[Federal Register Volume 69, Number 80 (Monday, April 26, 2004)]
[Rules and Regulations]
[Pages 22399-22401]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-9448]


-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9122]
RIN 1545-BC28


Guidance Under Section 1502; Stock Basis After a Group Structure 
Change

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations under section 1502 
providing guidance regarding the determination of basis in the stock of 
the former common parent following a group structure change. These 
final regulations affect corporations filing consolidated returns.

DATES: These regulations are effective April 26, 2004.

FOR FURTHER INFORMATION CONTACT: Ross Poulsen, (202) 622-7770 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 1502 of the Internal Revenue Code of 1986 
(Code), specifically Sec.  1.1502-31, relating to the determination of 
the basis of stock in the former common parent after a group structure 
change. Section 1.1502-31 applies if one corporation (P) succeeds 
another corporation (T) under the principles of Sec.  1.1502-75(d)(2) 
or (3) as the common parent of a consolidated group in a group 
structure change. Section 1.1502-31 provides that if a corporation 
acquires stock of the former common parent in a group structure change, 
the basis of the members in the former common parent's stock 
immediately after the group structure change is generally redetermined 
to reflect the former common parent's net asset basis.
    Because of a concern that the application of the net asset basis 
rule may produce inappropriate results on the disposition of stock 
acquired in a transaction in which, under generally applicable rules, 
the basis of the acquired stock would otherwise be determined by 
reference to the acquirer's cost, the IRS and Treasury Department 
issued regulations proposing to except from the application of the net 
asset basis rule stock acquired in a transaction in which gain or loss 
was recognized in whole. Those regulations were included in a notice of 
proposed rulemaking (REG-130262-03) published in the Federal Register 
(68 FR 40579 [technical correction published in 68 FR 52545]) on July 
8, 2003.
    No public hearing was requested or held regarding the proposed 
regulations. One written comment, however, was received. That comment 
urged the expeditious promulgation of the proposed regulations as final 
regulations.
    This Treasury decision adopts the proposed regulations without 
substantive changes as final regulations. The final regulations apply 
to group structure changes that occur after April 26, 2004. With 
respect to group structure changes that occur on or before April 26, 
2004, and in a consolidated return year beginning on or after January 
1, 1995, these regulations apply at the election of the group.

Special Analyses

    It has been determined that these regulations are not a significant 
regulatory action as defined in Executive Order 12866. Therefore, a 
regulatory assessment is not required. It is hereby certified that 
these regulations do not have a significant impact on a substantial 
number of small entities. This certification is based on the fact that 
these regulations primarily will affect affiliated groups of 
corporations, which tend to be larger businesses. Moreover, the number 
of taxpayers affected is minimal and the regulations will simplify 
basis determinations. Therefore, a Regulatory Flexibility Analysis 
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not 
required. Pursuant to section 7805(f) of the Code, the proposed 
regulations preceding these regulations were submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact.

[[Page 22400]]

Drafting Information

    The principal author of this regulation is Ross Poulsen, 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
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

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


0
Par. 2. Section 1.1502-31 is amended by revising paragraphs (b)(2), 
(d)(2)(ii), (g), and (h) to read as follows:


Sec.  1.1502-31  Stock basis after a group structure change.

* * * * *
    (b) * * *
    (2) Stock acquisitions. If a corporation acquires stock of the 
former common parent in a group structure change, the basis of the 
members in the former common parent's stock immediately after the group 
structure change (including any stock of the former common parent owned 
before the group structure change) that is, or would otherwise be, 
transferred basis property is redetermined in accordance with the 
results for an asset acquisition described in paragraph (b)(1) of this 
section. For example, if all of T's stock is contributed to P in a 
group structure change to which section 351 applies, P's basis in T's 
stock is T's net asset basis, rather than the amount determined under 
section 362. Similarly, if S merges into T in a group structure change 
described in section 368(a)(2)(E) and P acquires all of the T stock, 
P's basis in T's stock is the basis that P would have in S's stock 
under paragraph (b)(1) of this section if T had merged into S in a 
group structure change described in section 368(a)(2)(D).
* * * * *
    (d) * * *
    (2) * * *
    (ii) Stock acquisitions. If less than all of the former common 
parent's stock is subject to the redetermination described in paragraph 
(b)(2) of this section, the percentage of the former common parent's 
net asset basis taken into account in the redetermination equals the 
percentage (by fair market value) of the former common parent's stock 
subject to the redetermination. For example, if P owns less than all of 
the former common parent's stock immediately after the group structure 
change and such stock would otherwise be transferred basis property, 
only an allocable part of the basis determined under this section is 
reflected in the shares owned by P (and the amount allocable to shares 
owned by nonmembers has no effect on the basis of their shares). 
Alternatively, if P acquired 10 percent of the former common parent's 
stock in a transaction in which the stock basis was determined by P's 
cost, and P later acquires the remaining 90 percent of the former 
common parent's stock in a separate transaction that is described in 
paragraph (b)(2) of this section, P retains its cost basis in its 
original stock and the basis of P's newly acquired shares reflects only 
an allocable part of the former common parent's net asset basis.
* * * * *
    (g) Examples. For purposes of the examples in this section, unless 
otherwise stated, all corporations have only one class of stock 
outstanding, the tax year of all persons is the calendar year, all 
persons use the accrual method of accounting, the facts set forth the 
only corporate activity, all transactions are between unrelated 
persons, and tax liabilities are disregarded. The principles of this 
section are illustrated by the following examples:

    Example 1. Forward triangular merger. (i) Facts. P is the common 
parent of one group and T is the common parent of another. T has 
assets with an aggregate basis of $60 and fair market value of $100 
and no liabilities. T's shareholders have an aggregate basis of $50 
in T's stock. In Year 1, pursuant to a plan, P forms S and T merges 
into S with the T shareholders receiving $100 of P stock in exchange 
for their T stock. The transaction is a reorganization described in 
section 368(a)(2)(D). The transaction is also a reverse acquisition 
under Sec.  1.1502-75(d)(3) because the T shareholders, as a result 
of owning T's stock, own more than 50% of the value of P's stock 
immediately after the transaction. Thus, the transaction is a group 
structure change under Sec.  1.1502-33(f)(1), and P's earnings and 
profits are adjusted to reflect T's earnings and profits immediately 
before T ceases to be the common parent of the T group.
    (ii) Analysis. Under paragraph (b)(1) of this section, P's basis 
in S's stock is adjusted to reflect T's net asset basis. Under 
paragraph (c) of this section, T's net asset basis is $60, the basis 
T would have in the stock of a subsidiary under section 358 if T had 
transferred all of its assets and liabilities to the subsidiary in a 
transaction to which section 351 applies. Thus, P has a $60 basis in 
S's stock.
    (iii) Pre-existing S. The facts are the same as in paragraph (i) 
of this Example 1, except that P has owned the stock of S for 
several years and P has a $50 basis in the S stock before the merger 
with T. Under paragraph (b)(1) of this section, P's $50 basis in S's 
stock is adjusted to reflect T's net asset basis. Thus, P's basis in 
S's stock is $110 ($50 plus $60).
    (iv) Excess loss account included in former common parent's net 
asset basis. The facts are the same as in paragraph (i) of this 
Example 1, except that T has two assets, an operating asset with an 
$80 basis and $90 fair market value, and stock of a subsidiary with 
a $20 excess loss account and $10 fair market value. Under paragraph 
(c) of this section, T's net asset basis is $60 ($80 minus $20). See 
sections 351 and 358, and Sec.  1.1502-19. Consequently, P has a $60 
basis in S's stock. Under section 362 and Sec.  1.1502-19, S has an 
$80 basis in the operating asset and a $20 excess loss account in 
the stock of the subsidiary.
    (v) Liabilities in excess of basis. The facts are the same as in 
paragraph (i) of this Example 1, except that T's assets have a fair 
market value of $170 (and $60 basis) and are subject to $70 of 
liabilities. Under paragraph (c) of this section, T's net asset 
basis is negative $10 ($60 minus $70). See sections 351 and 358, and 
Sec. Sec.  1.1502-19 and 1.1502-80(d). Thus, P has a $10 excess loss 
account in S's stock. Under section 362, S has a $60 basis in its 
assets (which are subject to $70 of liabilities). (Under paragraph 
(a)(2) of this section, because the liabilities are taken into 
account in determining net asset basis under paragraph (c) of this 
section, the liabilities are not also taken into account as 
consideration not provided by P under paragraph (d)(1) of this 
section.)
    (vi) Consideration provided by S. The facts are the same as in 
paragraph (i) of this Example 1, except that P forms S with a $100 
contribution at the beginning of Year 1, and during Year 6, pursuant 
to a plan, S purchases $100 of P stock and T merges into S with the 
T shareholders receiving P stock in exchange for their T stock. 
Under paragraph (b)(1) of this section, P's $100 basis in S's stock 
is increased by $60 to reflect T's net asset basis. Under paragraph 
(d)(1) of this section, P's basis in S's stock is decreased by $100 
(the fair market value of the P stock) because the P stock purchased 
by S and used in the transaction is consideration not provided by P.
    (vii) Appreciated asset provided by S. The facts are the same as 
in paragraph (i) of this Example 1, except that P has owned the 
stock of S for several years, and the shareholders of T receive $60 
of P stock and an asset of S with a $30 adjusted basis and $40 fair 
market value. S recognizes a $10 gain from the asset under section 
1001. Under paragraph (b)(1) of this section, P's basis in S's stock 
is increased by $60 to reflect T's net asset basis. Under paragraph 
(d)(1) of this section, P's basis in S's stock is decreased by $40 
(the fair market value of the asset provided by S). In addition, P's 
basis in S's stock is increased under Sec.  1.1502-32(b) by S's $10 
gain.
    (viii) Depreciated asset provided by S. The facts are the same 
as in paragraph (i) of this

[[Page 22401]]

Example 1, except that P has owned the stock of S for several years, 
and the shareholders of T receive $60 of P stock and an asset of S 
with a $50 adjusted basis and $40 fair market value. S recognizes a 
$10 loss from the asset under section 1001. Under paragraph (b)(1) 
of this section, P's basis in S's stock is increased by $60 to 
reflect T's net asset basis. Under paragraph (d)(1) of this section, 
P's basis in S's stock is decreased by $40 (the fair market value of 
the asset provided by S). In addition, S's $10 loss is taken into 
account under Sec.  1.1502-32(b) in determining P's basis 
adjustments under that section.
    Example 2. Stock acquisition. (i) Facts. P is the common parent 
of one group and T is the common parent of another. T has assets 
with an aggregate basis of $60 and fair market value of $100 and no 
liabilities. T's shareholders have an aggregate basis of $50 in T's 
stock. Pursuant to a plan, P forms S and S acquires all of T's stock 
in exchange for P stock in a transaction described in section 
368(a)(1)(B). The transaction is also a reverse acquisition under 
Sec.  1.1502-75(d)(3). Thus, the transaction is a group structure 
change under Sec.  1.1502-33(f)(1), and the earnings and profits of 
P and S are adjusted to reflect T's earnings and profits immediately 
before T ceases to be the common parent of the T group.
    (ii) Analysis. Under paragraph (d)(4) of this section, although 
S is not the new common parent of the T group, adjustments must be 
made to S's basis in T's stock in accordance with the principles of 
this section. Although S's basis in T's stock would ordinarily be 
determined under section 362 by reference to the basis of T's 
shareholders in T's stock immediately before the group structure 
change, under the principles of paragraph (b)(2) of this section, 
S's basis in T's stock is determined by reference to T's net asset 
basis. Thus, S's basis in T's stock is $60.
    (iii) Higher-tier adjustments. Under paragraph (d)(4) of this 
section, P's basis in S's stock is increased by $60 (to be 
consistent with the adjustment to S's basis in T's stock).
    (iv) Cross ownership. 1 The facts are the same as in paragraph 
(i) of this Example 2, except S purchased 10% of T's stock from an 
unrelated person for cash. In an unrelated transaction, S acquires 
the remaining 90% of T's stock in exchange for P stock. S's basis in 
the initial 10% of T's stock is not redetermined under this section. 
However, S's basis in the additional 90% of T's stock is 
redetermined under this section. S's basis in that stock is adjusted 
to $54 (90% of T's net asset basis).
    (v) Allocable share. The facts are the same as in paragraph (i) 
of this Example 2, except that P owns only 90% of S's stock 
immediately after the group structure change. S's basis in T's stock 
is the same as in paragraph (ii) of this Example 2. Under paragraph 
(d)(2) of this section, P's basis in its S stock is increased by $54 
(90% of S's $60 adjustment).
    Example 3. Taxable stock acquisition. (i) Facts. P is the common 
parent of one group and T is the common parent of another. T has 
assets with an aggregate basis of $60 and fair market value of $100 
and no liabilities. T's shareholders have an aggregate basis of $50 
in T's stock. Pursuant to a plan, P acquires all of T's stock in 
exchange for $70 of P's stock and $30 in a transaction that is a 
group structure change under Sec.  1.1502-33(f)(1). P's acquired T 
stock is not transferred basis property. (Because of P's use of 
cash, the acquisition is not a transaction described in section 
368(a)(1)(B).)
    (ii) Analysis. The rules of this section do not apply to 
determine P's basis in T's stock. Therefore, P's basis in T's stock 
is $100.

    (h) Effective dates--(1) General rule. This section applies to 
group structure changes that occur after April 26, 2004. However, a 
group may apply this section to group structure changes that occurred 
on or before April 26, 2004, and in consolidated return years beginning 
on or after January 1, 1995.
    (2) Prior law. For group structure changes that occur on or before 
April 26, 2004, and in consolidated return years beginning on or after 
January 1, 1995, with respect to which the group does not elect to 
apply the provisions of this section, see Sec.  1.1502-31 as contained 
in the 26 CFR part 1 edition revised as of April 1, 2003. For group 
structure changes that occur in consolidated return years beginning 
before January 1, 1995, see Sec. 1.1502-31T as contained in the 26 CFR 
part 1 edition revised as of April 1, 1994.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: April 14, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-9448 Filed 4-23-04; 8:45 am]
BILLING CODE 4830-01-P