The merger or liquidation of a CFA sub into its CFA parent may double-up exempt surplus

A foreign affiliate (Sub) that is generating exempt earnings pays a dividend to its foreign affiliate parent (Parent) more than 90 days into the year, and then is merged into Parent, who is the survivor. It would appear that Reg. 5907(8) deems Sub to have a year end prior to the merger for purposes of the 90-day rule in Reg. 5901(2) and that Sub satisfies an implicit requirement under that rule that it continues to exist for at least a moment after such deemed year end.

On this basis, under Reg. 5907(1)(c)(A)(v) the exempt surplus dividend paid by Sub to Parent is included in Parent's surplus at the date Parent receives the dividend and, under Reg. 5901(2), Sub is deemed to pay that dividend to Parent immediately following the end of the deemed year – so that Sub's exempt surplus balance immediately before that year end (and before the merger) includes the exempt surplus distributed from Sub to Parent earlier in the year. As a result:

The surplus paid out through Sub's dividend to Parent is double-counted in the exempt surplus balance after the merger… . First, under Regulation 5905 the opening surplus balances combines the surplus and deficit balances of Sub and Parent immediately before the merger time … .. Next, the 90-day rule in Regulation 5901(2) deems Sub to pay the dividend to Parent immediately following the end of the year. As a result of this timing, Sub's surplus balance before the merger … includes the surplus previously paid out and already included in Parent's surplus as a result of the dividend.

Similar issues arise if Sub is liquidated.

Neal Armstrong. Summary of Susan Mckilligan, "The 90-Day Rule and Mergers or Liquidations of Foreign Affiliates," International Tax (Wolters Kluwer CCH), October 2017, No. 96, p. 10 under Reg. 5901(2)(a).