[Federal Register Volume 64, Number 163 (Tuesday, August 24, 1999)]
[Proposed Rules]
[Pages 46155-46165]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21876]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-116733-98]
RIN 1545-AW79
Guidance Under Section 355(e); Recognition of Gain on Certain
Distributions of Stock or Securities in Connection With an Acquisition
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
recognition of gain on certain distributions of stock or securities of
a controlled corporation in connection with an acquisition. Changes to
the applicable law were made by the Taxpayer Relief Act of 1997. These
proposed regulations affect corporations and are necessary to provide
them with guidance needed to comply with these changes. This document
also provides notice of a public hearing on these proposed regulations.
DATES: Written or electronic comments must be received by January 5,
2000. Outlines of topics to be discussed at the public hearing
scheduled for January 26, 2000, at 10 a.m. must be received by January
5, 2000.
ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-116733-98), 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-
116733-98), 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 proposed regulations,
Brendan O'Hara, (202) 622-7530; concerning submissions of comments,
delivering comments, the hearing, and/or to be placed on the building
access list to attend the hearing, LaNita Van Dyke, (202) 622-7190 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. State of the Law Before Section 355(e)
Section 355 generally provides that, if a corporation distributes
to its shareholders stock of a corporation which it controls
immediately before the distribution and certain other conditions are
met, neither the distributing corporation nor its shareholders
recognize gain or loss. A number of the conditions for tax free
treatment (for example, the continuity of interest requirement of
Sec. 1.355-2(c), the ``no device'' requirement of section 355(a)(1)(B),
the five-year active business requirement of section 355(b), and the
limitation on disqualified stock under section 355(d)) operate to limit
the circumstances in which the distributing or controlled corporation
can undergo changes of control in conjunction with a distribution that
qualifies for corporate and shareholder-level nonrecognition under
section 355. Nevertheless, prior to the enactment of section 355(e), it
was possible for such changes to occur, for example, in the context of
tax free reorganizations, while qualifying for tax free treatment under
section 355. See, e.g., Commissioner v. Mary Archer W. Morris Trust,
367 F.2d 794 (4th Cir. 1966).
B. Legislative Proposals Leading to Section 355(e)
As part of its Fiscal Year 1997 Budget, the Administration proposed
a provision that would require a distributing corporation to recognize
gain on the distribution of a controlled
[[Page 46156]]
corporation's stock unless the direct and indirect shareholders of the
distributing corporation, as a group, controlled at least 50 percent of
the vote and value of both corporations at all times during the 4-year
period beginning 2 years before the distribution. See Department of the
Treasury, General Explanation of the Administration's Revenue
Proposals, p. 86 (March 1996) (hereinafter referred to as the
``Administration Proposal''). Under the Administration Proposal, the
retained 50-percent interest must consist of ``permissible stock,''
which includes, in addition to stock retained over the 4-year period,
stock of the distributing or controlled corporation ``received by the
shareholder in a transaction which is unrelated to the distribution * *
*.'' Revenue Proposals Contained in President Clinton's Budget Plan as
Released on Mar. 19, 1996, Sec. 9522, [1996] 83 Stand. Fed. Tax Rep.
(CCH) No. 15A.
The Administration Proposal described an unrelated transaction as,
``[a] transaction that is not pursuant to a common plan or arrangement
that includes the distribution,'' and cited a hostile acquisition of
the distributing or controlled corporation commencing after the
distribution as an example of an unrelated transaction. The
Administration Proposal contrasted this with a friendly acquisition,
which generally would be considered related to the distribution if the
acquisition was pursuant to an arrangement negotiated prior to the
distribution, even if the acquisition was subject to various conditions
at the time of the distribution.
On April 17, 1997, House Ways and Means Committee Chairman Archer
and Senate Finance Committee Chairman Roth and Ranking Member Moynihan
introduced identical bills (H.R. 1365, 105th Cong. (1997) and S. 612,
105th Cong. (1997), hereinafter referred to as the ``Bills'') that
provided for a new section 355(e) that is similar to the enacted
version. The Bills were concerned with a ``plan (or series of related
transactions) pursuant to which a person acquires stock representing a
50-percent or greater interest in the distributing corporation or any
controlled corporation * * *.'' S. 612, 105th Cong. (1997). The
introductory statement to the legislation contained a reference to
acquisitions ``pursuant to a plan or arrangement in existence on the
date of distribution * * *.'' The statement further explained:
``Whether a corporation is acquired would be determined under rules
similar to those of present-law section 355(d), except that
acquisitions would not be restricted to purchase transactions. Thus an
acquisition would occur if a person--or persons acting in concert--* *
* acquired * * * stock * * * pursuant to a plan or arrangement.'' See
143 Cong. Rec. E703 (Apr. 17, 1997) (introductory statement of Chairman
Archer); 143 Cong. Rec. S3360 (Apr. 17, 1997) (introductory statement
of Chairman Roth).
C. Enactment of Section 355(e)
Section 355(e) was enacted in 1997. Public Law 105-34, section
1012(a) (1997). The committee reports state that section 355 was
intended to permit the tax free division of existing business
arrangements among existing shareholders. The reports state that ``[i]n
cases in which it is intended that new shareholders will acquire
ownership of a business in connection with a spin off, the transaction
more closely resembles a corporate level disposition of the portion of
the business that is acquired'' and provide that gain is recognized
``if, pursuant to a plan or arrangement in existence on the date of
distribution, either the controlled or distributing corporation is
acquired * * *.'' H.R. Rep. No. 105-148, at 462 (1997); see also S.
Rep. No. 105-33, at 139-40 (1997) (slight variation in language). The
Conference Report adds, ``[a]s under the House bill and Senate
amendment, a public offering of sufficient size can result in an
acquisition that causes gain recognition under the provision.'' H.R.
Conf. Rep. No. 105-220, at 533 (1997).
The statute as enacted contained two important changes from the
Administration Proposal and Bills relevant to determining whether an
acquisition is part of a plan (or series of related transactions) that
includes the distribution. In the Bills, proposed sections
355(e)(2)(A)(ii) and (4)(C)(i) provided that a ``person,'' as modified
by section 355(d)(7), must acquire 50 percent or more of the
distributing or controlled corporation. The term ``plan or
arrangement'' used in section 355(d)(7)(B) treats two or more persons
acting ``pursuant to a plan or arrangement'' with regard to a stock
acquisition as one person. However, when section 355(e) was enacted,
the reference in section 355(e)(2)(A)(ii) to acquisitions by a
``person'' was changed to ``1 or more persons.'' In addition, the
reference to section 355(d)(7)(B) (treating two or more persons acting
``pursuant to a plan or arrangement'' as one person) was deleted from
section 355(e)(4)(C)(i). The effect of these two changes is to remove
the requirement that 50 percent or more of the stock of the
distributing or controlled corporation must be acquired by acquirors
acting in concert for section 355(e) to apply.
In addition, the reference in the Conference Report to public
offerings as transactions that could cause gain to be recognized under
section 355(e) indicates Congress did not believe negotiations between
the distributing corporation and an acquiror were necessary in order
for an acquisition to be pursuant to a plan that included the
distribution. Thus, to determine whether a plan of acquisition exists,
one must look at all parties to the transaction, including the
distributing and controlled corporations and their shareholders, not
just the potential acquirors.
As enacted, section 355(e)(1) provides that the stock of a
controlled corporation will not be qualified property under section
355(c)(2) or section 361(c)(2) if, under section 355(e)(2)(A), the
stock is distributed as ``part of a plan (or series of related
transactions) pursuant to which 1 or more persons acquire directly or
indirectly stock representing a 50-percent or greater interest in the
distributing corporation or any controlled corporation.'' Thus, if
section 355(e)(1) applies to a distribution, the distributing
corporation is taxed on the amount by which the distributed stock's
fair market value exceeds its basis. Distributee shareholders receive
the controlled corporation stock tax free, but do not increase their
bases to reflect the corporate level gain recognized by the
distributing corporation on the distribution.
Explanation of Provisions
The proposed regulations under section 355(e) provide guidance
concerning the interpretation of the phrase ``plan (or series of
related transactions).'' The proposed regulations also address the
determination of the distributing corporation's gain when multiple
controlled corporations are distributed and the distributions are part
of a plan (or series of related transactions) pursuant to which a 50-
percent or greater interest in one or more, but not all, of the
distributed controlled corporations is acquired. The Department of the
Treasury and the IRS plan to issue regulations addressing other issues
arising under section 355(e), including aggregation and attribution
rules (including provisions for public trading) and the administration
of the statute of limitations provision of section 355(e)(4)(E).
Comments concerning the proposed regulations and additional
[[Page 46157]]
issues that should be addressed in regulations are welcome.
A. Plan or Series of Related Transactions
Whether two transactions are part of the same ``plan (or series of
related transactions)'' under section 355(e)(2)(A) is a subjective
test, depending ultimately on the intentions and expectations of the
relevant parties. As discussed above, indications are that Congress
intended ``plan (or series of related transactions)'' to be interpreted
broadly. Unlike the Administration Proposal and the Bills, which
utilized the section 355(d) concept of ``a person'' (with aggregation)
as the reference for relevant acquirors, the statute, as enacted,
expanded the universe of transactions to which section 355(e)
potentially applies by providing that the relevant acquirors could be
``1 or more persons.'' Also, the guidance in the Conference Report that
public offerings of a sufficient size could trigger section 355(e)
suggests that there does not necessarily have to be an identified
acquiror on the date of the distribution for section 355(e) to apply,
nor is the intent of the acquiror at the time of the distribution
necessarily relevant in determining whether there is a plan.
The proposed regulations rely on a variety of factors to determine
the existence of a plan (or series of related transactions)
(hereinafter referred to as a ``plan''). These factors include the
business purpose or purposes for the distribution; the intentions of
the parties; the existence of agreements, understandings, arrangements,
or substantial negotiations; the timing of the transactions; the
likelihood of an acquisition; and the causal connection between the
distribution and the acquisition.
Congress specified one factor, temporal proximity, as affecting the
determination of whether a plan exists. Specifically, section
355(e)(2)(B) provides a presumption that a plan exists if ``1 or more
persons acquire directly or indirectly stock representing a 50-percent
or greater interest in the distributing corporation or any controlled
corporation during the 4-year period beginning on the date which is 2
years before the date of the distribution.'' Accordingly, the proposed
regulations provide that distributions within 2 years of an acquisition
of the distributing corporation or a controlled corporation are
presumed to be part of a plan. The proposed regulations outline the
elements the distributing corporation must establish to rebut the
statutory presumption.
1. Acquisitions On or After a Distribution
General Rebuttal
In the case of an acquisition occurring within 2 years after a
distribution, the proposed regulations allow the distributing
corporation to rebut the presumption by establishing by clear and
convincing evidence that (i) the distribution was motivated in whole or
substantial part by a corporate business purpose (other than an intent
to facilitate an acquisition or decrease the likelihood of the
acquisition of one or more businesses by separating those businesses
from others that are likely to be acquired) and (ii) the acquisition
occurred more than 6 months after the distribution and there was no
agreement, understanding, arrangement, or substantial negotiations
concerning the acquisition at the time of the distribution or within 6
months thereafter. Decreasing ``the likelihood of the acquisition of
one or more businesses by separating those businesses from others that
are likely to be acquired'' generally refers to transactions in which
one business, a perceived takeover target, is separated from another
via a stock distribution in an attempt to spare the other business from
acquisition. Distributions intended to ``decrease the likelihood of the
acquisition of one or more businesses by separating those businesses
from others that are likely to be acquired'' are often difficult to
differentiate from those intended to ``facilitate an acquisition.''
Both relate to a perceived possibility of acquisition and should
receive similar treatment.
In this general rebuttal, the proposed regulations rely on
corporate business purpose as a key factor indicating whether a
distribution and an acquisition are part of a plan. Corporate business
purpose is an important concept in the overall administration of
section 355. The existence of a nonacquisition related corporate
business purpose that prompted, in whole or substantial part, the
distributing corporation to make the stock distribution suggests there
is not a significant causal connection between the distribution and
acquisition. The intent of the distributing corporation, the controlled
corporation, or the controlling shareholders of either the distributing
or controlled corporation to facilitate an acquisition or decrease the
likelihood of the acquisition of one or more businesses by separating
those businesses from others that are likely to be acquired is relevant
in determining the extent to which the distribution was motivated in
whole or substantial part by another corporate business purpose within
the meaning of Sec. 1.355-2. Analyzing whether there is another
substantial corporate business purpose for the distribution in light of
an acquisition-related purpose is similar to analyzing whether there is
a corporate business purpose for a distribution in light of the
potential avoidance of federal taxes. See Sec. 1.355-2(b)(1) and (5),
Example 8. Thus, another business purpose must be real and substantial
even in light of the acquisition business purpose.
The reliance on business purpose in the general rebuttal is
consistent with the suggestions of many commentators writing about
section 355(e), who identified corporate business purpose as an
important factor in determining whether an acquisition and distribution
are part of a plan.
Alternative Rebuttal
Reliance on a substantial nonacquisition business purpose as proof
of no ``plan'' is appropriate when the distribution and acquisition are
separated by a sufficient amount of time. Thus, the general rebuttal is
not satisfied in certain cases, including where an acquisition occurs
within 6 months after a distribution or where a distribution was not
substantially motivated by a corporate business purpose other than an
intention to facilitate (or decrease the likelihood of) an acquisition.
These acquisitions occur in circumstances more likely to indicate the
existence of a plan at the time of the distribution. Thus, these
acquisitions are subject to heightened scrutiny and will be considered
part of a plan unless taxpayers satisfy a more stringent alternative
rebuttal.
Unlike the general rebuttal, a nonacquisition business purpose
alone is not sufficient under the alternative rebuttal. Rather,
taxpayers must satisfy all prongs of a three-prong test.
The first prong of the alternative rebuttal may be satisfied in
either of two ways. The distributing corporation must establish by
clear and convincing evidence either that (i) at the time of the
distribution, the distributing corporation, the controlled corporation,
and their controlling shareholders did not intend that one or more
persons would acquire a 50-percent or greater interest in the
distributing or any controlled corporation during the statutory
presumption period (or later pursuant to an agreement, understanding,
or arrangement existing at the time of the distribution or within 6
months thereafter) or (ii) the distribution was not motivated in whole
or substantial part by an intention to
[[Page 46158]]
facilitate an acquisition of an interest in the distributing or
controlled corporation. Clause (i) may be satisfied even in situations
where one or more of the relevant parties intend that the distribution
will facilitate an acquisition or acquisitions, so long as the parties
do not intend that there be a 50-percent or greater change in ownership
during the statutory presumption period. Alternatively, clause (ii) may
be satisfied where the parties intend a 50-percent or greater change in
ownership during the presumption period, provided that the parties do
not intend that the distribution will facilitate any part of the
acquisitions.
Under the second prong of the alternative rebuttal, the
distributing corporation must establish by clear and convincing
evidence that, at the time of the distribution, neither the
distributing corporation, the controlled corporation, nor their
controlling shareholders reasonably would have anticipated that it was
more likely than not that one or more persons would acquire a 50-
percent or greater interest in the distributing corporation or the
controlled corporation within 2 years after the distribution (or later
pursuant to an agreement, understanding, or arrangement existing at the
time of the distribution or within 6 months thereafter) who would not
have acquired such interests if the distribution had not occurred.
This prong of the alternative rebuttal (hereinafter referred to as
the ``reasonable anticipation'' test) incorporates two important
concepts. First, it identifies reasonably anticipated acquisitions of
the distributing or controlled corporation that would not have occurred
but for the distribution and, because a causal connection exists
between the two transactions, treats them as part of a plan. Second, it
reflects the idea that reasonable anticipation, not just the presence
of negotiations, is important in determining whether a plan exists.
Considering reasonable anticipation of certain acquisitions is
consistent with the legislative history. Though descriptions of the
Administration Proposal included references to negotiations and
distinctions between hostile and friendly acquisitions, the focus of
section 355(e), as enacted, is whether a relationship exists between
the distribution and the fact that persons other than the existing
shareholders became owners of the distributing or controlled
corporation.
A reasonable anticipation standard is necessary to implement
section 355(e). Otherwise, a distributing corporation could attempt to
avoid section 355(e) by distributing a controlled corporation under
circumstances that virtually assure an acquisition of the distributing
or controlled corporation, but arguing that, despite the imminence of
the acquisition, effectuating the acquisition was not a motive for the
distribution. A part of planning any transaction includes attempting to
foresee actions others might take in response. Consistent with this
business practice, it is appropriate, especially for acquisitions
subject to heightened scrutiny, to require the distributing corporation
to take into account the reasonably anticipated, likely actions of
others to demonstrate that a distribution and acquisition are not part
of a plan.
The second prong of the alternative rebuttal is not satisfied if,
at the time of the distribution, the relevant parties would reasonably
anticipate that the distribution would give rise to all of an
acquisition of a 50 percent interest in the distributing or controlled
corporation. (The rebuttal is satisfied if the distributing corporation
establishes by clear and convincing evidence that the relevant parties
would not reasonably anticipate an acquisition of a 50 percent or
greater interest by persons who would not acquire such interests absent
the distribution.) This standard is to be contrasted with the first
prong of the rebuttal, which is not satisfied if one or more of the
relevant parties intended that there be a 50 percent or greater
acquisition of distributing or controlled during the applicable time
period, and the distribution is intended to facilitate all or any part
of that acquisition. Because some acquisitions might be reasonably
anticipated to occur without regard to whether the distribution takes
place, the Department of the Treasury and the IRS believe that the
distribution must be directly linked to all 50 percent of the
acquisition to fail the ``reasonable anticipation'' test. However, a
different result is called for where the relevant parties intend a 50
percent acquisition. In that case, it would appear that the aggregation
of the various acquisitions comprising the 50 percent acquisition are
themselves part of a single plan, so a distribution intended to
facilitate only some of those acquisitions would be part of a plan also
involving those other acquisitions not directly facilitated by the
acquisition.
In developing the reasonable anticipation test, the Department of
the Treasury and the IRS rejected suggestions by some commentators that
serious negotiations or agreement with an acquiror need to have taken
place at the time of distribution for a plan to exist. Requiring mutual
agreement or negotiation is inappropriate because Congress intended the
statute to apply in situations beyond those in which a distribution is
made prior to and as part of an acquisition by a specifically
identified acquiror. Section 355(e)(2)(B) makes clear that the section
is intended to apply to acquisitions before and after a distribution.
The legislative history also clarifies that a public offering after a
distribution can trigger section 355(e) even though presumably no
public buyer would have been negotiated with or even identified at the
time of the distribution. Because Congress intended distributions
designed to facilitate public offerings to be covered, other
transactions that are economically similar also should be covered.
These transactions include a private placement of the distributing or
controlled corporation's stock or an auction of such stock by an
investment banker. Like public offerings, these transactions do not
necessarily involve predistribution negotiations or agreements
regarding subsequent acquisitions and yet may still be part of the
distributing or controlled corporation's plan.
Thus, we believe that section 355(e) was intended to apply to a
range of transactions, not limited to those in which a mutual agreement
or negotiations relating to the acquisition occurred prior to the
distribution. To require negotiations or agreements to be present prior
to a distribution either would inappropriately exclude certain
transactions from the coverage of the statute or would create a higher
threshold for the existence of a plan in certain acquisitions than in
other acquisitions.
The third prong of the alternative rebuttal reiterates a
requirement in the general rebuttal. The distributing corporation must
establish by clear and convincing evidence that the distribution was
not motivated in whole or substantial part by an intention to decrease
the likelihood of the acquisition of one or more businesses by
separating those businesses from others that are likely to be acquired.
For purposes of applying the alternative rebuttal, the consequences
of the application of section 355(e), directly or by indemnity, are
disregarded in determining the intentions, motivations, and reasonable
anticipations of the relevant parties. To do otherwise might give rise
to a circularity in the application of the rules. If the consequences
of the application of section 355(e) were relevant in determining such
intentions, motivations, and reasonable anticipations, the distributing
corporation could argue that objective evidence indicated that it would
satisfy
[[Page 46159]]
the alternative rebuttal, since arguably it would not be reasonable for
an acquiror to act in a manner that would cause liability for tax under
section 355(e). Conversely, the IRS could argue that the presence of an
indemnity agreement indicated that the parties anticipated liability
for tax under section 355(e).
Acquisitions More Than 2 Years After a Distribution
To prevent taxpayers from attempting to avoid the presumption
period by delaying a planned acquisition beyond 2 years from the date
of distribution, the proposed regulations provide that an acquisition
occurring more than 2 years after the distribution is presumed part of
a plan if there was an agreement, understanding, or arrangement
concerning the acquisition at the time of the distribution or within 2
years thereafter. The distributing corporation may rebut the
presumption using the general or alternative rebuttal discussed above.
To provide certainty for transactions that, because of their separation
in time, are unlikely to be part of a plan, the proposed regulations
provide that, if there was no agreement, understanding, or arrangement
concerning the acquisition at the time of the distribution or within 2
years thereafter, a distribution and an acquisition occurring more than
2 years afterwards are not part of a plan.
2. Acquisitions Before a Distribution
Acquisitions Within 2 Years Before a Distribution
Section 355(e) also applies to transactions in which an acquisition
of the distributing or controlled corporation's stock precedes a
distribution of the controlled corporation. When the transactions being
tested as part of a plan occur in this order, the most reliable
indicators that a plan exists are an intent to make the distribution at
the time of the acquisition and a causal connection between the
acquisition and the distribution. In particular, if a person becomes a
controlling shareholder by acquisition, that person's intention becomes
the single best indicator of whether a later distribution was part of a
plan. The proposed regulations allow a distributing corporation to
rebut the presumption by establishing by clear and convincing evidence
that, at the time of the acquisition, the distributing corporation and
its controlling shareholders (determined immediately after the
acquisition) did not intend to effectuate a distribution.
Alternatively, the distributing corporation can rebut the presumption
by establishing by clear and convincing evidence that the distribution
would have occurred at approximately the same time and under
substantially the same terms regardless of the acquisition (and, in the
case of an issuance of stock, all acquisitions that are part of such
issuance), unless a person acquiring an interest becomes a controlling
shareholder by reason of the acquisition or at any point thereafter and
before the end of the 2-year period beginning on the date of the
distribution (or later pursuant to an agreement, understanding, or
arrangement existing at the time of the distribution or within 6 months
thereafter).
Acquisitions More Than 2 Years Before a Distribution
If an acquisition of an interest in the distributing corporation or
the controlled corporation occurs more than 2 years before a
distribution, the presumption shifts in favor of the taxpayer. The
acquisition and the distribution are presumed not to be part of a plan
unless the Commissioner can establish by clear and convincing evidence
that, at the time of the acquisition, (i) the distributing corporation
or its controlling shareholders intended to effectuate the distribution
and (ii) that the distribution would not have occurred at approximately
the same time and under substantially the same terms regardless of that
acquisition (and, in the case of an issuance of stock, all acquisitions
that are part of such issuance) or that a person acquiring an interest
in that acquisition becomes a controlling shareholder by reason of that
acquisition or at any point thereafter and before the end of the 2-year
period beginning on the date of the distribution (or later pursuant to
an agreement, understanding, or arrangement existing at the time of the
distribution or within six months thereafter). Because the passage of
time makes it less likely that an acquisition and distribution are part
of a plan, after two years the proposed regulations shift the burden of
proof to the IRS to prove the existence of a plan. However, the
proposed regulations do not allow a taxpayer to avoid section 355(e) by
delaying the distribution when the distribution clearly was intended at
the time of the acquisition.
3. Agreement, Understanding, Arrangement, or Substantial Negotiations
The proposed regulations do not define with precision the terms
agreement, understanding, arrangement, or substantial negotiations. A
binding contract is clearly included as an agreement, but, depending on
all relevant facts and circumstances, parties can have an agreement,
understanding, or arrangement even though they have not reached
agreement on all terms. Under certain circumstances, such as in public
offerings or auctions of the distributing or controlled corporation's
stock by an investment banker, an agreement, understanding,
arrangement, or substantial negotiations can take place regarding an
acquisition even if the acquiror has not been specifically identified.
The Department of the Treasury and the IRS are particularly interested
in receiving comments regarding transactions that involve an investment
banker and when contacts by the distributing corporation or the
controlled corporation with an investment banker or contacts with
potential acquirors by an investment banker on behalf of the
distributing corporation or the controlled corporation should or should
not be considered an agreement, understanding, arrangement, or
substantial negotiations.
4. Options
The proposed regulations also treat certain options as agreements.
If stock of the distributing or controlled corporation is acquired
pursuant to an option, the option is treated as an agreement unless the
distributing corporation establishes by clear and convincing evidence
that, on the later of the date of distribution or issuance, the option
was not more likely than not to be exercised. Generally, call options,
warrants, convertible obligations, the conversion feature of
convertible stock, put options, redemption agreements, restricted
stock, and any other instruments that provide for the right or
possibility to issue, redeem, or transfer stock, cash settlement
options, and other similar interests are treated as options. An option
on an option is treated as an option under the proposed regulations. If
there is an agreement, understanding, or arrangement to issue an option
before the end of the 6 month period beginning on the date of the
distribution, the option will be treated as issued on the date of the
agreement, understanding, or arrangement. If an agreement,
understanding, or arrangement to issue an option is reached, or an
option is issued, more than 6 months but not more than 2 years after
the distribution, and there were substantial negotiations regarding the
issuance of the option or the acquisition of the stock underlying the
option before the end of the 6 month period beginning on the date of
the distribution, the option will be treated as issued 6 months after
the
[[Page 46160]]
distribution. If there is an agreement, understanding, or an
arrangement to issue an option more than 6 months but not more than 2
years after the distribution, and there were no substantial
negotiations regarding the issuance of the option or the acquisition of
the stock underlying the option before the end of the 6 month period
beginning on the date of the distribution, the option will be treated
as issued on the date of the agreement, understanding, or arrangement.
The proposed regulations exempt certain options from treatment as
options unless they are issued, transferred, or listed with a principal
purpose of avoiding the application of section 355(e) or the proposed
regulations. The enumerated exceptions cover certain commercially
customary options unlikely to be used to avoid section 355(e) or the
proposed regulations.
5. Aggregating Acquisitions That are Pursuant to a Plan
Under the proposed regulations, each acquisition of stock of a
distributing or controlled corporation must be tested to determine
whether the acquisition is pursuant to a plan involving a distribution.
Each acquisition of stock of a corporation acquired pursuant to a plan
involving a distribution is aggregated with all acquisitions of stock
of that corporation acquired pursuant to a plan involving that
distribution to determine whether an acquisition of a 50-percent or
greater interest as proscribed in section 355(e)(2)(A)(ii) has
occurred.
B. Any Controlled Corporation
Section 355(e)(2)(A)(ii) provides that section 355(e)(1), which
causes the distributing corporation to recognize its gain in the
controlled corporation stock as if the distributing corporation had
sold the stock for its fair market value, applies to any distribution
to which section 355 applies and ``which is part of a plan * * *
pursuant to which 1 or more persons acquire directly or indirectly
stock representing a 50-percent or greater interest in the distributing
corporation or any controlled corporation'' (emphasis added). A
question has arisen concerning the measure of gain to the distributing
corporation if, pursuant to a plan, the stock of more than one
controlled corporation is distributed and stock representing a 50-
percent or greater interest is acquired in some, but not all, of the
distributed controlled corporations. The proposed regulations clarify
that under those circumstances, the distributing corporation only
recognizes gain on the stock of the distributed controlled corporations
that were subject to 50-percent or greater acquisitions. If the
distributing corporation is the acquired corporation, it must recognize
gain on all of the distributed controlled corporations.
Proposed Effective Date
The regulations in this section are proposed to apply to
distributions occurring after the regulations in this section are
published as final regulations in the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
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) 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. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking 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 (preferably a
signed original and eight (8) copies) and comments sent via the
Internet that are submitted timely to the IRS. The IRS and the
Department of the Treasury specifically request comments on the clarity
of the proposed regulations and how they may be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for January 26, 2000, beginning
at 10 a.m. in Room 2615, 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 submit written or
electronic comments and an outline of the topics to be discussed and
the time to be devoted to each topic (preferably a signed original and
eight (8) copies) by January 5, 2000. A period of 10 minutes will be
allotted 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 proposed
regulations is Brendan O'Hara, Office of the Assistant Chief Counsel
(Corporate). 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.
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 is amended by adding
an entry in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.355-7 also issued under 26 U.S.C. 355(e)(5). * * *
Par. 2. Section 1.355-0 is amended by revising the section heading
and adding introductory text and an entry for Sec. 1.355-7 to read as
follows:
Sec. 1.355-0 Outline of sections.
In order to facilitate the use of Secs. 1.355-1 through 1.355-7,
this section lists the major paragraphs in those sections as follows:
* * * * *
Sec. 1.355-7 Recognition of gain on certain distributions of stock
or securities in connection with an acquisition.
(a) Plan or series of related transactions.
(1) In general.
(2) Distributions within 2 years of an acquisition.
(i) Presumption.
(ii) Rebuttal for acquisitions after a distribution.
(iii) Alternative rebuttal for acquisitions on or after a
distribution.
(iv) Operating rules for paragraph (a)(2)(iii) of this section.
[[Page 46161]]
(v) Rebuttals for acquisitions before a distribution.
(A) General rebuttal.
(B) Alternative rebuttal.
(3) Distributions more than 2 years from an acquisition.
(i) Acquisitions after a distribution.
(ii) Acquisitions before a distribution.
(4) Controlling shareholder.
(5) Agreement, understanding, or arrangement.
(6) Multiple acquisitions.
(7) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests.
(i) Treatment of options.
(A) General rule.
(B) Agreement, understanding, arrangement, or substantial
negotiations to issue an option.
(ii) Instruments treated as options.
(iii) Instruments generally not treated as options.
(A) Escrow, pledge, or other security agreements.
(B) Compensatory options.
(C) Options exercisable only upon death, disability, mental
incompetency, or retirement.
(D) Rights of first refusal.
(E) Other enumerated instruments.
(8) Examples.
(b) Multiple controlled corporations.
(c) Valuation.
(d) Effective date.
Par. 3. Section 1.355-7 is added to read as follows:
Sec. 1.355-7 Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
(a) Plan or series of related transactions--(1) In general. (i)
Except as provided in section 355(e) and this section, section 355(e)
applies to any distribution--
(A) To which section 355 (or so much of section 356 as relates to
section 355) applies; and
(B) Which is part of a plan (or series of related transactions)
pursuant to which one or more persons acquire directly or indirectly
stock representing a 50-percent or greater interest in the distributing
corporation or any controlled corporation.
(ii) For purposes of this section, a controlled corporation is a
corporation the stock of which is distributed in a distribution to
which section 355 applies.
(iii) The existence of a plan (or series of related transactions)
does not depend on whether or not more than one person acts in concert.
(2) Distributions within 2 years of an acquisition--(i)
Presumption. If a distribution occurs within 2 years of an acquisition
by one or more persons of an interest in the distributing corporation
or any controlled corporation, the distribution and that acquisition
are presumed to be part of a plan (or series of related transactions).
(ii) Rebuttal for acquisitions after a distribution. (A) In the
case of an acquisition occurring after a distribution, the distributing
corporation may rebut the presumption of paragraph (a)(2)(i) of this
section by establishing by clear and convincing evidence that--
(1) The distribution was motivated in whole or substantial part by
a corporate business purpose within the meaning of Sec. 1.355-2(b)
(other than an intent to facilitate an acquisition or decrease the
likelihood of the acquisition of one or more businesses by separating
those businesses from others that are likely to be acquired); and
(2) The acquisition occurred more than 6 months after the
distribution and there was no agreement, understanding, arrangement, or
substantial negotiations concerning the acquisition at the time of the
distribution or within 6 months thereafter.
(B) The intent of the distributing corporation, the controlled
corporation, or the controlling shareholders of either the distributing
or controlled corporation to facilitate an acquisition or decrease the
likelihood of the acquisition of one or more businesses by separating
those businesses from others that are likely to be acquired is relevant
in determining the extent to which the distribution was motivated by a
corporate business purpose within the meaning of Sec. 1.355-2(b) (other
than an intent to facilitate an acquisition or decrease the likelihood
of the acquisition of one or more businesses by separating those
businesses from others that are likely to be acquired).
(iii) Alternative rebuttal for acquisitions on or after a
distribution. In the case of an acquisition occurring on or after a
distribution, the distributing corporation also may rebut the
presumption of paragraph (a)(2)(i) of this section by establishing by
clear and convincing evidence that--
(A)(1) At the time of the distribution, the distributing
corporation, the controlled corporation, and their controlling
shareholders did not intend that one or more persons would acquire a
50-percent or greater interest in the distributing or any controlled
corporation during the 2-year period beginning on the date of the
distribution (or later pursuant to an agreement, understanding, or
arrangement existing at the time of the distribution or within 6 months
thereafter); or
(2) The distribution was not motivated in whole or substantial part
by an intention to facilitate an acquisition of an interest in the
distributing or controlled corporation; and
(B) At the time of the distribution, neither the distributing
corporation, the controlled corporation, nor their controlling
shareholders would reasonably have anticipated that it was more likely
than not that one or more persons would acquire a 50-percent or greater
interest in the distributing corporation or the controlled corporation
within 2 years after the distribution (or later pursuant to an
agreement, understanding, or arrangement existing at the time of the
distribution or within 6 months thereafter) who would not have acquired
such interests if the distribution had not occurred; and
(C) The distribution was not motivated in whole or substantial part
by an intention to decrease the likelihood of the acquisition of one or
more businesses by separating those businesses from others that are
likely to be acquired.
(iv) Operating rules for paragraph (a)(2)(iii) of this section. (A)
For purposes of paragraph (a)(2)(iii)(A)(1) of this section, if an
acquisition by one or more persons of an interest in the distributing
corporation or any controlled corporation before the distribution is
part of a plan (or series of related transactions) involving the
distribution, the distributing corporation, the controlled corporation,
and their controlling shareholders must include the amount of stock
acquired in that acquisition as an amount they intended at the time of
the distribution to be acquired during the 2-year period beginning on
the date of the distribution.
(B) For purposes of paragraph (a)(2)(iii)(B) of this section,
persons who more likely than not would have acquired interests in the
distributing corporation if the distribution had not occurred are also
treated as persons who more likely than not would have acquired
proportionate interests in the controlled corporation if the
distribution had not occurred. No other persons are treated as persons
who would have acquired interests in the controlled corporation if the
distribution had not occurred.
(C) For purposes of paragraph (a)(2)(iii)(B) of this section, if an
acquisition by one or more persons of an interest in the distributing
corporation or any controlled corporation before the distribution is
part of a plan (or series of related transactions) involving the
distribution, the distributing corporation, the controlled corporation,
and their controlling shareholders must treat the amount of stock
acquired in
[[Page 46162]]
that acquisition as an amount they would reasonably have anticipated
was more likely than not to be acquired within 2 years after the
distribution that would not have been acquired if the distribution had
not occurred.
(D) For purposes of determining the intentions, motivations, and
reasonable anticipations of the relevant parties under paragraph
(a)(2)(iii) of this section, the consequences of the application of
section 355(e), directly or by indemnity, are disregarded.
(v) Rebuttals for acquisitions before a distribution--(A) General
rebuttal. In the case of an acquisition occurring before a
distribution, the distributing corporation may rebut the presumption of
paragraph (a)(2)(i) of this section by establishing by clear and
convincing evidence that, at the time of the acquisition, the
distributing corporation and its controlling shareholders (determined
immediately after the acquisition) did not intend to effectuate a
distribution.
(B) Alternative rebuttal. In the case of an acquisition occurring
before a distribution, the distributing corporation may rebut the
presumption of paragraph (a)(2)(i) of this section by establishing by
clear and convincing evidence that the distribution would have occurred
at approximately the same time and under substantially the same terms
regardless of that acquisition (and, in the case of an issuance of
stock, all acquisitions that are part of such issuance), provided no
person acquiring an interest in that acquisition becomes a controlling
shareholder by reason of that acquisition or at any point thereafter
and before the end of the 2-year period beginning on the date of the
distribution (or later pursuant to an agreement, understanding, or
arrangement existing at the time of the distribution or within 6 months
thereafter).
(3) Distributions more than 2 years from an acquisition--(i)
Acquisitions after a distribution. (A) If an acquisition by one or more
persons of an interest in the distributing corporation or any
controlled corporation occurs more than 2 years after a distribution,
the distribution and that acquisition are presumed part of a plan (or
series of related transactions) only if there was an agreement,
understanding, or arrangement concerning the acquisition at the time of
the distribution or within 2 years thereafter. The distributing
corporation may rebut the presumption under paragraph (a)(2)(ii) or
(a)(2)(iii) of this section.
(B) If an acquisition by one or more persons of an interest in the
distributing corporation or any controlled corporation occurs more than
2 years after a distribution, and there was no agreement,
understanding, or arrangement concerning the acquisition at the time of
the distribution or within 2 years thereafter, the acquisition and the
distribution are not part of a plan (or series of related
transactions).
(ii) Acquisitions before a distribution. If an acquisition by one
or more persons of an interest in the distributing corporation or the
controlled corporation occurs more than 2 years before a distribution,
the acquisition and the distribution are not part of a plan (or series
of related transactions) unless the Commissioner can establish by clear
and convincing evidence that--
(A) At the time of the acquisition, the distributing corporation or
its controlling shareholders (determined immediately after the
acquisition) intended to effectuate the distribution; and
(B)(1) The distribution would not have occurred at approximately
the same time and under substantially the same terms regardless of that
acquisition (and, in the case of an issuance of stock, all acquisitions
that are part of such issuance); or
(2) A person acquiring an interest in that acquisition becomes a
controlling shareholder by reason of that acquisition or at any point
thereafter and before the end of the 2-year period beginning on the
date of the distribution (or later pursuant to an agreement,
understanding, or arrangement existing at the time of the distribution
or within 6 months thereafter).
(4) Controlling shareholder. For purposes of paragraphs (a) (2) and
(3) of this section, a controlling shareholder is any person who,
directly or indirectly, or together with related persons (as described
in sections 267(b) and 707(b)), possesses voting power in the
distributing or controlled corporation representing a meaningful voice
in the governance of the corporation. A controlling shareholder of a
publicly traded corporation is any person who, directly or indirectly,
or together with related persons (as described in sections 267(b) and
707(b)), owns 5 percent or more of any class of stock of the
distributing or controlled corporation and who actively participates in
the management or operation of the corporation. If a distribution
precedes an acquisition, the controlled corporation's controlling
shareholders immediately after the distribution are considered the
controlled corporation's controlling shareholders at the time of the
distribution.
(5) Agreement, understanding, or arrangement. For purposes of this
section, the parties do not necessarily have to have entered into a
binding contract or have reached agreement on all terms to have an
``agreement, understanding, or arrangement.''
(6) Multiple acquisitions. Each acquisition of stock of a
corporation acquired pursuant to a plan (or series of related
transactions) involving a distribution will be aggregated with all
acquisitions of stock of that corporation acquired pursuant to a plan
(or series of related transactions) involving that distribution to
determine whether an acquisition described in section 355(e)(2)(A)(ii)
occurred. The appropriate presumption and rules for rebuttal will be
applied to each acquisition depending on when the acquisition occurred.
(7) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests--(i) Treatment of options--(A)
General rule. For purposes of this section, if stock of the
distributing or controlled corporation is acquired pursuant to an
option, the option will be treated as an agreement on the date of
issuance unless the distributing corporation establishes by clear and
convincing evidence that, on the later of the date of distribution or
date of issuance, the option was not more likely than not to be
exercised. The determination of whether an option was more likely than
not to be exercised is based on all the facts and circumstances. In
applying the previous sentence, the fair market value of stock
underlying an option is determined by taking into account control
premiums and minority and blockage discounts.
(B) Agreement, understanding, arrangement, or substantial
negotiations to issue an option. If there is an agreement,
understanding, or arrangement to issue an option before the end of the
6-month period beginning on the date of the distribution, the option
will be treated as issued on the date of the agreement, understanding,
or arrangement. If an agreement, understanding, or arrangement to issue
an option is reached, or an option is issued, more than 6 months but
not more than 2 years after the distribution, and there were
substantial negotiations regarding the issuance of the option or the
acquisition of the stock underlying the option before the end of the 6-
month period beginning on the date of the distribution, the option will
be treated as issued 6 months after the distribution. If there is an
agreement, understanding, or an arrangement to issue an option more
than 6 months but not more than 2 years after the distribution, and
there were no
[[Page 46163]]
substantial negotiations regarding the issuance of the option or the
acquisition of the stock underlying the option before the end of the 6
month period beginning on the date of the distribution, the option will
be treated as issued on the date of the agreement, understanding, or
arrangement.
(ii) Instruments treated as options. For purposes of this paragraph
(a)(7), except to the extent provided in paragraph (a)(7)(iii) of this
section, call options, warrants, convertible obligations, the
conversion feature of convertible stock, put options, redemption
agreements (including rights to cause the redemption of stock),
restricted stock, any other instruments that provide for the right or
possibility to issue, redeem, or transfer stock (including an option on
an option), cash settlement options, or any other similar interests are
treated as options.
(iii) Instruments generally not treated as options. For purposes of
this paragraph (a)(7), the following are not treated as options unless
issued, transferred (directly or indirectly), or listed with a
principal purpose of avoiding the application of section 355(e) or this
section:
(A) Escrow, pledge, or other security agreements. An option that is
part of a security arrangement in a typical lending transaction
(including a purchase money loan), if the arrangement is subject to
customary commercial conditions. For this purpose, a security
arrangement includes, for example, an agreement for holding stock in
escrow or under a pledge or other security agreement, or an option to
acquire stock contingent upon a default under a loan.
(B) Compensatory options. An option to acquire stock in the
distributing or controlled corporation with customary terms and
conditions provided to an employee or director in connection with the
performance of services for the corporation or a person related to it
under section 355(d)(7)(A) (and that is not excessive by reference to
the services performed) and that immediately after the distribution and
within 6 months thereafter--
(1) Is nontransferable within the meaning of Sec. 1.83-3(d); and
(2) Does not have a readily ascertainable fair market value as
defined in Sec. 1.83-7(b).
(C) Options exercisable only upon death, disability, mental
incompetency, or retirement. Any option entered into between
stockholders of a corporation (or a stockholder and the corporation)
that is exercisable only upon the death, disability, or mental
incompetency of the stockholder, or, in the case of stock acquired in
connection with the performance of services for the corporation or a
person related to it under section 355(d)(7)(A) (and that is not
excessive by reference to the services performed), the stockholder's
retirement.
(D) Rights of first refusal. A bona fide right of first refusal
regarding the corporation's stock with customary terms, entered into
between stockholders of a corporation (or between the corporation and a
stockholder).
(E) Other enumerated instruments. Any other instruments specified
in regulations, a revenue ruling, or a revenue procedure. See
Sec. 601.601(d)(2) of this chapter.
(8) Examples. The following examples illustrate this paragraph (a).
Throughout these examples, assume that the distributing corporation (D)
owns all of the stock of the controlled corporation (C). Assume further
that D distributes the stock of C in a distribution to which section
355 applies and to which section 355(d) does not apply. For purposes of
these examples, unless otherwise stated, assume that all transactions
described are respected under applicable general tax principles. No
inference should be drawn from any example concerning whether any
requirements of section 355 other than those of section 355(e) are
satisfied. The examples are as follows:
Example 1. To facilitate a stock offering by D of 50 percent of
its stock, D distributes C pro rata to its shareholders. D issues
new shares amounting to 50 percent of its stock to the public in a
public offering within 6 months of the distribution. Under paragraph
(a)(2)(i) of this section, the distribution and acquisition are
presumed to be part of a plan (or series of related transactions)
because the acquisition occurred within 2 years of the distribution.
Because the acquisition occurred within 6 months after the
distribution, D must rely on the rules of paragraph (a)(2)(iii) of
this section to rebut the presumption. D will not be able to rebut
the presumption because D cannot establish either that D did not
intend that one or more persons would acquire a 50-percent or
greater interest in D during the relevant period under paragraph
(a)(2)(iii)(A)(1) of this section or that the distribution was not
motivated in whole or substantial part by an intention to facilitate
an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2)
of this section. Because the presumption of paragraph (a)(2)(i) of
this section cannot be rebutted regarding the acquisition of a 50-
percent or greater interest in D, section 355(e) applies to the
distribution of C.
Example 2. (i) X corporation announces an intention to acquire
D, principally to acquire C's business. Due to market conditions,
X's available capital, and X's success in acquiring other
corporations, D would reasonably anticipate that an acquisition of a
50-percent or greater interest in D is more likely than not to occur
within 2 years. To lower its financing costs and, in substantial
part, to deter the acquisition of D (by separating it from the more
attractive C), D distributes C pro rata to the D shareholders. X
acquires C within 6 months of the distribution.
(ii) Under paragraph (a)(2)(i) of this section, the distribution
and acquisition are presumed to be part of a plan (or series of
related transactions) because the acquisition occurred within 2
years of the distribution. Because the acquisition occurred within 6
months after the distribution, D must rely on the rules of paragraph
(a)(2)(iii) of this section to rebut the presumption. Under
paragraph (a)(2)(iii)(A)(2) of this section, D will be able to
establish that the distribution was not motivated in whole or
substantial part by an intention to facilitate an acquisition of an
interest in D or C. Under paragraph (a)(2)(iv)(B) of this section,
for purposes of paragraph (a)(2)(iii)(B) of this section, persons
who more likely than not would have acquired interests in D if the
distribution had not occurred are also treated as persons who more
likely than not would have acquired proportionate interests in C if
the distribution had not occurred. Therefore, under paragraph
(a)(2)(iii)(B) of this section, D will be able to establish that, at
the time of the distribution, neither D, C, nor their controlling
shareholders would reasonably have anticipated that it was more
likely than not that one or more persons would acquire a 50-percent
or greater interest in D or C within 2 years after the distribution
who would not have acquired such interests if the distribution had
not occurred.
(iii) Under paragraph (a)(2)(iii)(C) of this section, D will not
be able to establish that the distribution was not motivated in
whole or substantial part by an intention to decrease the likelihood
of the acquisition of D's business by separating it from the C
business that was likely to be acquired. Because the presumption of
paragraph (a)(2)(i) of this section cannot be rebutted regarding the
acquisition by X of a 50-percent or greater interest in C, section
355(e) applies to the distribution of C.
Example 3. The facts are the same as Example 2 except the
acquisition takes place 1 year after the distribution. The parties
had not reached an agreement, understanding, or arrangement
concerning, and had not substantially negotiated, the acquisition of
C stock within 6 months after the distribution. Under paragraph
(a)(2)(i) of this section, the distribution and acquisition are
presumed to be part of a plan (or series of related transactions)
because the acquisition occurred within 2 years of the distribution.
Under paragraph (a)(2)(ii)(B) of this section, D's intent to deter
an acquisition of D is a factor tending to disprove that the
distribution was motivated in substantial part by the desire to
lower its financing costs. If D can establish by clear and
convincing evidence that the distribution was nonetheless motivated
in substantial part by the need to lower its financing costs, D can
rebut the presumption using paragraph (a)(2)(ii) of this section. D
will not be able to rebut the presumption by using the
[[Page 46164]]
alternative rebuttal under paragraph (a)(2)(iii) of this section for
the same reason as in Example 2.
Example 4. D is a widely held, publicly traded corporation. D
distributes C pro rata to D's shareholders. By contract, C agrees to
indemnify D for any imposition of tax under section 355(e). The
distribution is motivated solely by a corporate business purpose
within the meaning of Sec. 1.355-2(b) (other than an intent to
facilitate an acquisition or decrease the likelihood of the
acquisition of one or more businesses by separating those businesses
from others that are likely to be acquired). At the time of the
distribution, although D has not been approached by any potential
acquirors of C, D would reasonably anticipate that, under current
market conditions, if C is separated from D, an acquisition of a 50-
percent or greater interest in C is more likely than not to occur
within 2 years by persons who would not have acquired a
proportionate interest in D if the distribution of C had not
occurred. C is acquired within 6 months after the distribution.
Under paragraph (a)(2)(i) of this section, the distribution and
acquisition are presumed to be part of a plan (or series of related
transactions) because the acquisition occurred within 2 years of the
distribution. Because the acquisition occurred within 6 months after
the distribution, D must rely on the rules of paragraph (a)(2)(iii)
of this section to rebut the presumption. D will be able to
establish that the distribution was not motivated in whole or
substantial part by an intention to facilitate an acquisition of an
interest in D or C under paragraph (a)(2)(iii)(A)(2) of this
section. However, D will not be able to establish the requirements
of paragraph (a)(2)(iii)(B) of this section. Under paragraph
(a)(2)(iv)(B) of this section, for purposes of paragraph
(a)(2)(iii)(B) of this section, only persons who more likely than
not would have acquired interests in D if the distribution had not
occurred are treated as persons who more likely than not would have
acquired proportionate interests in C if the distribution had not
occurred. Therefore, under paragraph (a)(2)(iii)(B) of this section,
D will not be able to establish that, at the time of the
distribution, neither D, C, nor their controlling shareholders would
reasonably have anticipated that it was more likely than not that
one or more persons would acquire a 50-percent or greater interest
in D or C within 2 years after the distribution who would not have
acquired such interests if the distribution had not occurred. Under
paragraph (a)(2)(iv)(D) of this section, the consequences of the
indemnity agreement are disregarded for purposes of applying
paragraph (a)(2)(iii)(B) of this section. Because the presumption of
paragraph (a)(2)(i) of this section cannot be rebutted regarding the
acquisition of a 50-percent or greater interest in C, section 355(e)
applies to the distribution of C.
Example 5. (i) D believes it would be a more attractive
acquisition candidate if it did not own C. To achieve significant
nontax cost savings and, in substantial part, to maximize the
possibility of D's acquisition, D distributes C pro rata. At the
time of the distribution, D has not, directly or indirectly,
solicited or received any indication of interest from potential
acquirors. At the end of 6 months after the distribution, no
agreement, arrangement, understanding, or substantial negotiations
regarding the acquisition of D have taken place. Seven months after
the distribution, D engages an investment banker to conduct an
auction of D. One of the bidders acquires D 1 year after the
distribution. Under paragraph (a)(2)(i) of this section, the
distribution and acquisition are presumed to be part of a plan (or
series of related transactions) because the acquisition occurred
within 2 years of the distribution. Because there was no agreement,
understanding, arrangement, or substantial negotiations concerning
the acquisition at the time of the distribution or within 6 months
thereafter, D can use the rebuttal under paragraph (a)(2)(ii) of
this section if D can establish that the distribution was motivated
in whole or substantial part by the corporate business purpose of
achieving significant nontax cost savings. Under paragraph
(a)(2)(ii)(B) of this section, D's intent to facilitate an
acquisition of D is a factor tending to disprove that the
distribution was motivated in substantial part by the desire to
achieve nontax cost savings. If D can establish by clear and
convincing evidence that the distribution was nonetheless motivated
in substantial part by the need to achieve nontax cost savings for D
and C, D can rebut the presumption using paragraph (a)(2)(ii) of
this section.
(ii) D cannot rebut the presumption using the rules of paragraph
(a)(2)(iii) of this section because D cannot establish either that D
did not intend that one or more persons would acquire a 50-percent
or greater interest in D during the relevant period under paragraph
(a)(2)(iii)(A)(1) of this section or that the distribution was not
motivated in whole or substantial part by an intention to facilitate
an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2)
of this section.
Example 6. D announces that it will distribute C pro rata to D's
shareholders. The distribution is motivated solely by a corporate
business purpose within the meaning of Sec. 1.355-2(b) (other than
an intent to facilitate an acquisition or decrease the likelihood of
the acquisition of one or more businesses by separating those
businesses from others that are likely to be acquired). After the
announcement but before the distribution, D acquires X, a widely
held corporation. The X shareholders receive D stock in exchange for
their X stock. No person who acquired D stock in the X acquisition
became a controlling shareholder of D, as defined in paragraph
(a)(4) of this section, within the time period described in
paragraph (a)(2)(v)(B) of this section. Under paragraph (a)(2)(i) of
this section, the distribution and the acquisition of D stock by the
X shareholders are presumed to be part of a plan (or series of
related transactions) because the acquisition occurred within 2
years of the distribution. If D can establish by clear and
convincing evidence that the distribution of C would have occurred
at approximately the same time and under substantially the same
terms regardless of the acquisition of X, D may rebut the
presumption under paragraph (a)(2)(v)(B) of this section.
Example 7. (i) D engages in business 1. C engages in business 2.
D is interested in expanding business 1 through acquisitions, but
D's ownership of C has been an impediment to acquisitions using D
stock. On the advice of its investment banker, D plans to distribute
its C stock to its shareholders solely to facilitate acquisitions by
D. D has no specific goals regarding how much D stock will be
acquired after the distribution. D and its investment banker have
identified X and Y as potential acquisition targets. After D decides
to distribute its C stock, but before the distribution date, D
negotiates with and acquires X, but has no contact with Y. A, X's
sole shareholder, receives 30 percent of D's stock, becoming a
controlling shareholder of D within the meaning of paragraph (a)(4)
of this section. One year after the distribution, D acquires Y. Y's
shareholders receive 19 percent of D's stock. After the
distribution, D and its investment banker identify Z as another
desirable target. Eighteen months after the distribution, D acquires
Z. Z's shareholders receive 17 percent of D's stock.
(ii) Under paragraph (a)(2)(i) of this section, the distribution
and each acquisition are presumed to be part of a plan (or series of
related transactions) because each acquisition occurred within 2
years of the distribution. In addition, under paragraph (a)(6) of
this section, all acquisitions for which the presumption is not
rebutted are aggregated to determine whether an acquisition
described in section 355(e)(2)(A)(ii) has occurred.
(iii) Regarding the acquisition of X, D will not be able to
rebut the presumption under paragraph (a)(2)(v)(A) of this section
because D cannot establish that at the time A acquired D stock, D
did not intend to effectuate a distribution. In addition, D cannot
rebut the presumption under paragraph (a)(2)(v)(B) of this section
because that paragraph does not apply to an acquisition in which a
person becomes a controlling shareholder.
(iv) Regarding the acquisitions of Y and Z, D will not be able
to rebut the presumption under paragraph (a)(2)(ii)(A) of this
section because D cannot establish that the distribution was
motivated in whole or substantial part by a corporate business
purpose within the meaning of Sec. 1.355-2(b) (other than an intent
to facilitate an acquisition or decrease the likelihood of the
acquisition of one or more businesses by separating those businesses
from others that are likely to be acquired).
(v) To rebut the presumption with regard to each acquisition of
Y and Z using the alternative rebuttal of paragraph (a)(2)(iii) of
this section, D must establish three facts. First, under paragraph
(a)(2)(iii)(A)(1) of this section, D must establish that, at the
time of the distribution, D and its controlling shareholders did not
intend that one or more persons would acquire a 50-percent or
greater interest in D or C during the presumption period described
in that paragraph. For that purpose, the interests intended to be
acquired in D or C will include A's acquisition of D stock under
paragraph (a)(2)(iv)(A) of this section. Second, under paragraph
(a)(2)(iii)(B) of this section, D must establish that, at the time
of the distribution, neither D, C, nor their controlling
[[Page 46165]]
shareholders would reasonably have anticipated that it was more
likely than not that one or more persons would acquire a 50-percent
or greater interest in D or C within 2 years after the distribution
(or later pursuant to an agreement, understanding, or arrangement
existing at the time of the distribution or within 6 months
thereafter) who would not have acquired such interests if the
distribution had not occurred. Under paragraph (a)(2)(iv)(C) of this
section, D, C, and their controlling shareholders must treat the
amount of D stock acquired by A as an amount they would reasonably
have anticipated was more likely than not to be acquired within 2
years after the distribution that would not have been acquired if
the distribution had not occurred. Third, under paragraph
(a)(2)(iii)(C) of this section, D will be able to establish that the
distribution was not motivated in whole or substantial part by an
intention to decrease the likelihood of the acquisition of one or
more businesses by separating those businesses from others that are
likely to be acquired.
Example 8. D plans to distribute C pro rata to its shareholders.
The distribution is substantially motivated by a corporate business
purpose within the meaning of Sec. 1.355-2(b) (other than an intent
to facilitate an acquisition or decrease the likelihood of the
acquisition of one or more businesses by separating those businesses
from others that are likely to be acquired). After the announcement
date, D's investment banker informs D's management that there is a
lot of interest in new investment in D now that it will no longer
own C. At the time of the distribution, D would reasonably
anticipate that it was more likely than not that one or more persons
would acquire a 50-percent or greater interest in D within 2 years
(or later pursuant to an agreement, understanding, or arrangement
existing at the time of the distribution or within 6 months
thereafter) who would not acquire such interests absent the
distribution. Three months after the distribution, D issues an
option to X to purchase 50 percent of the D stock. At the time of
issuance, the facts and circumstances indicate that the option is
more likely than not to be exercised. Two years after issuance, X
exercises the option and purchases 50 percent of the D stock. Under
paragraph (a)(7)(i)(A) of this section, the option is treated as an
agreement on the date it is issued. Under paragraph (a)(3)(i)(A) of
this section, the distribution and the acquisition are presumed to
be part of a plan (or series of related transactions) because there
was an agreement concerning the acquisition within 2 years of the
distribution. D will not be able to rebut the presumption using the
rebuttals of paragraphs (a)(2)(ii) or (a)(2)(iii) of this section.
The rebuttal of paragraph (a)(2)(ii) of this section is unavailable
because there was an agreement concerning the acquisition within 6
months of the distribution. The rebuttal of paragraph (a)(2)(iii) of
this section is unavailable because D cannot establish that, at the
time of the distribution, neither D, C, nor their controlling
shareholders would reasonably have anticipated that it was more
likely than not that one or more persons would acquire a 50-percent
or greater interest in D within 2 years (or later pursuant to an
agreement, understanding, or arrangement existing at the time of the
distribution or within 6 months thereafter) who would not have
acquired such interests absent the distribution. Because the
presumption relating to the acquisition of a 50-percent interest in
D cannot be rebutted, section 355(e) applies to the distribution of
C.
Example 9. (i) D distributes C pro rata to its shareholders
solely to facilitate a stock offering by C. To take advantage of
favorable market conditions, C issues new shares amounting to 20
percent of its stock in a public offering followed 1 month later by
the distribution. The public offering documents disclosed the
intended distribution of C. Neither D, C, nor their controlling
shareholders intended any further transactions involving D or C
stock. In addition, at the time of the distribution, neither D, C,
nor their controlling shareholders would reasonably anticipate that
it was more likely than not that one or more persons would acquire a
50-percent interest in D or C within 2 years (or later pursuant to
an agreement, understanding, or arrangement existing at the time of
the distribution or within 6 months thereafter) who would not have
acquired such interests absent the distribution. Two months after
the distribution, C is approached unexpectedly regarding an
opportunity to acquire X. Five months after the distribution, C
acquires X in exchange for 40 percent of the C stock. Under
paragraph (a)(2)(i) of this section, the distribution and each
acquisition are presumed to be part of a plan (or series of related
transactions) because each acquisition occurred within 2 years of
the distribution.
(ii) Regarding the public offering, D cannot rebut the
presumption using paragraph (a)(2)(v) of this section. At the time
of the acquisition, D and its controlling shareholders intended to
effectuate the distribution. Also, the distribution would not have
occurred at approximately the same time and under substantially the
same terms regardless of the public offering.
(iii) Regarding C's acquisition of X, D will not be able to
rebut the presumption using paragraph (a)(2)(ii) of this section
because the acquisition occurred within 6 months after the
distribution. However, D will be able to rebut the presumption
regarding the acquisition of X using paragraph (a)(2)(iii) of this
section. Neither D, C, nor their controlling shareholders intended
that one or more persons would acquire a 50-percent or greater
interest in D or C during the relevant period under paragraph
(a)(2)(iii)(A)(1) of this section. Under paragraph (a)(2)(iii)(B) of
this section, at the time of the distribution, neither D, C, nor
their controlling shareholders would reasonably have anticipated
that it was more likely than not that one or more persons would
acquire a 50-percent or greater interest in C within 2 years who
would not have acquired such interests if the distribution had not
occurred. Under paragraph (a)(2)(iii)(C) of this section, the
distribution was not motivated in whole or substantial part by an
intention to decrease the likelihood of the acquisition of one or
more businesses by separating those businesses from others that are
likely to be acquired. Because only the 20-percent acquisition by
public offering is part of a plan (or series of related
transactions) involving the distribution, section 355(e) does not
apply.
(b) Multiple controlled corporations. Only the stock or securities
of a controlled corporation in which one or more persons acquire
directly or indirectly stock representing a 50-percent or greater
interest as part of a plan (or series of related transactions)
involving the distribution of that corporation will be treated as not
qualified property under section 355(e)(1) if--
(1) The stock or securities of more than one controlled corporation
are distributed in distributions to which section 355 applies; and
(2) One or more persons do not acquire, directly or indirectly,
stock representing a 50-percent or greater interest in the distributing
corporation pursuant to a plan (or series of related transactions)
involving any of those distributions.
(c) Valuation. Except as provided in paragraph (a)(7)(i)(A) of this
section, for purposes of section 355(e) and this section, all shares of
stock within a single class are considered to have the same value.
Thus, control premiums and minority and blockage discounts within a
single class are not taken into account.
(d) Effective date. The regulations in this section apply to
distributions occurring after the regulations in this section are
published as final regulations in the Federal Register.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-21876 Filed 8-19-99; 1:37 pm]
BILLING CODE 4830-01-U
