[Federal Register Volume 71, Number 243 (Tuesday, December 19, 2006)]
[Rules and Regulations]
[Pages 75879-75882]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-21565]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9303]
RIN 1545-BF84


Corporate Reorganizations; Distributions Under Sections 
368(a)(1)(D) and 354(b)(1)(B)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations under section 368 
of the Internal Revenue Code of 1986 (Code). The temporary regulations 
provide guidance regarding the qualification of certain transactions as 
reorganizations described in section 368(a)(1)(D) where no stock and/or 
securities of the acquiring corporation is issued and distributed in 
the transaction. These regulations affect corporations engaging in such 
transactions 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 December 19, 
2006.
    Applicability Date: For dates of applicability, see Sec.  1.368-
2T(l)(4)(i).

FOR FURTHER INFORMATION CONTACT: Bruce A. Decker at (202) 622-7550 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    The IRS and Treasury Department have received requests for 
immediate guidance regarding whether certain acquisitive transactions 
can qualify as reorganizations described in section 368(a)(1)(D) where 
no stock of the transferee corporation is issued and distributed in the 
transaction. Currently, the IRS and Treasury Department are undertaking 
a broad study of issues related to acquisitive section 368(a)(1)(D) 
reorganizations. In the interest of efficient tax administration, the 
IRS and Treasury Department are issuing these temporary regulations to 
provide the requested certainty for taxpayers regarding these 
acquisitive transactions pending the broader study of issues. Although 
these rules also are being proposed in the Proposed Rules section in 
this issue of the Federal Register, the IRS and Treasury Department 
contemplate that the proposed rules may change upon completion of this 
broader study and the comments received.
    The Code provides general nonrecognition treatment for 
reorganizations specifically described in section 368(a). Section 
368(a)(1)(D) describes as a reorganization a transfer by a corporation 
(transferor corporation) of all or a part of its assets to another 
corporation (transferee corporation) if, immediately after the 
transfer, the transferor corporation or one or more of its shareholders 
(including persons who were shareholders immediately before the 
transfer), or any combination thereof, is in control of the transferee 
corporation; but only if stock or securities of the controlled 
corporation are distributed in pursuance of a plan of reorganization in 
a transaction that qualifies under section 354, 355, or 356.
    Section 354(a)(1) provides that no gain or loss shall be recognized 
if stock or securities in a corporation a party to a reorganization 
are, in pursuance of the plan of reorganization, exchanged solely for 
stock or securities in such corporation or in another corporation a 
party to the reorganization. Section 354(b)(1)(B) provides that section 
354(a)(1) shall not apply to an exchange in pursuance of a plan of 
reorganization described in section 368(a)(1)(D) unless the transferee 
corporation acquires substantially all of the assets of the transferor 
corporation, and the stock, securities, and other properties received 
by such transferor corporation, as well as the other properties of such 
transferor corporation, are distributed in pursuance of the plan of 
reorganization.
    Further, section 356 provides that if section 354 or 355 would 
apply to an exchange but for the fact that the property received in the 
exchange consists not only of property permitted by section 354 or 355 
without the recognition of gain or loss but also of other property or 
money, then the gain, if any, to the recipient shall be recognized, but 
not in excess of the amount of money and fair market value of such 
other property. Accordingly, in the case of an acquisitive transaction, 
there can only be a distribution to which section 354 or 356 applies 
where the target shareholder(s) receive at least some property 
permitted to be received by section 354.
    Notwithstanding the requirement in section 368(a)(1)(D) that 
``stock or securities of the corporation to which the assets are 
transferred are distributed in a transaction which qualifies under 
section 354, 355, or 356'', the IRS and the courts have not required 
the actual issuance and distribution of stock and/or securities of the 
transferee corporation in circumstances where the same person or 
persons own all the stock of the transferor corporation and the 
transferee corporation. In such circumstances, the IRS and the courts 
have viewed an issuance of stock to be

[[Page 75880]]

a ``meaningless gesture'' not mandated by sections 368(a)(1)(D) and 
354(b).
    In Revenue Ruling 70-240, 1970-1 CB 81 (see Sec.  601.601(d)(2) of 
this chapter), B owned all of the stock of both corporation X and 
corporation Y. X sold its operating assets to Y for $34x dollars, which 
represented the fair market value of X's assets. X had $33x of other 
assets, consisting generally of cash, accounts receivables, and 
investments in stocks and bonds, so that the assets sold by X to Y 
constituted approximately 51% of X's total assets. Following the sale 
to Y, X paid its debts, which amounted to $38x, and then liquidated, 
distributing $29x to B, while Y continued to conduct the business 
formerly operated by X. The IRS concluded that ``although no actual 
shares of the stock of Y were distributed to B as a result of the 
transaction, B is treated as having received Y stock since he already 
owned all the stock of Y.'' Accordingly, the IRS held that the sale of 
the operating assets by X to Y, followed by the liquidation and 
distribution of X's assets to B, resulted in a reorganization under 
section 368(a)(1)(D) and a distribution under section 356(a), despite 
the absence of an actual issuance and distribution of Y stock.
    When considering a similar transaction between two corporations 
owned in identical proportions by a husband and wife, the Tax Court 
concluded that there was in substance an exchange of stock which meets 
the requirements of section 354 and 356, and stated, ``[t]he issuance 
of further stock would have been a meaningless gesture, and we cannot 
conclude that the statute requires such a vain act.'' James Armour, 
Inc. v. Commissioner, 43 T.C. 295, 307 (1964). See also Wilson v. 
Commissioner, 46 T.C. 334 (1966). The IRS has also applied this 
meaningless gesture doctrine to circumstances where the transferor 
corporation and the transferee corporation are wholly owned by a single 
party directly or indirectly through subsidiaries, or as a result of 
family attribution pursuant to section 318(a)(1).
    However, the application of this meaningless gesture doctrine has 
generally been limited to situations in which there is identical 
shareholder identity and proportionality of interest in the transferor 
corporation and the transferee corporation. For example, in Warsaw 
Photographic Associates, Inc. v. Commissioner, 84 T.C. 21 (1985), there 
was no issuance of stock by the transferee corporation to the 
transferor corporation, and the stock ownership in the two corporations 
was not identical. On the basis of these facts, the Tax Court concluded 
that the distribution of stock would not be a mere formality and 
refused to apply the meaningless gesture doctrine. Accordingly, the 
transaction failed to qualify as a section 368(a)(1)(D) reorganization 
because there was no distribution of stock of the transferee 
corporation under sections 368(a)(1)(D) and 354(b)(1)(B).

Explanation of Provisions

    These temporary regulations provide guidance regarding the 
circumstances in which the distribution requirement under sections 
368(a)(1)(D) and 354(b)(1)(B) is deemed satisfied despite the fact that 
no stock and/or securities are actually issued in a transaction 
otherwise described in section 368(a)(1)(D). In cases where the same 
person or persons own, directly or indirectly, all of the stock of the 
transferor and transferee corporations in identical proportions, these 
temporary regulations provide that the distribution requirement under 
sections 368(a)(1)(D) and 354(b)(1)(B) will be treated as satisfied 
even though no stock is actually issued in the transaction. For 
purposes of determining whether the same person or persons own all of 
the stock of the transferor and transferee corporations in identical 
proportions, these temporary regulations provide that an individual and 
all members of his family that have a relationship described in section 
318(a)(1) will be treated as one individual.
    The temporary regulations also provide that the distribution 
requirement under sections 368(a)(1)(D) and 354(b)(1)(B) will be 
treated as satisfied in the absence of any issuance of stock and/or 
securities where there is a de minimis variation in shareholder 
identity or proportionality of ownership in the transferor and 
transferee corporations. Further, stock described in section 1504(a)(4) 
is disregarded for purposes of determining whether the same person or 
persons own all of the stock of the transferor and transferee 
corporations in identical proportions.
    Under these temporary regulations, in each case where it is 
determined that the same person or persons own all of the stock of the 
transferor and transferee corporations in identical proportions, a 
nominal share of stock of the transferee corporation will be deemed 
issued in addition to the actual consideration exchanged in the 
transaction. The nominal share of stock in the transferee corporation 
will then be deemed distributed by the transferor corporation to its 
shareholders and, in appropriate circumstances, further transferred to 
the extent necessary to reflect the actual ownership of the transferor 
and transferee corporations.
    These temporary regulations are being issued in response to 
requests for immediate guidance regarding whether transactions 
otherwise described in section 368(a)(1)(D) qualify as reorganizations 
where no stock and/or securities of the transferee corporation are 
actually issued in the transaction. The IRS and Treasury Department 
currently are undertaking a broad study of issues related to 
acquisitive reorganizations, including issues addressed by these 
temporary regulations. The IRS and Treasury Department are issuing 
these temporary regulations in order to provide certainty for taxpayers 
while these issues are under study.
    The IRS and Treasury Department believe that these temporary 
regulations are a reasonable interpretation of section 368(a)(1)(D) and 
section 354(b)(1)(B) given the history of those provisions and the 
manner in which they have previously been interpreted by the courts and 
the IRS. However, no inference should be drawn from these temporary 
regulations regarding the law prior to the effective date of these 
temporary regulations. In the Proposed Rules section in this issue of 
the Federal Register, the IRS and Treasury Department are requesting 
comments on several issues relating to acquisitive reorganizations 
described in section 368(a)(1)(D).
    In addition, the IRS and Treasury Department note that these 
temporary regulations do not expressly implement Prop. Reg. Sec.  
1.368-1(f)(4) (FR 70, 11903-11912), which provides that there must be 
an exchange of net value except in the case of a transaction that would 
otherwise qualify as a reorganization described in section 
368(a)(1)(D), provided that the fair market value of the property 
transferred to the acquiring corporation by the target corporation 
exceeds the amount of liabilities of the target corporation immediately 
before the exchange (including any liabilities cancelled, extinguished, 
or assumed in connection with the exchange), and the fair market value 
of the assets of the acquiring corporation equals or exceeds the amount 
of its liabilities immediately after the exchange. The solvency 
requirement remains the IRS's and Treasury Department's proposal but 
the IRS and Treasury Department continue to consider whether this 
solvency requirement should be applied to the transactions described in 
these temporary regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in

[[Page 75881]]

Executive Order 12866. Therefore, a regulatory assessment is not 
required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. For the applicability of the Regulatory Flexibility 
Act, please refer to the cross-reference notice of proposed rulemaking 
published elsewhere in this Federal Register. Pursuant to section 
7805(f) of the Internal Revenue Code, these regulations were submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Bruce A. Decker of the 
Office of the Associate Chief Counsel (Corporate).

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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 1.368-2 is amended by adding paragraph (l) to read 
as follows:


Sec.  1.368-2  Definition of terms.

* * * * *
    (l) [Reserved]. For further guidance, see Sec.  1.368-2T(l).
    Par. 3. Section 1.368-2T is added to read as follows:


Sec.  1.368-2T  Definition of terms (temporary).

    (a) through (k) [Reserved]. For further guidance, see Sec.  1.368-
2(a) through (k).
    (l) Certain transactions treated as reorganizations described in 
section 368(a)(1)(D)--(1) General rule. In order to qualify as a 
reorganization under section 368(a)(1)(D), a corporation (transferor 
corporation) must transfer all or part of its assets to another 
corporation (transferee corporation) and immediately after the transfer 
the transferor corporation, or one or more of its shareholders 
(including persons who were shareholders immediately before the 
transfer), or any combination thereof, must be in control of the 
transferee corporation; but only if, in pursuance of the plan, stock or 
securities of the transferee are distributed in a transaction which 
qualifies under section 354, 355, or 356.
    (2) Distribution requirement--(i) In general. For purposes of 
paragraph (l)(1) of this section, a transaction otherwise described in 
section 368(a)(1)(D) will be treated as satisfying the requirements of 
sections 368(a)(1)(D) and 354(b)(1)(B) notwithstanding that there is no 
actual issuance of stock and/or securities of the transferee 
corporation if the same person or persons own, directly or indirectly, 
all of the stock of the transferor and transferee corporations in 
identical proportions. In such cases, the transferee corporation will 
be deemed to issue a nominal share of stock to the transferor 
corporation in addition to the actual consideration exchanged for the 
transferor corporation's assets. The nominal share of stock in the 
transferee corporation will then be deemed distributed by the 
transferor corporation to its shareholders and, where appropriate, 
further transferred through chains of ownership to the extent necessary 
to reflect the actual ownership of the transferor and transferee 
corporations.
    (ii) Attribution. For purposes of paragraph (l)(2)(i) of this 
section, ownership of stock will be determined by applying the 
principles of section 318(a)(2) without regard to the 50 percent 
limitation in section 318(a)(2)(C). In addition, an individual and all 
members of his family described in section 318(a)(1) shall be treated 
as one individual.
    (iii) De minimis variations in ownership and certain stock not 
taken into account. For purposes of paragraph (l)(2)(i) of this 
section, the same person or persons will be treated as owning, directly 
or indirectly, all of the stock of the transferor and transferee 
corporations in identical proportions notwithstanding the fact that 
there is a de minimis variation in shareholder identity or 
proportionality of ownership. Additionally, for purposes of paragraph 
(l)(2)(i) of this section, stock described in section 1504(a)(4) is not 
taken into account.
    (3) Examples. The following examples illustrate the principles of 
paragraph (l) of this section. For purposes of these examples, each of 
A, B, C, and D is an individual, T is the acquired corporation, S is 
the acquiring corporation, P is the parent corporation, and each of S1, 
S2, S3, and S4 is a direct or indirect subsidiary of P. Further, all of 
the requirements of section 368(a)(1)(D) other than the requirement 
that stock or securities be distributed in a transaction to which 
section 354 or 356 applies are satisfied. The examples are as follows:

    Example 1. A owns all the stock of T and S. The T stock has a 
fair market value of $100x. T sells all of its assets to S in 
exchange for $100x of cash and immediately liquidates. Because there 
is complete shareholder identity and proportionality of ownership in 
T and S, under paragraph (l)(2)(i) of this section, the requirements 
of sections 368(a)(1)(D) and 354(b)(1)(B) are treated as satisfied 
notwithstanding the fact that no S stock is issued. Pursuant to 
paragraph (l)(2)(i) of this section, S will be deemed to issue a 
nominal share of S stock to T in addition to the $100x of cash 
actually exchanged for the T assets, and T will be deemed to 
distribute all such consideration to A. The transaction qualifies as 
a reorganization described in section 368(a)(1)(D).

    Example 2. The facts are the same as in Example 1 except that C, 
A's son, owns all of the stock of S. Under paragraph (l)(2)(ii) of 
this section, A and C are treated as one individual. Accordingly, 
there is complete shareholder identity and proportionality of 
ownership in T and S. Therefore, under paragraph (l)(2)(i) of this 
section, the requirements of sections 368(a)(1)(D) and 354(b)(1)(B) 
are treated as satisfied notwithstanding the fact that no S stock is 
issued. Pursuant to paragraph (l)(2)(i) of this section, S will be 
deemed to issue a nominal share of S stock to T in addition to the 
$100x of cash actually exchanged for the T assets, and T will be 
deemed to distribute all such consideration to A. A will be deemed 
to transfer the nominal share of S stock to C. The transaction 
qualifies as a reorganization described in section 368(a)(1)(D).

    Example 3. P owns all of the stock of S1 and S2. S1 owns all of 
the stock of S3, which owns all of the stock of T. S2 owns all of 
the stock of S4, which owns all of the stock of S. The T stock has a 
fair market value of $70x. T sells all of its assets to S in 
exchange for $70x of cash and immediately liquidates. Under 
paragraph (l)(2)(ii) of this section, there is indirect, complete 
shareholder identity and proportionality of ownership in T and S. 
Accordingly, the requirements of sections 368(a)(1)(D) and 
354(b)(1)(B) are treated as satisfied notwithstanding the fact that 
no S stock is issued. Pursuant to paragraph (l)(2)(i) of this 
section, S will be deemed to issue a nominal share of S stock to T 
in addition to the $70x of cash actually exchanged for the T assets, 
and T will be deemed to distribute all such consideration to S3. S3 
will be deemed to distribute the nominal share of S stock to S1, 
which, in turn, will be deemed to distribute the nominal share of S 
stock to P. P will be deemed to transfer the nominal share of S 
stock to S2, which, in turn, will be deemed to transfer such share 
of S stock to S4. The transaction qualifies as a reorganization 
described in section 368(a)(1)(D).

    Example 4. A, B, and C own 34%, 33%, and 33%, respectively, of 
the stock of T. The T stock has a fair market value of $100x. A, B, 
and C each own 33% of the stock of S. D owns the remaining 1% of the 
stock of S. T sells all of its assets to S in exchange for $100x of 
cash and immediately liquidates. For purposes of determining whether 
the distribution requirement of sections

[[Page 75882]]

368(a)(1)(D) and 354(b)(1)(B) is met, under paragraph (l)(2)(iii) of 
this section, D's ownership of a de minimis amount of stock of S is 
disregarded and the transaction is treated as if there is complete 
shareholder identity and proportionality of ownership in T and S. 
Because there is complete shareholder identity and proportionality 
of ownership in T and S, under paragraph (l)(2)(i) of this section, 
the requirements of sections 368(a)(1)(D) and 354(b)(1)(B) are 
treated as satisfied notwithstanding the fact that no S stock is 
issued. Pursuant to paragraph (l)(2)(i) of this section, S will be 
deemed to issue a nominal share of S stock to T in addition to the 
$100x of cash actually exchanged for the T assets, T will be deemed 
to distribute all such consideration to A, B, and C, and the nominal 
S stock will be deemed transferred among the S shareholders to the 
extent necessary to reflect their actual ownership of S. The 
transaction qualifies as a reorganization described in section 
368(a)(1)(D).

    Example 5. The facts are the same as in Example 4 except that A, 
B, and C own 34%, 33%, and 33%, respectively, of the common stock of 
T and S. D owns preferred stock in S described in section 
1504(a)(4). For purposes of determining whether the distribution 
requirement of sections 368(a)(1)(D) and 354(b)(1)(B) is met, under 
paragraph (l)(2)(iii) of this section, D's ownership of S stock 
described in section 1504(a)(4) is ignored and the transaction is 
treated as if there is complete shareholder identity and 
proportionality of ownership in T and S. Because there is complete 
shareholder identity and proportionality of ownership in T and S, 
under paragraph (l)(2)(i) of this section, the requirements of 
sections 368(a)(1)(D) and 354(b)(1)(B) are treated as satisfied 
notwithstanding the fact that no S stock is issued. Pursuant to 
paragraph (l)(2)(i) of this section, S will be deemed to issue a 
nominal share of S stock to T in addition to the $100x of cash 
actually exchanged for the T assets, and T will be deemed to 
distribute all such consideration to A, B, and C. The transaction 
qualifies as a reorganization described in section 368(a)(1)(D).

    Example 6. A and B each own 50% of the stock of T. The T stock 
has a fair market value of $100x. B and C own 90% and 10%, 
respectively, of the stock of S. T sells all of its assets to S in 
exchange for $100x of cash and immediately liquidates. Because 
complete shareholder identity and proportionality of ownership in T 
and S does not exist, paragraph (l)(2)(i) of this section does not 
apply. The requirements of sections 368(a)(1)(D) and 354(b)(1)(B) 
are not satisfied, and the transaction does not qualify as a 
reorganization described in section 368(a)(1)(D).

    (4) Effective date--(i) In general. This section applies to 
transactions occurring on or after March 19, 2007, except that they do 
not apply to any transaction occurring pursuant to a written agreement 
which is binding before December 19, 2006, and at all times thereafter. 
A taxpayer may apply the provisions of these temporary regulations to 
transactions occurring before March 19, 2007. However, the transferor 
corporation, the transferee corporation, any direct or indirect 
transferee of transferred basis property from either of the foregoing, 
and any shareholder of the transferor or transferee corporation may not 
apply the provisions of these temporary regulations unless all such 
taxpayers apply the provisions of the temporary regulations.
    (ii) Expiration. This section expires on or before December 18, 
2009.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: December 6, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury, (Tax Policy).
 [FR Doc. E6-21565 Filed 12-18-06; 8:45 am]
BILLING CODE 4830-01-P