[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2003 Edition]
[From the U.S. Government Printing Office]
[[Page i]]
26
Part 1 (Secs. 1.301 to 1.400)
Revised as of April 1, 2003
Internal Revenue
Containing a codification of documents of general
applicability and future effect
As of April 1, 2003
With Ancillaries
Published by
Office of the Federal Register
National Archives and Records
Administration
A Special Edition of the Federal Register
[[Page ii]]
U.S. GOVERNMENT PRINTING OFFICE
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[[Page iii]]
Table of Contents
Page
Explanation................................................. v
Title 26:
Chapter I--Internal Revenue Service, Department of
the Treasury (Continued) 3
Finding Aids:
Table of CFR Titles and Chapters........................ 532
Alphabetical List of Agencies Appearing in the CFR...... 549
Table of OMB Control Numbers............................ 559
List of CFR Sections Affected........................... 577
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 26 CFR 1.301-1
refers to title 26, part
1, section 301-1.
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[[Page v]]
EXPLANATION
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
The appropriate revision date is printed on the cover of each
volume.
LEGAL STATUS
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HOW TO USE THE CODE OF FEDERAL REGULATIONS
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EFFECTIVE AND EXPIRATION DATES
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OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires
Federal agencies to display an OMB control number with their information
collection request.
[[Page vi]]
Many agencies have begun publishing numerous OMB control numbers as
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OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
the cover of each volume are not carried. Code users may find the text
of provisions in effect on a given date in the past by using the
appropriate numerical list of sections affected. For the period before
January 1, 2001, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, 1973-1985, or 1986-2000, published in 11 separate
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Sections Affected'' is published at the end of each CFR volume.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
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the revision dates of the 50 CFR titles.
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[[Page vii]]
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Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 2003.
[[Page ix]]
THIS TITLE
Title 26--Internal Revenue is composed of twenty volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
2003. The first thirteen volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Secs. 1.0-1-1.60;
Secs. 1.61-1.169; Secs. 1.170-1.300; Secs. 1.301-1.400; Secs. 1.401-
1.440; Secs. 1.441-1.500; Secs. 1.501-1.640; Secs. 1.641-1.850;
Secs. 1.851-1.907; Secs. 1.908-1.1000; Secs. 1.1001-1.1400;
Secs. 1.1401-1.1503-2A; and Sec. 1.1551-1 to end. The fourteenth volume
containing parts 2-29, includes the remainder of subchapter A and all of
Subchapter B--Estate and Gift Taxes. The last six volumes contain parts
30-39 (Subchapter C--Employment Taxes and Collection of Income Tax at
Source); parts 40-49; parts 50-299 (Subchapter D--Miscellaneous Excise
Taxes); parts 300-499 (Subchapter F--Procedure and Administration);
parts 500-599 (Subchapter G--Regulations under Tax Conventions); and
part 600 to end (Subchapter H--Internal Revenue Practice).
The OMB control numbers for Title 26 appear in Sec. 602.101 of this
chapter. For the convenience of the user, Sec. 602.101 appears in the
Finding Aids section of the volumes containing parts 1 to 599.
[[Page x]]
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains part 1, Secs. 1.301 to 1.400)
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Part
chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 1
[[Page 3]]
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
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Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980,
deleting statutory sections from their regulations. In chapter I cross
references to the deleted material have been changed to the
corresponding sections of the IRS Code of 1954 or to the appropriate
regulations sections. When either such change produced a redundancy, the
cross reference has been deleted. For further explanation, see 45 FR
20795, March 31, 1980.
SUBCHAPTER A--INCOME TAX (CONTINUED)
Part Page
1 Income taxes................................ 5
Supplementary Publication: Internal Revenue Service Looseleaf
Regulations System.
Additional supplementary publications are issued covering Alcohol and
Tobacco Tax Regulations, and Regulations Under Tax Conventions.
[[Page 5]]
SUBCHAPTER A--INCOME TAX (CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Normal Taxes and Surtaxes
CORPORATE DISTRIBUTIONS AND ADJUSTMENTS
DISTRIBUTIONS BY CORPORATIONS
Effects on Recipients
Sec.
1.301-1 Rules applicable with respect to distributions of money and
other property.
1.302-1 General.
1.302-2 Redemptions not taxable as dividends.
1.302-3 Substantially disproportionate redemption.
1.302-4 Termination of shareholder's interest.
1.303-1 General.
1.303-2 Requirements.
1.303-3 Application of other sections.
1.304-1 General.
1.304-2 Acquisition by related corporation (other than subsidiary).
1.304-3 Acquisition by a subsidiary.
1.304-4T Special rule for use of a related corporation to acquire for
property the stock of another commonly owned corporation
(temporary).
1.304-5 Control.
1.305-1 Stock dividends.
1.305-2 Distributions in lieu of money.
1.305-3 Disproportionate distributions.
1.305-4 Distributions of common and preferred stock.
1.305-5 Distributions on preferred stock.
1.305-6 Distributions of convertible preferred.
1.305-7 Certain transactions treated as distributions.
1.305-8 Effective dates.
1.306-1 General
1.306-2 Exception
1.306-3 Section 306 stock defined.
1.307-1 General.
1.307-2 Exception.
effects on corporation
1.312-1 Adjustment to earnings and profits reflecting distributions by
corporations.
1.312-2 Distribution of inventory assets.
1.312-3 Liabilities.
1.312-4 Examples of adjustments provided in section 312(c).
1.312-5 Special rule for partial liquidations and certain redemptions.
1.312-6 Earnings and profits.
1.312-7 Effect on earnings and profits of gain or loss realized after
February 28, 1913.
1.312-8 Effect on earnings and profits of receipt of tax-free
distributions requiring adjustment or allocation of basis of
stock.
1.312-9 Adjustments to earnings and profits reflecting increase in
value accrued before March 1, 1913.
1.312-10 Allocation of earnings in certain corporate separations.
1.312-11 Effect on earnings and profits of certain other tax-free
exchanges, tax-free distributions, and tax-free transfers from
one corporation to another.
1.312-12 Distributions of proceeds of loans guaranteed by the United
States.
1.312-15 Effect of depreciation on earnings and profits.
definitions; constructive ownership of stock
1.316-1 Dividends.
1.316-2 Sources of distribution in general.
1.317-1 Property defined.
1.318-1 Constructive ownership of stock; introduction.
1.318-2 Application of general rules.
1.318-3 Estates, trusts, and options.
1.318-4 Constructive ownership as actual ownership; exceptions.
Corporate Liquidations
effects on recipients
1.331-1 Corporate liquidations.
1.332-1 Distributions in liquidation of subsidiary corporation;
general.
1.332-2 Requirements for nonrecognition of gain or loss.
1.332-3 Liquidations completed within one taxable year.
1.332-4 Liquidations covering more than one taxable year.
1.332-5 Distributions in liquidation as affecting minority interests.
1.332-6 Records to be kept and information to be filed with return.
1.332-7 Indebtedness of subsidiary to parent.
1.334-1 Basis of property received in liquidations.
effects on corporation
1.337(d)-1 Transitional loss limitation rule.
1.337(d)-1T [Reserved]
1.337(d)-2 Loss limitation window period.
1.337(d)-2T Loss limitation window period (temporary).
1.337(d)-4 Taxable to tax-exempt.
1.337(d)-5 Old transitional rules imposing tax on property owned by a C
corporation that becomes property of a RIC or REIT .
1.337(d)-6 New transitional rules imposing tax on property owned by a C
corporation that becomes property of a RIC or REIT.
[[Page 6]]
1.337(d)-7 Tax on property owned by a C corporation that becomes
property of a RIC or REIT.
1.338-0 Outline of topics.
1.338-1 General principles; status of old target and new target.
1.338-2 Nomenclature and definitions; mechanics of the section 338
election.
1.338-3 Qualification for the section 338 election.
1.338-4 Aggregate deemed sale price; various aspects of taxation of the
deemed asset sale.
1.338-5 Adjusted grossed-up basis.
1.338-6 Allocation of ADSP and AGUB among target assets.
1.338-7 Allocation of redetermined ADSP and AGUB among target assets.
1.338-8 Asset and stock consistency.
1.338-9 International aspects of section 338.
1.338-10 Filing of returns.
1.338(h)(10)-1 Deemed asset sale and liquidation.
1.338(i)(1)-1 Effective dates.
Collapsible Corporations; Foreign Personal Holding Companies
1.341-1 Collapsible corporations; in general.
1.341-2 Definitions.
1.341-3 Presumptions.
1.341-4 Limitations on application of section.
1.341-5 Application of section.
1.341-6 Exceptions to application of section.
1.341-7 Certain sales of stock of consenting corporations.
1.342-1 General.
definition
1.346-1 Partial liquidation.
1.346-2 Treatment of certain redemptions.
1.346-3 Effect of certain sales.
Corporate Organizations and Reorganizations
corporate organizations
1.351-1 Transfer to corporation controlled by transferor.
1.351-2 Receipt of property.
1.351-3 Records to be kept and information to be filed.
effects on shareholders and security holders
1.354-1 Exchanges of stock and securities in certain reorganizations.
1.355-0 Table of contents.
1.355-1 Distribution of stock and securities of controlled corporation.
1.355-2 Limitations.
1.355-3 Active conduct of a trade or business.
1.355-4 Non pro rata distributions, etc.
1.355-5 Records to be kept and information to be filed.
1.355-6 Recognition of gain on certain distributions of stock or
securities in controlled corporation.
1.355-7T Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
1.356-1 Receipt of additional consideration in connection with an
exchange.
1.356-2 Receipt of additional consideration not in connection with an
exchange.
1.356-3 Rules for treatment of securities as ``other property''.
1.356-4 Exchanges for section 306 stock.
1.356-5 Transactions involving gift or compensation.
1.356-6 Rules for treatment of nonqualified preferred stock as other
property.
1.356-7 Rules for treatment of nonqualified preferred stock and other
preferred stock received in certain transactions.
1.357-1 Assumption of liability.
1.357-2 Liabilities in excess of basis.
1.358-1 Basis to distributees.
1.358-2 Allocation of basis among nonrecognition property.
1.358-3 Treatment of assumption of liabilities.
1.358-4 Exceptions.
1.358-5 [Reserved]
1.358-6 Stock basis in certain triangular reorganizations.
effects on corporation
1.361-1 Nonrecognition of gain or loss to corporations.
1.362-1 Basis to corporations.
1.362-2 Certain contributions to capital.
1.367(a)-1T Transfers to foreign corporations subject to section
367(a): In general (temporary).
1.367(a)-2T Exception for transfers of property for use in the active
conduct of a trade or business (temporary).
1.367(a)-3 Treatment of transfers of stock or securities to foreign
corporations.
1.367(a)-4T Special rules applicable to specified transfers of property
(temporary).
1.367(a)-5T Property subject to section 367(a)(1) regardless of use in
trade or business (temporary).
1.367(a)-6T Transfer of foreign branch with previously deducted losses
(temporary).
1.367(a)-8 Gain recognition agreement requirements.
1.367(b)-0 Table of contents.
1.367(b)-1 Other transfers.
1.367(b)-2 Definitions and special rules.
1.367(b)-3 Repatriation of foreign corporate assets in certain
nonrecognition transactions.
1.367(b)-3T Repatriation of foreign corporate assets in certain
nonrecognition transactions (temporary).
1.367(b)-4 Acquisition of foreign corporate stock or assets by a
foreign corporation in certain nonrecognition transactions.
[[Page 7]]
1.367(b)-5 Distributions of stock described in section 355.
1.367(b)-6 Effective dates and coordination rules.
1.367(b)-12 Subsequent treatment of amounts attributed or included in
income.
1.367(d)-1T Transfers of intangible property to foreign corporations
(temporary).
1.367(e)-0 Outline of Secs. 1.367(e)-1 and 1.367(e)-2.
1.367(e)-1 Distributions described in section 367(e)(1).
1.367(e)-2 Distributions described in section 367(e)(2).
special rule; definitions
1.368-1 Purpose and scope of exception of reorganization exchanges.
1.368-2 Definition of terms.
1.368-2T Definition of terms (temporary).
1.368-3 Records to be kept and information to be filed with returns.
Insolvency Reorganizations
1.371-1 Exchanges by corporations.
1.371-2 Exchanges by security holders.
1.372-1 Corporations.
1.374-1 Exchanges by insolvent railroad corporations.
1.374-2 Basis of property acquired after December 31, 1938, by railroad
corporation in a receivership or railroad reorganization
proceeding.
1.374-3 Records to be kept and information to be filed.
1.374-4 Property acquired by electric railway corporation in corporate
reorganization proceeding.
Carryovers
1.381(a)-1 General rule relating to carryovers in certain corporate
acquisitions.
1.381(b)-1 Operating rules applicable to carryovers in certain
corporate acquisitions.
1.381(c)(1)-1 Net operating loss carryovers in certain corporate
acquisitions.
1.381(c)(1)-2 Net operating loss carryovers; two or more dates of
distribution or transfer in the taxable year.
1.381(c)(2)-1 Earnings and profits.
1.381(c)(3)-1 Capital loss carryovers.
1.381(c)(4)-1 Method of accounting.
1.381(c)(5)-1 Inventories.
1.381(c)(6)-1 Depreciation method.
1.381(c)(8)-1 Installment method.
1.381(c)(9)-1 Amortization of bond discount or premium.
1.381(c)(10)-1 Deferred exploration and development expenditures.
1.381(c)(11)-1 Contributions to pension plan, employees' annuity plans,
and stock bonus and profit-sharing plans.
1.381(c)(12)-1 Recovery of bad debts, prior taxes, or delinquency
amounts.
1.381(c)(13)-1 Involuntary conversions.
1.381(c)(14)-1 Dividend carryover to personal holding company.
1.381(c)(15)-1 Indebtedness of certain personal holding companies.
1.381(c)(16)-1 Obligations of distributor or transferor corporation.
1.381(c)(17)-1 Deficiency dividend of personal holding company.
1.381(c)(18)-1 Depletion on extraction of ores or minerals from the
waste or residue of prior mining.
1.381(c)(19)-1 Charitable contribution carryovers in certain
acquisitions.
1.381(c)(21)-1 Pre-1954 adjustments resulting from change in method of
accounting.
1.381(c)(22)-1 Successor life insurance company.
1.381(c)(23)-1 Investment credit carryovers in certain corporate
acquisitions.
1.381(c)(24)-1 Work incentive program credit carryovers in certain
corporate acquisitions.
1.381(c)(25)-1 Deficiency dividend of a qualified investment entity.
1.381(c)(26)-1 Credit for employment of certain new employees.
1.381(d)-1 Operations loss carryovers of life insurance companies.
1.382-1 Table of contents.
1.382-1T [Reserved]
1.382-2 General rules for ownership change.
1.382-2T Definition of ownership change under section 382, as amended
by the Tax Reform Act of 1986 (temporary).
1.382-3 Definitions and rules relating to a 5-percent shareholder.
1.382-4 Constructive ownership of stock.
1.382-5 Section 382 limitation. [Reserved]
1.382-6 Allocation of income and loss to periods before and after the
change date for purposes of section 382.
1.382-7 Built-in gains and loses. [Reserved]
1.382-8 Controlled groups. [Reserved]
1.382-9 Special rules under section 382 for corporations under the
jurisdiction of a court in a title 11 or similar case.
1.382-10 [Reserved]
1.382-11 Effective dates. [Reserved]
1.383-0 Effective date.
1.383-1 Special limitations on certain capital losses and excess
credits.
1.383-2 Limitations on certain capital losses and excess credits in
computing alternative minimum tax. [Reserved]
Authority: 26 U.S.C. 7805, unless otherwise noted.
Section 1.301-1 also issued under 26 U.S.C. 357(d)(3).
Section 1.301-1T also issued under 26 U.S.C. 357(d)(3).
Section 1.304-5 also issued under 26 U.S.C. 304.
Section 1.305-3 also issued under 26 U.S.C. 305.
[[Page 8]]
Section 1.305-5 also issued under 26 U.S.C. 305.
Section 1.305-7 also issued under 26 U.S.C. 305.
Section 1.337(d)-1 also issued under 26 U.S.C. 337(d).
Section 1.337(d)-2 also issued under 26 U.S.C. 337(d).
Section 1.337(d)-2T also issued under 26 U.S.C. 337(d).
Section 1.337(d)-4 also issued under 26 U.S.C. 337.
Section 1.337(d)-5 also issued under 26 U.S.C. 337.
Section 1.337(d)-6 also issued under 26 U.S.C. 337.
Section 1.337(d)-7 also issued under 26 U.S.C. 337.
Section 1.338-1 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-2 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-3 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-4 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-5 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-6 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-7 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-8 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-9 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338-10 also issued under 26 U.S.C. 337(d), 338, and 1502.
Section 1.338(h)(10)-1 also issued under 26 U.S.C. 337(d), 338, and
1502.
Section 1.338(i)-1 also issued under 26 U.S.C. 337(d), 338, and
1502.
Section 1.351-1 also issued under 26 U.S.C. 351.
Section 1.351-2 also issued under 26 U.S.C. 351(g)(4).
Section 1.354-1 also issued under 26 U.S.C. 351(g)(4).
Section 1.355-1 also issued under 26 U.S.C. 351(g)(4).
Section 1.355-6 also issued under 26 U.S.C. 355(d)(9).
Section 1.356-6 also issued under 26 U.S.C. 351(g)(4).
Section 1.355-7T also issued under 26 U.S.C. 355(e)(5).
Section 1.356-7 also issued under 26 U.S.C. 351(g)(4).
Section 1.367(a)-3 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(a)-8 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-1 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-2 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-3 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-3T also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-4 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-7 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-8 also issued under 26 U.S.C. 367(b).
Section 1.367(b)-9 also issued under 26 U.S.C. 367(b).
Section 1.367(b)-12 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(e)-1 also issued under 26 U.S.C. 367(e)(1).
Section 1.367(e)-2 also issued under 26 U.S.C. 367(e)(2).
Section 1.382-2 also issued under 26 U.S.C. 382(k)(1), (l)(3), (m),
and 26 U.S.C. 383.
Section 1.382-2T also issued under 26 U.S.C. 382(g)(4)(C), (i),
(k)(1) and (6), (l)(3), (m), and 26 U.S.C. 383.
Section 1.382-3 also issued under 26 U.S.C. 382(m).
Section 1.382-4 also issued under 26 U.S.C. 382(l)(3) and 382(m).
Section 1.382-5 also issued under 26 U.S.C. 382(m).
Section 1.382-5T also issued under 26 U.S.C. 382(m).
Section 1.382-6 also issued under 26 U.S.C. 382(b)(3)(A), 26
U.S.C.(d)(1), 26 U.S.C. 382(m), and 26 U.S.C.383(d).
Section 1.382-8 also issued under 26 U.S.C. 382(m).
Section 1.382-8T also issued under 26 U.S.C. 382(m).
Section 1.382-9 also issued under 26 U.S.C. 382(l)(3) and (m).
Section 1.383-1 also issued under 26 U.S.C. 383.
Section 1.383-2 also issued under 26 U.S.C. 383.
Source: T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31,
1960, unless otherwise noted.
CORPORATE DISTRIBUTIONS AND ADJUSTMENTS
DISTRIBUTIONS BY CORPORATIONS
Effects on Recipients
Sec. 1.301-1 Rules applicable with respect to distributions of money and other property.
(a) General. Section 301 provides the general rule for treatment of
distributions on or after June 22, 1954, of property by a corporation to
a shareholder with respect to its stock. The term property is defined in
section 317(a). Such distributions, except as otherwise
[[Page 9]]
provided in this chapter, shall be treated as provided in section
301(c). Under section 301(c), distributions may be included in gross
income, applied against and reduce the adjusted basis of the stock,
treated as gain from the sale or exchange of property, or (in the case
of certain distributions out of increase in value accrued before March
1, 1913) may be exempt from tax. The amount of the distributions to
which section 301 applies is determined in accordance with the
provisions of section 301(b). The basis of property received in a
distribution to which section 301 applies is determined in accordance
with the provisions of section 301(d). Accordingly, except as otherwise
provided in this chapter, a distribution on or after June 22, 1954, of
property by a corporation to a shareholder with respect to its stock
shall be included in gross income to the extent the amount distributed
is considered a dividend under section 316. For examples of
distributions treated otherwise, see sections 116, 301(c)(2),
301(c)(3)(B), 301(e), 302(b), 303, and 305. See also part II (relating
to distributions in partial or complete liquidation), part III (relating
to corporate organizations and reorganizations), and part IV (relating
to insolvency reorganizations), subchapter C, chapter 1 of the Code.
(b) Time of inclusion in gross income and of determination of fair
market value. A distribution made by a corporation to its shareholders
shall be included in the gross income of the distributees when the cash
or other property is unqualifiedly made subject to their demands.
However, if such distribution is a distribution other than in cash, the
fair market value of the property shall be determined as of the date of
distribution without regard to whether such date is the same as that on
which the distribution is includible in gross income. For example, if a
corporation distributes a taxable dividend in property (the adjusted
basis of which exceeds its fair market value on December 31, 1955) on
December 31, 1955, which is received by, or unqualifiedly made subject
to the demand of, its shareholders on January 2, 1956, the amount to be
included in the gross income of the shareholders will be the fair market
value of such property on December 31, 1955, although such amount will
not be includible in the gross income of the shareholders until January
2, 1956.
(c) Application of section to shareholders. Section 301 is not
applicable to an amount paid by a corporation to a shareholder unless
the amount is paid to the shareholder in his capacity as such.
(d) Distributions to corporate shareholders. (1) If the shareholder
is a corporation, the amount of any distribution to be taken into
account under section 301(c) shall be:
(i) The amount of money distributed,
(ii) An amount equal to the fair market value of any property
distributed which consists of any obligations of the distributing
corporation, stock of the distributing corporation treated as property
under section 305(b), or rights to acquire such stock treated as
property under section 305(b), plus
(iii) In the case of a distribution not described in subdivision
(iv) of this subparagraph, an amount equal to (a) the fair market value
of any other property distributed or, if lesser, (b) the adjusted basis
of such other property in the hands of the distributing corporation
(determined immediately before the distribution and increased for any
gain recognized to the distributing corporation under section 311 (b),
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c),
1252(a), or 1254(a)), or
(iv) In the case of a distribution made after November 8, 1971, to a
shareholder which is a foreign corporation, an amount equal to the fair
market value of any other property distributed, but only if the
distribution received by such shareholder is not effectively connected
for the taxable year with the conduct of a trade or business in the
United States by such shareholder.
(2) In the case of a distribution the amount of which is determined
by reference to the adjusted basis described in subparagraph (1)(iii)(b)
of this paragraph:
(i) That portion of the distribution which is a dividend under
section 301(c)(1) may not exceed such adjusted basis, or
(ii) If the distribution is not out of earnings and profits, the
amount of the reduction in basis of the shareholder's
[[Page 10]]
stock, and the amount of any gain resulting from such distribution, are
to be determined by reference to such adjusted basis of the property
which is distributed.
(3) Notwithstanding paragraph (d)(1)(iii), if a distribution of
property described in such paragraph is made after December 31, 1962, by
a foreign corporation to a shareholder which is a corporation, the
amount of the distribution to be taken into account under section 301(c)
shall be determined under section 301(b)(1)(C) and paragraph (n) of this
section.
(e) Adjusted basis. In determining the adjusted basis of property
distributed in the hands of the distributing corporation immediately
before the distribution for purposes of section 301(b)(1)(B)(ii),
(b)(1)(C)(i), and (d)(2)(B), the basis to be used shall be the basis for
determining gain upon a sale or exchange.
(f) Examples. The application of this section (except paragraph (n))
may be illustrated by the following examples:
Example (1). On January 1, 1955, A, an individual owned all of the
stock of Corporation M with an adjusted basis of $2,000. During 1955, A
received distributions from Corporation M totaling $30,000, consisting
of $10,000 in cash and listed securities having a basis in the hands of
Corporation M and a fair market value on the date distributed of
$20,000. Corporation M's taxable year is the calendar year. As of
December 31, 1954, Corporation M had earnings and profits accumulated
after February 28, 1913, in the amount of $26,000, and it had no
earnings and profits and no deficit for 1955. Of the $30,000 received by
A, $26,000 will be treated as an ordinary dividend; the remaining $4,000
will be applied against the adjusted basis of his stock; the $2,000 in
excess of the adjusted basis of his stock will either be treated as gain
from the sale or exchange of property (under section 301(c)(3)(A)) or,
if out of increase in value accrued before March 1, 1913, will (under
section 301(c)(3)(B)) be exempt from tax. If A subsequently sells his
stock in Corporation M, the basis for determining gain or loss on the
sale will be zero.
Example (2). The facts are the same as in Example 1 with the
exceptions that the shareholder of Corporation M is Corporation W and
that the securities which were distributed had an adjusted basis to
Corporation M of $15,000. The distribution received by Corporation W
totals $25,000 consisting of $10,000 in cash and securities with an
adjusted basis of $15,000. The total $25,000 will be treated as a
dividend to Corporation W since the earnings and profits of Corporation
M ($26,000) are in excess of the amount of the distribution.
Example (3). Corporation X owns timber land which it acquired prior
to March 1, 1913, at a cost of $50,000 with $5,000 allocated as the
separate cost of the land. On March 1, 1913, this property had a fair
market value of $150,000 of which $135,000 was attributable to the
timber and $15,000 to the land. All of the timber was cut prior to 1955
and the full appreciation in the value thereof, $90,000 ($135,000-
$45,000), realized through depletion allowances based on March 1, 1913,
value. None of this surplus from realized appreciation had been
distributed. In 1955, Corporation X sold the land for $20,000 thereby
realizing a gain of $15,000. Of this gain, $10,000 is due to realized
appreciation in value which accrued before March 1, 1913 ($15,000-
$5,000). Of the gain of $15,000, $5,000 is taxable. Therefore, at
December 31, 1955, Corporation X had a surplus from realized
appreciation in the amount of $100,000. It had no accumulated earnings
and profits and no deficit at January 1, 1955. The net earnings for 1955
(including the $5,000 gain on the sale of the land) were $20,000. During
1955, Corporation X distributed $75,000 to its stockholders. Of this
amount, $20,000 will be treated as a dividend. The remaining $55,000,
which is a distribution of realized appreciation, will be applied
against and reduce the adjusted basis of the shareholders' stock. If any
part of the $55,000 is in excess of the adjusted basis of a
shareholder's stock, such part will be exempt from tax.
(h) Basis. The basis of property received in the distribution to
which section 301 applies shall be--
(1) If the shareholder is not a corporation, the fair market value
of such property;
(2) If the shareholder is a corporation--
(i) In the case of a distribution of the obligations of the
distributing corporation or of the stock of such corporation or rights
to acquire such stock (if such stock or rights are treated as property
under section 305(b)), the fair market value of such obligations, stock,
or rights;
(ii) In the case of the distribution of any other property, except
as provided in subdivision (iii) (relating to certain distributions by a
foreign corporation) or subdivision (iv) (relating to certain
distributions to foreign corporate distributees) of this subparagraph,
whichever of the following is the lesser--
[[Page 11]]
(a) The fair market value of such property; or
(b) The adjusted basis (in the hands of the distributing corporation
immediately before the distribution) of such property increased in the
amount of gain to the distributing corporation which is recognized under
section 311(b) (relating to distributions of LIFO inventory), section
311(c) (relating to distributions of property subject to liabilities in
excess of basis), section 311(d) (relating to appreciated proterty used
to redeem stock), section 341(f) (relating to certain sales of stock of
consenting corporations), section 617(d) (relating to gain from
dispositions of certain mining property), section 1245(a) or 1250(a)
(relating to gain from dispositions of certain depreciable property),
section 1251(c) (relating to gain from disposition of farm recapture
property), section 1252(a) (relating to gain from disposition of farm
land), or 1254(a) (relating to gain from disposition of interest in
natural resource recapture property);
(iii) In the case of the distribution by a foreign corporation of
any other property after December 31, 1962, in a distribution not
described in subdivision (iv) of this subparagraph, the amount
determined under paragraph (n) of this section;
(iv) In the case of the distribution of any other property made
after November 8, 1971, to a shareholder which is a foreign corporation,
the fair market value of such property, but only if the distribution
received by such shareholder is not effectively connected for the
taxable year with the conduct of a trade or business in the United
States by such shareholder.
(i) [Reserved]
(j) Transfers for less than fair market value. If property is
transferred by a corporation to a shareholder which is not a corporation
for an amount less than its fair market value in a sale or exchange,
such shareholder shall be treated as having received a distribution to
which section 301 applies. In such case, the amount of the distribution
shall be the difference between the amount paid for the property and its
fair market value. If property is transferred in a sale or exchange by a
corporation to a shareholder which is a corporation, for an amount less
than its fair market value and also less than its adjusted basis, such
shareholder shall be treated as having received a distribution to which
section 301 applies, and--
(1) Where the fair market value of the property equals or exceeds
its adjusted basis in the hands of the distributing corporation the
amount of the distribution shall be the excess of the adjusted basis
(increased by the amount of gain recognized under section 311 (b), (c),
or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c),
1252(a), or 1254(a) to the distributing corporation) over the amount
paid for the property;
(2) Where the fair market value of the property is less than its
adjusted basis in the hands of the distributing corporation, the amount
of the distribution shall be the excess of such fair market value over
the amount paid for the property. If property is transferred in a sale
or exchange after December 31, 1962, by a foreign corporation to a
shareholder which is a corporation for an amount less than the amount
which would have been computed under paragraph (n) of this section if
such property had been received in a distribution to which section 301
applied, such shareholder shall be treated as having received a
distribution to which section 301 applies, and the amount of the
distribution shall be the excess of the amount which would have been
computed under paragraph (n) of this section with respect to such
property over the amount paid for the property. In all cases, the
earnings and profits of the distributing corporation shall be decreased
by the excess of the basis of the property in the hands of the
distributing corporation over the amount received therefor. In computing
gain or loss from the subsequent sale of such property, its basis shall
be the amount paid for the property increased by the amount of the
distribution.
If property is transferred in a sale or exchange after December 31,
1962, by a foreign corporation to a shareholder which is a corporation
for an amount less than the amount which would have been computed under
paragraph (n) of this section if such property had been
[[Page 12]]
received in a distribution to which section 301 applied, such
shareholder shall be treated as having received a distribution to which
section 301 applies, and the amount of the distribution shall be the
excess of the amount which would have been computed under paragraph (n)
of this section with respect to such property over the amount paid for
the property. Notwithstanding the preceding provisions of this
paragraph, if property is transferred in a sale or exchange after
November 8, 1971, by a corporation to a shareholder which is a foreign
corporation, for an amount less than its fair market value, and if
paragraph (d)(1)(iv) of this section would apply if such property were
received in a distribution to which section 301 applies, such
shareholder shall be treated as having received a distribution to which
section 301 applies and the amount of the distribution shall be the
difference between the amount paid for the property and its fair market
value. In all cases, the earnings and profits of the distributing
corporation shall be decreased by the excess of the basis of the
property in the hands of the distributing corporation over the amount
received therefor. In computing gain or loss from the subsequent sale of
such property, its basis shall be the amount paid for the property
increased by the amount of the distribution.
(k) Application of rule respecting transfers for less than fair
market value. The application of paragraph (j) of this section may be
illustrated by the following examples:
Example (1). On January 1, 1955, A, an individual shareholder of
corporation X, purchased property from that corporation for $20. The
fair market value of such property was $100, and its basis in the hands
of corporation X was $25. The amount of the distribution determined
under section 301(b) is $80. If A were a corporation, the amount of the
distribution would be $5 (assuming that sections 311 (b) and (c),
1245(a), and 1250(a) do not apply), the excess of the basis of the
property in the hands of corporation X over the amount received
therefor. The basis of such property to corporation A would be $25. If
the basis of the property in the hands of corporation X were $10, the
corporate shareholder, A, would not receive a distribution. The basis of
such property to corporation A would be $20. Whether or not A is a
corporation, the excess of the amount paid over the basis of the
property in the hands of corporation X ($20 over $10) would be a taxable
gain to corporation X.
Example (2). On January 1, 1963, corporation A, which is a
shareholder of corporation B (a foreign corporation engaged in business
within the United States), purchased one share of corporation X stock
from B for $20. The fair market value of the share was $100, and its
adjusted basis in the hands of B was $25. Assume that if the share of
corporation X stock had been received by A in a distribution to which
section 301 applied, the amount of the distribution under paragraph (n)
of this section would have been $55. The amount of the distribution
under section 301 is $35, i.e., $55 (amount computed under paragraph (n)
of this section) minus $20 (amount paid for the property). The basis of
such property to A is $55.
(l) Transactions treated as distributions. A distribution to
shareholders with respect to their stock is within the terms of section
301 although it takes place at the same time as another transaction if
the distribution is in substance a separate transaction whether or not
connected in a formal sense. This is most likely to occur in the case of
a recapitalization, a reincorporation, or a merger of a corporation with
a newly organized corporation having substantially no property. For
example, if a corporation having only common stock outstanding,
exchanges one share of newly issued common stock and one bond in the
principal amount of $10 for each share of outstanding common stock, the
distribution of the bonds will be a distribution of property (to the
extent of their fair market value) to which section 301 applies, even
though the exchange of common stock for common stock may be pursuant to
a plan of reorganization under the terms of section 368(a)(1)(E)
(recapitalization) and even though the exchange of common stock for
common stock may be tax free by virtue of section 354.
(m) Cancellation of indebtedness. The cancellation of indebtedness
of a shareholder by a corporation shall be treated as a distribution of
property.
(n) [Reserved]
(o) Distributions of certain property by DISC's to corporate
shareholders. See Sec. 1.997-1 for the rule that if a corporation which
is a DISC or former DISC (as defined in section 992(a)(1) or (3) as the
case may be) makes a distribution
[[Page 13]]
of property (other than money and other than the obligations of the DISC
or former DISC) out of accumulated DISC income (as defined in section
996(f)(1)) or previously taxed income (as defined in section 996(f)(2)),
such distribution of property shall be treated as if it were made to an
individual and that the basis of the property distributed, in the hands
of the recipient corporation, shall be determined as if such property
were distributed to an individual.
(p) Cross references. For certain rules relating to adjustments to
earnings and profits and for determining the extent to which a
distribution is a dividend, see sections 312 and 316 and regulations
thereunder.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6752, 29 FR
12701, Sept. 9, 1964; T.D. 7084, 36 FR 267, Jan. 8, 1971; T.D. 7209, 37
FR 20800, Oct. 5, 1972; 38 FR 20824, Aug. 3, 1973; 38 FR 32794, Nov. 28,
1973; T.D. 7556, 44 FR 1376, Jan. 5, 1979; T.D. 8474, 58 FR 25557, Apr.
27, 1993; T.D. 8586, 60 FR 2500, Jan. 10, 1995; T.D. 8924, 66 FR 725,
Jan. 4, 2001; T.D. 8964, Sept. 27, 2001, 66 FR 49276]
Sec. 1.302-1 General.
(a) Under section 302(d), unless otherwise provided in subchapter C,
chapter 1 of the Code, a distribution in redemption of stock shall be
treated as a distribution of property to which section 301 applies if
the distribution is not within any of the provisions of section 302(b).
A distribution in redemption of stock shall be considered a distribution
in part or full payment in exchange for the stock under section 302(a)
provided paragraph (1), (2), (3), or (4) of section 302(b) applies.
Section 318(a) (relating to constructive ownership of stock) applies to
all redemptions under section 302 except that in the termination of a
shareholder's interest certain limitations are placed on the application
of section 318(a)(1) by section 302(c)(2). The term redemption of stock
is defined in section 317(b). Section 302 does not apply to that portion
of any distribution which qualifies as a distribution in partial
liquidation under section 346. For special rules relating to redemption
of stock to pay death taxes see section 303. For special rules relating
to redemption of section 306 stock see section 306. For special rules
relating to redemption of stock in partial or complete liquidation see
section 331.
(b) If, in connection with a partial liquidation under the terms of
section 346, stock is redeemed in an amount in excess of the amount
specified by section 331(a)(2), section 302(b) shall first apply as to
each shareholder to which it is applicable without limitation because of
section 331(a)(2). That portion of the total distribution which is used
in all redemptions from specific shareholders which are within the terms
of section 302(a) shall be excluded in determining the application of
sections 346 and 331(a)(2). For example, Corporation X has $50,000 which
is attributable to the sale of one of two active businesses and which,
if distributed in redemption of stock, would qualify as a partial
liquidation under the terms of section 346(b). Corporation X distributes
$60,000 to its shareholders in redemption of stock, $20,000 of which is
in redemption of all of the stock of shareholder A within the meaning of
section 302(b)(3). The $20,000 distributed in redemption of the stock of
shareholder A will be excluded in determining the application of
sections 346 and 331(a)(2). The entire $60,000 will be treated as in
part or full payment for stock ($20,000 qualifying under section 302(a)
and $40,000 qualifying under sections 346 and 331(a)(2)).
Sec. 1.302-2 Redemptions not taxable as dividends.
(a) The fact that a redemption fails to meet the requirements of
paragraph (2), (3) or (4) of section 302(b) shall not be taken into
account in determining whether the redemption is not essentially
equivalent to a dividend under section 302(b)(1). See, however,
paragraph (b) of this section. For example, if a shareholder owns only
nonvoting stock of a corporation which is not section 306 stock and
which is limited and preferred as to dividends and in liquidation, and
one-half of such stock is redeemed, the distribution will ordinarily
meet the requirements of paragraph (1) of section 302(b) but will not
meet the requirements of paragraph (2), (3) or (4) of such section. The
determination of whether or not a distribution is within the phrase
``essentially
[[Page 14]]
equivalent to a dividend'' (that is, having the same effect as a
distribution without any redemption of stock) shall be made without
regard to the earnings and profits of the corporation at the time of the
distribution. For example, if A owns all the stock of a corporation and
the corporation redeems part of his stock at a time when it has no
earnings and profits, the distribution shall be treated as a
distribution under section 301 pursuant to section 302(d).
(b) The question whether a distribution in redemption of stock of a
shareholder is not essentially equivalent to a dividend under section
302(b)(1) depends upon the facts and circumstances of each case. One of
the facts to be considered in making this determination is the
constructive stock ownership of such shareholder under section 318(a).
All distributions in pro rata redemptions of a part of the stock of a
corporation generally will be treated as distributions under section 301
if the corporation has only one class of stock outstanding. However, for
distributions in partial liquidation, see section 346. The redemption of
all of one class of stock (except section 306 stock) either at one time
or in a series of redemptions generally will be considered as a
distribution under section 301 if all classes of stock outstanding at
the time of the redemption are held in the same proportion. Distribution
in redemption of stock may be treated as distributions under section 301
regardless of the provisions of the stock certificate and regardless of
whether all stock being redeemed was acquired by the stockholders from
whom the stock was redeemed by purchase or otherwise. In every case in
which a shareholder transfers stock to the corporation which issued such
stock in exchange for property, the facts and circumstances shall be
reported on his return except as provided in paragraph (d) of
Sec. 1.331-1. See sections 346(a) and 6043 for requirements relating to
returns by corporations.
(c) In any case in which an amount received in redemption of stock
is treated as a distribution of a dividend, proper adjustment of the
basis of the remaining stock will be made with respect to the stock
redeemed. (For adjustments to basis required for certain redemptions of
corporate shareholders that are treated as extraordinary dividends, see
section 1059 and the regulations thereunder.) The following examples
illustrate the application of this rule:
Example (1). A, an individual, purchased all of the stock of
Corporation X for $100,000. In 1955 the corporation redeems half of the
stock for $150,000, and it is determined that this amount constitutes a
dividend. The remaining stock of Corporation X held by A has a basis of
$100,000.
Example (2). H and W, husband and wife, each own half of the stock
of Corporation X. All of the stock was purchased by H for $100,000 cash.
In 1950 H gave one-half of the stock to W, the stock transferred having
a value in excess of $50,000. In 1955 all of the stock of H is redeemed
for $150,000, and it is determined that the distribution to H in
redemption of his shares constitutes the distribution of a dividend.
Immediately after the transaction, W holds the remaining stock of
Corporation X with a basis of $100,000.
Example (3). The facts are the same as in Example (2) with the
additional facts that the outstanding stock of Corporation X consists of
1,000 shares and all but 10 shares of the stock of H is redeemed.
Immediately after the transaction, H holds 10 shares of the stock of
Corporation X with a basis of $50,000, and W holds 500 shares with a
basis of $50,000.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 8724, 62 FR
38028, July 26, 1997]
Sec. 1.302-3 Substantially disproportionate redemption.
(a) Section 302(b)(2) provides for the treatment of an amount
received in redemption of stock as an amount received in exchange for
such stock if--
(1) Immediately after the redemption the shareholder owns less than
50 percent of the total combined voting power of all classes of stock as
provided in section 302(b)(2)(B),
(2) The redemption is a substantially disproportionate redemption
within the meaning of section 302(b)(2)(C), and
(3) The redemption is not pursuant to a plan described in section
302(b)(2)(D).
Section 318(a) (relating to constructive ownership of stock) shall apply
both in making the disproportionate redemption test and in determining
the percentage of stock ownership after the redemption. The requirements
under section 302(b)(2) shall be applied to
[[Page 15]]
each shareholder separately and shall be applied only with respect to
stock which is issued and outstanding in the hands of the shareholders.
Section 302(b)(2) only applies to a redemption of voting stock or to a
redemption of both voting stock and other stock. Section 302(b)(2) does
not apply to the redemption solely of nonvoting stock (common or
preferred). However, if a redemption is treated as an exchange to a
particular shareholder under the terms of section 302(b)(2), such
section will apply to the simultaneous redemption of nonvoting preferred
stock (which is not section 306 stock) owned by such shareholder and
such redemption will also be treated as an exchange. Generally, for
purposes of this section, stock which does not have voting rights until
the happening of an event, such as a default in the payment of dividends
on preferred stock, is not voting stock until the happening of the
specified event. Subsection 302(b)(2)(D) provides that a redemption will
not be treated as substantially disproportionate if made pursuant to a
plan the purpose or effect of which is a series of redemptions which
result in the aggregate in a distribution which is not substantially
disproportionate. Whether or not such a plan exists will be determined
from all the facts and circumstances.
(b) The application of paragraph (a) of this section is illustrated
by the following example:
Example. Corporation M has outstanding 400 shares of common stock of
which A, B, C and D each own 100 shares or 25 percent. No stock is
considered constructively owned by A, B, C or D under section 318.
Corporation M redeems 55 shares from A, 25 shares from B, and 20 shares
from C. For the redemption to be disproportionate as to any shareholder,
such shareholder must own after the redemptions less than 20 percent (80
percent of 25 percent) of the 300 shares of stock then outstanding.
After the redemptions, A owns 45 shares (15 percent), B owns 75 shares
(25 percent), and C owns 80 shares (26 2/3 percent). The distribution is
disproportionate only with respect to A.
Sec. 1.302-4 Termination of shareholder's interest.
Section 302(b)(3) provides that a distribution in redemption of all
of the stock of the corporation owned by a shareholder shall be treated
as a distribution in part or full payment in exchange for the stock of
such shareholder. In determining whether all of the stock of the
shareholder has been redeemed, the general rule of section 302(c)(1)
requires that the rules of constructive ownership provided in section
318(a) shall apply. Section 302(c)(2), however, provides that section
318(a)(1) (relating to constructive ownership of stock owned by members
of a family) shall not apply where the specific requirements of section
302(c)(2) are met. The following rules shall be applicable in
determining whether the specific requirements of section 302(c)(2) are
met:
(a)(1) The agreement specified in section 302(c)(2)(A)(iii) shall be
in the form of a separate statement in duplicate signed by the
distributee and attached to the first return filed by the distributee
for the taxable year in which the distribution described in section
302(b)(3) occurs. The agreement shall recite that the distributee has
not acquired, other than by bequest or inheritance, any interest in the
corporation (as described in section 302(c)(2)(A)(i)) since the
distribution and that the distributee agrees to notify the district
director for the internal revenue district in which the distributee
resides of any acquisition, other than by bequest or inheritance, of
such an interest in the corporation within 30 days after the
acquisition, if the acquisition occurs within 10 years from the date of
the distribution.
(2) If the distributee fails to file the agreement specified in
section 302(c)(2)(A)(iii) at the time provided in paragraph (a)(1) of
this section, then the district director for the internal revenue
district in which the distributee resided at the time of filing the
first return for the taxable year in which the distribution occurred
shall grant a reasonable extension of time for filing such agreement,
provided (i) it is established to the satisfaction of the district
director that there was reasonable cause for failure to file the
agreement within the prescribed time and (ii) a request for such
extension is filed within such time as the district director considers
reasonable under the circumstances.
[[Page 16]]
(b) The distributee who files an agreement under section
302(c)(2)(A)(iii) shall retain copies of income tax returns and any
other records indicating fully the amount of tax which would have been
payable had the redemption been treated as a distribution subject to
section 301.
(c) If stock of a parent corporation is redeemed, section
302(c)(2)(A), relating to acquisition of an interest in the corporation
within 10 years after termination shall be applied with reference to an
interest both in the parent corporation and any subsidiary of such
parent corporation. If stock of a parent corporation is sold to a
subsidiary in a transaction described in section 304, section
302(c)(2)(A) shall be applicable to the acquisition of an interest in
such subsidiary corporation or in the parent corporation. If stock of a
subsidiary corporation is redeemed, section 302(c)(2)(A) shall be
applied with reference to an interest both in such subsidiary
corporation and its parent. Section 302(c)(2)(A) shall also be applied
with respect to an interest in a corporation which is a successor
corporation to the corporation the interest in which has been
terminated.
(d) For the purpose of section 302(c)(2)(A)(i), a person will be
considered to be a creditor only if the rights of such person with
respect to the corporation are not greater or broader in scope than
necessary for the enforcement of his claim. Such claim must not in any
sense be proprietary and must not be subordinate to the claims of
general creditors. An obligation in the form of a debt may thus
constitute a proprietary interest. For example, if under the terms of
the instrument the corporation may discharge the principal amount of its
obligation to a person by payments, the amount or certainty of which are
dependent upon the earnings of the corporation, such a person is not a
creditor of the corporation. Furthermore, if under the terms of the
instrument the rate of purported interest is dependent upon earnings,
the holder of such instrument may not, in some cases, be a creditor.
(e) In the case of a distributee to whom section 302(b)(3) is
applicable, who is a creditor after such transaction, the acquisition of
the assets of the corporation in the enforcement of the rights of such
creditor shall not be considered an acquisition of an interest in the
corporation for purposes of section 302(c)(2) unless stock of the
corporation, its parent corporation, or, in the case of a redemption of
stock of a parent corporation, of a subsidiary of such corporation is
acquired.
(f) In determining whether an entire interest in the corporation has
been terminated under section 302(b)(3), under all circumstances
paragraphs (2), (3), (4), and (5) of section 318(a) (relating to
constructive ownership of stock) shall be applicable.
(g) Section 302(c)(2)(B) provides that section 302(c)(2)(A) shall
not apply--
(1) If any portion of the stock redeemed was acquired directly or
indirectly within the 10-year period ending on the date of the
distribution by the distributee from a person, the ownership of whose
stock would (at the time of distribution) be attributable to the
distributee under section 318(a), or
(2) If any person owns (at the time of the distribution) stock, the
ownership of which is attributable to the distributee under section
318(a), such person acquired any stock in the corporation directly or
indirectly from the distributee within the 10-year period ending on the
date of the distribution, and such stock so acquired from the
distributee is not redeemed in the same transaction,unless the
acquisition (described in subparagraph (1) of this paragraph) or the
disposition by the distributee (described in subparagraph (2) of this
paragraph) did not have as one of its principal purposes the avoidance
of Federal income tax. A transfer of stock by the transferor, within the
10-year period ending on the date of the distribution, to a person whose
stock would be attributable to the transferor shall not be deemed to
have as one of its principal purposes the avoidance of Federal income
tax merely because the transferee is in a lower income tax bracket than
the transferor.
(Sec. 302(c)(2)(A)(iii) (68A Stat. 87; 26 U.S.C. 302 (c)(2)(A)(iii)))
[T.D. 7535, 43 FR 10686, Mar. 15, 1978]
[[Page 17]]
Sec. 1.303-1 General.
Section 303 provides that in certain cases a distribution in
redemption of stock, the value of which is included in determining the
value of the gross estate of a decedent, shall be treated as a
distribution in full payment in exchange for the stock so redeemed.
Sec. 1.303-2 Requirements.
(a) Section 303 applies only where the distribution is with respect
to stock of a corporation the value of whose stock in the gross estate
of the decedent for Federal estate tax purposes is an amount in excess
of (1) 35 percent of the value of the gross estate of such decedent, or
(2) 50 percent of the taxable estate of such decedent. For the purposes
of such 35 percent and 50 percent requirements, stock of two or more
corporations shall be treated as the stock of a single corporation if
more than 75 percent in value of the outstanding stock of each such
corporation is included in determining the value of the decedent's gross
estate. For the purpose of the 75 percent requirement, stock which, at
the decedent's death, represents the surviving spouse's interest in
community property shall be considered as having been included in
determining the value of the decedent's gross estate.
(b) For the purpose of section 303(b)(2)(A)(i), the term gross
estate means the gross estate as computed in accordance with section
2031 (or, in the case of the estate of a decedent nonresident not a
citizen of the United States, in accordance with section 2103). For the
purpose of section 303(b)(2)(A)(ii), the term taxable estate means the
taxable estate as computed in accordance with section 2051 (or, in the
case of the estate of a decedent nonresident not a citizen of the United
States, in accordance with section 2106). In case the value of an estate
is determined for Federal estate tax purposes under section 2032
(relating to alternate valuation), then, for purposes of section
303(b)(2), the value of the gross estate, the taxable estate, and the
stock shall each be determined on the applicable date prescribed in
section 2032.
(c)(1) In determining whether the estate of the decedent is
comprised of stock of a corporation of sufficient value to satisfy the
percentage requirements of section 303(b)(2)(A) and section
303(b)(2)(B), the total value, in the aggregate, of all classes of stock
of the corporation includible in determining the value of the gross
estate is taken into account. A distribution under section 303(a) may be
in redemption of the stock of the corporation includible in determining
the value of the gross estate, without regard to the class of such
stock.
(2) The above may be illustrated by the following example:
Example. The gross estate of the decedent has a value of $1,000,000,
the taxable estate is $700,000, and the sum of the death taxes and
funeral and administration expenses is $275,000. Included in determining
the gross estate of the decedent is stock of three corporations which,
for Federal estate tax purposes, is valued as follows:
Corporation A:
Common stock............................................... $100,000
Preferred stock............................................ 100,000
Corporation B:
Common stock............................................... 50,000
Preferred stock............................................ 350,000
Corporation C: Common stock.................................. 200,000
The stock of Corporation A and Corporation C included in the estate of
the decedent constitutes all of the outstanding stock of both
corporations. The stock of Corporation A and the stock of Corporation C,
treated as the stock of a single corporation under section 303(b)(2)(B),
has a value in excess of $350,000 (35 percent of the gross estate or 50
percent of the taxable estate). Likewise, the stock of Corporation B has
a value in excess of $350,000. The distribution by one or more of the
above corporations, within the period prescribed in section 303(b)(1),
of amounts not exceeding, in the aggregate, $275,000, in redemption of
preferred stock or common stock of such corporation or corporations,
will be treated as in full payment in exchange for the stock so
redeemed.
(d) If stock includible in determining the value of the gross estate
of a decedent is exchanged for new stock, the basis of which is
determined by reference to the basis of the old stock, the redemption of
the new stock will be treated the same under section 303 as the
redemption of the old stock would have been. Thus section 303 shall
apply with respect to a distribution in redemption of stock received by
the estate of a decedent (1) in connection with a reorganization under
section 368, (2) in a distribution or exchange
[[Page 18]]
under section 355 (or so much of section 356 as relates to section 355),
(3) in an exchange under section 1036 or (4) in a distribution to which
section 305(a) applies. Similarly, a distribution in redemption of stock
will qualify under section 303, notwithstanding the fact that the stock
redeemed is section 306 stock to the extent that the conditions of
section 303 are met.
(e) Section 303 applies to distributions made after the death of the
decedent and (1) before the expiration of the 3-year period of
limitations for the assessment of estate tax provided in section 6501(a)
(determined without the application of any provisions of law extending
or suspending the running of such period of limitations), or within 90
days after the expiration of such period, or (2) if a petition for
redetermination of a deficiency in such estate tax has been filed with
the Tax Court within the time prescribed in section 6213, at any time
before the expiration of 60 days after the decision of the Tax Court
becomes final. The extension of the period of distribution provided in
section 303(b)(1)(B) has reference solely to bona fide contests in the
Tax Court and will not apply in the case of a petition for
redetermination of a deficiency which is initiated solely for the
purpose of extending the period within which section 303 would otherwise
be applicable.
(f) While section 303 will most frequently have application in the
case where stock is redeemed from the executor or administrator of an
estate, the section is also applicable to distributions in redemption of
stock included in the decedent's gross estate and held at the time of
the redemption by any person who acquired the stock by any of the means
comprehended by part III, subchapter A, chapter 11 of the Code,
including the heir, legatee, or donee of the decedent, a surviving joint
tenant, surviving spouse, appointee, or taker in default of appointment,
or a trustee of a trust created by the decedent. Thus section 303 may
apply with respect to a distribution in redemption of stock from a donee
to whom the decedent has transferred stock in contemplation of death
where the value of such stock is included in the decedent's gross estate
under section 2035. Similarly, section 303 may apply to the redemption
of stock from a beneficiary of the estate to whom an executor has
distributed the stock pursuant to the terms of the will of the decedent.
However, section 303 is not applicable to the case where stock is
redeemed from a stockholder who has acquired the stock by gift or
purchase from any person to whom such stock has passed from the
decedent. Nor is section 303 applicable to the case where stock is
redeemed from a stockholder who has acquired the stock from the executor
in satisfaction of a specific monetary bequest.
(g)(1) The total amount of the distributions to which section 303
may apply with respect to redemptions of stock included in the gross
estate of a decedent may not exceed the sum of the estate, inheritance,
legacy, and succession taxes (including any interest collected as a part
of such taxes) imposed because of the decedent's death and the amount of
funeral and administration expenses allowable as deductions to the
estate. Where there is more than one distribution in redemption of stock
described in section 303(b)(2) during the period of time prescribed in
section 303(b)(1), the distributions shall be applied against the total
amount which qualifies for treatment under section 303 in the order in
which the distributions are made. For this purpose, all distributions in
redemption of such stock shall be taken into account, including
distributions which under another provision of the Code are treated as
in part or full payment in exchange for the stock redeemed.
(2) Subparagraph (1) of this paragraph may be illustrated by the
following example:
Example. (i) The gross estate of the decedent has a value of
$800,000, the taxable estate is $500,000, and the sum of the death taxes
and funeral and administrative expenses is $225,000. Included in
determining the gross estate of the decedent is the stock of a
corporation which for Federal estate tax purposes is valued at $450,000.
During the first year of administration, one-third of such stock is
distributed to a legatee and shortly thereafter this stock is redeemed
by the corporation for $150,000. During the second year of
administration, another one-
[[Page 19]]
third of such stock includible in the estate is redeemed for $150,000.
(ii) The first distribution of $150,000 is applied against the
$225,000 amount that qualifies for treatment under section 303,
regardless of whether the first distribution was treated as in payment
in exchange for stock under section 302(a). Thus, only $75,000 of the
second distribution may be treated as in full payment in exchange for
stock under section 303. The tax treatment of the remaining $75,000
would be determined under other provisions of the Code.
(h) For the purpose of section 303, the estate tax or any other
estate, inheritance, legacy, or succession tax shall be ascertained
after the allowance of any credit, relief, discount, refund, remission
or reduction of tax.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6724, 29 FR
5343, Apr. 21, 1964; T.D. 7346, 40 FR 10669, Mar. 7, 1975]
Sec. 1.303-3 Application of other sections.
(a) The sole effect of section 303 is to exempt from tax as a
dividend a distribution to which such section is applicable when made in
redemption of stock includible in a decedent's gross estate. Such
section does not, however, in any other manner affect the principles set
forth in sections 302 and 306. Thus, if stock of a corporation is owned
equally by A, B, and the C Estate, and the corporation redeems one-half
of the stock of each shareholder, the determination of whether the
distributions to A and B are essentially equivalent to dividends shall
be made without regard to the effect which section 303 may have upon the
taxability of the distribution to the C Estate.
(b) See section 304 relative to redemption of stock through the use
of related corporations.
Sec. 1.304-1 General.
(a) Except as provided in paragraph (b) of this section, section 304
is applicable where a shareholder sells stock of one corporation to a
related corporation as defined in section 304. Sales to which section
304 is applicable shall be treated as redemptions subject to sections
302 and 303.
(b) In the case of--
(1) Any acquisition of stock described in section 304 which occurred
before June 22, 1954, and
(2) Any acquisition of stock described in section 304 which occurred
on or after June 22, 1954, and on or before December 31, 1958, pursuant
to a contract entered into before June 22, 1954.
The extent to which the property received in return for such acquisition
shall be treated as a dividend shall be determined as if the Internal
Revenue Code of 1939 continued to apply in respect of such acquisition
and as if the Internal Revenue Code of 1954 had not been enacted. See
section 391. In cases to which this paragraph applies, the basis of the
stock received by the acquiring corporation shall be determined as if
the Internal Revenue Code of 1939 continued to apply in respect of such
acquisition and as if the Internal Revenue Code of 1954 had not been
enacted.
[T.D. 6533, 26 FR 401, Jan. 19, 1961]
Sec. 1.304-2 Acquisition by related corporation (other than subsidiary).
(a) If a corporation, in return for property, acquires stock of
another corporation from one or more persons, and the person or persons
from whom the stock was acquired were in control of both such
corporations before the acquisition, then such property shall be treated
as received in redemption of stock of the acquiring corporation. The
stock received by the acquiring corporation shall be treated as a
contribution to the capital of such corporation. See section 362(a) for
determination of the basis of such stock. The transferor's basis for his
stock in the acquiring corporation shall be increased by the basis of
the stock surrendered by him. (But see below in this paragraph for
subsequent reductions of basis in certain cases.) As to each person
transferring stock, the amount received shall be treated as a
distribution of property under section 302(d), unless as to such person
such amount is to be treated as received in exchange for the stock under
the terms of section 302(a) or section 303. In applying section 302(b),
reference shall be had to the shareholder's ownership of stock in the
issuing corporation and not to his ownership of stock in the acquiring
corporation (except for purposes of applying section 318(a)). In
determining control and applying section 302(b), section
[[Page 20]]
318(a) (relating to the constructive ownership of stock) shall be
applied without regard to the 50-percent limitation contained in section
318(a)(2)(C) and (3)(C). A series of redemptions referred to in section
302(b)(2)(D) shall include acquisitions by either of the corporations of
stock of the other and stock redemptions by both corporations. If
section 302(d) applies to the surrender of stock by a shareholder, his
basis for his stock in the acquiring corporation after the transaction
(increased as stated above in this paragraph) shall not be decreased
except as provided in section 301. If section 302(d) does not apply, the
property received shall be treated as received in a distribution in
payment in exchange for stock of the acquiring corporation under section
302(a), which stock has a basis equal to the amount by which the
shareholder's basis for his stock in the acquiring corporation was
increased on account of the contribution to capital as provided for
above in this paragraph. Accordingly, such amount shall be applied in
reduction of the shareholder's basis for his stock in the acquiring
corporation. Thus, the basis of each share of the shareholder's stock in
the acquiring corporation will be the same as the basis of such share
before the entire transaction. The holding period of the stock which is
considered to have been redeemed shall be the same as the holding period
of the stock actually surrendered.
(b) In any case in which two or more persons, in the aggregate,
control two corporations, section 304(a)(1) will apply to sales by such
persons of stock in either corporation to the other (whether or not made
simultaneously) provided the sales by each of such persons are related
to each other. The determination of whether the sales are related to
each other shall be dependent upon the facts and circumstances
surrounding all of the sales. For this purpose, the fact that the sales
may occur during a period of one or more years (such as in the case of a
series of sales by persons who together control each of such
corporations immediately prior to the first of such sales and
immediately subsequent to the last of such sales) shall be disregarded,
provided the other facts and circumstances indicate related
transactions.
(c) The application of section 304(a)(1) may be illustrated by the
following examples:
Example (1). Corporation X and corporation Y each have outstanding
200 shares of common stock. One-half of the stock of each corporation is
owned by an individual, A, and one-half by another individual, B, who is
unrelated to A. On or after August 31, 1964, A sells 30 shares of
corporation X stock to corporation Y for $50,000, such stock having an
adjusted basis of $10,000 to A. After the sale, A is considered as
owning corporation X stock as follows: (i) 70 shares directly, and (ii)
15 shares constructively, since by virtue of his 50-percent ownership of
Y he constructively owns 50 percent of the 30 shares owned directly by
Y. Since A's percentage of ownership of X's voting stock after the sale
(85 out of 200 shares, or 42.5%) is not less than 80 percent of his
percentage of ownership of X's voting stock before the sale (100 out of
200 shares, or 50%), the transfer is not ``substantially
disproportionate'' as to him as provided in section 302(b)(2). Under
these facts, and assuming that section 302(b)(1) is not applicable, the
entire $50,000 is treated as a dividend to A to the extent of the
earnings and profits of corporation Y. The basis of the corporation X
stock to corporation Y is $10,000, its adjusted basis to A. The amount
of $10,000 is added to the basis of the stock of corporation Y in the
hands of A.
Example (2). The facts are the same as in Example (1) except that A
sells 80 shares of corporation X stock to corporation Y, and the sale
occurs before August 31, 1964. After the sale, A is considered as owning
corporation X stock as follows: (i) 20 shares directly, and (ii) 90
shares indirectly, since by virtue of his 50-percent ownership of Y he
constructively owns 50 percent of the 80 shares owned directly by Y and
50 percent of the 100 shares attributed to Y because they are owned by
Y's stockholder, B. Since after the sale A owns a total of more than 50
percent of the voting power of all of the outstanding stock of X (110
out of 200 shares, or 55%), the transfer is not ``substantially
disproportionate'' as to him as provided in section 302(b)(2).
Example (3). Corporation X and corporation Y each have outstanding
100 shares of common stock. A, an individual, owns one-half the stock of
corporation X, and C owns one-half the stock of corporation Y. A, B, and
C are unrelated. A sells 30 shares of the stock of corporation X to
corporation Y for $50,000, such stock having an adjusted basis of
$10,000 to him. After the sale, A is considered as owning 35 shares of
the stock of corporation X (20 shares directly and 15 constructively
because one-half of the 30 shares owned by corporation Y are attributed
to him). Since
[[Page 21]]
before the sale he owned 50 percent of the stock of corporation X and
after the sale he owned directly and constructively only 35 percent of
such stock, the redemption is substantially disproportionate as to him
pursuant to the provisions of section 302(b)(2). He, therefore, realizes
a gain of $40,000 ($50,000 minus $10,000). If the stock surrendered is a
capital asset, such gain is long-term or short-term capital gain
depending on the period of time that such stock was held. The basis to A
for the stock of corporation Y is not changed as a result of the entire
transaction. The basis to corporation Y for the stock of corporation X
is $50,000, i.e., the basis of the transferor ($10,000), increased in
the amount of gain recognized to the transferor ($40,000) on the
transfer.
Example (4). Corporation X and corporation Y each have outstanding
100 shares of common stock. H, an individual, W, his wife, S, his son,
and G, his grandson, each own 25 shares of stock of each corporation. H
sells all of his 25 shares of stock of corporation X to corporation Y.
Since both before and after the transaction H owned directly and
constructively 100 percent of the stock of corporation X, and assuming
that section 302(b)(1) is not applicable, the amount received by him for
his stock of corporation X is treated as a dividend to him to the extent
of the earnings and profits of corporation Y.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR
11997, Aug. 23, 1968]
Sec. 1.304-3 Acquisition by a subsidiary.
(a) If a subsidiary acquires stock of its parent corporation from a
shareholder of the parent corporation, the acquisition of such stock
shall be treated as though the parent corporation had redeemed its own
stock. For the purpose of this section, a corporation is a parent
corporation if it meets the 50 percent ownership requirements of section
304(c). The determination whether the amount received shall be treated
as an amount received in payment in exchange for the stock shall be made
by applying section 303, or by applying section 302(b) with reference to
the stock of the issuing parent corporation. If such distribution would
have been treated as a distribution of property (pursuant to section
302(d)) under section 301, the entire amount of the selling price of the
stock shall be treated as a dividend to the seller to the extent of the
earnings and profits of the parent corporation determined as if the
distribution had been made to it of the property that the subsidiary
exchanged for the stock. In such cases, the transferor's basis for his
remaining stock in the parent corporation will be determined by
including the amount of the basis of the stock of the parent corporation
sold to the subsidiary.
(b) Section 304(a)(2) may be illustrated by the following example:
Example. Corporation M has outstanding 100 shares of common stock
which are owned as follows: B, 75 shares, C, son of B, 20 shares, and D,
daughter of B, 5 shares. Corporation M owns the stock of Corporation X.
B sells his 75 shares of Corporation M stock to Corporation X. Under
section 302(b)(3) this is a termination of B's entire interest in
Corporation M and the full amount received from the sale of his stock
will be treated as payment in exchange for this stock, provided he
fulfills the requirements of section 302(c)(2) (relating to an
acquisition of an interest in the corporations).
Sec. 1.304-4T Special rule for use of a related corporation to acquire for property the stock of another commonly owned corporation (temporary).
(a) In general. At the discretion of the District Director, for
purposes of determining the amount constituting a dividend, and source
thereof, under section 304(b)(2), a corporation (deemed acquiring
corporation) will be considered to have acquired for property the stock
of a corporation (issuing corporation) acquired for property by another
corporation (acquiring corporation) that is controlled by the deemed
acquiring corporation, if one of the principal purposes for creating,
organizing, or funding the acquiring corporation, through capital
contributions or debt, is to avoid the application of section 304 to the
deemed acquiring corporation. The following example illustrates the
application of this paragraph (a).
Example. P, a domestic corporation, owns all of the stock of CFC1, a
controlled foreign corporation with substantial accumulated earnings and
profits. CFC1 is organized in Country X, which imposes a high rate of
tax on CFC1's income. P also owns all of the stock of CFC2, another
controlled foreign corporation, which has accumulated earnings and
profits of $200x. CFC2 is organized in Country Y which imposes a low
rate of tax on CFC2's income. P wishes to own all of its foreign
corporations in a direct chain and to effectuate a repatriation of
CFC2's cash to P. In order to avoid having to obtain Country X
[[Page 22]]
approval for the acquisition of CFC1 (a Country X corporation) by CFC2
(a Country Y corporation) and to avoid a dividend to P out of CFC2's
earnings and profits that would otherwise occur as a result of the
application of section 304, P causes CFC2 to form RFC as a Country X
wholly-owned subsidiary and to contribute $100x to RFC. RFC will
purchase, for $100x, all of the stock of CFC1 from P. Because one of P's
principal purposes for having CFC1 owned by RFC is to avoid section 304,
under Sec. 1.304-4T(a), CFC2 is considered to have acquired the stock of
CFC1 for $100x for purposes of determining the amount constituting a
dividend (and source thereof) for purposes of section 304(b)(2).
(b) Availability to taxpayers. Nothing in this regulation shall be
construed to provide a taxpayer the right to compel the Internal Revenue
Service to disregard the form of its transaction for Federal income tax
purposes.
(c) Effective date. This section is effective June 14, 1988, with
respect to acquisitions of stock occurring on or after June 14, 1988.
[T.D. 8209, 53 FR 22171, June 14, 1988]
Sec. 1.304-5 Control.
(a) Control requirement in general. Section 304(c)(1) provides that,
for purposes of section 304, control means the ownership of stock
possessing at least 50 percent of the total combined voting power of all
classes of stock entitled to vote or at least 50 percent of the total
value of shares of all classes of stock. Section 304(c)(3) makes section
318(a) (relating to constructive ownership of stock), as modified by
section 304(c)(3)(B), applicable to section 304 for purposes of
determining control under section 304(c)(1).
(b) Effect of section 304(c)(2)(B)--(1) In general. In determining
whether the control test with respect to both the issuing and acquiring
corporations is satisfied, section 304(a)(1) considers only the person
or persons that--
(i) Control the issuing corporation before the transaction;
(ii) Transfer issuing corporation stock to the acquiring corporation
for property; and
(iii) Control the acquiring corporation thereafter.
(2) Application. Section 317 defines property to include money,
securities, and any other property except stock (or stock rights) in the
distributing corporation. However, section 304(c)(2)(B) provides a
special rule to extend the relevant group of persons to be tested for
control of both the issuing and acquiring corporations to include the
person or persons that do not acquire property, but rather solely stock
from the acquiring corporation in the transaction. Section 304(c)(2)(B)
provides that if two or more persons in control of the issuing
corporation transfer stock of such corporation to the acquiring
corporation, and if the transferors are in control of the acquiring
corporation after the transfer, the person or persons in control of each
corporation include each of those transferors. Because the purpose of
section 304(c)(2)(B) is to include in the relevant control group the
person or persons that retain or acquire acquiring corporation stock in
the transaction, only the person or persons transferring stock of the
issuing corporation that retain or acquire any proprietary interest in
the acquiring corporation are taken into account for purposes of
applying section 304(c)(2)(B).
(3) Example. This section may be illustrated by the following
example.
Example (a) A, the owner of 20% of T's only class of stock,
transfers that stock to P solely in exchange for all of the P stock.
Pursuant to the same transaction, P, solely in exchange for cash,
acquires the remaining 80% of the T stock from T's other shareholder, B,
who is unrelated to A and P.
(b) Although A and B together were in control of T (the issuing
corporation) before the transaction and A and B each transferred T stock
to P (the acquiring corporation), sections 304(a)(1) and (c)(2)(B) do
not apply to B because B did not retain or acquire any proprietary
interest in P in the transaction. Section 304(a)(1) also does not apply
to A because A (or any control group of which A was a member) did not
control T before the transaction and P after the transaction.
(c) Effective date. This section is effective on January 20, 1994.
[T.D. 8515, 59 FR 2960, Jan. 20, 1994]
Sec. 1.305-1 Stock dividends.
(a) In general. Under section 305, a distribution made by a
corporation to its shareholders in its stock or in rights to acquire its
stock is not included in gross income except as provided in section
305(b) and the regulations promulgated under the authority
[[Page 23]]
of section 305(c). A distribution made by a corporation to its
shareholders in its stock or rights to acquire its stock which would not
otherwise be included in gross income by reason of section 305 shall not
be so included merely because such distribution was made out of Treasury
stock or consisted of rights to acquire Treasury stock. See section 307
for rules as to basis of stock and stock rights acquired in a
distribution.
(b) Amount of distribution. (1) In general, where a distribution of
stock or rights to acquire stock of a corporation is treated as a
distribution of property to which section 301 applies by reason of
section 305(b), the amount of the distribution, in accordance with
section 301(b) and Sec. 1.301-1, is the fair market value of such stock
or rights on the date of distribution. See Example (1) of Sec. 1.305-
2(b).
(2) Where a corporation which regularly distributes its earnings and
profits, such as a regulated investment company, declares a dividend
pursuant to which the shareholders may elect to receive either money or
stock of the distributing corporation of equivalent value, the amount of
the distribution of the stock received by any shareholder electing to
receive stock will be considered to equal the amount of the money which
could have been received instead. See Example (2) of Sec. 1.305-2(b).
(3) For rules for determining the amount of the distribution where
certain transactions, such as changes in conversion ratios or periodic
redemptions, are treated as distributions under section 305(c), see
Examples (6), (8), (9), and (15) of Sec. 1.305-3(e).
(c) Adjustment in purchase price. A transfer of stock (or rights to
acquire stock) or an increase or decrease in the conversion ratio or
redemption price of stock which represents an adjustment of the price to
be paid by the distributing corporation in acquiring property (within
the meaning of section 317(a)) is not within the purview of section 305
because it is not a distribution with respect to its stock. For example,
assume that on January 1, 1970, pursuant to a reorganization,
corporation X acquires all the stock of corporation Y solely in exchange
for its convertible preferred class B stock. Under the terms of the
class B stock, its conversion ratio is to be adjusted in 1976 under a
formula based upon the earnings of corporation Y over the 6-year period
ending on December 31, 1975. Such an adjustment in 1976 is not covered
by section 305.
(d) Definitions. (1) For purposes of this section and Secs. 1.305-2
through 1.305-7, the term stock includes rights or warrants to acquire
such stock.
(2) For purposes of Secs. 1.305-2 through 1.305-7, the term
shareholder includes a holder of rights or warrants or a holder of
convertible securities.
[T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, July 25, 1973]
Sec. 1.305-2 Distributions in lieu of money.
(a) In general. Under section 305(b)(1), if any shareholder has the
right to an election or option with respect to whether a distribution
shall be made either in money or any other property, or in stock or
rights to acquire stock of the distributing corporation, then, with
respect to all shareholders, the distribution of stock or rights to
acquire stock is treated as a distribution of property to which section
301 applies regardless of--
(1) Whether the distribution is actually made in whole or in part in
stock or in stock rights;
(2) Whether the election or option is exercised or exercisable
before or after the declaration of the distribution;
(3) Whether the declaration of the distribution provides that the
distribution will be made in one medium unless the shareholder
specifically requests payment in the other;
(4) Whether the election governing the nature of the distribution is
provided in the declaration of the distribution or in the corporate
charter or arises from the circumstances of the distribution; or
(5) Whether all or part of the shareholders have the election.
(b) Examples. The application of section 305(b)(1) may be
illustrated by the following examples:
Example (1). (i) Corporation X declared a dividend payable in
additional shares of its common stock to the holders of its outstanding
common stock on the basis of two additional shares for each share held
on the record date but with the provision that, at
[[Page 24]]
the election of any shareholder made within a specified period prior to
the distribution date, he may receive one additional share for each
share held on the record date plus $12 principal amount of securities of
corporation Y owned by corporation X. The fair market value of the stock
of corporation X on the distribution date was $10 per share. The fair
market value of $12 principal amount of securities of corporation Y on
the distribution date was $11 but such securities had a cost basis to
corporation X of $9.
(ii) The distribution to all shareholders of one additional share of
stock of corporation X (with respect to which no election applies) for
each share outstanding is not a distribution to which section 301
applies.
(iii) The distribution of the second share of stock of corporation X
to those shareholders who do not elect to receive securities of
corporation Y is a distribution of property to which section 301
applies, whether such shareholders are individuals or corporations. The
amount of the distribution to which section 301 applies is $10 per share
of stock of corporation X held on the record date (the fair market value
of the stock of corporation X on the distribution date).
(iv) The distribution of securities of corporation Y in lieu of the
second share of stock of corporation X to the shareholders of
corporation X whether individuals or corporations, who elect to receive
such securities, is also a distribution of property to which section 301
applies.
(v) In the case of the individual shareholders of corporation X who
elects to receive such securities, the amount of the distribution to
which section 301 applies is $11 per share of stock of corporation X
held on the record date (the fair market value of the $12 principal
amount of securities of corporation Y on the distribution date).
(vi) In the case of the corporate shareholders of corporation X
electing to receive such securities, the amount of the distribution to
which section 301 applies is $9 per share of stock of corporation X held
on the record date (the basis of the securities of corporation Y in the
hands of corporation X).
Example (2). On January 10, 1970, corporation X, a regulated
investment company, declared a dividend of $1 per share on its common
stock payable on February 11, 1970, in cash or in stock of corporation X
of equivalent value determined as of January 22, 1970, at the election
of the shareholder made on or before January 22, 1970. The amount of the
distribution to which section 301 applies is $1 per share whether the
shareholder elects to take cash or stock and whether the shareholder is
an individual or a corporation. Such amount will also be used in
determining the dividend paid deduction of corporation X and the
reduction in earnings and profits of corporation X.
[T.D. 7281, 38 FR 18532, July 12, 1973]
Sec. 1.305-3 Disproportionate distributions.
(a) In general. Under section 305(b)(2), a distribution (including a
deemed distribution) by a corporation of its stock or rights to acquire
its stock is treated as a distribution of property to which section 301
applies if the distribution (or a series of distributions of which such
distribution is one) has the result of (1) the receipt of money or other
property by some shareholders, and (2) an increase in the proportionate
interests of other shareholders in the assets or earnings and profits of
the corporation. Thus, if a corporation has two classes of common stock
outstanding and cash dividends are paid on one class and stock dividends
are paid on the other class, the stock dividends are treated as
distributions to which section 301 applies.
(b) Special rules. (1) As used in section 305(b)(2), the term a
series of distributions encompasses all distributions of stock made or
deemed made by a corporation which have the result of the receipt of
cash or property by some shareholders and an increase in the
proportionate interests of other shareholders.
(2) In order for a distribution of stock to be considered as one of
a series of distributions it is not necessary that such distribution be
pursuant to a plan to distribute cash or property to some shareholders
and to increase the proportionate interests of other shareholders. It is
sufficient if there is an actual or deemed distribution of stock (of
which such distribution is one) and as a result of such distribution or
distributions some shareholders receive cash or property and other
shareholders increase their proportionate interests. For example, if a
corporation pays quarterly stock dividends to one class of common
shareholders and annual cash dividends to another class of common
shareholders the quarterly stock dividends constitute a series of
distributions of stock having the result of the receipt of cash or
property by some shareholders and an increase in the proportionate
interests of other
[[Page 25]]
shareholders. This is so whether or not the stock distributions and the
cash distributions are steps in an overall plan or are independent and
unrelated. Accordingly, all the quarterly stock dividends are
distributions to which section 301 applies.
(3) There is no requirement that both elements of section 305(b)(2)
(i.e., receipt of cash or property by some shareholders and an increase
in proportionate interests of other shareholders) occur in the form of a
distribution or series of distributions as long as the result of a
distribution or distributions of stock is that some shareholders'
proportionate interests increase and other shareholders in fact receive
cash or property. Thus, there is no requirement that the shareholders
receiving cash or property acquire the cash or property by way of a
corporate distribution with respect to their shares, so long as they
receive such cash or property in their capacity as shareholders, if
there is a stock distribution which results in a change in the
proportionate interests of some shareholders and other shareholders
receive cash or property. However, in order for a distribution of
property to meet the requirement of section 305(b)(2), such distribution
must be made to a shareholder in his capacity as a shareholder, and must
be a distribution to which section 301, 356(a)(2), 871(a)(1)(A),
881(a)(1), 852(b), or 857(b) applies. (Under section 305(d)(2), the
payment of interest to a holder of a convertible debenture is treated as
a distribution of property to a shareholder for purposes of section
305(b)(2).) For example if a corporation makes a stock distribution to
its shareholders and, pursuant to a prearranged plan with such
corporation, a related corporation purchases such stock from those
shareholders who want cash, in a transaction to which section 301
applies by virtue of section 304, the requirements of section 305(b)(2)
are satisfied. In addition, a distribution of property incident to an
isolated redemption of stock (for example, pursuant to a tender offer)
will not cause section 305(b)(2) to apply even though the redemption
distribution is treated as a distribution of property to which section
301, 871(a)(1)(A), 881(a)(1), or 356(a)(2) applies.
(4) Where the receipt of cash or property occurs more than 36 months
following a distribution or series of distributions of stock, or where a
distribution or series of distributions of stock is made more than 36
months following the receipt of cash or property, such distribution or
distributions will be presumed not to result in the receipt of cash or
property by some shareholders and an increase in the proportionate
interest of other shareholders, unless the receipt of cash or property
and the distribution or series of distributions of stock are made
pursuant to a plan. For example, if, pursuant to a plan, a corporation
pays cash dividends to some shareholders on January 1, 1971 and
increases the proportionate interests of other shareholders on March 1,
1974, such increases in proportionate interests are distributions to
which section 301 applies.
(5) In determining whether a distribution or a series of
distributions has the result of a disproportionate distribution, there
shall be treated as outstanding stock of the distributing corporation
(i) any right to acquire such stock (whether or not exercisable during
the taxable year), and (ii) any security convertible into stock of the
distributing corporation (whether or not convertible during the taxable
year).
(6) In cases where there is more than one class of stock
outstanding, each class of stock is to be considered separately in
determining whether a shareholder has increased his proportionate
interest in the assets or earnings and profits of a corporation. The
individual shareholders of a class of stock will be deemed to have an
increased interest if the class of stock as a whole has an increased
interest in the corporation.
(c) Distributions of cash in lieu of fractional shares. (1) Section
305(b)(2) will not apply if--
(i) A corporation declares a dividend payable in stock of the
corporation and distributes cash in lieu of fractional shares to which
shareholders would otherwise be entitled, or
(ii) Upon a conversion of convertible stock or securities a
corporation distributes cash in lieu of fractional shares to which
shareholders would otherwise be entitled.
[[Page 26]]
Provided the purpose of the distribution of cash is to save the
corporation the trouble, expense, and inconvenience of issuing and
transferring fractional shares (or scrip representing fractional
shares), or issuing full shares representing the sum of fractional
shares, and not to give any particular group of shareholders an
increased interest in the assets or earnings and profits of the
corporation. For purposes of paragraph (c)(1)(i) of this section, if the
total amount of cash distributed in lieu of fractional shares is 5
percent or less of the total fair market value of the stock distributed
(determined as of the date of declaration), the distribution shall be
considered to be for such valid purpose.
(2) In a case to which subparagraph (1) of this paragraph applies,
the transaction will be treated as though the fractional shares were
distributed as part of the stock distribution and then were redeemed by
the corporation. The treatment of the cash received by a shareholder
will be determined under section 302.
(d) Adjustment in conversion ratio. (1)(i) Except as provided in
subparagraph (2) of this paragraph, if a corporation has convertible
stock or convertible securities outstanding (upon which it pays or is
deemed to pay dividends or interest in money or other property) and
distributes a stock dividend (or rights to acquire such stock) with
respect to the stock into which the convertible stock or securities are
convertible, an increase in proportionate interest in the assets or
earnings and profits of the corporation by reason of such stock dividend
shall be considered to have occurred unless a full adjustment in the
conversion ratio or conversion price to reflect such stock dividend is
made. Under certain circumstances, however, the application of an
adjustment formula which in effect provides for a ``credit'' where stock
is issued for consideration in excess of the conversion price may not
satisfy the requirement for a ``full adjustment.'' Thus, if under a
``conversion price'' antidilution formula the formula provides for a
``credit'' where stock is issued for consideration in excess of the
conversion price (in effect as an offset against any decrease in the
conversion price which would otherwise be required when stock is
subsequently issued for consideration below the conversion price) there
may still be an increase in proportionate interest by reason of a stock
dividend after application of the formula, since any downward adjustment
of the conversion price that would otherwise be required to reflect the
stock dividend may be offset, in whole or in part, by the effect of
prior sales made at prices above the conversion price. On the other
hand, if there were no prior sales of stock above the conversion price
then a full adjustment would occur upon the application of such an
adjustment formula and there would be no change in proportionate
interest. Similarly, if consideration is to be received in connection
with the issuance of stock, such as in the case of a rights offering or
a distribution of warrants, the fact that such consideration is taken
into account in making the antidilution adjustment will not preclude a
full adjustment. See paragraph (b) of the example in this subparagraph
for a case where the application of an adjustment formula with a
cumulative feature does not result in a full adjustment and where a
change in proportionate interest therefore occurs. See paragraph (c) for
a case where the application of an adjustment formula with a cumulative
feature does result in a full adjustment and where no change in
proportionate interest therefore occurs. See paragraph (d) for an
application of an antidilution formula in the case of a rights offering.
See paragraph (e) for a case where the application of a noncumulative
type adjustment formula will in all cases prevent a change in
proportionate interest from occurring in the case of a stock dividend,
because of the omission of the cumulative feature.
(ii) The principles of this subparagraph may be illustrated by the
following example.
Example. (a) Corporation S has two classes of securities
outstanding, convertible debentures and common stock. At the time of
issuance of the debentures the corporation had 100 shares of common
stock outstanding. Each debenture is interest-paying and is convertible
into common stock at a conversion price of $2. The debenture's
conversion price
[[Page 27]]
is subject to reduction pursuant to the following formula:
(Number of common shares outstanding at date of issue of debentures
times initial conversion price) plus (Consideration received upon
issuance of additional common shares) divided by (Number of common
shares outstanding at date of issue of debentures) plus (Number of
additional common shares issued)
Under the formula, common stock dividends are treated as an issue of
common stock for zero consideration. If the computation results in a
figure which is less than the existing conversion price the conversion
price is reduced. However, under the formula, the existing conversion
price is never increased. The formula works upon a cumulative basis
since the numerator includes the consideration received upon the
issuance of all common shares subsequent to the issuance of the
debentures, and the reduction effected by the formula because of a sale
or issuance of common stock below the existing conversion price is thus
limited by any prior sales made above the existing conversion price.
(b) In 1972 corporation S sells 100 common shares at $3 per share.
In 1973 the corporation declares a stock dividend of 20 shares to all
holders of common stock. Under the antidilution formula no adjustment
will be made to the conversion price of the debentures to reflect the
stock dividend to common stockholders since the prior sale of common
stock in excess of the conversion price in 1972 offsets the reduction in
the conversion price which would otherwise result, as follows:
100x$2+$300/100+120=$500/220=$2.27
Since $2.27 is greater than the existing conversion price of $2 no
adjustment is required. As a result, there is an increase in
proportionate interest of the common stockholders by reason of the stock
dividend and the additional shares of common stock will be treated,
pursuant to section 305(b)(2), as a distribution of property to which
section 301 applies.
(c) Assume the same facts as above, but instead of selling 100
common shares at $3 per share in 1972, assume corporation S sold no
shares. Application of the antidilution formula would give rise to an
adjustment in the conversion price as follows:
100x$2+$0/100+20=$200/120=$1.67
The conversion price, being reduced from $2 to $1.67, fully reflects the
stock dividend distributed to the common stockholders. Hence, the
distribution of common stock is not treated under section 305(b)(2) as
one to which section 301 applies because the distribution does not
increase the proportionate interests of the common shareholders as a
class.
(d) Corporation S distributes to its shareholders rights entitling
the shareholders to purchase a total of 20 shares at $1 per share.
Application of the antidilution formula would produce an adjustment in
the conversion price as follows:
100x$2+20x$1/100+20=$220/120=$1.83
The conversion price, being reduced from $2 to $1.83, fully reflects the
distribution of rights to purchase stock at a price lower than the
conversion price. Hence, the distribution of the rights is not treated
under section 305(b)(2) as one to which section 301 applies because the
distribution does not increase the proportionate interests of the common
shareholders as a class.
(e) Assume the same facts as in (b) above, but instead of using a
``conversion price'' antidilution formula which operates on a cumulative
basis, assume corporation S has employed a formula which operates as
follows with respect to all stock dividends: The conversion price in
effect at the opening of business on the day following the dividend
record date is reduced by multiplying such conversion price by a
fraction the numerator of which is the number of shares of common stock
outstanding at the close of business on the record date and the
denominator of which is the sum of such shares so outstanding and the
number of shares constituting the stock dividend. Under such a formula
the following adjustment would be made to the conversion price upon the
declaration of a stock dividend of 20 shares in 1973:
200/200+20=200/220x$2=$1.82
The conversion price, being reduced from $2 to $1.82, fully reflects the
stock dividend distributed to the common stockholders. Hence, the
distribution of common stock is not treated under section 305(b)(2) as
one to which section 301 applies because the distribution does not
increase the proportionate interests of the common shareholders as a
class.
(2)(i) A distributing corporation either must make the adjustment
required by subparagraph (1) of this paragraph as of the date of the
distribution of the stock dividend, or must elect (in the manner
provided in subdivision (iii) of this subparagraph) to make such
adjustment within the time provided in subdivision (ii) of this
subparagraph.
(ii) If the distributing corporation elects to make such adjustment,
such adjustment must be made no later than the earlier of (a) 3 years
after the date of the stock dividend, or (b) that date as of which the
aggregate stock dividends for which adjustment of the conversion ratio
has not previously been made total at least 3 percent of the
[[Page 28]]
issued and outstanding stock with respect to which such stock dividends
were distributed.
(iii) The election provided by subdivision (ii) of this subparagraph
shall be made by filing with the income tax return for the taxable year
during which the stock dividend is distributed--
(a) A statement that an adjustment will be made as provided by that
subdivision, and
(b) A description of the antidilution provisions under which the
adjustment will be made.
(3) Notwithstanding the preceding subparagraph, if a distribution
has been made before July 12, 1973, and the adjustment required by
subparagraph (1) or the election to make such adjustment was not made
before such date, the adjustment or the election to make such
adjustment, as the case may be, shall be considered valid if made no
later than 15 days following the date of the first annual meeting of the
shareholders after July 12, 1973, or July 12, 1974, whichever is
earlier. If the election is made within such period, and, if the income
tax return has been filed before the time of such election, the
statement of adjustment and the description of the antidilution
provisions required by subparagraph (2)(iii) shall be filed with the
Internal Revenue Service Center with which the income tax return was
filed.
(4) See Sec. 1.305-7(b) for a discussion of antidilution adjustments
in connection with the application of section 305(c) in conjunction with
section 305(b).
(e) Examples. The application of section 305(b)(2) to distributions
of stock and section 305(c) to deemed distributions of stock may be
illustrated by the following examples:
Example 1. Corporation X is organized with two classes of common
stock, class A and class B. Each share of stock is entitled to share
equally in the assets and earnings and profits of the corporation.
Dividends may be paid in stock or in cash on either class of stock
without regard to the medium of payment of dividends on the other class.
A dividend is declared on the class A stock payable in additional shares
of class A stock and a dividend is declared on class B stock payable in
cash. Since the class A shareholders as a class will have increased
their proportionate interests in the assets and earnings and profits of
the corporation and the class B shareholders will have received cash,
the additional shares of class A stock are distributions of property to
which section 301 applies. This is true even with respect to those
shareholders who may own class A stock and class B stock in the same
proportion.
Example 2. Corporation Y is organized with two classes of stock,
class A common, and class B, which is nonconvertible and limited and
preferred as to dividends. A dividend is declared upon the class A stock
payable in additional shares of class A stock and a dividend is declared
on the class B stock payable in cash. The distribution of class A stock
is not one to which section 301 applies because the distribution does
not increase the proportionate interests of the class A shareholders as
a class.
Example 3. Corporation K is organized with two classes of stock,
class A common, and class B, which is nonconvertible preferred stock. A
dividend is declared upon the class A stock payable in shares of class B
stock and a dividend is declared on the class B stock payable in cash.
Since the class A shareholders as a class have an increased interest in
the assets and earnings and profits of the corporation, the stock
distribution is treated as a distribution to which section 301 applies.
If, however, a dividend were declared upon the class A stock payable in
a new class of preferred stock that is subordinated in all respects to
the class B stock, the distribution would not increase the proportionate
interests of the class A shareholders in the assets or earnings and
profits of the corporation and would not be treated as a distribution to
which section 301 applies.
Example 4. (i) Corporation W has one class of stock outstanding,
class A common. The corporation also has outstanding interest paying
securities convertible into class A common stock which have a fixed
conversion ratio that is not subject to full adjustment in the event
stock dividends or rights are distributed to the class A shareholders.
Corporation W distributes to the class A shareholders rights to acquire
additional shares of class A stock. During the year, interest is paid on
the convertible securities.
(ii) The stock rights and convertible securities are considered to
be outstanding stock of the corporation and the distribution increases
the proportionate interests of the class A shareholders in the assets
and earnings and profits of the corporation. Therefore, the distribution
is treated as a distribution to which section 301 applies. The same
result would follow if, instead of convertible securities, the
corporation had outstanding convertible stock. If, however, the
conversion ratio of the securities or stock were fully adjusted to
reflect the distribution of rights to the class A shareholders, the
rights to acquire class A stock would not increase the proportionate
interests of the class A shareholders in the assets and earnings and
[[Page 29]]
profits of the corporation and would not be treated as a distribution to
which section 301 applies.
Example 5. (i) Corporation S is organized with two classes of stock,
class A common and class B convertible preferred. The class B is fully
protected against dilution in the event of a stock dividend or stock
split with respect to the class A stock; however, no adjustment in the
conversion ratio is required to be made until the stock dividends equal
3 percent of the common stock issued and outstanding on the date of the
first such stock dividend except that such adjustment must be made no
later than 3 years after the date of the stock dividend. Cash dividends
are paid annually on the class B stock.
(ii) Corporation S pays a 1 percent stock dividend on the class A
stock in 1970. In 1971, another 1 percent stock dividend is paid and in
1972 another 1 percent stock dividend is paid. The conversion ratio of
the class B stock is increased in 1972 to reflect the three stock
dividends paid on the class A stock. The distributions of class A stock
are not distributions to which section 301 applies because they do not
increase the proportionate interests of the class A shareholders in the
assets and earnings and profits of the corporation.
Example 6. (i) Corporation M is organized with two classes of stock
outstanding, class A and class B. Each class B share may be converted,
at the option of the holder, into class A shares. During the first year,
the conversion ratio is one share of class A stock for each share of
class B stock. At the beginning of each subsequent year, the conversion
ratio is increased by 0.05 share of class A stock for each share of
class B stock. Thus, during the second year, the conversion ratio would
be 1.05 shares of class A stock for each share of class B stock, during
the third year, the ratio would be 1.10 shares, etc.
(ii) M pays an annual cash dividend on the class A stock. At the
beginning of the second year, when the conversion ratio is increased to
1.05 shares of class A stock for each share of class B stock, a
distribution of 0.05 shares of class A stock is deemed made under
section 305(c) with respect to each share of class B stock, since the
proportionate interests of the class B shareholders in the assets or
earnings and profits of M are increased and the transaction has the
effect described in section 305(b)(2). Accordingly, sections 305(b)(2)
and 301 apply to the transaction.
Example 7. (i) Corporation N has two classes of stock outstanding,
class A and class B. Each class B share is convertible into class A
stock. However, in accordance with a specified formula, the conversion
ratio is decreased each time a cash dividend is paid on the class B
stock to reflect the amount of the cash dividend. The conversion ratio
is also adjusted in the event that cash dividends are paid on the class
A stock to increase the number of class A shares into which the class B
shares are convertible to compensate the class B shareholders for the
cash dividend paid on the class A stock.
(ii) In 1972, a $1 cash dividend per share is declared and paid on
the class B stock. On the date of payment, the conversion ratio of the
class B stock is decreased. A distribution of stock is deemed made under
section 305(c) to the class A shareholders, since the proportionate
interest of the class A shareholders in the assets or earnings and
profits of the corporation is increased and the transaction has the
effect described in section 305(b)(2). Accordingly, sections 305(b)(2)
and 301 apply to the transaction.
(iii) In the following year a cash dividend is paid on the class A
stock and none is paid on the class B stock. The increase in conversion
rights of the class B shares is deemed to be a distribution under
section 305(c) to the class B shareholders since their proportionate
interest in the assets or earnings and profits of the corporation is
increased and since the transaction has the effect described in section
305(b)(2). Accordingly, sections 305(b)(2) and 301 apply to the
transaction.
Example 8. Corporation T has 1,000 shares of stock outstanding. C
owns 100 shares. Nine other shareholders each owns 100 shares. Pursuant
to a plan for periodic redemptions, T redeems up to 5 percent of each
shareholder's stock each year. During the year, each of the nine other
shareholders has 5 shares of his stock redeemed for cash. Thus, C's
proportionate interest in the assets and earnings and profits of T is
increased. Assuming that the cash received by the nine other
shareholders is taxable under section 301, C is deemed under section
305(c) to have received a distribution under section 305(b)(2) of 5.25
shares of T stock to which section 301 applies. The amount of C's
distribution is measured by the fair market value of the number of
shares which would have been distributed to C had the corporation sought
to increase his interest by 0.47 percentage points (C owned 10 percent
of the T stock immediately before the redemption and 10.47 percent
immediately thereafter) and the other shareholders continued to hold 900
shares (i.e.,
(a) 100/955=10.47% (percent of C's ownership after redemption)
(b) 100+x/1000+x=10.47%; x=5.25 (additional shares considered to be
distributed to C)).
Since in computing the amount of additional shares deemed to be
distributed to C the redemption of shares is disregarded, the redemption
of shares will be similarly disregarded in determining the value of the
stock of the corporation which is deemed to be distributed. Thus, in the
example, 1,005.25 shares of stock are considered as outstanding after
the redemption. The value of each share deemed to be distributed to C is
then
[[Page 30]]
determined by dividing the 1,005.25 shares into the aggregate fair
market value of the actual shares outstanding (955) after the
redemption.
Example 9. (i) Corporation O has a stock redemption program under
which, instead of paying out earnings and profits to its shareholders in
the form of dividends, it redeems the stock of its shareholders up to a
stated amount which is determined by the earnings and profits of the
corporation. If the stock tendered for redemption exceeds the stated
amount, the corporation redeems the stock on a pro rata basis up to the
stated amount.
(ii) During the year corporation O offers to distribute $10,000 in
redemption of its stock. At the time of the offering, corporation O has
1,000 shares outstanding of which E and F each owns 150 shares and G and
H each owns 350 shares. The corporation redeems 15 shares from E and 35
shares from G. F and H continue to hold all of their stock.
(iii) F and H have increased their proportionate interests in the
assets and earnings and profits of the corporation. Assuming that the
cash E and G receive is taxable under section 301, F will be deemed
under section 305(c) to have received a distribution under section
305(b)(2) of 16.66 shares of stock to which section 301 applies and H
will be deemed under section 305(c) to have received a distribution
under section 305(b)(2) of 38.86 shares of stock to which section 301
applies. The amount of the distribution to F and H is measured by the
number of shares which would have been distributed to F and H had the
corporation sought to increase the interest of F by 0.79 percentage
points (F owned 15 percent of the stock immediately before the
redemption and 15.79 percent immediately thereafter) and the interest of
H by 1.84 percentage points (H owned 35 percent of the stock immediately
before the redemption and 36.84 percent immediately thereafter) and E
and G had continued to hold 150 shares and 350 shares, respectively
(i.e.,
(a) 150/950+350/950=52.63% (percent of F and H's ownership after
redemption)
(b) 500+y/1000+y=52.63%; y=55.52 (additional shares considered to be
distributed to F and H)
(c)(1) 150/500x55.52=16.66 (shares considered to be distributed to F)
(2) 350/500x55.52=38.86 (shares considered to be distributed to H)).
Since in computing the amount of additional shares deemed to be
distributed to F and H the redemption of shares is disregarded, the
redemption of shares will be similarly disregarded in determining the
value of the stock of the corporation which is deemed to be distributed.
Thus, in the example, 1,055.52 shares of stock are considered as
outstanding after the redemption. The value of each share deemed to be
distributed to F and H is then determined by dividing the 1,055.52
shares into the aggregate fair market value of the actual shares
outstanding (950) after the redemption.
Example 10. Corporation P has 1,000 shares of stock outstanding. T
owns 700 shares of the P stock and G owns 300 shares of the P stock. In
a single and isolated redemption to which section 301 applies, the
corporation redeems 150 shares of T's stock. Since this is an isolated
redemption and is not a part of a periodic redemption plan, G is not
treated as having received a deemed distribution under section 305(c) to
which sections 305(b)(2) and 301 apply even though he has an increased
proportionate interest in the assets and earnings and profits of the
corporation.
Example 11. Corporation Q is a large corporation whose sole class of
stock is widely held. However, the four largest shareholders are
officers of the corporation and each owns 8 percent of the outstanding
stock. In 1974, in a distribution to which section 301 applies, the
corporation redeems 1.5 percent of the stock from each of the four
largest shareholders in preparation for their retirement. From 1970
through 1974, the corporation distributes annual stock dividends to its
shareholders. No other distributions were made to these shareholders.
Since the 1974 redemptions are isolated and are not part of a plan for
periodically redeeming the stock of the corporation, the shareholders
receiving stock dividends will not be treated as having received a
distribution under section 305(b)(2) even though they have an increased
proportionate interest in the assets and earnings and profits of the
corporation and whether or not the redemptions are treated as
distributions to which section 301 applies.
Example 12. Corporation R has 2,000 shares of class A stock
outstanding. Five shareholders own 300 shares each and five shareholders
own 100 shares each. In preparation for the retirement of the five major
shareholders, corporation R, in a single and isolated transaction, has a
recapitalization in which each share of class A stock may be exchanged
either for five shares of new class B nonconvertible preferred stock
plus 0.4 share of new class C common stock, or for two shares of new
class C common stock. As a result of the exchanges, each of the five
major shareholders receives 1,500 shares of class B nonconvertible
preferred stock and 120 shares of class C common stock. The remaining
shareholders each receives 200 shares of class C common stock. None of
the exchanges are within the purview of section 305.
Example 13. Corporation P is a widely-held company whose shares are
listed for trading on a stock exchange. P distributes annual cash
dividends to its shareholders. P purchases shares of its common stock
directly from small stockholders (holders of record of 100 shares or
less) or through brokers where the holders may not be known at the time
of purchase. Where such purchases are made
[[Page 31]]
through brokers, they are pursuant to the rules and regulations of the
Securities and Exchange Commission. The shares are purchased for the
purpose of issuance to employee stock investment plans, to holders of
convertible stock or debt, to holders of stock options, or for future
acquisitions. Provided the purchases are not pursuant to a plan to
increase the proportionate interest of some shareholders and distribute
property to other shareholders, the remaining shareholders of P are not
treated as having received a deemed distribution under section 305(c) to
which section 305(b)(2) and 301 apply, even though they have an
increased proportionate interest in the assets and earnings and profits
of the corporation.
Example 14. Corporation U is a large manufacturing company whose
products are sold through independent dealers. In order to assist
individuals who lack capital to become dealers, the corporation has an
established investment plan under which it provides 75 percent of the
capital necessary to form a dealership corporation and the individual
dealer provides the remaining 25 percent. Corporation U receives class A
stock and a note representing its 75 percent interest. The individual
dealer receives class B stock representing his 25 percent interest. The
class B stock is nonvoting until all the class A shares are redeemed. At
least 70 percent of the earnings and profits of the dealership
corporation must be used each year to retire the note and to redeem the
class A stock. The class A stock is redeemed at a fixed price. The
individual dealer has no control over the redemption of stock and has no
right to have his stock redeemed during the period the plan is in
existence. U's investment is thus systematically eliminated and the
individual becomes the sole owner of the dealership corporation. Since
this type of plan is akin to a security arrangement, the redemptions of
the class A stock will not be deemed under section 305(c) as
distributions taxable under sections 305(b)(2) and 301 during the years
in which the class A stock is redeemed.
Example 15. (i) Facts. Corporation V is organized with two classes
of stock, class A common and class B convertible preferred. The class B
stock is issued for $100 per share and is convertible at the holder's
option into class A at a fixed ratio that is not subject to full
adjustment in the event stock dividends or rights are distributed to the
class A shareholders. The class B stock pays no dividends but it is
mandatorily redeemable in 10 years for $200. Under sections 305(c) and
305(b)(4), the entire redemption premium (i.e., the excess of the
redemption price over the issue price) is deemed to be a distribution of
preferred stock on preferred stock which is taxable as a distribution of
property under section 301. This amount is considered to be distributed
over the 10-year period under principles similar to the principles of
section 1272(a). During the year, the corporation declares a dividend on
the class A stock payable in additional shares of class A stock.
(ii) Analysis. The distribution on the class A stock is a
distribution to which sections 305(b)(2) and 301 apply since it
increases the proportionate interests of the class A shareholders in the
assets and earnings and profits of the corporation and the class B
shareholders have received property (i.e., the constructive distribution
described above). If, however, the conversion ratio of the class B stock
were subject to full adjustment to reflect the distribution of stock to
class A shareholders, the distribution of stock dividends on the class A
stock would not increase the proportionate interest of the class A
shareholders in the assets and earnings and profits of the corporation
and such distribution would not be a distribution to which section 301
applies.
(iii) Effective date. This Example 15 applies to stock issued on or
after December 20, 1995. For previously issued stock, see Sec. 1.305-
3(e) Example (15) (as contained in the 26 CFR part 1 edition revised
April 1, 1995).
[T.D. 7281, 38 FR 18532, July 12, 1973; 38 FR 19910, 19911, July 25,
1973; as amended by T.D. 7329, 39 FR 36860, Oct. 15, 1974; T.D. 8643, 60
FR 66136, Dec. 21, 1995]
Sec. 1.305-4 Distributions of common and preferred stock.
(a) In general. Under section 305(b)(3), a distribution (or a series
of distributions) by a corporation which results in the receipt of
preferred stock whether or not convertible into common stock) by some
common shareholders and the receipt of common stock by other common
shareholders is treated as a distribution of property to which section
301 applies. For the meaning of the term a series of distribution, see
subparagraphs (1) through (6) of Sec. 1.305-3(b).
(b) Examples. The application of section 305(b)(3) may be
illustrated by the following examples:
Example (1). Corporation X is organized with two classes of common
stock, class A and class B. Dividends may be paid in stock or in cash on
either class of stock without regard to the medium of payment of
dividends on the other class. A dividend is declared on the class A
stock payable in additional shares of class A stock and a dividend is
declared on class B stock payable in newly authorized class C stock
which is nonconvertible and limited and preferred as to dividends. Both
the distribution of class A shares and the distribution of new class C
[[Page 32]]
shares are distributions to which section 301 applies.
Example (2). Corporation Y is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized class B preferred stock
which is convertible into class A stock no later than 6 months from the
date of distribution at a price that is only slightly higher than the
market price of class A stock on the date of distribution. Taking into
account the dividend rate, redemption provisions, the marketability of
the convertible stock, and the conversion price, it is reasonable to
anticipate that within a relatively short period of time some
shareholders will exercise their conversion rights and some will not.
Since the distribution can reasonably be expected to result in the
receipt of preferred stock by some common shareholders and the receipt
of common stock by other common shareholders, the distribution is a
distribution of property to which section 301 applies.
[T.D. 7281, 38 FR 18536, July 12, 1973]
Sec. 1.305-5 Distributions on preferred stock.
(a) In general. Under section 305(b)(4), a distribution by a
corporation of its stock (or rights to acquire its stock) made (or
deemed made under section 305(c)) with respect to its preferred stock is
treated as a distribution of property to which section 301 applies
unless the distribution is made with respect to convertible preferred
stock to take into account a stock dividend, stock split, or any similar
event (such as the sale of stock at less than the fair market value
pursuant to a rights offering) which would otherwise result in the
dilution of the conversion right. For purposes of the preceding
sentence, an adjustment in the conversion ratio of convertible preferred
stock made solely to take into account the distribution by a closed end
regulated investment company of a capital gain dividend with respect to
the stock into which such stock is convertible shall not be considered a
``similar event.'' The term preferred stock generally refers to stock
which, in relation to other classes of stock outstanding, enjoys certain
limited rights and privileges (generally associated with specified
dividend and liquidation priorities) but does not participate in
corporate growth to any significant extent. The distinguishing feature
of preferred stock for the purposes of section 305(b)(4) is not its
privileged position as such, but that such privileged position is
limited, and that such stock does not participate in corporate growth to
any significant extent. However, a right to participate which lacks
substance will not prevent a class of stock from being treated as
preferred stock. Thus, stock which enjoys a priority as to dividends and
on liquidation but which is entitled to participate, over and above such
priority, with another less privileged class of stock in earnings and
profits and upon liquidation, may nevertheless be treated as preferred
stock for purposes of section 305 if, taking into account all the facts
and circumstances, it is reasonable to anticipate at the time a
distribution is made (or is deemed to have been made) with respect to
such stock that there is little or no likelihood of such stock actually
participating in current and anticipated earnings and upon liquidation
beyond its preferred interest. Among the facts and circumstances to be
considered are the prior and anticipated earnings per share, the cash
dividends per share, the book value per share, the extent of preference
and of participation of each class, both absolutely and relative to each
other, and any other facts which indicate whether or not the stock has a
real and meaningful probability of actually participating in the
earnings and growth of the corporation. The determination of whether
stock is preferred for purposes of section 305 shall be made without
regard to any right to convert such stock into another class of stock of
the corporation. The term preferred stock, however, does not include
convertible debentures.
(b) Redemption premium--(1) In general. If a corporation issues
preferred stock that may be redeemed under the circumstances described
in this paragraph (b) at a price higher than the issue price, the
difference (the redemption premium) is treated under section 305(c) as a
constructive distribution (or series of constructive distributions) of
additional stock on preferred stock that is taken into account under
principles similar to the principles of section 1272(a). However,
constructive distribution treatment does not result
[[Page 33]]
under this paragraph (b) if the redemption premium does not exceed a de
minimis amount, as determined under the principles of section
1273(a)(3). For purposes of this paragraph (b), preferred stock that may
be acquired by a person other than the issuer (the third person) is
deemed to be redeemable under the circumstances described in this
paragraph (b), and references to the issuer include the third person,
if--
(i) This paragraph (b) would apply to the stock if the third person
were the issuer; and
(ii) Either--
(A) The acquisition of the stock by the third person would be
treated as a redemption for federal income tax purposes (under section
304 or otherwise); or
(B) The third person and the issuer are members of the same
affiliated group (having the meaning for this purpose given the term by
section 1504(a), except that section 1504(b) shall not apply) and a
principal purpose of the arrangement for the third person to acquire the
stock is to avoid the application of section 305 and paragraph (b)(1) of
this section.
(2) Mandatory redemption or holder put. Paragraph (b)(1) of this
section applies to stock if the issuer is required to redeem the stock
at a specified time or the holder has the option (whether or not
currently exercisable) to require the issuer to redeem the stock.
However, paragraph (b)(1) of this section will not apply if the issuer's
obligation to redeem or the holder's ability to require the issuer to
redeem is subject to a contingency that is beyond the legal or practical
control of either the holder or the holders as a group (or through a
related party within the meaning of section 267(b) or 707(b)), and that,
based on all of the facts and circumstances as of the issue date,
renders remote the likelihood of redemption. For purposes of this
paragraph, a contingency does not include the possibility of default,
insolvency, or similar circumstances, or that a redemption may be
precluded by applicable law which requires that the issuer have a
particular level of capital, surplus, or similar items. A contingency
also does not include an issuer's option to require earlier redemption
of the stock. For rules applicable if stock may be redeemed at more than
one time, see paragraph (b)(4) of this section.
(3) Issuer call--(i) In general. Paragraph (b)(1) of this section
applies to stock by reason of the issuer's right to redeem the stock
(even if the right is immediately exercisable), but only if, based on
all of the facts and circumstances as of the issue date, redemption
pursuant to that right is more likely than not to occur. However, even
if redemption is more likely than not to occur, paragraph (b)(1) of this
section does not apply if the redemption premium is solely in the nature
of a penalty for premature redemption. A redemption premium is not a
penalty for premature redemption unless it is a premium paid as a result
of changes in economic or market conditions over which neither the
issuer nor the holder has legal or practical control.
(ii) Safe harbor. For purposes of this paragraph (b)(3), redemption
pursuant to an issuer's right to redeem is not treated as more likely
than not to occur if--
(A) The issuer and the holder are not related within the meaning of
section 267(b) or 707(b) (for purposes of applying sections 267(b) and
707(b) (including section 267(f)(1)), the phrase ``20 percent'' shall be
substituted for the phrase ``50 percent'');
(B) There are no plans, arrangements, or agreements that effectively
require or are intended to compel the issuer to redeem the stock
(disregarding, for this purpose, a separate mandatory redemption
obligation described in paragraph (b)(2) of this section); and
(C) Exercise of the right to redeem would not reduce the yield of
the stock, as determined under principles similar to the principles of
section 1272(a) and the regulations under sections 1271 through 1275.
(iii) Effect of not satisfying safe harbor. The fact that a
redemption right is not described in paragraph (b)(3)(ii) of this
section does not affect the determination of whether a redemption
pursuant to the right to redeem is more likely than not to occur.
(4) Coordination of multiple redemption provisions. If stock may be
redeemed at
[[Page 34]]
more than one time, the time and price at which redemption is most
likely to occur must be determined based on all of the facts and
circumstances as of the issue date. Any constructive distribution under
paragraph (b)(1) of this section will result only with respect to the
time and price identified in the preceding sentence. However, if
redemption does not occur at that identified time, the amount of any
additional premium payable on any later redemption date, to the extent
not previously treated as distributed, is treated as a constructive
distribution over the period from the missed call or put date to that
later date, to the extent required under the principles of this
paragraph (b).
(5) Consistency. The issuer's determination as to whether there is a
constructive distribution under this paragraph (b) is binding on all
holders of the stock, other than a holder that explicitly discloses that
its determination as to whether there is a constructive distribution
under this paragraph (b) differs from that of the issuer. Unless
otherwise prescribed by the Commissioner, the disclosure must be made on
a statement attached to the holder's timely filed federal income tax
return for the taxable year that includes the date the holder acquired
the stock. The issuer must provide the relevant information to the
holder in a reasonable manner. For example, the issuer may provide the
name or title and either the address or telephone number of a
representative of the issuer who will make available to holders upon
request the information required for holders to comply with this
provision of this paragraph (b).
(c) Cross reference. For rules for applying sections 305(b)(4) and
305(c) to recapitalizations, see Sec. 1.305-7(c).
(d) Examples. The application of sections 305(b)(4) and 305(c) may
be illustrated by the following examples:
Example 1. (i) Corporation T has outstanding 1,000 shares of $100
par 5-percent cumulative preferred stock and 10,000 shares of no-par
common stock. The corporation is 4 years in arrears on dividends to the
preferred shareholders. The issue price of the preferred stock is $100
per share. Pursuant to a recapitalization under section 368(a)(1)(E),
the preferred shareholders exchange their preferred stock, including the
right to dividend arrearages, on the basis of one old preferred share
for 1.20 newly authorized class A preferred shares. Immediately
following the recapitalization, the new class A shares are traded at
$100 per share. The class A shares are entitled to a liquidation
preference of $100. The preferred shareholders have increased their
proportionate interest in the assets or earnings and profits of
corporation T since the fair market value of 1.20 shares of class A
preferred stock ($120) exceeds the issue price of the old preferred
stock ($100). Accordingly, the preferred shareholders are deemed under
section 305(c) to receive a distribution in the amount of $20 on each
share of old preferred stock and the distribution is one to which
sections 305(b)(4) and 301 apply.
(ii) The same result would occur if the fair market value of the
common stock immediately following the recapitalization were $20 per
share and each share of preferred stock were exchanged for one share of
the new class A preferred stock and one share of common stock.
Example 2. Corporation A, a publicly held company whose stock is
traded on a securities exchange (or in the over-the-counter market) has
two classes of stock outstanding, common and cumulative preferred. Each
share of preferred stock is convertible into .75 shares of common stock.
There are no dividend arrearages. At the time of issue of the preferred
stock, there was no plan or prearrangement by which it was to be
exchanged for common stock. The issue price of the preferred stock is
$100 per share. In order to retire the preferred stock, corporation A
recapitalizes in a transaction to which section 368(a)(1)(E) applies and
each share of preferred stock is exchanged for one share of common
stock. Immediately after the recapitalization the common stock has a
fair market value of $110 per share. Notwithstanding the fact that the
fair market value of the common stock received in the exchange
(determined immediately following the recapitalization) exceeds the
issue price of the preferred stock surrendered, the recapitalization is
not deemed under section 305(c) to result in a distribution to which
sections 305(b)(4) and 301 apply since the recapitalization is not
pursuant to a plan to periodically increase a shareholder's
proportionate interest in the assets or earnings and profits and does
not involve dividend arrearages.
Example 3. Corporation V is organized with two classes of stock,
1,000 shares of class A common and 1,000 shares of class B convertible
preferred. Each share of class B stock may be converted into two shares
of class A stock. Pursuant to a recapitalization under section
368(a)(1)(E), the 1,000 shares of class A stock are surrendered in
exchange for 500 shares of new class A common and 500 shares of newly
authorized class C common. The conversion right of class B stock is
changed
[[Page 35]]
to one share of class A stock and one share of class C stock for each
share of class B stock. The change in the conversion right is not deemed
under section 305(c) to be a distribution on preferred stock to which
sections 305(b)(4) and 301 apply.
Example 4 --(i) Facts. Corporation X is a domestic corporation with
only common stock outstanding. In connection with its acquisition of
Corporation T, X issues 100 shares of its 4% preferred stock to the
shareholders of T, who are unrelated to X both before and after the
transaction. The issue price of the preferred stock is $40 per share.
Each share of preferred stock is convertible at the shareholder's
election into three shares of X common stock. At the time the preferred
stock is issued, the X common stock has a value of $10 per share. The
preferred stock does not provide for its mandatory redemption or for
redemption at the option of the holder. It is callable at the option of
X at any time beginning three years from the date of issuance for $100
per share. There are no other plans, arrangements, or agreements that
effectively require or are intended to compel X to redeem the stock.
(ii) Analysis. The preferred stock is described in the safe harbor
rule of paragraph (b)(3)(ii) of this section because X and the former
shareholders of T are unrelated, there are no plans, arrangements, or
agreements that effectively require or are intended to compel X to
redeem the stock, and calling the stock for $100 per share would not
reduce the yield of the preferred stock. Therefore, the $60 per share
call premium is not treated as a constructive distribution to the
shareholders of the preferred stock under paragraph (b) of this section.
Example 5 --(i) Facts--(A) Corporation Y is a domestic corporation
with only common stock outstanding. On January 1, 1996, Y issues 100
shares of its 10% preferred stock to a holder. The holder is unrelated
to Y both before and after the stock issuance. The issue price of the
preferred stock is $100 per share. The preferred stock is--
(1) Callable at the option of Y on or before January 1, 2001, at a
price of $105 per share plus any accrued but unpaid dividends; and
(2) Mandatorily redeemable on January 1, 2006, at a price of $100
per share plus any accrued but unpaid dividends.
(B) The preferred stock provides that if Y fails to exercise its
option to call the preferred stock on or before January 1, 2001, the
holder will be entitled to appoint a majority of Y's directors. Based on
all of the facts and circumstances as of the issue date, Y is likely to
have the legal and financial capacity to exercise its right to redeem.
There are no other facts and circumstances as of the issue date that
would affect whether Y will call the preferred stock on or before
January 1, 2001.
(ii) Analysis. Under paragraph (b)(3)(i) of this section, paragraph
(b)(1) of this section applies because, by virtue of the change of
control provision and the absence of any contrary facts, it is more
likely than not that Y will exercise its option to call the preferred
stock on or before January 1, 2001. The safe harbor rule of paragraph
(b)(3)(ii) of this section does not apply because the provision that
failure to call will cause the holder to gain control of the corporation
is a plan, arrangement, or agreement that effectively requires or is
intended to compel Y to redeem the preferred stock. Under paragraph
(b)(4) of this section, the constructive distribution occurs over the
period ending on January 1, 2001. Redemption is most likely to occur on
that date, because that is the date on which the corporation minimizes
the rate of return to the holder while preventing the holder from
gaining control. The de minimis exception of paragraph (b)(1) of this
section does not apply because the $5 per share difference between the
redemption price and the issue price exceeds the amount determined under
the principles of section 1273(a)(3) (5x.0025x$105 = $1.31).
Accordingly, $5 per share, the difference between the redemption price
and the issue price, is treated as a constructive distribution received
by the holder on an economic accrual basis over the five-year period
ending on January 1, 2001, under principles similar to the principles of
section 1272(a).
Example 6. Corporation A, a publicly held company whose stock is
traded on a securities exchange (or in the over-the-counter market) has
two classes of stock outstanding, common and preferred. The preferred
stock is nonvoting and nonconvertible, limited and preferred as to
dividends, and has a fixed liquidation preference. There are no dividend
arrearages. At the time of issue of the preferred stock, there was no
plan or prearrangement by which it was to be exchanged for common stock.
In order to retire the preferred stock, corporation A recapitalizes in a
transaction to which section 368(a)(1)(E) applies and the preferred
stock is exchanged for common stock. The transaction is not deemed to be
a distribution under section 305(c) and sections 305(b) and 301 do not
apply to the transaction. The same result would follow if the preferred
stock was exchanged in any reorganization described in section 368(a)(1)
for a new preferred stock having substantially the same market value and
having no greater call price or liquidation preference than the old
preferred stock, whether the new preferred stock has voting rights or is
convertible into common stock of corporation A at a fixed ratio subject
to change solely to take account of stock dividends, stock splits, or
similar transactions with respect to the stock into which the preferred
stock is convertible.
[[Page 36]]
Example 7 --(i) Facts--(A) Corporation Z is a domestic corporation
with only common stock outstanding. On January 1, 1996, Z issues 100
shares of its 10% preferred stock to C, an individual unrelated to Z
both before and after the stock issuance. The issue price of the
preferred stock is $100 per share. The preferred stock is--
(1) Not callable for a period of 5 years from the issue date;
(2) Callable at the option of Z on January 1, 2001, at a price of
$110 per share plus any accrued but unpaid dividends;
(3) Callable at the option of Z on July 1, 2002, at a price of $120
per share plus any accrued but unpaid dividends; and
(4) Mandatorily redeemable on January 1, 2004, at a price of $150
per share plus any accrued but unpaid dividends.
(B) There are no other plans, arrangements, or agreements between Z
and C concerning redemption of the stock. Moreover, there are no other
facts and circumstances as of the issue date that would affect whether Z
will call the preferred stock on either January 1, 2001, or July 1,
2002.
(ii) Analysis. This stock is described in paragraph (b)(2) of this
section because it is mandatorily redeemable. It is also potentially
described in paragraph (b)(3)(i) of this section because it is callable
at the option of the issuer. The safe harbor rule of paragraph
(b)(3)(ii) of this section does not apply to the option to call on
January 1, 2001, because the call would reduce the yield of the stock
when compared to the yield produced by the January 1, 2004, mandatory
redemption feature. Moreover, absent any other facts indicating a
contrary result, the fact that redemption on January 1, 2001, would
produce the lowest yield indicates that redemption is most likely to
occur on that date. Under paragraph (b)(4) of this section, paragraph
(b)(1) of this section applies with respect to the issuer's right to
call on January 1, 2001, because redemption is most likely to occur on
January 1, 2001, for $110 per share. The de minimis exception of
paragraph (b)(1) of this section does not apply because the $10 per
share difference between the redemption price payable in 2001 and the
issue price exceeds the amount determined under the principles of
section 1273(a)(3) (5x.0025x$110=$1.38). Accordingly, $10 per share, the
difference between the redemption price and the issue price, is treated
as a constructive distribution received by the holder on an economic
accrual basis over the five-year period ending January 1, 2001, under
principles similar to the principles of section 1272(a).
(iii) Coordination rules--(A) If Z does not exercise its option to
call the preferred stock on January 1, 2001, paragraph (b)(4) of this
section provides that the principles of paragraph (b) of this section
must be applied to determine if any remaining constructive distribution
occurs. Under paragraphs (b)(3)(i) and (b)(4) of this section, paragraph
(b)(1) of this section applies because, absent any other facts
indicating a contrary result, the fact that redemption on July 1, 2002,
would produce a lower yield than the yield produced by the mandatory
redemption feature indicates that redemption on that date is most likely
to occur. The safe harbor rule of paragraph (b)(3)(ii) of this section
does not apply to the option to call on July 1, 2002, because, as of
January 1, 2001, a call by Z on July 1, 2002, for $120 would reduce the
yield of the stock. The de minimis exception of paragraph (b)(1) of this
section does not apply because the $10 per share difference between the
redemption price and the issue price (revised as of the missed call date
as provided by paragraph (b)(4) of this section) exceeds the amount
determined under the principles of section 1273(a)(3)
(1x.0025x$120=$.30). Accordingly, the $10 per share of additional
redemption premium that is payable on July 1, 2002, is treated as a
constructive distribution received by the holder on an economic accrual
basis over the period between January 1, 2001, and July 1, 2002, under
principles similar to the principles of section 1272(a).
(B) If Z does not exercise its second option to call the preferred
stock on July 1, 2002, then the $30 additional redemption premium that
is payable on January 1, 2004, is treated as a constructive distribution
under paragraphs (b)(2) and (b)(1) of this section. The de minimis
exception of paragraph (b)(1) of this section does not apply because the
$30 per share difference between the redemption price and the issue
price (revised as of the second missed call date) exceeds the amount
determined under the principles of section 1273(a)(3)
(1x.0025x$150=$.38). The holder is treated as receiving the constructive
distribution on an economic accrual basis over the period between July
1, 2002, and January 1, 2004, under principles similar to the principles
of section 1272(a).
Example 8 --(i) Facts. The facts are the same as in paragraph (i) of
Example 7, except that, based on all of the facts and circumstances as
of the issue date (including an expected lack of funds on the part of
Z), it is unlikely that Z will exercise the right to redeem on either
January 1, 2001, or July 1, 2002.
(ii) Analysis. The safe harbor rule of paragraph (b)(3)(ii) of this
section does not apply to the option to call on either January 1, 2001,
or July 1, 2002, because each call would reduce the yield of the stock.
Under paragraph (b)(3)(i) of this section, neither option to call is
more likely than not to occur, because, based on all of the facts and
circumstances as of the issue date (including an expected lack of funds
on the part of Z), it is not more likely than not that Z will exercise
[[Page 37]]
either option. However, the $50 per share redemption premium that is
payable on January 1, 2004, is treated as a constructive distribution
under paragraphs (b)(1) and (2) of this section, regardless of whether Z
is anticipated to have sufficient funds to redeem on that date, because
Z is required to redeem the stock on that date. The de minimis exception
of paragraph (b)(1) of this section does not apply because the $50 per
share difference between the redemption price and the issue price
exceeds the amount determined under the principles of section
1273(a)(3)(8x.0025x$150=$3).
Example 9. Corporation Q is organized with 10,000 shares of class A
stock and 1,000 shares of class B stock. The terms of the class B stock
require that the class B have a preference of $5 per share with respect
to dividends and $100 per share with respect to liquidation. In
addition, upon a distribution of $10 per share to the class A stock,
class B participates equally in any additional dividends. The terms also
provide that upon liquidation the class B stock participates equally
after the class A stock receives $100 per share. Corporation Q has no
accumulated earnings and profits. In 1971 it earned $10,000, the highest
earnings in its history. The corporation is in an industry in which it
is reasonable to anticipate a growth in earnings of 5 percent per year.
In 1971 the book value of corporation Q's assets totalled $100,000. In
that year the corporation paid a dividend of $5 per share to the class B
stock and $.50 per share to the class A. In 1972 the corporation had no
earnings and in lieu of a $5 dividend distributed one share of class B
stock for each outstanding share of class B. No distribution was made to
the class A stock. Since, in 1972, it was not reasonable to anticipate
that the class B stock would participate in the current and anticipated
earnings and growth of the corporation beyond its preferred interest,
the class B stock is preferred stock and the distribution of class B
shares to the class B shareholders is a distribution to which sections
305(b)(4) and 301 apply.
Example 10. Corporation P is organized with 10,000 shares of class A
stock and 1,000 shares of class B stock. The terms of the class B stock
require that the class B have a preference of $5 per share with respect
to dividends and $100 per share with respect to liquidation. In
addition, upon a distribution of $5 per share to the class A stock,
class B participates equally in any additional dividends. The terms also
provide that upon liquidation the class B stock participates equally
after the class A receives $100 per share. Corporation P has accumulated
earnings and profits of $100,000. In 1971 it earned $75,000. The
corporation is in an industry in which it is reasonable to anticipate a
growth in earnings of 10 percent per year. In 1971 the book value of
corporation P's assets totalled $5 million. In that year the corporation
paid a dividend of $5 per share to the class B stock, $5 per share to
the class A stock, and it distributed an additional $1 per share to both
class A and class B stock. In 1972 the corporation had earnings of
$82,500. In that year it paid a dividend of $5 per share to the class B
stock and $5 per share to the class A stock. In addition, the
corporation declared stock dividends of one share of class B stock for
every 10 outstanding shares of class B and one share of class A stock
for every 10 outstanding shares of class A. Since, in 1972, it was
reasonable to anticipate that both the class B stock and the class A
stock would participate in the current and anticipated earnings and
growth of the corporation beyond their preferred interests, neither
class is preferred stock and the stock dividends are not distributions
to which section 305(b)(4) applies.
(e) Effective date. The rules of paragraph (b) of this section and
Examples 4, 5, 7, and 8 of paragraph (d) of this section apply to stock
issued on or after December 20, 1995. For rules applicable to previously
issued stock, see Sec. 1.305-5 (b) and (d) Examples (4), (5), and (7 )
(as contained in the 26 CFR part 1 edition revised April 1, 1995).
Although the rules of paragraph (b) of this section and the revised
examples do not apply to stock issued before December 20, 1995, the
rules of sections 305(c)(1), (2), and (3) apply to stock described
therein issued on or after October 10, 1990, except as provided in
section 11322(b)(2) of the Revenue Reconciliation Act of 1990 (Public
Law 101-508 Stat.). Moreover, except as provided in section 11322(b)(2)
of the Revenue Reconciliation Act of 1990 (Public Law 101-508 Stat.),
with respect to stock issued on or after October 10, 1990, and issued
before December 20, 1995, the economic accrual rule of section 305(c)(3)
will apply to the entire call premium on stock that is not described in
paragraph (b)(2) of this section if the premium is considered to be
unreasonable under the principles of Sec. 1.305-5(b) (as contained in
the 26 CFR part 1 edition revised April 1, 1995). A call premium
described in the preceding sentence will be accrued over the period of
time during which the preferred stock cannot be called for redemption.
[T.D. 7281, 38 FR 18536, July 12, 1973, as amended by T.D. 7329, 39 FR
36860, Oct. 15, 1974; T.D. 8643, 60 FR 66136, Dec. 21, 1995]
[[Page 38]]
Sec. 1.305-6 Distributions of convertible preferred.
(a) In general. (1) Under section 305(b)(5), a distribution by a
corporation of its convertible preferred stock or rights to acquire such
stock made or considered as made with respect to its stock is treated as
a distribution of property to which section 301 applies unless the
corporation establishes that such distribution will not result in a
disproportionate distribution as described in Sec. 1.305-3.
(2) The distribution of convertible preferred stock is likely to
result in a disproportionate distribution when both of the following
conditions exist: (i) The conversion right must be exercised within a
relatively short period of time after the date of distribution of the
stock; and (ii) taking into account such factors as the dividend rate,
the redemption provisions, the marketability of the convertible stock,
and the conversion price, it may be anticipated that some shareholders
will exercise their conversion rights and some will not. On the other
hand, where the conversion right may be exercised over a period of many
years and the dividend rate is consistent with market conditions at the
time of distribution of the stock, there is no basis for predicting at
what time and the extent to which the stock will be converted and it is
unlikely that a disproportionate distribution will result.
(b) Examples. The application of section 305(b)(5) may be
illustrated by the following examples:
Example (1). Corporation Z is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized class B preferred stock
which is convertible into class A stock for a period of 20 years from
the date of issuance. Assuming dividend rates are normal in light of
existing conditions so that there is no basis for predicting the extent
to which the stock will be converted, the circumstances will ordinarily
be sufficient to establish that a disproportionate distribution will not
result since it is impossible to predict the extent to which the class B
stock will be converted into class A stock. Accordingly, the
distribution of class B stock is not one to which section 301 applies.
Example (2). Corporation X is organized with one class of stock,
class A common. During the year the corporation declares a dividend on
the class A stock payable in newly authorized redeemable class C
preferred stock which is convertible into class A common stock no later
than 4 months from the date of distribution at a price slightly higher
than the market price of class A stock on the date of distribution. By
prearrangement with corporation X, corporation Y, an insurance company,
agrees to purchase class C stock from any shareholder who does not wish
to convert. By reason of this prearrangement, it is anticipated that the
shareholders will either sell the class C stock to the insurance company
(which expects to retain the shares for investment purposes) or will
convert. As a result, some of the shareholders exercise their conversion
privilege and receive additional shares of class A stock, while other
shareholders sell their class C stock to corporation Y and receive cash.
The distribution is a distribution to which section 301 applies since it
results in the receipt of property by some shareholders and an increase
in the proportionate interests of other shareholders.
[T.D. 7281, 38 FR 18538, July 12, 1973]
Sec. 1.305-7 Certain transactions treated as distributions.
(a) In general. Under section 305(c), a change in conversion ratio,
a change in redemption price, a difference between redemption price and
issue price, a redemption which is treated as a distribution to which
section 301 applies, or any transaction (including a recapitalization)
having a similar effect on the interest of any shareholder may be
treated as a distribution with respect to any shareholder whose
proportionate interest in the earnings and profits or assets of the
corporation is increased by such change, difference, redemption, or
similar transaction. In general, such change, difference, redemption, or
similar transaction will be treated as a distribution to which sections
305(b) and 301 apply where--
(1) The proportionate interest of any shareholder in the earnings
and profits or assets of the corporation deemed to have made such
distribution is increased by such change, difference, redemption, or
similar transaction; and
(2) Such distribution has the result described in paragraph (2),
(3), (4), or (5) of section 305(b).
Where such change, difference, redemption, or similar transaction is
treated as a distribution under the provisions of this section, such
distribution will
[[Page 39]]
be deemed made with respect to any shareholder whose interest in the
earnings and profits or assets of the distributing corporation is
increased thereby. Such distribution will be deemed to be a distribution
of the stock of such corporation made by the corporation to such
shareholder with respect to his stock. Depending upon the facts
presented, the distribution may be deemed to be made in common or
preferred stock. For example, where a redemption premium exists with
respect to a class of preferred stock under the circumstances described
in Sec. 1.305-5(b) and the other requirements of this section are also
met, the distribution will be deemed made with respect to such preferred
stock, in stock of the same class. Accordingly, the preferred
shareholders are considered under sections 305(b)(4) and 305(c) to have
received a distribution of preferred stock to which section 301 applies.
See the examples in Secs. 1.305-3(e) and 1.305-5(d) for further
illustrations of the application of section 305(c).
(b) Antidilution provisions. (1) For purposes of applying section
305(c) in conjunction with section 305(b), a change in the conversion
ratio or conversion price of convertible preferred stock (or
securities), or in the exercise price of rights or warrants, made
pursuant to a bona fide, reasonable, adjustment formula (including, but
not limited to, either the so-called ``market price'' or ``conversion
price'' type of formulas) which has the effect of preventing dilution of
the interest of the holders of such stock (or securities) will not be
considered to result in a deemed distribution of stock. An adjustment in
the conversion ratio or price to compensate for cash or property
distributions to other shareholders that are taxable under section 301,
356(a)(2), 871(a)(1)(A), 881(a)(1), 852(b), or 857(b) will not be
considered as made pursuant to a bona fide adjustment formula.
(2) The principles of this paragraph may be illustrated by the
following example:
Example. (i) Corporation U has two classes of stock outstanding,
class A and class B. Each class B share is convertible into class A
stock. In accordance with a bonafide, reasonable, antidilution
provision, the conversion price is adjusted if the corporation transfers
class A stock to anyone for a consideration that is below the conversion
price.
(ii) The corporation sells class A stock to the public at the
current market price but below the conversion price. Pursuant to the
antidilution provision, the conversion price is adjusted downward. Such
a change in conversion price will not be deemed to be a distribution
under section 305(c) for the purposes of section 305(b).
(c) Recapitalizations. (1) A recapitalization (whether or not an
isolated transaction) will be deemed to result in a distribution to
which section 305(c) and this section apply if--
(i) It is pursuant to a plan to periodically increase a
shareholder's proportionate interest in the assets or earnings and
profits of the corporation, or
(ii) A shareholder owning preferred stock with dividends in arrears
exchanges his stock for other stock and, as a result, increases his
proportionate interest in the assets or earnings and profits of the
corporation. An increase in a preferred shareholder's proportionate
interest occurs in any case where the fair market value or the
liquidation preference, whichever is greater, of the stock received in
the exchange (determined immediately following the recapitalization),
exceeds the issue price of the preferred stock surrendered.
(2) In a case to which subparagraph (1)(ii) of this paragraph
applies, the amount of the distribution deemed under section 305(c) to
result from the recapitalization is the lesser of (i) the amount by
which the fair market value or the liquidation preference, whichever is
greater, of the stock received in the exchange (determined immediately
following the recapitalization) exceeds the issue price of the preferred
stock surrendered, or (ii) the amount of the dividends in arrears.
(3) For purposes of applying subparagraphs (1) and (2) of this
paragraph with respect to stock issued before July 12, 1973, the term
issue price of the preferred stock surrendered shall mean the greater of
the issue price or the liquidation preference (not including dividends
in arrears) of the stock surrendered.
(4) For an illustration of the application of this paragraph, see
Example (12) of Sec. 1.305-3(e) and Examples (1), (2), (3), and (6) of
Sec. 1.305-5(d).
[[Page 40]]
(5) For rules relating to redemption premiums on preferred stock,
see Sec. 1.305-5(b).
[T.D. 7281, 38 FR 18538, July 12, 1973, as amended by T.D. 8643, 60 FR
66138, Dec. 21, 1995]
Sec. 1.305-8 Effective dates.
(a) In general. Section 421(b) of the Tax Reform Act of 1969 (83
Stat. 615) provides as follows:
(b) Effective dates. (1) Except as otherwise provided in this
subsection, the amendment made by subsection (a) shall apply with
respect to distributions (or deemed distributions) made after January
10, 1969, in taxable years ending after such date.
(2)(A) Section 305(b)(2) of the Internal Revenue Code of 1954 (as
added by subsection (a) shall not apply to a distribution (or deemed
distribution) of stock made before January 1, 1991, with respect to
stock (i) outstanding on January 10, 1969, (ii) issued pursuant to a
contract binding on January 10, 1969, on the distributing corporation,
(iii) which is additional stock of that class of stock which (as of
January 10, 1969) had the largest fair market value of all classes of
stock of the corporation (taking into account only stock outstanding on
January 10, 1969, or issued pursuant to a contract binding on January
10, 1969), (iv) described in subparagraph (c)(iii), or (v) issued in a
prior distribution described in clause (i), (ii), (iii), or (iv).
(B) Subparagraph (A) shall apply only if--
(i) The stock as to which there is a receipt of property was
outstanding on January 10, 1969 (or was issued pursuant to a contract
binding on January 10, 1969, on the distributing corporation), and
(ii) If such stock and any stock described in subparagraph (A)(i)
were also outstanding on January 10, 1968, a distribution of property
was made on or before January 10, 1969, with respect to such stock, and
a distribution of stock was made on or before January 10, 1969, with
respect to such stock described in subparagraph (A)(i).
(C) Subparagraph (A) shall cease to apply when at any time after
October 9, 1969, the distributing corporation issues any of its stock
(other than in a distribution of stock with respect to stock of the same
class) which is not--
(i) Nonconvertible preferred stock,
(ii) Additional stock of that class of stock which meets the
requirements of subparagraph (A)(iii), or
(iii) Preferred stock which is convertible into stock which meets
the requirements of subparagraph (A)(iii) at a fixed conversion ratio
which takes account of all stock dividends and stock splits with respect
to the stock into which such convertible stock is convertible.
(D) For purposes of this paragraph, the term stock includes rights
to acquire such stock.
(3) In cases to which Treasury Decision 6990 (promulgated January
10, 1969) would not have applied, in applying paragraphs (1) and (2)
April 22, 1969, shall be substituted for January 10, 1969.
(4) Section 305(b)(4) of the Internal Revenue Code of 1954 (as added
by subsection (a)) shall not apply to any distribution (or deemed
distribution) with respect to preferred stock (including any increase in
the conversation ratio of convertible stock) made before January 1,
1991, pursuant to the terms relating to the issuance of such stock which
were in effect on January 10, 1969.
(5) With respect to distributions made or considered as made after
January 10, 1969, in taxable years ending after such date, to the extent
that the amendment made by subsection (a) does not apply by reason of
paragraph (2), (3), or (4) of this subsection, section 305 of the
Internal Revenue Code of 1954 (as in effect before the amendment made by
subsection (a)) shall continue to apply.
(b) Rules of application. (1) The rules contained in section
421(b)(2) of the Tax Reform Act of 1969 (83 Stat. 615), hereinafter
called ``the Act'', shall apply with respect to the application of
section 305(b)(2), section 305(b)(3), and section 305(b)(5). Thus, for
example, section 305(b)(5) of the Code will not apply to a distribution
of convertible preferred stock made before January 1, 1991, with respect
to stock outstanding on January 10, 1969 (or which was issued pursuant
to a contract binding on the distributing corporation on January 10,
1969), provided the distribution is pursuant to the terms relating to
the issuance of such stock which were in effect on January 10, 1969.
(2)(i) For purposes of section 421(b)(2)(A), (B)(i), and (C) of the
Act, stock is considered as outstanding on January 10, 1969, if it could
be acquired on such date or some future date by the exercise of a right
or conversion privilege in existence on such date (including a right or
conversion privilege with respect to stock issued pursuant to a contract
binding, on January 10, 1969, on the distributing corporation). Thus, if
on January 10, 1969, corporation X has outstanding 1,000 shares of class
A common stock and 3,000 shares of class B common stock which are
convertible on a one-to-one basis into
[[Page 41]]
class A stock, corporation X is considered for purposes of section
421(b)(2)(A), (B)(i), and (C) of the Act to have outstanding on January
10, 1969, 4,000 shares of class A stock (1,000 shares actually
outstanding and 3,000 shares that could be acquired by the exercise of
the conversion privilege contained in the class B stock) and 3,000
shares of class B stock.
(ii) For the purposes of section 421(b)(2)(A) (other than for the
purpose of determining under section 421(b)(2)(A)(iii) that class of
stock which as of January 10, 1969, had the largest fair market value of
all classes of stock of the corporation), (B)(i), and (C) of the Act,
stock will be considered as outstanding on January 10, 1969, if it is
issued pursuant to a conversion privilege contained in stock issued,
mediately or immediately, as a stock dividend with respect to stock
outstanding on January 10, 1969.
(3) If, after applying subparagraph (2) of this paragraph, the class
of stock which as of January 10, 1969, had the largest fair market value
of all classes of stock of the corporation is a class of stock which is
convertible into another class of nonconvertible stock, then for
purposes of section 421(b)(2)(C)(ii) of the Act stock issued upon
conversion of any such convertible stock (whether or not outstanding on
January 10, 1969) into stock of such other class shall be deemed to be
stock which meets the requirements of section 421(b)(2)(A)(iii) of the
Act.
(4) For purposes of section 421(b) of the Act, stock of a
corporation held in its treasury will not be considered as outstanding
and a distribution of such stock will be considered to be an issuance of
such stock on the date of distribution. Stock of a parent corporation
held by its subsidiary is not considered treasury stock.
(5) The following stock shall not be taken into account for purposes
of applying section 421(b)(2)(B)(i) of the Act: (i) Stock issued after
January 10, 1969, and before October 10, 1969 (other than stock which
was issued pursuant to a contract binding on January 10, 1969, on the
distributing corporation); (ii) stock described in section
421(b)(2)(C)(i), (ii), or (iii) of the Act; and (iii) stock issued,
mediately or immediately, as a stock dividend with respect to stock of
the same class outstanding on January 10, 1969. For example, if on June
1, 1970, corporation Y issues additional stock of that class of stock
which as of January 10, 1969, had the largest fair market value of all
classes of stock of the corporation, such additional stock will not be
taken into account for the purpose of meeting the requirement under
section 421(b)(2)(B)(i) of the Act that the stock as to which there is a
receipt of property must have been outstanding on January 10, 1969, and
thus subparagraph (A) of section 421(b)(2) of the Act will not, where
otherwise applicable, cease to apply.
(6) Section 421(b)(2)(A) of the Act, if otherwise applicable, will
not cease to apply if the distributing corporation issues after October
9, 1969, securities which are convertible into stock that meets the
requirements of section 421(b)(2)(A)(iii) of the Act at a fixed
conversion ratio which takes account of all stock dividends and stock
splits with respect to the stock into which the securities are
convertible.
(7) Under section 421(b)(4) of the Act, section 305(b)(4) does not
apply to any distribution (or deemed distribution) by a corporation with
respect to preferred stock made before January 1, 1991, if such
distribution is pursuant to the terms relating to the issuance of such
stock which were in effect on January 10, 1969. For example, if as of
January 10, 1969, a corporation had followed the practice of paying
stock dividends on preferred stock (or of periodically increasing the
conversion ratio of convertible preferred stock) or if the preferred
stock provided for a redemption price in excess of the issue price, then
section 305(b)(4) would not apply to any distribution of stock made (or
which would be considered made if section 305(b)(4) applied) before
January 1, 1991, pursuant to such practice.
(8) If section 421(b)(2) is not applicable and, for that reason, a
distribution (or deemed distribution) is treated as a distribution to
which section 301 applies by virtue of the application of section
305(b)(2), (b)(3), or (b)(5), it is irrelevant that, by reason of the
application of section 421(b)(4) of such Act,
[[Page 42]]
section 305(b)(4) is not applicable to the distribution.
[T.D. 7281, 38 FR 18539, July 12, 1973]
Sec. 1.306-1 General.
(a) Section 306 provides, in general, that the proceeds from the
sale or redemption of certain stock (referred to as ``section 306
stock'') shall be treated either as ordinary income or as a distribution
of property to which section 301 applies. Section 306 stock is defined
in section 306(c) and is usually preferred stock received either as a
nontaxable dividend or in a transaction in which no gain or loss is
recognized. Section 306(b) lists certain circumstances in which the
special rules of section 306(a) shall not apply.
(b)(1) If a shareholder sells or otherwise disposes of section 306
stock (other than by redemption or within the exceptions listed in
section 306(b)), the entire proceeds received from such disposition
shall be treated as ordinary income to the extent that the fair market
value of the stock sold, on the date distributed to the shareholder,
would have been a dividend to such shareholder had the distributing
corporation distributed cash in lieu of stock. Any excess of the amount
received over the sum of the amount treated as ordinary income plus the
adjusted basis of the stock disposed of, shall be treated as gain from
the sale of a capital asset or noncapital asset as the case may be. No
loss shall be recognized. No reduction of earnings and profits results
from any disposition of stock other than a redemption. The term
disposition under section 306(a)(1) includes, among other things,
pledges of stock under certain circumstances, particularly where the
pledgee can look only to the stock itself as its security.
(2) Section 306(a)(1) may be illustrated by the following examples:
Example (1). On December 15, 1954, A and B owned equally all of the
stock of Corporation X which files its income tax return on a calendar
year basis. On that date Corporation X distributed pro rata 100 shares
of preferred stock as a dividend on its outstanding common stock. On
December 15, 1954, the preferred stock had a fair market value of
$10,000. On December 31, 1954, the earnings and profits of Corporation X
were $20,000. The 50 shares of preferred stock so distributed to A had
an allocated basis to him of $10 per share or a total of $500 for the 50
shares. Such shares had a fair market value of $5,000 when issued. A
sold the 50 shares of preferred stock on July 1, 1955, for $6,000. Of
this amount $5,000 will be treated as ordinary income; $500 ($6,000
minus $5,500) will be treated as gain from the sale of a capital or
noncapital asset as the case may be.
Example (2). The facts are the same as in Example 1 except that A
sold his 50 shares of preferred stock for $5,100. Of this amount $5,000
will be treated as ordinary income. No loss will be allowed. There will
be added back to the basis of the common stock of Corporation X with
respect to which the preferred stock was distributed, $400, the
allocated basis of $500 reduced by the $100 received.
Example (3). The facts are the same as in Example 1 except that A
sold 25 of his shares of preferred stock for $2,600. Of this amount
$2,500 will be treated as ordinary income. No loss will be allowed.
There will be added back to the basis of the common stock of Corporation
X with respect to which the preferred stock was distributed, $150, the
allocated basis of $250 reduced by the $100 received.
(c) The entire amount received by a shareholder from the redemption
of section 306 stock shall be treated as a distribution of property
under section 301. See also section 303 (relating to distribution in
redemption of stock to pay death taxes).
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7556, 43 FR
34128, Aug. 3, 1978]
Sec. 1.306-2 Exception.
(a) If a shareholder terminates his entire stock interest in a
corporation--
(1) By a sale or other disposition within the requirements of
section 306(b)(1)(A), or
(2) By redemption under section 302(b)(3) (through the application
of section 306(b)(1)(B)),
the amount received from such disposition shall be treated as an amount
received in part or full payment for the stock sold or redeemed. In the
case of a sale, only the stock interest need be terminated. In
determining whether an entire stock interest has been terminated under
section 306(b)(1)(A), all of the provisions of section 318(a) (relating
to constructive ownership of stock) shall be applicable. In determining
whether a shareholder has terminated
[[Page 43]]
his entire interest in a corporation by a redemption of his stock under
section 302(b)(3), all of the provisions of section 318(a) shall be
applicable unless the shareholder meets the requirements of section
302(c)(2) (relating to termination of all interest in the corporation).
If the requirements of section 302(c)(2) are met, section 318(a)(1)
(relating to members of a family) shall be inapplicable. Under all
circumstances paragraphs (2), (3), (4), and (5) of section 318(a) shall
be applicable.
(b) Section 306(a) does not apply to--
(1) Redemptions of section 306 stock pursuant to a partial or
complete liquidation of a corporation to which part II (section 331 and
following), subchapter C, chapter 1 of the Code applies,
(2) Exchanges of section 306 stock solely for stock in connection
with a reorganization or in an exchange under section 351, 355, or
section 1036 (relating to exchanges of stock for stock in the same
corporation) to the extent that gain or loss is not recognized to the
shareholder as the result of the exchange of the stock (see paragraph
(d) of Sec. 1.306-3 relative to the receipt of other property), and
(3) A disposition or redemption, if it is established to the
satisfaction of the Commissioner that the distribution, and the
disposition or redemption, was not in pursuance of a plan having as one
of its principal purposes the avoidance of Federal income tax. However,
in the case of a prior or simultaneous disposition (or redemption) of
the stock with respect to which the section 306 stock disposed of (or
redeemed) was issued, it is not necessary to establish that the
distribution was not in pursuance of such a plan. For example, in the
absence of such a plan and of any other facts the first sentence of this
subparagraph would be applicable to the case of dividends and isolated
dispositions of section 306 stock by minority shareholders. Similarly,
in the absence of such a plan and of any other facts, if a shareholder
received a distribution of 100 shares of section 306 stock on his
holdings of 100 shares of voting common stock in a corporation and sells
his voting common stock before he disposes of his section 306 stock, the
subsequent disposition of his section 306 stock would not ordinarily be
considered a disposition one of the principal purposes of which is the
avoidance of Federal income tax.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR
11998, Aug. 23, 1968]
Sec. 1.306-3 Section 306 stock defined.
(a) For the purpose of subchapter C, chapter 1 of the code, the term
section 306 stock means stock which meets the requirements of section
306(c)(1). Any class of stock distributed to a shareholder in a
transaction in which no amount is includible in the income of the
shareholder or no gain or loss is recognized may be section 306 stock,
if a distribution of money by the distributing corporation in lieu of
such stock would have been a dividend in whole or in part. However,
except as provided in section 306(g), if no part of a distribution of
money by the distributing corporation in lieu of such stock would have
been a dividend, the stock distributed will not constitute section 306
stock.
(b) For the purpose of section 306, rights to acquire stock shall be
treated as stock. Such rights shall not be section 306 stock if no part
of the distribution would have been a dividend if money had been
distributed in lieu of the rights. When stock is acquired by the
exercise of rights which are treated at section 306 stock, the stock
acquired is section 306 stock. Upon the disposition of such stock (other
than by redemption or within the exceptions listed in section 306(b)),
the proceeds received from the disposition shall be treated as ordinary
income to the extent that the fair market value of the stock rights, on
the date distributed to the shareholder, would have been a dividend to
the shareholder had the distributing corporation distributed cash in
lieu of stock rights. Any excess of the amount realized over the sum of
the amount treated as ordinary income plus the adjusted basis of the
stock, shall be treated as gain from the sale of the stock.
(c) Section 306(c)(1)(A) provides that section 306 stock is any
stock (other than common issued with respect to common) distributed to
the shareholder selling or otherwise disposing
[[Page 44]]
thereof if, under section 305(a) (relating to distributions of stock and
stock rights) any part of the distribution was not included in the gross
income of the distributee.
(d) Section 306(c)(1)(B) includes in the definition of section 306
stock any stock except common stock, which is received by a shareholder
in connection with a reorganization under section 368 or in a
distribution or exchange under section 355 (or so much of section 356 as
relates to section 355) provided the effect of the transaction is
substantially the same as the receipt of a stock dividend, or the stock
is received in exchange for section 306 stock. If, in a transaction to
which section 356 is applicable, a shareholder exchanges section 306
stock for stock and money or other property, the entire amount of such
money and of the fair market value of the other property (not limited to
the gain recognized) shall be treated as a distribution of property to
which section 301 applies. Common stock received in exchange for section
306 stock in a recapitalization shall not be considered section 306
stock. Ordinarily, section 306 stock includes stock which is not common
stock received in pursuance of a plan of reorganization (within the
meaning of section 368(a)) or received in a distribution or exchange to
which section 355 (or so much of section 356 as relates to section 355)
applies if cash received in lieu of such stock would have been treated
as a dividend under section 356(a)(2) or would have been treated as a
distribution to which section 301 applies by virtue of section 356(b) or
section 302(d). The application of the preceding sentence is illustrated
by the following examples:
Example (1). Corporation A, having only common stock outstanding, is
merged in a statutory merger (qualifying as a reorganization under
section 368(a)) with Corporation B. Pursuant to such merger, the
shareholders of Corporation A received both common and preferred stock
in Corporation B. The preferred stock received by such shareholders is
section 306 stock.
Example (2). X and Y each own one-half of the 2,000 outstanding
shares of preferred stock and one-half of the 2,000 outstanding shares
of common stock of Corporation C. Pursuant to a reorganization within
the meaning of section 368(a)(1)(E) (recapitalization) each shareholder
exchanges his preferred stock for preferred stock of a new issue which
is not substantially different from the preferred stock previously held.
Unless the preferred stock exchanged was itself section 306 stock the
preferred stock received is not section 306 stock.
(e) Section 306(c)(1)(C) includes in the definition of section 306
stock any stock (except as provided in section 306(c)(1)(B)) the basis
of which in the hands of the person disposing of such stock, is
determined by reference to section 306 stock held by such shareholder or
any other person. Under this paragraph common stock can be section 306
stock. Thus, if a person owning section 306 stock in Corporation A
transfers it to Corporation B which is controlled by him in exchange for
common stock of Corporation B in a transaction to which section 351 is
applicable, the common stock so received by him would be section 306
stock and subject to the provisions of section 306(a) on its
disposition. In addition, the section 306 stock transferred is section
306 stock in the hands of Corporation B, the transferee. Section 306
stock transferred by gift remains section 306 stock in the hands of the
donee. Stock received in exchange for section 306 stock under section
1036(a) (relating to exchange of stock for stock in the same
corporation) or under so much of section 1031(b) as relates to section
1036(a) becomes section 306 stock and acquires, for purposes of section
306, the characteristics of the section 306 stock exchanged. The entire
amount of the fair market value of the other property received in such
transaction shall be considered as received upon a disposition (other
than a redemption) to which section 306(a) applies. Section 306 stock
ceases to be so classified if the basis of such stock is determined by
reference to its fair market value on the date of the decedent-
stockholder's death or the optional valuation date under section 1014.
(f) If section 306 stock which was distributed with respect to
common stock is exchanged for common stock in the same corporation
(whether or not such exchange is pursuant to a conversion privilege
contained in section 306 stock), such common stock shall not be section
306 stock. This paragraph applies to exchanges not coming within
[[Page 45]]
the purview of section 306(c)(1)(B). Common stock which is convertible
into stock other than common stock or into property, shall not be
considered common stock. It is immaterial whether the conversion
privilege is contained in the stock or in some type of collateral
agreement.
(g) If there is a substantial change in the terms and conditions of
any stock, then, for the purpose of this section--
(1) The fair market value of such stock shall be the fair market
value at the time of distribution or the fair market value at the time
of such change, whichever is higher;
(2) Such stock's ratable share of the amount which would have been a
dividend if money had been distributed in lieu of stock shall be
determined by reference to the time of distribution or by reference to
the time of such change, whichever ratable share is higher; and
(3) Section 306(c)(2) shall be inapplicable if there would have been
a dividend to any extent if money had been distributed in lieu of the
stock either at the time of the distribution or at the time of such
change.
(h) When section 306 stock is disposed of, the amount treated under
section 306(a)(1)(A) as ordinary income, for the purposes of part I,
subchapter N, chapter 1 of the Code, be treated as derived from the same
source as would have been the source if money had been received from the
corporation as a dividend at the time of the distribution of such stock.
If the amount is determined to be derived from sources within the United
States, the amount shall be considered to be fixed or determinable
annual or periodic gains, profits, and income within the meaning of
section 871(a) or section 881(a), relating, respectively, to the tax on
nonresident alien individuals and on foreign corporations not engaged in
business in the United States.
(i) Section 306 shall be inapplicable to stock received before June
22, 1954, and to stock received on or after June 22, 1954, in
transactions subject to the provisions of the Internal Revenue Code of
1939.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7281, 38 FR
18540, July 12, 1973; T.D. 7556, 43 FR 34128, Aug. 3, 1978]
Sec. 1.307-1 General.
(a) If a shareholder receives stock or stock rights as a
distribution on stock previously held and under section 305 such
distribution is not includible in gross income then, except as provided
in section 307(b) and Sec. 1.307-2, the basis of the stock with respect
to which the distribution was made shall be allocated between the old
and new stocks or rights in proportion to the fair market values of each
on the date of distribution. If a shareholder receives stock or stock
rights as a distribution on stock previously held and pursuant to
section 305 part of the distribution is not includible in gross income,
then (except as provided in section 307(b) and Sec. 1.307-2) the basis
of the stock with respect to which the distribution is made shall be
allocated between (1) the old stock and (2) that part of the new stock
or rights which is not includible in gross income, in proportion to the
fair market values of each on the date of distribution. The date of
distribution in each case shall be the date the stock or the rights are
distributed to the stockholder and not the record date. The general rule
will apply with respect to stock rights only if such rights are
exercised or sold.
(b) The application of paragraph (a) of this section is illustrated
by the following example:
Example A taxpayer in 1947 purchased 100 shares of common stock at
$100 per share and in 1954 by reason of the ownership of such stock
acquired 100 rights entitling him to subscribe to 100 additional shares
of such stock at $90 a share. Immediately after the issuance of the
rights, each of the shares of stock in respect of which the rights were
acquired had a fair market value, ex-rights, of $110 and the rights had
a fair market value of $19 each. The basis of the rights and the common
stock for the purpose of determining the basis for gain or loss on a
subsequent sale or exercise of the rights or a sale of the old stock is
computed as follows:
100 (shares)x$100=$10,000, cost of old stock (stock in respect of which
the rights were acquired).
100 (shares)x$110=$11,000, market value of old stock.
100 (rights)x$19=$1,900, market value of rights.
11,000/12,900 of $10,000=$8,527.13, cost of old stock apportioned to
such stock.
1,900/12,900 of $10,000=$1,472.87, cost of old stock apportioned to
rights.
[[Page 46]]
If the rights are sold, the basis for determining gain or loss will be
$14.7287 per right. If the rights are exercised, the basis of the new
stock acquired will be the subscription price paid therefor ($90) plus
the basis of the rights exercised ($14.7287 each) or $104.7287 per
share. The remaining basis of the old stock for the purpose of
determining gain or loss on a subsequent sale will be $85.2713 per
share.
Sec. 1.307-2 Exception.
The basis of rights to buy stock which are excluded from gross
income under section 305(a), shall be zero if the fair market value of
such rights on the date of distribution is less than 15 percent of the
fair market value of the old stock on that date, unless the shareholder
elects to allocate part of the basis of the old stock to the rights as
provided in paragraph (a) of Sec. 1.307-1. The election shall be made by
a shareholder with respect to all the rights received by him in a
particular distribution in respect of all the stock of the same class
owned by him in the issuing corporation at the time of such
distribution. Such election to allocate basis to rights shall be in the
form of a statement attached to the shareholder's return for the year in
which the rights are received. This election, once made, shall be
irrevocable with respect to the rights for which the election was made.
Any shareholder making such an election shall retain a copy of the
election and of the tax return with which it was filed, in order to
substantiate the use of an allocated basis upon a subsequent disposition
of the stock acquired by exercise.
effects on corporation
Sec. 1.312-1 Adjustment to earnings and profits reflecting distributions by corporations.
(a) In general, on the distribution of property by a corporation
with respect to its stock, its earnings, and profits (to the extent
thereof) shall be decreased by--
(1) The amount of money,
(2) The principal amount of the obligations of such corporation
issued in such distribution, and
(3) The adjusted basis of other property.
For special rule with respect to distributions to which section 312(e)
applies, see Sec. 1.312-5.
(b) The adjustment provided in section 312(a)(3) and paragraph
(a)(3) of this section with respect to a distribution of property (other
than money or its own obligations) shall be made notwithstanding the
fact that such property has appreciated or depreciated in value since
acquisition.
(c) The application of paragraphs (a) and (b) of this section may be
illustrated by the following examples:
Example (1). Corporation A distributes to its sole shareholder
property with a value of $10,000 and a basis of $5,000. It has $12,500
in earnings and profits. The reduction in earnings and profits by reason
of such distribution is $5,000. Such is the reduction even though the
amount of $10,000 is includible in the income of the shareholder (other
than a corporation) as a dividend.
Example (2). The facts are the same as in Example (1) above except
that the property has a basis of $15,000 and the earnings and profits of
the corporation are $20,000. The reduction in earnings and profits is
$15,000. Such is the reduction even though only the amount of $10,000 is
includible in the income of the shareholder as a dividend.
(d) In the case of a distribution of stock or rights to acquire
stock a portion of which is includible in income by reason of section
305(b), the earnings and profits shall be reduced by the fair market
value of such portion. No reduction shall be made if a distribution of
stock or rights to acquire stock is not includible in income under the
provisions of section 305.
(e) No adjustment shall be made in the amount of the earnings and
profits of the issuing corporation upon a disposition of section 306
stock unless such disposition is a redemption.
Sec. 1.312-2 Distribution of inventory assets.
Section 312(b) provides for the increase and the decrease of the
earnings and profits of a corporation which distributes, with respect to
its stock, inventory assets as defined in section 312(b)(2), where the
fair market value of such assets exceeds their adjusted basis. The rules
provided in section 312(b) (relating to distributions of certain
inventory assets) shall be applicable without regard to the method used
[[Page 47]]
in computing inventories for the purpose of the computation of taxable
income. Section 312(b) does not apply to distributions described in
section 312(e).
Sec. 1.312-3 Liabilities.
The amount of any reductions in earnings and profits described in
section 312 (a) or (b) shall be (a) reduced by the amount of any
liability to which the property distributed was subject and by the
amount of any other liability of the corporation assumed by the
shareholder in connection with such distribution, and (b) increased by
the amount of gain recognized to the corporation under section 311 (b),
(c), or (d), or under section 341(f), 617(d), 1245(a), 1250(a), 1251(c),
1252(a), or 1254(a).
[T.D. 7209, 37 FR 20804, Oct. 5, 1972, as amended by T.D. 8586, 60 FR
2500, Jan. 10, 1995]
Sec. 1.312-4 Examples of adjustments provided in section 312(c).
The adjustments provided in section 312(c) may be illustrated by the
following examples:
Example (1). On December 2, 1954, Corporation X distributed to its
sole shareholder, A, an individual, as a dividend in kind a vacant lot
which was not an inventory asset. On that date, the lot had a fair
market value of $5,000 and was subject to a mortgage of $2,000. The
adjusted basis of the lot was $3,100. The amount of the earnings and
profits was $10,000. The amount of the dividend received by A is $3,000
($5,000, the fair market value, less $2,000, the amount of the mortgage)
and the reduction in the earnings and profits of Corporation X is $1,100
($3,100, the basis, less $2,000, the amount of mortgage).
Example (2). The facts are the same as in Example (1) above with the
exception that the amount of the mortgage to which the property was
subject was $4,000. The amount of the dividend received by A is $1,000,
and there is no reduction in the earnings and profits of the corporation
as a result of the distribution (disregarding such reduction as may
result from an increase in tax to Corporation X because, of gain
resulting from the distribution). There is a gain of $900 recognized to
Corporation X, the difference between the basis of the property ($3,100)
and the amount of the mortgage ($4,000), under section 311(c) and an
increase in earnings and profits of $900.
Example (3). Corporation A, having accumulated earnings and profits
of $100,000, distributed in kind to its shareholders, not in
liquidation, inventory assets which had a basis to it on the ``Lifo''
method (section 472) of $46,000 and on the basis of cost or market
(section 471) of $50,000. The inventory had a fair market value of
$55,000 and was subject to a liability of $35,000. This distribution
results in a net decrease in earnings and profits of Corporation A of
$11,000, (without regard to any tax on Corporation A) computed as
follows:
``Fifo'' basis of inventory.......................... $50,000
Less: ``Lifo'' basis of inventory.................... 46,000
----------
Gain recognized--addition to earnings and profits (section $4,000
311(b)).......................................................
Adjustment to earnings and profits required by
section 312(b)(1)(A):
Fair market value of inventory..................... $55,000
Less: ``Lifo'' basis plus adjustment under section 50,000 5,000
311(b)............................................
------------------
Total increase in earnings and profits................... 9,000
Decrease in earnings and profits--under section $55,000
312(b)(1)(B)(i).....................................
Less: Liability assumed.............................. 35,000
----------
Net amount of distribution (decrease in earnings).............. 20,000
-----------
Net decrease in earnings and profits..................... 11,000
Sec. 1.312-5 Special rule for partial liquidations and certain redemptions.
The part of the distribution properly chargeable to capital account
within the provisions of section 312(e) shall not be considered a
distribution of earnings and profits within the meaning of section 301
for the purpose of determining taxability of subsequent distributions by
the corporation.
Sec. 1.312-6 Earnings and profits.
(a) In determining the amount of earnings and profits (whether of
the taxable year, or accumulated since February 28, 1913, or accumulated
before March 1, 1913) due consideration must be given to the facts, and,
while mere bookkeeping entries increasing or decreasing surplus will not
be conclusive, the amount of the earnings and profits in any case will
be dependent upon the method of accounting properly employed in
computing taxable income (or net income, as the case may be). For
instance, a corporation keeping its books and filing its income tax
returns under subchapter E, chapter 1 of the Code, on the cash receipts
and disbursements basis may not use the accrual basis in determining
earnings and profits; a corporation computing income on the installment
basis as provided in section 453 shall, with respect
[[Page 48]]
to the installment transactions, compute earnings and profits on such
basis; and an insurance company subject to taxation under section 831
shall exclude from earnings and profits that portion of any premium
which is unearned under the provisions of section 832(b)(4) and which is
segregated accordingly in the unearned premium reserve.
(b) Among the items entering into the computation of corporate
earnings and profits for a particular period are all income exempted by
statute, income not taxable by the Federal Government under the
Constitution, as well as all items includible in gross income under
section 61 or corresponding provisions of prior revenue acts. Gains and
losses within the purview of section 1002 or corresponding provisions of
prior revenue acts are brought into the earnings and profits at the time
and to the extent such gains and losses are recognized under that
section. Interest on State bonds and certain other obligations, although
not taxable when received by a corporation, is taxable to the same
extent as other dividends when distributed to shareholders in the form
of dividends.
(c)(1) In the case of a corporation in which depletion or
depreciation is a factor in the determination of income, the only
depletion or depreciation deductions to be considered in the computation
of the total earnings and profits are those based on cost or other basis
without regard to March 1, 1913, value. In computing the earnings and
profits for any period beginning after February 28, 1913, the only
depletion or depreciation deductions to be considered are those based on
(i) cost or other basis, if the depletable or depreciable asset was
acquired subsequent to February 28, 1913, or (ii) adjusted cost or March
1, 1913, value, whichever is higher, if acquired before March 1, 1913.
Thus, discovery or percentage depletion under all revenue acts for mines
and oil and gas wells is not to be taken into consideration in computing
the earnings and profits of a corporation. Similarly, where the basis of
property in the hands of a corporation is a substituted basis, such
basis, and not the fair market value of the property at the time of the
acquisition by the corporation, is the basis for computing depletion and
depreciation for the purpose of determining earnings and profits of the
corporation.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example Oil producing property which A had acquired in 1949 at a
cost of $28,000 was transferred to Corporation Y in December 1951, in
exchange for all of its capital stock. The fair market value of the
stock and of the property as of the date of the transfer was $247,000.
Corporation Y, after four years' operation, effected in 1955 a cash
distribution to A in the amount of $165,000. In determining the extent
to which the earnings and profits of Corporation Y available for
dividend distributions have been increased as the result of production
and sale of oil, the depletion to be taken into account is to be
computed upon the basis of $28,000 established in the nontaxable
exchange in 1951 regardless of the fair market value of the property or
of the stock issued in exchange therefor.
(d) A loss sustained for a year before the taxable year does not
affect the earnings and profits of the taxable year. However, in
determining the earnings and profits accumulated since February 28,
1913, the excess of a loss sustained for a year subsequent to February
28, 1913, over the undistributed earnings and profits accumulated since
February 28, 1913, and before the year for which the loss was sustained,
reduces surplus as of March 1, 1913, to the extent of such excess. If
the surplus as of March 1, 1913, was sufficient to absorb such excess,
distributions to shareholders after the year of the loss are out of
earnings and profits accumulated since the year of the loss to the
extent of such earnings.
(e) With respect to the effect on the earnings and profits
accumulated since February 28, 1913, of distributions made on or after
January 1, 1916, and before August 6, 1917, out of earnings or profits
accumulated before March 1, 1913, which distributions were specifically
declared to be out of earnings and profits accumulated before March 1,
1913, see section 31(b) of the Revenue Act of 1916, as added by section
1211 of the Revenue Act of 1917 (40 Stat. 336).
[[Page 49]]
Sec. 1.312-7 Effect on earnings and profits of gain or loss realized after February 28, 1913.
(a) In order to determine the effect on earnings and profits of gain
or loss realized from the sale or other disposition (after February 28,
1913) of property by a corporation, section 312(f)(1) prescribed certain
rules for--
(1) The computation of the total earnings and profits of the
corporation of most frequent application in determining invested
capital; and
(2) The computation of earnings and profits of the corporation for
any period beginning after February 28, 1913, of most frequent
application in determining the source of dividend distributions.
Such rules are applicable whenever under any provision of subtitle A of
the Code it is necessary to compute either the total earnings and
profits of the corporation or the earnings and profits for any period
beginning after February 28, 1913. For example, since the earnings and
profits accumulated after February 28, 1913, or the earnings and profits
of the taxable year, are earnings and profits for a period beginning
after February 28, 1913, the determination of either must be in
accordance with the regulations prescribed by this section for the
ascertainment of earnings and profits for any period beginning after
February 28, 1913. Under subparagraph (1) of this paragraph, such gain
or loss is determined by using the adjusted basis (under the law
applicable to the year in which the sale or other disposition was made)
for determining gain, but disregarding value as of March 1, 1913. Under
subparagraph (2) of this paragraph, there is used such adjusted basis
for determining gain, giving effect to the value as of March 1, 1913,
whenever applicable. In both cases the rules are the same as those
governing depreciation and depletion in computing earnings and profits
(see Sec. 1.312-6). Under both subparagraphs (1) and (2) of this
paragraph, the adjusted basis is subject to the limitations of the third
sentence of section 312(f)(1) requiring the use of adjustments proper in
determining earnings and profits. The proper adjustments may differ
under section 312(f)(1)(A) and (B) depending upon the basis to which the
adjustments are to be made. If the application of section 312(f)(1)(B)
results in a loss and if the application of section 312(f)(1)(A) to the
same transaction reaches a different result, then the loss under section
312(f)(1)(B) will be subject to the adjustment thereto required by
section 312(g)(2). (See Sec. 1.312-9.)
(b)(1) The gain or loss so realized increases or decreases the
earnings and profits to, but not beyond, the extent to which such gain
or loss was recognized in computing taxable income (or net income, as
the case may be) under the law applicable to the year in which such sale
or disposition was made. As used in this paragraph, the term
``recognized'' has reference to that kind of realized gain or loss which
is recognized for income tax purposes by the statute applicable to the
year in which the gain or loss was realized. For example, see section
356. A loss (other than a wash sale loss with respect to which a
deduction is disallowed under the provisions of section 1091 or
corresponding provisions of prior revenue laws) may be recognized though
not allowed as a deduction (by reason, for example, of the operation of
sections 267 and 1211 and corresponding provisions of prior revenue
laws) but the mere fact that it is not allowed does not prevent decrease
in earnings and profits by the amount of such disallowed loss. Wash sale
losses, however, disallowed under section 1091 and corresponding
provisions of prior revenue laws, are deemed nonrecognized losses and do
not reduce earnings or profits. The recognized gain or loss for the
purpose of computing earnings and profits is determined by applying the
recognition provisions to the realized gain or loss computed under the
provisions of section 312(f)(1) as distinguished from the realized gain
or loss used in computing taxable income (or net income, as the case may
be).
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following examples:
Example (1). Corporation X on January 1, 1952, owned stock in
Corporation Y which it had acquired from Corporation Y in December 1951,
in an exchange transaction in which no gain or loss was recognized. The
adjusted basis to Corporation X of the property exchanged by it for the
stock in Corporation Y was $30,000. The fair market value of the
[[Page 50]]
stock in Corporation Y when received by Corporation X was $930,000. On
April 9, 1955, Corporation X made a cash distribution of $900,000 and,
except for the possible effect of the transaction in 1951, had no
earnings or profits accumulated after February 28, 1913, and had no
earnings or profits for the taxable year. The amount of $900,000
representing the excess of the fair market value of the stock of
Corporation Y over the adjusted basis of the property exchanged therefor
was not recognized gain to Corporation X under the provisions of section
112 of the Internal Revenue Code of 1939. Accordingly, the earnings and
profits of Corporation X are not increased by $900,000, the amount of
the gain realized but not recognized in the exchange, and the
distribution was not a taxable dividend. The basis in the hands of
Corporation Y of the property acquired by it from Corporation X is
$30,000. If such property is thereafter sold by Corporation Y, gain or
loss will be computed on such basis of $30,000, and earnings and profits
will be increased or decreased accordingly.
Example (2). On January 2, 1910, Corporation M acquired
nondepreciable property at a cost of $1,000. On March 1, 1913, the fair
market value of such property in the hands of Corporation M was $2,200.
On December 31, 1952, Corporation M transfers such property to
Corporation N in exchange for $1,900 in cash and all Corporation N's
stock, which has a fair market value of $1,100. For the purpose of
computing the total earnings and profits of Corporation M, the gain on
such transaction is $2,000 (the sum of $1,900 in cash and stock worth
$1,100 minus $1,000, the adjusted basis for computing gain, determined
without regard to March 1, 1913, value), $1,900 of which is recognized
under section 356, since this was the amount of money received, although
for the purpose of computing net income the gain is only $800 (the sum
of $1,900 in cash and stock worth $1,100, minus $2,200, the adjusted
basis for computing gain determined by giving effect to March 1, 1913,
value). Such earnings and profits will therefore be increased by only
$800 as a reputing the earnings and profits of Corporation M for any
period beginning after February 28, 1913, however, the gain arising from
the transaction, like the taxable gain, is only $800, all of which is
recognized under section 112(c) of the Internal Revenue Code of 1939,
the money received being in excess of such amount. Such earnings and
profits will therefore be increased by only $800 as a result of the
transaction. For increase in that part of the earnings and profits
consisting of increase in value of property accrued before, but realized
on or after March 1, 1913, see Sec. 1.312-9.
Example (3). On July 31, 1955, Corporation R owned oil-producing
property acquired after February 28, 1913, at a cost of $200,000, but
having an adjusted basis (by reason of taking percentage depletion) of
$100,000 for determining gain. However, the adjusted basis of such
property to be used in computing gain or loss for the purpose of
earnings and profits is, because of the provisions of the third sentence
of section 312(f)(1), $150,000. On such day Corporation R transferred
such property to Corporation S in exchange for $25,000 in cash and all
of the stock of Corporation S, which had a fair market value of
$100,000. For the purpose of computing taxable income, Corporation R has
realized a gain of $25,000 as a result of this transaction, all of which
is recognized under section 356. For the purpose of computing earnings
and profits, however, Corporation R has realized a loss of $25,000, none
of which is recognized owing to the provisions of section 356(c). The
earnings and profits of Corporation R are therefore neither increased
nor decreased as a result of the transaction. The adjusted basis of the
Corporation S stock in the hands of Corporation R for purposes of
computing earnings and profits, however, will be $125,000 (though only
$100,000 for the purpose of computing taxable income), computed as
follows:
Basis of property transferred................................ $200,000
Less money received on exchange.............................. 25,000
Plus gain or minus loss recognized on exchange............... None
----------
Basis of stock......................................... 175,000
Less adjustments (same as those used in determining adjusted 50,000
basis of property transferred)..............................
----------
Adjusted basis of stock................................ 125,000
If, therefore, Corporation R should subsequently sell the Corporation S
stock for $100,000, a loss of $25,000 will again be realized for the
purpose of computing earnings and profits, all of which will be
recognized and will be applied to decrease the earnings and profits of
Corporation R.
(c)(1) The third sentence of section 312(f)(1) provides for cases in
which the adjustments, prescribed in section 1016, to the basis
indicated in section 312(f)(1)(A) or (B), as the case may be, differ
from the adjustments to such basis proper for the purpose of determining
earnings or profits. The adjustments provided by such third sentence
reflect the treatment provided by Secs. 1.312-6 and 1.312-15 relative to
cases where the deductions for depletion and depreciation in computing
taxable income (or net income, as the case may be) differ from the
deductions proper for the purpose of computing earnings and profits.
(2) The effect of the third sentence of section 312(f)(1) may be
illustrated by the following examples:
[[Page 51]]
Example (1). Corporation X purchased on January 2, 1931, an oil
lease at a cost of $10,000. The lease was operated only for the years
1931 and 1932. The deduction for depletion in each of the years 1931 and
1932 amounted to $2,750, of which amount $1,750 represented percentage
depletion in excess of depletion based on cost. The lease was sold in
1955 for $15,000. Under section 1016(a)(2), in determining the gain or
loss from the sale of the property, the basis must be adjusted for cost
depletion of $1,000 in 1931 and percentage depletion of $2,750 in 1932.
However, the adjustment of such basis, proper for the determination of
earnings and profits, is $1,000 for each year, or $2,000. Hence, the
cost is to be adjusted only to the extent of $2,000, leaving an adjusted
basis of $8,000 and the earnings and profits will be increased by
$7,000, and not by $8,750. The difference of $1,750 is equal to the
amount by which the percentage depletion for the year 1932 ($2,750)
exceeds the depletion on cost for that year ($1,000) and has already
been applied in the computation of earnings and profits for the year
1932 by taking into account only $1,000 instead of $2,750 for depletion
in the computation of such earnings and profits. (See Sec. 1.316-1.)
Example (2). If, in Example (1), above, the property, instead of
being sold, is exchanged in a transaction described in section 1031 for
like property having a fair market value of $7,750 and cash of $7,250,
then the increase in earnings and profits amounts to $7,000, that is,
$15,000 ($7,750 plus $7,250) minus the basis of $8,000. However, in
computing taxable income of Corporation X, the gain is $8,750, that is,
$15,000 minus $6,250 ($10,000 less depletion of $3,750), of which only
$7,250 is recognized because the recognized gain cannot exceed the sum
of money received in the transaction. See section 1031(b) and the
corresponding provisions of prior revenue laws. If, however, the cash
received was only $2,250 and the value of the property received was
$12,750, then the increase in earnings and profits would be $2,250, that
amount being the gain recognized under section 1031.
Example (3). On January 1, 1973, corporation X purchased for $10,000
a depreciable asset with an estimated useful life of 20 years and no
salvage value. In computing depreciation on the asset, corporation X
used the declining balance method with a rate twice the straight line
rate. On December 31, 1976, the asset was sold for $9,000. Under section
1016(a)(2), the basis of the asset is adjusted for depreciation allowed
for the years 1973 through 1976, or a total of $3,439. Thus, X realizes
a gain of $2,439 (the excess of the amount realized, $9,000, over the
adjusted basis, $6,561). However, the proper adjustment to basis for the
purpose of determining earnings and profits is only $2,000, i.e., the
total amount which, under Sec. 1.312-15, was applied in the computation
of earnings and profits for the years 1973-76. Hence, upon sale of the
asset, earnings and profits are increased by only $1,000, i.e., the
excess of the amount realized, $9,000, over the adjusted basis for
earnings and profits purposes, $8,000.
(d) For adjustment and allocation of the earnings and profits of the
transferor as between the transferor and the transferee in cases where
the transfer of property by one corporation to another corporation
results in the nonrecognition in whole or in part of gain or loss, see
Sec. 1.312-10; and see section 381 for earnings and profits of successor
corporations in certain transactions.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7221, 37 FR
24746, Nov. 21, 1972]
Sec. 1.312-8 Effect on earnings and profits of receipt of tax-free distributions requiring adjustment or allocation of basis of stock.
(a) In order to determine the effect on earnings and profits, where
a corporation receives (after February 28, 1913) from a second
corporation a distribution which (under the law applicable to the year
in which the distribution was made) was not a taxable dividend to the
shareholders of the second corporation, section 312(f) prescribes
certain rules. It provides that the amount of such distribution shall
not increase the earnings and profits of the first or receiving
corporation in the following cases: (1) No such increase shall be made
in respect of the part of such distribution which (under the law
applicable to the year in which the distribution was made) is directly
applied in reduction of the basis of the stock in respect of which the
distribution was made and (2) no such increase shall be made if (under
the law applicable to the year in which the distribution was made) the
distribution causes the basis of the stock in respect of which the
distribution was made to be allocated between such stock and the
property received (or such basis would but for section 307(b) be so
allocated). Where, therefore, the law (applicable to the year in which
the distribution was made, as, for example, a distribution in 1934 from
earnings and profits accumulated before March 1, 1913) requires that the
amount of such distribution shall be applied against and reduce the
[[Page 52]]
basis of the stock with respect to which the distribution was made,
there is no increase in the earnings and profits by reason of the
receipt of such distribution. Similarly, where there is received by a
corporation a distribution from another corporation in the form of a
stock dividend and the law applicable to the year in which such
distribution was made requires the allocation, as between the old stock
and the stock received as a dividend, of the basis of the old stock (or
such basis would but for section 307(b) be so allocated), then there is
no increase in the earnings and profits by reason of the receipt of such
stock dividend even though such stock dividend constitutes income within
the meaning of the sixteenth amendment to the Constitution.
(b) The principles set forth in paragraph (a) of this section may be
illustrated by the following examples:
Example (1). Corporation X in 1955 distributed to Corporation Y, one
of its shareholders, $10,000 which was out of earnings or profits
accumulated before March 1, 1913, and did not exceed the adjusted basis
of the stock in respect of which the distribution was made. This amount
of $10,000 was, therefore, a tax-free distribution and under the
provisions of section 301(c)(2) must be applied against and reduce the
adjusted basis of the stock in respect of which the distribution was
made. The earnings and profits of Corporation Y are not increased by
reason of the receipt of this distribution.
Example (2). Corporation Z in 1955 had outstanding common and
preferred stock of which Corporation Y held 100 shares of the common and
no preferred. The stock had a cost basis to Corporation Y of $100 per
share, or a total cost of $10,000. In December of that year it received
a dividend of 100 shares of the preferred stock of Corporation Z. Such
distribution is a stock dividend which, under section 305, was not
taxable and was accordingly not included in the gross income of
Corporation Y. The original cost of $10,000 is allocated to the 200
shares of Corporation Z none of which has been sold or otherwise
disposed of by Corporation Y. See section 307 and Sec. 1.307-1. The
earnings and profits of Corporation Y are not increased by reason of the
receipt of such stock dividend.
Sec. 1.312-9 Adjustments to earnings and profits reflecting increase in value accrued before March 1, 1913.
(a) In order to determine, for the purpose of ascertaining the
source of dividend distributions, that part of the earnings and profits
which is represented by increase in value of property accrued before,
but realized on or after, March 1, 1913, section 312(g) prescribes
certain rules.
(b)(1) Section 312(g)(1) sets forth the general rule with respect to
computing the increase to be made in that part of the earnings and
profits consisting of increase in value of property accrued before, but
realized on or after, March 1, 1913.
(2) The effect of section 312(g)(1) may be illustrated by the
following examples:
Example (1). Corporation X acquired nondepreciable property before
March 1, 1913, at a cost of $10,000. Its fair market value as of March
1, 1913, was $12,000 and it was sold in 1955 for $15,000. The increase
in earnings and profits based on the value as of March 1, 1913,
representing earnings and profits accumulated since February 28, 1913,
is $3,000. If the basis is determined without regard to the value as of
March 1, 1913, there would be an increase in earnings and profits of
$5,000. The difference of $2,000 ($5,000 minus $3,000) represents the
increase to be made in that part of the earnings and profits of
Corporation X consisting of the increase in value of property accrued
before, but realized on or after, March 1, 1913.
Example (2). Corporation Y acquired depreciable property in 1908 at
a cost of $100,000. Assuming no additions or betterments, and that the
depreciation sustained before March 1, 1913, was $10,000, the adjusted
cost as of that date was $90,000. Its fair market value as of March 1,
1913, was $94,000 and on February 28, 1955, it was sold for $25,000. For
the purpose of determining gain from the sale, the basis of the property
is the fair market value of $94,000 as of March 1, 1913, adjusted for
depreciation for the period subsequent to February 28, 1913, computed on
such fair market value. If the amount of the depreciation deduction
allowed after February 28, 1913, and properly allowable for each of such
years to the date of the sale in 1955 is the aggregate sum of $81,467,
the adjusted basis for determining gain in 1955 ($94,000 less $81,467)
is $12,533 and the gain would be $12,467 ($25,000 less $12,533). The
increase in earnings and profits accumulated since February 28, 1913, by
reason of the sale, based on the value as of March 1, 1913, adjusted for
depreciation is $12,467. If the depreciation since February 28, 1913,
had been based on the adjusted cost of $90,000 ($100,000 less $10,000)
instead of the March 1, 1913, value of $94,000, the depreciation
sustained from that date to the date of sale would have been $78,000
instead of $81,467 and the actual gain on the sale based on the cost of
$100,000 adjusted by depreciation on
[[Page 53]]
such cost to $12,000 ($100,000 reduced by the sum of $10,000 and
$78,000) would be $13,000 ($25,000 less $12,000). If the adjusted basis
of the property was determined without regard to the value as of March
1, 1913, there would be an increase in earnings and profits of $13,000.
The difference of $533 ($13,000 minus $12,467) represents the increase
to be made in that part of the earnings and profits of Corporation Y
consisting of the increase in value of property accrued before, but
realized on or after, March 1, 1913 (assuming that the proper increase
in such surplus had been made each year for the difference between
depreciation based on cost and the depreciation based on March 1, 1913,
value). Thus, the total increase in that part of earnings and profits
consisting of the increase in value of property accrued before, but
realized on or after, March 1, 1913, is $4,000 ($94,000 less $90,000).
(c)(1) Section 312(g)(2) is an exception to the general rule in
section 312(g)(1) and also operates as a limitation on the application
of section 312(f). It provides that, if the application of section
312(f)(1)(B) to a sale or other disposition after February 28, 1913,
results in a loss which is to be applied in decrease of earnings and
profits for any period beginning after February 28, 1913, then,
notwithstanding section 312(f) and in lieu of the rule provided in
section 312(g)(1), the amount of such loss so to be applied shall be
reduced by the amount, if any, by which the adjusted basis of the
property used in determining the loss, exceeds the adjusted basis
computed without regard to the fair market value of the property on
March 1, 1913. If the amount so applied in reduction of the loss exceeds
such loss, the excess over such loss shall increase that part of the
earnings and profits consisting of increase in value of property accrued
before, but realized on or after March 1, 1913.
(2) The application of section 312(g)(2) may be illustrated by the
following examples:
Example (1). Corporation Y acquired nondepreciable property before
March 1, 1913, at a cost of $8,000. Its fair market value as of March 1,
1913, was $13,000, and it was sold in 1955 for $10,000. Under section
312(f)(1)(B) the adjusted basis would be $13,000 and there would be a
loss of $3,000. The application of section 312(f)(1)(B) would result in
a loss from the sale in 1955 to be applied in decrease of earnings and
profits for that year. Section 312(g)(2), however, applies and the loss
of $3,000 is reduced by the amount by which the adjusted basis of
$13,000 exceeds the cost of $8,000 (the adjusted basis computed without
regard to the value on March 1, 1913), namely $5,000. The amount of the
loss is, accordingly, reduced from $3,000 to zero and there is no
decrease in earnings and profits of Corporation Y for the year 1955 as a
result of the sale. The amount applied in reduction of the decrease,
namely, $5,000, exceeds $3,000. Accordingly, as a result of the sale the
excess of $2,000 increases that part of the earnings and profits of
Corporation Y consisting of increase in value of property accrued
before, but realized on or after March 1, 1913.
Example (2). Corporation Z acquired nondepreciable property before
March 1, 1913, at a cost of $10,000. Its fair market value as of March
1, 1913, was $12,000, and it was sold in 1955 for $8,000. Under section
312(f)(1)(B) the adjusted basis would be $12,000 and there would be a
loss of $4,000. The application of section 312(f)(1)(B) would result in
a loss from the sale in 1955 to be applied in decrease of earnings and
profits for that year. Section 312(g)(2), however, applies and the loss
of $4,000 is reduced by the amount by which the adjusted basis of
$12,000 exceeds the cost of $10,000 (the adjusted basis computed without
regard to the value on March 1, 1913), namely, $2,000. The amount of the
loss is, accordingly, reduced from $4,000 to $2,000 and the decrease in
earnings and profits of Corporation Z for the year 1955 as a result of
the sale is $2,000 instead of $4,000. The amount applied in reduction of
the decrease, namely, $2,000, does not exceed $4,000. Accordingly, as a
result of the sale there is no increase in that part of the earnings and
profits of Corporation Z consisting of increase in value of property
accrued before, but realized on or after, March 1, 1913.
Sec. 1.312-10 Allocation of earnings in certain corporate separations.
(a) If one corporation transfers part of its assets constituting an
active trade or business to another corporation in a transaction to
which section 368(a)(1)(4) applies and immediately thereafter the stock
and securities of the controlled corporation are distributed in a
distribution or exchange to which section 355 (or so much of section 356
as relates to section 355) applies, the earnings and profits of the
distributing corporation immediately before the transaction shall be
allocated between the distributing corporation and the controlled
corporation. In the case of a newly created controlled corporation, such
allocation generally shall be made in proportion to the fair
[[Page 54]]
market value of the business or businesses (and interests in any other
properties) retained by the distributing corporation and the business or
businesses (and interests in any other properties) of the controlled
corporation immediately after the transaction. In a proper case,
allocation shall be made between the distributing corporation and the
controlled corporation in proportion to the net basis of the assets
transferred and of the assets retained or by such other method as may be
appropriate under the facts and circumstances of the case. The term net
basis means the basis of the assets less liabilities assumed or
liabilities to which such assets are subject. The part of the earnings
and profits of the taxable year of the distributing corporation in which
the transaction occurs allocable to the controlled corporation shall be
included in the computation of the earnings and profits of the first
taxable year of the controlled corporation ending after the date of the
transaction.
(b) If a distribution or exchange to which section 355 applies (or
so much of section 356 as relates to section 355) is not in pursuance of
a plan meeting the requirements of a reorganization as defined in
section 368(a)(1)(D), the earnings and profits of the distributing
corporation shall be decreased by the lesser of the following amounts:
(1) The amount by which the earnings and profits of the distributing
corporation would have been decreased if it had transferred the stock of
the controlled corporation to a new corporation in a reorganization to
which section 368(a)(1)(D) applied and immediately thereafter
distributed the stock of such new corporation or,
(2) The net worth of the controlled corporation. (For this purpose
the term net worth means the sum of the basis of all of the properties
plus cash minus all liabilities.)
If the earnings and profits of the controlled corporation immediately
before the transaction are less than the amount of the decrease in
earnings and profits of the distributing corporation (including a case
in which the controlled corporation has a deficit) the earnings and
profits of the controlled corporation, after the transaction, shall be
equal to the amount of such decrease. If the earnings and profits of the
controlled corporation immediately before the transaction are more than
the amount of the decrease in the earnings and profits of the
distributing corporation, they shall remain unchanged.
(c) In no case shall any part of a deficit of a distributing
corporation within the meaning of section 355 be allocated to a
controlled corporation.
Sec. 1.312-11 Effect on earnings and profits of certain other tax-free exchanges, tax-free distributions, and tax-free transfers from one corporation to
another.
(a) If property is transferred by one corporation to another, and,
under the law applicable to the year in which the transfer was made, no
gain or loss was recognized (or was recognized only to the extent of the
property received other than that permitted by such law to be received
without the recognition of gain), then proper adjustment and allocation
of the earnings and profits of the transferor shall be made as between
the transferor and the transferee. Transfers to which the preceding
sentence applies include contributions to capital, transfers under
section 351, transfers in connection with reorganizations under section
368, transfers in liquidations under section 332 and intercompany
transfers during a period of affiliation. However, if, for example,
property is transferred from one corporation to another in a transaction
under section 351 or as a contribution to capital and the transfer is
not followed or preceded by a reorganization, a transaction under
section 302(a) involving a substantial part of the transferor's stock,
or a total or partial liquidation, then ordinarily no allocation of the
earnings and profits of the transferor shall be made. For specific rules
as to allocation of earnings and profits in certain reorganizations
under section 368 and in certain liquidations under section 332 see
section 381 and the regulations thereunder. For allocation of earnings
and profits in certain corporate separations see section 312(i) and
Sec. 1.312-10.
(b) The general rule provided in section 316 that every distribution
is made out of earnings or profits to the extent
[[Page 55]]
thereof and from the most recently accumulated earnings or profits does
not apply to:
(1) The distribution, in pursuance of a plan of reorganization, by
or on behalf of a corporation a party to the reorganization, or in a
transaction subject to section 355, to its shareholders--
(i) Of stock or securities in such corporation or in another
corporation a party to the reorganization in any taxable year beginning
before January 1, 1934, without the surrender by the distributees of
stock or securities in such corporation (see section 112(g) of the
Revenue Act of 1932 (47 Stat. 197)); or
(ii) Of stock (other than preferred stock) in another corporation
which is a party to the reorganization without the surrender by the
distributees of stock in the distributing corporation if the
distribution occurs after October 20, 1951, and is subject to section
112(b)(11) of the Internal Revenue Code of 1939; or
(iii) Of stock or securities in such corporation or in another
corporation a party to the reorganization in any taxable year beginning
before January 1, 1939, or on or after such date, in exchange for its
stock or securities in a transaction to which section 112(b)(3) of the
Internal Revenue Code of 1939 was applicable; or
(iv) Of stock or securities in such corporation or in another
corporation in exchange for its stock or securities in a transaction
subject to section 354 or 355,
if no gain to the distributees from the receipt of such stock or
securities was recognized by law.
(2) The distribution in any taxable year (beginning before January
1, 1939, or on or after such date) of stock or securities, or other
property or money, to a corporation in complete liquidation of another
corporation, under the circumstances described in section 112(b)(6) of
the Revenue Act of 1936 (49 Stat. 1679), the Revenue Act of 1938 (52
Stat. 485), of the Internal Revenue Code of 1939, or section 332 of the
Internal Revenue Code of 1954.
(3) The distribution in any taxable year (beginning after December
31, 1938), of stock or securities, or other property or money, in the
case of an exchange or distribution described in section 371 of the
Internal Revenue Code of 1939 or in section 1081 of the Internal Revenue
Code of 1954 (relating to exchanges and distributions in obedience to
orders of the Securities and Exchange Commission), if no gain to the
distributee from the receipt of such stock, securities, or other
property or money was recognized by law.
(4) A stock dividend which was not subject to tax in the hands of
the distributee because either it did not constitute income to him
within the meaning of the sixteenth amendment to the Constitution or
because exempt to him under section 115(f) of the Revenue Act of 1934
(48 Stat. 712) or a corresponding provision of a prior Revenue Act, or
section 305 of the Code.
(5) The distribution, in a taxable year of the distributee beginning
after December 31, 1931, by or on behalf of an insolvent corporation, in
connection with a section 112(b)(10) reorganization under the Internal
Revenue Code of 1939, or in a transaction subject to section 371 of the
Internal Revenue Code of 1954, of stock or securities in a corporation
organized or made use of to effectuate the plan of reorganization, if
under section 112(e) of the Internal Revenue Code of 1939 or section 371
of the Internal Revenue Code of 1954 no gain to the distributee from the
receipt of such stock or securities was recognized by law.
(c) A distribution described in paragraph (b) of this section does
not diminish the earnings or profits of any corporation. In such cases,
the earnings or profits remain intact and available for distribution as
dividends by the corporation making such distribution, or by another
corporation to which the earnings or profits are transferred upon such
reorganization or other exchange. In the case, however, of amounts
distributed in liquidation (other than a taxfree liquidation or
reorganization described in paragraph (b)(1), (2), (3), or (5) of this
section) the earnings or profits of the corporation making the
distribution are diminished by the portion of such distribution properly
chargeable to earnings or profits accumulated after February 28, 1913,
after first deducting from the
[[Page 56]]
amount of such distribution the portion thereof allocable to capital
account.
(d) For the purposes of this section, the terms reorganization and
party to the reorganization shall, for any taxable year beginning before
January 1, 1934, have the meanings assigned to such terms in section 112
of the Revenue Act of 1932 (47 Stat. 196); for any taxable year
beginning after December 31, 1933, and before January 1, 1936, have the
meanings assigned to such terms in section 112 of the Revenue Act of
1934 (48 Stat. 704); for any taxable year beginning after December 31,
1935, and before January 1, 1938, have the meanings assigned to such
terms in section 112 of the Revenue Act of 1936 (49 Stat. 1678); for any
taxable year beginning after December 31, 1937, and before January 1,
1939, have the meanings assigned to such terms in section 112 of the
Revenue Act of 1938 (52 Stat. 485); and for any taxable year beginning
after December 31, 1938, and ending before June 22, 1954, providing no
election is made under section 393(b)(2) of the Internal Revenue Code of
1954, have the meanings assigned to such terms in section 112(g)(1) of
the Internal Revenue Code of 1939.
Sec. 1.312-12 Distributions of proceeds of loans guaranteed by the United States.
(a) The provisions of section 312(j) are applicable with respect to
a loan, any portion of which is guaranteed by an agency of the United
States Government without regard to the percentage of such loan subject
to such guarantee.
(b) The application of section 312(j) is illustrated by the
following example:
Example. Corporation A borrowed $1,000,000 for the purpose of
construction of an apartment house, the cost and adjusted basis of which
was $900,000. This loan was guaranteed by an agency of the United States
Government. One year after such loan was made and after the completion
of construction of the building (but before such corporation had
received any income) it distributed $100,000 cash to its shareholders.
The earnings and profits of the taxable year of such corporation are
increased (pursuant to section 312(j)) by $100,000 immediately prior to
such distribution and are decreased by $100,000 immediately after such
distribution. Such decrease, however, does not reduce the earnings and
profits below zero. Two years later, it has no accumulated earnings and
has earnings of the taxable year of $100,000. Before it has made any
payments on the loan, it distributes $200,000 to its shareholders. The
earnings and profits of the taxable year of the corporation ($100,000)
are increased by $100,000, the excess of the amount of the guaranteed
loan over the adjusted basis of the apartment house (calculated without
adjustment for depreciation). The entire amount of each distribution is
treated as a distribution out of earnings and profits and, accordingly,
as a taxable dividend.
Sec. 1.312-15 Effect of depreciation on earnings and profits.
(a) Depreciation for taxable years beginning after June 30, 1972--
(1) In general. Except as provided in subparagraph (2) of this paragraph
and paragraph (c) of this section, for purposes of computing the
earnings and profits of a corporation (including a real estate
investment trust as defined in section 856) for any taxable year
beginning after June 30, 1972, the allowance for depreciation (and
amortization, if any) shall be deemed to be the amount which would be
allowable for such year if the straight line method of depreciation had
been used for all property for which depreciation is allowable for each
taxable year beginning after June 30, 1972. Thus, for taxable years
beginning after June 30, 1972, in determining the earnings and profits
of a corporation, depreciation must be computed under the straight line
method, notwithstanding that in determining taxable income the
corporation uses an accelerated method of depreciation described in
subparagraph (A), (B), or (C) of section 312(m)(2) or elects to amortize
the basis of property under section 169, 184, 187, or 188, or any
similar provision.
(2) Exception. (i) If, for any taxable year beginning after June 30,
1972, a method of depreciation is used by a corporation in computing
taxable income which the Secretary or his delegate has determined
results in a reasonable allowance under section 167(a) and which is not
a declining balance method of depreciation (described in Sec. 1.167(b)-
2), the sum of the years-digits method (described in Sec. 1.167(b)-3),
or any other method allowed solely by reason of the application of
subsection (b)(4) or (j)(1)(C) of section 167, then the adjustment to
earnings and profits for
[[Page 57]]
depreciation for such year shall be determined under the method so used
(in lieu of the straight line method).
(ii) The Commissioner has determined that the ``unit of production''
(see Sec. 1.167(b)-0(b)), and the ``machine hour'' methods of
depreciation, when properly used under appropriate circumstances, meet
the requirements of subdivision (i) of this subparagraph. Thus, the
adjustment to earnings and profits for depreciation (for the taxable
year for which either of such methods is properly used under appropriate
circumstances) shall be determined under whichever of such methods is
used to compute taxable income.
(3) Determinations under straight line method. (i) In the case of
property with respect to which an allowance for depreciation is claimed
in computing taxable income, the determination of the amount which would
be allowable under the straight line method shall be based on the manner
in which the corporation computes depreciation in determining taxable
income. Thus, if an election under Sec. 1.167(a)-11 is in effect with
respect to the property, the amount of depreciation which would be
allowable under the straight line method shall be determined under
Sec. 1.167(a)-11(g)(3). On the other hand, if property is not
depreciated under the provisions of Sec. 1.167(a)-11, the amount of
depreciation which would be allowable under the straight line method
shall be determined under Sec. 1.167(b)-1. Any election made under
section 167(f), with respect to reducing the amount of salvage value
taken into account in computing the depreciation allowance for certain
property, or any convention adopted under Sec. 1.167(a)-10(b) or
Sec. 1.167(a)-11(c)(2), with respect to additions and retirements from
multiple asset accounts, which is used in computing depreciation for
taxable income shall be used in computing depreciation for earnings and
profits purposes.
(ii) In the case of property with respect to which an election to
amortize is in effect under section 169, 184, 187, or 188, or any
similar provision, the amount which would be allowable under the
straight line method of depreciation shall be determined under the
provisions of Sec. 1.167(b)-1. Thus, the cost or other basis of the
property, less its estimated salvage value, is to be deducted in equal
annual amounts over the period of the estimated useful life of the
property. In computing the amount of depreciation for earnings and
profits purposes, a taxpayer may utilize the provisions of section
167(f) (relating to the reduction in the amount of salvage value taken
into account in computing the depreciation allowance for certain
property) and any convention which could have been adopted for such
property under Sec. 1.167(a)-10(b) (relating to additions and
retirements from multiple asset accounts).
(b) Transitional rules--(1) Depreciation. If, for the taxable year
which includes June 30, 1972, (i) the allowance for depreciation of any
property is computed under a method other than the straight line method
or a method described in paragraph (a)(2) of this section, and (ii)
paragraph (a)(1) of this section applies to such property for the first
taxable year beginning after June 30, 1972, then adjustments to earnings
and profits for depreciation of such property for taxable years
beginning after June 30, 1972, shall be determined as if the corporation
changed to the straight line method with respect to such property as of
the first day of the first taxable year beginning after June 30, 1972.
Thus, if an election under Sec. 1.167 (a)-11 is in effect with respect
to the property, the change shall be made under the provisions of
Sec. 1.167(a)-11(c)(1)(iii), except that no statement setting forth the
vintage accounts for which the change is made shall be furnished with
the income tax return of the year of change if the change is only for
purposes of computing earnings and profits. In all other cases, the
unrecovered cost or other basis of the property (less a reasonable
estimate for salvage) as of such first day shall be recovered through
equal annual allowances over the estimated remaining useful life
determined in accordance with the circumstances existing at that time.
See paragraph (a)(3)(i) of this section for rules relating to the
applicability of section 167(f) in determining salvage value.
(2) Amortization. If, for the taxable year which includes June 30,
1972, the basis of any property is amortized
[[Page 58]]
under section 169, 184, 187, or 188, or any similar provision, then
adjustments to earnings and profits for depreciation or amortization of
such property for taxable years beginning after June 30, 1972, shall be
determined as if the unrecovered cost or other basis of the property
(less a reasonable estimate for salvage) as of the first day of the
first taxable year beginning after June 30, 1972, were recovered through
equal annual allowances over the estimated remaining useful life of the
property determined in accordance with the circumstances existing at
that time. See paragraph (a)(3)(ii) of this section for rules relating
to the applicability of section 167(f).
(c) Certain foreign corporations. Paragraphs (a) and (b) of this
section shall not apply in computing the earnings and profits of a
foreign corporation for any taxable year for which less than 20 percent
of the gross income from all sources of such corporation is derived from
sources within the United States.
(d) Books and records. Wherever different methods of depreciation
are used for taxable income and earnings and profits purposes, records
shall be maintained which show the depreciation taken for earnings and
profits purposes each year and which will allow computation of the
adjusted basis of the property in each account using the depreciation
taken for earnings and profits purposes.
[T.D. 7221, 37 FR 24746, Nov. 21, 1972]
definitions; constructive ownership of stock
Sec. 1.316-1 Dividends.
(a)(1) The term dividend for the purpose of subtitle A of the Code
(except when used in subchapter L, chapter 1 of the Code, in any case
where the reference is to dividends and similar distributions of
insurance companies paid to policyholders as such) comprises any
distribution of property as defined in section 317 in the ordinary
course of business, even though extraordinary in amount, made by a
domestic or foreign corporation to its shareholders out of either--
(i) Earnings and profits accumulated since February 28, 1913, or
(ii) Earnings and profits of the taxable year computed without
regard to the amount of the earnings and profits (whether of such year
or accumulated since February 28, 1913) at the time the distribution was
made.
The earnings and profits of the taxable year shall be computed as of the
close of such year, without diminution by reason of any distributions
made during the taxable year. For the purpose of determining whether a
distribution constitutes a dividend, it is unnecessary to ascertain the
amount of the earnings and profits accumulated since February 28, 1913,
if the earnings and profits of the taxable year are equal to or in
excess of the total amount of the distributions made within such year.
(2) Where a corporation distributes property to its shareholders on
or after June 22, 1954, the amount of the distribution which is a
dividend to them may not exceed the earnings and profits of the
distributing corporation.
(3) The rule of (2) above may be illustrated by the following
example:
Example X and Y, individuals, each own one-half of the stock of
Corporation A which has earnings and profits of $10,000. Corporation A
distributes property having a basis of $6,000 and a fair market value of
$16,000 to its shareholders, each shareholder receiving property with a
basis of $3,000 and with a fair market value of $8,000 in a distribution
to which section 301 applies. The amount taxable to each shareholder as
a dividend under section 301(c) is $5,000.
(b)(1) In the case of a corporation which, under the law applicable
to the taxable year in which a distribution is made, is a personal
holding company or which, for the taxable year in respect of which a
distribution is made under section 563 (relating to dividends paid
within 2 1/2 months after the close of the taxable year), or section 547
(relating to deficiency dividends), or corresponding provisions of a
prior income tax law, was under the applicable law a personal holding
company, the term dividend, in addition to the meaning set forth in the
first sentence of section 316, also means a distribution to its
shareholders as follows: A distribution within a taxable year of the
corporation, or of a shareholder, is a dividend to the extent of the
corporation's undistributed personal holding company
[[Page 59]]
income (determined under section 545 without regard to distributions
under section 316(b)(2)) for the taxable year in which, or, in the case
of a distribution under section 563 or section 547, the taxable year in
respect of which, the distribution was made. This subparagraph does not
apply to distributions in partial or complete liquidation of a personal
holding company. In the case of certain complete liquidations of a
personal holding company see subparagraph (2) of this paragraph.
(2) In the case of a corporation which, under the law applicable to
the taxable year in which a distribution is made, is a personal holding
company or which, for the taxable year in respect of which a
distribution is made under section 563, or section 547, or corresponding
provisions of a prior income tax law, was under the applicable law a
personal holding company, the term dividend, in addition to the meaning
set forth in the first sentence of section 316, also means, in the case
of a complete liquidation occurring within 24 months after the adoption
of a plan of liquidation, a distribution of property to its shareholders
within such period, but--
(i) Only to the extent of the amounts distributed to distributees
other than corporate shareholders, and
(ii) Only to the extent that the corporation designates such amounts
as a dividend distribution and duly notifies such distributees in
accordance with subparagraph (5) of this paragraph, but
(iii) Not in excess of the sum of such distributees' allocable share
of the undistributed personal holding company income for such year
(determined under section 545 without regard to sections 562(b) and
316(b)(2)(B)).
Section 316(b)(2)(B) and this subparagraph apply only to distributions
made in any taxable year of the distributing corporation beginning after
December 31, 1963. The amount designated with respect to a noncorporate
distributee may not exceed the amount actually distributed to such
distributee. For purposes of determining a noncorporate distributee's
gain or loss on liquidation, amounts distributed in complete liquidation
to such distributee during a taxable year are reduced by the amounts
designated as a dividend with respect to such distributee for such year.
For purposes of section 333(e)(1), a shareholder's ratable share of the
earnings and profits of the corporation accumulated after February 28,
1913, shall be reduced by the amounts designated as a dividend with
respect to such shareholder (even though such designated amounts are
distributed during the 1-month period referred to in section 333).
(3) For purposes of subparagraph (2)(iii) of this paragraph--
(i) Except as provided in subdivision (ii) of this subparagraph, the
sum of the noncorporate distributees' allocable share of undistributed
personal holding company income for the taxable year in which, or in
respect of which, the distribution was made (computed without regard to
sections 562(b) and 316(b)(2)(B)) shall be determined by multiplying
such undistributed personal holding company income by the ratio which
the aggregate value of the stock held by all noncorporate shareholders
immediately before the record date of the last liquidating distribution
in such year bears to the total value of all stock outstanding on such
date. For rules applicable in a case where the distributing corporation
has more than one class of stock, see subdivision (iii) of this
subparagraph.
(ii) If more than one liquidating distribution was made during the
year, and if, after the record date of the first distribution but before
the record date of the last distribution, there was a change in the
relative shareholdings as between noncorporate shareholders and
corporate shareholders, then the sum of the noncorporate distributees'
allocable share of undistributed personal holding company income for the
taxable year in which, or in respect of which, the distributions were
made (computed without regard to sections 562(b) and 316(b)(2)(B)) shall
be determined as follows:
(a) First, allocate the corporation's undistributed personal holding
company income among the distributions made during the taxable year by
reference to the ratio which the aggregate amount of each distribution
bears to the total amount of all distributions during such year;
(b) Second, determine the noncorporate distributees' allocable share
of
[[Page 60]]
the corporation's undistributed personal holding company income for each
distribution by multiplying the amount determined under (a) of this
subdivision (ii) for each distribution by the ratio which the aggregate
value of the stock held by all noncorporate shareholders immediately
before the record date of such distribution bears to the total value of
all stock outstanding on such date; and
(c) Last, determine the sum of the noncorporate distributees'
allocable share of the corporation's undistributed personal holding
company income for all such distributions.
For rules applicable in a case where the distributing corporation has
more than one class of stock, see subdivision (iii) of this
subparagraph.
(iii) Where the distributing corporation has more than one class of
stock--
(a) The undistributed personal holding company income for the
taxable year in which, or in respect of which the distribution was made
shall be treated as a fund from which dividends may properly be paid and
shall be allocated between or among the classes of stock in a manner
consistent with the dividend rights of such classes under local law and
the pertinent governing instruments, such as, for example, the
distributing corporation's articles or certificate of incorporation and
bylaws;
(b) The noncorporate distributees' allocable share of the
undistributed personal holding company income for each class of stock
shall be determined separately in accordance with the rules set forth in
subdivisions (i) or (ii) of this subparagraph, as if each class of stock
were the only class of stock outstanding; and
(c) The sum of the noncorporate distributees' allocable share of the
undistributed personal holding company income for the taxable year in
which, or in respect of which, the distribution was made shall be the
sum of the noncorporate distributees' allocable share of the
undistributed personal holding company income for all classes of stock.
(iv) For purposes of this subparagraph, in any case where the record
date of a liquidating distribution cannot be ascertained, the record
date of the distribution shall be the date on which the liquidating
distribution was actually made.
(4) The amount designated as a dividend to a noncorporate
distributee for any taxable year of the distributing corporation may not
exceed an amount equal to the sum of the noncorporate distributees'
allocable share of undistributed personal holding company income (as
determined under subparagraph (3) of this paragraph) for such year
multiplied by the ratio which the aggregate value of the stock held by
such distributee immediately before the record date of the liquidating
distribution or, if the record date cannot be ascertained, immediately
before the date on which the liquidating distribution was actually made,
bears to the aggregate value of stock outstanding held by all
noncorporate distributees on such date. In any case where more than one
liquidating distribution is made during the taxable year, the aggregate
amount which may be designated as a dividend to a noncorporate
distributee for such year may not exceed the aggregate of the amounts
determined by applying the principle of the preceding sentence to the
amounts determined under subparagraphs (3)(ii)(a) and (b) of this
paragraph for each distribution. Where the distributing corporation has
more than one class of stock, the limitation on the amount which may be
designated as a dividend to a noncorporate distributee for any taxable
year shall be determined by applying the rules of this subparagraph
separately with respect to the noncorporate distributees' allocable
share of the undistributed personal holding company income for each
class of stock (as determined under subparagraphs (3)(iii)(a) and (b) of
this paragraph).
(5) A corporation may designate as a dividend to a shareholder all
or part of a distribution in complete liquidation described in section
316(b)(2)(B) of this paragraph by:
(i) Claiming a dividends paid deduction for such amount in its
return for the year in which, or in respect of which, the distribution
is made,
(ii) Including such amount as a dividend in Form 1099 filed in
respect of such shareholder pursuant to section 6042(a) and the
regulations thereunder
[[Page 61]]
and in a written statement of dividend payments furnished to such
shareholder pursuant to section 6042(c) and Sec. 1.6042-4, and
(iii) Indicating on the written statement of dividend payments
furnished to such shareholder the amount included in such statement
which is designated as a dividend under section 316(b)(2)(B) and this
paragraph.
If a corporation complies with the procedure prescribed in the preceding
sentence, it satisfies both the designation and notification
requirements of section 316(b)(2)(B)(ii) and paragraph (b)(2)(ii) of
this section. An amount designated as a dividend shall not be included
as a distribution in liquidation on Form 1099L filed pursuant to
Sec. 1.6043-2 (relating to returns of information respecting
distributions in liquidation). If a corporation designates a dividend in
accordance with this subparagraph, it shall attach to the return in
which it claims a deduction for such designated dividend a schedule
indicating all facts necessary to determine the sum of the noncorporate
distributees' allocable share of undistributed personal holding company
income (determined in accordance with subparagraph (3) of this
paragraph) for the year in which, or in respect of which, the
distribution is made.
(c) Except as provided in section 316(b)(1), the term dividend
includes any distribution of property to shareholders to the extent made
out of accumulated or current earnings and profits. See, however,
section 331 (relating to distributions in complete or partial
liquidation), section 301(e) (relating to distributions by personal
service corporations), section 302(b) (relating to redemptions treated
as amounts received from the sale or exchange of stock), and section 303
(relating to distributions in redemption of stock to pay death taxes).
See also section 305(b) for certain distributions of stock or stock
rights treated as distributions of property.
(d) In the case of a corporation which, under the law applicable to
the taxable year in respect of which a distribution is made under
section 860 (relating to deficiency dividends), was a regulated
investment company (within the meaning of section 851), or a real estate
investment trust (within the meaning of section 856), the term dividend,
in addition to the meaning set forth in paragraphs (a) and (b) of
section 316, means a distribution of property to its shareholders which
constitutes a ``deficiency dividend'' as defined in section 860(f).
(e) The application of section 316 may be illustrated by the
following examples:
Example (1). At the beginning of the calendar year 1955, Corporation
M had an operating deficit of $200,000 and the earnings and profits for
the year amounted to $100,000. Beginning on March 16, 1955, the
corporation made quarterly distributions of $25,000 during the taxable
year to its shareholders. Each distribution is a taxable dividend in
full, irrespective of the actual or the pro rata amount of the earnings
and profits on hand at any of the dates of distribution, since the total
distributions made during the year ($100,000) did not exceed the total
earnings and profits of the year ($100,000).
Example (2). At the beginning of the calendar year 1955, Corporation
N, a personal holding company, had no accumulated earnings and profits.
During that year it made no earnings and profits but, due to the
disallowance of certain deductions, its undistributed personal holding
company income (determined under section 545 without regard to
distributions under section 316(b)(2)) was $16,000. It distributed to
shareholders on December 15, 1955, $15,000, and on February 1, 1956,
$1,000, the latter amount being claimed as a deduction under section 563
in its personal holding company schedule for 1955 filed with its return
for 1955 on March 15, 1956. Both distributions are taxable dividends in
full, since they do not exceed the undistributed personal holding
company income (determined without regard to such distributions) for
1955, the taxable year in which the distribution of $15,000 was made and
with respect to which the distribution of $1,000 was made. It is
immaterial whether Corporation N is a personal holding company for the
taxable year 1956 or whether it had any income for that year.
Example (3). In 1959, a deficiency in personal holding company tax
was established against Corporation O for the taxable year 1955 in the
amount of $35,500 based on an undistributed personal holding company
income of $42,000. Corporation O complied with the provisions of section
547 and in December 1959 distributed $42,000 to its stockholders as
``deficiency dividends.'' The distribution of $42,000 is a taxable
dividend since it does not exceed $42,000 (the undistributed personal
holding company income for 1955, the taxable year with respect to which
the distribution
[[Page 62]]
was made). It is immaterial whether Corporation O is a personal holding
company for the taxable year 1959 or whether it had any income for that
year.
Example (4). At the beginning of the taxable year 1955, Corporation
P, a personal holding company, had a deficit in earnings and profits of
$200,000. During that year it made earnings and profits of $90,000. For
that year, however, it had an undistributed personal holding income
(determined under section 545 without regard to distributions under
section 316(b)(2)) of $80,000. During such taxable year it distributed
to its shareholders $100,000. The distribution of $100,000 is a taxable
dividend to the extent of $90,000 since its earnings and profits for
that year, $90,000, exceed $80,000, the undistributed personal holding
company income determined without regard to such distribution.
Example (5). Corporation O, a calendar year taxpayer, is completely
liquidated on December 31, 1964, pursuant to a plan of liquidation
adopted July 1, 1964. No distributions in liquidation were made pursuant
to the plan of liquidation adopted July 1, 1964, until the distribution
in complete liquidation on December 31, 1964. Corporation O has
undistributed personal holding company income of $300,000 for the year
1964 (computed without regard to section 562(b) or section
316(b)(2)(B)). On December 31, 1964, immediately before the record date
of the distribution in complete liquidation, individual A owns 200
shares of Corporation O's outstanding stock and Corporation P owns the
remaining 100 shares of outstanding stock. All shares are equal in
value. The noncorporate distributees' allocable share of undistributed
personal holding company income for 1964 is $200,000
200 shares/300 shares x $300,000.
If at least $200,000 is distributed to A in the liquidation, then
Corporation O may designate $200,000 to A as a dividend in accordance
with paragraph (b)(5) of this section, and, if such amount is
designated, then A must treat $200,000 as a dividend to which section
301 applies. For an example of the treatment of the distribution to
Corporation P see paragraph (b)(2)(iii) of Sec. 1.562-1.
Example (6). Corporation Q, a calendar year taxpayer, is completely
liquidated on December 31, 1964, pursuant to a plan of liquidation
adopted July 1, 1964. No distributions in liquidation were made pursuant
to the plan of liquidation adopted July 1, 1964, until the distribution
in complete liquidation on December 31, 1964. Corporation Q has
undistributed personal holding company income of $40,000 for the year
1964 (computed without regard to section 562(b) or section
316(b)(2)(B)). On December 31, 1964, immediately before the record date
of the distribution in complete liquidation, Corporation Q has
outstanding 300 shares of common stock and 100 shares of noncumulative
preferred stock. Corporation Q's articles of incorporation provide that
the preferred stock is entitled to dividends of $10 per share per year.
Of Corporation Q's stock, individual B owns 200 shares of the common
stock and 50 shares of the preferred stock, and Corporation R owns all
remaining shares. All of the common shares are equal in value, and all
of the preferred shares are equal in value. No dividends had been paid
on the preferred stock during the year 1964. Of the $40,000 of
undistributed personal holding company income, $1,000 must be allocated
to the preferred stock because of the rights of the holders of such
stock, under Q's articles of incorporation, to receive that amount in
dividends for the year 1964. The noncorporate distributees' allocable
share of undistributed personal holding company income for 1964 is
$26,500.
50 preferred shares/100 preferred sharesx$1,000+200 common shares / 300
common sharesx$39,000
If at least $26,500 is distributed to B in the liquidation, then
corporation Q may designate $26,500 to B as a dividend in accordance
with paragraph (b)(5) of this section, and, if such amount is
designated, then B must treat $26,500 as a dividend to which section 301
applies.
Example (7). In 1979, a deficiency of $46,000 in the tax on real
estate investment trust taxable income is established against
corporation R for the taxable year 1977, based on an increase in real
estate investment trust taxable income of $100,000. Corporation R
complied with the provisions of section 860 and in December 1979
distributed to its stockholders $100,000, which qualified as
``deficiency dividends'' under section 860. The distribution of $100,000
is a taxable dividend. It is immaterial whether corporation R is a real
estate investment trust for the taxable year 1979 or whether it had
accumulated or current earnings and profits in 1979. See section
316(b)(3).
(Sec. 860(l) (92 Stat. 2849, 26 U.S.C. 860(l)); sec. 860(g) (92 Stat.
2850, 26 U.S.C. 860(g)); and sec. 7805 (68A Stat. 917, 26 U.S.C. 7805))
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6625, 27 FR
12541, Dec. 19, 1962; T.D. 6949, 33 FR 5519, Apr. 9, 1968; T.D. 7767, 46
FR 11264, Feb. 6, 1981; T.D. 7936, 49 FR 2105, Jan. 18, 1984]
Sec. 1.316-2 Sources of distribution in general.
(a) For the purpose of income taxation every distribution made by a
corporation is made out of earnings and profits to the extent thereof
and from the most recently accumulated earnings and profits. In
determining the source of a distribution, consideration should be given
first, to the earnings
[[Page 63]]
and profits of the taxable year; second, to the earnings and profits
accumulated since February 28, 1913, only in the case where, and to the
extent that, the distributions made during the taxable year are not
regarded as out of the earnings and profits of that year; third, to the
earnings and profits accumulated before March 1, 1913, only after all
the earnings and profits of the taxable year and all the earnings and
profits accumulated since February 28, 1913, have been distributed; and,
fourth, to sources other than earnings and profits only after the
earnings and profits have been distributed.
(b) If the earnings and profits of the taxable year (computed as of
the close of the year without diminution by reason of any distributions
made during the year and without regard to the amount of earnings and
profits at the time of the distribution) are sufficient in amount to
cover all the distributions made during that year, then each
distribution is a taxable dividend. See Sec. 1.316-1. If the
distributions made during the taxable year consist only of money and
exceed the earnings and profits of such year, then that proportion of
each distribution which the total of the earnings and profits of the
year bears to the total distributions made during the year shall be
regarded as out of the earnings and profits of that year. The portion of
each such distribution which is not regarded as out of earnings and
profits of the taxable year shall be considered a taxable dividend to
the extent of the earnings and profits accumulated since February 28,
1913, and available on the date of the distribution. In any case in
which it is necessary to determine the amount of earnings and profits
accumulated since February 28, 1913, and the actual earnings and profits
to the date of a distribution within any taxable year (whether beginning
before January 1, 1936, or, in the case of an operating deficit, on or
after that date) cannot be shown, the earnings and profits for the year
(or accounting period, if less than a year) in which the distribution
was made shall be prorated to the date of the distribution not counting
the date on which the distribution was made.
(c) The provisions of the section may be illustrated by the
following example:
Example At the beginning of the calendar year 1955, Corporation M
had $12,000 in earnings and profits accumulated since February 28, 1913.
Its earnings and profits for 1955 amounted to $30,000. During the year
it made quarterly cash distributions of $15,000 each. Of each of the
four distributions made, $7,500 (that portion of $15,000 which the
amount of $30,000, the total earnings and profits of the taxable year,
bears to $60,000, the total distributions made during the year) was paid
out of the earnings and profits of the taxable year; and of the first
and second distributions, $7,500 and $4,500, respectively, were paid out
of the earnings and profits accumulated after February 28, 1913, and
before the taxable year, as follows:
----------------------------------------------------------------------------------------------------------------
Distributions during 1955 Portion Portion out
---------------------------------------------------------------------------- out of of earnings
earnings accumulated
and since Feb. Taxable amt.
profits 28, 1913, of each
Date Amount of the and before distribution
taxable the taxable
year year
----------------------------------------------------------------------------------------------------------------
March 10......................................................... $15,000 $7,500 $7,500 $15,000
June 10.......................................................... 15,000 7,500 4,500 12,000
September 10..................................................... 15,000 7,500 ........... 7,500
December 10...................................................... 15,000 7,500 ........... 7,500
----------------------------------------------
Total amount taxable as dividends.............................. ........ ........ ........... 42,000
----------------------------------------------------------------------------------------------------------------
(d) Any distribution by a corporation out of earnings and profits
accumulated before March 1, 1913, or out of increase in value of
property accrued before March 1, 1913 (whether or not realized by sale
or other disposition, and, if realized, whether before, on, or after
March 1, 1913), is not a dividend within the meaning of subtitle A of
the Code.
(e) A reserve set up out of gross income by a corporation and
maintained for the purpose of making good any loss of capital assets on
account of depletion or depreciation is not a part of surplus out of
which ordinary dividends may be paid. A distribution made from a
depletion or a depreciation reserve based upon the cost or other basis
of the property will not be considered as having been paid out of
earnings and profits, but the amount thereof shall be applied against
and reduce the cost or
[[Page 64]]
other basis of the stock upon which declared. If such a distribution is
in excess of the basis, the excess shall be taxed as a gain from the
sale or other disposition of property as provided in section
301(c)(3)(A). A distribution from a depletion reserve based upon
discovery value to the extent that such reserve represents the excess of
the discovery value over the cost or other basis for determining gain or
loss, is, when received by the shareholders, taxable as an ordinary
dividend. The amount by which a corporation's percentage depletion
allowance for any year exceeds depletion sustained on cost or other
basis, that is, determined without regard to discovery or percentage
depletion allowances for the year of distribution or prior years,
constitutes a part of the corporation's ``earnings and profits
accumulated after February 28, 1913,'' within the meaning of section
316, and, upon distribution to shareholders, is taxable to them as a
dividend. A distribution made from that portion of a depletion reserve
based upon a valuation as of March 1, 1913, which is in excess of the
depletion reserve based upon cost, will not be considered as having been
paid out of earnings and profits, but the amount of the distribution
shall be applied against and reduce the cost or other basis of the stock
upon which declared. See section 301. No distribution, however, can be
made from such a reserve until all the earnings and profits of the
corporation have first been distributed.
Sec. 1.317-1 Property defined.
The term property, for purposes of part 1, subchapter C, chapter 1
of the Code, means any property (including money, securities, and
indebtedness to the corporation) other than stock, or rights to acquire
stock, in the corporation making the distribution.
Sec. 1.318-1 Constructive ownership of stock; introduction.
(a) For the purposes of certain provisions of chapter 1 of the Code,
section 318(a) provides that stock owned by a taxpayer includes stock
constructively owned by such taxpayer under the rules set forth in such
section. An individual is considered to own the stock owned, directly or
indirectly, by or for his spouse (other than a spouse who is legally
separated from the individual under a decree of divorce or separate
maintenance), and by or for his children, grandchildren, and parents.
Under section 318(a)(2) and (3), constructive ownership rules are
established for partnerships and partners, estates and beneficiaries,
trusts and beneficiaries, and corporations and stockholders. If any
person has an option to acquire stock, such stock is considered as owned
by such person. The term option includes an option to acquire such an
option and each of a series of such options.
(b) In applying section 318(a) to determine the stock ownership of
any person for any one purpose--
(1) A corporation shall not be considered to own its own stock by
reason of section 318(a)(3)(C);
(2) In any case in which an amount of stock owned by any person may
be included in the computation more than one time, such stock shall be
included only once, in the manner in which it will impute to the person
concerned the largest total stock ownership; and
(3) In determining the 50-percent requirement of section
318(a)(2)(C) and (3)(C), all of the stock owned actually and
constructively by the person concerned shall be aggregated.
[T.D. 6969, 33 FR 11999, Aug. 23, 1968]
Sec. 1.318-2 Application of general rules.
(a) The application of paragraph (b) of Sec. 1.318-1 may be
illustrated by the following examples:
Example (1). H, an individual, owns all of the stock of corporation
A. Corporation A is not considered to own the stock owned by H in
corporation A.
Example (2). H, an individual, his wife, W, and his son, S, each own
one-third of the stock of the Green Corporation. For purposes of
determining the amount of stock owned by H, W, or S for purposes of
section 318(a)(2)(C) and (3)(C), the amount of stock held by the other
members of the family shall be added pursuant to paragraph (b)(3) of
Sec. 1.318-1 in applying the 50-percent requirement of such section. H,
W, or S, as the case may be, is for this purpose deemed to own 100
percent of the stock of the Green Corporation.
[[Page 65]]
(b) The application of section 318(a)(1), relating to members of a
family, may be illustrated by the following example:
Example An individual, H, his wife, W, his son, S, and his grandson
(S's son), G, own the 100 outstanding shares of stock of a corporation,
each owning 25 shares. H, W, and S are each considered as owning 100
shares. G is considered as owning only 50 shares, that is, his own and
his father's.
(c) The application of section 318(a)(2) and (3), relating to
partnerships, trusts and corporations, may be illustrated by the
following examples:
Example (1). A, an individual, has a 50 percent interest in a
partnership. The partnership owns 50 of the 100 outstanding shares of
stock of a corporation, the remaining 50 shares being owned by A. The
partnership is considered as owning 100 shares. A is considered as
owning 75 shares.
Example (2). A testamentary trust owns 25 of the outstanding 100
shares of stock of a corporation. A, an individual, who holds a vested
remainder in the trust having a value, computed actuarially equal to 4
percent of the value of the trust property, owns the remaining 75
shares. Since the interest of A in the trust is a vested interest rather
than a contingent interest (whether or not remote), the trust is
considered as owning 100 shares. A is considered as owning 76 shares.
Example (3). The facts are the same as in (2), above, except that
A's interest in the trust is a contingent remainder. A is considered as
owning 76 shares. However, since A's interest in the trust is a remote
contingent interest, the trust is not considered as owning any of the
shares owned by A.
Example (4). A and B, unrelated individuals, own 70 percent and 30
percent, respectively, in value of the stock of Corporation M.
Corporation M owns 50 of the 100 outstanding shares of stock of
Corporation O, the remaining 50 shares being owned by A. Corporation M
is considered as owning 100 shares of Corporation O, and A is considered
as owning 85 shares.
Example (5). A and B, unrelated individuals, own 70 percent and 30
percent, respectively, of the stock of corporation M. A, B, and
corporation M all own stock of corporation O. Since B owns less than 50
percent in value of the stock of corporation M, neither B nor
corporation M constructively owns the stock of corporation O owned by
the other. However, for purposes of certain sections of the Code, such
as sections 304 and 856(d), the 50-percent limitation of section
318(a)(2)(C) and (3)(C) is disregarded or is reduced to less than 30
percent. For such purposes, B constructively owns his proportionate
share of the stock of corporation O owned directly by corporation M, and
corporation M constructively owns the stock of corporation O owned by B.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR
11999, Aug. 23, 1968]
Sec. 1.318-3 Estates, trusts, and options.
(a) For the purpose of applying section 318(a), relating to estates,
property of a decedent shall be considered as owned by his estate if
such property is subject to administration by the executor or
administrator for the purpose of paying claims against the estate and
expenses of administration notwithstanding that, under local law, legal
title to such property vests in the decedent's heirs, legatees or
devisees immediately upon death. The term beneficiary includes any
person entitled to receive property of a decedent pursuant to a will or
pursuant to laws of descent and distribution. A person shall no longer
be considered a beneficiary of an estate when all the property to which
he is entitled has been received by him, when he no longer has a claim
against the estate arising out of having been a beneficiary, and when
there is only a remote possibility that it will be necessary for the
estate to seek the return of property or to seek payment from him by
contribution or otherwise to satisfy claims against the estate or
expenses of administration. When, pursuant to the preceding sentence, a
person ceases to be a beneficiary, stock owned by him shall not
thereafter be considered owned by the estate, and stock owned by the
estate shall not thereafter be considered owned by him. The application
of section 318(a) relating to estates may be illustrated by the
following examples:
Example (1). (a) A decedent's estate owns 50 of the 100 outstanding
shares of stock of corporation X. The remaining shares are owned by
three unrelated individuals, A, B, and C, who together own the entire
interest in the estate. A owns 12 shares of stock of corporation X
directly and is entitled to 50 percent of the estate. B owns 18 shares
directly and has a life estate in the remaining 50 percent of the
estate. C owns 20 shares directly and also owns the remainder interest
after B's life estate.
(b) If section 318(a)(5)(C) applies (see paragraph (c)(3) of
Sec. 1.318-4), the stock of corporation X is considered to be owned as
follows: the estate is considered as owning 80 shares,
[[Page 66]]
50 shares directly, 12 shares constructively through A, and 18 shares
constructively through B; A is considered as owning 37 shares, 12 shares
directly, and 25 shares constructively (50 percent of the 50 shares
owned directly by the estate); B is considered as owning 43 shares, 18
shares directly and 25 shares constructively (50 percent of the 50
shares owned directly by the estate); C is considered as owning 20
shares directly and no shares constructively. C is not considered a
beneficiary of the estate under section 318(a) since he has no direct
present interest in the property held by the estate nor in the income
produced by such property.
(c) If section 318(a)(5)(C) does not apply, A is considered as
owning nine additional shares (50 percent of the 18 shares owned
constructively by the estate through B), and B is considered as owning
six additional shares (50 percent of the 12 shares owned constructively
by the estate through A).
Example (2). Under the will of A, Blackacre is left to B for life,
remainder to C, an unrelated individual. The residue of the estate
consisting of stock of a corporation is left to D. B and D are
beneficiaries of the estate under section 318(a). C is not considered a
beneficiary since he has no direct present interest in Blackacre nor in
the income produced by such property. The stock owned by the estate is
considered as owned proportionately by B and D.
(b) For the purpose of section 318(a)(2)(B) stock owned by a trust
will be considered as being owned by its beneficiaries only to the
extent of the interest of such beneficiaries in the trust. Accordingly,
the interest of income beneficiaries, remainder beneficiaries, and other
beneficiaries will be computed on an actuarial basis. Thus, if a trust
owns 100 percent of the stock of Corporation A, and if, on an actuarial
basis, W's life interest in the trust is 15 percent, Y's life interest
is 25 percent, and Z's remainder interest is 60 percent, under this
provision W will be considered to be the owner of 15 percent of the
stock of Corporation A, Y will be considered to be the owner of 25
percent of such stock, and Z will be considered to be the owner of 60
percent of such stock. The factors and methods prescribed in
Sec. 20.2031-7 of this chapter (Estate Tax Regulations) for use in
ascertaining the value of an interest in property for estate tax
purposes shall be used in determining a beneficiary's actuarial interest
in a trust for purposes of this section. See Sec. 20.2031-7 of this
chapter (Estate Tax Regulations) for examples illustrating the use of
these factors and methods.
(c) The application of section 318(a) relating to options may be
illustrated by the following example:
Example. A and B, unrelated individuals, own all of the 100
outstanding shares of stock of a corporation, each owning 50 shares. A
has an option to acquire 25 of B's shares and has an option to acquire a
further option to acquire the remaining 25 of B's shares. A is
considered as owning the entire 100 shares of stock of the corporation.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6969, 33 FR
11999, Aug. 23, 1968]
Sec. 1.318-4 Constructive ownership as actual ownership; exceptions.
(a) In general. Section 318(a)(5)(A) provides that, except as
provided in section 318(a)(5) (B) and (C), stock constructively owned by
a person by reason of the application of section 318(a) (1), (2), (3),
or (4) shall be considered as actually owned by such person for purposes
of applying section 318(a) (1), (2), (3), and (4). For example, if a
trust owns 50 percent of the stock of corporation X, stock of
corporation Y owned by corporation X which is attributed to the trust
may be further attributed to the beneficiaries of the trust.
(b) Constructive family ownership. Section 318(a)(5)(B) provides
that stock constructively owned by an individual by reason of ownership
by a member of his family shall not be considered as owned by him for
purposes of making another family member the constructive owner of such
stock under section 318(a)(1). For example, if F and his two sons, A and
B, each own one-third of the stock of a corporation, under section
318(a)(1), A is treated as owning constructively the stock owned by his
father but is not treated as owning the stock owned by B. Section
318(a)(5)(B) prevents the attribution of the stock of one brother
through the father to the other brother, an attribution beyond the scope
of section 318(a)(1) directly.
(c) Reattribution. (1) Section 318(a)(5)(C) provides that stock
constructively owned by a partnership, estate, trust, or corporation by
reason of the application of section 318(a)(3) shall not be considered
as owned by it for purposes of applying section 318(a)(2) in
[[Page 67]]
order to make another the constructive owner of such stock. For example,
if two unrelated individuals are beneficiaries of the same trust, stock
held by one which is attributed to the trust under section 318(a)(3) is
not reattributed from the trust to the other beneficiary. However, stock
constructively owned by reason of section 318(a)(2) may be reattributed
under section 318(a)(3). Thus, for example, if all the stock of
corporations X and Y is owned by A, stock of corporation Z held by X is
attributed to Y through A.
(2) Section 318(a)(5)(C) does not prevent reattribution under
section 318(a)(2) of stock constructively owned by an entity under
section 318(a)(3) if the stock is also constructively owned by the
entity under section 318(a)(4). For example, if individuals A and B are
beneficiaries of a trust and the trust has an option to buy stock from
A, B is considered under section 318(a)(2)(B) as owning a proportionate
part of such stock.
(3) Section 318(a)(5)(C) is effective on and after August 31, 1964,
except that for purposes of sections 302 and 304 it does not apply with
respect to distributions in payment for stock acquisitions or
redemptions if such acquisitions or redemptions occurred before August
31, 1964.
[T.D. 6969, 33 FR 11999, Aug. 23, 1968]
Corporate Liquidations
effects on recipients
Sec. 1.331-1 Corporate liquidations.
(a) Section 331 contains rules governing the extent to which gain or
loss is recognized to a shareholder receiving a distribution in complete
or partial liquidation of a corporation. Under section 331(a)(1), it is
provided that amounts distributed in complete liquidation of a
corporation shall be treated as in full payment in exchange for the
stock. Under section 331(a)(2), it is provided that amounts distributed
in partial liquidation of a corporation shall be treated as in full or
part payment in exchange for the stock. For this purpose, the term
partial liquidation shall have the meaning ascribed in section 346. If
section 331 is applicable to the distribution of property by a
corporation, section 301 (relating to the effects on a shareholder of
distributions of property) has no application other than to a
distribution in complete liquidation to which section 316(b)(2)(B)
applies. See paragraph (b)(2) of Sec. 1.316-1.
(b) The gain or loss to a shareholder from a distribution in partial
or complete liquidation is to be determined under section 1001 by
comparing the amount of the distribution with the cost or other basis of
the stock. The gain or loss will be recognized to the extent provided in
section 1002 and will be subject to the provisions of parts I, II, and
III (section 1201 and following), subchapter P, chapter 1 of the Code.
(c) A liquidation which is followed by a transfer to another
corporation of all or part of the assets of the liquidating corporation
or which is preceded by such a transfer may, however, have the effect of
the distribution of a dividend or of a transaction in which no loss is
recognized and gain is recognized only to the extent of ``other
property.'' See sections 301 and 356.
(d) In every case in which a shareholder transfers stock in exchange
for property to the corporation which issued such stock, the facts and
circumstances shall be reported on his return unless the property is
part of a distribution made pursuant to a corporate resolution reciting
that the distribution is made in liquidation of the corporation and the
corporation is completely liquidated and dissolved within one year after
the distribution. See section 6043 for requirements relating to returns
by corporations.
(e) The provisions of this section may be illustrated by the
following example:
Example A, an individual who makes his income tax returns on the
calendar year basis, owns 20 shares of stock of the P Corporation, a
domestic corporation, 10 shares of which were acquired in 1951 at a cost
of $1,500 and the remainder of 10 shares in December 1954 at a cost of
$2,900. He receives in April 1955 a distribution of $250 per share in
complete liquidation, or $2,500 on the 10 shares acquired in 1951, and
$2,500 on the 10 shares acquired in December 1954. The gain of $1,000 on
the shares acquired in 1951 is a long-term capital gain to be treated as
provided in parts I, II, and III (section 1201 and following),
subchapter P, chapter 1 of the Code. The loss of
[[Page 68]]
$400 on the shares acquired in 1954 is a short-term capital loss to be
treated as provided in parts I, II, and III (section 1201 and
following), subchapter P, chapter 1 of the Code.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33 FR
5521, Apr. 9, 1968]
Sec. 1.332-1 Distributions in liquidation of subsidiary corporation; general.
Under the general rule prescribed by section 331 for the treatment
of distributions in liquidation of a corporation, amounts received by
one corporation in complete liquidation of another corporation are
treated as in full payment in exchange for stock in such other
corporation, and gain or loss from the receipt of such amounts is to be
determined as provided in section 1001. Section 332 excepts from the
general rule property received, under certain specifically described
circumstances, by one corporation as a distribution in complete
liquidation of the stock of another corporation and provides for the
nonrecognition of gain or loss in those cases which meet the statutory
requirements. Section 367 places a limitation on the application of
section 332 in the case of foreign corporations. See section 334(b) for
the basis for determining gain or loss from the subsequent sale of
property received upon complete liquidations such as described in this
section. See section 453(d)(4)(A) relative to distribution of
installment obligations by subsidiary.
Sec. 1.332-2 Requirements for nonrecognition of gain or loss.
(a) The nonrecognition of gain or loss is limited to the receipt of
such property by a corporation which is the actual owner of stock (in
the liquidating corporation) possessing at least 80 percent of the total
combined voting power of all classes of stock entitled to vote and the
owner of at least 80 percent of the total number of shares of all other
classes of stock (except nonvoting stock which is limited and preferred
as to dividends). The recipient corporation must have been the owner of
the specified amount of such stock on the date of the adoption of the
plan of liquidation and have continued so to be at all times until the
receipt of the property. If the recipient corporation does not continue
qualified with respect to the ownership of stock of the liquidating
corporation and if the failure to continue qualified occurs at any time
prior to the completion of the transfer of all the property, the
provisions for the nonrecognition of gain or loss do not apply to any
distribution received under the plan.
(b) Section 332 applies only to those cases in which the recipient
corporation receives at least partial payment for the stock which it
owns in the liquidating corporation. If section 332 is not applicable,
see section 165(g) relative to allowance of losses on worthless
securities.
(c) To constitute a distribution in complete liquidation within the
meaning of section 332, the distribution must be (1) made by the
liquidating corporation in complete cancellation or redemption of all of
its stock in accordance with a plan of liquidation, or (2) one of a
series of distributions in complete cancellation or redemption of all
its stock in accordance with a plan of liquidation. Where there is more
than one distribution, it is essential that a status of liquidation
exist at the time the first distribution is made under the plan and that
such status continue until the liquidation is completed. Liquidation is
completed when the liquidating corporation and the receiver or trustees
in liquidation are finally divested of all the property (both tangible
and intangible). A status of liquidation exists when the corporation
ceases to be a going concern and its activities are merely for the
purpose of winding up its affairs, paying its debts, and distributing
any remaining balance to its shareholders. A liquidation may be
completed prior to the actual dissolution of the liquidating
corporation. However, legal dissolution of the corporation is not
required. Nor will the mere retention of a nominal amount of assets for
the sole purpose of preserving the corporation's legal existence
disqualify the transaction. (See 26 CFR (1939) 39.22(a)-20 (Regulations
118).)
(d) If a transaction constitutes a distribution in complete
liquidation within the meaning of the Internal Revenue Code of 1954 and
satisfies the requirements of section 332, it is not material that it is
otherwise described under the
[[Page 69]]
local law. If a liquidating corporation distributes all of its property
in complete liquidation and if pursuant to the plan for such complete
liquidation a corporation owning the specified amount of stock in the
liquidating corporation receives property constituting amounts
distributed in complete liquidation within the meaning of the Code and
also receives other property attributable to shares not owned by it, the
transfer of the property to the recipient corporation shall not be
treated, by reason of the receipt of such other property, as not being a
distribution (or one of a series of distributions) in complete
cancellation or redemption of all of the stock of the liquidating
corporation within the meaning of section 332, even though for purposes
of those provisions relating to corporate reorganizations the amount
received by the recipient corporation in excess of its ratable share is
regarded as acquired upon the issuance of its stock or securities in a
tax-free exchange as described in section 361 and the cancellation or
redemption of the stock not owned by the recipient corporation is
treated as occurring as a result of a taxfree exchange described in
section 354.
(e) The application of these rules may be illustrated by the
following example:
Example On September 1, 1954, the M Corporation had outstanding
capital stock consisting of 3,000 shares of common stock, par value $100
a share, and 1,000 shares of preferred stock, par value $100 a share,
which preferred stock was limited and preferred as to dividends and had
no voting rights. On that date, and thereafter until the date of
dissolution of the M Corporation, the O Corporation owned 2,500 shares
of common stock of the M Corporation. By statutory merger consummated on
October 1, 1954, pursuant to a plan of liquidation adopted on September
1, 1954, the M Corporation was merged into the O Corporation, the O
Corporation under the plan issuing stock which was received by the other
holders of the stock of the M Corporation. The receipt by the O
Corporation of the properties of the M Corporation is a distribution
received by the O Corporation in complete liquidation of the M
Corporation within the meaning of section 332, and no gain or loss is
recognized as the result of the receipt of such properties.
Sec. 1.332-3 Liquidations completed within one taxable year.
If in a liquidation completed within one taxable year pursuant to a
plan of complete liquidation, distributions in complete liquidation are
received by a corporation which owns the specified amount of stock in
the liquidating corporation and which continues qualified with respect
to the ownership of such stock until the transfer of all the property
within such year is completed (see paragraph (a) of Sec. 1.332-2), then
no gain or loss shall be recognized with respect to the distributions
received by the recipient corporation. In such case no waiver or bond is
required of the recipient corporation under section 332.
Sec. 1.332-4 Liquidations covering more than one taxable year.
(a) If the plan of liquidation is consummated by a series of
distributions extending over a period of more than one taxable year, the
nonrecognition of gain or loss with respect to the distributions in
liquidation shall, in addition to the requirements of Sec. 1.332-2, be
subject to the following requirements:
(1) In order for the distribution in liquidation to be brought
within the exception provided in section 332 to the general rule for
computing gain or loss with respect to amounts received in liquidation
of a corporation, the entire property of the corporation shall be
transferred in accordance with a plan of liquidation, which plan shall
include a statement showing the period within which the transfer of the
property of the liquidating corporation to the recipient corporation is
to be completed. The transfer of all the property under the liquidation
must be completed within three years from the close of the taxable year
during which is made the first of the series of distributions under the
plan.
(2) For each of the taxable years which falls wholly or partly
within the period of liquidation, the recipient corporation shall, at
the time of filing its return, file with the district director of
internal revenue a waiver of the statute of limitations on assessment.
The waiver shall be executed on such form as may be prescribed by the
Commissioner and shall extend the period of assessment of all income and
profits
[[Page 70]]
taxes for each such year to a date not earlier than one year after the
last date of the period for assessment of such taxes for the last
taxable year in which the transfer of the property of such liquidating
corporation to the controlling corporation may be completed in
accordance with section 332. Such waiver shall also contain such other
terms with respect to assessment as may be considered by the
Commissioner to be necessary to insure the assessment and collection of
the correct tax liability for each year within the period of
liquidation.
(3) For each of the taxable years which falls wholly or partly
within the period of liquidation, the recipient corporation may be
required to file a bond, the amount of which shall be fixed by the
district director. The bond shall contain all terms specified by the
Commissioner, including provisions unequivocally assuring prompt payment
of the excess of income and profits taxes (plus penalty, if any, and
interest) as computed by the district director without regard to the
provisions of sections 332 and 334(b) over such taxes computed with
regard to such provisions, regardless of whether such excess may or may
not be made the subject of a notice of deficiency under section 6212 and
regardless of whether it may or may not be assessed. Any bond required
under section 332 shall have such surety or sureties as the Commissioner
may require. However, see 6 U.S.C. 15, providing that where a bond is
required by law or regulations, in lieu of surety or sureties there may
be deposited bonds or notes of the United States. Only surety companies
holding certificates of authority from the Secretary as acceptable
sureties on Federal bonds will be approved as sureties. The bonds shall
be executed in triplicate so that the Commissioner, the taxpayer, and
the surety or the depositary may each have a copy. On and after
September 1, 1953, the functions of the Commissioner with respect to
such bonds shall be performed by the district director for the internal
revenue district in which the return was filed and any bond filed on or
after such date shall be filed with such district director.
(b) Pending the completion of the liquidation, if there is a
compliance with paragraph (a) (1), (2), and (3) of this section and
Sec. 1.332-2 with respect to the nonrecognition of gain or loss, the
income and profits tax liability of the recipient corporation for each
of the years covered in whole or in part by the liquidation shall be
determined without the recognition of any gain or loss on account of the
receipt of the distributions in liquidation. In such determination, the
basis of the property or properties received by the recipient
corporation shall be determined in accordance with section 334(b).
However, if the transfer of the property is not completed within the
three-year period allowed by section 332 or if the recipient corporation
does not continue qualified with respect to the ownership of stock of
the liquidating corporation as required by that section, gain or loss
shall be recognized with respect to each distribution and the tax
liability for each of the years covered in whole or in part by the
liquidation shall be recomputed without regard to the provisions of
section 332 or section 334(b) and the amount of any additional tax due
upon such recomputation shall be promptly paid.
Sec. 1.332-5 Distributions in liquidation as affecting minority interests.
Upon the liquidation of a corporation in pursuance of a plan of
complete liquidation, the gain or loss of minority shareholders shall be
determined without regard to section 332, since it does not apply to
that part of distributions in liquidation received by minority
shareholders.
Sec. 1.332-6 Records to be kept and information to be filed with return.
(a) Permanent records in substantial form shall be kept by every
corporation receiving distributions in complete liquidation within the
exception provided in section 332 showing the information required by
this section to be submitted with its return. The plan of liquidation
must be adopted by each of the corporations parties thereto; and the
adoption must be shown by the acts of its duly constituted responsible
officers, and appear upon the official records of each such corporation.
[[Page 71]]
(b) For the taxable year in which the liquidation occurs, or, if the
plan of liquidation provides for a series of distributions over a period
of more than one year, for each taxable year in which a distribution is
received under the plan the recipient must file with its return a
complete statement of all facts pertinent to the nonrecognition of gain
or loss, including:
(1) A certified copy of the plan for complete liquidation, and of
the resolutions under which the plan was adopted and the liquidation was
authorized, together with a statement under oath showing in detail all
transactions incident to, or pursuant to, the plan.
(2) A list of all the properties received upon the distribution,
showing the cost or other basis of such properties to the liquidating
corporation at the date of distribution and the fair market value of
such properties on the date distributed.
(3) A statement of any indebtedness of the liquidating corporation
to the recipient corporation on the date the plan of liquidation was
adopted and on the date of the first liquidating distribution. If any
such indebtedness was acquired at less than face value, the cost thereof
to the recipient corporation must also be shown.
(4) A statement as to its ownership of all classes of stock of the
liquidating corporation (showing as to each class the number of shares
and percentage owned and the voting power of each share) as of the date
of the adoption of the plan of liquidation, and at all times since, to
and including the date of the distribution in liquidation. The cost or
other basis of such stock and the date or dates on which purchased must
also be shown.
Sec. 1.332-7 Indebtedness of subsidiary to parent.
If section 332(a) is applicable to the receipt of the subsidiary's
property in complete liquidation, then no gain or loss shall be
recognized to the subsidiary upon the transfer of such properties even
though some of the properties are transferred in satisfaction of the
subsidiary's indebtedness to its parent. However, any gain or loss
realized by the parent corporation on such satisfaction of indebtedness,
shall be recognized to the parent corporation at the time of the
liquidation. For example, if the parent corporation purchased its
subsidiary's bonds at a discount and upon liquidation of the subsidiary
the parent corporation receives payment for the face amount of such
bonds, gain shall be recognized to the parent corporation. Such gain
shall be measured by the difference between the cost or other basis of
the bonds to the parent and the amount received in payment of the bonds.
Sec. 1.334-1 Basis of property received in liquidations.
(a) In general. Section 334 sets forth rules prescribing the basis
of property received in a distribution in partial or complete
liquidation of a corporation. The general rule of section 334 is set
forth in section 334(a) to the effect that if property is received in a
distribution in partial or complete liquidation and if gain or loss is
recognized on the receipt of such property, then the basis of the
property in the hands of the distributee shall be the fair market value
of such property at the time of the distribution. Such general rule has
no application to a liquidation to which section 332 or section 333
applies. See section 334 (b) and (c).
(b) Transferor's basis. Unless section 334(b)(2) and subsection (c)
of this section apply, property received by a parent corporation in a
complete liquidation to which section 332 is applicable shall, under
section 334(b)(1), have the same basis in the hands of the parent as its
adjusted basis in the hands of the subsidiary. The rule stated above is
applicable even though the subsidiary was indebted to the parent on the
date the plan of liquidation was adopted and part of such property was
received in satisfaction of such indebtedness in a transfer to which
section 332(c) is applicable. See Sec. 1.460-4(k)(3)(iv)(B)(2) for rules
relating to adjustments to the basis of certain contracts accounted for
using a long-term contract method of accounting that are acquired in
certain liquidations described in section 332.
[T.D. 7231, 37 FR 28287, Dec. 22, 1972, as amended at T.D. 8474, 58 FR
25557, Apr. 27, 1993; T.D. 8995, 67 FR 34605, May 15, 2002]
[[Page 72]]
effects on corporation
Sec. 1.337(d)-1 Transitional loss limitation rule.
(a) Loss limitation rule for transitional subsidiary--(1) General
rule. No deduction is allowed for any loss recognized by a member of a
consolidated group with respect to the disposition of stock of a
transitional subsidiary.
(2) Allowable loss--(i) In general. Paragraph (a)(1) of this section
does not apply to the extent the taxpayer establishes that the loss is
not attributable to the recognition of built-in gain by any transitional
subsidiary on the disposition of an asset (including stock and
securities) after January 6, 1987.
(ii) Statement of allowable loss. Paragraph (a)(2)(i) of this
section applies only if a separate statement entitled ``Allowable Loss
Under Sec. 1.337(d)-1(a)'' is filed with the taxpayer's return for the
year of the stock disposition. If the separate statement is required to
be filed with a return the due date (including extensions) of which is
before January 16, 1991, or with a return due (including extensions)
after January 15, 1991 but filed before that date, the statement may be
filed with an amended return for the year of the disposition or with the
taxpayer's first subsequent return the due date (including extensions)
of which is after January 15, 1991.
(iii) Contents of statement. The statement required under paragraph
(a)(2)(ii) of this section must contain--
(A) The name and employer identification number (E.I.N.) of the
transitional subsidiary.
(B) The basis of the stock of the transitional subsidiary
immediately before the disposition.
(C) The amount realized on the disposition.
(D) The amount of the deduction not disallowed under paragraph
(a)(1) of this section by reason of this paragraph (a)(2).
(E) The amount of loss disallowed under paragraph (a)(1) of this
section.
(3) Coordination with loss deferral and other disallowance rules.
(i) For purposes of this section, the rules of Sec. 1.1502-20(a)(3)
apply, with appropriate adjustments to reflect differences between the
approach of this section and that of Sec. 1.1502-20.
(ii) Other loss deferral rules. If paragraph (a)(1) of this section
applies to a loss subject to deferral or disallowance under any other
provision of the Code or the regulations, the other provision applies to
the loss only to the extent it is not disallowed under paragraph (a)(1).
(4) Definitions. For purposes of this section--
(i) The definitions in Sec. 1.1502-1 apply.
(ii) Transitional subsidiary means any corporation that became a
subsidiary of the group (whether or not the group was a consolidated
group) after January 6, 1987. Notwithstanding the preceding sentence, a
subsidiary is not a transitional subsidiary if the subsidiary (and each
predecessor) was a member of the group at all times after the
subsidiary's (and each predecessor's) organization.
(iii) Built-in gain of a transitional subsidiary means gain
attributable, directly or indirectly, in whole or in part, to any excess
of value over basis, determined immediately before the transitional
subsidiary became a subsidiary, with respect to any asset owned directly
or indirectly by the transitional subsidiary at that time.
(iv) Disposition means any event in which gain or loss is
recognized, in whole or in part.
(v) Value means fair market value.
(5) Examples. For purposes of the examples in this section, unless
otherwise stated, the group files consolidated returns on a calendar
year basis, the facts set forth the only corporate activity, and all
sales and purchases are with unrelated buyers or sellers. The basis of
each asset is the same determining earnings and profits adjustments and
taxable income. Tax liability and its effect on basis, value, and
earnings and profits are disregarded. Investment adjustment system means
the rules of Sec. 1.1502-32. The principles of this paragraph (a) are
illustrated by the following examples:
Example 1. Loss attributable to recognized built-in gain.
(i) P buys all the stock of T for $100 on February 1, 1987, and T
becomes a member of the P group. T has an asset with a value of $100 and
basis of $0. T sells the asset in 1989 and
[[Page 73]]
recognizes $100 of built-in gain on the sale (i.e., the asset's value
exceeded its basis by $100 at the time T became a member of the P
group). Under the investment adjustment system, P's basis in the T stock
increases to $200. P sells all the stock of T on December 31, 1989, and
recognizes a loss of $100. Under paragraph (a)(1) of this section, no
deduction is allowed to P for the $100 loss.
(ii) Assume that, after T sells its asset but before P sells the T
stock, T issues additional stock to unrelated persons and ceases to be a
member of the P group. P then sells all its stock of T in 1997. Although
T ceases to be a subsidiary within the meaning of Sec. 1.1502-1, T
continues to be a transitional subsidiary within the meaning of this
section. Consequently, under paragraph (a)(1) of this section, no
deduction is allowed to P for its $100 loss.
Example 2. Loss attributable to post-acquisition loss.
P buys all the stock of T for $100 on February 1, 1987, and T
becomes a member of the P group. T has $50 cash and an asset with $50 of
built-in gain. During 1988, T retains the asset but loses $40 of the
cash. The P group is unable to use the loss, and the loss becomes a net
operating loss carryover attributable to T. Under the investment
adjustment system, P's basis in the stock of T remains $100. P sells all
the stock of T on December 31, 1988, for $60 and recognizes a $40 loss.
Under paragraph (a)(2)(i) of this section, P establishes that it did not
dispose of the built-in gain asset. None of P's loss is disallowed under
paragraph (a)(1) if P satisfies the requirements of paragraph (a)(2)(ii)
of this section.
Example 3. Stacking rules--postacquisition loss offsets
postacquisition gain.
(i) P. buys all the stock of T for $100 on February 1, 1987, and T
becomes a member of the P group. T has 2 assets. Asset 1 has a basis and
value of $50, and asset 2 has a basis of $0 and a value of $50. During
1989, asset 1 declines in value to $0, and T sells asset 2 for $50, and
reinvests the proceeds in asset 3. The value of asset 3 appreciates to
$90. Under the investment adjustment system, P's basis in the stock of T
increases from $100 to $150 as a result of the gain recognized on the
sale of asset 2 but is unaffected by the unrealized post-acquisition
decline in the value of asset 1. On December 31, 1989, P sells all the
stock of T for $90 and recognizes a $60 loss.
(ii) Although T incurred a $50 post-acquisition loss of built-in
gain because of the decline in the value of asset 1, T also recognized
$50 of built-in gain. Under paragraph (a)(2) of this section, any loss
on the sale of stock is treated first as attributable to recognized
built-in gain. Thus, for purposes of determining under paragraph (a)(2)
of this section whether P's $60 loss on the disposition of the T stock
is attributable to the recognition of built-in gain on the disposition
of an asset, T's unrealized post-acquisition gain of $40 offsets $40 of
the $50 of unrealized post-acquisition loss. Therefore, $50 of the $60
loss is attributable to the recognition of built-in gain on the
disposition of an asset and is disallowed under paragraph (a)(1) of this
section.
Example 4. Stacking rules--built-in loss offsets built-in gain.
(i) P buys all the stock of T for $50 on February 1, 1987, and T
becomes a member of the P group. T has 2 assets. Asset 1 has a basis of
$50 and a value of $0, and asset 2 has a basis of $0 and a value of $50.
During 1989, T sells asset 1 for $0 and asset 2 for $50, and reinvests
the $50 proceeds in asset 3. The value of asset 3 declines to $40. Under
the investment adjustment system, P's basis in the stock of T remains
$50 as a result of the offsetting gain and loss recognized on the sale
of assets 1 and 2 and is unaffected by the unrealized post-acquisition
decline in the value of asset 3. On December 31, 1989, P sells all the
stock of T for $40 and recognizes a $10 loss.
(ii) Although T recognized a $50 built-in gain on the sale of asset
2, T also recognized a $50 built-in loss on the sale of asset 1. For
purposes of determining under paragraph (a)(2) of this section whether
P's $10 loss on the disposition of the T stock is attributable to the
recognition of built-in gain on the disposition of an asset, T's
recognized built-in gain is offset by its recognized built-in loss. Thus
none of P's $10 loss is attributable to the recognition of built-in gain
on the disposition of an asset.
(iii) The result would be the same if, instead of a $50 built-in
loss in asset 2, T has a $50 net operating loss carryover when P buys
the T stock, and the net operating loss carryover is used to offset the
built-in gain.
Example 5. Outside basis partially corresponds to inside basis.
(i) Individual A owns all the stock of T, for which A has a basis of
$60. On February 1, 1987, T owns 1 asset with a basis of $0 and a value
of $100, P acquires all the stock of T from A in an exchange to which
section 351(a) applies, and T becomes a member of the P group. P has a
carryover basis of $60 in the T stock. During 1988, T sells the asset
and recognizes $100 of gain. Under the investment adjustment system, P's
basis in the T stock increases from $60 to $160. T reinvests the $100
proceeds in another asset, which declines in value to $90. On January 1,
1989, P sells all the stock of T for $90 and recognizes a loss of $70.
(ii) Although P's basis in the T stock was increased by $100 as a
result of the recognition of built-in gain on the disposition of T's
asset, only $60 of the $70 loss on the sale of the stock is attributable
under paragraph (a)(2) of this section to the recognition of built-in
gain from the disposition of the asset. (Had T's asset not declined in
value to
[[Page 74]]
$90, the T stock would have been sold for $100, and a $60 loss would
have been attributable to the recognition of the built-in gain.)
Therefore, $60 of the $70 loss is disallowed under paragraph (a)(2), and
$10 is not disallowed if P satisfies the requirements of paragraph
(a)(2). If P had sold the stock of T for $95 because T's other assets
had unrealized appreciation of $5, $60 of the $65 loss would still be
attributable to T's recognition of built-in gain on the disposition of
assets.
Example 6. Creeping acquisition.
P owns 60 percent of the stock of S on January 6, 1987. On February
1, 1987, P buys an additional 20 percent of the stock of S, and S
becomes a member of the P group. P sells all the S stock on March 1,
1989 and recognizes a loss of $100. All 80 percent of the stock of S
owned by P is subject to the rules of this section and, under paragraph
(a) (1) and (2) of this section, P is not allowed to deduct the $100
loss, except to the extent P establishes the loss is not attributable to
the recognition by S of built-in gain on the disposition of assets.
Example 7. Effect of post-acquisition appreciation. P buys all the
stock of T for $100, and T becomes a member of the P group. T has an
asset with a basis of $0 and a value of $100. T sells the asset for
$100. Under the investment adjustment system, P's basis in the T stock
increases to $200. T reinvests the proceeds of the sale in an asset that
appreciates in value to $180. Five years after the sale, P sells all the
stock of T for $180 and recognizes a $20 loss. Under paragraph (a)(1) of
this section, no deduction is allowed to P for the $20 loss.
Example 8. Deferred loss and recognized gain.
(i) P is the common parent of a consolidated group, S is a wholly
owned subsidiary of P, and T is a wholly owned subsidiary of S. S
purchased all of the T stock on February 1, 1987 for $100, and T has an
asset with a basis of $40 and a value of $100. T sells the asset for
$100, recognizing $60 of gain. Under the investment adjustment system,
S's basis in the T stock increases from $100 to $160. S sells its T
stock to P for $100 in a deferred intercompany transaction, recognizing
a $60 loss that is deferred under section 267(f) and Sec. 1.1502-13. P
subsequently sells all the stock of T for $100 to X, a member of the
same controlled group (as defined in section 267(f)) as P but not a
member of the P consolidated group.
(ii) Under paragraph (a)(3) of this section, the application of
paragraph (a)(1) of this section to S's $60 loss is deferred, because
S's loss is deferred under section 267(f) and Sec. 1.1502-13. Although
P's sale of the T stock to X would cause S's deferred loss to be taken
into account under Sec. 1.1502-13, Sec. 1.267(f)-1 provides that the
loss is not taken into account because X is a member of the same
controlled group as P and S. Nevertheless, under paragraph (a)(3) of
this section, because the T stock ceases to be owned by a member of the
P consolidated group, S's deferred loss is disallowed immediately before
the sale and is never taken into account under section 267(f).
(b) Indirect disposition of transitional subsidiary--(1) Loss
limitation rule for transitional parent. No deduction is allowed for any
loss recognized by a member of a consolidated group with respect to the
disposition of stock of a transitional parent.
(2) Allowable loss--(i) In general. Paragraph (b)(1) of this section
does not apply to the extent the taxpayer establishes that the loss
exceeds the amount that would be disallowed under paragraph (a) of this
section if each highest tier transitional subsidiary's stock in which
the transitional parent has a direct or indirect interest had been sold
immediately before the disposition of the transitional parent's stock.
In applying the preceding sentence, appropriate adjustments shall be
made to take into account circumstances where less than all the stock of
a transitional parent owned by members of a consolidated group is
disposed of in the same transaction, or the stock of a transitional
subsidiary or a transitional parent is directly owned by more than 1
member.
(ii) Statement of allowable loss. Paragraph (b)(2)(i) of this
section applies only if a separate statement entitled ``Allowable Loss
Under Section 1.337(d)-1(b)'' is filed with the taxpayer's return for
the year of the stock disposition. If the separate statement is required
to be filed with a return the due date (including extensions) of which
is before January 16, 1991, or with a return due (including extensions)
after January 15, 1991 but filed before that date, the statement may be
filed with an amended return for the year of the disposition or with the
taxpayer's first subsequent return the due date (including extensions)
of which is after January 15, 1991.
(iii) Contents of statement. The statement required under paragraph
(b)(2)(ii) of this section must contain--
(A) The name and employer identification number (E.I.N.) of the
transitional parent.
[[Page 75]]
(B) The basis of the stock of the transitional parent immediately
before the disposition.
(C) The amount realized on the disposition.
(D) The amount of the deduction not disallowed under paragraph
(b)(1) of this section by reason of this paragraph (b)(2).
(E) The amount of loss disallowed under paragraph (b)(1) of this
section.
(3) Coordination with loss deferral and other disallowance rules.
(i) For purposes of this section, the rules of Sec. 1.1502-20(a)(3)
apply, with appropriate adjustments to reflect differences between the
approach of this section and that of Sec. 1.1502-20.
(ii) Other loss deferral rules. If paragraph (b)(1) of this section
applies to a loss subject to deferral or disallowance under any other
provision of the Code or the regulations, the other provision applies to
the loss only to the extent it is not disallowed under paragraph (b)(1).
(4) Definitions. For purposes of this section--
(i) Transitional parent means any subsidiary, other than a
transitional subsidiary, that owned at any time after January 6, 1987, a
direct or indirect interest in the stock of a corporation that is a
transitional subsidiary.
(ii) Highest tier transitional subsidiary means the transitional
subsidiary (or subsidiaries) in which the transitional parent has a
direct or indirect interest and that is the highest transitional
subsidiary (or subsidiaries) in a chain of members.
(5) Examples. The principles of this paragraph (b) are illustrated
by the following examples:
Example 1. Ownership of chain of transitional subsidiaries. (i) P
forms S with $200 on January 1, 1985, and S becomes a member of the P
group. On February 1, 1987, S buys all the stock of T, and T buys all
the stock of T1, and both T and T1 become members of the P group. On
January 1, 1988, P sells all the stock of S and recognizes a $90 loss on
the sale.
(ii) Under paragraph (a)(4)(ii) of this section, both T and T1 are
transitional subsidiaries, because they became members of the P group
after January 6, 1987. Under paragraph (b)(4)(i) of this section, S is a
transitional parent, because it owns a direct interest in stock of
transitional subsidiaries and is not itself a transitional subsidiary.
(iii) Under paragraph (b) (1) and (2) of this section, because S is
a transitional parent, no deduction is allowed to P for its $90 loss
except to the extent the loss exceeds the amount of S's loss that would
have been disallowed if S had sold all the stock of T, S's highest tier
transitional subsidiary, immediately before P's sale of all the S stock.
Assume all the T stock would have been sold for a $90 loss and that all
the loss would be attributable to the recognition of built-in gain from
the disposition of assets. Because in that case $90 of loss would be
disallowed, all of P's loss on the sale of the S stock is disallowed
under paragraph (b).
Example 2. Ownership of brother-sister transitional subsidiaries.
(i) P forms S with $200 on January 1, 1985, and S becomes a member
of the P group. On February 1, 1987, S buys all the stock of both T and
T1, and T and T1 become members of the P group. On January 1, 1988, P
sells all the stock of S and recognizes a $90 loss on the sale.
(ii) Under paragraph (b) (1) and (2) of this section, no deduction
is allowed to P for its $90 loss except to the extent P establishes that
the loss exceeds the amount of S's stock losses that would be disallowed
if S sold all the stock of T and T1, S's highest tier transitional
subsidiaries, immediately before P's sale of all the S stock. Assume
that all the T stock would have been sold for a $50 loss, all the T1
stock of a $40 loss, and that the entire amount of each loss would be
attributable to the recognition of built-in gain on the disposition of
assets. Because $90 of loss would be disallowed with respect to the sale
of S's T and T1 stock, P's $90 loss on the sale of all the S stock is
disallowed under paragraph (b).
(c) Successors--(1) General rule. This section applies, to the
extent necessary to effectuate the purposes of this section, to--
(i) Any property owned by a member or former member, the basis of
which is determined, directly or indirectly, in whole or in part, by
reference to the basis in a subsidiary's stock, and
(ii) Any property owned by any other person whose basis in the
property is determined, directly or indirectly, in whole or in part, by
reference to a member's (or former member's) basis in a subsidiary's
stock.
(2) Examples. The principles of this paragraph (c) are illustrated
by the following examples:
Example 1. Merger into grandfathered subsidiary. P, the common
parent of a group, owns all the stock of T, a transitional subsidiary.
On January 1, 1989, T merges into S,
[[Page 76]]
a wholly owned subsidiary of P that is not a transitional subsidiary.
Under paragraph (c)(1) of this section, all the stock of S is treated as
stock of a transitional subsidiary. As a result, no deduction is allowed
for any loss recognized by P on the disposition of any S stock, except
to the extent the P group establishes under paragraph (a)(2) that the
loss is not attributable to the recognition of built-in gain on the
disposition of assets of T.
Example 2. Nonrecognition exchange of transitional stock.
(i) P, the common parent of a group, owns all the stock of T, a
transitional subsidiary. On January 1, 1989, P transfers the stock of T
to X, a corporation that is not a member of the P group, in exchange for
20 percent of its stock in a transaction to which section 351(a)
applies. T and X file separate returns.
(ii) Under paragraph (c)(1) of this section, all the stock of X
owned by P is treated as stock of a transitional subsidiary because P's
basis for the X stock is determined by reference to its basis for the T
stock. As a result, no deduction is allowed to P for any loss recognized
on the disposition of the X stock, except to the extent permitted under
paragraph (a) of this section.
(iii) Under paragraph (c)(1), X is treated as a member subject to
paragraph (a) of this section with respect to the T stock because X's
basis for the stock is determined by reference to P's basis for the
stock. Moreover, all of the T stock owned by X continues to be stock of
a transitional subsidiary. As a result, no deduction is allowed to X for
any loss recognized on the disposition of any T stock, except to the
extent permitted under paragraph (a) of this section.
(d) Investment adjustments and earnings and profits--(1) In general.
For purposes of determining investment adjustments under Sec. 1.1502-32
and earnings and profits under Sec. 1.1502-33(c) with respect to a
member of a consolidated group that owns stock in a subsidiary, any
deduction that is disallowed under this section is treated as a loss
arising and absorbed by the member in the tax year in which the
disallowance occurs.
(2) Example. (i) In 1986, P forms S with a contribution of $100, and
S becomes a member of the P group. On February 1, 1987, S buys all the
stock of T for $100. T has an asset with a basis of $0 and a value of
$100. In 1988, T sells the asset for $100. Under the investment
adjustment system, S's basis in the T stock increases to adjustment
system, S's basis in the T stock increases to $200, P's basis in the S
stock increases to $200, and P's earnings and profits and S's earnings
and profits increase by $100. In 1989, S sells all of the T stock for
$100, and S's recognized loss of $100 is disallowed under paragraph
(a)(1) of this section.
(ii) Under paragraph (d)(1) of this section, S's earnings and
profits for 1989 are reduced by $100, the amount of the loss disallowed
under paragraph (a)(1). As a result, P's basis in the S stock is reduced
from $200 to $100 under the investment adjustment system. P's earnings
and profits for 1989 are correspondingly reduced by $100.
(e) Effective dates--(1) General rule. This section applies with
respect to dispositions after January 6, 1987. For dispositions on or
after November 19, 1990, however, this section applies only if the stock
was deconsolidated (as that term is defined in Sec. 1.337(d)-2(b)(2))
before November 19, 1990, and only to the extent the disposition is not
subject to Sec. 1.337(d)-2 or Sec. 1.1502-20.
(2) Binding contract rule. For purposes of this paragraph (e), if a
corporation became a subsidiary pursuant to a binding written contract
entered into before January 6, 1987, and in continuous effect until the
corporation became a subsidiary, or a disposition was pursuant to a
binding written contract entered into before March 9, 1990, and in
continuous effect until the disposition, the date the contract became
binding shall be treated as the date the corporation became a subsidiary
or as the date of disposition.
(3) Application of Sec. 1.1502-20T to certain transactions--(i) In
general. If a group files the certification described in paragraph
(e)(3)(ii) of this section, it may apply Sec. 1.1502-20T (as contained
in the CFR edition revised as of April 1, 1990), to all of its members
with respect to all dispositions and deconsolidations by the certifying
group to which Sec. 1.1502-20T otherwise applied by its terms occurring-
-
(A) On or after March 9, 1990 (but only if not pursuant to a binding
contract described in Sec. 1.337(d)-1T(e)(2) (as contained in the CFR
edition revised as of April 1, 1990) that was entered into before March
9, 1990); and
(B) Before November 19, 1990 (or thereafter, if pursuant to a
binding contract described in Sec. 1.1502-20T(g)(3) that was entered
into on or after
[[Page 77]]
March 9, 1990 and before November 19, 1990).
The certification under this paragraph (e)(3)(i) with respect to the
application of Sec. 1.1502-20T to any transaction described in this
paragraph (e)(3)(i) may not be withdrawn and, if the certification is
filed, Sec. 1.1502-20T must be applied to all such transactions on all
returns (including amended returns) on which such transactions are
included.
(ii) Time and manner of filing certification. The certification
described in paragraph (e)(3)(i) of this section must be made in a
separate statement entitled ``[insert name and employer identification
number of common parent] hereby certifies under Sec. 1.337(d)-1 (e)(3)
that the group of which it is the common parent is applying Sec. 1.1502-
20T to all transactions to which that section otherwise applied by it
terms.'' The statement must be signed by the common parent and filed
with the group's income tax return for the taxable year of the first
disposition or deconsolidation to which the certification applies. If
the separate statement required under this paragraph (e)(3) is to be
filed with a return the due date (including extensions) of which is
before November 16, 1991, the statement may be filed with an amended
return for the year of the disposition or deconsolidation that is filed
within 180 days after September 13, 1991. Any other filings required
under Sec. 1.1502-20T, such as the statement required under Sec. 1.1502-
20T(f)(5), may be made with the amended return, regardless of whether
Sec. 1.1502-20T permits such filing by amended return.
[T.D. 8319, 55 FR 49031, Nov. 26, 1990, as amended by T.D. 8364, 56 FR
47389, Sept. 19, 1991; 57 FR 53550, Nov. 12, 1992; T.D. 8560, 59 FR
41674, 41675, Aug. 15, 1994; T.D. 8597, 60 FR 36679, July 18, 1995]
Sec. 1.337(d)-1T [Reserved]
Sec. 1.337(d)-2 Loss limitation window period.
(a) Loss disallowance--(1) General rule. No deduction is allowed for
any loss recognized by a member of a consolidated group with respect to
the disposition of stock of a subsidiary.
(2) Definitions. For purposes of this section--
(i) The definitions in Sec. 1.1502-1 apply.
(ii) Disposition means any event in which gain or loss is
recognized, in whole or in part.
(3) Coordination with loss deferral and other disallowance rules.
For purposes of this section, the rules of Sec. 1.1502-20(a)(3) apply,
with appropriate adjustments to reflect differences between the approach
of this section and that of Sec. 1.1502-20.
(b) Basis reduction on deconsolidation--(1) General rule. If the
basis of a member of a consolidated group in a share of stock of a
subsidiary exceeds its value immediately before a deconsolidation of the
share, the basis of the share is reduced at that time to an amount equal
to its value. If both a disposition and a deconsolidation occur with
respect to a share in the same transaction, paragraph (a) of this
section applies and, to the extent necessary to effectuate the purposes
of this section, this paragraph (b) applies following the application of
paragraph (a) of this section.
(2) Deconsolidation. ``Deconsolidation'' means any event that causes
a share of stock of a subsidiary that remains outstanding to be no
longer owned by a member of any consolidated group of which the
subsidiary is also a member.
(3) Value. ``Value'' means fair market value.
(4) Loss within 2 years after basis reduction--(i) In general. If a
share is deconsolidated and a direct or indirect disposition of the
share occurs within 2 years after the date of the deconsolidation, a
separate statement entitled ``statement pursuant to Sec. 1.337(d)-
2(b)(4)'' must be filed with the taxpayer's return for the year of
disposition. If the taxpayer fails to file the statement as required, no
deduction is allowed for any loss recognized with respect to the
disposition. If the separate statement is required to be filed with a
return the due date (including extensions) of which is before January
16, 1991, or with a return due (including extensions) after January 15,
1991 but filed before that date, the statement may be filed with an
amended return for the year of the disposition or with the taxpayer's
first subsequent return the due date (including
[[Page 78]]
extensions) of which is after January 15, 1991. A disposition after the
2-year period described in this paragraph (b)(4) that is pursuant to an
agreement, option, or other arrangement entered into within the 2-year
period is treated as a disposition within the 2-year period for purposes
of this section.
(ii) Contents of statement. The statement required under paragraph
(b)(4)(i) of this section must contain--
(A) The name and employer identification number (E.I.N.) of the
subsidiary.
(B) The amount of prior basis reduction with respect to the stock of
the subsidiary under paragraph (b)(1) of this section.
(C) The basis of the stock of the subsidiary immediately before the
disposition.
(D) The amount realized on the disposition.
(E) The amount of the loss recognized on the disposition.
(c) Allowable loss--(1) Application. This paragraph (c) applies with
respect to stock of a subsidiary only if--
(i) Before February 1, 1991, the consolidated group either--
(A) Disposes (in one or more transactions) of its entire equity
interest in the subsidiary to persons not related to any member of the
consoldiated group within the meaning of section 267(b) or section
707(b)(1) (substituting ``10 percent'' for ``50 percent'' each place
that it appears); or
(B) Sustains a worthless stock loss under section 165(g); and
(ii) A separate statement entitled ``allowed loss under
Sec. 1.337(d)-2(c)'' is filed in accordance with paragraph (c)(3) of
this section.
(2) General rule. Loss is not disallowed under paragraph (a)(1) of
this section and basis is not reduced under paragraph (b)(1) of this
section to the extent the taxpayer establishes that the loss or basis is
not attributable to the recognition of built-in gain on the disposition
of an asset (including stock and securities). Loss or basis may be
attributable to the recognition of built-in gain on the disposition of
an asset by a prior group. For purposes of this section, gain recognized
on the disposition of an asset is built-in gain to the extent
attributable, directly or indirectly, in whole or in part, to any excess
of value over basis that is reflected, before the disposition of the
asset, in the basis of the share, directly or indirectly, in whole or in
part, after applying section 1503(e) and other applicable provisions of
the Code and regulations.
(3) Contents of statement and time of filing. The statement required
under paragraph (c)(1)(ii) of this section must be filed with the
taxpayer's return for the year of the disposition or deconsolidation,
and must contain--
(i) The name and employer identification number (E.I.N.) of the
subsidiary.
(ii) The basis of the stock of the subsidiary immediately before the
disposition or deconsolidation.
(iii) The amount realized on the disposition and the amount of fair
market value on the deconsolidation.
(iv) The amount of the deduction not disallowed under paragraph
(a)(1) of this section by reason of this paragraph (c) and the amount of
basis not reduced under paragraph (b)(1) of this section by reason of
this paragraph (c).
(v) The amount of loss disallowed under paragraph (a)(1) of this
section and the amount of basis reduced under paragraph (b)(1) of this
section.
If the separate statement is required to be filed with a return the
due date (including extensions) of which is before January 16, 1991, or
with a return due (including extensions) after January 15, 1991 but
filed before that date, the statement may be filed with an amended
return for the year of the disposition or deconsolidation or with the
taxpayer's first subsequent return the due date (including extensions)
of which is after January 15, 1991.
(4) Example. The principles of paragraphs (a), (b), and (c) of this
section are illustrated by the examples in Secs. 1.337(d)-1(a) and
1.1502-20(a) (other than Examples 3, 4, and 5) and (b), with appropriate
adjustments to reflect differences between the approach of this section
and that of Sec. 1.1502-20, and by the following example. For purposes
of the examples in this section, unless otherwise stated, the group
files consolidated returns on a calendar year
[[Page 79]]
basis, the facts set forth the only corporate activity, and all sales
and purchases are with unrelated buyers or sellers. The basis of each
asset is the same for determining earnings and profits adjustments and
taxable income. Tax liability and its effect on basis, value, and
earnings and profits are disregarded. Investment adjustment system means
the rules of Sec. 1.1502-32.
Example. Loss offsetting built-in gain in a prior group. (i) P buys
all the stock of T for $50 in Year 1, and T becomes a member of the P
group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0, and
asset 2 has a basis of $0 and a value of $50. T sells asset 2 during
Year 3 for $50, and recognizes a $50 gain. Under the investment
adjustment system, P's basis in the T stock increases to $100 as a
result of the recognition of gain. In year 5, all of the stock of P is
acquired by the P1 group, and the former members of the P group become
members of the P1 group. T then sells asset 1 for $0, and recognizes a
$50 loss. Under the investment adjustment system. P's basis in the T
stock decreases to $50 as a result of the loss. T's assets decline in
value from $50 to $40. P then sells all the stock of T for $40 and
recognizes a $10 loss.
(ii) P's basis in the T stock reflects both T's unrecognized gain
and unrecognized loss with respect to its assets. The gain T recognizes
on the disposition of asset 2 is built-in gain with respect to both the
P and the P1 groups for purposes of paragraph (c)(2) of this section. In
addition, the loss T recognizes on the disposition of asset 2 is built-
in loss with respect to the P and P1 groups for purposes of paragraph
(c)(2) of this section. T's recognition of the built-in loss while a
member of the P1 group offsets the effect on T's stock basis of T's
recognition of the built-in gain while a member of the P group. Thus,
P's $10 loss on the sale of the T stock is not attributable to the
recognition of built-in gain, and the loss is therefore not disallowed
under paragraph (c)(2) of this section.
(iii) The result would be the same if, instead of having a $50
built-in loss in asset 2 when it becomes a member of the P group, T has
a $50 net operating loss carryover and the carryover is used by the P
group.
(d) Successors. For purposes of this section, the rules and examples
of Sec. 1.1502-20(d) apply, with appropriate adjustments to reflect
differences between the approach of this section and that of
Sec. 1.1502-20.
(e) Anti-avoidance rules. For purposes of this section, the rules
and examples of Sec. 1.1502-20(e) apply, with appropriate adjustments to
reflect differences between the approach of this section and that of
Sec. 1.1502-20.
(f) Investment adjustments and earnings and profits. For purposes of
this section, the rules and examples of Sec. 1.1502-20 (f) apply, with
appropriate adjustments to reflect differences between the approach of
this section and that of Sec. 1.1502-20.
(g) Effective dates--(1) General rule. Except as otherwise provided
in this paragraph (g), this section applies with respect to dispositions
and deconsolidations on or after November 19, 1990, but only to the
extent the disposition or deconsolidation is not subject to Sec. 1.1502-
20. For this purpose, dispositions deferred under Secs. 1.1502-13 and
1.1502-14 (as contained in the 26 CFR part 1 edition revised as of April
1, 1995) are deemed to occur at the time the deferred gain or loss is
taken into account unless the stock was deconsolidated before November
19, 1990. If stock of a subsidiary became worthless during a taxable
year including November 19, 1990, the disposition with respect to the
stock is treated as occurring on the date the stock became worthless.
(2) Binding contract rule. For purposes of this paragraph (g), if a
disposition or deconsolidation is pursuant to a binding written contract
entered into before March 9, 1990, and in continuous effect until the
disposition or deconsolidation, the date the contract became binding is
treated as the date of the disposition or deconsolidation.
(3) Application of Sec. 1.1502-20T to certain transactions--(i) In
general. If a group files the certification described in paragraph
(g)(3)(ii) of this section, it may apply Sec. 1.1502-20T (as contained
in the CFR edition revised as of April 1, 1990), to all of its members
with respect to all dispositions and deconsolidations by the certifying
group to which Sec. 1.1502-20T otherwise applied by its terms occurring-
-
(A) On or after March 9, 1990 (but only if not pursuant to a binding
contract described in Sec. 1.337(d)-1T(e)(2) (as contained in the CFR
edition revised as of April 1, 1990) that was entered into before March
9, 1990); and
(B) Before November 19, 1990 (or thereafter, if pursuant to a
binding contract described in Sec. 1.1502-20T(g)(3)
[[Page 80]]
that was entered into on or after March 9, 1990 and before November 19,
1990).
The certification under this paragraph (g)(3)(i) with respect to the
application of Sec. 1.1502-20T to any transaction described in this
paragraph (g)(3)(i) may not be withdrawn and, if the certification is
filed, Sec. 1.1502-20T must be applied to all such transactions on all
returns (including amended returns) on which such transactions are
included.
(ii) Time and manner of filing certification. The certification
described in paragraph (g)(3)(i) of this section must be made in a
separate statement entitled ``[insert name and employer identification
number of common parent] hereby certifies under Sec. 1.337(d)-2(g)(3)
that the group of which it is the common parent is applying Sec. 1.1502-
20T to all transactions to which that section otherwise applied by its
terms.'' The statement must be signed by the common parent and filed
with the group's income tax return for the taxable year of the first
disposition or deconsolidation to which the certification applies. If
the separate statement required under this paragraph (g)(3) is to be
filed with a return the due date (including extensions) of which is
before November 16, 1991, the statement may be filed with an amended
return for the year of the disposition or deconsolidation that is filed
within 180 days after September 13, 1991. Any other filings required
under Sec. 1.1502-20T, such as the statement required under Sec. 1.1502-
20T(f)(5), may be made with the amended return, regardless of whether
Sec. 1.1502-20T permits such filing by amended return.
(4) For dispositions and deconsolidations on and after March 7,
2002, see Sec. 1.337(d)-2T.
[T.D. 8364, 56 FR 47390, Sept. 19, 1991; 57 FR 53550, Nov. 12, 1992;
T.D. 8560, 59 FR 41674, Aug. 15, 1994; T.D. 8597, 60 FR 36679, July 18,
1995; T.D. 8984, 67 FR 11036, Mar. 12, 2002]
Sec. 1.337(d)-2T Loss limitation window period (temporary).
(a) Loss disallowance--(1) General rule. No deduction is allowed for
any loss recognized by a member of a consolidated group with respect to
the disposition of stock of a subsidiary.
(2) Definitions. For purposes of this section:
(i) The definitions in Sec. 1.1502-1 apply.
(ii) Disposition means any event in which gain or loss is
recognized, in whole or in part.
(3) Coordination with loss deferral and other disallowance rules.
For purposes of this section, the rules of Sec. 1.1502-20(a)(3) apply,
with appropriate adjustments to reflect differences between the approach
of this section and that of Sec. 1.1502-20.
(4) Netting. Paragraph (a)(1) of this section does not apply to loss
with respect to the disposition of stock of a subsidiary, to the extent
that, as a consequence of the same plan or arrangement, gain is taken
into account by members with respect to stock of the same subsidiary
having the same material terms. If the gain to which this paragraph
applies is less than the amount of the loss with respect to the
disposition of the subsidiary's stock, the gain is applied to offset
loss with respect to each share disposed of as a consequence of the same
plan or arrangement in proportion to the amount of the loss deduction
that would have been disallowed under paragraph (a)(1) of this section
with respect to such share before the application of this paragraph
(a)(4). If the same item of gain could be taken into account more than
once in limiting the application of paragraphs (a)(1) and (b)(1) of this
section, the item is taken into account only once.
(b) Basis reduction on deconsolidation--(1) General rule. If the
basis of a member of a consolidated group in a share of stock of a
subsidiary exceeds its value immediately before a deconsolidation of the
share, the basis of the share is reduced at that time to an amount equal
to its value. If both a disposition and a deconsolidation occur with
respect to a share in the same transaction, paragraph (a) of this
section applies and, to the extent necessary to effectuate the purposes
of this section, this paragraph (b) applies following the application of
paragraph (a) of this section.
(2) Deconsolidation. Deconsolidation means any event that causes a
share of stock of a subsidiary that remains outstanding to be no longer
owned by a
[[Page 81]]
member of any consolidated group of which the subsidiary is also a
member.
(3) Value. Value means fair market value.
(4) Netting. Paragraph (b)(1) of this section does not apply to
reduce the basis of stock of a subsidiary, to the extent that, as a
consequence of the same plan or arrangement, gain is taken into account
by members with respect to stock of the same subsidiary having the same
material terms. If the gain to which this paragraph applies is less than
the amount of basis reduction with respect to shares of the subsidiary's
stock, the gain is applied to offset basis reduction with respect to
each share deconsolidated as a consequence of the same plan or
arrangement in proportion to the amount of the reduction that would have
been required under paragraph (b)(1) of this section with respect to
such share before the application of this paragraph (b)(4).
(c) Allowable Loss--(1) Application. This paragraph (c) applies with
respect to stock of a subsidiary only if a separate statement entitled
``Sec. 1.337(d)-2T(c) statement'' is included with the return in
accordance with paragraph (c)(3) of this section.
(2) General rule. Loss is not disallowed under paragraph (a)(1) of
this section and basis is not reduced under paragraph (b)(1) of this
section to the extent the taxpayer establishes that the loss or basis is
not attributable to the recognition of built-in gain on the disposition
of an asset (including stock and securities). Loss or basis may be
attributable to the recognition of built-in gain on the disposition of
an asset by a prior group. For purposes of this section, gain recognized
on the disposition of an asset is built-in gain to the extent
attributable, directly or indirectly, in whole or in part, to any excess
of value over basis that is reflected, before the disposition of the
asset, in the basis of the share, directly or indirectly, in whole or in
part, after applying section 1503(e) and other applicable provisions of
the Internal Revenue Code and regulations.
(3) Contents of statement and time of filing. The statement required
under paragraph (c)(1) of this section must be included with or as part
of the taxpayer's return for the year of the disposition or
deconsolidation and must contain:
(i) The name and employer identification number (E.I.N.) of the
subsidiary.
(ii) The amount of the loss not disallowed under paragraph (a)(1) of
this section by reason of this paragraph (c) and the amount of basis not
reduced under paragraph (b)(1) of this section by reason of this
paragraph (c).
(4) Example. The principles of paragraphs (a), (b), and (c) of this
section are illustrated by the examples in Secs. 1.337(d)-1(a)(5) and
1.1502-20(a)(5) (other than Examples 3, 4, and 5) and (b), with
appropriate adjustments to reflect differences between the approach of
this section and that of Sec. 1.1502-20, and by the following example.
For purposes of the examples in this section, unless otherwise stated,
the group files consolidated returns on a calendar year basis, the facts
set forth the only corporate activity, and all sales and purchases are
with unrelated buyers or sellers. The basis of each asset is the same
for determining earnings and profits adjustments and taxable income. Tax
liability and its effect on basis, value, and earnings and profits are
disregarded. Investment adjustment system means the rules of
Sec. 1.1502-32.
Example. Loss offsetting built-in gain in a prior group. (i) P buys
all the stock of T for $50 in Year 1, and T becomes a member of the P
group. T has 2 assets. Asset 1 has a basis of $50 and a value of $0, and
asset 2 has a basis of $0 and a value of $50. T sells asset 2 during
Year 3 for $50, and recognizes a $50 gain. Under the investment
adjustment system, P's basis in the T stock increased to $100 as a
result of the recognition of gain. In Year 5, all of the stock of P is
acquired by the P1 group, and the former members of the P group become
members of the P1 group. T then sells asset 1 for $0, and recognizes a
$50 loss. Under the investment adjustment system, P's basis in the T
stock decreases to $50 as a result of the loss. T's assets decline in
value from $50 to $40. P then sells all the stock of T for $40 and
recognizes a $10 loss.
(ii) P's basis in the T stock reflects both T's unrecognized gain
and unrecognized loss with respect to its assets. The gain T recognizes
on the disposition of asset 2 is built-in gain with respect to both the
P and the P1 groups for purposes of paragraph (c)(2) of this section. In
addition, the loss T recognizes on the disposition of asset 2 is built-
in loss with respect to the P and P1 groups for purposes
[[Page 82]]
of paragraph (c)(2) of this section. T's recognition of the built-in
loss while a member of the P1 group offsets the effect on T's stock
basis of T's recognition of the built-in gain while a member of the P
group. Thus, P's $10 loss on the sale of the T stock is not attributable
to the recognition of built-in gain, and the loss is therefore not
disallowed under paragraph (c)(2) of this section.
(iii) The result would be the same if, instead of having a $50
built-in loss in asset 2 when it becomes a member of the P group, T has
a $50 net operating loss carryover and the carryover is used by the P
group.
(d) Successors. For purposes of this section, the rules and examples
of Sec. 1.1502-20(d) apply, with appropriate adjustments to reflect
differences between the approach of this section and that of
Sec. 1.1502-20.
(e) Anti-avoidance rules. For purposes of this section, the rules
and examples of Sec. 1.1502-20(e) apply, with appropriate adjustments to
reflect differences between the approach of this section and that of
Sec. 1.1502-20.
(f) Investment adjustments. For purposes of this section, the rules
and examples of Sec. 1.1502-20(f) apply, with appropriate adjustments to
reflect differences between the approach of this section and that of
Sec. 1.1502-20.
(g) Effective dates. This section applies with respect to
dispositions and deconsolidations on or after March 7, 2002, unless the
disposition or deconsolidation was effected pursuant to a binding
written contract entered into before March 7, 2002, that was in
continuous effect until the disposition or deconsolidation. In addition,
this section applies to dispositions and deconsolidations for which an
election is made under Sec. 1.1502-20T(i)(2) to determine allowable loss
under this section. If loss is recognized because stock of a subsidiary
became worthless, the disposition with respect to the stock is treated
as occurring on the date the stock became worthless. For dispositions
and deconsolidations prior to March 7, 2002, see Secs. 1.337(d)-1 and
1.337(d)-2 as contained in the 26 CFR part 1 edition revised as of April
1, 2001.
[T.D. 8984, 67 FR 11036, Mar. 12, 2002, as amended by T.D. 8998, 67 FR
37999, May 31, 2002]
Sec. 1.337(d)-4 Taxable to tax-exempt.
(a) Gain or loss recognition--(1) General rule. Except as provided
in paragraph (b) of this section, if a taxable corporation transfers all
or substantially all of its assets to one or more tax-exempt entities,
the taxable corporation must recognize gain or loss immediately before
the transfer as if the assets transferred were sold at their fair market
values. But see section 267 and paragraph (d) of this section concerning
limitations on the recognition of loss.
(2) Change in corporation's tax status treated as asset transfer.
Except as provided in paragraphs (a)(3) and (b) of this section, a
taxable corporation's change in status to a tax-exempt entity will be
treated as if it transferred all of its assets to a tax-exempt entity
immediately before the change in status becomes effective in a
transaction to which paragraph (a)(1) of this section applies. For
example, if a State, a political subdivision thereof, or an entity any
portion of whose income is excluded from gross income under section 115,
acquires the stock of a taxable corporation and thereafter any of the
taxable corporation's income is excluded from gross income under section
115, the taxable corporation will be treated as if it transferred all of
its assets to a tax-exempt entity immediately before the stock
acquisition.
(3) Exceptions for certain changes in status--(i) To whom available.
Paragraph (a)(2) of this section does not apply to the following
corporations--
(A) A corporation previously tax-exempt under section 501(a) which
regains its tax-exempt status under section 501(a) within three years
from the later of a final adverse adjudication on the corporation's tax
exempt status, or the filing by the corporation, or by the Secretary or
his delegate under section 6020(b), of a federal income tax return of
the type filed by a taxable corporation;
(B) A corporation previously tax-exempt under section 501(a) or that
applied for but did not receive recognition of exemption under section
501(a) before January 15, 1997, if such corporation is tax-exempt under
section 501(a) within three years from January 28, 1999;
[[Page 83]]
(C) A newly formed corporation that is tax-exempt under section
501(a) (other than an organization described in section 501(c)(7))
within three taxable years from the end of the taxable year in which it
was formed;
(D) A newly formed corporation that is tax-exempt under section
501(a) as an organization described in section 501(c)(7) within seven
taxable years from the end of the taxable year in which it was formed;
(E) A corporation previously tax-exempt under section 501(a) as an
organization described in section 501(c)(12), which, in a given taxable
year or years prior to again becoming tax-exempt, is a taxable
corporation solely because less than 85 percent of its income consists
of amounts collected from members for the sole purpose of meeting losses
and expenses; if, in a taxable year, such a corporation would be a
taxable corporation even if 85 percent or more of its income consists of
amounts collected from members for the sole purpose of meeting losses
and expenses (a non-85 percent violation), paragraph (a)(3)(i)(A) of
this section shall apply as if the corporation became a taxable
corporation in its first taxable year that a non-85 percent violation
occurred; or
(F) A corporation previously taxable that becomes tax-exempt under
section 501(a) as an organization described in section 501(c)(15) if
during each taxable year in which it is described in section 501(c)(15)
the organization is the subject of a court supervised rehabilitation,
conservatorship, liquidation, or similar state proceeding; if such a
corporation continues to be described in section 501(c)(15) in a taxable
year when it is no longer the subject of a court supervised
rehabilitation, conservatorship, liquidation, or similar state
proceeding, paragraph (a)(2) of this section shall apply as if the
corporation first became tax-exempt for such taxable year.
(ii) Application for recognition. An organization is deemed to have
or regain tax-exempt status within one of the periods described in
paragraph (a)(3)(i)(A), (B), (C), or (D) of this section if it files an
application for recognition of exemption with the Commissioner within
the applicable period and the application either results in a
determination by the Commissioner or a final adjudication that the
organization is tax-exempt under section 501(a) during any part of the
applicable period. The preceding sentence does not require the filing of
an application for recognition of exemption by any organization not
otherwise required, such as by Sec. 1.501(a)-1, Sec. 1.505(c)-1T, and
Sec. 1.508-1(a), to apply for recognition of exemption.
(iii) Anti-abuse rule. This paragraph (a)(3) does not apply to a
corporation that, with a principal purpose of avoiding the application
of paragraph (a)(1) or (a)(2) of this section, acquires all or
substantially all of the assets of another taxable corporation and then
changes its status to that of a tax-exempt entity.
(4) Related transactions. This section applies to any series of
related transactions having an effect similar to any of the transactions
to which this section applies.
(b) Exceptions. Paragraph (a) of this section does not apply to--
(1) Any assets transferred to a tax-exempt entity to the extent that
the assets are used in an activity the income from which is subject to
tax under section 511(a) (referred to hereinafter as a ``section 511(a)
activity''). However, if assets used to any extent in a section 511(a)
activity are disposed of by the tax-exempt entity, then, notwithstanding
any other provision of law (except section 1031 or section 1033), any
gain (not in excess of the amount not recognized by reason of the
preceding sentence) shall be included in the tax-exempt entity's
unrelated business taxable income. To the extent that the tax-exempt
entity ceases to use the assets in a section 511(a) activity, the entity
will be treated for purposes of this paragraph (b)(1) as having disposed
of the assets on the date of the cessation for their fair market value.
For purposes of paragraph (a)(1) of this section and this paragraph
(b)(1)--
(i) If during the first taxable year following the transfer of an
asset or the corporation's change to tax-exempt status the asset will be
used by the tax-exempt entity partly or wholly in a
[[Page 84]]
section 511(a) activity, the taxable corporation will recognize an
amount of gain or loss that bears the same ratio to the asset's built-in
gain or loss as 100 percent reduced by the percentage of use for such
taxable year in the section 511(a) activity bears to 100 percent. For
purposes of determining the gain or loss, if any, to be recognized, the
taxable corporation may rely on a written representation from the tax-
exempt entity estimating the percentage of the asset's anticipated use
in a section 511(a) activity for such taxable year, using a reasonable
method of allocation, unless the taxable corporation has reason to
believe that the tax-exempt entity's representation is not made in good
faith;
(ii) If for any taxable year the percentage of an asset's use in a
section 511(a) activity decreases from the estimate used in computing
gain or loss recognized under paragraph (b)(1)(i) of this section,
adjusted for any decreases taken into account under this paragraph
(b)(1)(ii) in prior taxable years, the tax-exempt entity shall recognize
an amount of gain or loss that bears the same ratio to the asset's
built-in gain or loss as the percentage point decrease in use in the
section 511(a) activity for the taxable year bears to 100 percent;
(iii) If property on which all or a portion of the gain or loss is
not recognized by reason of the first sentence of paragraph (b)(1) of
this section is disposed of in a transaction that qualifies for
nonrecognition treatment under section 1031 or section 1033, the tax-
exempt entity must treat the replacement property as remaining subject
to paragraph (b)(1) of this section to the extent that the exchanged or
involuntarily converted property was so subject;
(iv) The tax-exempt entity must use the same reasonable method of
allocation for determining the percentage that it uses the assets in a
section 511(a) activity as it uses for other tax purposes, such as
determining the amount of depreciation deductions. The tax-exempt entity
also must use this same reasonable method of allocation for each taxable
year that it holds the assets; and
(v) An asset's built-in gain or loss is the amount that would be
recognized under paragraph (a)(1) of this section except for this
paragraph (b)(1);
(2) Any transfer of assets to the extent gain or loss otherwise is
recognized by the taxable corporation on the transfer. See, for example,
sections 336, 337(b)(2), 367, and 1001;
(3) Any transfer of assets to the extent the transaction qualifies
for nonrecognition treatment under section 1031 or section 1033; or
(4) Any forfeiture of a taxable corporation's assets in a criminal
or civil action to the United States, the government of a possession of
the United States, a state, the District of Columbia, the government of
a foreign country, or a political subdivision of any of the foregoing;
or any expropriation of a taxable corporation's assets by the government
of a foreign country.
(c) Definitions. For purposes of this section:
(1) Taxable corporation. A taxable corporation is any corporation
that is not a tax-exempt entity as defined in paragraph (c)(2) of this
section.
(2) Tax-exempt entity. A tax-exempt entity is--
(i) Any entity that is exempt from tax under section 501(a) or
section 529;
(ii) A charitable remainder annuity trust or charitable remainder
unitrust as defined in section 664(d);
(iii) The United States, the government of a possession of the
United States, a state, the District of Columbia, the government of a
foreign country, or a political subdivision of any of the foregoing;
(iv) An Indian Tribal Government as defined in section 7701(a)(40),
a subdivision of an Indian Tribal Government determined in accordance
with section 7871(d), or an agency or instrumentality of an Indian
Tribal Government or subdivision thereof;
(v) An Indian Tribal Corporation organized under section 17 of the
Indian Reorganization Act of 1934, 25 U.S.C. 477, or section 3 of the
Oklahoma Welfare Act, 25 U.S.C. 503;
(vi) An international organization as defined in section
7701(a)(18);
(vii) An entity any portion of whose income is excluded under
section 115; or
[[Page 85]]
(viii) An entity that would not be taxable under the Internal
Revenue Code for reasons substantially similar to those applicable to
any entity listed in this paragraph (c)(2) unless otherwise explicitly
made exempt from the application of this section by statute or by action
of the Commissioner.
(3) Substantially all. The term substantially all has the same
meaning as under section 368(a)(1)(C).
(d) Loss limitation rule. For purposes of determining the amount of
gain or loss recognized by a taxable corporation on the transfer of its
assets to a tax-exempt entity under paragraph (a) of this section, if
assets are acquired by the taxable corporation in a transaction to which
section 351 applied or as a contribution to capital, or assets are
distributed from the taxable corporation to a shareholder or another
member of the taxable corporation's affiliated group, and in either case
such acquisition or distribution is made as part of a plan a principal
purpose of which is to recognize loss by the taxable corporation on the
transfer of such assets to the tax-exempt entity, the losses recognized
by the taxable corporation on such assets transferred to the tax-exempt
entity will be disallowed. For purposes of the preceding sentence, the
principles of section 336(d)(2) apply.
(e) Effective date. This section is applicable to transfers of
assets as described in paragraph (a) of this section occurring after
January 28, 1999, unless the transfer is pursuant to a written agreement
which is (subject to customary conditions) binding on or before January
28, 1999.
[T.D. 8802, 63 FR 71594, Dec. 29, 1998]
Sec. 1.337(d)-5 Old transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT
(a) Treatment of C corporations--(1) Scope. This section applies to
the net built-in gain of C corporation assets that become assets of a
RIC or REIT by--
(i) The qualification of a C corporation as a RIC or REIT; or
(ii) The transfer of assets of a C corporation to a RIC or REIT in a
transaction in which the basis of such assets are determined by
reference to the C corporation's basis (a carryover basis).
(2) Net built-in gain. Net built-in gain is the excess of aggregate
gains (including items of income) over aggregate losses.
(3) General rule. Unless an election is made pursuant to paragraph
(b) of this section, the C corporation will be treated, for all purposes
including recognition of net built-in gain, as if it had sold all of its
assets at their respective fair market values on the deemed liquidation
date described in paragraph (a)(7) of this section and immediately
liquidated.
(4) Loss. Paragraph(a)(3) of this section shall not apply if its
application would result in the recognition of net built-in loss.
(5) Basis adjustment. If a corporation is subject to corporate-level
tax under paragraph (a)(3) of this section, the bases of the assets in
the hands of the RIC or REIT will be adjusted to reflect the recognized
net built-in gain. This adjustment is made by taking the C corporation's
basis in each asset, and, as appropriate, increasing it by the amount of
any built-in gain attributable to that asset, or decreasing it by the
amount of any built-in loss attributable to that asset.
(6) Exception--(i) In general. Paragraph (a)(3) of this section does
not apply to any C corporation that--
(A) Immediately prior to qualifying to be taxed as a RIC was subject
to tax as a C corporation for a period not exceeding one taxable year;
and
(B) Immediately prior to being subject to tax as a C corporation was
subject to the RIC tax provisions for a period of at least one taxable
year.
(ii) Additional requirement. The exception described in paragraph
(a)(6)(i) of this section applies only to assets acquired by the
corporation during the year when it was subject to tax as a C
corporation in a transaction that does not result in its basis in the
asset being determined by reference to a corporate transferor's basis.
(7) Deemed liquidation date--(i) Conversions. In the case of a C
corporation that qualifies to be taxed as a RIC or REIT, the deemed
liquidation date is
[[Page 86]]
the last day of its last taxable year before the taxable year in which
it qualifies to be taxed as a RIC or REIT.
(ii) Carryover basis transfers. In the case of a C corporation that
transfers property to a RIC or REIT in a carryover basis transaction,
the deemed liquidation date is the day before the date of the transfer.
(b) Section 1374 treatment--(1) In general. Paragraph (a) of this
section will not apply if the transferee RIC or REIT elects (as
described in paragraph (b)(3) of this section) to be subject to the
rules of section 1374, and the regulations thereunder. The electing RIC
or REIT will be subject to corporate-level taxation on the built-in gain
recognized during the 10-year period on assets formerly held by the
transferor C corporation. The built-in gains of electing RICs and REITs,
and the corporate-level tax imposed on such gains, are subject to rules
similar to the rules relating to net income from foreclosure property of
REITs. See sections 857(a)(1)(A)(ii), and 857(b)(2)(B), (D), and (E). An
election made under this paragraph (b) shall be irrevocable.
(2) Ten-year recognition period. In the case of a C corporation that
qualifies to be taxed as a RIC or REIT, the 10-year recognition period
described in section 1374(d)(7) begins on the first day of the RIC's or
REIT's taxable year for which the corporation qualifies to be taxed as a
RIC or REIT. In the case of a C corporation that transfers property to a
RIC or REIT in a carryover basis transaction, the 10-year recognition
period begins on the day the assets are acquired by the RIC or REIT.
(3) Making the election. A RIC or REIT validly makes a section 1374
election with the following statement: ``[Insert name and employer
identification number of electing RIC or REIT] elects under paragraph
(b) of this section to be subject to the rules of section 1374 and the
regulations thereunder with respect to its assets which formerly were
held by a C corporation, [insert name and employer identification number
of the C corporation, if different from name and employer identification
number of RIC or REIT].'' This statement must be signed by an official
authorized to sign the income tax return of the RIC or REIT and attached
to the RIC's or REIT's Federal income tax return for the first taxable
year in which the assets of the C corporation become assets of the RIC
or REIT.
(c) Special rule. In cases where the first taxable year in which the
assets of the C corporation become assets of the RIC or REIT ends after
June 10, 1987 but before March 8, 2000, the section 1374 election may be
filed with the first Federal income tax return filed by the RIC or REIT
after March 8, 2000.
(d) Effective date. In the case of carryover basis transactions
involving the transfer of property of a C corporation to a RIC or REIT,
the regulations apply to transactions occurring on or after June 10,
1987, and before January 2, 2002. In the case of a C corporation that
qualifies to be taxed as a RIC or REIT, the regulations apply to such
qualifications that are effective for taxable years beginning on or
after June 10, 1987, and before January 2, 2002. However, RICs and REITs
that are subject to section 1374 treatment under this section may not
rely on paragraph (b)(1) of this section, but must apply paragraphs
(c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of Sec. 1.337(d)-6, with
respect to built-in gains and losses recognized in taxable years
beginning on or after January 2, 2002. In lieu of applying this section,
taxpayers may rely on Sec. 1.337(d)-6 to determine the tax consequences
(for all taxable years) of any conversion transaction. For transactions
and qualifications that occur on or after January 2, 2002, see
Sec. 1.337(d)-7.
[T.D. 8872, 65 FR 5776, Feb. 7, 2000, as amended by T.D. 8975, 67 FR 12,
Jan. 2, 2002. Redesignated and amended by T.D. 9047, 68 FR 12819, Mar.
19, 2003]
Sec. 1.337(d)-6 New transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT.
(a) General rule--(1) Property owned by a C corporation that becomes
property of a RIC or REIT. If property owned by a C corporation (as
defined in paragraph (a)(2)(i) of this section) becomes the property of
a RIC or REIT (the converted property) in a conversion transaction (as
defined in paragraph (a)(2)(ii) of this section), then deemed sale
treatment will apply as described
[[Page 87]]
in paragraph (b) of this section, unless the RIC or REIT elects section
1374 treatment with respect to the conversion transaction as provided in
paragraph (c) of this section. See paragraph (d) of this section for
exceptions to this paragraph (a).
(2) Definitions--(i) C corporation. For purposes of this section,
the term C corporation has the meaning provided in section 1361(a)(2)
except that the term does not include a RIC or REIT.
(ii) Conversion transaction. For purposes of this section, the term
conversion transaction means the qualification of a C corporation as a
RIC or REIT or the transfer of property owned by a C corporation to a
RIC or REIT.
(b) Deemed sale treatment--(1) In general. If property owned by a C
corporation becomes the property of a RIC or REIT in a conversion
transaction, then the C corporation recognizes gain and loss as if it
sold the converted property to an unrelated party at fair market value
on the deemed sale date (as defined in paragraph (b)(3) of this
section). This paragraph (b) does not apply if its application would
result in the recognition of a net loss. For this purpose, net loss is
the excess of aggregate losses over aggregate gains (including items of
income), without regard to character.
(2) Basis adjustment. If a corporation recognizes a net gain under
paragraph (b)(1) of this section, then the converted property has a
basis in the hands of the RIC or REIT equal to the fair market value of
such property on the deemed sale date.
(3) Deemed sale date--(i) RIC or REIT qualifications. If the
conversion transaction is a qualification of a C corporation as a RIC or
REIT, then the deemed sale date is the end of the last day of the C
corporation's last taxable year before the first taxable year in which
it qualifies to be taxed as a RIC or REIT.
(ii) Other conversion transactions. If the conversion transaction is
a transfer of property owned by a C corporation to a RIC or REIT, then
the deemed sale date is the end of the day before the day of the
transfer.
(4) Example. The rules of this paragraph (b) are illustrated by the
following example:
Example. Deemed sale treatment on merger into RIC. (i) X, a
calendar-year taxpayer, has qualified as a RIC since January 1, 1991. On
May 31, 1994, Y, a C corporation and calendar-year taxpayer, transfers
all of its property to X in a transaction that qualifies as a
reorganization under section 368(a)(1)(C). X does not elect section 1374
treatment under paragraph (c) of this section and chooses not to rely on
Sec. 1.337(d)-5. As a result of the transfer, Y is subject to deemed
sale treatment under this paragraph (b) on its tax return for the short
taxable year ending May 31, 1994. On May 31, 1994, Y's only assets are
Capital Asset, which has a fair market value of $100,000 and a basis of
$40,000 as of the end of May 30, 1994, and $50,000 cash. Y also has an
unrestricted net operating loss carryforward of $12,000 and accumulated
earnings and profits of $50,000. Y has no taxable income for the short
taxable year ending May 31, 1994, other than gain recognized under this
paragraph (b). In 1997, X sells Capital Asset for $110,000. Assume the
applicable corporate tax rate is 35%.
(ii) Under this paragraph (b), Y is treated as if it sold the
converted property (Capital Asset and $50,000 cash) at fair market value
on May 30, 1994, recognizing $60,000 of gain ($150,000 amount realized--
$90,000 basis). Y must report the gain on its tax return for the short
taxable year ending May 31, 1994. Y may offset this gain with its
$12,000 net operating loss carryforward and will pay tax of $16,800 (35%
of $48,000).
(iii) Under section 381, X succeeds to Y's accumulated earnings and
profits. Y's accumulated earnings and profits of $50,000 increase by
$60,000 and decrease by $16,800 as a result of the deemed sale. Thus,
the aggregate amount of subchapter C earnings and profits that must be
distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 +
$60,000 - $16,800). X's basis in Capital Asset is $100,000. On X's sale
of Capital Asset in 1997, X recognizes $10,000 of gain, which is taken
into account in computing X's net capital gain for purposes of section
852(b)(3).
(c) Election of section 1374 treatment--(1) In general--(i) Property
owned by a C corporation that becomes property of a RIC or REIT.
Paragraph (b) of this section does not apply if the RIC or REIT that was
formerly a C corporation or that acquired property from a C corporation
makes the election described in paragraph (c)(4) of this section. A RIC
or REIT that makes such an election will be subject to tax on the net
built-in gain in the converted property under the rules of section 1374
and the regulations thereunder, as modified by this paragraph (c), as if
the RIC or REIT were an S corporation.
[[Page 88]]
(ii) Property subject to the rules of section 1374 owned by a RIC,
REIT, or S corporation that becomes property of a RIC or REIT. If
property subject to the rules of section 1374 owned by a RIC, a REIT, or
an S corporation (the predecessor) becomes the property of a RIC or REIT
(the successor) in a continuation transaction, the rules of section 1374
apply to the successor to the same extent that the predecessor was
subject to the rules of section 1374 with respect to such property, and
the 10-year recognition period of the successor with respect to such
property is reduced by the portion of the 10-year recognition period of
the predecessor that expired before the date of the continuation
transaction. For this purpose, a continuation transaction means the
qualification of the predecessor as a RIC or REIT or the transfer of
property from the predecessor to the successor in a transaction in which
the successor's basis in the transferred property is determined, in
whole or in part, by reference to the predecessor's basis in that
property.
(2) Modification of section 1374 treatment--(i) Net recognized
built-in gain for REITs--(A) Prelimitation amount. The prelimitation
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the
portion of such amount, if any, that is subject to tax under section
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's
recognized built-in gain that is subject to tax under section 857(b)(5)
is computed as follows:
(1) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(A), the amount of a REIT's recognized built-in gain
that is subject to tax under section 857(b)(5) is the tax imposed by
section 857(b)(5) multiplied by a fraction the numerator of which is the
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-in gain from prohibited transactions) that
is not derived from sources referred to in section 856(c)(2) and the
denominator of which is the gross income (without regard to gross income
from prohibited transactions) of the REIT that is not derived from
sources referred to in section 856(c)(2).
(2) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(B), the amount of a REIT's recognized built-in gain
that is subject to tax under section 857(b)(5) is the tax imposed by
section 857(b)(5) multiplied by a fraction the numerator of which is the
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-in gain from prohibited transactions) that
is not derived from sources referred to in section 856(c)(3) and the
denominator of which is the gross income (without regard to gross income
from prohibited transactions) of the REIT that is not derived from
sources referred to in section 856(c)(3).
(B) Taxable income limitation. The taxable income limitation
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount
equal to the tax imposed under sections 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and credit carryforwards--(A) Loss
carryforwards. Consistent with paragraph (c)(1)(i) of this section, net
operating loss carryforwards and capital loss carryforwards arising in
taxable years for which the corporation that generated the loss was not
subject to subchapter M of chapter 1 of the Internal Revenue Code are
allowed as a deduction against net recognized built-in gain to the
extent allowed under section 1374 and the regulations thereunder. Such
loss carryforwards must be used as a deduction against net recognized
built-in gain for a taxable year to the greatest extent possible before
such losses can be used to reduce other investment company taxable
income for purposes of section 852(b) or other real estate investment
trust taxable income for purposes of section 857(b) for that taxable
year.
(B) Credits and credit carryforwards. Consistent with paragraph
(c)(1)(i) of this section, minimum tax credits and business credit
carryforwards arising in taxable years for which the corporation that
generated the credit was not subject to subchapter M of chapter 1 of the
Internal Revenue Code are allowed to reduce the tax imposed on net
recognized built-in gain under this paragraph (c) to the extent allowed
under section 1374 and the regulations thereunder. Such credits and
credit
[[Page 89]]
carryforwards must be used to reduce the tax imposed under this
paragraph (c) on net recognized built-in gain for a taxable year to the
greatest extent possible before such credits and credit carryforwards
can be used to reduce the tax, if any, on other investment company
taxable income for purposes of section 852(b) or on other real estate
investment trust taxable income for purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the case of a conversion
transaction that is a qualification of a C corporation as a RIC or REIT,
the 10-year recognition period described in section 1374(d)(7) begins on
the first day of the RIC's or REIT's first taxable year. In the case of
other conversion transactions, the 10-year recognition period begins on
the day the property is acquired by the RIC or REIT.
(3) Coordination with subchapter M rules--(i) Recognized built-in
gains and losses subject to subchapter M. Recognized built-in gains and
losses of a RIC or REIT are included in computing investment company
taxable income for purposes of section 852(b)(2), real estate investment
trust taxable income for purposes of section 857(b)(2), capital gains
for purposes of sections 852(b)(3) and 857(b)(3), gross income derived
from sources within any foreign country or possession of the United
States for purposes of section 853, and the dividends paid deduction for
purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and
857(b)(3)(A). In computing such income and deduction items, capital loss
carryforwards and net operating loss carryforwards that are used by the
RIC or REIT to reduce recognized built-in gains are allowed as a
deduction, but only to the extent that they are otherwise allowable as a
deduction against such income under the Internal Revenue Code (including
section 852(b)(2)(B)).
(ii) Treatment of tax imposed. The amount of tax imposed under this
paragraph (c) on net recognized built-in gain for a taxable year is
treated as a loss sustained by the RIC or the REIT during such taxable
year. The character of the loss is determined by allocating the tax
proportionately (based on recognized built-in gain) among the items of
recognized built-in gain included in net recognized built-in gain. With
respect to RICs, the tax imposed under this paragraph (c) on net
recognized built-in gain is treated as attributable to the portion of
the RIC's taxable year occurring after October 31.
(4) Making the section 1374 election--(i) In general. A RIC or REIT
makes a section 1374 election with the following statement: ``[Insert
name and employer identification number of electing RIC or REIT] elects
under Sec. 1.337-6(c) to be subject to the rules of section 1374 and the
regulations thereunder with respect to its property that formerly was
held by a C corporation, [insert name and employer identification number
of the C corporation, if different from name and employer identification
number of the RIC or REIT].'' However, a RIC or REIT need not file an
election under this paragraph (c), but will be deemed to have made such
an election if it can demonstrate that it informed the Internal Revenue
Service prior to January 2, 2002 of its intent to make a section 1374
election. An election under this paragraph (c) is irrevocable.
(ii) Time for making the election. An election under this paragraph
(c) may be filed by the RIC or REIT with any Federal income tax return
filed by the RIC or REIT on or before September 15, 2003, provided that
the RIC or REIT has reported consistently with such election for all
periods.
(5) Example. The rules of this paragraph (c) are illustrated by the
following example:
Example. Section 1374 treatment on REIT election. (i) X, a C
corporation that is a calendar-year taxpayer, elects to be taxed as a
REIT on its 1994 tax return, which it files on March 15, 1995. As a
result, X is a REIT for its 1994 taxable year and would be subject to
deemed sale treatment under paragraph (b) of this section but for X's
timely election of section 1374 treatment under this paragraph (c). X
chooses not to rely on Sec. 1.337(d)-5. As of the beginning of the 1994
taxable year, X's property consisted of Real Property, which is not
section 1221(a)(1) property and which had a fair market value of
$100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had
accumulated earnings and profits of $25,000, unrestricted capital loss
carryforwards of $3,000, and unrestricted business credit carryforwards
of $2,000. On July 1, 1997, X sells Real Property for $110,000. For its
1997
[[Page 90]]
taxable year, X has no other income or deduction items. Assume the
highest corporate tax rate is 35%.
(ii) Upon its election to be taxed as a REIT, X retains its $80,000
basis in Real Property and its $25,000 accumulated earnings and profits.
X retains its $3,000 of capital loss carryforwards and its $2,000 of
business credit carryforwards. To satisfy section 857(a)(2)(B), X must
distribute $25,000, an amount equal to its earnings and profits
accumulated in non-REIT years, to its shareholders by the end of its
1994 taxable year.
(iii) Upon X's sale of Real Property in 1997, X recognizes gain of
$30,000 ($110,000--$80,000). X's recognized built-in gain for purposes
of applying section 1374 is $20,000 ($100,000 fair market value as of
the beginning of X's first taxable year as a REIT--$80,000 basis).
Because X's $30,000 of net income for the 1997 taxable year exceeds the
net recognized built-in gain of $20,000, the taxable income limitation
does not apply. X, therefore, has $20,000 net recognized built-in gain
for the year. Assuming that X has not used its $3,000 of capital loss
carryforwards in a prior taxable year and that their use is allowed
under section 1374(b)(2) and Sec. 1.1374-5, X is allowed a $3,000
deduction against the $20,000 net recognized built-in gain. X would owe
tax of $5,950 (35% of $17,000) on its net recognized built-in gain,
except that X may use its $2,000 of business credit carryforwards to
reduce this tax, assuming that X has not used the credit carryforwards
in a prior taxable year and that their use is allowed under section
1374(b)(3) and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this
paragraph (c).
(iv) For purposes of subchapter M of chapter 1 of the Internal
Revenue Code, X's earnings and profits for the year increase by $26,050
($30,000 capital gain on the sale of Real Property--$3,950 tax under
this paragraph (c)). For purposes of section 857(b)(2) and (b)(3), X's
net capital gain for the year is $23,050 ($30,000 capital gain reduced
by $3,000 capital loss carryforward and further reduced by $3,950 tax).
(d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of this
section does not apply to any conversion transaction to the extent that
gain or loss otherwise is recognized on such conversion transaction.
See, for example, sections 336, 351(b), 351(e), 356, 357(c), 367,
368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status--(i) Generally. Except as
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph
(a)(1) of this section does not apply to any corporation that--
(A) Immediately prior to qualifying to be taxed as a RIC or REIT was
subject to tax as a C corporation for a period not exceeding two taxable
years; and
(B) Immediately prior to being subject to tax as a C corporation was
subject to tax as a RIC or REIT for a period of at least one taxable
year.
(ii) Property acquired from another corporation while a C
corporation. The exception described in paragraph (d)(2)(i) of this
section does not apply to property acquired by the corporation while it
was subject to tax as a C corporation from any person in a transaction
that results in the acquirer's basis in the property being determined by
reference to a C corporation's basis in the property.
(iii) RICs and REITs previously subject to section 1374 treatment.
If the RIC or REIT had property subject to paragraph (c) of this section
before the RIC or REIT became subject to tax as a C corporation as
described in paragraph (d)(2)(i) of this section, then paragraph (c) of
this section applies to the RIC or REIT upon its requalification as a
RIC or REIT, except that the 10-year recognition period with respect to
such property is reduced by the portion of the 10-year recognition
period that expired before the RIC or REIT became subject to tax as a C
corporation and by the period of time that the corporation was subject
to tax as a C corporation.
(e) Effective date. This section applies to conversion transactions
that occur on or after June 10, 1987, and before January 2, 2002. In
lieu of applying this section, taxpayers generally may apply
Sec. 1.337(d)-5 to determine the tax consequences (for all taxable
years) of any conversion transaction that occurs on or after June 10,
1987 and before January 2, 2002, except that RICs and REITs that are
subject to section 1374 treatment with respect to a conversion
transaction may not rely on Sec. 1.337(d)-5(b)(1), but must apply
paragraphs (c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of this section,
with respect to built-in gains and losses recognized in taxable years
beginning on or after January 2, 2002. Taxpayers are not prevented from
relying on Sec. 1.337(d)-5 merely because they elect section 1374
treatment in the manner described in paragraph (c)(4) of this section
instead of in the manner
[[Page 91]]
described in Sec. 1.337(d)-5(b)(3) and (c). For conversion transactions
that occur on or after January 2, 2002, see Sec. 1.337(d)-7.
[T.D. 9047, 68 FR 12820, Mar. 18, 2003]
Sec. 1.337(d)-7 Tax on property owned by a C corporation that becomes property of a RIC or REIT.
(a) General rule--(1) Property owned by a C corporation that becomes
property of a RIC or REIT. If property owned by a C corporation (as
defined in paragraph (a)(2)(i) of this section) becomes the property of
a RIC or REIT (the converted property) in a conversion transaction (as
defined in paragraph (a)(2)(ii) of this section), then section 1374
treatment will apply as described in paragraph (b) of this section,
unless the C corporation elects deemed sale treatment with respect to
the conversion transaction as provided in paragraph (c) of this section.
See paragraph (d) of this section for exceptions to this paragraph (a).
(2) Definitions--(i) C corporation. For purposes of this section,
the term C corporation has the meaning provided in section 1361(a)(2)
except that the term does not include a RIC or REIT.
(ii) Conversion transaction. For purposes of this section, the term
conversion transaction means the qualification of a C corporation as a
RIC or REIT or the transfer of property owned by a C corporation to a
RIC or REIT.
(b) Section 1374 treatment--(1) In general--(i) Property owned by a
C corporation that becomes property of a RIC or REIT. If property owned
by a C corporation becomes the property of a RIC or REIT in a conversion
transaction, then the RIC or REIT will be subject to tax on the net
built-in gain in the converted property under the rules of section 1374
and the regulations thereunder, as modified by this paragraph (b), as if
the RIC or REIT were an S corporation.
(ii) Property subject to the rules of section 1374 owned by a RIC,
REIT, or S corporation that becomes property of a RIC or REIT. If
property subject to the rules of section 1374 owned by a RIC, a REIT, or
an S corporation (the predecessor) becomes the property of a RIC or REIT
(the successor) in a continuation transaction, the rules of section 1374
apply to the successor to the same extent that the predecessor was
subject to the rules of section 1374 with respect to such property, and
the 10-year recognition period of the successor with respect to such
property is reduced by the portion of the 10-year recognition period of
the predecessor that expired before the date of the continuation
transaction. For this purpose, a continuation transaction means the
qualification of the predecessor as a RIC or REIT or the transfer of
property from the predecessor to the successor in a transaction in which
the successor's basis in the transferred property is determined, in
whole or in part, by reference to the predecessor's basis in that
property.
(2) Modification of section 1374 treatment--(i) Net recognized
built-in gain for REITs--(A) Prelimitation amount. The prelimitation
amount determined as provided in Sec. 1.1374-2(a)(1) is reduced by the
portion of such amount, if any, that is subject to tax under section
857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT's
recognized built-in gain that is subject to tax under section 857(b)(5)
is computed as follows:
(1) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(A), the amount of a REIT's recognized built-in gain
that is subject to tax under section 857(b)(5) is the tax imposed by
section 857(b)(5) multiplied by a fraction the numerator of which is the
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-in gain from prohibited transactions) that
is not derived from sources referred to in section 856(c)(2) and the
denominator of which is the gross income (without regard to gross income
from prohibited transactions) of the REIT that is not derived from
sources referred to in section 856(c)(2).
(2) Where the tax under section 857(b)(5) is computed by reference
to section 857(b)(5)(B), the amount of a REIT's recognized built-in gain
that is subject to tax under section 857(b)(5) is the tax imposed by
section 857(b)(5) multiplied by a fraction the numerator of which is the
amount of recognized built-in gain (without regard to recognized built-
in loss and recognized built-
[[Page 92]]
in gain from prohibited transactions) that is not derived from sources
referred to in section 856(c)(3) and the denominator of which is the
gross income (without regard to gross income from prohibited
transactions) of the REIT that is not derived from sources referred to
in section 856(c)(3).
(B) Taxable income limitation. The taxable income limitation
determined as provided in Sec. 1.1374-2(a)(2) is reduced by an amount
equal to the tax imposed under section 857(b)(5), (6), and (7).
(ii) Loss carryforwards, credits and credit carryforwards --(A) Loss
carryforwards. Consistent with paragraph (b)(1)(i) of this section, net
operating loss carryforwards and capital loss carryforwards arising in
taxable years for which the corporation that generated the loss was not
subject to subchapter M of chapter 1 of the Internal Revenue Code are
allowed as a deduction against net recognized built-in gain to the
extent allowed under section 1374 and the regulations thereunder. Such
loss carryforwards must be used as a deduction against net recognized
built-in gain for a taxable year to the greatest extent possible before
such losses can be used to reduce other investment company taxable
income for purposes of section 852(b) or other real estate investment
trust taxable income for purposes of section 857(b) for that taxable
year.
(B) Credits and credit carryforwards. Consistent with paragraph
(b)(1)(i) of this section, minimum tax credits and business credit
carryforwards arising in taxable years for which the corporation that
generated the credit was not subject to subchapter M of chapter 1 of the
Internal Revenue Code are allowed to reduce the tax imposed on net
recognized built-in gain under this paragraph (b) to the extent allowed
under section 1374 and the regulations thereunder. Such credits and
credit carryforwards must be used to reduce the tax imposed under this
paragraph (b) on net recognized built-in gain for a taxable year to the
greatest extent possible before such credits and credit carryforwards
can be used to reduce the tax, if any, on other investment company
taxable income for purposes of section 852(b) or on other real estate
investment trust taxable income for purposes of section 857(b) for that
taxable year.
(iii) 10-year recognition period. In the case of a conversion
transaction that is a qualification of a C corporation as a RIC or REIT,
the 10-year recognition period described in section 1374(d)(7) begins on
the first day of the RIC's or REIT's first taxable year. In the case of
other conversion transactions, the 10-year recognition period begins on
the day the property is acquired by the RIC or REIT.
(3) Coordination with subchapter M rules--(i) Recognized built-in
gains and losses subject to subchapter M. Recognized built-in gains and
losses of a RIC or REIT are included in computing investment company
taxable income for purposes of section 852(b)(2), real estate investment
trust taxable income for purposes of section 857(b)(2), capital gains
for purposes of sections 852(b)(3) and 857(b)(3), gross income derived
from sources within any foreign country or possession of the United
States for purposes of section 853, and the dividends paid deduction for
purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and
857(b)(3)(A). In computing such income and deduction items, capital loss
carryforwards and net operating loss carryforwards that are used by the
RIC or REIT to reduce recognized built-in gains are allowed as a
deduction, but only to the extent that they are otherwise allowable as a
deduction against such income under the Internal Revenue Code (including
section 852(b)(2)(B)).
(ii) Treatment of tax imposed. The amount of tax imposed under this
paragraph (b) on net recognized built-in gain for a taxable year is
treated as a loss sustained by the RIC or the REIT during such taxable
year. The character of the loss is determined by allocating the tax
proportionately (based on recognized built-in gain) among the items of
recognized built-in gain included in net recognized built-in gain. With
respect to RICs, the tax imposed under this paragraph (b) on net
recognized built-in gain is treated as attributable to the portion of
the RIC's taxable year occurring after October 31.
(4) Example. The rules of this paragraph (b) are illustrated by the
following example:
[[Page 93]]
Example. Section 1374 treatment on REIT election. (i) X, a C
corporation that is a calendar-year taxpayer, elects to be taxed as a
REIT on its 2004 tax return, which it files on March 15, 2005. As a
result, X is a REIT for its 2004 taxable year and is subject to section
1374 treatment under this paragraph (b). X does not elect deemed sale
treatment under paragraph (c) of this section. As of the beginning of
the 2004 taxable year, X's property consisted of Real Property, which is
not section 1221(a)(1) property and which had a fair market value of
$100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had
accumulated earnings and profits of $25,000, unrestricted capital loss
carryforwards of $3,000, and unrestricted business credit carryforwards
of $2,000. On July 1, 2007, X sells Real Property for $110,000. For its
2007 taxable year, X has no other income or deduction items. Assume the
highest corporate tax rate is 35%.
(ii) Upon its election to be taxed as a REIT, X retains its $80,000
basis in Real Property and its $25,000 accumulated earnings and profits.
X retains its $3,000 of capital loss carryforwards and its $2,000 of
business credit carryforwards. To satisfy section 857(a)(2)(B), X must
distribute $25,000, an amount equal to its earnings and profits
accumulated in non-REIT years, to its shareholders by the end of its
2004 taxable year.
(iii) Upon X's sale of Real Property in 2007, X recognizes gain of
$30,000 ($110,000--$80,000). X's recognized built-in gain for purposes
of applying section 1374 is $20,000 ($100,000 fair market value as of
the beginning of X's first taxable year as a REIT--$80,000 basis).
Because X's $30,000 of net income for the 2007 taxable year exceeds the
net recognized built-in gain of $20,000, the taxable income limitation
does not apply. X, therefore, has $20,000 net recognized built-in gain
for the year. Assuming that X has not used its $3,000 of capital loss
carryforwards in a prior taxable year and that their use is allowed
under section 1374(b)(2) and Sec. 1.1374-5, X is allowed a $3,000
deduction against the $20,000 net recognized built-in gain. X would owe
tax of $5,950 (35% of $17,000) on its net recognized built-in gain,
except that X may use its $2,000 of business credit carryforwards to
reduce the tax, assuming that X has not used the credit carryforwards in
a prior taxable year and that their use is allowed under section
1374(b)(3) and Sec. 1.1374-6. Thus, X owes tax of $3,950 under this
paragraph (b).
(iv) For purposes of subchapter M of chapter 1 of the Internal
Revenue Code, X's earnings and profits for the year increase by $26,050
($30,000 capital gain on the sale of Real Property--$3,950 tax under
this paragraph (b)). For purposes of section 857(b)(2) and (b)(3), X's
net capital gain for the year is $23,050 ($30,000 capital gain reduced
by $3,000 capital loss carryforward and further reduced by $3,950 tax).
(c) Election of deemed sale treatment--(1) In general. Paragraph (b)
of this section does not apply if the C corporation that qualifies as a
RIC or REIT or transfers property to a RIC or REIT makes the election
described in paragraph (c)(5) of this section. A C corporation that
makes such an election recognizes gain and loss as if it sold the
converted property to an unrelated party at fair market value on the
deemed sale date (as defined in paragraph (c)(3) of this section). See
paragraph (c)(4) of this section concerning limitations on the use of
loss in computing gain. This paragraph (c) does not apply if its
application would result in the recognition of a net loss. For this
purpose, net loss is the excess of aggregate losses over aggregate gains
(including items of income), without regard to character.
(2) Basis adjustment. If a corporation recognizes a net gain under
paragraph (c)(1) of this section, then the converted property has a
basis in the hands of the RIC or REIT equal to the fair market value of
such property on the deemed sale date.
(3) Deemed sale date--(i) RIC or REIT qualifications. If the
conversion transaction is a qualification of a C corporation as a RIC or
REIT, then the deemed sale date is the end of the last day of the C
corporation's last taxable year before the first taxable year in which
it qualifies to be taxed as a RIC or REIT.
(ii) Other conversion transactions. If the conversion transaction is
a transfer of property owned by a C corporation to a RIC or REIT, then
the deemed sale date is the end of the day before the day of the
transfer.
(4) Anti-stuffing rule. A C corporation must disregard converted
property in computing gain or loss recognized on the conversion
transaction under this paragraph (c), if--
(i) The converted property was acquired by the C corporation in a
transaction to which section 351 applied or as a contribution to
capital;
(ii) Such converted property had an adjusted basis immediately after
its acquisition by the C corporation in excess of its fair market value
on the date of acquisition; and
(iii) The acquisition of such converted property by the C
corporation
[[Page 94]]
was part of a plan a principal purpose of which was to reduce gain
recognized by the C corporation in connection with the conversion
transaction. For purposes of this paragraph (c)(4), the principles of
section 336(d)(2) apply.
(5) Making the deemed sale election. A C corporation (or a
partnership to which the principles of this section apply under
paragraph (e) of this section) makes the deemed sale election with the
following statement: ``[Insert name and employer identification number
of electing corporation or partnership] elects deemed sale treatment
under Sec. 1.337(d)-7(c) with respect to its property that was converted
to property of, or transferred to, a RIC or REIT, [insert name and
employer identification number of the RIC or REIT, if different from the
name and employer identification number of the C corporation or
partnership].'' This statement must be attached to the Federal income
tax return of the C corporation or partnership for the taxable year in
which the deemed sale occurs. An election under this paragraph (c) is
irrevocable.
(6) Examples. The rules of this paragraph (c) are illustrated by the
following examples:
Example 1. Deemed sale treatment on merger into RIC. (i) X, a
calendar-year taxpayer, has qualified as a RIC since January 1, 2001. On
May 31, 2004, Y, a C corporation and calendar-year taxpayer, transfers
all of its property to X in a transaction that qualifies as a
reorganization under section 368(a)(1)(C). As a result of the transfer,
Y would be subject to section 1374 treatment under paragraph (b) of this
section but for its timely election of deemed sale treatment under this
paragraph (c). As a result of such election, Y is subject to deemed sale
treatment on its tax return for the short taxable year ending May 31,
2004. On May 31, 2004, Y's only assets are Capital Asset, which has a
fair market value of $100,000 and a basis of $40,000 as of the end of
May 30, 2004, and $50,000 cash. Y also has an unrestricted net operating
loss carryforward of $12,000 and accumulated earnings and profits of
$50,000. Y has no taxable income for the short taxable year ending May
31, 2004, other than gain recognized under this paragraph (c). In 2007,
X sells Capital Asset for $110,000. Assume the applicable corporate tax
rate is 35%.
(ii) Under this paragraph (c), Y is treated as if it sold the
converted property (Capital Asset and $50,000 cash) at fair market value
on May 30, 2004, recognizing $60,000 of gain ($150,000 amount realized--
$90,000 basis). Y must report the gain on its tax return for the short
taxable year ending May 31, 2004. Y may offset this gain with its
$12,000 net operating loss carryforward and will pay tax of $16,800 (35%
of $48,000).
(iii) Under section 381, X succeeds to Y's accumulated earnings and
profits. Y's accumulated earnings and profits of $50,000 increase by
$60,000 and decrease by $16,800 as a result of the deemed sale. Thus,
the aggregate amount of subchapter C earnings and profits that must be
distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 +
$60,000-$16,800). X's basis in Capital Asset is $100,000. On X's sale of
Capital Asset in 2007, X recognizes $10,000 of gain which is taken into
account in computing X's net capital gain for purposes of section
852(b)(3).
Example 2. Loss limitation. (i) Assume the facts are the same as
those described in Example 1, but that, prior to the reorganization, a
shareholder of Y contributed to Y a capital asset, Capital Asset 2,
which has a fair market value of $10,000 and a basis of $20,000, in a
section 351 transaction.
(ii) Assuming that Y's acquisition of Capital Asset 2 was made
pursuant to a plan a principal purpose of which was to reduce the amount
of gain that Y would recognize in connection with the conversion
transaction, Capital Asset 2 would be disregarded in computing the
amount of Y's net gain on the conversion transaction.
(d) Exceptions--(1) Gain otherwise recognized. Paragraph (a) of this
section does not apply to any conversion transaction to the extent that
gain or loss otherwise is recognized on such conversion transaction.
See, for example, sections 336, 351(b), 351(e), 356, 357(c), 367,
368(a)(2)(F), and 1001.
(2) Re-election of RIC or REIT status--(i) Generally. Except as
provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph
(a)(1) of this section does not apply to any corporation that--
(A) Immediately prior to qualifying to be taxed as a RIC or REIT was
subject to tax as a C corporation for a period not exceeding two taxable
years; and
(B) Immediately prior to being subject to tax as a C corporation was
subject to tax as a RIC or REIT for a period of at least one taxable
year.
(ii) Property acquired from another corporation while a C
corporation. The exception described in paragraph (d)(2)(i) of this
section does not apply to property acquired by the corporation while it
was subject to tax as a C corporation
[[Page 95]]
from any person in a transaction that results in the acquirer's basis in
the property being determined by reference to a C corporation's basis in
the property.
(iii) RICs and REITs previously subject to section 1374 treatment.
If the RIC or REIT had property subject to paragraph (b) of this section
before the RIC or REIT became subject to tax as a C corporation as
described in paragraph (d)(2)(i) of this section, then paragraph (b) of
this section applies to the RIC or REIT upon its requalification as a
RIC or REIT, except that the 10-year recognition period with respect to
such property is reduced by the portion of the 10-year recognition
period that expired before the RIC or REIT became subject to tax as a C
corporation and by the period of time that the corporation was subject
to tax as a C corporation.
(e) Special rule for partnerships. The principles of this section
apply to property transferred by a partnership to a RIC or REIT to the
extent of any C corporation partner's distributive share of the gain or
loss in the transferred property. If the partnership were to elect
deemed sale treatment under paragraph (c) of this section in lieu of
section 1374 treatment under paragraph (b) of this section with respect
to such transfer, then any net gain recognized by the partnership on the
deemed sale must be allocated to the C corporation partner, but does not
increase the capital account of any partner. Any adjustment to the
partnership's basis in the RIC or REIT stock as a result of deemed sale
treatment under paragraph (c) of this section shall constitute an
adjustment to the basis of that stock with respect to the C corporation
partner only. The principles of section 743 apply to such basis
adjustment.
(f) Effective date. This section applies to conversion transactions
that occur on or after January 2, 2002. For conversion transactions that
occurred on or after June 10, 1987, and before January 2, 2002, see
Secs. 1.337(d)-5 and 1.337(d)-6.
[T.D. 9047, 68 FR 12822, Mar. 18, 2003]
Sec. 1.338-0 Outline of topics.
This section lists the captions contained in the regulations under
section 338 as follows:
Sec. 1.338-1 General principles; status of old target and new target.
(a) In general.
(1) Deemed transaction.
(2) Application of other rules of law.
(3) Overview.
(b) Treatment of target under other provisions of the Internal
Revenue Code.
(1) General rule for subtitle A.
(2) Exceptions for subtitle A.
(3) General rule for other provisions of the Internal Revenue Code.
(c) Anti-abuse rule.
(1) In general.
(2) Examples.
(d) Next day rule for post-closing transactions.
Sec. 1.338-2 Nomenclature and definitions; mechanics of the section 338
election.
(a) Scope.
(b) Nomenclature.
(c) Definitions.
(1) Acquisition date.
(2) Acquisition date assets.
(3) Affiliated group.
(4) Common parent.
(5) Consistency period.
(6) Deemed asset sale.
(7) Deemed sale tax consequences.
(8) Deemed sale return.
(9) Domestic corporation.
(10) Old target's final return.
(11) Purchasing corporation.
(12) Qualified stock purchase.
(13) Related persons.
(14) Section 338 election.
(15) Section 338(h)(10) election.
(16) Selling group.
(17) Target; old target; new target.
(18) Target affiliate.
(19) 12-month acquisition period.
(d) Time and manner of making election.
(e) Special rules for foreign corporations or DISCs.
(1) Elections by certain foreign purchasing corporations.
(i) General rule.
(ii) Qualifying foreign purchasing corporation.
(iii) Qualifying foreign target.
(iv) Triggering event.
(v) Subject to United States tax.
(2) Acquisition period.
(3) Statement of section 338 may be filed by United States
shareholders in certain cases.
(4) Notice requirement for U.S. persons holding stock in foreign
target.
(i) General rule.
(ii) Limitation.
(iii) Form of notice.
(iv) Timing of notice.
[[Page 96]]
(v) Consequence of failure to comply.
(vi) Good faith effort to comply.
Sec. 1.338-3 Qualification for the section 338 election.
(a) Scope.
(b) Rules relating to qualified stock purchases.
(1) Purchasing corporation requirement.
(2) Purchase.
(3) Acquisitions of stock from related corporations.
(i) In general.
(ii) Time for testing relationship.
(iii) Cases where section 338(h)(3)(C) applies--acquisitions treated
as purchases.
(iv) Examples.
(4) Acquisition date for tiered targets.
(i) Stock sold in deemed asset sale.
(ii) Examples.
(5) Effect of redemptions.
(i) General rule.
(ii) Redemptions from persons unrelated to the purchasing
corporation.
(iii) Redemptions from the purchasing corporation or related persons
during 12-month acquisition period.
(A) General rule.
(B) Exception for certain redemptions from related corporations.
(iv) Examples.
(c) Effect of post-acquisition events on eligibility for section 338
election.
(1) Post-acquisition elimination of target.
(2) Post-acquisition elimination of the purchasing corporation.
(d) Consequences of post-acquisition elimination of target where
section 338 election not made.
(1) Scope.
(2) Continuity of interest.
(3) Control requirement.
(4) Solely for voting stock requirement.
(5) Example.
Sec. 1.338-4 Aggregate deemed sale price; various aspects of taxation
of the deemed asset sale.
(a) Scope.
(b) Determination of ADSP.
(1) General rule.
(2) Time and amount of ADSP.
(i) Original determination.
(ii) Redetermination of ADSP.
(iii) Example.
(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased target
stock.
(1) Determination of amount.
(2) Example.
(d) Liabilities of old target.
(1) In general.
(2) Time and amount of liabilities.
(e) Deemed sale tax consequences.
(f) Other rules apply in determining ADSP.
(g) Examples.
(h) Deemed sale of target affiliate stock.
(1) Scope.
(2) In general.
(3) Deemed sale of foreign target affiliate by a domestic target.
(4) Deemed sale producing effectively connected income.
(5) Deemed sale of insurance company target affiliate electing under
section 953(d).
(6) Deemed sale of DISC target affiliate.
(7) Anti-stuffing rule.
(8) Examples.
Sec. 1.338-5 Adjusted grossed-up basis.
(a) Scope.
(b) Determination of AGUB.
(1) General rule.
(2) Time and amount of AGUB.
(i) Original determination.
(ii) Redetermination of AGUB.
(iii) Examples.
(c) Grossed-up basis of recently purchased stock.
(d) Basis of nonrecently purchased stock; gain recognition election.
(1) No gain recognition election.
(2) Procedure for making gain recognition election.
(3) Effect of gain recognition election.
(i) In general.
(ii) Basis amount.
(iii) Losses not recognized.
(iv) Stock subject to election.
(e) Liabilities of new target.
(1) In general.
(2) Time and amount of liabilities.
(3) Interaction with deemed sale tax consequences.
(f) Adjustments by the Internal Revenue Service.
(g) Examples.
Sec. 1.338-6 Allocation of ADSP and AGUB among target assets.
(a) Scope.
(1) In general.
(2) Fair market value.
(i) In general.
(ii) Transaction costs.
(iii) Internal Revenue Service authority.
(b) General rule for allocating ADSP and AGUB.
(1) Reduction in the amount of consideration for Class I assets.
(2) Other assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
(vi) Class VI assets.
(vii) Class VII assets.
(3) Other items designated by the Internal Revenue Service.
(c) Certain limitations and other rules for allocation to an asset.
(1) Allocation not to exceed fair market value.
(2) Allocation subject to other rules.
[[Page 97]]
(3) Special rule for allocating AGUB when purchasing corporation has
nonrecently purchased stock.
(i) Scope.
(ii) Determination of hypothetical purchase price.
(iii) Allocation of AGUB.
(4) Liabilities taken into account in determining amount realized on
subsequent disposition.
(d) Examples.
Sec. 1.338-7 Allocation of redetermined ADSP and AGUB among target
assets.
(a) Scope.
(b) Allocation of redetermined ADSP and AGUB.
(c) Special rules for ADSP.
(1) Increases or decreases in deemed sale tax consequences taxable
notwithstanding old target ceases to exist.
(2) Procedure for transactions in which section 338(h)(10) is not
elected.
(i) Deemed sale tax consequences included in new target's return.
(ii) Carryovers and carrybacks.
(A) Loss carryovers to new target taxable years.
(B) Loss carrybacks to taxable years of old target.
(C) Credit carryovers and carrybacks.
(3) Procedure for transactions in which section 338(h)(10) is
elected.
(d) Special rules for AGUB.
(1) Effect of disposition or depreciation of acquisition date
assets.
(2) Section 38 property.
(e) Examples.
Sec. 1.338-8 Asset and stock consistency.
(a) Introduction.
(1) Overview.
(2) General application.
(3) Extension of the general rules.
(4) Application where certain dividends are paid.
(5) Application to foreign target affiliates.
(6) Stock consistency.
(b) Consistency for direct acquisitions.
(1) General rule.
(2) Section 338(h)(10) elections.
(c) Gain from disposition reflected in basis of target stock.
(1) General rule.
(2) Gain not reflected if section 338 election made for target.
(3) Gain reflected by reason of distributions.
(4) Controlled foreign corporations.
(5) Gain recognized outside the consolidated group.
(d) Basis of acquired assets.
(1) Carryover basis rule.
(2) Exceptions to carryover basis rule for certain assets.
(3) Exception to carryover basis rule for de minimis assets.
(4) Mitigation rule.
(i) General rule.
(ii) Time for transfer.
(e) Examples.
(1) In general.
(2) Direct acquisitions.
(f) Extension of consistency to indirect acquisitions.
(1) Introduction.
(2) General rule.
(3) Basis of acquired assets.
(4) Examples.
(g) Extension of consistency if dividends qualifying for 100 percent
dividends received deduction are paid.
(1) General rule for direct acquisitions from target.
(2) Other direct acquisitions having same effect.
(3) Indirect acquisitions.
(4) Examples.
(h) Consistency for target affiliates that are controlled foreign
corporations.
(1) In general.
(2) Income or gain resulting from asset dispositions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate that is a controlled foreign
corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corporation stock.
(iii) Increase in asset or stock basis.
(5) Examples.
(i) [Reserved]
(j) Anti-avoidance rules.
(1) Extension of consistency period.
(2) Qualified stock purchase and 12-month acquisition period.
(3) Acquisitions by conduits.
(i) Asset ownership.
(A) General rule.
(B) Application of carryover basis rule.
(ii) Stock acquisitions.
(A) Purchase by conduit.
(B) Purchase of conduit by corporation.
(C) Purchase of conduit by conduit.
(4) Conduit.
(5) Existence of arrangement.
(6) Predecessor and successor.
(i) Persons.
(ii) Assets.
(7) Examples.
Sec. 1.338-9 International aspects of section 338.
(a) Scope.
(b) Application of section 338 to foreign targets.
(1) In general.
(2) Ownership of FT stock on the acquisition date.
(3) Carryover FT stock.
(i) Definition.
(ii) Carryover of earnings and profits.
[[Page 98]]
(iii) Cap on carryover of earnings and profits.
(iv) Post-acquisition date distribution of old FT earnings and
profits.
(v) Old FT earnings and profits unaffected by post-acquisition date
deficits.
(vi) Character of FT stock as carryover FT stock eliminated upon
disposition.
(4) Passive foreign investment company stock.
(c) Dividend treatment under section 1248(e).
(d) Allocation of foreign taxes.
(e) Operation of section 338(h)(16). [Reserved]
(f) Examples.
Sec. 1.338-10 Filing of returns.
(a) Returns including tax liability from deemed asset sale.
(1) In general.
(2) Old target's final taxable year otherwise included in
consolidated return of selling group.
(i) General rule.
(ii) Separate taxable year.
(iii) Carryover and carryback of tax attributes.
(iv) Old target is a component member of purchasing corporation's
controlled group.
(3) Old target is an S corporation.
(4) Combined deemed sale return.
(i) General rule.
(ii) Gain and loss offsets.
(iii) Procedure for filing a combined return.
(iv) Consequences of filing a combined return.
(5) Deemed sale excluded from purchasing corporation's consolidated
return.
(6) Due date for old target's final return.
(i) General rule.
(ii) Application of Sec. 1.1502-76(c).
(A) In general.
(B) Deemed extension.
(C) Erroneous filing of deemed sale return.
(D) Erroneous filing of return for regular tax year.
(E) Last date for payment of tax.
(7) Examples.
(b) Waiver.
(1) Certain additions to tax.
(2) Notification.
(3) Elections or other actions required to be specified on a timely
filed return.
(i) In general.
(ii) New target in purchasing corporation's consolidated return.
(4) Examples.
Sec. 1.338(h)(10)-1 Deemed asset sale and liquidation.
(a) Scope.
(b) Definitions.
(1) Consolidated target.
(2) Selling consolidated group.
(3) Selling affiliate; affiliated target.
(4) S corporation target.
(5) S corporation shareholders.
(6) Liquidation.
(c) Section 338(h)(10) election.
(1) In general.
(2) Simultaneous joint election requirement.
(3) Irrevocability.
(4) Effect of invalid election.
(d) Certain consequences of section 338(h)(10) election.
(1) P.
(2) New T.
(3) Old T--deemed sale.
(i) In general.
(ii) Tiered targets.
(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax characterization.
(i) In general.
(ii) Tiered targets.
(5) Selling consolidated group, selling affiliate, or S corporation
shareholders.
(i) In general.
(ii) Basis and holding period of T stock not acquired.
(iii) T stock sale.
(6) Nonselling minority shareholders other than nonselling S
corporation shareholders.
(i) In general.
(ii) T stock sale.
(iii) T stock not acquired.
(7) Consolidated return of selling consolidated group.
(8) Availability of the section 453 installment method.
(i) In deemed asset sale.
(ii) In deemed liquidation.
(9) Treatment consistent with an actual asset sale.
(e) Examples.
(f) Inapplicability of provisions.
(g) Required information.
Sec. 1.338(i)-1 Effective dates.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001]
Sec. 1.338-1 General principles; status of old target and new target.
(a) In general--(1) Deemed transaction. Elections are available
under section 338 when a purchasing corporation acquires the stock of
another corporation (the target) in a qualified stock purchase. One type
of election, under section 338(g), is available to the purchasing
corporation. Another type of election, under section 338(h)(10), is, in
more limited circumstances, available jointly to the purchasing
corporation and the sellers of the stock. (Rules concerning eligibility
for these elections are contained in Secs. 1.338-2, 1.338-3, and
1.338(h)(10)-1.) Although target is a single corporation under corporate
law, if a section 338 election is made, then two
[[Page 99]]
separate corporations, old target and new target, generally are
considered to exist for purposes of subtitle A of the Internal Revenue
Code. Old target is treated as transferring all of its assets to an
unrelated person in exchange for consideration that includes the
discharge of its liabilities (see Sec. 1.1001-2(a)), and new target is
treated as acquiring all of its assets from an unrelated person in
exchange for consideration that includes the assumption of those
liabilities. (Such transaction is, without regard to its
characterization for Federal income tax purposes, referred to as the
deemed asset sale and the income tax consequences thereof as the deemed
sale tax consequences.) If a section 338(h)(10) election is made, old
target is deemed to liquidate following the deemed asset sale.
(2) Application of other rules of law. Other rules of law apply to
determine the tax consequences to the parties as if they had actually
engaged in the transactions deemed to occur under section 338 and the
regulations thereunder except to the extent otherwise provided in those
regulations. See also Sec. 1.338-6(c)(2). Other rules of law may
characterize the transaction as something other than or in addition to a
sale and purchase of assets; however, the transaction between old and
new target must be a taxable transaction. For example, if target is an
insurance company for which a section 338 election is made, the deemed
asset sale would be characterized and taxed as an assumption-reinsurance
transaction under applicable Federal income tax law. See Sec. 1.817-
4(d).
(3) Overview. Definitions and special nomenclature and rules for
making the section 338 election are provided in Sec. 1.338-2.
Qualification for the section 338 election is addressed in Sec. 1.338-3.
The amount for which old target is treated as selling all of its assets
(the aggregate deemed sale price, or ADSP) is addressed in Sec. 1.338-4.
The amount for which new target is deemed to have purchased all its
assets (the adjusted grossed-up basis, or AGUB) is addressed in
Sec. 1.338-5. Section 1.338-6 addresses allocation both of ADSP among
the assets old target is deemed to have sold and of AGUB among the
assets new target is deemed to have purchased. Section 1.338-7 addresses
allocation of ADSP or AGUB when those amounts subsequently change. Asset
and stock consistency are addressed in Sec. 1.338-8. International
aspects of section 338 are covered in Sec. 1.338-9. Rules for the filing
of returns are provided in Sec. 1.338-10. Eligibility for and treatment
of section 338(h)(10) elections is addressed in Sec. 1.338(h)(10)-1.
(b) Treatment of target under other provisions of the Internal
Revenue Code--(1) General rule for subtitle A. Except as provided in
this section, new target is treated as a new corporation that is
unrelated to old target for purposes of subtitle A of the Internal
Revenue Code. Thus--
(i) New target is not considered related to old target for purposes
of section 168 and may make new elections under section 168 without
taking into account the elections made by old target; and
(ii) New target may adopt, without obtaining prior approval from the
Commissioner, any taxable year that meets the requirements of section
441 and any method of accounting that meets the requirements of section
446. Notwithstanding Sec. 1.441-1T(b)(2), a new target may adopt a
taxable year on or before the last day for making the election under
section 338 by filing its first return for the desired taxable year on
or before that date.
(2) Exceptions for subtitle A. New target and old target are treated
as the same corporation for purposes of--
(i) The rules applicable to employee benefit plans (including those
plans described in sections 79, 104, 105, 106, 125, 127, 129, 132, 137,
and 220), qualified pension, profit-sharing, stock bonus and annuity
plans (sections 401(a) and 403(a)), simplified employee pensions
(section 408(k)), tax qualified stock option plans (sections 422 and
423), welfare benefit funds (sections 419, 419A, 512(a)(3), and 4976),
and voluntary employee benefit associations (section 501(c)(9) and the
regulations thereunder);
(ii) Sections 1311 through 1314 (relating to the mitigation of the
effect of limitations), if a section 338(h)(10) election is not made for
target;
(iii) Section 108(e)(5) (relating to the reduction of purchase money
debt);
[[Page 100]]
(iv) Section 45A (relating to the Indian Employment Credit), section
51 (relating to the Work Opportunity Credit), section 51A (relating to
the Welfare to Work Credit), and section 1396 (relating to the
Empowerment Zone Act);
(v) Sections 401(h) and 420 (relating to medical benefits for
retirees);
(vi) Section 414 (relating to definitions and special rules); and
(vii) Any other provision designated in the Internal Revenue
Bulletin by the Internal Revenue Service. See Sec. 601.601(d)(2)(ii) of
this chapter. See, for example, Sec. 1.1001-3(e)(4)(i)(F) providing that
an election under section 338 does not result in the substitution of a
new obligor on target's debt. See also, for example, Sec. 1.1502-
77(e)(4), providing that an election under section 338 does not result
in a deemed termination of target's existence for purposes of the rules
applicable to the agent for a consolidated group.
(3) General rule for other provisions of the Internal Revenue Code.
Except as provided in the regulations under section 338 or in the
Internal Revenue Bulletin by the Internal Revenue Service (see
Sec. 601.601(d)(2)(ii) of this chapter), new target is treated as a
continuation of old target for purposes other than subtitle A of the
Internal Revenue Code. For example--
(i) New target is liable for old target's Federal income tax
liabilities, including the tax liability for the deemed sale tax
consequences and those tax liabilities of the other members of any
consolidated group that included old target that are attributable to
taxable years in which those corporations and old target joined in the
same consolidated return (see Sec. 1.1502-6(a));
(ii) Wages earned by the employees of old target are considered
wages earned by such employees from new target for purposes of sections
3101 and 3111 (Federal Insurance Contributions Act) and section 3301
(Federal Unemployment Tax Act); and
(iii) Old target and new target must use the same employer
identification number.
(c) Anti-abuse rule--(1) In general. The rules of this paragraph (c)
apply for purposes of applying the residual method as provided for under
the regulations under sections 338 and 1060. The Commissioner is
authorized to treat any property (including cash) transferred by old
target in connection with the transactions resulting in the application
of the residual method (and not held by target at the close of the
acquisition date) as, nonetheless, property of target at the close of
the acquisition date if the property so transferred is, within 24 months
after the deemed asset sale, owned by new target, or is owned, directly
or indirectly, by a member of the affiliated group of which new target
is a member and continues after the acquisition date to be held or used
primarily in connection with one or more of the activities of new
target. In addition, the Commissioner is authorized to treat any
property (including cash) transferred to old target in connection with
the transactions resulting in the application of the residual method
(and held by target at the close of the acquisition date) as,
nonetheless, not being property of target at the close of the
acquisition date if the property so transferred is, within 24 months
after the deemed asset sale, not owned by new target but owned, directly
or indirectly, by a member of the affiliated group of which new target
is a member, or owned by new target but held or used primarily in
connection with an activity conducted, directly or indirectly, by
another member of the affiliated group of which new target is a member
in combination with other property retained by or acquired, directly or
indirectly, from the transferor of the property (or a member of the same
affiliated group) to old target. For purposes of this paragraph (c)(1),
an interest in an entity is considered held or used in connection with
an activity if property of the entity is so held or used. The authority
of the Commissioner under this paragraph (c)(1) includes the making of
any appropriate correlative adjustments (avoiding, to the extent
possible, the duplication or omission of any item of income, gain, loss,
deduction, or basis).
(2) Examples. The following examples illustrate this paragraph (c):
Example 1. Prior to a qualified stock purchase under section 338,
target transfers one
[[Page 101]]
of its assets to a related party. The purchasing corporation then
purchases the target stock and also purchases the transferred asset from
the related party. After its purchase of target, the purchasing
corporation and target are members of the same affiliated group. A
section 338 election is made. Under an arrangement with the purchaser,
the separately transferred asset is used primarily in connection with
target's activities. Applying the anti-abuse rule of this paragraph (c),
the Commissioner may consider target to own the transferred asset for
purposes of applying the residual method under section 338.
Example 2. T owns all the stock of T1. T1 leases intellectual
property to T, which T uses in connection with its own activities. P, a
purchasing corporation, wishes to buy the T-T1 chain of corporations. P,
in connection with its planned purchase of the T stock, contracts to
consummate a purchase of all the stock of T1 on March 1 and of all the
stock of T on March 2. Section 338 elections are thereafter made for
both T and T1. Immediately after the purchases, P, T and T1 are members
of the same affiliated group. T continues to lease the intellectual
property from T1 and that is the primary use of the intellectual
property. Thus, an asset of T, the T1 stock, was removed from T's own
assets prior to the qualified stock purchase of the T stock, T1's own
assets are used after the deemed asset sale in connection with T's own
activities, and the T1 stock is after the deemed asset sale owned by P,
a member of the same affiliated group of which T is a member. Applying
the anti-abuse rule of this paragraph (c), the Commissioner may, for
purposes of application of the residual method under section 338 both to
T and to T1, consider P to have bought only the stock of T, with T at
the time of the qualified stock purchases of both T and T1 (the
qualified stock purchase of T1 being triggered by the deemed sale under
section 338 of T's assets) owning T1. The Commissioner accordingly would
allocate consideration to T's assets as though the T1 stock were one of
those assets, and then allocate consideration within T1 based on the
amount allocated to the T1 stock at the T level.
(d) Next day rule for post-closing transactions. If a target
corporation for which an election under section 338 is made engages in a
transaction outside the ordinary course of business on the acquisition
date after the event resulting in the qualified stock purchase of the
target or a higher tier corporation, the target and all persons related
thereto (either before or after the qualified stock purchase) under
section 267(b) or section 707 must treat the transaction for all Federal
income tax purposes as occurring at the beginning of the day following
the transaction and after the deemed purchase by new target.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001, as amended by T.D. 9002, 67 FR
43540, June 28, 2002]
Sec. 1.338-2 Nomenclature and definitions; mechanics of the section 338 election.
(a) Scope. This section prescribes rules relating to elections under
section 338.
(b) Nomenclature. For purposes of the regulations under section 338
(except as otherwise provided):
(1) T is a domestic target corporation that has only one class of
stock outstanding. Old T refers to T for periods ending on or before the
close of T's acquisition date; new T refers to T for subsequent periods.
(2) P is the purchasing corporation.
(3) The P group is an affiliated group of which P is a member.
(4) P1, P2, etc., are domestic corporations that are members of the
P group.
(5) T1, T2, etc., are domestic corporations that are target
affiliates of T. These corporations (T1, T2, etc.) have only one class
of stock outstanding and may also be targets.
(6) S is a domestic corporation (unrelated to P and B) that owns T
prior to the purchase of T by P. (S is referred to in cases in which it
is appropriate to consider the effects of having all of the outstanding
stock of T owned by a domestic corporation.)
(7) A, a U.S. citizen or resident, is an individual (unrelated to P
and B) who owns T prior to the purchase of T by P. (A is referred to in
cases in which it is appropriate to consider the effects of having all
of the outstanding stock of T owned by an individual who is a U.S.
citizen or resident. Ownership of T by A and ownership of T by S are
mutually exclusive circumstances.)
(8) B, a U.S. citizen or resident, is an individual (unrelated to T,
S, and A) who owns the stock of P.
(9) F, used as a prefix with the other terms in this paragraph (b),
connotes foreign, rather than domestic, status. For example, FT is a
foreign corporation (as defined in section 7701(a)(5)) and FA is an
individual other than a U.S. citizen or resident.
[[Page 102]]
(10) CFC, used as a prefix with the other terms in this paragraph
(b) referring to a corporation, connotes a controlled foreign
corporation (as defined in section 957, taking into account section
953(c)). A corporation identified with the prefix F may be a controlled
foreign corporation. (The prefix CFC is used when the corporation's
status as a controlled foreign corporation is significant.)
(c) Definitions. For purposes of the regulations under section 338
(except as otherwise provided):
(1) Acquisition date. The term acquisition date has the same meaning
as in section 338(h)(2).
(2) Acquisition date assets. Acquisition date assets are the assets
of the target held at the beginning of the day after the acquisition
date (but see Sec. 1.338-1(d) (regarding certain transactions on the
acquisition date)).
(3) Affiliated group. The term affiliated group has the same meaning
as in section 338(h)(5). Corporations are affiliated on any day they are
members of the same affiliated group.
(4) Common parent. The term common parent has the same meaning as in
section 1504.
(5) Consistency period. The consistency period is the period
described in section 338(h)(4)(A) unless extended pursuant to
Sec. 1.338-8(j)(1).
(6) Deemed asset sale. The deemed asset sale is the transaction
described in Sec. 1.338-1(a)(1) that is deemed to occur for purposes of
subtitle A of the Internal Revenue Code if a section 338 election is
made.
(7) Deemed sale tax consequences. Deemed sale tax consequences
refers to, in the aggregate, the Federal income tax consequences
(generally, the income, gain, deduction, and loss) of the deemed asset
sale. Deemed sale tax consequences also refers to the Federal income tax
consequences of the transfer of a particular asset in the deemed asset
sale.
(8) Deemed sale return. The deemed sale return is the return on
which target's deemed sale tax consequences are reported that does not
include any other items of target. Target files a deemed sale return
when a section 338 election (but not a section 338(h)(10) election) is
filed for target and target is a member of a selling group (defined in
paragraph (c)(16) of this section) that files a consolidated return for
the period that includes the acquisition date. See Sec. 1.338-10. If
target is an S corporation for the period that ends on the day before
the acquisition date and a section 338 election (but not a section
338(h)(10) election) is filed for target, see Sec. 1.338-10(a)(3).
(9) Domestic corporation. A domestic corporation is a corporation--
(i) That is domestic within the meaning of section 7701(a)(4) or
that is treated as domestic for purposes of subtitle A of the Internal
Revenue Code (e.g., to which an election under section 953(d) or 1504(d)
applies); and
(ii) That is not a DISC, a corporation described in section 1248(e),
or a corporation to which an election under section 936 applies.
(10) Old target's final return. Old target's final return is the
income tax return of old target for the taxable year ending at the close
of the acquisition date that includes the deemed sale tax consequences.
However, if a deemed sale return is filed for old target, the deemed
sale return is considered old target's final return.
(11) Purchasing corporation. The term purchasing corporation has the
same meaning as in section 338(d)(1). The purchasing corporation may
also be referred to as purchaser. Unless otherwise provided, any
reference to the purchasing corporation is a reference to all members of
the affiliated group of which the purchasing corporation is a member.
See sections 338(h)(5) and (8). Also, unless otherwise provided, any
reference to the purchasing corporation is, with respect to a deemed
purchase of stock under section 338(a)(2), a reference to new target
with respect to its own deemed purchase of stock in another target.
(12) Qualified stock purchase. The term qualified stock purchase has
the same meaning as in section 338(d)(3).
(13) Related persons. Two persons are related if stock in a
corporation owned by one of the persons would be attributed under
section 318(a) (other than section 318(a)(4)) to the other.
(14) Section 338 election. A section 338 election is an election to
apply section 338(a) to target. A section 338 election
[[Page 103]]
is made by filing a statement of section 338 election pursuant to
paragraph (d) of this section. The form on which this statement is filed
is referred to in the regulations under section 338 as the Form 8023,
``Elections Under Section 338 For Corporations Making Qualified Stock
Purchases.''
(15) Section 338(h)(10) election. A section 338(h)(10) election is
an election to apply section 338(h)(10) to target. A section 338(h)(10)
election is made by making a joint election for target under
Sec. 1.338(h)(10)-1 on Form 8023.
(16) Selling group. The selling group is the affiliated group (as
defined in section 1504) eligible to file a consolidated return that
includes target for the taxable period in which the acquisition date
occurs. However, a selling group is not an affiliated group of which
target is the common parent on the acquisition date.
(17) Target; old target; new target. Target is the target
corporation as defined in section 338(d)(2). Old target refers to target
for periods ending on or before the close of target's acquisition date.
New target refers to target for subsequent periods.
(18) Target affiliate. The term target affiliate has the same
meaning as in section 338(h)(6) (applied without section
338(h)(6)(B)(i)). Thus, a corporation described in section
338(h)(6)(B)(i) is considered a target affiliate for all purposes of
section 338. If a target affiliate is acquired in a qualified stock
purchase, it is also a target.
(19) 12-month acquisition period. The 12-month acquisition period is
the period described in section 338(h)(1), unless extended pursuant to
Sec. 1.338-8(j)(2).
(d) Time and manner of making election. The purchasing corporation
makes a section 338 election for target by filing a statement of section
338 election on Form 8023 in accordance with the instructions to the
form. The section 338 election must be made not later than the 15th day
of the 9th month beginning after the month in which the acquisition date
occurs. A section 338 election is irrevocable. See Sec. 1.338(h)(10)-
1(c)(2) for section 338(h)(10) elections.
(e) Special rules for foreign corporations or DISCs--(1) Elections
by certain foreign purchasing corporations--(i) General rule. A
qualifying foreign purchasing corporation is not required to file a
statement of section 338 election for a qualifying foreign target before
the earlier of 3 years after the acquisition date and the 180th day
after the close of the purchasing corporation's taxable year within
which a triggering event occurs.
(ii) Qualifying foreign purchasing corporation. A purchasing
corporation is a qualifying foreign purchasing corporation only if,
during the acquisition period of a qualifying foreign target, all the
corporations in the purchasing corporation's affiliated group are
foreign corporations that are not subject to United States tax.
(iii) Qualifying foreign target. A target is a qualifying foreign
target only if target and its target affiliates are foreign corporations
that, during target's acquisition period, are not subject to United
States tax (and will not become subject to United States tax during such
period because of a section 338 election). A target affiliate is taken
into account for purposes of the preceding sentence only if, during
target's 12-month acquisition period, it is or becomes a member of the
affiliated group that includes the purchasing corporation.
(iv) Triggering event. A triggering event occurs in the taxable year
of the qualifying foreign purchasing corporation in which either that
corporation or any corporation in its affiliated group becomes subject
to United States tax.
(v) Subject to United States tax. For purposes of this paragraph
(e)(1), a foreign corporation is considered subject to United States
tax--
(A) For the taxable year for which that corporation is required
under Sec. 1.6012-2(g) (other than Sec. 1.6012-2(g)(2)(i)(B)(2)) to file
a United States income tax return; or
(B) For the period during which that corporation is a controlled
foreign corporation, a passive foreign investment company for which an
election under section 1295 is in effect, a foreign investment company,
or a foreign corporation the stock ownership of which is described in
section 552(a)(2).
(2) Acquisition period. For purposes of this paragraph (e), the term
acquisition period means the period beginning on
[[Page 104]]
the first day of the 12-month acquisition period and ending on the
acquisition date.
(3) Statement of section 338 election may be filed by United States
shareholders in certain cases. The United States shareholders (as
defined in section 951(b)) of a foreign purchasing corporation that is a
controlled foreign corporation (as defined in section 957 (taking into
account section 953(c))) may file a statement of section 338 election on
behalf of the purchasing corporation if the purchasing corporation is
not required under Sec. 1.6012-2(g) (other than Sec. 1.6012-
2(g)(2)(i)(B)(2)) to file a United States income tax return for its
taxable year that includes the acquisition date. Form 8023 must be filed
as described in the form and its instructions and also must be attached
to the Form 5471, ``Information Returns Of U.S. Persons With Respect To
Certain Foreign Corporations,'' filed with respect to the purchasing
corporation by each United States shareholder for the purchasing
corporation's taxable year that includes the acquisition date (or, if
paragraph (e)(1)(i) of this section applies to the election, for the
purchasing corporation's taxable year within which it becomes a
controlled foreign corporation). The provisions of Sec. 1.964-1(c)
(including Sec. 1.964-1(c)(7)) do not apply to an election made by the
United States shareholders.
(4) Notice requirement for U.S. persons holding stock in foreign
target--(i) General rule. If a target subject to a section 338 election
was a controlled foreign corporation, a passive foreign investment
company, or a foreign personal holding company at any time during the
portion of its taxable year that ends on its acquisition date, the
purchasing corporation must deliver written notice of the election (and
a copy of Form 8023, its attachments and instructions) to--
(A) Each U.S. person (other than a member of the affiliated group of
which the purchasing corporation is a member (the purchasing group
member)) that, on the acquisition date of the foreign target, holds
stock in the foreign target; and
(B) Each U.S. person (other than a purchasing group member) that
sells stock in the foreign target to a purchasing group member during
the foreign target's 12-month acquisition period.
(ii) Limitation. The notice requirement of this paragraph (e)(4)
applies only where the section 338 election for the foreign target
affects income, gain, loss, deduction, or credit of the U.S. person
described in paragraph (e)(4)(i) of this section under section 551, 951,
1248, or 1293.
(iii) Form of notice. The notice to U.S. persons must be identified
prominently as a notice of section 338 election and must--
(A) Contain the name, address, and employer identification number
(if any) of, and the country (and, if relevant, the lesser political
subdivision) under the laws of which are organized the purchasing
corporation and the relevant target (i.e., the target the stock of which
the particular U.S. person held or sold under the circumstances
described in paragraph (e)(4)(i) of this section);
(B) Identify those corporations as the purchasing corporation and
the foreign target, respectively; and
(C) Contain the following declaration (or a substantially similar
declaration):
THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER SECTION 338 FOR
THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH YOU EITHER HELD OR
SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY REGULATIONS SECTION
1.338-2(e)(4). FOR POSSIBLE UNITED STATES FEDERAL INCOME TAX
CONSEQUENCES UNDER SECTION 551, 951, 1248, OR 1293 OF THE INTERNAL
REVENUE CODE OF 1986 THAT MAY APPLY TO YOU, SEE TREASURY REGULATIONS
SECTION 1.338-9(b). YOU MAY BE REQUIRED TO ATTACH THE INFORMATION
ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.
(iv) Timing of notice. The notice required by this paragraph (e)(4)
must be delivered to the U.S. person on or before the later of the 120th
day after the acquisition date of the particular target or the day on
which Form 8023 is filed. The notice is considered delivered on the date
it is mailed to the proper address (or an address similar enough to
complete delivery), unless the date it is mailed cannot be reasonably
determined. The date of mailing will be
[[Page 105]]
determined under the rules of section 7502. For example, the date of
mailing is the date of U.S. postmark or the applicable date recorded or
marked by a designated delivery service.
(v) Consequence of failure to comply. A statement of section 338
election is not valid if timely notice is not given to one or more U.S.
persons described in this paragraph (e)(4). If the form of notice fails
to comply with all requirements of this paragraph (e)(4), the section
338 election is valid, but the waiver rule of Sec. 1.338-10(b)(1) does
not apply.
(vi) Good faith effort to comply. The purchasing corporation will be
considered to have complied with this paragraph (e)(4), even though it
failed to provide notice or provide timely notice to each person
described in this paragraph (e)(4), if the Commissioner determines that
the purchasing corporation made a good faith effort to identify and
provide timely notice to those U.S. persons.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001]
Sec. 1.338-3 Qualification for the section 338 election.
(a) Scope. This section provides rules on whether certain
acquisitions of stock are qualified stock purchases and on other
miscellaneous issues under section 338.
(b) Rules relating to qualified stock purchases--(1) Purchasing
corporation requirement. An individual cannot make a qualified stock
purchase of target. Section 338(d)(3) requires, as a condition of a
qualified stock purchase, that a corporation purchase the stock of
target. If an individual forms a corporation (new P) to acquire target
stock, new P can make a qualified stock purchase of target if new P is
considered for tax purposes to purchase the target stock. Facts that may
indicate that new P does not purchase the target stock include new P's
merging downstream into target, liquidating, or otherwise disposing of
the target stock following the purported qualified stock purchase.
(2) Purchase. The term purchase has the same meaning as in section
338(h)(3). Stock in a target (or target affiliate) may be considered
purchased if, under general principles of tax law, the purchasing
corporation is considered to own stock of the target (or target
affiliate) meeting the requirements of section 1504(a)(2),
notwithstanding that no amount may be paid for (or allocated to) the
stock.
(3) Acquisitions of stock from related corporations--(i) In general.
Stock acquired by a purchasing corporation from a related corporation
(R) is generally not considered acquired by purchase. See section
338(h)(3)(A)(iii).
(ii) Time for testing relationship. For purposes of section
338(h)(3)(A)(iii), a purchasing corporation is treated as related to
another person if the relationship specified in section
338(h)(3)(A)(iii) exists--
(A) In the case of a single transaction, immediately after the
purchase of target stock;
(B) In the case of a series of acquisitions otherwise constituting a
qualified stock purchase within the meaning of section 338(d)(3),
immediately after the last acquisition in such series; and
(C) In the case of a series of transactions effected pursuant to an
integrated plan to dispose of target stock, immediately after the last
transaction in such series.
(iii) Cases where section 338(h)(3)(C) applies--acquisitions treated
as purchases. If section 338(h)(3)(C) applies and the purchasing
corporation is treated as acquiring stock by purchase from R, solely for
purposes of determining when the stock is considered acquired, target
stock acquired from R is considered to have been acquired by the
purchasing corporation on the day on which the purchasing corporation is
first considered to own that stock under section 318(a) (other than
section 318(a)(4)).
(iv) Examples. The following examples illustrate this paragraph
(b)(3):
Example 1. (i) S is the parent of a group of corporations that are
engaged in various businesses. Prior to January 1, Year 1, S decided to
discontinue its involvement in one line of business. To accomplish this,
S forms a new corporation, Newco, with a nominal amount of cash. Shortly
thereafter, on January 1, Year 1, S transfers all the stock of the
subsidiary conducting the unwanted business (T) to Newco in exchange for
100 shares of Newco common stock and a Newco promissory note. Prior to
January 1, Year 1, S and Underwriter (U) had entered into a binding
agreement pursuant to which U would purchase 60 shares of Newco common
stock from
[[Page 106]]
S and then sell those shares in an Initial Public Offering (IPO). On
January 6, Year 1, the IPO closes.
(ii) Newco's acquisition of T stock is one of a series of
transactions undertaken pursuant to one integrated plan. The series of
transactions ends with the closing of the IPO and the transfer of all
the shares of stock in accordance with the agreements. Immediately after
the last transaction effected pursuant to the plan, S owns 40 percent of
Newco, which does not give rise to a relationship described in section
338(h)(3)(A)(iii). See Sec. 1.338-3(b)(3)(ii)(C). Accordingly, S and
Newco are not related for purposes of section 338(h)(3)(A)(iii).
(iii) Further, because Newco's basis in the T stock is not
determined by reference to S's basis in the T stock and because the
transaction is not an exchange to which section 351, 354, 355, or 356
applies, Newco's acquisition of the T stock is a purchase within the
meaning of section 338(h)(3).
Example 2. (i) On January 1 of Year 1, P purchases 75 percent in
value of the R stock. On that date, R owns 4 of the 100 shares of T
stock. On June 1 of Year 1, R acquires an additional 16 shares of T
stock. On December 1 of Year 1, P purchases 70 shares of T stock from an
unrelated person and 12 of the 20 shares of T stock held by R.
(ii) Of the 12 shares of T stock purchased by P from R on December 1
of Year 1, 3 of those shares are deemed to have been acquired by P on
January 1 of Year 1, the date on which 3 of the 4 shares of T stock held
by R on that date were first considered owned by P under section
318(a)(2)(C) (i.e., 4 x .75). The remaining 9 shares of T stock
purchased by P from R on December 1 of Year 1 are deemed to have been
acquired by P on June 1 of Year 1, the date on which an additional 12 of
the 20 shares of T stock owned by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., (20 x .75)-3). Because
stock acquisitions by P sufficient for a qualified stock purchase of T
occur within a 12-month period (i.e., 3 shares constructively on January
1 of Year 1, 9 shares constructively on June 1 of Year 1, and 70 shares
actually on December 1 of Year 1), a qualified stock purchase is made on
December 1 of Year 1.
Example 3. (i) On February 1 of Year 1, P acquires 25 percent in
value of the R stock from B (the sole shareholder of P). That R stock is
not acquired by purchase. See section 338(h)(3)(A)(iii). On that date, R
owns 4 of the 100 shares of T stock. On June 1 of Year 1, P purchases an
additional 25 percent in value of the R stock, and on January 1 of Year
2, P purchases another 25 percent in value of the R stock. On June 1 of
Year 2, R acquires an additional 16 shares of the T stock. On December 1
of Year 2, P purchases 68 shares of the T stock from an unrelated person
and 12 of the 20 shares of the T stock held by R.
(ii) Of the 12 shares of the T stock purchased by P from R on
December 1 of Year 2, 2 of those shares are deemed to have been acquired
by P on June 1 of Year 1, the date on which 2 of the 4 shares of the T
stock held by R on that date were first considered owned by P under
section 318(a)(2)(C) (i.e., 4 x .5). For purposes of this attribution,
the R stock need not be acquired by P by purchase. See section
338(h)(1). (By contrast, the acquisition of the T stock by P from R does
not qualify as a purchase unless P has acquired at least 50 percent in
value of the R stock by purchase. Section 338(h)(3)(C)(i).) Of the
remaining 10 shares of the T stock purchased by P from R on December 1
of Year 2, 1 of those shares is deemed to have been acquired by P on
January 1 of Year 2, the date on which an additional 1 share of the 4
shares of the T stock held by R on that date was first considered owned
by P under section 318(a)(2)(C) (i.e., (4 x .75)-2). The remaining 9
shares of the T stock purchased by P from R on December 1 of Year 2, are
deemed to have been acquired by P on June 1 of Year 2, the date on which
an additional 12 shares of the T stock held by R on that date were first
considered owned by P under section 318(a)(2)(C) (i.e., (20 x .75)-3).
Because a qualified stock purchase of T by P is made on December 1 of
Year 2 only if all 12 shares of the T stock purchased by P from R on
that date are considered acquired during a 12-month period ending on
that date (so that, in conjunction with the 68 shares of the T stock P
purchased on that date from the unrelated person, 80 of T's 100 shares
are acquired by P during a 12-month period) and because 2 of those 12
shares are considered to have been acquired by P more than 12 months
before December 1 of Year 2 (i.e., on June 1 of Year 1), a qualified
stock purchase is not made. (Under Sec. 1.338-8(j)(2), for purposes of
applying the consistency rules, P is treated as making a qualified stock
purchase of T if, pursuant to an arrangement, P purchases T stock
satisfying the requirements of section 1504(a)(2) over a period of more
than 12 months.)
Example 4. Assume the same facts as in Example 3, except that on
February 1 of Year 1, P acquires 25 percent in value of the R stock by
purchase. The result is the same as in Example 3.
(4) Acquisition date for tiered targets--(i) Stock sold in deemed
asset sale. If an election under section 338 is made for target, old
target is deemed to sell target's assets and new target is deemed to
acquire those assets. Under section 338(h)(3)(B), new target's deemed
purchase of stock of another corporation is a purchase for purposes of
section
[[Page 107]]
338(d)(3) on the acquisition date of target. If new target's deemed
purchase causes a qualified stock purchase of the other corporation and
if a section 338 election is made for the other corporation, the
acquisition date for the other corporation is the same as the
acquisition date of target. However, the deemed sale and purchase of the
other corporation's assets is considered to take place after the deemed
sale and purchase of target's assets.
(ii) Example. The following example illustrates this paragraph
(b)(4):
Example. A owns all of the T stock. T owns 50 of the 100 shares of X
stock. The other 50 shares of X stock are owned by corporation Y, which
is unrelated to A, T, or P. On January 1 of Year 1, P makes a qualified
stock purchase of T from A and makes a section 338 election for T. On
December 1 of Year 1, P purchases the 50 shares of X stock held by Y. A
qualified stock purchase of X is made on December 1 of Year 1, because
the deemed purchase of 50 shares of X stock by new T because of the
section 338 election for T and the actual purchase of 50 shares of X
stock by P are treated as purchases made by one corporation. Section
338(h)(8). For purposes of determining whether those purchases occur
within a 12-month acquisition period as required by section 338(d)(3), T
is deemed to purchase its X stock on T's acquisition date, i.e., January
1 of Year 1.
(5) Effect of redemptions--(i) General rule. Except as provided in
this paragraph (b)(5), a qualified stock purchase is made on the first
day on which the percentage ownership requirements of section 338(d)(3)
are satisfied by reference to target stock that is both--
(A) Held on that day by the purchasing corporation; and
(B) Purchased by the purchasing corporation during the 12-month
period ending on that day.
(ii) Redemptions from persons unrelated to the purchasing
corporation. Target stock redemptions from persons unrelated to the
purchasing corporation that occur during the 12-month acquisition period
are taken into account as reductions in target's outstanding stock for
purposes of determining whether target stock purchased by the purchasing
corporation in the 12-month acquisition period satisfies the percentage
ownership requirements of section 338(d)(3).
(iii) Redemptions from the purchasing corporation or related persons
during 12-month acquisition period--(A) General rule. For purposes of
the percentage ownership requirements of section 338(d)(3), a redemption
of target stock during the 12-month acquisition period from the
purchasing corporation or from any person related to the purchasing
corporation is not taken into account as a reduction in target's
outstanding stock.
(B) Exception for certain redemptions from related corporations. A
redemption of target stock during the 12-month acquisition period from a
corporation related to the purchasing corporation is taken into account
as a reduction in target's outstanding stock to the extent that the
redeemed stock would have been considered purchased by the purchasing
corporation (because of section 338(h)(3)(C)) during the 12-month
acquisition period if the redeemed stock had been acquired by the
purchasing corporation from the related corporation on the day of the
redemption. See paragraph (b)(3) of this section.
(iv) Examples. The following examples illustrate this paragraph
(b)(5):
Example 1. QSP on stock purchase date; redemption from unrelated
person during 12-month period. A owns all 100 shares of T stock. On
January 1 of Year 1, P purchases 40 shares of the T stock from A. On
July 1 of Year 1, T redeems 25 shares from A. On December 1 of Year 1, P
purchases 20 shares of the T stock from A. P makes a qualified stock
purchase of T on December 1 of Year 1, because the 60 shares of T stock
purchased by P within the 12-month period ending on that date satisfy
the 80-percent ownership requirements of section 338(d)(3) (i.e., 60/75
shares), determined by taking into account the redemption of 25 shares.
Example 2. QSP on stock redemption date; redemption from unrelated
person during 12-month period. The facts are the same as in Example 1,
except that P purchases 60 shares of T stock on January 1 of Year 1 and
none on December 1 of Year 1. P makes a qualified stock purchase of T on
July 1 of Year 1, because that is the first day on which the T stock
purchased by P within the preceding 12-month period satisfies the 80-
percent ownership requirements of section 338(d)(3) (i.e., 60/75
shares), determined by taking into account the redemption of 25 shares.
Example 3. Redemption from purchasing corporation not taken into
account. On December 15 of Year 1, T redeems 30 percent of its
[[Page 108]]
stock from P. The redeemed stock was held by P for several years and
constituted P's total interest in T. On December 1 of Year 2, P
purchases the remaining T stock from A. P does not make a qualified
stock purchase of T on December 1 of Year 2. For purposes of the 80-
percent ownership requirements of section 338(d)(3), the redemption of
P's T stock on December 15 of Year 1 is not taken into account as a
reduction in T's outstanding stock.
Example 4. Redemption from related person taken into account. On
January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On
that date, X owns 40 of the 100 shares of T stock. On April 1 of Year 1,
T redeems X's T stock and P purchases the remaining 60 shares of T stock
from an unrelated person. For purposes of the 80-percent ownership
requirements of section 338(d)(3), the redemption of the T stock from X
(a person related to P) is taken into account as a reduction in T's
outstanding stock. If P had purchased the 40 redeemed shares from X on
April 1 of Year 1, all 40 of the shares would have been considered
purchased (because of section 338(h)(3)(C)(i)) during the 12-month
period ending on April 1 of Year 1 (24 of the 40 shares would have been
considered purchased by P on January 1 of Year 1 and the remaining 16
shares would have been considered purchased by P on April 1 of Year 1).
See paragraph (b)(3) of this section. Accordingly, P makes a qualified
stock purchase of T on April 1 of Year 1, because the 60 shares of T
stock purchased by P on that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/60 shares), determined by
taking into account the redemption of 40 shares.
(c) Effect of post-acquisition events on eligibility for section 338
election--(1) Post-acquisition elimination of target. (i) The purchasing
corporation may make an election under section 338 for target even
though target is liquidated on or after the acquisition date. If target
liquidates on the acquisition date, the liquidation is considered to
occur on the following day and immediately after new target's deemed
purchase of assets. The purchasing corporation may also make an election
under section 338 for target even though target is merged into another
corporation, or otherwise disposed of by the purchasing corporation
provided that, under the facts and circumstances, the purchasing
corporation is considered for tax purposes as the purchaser of the
target stock.
(ii) The following examples illustrate this paragraph (c)(1):
Example 1. On January 1 of Year 1, P purchases 100 percent of the
outstanding common stock of T. On June 1 of Year 1, P sells the T stock
to an unrelated person. Assuming that P is considered for tax purposes
as the purchaser of the T stock, P remains eligible, after June 1 of
Year 1, to make a section 338 election for T that results in a deemed
asset sale of T's assets on January 1 of Year 1.
Example 2. On January 1 of Year 1, P makes a qualified stock
purchase of T. On that date, T owns the stock of T1. On March 1 of Year
1, T sells the T1 stock to an unrelated person. On April 1 of Year 1, P
makes a section 338 election for T. Notwithstanding that the T1 stock
was sold on March 1 of Year 1, the section 338 election for T on April 1
of Year 1 results in a qualified stock purchase by T of T1 on January 1
of Year 1. See paragraph (b)(4)(i) of this section.
(2) Post-acquisition elimination of the purchasing corporation. An
election under section 338 may be made for target after the acquisition
of assets of the purchasing corporation by another corporation in a
transaction described in section 381(a), provided that the purchasing
corporation is considered for tax purposes as the purchaser of the
target stock. The acquiring corporation in the section 381(a)
transaction may make an election under section 338 for target.
(d) Consequences of post-acquisition elimination of target where
section 338 election not made--(1) Scope. The rules of this paragraph
(d) apply to the transfer of target assets to the purchasing corporation
(or another member of the same affiliated group as the purchasing
corporation) (the transferee) following a qualified stock purchase of
target stock, if the purchasing corporation does not make a section 338
election for target. Notwithstanding the rules of this paragraph (d),
section 354(a) (and so much of section 356 as relates to section 354)
cannot apply to any person other than the purchasing corporation or
another member of the same affiliated group as the purchasing
corporation unless the transfer of target assets is pursuant to a
reorganization as determined without regard to this paragraph (d).
(2) Continuity of interest. By virtue of section 338, in determining
whether the continuity of interest requirement of Sec. 1.368-1(b) is
satisfied on the transfer of assets from target to the transferee,
[[Page 109]]
the purchasing corporation's target stock acquired in the qualified
stock purchase represents an interest on the part of a person who was an
owner of the target's business enterprise prior to the transfer that can
be continued in a reorganization.
(3) Control requirement. By virtue of section 338, the acquisition
of target stock in the qualified stock purchase will not prevent the
purchasing corporation from qualifying as a shareholder of the target
transferor for the purpose of determining whether, immediately after the
transfer of target assets, a shareholder of the transferor is in control
of the corporation to which the assets are transferred within the
meaning of section 368(a)(1)(D).
(4) Solely for voting stock requirement. By virtue of section 338,
the acquisition of target stock in the qualified stock purchase for
consideration other than voting stock will not prevent the subsequent
transfer of target assets from satisfying the solely for voting stock
requirement for purposes of determining if the transfer of target assets
qualifies as a reorganization under section 368(a)(1)(C).
(5) Example. The following example illustrates this paragraph (d):
Example. (i) Facts. P, T, and X are domestic corporations. T and X
each operate a trade or business. A and K, individuals unrelated to P,
own 85 and 15 percent, respectively, of the stock of T. P owns all of
the stock of X. The total adjusted basis of T's property exceeds the sum
of T's liabilities plus the amount of liabilities to which T's property
is subject. P purchases all of A's T stock for cash in a qualified stock
purchase. P does not make an election under section 338(g) with respect
to its acquisition of T stock. Shortly after the acquisition date, and
as part of the same plan, T merges under applicable state law into X in
a transaction that, but for the question of continuity of interest,
satisfies all the requirements of section 368(a)(1)(A). In the merger,
all of T's assets are transferred to X. P and K receive X stock in
exchange for their T stock. P intends to retain the stock of X
indefinitely.
(ii) Status of transfer as a reorganization. By virtue of section
338, for the purpose of determining whether the continuity of interest
requirement of Sec. 1.368-1(b) is satisfied, P's T stock acquired in the
qualified stock purchase represents an interest on the part of a person
who was an owner of T's business enterprise prior to the transfer that
can be continued in a reorganization through P's continuing ownership of
X. Thus, the continuity of interest requirement is satisfied and the
merger of T into X is a reorganization within the meaning of section
368(a)(1)(A). Moreover, by virtue of section 338, the requirement of
section 368(a)(1)(D) that a target shareholder control the transferee
immediately after the transfer is satisfied because P controls X
immediately after the transfer. In addition, all of T's assets are
transferred to X in the merger and P and K receive the X stock exchanged
therefor in pursuance of the plan of reorganization. Thus, the merger of
T into X is also a reorganization within the meaning of section
368(a)(1)(D).
(iii) Treatment of T and X. Under section 361(a), T recognizes no
gain or loss in the merger. Under section 362(b), X's basis in the
assets received in the merger is the same as the basis of the assets in
T's hands. X succeeds to and takes into account the items of T as
provided in section 381.
(iv) Treatment of P. By virtue of section 338, the transfer of T
assets to X is a reorganization. Pursuant to that reorganization, P
exchanges its T stock solely for stock of X, a party to the
reorganization. Because P is the purchasing corporation, section 354
applies to P's exchange of T stock for X stock in the merger of T into
X. Thus, P recognizes no gain or loss on the exchange. Under section
358, P's basis in the X stock received in the exchange is the same as
the basis of P's T stock exchanged therefor.
(v) Treatment of K. Because K is not the purchasing corporation (or
an affiliate thereof), section 354 cannot apply to K's exchange of T
stock for X stock in the merger of T into X unless the transfer of T's
assets is pursuant to a reorganization as determined without regard to
this paragraph (d). Under general principles of tax law applicable to
reorganizations, the continuity of interest requirement is not satisfied
because P's stock purchase and the merger of T into X are pursuant to an
integrated transaction in which A, the owner of 85 percent of the stock
of T, received solely cash in exchange for A's T stock. See, e.g.,
Sec. 1.368-1(e)(1)(i); Yoc Heating v. Commissioner, 61 T.C. 168 (1973);
Kass v. Commissioner, 60 T.C. 218 (1973), aff'd, 491 F.2d 749 (3d Cir.
1974). Thus, the requisite continuity of interest under Sec. 1.368-1(b)
is lacking and section 354 does not apply to K's exchange of T stock for
X stock. K recognizes gain or loss, if any, pursuant to section 1001(c)
with respect to its T stock.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17363, Mar. 30, 2001]
Sec. 1.338-4 Aggregate deemed sale price; various aspects of taxation of the deemed asset sale.
(a) Scope. This section provides rules under section 338(a)(1) to
determine the
[[Page 110]]
aggregate deemed sale price (ADSP) for target. ADSP is the amount for
which old target is deemed to have sold all of its assets in the deemed
asset sale. ADSP is allocated among target's assets in accordance with
Sec. 1.338-6 to determine the amount for which each asset is deemed to
have been sold. When a subsequent increase or decrease is required under
general principles of tax law with respect to an element of ADSP, the
redetermined ADSP is allocated among target's assets in accordance with
Sec. 1.338-7. This Sec. 1.338-4 also provides rules regarding the
recognition of gain or loss on the deemed sale of target affiliate
stock. Notwithstanding section 338(h)(6)(B)(ii), stock held by a target
affiliate in a foreign corporation or in a corporation that is a DISC or
that is described in section 1248(e) is not excluded from the operation
of section 338.
(b) Determination of ADSP--(1) General rule. ADSP is the sum of--
(i) The grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased target
stock (as defined in section 338(b)(6)(A)); and
(ii) The liabilities of old target.
(2) Time and amount of ADSP--(i) Original determination. ADSP is
initially determined at the beginning of the day after the acquisition
date of target. General principles of tax law apply in determining the
timing and amount of the elements of ADSP.
(ii) Redetermination of ADSP. ADSP is redetermined at such time and
in such amount as an increase or decrease would be required, under
general principles of tax law, for the elements of ADSP. For example,
ADSP is redetermined because of an increase or decrease in the amount
realized for recently purchased stock or because liabilities not
originally taken into account in determining ADSP are subsequently taken
into account. Increases or decreases with respect to the elements of
ADSP result in the reallocation of ADSP among target's assets under
Sec. 1.338-7.
(iii) Example. The following example illustrates this paragraph
(b)(2):
Example. In Year 1, T, a manufacturer, purchases a customized
delivery truck from X with purchase money indebtedness having a stated
principal amount of $100,000. P acquires all of the stock of T in Year 3
for $700,000 and makes a section 338 election for T. Assume T has no
liabilities other than its purchase money indebtedness to X. In Year 4,
when T is neither insolvent nor in a title 11 case, T and X agree to
reduce the amount of the purchase money indebtedness to $80,000. Assume
further that the reduction would be a purchase price reduction under
section 108(e)(5). T and X's agreement to reduce the amount of the
purchase money indebtedness would not, under general principles of tax
law that would apply if the deemed asset sale had actually occurred,
change the amount of liabilities of old target taken into account in
determining its amount realized. Accordingly, ADSP is not redetermined
at the time of the reduction. See Sec. 1.338-5(b)(2)(iii) Example 1 for
the effect on AGUB.
(c) Grossed-up amount realized on the sale to the purchasing
corporation of the purchasing corporation's recently purchased target
stock--(1) Determination of amount. The grossed-up amount realized on
the sale to the purchasing corporation of the purchasing corporation's
recently purchased target stock is an amount equal to--
(i) The amount realized on the sale to the purchasing corporation of
the purchasing corporation's recently purchased target stock determined
as if the selling shareholder(s) were required to use old target's
accounting methods and characteristics and the installment method were
not available and determined without regard to the selling costs taken
into account under paragraph (c)(1)(iii) of this section;
(ii) Divided by the percentage of target stock (by value, determined
on the acquisition date) attributable to that recently purchased target
stock;
(iii) Less the selling costs incurred by the selling shareholders in
connection with the sale to the purchasing corporation of the purchasing
corporation's recently purchased target stock that reduce their amount
realized on the sale of the stock (e.g., brokerage commissions and any
similar costs to sell the stock).
(2) Example. The following example illustrates this paragraph (c):
Example. T has two classes of stock outstanding, voting common stock
and preferred stock described in section 1504(a)(4). On March 1 of Year
1, P purchases 40 percent of the outstanding T stock from S1 for $500,
[[Page 111]]
20 percent of the outstanding T stock from S2 for $225, and 20 percent
of the outstanding T stock from S3 for $275. On that date, the fair
market value of all the T voting common stock is $1,250 and the
preferred stock $750. S1, S2, and S3 incur $40, $35, and $25
respectively of selling costs. S1 continues to own the remaining 20
percent of the outstanding T stock. The grossed-up amount realized on
the sale to P of P's recently purchased T stock is calculated as
follows: The total amount realized (without regard to selling costs) is
$1,000 (500 + 225 + 275). The percentage of T stock by value on the
acquisition date attributable to the recently purchased T stock is 50%
(1,000/(1,250 + 750)). The selling costs are $100 (40 + 35 + 25). The
grossed-up amount realized is $1,900 (1,000/.5 - 100).
(d) Liabilities of old target--(1) In general. In general, the
liabilities of old target are measured as of the beginning of the day
after the acquisition date. (But see Sec. 1.338-1(d) (regarding certain
transactions on the acquisition date).) In order to be taken into
account in ADSP, a liability must be a liability of target that is
properly taken into account in amount realized under general principles
of tax law that would apply if old target had sold its assets to an
unrelated person for consideration that included the discharge of its
liabilities. See Sec. 1.1001-2(a). Such liabilities may include
liabilities for the tax consequences resulting from the deemed sale.
(2) Time and amount of liabilities. The time for taking into account
liabilities of old target in determining ADSP and the amount of the
liabilities taken into account is determined as if old target had sold
its assets to an unrelated person for consideration that included the
discharge of the liabilities by the unrelated person. For example, if no
amount of a target liability is properly taken into account in amount
realized as of the beginning of the day after the acquisition date, the
liability is not initially taken into account in determining ADSP
(although it may be taken into account at some later date).
(e) Deemed sale tax consequences. Gain or loss on each asset in the
deemed sale is computed by reference to the ADSP allocated to that
asset. ADSP is allocated under the rules of Sec. 1.338-6. Though deemed
sale tax consequences may increase or decrease ADSP by creating or
reducing a tax liability, the amount of the tax liability itself may be
a function of the size of the deemed sale tax consequences. Thus, these
determinations may require trial and error computations.
(f) Other rules apply in determining ADSP. ADSP may not be applied
in such a way as to contravene other applicable rules. For example, a
capital loss cannot be applied to reduce ordinary income in calculating
the tax liability on the deemed sale for purposes of determining ADSP.
(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), unless otherwise stated,
T is a calendar year taxpayer that files separate returns and that has
no loss, tax credit, or other carryovers to Year 1. Depreciation for
Year 1 is not taken into account. T has no liabilities other than the
Federal income tax liability resulting from the deemed asset sale, and
the T shareholders have no selling costs. Assume that T's tax rate for
any ordinary income or net capital gain resulting from the deemed sale
of assets is 34 percent and that any capital loss is offset by capital
gain. On July 1 of Year 1, P purchases all of the stock of T and makes a
section 338 election for T. The examples are as follows:
Example 1. One class. (i) On July 1 of Year 1, T's only asset is an
item of section 1245 property with an adjusted basis to T of $50,400, a
recomputed basis of $80,000, and a fair market value of $100,000. P
purchases all of the T stock for $75,000, which also equals the amount
realized for the stock determined as if the selling shareholder(s) were
required to use old target's accounting methods and characteristics.
(ii) ADSP is determined as follows (for purposes of this section
(g), G is the grossed-up amount realized on the sale to P of P's
recently purchased T stock, L is T's liabilities other than T's tax
liability for the deemed sale tax consequences, TR is the
applicable tax rate, and B is the adjusted basis of the asset deemed
sold):
ADSP = G + L + TR x (ADSP-B)
ADSP = ($75,000/1) + $0 + .34 x (ADSP - $50,400)
ADSP = $75,000 + .34ADSP - $17,136 .66ADSP = $57,864
ADSP = $87,672.72
(iii) Because ADSP for T ($87,672.72) does not exceed the fair
market value of T's asset ($100,000), a Class V asset, T's entire ADSP
is allocated to that asset. Thus, T's deemed sale results in $37,272.72
of taxable income
[[Page 112]]
(consisting of $29,600 of ordinary income and $7,672.72 of capital
gain).
(iv) The facts are the same as in paragraph (i) of this Example 1,
except that on July 1 of Year 1, P purchases only 80 of the 100 shares
of T stock for $60,000. The grossed-up amount realized on the sale to P
of P's recently purchased T stock (G) is $75,000 ($60,000/.8).
Consequently, ADSP and the deemed sale tax consequences are the same as
in paragraphs (ii) and (iii) of this Example 1.
(v) The facts are the same as in paragraph (i) of this Example 1,
except that T also has goodwill (a Class VII asset) with an appraised
value of $10,000. The results are the same as in paragraphs (ii) and
(iii) of this Example 1. Because ADSP does not exceed the fair market
value of the Class V asset, no amount is allocated to the Class VII
asset (goodwill).
Example 2. More than one class. (i) P purchases all of the T stock
for $140,000, which also equals the amount realized for the stock
determined as if the selling shareholder(s) were required to use old
target's accounting methods and characteristics. On July 1 of Year 1, T
has liabilities (not including the tax liability for the deemed sale tax
consequences) of $50,000, cash (a Class I asset) of $10,000, actively
traded securities (a Class II asset) with a basis of $4,000 and a fair
market value of $10,000, goodwill (a Class VII asset) with a basis of
$3,000, and the following Class V assets:
------------------------------------------------------------------------
Ratio of
asset FMV
Asset Basis FMV to total
Class V FMV
------------------------------------------------------------------------
Land............................. $5,000 $35,000 .14
Building......................... 10,000 50,000 .20
Equipment A (Recomputed basis 5,000 90,000 .36
$80,000)........................
Equipment B (Recomputed basis 10,000 75,000 .30
$20,000)........................
--------------------------------------
Totals....................... $30,000 $250,000 1.00
------------------------------------------------------------------------
(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the
cash and $10,000 to the actively traded securities. The amount allocated
to an asset (other than a Class VII asset) cannot exceed its fair market
value (however, the fair market value of any property subject to
nonrecourse indebtedness is treated as being not less than the amount of
such indebtedness; see Sec. 1.338-6(a)(2)). See Sec. 1.338-6(c)(1)
(relating to fair market value limitation).
(iii) The portion of ADSP allocable to the Class V assets is
preliminarily determined as follows (in the formula, the amount
allocated to the Class I assets is referred to as I and the amount
allocated to the Class II assets as II):
ADSPV = (G-(I + II)) + L+ TR x [(II -
BII) + (ADSPV - BV)]
ADSPV = ($140,000 - ($10,000 + $10,000)) + $50,000 + .34
x [($10,000 - $4,000) + (ADSPV - ($5,000 + $10,000 + $5,000 +
$10,000))]
ADSPV = $161,840 + .34ADSPV
.66 ADSPV = $161,840
ADSPV = $245,212.12
(iv) Because, under the preliminary calculations of ADSP, the amount
to be allocated to the Class I, II, III, IV, V, and VI assets does not
exceed their aggregate fair market value, no ADSP amount is allocated to
goodwill. Accordingly, the deemed sale of the goodwill results in a
capital loss of $3,000. The portion of ADSP allocable to the Class V
assets is finally determined by taking into account this loss as
follows:
ADSPV = (G - (I + II)) + L + T R x [(II -
BII) + (ADSPV - BV) + (ADSPVII - B
VII)]
ADSPV = ($140,000 - ($10,000 + $10,000))+ $50,000 + .34 x
[($10,000 - $4,000) + (ADSPV - $30,000) + ($0 - $3,000)]
ADSPV = $160,820 + .34ADSPV
.66 ADSPV = $160,820
ADSPV = $243,666.67
(v) The allocation of ADSPV among the Class V assets is
in proportion to their fair market values, as follows:
------------------------------------------------------------------------
Asset ADSP Gain
------------------------------------------------------------------------
Land.......................... $34,113.33 $29,113.33 (capital
gain).
Building...................... 48,733.34 38,733.34 (capital
gain).
Equipment A................... 87,720.00 82,720.00 (75,000
ordinary income 7,720
capital gain).
Equipment B................... 73,100.00 63,100.00 (10,000
ordinary income
53,100 capital gain).
-----------------------------------------
Totals.................... 243,666.67 213,666.67.
------------------------------------------------------------------------
[[Page 113]]
Example 3. More than one class. (i) The facts are the same as in
Example 2, except that P purchases the T stock for $150,000, rather than
$140,000. The amount realized for the stock determined as if the selling
shareholder(s) were required to use old target's accounting methods and
characteristics is also $150,000.
(ii) As in Example 2, ADSP exceeds $20,000. Thus, $10,000 of ADSP is
allocated to the cash and $10,000 to the actively traded securities.
(iii) The portion of ADSP allocable to the Class V assets as
preliminarily determined under the formula set forth in paragraph (iii)
of Example 2 is $260,363.64. The amount allocated to the Class V assets
cannot exceed their aggregate fair market value ($250,000). Thus,
preliminarily, the ADSP amount allocated to Class V assets is $250,000.
(iv) Based on the preliminary allocation, the ADSP is determined as
follows (in the formula, the amount allocated to the Class I assets is
referred to as I, the amount allocated to the Class II assets as II, and
the amount allocated to the Class V assets as V):
ADSP = G + L + TR x [(II - BII) + (V -
BV) + (ADSP - (I + II + V + BVII))]
ADSP = $150,000 + $50,000 + .34 x [($10,000 - $4,000) + ($250,000 -
$30,000) + (ADSP - ($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP - $15,980
.66ADSP = $184,020
ADSP = $278,818.18
(v) Because ADSP as determined exceeds the aggregate fair market
value of the Class I, II, III, IV, V, and VI assets, the $250,000 amount
preliminarily allocated to the Class V assets is appropriate. Thus, the
amount of ADSP allocated to Class V assets equals their aggregate fair
market value ($250,000), and the allocated ADSP amount for each Class V
asset is its fair market value. Further, because there are no Class VI
assets, the allocable ADSP amount for the Class VII asset (goodwill) is
$8,818.18 (the excess of ADSP over the aggregate ADSP amounts for the
Class I, II, III, IV, V and VI assets).
Example 4. Amount allocated to T1 stock. (i) The facts are the same
as in Example 2, except that T owns all of the T1 stock (instead of the
building), and T1's only asset is the building. The T1 stock and the
building each have a fair market value of $50,000, and the building has
a basis of $10,000. A section 338 election is made for T1 (as well as
T), and T1 has no liabilities other than the tax liability for the
deemed sale tax consequences. T is the common parent of a consolidated
group filing a final consolidated return described in Sec. 1.338-
10(a)(1).
(ii) ADSP exceeds $20,000. Thus, $10,000 of ADSP is allocated to the
cash and $10,000 to the actively traded securities.
(iii) Because T does not recognize any gain on the deemed sale of
the T1 stock under paragraph (h)(2) of this section, appropriate
adjustments must be made to reflect accurately the fair market value of
the T and T1 assets in determining the allocation of ADSP among T's
Class V assets (including the T1 stock). In preliminarily calculating
ADSPV in this case, the T1 stock can be disregarded and,
because T owns all of the T1 stock, the T1 asset can be treated as a T
asset. Under this assumption, ADSPV is $243,666.67. See
paragraph (iv) of Example 2.
(iv) Because the portion of the preliminary ADSP allocable to Class
V assets ($243,666.67) does not exceed their fair market value
($250,000), no amount is allocated to Class VII assets for T. Further,
this amount ($243,666.67) is allocated among T's Class V assets in
proportion to their fair market values. See paragraph (v) of Example 2.
Tentatively, $48,733.34 of this amount is allocated to the T1 stock.
(v) The amount tentatively allocated to the T1 stock, however,
reflects the tax incurred on the deemed sale of the T1 asset equal to
$13,169.34 (.34x($48,733.34-$10,000)). Thus, the ADSP allocable to the
Class V assets of T, and the ADSP allocable to the T1 stock, as
preliminarily calculated, each must be reduced by $13,169.34.
Consequently, these amounts, respectively, are $230,497.33 and
$35,564.00. In determining ADSP for T1, the grossed-up amount realized
on the deemed sale to new T of new T's recently purchased T1 stock is
$35,564.00.
(vi) The facts are the same as in paragraph (i) of this Example 4,
except that the T1 building has a $12,500 basis and a $62,500 value, all
of the outstanding T1 stock has a $62,500 value, and T owns 80 percent
of the T1 stock. In preliminarily calculating ADSPV, the T1
stock can be disregarded but, because T owns only 80 percent of the T1
stock, only 80 percent of T1 asset basis and value should be taken into
account in calculating T's ADSP. By taking into account 80 percent of
these amounts, the remaining calculations and results are the same as in
paragraphs (ii), (iii), (iv), and (v) of this Example 4, except that the
grossed-up amount realized on the sale of the recently purchased T1
stock is $44,455.00 ($35,564.00/0.8).
(h) Deemed sale of target affiliate stock--(1) Scope. This paragraph
(h) prescribes rules relating to the treatment of gain or loss realized
on the deemed sale of stock of a target affiliate when a section 338
election (but not a section 338(h)(10) election) is made for the target
affiliate. For purposes of this paragraph (h), the definition of
domestic corporation in Sec. 1.338-2(c)(9) is applied without the
exclusion therein for DISCs, corporations described in section 1248(e),
and corporations to which an election under section 936 applies.
[[Page 114]]
(2) In general. Except as otherwise provided in this paragraph (h),
if a section 338 election is made for target, target recognizes no gain
or loss on the deemed sale of stock of a target affiliate having the
same acquisition date and for which a section 338 election is made if--
(i) Target directly owns stock in the target affiliate satisfying
the requirements of section 1504(a)(2);
(ii) Target and the target affiliate are members of a consolidated
group filing a final consolidated return described in Sec. 1.338-
10(a)(1); or
(iii) Target and the target affiliate file a combined return under
Sec. 1.338-10(a)(4).
(3) Deemed sale of foreign target affiliate by a domestic target. A
domestic target recognizes gain or loss on the deemed sale of stock of a
foreign target affiliate. For the proper treatment of such gain or loss,
see, e.g., sections 1246, 1248, 1291 et seq., and 338(h)(16) and
Sec. 1.338-9.
(4) Deemed sale producing effectively connected income. A foreign
target recognizes gain or loss on the deemed sale of stock of a foreign
target affiliate to the extent that such gain or loss is effectively
connected (or treated as effectively connected) with the conduct of a
trade or business in the United States.
(5) Deemed sale of insurance company target affiliate electing under
section 953(d). A domestic target recognizes gain (but not loss) on the
deemed sale of stock of a target affiliate that has in effect an
election under section 953(d) in an amount equal to the lesser of the
gain realized or the earnings and profits described in section
953(d)(4)(B).
(6) Deemed sale of DISC target affiliate. A foreign or domestic
target recognizes gain (but not loss) on the deemed sale of stock of a
target affiliate that is a DISC or a former DISC (as defined in section
992(a)) in an amount equal to the lesser of the gain realized or the
amount of accumulated DISC income determined with respect to such stock
under section 995(c). Such gain is included in gross income as a
dividend as provided in sections 995(c)(2) and 996(g).
(7) Anti-stuffing rule. If an asset the adjusted basis of which
exceeds its fair market value is contributed or transferred to a target
affiliate as transferred basis property (within the meaning of section
7701(a)(43)) and a purpose of such transaction is to reduce the gain (or
increase the loss) recognized on the deemed sale of such target
affiliate's stock, the gain or loss recognized by target on the deemed
sale of stock of the target affiliate is determined as if such asset had
not been contributed or transferred.
(8) Examples. The following examples illustrate this paragraph (h):
Example 1. (i) P makes a qualified stock purchase of T and makes a
section 338 election for T. T's sole asset, all of the T1 stock, has a
basis of $50 and a fair market value of $150. T's deemed purchase of the
T1 stock results in a qualified stock purchase of T1 and a section 338
election is made for T1. T1's assets have a basis of $50 and a fair
market value of $150.
(ii) T realizes $100 of gain on the deemed sale of the T1 stock, but
the gain is not recognized because T directly owns stock in T1
satisfying the requirements of section 1504(a)(2) and a section 338
election is made for T1.
(iii) T1 recognizes gain of $100 on the deemed sale of its assets.
Example 2. The facts are the same as in Example 1, except that P
does not make a section 338 election for T1. Because a section 338
election is not made for T1, the $100 gain realized by T on the deemed
sale of the T1 stock is recognized.
Example 3. (i) P makes a qualified stock purchase of T and makes a
section 338 election for T. T owns all of the stock of T1 and T2. T's
deemed purchase of the T1 and T2 stock results in a qualified stock
purchase of T1 and T2 and section 338 elections are made for T1 and T2.
T1 and T2 each own 50 percent of the vote and value of T3 stock. The
deemed purchases by T1 and T2 of the T3 stock result in a qualified
stock purchase of T3 and a section 338 election is made for T3. T is the
common parent of a consolidated group and all of the deemed asset sales
are reported on the T group's final consolidated return. See Sec. 1.338-
10(a)(1).
(ii) Because T, T1, T2 and T3 are members of a consolidated group
filing a final consolidated return, no gain or loss is recognized by T,
T1 or T2 on their respective deemed sales of target affiliate stock.
Example 4. (i) T's sole asset, all of the FT1 stock, has a basis of
$25 and a fair market value of $150. FT1's sole asset, all of the FT2
stock, has a basis of $75 and a fair market value of $150. FT1 and FT2
each have $50 of accumulated earnings and profits for purposes of
section 1248(c) and (d). FT2's assets have a basis of $125 and a fair
market value of $150, and their sale would not generate subpart F income
under section 951. The sale
[[Page 115]]
of the FT2 stock or assets would not generate income effectively
connected with the conduct of a trade or business within the United
States. FT1 does not have an election in effect under section 953(d) and
neither FT1 nor FT2 is a passive foreign investment company.
(ii) P makes a qualified stock purchase of T and makes a section 338
election for T. T's deemed purchase of the FT1 stock results in a
qualified stock purchase of FT1 and a section 338 election is made for
FT1. Similarly, FT1's deemed purchase of the FT2 stock results in a
qualified stock purchase of FT2 and a section 338 election is made for
FT2.
(iii) T recognizes $125 of gain on the deemed sale of the FT1 stock
under paragraph (h)(3) of this section. FT1 does not recognize $75 of
gain on the deemed sale of the FT2 stock under paragraph (h)(2) of this
section. FT2 recognizes $25 of gain on the deemed sale of its assets.
The $125 gain T recognizes on the deemed sale of the FT1 stock is
included in T's income as a dividend under section 1248, because FT1 and
FT2 have sufficient earnings and profits for full recharacterization
($50 of accumulated earnings and profits in FT1, $50 of accumulated
earnings and profits in FT2, and $25 of deemed sale earnings and profits
in FT2). Section 1.338-9(b). For purposes of sections 901 through 908,
the source and foreign tax credit limitation basket of $25 of the
recharacterized gain on the deemed sale of the FT1 stock is determined
under section 338(h)(16).
[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17466, Mar. 30, 2001]
Sec. 1.338-5 Adjusted grossed-up basis.
(a) Scope. This section provides rules under section 338(b) to
determine the adjusted grossed-up basis (AGUB) for target. AGUB is the
amount for which new target is deemed to have purchased all of its
assets in the deemed purchase under section 338(a)(2). AGUB is allocated
among target's assets in accordance with Sec. 1.338-6 to determine the
price at which the assets are deemed to have been purchased. When a
subsequent increase or decrease with respect to an element of AGUB is
required under general principles of tax law, redetermined AGUB is
allocated among target's assets in accordance with Sec. 1.338-7.
(b) Determination of AGUB--(1) General rule. AGUB is the sum of--
(i) The grossed-up basis in the purchasing corporation's recently
purchased target stock;
(ii) The purchasing corporation's basis in nonrecently purchased
target stock; and
(iii) The liabilities of new target.
(2) Time and amount of AGUB--(i) Original determination. AGUB is
initially determined at the beginning of the day after the acquisition
date of target. General principles of tax law apply in determining the
timing and amount of the elements of AGUB.
(ii) Redetermination of AGUB. AGUB is redetermined at such time and
in such amount as an increase or decrease would be required, under
general principles of tax law, with respect to an element of AGUB. For
example, AGUB is redetermined because of an increase or decrease in the
amount paid or incurred for recently purchased stock or nonrecently
purchased stock or because liabilities not originally taken into account
in determining AGUB are subsequently taken into account. An increase or
decrease to one element of AGUB also may cause an increase or decrease
to another element of AGUB. For example, if there is an increase in the
amount paid or incurred for recently purchased stock after the
acquisition date, any increase in the basis of nonrecently purchased
stock because a gain recognition election was made is also taken into
account when AGUB is redetermined. Increases or decreases with respect
to the elements of AGUB result in the reallocation of AGUB among
target's assets under Sec. 1.338-7.
(iii) Examples. The following examples illustrate this paragraph
(b)(2):
Example 1. In Year 1, T, a manufacturer, purchases a customized
delivery truck from X with purchase money indebtedness having a stated
principal amount of $100,000. P acquires all of the stock of T in Year 3
for $700,000 and makes a section 338 election for T. Assume T has no
liabilities other than its purchase money indebtedness to X. In Year 4,
when T is neither insolvent nor in a title 11 case, T and X agree to
reduce the amount of the purchase money indebtedness to $80,000. Assume
that the reduction would be a purchase price reduction under section
108(e)(5). T and X's agreement to reduce the amount of the purchase
money indebtedness would, under general principles of tax law that would
apply if the deemed asset sale had actually occurred, change the amount
of liabilities of old target taken into account in determining its
basis. Accordingly, AGUB is redetermined at the time of the reduction.
[[Page 116]]
See paragraph (e)(2) of this section. Thus the purchase price reduction
affects the basis of the truck only indirectly, through the mechanism of
Secs. 1.338-6 and 1.338-7. See Sec. 1.338-4(b)(2)(iii) Example for the
effect on ADSP.
Example 2. T, an accrual basis taxpayer, is a chemical manufacturer.
In Year 1, T is obligated to remediate environmental contamination at
the site of one of its plants. Assume that all the events have occurred
that establish the fact of the liability and the amount of the liability
can be determined with reasonable accuracy but economic performance has
not occurred with respect to the liability within the meaning of section
461(h). P acquires all of the stock of T in Year 1 and makes a section
338 election for T. Assume that, if a corporation unrelated to T had
actually purchased T's assets and assumed T's obligation to remediate
the contamination, the corporation would not satisfy the economic
performance requirements until Year 5. Under section 461(h), the assumed
liability would not be treated as incurred and taken into account in
basis until that time. The incurrence of the liability in Year 5 under
the economic performance rules is an increase in the amount of
liabilities properly taken into account in basis and results in the
redetermination of AGUB. (Respecting ADSP, compare Sec. 1.461-4(d)(5),
which provides that economic performance occurs for old T as the amount
of the liability is properly taken into account in amount realized on
the deemed asset sale. Thus ADSP is not redetermined when new T
satisfies the economic performance requirements.)
(c) Grossed-up basis of recently purchased stock. The purchasing
corporation's grossed-up basis of recently purchased target stock (as
defined in section 338(b)(6)(A)) is an amount equal to--
(1) The purchasing corporation's basis in recently purchased target
stock at the beginning of the day after the acquisition date determined
without regard to the acquisition costs taken into account in paragraph
(c)(3) of this section;
(2) Multiplied by a fraction, the numerator of which is 100 minus
the number that is the percentage of target stock (by value, determined
on the acquisition date) attributable to the purchasing corporation's
nonrecently purchased target stock, and the denominator of which is the
number equal to the percentage of target stock (by value, determined on
the acquisition date) attributable to the purchasing corporation's
recently purchased target stock;
(3) Plus the acquisition costs the purchasing corporation incurred
in connection with its purchase of the recently purchased stock that are
capitalized in the basis of such stock (e.g., brokerage commissions and
any similar costs incurred by the purchasing corporation to acquire the
stock).
(d) Basis of nonrecently purchased stock; gain recognition election-
-(1) No gain recognition election. In the absence of a gain recognition
election under section 338(b)(3) and this section, the purchasing
corporation retains its basis in the nonrecently purchased stock.
(2) Procedure for making gain recognition election. A gain
recognition election may be made for nonrecently purchased stock of
target (or a target affiliate) only if a section 338 election is made
for target (or the target affiliate). The gain recognition election is
made by attaching a gain recognition statement to a timely filed Form
8023 for target. The gain recognition statement must contain the
information specified in the form and its instructions. The gain
recognition election is irrevocable. If a section 338(h)(10) election is
made for target, see Sec. 1.338(h)(10)-1(d)(1) (providing that the
purchasing corporation is automatically deemed to have made a gain
recognition election for its nonrecently purchased T stock).
(3) Effect of gain recognition election--(i) In general. If the
purchasing corporation makes a gain recognition election, then for all
purposes of the Internal Revenue Code--
(A) The purchasing corporation is treated as if it sold on the
acquisition date the nonrecently purchased target stock for the basis
amount determined under paragraph (d)(3)(ii) of this section; and
(B) The purchasing corporation's basis on the acquisition date in
nonrecently purchased target stock immediately following the deemed sale
in paragraph (d)(3)(i)(A) of this section is the basis amount.
(ii) Basis amount. The basis amount is equal to the amount in
paragraph (c)(1) of this section (the purchasing corporation's basis in
recently purchased target stock at the beginning of the day after the
acquisition date determined
[[Page 117]]
without regard to the acquisition costs taken into account in paragraph
(c)(3) of this section) multiplied by a fraction the numerator of which
is the percentage of target stock (by value, determined on the
acquisition date) attributable to the purchasing corporation's
nonrecently purchased target stock and the denominator of which is 100
percent minus the numerator amount. Thus, if target has a single class
of outstanding stock, the purchasing corporation's basis in each share
of nonrecently purchased target stock after the gain recognition
election is equal to the average price per share of the purchasing
corporation's recently purchased target stock.
(iii) Losses not recognized. Only gains (unreduced by losses) on the
nonrecently purchased target stock are recognized.
(iv) Stock subject to election. The gain recognition election
applies to--
(A) All nonrecently purchased target stock; and
(B) Any nonrecently purchased stock in a target affiliate having the
same acquisition date as target if such target affiliate stock is held
by the purchasing corporation on such date.
(e) Liabilities of new target--(1) In general. The liabilities of
new target are the liabilities of target as of the beginning of the day
after the acquisition date (but see Sec. 1.338-1(d) (regarding certain
transactions on the acquisition date)). In order to be taken into
account in AGUB, a liability must be a liability of target that is
properly taken into account in basis under general principles of tax law
that would apply if new target had acquired its assets from an unrelated
person for consideration that included discharge of the liabilities of
that unrelated person. Such liabilities may include liabilities for the
tax consequences resulting from the deemed sale.
(2) Time and amount of liabilities. The time for taking into account
liabilities of old target in determining AGUB and the amount of the
liabilities taken into account is determined as if new target had
acquired its assets from an unrelated person for consideration that
included the discharge of its liabilities.
(3) Interaction with deemed sale tax consequences. In general, see
Sec. 1.338-4(e). Although ADSP and AGUB are not necessarily linked, if
an increase in the amount realized for recently purchased stock of
target is taken into account after the acquisition date, and if the tax
on the deemed sale tax consequences is a liability of target, any
increase in that liability is also taken into account in redetermining
AGUB.
(f) Adjustments by the Internal Revenue Service. In connection with
the examination of a return, the Commissioner may increase (or decrease)
AGUB under the authority of section 338(b)(2) and allocate such amounts
to target's assets under the authority of section 338(b)(5) so that AGUB
and the basis of target's assets properly reflect the cost to the
purchasing corporation of its interest in target's assets. Such items
may include distributions from target to the purchasing corporation,
capital contributions from the purchasing corporation to target during
the 12-month acquisition period, or acquisitions of target stock by the
purchasing corporation after the acquisition date from minority
shareholders. See also Sec. 1.338-1(d) (regarding certain transactions
on the acquisition date).
(g) Examples. The following examples illustrate this section. For
purposes of the examples in this paragraph (g), T has no liabilities
other than the tax liability for the deemed sale tax consequences, T
shareholders incur no costs in selling the T stock, and P incurs no
costs in acquiring the T stock. The examples are as follows:
Example 1. (i) Before July 1 of Year 1, P purchases 10 of the 100
shares of T stock for $5,000. On July 1 of Year 2, P purchases 80 shares
of T stock for $60,000 and makes a section 338 election for T. As of
July 1 of Year 2, T's only asset is raw land with an adjusted basis to T
of $50,400 and a fair market value of $100,000. T has no loss or tax
credit carryovers to Year 2. T's marginal tax rate for any ordinary
income or net capital gain resulting from the deemed asset sale is 34
percent. The 10 shares purchased before July 1 of Year 1 constitute
nonrecently purchased T stock with respect to P's qualified stock
purchase of T stock on July 1 of Year 2.
(ii) The ADSP formula as applied to these facts is the same as in
Sec. 1.338-4(g) Example 1. Accordingly, the ADSP for T is $87,672.72.
The existence of nonrecently purchased T stock is irrelevant for
purposes of the ADSP formula, because that formula treats P's
[[Page 118]]
nonrecently purchased T stock in the same manner as T stock not held by
P.
(iii) The total tax liability resulting from T's deemed asset sale,
as calculated under the ADSP formula, is $12,672.72.
(iv) If P does not make a gain recognition election, the AGUB of new
T's assets is $85,172.72, determined as follows (In the following
formula below, GRP is the grossed-up basis in P's recently purchased T
stock, BNP is P's basis in nonrecently purchased T stock, L is T's
liabilities, and X is P's acquisition costs for the recently purchased T
stock):
AGUB = GRP + BNP + L + X
AGUB = $60,000 x [(1 - .1)/.8] + $5,000 + $12,672.72 + 0
AGUB = $85,172.72
(v) If P makes a gain recognition election, the AGUB of new T's
assets is $87,672.72, determined as follows:
AGUB = $60,000 x [(1 - .1)/.8] + $60,000 x [(1 - .1)/.8] x [.1/(1 - .1)]
+ $12,672.72
AGUB = $87,672.72
(vi) The calculation of AGUB if P makes a gain recognition election
may be simplified as follows:
AGUB = $60,000/.8 + $12,672.72
AGUB = $87,672.72
(vii) As a result of the gain recognition election, P's basis in its
nonrecently purchased T stock is increased from $5,000 to $7,500 (i.e.,
$60,000 x [(1 - .1)/.8] x [.1/(1 - .1)]). Thus, P recognizes a gain in
Year 2 with respect to its nonrecently purchased T stock of $2,500
(i.e., $7,500 - $5,000).
Example 2. On January 1 of Year 1, P purchases one-third of the T
stock. On March 1 of Year 1, T distributes a dividend to all of its
shareholders. On April 15 of Year 1, P purchases the remaining T stock
and makes a section 338 election for T. In appropriate circumstances,
the Commissioner may decrease the AGUB of T to take into account the
payment of the dividend and properly reflect the fair market value of
T's assets deemed purchased.
Example 3. (i) T's sole asset is a building worth $100,000. At this
time, T has 100 shares of stock outstanding. On August 1 of Year 1, P
purchases 10 of the 100 shares of T stock for $8,000. On June 1 of Year
2, P purchases 50 shares of T stock for $50,000. On June 15 of Year 2, P
contributes a tract of land to the capital of T and receives 10
additional shares of T stock as a result of the contribution. Both the
basis and fair market value of the land at that time are $10,800. On
June 30 of Year 2, P purchases the remaining 40 shares of T stock for
$40,000 and makes a section 338 election for T. The AGUB of T is
$108,800.
(ii) To prevent the shifting of basis from the contributed property
to other assets of T, the Commissioner may allocate $10,800 of the AGUB
to the land, leaving $98,000 to be allocated to the building. See
paragraph (f) of this section. Otherwise, applying the allocation rules
of Sec. 1.338-6 would, on these facts, result in an allocation to the
recently contributed land of an amount less than its value of $10,800,
with the difference being allocated to the building already held by T.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001]
Sec. 1.338-6 Allocation of ADSP and AGUB among target assets.
(a) Scope--(1) In general. This section prescribes rules for
allocating ADSP and AGUB among the acquisition date assets of a target
for which a section 338 election is made.
(2) Fair market value--(i) In general. Generally, the fair market
value of an asset is its gross fair market value (i.e., fair market
value determined without regard to mortgages, liens, pledges, or other
liabilities). However, for purposes of determining the amount of old
target's deemed sale tax consequences, the fair market value of any
property subject to a nonrecourse indebtedness will be treated as being
not less than the amount of such indebtedness. (For purposes of the
preceding sentence, a liability that was incurred because of the
acquisition of the property is disregarded to the extent that such
liability was not taken into account in determining old target's basis
in such property.)
(ii) Transaction costs. Transaction costs are not taken into account
in allocating ADSP or AGUB to assets in the deemed sale (except
indirectly through their effect on the total ADSP or AGUB to be
allocated).
(iii) Internal Revenue Service authority. In connection with the
examination of a return, the Internal Revenue Service may challenge the
taxpayer's determination of the fair market value of any asset by any
appropriate method and take into account all factors, including any lack
of adverse tax interests between the parties.
(b) General rule for allocating ADSP and AGUB--(1) Reduction in the
amount of consideration for Class I assets. Both ADSP and AGUB, in the
respective allocation of each, are first reduced by the amount of Class
I assets. Class I assets are cash and general deposit accounts
(including savings and checking accounts) other than certificates of
deposit held in banks, savings and loan
[[Page 119]]
associations, and other depository institutions. If the amount of Class
I assets exceeds AGUB, new target will immediately realize ordinary
income in an amount equal to such excess. The amount of ADSP or AGUB
remaining after the reduction is to be allocated to the remaining
acquisition date assets.
(2) Other assets--(i) In general. Subject to the limitations and
other rules of paragraph (c) of this section, ADSP and AGUB (as reduced
by the amount of Class I assets) are allocated among Class II
acquisition date assets of target in proportion to the fair market
values of such Class II assets at such time, then among Class III assets
so held in such proportion, then among Class IV assets so held in such
proportion, then among Class V assets so held in such proportion, then
among Class VI assets so held in such proportion, and finally to Class
VII assets. If an asset is described below as includible in more than
one class, then it is included in such class with the lower or lowest
class number (for instance, Class III has a lower class number than
Class IV).
(ii) Class II assets. Class II assets are actively traded personal
property within the meaning of section 1092(d)(1) and Sec. 1.1092(d)-1
(determined without regard to section 1092(d)(3)). In addition, Class II
assets include certificates of deposit and foreign currency even if they
are not actively traded personal property. Class II assets do not
include stock of target affiliates, whether or not of a class that is
actively traded, other than actively traded stock described in section
1504(a)(4). Examples of Class II assets include U.S. government
securities and publicly traded stock.
(iii) Class III assets. Class III assets are assets that the
taxpayer marks to market at least annually for Federal income tax
purposes and debt instruments (including accounts receivable). However,
Class III assets do not include--
(A) Debt instruments issued by persons related at the beginning of
the day following the acquisition date to the target under section
267(b) or 707;
(B) Contingent debt instruments subject to Sec. 1.1275-4,
Sec. 1.483-4, or section 988, unless the instrument is subject to the
non-contingent bond method of Sec. 1.1275-4(b) or is described in
Sec. 1.988-2(b)(2)(i)(B)(2); and
(C) Debt instruments convertible into the stock of the issuer or
other property.
(iv) Class IV assets. Class IV assets are stock in trade of the
taxpayer or other property of a kind that would properly be included in
the inventory of taxpayer if on hand at the close of the taxable year,
or property held by the taxpayer primarily for sale to customers in the
ordinary course of its trade or business.
(v) Class V assets. Class V assets are all assets other than Class
I, II, III, IV, VI, and VII assets.
(vi) Class VI assets. Class VI assets are all section 197
intangibles, as defined in section 197, except goodwill and going
concern value.
(vii) Class VII assets. Class VII assets are goodwill and going
concern value (whether or not the goodwill or going concern value
qualifies as a section 197 intangible).
(3) Other items designated by the Internal Revenue Service. Similar
items may be added to any class described in this paragraph (b) by
designation in the Internal Revenue Bulletin by the Internal Revenue
Service (see Sec. 601.601(d)(2) of this chapter).
(c) Certain limitations and other rules for allocation to an asset--
(1) Allocation not to exceed fair market value. The amount of ADSP or
AGUB allocated to an asset (other than Class VII assets) cannot exceed
the fair market value of that asset at the beginning of the day after
the acquisition date.
(2) Allocation subject to other rules. The amount of ADSP or AGUB
allocated to an asset is subject to other provisions of the Internal
Revenue Code or general principles of tax law in the same manner as if
such asset were transferred to or acquired from an unrelated person in a
sale or exchange. For example, if the deemed asset sale is a transaction
described in section 1056(a) (relating to basis limitation for player
contracts transferred in connection with the sale of a franchise), the
amount of AGUB allocated to a contract for the services of an athlete
cannot exceed the limitation imposed by that section. As another
example, section 197(f)(5) applies in determining the
[[Page 120]]
amount of AGUB allocated to an amortizable section 197 intangible
resulting from an assumption-reinsurance transaction.
(3) Special rule for allocating AGUB when purchasing corporation has
nonrecently purchased stock--(i) Scope. This paragraph (c)(3) applies if
at the beginning of the day after the acquisition date--
(A) The purchasing corporation holds nonrecently purchased stock for
which a gain recognition election under section 338(b)(3) and
Sec. 1.338-5(d) is not made; and
(B) The hypothetical purchase price determined under paragraph
(c)(3)(ii) of this section exceeds the AGUB determined under Sec. 1.338-
5(b).
(ii) Determination of hypothetical purchase price. Hypothetical
purchase price is the AGUB that would result if a gain recognition
election were made.
(iii) Allocation of AGUB. Subject to the limitations in paragraphs
(c)(1) and (2) of this section, the portion of AGUB (after reduction by
the amount of Class I assets) to be allocated to each Class II, III, IV,
V, VI, and VII asset of target held at the beginning of the day after
the acquisition date is determined by multiplying--
(A) The amount that would be allocated to such asset under the
general rules of this section were AGUB equal to the hypothetical
purchase price; by
(B) A fraction, the numerator of which is actual AGUB (after
reduction by the amount of Class I assets) and the denominator of which
is the hypothetical purchase price (after reduction by the amount of
Class I assets).
(4) Liabilities taken into account in determining amount realized on
subsequent disposition. In determining the amount realized on a
subsequent sale or other disposition of property deemed purchased by new
target, Sec. 1.1001-2(a)(3) shall not apply to any liability that was
taken into account in AGUB.
(d) Examples. The following examples illustrate Secs. 1.338-4,
1.338-5, and this section:
Example 1. (i) T owns 90 percent of the outstanding T1 stock. P
purchases 100 percent of the outstanding T stock for $2,000. There are
no acquisition costs. P makes a section 338 election for T and, as a
result, T1 is considered acquired in a qualified stock purchase. A
section 338 election is made for T1. The grossed-up basis of the T stock
is $2,000 (i.e., $2,000 + 1/1).
(ii) The liabilities of T as of the beginning of the day after the
acquisition date (including the tax liability for the deemed sale tax
consequences) that would, under general principles of tax law, properly
be taken into account at that time, are as follows:
Liabilities (nonrecourse mortgage plus unsecured liabilities).. $700
Taxes Payable.................................................. 300
--------
Total...................................................... 1,000
(iii) The AGUB of T is determined as follows:
Grossed-up basis............................................... $2,000
Total liabilities.............................................. 1,000
--------
AGUB....................................................... 3,000
(iv) Assume that ADSP is also $3,000.
(v) Assume that, at the beginning of the day after the acquisition
date, T's cash and the fair market values of T's Class II, III, IV, and
V assets are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
I........................... Cash............................. * $200
II.......................... Portfolio of actively traded 300
securities.
III......................... Accounts receivable.............. 600
IV.......................... Inventory........................ 300
V........................... Building......................... 800
V........................... Land............................. 200
V........................... Investment in T1................. 450
--------
Total........................ 2,850
------------------------------------------------------------------------
*Amount.
(vi) Under paragraph (b)(1) of this section, the amount of ADSP and
AGUB allocable to T's Class II, III, IV, and V assets is reduced by the
amount of cash to $2,800, i.e., $3,000--$200. $300 of ADSP and of AGUB
is then allocated to actively traded securities. $600 of ADSP and of
AGUB is then allocated to accounts receivable. $300 of ADSP and of AGUB
is then allocated to the inventory. Since the remaining amount of ADSP
and of AGUB is $1,600 (i.e., $3,000--($200 + $300 + $600 + $300)), an
amount which exceeds the sum of the fair market values of T's Class V
assets, the amount of ADSP and of AGUB allocated to each Class V asset
is its fair market value:
Building....................................................... $800
Land........................................................... 200
Investment in T1............................................... 450
--------
Total...................................................... 1,450
(vii) T has no Class VI assets. The amount of ADSP and of AGUB
allocated to T's Class
[[Page 121]]
VII assets (goodwill and going concern value) is $150, i.e., $1,600-
$1,450.
(viii) The grossed-up basis of the T1 stock is $500, i.e., $450 x
1/.9.
(ix) The liabilities of T1 as of the beginning of the day after the
acquisition date (including the tax liability for the deemed sale tax
consequences) that would, under general principles of tax law, properly
be taken into account at that time, are as follows:
General Liabilities............................................. $100
Taxes Payable................................................... 20
-------
Total....................................................... 120
(x) The AGUB of T1 is determined as follows:
Grossed-up basis of T1 Stock.................................... $ 500
Liabilities..................................................... 120
-------
AGUB........................................................ 620
(xi) Assume that ADSP is also $620.
(xii) Assume that at the beginning of the day after the acquisition
date, T1's cash and the fair market values of its Class IV and VI assets
are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
I........................... Cash............................. *$50
IV.......................... Inventory........................ 200
VI.......................... Patent........................... 350
--------
Total........................ 600
------------------------------------------------------------------------
* Amount.
(xiii) The amount of ADSP and of AGUB allocable to T1's Class IV and
VI assets is first reduced by the $50 of cash.
(xiv) Because the remaining amount of ADSP and of AGUB ($570) is an
amount which exceeds the fair market value of T1's only Class IV asset,
the inventory, the amount allocated to the inventory is its fair market
value ($200). After that, the remaining amount of ADSP and of AGUB
($370) exceeds the fair market value of T1's only Class VI asset, the
patent. Thus, the amount of ADSP and of AGUB allocated to the patent is
its fair market value ($350).
(xv) The amount of ADSP and of AGUB allocated to T1's Class VII
assets (goodwill and going concern value) is $20, i.e., $570-$550.
Example 2. (i) Assume that the facts are the same as in Example 1
except that P has, for five years, owned 20 percent of T's stock, which
has a basis in P's hands at the beginning of the day after the
acquisition date of $100, and P purchases the remaining 80 percent of
T's stock for $1,600. P does not make a gain recognition election under
section 338(b)(3).
(ii) Under Sec. 1.338-5(c), the grossed-up basis of recently
purchased T stock is $1,600, i.e., $1,600 x (1-.2)/.8.
(iii) The AGUB of T is determined as follows:
Grossed-up basis of recently purchased stock as determined $1,600
under Sec. 1.338-5(c) ($1,600 x (1-.2)/.8)...................
Basis of nonrecently purchased stock........................... 100
Liabilities.................................................... 1,000
--------
AGUB....................................................... 2,700
(iv) Since P holds nonrecently purchased stock, the hypothetical
purchase price of the T stock must be computed and is determined as
follows:
Grossed-up basis of recently purchased stock as determined $1,600
under Sec. 1.338-5(c) ($1,600 x (1-.2)/.8)...................
Basis of nonrecently purchased stock as if the gain recognition 400
election under Sec. 1.338-5(d)(2) had been made ($1,600 x .2/
(1-.2)).......................................................
Liabilities.................................................... 1,000
--------
Total...................................................... 3,000
(v) Since the hypothetical purchase price ($3,000) exceeds the AGUB
($2,700) and no gain recognition election is made under section
338(b)(3), AGUB is allocated under paragraph (c)(3) of this section.
(vi) First, an AGUB amount equal to the hypothetical purchase price
($3,000) is allocated among the assets under the general rules of this
section. The allocation is set forth in the column below entitled
Original Allocation. Next, the allocation to each asset in Class II
through Class VII is multiplied by a fraction having a numerator equal
to the actual AGUB reduced by the amount of Class I assets ($2,700-$200
= $2,500) and a denominator equal to the hypothetical purchase price
reduced by the amount of Class I assets ($3,000-$200 = $2,800), or
2,500/2,800. This produces the Final Allocation:
------------------------------------------------------------------------
Original Final
Class Asset allocation allocation
------------------------------------------------------------------------
I.................... Cash..................... $200 $200
II................... Portfolio of actively 300 *268
traded securities.
III.................. Accounts receivable...... 600 536
IV................... Inventory................ 300 268
V.................... Building................. 800 714
V.................... Land..................... 200 178
V.................... Investment in T1......... 450 402
VII.................. Goodwill and going 150 134
concern value.
-----------------------
Total................ 3,000 2,700
------------------------------------------------------------------------
* All numbers rounded for convenience.
[[Page 122]]
[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17363, Mar. 30, 2001]
Sec. 1.338-7 Allocation of redetermined ADSP and AGUB among target assets.
(a) Scope. ADSP and AGUB are redetermined at such time and in such
amount as an increase or decrease would be required under general
principles of tax law for the elements of ADSP or AGUB. This section
provides rules for allocating redetermined ADSP or AGUB.
(b) Allocation of redetermined ADSP and AGUB. When ADSP or AGUB is
redetermined, a new allocation of ADSP or AGUB is made by allocating the
redetermined ADSP or AGUB amount under the rules of Sec. 1.338-6. If the
allocation of the redetermined ADSP or AGUB amount under Sec. 1.338-6 to
a given asset is different from the original allocation to it, the
difference is added to or subtracted from the original allocation to the
asset, as appropriate. (See paragraph (d) of this section for new
target's treatment of the amount so allocated.) Amounts allocable to an
acquisition date asset (or with respect to a disposed-of acquisition
date asset) are subject to all the asset allocation rules (for example,
the fair market value limitation in Sec. 1.338-6(c)(1)) as if the
redetermined ADSP or AGUB were the ADSP or AGUB on the acquisition date.
(c) Special rules for ADSP--(1) Increases or decreases in deemed
sale tax consequences taxable notwithstanding old target ceases to
exist. To the extent general principles of tax law would require a
seller in an actual asset sale to account for events relating to the
sale that occur after the sale date, target must make such an
accounting. Target is not precluded from realizing additional deemed
sale tax consequences because the target is treated as a new corporation
after the acquisition date.
(2) Procedure for transactions in which section 338(h)(10) is not
elected--(i) Deemed sale tax consequences included in new target's
return. If an election under section 338(h)(10) is not made, any
additional deemed sale tax consequences of old target resulting from an
increase or decrease in the ADSP are included in new target's income tax
return for new target's taxable year in which the increase or decrease
is taken into account. For example, if after the acquisition date there
is an increase in the allocable ADSP of section 1245 property for which
the recomputed basis (but not the adjusted basis) exceeds the portion of
the ADSP allocable to that particular asset on the acquisition date, the
additional gain is treated as ordinary income to the extent it does not
exceed such excess amount. See paragraph (c)(2)(ii) of this section for
the special treatment of old target's carryovers and carrybacks.
Although included in new target's income tax return, the deemed sale tax
consequences are separately accounted for as an item of old target and
may not be offset by income, gain, deduction, loss, credit, or other
amount of new target. The amount of tax on income of old target
resulting from an increase or decrease in the ADSP is determined as if
such deemed sale tax consequences had been recognized in old target's
taxable year ending at the close of the acquisition date. However,
because the income resulting from the increase or decrease in ADSP is
reportable in new target's taxable year of the increase or decrease, not
in old target's taxable year ending at the close of the acquisition
date, there is not a resulting underpayment of tax in that past taxable
year of old target for purposes of calculation of interest due.
(ii) Carryovers and carrybacks--(A) Loss carryovers to new target
taxable years. A net operating loss or net capital loss of old target
may be carried forward to a taxable year of new target, under the
principles of section 172 or 1212, as applicable, but is allowed as a
deduction only to the extent of any recognized income of old target for
such taxable year, as described in paragraph (c)(2)(i) of this section.
For this purpose, however, taxable years of new target are not taken
into account in applying the limitations in section 172(b)(1) or
1212(a)(1)(B) (or other similar limitations). In applying sections
172(b) and 1212(a)(1), only income, gain, loss, deduction, credit, and
other amounts of old target are taken into account. Thus, if old target
has an unexpired net operating loss at the close of its taxable year in
which the deemed
[[Page 123]]
asset sale occurred that could be carried forward to a subsequent
taxable year, such loss may be carried forward until it is absorbed by
old target's income.
(B) Loss carrybacks to taxable years of old target. An ordinary loss
or capital loss accounted for as a separate item of old target under
paragraph (c)(2)(i) of this section may be carried back to a taxable
year of old target under the principles of section 172 or 1212, as
applicable. For this purpose, taxable years of new target are not taken
into account in applying the limitations in section 172(b) or 1212(a)
(or other similar limitations).
(C) Credit carryovers and carrybacks. The principles described in
paragraphs (c)(2)(ii)(A) and (B) of this section apply to carryovers and
carrybacks of amounts for purposes of determining the amount of a credit
allowable under part IV, subchapter A, chapter 1 of the Internal Revenue
Code. Thus, for example, credit carryovers of old target may offset only
income tax attributable to items described in paragraph (c)(2)(i) of
this section.
(3) Procedure for transactions in which section 338(h)(10) is
elected. If an election under section 338(h)(10) is made, any changes in
the deemed sale tax consequences caused by an increase or decrease in
the ADSP are accounted for in determining the taxable income (or other
amount) of the member of the selling consolidated group, the selling
affiliate, or the S corporation shareholders to which such income, loss,
or other amount is attributable for the taxable year in which such
increase or decrease is taken into account.
(d) Special rules for AGUB--(1) Effect of disposition or
depreciation of acquisition date assets. If an acquisition date asset
has been disposed of, depreciated, amortized, or depleted by new target
before an amount is added to the original allocation to the asset, the
increased amount otherwise allocable to such asset is taken into account
under general principles of tax law that apply when part of the cost of
an asset not previously taken into account in basis is paid or incurred
after the asset has been disposed of, depreciated, amortized, or
depleted. A similar rule applies when an amount is subtracted from the
original allocation to the asset. For purposes of the preceding
sentence, an asset is considered to have been disposed of to the extent
that its allocable portion of the decrease in AGUB would reduce its
basis below zero.
(2) Section 38 property. Section 1.47-2(c) applies to a reduction in
basis of section 38 property under this section.
(e) Examples. The following examples illustrate this section. Any
amount described in the following examples is exclusive of interest. For
rules characterizing deferred contingent payments as principal or
interest, see Secs. 1.483-4, 1.1274-2(g), and 1.1275-4(c). The examples
are as follows:
Example 1. (i)(A) T's assets other than goodwill and going concern
value, and their fair market values at the beginning of the day after
the acquisition date, are as follows:
------------------------------------------------------------------------
Fair
Asset class Asset market
value
------------------------------------------------------------------------
V........................... Building........................ $ 100
V........................... Stock of X (not a target)....... 200
---------
Total....................... 300
------------------------------------------------------------------------
(B) T has no liabilities other than a contingent liability that
would not be taken into account under general principles of tax law in
an asset sale between unrelated parties when the buyer assumed the
liability or took property subject to it.
(ii)(A) On September 1, 2000, P purchases all of the outstanding
stock of T for $270 and makes a section 338 election for T. The grossed-
up basis of the T stock and T's AGUB are both $270. The AGUB is ratably
allocated among T's Class V assets in proportion to their fair market
values as follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Building ($270 x 100/300)....................................... $90
Stock ($270 x 200/300).......................................... 180
-------
Total....................................................... 270
------------------------------------------------------------------------
(B) No amount is allocated to the Class VII assets. New T is a
calendar year taxpayer. Assume that the X stock is a capital asset in
the hands of new T.
(iii) On January 1, 2001, new T sells the X stock and uses the
proceeds to purchase inventory.
(iv) Pursuant to events on June 30, 2002, the contingent liability
of old T is at that time properly taken into account under general
principles of tax law. The amount of the liability is $60.
[[Page 124]]
(v) T's AGUB increases by $60 from $270 to $330. This $60 increase
in AGUB is first allocated among T's acquisition date assets in
accordance with the provisions of Sec. 1.338-6. Because the redetermined
AGUB for T ($330) exceeds the sum of the fair market values at the
beginning of the day after the acquisition date of the Class V
acquisition date assets ($300), AGUB allocated to those assets is
limited to those fair market values under Sec. 1.338-6(c)(1). As there
are no Class VI assets, the remaining AGUB of $30 is allocated to
goodwill and going concern value (Class VII assets). The amount of
increase in AGUB allocated to each acquisition date asset is determined
as follows:
------------------------------------------------------------------------
Original Redetermined
Asset AGUB AGUB Increase
------------------------------------------------------------------------
Building.............................. $90 $100 $10
X Stock............................... 180 200 20
Goodwill and going concern value...... 0 30 30
---------------------------------
Total............................. 270 330 60
------------------------------------------------------------------------
(vi) Since the X stock was disposed of before the contingent
liability was properly taken into account for tax purposes, no amount of
the increase in AGUB attributable to such stock may be allocated to any
T asset. Rather, such amount ($20) is allowed as a capital loss to T for
the taxable year 2002 under the principles of Arrowsmith v.
Commissioner, 344 U.S. 6 (1952). In addition, the $10 increase in AGUB
allocated to the building and the $30 increase in AGUB allocated to the
goodwill and going concern value are treated as basis redeterminations
in 2002. See paragraph (d)(1) of this section.
Example 2. (i) On January 1, 2002, P purchases all of the
outstanding stock of T and makes a section 338 election for T. Assume
that ADSP and AGUB of T are both $500 and are allocated among T's
acquisition date assets as follows:
------------------------------------------------------------------------
Asset Class Asset Basis
------------------------------------------------------------------------
V........................... Machinery........................ $150
V........................... Land............................. 250
VII......................... Goodwill and going concern value. 100
--------
Total........................ 500
------------------------------------------------------------------------
(ii) On September 30, 2004, P filed a claim against the selling
shareholders of T in a court of appropriate jurisdiction alleging fraud
in the sale of the T stock.
(iii) On January 1, 2007, the former shareholders refund $140 of the
purchase price to P in a settlement of the lawsuit. Assume that, under
general principles of tax law, both the seller and the buyer properly
take into account such refund when paid. Assume also that the refund has
no effect on the tax liability for the deemed sale tax consequences.
This refund results in a decrease of T's ADSP and AGUB of $140, from
$500 to $360.
(iv) The redetermined ADSP and AGUB of $360 is allocated among T's
acquisition date assets. Because ADSP and AGUB do not exceed the fair
market value of the Class V assets, the ADSP and AGUB amounts are
allocated to the Class V assets in proportion to their fair market
values at the beginning of the day after the acquisition date. Thus,
$135 ($150 x ($360/($150 + $250))) is allocated to the machinery and
$225 ($250 x ($360/($150 + $250))) is allocated to the land.
Accordingly, the basis of the machinery is reduced by $15 ($150 original
allocation--$135 redetermined allocation) and the basis of the land is
reduced by $25 ($250 original allocation--$225 redetermined allocation).
No amount is allocated to the Class VII assets. Accordingly, the basis
of the goodwill and going concern value is reduced by $100 ($100
original allocation--$0 redetermined allocation).
(v) Assume that, as a result of deductions under section 168, the
adjusted basis of the machinery immediately before the decrease in AGUB
is zero. The machinery is treated as if it were disposed of before the
decrease is taken into account. In 2007, T recognizes income of $15, the
character of which is determined under the principles of Arrowsmith v.
Commissioner and the tax benefit rule. No adjustment to the basis of T's
assets is made for any tax paid on this amount. Assume also that, as a
result of amortization deductions, the adjusted basis of the goodwill
and going concern value immediately before the decrease in AGUB is $40.
A similar adjustment to income is made in 2007 with respect to the $60
of previously amortized goodwill and going concern value.
(vi) In summary, the basis of T's acquisition date assets, as of
January 1, 2007, is as follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Machinery...................................................... $0
Land........................................................... 225
Goodwill and going concern value............................... 0
------------------------------------------------------------------------
Example 3. (i) Assume that the facts are the same as Sec. 1.338-6(d)
Example 2 except that the recently purchased stock is acquired for
$1,600 plus additional payments that are contingent upon T's future
earnings. Assume that, under general principles of tax law, such later
payments are properly taken into account when paid. Thus, T's AGUB,
determined as of the beginning of the day after the acquisition date
(after reduction by T's cash of $200), is $2,500 and is allocated among
T's acquisition date assets under Sec. 1.338-6(c)(3)(iii) as follows:
------------------------------------------------------------------------
Final
Class Asset allocation
------------------------------------------------------------------------
I.......................... Cash........................... $200
[[Page 125]]
II......................... Portfolio of actively traded *268
securities.
III........................ Accounts receivable............ 536
IV......................... Inventory...................... 268
V.......................... Building....................... 714
V.......................... Land........................... 178
V.......................... Investment in T1............... 402
VII........................ Goodwill and going concern 134
value.
------------------------------------------------------------------------
* All numbers rounded for convenience.
(ii) At a later point in time, P pays an additional $200 for its
recently purchased T stock. Assume that the additional consideration
paid would not increase T's tax liability for the deemed sale tax
consequences.
(iii) T's AGUB increases by $200, from $2,700 to $2,900. This $200
increase in AGUB is accounted for in accordance with the provisions of
Sec. 1.338-6(c)(3)(iii).
(iv) The hypothetical purchase price of the T stock is redetermined
as follows:
Grossed-up basis of recently purchased stock as determined $ 1,800
under Sec. 1.338-5(c) ($1,800 x (1- .2)/.8)..................
Basis of nonrecently purchased stock as if the gain recognition 450
election under Sec. 1.338-5(d)(2) had been made ($1,800 x .2/
(1- .2))......................................................
Liabilities.................................................... 1,000
--------
Total...................................................... 3,250
(v) Since the redetermined hypothetical purchase price ($3,250)
exceeds the redetermined AGUB ($2,900) and no gain recognition election
was made under section 338(b)(3), the rules of Sec. 1.338-6(c)(3)(iii)
are reapplied using the redetermined hypothetical purchase price and the
redetermined AGUB.
(vi) First, an AGUB amount equal to the redetermined hypothetical
purchase price ($3,250) is allocated among the assets under the general
rules of Sec. 1.338-6. The allocation is set forth in the column below
entitled Hypothetical Allocation. Next, the allocation to each asset in
Class II through Class VII is multiplied by a fraction with a numerator
equal to the actual redetermined AGUB reduced by the amount of Class I
assets ($2,900 - $200 = $2,700) and a denominator equal to the
redetermined hypothetical purchase price reduced by the amount of Class
I assets ($3,250 - $200 = $3,050), or 2,700/3,050. This produces the
Final Allocation:
------------------------------------------------------------------------
Hypothetical Final
Class Asset allocation allocation
------------------------------------------------------------------------
I................... Cash.................... $200 $200
II.................. Portfolio of actively 300 *266
traded securities.
III................. Accounts receivable..... 600 531
IV.................. Inventory............... 300 266
V................... Building................ 800 708
V................... Land.................... 200 177
V................... Investment in T1........ 450 398
VII................. Goodwill and going 400 354
concern value.
-------------------------
Total............... 3,250 2900
------------------------------------------------------------------------
* All numbers rounded for convenience.
(vii) As illustrated by this example, reapplying Sec. 1.338-6(c)(3)
results in a basis increase for some assets and a basis decrease for
other assets. The amount of redetermined AGUB allocated to each
acquisition date asset is determined as follows:
------------------------------------------------------------------------
Original Redetermined
Asset (c)(3) (c)(3) Increase
allocation allocation (decrease)
------------------------------------------------------------------------
Portfolio of actively traded $268 $266 $(2)
securities.......................
Accounts receivable............... 536 531 (5)
Inventory......................... 268 266 (2)
Building.......................... 714 708 (6)
Land.............................. 178 177 (1)
Investment in T1.................. 402 398 (4)
Goodwill and going concern value.. 134 354 220
-------------------------------------
Total......................... 2,500 2,700 200
------------------------------------------------------------------------
Example 4. (i) On January 1, 2001, P purchases all of the
outstanding T stock and makes a section 338 election for T. P pays $700
of cash and promises also to pay a maximum $300 of contingent
consideration at various times in the future. Assume that, under general
principles of tax law, such later payments are properly taken into
account by P when paid. Assume also, however, that the current fair
market value of the contingent payments is reasonably ascertainable. The
fair market value of T's assets (other than goodwill and going concern
[[Page 126]]
value) as of the beginning of the following day is as follows:
------------------------------------------------------------------------
Fair
Asset class Assets market
value
------------------------------------------------------------------------
V.......................... Equipment....................... $200
V.......................... Non-actively traded securities.. 100
V.......................... Building........................ 500
----------
Total....................... 800
------------------------------------------------------------------------
(ii) T has no liabilities. The AGUB is $700. In calculating ADSP,
assume that, under Sec. 1.1001-1, the current amount realized
attributable to the contingent consideration is $200. ADSP is therefore
$900 ($700 cash plus $200).
(iii) (A) The AGUB of $700 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values as
follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Equipment ($700 x 200/800)................................... $175.00
Non-actively traded securities ($700 x 100/800).............. 87.50
Building ($700 x 500/800).................................... 437.50
----------
Total.................................................... 700.00
------------------------------------------------------------------------
(B) No amount is allocated to goodwill or going concern value.
(iv) (A) The ADSP of $900 is ratably allocated among T's Class V
acquisition date assets in proportion to their fair market values as
follows:
------------------------------------------------------------------------
Asset Basis
------------------------------------------------------------------------
Equipment.................................................... $200
Non-actively traded securities............................... 100
Building..................................................... 500
----------
Total.................................................... 800
------------------------------------------------------------------------
(B) The remaining ADSP, $100, is allocated to goodwill and going
concern value (Class VII).
(v) P and T file a consolidated return for 2001 and each following
year with P as the common parent of the affiliated group.
(vi) In 2004, a contingent amount of $120 is paid by P. For old T,
this payment has no effect on ADSP, because the payment is accounted for
as a separate transaction. We have assumed that, under general
principles of tax law, the payment is properly taken into account by P
at the time made. Therefore, in 2004, there is an increase in new T's
AGUB of $120. The amount of the increase allocated to each acquisition
date asset is determined as follows:
------------------------------------------------------------------------
Original Redetermined
Asset AGUB AGUB Increase
------------------------------------------------------------------------
Equipment........................... $175.00 $200.00 $25.00
Land................................ 87.50 100.00 12.50
Building............................ 437.50 500.00 62.50
Goodwill and going concern value.... 0.00 20.00 20.00
-----------------------------------
Total........................... 700.00 820.00 120.00
------------------------------------------------------------------------
[T.D. 8940, 66 FR 9929, Feb. 13, 2001]
Sec. 1.338-8 Asset and stock consistency.
(a) Introduction--(1) Overview. This section implements the
consistency rules of sections 338(e) and (f). Under this section, no
election under section 338 is deemed made or required with respect to
target or any target affiliate. Instead, the person acquiring an asset
may have a carryover basis in the asset.
(2) General application. The consistency rules generally apply if
the purchasing corporation acquires an asset directly from target during
the target consistency period and target is a subsidiary in a
consolidated group. In such a case, gain from the sale of the asset is
reflected under the investment adjustment provisions of the consolidated
return regulations in the basis of target stock and may reduce gain from
the sale of the stock. See Sec. 1.1502-32 (investment adjustment
provisions). Under the consistency rules, the purchasing corporation
generally takes a carryover basis in the asset, unless a section 338
election is made for target. Similar rules apply if the purchasing
corporation acquires an asset directly from a lower-tier target
affiliate if gain from the sale is reflected under the investment
adjustment provisions in the basis of target stock.
(3) Extensions of the general rules. If an arrangement exists,
paragraph (f) of this section generally extends the carryover basis rule
to certain cases in which the purchasing corporation acquires assets
indirectly from target (or a lower-tier target affiliate). To prevent
avoidance of the consistency rules, paragraph (j) of this section also
may extend the consistency period or the 12-month acquisition period and
may disregard the presence of conduits.
(4) Application where certain dividends are paid. Paragraph (g) of
this section extends the carryover basis rule to certain cases in which
dividends are paid to a corporation that is not a member
[[Page 127]]
of the same consolidated group as the distributing corporation.
Generally, this rule applies where a 100 percent dividends received
deduction is used in conjunction with asset dispositions to achieve an
effect similar to that available under the investment adjustment
provisions of the consolidated return regulations.
(5) Application to foreign target affiliates. Paragraph (h) of this
section extends the carryover basis rule to certain cases involving
target affiliates that are controlled foreign corporations.
(6) Stock consistency. This section limits the application of the
stock consistency rules to cases in which the rules are necessary to
prevent avoidance of the asset consistency rules. Following the general
treatment of a section 338(h)(10) election, a sale of a corporation's
stock is treated as a sale of the corporation's assets if a section
338(h)(10) election is made. Because gain from this asset sale may be
reflected in the basis of the stock of a higher-tier target, the
carryover basis rule may apply to the assets.
(b) Consistency for direct acquisitions--(1) General rule. The basis
rules of paragraph (d) of this section apply to an asset if--
(i) The asset is disposed of during the target consistency period;
(ii) The basis of target stock, as of the target acquisition date,
reflects gain from the disposition of the asset (see paragraph (c) of
this section); and
(iii) The asset is owned, immediately after its acquisition and on
the target acquisition date, by a corporation that acquires stock of
target in the qualified stock purchase (or by an affiliate of an
acquiring corporation).
(2) Section 338(h)(10) elections. For purposes of this section, if a
section 338(h)(10) election is made for a corporation acquired in a
qualified stock purchase--
(i) The acquisition is treated as an acquisition of the
corporation's assets (see Sec. 1.338(h)(10)-1); and
(ii) The corporation is not treated as target.
(c) Gain from disposition reflected in basis of target stock. For
purposes of this section:
(1) General rule. Gain from the disposition of an asset is reflected
in the basis of a corporation's stock if the gain is taken into account
under Sec. 1.1502-32, directly or indirectly, in determining the basis
of the stock, after applying section 1503(e) and other provisions of the
Internal Revenue Code.
(2) Gain not reflected if section 338 election made for target. Gain
from the disposition of an asset that is otherwise reflected in the
basis of target stock as of the target acquisition date is not
considered reflected in the basis of target stock if a section 338
election is made for target.
(3) Gain reflected by reason of distributions. Gain from the
disposition of an asset is not considered reflected in the basis of
target stock merely by reason of the receipt of a distribution from a
target affiliate that is not a member of the same consolidated group as
the distributee. See paragraph (g) of this section for the treatment of
dividends eligible for a 100 percent dividends received deduction.
(4) Controlled foreign corporations. For a limitation applicable to
gain of a target affiliate that is a controlled foreign corporation, see
paragraph (h)(2) of this section.
(5) Gain recognized outside the consolidated group. Gain from the
disposition of an asset by a person other than target or a target
affiliate is not reflected in the basis of a corporation's stock unless
the person is a conduit, as defined in paragraph (j)(4) of this section.
(d) Basis of acquired assets--(1) Carryover basis rule. If this
paragraph (d) applies to an asset, the asset's basis immediately after
its acquisition is, for all purposes of the Internal Revenue Code, its
adjusted basis immediately before its disposition.
(2) Exceptions to carryover basis rule for certain assets. The
carryover basis rule of paragraph (d)(1) of this section does not apply
to the following assets--
(i) Any asset disposed of in the ordinary course of a trade or
business (see section 338(e)(2)(A));
(ii) Any asset the basis of which is determined wholly by reference
to the adjusted basis of the asset in the hands of the person that
disposed of the asset (see section 338(e)(2)(B));
[[Page 128]]
(iii) Any debt or equity instrument issued by target or a target
affiliate (see paragraph (h)(3) of this section for an exception
relating to the stock of a target affiliate that is a controlled foreign
corporation);
(iv) Any asset the basis of which immediately after its acquisition
would otherwise be less than its adjusted basis immediately before its
disposition; and
(v) Any asset identified by the Internal Revenue Service in a
revenue ruling or revenue procedure.
(3) Exception to carryover basis rule for de minimis assets. The
carryover basis rules of this section do not apply to an asset if the
asset is not disposed of as part of the same arrangement as the
acquisition of target and the aggregate amount realized for all assets
otherwise subject to the carryover basis rules of this section does not
exceed $250,000.
(4) Mitigation rule--(i) General rule. If the carryover basis rules
of this section apply to an asset and the asset is transferred to a
domestic corporation in a transaction to which section 351 applies or as
a contribution to capital and no gain is recognized, the transferor's
basis in the stock of the transferee (but not the transferee's basis in
the asset) is determined without taking into account the carryover basis
rules of this section.
(ii) Time for transfer. This paragraph (d)(4) applies only if the
asset is transferred before the due date (including extensions) for the
transferor's income tax return for the year that includes the last date
for which a section 338 election may be made for target.
(e) Examples--(1) In general. For purposes of the examples in this
section, unless otherwise stated, the basis of each asset is the same
for determining earnings and profits and taxable income, the exceptions
to paragraph (d)(1) of this section do not apply, the taxable year of
all persons is the calendar year, and the following facts apply: S is
the common parent of a consolidated group that includes T, T1, T2, and
T3; S owns all of the stock of T and T3; and T owns all of the stock of
T1, which owns all of the stock of T2. B is unrelated to the S group and
owns all of the stock of P, which owns all of the stock of P1. Y and Y1
are partnerships that are unrelated to the S group but may be related to
the P group. Z is a corporation that is not related to any of the other
parties.
[GRAPHIC] [TIFF OMITTED] TC17OC91.000
[[Page 129]]
(2) Direct acquisitions. Paragraphs (b), (c), and (d) of this
section may be illustrated by the following examples:
Example 1. Asset acquired from target by purchasing corporation. (a)
On February 1 of Year 1, T sells an asset to P1 and recognizes gain. T's
gain from the disposition of the asset is taken into account under
Sec. 1.1502-32 in determining S's basis in the T stock. On January 1 of
Year 2, P1 makes a qualified stock purchase of T from S. No section 338
election is made for T.
(b) T disposed of the asset during its consistency period, gain from
the asset disposition is reflected in the basis of the T stock as of T's
acquisition date (January 1 of Year 2), and the asset is owned both
immediately after the asset disposition (February 1 of Year 1) and on
T's acquisition date by P1, the corporation that acquired T stock in the
qualified stock purchase. Consequently, under paragraph (b) of this
section, paragraph (d)(1) of this section applies to the asset and P1's
basis in the asset is T's adjusted basis in the asset immediately before
the sale to P1.
Example 2. Gain from section 338(h)(10) election reflected in stock
basis. (a) On February 1 of Year 1, P1 makes a qualified stock purchase
of T2 from T1. A section 338(h)(10) election is made for T2 and T2
recognizes gain on each of its assets. T2's gain is taken into account
under Sec. 1.1502-32 in determining S's basis in the T stock. On January
1 of Year 2, P1 makes a qualified stock purchase of T from S. No section
338 election is made for T.
(b) Under paragraph (b)(2) of this section, the acquisition of the
T2 stock is treated as an acquisition of T2's assets on February 1 of
Year 1, because a section 338(h)(10) election is made for T2. The gain
recognized by T2 under section 338(h)(10) is reflected in S's basis in
the T stock as of T's acquisition date. Because the other requirements
of paragraph (b) of this section are satisfied, paragraph (d)(1) of this
section applies to the assets and new T2's basis in its assets is old
T2's adjusted basis in the assets immediately before the disposition.
Example 3. Corporation owning asset ceases affiliation with
corporation purchasing target before target acquisition date. (a) On
February 1 of Year 1, T sells an asset to P1 and recognizes gain. On
December 1 of Year 1, P disposes of all of the P1 stock while P1 still
owns the asset. On January 1 of Year 2, P makes a qualified stock
purchase of T from S. No section 338 election is made for T.
(b) Immediately after T's disposition of the asset, the asset is
owned by P1 which is affiliated on that date with P, the corporation
that acquired T stock in the qualified stock purchase. However, the
asset is owned by a corporation (P1) that is no longer affiliated with P
on T's acquisition date. Although the other requirements of paragraph
(b) of this section are satisfied, the requirements of paragraph
(b)(1)(iii) of this section are not satisfied. Consequently, the basis
rules of paragraph (d) of this section do not apply to the asset by
reason of P1's acquisition.
(c) If P acquires all of the Z stock and P1 transfers the asset to Z
on or before T's acquisition date (January 1 of Year 2), the asset is
owned by an affiliate of P both on February 1 of Year 1 (P1) and on
January 1 of Year 2 (Z). Consequently, all of the requirements of
paragraph (b) of this section are satisfied and paragraph (d)(1) of this
section applies to the asset and P1's basis in the asset is T's adjusted
basis in the asset immediately before the sale to P1.
Example 4. Gain reflected in stock basis notwithstanding offsetting
loss or distribution. (a) On April 1 of Year 1, T sells an asset to P1
and recognizes gain. In Year 1, T distributes an amount equal to the
gain. On March 1 of Year 2, P makes a qualified stock purchase of T from
S. No section 338 election is made for T.
(b) Although, as a result of the distribution, there is no
adjustment with respect to the T stock under Sec. 1.1502-32 for Year 1,
T's gain from the disposition of the asset is considered reflected in
S's basis in the T stock. The gain is considered to have been taken into
account under Sec. 1.1502-32 in determining the adjustments to S's basis
in the T stock because S's basis in the T stock is different from what
it would have been had there been no gain.
(c) If T distributes an amount equal to the gain on February 1 of
Year 2, rather than in Year 1, the results would be the same because S's
basis in the T stock is different from what it would have been had there
been no gain. If the distribution in Year 2 is by reason of an election
under Sec. 1.1502-32(f)(2), the results would be the same.
(d) If, in Year 1, T does not make a distribution and the S group
does not file a consolidated return, but, in Year 2, the S group does
file a consolidated return and makes an election under Sec. 1.1502-
32(f)(2) for T, the results would be the same. S's basis in the T stock
is different from what it would have been had there been no gain.
Paragraph (c)(3) of this section (gain not considered reflected by
reason of distributions) does not apply to the deemed distribution under
the election because S and T are members of the same consolidated group.
If T distributes an amount equal to the gain in Year 2 and no election
is made under Sec. 1.1502-32(f)(2), the results would be the same.
(e) If, in Year 1, T incurs an unrelated loss in an amount equal to
the gain, rather than distributing an amount equal to the gain, the
results would be the same because the gain is taken into account under
Sec. 1.1502-32 in determining S's basis in the T stock.
Example 5. Gain of a target affiliate reflected in stock basis after
corporate reorganization. (a)
[[Page 130]]
On February 1 of Year 1, T3 sells an asset to P1 and recognizes gain. On
March 1 of Year 1, S contributes the T3 stock to T in a transaction
qualifying under section 351. On January 15 of Year 2, P1 makes a
qualified stock purchase of T from S. No section 338 election is made
for T.
(b) T3's gain from the asset sale is taken into account under
Sec. 1.1502-32 in determining S's basis in the T3 stock. Under section
358, the gain that is taken into account under Sec. 1.1502-32 in
determining S's basis in the T3 stock is also taken into account in
determining S's basis in the T stock following S's contribution of the
T3 stock to T. Consequently, under paragraph (b) of this section,
paragraph (d)(1) of this section applies to the asset and P1's basis in
the asset is T3's adjusted basis in the asset immediately before the
sale to P1.
(c) If on March 1 of Year 1, rather than S contributing the T3 stock
to T, S causes T3 to merge into T in a transaction qualifying under
section 368(a)(1)(D), the results would be the same.
Example 6. Gain not reflected if election under section 338 made.
(a) On February 1 of Year 1, T1 sells an asset to P1 and recognizes
gain. On January 1 of Year 2, P1 makes a qualified stock purchase of T1
from T. A section 338 election (but not a section 338(h)(10) election)
is made for T1.
(b) Under paragraph (c)(2) of this section, because a section 338
election is made for T1, T's basis in the T1 stock is considered not to
reflect gain from the disposition. Consequently, the requirement of
paragraph (b)(1)(ii) of this section is not satisfied. Thus, P1's basis
in the asset is not determined under paragraph (d) of this section.
Although the section 338 election for T1 results in a qualified stock
purchase of T2, the requirement of paragraph (b)(1)(ii) of this section
is not satisfied with respect to T2, whether or not a section 338
election is made for T2.
(c) If, on January 1 of Year 2, P1 makes a qualified stock purchase
of T from S and a section 338 election for T, rather than T1, S's basis
in the T stock is considered not to reflect gain from T1's disposition
of the asset. However, the section 338 election for T results in a
qualified stock purchase of T1. Because the gain is reflected in T's
basis in the T1 stock, the requirements of paragraph (b) of this section
are satisfied. Consequently, P1's basis in the asset is determined under
paragraph (d)(1) of this section unless a section 338 election is also
made for T1.
(f) Extension of consistency to indirect acquisitions--(1)
Introduction. If an arrangement exists (see paragraph (j)(5) of this
section), this paragraph (f) generally extends the consistency rules to
indirect acquisitions that have the same effect as direct acquisitions.
For example, this paragraph (f) applies if, pursuant to an arrangement,
target sells an asset to an unrelated person who then sells the asset to
the purchasing corporation.
(2) General rule. This paragraph (f) applies to an asset if,
pursuant to an arrangement--
(i) The asset is disposed of during the target consistency period;
(ii) The basis of target stock as of, or at any time before, the
target acquisition date reflects gain from the disposition of the asset;
and
(iii) The asset ownership requirements of paragraph (b)(1)(iii) of
this section are not satisfied, but the asset is owned, at any time
during the portion of the target consistency period following the target
acquisition date, by--
(A) A corporation--
(1) The basis of whose stock, as of, or at any time before, the
target acquisition date, reflects gain from the disposition of the
asset; and
(2) That is affiliated, at any time during the target consistency
period, with a corporation that acquires stock of target in the
qualified stock purchase; or
(B) A corporation that at the time it owns the asset is affiliated
with a corporation described in paragraph (f)(2)(iii)(A) of this
section.
(3) Basis of acquired assets. If this paragraph (f) applies to an
asset, the principles of the basis rules of paragraph (d) of this
section apply to the asset as of the date, following the disposition
with respect to which gain is reflected in the basis of target's stock,
that the asset is first owned by a corporation described in paragraph
(f)(2)(iii) of this section. If the principles of the carryover basis
rule of paragraph (d)(1) of this section apply to an asset, the asset's
basis also is reduced (but not below zero) by the amount of any
reduction in its basis occurring after the disposition with respect to
which gain is reflected in the basis of target's stock.
(4) Examples. This paragraph (f) may be illustrated by the following
examples:
Example 1. Acquisition of asset from unrelated party by purchasing
corporation. (a) On February 1 of Year 1, T sells an asset to Z and
[[Page 131]]
recognizes gain. On February 15 of Year 1, P1 makes a qualified stock
purchase of T from S. No section 338 election is made for T. P1 buys the
asset from Z on March 1 of Year 1, before Z has reduced the basis of the
asset through depreciation or otherwise.
(b) Paragraph (b) of this section does not apply to the asset
because the asset ownership requirements of paragraph (b)(1)(iii) of
this section are not satisfied. However, the asset ownership
requirements of paragraph (f)(2)(iii) of this section are satisfied
because, during the portion of T's consistency period following T's
acquisition date, the asset is owned by P1 while it is affiliated with
T. Consequently, paragraph (f) of this section applies to the asset if
there is an arrangement for T to dispose of the asset during T's
consistency period, for the gain to be reflected in S's basis in the T
stock as of T's acquisition date, and for P1 to own the asset during the
portion of T's consistency period following T's acquisition date. If the
arrangement exists, under paragraph (f)(3) of this section, P1's basis
in the asset is determined as of March 1 of Year 1, under the principles
of paragraph (d) of this section. Consequently, P1's basis in the asset
is T's adjusted basis in the asset immediately before the sale to Z.
(c) If P1 acquires the asset from Z on January 15 of Year 2 (rather
than on March 1 of Year 1), and Z's basis in the asset has been reduced
through depreciation at the time of the acquisition, P1's basis in the
asset as of January 15 of Year 2 would be T's adjusted basis in the
asset immediately before the sale to Z, reduced (but not below zero) by
the amount of the depreciation. Z's basis and depreciation are
determined without taking into account the basis rules of paragraph (d)
of this section.
(d) If P, rather than P1, acquires the asset from Z, the results
would be the same.
(e) If, on March 1 of Year 1, P1 acquires the Z stock, rather than
acquiring the asset from Z, paragraph (f) of this section would apply to
the asset if an arrangement exists. However, under paragraph (f)(3) of
this section, Z's basis in the asset would be determined as of February
1 of Year 1, the date the asset is first owned by a corporation (Z)
described in paragraph (f)(2)(iii) of this section. Consequently, Z's
basis in the asset as of February 1 of Year 1, determined under the
principles of paragraph (d) of this section, would be T's adjusted basis
in the asset immediately before the sale to Z.
Example 2. Acquisition of asset from target by target affiliate. (a)
On February 1 of Year 1, T contributes an asset to T1 in a transaction
qualifying under section 351 and in which T recognizes gain under
section 351(b) that is deferred under Sec. 1.1502-13. On March 1 of Year
1, P1 makes a qualified stock purchase of T from S and, pursuant to
Sec. 1.1502-13, the deferred gain is taken into account by T immediately
before T ceases to be a member of the S group. No section 338 election
is made for T.
(b) Paragraph (b) of this section does not apply to the asset
because the asset ownership requirements of paragraph (b)(1)(iii) of
this section are not satisfied.
(c) T1 is not described in paragraph (f)(2)(iii)(A) of this section
because the basis of the T1 stock does not reflect gain from the
disposition of the asset. Although, under section 358(a)(1)(B)(ii), T's
basis in the T1 stock is increased by the amount of the gain, the gain
is not taken into account directly or indirectly under Sec. 1.1502-32 in
determining T's basis in the T1 stock.
(d) T1 is described in paragraph (f)(2)(iii)(B) of this section
because, during the portion of T's consistency period following T's
acquisition date, T1 owns the asset while it is affiliated with T, a
corporation described in paragraph (f)(2)(iii)(A) of this section.
Consequently, paragraph (f) of this section applies to the asset if
there is an arrangement. Under paragraph (j)(5) of this section, the
fact that, at the time T1 acquires the asset from T, T1 is related
(within the meaning of section 267(b)) to T indicates that an
arrangement exists.
Example 3. Acquisition of asset from target and indirect acquisition
of target stock. (a) On February 1 of Year 1, T sells an asset to P1 and
recognizes gain. On March 1 of Year 1, Z makes a qualified stock
purchase of T from S. No section 338 election is made for T. On January
1 of Year 2, P1 acquires the T stock from Z other than in a qualified
stock purchase.
(b) The asset ownership requirements of paragraph (b)(1)(iii) of
this section are not satisfied because the asset was never owned by Z,
the corporation that acquired T stock in the qualified stock purchase
(or by a corporation that was affiliated with Z at the time it owned the
asset). However, because the asset is owned by P1 while it is affiliated
with T during the portion of T's consistency period following T's
acquisition date, paragraph (f) of this section applies to the asset if
there is an arrangement. If there is an arrangement, the principles of
the carryover basis rule of paragraph (d)(1) of this section apply to
determine P1's basis in the asset unless Z makes a section 338 election
for T. See paragraph (c)(2) of this section.
(c) If P1 also makes a qualified stock purchase of T from Z, the
results would be the same. If there is an arrangement, the principles of
the carryover basis rule of paragraph (d)(1) of this section apply to
determine P1's basis in the asset unless Z makes a section 338 election
for T. However, these principles apply to determine P1's basis in the
asset if P1, but not Z, makes a section 338 election for T. The basis of
the T stock no longer reflects, as of T's acquisition date
[[Page 132]]
by P1, the gain from the disposition of the asset.
(d) Assume Z purchases the T stock other than in a qualified stock
purchase and P1 makes a qualified stock purchase of T from Z. Paragraph
(b) of this section does not apply to the asset because gain from the
disposition of the asset is not reflected in the basis of T's stock as
of T's acquisition date (January 1 of Year 2). However, because the gain
is reflected in S's basis in the T stock before T's acquisition date and
the asset is owned by P1 while it is affiliated with T during the
portion of T's consistency period following T's acquisition date,
paragraph (f) of this section applies to the asset if there is an
arrangement. If there is an arrangement, the principles of the carryover
basis rule of paragraph (d)(1) of this section apply to determine P1's
basis in the asset even if P1 makes a section 338 election for T. The
basis of the T stock no longer reflects, as of T's acquisition date, the
gain from the disposition of the asset.
Example 4. Asset acquired from target affiliate by corporation that
becomes its affiliate.(a) On February 1 of Year 1, T1 sells an asset to
P1 and recognizes gain. On February 15 of Year 1, Z makes a qualified
stock purchase of T from S. No section 338 election is made for T. On
June 1 of Year 1, P1 acquires the T1 stock from T, other than in a
qualified stock purchase.
(b) The asset ownership requirements of paragraph (b)(1)(iii) of
this section are not satisfied because the asset was never owned by Z,
the corporation that acquired T stock in the qualified stock purchase
(or by a corporation that was affiliated with Z at the time it owned the
asset).
(c) P1 is not described in paragraph (f)(2)(iii)(A) of this section
because gain from the disposition of the asset is not reflected in the
basis of the P1 stock.
(d) P1 is described in paragraph (f)(2)(iii)(B) of this section
because the asset is owned by P1 while P1 is affiliated with T1 during
the portion of T's consistency period following T's acquisition date. T1
becomes affiliated with Z, the corporation that acquired T stock in the
qualified stock purchase, during T's consistency period, and, as of T's
acquisition date, the basis of T1's stock reflects gain from the
disposition of the asset. Consequently, paragraph (f) of this section
applies to the asset if there is an arrangement.
Example 5. De minimis rules.(a) On February 1 of Year 1, T sells an
asset to P and recognizes gain. On February 15 of Year 1, T1 sells an
asset to Z and recognizes gain. The aggregate amount realized by T and
T1 on their respective sales of assets is not more than $250,000. On
March 1 of Year 1, T3 sells an asset to P and recognizes gain. On April
1 of Year 1, P makes a qualified stock purchase of T from S. No section
338 election is made for T. On June 1 of Year 1, P1 buys from Z the
asset sold by T1.
(b) Under paragraph (b) of this section, the basis rules of
paragraph (d) of this section apply to the asset sold by T. Under
paragraph (f) of this section, the principles of the basis rules of
paragraph (d) of this section apply to the asset sold by T1 if there is
an arrangement. Because T3's gain is not reflected in the basis of the T
stock, the basis rules of this section do not apply to the asset sold by
T3.
(c) The de minimis rule of paragraph (d)(3) of this section applies
to an asset if the asset is not disposed of as part of the same
arrangement as the acquisition of T and the aggregate amount realized
for all assets otherwise subject to the carryover basis rules does not
exceed $250,000. The aggregate amount realized by T and T1 does not
exceed $250,000. (The asset sold by T3 is not taken into account for
purposes of the de minimis rule.) Thus, the de minimis rule applies to
the asset sold by T if the asset is not disposed of as part of the same
arrangement as the acquisition of T.
(d) If, under paragraph (f) of this section, the principles of the
carryover basis rules of paragraph (d)(1) of this section otherwise
apply to the asset sold by T1 because of an arrangement, the de minimis
rules of this section do not apply to the asset because of the
arrangement.
(e) Assume on June 1 of Year 1, Z acquires the T1 stock from T,
other than in a qualified stock purchase, rather than P1 buying the T1
asset, and paragraph (f) of this section applies because there is an
arrangement. Because the asset was disposed of and the T1 stock was
acquired as part of the arrangement, the de minimis rules of this
section do not apply to the asset.
(g) Extension of consistency if dividends qualifying for 100 percent
dividends received deduction are paid--(1) General rule for direct
acquisitions from target. Unless a section 338 election is made for
target, the basis rules of paragraph (d) of this section apply to an
asset if--
(i) Target recognizes gain (whether or not deferred) on disposition
of the asset during the portion of the target consistency period that
ends on the target acquisition date;
(ii) The asset is owned, immediately after the asset disposition and
on the target acquisition date, by a corporation that acquires stock of
target in the qualified stock purchase (or by an affiliate of an
acquiring corporation); and
(iii) During the portion of the target consistency period that ends
on the target acquisition date, the aggregate
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amount of dividends paid by target, to which section 243(a)(3) applies,
exceeds the greater of--
(A) $250,000; or
(B) 125 percent of the yearly average amount of dividends paid by
target, to which section 243(a)(3) applies, during the three calendar
years immediately preceding the year in which the target consistency
period begins (or, if shorter, the period target was in existence).
(2) Other direct acquisitions having same effect. The basis rules of
paragraph (d) of this section also apply to an asset if the effect of a
transaction described in paragraph (g)(1) of this section is achieved
through any combination of disposition of assets and payment of
dividends to which section 243(a)(3) applies (or any other dividends
eligible for a 100 percent dividends received deduction). See paragraph
(h)(4) of this section for additional rules relating to target
affiliates that are controlled foreign corporations.
(3) Indirect acquisitions. The principles of paragraph (f) of this
section also apply for purposes of this paragraph (g).
(4) Examples. This paragraph (g) may be illustrated by the following
examples:
Example 1. Asset acquired from target paying dividends to which
section 243(a)(3) applies.(a) The S group does not file a consolidated
return. In Year 1, Year 2, and Year 3, T pays dividends to S to which
section 243(a)(3) applies of $200,000, $250,000, and $300,000,
respectively. On February 1 of Year 4, T sells an asset to P and
recognizes gain. On January 1 of Year 5, P makes a qualified stock
purchase of T from S. No section 338 election is made for T. During the
portion of T's consistency period that ends on T's acquisition date, T
pays S dividends to which section 243(a)(3) applies of $1,000,000.
(b) Under paragraph (g)(1) of this section, paragraph (d) of this
section applies to the asset. T recognizes gain on disposition of the
asset during the portion of T's consistency period that ends on T's
acquisition date, the asset is owned by P immediately after the
disposition and on T's acquisition date, and T pays dividends described
in paragraph (g)(1)(iii) of this section. Consequently, under paragraph
(d)(1) of this section, P's basis in the asset is T's adjusted basis in
the asset immediately before the sale to P.
(c) If T is a controlled foreign corporation, the results would be
the same if T pays dividends in the amount described in paragraph
(g)(1)(iii) of this section that qualify for a 100 percent dividends
received deduction. See sections 243(e) and 245.
(d) If S and T3 file a consolidated return in which T, T1, and T2 do
not join, the results would be the same because the dividends paid by T
are still described in paragraph (g)(1)(iii) of this section.
(e) If T, T1, and T2 file a consolidated return in which S and T3 do
not join, the results would be the same because the dividends paid by T
are still described in paragraph (g)(1)(iii) of this section.
Example 2. Asset disposition by target affiliate achieving same
effect.(a) The S group does not file a consolidated return. On February
1 of Year 1, T2 sells an asset to P and recognizes gain. T pays
dividends to S described in paragraph (g)(1)(iii) of this section. On
January 1 of Year 2, P makes a qualified stock purchase of T from S. No
section 338 election is made for T.
(b) Paragraph (g)(1) of this section does not apply to the asset
because T did not recognize gain on the disposition of the asset.
However, under paragraph (g)(2) of this section, because the asset
disposition by T2 and the dividends paid by T achieve the effect of a
transaction described in paragraph (g)(1) of this section, the carryover
basis rule of paragraph (d)(1) of this section applies to the asset. The
effect was achieved because T2 is a lower-tier affiliate of T and the
dividends paid by T to S reduce the value to S of T and its lower-tier
affiliates.
(c) If T2 is a controlled foreign corporation, the results would be
the same because T2 is a lower-tier affiliate of T and the dividends
paid by T to S reduce the value to S of T and its lower-tier affiliates.
(d) If P buys an asset from T3, rather than T2, the asset
disposition and the dividends do not achieve the effect of a transaction
described in paragraph (g)(1) of this section because T3 is not a lower-
tier affiliate of T. Thus, the basis rules of paragraph (d) of this
section do not apply to the asset. The results would be the same whether
or not P also acquires the T3 stock (whether or not in a qualified stock
purchase).
Example 3. Dividends by target affiliate achieving same effect.(a)
The S group does not file a consolidated return. On February 1 of Year
1, T1 sells an asset to P and recognizes gain. On January 1 of Year 2, P
makes a qualified stock purchase of T from S. No section 338 election is
made for T. T does not pay dividends to S described in paragraph
(g)(1)(iii) of this section. However, T1 pays dividends to T that would
be described in paragraph (g)(1)(iii) of this section if T1 were a
target.
(b) Paragraph (g)(1) of this section does not apply to the asset
because T did not recognize gain on the disposition of the asset and did
not pay dividends described in paragraph (g)(1)(iii) of this section.
Further, paragraph (g)(2) of this section does not apply because
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the dividends paid by T1 to T do not reduce the value to S of T and its
lower-tier affiliates.
(c) If both S and T own T1 stock and T1 pays dividends to S that
would be described in paragraph (g)(1)(iii) of this section if T1 were a
target, paragraph (g)(2) of this section would apply because the
dividends paid by T1 to S reduce the value to S of T and its lower-tier
affiliates. If T, rather than T1, sold the asset to P, the results would
be the same. Further, if T and T1 pay dividends to S that, only when
aggregated, would be described in paragraph (g)(1)(iii) of this section
(if they were all paid by T), the results would be the same.
Example 4. Gain reflected by reason of dividends.(a) S and T file a
consolidated return in which T1 and T2 do not join. On February 1 of
Year 1, T1 sells an asset to P and recognizes gain. On January 1 of Year
2, P makes a qualified stock purchase of T from S. No section 338
election is made for T. T1 pays dividends to T that would be described
in paragraph (g)(1)(iii) of this section if T1 were a target.
(b) The requirements of paragraph (b) of this section are not
satisfied because, under paragraph (c)(3) of this section, gain from
T1's sale is not reflected in S's basis in the T stock by reason of the
dividends paid by T1 to T.
(c) Although the dividends paid by T1 to T do not reduce the value
to S of T and its lower-tier affiliates, paragraph (g)(2) of this
section applies because the dividends paid by T1 to T are taken into
account under Sec. 1.1502-32 in determining S's basis in the T stock.
Consequently, the carryover basis rule of paragraph (d)(1) of this
section applies to the asset.
(h) Consistency for target affiliates that are controlled foreign
corporations--(1) In general. This paragraph (h) applies only if target
is a domestic corporation. For additional rules that may apply with
respect to controlled foreign corporations, see paragraph (g) of this
section. The definitions and nomenclature of Sec. 1.338-2(b) and (c) and
paragraph (e) of this section apply for purposes of this section.
(2) Income or gain resulting from asset dispositions--(i) General
rule. Income or gain of a target affiliate that is a controlled foreign
corporation from the disposition of an asset is not reflected in the
basis of target stock under paragraph (c) of this section unless the
income or gain results in an inclusion under section 951(a)(1)(A),
951(a)(1)(C), 1291 or 1293.
(ii) Basis of controlled foreign corporation stock. If, by reason of
paragraph (h)(2)(i) of this section, the carryover basis rules of this
section apply to an asset, no increase in basis in the stock of a
controlled foreign corporation under section 961(a) or 1293(d)(1), or
under regulations issued pursuant to section 1297(b)(5), is allowed to
target or a target affiliate to the extent the increase is attributable
to income or gain described in paragraph (h)(2)(i) of this section. A
similar rule applies to the basis of any property by reason of which the
stock of the controlled foreign corporation is considered owned under
section 958(a)(2) or 1297(a).
(iii) Operating rule. For purposes of this paragraph (h)(2)--
(A) If there is an income inclusion under section 951 (a)(1)(A) or
(C), the shareholder's income inclusion is first attributed to the
income or gain of the controlled foreign corporation from the
disposition of the asset to the extent of the shareholder's pro rata
share of such income or gain; and
(B) Any income or gain under section 1293 is first attributed to the
income or gain from the disposition of the asset to the extent of the
shareholder's pro rata share of the income or gain.
(iv) Increase in asset or stock basis--(A) If the carryover basis
rules under paragraph (h)(2)(i) of this section apply to an asset, and
the purchasing corporation disposes of the asset to an unrelated party
in a taxable transaction and recognizes and includes in its U.S. gross
income or the U.S. gross income of its shareholders the greater of the
income or gain from the disposition of the asset by the selling
controlled foreign corporation that was reflected in the basis of the
target stock under paragraph (c) of this section, or the gain recognized
on the asset by the purchasing corporation on the disposition of the
asset, then the purchasing corporation or the target or a target
affiliate, as appropriate, shall increase the basis of the selling
controlled foreign corporation stock subject to paragraph (h)(2)(ii) of
this section, as of the date of the disposition of the asset by the
purchasing corporation, by the amount of the basis increase that was
denied under paragraph (h)(2)(ii) of this section. The preceding
sentence shall
[[Page 135]]
apply only to the extent that the controlled foreign corporation stock
is owned (within the meaning of section 958(a)) by a member of the
purchasing corporation's affiliated group.
(B) If the carryover basis rules under paragraph (h)(2)(i) of this
section apply to an asset, and the purchasing corporation or the target
or a target affiliate, as appropriate, disposes of the stock of the
selling controlled foreign corporation to an unrelated party in a
taxable transaction and recognizes and includes in its U.S. gross income
or the U.S. gross income of its shareholders the greater of the gain
equal to the basis increase that was denied under paragraph (h)(2)(ii)
of this section, or the gain recognized in the stock by the purchasing
corporation or by the target or a target affiliate, as appropriate, on
the disposition of the stock, then the purchasing corporation shall
increase the basis of the asset, as of the date of the disposition of
the stock of the selling controlled foreign corporation by the
purchasing corporation or by the target or a target affiliate, as
appropriate, by the amount of the basis increase that was denied
pursuant to paragraph (h)(2)(i) of this section. The preceding sentence
shall apply only to the extent that the asset is owned (within the
meaning of section 958(a)) by a member of the purchasing corporation's
affiliated group.
(3) Stock issued by target affiliate that is a controlled foreign
corporation. The exception to the carryover basis rules of this section
provided in paragraph (d)(2)(iii) of this section does not apply to
stock issued by a target affiliate that is a controlled foreign
corporation. After applying the carryover basis rules of this section to
the stock, the basis in the stock is increased by the amount treated as
a dividend under section 1248 on the disposition of the stock (or that
would have been so treated but for section 1291), except to the extent
the basis increase is attributable to the disposition of an asset in
which a carryover basis is taken under this section.
(4) Certain distributions--(i) General rule. In the case of a target
affiliate that is a controlled foreign corporation, paragraph (g) of
this section applies with respect to the target affiliate by treating
any reference to a dividend to which section 243(a)(3) applies as a
reference to any amount taken into account under Sec. 1.1502-32 in
determining the basis of target stock that is--
(A) A dividend;
(B) An amount treated as a dividend under section 1248 (or that
would have been so treated but for section 1291); or
(C) An amount included in income under section 951(a)(1)(B).
(ii) Basis of controlled foreign corporation stock. If the carryover
basis rules of this section apply to an asset, the basis in the stock of
the controlled foreign corporation (or any property by reason of which
the stock is considered owned under section 958(a)(2)) is reduced (but
not below zero) by the sum of any amounts that are treated, solely by
reason of the disposition of the asset, as a dividend, amount treated as
a dividend under section 1248 (or that would have been so treated but
for section 1291), or amount included in income under section
951(a)(1)(B). For this purpose, any dividend, amount treated as a
dividend under section 1248 (or that would have been so treated but for
section 1291), or amount included in income under section 951(a)(1)(B)
is considered attributable first to earnings and profits resulting from
the disposition of the asset.
(iii) Increase in asset or stock basis--(A) If the carryover basis
rules under paragraphs (g) and (h)(4)(i) of this section apply to an
asset, and the purchasing corporation disposes of the asset to an
unrelated party in a taxable transaction and recognizes and includes in
its U.S. gross income or the U.S. gross income of its shareholders the
greater of the gain equal to the basis increase denied in the asset
pursuant to paragraphs (g) and (h)(4)(i) of this section, or the gain
recognized on the asset by the purchasing corporation on the disposition
of the asset, then the purchasing corporation or the target or a target
affiliate, as appropriate, shall increase the basis of the selling
controlled foreign corporation stock subject to paragraph (h)(4)(ii) of
this section, as of the date of the disposition of the asset by the
purchasing corporation, by the amount of the basis reduction under
paragraph (h)(4)(ii) of
[[Page 136]]
this section. The preceding sentence shall apply only to the extent that
the controlled foreign corporation stock is owned (within the meaning of
section 958(a)) by a member of the purchasing corporation's affiliated
group.
(B) If the carryover basis rules under paragraphs (g) and (h)(4)(i)
of this section apply to an asset, and the purchasing corporation or the
target or a target affiliate, as appropriate, disposes of the stock of
the selling controlled foreign corporation to an unrelated party in a
taxable transaction and recognizes and includes in its U.S. gross income
or the U.S. gross income of its shareholders the greater of the amount
of the basis reduction under paragraph (h)(4)(ii) of this section, or
the gain recognized in the stock by the purchasing corporation or by the
target or a target affiliate, as appropriate, on the disposition of the
stock, then the purchasing corporation shall increase the basis of the
asset, as of the date of the disposition of the stock of the selling
controlled foreign corporation by the purchasing corporation or by the
target or a target affiliate, as appropriate, by the amount of the basis
increase that was denied pursuant to paragraphs (g) and (h)(4)(i) of
this section. The preceding sentence shall apply only to the extent that
the asset is owned (within the meaning of section 958(a)) by a member of
the purchasing corporation's affiliated group.
(5) Examples. This paragraph (h) may be illustrated by the following
examples:
Example 1. Stock of target affiliate that is a CFC.(a) The S group
files a consolidated return; however, T2 is a controlled foreign
corporation. On December 1 of Year 1, T1 sells the T2 stock to P and
recognizes gain. On January 2 of Year 2, P makes a qualified stock
purchase of T from S. No section 338 election is made for T.
(b) Under paragraph (b)(1) of this section, paragraph (d) of this
section applies to the T2 stock. Under paragraph (h)(3) of this section,
paragraph (d)(2)(iii) of this section does not apply to the T2 stock.
Consequently, paragraph (d)(1) of this section applies to the T2 stock.
However, after applying paragraph (d)(1) of this section, P's basis in
the T2 stock is increased by the amount of T1's gain on the sale of the
T2 stock that is treated as a dividend under section 1248. Because P has
a carryover basis in the T2 stock, the T2 stock is not considered
purchased within the meaning of section 338(h)(3) and no section 338
election may be made for T2.
Example 2. Stock of target affiliate CFC; inclusion under subpart
F.(a) The S group files a consolidated return; however, T2 is a
controlled foreign corporation. On December 1 of Year 1, T2 sells an
asset to P and recognizes subpart F income that results in an inclusion
in T1's gross income under section 951(a)(1)(A). On January 2 of Year 2,
P makes a qualified stock purchase of T from S. No section 338 election
is made for T.
(b) Because gain from the disposition of the asset results in an
inclusion under section 951(a)(1)(A), the gain is reflected in the basis
of the T stock as of T's acquisition date. See paragraph (h)(2)(i) of
this section. Consequently, under paragraph (b)(1) of this section,
paragraph (d)(1) of this section applies to the asset. In addition,
under paragraph (h)(2)(ii) of this section, T1's basis in the T2 stock
is not increased under section 961(a) by the amount of the inclusion
that is attributable to the sale of the asset.
(c) If, in addition to making a qualified stock purchase of T, P
acquires the T2 stock from T1 on January 1 of Year 2, the results are
the same for the asset sold by T2. In addition, under paragraph
(h)(2)(ii) of this section, T1's basis in the T2 stock is not increased
by the amount of the inclusion that is attributable to the gain on the
sale of the asset. Further, under paragraph (h)(3) of this section,
paragraph (d)(1) of this section applies to the T2 stock. However, after
applying paragraph (d)(1) of this section, P's basis in the T2 stock is
increased by the amount of T1's gain on the sale of the T2 stock that is
treated as a dividend under section 1248. Finally, because P has a
carryover basis in the T2 stock, the T2 stock is not considered
purchased within the meaning of section 338(h)(3) and no section 338
election may be made for T2.
(d) If P makes a qualified stock purchase of T2 from T1, rather than
of T from S, and T1's gain on the sale of T2 is treated as a dividend
under section 1248, under paragraph (h)(1) of this section, paragraphs
(h)(2) and (3) of this section do not apply because there is no target
that is a domestic corporation. Consequently, the carryover basis rules
of paragraph do not apply to the asset sold by T2 or the T2 stock.
Example 3. Gain reflected by reason of section 1248 dividend; gain
from non-subpart F asset.(a) The S group files a consolidated return;
however, T2 is a controlled foreign corporation. In Years 1 through 4,
T2 does not pay any dividends to T1 and no amount is included in T1's
income under section 951(a)(1)(B). On December 1 of Year 4, T2 sells an
asset with a basis of $400,000 to P for $900,000. T2's gain of $500,000
is not subpart F income. On December 15 of Year 4, T1 sells T2, in which
it has a basis of $600,000, to P for $1,600,000. Under section 1248,
$800,000 of T1's gain of
[[Page 137]]
$1,000,000 is treated as a dividend. However, in the absence of the sale
of the asset by T2 to P, only $300,000 would have been treated as a
dividend under section 1248. On December 30 of Year 4, P makes a
qualified stock purchase of T1 from T. No section 338 election is made
for T1.
(b) Under paragraph (h)(4) of this section, paragraph (g)(2) of this
section applies by reference to the amount treated as a dividend under
section 1248 on the disposition of the T2 stock. Because the amount
treated as a dividend is taken into account in determining T's basis in
the T1 stock under Sec. 1.1502-32, the sale of the T2 stock and the
deemed dividend have the effect of a transaction described in paragraph
(g)(1) of this section. Consequently, paragraph (d)(1) of this section
applies to the asset sold by T2 to P and P's basis in the asset is
$400,000 as of December 1 of Year 4.
(c) Under paragraph (h)(3) of this section, paragraph (d)(1) of this
section applies to the T2 stock and P's basis in the T2 stock is
$600,000 as of December 15 of Year 4. Under paragraphs (h)(3) and
(4)(ii) of this section, however, P's basis in the T2 stock is increased
by $300,000 (the amount of T1's gain treated as a dividend under section
1248 ($800,000), other than the amount treated as a dividend solely as a
result of the sale of the asset by T2 to P ($500,000)) to $900,000.
(i) [Reserved]
(j) Anti-avoidance rules. For purposes of this section--
(1) Extension of consistency period. The target consistency period
is extended to include any continuous period that ends on, or begins on,
any day of the consistency period during which a purchasing corporation,
or any person related, within the meaning of section 267(b) or
707(b)(1), to a purchasing corporation, has an arrangement--
(i) To purchase stock of target; or
(ii) To own an asset to which the carryover basis rules of this
section apply, taking into account the extension.
(2) Qualified stock purchase and 12-month acquisition period. The
12-month acquisition period is extended if, pursuant to an arrangement,
a corporation acquires by purchase stock of another corporation
satisfying the requirements of section 1504(a)(2) over a period of more
than 12 months.
(3) Acquisitions by conduits--(i) Asset ownership--(A) General rule.
A corporation is treated as owning any portion of an asset attributed to
the corporation from a conduit under section 318(a) (treating any asset
as stock for this purpose), for purposes of--
(1) The asset ownership requirements of this section; and
(2) Determining whether a controlled foreign corporation is a target
affiliate for purposes of paragraph (h) of this section.
(B) Application of carryover basis rule. If the basis rules of this
section apply to the asset, the basis rules of this section apply to the
entire asset (not just the portion for which ownership is attributed).
(ii) Stock acquisitions--(A) Purchase by conduit. A corporation is
treated as purchasing stock of another corporation attributed to the
corporation from a conduit under section 318(a) on the day the stock is
purchased by the conduit. The corporation is not treated as purchasing
the stock, however, if the conduit purchased the stock more than two
years before the date the stock is first attributed to the corporation.
(B) Purchase of conduit by corporation. If a corporation purchases
an interest in a conduit (treating the interest as stock for this
purpose), the corporation is treated as purchasing on that date any
stock owned by a conduit on that date and attributed to the corporation
under section 318(a) with respect to the interest in the conduit that
was purchased.
(C) Purchase of conduit by conduit. If a conduit (the first conduit)
purchases an interest in a second conduit (treating the interest as
stock for this purpose), the first conduit is treated as purchasing on
that date any stock owned by a conduit on that date and attributed to
the first conduit under section 318(a) with respect to the interest in
the second conduit that was purchased.
(4) Conduit. A person (other than a corporation) is a conduit as to
a corporation if--
(i) The corporation would be treated under section 318(a)(2)(A) and
(B) (attribution from partnerships, estates, and trusts) as owning any
stock owned by the person; and
(ii) The corporation, together with its affiliates, would be treated
as owning an aggregate of at least 50 percent of the stock owned by the
person.
(5) Existence of arrangement. The existence of an arrangement is
determined under all the facts and circumstances. For an arrangement to
[[Page 138]]
exist, there need not be an enforceable, written, or unconditional
agreement, and all the parties to the transaction need not have
participated in each step of the transaction. One factor indicating the
existence of an arrangement is the participation of a related party. For
this purpose, persons are related if they are related within the meaning
of section 267(b) or 707(b)(1).
(6) Predecessor and successor--(i) Persons. A reference to a person
(including target, target affiliate, and purchasing corporation)
includes, as the context may require, a reference to a predecessor or
successor. For this purpose, a predecessor is a transferor or
distributor of assets to a person (the successor) in a transaction--
(A) To which section 381(a) applies; or
(B) In which the successor's basis for the assets is determined,
directly or indirectly, in whole or in part, by reference to the basis
of the transferor or distributor.
(ii) Assets. A reference to an asset (the first asset) includes, as
the context may require, a reference to any asset the basis of which is
determined, directly or indirectly, in whole or in part, by reference to
the first asset.
(7) Examples. This paragraph (j) may be illustrated by the following
examples:
Example 1. Asset owned by conduit treated as owned by purchaser of
target stock.(a) P owns a 60-percent interest in Y. On March 1 of Year
1, T sells an asset to Y and recognizes gain. On January 1 of Year 2, P
makes a qualified stock purchase of T from S. No section 338 election is
made for T.
(b) Under paragraph (j)(4) of this section, Y is a conduit with
respect to P. Consequently, under paragraph (j)(3)(i)(A) of this
section, P is treated as owning 60% of the asset on March 1 of Year 1
and January 1 of Year 2. Because P is treated as owning part or all of
the asset both immediately after the asset disposition and on T's
acquisition date, paragraph (b) of this section applies to the asset.
Consequently, paragraph (d)(1) of this section applies to the asset and
Y's basis in the asset is T's adjusted basis in the asset immediately
before the sale to Y.
Example 2. Corporation whose stock is owned by conduit treated as
affiliate.(a) P owns an 80-percent interest in Y. Y owns all of the
stock of Z. On March 1 of Year 1, T sells an asset to Z and recognizes
gain. On January 1 of Year 2, P makes a qualified stock purchase of T
from S. No section 338 election is made for T.
(b) Under paragraph (j)(4) of this section, Y is a conduit with
respect to P. Consequently, under paragraph (j)(3)(i)(A) of this
section, P is treated as owning 80% of the Z stock and Z is therefore
treated as an affiliate of P for purposes of applying the asset
ownership requirements of paragraph (b)(1)(iii) of this section. Because
Z, an affiliate of P, owns the asset both immediately after the asset
disposition and on T's acquisition date, paragraph (b) of this section
applies to the asset, and the asset's basis is determined under
paragraph (d) of this section.
(c) If, instead of owning an 80-percent interest in Y, P owned a 79-
percent interest in Y, Z would not be treated as an affiliate of P and
paragraph (b) of this section would not apply to the asset.
Example 3. Qualified stock purchase by reason of stock purchase by
conduit.(a) P owns a 90-percent interest in Y. Y owns a 60-percent
interest in Y1. On February 1 of Year 2, T sells an asset to P and
recognizes gain. On January 1 of Year 3, P purchases 70% of the T stock
from S and Y1 purchases the remaining 30% of the T stock from S.
(b) Under paragraph (j)(3)(ii)(A) of this section, P is treated as
purchasing on January 1 of Year 3, the 16.2% of the T stock that is
attributed to P from Y and Y1 under section 318(a). Thus, for purposes
of this section, P is treated as making a qualified stock purchase of T
on January 1 of Year 3, paragraph (b) of this section applies to the
asset, and the asset's basis is determined under paragraph (d) of this
section. However, because P is not treated as having made a qualified
stock purchase of T for purposes of making an election under section
338, no election can be made for T.
(c) If Y1 purchases 20% of the T stock from S on December 1 of Year
1, rather than 30% on January 1 of Year 3, P would be treated as
purchasing 10.8% of the T stock on December 1 of Year 1. Thus, if
paragraph (j)(2) of this section (relating to extension of the 12-month
acquisition period) does not apply, P would not be treated as making a
qualified stock purchase of T, because P is not treated as purchasing T
stock satisfying the requirements of section 1504(a)(2) within a 12-
month period.
Example 4. Successor asset.(a) On February 1 of Year 1, T sells
stock of X to P1 and recognizes gain. On December 1 of Year 1, P1
exchanges its X stock for stock in new X in a reorganization qualifying
under section 368(a)(1)(F). On January 1 of Year 2, P1 makes a qualified
stock purchase of T from S. No section 338 election is made for T.
(b) The asset ownership requirements of paragraph (b)(1)(iii) of
this section are satisfied because, under paragraph (j)(6)(ii) of this
section, P1 is treated as owning the X stock on T's acquisition date. P1
is treated as owning the X stock on that date because P1 owns the new X
stock and P1's basis in the new X
[[Page 139]]
stock is determined by reference to P1's basis in the X stock.
Consequently, under paragraph (d)(1) of this section, P1's basis in the
X stock on February 1 of Year 1 is T's adjusted basis in the X stock
immediately before the sale to P1.
[T.D. 8515, 59 FR 2972, Jan. 20, 1994, as amended by T.D. 8597, 60 FR
36679, July 18, 1995; T.D. 8710, 62 FR 3459, Jan. 23, 1997. Redesignated
by T.D. 8858, 65 FR 1246, Jan. 7, 2000, as amended by T.D. 8940, 66 FR
9929, Feb. 13, 2001; 66 FR 17466, Mar. 30, 2001]
Sec. 1.338-9 International aspects of section 338.
(a) Scope. This section provides guidance regarding international
aspects of section 338. As provided in Sec. 1.338-2(c)(18), a foreign
corporation, a DISC, or a corporation for which a section 936 election
has been made is considered a target affiliate for all purposes of
section 338. In addition, stock described in section 338(h)(6)(B)(ii)
held by a target affiliate is not excluded from the operation of section
338.
(b) Application of section 338 to foreign targets--(1) In general.
For purposes of subtitle A, the deemed sale tax consequences, as defined
in Sec. 1.338-2(c)(7), of a foreign target for which a section 338
election is made (FT), and the corresponding earnings and profits, are
taken into account in determining the taxation of FT and FT's direct and
indirect shareholders. See, however, section 338(h)(16). For example,
the income and earnings and profits of FT are determined, for purposes
of sections 551, 951, 1248, and 1293, by taking into account the deemed
sale tax sentence consequences.
(2) Ownership of FT stock on the acquisition date. A person who
transfers FT stock to the purchasing corporation on FT's acquisition
date is considered to own the transferred stock at the close of FT's
acquisition date. See, e.g., Sec. 1.951-1(f) (relating to determination
of holding period for purposes of sections 951 through 964). If on the
acquisition date the purchasing corporation owns a block of FT stock
that was acquired before FT's acquisition date, the purchasing
corporation is considered to own such block of stock at the close of the
acquisition date.
(3) Carryover FT stock--(i) Definition. FT stock is carryover FT
stock if--
(A) FT was a controlled foreign corporation within the meaning of
section 957 (taking into account section 953(c)) at any time during the
portion of the 12-month acquisition period that ends on the acquisition
date; and
(B) Such stock is owned as of the beginning of the day after FT's
acquisition date by a person other than a purchasing corporation, or by
a purchasing corporation if the stock is nonrecently purchased and is
not subject to a gain recognition election under Sec. 1.338-5(d).
(ii) Carryover of earnings and profits. The earnings and profits of
old FT (and associated foreign taxes) attributable to the carryover FT
stock (adjusted to reflect deemed sale tax sentence consequences) carry
over to new FT solely for purposes of--
(A) Characterizing an actual distribution with respect to a share of
carryover FT stock as a dividend;
(B) Characterizing gain on a post-acquisition date transfer of a
share of carryover FT stock as a dividend under section 1248 (if such
section is otherwise applicable);
(C) Characterizing an investment of earnings in United States
property as income under sections 951(a)(1)(B) and 956 (if such sections
are otherwise applicable); and
(D) Determining foreign taxes deemed paid under sections 902 and 960
with respect to the amount treated as a dividend or income by virtue of
this paragraph (b)(3)(ii) (subject to the operation of section
338(h)(16)).
(iii) Cap on carryover of earnings and profits. The amount of
earnings and profits of old FT taken into account with respect to a
share of carryover FT stock is limited to the amount that would have
been included in gross income of the owner of such stock as a dividend
under section 1248 if--
(A) The shareholder transferred that share to the purchasing
corporation on FT's acquisition date for a consideration equal to the
fair market value of that share on that date; or
(B) In the case of nonrecently purchased FT stock treated as
carryover FT stock, a gain recognition election under section
338(b)(3)(A) applied to that share. For purposes of the preceding
sentence, a shareholder that is a
[[Page 140]]
controlled foreign corporation is considered to be a United States
person, and the principle of section 1248(c)(2)(D)(ii) (concerning a
United States person's indirect ownership of stock in a foreign
corporation) applies in determining the correct holding period.
(iv) Post-acquisition date distribution of old FT earnings and
profits. A post-acquisition date distribution with respect to a share of
carryover FT stock is considered to be derived first from earnings and
profits derived after FT's acquisition date and then from earnings and
profits derived on or before FT's acquisition date.
(v) Old FT earnings and profits unaffected by post-acquisition date
deficits. The carryover amount for a share of carryover FT stock is not
reduced by deficits in earnings and profits incurred by new FT. This
rule applies for purposes of determining the amount of foreign taxes
deemed paid regardless of the fact that there are no accumulated
earnings and profits. For example, a distribution by new FT with respect
to a share of carryover FT stock is treated as a dividend by the
distributee to the extent of the carryover amount for that share
notwithstanding that new FT has no earnings and profits.
(vi) Character of FT stock as carryover FT stock eliminated upon
disposition. A share of FT stock is not considered carryover FT stock
after it is disposed of provided that all gain realized on the transfer
is recognized at the time of the transfer, or that, if less than all of
the realized gain is recognized, the recognized amount equals or exceeds
the remaining carryover amount for that share.
(4) Passive foreign investment company stock. Stock that is owned as
of the beginning of the day after FT's acquisition date by a person
other than a purchasing corporation, or by a purchasing corporation if
the FT stock is nonrecently purchased stock not subject to a gain
recognition election under Sec. 1.338-5(d), is treated as passive
foreign investment company stock to the extent provided in section
1297(b)(1).
(c) Dividend treatment under section 1248(e). The principles of this
paragraph (b) apply to shareholders of a domestic corporation subject to
section 1248(e).
(d) Allocation of foreign taxes. If a section 338 election is made
for target (whether foreign or domestic), and target's taxable year
under foreign law (if any) does not close at the end of the acquisition
date, foreign income taxes attributable to the foreign taxable income
earned by target during such foreign taxable year are allocated to old
target and new target. Such allocation is made under the principles of
Sec. 1.1502-76(b).
(e) Operation of section 338(h)(16). [Reserved]
(f) Examples. (1) Except as otherwise provided, all corporations use
the calendar year as the taxable year, have no earnings and profits (or
deficit) accumulated for any taxable year, and have only one class of
outstanding stock.
(2) This section may be illustrated by the following examples:
Example 1. Gain recognition election for carryover FT stock.(a) A
has owned 90 of the 100 shares of CFCT stock since CFCT was organized on
March 13, 1989. P has owned the remaining 10 shares of CFCT stock since
CFCT was organized. Those 10 shares constitute nonrecently purchased
stock in P's hands within the meaning of section 338(b)(6)(B). On
November 1, 1994, P purchases A's 90 shares of CFCT stock for $90,000
and makes a section 338 election for CFCT. P also makes a gain
recognition election under section 338(b)(3)(A) and Sec. 1.338-5(d).
(b) CFCT's earnings and profits for its short taxable year ending on
November 1, 1994, are $50,000, determined without taking into account
the deemed asset sale. Assume A recognizes gain of $81,000 on the sale
of the CFCT stock. Further, assume that CFCT recognizes gain of $40,000
by reason of its deemed sale of assets under section 338(a)(1).
(c) A's sale of CFCT stock to P is a transfer to which section 1248
and paragraphs (b)(1) and (2) of this section apply. For purposes of
applying section 1248(a) to A, the earnings and profits of CFCT for its
short taxable year ending on November 1, 1994, are $90,000 (the earnings
and profits for that taxable year as determined under Sec. 1.1248-2(e)
($50,000) plus earnings from the deemed sale ($40,000)). Thus, A's
entire gain is characterized as a dividend under section 1248 (but see
section 338(h)(16)).
(d) Assume that P recognizes a gain of $9,000 with respect to the 10
shares of nonrecently purchased CFCT stock by reason of the gain
recognition election. Because P is treated as selling the nonrecently
purchased
[[Page 141]]
stock for all purposes of the Internal Revenue Code, section 1248
applies. Thus, under Sec. 1.1248-2(e), $9,000 of the $90,000 of earnings
and profits for 1994 are attributable to the block of 10 shares of CFCT
stock deemed sold by P at the close of November 1, 1994 ($90,000 x 10/
100). Accordingly, P's entire gain on the deemed sale of 10 shares of
CFCT stock is included under section 1248(a) in P's gross income as a
dividend (but see section 338(h)(16)).
Example 2. No gain recognition election for carryover FT stock.(a)
Assume the same facts as in Example 1, except that P does not make a
gain recognition election.
(b) The 10 shares of nonrecently purchased CFCT stock held by P is
carryover FT stock under paragraph (b)(3) of this section. Accordingly,
the earnings and profits (and attributable foreign taxes) of old CFCT
carry over to new CFCT solely for purposes of that block of 10 shares.
The amount of old CFCT's earnings and profits taken into account with
respect to that block in the event, for example, of a distribution by
new CFCT with respect to that block is the amount of the section 1248
dividend that P would have recognized with respect to that block had it
made a gain recognition election under section 338(b)(3)(A). Under the
facts of Example 1, P would have recognized a gain of $9,000 with
respect to that block, all of which would have been a section 1248
dividend ($90,000 x 10/100). Accordingly, the carryover amount for the
block of 10 shares of nonrecently purchased CFCT stock is $9,000.
Example 3. Sale of controlled foreign corporation stock prior to and
on the acquisition date.(a) X and Y, both U.S. corporations, have each
owned 50% of the CFCT stock since 1986. Among CFCT's assets are assets
the sale of which would generate subpart F income. On December 31, 1994,
X sells its CFCT stock to P. On June 30, 1995, Y sells its CFCT stock to
P. P makes a section 338 election for CFCT. In both 1994 and 1995, CFCT
has subpart F income resulting from operations.
(b) For taxable year 1994, X and Y are United States shareholders on
the last day of CFCT's taxable year, so pursuant to section 951(a)(1)(A)
each must include in income its pro rata share of CFCT's subpart F
income for 1994. Because P's holding period in the CFCT stock acquired
from X does not begin until January 1, 1995, P is not a United States
shareholder on the last day of 1994 for purposes of section 951(a)(1)(A)
(see Sec. 1.951-1(f)). X must then determine the extent to which section
1248 recharacterizes its gain on the sale of CFCT stock as a dividend.
(c) For the short taxable year ending June 30, 1995, Y is considered
to own the CFCT stock sold to P at the close of CFCT's acquisition date.
Because the acquisition date is the last day of CFCT's taxable year, Y
and P are United States shareholders on the last day of CFCT's taxable
year. Pursuant to section 951(a)(1)(A), each must include its pro rata
share of CFCT's subpart F income for the short taxable year ending June
30, 1995. This includes any income generated on the deemed sale of
CFCT's assets. Y must then determine the extent to which section 1248
recharacterizes its gain on the sale of the CFCT stock as a dividend,
taking into account any increase in CFCT's earnings and profits due to
the deemed sale of assets.
Example 4. Acquisition of control for purposes of section 951 prior
to the acquisition date.FS owns 100% of the FT stock. On July 1, 1994, P
buys 60% of the FT stock. On December 31, 1994, P buys the remaining 40%
of the FT stock and makes a section 338 election for FT. For tax year
1994, FT has earnings and profits of $1,000 (including earnings
resulting from the deemed sale). The section 338 election results in
$500 of subpart F income. As a result of the section 338 election, P
must include in gross income the following amount under section
951(a)(1)(A) (see Sec. 1.951-(b)(2)):
FT's subpart F income for 1994................................ $500.00
Less: reduction under section 951(a)(2)(A) for period (1-1-94 249.32
through 7-1-94) during which FT is not a controlled foreign
corporation ($500x182/365)...................................
---------
Subpart F income as limited by section 951 (a)(2)(A).......... 250.68
P's pro rata share of subpart F income as determined under 150.41
section 951(a)(2)(A) (60%x250.68)............................
Example 5. Coordination with section 936.(a) T is a corporation for
which a section 936 election has been made. P makes a qualified stock
purchase of T and makes a section 338 election for T.
(b) T's deemed sale of assets under section 338 constitutes a sale
for purposes of subtitle A of the Internal Revenue Code, including
section 936(a)(1)(A)(ii). To the extent that the assets deemed sold are
used in the conduct of an active trade or business in a possession for
purposes of section 936(a)(1)(A)(i), and assuming all the other
conditions of section 936 are satisfied, the income from the deemed sale
qualifies for the credit granted by section 936(a). The source of income
from the deemed sale is determined as if the assets had actually been
sold and is not affected for purposes of section 936 by section
338(h)(16).
(c) Because new T is treated a new corporation for purposes of
subtitle A of the Internal Revenue Code, the three year testing period
in section 936(a)(2)(A) begins again for new T on the day following T's
acquisition date. Thus, if the character or source of old T's gross
income disqualified it for the credit
[[Page 142]]
under section 936, a fresh start is allowed by a section 338 election.
[T.D. 8515, 59 FR 2978, Jan. 20, 1994. Redesignated by T.D. 8858, 65 FR
1246, Jan. 7, 2000, as amended by T.D. 8940, 66 FR 9929, Feb. 13, 2001;
66 FR 17466, Mar. 30, 2001]
Sec. 1.338-9 International aspects of section 338.
(a) Scope. This section provides guidance regarding international
aspects of section 338. As provided in Sec. 1.338-1(c)(14), a foreign
corporation, a DISC, or a corporation for which a section 936 election
has been made is considered a target affiliate for all purposes of
section 338. In addition, stock described in section 338(h)(6)(B)(ii)
held by a target affiliate is not excluded from the operation of section
338.
(b) Application of section 338 to foreign targets--(1) In general.
For purposes of subtitle A, the deemed sale gain, as defined in
Sec. 1.338-3(b)(4), of a foreign target for which a section 338 election
is made (FT), and the corresponding earnings and profits, are taken into
account in determining the taxation of FT and FT's direct and indirect
shareholders. See, however, section 338(h)(16). For example, the income
and earnings and profits of FT are determined, for purposes of sections
551, 951, 1248, and 1293, by taking into account the deemed sale gain.
(2) Ownership of FT stock on the acquisition date. A person who
transfers FT stock to the purchasing corporation on FT's acquisition
date is considered to own the transferred stock at the close of FT's
acquisition date. See, e.g., Sec. 1.951-1(f) (relating to determination
of holding period for purposes of sections 951 through 964). If on the
acquisition date the purchasing corporation owns a block of FT stock
that was acquired before FT's acquisition date, the purchasing
corporation is considered to own such block of stock at the close of the
acquisition date.
(3) Carryover FT stock--(i) Definition. FT stock is carryover FT
stock if--
(A) FT was a controlled foreign corporation within the meaning of
section 957 (taking into account section 953(c)) at any time during the
portion of the 12-month acquisition period that ends on the acquisition
date; and
(B) Such stock is owned as of the beginning of the day after FT's
acquisition date by a person other than a purchasing corporation, or by
a purchasing corporation if the stock is nonrecently purchased and is
not subject to a gain recognition election under Sec. 1.338(b)-1(e)(2).
(ii) Carryover of earnings and profits. The earnings and profits of
old FT (and associated foreign taxes) attributable to the carryover FT
stock (adjusted to reflect deemed sale gain) carry over to new FT solely
for purposes of--
(A) Characterizing an actual distribution with respect to a share of
carryover FT stock as a dividend;
(B) Characterizing gain on a post-acquisition date transfer of a
share of carryover FT stock as a dividend under section 1248 (if such
section is otherwise applicable);
(C) Characterizing an investment of earnings in United States
property as income under sections 951(a)(1)(B) and 956 (if such sections
are otherwise applicable); and
(D) Determining foreign taxes deemed paid under sections 902 and 960
with respect to the amount treated as a dividend or income by virtue of
this paragraph (b)(3)(ii) (subject to the operation of section
338(h)(16)).
(iii) Cap on carryover of earnings and profits. The amount of
earnings and profits of old FT taken into account with respect to a
share of carryover FT stock is limited to the amount that would have
been included in gross income of the owner of such stock as a dividend
under section 1248 if--
(A) The shareholder transferred that share to the purchasing
corporation on FT's acquisition date for a consideration equal to the
fair market value of that share on that date; or
(B) In the case of nonrecently purchased FT stock treated as
carryover FT stock, a gain recognition election under section
338(b)(3)(A) applied to that share. For purposes of the preceding
sentence, a shareholder that is a controlled foreign corporation is
considered to be a United States person, and the principle of section
1248(c)(2)(D)(ii) (concerning a United States person's indirect
ownership of stock in a foreign corporation) applies
[[Page 143]]
in determining the correct holding period.
(iv) Post-acquisition date distribution of old FT earnings and
profits. A post-acquisition date distribution with respect to a share of
carryover FT stock is considered to be derived first from earnings and
profits derived after FT's acquisition date and then from earnings and
profits derived on or before FT's acquisition date.
(v) Old FT earnings and profits unaffected by post-acquisition date
deficits. The carryover amount for a share of carryover FT stock is not
reduced by deficits in earnings and profits incurred by new FT. This
rule applies for purposes of determining the amount of foreign taxes
deemed paid regardless of the fact that there are no accumulated
earnings and profits. For example, a distribution by new FT with respect
to a share of carryover FT stock is treated as a dividend by the
distributee to the extent of the carryover amount for that share
notwithstanding that new FT has no earnings and profits.
(vi) Character of FT stock as carryover FT stock eliminated upon
disposition. A share of FT stock is not considered carryover FT stock
after it is disposed of provided that all gain realized on the transfer
is recognized at the time of the transfer, or that, if less than all of
the realized gain is recognized, the recognized amount equals or exceeds
the remaining carryover amount for that share.
(4) Passive foreign investment company stock. Stock that is owned as
of the beginning of the day after FT's acquisition date by a person
other than a purchasing corporation, or by a purchasing corporation if
the FT stock is nonrecently purchased stock not subject to a gain
recognition election under Sec. 1.338(b)-1(e)(2), is treated as passive
foreign investment company stock to the extent provided in section
1297(b)(1).
(c) Dividend treatment under section 1248(e). The principles of this
paragraph (b) apply to shareholders of a domestic corporation subject to
section 1248(e).
(d) Allocation of foreign taxes. If a section 338 election is made
for target (whether foreign or domestic), and target's taxable year
under foreign law (if any) does not close at the end of the acquisition
date, foreign income taxes attributable to the foreign taxable income
earned by target during such foreign taxable year are allocated to old
target and new target. Such allocation is made under the principles of
Sec. 1.1502-76(b).
(e) Operation of section 338(h)(16). [Reserved]
(f) Examples. (1) Except as otherwise provided, all corporations use
the calendar year as the taxable year, have no earnings and profits (or
deficit) accumulated for any taxable year, and have only one class of
outstanding stock.
(2) This section may be illustrated by the following examples:
Example 1. Gain recognition election for carryover FT stock.(a) A
has owned 90 of the 100 shares of CFCT stock since CFCT was organized on
March 13, 1989. P has owned the remaining 10 shares of CFCT stock since
CFCT was organized. Those 10 shares constitute nonrecently purchased
stock in P's hands within the meaning of section 338(b)(6)(B). On
November 1, 1994, P purchases A's 90 shares of CFCT stock for $90,000
and makes a section 338 election for CFCT. P also makes a gain
recognition election under section 338(b)(3)(A) and Sec. 1.338(b)-
1(e)(2).
(b) CFCT's earnings and profits for its short taxable year ending on
November 1, 1994, are $50,000, determined without taking into account
the deemed asset sale. Assume A recognizes gain of $81,000 on the sale
of the CFCT stock. Further, assume that CFCT recognizes gain of $40,000
by reason of its deemed sale of assets under section 338(a)(1).
(c) A's sale of CFCT stock to P is a transfer to which section 1248
and paragraphs (b)(1) and (2) of this section apply. For purposes of
applying section 1248(a) to A, the earnings and profits of CFCT for its
short taxable year ending on November 1, 1994, are $90,000 (the earnings
and profits for that taxable year as determined under Sec. 1.1248-2(e)
($50,000) plus earnings from the deemed sale ($40,000)). Thus, A's
entire gain is characterized as a dividend under section 1248 (but see
section 338(h)(16)).
(d) Assume that P recognizes a gain of $9,000 with respect to the 10
shares of nonrecently purchased CFCT stock by reason of the gain
recognition election. Because P is treated as selling the nonrecently
purchased stock for all purposes of the Internal Revenue Code, section
1248 applies. Thus, under Sec. 1.1248-2(e), $9,000 of the $90,000 of
earnings and profits for 1994 are attributable to the block of 10 shares
of CFCT stock deemed sold by P at the close of November 1, 1994 ($90,000
x 10/100). Accordingly, P's entire gain on the
[[Page 144]]
deemed sale of 10 shares of CFCT stock is included under section 1248(a)
in P's gross income as a dividend (but see section 338(h)(16)).
Example 2. No gain recognition election for carryover FT stock.(a)
Assume the same facts as in Example 1, except that P does not make a
gain recognition election.
(b) The 10 shares of nonrecently purchased CFCT stock held by P is
carryover FT stock under paragraph (b)(3) of this section. Accordingly,
the earnings and profits (and attributable foreign taxes) of old CFCT
carry over to new CFCT solely for purposes of that block of 10 shares.
The amount of old CFCT's earnings and profits taken into account with
respect to that block in the event, for example, of a distribution by
new CFCT with respect to that block is the amount of the section 1248
dividend that P would have recognized with respect to that block had it
made a gain recognition election under section 338(b)(3)(A). Under the
facts of Example 1, P would have recognized a gain of $9,000 with
respect to that block, all of which would have been a section 1248
dividend ($90,000 x 10/100). Accordingly, the carryover amount for the
block of 10 shares of nonrecently purchased CFCT stock is $9,000.
Example 3. Sale of controlled foreign corporation stock prior to and
on the acquisition date.(a) X and Y, both U.S. corporations, have each
owned 50% of the CFCT stock since 1986. Among CFCT's assets are assets
the sale of which would generate subpart F income. On December 31, 1994,
X sells its CFCT stock to P. On June 30, 1995, Y sells its CFCT stock to
P. P makes a section 338 election for CFCT. In both 1994 and 1995, CFCT
has subpart F income resulting from operations.
(b) For taxable year 1994, X and Y are United States shareholders on
the last day of CFCT's taxable year, so pursuant to section 951(a)(1)(A)
each must include in income its pro rata share of CFCT's subpart F
income for 1994. Because P's holding period in the CFCT stock acquired
from X does not begin until January 1, 1995, P is not a United States
shareholder on the last day of 1994 for purposes of section 951(a)(1)(A)
(see Sec. 1.951-1(f)). X must then determine the extent to which section
1248 recharacterizes its gain on the sale of CFCT stock as a dividend.
(c) For the short taxable year ending June 30, 1995, Y is considered
to own the CFCT stock sold to P at the close of CFCT's acquisition date.
Because the acquisition date is the last day of CFCT's taxable year, Y
and P are United States shareholders on the last day of CFCT's taxable
year. Pursuant to section 951(a)(1)(A), each must include its pro rata
share of CFCT's subpart F income for the short taxable year ending June
30, 1995. This includes any income generated on the deemed sale of
CFCT's assets. Y must then determine the extent to which section 1248
recharacterizes its gain on the sale of the CFCT stock as a dividend,
taking into account any increase in CFCT's earnings and profits due to
the deemed sale of assets.
Example 4. Acquisition of control for purposes of section 951 prior
to the acquisition date.FS owns 100% of the FT stock. On July 1, 1994, P
buys 60% of the FT stock. On December 31, 1994, P buys the remaining 40%
of the FT stock and makes a section 338 election for FT. For tax year
1994, FT has earnings and profits of $1,000 (including earnings
resulting from the deemed sale). The section 338 election results in
$500 of subpart F income. As a result of the section 338 election, P
must include in gross income the following amount under section
951(a)(1)(A) (see Sec. 1.951-(b)(2)):
FT's subpart F income for 1994................................ $500.00
Less: reduction under section 951(a)(2)(A) for period (1-1-94 249.32
through 7-1-94) during which FT is not a controlled foreign
corporation ($500x182/365)...................................
---------
Subpart F income as limited by section 951 (a)(2)(A).......... 250.68
P's pro rata share of subpart F income as determined under 150.41
section 951(a)(2)(A) (60%x250.68)............................
Example 5. Coordination with section 936.(a) T is a corporation for
which a section 936 election has been made. P makes a qualified stock
purchase of T and makes a section 338 election for T.
(b) T's deemed sale of assets under section 338 constitutes a sale
for purposes of subtitle A of the Internal Revenue Code, including
section 936(a)(1)(A)(ii). To the extent that the assets deemed sold are
used in the conduct of an active trade or business in a possession for
purposes of section 936(a)(1)(A)(i), and assuming all the other
conditions of section 936 are satisfied, the income from the deemed sale
qualifies for the credit granted by section 936(a). The source of income
from the deemed sale is determined as if the assets had actually been
sold and is not affected for purposes of section 936 by section
338(h)(16).
(c) Because new T is treated a new corporation for purposes of
subtitle A of the Internal Revenue Code, the three year testing period
in section 936(a)(2)(A) begins again for new T on the day following T's
acquisition date. Thus, if the character or source of old T's gross
income disqualified it for the credit under section 936, a fresh start
is allowed by a section 338 election.
[T.D. 8515, 59 FR 2978, Jan. 20, 1994. Redesignated by T.D. 8858, 65 FR
1246, Jan. 7, 2000]
[[Page 145]]
Sec. 1.338-10 Filing of returns.
(a) Returns including tax liability from deemed asset sale--(1) In
general. Except as provided in paragraphs (a)(2) and (3) of this
section, any deemed sale tax consequences are reported on the final
return of old target filed for old target's taxable year that ends at
the close of the acquisition date. Paragraphs (a)(2), (3) and (4) of
this section do not apply to elections under section 338(h)(10). If old
target is the common parent of an affiliated group, the final return may
be a consolidated return (any such consolidated return must also include
any deemed sale tax consequences of any members of the consolidated
group that are acquired by the purchasing corporation on the same
acquisition date as old target).
(2) Old target's final taxable year otherwise included in
consolidated return of selling group--(i) General rule. If the selling
group files a consolidated return for the period that includes the
acquisition date, old target is disaffiliated from that group
immediately before the deemed asset sale and must file a deemed sale
return separate from the group, which includes only the deemed sale tax
consequences and the carryover items specified in paragraph (a)(2)(iii)
of this section. The deemed asset sale occurs at the close of the
acquisition date and is the last transaction of old target and the only
transaction reported on the separate return. Except as provided in
Sec. 1.338-1(d) (regarding certain transactions on the acquisition
date), any transactions of old target occurring on the acquisition date
other than the deemed asset sale are included in the selling group's
consolidated return. A deemed sale return includes a combined deemed
sale return as defined in paragraph (a)(4) of this section.
(ii) Separate taxable year. The deemed asset sale included in the
deemed sale return under this paragraph (a)(2) occurs in a separate
taxable year, except that old target's taxable year of the sale and the
consolidated year of the selling group that includes the acquisition
date are treated as the same year for purposes of determining the number
of years in a carryover or carryback period.
(iii) Carryover and carryback of tax attributes. Target's attributes
may be carried over to, and carried back from, the deemed sale return
under the rules applicable to a corporation that ceases to be a member
of a consolidated group.
(iv) Old target is a component member of purchasing corporation's
controlled group. For purposes of its deemed sale return, target is a
component member of the controlled group of corporations including the
purchasing corporation unless target is treated as an excluded member
under section 1563(b)(2).
(3) Old target is an S corporation. If target is an S corporation
for the period that ends on the day before the acquisition date and a
section 338 election (but not a section 338(h)(10) election) is filed
for target, old target files a return as a C corporation reflecting its
activities on the acquisition date, including target's deemed sale. See
section 1362(d)(2). For purposes of this return, target is a component
member of the controlled group of corporations including the purchasing
corporation unless target is treated as an excluded member under section
1563(b)(2).
(4) Combined deemed sale return--(i) General rule. Under section
338(h)(15), a combined deemed sale return (combined return) may be filed
for all targets from a single selling consolidated group (as defined in
Sec. 1.338(h)(10)-1(b)(3)) that are acquired by the purchasing
corporation on the same acquisition date and that otherwise would be
required to file separate deemed sale returns. The combined return must
include all such targets. For example, T and T1 may be included in a
combined return if--
(A) T and T1 are directly owned subsidiaries of S;
(B) S is the common parent of a consolidated group; and
(C) P makes qualified stock purchases of T and T1 on the same
acquisition date.
(ii) Gain and loss offsets. Gains and losses recognized on the
deemed asset sales by targets included in a combined return are treated
as the gains and losses of a single target. In addition, loss carryovers
of a target that were
[[Page 146]]
not subject to the separate return limitation year restrictions (SRLY
restrictions) of the consolidated return regulations while that target
was a member of the selling consolidated group may be applied without
limitation to the gains of other targets included in the combined
return. If, however, a target has loss carryovers that were subject to
the SRLY restrictions while that target was a member of the selling
consolidated group, the use of those losses in the combined return
continues to be subject to those restrictions, applied in the same
manner as if the combined return were a consolidated return. A similar
rule applies, when appropriate, to other tax attributes.
(iii) Procedure for filing a combined return. A combined return is
made by filing a single corporation income tax return in lieu of
separate deemed sale returns for all targets required to be included in
the combined return. The combined return reflects the deemed asset sales
of all targets required to be included in the combined return. If the
targets included in the combined return constitute a single affiliated
group within the meaning of section 1504(a), the income tax return is
signed by an officer of the common parent of that group. Otherwise, the
return must be signed by an officer of each target included in the
combined return. Rules similar to the rules in Sec. 1.1502-75(j) apply
for purposes of preparing the combined return. The combined return must
include an attachment prominently identified as an ``ELECTION TO FILE A
COMBINED RETURN UNDER SECTION 338(h)(15).'' The attachment must--
(A) Contain the name, address, and employer identification number of
each target required to be included in the combined return;
(B) Contain the following declaration (or a substantially similar
declaration): EACH TARGET IDENTIFIED IN THIS ELECTION TO FILE A COMBINED
RETURN CONSENTS TO THE FILING OF A COMBINED RETURN;
(C) For each target, be signed by a person who states under
penalties of perjury that he or she is authorized to act on behalf of
such target.
(iv) Consequences of filing a combined return. Each target included
in a combined return is severally liable for any tax associated with the
combined return. See Sec. 1.338-1(b)(3).
(5) Deemed sale excluded from purchasing corporation's consolidated
return. Old target may not be considered a member of any affiliated
group that includes the purchasing corporation with respect to its
deemed asset sale.
(6) Due date for old target's final return--(i) General rule. Old
target's final return is generally due on the 15th day of the third
calendar month following the month in which the acquisition date occurs.
See section 6072 (time for filing income tax returns).
(ii) Application of Sec. 1.1502-76(c)--(A) In general. Section
1.1502-76(c) applies to old target's final return if old target was a
member of a selling group that did not file consolidated returns for the
taxable year of the common parent that precedes the year that includes
old target's acquisition date. If the selling group has not filed a
consolidated return that includes old target's taxable period that ends
on the acquisition date, target may, on or before the final return due
date (including extensions), either--
(1) File a deemed sale return on the assumption that the selling
group will file the consolidated return; or
(2) File a return for so much of old target's taxable period as ends
at the close of the acquisition date on the assumption that the
consolidated return will not be filed.
(B) Deemed extension. For purposes of applying Sec. 1.1502-76(c)(2),
an extension of time to file old target's final return is considered to
be in effect until the last date for making the election under section
338.
(C) Erroneous filing of deemed sale return. If, under this paragraph
(a)(6)(ii), target files a deemed sale return but the selling group does
not file a consolidated return, target must file a substituted return
for old target not later than the due date (including extensions) for
the return of the common parent with which old target would have been
included in the consolidated return. The substituted return is for so
much of old target's taxable year as ends at the close of the
acquisition date. Under Sec. 1.1502-76(c)(2), the deemed sale return is
not considered a return
[[Page 147]]
for purposes of section 6011 (relating to the general requirement of
filing a return) if a substituted return must be filed.
(D) Erroneous filing of return for regular tax year. If, under this
paragraph (a)(6)(ii), target files a return for so much of old target's
regular taxable year as ends at the close of the acquisition date but
the selling group files a consolidated return, target must file an
amended return for old target not later than the due date (including
extensions) for the selling group's consolidated return. (The amended
return is a deemed sale return.)
(E) Last date for payment of tax. If either a substituted or amended
final return of old target is filed under this paragraph (a)(6)(ii), the
last date prescribed for payment of tax is the final return due date (as
defined in paragraph (a)(6)(i) of this section).
(7) Examples. The following examples illustrate this paragraph (a):
Example 1. (i) S is the common parent of a consolidated group that
includes T. The S group files calendar year consolidated returns. At the
close of June 30 of Year 1, P makes a qualified stock purchase of T from
S. P makes a section 338 election for T, and T's deemed asset sale
occurs as of the close of T's acquisition date (June 30).
(ii) T is considered disaffiliated for purposes of reporting the
deemed sale tax consequences. Accordingly, T is included in the S
group's consolidated return through T's acquisition date except that the
tax liability for the deemed sale tax consequences is reported in a
separate deemed sale return of T. Provided that T is not treated as an
excluded member under section 1563(b)(2), T is a component member of P's
controlled group for the taxable year of the deemed asset sale, and the
taxable income bracket amounts available in calculating tax on the
deemed sale return must be limited accordingly.
(iii) If P purchased the stock of T at 10 a.m. on June 30 of Year 1,
the results would be the same. See paragraph (a)(2)(i) of this section.
Example 2. The facts are the same as in Example 1, except that the S
group does not file consolidated returns. T must file a separate return
for its taxable year ending on June 30 of Year 1, which return includes
the deemed asset sale.
(b) Waiver--(1) Certain additions to tax. An addition to tax or
additional amount (addition) under subchapter A of chapter 68 of the
Internal Revenue Code arising on or before the last day for making the
election under section 338 because of circumstances that would not exist
but for an election under section 338 is waived if--
(i) Under the particular statute the addition is excusable upon a
showing of reasonable cause; and
(ii) Corrective action is taken on or before the last day.
(2) Notification. The Internal Revenue Service should be notified at
the time of correction (e.g., by attaching a statement to a return that
constitutes corrective action) that the waiver rule of this paragraph
(b) is being asserted.
(3) Elections or other actions required to be specified on a timely
filed return--(i) In general. If paragraph (b)(1) of this section
applies or would apply if there were an underpayment, any election or
other action that must be specified on a timely filed return for the
taxable period covered by the late filed return described in paragraph
(b)(1) of this section is considered timely if specified on a late-filed
return filed on or before the last day for making the election under
section 338.
(ii) New target in purchasing corporation's consolidated return. If
new target is includible for its first taxable year in a consolidated
return filed by the affiliated group of which the purchasing corporation
is a member on or before the last day for making the election under
section 338, any election or other action that must be specified in a
timely filed return for new target's first taxable year (but which is
not specified in the consolidated return) is considered timely if
specified in an amended return filed on or before such last day, at the
place where the consolidated return was filed.
(4) Examples. The following examples illustrate this paragraph (b):
Example 1. T is an unaffiliated corporation with a tax year ending
March 31. At the close of September 20 of Year 1, P makes a qualified
stock purchase of T. P does not join in filing a consolidated return. P
makes a section 338 election for T on or before June 15 of Year 2, which
causes T's taxable year to end as of the close of September 20 of Year
1. An income tax return for T's taxable period ending on September 20 of
Year 1 was due on December 15 of Year 1. Additions to tax for failure to
file a return and to pay tax shown on a return will not be imposed if
T's return is filed and the tax paid on or before June 15 of
[[Page 148]]
Year 2. (This waiver applies even if the acquisition date coincides with
the last day of T's former taxable year, i.e., March 31 of Year 2.)
Interest on any underpayment of tax for old T's short taxable year
ending September 20 of Year 1 runs from December 15 of Year 1. A
statement indicating that the waiver rule of this paragraph is being
asserted should be attached to T's return.
Example 2. Assume the same facts as in Example 1. Assume further
that new T adopts the calendar year by filing, on or before June 15 of
Year 2, its first return (for the period beginning on September 21 of
Year 1 and ending on December 31 of Year 1) indicating that a calendar
year is chosen. See Sec. 1.338-1(b)(1). Any additions to tax or amounts
described in this paragraph (b) that arise because of the late filing of
a return for the period ending on December 31 of Year 1 are waived,
because they are based on circumstances that would not exist but for the
section 338 election. Notwithstanding this waiver, however, the return
is still considered due March 15 of Year 2, and interest on any
underpayment runs from that date.
Example 3. Assume the same facts as in Example 2, except that T's
former taxable year ends on October 31. Although prior to the election
old T had a return due on January 15 of Year 2 for its year ending
October 31 of Year 1, that return need not be filed because a timely
election under section 338 was made. Instead, old T must file a final
return for the period ending on September 20 of Year 1, which is due on
December 15 of Year 1.
[T.D. 8940, 66 FR 9948, Feb. 13, 2001]
Sec. 1.338(h)(10)-1 Deemed asset sale and liquidation.
(a) Scope. This section prescribes rules for qualification for a
section 338(h)(10) election and for making a section 338(h)(10)
election. This section also prescribes the consequences of such
election. The rules of this section are in addition to the rules of
Secs. 1.338-1 through 1.338-10 and, in appropriate cases, apply instead
of the rules of Secs. 1.338-1 through 1.338-10.
(b) Definitions--(1) Consolidated target. A consolidated target is a
target that is a member of a consolidated group within the meaning of
Sec. 1.1502-1(h) on the acquisition date and is not the common parent of
the group on that date.
(2) Selling consolidated group. A selling consolidated group is the
consolidated group of which the consolidated target is a member on the
acquisition date.
(3) Selling affiliate; affiliated target. A selling affiliate is a
domestic corporation that owns on the acquisition date an amount of
stock in a domestic target, which amount of stock is described in
section 1504(a)(2), and does not join in filing a consolidated return
with the target. In such case, the target is an affiliated target.
(4) S corporation target. An S corporation target is a target that
is an S corporation immediately before the acquisition date.
(5) S corporation shareholders. S corporation shareholders are the S
corporation target's shareholders. Unless otherwise indicated, a
reference to S corporation shareholders refers both to S corporation
shareholders who do and those who do not sell their target stock.
(6) Liquidation. Any reference in this section to a liquidation is
treated as a reference to the transfer described in paragraph (d)(4) of
this section notwithstanding its ultimate characterization for Federal
income tax purposes.
(c) Section 338(h)(10) election--(1) In general. A section
338(h)(10) election may be made for T if P acquires stock meeting the
requirements of section 1504(a)(2) from a selling consolidated group, a
selling affiliate, or the S corporation shareholders in a qualified
stock purchase.
(2) Simultaneous joint election requirement. A section 338(h)(10)
election is made jointly by P and the selling consolidated group (or the
selling affiliate or the S corporation shareholders) on Form 8023 in
accordance with the instructions to the form. S corporation shareholders
who do not sell their stock must also consent to the election. The
section 338(h)(10) election must be made not later than the 15th day of
the 9th month beginning after the month in which the acquisition date
occurs.
(3) Irrevocability. A section 338(h)(10) election is irrevocable. If
a section 338(h)(10) election is made for T, a section 338 election is
deemed made for T.
(4) Effect of invalid election. If a section 338(h)(10) election for
T is not valid, the section 338 election for T is also not valid.
(d) Certain consequences of section 338(h)(10) election. For
purposes of subtitle A of the Internal Revenue Code (except as provided
in Sec. 1.338-1(b)(2)),
[[Page 149]]
the consequences to the parties of making a section 338(h)(10) election
for T are as follows:
(1) P. P is automatically deemed to have made a gain recognition
election for its nonrecently purchased T stock, if any. The effect of a
gain recognition election includes a taxable deemed sale by P on the
acquisition date of any nonrecently purchased target stock. See
Sec. 1.338-5(d).
(2) New T. The AGUB for new T's assets is determined under
Sec. 1.338-5 and is allocated among the acquisition date assets under
Secs. 1.338-6 and 1.338-7. Notwithstanding paragraph (d)(4) of this
section (deemed liquidation of old T), new T remains liable for the tax
liabilities of old T (including the tax liability for the deemed sale
tax consequences). For example, new T remains liable for the tax
liabilities of the members of any consolidated group that are
attributable to taxable years in which those corporations and old T
joined in the same consolidated return. See Sec. 1.1502-6(a).
(3) Old T--deemed sale--(i) In general. Old T is treated as
transferring all of its assets to an unrelated person in exchange for
consideration that includes the discharge of its liabilities in a single
transaction at the close of the acquisition date (but before the deemed
liquidation). See Sec. 1.338-1(a) regarding the tax characterization of
the deemed asset sale. Except as provided in Sec. 1.338(h)(10)-1(d)(8)
(regarding the installment method), old T recognizes all of the gain
realized on the deemed transfer of its assets in consideration for the
ADSP. ADSP for old T is determined under Sec. 1.338-4 and allocated
among the acquisition date assets under Secs. 1.338-6 and 1.338-7. Old T
realizes the deemed sale tax consequences from the deemed asset sale
before the close of the acquisition date while old T is a member of the
selling consolidated group (or owned by the selling affiliate or owned
by the S corporation shareholders). If T is an affiliated target, or an
S corporation target, the principles of Secs. 1.338-2(c)(10) and 1.338-
10(a)(1), (5), and (6)(i) apply to the return on which the deemed sale
tax consequences are reported. When T is an S corporation target, T's S
election continues in effect through the close of the acquisition date
(including the time of the deemed asset sale and the deemed liquidation)
notwithstanding section 1362(d)(2)(B). Also, when T is an S corporation
target (but not a qualified subchapter S subsidiary), any direct and
indirect subsidiaries of T which T has elected to treat as qualified
subchapter S subsidiaries under section 1361(b)(3) remain qualified
subchapter S subsidiaries through the close of the acquisition date.
(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed asset
sale of a parent corporation is considered to precede that of its
subsidiary. See Sec. 1.338-3(b)(4)(i).
(4) Old T and selling consolidated group, selling affiliate, or S
corporation shareholders--deemed liquidation; tax characterization--(i)
In general. Old T is treated as if, before the close of the acquisition
date, after the deemed asset sale in paragraph (d)(3) of this section,
and while old T is a member of the selling consolidated group (or owned
by the selling affiliate or owned by the S corporation shareholders), it
transferred all of its assets to members of the selling consolidated
group, the selling affiliate, or S corporation shareholders and ceased
to exist. The transfer from old T is characterized for Federal income
tax purposes in the same manner as if the parties had actually engaged
in the transactions deemed to occur because of this section and taking
into account other transactions that actually occurred or are deemed to
occur. For example, the transfer may be treated as a distribution in
pursuance of a plan of reorganization, a distribution in complete
cancellation or redemption of all its stock, one of a series of
distributions in complete cancellation or redemption of all its stock in
accordance with a plan of liquidation, or part of a circular flow of
cash. In most cases, the transfer will be treated as a distribution in
complete liquidation to which section 336 or 337 applies.
(ii) Tiered targets. In the case of parent-subsidiary chains of
corporations making elections under section 338(h)(10), the deemed
liquidation of a subsidiary corporation is considered to
[[Page 150]]
precede the deemed liquidation of its parent.
(5) Selling consolidated group, selling affiliate, or S corporation
shareholders--(i) In general. If T is an S corporation target, S
corporation shareholders (whether or not they sell their stock) take
their pro rata share of the deemed sale tax consequences into account
under section 1366 and increase or decrease their basis in T stock under
section 1367. Members of the selling consolidated group, the selling
affiliate, or S corporation shareholders are treated as if, after the
deemed asset sale in paragraph (d)(3) of this section and before the
close of the acquisition date, they received the assets transferred by
old T in the transaction described in paragraph (d)(4)(i) of this
section. In most cases, the transfer will be treated as a distribution
in complete liquidation to which section 331 or 332 applies.
(ii) Basis and holding period of T stock not acquired. A member of
the selling consolidated group (or the selling affiliate or an S
corporation shareholder) retaining T stock is treated as acquiring the
stock so retained on the day after the acquisition date for its fair
market value. The holding period for the retained stock starts on the
day after the acquisition date. For purposes of this paragraph, the fair
market value of all of the T stock equals the grossed-up amount realized
on the sale to P of P's recently purchased target stock. See Sec. 1.338-
4(c).
(iii) T stock sale. Members of the selling consolidated group (or
the selling affiliate or S corporation shareholders) recognize no gain
or loss on the sale or exchange of T stock included in the qualified
stock purchase (although they may recognize gain or loss on the T stock
in the deemed liquidation).
(6) Nonselling minority shareholders other than nonselling S
corporation shareholders--(i) In general. This paragraph (d)(6)
describes the treatment of shareholders of old T other than the
following: Members of the selling consolidated group, the selling
affiliate, S corporation shareholders (whether or not they sell their
stock), and P. For a description of the treatment of S corporation
shareholders, see paragraph (d)(5) of this section. A shareholder to
which this paragraph (d)(6) applies is called a minority shareholder.
(ii) T stock sale. A minority shareholder recognizes gain or loss on
the shareholder's sale or exchange of T stock included in the qualified
stock purchase.
(iii) T stock not acquired. A minority shareholder does not
recognize gain or loss under this section with respect to shares of T
stock retained by the shareholder. The shareholder's basis and holding
period for that T stock is not affected by the section 338(h)(10)
election.
(7) Consolidated return of selling consolidated group. If P acquires
T in a qualified stock purchase from a selling consolidated group--
(i) The selling consolidated group must file a consolidated return
for the taxable period that includes the acquisition date;
(ii) A consolidated return for the selling consolidated group for
that period may not be withdrawn on or after the day that a section
338(h)(10) election is made for T; and
(iii) Permission to discontinue filing consolidated returns cannot
be granted for, and cannot apply to, that period or any of the
immediately preceding taxable periods during which consolidated returns
continuously have been filed.
(8) Availability of the section 453 installment method. Solely for
purposes of applying sections 453, 453A, and 453B, and the regulations
thereunder (the installment method) to determine the consequences to old
T in the deemed asset sale and to old T (and its shareholders, if
relevant) in the deemed liquidation, the rules in paragraphs (d)(1)
through (7) of this section are modified as follows:
(i) In deemed asset sale. Old T is treated as receiving in the
deemed asset sale new T installment obligations, the terms of which are
identical (except as to the obligor) to P installment obligations issued
in exchange for recently purchased stock of T. Old T is treated as
receiving in cash all other consideration in the deemed asset sale other
than the assumption of, or taking subject to, old T liabilities. For
example, old T is treated as receiving in cash any amounts attributable
to the grossing-up of amount realized under
[[Page 151]]
Sec. 1.338-4(c). The amount realized for recently purchased stock taken
into account in determining ADSP is adjusted (and, thus, ADSP is
redetermined) to reflect the amounts paid under an installment
obligation for the stock when the total payments under the installment
obligation are greater or less than the amount realized.
(ii) In deemed liquidation. Old T is treated as distributing in the
deemed liquidation the new T installment obligations that it is treated
as receiving in the deemed asset sale. The members of the selling
consolidated group, the selling affiliate, or the S corporation
shareholders are treated as receiving in the deemed liquidation the new
T installment obligations that correspond to the P installment
obligations they actually received individually in exchange for their
recently purchased stock. The new T installment obligations may be
recharacterized under other rules. See for example Sec. 1.453-11(a)(2)
which, in certain circumstances, treats the new T installment
obligations deemed distributed by old T as if they were issued by new T
in exchange for the stock in old T owned by members of the selling
consolidated group, the selling affiliate, or the S corporation
shareholders. The members of the selling consolidated group, the selling
affiliate, or the S corporation shareholders are treated as receiving
all other consideration in the deemed liquidation in cash.
(9) Treatment consistent with an actual asset sale. No provision in
section 338(h)(10) or this section shall produce a Federal income tax
result under subtitle A of the Internal Revenue Code that would not
occur if the parties had actually engaged in the transactions deemed to
occur because of this section and taking into account other transactions
that actually occurred or are deemed to occur. See, however, Sec. 1.338-
1(b)(2) for certain exceptions to this rule.
(e) Examples. The following examples illustrate the provisions of
this section:
Example 1. (i) S1 owns all of the T stock and T owns all of the
stock of T1 and T2. S1 is the common parent of a consolidated group that
includes T, T1, and T2. P makes a qualified stock purchase of all of the
T stock from S1. S1 joins with P in making a section 338(h)(10) election
for T and for the deemed purchase of T1. A section 338 election is not
made for T2.
(ii) S1 does not recognize gain or loss on the sale of the T stock
and T does not recognize gain or loss on the sale of the T1 stock
because section 338(h)(10) elections are made for T and T1. Thus, for
example, gain or loss realized on the sale of the T or T1 stock is not
taken into account in earnings and profits. However, because a section
338 election is not made for T2, T must recognize any gain or loss
realized on the deemed sale of the T2 stock. See Sec. 1.338-4(h).
(iii) The results would be the same if S1, T, T1, and T2 are not
members of any consolidated group, because S1 and T are selling
affiliates.
Example 2. (i) S and T are solvent corporations. S owns all of the
outstanding stock of T. S and P agree to undertake the following
transaction: T will distribute half its assets to S, and S will assume
half of T's liabilities. Then, P will purchase the stock of T from S. S
and P will jointly make a section 338(h)(10) election with respect to
the sale of T. The corporations then complete the transaction as agreed.
(ii) Under section 338(a), the assets present in T at the close of
the acquisition date are deemed sold by old T to new T. Under paragraph
(d)(4) of this section, the transactions described in paragraph (d) of
this section are treated in the same manner as if they had actually
occurred. Because S and P had agreed that, after T's actual distribution
to S of part of its assets, S would sell T to P pursuant to an election
under section 338(h)(10), and because paragraph (d)(4) of this section
deems T subsequently to have transferred all its assets to its
shareholder, T is deemed to have adopted a plan of complete liquidation
under section 332. T's actual transfer of assets to S is treated as a
distribution pursuant to that plan of complete liquidation.
Example 3. (i) S1 owns all of the outstanding stock of both T and
S2. All three are corporations. S1 and P agree to undertake the
following transaction. T will transfer substantially all of its assets
and liabilities to S2, with S2 issuing no stock in exchange therefor,
and retaining its other assets and liabilities. Then, P will purchase
the stock of T from S1. S1 and P will jointly make a section 338(h)(10)
election with respect to the sale of T. The corporations then complete
the transaction as agreed.
(ii) Under section 338(a), the remaining assets present in T at the
close of the acquisition date are deemed sold by old T to new T. Under
paragraph (d)(4) of this section, the transactions described in this
section are treated in the same manner as if they had actually occurred.
Because old T transferred substantially all of its assets to S2, and is
[[Page 152]]
deemed to have distributed all its remaining assets and gone out of
existence, the transfer of assets to S2, taking into account the related
transfers, deemed and actual, qualifies as a reorganization under
section 368(a)(1)(D). Section 361(c)(1) and not section 332 applies to
T's deemed liquidation.
Example 4. (i) T owns two assets: an actively traded security (Class
II) with a fair market value of $100 and an adjusted basis of $100, and
inventory (Class IV) with a fair market value of $100 and an adjusted
basis of $100. T has no liabilities. S is negotiating to sell all the
stock in T to P for $100 cash and contingent consideration. Assume that
under generally applicable tax accounting rules, P's adjusted basis in
the T stock immediately after the purchase would be $100, because the
contingent consideration is not taken into account. Thus, under the
rules of Sec. 1.338-5, AGUB would be $100. Under the allocation rules of
Sec. 1.338-6, the entire $100 would be allocated to the Class II asset,
the actively traded security, and no amount would be allocated to the
inventory. P, however, plans immediately to cause T to sell the
inventory, but not the actively traded security, so it requests that,
prior to the stock sale, S cause T to create a new subsidiary, Newco,
and contribute the actively traded security to the capital of Newco.
Because the stock in Newco, which would not be actively traded, is a
Class V asset, under the rules of Sec. 1.338-6 $100 of AGUB would be
allocated to the inventory and no amount of AGUB would be allocated to
the Newco stock. Newco's own AGUB, $0 under the rules of Sec. 1.338-5,
would be allocated to the actively traded security. When P subsequently
causes T to sell the inventory, T would realize no gain or loss instead
of realizing gain of $100.
(ii) Assume that, if the T stock had not itself been sold but T had
instead sold both its inventory and the Newco stock to P, T would for
tax purposes be deemed instead to have sold both its inventory and
actively traded security directly to P, with P deemed then to have
created Newco and contributed the actively traded security to the
capital of Newco. Section 338, if elected, generally recharacterizes a
stock sale as a deemed sale of assets. However, paragraph (d)(9) of this
section states, in general, that no provision of section 338(h)(10) or
the regulations thereunder shall produce a Federal income tax result
under subtitle A of the Internal Revenue Code that would not occur if
the parties had actually engaged in the transactions deemed to occur by
virtue of the section 338(h)(10) election, taking into account other
transactions that actually occurred or are deemed to occur. Hence, the
deemed sale of assets under section 338(h)(10) should be treated as one
of the inventory and actively traded security themselves, not of the
inventory and Newco stock. The anti-abuse rule of Sec. 1.338-1(c) does
not apply, because the substance of the deemed sale of assets is a sale
of the inventory and the actively traded security themselves, not of the
inventory and the Newco stock. Otherwise, the anti-abuse rule might
apply.
Example 5. (i) T, a member of a selling consolidated group, has only
one class of stock, all of which is owned by S1. On March 1 of Year 2,
S1 sells its T stock to P for $80,000, and joins with P in making a
section 338(h)(10) election for T. There are no selling costs or
acquisition costs. On March 1 of Year 2, T owns land with a $50,000
basis and $75,000 fair market value and equipment with a $30,000
adjusted basis, $70,000 recomputed basis, and $60,000 fair market value.
T also has a $40,000 liability. S1 pays old T's allocable share of the
selling group's consolidated tax liability for Year 2 including the tax
liability for the deemed sale tax consequences (a total of $13,600).
(ii) ADSP of $120,000 ($80,000 + $40,000 + 0) is allocated to each
asset as follows:
----------------------------------------------------------------------------------------------------------------
Assets Basis FMV Fraction Allocable ADSP
----------------------------------------------------------------------------------------------------------------
Land.................................... $50,000 $75,000 \5/9\ $66,667
Equipment............................... 30,000 60,000 \4/9\ 53,333
-----------------------------------------------------------------------
Total............................. 80,000 135,000 1 120,000
----------------------------------------------------------------------------------------------------------------
(iii) Under paragraph (d)(3) of this section, old T has gain on the
deemed sale of $40,000 (consisting of $16,667 of capital gain and
$23,333 of ordinary income).
(iv) Under paragraph (d)(5)(iii) of this section, S1 recognizes no
gain or loss upon its sale of the old T stock to P. S1 also recognizes
no gain or loss upon the deemed liquidation of T. See paragraph (d)(4)
of this section and section 332.
(v) P's basis in new T stock is P's cost for the stock, $80,000. See
section 1012.
(vi) Under Sec. 1.338-5, the AGUB for new T is $120,000, i.e., P's
cost for the old T stock ($80,000) plus T's liability ($40,000). This
AGUB is allocated as basis among the new T assets under Secs. 1.338-6
and 1.338-7.
Example 6. (i) The facts are the same as in Example 5, except that
S1 sells 80 percent of the old T stock to P for $64,000, rather than 100
percent of the old T stock for $80,000.
(ii) The consequences to P, T, and S1 are the same as in Example 5,
except that:
[[Page 153]]
(A) P's basis for its 80-percent interest in the new T stock is P's
$64,000 cost for the stock. See section 1012.
(B) Under Sec. 1.338-5, the AGUB for new T is $120,000 (i.e.,
$64,000/.8 + $40,000 + $0).
(C) Under paragraph (d)(4) of this section, S1 recognizes no gain or
loss with respect to the retained stock in T. See section 332.
(D) Under paragraph (d)(5)(ii) of this section, the basis of the T
stock retained by S1 is $16,000 (i.e., $120,000 - $40,000 (the ADSP
amount for the old T assets over the sum of new T's liabilities
immediately after the acquisition date) `` .20 (the proportion of T
stock retained by S1)).
Example 7. (i) The facts are the same as in Example 6, except that
K, a shareholder unrelated to T or P, owns the 20 percent of the T stock
that is not acquired by P in the qualified stock purchase. K's basis in
its T stock is $5,000.
(ii) The consequences to P, T, and S1 are the same as in Example 6.
(iii) Under paragraph (d)(6)(iii) of this section, K recognizes no
gain or loss, and K's basis in its T stock remains at $5,000.
Example 8. (i) The facts are the same as in Example 5, except that
the equipment is held by T1, a wholly-owned subsidiary of T, and a
section 338(h)(10) election is also made for T1. The T1 stock has a fair
market value of $60,000. T1 has no assets other than the equipment and
no liabilities. S1 pays old T's and old T1's allocable shares of the
selling group's consolidated tax liability for Year 2 including the tax
liability for T and T1's deemed sale tax consequences.
(ii) ADSP for T is $120,000, allocated $66,667 to the land and
$53,333 to the stock. Old T's deemed sale results in $16,667 of capital
gain on its deemed sale of the land. Under paragraph (d)(5)(iii) of this
section, old T does not recognize gain or loss on its deemed sale of the
T1 stock. See section 332.
(iii) ADSP for T1 is $53,333 (i.e., $53,333 + $0 + $0). On the
deemed sale of the equipment, T1 recognizes ordinary income of $23,333.
(iv) Under paragraph (d)(5)(iii) of this section, S1 does not
recognize gain or loss upon its sale of the old T stock to P.
Example 9. (i) The facts are the same as in Example 8, except that P
already owns 20 percent of the T stock, which is nonrecently purchased
stock with a basis of $6,000, and that P purchases the remaining 80
percent of the T stock from S1 for $64,000.
(ii) The results are the same as in Example 8, except that under
paragraph (d)(1) of this section and Sec. 1.338-5(d), P is deemed to
have made a gain recognition election for its nonrecently purchased T
stock. As a result, P recognizes gain of $10,000 and its basis in the
nonrecently purchased T stock is increased from $6,000 to $16,000. P's
basis in all the T stock is $80,000 (i.e., $64,000 + $16,000). The
computations are as follows:
(A) P's grossed-up basis for the recently purchased T stock is
$64,000 (i.e., $64,000 (the basis of the recently purchased T stock) x
(1-.2)/(.8) (the fraction in section 338(b)(4))).
(B) P's basis amount for the nonrecently purchased T stock is
$16,000 (i.e., $64,000 (the grossed-up basis in the recently purchased T
stock) x (.2)/(1.0-.2) (the fraction in section 338(b)(3)(B))).
(C) The gain recognized on the nonrecently purchased stock is
$10,000 (i.e., $16,000-$6,000).
Example 10. (i) T is an S corporation whose sole class of stock is
owned 40 percent each by A and B and 20 percent by C. T, A, B, and C all
use the cash method of accounting. A and B each has an adjusted basis of
$10,000 in the stock. C has an adjusted basis of $5,000 in the stock. A,
B, and C hold no installment obligations to which section 453A applies.
On March 1 of Year 1, A sells its stock to P for $40,000 in cash and B
sells its stock to P for a $25,000 note issued by P and real estate
having a fair market value of $15,000. The $25,000 note, due in full in
Year 7, is not publicly traded and bears adequate stated interest. A and
B have no selling expenses. T's sole asset is real estate, which has a
value of $110,000 and an adjusted basis of $35,000. Also, T's real
estate is encumbered by long-outstanding purchase-money indebtedness of
$10,000. The real estate does not have built-in gain subject to section
1374. A, B, and C join with P in making a section 338(h)(10) election
for T.
(ii) Solely for purposes of application of sections 453, 453A, and
453B, old T is considered in its deemed asset sale to receive back from
new T the $25,000 note (considered issued by new T) and $75,000 of cash
(total consideration of $80,000 paid for all the stock sold, which is
then divided by .80 in the grossing-up, with the resulting figure of
$100,000 then reduced by the amount of the installment note). Absent an
election under section 453(d), gain is reported by old T under the
installment method.
(iii) In applying the installment method to old T's deemed asset
sale, the contract price for old T's assets deemed sold is $100,000, the
$110,000 selling price reduced by the indebtedness of $10,000 to which
the assets are subject. (The $110,000 selling price is itself the sum of
the $80,000 grossed-up in paragraph (ii) above to $100,000 and the
$10,000 liability.) Gross profit is $75,000 ($110,000 selling price -
old T's basis of $35,000). Old T's gross profit ratio is 0.75 (gross
profit of $75,000 / $100,000 contract price). Thus, $56,250 (0.75 x the
$75,000 cash old T is deemed to receive in Year 1) is Year 1 gain
attributable to the sale, and $18,750 ($75,000 - $56,250) is recovery of
basis.
[[Page 154]]
(iv) In its liquidation, old T is deemed to distribute the $25,000
note to B, since B actually sold the stock partly for that
consideration. To the extent of the remaining liquidating distribution
to B, it is deemed to receive, along with A and C, the balance of old
T's liquidating assets in the form of cash. Under section 453(h), B,
unless it makes an election under section 453(d), is not required to
treat the receipt of the note as a payment for the T stock; P's payment
of the $25,000 note in Year 7 to B is a payment for the T stock. Because
section 453(h) applies to B, old T's deemed liquidating distribution of
the note is, under section 453B(h), not treated as a taxable disposition
by old T.
(v) Under section 1366, A reports 40 percent, or $22,500, of old T's
$56,250 gain recognized in Year 1. Under section 1367, this increases
A's $10,000 adjusted basis in the T stock to $32,500. Next, in old T's
deemed liquidation, A is considered to receive $40,000 for its old T
shares, causing it to recognize an additional $7,500 gain in Year 1.
(vi) Under section 1366, B reports 40 percent, or $22,500, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases B's $10,000 adjusted basis in its T stock to $32,500. Next, in
old T's deemed liquidation, B is considered to receive the $25,000 note
and $15,000 of other consideration. Applying section 453, including
section 453(h), to the deemed liquidation, B's selling price and
contract price are both $40,000. Gross profit is $7,500 ($40,000 selling
price - B's basis of $32,500). B's gross profit ratio is 0.1875 (gross
profit of $7,500 / $40,000 contract price). Thus, $2,812.50 (0.1875 x
$15,000) is Year 1 gain attributable to the deemed liquidation. In Year
7, when the $25,000 note is paid, B has $4,687.50 (0.1875 x $25,000) of
additional gain.
(vii) Under section 1366, C reports 20 percent, or $11,250, of old
T's $56,250 gain recognized in Year 1. Under section 1367, this
increases C's $5,000 adjusted basis in its T stock to $16,250. Next, in
old T's deemed liquidation, C is considered to receive $20,000 for its
old T shares, causing it to recognize an additional $3,750 gain in Year
1. Finally, under paragraph (d)(5)(ii) of this section, C is considered
to acquire its stock in T on the day after the acquisition date for
$20,000 (fair market value = grossed-up amount realized of $100,000 x
20%). C's holding period in the stock deemed received in new T begins at
that time.
(f) Inapplicability of provisions. The provisions of section 6043,
Sec. 1.331-1(d), and Sec. 1.332-6 (relating to information returns and
recordkeeping requirements for corporate liquidations) do not apply to
the deemed liquidation of old T under paragraph (d)(4) of this section.
(g) Required information. The Commissioner may exercise the
authority granted in section 338(h)(10)(C)(iii) to require provision of
any information deemed necessary to carry out the provisions of section
338(h)(10) by requiring submission of information on any tax reporting
form.
[T.D. 8940, 66 FR 8950, Feb. 13, 2001]
Sec. 1.338(i)-1 Effective dates.
(a) In general. The provisions of Secs. 1.338-1 through 1.338-7,
1.338-10 and 1.338(h)(10)-1 apply to any qualified stock purchase
occurring after March 15, 2001. For rules applicable to qualified stock
purchases on or before March 15, 2001, see Secs. 1.338-1T through 1.338-
7T, 1.338-10T, 1.338(h)(10)-1T and 1.338(i)-1T in effect prior to March
16, 2001 (see 26 CFR part 1 revised April 1, 2000).
(b) Section 338(h)(10) elections for S corporation targets. The
requirements of Secs. 1.338(h)(10)-1T(c)(2) and 1.338(h)(10)-1(c)(2)
that S corporation shareholders who do not sell their stock must also
consent to an election under section 338(h)(10) will not invalidate an
otherwise valid election made on the September 1997 revision of Form
8023, ``Elections Under Section 338 For Corporations Making Qualified
Stock Purchases,'' not signed by the nonselling shareholders, provided
that the S corporation and all of its shareholders (including nonselling
shareholders) report the tax consequences consistently with the results
under section 338(h)(10).
[T.D. 8940, 66 FR 9954, Feb. 13, 2001]
collapsible corporations; foreign personal holding companies
Sec. 1.341-1 Collapsible corporations; in general.
Subject to the limitations contained in Sec. 1.341-4 and the
exceptions contained in Sec. 1.341-6 and Sec. 1.341-7(a), the entire
gain from the actual sale or exchange of stock of a collapsible
corporation, (b) amounts distributed in complete or partial liquidation
of a collapsible corporation which are treated, under section 331, as
payment in exchange for stock, and (c) a distribution made by a
collapsible corporation which, under section 301(c)(3),
[[Page 155]]
is treated, to the extent it exceeds the basis of the stock, in the same
manner as a gain from the sale or exchange of property, shall be
considered as ordinary income.
[T.D. 7655, 44 FR 68459, Nov. 29, 1979]
Sec. 1.341-2 Definitions.
(a) Determination of collapsible corporation. (1) A collapsible
corporation is defined by section 341(b)(1) to be a corporation formed
or availed of principally (i) for the manufacture, construction, or
production of property, (ii) for the purchase of property which (in the
hands of the corporation) is property described in section 341(b)(3), or
(iii) for the holding of stock in a corporation so formed or availed of,
with a view to (a) the sale or exchange of stock by its shareholders
(whether in liquidation or otherwise), or a distribution to its
shareholders, prior to the realization by the corporation manufacturing,
constructing, producing, or purchasing the property of a substantial
part of the taxable income to be derived from such property, and (b) the
realization by such shareholders of gain attributable to such property.
See Sec. 1.341-5 for a description of the facts which will ordinarily be
considered sufficient to establish whether or not a corporation is a
collapsible corporation under the rules of this section. See paragraph
(d) of Sec. 1.341-5 for examples of the application of section 341.
(2) Under section 341(b)(1) the corporation must be formed or
availed of with a view to the action therein described, that is, the
sale or exchange of its stock by its shareholders, or a distribution to
them prior to the realization by the corporation manufacturing,
constructing, producing, or purchasing the property of a substantial
part of the taxable income to be derived from such property, and the
realization by the shareholders of gain attributable to such property.
This requirement is satisfied in any case in which such action was
contemplated by those persons in a position to determine the policies of
the corporation, whether by reason of their owning a majority of the
voting stock of the corporation or otherwise. The requirement is
satisfied whether such action was contemplated, unconditionally,
conditionally, or as a recognized possibility. If the corporation was so
formed or availed of, it is immaterial that a particular shareholder was
not a shareholder at the time of the manufacture, construction,
production, or purchase of the property, or if a shareholder at such
time, did not share in such view. Any gain of such a shareholder on his
stock in the corporation shall be treated in the same manner as gain of
a shareholder who did share in such view. The existence of a bona fide
business reason for doing business in the corporate form does not, by
itself, negate the fact that the corporation may also have been formed
or availed of with a view to the action described in section 341(b).
(3) A corporation is formed or availed of with a view to the action
described in section 341(b) if the requisite view existed at any time
during the manufacture, production, construction, or purchase referred
to in that section. Thus, if the sale, exchange, or distribution is
attributable solely to circumstances which arose after the manufacture,
construction, production, or purchase (other than circumstances which
reasonably could be anticipated at the time of such manufacture,
construction, production, or purchase), the corporation shall, in the
absence of compelling facts to the contrary, be considered not to have
been so formed or availed of. However, if the sale, exchange or
distribution is attributable to circumstances present at the time of the
manufacture, construction, production, or purchase, the corporation
shall, in the absence of compelling facts to the contrary, be considered
to have been so formed or availed of.
(4) The property referred to in section 341(b) is that property or
the aggregate of those properties with respect to which the requisite
view existed. In order to ascertain the property or properties as to
which the requisite view existed, reference shall be made to each
property as to which, at the time of the sale, exchange, or distribution
referred to in section 341(b) there has not been a realization by the
corporation manufacturing, constructing, producing, or purchasing the
property of a substantial part of the taxable income to be derived from
such property. However, where any such
[[Page 156]]
property is a unit of an integrated project involving several properties
similar in kind, the determination whether the requisite view existed
shall be made only if a substantial part of the taxable income to be
derived from the project has not been realized at the time of the sale,
exchange, or distribution, and in such case the determination shall be
made by reference to the aggregate of the properties constituting the
single project.
(5) A corporation shall be deemed to have manufactured, constructed,
produced, or purchased property if it (i) engaged in the manufacture,
construction, or production of property to any extent, or (ii) holds
property having a basis determined, in whole or in part, by reference to
the cost of such property in the hands of a person who manufactured,
constructed, produced, or purchased the property, or (iii) holds
property having a basis determined, in whole or in part, by reference to
the cost of property manufactured, constructed, produced, or purchased
by the corporation. Thus, under subdivision (i) of this subparagraph,
for example, a corporation need not have originated nor have completed
the manufacture, construction, or production of the property. Under
subdivision (ii) of this subparagraph, for example, if an individual
were to transfer property constructed by him to a corporation in
exchange for all of the capital stock of such corporation, and such
transfer qualifies under section 351, then the corporation would be
deemed to have constructed the property, since the basis of the property
in the hands of the corporation would, under section 362 be determined
by reference to the basis of the property in the hands of the
individual. Under subdivision (iii) of this subparagraph, for example,
if a corporation were to exchange property constructed by it for
property of like kind constructed by another person, and such exchange
qualifies under section 1031(a), then the corporation would be deemed to
have constructed the property received by it in the exchange, since the
basis of the property received by it in the exchange would, under
section 1031(d), be determined by reference to the basis of the property
constructed by the corporation.
(6) In determining whether a corporation is a collapsible
corporation by reason of the purchase of property, it is immaterial
whether the property is purchased from the shareholders of the
corporation or from persons other than such shareholders. The property,
however, must be property which, in the hands of the corporation, is
property of a kind described in section 341(b)(3). The determination
whether property is of a kind described in section 341(b)(3) shall be
made without regard to the fact that the corporation is formed or
availed of with a view to the action described in section 341(b)(1).
(7) Section 341 is applicable whether the shareholder is an
individual, a trust, an estate, a partnership, a company, or a
corporation.
(b) Section 341 assets. For the purposes of this section, the term
``section 341 assets'' means the following listed property if held for
less than 3 years:
(1) Stock in trade of the corporation, or other property of a kind
which would properly be included in the inventory of the corporation if
on hand at the close of the taxable year.
(2) Property held primarily for sale to customers in the ordinary
course of a trade or business.
(3) Property used in a trade or business as defined in section
1231(b) and held for less than 3 years, except property that is or has
been used in connection with the manufacture, construction, production
or sale of property described in subparagraphs (1) and (2) of this
paragraph.
(4) Unrealized receivables or fees pertaining to property listed in
this paragraph. The term unrealized receivables or fees means any rights
(contractual or otherwise) to payment for property listed in
subparagraphs (1), (2), and (3) of this paragraph which has been
delivered or is to be delivered and rights to payments for services
rendered or to be rendered, to the extent such rights have not been
included in the income of the corporation under the method of accounting
used by it. In determining whether the assets referred to in this
paragraph have been held for 3 years, the time such assets were held by
a transferor shall be taken into consideration (section 1223). However,
no such period shall begin before the date the
[[Page 157]]
manufacture, construction, production, or purchase of such assets is
completed.
Sec. 1.341-3 Presumptions.
(a) Unless shown to the contrary a corporation shall be considered
to be a collapsible corporation if at the time of the transactions
described in Sec. 1.341-1 the fair market value of the section 341
assets held by it constitutes 50 percent or more of the fair market
value of its total assets and the fair market value of the section 341
assets is 120 percent or more of the adjusted basis of such assets. In
determining the fair market value of the total assets, cash, obligations
which are capital assets in the hands of the corporation, governmental
obligations, and stock in any other corporation shall not be taken into
consideration. The failure of a corporation to meet the requirements of
this paragraph, shall not give rise to the presumption that the
corporation was not a collapsible corporation.
(b) The following example will illustrate the application of this
section:
Example A corporation, filing its income tax returns on the accrual
basis, on July 31, 1955, owned assets with the following fair market
values: Cash, $175,000; note receivable held for investment, $130,000;
stocks of other corporations, $545,000; rents receivable, $15,000; and a
building constructed by the corporation in 1953 and held thereafter as
rental property, $750,000. The adjusted basis of the building on that
date was $600,000. The only debt outstanding was a $500,000 mortgage on
the building. On July 31, 1955, the corporation liquidated and
distributed all of its assets to its shareholders. In computing whether
the fair market value of the section 341 assets (only the building) is
50 percent or more of the fair market value of the total assets, the
cash, note receivable, and stocks of other corporations are not taken
into account in determining the value of the total assets, with the
result that the fair market value of the total assets was $765,000
($750,000 (building) plus $15,000 rents receivable). Therefore, the
value of the building is 98 percent of the total assets ($750,000/
$765,000). The value of the building is also 125 percent of the adjusted
basis of the building ($750,000/$600,000). In view of the above facts,
there arises a presumption that the corporation is a collapsible
corporation.
Sec. 1.341-4 Limitations on application of section.
(a) General. This section shall apply only to the extent that the
recognized gain of a shareholder upon his stock in a collapsible
corporation would be considered, but for the provisions of this section,
as gain from the sale or exchange of a capital asset held for more than
1 year (6 months for taxable years before 1977; 9 months for taxable
years beginning in 1977). Thus, if a taxpayer sells at a gain stock of a
collapsible corporation which he had held for six months or less, this
section would not, in any event, apply to such gain. Also, if it is
determined, under provisions of law other than section 341, that a sale
or exchange at a gain of stock of a collapsible corporation which has
been held for more than 1 year (6 months for taxable years before 1977;
9 months for taxable years beginning in 1977) results in ordinary income
rather than long-term capital gain, then this section (including the
limitations contained herein) has no application whatsoever to such
gain.
(b) Stock ownership rules. (1) This section shall apply in the case
of gain realized by a shareholder upon his stock in a collapsible
corporation only if the shareholder, at any time after the actual
commencement of the manufacture, construction, or production of the
property, or at the time of the purchase of the property described in
section 341(b)(3) or at any time thereafter, (i) owned, or was
considered as owning, more than 5 percent in value of the outstanding
stock of the corporation, or (ii) owned stock which was considered as
owned at such time by another shareholder who then owned, or was
considered as owning, more than 5 percent in value of the outstanding
stock of the corporation.
(2) The ownership of stock shall be determined in accordance with
the rules prescribed by section 544(a)(1), (2), (3), (5), and (6),
except that, in addition to the persons prescribed by section 544(a)(2),
the family of an individual shall include the spouses of that
individual's brothers and sisters, whether such brothers and sisters are
by the whole or the half blood, and the spouses of that individual's
lineal descendants.
[[Page 158]]
(3) For the purpose of this limitation, treasury stock shall not be
considered as outstanding stock.
(4) It is possible, under this limitation, that a shareholder in a
collapsible corporation may have gain upon his stock in that corporation
treated differently from the gain of another shareholder in the same
collapsible corporation.
(c) Seventy-percent rule. (1) This section shall apply to the gain
recognized during a taxable year upon the stock in a collapsible
corporation only if more than 70 percent of such gain is attributable to
the property referred to in section 341(b)(1). If more than 70 percent
of such gain is so attributable, then all of such gain is subject to
this section, and, if 70 percent or less of such gain is so
attributable, then none of such gain is subject to this section.
(2) For the purpose of this limitation, the gain attributable to the
property referred to in section 341(b)(1) is the excess of the
recognized gain of the shareholder during the taxable year upon his
stock in the collapsible corporation over the recognized gain which the
shareholder would have if the property had not been manufactured,
constructed, produced, or purchased. In the case of gain on a
distribution in partial liquidation or a distribution described in
section 301(c)(3)(A), the gain attributable to the property shall not be
less than an amount which bears the same ratio to the gain on such
distribution as the gain which would be attributable to the property if
there had been a complete liquidation at the time of such distribution
bears to the total gain which would have resulted from such complete
liquidation.
(3) Gain may be attributable to the property referred to in section
341(b)(1) even though such gain is represented by an appreciation in the
value of property other than that manufactured, constructed, produced,
or purchased. Where, for example, a corporation owns a tract of land and
the development of one-half of the tract increases the value of the
other half, the gain attributable to the developed half of the tract
includes the increase in the value of the other half.
(4) The following example will illustrate the application of the 70
percent rule:
Example: On January 2, 1954, A formed the Z Corporation and
contributed $1,000,000 cash in exchange for all of the stock thereof.
The Z Corporation invested $400,000 in one project for the purpose of
building and selling residential houses. As of December 31, 1954, the
residential houses in this project were all sold, resulting in a profit
of $100,000 (after taxes). Simultaneously with the development of the
first project and in connection with a second and separate project the Z
Corporation invested $600,000 in land for the purpose of subdividing
such land into lots suitable for sale as home sites and distributing
such lots in liquidation before the realization by the corporation of a
substantial part of the taxable income to be realized from this second
project. As of December 31, 1954, Corporation Z had derived $60,000 in
profits (after taxes) from the sale of some of the lots. On January 2,
1955, the Z Corporation made a distribution in complete liquidation to
shareholder A who received:
(i) $560,000 in cash and notes, and
(ii) Lots having a fair market value of $940,000.
The gain recognized to shareholder A upon the liquidation is $500,000
($1,500,000 minus $1,000,000). The gain which would have been recognized
to A if the second project had not been undertaken is $100,000
($1,100,000 minus $1,000,000). Therefore, the gain attributable to the
second project which is property referred to in section 341(b)(1), is
$400,000 ($500,000 minus $100,000). Since this gain ($400,000) is more
than 70 percent of the entire gain ($500,000) recognized to A on the
liquidation, the entire gain so recognized is gain subject to section
341(a).
(d) Three-year rule. This section shall not apply to that portion of
the gain of a shareholder that is realized more than three years after
the actual completion of the manufacture, construction, production, or
purchase of the property referred to in section 341(b)(1) to which such
portion is attributable. However, if the actual completion of the
manufacture, construction, production, or purchase of all of such
property occurred more than 3 years before the date on which the gain is
realized, this section shall not apply to any part of the gain realized.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6738, 29 FR
7671, June 16, 1964; T.D. 7728, 45 FR 72650, Nov. 3, 1980]
[[Page 159]]
Sec. 1.341-5 Application of section.
(a) Whether or not a corporation is a collapsible corporation shall
be determined under the regulations of Secs. 1.341-2 and 1.341-3 on the
basis of all the facts and circumstances in each particular case. The
following paragraphs of this section set forth those facts which will
ordinarily be considered sufficient to establish that a corporation is
or is not a collapsible corporation. The facts set forth in the
following paragraphs of this section are not exclusive of other facts
which may be controlling in any particular case. For example, if the
facts in paragraph (b) of this section, but not the facts in paragraph
(c) of this section, are present, the corporation may nevertheless not
be a collapsible corporation if there are other facts which clearly
establish that the regulations of Secs. 1.341-2 and 1.341-3 are not
satisfied. Similarly, if the facts in paragraph (c) of this section are
present, the corporation may nevertheless be a collapsible corporation
if there are other facts which clearly establish that the corporation
was formed or availed of in the manner described in Secs. 1.341-2 and
1.341-3 or if the facts in paragraph (c) of this section are not
significant by reason of other facts, such as the fact that the
corporation is subject to the control of persons other than those who
were in control immediately prior to the manufacture, construction,
production, or purchase of the property. See Sec. 1.341-4 for provisions
which make section 341 inapplicable to certain shareholders of
collapsible corporations.
(b) The following facts will ordinarily be considered sufficient
(except as otherwise provided in paragraph (a) of this section and
paragraph (c) of this section) to establish that a corporation is a
collapsible corporation:
(1) A shareholder of the corporation sells or exchanges his stock,
or receives a liquidating distribution, or a distribution described in
section 301(c)(3)(A),
(2) Upon such sale, exchange, or distribution, such shareholder
realizes gain attributable to the property described in subparagraphs
(4) and (5) of this paragraph, and
(3) At the time of the manufacture, construction, production, or
purchase of the property described in subparagraphs (4) and (5) of this
paragraph, such activity was substantial in relation to the other
activities of the corporation which manufactured, constructed, produced,
or purchased such property.
The property referred to in subparagraphs (2) and (3) of this paragraph
is that property or the aggregate of those properties which meet the
following two requirements:
(4) The property is manufactured, constructed, or produced by the
corporation or by another corporation stock of which is held by the
corporation, or is property purchased by the corporation or by such
other corporation which (in the hands of the corporation holding such
property) is property described in section 341(b)(3), and
(5) At the time of the sale, exchange, or distribution described in
subparagraph (1) of this paragraph, the corporation which manufactured,
constructed, produced, or purchased such property has not realized a
substantial part of the taxable income to be derived from such property.
In the case of property which is a unit of an integrated project
involving several properties similar in kind, the rules of this
subparagraph shall be applied to the aggregate of the properties
constituting the single project rather than separately to such unit.
Under the rules of this subparagraph, a corporation shall be considered
a collapsible corporation by reason of holding stock in other
corporations which manufactured, constructed, produced, or purchased the
property only if the activity of the corporation in holding stock in
such other corporations is substantial in relation to the other
activities of the corporation.
(c) The absence of any of the facts set forth in paragraph (b) of
this section or the presence of the following facts will ordinarily be
considered sufficient (except as otherwise provided in paragraph (a) of
this section) to establish that a corporation is not a collapsible
corporation:
(1) In the case of a corporation subject to paragraph (b) of this
section only by reason of the manufacture, construction, production, or
purchase
[[Page 160]]
(either by the corporation or by another corporation the stock of which
is held by the corporation) of property which is property described in
section 341(b)(3)(A) and (B), the amount (both in quantity and value) of
such property is not in excess of the amount which is normal--
(i) For the purpose of the business activities of the corporation
which manufactured, constructed, produced, or purchased the property if
such corporation has a substantial prior business history involving the
use of such property and continues in business, or
(ii) For the purpose of an orderly liquidation of the business if
the corporation which manufactured, constructed, produced, or purchased
such property has a substantial prior business history involving the use
of such property and is in the process of liquidation.
(2) In the case of a corporation subject to paragraph (b) of this
section with respect to the manufacture, construction, or production
(either by the corporation or by another corporation the stock of which
is held by the corporation) of property, the amount of the unrealized
taxable income from such property is not substantial in relation to the
amount of the taxable income realized (after the completion of a
material part of such manufacture, construction, or production, and
prior to the sale, exchange, or distribution referred to in paragraph
(b)(1) of this section) from such property and from other property
manufactured, constructed, or produced by the corporation.
(d) The following examples will illustrate the application of this
section:
Example (1). (i) On January 2, 1954, A formed the W Corporation and
contributed $50,000 cash in exchange for all of the stock thereof. The W
Corporation borrowed $900,000 from a bank and used $800,000 of such sum
in the construction of an apartment house on land which it purchased for
$50,000. The apartment house was completed on December 31, 1954. On
December 31, 1954, the corporation, having determined that the fair
market value of the apartment house, separate and apart from the land,
was $900,000, made a distribution (permitted under the applicable State
law) to A of $100,000. At this time, the fair market value of the land
was $50,000. As of December 31, 1954, the corporation has not realized
any earnings and profits. In 1955, the corporation began the operation
of the apartment house and received rentals therefrom. The corporation
has since continued to own and operate the building. The corporation
reported on the basis of the calendar year and cash receipts and
disbursements.
(ii) Since A received a distribution and realized a gain
attributable to the building constructed by the corporation, since, at
the time of such distribution, the corporation has not realized a
substantial part of the taxable income to be derived from such building,
and since the construction of the building was a substantial activity of
the corporation, the W Corporation is considered a collapsible
corporation under paragraph (b) of Sec. 1.341-5. The provisions of
section 341(d) do not prohibit the application of section 341(a).
Therefore, the distribution, if and to the extent that it may be
considered long-term capital gain rather than ordinary income without
regard to section 341, will be considered ordinary income under section
341(a).
(iii) In the event of the existence of additional facts and
circumstances in the above case, the corporation, notwithstanding the
above facts, might not be considered a collapsible corporation. See
Sec. 1.342-2 and paragraph (a) of Sec. 1.341-5.
Example (2). (i) On January 2, 1954, B formed X Corporation and
became its sole shareholder. In August 1954, the corporation completed
construction of an office building. It immediately sold this building at
a gain of $50,000, included this entire gain in its return for 1954, and
distributed this entire gain (less taxes) to B. In June 1955, the
corporation completed construction of a second office building. In
August 1955, B sold the entire stock of X Corporation at a gain of
$12,000, which gain is attributable to the second building.
(ii) X Corporation is a collapsible corporation under section 341(b)
for the following reasons: The gain realized through the sale of the
stock of X Corporation was attributable to the second office building;
the construction of that building was a substantial activity of X
Corporation during the time of construction and, at the time of sale,
the corporation had not realized a substantial part of the taxable
income to be derived from such building. Since the provisions of section
341(d) do not prohibit the application of section 341 (a) to B, the gain
of $12,000 to B is, accordingly, considered ordinary income.
Example (3). The facts are the same as in Example (2), except that
the following facts are shown: B was the president of the X Corporation
and active in the conduct of its business. The second building was
constructed as the first step in a project of the X Corporation for the
development for rental purposes of a large suburban center involving the
construction of several buildings by the corporation. The sale of the
stock by B was caused by his retiring from all business
[[Page 161]]
activity as a result of illness arising after the second building was
constructed. Under these additional facts, the corporation is not
considered a collapsible corporation. See Sec. 1.341-2 and paragraph (a)
of Sec. 1.341-5.
Example (4). (i) On January 2, 1948, C formed the Y Corporation and
became the sole shareholder thereof. The Y Corporation has been engaged
solely in the business of producing motion pictures and licensing their
exhibition. On January 2, 1955, C sold all of the stock of the Y
Corporation at a gain. The Y Corporation has produced one motion picture
each year since its organization and before January 2, 1955, it has
realized a substantial part of the taxable income to be derived from
each of its motion pictures except the last one made in 1954. This last
motion picture was completed September 1, 1954. As of January 2, 1955,
no license had been made for its exhibition. The fair market value on
January 2, 1955, of this last motion picture exceeds the cost of its
production by $50,000. A material part of the production of this last
picture was completed on January 1, 1954, and between that date and
January 2, 1955, the corporation had realized taxable income of $500,000
from other motion pictures produced by it. The corporation has
consistently distributed to its shareholder its taxable income when
received (after adjustment for taxes).
(ii) Although the corporation is within paragraph (b) of this
section with respect to the production of property, the amount of the
unrealized income from such property ($50,000) is not substantial in
relation to the amount of the income realized, after the completion of a
material part of the production of such property and prior to sale of
the stock, from such property and other property produced by the
corporation ($500,000). Accordingly, the Y Corporation is within
paragraph (c)(2) of this section, and is not considered a collapsible
corporation.
Example (5). The facts are the same as in Example (4) except that C
sold all of his stock to D on February 1, 1954. On January 2, 1955, D
sold all of the Y Corporation stock at a gain, the gain being
attributable to the picture completed September 1, 1954, and not
released by the corporation for exhibition. In view of the change of
control of the corporation, the provisions of paragraph (c)(2) of this
section are not significant at the time of the sale by D, and the Y
Corporation would be considered a collapsible corporation on January 2,
1955. See Sec. 1.341-2 and paragraph (a) of Sec. 1.341-5.
Sec. 1.341-6 Exceptions to application of section.
(a) In general--(1) Transactions excepted. Section 341(e) excepts 4
types of transactions from the application of the collapsible
corporation provisions. These exceptions, where applicable, eliminate
the necessity of determining whether a corporation is a collapsible
corporation within the meaning of section 341(b) or whether any of the
limitations of section 341(d) are applicable. Under section 341(e)(1)
and (2), there are 2 exceptions which are designed to allow the
shareholders of a corporation either to sell or exchange their stock or
to receive distributions in certain complete liquidations without having
any gain considered under section 341(a)(1) or (2) as gain from the sale
or exchange of property which is not a capital asset. Under section
341(e)(3), a third exception is designed to permit the shareholders of a
corporation to make use of section 333, relating to elections as to
recognition of gain in certain complete liquidations occurring within
one calendar month. Under section 341(e)(4), the fourth exception
permits a corporation to make use of section 337, relating to
nonrecognition of gain or loss on sales or exchanges of property by a
corporation following the adoption of a plan of complete liquidation.
Section 341(e) does not apply to distributions in partial liquidation or
in redemption of stock (other than any such distribution pursuant to a
plan of complete liquidation), or to distributions described in section
301(c)(3)(A).
(2) Effective date. The exceptions in section 341(e)(1), (2), and
(3) apply only with respect to taxable years of shareholders beginning
after December 31, 1957, and only with respect to sales or exchanges of
stock and distributions of property occurring after September 2, 1958.
The exception in section 341(e)(4) applies only with respect to taxable
years of corporations beginning after December 31, 1957, and only if all
sales or exchanges of property, and all liquidating distributions, made
by the corporation under the plan of complete liquidation occur after
September 2, 1958.
(3) Definition of constructive shareholder and attribution rules.
(i) For purposes of this section, the term constructive shareholder
means a person who does not actually own any stock but who is considered
to own stock by reason of the application of subdivision (ii) of this
subparagraph.
[[Page 162]]
(ii) For purposes of this section (other than paragraph (k),
relating to definition of related person) a person shall be considered
to own the stock he actually owns plus any stock which is attributed to
him by reason of applying the rules prescribed in paragraph (b)(2) and
(3) of Sec. 1.341-4. See section 341(e)(10).
(iii) As an example of this subparagraph, if a husband does not
actually own any stock in a corporation but his wife is the actual owner
of 5 shares in the corporation, then the husband is a constructive
shareholder who is considered to own 5 shares in the corporation.
(4) General corporate test. No exception provided in section 341(e)
applies unless a general corporate test and, where applicable, a
specific shareholder test are satisfied. Under the general corporate
test no taxpayer may utilize the provisions of section 341(e) unless the
net increase in value (called ``net unrealized appreciation'') in the
corporation's ``subsection (e) assets'' does not exceed 15 percent of
the corporation's net worth. Subsection (e) assets are, in general,
those assets of the corporation which, if sold at a gain by the
corporation or by any actual or constructive shareholder who is
considered to own more than 20 percent in value of the outstanding
stock, would result in the realization of ordinary income. See paragraph
(b) of this section for the definition of subsection (e) assets, and
paragraph (h) of this section for definition of net unrealized
appreciation. This subparagraph may be illustrated by the following
examples:
Example (1). X Corporation is in the business of selling whiskey.
The net unrealized appreciation in its whiskey is $20,000 and the net
worth of the corporation is $100,000. Since the corporation's whiskey is
a subsection (e) asset and since the net unrealized appreciation in
subsection (e) assets ($20,000) exceeds 15 percent of net worth
($15,000), the general corporate test is not satisfied and section
341(e) is inapplicable to the corporation or its shareholders.
Example (2). Assume the same facts as in Example (1) except that X
Corporation is not in the business of selling whiskey. Assume further
that an actual shareholder who owns more than 20 percent in value of the
outstanding X stock (or a person who is considered to own such actual
shareholder's stock, such as his spouse) is in the business of selling
whiskey. The result is the same as in Example (1).
(5) Specific shareholder test. Even if the general corporate test is
met, a shareholder selling or exchanging his stock or receiving a
distribution with respect to his stock (referred to as a ``specific
shareholder'') who is considered to own more than 5 percent in value of
the outstanding stock of the corporation may not utilize the benefits of
the exception in section 341(e)(1) (or the exception in section
341(e)(2)) unless he satisfies the applicable specific shareholder test.
In general, the specific shareholder test is satisfied if the net
unrealized appreciation in subsection (e) assets of the corporation,
plus the net unrealized appreciation in certain other assets of the
corporation which would be subsection (e) assets in respect of the
specific shareholder under the following circumstances, does not exceed
15 percent of the corporation's net worth:
(i) If the specific shareholder is considered to own more than 5
percent but not more than 20 percent in value of the outstanding stock,
he must take into account the net unrealized appreciation in assets of
the corporation which would be subsection (e) assets if he was
considered to own more than 20 percent in value of the outstanding stock
(see paragraph (c)(3)(i) of this section);
(ii) In addition, if the specific shareholder is considered to own
more than 20 percent in value of the outstanding stock, he must also
take into account the net unrealized appreciation in assets of the
corporation which would be subsection (e) assets under section
341(e)(5)(A)(i) and (iii) if his ownership within the preceding 3 years
of stock in certain ``related'' corporations were taken into account in
the manner prescribed in paragraphs (c)(3)(ii) and (d) of this section.
(b) Subsection (e) asset defined--(1) General. The benefits of
section 341(e) are unavailable if the net unrealized appreciation (as
defined in paragraph (h) of this section) in certain assets of the
corporation (hereinafter called ``subsection (e) assets'') exceeds 15
percent of the corporation's net worth. In determining whether property
is a subsection (e) asset, it is immaterial
[[Page 163]]
whether the property is described in section 341(b), and there shall not
be taken into account sections 617(d) (relating to gain from
dispositions of certain mining property), 1245 and 1250 (relating to
gain from dispositions of certain depreciable property), 1251 (relating
to gain from disposition of farm property where farm losses offset
nonfarm income), 1252 (relating to gain from disposition of farm land),
and 1254 (relating to gain from disposition of natural resource
recapture property).
(2) Categories of subsection (e) assets. The term subsection (e)
assets, as defined in section 341(e)(5)(A)(i), (ii), (iii), and (iv),
means the following categories of property held by a corporation:
(i) The first category is property (except property described in
section 1231(b), without regard to any holding period prescribed
therein) which in the hands of the corporation is, or in the hands of
any actual or constructive shareholder who is considered to own more
than 20 percent in value of the outstanding stock of the corporation
would be, property gain from the sale or exchange of which would under
any provision of chapter 1 of the Code (other than section 617(d), 1245,
1250, 1251, 1252, or 1254) be considered in whole or in part as gain
from the sale or exchange of property which is neither a capital asset
nor property described in section 1231(b). For example, included in this
category is property held by a corporation which in its hands is stock
in trade, inventory, or property held by it primarily for sale to
customers in the ordinary course of its trade or business regardless of
whether such property is appreciated or depreciated in value. Also
included in this category is property held by a corporation which is a
capital asset in its hands but which, in the hands of any actual or
constructive shareholder who is considered to own more than 20 percent
in value of the outstanding stock, would be stock in trade, inventory,
or property held by such actual or constructive shareholder primarily
for sale to customers in the ordinary course of his trade or business.
For additional rules relating to whether property is a subsection (e)
asset under this subdivision, see subparagraphs (3), (4), and (5) of
this paragraph.
(ii) The second category of subsection (e) assets is property which
in the hands of the corporation is property described in section 1231(b)
(without regard to any holding period prescribed therein), but only if
there is net unrealized depreciation (within the meaning of paragraph
(h)(2) of this section) on all such property. This subdivision may be
illustrated by the following example:
Example. X Corporation owns only the following section 1231(b)
property (determined without regard to holding period).
------------------------------------------------------------------------
Fair Unreal- ized
Oil leaseholds Adjusted market appreciation
basis value (depreciation)
------------------------------------------------------------------------
No. 1............................... $16,000 $10,000 ($6,000)
No. 2............................... 8,000 5,000 (3,000)
No. 3............................... 5,000 5,000 0
No. 4............................... 3,000 5,000 2,000
-----------------------------------
Totals........................ 32,000 25,000 (7,000)
------------------------------------------------------------------------
Since with respect to such property the unrealized depreciation in
property on which there is unrealized depreciation ($9,000) exceeds the
unrealized appreciation in property on which there is unrealized
appreciation ($2,000), all such property is included in subsection (e)
assets under clause (ii) of section 341(e)(5)(A).
(iii) The third category of subsection (e) assets exists only if
there is net unrealized appreciation on all property which in the hands
of the corporation is property described in section 1231(b) (without
regard to any holding period prescribed therein). In such case, any such
section 1231(b) property (whether appreciated or depreciated) is a
subsection (e) asset of the third category if, in the hands of an actual
or constructive shareholder who is considered to own more than 20
percent in value of the outstanding stock of the corporation, such
property would be property gain from the sale or exchange of which would
under any provision of chapter 1 of the Code (other than section 617(d),
1245, 1250, 1251, 1252, or 1254) be considered in whole or in part as
gain from the sale or exchange of property which is neither a capital
asset nor property described in section 1231(b). Included in this
category, for example, is property which in the hands of the corporation
is property
[[Page 164]]
described in section 1231(b) (without regard to any holding period
prescribed therein), but which in the hands of an actual or constructive
more-than-20-percent shareholder would be property used in his trade or
business held for not more than 1 year (6 months for taxable years
beginning before 1977; 9 months for taxable years beginning in 1977),
stock in trade, inventory, or property held by such shareholder
primarily for sale to customers in the ordinary course of his trade or
business. For additional rules relating to whether property is a
subsection (e) asset under this subdivision, see subparagraphs (3) and
(4) of this paragraph. This subdivision may be further illustrated by
the following example:
Example. Assume the same facts as stated in the example under
subdivision (ii) of this subparagraph, except that in addition to the
oil leaseholds the corporation also owns land which has a fair market
value of $30,000 and an adjusted basis of $20,000 and which in the hands
of the corporation is property described in section 1231(b) (without
regard to any holding period prescribed therein). Assume further that A
is a constructive shareholder of the corporation who is considered to
own 25 percent in value of its outstanding stock and that A holds land
primarily for sale to customers in the ordinary course of his trade or
business, and that no actual or constructive shareholder who is
considered to own more than 20 percent in value of the stock of
corporation X so holds oil leases. Since with respect to the
corporation's section 1231(b) property the unrealized appreciation in
such property on which there is unrealized appreciation ($12,000)
exceeds the unrealized depreciation in such property on which there is
unrealized depreciation ($9,000), then clause (iii), and not clause
(ii), of section 341(e)(5)(A) is applicable. Therefore, no oil lease of
the corporation is a subsection (e) asset. However, since in the hands
of A, a more-than-20-percent constructive shareholder, the land would be
property gain from the sale or exchange of which would be considered as
gain from the sale or exchange of property which is neither a capital
asset nor property described in section 1231(b), the land is a
subsection (e) asset. Consequently, the net unrealized appreciation on
subsection (e) assets of the corporation is $10,000 since the net
unrealized depreciation on the oil leases is not taken into account.
(iv) The fourth category of subsection (e) assets is property
(unless included under subdivision (i), (ii), or (iii) of this
subparagraph) which consists of a copyright, a literary, musical, or
artistic composition, a letter or memorandum, or similar property, or
any interest in any such property, if the property was created in whole
or in part by the personal efforts of, or, in the case of a letter,
memorandum, or property similar to a letter or memorandum, was prepared,
or produced in whole or in part, for, any individual actual or
constructive shareholder who is considered to own more than 5 percent in
value of the outstanding stock of the corporation. For items included in
the phrase ``similar property'' see paragraph (c) of Sec. 1.1221-1. In
general, property is created in whole or in part by the personal efforts
of an individual if such individual performs literary, theatrical,
musical, artistic, or other creative or productive work which
affirmatively contributes to the creation of the property, or if such
individual directs and guides others in the performance of such work. An
individual, such as a corporate executive, who merely has administrative
control of writers, actors, artists, or personnel and who does not
substantially engage in the direction and guidance of such persons in
the performance of their work, does not create property by his personal
efforts. However, a letter or memorandum, or property similar to a
letter or memorandum, which is prepared by personnel who are under the
administrative control of an individual, such as a corporate executive,
shall be deemed to have been prepared or produced for him whether or not
such letter, memorandum, or similar property is reviewed by him. In
addition, a letter, memorandum, or property similar to a letter or
memorandum, addressed to an individual shall be considered as prepared
or produced for him. In the case of a letter, memorandum, or property
similar to a letter or memorandum, this subdivision applies only to
sales and other dispositions occurring after July 25, 1969.
(3) Manner of determination. For purposes of determining whether
property is a subsection (e) asset under subparagraph (2)(i) or (iii) of
this paragraph, the determination as to whether property of a
corporation in the hands of the corporation is, or in the hands of an
actual or constructive shareholder of the corporation would be, property
[[Page 165]]
gain from the sale or exchange of which would under any provision of
chapter 1 of the Code (other than section 617(d), 1245, 1250, 1251,
1252, or 1254) be considered in whole or in part as gain from the sale
or exchange of property which is neither a capital asset nor property
described in section 1231(b) shall be made as if all property of the
corporation had been sold or exchanged to one person in one transaction.
For example, if a corporation whose sole asset is an interest in a gas
well has entered into a long-term contract for the future delivery of
gas from the well, the ownership of which will pass to the buyer only
after extraction or severance from the well, the determination as to
whether such contract is a subsection (e) asset shall be made as if the
contract were sold or exchanged to one person in one transaction
together with such corporation's interest in the well. An assumed sale
under this subparagraph does not affect the character of property which
is held for sale to customers in the ordinary course of a person's trade
or business or the character of a transaction which would be an
anticipatory assignment of income. Thus, for example, if a corporation
holds subdivided lots for sale to customers in the ordinary course of
its trade or business, this subparagraph shall not be applied to change
the manner in which the lots are held.
(4) Shareholder reference test. For purposes of subparagraph (2)(i)
and (iii) of this paragraph, in determining whether any property of the
corporation would, in the hands of a particular actual or constructive
shareholder, be property gain from the sale or exchange of which would
be considered in whole or in part as gain from the sale or exchange of
property which is neither a capital asset nor property described in
section 1231(b), all the facts and circumstances of the direct and
indirect activities of the shareholder must be taken into account. If
the particular shareholder holds property primarily for sale to
customers in the ordinary course of his trade or business and if similar
property is held by the corporation, then in the hands of the
shareholder such corporate property will be treated as held primarily
for sale to customers in the ordinary course of his trade or business.
Moreover, even if the shareholder does not presently so hold property
which is similar to property held by the corporation, it may be
determined under the particular facts and circumstances (taking into
account an assumed sale of such corporate property by the shareholder,
all his other direct and indirect activities, and, if applicable, the
fact that he previously so held similar property) that he would hold the
corporate property primarily for sale to customers in the ordinary
course of his trade or business. See also paragraph (d) of this section,
pertaining to effect of stock in related corporations.
(5) Special rule for stock in shareholder's investment account. If--
(i) A dealer in stock or securities is an actual shareholder
(considered to own more than 20 percent of the outstanding stock of a
corporation) and holds such stock which he actually owns in his
investment account pursuant to section 1236(a), or
(ii) A dealer in stock or securities is a constructive shareholder
who is considered to own more than 20 percent of the outstanding stock
of a corporation,
then stock or securities held by such corporation shall not be
considered subsection (e) assets under subparagraph (2)(i) of this
paragraph solely because such actual or constructive shareholder is a
dealer in stock or securities. However, stock held by such corporation
shall be considered as a subsection (e) asset if, in the hands of any
more-than-20-percent actual or constructive shareholder of the
corporation, the gain (or any portion thereof) upon a sale of such stock
would (if it were held for more than 1 year (6 months for taxable years
beginning before 1977; 9 months for taxable years beginning in 1977),
constitute, by reason of the application of section 341, gain from the
sale of property which is not a capital asset. This subparagraph may be
illustrated by the following example:
Example. Jones, a more-than-20-percent actual shareholder in
corporation X holds his X stock in an investment account in the manner
prescribed in section 1236(a). Jones is a dealer in stock and securities
and holds land for sale to customers in the ordinary course
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of his trade or business. No other actual or constructive shareholder is
a dealer in stock and securities or so holds land. X holds all of the
stock in corporation Y, a collapsible corporation within the meaning of
section 341(b). Y's sole asset is land on which unrealized appreciation
exceeds 15 percent of Y's net worth. Since Jones holds his X stock in an
investment account pursuant to section 1236(a), the Y stock cannot be
considered a subsection (e) asset of the X Corporation merely because
Jones is a dealer in stock and securities. Nevertheless, the Y stock is
a subsection (e) asset of the X Corporation because if Jones were
treated as having sold the Y stock, his gain would be treated as gain
from the sale of property which is not a capital asset by reason of the
application of section 341. If, however, the net unrealized appreciation
on Y's land did not exceed 15 percent of Y's net worth the Y stock would
not be a subsection (e) asset since section 341(e)(1) would except such
sale from the application of section 341.
(c) Sales or exchanges of stock--(1) General. Section 341(e)(1)
provides that, if certain requirements are satisfied, the provisions of
section 341(a)(1) shall in no event apply to certain sales or exchanges
of stock by a shareholder. See subparagraph (5) of this paragraph for
sales or exchanges of stock which do not qualify under section
341(e)(1). Section 341(e)(1) applies to a sale or exchange of stock by a
shareholder only if, at the time of such sale or exchange, the general
corporate test and, if applicable, the specific shareholder test are
satisfied.
(2) General corporate test. The general corporate test is satisfied
if the net unrealized appreciation in subsection (e) assets of the
corporation does not exceed an amount equal to 15 percent of the net
worth of the corporation. See paragraphs (h), (b), and (j) of this
section for the definition of ``net unrealized appreciation,''
``subsection (e) assets,'' and ``net worth.''
(3) Specific shareholder test. The specific shareholder test (if
applicable) is satisfied if the following conditions are met:
(i) If the shareholder selling or exchanging the stock is considered
to own more than 5 percent but not more than 20 percent in value of the
outstanding stock, the sum of the net unrealized appreciation in the
following assets of the corporation must not exceed an amount equal to
15 percent of the net worth of the corporation:
(a) The subsection (e) assets of the corporation, plus
(b) The other assets of the corporation which would be subsection
(e) assets under section 341(e)(5)(A)(i) and (iii) if such shareholder
were considered to own more than 20 percent in value of the outstanding
stock.
(ii) If the shareholder selling or exchanging the stock is
considered to own more than 20 percent in value of the outstanding
stock, the sum of the net unrealized appreciation in the following
assets of the corporation must not exceed an amount equal to 15 percent
of the net worth of the corporation:
(a) The subsection (e) assets of the corporation, plus
(b) The other assets of the corporation which would be subsection
(e) assets under section 341(e)(5)(A)(i) and (iii) if the shareholder's
ownership of stock in certain related corporations were taken into
account in the manner prescribed in paragraph (d) of this section.
(4) Example. Subparagraph (3) of this paragraph may be illustrated
by the following example:
Example. Assume an individual, A, and his grandfather, G, each
actually owns 3 percent in value of the stock of corporation X, a
corporation holding apartment houses used in its trade or business on
which net unrealized appreciation exceeds 15 percent of X's net worth.
A, but not G, holds apartment houses primarily for sale to customers in
the ordinary course of trade or business. Assume that X satisfies the
general corporate test. A and G desire to sell their stock and to take
advantage of section 341(e)(1). Since a grandfather and grandson are
each considered to own the other's stock under paragraph (a)(3)(ii) of
this section, A and G are each considered to own 6 percent in value of
corporation X's outstanding stock. Therefore, A cannot avail himself of
section 341(e)(1) since he does not satisfy the specific shareholder
test prescribed in subparagraph (3)(i) of this paragraph. G, however,
who is considered to own 6 percent in value of the stock, does not hold
apartment houses for sale to customers in the ordinary course of trade
or business. Therefore, G satisfies the specific shareholder test and
may benefit from section 341(e)(1).
(5) Nonqualifying sales or exchanges. Section 341(e)(1) does not
apply to any
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sale or exchange of stock to the issuing corporation. Thus, stock
redemptions (including distributions in complete or partial liquidation)
cannot qualify under section 341(e)(1). In addition, section 341(e)(1)
does not apply in any case where a shareholder who is considered to own
more than 20 percent in value of the outstanding stock sells or
exchanges stock to any person related (within the meaning of paragraph
(k) of this section) to such shareholder. A sale or exchange of stock of
the corporation by a shareholder to which section 341(e)(1) does not
apply because of this subparagraph shall have no effect on the
application of this section to other sales or exchanges of stock of the
corporation.
(6) Example. For an illustration of the application of this
paragraph, see Example (2) in paragraph (o) of this section.
(d) Stock in related corporations--(1) General. This paragraph
provides rules for applying the specific shareholder test prescribed in
paragraph (c)(3)(ii) of this section for purposes of determining whether
section 341(e)(1) (relating to sales or exchanges of stock of a
corporation) or section 341(e)(2) (relating to distributions in complete
liquidation of a corporation) applies to an actual shareholder who is
considered as owning more than 20 percent in value of the corporation's
outstanding stock. In general, if such a more-than-20-percent
shareholder of such corporation (referred to as a ``first'' corporation)
owns, or at any time during the preceding 3 years has owned, more than
20 percent in value of the outstanding stock of a ``related''
corporation (see subparagraph (2) of this paragraph), then certain
transactions in respect of the stock of the related corporation are
taken into account in the manner prescribed in subparagraph (3) of this
paragraph. By taking such transactions into account, such shareholder of
the first corporation may be deemed to hold primarily for sale to
customers in the ordinary course of trade or business property similar
or related in service or use to property owned by the first corporation
where his other activities, direct and indirect, are insufficient to
treat him as so holding such property. See section 341(e)(1)(C) and
(2)(C). The transactions in respect of stock in a related corporation
are taken into account solely for the purpose of determining the extent
to which assets (other than subsection (e) assets) of the first
corporation are treated as subsection (e) assets under the shareholder
reference tests of section 341(e)(5)(A)(i) and (iii). For purposes of
this paragraph, the term ``similar or related in service or use'' shall
have the same meaning as such term has in section 1033 (relating to
involuntary conversions), without regard to subsection (g) thereof.
(2) Related corporation defined. (i) A corporation (referred to as a
``second'' corporation) is ``related'' to another corporation (referred
to as a ``first'' corporation) if the stock ownership test specified in
subdivision (ii) of this subparagraph and the more-than-70-percent-asset
comparison test specified in subdivision (iii) of this subparagraph are
met.
(ii) The stock ownership test specified in this subdivision is met--
(a) In the case of a sale or exchange referred to in paragraph
(c)(1) of this section, if the shareholder in the first corporation is
considered to own on the date of such sale or exchange more than 20
percent in value of the outstanding stock of the first corporation, and
if on such date (or at any time during the 3-year period preceding such
date) such shareholder in the first corporation is an actual or
constructive shareholder in the second corporation who was considered to
own more than 20 percent in value of the outstanding stock of the second
corporation, or
(b) In the case of a distribution pursuant to the adoption by the
first corporation of a plan of complete liquidation referred to in
paragraph (e) of this section, if the shareholder in the first
corporation is considered to own on any date after the adoption of such
plan more than 20 percent in value of the outstanding stock of the first
corporation, and if on such date (or at any time during the 3-year
period preceding such date) such shareholder in the first corporation
was an actual or constructive shareholder in the second corporation who
was considered to own more
[[Page 168]]
than 20 percent in value of the outstanding stock of the second
corporation.
(iii) The more-than-70-percent-asset comparison test specified in
this subdivision is met if more than 70 percent in value of the assets
of the second corporation (at any of the applicable times determined
under subdivision (ii) of this subparagraph during which the shareholder
of the first corporation is or was considered to own more than 20
percent in value of the outstanding stock of the second corporation)
are, or were, assets similar or related in service or use to assets
comprising more than 70 percent in value of the assets of the first
corporation (at any of the times determined under subdivision (ii) of
this subparagraph during which the shareholder of the first corporation
is or was considered to own more than 20 percent in value of the
outstanding stock of the first corporation).
(iv) This subparagraph may be illustrated by the following example:
Example. X is a first corporation and Y is a second corporation. On
January 15, 1960, Jones purchased 21 percent in value of the outstanding
stock of X, which he sold on January 1, 1961. On January 15, 1955, Jones
had purchased 21 percent in value of the outstanding stock of Y which he
sold on December 15, 1959. Since Jones owned 21 percent of the
outstanding X stock on January 1, 1961 (the date he sold his X stock)
and also owned 21 percent of the outstanding Y stock at some time during
the 3-year period preceding January 1, 1961, the stock ownership test
specified in subdivision (ii)(a) of this subparagraph is met. Assume
that more than 70 percent in value of the assets of Y were apartment
houses held for rental purposes at some time between January 1, 1958,
and December 15, 1959 (the portion of the 3-year period preceding the
date Jones sold his X stock during which he was a more-than-20-percent
shareholder in Y) and that more than 70 percent in value of the assets
of X were apartment houses held for rental purposes at some time during
the period January 15, 1960, to January 1, 1961, inclusive (the portion
of the 3-year period preceding the date he sold his X stock during which
he was a more-than-20-percent shareholder in X). Thus, the more-than-70-
percent-asset comparison test specified in subdivision (iii) of this
subparagraph is met. Accordingly, corporation Y is related to
corporation X within the meaning of this subparagraph.
(3) Manner of taking into account. If an actual shareholder in a
first corporation who is considered to own more than 20 percent of the
first corporation's stock, owns or has owned stock in a related
corporation, then--
(i) Any sale or exchange by such shareholder, during the applicable
period specified in subparagraph (2)(ii) of this paragraph, of stock in
the related corporation shall be treated as a sale or exchange by him of
his proportionate share of the assets of the related corporation, if
immediately before such sale or exchange he was an actual shareholder of
the related corporation who was considered to own more than 20 percent
in value of the outstanding stock of the related corporation. A
shareholder's proportionate share of the assets of a related corporation
shall be that percent of each asset of the related corporation as the
fair market value of the stock of the related corporation which he
actually sold or exchanged bears, immediately before such sale or
exchange, to the total fair market value of the outstanding stock of
such related corporation; and
(ii) Any sale or exchange of property by the related corporation
during the applicable period specified in subparagraph (2)(ii) of this
paragraph, gain or loss on which was not recognized to the related
corporation by reason of the application of section 337(a), shall be
treated as a sale or exchange by him of his proportionate share of the
related corporation's property sold or exchanged, if at the time of such
sale or exchange he was an actual or constructive shareholder of the
related corporation who was considered to own more than 20 percent in
value of the outstanding stock of such related corporation. A
shareholder's proportionate share of such related corporation's property
sold or exchanged shall be that percent of each such property sold or
exchanged as the fair market value of the stock which he was considered
to own in the related corporation immediately before such sale or
exchange bears to the total fair market value of the outstanding stock
of such related corporation at such time.
(4) Example. This paragraph may be illustrated by the following
example:
Example. (i) A owns 25 percent in value of the outstanding stock of
Z Corporation. On
[[Page 169]]
December 31, 1959, he sells all his stock in the corporation and desires
to take advantage of section 341(e)(1). The only asset of Z Corporation
is an appreciated apartment house held for rental purposes but which is
not a subsection (e) asset. However, during the preceding 3-year period
A sold 25 percent in value of the outstanding stock of each of 3 related
corporations. More than 70 percent in value of the assets of each
related corporation consisted of an apartment house.
(ii) In determining whether the apartment house owned by Z
Corporation would be a subsection (e) asset under the shareholder
reference test of section 341(e)(5)(A)(iii), A is treated as having sold
a one-fourth interest in each of 3 apartment houses during the preceding
3-year period and these sales must be taken into account, together with
all other facts and circumstances, in determining whether the apartment
house owned by Z Corporation would be, in the hands of A, property gain
from the sale or exchange of which would under any provision of chapter
1 of the Code (other than section 1245 or 1250) be considered as gain
from the sale or exchange of property which is neither a capital asset
nor property described in section 1231(b). However, A's sales of related
corporation stock are not taken into account in determining whether
section 341(e)(1) or (2) would be applicable to sales or exchanges of
stock by (or liquidating distributions to) other shareholders of Z
Corporation.
(e) Distributions in certain liquidations pursuant to section 337--
(1) In general. Section 341(e)(2) provides that, if certain requirements
are met, the provisions of section 341(a)(2) shall in no event apply to
certain distributions in complete liquidation of a corporation. Section
341(e)(2) applies with respect to any distribution to a shareholder
pursuant to a plan of complete liquidation if the following 3
requirements are satisfied:
(i) By reason of the application of section 341(e)(4) and paragraph
(g) of this section, section 337(a) applies to sales or exchanges of
property by the corporation within the 12-month period beginning on the
date of the adoption of such plan. Thus, for example, section 341(e)(2)
is not applicable in any case where depreciable, amortizable, or
depletable property is distributed after the date of adoption of the
plan or if the corporation does not sell substantially all of the
properties held by it on such date within such 12-month period, since
such a distribution, or the failure to make such a sale, makes section
337(a) inapplicable under section 341(e)(4).
(ii) At all times within such 12-month period the general corporate
test of paragraph (c)(2) of this section is satisfied.
(iii) In respect of the shareholder who receives the distribution--
(a) At all times within such 12-month period while such shareholder
is considered to own more than 5 percent but not more than 20 percent in
value of the outstanding stock of the corporation, the shareholder must
satisfy the specific shareholder test of paragraph (c)(3)(i) of this
section, and
(b) At all times within such 12-month period while such shareholder
is considered to own more than 20 percent in value of the outstanding
stock of the corporation, the shareholder must satisfy the specific
shareholder test of paragraph (c)(3)(ii) of this section.
(2) Illustration. For an illustration of this paragraph, see Example
(4) in paragraph (o) of this section.
(f) Recognition of gain in certain liquidations under section 333.
Section 341(e)(3) provides that, for purposes of section 333 (relating
to elections as to recognition of gain in certain complete liquidations
occurring within one calendar month), a corporation is considered not to
be a collapsible corporation if, at all times after the adoption of the
plan of complete liquidation, the net unrealized appreciation in
subsection (e) assets of the corporation does not exceed an amount equal
to 15 percent of the net worth of the corporation. For purposes of the
preceding sentence, the determination of subsection (e) assets shall be
made in accordance with paragraph (b) of this section except that
subparagraph (2)(i) and (iii) of such paragraph (b) shall apply in
respect of any actual or constructive shareholder who is considered to
own more than 5 percent in value of the outstanding stock (in lieu of
any actual or constructive shareholder who is considered to own more
than 20 percent in value of such stock). Thus, no shareholder of the
corporation can qualify under paragraph (3) of section 341(e) for use of
section 333 if, because of any actual or constructive shareholder who is
considered to own more than 5 percent in value of the stock, this
modified
[[Page 170]]
general corporate test is not satisfied. On the other hand, once this
modified general corporate test is satisfied, all the shareholders can
use section 333 (assuming that the requirements of that section are
satisfied) since there is no specific shareholder test. For an
illustration of this paragraph, see Example (3) in paragraph (o) of this
section.
(g) Gain or loss on sales or exchanges in connection with certain
liquidations, pursuant to section 337--(1) General. Section 341(e)(4)
provides that solely for purposes of section 337, a corporation is
considered not to be a collapsible corporation if (i) at all times
within the 12-month period beginning on the date of the adoption of a
plan of complete liquidation, the net unrealized appreciation in
subsection (e) assets of the corporation does not exceed an amount equal
to 15 percent of the net worth of the corporation; (ii) within the 12-
month period beginning on the date of the adoption of such plan, the
corporation sells substantially all of the properties held by it on such
date; and (iii) following the adoption of such plan, no distribution is
made of any property which in the hands of the corporation or in the
hands of the distributee is property in respect of which a deduction for
exhaustion, wear and tear, obsolescence, amortization, or depletion is
allowable. Thus, if at the time of the adoption of the plan of
liquidation the corporation is a collapsible corporation within the
meaning of section 341(b) and if the preceding requirements are
satisfied, then except as provided in subparagraph (2) of this paragraph
section 337(a) will apply to such corporation but the corporation will
continue to be a collapsible corporation within the meaning of section
341(b) (including for purposes of section 341(e)(2)) with the result
that each shareholder must still satisfy all the tests in paragraph (e)
of this section before he can utilize the benefits of section 341(e)(2).
(2) Exception to section 337 treatment. Section 341(e)(4) shall not
apply with respect to any sale or exchange of property by the
corporation to any actual or constructive shareholder who is considered
to own more than 20 percent in value of the outstanding stock of the
corporation or to any person related (within the meaning of paragraph
(k) of this section) to such actual or constructive shareholder if such
property in the hands of the corporation, or in the hands of such
shareholder or such related person, is property in respect of which a
deduction for exhaustion, wear and tear, obsolescence, amortization, or
depletion is allowable. Thus, gain or loss will be recognized on such
sales or exchanges.
(3) Cross references. For effective date of section 341(e)(4) and
this paragraph, see paragraph (a)(2) of this section. For an
illustration of this paragraph, see Example (4) in paragraph (o) of this
section.
(h) Net unrealized appreciation and depreciation defined--(1) Net
unrealized appreciation. For purposes of this section, the term net
unrealized appreciation means, with respect to the assets of a
corporation, the amount by which--
(i) The unrealized appreciation in such assets on which there is
unrealized appreciation, exceeds
(ii) The unrealized depreciation in such assets on which there is
unrealized depreciation.
(2) Net unrealized depreciation. For purposes of paragraph
(b)(2)(ii) of this section, there is net unrealized depreciation on all
property of a corporation which in its hands is property described in
section 1231(b) (without regard to any holding period prescribed
therein) if--
(i) The unrealized depreciation in such property on which there is
unrealized depreciation, exceeds
(ii) The unrealized appreciation in such property on which there is
unrealized appreciation.
(3) Unrealized appreciation or depreciation. For purposes of this
paragraph--
(i) The term unrealized appreciation means (except as provided in
subparagraph (4) of this paragraph), with respect to any asset, the
amount by which (a) the fair market value of such asset, exceeds (b) the
adjusted basis for determining gain from the sale or other disposition
of such asset; and
(ii) The term unrealized depreciation means, with respect to any
asset, the amount by which (a) the adjusted basis for determining gain
from the sale or other disposition of such asset, exceeds (b) the fair
market value of such asset.
[[Page 171]]
(4) Special rule. For purposes of determining whether the net
unrealized appreciation in subsection (e) assets of a corporation
exceeds an amount equal to 15 percent of the corporation's net worth
under the tests of section 341(e)(1), (2), (3), and (4), in the case of
any asset on the sale or exchange of which only a portion of the gain
would under any provision of chapter 1 of the Code (other than section
617(d), 1245, 1250, 1251, 1252, or 1254) be considered as gain from the
sale or exchange of property which is neither a capital asset nor
property described in section 1231(b), there shall be taken into account
only an amount equal to the unrealized appreciation in such asset which
is equal to such portion of the gain. This subparagraph shall have no
effect on whether paragraph (b)(2)(ii) or (iii) of this section applies
for purposes of identifying the subsection (e) assets of the
corporation.
(i) [Reserved]
(j) Net worth defined. For purposes of this section, the net worth
of a corporation, as of any day, is the amount by which--
(1) The fair market value of all its assets at the close of such
day, plus the amount of any distribution (taken into account at fair
market value on the date of such distribution) in complete liquidation
made by it on or before such day, exceeds
(2) All its liabilities at the close of such day.
In computing the fair market value of all the assets of a corporation at
the close of such day, there shall be excluded any amount attributable
to money or property received by it during the one-year period ending on
such day for stock, or as a contribution to capital or as paid-in
surplus, if it appears that there was not a bona fide business purpose
for the transaction in respect of which such money or property was
received.
(k) Related person defined--(1) General. For purposes of paragraphs
(c)(5) and (g)(2) of this section, the following persons are considered
to be related to a shareholder:
(i) If the shareholder is an individual--
(a) His spouse, ancestors, and lineal descendants, and
(b) Any corporation which is controlled by him.
(ii) If the shareholder is a corporation--
(a) A corporation which controls, or is controlled by, such
shareholder, and
(b) If more than 50 percent in value of the outstanding stock of
such shareholder is owned by any person, any corporation more than 50
percent in value of the outstanding stock of which is owned by the same
person.
(2) Control. For purposes of this paragraph, control means the
ownership of stock possessing at least 50 percent of the total combined
voting power of all classes of stock entitled to vote or at least 50
percent of the total value of shares of all classes of stock of the
corporation.
(3) Constructive ownership rules. In determining the ownership of
stock for purposes of this paragraph, the constructive ownership rules
of section 267(c) shall apply, except that the family of an individual
shall include only his spouse, ancestors, and lineal descendants.
(l) [Reserved]
(m) Corporations and shareholders not meeting requirements. In
determining whether the provisions of section 341 (a) through (d) apply
with respect to any corporation, the fact that such corporation, or such
corporation with respect to any of its shareholders, does not meet the
requirements of section 341(e)(1), (2), (3), or (4) shall not be taken
into account, and such determination shall be made as if section 341(e)
had not been enacted.
(n) Determinations without regard to sections 617(d), 1245, 1250,
1251, 1252, and 1254. For purposes of this section, the determination of
whether gain from the sale or exchange of property would under any
provision of chapter 1 of the Code be considered as gain from the sale
or exchange of property which is neither a capital asset nor property
described in section 1231(b) shall be made without regard to the
application of sections 617(d)(1) (relating to gain from dispositions of
certain mining property), 1245(a) and 1250(a) (relating to gain from
dispositions of certain depreciable property), 1251(c) (relating to gain
from the disposition of farm property where farm losses offset nonfarm
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income), 1252(a) (relating to gain from disposition of farm land), and
1254(a) (relating to gain from disposition of interest in natural
resource recapture property).
(o) Illustrations. The operation of section 341(e) may be
illustrated by the following examples:
Example (1). (i) The outstanding stock of X Corporation is actually
owned, on the basis of value, 75 percent by A, 15 percent by B, and 10
percent by C. None of the stock actually owned by one is attributed to
another under the constructive ownership rules of paragraph (a)(3) of
this section. The corporation owns no property which, in its hands, is
property gain from the sale or exchange of which would be considered
(without regard to section 617(d), 1245 or 1250, 1251, or 1252) as gain
from the sale or exchange of property which is neither a capital asset
nor property described in section 1231(b). The corporation owns no
property described in section 1231(b) except an apartment house on which
the unrealized appreciation is $20,000 and which in the hands of A would
be property held primarily for sale to customers in the ordinary course
of trade or business. The corporation owns no property of the type
described in clause (iv) of section 341(e)(5)(A). The net worth of the
corporation is $100,000.
(ii) Although the apartment house in the hands of the corporation is
section 1231(b) property, in the hands of A, a more-than-20-percent
shareholder, the apartment house would be ordinary-income type property.
Therefore, the apartment house is a subsection (e) asset under clause
(iii) of section 341(e)(5)(A). Accordingly, since the net unrealized
appreciation in subsection (e) assets ($20,000) exceeds 15 percent of
net worth ($15,000), the general corporate test is not satisfied and
section 341(e) is unavailable to the corporation or its shareholders.
Example (2). (i) Assume the same facts as in Example (1), except
that in the hands of B, but not in the hands of A or C, the apartment
house would be property held primarily for sale to customers in the
ordinary course of trade or business.
(ii) Since B does not own more than 20 percent in value of the
outstanding stock, the fact that the apartment house owned by the
corporation would, in his hands, be property held primarily for sale to
customers in the ordinary course of trade or business does not make the
apartment house owned by the corporation a subsection (e) asset.
Therefore, since the net unrealized appreciation in subsection (e)
assets (zero) does not exceed 15 percent of net worth, the general
corporate test is satisfied. C may sell his stock to anyone (other than
X Corporation) and will qualify under section 341(e)(1). However, a sale
by A of his stock to persons related to A within the meaning of
paragraph (k) of this section will not so qualify.
(iii) B, however, since he owns more than 5 percent but not more
than 20 percent in value of the outstanding stock, must take into
account not only the net unrealized appreciation in subsection (e)
assets but also the net unrealized appreciation in any other assets of
the corporation which would be subsection (e) assets under section
341(e)(5)(A) if he owned more than 20 percent in value of the
outstanding stock. Therefore, since the apartment house owned by the
corporation would be, in B's hands, property held primarily for sale to
customers in the ordinary course of trade or business, and since the net
unrealized appreciation in such property ($20,000) exceeds 15 percent of
net worth ($15,000), B does not satisfy the specific shareholder test
and therefore cannot avail himself of section 341(e)(1).
Example (3). (i) Assume the same facts as in Example (1), except
that in the hands of B, but not in the hands of A or C, the apartment
house of the corporation would be property held primarily for sale to
customers in the ordinary course of trade or business. Assume further
that the shareholders of X Corporation wish to avail themselves of
section 333.
(ii) For purposes of section 341(e)(3), section 341(e)(5)(A)(iii)
applies in respect of any shareholder who owns more than 5 percent
(instead of more than 20 percent) in value of the outstanding stock.
Since in the hands of B, a more-than-5-percent shareholder, the
apartment house would be held primarily for sale to customers in the
ordinary course of trade or business, the corporation's apartment house
is a subsection (e) asset. Therefore, since the net unrealized
appreciation in subsection (e) assets ($20,000) exceeds 15 percent of
net worth ($15,000), no shareholder of the corporation may qualify under
section 341(e)(3) for use of section 333. However, if B were not a more-
than-5-percent shareholder of the corporation, or if, in his hands, the
apartment house would not be held primarily for sale to customers in the
ordinary course of trade or business, then all shareholders of the
corporation could qualify under section 341(e)(3) for use of section 333
since the apartment house would not be a subsection (e) asset.
Example (4). (i) Assume the same facts as in Example (1), except
that in the hands of no shareholder of the corporation would the
apartment house be deemed property held primarily for sale to customers
in the ordinary course of trade or business (such determination,
however, having been made without regard to A's ownership of stock of
related corporations). Assume further that (a) X Corporation adopts a
plan of complete liquidation, (b) within the 12-month period beginning
on the date of such adoption X Corporation sells substantially all the
property
[[Page 173]]
held by it on such date and distributes all its assets in complete
liquidation, (c) following the adoption of such plan, no distribution is
made of any property which in the hands of the corporation or in the
hands of the distributee is property in respect of which a deduction for
exhaustion, wear and tear, obsolescence, amortization, or depletion is
allowable, and (d) following the adoption of such plan no property is
sold or exchanged to A, to a constructive owner of A's stock, or to a
person ``related'' (within the meaning of paragraph (k) of this section)
to A or such constructive owner.
(ii) Since, under the above-stated facts, the requirements of
section 341(e)(4) are satisfied, section 337(a) will apply to sales or
exchanges of property by the corporation within the 12-month period
beginning on the date of the adoption of the plan of liquidation.
(iii) Any distribution in complete liquidation to B and C, who own
15 and 10 percent, respectively, in value of the outstanding stock, will
qualify under section 341(e)(2) because (a) by reason of the application
of section 341(e)(4), section 337(a) applies to sales or exchanges of
property by the corporation, and (b) at all times within the 12-month
period beginning on the date of the adoption of the plan of complete
liquidation the general corporate test is satisfied and B and C each
satisfy the specific shareholder test of paragraph (e)(1)(iii)(a) of
this section.
(iv) Any distribution in complete liquidation to A, who owns 75
percent in value of the outstanding stock, will qualify under section
341(e)(2) if, at all times within the 12-month period beginning on the
date of the adoption of the plan of complete liquidation, and after
taking into account A's ownership of stock in related corporations in
the manner prescribed in paragraph (d) of this section, A satisfies the
specific shareholder test of paragraph (e)(1)(iii)(b) of this section.
[T.D. 6806, 30 FR 2845, Mar. 5, 1965, as amended by T.D. 7369, 40 FR
29840, July 16, 1975; T.D. 7418, 41 FR 18811, May 7, 1976; T.D. 7728, 45
FR 72650, Nov. 3, 1980; T.D. 8586, 60 FR 2500, Jan. 10, 1995]
Sec. 1.341-7 Certain sales of stock of consenting corporations.
(a) In general. (1) Under section 341(f)(1), if a corporation
consents (in the manner provided in paragraph (b) of this section) to
the application of section 341(f)(2) with respect to dispositions by it
of its subsection (f) assets (as defined in paragraph (g) of this
section), then section 341(a)(1) does not apply to any sales of stock of
such consenting corporation (other than sale to such corporation) made
by any of its shareholders within the 6-month period beginning on the
date on which such consent is filed.
(2) For purposes of section 341(f)(1) and (5)--(i) The term sale
means a sale of exchange of stock at a gain, but only if such gain would
be recognized as long-term capital gain were section 341 not a part of
the Code. Thus, a sale or exchange of stock is not a ``sale'' within the
meaning of section 341(f)(1) and (5) if there is no gain on the
transaction, or if the sale or exchange gives rise to ordinary income
under a provision of the Code other than section 341, or if gain on the
transaction is not recognized under any provisions of subtitle A of the
Code.
(ii) A sale of stock in a corporation does not include any
disposition of such stock by a shareholder, if, by reason of section
341(d)(1), section 341(a) could not have applied to that disposition.
(Under section 341(d)(1), section 341(a) does not apply except to more-
than-5-percent shareholders.) Except as otherwise provided in paragraph
(a)(2)(i) of this section, the term ``sale'' included a disposition of
stock in a corporation by a more-than-5-percent shareholders described
in section 341(d)(1), even though section 341(a) did not apply to the
disposition because the corporation was not collapsible or by reason of
the application of section 341(d)(2), (3), or (e).
(3) A corporation which consents to the application of section
341(f)(2) does not thereby become noncollapsible, and the fact that a
corporation consents to the application of section 341(f)(2) does not
affect the determination as to whether it is a collapsible corporation.
(4) For limitation on the application of section 341(f)(1) see
section 341(f)(5) and (6) and paragraphs (h) and (j) of this section.
(b) Statement of consent. (1) The consent of a corporation referred
to in paragraph (a)(1) or (j)(1) of this section shall be given by means
of a statement, signed by any officer who is duly authorized to act on
behalf of the consenting corporation stating that the corporation
consents to have the provisions of section 341(f)(2) apply to any
disposition by it of its subsection (f) assets. The statement shall be
filed with the district director having jurisdiction over the income tax
return of the
[[Page 174]]
consenting corporation for the taxable year during which the statement
is filed.
(2)(i) The statement shall contain the name, address, and employer
identification number of any corporation 5 percent or more in value of
the outstanding stock of which is owned directly by the consenting
corporation, and of any other corporation connected to the consenting
corporation through a chain of stock ownership described in paragraph
(j)(4) of this section. The statement shall also indicate where such 5-
percent-or-more corporation (or such ``connected'' corporation) has
consented within the 6-month period ending on the date on which the
statement filed to the application of section 341 (f)(2) with respect to
any dispositions of its subsection (f) assets (see paragraph (j) of this
section), and, if so, the district director with whom such consent was
filed and the date on which such consent was filed.
(ii) If, during the 6-month period beginning on the date on which
the statement is filed, the consenting corporation becomes the owner of
5 percent or more in value of the outstanding stock of another
corporation or becomes connected to another corporation through a chain
of stock ownership described in paragraph (j)(4) of this section, then
the consenting corporation shall, within 5 days after such occurrence,
notify the district director with whom it filed the statement of the
name, address and employer identification number of such corporation.
(3) A consent under section 341(f)(1) may be filed at any time and
there is no limit as to the number of such consents that may be filed.
If a consent is filed by a corporation under section 341(f)(1) and if a
shareholder sells stock (i) in such corporation, or (ii) in another
corporation a sale of whose stock is treated under section 341(f)(6) as
a sale of stock in such corporation, at any time during the applicable
6-month period, then the consent cannot thereafter be revoked or
withdrawn by the corporation. However, a consent may be revoked or
withdrawn at any time prior to a sale during the applicable 6-month
period. If no sale is made during such period, the consent will have no
effect on the corporation. See paragraph (g) of this section.
(c) Consenting corporation. (1) A consenting corporation at the time
that is filed a consent under section 341(f)(10) shall notify its
shareholders that such consent is being filed. In addition, the
consenting corporation shall, at the request of any shareholder,
promptly supply the shareholder with a copy of the consent.
(2) A consenting corporation shall maintain records adequate to
permit identification of its subsection (F) assets.
(d) Shareholders of consenting corporation. (1) A shareholder who
sells stock in a consenting corporation within the 6-month period
beginning on the date on which the consent is filed shall--
(i) Notify the corporation, within 5 days after such sale, of the
date on which such sale is made, and
(ii) Attach a copy of the corporation's consent to the shareholder's
income tax return for the taxable year in which the sale is made.
(2) If the sale of stock in a consenting corporation is treated
under section 341(f)(6) as the sale of stock in any other corporation,
the consenting corporation shall notify such other corporation, within 5
days after receiving notification of a sale of its stock, of the date on
which such sale was made.
(e) Recognition of gain under section 341(f)(2). (1) Under section
341(f)(2), if a subsection (f) asset (as defined in paragraph (g) of
this section) is disposed of any time by a consenting corporation, then,
except as provided in section 341(f)(3) and paragraph (f) of this
section, the amount by which--
(i) The amount realized (in the case of a sale, exchange, or
involuntary conversion), or
(ii) The fair market value of such asset (in the case of any other
disposition), exceeds the adjusted base of such asset is treated as gain
from the sale of exchange of such asset. Such gain is recognized
notwithstanding any contrary non-recognition provisions of subtitle A of
the Code, but only to the extent such gain is not recognized under any
other provisions of subtitle A of the Code (for example, section 1245
(a)(1) or 1250(a)). Gain recognized under
[[Page 175]]
section 341(f)(2) with respect to a disposition of a subsection (f)
asset has the same character (i.e., ordinary income or capital gain)
that such gain would have if it arose from a sale of such asset.
(2) The nonrecognition provisions of subtitle A of the Code which
section 341(f)(2) override include, but are not limited to, sections
311(a), 332(c), 336, 337, 351, 361, 371(a), 374(a), 721, 1031, 1033,
1071, and 1081.
(3) In the case of a foreign corporation which files a statement of
consent pursuant to paragraph (b) of this section, such statement, in
addition to the information required in paragraph (b) of this section,
shall also contain a declaration that the corporation consents that any
gain upon the disposition of a subsection (f) asset which would
otherwise be recognized under section 341(f)(2) will, for purposes of
section 882(a)(2), be considered as gross income which is effectively
connected with the conduct of a trade or business which is conducted
through a permanent establishment within the United States.
(4) The provisions of subparagraphs (1) and (2) of this paragraph
may be illustrated by the following examples:
Example (1). Corporation X, a consenting corporation, distributes a
subsection (f) asset to its shareholders in complete or partial
liquidation of the corporation. The asset, at the line of the
distribution, is held by the corporation primarily for sale to customers
in the ordinary course of business and has an adjusted basis of $1,000
and a fair market value of $2,000. Under section 341(f)(2), the excess
of the fair market value of the asset over its adjusted basis, or $1,000
is treated as ordinary income. Assuming the gain is not recognized by
corporation X under another provision of the Code, corporation X
recognizes the $1,000 gain as ordinary income under section 341(f)(2)
even though, in the absence of section 341(f)(2), section 336 would
preclude the recognition of such gain.
Example (2). Corporation Y, a consenting corporation, distributes a
subsection (f) asset to its shareholders as a dividend. The asset at the
time of the distribution is properly described in section 1231 and has
an adjusted basis of $6,000 and a fair market value of $8,000. Assuming
that no other section of the Code would require recognition of gain,
under section 341(f)(2) the excess of the fair market value of the asset
over its adjusted basis, or $2,000, is recognized by corporation Y as
gain from the sale or exchange of property described in section 1231
even though, in the absence of section 341(f)(2), section 311(a) would
preclude the recognition of such gain.
Example (3). Assume the same facts as in Example (2) except that the
subsection (f) asset is section 1245 property having a ``recomputed
basis'' (as defined in section 1245(a)(2)) or $7,200. Since the
recomputed basis of the asset is lower than its fair market value, the
excess of the recomputed basis over the adjusted basis, or $1,200, is
recognized as ordinary income under section 1245(a)(1). The remaining
amount, or $800, is recognized under section 341(f)(2) as gain from the
sale or exchange or property described in section 1231.
(5) The provisions of section 341(f)(2) apply whether or not (i) on
the date on which a consent is filed or at any time thereafter, the
consenting corporation was in fact a collapsible corporation within the
meaning of section 341(b), or (ii) on the date of any sale of stock of
the consenting corporation, the purchaser of such stock was aware that a
consent had been filed under section 341(f)(1) within the 6-month period
ending on the date of such sale.
(6) Section 341(f)(2) does not apply to losses. Thus, section
341(f)(2) does not apply if a loss is realized upon a sale, exahnger or
involuntary conversion of a subsection (f) asset nor does the section
appy to a disposition other than by way of sale, exchange, or
involuntary conversion if at the time of the disposition the fair market
value of such property is not greater than its adjusted basis.
(7) For purposes of this paragraph, the term ``disposition''
includes an abandonment or retirement, a gift, a sale in a sale-and-
leasback transaction, and a transfer upon the foreclosure of a security
interest. Such term, however, does not include a mere transfer of title
to a creditor upon creation of a security interest or to a debtor upon
termination of a security interest. Thus, for example, a disposition
occurs upon a sale of property prusuant to a conditional sales contract
even though the seller retains legal title to the propoerty for purposes
of security, but a disposition does not occur when the seller ultimately
gives up his security interest following payment by the purchaser.
(8) The amount of gain required to be recognized by section
341(f)(2) shall be
[[Page 176]]
determined separately for each subsection (f) asset disposed of by the
corporation. For purposes of applying section 341(f)(2), the facts and
circumstances of each disposition shall be considered in determining
whether the transactions involves more than one subsection (f) asset or
involves both subsection (f) and nonsubsection (f) assets. In
appropriate cases, several subsection (f) assets may be treated as a
single asset as long as it is reasonably clear, from the best estimates
obtainable on the basis of all the facts and circumstances, that the
amount of gain required to be recognized by section 341(f)(2) is not
less than the total gain under section 341(f)(2) whish would be computed
separately for each subsection (f) asset.
(9) In the case of a sale, exchange, or involuntary conversion of a
subsection (f) asset and a nonsubsection (f) asset in one transaction,
the total amount realized upon the disposition shall be allocated
between the subsection (f) asset any arm's length agreement between the
buyer and the seller will establish the allocation. In the absence of
such an agreement, the allocation shall be made by taking into account
the appropriate facts and circumstances. Some of the facts and
circumstances which shall be taken into account to the extent
appropriate included, but are not limited to, a comparision between the
subsection (f) asset and all property disposed of in such transaction of
(i) the original costs and reproduction costs of construction, erection,
or production, (ii) the remaining economic useful life, (ii) state of
obsolencence, and (iv) anticipated expenditures to maintain, renovate,
or modernize.
(10) See Sec. 1.1502-13 for the treatment of gain recognized upon a
distribution other than in complete liquidation made by one member of a
group which files a consolidated return to another such members.
(f) Exception for certain tax-free transactions. (1) Under section
341(f)(3), no gain is taken into account under section 341(f)(2) by a
transferor corporation on the transfer of a subsection (f) asset to
another corporation (other than a corporation exempt from tax imposed by
chapter 1 of the Code) if--
(i) The basis of such asset in the hands of the transferee
corporation is determined by reference to its basis in the hands of the
transferor by reason of the application of section 332 (relating to
distributions in liquidation of an 80-percent-or-more controlled
subsidairy corporation), section 351 (relating to transfers to a
corporation controlled by the transferor), section 361 (relating to
exchanges pursuant to certain reorganizations), section 371(a) (relating
to exchanges pursuant to certain receivership and bankruptcy
proceedings), or section 374 (a) (relating to exchanges pursuant to
certain railroad reorganizations), and
(ii) The transferee corporation agrees (as provided in subparagraph
(3) of this paragraph) to have the provisiions of section 341(f)(2)
apply to any disposition by it of such asset.
(2) The provisions of subparagraph (1) of this paragraph may be
illustrated by the following examples:
Example (1). Corporation M. in exchange for its voting stock worth
$20,000 and $1,000 in cash, acquires the entire property of corporation
N (an unencumbered apartment building) in a transaction which is
described in section 368(a)(2)(B) and which, therefore, qualifies as a
reorganization under section 368(a)(1)(C). The apartment building, which
in the hands of corporation N. a consenting corporation, is a subsection
(f) asset, has an adjusted basis of $15,000 and a fair market value of
$21,000. The basis of the apartment house in the hands of corporation M
is determined by reference to its basis in the hands of corporation N by
reason of the application of section 361. Thus, under section 341(f)(3),
if corporation M agrees to have the provisions of section 341(f)(2)
apply to any disposition by it of the apartment house, then corporation
N will recognize no gain under section 341(f)(2) but will recognize
$1,000 gain under section 361(b) (assuming the cash it receives is not
distributed in pursuance of the plan of reorganization). However, if
corporation M does not so agree, the gain recognized by corporation N
will be $6,000, that is, the gain of $1,000 recognized under section
361(b) plus $5,000 gain recognized under section 341(f)(2). In either
case, if section 1245, 1250, or 1251 applies, some or all of the gain
may be recognized under sections in lieu of sections 341(f)(2) and
361(b).
Example (2). Corporation Y, a consenting corporation, is a wholly
owned subsidiary of corporation X. In the complete liquidation of Y it
distributes to X a subsection (f) asset which is section 1245 property.
The asset at the time of the distribution has an adjusted
[[Page 177]]
basis of $10,000, a recomputed basis of $14,000, and a fair market value
of $10,000. The basis of the asset in the hands of X is determined by
reference to its basis in the hands of corporation Y by reason of the
application of section 332. Thus, under section 341(f)(3), if
corporation X agrees to have the provisions of section 341(f)(2) apply
to any disposition by it of the subsection (f) asset, then Y will
recognize no gain under section 341(f)(2) and will recognize no gain
under section 1245(a)(1) by reason of the application of section
1245(b)(3). Under section 334(b)(1), the basis of the subsection (f)
asset to corporation X will be the same as it would be in the hands of
Y, or $10,000. However, if corporation X does not so agree, then under
section 341(f)(2) $6,000 (the excess of the fair market value of the
asset over its adjusted basis) will be treated as gain from the sale or
exchange of the asset. Moreover, under section 1245(a)(1) $4,000 (the
excess of the recomputed basis over the adjusted basis) of the $6,000
will be recognized as ordinary income. The basis of the asset to
corporation X is $16,000, i.e., the same as it would be in the hands of
Y ($10,000) increased in the amount of gain recognized by Y on the
distribution ($6,000).
(3) The agreement of a transferee corporation referred to in
subparagraph (1) of this paragraph shall be filed, on or before the date
on which the subsection (f) assets are transferred, with the district
director having jurisdiction over its income tax return for the taxable
year during which the transfer is to be made. The agreement shall be
signed by any officer who is duly authorized to act on behalf of the
transferee corporation (if the transaxtion is one to which section
371(a) or 374(a) applies, the fiduciary for the transferee corporation,
in appropriate cases, may sign the agreement) and shall apply to all the
subsection (f) assets to be transferred pursuant to the applicable
transaction described in section 341(f)(3). The agreement shall identify
the transaction by which the subsection (f) assets will be acquired,
including the names, addresses, and employer identification numbers of
the transferor and transferee corporations, and shall contain a schedule
of the subsection (f) assets to be acquired. The agreement shall also
state that the transferee corporation (i) agrees to have the provisions
of section 341(f)(2) apply to any disposition by it of the subsection
(f) assets acquired, and (ii) agrees to maintain records adequate to
permit identification of such subsection (f) assets.
(4) The transferor corporation shall attach a copy of the agreement
to its income tax return for the taxable year in which the subsection
(f) assets are transferred.
(g) Subsection (f) asset defined. (1) Under section 341(f)(4), a
subsection (f) asset is any property which, as of the date of any sale
of stock to which paragraph (a) or (j)(3) of this section applies, is
not a capital asset and is property owned by, or subject to a binding
contract or an option to acquire held by, the consenting corporation.
Land or any interest in real property (other than a security interest)
is treated as property which is not a capital asset. Also, unrealized
receivables or fees (as defined in section 341(b)(4)) are treated as
property which are not capital assets.
(2) If, with respect to any property described in subparagraph (1)
of this paragraph, manufacture, construction, or production has been
commenced by either the consenting corporation or another person before
any date of sale of stock described in subparagraph (1) of this
paragraph, a consenting corporation's subsection (f) assets include any
property resulting from such manufacture, construction, or production.
Thus, for example, if, on the date of any sale of stock within the 6-
month period, manufacture, construction, or production has been
commended on a tract of land to be used for residential housing or on a
television series, the term ``subsection (f) asset'' includes the
residential homes of the television tapes resulting from such
manufacture, construction, or production by the consenting corporation
(or by a transferee corporation which has agreed to the application of
section 341(f)(2)). If land or any interest in real property (other than
a security interest) is owned or held under an option by the consenting
corporation on the date of any sale of stock described in subparagraph
(1) of this paragraph, the term ``subsection (f) asset'' includes any
improvements resulting from construction with respect to such property
(by the consenting corporation or by a transferee corporation which has
agreed to the application of section 341(f)(2)) if such
[[Page 178]]
construction is commenced within 2 years after the date of any such
sale. The property or improvements resulting from any manufacture,
construction, or production is a question to be determined on the basis
of the particular facts and circumstances of each individual case. Thus,
for example, a building which is a part of an integrated project is a
subsection (f) asset if construction of the project commenced before the
date of sale or within 2 years thereafter even if construction of the
building commenced more than 2 years thereafter. Similarly a television
tape which is part of a series is a subsection (i) asset if production
of the series was commenced on the date of sale even if production of
the tape commenced after the sale.
(3) The provisions of subparagraphs (1) and (2) of this paragraph
may be illustrated by the following examples:
Example (1). Corporation X files a consent to the application of
section 341(f)(2) on January 1, 1985. Shareholder A owns 100 percent of
the outstanding stock of the consenting corporation on January 1, 1965,
and sells 5 percent of the stock on January 2, 1965, 10 percent on
February 10, 1963, and 1 percent on May 1, 1965. No other sales of X
stock were made during the 6-month period beginning on January 1, 1965.
On such date X owns an apartment building and on March 1 X purchases an
office building. X's subsection (f) assets include the apartment
building owned on January 1 and the office building purchased on March
1.
Example (2). Assume the same facts as in Example (1) except that on
January 1, 1965, X also owns a tract of raw land. On April 1, 1965,
construction of a residential housing project is commenced on the tract
of land. Corporation X's subsection (i) assets will include the tract of
land plus the resulting improvements to the land. This result would not
be changed if construction of the residential housing project were not
commenced until July 1, 1966, since the construction would have been
commenced within 2 years after May 1, 1965.
Example (3). Corporation X files a consent to the application of
section 341(f)(2) on January 1, 1965. Shareholder B owns 100 percent of
the outstanding stock of the consenting corporation on January 1, 1965,
and sells 10 percent of the stock on June 1, 1965. On April 1, 1965, Y
acquires an option to purchase a motion picture when completed. On May
1, 1965, production is started on the motion picture. On February 1,
1967, production is completed, and Y exercises its option. Y holds the
option and the motion picture for use in its trade or business. Y's
subsection (f) assets initially include the option and ultimately
include the motion picture. However the exercise of the option is not a
disposition of the option within the meaning of section 341(f)(2).
(h) Five-year limitation as to shareholder. Under section 341(f)(5),
section 341(f)(1) does not apply to the sale of stock of a consenting
corporation if, during the 5-year period ending on the date of such
sale, such shareholder (or any person related to such shareholder within
the meaning of section 341(e)(8)(A)) made a sale (as defined in
paragraph (a)(2) of this section) of any stock of another consenting
corporation within any 6-month period beginning on a date on which a
consent was filed under section 341(f)(1) by such other corporation.
Section 341(f)(5) does not prevent a shareholder of a consenting
corporation from receiving the benefit of section 341(f)(1) on the sale
of additional shares of the stock of the same consenting corporation.
(i) [Reserved]
(j) Special rule for stock ownership in other corporations--(1)
Section 341(f)(6) provides a special rule applicable to a consenting
corporation which owns 5 percent or more in value of the outstanding
stock of another corporation. In such a case, a consent filed by the
consenting corporation shall not be valid with respect to a sale of its
stock during the applicable 6-month period unless each corporation, 5
percent or more in value of the outstanding stock of which is owned by
the consenting corporation on the date of such sale, file (within the 6-
month period ending on the date of such sale) a valid consent under
section 341(f)(1) with respect to sales of its own stock.
(2) The provisions of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example: Corporation X files a consent under section 341(f)(1) on
November 1, 1965. On January 1, 1966, the date on which a shareholder of
corporation X sells stock of X. X owns 80 percent in value of the
outstanding stock of corporation Y. In order for the consent filed by
corporation X to be valid with respect to the sale of its stock on
January 1, 1966, corporation Y must have filed, during the 6-month
period ending on January 1, 1966, a valid consent under section
341(f)(1) with respect to sales of its stock.
[[Page 179]]
(3) For purposes of applying section 341(f)(4) (relating to the
definition of a subsection (f) asset) to a corporation 5 percent or more
in value of the outstanding stock of which is owned by the consenting
corporation, a sale of stock of the consenting corporation to which
section 341(f)(1) applies shall be treated as a sale of stock of such
other corporation. Thus, in the example in subparagraph (2) of this
paragraph, the subsection (f) assets of corporation Y would include
property described in section 341(f)(4) owned by or held under an option
by corporation Y on January 1, 1966.
(4) In the case of a chain of corporations connected by the 5-
percent ownership requirement described in subparagraph (1) of this
paragraph, rules similar to the rules described in subparagraphs (2) and
(3) of this paragraph shall apply. Thus, in the example in subparagraph
(2) of this paragraph, if corporation Y owned 5 percent or more of the
stock of corporation Z on January 1, 1966, then Z must have filed a
valid consent during the 6-month period ending January 1, 1966, in order
for the consent filed by X to be valid with respect to the sale of its
stock on January 1, 1966. In such case any of stock of either X or Y is
treated as a sale of stock of Z for purposes of applying section
341(f)(4) to Z.
(5) If a corporation is a member of an affiliated group (as defined
in section 1504(a)) that files a consolidated return, a corporation will
be considered to have filed a consent if a consent is filed on its
behalf by the common parent under Sec. 1.1502-77(a).
(k) Effective date. Paragraphs (b), (c), (e)(3), and (f)(3) of this
section apply only with respect to statements and notifications filed
more than 30 days after July 6, 1977. Paragraph (d) applies only with
respect to sales of stock made more than 30 days after July 6, 1977. All
other provisions of this section appy with respect to transactions after
August 22, 1964.
[T.D. 7655, 44 FR 68460, Nov. 29, 1979; 45 FR 17982, Mar. 20, 1980; 45
FR 20464, Mar. 28, 1980; T.D. 8597, 60 FR 36679, July 18, 1995]
Sec. 1.342-1 General.
The determination of whether a foreign corporation was a foreign
personal holding company with respect to a taxable year beginning on or
before, and ending after August 26, 1937, shall be made under section
331 of the Revenue Act of 1936 (50 Stat. 818) and the regulations
thereunder. For the purpose of section 342(a), a liquidation may be
completed before the actual dissolution of the liquidating corporation.
However, no liquidation shall be considered as completed until the
liquidating corporation and the receiver (or trustees in liquidation)
are finally divested of all the property, whether tangible or
intangible.
definition
Sec. 1.346-1 Partial liquidation.
(a) General. This section defines a partial liquidation. If amounts
are distributed in partial liquidation such amounts are treated under
section 331(a)(2) as received in part or full payment in exchange for
the stock. A distribution is treated as in partial liquidation of a
corporation if:
(1) The distribution is one of a series of distributions in
redemption of all of the stock of the corporation pursuant to a plan of
complete liquidation, or
(2) The distribution:
(i) Is not essentially equivalent to a dividend,
(ii) Is in redemption of a part of the stock of the corporation
pursuant to a plan, and
(iii) Occurs within the taxable year in which the plan is adopted or
within the succeeding taxable year.
An example of a distribution which will qualify as a partial liquidation
under subparagraph (2) of this paragraph and section 346(a) is a
distribution resulting from a genuine contraction of the corporate
business such as the distribution of unused insurance proceeds recovered
as a result of a fire which destroyed part of the business causing a
cessation of a part of its activities. On the other hand, the
distribution of funds attributable to a reserve for an expansion program
which has been abandoned does not qualify as a partial liquidation
within the meaning of section 346(a). A distribution to which section
355 applies (or so much of section 356 as relates to section 355) is not
a
[[Page 180]]
distribution in partial liquidation within the meaning of section
346(a).
(b) Special requirements on termination of business. A distribution
which occurs within the taxable year in which the plan is adopted or
within the succeeding taxable year and which meets the requirements of
subsection (b) of section 346 falls within paragraph (a)(2) of this
section and within section 346(a)(2). The requirements which a
distribution must meet to fall within subsection (b) of section 346 are:
(1) Such distribution is attributable to the corporation's ceasing
to conduct, or consists of assets of, a trade or business which has been
actively conducted throughout the five-year period immediately before
the distribution, which trade or business was not acquired by the
corporation within such period in a transaction in which gain or loss
was recognized in whole or in part, and
(2) Immediately after such distribution by the corporation it is
actively engaged in the conduct of a trade or business, which trade or
business was actively conducted throughout the five-year period ending
on the date of such distribution and was not acquired by the corporation
within such period in a transaction in which gain or loss was recognized
in whole or in part.
A distribution shall be treated as having been made in partial
liquidation pursuant to section 346(b) if it consists of the proceeds of
the sale of the assets of a trade or business which has been actively
conducted for the five-year period and has been terminated, or if it is
a distribution in kind of the assets of such a business, or if it is a
distribution in kind of some of the assets of such a business and of the
proceeds of the sale of the remainder of the assets of such a business.
In general, a distribution which will qualify under section 346(b) may
consist of, but is not limited to:
(i) Assets (other than inventory or property described in
subdivision (ii) of this subparagraph) used in the trade or business
throughout the five-year period immediately before the distribution (for
this purpose an asset shall be considered used in the trade or business
during the period of time the asset which it replaced was so used), or
(ii) Proceeds from the sale of assets described in subdivision (i)
of this subparagraph, and, in addition,
(iii) The inventory of such trade or business or property held
primarily for sale to customers in the ordinary course of business, if:
(a) The items constituting such inventory or such property were
substantially similar to the items constituting such inventory or
property during the five-year period immediately before the
distribution, and
(b) The quantity of such items on the date of distribution was not
substantially in excess of the quantity of similar items regularly on
hand in the conduct of such business during such five-year period, or
(iv) Proceeds from the sale of inventory or property described in
subdivision (iii) of this subparagraph, if such inventory or property is
sold in bulk in the course of termination of such trade or business and
if with respect to such inventory the conditions of subdivision (iii)(a)
and (b) of this subparagraph would have been met had such inventory or
property been distributed on the date of such sale.
(c) Active conduct of a trade or business. For the purpose of
section 346(b)(1), a corporation shall be deemed to have actively
conducted a trade or business immediately before the distribution, if:
(1) In the case of a business the assets of which have been
distributed in kind, the business was operated by such corporation until
the date of distribution, or
(2) In the case of a business the proceeds of the sale of the assets
of which are distributed, such business was actively conducted until the
date of sale and the proceeds of such sale were distributed as soon
thereafter as reasonably possible.
The term active conduct of a trade or business shall have the same
meaning in this section as in paragraph (c) of Sec. 1.355-1.
Sec. 1.346-2 Treatment of certain redemptions.
If a distribution in a redemption of stock qualifies as a
distribution in part or full payment in exchange for the stock under
both section 302(a) and this
[[Page 181]]
section, then only this section shall be applicable. None of the
limitations of section 302 shall be applicable to such redemption.
Sec. 1.346-3 Effect of certain sales.
The determination of whether assets sold in connection with a
partial liquidation are sold by the distributing corporation or by the
shareholder is a question of fact to be determined under the facts and
circumstances of each case.
Corporate Organizations and Reorganizations
corporate organizations
Sec. 1.351-1 Transfer to corporation controlled by transferor.
(a)(1) Section 351(a) provides, in general, for the nonrecognition
of gain or loss upon the transfer by one or more persons of property to
a corporation solely in exchange for stock or securities in such
corporation, if immediately after the exchange, such person or persons
are in control of the corporation to which the property was transferred.
As used in section 351, the phrase ``one or more persons'' includes
individuals, trusts, estates, partnerships, associations, companies, or
corporations (see section 7701(a)(1)). To be in control of the
transferee corporation, such person or persons must own immediately
after the transfer stock possessing at least 80 percent of the total
combined voting power of all classes of stock entitled to vote and at
least 80 percent of the total number of shares of all other classes of
stock of such corporation (see section 368(c)). In determining control
under this section, the fact that any corporate transferor distributes
part or all of the stock which it receives in the exchange to its
shareholders shall not be taken into account. The phrase ``immediately
after the exchange'' does not necessarily require simultaneous exchanges
by two or more persons, but comprehends a situation where the rights of
the parties have been previously defined and the execution of the
agreement proceeds with an expedition consistent with orderly procedure.
For purposes of this section--
(i) Stock or securities issued for services rendered or to be
rendered to or for the benefit of the issuing corporation will not be
treated as having been issued in return for property, and
(ii) Stock or securities issued for property which is of relatively
small value in comparison to the value of the stock and securities
already owned (or to be received for services) by the person who
transferred such property, shall not be treated as having been issued in
return for property if the primary purpose of the transfer is to qualify
under this section the exchanges of property by other persons
transferring property.
For the purpose of section 351, stock rights or stock warrants are not
included in the term ``stock or securities.''
(2) The application of section 351(a) is illustrated by the
following examples:
Example (1). C owns a patent right worth $25,000 and D owns a
manufacturing plant worth $75,000. C and D organize the R Corporation
with an authorized capital stock of $100,000. C transfers his patent
right to the R Corporation for $25,000 of its stock and D transfers his
plant to the new corporation for $75,000 of its stock. No gain or loss
to C or D is recognized.
Example (2). B owns certain real estate which cost him $50,000 in
1930, but which has a fair market value of $200,000 in 1955. He
transfers the property to the N Corporation in 1955 for 78 percent of
each class of stock of the corporation having a fair market value of
$200,000, the remaining 22 percent of the stock of the corporation
having been issued by the corporation in 1940 to other persons for cash.
B realized a taxable gain of $150,000 on this transaction.
Example (3). E, an individual, owns property with a basis of $10,000
but which has a fair market value of $18,000. E also had rendered
services valued at $2,000 to Corporation F. Corporation F has
outstanding 100 shares of common stock all of which are held by G.
Corporation F issues 400 shares of its common stock (having a fair
market value of $20,000) to E in exchange for his property worth $18,000
and in compensation for the services he has rendered worth $2,000. Since
immediately after the transaction, E owns 80 percent of the outstanding
stock of Corporation F, no gain is recognized upon the exchange of the
property for the stock. However, E realized $2,000 of ordinary income as
compensation for services rendered to Corporation F.
(3) Underwritings of stock--(i) In general. For the purpose of
section 351, if a
[[Page 182]]
person acquires stock of a corporation from an underwriter in exchange
for cash in a qualified underwriting transaction, the person who
acquires stock from the underwriter is treated as transferring cash
directly to the corporation in exchange for stock of the corporation and
the underwriter is disregarded. A qualified underwriting transaction is
a transaction in which a corporation issues stock for cash in an
underwriting in which either the underwriter is an agent of the
corporation or the underwriter's ownership of the stock is transitory.
(ii) Effective date. This paragraph (a)(3) is effective for
qualified underwriting transactions occurring on or after May 1, 1996.
(b)(1) Where property is transferred to a corporation by two or more
persons in exchange for stock or securities, as described in paragraph
(a) of this section, it is not required that the stock and securities
received by each be substantially in proportion to his interest in the
property immediately prior to the transfer. However, where the stock and
securities received are received in disproportion to such interest, the
entire transaction will be given tax effect in accordance with its true
nature, and in appropriate cases the transaction may be treated as if
the stock and securities had first been received in proportion and then
some of such stock and securities had been used to make gifts (section
2501 and following), to pay compensation (section 61(a)(1)), or to
satisfy obligations of the transferor of any kind.
(2) The application of paragraph (b)(1) of this section may be
illustrated as follows:
Example (1). Individuals A and B, father and son, organize a
corporation with 100 shares of common stock to which A transfers
property worth $8,000 in exchange for 20 shares of stock, and B
transfers property worth $2,000 in exchange for 80 shares of stock. No
gain or loss will be recognized under section 351. However, if it is
determined that A in fact made a gift to B, such gift will be subject to
tax under section 2501 and following. Similarly, if B had rendered
services to A (such services having no relation to the assets
transferred or to the business of the corporation) and the disproportion
in the amount of stock received constituted the payment of compensation
by A to B, B will be taxable upon the fair market value of the 60 shares
of stock received as compensation for services rendered, and A will
realize gain or loss upon the difference between the basis to him of the
60 shares and their fair market value at the time of the exchange.
Example (2). Individuals C and D each transferred, to a newly
organized corporation, property having a fair market value of $4,500 in
exchange for the issuance by the corporation of 45 shares of its capital
stock to each transferor. At the same time, the corporation issued to E,
an individual, 10 shares of its capital stock in payment for
organizational and promotional services rendered by E for the benefit of
the corporation. E transferred no property to the corporation. C and D
were under no obligation to pay for E's services. No gain or loss is
recognized to C or D. E received compensation taxable as ordinary income
to the extent of the fair market value of the 10 shares of stock
received by him.
(c)(1) The general rule of section 351 does not apply, and
consequently gain or loss will be recognized, where property is
transferred to an investment company after June 30, 1967. A transfer of
property after June 30, 1967, will be considered to be a transfer to an
investment company if--
(i) The transfer results, directly or indirectly, in diversification
of the transferors' interests, and
(ii) The transferee is (a) a regulated investment company, (b) a
real estate investment trust, or (c) a corporation more than 80 percent
of the value of whose assets (excluding cash and nonconvertible debt
obligations from consideration) are held for investment and are readily
marketable stocks or securities, or interests in regulated investment
companies or real estate investment trusts.
(2) The determination of whether a corporation is an investment
company shall ordinarily be made by reference to the circumstances in
existence immediately after the transfer in question. However, where
circumstances change thereafter pursuant to a plan in existence at the
time of the transfer, this determination shall be made by reference to
the later circumstances.
(3) Stocks and securities will be considered readily marketable if
(and only if) they are part of a class of stock or
[[Page 183]]
securities which is traded on a securities exchange or traded or quoted
regularly in the over-the-counter market. For purposes of subparagraph
(1)(ii)(c) of this paragraph, the term ``readily marketable stocks or
securities'' includes convertible debentures, convertible preferred
stock, warrants, and other stock rights if the stock for which they may
be converted or exchanged is readily marketable. Stocks and securities
will be considered to be held for investment unless they are (i) held
primarily for sale to customers in the ordinary course of business, or
(ii) used in the trade or business of banking, insurance, brokerage, or
a similar trade or business.
(4) In making the determination required under subparagraph
(1)(ii)(c) of this paragraph, stock and securities in subsidiary
corporations shall be disregarded and the parent corporation shall be
deemed to own its ratable share of its subsidiaries' assets. A
corporation shall be considered a subsidiary if the parent owns 50
percent or more of (i) the combined voting power of all classes of stock
entitled to vote, or (ii) the total value of shares of all classes of
stock outstanding.
(5) A transfer ordinarily results in the diversification of the
transferors' interests if two or more persons transfer nonidentical
assets to a corporation in the exchange. For this purpose, if any
transaction involves one or more transfers of nonidentical assets which,
taken in the aggregate, constitute an insignificant portion of the total
value of assets transfered, such transfers shall be disregarded in
determining whether diversification has occurred. If there is only one
transferor (or two or more transferors of identical assets) to a newly
organized corporation, the transfer will generally be treated as not
resulting in diversification. If a transfer is part of a plan to achieve
diversification without recognition of gain, such as a plan which
contemplates a subsequent transfer, however delayed, of the corporate
assets (or of the stock or securities received in the earlier exchange)
to an investment company in a transaction purporting to qualify for
nonrecognition treatment, the original transfer will be treated as
resulting in diversification.
(6)(i) For purposes of paragraph (c)(5) of this section, a transfer
of stocks and securities will not be treated as resulting in a
diversification of the transferors' interests if each transferor
transfers a diversified portfolio of stocks and securities. For purposes
of this paragraph(c)(6), a portfolio of stocks and securities is
diversified if it satisfies the 25 and 50-percent tests of section
368(a)(2)(F)(ii), applying the relevant provisions of section
368(a)(2)(F). However, Government securities are included in total
assets for purposes of the denominator of the 25 and 50-percent tests
(unless the Government securities are acquired to meet the 25 and 50-
percent tests), but are not treated as securities of an issuer for
purposes of the numerator of the 25 and 50-percent tests.
(ii) Paragraph (c)(6)(i) of this section is effective for transfers
completed on or after May 2, 1996. Transfers of diversified (within the
meaning of paragraph (c)(6)(i) of this section), but nonidentical,
portfolios of stocks and securities completed before May 2, 1996, may be
treated either--
(A) Consistent with paragraph (c)(6)(i) of this section; or
(B) As resulting in diversification of the transferors' interests.
(7) The application of subparagraph (5) of this paragraph may be
illustrated as follows:
Example (1). Individuals A, B, and C organize a corporation with 101
shares of common stock. A and B each transfers to it $10,000 worth of
the only class of stock of corporation X, listed on the New York Stock
Exchange, in exchange for 50 shares of stock. C transfers $200 worth of
readily marketable securities in corporation Y for one share of stock.
In determining whether or not diversification has occurred, C's
participation in the transaction will be disregarded. There is,
therefore, no diversification, and gain or loss will not be recognized.
Example (2). A, together with 50 other transferors, organizes a
corporation with 100 shares of stock. A transfers $10,000 worth of stock
in corporation X, listed on the New York Stock Exchange, in exchange for
50 shares of stock. Each of the other 50 transferors transfers $200
worth of readily marketable securities in corporations other than X
[[Page 184]]
in exchange for one share of stock. In determining whether or not
diversification has occurred, all transfers will be taken into account.
Therefore, diversification is present, and gain or loss will be
recognized.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6942, 32 FR
20977, Dec. 29, 1967; T.D. 8665, 61 FR 19189, May 1, 1996; T.D. 8663, 61
FR 19545, May 2, 1996]
Sec. 1.351-2 Receipt of property.
(a) If an exchange would be within the provisions of section 351(a)
if it were not for the fact that the property received in exchange
consists not only of property permitted by such subsection to be
received without the recognition of gain, but also of other property or
money, then the gain, if any, to the recipient shall be recognized, but
in an amount not in excess of the sum of such money and the fair market
value of such other property. No loss to the recipient shall be
recognized.
(b) See section 357 and the regulations pertaining to that section
for applicable rules as to the treatment of liabilities as ``other
property'' in cases subject to section 351, where another party to the
exchange assumes a liability, or acquires property subject to a
liability.
(c) See sections 358 and 362 and the regulations pertaining to those
sections for applicable rules with respect to the determination of the
basis of stock, securities, or other property received in exchanges
subject to section 351.
(d) See part I (section 301 and following), subchapter C, chapter 1
of the Code, and the regulations thereunder for applicable rules with
respect to the taxation of dividends where a distribution by a
corporation of its stock or securities in connection with an exchange
subject to section 351(a) has the effect of the distribution of a
taxable dividend.
(e) See Sec. 1.356-7(a) for the applicability of the definition of
nonqualified preferred stock in section 351(g)(2) for stock issued prior
to June 9, 1997, and for stock issued in transactions occurring after
June 8, 1997, that are described in section 1014(f)(2) of the Taxpayer
Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 921). See
Sec. 1.356-7(c) for the treatment of preferred stock received in certain
exchanges for common or preferred stock described in section
351(g)(2)(C)(i)(II).
[T.D. 6500, 25 FR 11607, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 8904, 65 FR 58650, Oct. 2, 2000]
Sec. 1.351-3 Records to be kept and information to be filed.
(a) Every person who received the stock or securities of a
controlled corporation, or other property as part of the consideration,
in exchange for property under section 351, shall file with his income
tax return for the taxable year in which the exchange is consummated a
complete statement of all facts pertinent to such exchange, including--
(1) A description of the property transferred, or of his interest in
such property, together with a statement of the cost or other basis
thereof, adjusted to the date of transfer.
(2) With respect to stock of the controlled corporation received in
the exchange, a statement of--
(i) The kind of stock and preferences, if any;
(ii) The number of shares of each class received; and
(iii) The fair market value per share of each class at the date of
the exchange.
(3) With respect to securities of the controlled corporation
received in the exchange, a statement of--
(i) The principal amount and terms; and
(ii) The fair market value at the date of exchange.
(4) The amount of money received, if any.
(5) With respect to other property received--
(i) A complete description of each separate item;
(ii) The fair market value of each separate item at the date of
exchanges; and
(iii) In the case of a corporate shareholder, the adjusted basis of
the other property in the hands of the controlled corporation
immediately before the distribution of such other property to the
corporate shareholder in connection with the exchange.
(6) With respect to liabilities of the transferors assumed by the
controlled corporation, a statement of--
[[Page 185]]
(i) The nature of the liabilities;
(ii) When and under what circumstances created;
(iii) The corporate business reason for assumption by the controlled
corporation; and
(iv) Whether such assumption eliminates the transferor's primary
liability.
(b) Every such controlled corporation shall file with its income tax
return for the taxable year in which the exchange is consummated--
(1) A complete description of all the property received from the
transferors.
(2) A statement of the cost or other basis thereof in the hands of
the transferors adjusted to the date of transfer.
(3) The following information with respect to the capital stock of
the controlled corporation--
(i) The total issued and outstanding capital stock immediately prior
to and immediately after the exchange, with a complete description of
each class of stock;
(ii) The classes of stock and number of shares issued to each
transferor in the exchange, and the number of shares of each class of
stock owned by each transferor immediately prior to and immediately
after the exchange, and
(iii) The fair market value of the capital stock as of the date of
exchange which was issued to each transferor.
(4) The following information with respect to securities of the
controlled corporation--
(i) The principal amount and terms of all securities outstanding
immediately prior to and immediately after the exchange,
(ii) The principal amount and terms of securities issued to each
transferor in the exchange, with a statement showing each transferor's
holdings of securities of the controlled corporation immediately prior
to and immediately after the exchange,
(iii) The fair market value of the securities issued to the
transferors on the date of the exchange, and
(iv) A statement as to whether the securities issued in the exchange
are subordinated in any way to other claims against the controlled
corporation.
(5) The amount of money, if any, which passed to each of the
transferors in connection with the transaction.
(6) With respect to other property which passed to each transferor--
(i) A complete description of each separate item;
(ii) The fair market value of each separate item at the date of
exchange, and
(iii) In the case of a corporate transferor, the adjusted basis of
each separate item in the hands of the controlled corporation
immediately before the distribution of such other property to the
corporate transferor in connection with the exchange.
(7) The following information as to the transferor's liabilities
assumed by the controlled corporation in the exchange--
(i) The amount and a description thereof,
(ii) When and under what circumstances created, and
(iii) The corporate business reason or reasons for assumption by the
controlled corporation.
(c) Permanent records in substantial form shall be kept by every
taxpayer who participates in the type of exchange described in section
351, showing the information listed above, in order to facilitate the
determination of gain or loss from a subsequent disposition of stock or
securities and other property, if any, received in the exchange.
effects on shareholders and security holders
Sec. 1.354-1 Exchanges of stock and securities in certain reorganizations.
(a) Section 354 provides that under certain circumstances no gain or
loss is recognized to a shareholder who surrenders his stock in exchange
for other stock or to a security holder who surrenders his securities in
exchange for stock. Section 354 also provides that under certain
circumstances a security holder may surrender securities and receive
securities in the same principal amount or in a lesser principal amount
without the recognition of gain or loss to him. The exchanges to which
section 354 applies must be pursuant to a plan of reorganization as
provided in section
[[Page 186]]
368(a) and the stock and securities surrendered as well as the stock and
securities received must be those of a corporation which is a party to
the reorganization. Section 354 does not apply to exchanges pursuant to
a reorganization described in section 368(a)(1)(D) unless the transferor
corporation--
(1) Transfers all or substantially all of its assets to a single
corporation, and
(2) Distributes all of its remaining properties (if any) and the
stock, securities and other properties received in the exchange to its
shareholders or security holders in pursuance of the plan of
reorganization. The fact that properties retained by the transferor
corporation, or received in exchange for the properties transferred in
the reorganization, are used to satisfy existing liabilities not
represented by securities and which were incurred in the ordinary course
of business before the reorganization does not prevent the application
of section 354 to an exchange pursuant to a plan of reorganization
defined in section 368(a)(1)(D).
(b) Except as provided in section 354 (c) and (d), section 354 is
not applicable to an exchange of stock or securities if a greater
principal amount of securities is received than the principal amount of
securities the recipient surrenders, or if securities are received and
the recipient surrenders no securities. See, however, section 356 and
regulations pertaining to such section. See also section 306 with
respect to the receipt of preferred stock in a transaction to which
section 354 is applicable.
(c) An exchange of stock or securities shall be subject to section
354(a)(1) even though--
(1) Such exchange is not pursuant to a plan of reorganization
described in section 368(a), and
(2) The principal amount of the securities received exceeds the
principal amount of the securities surrendered or if securities are
received and no securities are surrendered--
if such exchange is pursuant to a plan of reorganization for a railroad
corporation as defined in section 77(m) of the Bankruptcy Act (11 U.S.C.
205(m)) and is approved by the Interstate Commerce Commission under
section 77 of such act or under section 20b of the Interstate Commerce
Act (49 U.S.C. 20b) as being in the public interest. Section 354 is not
applicable to such exchanges if there is received property other than
stock or securities. See, however, section 356 and regulations
pertaining to such section.
(d) The rules of section 354 may be illustrated by the following
examples:
Example 1. Pursuant to a reorganization under section 368(a) to
which Corporations T and W are parties, A, a shareholder in Corporation
T, surrenders all his common stock in Corporation T in exchange for
common stock of Corporation W. No gain or loss is recognized to A.
Example 2. Pursuant to a reorganization under section 368(a) to
which Corporations X and Y (which are not railroad corporations) are
parties, B, a shareholder in Corporation X, surrenders all his stock in
X for stock and securities in Y. Section 354 does not apply to this
exchange. See, however, section 356.
Example 3. C, a shareholder in Corporation Z (which is not a
railroad corporation), surrenders all his stock in Corporation Z in
exchange for securities in Corporation Z. Whether or not this exchange
is in connection with a recapitalization under section 368(a)(1)(E),
section 354 does not apply. See, however, section 302.
Example 4. The facts are the same as in Example 3 of this paragraph
(d), except that C receivies solely rights to acquire stock in
Corporation Z. Section 354 does not apply.
(e) Except as provided in Sec. 1.356-6, for purposes of section 354,
the term securities includes rights issued by a party to the
reorganization to acquire its stock. For purposes of this section and
section 356(d)(2)(B), a right to acquire stock has no principal amount.
For this purpose, rights to acquire stock has the same meaning as it
does under sections 305 and 317(a). Other Internal Revenue Code
provisions governing the treatment of rights to acquire stock may also
apply to certain exchanges occurring in connection with a
reorganization. See, for example, sections 83 and 421 through 424 and
the regulations thereunder. This paragraph (e) applies to exchanges
occurring on or after March 9, 1998.
(f) See Sec. 1.356-7(a) and (b) for the treatment of nonqualified
preferred stock (as defined in section 351(g)(2)) received in certain
exchanges for nonqualified preferred stock or preferred stock. See
Sec. 1.356-7(c) for the treatment
[[Page 187]]
of preferred stock received in certain exchanges for common or preferred
stock described in section 351(g)(2)(C)(i)(II).
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7616, 44 FR
26869, May 8, 1979; T.D. 8752, 63 FR 410, Jan. 6, 1998; T.D. 8882, 65 FR
31078, May 16, 2000; T.D. 8904, 65 FR 58651, Oct. 2, 2000]
Sec. 1.355-0 Outline of sections.
In order to facilitate the use of Secs. 1.355-1 through 1.355-7T,
this section lists the major paragraphs in those sections as follows:
Sec. 1.355-1 Distribution of stock and securities of a controlled
corporation.
(a) Effective date of certain sections.
(b) Application of section.
Sec. 1.355-2 Limitations.
(a) Property distributed.
(b) Independent business purpose.
(1) Independent business purpose requirement.
(2) Corporate business purpose.
(3) Business purpose for distribution.
(4) Business purpose as evidence of nondevice.
(5) Examples.
(c) Continuity of interest requirement.
(1) Requirement.
(2) Examples.
(d) Device for distribution of earnings and profits.
(1) In general.
(2) Device factors.
(i) In general.
(ii) Pro rata distribution.
(iii) Subsequent sale or exchange of stock.
(A) In general.
(B) Sale or exchange negotiated or agreed upon before the
distribution.
(C) Sale or exchange not negotiated or agreed upon before the
distribution.
(D) Negotiated or agreed upon before the distribution.
(E) Exchange in pursuance of a plan of reorganization.
(iv) Nature and use of assets.
(A) In general.
(B) Assets not used in a trade or business meeting the requirement
of section 355(b).
(C) Related function.
(3) Nondevice factors.
(i) In general.
(ii) Corporate business purpose.
(iii) Distributing corporation publicly traded and widely held.
(iv) Distribution to domestic corporate shareholders.
(4) Examples.
(5) Transactions ordinarily not considered as a device.
(i) In general.
(ii) Absence of earnings and profits.
(iii) Section 303(a) transactions.
(iv) Section 302(a) transactions.
(v) Examples.
(e) Stock and securities distributed.
(1) In general.
(2) Additional rules.
(f) Principal amount of securities.
(1) Securities received.
(2) Only stock received.
(g) Period of ownership.
(1) Other property.
(2) Example.
(h) Active conduct of a trade or business.
Sec. 1.355-3 Active conduct of a trade or business.
(a) General requirements.
(1) Application of section 355.
(2) Examples.
(b) Active conduct of a trade or business defined.
(1) In general.
(2) Active conduct or a trade or business immediately after
distribution.
(i) In general.
(ii) Trade or business.
(iii) Active conduct.
(iv) Limitations.
(3) Active conduct for five-year period preceding distribution.
(4) Special rules for acquisition of a trade or business (Prior to
the Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of
1988).
(i) In general.
(ii) Example.
(iii) Gain or loss recognized in certain transactions.
(iv) Affiliated group.
(5) Special rules for acquisition of a trade or business (After the
Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of
1988).
(c) Examples.
Sec. 1.355-4 Non pro rata distributions, etc.
Sec. 1.355-5 Records to be kept and information to be filed.
Sec. 1.355-6 Recognition of gain on certain distributions of stock or
securities in controlled corporation.
(a) Conventions.
(1) Examples.
(2) Five-year period.
(3) Distributing securities.
(4) Marketable securities.
(b) General rules and purposes of section 355(d).
(1) Disqualified distributions in general.
(2) Disqualified stock.
(i) In general.
(ii) Purchase.
(iii) Exceptions.
(A) Purchase eliminated.
(B) Deemed purchase eliminated.
(C) Elimination of basis.
(1) General rule.
(2) Special rule for transferred and exchanged basis property.
[[Page 188]]
(3) Special rule for Split-offs and Split-ups.
(D) Special rule if basis allocated between two corporations.
(3) Certain distributions not disqualified distributions because
purposes of section 355(d) not violated.
(i) In general.
(ii) Disqualified person.
(iii) Purchased basis.
(iv) Increase in interest because payment of cash in lieu of
fractional shares.
(v) Other exceptions.
(vi) Examples.
(4) Anti-avoidance rule.
(i) In general.
(ii) Example.
(c) Whether a person holds a 50 percent or greater interest.
(1) In general.
(2) Valuation.
(3) Effect of options, warrants, convertible obligations, and other
similar interests.
(i) Application.
(ii) General rule.
(iii) Options deemed newly issued and substituted options.
(A) Exchange, adjustment, or alteration of existing option.
(B) Certain compensatory options.
(C) Substituted options.
(iv) Effect of treating an option as exercised.
(A) In general.
(B) Stock purchase agreement or similar arrangement.
(v) Instruments treated as options.
(vi) Instruments generally not treated as options.
(A) Escrow, pledge, or other security agreements.
(B) Compensatory options.
(1) General rule.
(2) Exception.
(C) Certain stock conversion features.
(D) Options exercisable only upon death, disability, mental
imcompetency, or separation from service.
(E) Rights of first refusal.
(F) Other enumerated instruments.
(vii) Reasonably certain that the option will be exercised.
(A) In general.
(B) Stock purchase agreement or similar arrangement.
(viii) Examples.
(4) Plan or arrangement.
(i) In general.
(ii) Understanding.
(iii) Examples.
(iv) Exception.
(A) Subsequent disposition.
(B) Example.
(d) Purchase.
(1) In general.
(i) Definition of purchase under section 355(d)(5)(A).
(ii) Section 355 distributions.
(iii) Example.
(2) Exceptions to definition of purchase under section 355(d)(5)(A).
(i) Acquisition of stock in a transaction which includes other
property or money.
(A) Transferors and shareholders of transferor or distributing
corporations.
(1) In general.
(2) Exception.
(B) Transferee corporations.
(1) In general.
(2) Exception.
(C) Examples.
(ii) Acquisition of stock in a distribution to which section 305(a)
applies.
(iii) Section 1036(a) exchange.
(iv) Section 338 elections.
(A) In general.
(B) Example.
(v) Partnership distributions.
(A) Section 732(b).
(B) Section 734(b).
(3) Certain section 351 exchanges treated as purchases.
(i) In general.
(A) Treatment of stock received by transferor.
(B) Multiple classes of stock.
(ii) Cash item, marketable stock.
(iii) Exception for certain acquisitions.
(A) In general.
(B) Example.
(iv) Exception for assets transferred as part of an active trade or
business.
(A) In general.
(B) Active conduct of a trade or business.
(C) Reasonable needs of the trade or business.
(D) Consideration of all facts and circumstances.
(E) Successive transfers.
(v) Exception for transfer between members of the same affiliated
group.
(A) In general.
(B) Examples.
(4) Triangular asset reorganizations.
(i) Definition.
(ii) Treatment.
(iii) Example.
(5) Reverse triangular reorganizations other than triangular asset
reorganizations.
(i) In general.
(ii) Letter ruling and closing agreement.
(iii) Example.
(6) Treatment of group structure changes.
(i) In general.
(ii) Adjustments to basis of higher-tier members.
(iii) Example.
(7) Special rules for triangular asset reorganizations, other
reverse triangular reorganizations, and group structure changes.
(e) Deemed purchase and timing rules.
(1) Attribution and aggregation.
(i) In general.
(ii) Purchase of additional interest.
[[Page 189]]
(iii) Purchase between persons treated as one person.
(iv) Purchase by a person already treated as holding stock under
section 355(d)(8)(A).
(v) Examples.
(2) Transferred basis rule.
(3) Exchanged basis rule.
(i) In general.
(ii) Example.
(4) Certain section 355 or section 305 distributions.
(i) Section 355.
(ii) Section 305.
(5) Substantial diminution of risk.
(i) In general.
(ii) Property to which suspension applies.
(iii) Risk of loss substantially diminished.
(iv) Special class of stock.
(f) Duty to determine stockholders.
(1) In general.
(2) Deemed knowledge of contents of securities filings.
(3) Presumptions as to securities filings.
(4) Presumption as to less-than-five-percent shareholders.
(5) Examples.
(g) Effective date.
Sec. 1.355-7T Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
(a) In general.
(b) Plan.
(1) In general.
(2) Certain post-distribution acquisitions.
(3) Plan factors.
(4) Non-plan factors.
(c) Operating rules.
(1) Internal discussions and discussions with outside advisors
evidence of business purpose.
(2) Takeover defense.
(3) Effect of distribution on trading in stock.
(4) Consequences of section 355(e) disregarded for certain purposes.
(5) Multiple acquisitions.
(d) 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.
(i) In general.
(ii) Special rule.
(7) Safe Harbor VII.
(i) In general.
(ii) Special rule.
(e) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests.
(1) Treatment of options.
(i) General rule.
(ii) Agreement, understanding, or arrangement to write an option.
(iii) Substantial negotiations related to options.
(2) Instruments treated as options.
(3) Instruments generally not treated as options.
(i) Escrow, pledge, or other security agreements.
(ii) Compensatory options.
(iii) Options exercisable only upon death, disability, mental
incompetency, or separation from service.
(iv) Rights of first refusal.
(v) Other enumerated instruments.
(f) Multiple controlled corporations.
(g) Valuation.
(h) Definitions.
(1) Agreement, understanding, arrangement, or substantial
negotiations.
(2) Controlled corporation.
(3) Controlling shareholder.
(4) Coordinating group.
(5) Discussions.
(6) Established market.
(7) Five-percent shareholder.
(8) Similar acquisition.
(9) Ten-percent shareholder.
(i) [Reserved]
(j) Examples.
(k) Effective dates.
[T.D. 8238, 54 FR 289, Jan. 5, 1989, as amended by T.D. 8913, 65 FR
79722, Dec. 20, 2000; T.D. 8960, 66 FR 40591, Aug. 3, 2001; T.D. 8988,
67 FR 20636, Apr. 26, 2002; 67 FR 38200, June 3, 2002]
Sec. 1.355-1 Distribution of stock and securities of a controlled corporation.
(a) Effective date of certain sections. Sections 1.355-1 through
1.355-4 apply to transactions occurring after February 6, 1989. For
transactions occurring on or before that date, see 26 CFR 1.355-1
through 1.355-4 (revised as of April 1, 1987). Sections 1.355-1 through
1.355-4 do not reflect the amendments to section 355 made by the Revenue
Act of 1987 and the Technical and Miscellaneous Revenue Act of 1988.
(b) Application of section. Section 355 provides for the separation,
without recognition of gain or loss to (or the inclusion in income of)
the shareholders and security holders, of one or more existing
businesses formerly operated, directly or indirectly, by a single
corporation (the ``distributing corporation''). It applies only to the
separation of existing businesses that have been in active operation for
at least five years (or a business that has been in active operation for
at least five years into separate businesses), and which, in general,
have been owned, directly or indirectly, for at least five years by the
[[Page 190]]
distributing corporation. A separation is achieved through the
distribution by the distributing corporation of stock, or stock and
securities, of one or more subsidiaries (the ``controlled
corporations'') to its shareholders with respect to its stock or to its
security holders in exchange for its securities. The controlled
corporations may be preexisting or newly created subsidiaries.
Throughout the regulations under section 355, the term distribution
refers to a distribution by the distributing corporation of stock, or
stock and securities, of one or more controlled corporations, unless the
context indicates otherwise. Section 355 contemplates the continued
operation of the business or businesses existing prior to the
separation. See Sec. 1.355-4 for types of distributions that may qualify
under section 355, including pro rata distributions and non pro rata
distributions.
(c) Stock rights. Except as provided in Sec. 1.356-6, for purposes
of section 355, the term securities includes rights issued by the
distributing corporation or the controlled corporation to acquire the
stock of that corporation. For purposes of this section and section
356(d)(2)(B), a right to acquire stock has no principal amount. For this
purpose, rights to acquire stock has the same meaning as it does under
sections 305 and 317(a). Other Internal Revenue Code provisions
governing the treatment of rights to acquire stock may also apply to
certain distributions occurring in connection with a transaction
described in section 355. See, for example, sections 83 and 421 through
424 and the regulations thereunder. This paragraph (c) applies to
distributions occurring on or after March 9, 1998.
(d) Nonqualified preferred stock. See Sec. 1.356-7(a) and (b) for
the treatment of nonqualified preferred stock (as defined in section
351(g)(2)) received in certain exchanges for (or in certain
distributions with respect to) nonqualified preferred stock or preferred
stock. See Sec. 1.356-7(c) for the treatment of the receipt of preferred
stock in certain exchanges for (or in certain distributions with respect
to) common or preferred stock described in section 351(g)(2)(C)(i)(II).
[T.D. 8238, 54 FR 289, Jan. 5, 1989, as amended by T.D. 8752, 63 FR 410,
Jan. 6, 1998; T.D. 8882, 65 FR 31078, May 16, 2000; T.D. 8904, 65 FR
58651, Oct. 2, 2000]
Sec. 1.355-2 Limitations.
(a) Property distributed. Section 355 applies to a distribution only
if the property distributed consists solely of stock, or stock and
securities, of a controlled corporation. If additional property
(including an excess principal amount of securities received over
securities surrendered) is received, see section 356.
(b) Independent business purpose--(1) Independent business purpose
requirement. Section 355 applies to a transaction only if it is carried
out for one or more corporate business purposes. A transaction is
carried out for a corporate business purpose if it is motivated, in
whole or substantial part, by one or more corporate business purposes.
The potential for the avoidance of Federal taxes by the distributing or
controlled corporations (or a corporation controlled by either) is
relevant in determining the extent to which an existing corporate
business purpose motivated the distribution. The principal reason for
this business purpose requirement is to provide nonrecognition treatment
only to distributions that are incident to readjustments of corporate
structures required by business exigencies and that effect only
readjustments of continuing interests in property under modified
corporate forms. This business purpose requirement is independent of the
other requirements under section 355.
(2) Corporate business purpose. A corporate business purpose is a
real and substantial non Federal tax purpose germane to the business of
the distributing corporation, the controlled corporation, or the
affiliated group (as defined in Sec. 1.355-3(b)(4)(iv)) to which the
distributing corporation belongs. A purpose of reducing non Federal
taxes is not a corporate business purpose if (i) the transaction will
effect a reduction in both Federal and non Federal taxes because of
similarities between
[[Page 191]]
Federal tax law and the tax law of the other jurisdiction and (ii) the
reduction of Federal taxes is greater than or substantially coextensive
with the reduction of non Federal taxes. See Examples (7) and (8) of
paragraph (b)(5) of this section. A shareholder purpose (for example,
the personal planning purposes of a shareholder) is not a corporate
business purpose. Depending upon the facts of a particular case,
however, a shareholder purpose for a transaction may be so nearly
coextensive with a corporate business purpose as to preclude any
distinction between them. In such a case, the transaction is carried out
for one or more corporate business purposes. See Example (2) of
paragraph (b)(5) of this section.
(3) Business purpose for distribution. The distribution must be
carried out for one or more corporate business purposes. See Example (3)
of paragraph (b)(5) of this section. If a corporate business purpose can
be achieved through a nontaxable transaction that does not involve the
distribution of stock of a controlled corporation and which is neither
impractical nor unduly expensive, then, for purposes of paragraph (b)(1)
of this section, the separation is not carried out for that corporate
business purpose. See Examples (3) and (4) of paragraph (b)(5) of this
section. For rules with respect to the requirement of a business purpose
for a transfer of assets to a controlled corporation in connection with
a reorganization described in section 368(a)(1)(D), See Sec. 1.368-1(b).
(4) Business purpose as evidence of nondevice. The corporate
business purpose or purposes for a transaction are evidence that the
transaction was not used principally as a device for the distribution of
earnings and profits within the meaning of section 355(a)(1)(B). See
paragraph (d)(3)(ii) of this section.
(5) Examples. The provisions of this paragraph (b) may be
illustrated by the following examples:
Example (1). Corporation X is engaged in the production,
transportation, and refining of petroleum products. In 1985, X acquires
all of the properties of corporation Z, which is also engaged in the
production, transportation, and refining of petroleum products. In 1991,
as a result of antitrust litigation, X is ordered to divest itself of
all of the properties acquired from Z. X transfers those properties to
new corporation Y and distributes the stock of Y pro rata to X's
shareholders. In view of the divestiture order, the distribution is
carried out for a corporate business purpose. See paragraph (b)(1) of
this section.
Example (2). Corporation X is engaged in two businesses: The
manufacture and sale of furniture and the sale of jewelry. The
businesses are of equal value. The outstanding stock of X is owned
equally by unrelated individuals A and B. A is more interested in the
furniture business, while B is more interested in the jewelry business.
A and B decide to split up the businesses and go their separate ways. A
and B anticipate that the operations of each business will be enhanced
by the separation because each shareholder will be able to devote his
undivided attention to the business in which he is more interested and
more proficient. Accordingly, X transfers the jewelry business to new
corporation Y and distributes the stock of Y to B in exchange for all of
B's stock in X. The distribution is carried out for a corporate business
purpose, notwithstanding that it is also carried out in part for
shareholder purposes. See paragraph (b)(2) of this section.
Example (3). Corporation X is engaged in the manufacture and sale of
toys and the manufacture and sale of candy. The shareholders of X wish
to protect the candy business from the risks and vicissitudes of the toy
business. Accordingly, X transfers the toy business to new corporation Y
and distributes the stock of Y to X's shareholders. Under applicable
law, the purpose of protecting the candy business from the risks and
vicissitudes of the toy business is achieved as soon as X transfers the
toy business to Y. Therefore, the distribution is not carried out for a
corporate business purpose. See paragraph (b)(3) of this section.
Example (4). Corporation X is engaged in a regulated business in
State T. X owns all of the stock of corporation Y, a profitable
corporation that is not engaged in a regulated business. Commission C
sets the rates that X may charge its customers, based on its total
income. C has recently adopted rules according to which the total income
of a corporation includes the income of a business if, and only if, the
business is operated, directly or indirectly, by the corporation. Total
income, for this purpose, includes the income of a wholly owned
subsidiary corporation but does not include the income of a parent or
``brother/sister'' corporation. Under C's new rule, X's total income
includes the income of Y, with the result that X has suffered a
reduction of the rates that it may charge its customers. It would not be
impractical or unduly expensive to create in a nontaxable transaction
(such as a transaction qualifying under section 351) a holding company
to hold the stock of X and Y. X distributes the stock of Y to X's
shareholders. The distribution is
[[Page 192]]
not carried out for the purpose of increasing the rates that X may
charge its customers because that purpose could be achieved through a
nontaxable transaction, the creation of a holding company, that does not
involve the distribution of stock of a controlled corporation and which
is neither impractical nor unduly expensive. See paragraph (b)(3) of
this section.
Example (5). The facts are the same as in Example (4), except that C
has recently adopted rules according to which the total income of a
corporation includes not only the income included in Example (3), but
also the income of any member of the affiliated group to which the
corporation belongs. In order to avoid a reduction in the rates that it
may charge its customers, X distributes the stock of Y to X's
shareholders. The distribution is carried out for a corporate business
purpose. See paragraph (b)(3) of this section.
Example (6). (i) Corporation X owns all of the one class of stock of
corporation Y. X distributes the stock of Y pro rata to its five
shareholders, all of whom are individuals, for the sole purpose of
enabling X and/or Y to elect to become an S corporation. The
distribution does not meet the corporate business purpose requirement.
See paragraph (b)(1) and (2) of this section.
(ii) The facts are the same as in Example 6(i), except that the
business of Y is operated as a division of X. X transfers this division
to new corporation Y and distributes the stock of Y pro rata to its
shareholders, all of whom are individuals, for the sole purpose of
enabling X and/or Y to elect to become an S corporation. The
distribution does not meet the corporate business purpose requirement.
See paragraph (b)(1) and (2) of this section.
Example (7). The facts are the same as in Example (6)(i), except
that the distribution is made to enable X to elect to become an S
corporation both for Federal tax purposes and for purposes of the income
tax imposed by State M. State M has tax law provisions similar to
subchapter S of the Internal Revenue Code of 1986. An election to be an
S corporation for Federal tax purposes will effect a substantial
reduction in Federal taxes that is greater than the reduction of State M
taxes pursuant to an election to be an S corporation for State M
purposes. The purpose of reducing State M taxes is not a corporate
business purpose. The distribution does not meet the corporate business
purpose requirements. See paragraph (b)(1) and (2) of this section.
Example (8). The facts are the same as Example (7), except that the
distribution also is made to enable A, a key employee of Y, to acquire
stock of Y without investing in X. A is considered to be critical to the
success of Y and he has indicated that he will seriously consider
leaving the company if he is not given the opportunity to purchase a
significant amount of stock of Y. As a matter of state law, Y could not
issue stock to the employee while it was a subsidiary of X. As in
Example (7), the purpose of reducing State M taxes is not a corporate
business purpose. In order to determine whether the issuance of stock to
the key employee, in fact, motivated the distribution of the Y stock,
the potential avoidance of Federal taxes is a relevant factor to take
into account. If the facts and circumstances establish that the
distribution was substantially motivated by the need to issue stock to
the employee, the distribution will meet the corporate business purpose
requirement.
(c) Continuity of interest requirement--(1) Requirement. Section 355
applies to a separation that effects only a readjustment of continuing
interests in the property of the distributing and controlled
corporations. In this regard section 355 requires that one or more
persons who, directly or indirectly, were the owners of the enterprise
prior to the distribution or exchange own, in the aggregate, an amount
of stock establishing a continuity of interest in each of the modified
corporate forms in which the enterprise is conducted after the
separation. This continuity of interest requirement is independent of
the other requirements under section 355.
(2) Examples.
Example (1). For more than five years, corporation X has been
engaged directly in one business, and indirectly in a different business
through its wholly owned subsidiary, S. The businesses are equal in
value. At all times, the outstanding stock of X has been owned equally
by unrelated individuals A and B. For valid business reasons, A and B
cause X to distribute all of the stock of S to B in exchange for all of
B's stock in X. After the transaction, A owns all the stock of X and B
owns all the stock of S. The continuity of interest requirement is met
because one or more persons who were the owners of X prior to the
distribution (A and B) own, in the aggregate, an amount of stock
establishing a continuity of interest in each of X and S after the
distribution.
Example (2). Assume the same facts as in Example (1), except that
pursuant to a plan to acquire a stock interest in X without acquiring,
directly or indirectly, an interest in S, C purchased one-half of the X
stock owned by A and immediately thereafter X distributed all of the S
stock to B in exchange for all of B's stock in X. After the
transactions, A owns 50 percent of X and B owns 100 percent of S. The
distribution by X of all of the stock of S to B in exchange for all of
B's stock in
[[Page 193]]
X will satisfy the continuity of interest requirement for section 355
because one or more persons who were the owners of X prior to the
distribution (A and B) own, in the aggregate, an amount of stock
establishing a continuity of interest in each of X and S after the
distribution.
Example (3). Assume the same facts as in Examples (1) and (2),
except that C purchased all of the X stock owned by A. After the
transactions, neither A nor B own any of the stock of X, and B owns all
the stock of S. The continuity of interest requirement is not met
because the owners of X prior to the distribution (A and B) do not, in
the aggregate, own an amount of stock establishing a continuity of
interest in each of X and S after the distribution, i.e., although A and
B collectively have retained 50 percent of their equity interest in the
former combined enterprise, they have failed to continue to own the
minimum stock interest in the distributing corporation, X, that would be
required in order to meet the continuity of interest requirement.
Example (4). Assume the same facts as in Examples (1) and (2),
except that C purchased 80 percent of the X stock owned by A. After the
transactions, A owns 20 percent of the stock of X, B owns no X stock,
and B owns 100 percent of the S stock. The continuity of interest
requirement is not met because the owners of X prior to the distribution
(A and B) do not, in the aggregate, have a continuity of interest in
each of X and S after the distribution, i.e., although A and B
collectively have retained 60 percent of their equity interest in the
former combined enterprise, the 20 percent interest of A in X is less
than the minimum equity interest in the distributing corporation, X,
that would be required in order to meet the continuity of interest
requirement.
(d) Device for distribution of earnings and profits--(1) In general.
Section 355 does not apply to a transaction used principally as a device
for the distribution of the earnings and profits of the distributing
corporation, the controlled corporation, or both (a ``device''). Section
355 recognizes that a tax-free distribution of the stock of a controlled
corporation presents a potential for tax avoidance by facilitating the
avoidance of the dividend provisions of the Code through the subsequent
sale or exchange of stock of one corporation and the retention of the
stock of another corporation. A device can include a transaction that
effects a recovery of basis. In this paragraph (d), ``exchange''
includes transactions, such as redemptions, treated as exchanges under
the Code. Generally, the determination of whether a transaction was used
principally as a device will be made from all of the facts and
circumstances, including, but not limited to, the presence of the device
factors specified in paragraph (d)(2) of this section (``evidence of
device''), and the presence of the nondevice factors specified in
paragraph (d)(3) of this section (``evidence of nondevice''). However,
if a transaction is specified in paragraph (d)(5) of this section, then
it is ordinarily considered not to have been used principally as a
device.
(2) Device factors--(i) In general. The presence of any of the
device factors specified in this subparagraph (2) is evidence of device.
The strength of this evidence depends on the facts and circumstances.
(ii) Pro rata distribution. A distribution that is pro rata or
substantially pro rata among the shareholders of the distributing
corporation presents the greatest potential for the avoidance of the
dividend provisions of the Code and, in contrast to other types of
distributions, is more likely to be used principally as a device.
Accordingly, the fact that a distribution is pro rata or substantially
pro rata is evidence of device.
(iii) Subsequent sale or exchange of stock--(A) In general. A sale
or exchange of stock of the distributing or the controlled corporation
after the distribution (a ``subsequent sale or exchange'') is evidence
of device. Generally, the greater the percentage of the stock sold or
exchanged after the distribution, the stronger the evidence of device.
In addition, the shorter the period of time between the distribution and
the sale or exchange, the stronger the evidence of device.
(B) Sale or exchange negotiated or agreed upon before the
distribution. A subsequent sale or exchange pursuant to an arrangement
negotiated or agreed upon before the distribution is substantial
evidence of device.
(C) Sale or exchange not negotiated or agreed upon before the
distribution. A subsequent sale or exchange not pursuant to an
arrangement negotiated or agreed upon before the distribution is
evidence of device.
[[Page 194]]
(D) Negotiated or agreed upon before the distribution. For purposes
of this subparagraph (2), a sale or exchange is always pursuant to an
arrangement negotiated or agreed upon before the distribution if
enforceable rights to buy or sell existed before the distribution. If a
sale or exchange was discussed by the buyer and the seller before the
distribution and was reasonably to be anticipated by both parties, then
the sale or exchange will ordinarily be considered to be pursuant to an
arrangement negotiated or agreed upon before the distribution.
(E) Exchange in pursuance of a plan of reorganization. For purposes
of this subparagraph (2), if stock is exchanged for stock in pursuance
of a plan of reorganization, and either no gain or loss or only an
insubstantial amount of gain is recognized on the exchange, then the
exchange is not treated as a subsequent sale or exchange, but the stock
received in the exchange is treated as the stock surrendered in the
exchange. For this purpose, gain treated as a dividend pursuant to
sections 356(a)(2) and 316 shall be disregarded.
(iv) Nature and use of assets--(A) In general. The determination of
whether a transaction was used principally as a device will take into
account the nature, kind, amount, and use of the assets of the
distributing and the controlled corporations (and corporations
controlled by them) immediately after the transaction.
(B) Assets not used in a trade or business meeting the requirement
of section 355(b). The existence of assets that are not used in a trade
or business that satisfies the requirements of section 355(b) is
evidence of device. For this purpose, assets that are not used in a
trade or business that satisfies the requirements of section 355(b)
include, but are not limited to, cash and other liquid assets that are
not related to the reasonable needs of a business satisfying such
section. The strength of the evidence of device depends on all the facts
and circumstances, including, but not limited to, the ratio for each
corporation of the value of assets not used in a trade or business that
satisfies the requirements of section 355(b) to the value of its
business that satisfies such requirements. A difference in the ratio
described in the preceding sentence for the distributing and controlled
corporation is ordinarily not evidence of device if the distribution is
not pro rata among the shareholders of the distributing corporation and
such difference is attributable to a need to equalize the value of the
stock distributed and the value of the stock or securities exchanged by
the distributees.
(C) Related function. There is evidence of device if a business of
either the distributing or controlled corporation (or a corporation
controlled by it) is (1) a ``secondary business'' that continues as a
secondary business for a significant period after the separation, and
(2) can be sold without adversely affecting the business of the other
corporation (or a corporation controlled by it). A secondary business is
a business of either the distributing or controlled corporation, if its
principal function is to serve the business of the other corporation (or
a corporation controlled by it). A secondary business can include a
business transferred to a newly-created subsidiary or a business which
serves a business transferred to a newly-created subsidiary. The
activities of the secondary business may consist of providing property
or performing services. Thus, in Example (11) of Sec. 1.355-3(c),
evidence of device would be presented if the principal function of the
coal mine (satisfying the requirements of the steel business) continued
after the separation and the coal mine could be sold without adversely
affecting the steel business. Similarly, in Example (10) of Sec. 1.355-
3(c), evidence of device would be presented if the principal function of
the sales operation after the separation is to sell the output from the
manufacturing operation and the sales operation could be sold without
adversely affecting the manufacturing operation.
(3) Nondevice factors--(i) In general. The presence of any of the
nondevice factors specified in this subparagraph (3) is evidence of
nondevice. The strength of this evidence depends on all of the facts and
circumstances.
(ii) Corporate business purpose. The corporate business purpose for
the transaction is evidence of nondevice. The stronger the evidence of
device (such as the presence of the device factors specified in
paragraph (d)(2) of this
[[Page 195]]
section), the stronger the corporate business purpose required to
prevent the determination that the transaction was used principally as a
device. Evidence of device presented by the transfer or retention of
assets not used in a trade or business that satisfies the requirements
of section 355(b) can be outweighed by the existence of a corporate
business purpose for those transfers or retentions. The assessment of
the strength of a corporate business purpose will be based on all of the
facts and circumstances, including, but not limited to, the following
factors:
(A) The importance of achieving the purpose to the success of the
business;
(B) The extent to which the transaction is prompted by a person not
having a proprietary interest in either corporation, or by other outside
factors beyond the control of the distributing corporation; and
(C) The immediacy of the conditions prompting the transaction.
(iii) Distributing corporation publicly traded and widely held. The
fact that the distributing corporation is publicly traded and has no
shareholder who is directly or indirectly the beneficial owner of more
than five percent of any class of stock is evidence of nondevice.
(iv) Distribution to domestic corporate shareholders. The fact that
the stock of the controlled corporation is distributed to one or more
domestic corporations that, if section 355 did not apply, would be
entitled to a deduction under section 243(a)(1) available to
corporations meeting the stock ownership requirements of section 243(c),
or a deduction under section 243(a)(2) or (3) or 245(b) is evidence of
nondevice.
(4) Examples. The provisions of paragraph (d)(1) through (3) of this
section may be illustrated by the following examples:
Example (1). Individual A owns all of the stock of corporation X,
which is engaged in the warehousing business. X owns all of the stock of
corporation Y, which is engaged in the transportation business. X
employs individual B, who is extremely knowledgeable of the warehousing
business in general and the operations of X in particular. B has
informed A that he will seriously consider leaving the company if he is
not given the opportunity to purchase a significant amount of stock of
X. Because of his knowledge and experience, the loss of B would
seriously damage the business of X. B cannot afford to purchase any
significant amount of stock of X as long as X owns Y. Accordingly, X
distributes the stock of Y to A and A subsequently sells a portion of
his X stock to B. However, X could have issued additional shares to B
sufficient to give B an equivalent ownership interest in X. There is no
other evidence of device or evidence of nondevice. In light of the fact
that X could have issued additional shares to B, the sale of X stock by
A is substantial evidence of device. The transaction is considered to
have been used principally as a device. See paragraph (d)(1), (2)(ii),
(iii)(A), (B) and (D), and (3)(i) and (ii) of this section.
Example (2). Corporation X owns and operates a fast food restaurant
in State M and owns all of the stock of corporation Y, which owns and
operates a fast food restaurant in State N. X and Y operate their
businesses under franchises granted by D and E, respectively. X owns
cash and marketable securities that exceed the reasonable needs of its
business but whose value is small relative to the value of its business.
E has recently changed its franchise policy and will no longer grant or
renew franchises to subsidiaries (or other members of the same
affiliated group) of corporations operating businesses under franchises
granted by its competitors. Thus, Y will lose its franchise if it
remains a subsidiary of X. The franchise is about to expire.
Accordingly, X distributes the stock of Y pro rata among X's
shareholders. X retains its business and transfers cash and marketable
securities to Y in an amount proportional to the value of Y's business.
There is no other evidence of device or evidence of nondevice. The
transfer by X to Y and the retention by X of cash and marketable
securities is relatively weak evidence of device because after the
transfer X and Y hold cash and marketable securities in amounts
proportional to the values of their businesses. The fact that the
distribution is pro rata is evidence of device. A strong corporate
business purpose is relatively strong evidence of nondevice.
Accordingly, the transaction is considered not to have been used
principally as a device. See paragraph (d)(1), (2)(ii), (iv)(A), and (B)
and (3)(i) and (ii)(A), (B) and (C) of this section.
Example (3). Corporation X is engaged in a regulated business in
State M and owns all of the stock of corporation Y, which is not engaged
in a regulated business in State M. State M has recently amended its
laws to provide that affiliated corporations operating in M may not
conduct both regulated and unregulated businesses. X transfers cash not
related to the reasonable needs of the business of X or Y to Y and then
distributes the stock of Y pro rata among X's shareholders. As a result
of the transfer of cash, the ratio of the value of its assets not used
in a trade or business that satisfies the requirements of section 355(b)
to the value of
[[Page 196]]
its business is substantially greater for Y than for X. There is no
other evidence of device or evidence of nondevice. The transfer of cash
by X to Y is relatively strong evidence of device because after the
transfer Y holds disproportionately many assets that are not used in a
trade or business that satisfies the requirements of section 355(b). The
fact that the distribution is pro rata is evidence of device. The strong
business purpose is relatively strong evidence of nondevice, but it does
not pertain to the transfer. Accordingly, the transaction is considered
to have been used principally as a device. See paragraph (d)(1),
(2)(ii), (iv)(A) and (B), and (3) and (i) and (ii) of this section.
Example (4). The facts are the same as in Example (3), except that,
instead of transferring cash to Y, X purchases operating assets
unrelated to the business of Y and transfers them to Y prior to the
distribution. There is no other evidence of device or evidence of
nondevice. The transaction is considered to have been used principally
as a device. See paragraph (d)(1), (2)(ii), (iv)(A) and (B), and (3)(i)
and (ii) of this section.
(5) Transactions ordinarily not considered as a device--(i) In
general. This subparagraph (5) specifies three distributions that
ordinarily do not present the potential for tax avoidance described in
paragraph (d)(1) of this section. Accordingly, such distributions are
ordinarily considered not to have been used principally as a device,
notwithstanding the presence of any of the device factors described in
paragraph (d)(2) of this section. A transaction described in paragraph
(d)(5)(iii) or (iv) of this section is not protected by this
subparagraph (5) from a determination that it was used principally as a
device if it involves the distribution of the stock of more than one
controlled corporation and facilitates the avoidance of the dividend
provisions of the Code through the subsequent sale or exchange of stock
of one corporation and the retention of the stock of another
corporation.
(ii) Absence of earnings and profits. A distribution is ordinarily
considered not to have been used principally as a device if--
(A) The distributing and controlled corporations have no accumulated
earnings and profits at the beginning of their respective taxable years,
(B) The distributing and controlled corporations have no current
earnings and profits as of the date of the distribution, and
(C) No distribution of property by the distributing corporation
immediately before the separation would require recognition of gain
resulting in current earnings and profits for the taxable year of the
distribution.
(iii) Section 303(a) transactions. A distribution is ordinarily
considered not to have been used principally as a device if, in the
absence of section 355, with respect to each shareholder distributee,
the distribution would be a redemption to which section 303(a) applied.
(iv) Section 302(a) transactions. A distribution is ordinarily
considered not to have been used principally as a device if, in the
absence of section 355, with respect to each shareholder distributee,
the distribution would be a redemption to which section 302(a) applied.
For purposes of the preceding sentence, section 302(c)(2)(A)(ii) and
(iii) shall not apply.
(v) Examples. The provisions of this subparagraph (5) may be
illustrated by the following examples:
Example (1) . The facts are the same as in Example (3) of paragraph
(d)(4) of this section, except that X and Y had no accumulated earnings
and profits at the beginning of its taxable year, X and Y have no
current earnings and profits as of the date of the distribution, and no
distribution of property by X immediately before the separation would
require recognition of gain that would result in earnings and profits
for the taxable year of the distribution. The transaction is considered
not to have been used principally as a device. See paragraph (d)(5)(i)
and (ii) of this section.
Example (2) . Corporation X is engaged in three businesses: a hotel
business, a restaurant business, and a rental real estate business.
Individuals A, B, and C own all of the stock of X. X transfers the
restaurant business to new corporation Y and transfers the rental real
estate business to new corporation Z. X then distributes the stock of Y
and Z pro rata between B and C in exchange for all of their stock in X.
In the absence of section 355, the distribution would be a redemption to
which section 302(a) applied. Since this distribution involves the stock
of more than one controlled corporation and facilitates the avoidance of
the dividend provisions of the Code through the subsequent sale or
exchange of stock in one corporation and the retention of the stock of
another corporation, it is not protected by paragraph (d)(5)(i) and (iv)
of this section from a determination that it was used principally as a
device. Thus, the determination of whether
[[Page 197]]
the transaction was used principally as a device must be made from all
the facts and circumstances, including the presence of the device
factors and nondevice factors specified in paragraph (d)(2) and (3) of
this section.
(e) Stock and securities distributed--(1) In general. Section 355
applies to a distribution only if the distributing corporation
distributes--
(i) All of the stock and securities of the controlled corporation
that it owns, or
(ii) At least an amount of the stock of the controlled corporation
that constitutes control as defined in section 368(c). In such a case,
all, or any part, of the securities of the controlled corporation may be
distributed, and paragraph (e)(2) of this section shall apply.
(2) Additional rules. Where a part of either the stock or the
securities of the controlled corporation is retained under paragraph
(e)(1)(ii) of this section, it must be established to the satisfaction
of the Commissioner that the retention by the distributing corporation
was not in pursuance of a plan having as one of its principal purposes
the avoidance of Federal income tax. Ordinarily, the corporate business
purpose or purposes for the distribution will require the distribution
of all of the stock and securities of the controlled corporation. If the
distribution of all of the stock and securities of a controlled
corporation would be treated to any extent as a distribution of ``other
property'' under section 356, this fact tends to establish that the
retention of stock or securities is in pursuance of a plan having as one
of its principal purposes the avoidance of Federal income tax.
(f) Principal amount of securities--(1) Securities received. Section
355 does not apply to a distribution if, with respect to any shareholder
or security holder, the principal amount of securities received exceeds
the principal amount of securities surrendered, or securities are
received but no securities are surrendered. In such cases, see section
356.
(2) Only stock received. If only stock is received in a distribution
to which section 355(a)(1)(A) applies, the principal amount of the
securities surrendered, if any, and the par value or stated value of the
stock surrendered, if any, are not relevant to the application of that
section.
(g) Period of ownership--(1) Other property. For purposes of section
355(a)(1)(A), stock of a controlled corporation acquired in a
transaction in which gain or loss was recognized in whole or in part
(other than a transaction described in Sec. 1.355-3(b)(4)(iii)) within
the five-year period ending on the date of the distribution shall not be
treated as stock of the controlled corporation but shall be treated as
``other property.'' See section 356. However, for purposes of section
355(a)(1)(D), the stock so acquired is stock of the controlled
corporation.
(2) Example. Paragraph (g)(1) of this section may be illustrated by
the following example:
Example. Corporation X has held 85 of the 100 outstanding shares of
the stock of corporation Y for more than five years on the date of the
distribution. Six months before that date, X purchased ten more shares.
If X distributes all of its 95 shares of the stock of Y, so much of
section 356 as relates to section 355 may apply to the transaction and
the ten newly acquired shares are treated as other property. On the
other hand, if X retains ten of the shares of the stock of Y then the
application of paragraph (e) of this section must take into account all
of the stock of Y, including the ten shares newly acquired by X and the
five shares owned by others. Similarly, if, by the use of any agency, X
acquired any of the stock of Y within the five-year period ending on the
date of the distribution in a transaction in which gain or loss was
recognized in whole or in part (for example, where another subsidiary of
X purchased stock of Y), then that stock is treated as other property.
If X had held only 75 of the 100 outstanding shares of the stock of Y
for more than five years on the date of the distribution and had
purchased the remaining 25 shares six months before that date, then
neither section 355 nor section 356 would apply to the distribution.
(h) Active conduct of a trade or business. Section 355 applies to a
distribution only if the requirements of Sec. 1.355-3 (relating to the
active conduct of a trade or business) are satisfied.
[T.D. 8238, 54 FR 290, Jan. 5, 1989; 54 FR 5577, Feb. 3, 1989; 57 FR
28463, June 25, 1992]
Sec. 1.355-3 Active conduct of a trade or business.
(a) General requirements--(1) Application of section 355. Under
section
[[Page 198]]
355(b)(1), a distribution of stock, or stock and securities, of a
controlled corporation qualifies under section 355 only if--
(i) The distributing and the controlled corporations are each
engaged in the active conduct of a trade or business immediately after
the distribution (section 355(b)(1)(A)), or
(ii) Immediately before the distribution, the distributing
corporation had no assets other than stock or securities of the
controlled corporations, and each of the controlled corporations is
engaged in the active conduct of a trade or business immediately after
the distribution (section 355(b)(1)(B)). A de minimis amount of assets
held by the distributing corporation shall be disregarded for purposes
of this paragraph (a)(1)(ii).
(2) Examples. Paragraph (a)(1) of this section may be illustrated by
the following examples:
Example (1). Prior to the distribution, corporation X is engaged in
the active conduct of a trade or business and owns all of the stock of
corporation Y, which also is engaged in the active conduct of a trade or
business. X distributes all of the stock of Y to X's shareholders, and
each corporation continues the active conduct of its trade or business.
The active business requirement of section 355(b)(1)(A) is satisfied.
Example (2). The facts are the same as in Example (1), except that X
transfers all of its assets other than the stock of Y to a new
corporation in exchange for all of the stock of the new corporation and
then distributes the stock of both controlled corporations to X's
shareholders. The active business requirement of section 355(b)(1)(B) is
satisfied.
(b) Active conduct of a trade or business defined--(1) In general.
Section 355(b)(2) provides rules for determining whether a corporation
is treated as engaged in the active conduct of a trade or business for
purposes of section 355(b)(1). Under section 355(b)(2)(A), a corporation
is treated as engaged in the active conduct of a trade or business if it
is itself engaged in the active conduct of a trade or business or if
substantially all of its assets consist of the stock, or stock and
securities, of a corporation or corporations controlled by it
(immediately after the distribution) each of which is engaged in the
active conduct of a trade or business.
(2) Active conduct of a trade or business immediately after
distribution--(i) In general. For purposes of section 355(b), a
corporation shall be treated as engaged in the ``active conduct of a
trade or business'' immediately after the distribution if the assets and
activities of the corporation satisfy the requirements and limitations
described in paragraph (b)(2)(ii), (iii), and (iv) of this section.
(ii) Trade or business. A corporation shall be treated as engaged in
a trade or business immediately after the distribution if a specific
group of activities are being carried on by the corporation for the
purpose of earning income or profit, and the activities included in such
group include every operation that forms a part of, or a step in, the
process of earning income or profit. Such group of activities ordinarily
must include the collection of income and the payment of expenses.
(iii) Active conduct. For purposes of section 355(b), the
determination whether a trade or business is actively conducted will be
made from all of the facts and circumstances. Generally, the corporation
is required itself to perform active and substantial management and
operational functions. Generally, activities performed by the
corporation itself do not include activities performed by persons
outside the corporation, including independent contractors. A
corporation may satisfy the requirements of this subdivision (iii)
through the activities that it performs itself, even though some of its
activities are performed by others. Separations of real property all or
substantially all of which is occupied prior to the distribution by the
distributing or the controlled corporation (or by any corporation
controlled directly or indirectly by either of those corporations) will
be carefully scrutinized with respect to the requirements of section
355(b) and this Sec. 1.355-3.
(iv) Limitations. The active conduct of a trade or business does not
include--
(A) The holding for investment purposes of stock, securities, land,
or other property, or
(B) The ownership and operation (including leasing) of real or
personal property used in a trade or business, unless the owner performs
significant
[[Page 199]]
services with respect to the operation and management of the property.
(3) Active conduct for five-year period preceding distribution.
Under section 355(b)(2)(B), a trade or business that is relied upon to
meet the requirements of section 355(b) must have been actively
conducted throughout the five-year period ending on the date of the
distribution. For purposes of this subparagraph (3)--
(i) Activities which constitute a trade or business under the tests
described in paragraph (b)(2) of this section shall be treated as
meeting the requirement of the preceding sentence if such activities
were actively conducted throughout the 5-year period ending on the date
of distribution, and
(ii) The fact that a trade or business underwent change during the
five-year period preceding the distribution (for example, by the
addition of new or the dropping of old products, changes in production
capacity, and the like) shall be disregarded, provided that the changes
are not of such a character as to constitute the acquisition of a new or
different business. In particular, if a corporation engaged in the
active conduct of one trade or business during that five-year period
purchased, created, or otherwise acquired another trade or business in
the same line of business, then the acquisition of that other business
is ordinarily treated as an expansion of the original business, all of
which is treated as having been actively conducted during that five-year
period, unless that purchase, creation, or other acquisition effects a
change of such a character as to constitute the acquisition of a new or
different business.
(4) Special rules for acquisition of a trade or business (Prior to
the Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of
1988)--(i) In general. Under section 355(b)(2)(C), a trade or business
relied upon to meet the requirements of section 355(b) must not have
been acquired by the distributing corporation, the controlled
corporation, or another member of the affiliated group during the five-
year period ending on the date of the distribution unless it was
acquired in a transaction in which no gain or loss was recognized.
Similarly, under section 355(b)(2)(D), the trade or business must not
have been indirectly acquired by any of those corporations (or a
predecessor in interest of any of those corporations) during that five-
year period in a transaction in which gain or loss was recognized in
whole or in part and which consisted of the acquisition of control of
the corporation directly engaged in the trade or business, or the
indirect acquisition of control of that corporation through the direct
or indirect acquisition of control of one or more other corporations. A
trade or business acquired, directly or indirectly, within the five-year
period ending on the date of the distribution in a transaction in which
the basis of the assets acquired was not determined in whole or in part
by reference to the transferor's basis does not qualify under section
355(b)(2), even though no gain or loss was recognized by the
transferror.
(ii) Example. Paragraph (b)(4)(i) of this section may be illustrated
by the following example:
Example. In 1985, corporation X, which operates a business and has
cash and other liquid assets, purchases all of the stock of corporation
Y, which is engaged in the active conduct of a trade or business. Later
in the same year, X merges into Y in a ``downstream'' statutory merger.
In 1986, Y transfers the business assets formerly owned by X to a new
subsidiary, corporation Z, and then distributes the stock of Z to Y's
shareholders. Section 355 does not apply to the distribution of the
stock of Z because the trade or business of Y was indirectly acquired by
X, a predecessor in interest of Y, during the five-year period preceding
the distribution.
(iii) Gain or loss recognized in certain transactions. The
requirements of section 355(b)(2)(C) and (D) are intended to prevent the
direct or indirect acquisition of a trade or business by a corporation
in anticipation of a distribution by the corporation of that trade of
business in a distribution to which section 355 would otherwise apply. A
direct or indirect acquisition of a trade or business by one member of
an affiliated group from another member of the group is not the type of
transaction to which section 355(b)(2)(C) and (D) is intended to apply.
Therefore, in applying
[[Page 200]]
section 355(b)(2)(C) or (D), such an acquisition, even though taxable,
shall be disregarded.
(iv) Affiliated group. For purposes of this subparagraph (4), the
term affiliated group means an affiliated group as defined in section
1504(a) (without regard to section 1504(b)), except that the term stock
includes nonvoting stock described in section 1504(a)(4).
(5) Special rules for acquisition of a trade or business (After the
Revenue Act of 1987 and Technical and Miscellaneous Revenue Act of
1988). [Reserved]
(c) Examples. The following examples illustrate section 355(b)(2)(A)
and (B) and paragraph (b)(1), (2), and (3) of this section. However, a
transaction that satisfies these active business requirements will
qualify under section 355 only if it satisfies the other requirements of
section 355 (a) and (b).
Example (1). Corporation X is engaged in the manufacture and sale of
soap and detergents and also owns investment securities. X transfers the
investment securities to new subsidiary Y and distributes the stocks of
Y to X's shareholders. Y does not satisfy the requirements of section
355(b) because the holding of investment securities does not constitute
the active conduct of a trade or business. See paragraph (b)(2)(iv)(A)
of this section.
Example (2). Corporation X owns, manages, and derives rental income
from an office building and also owns vacant land. X transfers the land
to new subsidiary Y and distributes the stock of Y to X's shareholders.
Y will subdivide the land, install streets and utilities, and sell the
developed lots to various homebuilders. Y does not satisfy the
requirements of section 355(b) because no significant development
activities were conducted with respect to the land during the five-year
period ending on the date of the distribution. See paragraph (b)(3) of
this section.
Example (3). Corporation X owns land on which it conducts a ranching
business. Oil has been discovered in the area, and it is apparent that
oil may be found under the land on which the ranching business is
conducted. X has engaged in no significant activities in connection with
its mineral rights. X transfers its mineral rights to new subsidiary Y
and distributes the stock of Y to X's shareholders. Y will actively
pursue the development of the oil producing potential of the property. Y
does not satisfy the requirements of section 355(b) because X engaged in
no significant exploitation activities with respect to the mineral
rights during the five-year period ending on the date of the
distribution. See paragraph (b)(3) of this section.
Example (4). For more than five years, corporation X has conducted a
single business of constructing sewage disposal plants and other
facilities. X transfers one-half of its assets to new subsidiary Y.
These assets include a contract for the construction of a sewage
disposal plant in State M, construction equipment, cash, and other
tangible assets. X retains a contract for the construction of a sewage
disposal plant in State N, construction equipment, cash, and other
intangible assets. X then distributes the stock of Y to one of X's
shareholders in exchange for all of his stock of X. X and Y both satisfy
the requirements of section 355(b). See paragraph (b)(3)(i) of this
section.
Example (5). For the past six years, corporation X has owned and
operated two factories devoted to the production of edible pork skins.
The entire output of one factory is sold to one customer, C, while the
output of the second factory is sold to C and a number of other
customers. To eliminate errors in packaging, X opens a new factory.
Thereafter, orders from C are processed and packaged at the two original
factories, while the new factory handles only orders from other
customers. Eight months after opening the new factory, X transfers it
and related business assets to new subsidiary Y and distributes the
stock of Y to X's shareholders. X and Y both satisfy the requirements of
section 355(b). See paragraph (b)(3)(i) and (ii) of this section.
Example (6). Corporation X has owned and operated a men's retail
clothing store in the downtown area of the City of G for nine years and
has owned and operated another men's retail clothing store in a suburban
area of G for seven years. X transfers the store building, fixtures,
inventory, and other assets related to the operations of the suburban
store to new subsidiary Y. X also transfers to Y the delivery trucks and
delivery personnel that formerly served both stores. Henceforth, X will
contract with a local public delivery service to make its deliveries. X
retains the warehouses that formerly served both stores. Henceforth, Y
will lease warehouse space from an unrelated public warehouse company. X
then distributes the stock of Y to X's shareholders. X and Y both
satisfy the requirements of section 355(b). See paragraph (b)(3)(i) of
this section.
Example (7). For the past nine years, corporation X has owned and
operated a department store in the downtown area of the City of G. Three
years ago, X acquired a parcel of land in a suburban area of G and
constructed a new department store on it. X transfers the suburban store
and related business assets to new subsidiary Y and distributes the
stock of Y to X's shareholders. After the distribution, each store has
its own manager and is operated independently of the other store. X and
[[Page 201]]
Y both satisfy the requirements of section 355(b). See paragraph
(b)(3)(i) and (ii) of this section.
Example (8). For the past six years, corporation X has owned and
operated hardware stores in several states. Two years ago, X purchased
all of the assets of a hardware store in State M, where X had not
previously conducted business. X transfers the State M store and related
business assets to new subsidiary Y and distributes the stock of Y to
X's shareholders. After the distribution, the State M store has its own
manager and is operated independently of the other stores. X and Y both
satisfy the requirements of section 355(b). See paragraph (b)(3)(i) and
(ii) of this section.
Example (9). For the past eight years, corporation X has engaged in
the manufacture and sale of household products. Throughout this period,
X has maintained a research department for use in connection with its
manufacturing activities. The research department has 30 employees
actively engaged in the development of new products. X transfers the
research department to new subsidiary Y and distributes the stock of Y
to X's shareholders. After the distribution, Y continues its research
operations on a contractual basis with several corporations, including
X. X and Y both satisfy the requirements of section 355(b). See
paragraph (b)(3)(i) of this section. The result in this example is the
same if, after the distribution, Y continues its research operations but
furnishes its services only to X. See paragraph (b)(3)(i) of this
section. However, see Sec. 1.355-2 (d)(2)(iv)(C) (related function
device factor) for possible evidence of device.
Example (10). For the past six years, corporation X has processed
and sold meat products. X derives income from no other source. X
separates the sales function from the processing function by
transferring the business assets related to the sales function and cash
for working capital to new subsidiary Y. X then distributes the stock of
Y to X's shareholders. After the distribution, Y purchases for resale
the meat products processed by X. X and Y both satisfy the requirements
of section 355(b). See paragraph (b)(3)(i) of this section. However, see
Sec. 1.355-2(d)(2)(iv)(C) (related function device factor) for possible
evidence of device.
Example (11) . For the past eight years, corporation X has been
engaged in the manufacture and sale of steel and steel products. X owns
all of the stock of corporation Y, which, for the past six years, has
owned and operated a coal mine for the sole purpose of supplying X's
coal requirements in the manufacture of steel. X distributes the stock
of Y to X's shareholders. X and Y both satisfy the requirements of
section 355 (b). See paragraph (b)(3)(i) of this section. However, see
Sec. 1.355-2 (d)(2)(iv)(C) (related function device factor) for possible
evidence of device.
Example (12) . For the past seven years, corporation X, a bank, has
owned an eleven-story office building, the ground floor of which X has
occupied in the conduct of its banking business. The remaining ten
floors are rented to various tenants. Throughout this seven-year period,
the building has been managed and maintained by employees of the bank. X
transfers the building to new subsidiary Y and distributes the stock of
Y to X's shareholders. Henceforth, Y will manage the building, negotiate
leases, seek new tenants, and repair and maintain the building. X and Y
both satisfy the requirements of section 355 (b). See paragraph (b)(3)
of this section.
Example (13) . For the past nine years, corporation X, a bank, has
owned a two-story building, the ground floor and one half of the second
floor of which X has occupied in the conduct of its banking business.
The other half of the second floor has been rented as storage space to a
neighboring retail merchant. X transfers the building to new subsidiary
Y and distributes the stock of Y to X's shareholders. After the
distribution, X leases from Y the space in the building that it formerly
occupied. Under the lease, X will repair and maintain its portion of the
building and pay property taxes and insurance. Y does not satisfy the
requirements of section 355 (b) because it is not engaged in the active
conduct of a trade or business immediately after the distribution. See
paragraph (b)(2)(iv)(A) of this section. This example does not address
the question of whether the activities of X with respect to the building
prior to the separation would constitute the active conduct of a trade
or business.
[T.D. 8238, 54 FR 294, Jan. 5, 1989]
Sec. 1.355-4 Non pro rata distributions, etc.
Section 355 provides for nonrecognition of gain or loss with respect
to a distribution whether or not (a) the distribution is pro rata with
respect to all of the shareholders of the distributing corporation, (b)
the distribution is pursuant to a plan of reorganization within the
meaning of section 368 (a) (1)(D), or (c) the shareholder surrenders
stock in the distributing corporation. Under section 355, the stock of a
controlled corporation may consist of common stock or preferred stock.
(See, however, section 306 and the regulations thereunder.) Section 355
does not apply, however, if the substance of a transaction is merely an
exchange between shareholders or security holders of stock or securities
in one corporation
[[Page 202]]
for stock or securities in another corporation. For example, if two
individuals, A and B, each own directly 50 percent of the stock of
corporation X and 50 percent of the stock of corporation Y, section 355
would not apply to a transaction in which A and B transfer all of their
stock of X and Y to a new corporation Z, for all of the stock of Z, and
Z then distributes the stock of X to A and the stock of Y to B.
[T.D. 8238, 54 FR 296, Jan. 5, 1989]
Sec. 1.355-5 Records to be kept and information to be filed.
(a) Every corporation that makes a distribution of stock or
securities of a controlled corporation, as described in section 355,
shall attach to its return for the year of the distribution a detailed
statement setting forth such data as may be appropriate in order to show
compliance with the provisions of such section.
(b) Every taxpayer who receives a distribution of stock or
securities of a corporation that was controlled by a corporation in
which he holds stock or securities shall attach to his return for the
year in which such distribution is received a detailed statement setting
forth such data as may be appropriate in order to show the applicability
of section 355. Such statement shall include, but shall not be limited
to, a description of the stock and securities surrendered (if any) and
received, and the names and addresses of all of the corporations
involved in the transaction.
Sec. 1.355-6 Recognition of gain on certain distributions of stock or securities in controlled corporation.
(a) Conventions--(1) Examples. For purposes of the examples in this
section, unless otherwise stated, assume that P, S, T, X, Y, N, HC, D,
D1, D2, D3, and C are corporations, A and B are individuals,
shareholders are not treated as one person under section 355(d)(7),
stock has been owned for more than five years and section 355(d)(6) and
paragraph (e)(4) of this section do not apply, no election under section
338 (if available) is made, and all transactions described are respected
under general tax principles, including the step transaction doctrine.
No inference should be drawn from any example as to whether any
requirements of section 355 other than those of section 355(d), as
specified, are satisfied.
(2) Five-year period. For purposes of this section, the term five-
year period means the five-year period (determined after applying
section 355(d)(6) and paragraph (e)(4) of this section) ending on the
date of the distribution, but in no event beginning earlier than October
10, 1990.
(3) Distributing securities. For purposes of determining if stock of
any controlled corporation received in the distribution is disqualified
stock described in section 355(d)(3)(B)(ii)(II) (relating to a
distribution of controlled corporation stock on any securities in the
distributing corporation acquired by purchase during the five-year
period), references in this section to stock of a corporation that is or
becomes a distributing corporation includes securities of the
corporation. Similarly, a reference to stock in paragraph (c)(4) of this
section (relating to a plan or arrangement) includes securities.
(4) Marketable securities. Unless otherwise stated, any reference in
this section to marketable stock includes marketable securities.
(b) General rules and purposes of section 355(d)--(1) Disqualified
distributions in general. In the case of a disqualified distribution,
any stock or securities in the controlled corporation shall not be
treated as qualified property for purposes of section 355(c)(2) or
361(c)(2). In general, a disqualified distribution is any distribution
to which section 355 (or so much of section 356 as relates thereto)
applies if, immediately after the distribution--
(i) Any person holds disqualified stock in the distributing
corporation that constitutes a 50 percent or greater interest in such
corporation; or
(ii) Any person holds disqualified stock in the controlled
corporation (or, if stock of more than one controlled corporation is
distributed, in any controlled corporation) that constitutes a 50
percent or greater interest in such corporation.
(2) Disqualified stock--(i) In general. Disqualified stock is--
[[Page 203]]
(A) Any stock in the distributing corporation acquired by purchase
during the five-year period; and
(B) Any stock in any controlled corporation--
(1) Acquired by purchase during the five-year period; or
(2) Received in the distribution to the extent attributable to
distributions on any stock in the distributing corporation acquired by
purchase during the five-year period.
(ii) Purchase. For the definition of a purchase for purposes of
section 355(d) and this section, see section 355(d)(5) and paragraph (d)
of this section.
(iii) Exceptions--(A) Purchase eliminated. Stock (or an interest in
another entity) that is acquired by purchase (including stock (or
another interest) that is treated as acquired by purchase under
paragraph (e)(2), (3), or (4) of this section) ceases to be acquired by
that purchase if (and when) the basis resulting from the purchase is
eliminated. For purposes of this paragraph (b)(2)(iii), basis resulting
from the purchase is basis in the stock (or in an interest in another
entity) that is directly purchased during the five-year period or that
is treated as acquired by purchase during such period under paragraph
(e)(2), (3), or (4) of this section.
(B) Deemed purchase eliminated. Stock (or an interest in another
entity) that is deemed purchased under section 355(d)(8) or paragraph
(e)(1) of this section shall cease to be treated as purchased if (and
when) the basis resulting from the purchase that effects the deemed
purchase is eliminated.
(C) Elimination of basis--(1) General rule. Basis in the stock of a
corporation (or in an interest in another entity) is eliminated if (and
when) it would no longer be taken into account by any person in
determining gain or loss on a sale or exchange of any stock of such
corporation (or an interest in the other entity). Basis is not
eliminated, however, if it is allocated between stock of two
corporations under Sec. 1.358-2(a).
(2) Special rule for transferred and exchanged basis property. Basis
of stock (or an interest in another entity) resulting from a purchase
(the first purchase) is eliminated if (and when) such stock (or other
interest) is subsequently transferred to another person in an exchange
or other transfer to which paragraph (e)(2) or (3) of this section
applies (the second purchase). The elimination of basis in stock (or in
another interest) resulting from the first purchase, however, does not
eliminate the basis resulting from the second purchase in the stock (or
other interest) that is treated as acquired by purchase by the acquirer
in a transaction to which paragraph (e)(2) of this section applies or by
the person making the exchange in a transaction to which paragraph
(e)(3) of this section applies.
(3) Special rule for Split-offs and Split-ups. Under section
355(d)(3)(B)(ii) and paragraph (b)(2)(i)(B)(2) of this section,
disqualified stock includes controlled corporation stock received in
exchange for distributing corporation stock acquired by purchase. Solely
for purposes of determining whether controlled corporation stock
received in a distribution in exchange for distributing corporation
stock is disqualified stock described in that section and paragraph
immediately after the distribution, paragraph (b)(2)(iii)(C)(2) of this
section does not apply to the exchange to eliminate basis resulting from
a purchase of that distributing corporation stock (notwithstanding that
paragraph (e)(3) of this section applies to the exchange).
(D) Special rule if basis allocated between two corporations. If the
shareholder of a distributing corporation, pursuant to Sec. 1.358-2,
allocates basis resulting from a purchase between the stock of two or
more corporations then, following such allocation, the determination of
whether such basis has been eliminated shall be made separately with
respect to the stock of each such corporation.
(3) Certain distributions not disqualified distributions because
purposes of section 355(d) not violated--(i) In general. Notwithstanding
the provisions of section 355(d)(2) and this paragraph (b), a
distribution is not a disqualified distribution if the distribution does
not violate the purposes of section 355(d) as provided in this paragraph
(b)(3). A distribution does not violate the purposes of section 355(d)
if the effect of the distribution is neither--
[[Page 204]]
(A) To increase ownership (combined direct and indirect) in the
distributing corporation or any controlled corporation by a disqualified
person; nor
(B) To provide a disqualified person with a purchased basis in the
stock of any controlled corporation.
(ii) Disqualified person. A disqualified person is any person
(taking into account section 355(d)(7) and paragraph (c)(4) of this
section) that, immediately after a distribution, holds (directly or
indirectly under section 355(d)(8) and paragraph (e)(1) of this section)
disqualified stock in the distributing corporation or controlled
corporation that--
(A) The person--
(1) Acquired by purchase under section 355(d)(5) or (8) and
paragraphs (d) and (e) of this section during the five-year period, or
(2) Received in the distribution to the extent attributable to
distributions on any stock in the distributing corporation acquired by
purchase under section 355(d)(5) or (8) and paragraphs (d) and (e) of
this section by that person during the five-year period; and
(B) Constitutes a 50 percent or greater interest in such corporation
(under section 355(d)(4) and paragraph (c) of this section).
(iii) Purchased basis. In general, a purchased basis is basis in
controlled corporation stock that is disqualified stock. However, basis
in controlled corporation stock that is disqualified stock will not be
treated as purchased basis if the controlled corporation stock and any
distributing corporation stock with respect to which the controlled
corporation stock is distributed are treated as acquired by purchase
solely under the attribution rules of section 355(d)(8) and paragraph
(e)(1) of this section. The prior sentence will not apply, however, if
the distributing corporation stock is treated as acquired by purchase
under the attribution rules as a result of the acquisition of an
interest in a partnership (the purchased partnership), and following the
distribution, the controlled corporation stock is directly held by the
purchased partnership (or a chain of partnerships that includes the
purchased partnership).
(iv) Increase in interest because of payment of cash in lieu of
fractional shares. Any increase in direct or indirect ownership in the
distributing corporation or any controlled corporation by a disqualified
person because of a payment of cash in lieu of issuing fractional shares
will be disregarded for purposes of paragraph (b)(3)(i)(A) of this
section if the payment of the cash is solely to avoid the expense and
inconvenience of issuing fractional share interests, and does not
represent separately bargained for consideration.
(v) Other exceptions. The Commissioner may provide by guidance
published in the Internal Revenue Bulletin that other distributions are
not disqualified distributions because they do not violate the purposes
of section 355(d).
(vi) Examples. The following examples illustrate this paragraph
(b)(3):
Example 1. Stock distributed in spin-off; no purchased basis. D owns
all of the stock of D1, and D1 owns all the stock of C. A purchases 60
percent of the D stock for cash. Within five years of A's purchase, D1
distributes the C stock to D. A is treated as having purchased 60
percent of the stock of both D1 and C on the date A purchases 60 percent
of the D stock under the attribution rules of section 355(d)(8) and
paragraph (e)(1) of this section. The C stock received by D is
attributable to a distribution on purchased D1 stock under section
355(d)(3)(B)(ii). Accordingly, the D1 and C stock each is disqualified
stock under section 355(d)(3) and paragraph (b)(2) of this section, and
A is a disqualified person under paragraph (b)(3)(ii) of this section.
However, the purposes of section 355(d) under paragraph (b)(3)(i) of
this section are not violated. A did not increase direct or indirect
ownership in D1 or C. In addition, D's basis in the C stock is not a
purchased basis under paragraph (b)(3)(iii) of this section because both
the D1 and the C stock are treated as acquired by purchase solely under
the attribution rules of section 355(d)(8) and paragraph (e)(1) of this
section. Accordingly, D1's distribution of the C stock to D is not a
disqualified distribution under section 355(d)(2) and paragraph (b)(1)
of this section.
Example 2. Stock distributed in spin-off; purchased basis. The facts
are the same as Example 1, except that D immediately further distributes
the C stock to its shareholders (including A) pro rata. The D and C
stock each is disqualified stock under section 355(d)(3) and paragraph
(b)(2) of this section, and A is a disqualified person under paragraph
(b)(3)(ii) of this section. The purposes of section 355(d) under
paragraph (b)(3)(i) of this
[[Page 205]]
section are violated. A did not increase direct or indirect ownership in
D or C. However, A's basis in the C stock is a purchased basis under
paragraph (b)(3)(iii) of this section because the D stock is not treated
as acquired by purchase solely under the attribution rules of section
355(d)(8) and paragraph (e)(1) of this section. Accordingly, the further
distribution is a disqualified distribution under section 355(d)(2) and
paragraph (b)(1) of this section.
Example 3. Stock distributed in split-off with ownership increase;
purchased basis. The facts are the same as Example 1, except that D
immediately further distributes the C stock to A in exchange for A's
purchased stock in D. The C stock received by A is attributable to a
distribution on purchased D stock under section 355(d)(3)(B)(ii), and
A's basis in the C stock is determined by reference to the adjusted
basis of A's purchased D stock under paragraph (e)(3) of this section.
(Under paragraph (b)(2)(iii)(B)(3) of this section, the basis resulting
from A's purchase of D stock is not eliminated solely for purposes of
determining if the C stock acquired by A is disqualified stock
immediately after the distribution, notwithstanding that paragraph
(e)(3) of this section applies to the exchange.) Accordingly, the D
stock and the C stock each is disqualified stock under section 355(d)(3)
and paragraph (b)(2) of this section, and A is a disqualified person
under paragraph (b)(3)(ii) of this section. The purposes of section
355(d) under paragraph (b)(3)(i) of this section are violated because A
increased its ownership in C from a 60 percent indirect interest to a
100 percent direct interest, and because A's basis in the C stock is a
purchased basis under paragraph (b)(3)(iii) of this section.
Accordingly, the further distribution is a disqualified distribution
under section 355(d)(2) and paragraph (b)(1) of this section.
Example 4. Stock distributed in spin-off; purchased basis. D1 owns
all the stock of C. D purchases all of the stock of D1 for cash. Within
five years of D's purchase of D1, P acquires all of the stock of D1 from
D in a section 368(a)(1)(B) reorganization that is not a reorganization
under section 368(a)(1)(A) by reason of section 368(a)(2)(E), and D1
distributes all of its C stock to P. P is treated as having acquired the
D1 stock by purchase on the date D acquired it under the transferred
basis rule of section 355(d)(5)(C) and paragraph (e)(2) of this section.
P is treated as having purchased all of the C stock on the date D
purchased the D1 stock under the attribution rules of section 355(d)(8)
and paragraph (e)(1) of this section, and the C stock received by P is
attributable to a distribution on purchased D1 stock under section
355(d)(3)(B)(ii). Accordingly, the D1 and C stock each is disqualified
stock under section 355(d)(3) and paragraph (b)(2) of this section, and
P is a disqualified person under paragraph (b)(3)(ii) of this section.
The purposes of section 355(d) under paragraph (b)(3)(i) of this section
are violated. P did not increase direct or indirect ownership in D1 or
C. However, P's basis in the C stock is a purchased basis under
paragraph (b)(3)(iii) of this section because the D1 stock is not
treated as acquired by purchase solely under the attribution rules of
section 355(d)(8) and paragraph (e)(1) of this section. Accordingly,
D1's distribution of the C stock to P is a disqualified distribution
under section 355(d)(2) and paragraph (b)(1) of this section.
Example 5. Stock distributed in split-off with ownership increase;
no purchased basis. P owns 50 percent of the stock of D, the remaining D
stock is owned by unrelated persons, D owns all the stock of C, and A
purchases all of the P stock from the P shareholders. Within five years
of A's purchase, D distributes all of the C stock to P in exchange for
P's D stock. A is treated as having purchased 50 percent of the stock of
both D and C on the date A purchases the P stock under the attribution
rules of section 355(d)(8) and paragraph (e)(1) of this section. The C
stock received by P is attributable to a distribution on purchased D
stock under section 355(d)(3)(B)(ii). Accordingly, the D stock and the C
stock each is disqualified stock under section 355(d)(3) and paragraph
(b)(2) of this section, and A is a disqualified person under paragraph
(b)(3)(ii) of this section. The purposes of section 355(d) under
paragraph (b)(3)(i) of this section are violated because, even though
P's basis in the C stock is not a purchased basis under paragraph
(b)(3)(iii) of this section, A increased its direct or indirect
ownership in C from a 50 percent indirect interest to a 100 percent
indirect interest. Accordingly, D's distribution of the C stock to P is
a disqualified distribution under section 355(d)(2) and paragraph (b)(1)
of this section.
Example 6. Stock distributed in split-off with no ownership
increase; no purchased basis. A purchases all of the stock of T. T later
merges into D in a section 368(a)(1)(A) reorganization and A exchanges
its purchased T stock for 60 percent of the stock of D. D owns all of
the stock of D1 and D2, D1 and D2 each owns 50 percent of the stock of
D3, and D3 owns all of the stock of C. Within five years of A's purchase
of the T stock, D3 distributes the C stock to D1 in exchange for all of
D1's D3 stock. A is treated as having acquired 60 percent of the D stock
by purchase on the date A purchases the T stock under paragraph (e)(3)
of this section. A is treated as having purchased 60 percent of the
stock of D1, D2, D3, and C on the date A purchases the T stock under the
attribution rules of section 355(d)(8) and paragraph (e)(1) of this
section. The C stock received by D1 is attributable to a distribution on
purchased D3 stock under section 355(d)(3)(B)(ii). Accordingly, the D3
stock and the C stock each is disqualified stock under section 355(d)(3)
and
[[Page 206]]
paragraph (b)(2) of this section, and A is a disqualified person under
paragraph (b)(3)(ii) of this section. However, the purposes of section
355(d) under paragraph (b)(3)(i) of this section are not violated. A did
not increase direct or indirect ownership in D3 or C, and D1's basis in
the C stock is not a purchased basis under paragraph (b)(3)(iii) of this
section because the D3 stock is treated as acquired by purchase solely
under the attribution rules of section 355(d)(8) and paragraph (e)(1) of
this section. Accordingly, D3's distribution of the C stock to D1 is not
a disqualified distribution under section 355(d)(2) and paragraph (b)(1)
of this section.
Example 7. Purchased basis eliminated by liquidation; stock
distributed in spin-off. P owns 30 percent of the stock of D, D owns all
of the stock of D1, and D1 owns all of the stock of C. P purchases the
remaining 70 percent of the D stock for cash. Within five years of P's
purchase, P liquidates D in a transaction qualifying under sections 332
and 337(a), and D1 then distributes the stock of C to P. Prior to the
liquidation, P is treated as having purchased 70 percent of the stock of
D1 and C on the date P purchases the D stock under the attribution rules
of section 355(d)(8)(B) and paragraph (e)(1) of this section. After the
liquidation, however, under paragraph (b)(2)(iii) of this section, P is
not treated as having acquired by purchase the D1 or the C stock under
section 355(d)(8)(B) and paragraph (e)(1) of this section because P's
basis in the D stock is eliminated in the liquidation of D. Under
section 334(b)(1), P's basis in the D1 stock is determined by reference
to D's basis in the D1 stock and not by reference to P's basis in D.
Paragraph (d)(2)(i)(B) of this section does not treat the D1 stock as
newly purchased in P's hands because no gain or loss was recognized by D
in the liquidation. Accordingly, neither the D1 stock nor the C stock is
disqualified stock under section 355(d)(3) and paragraph (b)(2) of this
section in P's hands, and the distribution is not a disqualified
distribution under section 355(d)(2) and paragraph (b)(1) of this
section.
Example 8. Purchased basis eliminated by upstream merger; stock
distributed in spin-off. D owns all of the stock of D1, and D1 owns all
of the stock of C. P purchases 60 percent of the D stock for cash.
Within five years of P's purchase, D merges into P in a section
368(a)(1)(A) reorganization, with the D shareholders other than P
receiving solely P stock in exchange for their D stock, and D1 then
distributes the stock of C to P. Prior to the merger, P is treated as
having purchased 60 percent of the stock of D1 and C on the date P
purchases the D stock under the attribution rules of section 355(d)(8)
and paragraph (e)(1) of this section. After the merger, however, under
paragraph (b)(2)(iii) of this section, P is not treated as having
acquired by purchase the D1 or the C stock under section 355(d)(8)(B)
and paragraph (e)(1) of this section because P's basis in the D stock is
eliminated in the merger. Under section 362(b), P's basis in the D1
stock is determined by reference to D's basis in the D1 stock and not by
reference to P's basis in D. Paragraph (d)(2)(i)(B) of this section does
not treat the D1 stock as newly purchased in P's hands because no gain
or loss was recognized by D in the merger. Accordingly, neither the D1
stock nor the C stock is disqualified stock under section 355(d)(3) and
paragraph (b)(2) of this section in P's hands, and the distribution is
not a disqualified distribution under section 355(d)(2) and paragraph
(b)(1) of this section.
Example 9. Purchased basis eliminated by distribution; stock
distributed in spin-off. A purchases all the stock of C for cash on Date
1. D acquires all of the stock of C from A in a section 368(a)(1)(B)
reorganization that is not a reorganization under section 368(a)(1)(A)
by reason of section 368(A)(1)(E). A receives ten percent of the D stock
in the transaction. The remaining D stock is owned by B. Within five
years of A's purchase of the C stock, D distributes all the stock of C
pro rata to A and B. Under the transferred basis rule of paragraph
(e)(2) of this section, D is treated as having purchased all of the C
stock on the date A acquired it. Under the exchanged basis rule of
paragraph (e)(3) of this section, A is treated as having purchased its D
stock on Date 1 and A is treated as having purchased ten percent of the
C stock on Date 1 under the attribution rules of section 355(d)(8) and
paragraph (e)(3) of this section. Moreover, under paragraph
(b)(2)(iii)(C) of this section, A's basis in the C stock resulting from
A's Date 1 purchase of C stock is eliminated. After the distribution,
A's and B's bases in their C stock are determined by reference to the
bases of their D stock under Sec. 1.358-2(a)(2) (and not by reference to
D's basis in the C stock). D's basis in the stock of C resulting from
its deemed purchase of that stock under paragraph (e)(2) of this section
is eliminated by the distribution of the C stock because it would no
longer be taken into account by any person in determining gain or loss
on the sale of C stock. Therefore, the C stock distributed to A and B is
not disqualified stock as a result of D's purchase of C. However, A's
basis in its D stock resulting from its deemed purchase of that stock
under paragraph (e)(3) of this section is not eliminated. Therefore, A's
ten percent interest in the stock of D is disqualified stock.
Furthermore, A's ten percent interest in the stock of C is disqualified
stock because the distribution of the C stock is attributable to A's D
stock that was acquired by purchase. However, there has not been a
disqualified distribution because no person, immediately after the
distribution, holds disqualified stock in either D or C that constitutes
a 50
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percent or greater interest in such corporation.
Example 10. Allocation of purchased basis analyzed separately. --(i)
P owns all the stock of D. D purchases all the stock of D1 for cash on
Date 1. D1 owns all the stock of C (which owns all the stock of C1) and
S. Within five years of Date 1, D1 distributes all the stock of C to D.
The D1 and C stock each is disqualified stock under section 355(d)(3)
and paragraph (b)(2) of this section, and D is a disqualified person
under paragraph (b)(3)(ii) of this section. The purposes of section
355(d) under paragraph (b)(3)(i) of this section are violated. D did not
increase direct or indirect ownership in D1 or C. However, D's basis in
the C stock is a purchased basis under paragraph (b)(3)(iii) of this
section because the D1 stock is not treated as acquired by purchase
solely under the attribution rules of section 355(d)(8) and paragraph
(e)(1) of this section. Accordingly, the distribution is a disqualified
distribution under section 355(d) and paragraph (b)(1) of this section.
D's basis in the D1 stock is allocated pursuant to Sec. 1.358-2 between
the D1 stock and the C stock. Therefore, under paragraph (e)(4) of this
section, the C stock is deemed to be acquired by purchase on Date 1, the
date D purchased all the stock of D1. If thereafter, and within five
years of Date 1, C were to distribute all the stock of C1 to D, that
distribution would also be a disqualified distribution because of D's
deemed purchase of the stock of C.
(ii) Following the distribution of the stock of C by D1, and within
five years of Date 1, D distributes all the stock of D1 to P. Under
paragraph (b)(2)(iii)(D) of this section, the determination of whether
D's basis in D1 has been eliminated shall be made without regard to D's
allocated basis in C. After the distribution, P's basis in the D1 stock
is determined by reference to its basis in its D stock under Sec. 1.358-
2(a)(2) (and not by reference to D's basis in the D1 stock). D's basis
in the D1 stock resulting from the purchase of that stock is eliminated
by the distribution of the D1 stock because it would no longer be taken
into account by any person in determining gain or loss on the sale of D1
stock. Therefore, the D1 stock distributed to P is not disqualified
stock as a result of D's purchase of D1. Moreover, a subsequent
distribution of the S stock by D1 to P would not be a disqualified
distribution because both the D1 and S stock would cease to be treated
as purchased when D's basis in D1 has been eliminated.
(4) Anti-avoidance rule--(i) In general. Notwithstanding any
provision of section 355(d) or this section, the Commissioner may treat
any distribution as a disqualified distribution under section 355(d)(2)
and paragraph (b)(1) of this section if the distribution or another
transaction or transactions are engaged in or structured with a
principal purpose to avoid the purposes of section 355(d) or this
section with respect to the distribution. Without limiting the preceding
sentence, the Commissioner may determine that the existence of a related
person, intermediary, pass-through entity, or similar person (an
intermediary) should be disregarded, in whole or in part, if the
intermediary is formed or availed of with a principal purpose to avoid
the purposes of section 355(d) or this section.
(ii) Example. The following example illustrates this paragraph
(b)(4):
Example. Post-distribution redemption. B wholly owns D, which wholly
owns C. With a principal purpose to avoid the purposes of section
355(d), A, B, D, and C engage in the following transactions. A purchases
45 of 100 shares of the only class of D stock. Within five years after
A's purchase, D distributes all of its 100 shares in C to A and B pro
rata. D then redeems 20 shares of B's D stock, and C redeems 20 shares
of B's C stock. After the redemption, A owns 45 shares and B owns 35
shares in each of D and C. Under paragraph (b)(4)(i) of this section,
the Commissioner may treat A as owning disqualified stock in D and C
that constitutes a 50 percent or greater interest in D and C immediately
after the distribution. Under that treatment, the distribution is a
disqualified distribution under section 355(d)(2) and paragraph (b)(1)
of this section.
(c) Whether a person holds a 50 percent or greater interest--(1) In
general. Under section 355(d)(4), 50 percent or greater interest means
stock possessing at least 50 percent of the total combined voting power
of all classes of stock entitled to vote or at least 50 percent of the
total value of shares of all classes of stock.
(2) Valuation. For purposes of section 355(d)(4) and this section,
all shares of stock within a single class are considered to have the
same value. But see paragraph (c)(3)(vii)(A) of this section
(determination of whether it is reasonably certain that an option will
be exercised).
(3) Effect of options, warrants, convertible obligations, and other
similar interests--(i) Application. This paragraph (c)(3) provides rules
to determine when an option is treated as exercised
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for purposes of section 355(d) (other than section 355(d)(6)). Except as
provided in this paragraph (c)(3), an option is not treated as exercised
for purposes of section 355(d). This paragraph (c)(3) does not affect
the determination of whether an instrument is an option or stock under
general principles of tax law (such as substance over form).
(ii) General rule. In determining whether a person has acquired by
purchase a 50 percent or greater interest under section 355(d)(4), an
option to acquire stock (as described in paragraphs (c)(3)(v) and (vi)
of this section) that has not been exercised when a distribution occurs
is treated as exercised on the date it was issued or most recently
transferred if--
(A) Its exercise (whether by itself or in conjunction with the
deemed exercise of one or more other options) would cause a person to
become a disqualified person; and
(B) Immediately after the distribution, it is reasonably certain (as
described in paragraph (c)(3)(vii) of this section) that the option will
be exercised.
(iii) Options deemed newly issued and substituted options--(A)
Exchange, adjustment, or alteration of existing option. For purposes of
this paragraph (c)(3), each of the following is treated as a new
issuance or transfer of an existing option only if it materially
increases the likelihood that an option will be exercised--
(1) An exchange of an option for another option or options;
(2) An adjustment to the terms of an option (including an adjustment
pursuant to the terms of the option);
(3) An adjustment to the terms of the underlying stock (including an
adjustment pursuant to the terms of the stock);
(4) A change to the capital structure of the issuing corporation;
and
(5) An alteration to the fair market value of issuing corporation
stock through an asset transfer (other than regular, ordinary dividends)
or through any other means.
(B) Certain compensatory options. An option described in paragraph
(c)(3)(vi)(B)(2) of this section is treated as issued on the date it
becomes transferable.
(C) Substituted options. If an option (existing option) is exchanged
for another option or options (substituted option or options) and
paragraph (c)(3)(iii)(A) of this section does not apply to treat such
exchange as a new issuance or transfer of the existing option, the
substituted option or options will be treated as issued or most recently
transferred on the date that the existing option was issued or most
recently transferred.
(iv) Effect of treating an option as exercised--(A) In general. For
purposes of section 355(d), an option that is treated as exercised under
this paragraph (c)(3) is treated as exercised both for purposes of
determining the percentage of the voting power of stock owned by the
holder and for purposes of determining the percentage of the value of
stock owned by the holder.
(B) Stock purchase agreement or similar arrangement. If a stock
purchase agreement or similar arrangement is deemed exercised, the
purchaser is treated as having purchased the stock under the terms of
the agreement or arrangement as though all covenants had been satisfied
and all contingencies met. The agreement or arrangement is deemed to
have been exercised as of the date it is entered into or most recently
assigned.
(v) Instruments treated as options. For purposes of this paragraph
(c)(3), except to the extent provided in paragraph (c)(3)(vi) of this
section, the following are treated as options: A call option, warrant,
convertible obligation, the conversion feature of convertible stock, put
option, redemption agreement (including a right to cause the redemption
of stock), notional principal contract (as defined in Sec. 1.446-3(c))
that provides for the payment of amounts in stock, stock purchase
agreement or similar arrangement, or any other instrument that provides
for the right to purchase, issue, redeem, or transfer stock (including
an option on an option).
(vi) Instruments generally not treated as options. For purposes of
this paragraph (c)(3), the following are not treated as options, unless
issued, transferred, or listed with a principal purpose to avoid the
application of section 355(d) or this section:
[[Page 209]]
(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--(1) General rule. An option to acquire
stock in a corporation with customary terms and conditions, provided to
an employee, director, or independent contractor 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--
(i) Is nontransferable within the meaning of Sec. 1.83-3(d); and
(ii) Does not have a readily ascertainable fair market value as
defined in Sec. 1.83-7(b).
(2) Exception. Paragraph (c)(3)(vi)(B)(1) of this section ceases to
apply to an option that becomes transferable.
(C) Certain stock conversion features. The conversion feature of
convertible stock, provided that--
(1) The stock is not convertible for at least five years after
issuance or transfer; and
(2) The terms of the conversion feature do not require the tender of
any consideration other than the stock being converted.
(D) Options exercisable only upon death, disability, mental
incompetency, or separation from service. Any option entered into
between stockholders of a corporation (or a stockholder and the
corporation) with respect to the stock of either stockholder that is
exercisable only upon the death, disability, 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 separation from service.
(E) 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).
(F) 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.
(vii) Reasonably certain that the option will be exercised--(A) In
general. The determination of whether, immediately after the
distribution, an option is reasonably certain 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) Stock purchase agreement or similar arrangement. A stock
purchase agreement or similar arrangement is treated as reasonably
certain to be exercised if the parties' obligations to complete the
transaction are subject only to reasonable closing conditions.
(viii) Examples. The following examples illustrate this paragraph
(c)(3):
Example 1. D owns all of the stock of C. A purchases 40 percent of
D's only class of stock and an option to purchase D stock from D, that
if deemed exercised, would result in A owning a total of 60 percent of
the stock of D. Assume that no control premium or minority or blockage
discount applies to the D stock underlying the option. The option
permits A to acquire the D stock at $30 per share, and D's stock has a
fair market value of $27 per share on the date the option is issued. The
option is subject to no contingencies or restrictive covenants, may be
exercised within five years after its issuance, and is not described in
paragraph (c)(3)(vi) of this section (regarding instruments generally
not treated as options). Within five years of A's purchase of the D
stock and option, D distributes the stock of its subsidiary C pro rata
and A receives 40 percent of the C stock in the distribution.
Immediately after the distribution, D's stock has a fair market value of
$30 per share and C's stock has a fair market value of $15 per share. At
the time of the distribution, A exchanges A's option for an option to
purchase 20 percent of the D stock at $20 per share and an option to
purchase 20 percent of the C stock at $10 per share. The exchange of the
options in D for options in D and C did not materially increase the
likelihood that the options would
[[Page 210]]
be exercised. Nonetheless, based on all the facts and circumstances, it
is reasonably certain, immediately after the distribution, that A will
exercise its options. Under paragraph (c)(3)(iii)(C) of this section,
the substituted options are treated as issued on the date the original
option was issued. Accordingly, the options are treated as exercised by
A on the date that A purchased the original option. A is treated as
owning 60 percent of the D stock and 60 percent of the C stock that is
disqualified stock, and the distribution is a disqualified distribution
under section 355(d)(2) and paragraph (b)(1) of this section.
Example 2. D owns all of the stock of C. A purchases 37 percent of
D's only class of stock. B owns 38 percent of the D stock, and the
remaining 25 percent is owned by 20 individuals, each of whom owns less
than five percent of D's stock. A purchases an option to purchase an
additional 14 percent of the D stock from shareholders other than B for
$50 per share. The option is subject to no contingencies or restrictive
covenants, may be exercised within five years after its issuance, and is
not described in paragraph (c)(3)(vi) of this section. Within five years
of A's purchase of the option and 37 percent interest in D, D
distributes the stock of its subsidiary C pro rata and A receives 37
percent of the C stock in the distribution. At the time of the
distribution, A exchanges its option for an option to purchase 14
percent of the D stock at $25 per share and an option to purchase 14
percent of the C stock at $25 per share. Assume that, although a
shareholder that owned no D or C stock would pay only $20 per share for
D or C stock immediately after the distribution, a shareholder in A's
position would pay $30 per share for 14 percent of the stock of D or C
because of the control premium which attaches to the shares. The control
premium is taken into account under paragraph (c)(3)(vii)(A) of this
section to determine whether A is reasonably certain to exercise the
options. The exchange of the options in D for options in D and C did not
materially increase the likelihood that the options would be exercised.
Nonetheless, based on all the facts and circumstances, it is reasonably
certain, immediately after the distribution, that A will exercise its
options. Under paragraph (c)(3)(iii)(C) of this section, the substituted
options are treated as issued on the date the original option was
issued. Accordingly, the options are treated as exercised by A on the
date that A purchased the original option. Under paragraph (c)(2) of
this section, all shares of D and C are considered to have the same
value to determine the amount of stock A is treated as purchasing under
the options. A is treated as owning 51 percent of the D stock and 51
percent of the C stock that is disqualified stock, and the distribution
is a disqualified distribution under section 355(d)(2).
(4) Plan or arrangement--(i) In general. Under section 355(d)(7)(B),
if two or more persons act pursuant to a plan or arrangement with
respect to acquisitions of stock in the distributing corporation or
controlled corporation, those persons are treated as one person for
purposes of section 355(d).
(ii) Understanding. For purposes of section 355(d)(7)(B), two or
more persons who are (or will after an acquisition become) shareholders
(or are treated as shareholders under paragraph (c)(3)(ii) of this
section) act pursuant to a plan or arrangement with respect to an
acquisition of stock only if they have a formal or informal
understanding among themselves to make a coordinated acquisition of
stock. 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 one or more other existing or prospective
shareholders. However, the participation by creditors in formulating a
plan for an insolvency workout or a reorganization in a title 11 or
similar case (whether as members of a creditors' committee or otherwise)
and the receipt of stock by creditors in satisfaction of indebtedness
pursuant to the workout or reorganization do not cause the creditors to
be considered as acting pursuant to a plan or arrangement.
(iii) Examples. The following examples illustrate paragraph
(c)(4)(ii) of this section:
Example 1. D has 1,000 shares of common stock outstanding. A group
of 20 unrelated individuals who previously owned no D stock (the Group)
agree among themselves to acquire 50 percent or more of D's stock. The
Group is not a person under section 7701(a)(1). Subsequently, pursuant
to their understanding, the members of the Group purchase 600 shares of
D common stock from the existing D shareholders (a total of 60 percent
of the D stock), with each member purchasing 30 shares. Under paragraph
(c)(4)(ii) of this section, the members of the Group have a formal or
informal understanding among themselves to make a coordinated
acquisition of stock. Their interests are therefore aggregated under
section 355(d)(7)(B), and they are treated as one person that purchased
600 shares of D's stock for purposes of section 355(d).
[[Page 211]]
Example 2. D has 1,000 shares of outstanding stock owned by
unrelated individuals. D's management is concerned that D may become
subject to a takeover bid. In separate meetings, D's management meets
with potential investors who own no stock and are friendly to management
to convince them to acquire D's stock based on an understanding that D
will assemble a group that in the aggregate will acquire more than 50
percent of D's stock. Subsequently, 15 of these investors each purchases
four percent of D's outstanding stock. Under paragraph (c)(4)(ii) of
this section, the 15 investors have a formal or informal understanding
among themselves to make a coordinated acquisition of stock. Their
interests are therefore aggregated under section 355(d)(7)(B), and they
are treated as one person that purchased 600 shares of D stock for
purposes of section 355(d).
Example 3. (i) D has 1,000 shares of outstanding stock owned by
unrelated individuals. An investment advisor advises its clients that it
believes D's stock is undervalued and recommends that they acquire D
stock. Acting on the investment advisor's recommendation, 20 unrelated
individuals each purchases 30 shares of the outstanding D stock. Each
client's decision was not based on the investment decisions made by one
or more other clients. Because there is no formal or informal
understanding among the clients to make a coordinated acquisition of D
stock, their interests are not aggregated under section 355(d)(7)(B) and
they are treated as making separate purchases.
(ii) The facts are the same as in paragraph (i) of this Example 3,
except that the investment advisor is also the underwriter (without
regard to whether it is a firm commitment or best efforts underwriting)
for a primary or secondary offering of D stock. The result is the same.
(iii) The facts are the same as in paragraph (i) of this Example 3,
except that, instead of an investment advisor recommending that clients
purchase D stock, the trustee of several trusts qualified under section
401(a) sponsored by unrelated corporations causes each trust to purchase
the D stock. The result is the same, provided that the trustee's
investment decision made on behalf of each trust was not based on the
investment decision made on behalf of one or more of the other trusts.
(iv) Exception--(A) Subsequent disposition. If two or more persons
do not act pursuant to a plan or arrangement within the meaning of this
paragraph (c)(4) with respect to an acquisition of stock in a
corporation (the first corporation), a subsequent acquisition in which
such persons exchange their stock in the first corporation for stock in
another corporation (the second corporation) in a transaction in which
the basis of the second corporation's stock in the hands of such persons
is determined in whole or in part by reference to the basis of their
stock in the first corporation, will not result in such persons being
treated as one person, even if the acquisition of the second
corporation's stock is pursuant to a plan or arrangement.
(B) Example. The following example illustrates this paragraph
(c)(4)(iv):
Example. In an initial public offering of D stock on Date 1, 100
investors independently purchase one percent each of the D stock. Two
years later, D merges into P (in a reorganization described in section
368(a)(1)(A)) and, pursuant to the plan of reorganization, the D
shareholders exchange their D stock for 50 percent of the stock of P.
The D shareholders approve the plan by a two-thirds vote, as required by
state law. Under section 358(a), each shareholder's basis in its P stock
is determined by reference to the basis of the D stock it purchased.
Under paragraph (e)(3) of this section, the former D shareholders are
treated as purchasing their P stock on Date 1. The investors do not
become a single person under paragraph (c)(4) of this section with
respect to the deemed purchase of the P stock on Date 1 by virtue of
their acquisition of the P stock pursuant to the merger on Date 2.
(d) Purchase--(1) In general--(i) Definition of purchase under
section 355(d)(5)(A). Under section 355(d)(5)(A), except as otherwise
provided in section 355(d)(5)(B) and (C), a purchase means any
acquisition, but only if--
(A) The basis of the property acquired in the hands of the acquirer
is not determined--
(1) In whole or in part by reference to the adjusted basis of such
property in the hands of the person from whom acquired; or
(2) Under section 1014(a); and
(B) The property is not acquired in an exchange to which section
351, 354, 355, or 356 applies.
(ii) Section 355 distributions. Paragraph (d)(1)(i)(B) of this
section includes all section 355 distributions, whether in exchange (in
whole or in part) for stock or pro rata.
(iii) Example. The following example illustrates this paragraph
(d)(1):
Example. Section 304(a)(1) acquisition. A, who owns all of the stock
of P and T, sells the T
[[Page 212]]
stock to P for cash. The T stock is not marketable stock under section
355(d)(5)(B)(ii) and paragraph (d)(3)(ii) of this section. A is treated
under section 304(a)(1) as receiving a distribution in redemption of the
P stock. Under section 302(d), the deemed redemption is treated as a
section 301 distribution. Assume that under sections 304(b)(2) and
301(c)(1), all of the distribution is a dividend. A and P are treated in
the same manner as if A had transferred the T stock to P in exchange for
stock of P in a transaction to which section 351(a) applies, and P had
then redeemed the stock P was treated as issuing in the transaction.
Under section 362(a), P's basis in the T stock is determined by
reference to A's adjusted basis in the T stock, and there is no basis
increase in the T stock because A recognizes no gain on the deemed
transfer. Accordingly, P's acquisition of the T stock from A is not a
purchase by P under section 355(d)(5)(A)(i)(I) and paragraphs
(d)(1)(i)(A)(1) and (d)(2)(i)(B) of this section.
(2) Exceptions to definition of purchase under section 355(d)(5)(A).
The following acquisitions are not treated as purchases under section
355(d)(5)(A):
(i) Acquisition of stock in a transaction which includes other
property or money--(A) Transferors and shareholders of transferor or
distributing corporations--(1) In general. An acquisition of stock
permitted to be received by a transferor of property without the
recognition of gain under section 351(a), or permitted to be received
without the recognition of gain under section 354, 355, or 356 is not a
purchase to the extent section 358(a)(1) applies to determine the
recipient's basis in the stock received, whether or not the recipient
recognizes gain under section 351(b) or 356. But see paragraph (e)(3) of
this section (interest received in exchange for purchased interest in
exchanged basis transaction treated as purchased).
(2) Exception. To the extent there is received in the exchange or
distribution, in addition to stock described in paragraph
(d)(2)(i)(A)(1) of this section, stock that is other property under
section 351(b) or 356(a)(1), the stock is treated as purchased on the
date of the exchange or distribution for purposes of section 355(d).
(B) Transferee corporations--(1) In general. An acquisition of stock
by a corporation is not a purchase to the extent section 334(b) or
362(a) or (b) applies to determine the corporation's basis in the stock
received. But see section 355(d)(5)(C) and paragraph (e)(2) of this
section (purchased property transferred in transferred basis transaction
is treated as purchased by transferee).
(2) Exception. If a corporation acquires stock, the stock is treated
as purchased on the date of the stock acquisition for purposes of
section 355(d)--
(i) If the liquidating corporation recognizes gain or loss with
respect to the transferred stock as described in section 334(b)(1); or
(ii) To the extent the basis of the transferred stock is increased
through the recognition of gain by the transferor under section 362(a)
or (b).
(C) Examples. The following examples illustrate this paragraph
(d)(2)(i):
Example 1. (i) A owns all the stock of T. T merges into D in a
transaction qualifying under section 368(a)(1)(A), with A exchanging all
of the T stock for D stock and $100 cash. Under section 356(a)(1), A
recognizes $100 of the realized gain on the transaction. Under section
358(a)(1), A's basis in the D stock equals A's basis in the T stock,
decreased by the $100 received and increased by the gain recognized,
also $100. Under paragraph (d)(2)(i)(A) of this section, A is not
treated as having purchased the D stock for purposes of section
355(d)(5).
(ii) The facts are the same as in paragraph (i) of this Example 1,
except that rather than D stock and $100 cash, A receives D stock and
stock in C, a corporation not a party to the reorganization, with a fair
market value of $100. Under section 358(a)(2), A's basis in the C stock
is its fair market value, or $100. Under paragraph (d)(2)(i)(A)(2) of
this section, A is treated as having purchased the C stock, but not the
D stock, for purposes of section 355(d)(5).
Example 2. A purchases all of the stock of D, which is not
marketable stock, on Date 1 for $90. Within five years of A's purchase,
on Date 2, A contributes the D stock to P in exchange for P stock worth
$90 and $10 cash in a transaction qualifying under section 351. A
recognizes a gain of $10 as a result of the transfer. Under section
362(a), P's basis in D is $100. P is treated as having purchased 90
percent ($90 worth) of the D stock on Date 1 under section 355(d)(5)(C)
and paragraph (e)(2) of this section and as having purchased 10 percent
($10 worth) of the D stock on Date 2 under paragraph (d)(2)(i)(B)(2)(ii)
of this section.
[[Page 213]]
(ii) Acquisition of stock in a distribution to which section 305(a)
applies. An acquisition of stock in a distribution qualifying under
section 305(a) is not a purchase to the extent section 307(a) applies to
determine the recipient's basis. However, to the extent the distribution
is of rights to acquire stock, see paragraph (c)(3) of this section for
rules regarding options, warrants, convertible obligations, and other
similar interests.
(iii) Section 1036(a) exchange. An exchange of stock qualifying
under section 1036(a) is not a purchase by either party to the exchange
to the extent the basis of the property acquired equals that of the
property exchanged under section 1031(d).
(iv) Section 338 elections--(A) In general. Stock acquired in a
qualified stock purchase with respect to which a section 338 election
(or a section 338(h)(10) election) is made is not treated as a purchase
for purposes of section 355(d)(5)(A). However, any stock (or an interest
in another entity) held by old target that is treated as purchased by
new target is treated as acquired by purchase for purposes of section
355(d)(5)(A) unless a section 338 election or section 338(h)(10)
election also is made for that stock. See Sec. 1.338-2T(c) for the
definitions of section 338 election, section 338(h)(10) election, old
target, and new target.
(B) Example. The following example illustrates this paragraph
(d)(2)(iv):
Example. T owns all of the stock of S and no other assets. X
acquires all of the T stock from the T shareholders for cash and makes
an election under section 338. Under section 338(a) and (b), T, as Old
T, is treated as having sold all of its assets at fair market value and
purchased the assets as a new corporation, New T, as of the beginning of
the day after the acquisition date. Under paragraph (d)(2)(iv)(A) of
this section, X is not treated as having purchased the T stock. Absent a
section 338 election or a section 338(h)(10) election with respect to S,
New T is treated as having purchased all of the S stock under section
355(d)(5)(A).
(v) Partnership distributions--(A) Section 732(b). An acquisition of
stock (or an interest in another entity) in a liquidation of a partner's
interest in a partnership in which basis is determined pursuant to
section 732(b) is a purchase at the time of the liquidation.
(B) Section 734(b). If the adjusted basis of stock (or an interest
in another entity) held by a partnership is increased under section
734(b), a proportionate amount of the stock (or other interest) will be
treated as purchased at the time of the basis adjustment, determined by
reference to the amount of the basis adjustment (but not in excess of
the fair market value of the stock (or other interest) at the time of
the adjustment) over the fair market value of the stock (or other
interest) at the time of the adjustment.
(3) Certain section 351 exchanges treated as purchases--(i) In
general--(A) Treatment of stock received by transferor. Under section
355(d)(5)(B), a purchase includes any acquisition of property in an
exchange to which section 351 applies to the extent the property is
acquired in exchange for any cash or cash item, any marketable stock, or
any debt of the transferor. The property treated as acquired by purchase
is the property received by the transferor in the exchange.
(B) Multiple classes of stock. If the transferor in a transaction
described in section 355(d)(5)(B) receives stock or securities of more
than one class, or receives both stock and securities, then the amount
of stock or securities purchased is determined in a manner that
corresponds to the allocation of basis to the stock or securities under
section 358. See Sec. 1.358-2(b).
(ii) Cash item, marketable stock. For purposes of section
355(d)(5)(B) and this paragraph (d)(3), either or both of the terms cash
item and marketable stock include personal property within the meaning
of section 1092(d)(1) and Sec. 1.1092(d)-1, without giving effect to
section 1092(d)(3).
(iii) Exception for certain acquisitions--(A) In general. Except to
the extent provided in paragraph (e)(3) of this section (interest
received in exchange for purchased interest in exchanged basis
transaction treated as purchased), an acquisition of stock in a
corporation in a section 351 transaction by one or more persons in
exchange for an amount of stock in another corporation (the transferred
corporation) that meets the requirements of section 1504(a)(2) is not a
purchase by the transferor or transferors, regardless of
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whether the stock of the transferred corporation is marketable stock
under section 355(d)(5)(B)(ii) and paragraph (d)(3)(ii) of this section.
(B) Example. The following example illustrates this paragraph
(d)(3)(iii):
Example. D's two classes of stock, voting common and nonvoting
preferred, are both widely held and publicly traded. The nonvoting
preferred stock is stock described in section 1504(a)(4). Assume that
all of the D stock is marketable stock under section 355(d)(5)(B)(ii)
and paragraph (d)(3)(ii) of this section. D's board of directors
proposes that, for valid business purposes, D's common stock should be
held by a holding company, HC, but its preferred stock should not be
transferred to HC. As proposed, the D common shareholders exchange their
D stock solely for HC common stock in a section 351(a) transaction. The
D preferred shareholders retain their stock. HC acquires an amount of D
stock that meets the requirements of section 1504(a)(2). Although the D
common stock was marketable stock in the hands of the D shareholders
immediately before the transfer, and the D nonvoting preferred stock is
marketable stock after the transfer, the D shareholders are not treated
as having acquired the HC stock by purchase (except to the extent the
exchanged basis rule of paragraph (e)(3) of this section may apply to
treat HC stock as purchased on the date the exchanged D stock was
purchased).
(iv) Exception for assets transferred as part of an active trade or
business--(A) In general. Except to the extent provided in paragraph
(e)(3) of this section, an acquisition not described in paragraph
(d)(3)(iii) of this section of stock in exchange for any cash or cash
item, any marketable stock, or any debt of the transferor in a section
351 transaction is not a purchase if--
(1) The transferor is engaged in the active conduct of a trade or
business under paragraph (d)(3)(iv)(B) of this section and the
transferred items (including debt incurred in the ordinary course of the
trade or business) are used in the trade or business;
(2) The transferred items do not exceed the reasonable needs of the
trade or business under paragraph (d)(3)(iv)(C) of this section;
(3) The transferor transfers the items as part of the trade or
business; and
(4) The transferee continues the active conduct of the trade or
business.
(B) Active conduct of a trade or business. For purposes of this
paragraph (d)(3)(iv), whether, with respect to the trade or business at
issue, the transferor and transferee are engaged in the active conduct
of a trade or business is determined under Sec. 1.355-3(b)(2) and (3),
except that--
(1) Conduct is tested before the transfer (with respect to the
transferor) and after the transfer (with respect to the transferee)
rather than immediately after a distribution; and
(2) The trade or business need not have been conducted for five
years before its transfer, but it must have been conducted for a
sufficient period of time to establish that it is a viable and ongoing
trade or business.
(C) Reasonable needs of the trade or business. For purposes of this
paragraph (d)(3)(iv), the reasonable needs of the trade or business
include only the amount of cash or cash items, marketable stock, or debt
of the transferor that a prudent business person apprised of all
relevant facts would consider necessary for the present and reasonably
anticipated future needs of the business. Transferred items may be
considered necessary for reasonably anticipated future needs only if the
transferor and transferee have specific, definite, and feasible plans
for their use. Those plans must require that items intended for
anticipated future needs rather than present needs be used as
expeditiously as possible consistent with the business purpose for
retention of the items. Future needs are not reasonably anticipated if
they are uncertain or vague or where the execution of the plan for their
use is substantially postponed. The reasonable needs of a trade or
business are generally its needs at the time of the transfer of the
business including the items. However, for purposes of applying section
355(d) to a distribution, events and conditions after the transfer and
through the date immediately after the distribution (including whether
plans for the use of transferred items have been consummated or
substantially postponed) may be considered to determine whether at the
time of the transfer the items were necessary for the present and
reasonably anticipated future needs of the business.
(D) Consideration of all facts and circumstances. All facts and
circumstances
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are considered in determining whether this paragraph (d)(3)(iv) applies.
(E) Successive transfers. A transfer of assets does not fail to meet
the requirements of paragraph (d)(3)(iv)(A)(4) of this section solely
because the transferee transfers the assets directly (or indirectly
through other members) to another member of the transferee's affiliated
group, as defined in Sec. 1.355-3(b)(4)(iv) (the final transferee), if
the requirements of paragraphs (d)(3)(iv)(A)(1), (2), (3) and (4) of
this section would be met if the transferor had transferred the assets
directly to the final transferee.
(v) Exception for transfer between members of the same affiliated
group--(A) In general. Except to the extent provided in paragraph (e)(3)
of this section, an acquisition of stock (whether actual or
constructive) not described in paragraphs (d)(3)(iii) and (iv) of this
section in exchange for any cash or cash item, marketable stock, or debt
of the transferor in a section 351 transaction is not a purchase if--
(1) The transferor corporation or corporations and the transferee
corporation (whether formed in the transaction or already existing) are
members of the same affiliated group as defined in section 1504(a)
before the section 351 transaction (if the transferee corporation is in
existence before the transaction);
(2) The cash or cash item, marketable stock or debt of the
transferor are not included in assets that are acquired (or treated as
acquired) by the transferor (or another member of the transferor's
affiliated group) from a nonmember in a related transaction in which
section 362(a) or (b) applies to determine the basis in the acquired
assets; and
(3) The transferor corporation or corporations, the transferee
corporation, and any distributed controlled corporation of the
transferee corporation do not cease to be members of such affiliated
group in any transaction pursuant to a plan that includes the section
351 transaction (including any distribution of a controlled corporation
by the transferee corporation). But see paragraph (b)(4) of this section
where the transfer is made for a principal purpose to avoid the purposes
of section 355(d).
(B) Examples. The following examples illustrate this paragraph
(d)(3)(v):
Example 1. Publicly traded P has wholly owned S since 1990. S is
engaged in the telecommunications business and the business of computer
software development. S is developing new software for use in the
managed health care industry. Over a period of four years beginning on
January 31, 2000, P contributes a substantial amount of cash to S solely
for the purpose of funding the software development. On completion of
the software in January of 2004, 60 percent of the value of the S stock
is attributable to the cash contributions made within the last four
years. The P group's primary lender requires that S separately
incorporate the software and related assets and distribute the new
subsidiary to P as a condition of providing required funding to market
the software. Accordingly, on February 1, 2004, S forms N, contributes
the software and related assets to N, and distributes all of the N stock
to P in a transaction intended to qualify under section 355(a). P, S,
and N will not leave the affiliated group in any transaction related to
the cash contributions. Under paragraph (d)(3)(v)(A) of this section,
P's cash contributions to S are not treated as purchases of additional S
stock, and the distribution of N from S to P is not a disqualified
distribution under section 355(d)(2) and paragraph (b)(1) of this
section.
Example 2. On Date 1, P contributes cash to its subsidiary S with a
principal purpose to increase its stock basis in S. Sixty percent of the
value of P's S stock is attributable to the cash contribution. Under
paragraph (b)(4) of this section (anti-avoidance rule), 60 percent of
the S stock is treated as purchased under section 355(d)(5)(B),
notwithstanding paragraph (d)(3)(v)(A) of this section. Accordingly, any
distribution of a subsidiary of S to P within the five-year period after
Date 1 will be a disqualified distribution, regardless of whether P, S,
and any distributed S subsidiary remain affiliated after the
distribution and any transactions related to the cash contribution.
(4) Triangular asset reorganizations--(i) Definition. A triangular
asset reorganization is a reorganization that qualifies under--
(A) Section 368(a)(1)(A) or (G) by reason of section 368(a)(2)(D);
(B) Section 368(a)(1)(A) by reason of section 368(a)(2)(E)
(regardless of whether section 368(a)(3)(E) applies), unless the
transaction also qualifies as either a section 351 transfer or a
reorganization under section 368(a)(1)(B); or
(C) Section 368(a)(1)(C), and stock of the controlling corporation
rather than
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the acquiring corporation is exchanged for the acquired corporation's
properties.
(ii) Treatment. Notwithstanding section 355(d)(5)(A), for purposes
of section 355(d), the controlling corporation in a triangular asset
reorganization is treated as having--
(A) Acquired the assets of the acquired corporation (and as having
assumed any liabilities assumed by the controlling corporation's
subsidiary corporation or to which the acquired corporation's assets
were subject (the acquired liabilities)) in a transaction in which the
controlling corporation's basis in the acquired corporation's assets was
determined under section 362(b); and
(B) Transferred the acquired assets and acquired liabilities to its
subsidiary corporation in a section 351 transfer.
(iii) Example. The following example illustrates this paragraph
(d)(4):
Example. Forward triangular reorganization. P forms S with $25 of
cash and T merges into S in a reorganization qualifying under section
368(a)(1)(A) by reason of section 368(a)(2)(D) in which the T
shareholders receive $70 of P stock and $15 of cash in exchange for
their T stock. T is not a common parent of a consolidated group of
corporations. The remaining $10 of cash with which P formed S will not
be used in the acquired business. T's assets consist only of assets part
of and used in its business with a value of $80, and $5 of cash that is
not part of or used in T's business. T has no liabilities. S will use
T's business assets in T's business (which will become S's business),
but will invest the $5 of cash in an unrelated passive investment. Under
paragraph (d)(4)(ii) of this section, P is treated as acquiring the T
assets in a transaction in which P's basis in the T assets was
determined under section 362(b) and contributing them to S in a section
351 transfer. Under paragraph (d)(3)(v) of this section, $10 (of the
total $25) of cash contributed by P to S upon S's formation is not
treated as a purchase of S stock. The $15 (of the total $25) of cash
contributed by P to S upon S's formation that is paid to T's
shareholders is not treated as a purchase of S stock. The exception in
paragraph (d)(3)(v) of this section does not apply to the $5 of cash
from T's business because P is treated as having acquired T's assets in
a related transaction in which section 362(b) applies to determine P's
basis in such assets. Accordingly, P is treated under section
355(d)(5)(B) and paragraph (d)(3)(iv) of this section as having
purchased $5 of the S stock, but is not deemed to have purchased the
remaining $80 of the S stock.
(5) Reverse triangular reorganizations other than triangular asset
reorganizations--(i) In general. Except as provided in paragraph
(d)(5)(ii) of this section, if a transaction qualifies as a
reorganization under section 368(a)(1)(A) by reason of section
368(a)(2)(E) and also as either a reorganization under section
368(a)(1)(B) or a section 351 transfer, then either section 355(d)(5)(B)
(and paragraphs (d)(3)(i) through (iv) of this section) or 355(d)(5)(C)
(and paragraph (e)(2) of this section) applies. Regardless of which
method the controlling corporation employs to determine its basis in the
surviving corporation stock under Sec. 1.358-6(c)(2)(ii) or Sec. 1.1502-
30(b), the total amount of surviving corporation stock treated as
purchased by the controlling corporation will equal the higher of--
(A) The amount of surviving corporation stock that would be treated
as purchased (on the date of the deemed section 351 transfer) by the
controlling corporation if the controlling corporation acquired the
surviving corporation's assets and assumed its liabilities in a
transaction in which the controlling corporation's basis in the
surviving corporation assets was determined under section 362(b), and
then transferred the acquired assets and liabilities to the surviving
corporation in a section 351 transfer (see Secs. 1.358-6(c)(1) and
(2)(ii)(A), and 1.1502-30(b)); or
(B) The amount of surviving corporation stock that would be treated
as purchased (on the date the surviving corporation shareholders
purchased their surviving corporation stock) if the controlling
corporation acquired the stock of the surviving corporation in a
transaction in which the basis in the surviving corporation's stock was
determined under section 362(b) (see Secs. 1.358-6(c)(2)(ii)(B) and
1.1502-30(b)).
(ii) Letter ruling and closing agreement. If a controlling
corporation obtains a letter ruling and enters into a closing agreement
under section 7121 in which it agrees to determine its basis in
surviving corporation stock under Sec. 1.358-6(c)(2)(ii)(A), or under
Sec. 1.1502-30(b) by applying Sec. 1.358-6(c)(2)(ii)(A) (deemed
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asset acquisition and transfer by controlling corporation), then section
355(d)(5)(B) and paragraphs (d)(3)(i) through (iv) of this section
apply, and section 355(d)(5)(C) and paragraph (e)(2) of this section do
not apply. If a controlling corporation obtains a letter ruling and
enters into a closing agreement under section 7121 under which it agrees
to determine its basis in surviving corporation stock under Sec. 1.358-
6(c)(2)(ii)(B), or under Sec. 1.1502-30(b) by applying Sec. 1.358-
6(c)(2)(ii)(B) (deemed stock acquisition), then section 355(d)(5)(C) and
paragraph (e)(2) of this section apply, and section 355(d)(5)(B) and
paragraphs (d)(3)(i) through (iv) of this section do not apply.
(iii) Example. The following example illustrates this paragraph
(d)(5):
Example. Reverse triangular reorganization; purchase. (i) A
purchases 60 percent of the stock of D on Date 1. D owns no cash items,
marketable stock, or transferor debt, but holds cash that is not part of
or used in D's trade or business under paragraph (d)(3)(iv) of this
section and that represents 20 percent of D's value. On Date 2, P forms
S, and S merges into D in a reorganization qualifying under section
368(a)(1)(B) and under section 368(a)(1)(A) by reason of section
368(a)(2)(E). In the reorganization, P acquires all of the D stock in
exchange solely for P stock. After Date 2, and within five years after
Date 1, D distributes its wholly owned subsidiary C to P. P does not
obtain a letter ruling and enter into a closing agreement under
paragraph (d)(5)(ii) of this section. P would acquire 20 percent of the
D stock by purchase on Date 2 under paragraph (d)(5)(i)(A) of this
section by operation of section 355(d)(5)(B) and paragraph (d)(3)(iv) of
this section. The exception in paragraph (d)(3)(v) of this section does
not apply because D was not affiliated with P before the transaction in
which the section 351 transfer is deemed to occur and D's assets are
treated as acquired by P in a related transaction in which section
362(b) applies to determine P's basis in the D assets. P would acquire
60 percent of the D stock by purchase on Date 1 under paragraph
(d)(5)(i)(B) of this section because, under the transferred basis rule
of section 355(d)(5)(C) and paragraph (e)(2) of this section, P is
treated as though P purchased the D stock on the date A purchased it.
Accordingly, under paragraph (d)(5)(i) of this section, P is treated as
acquiring the higher amount (60 percent) by purchase on Date 1. D's
distribution of C to P is a disqualified distribution under section
355(d)(2) and paragraph (b)(1) of this section. In addition, A is
treated as acquiring the P stock by purchase on Date 1 under paragraph
(e)(3) of this section because A's basis in the P stock is determined by
reference to A's basis in the D stock.
(ii) The facts are the same as in paragraph (i) of this Example,
except that P obtains a letter ruling and enters into a closing
agreement under which it agrees to determine its basis in the D stock
under Sec. 1.358-6(c)(2)(ii)(A). Under paragraph (d)(5)(ii) of this
section, section 355(d)(5)(B) (and paragraphs (d)(3)(i) through (iv) of
this section) applies, and section 355(d)(5)(C) (and paragraph (e)(2) of
this section) does not apply. Accordingly, P is treated as acquiring
only 20 percent of the D stock by purchase on Date 2. D's distribution
of C to P is not a disqualified distribution under section 355(d)(2) and
paragraph (b)(1) of this section.
(6) Treatment of group structure changes--(i) In general.
Notwithstanding section 355(d)(5)(A), for purposes of section 355(d), if
a corporation succeeds another corporation as the common parent of a
consolidated group in a group structure change to which Sec. 1.1502-31
applies, the new common parent is treated as having acquired the assets
and assumed the liabilities of the former common parent in a transaction
in which the new common parent's basis in the former common parent's
assets was determined under section 362(b), and then transferred the
acquired assets and liabilities to the former common parent (or, if the
former common parent does not survive, to the new common parent's
subsidiary) in a section 351 transfer, with the new common parent and
former common parent being treated as not in the same affiliated group
at the time of the transfer for purposes of applying paragraph (d)(3)(v)
of this section (notwithstanding Sec. 1.1502-31(c)(2)).
(ii) Adjustments to basis of higher-tier members. A higher-tier
member that indirectly owns all or part of the former common parent's
stock after a group structure change is treated as having purchased the
stock of an immediate subsidiary to the extent that the higher-tier
member's basis in the subsidiary is increased under Sec. 1.1502-
31(d)(4).
(iii) Example. The following example illustrates this paragraph
(d)(6):
Example. P is the common parent of a consolidated group, and T is
the common parent of another group. P has owned S for more than five
years, and the fair market value of the S stock is $50. T's assets
consist only of non-marketable stock of direct and indirect
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wholly owned subsidiaries with a value of $50, assets used in its
business with a value of $50, and $50 of marketable stock that is not
part of or used in T's business. T has no liabilities. T merges into S
with the T shareholders receiving solely P stock with a value of $150 in
exchange for their T stock in a section 368(a)(2)(D) reorganization. S
will use T's business assets in T's business (which will become S's
business), but will hold the $50 of marketable stock for investment
purposes. Assume that the transaction is a reverse acquisition under
Sec. 1.1502-75(d)(3) because the T shareholders, as a result of owning T
stock, own more than 50 percent of the value of P's stock immediately
after the transaction. Thus, the transaction is a group structure change
under Sec. 1.1502-33(f)(1). Under paragraph (d)(6) of this section, P is
treated as having acquired the assets of T in a transaction in which P's
basis in the T assets was determined under section 362(b), and then
transferred the acquired assets to S in a section 351 transfer, with P
and T being treated as not in the same affiliated group at the time of
the transfer solely for purposes of paragraph (d)(3)(v) of this section.
The exception in paragraph (d)(3)(v) of this section (transfers within
an affiliated group) does not apply. Accordingly, P is treated under
section 355(d)(5)(B) and paragraph (d)(3)(iv) of this section as having
purchased $50 of the S stock (attributable to the marketable stock), but
is not deemed to have purchased the remaining $150 of the S stock.
(7) Special rules for triangular asset reorganizations, other
reverse triangular reorganizations, and group structure changes. The
amount of acquiring subsidiary, surviving corporation, or former common
parent stock that is treated as purchased under paragraph (c)(4),
(5)(i)(A), or (6) of this section (by operation of section 355(d)(5)(B)
and paragraphs (d)(3)(i) through (iv) of this section) is adjusted to
reflect any basis adjustment under--
(i) Section 1.358-6(c)(2)(i)(B) and (C) (reduction of basis
adjustment in reverse triangular reorganization where controlling
corporation acquires less than all of the surviving corporation stock),
Sec. 1.1502-30(b) (applying Sec. 1.358-6(c)(2)(i)(B) and (C) to a
consolidated group), and Sec. 1.1502-31(d)(2)(ii) (reduction of basis
adjustment in group structure change where new common parent acquires
less than all of the former common parent stock); or
(ii) Section 1.358-6(d) (reduction of basis adjustment in any
triangular reorganization to the extent controlling corporation does not
provide consideration), Sec. 1.1502-30(b) (applying Sec. 1.358-6(d)
(except Sec. 1.358-6(d)(2)) to a consolidated group), and Sec. 1.1502-
31(d)(1) (reduction of basis adjustment in group structure change to the
extent new common parent does not provide consideration).
(e) Deemed purchase and timing rules--(1) Attribution and
aggregation--(i) In general. Under section 355(d)(8)(B), if any person
acquires by purchase an interest in any entity, and the person is
treated under section 355(d)(8)(A) as holding any stock by reason of
holding the interest, the stock shall be treated as acquired by purchase
on the later of the date of the purchase of the interest in the entity
or the date the stock is acquired by purchase by such entity.
(ii) Purchase of additional interest. If a per