| REG-107566-00 |
December 30, 2000 |
Guidance under section 355(e); Recognition
of Gain on Certain Distributions of Stock or
Securities In Connection with an Acquisition.
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-107566-00] RIN 1545-AY42
TITLE: 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.
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 April 24, 2001. Outlines of topics to be
discussed at the public hearing scheduled for May 15, 2001, at 10
a.m. must be received by April 24, 2001.
ADDRESSES: Send submissions to: CC:M&SP:RU (REG-107566-00), 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:M&SP:RU
(REG-107566-00), 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 4718, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed
regulations, Brendan P. 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, Guy R.
Traynor, (202) 622-7180 (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 that it controls immediately before the
distribution and certain other conditions are met, neither the
distributing corporation (hereinafter referred to as
Distributing) nor its shareholders recognize gain or loss. A
number of the conditions for tax free treatment (for example, the
continuity of interest requirement of §1.355-2(c), the "no
device" requirement of section 355(a)(1)(B), the 5-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 Distributing or the controlled corporation
(hereinafter referred to as Controlled) 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 (4 Cir. 1966). th B.
Enactment of Section 355(e)
Section 355(e), which was enacted in 1997, provides that the
stock of a controlled corporation generally will not be qualified
property under section 355(c)(2) or section 361(c)(2) if 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) applies to a distribution, Distributing is taxed
on the amount by which the distributed stock’s fair market value
exceeds its basis. Distributee shareholders receive Controlled stock
tax free, but do not increase their bases to reflect the corporate
level gain recognized by Distributing on the distribution.
Section 355(e)(2)(B) provides that, unless the taxpayer
establishes otherwise, a plan (or series of related transactions)
(hereinafter referred to as 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."
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).
C. Previous Proposal of Regulations
On August 24, 1999, the IRS and the Department of the Treasury
published proposed regulations under section 355(e) (REG-116733-98)
in the Federal Register (64 FR 46155) (hereinafter referred to as
the 1999 proposed regulations). The 1999 proposed regulations
provided the exclusive means by which a taxpayer could establish
that a distribution and an acquisition were not part of a plan, and
required that the taxpayer must establish the absence of a plan with
clear and convincing evidence.
A public hearing regarding the 1999 proposed regulations was held
on March 2, 2000. In addition, written comments were received.
Commentators asserted that the approach of the 1999 proposed
regulations, providing exclusive rebuttals for establishing that
transactions are not part of a plan, was inappropriate because it
unfairly limited the evidence taxpayers could produce that may be
relevant to whether transactions are part of a plan. In addition,
commentators argued that section 355(e) does not require the IRS and
the Department of the Treasury to adopt a clear and convincing
evidence standard for establishing whether transactions are part of
a plan. Further, commentators were concerned that the exclusive
rebuttals contained in the 1999 proposed regulations may not be
available in cases in which there was an intent to facilitate any
Lquisition, regardless of its type or size, even if the acquisition
being tested was not the intended acquisition. Finally, one of the
rebuttals in the 1999 proposed regulations was only available if the
taxpayer proves, among other things, that "[a]t 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 . . . who would not have acquired such
interests if the distribution had not occurred." 1999 Prop. Reg.
§1.355-7(a)(2)(iii)(B). Many commentators indicated that determining
whether it was reasonably anticipated that an event was more likely
than not to occur was impractical and that the consequent
uncertainty inhibited normal business transactions.
Explanation of Provisions
After consideration of the comments received, the IRS and the
Department of the Treasury have decided to withdraw the 1999
proposed regulations and issue new proposed regulations (hereinafter
referred to as the 2000 proposed regulations) to provide guidance
concerning the interpretation of the phrase "plan (or series of
related transactions)." The 2000 proposed regulations also address
the determination of Distributing’s gain when multiple controlled
corporations are distributed and the distributions are part of a
plan pursuant to which a 50-percent or greater interest in one or
more, but not all, of the distributed controlled corporations is
acquired.
The IRS and the Department of the Treasury plan to issue
regulations addressing other issues arising under section 355(e),
including the definition of an acquisition, the application of the
aggregation and attribution rules, the treatment of successors and
predecessors, and the administration of the statute of limitations
provision of section 355(e)(4)(E). Comments concerning the 2000
proposed regulations, the additional issues described above, and
other issues that should be addressed in regulations are welcome.
A. Plan or Series of Related Transactions
The 2000 proposed regulations provide that whether a distribution
and an acquisition are part of a plan is determined based on all the
facts and circumstances. They include nonexclusive lists of facts
and circumstances to be considered in making the determination.
Because the determination of whether a plan exists is dependent on
the facts and circumstances, the 2000 proposed regulations provide a
general statement of the policy underlying whether a distribution
and an acquisition are part of a plan for purposes of section
355(e).
In the case of an acquisition after a distribution, the 2000
proposed regulations provide that, in general, the distribution and
acquisition are considered part of a plan if Distributing,
Controlled, or any of their respective controlling shareholders
intended, on the date of the distribution, that the acquisition or a
similar acquisition occur in connection with the distribution. The
reference to "a similar acquisition" ensures that changes in the
terms of the acquisition intended at the time of the distribution
(including, in certain circumstances, a substitution of acquirer) do
not prevent the distribution and the acquisition that actually
occurs from being considered part of a plan.
In the case of an acquisition before a distribution, the 2000
proposed regulations provide that, in general, the distribution and
acquisition are considered part of a plan if Distributing,
Controlled, or any of their respective controlling shareholders
intended, on the date of the acquisition, that a distribution occur
in connection with the acquisition. As indicated above, the facts
and circumstances surrounding the distribution and the acquisition
must be examined to determine whether the transactions were intended
to occur in connection with each other. In addition, the 2000
proposed regulations contain six safe harbor provisions that, when
applicable, provide that the acquisition and distribution are not
part of a plan.
Under the 2000 proposed regulations, Distributing must test each
acquisition of Distributing or Controlled stock to determine whether
it is part of a plan that includes a distribution. The 2000 proposed
regulations aggregate all acquisitions of stock of a corporation
that are pursuant to a plan including a particular distribution to
determine whether the 50 percent threshold of section 355(e)(2)(A)
(ii) is met.
1. Facts and Circumstances
For those situations to which the safe harbor provisions do not
apply, the 2000 proposed regulations provide two nonexclusive lists
of facts and circumstances (hereinafter referred to as factors) to
consider in assessing whether an acquisition and a distribution are
part of a plan. One list of factors tends to demonstrate that a
distribution and an acquisition are part of a plan and the other
list tends to demonstrate that a distribution and an acquisition are
not part of a plan. The weight of the factors depends on the
particular case. The existence of a plan should not be determined
merely by comparing the number of factors tending to show that the
acquisition and distribution are, or are not, part of a plan.
Plan Factors
Many of the factors tending to show that a distribution and an
acquisition are part of a plan (the plan factors) focus on whether
Distributing, Controlled or their respective controlling
shareholders participated in discussions with outside parties
regarding the second transaction of the pair being tested before the
first transaction occurred (factors (i), (ii), (iii), (iv), (v), and
(vi)). Such discussions provide evidence that Distributing,
Controlled or any of their respective controlling shareholders had
an intent that the transactions occur in connection with each other.
Other plan factors (factors (vii), (viii), and (ix)) inquire
into other indications of the intent of Distributing, Controlled and
their respective controlling shareholders. Factor (vii) considers
whether the distribution was motivated by a business purpose to
facilitate the acquisition or a similar acquisition of distributing
or Controlled. The operating rule in proposed §1.355-7(e)(1)(i)
states that evidence of a business purpose to facilitate an
Lquisition of distributing or Controlled exists if there was a
reasonable certainty that within 6 months after the distribution an
acquisition would occur, an agreement, understanding, or arrangement
would exist, or substantial negotiations would occur regarding an
acquisition. The operating rule in proposed §1.355-7(e)(1)(ii)
applies to acquisitions before a distribution, asking whether the
acquisition occurred after the date of the public announcement of
the planned distribution, or whether, at the time of the
acquisition, it was reasonably certain that within 6 months after
the acquisition the distribution would occur, an agreement,
understanding, or arrangement would exist, or substantial
negotiations would occur regarding the distribution. The operating
rule in proposed §1.355-7(e)(2) provides that the fact that internal
discussions occurred may be indicative of the business purpose that
motivated the distribution. The operating rule contained in proposed
§1.355-7(e)(3) provides that, if Distributing distributes Controlled
stock intending, in whole or substantial part, to decrease the
likelihood of the acquisition of Distributing or Controlled by
separating it from another corporation that is likely to be
acquired, Distributing is treated as having a business purpose to
facilitate the acquisition of the corporation that was acquired.
The rule regarding reasonable certainty is necessary to implement
section 355(e) because where a taxpayer was reasonably certain that
an acquisition would occur, that acquisition was likely to be taken
into account in determining whether to effect a distribution. While
the IRS and the Department of the Treasury believe that reasonable
certainty (even where no discussions with potential acquirers have
occurred) is relevant in determining whether a plan exists, it
should be noted that this concept is significantly modified from the
1999 proposed regulations. This operating rule will apply only in
cases where there was a strong probability that, within 6 months
after the distribution, an acquisition would occur, an agreement,
understanding, or arrangement would exist, or substantial
negotiations would occur.
Factor (viii) considers whether an acquisition and a distribution
occured within 6 months of each other, or whether there was an
agreement, understanding, arrangement, or substantial negotiations
regarding the second transaction (or, if an acquisition is the
second transaction, a similar acquisition) within 6 months after the
first transaction.
Finally, factor (ix) examines whether the debt allocation between
Distributing and Controlled made an acquisition of Distributing or
Controlled likely in order to service the debt.
Nonplan Factors
The 2000 proposed regulations also provide a nonexclusive list of
factors tending to show that a distribution and an acquisition are
not part of a plan (the nonplan factors). Just as discussions with
outside parties about the second transaction prior to the first
transaction tend to show that Distributing, Controlled or their
respective controlling shareholders had an intent that the second
transaction occur in connection with the first transaction, the
absence of such discussions tends to show that the transactions did
not occur in connection with each other. Thus, there are nonplan
factors that are analogous to the plan factors related to
discussions (factors (i), (ii), and (iv)).
The existence of a corporate business purpose, other than a
business purpose to facilitate the acquisition or a similar
Lquisition, that motivated Lstributing, in whole or substantial
part, to make the stock distribution tends to show that a
distribution and an acquisition are not part of a plan (factor
(vi)). The presence of a business purpose to facilitate the
Lquisition or a similar acquisition is relevant in Ltermining the
extent to which the distribution was motivated in whole or
substantial part by another corporate business purpose within the
meaning of §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 §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. In
making this determination, the operating rules in proposed
§1.355-7(e) apply.
Factors (iii) and (v) consider whether there was an identifiable,
unexpected change in market or business conditions after the first
of the two transactions being tested that resulted in the second,
unexpected transaction. Factor (vii) considers whether the
distribution would have occurred at approximately the same time and
in similar form regardless of the acquisition or a previously
proposed similar acquisition.
2. Safe Harbors
The 2000 proposed regulations include six safe harbor
provisions. A distribution and an acquisition are not part of a plan
if they are described in one of the safe harbors. The first two safe
harbors address acquisitions more than 6 months after a
distribution. Safe Harbor I applies to an acquisition more than 6
months after a distribution if there was no agreement,
understanding, arrangement, or substantial negotiations concerning
the acquisition before a date that is 6 months after the
distribution and the distribution was motivated in whole or
substantial part by a corporate business purpose other than a
business purpose to facilitate an Lquisition. The nonacquisition
corporate business purpose for the distribution is considered in
light of any business purpose to facilitate an Lquisition, and the
operating rules in proposed §1.355-7(e) apply.
Safe Harbor II, like Safe Harbor I, applies only to acquisitions
more than 6 months after a distribution for which there was no
agreement, understanding, arrangement, or substantial negotiations
concerning the acquisition before a date that is 6 months after the
distribution. However, where Safe Harbor I applies to cases where
the distribution was motivated in whole or substantial part by a
nonacquisition business purpose, Safe Harbor II applies to
situations where the distribution was motivated in whole or
substantial part by a business purpose to facilitate an Lquisition.
Under Safe Harbor II, an acquisition will not be treated as part of
a plan with a distribution if the distribution was motivated in
whole or Lbstantial part by a corporate business purpose to
facilitate an acquisition or acquisitions of no more than 33 percent
of the stock of Distributing or Controlled, and no more than 20
percent of the stock of the corporation whose stock was acquired in
the acquisition or acquisitions that motivated the distribution was
either acquired or the subject of an agreement, understanding,
arrangement, or substantial negotiations before a date that is 6
months after the distribution. Safe Harbor II is intended to
alleviate the concerns commentators expressed about the
unavailability of the rebuttals in the 1999 proposed regulations if
the distribution was motivated by an intent to facilitate an
Lquisition regardless of its type or size.
Safe Harbors III and IV address acquisitions and distributions
more than 2 years apart. Under Safe Harbor III, acquisitions more
than 2 years after a distribution are not pursuant to a plan if
there is no agreement, understanding, arrangement, or substantial
negotiations concerning the acquisition at the time of the
distribution or within 6 months thereafter. Under Safe Harbor IV,
acquisitions more than 2 years before a distribution are not part of
a plan if there is no agreement, understanding, arrangement, or
substantial negotiations concerning the distribution at the time of
the acquisition or within 6 months thereafter.
Safe Harbor V provides that an acquisition of Distributing or
Controlled stock that is listed on an established market (as defined
in the 2000 proposed regulations) is not part of a plan if the stock
is transferred between shareholders of Distributing or Controlled
who are not 5-percent shareholders. In general, a person will be
considered a 5-percent shareholder if, immediately before or after
each transfer, the person owns, directly or indirectly, or together
with related persons (as described in sections 267(b) and 707(b)), 5
percent or more of any class of stock of the corporation whose stock
is transferred.
Safe Harbor VI provides that an acquisition of stock by an
employee or director in connection with the performance of services,
including an acquisition resulting from the exercise of certain
compensatory stock options, is not part of a plan.
3. Agreement, Understanding, Arrangement, or Substantial
Negotiations
There are many references in the 2000 proposed regulations to the
existence of an agreement, understanding, arrangement, or
substantial negotiations. The 2000 proposed regulations do not
define those concepts precisely. A binding contract clearly is
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 Distributing’s or Controlled’s stock, an agreement,
understanding, arrangement, or substantial negotiations can exist
regarding an acquisition even if the acquirer has not been
specifically identified.
4. Options
The 2000 proposed regulations enumerate interests treated as
options. If stock of Distributing or Controlled is acquired pursuant
to an option, the option is treated as an agreement to acquire stock
on the date of writing unless Distributing establishes that, on the
later of the date of the stock distribution or the writing of the
option, the option was not more likely than not to be exercised. The
2000 proposed regulations also address the treatment of an
agreement, understanding, or arrangement to write an option and
substantial negotiations regarding the writing of an option. The
2000 proposed regulations exempt certain options from treatment as
options unless they are written, transferred, or listed with a
principal purpose of avoiding the application of section 355(e) or
the 2000 proposed regulations. The enumerated exceptions cover
certain commercially customary options that are unlikely to be used
to avoid section 355(e) or the 2000 proposed regulations.
B. Any Controlled Corporation
Section 355(e)(2)(A)(ii) provides that section 355(e)(1), which
causes Distributing to recognize its gain in Controlled stock as if
Distributing had sold the stock for its fair market value, applies
to any distribution to which section 355 (or so much of section 356
as relates to 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
Distributing if, pursuant to a plan, the stock of more than 1
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 2000 proposed regulations
clarify that under those circumstances, Distributing only recognizes
gain on the stock of the distributed controlled corporations that
were subject to 50-percent or greater acquisitions. If Distributing
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 Federa 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
Department of the Treasury and the IRS 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 May 15, 2001, beginning at
10 a.m. in Room 4718, Internal Revenue Building, 1111 Constitution
Avenue, NW., Washington, DC. Due to building security procedures,
visitors must enter at the 10 Street entrance, th 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 April 24, 2001. 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 P.
O’Hara, Office of the Associate Chief Counsel (Corporate). However,
other personnel from the Department of the Treasury and the IRS
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 §1.355-7 to
read in part as follows:
§1.355-0 Outline of sections.
In order to facilitate the use of §§1.355-1 through 1.355-7, this
section lists the major paragraphs in those sections as follows:
* * * * *
§1.355-7 Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
(a) In general.
(b) Plan.
(c) Multiple acquisitions.
(d) Facts and circumstances.
(e) Operating rules.
(1) Reasonable certainty evidence of business purpose to facilitate
an acquisition.
(2) Internal discussion evidence of business purpose.
(3) Hostile takeover defense.
(4) Effect of distribution on trading in stock.
(5) Consequences of section 355(e) disregarded for certain purposes.
(6) Substantial diminution of risk.
(f) Safe harbors.
(1) Safe Harbor I.
(2) Safe Harbor II.
(3) Safe Harbor III.
(4) Safe Harbor IV.
(5) Safe Harbor V.
(i) In general.
(ii) Special rules.
(6) Safe Harbor VI.
(g) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests.
(1) Treatment of options.
(i) General rule.
(ii) Agreement, understanding, arrangement, or substantial
negotiations to write an option.
(2) Instruments treated as options.
(3) Instruments generally not treated as options.
(i) Escrow, pledge, or other security agreements.
(ii) Compensatory options.
(iii) Options Lercisable only upon death, disability, mental
Competency, or separation from service.
(iv) Rights of first refusal.
(v) Other enumerated instruments.
(h) Multiple controlled corporations.
(i) [Reserved]
(j) Valuation.
(k) Definitions.
(1) Agreement, understanding, arrangement, or substantial
negotiations.
(2) Controlled corporation.
(3) Controlling shareholder.
(4) Established market.
(5) Five-percent shareholder.
(l) [Reserved]
(m) Examples.
(n) Effective date.
Par. 3. Section 1.355-7 is added to read as follows:
§1.355-7 Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
(a) In general. Except as provided in section 355(e) and in this
section, section 355(e) applies to any distribution--
(1) To which section 355 (or so much of section 356 as relates to
section 355) applies; and
(2) That is part of a plan (or series of related transactions)
(hereinafter, plan) pursuant to which 1 or more persons acquire
directly or indirectly stock representing a 50-percent or greater
interest in the distributing corporation (Distributing) or any
controlled corporation (Controlled).
(b) Plan. (1) Whether a distribution and an acquisition are part
of a plan is determined based on all the facts and circumstances. In
general, in the case of an acquisition after a distribution, the
distribution and the acquisition are considered part of a plan if
Distributing, Controlled, or any of their respective controlling
shareholders intended, on the date of the distribution, that the
acquisition or a similar acquisition occur in connection with the
distribution. In general, in the case of an acquisition before a
distribution, the acquisition and the distribution are considered
part of a plan if Distributing, Controlled, or any of their
respective controlling shareholders intended, on the date of the
acquisition, that a distribution occur in connection with the
acquisition.
(2) For purposes of paragraph (b)(1) of this section, the actual
acquisition and the intended acquisition may be similar even though
the identity of the person acquiring stock of Distributing or
Controlled (acquirer), the timing of the acquisition or the terms of
the actual acquisition are different from the intended acquisition.
For example, in the case of a public offering or auction, the actual
acquisition and the intended acquisition may be similar even though
there are changes in the terms of the stock, the class of stock
being offered, the size of the offering, the timing of the offering,
the price of the stock, or the participants in the public offering
or auction.
(c) Multiple acquisitions. All acquisitions of stock of
Distributing or Controlled that are considered to be part of a plan
with a distribution pursuant to paragraph (b) of this section will
be aggregated for purposes of the 50-percent test of paragraph (a)
(2) of this section.
(d) Facts and circumstances. (1) The facts and circumstances to
be considered in demonstrating whether a distribution and an
acquisition are part of a plan include, but are not limited to, the
facts and circumstances specified in paragraphs (d)(2) and (d)(3) of
this section. The weight to be given each of the facts and
circumstances depends on the particular case. Therefore, whether a
distribution and an acquisition are part of a plan does not depend
on the relative number of facts and circumstances present under
paragraph (d)(2) as compared to paragraph (d)(3) of this section.
(2) Among the facts and circumstances tending to show that a
distribution and an acquisition are part of a plan are the
following:
(i) In the case of an acquisition (other than involving a public
offering or auction) after a distribution, Distributing or
Controlled and the acquirer (or any of their respective controlling
shareholders) discussed the acquisition or a similar acquisition by
the acquirer before the distribution. The weight to be accorded the
discussions depends on the nature, extent and timing of the
discussions. The existence of an agreement, understanding,
arrangement or substantial negotiations at the time of the
distribution is given substantial weight.
(ii) In the case of an acquisition (other than involving a public
offering or auction) after a distribution, Distributing or
Controlled and a potential acquirer (or any of their respective
controlling shareholders) discussed an acquisition before the
distribution and a similar acquisition by a different person
occurred after the distribution. The weight to be accorded the
discussions depends on the nature, extent and timing of the
discussions and the similarity of the acquisition actually occurring
to the acquisition discussed before the distribution.
(iii) In the case of an acquisition involving a public offering
or auction after a
Lstribution, distributing or Controlled (or any of their Lspective
controlling shareholders) discussed the acquisition with an
investment banker or other outside adviser before the distribution.
The weight to be accorded the discussions depends on the nature,
extent and timing of the discussions.
(iv) In the case of an acquisition before a distribution,
Distributing or Controlled and the acquirer (or any of their
respective controlling shareholders) discussed a distribution before
the acquisition. The weight to be accorded the discussions depends
on the nature, extent and timing of the discussions.
(v) In the case of an acquisition before a distribution,
Distributing or Controlled and a potential acquirer (or any of their
respective controlling shareholders) discussed a distribution before
the acquisition and a similar acquisition by a different person
occurred before the distribution. The weight to be accorded the
discussions depends on the nature, extent and timing of the
discussions and the similarity of the acquisition actually occurring
to the potential acquisition that was discussed.
(vi) In the case of an acquisition involving a public offering or
auction before a
Lstribution, distributing or Controlled (or any of their Lspective
controlling shareholders) discussed a distribution with an
investment banker or other outside adviser before the acquisition.
The weight to be accorded the discussions depends on the nature,
extent and timing of the discussions.
(vii) In the case of an acquisition either before or after a
distribution, the distribution was motivated by a business purpose
to facilitate the acquisition or a similar acquisition of
Distributing or Controlled.
(viii) In the case of an acquisition either before or after a
Lstribution, the acquisition and the distribution occurred within 6
months of each other or there was an agreement, understanding,
arrangement, or substantial negotiations regarding the second
transaction within 6 months after the first transaction. Also, in
the case of an acquisition occurring after a distribution, there was
an agreement, understanding, arrangement, or substantial
negotiations regarding a similar acquisition at the time of the
distribution or within 6 months thereafter.
(ix) In the case of an acquisition either before or after a
distribution, the debt allocation between Distributing and
Controlled made an acquisition of Distributing or Controlled likely
in order to service the debt.
(3) Among the facts and circumstances tending to show that a
distribution and an acquisition are not part of a plan are the
following:
(i) In the case of an acquisition (other than involving a public
offering or auction) after a distribution, neither Distributing nor
Controlled and the acquirer or any potential acquirer (nor any of
their respective controlling shareholders) discussed the acquisition
or a similar acquisition before the distribution.
(ii) In the case of an acquisition involving a public offering or
auction after a
Lstribution, neither distributing nor Controlled (nor any of their
Lspective controlling shareholders) discussed the acquisition with
an investment banker or other outside adviser before the
distribution.
(iii) In the case of an acquisition after a Lstribution, there
was an identifiable, unexpected change in market or business
conditions occurring after the distribution that resulted in the
acquisition that was otherwise unexpected at the time of the
distribution.
(iv) In the case of an acquisition (other than involving a public
offering or auction) before a distribution, neither Distributing nor
Controlled and the acquirer (nor any of their respective controlling
shareholders) discussed a distribution before the acquisition. This
paragraph (d)(3)(iv) does not apply if the acquisition occurred
after the date of the public announcement of the planned
distribution.
(v) In the case of an acquisition before a distribution, there
was an identifiable, unexpected change in market or business
conditions occurring after the acquisition that resulted in a
distribution that was otherwise unexpected.
(vi) In the case of an acquisition either before or after a
distribution, the distribution was motivated in whole or substantial
part by a corporate business purpose (within the meaning of
§1.355-2(b)) other than a business purpose to facilitate the
Lquisition or a similar acquisition of Distributing or Controlled.
The presence of a business purpose to facilitate the acquisition or
a similar acquisition of distributing or Controlled is relevant in
determining the extent to which the distribution was motivated by a
corporate business purpose (within the meaning of §1.355-2(b)) other
than a business purpose to facilitate the acquisition or a similar
Lquisition of distributing or Controlled.
(vii) In the case of an acquisition either before or after a
distribution, the distribution would have occurred at approximately
the same time and in similar form regardless of the acquisition or a
similar acquisition (including a previously proposed similar
acquisition that did not occur).
(e) Operating rules. The operating rules contained in this
paragraph (e) apply for all purposes of this section.
(1) Reasonable certainty evidence of business purpose to
facilitate an Lquisition. (i) In the case of an acquisition after a
distribution, if, at the time of the distribution, it was reasonably
certain that before a date that is 6 months after the distribution
an acquisition would occur, an agreement, understanding, or
arrangement would exist, or substantial negotiations would occur
regarding an acquisition of Distributing or Controlled, the
reasonable certainty is evidence of a business purpose to facilitate
an acquisition of Distributing or Controlled.
(ii) In the case of an acquisition before a distribution, if the
acquisition occurred after the date of the public announcement of
the planned distribution, or if, at the time of the acquisition, it
was reasonably certain that before a date that is 6 months after the
acquisition the distribution would occur, an agreement,
understanding, or arrangement would exist, or substantial
negotiations would occur regarding the distribution, the public
announcement or reasonable certainty is evidence of a business
purpose to facilitate an acquisition of distributing or Controlled.
(2) Internal discussions evidence of business purpose. The fact
that internal discussions regarding an acquisition occurred may be
indicative of the business purpose that motivated the distribution.
(3) Hostile takeover defense. If Distributing distributes
Controlled stock intending, in whole or substantial part, to
decrease the likelihood of the acquisition of Distributing or
Controlled by separating it from another corporation that is likely
to be acquired, Lstributing will be treated as having a business
purpose to facilitate the acquisition of the corporation that was
likely to be acquired.
(4) Effect of distribution on trading in stock. The fact that the
distribution made all or a part of the stock of Controlled available
for trading or made Distributing or Controlled’s stock trade more
actively is not taken into account in determining whether the
distribution and an acquisition of Distributing or Controlled stock
were part of a plan.
(5) Consequences of section 355(e) disregarded for certain
purposes. For purposes of determining the intentions of the relevant
parties under this section, the consequences of the application of
section 355(e), and the existence of any contractual indemnity by
Controlled for tax resulting from the application of section 355(e)
caused by an acquisition of Controlled, are disregarded.
(6) Substantial diminution of risk. The running of any time
period prescribed in this section shall be suspended for any period
during which risk of loss is substantially diminished under the
principles of section 355(d)(6)(B).
(f) Safe harbors--(1) Safe Harbor I. (i) A distribution and an
acquisition occurring after the distribution will not be considered
part of a plan if--
(A) The acquisition occurred more than 6 months after the
distribution and there was no agreement, understanding, arrangement,
or substantial negotiations concerning the acquisition before a date
that is 6 months after the distribution; and
(B) The distribution was motivated in whole or substantial part
by a corporate business purpose (within the meaning of §1.355-2(b))
other than a business purpose to facilitate an acquisition of
Lstributing or Controlled.
(ii) For purposes of paragraph (f)(1)(i)(B) of this section, the
presence of a business purpose to facilitate an acquisition of
Lstributing or Controlled is relevant in determining the extent to
which the distribution was motivated by a corporate business purpose
(within the meaning of §1.355-2(b)) other than a business purpose to
facilitate an acquisition of Distributing or Controlled.
(2) Safe Harbor II. A distribution and an acquisition occurring
after the distribution will not be considered part of a plan if--
(i) The acquisition occurred more than 6 months after the
distribution and there was no agreement, understanding, arrangement,
or substantial negotiations concerning the acquisition before a date
that is 6 months after the distribution; and
(ii) The distribution was motivated in whole or substantial part
by a corporate business purpose (within the meaning of §1.355-2(b))
to facilitate an acquisition or acquisitions of no more than 33
percent of the stock of Distributing or Controlled, and no more than
20 percent of the stock of the corporation (whose stock was acquired
in the acquisition or acquisitions that motivated the distribution)
was either acquired or the subject of an agreement, understanding,
arrangement, or substantial negotiations before a date that is 6
months after the distribution.
(3) Safe Harbor III. If an acquisition occurs more than 2 years
after a 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, the
acquisition and the distribution are not part of a plan.
(4) Safe Harbor IV. If an acquisition occurs more than 2 years
before a distribution, and there was no agreement, understanding,
arrangement, or substantial negotiations concerning the distribution
at the time of the acquisition or within 6 months thereafter, the
acquisition and the distribution are not part of a plan.
(5) Safe Harbor V--(i) In general. An acquisition of Distributing
or Controlled stock that is listed on an established market is not
part of a plan if the acquisition is pursuant to a transfer between
shareholders of Distributing or Controlled, neither of whom is a 5-
percent shareholder. For purposes of the preceding sentence, the
term 5-percent shareholder is defined in paragraph (k)(5) of this
section, except that the corporation can rely on Schedules 13D and
13G (or any similar schedules) filed with the Securities and
Exchange Commission to identify its 5-percent shareholders.
(ii) Special rules--(A) This paragraph (f)(5) does not apply to
public offerings or redemptions.
(B) This paragraph (f)(5) does not apply to a transfer of stock
by or to a person who, pursuant to a formal or informal
understanding with other persons (the coordinating group), has
joined in coordinated transfers of stock if, at any time during the
period the understanding exists, the coordinating group owns, in the
aggregate, 5 percent or more of the stock of the corporation whose
stock is transferred (determined by vote or value) immediately
before or after each transfer or at the time of the distribution. A
principal element in determining if such an understanding exists is
whether the investment decision of each person is based on the
investment decision of 1 or more other existing or prospective
shareholders.
(C) This paragraph (f)(5) does not apply to a transfer of stock
by or to a person if the corporation the stock of which is being
transferred knows, or has reason to know, that the person (or a
coordinating group, treating it as a single person) intends to
become a 5-percent shareholder at any time during the 4-year period
beginning 2 years before the distribution.
(6) Safe Harbor VI. If stock of Distributing or Controlled is
acquired by an employee or director of Distributing, Controlled, or
a person related to Distributing or Controlled under section 355(d)
(7)(A), in connection with the performance of services as an
employee or director 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) in a transaction to which section 83
applies, the acquisition is not an acquisition that is part of a
plan as described in paragraph (b)(1) of this section.
(g) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests--(1) Treatment of
options--(i) General rule. For purposes of this section, if stock of
Distributing or Controlled is acquired pursuant to an option, the
option will be treated as an agreement to acquire the stock on the
date the option is written unless Distributing establishes that on
the later of the date of the stock distribution or the writing of
the option, 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, taking
control premiums and minority and blockage discounts into account in
determining the fair market value of stock underlying an option.
(ii) Agreement, understanding, arrangement, or substantial
negotiations to write an option. If there is an agreement,
understanding, or arrangement to write an option, the option will be
treated as written on the date of the Lreement, understanding, or
arrangement. If an agreement, understanding, or arrangement to write
an option is reached, or an option is written, more than 6 months
but not more than 2 years after the distribution, and there were
substantial negotiations regarding the writing 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 written within 6 months after the distribution.
(2) Instruments treated as options. For purposes of this
paragraph (g), except to the extent provided in paragraph (g)(3) 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), any
other instruments that provide for the right or possibility to
issue, redeem, or transfer stock (including an option on an option),
or any other similar interests are treated as options.
(3) Instruments generally not treated as options. For purposes
of this paragraph (g), the following are not treated as options
unless (in the case of paragraphs (g)(3)(i), (iii), and (iv) of this
section) written, transferred (directly or indirectly), or listed
with a principal purpose of avoiding the application of section
355(e) or this section.
(i) 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.
(ii) Compensatory options. An option to acquire stock in
Distributing or Controlled with customary terms and conditions
provided to an employee or director of Distributing, Controlled, or
a person related to Distributing or Controlled under section 355(d)
(7)(A), in connection with the performance of services as an
employee or director 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--
(A) Is nontransferable within the meaning of §1.83-3(d); and
(B) Does not have a readily ascertainable fair market value as
defined in §1.83-7(b).
(iii) Options exercisable only upon death, disability, mental
incompetency, or separation from service. Any option entered into
between shareholders of a corporation (or a shareholder and the
corporation) that is exercisable only upon the death, disability, or
mental Lcompetency of the shareholder, 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 shareholder’s separation from service.
(iv) Rights of first refusal. A bona fide right of first refusal
regarding the corporation’s stock with customary terms, entered into
between shareholders of a corporation (or between the corporation
and a shareholder).
(v) Other enumerated instruments. Any other instrument the
Commissioner may designate in revenue procedures, notices, or other
guidance published in the Internal Revenue Bulletin. See §601.601(d)
(2) of this chapter.
(h) Multiple controlled corporations. Only the stock or securities
of a controlled corporation in which 1 or more persons acquire
directly or indirectly stock representing a 50-percent or greater
interest as part of a plan 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 1 controlled corporation
are distributed in distributions to which section 355 (or so much of
section 356 as relates to section 355) applies; and
(2) One or more persons do not acquire, directly or indirectly,
stock representing a 50-percent or greater interest in Distributing
pursuant to a plan involving any of those distributions.
(i) [Reserved]
(j) Valuation. Except as provided in paragraph (g)(1)(i) 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.
(k) Definitions--(1) Agreement, understanding, arrangement, or
substantial negotiations. Whether an agreement, understanding, or
arrangement exists depends on the facts and circumstances. 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. However, an agreement,
understanding, or arrangement clearly exists if enforceable rights
to acquire stock exist. In public offerings or auctions by
Distributing or Controlled of Distributing or Controlled’s stock, an
agreement, understanding, arrangement, or substantial negotiations
can exist even if the acquirer has not been specifically identified.
The existence of such an agreement, understanding, arrangement, or
substantial negotiations will be based on discussions with an
investment banker or other outside adviser.
(2) Controlled corporation. For purposes of this section, a
controlled corporation is a corporation the stock of which is
distributed in a distribution to which section 355 (or so much of
section 356 as relates to section 355) applies.
(3) Controlling shareholder. (i) A controlling shareholder of a
corporation the stock of which is not listed on an established
market 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 Distributing or Controlled representing a
meaningful voice in the governance of the corporation.
(ii) A controlling shareholder of a corporation the stock of
which is listed on an established market is a 5-percent shareholder
who actively participates in the management or operation of the
corporation.
(iii) For purposes of this section, a person is a controlling
shareholder if that person meets the definition of controlling
shareholder in this paragraph (k)(3) immediately before or
immediately after the acquisition being tested.
(iv) If a distribution precedes an acquisition, Controlled’s
controlling shareholders immediately after the distribution are
considered Controlled’s controlling shareholders at the time of the
distribution.
(4) Established Market. An established market is--
(i) A national securities exchange registered under section 6 of
the Securities Exchange Act of 1934 (15 U.S.C. 78f);
(ii) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the
Securities Act of 1934 (15 U.S.C. 78o-3); or
(iii) Any additional market that the Commissioner may designate
in revenue procedures, notices, or other guidance published in the
Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).
(5) Five-percent shareholder. A person will be considered a 5-
percent shareholder of a corporation the stock of which is listed on
an established market if the person owns, directly or indirectly, or
together with related persons (as described in sections 267(b) and
707(b)) 5 percent or more of any class of stock of the corporation
whose stock is transferred. A person is a 5-percent shareholder if
the person meets the requirements of the preceding sentence
immediately before or after each transfer. All options are treated
as exercised for the purpose of determining whether the shareholder
is a 5-percent shareholder.
(l) [Reserved]
(m) Examples. The following examples illustrate paragraphs (a)
through (k) of this section. Throughout these examples, assume that
Distributing (D) owns all of the stock of Controlled (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.
Unless otherwise stated, assume the corporations do not have
controlling shareholders. 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. Unwanted assets. (i) D is in business 1. C is in
business 2. D is relatively small in its industry. D wants to
combine with X, a larger corporation also engaged in business 1. X
and D begin negotiating for X to acquire D, but X does not want to
acquire C. To facilitate the acquisition of D by X, D agrees to
Lstribute all the stock of C pro rata before the acquisition. D and
X enter into a binding contract for D to merge into X subject to
several conditions. D distributes C and D merges into X one month
later. As a result of the merger, D’s former shareholders own less
than 50 percent of the stock of X.
(ii) No Safe Harbor applies to this acquisition.
(iii) The issue is whether the distribution of C and the merger
of D into X are part of a plan. To determine whether the
distribution of C and the merger of D into X are part of a plan, D
must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(iv) The following tends to show that the distribution of C and
the merger of D into X are part of a plan: X and D discussed the
acquisition before the distribution (paragraph (d)(2)(i) of this
section), D was motivated by a business purpose to facilitate the
merger (paragraph (d)(2)(vii) of this section), and the distribution
and the merger occurred within 6 months of each other (paragraph (d)
(2)(viii) of this section). Because the merger was not only
discussed, but was agreed to, before the distribution, the fact
described in paragraph (d)(2)(i) of this section is given
substantial weight.
(v) None of the facts and circumstances listed in paragraph (d)
(3) of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.
(vi) The distribution of C and the merger of D into X are part of
a plan under paragraph (b)(1) of this section.
Example 2. Substituted acquirer. (i) The facts are the same as in
Example 1, except that after D distributes C, X is unable to fulfill
one of the conditions of the merger agreement and the merger of D
into X does not occur. Y, one of X’s competitors, perceives this as
an opportunity and begins discussing with D a merger into Y. Five
months after D distributes C, D merges into Y. As a result of the
merger, the D shareholders own less than 50 percent of the
outstanding Y stock.
(ii) No Safe Harbor applies to this acquisition.
(iii) The issue is whether the distribution of C and the merger
of D into Y are part of a plan. To determine whether the
distribution of C and the merger of D into Y are part of a plan, D
must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(iv) The following tends to show that the distribution of C and
the merger of D into Y are part of a plan: X, a potential acquirer,
and D discussed an acquisition before the distribution and a similar
acquisition by Y occurred (paragraph (d)(2)(ii) of this section), D
was motivated by a business purpose to facilitate an acquisition
similar to the merger with Y (paragraph (d)(2)(vii) of this
section), and the distribution and the merger occurred within 6
months of each other (paragraph (d)(2)(viii) of this section).
(v) As in Example 1, none of the facts and circumstances listed
in paragraph (d)(3) of this section exist in this case. Although a
substituted acquirer acquired D, the merger of D into Y was similar
to the negotiated merger of D into X.
(vi) The distribution of C and the merger of D into Y are part of
a plan under paragraph (b)(1) of this section.
Example 3. Public offering. (i) D’s managers, directors, and
investment banker discuss the possibility of offering D stock to the
public. They decide a public offering of 50 percent of D’s stock
with D as a stand alone corporation would be in D’s best interest.
To facilitate a stock offering by D of 50 percent of its stock, D
distributes all the stock of C pro rata to D’s shareholders. D
issues new shares amounting to 50 percent of its stock to the public
in a public offering 7 months after the distribution.
(ii) No Safe Harbor applies to this acquisition. Safe Harbor V,
relating to public trading, does not apply to public offerings
(paragraph (f)(5)(ii)(A) of this section).
(iii) The issue is whether the distribution of C and the public
offering by D are part of a plan. To determine whether the
distribution of C and the public offering by D are part of a plan, D
must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(iv) The following tends to show that the distribution of C and
the public offering by D are part of a plan: D discussed the public
offering with its investment banker before the distribution
(paragraph (d)(2)(iii) of this section), D was motivated by a
business purpose to facilitate the public offering (paragraph (d)(2)
(vii) of this section), and there were substantial negotiations
regarding the public offering within 6 months after the distribution
(paragraph (d)(2)(viii) of this section).
(v) None of the facts and circumstances listed in paragraph (d)
(3) of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.
(vi) The distribution of C and the public offering by D are part
of a plan under paragraph (b)(1) of this section.
Example 4. Public offering followed by unexpected
opportunity--(i) Facts. D’s managers, directors, and investment
banker discuss the possibility of offering C stock to the public. D
decides to distribute C pro rata to D’s shareholders solely to
facilitate a 20 percent 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 1 month before D
distributes its remaining 80 percent of the C stock. The public
offering documents disclose the intended distribution of C, which is
expected to occur shortly after the public offering. At the time of
the distribution, it is not reasonably certain that an acquisition
will occur, an agreement, understanding, or arrangement concerning
an acquisition will exist, or substantial negotiations concerning an
acquisition will occur within 6 months. 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.
(ii) Public offering. (A) No Safe Harbor applies to the public
offering. Safe Harbor V, related to public trading, does not apply
to public offerings (paragraph (f)(5)(ii)(A) of this section).
(B) The issue is whether the 20 percent public offering by C and
the distribution by D of the remaining C stock are part of a plan.
To determine whether the distribution and the public offering are
part of a plan, D must consider all the facts and circumstances,
including those described in paragraph (d) of this section.
(C) Under paragraph (d)(2) of this section, the following tends
to show that the distribution of C and the public offering are part
of a plan: D discussed the distribution with its investment banker
before the public offering (paragraph (d)(2)(vi) of this section), D
was motivated by a business purpose to facilitate the public
offering (paragraph (d)(2)(vii) of this section), and the public
offering and the distribution occurred within 6 months of each other
(paragraph (d)(2)(viii) of this section).
(D) None of the facts and circumstances listed in paragraph (d)
(3) of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.
(E) The public offering of C and the distribution of C are part
of a plan under paragraph (b)(1) of this section.
(iii) X Lquisition. (A) No Safe Harbor applies to the X
acquisition.
(B) The issue is whether the distribution of C and the
acquisition by C of X are part of a plan. To determine whether the
distribution of C and the acquisition by C of X are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(C) Under paragraph (d)(2) of this section, the following tends
to show that the distribution of C and acquisition by C of X are
part of a plan: The distribution and the acquisition occurred within
6 months of each other (paragraph (d)(2)(viii) of this section). The
fact described in paragraph (d)(2)(vii) of this section does not
exist in this case because D’s business purpose was to facilitate
the public offering and C’s acquisition of X is not similar to that
acquisition.
(D) Under paragraph (d)(3) of this section, the following tends
to show that the distribution of C and the acquisition by C of X are
not part of a plan: Neither D, C, nor their respective controlling
shareholders discussed the acquisition of X or a similar acquisition
with potential acquirers before the distribution (paragraph (d)(3)
(i) of this section), D had a substantial business purpose for the
distribution other than a business purpose to facilitate the
acquisition of X or a similar acquisition (paragraph
(d)(3)(vi) of this section), and the distribution would have
occurred at approximately the same time and in similar form
regardless of the acquisition of X (paragraph (d)(3)(vii) of this
section). The distribution was announced and accomplished to
facilitate the 20 percent public offering by C. D and C were unaware
of the opportunity to acquire X at the time of the distribution.
(E) Weighing the facts and circumstances, the acquisition by C of
X and the distribution of C by D are not part of a plan under
paragraph (b)(1) of this section.
(F) If C’s acquisition of X had occurred more than 6 months after
the distribution and had not been the subject of an agreement,
understanding, arrangement, or substantial negotiations before the
date that is 6 months after the distribution, Safe Harbor II would
have applied to C’s acquisition of X.
Example 5. Hot market. (i) D is a widely held corporation the
stock of which is listed on an established market. D announces a
distribution of C and distributes C pro rata to D’s shareholders. By
contract, C agrees to indemnify D for any imposition of tax under
section 355(e) caused by the acts of C. The distribution is
motivated by a desire to improve D’s access to financing at
preferred customer interest rates, which will be more readily
available if D separates from C. At the time of the distribution,
although D has not been approached by any potential acquirer of C,
it is reasonably certain that within 6 months after the distribution
either an acquisition of C will occur or there will be an agreement,
understanding, arrangement, or substantial negotiations regarding an
acquisition of C. Corporation Y acquires C in a merger described in
section 368(a)(2)(E) within 6 months after the distribution. The C
shareholders receive less than 50 percent of the stock of Y in the
exchange.
(ii) No Safe Harbor applies to this acquisition.
(iii) The issue is whether the distribution of C and the
acquisition of C by Y are part of a plan. To determine whether the
distribution of C and the acquisition of C by Y are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(iv) Under paragraph (d)(2) of this section, the following tends
to show that the distribution of C and the acquisition of C by Y are
part of a plan: The acquisition and the distribution occurred within
6 months of each other (paragraph (d)(2)(viii) of this section). In
addition, the distribution may be motivated by a business purpose to
facilitate the acquisition or a similar acquisition because there is
evidence of a business purpose to facilitate an acquisition by
reason of the fact that at the time of the distribution it was
reasonably certain that an acquisition of C would occur or there
would be an agreement, understanding, arrangement, or substantial
negotiations regarding an acquisition of C within 6 months after the
distribution (paragraphs (d)(2)(vii) and (e)(1)(i) of this section).
(v) Under paragraph (d)(3) of this section, the following tends
to show that the distribution of C and the acquisition of C by Y are
not part of a plan: Neither D, C, nor their respective controlling
shareholders discussed the acquisition or a similar acquisition with
Y or any other potential acquirers before the distribution
(paragraph (d)(3)(i) of this section). Furthermore, D may be able to
demonstrate that the distribution was motivated in whole or
substantial part by a corporate business purpose other than a
business purpose to facilitate the acquisition or a similar
Lquisition (paragraph (d)(3)(vi) of this section). D’s stated
purpose for the distribution (facilitating D’s access to favorable
financing) must be evaluated in light of the evidence of a business
purpose to facilitate an acquisition. D also may be able to
demonstrate that the distribution would have occurred at
approximately the same time and in similar form regardless of the
acquisition (paragraph (d)(3)(vii) of this section).
(vi) Under paragraph (e)(5) of this section, the existence of the
indemnity is irrelevant in analyzing whether the distribution and
acquisition of C are part of a plan.
(vii) In determining whether the distribution of C and the
acquisition of C by Y are part of a plan, one should consider the
importance of D’s stated business purpose for the distribution in
light of the reasonable certainty that C would be acquired or there
would be an agreement, understanding, arrangement, or substantial
negotiations regarding an acquisition of C within 6 months after the
distribution. If D’s stated business purpose for the distribution is
substantial even though the reasonable certainty that C would be
acquired is evidence of a business purpose to facilitate an
acquisition, and if D would have distributed C regardless of Y’s
acquisition of C, Y’s acquisition of C and D’s distribution of C are
not part of a plan.
Example 6. Unexpected opportunity. (i) D, the stock of which is
listed on an established market, announces that it will distribute
all the stock of C pro rata to D’s shareholders. At the time of the
announcement, the distribution is motivated wholly by a corporate
business purpose (within the meaning of §1.355-2(b)) other than a
business purpose to facilitate an acquisition. After the
announcement but before the distribution, widely held X becomes
available as an acquisition target. There were no discussions
between D and X before the announcement. D negotiates with and
acquires X before the distribution. After the acquisition, X’s
former shareholders own 55 percent of D’s stock. D distributes the
stock of C pro rata within 6 months after the acquisition of X.
(ii) No Safe Harbor applies to this acquisition.
(iii) The issue is whether the acquisition of X by D and the
distribution of C are part of a plan. To determine whether the
distribution of C and the acquisition of X by D are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(iv) Under paragraph (d)(2) of this section, the following tends
to show that the acquisition of X by D and the distribution of C are
part of a plan: The acquisition and the distribution occurred within
6 months of each other (paragraph (d)(2)(viii) of this section).
Also, the distribution may be motivated by a business purpose to
facilitate the acquisition or a similar acquisition because there is
evidence of a business purpose to facilitate an acquisition by
reason of the fact that the acquisition occurred after the public
announcement of the planned distribution (paragraphs (d)(2)(vii) and
(e)(1)(ii) of this section).
(v) Under paragraph (d)(3) of this section, D would assert that
the following tends to show that the distribution of C and the
acquisition of X by D are not part of a plan: The distribution was
motivated by a corporate business purpose other than a business
purpose to facilitate the acquisition or a similar acquisition
(paragraph (d)(3)(vi) of this section), and the distribution would
have occurred at approximately the same time and in similar form
regardless of the acquisition (paragraph (d)(3)(vii) of this
section). That D decided to distribute C and announced that decision
before it became aware of the opportunity to acquire X suggests that
the distribution would have occurred at approximately the same time
and in similar form regardless of D’s acquisition of X. X’s lack of
participation in the decision also helps establish that fact.
(vi) In determining whether the distribution of C and acquisition
of X by D are part of a plan, one should consider the importance of
D’s business purpose for the distribution in light of D’s
opportunity to acquire X. If D can establish that the distribution
continued to be motivated by the stated business purpose, and if D
would have distributed C regardless of D’s acquisition of X, then
D’s acquisition of X and D’s distribution of C are not part of a
plan.
Example 7. Multiple acquisitions--(i) Facts. (A) D, the stock of
which is listed on an established market, engages in business 1. C
engages in business 2. D has a business strategy of growth through
acquisitions and is interested in continually expanding business 1.
D’s ownership of C has been an impediment to acquisitions by D. D
believes the distribution of C will make its acquisition program
more economical overall, regardless of D’s success with any
particular acquisition target. D has no specific goals regarding how
much D stock will be used for acquisitions.
(B) D and its investment banker identify X and Y as potential
acquisition targets before D publicly announces the planned
distribution. After D publicly announces the distribution, the sole
purpose of which is to facilitate acquisitions by D, but before the
distribution date, D negotiates with X, but has no contact with Y. D
distributes all of the C stock. One month after the distribution, D
consummates the negotiated acquisition of X. A, X’s sole
shareholder, receives 30 percent of D’s stock. Seven months after
the distribution, D begins negotiating with Y. 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. If aggregated, the acquisitions of X, Y and Z would
result in a change in the stock ownership of D of more than 50
percent.
(ii) X acquisition. (A) No Safe Harbor applies to the X
acquisition.
(B) The issue is whether the distribution of C and the
acquisition of X by D are part of a plan. To determine whether the
distribution of C and the acquisition of X by D are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(C) Under paragraph (d)(2) of this section, the following tends
to show that the distribution of C and the acquisition of X by D are
part of a plan: D and X discussed the acquisition before the
distribution (paragraph (d)(2)(i) of this section), D had a business
purpose to facilitate the X acquisition or a similar acquisition
(paragraph (d)(2)(vii) of this section), and the distribution and
the X acquisition occurred within 6 months of each other (paragraph
(d)(2)(viii) of this section).
(D) None of the facts and circumstances listed in paragraph (d)
(3) of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.
(E) The distribution of C and the acquisition of X are part of a
plan under paragraph (b)(1) of this section.
(iii) Y acquisition. (A) No Safe Harbor applies to the Y
acquisition. Safe Harbor I does not apply because the distribution
was not motivated in whole or substantial part by a corporate
business purpose (within the meaning of §1.355-2(b)) other than a
business purpose to facilitate an acquisition. Safe Harbor II does
not apply because D’s business purpose to facilitate acquisitions
was not limited to 33 percent or less of the D stock. Also, more
than 20 percent of D’s stock was acquired in an acquisition that
motivated the distribution before the date that was 6 months after
the distribution (D’s acquisition of X using 30 percent of D’s stock
1 month after the distribution).
(B) The issue is whether the distribution of C and the
acquisition of Y by D are part of a plan. To determine whether the
distribution of C and the acquisition of Y by D are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section.
(C) Under paragraph (d)(2) of this section, the following tends
to show that the distribution of C and the acquisition of Y by D are
part of a plan: D and a potential acquirer (X) discussed an
acquisition before the distribution and a similar acquisition with a
different acquirer (Y) occurred (paragraph (d)(2)(ii) of this
section) and D had a business purpose to facilitate the Y
Lquisition or a similar acquisition (paragraph(d)(2)(vii) of this
section).
(D) None of the facts and circumstances listed in paragraph (d)
(3) of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.
(E) The distribution of C and the acquisition of Y are part of a
plan under paragraph (b)(1) of this section.
(iv) Z acquisition. The analysis is identical to the Y
acquisition. The distribution of C and the acquisition of Z are part
of a plan under paragraph (b)(1) of this section.
(v) Under paragraph (c) of this section, all acquisitions of
stock of D pursuant to a plan involving a distribution will be
aggregated for purposes of the 50-percent test of paragraph (a)(2)
of this section. Because the acquisitions by D of X, Y, and Z are
each part of a plan involving D’s distribution of C, those three
acquisitions are aggregated.
(n) Effective date. This section applies to distributions
occurring after these regulations are published as final regulations
in the Federal Register.
Robert E. Wenzel
Deputy Commissioner of Internal Revenue
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