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Introduction to Section 367(a)(1), Outbound Stock Transfers, and Gain Recognition Agreements
Section 367(a) of the Internal Revenue Code (the “Code”) governs the outbound transfer of property by a U.S. person to a foreign corporation in certain non-recognition transactions. If section 367(a) is triggered the relevant non-recognition provision is “turned off” and the U.S. person that transferred the property outbound must recognize gain on the transfer. The section 367(a) outbound transfer can be of stock or non-stock assets. If the section 367(a) outbound transfer is a stock transfer (“transferred stock”) the U.S. person may be able to avoid gain recognition if: (i) the U.S. person is a five percent or greater shareholder of the recipient corporation (the “transferee foreign corporation”) and (ii) the U.S. person enters into a five-year gain recognition agreement (“GRA”) with respect to the transferred stock.[1] A gain recognition agreement is, in effect, a contract with the IRS, wherein the taxpayer agrees to report certain events with respect to transferred stock, each year, for five full taxable years after the outbound stock transfer. The ability of a U.S. person to enter into a gain recognition agreement is a valuable tool to avoid (or defer) gain recognition on outbound stock transfers. However, the GRA rules are nuanced and can be difficult to interpret. Additionally, the GRA rules have very specific requirements for what must be included in a gain recognition agreement. If the gain recognition agreement does not comply with the rules, it may be invalid and cause the immediate gain recognition on the outbound stock transfer under section 367(a)(1). This note will briefly discuss an overview of section 367(a), the gain recognition agreement rules, and related compliance filings.
Section 367(a) Overview
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