[Federal Register Volume 63, Number 3 (Tuesday, January 6, 1998)]
[Rules and Regulations]
[Pages 409-410]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-5]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8752]
RIN 1545-AU67


Reorganizations/ Treatment of Warrants as Securities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that in certain 
instances provide for nonrecognition of gain or loss on the receipt, in 
pursuance of a reorganization, of rights to acquire stock of a 
corporation that is a party to the reorganization. These regulations 
change the existing rules for such rights under sections 354, 355, and 
356 of the Internal Revenue Code. These regulations will affect holders 
of these rights who are involved in corporate reorganizations under 
sections 355 and 368.

DATES: These regulations are effective March 9, 1998.

FOR FURTHER INFORMATION CONTACT: Michael J. Danbury, (202) 622-7750 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On December 23, 1996, the IRS and Treasury Department published a 
notice of proposed rulemaking (REG-249819-96) in the Federal Register 
(61 FR 67508) containing proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 354, 355, and 356, relating 
to exchanges of stock and securities in certain reorganizations and 
corporate divisions. Written and oral comments responding to this 
notice were received. There were no requests to attend a public hearing 
and none was held. After consideration of all comments received, the 
proposed amendments are adopted as revised by this Treasury decision. 
The principal changes to the regulations, as well as the major comments 
and suggestions, are discussed below.

Explanation of Provisions

A. The Proposed Regulations

    In general, sections 354, 355, and 356 provide for nonrecognition 
of gain or loss, in whole or in part, to a stockholder or security 
holder on the exchange of stock or securities of parties to a 
reorganization and in pursuance of a plan of reorganization.
    The proposed regulations would extend the nonrecognition rule of 
sections 354, 355, and 356 to certain rights to acquire stock. Thus, 
for purposes of sections 354, 355, and 356, the proposed regulations 
would treat rights to acquire stock issued by a corporation that is a 
party to a reorganization as securities of the corporation with no 
principal amount. The preamble to the proposed regulations provided 
that, for this purpose, the term rights to acquire stock issued by that 
corporation would have the same meaning as the term has in sections 
305(d)(1) and 317(a). In addition, the preamble stated that the 
proposed regulations would have no effect on other Internal Revenue 
Code rules that pertain to securities, including sections 83 and 421 
through 424 and the regulations thereunder.

B. Comments on the Proposed Regulations

1. Elaboration on the Definition of ``Rights To Acquire Stock''
    Commentators recommended that the final regulations include an 
explicit definition of rights to acquire stock. They submitted 
particular examples for inclusion in the definition.
    The final regulations add a cross-reference to sections 305 and 
317(a) in defining rights to acquire stock. This cross-reference should 
provide sufficient guidance in most cases for taxpayers to determine 
the consequences on a receipt of rights. The IRS and Treasury believe 
that illustrating the terms of sections 305 and 317 is outside the 
scope of these regulations. Accordingly, the final regulations provide 
no definition other than the cross-reference.
2. Treatment of Stock-for-Warrant Exchanges
    Section 1.354-1(d), Example 3, states that section 354 does not 
apply to a shareholder's receipt of solely debt securities in exchange 
for stock. Commentators requested confirmation that section 354 also 
does not apply to a shareholder's receipt of solely securities that are 
rights to acquire stock in exchange for stock. The final regulations 
confirm this result in Example 4 to Sec. 1.354-1(d).
3. Effective Date
    These final regulations are effective March 9, 1998. This accords 
with the delayed effective date in the proposed regulations. 
Commentators requested more immediate effectiveness.
    The IRS and Treasury are concerned that taxpayers who have planned 
transactions based on the proposed regulations' delayed effective date 
could be disadvantaged by a change in the effective date. Accordingly, 
the final regulations retain the delayed effective date.
4. Interrelationship With Section 83
    The preamble to the proposed regulations noted that the rules would 
apply to rights to acquire stock only for purposes of sections 354 
through 356, and that such rights may remain subject to other special 
rules under the Internal Revenue Code and the regulations including 
sections 83 and 421 through 424.
    Commentators recommended an explicit statement to that effect in 
the final regulations. The regulations adopt this recommendation.
5. Effect in ``B'' Reorganizations
    Commentators requested a review of published guidance that concerns 
exchanges of rights to acquire stock as part of a larger transaction 
that includes a stock-for-stock reorganization under section 
368(a)(1)(B). The IRS intends to address this issue in the near future.
6. No Principal Amount
    Commentators sought clarification of the proposed rule that rights 
to acquire stock would have no principal amount.

[[Page 410]]

    The IRS and Treasury add Examples 7, 8, and 9 to Sec. 1.356-3(b) to 
illustrate the effect of a right to acquire stock having no principal 
amount.
7. Comments Not Addressed in the Final Regulations
    Comments were received with regard to the tax issues of rights to 
acquire stock under sections 302, 305, 306, and 351. Resolution of 
these issues is beyond the scope of this project and they are not 
addressed herein.
8. Interrelationship With Nonqualified Preferred Stock Provisions
    In connection with the finalization of these regulations, the IRS 
and Treasury became aware that additional rules were needed to 
coordinate these regulations with the treatment of rights to acquire 
nonqualified preferred stock and new sections 354(a)(2)(C), 
355(a)(3)(D), and 356(e). See Sec. 1.356-6T (TD 8753) published 
elsewhere in this issue of the Federal Register.

Special Analyses

    It has been determined that this Treasury decision 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 these regulations do 
not impose a collection of information requirement 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, the notice of 
proposed rulemaking preceding these regulations was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.
    Drafting Information: The principal author of these regulations is 
Michael J. Danbury of the Office of Assistant Chief Counsel 
(Corporate). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

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

    Par 2. Section 1.354-1 is amended by:
    1. In paragraph (d), redesignating Example (1) through Example (3) 
as Example 1 through Example 3.
    2. Adding Example 4 to paragraph (d).
    3. Revising paragraph (e).
    The addition and revision read as follows:


Sec. 1.354-1  Exchanges of stock and securities in certain 
reorganizations.

* * * * *
    (d) * * *
    Example 4. The facts are the same as in Example 3 of this 
paragraph (d), except that C receives solely rights to acquire stock 
in Corporation Z. Section 354 does not apply.

    (e) Except as provided in Sec. 1.356-6T, for purposes of section 
354, the term securities includes rights issued by a party to the 
reorganization to acquire its stock. For purposes of this section and 
section 356(d)(2)(B), a right to acquire stock has no principal amount. 
For this purpose, rights to acquire stock has the same meaning as it 
does under sections 305 and 317(a). Other Internal Revenue Code 
provisions governing the treatment of rights to acquire stock may also 
apply to certain exchanges occurring in connection with a 
reorganization. See, for example, sections 83 and 421 through 424 and 
the regulations thereunder. This paragraph (e) applies to exchanges 
occurring on or after March 9, 1998.
    Par 3. Section 1.355-1 is amended by removing the last sentence of 
paragraph (b) and adding paragraph (c) to read as follows:


Sec. 1.355-1  Distribution of stock and securities of a controlled 
corporation.

* * * * *
    (c) Stock rights. Except as provided in Sec. 1.356-6T, for purposes 
of section 355, the term securities includes rights issued by the 
distributing corporation or the controlled corporation to acquire the 
stock of that corporation. For purposes of this section and section 
356(d)(2)(B), a right to acquire stock has no principal amount. For 
this purpose, rights to acquire stock has the same meaning as it does 
under sections 305 and 317(a). Other Internal Revenue Code provisions 
governing the treatment of rights to acquire stock may also apply to 
certain distributions occurring in connection with a transaction 
described in section 355. See, for example, sections 83 and 421 through 
424 and the regulations thereunder. This paragraph (c) applies to 
distributions occurring on or after March 9, 1998.
    Par 4. Section 1.356-3 is amended by:
    1. Redesignating paragraph (b) as paragraph (c).
    2. Adding a new paragraph (b).
    3. In newly designated paragraph (c), redesignating Example (1) 
through Example (6) as Example 1 through Example 6.
    4. Revising paragraph (c) introductory text.
    5. Adding Example 7 through Example 9 to paragraph (c).
    The revisions and additions read as follows:


Sec. 1.356-3  Rules for treatment of securities as ``other property.''

* * * * *
    (b) Except as provided in Sec. 1.356-6T, for purposes of this 
section, a right to acquire stock that is treated as a security for 
purposes of section 354 or 355 has no principal amount. Thus, such 
right is not other property when received in a transaction to which 
section 356 applies (regardless of whether securities are surrendered 
in the exchange). This paragraph (b) applies to transactions occurring 
on or after March 9, 1998.
    (c) In the examples in this paragraph (c), stock means common stock 
and warrants means rights to acquire common stock. The following 
examples illustrate the rules of paragraph (a) of this section:
* * * * *
    Example 7. G, an individual, exchanged stock for stock and a 
warrant. The warrant had no principal amount. Thus, G received no 
excess principal amount within the meaning of section 356(d).
    Example 8. H, an individual, exchanged a warrant for stock and a 
warrant. The warrants had no principal amount. Thus, H received no 
excess principal amount within the meaning of section 356(d).
    Example 9. I, an individual, exchanged a warrant for stock and a 
debt security. The warrant had no principal amount. The debt 
security had a $100 principal amount. I received $100 of excess 
principal amount within the meaning of section 356(d).
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
    Approved: December 17, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-5 Filed 1-5-98; 8:45 am]
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