[Federal Register Volume 60, Number 154 (Thursday, August 10, 1995)]
[Proposed Rules]
[Pages 40792-40794]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-19447]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[CO-26-95]
RIN 1545-AT55


Treatment of Underwriters in Section 351 and Section 721 
Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document proposes rules for transfers of cash to a 
corporation or a partnership. The proposed regulations will affect 
taxpayers in transactions intended to qualify under section 351 and 
section 721 when there is an offering of stock or partnership interests 
through an underwriter. This document also provides notice of a public 
hearing on these proposed regulations.

DATES: Written comments must be received by November 8, 1995. Requests 
to speak at the public hearing scheduled for Wednesday, January 17, 
1996, at 10 a.m., with outlines of oral comments, must be received by 
Wednesday, December 27, 1995.

ADDRESSES: Send submissions: CC:DOM:CORP:T:R (CO-26-95), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (CO-26-95), 
Courier's Desk, Internal Revenue Building, 1111 Constitution Avenue 
NW., Washington, DC. The hearing will be held in the Auditorium, 
Internal Revenue Building, 1111 Constitution Avenue NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation 
under section 351(a), Susan T. Edlavitch, (202) 622-7750; concerning 
the proposed regulation under section 721(a), Brian J. O'Connor, (202) 
622-3060; concerning submissions and the hearing, Mike Slaughter, (202) 
622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 351(a) provides that no gain or loss is recognized if 
property is transferred to a corporation by one or more persons solely 
in exchange for stock in the corporation and immediately after the 
exchange the person or persons are in control (as defined in section 
368(c)) of the corporation.
    Section 721(a) provides that no gain or loss is recognized to a 
partnership or to any of its partners in the case of a contribution of 
property to the partnership in exchange for an interest in the 
partnership.
    Rev. Rul. 78-294, 1978-2 C.B. 141, involves the incorporation of an 
existing sole proprietorship by an individual to raise capital through 
a public offering. The individual sought the assistance of an 
underwriter. In accordance with the plan, the individual organized a 
new corporation, which had capital stock of 1,000 authorized but 
unissued shares.
    Situation 1 describes a transaction that was considered to fall 
within the general definition of a ``best efforts'' underwriting. 
Pursuant to an agreement among the individual, the new corporation, and 
the underwriter, the individual transferred all the business property 
to the new corporation in exchange for 500 shares of stock. The 
underwriter agreed to use its best efforts as an agent of the 
corporation to sell the 500 unissued shares to the general public at 
$200 per share. The underwriter succeeded in selling the stock within 
two weeks of the initial offering with no change in the terms of the 
offering.
    Situation 2 describes a transaction that was considered to fall 
within the general definition of a ``firm commitment'' underwriting. 
Pursuant to an agreement among the individual, the new corporation, and 
the underwriter, the individual transferred all the business property 
to the new corporation in exchange for 500 shares of stock, and the 
underwriter transferred $100,000 in cash to the new corporation in 
exchange for the remaining 500 shares. At the time of the underwriter's 
purchase, the underwriter had not entered into a binding contract to 
dispose of its stock in the new corporation. However, the underwriter 
intended to sell its 500 shares, but, if unsuccessful, was required to 
retain them. Following the exchanges, the underwriter sold its 500 
shares of stock in the new corporation to the general public within two 
weeks of the initial offering. The individual retained the 

[[Page 40793]]
500 shares of stock in the new corporation.
    In Situation 1, the ruling holds that the individual who 
transferred the business property to the corporation and the investors 
in the public offering were co-transferors in a single transaction that 
qualified under section 351. In Situation 2, the ruling holds that the 
firm commitment underwriter was a transferor along with the individual 
and that their control was not defeated by the subsequent resale of 50 
percent of the stock in the public offering.
    The IRS and Treasury believe that Situation 2 of Rev. Rul. 78-294 
does not reflect current underwriting practices. In addition, the IRS 
and Treasury believe that underwritings of partnership interests should 
be treated similarly to underwritings of stock. Further, the proposed 
regulations are necessary to prevent inappropriate imposition and 
inappropriate avoidance of tax.
    The proposed regulations, under certain circumstances, disregard 
underwriters of stock and partnership interests for purposes of section 
351 and section 721. The proposed treatment of underwriters is similar 
to their treatment under Sec. 1.382-3(j)(7) and Sec. 1.1273-2(e).

Explanation of Provisions

Proposed Amendment Adding Sec. 1.351-1(a)(3)

    This document proposes to add Sec. 1.351-1(a)(3) to 26 CFR part 1. 
The proposed regulation provides that, for the purpose of section 351, 
if a person acquires stock from an underwriter in exchange for cash in 
a qualified underwriting transaction, the person who acquires the stock 
from the underwriter is treated as transferring cash directly to the 
corporation in exchange for the stock and the underwriter is 
disregarded. A qualified underwriting transaction is a transaction in 
which a corporation issues stock for cash in an underwriting in which 
either the underwriter is an agent of the corporation or the 
underwriter's ownership of stock is transitory. The proposed regulation 
would render Rev. Rul. 78-294 obsolete. No inference is intended as to 
transactions not within the scope of the proposed regulation.

Proposed Amendment Adding Sec. 1.721-1(c)

    This document proposes to add Sec. 1.721-1(c) to 26 CFR part 1. The 
proposed regulation provides that, for the purpose of section 721, if a 
person acquires a partnership interest from an underwriter in exchange 
for cash in a qualified underwriting transaction, the person who 
acquires the partnership interest from the underwriter is treated as 
transferring cash directly to the partnership in exchange for the 
partnership interest and the underwriter is disregarded. A qualified 
underwriting transaction is a transaction in which a partnership issues 
partnership interests for cash in an underwriting in which either the 
underwriter is an agent of the partnership or the underwriter's 
ownership of the partnership interests is transitory. No inference is 
intended as to transactions not within the scope of the proposed 
regulation.

Comments Solicited

    The IRS and Treasury invite public comment on the proposed 
regulations. In particular, the IRS and Treasury solicit comments on 
(a) whether the proposed rules should apply for all tax purposes; (b) 
whether the proposed rules should be limited to underwriters; and (c) 
whether the proposed rules should be limited to cash transactions.

Proposed Effective Dates

    New Sec. 1.351-1(a)(3) and new Sec. 1.721-1(c) are proposed to be 
effective for qualified underwriting transactions occurring on or after 
the date of publication as final regulations in the Federal Register.

Effect on Other Documents

    The following publication would become obsolete as of the date of 
publication in the Federal Register of the final regulations: Rev. Rul. 
78-294, 1978-2 C.B. 141.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.
Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the Internal Revenue 
Service. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for Wednesday, January 17, 
1996, beginning at 10 a.m., in the Auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC. Because of 
access restrictions, visitors will not be admitted beyond the Internal 
Revenue Building lobby more than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit written comments, an outline of topics to be discussed and the 
time to be devoted to each topic (signed original and eight (8) copies) 
by Wednesday, December 27, 1995.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these proposed regulations are Susan T. 
Edlavitch of the Office of Assistant Chief Counsel (Corporate) and 
Brian J. O'Connor of the Office of Assistant Chief Counsel 
(Passthroughs and Special Industries). However, other personnel from 
the IRS and Treasury participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.351-1 also issued under 26 U.S.C. 351. * * *
    Section 1.721-1 also issued under 26 U.S.C. 721. * * *

    Par. 2. In Sec. 1.351-1, paragraph (a)(3) is added to read as 
follows:


Sec. 1.351-1  Transfer to corporation controlled by transferor.

    (a) * * *
    (3) Underwritings of stock--(i) In general. For the purpose of 
section 351, 

[[Page 40794]]
if a person acquires stock of a corporation from an underwriter in 
exchange for cash in a qualified underwriting transaction, the person 
who acquires stock from the underwriter is treated as transferring cash 
directly to the corporation in exchange for stock of the corporation 
and the underwriter is disregarded. A qualified underwriting 
transaction is a transaction in which a corporation issues stock for 
cash in an underwriting in which either the underwriter is an agent of 
the corporation or the underwriter's ownership of the stock is 
transitory.
    (ii) Effective date. This paragraph (a)(3) is effective for 
qualified underwriting transactions occurring on or after the date of 
publication of the final regulation in the Federal Register.
* * * * *
    Par. 3. In Sec. 1.721-1, paragraph (c) is added to read as follows:


Sec. 1.721-1  Nonrecognition of gain or loss on contribution.

* * * * *
    (c) Underwritings of partnership interests--(1) In general. For the 
purpose of section 721, if a person acquires a partnership interest 
from an underwriter in exchange for cash in a qualified underwriting 
transaction, the person who acquires the partnership interest is 
treated as transferring cash directly to the partnership in exchange 
for the partnership interest and the underwriter is disregarded. A 
qualified underwriting transaction is a transaction in which a 
partnership issues partnership interests for cash in an underwriting in 
which either the underwriter is an agent of the partnership or the 
underwriter's ownership of the partnership interests is transitory.
    (2) Effective date. This paragraph (c) is effective for qualified 
underwriting transactions occurring on or after the date of publication 
of the final regulation in the Federal Register.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-19447 Filed 8-9-95; 8:45 am]
BILLING CODE 4830-01-U