[Federal Register Volume 72, Number 206 (Thursday, October 25, 2007)]
[Rules and Regulations]
[Pages 60552-60558]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-20863]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9361]
RIN 1545-BD56


Corporate Reorganizations; Transfers of Assets or Stock Following 
a Reorganization

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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

SUMMARY: This document contains final regulations that provide guidance 
regarding the effect of certain transfers of assets or stock on the 
continuing qualification of transactions as reorganizations under 
section 368(a). This document also contains final regulations that 
provide guidance on the continuity of business enterprise requirement 
and the definitions of ``qualified group'' and ``party to a 
reorganization.'' These regulations affect corporations and their 
shareholders.

DATES: Effective Date: These regulations are effective October 25, 
2007.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.368-1(d)(4)(iv), 1.368-1(d)(5), 1.368-2(f), 1.368-2(j)(3)(iv), and 
1.368-2(k)(3).

FOR FURTHER INFORMATION CONTACT: Mary W. Lyons, at (202) 622-7930 (not 
a toll free number).

SUPPLEMENTARY INFORMATION:

Background

    On August 18, 2004, the IRS and Treasury Department published a 
notice of proposed rulemaking (REG-130863-04) in the Federal Register 
(69 FR 51209) proposing regulations that would provide guidance 
regarding the effect of certain transfers of assets or stock on the 
qualification of a transaction as a reorganization under section 368(a) 
(the proposed regulations). The proposed regulations also included 
amendments to the continuity of business enterprise (COBE) regulations 
under Sec.  1.368-1(d) and the definition of a ``party to a 
reorganization'' under Sec.  1.368-2(f). The proposed regulations 
replaced an earlier proposal, dated March 2, 2004 (REG-165579-02) and 
published in the Federal Register (69 FR 9771), which was withdrawn. No 
public hearing regarding the proposed regulations was requested or 
held. However, a number of comments were received, the most significant 
of which are discussed in this preamble.
    The theory underlying the tax-free treatment afforded 
reorganizations described in section 368 is that such transactions 
``effect only a readjustment of continuing interest in property under 
modified corporate forms.'' See Sec.  1.368-1(b). The continuity of 
interest and continuity of business enterprise requirements are 
expressions of this principle. Earlier cases also implemented this 
principle through a concept that later became known as the prohibition 
of ``remote'' continuity of interest. Commonly viewed as arising out of 
the Supreme Court decisions in Groman v. Commissioner, 302 U.S. 82 
(1937), and Helvering v. Bashford, 302 U.S. 454 (1938), remote 
continuity of interest focuses on the link between the former target 
corporation (T)

[[Page 60553]]

shareholders and the T business assets following the reorganization.
    Since the Supreme Court's decisions in Groman and Bashford, it has 
been recognized that other transactions, including transactions 
involving the same level of ``remoteness'' as addressed in the Groman 
and Bashford decisions, adequately preserve the link between the former 
T shareholders and the T business assets and therefore constitute mere 
readjustments of continuing interests. Accordingly, legislative, 
regulatory, and administrative developments have provided significantly 
more flexibility regarding transfers of stock and assets following 
otherwise tax-free reorganizations where this link is adequately 
maintained. For example, Congress enacted section 368(a)(2)(D) to 
expressly allow a triangular reorganization by permitting a controlled 
subsidiary to use its parent's stock as consideration in a merger. 
Similarly, the term ``party to a reorganization'' was broadened to 
include the parent in such a case.
    In addition, Congress enacted section 368(a)(2)(C), which provides 
that a transaction otherwise qualifying under section 368(a)(1)(A), 
(B), (C), or (G) (where the requirements of section 354(b) are met) is 
not disqualified where part or all of the acquired assets or stock is 
transferred to a corporation that is controlled (as defined in section 
368(c)) by the acquiring corporation. Section 1.368-2(k), as in effect 
prior to these final regulations, expanded the scope of section 
368(a)(2)(C) by permitting successive transfers of the acquired assets 
or stock to one or more corporations, provided that the transferee 
corporation was controlled in each transfer by the transferor 
corporation. Administratively, the IRS and Treasury Department have 
since interpreted section 368(a)(2)(C) and Sec.  1.368-2(k) as 
permissive rather than exclusive or restrictive, concluding that 
certain transfers not specifically described in either of those 
provisions did not disqualify the reorganization. See Rev. Rul. 2001-24 
(2001-1 CB 1290) permitting the transfer of acquiring subsidiary stock 
to a controlled subsidiary following a reorganization described in 
section 368(a)(1)(A) by reason of (a)(2)(D), and Rev. Rul. 2002-85 
(2002-2 CB 986) permitting the transfer of acquired assets to a 
controlled subsidiary following a reorganization described in section 
368(a)(1)(D).
    The current regulations do not contain separate rules addressing 
remote continuity because the IRS and Treasury Department believe that 
these issues are adequately addressed by the rules adopted to implement 
the continuity of business enterprise requirement. See TD 8760 (63 FR 
4174). Similarly, the rules relating to the continuity of business 
enterprise requirement have been broadened over the years to permit 
transactions that adequately preserve the link between the former T 
shareholders and the T business assets. Under Sec.  1.368-1(d), as in 
effect prior to these final regulations, the COBE requirement generally 
is satisfied as long as a member of the qualified group (or, in certain 
cases, a partnership) either continues T's historic business or uses a 
significant portion of T's historic business assets in a business. A 
qualified group is defined in Sec.  1.368-1(d)(4)(ii), as in effect 
prior to these final regulations, as one or more chains of corporations 
connected through stock ownership with the issuing corporation, but 
only if the issuing corporation owns directly stock meeting the 
requirements of section 368(c) in at least one of the corporations, and 
stock meeting the requirements of section 368(c) in each of the 
corporations (other than the issuing corporation) is owned directly by 
one of the other corporations.
    These final regulations continue the trend of broadening the rules 
regarding transfers of assets or stock following an otherwise tax-free 
reorganization where the transaction adequately preserves the link 
between the former T shareholders and the T business assets. 
Accordingly, the definition of a ``qualified group'' in Sec.  1.368-
1(d)(4)(ii) and the rules regarding stock or asset transfers in Sec.  
1.368-2(k) have been expanded. Conforming changes to Sec.  1.368-2(f), 
relating to the definition of ``a party to a reorganization,'' also 
have been made.

A. Continuity of Business Enterprise (COBE) Regulations

    Several commentators urged that the definition of ``qualified 
group'' under Sec.  1.368-1(d)(4)(ii) should not be restricted by the 
control requirement of section 368(c), but rather should be expanded to 
parallel the definition of an affiliated group under section 1504(a). 
The IRS and Treasury Department have declined to make this change, 
primarily because the section 368(c) definition of control is a major 
structural component underlying the statutory framework of the 
reorganization provisions. On the other hand, the IRS and Treasury 
Department have concluded that it is consistent with reorganization 
policy to expand the definition of a qualified group. Specifically, 
Sec.  1.368-1(d)(4)(ii), as revised by this Treasury decision, permits 
qualified group members to aggregate their direct stock ownership of a 
corporation in determining whether they own the requisite section 
368(c) control in such corporation (provided that the issuing 
corporation owns directly stock meeting such control requirement in at 
least one other corporation). This aggregation concept is similar to 
the one found in section 1504(a). The IRS and Treasury Department 
believe that aggregating stock ownership within the qualified group 
adequately preserves the link between the former T shareholders and the 
T business assets while further facilitating the post-acquisition 
relocation of assets and stock as necessary within the group.
    Finally, as discussed in section B.3. of this preamble, and in 
response to comments, the COBE regulations have been expanded to 
provide that if members of the qualified group own interests in a 
partnership that meets requirements equivalent to the control 
definition in section 368(c), any stock owned by such partnership is 
treated as owned by members of the qualified group. Thus, for example, 
following a reorganization under section 368(a)(1)(B), T remains a 
member of the qualified group upon a transfer of the T stock to a 
partnership in which members of the qualified group own all the 
interests. See section B.3. of this preamble. Similarly, a wholly owned 
subsidiary of a partnership in which members of the qualified group own 
all the interests will be a member of the qualified group. Accordingly, 
following a reorganization under section 368(a)(1)(A), the acquiring 
corporation may transfer the T assets to the subsidiary (either 
directly or through the partnership) without violating the COBE 
requirement.

B. Section 1.368-2(k)

    As provided in Sec.  1.368-1(a), a transaction must be evaluated 
under all relevant provisions of law, including the step transaction 
doctrine, in determining whether it qualifies as a reorganization under 
section 368(a). Section 1.368-2 provides guidance regarding whether a 
transaction satisfies the explicit statutory requirements of a 
particular reorganization. Section 1.368-2(k) generally provides that a 
transaction otherwise qualifying as a reorganization will not be 
disqualified as a result of certain subsequent transfers of assets or 
stock. The fact that a subsequent transfer of assets or stock is not 
described in Sec.  1.368-2(k) does not necessarily preclude 
reorganization qualification, but the overall transaction would then be 
subject to analysis under the step transaction doctrine.

[[Page 60554]]

    These final regulations adopt the rules of the proposed regulations 
regarding subsequent transfers of assets or stock with certain 
modifications. Section 1.368-2(k), as revised by this Treasury 
decision, generally provides that a transaction otherwise qualifying as 
a reorganization under section 368(a) shall not be disqualified or 
recharacterized as a result of one or more subsequent transfers (or 
successive transfers) of assets or stock, provided that the COBE 
requirement is satisfied and the transfer(s) qualify as 
``distributions'' or ``other transfers'' (as described in Sec.  1.368-
2(k)(1), and as discussed in section B.1. and B.2., respectively, of 
this preamble).
1. Distributions
    Proposed Sec.  1.368-2(k) would permit the acquiring corporation to 
distribute to certain shareholders part or all of the stock or assets 
acquired in a transaction otherwise qualifying as a reorganization 
without affecting its characterization as such. The proposed 
regulations would generally permit distributions to certain 
shareholders provided that no distributee receives ``substantially 
all'' of the acquired assets, including the assets of a corporation 
whose stock is acquired in the reorganization, or stock constituting 
control of the acquired corporation. This limitation reflected the 
concern that such a transaction might be more properly characterized as 
a direct acquisition by the distributee. For example, Rev. Rul. 67-274 
(1967-2 CB 141) held that an acquisition of T stock in a purported 
reorganization under section 368(a)(1)(B) followed by a prearranged 
liquidation of T is treated as a reorganization under section 
368(a)(1)(C); Rev. Rul. 72-405 (1972-2 CB 217) held that an acquisition 
of T in a forward triangular merger followed by a prearranged 
liquidation of the acquiring corporation is treated as a reorganization 
under section 368(a)(1)(C); and Rev. Rul. 2004-83 (2004-2 CB 157) held 
that a purchase of T stock from the common shareholder followed by a 
prearranged liquidation of T is treated as a reorganization under 
section 368(a)(1)(D).
    Commentators raised an administrative concern that the parameters 
of the ``substantially all'' standard are less than certain, at least 
under case law, and, thus, requested that a safe harbor test be adopted 
in the final regulations. The IRS and Treasury Department believe that 
this is a valid concern. Accordingly, these final regulations have 
adopted a different approach than the ``substantially all'' standard of 
the proposed regulations. The new approach in these final regulations 
focuses on whether the distribution consists of an amount of assets 
(disregarding any assets held by the acquiring corporation, or the 
merged corporation in the case of a reorganization under section 
368(a)(1)(A) by reason of (a)(2)(E), prior to the transaction) that 
would result in the distributing corporation being treated as 
liquidated for Federal income tax purposes.
    The IRS and Treasury Department believe that this approach will be 
easier for taxpayers to apply and the government to administer than the 
``substantially all'' standard in the proposed regulations. In 
addition, this approach more fully preserves the analysis and 
conclusions set forth in Rev. Rul. 67-274, Rev. Rul. 72-405, and Rev. 
Rul. 2004-83, in the context of Congress having required the target 
corporation to liquidate in all asset reorganizations. Finally, this 
approach more consistently applies the principles of section 
368(a)(2)(C) (which allows for transfers of all of the acquired assets 
or stock) to post-acquisition distributions.
    Specifically, these final regulations provide that a transaction 
otherwise qualifying as a reorganization will not be disqualified or 
recharacterized as a result of one or more distributions of assets, 
stock of the acquired corporation, or both, provided the COBE 
requirement is satisfied and the distributions do not result in a 
liquidation of the distributing corporation for Federal income tax 
purposes (disregarding, for this purpose, assets held by the acquiring 
corporation, or the merged corporation in the case of a reorganization 
under section 368(a)(1)(A) by reason of (a)(2)(E), prior to the 
transaction). Additionally, in the case of distributions of stock of 
the acquired corporation, these final regulations only protect the 
transaction from disqualification or recharacterization if the 
distributions consist of less than all of the stock of the acquired 
corporation that was acquired in the transaction and do not cause the 
acquired corporation to cease to be a member of the qualified group.
    These final regulations also clarify that certain indirect 
distributions of assets are treated under Sec.  1.368-2(k) in the same 
manner as a direct distribution of those assets. For example, such an 
indirect distribution of assets can occur where, following a 
transaction that otherwise qualifies as a reorganization under section 
368(a)(1)(A), the acquiring corporation transfers a portion of the T 
assets to a partnership (or a corporation) in exchange for an interest 
in the transferee partnership (or stock in the transferee corporation) 
in an ``other transfer'' described in Sec.  1.368-2(k)(1)(ii), and then 
distributes that partnership interest (or stock) to a shareholder.
    Finally, the IRS and Treasury Department believe that distributions 
of assets under these final regulations that involve the assumption of 
liabilities are distinguishable from the transaction analyzed in Rev. 
Rul. 70-107 (1970-1 CB 78). That ruling considered a transaction in 
which the acquiring corporation acquired all of the target 
corporation's assets in exchange for voting stock of the acquiring 
corporation's parent. In the transaction, the target corporation's 
liabilities were assumed in part by the acquiring corporation and in 
part by the acquiring corporation's parent. The ruling holds that the 
parent corporation's direct assumption of some of the target 
corporation's liabilities violates the solely for voting stock 
requirement of section 368(a)(1)(C). These final regulations do not 
implicate the fact pattern addressed in Rev. Rul. 70-107.
2. Other transfers
    Proposed Sec.  1.368-2(k) would provide, in part, that a 
transaction otherwise qualifying as a reorganization under section 
368(a) would not be disqualified if any assets or stock of a party to 
the reorganization, other than the stock of the issuing corporation, is 
subsequently transferred to a member of the qualified group. 
Commentators asked that the reference to transfers of stock of the 
issuing corporation be removed, stating that the effect, if any, of a 
transfer of the stock of the issuing corporation is adequately 
addressed by the continuity of interest rules under Sec.  1.368-1(e). 
The IRS and Treasury Department agree. In response to this comment (and 
comments regarding the interaction with the definition of a party to 
the reorganization in Sec.  1.368-2(f)), this provision has been 
revised to refer to the assets or stock of the acquired corporation, 
the acquiring corporation, or the surviving corporation, as the case 
may be.
    Accordingly, these final regulations provide that a transaction 
otherwise qualifying as a reorganization will not be disqualified or 
recharacterized as a result of one or more transfers (that do not 
constitute distributions) of assets or stock, or both, of the acquired 
corporation, the acquiring corporation, or the surviving corporation, 
as the case may be, provided the COBE requirement is satisfied, and the 
acquired corporation, the acquiring corporation, or the surviving 
corporation, as the case may be, does not terminate its corporate 
existence in connection with the transfer(s). In the case of transfers 
of stock of the acquired corporation, the

[[Page 60555]]

acquiring corporation, or the surviving corporation, as the case may 
be, these final regulations only protect the transaction from 
disqualification or recharacterization if the transfers do not cause 
such corporation to cease to be a member of the qualified group.
3. Transfers of stock to partnerships
    Example 3 of former Sec.  1.368-2(k), issued January 28, 1998 (63 
FR 4174), involved a transfer of stock of the acquired corporation to a 
partnership. In the example, P acquired all the stock of T solely in 
exchange for P stock in a transaction that otherwise qualified as a 
reorganization under section 368(a)(1)(B). Immediately thereafter, P 
transferred the T stock to members of its qualified group, who then 
transferred the T stock to a partnership all of the interests in which 
were owned by such members. The example concludes that because the 
transfer of T stock to the partnership is not described in Sec.  1.368-
2(k), the characterization of the transaction must be determined under 
relevant provisions of law, including the step transaction doctrine. 
The example further concludes that the transaction fails to meet the 
control requirement of a reorganization described in section 
368(a)(1)(B) because immediately after the transaction the acquiring 
corporation does not have control of T. The preamble to the proposed 
regulations indicated that the IRS and Treasury Department were 
reexamining the conclusion set forth in Example 3 and requested 
comments in this regard. Consequently, Example 3 was not included in 
the proposed regulations. Comments were received and considered in the 
course of studying this issue.
    After further examination, the IRS and Treasury Department have 
concluded that transfers of stock of a corporation to a controlled 
partnership (that is, one in which members of the qualified group own 
interests meeting requirements equivalent to section 368(c)) adequately 
preserve the link between the former T shareholders and the T business 
assets. This section 368(c) equivalent control standard is applied to 
transfers of stock to a partnership in order to protect the section 
368(c) control requirement applicable to triangular and stock 
acquisition reorganizations. Accordingly, these final regulations 
reverse the conclusion reached in Example 3 of former Sec.  1.368-2(k).
    To accommodate these policy considerations, the final regulations 
permit both distributions of stock of the acquired corporation and 
other transfers of stock of the acquired corporation, the acquiring 
corporation, or the surviving corporation, as the case may be, provided 
the transfer of stock does not cause the transferred corporation to 
cease to be a member of the COBE qualified group. To that end, as 
described in section A. of this preamble, the COBE regulations have 
been expanded to provide that if members of the qualified group own 
interests in a partnership that meet requirements equivalent to the 
control definition in section 368(c), any stock owned by such 
partnership is attributed to and treated as owned by members of the 
qualified group. Accordingly, this full stock attribution rule treats 
partnerships in a manner similar to members of the COBE qualified 
group.

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 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 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. Therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations have been submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on their impact on small 
businesses.

Drafting Information

    The principal author of these final regulations is Mary W. Lyons of 
the Office of Associate Chief Counsel (Corporate). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

Availability of IRS Documents

    IRS revenue rulings, procedures, and notices cited in this preamble 
are made available by the Superintendent of Documents, U.S. Government 
Printing Office, Washington, DC 20402.

List of Subjects in 26 CFR part 1

    Income taxes, Reporting and record keeping 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 1.368-1 is amended as follows:
0
1. Paragraph (d)(4)(ii) is revised.
0
2. Paragraph (d)(4)(iii)(D) is added.
0
3. Paragraph (d)(4)(iv) is revised.
0
4. Paragraph (d)(5) introductory text is revised.
0
5. In paragraph (d)(5), Examples 7 through 12 are redesignated as 
Examples 8 through 13, respectively, and new Examples 7, 14, and 15 are 
added.
0
6. In paragraph (d)(5), the first sentences of paragraph (i) in 
redesignated Examples 9, 10, and 12 are revised.
    The revisions and additions read as follows:


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

* * * * *
    (d) * * *
    (4) * * *
    (ii) Qualified group. A qualified group is one or more chains of 
corporations connected through stock ownership with the issuing 
corporation, but only if the issuing corporation owns directly stock 
meeting the requirements of section 368(c) in at least one other 
corporation, and stock meeting the requirements of section 368(c) in 
each of the corporations (except the issuing corporation) is owned 
directly (or indirectly as provided in paragraph (d)(4)(iii)(D) of this 
section) by one or more of the other corporations.
    (iii) * * *
    (D) Stock attributed from certain partnerships. Solely for purposes 
of paragraph (d)(4)(ii) of this section, if members of the qualified 
group own interests in a partnership meeting requirements equivalent to 
section 368(c) (a section 368(c) controlled partnership), any stock 
owned by the section 368(c) controlled partnership shall be treated as 
owned by members of the qualified group. Solely for purposes of 
determining whether a lower-tier partnership is a section 368(c) 
controlled partnership, any interest in a lower-tier partnership that 
is owned by a section 368(c) controlled partnership shall be treated as 
owned by members of the qualified group.
    (iv) Effective/applicability dates. Paragraphs (d)(4)(i) and 
(d)(4)(iii) (other than paragraph (d)(4)(iii)(D)) of this section apply 
to transactions occurring after January 28, 1998, except that they do 
not apply to any transaction

[[Page 60556]]

occurring pursuant to a written agreement which is binding on January 
28, 1998, and at all times thereafter. Paragraphs (d)(4)(ii) and 
(d)(4)(iii)(D) of this section apply to transactions occurring on or 
after October 25, 2007, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
before October 25, 2007, and at all times after that.
    (5) Examples. The following examples illustrate this paragraph (d). 
All the corporations have only one class of stock outstanding. The 
preceding sentence and paragraph (d)(5) Example 6 and Example 8 through 
Example 13 apply to transactions occurring after January 28, 1998, 
except that they do not apply to any transaction occurring pursuant to 
a written agreement which is binding on January 28, 1998, and at all 
times thereafter. Paragraph (d)(5) Example 7, Example 14, and Example 
15 apply to transactions occurring on or after October 25, 2007, except 
that they do not apply to any transaction occurring pursuant to a 
written agreement which is binding before October 25, 2007, and at all 
times after that. The examples read as follows:
* * * * *
    Example 7. Transfers of acquired stock to members of the 
qualified group--continuity of business enterprise satisfied. (i) 
Facts. The facts are the same as Example 6, except that, instead of 
P acquiring the assets of T, HC acquires all of the outstanding 
stock of T in exchange solely for stock of P. In addition, as part 
of the plan of reorganization, HC transfers 10 percent of the stock 
of T to each of subsidiaries S-1 through S-10. T will continue to 
operate an auto parts distributorship. Without regard to whether the 
transaction satisfies the COBE requirement, the transaction 
qualifies as a triangular B reorganization (as defined in Sec.  
1.358-6(b)(2)(iv)).
    (ii) Continuity of business enterprise. Under paragraph 
(d)(4)(i) of this section, P is treated as holding the assets and 
conducting the business of T because T is a member of the qualified 
group (as defined in paragraph (d)(4)(ii) of this section). The COBE 
requirement of paragraph (d)(1) of this section is satisfied.
* * * * *
    Example 9. * * * (i) Facts. The facts are the same as Example 8, 
except that S-3 transfers the historic T business to PRS in exchange 
for a 1 percent interest in PRS.
    (ii) * * *
    Example 10. * * * (i) Facts. The facts are the same as Example 
8, except that S-3 transfers the historic T business to PRS in 
exchange for a 33\1/3\ percent interest in PRS, and no member of P's 
qualified group performs active and substantial management functions 
for the ski boot business operated in PRS.
* * * * *
    Example 12. * * * (i) Facts. The facts are the same as Example 
11, except that S-1 transfers all the T assets to PRS, and P and X 
each transfer cash to PRS in exchange for partnership interests. * * 
*
* * * * *
    Example 14. Transfer of acquired stock to a partnership--
continuity of business enterprise satisfied. (i) Facts. Pursuant to 
a plan of reorganization, the T shareholders transfer all of their T 
stock to a subsidiary of P, S-1, solely in exchange for P stock. In 
addition, as part of the plan of reorganization, S-1 transfers the T 
stock to its subsidiary, S-2, and S-2 transfers the T stock to its 
subsidiary, S-3. S-2 and S-3 form a new partnership, PRS. 
Immediately thereafter, S-3 transfers all of the T stock to PRS in 
exchange for an 80 percent interest in PRS, and S-2 transfers cash 
to PRS in exchange for a 20 percent interest in PRS.
    (ii) Continuity of business enterprise. Members of the qualified 
group, in the aggregate, own all of the interests in PRS. Because 
these interests in PRS meet requirements equivalent to section 
368(c), under paragraph (d)(4)(iii)(D) of this section, the T stock 
owned by PRS is treated as owned by members of the qualified group. 
P is treated as holding all of the businesses and assets of T 
because T is a member of the qualified group (as defined in 
paragraph (d)(4)(ii) of this section). The COBE requirement of 
paragraph (d)(1) of this section is satisfied because P is treated 
as continuing T's business.
    Example 15. Transfer of acquired stock to a partnership--
continuity of business enterprise not satisfied. (i) Facts. The 
facts are the same as in Example 14, except that S-3 and U, an 
unrelated corporation, form a new partnership, PRS, and, immediately 
thereafter, S-3 transfers all of the T stock to PRS in exchange for 
a 50 percent interest in PRS, and U transfers cash to PRS in 
exchange for a 50 percent interest in PRS.
    (ii) Continuity of business enterprise. Members of the qualified 
group, in the aggregate, own 50 percent of the interests in PRS. 
Because these interests in PRS do not meet requirements equivalent 
to section 368(c), the T stock owned by PRS is not treated as owned 
by members of the qualified group under paragraph (d)(4)(iii)(D) of 
this section. P is not treated as holding all of the businesses and 
assets of T because T has ceased to be a member of the qualified 
group (as defined in paragraph (d)(4)(ii) of this section). The COBE 
requirement of paragraph (d)(1) of this section is not satisfied 
because P is not treated as continuing T's business or using T's 
historic business assets in a business.
* * * * *
0
Par. 3. Section 1.368-2 is amended by:
0
1. Adding three sentences at the end of paragraph (f).
0
2. Revising paragraphs (j)(3)(ii) and (iv).
0
3. Removing the first sentence of paragraph (j)(3)(iii) and adding two 
new sentences at the beginning of the paragraph.
0
4. Revising paragraph (k).
    The additions and the revisions read as follows:


Sec.  1.368-2  Definition of terms.

* * * * *
    (f) * * * If a transaction otherwise qualifies as a reorganization 
under section 368(a)(1)(B) or as a reverse triangular merger (as 
defined in Sec.  1.358-6(b)(2)(iii)), the target corporation (in the 
case of a transaction that otherwise qualifies as a reorganization 
under section 368(a)(1)(B)) or the surviving corporation (in the case 
of a transaction that otherwise qualifies as a reverse triangular 
merger) remains a party to the reorganization even though its stock or 
assets are transferred in a transaction described in paragraph (k) of 
this section. If a transaction otherwise qualifies as a forward 
triangular merger (as defined in Sec.  1.358-6(b)(2)(i)), a triangular 
B reorganization (as defined in Sec.  1.358-6(b)(2)(iv)), a triangular 
C reorganization (as defined in Sec.  1.358-6(b)(2)(ii)), or a 
reorganization under section 368(a)(1)(G) by reason of section 
368(a)(2)(D), the acquiring corporation remains a party to the 
reorganization even though its stock is transferred in a transaction 
described in paragraph (k) of this section. The two preceding sentences 
apply to transactions occurring on or after October 25, 2007, except 
that they do not apply to any transaction occurring pursuant to a 
written agreement which is binding before October 25, 2007, and at all 
times after that.
* * * * *
    (j) * * *
    (3) * * *
    (ii) Except as provided in paragraph (k) of this section, the 
controlling corporation must control the surviving corporation 
immediately after the transaction.
    (iii) After the transaction, the surviving corporation must hold 
substantially all of its own properties and substantially all of the 
properties of the merged corporation (other than stock of the 
controlling corporation distributed in the transaction). The surviving 
corporation may transfer such properties as provided in paragraph (k) 
of this section. * * *
    (iv) Paragraph (j)(3)(ii) and the first two sentences of paragraph 
(j)(3)(iii) of this section apply to transactions occurring on or after 
October 25, 2007, except that they do not apply to any transaction 
occurring pursuant to a written agreement which is binding before 
October 25, 2007, and at all times thereafter. The remainder of 
paragraph (j)(3)(iii) of this section applies to transactions occurring 
after January 28,

[[Page 60557]]

1998, except that it does not apply to any transaction occurring 
pursuant to a written agreement which is binding on January 28, 1998, 
and at all times after that.
* * * * *
    (k) Certain transfers of assets or stock in reorganizations--(1) 
General rule. A transaction otherwise qualifying as a reorganization 
under section 368(a) shall not be disqualified or recharacterized as a 
result of one or more subsequent transfers (or successive transfers) of 
assets or stock, provided that the requirements of Sec.  1.368-1(d) are 
satisfied and the transfer(s) are described in either paragraph 
(k)(1)(i) or (k)(1)(ii) of this section.
    (i) Distributions. One or more distributions to shareholders 
(including distribution(s) that involve the assumption of liabilities) 
are described in this paragraph (k)(1)(i) if--
    (A) The property distributed consists of--
    (1) Assets of the acquired corporation, the acquiring corporation, 
or the surviving corporation, as the case may be, or an interest in an 
entity received in exchange for such assets in a transfer described in 
paragraph (k)(1)(ii) of this section;
    (2) Stock of the acquired corporation provided that such 
distribution(s) of stock do not cause the acquired corporation to cease 
to be a member of the qualified group (as defined in Sec.  1.368-
1(d)(4)(ii)); or
    (3) A combination thereof; and
    (B) The aggregate of such distributions does not consist of--
    (1) An amount of assets of the acquired corporation, the acquiring 
corporation (disregarding assets held prior to the potential 
reorganization), or the surviving corporation (disregarding assets of 
the merged corporation), as the case may be, that would result in a 
liquidation of such corporation for Federal income tax purposes; or
    (2) All of the stock of the acquired corporation that was acquired 
in the transaction.
    (ii) Other Transfers. One or more other transfers are described in 
this paragraph (k)(1)(ii) if--
    (A) The transfer(s) are not described in paragraph (k)(1)(i) of 
this section;
    (B) The property transferred consists of--
    (1) Part or all of the assets of the acquired corporation, the 
acquiring corporation, or the surviving corporation, as the case may 
be;
    (2) Part or all of the stock of the acquired corporation, the 
acquiring corporation, or the surviving corporation, as the case may 
be, provided that such transfer(s) of stock do not cause such 
corporation to cease to be a member of the qualified group (as defined 
in Sec.  1.368-1(d)(4)(ii)); or
    (3) A combination thereof; and
    (C) The acquired corporation, the acquiring corporation, or the 
surviving corporation, as the case may be, does not terminate its 
corporate existence in connection with the transfer(s).
    (2) Examples. The following examples illustrate the application of 
this paragraph (k). Except as otherwise noted, P is the issuing 
corporation, and T is an unrelated target corporation. All corporations 
have only one class of stock outstanding. T operates a bakery that 
supplies delectable pastries and cookies to local retail stores. The 
acquiring corporate group produces a variety of baked goods for 
nationwide distribution. Except as otherwise noted, P owns all of the 
stock of S-1 and 80 percent of the stock of S-4, S-1 owns 80 percent of 
the stock of S-2 and 50 percent of the stock of S-5, S-2 owns 80 
percent of the stock of S-3, and S-4 owns the remaining 50 percent of 
the stock of S-5. The examples are as follows:
    Example 1. Transfers of acquired assets to members of the 
qualified group after a reorganization under section 368(a)(1)(C). 
(i) Facts. Pursuant to a plan of reorganization, T transfers all of 
its assets to S-1 solely in exchange for P stock, which T 
distributes to its shareholders, and S-1's assumption of T's 
liabilities. In addition, pursuant to the plan, S-1 transfers all of 
the T assets to S-2, and S-2 transfers all of the T assets to S-3.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), 
is not disqualified by the successive transfers of all of the T 
assets to S-2 and from S-2 to S-3 because the transfers are not 
distributions described in paragraph (k)(1)(i) of this section, the 
transfers consist of part or all of the assets of the acquiring 
corporation, the acquiring corporation does not terminate its 
corporate existence in connection with the transfers, and the 
transaction satisfies the requirements of Sec.  1.368-1(d).
    Example 2. Distribution of acquired assets to a member of the 
qualified group after a reorganization under section 368(a)(1)(C). 
(i) Facts. Pursuant to a plan of reorganization, T transfers all of 
its assets to S-1 solely in exchange for P stock, which T 
distributes to its shareholders, and S-1's assumption of T's 
liabilities. In addition, pursuant to the plan, S-1 distributes half 
of the T assets to P, and P assumes half of the T liabilities.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), 
is not disqualified by the distribution of half of the T assets from 
S-1 to P, or P's assumption of half of the T liabilities from S-1, 
because the distribution consists of assets of the acquiring 
corporation, the distribution does not consist of an amount of S-1's 
assets that would result in a liquidation of S-1 for Federal income 
tax purposes (disregarding S-1's assets held prior to the 
acquisition of T), and the transaction satisfies the requirements of 
Sec.  1.368-1(d).
    Example 3. Indirect distribution of acquired assets to a member 
of the qualified group after a reorganization under section 
368(a)(1)(C). (i) Facts. The facts are the same as Example 2, except 
that, pursuant to the plan, S-1 contributes half of the T assets to 
newly formed S-6, S-6 assumes half of the T liabilities, and S-1 
distributes all of the S-6 stock to P.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), 
is not disqualified by the transfer of half of the T assets to S-6 
and the distribution of the S-6 stock to P because the transfer of 
half of the T assets to S-6 is described in paragraph (k)(1)(ii) of 
this section, the distribution of the S-6 stock to P is an indirect 
distribution of assets of the acquiring corporation, the 
distribution does not consist of an amount of S-1's assets that 
would result in a liquidation of S-1 for Federal income tax purposes 
(disregarding S-1's assets held prior to the acquisition of T), and 
the transaction satisfies the requirements of Sec.  1.368-1(d).
    Example 4. Distribution of acquired stock to a controlled 
partnership after a reorganization under section 368(a)(1)(B). (i) 
Facts. P owns 80 percent of the stock of S-1, and an 80-percent 
interest in PRS, a partnership. S-4 owns the remaining 20 percent 
interest in PRS. PRS owns the remaining 20 percent of the stock of 
S-1. Pursuant to a plan of reorganization, the T shareholders 
transfer all of their T stock to S-1 solely in exchange for P stock. 
In addition, pursuant to the plan, S-1 distributes 90 percent of the 
T stock to PRS in redemption of 5 percent of the stock of S-1 owned 
by PRS.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(B), 
is not disqualified by the distribution of 90 percent of the T stock 
from S-1 to PRS because the distribution consists of less than all 
of the stock of the acquired corporation that was acquired in the 
transaction, the distribution does not cause T to cease to be a 
member of the qualified group (as defined in Sec.  1.368-
1(d)(4)(ii)), and the transaction satisfies the requirements of 
Sec.  1.368-1(d).
    Example 5. Transfer of acquired stock to a non-controlled 
partnership. (i) Facts. Pursuant to a plan, the T shareholders 
transfer all of their T stock to S-1 solely in exchange for P stock. 
In addition, as part of the plan, T distributes half of its assets 
to S-1, S-1 assumes half of the T liabilities, and S-1 transfers the 
T stock to S-2. S-2 and U, an unrelated corporation, form a new 
partnership, PRS. Immediately thereafter, S-2 transfers all of the T 
stock to PRS in exchange for a 50 percent interest in PRS, and U 
transfers cash to PRS in exchange for a 50 percent interest in PRS.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(B), 
is not disqualified by the distribution of half of the T assets from 
T to S-1, or S-1's assumption of half of the T liabilities from T,

[[Page 60558]]

because the distribution consists of assets of the acquired 
corporation, the distribution does not consist of an amount of T's 
assets that would result in a liquidation of T for Federal income 
tax purposes, and the transaction satisfies the requirements of 
Sec.  1.368-1(d). Further, this paragraph (k) describes the transfer 
of the acquired stock from S-1 to S-2, but does not describe the 
transfer of the acquired stock from S-2 to PRS because such transfer 
causes T to cease to be a member of the qualified group (as defined 
in Sec.  1.368-1(d)(4)(ii)). Therefore, the characterization of this 
transaction must be determined under the relevant provisions of law, 
including the step transaction doctrine. See Sec.  1.368-1(a). The 
transaction fails to meet the control requirement of a 
reorganization described in section 368(a)(1)(B) because immediately 
after the acquisition of the T stock, the acquiring corporation does 
not have control of T.
    Example 6. Transfers of acquired assets to members of the 
qualified group after a reorganization under section 368(a)(1)(D). 
(i) Facts. P owns all of the stock of T. Pursuant to a plan of 
reorganization, T transfers all of its assets to S-1 solely in 
exchange for S-1 stock, which T distributes to P, and S-1's 
assumption of T's liabilities. In addition, pursuant to the plan, S-
1 transfers all of the T assets to S-2, and S-2 transfers all of the 
T assets to S-3.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(D), 
is not disqualified by the successive transfers of all the T assets 
from S-1 to S-2 and from S-2 to S-3 because the transfers are not 
distributions described in paragraph (k)(1)(i) of this section, the 
transfers consist of part or all of the assets of the acquiring 
corporation, the acquiring corporation does not terminate its 
corporate existence in connection with the transfers, and the 
transaction satisfies the requirements of Sec.  1.368-1(d).
    Example 7. Transfer of stock of the acquiring corporation to a 
member of the qualified group after a reorganization under section 
368(a)(1)(A) by reason of section 368(a)(2)(D). (i) Facts. Pursuant 
to a plan of reorganization, S-1 acquires all of the T assets in the 
merger of T into S-1. In the merger, the T shareholders receive 
solely P stock. Also, pursuant to the plan, P transfers all of the 
S-1 stock to S-4.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(A) 
by reason of section 368(a)(2)(D), is not disqualified by the 
transfer of all of the S-1 stock to S-4 because the transfer is not 
a distribution described in paragraph (k)(1)(i) of this section, the 
transfer consists of part or all of the stock of the acquiring 
corporation, the transfer does not cause S-1 to cease to be a member 
of the qualified group (as defined in Sec.  1.368-1(d)(4)(ii)), the 
acquiring corporation does not terminate its corporate existence in 
connection with the transfer, and the transaction satisfies the 
requirements of Sec.  1.368-1(d).
    Example 8. Transfer of acquired assets to a partnership after a 
reorganization under section 368(a)(1)(A) by reason of section 
368(a)(2)(D). (i) Facts. Pursuant to a plan of reorganization, S-1 
acquires all of the T assets in the merger of T into S-1. In the 
merger, the T shareholders receive solely P stock. In addition, 
pursuant to the plan, S-1 transfers all of the T assets to PRS, a 
partnership in which S-1 owns a 33\1/3\-percent interest. PRS 
continues T's historic business. S-1 does not perform active and 
substantial management functions as a partner with respect to PRS's 
business.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(A) 
by reason of section 368(a)(2)(D), is not disqualified by the 
transfer of T assets from S-1 to PRS because the transfer is not a 
distribution described in paragraph (k)(1)(i) of this section, the 
transfer consists of part or all of the assets of the acquiring 
corporation, the acquiring corporation does not terminate its 
corporate existence in connection with the transfers, and the 
transaction satisfies the requirements of Sec.  1.368-1(d).
    Example 9. Sale of acquired assets to a member of the qualified 
group after a reorganization under section 368(a)(1)(C). (i) Facts. 
Pursuant to a plan of reorganization, T transfers all of its assets 
to S-1 in exchange for P stock, which T distributes to its 
shareholders, and S-1's assumption of T's liabilities. In addition, 
pursuant to the plan, S-1 sells all of the T assets to S-5 for cash 
equal to the fair market value of those assets.
    (ii) Analysis. Under this paragraph (k), the transaction, which 
otherwise qualifies as a reorganization under section 368(a)(1)(C), 
is not disqualified by the sale of all of the T assets from S-1 to 
S-5 because the transfer is not a distribution described in 
paragraph (k)(1)(i) of this section, the transfer consists of part 
or all of the assets of the acquiring corporation, the acquiring 
corporation does not terminate its corporate existence in connection 
with the transfers, and the transaction satisfies the requirements 
of Sec.  1.368-1(d).

    (3) Effective/applicability date. This paragraph (k) applies to 
transactions occurring on or after October 25, 2007, except that it 
does not apply to any transaction occurring pursuant to a written 
agreement which is binding before October 25, 2007, and at all times 
after that.

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: October 16, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E7-20863 Filed 10-24-07; 8:45 am]
BILLING CODE 4830-01-P