqualified property fraction is $150x (the gross 
value of Asset B) and the denominator is $250x (the sum of the gross 
values of Assets B and C). Accordingly, 12 shares of FA stock are 
excluded from the denominator of the ownership fraction pursuant to 
paragraph (b) of this section (20 shares multiplied by $150x/$250x). 
Thus, a total of 16 shares are excluded from the denominator of the 
ownership fraction (4 + 12). As a result, the ownership fraction is 
76/84.
    Example 2. Application of de minimis exception--(i) Facts. 
Individual A owns all 96 shares of the sole class of stock of FA, a 
foreign corporation. Individual B wholly owns DT, a domestic 
corporation. Individuals A and B are not related. FA acquires all 
the stock of DT solely in exchange for 4 shares of newly issued FA 
stock (DT acquisition). On the completion date, in addition to all 
of the stock of DT, FA holds Asset A, which is nonqualified property 
(within the meaning of Sec.  1.7874-4T(i)(7)).
    (ii) Analysis. Without regard to the application of Sec.  
1.7874-4T(b) and paragraph (b) of this section, the ownership 
percentage described in section 7874(a)(2)(B)(ii) would be less than 
5 (by vote and value), or 4 (4/100, or 4 shares of FA stock held by 
Individual B by reason of owning the DT stock, determined under 
Sec.  1.7874-2(f)(2), over 100 shares of FA stock outstanding after 
the DT acquisition). Furthermore, on the completion date, Individual 
B owns less than 5% (by vote and value) of the stock of FA and DT 
(the members of the expanded affiliated group). Accordingly, the de 
minimis exception in paragraph (c) of this section applies. 
Therefore, paragraph (b) of this section does not apply and the 
ownership fraction is 4/100.
    Example 3. Foreign acquiring corporation not common parent of 
EAG--(i) Facts. FP, a foreign corporation, owns all 85 shares of the 
sole class of stock of FA, a foreign corporation. FA acquires all 
the stock of DT, a domestic corporation, solely in exchange for 65 
shares of newly issued FA stock (DT acquisition). On the completion 
date, FA, in addition to all of the stock of DT, owns Asset A, which 
has a gross value of $40x, and Asset B, which has a gross value of 
$45x. Moreover, on the completion date, in addition to the 85 shares 
of FA stock, FP owns Asset C, which has a gross value of $10x. 
Assets A and C, but not Asset B, are nonqualified property (within 
the meaning of Sec.  1.7874-4T(i)(7)). Further, Asset B was not 
acquired in a transaction related to the DT acquisition in exchange 
for nonqualified property.
    (ii) Analysis. Under paragraph (f)(2) of this section, Assets A 
and B, but not Asset C, are foreign group property. Although Asset C 
is held on the completion date by FP, a member of the expanded 
affiliated group, Asset C is not foreign group property because FP 
is not a member of the modified expanded affiliated group. This is 
the case because if the expanded affiliated group were determined 
based on FA as the common parent corporation, FP would not be a 
member of such expanded affiliated group (see paragraph (f)(4)(i) of 
this section). Under paragraph (f)(1) of this section, Asset A, but 
not Asset B, is foreign group nonqualified property. Therefore, on 
the completion date,

[[Page 20902]]

the gross value of all foreign group property is $85x (the sum of 
the gross values of Assets A and B), and the gross value of all 
foreign group nonqualified property is $40x (the gross value of 
Asset A). Accordingly, on the completion date, only 47.06% of the 
gross value of all foreign group property constitutes foreign group 
nonqualified property ($40x/$85x). Consequently, paragraph (b) of 
this section does not apply to exclude any FA stock from the 
denominator of the ownership fraction.

    (h) Applicability dates. Except as otherwise provided in this 
paragraph (h), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. Paragraphs (c), (d), and 
(f)(2) and (4) of this section apply to domestic entity acquisitions 
completed on or after April 4, 2016. Paragraphs (f)(1)(i)(A)(2) and 
(f)(1)(i)(D) of this section, as well as the portion of paragraph 
(f)(1)(i)(C) of this section relating to property that gives rise to 
income described in section 1297(b)(2)(B), apply to domestic entity 
acquisitions completed on or after November 19, 2015. For domestic 
entity acquisitions completed on or after September 22, 2014, and 
before April 4, 2016, however, taxpayers may elect to apply paragraphs 
(c), (d), and (f)(2) and (4) of this section. In addition, for domestic 
entity acquisitions completed on or after September 22, 2014, and 
before April 4, 2016, taxpayers may elect to apply paragraph (f)(2) of 
this section by substituting the term ``expanded affiliated group'' for 
the term ``modified expanded affiliated group.'' Furthermore, for 
domestic entity acquisitions completed on or after September 22, 2014, 
and before November 19, 2015, taxpayers may elect to apply paragraphs 
(f)(1)(i)(A)(2) and (f)(1)(i)(D) of this section, as well as the 
portion of paragraph (f)(1)(i)(C) of this section relating to property 
that gives rise to income described in section 1297(b)(2)(B).
    (i) Expiration date. The applicability of this section expires on 
April 4, 2019.

0
Par. 20. Section 1.7874-8T is added to read as follows:


Sec.  1.7874-8T  Disregard of certain stock attributable to multiple 
domestic entity acquisitions (temporary).

    (a) Scope. This section identifies stock of a foreign acquiring 
corporation that is disregarded in determining an ownership fraction by 
value because it is attributable to certain prior domestic entity 
acquisitions. Paragraph (b) of this section sets forth the general rule 
regarding the amount of stock of a foreign acquiring corporation that 
is excluded from the denominator of the ownership fraction by value 
under this section, and paragraphs (c) through (f) of this section 
provide rules for determining this amount. Paragraph (g) provides 
definitions. Paragraph (h) of this section provides examples 
illustrating the application of the rules of this section. Paragraph 
(i) of this section provides dates of applicability, and paragraph (j) 
of this section provides the date of expiration. This section applies 
after taking into account Sec.  1.7874-2(e).
    (b) General rule. This paragraph (b) applies to a domestic entity 
acquisition (relevant domestic entity acquisition) when the foreign 
acquiring corporation (including a predecessor) has completed one or 
more prior domestic entity acquisitions. When this paragraph (b) 
applies, then, for purposes of determining the ownership percentage by 
value (but not vote) described in section 7874(a)(2)(B)(ii), stock of 
the foreign acquiring corporation is excluded from the denominator of 
the ownership fraction in an amount equal to the sum of the excluded 
amounts computed separately with respect to each prior domestic entity 
acquisition and each relevant share class.
    (c) Computation of excluded amounts. With respect to each prior 
domestic entity acquisition and each relevant share class, the excluded 
amount is the product of--
    (1) The total number of prior acquisition shares, reduced by the 
sum of the number of allocable redeemed shares for all redemption 
testing periods; and
    (2) The fair market value of a single share of stock of the 
relevant share class on the completion date of the relevant domestic 
entity acquisition.
    (d) Computation of allocable redeemed shares--(1) In general. With 
respect to each prior domestic entity acquisition and each relevant 
share class, the allocable redeemed shares, determined separately for 
each redemption testing period, is the product of the number of 
redeemed shares during the redemption testing period and the redemption 
fraction.
    (2) Redemption fraction. The redemption fraction is determined 
separately with respect to each prior domestic entity acquisition, each 
relevant share class, and each redemption testing period, as follows:
    (i) The numerator is the total number of prior acquisition shares, 
reduced by the sum of the number of allocable redeemed shares for all 
prior redemption testing periods.
    (ii) The denominator is the sum of--
    (A) The number of outstanding shares of the foreign acquiring 
corporation stock as of the end of the last day of the redemption 
testing period; and
    (B) The number of redeemed shares during the redemption testing 
period.
    (e) Rules for determining redemption testing periods--(1) In 
general. Except as provided in paragraph (e)(2) of this section, a 
redemption testing period with respect to a prior domestic entity 
acquisition is the period beginning on the day after the completion 
date of the prior domestic entity acquisition and ending on the day 
prior to the completion date of the relevant domestic entity 
acquisition.
    (2) Election to use multiple redemption testing periods. A foreign 
acquiring corporation may establish a reasonable method for dividing 
the period described in paragraph (e)(1) of this section into shorter 
periods (each such shorter period, a redemption testing period). A 
reasonable method would include a method based on a calendar convention 
(for example, daily, monthly, quarterly, or yearly), or on a convention 
that triggers the start of a new redemption testing period whenever a 
share issuance occurs that exceeds a certain threshold. In order to be 
reasonable, the method must be consistently applied with respect to all 
prior domestic entity acquisitions and all relevant share classes.
    (f) Appropriate adjustments required to take into account share 
splits and similar transactions. For purposes of this section, 
appropriate adjustments must be made to take into account changes in a 
foreign acquiring corporation's capital structure, including, for 
example, stock splits, reverse stock splits, stock distributions, 
recapitalizations, and similar transactions. Thus, for example, in 
determining the total number of prior acquisition shares with respect 
to a relevant share class, appropriate adjustments must be made to take 
into account a stock split with respect to that relevant share class 
that occurs after the completion date with respect to a prior domestic 
entity acquisition.
    (g) Definitions. In addition to the definitions provided in Sec.  
1.7874-12T, the following definitions apply for purposes of this 
section.
    (1) A binding contract means an instrument enforceable under 
applicable law against the parties to the instrument. The presence of a 
condition outside the control of the parties (including, for example, 
regulatory agency approval) does not prevent an instrument from being a 
binding contract. Further, the fact that insubstantial terms remain to 
be negotiated by the parties to the contract, or that customary 
conditions remain to be satisfied, does not prevent an instrument from 
being a binding

[[Page 20903]]

contract. A tender offer that is subject to section 14(d) of the 
Securities and Exchange Act of 1934, (15 U.S.C. 78n(d)(1)), and 
Regulation 14D (17 CFR 240.14d-1 through 240.14d-103) and that is not 
pursuant to a binding contract, is treated as a binding contract made 
on the date of its announcement, notwithstanding that it may be 
modified by the offeror or that it is not enforceable against the 
offerees.
    (2) A relevant share class means, with respect to a prior domestic 
entity acquisition, each separate legal class of shares in the foreign 
acquiring corporation from which prior acquisition shares were issued. 
See also paragraph (f) of this section (requiring appropriate 
adjustments in certain cases).
    (3) Total number of prior acquisition shares means, with respect to 
a prior domestic entity acquisition and each relevant share class, the 
total number of shares of stock of the foreign acquiring corporation 
that were described in section 7874(a)(2)(B)(ii) as a result of that 
acquisition (without regard to whether the 60 percent test of section 
7874(a)(2)(B)(ii) was satisfied), adjusted as appropriate under 
paragraph (f) of this section.
    (4) A prior domestic entity acquisition--(i) General rule. Except 
as provided in this paragraph (g)(4), a prior domestic entity 
acquisition means, with respect to a relevant domestic entity 
acquisition, a domestic entity acquisition that occurred within the 36-
month period ending on the signing date of the relevant domestic entity 
acquisition.
    (ii) Exception. A domestic entity acquisition is not a prior 
domestic entity acquisition if--
    (A) The ownership percentage described in section 7874(a)(2)(B)(ii) 
with respect to the domestic entity acquisition was less than five (by 
vote and value); and
    (B) The fair market value of the stock of the foreign acquiring 
corporation that was described in section 7874(a)(2)(B)(ii) as a result 
of the domestic entity acquisition (without regard to whether the 60 
percent test of section 7874(a)(2)(B)(ii) was satisfied) did not exceed 
$50 million, as determined on the completion date with respect to the 
domestic entity acquisition.
    (5) A redeemed share means a share of stock in a relevant share 
class that was redeemed (within the meaning of section 317(b)).
    (6) A signing date means the first date on which the contract to 
effect the relevant domestic entity acquisition is a binding contract, 
or if another binding contract to effect a substantially similar 
acquisition was terminated with a principal purpose of avoiding section 
7874, the first date on which such other contract was a binding 
contract.
    (h) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Application of general rule--(i) Facts. Individual A 
wholly owns DT1, a domestic corporation. Individual B owns all 100 
shares of the sole class of stock of FA, a foreign corporation. In 
Year 1, FA acquires all the stock of DT1 solely in exchange for 100 
shares of newly issued FA stock (DT1 acquisition). On the completion 
date with respect to the DT1 acquisition, the fair market value of 
each share of FA stock is $1x. In Year 3, FA enters into a binding 
contract to acquire all the stock of DT2, a domestic corporation 
wholly owned by Individual C. Thereafter, FA acquires all the stock 
of DT2 solely in exchange for 150 shares of newly issued FA stock 
(DT2 acquisition). On the completion date with respect to the DT2 
acquisition, the fair market value of each share of FA stock is 
$1.50x. FA did not complete the DT1 acquisition and DT2 acquisition 
pursuant to a plan (or series of related transactions) for purposes 
of applying Sec.  1.7874-2(e). In addition, there have been no 
redemptions of FA stock subsequent to the DT1 acquisition.
    (ii) Analysis. The DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition) because the DT1 acquisition occurred 
within the 36-month period ending on the signing date with respect 
to the DT2 acquisition. Accordingly, paragraph (b) of this section 
applies to the DT2 acquisition. As a result, and because there were 
no redemptions of FA stock, the excluded amount is $150x (calculated 
as 100, the total number of prior acquisition shares, multiplied by 
$1.50x, the fair market value of a single class of FA stock on the 
completion date with respect to the DT2 acquisition). Accordingly, 
the numerator of the ownership fraction by value is $225x (the fair 
market value of the stock of FA that, with respect to the DT2 
acquisition, is described in section 7874(a)(2)(B)(ii)). In 
addition, the denominator of the ownership fraction is $375x 
(calculated as $525x, the fair market value of all shares of FA 
stock as of the completion date with respect to the DT2 acquisition, 
less $150x, the excluded amount). Therefore, the ownership 
percentage by value is 60.
    Example 2. Effect of certain redemptions--(i) Facts. The facts 
are the same as in paragraph (i) of Example 1 of this paragraph (h), 
except that in Year 2 FA redeems 50 shares of its stock (the Year 2 
redemption).
    (ii) Analysis. As is the case in paragraph (ii) of Example 1 of 
this paragraph (h), the DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition), and paragraph (b) of this section thus 
applies to the DT2 acquisition. Because of the Year 2 redemption, 
the allocable redeemed shares, and thus the redemption fraction, 
must be calculated. For this purpose, the redemption testing period 
is the period beginning on the day after the completion date with 
respect to the DT1 acquisition and ending on the day prior to the 
completion date with respect to the DT2 acquisition. The redemption 
fraction for the redemption testing period is thus 100/200, 
calculated as 100 (the total number of prior acquisition shares) 
divided by 200 (150, the number of outstanding shares of FA stock on 
the last day of the redemption testing period, plus 50, the number 
of redeemed shares during the redemption testing period), and the 
allocable redeemed shares for the redemption testing period is 25, 
calculated as 50 (the number of redeemed shares during the 
redemption testing period) multiplied by 100/200 (the redemption 
fraction for the redemption testing period). As a result, the 
excluded amount is $112.50x, calculated as 75 (100, the total number 
of prior acquisition shares, less 25, the allocable redeemed shares) 
multiplied by $1.50x, the fair market value of a single share of FA 
stock on the completion date with respect to the DT2 acquisition). 
Accordingly, the numerator of the ownership fraction by value is 
$225x (the fair market value of the stock of FA that, with respect 
to the DT2 acquisition, is described in section 7874(a)(2)(B)(ii)), 
and the denominator of the ownership fraction is $337.50x 
(calculated as $450x, the fair market value of all shares of FA 
stock as of the completion date with respect to the DT2 acquisition, 
less $112.50x, the excluded amount). Therefore, the ownership 
percentage by value is 66.67.
    Example 3. Stock split--(i) Facts. The facts are the same as in 
paragraph (i) of Example 2 of this paragraph (h), except as follows. 
After the Year 2 redemption, but before the DT2 acquisition, FA 
undergoes a stock split and, as a result, each of the 150 shares of 
FA stock outstanding are converted into two shares (Year 2 stock 
split). Further, pursuant to the DT2 acquisition, FA acquires all 
the stock of DT2 solely in exchange for 300 shares of newly issued 
FA stock. Moreover, on the completion date with respect to the DT2 
acquisition, the fair market value of each share of FA stock is 
$0.75x.
    (ii) Analysis. As is the case in paragraph (ii) of Example 1 of 
this paragraph (h), the DT1 acquisition is a prior domestic entity 
acquisition with respect to the DT2 acquisition (the relevant 
domestic entity acquisition), and paragraph (b) of this section thus 
applies to the DT2 acquisition. In addition, as is the case in 
paragraph (ii) of Example 2 of this paragraph (h), the redemption 
testing period is the period beginning on the day after the 
completion date with respect to the DT1 acquisition and ending on 
the day prior to the completion date with respect to the DT2 
acquisition. To calculate the redemption fraction, the total number 
of prior acquisition shares and the number of redeemed shares during 
the redemption testing period must be appropriately adjusted to take 
into account the Year 2 stock split. See paragraph (f) of this 
section. In this case, the appropriate adjustment is to increase the 
total number of prior acquisition shares from 100 to 200 and to 
increase the number of redeemed shares during the redemption testing 
period from 50 to 100. Thus, the redemption fraction for the

[[Page 20904]]

redemption testing period is 200/400, calculated as 200 (the total 
number of prior acquisition shares) divided by 400 (300, the number 
of outstanding shares of FA stock on the last day of the redemption 
testing period, plus 100, the number of redeemed shares during the 
redemption testing period), and the allocable redeemed shares for 
the redemption testing period is 50, calculated as 100 (the number 
of redeemed shares during the redemption testing period) multiplied 
by 200/400 (the redemption fraction for the redemption testing 
period). In addition, for purposes of calculating the excluded 
amount, the total number of prior acquisition shares must be 
adjusted from 100 to 200. See paragraph (f) of this section. 
Accordingly, the excluded amount is $112.50x, calculated as 150 
(200, the total number of prior acquisition shares, less 50, the 
allocable redeemed shares) multiplied by $0.75x, the fair market 
value of a single class of FA stock on the completion date with 
respect to the DT2 acquisition). Consequently, the numerator of the 
ownership fraction by value is $225x (the fair market value of the 
stock of FA that, with respect to the DT2 acquisition, is described 
in section 7874(a)(2)(B)(ii)), and the denominator of the ownership 
fraction is $337.50x (calculated as $450x, the fair market value of 
all shares of FA stock as of the completion date with respect to the 
DT2 acquisition, less $112.50x, the excluded amount). Therefore, the 
ownership percentage by value is 66.67.

    (i) Applicability dates. This section applies to domestic entity 
acquisitions completed on or after April 4, 2016, regardless of when a 
prior domestic entity acquisition was completed.
    (j) Expiration date. The applicability of this section expires on 
April 4, 2019.

0
Par. 21. Section 1.7874-9T is added to read as follows:


Sec.  1.7874-9T  Disregard of certain stock in third-country 
transactions (temporary).

    (a) Scope. This section identifies certain stock of a foreign 
acquiring corporation that is disregarded in determining the ownership 
fraction. Paragraph (b) of this section provides a rule that, in a 
third-country transaction, excludes from the denominator of the 
ownership fraction stock in the foreign acquiring corporation held by 
former shareholders of an acquired foreign corporation by reason of 
holding certain stock in that foreign corporation. Paragraph (c) of 
this section defines a third-country transaction, and paragraph (d) of 
this section provides other definitions. Paragraph (e) of this section 
provides operating rules. Paragraph (f) of this section provides an 
example illustrating the application of the rules of this section. 
Paragraph (g) of this section provides the dates of applicability, and 
paragraph (h) of this section provides the date of expiration.
    (b) Exclusion of certain stock of a foreign acquiring corporation 
from the ownership fraction. When a domestic entity acquisition is a 
third-country transaction, stock of the foreign acquiring corporation 
held by reason of holding stock in the acquired foreign corporation 
(within the meaning of paragraph (e)(4) of this section) is, to the 
extent the stock otherwise would be included in the denominator of the 
ownership fraction, excluded from the denominator of the ownership 
fraction pursuant to this paragraph.
    (c) Third-country transaction. A domestic entity acquisition is a 
third-country transaction if the following requirements are satisfied:
    (1) The foreign acquiring corporation completes a covered foreign 
acquisition pursuant to a plan (or series of related transactions) that 
includes the domestic entity acquisition.
    (2) After the covered foreign acquisition and all related 
transactions are complete, the foreign acquiring corporation is not 
subject to tax as a resident in the foreign country in which the 
acquired foreign corporation was subject to tax as a resident before 
the covered foreign acquisition and all related transactions.
    (3) The ownership percentage, determined without regard to the 
application of paragraph (b) of this section, is at least 60.
    (d) Definitions. In addition to the definitions provided in Sec.  
1.7874-12T, the following definitions apply for purposes of this 
section.
    (1) A foreign acquisition means a transaction in which a foreign 
acquiring corporation directly or indirectly acquires substantially all 
of the properties held directly or indirectly by an acquired foreign 
corporation (within the meaning of paragraph (e)(2) of this section).
    (2) An acquired foreign corporation means a foreign corporation 
whose properties are acquired in a foreign acquisition.
    (3) Foreign ownership percentage means, with respect to a foreign 
acquisition, the percentage of stock (by vote or value) of the foreign 
acquiring corporation held by reason of holding stock in the acquired 
foreign corporation (within the meaning of paragraph (e)(3) of this 
section).
    (4) Covered foreign acquisition means a foreign acquisition in 
which, after the acquisition and all related transactions are complete, 
the foreign ownership percentage is at least 60.
    (e) Operating rules. The following rules apply for purposes of this 
section.
    (1) Acquisition of multiple foreign corporations that are tax 
residents of the same foreign country. When multiple foreign 
acquisitions occur pursuant to a plan (or series of related 
transactions) and two or more of the acquired foreign corporations were 
subject to tax as a resident of the same foreign country before the 
foreign acquisitions and all related transactions, then those foreign 
acquisitions are treated as a single foreign acquisition and those 
acquired foreign corporations are treated as a single acquired foreign 
corporation for purposes of this section.
    (2) Acquisition of properties of an acquired foreign corporation. 
For purposes of determining whether a foreign acquisition occurs, the 
principles of section 7874(a)(2)(B)(i) and Sec.  1.7874-2(c) and (d) 
(regarding acquisitions of properties of a domestic entity and 
acquisitions by multiple foreign corporations) apply with the following 
modifications:
    (i) The principles of Sec.  1.7874-2(c)(1) (providing rules for 
determining whether there is an indirect acquisition of properties of a 
domestic entity), including Sec.  1.7874-2(b)(5) (providing rules for 
determining the proportionate amount of properties indirectly 
acquired), apply by substituting the term ``foreign'' for ``domestic'' 
wherever it appears.
    (ii) The principles of Sec.  1.7874-2(c)(2) (regarding acquisitions 
of stock of a foreign corporation that owns a domestic entity) apply by 
substituting the term ``domestic'' for ``foreign'' wherever it appears.
    (3) Computation of foreign ownership percentage. For purposes of 
determining a foreign ownership percentage, the principles of all rules 
applicable to calculating an ownership percentage apply (including 
section 7874(c)(4) and Sec. Sec.  1.7874-2, 1.7874-2T, 1.7874-4T, 
1.7874-5T, and 1.7874-7T) with the following modifications:
    (i) Stock of a foreign acquiring corporation described in section 
7874(a)(2)(B)(ii) is not taken into account.
    (ii) The principles of this section, section 7874(c)(2)(A), and 
Sec. Sec.  1.7874-1, 1.7874-6T, 1.7874-8T, and 1.7874-10T do not apply.
    (iii) The principles of Sec.  1.7874-7T apply by, in addition to 
the exclusions listed in Sec.  1.7874-7T(f)(2)(i) through (iii), also 
excluding from the definition of foreign group property any property 
held directly or indirectly by the acquired foreign corporation 
immediately before the foreign acquisition and directly or indirectly 
acquired in the foreign acquisition.
    (4) Stock held by reason of holding stock in an acquired foreign 
corporation. For purposes of determining stock of a foreign acquiring 
corporation held by reason of holding

[[Page 20905]]

stock in an acquired foreign corporation, the principles of section 
7874(a)(2)(B)(ii) and Sec. Sec.  1.7874-2(f), 1.7874-2T(f), and 1.7874-
5T apply.
    (5) Change in the tax residency of a foreign corporation. For 
purposes of this section, a change in a country in which a foreign 
corporation is subject to tax as a resident is treated as a 
transaction. Thus, for example, a change in the location of the 
management and control of an acquired foreign corporation that results 
in a change in a country in which the acquired foreign corporation is 
subject to tax as a resident would be treated as a transaction.
    (f) Example. The following example illustrates the rules of this 
section.

    Example. Third-country transaction--(i) Facts. FA, a newly 
formed foreign corporation that is subject to tax as a resident of 
Country Y, acquires all the stock of DT, a domestic corporation that 
is wholly owned by Individual A, solely in exchange for 65 shares of 
newly issued FA stock (DT acquisition). Pursuant to a plan that 
includes the DT acquisition, FA acquires all the stock of FT, a 
foreign corporation that is subject to tax as a resident of Country 
X and wholly owned by Individual B, solely in exchange for the 
remaining 35 shares of newly issued FA stock (FT acquisition).
    (ii) Analysis. As described in paragraphs (A) through (C) of 
this Example, the requirements set forth in paragraphs (c)(1) 
through (3) of this section are satisfied and, as result, the DT 
acquisition is a third-country transaction.
    (A) The FT acquisition is a foreign acquisition because, 
pursuant to the FT acquisition, FA (a foreign corporation) acquires 
100 percent of the stock of FT and is thus treated as indirectly 
acquiring 100 percent of the properties held by FT (an acquired 
foreign corporation). See Sec.  1.7874-2(c)(1) and paragraph (e)(2) 
of this section. Moreover, Individual B is treated as receiving 35 
shares of FA stock by reason of holding stock in FT. See Sec.  
1.7874-2(f)(1)(i) and paragraph (e)(4) of this section. As a result, 
not taking into account the 65 shares of FA stock held by Individual 
A (a former domestic entity shareholder), 100 percent (35/35) of the 
stock of FA is held by reason of holding stock in FT and, thus, the 
foreign ownership percentage is 100. See paragraph (e)(3) of this 
section. Accordingly, the FT acquisition is a covered foreign 
acquisition. Therefore, because the FT acquisition occurs pursuant 
to a plan that includes the DT acquisition, the requirement set 
forth in paragraph (c)(1) of this section is satisfied.
    (B) The requirement set forth in paragraph (c)(2) of this 
section is satisfied because, after the FT acquisition and all 
related transactions, the foreign country in which FA is subject to 
tax as a resident (Country Y) is different than the foreign country 
in which FT was subject to tax as a resident (Country X) before the 
FT acquisition and all related transactions.
    (C) The requirement set forth in paragraph (c)(3) of this 
section is satisfied because, not taking into account paragraph (b) 
of this section, the ownership fraction is 65/100 and the ownership 
percentage is 65.
    (D) Because the DT acquisition is a third-country transaction, 
the 35 shares of FA stock held by reason of holding stock in FT are 
excluded from the denominator of the ownership fraction. See 
paragraph (b) of this section. As a result, the ownership fraction 
is 65/65 and the ownership percentage is 100. The result would be 
the same if instead FA had directly acquired all of the properties 
held by FT in exchange for FA stock, for example, in a transaction 
that would qualify for U.S. federal income tax purposes as an asset 
reorganization under section 368.
    (iii) Alternative facts. The facts are the same as in paragraph 
(i) of this example, except that before the FT acquisition, but in a 
transaction related to the FT acquisition, FT becomes subject to tax 
as a resident of Country Y by reincorporating in Country Y. As is 
the case in paragraph (ii) of this Example, the requirements set 
forth in paragraphs (c)(1) and (3) of this section are satisfied. 
The requirement set forth in paragraph (c)(2) of this section is 
satisfied because, after the FT acquisition and any related 
transactions, the foreign country of which FA is subject to tax as a 
resident (Country Y) is different than the foreign country of which 
FT was subject to tax as a resident (Country X) before the FT 
acquisition and the reincorporation. See paragraph (e)(5) of this 
section. Accordingly, the DT acquisition is a third-country 
transaction and the consequences are the same as in paragraph 
(ii)(D) of this Example.
    (iv) Alternative facts. The facts are the same as in paragraph 
(i) of this Example, except that, instead of FA acquiring all of the 
stock of FT, FS, a newly formed foreign corporation that is wholly 
owned by FA and that is subject to tax as a resident of Country X, 
acquires all the stock of FT solely in exchange for 35 shares of 
newly issued FA stock (FT acquisition). As a result of the FT 
acquisition, FS and FA are each treated as indirectly acquiring 100 
percent of the properties held by FT. See Sec.  1.7874-2(c)(1)(i) 
and (iii) and paragraph (e)(2) of this section. Accordingly, each of 
FS's and FA's indirect acquisition of properties of FT (an acquired 
foreign corporation) is a foreign acquisition. However, FS's 
indirect acquisition of FT's properties is not a covered foreign 
acquisition because no shares of FS stock are held by reason of 
holding stock in FT; thus, with respect to this foreign acquisition, 
the foreign ownership percentage is zero. See Sec.  1.7874-2(f) and 
paragraphs (e)(3) and (4) of this section. FA's indirect acquisition 
of FT's properties is a covered foreign acquisition because 35 
shares of FA stock (the shares received by Individual B) are held by 
reason of holding stock in FT; thus, the foreign ownership 
percentage is 100 percent (100/100). See Sec.  1.7874-2(f)(1)(i) and 
paragraphs (e)(3) and (4) of this section. Accordingly, because the 
FT acquisition occurs pursuant to a plan that includes the DT 
acquisition, the requirement set forth in paragraph (c)(1) of this 
section is satisfied. Further, as is the case in paragraphs (ii)(B) 
through (C) of this Example, the requirements set forth in 
paragraphs (c)(2) and (3) of this section are satisfied. Therefore, 
the DT acquisition is a third-country transaction and the 
consequences are the same as in paragraph (ii)(D) of this Example.

    (g) Applicability dates. Except as otherwise provided in this 
paragraph (g), this section applies to domestic entity acquisitions 
completed on or after November 19, 2015. For domestic entity 
acquisitions completed on or after November 19, 2015, and before April 
4, 2016, however, in lieu of applying paragraphs (d)(3) and (4) of this 
section, taxpayers may elect to define a covered foreign acquisition as 
a foreign acquisition in which the gross value of all property directly 
or indirectly acquired by the foreign acquiring corporation in the 
foreign acquisition exceeds 60 percent of the gross value of all 
foreign group property (as defined in Sec.  1.7874-7T(f)(2), but 
substituting the term ``expanded affiliated group'' for the term 
``modified expanded affiliated group''), but, for this purpose, gross 
value shall not include any property that is foreign group nonqualified 
property (as defined in Sec.  1.7874-7T(f)(1)). In addition, for 
domestic entity acquisitions completed on or after November 19, 2015, 
and before April 4, 2016, taxpayers may elect to substitute the 
requirement of paragraph (c)(2) of this section with the requirement 
that the tax residence of the foreign acquiring corporation is not the 
same as that of the acquired foreign corporation, as determined before 
the foreign acquisition and any related transaction.
    (h) Expiration date. The applicability of this section expires on 
April 4, 2019.

0
Par. 22. Section 1.7874-10T is added to read as follows:


Sec.  1.7874-10T  Disregard of certain distributions (temporary).

    (a) Scope. This section identifies distributions made by a domestic 
entity that are disregarded in determining an ownership fraction. 
Paragraph (b) of this section provides the general rule that former 
domestic entity shareholders or former domestic entity partners are 
treated as receiving additional stock of the foreign acquiring 
corporation when the domestic entity has made non-ordinary course 
distributions (NOCDs). Paragraph (c) of this section identifies 
distributions that, in whole or in part, are outside the scope of this 
section. Paragraph (d) of this section provides a de minimis exception 
to the application of the general rule in paragraph (b) of this 
section. Paragraph (e) of this section provides rules concerning the 
treatment of distributions made by a predecessor, and paragraph (f) of 
this section provides rules for identifying a predecessor. Paragraph 
(g) of this section provides a special rule for

[[Page 20906]]

certain distributions described in section 355. Paragraph (h) of this 
section provides definitions. Paragraph (i) of this section provides 
dates of applicability, and paragraph (j) of this section provides the 
date of expiration.
    (b) General rule regarding NOCDs. Except as provided in paragraph 
(d) of this section, for purposes of determining the ownership 
percentage by value (but not vote) described in section 
7874(a)(2)(B)(ii), former domestic entity shareholders or former 
domestic entity partners, as applicable, are treated as receiving, by 
reason of holding stock or partnership interests in a domestic entity, 
stock of the foreign acquiring corporation with a fair market value 
equal to the amount of the non-ordinary course distributions (NOCDs), 
determined as of the date of the distributions, made by the domestic 
entity during the look-back period. The stock of the foreign acquiring 
corporation treated as received under this paragraph (b) is in addition 
to stock of the foreign acquiring corporation otherwise treated as 
received by the former domestic entity shareholders or former domestic 
entity partners by reason of holding stock or partnership interests in 
the domestic entity.
    (c) Distributions that are not NOCDs. If only a portion of a 
distribution is an NOCD, section 7874(c)(4) may apply to the remainder 
of the distribution. This section does not, however, create a 
presumption that section 7874(c)(4) applies to the remainder of the 
distribution.
    (d) De minimis exception to the general rule. Paragraph (b) of this 
section does not apply if--
    (1) The ownership percentage described in section 
7874(a)(2)(B)(ii), determined without regard to the application of 
paragraph (b) of this section and Sec. Sec.  1.7874-4T(b) and 1.7874-
7T(b), is less than five (by vote and value); and
    (2) On the completion date, former domestic entity shareholders or 
former domestic entity partners, as applicable, in the aggregate, own 
(applying the attribution rules of section 318(a) with the 
modifications described in section 304(c)(3)(B)) less than five percent 
(by vote and value) of the stock of (or a partnership interest in) each 
member of the expanded affiliated group (within the meaning of Sec.  
1.7874-4T(i)(3)).
    (e) Treatment of distributions made by a predecessor. For purposes 
of this section, a corporation or a partnership (relevant entity), 
including a domestic entity, is treated as making the following 
distributions made by a predecessor with respect to the relevant 
entity:
    (1) A distribution made before the predecessor acquisition with 
respect to the predecessor; and
    (2) A distribution made in connection with the predecessor 
acquisition to the extent the property distributed is directly or 
indirectly provided by the predecessor. See paragraph (h)(1)(iv) of 
this section.
    (f) Rules for identifying a predecessor--(1) Definition of 
predecessor. A corporation or a partnership (tentative predecessor) is 
a predecessor with respect to a relevant entity if--
    (i) The relevant entity completes a predecessor acquisition; and
    (ii) After the predecessor acquisition and all related transactions 
are complete, the tentative predecessor ownership percentage is at 
least 10.
    (2) Definition of predecessor acquisition--(i) In general. 
Predecessor acquisition means a transaction in which a relevant entity 
directly or indirectly acquires substantially all of the properties 
held directly or indirectly by a tentative predecessor.
    (ii) Acquisition of properties of a tentative predecessor. For 
purposes of determining whether a predecessor acquisition occurs, the 
principles of section 7874(a)(2)(B)(i) apply, including Sec.  1.7874-
2(c) other than Sec.  1.7874-2(c)(2) and (4) (regarding acquisitions of 
properties of a domestic entity), without regard to whether the 
tentative predecessor is domestic or foreign.
    (iii) Lower-tier entities of a predecessor. If, before a 
predecessor acquisition and all related transactions, the predecessor 
held directly or indirectly stock in a corporation or an interest in a 
partnership, then, for purposes of this section, the relevant entity is 
not considered to directly or indirectly acquire the properties held 
directly or indirectly by the corporation or partnership.
    (3) Definition of tentative predecessor ownership percentage. 
Tentative predecessor ownership percentage means, with respect to a 
predecessor acquisition, the percentage of stock or partnership 
interests (by value) in a relevant entity held by reason of holding 
stock or partnership interests in the tentative predecessor. For 
purposes of computing the tentative predecessor ownership percentage, 
the following rules apply:
    (i) For purposes of determining the stock or partnership interests 
in a relevant entity held by reason of holding stock or partnership 
interests in the tentative predecessor, the principles of section 
7874(a)(2)(B)(ii) and Sec. Sec.  1.7874-2(f)(1)(i) through (iii) and 
1.7874-5T apply.
    (ii) For purposes of determining the stock or partnership interests 
in a relevant entity included in the numerator of the fraction used to 
compute the tentative predecessor ownership percentage, the rules of 
paragraph (f)(3)(i) of this section apply, and all the rules applicable 
to calculating the numerator of an ownership fraction with respect to a 
domestic entity acquisition apply, except that--
    (A) The principles of section 7874(c)(2)(A) and Sec. Sec.  1.7874-1 
and 1.7874-6T do not apply; and
    (B) The principles of paragraph (b) of this section do not apply.
    (iii) For purposes of determining stock or partnership interests in 
a relevant entity included in the denominator of the fraction used to 
compute the tentative predecessor ownership percentage, the principles 
of section 7874(a)(2)(B)(ii) and all rules applicable to calculating 
the denominator of an ownership fraction with respect to a domestic 
entity acquisition apply, except that--
    (A) The principles of section 7874(c)(2)(A) and Sec. Sec.  1.7874-1 
and 1.7874-6T do not apply; and
    (B) The principles of Sec. Sec.  1.7874-4T and 1.7874-7T through 
1.7874-9T do not apply.
    (g) Rule regarding direction of a section 355 distribution. For 
purposes of this section, if a domestic corporation (distributing 
corporation) distributes the stock of another domestic corporation 
(controlled corporation) pursuant to a transaction described in section 
355, and, immediately before the distribution, the fair market value of 
the stock of the controlled corporation represents more than 50 percent 
of the fair market value of the stock of the distributing corporation, 
then, the controlled corporation is deemed, on the date of the 
distribution, to have distributed the stock of the distributing 
corporation. The deemed distribution is equal to the fair market value 
of the stock of the distributing corporation (but not taking into 
account the fair market value of the stock of the controlled 
corporation) on the date of the distribution.
    (h) Definitions. In addition to the definitions provided in Sec.  
1.7874-12T, the following definitions apply for purposes of this 
section.
    (1) A distribution means the following:
    (i) Any distribution made by a corporation with respect to its 
stock other than--
    (A) A distribution to which section 305 applies;

[[Page 20907]]

    (B) A distribution to which section 304(a)(1) applies; and
    (C) Except as provided in paragraphs (h)(1)(iii) and (iv) of this 
section, a distribution pursuant to section 361(c)(1).
    (ii) Any distribution by a partnership.
    (iii) In the case of a domestic entity, a transfer of money or 
other property to the former domestic entity shareholders or former 
domestic entity partners that is made in connection with the domestic 
entity acquisition to the extent the money or other property is 
directly or indirectly provided by the domestic entity.
    (iv) In the case of a predecessor, a transfer of money or other 
property to the former owners of the predecessor that is made in 
connection with the predecessor acquisition to the extent the money or 
other property is directly or indirectly provided by the predecessor.
    (2) Distribution history period--(i) In general. Except as provided 
in paragraph (h)(2)(ii) or (iii) of this section, a distribution 
history period means, with respect to a look-back year, the 36-month 
period preceding the start of the look-back year.
    (ii) Formation date less than 36 months but at least 12 months 
before look-back year. If the formation date is less than 36 months, 
but at least 12 months, before the start of a look-back year, then the 
distribution history period with respect to that look-back year means 
the entire period, starting with the formation date, that precedes the 
start of the look-back year.
    (iii) Formation date less than 12 months before look-back year. If 
the formation date is less than 12 months before the start of a look-
back year, then there is no distribution history period with respect to 
that look-back year.
    (3) Formation date means, with respect to a domestic entity, the 
date that the domestic entity was created or organized, or, if earlier, 
the earliest date that any predecessor of the domestic entity was 
created or organized.
    (4) Look-back period means, with respect to a domestic acquisition, 
the 36-month period ending on the completion date or, if shorter, the 
entire period, starting with the formation date, that ends on the 
completion date.
    (5) Look-back year means, with respect to a look-back period, the 
following:
    (i) If the look-back period is 36 months, the three consecutive 12-
month periods that comprise the look-back period.
    (ii) If the look-back period is less than 36 months, but at least 
24 months--
    (A) The 12-month period that ends on the completion date;
    (B) The 12-month period that immediately precedes the period 
described in paragraph (h)(5)(ii)(A) of this section; and
    (C) The period, if any, that immediately precedes the period 
described in paragraph (h)(5)(ii)(B) of this section.
    (iii) If the look-back period is less than 24 months, but at least 
12 months--
    (A) The 12-month period that ends on the completion date; and
    (B) The period, if any, that immediately precedes the period 
described in paragraph (h)(5)(iii)(A) of this section.
    (iv) If the look-back period is less than 12 months, the entire 
period, starting with the formation date, that ends on the completion 
date.
    (6) NOCDs mean, with respect to a look-back year, the excess of all 
distributions made during the look-back year over the NOCD threshold 
for the look-back year.
    (7) NOCD threshold means, with respect to a look-back year, the 
following:
    (i) If the look-back year has at least a 12-month distribution 
history period, 110 percent of the sum of all distributions made during 
the distribution history period multiplied by a fraction. The numerator 
of the fraction is the number of days in the look-back year and the 
denominator is the number of days in the distribution history period 
with respect to the look-back year.
    (ii) If the look-back year has no distribution history period, 
zero.
    (i) Applicability date. Except as otherwise provided in this 
paragraph (i), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. Paragraph (d) of this section 
applies to domestic entity acquisitions completed on or after November 
19, 2015. Paragraph (g) of this section applies to domestic entity 
acquisitions completed on or after April 4, 2016. For domestic entity 
acquisitions completed on or after September 22, 2014, and before 
November 19, 2015, however, taxpayers may elect to apply paragraph (d) 
of this section. In addition, for domestic entity acquisitions 
completed on or after September 22, 2014, and before April 4, 2016, 
taxpayers may elect to determine NOCDs consistently on the basis of 
taxable years, in lieu of 12-month periods, in a manner consistent with 
the principles of this section. See paragraph (h)(5) of this section.
    (j) Expiration date. This section expires on April 4, 2019.

0
Par. 23. Section 1.7874-11T is added to read as follows:


Sec.  1.7874-11T  Rules regarding inversion gain (temporary).

    (a) Scope. This section provides rules for determining the 
inversion gain of an expatriated entity for purposes of section 7874. 
Paragraph (b) of this section provides rules for determining the 
inversion gain of an expatriated entity. Paragraph (c) of this section 
provides special rules with respect to certain foreign partnerships in 
which an expatriated entity owns an interest. Paragraph (d) of this 
section provides additional definitions. Paragraph (e) of this section 
provides an example that illustrates the rules of this section. 
Paragraph (f) of this section provides the applicability dates, and 
paragraph (g) of this section provides the date of expiration.
    (b) Inversion gain--(1) General rule. Except as provided in 
paragraphs (b)(2) and (3) of this section, inversion gain includes 
income (including an amount treated as a dividend under section 78) or 
gain recognized by an expatriated entity for any taxable year that 
includes any portion of the applicable period by reason of a direct or 
indirect transfer of stock or other properties or license of any 
property either as part of the acquisition described in section 
7874(a)(2)(B)(i), or after such acquisition if the transfer or license 
is to a specified related person.
    (2) Exception for property described in section 1221(a)(1). 
Inversion gain does not include income or gain recognized by reason of 
the transfer or license, after the acquisition, of property that is 
described in section 1221(a)(1) in the hands of the transferor or 
licensor.
    (3) Treatment of partnerships. Except to the extent provided in 
paragraph (c) of this section and section 7874(e)(2), inversion gain 
does not include income or gain recognized by reason of the transfer or 
license of property by a partnership.
    (c) Transfers and licenses by partnerships. If a partnership that 
is a foreign related person transfers or licenses property, a partner 
of the partnership shall be treated as having transferred or licensed 
its proportionate share of that property, as determined under the rules 
and principles of sections 701 through 777, for purposes of determining 
the inversion gain of an expatriated entity. See section 7874(e)(2) for 
rules regarding the treatment of transfers and licenses by domestic 
partnerships and transfers of interests in certain domestic 
partnerships.

[[Page 20908]]

    (d) Definitions. The definitions provided in Sec.  1.7874-12T apply 
for purposes of this section.
    (e) Example. The following example illustrates the rules of this 
section.

    Example --(i) Facts. On July 1, 2016, FA, a foreign corporation, 
acquires all the stock of DT, a domestic corporation, in an 
inversion transaction. When the inversion transaction occurred, DT 
wholly owned FS, a foreign corporation that is a controlled foreign 
corporation (within the meaning of section 957(a)). During the 
applicable period, FS sells to FA property that is not described in 
section 1221(a)(1) in the hands of FS. Under section 951(a)(1)(A), 
DT has a $80x gross income inclusion that is attributable to FS's 
gain from the sale of the property. Under section 960(a)(1), DT is 
deemed to have paid $20x of the post-1986 foreign income taxes of FS 
by reason of this income inclusion and includes $20x in gross income 
as a deemed dividend under section 78. Accordingly, DT recognizes 
$100x ($80x + $20x) of gross income because of FS's sale of property 
to FA.
    (ii) Analysis. Pursuant to section 7874(a)(2)(A), DT is an 
expatriated entity. Under paragraph (b)(1) of this section, DT's 
$100x gross income recognized under sections 951(a)(1)(A) and 78 is 
inversion gain, because it is income recognized by an expatriated 
entity during the applicable period by reason of an indirect 
transfer of property by DT (through its wholly-owned CFC, FS) after 
the inversion transaction to a specified related person (FA). 
Sections 7874(a)(1) and (e) therefore prevent the use of certain tax 
attributes (such as net operating losses) to reduce the U.S. tax 
owed with respect to DT's $100x gross income recognized under 
sections 951(a)(1)(A) and 78.

    (f) Applicability dates. Except as otherwise provided in this 
paragraph (f), this section applies to transfers and licenses of 
property completed on or after November 19, 2015, but only if the 
inversion transaction was completed on or after September 22, 2014. For 
inversion transactions completed on or after September 22, 2014, 
however, taxpayers may elect to apply paragraph (b) of this section by 
excluding the phrase ``(including an amount treated as a dividend under 
section 78)'' for transfers and licenses of property completed on or 
after November 19, 2015, and before April 4, 2016.
    (g) Expiration date. This section expires on April 4, 2019.

0
Par. 24. Section 1.7874-12T is added to read as follows:


Sec.  1.7874-12T  Definitions (temporary).

    (a) Definitions. Except as otherwise provided, the following 
definitions apply for purposes of Sec. Sec.  1.367(b)-4T, 1.956-2T, 
1.7701(l)-4T, 1.7874-2, 1.7874-2T, and 1.7874-6T through 1.7874-11T.
    (1) An affiliated group has the meaning set forth in section 
1504(a) but without regard to section 1504(b)(3), except that section 
1504(a) is applied by substituting ``more than 50 percent'' for ``at 
least 80 percent'' each place it appears. A member of the affiliated 
group is an entity included in the affiliated group.
    (2) The applicable period means, with respect to an inversion 
transaction, the period described in section 7874(d)(1). However, see 
also Sec.  1.7874-2T(b)(13) in the case of a subsequent acquisition (or 
a similar acquisition under the principles of Sec.  1.7874-2T(c)(4)(i)) 
that is an inversion transaction.
    (3) The completion date means, with respect to a domestic entity 
acquisition, the date that the domestic entity acquisition and all 
transactions related to the domestic entity acquisition are complete.
    (4) A controlled foreign corporation (or CFC) has the meaning 
provided in section 957.
    (5) A domestic entity acquisition means an acquisition described in 
section 7874(a)(2)(B)(i).
    (6) A domestic entity means, with respect to a domestic entity 
acquisition, a domestic corporation or domestic partnership described 
in section 7874(a)(2)(B)(i). A reference to a domestic entity includes 
a successor to such domestic corporation or domestic partnership, 
including a corporation that succeeds to and takes into account amounts 
with respect to the domestic entity pursuant to section 381.
    (7) An expanded affiliated group (or EAG) means, with respect to a 
domestic entity acquisition, an affiliated group that includes the 
foreign acquiring corporation, determined as of the completion date. A 
member of the EAG is an entity included in the EAG.
    (8) An expatriated entity means, with respect to an inversion 
transaction--
    (i) The domestic entity; and
    (ii) A United States person that, on any date on or after the 
completion date, is or was related (within the meaning of section 
267(b) or 707(b)(1)) to the domestic entity.
    (9) Expatriated foreign subsidiary--(i) General rule. Except as 
provided in paragraph (a)(9)(ii) of this section, an expatriated 
foreign subsidiary means a foreign corporation that is a CFC and in 
which an expatriated entity is a United States shareholder.
    (ii) Exception to the general rule. A foreign corporation is not an 
expatriated foreign subsidiary if, with respect to the inversion 
transaction as a result of which the foreign corporation otherwise 
would be an expatriated foreign subsidiary--
    (A) On the completion date, the foreign corporation was both a CFC 
and a member of the EAG; and
    (B) On or before the completion date, the domestic entity was not a 
United States shareholder with respect to the foreign corporation.
    (10) A foreign acquiring corporation means, with respect to a 
domestic entity acquisition, the foreign corporation described in 
section 7874(a)(2)(B). A reference to a foreign acquiring corporation 
includes a successor to the foreign acquiring corporation, including a 
corporation that succeeds to and takes into account amounts with 
respect to the foreign acquiring corporation pursuant to section 381.
    (11) A foreign related person means, with respect to an inversion 
transaction, a foreign person that is related (within the meaning of 
section 267(b) or 707(b)(1)) to, or under the same common control as 
(within the meaning of section 482), a person that is an expatriated 
entity with respect to the inversion transaction.
    (12) A former domestic entity partner of a domestic entity that is 
a domestic partnership is any person that held an interest in the 
partnership before the domestic entity acquisition, including any 
person that holds an interest in the partnership both before and after 
the domestic entity acquisition.
    (13) A former domestic entity shareholder of a domestic entity that 
is a domestic corporation is any person that held stock in the domestic 
corporation before the domestic entity acquisition, including any 
person that holds stock in the domestic corporation both before and 
after the domestic entity acquisition.
    (14) An interest in a partnership includes a capital or profits 
interest.
    (15) An inversion transaction means a domestic entity acquisition 
in which the foreign acquiring corporation is treated as a surrogate 
foreign corporation under section 7874(a)(2)(B), taking into account 
section 7874(a)(3).
    (16) A non-CFC foreign related person means, with respect to an 
inversion transaction, a foreign related person that is not an 
expatriated foreign subsidiary.
    (17) The ownership fraction means, with respect to a domestic 
entity acquisition, the ownership percentage described in section 
7874(a)(2)(B)(ii), expressed as a fraction.
    (18) A specified related person means, with respect to an inversion 
transaction--
    (i) A non-CFC foreign related person;
    (ii) A domestic partnership in which a non-CFC foreign related 
person is a partner; and

[[Page 20909]]

    (iii) A domestic trust of which a non-CFC foreign related person is 
a beneficiary.
    (19) A United States person means a person described in section 
7701(a)(30).
    (20) A United States shareholder has the meaning provided in 
section 951(b).
    (b) Applicability dates. Except as otherwise provided in this 
paragraph (b), this section applies to domestic entity acquisitions 
completed on or after September 22, 2014. Paragraph (a)(8) of this 
section; the phrase ``, including a corporation that succeeds to and 
takes into account amounts with respect to the domestic entity pursuant 
to section 381'' in paragraph (a)(6) of this section; and the second 
sentence of paragraph (a)(10) of this section apply to domestic entity 
acquisitions completed on or after April 4, 2016. For domestic entity 
acquisitions completed on or after September 22, 2014, and before April 
4, 2016, however, taxpayers, may elect to apply paragraph (a)(8) of 
this section; the phrase ``, including a corporation that succeeds to 
and takes into account amounts with respect to the domestic entity 
pursuant to section 381'' in paragraph (a)(6) of this section; and the 
second sentence of paragraph (a)(10) of this section.
    (c) Expiration date. This section expires on April 4, 2019.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: March 25, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-07300 Filed 4-4-16; 5:00 pm]
BILLING CODE 4830-01-P