[Federal Register Volume 64, Number 113 (Monday, June 14, 1999)]
[Proposed Rules]
[Pages 31770-31772]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-14889]
[[Page 31770]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-115086-98]
RIN 1545-AW55
The Solely for Voting Stock Requirement in Certain Corporate
Reorganizations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
solely for voting stock requirement in certain corporate
reorganizations under section 368(a)(1)(C) of the Internal Revenue
Code. The proposed regulations provide that prior ownership of a
portion of a target corporation's stock by an acquiring corporation
generally will not prevent the solely for voting stock requirement in a
``C'' reorganization of the target corporation and the acquiring
corporation from being satisfied. This document also provides notice of
a public hearing on these proposed regulations.
DATES: Written comments must be received by September 13, 1999.
Requests to speak and outlines of topics to be discussed at the hearing
scheduled for October 5, 1999, must be received by September 13, 1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-115086-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-
115086-98), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Internet by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS Internet site at http://www.irs.ustreas.gov/tax_regs/
regslist.html. The public hearing will be held in Room 2615, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Marnie
Rapaport, (202) 622-7550; concerning submissions of comments, the
hearing, and/or to be placed on the building access list to attend the
hearing, Guy R. Traynor, (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. General Information
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under section 368(a)(1)(C) relating to the
definition of a ``C'' reorganization. A ``C'' reorganization is
described as the acquisition by one corporation of substantially all of
the properties of a target corporation in exchange solely for voting
stock of the acquiring corporation (or solely for voting stock of its
parent). See section 368(a)(1)(C). The use of money or other property
will not prevent an exchange from qualifying under section 368(a)(1)(C)
if at least 80 percent of the gross fair market value of all of the
property of the target corporation is acquired for voting stock (the
so-called boot relaxation rule). See section 368(a)(2)(B). The proposed
regulations provide that prior ownership of a portion of a target
corporation's stock by an acquiring corporation generally will not
prevent the solely for voting stock requirement in a ``C''
reorganization of the target corporation and the acquiring corporation
from being satisfied. These regulations propose to reverse the IRS's
longstanding position that the acquisition of assets of a partially
controlled subsidiary does not qualify as a tax-free reorganization
under section 368(a)(1)(C).
B. The Bausch & Lomb Doctrine
The IRS's position that the acquisition of assets of a partially
controlled subsidiary does not qualify as a tax-free reorganization
under section 368(a)(1)(C) is articulated in Rev. Rul. 54-396 (1954-2
C.B. 147). This position subsequently was sustained in litigation in
Bausch & Lomb Optical Co. v. Commissioner, 30 T.C. 602 (1958), aff'd,
267 F.2d 75 (2d Cir.), cert. denied, 361 U.S. 835 (1959) (the Bausch &
Lomb doctrine). In Rev. Rul. 54-396, a parent corporation owning 79
percent of the stock of a subsidiary as the result of a prior unrelated
cash purchase acquires all of the assets of the subsidiary in exchange
for a block of the parent's voting stock. The block of the parent's
stock that has been transferred to the subsidiary is then distributed
in liquidation pro rata to its shareholders. The ruling concludes that
the transaction does not qualify as a ``C'' reorganization under the
1939 Internal Revenue Code, but rather is a taxable liquidation of the
subsidiary. The rationale of the revenue ruling is that the acquisition
violates the solely for voting stock requirement, because the parent
corporation acquires only 21 percent of the subsidiary's assets in
exchange for the parent's voting stock, while the remaining 79 percent
of the subsidiary's assets is acquired as a liquidating distribution in
exchange for the previously held stock of the subsidiary.
In Bausch & Lomb (which had nearly identical facts to Rev. Rul. 54-
396), the parent corporation, Bausch & Lomb, owned 79.9 percent of the
stock of Riggs Optical Company. In order to acquire the assets of
Riggs, Bausch & Lomb exchanged shares of its voting stock for all of
the Riggs assets. Pursuant to a prearranged plan, Riggs subsequently
was dissolved and distributed its only asset, the Bausch & Lomb shares,
pro rata to its shareholders. The Tax Court and the Second Circuit
Court of Appeals sustained the Commissioner's contention that the
acquisition of the Riggs assets and the dissolution of Riggs should be
viewed together as part of a single plan, and that the surrender by
Bausch & Lomb of its Riggs stock constituted nonstock consideration in
violation of the ``C'' reorganization requirements.
C. The Solely for Voting Stock Requirement
The ``C'' reorganization first appeared in 1921 when a tax-free
reorganization was defined as a merger or consolidation ``including the
acquisition by one corporation * * * of substantially all of the
properties of another corporation.'' Revenue Act of 1921, section
202(c)(2), 42 Stat. 227, 230. The statutory language failed to limit
the type of permissible consideration, arguably allowing an acquisition
for cash to qualify as a merger.
In 1934, Congress restricted the permissible consideration in an
acquisition of a target's stock or assets (in other than a statutory
merger or consolidation) to voting stock. Revenue Act of 1934, section
112(g)(1), 48 Stat. 680, 705. The stated purpose for this limitation
was to ``remove the danger that taxable sales [could] be cast into the
form of a reorganization.'' See H.R. Rep. No. 704, 73d Cong., 2d Sess.
12-14 (1934), 1939-1 C.B. (Part 2) 554, 563-565; S. Rep. No. 558, 73d
Cong., 2d Sess. 16-17 (1934), 1939-1 C.B. (Part 2) 586, 598-599.
D. Reasons for Change
The legislative history of the ``C'' reorganization provisions
provides that the purpose of the solely for voting
[[Page 31771]]
stock requirement in section 368(a)(1)(C) is to prevent transactions
that resemble sales from qualifying for nonrecognition of gain or loss
available to corporate reorganizations. The IRS and Treasury Department
have concluded that a transaction in which the acquiring corporation
converts an indirect ownership interest in assets to a direct interest
in those assets does not resemble a sale and, thus, have concluded that
Congress did not intend to disqualify a transaction from qualifying
under section 368(a)(1)(C) merely because the acquiring corporation has
prior ownership of a portion of a target corporation's stock. Because
the judicial doctrine of continuity of interest arose from similar
concerns, the regulations under Sec. 1.368-1(e)(1)(i) reach a similar
conclusion with respect to the continuity of interest doctrine.
Moreover, the taxable treatment of the ``upstream'' ``C''
reorganization under the Bausch & Lomb doctrine contrasts with the tax-
free treatment of the ``upstream'' ``A'' reorganization under section
368(a)(1)(A). See also Rev. Rul. 57-278 (1957-1 C.B. 124) (Bausch &
Lomb does not apply to an asset acquisition by a newly formed
corporation in exchange for its parent's stock, even though prior to
the acquisition the parent already owned 72 percent of the transferor's
stock). In the ``upstream'' ``A'' reorganization, the indirect interest
of the parent in the assets of its subsidiary (i.e., the target
corporation) is converted into a direct interest in the subsidiary's
assets. An exchange is deemed to occur for purposes of section 354 even
if, in form, one does not occur. The IRS and Treasury Department have
concluded that the ``upstream'' reorganization under section
368(a)(1)(C) (i.e., the Bausch & Lomb transaction) should not be
treated differently from the ``upstream'' ``A'' reorganization solely
because the acquiring corporation already owns stock in the target
corporation. Accordingly, the IRS and Treasury Department have
concluded that the Bausch & Lomb doctrine does not further the
principles of reorganization treatment.
Explanation of Provisions
The proposed regulations provide that preexisting ownership of a
portion of a target corporation's stock by an acquiring corporation
generally will not prevent the solely for voting stock requirement in a
``C'' reorganization from being satisfied. If the boot relaxation rule
applies, the sum of (i) the money or other property that is distributed
in pursuance of the plan of reorganization to the shareholders of the
target corporation other than the acquiring corporation and to the
creditors of the target corporation pursuant to section 361(b)(3), and
(ii) the assumption of all the liabilities of the target corporation
(including liabilities to which the properties of the target
corporation are subject), cannot exceed 20 percent of the value of all
of the properties of the target corporation. In this regard, the
proposed regulations provide that if, in connection with a potential
``C'' reorganization of a target corporation into an acquiring
corporation, the acquiring corporation acquires the target
corporation's stock for consideration other than its own voting stock
(or voting stock of a corporation in control of the acquiring
corporation if such stock is used in the acquisition of the target
corporation's properties), whether from a shareholder of the target
corporation or from the target corporation itself, such consideration
will be treated as money or other property exchanged by the acquiring
corporation for the target corporation's assets. Accordingly, the
requirements of section 368(a)(1)(C) will not be satisfied unless the
transaction can qualify under the boot relaxation rule of section
368(a)(2)(B). The determination of whether there has been an
acquisition in connection with a potential ``C'' reorganization of a
target corporation's stock for consideration other than an acquiring
corporation's own voting stock (or voting stock of a corporation in
control of the acquiring corporation if such stock is used in the
acquisition of the target corporation's properties) will be made on the
basis of all of the facts and circumstances.
Rev. Rul. 54-396 (1954-2 C.B. 147) will become obsolete when the
proposed regulations are issued in final form.
The regulations are proposed to apply to transactions occurring
after the date that a Treasury decision adopting these rules is
published in the Federal Register, except that they do not apply to any
transactions occurring pursuant to a written agreement which is
(subject to customary conditions) binding on the date the regulations
are published as final regulations in the Federal Register, and at all
times thereafter.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 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 proposed regulations and, because
the proposed 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 will be submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on its impact on small
business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are timely submitted to the IRS. The IRS and
Treasury request comments on the clarity of the proposed rule and how
it may be made easier to understand. All comments will be available for
public inspection and copying.
A public hearing has been scheduled for October 5, 1999, beginning
at 10:00 a.m. in Room 2615 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must request to speak, and
submit written comments and an outline of the topics to be discussed
and the time to be devoted to each topic (signed original and eight (8)
copies) by September 13, 1999. A period of ten minutes will be
allocated to each person for making comments. An agenda showing the
scheduling of the speakers will be prepared after the deadline for
receiving outlines has passed. Copies of the agenda will be available
free of charge at the hearing.
Drafting Information: The principal author of these regulations is
Marnie Rapaport of the Office of the Assistant Chief Counsel
(Corporate), IRS. However, other personnel from the IRS and Treasury
Department participated in their development.
[[Page 31772]]
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 1.368-2 is amended by adding paragraph (d)(4) to
read as follows:
Sec. 1.368-2 Definition of terms.
* * * * *
(d) * * *
(4) (i) For purposes of paragraphs (d)(1) and (2)(ii) of this
section, prior ownership of a portion of the stock of the target
corporation by an acquiring corporation will not by itself prevent the
solely for voting stock requirement of such paragraphs from being
satisfied. In a transaction in which the acquiring corporation has
prior ownership of a portion of the stock of the target corporation,
the requirement of paragraph (2)(ii) is satisfied only if the sum of
the money or other property that is distributed in pursuance of the
plan of reorganization to the shareholders of the target corporation
other than the acquiring corporation and to the creditors of the target
corporation pursuant to section 361(b)(3), and all of the liabilities
of the target corporation assumed by the acquiring corporation
(including liabilities to which the properties of the target
corporation are subject), does not exceed 20 percent of the value of
all of the properties of the target corporation. If, in connection with
a potential acquisition by an acquiring corporation of substantially
all of a target corporation's properties, the acquiring corporation
acquires the target corporation's stock for consideration other than
the acquiring corporation's own voting stock (or voting stock of a
corporation in control of the acquiring corporation if such stock is
used in the acquisition of the target corporation's properties),
whether from a shareholder of the target corporation or the target
corporation itself, such consideration is treated, for purposes of
paragraphs (d)(1) and (2) of this section, as money or other property
exchanged by the acquiring corporation for the target corporation's
properties. Accordingly, the transaction will not qualify under section
368(a)(1)(C) unless, treating such consideration as money or other
property, the requirements of section 368(a)(2)(B) and paragraph
(d)(2)(ii) of this section are met. The determination of whether there
has been an acquisition in connection with a potential reorganization
under section 368(a)(1)(C) of a target corporation's stock for
consideration other than an acquiring corporation's own voting stock
(or voting stock of a corporation in control of the acquiring
corporation if such stock is used in the acquisition of the target
corporation's properties) will be made on the basis of all of the facts
and circumstances.
(ii) The following examples illustrate the principles of this
paragraph (d)(4):
Example 1. Corporation P (P) holds 60 percent of the Corporation
T (T) stock that P purchased several years ago in an unrelated
transaction. T has 100 shares of stock outstanding. The other 40
percent of the T stock is owned by Corporation X (X), an unrelated
corporation. T has properties with a fair market value of $110 and
liabilities of $10. T transfers all of its properties to P. In
exchange, P assumes the $10 of liabilities, and transfers to T $30
of P voting stock and $10 of cash. T distributes the P voting stock
and $10 of cash to X and liquidates. The transaction satisfies the
solely for voting stock requirement of paragraph (d)(2)(ii) of this
section because the sum of $10 of cash paid to X and the assumption
by P of $10 of liabilities does not exceed 20% of the value of the
properties of T.
Example 2. The facts are the same as in Example 1 except that P
purchased the 60 shares of T for $60 in cash in connection with the
acquisition of T's assets. The transaction does not satisfy the
solely for voting stock requirement of paragraph (d)(2)(ii) of this
section because P is treated as having acquired all of the T assets
for consideration consisting of $70 of cash, $10 of liability
assumption and $30 of P voting stock, and the sum of $70 of cash and
the assumption by P of $10 of liabilities exceeds 20% of the value
of the properties of T.
(iii) This paragraph (d)(4) applies to transactions occurring after
the date these regulations are published as final regulations in the
Federal Register, except that this paragraph (d)(4) does not apply to
any transactions occurring pursuant to a written agreement which is
(subject to customary conditions) binding on the date the regulations
are published as final regulations in the Federal Register, and at all
times thereafter.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-14889 Filed 6-11-99; 8:45 am]
BILLING CODE 4830-01-P
