[Federal Register Volume 64, Number 163 (Tuesday, August 24, 1999)]
[Proposed Rules]
[Pages 46155-46165]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21876]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-116733-98]
RIN 1545-AW79


Guidance Under Section 355(e); Recognition of Gain on Certain 
Distributions of Stock or Securities in Connection With an Acquisition

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 
recognition of gain on certain distributions of stock or securities of 
a controlled corporation in connection with an acquisition. Changes to 
the applicable law were made by the Taxpayer Relief Act of 1997. These 
proposed regulations affect corporations and are necessary to provide 
them with guidance needed to comply with these changes. This document 
also provides notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by January 5, 
2000. Outlines of topics to be discussed at the public hearing 
scheduled for January 26, 2000, at 10 a.m. must be received by January 
5, 2000.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-116733-98), 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-
116733-98), 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 proposed regulations, 
Brendan O'Hara, (202) 622-7530; concerning submissions of comments, 
delivering comments, the hearing, and/or to be placed on the building 
access list to attend the hearing, LaNita Van Dyke, (202) 622-7190 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. State of the Law Before Section 355(e)

    Section 355 generally provides that, if a corporation distributes 
to its shareholders stock of a corporation which it controls 
immediately before the distribution and certain other conditions are 
met, neither the distributing corporation nor its shareholders 
recognize gain or loss. A number of the conditions for tax free 
treatment (for example, the continuity of interest requirement of 
Sec. 1.355-2(c), the ``no device'' requirement of section 355(a)(1)(B), 
the five-year active business requirement of section 355(b), and the 
limitation on disqualified stock under section 355(d)) operate to limit 
the circumstances in which the distributing or controlled corporation 
can undergo changes of control in conjunction with a distribution that 
qualifies for corporate and shareholder-level nonrecognition under 
section 355. Nevertheless, prior to the enactment of section 355(e), it 
was possible for such changes to occur, for example, in the context of 
tax free reorganizations, while qualifying for tax free treatment under 
section 355. See, e.g., Commissioner v. Mary Archer W. Morris Trust, 
367 F.2d 794 (4th Cir. 1966).

B. Legislative Proposals Leading to Section 355(e)

    As part of its Fiscal Year 1997 Budget, the Administration proposed 
a provision that would require a distributing corporation to recognize 
gain on the distribution of a controlled

[[Page 46156]]

corporation's stock unless the direct and indirect shareholders of the 
distributing corporation, as a group, controlled at least 50 percent of 
the vote and value of both corporations at all times during the 4-year 
period beginning 2 years before the distribution. See Department of the 
Treasury, General Explanation of the Administration's Revenue 
Proposals, p. 86 (March 1996) (hereinafter referred to as the 
``Administration Proposal''). Under the Administration Proposal, the 
retained 50-percent interest must consist of ``permissible stock,'' 
which includes, in addition to stock retained over the 4-year period, 
stock of the distributing or controlled corporation ``received by the 
shareholder in a transaction which is unrelated to the distribution * * 
*.'' Revenue Proposals Contained in President Clinton's Budget Plan as 
Released on Mar. 19, 1996, Sec. 9522, [1996] 83 Stand. Fed. Tax Rep. 
(CCH) No. 15A.
    The Administration Proposal described an unrelated transaction as, 
``[a] transaction that is not pursuant to a common plan or arrangement 
that includes the distribution,'' and cited a hostile acquisition of 
the distributing or controlled corporation commencing after the 
distribution as an example of an unrelated transaction. The 
Administration Proposal contrasted this with a friendly acquisition, 
which generally would be considered related to the distribution if the 
acquisition was pursuant to an arrangement negotiated prior to the 
distribution, even if the acquisition was subject to various conditions 
at the time of the distribution.
    On April 17, 1997, House Ways and Means Committee Chairman Archer 
and Senate Finance Committee Chairman Roth and Ranking Member Moynihan 
introduced identical bills (H.R. 1365, 105th Cong. (1997) and S. 612, 
105th Cong. (1997), hereinafter referred to as the ``Bills'') that 
provided for a new section 355(e) that is similar to the enacted 
version. The Bills were concerned with a ``plan (or series of related 
transactions) pursuant to which a person acquires stock representing a 
50-percent or greater interest in the distributing corporation or any 
controlled corporation * * *.'' S. 612, 105th Cong. (1997). The 
introductory statement to the legislation contained a reference to 
acquisitions ``pursuant to a plan or arrangement in existence on the 
date of distribution * * *.'' The statement further explained: 
``Whether a corporation is acquired would be determined under rules 
similar to those of present-law section 355(d), except that 
acquisitions would not be restricted to purchase transactions. Thus an 
acquisition would occur if a person--or persons acting in concert--* * 
* acquired * * * stock * * * pursuant to a plan or arrangement.'' See 
143 Cong. Rec. E703 (Apr. 17, 1997) (introductory statement of Chairman 
Archer); 143 Cong. Rec. S3360 (Apr. 17, 1997) (introductory statement 
of Chairman Roth).

C. Enactment of Section 355(e)

    Section 355(e) was enacted in 1997. Public Law 105-34, section 
1012(a) (1997). The committee reports state that section 355 was 
intended to permit the tax free division of existing business 
arrangements among existing shareholders. The reports state that ``[i]n 
cases in which it is intended that new shareholders will acquire 
ownership of a business in connection with a spin off, the transaction 
more closely resembles a corporate level disposition of the portion of 
the business that is acquired'' and provide that gain is recognized 
``if, pursuant to a plan or arrangement in existence on the date of 
distribution, either the controlled or distributing corporation is 
acquired * * *.'' H.R. Rep. No. 105-148, at 462 (1997); see also S. 
Rep. No. 105-33, at 139-40 (1997) (slight variation in language). The 
Conference Report adds, ``[a]s under the House bill and Senate 
amendment, a public offering of sufficient size can result in an 
acquisition that causes gain recognition under the provision.'' H.R. 
Conf. Rep. No. 105-220, at 533 (1997).
    The statute as enacted contained two important changes from the 
Administration Proposal and Bills relevant to determining whether an 
acquisition is part of a plan (or series of related transactions) that 
includes the distribution. In the Bills, proposed sections 
355(e)(2)(A)(ii) and (4)(C)(i) provided that a ``person,'' as modified 
by section 355(d)(7), must acquire 50 percent or more of the 
distributing or controlled corporation. The term ``plan or 
arrangement'' used in section 355(d)(7)(B) treats two or more persons 
acting ``pursuant to a plan or arrangement'' with regard to a stock 
acquisition as one person. However, when section 355(e) was enacted, 
the reference in section 355(e)(2)(A)(ii) to acquisitions by a 
``person'' was changed to ``1 or more persons.'' In addition, the 
reference to section 355(d)(7)(B) (treating two or more persons acting 
``pursuant to a plan or arrangement'' as one person) was deleted from 
section 355(e)(4)(C)(i). The effect of these two changes is to remove 
the requirement that 50 percent or more of the stock of the 
distributing or controlled corporation must be acquired by acquirors 
acting in concert for section 355(e) to apply.
    In addition, the reference in the Conference Report to public 
offerings as transactions that could cause gain to be recognized under 
section 355(e) indicates Congress did not believe negotiations between 
the distributing corporation and an acquiror were necessary in order 
for an acquisition to be pursuant to a plan that included the 
distribution. Thus, to determine whether a plan of acquisition exists, 
one must look at all parties to the transaction, including the 
distributing and controlled corporations and their shareholders, not 
just the potential acquirors.
    As enacted, section 355(e)(1) provides that the stock of a 
controlled corporation will not be qualified property under section 
355(c)(2) or section 361(c)(2) if, under section 355(e)(2)(A), the 
stock is distributed as ``part of a plan (or series of related 
transactions) pursuant to which 1 or more persons acquire directly or 
indirectly stock representing a 50-percent or greater interest in the 
distributing corporation or any controlled corporation.'' Thus, if 
section 355(e)(1) applies to a distribution, the distributing 
corporation is taxed on the amount by which the distributed stock's 
fair market value exceeds its basis. Distributee shareholders receive 
the controlled corporation stock tax free, but do not increase their 
bases to reflect the corporate level gain recognized by the 
distributing corporation on the distribution.

Explanation of Provisions

    The proposed regulations under section 355(e) provide guidance 
concerning the interpretation of the phrase ``plan (or series of 
related transactions).'' The proposed regulations also address the 
determination of the distributing corporation's gain when multiple 
controlled corporations are distributed and the distributions are part 
of a plan (or series of related transactions) pursuant to which a 50-
percent or greater interest in one or more, but not all, of the 
distributed controlled corporations is acquired. The Department of the 
Treasury and the IRS plan to issue regulations addressing other issues 
arising under section 355(e), including aggregation and attribution 
rules (including provisions for public trading) and the administration 
of the statute of limitations provision of section 355(e)(4)(E). 
Comments concerning the proposed regulations and additional

[[Page 46157]]

issues that should be addressed in regulations are welcome.

A. Plan or Series of Related Transactions

    Whether two transactions are part of the same ``plan (or series of 
related transactions)'' under section 355(e)(2)(A) is a subjective 
test, depending ultimately on the intentions and expectations of the 
relevant parties. As discussed above, indications are that Congress 
intended ``plan (or series of related transactions)'' to be interpreted 
broadly. Unlike the Administration Proposal and the Bills, which 
utilized the section 355(d) concept of ``a person'' (with aggregation) 
as the reference for relevant acquirors, the statute, as enacted, 
expanded the universe of transactions to which section 355(e) 
potentially applies by providing that the relevant acquirors could be 
``1 or more persons.'' Also, the guidance in the Conference Report that 
public offerings of a sufficient size could trigger section 355(e) 
suggests that there does not necessarily have to be an identified 
acquiror on the date of the distribution for section 355(e) to apply, 
nor is the intent of the acquiror at the time of the distribution 
necessarily relevant in determining whether there is a plan.
    The proposed regulations rely on a variety of factors to determine 
the existence of a plan (or series of related transactions) 
(hereinafter referred to as a ``plan''). These factors include the 
business purpose or purposes for the distribution; the intentions of 
the parties; the existence of agreements, understandings, arrangements, 
or substantial negotiations; the timing of the transactions; the 
likelihood of an acquisition; and the causal connection between the 
distribution and the acquisition.
    Congress specified one factor, temporal proximity, as affecting the 
determination of whether a plan exists. Specifically, section 
355(e)(2)(B) provides a presumption that a plan exists if ``1 or more 
persons acquire directly or indirectly stock representing a 50-percent 
or greater interest in the distributing corporation or any controlled 
corporation during the 4-year period beginning on the date which is 2 
years before the date of the distribution.'' Accordingly, the proposed 
regulations provide that distributions within 2 years of an acquisition 
of the distributing corporation or a controlled corporation are 
presumed to be part of a plan. The proposed regulations outline the 
elements the distributing corporation must establish to rebut the 
statutory presumption.
1. Acquisitions On or After a Distribution
General Rebuttal
    In the case of an acquisition occurring within 2 years after a 
distribution, the proposed regulations allow the distributing 
corporation to rebut the presumption by establishing by clear and 
convincing evidence that (i) the distribution was motivated in whole or 
substantial part by a corporate business purpose (other than an intent 
to facilitate an acquisition or decrease the likelihood of the 
acquisition of one or more businesses by separating those businesses 
from others that are likely to be acquired) and (ii) the acquisition 
occurred more than 6 months after the distribution and there was no 
agreement, understanding, arrangement, or substantial negotiations 
concerning the acquisition at the time of the distribution or within 6 
months thereafter. Decreasing ``the likelihood of the acquisition of 
one or more businesses by separating those businesses from others that 
are likely to be acquired'' generally refers to transactions in which 
one business, a perceived takeover target, is separated from another 
via a stock distribution in an attempt to spare the other business from 
acquisition. Distributions intended to ``decrease the likelihood of the 
acquisition of one or more businesses by separating those businesses 
from others that are likely to be acquired'' are often difficult to 
differentiate from those intended to ``facilitate an acquisition.'' 
Both relate to a perceived possibility of acquisition and should 
receive similar treatment.
    In this general rebuttal, the proposed regulations rely on 
corporate business purpose as a key factor indicating whether a 
distribution and an acquisition are part of a plan. Corporate business 
purpose is an important concept in the overall administration of 
section 355. The existence of a nonacquisition related corporate 
business purpose that prompted, in whole or substantial part, the 
distributing corporation to make the stock distribution suggests there 
is not a significant causal connection between the distribution and 
acquisition. The intent of the distributing corporation, the controlled 
corporation, or the controlling shareholders of either the distributing 
or controlled corporation to facilitate an acquisition or decrease the 
likelihood of the acquisition of one or more businesses by separating 
those businesses from others that are likely to be acquired is relevant 
in determining the extent to which the distribution was motivated in 
whole or substantial part by another corporate business purpose within 
the meaning of Sec. 1.355-2. Analyzing whether there is another 
substantial corporate business purpose for the distribution in light of 
an acquisition-related purpose is similar to analyzing whether there is 
a corporate business purpose for a distribution in light of the 
potential avoidance of federal taxes. See Sec. 1.355-2(b)(1) and (5), 
Example 8. Thus, another business purpose must be real and substantial 
even in light of the acquisition business purpose.
    The reliance on business purpose in the general rebuttal is 
consistent with the suggestions of many commentators writing about 
section 355(e), who identified corporate business purpose as an 
important factor in determining whether an acquisition and distribution 
are part of a plan.
Alternative Rebuttal
    Reliance on a substantial nonacquisition business purpose as proof 
of no ``plan'' is appropriate when the distribution and acquisition are 
separated by a sufficient amount of time. Thus, the general rebuttal is 
not satisfied in certain cases, including where an acquisition occurs 
within 6 months after a distribution or where a distribution was not 
substantially motivated by a corporate business purpose other than an 
intention to facilitate (or decrease the likelihood of) an acquisition. 
These acquisitions occur in circumstances more likely to indicate the 
existence of a plan at the time of the distribution. Thus, these 
acquisitions are subject to heightened scrutiny and will be considered 
part of a plan unless taxpayers satisfy a more stringent alternative 
rebuttal.
    Unlike the general rebuttal, a nonacquisition business purpose 
alone is not sufficient under the alternative rebuttal. Rather, 
taxpayers must satisfy all prongs of a three-prong test.
    The first prong of the alternative rebuttal may be satisfied in 
either of two ways. The distributing corporation must establish by 
clear and convincing evidence either that (i) at the time of the 
distribution, the distributing corporation, the controlled corporation, 
and their controlling shareholders did not intend that one or more 
persons would acquire a 50-percent or greater interest in the 
distributing or any controlled corporation during the statutory 
presumption period (or later pursuant to an agreement, understanding, 
or arrangement existing at the time of the distribution or within 6 
months thereafter) or (ii) the distribution was not motivated in whole 
or substantial part by an intention to

[[Page 46158]]

facilitate an acquisition of an interest in the distributing or 
controlled corporation. Clause (i) may be satisfied even in situations 
where one or more of the relevant parties intend that the distribution 
will facilitate an acquisition or acquisitions, so long as the parties 
do not intend that there be a 50-percent or greater change in ownership 
during the statutory presumption period. Alternatively, clause (ii) may 
be satisfied where the parties intend a 50-percent or greater change in 
ownership during the presumption period, provided that the parties do 
not intend that the distribution will facilitate any part of the 
acquisitions.
    Under the second prong of the alternative rebuttal, the 
distributing corporation must establish by clear and convincing 
evidence that, at the time of the distribution, neither the 
distributing corporation, the controlled corporation, nor their 
controlling shareholders reasonably would have anticipated that it was 
more likely than not that one or more persons would acquire a 50-
percent or greater interest in the distributing corporation or the 
controlled corporation within 2 years after the distribution (or later 
pursuant to an agreement, understanding, or arrangement existing at the 
time of the distribution or within 6 months thereafter) who would not 
have acquired such interests if the distribution had not occurred.
    This prong of the alternative rebuttal (hereinafter referred to as 
the ``reasonable anticipation'' test) incorporates two important 
concepts. First, it identifies reasonably anticipated acquisitions of 
the distributing or controlled corporation that would not have occurred 
but for the distribution and, because a causal connection exists 
between the two transactions, treats them as part of a plan. Second, it 
reflects the idea that reasonable anticipation, not just the presence 
of negotiations, is important in determining whether a plan exists. 
Considering reasonable anticipation of certain acquisitions is 
consistent with the legislative history. Though descriptions of the 
Administration Proposal included references to negotiations and 
distinctions between hostile and friendly acquisitions, the focus of 
section 355(e), as enacted, is whether a relationship exists between 
the distribution and the fact that persons other than the existing 
shareholders became owners of the distributing or controlled 
corporation.
    A reasonable anticipation standard is necessary to implement 
section 355(e). Otherwise, a distributing corporation could attempt to 
avoid section 355(e) by distributing a controlled corporation under 
circumstances that virtually assure an acquisition of the distributing 
or controlled corporation, but arguing that, despite the imminence of 
the acquisition, effectuating the acquisition was not a motive for the 
distribution. A part of planning any transaction includes attempting to 
foresee actions others might take in response. Consistent with this 
business practice, it is appropriate, especially for acquisitions 
subject to heightened scrutiny, to require the distributing corporation 
to take into account the reasonably anticipated, likely actions of 
others to demonstrate that a distribution and acquisition are not part 
of a plan.
    The second prong of the alternative rebuttal is not satisfied if, 
at the time of the distribution, the relevant parties would reasonably 
anticipate that the distribution would give rise to all of an 
acquisition of a 50 percent interest in the distributing or controlled 
corporation. (The rebuttal is satisfied if the distributing corporation 
establishes by clear and convincing evidence that the relevant parties 
would not reasonably anticipate an acquisition of a 50 percent or 
greater interest by persons who would not acquire such interests absent 
the distribution.) This standard is to be contrasted with the first 
prong of the rebuttal, which is not satisfied if one or more of the 
relevant parties intended that there be a 50 percent or greater 
acquisition of distributing or controlled during the applicable time 
period, and the distribution is intended to facilitate all or any part 
of that acquisition. Because some acquisitions might be reasonably 
anticipated to occur without regard to whether the distribution takes 
place, the Department of the Treasury and the IRS believe that the 
distribution must be directly linked to all 50 percent of the 
acquisition to fail the ``reasonable anticipation'' test. However, a 
different result is called for where the relevant parties intend a 50 
percent acquisition. In that case, it would appear that the aggregation 
of the various acquisitions comprising the 50 percent acquisition are 
themselves part of a single plan, so a distribution intended to 
facilitate only some of those acquisitions would be part of a plan also 
involving those other acquisitions not directly facilitated by the 
acquisition.
    In developing the reasonable anticipation test, the Department of 
the Treasury and the IRS rejected suggestions by some commentators that 
serious negotiations or agreement with an acquiror need to have taken 
place at the time of distribution for a plan to exist. Requiring mutual 
agreement or negotiation is inappropriate because Congress intended the 
statute to apply in situations beyond those in which a distribution is 
made prior to and as part of an acquisition by a specifically 
identified acquiror. Section 355(e)(2)(B) makes clear that the section 
is intended to apply to acquisitions before and after a distribution. 
The legislative history also clarifies that a public offering after a 
distribution can trigger section 355(e) even though presumably no 
public buyer would have been negotiated with or even identified at the 
time of the distribution. Because Congress intended distributions 
designed to facilitate public offerings to be covered, other 
transactions that are economically similar also should be covered. 
These transactions include a private placement of the distributing or 
controlled corporation's stock or an auction of such stock by an 
investment banker. Like public offerings, these transactions do not 
necessarily involve predistribution negotiations or agreements 
regarding subsequent acquisitions and yet may still be part of the 
distributing or controlled corporation's plan.
    Thus, we believe that section 355(e) was intended to apply to a 
range of transactions, not limited to those in which a mutual agreement 
or negotiations relating to the acquisition occurred prior to the 
distribution. To require negotiations or agreements to be present prior 
to a distribution either would inappropriately exclude certain 
transactions from the coverage of the statute or would create a higher 
threshold for the existence of a plan in certain acquisitions than in 
other acquisitions.
    The third prong of the alternative rebuttal reiterates a 
requirement in the general rebuttal. The distributing corporation must 
establish by clear and convincing evidence that the distribution was 
not motivated in whole or substantial part by an intention to decrease 
the likelihood of the acquisition of one or more businesses by 
separating those businesses from others that are likely to be acquired.
    For purposes of applying the alternative rebuttal, the consequences 
of the application of section 355(e), directly or by indemnity, are 
disregarded in determining the intentions, motivations, and reasonable 
anticipations of the relevant parties. To do otherwise might give rise 
to a circularity in the application of the rules. If the consequences 
of the application of section 355(e) were relevant in determining such 
intentions, motivations, and reasonable anticipations, the distributing 
corporation could argue that objective evidence indicated that it would 
satisfy

[[Page 46159]]

the alternative rebuttal, since arguably it would not be reasonable for 
an acquiror to act in a manner that would cause liability for tax under 
section 355(e). Conversely, the IRS could argue that the presence of an 
indemnity agreement indicated that the parties anticipated liability 
for tax under section 355(e).
Acquisitions More Than 2 Years After a Distribution
    To prevent taxpayers from attempting to avoid the presumption 
period by delaying a planned acquisition beyond 2 years from the date 
of distribution, the proposed regulations provide that an acquisition 
occurring more than 2 years after the distribution is presumed part of 
a plan if there was an agreement, understanding, or arrangement 
concerning the acquisition at the time of the distribution or within 2 
years thereafter. The distributing corporation may rebut the 
presumption using the general or alternative rebuttal discussed above. 
To provide certainty for transactions that, because of their separation 
in time, are unlikely to be part of a plan, the proposed regulations 
provide that, if there was no agreement, understanding, or arrangement 
concerning the acquisition at the time of the distribution or within 2 
years thereafter, a distribution and an acquisition occurring more than 
2 years afterwards are not part of a plan.
2. Acquisitions Before a Distribution
Acquisitions Within 2 Years Before a Distribution
    Section 355(e) also applies to transactions in which an acquisition 
of the distributing or controlled corporation's stock precedes a 
distribution of the controlled corporation. When the transactions being 
tested as part of a plan occur in this order, the most reliable 
indicators that a plan exists are an intent to make the distribution at 
the time of the acquisition and a causal connection between the 
acquisition and the distribution. In particular, if a person becomes a 
controlling shareholder by acquisition, that person's intention becomes 
the single best indicator of whether a later distribution was part of a 
plan. The proposed regulations allow a distributing corporation to 
rebut the presumption by establishing by clear and convincing evidence 
that, at the time of the acquisition, the distributing corporation and 
its controlling shareholders (determined immediately after the 
acquisition) did not intend to effectuate a distribution. 
Alternatively, the distributing corporation can rebut the presumption 
by establishing by clear and convincing evidence that the distribution 
would have occurred at approximately the same time and under 
substantially the same terms regardless of the acquisition (and, in the 
case of an issuance of stock, all acquisitions that are part of such 
issuance), unless a person acquiring an interest becomes a controlling 
shareholder by reason of the acquisition or at any point thereafter and 
before the end of the 2-year period beginning on the date of the 
distribution (or later pursuant to an agreement, understanding, or 
arrangement existing at the time of the distribution or within 6 months 
thereafter).
Acquisitions More Than 2 Years Before a Distribution
    If an acquisition of an interest in the distributing corporation or 
the controlled corporation occurs more than 2 years before a 
distribution, the presumption shifts in favor of the taxpayer. The 
acquisition and the distribution are presumed not to be part of a plan 
unless the Commissioner can establish by clear and convincing evidence 
that, at the time of the acquisition, (i) the distributing corporation 
or its controlling shareholders intended to effectuate the distribution 
and (ii) that the distribution would not have occurred at approximately 
the same time and under substantially the same terms regardless of that 
acquisition (and, in the case of an issuance of stock, all acquisitions 
that are part of such issuance) or that a person acquiring an interest 
in that acquisition becomes a controlling shareholder by reason of that 
acquisition or at any point thereafter and before the end of the 2-year 
period beginning on the date of the distribution (or later pursuant to 
an agreement, understanding, or arrangement existing at the time of the 
distribution or within six months thereafter). Because the passage of 
time makes it less likely that an acquisition and distribution are part 
of a plan, after two years the proposed regulations shift the burden of 
proof to the IRS to prove the existence of a plan. However, the 
proposed regulations do not allow a taxpayer to avoid section 355(e) by 
delaying the distribution when the distribution clearly was intended at 
the time of the acquisition.
3. Agreement, Understanding, Arrangement, or Substantial Negotiations
    The proposed regulations do not define with precision the terms 
agreement, understanding, arrangement, or substantial negotiations. A 
binding contract is clearly included as an agreement, but, depending on 
all relevant facts and circumstances, parties can have an agreement, 
understanding, or arrangement even though they have not reached 
agreement on all terms. Under certain circumstances, such as in public 
offerings or auctions of the distributing or controlled corporation's 
stock by an investment banker, an agreement, understanding, 
arrangement, or substantial negotiations can take place regarding an 
acquisition even if the acquiror has not been specifically identified. 
The Department of the Treasury and the IRS are particularly interested 
in receiving comments regarding transactions that involve an investment 
banker and when contacts by the distributing corporation or the 
controlled corporation with an investment banker or contacts with 
potential acquirors by an investment banker on behalf of the 
distributing corporation or the controlled corporation should or should 
not be considered an agreement, understanding, arrangement, or 
substantial negotiations.
4. Options
    The proposed regulations also treat certain options as agreements. 
If stock of the distributing or controlled corporation is acquired 
pursuant to an option, the option is treated as an agreement unless the 
distributing corporation establishes by clear and convincing evidence 
that, on the later of the date of distribution or issuance, the option 
was not more likely than not to be exercised. Generally, call options, 
warrants, convertible obligations, the conversion feature of 
convertible stock, put options, redemption agreements, restricted 
stock, and any other instruments that provide for the right or 
possibility to issue, redeem, or transfer stock, cash settlement 
options, and other similar interests are treated as options. An option 
on an option is treated as an option under the proposed regulations. If 
there is an agreement, understanding, or arrangement to issue an option 
before the end of the 6 month period beginning on the date of the 
distribution, the option will be treated as issued on the date of the 
agreement, understanding, or arrangement. If an agreement, 
understanding, or arrangement to issue an option is reached, or an 
option is issued, more than 6 months but not more than 2 years after 
the distribution, and there were substantial negotiations regarding the 
issuance of the option or the acquisition of the stock underlying the 
option before the end of the 6 month period beginning on the date of 
the distribution, the option will be treated as issued 6 months after 
the

[[Page 46160]]

distribution. If there is an agreement, understanding, or an 
arrangement to issue an option more than 6 months but not more than 2 
years after the distribution, and there were no substantial 
negotiations regarding the issuance of the option or the acquisition of 
the stock underlying the option before the end of the 6 month period 
beginning on the date of the distribution, the option will be treated 
as issued on the date of the agreement, understanding, or arrangement. 
The proposed regulations exempt certain options from treatment as 
options unless they are issued, transferred, or listed with a principal 
purpose of avoiding the application of section 355(e) or the proposed 
regulations. The enumerated exceptions cover certain commercially 
customary options unlikely to be used to avoid section 355(e) or the 
proposed regulations.
5. Aggregating Acquisitions That are Pursuant to a Plan
    Under the proposed regulations, each acquisition of stock of a 
distributing or controlled corporation must be tested to determine 
whether the acquisition is pursuant to a plan involving a distribution. 
Each acquisition of stock of a corporation acquired pursuant to a plan 
involving a distribution is aggregated with all acquisitions of stock 
of that corporation acquired pursuant to a plan involving that 
distribution to determine whether an acquisition of a 50-percent or 
greater interest as proscribed in section 355(e)(2)(A)(ii) has 
occurred.

B. Any Controlled Corporation

    Section 355(e)(2)(A)(ii) provides that section 355(e)(1), which 
causes the distributing corporation to recognize its gain in the 
controlled corporation stock as if the distributing corporation had 
sold the stock for its fair market value, applies to any distribution 
to which section 355 applies and ``which is part of a plan * * * 
pursuant to which 1 or more persons acquire directly or indirectly 
stock representing a 50-percent or greater interest in the distributing 
corporation or any controlled corporation'' (emphasis added). A 
question has arisen concerning the measure of gain to the distributing 
corporation if, pursuant to a plan, the stock of more than one 
controlled corporation is distributed and stock representing a 50-
percent or greater interest is acquired in some, but not all, of the 
distributed controlled corporations. The proposed regulations clarify 
that under those circumstances, the distributing corporation only 
recognizes gain on the stock of the distributed controlled corporations 
that were subject to 50-percent or greater acquisitions. If the 
distributing corporation is the acquired corporation, it must recognize 
gain on all of the distributed controlled corporations.

Proposed Effective Date

    The regulations in this section are proposed to apply to 
distributions occurring after the regulations in this section are 
published as final regulations in the Federal Register.

Special Analyses

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

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (preferably a 
signed original and eight (8) copies) and comments sent via the 
Internet that are submitted timely to the IRS. The IRS and the 
Department of the Treasury specifically request comments on the clarity 
of the proposed regulations and how they may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for January 26, 2000, beginning 
at 10 a.m. in Room 2615, 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 submit written or 
electronic comments and an outline of the topics to be discussed and 
the time to be devoted to each topic (preferably a signed original and 
eight (8) copies) by January 5, 2000. A period of 10 minutes will be 
allotted to each person for making comments. An agenda showing the 
scheduling of the speakers will be prepared after the deadline for 
receiving outlines has passed. Copies of the agenda will be available 
free of charge at the hearing.
    Drafting information. The principal author of these proposed 
regulations is Brendan O'Hara, Office of the 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.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

    Section 1.355-7 also issued under 26 U.S.C. 355(e)(5). * * *
    Par. 2. Section 1.355-0 is amended by revising the section heading 
and adding introductory text and an entry for Sec. 1.355-7 to read as 
follows:


Sec. 1.355-0  Outline of sections.

    In order to facilitate the use of Secs. 1.355-1 through 1.355-7, 
this section lists the major paragraphs in those sections as follows:
* * * * *

Sec. 1.355-7 Recognition of gain on certain distributions of stock 
or securities in connection with an acquisition.

    (a) Plan or series of related transactions.
    (1) In general.
    (2) Distributions within 2 years of an acquisition.
    (i) Presumption.
    (ii) Rebuttal for acquisitions after a distribution.
    (iii) Alternative rebuttal for acquisitions on or after a 
distribution.
    (iv) Operating rules for paragraph (a)(2)(iii) of this section.

[[Page 46161]]

    (v) Rebuttals for acquisitions before a distribution.
    (A) General rebuttal.
    (B) Alternative rebuttal.
    (3) Distributions more than 2 years from an acquisition.
    (i) Acquisitions after a distribution.
    (ii) Acquisitions before a distribution.
    (4) Controlling shareholder.
    (5) Agreement, understanding, or arrangement.
    (6) Multiple acquisitions.
    (7) Stock acquired by exercise of options, warrants, convertible 
obligations, and other similar interests.
    (i) Treatment of options.
    (A) General rule.
    (B) Agreement, understanding, arrangement, or substantial 
negotiations to issue an option.
    (ii) Instruments treated as options.
    (iii) Instruments generally not treated as options.
    (A) Escrow, pledge, or other security agreements.
    (B) Compensatory options.
    (C) Options exercisable only upon death, disability, mental 
incompetency, or retirement.
    (D) Rights of first refusal.
    (E) Other enumerated instruments.
    (8) Examples.
    (b) Multiple controlled corporations.
    (c) Valuation.
    (d) Effective date.

    Par. 3. Section 1.355-7 is added to read as follows:


Sec. 1.355-7  Recognition of gain on certain distributions of stock or 
securities in connection with an acquisition.

    (a) Plan or series of related transactions--(1) In general. (i) 
Except as provided in section 355(e) and this section, section 355(e) 
applies to any distribution--
    (A) To which section 355 (or so much of section 356 as relates to 
section 355) applies; and
    (B) Which is part of a plan (or series of related transactions) 
pursuant to which one or more persons acquire directly or indirectly 
stock representing a 50-percent or greater interest in the distributing 
corporation or any controlled corporation.
    (ii) For purposes of this section, a controlled corporation is a 
corporation the stock of which is distributed in a distribution to 
which section 355 applies.
    (iii) The existence of a plan (or series of related transactions) 
does not depend on whether or not more than one person acts in concert.
    (2) Distributions within 2 years of an acquisition--(i) 
Presumption. If a distribution occurs within 2 years of an acquisition 
by one or more persons of an interest in the distributing corporation 
or any controlled corporation, the distribution and that acquisition 
are presumed to be part of a plan (or series of related transactions).
    (ii) Rebuttal for acquisitions after a distribution. (A) In the 
case of an acquisition occurring after a distribution, the distributing 
corporation may rebut the presumption of paragraph (a)(2)(i) of this 
section by establishing by clear and convincing evidence that--
    (1) The distribution was motivated in whole or substantial part by 
a corporate business purpose within the meaning of Sec. 1.355-2(b) 
(other than an intent to facilitate an acquisition or decrease the 
likelihood of the acquisition of one or more businesses by separating 
those businesses from others that are likely to be acquired); and
    (2) The acquisition occurred more than 6 months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition at the time of the 
distribution or within 6 months thereafter.
    (B) The intent of the distributing corporation, the controlled 
corporation, or the controlling shareholders of either the distributing 
or controlled corporation to facilitate an acquisition or decrease the 
likelihood of the acquisition of one or more businesses by separating 
those businesses from others that are likely to be acquired is relevant 
in determining the extent to which the distribution was motivated by a 
corporate business purpose within the meaning of Sec. 1.355-2(b) (other 
than an intent to facilitate an acquisition or decrease the likelihood 
of the acquisition of one or more businesses by separating those 
businesses from others that are likely to be acquired).
    (iii) Alternative rebuttal for acquisitions on or after a 
distribution. In the case of an acquisition occurring on or after a 
distribution, the distributing corporation also may rebut the 
presumption of paragraph (a)(2)(i) of this section by establishing by 
clear and convincing evidence that--
    (A)(1) At the time of the distribution, the distributing 
corporation, the controlled corporation, and their controlling 
shareholders did not intend that one or more persons would acquire a 
50-percent or greater interest in the distributing or any controlled 
corporation during the 2-year period beginning on the date of the 
distribution (or later pursuant to an agreement, understanding, or 
arrangement existing at the time of the distribution or within 6 months 
thereafter); or
    (2) The distribution was not motivated in whole or substantial part 
by an intention to facilitate an acquisition of an interest in the 
distributing or controlled corporation; and
    (B) At the time of the distribution, neither the distributing 
corporation, the controlled corporation, nor their controlling 
shareholders would reasonably have anticipated that it was more likely 
than not that one or more persons would acquire a 50-percent or greater 
interest in the distributing corporation or the controlled corporation 
within 2 years after the distribution (or later pursuant to an 
agreement, understanding, or arrangement existing at the time of the 
distribution or within 6 months thereafter) who would not have acquired 
such interests if the distribution had not occurred; and
    (C) The distribution was not motivated in whole or substantial part 
by an intention to decrease the likelihood of the acquisition of one or 
more businesses by separating those businesses from others that are 
likely to be acquired.
    (iv) Operating rules for paragraph (a)(2)(iii) of this section. (A) 
For purposes of paragraph (a)(2)(iii)(A)(1) of this section, if an 
acquisition by one or more persons of an interest in the distributing 
corporation or any controlled corporation before the distribution is 
part of a plan (or series of related transactions) involving the 
distribution, the distributing corporation, the controlled corporation, 
and their controlling shareholders must include the amount of stock 
acquired in that acquisition as an amount they intended at the time of 
the distribution to be acquired during the 2-year period beginning on 
the date of the distribution.
    (B) For purposes of paragraph (a)(2)(iii)(B) of this section, 
persons who more likely than not would have acquired interests in the 
distributing corporation if the distribution had not occurred are also 
treated as persons who more likely than not would have acquired 
proportionate interests in the controlled corporation if the 
distribution had not occurred. No other persons are treated as persons 
who would have acquired interests in the controlled corporation if the 
distribution had not occurred.
    (C) For purposes of paragraph (a)(2)(iii)(B) of this section, if an 
acquisition by one or more persons of an interest in the distributing 
corporation or any controlled corporation before the distribution is 
part of a plan (or series of related transactions) involving the 
distribution, the distributing corporation, the controlled corporation, 
and their controlling shareholders must treat the amount of stock 
acquired in

[[Page 46162]]

that acquisition as an amount they would reasonably have anticipated 
was more likely than not to be acquired within 2 years after the 
distribution that would not have been acquired if the distribution had 
not occurred.
    (D) For purposes of determining the intentions, motivations, and 
reasonable anticipations of the relevant parties under paragraph 
(a)(2)(iii) of this section, the consequences of the application of 
section 355(e), directly or by indemnity, are disregarded.
    (v) Rebuttals for acquisitions before a distribution--(A) General 
rebuttal. In the case of an acquisition occurring before a 
distribution, the distributing corporation may rebut the presumption of 
paragraph (a)(2)(i) of this section by establishing by clear and 
convincing evidence that, at the time of the acquisition, the 
distributing corporation and its controlling shareholders (determined 
immediately after the acquisition) did not intend to effectuate a 
distribution.
    (B) Alternative rebuttal. In the case of an acquisition occurring 
before a distribution, the distributing corporation may rebut the 
presumption of paragraph (a)(2)(i) of this section by establishing by 
clear and convincing evidence that the distribution would have occurred 
at approximately the same time and under substantially the same terms 
regardless of that acquisition (and, in the case of an issuance of 
stock, all acquisitions that are part of such issuance), provided no 
person acquiring an interest in that acquisition becomes a controlling 
shareholder by reason of that acquisition or at any point thereafter 
and before the end of the 2-year period beginning on the date of the 
distribution (or later pursuant to an agreement, understanding, or 
arrangement existing at the time of the distribution or within 6 months 
thereafter).
    (3) Distributions more than 2 years from an acquisition--(i) 
Acquisitions after a distribution. (A) If an acquisition by one or more 
persons of an interest in the distributing corporation or any 
controlled corporation occurs more than 2 years after a distribution, 
the distribution and that acquisition are presumed part of a plan (or 
series of related transactions) only if there was an agreement, 
understanding, or arrangement concerning the acquisition at the time of 
the distribution or within 2 years thereafter. The distributing 
corporation may rebut the presumption under paragraph (a)(2)(ii) or 
(a)(2)(iii) of this section.
    (B) If an acquisition by one or more persons of an interest in the 
distributing corporation or any controlled corporation occurs more than 
2 years after a distribution, and there was no agreement, 
understanding, or arrangement concerning the acquisition at the time of 
the distribution or within 2 years thereafter, the acquisition and the 
distribution are not part of a plan (or series of related 
transactions).
    (ii) Acquisitions before a distribution. If an acquisition by one 
or more persons of an interest in the distributing corporation or the 
controlled corporation occurs more than 2 years before a distribution, 
the acquisition and the distribution are not part of a plan (or series 
of related transactions) unless the Commissioner can establish by clear 
and convincing evidence that--
    (A) At the time of the acquisition, the distributing corporation or 
its controlling shareholders (determined immediately after the 
acquisition) intended to effectuate the distribution; and
    (B)(1) The distribution would not have occurred at approximately 
the same time and under substantially the same terms regardless of that 
acquisition (and, in the case of an issuance of stock, all acquisitions 
that are part of such issuance); or
    (2) A person acquiring an interest in that acquisition becomes a 
controlling shareholder by reason of that acquisition or at any point 
thereafter and before the end of the 2-year period beginning on the 
date of the distribution (or later pursuant to an agreement, 
understanding, or arrangement existing at the time of the distribution 
or within 6 months thereafter).
    (4) Controlling shareholder. For purposes of paragraphs (a) (2) and 
(3) of this section, a controlling shareholder is any person who, 
directly or indirectly, or together with related persons (as described 
in sections 267(b) and 707(b)), possesses voting power in the 
distributing or controlled corporation representing a meaningful voice 
in the governance of the corporation. A controlling shareholder of a 
publicly traded corporation is any person who, directly or indirectly, 
or together with related persons (as described in sections 267(b) and 
707(b)), owns 5 percent or more of any class of stock of the 
distributing or controlled corporation and who actively participates in 
the management or operation of the corporation. If a distribution 
precedes an acquisition, the controlled corporation's controlling 
shareholders immediately after the distribution are considered the 
controlled corporation's controlling shareholders at the time of the 
distribution.
    (5) Agreement, understanding, or arrangement. For purposes of this 
section, the parties do not necessarily have to have entered into a 
binding contract or have reached agreement on all terms to have an 
``agreement, understanding, or arrangement.''
    (6) Multiple acquisitions. Each acquisition of stock of a 
corporation acquired pursuant to a plan (or series of related 
transactions) involving a distribution will be aggregated with all 
acquisitions of stock of that corporation acquired pursuant to a plan 
(or series of related transactions) involving that distribution to 
determine whether an acquisition described in section 355(e)(2)(A)(ii) 
occurred. The appropriate presumption and rules for rebuttal will be 
applied to each acquisition depending on when the acquisition occurred.
    (7) Stock acquired by exercise of options, warrants, convertible 
obligations, and other similar interests--(i) Treatment of options--(A) 
General rule. For purposes of this section, if stock of the 
distributing or controlled corporation is acquired pursuant to an 
option, the option will be treated as an agreement on the date of 
issuance unless the distributing corporation establishes by clear and 
convincing evidence that, on the later of the date of distribution or 
date of issuance, the option was not more likely than not to be 
exercised. The determination of whether an option was more likely than 
not to be exercised is based on all the facts and circumstances. In 
applying the previous sentence, the fair market value of stock 
underlying an option is determined by taking into account control 
premiums and minority and blockage discounts.
    (B) Agreement, understanding, arrangement, or substantial 
negotiations to issue an option. If there is an agreement, 
understanding, or arrangement to issue an option before the end of the 
6-month period beginning on the date of the distribution, the option 
will be treated as issued on the date of the agreement, understanding, 
or arrangement. If an agreement, understanding, or arrangement to issue 
an option is reached, or an option is issued, more than 6 months but 
not more than 2 years after the distribution, and there were 
substantial negotiations regarding the issuance of the option or the 
acquisition of the stock underlying the option before the end of the 6-
month period beginning on the date of the distribution, the option will 
be treated as issued 6 months after the distribution. If there is an 
agreement, understanding, or an arrangement to issue an option more 
than 6 months but not more than 2 years after the distribution, and 
there were no

[[Page 46163]]

substantial negotiations regarding the issuance of the option or the 
acquisition of the stock underlying the option before the end of the 6 
month period beginning on the date of the distribution, the option will 
be treated as issued on the date of the agreement, understanding, or 
arrangement.
    (ii) Instruments treated as options. For purposes of this paragraph 
(a)(7), except to the extent provided in paragraph (a)(7)(iii) of this 
section, call options, warrants, convertible obligations, the 
conversion feature of convertible stock, put options, redemption 
agreements (including rights to cause the redemption of stock), 
restricted stock, any other instruments that provide for the right or 
possibility to issue, redeem, or transfer stock (including an option on 
an option), cash settlement options, or any other similar interests are 
treated as options.
    (iii) Instruments generally not treated as options. For purposes of 
this paragraph (a)(7), the following are not treated as options unless 
issued, transferred (directly or indirectly), or listed with a 
principal purpose of avoiding the application of section 355(e) or this 
section:
    (A) Escrow, pledge, or other security agreements. An option that is 
part of a security arrangement in a typical lending transaction 
(including a purchase money loan), if the arrangement is subject to 
customary commercial conditions. For this purpose, a security 
arrangement includes, for example, an agreement for holding stock in 
escrow or under a pledge or other security agreement, or an option to 
acquire stock contingent upon a default under a loan.
    (B) Compensatory options. An option to acquire stock in the 
distributing or controlled corporation with customary terms and 
conditions provided to an employee or director in connection with the 
performance of services for the corporation or a person related to it 
under section 355(d)(7)(A) (and that is not excessive by reference to 
the services performed) and that immediately after the distribution and 
within 6 months thereafter--
    (1) Is nontransferable within the meaning of Sec. 1.83-3(d); and
    (2) Does not have a readily ascertainable fair market value as 
defined in Sec. 1.83-7(b).
    (C) Options exercisable only upon death, disability, mental 
incompetency, or retirement. Any option entered into between 
stockholders of a corporation (or a stockholder and the corporation) 
that is exercisable only upon the death, disability, or mental 
incompetency of the stockholder, or, in the case of stock acquired in 
connection with the performance of services for the corporation or a 
person related to it under section 355(d)(7)(A) (and that is not 
excessive by reference to the services performed), the stockholder's 
retirement.
    (D) Rights of first refusal. A bona fide right of first refusal 
regarding the corporation's stock with customary terms, entered into 
between stockholders of a corporation (or between the corporation and a 
stockholder).
    (E) Other enumerated instruments. Any other instruments specified 
in regulations, a revenue ruling, or a revenue procedure. See 
Sec. 601.601(d)(2) of this chapter.
    (8) Examples. The following examples illustrate this paragraph (a). 
Throughout these examples, assume that the distributing corporation (D) 
owns all of the stock of the controlled corporation (C). Assume further 
that D distributes the stock of C in a distribution to which section 
355 applies and to which section 355(d) does not apply. For purposes of 
these examples, unless otherwise stated, assume that all transactions 
described are respected under applicable general tax principles. No 
inference should be drawn from any example concerning whether any 
requirements of section 355 other than those of section 355(e) are 
satisfied. The examples are as follows:

    Example 1. To facilitate a stock offering by D of 50 percent of 
its stock, D distributes C pro rata to its shareholders. D issues 
new shares amounting to 50 percent of its stock to the public in a 
public offering within 6 months of the distribution. Under paragraph 
(a)(2)(i) of this section, the distribution and acquisition are 
presumed to be part of a plan (or series of related transactions) 
because the acquisition occurred within 2 years of the distribution. 
Because the acquisition occurred within 6 months after the 
distribution, D must rely on the rules of paragraph (a)(2)(iii) of 
this section to rebut the presumption. D will not be able to rebut 
the presumption because D cannot establish either that D did not 
intend that one or more persons would acquire a 50-percent or 
greater interest in D during the relevant period under paragraph 
(a)(2)(iii)(A)(1) of this section or that the distribution was not 
motivated in whole or substantial part by an intention to facilitate 
an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2) 
of this section. Because the presumption of paragraph (a)(2)(i) of 
this section cannot be rebutted regarding the acquisition of a 50-
percent or greater interest in D, section 355(e) applies to the 
distribution of C.
    Example 2. (i) X corporation announces an intention to acquire 
D, principally to acquire C's business. Due to market conditions, 
X's available capital, and X's success in acquiring other 
corporations, D would reasonably anticipate that an acquisition of a 
50-percent or greater interest in D is more likely than not to occur 
within 2 years. To lower its financing costs and, in substantial 
part, to deter the acquisition of D (by separating it from the more 
attractive C), D distributes C pro rata to the D shareholders. X 
acquires C within 6 months of the distribution.
    (ii) Under paragraph (a)(2)(i) of this section, the distribution 
and acquisition are presumed to be part of a plan (or series of 
related transactions) because the acquisition occurred within 2 
years of the distribution. Because the acquisition occurred within 6 
months after the distribution, D must rely on the rules of paragraph 
(a)(2)(iii) of this section to rebut the presumption. Under 
paragraph (a)(2)(iii)(A)(2) of this section, D will be able to 
establish that the distribution was not motivated in whole or 
substantial part by an intention to facilitate an acquisition of an 
interest in D or C. Under paragraph (a)(2)(iv)(B) of this section, 
for purposes of paragraph (a)(2)(iii)(B) of this section, persons 
who more likely than not would have acquired interests in D if the 
distribution had not occurred are also treated as persons who more 
likely than not would have acquired proportionate interests in C if 
the distribution had not occurred. Therefore, under paragraph 
(a)(2)(iii)(B) of this section, D will be able to establish that, at 
the time of the distribution, neither D, C, nor their controlling 
shareholders would reasonably have anticipated that it was more 
likely than not that one or more persons would acquire a 50-percent 
or greater interest in D or C within 2 years after the distribution 
who would not have acquired such interests if the distribution had 
not occurred.
    (iii) Under paragraph (a)(2)(iii)(C) of this section, D will not 
be able to establish that the distribution was not motivated in 
whole or substantial part by an intention to decrease the likelihood 
of the acquisition of D's business by separating it from the C 
business that was likely to be acquired. Because the presumption of 
paragraph (a)(2)(i) of this section cannot be rebutted regarding the 
acquisition by X of a 50-percent or greater interest in C, section 
355(e) applies to the distribution of C.
    Example 3. The facts are the same as Example 2 except the 
acquisition takes place 1 year after the distribution. The parties 
had not reached an agreement, understanding, or arrangement 
concerning, and had not substantially negotiated, the acquisition of 
C stock within 6 months after the distribution. Under paragraph 
(a)(2)(i) of this section, the distribution and acquisition are 
presumed to be part of a plan (or series of related transactions) 
because the acquisition occurred within 2 years of the distribution. 
Under paragraph (a)(2)(ii)(B) of this section, D's intent to deter 
an acquisition of D is a factor tending to disprove that the 
distribution was motivated in substantial part by the desire to 
lower its financing costs. If D can establish by clear and 
convincing evidence that the distribution was nonetheless motivated 
in substantial part by the need to lower its financing costs, D can 
rebut the presumption using paragraph (a)(2)(ii) of this section. D 
will not be able to rebut the presumption by using the

[[Page 46164]]

alternative rebuttal under paragraph (a)(2)(iii) of this section for 
the same reason as in Example 2.
    Example 4. D is a widely held, publicly traded corporation. D 
distributes C pro rata to D's shareholders. By contract, C agrees to 
indemnify D for any imposition of tax under section 355(e). The 
distribution is motivated solely by a corporate business purpose 
within the meaning of Sec. 1.355-2(b) (other than an intent to 
facilitate an acquisition or decrease the likelihood of the 
acquisition of one or more businesses by separating those businesses 
from others that are likely to be acquired). At the time of the 
distribution, although D has not been approached by any potential 
acquirors of C, D would reasonably anticipate that, under current 
market conditions, if C is separated from D, an acquisition of a 50-
percent or greater interest in C is more likely than not to occur 
within 2 years by persons who would not have acquired a 
proportionate interest in D if the distribution of C had not 
occurred. C is acquired within 6 months after the distribution. 
Under paragraph (a)(2)(i) of this section, the distribution and 
acquisition are presumed to be part of a plan (or series of related 
transactions) because the acquisition occurred within 2 years of the 
distribution. Because the acquisition occurred within 6 months after 
the distribution, D must rely on the rules of paragraph (a)(2)(iii) 
of this section to rebut the presumption. D will be able to 
establish that the distribution was not motivated in whole or 
substantial part by an intention to facilitate an acquisition of an 
interest in D or C under paragraph (a)(2)(iii)(A)(2) of this 
section. However, D will not be able to establish the requirements 
of paragraph (a)(2)(iii)(B) of this section. Under paragraph 
(a)(2)(iv)(B) of this section, for purposes of paragraph 
(a)(2)(iii)(B) of this section, only persons who more likely than 
not would have acquired interests in D if the distribution had not 
occurred are treated as persons who more likely than not would have 
acquired proportionate interests in C if the distribution had not 
occurred. Therefore, under paragraph (a)(2)(iii)(B) of this section, 
D will not be able to establish that, at the time of the 
distribution, neither D, C, nor their controlling shareholders would 
reasonably have anticipated that it was more likely than not that 
one or more persons would acquire a 50-percent or greater interest 
in D or C within 2 years after the distribution who would not have 
acquired such interests if the distribution had not occurred. Under 
paragraph (a)(2)(iv)(D) of this section, the consequences of the 
indemnity agreement are disregarded for purposes of applying 
paragraph (a)(2)(iii)(B) of this section. Because the presumption of 
paragraph (a)(2)(i) of this section cannot be rebutted regarding the 
acquisition of a 50-percent or greater interest in C, section 355(e) 
applies to the distribution of C.
    Example 5. (i) D believes it would be a more attractive 
acquisition candidate if it did not own C. To achieve significant 
nontax cost savings and, in substantial part, to maximize the 
possibility of D's acquisition, D distributes C pro rata. At the 
time of the distribution, D has not, directly or indirectly, 
solicited or received any indication of interest from potential 
acquirors. At the end of 6 months after the distribution, no 
agreement, arrangement, understanding, or substantial negotiations 
regarding the acquisition of D have taken place. Seven months after 
the distribution, D engages an investment banker to conduct an 
auction of D. One of the bidders acquires D 1 year after the 
distribution. Under paragraph (a)(2)(i) of this section, the 
distribution and acquisition are presumed to be part of a plan (or 
series of related transactions) because the acquisition occurred 
within 2 years of the distribution. Because there was no agreement, 
understanding, arrangement, or substantial negotiations concerning 
the acquisition at the time of the distribution or within 6 months 
thereafter, D can use the rebuttal under paragraph (a)(2)(ii) of 
this section if D can establish that the distribution was motivated 
in whole or substantial part by the corporate business purpose of 
achieving significant nontax cost savings. Under paragraph 
(a)(2)(ii)(B) of this section, D's intent to facilitate an 
acquisition of D is a factor tending to disprove that the 
distribution was motivated in substantial part by the desire to 
achieve nontax cost savings. If D can establish by clear and 
convincing evidence that the distribution was nonetheless motivated 
in substantial part by the need to achieve nontax cost savings for D 
and C, D can rebut the presumption using paragraph (a)(2)(ii) of 
this section.
    (ii) D cannot rebut the presumption using the rules of paragraph 
(a)(2)(iii) of this section because D cannot establish either that D 
did not intend that one or more persons would acquire a 50-percent 
or greater interest in D during the relevant period under paragraph 
(a)(2)(iii)(A)(1) of this section or that the distribution was not 
motivated in whole or substantial part by an intention to facilitate 
an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2) 
of this section.
    Example 6. D announces that it will distribute C pro rata to D's 
shareholders. The distribution is motivated solely by a corporate 
business purpose within the meaning of Sec. 1.355-2(b) (other than 
an intent to facilitate an acquisition or decrease the likelihood of 
the acquisition of one or more businesses by separating those 
businesses from others that are likely to be acquired). After the 
announcement but before the distribution, D acquires X, a widely 
held corporation. The X shareholders receive D stock in exchange for 
their X stock. No person who acquired D stock in the X acquisition 
became a controlling shareholder of D, as defined in paragraph 
(a)(4) of this section, within the time period described in 
paragraph (a)(2)(v)(B) of this section. Under paragraph (a)(2)(i) of 
this section, the distribution and the acquisition of D stock by the 
X shareholders are presumed to be part of a plan (or series of 
related transactions) because the acquisition occurred within 2 
years of the distribution. If D can establish by clear and 
convincing evidence that the distribution of C would have occurred 
at approximately the same time and under substantially the same 
terms regardless of the acquisition of X, D may rebut the 
presumption under paragraph (a)(2)(v)(B) of this section.
    Example 7. (i) D engages in business 1. C engages in business 2. 
D is interested in expanding business 1 through acquisitions, but 
D's ownership of C has been an impediment to acquisitions using D 
stock. On the advice of its investment banker, D plans to distribute 
its C stock to its shareholders solely to facilitate acquisitions by 
D. D has no specific goals regarding how much D stock will be 
acquired after the distribution. D and its investment banker have 
identified X and Y as potential acquisition targets. After D decides 
to distribute its C stock, but before the distribution date, D 
negotiates with and acquires X, but has no contact with Y. A, X's 
sole shareholder, receives 30 percent of D's stock, becoming a 
controlling shareholder of D within the meaning of paragraph (a)(4) 
of this section. One year after the distribution, D acquires Y. Y's 
shareholders receive 19 percent of D's stock. After the 
distribution, D and its investment banker identify Z as another 
desirable target. Eighteen months after the distribution, D acquires 
Z. Z's shareholders receive 17 percent of D's stock.
    (ii) Under paragraph (a)(2)(i) of this section, the distribution 
and each acquisition are presumed to be part of a plan (or series of 
related transactions) because each acquisition occurred within 2 
years of the distribution. In addition, under paragraph (a)(6) of 
this section, all acquisitions for which the presumption is not 
rebutted are aggregated to determine whether an acquisition 
described in section 355(e)(2)(A)(ii) has occurred.
    (iii) Regarding the acquisition of X, D will not be able to 
rebut the presumption under paragraph (a)(2)(v)(A) of this section 
because D cannot establish that at the time A acquired D stock, D 
did not intend to effectuate a distribution. In addition, D cannot 
rebut the presumption under paragraph (a)(2)(v)(B) of this section 
because that paragraph does not apply to an acquisition in which a 
person becomes a controlling shareholder.
    (iv) Regarding the acquisitions of Y and Z, D will not be able 
to rebut the presumption under paragraph (a)(2)(ii)(A) of this 
section because D cannot establish that the distribution was 
motivated in whole or substantial part by a corporate business 
purpose within the meaning of Sec. 1.355-2(b) (other than an intent 
to facilitate an acquisition or decrease the likelihood of the 
acquisition of one or more businesses by separating those businesses 
from others that are likely to be acquired).
    (v) To rebut the presumption with regard to each acquisition of 
Y and Z using the alternative rebuttal of paragraph (a)(2)(iii) of 
this section, D must establish three facts. First, under paragraph 
(a)(2)(iii)(A)(1) of this section, D must establish that, at the 
time of the distribution, D and its controlling shareholders did not 
intend that one or more persons would acquire a 50-percent or 
greater interest in D or C during the presumption period described 
in that paragraph. For that purpose, the interests intended to be 
acquired in D or C will include A's acquisition of D stock under 
paragraph (a)(2)(iv)(A) of this section. Second, under paragraph 
(a)(2)(iii)(B) of this section, D must establish that, at the time 
of the distribution, neither D, C, nor their controlling

[[Page 46165]]

shareholders would reasonably have anticipated that it was more 
likely than not that one or more persons would acquire a 50-percent 
or greater interest in D or C within 2 years after the distribution 
(or later pursuant to an agreement, understanding, or arrangement 
existing at the time of the distribution or within 6 months 
thereafter) who would not have acquired such interests if the 
distribution had not occurred. Under paragraph (a)(2)(iv)(C) of this 
section, D, C, and their controlling shareholders must treat the 
amount of D stock acquired by A as an amount they would reasonably 
have anticipated was more likely than not to be acquired within 2 
years after the distribution that would not have been acquired if 
the distribution had not occurred. Third, under paragraph 
(a)(2)(iii)(C) of this section, D will be able to establish that the 
distribution was not motivated in whole or substantial part by an 
intention to decrease the likelihood of the acquisition of one or 
more businesses by separating those businesses from others that are 
likely to be acquired.
    Example 8. D plans to distribute C pro rata to its shareholders. 
The distribution is substantially motivated by a corporate business 
purpose within the meaning of Sec. 1.355-2(b) (other than an intent 
to facilitate an acquisition or decrease the likelihood of the 
acquisition of one or more businesses by separating those businesses 
from others that are likely to be acquired). After the announcement 
date, D's investment banker informs D's management that there is a 
lot of interest in new investment in D now that it will no longer 
own C. At the time of the distribution, D would reasonably 
anticipate that it was more likely than not that one or more persons 
would acquire a 50-percent or greater interest in D within 2 years 
(or later pursuant to an agreement, understanding, or arrangement 
existing at the time of the distribution or within 6 months 
thereafter) who would not acquire such interests absent the 
distribution. Three months after the distribution, D issues an 
option to X to purchase 50 percent of the D stock. At the time of 
issuance, the facts and circumstances indicate that the option is 
more likely than not to be exercised. Two years after issuance, X 
exercises the option and purchases 50 percent of the D stock. Under 
paragraph (a)(7)(i)(A) of this section, the option is treated as an 
agreement on the date it is issued. Under paragraph (a)(3)(i)(A) of 
this section, the distribution and the acquisition are presumed to 
be part of a plan (or series of related transactions) because there 
was an agreement concerning the acquisition within 2 years of the 
distribution. D will not be able to rebut the presumption using the 
rebuttals of paragraphs (a)(2)(ii) or (a)(2)(iii) of this section. 
The rebuttal of paragraph (a)(2)(ii) of this section is unavailable 
because there was an agreement concerning the acquisition within 6 
months of the distribution. The rebuttal of paragraph (a)(2)(iii) of 
this section is unavailable because D cannot establish that, at the 
time of the distribution, neither D, C, nor their controlling 
shareholders would reasonably have anticipated that it was more 
likely than not that one or more persons would acquire a 50-percent 
or greater interest in D within 2 years (or later pursuant to an 
agreement, understanding, or arrangement existing at the time of the 
distribution or within 6 months thereafter) who would not have 
acquired such interests absent the distribution. Because the 
presumption relating to the acquisition of a 50-percent interest in 
D cannot be rebutted, section 355(e) applies to the distribution of 
C.
    Example 9. (i) D distributes C pro rata to its shareholders 
solely to facilitate a stock offering by C. To take advantage of 
favorable market conditions, C issues new shares amounting to 20 
percent of its stock in a public offering followed 1 month later by 
the distribution. The public offering documents disclosed the 
intended distribution of C. Neither D, C, nor their controlling 
shareholders intended any further transactions involving D or C 
stock. In addition, at the time of the distribution, neither D, C, 
nor their controlling shareholders would reasonably anticipate that 
it was more likely than not that one or more persons would acquire a 
50-percent interest in D or C within 2 years (or later pursuant to 
an agreement, understanding, or arrangement existing at the time of 
the distribution or within 6 months thereafter) who would not have 
acquired such interests absent the distribution. Two months after 
the distribution, C is approached unexpectedly regarding an 
opportunity to acquire X. Five months after the distribution, C 
acquires X in exchange for 40 percent of the C stock. Under 
paragraph (a)(2)(i) of this section, the distribution and each 
acquisition are presumed to be part of a plan (or series of related 
transactions) because each acquisition occurred within 2 years of 
the distribution.
    (ii) Regarding the public offering, D cannot rebut the 
presumption using paragraph (a)(2)(v) of this section. At the time 
of the acquisition, D and its controlling shareholders intended to 
effectuate the distribution. Also, the distribution would not have 
occurred at approximately the same time and under substantially the 
same terms regardless of the public offering.
    (iii) Regarding C's acquisition of X, D will not be able to 
rebut the presumption using paragraph (a)(2)(ii) of this section 
because the acquisition occurred within 6 months after the 
distribution. However, D will be able to rebut the presumption 
regarding the acquisition of X using paragraph (a)(2)(iii) of this 
section. Neither D, C, nor their controlling shareholders intended 
that one or more persons would acquire a 50-percent or greater 
interest in D or C during the relevant period under paragraph 
(a)(2)(iii)(A)(1) of this section. Under paragraph (a)(2)(iii)(B) of 
this section, at the time of the distribution, neither D, C, nor 
their controlling shareholders would reasonably have anticipated 
that it was more likely than not that one or more persons would 
acquire a 50-percent or greater interest in C within 2 years who 
would not have acquired such interests if the distribution had not 
occurred. Under paragraph (a)(2)(iii)(C) of this section, the 
distribution was not motivated in whole or substantial part by an 
intention to decrease the likelihood of the acquisition of one or 
more businesses by separating those businesses from others that are 
likely to be acquired. Because only the 20-percent acquisition by 
public offering is part of a plan (or series of related 
transactions) involving the distribution, section 355(e) does not 
apply.

    (b) Multiple controlled corporations. Only the stock or securities 
of a controlled corporation in which one or more persons acquire 
directly or indirectly stock representing a 50-percent or greater 
interest as part of a plan (or series of related transactions) 
involving the distribution of that corporation will be treated as not 
qualified property under section 355(e)(1) if--
    (1) The stock or securities of more than one controlled corporation 
are distributed in distributions to which section 355 applies; and
    (2) One or more persons do not acquire, directly or indirectly, 
stock representing a 50-percent or greater interest in the distributing 
corporation pursuant to a plan (or series of related transactions) 
involving any of those distributions.
    (c) Valuation. Except as provided in paragraph (a)(7)(i)(A) of this 
section, for purposes of section 355(e) and this section, all shares of 
stock within a single class are considered to have the same value. 
Thus, control premiums and minority and blockage discounts within a 
single class are not taken into account.
    (d) Effective date. The regulations in this section apply to 
distributions occurring after the regulations in this section are 
published as final regulations in the Federal Register.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-21876 Filed 8-19-99; 1:37 pm]
BILLING CODE 4830-01-U