[Federal Register Volume 67, Number 81 (Friday, April 26, 2002)]
[Rules and Regulations]
[Pages 20632-20642]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-9817]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8988]
RIN 1545-BA55


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: Temporary regulations.

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SUMMARY: This document contains temporary 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 
temporary regulations affect corporations and are necessary to provide 
them with guidance needed to comply with these changes. The text of 
these temporary regulations also serves as the text of the proposed 
regulations set forth in the notice of proposed rulemaking on this 
subject in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective Date: These temporary regulations are effective April 
26, 2002.
    Applicability Date: These temporary regulations apply to 
distributions occurring after April 26, 2002. For rules applicable to 
distributions occurring after August 3, 2001, and on or before April 
26, 2002, see Sec. 1.355-7T as in effect prior to April 26, 2002 (see 
26 CFR part 1 revised April 1, 2002). Taxpayers, however, may apply 
these regulations in whole, but not in part, to a distribution 
occurring on or before April 26, 2002.

FOR FURTHER INFORMATION CONTACT: Amber R. Cook of the Office of 
Associate Chief Counsel (Corporate), (202) 622-7530 (not a toll-free 
number).

SUPPLEMENTARY INFORMATION:

Background

    Section 355(e) of the Internal Revenue Code of 1986 provides that 
the stock of a controlled corporation will not be qualified property 
under section 355(c)(2) or 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.'' For this purpose, a 50-percent or greater 
interest means stock possessing at least 50 percent of the total 
combined voting power of all classes of stock entitled to vote or at 
least 50 percent of the total value of shares of all classes of stock. 
See I.R.C. Sec. 355(e)(4)(A) (referring to section 355(d)(4) for the 
definition of 50-percent or greater interest).
    On January 2, 2001, the IRS and Treasury published in the Federal 
Register (REG-107566-00, 66 FR 66 (2001-3 I.R.B. 346)) a notice of 
proposed rulemaking (the 2001 proposed regulations) under section 
355(e). The 2001 proposed regulations provide guidance concerning the 
interpretation of the phrase ``plan (or series of related 
transactions).'' The 2001 proposed regulations generally provide that 
whether a distribution and an acquisition are part of a plan is 
determined based on all the facts and circumstances. The 2001 proposed 
regulations list a number of factors that tend to show that an 
acquisition and a distribution are part of a plan and a number of 
factors that tend to show that an acquisition and a distribution are 
not part of a plan. In addition, they set forth six safe harbors, the 
satisfaction of which confirms that a distribution and an acquisition 
are not part of a plan.
    A public hearing regarding the 2001 proposed regulations was held 
on May 15, 2001. In addition, written comments were received. In 
response to comments that immediate guidance under section 355(e) was 
needed, on August 3, 2001, the IRS and Treasury published in the 
Federal Register (REG-107566-00, 66 FR 40590 (2001-34 I.R.B. 176)) the 
2001 proposed regulations as temporary regulations (the original 
temporary regulations). The original temporary regulations were 
identical to the 2001 proposed regulations, except that, pending 
further study of the comments received regarding the 2001 proposed 
regulations, they reserved Sec. 1.355-7(e)(6) (suspending the running 
of any time period prescribed in the 2001 proposed regulations during 
which there is a substantial diminution of risk of loss under the 
principles of section 355(d)(6)(B)) and Example 7 of the 2001 proposed 
regulations (interpreting the term similar acquisition in the context 
of a situation involving multiple acquisitions).

Explanation of Provisions

    The IRS and Treasury have studied the comments received regarding 
the 2001 proposed regulations and have concluded that it is desirable 
to revise various aspects of the original temporary regulations. 
Accordingly, the IRS and Treasury are promulgating these regulations 
(the revised temporary regulations) as temporary to amend the original 
temporary regulations. The following sections describe a number of the 
most significant comments and the extent to which they have been 
incorporated in the revised temporary regulations. Further changes to 
the revised temporary regulations, however, are possible before these 
regulations are finalized.

A. Facts and Circumstances Generally

    The 2001 proposed regulations identify a number of facts and 
circumstances that tend to show whether a distribution and an 
acquisition are part of a plan. While some of those facts and 
circumstances relating to a post-distribution acquisition focus on 
discussions before the distribution between the acquired corporation 
and the acquirer regarding the acquisition or a similar acquisition, 
others are unrelated to whether there were such discussions before the 
distribution. A number of comments suggested that the relevant facts 
and circumstances that evidence whether a distribution and a post-
distribution acquisition are part of a plan for

[[Page 20633]]

purposes of section 355(e) generally should focus more heavily on 
whether there were bilateral discussions or even an agreement, 
understanding, or arrangement regarding the acquisition within a 
certain period of time prior to the distribution.
    The IRS and Treasury agree with these comments and, accordingly, 
have revised the 2001 proposed regulations to reflect this emphasis. In 
particular, the revised temporary regulations provide that, other than 
in the case of an acquisition involving a public offering, a 
distribution and a post-distribution acquisition can be part of a plan 
only if there was an agreement, understanding, arrangement, or 
substantial negotiations regarding the acquisition or a similar 
acquisition at some time during the 2-year period ending on the date of 
the distribution. In addition, the list of facts and circumstances in 
the revised temporary regulations that tend to show that a distribution 
and an acquisition are part of a plan has been revised to reflect this 
change in emphasis.

B. Special Rules Relating to Auctions

    As set forth in the 2001 proposed regulations, the facts and 
circumstances tending to show whether a distribution and an acquisition 
are part of a plan distinguish between acquisitions other than 
acquisitions involving a public offering or auction, on the one hand, 
and acquisitions involving a public offering or auction, on the other 
hand. For example, while the distributing or controlled corporation's 
discussions with an acquirer regarding a post-distribution acquisition 
involving a public offering or auction are not listed as evidence that 
the distribution and the acquisition are part of a plan, the 
distributing or controlled corporation's discussions with an acquirer 
regarding a post-distribution acquisition not involving a public 
offering or auction tend to show that the distribution and the 
acquisition are part of a plan.
    One commentator suggested that the facts that tend to indicate that 
a distribution and an acquisition are part of a plan should not 
distinguish between an acquisition (other than an acquisition involving 
a public offering) that results from an auction and an acquisition 
(other than an acquisition involving a public offering) that does not 
result from an auction. In particular, the commentator asserted that 
although the factors might be weighted differently depending on the 
particular type of acquisition, in the context of both of these types 
of acquisitions, discussions with the acquirer regarding the 
acquisition are relevant to the determination of whether a distribution 
and an acquisition are part of a plan.
    The IRS and Treasury believe that it is difficult to define an 
auction in a manner that identifies those situations to which it is 
appropriate to apply the special auction rules contained in the 2001 
proposed regulations. For this reason, the revised temporary 
regulations eliminate the distinction between acquisitions (other than 
acquisitions involving a public offering) that result from an auction 
and acquisitions (other than acquisitions involving a public offering) 
that do not result from an auction. Accordingly, those facts and 
circumstances related to negotiations with the acquirer that evidence 
whether a post-distribution acquisition (other than an acquisition 
involving a public offering) that does not result from an auction is 
part of a plan are relevant to whether a post-distribution acquisition 
that results from an auction is part of a plan.

C. Similar Acquisition

    As described above, the 2001 proposed regulations identify a number 
of facts and circumstances that are relevant for purposes of 
determining whether a distribution and an acquisition are part of a 
plan. In the case of an acquisition after a distribution, certain 
factors focus on whether certain persons engaged in discussions 
regarding the acquisition or a ``similar acquisition'' before the 
distribution. The 2001 proposed regulations provide that an acquisition 
and an intended acquisition may be similar even though the identity of 
the person acquiring stock of the distributing or controlled 
corporation, the timing of the acquisition or the terms of the actual 
acquisition are different from the intended acquisition.
    Example 7 of the 2001 proposed regulations interprets the term 
similar acquisition in the context of multiple acquisitions following a 
distribution that was motivated by an acquisition business purpose. The 
example treats an acquisition where neither the distributing nor the 
controlled corporation had identified the acquirer prior to the 
distribution and another acquisition where the acquirer had been 
identified but not contacted regarding the acquisition prior to the 
distribution as similar to an acquisition that was in fact discussed 
with the acquirer prior to the distribution and that was consummated 
prior to these additional acquisitions. After analyzing the facts and 
circumstances, the example concludes that these additional acquisitions 
and the distribution are part of a plan.
    A number of commentators asserted that the interpretation of the 
term plan in the 2001 proposed regulations is overly broad, principally 
as a result of the illustration of the scope of the term similar 
acquisition in Example 7. Some of these commentators suggested that the 
unilateral intentions of one party should not result in a distribution 
and an acquisition being treated as part of a plan, unless that party 
has the unilateral ability to control both the distribution and the 
acquisition. In the context of acquisitions other than public 
offerings, therefore, some of these commentators argued that a 
distribution and an acquisition should not be treated as part of a plan 
unless there is some objective evidence of a bilateral agreement 
regarding the significant economic terms of the acquisition.
    In addition, while the comments generally reflected the view that 
an acquisition should not avoid being treated as part of a plan merely 
because the terms of the specific acquisition intended at the time of 
the distribution were modified, some comments suggested that the term 
similar acquisition should be narrowed. For example, certain comments 
suggested that where there is a change in acquirer and the new acquirer 
is not related to the originally intended acquirer under section 267(b) 
or 707(b), the new acquisition should not be treated as similar to the 
originally intended acquisition.
    Consistent with the comments' suggestions, the revised temporary 
regulations set forth a definition of similar acquisition that is 
narrower than the one set forth in the 2001 proposed regulations. The 
revised temporary regulations provide, in general, that an actual 
acquisition (other than a public offering or other stock issuance for 
cash) is similar to another potential acquisition if the actual 
acquisition effects a direct or indirect combination of all or a 
significant portion of the same business operations as the combination 
that would have been effected by such other potential acquisition. 
Further clarification is provided in the definition of similar 
acquisition, Example 6, and Example 7 of the revised temporary 
regulations. The revised definition of similar acquisition (and the 
revisions to the plan and non-plan factors) have the effect of 
reversing the conclusion of Example 7 of the 2001 proposed regulations 
that the additional acquisitions (i.e., the Y and Z acquisitions) and 
the distribution are part of a plan.

[[Page 20634]]

D. Substantial Negotiations

    In addition to the comments regarding the general approach of the 
2001 proposed regulations, the IRS and Treasury received a number of 
technical comments regarding the 2001 proposed regulations. A number of 
commentators suggested that substantial negotiations be defined. The 
revised temporary regulations add a definition of substantial 
negotiations providing that, in the case of an acquisition other than a 
public offering, substantial negotiations generally require discussions 
of significant economic terms, e.g., the exchange ratio in a 
reorganization, by one or more officers, directors, or controlling 
shareholders of the distributing or controlled corporation, or another 
person or persons with the implicit or explicit permission of one or 
more officers, directors, or controlling shareholders of the 
distributing or controlled corporation, with the acquirer or a person 
or persons with the implicit or explicit permission of the acquirer. 
This definition is intended to clarify that both the content of, and 
persons engaging in, the discussions are probative of whether 
discussions are properly treated as substantial negotiations.

E. Safe Harbors I and II

    Safe Harbors I and II of the 2001 proposed regulations provide 
certainty that a distribution and an acquisition occurring after the 
distribution will not be treated as part of a plan if, among other 
conditions, the acquisition occurs 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. Safe Harbors I and II of the 2001 
proposed regulations, therefore, are not available if there was an 
agreement, understanding, arrangement, or substantial negotiations 
regarding the acquisition at any time prior to the distribution. 
Commentators, however, suggested that not all pre-distribution 
substantial negotiations should prevent those Safe Harbors from being 
available. In particular, a number of commentators suggested that, even 
if the relevant parties engage in substantial negotiations regarding an 
acquisition prior to a distribution, provided that those negotiations 
terminate without agreement prior to the distribution and do not resume 
until 6 months or 1 year after the distribution, those substantial 
negotiations should not cause Safe Harbors I and II of the 2001 
proposed regulations to be unavailable. After consideration of these 
comments, the IRS and Treasury have decided that an agreement, 
understanding, arrangement, or substantial negotiations concerning the 
acquisition should make Safe Harbors I and II unavailable only if such 
events exist or occur during the period that begins 1 year prior to the 
distribution and ends 6 months thereafter.
    A number of commentators noted that Safe Harbors I and II of the 
2001 proposed regulations would be available if there was an agreement, 
understanding, arrangement, or substantial negotiations regarding an 
acquisition similar to another acquisition prior to the date that is 6 
months after the distribution. At least one commentator suggested that 
these Safe Harbors should not be available in these circumstances. The 
IRS and Treasury agree and have modified those Safe Harbors 
accordingly.
    Safe Harbor I of the 2001 proposed regulations states that it is 
only available if ``[t]he 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.'' Commentators proposed that 
Safe Harbor I of the 2001 proposed regulations be modified so that in 
testing the qualification of an acquisition for the Safe Harbor, only 
acquisitive business purposes related to the acquired corporation 
should be relevant. Safe Harbor I of the revised temporary regulations 
reflects this comment.
    Safe Harbor II of the 2001 proposed regulations is available only 
where (1) the amount of stock of the distributing corporation or the 
controlled corporation that is subject to an acquisition business 
purpose is not more than 33 percent of the distributing corporation or 
the controlled corporation; and (2) no more than 20 percent of the 
acquired corporation is acquired before a date that is 6 months after 
the distribution. Commentators suggested the elimination of one of the 
2 prongs. Alternatively, they suggested increasing the percentage of 
stock in the second prong. One commentator also suggested that certain 
acquisitions that were not treated as part of a plan that includes a 
distribution be disregarded for purposes of the second prong.
    To simplify Safe Harbor II of the 2001 proposed regulations, the 
revised temporary regulations eliminate the quantitative restriction of 
the first prong and increase the percentage of stock in the second 
prong to 25 percent. Furthermore, for purposes of the 25-percent test, 
only stock that is acquired or is the subject of an agreement, 
understanding, arrangement, or substantial negotiations at some time 
during the period that begins 1 year before the distribution and ends 6 
months thereafter, other than stock that is acquired in a transaction 
described in Safe Harbor V, Safe Harbor VI, or new Safe Harbor VII, 
described below, of the revised temporary regulations, is counted.

F. Safe Harbor V

    Subject to certain exceptions, Safe Harbor V of the 2001 proposed 
regulations provides that an acquisition of stock of the distributing 
or controlled corporation that is listed on an established market is 
not part of a plan if the acquisition occurs pursuant to a transfer 
between shareholders of the distributing corporation or the controlled 
corporation, neither of which is a 5-percent shareholder. Some 
commentators suggested that this Safe Harbor should be available for 
stock transfers between persons that do not actively participate in the 
management of the corporation, even if such persons are 5-percent 
shareholders. These commentators suggested that such acquisitions of 
stock are not part of a plan that includes a distribution. The IRS and 
Treasury generally agree that the trading activities of persons that do 
not actively participate in the management of the corporation should 
not cause an acquisition and a distribution to be treated as part of a 
plan. Accordingly, the revised temporary regulations extend the 
availability of Safe Harbor V to persons that are neither controlling 
shareholders nor 10-percent shareholders either immediately before or 
immediately after the transfer.
    Finally, the IRS and Treasury have become aware of the proposed use 
of publicly-traded stock, the voting rights associated with which 
decrease upon certain transfers, in connection with acquisitions that 
are part of a plan that includes a distribution. Questions have been 
asked regarding whether acquisitions of stock that result from public 
trading between persons that are not 5-percent shareholders immediately 
before or immediately after the transfer are protected by Safe Harbor 
V, even where the transferee does not succeed to all of the voting 
rights exercisable by the transferor with respect to such stock.
    Although the IRS and Treasury believe that Safe Harbor V may be 
available to prevent the acquisition of such stock that is listed on an 
established market from being treated as

[[Page 20635]]

part of a plan, the revised temporary regulations clarify that, if Safe 
Harbor V applies to an acquisition of stock that is listed on an 
established market and that acquisition results in an indirect 
acquisition of voting power by a person other than the acquirer of such 
stock, Safe Harbor V does not prevent an acquisition of stock (with the 
voting power such stock represents after the acquisition to which Safe 
Harbor V applies) by such other person from being treated as part of a 
plan. New Example 5 of the revised temporary regulations illustrates 
the application of Safe Harbor V of the revised temporary regulations 
and the plan and non-plan factors in the context of the public trading 
of stock, the relative voting power associated with which varies as a 
result of the trading.

G. Safe Harbor VI and New Safe Harbor VII

    Safe Harbor VI of the 2001 proposed regulations generally applies 
to acquisitions of the stock of the distributing or controlled 
corporation ``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).'' One commentator suggested that Safe 
Harbor VI of the 2001 proposed regulations should be extended to stock 
acquired by independent contractors in connection with the performance 
of services and stock acquired pursuant to certain stock compensation 
plans. Another commentator suggested that Safe Harbor VI of the 2001 
proposed regulations should not protect management leveraged buy-outs 
and going private transactions that are part of a plan that includes a 
distribution. Safe Harbor VI of the revised temporary regulations 
incorporates these comments and other technical comments received.
    Commentators also suggested that Safe Harbor VI of the 2001 
proposed regulations be extended to acquisitions of stock by qualified 
plans under section 401. In response to these commentators, the revised 
temporary regulations add new Safe Harbor VII. Subject to certain 
limitations, new Safe Harbor VII provides that acquisitions of stock of 
the distributing or controlled corporation by a retirement plan of an 
employer that qualifies under section 401(a) or 403(a) will not be 
treated as part of a plan that includes a distribution.

H. Operating Rules

1. Reasonable certainty
    Under the 2001 proposed regulations, the fact that the distribution 
was motivated by a business purpose to facilitate the acquisition or a 
similar acquisition of the distributing or controlled corporation tends 
to show that a distribution and an acquisition are part of a plan. The 
2001 proposed regulations provide that evidence of a business purpose 
to facilitate an acquisition after a distribution exists if, at the 
time of the distribution, there was ``reasonable certainty'' that, 
within six months after the distribution, an acquisition would occur, 
an agreement, understanding, or arrangement would exist, or substantial 
negotiations would occur regarding an acquisition. In addition, the 
2001 proposed regulations provide that in the case of an acquisition 
before a distribution, 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 reasonable certainty is evidence of a 
business purpose to facilitate an acquisition. The IRS and Treasury 
received a number of comments regarding the reasonable certainty rule. 
The revised temporary regulations delete the reasonable certainty 
operating rules in light of the emphasis in the revised temporary 
regulations on discussions or an agreement, understanding, arrangement, 
or substantial negotiations regarding the first step before the second 
step.
2. Substantial diminution of risk
    The 2001 proposed regulations contain an operating rule that 
suspends the running of any time period prescribed in the regulations 
during which risk of loss is diminished under the principles of section 
355(d)(6)(B). Commentators questioned the proper application of this 
rule. In light of these comments, as stated above, the original 
temporary regulations reserve as to the substantial diminution of risk 
rule pending IRS and Treasury consideration of its proper application. 
Although the revised temporary regulations have eliminated the 
substantial diminution of risk rule, the IRS and Treasury continue to 
consider its proper application.

I. Options

    The 2001 proposed regulations provide that under certain 
circumstances, the acquisition of stock upon the exercise of an option, 
as that term is defined in the 2001 proposed regulations, may be 
treated as an agreement to acquire stock on the date the option was 
written, unless the distributing corporation 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. 
Commentators suggested that, because an option may become more likely 
than not to be exercised for reasons other than the distribution, the 
date of the distribution should not be relevant in testing for the 
existence of a plan. Instead, the date the option is written, 
transferred or modified in a manner that materially increases the 
likelihood of exercise should be the relevant dates for purposes of 
determining whether an option is properly treated as an agreement to 
acquire stock. The revised temporary regulations modify the rule for 
determining whether and when an option will be treated as an agreement, 
understanding, or arrangement to acquire stock in a manner consistent 
with these comments and certain other technical comments received.

J. Effective Date

    The revised temporary regulations are effective for distributions 
occurring after April 26, 2002. A number of commentators requested that 
taxpayers be permitted to rely on the 2001 proposed regulations for 
distributions occurring after April 16, 1997. In response to these 
comments, the revised temporary regulations permit taxpayers to apply 
the revised temporary regulations in whole, but not in part, to 
distributions occurring after April 16, 1997, and on or before April 
26, 2002.

Special Analyses

    It has been determined that these temporary regulations are 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 temporary regulations, and, 
because no preceding notice of proposed rulemaking is required for 
these temporary regulations, the provisions of the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) do not apply. Pursuant to section 
7805(f) of the Internal Revenue Code, these temporary regulations will 
be submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

[[Page 20636]]

Drafting Information

    The principal author of these temporary regulations is Amber R. 
Cook. However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

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

Section 1.355-7T also issued under 26 U.S.C. 355(e)(5). * * *


    Par. 2. Section 1.355-0 is amended by revising the heading and the 
entry for Sec. 1.355-7T to read as follows:


Sec. 1.355-0  Table of contents.

* * * * *
Sec. 1.355-7T  Recognition of gain on certain distributions of stock 
or securities in connection with an acquisition.
    (a) In general.
    (b) Plan.
    (1) In general.
    (2) Certain post-distribution acquisitions.
    (3) Plan factors.
    (4) Non-plan factors.
    (c) Operating rules.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose.
    (2) Takeover defense.
    (3) Effect of distribution on trading in stock.
    (4) Consequences of section 355(e) disregarded for certain 
purposes.
    (5) Multiple acquisitions.
    (d) 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.
    (i) In general.
    (ii) Special rule.
    (7) Safe Harbor VII.
    (i) In general.
    (ii) Special rule.
    (e) Stock acquired by exercise of options, warrants, convertible 
obligations, and other similar interests.
    (1) Treatment of options.
    (i) General rule.
    (ii) Agreement, understanding, or arrangement to write an 
option.
    (iii) Substantial negotiations related to options.
    (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.
    (f) Multiple controlled corporations.
    (g) Valuation.
    (h) Definitions.
    (1) Agreement, understanding, arrangement, or substantial 
negotiations.
    (2) Controlled corporation.
    (3) Controlling shareholder.
    (4) Coordinating group.
    (5) Discussions.
    (6) Established market.
    (7) Five-percent shareholder.
    (8) Similar acquisition.
    (9) Ten-percent shareholder.
    (i) [Reserved]
    (j) Examples.
    (k) Effective date.


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


Sec. 1.355-7T  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) In general. Whether a distribution and an acquisition 
are part of a plan is determined based on all the facts and 
circumstances. 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 set 
forth in paragraphs (b)(3) and (4) of this section. In general, the 
weight to be given each of the facts and circumstances depends on the 
particular case. Whether a distribution and an acquisition are part of 
a plan does not depend on the relative number of facts and 
circumstances set forth in paragraph (b)(3) that evidence that a 
distribution and an acquisition are part of a plan as compared to the 
relative number of facts and circumstances set forth in paragraph 
(b)(4) that evidence that a distribution and an acquisition are not 
part of a plan.
    (2) Certain post-distribution acquisitions. In the case of an 
acquisition (other than involving a public offering) after a 
distribution, the distribution and the acquisition can be part of a 
plan only if there was an agreement, understanding, arrangement, or 
substantial negotiations regarding the acquisition or a similar 
acquisition at some time during the 2-year period ending on the date of 
the distribution. In the case of an acquisition (other than involving a 
public offering) after a distribution, the existence of an agreement, 
understanding, arrangement, or substantial negotiations regarding the 
acquisition or a similar acquisition at some time during the 2-year 
period ending on the date of the distribution tends to show that the 
distribution and the acquisition are part of a plan. See paragraph 
(b)(3)(i) of this section. However, all facts and circumstances must be 
considered to determine whether the distribution and the acquisition 
are part of a plan. For example, in the case of an acquisition (other 
than involving a public offering) after a distribution, if 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 (see paragraph (b)(4)(v) of this section) 
and would have occurred at approximately the same time and in similar 
form regardless of whether the acquisition or a similar acquisition was 
effected (see paragraph (b)(4)(vi) of this section), the taxpayer may 
be able to establish that the distribution and the acquisition are not 
part of a plan.
    (3) Plan factors. 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) after a distribution, at some time during the 2-year period 
ending on the date of the distribution, there was an agreement, 
understanding, arrangement, or substantial negotiations regarding the 
acquisition or a similar acquisition. The weight to be accorded this 
fact depends on the nature, extent, and timing of the agreement, 
understanding, arrangement, or substantial negotiations. The existence 
of an agreement, understanding, or arrangement at the time of the 
distribution is given substantial weight.
    (ii) In the case of an acquisition involving a public offering 
after a distribution, at some time during the 2-year period ending on 
the date of the distribution, there were discussions by

[[Page 20637]]

Distributing or Controlled with an investment banker regarding the 
acquisition or a similar acquisition. The weight to be accorded this 
fact depends on the nature, extent, and timing of the discussions.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, at some time during the 2-year period 
ending on the date of the acquisition, there were discussions by 
Distributing or Controlled with the acquirer regarding a distribution. 
The weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions. In addition, in the case of an acquisition 
(other than involving a public offering) before a distribution where a 
person other than Distributing or Controlled intends to cause a 
distribution and, as a result of the acquisition, can meaningfully 
participate in the decision regarding whether to make a distribution.
    (iv) In the case of an acquisition involving a public offering 
before a distribution, at some time during the 2-year period ending on 
the date of the acquisition, there were discussions by Distributing or 
Controlled with an investment banker regarding a distribution. The 
weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions.
    (v) 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.
    (4) Non-plan factors. 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 involving a public offering after 
a distribution, during the 2-year period ending on the date of the 
distribution, there were no discussions by Distributing or Controlled 
with an investment banker regarding the acquisition or a similar 
acquisition.
    (ii) 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.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, during the 2-year period ending on the 
date of the acquisition, there were no discussions by Distributing or 
Controlled with the acquirer regarding a distribution. This paragraph 
(b)(4)(iii) does not apply if the acquisition occurred after the date 
of the public announcement of the planned distribution. In addition, 
this paragraph (b)(4)(iii) does not apply in the case of an acquisition 
where a person other than Distributing or Controlled intends to cause a 
distribution and, as a result of the acquisition, can meaningfully 
participate in the decision regarding whether to make a distribution.
    (iv) 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.
    (v) 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.
    (vi) 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.
    (c) Operating rules. The operating rules contained in this 
paragraph (c) apply for all purposes of this section.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose. Internal discussions and discussions with 
outside advisors by or on behalf of officers or directors of 
Distributing or Controlled may be indicative of one or more business 
purposes for the distribution and the relative importance of such 
purposes.
    (2) Takeover defense. If Distributing engages in discussions with a 
potential acquirer regarding an acquisition of Distributing or 
Controlled and 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.
    (3) 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's 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.
    (4) 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.
    (5) 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) Safe harbors--(1) Safe Harbor I. A distribution and an 
acquisition occurring after the distribution will not be considered 
part of a plan if--
    (i) 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 the 
acquired corporation (Distributing or Controlled); and
    (ii) The acquisition occurred more than 6 months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins 1 year before the 
distribution and ends 6 months thereafter.
    (2) Safe Harbor II. (i) A distribution and an acquisition occurring 
after the distribution will not be considered part of a plan if--
    (A) The distribution was not motivated by a business purpose to 
facilitate the acquisition or a similar acquisition;
    (B) The acquisition occurred more than 6 months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins 1 year before the 
distribution and ends 6 months thereafter; and
    (C) No more than 25 percent of the stock of the acquired 
corporation (Distributing or Controlled) was either acquired or the 
subject of an agreement, understanding, arrangement, or substantial 
negotiations during the period that begins 1 year before the 
distribution and ends 6 months thereafter.
    (ii) For purposes of paragraph (d)(2)(i)(C) of this section, 
acquisitions of stock that are treated as not part of a plan pursuant 
to Safe Harbor V, Safe Harbor VI, or Safe Harbor VII are disregarded.
    (3) Safe Harbor III. If an acquisition occurs after a distribution, 
there was no

[[Page 20638]]

agreement, understanding, or arrangement concerning the acquisition or 
a similar acquisition at the time of the distribution, and there was no 
agreement, understanding, arrangement, or substantial negotiations 
concerning the acquisition or a similar acquisition within 1 year after 
the distribution, the acquisition and the distribution will not be 
considered part of a plan.
    (4) Safe Harbor IV. If a distribution occurs more than 2 years 
after an acquisition, 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 will not be considered 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, immediately before or immediately after the transfer, 
none of the transferor, the transferee, and any coordinating group of 
which either the transferor or the transferee is a member is--
    (A) The acquired corporation (Distributing or Controlled);
    (B) A corporation that the acquired corporation (Distributing or 
Controlled) controls within the meaning of section 368(c);
    (C) A member of a controlled group of corporations within the 
meaning of section 1563 of which the acquired corporation (Distributing 
or Controlled) is a member;
    (D) An underwriter with respect to such acquisition;
    (E) A controlling shareholder of the acquired corporation 
(Distributing or Controlled); or
    (F) A 10-percent shareholder of the acquired corporation 
(Distributing or Controlled).
    (ii) Special rules. (A) This paragraph (d)(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 of which such person is a member intends 
to become a controlling shareholder or a 10-percent shareholder of the 
acquired corporation (Distributing or Controlled) at any time after the 
acquisition and before the date that is 2 years after the distribution.
    (B) If a transfer of stock to which this paragraph (d)(5) applies 
results immediately, or upon a subsequent event or the passage of time, 
in an indirect acquisition of voting power by a person other than the 
transferee, this paragraph (d)(5) does not prevent an acquisition of 
stock (with the voting power such stock represents after the transfer 
to which this paragraph (d)(5) applies) by such other person from being 
treated as part of a plan.
    (6) Safe Harbor VI--(i) In general. If stock of Distributing or 
Controlled is acquired by a person in connection with such person's 
performance of services as an employee, director, or independent 
contractor for Distributing, Controlled, or a person related to 
Distributing or Controlled under section 355(d)(7)(A) (and that is not 
excessive by reference to the services performed) in a transaction to 
which section 83 or section 421(a) applies, the acquisition and the 
distribution will not be considered part of a plan.
    (ii) Special rule. This paragraph (d)(6) does not apply to a stock 
acquisition described in (d)(6)(i) if the acquirer or a coordinating 
group of which the acquirer is a member is a controlling shareholder or 
a 10-percent shareholder of the acquired corporation (Distributing or 
Controlled) immediately after the acquisition.
    (7) Safe Harbor VII--(i) In general. If stock of Distributing or 
Controlled is acquired by a retirement plan of an employer that 
qualifies under section 401(a) or 403(a), the acquisition and the 
distribution will not be considered part of a plan.
    (ii) Special rule. This paragraph (d)(7) does not apply to stock 
acquisitions described in (d)(7)(i) of this section to the extent that 
the stock acquired pursuant to such acquisitions by all of the 
qualified plans of the employer described in paragraph (d)(7)(i) of 
this section, and any other person treated as the same employer as that 
described in paragraph (d)(7)(i) of this section under section 414(b), 
(c), (m), or (o), during the 4-year period beginning 2 years before the 
distribution, in the aggregate, represents 10 percent or more of the 
total combined voting power of all classes of stock entitled to vote, 
or 10 percent or more of the total value of shares of all classes of 
stock, of the acquired corporation (Distributing or Controlled).
    (e) 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, understanding, or arrangement to acquire the 
stock on the earliest of the following dates: the date that the option 
is written, if the option was more likely than not to be exercised as 
of such date; the date that the option is transferred, if the option 
was more likely than not to be exercised as of such date; and the date 
that the option is modified in a manner that materially increases the 
likelihood of exercise, if the option was more likely than not to be 
exercised as of such date; provided, however, if the writing, transfer, 
or modification had a principal purpose of avoiding section 355(e), the 
option will be treated as an agreement, understanding, arrangement, or 
substantial negotiations to acquire the stock on the date of the 
distribution. 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, or arrangement 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.
    (iii) Substantial negotiations related to options. If an option is 
treated as an agreement, understanding, or arrangement to acquire the 
stock on the date that the option is written, substantial negotiations 
to acquire the option will be treated as substantial negotiations to 
acquire the stock subject to such option. If an option is treated as an 
agreement, understanding, or arrangement to acquire the stock on the 
date that the option is transferred, substantial negotiations regarding 
the transfer of the option will be treated as substantial negotiations 
to acquire the stock subject to such option. If an option is treated as 
an agreement, understanding, or arrangement to acquire the stock on the 
date that the option is modified in a manner that materially increases 
the likelihood of exercise, substantial negotiations regarding such 
modifications to the option will be treated as substantial negotiations 
to acquire the stock subject to such option.
    (2) Instruments treated as options. For purposes of this paragraph 
(e), except to the extent provided in paragraph (e)(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

[[Page 20639]]

paragraph (e), the following are not treated as options unless (in the 
case of paragraphs (e)(3)(i), (iii), and (iv) of this section) written, 
transferred (directly or indirectly), modified, 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 a person in connection with such person's performance of services as 
an employee, director, or independent contractor 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), provided that--
    (A) The transfer of stock pursuant to such option is described in 
section 421(a); or
    (B) The option is nontransferable within the meaning of Sec. 1.83-
3(d) and 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).
    (f) 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.
    (g) Valuation. Except as provided in paragraph (e)(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.
    (h) Definitions--(1) Agreement, understanding, arrangement, or 
substantial negotiations. (i) 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 significant economic terms to have an 
agreement, understanding, or arrangement. However, an agreement, 
understanding, or arrangement clearly exists if a binding contract to 
acquire stock exists.
    (ii) Substantial negotiations in the case of an acquisition (other 
than involving a public offering) generally require discussions of 
significant economic terms, e.g., the exchange ratio in a 
reorganization, by one or more officers, directors, or controlling 
shareholders of Distributing or Controlled, or another person or 
persons with the implicit or explicit permission of one or more 
officers, directors, or controlling shareholders of Distributing or 
Controlled, with the acquirer or a person or persons with the implicit 
or explicit permission of the acquirer.
    (iii) In the case of an acquisition involving a public offering by 
Distributing or Controlled, the existence of an agreement, 
understanding, arrangement, or substantial negotiations will be based 
on discussions by one or more officers, directors, or controlling 
shareholders of Distributing or Controlled, or another person or 
persons with the implicit or explicit permission of one or more 
officers, directors, or controlling shareholders of Distributing or 
Controlled, with an investment banker.
    (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 listed on an established market is a 
5-percent shareholder who actively participates in the management or 
operation of the corporation. For purposes of this paragraph (h)(3)(i), 
a corporate director will be treated as actively participating in the 
management of the corporation.
    (ii) A controlling shareholder of a corporation the stock of which 
is not listed on an established market is any person that owns, 
actually or constructively under the rules of section 318, stock 
possessing voting power representing a meaningful voice in the 
governance 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 (h)(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 and 
Distributing are included among Controlled's controlling shareholders 
at the time of the distribution.
    (4) Coordinating group. A coordinating group includes 2 or more 
persons that, pursuant to a formal or informal understanding, join in 
one or more coordinated acquisitions or dispositions of stock of 
Distributing or Controlled. 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 one or more other 
existing or prospective shareholders. A coordinating group is treated 
as a single shareholder for purposes of determining whether the 
coordinating group is treated as a controlling shareholder or a 10-
percent shareholder.
    (5) Discussions. Discussions by Distributing or Controlled 
generally require discussions by one or more officers, directors, or 
controlling shareholders of Distributing or Controlled, or another 
person or persons with the implicit or explicit permission of one or 
more officers, directors, or

[[Page 20640]]

controlling shareholders of Distributing or Controlled. Discussions 
with the acquirer generally require discussions with the acquirer or a 
person or persons with the implicit or explicit permission of the 
acquirer.
    (6) 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).
    (7) 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, actually or constructively under 
the rules of section 318, 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 described above 
immediately before or immediately after the transfer. All options owned 
by a person are treated as exercised for the purpose of determining 
whether such person is a 5-percent shareholder. Absent actual knowledge 
that a person is a 5-percent shareholder, a 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.
    (8) Similar acquisition. In general, an actual acquisition (other 
than a public offering or other stock issuance for cash) is similar to 
another potential acquisition if the actual acquisition effects a 
direct or indirect combination of all or a significant portion of the 
same business operations as the combination that would have been 
effected by such other potential acquisition. Thus, an actual 
acquisition may be similar to another acquisition even if the timing or 
terms of the actual acquisition are different from the timing or terms 
of the other acquisition. For example, an actual acquisition of 
Distributing by shareholders of another corporation in connection with 
a merger of such other corporation with and into Distributing is 
similar to another acquisition of Distributing by merger into such 
other corporation or into a subsidiary of such other corporation. 
However, in general, an actual acquisition (other than a public 
offering or other stock issuance for cash) is not similar to another 
acquisition if the ultimate owners of the business operations with 
which Distributing or Controlled is combined in the actual acquisition 
are substantially different from the ultimate owners of the business 
operations with which Distributing or Controlled was to be combined in 
such other acquisition. In the case of a public offering or other stock 
issuance for cash, an actual acquisition may be similar to another 
acquisition, 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 
offering.
    (9) Ten-percent shareholder. A person will be considered a 10-
percent shareholder of a corporation the stock of which is listed on an 
established market if the person owns, actually or constructively under 
the rules of section 318, 10 percent or more of any class of stock of 
the corporation whose stock is transferred. A person will be considered 
a 10-percent shareholder of a corporation the stock of which is not 
listed on an established market if the person owns, actually or 
constructively under the rules of section 318, stock possessing 10 
percent or more of the total voting power of the stock of the 
corporation whose stock is transferred or stock having a value equal to 
10 percent or more of the total value of the stock of the corporation 
whose stock is transferred. A person is a 10-percent shareholder if the 
person meets the requirements described above immediately before or 
immediately after the transfer. All options owned by a person are 
treated as exercised for the purpose of determining whether such person 
is a 10-percent shareholder. Absent actual knowledge that a person is a 
10-percent shareholder, a corporation the stock of which is listed on 
an established market can rely on Schedules 13D and 13G (or any similar 
schedules) filed with the Securities and Exchange Commission to 
identify its 10-percent shareholders.
    (i) [Reserved]
    (j) Examples. The following examples illustrate paragraphs (a) 
through (h) 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. Prior 
to the distribution, D and X enter into a contract for D to merge 
into X subject to several conditions. One month after D and X enter 
into the contract, D distributes C and, on the day after the 
distribution, D merges into X. As a result of the merger, D's former 
shareholders own less than 50 percent of the stock of X.
    (ii) The issue is whether the distribution of C and the merger 
of D into X are part of a plan. No Safe Harbor applies to this 
acquisition. 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 (b) of 
this section.
    (iii) 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 had an agreement 
regarding the acquisition during the 2-year period ending on the 
date of the distribution (paragraph (b)(3)(i) of this section), and 
the distribution was motivated by a business purpose to facilitate 
the merger (paragraph (b)(3)(v) of this section). Because the merger 
was agreed to at the time of the distribution, the fact described in 
paragraph (b)(3)(i) of this section is given substantial weight.
    (iv) None of the facts and circumstances listed in paragraph 
(b)(4) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (v) The distribution of C and the merger of D into X are part of 
a plan under paragraph (b) of this section.
    Example 2. 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 20 percent of D's stock 
with D as a stand alone corporation would be in D's best interest. 
One month later, to facilitate a stock offering by D of 20 percent 
of its stock, D distributes all the stock of C pro rata to D's 
shareholders. D issues new shares amounting to 20 percent of its 
stock to the public in a public offering 7 months after the 
distribution.
    (ii) The issue is whether the distribution of C and the public 
offering by D are part of a plan. No Safe Harbor applies to this 
acquisition. Safe Harbor V, relating to public trading, does not 
apply to public offerings (see paragraph (d)(5)(i)(A) of this 
section). 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 (b) of this 
section.
    (iii) The following tends to show that the distribution of C and 
the public offering by

[[Page 20641]]

D are part of a plan: D discussed the public offering with its 
investment banker during the 2-year period ending on the date of the 
distribution (paragraph (b)(3)(ii) of this section), and the 
distribution was motivated by a business purpose to facilitate the 
public offering (paragraph (b)(3)(v) of this section).
    (iv) None of the facts and circumstances listed in paragraph 
(b)(4) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (v) The distribution of C and the public offering by D are part 
of a plan under paragraph (b) of this section.
    Example 3. 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 neither D nor C has been approached by any potential 
acquirer of C, it is reasonably certain that soon 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) The issue is whether the distribution of C and the 
acquisition of C by Y are part of a plan. No Safe Harbor applies to 
this acquisition. Under paragraph (b)(2) of this section, because 
prior to the distribution neither D nor C and Y had an agreement, 
understanding, arrangement, or substantial negotiations regarding 
the acquisition or a similar acquisition, the distribution of C by D 
and the acquisition of C by Y are not part of a plan under paragraph 
(b) of this section.
    Example 4. 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 or C 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 of C pro rata within 6 months after the acquisition of X.
    (ii) The issue is whether the acquisition of X by D and the 
distribution of C are part of a plan. No Safe Harbor applies to this 
acquisition. To determine whether the acquisition of X by D and the 
distribution of C are part of a plan, D must consider all the facts 
and circumstances, including those described in paragraph (b) of 
this section.
    (iii) Depending on whether a person other than D or C intends to 
cause a distribution and, as a result of the acquisition, can 
meaningfully participate in the decision regarding whether to cause 
a distribution, the fact described in (b)(3)(iii) of this section, 
tending to show that a distribution and an acquisition are part of a 
plan, may exist in this case.
    (iv) Under paragraph (b)(4) 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 (within the meaning of 
Sec. 1.355-2(b)) other than a business purpose to facilitate the 
acquisition or a similar acquisition (paragraph (b)(4)(v) of this 
section), and the distribution would have occurred at approximately 
the same time and in similar form regardless of the acquisition or a 
similar acquisition (paragraph (b)(4)(vi) 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 or a similar acquisition. 
X's lack of participation in the decision to distribute C, even 
though the X shareholders may have been able to prevent a 
distribution of C, also helps establish that fact.
    (v) 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 under paragraph (b) of this section.
    Example 5. Vote shifting transaction. (i) D is in business 1. C 
is in business 2. D wants to combine with X, a larger corporation 
also engaged in business 1. The stock of X is closely held. X and D 
begin negotiating for D to acquire X, but the X shareholders do not 
want to acquire an indirect interest in C. To facilitate the 
acquisition of X by D, D agrees to distribute all the stock of C pro 
rata before the acquisition of X. D and X enter into a contract for 
X to merge into D subject to several conditions. Among those 
conditions is that D will amend its corporate charter to provide for 
2 classes of stock: Class A and Class B. Under all circumstances, 
each share of Class A stock will be entitled to 10 votes in the 
election of each director on D's board of directors. Upon issuance, 
each share of Class B stock will be entitled to 10 votes in the 
election of each director on D's board of directors; however, a 
disposition of such share by its original holder will result in such 
share being entitled to only 1 vote, rather than 10 votes, in the 
election of each director. Immediately after the merger, the Class B 
shares will be listed on an established market. One month after D 
and X enter into the contract, D distributes C. Immediately after 
the distribution, the shareholders of D exchange their D stock for 
the new Class B shares. On the day after the distribution, X merges 
into D. In the merger, the former shareholders of X exchange their X 
stock for Class A shares of D. Immediately after the merger, D's 
historic shareholders own stock of D representing 51 percent of the 
total combined voting power of all classes of stock of D entitled to 
vote. During the 30-day period following the merger, none of the 
Class A shares are transferred, but a number of D's historic 
shareholders sell their Class B stock of D in public trading with 
the result that, at the end of that 30-day period, the Class A 
shares owned by the former X shareholders represent 52 percent of 
the total combined voting power of all classes of stock of D 
entitled to vote.
    (ii) X acquisition. (A) The issue is whether the distribution of 
C and the merger of X into D are part of a plan. No Safe Harbor 
applies to this acquisition. To determine whether the distribution 
of C and the merger of X into D are part of a plan, D must consider 
all the facts and circumstances, including those described in 
paragraph (b) of this section.
    (B) The following tends to show that the distribution of C and 
the merger of X into D are part of a plan: X and D had an agreement 
regarding the acquisition during the 2-year period ending on the 
date of the distribution (paragraph (b)(3)(i) of this section), and 
the distribution was motivated by a business purpose to facilitate 
the merger (paragraph (b)(3)(v) of this section). Because the merger 
was agreed to at the time of the distribution, the fact described in 
paragraph (b)(3)(i) of this section is given substantial weight.
    (C) None of the facts and circumstances listed in paragraph 
(b)(4) of this section, tending to show that a distribution and an 
acquisition are not part of a plan, exist in this case.
    (D) The distribution of C and the merger of X into D are part of 
a plan under paragraph (b) of this section.
    (iii) Public trading of Class B shares. (A) Assuming that each 
of the transferors and the transferees of the Class B stock of D in 
public trading is not one of the prohibited transferors or 
transferees listed in paragraph (d)(5)(i), Safe Harbor V will apply 
to the acquisitions of the Class B stock during the 30-day period 
following the merger such that the distribution and those 
acquisitions will not be treated as part of the plan. However, to 
the extent that those acquisitions result in an indirect acquisition 
of voting power by a person other than the acquirer of the 
transferred stock, Safe Harbor V does not prevent the acquisition of 
the D stock (with the voting power such stock represents after those 
acquisitions) by the former X shareholders from being treated as 
part of a plan.
    (B) To the extent that the transfer of the Class B shares causes 
the voting power of D to shift to the Class A stock acquired by the 
former X shareholders, such shifted voting power will be treated as 
attributable to the stock acquired by the former X shareholders as 
part of the plan that includes the distribution and the X 
acquisition.
    Example 6. Acquisition that is not similar. (i) D, X, and Y are 
each corporations the stock of which is publicly traded and widely 
held. Each of D, X, and Y are engaged in the manufacture and sale of 
trucks. C is engaged in the manufacture and sale of buses. D and

[[Page 20642]]

X engage in substantial negotiations concerning X's acquisition of 
the stock of D from the D shareholders in exchange for stock of X. D 
and X do not reach an agreement regarding that acquisition. Three 
months after D and X first began negotiations regarding that 
acquisition, D distributes the stock of C pro rata to its 
shareholders. Three months after the distribution, Y acquires the 
stock of D from the D shareholders in exchange for stock of Y.
    (ii) Although both X and Y engage in the manufacture and sale of 
trucks, X's truck business and Y's truck business are not the same 
business operations. Therefore, because Y's acquisition of D does 
not effect a combination of the same business operations as X's 
acquisition of D would have effected, Y's acquisition of D is not 
similar to X's potential acquisition of D that was the subject of 
earlier negotiations.
    Example 7. Acquisition that is similar. (i) D is engaged in the 
business of writing custom software for several industries 
(industries 1 through 6). The software business of D related to 
industries 4, 5, and 6 is significant relative to the software 
business of D related to industries 3, 4, 5, and 6. X, an unrelated 
corporation, is engaged in the business of writing software and the 
business of manufacturing and selling hardware devices. X's business 
of writing software is significant relative to its total businesses. 
X and D engage in substantial negotiations regarding X's acquisition 
of D stock from the D shareholders in exchange for stock of X. 
Because X does not want to acquire the software businesses related 
to industries 1 and 2, these negotiations relate to an acquisition 
of D stock where D owns the software businesses related only to 
industries 3, 4, 5, and 6. Thereafter, D concludes that the 
intellectual property licenses central to the software business 
related to industries 1 and 2 are not transferable and that a 
separation of the software business related to industry 3 from the 
software business related to industry 2 is not desirable. One month 
after D begins negotiating with X, D contributes the software 
businesses related to industries 4, 5, and 6 to C, and distributes 
the stock of C pro rata to its shareholders. In addition, X sells 
its hardware businesses for cash. After the distribution, C and X 
negotiate for X's acquisition of the C stock from the C shareholders 
in exchange for X stock, and X acquires the stock of C.
    (ii) Although D and C are different corporations, C does not own 
the custom software business related to industry 3, and X sold its 
hardware business prior to the acquisition of C, because X's 
acquisition of C involves a combination of a significant portion of 
the same business operations as the combination that would have been 
effected by the acquisition of D that was the subject of 
negotiations between D and X, X's acquisition of C is the same as or 
similar to X's potential acquisition of D that was the subject of 
earlier negotiations.

    (k) Effective dates. This section applies to distributions 
occurring after April 26, 2002. Taxpayers, however, may apply these 
regulations in whole, but not in part, to a distribution occurring 
after April 16, 1997, and on or before April 26, 2002. For 
distributions occurring after August 3, 2001, and on or before April 
26, 2002 with respect to which a taxpayer chooses not to apply these 
regulations, see Sec. 1.355-7T as in effect prior to April 26, 2002 
(see 26 CFR part 1 revised April 1, 2002).

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: April 15, 2002.
Mark Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 02-9817 Filed 4-23-02; 12:14 pm]
BILLING CODE 4830-01-P