[Federal Register Volume 62, Number 10 (Wednesday, January 15, 1997)]
[Proposed Rules]
[Pages 2064-2068]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-771]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209121-89]
RIN 1545-AN21


Certain Asset Transfers to a Tax-Exempt Entity

AGENCY: Internal Revenue Service (IRS), Treasury.

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

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations. The proposed 
regulations effectuate provisions of the Tax Reform Act of 1986 and the 
Technical and Miscellaneous Revenue Act of 1988. The proposed 
regulations generally affect a taxable corporation that transfers all 
or substantially all of its assets to a tax-exempt entity or converts 
from a taxable corporation to a

[[Page 2065]]

tax-exempt entity, and generally require the taxable corporation to 
recognize gain or loss in such a transaction.

DATES: Written comments must be received by April 15, 1997. Requests to 
speak (with outlines of oral comments to be discussed) at the public 
hearing scheduled for May 6, 1997, at 10:00 a.m. must be submitted by 
April 15, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209121-89), Room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions also may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209121-89), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Ave. NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in the IRS Auditorium, 
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Stephen R. 
Cleary (202) 622-7530; concerning submissions and the hearing, 
Evangelista Lee, (202) 622-7180, (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) relating to the repeal of the General 
Utilities doctrine in the Tax Reform Act of 1986. Under the General 
Utilities doctrine, which took its name from General Utilities & 
Operating Co. v. Helvering, 296 U.S. 200 (1935), corporations were not 
required to recognize gain or loss when they distributed appreciated or 
depreciated property to their shareholders. The General Utilities 
doctrine applied to distributions of property in complete liquidation, 
certain sales of property that were in connection with a complete 
liquidation, and nonliquidating distributions of property. It was 
codified in former sections 311, 336, and 337 of the Internal Revenue 
Code of 1954.
    The General Utilities doctrine was an exception to the general rule 
that income earned by a corporation is taxed twice, once to the 
corporation when the income is earned and a second time to the 
corporation's shareholders when the earnings are distributed. The 
General Utilities doctrine generally permitted the permanent 
elimination of corporate-level tax on the disposition of appreciated 
assets because the transferee received a fair market value basis in the 
assets and the corporation generally did not recognize any gain. Thus, 
the appreciated assets left corporate solution without any corporate-
level tax having been paid.
    Beginning in 1969, the scope of the General Utilities doctrine was 
restricted by a series of amendments (initially relating to 
nonliquidating distributions governed by section 311), until ultimately 
the General Utilities doctrine was repealed, with limited exceptions, 
in the Tax Reform Act of 1986. Sections 336 and 337 were amended to 
generally require corporations to recognize gain or loss when 
appreciated or depreciated property is distributed in complete 
liquidation or sold in connection with a complete liquidation.
    Section 337(a) provides one of the limited exceptions from the 
repeal of the General Utilities doctrine by allowing a subsidiary to 
liquidate into its 80-percent distributee (a corporation meeting the 
stock ownership requirements of section 332(b) in the liquidating 
corporation) without recognizing gain or loss. The 80-percent 
distributee takes a carryover basis in the distributed property. 
However, under section 337(b)(2), this nonrecognition exception 
generally does not apply if the 80-percent distributee is a tax-exempt 
entity.
    The Tax Reform Act of 1986 added section 337(d), directing the 
Secretary to prescribe regulations as may be necessary to carry out the 
purposes of the repeal of the General Utilities doctrine. The 
legislative history of the Tax Reform Act of 1986 indicates that the 
General Utilities doctrine was repealed because it tended to undermine 
the corporate income tax by allowing appreciated property to leave 
corporate solution without imposition of a corporate level tax. H.R. 
Rep. No. 99-426, 99th Cong., 1st Sess. 282 (1985). The Technical and 
Miscellaneous Revenue Act of 1988 amended section 337(d) to specify 
that the section authorizes regulations to ``ensure that these purposes 
shall not be circumvented * * * through the use of a * * * tax-exempt 
entity.'' The legislative history concerning the 1988 amendment to 
section 337(d) explains:

    The bill also clarifies in connection with the built-in gain 
provisions of the Act that the Treasury Department shall prescribe 
such regulations as may be necessary or appropriate to carry out 
those provisions * * *. For example, this includes rules to require 
the recognition of gain if appreciated property of a C corporation 
is transferred to a * * * tax-exempt entity [footnote 32] in a 
carryover basis transaction that would otherwise eliminate corporate 
level tax on the built-in appreciation.
    [footnote 32] The Act generally requires recognition of gain if 
a C corporation transfers appreciated assets to a tax exempt entity 
in a section 332 liquidation. See Code section 337(b)(2).

S. Rep. No. 145, 100th Cong., 2d Sess. 66 (1988).

Explanation of Provision

    An acquisition by a tax-exempt entity of all or substantially all 
of the assets of a taxable corporation or a change in status of a 
taxable corporation to a tax-exempt entity, like a liquidation into an 
80-percent tax-exempt distributee that is taxable under section 
337(b)(2), could eliminate the corporate level tax on the appreciation 
in the taxable corporation's assets. Accordingly, the proposed 
regulations apply rules similar to section 337(b)(2) to these 
transactions. The proposed regulations generally do not affect the tax 
treatment of the taxable corporation's shareholders or the availability 
of any charitable contribution deduction.
    The proposed regulations provide that a taxable corporation that 
transfers all or substantially all of its assets to one or more tax-
exempt entities is required to recognize gain or loss as if the assets 
transferred were sold at their fair market values. Like section 
337(b)(2), the proposed regulations provide that no gain or loss will 
be recognized on any of the assets transferred that are used by the 
tax-exempt entity in an activity the income from which is subject to 
the unrelated business tax under section 511(a). However, gain on such 
assets will later be recognized as unrelated business taxable income if 
the tax-exempt entity disposes of the assets or ceases to use the 
assets in an unrelated trade or business activity.
    The proposed regulations generally treat a taxable corporation that 
changes its status to a tax-exempt entity as having transferred all of 
its assets to a tax-exempt entity immediately before the change in 
status becomes effective, irrespective of whether an actual transfer of 
the assets has occurred. For this purpose, if a state, a political 
subdivision thereof, or an entity any portion of whose income is 
excluded from gross income under section 115, acquires the stock of a 
taxable corporation and thereafter any of the taxable corporation's 
income is excluded from gross income under section 115, the taxable 
corporation will be treated as if it transferred all of its assets to a 
tax-exempt entity

[[Page 2066]]

immediately before the stock acquisition.
    Certain exceptions are provided to the change in status rule for 
organizations that are tax-exempt or are seeking tax-exempt status 
under section 501(a). These exceptions provide relief for corporations 
needing a brief start-up period to establish their tax-exempt status 
and for those that temporarily lose their tax-exempt status. Under the 
proposed regulations, the change in status rule does not apply to a 
corporation that is tax-exempt within three taxable years of the 
taxable year of its formation, or to a corporation that regains its 
tax-exempt status within three years after either a final adverse 
adjudication on its tax-exempt status or filing a tax return as a 
taxable corporation. The change in status rule also does not apply to 
an organization that before publication of these proposed regulations 
was exempt or unsuccessfully applied for exemption, if the organization 
is tax-exempt within three years after the date of publication of final 
regulations. An organization that files for recognition of its exempt 
status during one of the three-year periods will be deemed to have or 
regain tax-exempt status if the application ultimately results in 
recognition as of a date during the three-year period. An anti-abuse 
rule makes all these exceptions unavailable to a taxable corporation 
that acquires all or substantially all of the assets of another taxable 
corporation and then changes its status with a principal purpose of 
avoiding the gain or loss recognition rule made applicable by these 
regulations.
    The proposed regulations disallow the recognition of loss if assets 
are acquired by the taxable corporation in a section 351 transaction or 
a contribution to capital, or if assets are distributed by the taxable 
corporation to a shareholder, with a principal purpose to recognize 
loss by the taxable corporation on the transfer of its assets to a tax-
exempt entity (loss limitation rule). For example, the loss limitation 
rule may apply if (a) a loss asset is contributed to a taxable 
corporation and then is transferred with substantially all of the 
taxable corporation's assets to a tax-exempt entity; (b) loss assets 
not constituting substantially all of a taxable corporation's assets 
are contributed to a new subsidiary and then the new subsidiary 
transfers the loss assets which are its only assets to a tax-exempt 
entity, or (c) assets are distributed by a taxable corporation to its 
parent and then the taxable corporation transfers loss assets now 
constituting substantially all of its assets to a tax-exempt entity. 
For purposes of the loss limitation rule, the principles of section 
336(d)(2) apply.
    Under the proposed regulations, a ``taxable corporation'' is any 
corporation that is not a tax-exempt entity as defined in the proposed 
regulations. Thus, taxable corporations include all S corporations 
whether or not subject to tax on built-in gain under section 1374. 
After the repeal of the General Utilities doctrine, an S corporation 
like a C corporation is required to recognize gain or loss when it 
liquidates. This gain or loss passes through to the S corporation's 
shareholders under section 1366. The proposed regulations parallel this 
treatment.
    Under the proposed regulations, a ``tax-exempt entity'' includes 
organizations exempt from tax under section 501, section 527, section 
528, or section 529; Federal, state, and local governments; Indian 
tribal governments and federally chartered Indian tribal corporations; 
foreign governments and international organizations; and entities any 
portion of whose income is excluded from gross income under section 
115. The term does not, however, include a cooperative described in 
section 521, paralleling the exception to section 337(b)(2).
    A transaction conveying all or substantially all of the assets of a 
taxable corporation to an Indian tribal government or a corporation 
organized under section 17 of the Indian Reorganization Act (IRA) or 
section 3 of the Oklahoma Welfare Act (OWA) will be covered by these 
regulations. Rev. Rul. 94-16, 1994-1 C.B. 19, held that an 
unincorporated Indian tribe or a corporation organized under section 17 
of the IRA is not subject to federal income tax, but a corporation 
wholly owned by an Indian tribe and organized under state law is 
subject to federal income tax. Rev. Rul. 94-65, 1994-2 C.B. 14, held 
that a corporation organized under section 3 of the OWA also was not 
subject to federal income tax. In that ruling, the Service announced 
that an Indian tribe seeking to dissolve a corporation organized under 
state law and organized into a federally chartered corporation 
(corporation organized under either section 17 of the IRA or section 3 
of the OWA) will be granted relief under section 7805(b) of the Code 
upon application for such relief provided it demonstrates to the 
Service that it has acted reasonably and in good faith to achieve the 
dissolution and organization. The relief described in that ruling 
applied to taxes on income earned after September 30, 1994, by a 
corporation organized by an Indian tribe under state law from income 
earned within the boundaries of the reservation (including gain or loss 
properly allocable to such activities from the sale or exchange of 
assets). The Service intends to provide similar relief from tax 
resulting from any gain or loss recognized under the rules provided in 
these regulations. The relief will be available to state law 
corporations wholly owned by Indian tribes that have acted reasonably 
and in good faith to dissolve and reorganize as federally chartered 
corporations.

Proposed Effective Date

    These regulations are proposed to be applicable for transfers of 
assets as described in the regulations occurring after [date that is 30 
days after publication in the Federal Register of these regulations as 
final regulations], unless the transfer is pursuant to a written 
agreement which is (subject to customary conditions) binding on or 
before [date that is 30 days after publication in the Federal Register 
of these regulations as final regulations].

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 has also been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these regulations and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. Chapter 6) does not 
apply. 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 IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Tuesday, May 6, 1997, at 10 
a.m. in the IRS Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Because of access 
restrictions, visitors will not be admitted beyond the Internal Revenue 
Service Building lobby more than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.

[[Page 2067]]

    Persons that wish to present oral comments at the hearing must 
submit written comments by April 15, 1997, and submit an outline of the 
topics to be discussed and the time to be devoted to each topic (signed 
original and eight (8) copies) by April 15, 1997.
    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 author of these regulations 
is Stephen R. Cleary of the Office of Assistant Chief Counsel 
(Corporate), IRS. However, other personnel from the IRS and the 
Treasury Department 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 I--INCOME TAXES

    Paragraph 1. The authority citation for 26 CFR Part 1 is amended by 
adding an entry in numerical order to read as follows:

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

    Section 1.337(d)-4 also issued under 26 U.S.C. 337 * * *.
    Par. 2. Section 1.337(d)-4 is added to read as follows:


Sec. 1.337(d)-4  Taxable to tax-exempt.

    (a) Gain or loss recognition--(1) General rule. If a taxable 
corporation transfers all or substantially all of its assets to one or 
more tax-exempt entities, the taxable corporation must recognize gain 
or loss immediately before the transfer as if the assets transferred 
were sold at their fair market values. But see section 267 and 
paragraph (d) of this section concerning limitations on the recognition 
of loss.
    (2) Change in corporation's tax status treated as asset transfer. 
Except as provided in paragraph (a)(3) of this section, a taxable 
corporation's change in status to a tax-exempt entity will be treated 
as if it transferred all of its assets to a tax-exempt entity 
immediately before the change in status becomes effective in a 
transaction to which paragraph (a)(1) of this section applies. For 
purposes of this paragraph (a), if a state, a political subdivision 
thereof, or an entity any portion of whose income is excluded from 
gross income under section 115, acquires the stock of a taxable 
corporation and thereafter any of the taxable corporation's income is 
excluded from gross income under section 115, the taxable corporation 
will be treated as if it transferred all of its assets to a tax-exempt 
entity immediately before the stock acquisition.
    (3) Exceptions for certain changes in status--(i) To whom 
available. Paragraph (a)(2) of this section does not apply to the 
following corporations--
    (A) A corporation previously exempt under section 501(a) which 
regains its tax-exempt status under section 501(a) within three years 
from the later of a final adverse adjudication on the corporation's tax 
exempt status, or the filing by the corporation, or by the Secretary or 
his delegate under section 6020(b), of a federal income tax return of 
the type filed by a taxable corporation;
    (B) A newly-formed corporation that is tax-exempt under section 
501(a) within three taxable years from the end of the taxable year in 
which it was formed;
    (C) A corporation previously exempt under section 501(a) or that 
applied for but did not receive recognition of exemption under section 
501(a), before January 15, 1997, if such corporation is tax-exempt 
under section 501(a) within three years from [date of publication of 
these regulations in the Federal Register as final regulations].
    (ii) Application for recognition. An organization is deemed to have 
or regain tax-exempt status within one of the three-year periods 
described in paragraph (a)(3)(i) of this section if it files an 
application for recognition of exemption with the Commissioner within 
the three-year period and the application either results in a 
determination by the Commissioner or a final adjudication that the 
organization is tax-exempt under section 501(a) during any part of the 
three-year period. The preceding sentence does not require the filing 
of an application for recognition of exemption by any organization not 
otherwise required, such as by Sec. 1.501(a)-1, Sec. 1.505(c)-1T, and 
Sec. 1.508-1(a), to apply for recognition of exemption.
    (iii) Anti-abuse rule. This paragraph (a)(3) does not apply to a 
corporation that, with a principal purpose of avoiding the application 
of paragraphs (a)(1) and (a)(2) of this section, acquires all or 
substantially all of the assets of another taxable corporation and then 
changes its status to that of a tax-exempt entity.
    (4) Related transactions. This section applies to any series of 
related transactions having an effect similar to any of the 
transactions to which this section applies.
    (b) Exceptions. Paragraph (a) of this section does not apply to--
    (1) Any assets transferred to a tax-exempt entity if the assets are 
used in an activity the income from which is subject to tax under 
section 511(a). However, if assets on which no gain or loss was 
recognized by reason of the preceding sentence are disposed of by the 
tax-exempt entity, then, notwithstanding any other provision of law, 
any gain (not in excess of the amount not recognized by reason of the 
preceding sentence) shall be included in the tax-exempt entity's 
unrelated business taxable income. If the tax-exempt entity ceases to 
use the assets in an activity the income from which is subject to tax 
under section 511(a), the entity will be treated for purposes of this 
subparagraph as having disposed of the assets on the date of the 
cessation;
    (2) Any transfer of assets to the extent gain or loss otherwise is 
recognized by the taxable corporation on the transfer. See, for 
example, sections 336, 337(b)(2), 367, and 1001;
    (3) Any forfeiture of a taxable corporation's assets in a criminal 
or civil action to the United States, the government of a possession of 
the United States, a state, the District of Columbia, the government of 
a foreign country, or a political subdivision of any of the foregoing; 
or any expropriation of a taxable corporation's assets by the 
government of a foreign country; and
    (4) Any transfer of assets to a cooperative described in section 
521.
    (c) Definitions. For purposes of this section--
    (1) Taxable corporation. A taxable corporation is any corporation 
that is not a tax-exempt entity as defined in paragraph (c)(2) of this 
section.
    (2) Tax-exempt entity. A tax-exempt entity is--
    (i) Any entity that is exempt from tax under section 501(a), 
section 527, section 528, or section 529;
    (ii) A charitable remainder annuity trust or charitable remainder 
unitrust as defined in section 664(d);
    (iii) The United States, the government of a possession of the 
United States, a state, the District of Columbia, the government of a 
foreign country, or a political subdivision of any of the foregoing;
    (iv) An Indian Tribal Government as defined in section 7701(a)(40), 
a subdivision of an Indian tribal government determined in accordance 
with section 7871(d), or an agency or

[[Page 2068]]

instrumentality of an Indian tribal government or subdivision thereof;
    (v) An Indian Tribal Corporation organized under section 17 of the 
Indian Reorganization Act of 1934, 25 U.S.C. 477, or section 3 of the 
Oklahoma Welfare Act, 25 U.S.C. 503;
    (vi) An international organization as defined in section 
7701(a)(18);
    (vii) An entity any portion of whose income is excluded under 
section 115; or
    (viii) An entity that would not be taxable under the Internal 
Revenue Code for reasons substantially similar to those applicable to 
any entity listed in this paragraph (c)(2) unless otherwise explicitly 
made exempt from the application of this section by statute or by 
action of the Commissioner.
    (3) Substantially all. The term substantially all has the same 
meaning as under section 368(a)(1)(C).
    (d) Loss limitation rule. For purposes of determining the amount of 
loss recognized by a taxable corporation on the transfer of its assets 
to a tax-exempt entity under paragraph (a) of this section, if assets 
are acquired by the taxable corporation in a transaction to which 
section 351 applied or as a contribution to capital, or assets are 
distributed from the taxable corporation to a shareholder or another 
member of the taxable corporation's affiliated group, and in either 
case as part of a plan a principal purpose of which is to recognize 
loss by the taxable corporation on the transfer of its assets to the 
tax-exempt entity, the losses recognized by the taxable corporation on 
the assets transferred to the tax-exempt entity will be disallowed. For 
purposes of the preceding sentence, the principles of section 336(d)(2) 
apply.
    (e) Effective date. This section is applicable for transfers of 
assets as described in paragraph (a) of this section occurring after 
[date that is 30 days after publication in the Federal Register of 
these regulations as final regulations], unless the transfer is 
pursuant to a written agreement which is (subject to customary 
conditions) binding on or before [date that is 30 days after 
publication in the Federal Register of these regulations as final 
regulations].
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 97-771 Filed 1-10-97; 8:45 am]
BILLING CODE 4830-01-U