IRS has privately ruled that the domestication of a foreign corporation will be considered a reorganization under Code Sec. 368(a)(1)(F), and the domesticated company may elect to be considered an S corporation on the date it becomes domesticated. IRS also ruled that the trusts that wholly-own the domesticated corporation may elect to be treated as electing small business trusts (ESBTs).
Background on F reorganizations. Code Sec. 368(a)(1)(F) provides that a reorganization includes a mere change in identity, form, or place of organization of one corporation, however effected. In the case of an F reorganization, the acquiring corporation is treated (for purposes of Code Sec. 381) just as the transferor corporation would have been treated if there had been no reorganization. (Reg. §1.381(b)-1(a)(2)) Under Code Sec. 381, a corporation that acquires the assets of another corporation in certain tax-free reorganizations or liquidations also carries over numerous tax items of the transferor (predecessor) corporation.
Background on S corporations and ESBTs. An S corporation is a small business corporation for which an election under Code Sec. 1362(a) is in effect for a tax year. (Code Sec. 1361(a)(1)) A small business corporation cannot have as a shareholder a person (other than an estate, a trust described in Code Sec. 1361(c)(2), or an organization described in Code Sec. 1361(c)(6)) who is not an individual.
An ESBT may be an S shareholder. (Code Sec. 1361(c)(2)(A)(v)) An ESBT must meet the following requirements:
... The trust must not have any beneficiaries other than individuals, estates, or charitable organizations described in Code Sec. 170(c)(2) through Code Sec. 170(c)(5) (relating to various charitable organizations, war veterans organizations, fraternal lodges, and cemetery organizations). Nonresident aliens may be beneficiaries (but not potential current beneficiaries). Organizations described in Code Sec. 170(c)(1) (i.e, state governments, U.S. possessions, political subdivisions of states or U.S. possessions, and the U.S. and the District of Columbia) may also be ESBT beneficiaries. However, they may only hold contingent interests and may not be potential current beneficiaries. (Code Sec. 1361(e)(1)(A)(i))
... No interest in the trust may have been acquired by purchase. (Code Sec. 1361(e)(1)(A)(ii))
... An election to be an ESBT must apply to the trust. (Code Sec. 1361(e)(1)(A)(iii))
... A qualified Subchapter S trust (QSST) election must not have been made with respect to any stock held by the trust. (Code Sec. 1361(e)(1)(B)(i))
... The trust must not be a tax-exempt trust, a charitable remainder annuity trust (CRAT), or a charitable remainder unitrust (CRUT). (Code Sec. 1361(e)(1)(B)(ii), Code Sec. 1361(e)(1)(B)(iii))
Facts. Foreign corporation Oldco was wholly-owned by two trusts (Trusts). For federal tax purposes, Oldco was classified as an association taxable as a corporation. Subsequently, Trusts became domesticated under state law and made elections to be ESBTs under Code Sec. 1361(e)(3).
Thereafter, Oldco became a new state corporation (Newco) by filing certain certificates of incorporation pursuant to the statute of an unspecified state that permits a foreign corporation to elect to become a state corporation. On the date it filed to become a state corporation, Newco also filed to be treated as an S corporation.
The liabilities of Oldco that were assumed by Newco were acquired in the ordinary course of business. Newco was a domestic corporation within the meaning of Code Sec. 7701(a)(4) and Reg. §301.7701-5 immediately after domestication. Oldco did not own any U.S. real property interests as defined in Code Sec. 897(c)(1) and Reg. §1.897-1(c)(1).
Ruling request. A ruling was requested to ensure that the domesticated trusts would be considered ESBTs under Code Sec. 1361 on the date they elected to be so treated, the domesticated corporation would be considered an S corporation on the date it filed to become a domestic company, and the domestication would be considered a reorganization under Code Sec. 368(a)(1)(F).
Favorable PLR. In the private letter ruling (PLR), IRS held that Oldco's domestication will constitute a reorganization under Code Sec. 368(a)(1)(F), and Oldco will not recognize gain or loss on the deemed transfer of assets to Newco in exchange for stock and the assumption of the old entities liabilities under Code Sec. 361 and Code Sec. 357. Additionally, Newco won't recognize gain or loss on the receipt of Oldco's assets and liabilities in the deemed exchange for Newco's stock under Code Sec. 1032(a). Newco's basis in the stock will be the same as the foreign entity's basis immediately before domestication under Code Sec. 362(b). IRS further held that Newco may elect to be treated as an S corporation and Trusts may elect to be treated as ESBTs (but the PLR didn't rule on whether, in fact, Newco was an S corporation and Trusts were ESBTs).
Oldco will not recognize gain or loss on the deemed distribution to Trusts of the domesticated stock. (Code Sec. 361(c)(1)) Similarly, Trusts won't recognize gain or loss on the deemed exchange of Oldco's stock for Newco's stock. (Code Sec. 354(a)(1))
Trusts' basis in Newco's stock will be the same as their basis in Oldco's stock insofar as the trust companies hold Oldco's stock as capital assets on the date of domestication. (Code Sec. 1223(1)) Trusts will be required to include in gross income, in the form of a deemed dividend, the E&P amount attributable to their stock in Oldco. Reg. §1.367(b)-3(b)(3))
References: For Type F reorganizations, see FTC 2d/FIN ¶F-3100; United States Tax Reporter ¶3684.06; TaxDesk ¶235,801; TG ¶5169. For ESBTs, see FTC 2d/FIN ¶D-1482; United States Tax Reporter ¶13,614.03; TaxDesk ¶611,034; TG ¶4718.