[Federal Register Volume 64, Number 113 (Monday, June 14, 1999)]
[Proposed Rules]
[Pages 31770-31772]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-14889]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-115086-98]
RIN 1545-AW55


The Solely for Voting Stock Requirement in Certain Corporate 
Reorganizations

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations relating to the 
solely for voting stock requirement in certain corporate 
reorganizations under section 368(a)(1)(C) of the Internal Revenue 
Code. The proposed regulations provide that prior ownership of a 
portion of a target corporation's stock by an acquiring corporation 
generally will not prevent the solely for voting stock requirement in a 
``C'' reorganization of the target corporation and the acquiring 
corporation from being satisfied. This document also provides notice of 
a public hearing on these proposed regulations.

DATES: Written comments must be received by September 13, 1999. 
Requests to speak and outlines of topics to be discussed at the hearing 
scheduled for October 5, 1999, must be received by September 13, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-115086-98), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-
115086-98), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue 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/tax_regs/
regslist.html. The public hearing will be held in Room 2615, Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Marnie 
Rapaport, (202) 622-7550; concerning submissions of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, Guy R. Traynor, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. General Information

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 368(a)(1)(C) relating to the 
definition of a ``C'' reorganization. A ``C'' reorganization is 
described as the acquisition by one corporation of substantially all of 
the properties of a target corporation in exchange solely for voting 
stock of the acquiring corporation (or solely for voting stock of its 
parent). See section 368(a)(1)(C). The use of money or other property 
will not prevent an exchange from qualifying under section 368(a)(1)(C) 
if at least 80 percent of the gross fair market value of all of the 
property of the target corporation is acquired for voting stock (the 
so-called boot relaxation rule). See section 368(a)(2)(B). The proposed 
regulations provide that prior ownership of a portion of a target 
corporation's stock by an acquiring corporation generally will not 
prevent the solely for voting stock requirement in a ``C'' 
reorganization of the target corporation and the acquiring corporation 
from being satisfied. These regulations propose to reverse the IRS's 
longstanding position that the acquisition of assets of a partially 
controlled subsidiary does not qualify as a tax-free reorganization 
under section 368(a)(1)(C).

B. The Bausch & Lomb Doctrine

    The IRS's position that the acquisition of assets of a partially 
controlled subsidiary does not qualify as a tax-free reorganization 
under section 368(a)(1)(C) is articulated in Rev. Rul. 54-396 (1954-2 
C.B. 147). This position subsequently was sustained in litigation in 
Bausch & Lomb Optical Co. v. Commissioner, 30 T.C. 602 (1958), aff'd, 
267 F.2d 75 (2d Cir.), cert. denied, 361 U.S. 835 (1959) (the Bausch & 
Lomb doctrine). In Rev. Rul. 54-396, a parent corporation owning 79 
percent of the stock of a subsidiary as the result of a prior unrelated 
cash purchase acquires all of the assets of the subsidiary in exchange 
for a block of the parent's voting stock. The block of the parent's 
stock that has been transferred to the subsidiary is then distributed 
in liquidation pro rata to its shareholders. The ruling concludes that 
the transaction does not qualify as a ``C'' reorganization under the 
1939 Internal Revenue Code, but rather is a taxable liquidation of the 
subsidiary. The rationale of the revenue ruling is that the acquisition 
violates the solely for voting stock requirement, because the parent 
corporation acquires only 21 percent of the subsidiary's assets in 
exchange for the parent's voting stock, while the remaining 79 percent 
of the subsidiary's assets is acquired as a liquidating distribution in 
exchange for the previously held stock of the subsidiary.
    In Bausch & Lomb (which had nearly identical facts to Rev. Rul. 54-
396), the parent corporation, Bausch & Lomb, owned 79.9 percent of the 
stock of Riggs Optical Company. In order to acquire the assets of 
Riggs, Bausch & Lomb exchanged shares of its voting stock for all of 
the Riggs assets. Pursuant to a prearranged plan, Riggs subsequently 
was dissolved and distributed its only asset, the Bausch & Lomb shares, 
pro rata to its shareholders. The Tax Court and the Second Circuit 
Court of Appeals sustained the Commissioner's contention that the 
acquisition of the Riggs assets and the dissolution of Riggs should be 
viewed together as part of a single plan, and that the surrender by 
Bausch & Lomb of its Riggs stock constituted nonstock consideration in 
violation of the ``C'' reorganization requirements.

C. The Solely for Voting Stock Requirement

    The ``C'' reorganization first appeared in 1921 when a tax-free 
reorganization was defined as a merger or consolidation ``including the 
acquisition by one corporation * * * of substantially all of the 
properties of another corporation.'' Revenue Act of 1921, section 
202(c)(2), 42 Stat. 227, 230. The statutory language failed to limit 
the type of permissible consideration, arguably allowing an acquisition 
for cash to qualify as a merger.
    In 1934, Congress restricted the permissible consideration in an 
acquisition of a target's stock or assets (in other than a statutory 
merger or consolidation) to voting stock. Revenue Act of 1934, section 
112(g)(1), 48 Stat. 680, 705. The stated purpose for this limitation 
was to ``remove the danger that taxable sales [could] be cast into the 
form of a reorganization.'' See H.R. Rep. No. 704, 73d Cong., 2d Sess. 
12-14 (1934), 1939-1 C.B. (Part 2) 554, 563-565; S. Rep. No. 558, 73d 
Cong., 2d Sess. 16-17 (1934), 1939-1 C.B. (Part 2) 586, 598-599.

D. Reasons for Change

    The legislative history of the ``C'' reorganization provisions 
provides that the purpose of the solely for voting

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stock requirement in section 368(a)(1)(C) is to prevent transactions 
that resemble sales from qualifying for nonrecognition of gain or loss 
available to corporate reorganizations. The IRS and Treasury Department 
have concluded that a transaction in which the acquiring corporation 
converts an indirect ownership interest in assets to a direct interest 
in those assets does not resemble a sale and, thus, have concluded that 
Congress did not intend to disqualify a transaction from qualifying 
under section 368(a)(1)(C) merely because the acquiring corporation has 
prior ownership of a portion of a target corporation's stock. Because 
the judicial doctrine of continuity of interest arose from similar 
concerns, the regulations under Sec. 1.368-1(e)(1)(i) reach a similar 
conclusion with respect to the continuity of interest doctrine.
    Moreover, the taxable treatment of the ``upstream'' ``C'' 
reorganization under the Bausch & Lomb doctrine contrasts with the tax-
free treatment of the ``upstream'' ``A'' reorganization under section 
368(a)(1)(A). See also Rev. Rul. 57-278 (1957-1 C.B. 124) (Bausch & 
Lomb does not apply to an asset acquisition by a newly formed 
corporation in exchange for its parent's stock, even though prior to 
the acquisition the parent already owned 72 percent of the transferor's 
stock). In the ``upstream'' ``A'' reorganization, the indirect interest 
of the parent in the assets of its subsidiary (i.e., the target 
corporation) is converted into a direct interest in the subsidiary's 
assets. An exchange is deemed to occur for purposes of section 354 even 
if, in form, one does not occur. The IRS and Treasury Department have 
concluded that the ``upstream'' reorganization under section 
368(a)(1)(C) (i.e., the Bausch & Lomb transaction) should not be 
treated differently from the ``upstream'' ``A'' reorganization solely 
because the acquiring corporation already owns stock in the target 
corporation. Accordingly, the IRS and Treasury Department have 
concluded that the Bausch & Lomb doctrine does not further the 
principles of reorganization treatment.

Explanation of Provisions

    The proposed regulations provide that preexisting ownership of a 
portion of a target corporation's stock by an acquiring corporation 
generally will not prevent the solely for voting stock requirement in a 
``C'' reorganization from being satisfied. If the boot relaxation rule 
applies, the sum of (i) the money or other property that is distributed 
in pursuance of the plan of reorganization to the shareholders of the 
target corporation other than the acquiring corporation and to the 
creditors of the target corporation pursuant to section 361(b)(3), and 
(ii) the assumption of all the liabilities of the target corporation 
(including liabilities to which the properties of the target 
corporation are subject), cannot exceed 20 percent of the value of all 
of the properties of the target corporation. In this regard, the 
proposed regulations provide that if, in connection with a potential 
``C'' reorganization of a target corporation into an acquiring 
corporation, the acquiring corporation acquires the target 
corporation's stock for consideration other than its own voting stock 
(or voting stock of a corporation in control of the acquiring 
corporation if such stock is used in the acquisition of the target 
corporation's properties), whether from a shareholder of the target 
corporation or from the target corporation itself, such consideration 
will be treated as money or other property exchanged by the acquiring 
corporation for the target corporation's assets. Accordingly, the 
requirements of section 368(a)(1)(C) will not be satisfied unless the 
transaction can qualify under the boot relaxation rule of section 
368(a)(2)(B). The determination of whether there has been an 
acquisition in connection with a potential ``C'' reorganization of a 
target corporation's stock for consideration other than an acquiring 
corporation's own voting stock (or voting stock of a corporation in 
control of the acquiring corporation if such stock is used in the 
acquisition of the target corporation's properties) will be made on the 
basis of all of the facts and circumstances.
    Rev. Rul. 54-396 (1954-2 C.B. 147) will become obsolete when the 
proposed regulations are issued in final form.
    The regulations are proposed to apply to transactions occurring 
after the date that a Treasury decision adopting these rules is 
published in the Federal Register, except that they do not apply to any 
transactions occurring pursuant to a written agreement which is 
(subject to customary conditions) binding on the date the regulations 
are published as final regulations in the Federal Register, and at all 
times thereafter.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these proposed regulations and, because 
the proposed regulations do not impose a collection of information on 
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Therefore, a Regulatory Flexibility Analysis is not 
required. Pursuant to section 7805(f) of the Internal Revenue Code, 
these regulations 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 timely submitted to the IRS. The IRS and 
Treasury request comments on the clarity of the proposed rule and how 
it may be made easier to understand. All comments will be available for 
public inspection and copying.
    A public hearing has been scheduled for October 5, 1999, beginning 
at 10:00 a.m. in Room 2615 of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th Street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must request to speak, and 
submit written comments and an outline of the topics to be discussed 
and the time to be devoted to each topic (signed original and eight (8) 
copies) by September 13, 1999. A period of ten minutes will be 
allocated 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 
Marnie Rapaport of the Office of the Assistant Chief Counsel 
(Corporate), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

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List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

    Par. 2. Section 1.368-2 is amended by adding paragraph (d)(4) to 
read as follows:


Sec. 1.368-2  Definition of terms.

* * * * *
    (d) * * *
    (4) (i) For purposes of paragraphs (d)(1) and (2)(ii) of this 
section, prior ownership of a portion of the stock of the target 
corporation by an acquiring corporation will not by itself prevent the 
solely for voting stock requirement of such paragraphs from being 
satisfied. In a transaction in which the acquiring corporation has 
prior ownership of a portion of the stock of the target corporation, 
the requirement of paragraph (2)(ii) is satisfied only if the sum of 
the money or other property that is distributed in pursuance of the 
plan of reorganization to the shareholders of the target corporation 
other than the acquiring corporation and to the creditors of the target 
corporation pursuant to section 361(b)(3), and all of the liabilities 
of the target corporation assumed by the acquiring corporation 
(including liabilities to which the properties of the target 
corporation are subject), does not exceed 20 percent of the value of 
all of the properties of the target corporation. If, in connection with 
a potential acquisition by an acquiring corporation of substantially 
all of a target corporation's properties, the acquiring corporation 
acquires the target corporation's stock for consideration other than 
the acquiring corporation's own voting stock (or voting stock of a 
corporation in control of the acquiring corporation if such stock is 
used in the acquisition of the target corporation's properties), 
whether from a shareholder of the target corporation or the target 
corporation itself, such consideration is treated, for purposes of 
paragraphs (d)(1) and (2) of this section, as money or other property 
exchanged by the acquiring corporation for the target corporation's 
properties. Accordingly, the transaction will not qualify under section 
368(a)(1)(C) unless, treating such consideration as money or other 
property, the requirements of section 368(a)(2)(B) and paragraph 
(d)(2)(ii) of this section are met. The determination of whether there 
has been an acquisition in connection with a potential reorganization 
under section 368(a)(1)(C) of a target corporation's stock for 
consideration other than an acquiring corporation's own voting stock 
(or voting stock of a corporation in control of the acquiring 
corporation if such stock is used in the acquisition of the target 
corporation's properties) will be made on the basis of all of the facts 
and circumstances.
    (ii) The following examples illustrate the principles of this 
paragraph (d)(4):

    Example 1. Corporation P (P) holds 60 percent of the Corporation 
T (T) stock that P purchased several years ago in an unrelated 
transaction. T has 100 shares of stock outstanding. The other 40 
percent of the T stock is owned by Corporation X (X), an unrelated 
corporation. T has properties with a fair market value of $110 and 
liabilities of $10. T transfers all of its properties to P. In 
exchange, P assumes the $10 of liabilities, and transfers to T $30 
of P voting stock and $10 of cash. T distributes the P voting stock 
and $10 of cash to X and liquidates. The transaction satisfies the 
solely for voting stock requirement of paragraph (d)(2)(ii) of this 
section because the sum of $10 of cash paid to X and the assumption 
by P of $10 of liabilities does not exceed 20% of the value of the 
properties of T.
    Example 2. The facts are the same as in Example 1 except that P 
purchased the 60 shares of T for $60 in cash in connection with the 
acquisition of T's assets. The transaction does not satisfy the 
solely for voting stock requirement of paragraph (d)(2)(ii) of this 
section because P is treated as having acquired all of the T assets 
for consideration consisting of $70 of cash, $10 of liability 
assumption and $30 of P voting stock, and the sum of $70 of cash and 
the assumption by P of $10 of liabilities exceeds 20% of the value 
of the properties of T.

    (iii) This paragraph (d)(4) applies to transactions occurring after 
the date these regulations are published as final regulations in the 
Federal Register, except that this paragraph (d)(4) does not apply to 
any transactions occurring pursuant to a written agreement which is 
(subject to customary conditions) binding on the date the regulations 
are published as final regulations in the Federal Register, and at all 
times thereafter.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-14889 Filed 6-11-99; 8:45 am]
BILLING CODE 4830-01-P