Washington Law Review

Article Title

Section 367: An Enigma


Julie W. Weston


Section 367 of the Internal Revenue Code of 1954 was enacted in its original form in 1932 in order to close what Congress considered to be a serious tax loophole available to domestic corporations and individuals carrying on business through the use of foreign corporations or contemplating the use of foreign corporations to realize large gains without paying taxes. The loophole resulted from the operation of the nonrecognition provisions of the Code dealing with the organization and reorganization of corporations. By using these provisions, individuals and corporations—both foreign and domestic—could transfer greatly appreciated property and unrealized profits on a tax-free basis to a new corporation organized in countries where certain transactions, e.g., sales of capital assets, were either taxed at low rates or not at all. An example would be the transfer of appreciated American stock and equipment to a corporation in Canada in a transaction which qualified for nonrecognition treatment under section 351. Thereafter, the Canadian corporation could sell the stock and equipment at little or no tax cost because Canada does not impose a capital gains tax. The Canadian corporation could then dissolve into its parent American corporation in a tax-free liquidation under section 332. By using these several steps, the American corporation could sell the appreciated property with none of the tax consequences that would be imposed upon a similar transaction taking place solely within the United States. Concerned with this type of activity, Congress enacted what is now section 367 in order to stop the use of "tax haven" countries in world-wide.

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