[Federal Register Volume 63, Number 18 (Wednesday, January 28, 1998)]
[Rules and Regulations]
[Pages 4174-4183]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1819]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8760]
RIN 1545-AU72 and 1545-AU73
Continuity of Interest and Continuity of Business Enterprise
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations providing guidance
regarding satisfaction of the continuity of interest and continuity of
business enterprise requirements for corporate reorganizations. The
final regulations affect corporations and their shareholders.
DATES: These regulations are effective January 28, 1998.
Applicability: These regulations apply to transactions occurring
after January 28, 1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is (subject
to customary conditions) binding on January 28, 1998, and at all times
thereafter.
FOR FURTHER INFORMATION CONTACT: Regarding Sec. 1.368-1(e) (continuity
of interest) Secs. 1.338-2 and 1.368-1 (a) and (b): Phoebe Bennett,
(202) 622-7750 (not a toll-free number); regarding Sec. 1.368-1(d)
(continuity of business enterprise) and, Secs. 1.368-1 (a) and (b),
1.368-2(k): Marlene Peake Oppenheim, (202) 622-7750 (not a toll free
number).
SUPPLEMENTARY INFORMATION:
Background
On December 23, 1996, the IRS published a notice of proposed
rulemaking (REG-252231-96) in the Federal Register (61 FR 67512)
relating to the continuity of interest (COI) requirement (proposed COI
regulations). On January 3, 1997, the IRS published a notice of
proposed rulemaking (REG-252233-96) in the Federal Register (62 FR
36101) (proposed COBE regulations) relating to (1) the continuity of
business enterprise (COBE) requirement; and (2) transfers of acquired
assets or stock following certain otherwise qualifying reorganizations
(remote continuity of interest). Many written comments were received in
response to these notices of proposed rulemaking. A public hearing on
both proposed regulations was held on May 7, 1997. After consideration
of all comments, the regulations proposed by REG-252231-96 and REG-
252233-96 are adopted as revised by this
[[Page 4175]]
Treasury decision, along with temporary regulations and proposed
regulations cross-referencing the temporary regulations regarding COI
published elsewhere in this issue of the Federal Register.
Explanation of Provisions
The Internal Revenue Code of 1986 provides general nonrecognition
treatment for reorganizations specifically described in section 368. In
addition to complying with the statutory requirements and certain other
requirements, a transaction generally must satisfy the continuity of
interest requirement and the continuity of business enterprise
requirement.
A. Continuity of Interest
The purpose of the continuity of interest requirement is to prevent
transactions that resemble sales from qualifying for nonrecognition of
gain or loss available to corporate reorganizations. The final
regulations provide that the COI requirement is satisfied if in
substance a substantial part of the value of the proprietary interest
in the target corporation (T) is preserved in the reorganization. A
proprietary interest in T is preserved if, in a potential
reorganization, it is exchanged for a proprietary interest in the
issuing corporation (P), it is exchanged by the acquiring corporation
for a direct interest in the T enterprise, or it otherwise continues as
a proprietary interest in T. The issuing corporation means the
acquiring corporation (as the term is used in section 368(a)), except
that, in determining whether a reorganization qualifies as a triangular
reorganization (as defined in Sec. 1.358-6(b)(2)), the issuing
corporation means the corporation in control of the acquiring
corporation. However, a proprietary interest in T is not preserved if,
in connection with the potential reorganization, it is acquired by P
for consideration other than P stock, or P stock furnished in exchange
for a proprietary interest in T if the potential reorganization is
redeemed. All facts and circumstances must be considered in determining
whether, in substance, a proprietary interest in T is preserved.
Rationale for the COI Regulations
The proposed and final regulations permit former T shareholders to
sell P stock received in a potential reorganization to third parties
without causing the reorganization to fail to satisfy the COI
requirement. Some commentators have questioned whether the regulations
are consistent with existing authorities.
The COI requirement was applied first to reorganization provisions
that did not specify that P exchange a proprietary interest in P for a
proprietary interest in T. Supreme Court cases imposed the COI
requirement to further Congressional intent that tax-free status be
accorded only to transactions where P exchanges a substantial
proprietary interest in P for a proprietary interest in T held by the T
shareholders rather than to transactions resembling sales. See LeTulle
v. Scofield, 308 U.S. 415 (1940); Helvering v. Minnesota Tea Co., 296
U.S. 378 (1935); Pinellas Ice & Cold Storage Co. v. Commissioner, 287
U.S. 462 (1933). See also Cortland Specialty Co. v. Commissioner, 60
F.2d 937 (2d Cir. 1932), cert. denied 288 U.S. 599 (1933).
None of the Supreme Court cases establishing the COI requirement
addressed the issue of whether sales by former T shareholders of P
stock received in exchange for T stock in the potential reorganization
cause the COI requirement to fail to be satisfied. Since then, however,
some courts have premised decisions on the assumption that sales of P
stock received in exchange for T stock in the potential reorganization
may cause the COI requirement to fail to be satisfied. McDonald's
Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir.
1982); Penrod v. Commissioner, 88 T.C. 1415 (1987); Heintz v.
Commissioner, 25 T.C. 132 (1955), nonacq., 1958-2 C.B. 9; Estate of
Elizabeth Christian v. Commissioner, 57 T.C.M. (CCH) 1231 (1989). The
apparent focus of these cases is on whether the T shareholders intended
on the date of the potential reorganization to sell their P stock and
the degree, if any, to which P facilitates the sale. Based on an
intensive inquiry into nearly identical facts, some of these cases held
that as a result of the subsequent sale the potential reorganization
did not satisfy the COI requirement; others held that satisfaction of
the COI requirement was not adversely affected by the subsequent sale.
The IRS and Treasury Department have concluded that the law as
reflected in these cases does not further the principles of
reorganization treatment and is difficult for both taxpayers and the
IRS to apply consistently.
Therefore, consistent with Congressional intent and the Supreme
Court precedent which distinguishes between sales and reorganizations,
the final regulations focus the COI requirement generally on exchanges
between the T shareholders and P. Under this approach, sales of P stock
by former T shareholders generally are disregarded.
The final regulations will greatly enhance administrability in this
area by both taxpayers and the government. The regulations will prevent
``whipsaw'' of the government, such as where the former T shareholders
treat the transaction as a tax-free reorganization, and P later
disavows reorganization treatment to step up its basis in the T assets
based on the position that sales of P stock by the former T
shareholders did not satisfy the COI requirement. See, e.g., McDonald's
Restaurants, supra. In addition, this approach will prevent unilateral
sales of P stock by former majority T shareholders from adversely
affecting the section 354 nonrecognition treatment expected by former
minority T shareholders.
Dispositions of T Stock
The proposed COI regulations do not specifically address the effect
upon COI of dispositions of T stock prior to a potential
reorganization, but ask for comments on that issue. The IRS and
Treasury Department believe that issues concerning the COI requirement
raised by dispositions of T stock before a potential reorganization
correspond to those raised by subsequent dispositions of P stock
furnished in exchange for T stock in the potential reorganization. As
requested by commentators, the final regulations apply the rationale of
the proposed COI regulations to transactions occurring both prior to
and after a potential reorganization. Cf. J.E. Seagram Corp. v.
Commissioner, 104 T.C. 75 (1995) (sales of T stock prior to a potential
reorganization do not affect COI if not part of the plan of
reorganization). The final regulations provide that, for COI purposes,
a mere disposition of T stock prior to a potential reorganization to
persons not related to P is disregarded and a mere disposition of P
stock received in a potential reorganization to persons not related to
P is disregarded. But see Sec. 1.368-1T(e)(1)(ii)(A) and (B).
In soliciting comments on the effect upon COI of dispositions of T
stock prior to a potential reorganization, the preamble to the proposed
COI regulations specifically requests comments on King Enterprises,
Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969) (COI requirement
satisfied where, pursuant to a plan, P acquires the T stock for 51
percent P stock and 49 percent debt and cash, and T merges upstream
into P), and Yoc Heating Corp. v. Commissioner, 61 T.C. 168 (1973) (COI
requirement not satisfied where, pursuant to a plan, P acquires 85
percent of the T stock for cash and notes, and T merges into P's newly
formed subsidiary with minority
[[Page 4176]]
shareholders receiving cash). Consistent with these cases, where the
step transaction doctrine applies to link T stock purchases with later
acquisitions of T, the final regulations provide that a proprietary
interest in T is not preserved if, in connection with the potential
reorganization, it is acquired by P for consideration other than P
stock. Whether a stock acquisition is made in connection with a
potential reorganization will be determined based on the facts and
circumstances of each case. See generally Sec. 1.368-1(a). This
regulation does not address the effect, if any, of section 338 on
corporate transactions (except for conforming changes to Sec. 1.338-
2(c)(3)). See generally Sec. 1.338-2(c)(3) (certain tax effects of a
qualified stock purchase without a section 338 election on the post-
acquisition elimination of T).
Related Person Rule
The proposed COI regulations provide that ``[i]n determining
whether [COI is satisfied], all facts and circumstances must be
considered, including any plan or arrangement for the acquiring
corporation or its successor corporation (or a person related to the
acquiring corporation or its successor corporation within the meaning
of section 707(b)(1) or 267(b) (without regard to section 267(e))) to
redeem or acquire the consideration provided in the reorganization.''
The final regulations provide a more specific rule that a proprietary
interest in T is not preserved if, in connection with a potential
reorganization, a person related (as defined below) to P acquires, with
consideration other than a proprietary interest in P, T stock or P
stock furnished in exchange for a proprietary interest in T in the
potential reorganization. The IRS and Treasury Department believe,
however, that certain related party acquisitions preserve a proprietary
interest in T and therefore, the rule includes an exception to the
related party rule. Under this exception, a proprietary interest in T
is preserved to the extent those persons who were the direct or
indirect owners of T prior to the potential reorganization maintain a
direct or indirect proprietary interest in P. See, e.g., Rev. Rul. 84-
30 (1984-1 C.B. 114).
Commentators stated that the proposed COI regulations' rule, which
employs sections 707(b)(1) and 267(b) to define persons related to P,
is too broad. In response, the final regulations adopt a narrower
related person definition which has two components in order to address
two separate concerns.
First, the IRS and Treasury Department were concerned that
acquisitions of T or P stock by a member of P's affiliated group were
no different in substance from an acquisition or redemption by P,
because of the existence of various provisions in the Code that permit
members to transfer funds to other members without significant tax
consequences. Accordingly, Sec. 1.368-1(e)(3)(i)(A) includes as related
persons corporations that are members of the same affiliated group
under section 1504, without regard to the exceptions in section
1504(b).
Second, because the final regulations take into account whether, in
substance, P has redeemed the stock it exchanged for T stock in the
potential reorganization, the final regulations treat two corporations
as related persons if a purchase of the stock of one corporation by
another corporation would be treated as a distribution in redemption of
the stock of the first corporation under section 304(a)(2) (determined
without regard to Sec. 1.1502-80(b)).
Because the final regulations focus generally on the consideration
P exchanges, related persons do not include individual or other
noncorporate shareholders. Thus, the IRS will no longer apply the
holdings of South Bay Corporation v. Commissioner, 345 F.2d 698 (2d
Cir. 1965), and Superior Coach of Florida, Inc. v. Commissioner, 80
T.C. 895 (1983), to transactions governed by these regulations.
T Stock Not Acquired in Connection With a Potential Reorganization
Commentators requested clarification of whether P must actually
furnish stock to T shareholders that own T stock which was not acquired
in connection with a potential reorganization. The final regulations
provide that a proprietary interest in T is preserved if it is
exchanged by the acquiring corporation (which may or may not also be P)
for a direct interest in the T enterprise, or otherwise continues as a
proprietary interest in T.
Redemptions of T Stock or Extraordinary Distributions With Respect to T
Stock
In addition to the final regulations, the IRS and Treasury
Department are contemporaneously issuing temporary regulations and
proposed regulations cross-referencing the temporary regulations
published elsewhere in this issue of the Federal Register with the same
effective date as these final regulations. The temporary and proposed
regulations provide that a proprietary interest in T is not preserved
if, in connection with a potential reorganization, it is redeemed or
acquired by a person related to T, or to the extent that, prior to and
in connection with a potential reorganization, an extraordinary
distribution is made with respect to it.
Transactions Following a Qualified Stock Purchase
As stated above, these final regulations focus the COI requirement
generally on exchanges between the T shareholders and P. Accordingly,
the language of Sec. 1.338-2(c)(3) is conformed to these final COI
regulations to treat the stock of T acquired by the purchasing
corporation in the qualified stock purchase as though it was not
acquired in connection with the transfer of the T assets.
Effect on Other Authorities
The IRS and Treasury Department continue to study the role of the
COI requirement in section 368(a)(1)(D) reorganizations and section 355
transactions. Therefore, these final COI regulations do not apply to
section 368(a)(1)(D) reorganizations and section 355 transactions. See
Sec. 1.355-2(c).
These COI regulations apply solely for purposes of determining
whether the COI requirement is satisfied. No inference should be drawn
from any provision of this regulation as to whether other
reorganization requirements are satisfied, for example, whether P has
issued solely voting stock for purposes of section 368(a)(1)(B) or (C).
Effect on Other Documents
Rev. Proc. 77-37 (1977-2 C.B. 568) and Rev. Proc. 86-42 (1986-2
C.B. 722) will be modified to the extent inconsistent with these
regulations.
Rev. Rul. 66-23 (1966-1 C.B. 67) is hereby obsoleted because it
indicates that a plan or arrangement in connection with a potential
reorganization for disposition of stock to unrelated persons does not
satisfy the COI requirement.
B. Continuity of Business Enterprise
The COBE requirement is fundamental to the notion that tax-free
reorganizations merely readjust continuing interests in property. In
Sec. 1.368-1(d), as effective prior to these final regulations, COBE
generally required the acquiring corporation to either continue a
significant historic T business or use a significant portion of T's
historic business assets in a business. However, a valid reorganization
may qualify as tax-free even if the acquiring corporation does
[[Page 4177]]
not directly carry on the historic T business or use the historic T
assets in a business. See section 368(a)(2)(C). See also Rev. Rul. 68-
261 (1968-1 C.B. 147); Rev. Rul. 81-247 (1981-1 C.B. 87).
Consistent with the view that the acquiring corporation need not
directly conduct the T business or use the T assets, the final
regulations provide rules under which, in an otherwise qualifying
corporate reorganization, the assets and the businesses of the members
of a qualified group of corporations are treated as assets and
businesses of the issuing corporation. Accordingly, in the final
regulations, COBE requires that the issuing corporation either continue
T's historic business or use a significant portion of T's historic
business assets in a business.
A qualified group is one or more chains of corporations connected
through stock ownership with the issuing corporation, but only if the
issuing corporation owns directly stock meeting the requirements of
section 368(c) in at least one of the corporations, and stock meeting
the requirements of section 368(c) in each of the corporations is owned
directly by one of the other corporations.
The judicial continuity of interest doctrine historically included
a concept commonly known as remote continuity of interest. Commonly
viewed as arising out of Groman v. Commissioner, 302 U.S. 82 (1937),
and Helvering v. Bashford, 302 U.S. 454 (1938), remote continuity of
interest focuses on the link between the T shareholders and the former
T business assets following the reorganization. In Sec. 1.368-1(d), as
effective prior to these final regulations, COBE focuses on the
continuation of T's business, or the use of T's business assets, by the
acquiring corporation. Section 1.368-1(d), as revised herein, expands
this concept by treating the issuing corporation as conducting a T
business or owning T business assets if these activities are conducted
by a member of the qualified group or, in certain cases, by a
partnership that has a member of the qualified group as a partner.
The proposed COBE regulations separately address COBE (Sec. 1.368-
1(d)) and remote continuity of interest (Sec. 1.368-1(f)). The IRS and
Treasury Department believe the COBE requirements adequately address
the issues raised in Groman and Bashford and their progeny. Thus, these
final regulations do not separately articulate rules addressing remote
continuity of interest.
Definition of the Qualified Group
The proposed COBE regulations define the qualified group using a
control test based on section 368(c). The IRS and Treasury Department
received comments suggesting the replacement of the section 368(c)
definition of control by the affiliated group definition of control
stated in section 1504, without regard to section 1504(b). However,
because section 368 generally determines control by reference to
section 368(c), the final regulations retain the approach of the
proposed COBE regulations.
Rules for Aggregation of Interests in Historic T Assets and Businesses
Held in Partnership Solution
In determining whether COBE is satisfied, the proposed COBE
regulations aggregate the interests of the members of a qualified
group. In addition, the proposed COBE regulations attribute a business
of a partnership to a corporate transferor partner if the partner has a
sufficient nexus with that partnership business. However, the proposed
COBE regulations only consider the transferor partner's interest in the
partnership business, and do not aggregate this interest with interests
in the partnership held by other members of the qualified group.
In response to comments requesting a partnership aggregation rule,
the final regulations, through a system of attribution, aggregate the
interests in a partnership business held by all the members of a
qualified group. The final regulations provide rules under which a
corporate partner may be treated as holding assets of a business of a
partnership. Additionally, P is treated as holding all the assets, and
conducting all the businesses of its qualified group. Furthermore, in
certain circumstances, P will be treated as conducting a business of a
partnership. Once the relevant T businesses and T assets are attributed
to P, COBE is tested under the general rule of the final COBE
regulations. See Sec. 1.368-1(d)(1).
The proposed COBE regulations do not discuss tiered partnerships.
In response to comments, the final regulations provide guidance on this
issue. See Sec. 1.368-1(d)(5), Example 12.
C. Transfers of Assets or Stock to Controlled Corporations as Part of a
Plan of Reorganization
The proposed COBE regulations are limited in their application to
COBE and remote continuity of interest. The rules of the proposed COBE
regulations provide that for certain reorganizations, transfers of
acquired assets or stock among members of the qualified group, and in
certain cases, transfers of acquired assets to partnerships, do not
disqualify a transaction from satisfying the COBE and remote continuity
of interest requirements. The preamble to the proposed COBE regulations
states that these rules do not address any other issues concerning the
qualification of a transaction as a reorganization.
Comments suggest that the proposed COBE regulations are ambiguous
as they could be interpreted to mean that a transfer of stock or assets
to a qualified group member after an otherwise tax-free reorganization
would be given independent significance and the step transaction
doctrine would not apply. Under such an interpretation, the potential
reorganization would not be recast as a taxable acquisition or another
type of reorganization. To eliminate this ambiguity, Sec. 1.368-1(a) of
the final regulations provides that, in determining whether a
transaction qualifies as a reorganization under section 368(a), the
transaction must be evaluated under relevant provisions of law,
including the step transaction doctrine. Section 1.368-1(d) of the
final regulations is limited to a discussion of the COBE requirement,
and does not address satisfaction of the explicit statutory
requirements of a reorganization, which is the subject of Sec. 1.368-2.
However, Sec. 1.368-2(k) of the final regulations does provide guidance
in this regard, extending the application of section 368(a)(2)(C) to
certain successive transfers.
Section 1.368-2(k) of the final regulations states that a
transaction otherwise qualifying under section 368(a)(1) (A), (B), (C),
or (G) (where the requirements of sections 354(b)(1) (A) and (B) are
met) shall not be disqualified by reason of the fact that part or all
of the acquired assets or stock acquired in the transaction are
transferred or successively transferred to one or more corporations
controlled in each transfer by the transferor corporation. Control is
defined under section 368(c). The final regulations also provide a rule
for transfers of assets following a reorganization qualifying under
section 368(a)(1)(A) by reason of section 368(a)(2)(E). No inference is
to be drawn as to whether transactions not described in Sec. 1.368-2(k)
otherwise qualify as reorganizations.
The final regulations also provide that, if a transaction otherwise
qualifies as a reorganization, a corporation remains a party to the
reorganization even though stock or assets acquired in the
reorganization are transferred in a transaction described in
Sec. 1.368-2(k).
[[Page 4178]]
See Sec. 1.368-2(f). Furthermore, if a transaction otherwise qualifies
as a reorganization, a corporation shall not cease to be a party to the
reorganization solely because acquired assets are transferred to a
partnership in which the transferor is a partner if the COBE
requirement is satisfied.
Section 368(a)(1)(D), 368(a)(1)(F), and 355 Transactions
The proposed COBE regulations, applying only to the COBE and remote
continuity of interest requirements, are limited to transactions
otherwise qualifying for reorganization treatment under section
368(a)(1) (A), (B), (C), or (G) (where the requirements of sections
354(b)(1) (A) and (B) are met). The IRS and Treasury Department
received comments stating that the final regulations should apply to
reorganizations qualifying under section 368(a)(1) (D) or (F) or to
transactions qualifying under section 355.
The final regulations do not limit the application of Sec. 1.368-
1(d) to the transactions enumerated in section 368(a)(2)(C). The COBE
provisions in the final regulations apply to all reorganizations for
which COBE is relevant.
Section 1.368-2(k)(1) of the final regulations, however, is limited
in its application to the transactions described in section
368(a)(2)(C), and does not apply in determining whether a
reorganization qualifies under section 368(a)(1)(D), section
368(a)(1)(F), or section 355. The IRS and Treasury Department believe
that further study is needed prior to extending Sec. 1.368-2(k)(1) to
one or more of these provisions.
Effective Date
The amendments to these regulations apply to transactions occurring
after January 28, 1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is (subject
to customary conditions) binding on January 28, 1998, and at all times
thereafter. Commentators requested that the effective date be changed
to allow these regulations to apply to transactions occurring on or
before January 28, 1998. The IRS and Treasury Department believe that
adopting an earlier effective date increases the likelihood that T, P,
and each of the former T shareholders would report the transaction
inconsistently (in some cases using hindsight), and would reduce
administrability of the regulation. No inference should be drawn from
any provision of this regulation as to application of the COI or COBE
requirements to transactions occurring on or before January 28, 1998.
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 also has 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 regulation does
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, the notices
of proposed rulemaking preceding these regulations were submitted to
the Chief Counsel for Advocacy of the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal authors of these regulations are Phoebe Bennett,
regarding Sec. 1.368-1(e) (continuity of interest), and Marlene Peake
Oppenheim, regarding Sec. 1.368-1(d) (continuity of business
enterprise) and Sec. 1.368-2(k), both of the Office of the Assistant
Chief Counsel (Corporate), IRS. 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 1.338-2 is amended:
1. By revising paragraph (c)(3)(ii).
2. In paragraph (c)(3)(iv) example, by revising the first sentence
of paragraph (B).
The revisions read as follows:
Sec. 1.338-2 Miscellaneous issues under section 338.
* * * * *
(c) * * *
(3) * * *
(ii) Continuity of interest. By virtue of section 338, in
determining whether the continuity of interest requirement of
Sec. 1.368-1 (b) and (e) is satisfied on the transfer of assets from
target to the transferee, the purchasing corporation's target stock
acquired in the qualified stock purchase shall be treated as though it
was not acquired in connection with the transfer of target assets.
* * * * *
(iv) Example. * * *
(B) Status of transfer as a reorganization. By virtue of section
338, for the purpose of determining whether the continuity of interest
requirement of Sec. 1.368-1(b) is satisfied, P's T stock acquired in
the qualified stock purchase shall be treated as though it was not
acquired in connection with the transfer of T assets to X. * * *
* * * * *
Par. 3. Section 1.368-1 is amended by:
1. Adding three sentences immediately following the first sentence
of paragraph (a).
2. Removing the third sentence and adding four sentences in its
place to paragraph (b).
3. Removing paragraph (d)(1).
4. Redesignating paragraphs (d)(2), (d)(3), and (d)(4) as
paragraphs (d)(1), (d)(2), and (d)(3), respectively.
5. Removing the first sentence of newly designated paragraph (d)(1)
and adding two sentences in its place.
6. Adding new paragraph (d)(4).
7. Paragraph (d)(5) is amended by:
a. Adding two sentences to the end of paragraph (d)(5) introductory
text.
b. Removing the parentheses around the numbers in the paragraph
headings for Example (1) through Example (5).
c. Adding Example 6 through Example 12.
8. Adding paragraph (e).
The additions and revisions read as follows:
Sec. 1.368-1 Purpose and scope of exception of reorganization
exchanges.
(a) * * * In determining whether a transaction qualifies as a
reorganization under section 368(a), the transaction must be evaluated
under relevant provisions of law, including the step transaction
doctrine. But see Secs. 1.368-2 (f) and (k) and 1.338-2(c)(3). The
preceding two sentences apply to transactions occurring after January
28, 1998, except that they do not apply to any transaction occurring
pursuant to a written agreement which is binding on January 28, 1998,
and at all times thereafter. * * *
(b) * * * Requisite to a reorganization under the Internal Revenue
Code are a continuity of the business enterprise through the issuing
corporation under the modified corporate form as described in paragraph
(d) of this
[[Page 4179]]
section, and (except as provided in section 368(a)(1)(D)) a continuity
of interest as described in paragraph (e) of this section. (For rules
regarding the continuity of interest requirement under section 355, see
Sec. 1.355-2(c).) For purposes of this section, the term issuing
corporation means the acquiring corporation (as that term is used in
section 368(a)), except that, in determining whether a reorganization
qualifies as a triangular reorganization (as defined in Sec. 1.358-
6(b)(2)), the issuing corporation means the corporation in control of
the acquiring corporation. The preceding three sentences apply to
transactions occurring after January 28, 1998, except that they do not
apply to any transaction occurring pursuant to a written agreement
which is binding on January 28, 1998, and at all times thereafter. * *
*
* * * * *
(d) Continuity of business enterprise--(1) General rule. Continuity
of business enterprise (COBE) requires that the issuing corporation
(P), as defined in paragraph (b) of this section, either continue the
target corporation's (T's) historic business or use a significant
portion of T's historic business assets in a business. The preceding
sentence applies to transactions occurring after January 28, 1998,
except that it does not apply to any transaction occurring pursuant to
a written agreement which is binding on January 28, 1998, and at all
times thereafter. * * *
* * * * *
(4) Acquired assets or stock held by members of the qualified group
or partnerships. The following rules apply in determining whether the
COBE requirement of paragraph (d)(1) of this section is satisfied:
(i) Businesses and assets of members of a qualified group. The
issuing corporation is treated as holding all of the businesses and
assets of all of the members of the qualified group, as defined in
paragraph (d)(4)(ii) of this section.
(ii) Qualified group. A qualified group is one or more chains of
corporations connected through stock ownership with the issuing
corporation, but only if the issuing corporation owns directly stock
meeting the requirements of section 368(c) in at least one other
corporation, and stock meeting the requirements of section 368(c) in
each of the corporations (except the issuing corporation) is owned
directly by one of the other corporations.
(iii) Partnerships--(A) Partnership assets. Each partner of a
partnership will be treated as owning the T business assets used in a
business of the partnership in accordance with that partner's interest
in the partnership.
(B) Partnership businesses. The issuing corporation will be treated
as conducting a business of a partnership if --
(1) Members of the qualified group, in the aggregate, own an
interest in the partnership representing a significant interest in that
partnership business; or
(2) One or more members of the qualified group have active and
substantial management functions as a partner with respect to that
partnership business.
(C) Conduct of the historic T business in a partnership. If a
significant historic T business is conducted in a partnership, the fact
that P is treated as conducting such T business under paragraph
(d)(4)(iii)(B) of this section tends to establish the requisite
continuity, but is not alone sufficient.
(iv) Effective date. This paragraph (d)(4) applies to transactions
occurring after January 28, 1998, except that it does not apply to any
transaction occurring pursuant to a written agreement which is binding
on January 28, 1998, and at all times thereafter.
(5) * * * All corporations have only one class of stock
outstanding. The preceding sentence and paragraph (d)(5) Example 6
through Example 12 apply to transactions occurring after January 28,
1998, except that they do not apply to any transaction occurring
pursuant to a written agreement which is binding on January 28, 1998,
and at all times thereafter.
* * * * *
Example 6. Use of a significant portion of T's historic business
assets by the qualified group. (i) Facts. T operates an auto parts
distributorship. P owns 80 percent of the stock of a holding company
(HC). HC owns 80 percent of the stock of ten subsidiaries, S-1
through S-10. S-1 through S-10 each separately operate a full
service gas station. Pursuant to a plan of reorganization, T merges
into P and the T shareholders receive solely P stock. As part of the
plan of reorganization, P transfers T's assets to HC, which in turn
transfers some of the T assets to each of the ten subsidiaries. No
one subsidiary receives a significant portion of T's historic
business assets. Each of the subsidiaries will use the T assets in
the operation of its full service gas station. No P subsidiary will
be an auto parts distributor.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(i) of this section, P is treated as conducting the ten gas
station businesses of S-1 through S-10 and as holding the historic T
assets used in those businesses. P is treated as holding all the
assets and conducting the businesses of all of the members of the
qualified group, which includes S-1 through S-10 (paragraphs
(d)(4)(i) and (ii) of this section). No member of the qualified
group continues T's historic distributorship business. However,
subsidiaries S-1 through S-10 continue to use the historic T assets
in a business. Even though no one corporation of the qualified group
is using a significant portion of T's historic business assets in a
business, the COBE requirement of paragraph (d)(1) of this section
is satisfied because, in the aggregate, the qualified group is using
a significant portion of T's historic business assets in a business.
Example 7. Continuation of the historic T business in a
partnership satisfies continuity of business enterprise. (i) Facts.
T manufactures ski boots. P owns all of the stock of S-1. S-1 owns
all of the stock of S-2, and S-2 owns all of the stock of S-3. T
merges into P and the T shareholders receive consideration
consisting of P stock and cash. The T ski boot business is to be
continued and expanded. In anticipation of this expansion, P
transfers all of the T assets to S-1, S-1 transfers all of the T
assets to S-2, and S-2 transfers all of the T assets to S-3. S-3 and
X (an unrelated party) form a new partnership (PRS). As part of the
plan of reorganization, S-3 transfers all the T assets to PRS, and
S-3, in its capacity as a partner, performs active and substantial
management functions for the PRS ski boot business, including making
significant business decisions and regularly participating in the
overall supervision, direction, and control of the employees of the
ski boot business. S-3 receives a 20 percent interest in PRS. X
transfers cash in exchange for an 80 percent interest in PRS.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(B)(2) of this section, P is treated as conducting T's
historic business because S-3 performs active and substantial
management functions for the ski boot business in S-3's capacity as
a partner. P is treated as holding all the assets and conducting the
businesses of all of the members of the qualified group, which
includes S-3 (paragraphs (d)(4)(i) and (ii) of this section). The
COBE requirement of paragraph (d)(1) of this section is satisfied.
Example 8. Continuation of the historic T business in a
partnership does not satisfy continuity of business enterprise. (i)
Facts. The facts are the same as Example 7 except that S-3 transfers
the historic T business to PRS in exchange for a 1 percent interest
in PRS.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(B)(2) of this section, P is treated as conducting T's
historic business because S-3 performs active and substantial
management functions for the ski boot business in S-3's capacity as
a partner. The fact that a significant historic T business is
conducted in PRS, and P is treated as conducting such T business
under (d)(4)(iii)(B) tends to establish the requisite continuity,
but is not alone sufficient (paragraph (d)(4)(iii)(C) of this
section). The COBE requirement of paragraph (d)(1) of this section
is not satisfied.
Example 9. Continuation of the T historic business in a
partnership satisfies continuity of business enterprise. (i) Facts.
The facts are the same as Example 7 except that S-3 transfers the
historic T business to PRS in
[[Page 4180]]
exchange for a 33\1/3\ percent interest in PRS, and no member of P's
qualified group performs active and substantial management functions
for the ski boot business operated in PRS.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(B)(1) of this section, P is treated as conducting T's
historic business because S-3 owns an interest in the partnership
representing a significant interest in that partnership business. P
is treated as holding all the assets and conducting the businesses
of all of the members of the qualified group, which includes S-3
(paragraphs (d)(4)(i) and (ii) of this section). The COBE
requirement of paragraph (d)(1) of this section is satisfied.
Example 10. Use of T's historic business assets in a partnership
business. (i) Facts. T is a fabric distributor. P owns all of the
stock of S-1. T merges into P and the T shareholders receive solely
P stock. S-1 and X (an unrelated party) own interests in a
partnership (PRS). As part of the plan of reorganization, P
transfers all of the T assets to S-1, and S-1 transfers all the T
assets to PRS, increasing S-1's percentage interest in PRS from 5 to
33\1/3\ percent. After the transfer, X owns the remaining 66\2/3\
percent interest in PRS. Almost all of the T assets consist of T's
large inventory of fabric, which PRS uses to manufacture sportswear.
All of the T assets are used in the sportswear business. No member
of P's qualified group performs active and substantial management
functions for the sportswear business operated in PRS.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(A) of this section, S-1 is treated as owning 33\1/3\
percent of the T assets used in the PRS sportswear manufacturing
business. Under paragraph (d)(4)(iii)(B)(1) of this section, P is
treated as conducting the sportswear manufacturing business because
S-1 owns an interest in the partnership representing a significant
interest in that partnership business. P is treated as holding all
the assets and conducting the businesses of all of the members of
the qualified group, which includes S-1 (paragraphs (d)(4)(i) and
(ii) of this section). The COBE requirement of paragraph (d)(1) of
this section is satisfied.
Example 11. Aggregation of partnership interests among members
of the qualified group: use of T's historic business assets in a
partnership business. (i) Facts. The facts are the same as Example
10, except that S-1 transfers all the T assets to PRS, and P and X
each transfer cash to PRS in exchange for partnership interests.
After the transfers, P owns 11 percent, S-1 owns 22\1/3\ percent,
and X owns 66\2/3\ percent of PRS.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(B)(1) of this section, P is treated as conducting the
sportswear manufacturing business because members of the qualified
group, in the aggregate, own an interest in the partnership
representing a significant interest in that business. P is treated
as owning 11 percent of the assets directly, and S-1 is treated as
owning 22\1/3\ percent of the assets, used in the PRS sportswear
business (paragraph (d)(4)(iii)(A) of this section). P is treated as
holding all the assets of all of the members of the qualified group,
which includes S-1, and thus in the aggregate, P is treated as
owning 33\1/3\ of the T assets (paragraphs (d)(4)(i) and (ii) of
this section). The COBE requirement of paragraph (d)(1) of this
section is satisfied because P is treated as using a significant
portion of T's historic business assets in its sportswear
manufacturing business.
Example 12. Tiered partnerships: use of T's historic business
assets in a partnership business. (i) Facts. T owns and manages a
commercial office building in state Z. Pursuant to a plan of
reorganization, T merges into P, solely in exchange for P stock,
which is distributed to the T shareholders. P transfers all of the T
assets to a partnership, PRS-1, which owns and operates television
stations nationwide. After the transfer, P owns a 50 percent
interest in PRS-1. P does not have active and substantial management
functions as a partner with respect to the PRS-1 business. X, not a
member of P's qualified group, owns the remaining 50 percent
interest in PRS-1. PRS-1, in an effort to expand its state Z
television operation, enters into a joint venture with U, an
unrelated party. As part of the plan of reorganization, PRS-1
transfers all the T assets and its state Z television station to
PRS-2, in exchange for a 75 percent partnership interest. U
contributes cash to PRS-2 in exchange for a 25 percent partnership
interest and oversees the management of the state Z television
operation. PRS-1 does not actively and substantially manage PRS-2's
business. PRS-2's state Z operations are moved into the acquired T
office building. All of the assets that P acquired from T are used
in PRS-2's business.
(ii) Continuity of business enterprise. Under paragraph
(d)(4)(iii)(A) of this section, PRS-1 is treated as owning 75
percent of the T assets used in PRS-2's business. P, in turn, is
treated as owning 50 percent of PRS-1's interest the T assets. Thus,
P is treated as owning 37\1/2\ percent (50 percent x 75 percent) of
the T assets used in the PRS-2 business. Under paragraph
(d)(4)(iii)(B)(1) of this section, P is treated as conducting PRS-
2's business, the operation of the state Z television station, and
under paragraph (d)(4)(iii)(A) of this section, P is treated as
using 37\1/2\ percent of the historic T business assets in that
business. The COBE requirement of paragraph (d)(1) of this section
is satisfied because P is treated as using a significant portion of
T's historic business assets in its television business.
(e) Continuity of interest--(1) General rule. (i) The purpose of
the continuity of interest requirement is to prevent transactions that
resemble sales from qualifying for nonrecognition of gain or loss
available to corporate reorganizations. Continuity of interest requires
that in substance a substantial part of the value of the proprietary
interests in the target corporation be preserved in the reorganization.
A proprietary interest in the target corporation is preserved if, in a
potential reorganization, it is exchanged for a proprietary interest in
the issuing corporation (as defined in paragraph (b) of this section),
it is exchanged by the acquiring corporation for a direct interest in
the target corporation enterprise, or it otherwise continues as a
proprietary interest in the target corporation. However, a proprietary
interest in the target corporation is not preserved if, in connection
with the potential reorganization, it is acquired by the issuing
corporation for consideration other than stock of the issuing
corporation, or stock of the issuing corporation furnished in exchange
for a proprietary interest in the target corporation in the potential
reorganization is redeemed. All facts and circumstances must be
considered in determining whether, in substance, a proprietary interest
in the target corporation is preserved. For purposes of the continuity
of interest requirement, a mere disposition of stock of the target
corporation prior to a potential reorganization to persons not related
(as defined in paragraph (e)(3) of this section determined without
regard to paragraph (e)(3)(i)(A) of this section) to the target
corporation or to persons not related (as defined in paragraph (e)(3)
of this section) to the issuing corporation is disregarded and a mere
disposition of stock of the issuing corporation received in a potential
reorganization to persons not related (as defined in paragraph (e)(3)
of this section) to the issuing corporation is disregarded.
(ii) [Reserved] For further guidance see Sec. 1.368-1T(e)(1)(ii)(A)
and (B).
(2) Related person acquisitions. (i) A proprietary interest in the
target corporation is not preserved if, in connection with a potential
reorganization, a person related (as defined in paragraph (e)(3) of
this section) to the issuing corporation acquires, with consideration
other than a proprietary interest in the issuing corporation, stock of
the target corporation or stock of the issuing corporation furnished in
exchange for a proprietary interest in the target corporation in the
potential reorganization, except to the extent those persons who were
the direct or indirect owners of the target corporation prior to the
potential reorganization maintain a direct or indirect proprietary
interest in the issuing corporation.
(ii) [Reserved] For further guidance see Sec. 1.368-1T(e)(2)(ii).
(3) Definition of related person--(i) In general. For purposes of
this paragraph (e), two corporations are related persons if either--
(A) The corporations are members of the same affiliated group as
defined in
[[Page 4181]]
section 1504 (determined without regard to section 1504(b)); or
(B) A purchase of the stock of one corporation by another
corporation would be treated as a distribution in redemption of the
stock of the first corporation under section 304(a)(2) (determined
without regard to Sec. 1.1502-80(b)).
(ii) Special rules. The following rules apply solely for purposes
of this paragraph (e)(3):
(A) A corporation will be treated as related to another corporation
if such relationship exists immediately before or immediately after the
acquisition of the stock involved.
(B) A corporation, other than the target corporation or a person
related (as defined in paragraph (e)(3) of this section determined
without regard to paragraph (e)(3)(i)(A) of this section) to the target
corporation, will be treated as related to the issuing corporation if
the relationship is created in connection with the potential
reorganization.
(4) Acquisitions by partnerships. For purposes of this paragraph
(e), each partner of a partnership will be treated as owning or
acquiring any stock owned or acquired, as the case may be, by the
partnership in accordance with that partner's interest in the
partnership. If a partner is treated as acquiring any stock by reason
of the application of this paragraph (e)(4), the partner is also
treated as having furnished its share of any consideration furnished by
the partnership to acquire the stock in accordance with that partner's
interest in the partnership.
(5) Successors and predecessors. For purposes of this paragraph
(e), any reference to the issuing corporation or the target corporation
includes a reference to any successor or predecessor of such
corporation, except that the target corporation is not treated as a
predecessor of the issuing corporation and the issuing corporation is
not treated as a successor of the target corporation.
(6) Examples. For purposes of the examples in this paragraph
(e)(6), P is the issuing corporation, T is the target corporation, S is
a wholly owned subsidiary of P, all corporations have only one class of
stock outstanding, A and B are individuals, PRS is a partnership, all
reorganization requirements other than the continuity of interest
requirement are satisfied, and the transaction is not otherwise subject
to recharacterization. The following examples illustrate the
application of this paragraph (e):
Example 1. Sale of stock to third party. (i) Sale of issuing
corporation stock after merger. A owns all of the stock of T. T
merges into P. In the merger, A receives P stock having a fair
market value of $50x and cash of $50x. Immediately after the merger,
and pursuant to a preexisting binding contract, A sells all of the P
stock received by A in the merger to B. Assume that there are no
facts and circumstances indicating that the cash used by B to
purchase A's P stock was in substance exchanged by P for T stock.
Under paragraphs (e)(1) and (2) of this section, the sale to B is
disregarded because B is not a person related to P within the
meaning of paragraph (e)(3) of this section. Thus, the transaction
satisfies the continuity of interest requirement because 50 percent
of A's T stock was exchanged for P stock, preserving a substantial
part of the value of the proprietary interest in T.
(ii) Sale of target corporation stock before merger. The facts
are the same as paragraph (i) of this Example 1, except that B buys
A's T stock prior to the merger of T into P and then exchanges the T
stock for P stock having a fair market value of $50x and cash of
$50x. The sale by A is disregarded. The continuity of interest
requirement is satisfied because B's T stock was exchanged for P
stock, preserving a substantial part of the value of the proprietary
interest in T.
Example 2. Relationship created in connection with potential
reorganization. A owns all of the stock of T. X, a corporation which
owns 60 percent of the P stock and none of the T stock, buys A's T
stock for cash prior to the merger of T into P. X exchanges the T
stock solely for P stock in the merger which, when combined with X's
prior ownership of P stock, constitutes 80 percent of the stock of
P. X is a person related to P under paragraphs (e)(3)(i)(A) and
(ii)(B) of this section, because X becomes affiliated with P in the
merger. The continuity of interest requirement is not satisfied,
because X acquired a proprietary interest in T for consideration
other than P stock, and a substantial part of the value of the
proprietary interest in T is not preserved. See paragraph (e)(2) of
this section.
Example 3. Participation by issuing corporation in post-merger
sale. A owns 80 percent of the T stock and none of the P stock,
which is widely held. T merges into P. In the merger, A receives P
stock. In addition, A obtains rights pursuant to an arrangement with
P to have P register the P stock under the Securities Act of 1933,
as amended. P registers A's stock, and A sells the stock shortly
after the merger. No person who purchased the P stock from A is a
person related to P within the meaning of paragraph (e)(3) of this
section. Under paragraphs (e)(1) and (2) of this section, the sale
of the P stock by A is disregarded because no person who purchased
the P stock from A is a person related to P within the meaning of
paragraph (e)(3) of this section. The transaction satisfies the
continuity of interest requirement because A's T stock was exchanged
for P stock, preserving a substantial part of the value of the
proprietary interest in T.
Example 4. Redemptions and purchases by issuing corporation or
related persons. (i) Redemption by issuing corporation. A owns 100
percent of the stock of T and none of the stock of P. T merges into
S. In the merger, A receives P stock. In connection with the merger,
P redeems all of the P stock received by A in the merger for cash.
The continuity of interest requirement is not satisfied, because, in
connection with the merger, P redeemed the stock exchanged for a
proprietary interest in T, and a substantial part of the value of
the proprietary interest in T is not preserved. See paragraph (e)(1)
of this section.
(ii) Purchase of target corporation stock by issuing
corporation. The facts are the same as paragraph (i) of this Example
4, except that, instead of P redeeming its stock, prior to and in
connection with the merger of T into S, P purchases 90 percent of
the T stock from A for cash. The continuity of interest requirement
is not satisfied, because in connection with the merger, P acquired
a proprietary interest in T for consideration other than P stock,
and a substantial part of the value of the proprietary interest in T
is not preserved. See paragraph (e)(1) of this section. However, see
Sec. 1.338-2(c)(3) (which may change the result in this case by
providing that, by virtue of section 338, continuity of interest is
satisfied for certain parties after a qualified stock purchase).
(iii) Purchase of issuing corporation stock by person related to
issuing corporation. The facts are the same as paragraph (i) of this
Example 4, except that, instead of P redeeming its stock, S buys all
of the P stock received by A in the merger for cash. S is a person
related to P under paragraphs (e)(3)(i)(A) and (B) of this section.
The continuity of interest requirement is not satisfied, because S
acquired P stock issued in the merger, and a substantial part of the
value of the proprietary interest in T is not preserved. See
paragraph (e)(2) of this section.
Example 5. Redemption in substance by issuing corporation. A
owns 100 percent of the stock of T and none of the stock of P. T
merges into P. In the merger, A receives P stock. In connection with
the merger, B buys all of the P stock received by A in the merger
for cash. Shortly thereafter, in connection with the merger, P
redeems the stock held by B for cash. Based on all the facts and
circumstances, P in substance has exchanged solely cash for T stock
in the merger. The continuity of interest requirement is not
satisfied, because in substance P redeemed the stock exchanged for a
proprietary interest in T, and a substantial part of the value of
the proprietary interest in T is not preserved. See paragraph (e)(1)
of this section.
Example 6. Purchase of issuing corporation stock through
partnership. A owns 100 percent of the stock of T and none of the
stock of P. S is an 85 percent partner in PRS. The other 15 percent
of PRS is owned by unrelated persons. T merges into P. In the
merger, A receives P stock. In connection with the merger, PRS
purchases all of the P stock received by A in the merger for cash.
Under paragraph (e)(4) of this section, S, as an 85 percent partner
of PRS, is treated as having acquired 85 percent of the P stock
exchanged for A's T stock in the merger, and as having furnished 85
percent of the cash paid by PRS to acquire the P stock. S is a
person related to P under paragraphs
[[Page 4182]]
(e)(3)(i)(A) and (B) of this section. The continuity of interest
requirement is not satisfied, because S is treated as acquiring 85
percent of the P stock issued in the merger, and a substantial part
of the value of the proprietary interest in T is not preserved. See
paragraph (e)(2) of this section.
Example 7. Exchange by acquiring corporation for direct
interest. A owns 30 percent of the stock of T. P owns 70 percent of
the stock of T, which was not acquired by P in connection with the
acquisition of T's assets. T merges into P. A receives cash in the
merger. The continuity of interest requirement is satisfied, because
P's 70 percent proprietary interest in T is exchanged by P for a
direct interest in the assets of the target corporation enterprise.
Example 8. Effect of general stock repurchase program. T merges
into P, a corporation whose stock is widely held and publicly traded
and that has one class of common stock outstanding. In the merger, T
shareholders receive common stock of P. Immediately after the
merger, P repurchases a small percentage of its common stock in the
open market as part of its ongoing stock repurchase program. The
repurchase program was not created or modified in connection with
the acquisition of T. Continuity of interest is satisfied, because
based on all of the facts and circumstances, the redemption of a
small percentage of the P stock does not affect the T shareholders'
proprietary interest in T, because it was not in connection with the
merger, and the value of the proprietary interest in T is preserved.
See paragraph (e)(1) of this section.
Example 9. Maintenance of direct or indirect interest in issuing
corporation. X, a corporation, owns all of the stock of each of
corporations P and Z. Z owns all of the stock of T. T merges into P.
Z receives P stock in the merger. Immediately thereafter and in
connection with the merger, Z distributes the P stock received in
the merger to X. X is a person related to P under paragraph
(e)(3)(i)(A) of this section. The continuity of interest requirement
is satisfied, because X was an indirect owner of T prior to the
merger who maintains a direct or indirect proprietary interest in P,
preserving a substantial part of the value of the proprietary
interest in T. See paragraph (e)(2) of this section.
(7) Effective date. This paragraph (e) applies to transactions
occurring after January 28, 1998, except that it does not apply to any
transaction occurring pursuant to a written agreement which is binding
on January 28, 1998, and at all times thereafter.
Par. 4. Section 1.368-2 is amended by:
1. Removing the second sentence of paragraph (a) and adding two
sentences in its place.
2. Removing the second sentence of paragraph (f) and adding four
sentences in its place.
3. Removing the second sentence in paragraph (j)(1).
4. Revising paragraph (j)(3)(ii).
5. Revising the first sentence in paragraph (j)(3)(iii).
6. Adding paragraph (j)(3)(iv).
7. Removing paragraph (j)(4).
8. Redesignating paragraphs (j)(5), (j)(6), and (j)(7) as (j)(4),
(j)(5), and (j)(6), respectively.
9. Removing the parentheses around the numbers in the paragraph
headings for Example (1) through Example (9) in newly designated
paragraph (j)(6).
10. Adding paragraph (k).
The additions and revisions read as follows:
Sec. 1.368-2 Definition of terms.
(a) * * * The term does not embrace the mere purchase by one
corporation of the properties of another corporation. The preceding
sentence applies to transactions occurring after January 28, 1998,
except that it does not apply to any transaction occurring pursuant to
a written agreement which is binding on January 28, 1998, and at all
times thereafter. * * *
* * * * *
(f) * * * If a transaction otherwise qualifies as a reorganization,
a corporation remains a party to the reorganization even though stock
or assets acquired in the reorganization are transferred in a
transaction described in paragraph (k) of this section. If a
transaction otherwise qualifies as a reorganization, a corporation
shall not cease to be a party to the reorganization solely by reason of
the fact that part or all of the assets acquired in the reorganization
are transferred to a partnership in which the transferor is a partner
if the continuity of business enterprise requirement is satisfied. See
Sec. 1.368-1(d). The preceding three sentences apply to transactions
occurring after January 28, 1998, except that they do not apply to any
transaction occurring pursuant to a written agreement which is binding
on January 28, 1998, and at all times thereafter. * * *
* * * * *
(j) * * *
(3) * * *
(ii) Except as provided in paragraph (k)(2) of this section, the
controlling corporation must control the surviving corporation
immediately after the transaction.
(iii) After the transaction, except as provided in paragraph (k)(2)
of this section, the surviving corporation must hold substantially all
of its own properties and substantially all of the properties of the
merged corporation (other than stock of the controlling corporation
distributed in the transaction). * * *
(iv) Paragraphs (j)(3)(ii) and (iii) of this section apply to
transactions occurring after January 28, 1998, except that they do not
apply to any transaction occurring pursuant to a written agreement
which is binding on January 28, 1998, and at all times thereafter.
* * * * *
(k) Transfer of assets or stock in section 368(a)(1)(A), (B), (C),
or (G) reorganizations--(1) General rule for transfers to controlled
corporations. Except as otherwise provided in this section, a
transaction otherwise qualifying under section 368(a)(1)(A), (B), (C),
or (G) (where the requirements of sections 354(b)(1)(A) and (B) are
met) shall not be disqualified by reason of the fact that part or all
of the acquired assets or stock acquired in the transaction are
transferred or successively transferred to one or more corporations
controlled in each transfer by the transferor corporation. Control is
defined under section 368(c).
(2) Transfers following a reverse triangular merger. A transaction
qualifying under section 368(a)(1)(A) by reason of the application of
section 368(a)(2)(E) is not disqualified by reason of the fact that
part or all of the stock of the surviving corporation is transferred or
successively transferred to one or more corporations controlled in each
transfer by the transferor corporation, or because part or all of the
assets of the surviving corporation or the merged corporation are
transferred or successively transferred to one or more corporations
controlled in each transfer by the transferor corporation.
(3) Examples. The following examples illustrate the application of
this paragraph (k). P is the issuing corporation and T is the target
corporation. P has only one class of stock outstanding. The examples
are as follows:
Example 1. Transfers of acquired assets to controlled
corporations. (i) Facts. T operates a bakery which supplies
delectable pastries and cookies to local retail stores. The
acquiring corporate group produces a variety of baked goods for
nationwide distribution. P owns 80 percent of the stock of S-1.
Pursuant to a plan of reorganization, T transfers all of its assets
to S-1 solely in exchange for P stock, which T distributes to its
shareholders. S-1 owns 80 percent of the stock of S-2; S-2 owns 80
percent of the stock of S-3, which also makes and supplies pastries
and cookies. Pursuant to the plan of reorganization, S-1 transfers
the T assets to S-2; S-2 transfers the T assets to S-3.
(ii) Analysis. Under this paragraph (k), the transaction,
otherwise qualifying as a reorganization under section 368(a)(1)(C),
is not disqualified by reason of the fact of the successive
transfers of all of the acquired assets from S-1 to S-2, and from S-
2 to S-3 because in each transfer, the transferee corporation is
controlled by the transferor
[[Page 4183]]
corporation. Control is defined under section 368(c).
Example 2. Transfers of acquired stock to controlled
corporations. (i) Facts. The facts are the same as Example 1 except
that S-1 acquires all of the T stock rather than the T assets, and
as part of the plan of reorganization, S-1 transfers all of the T
stock to S-2, and S-2 transfers all of the T stock to S-3.
(ii) Analysis. Under this paragraph (k), the transaction,
otherwise qualifying as a reorganization under section 368(a)(1)(B),
is not disqualified by reason of the fact of the successive
transfers of all of the acquired stock from S-1 to S-2, and from S-2
to S-3 because in each transfer, the transferee corporation is
controlled by the transferor corporation.
Example 3. Transfers of acquired stock to partnerships. (i)
Facts. The facts are the same as in Example 2. However, as part of
the plan of reorganization, S-2 and S-3 form a new partnership, PRS.
Immediately thereafter, S-3 transfers all of the T stock to PRS in
exchange for an 80 percent partnership interest, and S-2 transfers
cash to PRS in exchange for a 20 percent partnership interest.
(ii) Analysis. This paragraph (k) describes the successive
transfer of the T stock to S-3, but does not describe S-3's transfer
of the T stock to PRS. Therefore, the characterization of this
transaction must be determined under the relevant provisions of law,
including the step transaction doctrine. See Sec. 1.368-1(a). The
transaction fails to meet the control requirement of a
reorganization described in section 368(a)(1)(B) because immediately
after the acquisition of the T stock, the acquiring corporation does
not have control of T.
(4) This paragraph (k) applies to transactions occurring after
January 28, 1998, except that it does not apply to any transaction
occurring pursuant to a written agreement which is binding on January
28, 1998, and at all times thereafter.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: January 12, 1998.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-1819 Filed 1-23-98; 12:15 pm]
BILLING CODE 4830-01-U