[Federal Register Volume 69, Number 153 (Tuesday, August 10, 2004)]
[Proposed Rules]
[Pages 48429-48431]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-18271]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-129706-04]
RIN 1545-BD53


Corporate Reorganizations; Guidance on the Measurement of 
Continuity of Interest

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding the satisfaction of the continuity of interest 
requirement for corporate reorganizations. These proposed regulations 
affect corporations and their shareholders. This document also provides 
a notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 8, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-129706-04), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
129706-04), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the IRS 
Internet site at http://www.irs.gov/regs or via the Federal eRulemaking 
Portal at http://www.regulations.gov (IRS-REG-129706-04).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, 
Christopher M. Bass, (202) 622-7770; concerning submissions of 
comments, the hearing, and/or to be placed on the building access list 
to attend the hearing, Guy Traynor, (202) 622-3693 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    The Internal Revenue Code of 1986 (Code) provides general 
nonrecognition treatment for reorganizations described in section 368 
of the Code. In addition to complying with the statutory requirements 
and certain other requirements, to qualify as a reorganization, a 
transaction generally must satisfy the continuity of interest (COI) 
requirement.
    Section 1.368-1(e) provides that the purpose of the COI requirement 
is to prevent transactions that resemble sales from qualifying for 
nonrecognition of gain or loss available to corporate reorganizations. 
COI requires that, in substance, a substantial part of the value of the 
proprietary interests in the target corporation be preserved in the 
reorganization. A proprietary interest in the target corporation is 
preserved if, in a potential reorganization, it is exchanged for a 
proprietary interest in the issuing corporation, it is exchanged by the 
acquiring corporation for a direct interest in the target corporation 
enterprise, or it otherwise continues as a proprietary interest in the 
target corporation.
    In a transaction in which the shareholders of the target 
corporation receive both money and acquiring corporation stock, 
commentators have expressed concern that the transaction could fail to 
satisfy the COI requirement as a result of a decline in the value of 
the acquiring corporation's stock between the date the parties agree to 
the terms of the transaction (the signing date) and the date the 
transaction closes. Commentators have noted that attempts to mitigate 
this concern have led to complexity in structuring transactions 
intended to qualify as reorganizations. These proposed regulations 
provide guidance to help address those concerns.

Explanation of Provisions

    The IRS and Treasury Department believe that there are certain 
cases in which the determination of whether the COI requirement is 
satisfied should be made by reference to the signing date value of the 
issuing corporation stock to be issued in the transaction. In these 
cases, the target corporation shareholders generally can be viewed as 
being subject to the economic fortunes of the issuing corporation as of 
the signing date. Therefore, these proposed regulations provide that in 
determining whether the COI requirement is satisfied, the consideration 
to be exchanged for the proprietary interests in the target corporation 
is valued as of the end of the last business day before the first date 
there is a binding contract to effect the potential reorganization, 
provided the consideration to be provided to the target corporation 
shareholders is fixed in such contract and includes only stock of the 
issuing corporation and money.
    For this purpose, a binding contract is an instrument enforceable 
under applicable law against the parties to the instrument. The IRS and 
Treasury Department understand that tender offers are a frequent 
acquisition vehicle. Because the terms of a tender offer that is 
subject to section 14(d) of the Securities and Exchange Act of 1934 (15 
U.S.C. 78n(d)(1)) and the regulations promulgated thereunder are fixed 
in a manner similar to those of a binding contract, these proposed 
regulations provide that such a tender offer, even if not pursuant to a 
binding contract, will be treated as a binding contract for purposes of 
these regulations.
    The proposed regulations provide that the presence of a condition 
outside the control of the parties shall not prevent an instrument from 
being a binding contract. For example, the fact that the completion of 
a tender offer is subject to a shareholder vote or the target 
shareholders tendering a sufficient amount of target stock will be 
considered a condition outside the control of the parties.
    Finally, these proposed regulations provide that consideration is 
fixed if the contract states the exact number of shares of the issuing 
corporation and the exact amount of money, if any, to be exchanged for 
the proprietary interests in the target corporation. However, where the 
consideration is comprised of only issuing corporation stock and money, 
variable consideration will be treated as fixed consideration if a 
target corporation shareholder has an election to receive stock and/or 
money in respect of target corporation stock and the minimum amount of 
issuing corporation stock and the maximum amount of money that the 
target shareholders might receive can be determined. For purposes of 
determining whether a transaction that involves such variable 
consideration satisfies the continuity of interest requirement, these 
proposed regulations assume the issuance of the minimum number of 
shares and the maximum amount of money allowable under the contract, 
without regard to the number of shares and amount of money actually 
exchanged for proprietary interests in the target corporation.
    In the course of developing these regulations, the IRS and Treasury 
Department considered whether the rule provided in these proposed 
regulations should be applied in other cases and what presumptions or 
conventions would be necessary to assess whether the COI requirement 
has been satisfied in such other cases. The IRS and Treasury Department 
request comments in this regard.
    This regulation is proposed to apply to transactions occurring 
pursuant to binding contracts entered into after the date these 
regulations are published as final regulations in the Federal Register.

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Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and, because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, these 
proposed regulations will be submitted to the Chief Counsel of Advocacy 
of the Small Business Administration for comment on their impact on 
small businesses.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and 8 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and Treasury Department request comments regarding the clarity 
of the proposed regulations and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Christopher 
M. Bass, Office of the 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.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

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

    Par. 2. Section 1.368-1 is amended by:
    1. Redesignating paragraphs (e)(2) through (e)(7) as (e)(3) through 
(e)(8), respectively.
    2. Adding new paragraph (e)(2).
    3. Newly redesignated paragraph (e)(7) is further redesignated as 
paragraph (e)(7)(i), and Examples 10, 11, and 12 are added.
    4. Adding paragraph (e)(7)(ii).
    The additions read as follows:


Sec.  1.368-1  Purpose and scope of exception of reorganization 
exchanges.

* * * * *
    (e) * * *
    (2) Measuring continuity of interest--(i) In general. In 
determining whether a proprietary interest in the target corporation is 
preserved, the consideration to be exchanged for the proprietary 
interests in the target corporation shall be valued as of the end of 
the last business day before the first date there is a binding contract 
to effect the potential reorganization, provided the consideration is 
fixed in such contract and includes only stock of the issuing 
corporation and money.
    (ii) Binding contract--(A) In general. A binding contract is an 
instrument enforceable under applicable law against the parties to the 
instrument. The presence of a condition outside the control of the 
parties (including, for example, regulatory agency approval) shall not 
prevent an instrument from being a binding contract. Further, the fact 
that insubstantial terms remain to be negotiated by the parties to the 
contract, or that customary conditions remain to be satisfied, shall 
not prevent an instrument from being a binding contract. If a term of a 
binding contract that relates to the amount or type of the 
consideration the target shareholders will receive in a potential 
reorganization is modified before the closing date of the potential 
reorganization, and the contract as modified is a binding contract, the 
date of the modification shall be treated as the first date there is a 
binding contract.
    (B) Tender offers. For purposes of this paragraph (e)(2), a tender 
offer that is subject to section 14(d) of the Securities and Exchange 
Act of 1934 [15 U.S.C. 78n(d)(1)] and Regulation 14D [17 CFR 240.14d-1 
through 240.14d-101] and is not pursuant to a binding contract, is 
treated as a binding contract made on the date of its announcement, 
notwithstanding that it may be modified by the offeror or that it is 
not enforceable against the offerees. If a modification of such a 
tender offer is subject to the provisions of Regulation 14d-6(c) [17 
CFR 240.14d-6(c)] and relates to the amount or type of the 
consideration received in the tender offer, then the date of the 
modification shall be treated as the first date there is a binding 
contract.
    (iii) Fixed consideration--(A) In general. Consideration is fixed 
in a contract if the contract states the number of shares of the 
issuing corporation and the amount of money, if any, to be exchanged 
for the proprietary interests in the target corporation. Placing part 
of the stock issued or money paid in escrow to secure customary target 
representations and warranties will not prevent the consideration from 
being fixed.
    (B) Special rule for shareholder elections. Notwithstanding the 
provisions of paragraph (e)(2)(iii)(A) of this section, consideration 
is also treated as fixed if a target corporation shareholder has an 
election to receive stock and/or money in respect of target corporation 
stock and the contract states the minimum number of shares of the 
issuing corporation and the maximum amount of money to be exchanged for 
the proprietary interests in the target corporation. In this case, the 
determination of whether a proprietary interest in the target 
corporation is preserved shall be made by assuming the issuance of the 
minimum number of shares and the maximum amount of money allowable 
under the contract and without regard to the number of shares and 
amount of money actually exchanged thereafter for proprietary interests 
in the target corporation.
    (iv) Effective date. Paragraph (e)(2) applies to transactions 
occurring pursuant to binding contracts entered into after the date 
these regulations are published as final regulations in the Federal 
Register.
* * * * *
    (7)(i) Examples. * * *
* * * * *

    Example 10. Fixed consideration on signing date. On January 3 of 
Year 1, P and T sign a binding contract pursuant to which T will be 
merged with and into P on June 2 of Year 1. Pursuant to the 
contract, the T shareholders will receive 40 P shares and $60 in 
exchange for all of the outstanding stock of T. Ten of the P shares, 
however, will be placed in escrow to secure customary target 
representations and warranties. At the end of the day on January 2 
of Year 1, the P stock trades for $1 per share. On June 1 of Year 1, 
the P stock trades for $.25 per share. Under paragraph (e)(2) of 
this section, there is a binding contract with fixed consideration 
as of January 3 of Year 1. Therefore, whether the transaction 
satisfies the continuity of interest requirement is determined by 
reference to the value of the P stock as of the end of the day on 
January 2 of Year 1. Because, for continuity of interest purposes, 
the T stock is exchanged for $40 of P stock and $60, the transaction 
preserves a substantial part of the

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value of the proprietary interest in T. Therefore, the transaction 
satisfies the continuity of interest requirement.
    Example 11. Modification of binding contract. The facts are the 
same as in Example 10, except that on April 1 of Year 1, the parties 
modify their contract. Pursuant to the modified contract, which is a 
binding contract, the T shareholders will receive 50 P shares and 
$60 in exchange for all of the outstanding T stock. At the end of 
the day on March 31 of Year 1, the P stock trades for $.80 per 
share. Under paragraph (e)(2) of this section, although there was a 
binding contract with fixed consideration as of January 3 of Year 1, 
terms of that contract relating to the consideration to be provided 
to the target shareholders were modified on April 1 of Year 1. 
Therefore, whether the transaction satisfies the continuity of 
interest requirement is determined by reference to the value of the 
P stock as of the end of the day on March 31 of Year 1. Because, for 
continuity of interest purposes, the T stock is exchanged for $40 of 
P stock and $60, the transaction preserves a substantial part of the 
value of the proprietary interest in T. Therefore, the transaction 
satisfies the continuity of interest requirement.
    Example 12. The facts are the same as in Example 11 except that, 
at the end of the day on March 31 of Year 1, the P stock trades for 
$.51 per share. As in Example 11, whether the transaction satisfies 
COI is determined by reference to the value of the P stock as of the 
end of the day on March 31 of Year 1. Because, for continuity of 
interest purposes, the T stock is exchanged for $25.50 of P stock 
and $60, a substantial part of the value of the proprietary interest 
in T is not preserved. Therefore, the transaction does not satisfy 
the continuity of interest requirement.

    (ii) Effective date. Paragraph (e)(7) Examples 10, 11, and 12 apply 
to transactions occurring pursuant to binding contracts entered into 
after the date these regulations are published as final regulations in 
the Federal Register.
* * * * *

    Approved: June 29, 2004.
Nancy Jardini,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-18271 Filed 8-9-04; 8:45 am]
BILLING CODE 4830-01-P