[Federal Register Volume 60, Number 208 (Friday, October 27, 1995)]
[Rules and Regulations]
[Pages 54942-54944]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-26739]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8626]
RIN 1545-AT15
Continuity of Interest in Transfer of Target Assets After
Qualified Stock Purchase of Target
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document prescribes final regulations under section 338
of the Internal Revenue Code regarding the transfer of target assets to
the purchasing corporation or another member of the same affiliated
group as the purchasing corporation after a qualified stock purchase
(QSP) of target stock, if a section 338 election is not made. These
regulations provide guidance to parties to such transfers.
DATES: These regulations are effective October 27, 1995.
These regulations are applicable to transfers of target assets that
occur on or after October 26, 1995.
FOR FURTHER INFORMATION CONTACT: Steven M. Flanagan at (202) 622-7790
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Explanation of Provisions
Background
This document contains final regulations under section 338 that
govern the treatment of an intragroup merger or similar transaction
following a QSP of target stock, if a section 338 election is not made
for the target.
Section 338 provides that, if a corporation makes a QSP of the
stock of a target, the purchasing corporation may elect to have the
target treated as having sold all of its assets at the close of the
acquisition date in a single transaction and as a new corporation that
purchased all such assets at the beginning of the following day. Under
section 338(i), the
[[Page 54943]]
IRS and Treasury are authorized to prescribe such regulations as may be
necessary or appropriate to carry out the purposes of section 338.
On February 17, 1995, proposed regulations under section 338 were
published in the Federal Register (60 FR 9309). The proposed rules are
based on the conclusion that the result in Yoc Heating v. Commissioner,
61 T.C. 168 (1973), is inconsistent with the legislative intent behind
section 338 when there is a QSP of target stock.
Public Comments and the Final Regulations
The IRS received comments from the public on the proposed
regulations, and a public hearing was held on June 7, 1995.
Commentators generally support the proposed regulations. Accordingly,
the final regulations adopt the proposed regulations with minor
technical changes. The principal comments on the proposed regulations
are discussed below.
Treatment of minority shareholders. The proposed regulations
generally treat the purchasing corporation's target stock acquired in
the QSP as an interest on the part of a person who is an owner of the
target's business enterprise prior to the transfer that can be
continued in a reorganization. Thus, if the purchasing corporation
purchases the bulk of the stock of a target corporation in a QSP and
subsequently merges the target into a subsidiary of the purchasing
corporation in exchange for the subsidiary's stock, the continuity of
interest requirement is treated as satisfied. However, this treatment
does not extend to minority shareholders of the target whose stock is
not acquired by the purchasing corporation.
Several commentators argue that the proposed regulations are
inconsistent because they provide tax-free treatment to the purchasing
corporation, but not minority shareholders who are the true historic
owners of the target. Therefore, they suggest that the proposed
regulations are contrary to traditional notions of shareholder
continuity, and that the final regulations should extend tax-free
treatment to minority shareholders who exchange their target stock for
stock in the acquiring entity.
The final regulations do not adopt this suggestion. The legislative
history of section 338 indicates a congressional intent to repeal the
Kimbell-Diamond doctrine and protect the exclusivity of the section 338
election for obtaining a cost rather than a carryover basis in the
target's assets after a QSP. See H.R. Conf. Rep. No. 760, 97th Cong.,
2d Sess. 467, 536 (1982), 1982-2 C.B. 600, 632. The regulations apply
the reorganization rules to the target corporation and purchasing group
because the IRS and Treasury believe it is the simplest and most
effective means of achieving this intent, as they provide a pre-
existing set of rules with well-understood consequences.
The legislative history does not indicate any intention to provide
reorganization treatment for all purposes to exchanges of stock
incident to asset transfers after QSPs. Under general income tax rules,
an exchange of shares is only accorded reorganization treatment if the
continuity of interest requirement is satisfied with respect to the
target shareholders generally. This requirement is not satisfied if the
acquisition of the target in a QSP and the merger of the target into
the purchasing corporation's subsidiary are pursuant to an integrated
transaction in which the owner of the majority stake in the target
receives solely cash. See, e.g., Yoc Heating, 61 T.C. 168; Kass v.
Commissioner, 60 T.C. 218 (1973), aff'd, 491 F.2d 749 (3d Cir. 1974).
Thus, extension of reorganization treatment to the minority
shareholders in this case would inappropriately alter general
reorganization principles, and would not be grounded in the policies of
section 338.
Scope of minority shareholder exclusion provision. One commentator
suggests that if the final regulations continue to deny reorganization
treatment to the preexisting minority shareholders, the exclusion
should expressly apply to both the continuity of interest and control
rules, rather than only the continuity of interest rule (as proposed).
The final regulations adopt the commentator's suggestion by moving the
minority shareholder exclusion to the scope section. This change is
intended to clarify that the minority shareholder exclusion applies to
any transaction that qualifies as a tax-free reorganization by
operation of these regulations.
Effect of section 338(h)(8). Section 338(h)(8) provides that stock
and asset acquisitions made by members of the same affiliated group
shall be treated as made by one corporation. One commentator suggests
that the final regulations should specifically provide that section
338(h)(8) does not apply in determining whether the merger of target
qualifies as a reorganization. Otherwise, the commentator contends, a
transaction in which target ``sprinkles'' its assets among several
members of the purchasing corporation's affiliated group would qualify
as a reorganization, because section 338(h)(8) treats the purchasing
corporation and its affiliates as one corporation.
The final regulations do not adopt this suggestion because section
338(h) (including section 338(h)(8)), by its terms, only applies for
purposes of section 338 (e.g., determining whether a transaction
qualifies as a QSP). The final regulations only modify the continuity
of interest and control requirements for reorganizations, and any
transaction in which the target ``sprinkles'' its assets among several
purchasing corporation affiliates would likely fail other
reorganization requirements.
Guidance regarding mergers after a section 338 election. The
Preamble to the proposed regulations requests comments on whether
guidance is necessary on the proper treatment of post-QSP mergers if a
section 338 election is made for target. Because this request did not
receive a strong response, the IRS and Treasury have decided not to
provide such guidance in this document.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f), the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regulations is Steven M. Flanagan,
Office of Assistant Chief Counsel (Corporate), Internal Revenue
Service. However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of 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 * * *
[[Page 54944]]
Par. 2. Section 1.338-0 is amended by adding contents entries for
Sec. 1.338-2(c)(3) in numerical order to read as follows:
Sec. 1.338-0 Outline of topics.
* * * * *
Sec. 1.338-2 Miscellaneous issues under section 338.
* * * * *
(c) * * *
(3) Consequences of post-acquisition elimination of target.
(i) Scope.
(ii) Continuity of interest.
(iii) Control requirement.
(iv) Example.
(v) Effective date.
* * * * *
Par. 3. Section 1.338-2 is amended by adding paragraph (c)(3) to
read as follows:
Sec. 1.338-2 Miscellaneous issues under section 338.
* * * * *
(c) * * *
(3) Consequences of post-acquisition elimination of target--(i)
Scope. The rules of this paragraph (c)(3) apply to the transfer of
target assets to the purchasing corporation (or another member of the
same affiliated group as the purchasing corporation) (the transferee)
following a qualified stock purchase of target stock, if the purchasing
corporation does not make a section 338 election for target.
Notwithstanding the rules of this paragraph (c)(3), section 354(a) (and
so much of section 356 as relates to section 354) cannot apply to any
person other than the purchasing corporation or another member of the
same affiliated group as the purchasing corporation unless the transfer
of target assets is pursuant to a reorganization as determined without
regard to this paragraph (c)(3).
(ii) Continuity of interest. By virtue of section 338, in
determining whether the continuity of interest requirement of
Sec. 1.368-1(b) is satisfied on the transfer of assets from target to
the transferee, the purchasing corporation's target stock acquired in
the qualified stock purchase represents an interest on the part of a
person who was an owner of the target's business enterprise prior to
the transfer that can be continued in a reorganization.
(iii) Control requirement. By virtue of section 338, the
acquisition of target stock in the qualified stock purchase will not
prevent the purchasing corporation from qualifying as a shareholder of
the target transferor for the purpose of determining whether,
immediately after the transfer of target assets, a shareholder of the
transferor is in control of the corporation to which the assets are
transferred within the meaning of section 368(a)(1)(D).
(iv) Example. This paragraph (c)(3) is illustrated by the following
example:
Example. (A) Facts. P, T, and X are domestic corporations. T and
X each operate a trade or business. A and K, individuals unrelated
to P, own 85 and 15 percent, respectively, of the stock of T. P owns
all of the stock of X. The total adjusted basis of T's property
exceeds the sum of T's liabilities plus the amount of liabilities to
which T's property is subject. P purchases all of A's T stock for
cash in a qualified stock purchase. P does not make an election
under section 338(g) with respect to its acquisition of T stock.
Shortly after the acquisition date, and as part of the same plan, T
merges under applicable state law into X in a transaction that, but
for the question of continuity of interest, satisfies all the
requirements of section 368(a)(1)(A). In the merger, all of T's
assets are transferred to X. P and K receive X stock in exchange for
their T stock. P intends to retain the stock of X indefinitely.
(B) Status of transfer as a reorganization. By virtue of section
338, for the purpose of determining whether the continuity of
interest requirement of Sec. 1.368-1(b) is satisfied, P's T stock
acquired in the qualified stock purchase represents an interest on
the part of a person who was an owner of T's business enterprise
prior to the transfer that can be continued in a reorganization
through P's continuing ownership of X. Thus, the continuity of
interest requirement is satisfied and the merger of T into X is a
reorganization within the meaning of section 368(a)(1)(A). Moreover,
by virtue of section 338, the requirement of section 368(a)(1)(D)
that a target shareholder control the transferee immediately after
the transfer is satisfied because P controls X immediately after the
transfer. In addition, all of T's assets are transferred to X in the
merger and P and K receive the X stock exchanged therefor in
pursuance of the plan of reorganization. Thus, the merger of T into
X is also a reorganization within the meaning of section
368(a)(1)(D).
(C) Treatment of T and X. Under section 361(a), T recognizes no
gain or loss in the merger. Under section 362(b), X's basis in the
assets received in the merger is the same as the basis of the assets
in T's hands. X succeeds to and takes into account the items of T as
provided in section 381.
(D) Treatment of P. By virtue of section 338, the transfer of T
assets to X is a reorganization. Pursuant to that reorganization, P
exchanges its T stock solely for stock of X, a party to the
reorganization. Because P is the purchasing corporation, section 354
applies to P's exchange of T stock for X stock in the merger of T
into X. Thus, P recognizes no gain or loss on the exchange. Under
section 358, P's basis in the X stock received in the exchange is
the same as the basis of P's T stock exchanged therefor.
(E) Treatment of K. Because K is not the purchasing corporation
(or an affiliate thereof), section 354 cannot apply to K's exchange
of T stock for X stock in the merger of T into X unless the transfer
of T's assets is pursuant to a reorganization as determined without
regard to Sec. 1.338-2(c)(3). Under general income tax principles
applicable to reorganizations, the continuity of interest
requirement is not satisfied because P's stock purchase and the
merger of T into X are pursuant to an integrated transaction in
which A, the owner of 85 percent of the stock of T, received solely
cash in exchange for A's T stock. See, e.g., Yoc Heating v.
Commissioner, 61 T.C. 168 (1973); Kass v. Commissioner, 60 T.C. 218
(1973), aff'd, 491 F.2d 749 (3d Cir. 1974). Thus, the requisite
continuity of interest under Sec. 1.368-1(b) is lacking and section
354 does not apply to K's exchange of T stock for X stock. K
recognizes gain or loss, if any, pursuant to section 1001(c) with
respect to its T stock.
(v) Effective date. The provisions of this paragraph (c)(3) are
effective for transfers of target assets on or after October 26, 1995.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: October 3, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-26739 Filed 10-26-95; 8:45 am]
BILLING CODE 4830-01-U
