[Federal Register Volume 66, Number 1 (Tuesday, January 2, 2001)]
[Proposed Rules]
[Pages 66-76]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32774]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-107566-00]
RIN 1545-AY42


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 April 24, 
2001. Outlines of topics to be discussed at the public hearing 
scheduled for May 15, 2001, at 10 a.m. must be received by April 24, 
2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-107566-00), 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:M&SP:RU (REG-107566-00), 
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 4718, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Brendan P. 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, Guy R. Traynor, (202) 622-7180 (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 that it controls immediately 
before the distribution and certain other conditions are met, neither 
the distributing corporation (hereinafter referred to as Distributing) 
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 5-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 Distributing or the 
controlled corporation (hereinafter referred to as Controlled) can 
undergo changes of control in conjunction with a distribution that 
qualifies for corporate

[[Page 67]]

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. Enactment of Section 355(e)

    Section 355(e), which was enacted in 1997, provides that the stock 
of a controlled corporation generally will not be qualified property 
under section 355(c)(2) or section 361(c)(2) if 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) 
applies to a distribution, Distributing is taxed on the amount by which 
the distributed stock's fair market value exceeds its basis. 
Distributee shareholders receive Controlled stock tax free, but do not 
increase their bases to reflect the corporate level gain recognized by 
Distributing on the distribution.
    Section 355(e)(2)(B) provides that, unless the taxpayer establishes 
otherwise, a plan (or series of related transactions) (hereinafter 
referred to as 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.''
    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).

C. Previous Proposal of Regulations

    On August 24, 1999, the IRS and the Department of the Treasury 
published proposed regulations under section 355(e) (REG-116733-98) in 
the Federal Register (64 FR 46155) (hereinafter referred to as the 1999 
proposed regulations). The 1999 proposed regulations provided the 
exclusive means by which a taxpayer could establish that a distribution 
and an acquisition were not part of a plan, and required that the 
taxpayer must establish the absence of a plan with clear and convincing 
evidence.
    A public hearing regarding the 1999 proposed regulations was held 
on March 2, 2000. In addition, written comments were received. 
Commentators asserted that the approach of the 1999 proposed 
regulations, providing exclusive rebuttals for establishing that 
transactions are not part of a plan, was inappropriate because it 
unfairly limited the evidence taxpayers could produce that may be 
relevant to whether transactions are part of a plan. In addition, 
commentators argued that section 355(e) does not require the IRS and 
the Department of the Treasury to adopt a clear and convincing evidence 
standard for establishing whether transactions are part of a plan. 
Further, commentators were concerned that the exclusive rebuttals 
contained in the 1999 proposed regulations may not be available in 
cases in which there was an intent to facilitate any acquisition, 
regardless of its type or size, even if the acquisition being tested 
was not the intended acquisition. Finally, one of the rebuttals in the 
1999 proposed regulations was only available if the taxpayer proves, 
among other things, that ``[a]t 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 * * * who 
would not have acquired such interests if the distribution had not 
occurred.'' 1999 Prop. Reg. Sec. 1.355-7(a)(2)(iii)(B). Many 
commentators indicated that determining whether it was reasonably 
anticipated that an event was more likely than not to occur was 
impractical and that the consequent uncertainty inhibited normal 
business transactions.

Explanation of Provisions

    After consideration of the comments received, the IRS and the 
Department of the Treasury have decided to withdraw the 1999 proposed 
regulations and issue new proposed regulations (hereinafter referred to 
as the 2000 proposed regulations) to provide guidance concerning the 
interpretation of the phrase ``plan (or series of related 
transactions).'' The 2000 proposed regulations also address the 
determination of Distributing's gain when multiple controlled 
corporations are distributed and the distributions are part of a plan 
pursuant to which a 50-percent or greater interest in one or more, but 
not all, of the distributed controlled corporations is acquired.
    The IRS and the Department of the Treasury plan to issue 
regulations addressing other issues arising under section 355(e), 
including the definition of an acquisition, the application of the 
aggregation and attribution rules, the treatment of successors and 
predecessors, and the administration of the statute of limitations 
provision of section 355(e)(4)(E). Comments concerning the 2000 
proposed regulations, the additional issues described above, and other 
issues that should be addressed in regulations are welcome.

A. Plan or Series of Related Transactions

    The 2000 proposed regulations provide that whether a distribution 
and an acquisition are part of a plan is determined based on all the 
facts and circumstances. They include nonexclusive lists of facts and 
circumstances to be considered in making the determination. Because the 
determination of whether a plan exists is dependent on the facts and 
circumstances, the 2000 proposed regulations provide a general 
statement of the policy underlying whether a distribution and an 
acquisition are part of a plan for purposes of section 355(e).
    In the case of an acquisition after a distribution, the 2000 
proposed regulations provide that, in general, the distribution and 
acquisition are considered part of a plan if Distributing, Controlled, 
or any of their respective controlling shareholders intended, on the 
date of the distribution, that the acquisition or a similar acquisition 
occur in connection with the distribution. The reference to ``a similar 
acquisition'' ensures that changes in the terms of the acquisition 
intended at the time of the distribution (including, in certain 
circumstances, a substitution of acquirer) do not prevent the 
distribution

[[Page 68]]

and the acquisition that actually occurs from being considered part of 
a plan.
    In the case of an acquisition before a distribution, the 2000 
proposed regulations provide that, in general, the distribution and 
acquisition are considered part of a plan if Distributing, Controlled, 
or any of their respective controlling shareholders intended, on the 
date of the acquisition, that a distribution occur in connection with 
the acquisition.
    As indicated above, the facts and circumstances surrounding the 
distribution and the acquisition must be examined to determine whether 
the transactions were intended to occur in connection with each other. 
In addition, the 2000 proposed regulations contain six safe harbor 
provisions that, when applicable, provide that the acquisition and 
distribution are not part of a plan.
    Under the 2000 proposed regulations, Distributing must test each 
acquisition of Distributing or Controlled stock to determine whether it 
is part of a plan that includes a distribution. The 2000 proposed 
regulations aggregate all acquisitions of stock of a corporation that 
are pursuant to a plan including a particular distribution to determine 
whether the 50 percent threshold of section 355(e)(2)(A)(ii) is met.
1. Facts and Circumstances
    For those situations to which the safe harbor provisions do not 
apply, the 2000 proposed regulations provide two nonexclusive lists of 
facts and circumstances (hereinafter referred to as factors) to 
consider in assessing whether an acquisition and a distribution are 
part of a plan. One list of factors tends to demonstrate that a 
distribution and an acquisition are part of a plan and the other list 
tends to demonstrate that a distribution and an acquisition are not 
part of a plan. The weight of the factors depends on the particular 
case. The existence of a plan should not be determined merely by 
comparing the number of factors tending to show that the acquisition 
and distribution are, or are not, part of a plan.

Plan Factors

    Many of the factors tending to show that a distribution and an 
acquisition are part of a plan (the plan factors) focus on whether 
Distributing, Controlled or their respective controlling shareholders 
participated in discussions with outside parties regarding the second 
transaction of the pair being tested before the first transaction 
occurred (factors (i), (ii), (iii), (iv), (v), and (vi)). Such 
discussions provide evidence that Distributing, Controlled or any of 
their respective controlling shareholders had an intent that the 
transactions occur in connection with each other.
    Other plan factors (factors (vii), (viii), and (ix)) inquire into 
other indications of the intent of Distributing, Controlled and their 
respective controlling shareholders. Factor (vii) considers whether the 
distribution was motivated by a business purpose to facilitate the 
acquisition or a similar acquisition of Distributing or Controlled. The 
operating rule in proposed Sec. 1.355-7(e)(1)(i) states that evidence 
of a business purpose to facilitate an acquisition of Distributing or 
Controlled exists if there was a reasonable certainty that within 6 
months after the distribution an acquisition would occur, an agreement, 
understanding, or arrangement would exist, or substantial negotiations 
would occur regarding an acquisition. The operating rule in proposed 
Sec. 1.355-7(e)(1)(ii) applies to acquisitions before a distribution, 
asking whether the acquisition occurred after the date of the public 
announcement of the planned distribution, or whether, at the time of 
the acquisition, it was reasonably certain that within 6 months after 
the acquisition the distribution would occur, an agreement, 
understanding, or arrangement would exist, or substantial negotiations 
would occur regarding the distribution. The operating rule in proposed 
Sec. 1.355-7(e)(2) provides that the fact that internal discussions 
occurred may be indicative of the business purpose that motivated the 
distribution. The operating rule contained in proposed Sec. 1.355-
7(e)(3) provides that, if Distributing distributes Controlled stock 
intending, in whole or substantial part, to decrease the likelihood of 
the acquisition of Distributing or Controlled by separating it from 
another corporation that is likely to be acquired, Distributing is 
treated as having a business purpose to facilitate the acquisition of 
the corporation that was acquired.
    The rule regarding reasonable certainty is necessary to implement 
section 355(e) because where a taxpayer was reasonably certain that an 
acquisition would occur, that acquisition was likely to be taken into 
account in determining whether to effect a distribution. While the IRS 
and the Department of the Treasury believe that reasonable certainty 
(even where no discussions with potential acquirers have occurred) is 
relevant in determining whether a plan exists, it should be noted that 
this concept is significantly modified from the 1999 proposed 
regulations. This operating rule will apply only in cases where there 
was a strong probability that, within 6 months after the distribution, 
an acquisition would occur, an agreement, understanding, or arrangement 
would exist, or substantial negotiations would occur.
    Factor (viii) considers whether an acquisition and a distribution 
occured within 6 months of each other, or whether there was an 
agreement, understanding, arrangement, or substantial negotiations 
regarding the second transaction (or, if an acquisition is the second 
transaction, a similar acquisition) within 6 months after the first 
transaction.
    Finally, factor (ix) examines whether the debt allocation between 
Distributing and Controlled made an acquisition of Distributing or 
Controlled likely in order to service the debt.

Nonplan Factors

    The 2000 proposed regulations also provide a nonexclusive list of 
factors tending to show that a distribution and an acquisition are not 
part of a plan (the nonplan factors). Just as discussions with outside 
parties about the second transaction prior to the first transaction 
tend to show that Distributing, Controlled or their respective 
controlling shareholders had an intent that the second transaction 
occur in connection with the first transaction, the absence of such 
discussions tends to show that the transactions did not occur in 
connection with each other. Thus, there are nonplan factors that are 
analogous to the plan factors related to discussions (factors (i), 
(ii), and (iv)).
    The existence of a corporate business purpose, other than a 
business purpose to facilitate the acquisition or a similar 
acquisition, that motivated Distributing, in whole or substantial part, 
to make the stock distribution tends to show that a distribution and an 
acquisition are not part of a plan (factor (vi)). The presence of a 
business purpose to facilitate the acquisition or a similar acquisition 
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. In 
making this determination, the operating rules in proposed Sec. 1.355-
7(e) apply.

[[Page 69]]

    Factors (iii) and (v) consider whether there was an identifiable, 
unexpected change in market or business conditions after the first of 
the two transactions being tested that resulted in the second, 
unexpected transaction. Factor (vii) considers whether the distribution 
would have occurred at approximately the same time and in similar form 
regardless of the acquisition or a previously proposed similar 
acquisition.
2. Safe Harbors
    The 2000 proposed regulations include six safe harbor provisions. A 
distribution and an acquisition are not part of a plan if they are 
described in one of the safe harbors. The first two safe harbors 
address acquisitions more than 6 months after a distribution. Safe 
Harbor I applies to an acquisition more than 6 months after a 
distribution if there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition before a date that 
is 6 months after the distribution and the distribution was motivated 
in whole or substantial part by a corporate business purpose other than 
a business purpose to facilitate an acquisition. The nonacquisition 
corporate business purpose for the distribution is considered in light 
of any business purpose to facilitate an acquisition, and the operating 
rules in proposed Sec. 1.355-7(e) apply.
    Safe Harbor II, like Safe Harbor I, applies only to acquisitions 
more than 6 months after a distribution for which there was no 
agreement, understanding, arrangement, or substantial negotiations 
concerning the acquisition before a date that is 6 months after the 
distribution. However, where Safe Harbor I applies to cases where the 
distribution was motivated in whole or substantial part by a 
nonacquisition business purpose, Safe Harbor II applies to situations 
where the distribution was motivated in whole or substantial part by a 
business purpose to facilitate an acquisition. Under Safe Harbor II, an 
acquisition will not be treated as part of a plan with a distribution 
if the distribution was motivated in whole or substantial part by a 
corporate business purpose to facilitate an acquisition or acquisitions 
of no more than 33 percent of the stock of Distributing or Controlled, 
and no more than 20 percent of the stock of the corporation whose stock 
was acquired in the acquisition or acquisitions that motivated the 
distribution was either acquired or the subject of an agreement, 
understanding, arrangement, or substantial negotiations before a date 
that is 6 months after the distribution. Safe Harbor II is intended to 
alleviate the concerns commentators expressed about the unavailability 
of the rebuttals in the 1999 proposed regulations if the distribution 
was motivated by an intent to facilitate an acquisition regardless of 
its type or size.
    Safe Harbors III and IV address acquisitions and distributions more 
than 2 years apart. Under Safe Harbor III, acquisitions more than 2 
years after a distribution are not pursuant to a plan if there is no 
agreement, understanding, arrangement, or substantial negotiations 
concerning the acquisition at the time of the distribution or within 6 
months thereafter. Under Safe Harbor IV, acquisitions more than 2 years 
before a distribution are not part of a plan if there is no agreement, 
understanding, arrangement, or substantial negotiations concerning the 
distribution at the time of the acquisition or within 6 months 
thereafter.
    Safe Harbor V provides that an acquisition of Distributing or 
Controlled stock that is listed on an established market (as defined in 
the 2000 proposed regulations) is not part of a plan if the stock is 
transferred between shareholders of Distributing or Controlled who are 
not 5-percent shareholders. In general, a person will be considered a 
5-percent shareholder if, immediately before or after each transfer, 
the person owns, directly or indirectly, or together with related 
persons (as described in sections 267(b) and 707(b)), 5 percent or more 
of any class of stock of the corporation whose stock is transferred.
    Safe Harbor VI provides that an acquisition of stock by an employee 
or director in connection with the performance of services, including 
an acquisition resulting from the exercise of certain compensatory 
stock options, is not part of a plan.
3. Agreement, Understanding, Arrangement, or Substantial Negotiations
    There are many references in the 2000 proposed regulations to the 
existence of an agreement, understanding, arrangement, or substantial 
negotiations. The 2000 proposed regulations do not define those 
concepts precisely. A binding contract clearly is 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 
Distributing's or Controlled's stock, an agreement, understanding, 
arrangement, or substantial negotiations can exist regarding an 
acquisition even if the acquirer has not been specifically identified.
4. Options
    The 2000 proposed regulations enumerate interests treated as 
options. If stock of Distributing or Controlled is acquired pursuant to 
an option, the option is treated as an agreement to acquire stock on 
the date of writing unless Distributing establishes that, on the later 
of the date of the stock distribution or the writing of the option, the 
option was not more likely than not to be exercised. The 2000 proposed 
regulations also address the treatment of an agreement, understanding, 
or arrangement to write an option and substantial negotiations 
regarding the writing of an option. The 2000 proposed regulations 
exempt certain options from treatment as options unless they are 
written, transferred, or listed with a principal purpose of avoiding 
the application of section 355(e) or the 2000 proposed regulations. The 
enumerated exceptions cover certain commercially customary options that 
are unlikely to be used to avoid section 355(e) or the 2000 proposed 
regulations.

B. Any Controlled Corporation

    Section 355(e)(2)(A)(ii) provides that section 355(e)(1), which 
causes Distributing to recognize its gain in Controlled stock as if 
Distributing had sold the stock for its fair market value, applies to 
any distribution to which section 355 (or so much of section 356 as 
relates to 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 Distributing if, 
pursuant to a plan, the stock of more than 1 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 2000 proposed regulations clarify that under those 
circumstances, Distributing only recognizes gain on the stock of the 
distributed controlled corporations that were subject to 50-percent or 
greater acquisitions. If Distributing 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

[[Page 70]]

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 Department of the 
Treasury and the IRS 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 May 15, 2001, beginning at 
10 a.m. in Room 4718, 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 April 24, 2001. 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 P. 
O'Hara, Office of the Associate Chief Counsel (Corporate). However, 
other personnel from the Department of the Treasury and the IRS 
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 in 
part 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) In general.
    (b) Plan.
    (c) Multiple acquisitions.
    (d) Facts and circumstances.
    (e) Operating rules.
    (1) Reasonable certainty evidence of business purpose to 
facilitate an acquisition.
    (2) Internal discussion evidence of business purpose.
    (3) Hostile takeover defense.
    (4) Effect of distribution on trading in stock.
    (5) Consequences of section 355(e) disregarded for certain 
purposes.
    (6) Substantial diminution of risk.
    (f) Safe harbors.
    (1) Safe Harbor I.
    (2) Safe Harbor II.
    (3) Safe Harbor III.
    (4) Safe Harbor IV.
    (5) Safe Harbor V.
    (i) In general.
    (ii) Special rules.
    (6) Safe Harbor VI.
    (g) Stock acquired by exercise of options, warrants, convertible 
obligations, and other similar interests.
    (1) Treatment of options.
    (i) General rule.
    (ii) Agreement, understanding, arrangement, or substantial 
negotiations to write an option.
    (2) Instruments treated as options.
    (3) Instruments generally not treated as options.
    (i) Escrow, pledge, or other security agreements.
    (ii) Compensatory options.
    (iii) Options exercisable only upon death, disability, mental 
incompetency, or separation from service.
    (iv) Rights of first refusal.
    (v) Other enumerated instruments.
    (h) Multiple controlled corporations.
    (i) [Reserved]
    (j) Valuation.
    (k) Definitions.
    (1) Agreement, understanding, arrangement, or substantial 
negotiations.
    (2) Controlled corporation.
    (3) Controlling shareholder.
    (4) Established market.
    (5) Five-percent shareholder.
    (l) [Reserved]
    (m) Examples.
    (n) 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) In general. Except as provided in section 355(e) and in this 
section, section 355(e) applies to any distribution--
    (1) To which section 355 (or so much of section 356 as relates to 
section 355) applies; and
    (2) That is part of a plan (or series of related transactions) 
(hereinafter, plan) pursuant to which 1 or more persons acquire 
directly or indirectly stock representing a 50-percent or greater 
interest in the distributing corporation (Distributing) or any 
controlled corporation (Controlled).
    (b) Plan. (1) Whether a distribution and an acquisition are part of 
a plan is determined based on all the facts and circumstances. In 
general, in the case of an acquisition after a distribution, the 
distribution and the acquisition are considered part of a plan if 
Distributing, Controlled, or any of their respective controlling 
shareholders intended, on the date of the distribution, that the 
acquisition or a similar acquisition occur in connection with the 
distribution. In general, in the case of an acquisition before a 
distribution, the acquisition and the distribution are considered part 
of a plan if Distributing,

[[Page 71]]

Controlled, or any of their respective controlling shareholders 
intended, on the date of the acquisition, that a distribution occur in 
connection with the acquisition.
    (2) For purposes of paragraph (b)(1) of this section, the actual 
acquisition and the intended acquisition may be similar even though the 
identity of the person acquiring stock of Distributing or Controlled 
(acquirer), the timing of the acquisition or the terms of the actual 
acquisition are different from the intended acquisition. For example, 
in the case of a public offering or auction, the actual acquisition and 
the intended acquisition may be similar even though there are changes 
in the terms of the stock, the class of stock being offered, the size 
of the offering, the timing of the offering, the price of the stock, or 
the participants in the public offering or auction.
    (c) Multiple acquisitions. All acquisitions of stock of 
Distributing or Controlled that are considered to be part of a plan 
with a distribution pursuant to paragraph (b) of this section will be 
aggregated for purposes of the 50-percent test of paragraph (a)(2) of 
this section.
    (d) Facts and circumstances. (1) The facts and circumstances to be 
considered in demonstrating whether a distribution and an acquisition 
are part of a plan include, but are not limited to, the facts and 
circumstances specified in paragraphs (d)(2) and (d)(3) of this 
section. The weight to be given each of the facts and circumstances 
depends on the particular case. Therefore, whether a distribution and 
an acquisition are part of a plan does not depend on the relative 
number of facts and circumstances present under paragraph (d)(2) as 
compared to paragraph (d)(3) of this section.
    (2) Among the facts and circumstances tending to show that a 
distribution and an acquisition are part of a plan are the following:
    (i) In the case of an acquisition (other than involving a public 
offering or auction) after a distribution, Distributing or Controlled 
and the acquirer (or any of their respective controlling shareholders) 
discussed the acquisition or a similar acquisition by the acquirer 
before the distribution. The weight to be accorded the discussions 
depends on the nature, extent and timing of the discussions. The 
existence of an agreement, understanding, arrangement or substantial 
negotiations at the time of the distribution is given substantial 
weight.
    (ii) In the case of an acquisition (other than involving a public 
offering or auction) after a distribution, Distributing or Controlled 
and a potential acquirer (or any of their respective controlling 
shareholders) discussed an acquisition before the distribution and a 
similar acquisition by a different person occurred after the 
distribution. The weight to be accorded the discussions depends on the 
nature, extent and timing of the discussions and the similarity of the 
acquisition actually occurring to the acquisition discussed before the 
distribution.
    (iii) In the case of an acquisition involving a public offering or 
auction after a distribution, Distributing or Controlled (or any of 
their respective controlling shareholders) discussed the acquisition 
with an investment banker or other outside adviser before the 
distribution. The weight to be accorded the discussions depends on the 
nature, extent and timing of the discussions.
    (iv) In the case of an acquisition before a distribution, 
Distributing or Controlled and the acquirer (or any of their respective 
controlling shareholders) discussed a distribution before the 
acquisition. The weight to be accorded the discussions depends on the 
nature, extent and timing of the discussions.
    (v) In the case of an acquisition before a distribution, 
Distributing or Controlled and a potential acquirer (or any of their 
respective controlling shareholders) discussed a distribution before 
the acquisition and a similar acquisition by a different person 
occurred before the distribution. The weight to be accorded the 
discussions depends on the nature, extent and timing of the discussions 
and the similarity of the acquisition actually occurring to the 
potential acquisition that was discussed.
    (vi) In the case of an acquisition involving a public offering or 
auction before a distribution, Distributing or Controlled (or any of 
their respective controlling shareholders) discussed a distribution 
with an investment banker or other outside adviser before the 
acquisition. The weight to be accorded the discussions depends on the 
nature, extent and timing of the discussions.
    (vii) In the case of an acquisition either before or after a 
distribution, the distribution was motivated by a business purpose to 
facilitate the acquisition or a similar acquisition of Distributing or 
Controlled.
    (viii) In the case of an acquisition either before or after a 
distribution, the acquisition and the distribution occurred within 6 
months of each other or there was an agreement, understanding, 
arrangement, or substantial negotiations regarding the second 
transaction within 6 months after the first transaction. Also, in the 
case of an acquisition occurring after a distribution, there was an 
agreement, understanding, arrangement, or substantial negotiations 
regarding a similar acquisition at the time of the distribution or 
within 6 months thereafter.
    (ix) In the case of an acquisition either before or after a 
distribution, the debt allocation between Distributing and Controlled 
made an acquisition of Distributing or Controlled likely in order to 
service the debt.
    (3) Among the facts and circumstances tending to show that a 
distribution and an acquisition are not part of a plan are the 
following:
    (i) In the case of an acquisition (other than involving a public 
offering or auction) after a distribution, neither Distributing nor 
Controlled and the acquirer or any potential acquirer (nor any of their 
respective controlling shareholders) discussed the acquisition or a 
similar acquisition before the distribution.
    (ii) In the case of an acquisition involving a public offering or 
auction after a distribution, neither Distributing nor Controlled (nor 
any of their respective controlling shareholders) discussed the 
acquisition with an investment banker or other outside adviser before 
the distribution.
    (iii) In the case of an acquisition after a distribution, there was 
an identifiable, unexpected change in market or business conditions 
occurring after the distribution that resulted in the acquisition that 
was otherwise unexpected at the time of the distribution.
    (iv) In the case of an acquisition (other than involving a public 
offering or auction) before a distribution, neither Distributing nor 
Controlled and the acquirer (nor any of their respective controlling 
shareholders) discussed a distribution before the acquisition. This 
paragraph (d)(3)(iv) does not apply if the acquisition occurred after 
the date of the public announcement of the planned distribution.
    (v) In the case of an acquisition before a distribution, there was 
an identifiable, unexpected change in market or business conditions 
occurring after the acquisition that resulted in a distribution that 
was otherwise unexpected.
    (vi) In the case of an acquisition either before or after a 
distribution, 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 a business purpose to facilitate the acquisition or a 
similar acquisition of Distributing or Controlled. The presence of a 
business

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purpose to facilitate the acquisition or a similar acquisition of 
Distributing or Controlled 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 a business purpose 
to facilitate the acquisition or a similar acquisition of Distributing 
or Controlled.
    (vii) In the case of an acquisition either before or after a 
distribution, the distribution would have occurred at approximately the 
same time and in similar form regardless of the acquisition or a 
similar acquisition (including a previously proposed similar 
acquisition that did not occur).
    (e) Operating rules. The operating rules contained in this 
paragraph (e) apply for all purposes of this section.
    (1) Reasonable certainty evidence of business purpose to facilitate 
an acquisition. (i) In the case of an acquisition after a distribution, 
if, at the time of the distribution, it was reasonably certain that 
before a date that is 6 months after the distribution an acquisition 
would occur, an agreement, understanding, or arrangement would exist, 
or substantial negotiations would occur regarding an acquisition of 
Distributing or Controlled, the reasonable certainty is evidence of a 
business purpose to facilitate an acquisition of Distributing or 
Controlled.
    (ii) In the case of an acquisition before a distribution, if the 
acquisition occurred after the date of the public announcement of the 
planned distribution, or if, at the time of the acquisition, it was 
reasonably certain that before a date that is 6 months after the 
acquisition the distribution would occur, an agreement, understanding, 
or arrangement would exist, or substantial negotiations would occur 
regarding the distribution, the public announcement or reasonable 
certainty is evidence of a business purpose to facilitate an 
acquisition of Distributing or Controlled.
    (2) Internal discussions evidence of business purpose. The fact 
that internal discussions regarding an acquisition occurred may be 
indicative of the business purpose that motivated the distribution.
    (3) Hostile takeover defense. If Distributing distributes 
Controlled stock intending, in whole or substantial part, to decrease 
the likelihood of the acquisition of Distributing or Controlled by 
separating it from another corporation that is likely to be acquired, 
Distributing will be treated as having a business purpose to facilitate 
the acquisition of the corporation that was likely to be acquired.
    (4) Effect of distribution on trading in stock. The fact that the 
distribution made all or a part of the stock of Controlled available 
for trading or made Distributing or Controlled's stock trade more 
actively is not taken into account in determining whether the 
distribution and an acquisition of Distributing or Controlled stock 
were part of a plan.
    (5) Consequences of section 355(e) disregarded for certain 
purposes. For purposes of determining the intentions of the relevant 
parties under this section, the consequences of the application of 
section 355(e), and the existence of any contractual indemnity by 
Controlled for tax resulting from the application of section 355(e) 
caused by an acquisition of Controlled, are disregarded.
    (6) Substantial diminution of risk. The running of any time period 
prescribed in this section shall be suspended for any period during 
which risk of loss is substantially diminished under the principles of 
section 355(d)(6)(B).
    (f) Safe harbors--(1) Safe Harbor I. (i) A distribution and an 
acquisition occurring after the distribution will not be considered 
part of a plan if--
    (A) The acquisition occurred more than 6 months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition before a date that 
is 6 months after the distribution; and
    (B) 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 a business purpose to facilitate an acquisition of 
Distributing or Controlled.
    (ii) For purposes of paragraph (f)(1)(i)(B) of this section, the 
presence of a business purpose to facilitate an acquisition of 
Distributing or Controlled 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 a business purpose 
to facilitate an acquisition of Distributing or Controlled.
    (2) Safe Harbor II. A distribution and an acquisition occurring 
after the distribution will not be considered part of a plan if--
    (i) The acquisition occurred more than 6 months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition before a date that 
is 6 months after the distribution; and
    (ii) The distribution was motivated in whole or substantial part by 
a corporate business purpose (within the meaning of Sec. 1.355-2(b)) to 
facilitate an acquisition or acquisitions of no more than 33 percent of 
the stock of Distributing or Controlled, and no more than 20 percent of 
the stock of the corporation (whose stock was acquired in the 
acquisition or acquisitions that motivated the distribution) was either 
acquired or the subject of an agreement, understanding, arrangement, or 
substantial negotiations before a date that is 6 months after the 
distribution.
    (3) Safe Harbor III. If an acquisition occurs more than 2 years 
after a 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, the 
acquisition and the distribution are not part of a plan.
    (4) Safe Harbor IV. If an acquisition occurs more than 2 years 
before a distribution, and there was no agreement, understanding, 
arrangement, or substantial negotiations concerning the distribution at 
the time of the acquisition or within 6 months thereafter, the 
acquisition and the distribution are not part of a plan.
    (5) Safe Harbor V--(i) In general. An acquisition of Distributing 
or Controlled stock that is listed on an established market is not part 
of a plan if the acquisition is pursuant to a transfer between 
shareholders of Distributing or Controlled, neither of whom is a 5-
percent shareholder. For purposes of the preceding sentence, the term 
5-percent shareholder is defined in paragraph (k)(5) of this section, 
except that the corporation can rely on Schedules 13D and 13G (or any 
similar schedules) filed with the Securities and Exchange Commission to 
identify its 5-percent shareholders.
    (ii) Special rules--(A) This paragraph (f)(5) does not apply to 
public offerings or redemptions.
    (B) This paragraph (f)(5) does not apply to a transfer of stock by 
or to a person who, pursuant to a formal or informal understanding with 
other persons (the coordinating group), has joined in coordinated 
transfers of stock if, at any time during the period the understanding 
exists, the coordinating group owns, in the aggregate, 5 percent or 
more of the stock of the corporation whose stock is transferred 
(determined by vote or value) immediately before or after each transfer 
or at the time of the distribution. A principal element in determining 
if such an understanding exists is whether the investment decision of 
each person is based on the investment decision of 1 or more other 
existing or prospective shareholders.

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    (C) This paragraph (f)(5) does not apply to a transfer of stock by 
or to a person if the corporation the stock of which is being 
transferred knows, or has reason to know, that the person (or a 
coordinating group, treating it as a single person) intends to become a 
5-percent shareholder at any time during the 4-year period beginning 2 
years before the distribution.
    (6) Safe Harbor VI. If stock of Distributing or Controlled is 
acquired by an employee or director of Distributing, Controlled, or a 
person related to Distributing or Controlled under section 
355(d)(7)(A), in connection with the performance of services as an 
employee or director 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) in a transaction to which section 83 applies, 
the acquisition is not an acquisition that is part of a plan as 
described in paragraph (b)(1) of this section.
    (g) Stock acquired by exercise of options, warrants, convertible 
obligations, and other similar interests--(1) Treatment of options--(i) 
General rule. For purposes of this section, if stock of Distributing or 
Controlled is acquired pursuant to an option, the option will be 
treated as an agreement to acquire the stock on the date the option is 
written unless Distributing establishes that on the later of the date 
of the stock distribution or the writing of the option, 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, taking control premiums and minority and 
blockage discounts into account in determining the fair market value of 
stock underlying an option.
    (ii) Agreement, understanding, arrangement, or substantial 
negotiations to write an option. If there is an agreement, 
understanding, or arrangement to write an option, the option will be 
treated as written on the date of the agreement, understanding, or 
arrangement. If an agreement, understanding, or arrangement to write an 
option is reached, or an option is written, more than 6 months but not 
more than 2 years after the distribution, and there were substantial 
negotiations regarding the writing 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 written within 6 months after the distribution.
    (2) Instruments treated as options. For purposes of this paragraph 
(g), except to the extent provided in paragraph (g)(3) 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), any other instruments that 
provide for the right or possibility to issue, redeem, or transfer 
stock (including an option on an option), or any other similar 
interests are treated as options.
    (3) Instruments generally not treated as options. For purposes of 
this paragraph (g), the following are not treated as options unless (in 
the case of paragraphs (g)(3)(i), (iii), and (iv) of this section) 
written, transferred (directly or indirectly), or listed with a 
principal purpose of avoiding the application of section 355(e) or this 
section.
    (i) 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.
    (ii) Compensatory options. An option to acquire stock in 
Distributing or Controlled with customary terms and conditions provided 
to an employee or director of Distributing, Controlled, or a person 
related to Distributing or Controlled under section 355(d)(7)(A), in 
connection with the performance of services as an employee or director 
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--
    (A) Is nontransferable within the meaning of Sec. 1.83-3(d); and
    (B) Does not have a readily ascertainable fair market value as 
defined in Sec. 1.83-7(b).
    (iii) Options exercisable only upon death, disability, mental 
incompetency, or separation from service. Any option entered into 
between shareholders of a corporation (or a shareholder and the 
corporation) that is exercisable only upon the death, disability, or 
mental incompetency of the shareholder, 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 
shareholder's separation from service.
    (iv) Rights of first refusal. A bona fide right of first refusal 
regarding the corporation's stock with customary terms, entered into 
between shareholders of a corporation (or between the corporation and a 
shareholder).
    (v) Other enumerated instruments. Any other instrument the 
Commissioner may designate in revenue procedures, notices, or other 
guidance published in the Internal Revenue Bulletin. See 
Sec. 601.601(d)(2) of this chapter.
    (h) Multiple controlled corporations. Only the stock or securities 
of a controlled corporation in which 1 or more persons acquire directly 
or indirectly stock representing a 50-percent or greater interest as 
part of a plan 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 1 controlled corporation 
are distributed in distributions to which section 355 (or so much of 
section 356 as relates to section 355) applies; and
    (2) One or more persons do not acquire, directly or indirectly, 
stock representing a 50-percent or greater interest in Distributing 
pursuant to a plan involving any of those distributions.
    (i) [Reserved]
    (j) Valuation. Except as provided in paragraph (g)(1)(i) 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.
    (k) Definitions--(1) Agreement, understanding, arrangement, or 
substantial negotiations. Whether an agreement, understanding, or 
arrangement exists depends on the facts and circumstances. 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. However, an agreement, understanding, or arrangement 
clearly exists if enforceable rights to acquire stock exist. In public 
offerings or auctions by Distributing or Controlled of Distributing or 
Controlled's stock, an agreement, understanding, arrangement, or 
substantial negotiations can exist even if the acquirer has not been 
specifically identified. The existence of such an agreement, 
understanding, arrangement, or substantial negotiations will be based 
on discussions with an

[[Page 74]]

investment banker or other outside adviser.
    (2) Controlled corporation. For purposes of this section, a 
controlled corporation is a corporation the stock of which is 
distributed in a distribution to which section 355 (or so much of 
section 356 as relates to section 355) applies.
    (3) Controlling shareholder. (i) A controlling shareholder of a 
corporation the stock of which is not listed on an established market 
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 Distributing or Controlled representing a meaningful voice in 
the governance of the corporation.
    (ii) A controlling shareholder of a corporation the stock of which 
is listed on an established market is a 5-percent shareholder who 
actively participates in the management or operation of the 
corporation.
    (iii) For purposes of this section, a person is a controlling 
shareholder if that person meets the definition of controlling 
shareholder in this paragraph (k)(3) immediately before or immediately 
after the acquisition being tested.
    (iv) If a distribution precedes an acquisition, Controlled's 
controlling shareholders immediately after the distribution are 
considered Controlled's controlling shareholders at the time of the 
distribution.
    (4) Established Market. An established market is--
    (i) A national securities exchange registered under section 6 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78f);
    (ii) An interdealer quotation system sponsored by a national 
securities association registered under section 15A of the Securities 
Act of 1934 (15 U.S.C. 78o-3); or
    (iii) Any additional market that the Commissioner may designate in 
revenue procedures, notices, or other guidance published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
    (5) Five-percent shareholder. A person will be considered a 5-
percent shareholder of a corporation the stock of which is listed on an 
established market if the person owns, directly or indirectly, or 
together with related persons (as described in sections 267(b) and 
707(b)) 5 percent or more of any class of stock of the corporation 
whose stock is transferred. A person is a 5-percent shareholder if the 
person meets the requirements of the preceding sentence immediately 
before or after each transfer. All options are treated as exercised for 
the purpose of determining whether the shareholder is a 5-percent 
shareholder.
    (l) [Reserved]
    (m) Examples. The following examples illustrate paragraphs (a) 
through (k) of this section. Throughout these examples, assume that 
Distributing (D) owns all of the stock of Controlled (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. Unless 
otherwise stated, assume the corporations do not have controlling 
shareholders. 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. Unwanted assets. (i) D is in business 1. C is in 
business 2. D is relatively small in its industry. D wants to 
combine with X, a larger corporation also engaged in business 1. X 
and D begin negotiating for X to acquire D, but X does not want to 
acquire C. To facilitate the acquisition of D by X, D agrees to 
distribute all the stock of C pro rata before the acquisition. D and 
X enter into a binding contract for D to merge into X subject to 
several conditions. D distributes C and D merges into X one month 
later. As a result of the merger, D's former shareholders own less 
than 50 percent of the stock of X.
    (ii) No Safe Harbor applies to this acquisition.
    (iii) The issue is whether the distribution of C and the merger 
of D into X are part of a plan. To determine whether the 
distribution of C and the merger of D into X are part of a plan, D 
must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (iv) The following tends to show that the distribution of C and 
the merger of D into X are part of a plan: X and D discussed the 
acquisition before the distribution (paragraph (d)(2)(i) of this 
section), D was motivated by a business purpose to facilitate the 
merger (paragraph (d)(2)(vii) of this section), and the distribution 
and the merger occurred within 6 months of each other (paragraph 
(d)(2)(viii) of this section). Because the merger was not only 
discussed, but was agreed to, before the distribution, the fact 
described in paragraph (d)(2)(i) of this section is given 
substantial weight.
    (v) None of the facts and circumstances listed in paragraph 
(d)(3) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (vi) The distribution of C and the merger of D into X are part 
of a plan under paragraph (b)(1) of this section.
    Example 2. Substituted acquirer. (i) The facts are the same as 
in Example 1, except that after D distributes C, X is unable to 
fulfill one of the conditions of the merger agreement and the merger 
of D into X does not occur. Y, one of X's competitors, perceives 
this as an opportunity and begins discussing with D a merger into Y. 
Five months after D distributes C, D merges into Y. As a result of 
the merger, the D shareholders own less than 50 percent of the 
outstanding Y stock.
    (ii) No Safe Harbor applies to this acquisition.
    (iii) The issue is whether the distribution of C and the merger 
of D into Y are part of a plan. To determine whether the 
distribution of C and the merger of D into Y are part of a plan, D 
must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (iv) The following tends to show that the distribution of C and 
the merger of D into Y are part of a plan: X, a potential acquirer, 
and D discussed an acquisition before the distribution and a similar 
acquisition by Y occurred (paragraph (d)(2)(ii) of this section), D 
was motivated by a business purpose to facilitate an acquisition 
similar to the merger with Y (paragraph (d)(2)(vii) of this 
section), and the distribution and the merger occurred within 6 
months of each other (paragraph (d)(2)(viii) of this section).
    (v) As in Example 1, none of the facts and circumstances listed 
in paragraph (d)(3) of this section exist in this case. Although a 
substituted acquirer acquired D, the merger of D into Y was similar 
to the negotiated merger of D into X.
    (vi) The distribution of C and the merger of D into Y are part 
of a plan under paragraph (b)(1) of this section.
    Example 3. Public offering.
    (i) D's managers, directors, and investment banker discuss the 
possibility of offering D stock to the public. They decide a public 
offering of 50 percent of D's stock with D as a stand alone 
corporation would be in D's best interest. To facilitate a stock 
offering by D of 50 percent of its stock, D distributes all the 
stock of C pro rata to D's shareholders. D issues new shares 
amounting to 50 percent of its stock to the public in a public 
offering 7 months after the distribution.
    (ii) No Safe Harbor applies to this acquisition. Safe Harbor V, 
relating to public trading, does not apply to public offerings 
(paragraph (f)(5)(ii)(A) of this section).
    (iii) The issue is whether the distribution of C and the public 
offering by D are part of a plan. To determine whether the 
distribution of C and the public offering by D are part of a plan, D 
must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (iv) The following tends to show that the distribution of C and 
the public offering by D are part of a plan: D discussed the public 
offering with its investment banker before the distribution 
(paragraph (d)(2)(iii) of this section), D was motivated by a 
business purpose to facilitate the public offering (paragraph 
(d)(2)(vii) of this section), and there were substantial 
negotiations regarding the public offering within 6 months after the 
distribution (paragraph (d)(2)(viii) of this section).
    (v) None of the facts and circumstances listed in paragraph 
(d)(3) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.

[[Page 75]]

    (vi) The distribution of C and the public offering by D are part 
of a plan under paragraph (b)(1) of this section.
    Example 4. Public offering followed by unexpected opportunity--
(i) Facts. D's managers, directors, and investment banker discuss 
the possibility of offering C stock to the public. D decides to 
distribute C pro rata to D's shareholders solely to facilitate a 20 
percent 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 1 month before D distributes its remaining 80 
percent of the C stock. The public offering documents disclose the 
intended distribution of C, which is expected to occur shortly after 
the public offering. At the time of the distribution, it is not 
reasonably certain that an acquisition will occur, an agreement, 
understanding, or arrangement concerning an acquisition will exist, 
or substantial negotiations concerning an acquisition will occur 
within 6 months. 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.
    (ii) Public offering. (A) No Safe Harbor applies to the public 
offering. Safe Harbor V, related to public trading, does not apply 
to public offerings (paragraph (f)(5)(ii)(A) of this section).
    (B) The issue is whether the 20 percent public offering by C and 
the distribution by D of the remaining C stock are part of a plan. 
To determine whether the distribution and the public offering are 
part of a plan, D must consider all the facts and circumstances, 
including those described in paragraph (d) of this section.
    (C) Under paragraph (d)(2) of this section, the following tends 
to show that the distribution of C and the public offering are part 
of a plan: D discussed the distribution with its investment banker 
before the public offering (paragraph (d)(2)(vi) of this section), D 
was motivated by a business purpose to facilitate the public 
offering (paragraph (d)(2)(vii) of this section), and the public 
offering and the distribution occurred within 6 months of each other 
(paragraph (d)(2)(viii) of this section).
    (D) None of the facts and circumstances listed in paragraph 
(d)(3) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (E) The public offering of C and the distribution of C are part 
of a plan under paragraph (b)(1) of this section.
    (iii) X acquisition. (A) No Safe Harbor applies to the X 
acquisition.
    (B) The issue is whether the distribution of C and the 
acquisition by C of X are part of a plan. To determine whether the 
distribution of C and the acquisition by C of X are part of a plan, 
D must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (C) Under paragraph (d)(2) of this section, the following tends 
to show that the distribution of C and acquisition by C of X are 
part of a plan: The distribution and the acquisition occurred within 
6 months of each other (paragraph (d)(2)(viii) of this section). The 
fact described in paragraph (d)(2)(vii) of this section does not 
exist in this case because D's business purpose was to facilitate 
the public offering and C's acquisition of X is not similar to that 
acquisition.
    (D) Under paragraph (d)(3) of this section, the following tends 
to show that the distribution of C and the acquisition by C of X are 
not part of a plan: Neither D, C, nor their respective controlling 
shareholders discussed the acquisition of X or a similar acquisition 
with potential acquirers before the distribution (paragraph 
(d)(3)(i) of this section), D had a substantial business purpose for 
the distribution other than a business purpose to facilitate the 
acquisition of X or a similar acquisition (paragraph (d)(3)(vi) of 
this section), and the distribution would have occurred at 
approximately the same time and in similar form regardless of the 
acquisition of X (paragraph (d)(3)(vii) of this section). The 
distribution was announced and accomplished to facilitate the 20 
percent public offering by C. D and C were unaware of the 
opportunity to acquire X at the time of the distribution.
    (E) Weighing the facts and circumstances, the acquisition by C 
of X and the distribution of C by D are not part of a plan under 
paragraph (b)(1) of this section.
    (F) If C's acquisition of X had occurred more than 6 months 
after the distribution and had not been the subject of an agreement, 
understanding, arrangement, or substantial negotiations before the 
date that is 6 months after the distribution, Safe Harbor II would 
have applied to C's acquisition of X.
    Example 5. Hot market. (i) D is a widely held corporation the 
stock of which is listed on an established market. D announces a 
distribution of C and distributes C pro rata to D's shareholders. By 
contract, C agrees to indemnify D for any imposition of tax under 
section 355(e) caused by the acts of C. The distribution is 
motivated by a desire to improve D's access to financing at 
preferred customer interest rates, which will be more readily 
available if D separates from C. At the time of the distribution, 
although D has not been approached by any potential acquirer of C, 
it is reasonably certain that within 6 months after the distribution 
either an acquisition of C will occur or there will be an agreement, 
understanding, arrangement, or substantial negotiations regarding an 
acquisition of C. Corporation Y acquires C in a merger described in 
section 368(a)(2)(E) within 6 months after the distribution. The C 
shareholders receive less than 50 percent of the stock of Y in the 
exchange.
    (ii) No Safe Harbor applies to this acquisition.
    (iii) The issue is whether the distribution of C and the 
acquisition of C by Y are part of a plan. To determine whether the 
distribution of C and the acquisition of C by Y are part of a plan, 
D must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (iv) Under paragraph (d)(2) of this section, the following tends 
to show that the distribution of C and the acquisition of C by Y are 
part of a plan: The acquisition and the distribution occurred within 
6 months of each other (paragraph (d)(2)(viii) of this section). In 
addition, the distribution may be motivated by a business purpose to 
facilitate the acquisition or a similar acquisition because there is 
evidence of a business purpose to facilitate an acquisition by 
reason of the fact that at the time of the distribution it was 
reasonably certain that an acquisition of C would occur or there 
would be an agreement, understanding, arrangement, or substantial 
negotiations regarding an acquisition of C within 6 months after the 
distribution (paragraphs (d)(2)(vii) and (e)(1)(i) of this section).
    (v) Under paragraph (d)(3) of this section, the following tends 
to show that the distribution of C and the acquisition of C by Y are 
not part of a plan: Neither D, C, nor their respective controlling 
shareholders discussed the acquisition or a similar acquisition with 
Y or any other potential acquirers before the distribution 
(paragraph (d)(3)(i) of this section). Furthermore, D may be able to 
demonstrate that the distribution was motivated in whole or 
substantial part by a corporate business purpose other than a 
business purpose to facilitate the acquisition or a similar 
acquisition (paragraph (d)(3)(vi) of this section). D's stated 
purpose for the distribution (facilitating D's access to favorable 
financing) must be evaluated in light of the evidence of a business 
purpose to facilitate an acquisition. D also may be able to 
demonstrate that the distribution would have occurred at 
approximately the same time and in similar form regardless of the 
acquisition (paragraph (d)(3)(vii) of this section).
    (vi) Under paragraph (e)(5) of this section, the existence of 
the indemnity is irrelevant in analyzing whether the distribution 
and acquisition of C are part of a plan.
    (vii) In determining whether the distribution of C and the 
acquisition of C by Y are part of a plan, one should consider the 
importance of D's stated business purpose for the distribution in 
light of the reasonable certainty that C would be acquired or there 
would be an agreement, understanding, arrangement, or substantial 
negotiations regarding an acquisition of C within 6 months after the 
distribution. If D's stated business purpose for the distribution is 
substantial even though the reasonable certainty that C would be 
acquired is evidence of a business purpose to facilitate an 
acquisition, and if D would have distributed C regardless of Y's 
acquisition of C, Y's acquisition of C and D's distribution of C are 
not part of a plan.
    Example 6. Unexpected opportunity. (i) D, the stock of which is 
listed on an established market, announces that it will distribute 
all the stock of C pro rata to D's shareholders. At the time of the 
announcement, the distribution is motivated wholly by a corporate 
business purpose (within the meaning of Sec. 1.355-2(b)) other than 
a business purpose to facilitate an acquisition. After the 
announcement but before the distribution, widely held X becomes 
available as an acquisition target. There were no discussions 
between D and X before the announcement. D negotiates with and 
acquires X before the distribution. After the acquisition, X's 
former shareholders own 55 percent of D's stock. D distributes the 
stock

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of C pro rata within 6 months after the acquisition of X.
    (ii) No Safe Harbor applies to this acquisition.
    (iii) The issue is whether the acquisition of X by D and the 
distribution of C are part of a plan. To determine whether the 
distribution of C and the acquisition of X by D are part of a plan, 
D must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (iv) Under paragraph (d)(2) of this section, the following tends 
to show that the acquisition of X by D and the distribution of C are 
part of a plan: The acquisition and the distribution occurred within 
6 months of each other (paragraph (d)(2)(viii) of this section). 
Also, the distribution may be motivated by a business purpose to 
facilitate the acquisition or a similar acquisition because there is 
evidence of a business purpose to facilitate an acquisition by 
reason of the fact that the acquisition occurred after the public 
announcement of the planned distribution (paragraphs (d)(2)(vii) and 
(e)(1)(ii) of this section).
    (v) Under paragraph (d)(3) of this section, D would assert that 
the following tends to show that the distribution of C and the 
acquisition of X by D are not part of a plan: The distribution was 
motivated by a corporate business purpose other than a business 
purpose to facilitate the acquisition or a similar acquisition 
(paragraph (d)(3)(vi) of this section), and the distribution would 
have occurred at approximately the same time and in similar form 
regardless of the acquisition (paragraph (d)(3)(vii) of this 
section). That D decided to distribute C and announced that decision 
before it became aware of the opportunity to acquire X suggests that 
the distribution would have occurred at approximately the same time 
and in similar form regardless of D's acquisition of X. X's lack of 
participation in the decision also helps establish that fact.
    (vi) In determining whether the distribution of C and 
acquisition of X by D are part of a plan, one should consider the 
importance of D's business purpose for the distribution in light of 
D's opportunity to acquire X. If D can establish that the 
distribution continued to be motivated by the stated business 
purpose, and if D would have distributed C regardless of D's 
acquisition of X, then D's acquisition of X and D's distribution of 
C are not part of a plan.
    Example 7. Multiple acquisitions--(i) Facts. (A) D, the stock of 
which is listed on an established market, engages in business 1. C 
engages in business 2. D has a business strategy of growth through 
acquisitions and is interested in continually expanding business 1. 
D's ownership of C has been an impediment to acquisitions by D. D 
believes the distribution of C will make its acquisition program 
more economical overall, regardless of D's success with any 
particular acquisition target. D has no specific goals regarding how 
much D stock will be used for acquisitions.
    (B) D and its investment banker identify X and Y as potential 
acquisition targets before D publicly announces the planned 
distribution. After D publicly announces the distribution, the sole 
purpose of which is to facilitate acquisitions by D, but before the 
distribution date, D negotiates with X, but has no contact with Y. D 
distributes all of the C stock. One month after the distribution, D 
consummates the negotiated acquisition of X. A, X's sole 
shareholder, receives 30 percent of D's stock. Seven months after 
the distribution, D begins negotiating with Y. 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. If aggregated, the acquisitions of X, Y and Z would 
result in a change in the stock ownership of D of more than 50 
percent.
    (ii) X acquisition. (A) No Safe Harbor applies to the X 
acquisition.
    (B) The issue is whether the distribution of C and the 
acquisition of X by D are part of a plan. To determine whether the 
distribution of C and the acquisition of X by D are part of a plan, 
D must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (C) Under paragraph (d)(2) of this section, the following tends 
to show that the distribution of C and the acquisition of X by D are 
part of a plan: D and X discussed the acquisition before the 
distribution (paragraph (d)(2)(i) of this section), D had a business 
purpose to facilitate the X acquisition or a similar acquisition 
(paragraph (d)(2)(vii) of this section), and the distribution and 
the X acquisition occurred within 6 months of each other (paragraph 
(d)(2)(viii) of this section).
    (D) None of the facts and circumstances listed in paragraph 
(d)(3) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (E) The distribution of C and the acquisition of X are part of a 
plan under paragraph (b)(1) of this section.
    (iii) Y acquisition. (A) No Safe Harbor applies to the Y 
acquisition. Safe Harbor I does not apply because the distribution 
was not motivated in whole or substantial part by a corporate 
business purpose (within the meaning of Sec. 1.355-2(b)) other than 
a business purpose to facilitate an acquisition. Safe Harbor II does 
not apply because D's business purpose to facilitate acquisitions 
was not limited to 33 percent or less of the D stock. Also, more 
than 20 percent of D's stock was acquired in an acquisition that 
motivated the distribution before the date that was 6 months after 
the distribution (D's acquisition of X using 30 percent of D's stock 
1 month after the distribution).
    (B) The issue is whether the distribution of C and the 
acquisition of Y by D are part of a plan. To determine whether the 
distribution of C and the acquisition of Y by D are part of a plan, 
D must consider all the facts and circumstances, including those 
described in paragraph (d) of this section.
    (C) Under paragraph (d)(2) of this section, the following tends 
to show that the distribution of C and the acquisition of Y by D are 
part of a plan: D and a potential acquirer (X) discussed an 
acquisition before the distribution and a similar acquisition with a 
different acquirer (Y) occurred (paragraph (d)(2)(ii) of this 
section) and D had a business purpose to facilitate the Y 
acquisition or a similar acquisition (paragraph (d)(2)(vii) of this 
section).
    (D) None of the facts and circumstances listed in paragraph 
(d)(3) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (E) The distribution of C and the acquisition of Y are part of a 
plan under paragraph (b)(1) of this section.
    (iv) Z acquisition. The analysis is identical to the Y 
acquisition. The distribution of C and the acquisition of Z are part 
of a plan under paragraph (b)(1) of this section.
    (v) Under paragraph (c) of this section, all acquisitions of 
stock of D pursuant to a plan involving a distribution will be 
aggregated for purposes of the 50-percent test of paragraph (a)(2) 
of this section. Because the acquisitions by D of X, Y, and Z are 
each part of a plan involving D's distribution of C, those three 
acquisitions are aggregated.
    (n) Effective date. This section applies to distributions 
occurring after these regulations are published as final regulations 
in the Federal Register.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-32774 Filed 12-29-00; 8:45 am]
BILLING CODE 4830-01-U