[Federal Register Volume 73, Number 240 (Friday, December 12, 2008)]
[Rules and Regulations]
[Pages 75566-75568]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-29271]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9434]
RIN 1545-BC88
Creditor Continuity of Interest
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations providing guidance
regarding when and to what extent creditors of a corporation will be
treated as proprietors of the corporation in determining whether
continuity of interest (``COI'') is preserved in a potential
reorganization. These final regulations are necessary to provide
clarity to parties engaging in reorganizations of insolvent
corporations, both inside and outside of bankruptcy. These final
regulations affect corporations, their creditors, and their
shareholders.
DATES: Effective Date: These final regulations are effective on
December 12, 2008.
Applicability Date: For dates of applicability see Sec. 1.368-
1(e)(8).
FOR FURTHER INFORMATION CONTACT: Jean Brenner (202) 622-7790, Douglas
Bates (202) 622-7550, or Bruce Decker (202) 622-7550 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
On March 10, 2005, the IRS and Treasury Department published a
notice of proposed rulemaking (REG-163314-03) in the Federal Register
(70 FR 11903) proposing regulations that would provide guidance
regarding the application of the nonrecognition rules of subchapter C
of the Internal Revenue Code (Code) to transactions involving insolvent
corporations and to other transactions that raise similar issues. No
public hearing regarding the proposed regulations was requested or
held. The IRS and Treasury Department have carefully considered the
comments regarding the proposed regulations. The IRS and Treasury
Department continue to consider the issues raised and to evaluate the
complexity and necessity for valuation under the exchange of net value
requirement. In the interim, these final regulations adopt the portion
of the proposed regulations that deals with the circumstances in which
(and the extent to which) creditors of a corporation will be treated as
proprietors of the corporation in determining whether continuity of
interest is preserved in a potential reorganization.
Explanation of Provisions
These final regulations provide that, in certain circumstances,
stock received by creditors may count for continuity of interest
purposes both inside and outside of bankruptcy proceedings. The
expansion of the application of the G reorganization rules to
reorganizations of insolvent corporations outside of bankruptcy is
consistent with Congress' intent to facilitate the rehabilitation of
troubled corporations. S. Rep. No. 96-1035, 96th Sess. 35 (1980).
Accordingly, the final regulations adopt the rules proposed for
creditors of an insolvent target corporation outside of a title 11 or
similar case in new Sec. 1.368-1(e)(6) with only minor modifications
and clarifications. The final regulations treat claims of the most
senior class of creditors to receive a proprietary interest in the
issuing corporation and claims of all equal classes of creditors
(together, the senior claims) differently from the claims of classes of
creditors junior to the senior claims (the junior claims). The final
regulations treat such senior claims as representing proprietary
interests in the target corporation. While such senior claims, and all
junior claims, are treated as representing a proprietary interest in
the target corporation, the determination of the value of proprietary
interests in the target corporation represented by the senior claims is
made by calculating the average treatment for all senior claims. The
final regulations provide that the value of a proprietary interest in
the target corporation represented by a senior claim is determined by
multiplying the fair market value of the creditor's claim by a
fraction, the numerator of which is the fair market value of the
proprietary interests in the issuing corporation that are received in
the aggregate in exchange for the senior claims, and the denominator of
which is the sum of the amount of money and the fair market value of
all other consideration (including the proprietary interests in the
issuing corporation) received in the aggregate in exchange for such
claims. In contrast to the treatment of the senior creditor class that
receives stock of the issuing corporation, the value of the proprietary
interest in the target corporation represented by a junior claim is the
fair market value of the junior claim. The effect of this rule is that
there is 100 percent continuity of interest if each senior claim is
satisfied with the same ratio of stock to nonstock consideration and no
junior claim is satisfied with nonstock consideration.
An example was added to the COI rule in response to a suggestion
that the final regulations demonstrate the bifurcation of senior claims
when the creditors of the class receive disproportionate amounts of
acquiring corporation stock and other property. Also, in response to
comments, a rule was added to the final regulations requiring that in
the situation where there is only one class of creditors receiving
stock, more than a de minimis amount of acquiring corporation stock
must be exchanged for the creditors' proprietary interests relative to
the total consideration received by the insolvent target corporation,
its shareholders, and its creditors, before the stock will be counted
for purposes of COI.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these final regulations and,
because the regulations do not impose a collection of information on
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f) of the Code, the notice of
proposed rulemaking preceding these regulations was submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal authors of these regulations are Jean Brenner,
Douglas Bates, and Bruce Decker of the Office of
[[Page 75567]]
Associate Chief Counsel (Corporate). However, other personnel from the
IRS and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.368-1 is amended by:
0
1. Adding a sentence after the fifth sentence of paragraph (e)(1)(i).
0
2. Adding a sentence at the end of paragraph (e)(1)(ii).
0
3. Revising paragraph (e)(3).
0
4. Redesignating paragraphs (e)(6), (e)(7), and (e)(8) as paragraphs
(e)(7), (e)(8), and (e)(9) respectively, and adding a new paragraph
(e)(6).
0
5. Adding Example 10 to the end of newly designated paragraph (e)(8).
0
6. Adding a sentence at the end of newly designated paragraph
(e)(9)(i).
The additions and revisions read as follows:
Sec. 1.368-1 Purpose and scope of exception to reorganization
exchanges.
* * * * *
(e) * * *
(1) * * *
(i) * * * See paragraph (e)(6) of this section for rules related to
when a creditor's claim against a target corporation is a proprietary
interest in the corporation. * * *
(ii) * * * A proprietary interest in the target corporation is not
preserved to the extent that creditors (or former creditors) of the
target corporation that own a proprietary interest in the corporation
under paragraph (e)(6) of this section (or would be so treated if they
had received the consideration in the potential reorganization) receive
payment for the claim prior to the potential reorganization and such
payment would be treated as other property or money received in the
exchange for purposes of section 356 had it been a distribution with
respect to stock.
(3) Related persons acquisitions. A proprietary interest in the
target corporation is not preserved if, in connection with a potential
reorganization, a person related (as defined in paragraph (e)(4) of
this section) to the issuing corporation acquires, for consideration
other than stock of the issuing corporation, either a proprietary
interest in the target corporation or stock of the issuing corporation
that was furnished in exchange for a proprietary interest in the target
corporation. The preceding sentence does not apply to the extent those
persons who were the direct or indirect owners of the target
corporation prior to the potential reorganization maintain a direct or
indirect proprietary interest in the issuing corporation.
* * * * *
(6) Creditors' claims as proprietary interests--(i) In general. A
creditor's claim against a target corporation may be a proprietary
interest in the target corporation if the target corporation is in a
title 11 or similar case (as defined in section 368(a)(3)) or the
amount of the target corporation's liabilities exceeds the fair market
value of its assets immediately prior to the potential reorganization.
In such cases, if any creditor receives a proprietary interest in the
issuing corporation in exchange for its claim, every claim of that
class of creditors and every claim of all equal and junior classes of
creditors (in addition to the claims of shareholders) is a proprietary
interest in the target corporation immediately prior to the potential
reorganization to the extent provided in paragraph (e)(6)(ii) of this
section.
(ii) Value of proprietary interest--(A) Claims of most senior class
of creditors receiving stock. A claim of the most senior class of
creditors receiving a proprietary interest in the issuing corporation
and a claim of any equal class of creditors will be treated as a
proprietary interest in accordance with the rules of this paragraph
(e)(6)(ii). For a claim of the most senior class of creditors receiving
a proprietary interest in the issuing corporation, and a claim of any
equal class of creditors, the value of the proprietary interest in the
target corporation represented by the claim is determined by
multiplying the fair market value of the claim by a fraction, the
numerator of which is the fair market value of the proprietary
interests in the issuing corporation that are received in the aggregate
in exchange for the claims of those classes of creditors, and the
denominator of which is the sum of the amount of money and the fair
market value of all other consideration (including the proprietary
interests in the issuing corporation) received in the aggregate in
exchange for such claims. If only one class (or one set of equal
classes) of creditors receives stock, such class (or set of equal
classes) is treated as the most senior class of creditors receiving
stock. When only one class (or one set of equal classes) of creditors
receives issuing corporation stock in exchange for a creditor's
proprietary interest in the target corporation, such stock will be
counted for measuring continuity of interest provided that the stock
issued by the acquiring corporation is not de minimis in relation to
the total consideration received by the insolvent target corporation,
its shareholders, and its creditors.
(B) Claims of junior classes of creditor receiving stock. The value
of a proprietary interest in the target corporation held by a creditor
whose claim is junior to the claims of other classes of target claims
which are receiving proprietary interests in the issuing corporation is
the fair market value of the junior creditor's claim.
(iii) Bifurcated claims. If a creditor's claim is bifurcated into a
secured claim and an unsecured claim pursuant to an order in a title 11
or similar case (as defined in section 368(a)(3)) or pursuant to an
agreement between the creditor and the debtor, the bifurcation of the
claim and the allocation of consideration to each of the resulting
claims will be respected in applying the rules of this paragraph
(e)(6).
(iv) Effect of treating creditors as proprietors. The treatment of
a creditor's claim as a proprietary interest in the target corporation
shall not preclude treating shares of the target corporation as
proprietary interests in the target corporation.
* * * * *
(8) * * *
Example 10. Creditors treated as owning a proprietary interest.
(i) More than one class of creditor receives issuing corporation
stock. T has assets with a fair market value of $150x and
liabilities of $200x. T has two classes of creditors: two senior
creditors with claims of $25x each; and one junior creditor with a
claim of $150x. T transfers all of its assets to P in exchange for
$95x in cash and shares of P stock with a fair market value of $55x.
Each T senior creditor receives $20x in cash and P stock with a fair
market value of $5x in exchange for his claim. The T junior creditor
receives $55x in cash and P stock with a fair market value of $45x
in exchange for his claim. The T shareholders receive no
consideration in exchange for their T stock. Under paragraph (e)(6)
of this section, because the amount of T's liabilities exceeds the
fair market value of its assets immediately prior to the potential
reorganization, the claims of the creditors of T may be proprietary
interests in T. Because the senior creditors receive proprietary
interests in P in the transaction in exchange for their claims,
their claims and the claim of the junior creditor and the T stock
are
[[Page 75568]]
treated as proprietary interests in T immediately prior to the
transaction. Under paragraph (e)(6)(ii)(A) of this section, the
value of the proprietary interest of each of the senior creditors'
claims is $5x (the fair market value of the senior creditor's claim,
$25x, multiplied by a fraction, the numerator of which is $10x, the
fair market value of the proprietary interests in the issuing
corporation, P, received in the aggregate in exchange for the claims
of all the creditors in the senior class, and the denominator of
which is $50x, the sum of the amount of money and the fair market
value of all other consideration (including the proprietary
interests in P) received in the aggregate in exchange for such
claims). Accordingly, $5x of the stock that each of the senior
creditors receives is counted in measuring continuity of interest.
Under paragraph (e)(6)(ii)(B) of this section, the value of the
junior creditor's proprietary interest in T immediately prior to the
transaction is $100x, the value of his claim. Thus, the value of the
creditors' proprietary interests in total is $110x and the creditors
received $55x worth of P stock in total in exchange for their
proprietary interests. Therefore, P acquired 50 percent of the value
of the proprietary interests in T in exchange for P stock. Because a
substantial part of the value of the proprietary interests in T is
preserved, the continuity of interest requirement is satisfied.
(ii) One class of creditor receives issuing corporation stock
and cash in disproportionate amounts. T has assets with a fair
market value of $80x and liabilities of $200x. T has one class of
creditor with two creditors, A and B, each having a claim of $100x.
T transfers all of its assets to P for $60x in cash and shares of P
stock with a fair market value of $20x. A receives $40x in cash in
exchange for its claim. B receives $20x in cash and P stock with a
fair market value of $20x in exchange for its claim. The T
shareholders receive no consideration in exchange for their T stock.
The P stock is not de minimis in relation to the total consideration
received. Under paragraph (e)(6) of this section, because the amount
of T's liabilities exceeds the fair market value of its assets
immediately prior to the potential reorganization, the claims of the
creditors of T may be proprietary interests in T. Because the
creditors of T received proprietary interests in P in the
transaction in exchange for their claims, their claims and the T
stock are treated as proprietary interests in T immediately prior to
the transaction. Under paragraph (e)(6)(ii)(A) of this section, the
value of the proprietary interest of each of the senior creditors is
$10x (the fair market value of a senior creditor's claim, $40x,
multiplied by a fraction, the numerator of which is $20x, the fair
market value of the proprietary interests in the issuing
corporation, P, received in the aggregate in exchange for the claims
of all the creditors in the class, and the denominator of which is
$80x, the sum of the amount of money and the fair market value of
all other consideration (including the proprietary interests in P)
received in the aggregate in exchange for such claims). Accordingly,
$10x of the cash that was received by A and $10x of the P stock that
was received by B are counted in measuring continuity of interest.
Thus, the value of the creditors' proprietary interests in total is
$20x and the creditors received $10x worth of P stock in total in
exchange for their proprietary interests. Therefore, P acquired 50
percent of the value of the proprietary interests in T in exchange
for P stock. Because a substantial part of the value of the
proprietary interests in T is preserved, the continuity of interest
requirement is satisfied.
(9) * * * The sixth sentence of paragraph (e)(1)(i) of this
section, the last sentence of paragraph (e)(1)(ii) of this section,
paragraph (e)(3) of this section, paragraph (e)(6) of this section, and
Example 10 of paragraph (e)(8) of this section apply to transactions
occurring after December 12, 2008.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
Approved: December 3, 2008.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E8-29271 Filed 12-11-08; 8:45 am]
BILLING CODE 4830-01-P