Recapitalization avoids branch profits dividend equivalent

Plain-English summary

A foreign corporation indirectly owned a U.S. holding company whose earnings and profits reflected amounts previously allocated under the branch profits tax regulations. The group proposed recapitalizing the holding company by exchanging its existing shares for two new classes while also completing a related merger. The foreign corporation represented that it would amend its prior statement so a later disposition of the new shares would be treated as a disposition under the applicable temporary regulation. The IRS ruled that the recapitalization itself would not be a disposition under that regulation. It also ruled that the foreign corporation would not have to treat any amount realized from the recapitalization as a dividend equivalent amount under section 884(a).

Ruling snapshot

• Question: Does the proposed U.S. holding-company recapitalization trigger a disposition and dividend equivalent amount under the branch profits tax rules?
• Outcome: approved, the recapitalization is not a disposition and does not produce a dividend equivalent amount
• Key authorities: IRC § 884(a); Treas. Reg. § 1.884-2T(d)(5)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201752001                                              Third Party Communication: None
Release Date: 12/29/2017                                       Date of Communication: Not Applicable
Index Number: 884.00-00
                                                               Person To Contact:
----------------------                                         ------------------------- , ID No.---------------
-----------------------------------------------------------    Telephone Number:
----------------------------                                   ----------------------
------------------------------------------------               Refer Reply To:
---------------------------                                    CC:INTL:B01
-----------------------------------                            PLR-111731-17
                                                               Date:
                                                               October 4, 2017




TY: -------

Legend

Transferor                          =        -------------------------------------------------
                                             -------------------------

Parent                              =        -------------------------------

Country A                           =        ------------

Exchange                            =        ----------------------------------

FSub1                               =        ----------------------------------------------------
                                             -------------------------

Disregarded Entity                  =        -------------------------------------------------------
                                             ----------------------------------------------------------

State A                             =        --------------

State B                             =        -------------

Holdco US                           =        -------------------------------------
                                    -------------------------

Holdco US Group                     =        -------------------------------------------

Financial                           =        -------------------------------
                                             -------------------------
PLR-111731-17                                             2

Operating                           =        ------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
                                    -------------------------

Entity Y                            =        ------------------------------------
                                    -------------------------

a                                   =        ----

b                                   =        --

Year 1                              =        -------

Year 2                              =        -------

Year 3                              =        -------

Year 4                              =        -------

Year 5                              =        -------

Date 1                              =        ---------------------------

Date 2                              =        -------------------

Date 3                              =        --------------------------

Date 4                              =        --------------------

Date 5                              =        ----------------------

Date 6                              =        ----------------------


Dear ---------------:

         This is in response to your letter dated Date 6, requesting rulings with respect to

the federal income tax treatment of Transferor’s proposed transactions (the “Proposed

Transactions”).
PLR-111731-17                                  3

        The rulings contained in this letter are predicated upon facts and representations

submitted by Transferor and accompanied by a penalty of perjury statement executed

by an appropriate party. This office has not verified any of the material submitted in

support of the request for rulings. Verification of the factual information,

representations, and other data may be required as part of the audit process. The

information submitted for consideration is substantially as set forth below.

   I.      PRE-TRANSACTION STRUCTURE

        Parent is a Country A corporation that functions as a holding company. Parent’s

common stock is traded on Exchange. Parent owns all of the outstanding stock of

Transferor and FSub1, each a Country A corporation.

        Transferor owns all of the outstanding interests in Disregarded Entity, an entity

chartered under a governmental subdivision of Country A that is disregarded as

separate from Transferor for federal tax purposes. Disregarded Entity owns all of the

outstanding stock of Holdco US, a State A limited liability company that is treated as a

corporation for federal tax purposes.

        Holdco US is the common parent of Holdco US Group, an affiliated group that

files a consolidated federal income tax return on a calendar year basis. Holdco US

owns all of the outstanding stock of Financial, a State A corporation. Financial owns all

of the outstanding stock of Operating, a State B corporation.

        Entity Y is a State A limited liability company that has elected to be treated as a

corporation for federal tax purposes. Entity Y has two classes of shares outstanding:

Class A and Class B. Holdco US wholly owns the Class A shares. The Class A shares
PLR-111731-17                                 4

represent approximately a percent (more than 80 percent) of the voting power and value

of Entity Y's outstanding shares. Senior management of Entity Y wholly owns the Class

B shares. The Class B shares represent the remaining, approximately b percent, voting

power and value of Entity Y's outstanding shares.


   II.      PREVIOUS TRANSACTIONS

   A. Incorporation of U.S. Assets

         In Year 1, and on subsequent occasions, FSub1 transferred U.S. assets used in

its U.S. trade or business to Operating in exchange for stock. These transfers qualified

for nonrecognition under section 351 of the Internal Revenue Code. FSub1 and

Operating received a private letter ruling from the Internal Revenue Service ("IRS") on

Date 1, stating that one of these transfers qualified for nonrecognition under section

351. With respect to these transfers, Operating elected under Treas. Reg. § 1.884-

2T(d)(4) to increase its earnings and profits ("E&P") by an allocable portion of FSub1's

effectively connected E&P ("ECE&P") and non-previously taxed accumulated ECE&P.

In addition, FSub1 reduced its ECE&P and non-previously taxed accumulated ECE&P

in accordance with Treas. Reg. § 1.884-2T(d)(4)(iii).

         Pursuant to Treas. Reg. § 1.884-2T(d)(5)(i), FSub1 agreed that, upon the

disposition of part or all of the stock or securities it owned in Operating (or a successor

in interest), it would treat as a dividend equivalent amount for the taxable year in which

the disposition occurred an amount equal to the lesser of (1) the amount realized upon

such disposition, or (2) the total amount of ECE&P and non-previously taxed
PLR-111731-17                                  5

accumulated ECE&P that was allocated to Operating pursuant to Treas. Reg. § 1.884-

2T(d)(4)(ii).

   B. Formation of Financial

       In Year 2, FSub1 formed Financial and transferred to it all of the stock of

Operating in exchange for Financial stock. This transfer qualified for nonrecognition

under section 351. As part of the same transaction, FSub1 transferred all of the stock

of Financial to Disregarded Entity in exchange for an ownership interest in Disregarded

Entity. In connection with the transfer, Parent and Operating received a private letter

ruling from the IRS on Date 2 stating, in part, the following:

       (1) Provided that the Actual Transaction qualifies as an exchange
       under § 351, and provided: (1) [Financial] makes a valid election to
       increase its earnings and profits by an amount equal to the
       earnings and profits previously allocated to [Operating] pursuant to
       the prior elections by [FSub1] under § 1.884-2T(d)(4); (2) [FSub1]
       attaches a statement to its timely filed (including extensions) federal
       income tax return treating such earnings and profits as if they had
       been allocated from [FSub1] to [Financial] pursuant to an election
       under § 1.884-2T(d)(4); and (3) [FSub1] attaches a statement to its
       timely filed (including extensions) federal income tax return
       agreeing that, upon the disposition of part or all of the stock or
       securities of either [Operating] (or a successor-in-interest) or
       Disregarded Entity (or a successor-in-interest), or upon a direct or
       indirect disposition of part or all of the stock or securities of
       [Financial] (or a successor-in-interest), [FSub1] shall treat such
       disposition as a "disposition" for purposes of § 1.884-2T(d)(5)(i):

       a. [FSub1's] transfer of [Operating's] stock to [Financial] will not
       constitute a "disposition" of part or all of [Operating's] stock within
       the meaning of § 1.884-2T(d)(5)(i); and

       b. [Operating's] earnings and profits will be reduced by an amount
       equal to the earnings and profits allocated to [Financial] pursuant to
       a valid election under § 1.884-2T(d)(4).
PLR-111731-17                                   6

       (2) If [FSub1] disposes of part or all of the stock or securities of
       either [Financial] (or a successor-in-interest) or [Disregarded Entity]
       (or a successor-in-interest), or if [Financial] disposes of part or all of
       the stock or securities of [Operating] (or a successor-in-interest),
       [FSub1] shall treat such disposition as a "disposition" for purposes
       of § 1.884-2T(d)(5)(i).

   C. Spin-Off of Transferor

       In Year 3 and Year 4, pursuant to a reorganization described in section

368(a)(1)(D), FSub1 transferred all of its interests in Disregarded Entity (which owned

all the stock of Financial) and cash to Transferor, a newly-formed corporation, in

exchange solely for stock of Transferor. FSub1 then distributed all the stock of

Transferor to Parent in a transaction to which section 355 applied. In connection with

this transaction, Parent and Operating received a private letter ruling from the IRS on

Date 3 stating, in part, the following:

       (10) Provided that [Transferor] attaches a statement to its timely
       filed (including extensions) federal income tax return agreeing that
       [Transferor] will treat a disposition of part or all of the stock or
       securities of either [Financial] (or a successor-in-interest) or
       [Disregarded Entity] (or a successor-in-interest), as a "disposition"
       for purposes of § 1.884-2T(d)(5)(i), then [Disregarded Entity's]
       transfer of the [Financial] stock to [Transferor] will not be treated as
       a "disposition" of stock under § 1.884-2T(d)(5)(i). If in the future
       [Financial] is liquidated into [Transferor] in a liquidation under §
       332, such liquidation of [Financial] will be treated as a "disposition"
       for purposes of § 1.884-2T(d)(5)(i), notwithstanding § 1.884-
       2T(d)(5)(ii).

                                            …

       (12) [Transferor's] sale of [Financial] stock is a "disposition" for
       purposes of § 1.884-2T(d)(5)(i), and [Transferor] must treat an
       appropriate amount as a dividend equivalent amount in accordance
       with § 1.884-2T(d)(5)(i).
PLR-111731-17                                    7

          The IRS supplemented this ruling on Date 4, adding, in part, a sentence to the

end of ruling (10), stating:

          This ruling is in lieu of and replaces Ruling 2 of [the ruling
          addressing the Formation of Financial] for transfers occurring after
          [FSub1's] transfer of the [Financial] stock to [Transferor].

   D. Acquisition of Entity Y Assets

          In Year 5, Disregarded Entity acquired all the assets of Entity Y. Pursuant to a

restructuring involving the assets acquired from Entity Y, Transferor (through

Disregarded Entity) formed Holdco US and transferred to Holdco US the assets

acquired from Entity Y and all of the stock of Financial, in exchange solely for stock of

Holdco US (the "Entity Y Acquisition"). As a result of the Entity Y Acquisition, Holdco

US became the new common parent of the Holdco US Group. In connection with the

Entity Y Acquisition, on Date 5 the IRS issued a private letter ruling stating, in part, the

following:

          3. Pursuant to Treas. Reg. § 1.884-2T(d)(5)(ii), the transfer by
          Disregarded Entity of the stock of Financial to [Holdco US] pursuant
          to the [Entity Y Acquisition] will not be treated as a "disposition" of
          the Financial stock under Treas. Reg. § 1.884-2T(d)(5)(i).

          4. Financial's earnings and profits will be reduced by an amount
          equal to the earnings and profits allocated to [Holdco US] in
          accordance with [representations made in] this ruling letter.

          5. The statement filed pursuant to [the representations made in] this
          ruling letter is in lieu of and replaces the statement filed pursuant to
          ruling 10 of the [ruling addressing the split-off of Transferor] for
          dispositions occurring after the date of the [Entity Y Acquisition].

   III.      PROPOSED TRANSACTIONS
PLR-111731-17                                 8

       A further restructuring of the assets acquired from Entity Y is contemplated that

will include (1) a recapitalization of the shares of Holdco US in a transaction that is

intended to qualify as a reorganization under section 368(a)(1)(E) (the

"Recapitalization") and (2) the merger of Entity Y with and into a disregarded subsidiary

of Holdco US in a transaction that is intended to qualify as a reorganization under

section 368(a)(1)(A) (the "Merger"). The Recapitalization and the Merger will involve

the following steps:

       1. The limited liability agreement of Holdco US will be amended to authorize
          Holdco US to issue Class I, Class II-A, and Class II-B shares. In this regard,
          it is contemplated that (a) the Class I shares will have terms that are
          consistent with the terms of the existing shares of Holdco US owned by
          Disregarded Entity (and, correspondingly, Transferor) (the "Existing Holdco
          US Shares"); (b) the Class II-A shares will have terms that are consistent with
          the terms of the existing Class A shares of Entity Y owned by Holdco US; and
          (c) the Class II-B shares will have terms that are consistent with the terms of
          the existing Class B shares of Entity Y owned by members of the senior
          management of Entity Y.

       2. Holdco US will form a new wholly owned, disregarded subsidiary ("Merger
          Sub") with a single class of shares, and Entity Y will merge with and into
          Merger Sub, with Merger Sub surviving. As part of this transaction (i.e., the
          Merger), each vested Class B share of Entity Y will be converted into and
          become the right to receive a Class II-B share of Holdco US and a cash
          payment from Holdco US of approximately $--.

       3. Following the completion of the Merger, Disregarded Entity (and,
          correspondingly, Transferor) will exchange the Existing Holdco US Shares for
          Class I and Class II-A shares of Holdco US, and, in conjunction with this
          exchange (i.e., the Recapitalization), the Existing Holdco US Shares will be
          canceled.

       At the conclusion of these transactions, it is anticipated that (1) the Class I and

Class II-A shares of Holdco US owned by Disregarded Entity (and, correspondingly,

Transferor) will represent approximately a percent (more than 80 percent) of the voting
PLR-111731-17                                    9

power and value of Holdco US's outstanding shares; and (2) the Class II-B shares of

Holdco US owned by members of the senior management of Entity Y will represent

approximately b percent of the voting power and value of Holdco US's outstanding

shares.

   IV.      REPRESENTATIONS

          Transferor has made the following representations in connection with the

Proposed Transaction:

         1. In connection with the Entity Y acquisition,

            a. Transferor filed a Year 5 federal income tax return within 30 days of the
               date of the letter ruling issued Date 5 and attached a statement to that
               return agreeing that it will treat a disposition of part or all of the shares or
               securities of Holdco US (or a successor-in-interest), or part or all of the
               interests in Disregarded Entity (or a successor-in-interest), as a
               "disposition" for purposes of Treas. Reg. § 1.884-2T(d)(5)(i); and

            b. Holdco US filed an amended Year 5 federal income tax return within 30
               days of the date of that letter ruling and attached to that return a statement
               described in Treas. Reg. § 1.884-2T(d)(4)(i) agreeing to increase its
               earnings and profits by an amount equal to the earnings and profits
               previously allocated to Financial pursuant to prior elections made with
               respect to Financial under Treas. Reg. § 1.884-2T(d)(4) as if they had
               been allocated from Transferor to Holdco US pursuant to an election
               under Treas. Reg. § 1.884-2T(d)(4).

         2. The Recapitalization will qualify as a reorganization under section
            368(a)(1)(E); as a consequence, the exchange by Disregarded Entity (and,
            correspondingly, Transferor) of the Existing Holdco US Shares for Class I and
            Class II-A shares of Holdco US will qualify for nonrecognition of gain or loss
            under section 354.

         3. The total fair market value of the Class I and Class II-A shares of Holdco US
            to be received by Disregarded Entity (and, correspondingly, Transferor) in the
            Recapitalization will be approximately equal to the total fair market value of
            the Existing Holdco US Shares immediately before that transaction.

         4. The aggregate basis of the Class I and Class II-A shares of Holdco US to be
            received by Disregarded Entity (and, correspondingly, Transferor) in the
PLR-111731-17                                   10

           Recapitalization will be equal to the aggregate basis of the Existing Holdco
           US Shares immediately before that transaction.

        5. There are no dividend arrearages on the Existing Holdco US Shares.

        6. Aside from the exchange by Disregarded Entity (and, correspondingly,
           Transferor) of the Existing Holdco US Shares for Class I and Class II-A
           shares of Holdco US, no cash or other property will be exchanged in the
           Recapitalization.

        7. Transferor will file an amendment to the statement described in
           Representation 1.a. in accordance with the provisions of Treas. Reg. § 1.884-
           2T(d)(5)(i) and (iv) providing that it will treat a disposition of part or all of the
           Class I shares, the Class II-A shares, or any securities of Holdco US (or a
           successor-in-interest) that it owns through Disregarded Entity, or part or all of
           the interests in Disregarded Entity (or a successor-in-interest), as a
           "disposition" for purposes of Treas. Reg. § 1.884-2T(d)(5)(i).

   V.    RULINGS

        Based solely on the information submitted and on the representations set forth

above, we rule as follows:

        1. Pursuant to Treas. Reg. § 1.884-2T(d)(5)(ii), the Recapitalization will not
           constitute a "disposition" of the shares of Holdco US by Transferor for
           purposes of Treas. Reg. § 1.884-2T(d)(5)(i).

        2. Transferor is not required to treat as a dividend equivalent amount for
           purposes of section 884(a) any portion of the amount realized on account of
           the Recapitalization.

        No opinion is expressed about the tax treatment of any of the transactions

described herein, including the Recapitalization and the Merger, under other provisions

of the Code and regulations, or about the tax treatment of any conditions existing at the

time of, or effects resulting from, the transactions not specifically covered by the above

rulings. In particular, no opinion is expressed as to whether the Recapitalization

qualifies under section 368(a)(1)(E), or the Merger qualifies under section 368(a)(1)(A).
PLR-111731-17                                 11

Lastly, no opinion is expressed as to the tax treatment of the $-------per share payment

issued from Holdco US to the Class II-B shareholders.

       This ruling letter is directed only to the taxpayer who requested it. Section

6110(k)(3) provides that it may not be used or cited as precedent.

       Each affected taxpayer must attach a copy of this letter to the taxpayer's federal

income tax return for the tax year in which the transaction covered by this ruling letter is

consummated.

       In accordance with the power of attorney on file with this office, a copy of this

ruling letter is being sent to your authorized representative. A copy of this ruling should

be attached to any federal income tax return to which it is relevant.


                                                   Sincerely,


                                                   __________________________

                                                   Rosy L. Lor
                                                   Senior Technical Reviewer, Branch 1
                                                   Associate Chief Counsel (International)
Enclosure:
Copy for 6110 Purposes