[Federal Register Volume 66, Number 221 (Thursday, November 15, 2001)]
[Proposed Rules]
[Pages 57400-57404]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-28670]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-126485-01]
RIN 1545-BA06


Statutory Mergers and Consolidations

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 that define the 
term statutory merger or consolidation as that term is used in section 
368(a)(1)(A). The proposed regulations permit certain transactions 
involving entities that are disregarded as entities separate from their 
corporate owners for Federal tax purposes to qualify as a statutory 
merger or consolidation. These proposed regulations affect corporations 
engaging in statutory mergers and consolidations, and their 
shareholders. This document also provides a notice of public hearing on 
these proposed regulations.

DATES: Written or electronic comments and requests to speak (with 
outlines of oral comments to be discussed) at the public hearing 
scheduled for March 13, 2002, must be received by February 20, 2002.

ADDRESSES: Send submissions to CC:ITA:RU (REG-126485-01), room 5226, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 am and 5 pm to: CC:ITA:RU (REG-126485-
01), Courier's desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW, Washington, DC 20044. Alternatively, taxpayers may submit 
comments electronically via the Internet by selecting the Tax Reg 
option on the IRS Home Page, or by submitting comments directly to the 
IRS Internet site at http:
//www.irs.gov/tax_regs.reglist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Reginald Mombrun (202) 622-7750 or Marlene P. Oppenheim, (202) 622-
7770; concerning submissions of comments, the hearing, and/or to be 
placed on the building access list to attend the hearing, Lanita Van 
Dyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. Section 368(a) Generally

    The Internal Revenue Code of 1986 (the Code) provides general 
nonrecognition treatment for reorganizations specifically described in 
section 368(a). Section 368(a)(1)(A) provides that the term 
reorganization includes ``a statutory merger or consolidation.'' 
Section 1.368-2(b)(1) currently provides that a statutory merger or 
consolidation must be ``effected pursuant to the corporation laws of 
the United States or a State or Territory or the District of 
Columbia.'' A transaction will only qualify as a reorganization under 
section 368(a)(1)(A), however, if it satisfies certain nonstatutory 
requirements, including the business purpose requirement of Sec. 1.368-
1(b), the continuity of business enterprise requirement of Sec. 1.368-
1(d), and the continuity of interest requirement of Sec. 1.368-1(e).

B. Disregarded Entities Generally

    A business entity (as defined in Sec. 301.7701-2(a)) that has only 
one owner may be disregarded as an entity separate from its owner for 
Federal tax purposes. Examples of disregarded entities include a 
domestic single member limited liability company that does not elect to 
be classified as a corporation for Federal tax purposes, a corporation 
(as defined in Sec. 301.7701-2(b)) that is a qualified REIT subsidiary

[[Page 57401]]

(within the meaning of section 856(i)(2)), and a corporation that is a 
qualified subchapter S subsidiary (within the meaning of section 
1361(b)(3)(B)).
    Because qualified REIT subsidiaries and qualified subchapter S 
subsidiaries are corporations under state law, state merger laws 
generally permit them to merge with other corporations. In addition, 
many state merger laws permit a limited liability company to merge with 
another limited liability company or with a corporation.

C. Previous Proposal of Regulations

    On May 16, 2000, the IRS and Treasury issued a notice of proposed 
rulemaking (REG-106186-98, 65 FR 31115) providing guidance under 
section 368(a)(1)(A), including guidance regarding whether certain 
mergers involving disregarded entities may qualify as statutory mergers 
under section 368(a)(1)(A) (hereinafter referred to as the 2000 
proposed regulations). The 2000 proposed regulations provided that 
neither the merger of a disregarded entity into a corporation nor the 
merger of a target corporation into a disregarded entity was a 
statutory merger or consolidation qualifying as a reorganization under 
section 368(a)(1)(A).
    A public hearing on the 2000 proposed regulations was held on 
August 8, 2000. In addition, written comments were received. While 
commentators generally agreed that the merger of a disregarded entity 
into a corporation should not qualify as a statutory merger under 
section 368(a)(1)(A), commentators asserted that the merger of a target 
corporation into a disregarded entity with a corporate owner should be 
able to qualify as a statutory merger under section 368(a)(1)(A). 
Commentators argued that not permitting the merger of a target 
corporation into a disregarded entity to qualify as a statutory merger 
under section 368(a)(1)(A) is inconsistent with the general treatment 
of the disregarded entity as a division of its owner for Federal tax 
purposes.

Explanation of Provisions

A. Definitions

    After consideration of the comments received, the IRS and Treasury 
have decided to withdraw the 2000 proposed regulations and issue new 
proposed regulations (hereinafter referred to as the 2001 proposed 
regulations) to provide guidance concerning the definition of the terms 
statutory merger and consolidation as those terms are used in section 
368(a)(1)(A), including as those terms relate to transactions involving 
disregarded entities.
    The 2001 proposed regulations introduce a number of terms that are 
employed in the definition of statutory merger or consolidation. The 
term disregarded entity is defined as a business entity (as defined in 
Sec. 301.7701-2(a)) that is disregarded as an entity separate from its 
owner for Federal tax purposes. The term combining entity is defined as 
a business entity that is a corporation (as defined in Sec. 301.7701-
2(b)) that is not a disregarded entity. The term combining unit is 
defined as a combining entity and all disregarded entities, if any, the 
assets of which are treated as owned by such combining entity for 
Federal tax purposes.
    The 2001 proposed regulations provide that, for purposes of section 
368(a)(1)(A), a statutory merger or consolidation must be effected 
pursuant to the laws of the United States or a State or the District of 
Columbia. Pursuant to such laws, the following events must occur 
simultaneously at the effective time of the transaction: (1) all of the 
assets (other than those distributed in the transaction) and 
liabilities (except to the extent satisfied or discharged in the 
transaction) of each member of one or more combining units (each a 
transferor unit) become the assets and liabilities of one or more 
members of one other combining unit (the transferee unit); and (2) the 
combining entity of each transferor unit ceases its separate legal 
existence for all purposes.
    The IRS and Treasury believe that these definitions of statutory 
merger and consolidation are consistent with the principles of current 
law. See Cortland Specialty Co. v. Commissioner, 60 F.2d 937 (2d Cir. 
1932), cert. denied, 288 U.S. 599 (1933); Rev. Rul. 2000-5 (2000-1 C.B. 
436). In particular, the IRS and Treasury do not intend for the 
requirement that all of the assets of one or more transferor units be 
transferred in the statutory merger or consolidation to be interpreted 
in the same manner as the ``substantially all'' requirement of 
368(a)(1)(C), 368(a)(1)(D), 368(a)(2)(D), and 368(a)(2)(E). However, 
the IRS and Treasury do intend this requirement to ensure that divisive 
transactions do not qualify as statutory mergers or consolidations 
under section 368(a)(1)(A). See Rev. Rul. 2000-5.
    In addition, the 2001 proposed regulations, like the 2000 proposed 
regulations, remove the word corporation from the requirement that, in 
order to qualify as a reorganization under section 368(a)(1)(A), a 
merger or consolidation must be ``effected pursuant to the corporation 
laws.'' This change conforms the regulations to the IRS's long-standing 
position that a transaction may qualify as a reorganization under 
section 368(a)(1)(A) even if it is undertaken pursuant to laws other 
than the corporation law of the relevant jurisdiction. See Rev. Rul. 
84-104 (1984-2 C.B. 94) (treating a consolidation pursuant to the 
National Banking Act, 12 U.S.C. 215, as a merger for Federal tax 
purposes).
    Finally, the 2001 proposed regulations remove the word 
``Territory'' from the types of jurisdictions pursuant to the laws of 
which a transaction that qualifies as a reorganization under section 
368(a)(1)(A) may be effected to be consistent with the definition of 
domestic under section 7701(a)(4), which was amended by section 1906(c) 
of Tax Reform Act of 1976 (Public Law 94-455; 90 Stat. 1525).
    In this guidance project, the IRS and Treasury are not addressing 
the treatment under section 368(a)(1)(A) of transactions that involve 
one or more foreign corporations. As discussed below, the IRS and 
Treasury are considering issuing guidance regarding such transactions 
as part of a separate regulations project.

B. Mergers Involving Disregarded Entities

    The 2001 proposed regulations' definition of a statutory merger or 
consolidation, unlike the approach of the 2000 proposed regulations, 
permits certain statutory mergers and consolidations involving 
disregarded entities to qualify as statutory mergers and consolidations 
under section 368(a)(1)(A). However, the 2001 proposed regulations 
provide that such a transaction in which any of the assets and 
liabilities of a combining entity of a transferor unit become assets 
and liabilities of one or more disregarded entities of the transferee 
unit is not a statutory merger or consolidation within the meaning of 
section 368(a)(1)(A) unless such combining entity, the combining entity 
of the transferee unit, such disregarded entities, and each business 
entity through which the combining entity of the transferee unit holds 
its interests in such disregarded entities is organized under the laws 
of the United States or a State or the District of Columbia.
    Permitting certain transactions involving disregarded entities that 
have a single corporate owner to qualify as statutory mergers and 
consolidations for purposes of section 368(a)(1)(A) is appropriate 
because it is consistent with the general treatment of a disregarded

[[Page 57402]]

entity as a division of its owner. Therefore, under the 2001 proposed 
regulations, the merger of a target corporation into a disregarded 
entity may qualify as a statutory merger or consolidation for purposes 
of section 368(a)(1)(A). Consistent with the 2000 proposed regulations, 
however, the 2001 proposed regulations do not permit the merger of a 
disregarded entity into a member of a transferee unit, where the owner 
of the disregarded entity does not also merge into a member of the 
transferee unit, to qualify as a statutory merger or consolidation 
under section 368(a)(1)(A). In such a transaction, all of the 
transferor unit's assets may not be transferred to the transferee unit, 
with the result that the transferor unit's assets may be divided 
between the transferor unit and the transferee unit. Moreover, the 
separate legal existence of the combining entity of the transferor unit 
does not terminate as a matter of law. Although such a transaction 
cannot qualify as a statutory merger or consolidation under section 
368(a)(1)(A), it may qualify for nonrecognition treatment under other 
provisions of the Code.

C. Request for Comments

    Treasury and the IRS are considering further revisions to the 
regulations under section 368(a)(1)(A) to address statutory mergers and 
consolidations that involve one or more foreign corporations, including 
transactions involving a disregarded entity. Comments are requested 
regarding the appropriate scope for any such revision. Comments also 
are specifically requested concerning what related changes would be 
necessary to the regulations under sections 358 (concerning the 
determination of stock basis in certain triangular reorganizations), 
367, and 897, as well as other international provisions of the Code. 
Because a revision of the regulations may include revisions related to 
transactions under foreign merger or consolidation laws, comments are 
requested on what changes, if any, may be appropriate to the definition 
of a statutory merger or consolidation to facilitate the application of 
the definition in the context of the laws of a foreign jurisdiction. 
Finally, comments are requested regarding what additional reporting 
requirements may be appropriate to facilitate administration of the 
rules regarding statutory mergers or consolidations involving foreign 
entities.

Effective Date

    These regulations are proposed to apply to transactions occurring 
on or after the date these regulations 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), 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 (a signed original 
and eight copies) that are submitted timely to the IRS. 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.gov/tax_regs/reglist.html. The IRS and Treasury Department request comments 
on the clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for March 13, 2002 beginning at 
10 am in the auditorium, 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 portion 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments must submit written comments and an 
outline of the topics to be discussed and the time to be devoted to 
each topic (a signed original and eight (8) copies) by February 20, 
2002. 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 reviewing outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these proposed regulations are Reginald 
Mombrun and Marlene P. Oppenheim of the office of the Associate Chief 
Counsel (Corporate), IRS. However, other personnel from 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 prepared to be amended as follows:

PART 1-- INCOME TAXES

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

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

    Par. 2. In Sec. 1.368-2, paragraph (b)(1) is revised to read as 
follows:


Sec. 1.368-2  Definition of terms.

* * * * *
    (b)(1)(i) Definitions. For purposes of this paragraph (b)(1), the 
following terms shall have the following meanings:
    (A) Disregarded entity. A disregarded entity is a business entity 
(as defined in Sec. 301.7701-2(a) of this chapter) that is disregarded 
as an entity separate from its owner for Federal tax purposes. Examples 
of disregarded entities include a domestic single member limited 
liability company that does not elect to be classified as a corporation 
for Federal tax purposes, a corporation (as defined in Sec. 301.7701-
2(b) of this chapter) that is a qualified REIT subsidiary (within the 
meaning of section 856(i)(2)), and a corporation that is a qualified 
subchapter S subsidiary (within the meaning of section 1361(b)(3)(B)).
    (B) Combining entity. A combining entity is a business entity that 
is a corporation that is not a disregarded entity.
    (C) Combining unit. A combining unit is comprised solely of a 
combining entity and all disregarded entities, if any, the assets of 
which are treated as

[[Page 57403]]

owned by such combining entity for Federal tax purposes.
    (ii) Statutory merger or consolidation generally. For purposes of 
section 368(a)(1)(A), a statutory merger or consolidation is a 
transaction effected pursuant to the laws of the United States or a 
State or the District of Columbia, in which, as a result of the 
operation of such laws, the following events occur simultaneously at 
the effective time of the transaction--
    (A) All of the assets (other than those distributed in the 
transaction) and liabilities (except to the extent satisfied or 
discharged in the transaction) of each member of one or more combining 
units (each a transferor unit) become the assets and liabilities of one 
or more members of one other combining unit (the transferee unit); and
    (B) The combining entity of each transferor unit ceases its 
separate legal existence for all purposes.
    (iii) Statutory merger or consolidation involving disregarded 
entities. A transaction effected pursuant to the laws of the United 
States or a State or the District of Columbia in which any of the 
assets and liabilities of a combining entity of a transferor unit 
become assets and liabilities of one or more disregarded entities of 
the transferee unit is not a statutory merger or consolidation within 
the meaning of section 368(a)(1)(A) and paragraph (b)(1)(ii) of this 
section unless such combining entity, the combining entity of the 
transferee unit, such disregarded entities, and each business entity 
through which the combining entity of the transferee unit holds its 
interests in such disregarded entities is organized under the laws of 
the United States or a State or the District of Columbia.
    (iv) Examples. The following examples illustrate the rules of 
paragraph (b)(1) of this section. In each of the examples, except as 
otherwise provided, each of V, Y, and Z is a domestic corporation. X is 
a domestic limited liability company. Except as otherwise provided, X 
is wholly owned by Y and is disregarded as an entity separate from Y 
for Federal tax purposes. The examples are as follows:

    Example 1. Divisive transaction pursuant to a merger statute. 
(i) Under State W law, Z transfers some of its assets and 
liabilities to Y, retains the remainder of its assets and 
liabilities, and remains in existence following the transaction. The 
transaction qualifies as a merger under state W corporate law. Prior 
to the transaction, Y is not treated as owning any assets of an 
entity that is disregarded as an entity separate from its owner for 
Federal tax purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets 
and liabilities of Z, the combining entity of the transferor unit, 
do not become the assets and liabilities of Y, the combining entity 
and sole member of the transferee unit. In addition, the transaction 
does not satisfy the requirements of paragraph (b)(1)(ii)(B) of this 
section because the separate legal existence of Z does not cease. 
Accordingly, the transaction does not qualify as a statutory merger 
or consolidation under section 368(a)(1)(A).
    Example 2. Merger of a target corporation into a disregarded 
entity in exchange for stock of the owner. (i) Under State W law, Z 
merges into X. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction all of the 
assets and liabilities of Z become the assets and liabilities of X 
and Z's separate legal existence ceases for all purposes. In the 
merger, the Z shareholders exchange their stock of Z for stock of Y. 
Prior to the transaction, Z is not treated as owning any assets of 
an entity that is disregarded as an entity separate from its owner 
for Federal tax purposes.
    (ii) The transaction meets the requirements of paragraph 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur 
simultaneously at the effective time of the transaction all of the 
assets and liabilities of Z, the combining entity and sole member of 
the transferor unit, become the assets and liabilities of one or 
more members of the transferee unit that is comprised of Y, the 
combining entity of the transferee unit, and X, a disregarded entity 
the assets of which Y is treated as owning for Federal tax purposes, 
and Z ceases its separate legal existence for all purposes. 
Paragraph (b)(1)(iii) of this section does not apply to prevent the 
transaction from qualifying as a statutory merger or consolidation 
for purposes of section 368(a)(1)(A) because each of Z, Y and X is a 
domestic entity. Accordingly, the transaction qualifies as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 3. Triangular merger of a target corporation into a 
disregarded entity. (i) The facts are the same as in Example 2, 
except that V owns 100 percent of the outstanding stock of Y and, in 
the merger of Z into X, the Z shareholders exchange their stock of Z 
for stock of V. In the transaction, Z transfers substantially all of 
its properties to X.
    (ii) The transaction is not prevented from qualifying as a 
statutory merger or consolidation under section 368(a)(1)(A), 
provided the requirements of section 368(a)(2)(D) are satisfied. 
Because the assets of X are treated for Federal tax purposes as the 
assets of Y, Y will be treated as acquiring substantially all of the 
properties of Z in the merger for purposes of determining whether 
the merger satisfies the requirements of section 368(a)(2)(D). As a 
result, the Z shareholders that receive stock of V will be treated 
as receiving stock of a corporation that is in control of Y, the 
combining entity of the transferee unit that is the acquiring 
corporation for purposes of section 368(a)(2)(D). Accordingly, the 
merger will satisfy the requirements of section 368(a)(2)(D) such 
that the Z shareholders' receipt of stock of V in the merger will 
not cause the transaction to fail to qualify as a reorganization 
under section 368(a)(1)(A).
    Example 4. Merger of a target corporation into a disregarded 
entity owned by a partnership. (i) The facts are the same as in 
Example 2, except that Y is organized as a partnership under the 
laws of State W and is classified as a partnership for Federal tax 
purposes.
    (ii) The transaction does not meet the requirements of paragraph 
(b)(1)(ii)(A) of this section. All of the assets and liabilities of 
Z, the combining entity and sole member of the transferor unit, do 
not become the assets and liabilities of one or more members of a 
transferee unit because neither X nor Y qualifies as a combining 
entity. Accordingly, the transaction cannot qualify as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 5. Merger of a disregarded entity into a corporation. 
(i) Under State W law, X merges into Z. Pursuant to such law, the 
following events occur simultaneously at the effective time of the 
transaction all of the assets and liabilities of X (but not the 
assets and liabilities of Y other than those of X) become the assets 
and liabilities of Z and X's separate legal existence ceases for all 
purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets 
and liabilities of a transferor unit do not become the assets and 
liabilities of one or more members of the transferee unit. The 
transaction also does not satisfy the requirements of paragraph 
(b)(1)(ii)(B) of this section because X does not qualify as a 
combining entity. Accordingly, the transaction cannot qualify as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 6. Merger of a corporation into a disregarded entity in 
exchange for interests in the disregarded entity. (i) Under State W 
law, Z merges into X. Pursuant to such law, the following events 
occur simultaneously at the effective time of the transaction all of 
the assets and liabilities of Z become the assets and liabilities of 
X and Z's separate legal existence ceases for all purposes. In the 
merger of Z into X, the Z shareholders exchange their stock of Z for 
interests in X so that, immediately after the merger, X is not 
disregarded as an entity separate from Y for Federal tax purposes. 
Following the merger, pursuant to Sec. 301.7701-2(b)(1)(i) of this 
chapter, X is classified as a partnership for Federal tax purposes.
    (ii) The transaction does not meet the requirements of paragraph 
(b)(1)(ii)(A) of this section because immediately after the merger X 
is not disregarded as an entity separate from Y and, consequently, 
all of the assets and liabilities of Z, the combining entity of the 
transferor unit, do not become the assets and liabilities of one or 
more members of a transferee unit. Accordingly, the transaction 
cannot qualify as a statutory merger or consolidation for purposes 
of section 368(a)(1)(A).

    (v) Effective date. This paragraph (b)(1) applies to transactions 
occurring

[[Page 57404]]

on or after the date these regulations are published as final 
regulations in the Federal Register.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 01-28670 Filed 11-14-01; 8:45 am]
BILLING CODE 4830-01-P