SERVICE PROVIDES GUIDANCE ON REINCORPORATION OF DUAL RESIDENT COMPANY IN A FOREIGN COUNTRY TO ISOLATE 'DUAL CONSOLIDATED LOSS.'

Rev. Rul. 87-27

ISSUE

What are the federal income tax consequences of a reincorporation of a United States corporation into a United Kingdom corporation under the following circumstances?

FACTS

Corporation X, a domestic corporation, is a wholly owned subsidiary of Corporation W, also a domestic corporation. X was formed solely to hold 100 percent of the stock of a Corporation Y, a domestic corporation, which was formed solely to hold 100 percent of the stock of Corporation Z, a United Kingdom corporation. At least fifty percent of the assets of Z are used in a trade or business and are located in the United Kingdom. In order to fund the purchase of the Z stock, X borrowed cash from an unrelated bank (Bank 1). X then contributed the borrowed cash to Y so that Y could purchase the stock of Z. X incurred additional indebtedness to another bank (Bank 2) in order to pay the interest on its original obligation to Bank 1. X has incurred net operating losses every year since its incorporation. X and Y file a consolidated United States federal income tax return on a calendar year basis with W and other members of the W affiliated group. W has an excess loss account in the X stock as defined in section 1.1502-32 of the Income Tax Regulations. Y has had no income or deductions and X does not have an excess loss account in the stock of Y. There have been no deferred intercompany transactions as defined in section 1.1502-13(a)(2) involving X or Y.

At all times since incorporation, X and Y have been managed and controlled in the United Kingdom. Under the income tax laws of the United Kingdom, X and Y are treated as residents, and are entitled to "group relief" with Z and other commonly owned United Kingdom resident corporations. Under United Kingdom group relief provisions, a United Kingdom resident corporation may "surrender" its losses to other commonly owned United Kingdom resident corporations thereby reducing or eliminating the income of the other United Kingdom resident corporations. For its taxable years beginning prior to January 1, 1987, X's net operating losses were applied against income from other members of the affiliated group in the W consolidated returns. X also surrendered losses to other members of the United Kingdom group for use in United Kingdom group relief.

For the taxable years of X and Y beginning after December 31, 1986, the net operating losses of X or Y are "dual consolidated losses" as defined by section 1503(d)(2) of the Internal Revenue Code, and, as provided by section 1503(d)(1), shell not be allowed to reduce the United States taxable income of any other member of the W affiliated group. The United Kingdom has recently proposed legislation effective April 1, 1987, which would also prohibit the surrender of a X or Y net operating loss to Z or any other member of the United Kingdom group. The combined effect of the two countries' statutes would be to deny the use of a X or Y loss to both the United States affiliated group and the United Kingdom group.

X has decided to consolidate its place of incorporation with its place of management and control in order to achieve a more efficient administration of the corporation. Therefore, X will reincorporate in the United Kingdom. Pursuant to the plan of reorganization, Y will liquidate into X in a nonrecognition exchange pursuant to section 332 of the Code. W will contribute cash to X, as a capital contribution, so X can satisfy its obligation to Bank 2. The capital contribution will be equal to W's excess loss account in the X stock. As a result of the capital contribution, the excess lose account will be reduced to zero. W will then transfer the stock of X as the initial capitalization of the newly organized United Kingdom corporation (Newco), 100 percent of the stock of which will be owned by W. Immediately after the contribution of the stock of X to Newco, X will transfer all of its assets and liabilities to Newco and liquidate. For United States tax purposes, stock of Newco is treated as transferred by Newco to X (in exchange for X's assets and liabilities) and distributed to W in liquidation of X. The effect of the transaction is to transfer all assets and liabilities of X to a United Kingdom corporation without a change in shareholder or shareholder proprietary interest. Newco will be the surviving corporation and will be engaged in the same business as X. If the excess loss account is not completely reduced by the contribution to capital, as described above, or if no contribution to capital is made, W could elect to apply all or part of its excess loss account to reduce the basis of any stock or obligations of X held by W immediately before the disposition. See section 1.1502-19(a)(6) of the regulations.

LAW AND ANALYSIS

Section 368(a)(1)(F) of the Code provides that the term "reorganization" includes a mere change in identity, form, or place of organization of one corporation, however effected. The transfer of the stock of X to Newco and the immediate liquidation of X, with no change in shareholder or shareholder proprietary interest, is recharacterized for United States tax purposes as a transfer of the assets and liabilities of X to Newco in exchange for Newco stock, followed by a distribution of the Newco stock to W in exchange for the X stock. In this instance, this recharacterization constitutes a reorganization as defined in section 368(a)(1)(F) because the effect of the transaction is a mere change in the place of organization of X. All of the assets and liabilities of X are transferred to a new corporation, Newco, without a change in shareholder or shareholder proprietary interest in the corporation. Although this transaction, as recharacterized, also qualifies as a reorganization as defined in section 368(a)(1)(D), X recognizes no gain on an assumption by Newco of a X liability because section 357(c) does not apply to transactions described in section 368(a)(1)(F). Rev. Rul. 79-289, 1979-2 C.B. 145.

Section 361(a) of the Code provides that no gain or loss shall be recognized by a transferor corporation which is a party to a reorganization on any exchange of property pursuant to the plan of reorganization. However, under section 367(a) a foreign corporation receiving assets in an exchange with a United States person will generally not be treated as a corporation for purposes of determining the gain or loss recognized on the transfer. The transferee's loss of corporate status for United States tax purposes precludes the treatment of the transfer as a reorganization under section 368 and denies the transferor the benefit of nonrecognition treatment under section 361(a).

An exception to the general rule of gain recognition on the transfer to a foreign corporation is provided in section 1.367(a)- 3T(d)(3) of the regulations, which states that section 367(a)(1) of the Code will not apply to a transfer of stock or securities to another corporation organized in the same country as the transferred corporation, provided certain requirements (concerning the assets transferred, stock ownership before and after the transfer and the filing of an agreement pursuant to section 1.367(a)-3T(g)) are satisfied. See section 1.367(a)-3T(d)(3)(ii) through (vii). Under section 1.367(a)-3T(d)(3)(ii), at least 50 percent of the assets used in the trade or business of the transferred corporation must be located in the same country in which the transferee and transferred corporations are organized. In this case, this asset requirement is satisfied because at least 50 percent of the assets used in the trade or business of Z are located in the United Kingdom. Given the facts of this ruling, the ownership requirements contained in section 1.367(a)-3(d)(3)(iii) through (vi) are satisfied because, prior to the transfer, the transferor was wholly owned by a domestic corporation and after the transfer the same domestic corporation owns all of the stock of Newco. Assuming X files the necessary agreement pursuant to section 1.367(a)-3T(g), section 367(a) will not apply to the transfer of the stock of Z, and no gain or loss will be recognized on the transfer of the X stock under section 361. Because this is a transnational reorganization, the taxable year of X will end with the close of the date of the transfer. Under the specific facts of this ruling, no branch loss recapture under section 1.367(a)-6T will be imposed.

HOLDING

Under the facts contained in this ruling, the transfer of all of the assets and liabilities of X to Newco in exchange for Newco stock and the subsequent distribution of Newco in liquidation of X is a reorganization as described in section 368(a)(1)(F) of the Code. No gain or loss is recognized on the exchange under section 361(a).