United States: Changes Proposed To US Tax Reporting Rules For "Outbound" Transfers

US IRS Proposes Amendments to "Gain Recognition Agreement" Rules, Clarifying Reporting Obligations

On January 30, 2013, the US Treasury Department (IRS) proposed amendments to existing gain recognition agreement ("GRA") regulations that apply to US persons who transfer stock of a US corporation or a foreign corporation to a foreign corporation. The proposed changes to the GRA regulations address the consequences to US persons for failing to file GRAs and related documents (failure to file), to comply in any material respect with the terms of, or rules governing, GRAs (failure to comply), or to satisfy other reporting obligations. The proposed changes would affect not only future reorganizations and contributions of stock to foreign corporations, but also prior transfers that continue to be subject to GRA reporting. The proposed changes also provide similar failure to comply rules with respect to liquidating distributions to foreign corporations and certain other document filing requirements arising with a US person's transfer of stock or assets to certain foreign corporations.

The announced changes are merely proposed and would be effective only upon the promulgation of final regulations. Consistent with the public statements of IRS officials, however, the proposed regulations confirm that the IRS intends to tighten the IRS directive originally implemented in 2010 that effectively permits automatic correction of a previously-filed GRA if certain requirements are met.

Background

Section 367(a)(1) of the US Internal Revenue Code generally provides that if a US person (US transferor) transfers property to a foreign corporation, the US transferor must recognize gain, but not loss, on the transfer, notwithstanding that the transfer otherwise qualifies as a nontaxable exchange. Section 367(a) is intended to prevent US persons from avoiding US tax by transferring appreciated property to foreign corporations in nontaxable exchanges, with the intent of having the foreign corporation dispose of such property outside of the US taxing jurisdiction. Section 367(e)(2) provides similar gain recognition rules in the context of otherwise nontaxable liquidations of subsidiary corporations into foreign parent corporations.

With respect to certain transfers of stock or securities to a foreign corporation, a US transferor may avoid gain recognition under Section 367(a)(1) by filing a GRA and other related documents describing the transfer. Under a GRA, the US transferor agrees to recognize gain realized on the initial transfer and pay interest on any additional tax due if a gain recognition event occurs during the 5-year term of the GRA. A failure to file or comply, unless such failure was due to reasonable cause and not willful neglect, is currently a gain recognition event.

If a GRA has not properly been filed, the US transferor is required to file IRS Form 926 "Return by a U.S. Transferor of Property to a Foreign Corporation," describing the transfer, pursuant to Internal Revenue Code Section 6038B and regulations. The penalty for failure to satisfy this reporting requirement is 10% of the fair market value (FMV) of the property at the time of initial transfer, but not in excess of $100,000 unless the failure was due to intentional disregard. If the failure was due to reasonable cause and not willful neglect, however, no penalty is imposed.

Overview of Proposed Regulations

• Willful Failure to File or Comply. The reasonable cause standard for relief for a failure to file or comply would be replaced with a willfulness standard, which would include a failure due to gross negligence, reckless disregard, or willful neglect, and would be determined by the Director of Field Operations International, Large Business & International Division based on all relevant facts and circumstances. 
• • On its face, this change is a relaxation of the current regulatory standard of "reasonable cause." Nonetheless, the change may not always be welcome for a couple of reasons. First, the definition of "willful" is not entirely clear, especially in light of the examples of willfulness that the IRS cites. In one of these example, the facts that a US transferor has a history of failing to file tax returns, and that it lacks adequate procedural safeguards to ensure timely filing of GRAs, would be indicative of a willful failure. In addition, merely providing that the basis or FMV of property is "available upon request" but failing to include such information in a GRA would be considered willful. By contrast, only one example is provided of an instance in which the failure is not willful: a failure to file due to an isolated and accidental oversight would not be considered a willful failure to comply. Second, the current regulatory rules are relaxed substantially in practice due to an IRS directive that effectively allows automatic correction of previously-filed GRAs if certain requirements are met.
  • Moreover, relief would no longer be granted solely because the IRS fails to respond to a request within 120 days. 
• Section 6038B and Form 926 Reporting. The reasonable cause standard for US transferors seeking Section 6038B penalty relief would be retained, but information reporting obligations on Form 926 would be expanded as follows. First, a US transferor would be required to include on Form 926 the basis and fair market value of the property transferred. Second, a US transferor would be required to file a Form 926 even if it has otherwise properly filed a GRA.
• Other Reporting. Rules similar to the ones described above would be provided with respect to reporting and filing obligations governing:
• • Liquidating distributions to foreign parent corporations under Section 367(e)(2) and regulations;
  • Certain transfers by domestic corporations of their stock or securities or assets to foreign corporations.

Open Issues

• IRS Directive Relief. As discussed above, an IRS directive (LMSB-4-0510-017) currently effective "until further notice is provided," allows US transferors to correct existing GRAs or file new GRAs, but not for initial transfers, without establishing reasonable cause. Although US transferors should be able to rely on the directive for now, the IRS has previously indicated its plans to withdraw the directive and the need for US taxpayers to "clean up" insufficient GRAs as soon as possible. Taxpayers should act quickly to get their GRA and reporting house in order. 
• Scope of Proposed "Willfulness" Standard. Although presumably more favorable than the current regulatory standard (at least in the absence of relief under the directive), the application of the new willfulness standard is uncertain, especially given the Director's discretion in making this facts and circumstances determination. Moreover, the proposed regulations still do not provide examples illustrating the reasonable cause standard under the Section 6038B reporting requirements. The IRS is likely to receive requests for greater clarification, especially regarding the interaction of the new standard with the reasonable cause standard.

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