[Federal Register Volume 71, Number 128 (Wednesday, July 5, 2006)]
[Rules and Regulations]
[Pages 38074-38075]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-10253]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9271]
RIN 1545-BB68


Effect of Elections in Certain Multi-Step Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that give effect to 
section 338(h)(10) elections in certain multi-step transactions. These 
final regulations are necessary in order to provide taxpayers with 
guidance regarding the validity of certain elections made under section 
338(h)(10). These final regulations affect corporations and their 
shareholders.

DATES: Effective Date: These regulations are effective July 5, 2006.
    Applicability Date: For dates of applicability, see Sec.  
1.338(h)(10)-1(h) of these regulations.

FOR FURTHER INFORMATION CONTACT: Daniel F. Heins, at (202) 622-7930 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    The IRS published temporary regulations (TD 9071) in the Federal 
Register on July 9, 2003 (68 FR 40766) (the temporary regulations), 
along with a notice of proposed rulemaking by cross-reference to the 
temporary regulations (REG-143679-02) (the proposed regulations). These 
temporary regulations provide, 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). For rules about the operation of the step transaction 
doctrine and the relationship between section 338 and the 
reorganization provisions when a section 338 election is not made, see 
Sec.  1.338-3(d). See also Rev. Rul. 90-95 (1990-2 CB 67). See Sec.  
601.601(d)(2).
    No public hearing regarding the proposed regulations was requested 
or held. The IRS received written and electronic comments regarding the 
proposed regulations. After consideration of the comments, the proposed 
regulations are adopted by this Treasury decision. The most significant 
comments received with respect to the proposed regulations are 
discussed in this preamble.

Explanation of Provisions

A. Section 338(g) Elections

    Some commentators recommend that the final regulations allow 
section 338(g) elections, as well as section 338(h)(10) elections, to 
turn off the step transaction doctrine in a multi-step transaction that 
constitutes a reorganization under section 368(a). Although a section 
338(g) election is made by the purchasing corporation and the 
shareholders of the target corporation (target) do not consent to the 
election, one commentator states that the IRS will not be subject to 
whipsaw if the IRS provides regulations requiring the shareholders of 
the acquired corporation to treat the transaction consistently with the 
acquiring corporation's election, rather than as a reorganization under 
section 368(a).
    The final regulations do not adopt the commentators' 
recommendation, and continue to turn off the step transaction doctrine 
only in the case of section 338(h)(10) elections. Extending the final 
regulations to section 338(g) elections would allow the acquiring 
corporation to unilaterally elect to treat the transaction, for all 
parties, as other than a reorganization under section 368(a). In light 
of potential whipsaw and other concerns, the final regulations continue 
to apply only to section 338(h)(10) elections, not section 338(g) 
elections.

B. Corporate Purchaser Requirement

    One commentator suggests that Sec.  1.338-3(b) be amended to 
clarify under what circumstances a corporation will be considered, for 
tax purposes, to have purchased the stock of target pursuant to section 
338(d)(3).
    Under Sec.  1.338-3(b), an individual cannot make a qualified stock 
purchase of target. If an individual forms a corporation (new P) to 
acquire target stock, new P can make a qualified stock purchase of 
target if new P is considered, for tax purposes, to purchase the target 
stock. Facts that may indicate that new P does not purchase the target 
stock include new P's merging downstream into target, liquidating, or 
otherwise disposing of the target stock following the purported 
qualified stock purchase.
    The IRS and Treasury Department are continuing to study whether any 
amendments to the portion of the regulations under section 338 related 
to the corporate purchaser requirement are appropriate.

Special Analyses

    It has been determined that this Treasury decision is 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 economic 
impact on a substantial amount of small entities. The number of 
corporations affected is limited because section 338(h)(10) elections 
are made only in extraordinary circumstances, the sale of a business. 
Furthermore, these

[[Page 38075]]

regulations only affect transactions in which the stock of the 
acquiring corporation is a significant part of the consideration. 
Accordingly, a regulatory flexibility analysis does not apply. Since 
these final regulations make no changes to the current effective 
temporary regulations, a delayed effective date pursuant to 5 U.S.C. 
553(d)(1) and (3) is not necessary. Pursuant to section 7805(f) of the 
Code, the notice of proposed rulemaking preceding these regulations was 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Daniel F. Heins of the 
Office of the Associate Chief Counsel (Corporate).

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 is amended by adding an 
entry in numerical order to read, in part, as follows:

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


0
Par 2. Sec.  1.338-3 is amended by revising the last sentence in 
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)-1(c)(2) for special rules 
concerning section 338(h)(10) elections in certain multi-step 
transactions.


0
Par. 3. Sec.  1.338(h)(10)-1 is amended as follows:
0
1. Paragraph (c)(2) is revised.
0
2. Paragraph (e) Examples 11 through 14 and paragraph (h) are added.
    The revision and additions read as follows:


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

* * * * *
    (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).
* * * * *
    (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 Sec.  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 described in 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 described in section 368(a).
* * * * *
    (h) Effective date. This section is applicable to stock 
acquisitions occurring on or after July 5, 2006. For stock acquisitions 
occurring before July 5, 2006, see Sec.  1.338(h)(10)-1T as contained 
in the edition of 26 CFR part 1, revised as of April 1, 2006.
* * * * *


Sec.  1.338(h)(10)-1T  [Removed]

0
Par. 4. Section 1.338(h)(10)-1T is removed.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: June 20, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury (Tax Policy).

[FR Doc. E6-10253 Filed 7-3-06; 8:45 am]
BILLING CODE 4830-01-P