What Is a 338(g) Election for a Foreign Target?

When a U.S. corporation acquires a foreign company, a Section 338(g) election can alter the transaction’s U.S. tax implications. This formal declaration to the Internal Revenue Service (IRS) allows a corporate buyer to treat a foreign stock purchase as an asset purchase for U.S. tax purposes. For legal and tax purposes in the foreign country, the transaction remains a stock acquisition.

The primary motivation for this election is to achieve a “step-up” in the tax basis of the foreign target’s assets to their fair market value. This can provide advantages related to the tax basis of the assets. The election is an irrevocable choice that changes the U.S. tax profile of the newly acquired foreign entity.

Core Mechanics of the Deemed Transaction

The ability to make a Section 338(g) election is contingent upon a “Qualified Stock Purchase” (QSP). A QSP occurs when a purchasing corporation acquires at least 80% of a target corporation’s stock by vote and value within a 12-month period. The acquisition must be a taxable purchase, not part of a tax-free reorganization.

After a QSP, the purchasing corporation can make the election, which creates a legal fiction for U.S. tax purposes. The foreign target, or “old target,” is treated as if it sold all its assets at fair market value on the acquisition date. Immediately after, a “new target” is treated as purchasing those same assets.

The purchase price for these assets is based on what the acquirer paid for the stock, plus the target’s liabilities. This process is a construct of U.S. tax law and does not affect the transaction’s legal or tax status in the foreign country.

U.S. Tax Consequences of the Election

A consequence of a Section 338(g) election is the change in the tax basis of the foreign target’s assets for U.S. tax purposes. The “new” foreign target is treated as having purchased the assets at fair market value. This “stepped-up” basis can lead to larger depreciation and amortization deductions, which may reduce the foreign target’s income subject to U.S. tax, such as Global Intangible Low-Taxed Income (GILTI).

The deemed sale of assets by the “old” target generates a gain or loss recognized for U.S. tax purposes. If the foreign target is a Controlled Foreign Corporation (CFC), this deemed gain can create income, such as Subpart F income, that is immediately taxable to the U.S. shareholders. The character of this gain depends on the nature of the assets sold.

The election also eliminates the foreign target’s historical tax attributes, including all accumulated earnings and profits (E&P) and foreign income taxes paid. The “new” target begins with a zero E&P balance, which prevents the U.S. acquirer from inheriting a large E&P account. This simplifies future tax planning for distributions.

The election impacts U.S. foreign tax credits. Internal Revenue Code Section 901 can disallow a foreign tax credit for foreign taxes paid on the portion of an asset’s value that is stepped-up for U.S. purposes but not for foreign tax purposes. If the foreign target is a Passive Foreign Investment Company (PFIC), the election’s deemed sale can purge the PFIC taint, allowing the “new” target to start fresh without that status.

Information and Calculations Required for Form 8023

To make a Section 338(g) election, the purchasing corporation must file Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases. The form requires information about the buyer and target, including names, employer identification numbers (EINs), addresses, and the acquisition date. If the target was a Controlled Foreign Corporation (CFC), information about its U.S. shareholders may also be needed.

Two calculations are necessary for the election’s reporting: the Aggregate Deemed Sale Price (ADSP) and the Adjusted Grossed-Up Basis (AGUB). The ADSP determines the gain or loss for the “old target” on the deemed asset sale. Its formula includes the grossed-up amount realized on the stock sale plus the old target’s liabilities.

The AGUB calculation determines the asset basis for the “new target.” This formula includes the grossed-up basis of the purchased stock plus the new target’s liabilities. The AGUB is then allocated among the target’s assets using a seven-class residual method:

• Class I: Cash and general deposit accounts.
• Class II: Actively traded personal property, certificates of deposit, and foreign currency.
• Class III: Accounts receivable, mortgages, and credit card receivables.
• Class IV: Inventory or stock in trade.
• Class V: All assets not in other classes.
• Class VI: Section 197 intangibles, except for goodwill and going concern value.
• Class VII: Goodwill and going concern value.

The Election Filing Process

The purchasing corporation must follow a strict timeline for filing the election. The completed Form 8023 must be filed no later than the 15th day of the ninth month after the month in which the acquisition date occurs. Failure to file on time can invalidate the election, which is irrevocable once made.

The form is filed with the IRS service center where the purchasing corporation files its income tax return. The U.S. acquirer must also file Form 8883, Asset Allocation Statement Under Section 338, which details the AGUB allocation. A copy of Form 8883 must be attached to the purchasing corporation’s income tax return for the year of the acquisition.

If the foreign target was a CFC, the election is not valid unless the buyer provides written notice to certain U.S. shareholders of the target. This notice informs them of the election and its potential tax consequences. For ongoing compliance, the “new” foreign target must use the stepped-up asset basis for all future U.S. tax reporting.