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IRS finalises section 1248 regulations on cross-border distributions

The Internal Revenue Service (IRS) and US Treasury Department recently released final regulations under section 1248 addressing the characterisation of gain recognised by US taxpayers on the receipt of certain types of distributions from foreign corporations (the final regulations) (T.D. 9585).

The final regulations finalise proposed regulations that were issued in February 2009 and remove corresponding temporary regulations (the 2009 regulations) (T.D. 9444).

Under the 2009 regulations, gain recognised by a US taxpayer on the receipt of a distribution of property, with respect to stock in a foreign corporation under section 301(c)(3) (very generally, a taxable distribution), was treated as gain from the sale or exchange of stock for purposes of section 1248(a). The final regulations adopt the 2009 regulations largely unmodified. The final regulations confirm that gain recognised by a US taxpayer under section 301(c)(3), on the receipt of a distribution of property from a foreign corporation with respect to its stock, will be treated as a sale or exchange of such stock for purposes of section 1248(a). The final regulations also provide that a distribution that gives rise to gain under sections 302(a) (a distribution in redemption of stock) or 331(a) (a distribution in a taxable liquidation) will also be treated as a sale or exchange for purposes of section 1248(a).

Very broadly, section 1248(a) provides that the sale or exchange of stock in a foreign corporation by a US taxpayer may be re-characterised from capital gain to dividend income, if certain ownership and other requirements are satisfied. Accordingly, the impact of the final regulations is that gain recognised by a US taxpayer on the receipt of a distribution from a foreign corporation in a transaction under section 301(c)(3), 302(a), or 331(a), can be re-characterised from what would otherwise be capital gain into dividend income. This can be true even if the distributing foreign corporation does not itself have any earnings and profits (E&P) because the E&P of lower-tier foreign subsidiaries are taken into account under section 1248(c)(2), when gain is recognised with respect to the stock of an upper-tier controlled foreign corporation (CFC). This concept is illustrated in the following example:

A US shareholder owns 100% of the stock of CFC1, which owns 100% of the stock of CFC2. CFC1 has zero E&P and CFC2 has $50 E&P. The US shareholder's tax basis in the stock of CFC1 is $10. CFC1 distributes $60 to the US shareholder.

The distribution would generally be treated as a $10 return of CFC1 stock basis under section 301(c)(2), and then as $50 of capital gain under section 301(c)(3). Under the final regulations, however, that $50 capital gain would instead be treated as a dividend to the extent CFC2's E&P.

The 2009 regulations also addressed the application of section 367 to certain related party stock transfers that are re-characterised as distributions under section 304. In February of this year, the IRS released Notice 2012-15 stating its intention to amend the regulations under section 367 to address the application of section 367 to these transactions separately. Accordingly, the final regulations do not finalise those portions of the 2009 regulations.

The final regulations apply to distributions occurring on or after February 10 2009 – the same effective date as the 2009 regulations.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Sean Foley ( Washington, DC, and Landon McGrew (, McLean, VA


Tel: +1 202 533 5588

Fax: +1 202 315 3087


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