Sec. 304 anti-abuse, anti-avoidance rules finalized


In T.D. 9606, the IRS finalized regulations that apply to transactions subject to Sec. 304 but that are structured with the principal purpose of avoiding the statute’s application. The regulations target transactions designed to avoid Sec. 304 treatment of a corporation that controls an acquiring corporation or a deemed acquiring corporation. They also target transactions designed to avoid Sec. 304 for a corporation that is controlled by the issuing corporation or deemed issuing corporation. They adopt, without change, temporary and proposed regulations issued in 2009 (T.D. 9477).

Sec. 304 anti-abuse rule

Sec. 304 was designed to ensure dividend treatment on related-party stock transactions that are in substance a dividend from earnings and profits (E&P). Use of related-party stock transactions is a common method of repatriating foreign earnings without paying U.S. taxes. Under Sec. 304(a)(1), if brother and sister corporations are under common control and the brother (the acquiring corporation) acquires the stock of the sister (the issuing corporation), the proceeds will be treated as received in redemption of the acquiring corporation.

The redemption results in dividend treatment under Sec. 302 because both the acquiring and issuing corporations are under common control. The dividend is treated as if first distributed by the acquiring corporation to the extent of its E&P and then distributed by the issuing corporation to the extent of its E&P.

Final regulation rule

The original version of the temporary regulations (T.D. 8209, issued in 1988) targeted transactions that sought to circumvent the E&P of the acquiring corporation through the use of a newly formed intermediary. The final regulations update the deemed acquirer rule and add a new deemed issuer rule that targets another variation of the cross-chain stock sale. The new rule eliminates a perceived loophole in the original temporary regulation because only the identity of the acquirer was previously considered.

Regulations apply automatically

Under the final regulations, the anti-avoidance rules apply automatically and are not subject to IRS discretion if a transaction was undertaken with a principal purpose of avoiding the application of Sec. 304 to the deemed acquiring corporation or the deemed issuing corporation.

The taxpayer cannot escape application of the rule with a bona fide business purpose if a “principal purpose” of the transaction is to avoid the application of Sec. 304. The regulations also clarify that the funding of the Sec. 304 proceeds may come from a borrowing, including a third-party borrowing. The final regulations have the same effective date as the temporary regulations they replace—they are effective for acquisitions of stock occurring on or after Dec. 29, 2009.
Sally P. Schreiber ( ) is a JofA senior editor.


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