[Federal Register Volume 68, Number 131 (Wednesday, July 9, 2003)]
[Rules and Regulations]
[Pages 40766-40768]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-17225]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9071]
RIN 1545-BB78


Effect of Elections in Certain Multi-step Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document gives effect to section 338(h)(10) elections in 
certain multi-step transactions. These regulations affect corporations 
and their shareholders. The text of the 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 regulations are effective on or after July 
9, 2003.
    Applicability Date: For dates of applicability, see Sec.  
1.338(h)(10)-1T(h).

FOR FURTHER INFORMATION CONTACT: Daniel Heins, Mary Goode or Reginald 
Mombrun at (202) 622-7930 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

[[Page 40767]]

Background

A. Section 338 Generally

    In the case of any qualified stock purchase, section 338 allows a 
purchasing corporation to elect to treat the target corporation as 
having sold all of its assets at the close of the acquisition date at 
fair market value and then treats the target corporation as a new 
corporation that purchased all of its assets as of the beginning of the 
day after the acquisition date. Section 338 was enacted to replace 
former section 334(b)(2) and to repeal the Kimbell-Diamond doctrine. 
See H.R. Rep. No. 97-760 at 536 (1982), 1982-2 C.B. 600, 632 
(reflecting that section 338 replaces ``any nonstatutory treatment of a 
stock purchase as an asset purchase under the Kimbell-Diamond 
doctrine''). In Kimbell-Diamond Milling Co. v. Commissioner, 14 T.C. 
74, aff'd per curiam, 342 U.S. 827 (1951), the court held that the 
purchase of the stock of a target corporation for the purpose of 
obtaining its assets through a prompt liquidation should be treated by 
the purchaser as a purchase of the target corporation's assets with the 
purchaser receiving a cost basis in the assets.

B. Revenue Ruling 2001-46

    Rev. Rul. 2001-46 (2001-2 C.B. 321) considers whether the step 
transaction doctrine should apply to treat certain acquisitions of 
stock of a target corporation followed by mergers of the target 
corporation into the acquiring corporation as reorganizations under 
section 368(a)(1)(A). In Situation 1 of that ruling, Corporation X owns 
all of the stock of Corporation Y. Pursuant to an integrated plan, X 
acquires all of the stock of Corporation T in a statutory merger of Y 
into T (the ``Acquisition Merger''), with T surviving. In the 
Acquisition Merger, the T shareholders exchange their T stock for 
consideration, 70 percent of which is X voting stock and 30 percent of 
which is cash. Following the Acquisition Merger and as part of the 
plan, T merges into X in a statutory merger (the ``Upstream Merger''). 
If viewed separately from the Upstream Merger, the Acquisition Merger 
would qualify as a qualified stock purchase. If viewed separately from 
the Acquisition Merger, the Upstream Merger would qualify as a 
liquidation described in section 332. However, if the step transaction 
doctrine were applied to the Acquisition Merger and the Upstream 
Merger, the integrated transaction would be treated as an integrated 
acquisition of T's assets by X in a single statutory merger qualifying 
as a reorganization under section 368(a).
    Considering the appropriate treatment of the Acquisition Merger and 
the Upstream Merger, Rev. Rul. 2001-46 examines, among other 
authorities, Rev. Rul. 67-274 (1967-2 C.B. 141) and Rev. Rul. 90-95 
(1990-2 C.B. 67). In Rev. Rul. 67-274, a corporation's acquisition of 
stock of a target corporation that, viewed independently, qualifies as 
a reorganization under section 368(a)(1)(B), is followed by a 
liquidation of the target corporation into the acquiring corporation 
that, viewed independently, qualifies as a liquidation described in 
section 332. Rev. Rul. 67-274 holds that the transaction is an 
acquisition by the acquiring corporation of the target corporation's 
assets in a reorganization under section 368(a)(1)(C). In Rev. Rul. 90-
95, a subsidiary of the acquiring corporation merges into the target 
corporation with the target corporation shareholders receiving solely 
cash in exchange for their stock. Immediately following this merger, 
the target corporation merges into the acquiring corporation. Rev. Rul. 
90-95 rules that the first step is accorded independent significance 
from the subsequent liquidation of the target corporation and, 
therefore, is treated as a qualified stock purchase, regardless of 
whether an election under section 338 is made.
    In Rev. Rul. 2001-46, the IRS concluded that treating the 
Acquisition Merger and the Upstream Merger as a single statutory merger 
of T into X would not violate the policy underlying section 338 because 
that treatment results in a transaction that qualifies as a 
reorganization under section 368(a)(1)(A) in which X acquires the 
assets of T with a carryover basis under section 362, not a cost basis 
under section 1012. Finally, Rev. Rul. 2001-46 states that the IRS and 
Treasury are considering whether to issue regulations that would 
reflect the general principles of the revenue ruling, but would allow 
taxpayers to make an election under section 338(h)(10) with respect to 
a step in a multi-step transaction that, viewed independently, is a 
qualified stock purchase and is pursuant to a written agreement that 
requires, or permits, the purchasing corporation to cause a section 
338(h)(10) election in respect of such step to be made. The IRS 
requested and received comments on this issue.

Explanation of Provisions

    The IRS and Treasury have studied the comments received in response 
to the request made in Rev. Rul. 2001-46, all of which urge the IRS and 
Treasury to allow taxpayers to make section 338(h)(10) elections in 
certain transactions as contemplated by Rev. Rul. 2001-46. These final 
and temporary regulations adopt this recommendation and provide that 
the step transaction doctrine will not be applied if a taxpayer makes a 
valid section 338(h)(10) election with respect to a step in a multi-
step transaction, even if the transaction would otherwise qualify as a 
reorganization, if the step, standing alone, is a qualified stock 
purchase. The IRS and Treasury are continuing to study the other 
comments received. In particular, the IRS and Treasury are considering 
whether any amendments to the portion of the regulations under section 
338 related to the corporate purchaser requirement are appropriate.

Effective Date

    These final and temporary regulations are applicable to 
acquisitions of stock occurring on or after the date of publication of 
the regulations.

Special Analyses

    These final and temporary regulations are necessary in order to 
provide taxpayers with immediate guidance regarding the validity of 
certain elections made under section 338(h)(10). Accordingly, good 
cause is found for dispensing with the notice and public procedure 
pursuant to 5 U.S.C. 553(b)(B) and with providing a delayed effective 
date pursuant to 5 U.S.C. 553(d)(1) and (3). For applicability of the 
Regulatory Flexibility Act, please refer to the cross-reference notice 
of proposed rulemaking published elsewhere in this issue of the Federal 
Register. These final and temporary regulations have been submitted to 
the Chief Counsel of Advocacy of the Small Business Administration for 
comment on their impact on small businesses.

Drafting Information

    The principal authors of these final and temporary regulations are 
Daniel Heins and Mary Goode, Office of Associate Chief Counsel 
(Corporate). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
1. The authority citation for part 1 is amended by adding an entry in

[[Page 40768]]

numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.338(h)(10)-1T also issued under 26 U.S.C. 337(d), 338 
and 1502. * * *


0
2. Section 1.338-3 is amended by adding a sentence at the end of 
paragraph (c)(1)(i) to read as follows:


Sec.  1.338-3  Qualification for the section 338 election.

* * * * *
    (c) * * *
    (1) * * *
    (i) * * * See Sec.  1.338(h)(10)-1T(c)(2) for special rules 
concerning section 338(h)(10) elections in certain multi-step 
transactions.

0
3. Section 1.338(h)(10)-1 is amended as follows:
0
1. Paragraphs (c)(2), (c)(3) and (c)(4) are redesignated as paragraphs 
(c)(3), (c)(4) and (c)(5) respectively.
0
2. A newly designated paragraph (c)(2) is added.
    The revisions and addition read as follows:


Sec.  1.338(h)(10)-1  Deemed asset sale and liquidation.

* * * * *
    (c) * * *
    (2) [Reserved] For further guidance see Sec.  1.338(h)(10)-
1T(c)(2).
* * * * *

0
4. Section 1.338(h)(10)-1T is added to read as follows:


Sec.  1.338(h)(10)-1T  Deemed asset sale and liquidation (temporary).

    (a) through (c)(1) [Reserved]. For further guidance, see Sec.  
1.338(h)(10)-1(a) through (c)(1).
    (c)(2) Availability of section 338(h)(10) election in certain 
multi-step transactions. Notwithstanding anything to the contrary in 
Sec.  1.338-3(c)(1)(i), a section 338(h)(10) election may be made for T 
where P's acquisition of T stock, viewed independently, constitutes a 
qualified stock purchase and, after the stock acquisition, T merges or 
liquidates into P (or another member of the affiliated group that 
includes P), whether or not, under relevant provisions of law, 
including the step transaction doctrine, the acquisition of the T stock 
and the merger or liquidation of T qualify as a reorganization 
described in section 368(a). If a section 338(h)(10) election is made 
in a case where the acquisition of T stock followed by a merger or 
liquidation of T into P qualifies as a reorganization described in 
section 368(a), for all Federal tax purposes, P's acquisition of T 
stock is treated as a qualified stock purchase and is not treated as 
part of a reorganization described in section 368(a).
    (c)(3) through (e) (Example 10) [Reserved]. For further guidance, 
see Sec.  1.338(h)(10)-1(c)(3) through (e) (Example 10).

    (e) Example 11. Stock acquisition followed by upstream merger--
without section 338(h)(10) election. (i) P owns all the stock of Y, 
a newly formed subsidiary. S owns all the stock of T. Each of P, S, 
T and Y is a domestic corporation. P acquires all of the T stock in 
a statutory merger of Y into T, with T surviving. In the merger, S 
receives consideration consisting of 50% P voting stock and 50% 
cash. Viewed independently of any other step, P's acquisition of T 
stock constitutes a qualified stock purchase. As part of the plan 
that includes P's acquisition of the T stock, T subsequently merges 
into P. Viewed independently of any other step, T's merger into P 
qualifies as a liquidation described in section 332. Absent the 
application of paragraph (c)(2) of this section, the step 
transaction doctrine would apply to treat P's acquisition of the T 
stock and T's merger into P as an acquisition by P of T's assets in 
a reorganization described in section 368(a). P and S do not make a 
section 338(h)(10) election with respect to P's purchase of the T 
stock.
    (ii) Because P and S do not make an election under section 
338(h)(10) for T, P's acquisition of the T stock and T's merger into 
P is treated as part of a reorganization described in section 
368(a).
    Example 12. Stock acquisition followed by upstream merger--with 
section 338(h)(10) election. (i) The facts are the same as in 
Example 11 except that P and S make a joint election under section 
338(h)(10) for T.
    (ii) Pursuant to paragraph (c)(2) of this section, as a result 
of the election under section 338(h)(10), for all Federal tax 
purposes, P's acquisition of the T stock is treated as a qualified 
stock purchase and P's acquisition of the T stock is not treated as 
part of a reorganization described in section 368(a).
    Example 13. Stock acquisition followed by brother-sister 
merger--with section 338(h)(10) election. (i) The facts are the same 
as in Example 12, except that, following P's acquisition of the T 
stock, T merges into X, a domestic corporation that is a wholly 
owned subsidiary of P. Viewed independently of any other step, T's 
merger into X qualifies as a reorganization described in section 
368(a). Absent the application of paragraph (c)(2) of this section, 
the step transaction doctrine would apply to treat P's acquisition 
of the T stock and T's merger into X as an acquisition by X of T's 
assets in a reorganization described in section 368(a).
    (ii) Pursuant to paragraph (c)(2) of this section, as a result 
of the election under section 338(h)(10), for all Federal tax 
purposes, P's acquisition of T stock is treated as a qualified stock 
purchase and P's acquisition of T stock is not treated as part of a 
reorganization described in section 368(a).
    Example 14. Stock acquisition that does not qualify as a 
qualified stock purchase followed by upstream merger. (i) The facts 
are the same as in Example 11, except that, in the statutory merger 
of Y into T, S receives only P voting stock.
    (ii) Pursuant to section 1.338-3(c)(1)(i) and paragraph (c)(2) 
of this section, no election under section 338(h)(10) can be made 
with respect to P's acquisition of the T stock because, pursuant to 
relevant provisions of law, including the step transaction doctrine, 
that acquisition followed by T's merger into P is treated as a 
reorganization under section 368(a)(1)(A), and that acquisition, 
viewed independently of T's merger into P, does not constitute a 
qualified stock purchase under section 338(d)(3). Accordingly, P's 
acquisition of the T stock and T's merger into P is treated as a 
reorganization under section 368(a).

    (f) through (g) [Reserved]. For further guidance, see Sec.  
1.338(h)(10)-1(f) through (g).
    (h) Effective date. This section is applicable to stock 
acquisitions occurring on or after July 9, 2003.
* * * * *

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: June 27, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-17225 Filed 7-8-03; 8:45 am]
BILLING CODE 4830-01-P