Rev. Rul. 81-4

1981-1 C.B. 126, 1981-1 I.R.B. 12.

                       Internal Revenue Service
                                 Revenue Ruling

        TRANSFER TO CONTROLLED CORPORATION; APPRECIATED FOREIGN CURRENCY

                           Published: January 5, 1981

SECTION 367.--FOREIGN CORPORATIONS, 26 CFR 7.367(a)-1: Ruling request under section 367 relating to certain transfers involving a foreign corporation

  Transfer to controlled corporation; appreciated foreign currency.  A domestic corporation's transfer of appreciated foreign currency to its wholly owned foreign subsidiary as a capital contribution is deemed to have as one of its principal purposes the avoidance of federal income tax.  The domestic corporation must recognize the gain realized on the currency's appreciation.

ISSUE

  In the instant situation, does a transfer of appreciated foreign currency by a domestic corporation to its wholly owned foreign subsidiary, as a capital contribution, have as one of its principle purposes the avoidance of federal income tax within the meaning of section 367(a)(1) of the Internal Revenue Code?

FACTS

  P, a domestic corporation, is engaged in the manufacture and sale of plastic components.  S, a country A corporation, is a wholly owned subsidiary of P that is engaged, in country A, in the same business as P.  In order to expand its manufacturing capacity, § entered into an agreement on September 1, 1979, with an unrelated party for the purchase of a factory in country A on December 1, 1979.   The purchase price for the facility was the local currency equivalent of 10x United States dollars.  P decided to finance the purchase by making a capital contribution to § of the purchase price.

  P owned 8x country A francs.  The cost of the 8x country A francs was 8x United States dollars.  From the date that P purchased its country A francs through the date of actual purchase of the factory, the value of 8x country A francs in United States dollars has increased 2x United States dollars due to changes in the rate of exchange.

  On December 1, 1979, P transferred the 8x country A francs (which were then worth 10x United States dollars) to § as a capital contribution.  § immediately used the money to purchase the factor which is used in S's business.

  P's transfer of property (country A francs) in exchange for § stock (by application of section 367(a)(2)), would have fulfilled all of the requirements of section 351 had the transferee (S) been a domestic corporation.  Within 183 days of the beginning of the transfer, P requested a ruling from the Internal Revenue Service that the transaction was not in pursuance of a plan of tax avoidance within the meaning of section 367.

LAW AND ANALYSIS

  Section 351 of the Code provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.

  Section 367(a)(1) of the Code provides that if, in connection with any exchange described in section 351, there is a transfer of property (other than stock or securities of a foreign corporation that is a party to the reorganization) by a United States person to a foreign corporation, for purposes of determining the extent to which gain shall be recognized on such transfer, a foreign corporation shall not be considered to be a corporation unless, pursuant to a request filed not later than the close of the 183rd day after the beginning of such transfer (and filed in such form and manner as may be prescribed by regulations by the Secretary), it is established to the satisfaction of the Secretary that such exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes.

  The transfer of property (country A francs) by P (a domestic corporation) to § (its wholly owned foreign subsidiary), as a contribution to capital, is treated as an exchange of such property for stock of § equal in value to the fair market value of the property transferred, pursuant to section 367(c)(2) of the Code.  Therefore, P's transfer of property to § solely in exchange (by application of section 367(c)(2)) for § stock is an exchange described in section 351 of the Code.  However, unless it is established under section 367(a)(1) that the transfer to § was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes, § will not be considered to be a corporation for purposes of determining the extent to which gain shall be recognized on the transfer.  Since nonrecognition of gain under section 351 will occur only if § is considered to be a corporation, failure to satisfy section 367(a)((1) would result in recognition of any gain realized by P on the transfer of property.

  Rev. Proc. 68-23, 1968-1 C.B. 821, sets forth guidelines to be used by taxpayers and their representatives in connection with

requests for rulings required under section 367(a) of the Code in respect of certain types of transactions involving foreign corporations.  Section 3.02(1) of Rev. Proc. 68- 23 relates to transfers to foreign corporations controlled by domestic transferors and provides that such a transfer of property will ordinarily receive favorable consideration where the transferred property is to be devoted by the transferee foreign corporation to the active conduct, in any foreign country, of a trade or business (emphasis supplied).  It is contemplated that the transferee foreign corporation, in addition to the active conduct of a trade or business, will have need for a substantial investment in fixed assets in such business.

  Sections 3.02(1)(a)(i)-(iii) of Rev. Proc. 68-23 provide that, notwithstanding that the other requirements of section 3.02(1) are satisfied, a favorable ruling under section 367 of the Code will not be issued for an exchange described in section 351 if the property to be transferred to the foreign corporation is property described in sections 1221(1) or 1221(3) (inventory or copyrights, etc.), property in respect of which income has been earned (accounts receivable or installment obligations), and passive property (stock or securities).  Section 3.02(1)(a)(iv) provides that the same treatment will be accorded property transferred under circumstances which make it reasonable to believe that its sale or disposition by the transferee is one of the principal purposes of its transfer.

  In Rev. Rul. 78-281, 1978-2 C.B. 204, the Service holds that foreign currency (country A francs) is treated as a commodity whose fluctuations in value can result in taxable gain or loss upon disposition.

  Appreciated foreign currency does not come literally within any of the specific categories of property described in Rev. Proc. 68-23 at sections 3.02(1)(a)(i)-(iii) the transfer of which will not be given favorable treatment under section 367 of the Code.  However, since such currency constitutes a readily saleable passive asset whose inherent gain will pass beyond the United States taxing jurisdiction unless a toll charge is assessed at the time of transfer, it is analogous, for section 367 purposes, to stock or securities. Furthermore, such currency comes, in this case, within the literal language of section 3.02(1)(a)(iv), i. e., property transferred under circumstances which make it reasonable to believe that its sale or disposition by the transferee is one of the principal purposes of the transfer.

HOLDING

  Pursuant to section 3.02(1)(a)(iii) and (iv) of Rev. Proc. 68-23, P's transfer of appreciated country A francs to S, as a capital contribution, is deemed to have as one of its principal purposes the avoidance of federal income tax within the meaning of section 367(a)(1) of the Code.  Since § will thus not be characterized as a corporation for purposes of determining gain on the transfer (that is, section 351 will not apply) P must recognize the 2x dollars of gain realized (a value of 10x dollars less a basis of 8x dollars equals a gain of 2x dollars).

Rev. Rul. 81-4, 1981-1 C.B. 126, 1981-1 I.R.B. 12.