[Federal Register Volume 76, Number 243 (Monday, December 19, 2011)]
[Proposed Rules]
[Pages 78591-78594]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-32079]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-124627-11]
RIN 1545-BK43
Corporate Reorganizations; Guidance on the Measurement of
Continuity of Interest
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations concerning the
continuity of interest requirement for corporate reorganizations. The
guidance is necessary to clarify the manner in which the continuity of
interest
[[Page 78592]]
requirement is measured in particular circumstances. The proposed
regulations affect corporations and their shareholders.
DATES: Written or electronic comments and requests for a public hearing
must be received by March 19, 2012.
ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-124627-11), room 5205,
Internal Revenue Service, PO Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
124627-11), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW., Washington, DC, or electronically, via the Federal e-
Rulemaking Portal at http://www.regulations.gov/ (IRS REG-124627-11).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Richard Starke (202) 622-3497, and concerning submission of comments,
Oluwafunmilayo Taylor (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This notice of proposed rulemaking accompanies publication of final
regulations regarding the continuity of interest requirement (COI) for
corporate reorganizations that are published in this issue of the
Federal Register (the 2011 regulations). In general, the 2011
regulations provide the circumstances under which the consideration to
be exchanged for the proprietary interests in the target corporation is
valued on the last business day before the first date there is a
binding contract (the signing date rule). The preamble explains that
the signing date rule is based on the principle that where a binding
contract provides for fixed consideration, the target corporation
shareholders can generally be viewed as being subject to the economic
fortunes of the issuing corporation as of the last business day before
the signing date (the Pre-Signing Date). However, if the contract does
not provide for fixed consideration, the signing date value of the
issuing corporation stock is not relevant for purposes of determining
the extent to which a proprietary interest in the target corporation is
preserved. For additional background regarding the signing date rule,
see the preamble to the 2011 regulations published elsewhere in this
issue of the Federal Register.
Explanation of Provisions
In response to comments, the IRS and the Treasury Department have
reconsidered the scope of the signing date rule, and agree that its
underlying principles support additional methods for determining
whether COI is satisfied. For example, a contract to effect a potential
reorganization may provide that the amount of an item of consideration
will vary as the value of issuing corporation stock declines between
the stock's Pre-Signing Date value and some lower value provided for in
the contract (Floor Price), but will not vary below the Floor Price. If
the closing date value is less than the Floor Price in such a case, the
target shareholders have been subjected to the economic fortunes of
owning the consideration received in the exchange in the same manner as
if the contract had fixed the consideration based upon the contract's
stated Floor Price. Accordingly, these proposed regulations generally
provide that if, pursuant to a binding contract, an item of
consideration varies as the value of issuing corporation stock declines
between the stock's Pre-Signing Date value and a Floor Price, and the
closing date value is less than the Floor Price, COI is determined as
if the consideration that would have been delivered at the Floor Price
were issued and valued based upon the Floor Price. Applying the same
principle, these proposed regulations provide that if, pursuant to a
binding contract, an item of consideration varies as the value of
issuing corporation stock increases between the stock's signing date
value and some higher value provided for in the contract (Ceiling
Price), and the closing date value is greater than the Ceiling Price,
COI is determined as if the consideration that would have been
delivered at the Ceiling Price were issued and valued based upon the
Ceiling Price. For purposes of this rule, the Closing Date means the
date upon which the exchange of consideration in the potential
reorganization occurs.
In response to comments, these proposed regulations also permit, in
lieu of the value of issuing corporation stock on the Closing Date, the
use of an average value for issuing corporation stock in certain
circumstances. The proposed regulations provide that an average value
may be used if it is based upon issuing corporation stock values
occurring after the signing date and before the Closing Date, and the
binding contract utilizes the average price, so computed, in
determining the number of shares of each class of stock of the issuing
corporation, the amount of money, and the other property to be
exchanged for all the proprietary interests in the target corporation,
or to be exchanged for each proprietary interest in the target
corporation. This rule also applies signing date rule principles
because the average value fixes the number of shares and amount of
other consideration. Accordingly, the target shareholders become
subject to the fortunes of the issuer's stock across the range of dates
being averaged.
Request for Comments
As previously stated, the signing date rule and these proposed
regulations are based upon the concept that for purposes of measuring
COI, in certain circumstances an item of consideration provided by the
issuing corporation can generally be valued on the date that the target
shareholders become subject to the economic fortunes of owning the
item, assuming the exchange ultimately occurs. Depending upon the
contract's terms, this may occur on a date between the signing date and
the closing date, and may occur for different items of consideration on
different dates. Accordingly, for purposes of COI, it may be
appropriate to value an item of consideration on a date between the
signing date and the closing date, and to value different items on
different dates. For example, future guidance could provide that an
item of consideration is valued for COI purposes at the earliest date
on which the target shareholders (in the aggregate) become fully
subject to the appreciation and depreciation in the value of that item
pursuant to a binding contract to effect the potential reorganization,
but not later than the date of the reorganization exchange. In
determining whether the target shareholders are fully subject to market
appreciation and depreciation, certain circumstances, such as the risk
of not closing, would be disregarded. The IRS and the Treasury
Department request comments on the propriety of such an approach.
Effective Date
These regulations are proposed to apply to transactions occurring
on or after the date the regulations are published as final regulations
in the Federal Register, unless completed pursuant to a binding
agreement that was in effect immediately before the date such final
regulations are published and all times afterwards.
Special Analysis
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order 12866
as supplemented by Executive Order 13563. Therefore, a regulatory
assessment is not required. It has also been determined that 5 U.S.C.
553(b)
[[Page 78593]]
does not apply to these regulations and because the regulations do not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. 601 et seq.) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, this notice of proposed
rulemaking has been submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
entities.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and 8 copies) or electronic comments that are submitted timely to the
IRS. The IRS and the Treasury Department request comments on the
clarity of the proposed rules and how they can be made easier to
understand. All comments will be available for public inspection and
copying. A public hearing will be scheduled if requested in writing by
any person that timely submits written comments. If a public hearing is
scheduled, notice of the date, time, and place for the public hearing
will be published in the Federal Register.
Drafting Information
The principal author of these regulations is Richard Starke of the
Office of Associate Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and the Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.368-1 is amended by adding new paragraphs
(e)(2)(vi), (e)(2)(vii), and revising (e)(9) to read as follows:
Sec. 1.368-1 Purpose and scope of exception of reorganization
exchanges.
* * * * *
(e) * * *
(2) * * *
(vi) Special Rules--(A) Floors. This paragraph (e)(2)(vi)(A)
applies if, pursuant to a binding contract, the amount of an item of
consideration to be exchanged for all the proprietary interests in the
target corporation, or to be exchanged for each proprietary interest in
the target corporation, changes as the value of a share of the issuing
corporation varies above a specified price (Floor Price), but does not
vary below the Floor Price. If the value of the share is greater than
or equal to the Floor Price on the Pre-Signing Date (as defined in
paragraph (e)(2)(i) of this section) but below the Floor Price on the
Closing Date (as defined in paragraph (e)(2)(vi)(D) of this section),
whether a proprietary interest is preserved is determined as if the
consideration was issued and valued based upon the Floor Price.
(B) Ceilings. This paragraph (e)(2)(vi)(B) applies if, pursuant to
a binding contract, the amount of an item of consideration to be
exchanged for all the proprietary interests in the target corporation,
or to be exchanged for each proprietary interest in the target
corporation, changes as the value of a share of the issuing corporation
varies below a specified price (Ceiling Price), but does not vary above
the Ceiling Price. If the value of the share is less than or equal to
the Ceiling Price on the Pre-Signing Date (as defined in paragraph
(e)(2)(i) of this section) but above the Ceiling Price on the Closing
Date (as defined in paragraph (e)(2)(vi)(D) of this section), whether a
proprietary interest is preserved is determined as if the consideration
was issued and valued based upon the Ceiling Price.
(C) Closing Date value--average values between signing date and
Closing Date. In determining the Closing Date value of issuing
corporation stock for purposes of determining whether a proprietary
interest in the target corporation is preserved, an average of prices
may be used in lieu of the Closing Date price if--
(1) The average price is based upon prices of issuing corporation
stock occurring after the signing date and before the Closing Date, and
(2) The binding contract utilizes the average price, so computed,
in determining the number of shares of each class of stock of the
issuing corporation, the amount of money, and the other property to be
exchanged for all the proprietary interests in the target corporation,
or to be exchanged for each proprietary interest in the target
corporation.
(D) Closing Date. For purposes of paragraphs (e)(2)(vi) and
(e)(2)(vii) of this section, the Closing Date means the date upon which
the exchange of consideration in the potential reorganization occurs.
(vii) Examples. For purposes of the examples in this paragraph
(e)(2)(vii), P is the issuing corporation, T is the target corporation,
each corporation has only one class of stock outstanding, no
transactions other than those described occur, and the transactions are
not otherwise subject to recharacterization. The following examples
illustrate the application of paragraph (e)(2)(vi) of this section:
Example 1. Price adjustment to provide more or less cash. (i)
Facts. On January 3 of year 1, P and T sign a binding contract
pursuant to which T will be merged into P. Pursuant to the contract,
the T shareholders will receive 50 shares of P stock and $50 cash in
exchange for all of the outstanding shares of T stock, subject to
the following price adjustment:
(A) If the average price of P stock over the five-day period
prior to the Closing Date exceeds $1, the amount of cash will be
reduced by 50 times the excess of that price over $1, and
(B) If the average price of P stock during the specified period
is less than $1, the amount of cash will be increased by 50 times
the excess of $1 over that price, provided that in no event will P
deliver cash of less than $40 or more than $60 to the T
shareholders. This adjustment ensures that the T shareholders will
be entitled to receive aggregate consideration with a value of $100
on the closing date if the average price of P stock during the
specified period is between $.80, at which point the T shareholders
would receive $60 of cash ($50 + (($1-$.80) x 50)), and $1.20, at
which point the T shareholders would receive $40 of cash ($50-
(($1.20-$1) x 50)).
(C) On January 2 of year 1, the value of the P stock is $1 per
share. On June 1 of year 1, T merges into P, when the value of P
stock is $.25 per share. The average price of P stock during the
specified period is also $.25 per share. In the merger, the T
shareholders receive $60 cash and 50 shares of P stock with a value
(determined as of the Closing Date) of $12.50.
(ii) COI determined at the Floor Price. For purposes of
determining whether a proprietary interest in the target corporation
is preserved, the rules of paragraph (e)(2)(vi)(A) of this section
apply because, pursuant to a binding contract, the amount of cash to
be exchanged for all the proprietary interests in the target
corporation varies above a Floor Price of $.80 but does not vary
below the Floor Price, the Pre-Signing Date value exceeds the Floor
Price, and the value on the Closing Date is less than the Floor
Price. Accordingly, whether a proprietary interest is preserved is
determined as if the consideration that would have been delivered at
the Floor Price was issued and valued based upon the Floor Price
value. At the Floor Price, the T shareholders would have received,
in the aggregate, $60 of cash and $40 of P stock. Therefore, the
transaction satisfies the continuity of interest requirement.
[[Page 78594]]
Example 2. No Floor Price. The facts are the same as in Example
1, except that the Pre-Signing Date value is $.50, the Closing Date
value is $1.50, and there is no limitation on the amount of
additional cash that the T shareholders may receive (that is, there
is no Floor Price). For purposes of determining whether a
proprietary interest in the target corporation is preserved, the
rules of paragraph (e)(2)(vi)(B) of this section apply because,
pursuant to a binding contract, the amount of cash to be exchanged
for all the proprietary interests in the target corporation varies
below a Ceiling Price of $1.20 but does not vary above the Ceiling
Price, the Pre-Signing Date value is less than the Ceiling Price,
and the value on the Closing Date exceeds the Ceiling Price.
Accordingly, whether a proprietary interest is preserved is
determined as if the consideration that would have been delivered at
the Ceiling Price was issued and valued based upon the Ceiling
Price. At the Ceiling Price, the T shareholders would have received,
in the aggregate, $40 of cash and $60 of P stock. Therefore, the
transaction satisfies the continuity of interest requirement.
Example 3. No Floor or Ceiling Price. (i) Facts. On January 3
of year 1, P and T sign a binding contract pursuant to which T will
be merged into P. Pursuant to the contract, the T shareholders will
receive $50 cash and $50 of P stock based upon the P stock value on
the Closing Date. On January 2 of year 1, the Pre-Signing Date, the
value of the P stock is $1 per share. On June 1 of year 1, when the
value of P stock is $5 per share, T merges into P.
(ii) COI determined on the Closing Date. For purposes of
determining whether a proprietary interest in the target corporation
is preserved, the rules of paragraph (e)(2)(vi) of this section do
not apply because the contract does not provide for either a Floor
Price or a Ceiling Price. There is no Floor Price because there is
not a value below which the amount of P stock will not vary. There
is no Ceiling Price because there is not a value above which the
amount of P stock will not vary. Because the transaction does not
satisfy the requirements of paragraph (e)(2)(vi) of this section and
does not satisfy the definition of fixed consideration, the
consideration will be valued on the Closing Date. The transaction
satisfies the continuity of interest requirement because the T
shareholders receive, in the aggregate, $50 cash and $50 of P stock.
* * * * *
(9) Effective/Applicability date. Paragraphs (e)(2)(vi) and
(e)(2)(vii) are proposed to apply to transactions occurring on or after
the date the regulations are published as final regulations in the
Federal Register, unless completed pursuant to a binding agreement that
was in effect immediately before the date such final regulations are
published and at all times afterwards.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-32079 Filed 12-16-11; 8:45 am]
BILLING CODE 4830-01-P