[Federal Register Volume 76, Number 243 (Monday, December 19, 2011)]
[Proposed Rules]
[Pages 78591-78594]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-32079]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-124627-11]
RIN 1545-BK43


Corporate Reorganizations; Guidance on the Measurement of 
Continuity of Interest

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations concerning the 
continuity of interest requirement for corporate reorganizations. The 
guidance is necessary to clarify the manner in which the continuity of 
interest

[[Page 78592]]

requirement is measured in particular circumstances. The proposed 
regulations affect corporations and their shareholders.

DATES: Written or electronic comments and requests for a public hearing 
must be received by March 19, 2012.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-124627-11), room 5205, 
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-
124627-11), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or electronically, via the Federal e-
Rulemaking Portal at http://www.regulations.gov/ (IRS REG-124627-11).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Richard Starke (202) 622-3497, and concerning submission of comments, 
Oluwafunmilayo Taylor (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This notice of proposed rulemaking accompanies publication of final 
regulations regarding the continuity of interest requirement (COI) for 
corporate reorganizations that are published in this issue of the 
Federal Register (the 2011 regulations). In general, the 2011 
regulations provide the circumstances under which the consideration to 
be exchanged for the proprietary interests in the target corporation is 
valued on the last business day before the first date there is a 
binding contract (the signing date rule). The preamble explains that 
the signing date rule is based on the principle that where a binding 
contract provides for fixed consideration, the target corporation 
shareholders can generally be viewed as being subject to the economic 
fortunes of the issuing corporation as of the last business day before 
the signing date (the Pre-Signing Date). However, if the contract does 
not provide for fixed consideration, the signing date value of the 
issuing corporation stock is not relevant for purposes of determining 
the extent to which a proprietary interest in the target corporation is 
preserved. For additional background regarding the signing date rule, 
see the preamble to the 2011 regulations published elsewhere in this 
issue of the Federal Register.

Explanation of Provisions

    In response to comments, the IRS and the Treasury Department have 
reconsidered the scope of the signing date rule, and agree that its 
underlying principles support additional methods for determining 
whether COI is satisfied. For example, a contract to effect a potential 
reorganization may provide that the amount of an item of consideration 
will vary as the value of issuing corporation stock declines between 
the stock's Pre-Signing Date value and some lower value provided for in 
the contract (Floor Price), but will not vary below the Floor Price. If 
the closing date value is less than the Floor Price in such a case, the 
target shareholders have been subjected to the economic fortunes of 
owning the consideration received in the exchange in the same manner as 
if the contract had fixed the consideration based upon the contract's 
stated Floor Price. Accordingly, these proposed regulations generally 
provide that if, pursuant to a binding contract, an item of 
consideration varies as the value of issuing corporation stock declines 
between the stock's Pre-Signing Date value and a Floor Price, and the 
closing date value is less than the Floor Price, COI is determined as 
if the consideration that would have been delivered at the Floor Price 
were issued and valued based upon the Floor Price. Applying the same 
principle, these proposed regulations provide that if, pursuant to a 
binding contract, an item of consideration varies as the value of 
issuing corporation stock increases between the stock's signing date 
value and some higher value provided for in the contract (Ceiling 
Price), and the closing date value is greater than the Ceiling Price, 
COI is determined as if the consideration that would have been 
delivered at the Ceiling Price were issued and valued based upon the 
Ceiling Price. For purposes of this rule, the Closing Date means the 
date upon which the exchange of consideration in the potential 
reorganization occurs.
    In response to comments, these proposed regulations also permit, in 
lieu of the value of issuing corporation stock on the Closing Date, the 
use of an average value for issuing corporation stock in certain 
circumstances. The proposed regulations provide that an average value 
may be used if it is based upon issuing corporation stock values 
occurring after the signing date and before the Closing Date, and the 
binding contract utilizes the average price, so computed, in 
determining the number of shares of each class of stock of the issuing 
corporation, the amount of money, and the other property to be 
exchanged for all the proprietary interests in the target corporation, 
or to be exchanged for each proprietary interest in the target 
corporation. This rule also applies signing date rule principles 
because the average value fixes the number of shares and amount of 
other consideration. Accordingly, the target shareholders become 
subject to the fortunes of the issuer's stock across the range of dates 
being averaged.

Request for Comments

    As previously stated, the signing date rule and these proposed 
regulations are based upon the concept that for purposes of measuring 
COI, in certain circumstances an item of consideration provided by the 
issuing corporation can generally be valued on the date that the target 
shareholders become subject to the economic fortunes of owning the 
item, assuming the exchange ultimately occurs. Depending upon the 
contract's terms, this may occur on a date between the signing date and 
the closing date, and may occur for different items of consideration on 
different dates. Accordingly, for purposes of COI, it may be 
appropriate to value an item of consideration on a date between the 
signing date and the closing date, and to value different items on 
different dates. For example, future guidance could provide that an 
item of consideration is valued for COI purposes at the earliest date 
on which the target shareholders (in the aggregate) become fully 
subject to the appreciation and depreciation in the value of that item 
pursuant to a binding contract to effect the potential reorganization, 
but not later than the date of the reorganization exchange. In 
determining whether the target shareholders are fully subject to market 
appreciation and depreciation, certain circumstances, such as the risk 
of not closing, would be disregarded. The IRS and the Treasury 
Department request comments on the propriety of such an approach.

Effective Date

    These regulations are proposed to apply to transactions occurring 
on or after the date the regulations are published as final regulations 
in the Federal Register, unless completed pursuant to a binding 
agreement that was in effect immediately before the date such final 
regulations are published and all times afterwards.

Special Analysis

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 12866 
as supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. It has also been determined that 5 U.S.C. 
553(b)

[[Page 78593]]

does not apply to these regulations and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. 601 et seq.) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, this notice of proposed 
rulemaking has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
entities.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and 8 copies) or electronic comments that are submitted timely to the 
IRS. The IRS and the 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 regulations is Richard Starke of the 
Office of Associate Chief Counsel (Corporate), IRS. However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

    Par. 2. Section 1.368-1 is amended by adding new paragraphs 
(e)(2)(vi), (e)(2)(vii), and revising (e)(9) to read as follows:


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

* * * * *
    (e) * * *
    (2) * * *
    (vi) Special Rules--(A) Floors. This paragraph (e)(2)(vi)(A) 
applies if, pursuant to a binding contract, the amount of an item of 
consideration to be exchanged for all the proprietary interests in the 
target corporation, or to be exchanged for each proprietary interest in 
the target corporation, changes as the value of a share of the issuing 
corporation varies above a specified price (Floor Price), but does not 
vary below the Floor Price. If the value of the share is greater than 
or equal to the Floor Price on the Pre-Signing Date (as defined in 
paragraph (e)(2)(i) of this section) but below the Floor Price on the 
Closing Date (as defined in paragraph (e)(2)(vi)(D) of this section), 
whether a proprietary interest is preserved is determined as if the 
consideration was issued and valued based upon the Floor Price.
    (B) Ceilings. This paragraph (e)(2)(vi)(B) applies if, pursuant to 
a binding contract, the amount of an item of consideration to be 
exchanged for all the proprietary interests in the target corporation, 
or to be exchanged for each proprietary interest in the target 
corporation, changes as the value of a share of the issuing corporation 
varies below a specified price (Ceiling Price), but does not vary above 
the Ceiling Price. If the value of the share is less than or equal to 
the Ceiling Price on the Pre-Signing Date (as defined in paragraph 
(e)(2)(i) of this section) but above the Ceiling Price on the Closing 
Date (as defined in paragraph (e)(2)(vi)(D) of this section), whether a 
proprietary interest is preserved is determined as if the consideration 
was issued and valued based upon the Ceiling Price.
    (C) Closing Date value--average values between signing date and 
Closing Date. In determining the Closing Date value of issuing 
corporation stock for purposes of determining whether a proprietary 
interest in the target corporation is preserved, an average of prices 
may be used in lieu of the Closing Date price if--
    (1) The average price is based upon prices of issuing corporation 
stock occurring after the signing date and before the Closing Date, and
    (2) The binding contract utilizes the average price, so computed, 
in determining the number of shares of each class of stock of the 
issuing corporation, the amount of money, and the other property to be 
exchanged for all the proprietary interests in the target corporation, 
or to be exchanged for each proprietary interest in the target 
corporation.
    (D) Closing Date. For purposes of paragraphs (e)(2)(vi) and 
(e)(2)(vii) of this section, the Closing Date means the date upon which 
the exchange of consideration in the potential reorganization occurs.
    (vii) Examples. For purposes of the examples in this paragraph 
(e)(2)(vii), P is the issuing corporation, T is the target corporation, 
each corporation has only one class of stock outstanding, no 
transactions other than those described occur, and the transactions are 
not otherwise subject to recharacterization. The following examples 
illustrate the application of paragraph (e)(2)(vi) of this section:

    Example 1. Price adjustment to provide more or less cash. (i) 
Facts. On January 3 of year 1, P and T sign a binding contract 
pursuant to which T will be merged into P. Pursuant to the contract, 
the T shareholders will receive 50 shares of P stock and $50 cash in 
exchange for all of the outstanding shares of T stock, subject to 
the following price adjustment:
    (A) If the average price of P stock over the five-day period 
prior to the Closing Date exceeds $1, the amount of cash will be 
reduced by 50 times the excess of that price over $1, and
    (B) If the average price of P stock during the specified period 
is less than $1, the amount of cash will be increased by 50 times 
the excess of $1 over that price, provided that in no event will P 
deliver cash of less than $40 or more than $60 to the T 
shareholders. This adjustment ensures that the T shareholders will 
be entitled to receive aggregate consideration with a value of $100 
on the closing date if the average price of P stock during the 
specified period is between $.80, at which point the T shareholders 
would receive $60 of cash ($50 + (($1-$.80) x 50)), and $1.20, at 
which point the T shareholders would receive $40 of cash ($50-
(($1.20-$1) x 50)).
    (C) On January 2 of year 1, the value of the P stock is $1 per 
share. On June 1 of year 1, T merges into P, when the value of P 
stock is $.25 per share. The average price of P stock during the 
specified period is also $.25 per share. In the merger, the T 
shareholders receive $60 cash and 50 shares of P stock with a value 
(determined as of the Closing Date) of $12.50.
    (ii) COI determined at the Floor Price. For purposes of 
determining whether a proprietary interest in the target corporation 
is preserved, the rules of paragraph (e)(2)(vi)(A) of this section 
apply because, pursuant to a binding contract, the amount of cash to 
be exchanged for all the proprietary interests in the target 
corporation varies above a Floor Price of $.80 but does not vary 
below the Floor Price, the Pre-Signing Date value exceeds the Floor 
Price, and the value on the Closing Date is less than the Floor 
Price. Accordingly, whether a proprietary interest is preserved is 
determined as if the consideration that would have been delivered at 
the Floor Price was issued and valued based upon the Floor Price 
value. At the Floor Price, the T shareholders would have received, 
in the aggregate, $60 of cash and $40 of P stock. Therefore, the 
transaction satisfies the continuity of interest requirement.


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    Example 2. No Floor Price.  The facts are the same as in Example 
1, except that the Pre-Signing Date value is $.50, the Closing Date 
value is $1.50, and there is no limitation on the amount of 
additional cash that the T shareholders may receive (that is, there 
is no Floor Price). For purposes of determining whether a 
proprietary interest in the target corporation is preserved, the 
rules of paragraph (e)(2)(vi)(B) of this section apply because, 
pursuant to a binding contract, the amount of cash to be exchanged 
for all the proprietary interests in the target corporation varies 
below a Ceiling Price of $1.20 but does not vary above the Ceiling 
Price, the Pre-Signing Date value is less than the Ceiling Price, 
and the value on the Closing Date exceeds the Ceiling Price. 
Accordingly, whether a proprietary interest is preserved is 
determined as if the consideration that would have been delivered at 
the Ceiling Price was issued and valued based upon the Ceiling 
Price. At the Ceiling Price, the T shareholders would have received, 
in the aggregate, $40 of cash and $60 of P stock. Therefore, the 
transaction satisfies the continuity of interest requirement.

    Example 3. No Floor or Ceiling Price.  (i) Facts. On January 3 
of year 1, P and T sign a binding contract pursuant to which T will 
be merged into P. Pursuant to the contract, the T shareholders will 
receive $50 cash and $50 of P stock based upon the P stock value on 
the Closing Date. On January 2 of year 1, the Pre-Signing Date, the 
value of the P stock is $1 per share. On June 1 of year 1, when the 
value of P stock is $5 per share, T merges into P.
    (ii) COI determined on the Closing Date. For purposes of 
determining whether a proprietary interest in the target corporation 
is preserved, the rules of paragraph (e)(2)(vi) of this section do 
not apply because the contract does not provide for either a Floor 
Price or a Ceiling Price. There is no Floor Price because there is 
not a value below which the amount of P stock will not vary. There 
is no Ceiling Price because there is not a value above which the 
amount of P stock will not vary. Because the transaction does not 
satisfy the requirements of paragraph (e)(2)(vi) of this section and 
does not satisfy the definition of fixed consideration, the 
consideration will be valued on the Closing Date. The transaction 
satisfies the continuity of interest requirement because the T 
shareholders receive, in the aggregate, $50 cash and $50 of P stock.
* * * * *
    (9) Effective/Applicability date. Paragraphs (e)(2)(vi) and 
(e)(2)(vii) are proposed to apply to transactions occurring on or after 
the date the regulations are published as final regulations in the 
Federal Register, unless completed pursuant to a binding agreement that 
was in effect immediately before the date such final regulations are 
published and at all times afterwards.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-32079 Filed 12-16-11; 8:45 am]
BILLING CODE 4830-01-P