Cadwalader Logo BrassTax Logo
New Proposed 'Killer B' Regulations Reduce Compliance Sting

On October 5, the U.S. Treasury released long-awaited proposed regulations regarding inbound cross-border reorganizations, implementing (with modifications) policies that had been announced in 2014 and 2016 notices. These proposed regulations are the latest in a long-running battle against different variations of the so-called “Killer B” transaction, triangular reorganizations designed to effect the tax-free repatriation of earnings held by non-U.S. subsidiaries of U.S. corporations. 

In the classic “Killer B” transaction, a foreign subsidiary (FS) of a U.S. parent (USP) would purchase USP stock from USP in exchange for property (including cash), and then use that USP stock to acquire stock of another foreign subsidiary of USP (FT) from a domestic affiliate of USP (USS). Although the result of the transaction was the repatriation of the property used to purchase USP stock, taxpayers would take the position that the purchase of USP stock was tax-free under Section 1032 of the Internal Revenue Code (which provides that corporations do not recognize gain or loss on the sale of their own stock), and that the acquisition of FT was tax-free to USS as a “B” reorganization. Following notices issued in 2006 and 2007, in 2011 the IRS adopted Section 1.367(b)-10 of the Treasury Regulations, which generally treats FS as having first made a taxable distribution to USP.

In the years that followed, the IRS and Treasury observed a number of transactions that they viewed as variants of the original Killer B designed to avoid the new anti-abuse rule in the 2011 regulations.  In Notice 2014-32 and Notice 2016-73, they announced their intention to issue regulations modifying Treasury Regulations Section 1.367(b)-10 to remedy these perceived abuses. One such variant involves a first-tier foreign subsidiary (FS1) of USP with little to no earnings and profits (E&P), which in turn owns a second-tier subsidiary (FS2) with E&P.  Under this variant, FS2 acquires stock of FS1 in exchange for property, which it then uses to acquire FT from USS.  Later, FS1 liquidates, distributing the property received from FS2 to USP. While such an inbound liquidation would ordinarily require USP to include a deemed dividend of FS1’s “all E&P amount,” that amount is calculated only by reference to FS1’s E&P, without regard to any undistributed E&P from FS2.  Accordingly, FS1 would be able to distribute to USP, at full basis, the property FS2 used to acquire FS1’s stock, with little to no dividend inclusion.

To address this concern, Notice 2016-73 provided that where a foreign corporation that has “excess asset basis” (EAB) engages in an inbound nonrecognition asset transfer, its “all E&P amount” would be increased by some or all of the E&P of the transferring foreign corporation’s lower-tier subsidiaries. (EAB is the excess of the foreign corporation’s inside asset basis over the sum of its outside stock basis, its E&P and its liabilities assumed in the asset transfer.)  This rule applied regardless of whether the foreign corporation had otherwise engaged in any triangular reorganization resembling the “Killer B,” however. Rather, EAB could be reduced only to the extent that it was “not attributable, directly or indirectly, to property provided by” a lower-tier foreign subsidiary.

The proposed regulations retain this basic EAB concept, but have narrowed its application to inbound transactions that follow certain triangular reorganizations or other transactions with a principal purpose of creating EAB. The preamble to the proposed regulations cited a comment (apparently a 2017 New York State Bar Association Report) noting that the prior rule effectively presumed any EAB illegitimate unless proven otherwise, placing a burden on taxpayers to account for the entire inside asset basis of a subsidiary to establish that no basis originated from lower-tier subsidiaries.  This more limited scope of the EAB rule, by contrast, requires a more limited showing by the taxpayer.

The proposed regulations also include a number of other changes and refinements, many in response to the sea change effected to the taxation of U.S. outbound investment by the 2017 Tax Cuts and Jobs Act (TCJA). Indeed, the preamble notes that certain TCJA provisions, including current taxation of GILTI income, the one-time “transition tax” of pre-TCJA CFC earnings and the foreign dividends received deduction of Section 245A, have significantly increased both the amount of foreign E&P that will be subject to U.S. tax prior to any repatriation and the ability of taxpayers to repatriate overseas earnings without incremental U.S. tax even in the absence of elaborate tax planning. It remains to be seen whether this paradigm shift will accomplish what over a decade of Treasury guidance failed to do and render the “Killer B” extinct—not through extirpation, but by obsolescence.

Key Contacts

Linda Z. Swartz
T. +1 212 504 6062


Adam Blakemore
T. +44 (0) 20 7170 8697

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

© 2024 | Notices