Amendment of section 355(e)

(a)

In general

Subsection (e) of section 355 of the Internal Revenue Code of 1986 (relating to recognition of gain on certain distributions of stock or securities in connection with acquisitions) is amended to read as follows:

(e)

Recognition of gain on certain distributions of stock or securities in connection with certain leveraged spin-merger transactions

(1)

In general

If there is a distribution to which this subsection applies, gain shall be recognized immediately prior to the distribution to the extent of the lesser of— (A)the excess relative leverage at the time of the distribution, and (B)the gain realized as a result of the distribution. (2)

Distributions to which subsection applies

This subsection shall apply to any distribution that would otherwise qualify under subsection 355(a) if— (A)there is a prearranged change in control, (B)the change in control company is highly leveraged immediately after the distribution (determined without regard to any post-distribution transactions), and (C)the change in control company has excess relative leverage. (3)

Definition of prearranged change in control

(A)

In general

For purposes of this subsection, a prearranged change in control shall be deemed to occur if the distribution is part of a plan (or series of related transactions) pursuant to which 1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or any controlled corporation. (B)

Plan presumed to exist in certain cases

If 1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in the distributing corporation or any controlled corporation during the 4-year period beginning on the date that is 2 years before the date of the distribution, such acquisition shall be treated as pursuant to a plan described in subparagraph (A) unless it is established that the distribution and the acquisition are not pursuant to a plan or series of related transactions. (C)

Certain plans disregarded

A plan or series of related transactions shall not be treated as described in subparagraph (A) if, immediately after the completion of such plan or series of transactions, the distributing corporation and all controlled corporations are members of a single affiliated group (as defined in section 1504 without regard to subsection (b) thereof). (D)

Certain acquisitions not taken into account

Except as provided in regulations, the following acquisitions shall not be taken into account in applying subparagraph (A): (i)The acquisition of stock in any controlled corporation by the distributing corporation. (ii)The acquisition by a person of stock in any controlled corporation by reason of holding stock or securities in the distributing corporation. (iii)The acquisition by a person of stock in any successor corporation of the distributing corporation or any controlled corporation by reason of holding stock or securities of such distributing or controlled corporation. (iv)The acquisition of stock in the distributing corporation or any controlled corporation to the extent that the percentage of stock owned directly or indirectly in such corporation by each person owning stock in such corporation immediately before the acquisition does not decrease.

This subparagraph shall not apply to any acquisition if the stock held before the acquisition was acquired pursuant to a plan (or series of related transactions) described in subparagraph (A).

(E)

Asset acquisitions

Except as provided in regulations, for purposes of this subsection, if the assets of the distributing corporation or any controlled corporation are acquired by a successor corporation in a transaction described in subparagraph (A), (C) or (D) of section 368(a)(1) or any other transaction specified in regulations by the Secretary, the shareholders (immediately before the acquisition) of the corporation acquiring such assets shall be treated as acquiring stock in the corporation from which the assets were acquired. (F)

Definitions and special rules

For purposes of this subsection— (i)

Change in control company

The term change in control company means, with respect to any prearranged change in control, the distributing or controlled corporation (or both) that undergoes such change in control. (ii)

50-percent or greater interest

The term 50-percent or greater interest has the meaning given such term by subsection (d)(4). (iii)

Distributions in title 11 or similar case

Paragraph (1) shall not apply to any distribution made in a title 11 or similar case (as defined in section 368(a)(3)). (iv)

Aggregation and attribution rules

(I)

Aggregation

The rules of paragraph (7)(A) of subsection (d) shall apply. (II)

Attribution

Section 318(a)(2) shall apply in determining whether a person holds stock or securities in any corporation. Except as provided in regulations, section 318(a)(2)(C) shall be applied without regard to the phrase 50 percent or more in value for purposes of the preceding sentence. (v)

Successors and predecessors

Any reference to a controlled corporation or a distributing corporation shall include a reference to any predecessor or successor of such corporation. (4)

Definition of highly leveraged

For purposes of this subsection— (A)

In general

A change in control company shall be considered to be highly leveraged for purpose of this subsection if its ratio of debt to equity exceeds 2 to 1. (B)

Ratio of debt to equity

The term ratio of debt to equity means the ratio which the total indebtedness of the company bears to the value of the company’s equity. (C)

When to measure ratio of debt to equity

The ratio of debt to equity of the distributing and controlled corporations shall be measured immediately following the distribution, but prior to any transactions occurring after the distribution involving the distributing or controlled corporations. (D)

Indebtedness

Indebtedness— (i)shall not include indebtedness between corporations that are members of an affiliated group immediately after the distribution, (ii)shall not include any liabilities described in section 357(c)(3), (iii)shall be computed with reference to the adjusted issue price (as defined in section 1272(a)(4)), and (iv)shall include stock described in section 1504(a)(4). (E)

Value of company’s equity

The value of the company’s equity shall be based on the fair market value of all the company’s equity immediately after the distribution excluding the value of any equity described subparagraph (D)(iv). (F)

Affiliated groups

In any case in which the issuing corporation of any indebtedness is a member of an affiliated group (within the meaning of section 1504(a)) which includes the distributing or controlled corporation, the calculation of the debt to equity ratio for purposes of this subsection shall be determined, pursuant to regulations prescribed by the Secretary, by treating all the members of the affiliated group in the aggregate as the issuing corporation of such indebtedness. (G)

Special rules for banks, lending or finance companies

With respect to any corporation which is a bank (as defined in section 581) or primarily engaged in a lending or finance business, in determining the debt to equity ratio of such corporation (or of the affiliated group of which such corporation is a member) for purposes of this subsection, the total indebtedness of such corporation shall be reduced by an amount equal to the total indebtedness owed to such corporation which arises out of the banking business of such corporation, or out of the lending or finance business of such corporation, as the case may be. (H)

Outside leverage test

If ratio of debt to equity of the change in control company equals or exceeds 6 to 1 and paragraph (2)(A) is met with respect to a distribution, then— (i)the requirements of subparagraphs (B) and (C) of paragraph (2) shall be treated as met with respect to such distribution and (ii)the gain realized as a result of the distribution shall be recognized notwithstanding paragraph (1). (5)

Definition of excess relative leverage

For purposes of this subsection— (A)

In general

The term excess relative leverage means the excess, if any, of— (i)the actual indebtedness of the change in control company, over (ii)the maximum permitted indebtedness of the change in control company. (B)

Maximum permitted indebtedness

The maximum permitted indebtedness of a change in control company equals the greater of— (i)the amount of indebtedness that would result in the change in control company having a debt to equity ratio of 2.0, and (ii)(I)if the change in control company is the controlled company in the distribution, the amount of indebtedness that would result in the controlled corporation having a debt to equity ratio that equals the sum of the debt to equity ratio of the distributing corporation plus 0.25, or (II)if the change in control company is the distributing company in the distribution, the amount of indebtedness that would result in the distributing corporation having a debt to equity ratio that equals the sum the debt to equity ratio of the controlled corporation plus 0.25.

To the extent the distribution involves more than one controlled corporation, the debt to equity ratio of the controlled corporation for purposes of the preceding sentence shall be determined by calculating aggregate indebtedness and equity value of all the controlled corporations.

(6)

Gain realized as result of distribution

For purposes of this subsection, the term gain realized as a result of the distribution means the excess (if any) of— (A)the value of the controlled corporation’s stock distributed pursuant to the distribution, over (B)the distributing corporation’s tax basis in the controlled corporation’s stock distributed pursuant to the distribution. (7)

Cross-reference to section 362 regarding basis step-up in connection with distributions to which this subsection applies

To the extent gain is recognized pursuant to this subsection, there shall be a corresponding basis step-up in the assets of the change in control company with excess relative leverage under section 362(f). (8)

Coordination with subsection (d)

This subsection shall not apply to any distribution to which subsection (d) applies. (9)

Certain capital contributions not taken into account

(A)

In general

Any equity capital received by a change in control company at the time of or prior to a distribution that is part of a plan a principal purpose of which is to avoid or reduce the gain that would otherwise be recognized pursuant to this subsection shall not be taken into account for purposes of calculating the debt to equity ratio and excess relative leverage of such change in control company. (B)

Certain contributions presumed to be part of plan

For purposes of subparagraph (A), any capital contribution received by the change in control company during the 12 month period ending on the date of the distribution shall be treated as pursuant to a plan described in subparagraph unless it is established that none of the principal purposes of the capital contribution was to avoid or reduce the gain that would otherwise have to be recognized pursuant to this subsection. (10)

Statute of limitations

If there is a distribution to which paragraph (1) applies— (A)the statutory period for the assessment of any deficiency attributable to any part of the gain recognized under this subsection by reason of such distribution shall not expire before the expiration of 3 years from the date the Secretary is notified by the taxpayer (in such manner as the Secretary may by regulations prescribe) that such distribution occurred, and (B)such deficiency may be assessed before the expiration of such 3-year period notwithstanding the provisions of any other law or rule of law which would otherwise prevent such assessment. (11)

Regulations

The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subsection, including regulations— (A)preventing taxpayers from circumventing the purpose of this subsection through distributions of multiple controlled corporations, the use of unaffiliated companies, capital contributions prior to the distribution, or the use of strategies that attempt to distort the debt to equity ratio calculations in a manner inconsistent with the purpose of this subsection, including, for example, transitory changes in capital structure entered into for the principal purpose of avoiding application of the debt to equity ratio calculations which have effects inconsistent with the purposes of section 355(e), (B)providing for the application of this subsection where there is more than 1 controlled corporation, and (C)providing for the application of rules similar to the rules of subsection (d)(6) where appropriate for the purposes of paragraph (3)(A).

(b)

Conforming amendment

Subsection (f) of section 362 of such Code is amended to read as follows:

(f)

Basis of assets in connection with distribution to which section 355(e) applies

In the case of a distribution to which section 355(e) applies, the basis of the assets of the change in control company (as defined in such section) and members of its affiliated group (other than stock in any member of the acquired group) shall be increased by the amount of the gain recognized pursuant to section 355(e)(1) and such increase shall be allocated among such assets in a manner that reflects the relative amounts by which the fair market values of such assets exceed their respective adjusted bases. The Secretary shall prescribe regulations providing for corresponding adjustments in the basis of stock of members of the members of the affiliate group which includes the change in control company.

(c)

Effective date

The amendments made by this section shall to— (1)any distribution completed after the date of the enactment of this Act, and (2)any distribution completed on or before such date to the extent any transaction completed on or after such date results in a prearranged change in control (as defined in section 355(e) of the Internal Revenue Code of 1986, as amended by this section).