[Federal Register Volume 69, Number 155 (Thursday, August 12, 2004)]
[Proposed Rules]
[Pages 49836-49840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-18476]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106889-04]
RIN 1545-BD31


Reorganizations Under Section 368(a)(1)(E) or (F)

AGENCY: Internal Revenue Service, Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding the requirements for a transaction to qualify as a 
reorganization under section 368(a)(1)(E) or (F) of the Internal 
Revenue Code. The proposed regulations will affect corporations and 
their shareholders.

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 10, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-106889-04), 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-
106889-04), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Internal 
Revenue Service Internet site at http://www.irs.gov/regs or via the 
Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-
106889-04).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Robert B. Gray, (202) 622-7550; concerning submissions of comments, Guy 
R. Traynor, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    In general, upon the exchange of property, gain or loss must be 
accounted for if the new property differs materially, in kind or 
extent, from the old property. See Internal Revenue Code (Code) Sec.  
1001; Sec.  1.368-1(b). The purpose of the reorganization provisions of 
the Internal Revenue Code (the Code) is to except from the general rule 
certain specifically described exchanges that are required by business 
exigencies and effect only a readjustment of continuing interests in 
property under modified corporate forms. See Sec.  1.368-1(b).
    Section 368(a)(1)(E) provides that the term reorganization includes 
a recapitalization (an E reorganization). A recapitalization has been 
defined as a ``reshuffling of a capital structure within the framework 
of an existing corporation.'' Helvering v. Southwest Consolidated 
Corp., 315 U.S. 194 (1942).
    Section 368(a)(1)(F) provides that the term reorganization includes 
a mere change in identity, form, or place of organization of one 
corporation, however effected (an F reorganization). One court has 
described the F reorganization as follows:

    [The F reorganization] encompass[es] only the simplest and least 
significant of corporate changes. The (F)-type reorganization 
presumes that the surviving corporation is the same corporation as 
the predecessor in every respect, except for minor or technical 
differences. For instance, the (F) reorganization typically has been 
understood to comprehend only such insignificant modifications as 
the reincorporation of the same corporate business with the same 
assets and the same stockholders surviving under a new charter 
either in the same or in a different State, the renewal of a 
corporate charter having a limited life, or the conversion of a 
U.S.-chartered savings and loan association to a State-chartered 
institution.

Berghash v. Commissioner, 43 T.C. 743, 752 (1965) (citation and 
footnotes omitted), aff'd, 361 F.2d 257 (2nd Cir. 1966).
    To qualify as a reorganization, a transaction must generally 
satisfy not only the statutory requirements of the reorganization 
provisions but also certain nonstatutory requirements, including the 
continuity of interest and continuity of business enterprise 
requirements. See Sec.  1.368-1(b). The purpose of the continuity 
requirements is to ensure that reorganizations are limited to 
readjustments of continuing interests in property under modified 
corporate form and to prevent transactions that resemble sales from 
qualifying for nonrecognition of gain or loss available to corporate 
reorganizations. Sec.  1.368-1(d)(1) and (e)(1); see also LeTulle v. 
Scofield, 308 U.S. 415 (1940); Helvering v. Minnesota Tea Co., 296 U.S. 
378 (1935); Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 
462 (1933).
    Despite the general rule, the courts and the Service have taken the 
position that the continuity of interest and continuity of business 
enterprise requirements need not be satisfied for a transaction to 
qualify as an E reorganization. See Hickok v. Commissioner, 32 T.C. 80 
(1959); Rev. Rul. 82-34 (1982-1 C.B. 59); Rev. Rul. 77-415 (1977-2 C.B. 
311). In Revenue Rulings 77-415 and 82-34, the IRS reasoned that the 
continuity of interest and continuity of business enterprise 
requirements are necessary in an acquisitive reorganization to ensure 
that the transaction does not involve an otherwise taxable transfer of 
stock or assets, but that they are not necessary when the transaction 
involves only a single corporation.
    Although an F reorganization may involve an actual or deemed 
transfer of assets from one corporation to another, such a transaction 
effectively involves only one corporation. In this way, an F 
reorganization is much like an E

[[Page 49837]]

reorganization, which can only involve one corporation even in form. As 
a result, an F reorganization is treated for most purposes of the Code 
as if the reorganized corporation were the same entity as the 
corporation in existence before the reorganization. Consequently, the 
taxable year of the corporation does not end on the date of the 
transfer, and the losses of the reorganized corporation can be carried 
back to offset income of its predecessor. See Sec.  1.381(b)-1(a)(2). 
Nonetheless, courts have applied the continuity requirements in 
determining whether a transaction qualifies as an F reorganization. 
See, e.g., Pridemark, Inc. v. Commissioner, 345 F.2d 35 (4th Cir. 1965) 
(stating that the application of the F reorganization statute is 
limited to cases where the corporate enterprise continues 
uninterrupted, except perhaps for a distribution of some of its liquid 
assets); Yoc Heating Corp. v. Commissioner, 61 T.C. 168 (1973) (holding 
that continuity of interest is required for an F reorganization).
    The Service and the Treasury Department have considered whether 
continuity of interest and continuity of business enterprise should be 
requirements of an F reorganization. Because F reorganizations involve 
only the slightest change in a corporation and do not resemble sales, 
the Service and the Treasury Department have concluded that applying 
the continuity of interest and continuity of business enterprise 
requirements to transactions that would otherwise qualify as F 
reorganizations is not necessary to protect the policies underlying the 
reorganization provisions. Therefore, these proposed regulations 
provide that a continuity of interest and a continuity of business 
enterprise are not required for a transaction to qualify as an F 
reorganization. In addition, to reflect the IRS' position in Revenue 
Rulings 77-415 and 82-34, these proposed regulations provide that a 
continuity of interest and a continuity of business enterprise are not 
required for a transaction to qualify as an E reorganization.
    In light of the proposed rules regarding the application of the 
continuity requirements to transactions that otherwise qualify as F 
reorganizations, the IRS and the Treasury Department believe it is 
desirable to provide guidance regarding the characteristics of F 
reorganizations. These regulations propose such criteria.
    Consistent with section 368(a)(1)(F), the proposed regulations 
provide that, to qualify as an F reorganization, a transaction must 
result in a mere change in identity, form, or place of organization of 
one corporation. The proposed regulations further provide that a 
transaction that involves an actual or deemed transfer is a mere change 
only if four requirements are satisfied. First, all the stock of the 
resulting corporation, including stock issued before the transfer, must 
be issued in respect of stock of the transferring corporation. Second, 
there must be no change in the ownership of the corporation in the 
transaction, except a change that has no effect other than that of a 
redemption of less than all the shares of the corporation. Third, the 
transferring corporation must completely liquidate in the transaction. 
Fourth, the resulting corporation must not hold any property or have 
any tax attributes (including those specified in section 381(c)) 
immediately before the transfer.
    The first two requirements reflect the Supreme Court's holding in 
Helvering v. Southwest Consolidated, 315 U.S. 194 (1942), that a 
transaction that shifts the ownership of the proprietary interests in a 
corporation cannot be a mere change. These requirements prevent a 
transaction that involves the introduction of a new shareholder or new 
capital into the corporation from qualifying as an F reorganization. 
Such an introduction may occur, for example, when a new shareholder 
contributes assets to the resulting corporation in exchange for stock 
before a merger of the transferring corporation into the resulting 
corporation. Notwithstanding these requirements, the proposed 
regulations permit the resulting corporation's issuance of a nominal 
amount of stock not in respect of stock of the transferring corporation 
to facilitate the organization of the resulting corporation. This rule 
is designed to permit reincorporation in a jurisdiction that requires, 
for example, minimum capitalization, two or more shareholders, or 
ownership of shares by directors. It is also intended to permit a 
transfer of assets to certain pre-existing entities.
    The second requirement allows changes of ownership that have no 
effect other than a redemption of less than all the shares of the 
corporation to reflect the case law holding that certain transactions 
qualify as F reorganizations even if shareholders are redeemed in the 
transaction. See Reef Corp. v. U.S., 368 F.2d 125 (5th Cir. 1966) 
(holding that a redemption of 48 percent of the stock of a corporation 
that occurred during a change in place of incorporation did not cause 
the transaction to fail to qualify as an F reorganization); cf. Casco 
Products Corp. v. Commissioner, 49 T.C. 32 (1967) (holding that the 
surviving corporation in a merger was the continuation of the merging 
corporation for purposes of allowing a loss carryback, despite the 
forced redemption of nine percent of the stock of the merging 
corporation).
    The third requirement (providing for the liquidation of the 
transferring corporation) and the fourth requirement (limiting the 
assets the resulting corporation may hold immediately before the 
transfer) reflect the statutory requirement that an F reorganization 
involve only one corporation. Although the proposed regulations 
generally require that the transferring corporation completely 
liquidate in the transaction, they do not require the transferring 
corporation to legally dissolve, thereby facilitating preservation of 
the value of the transferring corporation's charter. Further, to 
accommodate transactions in jurisdictions where it is customary to 
preserve pre-existing entities for future use rather than create new 
ones, the proposed regulations permit the retention of a nominal amount 
of assets for the sole purpose of preserving the transferring 
corporation's legal existence.
    Although the proposed regulations generally require that the 
resulting corporation not hold any property or have any tax attributes 
immediately before the transfer, they do allow the resulting 
corporation to hold or to have held a nominal amount of assets to 
facilitate its organization or preserve its existence, and to have tax 
attributes related to these assets. In addition, to accommodate 
transactions involving the refinancing of debt or the leveraged 
redemption of shareholders, the proposed regulations provide that this 
requirement will not be violated if, before the transfer, the resulting 
corporation holds the proceeds of borrowings undertaken in connection 
with the transaction.
    As described above, section 368(a)(1)(F) provides that an F 
reorganization includes a mere change in identity, form, or place of 
organization of one corporation, however effected. The IRS and the 
Treasury Department believe that the inclusion of the words ``however 
effected'' in the statutory definition of an F reorganization reflects 
a Congressional intent to treat as an F reorganization a series of 
transactions that together result in a mere change. The proposed 
regulations reflect this view by providing that a series of related 
transactions that together result in a mere change may qualify as an F 
reorganization.
    The IRS and the Treasury Department also recognize that a 
reorganization qualifying under section 368(a)(1)(F)

[[Page 49838]]

may be a step in a larger transaction that effects more than a mere 
change. For example, in Revenue Ruling 96-29 (1996-1 C.B. 50), the IRS 
ruled that a reincorporation qualified as an F reorganization even 
though it was a step in a transaction in which the reincorporated 
entity issued common stock in a public offering and redeemed stock 
having a value of 40 percent of the aggregate value of its outstanding 
stock before the offering. In the same ruling, the IRS ruled that a 
reincorporation of a corporation in another state qualified as an F 
reorganization even though it was a step in a transaction in which the 
reincorporated entity acquired the business of another entity.
    Consistent with Revenue Ruling 96-29, the proposed regulations 
provide that related events preceding or following the transaction or 
series of transactions that constitute a mere change do not cause that 
transaction or series of transactions to fail to qualify as an F 
reorganization. The proposed regulations further provide that the 
qualification of the mere change as an F reorganization does not alter 
the treatment of the larger transaction. For example, if a redemption 
of stock occurs in a transaction that qualifies as an F reorganization 
and the F reorganization is part of a plan that includes a subsequent 
merger, the step or series of steps constituting the F reorganization 
will not alter the tax consequences of the subsequent merger.
    A number of commentators have questioned whether distributions of 
money or other property in an F reorganization are distributions to 
which section 356 applies. The IRS and the Treasury Department believe 
it is appropriate to treat such distributions as transactions separate 
from the F reorganization, even if they occur during the F 
reorganization. See, e.g., Sec.  1.301-1(l). Accordingly, these 
proposed regulations provide that if a shareholder receives money or 
other property (including in exchange for its shares) from the 
transferring or resulting corporation in a transaction that constitutes 
an F reorganization, the money or other property is treated as 
distributed by the transferring corporation immediately before the 
transaction. The tax treatment of such distributions is governed by 
sections 301 and 302, and section 356 does not apply to such 
distributions. The IRS and the Treasury Department believe that the 
same rule should apply in the context of E reorganizations. Comments 
are requested on whether there are some E reorganizations to which this 
treatment should not apply.
    These regulations are proposed to be effective for transactions 
that occur on or after the date of these regulations are published as 
final regulations in the Federal Register.

Effect on Other Documents

    Upon the issuance of these regulations as final regulations, Rev. 
Rul. 66-284 (1966-2 C.B. 115), Rev. Rul. 74-36 (1974-1 C.B. 85), Rev. 
Rul. 77-415 (1977-2 C.B. 311), Rev. Rul. 77-479 (1977-2 C.B. 119), Rev. 
Rul. 79-250 (1979-2 C.B. 156), Rev. Rul. 82-34 (1982-1 C.B. 59), and 
Rev. Rul. 96-29 (1996-1 C.B. 50), will be obsoleted.

Special Analyses

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

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
Service. The IRS and Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing 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 Robert B. 
Gray of the Office of Associate Chief Counsel (Corporate). However, 
other personnel from the Service and Treasury Department participated 
in their development.

List of Subjects 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(b) is amended by adding a sentence after 
the third sentence to read as follows:


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

* * * * *
    (b) Purpose. * * * Notwithstanding the previous sentence, for 
transactions on or after [the date these regulations are published as 
final regulations in the Federal Register], a continuity of the 
business enterprise and a continuity of interest are not required for a 
transaction to qualify as a reorganization under section 368(a)(1)(E) 
or (F). * * *
* * * * *
    Par. 3. Section 1.368-2 is amended by:
    1. Adding and reserving new paragraph (l).
    2. Adding new paragraph (m).
    The addition reads as follows:


Sec.  1.368-2  Definition of terms.

* * * * *
    (l) [Reserved].
    (m) Qualification as a reorganization under section 368(a)(1)(F)--
(1) Mere change--(i) In general. To qualify as a reorganization under 
section 368(a)(1)(F), a transaction must result in a mere change in 
identity, form, or place of organization of one corporation (``mere 
change''). A transaction that involves an actual or deemed transfer is 
a mere change only if--
    (A) All the stock of the resulting corporation, including stock 
issued before the transfer, is issued in respect of stock of the 
transferring corporation;
    (B) There is no change in the ownership of the corporation in the 
transaction, except a change that has no effect other than that of a 
redemption of less than all the shares of the corporation;
    (C) The transferring corporation completely liquidates in the 
transaction; and
    (D) The resulting corporation does not hold any property or have 
any tax attributes (including those specified in

[[Page 49839]]

section 381(c)) immediately before the transfer.
    (ii) Exceptions and special rules--(A) Transferring corporation. 
Legal dissolution of the transferring corporation is not required, and 
the mere retention of a nominal amount of assets for the sole purpose 
of preserving the corporation's legal existence will not disqualify the 
transaction as a mere change.
    (B) Resulting corporation. A transaction will not fail to be a mere 
change solely because the resulting corporation, to facilitate its 
organization, issues a nominal amount of stock other than in respect of 
stock of the transferring corporation. At the time of or before the 
transfer, the resulting corporation may hold or have held a nominal 
amount of assets to facilitate its organization or preserve its 
existence as a corporation, and may have tax attributes related to 
holding such assets. Moreover, the resulting corporation may hold the 
proceeds of borrowings undertaken in connection with the transaction.
    (2) Non-application of continuity of interest and continuity of 
business enterprise requirements. A continuity of the business 
enterprise and a continuity of interest are not required for a 
transaction to qualify as a reorganization under section 368(a)(1)(F). 
See Sec.  1.368-1(b).
    (3) Related transactions--(i) Series of transactions. A series of 
related transactions that together result in a mere change may qualify 
as a reorganization under section 368(a)(1)(F).
    (ii) Mere change within a larger transaction. A reorganization 
under section 368(a)(1)(F) may occur within a larger transaction that 
effects more than a mere change. Related events that precede or follow 
the transaction or series of transactions that constitutes a mere 
change will not cause that transaction or series of transactions to 
fail to qualify as a reorganization under section 368(a)(1)(F). 
Qualification of the mere change as a reorganization under section 
368(a)(1)(F) will not alter the treatment of the larger transaction.
    (4) Treatment of distributions. If a shareholder receives money or 
other property (including in exchange for its shares) from the 
transferring or resulting corporation in a transaction that constitutes 
a reorganization under section 368(a)(1)(F), the money or other 
property is treated as distributed by the transferring corporation 
immediately before the transaction, and section 356(a) does not apply 
to such distribution. See, e.g., Sec.  1.301-1(l).
    (5) Examples. The following examples illustrate the application of 
this paragraph (m). In all examples, assume that each transaction is 
entered into for a valid business purpose and that all corporations are 
domestic corporations, unless stated otherwise. The examples are as 
follows:

    Example 1. C owns all of the stock of W, a State A corporation. 
The net value of W's assets and liabilities is $1,000,000. V, a 
State B corporation, seeks to acquire the assets of W. To effect the 
acquisition, V and W enter into an agreement under which V will 
contribute $1,000,000 to U, a newly formed corporation of which V is 
the sole shareholder, and W will merge into U. In the merger, C 
surrenders his W stock in exchange for the $1,000,000 V contributed 
to U. After the merger, U holds all of the assets and liabilities of 
W. However, the U stock is not issued in respect of the W stock as 
required by paragraph (m)(1)(i)(A) of this section, and the 
transaction results in a change in the ownership of W that has an 
effect other than that of a redemption of some of the W shares in 
violation of paragraph (m)(1)(i)(B) of this section. Therefore, the 
merger of W into U is not a mere change and does not qualify as a 
reorganization under section 368(a)(1)(F).
    Example 2.  A and B own 75 and 25 percent, respectively, of the 
stock of X, a State A corporation. The management of X determines 
that it would be in the best interest of X to reorganize under the 
laws of State B. Accordingly, X forms Y, a State B corporation, and 
X and Y enter into an agreement under which X will merge into Y. A 
does not wish to own stock in Y. In the merger, A surrenders her X 
stock in exchange for cash from X from X's cash reserves, and B 
exchanges all of his X stock for all the stock of Y. Without regard 
to A's surrender of her stock in X, the merger of X into Y is a mere 
change of X. The change in ownership caused by A's surrender of her 
stock in X has no effect other than that of a redemption of less 
than all the X shares as described in paragraph (m)(1)(i)(B) of this 
section. Therefore, the merger of X into Y is a mere change and 
qualifies as a reorganization under section 368(a)(1)(F).
    Example 3. D owns all of the stock of S, a Country A 
corporation. The management of S determines that it would be in the 
best interest of S to reorganize under the laws of Country B. Under 
Country B law, a corporation must have at least two shareholders to 
enjoy limited liability. D is advised by a Country B attorney that 
the new corporation should issue one percent of its stock to a 
shareholder that is not D's nominee to assure satisfaction of the 
two-shareholder requirement. As part of an integrated plan, E 
organizes T, a Country B corporation with 1,000 shares of common 
stock authorized, and contributes cash to T in exchange for ten of 
the common shares. S then merges into T under the laws of Country A 
and Country B. Pursuant to the plan of merger, D surrenders his 
shares of stock in S in exchange for 990 shares of T common stock. 
Without regard to the prior issuance of T stock to E, the merger of 
S into T is a mere change of S. The ten shares of stock issued to E 
not in respect of the S stock are nominal and used to facilitate the 
organization of T within the meaning of paragraph (m)(1)(ii)(B) of 
this section. Therefore, the issuance of this stock to a new 
shareholder does not cause the merger of S into T to fail to be a 
mere change. Accordingly, the merger is a reorganization under 
section 368(a)(1)(F).
    Example 4. A owns all of the stock of H, a corporation that owns 
all of the stock of S, a corporation engaged in a manufacturing 
business. H has owned the stock of S for many years. H owns no 
assets other than the stock of S. A decides to eliminate the holding 
company structure by merging H into S. Because it operates a 
manufacturing business, the resulting corporation, S, holds property 
and has tax attributes immediately before the transfer. Therefore, 
under paragraph (m)(1)(i)(D) of this section, the merger of H into S 
is not a mere change and does not qualify as a reorganization under 
section 368(a)(1)(F). The same result would occur if, instead of H 
merging into S, S merged into H.
    Example 5. Corporation P owns all of the stock of S1, a State X 
corporation. The management of P determines that it would be in the 
best interest of S1 to change its place of incorporation to State Y. 
Accordingly, under an integrated plan, P forms S2, a new State Y 
corporation, P contributes the S1 stock to S2, and S1 merges into S2 
under the laws of State X and State Y. Under paragraph (m)(3)(i) of 
this section, a series of transactions that together result in a 
mere change of one corporation may qualify as a reorganization under 
section 368(a)(1)(F). The contribution of S1 stock to S2 and the 
merger of S1 into S2 together constitute a mere change of S1. 
Therefore, the transaction qualifies as a reorganization under 
section 368(a)(1)(F). S1 is treated as transferring its assets to S2 
in exchange for the S2 stock and distributing the S2 stock to P in 
exchange for P's S1 stock.
    Example 6. Corporation P owns all of the stock of S, a State X 
corporation. The management of P determines that it would be in the 
best interest of S to change its place of incorporation to State Y. 
Accordingly, P forms New S, a State Y corporation. S then merges 
into New S under the laws of State X and State Y. As part of the 
same plan, P sells all of its stock in New S to an unrelated party. 
Without regard to the sale of New S stock, the merger of S into New 
S is a mere change within the meaning of paragraph (m)(1) of this 
section. Under paragraph (m)(3)(ii) of this section, related events 
that precede or follow the transaction or series of transactions 
that constitute a mere change do not cause that transaction to fail 
to qualify as a reorganization under section 368(a)(1)(F). 
Therefore, the sale of the New S stock is disregarded in determining 
whether the merger of S into New S is a mere change. Accordingly, 
the merger of S into New S is a reorganization under section 
368(a)(1)(F).
    Example 7. A owns all of the stock of T and none of the stock of 
P. P owns all of the stock of S. T and S are State M corporations 
engaged in manufacturing businesses. The following transactions 
occur pursuant to a single plan. First, T merges into S with A 
receiving solely stock in P. Second, P

[[Page 49840]]

changes its state of incorporation to State N by merging into newly 
organized New P under the laws of State M and State N. Third, P 
redeems all the stock issued to A in respect of his T stock for 
cash. Without regard to the other steps, the merger of T into S 
qualifies as a reorganization under section 368(a)(1)(A) by reason 
of section 368(a)(2)(D). Without regard to the other steps, the 
merger of P into New P qualifies as a reorganization under section 
368(a)(1)(F). Under paragraph (m)(3)(ii) of this section, related 
events that precede or follow the transaction or series of 
transactions that constitute a mere change do not cause that 
transaction to fail to qualify as a reorganization under section 
368(a)(1)(F). Therefore, the merger of P into New P qualifies as a 
reorganization under section 368(a)(1)(F). However, under paragraph 
(m)(3)(ii) of this section, the qualification of the merger of P 
into New P as a reorganization under section 368(a)(1)(F) does not 
alter the tax treatment of the merger of T into S. Because the P 
shares received by A in respect of the T shares are redeemed for 
cash pursuant to the plan, the merger of T into S does not satisfy 
the continuity of interest requirement and does not qualify as a 
reorganization under section 368(a)(1)(A).
    Example 8. Corporation P owns all of the stock of S, a State A 
corporation. The management of P determines that it would be in the 
best interest of S to change its form from a State A corporation to 
a State A limited partnership. Accordingly, P contributes one 
percent of the S stock to newly formed LLC, a limited liability 
company, in exchange for all of the membership interests in LLC. 
Under Sec.  301.7701-3 of this chapter, LLC is disregarded as an 
entity separate from its owner, P. Under a State A statute, S 
converts to a State A limited partnership. In the conversion, P's 
interest as a 99 percent shareholder of S is converted into a 99 
percent limited partner interest, and LLC's interest as a one 
percent shareholder of S is converted into a one percent general 
partner interest. S then elects, under Sec.  301.7701-3(c), to be 
classified as a corporation for federal income tax purposes, 
effective on the date of the conversion. The conversion of S from a 
State A corporation to a State A limited partnership, together with 
the election to treat S as a corporation for federal tax purposes, 
constitutes a mere change and is a reorganization under section 
368(a)(1)(F).

    (6) Effective Date. This paragraph (m) applies to transactions 
occurring on or after [the date these regulations are published as 
final regulations in the Federal Register].

Linda M. Kroening,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-18476 Filed 8-11-04; 8:45 am]
BILLING CODE 4830-01-P