Changes to rules on failure to file gain recognition agreements proposed

The IRS has issued proposed regulations to update the rules that apply to U.S. taxpayers that fail to file gain recognition agreements (GRAs) when they transfer certain property to foreign corporations in nonrecognition transactions (REG-140649-11). The proposed rules would change the standards under which transferors are required to recognize gain on the transfer of stock or securities.

Under Sec. 367(a), if, in any exchange described in Sec. 332, 351, 354, 356, or 361 (i.e., a nonrecognition transaction), a U.S. person transfers property to a foreign corporation, the transferee foreign corporation is not considered to be a corporation for purposes of determining the extent to which gain is recognized on the transfer. This results in recognition of the gain by the transferee.

One exception to this recognition treatment, however, involves the U.S. person’s transfer of stock or securities to a foreign corporation as long as the transferor files a gain recognition agreement (GRA) and “other related documents.” The GRA must require the transferor to agree to include in income the gain realized but not recognized on the initial transfer of the stock or securities and to pay interest on any additional tax due if a gain recognition event occurs during the term of the GRA (generally 60 months following the close of the tax year in which the initial transfer occurs). One gain recognition event is the failure to comply with any requirement under the Sec. 367(a) regulations (which include a requirement to file an annual certification) or any requirement in the GRA.

Under existing regulations, if there is a failure to comply with the Sec. 367(a) rules or a failure to have filed a timely GRA for the initial transfer, the U.S. transferor must recognize the full amount of gain realized on the initial transfer of stock or securities unless the U.S. transferor demonstrates that the failure was due to reasonable cause and not willful neglect. The proposed regulations would change this rule so that the U.S. transferor would have to recognize the full amount of gain only if the failure to comply was “willful” as that term is defined in the civil penalty provisions, e.g., if it was the result of gross negligence, reckless disregard, or willful neglect. Whether a failure was willful would be determined based on the facts and circumstances; the proposed regulations contain examples illustrating the application of the standard.

In related rules, under Sec. 6038B, a U.S. person who transfers certain property to a foreign corporation in certain nonrecognition transactions must report the transaction by filing Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, identifying the transferee foreign corporation and describing the property transferred. The penalty for not filing Form 926 is 10% of the fair market value of the property at the time of the exchange, not to exceed $100,000 unless the failure was due to intentional disregard of the reporting obligation. If the U.S. transferor demonstrates that the failure was due to reasonable cause and not willful neglect, no penalty is imposed.

However, if a taxpayer complies with the GRA requirement, existing Regs. Sec. 1.6038B-1(b)(2) exempts the taxpayer from filing Form 926. But, if a taxpayer fails to comply with the Sec. 367(a) GRA requirements and fails to file Form 926, the taxpayer could be subject to both penalties: the recognition of gain and the 10% of value penalty. Under the existing regulations, a taxpayer can avoid the Sec. 6038B penalty by demonstrating reasonable cause; the proposed regulations do not change this provision to the willful standard that would apply under Sec. 367. They do modify the information that must be reported on Form 926 and would require that a Form 926 be filed in all cases in which a GRA is filed. 

The regulations will apply to documents or statements that are required to be filed with a timely filed return on or after the date the regulations are published as final in the Federal Register and to any requests for relief for failures to file any of the required documents and statements for requests submitted on or after that date.

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.