[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2009 Edition]
[From the U.S. Government Printing Office]
[[Page i]]
26
Part 1 (Sec. Sec. 1.301 to 1.400)
Revised as of April 1, 2009
Internal Revenue
________________________
Containing a codification of documents of general
applicability and future effect
As of April 1, 2009
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 OFFICIAL EDITION NOTICE
Legal Status and Use of Seals and Logos
The seal of the National Archives and Records Administration
(NARA) authenticates the Code of Federal Regulations (CFR) as
the official codification of Federal regulations established
under the Federal Register Act. Under the provisions of 44
U.S.C. 1507, the contents of the CFR, a special edition of the
Federal Register, shall be judicially noticed. The CFR is
prima facie evidence of the original documents published in
the Federal Register (44 U.S.C. 1510).
It is prohibited to use NARA's official seal and the stylized Code
of Federal Regulations logo on any republication of this
material without the express, written permission of the
Archivist of the United States or the Archivist's designee.
Any person using NARA's official seals and logos in a manner
inconsistent with the provisions of 36 CFR part 1200 is
subject to the penalties specified in 18 U.S.C. 506, 701, and
1017.
Use of ISBN Prefix
This is the Official U.S. Government edition of this publication
and is herein identified to certify its authenticity. Use of
the 0-16 ISBN prefix is for U.S. Government Printing Office
Official Editions only. The Superintendent of Documents of the
U.S. Government Printing Office requests that any reprinted
edition clearly be labeled as a copy of the authentic work
with a new ISBN.
U . S . G O V E R N M E N T P R I N T I N G O F F I C E
------------------------------------------------------------------
U.S. Superintendent of Documents Washington, DC
20402-0001
http://bookstore.gpo.gov
Phone: toll-free (866) 512-1800; DC area (202) 512-1800
[[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........................ 635
Alphabetical List of Agencies Appearing in the CFR...... 655
Table of OMB Control Numbers............................ 665
List of CFR Sections Affected........................... 683
[[Page iv]]
----------------------------
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.
----------------------------
[[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
The contents of the Federal Register are required to be judicially
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie
evidence of the text of the original documents (44 U.S.C. 1510).
HOW TO USE THE CODE OF FEDERAL REGULATIONS
The Code of Federal Regulations is kept up to date by the individual
issues of the Federal Register. These two publications must be used
together to determine the latest version of any given rule.
To determine whether a Code volume has been amended since its
revision date (in this case, April 1, 2009), consult the ``List of CFR
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative
List of Parts Affected,'' which appears in the Reader Aids section of
the daily Federal Register. These two lists will identify the Federal
Register page number of the latest amendment of any given rule.
EFFECTIVE AND EXPIRATION DATES
Each volume of the Code contains amendments published in the Federal
Register since the last revision of that volume of the Code. Source
citations for the regulations are referred to by volume number and page
number of the Federal Register and date of publication. Publication
dates and effective dates are usually not the same and care must be
exercised by the user in determining the actual effective date. In
instances where the effective date is beyond the cut-off date for the
Code a note has been inserted to reflect the future effective date. In
those instances where a regulation published in the Federal Register
states a date certain for expiration, an appropriate note will be
inserted following the text.
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
amendments to existing regulations in the CFR. These OMB numbers are
placed as close as possible to the applicable recordkeeping or reporting
requirements.
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 eleven separate
volumes. For the period beginning January 1, 2001, a ``List of CFR
Sections Affected'' is published at the end of each CFR volume.
INCORPORATION BY REFERENCE
What is incorporation by reference? Incorporation by reference was
established by statute and allows Federal agencies to meet the
requirement to publish regulations in the Federal Register by referring
to materials already published elsewhere. For an incorporation to be
valid, the Director of the Federal Register must approve it. The legal
effect of incorporation by reference is that the material is treated as
if it were published in full in the Federal Register (5 U.S.C. 552(a)).
This material, like any other properly issued regulation, has the force
of law.
What is a proper incorporation by reference? The Director of the
Federal Register will approve an incorporation by reference only when
the requirements of 1 CFR part 51 are met. Some of the elements on which
approval is based are:
(a) The incorporation will substantially reduce the volume of
material published in the Federal Register.
(b) The matter incorporated is in fact available to the extent
necessary to afford fairness and uniformity in the administrative
process.
(c) The incorporating document is drafted and submitted for
publication in accordance with 1 CFR part 51.
What if the material incorporated by reference cannot be found? If
you have any problem locating or obtaining a copy of material listed as
an approved incorporation by reference, please contact the agency that
issued the regulation containing that incorporation. If, after
contacting the agency, you find the material is not available, please
notify the Director of the Federal Register, National Archives and
Records Administration, Washington DC 20408, or call 202-741-6010.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
separate volume, revised annually as of January 1, entitled CFR Index
and Finding Aids. This volume contains the Parallel Table of Statutory
Authorities and Agency Rules (Table I). A list of CFR titles, chapters,
and parts and an alphabetical list of agencies publishing in the CFR are
also included in this volume.
An index to the text of ``Title 3--The President'' is carried within
that volume.
The Federal Register Index is issued monthly in cumulative form.
This index is based on a consolidation of the ``Contents'' entries in
the daily Federal Register.
A List of CFR Sections Affected (LSA) is published monthly, keyed to
the revision dates of the 50 CFR titles.
[[Page vii]]
REPUBLICATION OF MATERIAL
There are no restrictions on the republication of material appearing
in the Code of Federal Regulations.
INQUIRIES
For a legal interpretation or explanation of any regulation in this
volume, contact the issuing agency. The issuing agency's name appears at
the top of odd-numbered pages.
For inquiries concerning CFR reference assistance, call 202-741-6000
or write to the Director, Office of the Federal Register, National
Archives and Records Administration, Washington, DC 20408 or e-mail
[email protected].
SALES
The Government Printing Office (GPO) processes all sales and
distribution of the CFR. For payment by credit card, call toll-free,
866-512-1800, or DC area, 202-512-1800, M-F 8 a.m. to 4 p.m. e.s.t. or
fax your order to 202-512-2250, 24 hours a day. For payment by check,
write to: US Government Printing Office - New Orders, P.O. Box 979050,
St. Louis, MO 63197-9000. For GPO Customer Service call 202-512-1803.
ELECTRONIC SERVICES
The full text of the Code of Federal Regulations, the LSA (List of
CFR Sections Affected), The United States Government Manual, the Federal
Register, Public Laws, Public Papers, Daily Compilation of Presidential
Documents and the Privacy Act Compilation are available in electronic
format via Federalregister.gov. For more information, contact Electronic
Information Dissemination Services, U.S. Government Printing Office.
Phone 202-512-1530, or 888-293-6498 (toll-free). E-mail,
[email protected].
The Office of the Federal Register also offers a free service on the
National Archives and Records Administration's (NARA) World Wide Web
site for public law numbers, Federal Register finding aids, and related
information. Connect to NARA's web site at www.archives.gov/federal-
register. The NARA site also contains links to GPO Access.
Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 2009.
[[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,
2009. The first thirteen volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Sec. Sec. 1.0-1.60;
Sec. Sec. 1.61-1.169; Sec. Sec. 1.170-1.300; Sec. Sec. 1.301-1.400;
Sec. Sec. 1.401-1.440; Sec. Sec. 1.441-1.500; Sec. Sec. 1.501-1.640;
Sec. Sec. 1.641-1.850; Sec. Sec. 1.851-1.907; Sec. Sec. 1.908-1.1000;
Sec. Sec. 1.1001-1.1400; Sec. Sec. 1.1401-1.1550; and Sec. 1.1551 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.
For this volume, Robert J. Sheehan, III was Chief Editor. The Code
of Federal Regulations publication program is under the direction of
Michael L. White, assisted by Ann Worley.
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains part 1, Sec. Sec. 1.301 to 1.400)
--------------------------------------------------------------------
Part
chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 1
[[Page 3]]
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
--------------------------------------------------------------------
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 (continued).................... 5
Supplementary Publications: 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.
1.338-11 Effect of section 338 election on insurance company targets.
1.338(h)(10)-1 Deemed asset sale and liquidation.
1.338(i)-1 Effective/applicability date.
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.
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.
1.355-0T Outline of sections (temporary).
1.355-1 Distribution of stock and securities of controlled corporation.
1.355-2 Limitations.
1.355-2T Limitations (temporary).
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.
1.355-7 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 Special rules for assumption of liabilities.
1.358-6 Stock basis in certain triangular reorganizations.
1.358-7 Transfers by partners and partnerships to corporations.
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.
1.362-4 Limitations on built-in loss duplication.
1.367(a)-1 Transfers to foreign corporations subject to section 367(a):
In general.
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)-3T Treatment of transfers of stock or securities to foreign
corporations (temporary).
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.
[[Page 7]]
1.367(a)-9T Treatment of deemed section 351 exchanges pursuant to
section 304(a)(1) (temporary).
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.
1.367(b)-4T Acquisition of foreign corporate stock or assets by a
foreign corporation in certain nonrecognition transactions
(temporary).
1.367(b)-5 Distributions of stock described in section 355.
1.367(b)-6 Effective dates and coordination rules.
1.367(b)-7 Carryover of earnings and profits and foreign income taxes in
certain foreign-to-foreign nonrecognition transactions.
1.367(b)-8 Allocation of earnings and profits and foreign income taxes
in certain foreign corporate separations. [Reserved]
1.367(b)-9 Special rule for F reorganizations and similar transactions.
1.367(b)-12 Subsequent treatment of amounts attributed or included in
income.
1.367(b)-13 Special rules for determining basis and holding period.
1.367(b)-14T Acquisition of parent stock for property in triangular
reorganizations (temporary).
1.367(d)-1T Transfers of intangible property to foreign corporations
(temporary).
1.367(e)-0 Outline of Sec. Sec. 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.
1.368-1T Purpose and scope of exception of reorganization exchanges
(temporary).
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
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]
[[Page 8]]
1.382-7T Built-in gains and losses (temporary).
1.382-8 Controlled groups.
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 Special rules for determining time and manner of acquisition of
an interest in a loss corporation.
1.382-11 Reporting requirements.
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.
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)-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 1.338-11 also issued under 26 U.S.C. 338.
Section 1.338-11T also issued under 26 U.S.C. 338.
Section 1.338(h)(10)-1 also issued under 26 U.S.C. 337(d), 338, and
1502.
Section 1.338(h)(10)-1T 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 1.355-2T(g) and (i) are also issued under 26 U.S.C.
355(b)(3)(D).
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 1.355-7 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 1.358-2 also issued under 26 U.S.C. 358.
Section 1.358-5 also issued under 26 U.S.C. 358(h)(2).
Section 1.358-5T also issued under 26 U.S.C. 358(h)(2).
Section 1.358-7 also issued under Public Law 106-554, 114 Stat.
2763, 2763A-638 (2001).
Section 1.367(a)-3 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(a)-3T(b)(2)(i)(C) 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(a)-9T 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).
Sections 1.367(b)-2(c)(1) and (2) also issued under 26 U.S.C.
367(b)(1) and (2).
Section 1.367(b)-2(d)(3) also issued under 26 U.S.C. 367(b)(1) and
(2).
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)-4(d) also issued under 26 U.S.C. 367(b)(1) and (2).
Section 1.367(b)-4T also issued under 26 U.S.C. 367(b).
Section 1.367(b)-7 also issued under 26 U.S.C. 367(a) and (b), 26
U.S.C. 902, and 26 U.S.C. 904.
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(a) and (b), 26
U.S.C. 902, and 26 U.S.C. 904.
[[Page 9]]
Section 1.367(b)-12 also issued under 26 U.S.C. 367(a) and (b).
Section 1.367(b)-13 also issued under 26 U.S.C. 367(b).
Section 1.367(b)-14T also issued under 26 U.S.C. 367(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 1.382-7T also issued under 26 U.S.C. 382(m).
Section 1.382-8 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 1.382-10 also issued under 26 U.S.C 382(m).
Section 1.382-10T is also issued under 26 U.S.C. 382(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 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.
[[Page 10]]
(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 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.
[[Page 11]]
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.
(g) Reduction for liabilities--(1) General rule. For the purpose of
section 301, no reduction shall be made for the amount of any liability,
unless the liability is assumed by the shareholder within the meaning of
section 357(d).
(2) No reduction below zero. Any reduction pursuant to paragraph
(g)(1) of this section shall not cause the amount of the distribution to
be reduced below zero.
(3) Effective dates--(i) In general. This paragraph (g) applies to
distributions occurring after January 4, 2001.
(ii) Retroactive application. This paragraph (g) also applies to
distributions made on or before January 4, 2001, if the distribution is
made as part of a transaction described in, or substantially similar to,
the transaction in Notice 99-59 (1999-2 C.B. 761), including
transactions designed to reduce gain (see Sec. 601.601(d)(2) of this
chapter). For rules for distributions on or before January 4, 2001
(other than distributions on or before that date to which this paragraph
(g) applies), see rules in effect on January 4, 2001 (see Sec. 1.301-
1(g) as contained in 26 CFR part 1 revised April 1, 2001).
(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--
(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
[[Page 12]]
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 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.
[[Page 13]]
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 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.
(q) Split-dollar and other life insurance arrangements--(1) Split-
dollar life insurance arrangements--(i) Distribution of economic
benefits. The provision by a corporation to its shareholder pursuant to
a split-dollar life insurance arrangement, as defined in Sec. 1.61-
22(b)(1) or (2), of economic benefits described in Sec. 1.61-22(d) or
of amounts described in Sec. 1.61-22(e) is treated as a distribution of
[[Page 14]]
property, the amount of which is determined under Sec. 1.61-22(d) and
(e), respectively.
(ii) Distribution of entire contract or undivided interest therein.
A transfer (within the meaning of Sec. 1.61-22(c)(3)) of the ownership
of a life insurance contract (or an undivided interest therein) that is
part of a split-dollar life insurance arrangement is a distribution of
property, the amount of which is determined pursuant to Sec. 1.61-
22(g)(1) and (2).
(2) Other life insurance arrangements. A payment by a corporation on
behalf of a shareholder of premiums on a life insurance contract or an
undivided interest therein that is owned by the shareholder constitutes
a distribution of property, even if such payment is not part of a split-
dollar life insurance arrangement under Sec. 1.61-22(b).
(3) When distribution is made--(i) In general. Except as provided in
paragraph (q)(3)(ii) of this section, paragraph (b) of this section
shall apply to determine when a distribution described in paragraph
(q)(1) or (2) of this section is taken into account by a shareholder.
(ii) Exception. Notwithstanding paragraph (b) of this section, a
distribution described in paragraph (q)(1)(ii) of this section shall be
treated as made by a corporation to its shareholder at the time that the
life insurance contract, or an undivided interest therein, is
transferred (within the meaning of Sec. 1.61-22(c)(3)) to the
shareholder.
(4) Effective date--(i) General rule. This paragraph (q) applies to
split-dollar and other life insurance arrangements entered into after
September 17, 2003. For purposes of this paragraph (q)(4), a split-
dollar life insurance arrangement is entered into as determined under
Sec. 1.61-22(j)(1)(ii).
(ii) Modified arrangements treated as new arrangements. If a split-
dollar life insurance arrangement entered into on or before September
17, 2003 is materially modified (within the meaning of Sec. 1.61-
22(j)(2)) after September 17, 2003, the arrangement is treated as a new
arrangement entered into on the date of the modification.
[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; T.D. 9092, 68 FR
54352, Sept. 17, 2003]
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
[[Page 15]]
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) In general. 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 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) Redemption not essentially equivalent to a dividend--(1) In
general. 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 302(e). 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.
Distributions 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.
(2) Statement. Unless Sec. 1.331-1(d) applies, every significant
holder that transfers stock to the issuing corporation in exchange for
property from such corporation must include on or with such holder's
return for the taxable year of such exchange a statement entitled,
``STATEMENT PURSUANT TO Sec. 1.302-2(b)(2) BY [INSERT NAME AND TAXPAYER
IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A SIGNIFICANT HOLDER OF THE
STOCK OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF
ISSUING CORPORATION].'' If a significant holder is a controlled foreign
corporation (within the meaning of section 957), each United States
shareholder (within the meaning of section 951(b)) with respect thereto
must include this statement on or with its return. The statement must
include--
(i) The fair market value and basis of the stock transferred by the
significant holder to the issuing corporation; and
(ii) A description of the property received by the significant
holder from the issuing corporation.
[[Page 16]]
(3) Definitions. For purposes of this section:
(i) Significant holder means any person that, immediately before the
exchange--
(A) Owned at least five percent (by vote or value) of the total
outstanding stock of the issuing corporation if the stock owned by such
person is publicly traded; or
(B) Owned at least one percent (by vote or value) of the total
outstanding stock of the issuing corporation if the stock owned by such
person is not publicly traded.
(ii) Publicly traded stock means stock that is listed on--
(A) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(B) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the Securities
Exchange Act of 1934 (15 U.S.C. 78o-3).
(iii) Issuing corporation means the corporation that issued the
shares of stock, some or all of which were transferred by a significant
holder to such corporation in the exchange described in paragraph (b)(2)
of this section.
(4) Cross reference. See section 6043 of the Internal Revenue Code
for requirements relating to a return by a liquidating corporation.
(c) Basis adjustments. 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.
(d) Effective/applicability date. Paragraphs (b)(2), (b)(3) and
(b)(4) of this section apply to any taxable year beginning on or after
May 30, 2006. However, taxpayers may apply paragraphs (b)(2), (b)(3) and
(b)(4) of this section to any original Federal income tax return
(including any amended return filed on or before the due date (including
extensions) of such original return) timely filed on or after May 30,
2006. For taxable years beginning before May 30, 2006, see Sec. 1.302-2
as contained in 26 CFR part 1 in effect on April 1, 2006.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 8724, 62 FR
38028, July 26, 1997; T.D. 9264, 71 FR 30593, May 30, 2006; T.D. 9329,
72 FR 32796, June 14, 2007]
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 each shareholder separately
and shall be applied only with respect to stock
[[Page 17]]
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) Statement. The agreement specified in section 302(c)(2)(A)(iii)
shall be in the form of a statement entitled, ``STATEMENT PURSUANT TO
SECTION 302(c)(2)(A)(iii) BY [INSERT NAME AND TAXPAYER IDENTIFICATION
NUMBER (IF ANY) OF TAXPAYER OR RELATED PERSON, AS THE CASE MAY BE], A
DISTRIBUTEE (OR RELATED PERSON) OF [INSERT NAME AND EMPLOYER
IDENTIFICATION NUMBER (IF ANY) OF DISTRIBUTING CORPORATION].'' The
distributee must include such statement on or with the distributee's
first return for the taxable year in which the distribution described in
section 302(b)(3) occurs. If the distributee is a controlled foreign
corporation (within the meaning of section 957), each United States
shareholder (within the meaning of section 951(b)) with respect thereto
must include this statement on or with its return. The distributee must
represent in the statement--
(1) THE DISTRIBUTEE (OR RELATED PERSON) 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
(2) THE DISTRIBUTEE (OR RELATED PERSON) WILL NOTIFY THE INTERNAL
REVENUE SERVICE 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.
[[Page 18]]
(b) Substantiation information. 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) Stock of parent, subsidiary or successor corporation redeemed.
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) Redeemed shareholder as creditor. 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) Acquisition of assets pursuant to creditor's rights. 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) Constructive ownership rules applicable. 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) Avoidance of Federal income tax. 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
[[Page 19]]
transferee is in a lower income tax bracket than the transferor.
(h) Effective/applicability date. Paragraph (a) of this section
applies to any taxable year beginning on or after May 30, 2006. However,
taxpayers may apply paragraph (a) of this section to any original
Federal income tax return (including any amended return filed on or
before the due date (including extensions) of such original return)
timely filed on or after May 30, 2006. For taxable years beginning
before May 30, 2006, see Sec. 1.302-4 as contained in 26 CFR part 1 in
effect on April 1, 2006.
(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, as amended by T.D. 9264, 71 FR
30594, 30607, May 30, 2006; T.D. 9329, 72 FR 32796, 32808, June 14,
2007]
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
[[Page 20]]
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 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
[[Page 21]]
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-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
[[Page 22]]
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 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
[[Page 23]]
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 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
[[Page 24]]
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 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
[[Page 25]]
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 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 Sec. Sec.
1.305-2 through 1.305-7, the term stock includes rights or warrants to
acquire such stock.
(2) For purposes of Sec. Sec. 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;
[[Page 26]]
(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 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
[[Page 27]]
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 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
[[Page 28]]
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.
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
[[Page 29]]
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 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.
[[Page 30]]
(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 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
[[Page 31]]
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
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
[[Page 32]]
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 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
[[Page 33]]
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 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
[[Page 34]]
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
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
[[Page 35]]
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 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
[[Page 36]]
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 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
[[Page 37]]
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 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
[[Page 38]]
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.
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
[[Page 39]]
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
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
[[Page 40]]
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]
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
[[Page 41]]
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 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 Sec. Sec. 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
[[Page 42]]
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).
(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
[[Page 43]]
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 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
[[Page 44]]
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, 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]
[[Page 45]]
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 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
[[Page 46]]
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 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,
[[Page 47]]
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 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:
[[Page 48]]
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.
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
[[Page 49]]
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
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.
[[Page 50]]
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 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
[[Page 51]]
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).
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
[[Page 52]]
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 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.
[[Page 53]]
(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 Sec. Sec. 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:
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
[[Page 54]]
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
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
[[Page 55]]
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 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.
[[Page 56]]
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 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,
[[Page 57]]
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 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.
[[Page 58]]
(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 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
[[Page 59]]
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. See Sec. 1.168(k)-1(f)(7)
with respect to the treatment of the additional first year depreciation
deduction allowable under section 168(k) for qualified property or 50-
percent bonus depreciation property, and Sec. 1.1400L(b)-1(f)(7) with
respect to the treatment of the additional first year depreciation
deduction allowable under section 1400L(b) for qualified New York
Liberty Zone property, for purposes of computing the earnings and
profits of a corporation.
(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 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
[[Page 60]]
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 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, as amended by T.D. 9283, 71 FR
51746, Aug. 31, 2006]
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
[[Page 61]]
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 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
[[Page 62]]
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 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
[[Page 63]]
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 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
[[Page 64]]
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 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 sharesx$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
[[Page 65]]
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 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:
[[Page 66]]
----------------------------------------------------------------------------------------------------------------
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 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--
[[Page 67]]
(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.
(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
[[Page 68]]
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, 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
[[Page 69]]
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 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) In general. 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) Gain or loss. 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.
[[Page 70]]
(c) Recharacterization. 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) Reporting requirement--(1) General rule. Every significant
holder that transfers stock to the issuing corporation in exchange for
property from such corporation must include on or with such holder's
return for the year of such exchange the statement described in
paragraph (d)(2) of this section unless--
(i) The property is part of a distribution made pursuant to a
corporate resolution reciting that the distribution is made in complete
liquidation of the corporation; and
(ii) The issuing corporation is completely liquidated and dissolved
within one year after the distribution.
(2) Statement. If required by paragraph (d)(1) of this section, a
significant holder must include on or with such holder's return a
statement entitled, ``STATEMENT PURSUANT TO Sec. 1.331-1(d) BY [INSERT
NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A
SIGNIFICANT HOLDER OF THE STOCK OF [INSERT NAME AND EMPLOYER
IDENTIFICATION NUMBER (IF ANY) OF ISSUING CORPORATION].'' If a
significant holder is a controlled foreign corporation (within the
meaning of section 957), each United States shareholder (within the
meaning of section 951(b)) with respect thereto must include this
statement on or with its return. The statement must include--
(i) The fair market value and basis of the stock transferred by the
significant holder to the issuing corporation; and
(ii) A description of the property received by the significant
holder from the issuing corporation.
(3) Definitions. For purposes of this section:
(i) Significant holder means any person that, immediately before the
exchange--
(A) Owned at least five percent (by vote or value) of the total
outstanding stock of the issuing corporation if the stock owned by such
person is publicly traded; or
(B) Owned at least one percent (by vote or value) of the total
outstanding stock of the issuing corporation if the stock owned by such
person is not publicly traded.
(ii) Publicly traded stock means stock that is listed on--
(A) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(B) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the Securities
Exchange Act of 1934 (15 U.S.C. 78o-3).
(iii) Issuing corporation means the corporation that issued the
shares of stock, some or all of which were transferred by a significant
holder to such corporation in the exchange described in paragraph (d)(1)
of this section.
(4) Cross reference. See section 6043 of the Code for requirements
relating to a return by a liquidating corporation.
(e) Example. 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 $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.
(f) Effective/applicability date. Paragraph (d) of this section
applies to any taxable year beginning on or after May 30, 2006. However,
taxpayers may apply paragraph (d) of this section to any original
Federal income tax return (including any amended return filed on or
[[Page 71]]
before the due date (including extensions) of such original return)
timely filed on or after May 30, 2006. For taxable years beginning
before May 30, 2006, see Sec. 1.331-1 as contained in 26 CFR part 1 in
effect on April 1, 2006.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6949, 33 FR
5521, Apr. 9, 1968; T.D. 9264, 71 FR 30594, May 30, 2006; T.D. 9329, 72
FR 32797, June 14, 2007]
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).)
[[Page 72]]
(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 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
[[Page 73]]
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 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) Statement filed by recipient corporation. If any recipient
corporation received a liquidating distribution from the liquidating
corporation pursuant to a plan (whether or not that recipient
corporation has received or will receive other such distributions from
the liquidating corporation in other tax years as part of the same plan)
during the
[[Page 74]]
current tax year, such recipient corporation must include a statement
entitled, ``STATEMENT PURSUANT TO SECTION 332 BY [INSERT NAME AND
EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A CORPORATION
RECEIVING A LIQUIDATING DISTRIBUTION,'' on or with its return for such
year. If any recipient corporation is a controlled foreign corporation
(within the meaning of section 957), each United States shareholder
(within the meaning of section 951(b)) with respect thereto must include
this statement on or with its return. The statement must include--
(1) The name and employer identification number (if any) of the
liquidating corporation;
(2) The date(s) of all distribution(s) (whether or not pursuant to
the plan) by the liquidating corporation during the current tax year;
(3) The aggregate fair market value and basis, determined
immediately before the liquidation, of all of the assets of the
liquidating corporation that have been or will be transferred to any
recipient corporation;
(4) The date and control number of any private letter ruling(s)
issued by the Internal Revenue Service in connection with the
liquidation;
(5) The following representation: THE PLAN OF COMPLETE LIQUIDATION
WAS ADOPTED ON [INSERT DATE (mm/dd/yyyy)]; and
(6) A representation by such recipient corporation either that--
(i) THE LIQUIDATION WAS COMPLETED ON [INSERT DATE (mm/dd/yyyy)]; or
(ii) THE LIQUIDATION IS NOT COMPLETE AND THE TAXPAYER HAS TIMELY
FILED [INSERT EITHER FORM 952, ``Consent To Extend the Time to Assess
Tax Under Section 332(b),'' OR NUMBER AND NAME OF THE SUCCESSOR FORM].
(b) Filings by the liquidating corporation. The liquidating
corporation must timely file Form 966, ``Corporate Dissolution or
Liquidation,'' (or its successor form) and its final Federal corporate
income tax return. See also section 6043 of the Code.
(c) Definitions. For purposes of this section:
(1) Plan means the plan of complete liquidation within the meaning
of section 332.
(2) Recipient corporation means the corporation described in section
332(b)(1).
(3) Liquidating corporation means the corporation that makes a
distribution of property to a recipient corporation pursuant to the
plan.
(4) Liquidating distribution means a distribution of property made
by the liquidating corporation to a recipient corporation pursuant to
the plan.
(d) Substantiation information. Under Sec. 1.6001-1(e), taxpayers
are required to retain their permanent records and make such records
available to any authorized Internal Revenue Service officers and
employees. In connection with a liquidation described in this section,
these records should specifically include information regarding the
amount, basis, and fair market value of all distributed property, and
relevant facts regarding any liabilities assumed or extinguished as part
of such liquidation.
(e) Effective/applicability date. This section applies to any
taxable year beginning on or after May 30, 2006. However, taxpayers may
apply this section to any original Federal income tax return (including
any amended return filed on or before the due date (including
extensions) of such original return) timely filed on or after May 30,
2006. For taxable years beginning before May 30, 2006, see Sec. 1.332-6
as contained in 26 CFR part 1 in effect on April 1, 2006.
[T.D. 9329, 72 FR 32797, June 14, 2007]
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
[[Page 75]]
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]
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. However, for transactions involving loss shares
of subsidiary stock occurring on or after September 17, 2008, see Sec.
1.1502-36. Further, this section does not apply to a transaction that is
subject to Sec. 1.1502-36.
(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.
[[Page 76]]
(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 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
[[Page 77]]
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 $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
[[Page 78]]
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.
(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.
[[Page 79]]
(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, 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
[[Page 80]]
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 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; T.D.
9424, 73 FR 53947, Sept. 17, 2008]
Sec. 1.337(d)-1T [Reserved]
Sec. 1.337(d)-2 Loss limitation rules.
(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. However, for transactions
involving loss shares of subsidiary stock occurring on or
[[Page 81]]
after September 17, 2008, see Sec. 1.1502-36. Further, this section
does not apply to a transaction that is subject to Sec. 1.1502-36.
(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 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)-2(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, net of directly
related expenses, 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
[[Page 82]]
applying section 1503(e) and other applicable provisions of the Internal
Revenue Code and regulations. Federal income taxes may be directly
related to built-in gain recognized on the disposition of an asset only
to the extent of the excess (if any) of the group's income tax liability
actually imposed under Subtitle A of the Internal Revenue Code for the
taxable year of the disposition of the asset over the group's income tax
liability for the taxable year redetermined by not taking into account
the built-in gain recognized on the disposition of the asset. For this
purpose, the group's income tax liability actually imposed and its
redetermined income tax liability are determined without taking into
account the foreign tax credit under section 27(a) of the Internal
Revenue Code.
(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; and
(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 Sec. Sec. 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. The example reads as follows:
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 P1 groups for purposes of paragraph (c)(2) of this section. In
addition, the loss T recognizes on the disposition of asset 1 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 1 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.
[[Page 83]]
(g) Effective dates. This section applies with respect to
dispositions and deconsolidations on or after March 3, 2005. In
addition, this section applies to dispositions and deconsolidations for
which an election is made under Sec. 1.1502-20(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 after March 6, 2002 and before
March 3, 2005, see Sec. 1.337(d)-2T as contained in the 26 CFR part 1
in effect on March 2, 2005.
[70 FR 10322, Mar. 3, 2005, as amended by T.D. 9424, 73 FR 53947, Sept.
17, 2008]
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;
(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
[[Page 84]]
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 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
[[Page 85]]
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
(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
[[Page 86]]
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 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.
[[Page 87]]
(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 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
[[Page 88]]
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.
(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
[[Page 89]]
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 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),
[[Page 90]]
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 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
[[Page 91]]
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 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
[[Page 92]]
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-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
[[Page 93]]
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:
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
[[Page 94]]
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 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:
[[Page 95]]
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 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
[[Page 96]]
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
Sec. Sec. 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.
(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.
[[Page 97]]
(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.
(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.
(5) Allocation to certain nuclear decommissioning funds.
(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.
[[Page 98]]
(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.
(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.
[[Page 99]]
(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.
(c) Effective/applicability date.
Sec. 1.338-11 Effect of section 338 election on insurance company
targets.
(a) In general.
(b) Computation of ADSP and AGUB.
(1) Reserves taken into account as a liability.
(2) Allocation of ADSP and AGUB to specific insurance contracts.
(c) Application of assumption reinsurance principles.
(1) In general.
(2) Reinsurance premium.
(3) Ceding commission.
(4) Examples.
(d) Reserve increases by new target after the deemed asset sale.
(1) In general.
(2) Exceptions.
(3) Amount of additional premium.
(i) In general.
(ii) Increases in unpaid loss reserves.
(iii) Increases in other reserves.
(4) Limitation on additional premium.
(5) Treatment of additional premium under section 848.
(6) Examples.
(7) Effective/applicability date.
(i) In general.
(ii) Application to pre-effective date increases to reserves.
(e) Effect of section 338 election on section 846(e) election.
(1) In general.
(2) Revocation of existing section 846(e) election.
(f) Effect of section 338 election on old target's capitalization
amounts under section 848.
(1) Determination of net consideration for specified insurance
contracts.
(2) Determination of capitalization amount.
(3) Section 381 transactions.
(g) Effect of section 338 election on policyholders surplus account.
(h) Effect of section 338 election on section 847 special estimated
tax payments.
Sec. 1.338-11T Effect of section 338 election on insurance company
targets (temporary).
(a) through (c) [Reserved]
(d) Reserve increases by new target after the deemed asset sale.
(1) In general.
(2) Exceptions.
(3) Amount of additional premium.
(i) In general.
(ii) Increases in unpaid loss reserves.
(iii) Increases in other reserves.
(4) Limitation on additional premium.
(5) Treatment of additional premium under section 848.
(6) Examples.
(7) Effective dates.
(i) In general.
(ii) Application to pre-effective date increases to reserves.
(e) Effect of section 338 election on section 846(e) election.
(1) In general.
(2) Revocation of existing section 846(e) election.
(f) through (h) [Reserved]
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.
[[Page 100]]
(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.
(a) In general.
(b) Section 338(h)(10) elections for S corporation targets.
(c) Section 338 elections for insurance company targets.
(1) In general.
(2) New target election for retroactive election.
(i) Availability of election.
(ii) Time and manner of making the election for new target.
(3) Old target election for retroactive election.
(i) Availability of election.
(ii) Time and manner of making the election for old target.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001, as amended by T.D. 9158, 70 FR
55741, Sept. 16, 2004; T.D. 9257, 71 FR 17999, Apr. 10, 2006; T.D. 9264,
71 FR 30595, May 30, 2006; T.D. 9358, 72 FR 51705, Sept. 11, 2007; T.D.
9377, 73 FR 3871, Jan. 23, 2008]
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 Sec. Sec. 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 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 the target is
an insurance company for which a section 338 election is made, the
deemed asset sale results in an assumption reinsurance transaction for
the insurance contracts deemed transferred from old target to new
target. See, generally, Sec. 1.817-4(d), and for special rules
regarding the acquisition of insurance company targets, Sec. 1.338-11.
See also Sec. 1.367(a)-8(k)(13) for a rule applicable to gain
recognition agreements (filed under Sec. Sec. 1.367(a)-3(b)(1)(ii) and
1.367(a)-8) and deemed asset sales as a result of an election under
section 338(g).
(3) Overview. Definitions and special nomenclature and rules for
making the
[[Page 101]]
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. Section 1.338-11 provides
special rules for insurance company targets. 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);
(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) Section 846(e) (relating to an election to use an insurance
company's historical loss payment pattern).
(viii) 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
[[Page 102]]
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 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
[[Page 103]]
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; T.D. 9257, 71 FR 18000, Apr. 10, 2006; T.D. 9377,
73 FR 3871, Jan. 23, 2008; T.D. 9446, 74 FR 6957, Feb. 11, 2009]
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.
(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).
[[Page 104]]
(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 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
[[Page 105]]
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 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.
[[Page 106]]
(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 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.
[[Page 107]]
(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 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
[[Page 108]]
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 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
[[Page 109]]
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 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)
[[Page 110]]
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. See Sec. 1.338(h)(10)-1(c)(2) for
special rules concerning section 338(h)(10) elections in certain multi-
step transactions.
(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, 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
[[Page 111]]
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, as
amended by T.D. 9071, 68 FR 40768, July 9, 2003; T.D. 9271, 71 FR 38075,
July 5, 2006]
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 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
[[Page 112]]
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,
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
[[Page 113]]
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 (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:
[[Page 114]]
------------------------------------------------------------------------
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.
------------------------------------------------------------------------
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
[[Page 115]]
(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.
(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
[[Page 116]]
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 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
[[Page 117]]
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.
See paragraph (e)(2) of this section. Thus the purchase price reduction
affects the basis of the truck only indirectly, through the mechanism of
Sec. Sec. 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
[[Page 118]]
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 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.
[[Page 119]]
(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
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)]).
[[Page 120]]
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 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).
[[Page 121]]
(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 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
[[Page 122]]
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.
(5) Allocation to certain nuclear decommissioning funds--(i) General
rule. For purposes of allocating ADSP or AGUB among the acquisition date
assets of a target (and for no other purpose), a taxpayer may elect to
treat a nonqualified nuclear decommissioning fund (as defined in
paragraph (c)(5)(ii) of this section) of the target as if--
(A) Such fund were an entity classified as a corporation;
(B) The stock of the corporation were among the acquisition date
assets of the target and a Class V asset;
(C) The corporation owned the assets of the fund;
(D) The corporation bore the responsibility for decommissioning one
or more nuclear power plants to the extent assets of the fund are
expected to be used for that purpose; and
(E) A section 338(h)(10) election were made for the corporation
(regardless of whether the requirements for a section 338(h)(10)
election are otherwise satisfied).
(ii) Definition of nonqualified nuclear decommissioning fund. A
nonqualified nuclear decommissioning fund means a trust, escrow account,
Government fund or other type of agreement--
(A) That is established in writing by the owner or licensee of a
nuclear generating unit for the exclusive purpose of funding the
decommissioning of one or more nuclear power plants;
(B) That is described to the Nuclear Regulatory Commission in a
report described in 10 CFR 50.75(b) as providing assurance that funds
will be available for decommissioning;
(C) That is not a Nuclear Decommissioning Reserve Fund, as described
in section 468A;
(D) That is maintained at all times in the United States; and
(E) The assets of which are to be used only as permitted by 10 CFR
50.82(a)(8).
(iii) Availability of election. P may make the election described in
this paragraph (c)(5) regardless of whether the selling consolidated
group (or the selling affiliate or the S corporation shareholders) also
makes the election. In addition, the selling consolidated group (or the
selling affiliate or the S corporation shareholders) may make the
election regardless of whether P also makes the election. If T is an S
corporation, all of the S corporation shareholders, including those that
do not sell their stock, must consent to the election for the election
to be effective as to any S corporation shareholder.
(iv) Time and manner of making election. The election described in
this paragraph (c)(5) is made by taking a position on an original or
amended tax return for the taxable year of the qualified stock purchase
that is consistent with having made the election. Such tax return must
be filed no later than the later of 30 days after the date on which the
section 338 election is due or the day the original tax return for the
taxable year of the qualified stock purchase is due (with extensions).
(v) Irrevocability of election. An election made pursuant to this
paragraph (c)(5) is irrevocable.
(vi) Effective/applicability date. This paragraph (c)(5) applies to
qualified stock purchases occurring on or after September 11, 2007. For
qualified stock purchases occurring before September 11, 2007 and on or
after September 15, 2004, see Sec. 1.338-6T as contained in 26 CFR Part
1 in effect on April 1, 2007. For qualified stock purchases occurring
before September 15, 2004, see Sec. 1.338-6 as contained in 26 CFR Part
1 in effect on April 1, 2004.
(d) Examples. The following examples illustrate Sec. Sec. 1.338-4,
1.338-5, and this section:
[[Page 123]]
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 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:
[[Page 124]]
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.
[T.D. 8940, 66 FR 9929, Feb. 13, 2001; 66 FR 17363, Mar. 30, 2001; T.D.
9158, 69 FR 55742, Sept. 16, 2004; T.D. 9358, 72 FR 51706, Sept. 11,
2007]
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,
[[Page 125]]
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 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.
[[Page 126]]
(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 Sec. Sec. 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.
(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
[[Page 127]]
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
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
[[Page 128]]
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
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
[[Page 129]]
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 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
[[Page 130]]
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));
(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.
[[Page 131]]
[GRAPHIC] [TIFF OMITTED] TC17OC91.000
(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
[[Page 132]]
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) 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.
[[Page 133]]
(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
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.
[[Page 134]]
(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 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
[[Page 135]]
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 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
[[Page 136]]
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 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
[[Page 137]]
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 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
[[Page 138]]
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 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.
[[Page 139]]
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 $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
[[Page 140]]
(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
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,
[[Page 141]]
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 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))
[[Page 142]]
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 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
[[Page 143]]
(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 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
[[Page 144]]
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, as amended by T.D. 8940, 66 FR 9929, Feb. 13, 2001;
66 FR 17466, Mar. 30, 2001]
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
[[Page 145]]
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).
(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 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 a statement entitled, ``ELECTION TO FILE A COMBINED RETURN UNDER
SECTION 338(h)(15).'' The statement must include--
(A) The name, address, and employer identification number of each
target required to be included in the combined return; and
(B) The following declaration: EACH TARGET IDENTIFIED IN THIS
ELECTION TO FILE A COMBINED RETURN CONSENTS TO THE FILING OF A COMBINED
RETURN.
(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
[[Page 146]]
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 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.
[[Page 147]]
(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 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.
(c) Effective/applicability date. Paragraph (a)(4)(iii) of this
section applies to any taxable year beginning on or after May 30, 2006.
However, taxpayers may apply paragraph (a)(4)(iii) of this section to
any original Federal income tax return (including any amended return
filed on or before the due date (including extensions) of such original
return) timely filed on or after May 30, 2006. For taxable years
beginning before May 30, 2006, see Sec. 1.338-10 as contained in 26 CFR
part 1 in effect on April 1, 2006.
[T.D. 8940, 66 FR 9948, Feb. 13, 2001, as amended by T.D. 9264, 71 FR
30596, May 30, 2006; T.D. 9329, 72 FR 32798, June 14, 2007]
Sec. 1.338-11 Effect of section 338 election on insurance company targets.
(a) In general. This section provides rules that apply when an
election under section 338 is made for a target that is an insurance
company. The rules in this section apply in addition to those generally
applicable upon the making of an election under section 338. In the case
of a conflict between the provisions of this section and other
provisions of the Internal Revenue Code or regulations, the rules set
forth in this section determine the Federal income tax treatment of the
parties and the transaction when a section 338 election is made for an
insurance company target.
(b) Computation of ADSP and AGUB--(1) Reserves taken into account as
a liability. Old target's tax reserves are the reserves for Federal
income tax purposes for any insurance, annuity, and reinsurance
contracts deemed sold by old target to new target in the deemed asset
sale. The amount of old target's tax reserves is the amount that is
properly taken into account by old target for the contracts at the close
of the taxable year that includes the deemed sale tax consequences
(before giving effect to the deemed asset sale and assumption
reinsurance transaction). Old target's tax reserves are a liability of
[[Page 148]]
old target taken into account in determining ADSP under Sec. 1.338-4
and a liability of new target taken into account in determining AGUB
under Sec. 1.338-5.
(2) Allocation of ADSP and AGUB to specific insurance contracts. For
purposes of allocating AGUB and ADSP under Sec. Sec. 1.338-6 and 1.338-
7, the fair market value of a specific insurance, reinsurance or annuity
contract or group of insurance, reinsurance or annuity contracts
(insurance contracts) is the amount of the ceding commission a willing
reinsurer would pay a willing ceding company in an arm's length
transaction for the reinsurance of the contracts if the gross
reinsurance premium for the contracts were equal to old target's tax
reserves for the contracts. See Sec. 1.197-2(g)(5) for rules concerning
the treatment of the amount allocable to insurance contracts acquired in
the deemed asset sale.
(c) Application of assumption reinsurance principles--(1) In
general. If a target is an insurance company, the deemed sale of
insurance contracts is treated for Federal income tax purposes as an
assumption reinsurance transaction between old target, as the reinsured
or ceding company, and new target, as the reinsurer or acquiring
company, at the close of the acquisition date. The Federal income tax
treatment of the assumption reinsurance transaction is determined under
the applicable provisions of subchapter L, chapter 1, subtitle A of the
Internal Revenue Code, as modified by the rules set forth in this
section.
(2) Reinsurance premium. Old target is deemed to pay a gross amount
of premium in the assumption reinsurance transaction equal to the amount
of old target's tax reserves for the insurance contracts that are
acquisition date assets (acquired contracts). New target is deemed to
receive a reinsurance premium in the amount of old target's tax reserves
for the acquired contracts. See paragraph (d) of this section for
circumstances in which new target is deemed to receive additional
premium. See Sec. 1.817-4(d)(2) for old target's and new target's
treatment of the premium.
(3) Ceding commission. Old target is deemed to receive a ceding
commission in an amount equal to the amount of ADSP allocated to the
acquired contracts, as determined under Sec. Sec. 1.338-6 and 1.338-7
and paragraph (b) of this section. New target is deemed to pay a ceding
commission in an amount equal to the amount of AGUB allocated to the
acquired contracts, as determined under Sec. Sec. 1.338-6 and 1.338-7
and paragraph (b) of this section. See Sec. 1.817-4(d)(2) for old
target's and new target's treatment of the ceding commission.
(4) Examples. The following examples illustrate this paragraph (c):
Example 1. (i) Facts. On January 1, 2003, T, an insurance company,
has the following assets with the following fair market values: $10
cash, $30 of securities, $10 of equipment, a life insurance contract
having a value, under paragraph (b)(2) of this section, of $17, and
goodwill and going concern value. T has tax reserves of $50 and no other
liabilities. On January 1, 2003, P purchases all of the stock of T for
$16 and makes a section 338 election for T. For purposes of the
capitalization requirements of section 848, assume new T has $20 of
general deductions in its first taxable year ending on December 31,
2003, and earns no other premiums during the year.
(ii) Analysis. (A) For Federal income tax purposes, the section 338
election results in a deemed sale of the assets of old T to new T. Old
T's ADSP is $66 ($16 amount realized for the T stock plus $50
liabilities). New T's AGUB also is $66 ($16 basis for the T stock plus
$50 liabilities). See paragraph (b)(1) of this section. Each of the AGUB
and ADSP is allocated under the residual method of Sec. 1.338-6 to
determine the purchase or sale price of each asset transferred. Each of
the AGUB and ADSP is allocated as follows: $10 to cash (Class I), $30 to
the securities (Class II), $10 to equipment (Class V), $16 to the life
insurance contract (Class VI), and $0 to goodwill and going concern
value (Class VII).
(B) Under section 1001, old T's amount realized for the securities
is $30 and for the equipment is $10. As a result of the deemed asset
sale, there is an assumption reinsurance transaction between old T (as
ceding company) and new T (as reinsurer) at the close of the acquisition
date for the life insurance contract issued by old T. See paragraph
(c)(1) of this section. Although the assumption reinsurance transaction
results in a $50 decrease in old T's reserves, which is taxable income
to old T, the reinsurance premium paid by old T is deductible by old T.
Under paragraph (c)(2) of this section, old T is deemed to pay a
reinsurance premium equal to the reserve for the life insurance contract
immediately before the deemed asset sale ($50) and is deemed to receive
a
[[Page 149]]
ceding commission from new T. Under paragraph (c)(3) of this section,
the portion of the ADSP allocated to the life insurance contract is $16;
thus, the ceding commission is $16. Old T, therefore, is deemed to pay
new T a reinsurance premium of $34 ($50 - $16 = $34). Old T also has $34
of net negative consideration for purposes of section 848. See paragraph
(f) of this section for rules relating to the effect of a section 338
election on the capitalization of amounts under section 848.
(C) New T obtains an initial basis of $30 in the securities and $10
in the equipment. New T is deemed to receive a reinsurance premium from
old T in an amount equal to the $50 of reserves for the life insurance
contract and to pay old T a $16 ceding commission for the contract. See
paragraphs (c)(2) and (3) of this section. Accordingly, new T includes
$50 of premium in income and deducts $50 for its increase in reserves.
For purposes of section 848, new T has $34 of net positive consideration
for the deemed assumption reinsurance transaction. Because the only
contract involved in the deemed assumption reinsurance transaction is a
life insurance contract, new T must capitalize $2.62 ($34 x 7.7% =
$2.62) under section 848. New T will amortize the $2.62 as provided
under section 848. New T's adjusted basis in the life insurance
contract, which is an amortizable section 197 intangible, is $13.38, the
excess of the $16 ceding commission over the $2.62 capitalized under
section 848. See section 197 and Sec. 1.197-2(g)(5). New T deducts the
$2.62 of the ceding commission that is not amortizable under section 197
because it is reflected in the amount capitalized under section 848 and
also deducts the remaining $17.38 of its general deductions.
Example 2. (i) Facts. Assume the same facts as in Example 1, except
the life insurance contract has a value of $0 and the fair market value
of T's securities are $60. Thus, to reinsure the contract in an arm's
length transaction, T would have to pay the reinsurer a reinsurance
premium in excess of T's $50 of tax reserves for the contract.
(ii) Analysis. (A) For Federal income tax purposes, the section 338
election results in a deemed sale of the assets of old T to new T. Old
T's ADSP is $66 ($16 amount realized for the T stock plus $50
liabilities). New T's AGUB also is $66 ($16 basis for the T stock plus
$50 liabilities). See paragraph (b)(1) of this section. Each of the AGUB
and ADSP is allocated under the residual method of Sec. 1.338-6 to
determine the purchase or sale price of each asset transferred. Each of
the AGUB and ADSP is allocated as follows: $10 to cash (Class I), $56 to
the securities (Class II), $0 to the equipment (Class V), $0 to the life
insurance contract (Class VI), and $0 to goodwill and going concern
value (Class VII).
(B) Under section 1001, old T's amount realized for the securities
is $56 and for the equipment is $0. As a result of the deemed asset
sale, there is an assumption reinsurance transaction between old T (as
ceding company) and new T (as reinsurer) at the close of the acquisition
date for the life insurance contract issued by old T. See paragraph
(c)(1) of this section. Although the assumption reinsurance transaction
results in a $50 decrease in old T's reserves, which is taxable income
to old T, the reinsurance premium deemed paid by old T to new T is
deductible by old T. Under paragraph (c)(2) of this section, old T is
deemed to pay a reinsurance premium equal to the reserve for the life
insurance contract immediately before the deemed asset sale ($50), and
is deemed to receive from new T a ceding commission equal to the amount
of AGUB allocated to the life insurance contract ($0), as provided in
paragraph (c)(3) of this section. Old T also has $50 of net negative
consideration for purposes of section 848. See paragraph (f) of this
section for rules relating to the effect of a section 338 election on
capitalization amounts under section 848.
(C) New T obtains an initial basis of $56 in the securities (with a
fair market value of $60) and $0 in the equipment (with a fair market
value of $10). New T is deemed to receive a reinsurance premium from old
T in an amount equal to the $50 of reserves for the life insurance
contract. Accordingly, new T includes $50 of premium in income and
deducts $50 for its increase in reserves. For purposes of section 848,
new T has $50 of net positive consideration for the deemed assumption
reinsurance transaction. Because the only contract involved in the
assumption reinsurance transaction is a life insurance contract, new T
must capitalize $3.85 ($50 x 7.7%) under section 848 from the
transaction and deducts the remaining $16.15 of its general deductions.
Because new T allocates $0 of the AGUB to the insurance contract, no
amount is amortizable under section 197 with respect to the insurance
contract. See Sec. 1.338-11T(d) for rules on adjustments required if
new T increases its reserves for, or reinsures at a loss, the acquired
life insurance contract.
(d) Reserve increases by new target after the deemed asset sale--(1)
In general. If in new target's first taxable year or any subsequent
year, new target increases its reserves for any acquired contracts, new
target is treated as receiving an additional premium, which is computed
under paragraph (d)(3) of this section, in the assumption reinsurance
transaction described in paragraph (c)(1) of this section. New target
includes the additional premium in gross income for the taxable year in
which new target increases its reserves
[[Page 150]]
for acquired contracts. New target's increase in reserves for the
insurance contracts acquired in the deemed asset sale is a liability of
new target not originally taken into account in determining AGUB that is
subsequently taken into account. Thus, AGUB is increased by the amount
of the additional premium included in new target's gross income. See
Sec. Sec. 1.338-5(b)(2)(ii) and 1.338-7. Old target has no deduction
under this paragraph (d) and makes no adjustments under Sec. Sec.
1.338-4(b)(2)(ii) and 1.338-7.
(2) Exceptions. New target is not treated as receiving additional
premium under paragraph (d)(1) of this section if--
(i) It is under state receivership as of the close of the taxable
year for which the increase in reserves occurs; or
(ii) It is required by section 807(f) to spread the reserve increase
over the 10 succeeding taxable years.
(3) Amount of additional premium--(i) In general. The additional
premium taken into account under this paragraph (d) is an amount equal
to the sum of the positive amounts described in paragraphs (d)(3)(ii)
and (d)(3)(iii) of this section. However, the additional premium cannot
exceed the limitation described in paragraph (d)(4) of this section.
(ii) Increases in unpaid loss reserves. The positive amount with
respect to unpaid loss reserves is computed using the formula A/B x (C-
[D + E]) where--
(A) A equals old target's discounted unpaid losses (determined under
section 846) included in AGUB under paragraph 11(b)(1) of this section;
(B) B equals old target's undiscounted unpaid losses (determined
under section 846(b)(1)) as of the close of the acquisition date;
(C) C equals new target's undiscounted unpaid losses (determined
under section 846(b)(1)) at the end of the taxable year that are
attributable to losses incurred by old target on or before the
acquisition date;
(D) D (which may be a negative number) equals old target's
undiscounted unpaid losses as of the close of the acquisition date,
reduced by the cumulative amount of losses, loss adjustment expenses,
and reinsurance premiums paid by new target through the end of the
taxable year for losses incurred by old target on or before the
acquisition date; and
(E) E equals the amount obtained by dividing the cumulative amount
of reserve increases taken into account under this paragraph (d) in
prior taxable years by A/B.
(iii) Increases in other reserves. The positive amount with respect
to reserves other than discounted unpaid loss reserves is the net
increase of those reserves due to changes in estimate, methodology, or
other assumptions used to compute the reserves (including the adoption
by new target of a methodology or assumptions different from those used
by old target).
(4) Limitation on additional premium. The additional premium taken
into account by new target under paragraph (d)(1) of this section is
limited to the excess, if any, of--
(i) The fair market value of old target's assets acquired by new
target in the deemed asset sale (other than Class VI and Class VII
assets); over
(ii) The AGUB allocated to those assets (including increases in AGUB
allocated to those assets as the result of reserve increases by new
target in prior taxable years).
(5) Treatment of additional premium under section 848. If a portion
of the positive amounts described in paragraphs (d)(3)(ii) and (iii) of
this section are attributable to an increase in reserves for specified
insurance contracts (as defined in section 848(e)), new target takes an
allocable portion of the additional premium in determining its specified
policy acquisition expenses under section 848(c) for the taxable year of
the reserve increase.
(6) Examples. The following examples illustrate this paragraph (d):
Example 1. (i) Facts. On January 1, 2006, P purchases all of the
stock of T, a non-life insurance company, for $120 and makes a section
338 election for T. On the acquisition date, old T has total reserve
liabilities under state law of $725, consisting of undiscounted unpaid
losses of $625 and unearned premiums of $100. Old T's tax reserves on
the acquisition date are $580, which consist of discounted unpaid losses
(as defined in section 846) of $500 and unearned premiums (as computed
under section 832(b)(4)(B)) of $80. Old T has Class I through Class V
assets with a fair market value of $800. Old T also has a Class
[[Page 151]]
VI asset with a fair market value of $75, consisting of the future
profit stream of certain insurance contracts. During 2006, new T makes
loss and loss adjustment expense payments of $200 with respect to the
unpaid losses incurred by old T before the acquisition date. As of
December 31, 2006, new T reports undiscounted unpaid losses of $475
attributable to losses incurred before the acquisition date. The related
amount of discounted unpaid losses (as defined in section 846) for those
losses is $390.
(ii) Computation and allocation of AGUB. Under Sec. 1.338-5 and
paragraph (b)(1) of this section, as of the acquisition date, AGUB is
$700, reflecting the sum of the amount paid for old T's stock ($120) and
the tax reserves assumed by new T in the transaction ($580). The fair
market value of old T's Class I through V assets is $800, whereas the
AGUB available for such assets under Sec. 1.338-6 is $700. There is no
AGUB available for old T's Class VI assets, even though such assets have
a fair market value of $75 on the acquisition date.
(iii) Adjustments for increases in reserves for unpaid losses. Under
paragraph (d) of this section, new T must determine whether there are
any amounts by which it increased its unpaid loss reserves that will be
treated as an additional premium and an increase in AGUB. New T applies
the formula of paragraph (d)(3) of this section, where A equals $500, B
equals $625, C equals $475, D equals $425 ($625 - $200), and E equals
$0. Under this formula, new T is treated as having increased its
reserves for discounted unpaid losses attributable to losses incurred by
old T by $40 ($500/$625 x ($475 - [$425 + 0]). The limitation under
paragraph (d)(5) of this section based on the difference between the
fair market value of old T's Class I through Class V assets and the AGUB
allocated to such assets is $100. Accordingly, new T includes an
additional premium of $40 in gross income for 2006, and increases the
AGUB allocated to old T's Class I through Class V assets to reflect this
additional premium.
Example 2. (i) Facts. Assume the same facts as in Example 1. Further
assume that during 2007 new T deducts total loss and loss expense
payments of $375 with respect to losses incurred by old T before the
acquisition date. On December 31, 2007, new T reports undiscounted
unpaid losses of $150 with respect to losses incurred before the
acquisition date. The related amount of discounted unpaid losses (as
defined in section 846) for those unpaid losses is $125.
(ii) Analysis. New T must determine whether any amounts by which it
increased its unpaid losses during 2007 will be treated as an additional
premium in paragraph (d)(3) of this section. New T applies the formula
under paragraph (d)(3) of this section, where A equals $500, B equals
$625, C equals $150, D equals $50 ($625 - $575), and E equals $50 ($40
divided by .8). In paragraph (d)(3) of this section, new T is treated as
increasing its reserves for discounted unpaid losses by $40 during 2007
with respect to losses incurred by old T ($500/$625 x ($150-[$50 +
$50]). New T determines the limitation of paragraph (d)(5) of this
section by comparing the $800 fair market value of the Class I through V
assets on the acquisition date to the $740 AGUB allocated to such assets
(which includes the $40 addition to AGUB included during 2006). Thus,
new T recognizes $40 of additional premium as a result of the increase
in reserves during 2007, and adjusts the AGUB allocable to the Class I
through V assets acquired from old T to reflect such additional premium.
Example 3. (i) Facts. The facts are the same as Example 2, except
that on January 1, 2008, new T reinsures the outstanding liability with
respect to losses incurred by old T before the acquisition date through
a portfolio reinsurance transaction with R, another non-life insurance
company. R agrees to assume any remaining liability relating to losses
incurred by old T before the acquisition date in exchange for a
reinsurance premium of $200. Accordingly, as of December 31, 2008, new T
reports no undiscounted unpaid losses with respect to losses incurred by
old T before the acquisition date.
(ii) Analysis. New T must determine whether any amount by which it
increased its unpaid loss reserves will be treated as an additional
premium under paragraph (d) of this section. New T applies the formula
of paragraph (d)(3) of this section, where A equals $500, B equals $625,
C equals $0, and D equals -$150 ($625 - ($575 + $200), and E equals $100
($80 divided by .8). Thus, new T is treated as having increased its
discounted unpaid losses by $40 in 2008 with respect to losses incurred
by old T before the acquisition date ($500/$625 x (0 -[-$150 + $100]).
New T includes this positive amount in gross income, subject to the
limitation of paragraph (d)(4) of this section. The limitation of
paragraph (d)(4) of this section equals $20, which is computed by
comparing the $800 fair market value of the Class I through V assets
acquired from old T with the $780 AGUB allocated to such assets (which
includes the $40 addition to AGUB in 2006 and the $40 addition to AGUB
in 2007). Thus, New T includes $20 in additional premium, and increases
the AGUB allocated to the Class I through V assets acquired from old T
by $20. As a result of these adjustments, the limitation under paragraph
(d)(4) of this section is reduced to zero.
(7) Effective/applicability date--(i) In general. This section
applies to increases to reserves made by new target after a deemed asset
sale occurring on or after April 10, 2006.
(ii) Application to pre-effective date increases to reserves. If
either new target
[[Page 152]]
makes an election under Sec. 1.338(i)-1(c)(2) or old target makes an
election under Sec. 1.338(i)-1(c)(3) to apply the rules of this
section, in whole, to a qualified stock purchase occurring before April
10, 2006, then the rules contained in this section shall apply in whole
to the qualified stock purchase.
(e) Effect of section 338 election on section 846(e) election--(1)
In general. New target and old target are treated as the same
corporation for purposes of an election by old target to use its
historical loss payment pattern under section 846(e). See Sec. 1.338-
1(b)(2)(vii). Therefore, if old target has a section 846(e) election in
effect on the acquisition date, new target will continue to use the
historical loss payment pattern of old target to discount unpaid losses
incurred in accident years covered by the election, unless new target
elects to revoke the section 846(e) election. In addition, new target
may consider old target's historical loss payment pattern when
determining whether to make the section 846(e) election for a
determination year that includes or is subsequent to the acquisition
date.
(2) Revocation of existing section 846(e) election. New target may
revoke old target's section 846(e) election to use its historical loss
payment pattern to discount unpaid losses. If new target elects to
revoke old target's section 846(e) election, new target will use the
industry-wide patterns determined by the Secretary to discount unpaid
losses incurred in accident years beginning on or after the acquisition
date through the subsequent determination year. New target may revoke
old target's section 846(e) election by attaching a statement to new
target's original tax return for its first taxable year.
(f) Effect of section 338 election on old target's capitalization
amounts under section 848--(1) Determination of net consideration for
specified insurance contracts. For purposes of applying section 848 and
Sec. 1.848-2(f) to the deemed assumption reinsurance transaction, old
target's net consideration (either positive or negative) for each
category of specified insurance contracts is an amount equal to--
(i) The allocable portion of the ceding commission (if any) relating
to contracts in that category; less
(ii) The amount by which old target's tax reserves for contracts in
that category has been reduced as a result of the deemed assumption
reinsurance transaction.
(2) Determination of capitalization amount. Except as provided in
Sec. 1.381(c)(22)-1(b)(13)--
(i) If, after the deemed asset sale, old target has an amount
otherwise required to be capitalized under section 848 for the taxable
year or an unamortized balance of specified policy acquisition expenses
from prior taxable years, then old target deducts such remaining amount
or unamortized balance as an expense incurred in the taxable year that
includes the deemed sale tax consequences; and
(ii) If, after the deemed asset sale, the negative capitalization
amount resulting from the reinsurance transaction exceeds the amount
that old target can deduct under section 848(f)(1), then old target's
capitalization amount is treated as zero at the close of the taxable
year that includes the deemed sale tax consequences.
(3) Section 381 transactions. For transactions described in section
381, see Sec. 1.381(c)(22)-1(b)(13).
(g) Effect of section 338 election on policyholders surplus account.
Except as specifically provided in Sec. 1.381(c)(22)-1(b)(7), the
deemed asset sale effects a distribution of old target's policyholders
surplus account to the extent the grossed-up amount realized on the sale
to the purchasing corporation of the purchasing corporation's recently
purchased target stock (as defined in Sec. 1.338-4(c)) exceeds old
target's shareholders surplus account under section 815(c).
(h) Effect of section 338 election on section 847 special estimated
tax payments. If old target had elected to claim an additional deduction
under section 847 for the taxable year that includes the deemed sale tax
consequences or any earlier years, the amount remaining in old target's
special loss discount account under section 847(3) must be reduced to
the extent it relates to contracts transferred to new target and the
amount of such reduction must be included in old target's gross income
for the taxable year that includes the
[[Page 153]]
deemed sale tax consequences. Old target may apply the balance of its
special estimated tax account as a credit against any tax resulting from
such inclusion in gross income. Any special estimated tax payments
remaining after this credit are voided and, therefore, are not available
for credit or refund. Under section 847(1), new target is permitted to
claim a section 847 deduction for losses incurred before the deemed
asset sale, subject to the general requirement that new target makes
timely special estimated tax payments equal to the tax benefit resulting
from this deduction. See Sec. 1.381(c)(22)-1(c)(14) regarding the
carryover of the special loss discount account attributable to contracts
transferred in a section 381 transaction.
[T.D. 9257, 71 FR 18000, Apr. 10, 2006, as amended by T.D. 9377, 73 FR
3872, Jan. 23, 2008]
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
Sec. Sec. 1.338-1 through 1.338-10 and, in appropriate cases, apply
instead of the rules of Sec. Sec. 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) Availability of section 338(h)(10) election in certain multi-
step transactions. Notwithstanding anything to the contrary in Sec.
1.338-3(c)(1)(i), a section 338(h)(10) election may be made for T where
P's acquisition of T stock, viewed independently, constitutes a
qualified stock purchase and, after the stock acquisition, T merges or
liquidates into P (or another member of the affiliated group that
includes P), whether or not, under relevant provisions of law, including
the step transaction doctrine, the acquisition of the T stock and the
merger or liquidation of T qualify as a reorganization described in
section 368(a). If a section 338(h)(10) election is made in a case where
the acquisition of T stock followed by a merger or liquidation of T into
P qualifies as a reorganization described in section 368(a), for all
Federal tax purposes, P's acquisition of T stock is treated as a
qualified stock purchase and is not treated as part of a reorganization
described in section 368(a).
(3) 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
[[Page 154]]
day of the 9th month beginning after the month in which the acquisition
date occurs.
(4) 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.
(5) 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)), 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
Sec. Sec. 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 Sec. Sec. 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 Sec. Sec. 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
[[Page 155]]
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 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:
[[Page 156]]
(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 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
[[Page 157]]
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
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).
[[Page 158]]
(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 Sec. Sec.
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:
(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.
[[Page 159]]
(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.
(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.
Example 11. Stock acquisition followed by upstream merger--without
section 338(h)(10) election. (i) P owns all the stock of Y, a newly
formed subsidiary. S owns all the stock of T. Each of P, S, T and Y is a
domestic corporation. P acquires all of the T stock in a statutory
merger of Y into T, with T surviving. In the merger, S receives
consideration consisting of 50% P voting stock and 50% cash. Viewed
independently of any other step, P's acquisition of T stock constitutes
a qualified stock purchase. As part of the plan that includes P's
acquisition of the T stock, T subsequently merges into P. Viewed
independently of any other step, T's merger into P qualifies as a
liquidation described in section 332. Absent the application of
paragraph (c)(2) of this section, the step transaction doctrine would
apply to treat P's acquisition of the T stock and T's merger into P as
an acquisition by P of T's assets in a reorganization described in
section 368(a). P and S do not make a section 338(h)(10) election with
respect to P's purchase of the T stock.
(ii) Because P and S do not make an election under section
338(h)(10) for T, P's acquisition of the T stock and T's merger into P
is treated as part of a reorganization described in section 368(a).
Example 12. Stock acquisition followed by upstream merger--with
section 338(h)(10) election. (i) The facts are the same as in Example 11
except that P and S make a joint election under section 338(h)(10) for
T.
(ii) Pursuant to paragraph (c)(2) of this section, as a result of
the election under section 338(h)(10), for all Federal tax purposes, P's
acquisition of the T stock is treated as a qualified stock purchase and
P's acquisition of the T stock is not treated as part of a
reorganization described in section 368(a).
Example 13. Stock acquisition followed by brother-sister merger--
with section 338(h)(10) election. (i) The facts are the same as in
Example 12, except that, following P's acquisition of the T stock, T
merges into X, a domestic corporation that is a wholly owned subsidiary
of P. Viewed independently of any other step, T's merger into X
qualifies as a reorganization described in section 368(a). Absent the
application of paragraph (c)(2) of this section, the step transaction
doctrine would apply to treat P's acquisition of the T stock and T's
merger into X as an acquisition by X of T's assets in a reorganization
described in section 368(a).
(ii) Pursuant to paragraph (c)(2) of this section, as a result of
the election under section 338(h)(10), for all Federal tax purposes, P's
acquisition of T stock is treated as a qualified stock purchase and P's
acquisition of T
[[Page 160]]
stock is not treated as part of a reorganization described in section
368(a).
Example 14. Stock acquisition that does not qualify as a qualified
stock purchase followed by upstream merger. (i) The facts are the same
as in Example 11, except that, in the statutory merger of Y into T, S
receives only P voting stock.
(ii) Pursuant to Sec. 1.338-3(c)(1)(i) and paragraph (c)(2) of this
section, no election under section 338(h)(10) can be made with respect
to P's acquisition of the T stock because, pursuant to relevant
provisions of law, including the step transaction doctrine, that
acquisition followed by T's merger into P is treated as a reorganization
described in section 368(a)(1)(A), and that acquisition, viewed
independently of T's merger into P, does not constitute a qualified
stock purchase under section 338(d)(3). Accordingly, P's acquisition of
the T stock and T's merger into P is treated as a reorganization
described in section 368(a).
(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.
(h) Effective date. This section is applicable to stock acquisitions
occurring on or after July 5, 2006. For stock acquisitions occurring
before July 5, 2006, see Sec. 1.338(h)(10)-1T as contained in the
edition of 26 CFR part 1, revised as of April 1, 2006.
[T.D. 8940, 66 FR 8950, Feb. 13, 2001, as amended by T.D. 9071, 68 FR
40768, July 9, 2003; T.D. 9264, 71 FR 30607, May 30, 2006; T.D. 9271, 71
FR 38075, July 5, 2006; T.D. 9329, 72 FR 32808, June 14, 2007]
Sec. 1.338(i)-1 Effective/applicability date.
(a) In general. The provisions of Sec. Sec. 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 Sec. Sec. 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 Sec. Sec. 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).
(c) Section 338 elections for insurance company targets--(1) In
general. The rules of Sec. 1.338-11 apply to qualified stock purchases
occurring on or after April 10, 2006.
(2) New target election for retroactive application--(i)
Availability of election. New target may make an irrevocable election to
apply the rules in Sec. Sec. 1.338-11 (including the applicable
provisions in Sec. Sec. 1.197-2(g)(5), 381(c)(22)-1, and 846) in whole,
but not in part, to a qualified stock purchase occurring before April
10, 2006 for which a section 338 election is made, provided that new
target's first taxable year and all subsequent affected taxable years
are years for which an assessment of deficiency or a refund for
overpayment is not prevented by any law or rule of law. In the case of a
section 338 election for which a section 338(h)(10) election is made (or
a section 338 election for a foreign target), new target may make the
election to apply the regulations retroactively without regard to
whether old target makes the election. In the case of a section 338
election for a domestic target for which no section 338(h)(10) election
is made, new target may make the election to apply the regulations
retroactively only if old target also makes the election. Paragraph
(c)(2)(ii) of this section prescribes the time and manner of the
election for new target.
(ii) Time and manner of making the election for new target. New
target may make an election described in paragraph (c)(2)(i) of this
section by attaching a statement to its original or
[[Page 161]]
amended income tax return for its first taxable year. The statement must
be entitled ``Election to Retroactively Apply the Rules in Sec. Sec.
1.338-11 (including the applicable provisions in Sec. Sec. 1.197-
2(g)(5), 1.381(c)(22)-1 and 846) in whole to a transaction completed
before April 10, 2006'' and must include the following information--
(A) The name and E.I.N. for new target; and
(B) The following declaration (or a substantially similar
declaration): New target has amended its income tax returns for its
first taxable year and for all affected subsequent years to reflect the
rules in Sec. Sec. 1.338-11 (including the applicable provisions in
Sec. Sec. 197-2(g)(5), 1.381(c)(22)-1 and 846). All other parties whose
income tax liabilities are affected by new target's election have
amended their income tax returns for all affected years to reflect the
rules in Sec. Sec. 1.338-11 (including the applicable provisions in
Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and 846).
(3) Old target election for retroactive application--(i)
Availability of election. Old target may make an irrevocable election to
apply the rules in Sec. Sec. 1.338-11 (including the applicable
provisions in Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and 846) in
whole, but not in part, to a qualified stock purchase occurring before
April 10, 2006 for which a section 338 election is made, provided that
old target's taxable year that includes the deemed sale tax consequences
and all subsequent affected taxable years are years for which an
assessment of deficiency or a refund for overpayment is not prevented by
any law or rule of law. In the case of a section 338 election for which
a section 338(h)(10) election is made (or a section 338 election for a
foreign target), old target may make the election to apply the
regulations retroactively without regard to whether new target makes the
election. In the case of a section 338 election for a domestic target
for which no section 338(h)(10) election is made, old target may make
the election to apply the regulations retroactively only if new target
also makes the election. Paragraph (c)(3)(ii) of this section prescribes
the time and manner of the election for old target.
(ii) Time and manner of making the election for old target. Old
target may make an election described in paragraph (c)(3)(i) of this
section by attaching a statement to each affected party's original or
amended income tax return for the taxable year that includes the deemed
sale tax consequences. The statement must be entitled ``Election to
Retroactively Apply the Rules in Sec. Sec. 1.338-11 (including the
applicable provisions in Sec. Sec. 1.197-2(g)(5), 1.381(c)(22)-1 and
846) to a transaction completed before April 10, 2006'' and must include
the following information--
(A) The name and E.I.N. for old target; and
(B) The following declaration (or a substantially similar
declaration): Old target has amended its income tax returns for the
taxable year that includes the deemed sale tax consequences and for all
affected subsequent years to reflect the rules in Sec. Sec. 1.338-11
(including the applicable provisions in Sec. Sec. 1.197-2(g)(5),
1.381(c)(22)-1 and 846). All other parties whose income tax liabilities
are affected by old target's election have amended their income tax
returns for all affected years to reflect the rules in Sec. Sec. 1.338-
11 (including the applicable provisions in Sec. Sec. 1.197-2(g)(5),
1.381(c)(22)-1 and 846).
[T.D. 8940, 66 FR 9954, Feb. 13, 2001, as amended by T.D. 9257, 71 FR
18003, Apr. 10, 2006; T.D. 9377, 73 FR 3873, 3874, Jan. 23, 2008]
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), 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]
[[Page 162]]
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 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
[[Page 163]]
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 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
[[Page 164]]
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.
(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.
[[Page 165]]
(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]
Sec. 1.341-5 Application of section.
(a) Whether or not a corporation is a collapsible corporation shall
be determined under the regulations of Sec. Sec. 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
[[Page 166]]
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 Sec. Sec. 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 Sec. Sec. 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 (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
[[Page 167]]
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 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
[[Page 168]]
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.
(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
[[Page 169]]
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 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
[[Page 170]]
(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 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
[[Page 171]]
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
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
[[Page 172]]
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 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
[[Page 173]]
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 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
[[Page 174]]
(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 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
[[Page 175]]
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 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
[[Page 176]]
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 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
[[Page 177]]
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.
(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
[[Page 178]]
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
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,
[[Page 179]]
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
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
[[Page 180]]
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 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
[[Page 181]]
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 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.
[[Page 182]]
(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 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
[[Page 183]]
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 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
[[Page 184]]
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 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
[[Page 185]]
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.
(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.
[[Page 186]]
(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]
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 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.
[[Page 187]]
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 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
[[Page 188]]
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 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
[[Page 189]]
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 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
[[Page 190]]
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 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
[[Page 191]]
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) Significant transferor. Every significant transferor must
include a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.351-3(a)
BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF
TAXPAYER], A SIGNIFICANT TRANSFEROR,'' on or with such transferor's
income tax return for the taxable year of the section 351 exchange. If a
significant transferor is a controlled foreign corporation (within the
meaning of section 957), each United States shareholder (within the
meaning of section 951(b)) with respect thereto must include this
statement on or with its return. The statement must include--
(1) The name and employer identification number (if any) of the
transferee corporation;
(2) The date(s) of the transfer(s) of assets;
(3) The aggregate fair market value and basis, determined
immediately before the exchange, of the property transferred by such
transferor in the exchange; and
(4) The date and control number of any private letter ruling(s)
issued by the Internal Revenue Service in connection with the section
351 exchange.
(b) Transferee corporation. Except as provided in paragraph (c) of
this section, every transferee corporation must include a statement
entitled, ``STATEMENT PURSUANT TO Sec. 1.351-3(b) BY [INSERT NAME AND
EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A TRANSFEREE
CORPORATION,'' on or with its income tax return for the taxable year of
the exchange. If the transferee corporation is a controlled foreign
corporation (within the meaning of section 957), each United States
shareholder (within the meaning of section 951(b)) with respect thereto
must include this statement on or with its return. The statement must
include--
(1) The name and taxpayer identification number (if any) of every
significant transferor;
(2) The date(s) of the transfer(s) of assets;
(3) The aggregate fair market value and basis, determined
immediately before the exchange, of all of the property received in the
exchange; and
(4) The date and control number of any private letter ruling(s)
issued by the Internal Revenue Service in connection with the section
351 exchange.
(c) Exception for certain transferee corporations. The transferee
corporation is not required to file a statement under paragraph (b) of
this section if all of the information that would be included in the
statement described in paragraph (b) of this section is included in any
statement(s) described in paragraph (a) of this section that is attached
to the same return for the same section 351 exchange.
(d) Definitions. For purposes of this section:
(1) Significant transferor means a person that transferred property
to a corporation and received stock of the transferee corporation in an
exchange described in section 351 if, immediately after the exchange,
such person--
(i) Owned at least five percent (by vote or value) of the total
outstanding stock of the transferee corporation if
[[Page 192]]
the stock owned by such person is publicly traded, or
(ii) Owned at least one percent (by vote or value) of the total
outstanding stock of the transferee corporation if the stock owned by
such person is not publicly traded.
(2) Publicly traded stock means stock that is listed on--
(i) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
(ii) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the Securities
Exchange Act of 1934 (15 U.S.C. 78o-3).
(e) Substantiation information. Under Sec. 1.6001-1(e), taxpayers
are required to retain their permanent records and make such records
available to any authorized Internal Revenue Service officers and
employees. In connection with the exchange described in this section,
these records should specifically include information regarding the
amount, basis, and fair market value of all transferred property, and
relevant facts regarding any liabilities assumed or extinguished as part
of such exchange.
(f) Effective/applicability date. This section applies to any
taxable year beginning on or after May 30, 2006. However, taxpayers may
apply this section to any original Federal income tax return (including
any amended return filed on or before the due date (including
extensions) of such original return) timely filed on or after May 30,
2006. For taxable years beginning before May 30, 2006, see Sec. 1.351-3
as contained in 26 CFR part 1 in effect on April 1, 2006.
[T.D. 9329, 72 FR 32798, June 14, 2007]
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 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
[[Page 193]]
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 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 Sec. Sec. 1.355-1 through 1.355-
7, 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.
[[Page 194]]
(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) [Reserved]
(h) Active conduct of a trade or business.
(i) [Reserved]
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.
(a) Distributing corporation.
(1) In general.
(2) Special rule when an asset transfer precedes a stock
distribution.
(b) Significant distributee.
(c) Definitions.
(1) Significant distributee.
(2) Publicly traded stock.
(d) Substantiation information.
(e) Effective/applicability date.
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.
(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.
[[Page 195]]
(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.
(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. 1.355-7 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.
[[Page 196]]
(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.
(i) In general.
(ii) Special rule.
(3) Safe Harbor III.
(4) Safe Harbor IV.
(i) In general.
(ii) Special rules.
(5) Safe Harbor V.
(i) In general.
(ii) Special rules.
(6) Safe Harbor VI.
(7) Safe Harbor VII.
(i) In general.
(ii) Special rules.
(8) Safe Harbor VIII.
(i) In general.
(ii) Special rule.
(9) Safe Harbor IX.
(i) In general.
(ii) Special rule.
(e) Options, warrants, convertible obligations, and other similar
interests.
(1) Treatment of options.
(i) General rule.
(ii) Agreement, understanding, or arrangement to write, transfer, or
modify an option.
(iii) Substantial negotiations related to options.
(2) Stock acquired pursuant to options.
(3) Instruments treated as options.
(4) Instruments generally not treated as options.
(i) Escrow, pledge, or other security agreements.
(ii) Options exercisable only upon death, disability, mental
incompetency, or separation from service.
(iii) Rights of first refusal.
(iv) 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) Disclosure event.
(6) Discussions.
(7) Established market.
(8) Five-percent shareholder.
(9) Implicit permission.
(10) Public announcement.
(11) Public offering.
(12) Similar acquisition (not involving a public offering).
(13) Similar acquisition involving a public offering.
(i) One public offering.
(ii) More than one public offering.
(iii) Potential acquisition involving a public offering.
(14) 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; T.D. 9198, 70 FR
20283, Apr. 19, 2005; T.D. 9264, 71 FR 30597, May 30, 2006; T.D. 9329,
72 FR 32799, June 14, 2007; T.D. 9435, 73 FR 75950, Dec. 15, 2008]
Sec. 1.355-0T Outline of sections (temporary).
This section lists the major paragraphs under Sec. 1.355-2T.
Sec. 1.355-2T Limitations (temporary).
(a) through (f)(2) [Reserved] For further guidance, see the entries
for Sec. 1.355-2(a) through (f)(2) in Sec. 1.355-0.
(g) Recently acquired controlled stock under section 355(a)(3)(B).
(1) Other property.
(2) Exceptions.
(3) DSAG.
(4) Taxable transaction.
(5) Examples.
(h) [Reserved] For further guidance, see the entry for Sec. 1.355-
2(h) in Sec. 1.355-0.
(i) Effective/applicability date.
(1) In general.
(2) Transition election.
(3) Retroactive election.
(4) Manner of election.
(5) Prior law.
(6) Expiration date.
[T.D. 9435, 73 FR 75950, Dec. 15, 2008]
Sec. 1.355-1 Distribution of stock and securities of a controlled
corporation.
(a) Effective/applicability date of certain sections. Except as
otherwise provided, this section and Sec. Sec. 1.355-2 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). This section and Sec. Sec. 1.355-2
through 1.355-4, other than Sec. 1.355-2(g) and (i) and Sec. 1.355-2T,
do not reflect the amendments to section 355 made by the Revenue Act of
1987, the Technical and Miscellaneous Revenue Act of 1988, and the Tax
Technical Corrections Act of 2007. For the applicability date of
Sec. Sec. 1.355-2T(g), 1.355-5, 1.355-6, and 1.355-
[[Page 197]]
7, see Sec. Sec. 1.355-2T(i), 1.355-5(e), 1.355-6(g), and 1.355-7(k),
respectively.
(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
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; T.D. 9435, 73 FR 75950, Dec. 15, 2008; 74 FR 3420,
Jan. 21, 2009]
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.
[[Page 198]]
(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 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
[[Page 199]]
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 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
[[Page 200]]
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 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.
[[Page 201]]
(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.
(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.
[[Page 202]]
(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 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
[[Page 203]]
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 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
[[Page 204]]
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 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) [Reserved] For further guidance, see Sec. 1.355-2T(g).
(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.
(i) [Reserved] For further guidance, see Sec. 1.355-2T(i).
[T.D. 8238, 54 FR 290, Jan. 5, 1989; 54 FR 5577, Feb. 3, 1989; 57 FR
28463, June 25, 1992; T.D. 9435, 73 FR 75950, Dec. 15, 2008]
Sec. 1.355-2T Limitations (temporary).
(a) through (f)(2) [Reserved] For further guidance, see Sec. 1.355-
2(a) through (f)(2).
(g) Recently acquired controlled stock under section 355(a)(3)(B)--
(1) Other property. Except as provided in paragraph (g)(2) of this
section, for purposes of section 355(a)(1)(A), section 355(c), and so
much of section 356 as relates to section 355, stock of a controlled
corporation acquired by the DSAG in a taxable transaction (as defined in
paragraph (g)(4) of this section) within the five-year period ending on
the date of the distribution (pre-distribution period) shall not be
treated as stock of the controlled corporation but shall be treated as
``other property.'' Transfers of controlled corporation stock that is
owned by the DSAG immediately before and immediately after the transfer
are disregarded and are not acquisitions for purposes of this paragraph
(g)(1).
(2) Exceptions. Paragraph (g)(1) of this section does not apply to
an acquisition of stock of the controlled corporation--
(i) If the controlled corporation is a DSAG member at any time after
the
[[Page 205]]
acquisition (but prior to the distribution); or
(ii) Described in Sec. 1.355-3(b)(4)(iii).
(3) DSAG. For purposes of this paragraph (g), a DSAG is the
distributing corporation's separate affiliated group (the affiliated
group which would be determined under section 1504(a) if such
corporation were the common parent and section 1504(b) did not apply)
that consists of the distributing corporation as the common parent and
all corporations affiliated with the distributing corporation through
stock ownership described in section 1504(a)(1)(B) (regardless of
whether the corporations are includible corporations under section
1504(b)). For purposes of paragraph (g)(1) of this section, any
reference to the DSAG is a reference to the distributing corporation if
it is not the common parent of a separate affiliated group.
(4) Taxable transaction--(i) Generally. For purposes of this
paragraph (g), a taxable transaction is a transaction in which gain or
loss was recognized in whole or in part.
(ii) Dunn Trust and predecessor issues. [Reserved]
(5) Examples. The following examples illustrate this paragraph (g).
Assume that C, D, P, and S are corporations, X is an unrelated
individual, each of the transactions is unrelated to any other
transaction and, but for the issue of whether C stock is treated as
``other property'' under section 355(a)(3)(B), the distributions satisfy
all of the requirements of section 355. No inference should be drawn
from any of these examples as to whether any requirements of section 355
other than section 355(a)(3)(B), as specified, are satisfied.
Furthermore, the following definitions apply:
(i) Purchase is an acquisition that is a taxable transaction.
(ii) Section 368(c) stock is stock constituting control within the
meaning of section 368(c).
(iii) Section 1504(a)(2) stock is stock meeting the requirements of
section 1504(a)(2).
Example 1. Hot stock. For more than five years, D has owned section
368(c) stock but not section 1504(a)(2) stock of C. In year 6, D
purchases additional C stock from X. However, D does not own section
1504(a)(2) stock of C after the year 6 purchase. If D distributes all of
its C stock within five years after the year 6 purchase, for purposes of
section 355(a)(1)(A), section 355(c), and so much of section 356 as
relates to section 355, the C stock purchased in year 6 would be treated
as ``other property.'' See paragraph (g)(1) of this section.
Example 2. C becomes a DSAG member. For more than five years, D has
owned section 368(c) stock but not section 1504(a)(2) stock of C. In
year 6, D purchases additional C stock from X such that D's total
ownership of C is section 1504(a)(2) stock. If D distributes all of its
C stock within five years after the year 6 purchase, the distribution of
the C stock purchased in year 6 would not be treated as ``other
property'' because C becomes a DSAG member. See paragraph (g)(2)(i) of
this section. The result would be the same if D did not own any C stock
prior to year 6 and D purchased all of the C stock in year 6. See
paragraph (g)(2)(i) of this section. Similarly, if D did not own any C
stock prior to year 6, D purchased 20 percent of the C stock in year 6,
and then acquired all of the remaining C stock in year 7, the C stock
purchased in year 6 and the C stock acquired in year 7 (even if
purchased) would not be treated as ``other property'' because C becomes
a DSAG member. See paragraph (g)(2)(i) of this section.
Example 3. Intra-SAG transaction. For more than five years, D has
owned all of the stock of S. D and S, in the aggregate, have owned
section 368(c) stock but not section 1504(a)(2) stock of C. Therefore, D
and S are DSAG members, but C is not. In year 6, D purchases S's C
stock. If D distributes all of its C stock within five years after the
year 6 purchase, the distribution of the C stock purchased in year 6
would not be treated as ``other property''. D's purchase of the C stock
from S is disregarded for purposes of paragraph (g)(1) of this section
because that C stock was owned by the DSAG immediately before and
immediately after the purchase. See paragraph (g)(1) of this section.
Example 4. Affiliate exception. For more than five years, P has
owned 90 percent of the sole outstanding class of the stock of D and a
portion of the stock of C, and X has owned the remaining 10 percent of
the D stock. Throughout this period, D has owned section 368(c) stock
but not section 1504(a)(2) stock of C. In year 6, D purchases P's C
stock. However, D does not own section 1504(a)(2) stock of C after the
year 6 purchase. If D distributes all of its C stock to X in exchange
for X's D stock within five years after the year 6 purchase, the
distribution of the C stock purchased in year 6 would not be treated as
``other property'' because the C stock was purchased from a member (P)
of the affiliated group (as defined in Sec. 1.355-3(b)(4)(iv)) of which
D is a member, and P did
[[Page 206]]
not purchase that C stock within the pre-distribution period. See
paragraph (g)(2)(ii) of this section.
(h) [Reserved] For further guidance, see Sec. 1.355-2(h).
(i) Effective/applicability date--(1) In general. Paragraphs (g)(1)
through (g)(5) of this section apply to distributions occurring after
December 15, 2008. However, except as provided in paragraph (i)(2) of
this section, paragraphs (g)(1) through (g)(5) of this section do not
apply to any distribution occurring after December 15, 2008, that is
pursuant to a transaction which is--
(i) Made pursuant to an agreement which was binding on December 15,
2008, and at all times thereafter;
(ii) Described in a ruling request submitted to the Internal Revenue
Service on or before such date; or
(iii) Described on or before such date in a public announcement or
in a filing with the Securities and Exchange Commission.
(2) Transition election. In the case of any distribution described
in the second sentence of paragraph (i)(1) of this section, taxpayers
may elect to apply all of paragraphs (g)(1) through (g)(5) of this
section. However, neither the distributing corporation nor any person
related to the distributing corporation within the meaning of section
267(b) (determined immediately before or immediately after the
distribution) may make such an election with respect to a distribution
unless all such persons make such an election with respect to such
distribution.
(3) Retroactive election. In the case of any distribution occurring
on or before December 15, 2008, taxpayers may elect to apply all of
paragraphs (g)(1) through (g)(5) of this section to distributions to
which section 4(b) of the Tax Technical Corrections Act of 2007, Public
Law 110-172 (121 Stat. 2473, 2476) applies (generally applicable to
distributions made after May 17, 2006, as provided in section 4(d) of
that act). However, neither the distributing corporation nor any person
related to the distributing corporation within the meaning of section
267(b) (determined immediately before or immediately after the
distribution) may make such an election with respect to a distribution
unless all such persons make such an election with respect to such
distribution.
(4) Manner of election. Taxpayers may make any election available
under this paragraph (i) by applying the selected rule on its original
or amended return.
(5) Prior law. For distributions to which paragraphs (g)(1) through
(g)(5) of this section do not apply, see Sec. 1.355-2(g), as contained
in 26 CFR part 1, revised as of April 1, 2008.
(6) Expiration date. The applicability of paragraph (i) of this
section will expire on December 15, 2011.
[T.D. 9435, 73 FR 75950, Dec. 15, 2008; 74 FR 3420, Jan. 21, 2009]
Sec. 1.355-3 Active conduct of a trade or business.
(a) General requirements--(1) Application of section 355. Under
section 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
[[Page 207]]
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 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-
[[Page 208]]
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 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
[[Page 209]]
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
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
[[Page 210]]
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 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) Distributing corporation--(1) In general. Every corporation that
makes a distribution (the distributing corporation) of stock or
securities of a controlled corporation, as described in section 355 (or
so much of section 356 as relates to section 355), must include a
statement entitled, ``STATEMENT PURSUANT TO Sec. 1.355-5(a) BY [INSERT
NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A
DISTRIBUTING CORPORATION,'' on or with its return for the year of the
distribution. If the distributing corporation is a controlled foreign
corporation (within the meaning of section 957), each United States
shareholder (within the meaning of section 951(b)) with respect thereto
must include this statement on or with its return. The statement must
include--
[[Page 211]]
(i) The name and employer identification number (if any) of the
controlled corporation;
(ii) The name and taxpayer identification number (if any) of every
significant distributee;
(iii) The date of the distribution of the stock or securities of the
controlled corporation;
(iv) The aggregate fair market value and basis, determined
immediately before the distribution or exchange, of the stock,
securities, or other property (including money) distributed by the
distributing corporation in the transaction; and
(v) The date and control number of any private letter ruling(s)
issued by the Internal Revenue Service in connection with the
transaction.
(2) Special rule when an asset transfer precedes a stock
distribution. If the distributing corporation transferred property to
the controlled corporation in a transaction described in section 351 or
368, as part of a plan to then distribute the stock or securities of the
controlled corporation in a transaction described in section 355 (or so
much of section 356 as relates to section 355), then, unless paragraph
(a)(1)(v) of this section applies, the distributing corporation must
also include on or with its return for the year of the distribution the
statement required by Sec. 1.351-3(a) or 1.368-3(a). If the
distributing corporation is a controlled foreign corporation (within the
meaning of section 957), each United States shareholder (within the
meaning of section 951(b)) with respect thereto must include the
statement required by Sec. 1.351-3(a) or 1.368-3(a) on or with its
return.
(b) Significant distributee. Every significant distributee must
include a statement entitled, ``STATEMENT PURSUANT TO Sec. 1.355-5(b)
BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF
TAXPAYER], A SIGNIFICANT DISTRIBUTEE,'' on or with such distributee's
return for the year in which such distribution is received. If a
significant distributee is a controlled foreign corporation (within the
meaning of section 957), each United States shareholder (within the
meaning of section 951(b)) with respect thereto must include this
statement on or with its return. The statement must include--
(1) The names and employer identification numbers (if any) of the
distributing and controlled corporations;
(2) The date of the distribution of the stock or securities of the
controlled corporation; and
(3) The aggregate basis, determined immediately before the exchange,
of any stock or securities transferred by the significant distributee in
the exchange, and the aggregate fair market value, determined
immediately before the distribution or exchange, of the stock,
securities or other property (including money) received by the
significant distributee in the distribution or exchange.
(c) Definitions. For purposes of this section:
(1) Significant distributee means--
(i) A holder of stock of a distributing corporation that receives,
in a transaction described in section 355 (or so much of section 356 as
relates to section 355), stock of a corporation controlled by the
distributing corporation if, immediately before the distribution or
exchange, such holder--
(A) Owned at least five percent (by vote or value) of the total
outstanding stock of the distributing corporation if the stock owned by
such holder is publicly traded; or
(B) Owned at least one percent (by vote or value) of the stock of
the distributing corporation if the stock owned by such holder is not
publicly traded; or
(ii) A holder of securities of a distributing corporation that
receives, in a transaction described in section 355 (or so much of
section 356 as relates to section 355), stock or securities of a
corporation controlled by the distributing corporation if, immediately
before the distribution or exchange, such holder owned securities in
such distributing corporation with a basis of $1,000,000 or more.
(2) Publicly traded stock means stock that is listed on--
(i) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f); or
[[Page 212]]
(ii) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the Securities
Exchange Act of 1934 (15 U.S.C. 78o-3).
(d) Substantiation information. Under Sec. 1.6001-1(e), taxpayers
are required to retain their permanent records and make such records
available to any authorized Internal Revenue Service officers and
employees. In connection with the distribution or exchange described in
this section, these records should specifically include information
regarding the amount, basis, and fair market value of all property
distributed or exchanged, and relevant facts regarding any liabilities
assumed or extinguished as part of such distribution or exchange.
(e) Effective/applicability date. This section applies to any
taxable year beginning on or after May 30, 2006. However, taxpayers may
apply this section to any original Federal income tax return (including
any amended return filed on or before the due date (including
extensions) of such original return) timely filed on or after May 30,
2006. For taxable years beginning before May 30, 2006, see Sec. 1.355-5
as contained in 26 CFR part 1 in effect on April 1, 2006.
[T.D. 9329, 72 FR 32799, June 14, 2007]
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--
(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
[[Page 213]]
(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--
(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.
[[Page 214]]
(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 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
[[Page 215]]
(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 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
[[Page 216]]
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 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
[[Page 217]]
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 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
[[Page 218]]
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:
(A) Escrow, pledge, or other security agreements. An option that is
part of a security arrangement in a typical lending transaction
(including a purchase
[[Page 219]]
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 be exercised. Nonetheless, based on
all the facts and circumstances, it is reasonably certain, immediately
after the distribution,
[[Page 220]]
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).
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
[[Page 221]]
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 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.
[[Page 222]]
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.
(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
[[Page 223]]
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 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):
[[Page 224]]
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 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)
[[Page 225]]
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 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
[[Page 226]]
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 Sec. Sec. 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 Sec. Sec. 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 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
[[Page 227]]
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 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
[[Page 228]]
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 person and an entity are
treated as a single person under section 355(d)(7), and the person later
purchases an additional interest in the entity, the person is treated as
purchasing on the date of the later purchase the amount of stock
attributed from the entity to the person under section 355(d)(8)(A) as a
result of the additional interest.
(iii) Purchase between persons treated as one person. If two persons
are treated as one person under section 355(d)(7), and one later
purchases stock from the other, the date of the later purchase is used
for purposes of determining when the five-year period commences.
(iv) Purchase by a person already treated as holding stock under
section 355(d)(8)(A). If a person who is already treated as holding
stock under section 355(d)(8)(A) later directly purchases such stock,
the date of the later direct purchase is used for purposes of
determining when the five-year period commences.
(v) Examples. The following examples illustrate this paragraph
(e)(1):
Example 1. On Date 1, A purchases 10 percent of the stock of P,
which has held 100 percent of the stock of T for more than five years at
the time of A's purchase. A is deemed to have purchased 10 percent of
P's T stock on Date 1. If A later purchases an additional 41 percent of
the stock of P on Date 2, A is deemed to have purchased an additional 41
percent of P's T stock on Date 2. Because A and P are now related
persons under section 267(b), they are treated as one person under
section 355(d)(7)(A), and A is treated as owning all of P's T stock. A
is treated as acquiring 51 percent of the T stock by purchase at the
times of A's respective purchases of P stock on Date 1 and Date 2. The
remaining 49 percent of T stock is treated as acquired when P acquired
the T stock, more than five years before Date 1. If P distributes T
after
[[Page 229]]
Date 2 and within five years after Date 1, the distribution will be a
disqualified distribution under section 355(d)(2) and paragraph (b)(1)
of this section.
Example 2. A has owned 60 percent of the stock of P for more than
five years, and P has owned 40 percent of the stock of T for more than
five years. A and P are treated as one person, and A is treated as
owning 40 percent of the stock of T for more than five years. If P later
purchases an additional 20 percent of the stock of T on Date 1, A is
treated as acquiring by purchase the additional 20 percent of T stock on
Date 1. If A then purchases an additional 10 percent of the stock of P
on Date 2, under paragraph (e)(1)(i) of this section, A is deemed to
have purchased on Date 2 an additional four percent of the T stock (10
percent of the 40 percent that P originally owned). In addition, even
though A and P were already treated as one person under section
355(d)(7)(A), A also is deemed to have purchased two percent of the T
stock on Date 2 (10 percent of the 20 percent of the T stock that it was
treated as purchasing on Date 1). A is still treated as owning all 60
percent of the T stock owned by P. However, of the 60 percent, A is
treated as having purchased 18 percent of the T stock on Date 1 and 6
percent of the T stock on Date 2, for a total of 24 percent purchased
stock.
Example 3. A purchases a 20 percent interest in partnership M on
Date 1. M has owned 30 percent of the stock and 25 percent of the
securities of P for more than five years. P has owned 40 percent of the
stock and 100 percent of the securities of T for more than five years.
Under section 318(a)(2)(C) as modified by section 355(d)(8)(A), M is
deemed to own 12 percent of the stock (30 percent of the 40 percent P
owns) and 30 percent of the securities (30 percent of the 100 percent P
owns) of T. Under sections 318(a)(2)(A) and 355(d)(8)(B), A is deemed to
have purchased 2.4 percent of the stock (20 percent of the 12 percent M
is deemed to own) and 6 percent of the securities (20 percent of the 30
percent M is deemed to own) of T on Date 1. Similarly, A is deemed to
have purchased 6 percent of the stock (20 percent of the 30 percent M
owns) and five percent of the securities (20 percent of the 25 percent M
owns) of P on Date 1. If M later purchases an additional 10 percent of P
stock on Date 2, M is deemed to have purchased four percent of the stock
(10 percent of the 40 percent P owns) and 10 percent of the securities
(10 percent of the 100 percent P owns) of T on Date 2. A is deemed to
have purchased two percent of the stock of P on Date 2 (20 percent of
the 10 percent M purchased). A is also deemed to have purchased 0.8
percent of the stock (20 percent of the four percent M is deemed to have
purchased) and two percent of the securities (20 percent of the 10
percent M is deemed to have purchased) of T on Date 2.
Example 4. A and B are brother and sister. For more than five years,
A has owned 75 percent of the stock of P, and B has owned 25 percent of
the stock of P. A and B are treated as one person under section 267(b),
and the stock of each is treated as purchased on the date it was
purchased by A and B, respectively. If B later purchases 50 percent of
the P stock from A on Date 1, A and B are still treated as one person.
However, under paragraph (e)(3)(iii) of this section, the 50 percent of
P stock that B purchased from A is treated as purchased on Date 1.
(2) Transferred basis rule. If any person acquires property from
another person who acquired the property by purchase (determined with
regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3) and (4)
of this section, but without regard to section 355(d)(8) and paragraph
(e)(1) of this section), and the adjusted basis of the property in the
hands of the acquirer is determined in whole or in part by reference to
the adjusted basis of the property in the hands of the other person, the
acquirer is treated as having acquired the property by purchase on the
date it was so acquired by the other person. The rule in this paragraph
(e)(2) applies, for example, where stock of a corporation acquired by
purchase is subsequently acquired in a section 351 transfer or a
reorganization qualifying under section 368(a)(1)(B), but does not apply
if the stock of a former common parent is acquired in a group structure
change to which Sec. 1.1502-31 applies. But see paragraph
(d)(2)(i)(B)(2) of this section for situations where the stock is
treated as purchased on the date of a transfer.
(3) Exchanged basis rule--(i) In general. If any person acquires an
interest in an entity (the first interest) by purchase (determined with
regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3) and (4)
of this section, but without regard to section 355(d)(8) and paragraph
(e)(1) of this section), and the first interest is exchanged for an
interest in the same or another entity (the second interest) where the
adjusted basis of the second interest is determined in whole or in part
by reference to the adjusted basis of the first interest, then the
second interest is treated as having been purchased on the date the
first interest was purchased. The rule in this paragraph (e)(3) applies
[[Page 230]]
only to exchanges that are not otherwise treated as purchases under
section 355(d)(5) and paragraph (d) of this section. The rule in this
paragraph (e)(3) applies, for example, where stock of a corporation
acquired by purchase is subsequently exchanged for other stock in a
section 351, 354, or 1036(a) exchange. But see paragraph (d)(2)(i)(A)(2)
of this section for situations where the stock is treated as purchased
on the date of an exchange or distribution.
(ii) Example. The following example illustrates this paragraph
(e)(3):
Example. A purchases 50 percent of the stock of T on Date 1. On Date
2, T merges into D in a section 368(a)(1)(A) reorganization, with A
exchanging all of the T stock solely for stock of D. Under section
358(a), A's basis in the D stock is determined by reference to the basis
of the T stock it purchased. Accordingly, A is treated as having
purchased the D stock on Date 1, and has a purchased basis in the D
stock under paragraph (b)(3)(iii) of this section.
(4) Certain section 355 or section 305 distributions--(i) Section
355. If a distributing corporation distributes any stock of a controlled
corporation with respect to recently purchased distributing stock in a
distribution that qualifies under section 355 (or so much of section 356
as relates to section 355), such controlled corporation stock is deemed
to be acquired by purchase by the distributee on the date the
distributee acquired the recently purchased distributing stock. Recently
purchased distributing stock is stock in the distributing corporation
acquired by purchase (determined with regard to section 355(d)(5) and
paragraphs (d) and (e)(2), (3), and (4) of this section, but without
regard to section 355(d)(8) and paragraph (e)(1) of this section) by the
distributee during the five-year period with respect to that
distribution.
(ii) Section 305. If a corporation distributes its stock in a
distribution that qualifies under section 305(a), the stock received in
the distribution (to the extent section 307(a) applies to determine the
recipient's basis) is deemed to be acquired by purchase by the recipient
on the date (if any) that the recipient acquired by purchase (determined
with regard to section 355(d)(5) and paragraphs (d) and (e)(2), (3), and
(4) of this section), the stock with respect to which the distribution
is made.
(5) Substantial diminution of risk--(i) In general. If section
355(d)(6) applies to any stock for any period, the running of any five-
year period set forth in section 355(d)(3) is suspended during such
period.
(ii) Property to which suspension applies. Section 355(d)(6) applies
to any stock for any period during which the holder's risk of loss with
respect to such stock, or with respect to any portion of the activities
of the corporation, is (directly or indirectly) substantially diminished
by an option, a short sale, any special class of stock, or any other
device or transaction.
(iii) Risk of loss substantially diminished. Whether a holder's risk
of loss is substantially diminished under section 355(d)(6) and
paragraph (e)(5)(ii) of this section will be determined based on all
facts and circumstances relating to the stock, the corporate activities,
and arrangements for holding the stock.
(iv) Special class of stock. For purposes of section 355(d)(6) and
paragraph (e)(5)(ii) of this section, the term special class of stock
includes a class of stock that grants particular rights to, or bears
particular risks for, the holder or the issuer with respect to the
earnings, assets, or attributes of less than all the assets or
activities of a corporation or any of its subsidiaries. The term
includes, for example, tracking stock and stock (or any related
instruments or arrangements) the terms of which provide for the
distribution (whether or not at the option of any party or in the event
of any contingency) of any controlled corporation or other specified
assets to the holder or to one or more persons other than the holder.
(f) Duty to determine stockholders--(1) In general. In determining
whether section 355(d) applies to a distribution of controlled
corporation stock, a distributing corporation must determine whether a
disqualified person holds its stock or the stock of any distributed
controlled corporation. This paragraph (f) provides rules regarding this
determination and the extent to which a distributing corporation must
investigate
[[Page 231]]
whether a disqualified person holds stock.
(2) Deemed knowledge of contents of securities filings. A
distributing corporation is deemed to have knowledge of the existence
and contents of all schedules, forms, and other documents filed with or
under the rules of the Securities and Exchange Commission, including
without limitation any Schedule 13D or 13G (or any similar schedules)
and amendments, with respect to any relevant corporation.
(3) Presumption as to securities filings. Absent actual knowledge to
the contrary, in determining whether section 355(d) applies to a
distribution, a distributing corporation may presume, with respect to
stock that is reporting stock (while such stock is reporting stock),
that every shareholder or other person required to file a schedule,
form, or other document with or under the rules of the Securities and
Exchange Commission as of a given date has filed the schedule, form, or
other document as of that date and that the contents of filed schedules,
forms, or other documents are accurate and complete. Reporting stock is
stock that is described in Rule 13d-1(i) of Regulation 13D (17 CFR
240.13d-1(i)) (or any rule or regulation to generally the same effect)
promulgated by the Securities and Exchange Commission under the
Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).
(4) Presumption as to less-than-five-percent shareholders. Absent
actual knowledge (or deemed knowledge under paragraph (f)(2) of this
section) immediately after the distribution to the contrary with regard
to a particular shareholder, a distributing corporation may presume that
no less-than-five-percent shareholder of a corporation acquired stock or
securities by purchase under section 355(d)(5) or (8) and paragraphs (d)
and (e) of this section during the five-year period. For purposes of
this paragraph (f), a less-than-five-percent shareholder is a person
that, at no time during the five-year period, holds directly (or by
application of paragraph (c)(3)(ii) of this section, but not by
application of section 355(d)(7) or (8)) stock possessing five percent
or more of the total combined voting power of all classes of stock
entitled to vote or the total value of shares of all classes of stock of
a corporation. However, this presumption does not apply to any less-
than-five-percent shareholder that, at any time during the five-year
period--
(i) Is related under section 355(d)(7)(A) to a shareholder in the
corporation that is, at any time during the five-year period, not a
less-than-five-percent shareholder;
(ii) Acted pursuant to a plan or arrangement, with respect to
acquisitions of the corporation's stock or securities under section
355(d)(7)(B) and paragraph (c)(4) of this section, with a shareholder in
the corporation that is, at any time during the five-year period, not a
less-than-five-percent shareholder; or
(iii) Holds stock or securities that is attributed under section
355(d)(8)(A) to a shareholder in the corporation that is, at any time
during the five-year period, not a less-than-five-percent shareholder.
(5) Examples. The following examples illustrate this paragraph (f):
Example 1. Publicly traded corporation; no schedules filed. D is a
widely held and publicly traded corporation with a single class of
reporting stock and no other class of stock. Assume that applicable
federal law requires any person that directly holds five percent or more
of the D stock to file a schedule with the Securities and Exchange
Commission within 10 days after an acquisition. D distributes its wholly
owned subsidiary C pro rata. D determines that no schedule, form, or
other document has been filed with respect to its stock or the stock of
any other relevant corporation during the five-year period or within 10
days after the distribution. Immediately after the distribution, D has
no knowledge that any of its shareholders are (or were at any time
during the five-year period) not less-than-five-percent shareholders, or
that any particular shareholder acquired D stock by purchase under
section 355(d)(5) or (8) and paragraphs (d) and (e) of this section
during the five-year period. Under paragraph (f)(3) of this section, D
may presume it has no shareholder that is or was not a less-than-five-
percent shareholder during the five-year period due to the absence of
any filed schedules, forms, or other documents. Under paragraph (f)(4)
of this section, D may presume that none of its less-than-five-percent
shareholders acquired D's stock by purchase during the five-year period.
Accordingly, D may presume that section 355(d) does not apply to the
distribution of C.
[[Page 232]]
Example 2. Publicly traded corporation; schedule filed. The facts
are the same as those in Example 1, except that D determines that, as of
10 days after the distribution, only one schedule has been filed with
respect to its stock. That schedule discloses that X acquired 15 percent
of the D stock one year before the distribution. Absent contrary
knowledge, D may rely on the presumptions in paragraph (f)(3) of this
section and so may presume that X is its only shareholder that is or was
not a less-than-five-percent shareholder during the five-year period. D
may not rely on the presumption in paragraph (f)(4) of this section with
respect to X. In addition, D may not rely on the presumption in
paragraph (f)(4) of this section with respect to any less-than-five-
percent shareholder that, at any time during the five-year period, is
related to X under section 355(d)(7)(A), acted pursuant to a plan or
arrangement with X under section 355(d)(7)(B) and paragraph (c)(4) of
this section with respect to acquisitions of D stock, or holds stock
that is attributed to X under section 355(d)(8)(A). Accordingly, under
paragraph (f)(1) of this section, to determine whether section 355(d)
applies, D must determine: whether X acquired its directly held D stock
by purchase under section 355(d)(5) and paragraphs (d) and (e)(2) and
(3) of this section during the five-year period; whether X is treated as
having purchased any additional D stock under section 355(d)(8) and
paragraph (e)(1) of this section during the five-year period; and
whether X is related to, or acquired its D stock pursuant to a plan or
arrangement with, one or more of D's other shareholders during the five-
year period under section 355(d)(7)(A) or (B) and paragraph (c)(4) of
this section, and if so, whether those shareholders acquired their D
stock by purchase under section 355(d)(5) or (8) and paragraphs (d) and
(e) of this section during the five-year period.
Example 3. Acquisition of publicly traded corporation. The facts are
the same as those in Example 1, except that P acquires all of the D
stock in a section 368(a)(1)(B) reorganization that is not also a
reorganization under section 368(a)(1)(A) by reason of section
368(a)(2)(E), and D distributes C to P one year later. Because D was
widely held, P applies statistical sampling procedures that involve less
than 50% of D's outstanding shares, to estimate the basis of all shares
acquired, instead of surveying each shareholder. Under the deemed
purchase rule of section 355(d)(5)(C) and paragraph (e)(2) of this
section, P is treated as having acquired the D stock by purchase on the
date the D shareholders acquired the D stock by purchase. Even though D
has no less-than-five-percent shareholder immediately after the
distribution, D may rely on the presumptions in paragraphs (f)(3) and
(4) of this section to determine whether and to what extent the D stock
is treated as purchased during the five-year period in P's hands under
the deemed purchase rule of section 355(d)(5)(C) and paragraph (e)(2) of
this section. Accordingly, D may presume that section 355(d) does not
apply to the distribution of C to P. This result would not change even
if the statistical sampling that involves less than 50 percent of D's
outstanding shares indicated that more than 50% of D's shares were
acquired by purchase during the five-year period.
Example 4. Non-publicly traded corporation. D is owned by 20
shareholders and has a single class of stock that is not reporting
stock. D knows that A owns 40 percent of the D stock, and D does not
know that any other shareholder has owned as much as five percent of the
D stock at any time during the five-year period. D may not rely on the
presumption in paragraph (f)(3) of this section because its stock is not
reporting stock. D may not rely on the presumption in paragraph (f)(4)
of this section with respect to A. In addition, D may not rely on the
presumption in paragraph (f)(4) of this section for any less-than-five-
percent shareholder that, at any time during the five-year period, is
related to A under section 355(d)(7)(A), acted pursuant to a plan or
arrangement with A under section 355(d)(7)(B) and paragraph (c)(4) of
this section with respect to acquisitions of D stock, or holds stock
that is attributed to A under section 355(d)(8)(A). D may rely on the
presumption in paragraph (f)(4) of this section for less-than-five-
percent shareholders that during the five-year period are not related to
A, did not act pursuant to a plan or arrangement with A, and do not hold
stock attributed to A. Accordingly, under paragraph (f)(1) of this
section, to determine whether section 355(d) applies, D must determine:
that A is its only shareholder that is (or was at any time during the
five-year period) not a less-than-five-percent shareholder; whether A
acquired its directly held D stock by purchase under section 355(d)(5)
and paragraphs (d) and (e)(2) and (3) of this section during the five-
year period; whether A is treated as having purchased any additional D
stock under section 355(d)(8) and paragraph (e)(1) of this section
during the five-year period; and whether A is related to, or acquired
its D stock pursuant to a plan or arrangement with, one or more of D's
other shareholders during the five-year period under section
355(d)(7)(A) or (B) and paragraph (c)(4) of this section, and if so,
whether those shareholders acquired their D stock by purchase under
section 355(d)(5) or (8) and paragraphs (d) and (e) of this section
during the five-year period.
(g) Effective date. This section applies to distributions occurring
after December 20, 2000, except that they do not apply to any
distributions occurring
[[Page 233]]
pursuant to a written agreement which is (subject to customary
conditions) binding on December 20, 2000, and at all times thereafter.
[T.D. 8913, 65 FR 79723, Dec. 20, 2000; 66 FR 9034, Feb. 6, 2001]
Sec. 1.355-7 Recognition of gain on certain distributions of stock or
securities in connection with an acquisition.
(a) In general. Except as provided in section 355(e) and in this
section, section 355(e) applies to any distribution--
(1) To which section 355 (or so much of section 356 as relates to
section 355) applies; and
(2) That is part of a plan (or series of related transactions)
(hereinafter, plan) pursuant to which 1 or more persons acquire directly
or indirectly stock representing a 50-percent or greater interest in the
distributing corporation (Distributing) or any controlled corporation
(Controlled).
(b) Plan--(1) In general. Whether a distribution and an acquisition
are part of a plan is determined based on all the facts and
circumstances. The facts and circumstances to be considered in
demonstrating whether a distribution and an acquisition are part of a
plan include, but are not limited to, the facts and circumstances set
forth in paragraphs (b)(3) and (4) of this section. In general, the
weight to be given each of the facts and circumstances depends on the
particular case. Whether a distribution and an acquisition are part of a
plan does not depend on the relative number of facts and circumstances
set forth in paragraph (b)(3) that evidence that a distribution and an
acquisition are part of a plan as compared to the relative number of
facts and circumstances set forth in paragraph (b)(4) that evidence that
a distribution and an acquisition are not part of a plan.
(2) Certain post-distribution acquisitions. In the case of an
acquisition (other than involving a public offering) after a
distribution, the distribution and the acquisition can be part of a plan
only if there was an agreement, understanding, arrangement, or
substantial negotiations regarding the acquisition or a similar
acquisition at some time during the two-year period ending on the date
of the distribution. In the case of an acquisition (other than involving
a public offering) after a distribution, the existence of an agreement,
understanding, arrangement, or substantial negotiations regarding the
acquisition or a similar acquisition at some time during the two-year
period ending on the date of the distribution tends to show that the
distribution and the acquisition are part of a plan. See paragraph
(b)(3)(i) of this section. However, all facts and circumstances must be
considered to determine whether the distribution and the acquisition are
part of a plan. For example, in the case of an acquisition (other than
involving a public offering) after a distribution, if the distribution
was motivated in whole or substantial part by a corporate business
purpose (within the meaning of Sec. 1.355-2(b)) other than a business
purpose to facilitate the acquisition or a similar acquisition of
Distributing or Controlled (see paragraph (b)(4)(v) of this section) and
would have occurred at approximately the same time and in similar form
regardless of whether the acquisition or a similar acquisition was
effected (see paragraph (b)(4)(vi) of this section), the taxpayer may be
able to establish that the distribution and the acquisition are not part
of a plan.
(3) Plan factors. Among the facts and circumstances tending to show
that a distribution and an acquisition are part of a plan are the
following:
(i) In the case of an acquisition (other than involving a public
offering) after a distribution, at some time during the two-year period
ending on the date of the distribution, there was an agreement,
understanding, arrangement, or substantial negotiations regarding the
acquisition or a similar acquisition. The weight to be accorded this
fact depends on the nature, extent, and timing of the agreement,
understanding, arrangement, or substantial negotiations. The existence
of an agreement, understanding, or arrangement at the time of the
distribution is given substantial weight.
(ii) In the case of an acquisition involving a public offering after
a distribution, at some time during the two-year period ending on the
date of the distribution, there were discussions by
[[Page 234]]
Distributing or Controlled with an investment banker regarding the
acquisition or a similar acquisition. The weight to be accorded this
fact depends on the nature, extent, and timing of the discussions.
(iii) In the case of an acquisition (other than involving a public
offering) before a distribution, at some time during the two-year period
ending on the date of the acquisition, there were discussions by
Distributing or Controlled with the acquirer regarding a distribution.
The weight to be accorded this fact depends on the nature, extent, and
timing of the discussions. In addition, in the case of an acquisition
(other than involving a public offering) before a distribution, the
acquirer intends to cause a distribution and, immediately after the
acquisition, can meaningfully participate in the decision regarding
whether to make a distribution.
(iv) In the case of an acquisition involving a public offering
before a distribution, at some time during the two-year period ending on
the date of the acquisition, there were discussions by Distributing or
Controlled with an investment banker regarding a distribution. The
weight to be accorded this fact depends on the nature, extent, and
timing of the discussions.
(v) In the case of an acquisition either before or after a
distribution, the distribution was motivated by a business purpose to
facilitate the acquisition or a similar acquisition.
(4) Non-plan factors. Among the facts and circumstances tending to
show that a distribution and an acquisition are not part of a plan are
the following:
(i) In the case of an acquisition involving a public offering after
a distribution, during the two-year period ending on the date of the
distribution, there were no discussions by Distributing or Controlled
with an investment banker regarding the acquisition or a similar
acquisition.
(ii) In the case of an acquisition after a distribution, there was
an identifiable, unexpected change in market or business conditions
occurring after the distribution that resulted in the acquisition that
was otherwise unexpected at the time of the distribution.
(iii) In the case of an acquisition (other than involving a public
offering) before a distribution, during the two-year period ending on
the date of the earlier to occur of the acquisition or the first public
announcement regarding the distribution, there were no discussions by
Distributing or Controlled with the acquirer regarding a distribution.
Paragraph (b)(4)(iii) of this section does not apply to an acquisition
where the acquirer intends to cause a distribution and, immediately
after the acquisition, can meaningfully participate in the decision
regarding whether to make a distribution.
(iv) In the case of an acquisition before a distribution, there was
an identifiable, unexpected change in market or business conditions
occurring after the acquisition that resulted in a distribution that was
otherwise unexpected.
(v) In the case of an acquisition either before or after a
distribution, the distribution was motivated in whole or substantial
part by a corporate business purpose (within the meaning of Sec. 1.355-
2(b)) other than a business purpose to facilitate the acquisition or a
similar acquisition.
(vi) In the case of an acquisition either before or after a
distribution, the distribution would have occurred at approximately the
same time and in similar form regardless of the acquisition or a similar
acquisition.
(c) Operating rules. The operating rules contained in this paragraph
(c) apply for all purposes of this section.
(1) Internal discussions and discussions with outside advisors
evidence of business purpose. Discussions by Distributing or Controlled
with outside advisors and internal discussions may be indicative of one
or more business purposes for the distribution and the relative
importance of such purposes.
(2) Takeover defense. If Distributing engages in discussions with a
potential acquirer regarding an acquisition of Distributing or
Controlled and distributes Controlled stock intending, in whole or
substantial part, to decrease the likelihood of the acquisition of
Distributing or Controlled by separating it from another corporation
that is likely to be acquired, Distributing will be treated as having a
business purpose to facilitate the acquisition of the corporation that
was likely to be acquired.
[[Page 235]]
(3) Effect of distribution on trading in stock. The fact that the
distribution made all or a part of the stock of Controlled available for
trading or made Distributing's or Controlled's stock trade more actively
is not taken into account in determining whether the distribution and an
acquisition of Distributing or Controlled stock were part of a plan.
(4) Consequences of section 355(e) disregarded for certain purposes.
For purposes of determining the intentions of the relevant parties under
this section, the consequences of the application of section 355(e), and
the existence of any contractual indemnity by Controlled for tax
resulting from the application of section 355(e) caused by an
acquisition of Controlled, are disregarded.
(5) Multiple acquisitions. All acquisitions of stock of Distributing
or Controlled that are considered to be part of a plan with a
distribution pursuant to paragraph (b) of this section will be
aggregated for purposes of the 50-percent test of paragraph (a)(2) of
this section.
(d) Safe harbors--(1) Safe Harbor I. A distribution and an
acquisition occurring after the distribution will not be considered part
of a plan if--
(i) The distribution was motivated in whole or substantial part by a
corporate business purpose (within the meaning of Sec. 1.355-2(b)),
other than a business purpose to facilitate an acquisition of the
acquired corporation (Distributing or Controlled); and
(ii) The acquisition occurred more than six months after the
distribution and there was no agreement, understanding, arrangement, or
substantial negotiations concerning the acquisition or a similar
acquisition during the period that begins one year before the
distribution and ends six months thereafter.
(2) Safe Harbor II--(i) In general. A distribution and an
acquisition occurring after the distribution will not be considered part
of a plan if--
(A) The distribution was not motivated by a business purpose to
facilitate the acquisition or a similar acquisition;
(B) The acquisition occurred more than six months after the
distribution and there was no agreement, understanding, arrangement, or
substantial negotiations concerning the acquisition or a similar
acquisition during the period that begins one year before the
distribution and ends six months thereafter; and
(C) No more than 25 percent of the stock of the acquired corporation
(Distributing or Controlled) was either acquired or the subject of an
agreement, understanding, arrangement, or substantial negotiations
during the period that begins one year before the distribution and ends
six months thereafter.
(ii) Special rule. For purposes of paragraph (d)(2)(i)(C) of this
section, acquisitions of stock that are treated as not part of a plan
pursuant to Safe Harbor VII, Safe Harbor VIII, or Safe Harbor IX are
disregarded.
(3) Safe Harbor III. If an acquisition occurs after a distribution,
there was no agreement, understanding, or arrangement concerning the
acquisition or a similar acquisition at the time of the distribution,
and there was no agreement, understanding, arrangement, or substantial
negotiations concerning the acquisition or a similar acquisition within
one year after the distribution, the acquisition and the distribution
will not be considered part of a plan.
(4) Safe Harbor IV--(i) In general. A distribution and an
acquisition (other than involving a public offering) occurring before
the distribution will not be considered part of a plan if the
acquisition occurs before the date of the first disclosure event
regarding the distribution.
(ii) Special rules. (A) Paragraph (d)(4)(i) of this section does not
apply to a stock acquisition if the acquirer or a coordinating group of
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of the acquired corporation (Distributing or
Controlled) at any time during the period beginning immediately after
the acquisition and ending on the date of the distribution.
(B) Paragraph (d)(4)(i) of this section does not apply to an
acquisition that occurs in connection with a transaction in which the
aggregate acquisitions are of stock possessing 20 percent or more of the
total voting power of the stock of the acquired corporation
[[Page 236]]
(Distributing or Controlled) or stock having a value of 20 percent or
more of the total value of the stock of the acquired corporation
(Distributing or Controlled).
(5) Safe Harbor V--(i) In general. A distribution that is pro rata
among the Distributing shareholders and an acquisition (other than
involving a public offering) of Distributing stock occurring before the
distribution will not be considered part of a plan if--
(A) The acquisition occurs after the date of a public announcement
regarding the distribution; and
(B) There were no discussions by Distributing or Controlled with the
acquirer regarding a distribution on or before the date of the first
public announcement regarding the distribution.
(ii) Special rules. (A) Paragraph (d)(5)(i) of this section does not
apply to a stock acquisition if the acquirer or a coordinating group of
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of Distributing at any time during the period
beginning immediately after the acquisition and ending on the date of
the distribution.
(B) Paragraph (d)(5)(i) of this section does not apply to an
acquisition that occurs in connection with a transaction in which the
aggregate acquisitions are of stock possessing 20 percent or more of the
total voting power of the stock of Distributing or stock having a value
of 20 percent or more of the total value of the stock of Distributing.
(6) Safe Harbor VI. A distribution and an acquisition involving a
public offering occurring before the distribution will not be considered
part of a plan if the acquisition occurs before the date of the first
disclosure event regarding the distribution in the case of an
acquisition of stock that is not listed on an established market
immediately after the acquisition, or before the date of the first
public announcement regarding the distribution in the case of an
acquisition of stock that is listed on an established market immediately
after the acquisition.
(7) Safe Harbor VII--(i) In general. An acquisition (other than
involving a public offering) of Distributing or Controlled stock that is
listed on an established market is not part of a plan if, immediately
before or immediately after the transfer, none of the transferor, the
transferee, and any coordinating group of which either the transferor or
the transferee is a member is--
(A) The acquired corporation (Distributing or Controlled);
(B) A corporation that the acquired corporation (Distributing or
Controlled) controls within the meaning of section 368(c);
(C) A member of a controlled group of corporations within the
meaning of section 1563 of which the acquired corporation (Distributing
or Controlled) is a member;
(D) A controlling shareholder of the acquired corporation
(Distributing or Controlled); or
(E) A ten-percent shareholder of the acquired corporation
(Distributing or Controlled).
(ii) Special rules. (A) Paragraph (d)(7)(i) of this section does not
apply to a transfer of stock by or to a person if the corporation the
stock of which is being transferred knows, or has reason to know, that
the person or a coordinating group of which such person is a member
intends to become a controlling shareholder or a ten-percent shareholder
of the acquired corporation (Distributing or Controlled) at any time
after the acquisition and before the date that is two years after the
distribution.
(B) If a transfer of stock to which paragraph (d)(7)(i) of this
section applies results immediately, or upon a subsequent event or the
passage of time, in an indirect acquisition of voting power by a person
other than the transferee, paragraph (d)(7)(i) of this section does not
prevent an acquisition of stock (with the voting power such stock
represents after the transfer to which paragraph (d)(7)(i) of this
section applies) by such other person from being treated as part of a
plan.
(8) Safe Harbor VIII--(i) In general. If, in a transaction to which
section 83 or section 421(a) or (b) applies, stock of Distributing or
Controlled is acquired by a person in connection with such person's
performance of services as an employee, director, or independent
contractor for Distributing, Controlled,
[[Page 237]]
a related person, a corporation the assets of which Distributing,
Controlled, or a related person acquires in a reorganization under
section 368(a), or a corporation that acquires the assets of
Distributing or Controlled in such a reorganization (and the stock
acquired is not excessive by reference to the services performed), the
acquisition and the distribution will not be considered part of a plan.
For purposes of this paragraph (d)(8)(i), a related person is a person
related to Distributing or Controlled under section 355(d)(7)(A).
(ii) Special rule. Paragraph (d)(8)(i) of this section does not
apply to a stock acquisition if the acquirer or a coordinating group of
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of the acquired corporation (Distributing or
Controlled) immediately after the acquisition.
(9) Safe Harbor IX--(i) In general. If stock of Distributing or
Controlled is acquired by a retirement plan of Distributing or
Controlled (or a retirement plan of any other person that is treated as
the same employer as Distributing or Controlled under section 414(b),
(c), (m), or (o)) that qualifies under section 401(a) or 403(a), the
acquisition and the distribution will not be considered part of a plan.
(ii) Special rule. Paragraph (d)(9)(i) of this section does not
apply to the extent that the stock acquired pursuant to acquisitions by
all of the qualified plans of the persons described in paragraph
(d)(9)(i) of this section during the four-year period beginning two
years before the distribution, in the aggregate, represents more than
ten percent of the total combined voting power of all classes of stock
entitled to vote, or more than ten percent of the total value of shares
of all classes of stock, of the acquired corporation (Distributing or
Controlled).
(e) Options, warrants, convertible obligations, and other similar
interests--(1) Treatment of options--(i) General rule. For purposes of
this section, if stock of Distributing or Controlled is acquired
pursuant to an option that is written by Distributing, Controlled, or a
person that is a controlling shareholder of Distributing or Controlled
at the time the option is written, or that is acquired by a person that
is a controlling shareholder of Distributing or Controlled immediately
after the option is written, the option will be treated as an agreement,
understanding, or arrangement to acquire the stock on the earliest of
the following dates: the date that the option is written, if the option
was more likely than not to be exercised as of such date; the date that
the option is transferred if, immediately before or immediately after
the transfer, the transferor or transferee was Distributing, Controlled,
a corporation that Distributing or Controlled controls within the
meaning of section 368(c), a member of a controlled group of
corporations within the meaning of section 1563 of which Distributing or
Controlled is a member, or a controlling shareholder or a ten-percent
shareholder of Distributing or Controlled and the option was more likely
than not to be exercised as of such date; and the date that the option
is modified in a manner that materially increases the likelihood of
exercise, if the option was more likely than not to be exercised as of
such date; provided, however, if the writing, transfer, or modification
had a principal purpose of avoiding section 355(e), the option will be
treated as an agreement, understanding, arrangement, or substantial
negotiations to acquire the stock on the date of the distribution. The
determination of whether an option was more likely than not to be
exercised is based on all the facts and circumstances, taking control
premiums and minority and blockage discounts into account in determining
the fair market value of stock underlying an option.
(ii) Agreement, understanding, or arrangement to write, transfer, or
modify an option. If there is an agreement, understanding, or
arrangement to write an option, the option will be treated as written on
the date of the agreement, understanding, or arrangement. If there is an
agreement, understanding, or arrangement to transfer an option, the
option will be treated as transferred on the date of the agreement,
understanding, or arrangement. If there is an agreement, understanding,
or arrangement to modify an option in a manner that materially increases
the likelihood of exercise, the option will
[[Page 238]]
be treated as so modified on the date of the agreement, understanding,
or arrangement.
(iii) Substantial negotiations related to options. If an option is
treated as an agreement, understanding, or arrangement to acquire the
stock on the date that the option is written, substantial negotiations
to acquire the option will be treated as substantial negotiations to
acquire the stock subject to such option. If an option is treated as an
agreement, understanding, or arrangement to acquire the stock on the
date that the option is transferred, substantial negotiations regarding
the transfer of the option will be treated as substantial negotiations
to acquire the stock subject to such option. If an option is treated as
an agreement, understanding, or arrangement to acquire the stock on the
date that the option is modified in a manner that materially increases
the likelihood of exercise, substantial negotiations regarding such
modifications to the option will be treated as substantial negotiations
to acquire the stock subject to such option.
(2) Stock acquired pursuant to options. For purposes of this
section, if an option is issued for cash, the terms of the acquisition
of the option and the terms of the option are established by the
corporation the stock of which is subject to the option (Distributing or
Controlled) or the writer with the involvement of one or more investment
bankers, and the potential acquirers of the option have no opportunity
to negotiate the terms of the acquisition of the option or the terms of
the option, then an acquisition pursuant to such option shall be treated
as an acquisition involving a public offering occurring after the
distribution if the option is exercised after the distribution or an
acquisition involving a public offering before a distribution if the
option is exercised before the distribution. Otherwise, an acquisition
pursuant to an option shall be treated as an acquisition not involving a
public offering.
(3) Instruments treated as options. For purposes of this section,
except to the extent provided in paragraph (e)(4) of this section, call
options, warrants, convertible obligations, the conversion feature of
convertible stock, put options, redemption agreements (including rights
to cause the redemption of stock), any other instruments that provide
for the right or possibility to issue, redeem, or transfer stock
(including an option on an option), or any other similar interests are
treated as options.
(4) Instruments generally not treated as options. For purposes of
this section, the following are not treated as options unless (in the
case of paragraphs (e)(4)(i), (ii), and (iii) of this section) written,
transferred (directly or indirectly), modified, or listed with a
principal purpose of avoiding the application of section 355(e) or this
section.
(i) Escrow, pledge, or other security agreements. An option that is
part of a security arrangement in a typical lending transaction
(including a purchase money loan), if the arrangement is subject to
customary commercial conditions. For this purpose, a security
arrangement includes, for example, an agreement for holding stock in
escrow or under a pledge or other security agreement, or an option to
acquire stock contingent upon a default under a loan.
(ii) Options exercisable only upon death, disability, mental
incompetency, or separation from service. Any option entered into
between shareholders of a corporation (or a shareholder and the
corporation) that is exercisable only upon the death, disability, or
mental incompetency of the shareholder, or, in the case of stock
acquired in connection with the performance of services for the
corporation or a person related to it under section 355(d)(7)(A) (and
that is not excessive by reference to the services performed), the
shareholder's separation from service.
(iii) Rights of first refusal. A bona fide right of first refusal
regarding the corporation's stock with customary terms, entered into
between shareholders of a corporation (or between the corporation and a
shareholder).
(iv) Other enumerated instruments. Any other instrument the
Commissioner may designate in revenue procedures, notices, or other
guidance published in the Internal Revenue Bulletin (see Sec.
601.601(d)(2) of this chapter).
[[Page 239]]
(f) Multiple controlled corporations. Only the stock or securities
of a controlled corporation in which one or more persons acquire
directly or indirectly stock representing a 50-percent or greater
interest as part of a plan involving the distribution of that
corporation will be treated as not qualified property under section
355(e)(1) if--
(1) The stock or securities of more than one controlled corporation
are distributed in distributions to which section 355 (or so much of
section 356 as relates to section 355) applies; and
(2) One or more persons do not acquire, directly or indirectly,
stock representing a 50-percent or greater interest in Distributing
pursuant to a plan involving any of those distributions.
(g) Valuation. Except as provided in paragraph (e)(1)(i) of this
section, for purposes of section 355(e) and this section, all shares of
stock within a single class are considered to have the same value. Thus,
control premiums and minority and blockage discounts within a single
class are not taken into account.
(h) Definitions. For purposes of this section, the following
definitions shall apply:
(1) Agreement, understanding, arrangement, or substantial
negotiations. (i) An agreement, understanding, or arrangement generally
requires either--
(A) An agreement, understanding, or arrangement by one or more
officers or directors acting on behalf of Distributing or Controlled, by
controlling shareholders of Distributing or Controlled, or by another
person or persons with the implicit or explicit permission of one or
more of such officers, directors, or controlling shareholders, with the
acquirer or with a person or persons with the implicit or explicit
permission of the acquirer; or
(B) An agreement, understanding, or arrangement by an acquirer that
is a controlling shareholder of Distributing or Controlled immediately
after the acquisition that is the subject of the agreement,
understanding, or arrangement, or by a person or persons with the
implicit or explicit permission of such acquirer, with the transferor or
with a person or persons with the implicit or explicit permission of the
transferor.
(ii) In the case of an acquisition by a corporation, an agreement,
understanding, or arrangement with the acquiring corporation generally
requires an agreement, understanding, or arrangement with one or more
officers or directors acting on behalf of the acquiring corporation,
with controlling shareholders of the acquiring corporation, or with
another person or persons with the implicit or explicit permission of
one or more of such officers, directors, or controlling shareholders.
(iii) Whether an agreement, understanding, or arrangement exists
depends on the facts and circumstances. The parties do not necessarily
have to have entered into a binding contract or have reached agreement
on all significant economic terms to have an agreement, understanding,
or arrangement. However, an agreement, understanding, or arrangement
clearly exists if a binding contract to acquire stock exists.
(iv) Substantial negotiations in the case of an acquisition (other
than involving a public offering) generally require discussions of
significant economic terms, e.g., the exchange ratio in a
reorganization, either--
(A) By one or more officers or directors acting on behalf of
Distributing or Controlled, by controlling shareholders of Distributing
or Controlled, or by another person or persons with the implicit or
explicit permission of one or more of such officers, directors, or
controlling shareholders, with the acquirer or with a person or persons
with the implicit or explicit permission of the acquirer; or
(B) If the acquirer is a controlling shareholder of Distributing or
Controlled immediately after the acquisition that is the subject of
substantial negotiations, by the acquirer or by a person or persons with
the implicit or explicit permission of the acquirer, with the transferor
or with a person or persons with the implicit or explicit permission of
the transferor.
(v) In the case of an acquisition (other than involving a public
offering) by a corporation, substantial negotiations generally require
discussions of significant economic terms with one or more officers or
directors acting on behalf of the acquiring corporation, with
[[Page 240]]
controlling shareholders of the acquiring corporation, or with another
person or persons with the implicit or explicit permission of one or
more of such officers, directors, or controlling shareholders.
(vi) In the case of an acquisition involving a public offering, the
existence of an agreement, understanding, arrangement, or substantial
negotiations will be based on discussions by one or more officers or
directors acting on behalf of Distributing or Controlled, by controlling
shareholders of Distributing or Controlled, or by another person or
persons with the implicit or explicit permission of one or more of such
officers, directors, or controlling shareholders, with an investment
banker.
(2) Controlled corporation. A controlled corporation is a
corporation the stock of which is distributed in a distribution to which
section 355 (or so much of section 356 as relates to section 355)
applies.
(3) Controlling shareholder. (i) A controlling shareholder of a
corporation the stock of which is listed on an established market is a
five-percent shareholder who actively participates in the management or
operation of the corporation. For purposes of this paragraph (h)(3)(i),
a corporate director will be treated as actively participating in the
management of the corporation.
(ii) A controlling shareholder of a corporation the stock of which
is not listed on an established market is any person that owns stock
possessing voting power representing a meaningful voice in the
governance of the corporation. For purposes of determining whether a
person owns stock possessing voting power representing a meaningful
voice in the governance of the corporation, the person shall be treated
as owning the stock that such person owns actually and constructively
under the rules of section 318 (without regard to section 318(a)(4)). In
addition, if the exercise of an option (whether by itself or in
conjunction with the deemed exercise of one or more other options) would
cause the holder to own stock possessing voting power representing a
meaningful voice in the governance of the corporation, then the option
will be treated as exercised.
(iii) If a distribution precedes an acquisition, Controlled's
controlling shareholders immediately after the distribution and
Distributing are included among Controlled's controlling shareholders at
the time of the distribution.
(4) Coordinating group. A coordinating group includes two or more
persons that, pursuant to a formal or informal understanding, join in
one or more coordinated acquisitions or dispositions of stock of
Distributing or Controlled. 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. A coordinating group is treated as a single
shareholder for purposes of determining whether the coordinating group
is treated as a controlling shareholder, a five-percent shareholder, or
a ten-percent shareholder.
(5) Disclosure event. A disclosure event regarding the distribution
means any communication by an officer, director, controlling
shareholder, or employee of Distributing, Controlled, or a corporation
related to Distributing or Controlled, or an outside advisor of any of
those persons (where such advisor makes the communication on behalf of
such person), regarding the distribution, or the possibility thereof, to
the acquirer or any other person (other than an officer, director,
controlling shareholder, or employee of Distributing, Controlled, or a
corporation related to Distributing or Controlled, or an outside advisor
of any of those persons). For purposes of this paragraph (h)(5), a
corporation is related to Distributing or Controlled if it is a member
of an affiliated group (as defined in section 1504(a) without regard to
section 1504(b)) that includes either Distributing or Controlled or it
is a member of a qualified group (as defined in Sec. 1.368-1(d)(4)(ii))
that includes either Distributing or Controlled.
(6) Discussions. Discussions by Distributing or Controlled generally
require discussions by one or more officers or directors acting on
behalf of Distributing or Controlled, by controlling shareholders of
Distributing or Controlled, or by another person or persons with the
implicit or explicit
[[Page 241]]
permission of one or more of such officers, directors, or controlling
shareholders. Discussions with the acquirer generally require
discussions with the acquirer or with a person or persons with the
implicit or explicit permission of the acquirer. In the case of an
acquisition by a corporation, discussions with the acquiring corporation
generally require discussions with one or more officers or directors
acting on behalf of the acquiring corporation, with controlling
shareholders of the acquiring corporation, or with another person or
persons with the implicit or explicit permission of one or more of such
officers, directors, or controlling shareholders.
(7) Established market. An established market is--
(i) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f);
(ii) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the Securities
Act of 1934 (15 U.S.C. 78o-3); or
(iii) Any additional market that the Commissioner may designate in
revenue procedures, notices, or other guidance published in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
(8) Five-percent shareholder. A person will be considered a five-
percent shareholder of a corporation the stock of which is listed on an
established market if the person owns five percent or more of any class
of stock of the corporation whose stock is transferred. For purposes of
determining whether a person owns five percent or more of any class of
stock of the corporation whose stock is transferred, the person shall be
treated as owning the stock that such person owns actually and
constructively under the rules of section 318 (without regard to section
318(a)(4)). In addition, if the exercise of an option (whether by itself
or in conjunction with the deemed exercise of one or more other options)
would cause the holder to become a five-percent shareholder, then the
option will be treated as exercised. Absent actual knowledge that a
person is a five-percent shareholder, a corporation can rely on
Schedules 13D and 13G (or any similar schedules) filed with the
Securities and Exchange Commission to identify its five-percent
shareholders.
(9) Implicit permission. A corporation is treated as having the
implicit permission of its shareholders when it engages in discussions
or negotiations, or enters into an agreement, understanding, or
arrangement.
(10) Public announcement. A public announcement regarding the
distribution means any communication by Distributing or Controlled
regarding Distributing's intention to effect the distribution where the
communication is generally available to the public.
(11) Public offering. An acquisition involving a public offering
means an acquisition of stock for cash where the terms of the
acquisition are established by the acquired corporation (Distributing or
Controlled) or the seller with the involvement of one or more investment
bankers and the potential acquirers have no opportunity to negotiate the
terms of the acquisition. For example, a public offering includes an
underwritten offering of registered stock for cash.
(12) Similar acquisition (not involving a public offering). In
general, an actual acquisition (other than involving a public offering)
is similar to another potential acquisition if the actual acquisition
effects a direct or indirect combination of all or a significant portion
of the same business operations as the combination that would have been
effected by such other potential acquisition. Thus, an actual
acquisition may be similar to another acquisition even if the timing or
terms of the actual acquisition are different from the timing or terms
of the other acquisition. For example, an actual acquisition of
Distributing by shareholders of another corporation in connection with a
merger of such other corporation with and into Distributing is similar
to another acquisition of Distributing by merger into such other
corporation or into a subsidiary of such other corporation. However, in
general, an actual acquisition (other than involving a public offering)
is not similar to another acquisition if the ultimate owners of the
business operations with which Distributing or Controlled is combined in
the
[[Page 242]]
actual acquisition are substantially different from the ultimate owners
of the business operations with which Distributing or Controlled was to
be combined in such other acquisition.
(13) Similar acquisition involving a public offering--(i) One public
offering. In general, an actual acquisition involving a public offering
may be similar to a potential acquisition involving a public offering,
even though there are changes in the terms of the stock, the class of
stock being offered, the size of the offering, the timing of the
offering, the price of the stock, or the participants in the offering.
(ii) More than one public offering. More than one actual acquisition
involving a public offering may be similar to a potential acquisition
involving a public offering. If there is an actual acquisition involving
a public offering (the first public offering) that is the same as, or
similar to, a potential acquisition involving a public offering, then
another actual acquisition involving a public offering (the second
public offering) cannot be similar to the potential acquisition unless
the purpose of the second public offering is similar to that of the
potential acquisition and occurs close in time to the first public
offering.
(iii) Potential acquisition involving a public offering. For
purposes of paragraph (h)(13)(i) and (ii) of this section, as the
context may require, a potential acquisition involving a public offering
means a potential acquisition involving a public offering that was
discussed by Distributing or Controlled with an investment banker, that
motivated the distribution, or that was the subject of an agreement,
understanding, arrangement, or substantial negotiations.
(14) Ten-percent shareholder. A person will be considered a ten-
percent shareholder of a corporation the stock of which is listed on an
established market if the person owns, actually or constructively under
the rules of section 318 (without regard to section 318(a)(4)), ten
percent or more of any class of stock of the corporation whose stock is
transferred. A person will be considered a ten-percent shareholder of a
corporation the stock of which is not listed on an established market if
the person owns stock possessing ten percent or more of the total voting
power of the stock of the corporation whose stock is transferred or
stock having a value equal to ten percent or more of the total value of
the stock of the corporation whose stock is transferred. For purposes of
determining whether a person owns ten percent or more of the total
voting power or value of the stock of the corporation whose stock is
transferred, the person shall be treated as owning the stock that such
person owns actually and constructively under the rules of section 318
(without regard to section 318(a)(4)). In addition, if the exercise of
an option (whether by itself or in conjunction with the deemed exercise
of one or more other options) would cause the holder to become a ten-
percent shareholder, then the option will be treated as exercised.
Absent actual knowledge that a person is a ten-percent shareholder, a
corporation the stock of which is listed on an established market can
rely on Schedules 13D and 13G (or any similar schedules) filed with the
Securities and Exchange Commission to identify its ten-percent
shareholders.
(i) [Reserved]
(j) Examples. The following examples illustrate paragraphs (a)
through (h) of this section. Throughout these examples, assume that
Distributing (D) owns all of the stock of Controlled (C). Assume further
that D distributes the stock of C in a distribution to which section 355
applies and to which section 355(d) does not apply. Unless otherwise
stated, assume the corporations do not have controlling shareholders. No
inference should be drawn from any example concerning whether any
requirements of section 355 other than those of section 355(e) are
satisfied. The examples are as follows:
Example 1. Unwanted assets. (i) D is in business 1. C is in business
2. D is relatively small in its industry. D wants to combine with X, a
larger corporation also engaged in business 1. X and D begin negotiating
for X to acquire D, but X does not want to acquire C. To facilitate the
acquisition of D by X, D agrees to distribute all the stock of C pro
rata before the acquisition. Prior to the distribution, D and X enter
into a contract for D to merge into X subject to several conditions. One
month after D and X enter into the contract, D distributes C and, on the
day after the distribution, D merges into X. As a
[[Page 243]]
result of the merger, D's former shareholders own less than 50 percent
of the stock of X.
(ii) The issue is whether the distribution of C and the merger of D
into X are part of a plan. No Safe Harbor applies to this acquisition.
To determine whether the distribution of C and the merger of D into X
are part of a plan, D must consider all the facts and circumstances,
including those described in paragraph (b) of this section.
(iii) The following tends to show that the distribution of C and the
merger of D into X are part of a plan: X and D had an agreement
regarding the acquisition during the two-year period ending on the date
of the distribution (paragraph (b)(3)(i) of this section), and the
distribution was motivated by a business purpose to facilitate the
merger (paragraph (b)(3)(v) of this section). Because the merger was
agreed to at the time of the distribution, the fact described in
paragraph (b)(3)(i) of this section is given substantial weight.
(iv) None of the facts and circumstances listed in paragraph (b)(4)
of this section, tending to show that a distribution and an acquisition
are not part of a plan, exist in this case.
(v) The distribution of C and the merger of D into X are part of a
plan under paragraph (b) of this section.
Example 2. Public offering. (i) D's managers, directors, and
investment banker discuss the possibility of offering D stock to the
public. They decide a public offering of 20 percent of D's stock with D
as a stand-alone corporation would be in D's best interest. One month
later, to facilitate a stock offering by D of 20 percent of its stock, D
distributes all the stock of C pro rata to D's shareholders. D issues
new shares amounting to 20 percent of its stock to the public in a
public offering seven months after the distribution.
(ii) The issue is whether the distribution of C and the public
offering by D are part of a plan. No Safe Harbor applies to this
acquisition. Safe Harbor VII, relating to public trading, does not apply
to public offerings (see paragraph (d)(7)(i) of this section). To
determine whether the distribution of C and the public offering by D are
part of a plan, D must consider all the facts and circumstances,
including those described in paragraph (b) of this section.
(iii) The following tends to show that the distribution of C and the
public offering by D are part of a plan: D discussed the public offering
with its investment banker during the two-year period ending on the date
of the distribution (paragraph (b)(3)(ii) of this section), and the
distribution was motivated by a business purpose to facilitate the
public offering (paragraph (b)(3)(v) of this section).
(iv) None of the facts and circumstances listed in paragraph (b)(4)
of this section, tending to show that a distribution and an acquisition
are not part of a plan, exist in this case.
(v) The distribution of C and the public offering by D are part of a
plan under paragraph (b) of this section.
Example 3. Hot market. (i) D is a widely-held corporation the stock
of which is listed on an established market. D announces a distribution
of C and distributes C pro rata to D's shareholders. By contract, C
agrees to indemnify D for any imposition of tax under section 355(e)
caused by the acts of C. The distribution is motivated by a desire to
improve D's access to financing at preferred customer interest rates,
which will be more readily available if D separates from C. At the time
of the distribution, although neither D nor C has been approached by any
potential acquirer of C, it is reasonably certain that soon after the
distribution either an acquisition of C will occur or there will be an
agreement, understanding, arrangement, or substantial negotiations
regarding an acquisition of C. Corporation Y acquires C in a merger
described in section 368(a)(1)(A) by reason of section 368(a)(2)(E)
within six months after the distribution. The C shareholders receive
less than 50 percent of the stock of Y in the exchange.
(ii) The issue is whether the distribution of C and the acquisition
of C by Y are part of a plan. No Safe Harbor applies to this
acquisition. Under paragraph (b)(2) of this section, because prior to
the distribution neither D nor C and Y had an agreement, understanding,
arrangement, or substantial negotiations regarding the acquisition or a
similar acquisition, the distribution of C by D and the acquisition of C
by Y are not part of a plan under paragraph (b) of this section.
Example 4. Unexpected opportunity. (i) D, the stock of which is
listed on an established market, makes a public announcement that it
will distribute all the stock of C pro rata to D's shareholders. After
the public announcement but before the distribution, widely-held X
becomes available as an acquisition target. There were no discussions by
D or C with X before the date of the public announcement. D negotiates
with X and X merges into D before the distribution. In the merger, X's
shareholders receive ten percent of D's stock. D distributes the stock
of C pro rata within six months after the acquisition of X. No
shareholder of X was a controlling shareholder or a ten-percent
shareholder of D at any time during the period beginning immediately
after the merger and ending on the date of the distribution
(ii) The issue is whether the acquisition of X by D and the
distribution of C are part of a plan. Safe Harbor V applies to this
acquisition because the distribution is pro rata among D's shareholders,
the acquisition occurs after the date of a public announcement regarding
the distribution, there were no discussions by D or C with X on or
before the
[[Page 244]]
date of the public announcement, no acquirer was a controlling
shareholder or a ten-percent shareholder of D during the period
beginning immediately after the merger and ending on the date of the
distribution, and not more than 20 percent of D's stock was acquired by
the X shareholders in the merger.
Example 5. Vote shifting transaction. (i) D is in business 1. C is
in business 2. D wants to combine with X, which is also engaged in
business 1. The stock of X is closely held. X and D begin negotiating
for D to acquire X, but the X shareholders do not want to acquire an
indirect interest in C. To facilitate the acquisition of X by D, D
agrees to distribute all the stock of C pro rata before the acquisition
of X. D and X enter into a contract for X to merge into D subject to
several conditions. Among those conditions is that D will amend its
corporate charter to provide for two classes of stock: Class A and Class
B. Under all circumstances, each share of Class A stock will be entitled
to ten votes in the election of each director on D's board of directors.
Upon issuance, each share of Class B stock will be entitled to ten votes
in the election of each director on D's board of directors; however, a
disposition of such share by its original holder will result in such
share being entitled to only one vote, rather than ten votes, in the
election of each director. Immediately after the merger, the Class B
shares will be listed on an established market. One month after D and X
enter into the contract, D distributes C. Immediately after the
distribution, the shareholders of D exchange their D stock for the new
Class B shares. On the day after the distribution, X merges into D. In
the merger, the former shareholders of X exchange their X stock for
Class A shares of D. Immediately after the merger, D's historic
shareholders own stock of D representing 51 percent of the total
combined voting power of all classes of stock of D entitled to vote and
more than 50 percent of the total value of all classes of stock of D.
During the 30-day period following the merger, none of the Class A
shares are transferred, but a number of D's historic shareholders sell
their Class B stock of D in public trading with the result that, at the
end of that 30-day period, the Class A shares owned by the former X
shareholders represent 52 percent of the total combined voting power of
all classes of stock of D entitled to vote.
(ii) X acquisition. (A) The issue is whether the distribution of C
and the merger of X into D are part of a plan. No Safe Harbor applies to
this acquisition. To determine whether the distribution of C and the
merger of X into D are part of a plan, D must consider all the facts and
circumstances, including those described in paragraph (b) of this
section.
(B) The following tends to show that the distribution of C and the
merger of X into D are part of a plan: X and D had an agreement
regarding the acquisition during the two-year period ending on the date
of the distribution (paragraph (b)(3)(i) of this section), and the
distribution was motivated by a business purpose to facilitate the
merger (paragraph (b)(3)(v) of this section). Because the merger was
agreed to at the time of the distribution, the fact described in
paragraph (b)(3)(i) of this section is given substantial weight.
(C) None of the facts and circumstances listed in paragraph (b)(4)
of this section, tending to show that a distribution and an acquisition
are not part of a plan, exist in this case.
(D) The distribution of C and the merger of X into D are part of a
plan under paragraph (b) of this section.
(iii) Public trading of Class B shares. (A) Assuming that each of
the transferors and the transferees of the Class B stock of D in public
trading is not one of the prohibited transferors or transferees listed
in paragraph (d)(7)(i), Safe Harbor VII will apply to the acquisitions
of the Class B stock during the 30-day period following the merger such
that the distribution and those acquisitions will not be treated as part
of a plan. However, to the extent that those acquisitions result in an
indirect acquisition of voting power by a person other than the acquirer
of the transferred stock, Safe Harbor VII does not prevent the
acquisition of the D stock (with the voting power such stock represents
after those acquisitions) by the former X shareholders from being
treated as part of a plan.
(B) To the extent that the transfer of the Class B shares causes the
voting power of D to shift to the Class A stock acquired by the former X
shareholders, such shifted voting power will be treated as attributable
to the stock acquired by the former X shareholders as part of a plan
that includes the distribution and the X acquisition.
Example 6. Acquisition not involving a public offering that is not
similar. (i) D, X, and Y are each corporations the stock of which is
publicly traded and widely held. Each of D, X, and Y is engaged in the
manufacture and sale of trucks. C is engaged in the manufacture and sale
of buses. D and X engage in substantial negotiations concerning X's
acquisition of the stock of D from the D shareholders in exchange for
stock of X. D and X do not reach an agreement regarding that
acquisition. Three months after D and X first began negotiations
regarding that acquisition, D distributes the stock of C pro rata to its
shareholders. Three months after the distribution, Y acquires the stock
of D from the D shareholders in exchange for stock of Y. The ultimate
owners of Y are substantially different from the ultimate owners of X.
[[Page 245]]
(ii) Although both X and Y engage in the manufacture and sale of
trucks, X's truck business and Y's truck business are not the same
business operations. Therefore, because Y's acquisition of D does not
effect a combination of the same business operations as X's acquisition
of D would have effected, and because the ultimate owners of Y are
substantially different from the ultimate owners of X, Y's acquisition
of D is not similar to X's potential acquisition of D that was the
subject of earlier negotiations.
Example 7. Acquisition not involving a public offering that is
similar. (i) D is engaged in the business of writing custom software for
several industries (industries 1 through 6). The software business of D
related to industries 4, 5, and 6 is significant relative to the
software business of D related to industries 3, 4, 5, and 6. X, an
unrelated corporation, is engaged in the business of writing software
and the business of manufacturing and selling hardware devices. X's
business of writing software is significant relative to its total
businesses. X and D engage in substantial negotiations regarding X's
acquisition of D stock from the D shareholders in exchange for stock of
X. Because X does not want to acquire the software businesses related to
industries 1 and 2, these negotiations relate to an acquisition of D
stock where D owns the software businesses related only to industries 3,
4, 5, and 6. Thereafter, D concludes that the intellectual property
licenses central to the software business related to industries 1 and 2
are not transferable and that a separation of the software business
related to industry 3 from the software business related to industry 2
is not desirable. One month after D begins negotiating with X, D
contributes the software businesses related to industries 4, 5, and 6 to
C, and distributes the stock of C pro rata to its shareholders. In
addition, X sells its hardware businesses for cash. After the
distribution, C and X negotiate for X's acquisition of the C stock from
the C shareholders in exchange for X stock, and X acquires the stock of
C.
(ii) Although D and C are different corporations, C does not own the
custom software business related to industry 3, and X sold its hardware
business prior to the acquisition of C, because X's acquisition of C
involves a combination of a significant portion of the same business
operations as the combination that would have been effected by the
acquisition of D that was the subject of negotiations between D and X,
X's acquisition of C is the same as, or similar to, X's potential
acquisition of D that was the subject of earlier negotiations.
Example 8. Acquisitions involving public offerings with different
purposes. (i) D's managers, directors, and investment banker discuss the
possibility of offering D stock to the public for the purpose of funding
the acquisition of the assets of X. They decide a public offering of 20
percent of D's stock with D as a stand-alone corporation would allow D
to raise the capital needed to effect the acquisition of X's assets. One
month later, to facilitate a stock offering by D of 20 percent of its
stock, D distributes all the stock of C pro rata to D's shareholders.
Two months after the distribution, D issues new shares amounting to 20
percent of its stock to the public in a public offering (the first
public offering). Four months after the distribution, D acquires the
assets of X. Seven months after the distribution, D's managers,
directors, and investment banker discuss the possibility of offering D
stock to the public solely for the purpose of funding the acquisition of
the assets of Y, a corporation unrelated to X. One year after the
distribution, D issues new shares amounting to 40 percent of its stock
to the public in a public offering (the second public offering). One
month after the second public offering, D acquires the assets of Y.
(ii) The first public offering is the same as the potential
acquisition that D's managers, directors, and investment banker
discussed prior to the distribution. The purpose of the second public
offering (funding the acquisition of the assets of Y) is not similar to
that of the potential acquisition (funding the acquisition of the assets
of X). Therefore, the second public offering is not similar to the
potential acquisition.
Example 9. Acquisitions involving public offerings that are close in
time. (i) D's managers, directors, and investment banker discuss the
possibility of offering D stock to the public for the purpose of raising
funds for general corporate purposes. They decide a public offering of
20 percent of D's stock with D as a stand-alone corporation would allow
D to raise such funds. One month later, to facilitate a stock offering
by D of 20 percent of its stock, D distributes all the stock of C pro
rata to D's shareholders. Two months after the distribution, D issues
new shares amounting to 20 percent of its stock to the public in a
public offering (the first public offering). After the first public
offering, D's managers, directors, and investment banker discuss the
possibility of another offering of D stock to the public for the purpose
of raising additional funds for general corporate purposes. Eight months
after the distribution, D issues new shares amounting to ten percent of
its stock to the public in a public offering (the second public
offering).
(ii) The first public offering is the same as the potential
acquisition that D's managers, directors, and investment banker
discussed prior to the distribution. The purpose of the second public
offering (raising funds for general corporate purposes) is the same as
that of the potential acquisition. In addition, the second public
offering is close in time to the first public offering. Therefore, the
second public offering is similar to the potential acquisition.
[[Page 246]]
Example 10. Acquisitions involving public offerings that are not
close in time. The facts are the same as those in Example 9, except that
the second public offering occurs fourteen months after the
distribution. Although the purpose of the second public offering is the
same as that of the potential acquisition, the second public offering is
not close in time to the first public offering. Therefore, the second
public offering is not similar to the potential acquisition.
(k) Effective dates. This section applies to distributions occurring
after April 19, 2005. For distributions occurring on or before April 19,
2005, and after April 26, 2002, see Sec. 1.355-7T as contained in 26
CFR part 1 revised as of April 1, 2003; however, taxpayers may apply
these regulations, in whole, but not in part, to such distributions. For
distributions occurring on or before April 26, 2002, and after August 3,
2001, see Sec. 1.355-7T as contained in 26 CFR part 1 revised as of
April 1, 2002; however, taxpayers may apply, in whole, but not in part,
either these regulations or Sec. 1.355-7T as contained in 26 CFR part 1
revised as of April 1, 2003, to such distributions. For distributions
occurring on or before August 3, 2001, and after April 16, 1997,
taxpayers may apply, in whole, but not in part, either these regulations
or Sec. 1.355-7T as contained in 26 CFR part 1 revised as of April 1,
2003, to such distributions.
[T.D. 9198, 70 FR 20283, Apr. 19, 2005]
Sec. 1.356-1 Receipt of additional consideration in connection with an
exchange.
(a) If in any exchange to which the provisions of section 354 or
section 355 would apply except for the fact that there is received by
the shareholders or security holders other property (in addition to
property permitted to be received without recognition of gain by such
sections) or money, then--
(1) The gain, if any, to the taxpayer shall be recognized in an
amount not in excess of the sum of the money and the fair market value
of the other property, but,
(2) The loss, if any, to the taxpayer from the exchange or
distribution shall not be recognized to any extent.
(b) For purposes of computing the gain, if any, recognized pursuant
to section 356 and paragraph (a)(1) of this section, to the extent the
terms of the exchange specify the other property or money that is
received in exchange for a particular share of stock or security
surrendered or a particular class of stock or securities surrendered,
such terms shall control provided that such terms are economically
reasonable. To the extent the terms of the exchange do not specify the
other property or money that is received in exchange for a particular
share of stock or security surrendered or a particular class of stock or
securities surrendered, a pro rata portion of the other property and
money received shall be treated as received in exchange for each share
of stock and security surrendered, based on the fair market value of
such surrendered share of stock or security.
(c) If the distribution of such other property or money by or on
behalf of a corporation has the effect of the distribution of a
dividend, then there shall be chargeable to each distributee (either an
individual or a corporation)--
(1) As a dividend, such an amount of the gain recognized as is not
in excess of the distributee's ratable share of the undistributed
earnings and profits of the corporation accumulated after February 28,
1913, and
(2) As a gain from the exchange of property, the remainder of the
gain so recognized.
(d) The rules of this section may be illustrated by the following
examples:
Example 1. In an exchange to which the provisions of section 356
apply and to which section 354 would apply but for the receipt of
property not permitted to be received without the recognition of gain or
loss, A (either an individual or a corporation), received the following
in exchange for a share of stock having an adjusted basis to A of $85:
One share of stock worth................................... $100
Cash....................................................... 25
Other property (basis $25) fair market value............... 50
Total fair market value of consideration received...... 175
Adjusted basis of stock surrendered in exchange........ 85
Total gain......................................... 90
[[Page 247]]
Gain to be recognized, limited to cash and other property 75
received..................................................
A's pro rata share of earnings and profits accumulated 30
after February 28, 1913 (taxable dividend)................
Remainder to be treated as a gain from the exchange of 45
property..............................................
------------------------------------------------------------------------
Example 2. If, in Example 1, A's stock had an adjusted basis to A of
$200, A would have realized a loss of $25 on the exchange, which loss
would not be recognized.
Example 3. (i) Facts. J, an individual, acquired 10 shares of Class
A stock of Corporation X on Date 1 for $3 each and 10 shares of Class B
stock of Corporation X on Date 2 for $9 each. On Date 3, Corporation Y
acquires the assets of Corporation X in a reorganization under section
368(a)(1)(A). Pursuant to the terms of the plan of reorganization, J
surrenders all of J's shares of Corporation X stock for 10 shares of
Corporation Y stock and $100 of cash. On the date of the exchange, the
fair market value of each share of Class A stock of Corporation X is
$10, the fair market value of each share of Class B stock of Corporation
X is $10, and the fair market value of each share of Corporation Y stock
is $10. The terms of the exchange do not specify that shares of
Corporation Y stock or cash are received in exchange for particular
shares of Class A stock or Class B stock of Corporation X.
(ii) Analysis. Under paragraph (b) of this section, because the
terms of the exchange do not specify that the cash is received in
exchange for shares of Class A or Class B stock of Corporation X, a pro
rata portion of the cash received is treated as received in exchange for
each share of Class A stock of Corporation X and each share of Class B
stock of Corporation X based on the fair market value of the surrendered
shares. Therefore, J is treated as receiving shares of Corporation Y
stock with a fair market value of $50 and $50 of cash in exchange for
its shares of Class A stock of Corporation X and shares of Corporation Y
stock with a fair market value of $50 and $50 of cash in exchange for
its shares of Class B stock of Corporation X. J realizes a gain of $70
on the exchange of shares of Class A stock, $50 of which is recognized
under section 356 and paragraph (a) of this section, and J realizes a
gain of $10 on the exchange of shares of Class B stock of Corporation X,
all of which is recognized under section 356 and paragraph (a) of this
section. Assuming that J's gain recognized is not treated as a dividend
under section 356(a)(2), such gain shall be treated as gain from the
exchange of property.
Example 4. (i) Facts. The facts are the same as in Example 3, except
that the terms of the plan of reorganization specify that J receives 10
shares of stock of Corporation Y in exchange for J's shares of Class A
stock of Corporation X and $100 of cash in exchange for J's shares of
Class B stock of Corporation X.
(ii) Analysis. Under paragraph (b) of this section, because the
terms of the exchange specify that J receives 10 shares of stock of
Corporation Y in exchange for J's shares of Class A stock of Corporation
X and $100 of cash in exchange for J's shares of Class B stock of
Corporation X and such terms are economically reasonable, such terms
control. J realizes a gain of $70 on the exchange of shares of Class A
stock, none of which is recognized under section 356 and paragraph (a)
of this section, and J realizes a gain of $10 on the exchange of shares
of Class B stock of Corporation X, all of which is recognized under
section 356 and paragraph (a) of this section.
(e) Section 301(b)(1)(B) and section 301(d)(2) do not apply to a
distribution of ``other property'' to a corporate shareholder if such
distribution is within the provisions of section 356.
(f) See paragraph (l) of Sec. 1.301-1 for certain transactions
which are not within the scope of section 356.
(g) This section applies to exchanges and distributions of stock and
securities occurring on or after January 23, 2006.
[T.D. 9244, 71 FR 4268, Jan. 26, 2006]
Sec. 1.356-2 Receipt of additional consideration not in connection with an
exchange.
(a) If, in a transaction to which section 355 would apply except for
the fact that a shareholder (individual or corporate) receives property
permitted by section 355 to be received without the recognition of gain,
together with other property or money, without the surrender of any
stock or securities of the distributing corporation, then the sum of the
money and the fair market value of the other property as of the date of
the distribution shall be treated as a distribution of property to which
the rules of section 301 (other than section 301(b) and section 301(d))
apply. See section 358 for determination of basis of such other
property.
(b) Paragraph (a) of this section may be illustrated by the
following examples:
[[Page 248]]
Example 1. Individuals A and B each own 50 of the 100 outstanding
shares of common stock of Corporation X. Corporation X owns all of the
stock of Corporation Y, 100 shares. Corporation X distributes to each
shareholder 50 shares of the stock of Corporation Y plus $100 cash
without requiring the surrender of any shares of its own stock. The $100
cash received by each is treated as a distribution of property to which
the rules of section 301 apply.
Example 2. If, in the above example, Corporation X distributes 50
shares of stock of Corporation Y to A and 30 shares of such stock plus
$100 cash to B without requiring the surrender of any of its own stock,
the amount of cash received by B is treated as a distribution of
property to which the rules of section 301 apply.
Sec. 1.356-3 Rules for treatment of securities as ``other property''.
(a) As a general rule, for purposes of section 356, the term other
property includes securities. However, it does not include securities
permitted under section 354 or section 355 to be received tax free.
Thus, when securities are surrendered in a transaction to which section
354 or section 355 is applicable, the characterization of the securities
received as ``other property'' does not include securities received
where the principal amount of such securities does not exceed the
principal amount of securities surrendered in the transaction. If a
greater principal amount of securities is received in an exchange
described in section 354 (other than subsection (c) or (d) thereof) or
section 355 over the principal amount of securities surrendered, the
term other property includes the fair market value of such excess
principal amount as of the date of the exchange. If no securities are
surrendered in exchange, the term other property includes the fair
market value, as of the date of receipt, of the entire principal amount
of the securities received.
(b) Except as provided in Sec. 1.356-6, for purposes of this
section, a right to acquire stock that is treated as a security for
purposes of section 354 or 355 has no principal amount. Thus, such right
is not other property when received in a transaction to which section
356 applies (regardless of whether securities are surrendered in the
exchange). This paragraph (b) applies to transactions occurring on or
after March 9, 1998.
(c) In the examples in this paragraph (c), stock means common stock
and warrants means rights to acquire common stock. The following
examples illustrate the rules of paragraph (a) of this section:
Example 1. A, an individual, exchanged 100 shares of stock for 100
shares of stock and a security in the principal amount of $1,000 with a
fair market value of $990. The amount of $990 is treated as ``other
property.''
Example 2. B, an individual, exchanged 100 shares of stock and a
security in the principal amount of $1,000 for 300 shares of stock and a
security in the principal amount of $1,500. The security had a fair
market value on the date of receipt of $1,575. The fair market value of
the excess principal amount, or $525, is treated as ``other property.''
Example 3. C, an individual, exchanged a security in the principal
amount of $1,000 for 100 shares of stock and a security in the principal
amount of $900. No part of the security received is treated as ``other
property.''
Example 4. D, an individual, exchanged a security in the principal
amount of $1,000 for 100 shares of stock and a security in the principal
amount of $1,200 with a fair market value of $1,100. The fair market
value of the excess principal amount, or $183.33, is treated as ``other
property.''
Example 5. E, an individual, exchanged a security in the principal
amount of $1,000 for another security in the principal amount of $1,200
with a fair market value of $1,080. The fair market value of the excess
principal amount, or $180, is treated as ``other property.''
Example 6. F, an individual, exchanged a security in the principal
amount of $1,000 for two different securities each in the principal
amount of $750. One of the securities had a fair market value of $750,
the other had a fair market value of $600. One-third of the fair market
value of each security ($250 and $200) is treated as ``other property.''
Example 7. G, an individual, exchanged stock for stock and a
warrant. The warrant had no principal amount. Thus, G received no excess
principal amount within the meaning of section 356(d).
Example 8. H, an individual, exchanged a warrant for stock and a
warrant. The warrants had no principal amount. Thus, H received no
excess principal amount within the meaning of section 356(d).
Example 9. I, an individual, exchanged a warrant for stock and a
debt security. The warrant had no principal amount. The debt
[[Page 249]]
security had a $100 principal amount. I received $100 of excess
principal amount within the meaning of section 356(d).
[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]
Sec. 1.356-4 Exchanges for section 306 stock.
If, in a transaction to which section 356 is applicable, other
property or money is received in exchange for section 306 stock, an
amount equal to the fair market value of the property plus the money, if
any, shall be treated as a distribution of property to which section 301
is applicable. The determination of whether section 306 stock is
surrendered for other property (including money) is a question of fact
to be decided under all of the circumstances of each case. Ordinarily,
the other property (including money) received will first be treated as
received in exchange for any section 306 stock owned by a shareholder
prior to such transaction. For example, if a shareholder who owns a
share of common stock (having a basis to him of $100) and a share of
preferred stock which is section 306 stock (having a basis to him of
$100) surrenders both shares in a transaction to which section 356 is
applicable for one share of common stock having a fair market value of
$80 and one $100 bond having a fair market value of $100, the bond will
be deemed received in exchange for the section 306 stock and it will be
treated as a distribution to which section 301 is applicable to the
extent of its entire fair market value ($100).
Sec. 1.356-5 Transactions involving gift or compensation.
With respect to transactions described in sections 354, 355, or 356,
but which--
(a) Result in a gift, see section 2501 and following, and the
regulations pertaining thereto, or
(b) Have the effect of the payment of compensation, see section
61(a)(1), and the regulations pertaining thereto.
Sec. 1.356-6 Rules for treatment of nonqualified preferred stock as other
property.
(a) In general. For purposes of Sec. Sec. 1.354-1(e), 1.355-1(c),
and 1.356-3(b), the terms stock and securities do not include--
(1) Nonqualified preferred stock, as defined in section 351(g)(2),
received in exchange for (or in a distribution with respect to) stock,
or a right to acquire stock, other than nonqualified preferred stock; or
(2) A right to acquire such nonqualified preferred stock, received
in exchange for (or in a distribution with respect to) stock, or a right
to acquire stock, other than nonqualified preferred stock.
(b) Exceptions. The following exceptions apply:
(1) Certain recapitalizations. Paragraph (a) of this section does
not apply in the case of a recapitalization under section 368(a)(1)(E)
of a family-owned corporation as described in section
354(a)(2)(C)(ii)(II).
(2) Transition rule. Paragraph (a) of this section does not apply to
a transaction described in section 1014(f)(2) of the Taxpayer Relief Act
of 1997 (111 Stat. 921).
(c) Effective date. This section applies to nonqualified preferred
stock, or a right to acquire such stock, received in connection with a
transaction occurring on or after March 9, 1998.
[T.D. 8753, 63 FR 411, Jan. 6, 1998. Redesignated by T.D. 8882, 65 FR
31078, May 16, 2000]
Sec. 1.356-7 Rules for treatment of nonqualified preferred stock and other
preferred stock received in certain transactions.
(a) Stock issued prior to effective date. Stock described in section
351(g)(2) is nonqualified preferred stock (NQPS) regardless of the date
on which the stock is issued. However, sections 351(g), 354(a)(2)(C),
355(a)(3)(D), 356(e), and 1036(b) do not apply to any transaction
occurring prior to June 9, 1997, or to any transaction occurring after
June 8, 1997, that is described in section 1014(f)(2) of the Taxpayer
Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 921). For purposes
of this section, preferred stock that is not NQPS is referred to as
Qualified Preferred Stock (QPS).
[[Page 250]]
(b) Receipt of preferred stock in exchange for (or distribution on)
substantially identical preferred stock--(1) General rule. For purposes
of sections 354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred
stock is QPS, even though it is described in section 351(g)(2), if it is
received in exchange for (or in a distribution with respect to)
preferred stock (the original preferred stock) that is QPS, provided--
(i) The original preferred stock is QPS solely because, on its issue
date, either a right or obligation described in clause (i), (ii), or
(iii) of section 351(g)(2)(A) was not exercisable until after a 20-year
period beginning on the issue date, or the right or obligation was
exercisable within the 20-year period beginning on the issue date but
was subject to a contingency which made remote the likelihood of the
redemption or purchase, or the issuer's (or a related party's) right to
redeem or purchase the stock was not more likely than not to be
exercised within a 20-year period beginning on the issue date, or
because of any combination of these reasons; and
(ii) The stock received is substantially identical to the original
preferred stock.
(2) Substantially identical. The stock received is substantially
identical to the original preferred stock if--
(i) The stock received does not contain any term or terms that, in
relation to any term or terms of the original preferred stock, either
decrease the period in which a right or obligation described in clause
(i), (ii), or (iii) of section 351(g)(2)(A) can be exercised, or
increase the likelihood that such a right or obligation will be
exercised, or accelerate the timing of the returns from the stock
instrument, including the timing of actual or deemed dividends or other
distributions received on the stock; and
(ii) As a result of the exchange or distribution, exercise of the
right or obligation does not become more likely than not to occur within
a 20-year period beginning on the issue date of the original preferred
stock.
(3) Treatment of stock received. The stock received will continue to
be treated as QPS in subsequent transactions involving such stock, and
the principles of this paragraph (b) apply to such transactions as
though the stock received is the original preferred stock issued on the
same date as the original preferred stock.
(c) Stock transferred for services. For purposes of sections
351(g)(1), 354(a)(2)(C)(i), 355(a)(3)(D), and 356(e)(2), preferred stock
containing a right or obligation described in clause (i), (ii) or (iii)
of section 351(g)(2)(A) that is exercisable only upon the holder's
separation from service from the issuer or a related person (as
described in section 351(g)(3)(B)) will be treated as transferred in
connection with the performance of services (and representing reasonable
compensation) within the meaning of section 351(g)(2)(C)(i)(II), if such
preferred stock is received in exchange for (or in a distribution with
respect to) existing stock containing a similar right or obligation
(exercisable only upon separation from service) and the existing stock
was transferred in connection with the performance of services for the
issuer or a related person (and represented reasonable compensation when
transferred). In applying the rules relating to NQPS, the preferred
stock received will continue to be treated as transferred in connection
with the performance of services (and representing reasonable
compensation) in subsequent transactions involving such stock, and the
principles of this paragraph (c) apply to such transactions.
(d) Rights to acquire stock. For purposes of Sec. 1.356-6, the
principles of paragraphs (a), (b), and (c) of this section apply.
(e) Examples. In the examples in this paragraph (e), T and P are
corporations, A is a shareholder of T, and A surrenders and receives (in
addition to the stock exchanged in the examples) common stock in the
reorganizations described. The following examples illustrate paragraphs
(a), (b), and (c) of this section:
Example 1. In 1995, A transfers property to T and receives T
preferred stock that is described in section 351(g)(2) in a transaction
under section 351. In 2002, pursuant to a reorganization under section
368(a)(1)(B), A surrenders the T preferred stock in exchange for P NQPS.
Under paragraph (a) of this section, the T preferred stock issued to A
in 1995 is NQPS. However, because section 351(g) does
[[Page 251]]
not apply to transactions occurring before June 9, 1997, the T NQPS was
not ``other property'' within the meaning of section 351(b) when issued
in 1995. Under sections 354(a)(2)(C) and 356(e)(2), the P NQPS received
by A in 2002 is not ``other property'' within the meaning of section
356(a)(1)(B) because it is received in exchange for NQPS.
Example 2. T issues QPS to A on January 1, 2000 that is not NQPS
solely because the holder cannot require T to redeem the stock until
January 1, 2022. In 2007, pursuant to a reorganization under section
368(a)(1)(A) in which T merges into P, A surrenders the T preferred
stock in exchange for P preferred stock with terms that are identical to
the terms of the T preferred stock, including the term that the holder
cannot require the redemption of the stock until January 1, 2022.
Because the P stock and the T stock have identical terms, and because
the redemption did not become more likely than not to occur within the
20-year period that begins on January 1, 2000 (which is the issue date
of the T preferred stock) as a result of the exchange, under paragraph
(b) of this section, the P preferred stock received by A is treated as
QPS. Thus, the P preferred stock received is not ``other property''
within the meaning of section 356(a)(1)(B).
Example 3. The facts are the same as in Example 2, except that, in
addition, in 2010, pursuant to a recapitalization of P under section
368(a)(1)(E), A exchanges the P preferred stock above for P NQPS that
permits the holder to require P to redeem the stock in 2020. Under
paragraph (b) of this section, the P preferred stock surrendered by A is
treated as QPS. Because the P preferred stock received by A in the
recapitalization is not substantially identical to the P preferred stock
surrendered, the P preferred stock received by A is not treated as QPS.
Thus, the P preferred stock received is ``other property'' within the
meaning of section 356(a)(1)(B).
Example 4. T issues preferred stock to A on January 1, 2000 that
permits the holder to require T to redeem the stock on January 1, 2018,
or at any time thereafter, but which is not NQPS solely because, as of
the issue date, the holder's right to redeem is subject to a contingency
that makes remote the likelihood of redemption on or before January 1,
2020. In 2007, pursuant to a reorganization under section 368(a)(1)(A)
in which T merges into P, A surrenders the T preferred stock in exchange
for P preferred stock with terms that are identical to the terms of the
T preferred stock. Immediately before the exchange, the contingency to
which the holder's right to cause redemption of the T stock is subject
makes remote the likelihood of redemption before January 1, 2020, but
the P stock, although subject to the same contingency, is more likely
than not to be redeemed before January 1, 2020. Because, as a result of
the exchange of T stock for P stock, the exercise of the redemption
right became more likely than not to occur within the 20-year period
beginning on the issue date of the T preferred stock, the P preferred
stock received by A is not substantially identical to the T stock
surrendered, and is not treated as QPS. Thus, the P preferred stock
received is ``other property'' within the meaning of section
356(a)(1)(B).
Example 5. The facts are the same as in Example 4, except that,
immediately before the merger of T into P in 2007, the contingency to
which the holder's right to cause redemption of the T stock is subject
makes it more likely than not that the T stock will be redeemed before
January 1, 2020. Because exercise of the redemption right did not become
more likely than not to occur within the 20-year period beginning on the
issue date of the T preferred stock as a result of the exchange, the P
preferred stock received by A is substantially identical to the T stock
surrendered, and is treated as QPS. Thus, the P preferred stock received
is not ``other property'' within the meaning of section 356(a)(1)(B).
Example 6. A is an employee of T. In connection with A's performance
of services for T, T transfers to A in 2000 an amount of T common stock
that represents reasonable compensation. The T common stock contains a
term granting A the right to require T to redeem the common stock, but
only upon A's separation from service from T. In 2005, pursuant to a
reorganization under section 368(a)(1)(A) in which T merges into P, A
receives, in exchange for A's T common stock, P preferred stock granting
a similar redemption right upon A's separation from P's service. Under
paragraph (c) of this section, the P preferred stock received by A is
treated as transferred in connection with the performance of services
(and representing reasonable compensation) within the meaning of section
351(g)(2)(C)(i)(II). Thus, the P preferred stock received by A is QPS.
(f) Effective dates. This section applies to transactions occurring
on or after October 2, 2000.
[T.D. 8904, 65 FR 58651, Oct. 2, 2000]
Sec. 1.357-1 Assumption of liability.
(a) General rule. Section 357(a) does not affect the rule that
liabilities assumed are to be taken into account for the purpose of
computing the amount of gain or loss realized under section 1001 upon an
exchange. Section 357(a) provides, subject to the exceptions and
limitations specified in section 357 (b) and (c), that--
[[Page 252]]
(1) Liabilities assumed are not to be treated as ``other property or
money'' for the purpose of determining the amount of realized gain which
is to be recognized under section 351, 361, 371, or 374, if the
transactions would, but for the receipt of ``other property or money''
have been exchanges of the type described in any one of such sections;
and
(2) If the only type of consideration received by the transferor in
addition to that permitted to be received by section 351, 361, 371, or
374, consists of an assumption of liabilities, the transaction, if
otherwise qualified, will be deemed to be within the provisions of
section 351, 361, 371, or 374.
(b) Application of general rule. The application of paragraph (a) of
this section may be illustrated by the following example:
Example. A, an individual, transfers to a controlled corporation
property with an adjusted basis of $10,000 in exchange for stock of the
corporation with a fair market value of $8,000, $3,000 cash, and the
assumption by the corporation of indebtedness of A amounting to $4,000.
A's gain is $5,000, computed as follows:
Stock received, fair market value............................. $8,000
Cash received................................................. 3,000
Liability assumed by transferee............................... 4,000
---------
Total consideration received................................. 15,000
Less: Adjusted basis of property transferred.................. 10,000
---------
Gain realized................................................ 5,000
Assuming that the exchange falls within section 351 as a transaction in
which the gain to be recognized is limited to ``other property or
money'' received, the gain recognized to A will be limited to the $3,000
cash received, since, under the general rule of section 357(a), the
assumption of the $4,000 liability does not constitute ``other
property.''
(c) Tax avoidance purpose. The benefits of section 357(a) do not
extend to any exchange involving an assumption of liabilities where it
appears that the principal purpose of the taxpayer with respect to such
assumption was to avoid Federal income tax on the exchange, or, if not
such purpose, was not a bona fide business purpose. In such cases, the
total amount of liabilities assumed or acquired pursuant to such
exchange (and not merely a particular liability with respect to which
the tax avoidance purpose existed) shall, for the purpose of determining
the amount of gain to be recognized upon the exchange in which the
liabilities are assumed or acquired, be treated as money received by the
taxpayer upon the exchange. Thus, if in the example set forth in
paragraph (b) of this section, the principal purpose of the assumption
of the $4,000 liability was to avoid tax on the exchange, or was not a
bona fide business purpose, then the amount of gain recognized would be
$5,000. In any suit or proceeding where the burden is on the taxpayer to
prove that an assumption of liabilities is not to be treated as ``other
property or money'' under section 357, which is the case if the
Commissioner determines that the taxpayer's purpose with respect thereto
was a purpose to avoid Federal income tax on the exchange or was not a
bona fide business purpose, and the taxpayer contests such determination
by litigation, the taxpayer must sustain such burden by the clear
preponderance of the evidence. Thus, the taxpayer must prove his case by
such a clear preponderance of all the evidence that the absence of a
purpose to avoid Federal income tax on the exchange, or the presence of
a bona fide business purpose, is unmistakable.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6528, 26 FR
399, Jan. 19, 1961]
Sec. 1.357-2 Liabilities in excess of basis.
(a) Section 357(c) provides in general that in an exchange to which
section 351 (relating to a transfer to a corporation controlled by the
transferor) is applicable, or to which section 361 (relating to the
nonrecognition of gain or loss to corporations) is applicable by reason
of a section 368(a)(1)(D) reorganization, if the sum of the amount of
liabilities assumed plus the amount of liabilities to which the property
is subject exceeds the total of the adjusted basis of the property
transferred pursuant to such exchange, then such excess shall be
considered as a gain from the sale or exchange of a capital asset or of
property which is not a capital asset as the case may be. Thus, if an
individual transfers, under section 351, properties having a total basis
in his hands of $20,000, one of which has a basis of $10,000 but is
subject to a mortgage of $30,000, to a corporation controlled by him,
such individual will be subject to
[[Page 253]]
tax with respect to $10,000, the excess of the amount of the liability
over the total adjusted basis of all the properties in his hands. The
same result will follow whether or not the liability is assumed by the
transferee. The determination of whether a gain resulting from the
transfer of capital assets is long-term or short-term capital gain shall
be made by reference to the holding period to the transferor of the
assets transferred. An exception to the general rule of section 357(c)
is made (1) for any exchange as to which under section 357(b) (relating
to assumption of liabilities for tax-avoidance purposes) the entire
amount of the liabilities is treated as money received and (2) for an
exchange to which section 371 (relating to reorganizations in certain
receivership and bankruptcy proceedings) or section 374 (relating to
gain or loss not recognized in certain railroad reorganizations) is
applicable.
(b) The application of paragraph (a) of this section may be
illustrated by the following examples:
Example 1. If all such assets transferred are capital assets and if
half the assets (ascertained by reference to their fair market value at
the time of the transfer) have been held for less than 1 year (6 months
for taxable years beginning before 1977; 9 months for taxable years
beginning in 1977), and the remaining half for more than 1 year (6
months for taxable years beginning before 1977; 9 months for taxable
years beginning in 1977), half the excess of the amount of the liability
over the total of the adjusted basis of the property transferred
pursuant to the exchange shall be treated as short-term capital gain,
and the remaining half shall be treated as long-term capital gain.
Example 2. If half of the assets (ascertained by reference to their
fair market value at the time of the transfer) transferred are capital
assets and half are assets other than capital assets, then half of the
excess of the amount of the liability over the total of the adjusted
basis of the property transferred pursuant to the exchange shall be
treated as capital gain, and the remaining half shall be treated as gain
from the sale or exchange of assets other than capital assets.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 6528, 26 FR
399, Jan. 19, 1961; T.D. 7728, 45 FR 72650, Nov. 3, 1980]
Sec. 1.358-1 Basis to distributees.
(a) In the case of an exchange to which section 354 or 355 applies
in which, under the law applicable to the year in which the exchange is
made, only nonrecognition property is received, immediately after the
transaction, the sum of the basis of all of the stock and securities
received in the transaction shall be the same as the basis of all the
stock and securities in such corporation surrendered in the transaction,
allocated in the manner described in Sec. 1.358-2. In the case of a
distribution to which section 355 applies in which, under the law
applicable to the year in which the distribution is made, only
nonrecognition property is received, immediately after the transaction,
the sum of the basis of all of the stock and securities with respect to
which the distribution is made plus the basis of all stock and
securities received in the distribution with respect to such stock and
securities shall be the same as the basis of the stock and securities
with respect to which the distribution is made immediately before the
transaction, allocated in the manner described in Sec. 1.358-2. In the
case of an exchange to which section 351 or 361 applies in which, under
the law applicable to the year in which the exchange was made, only
nonrecognition property is received, the basis of all the stock and
securities received in the exchange shall be the same as the basis of
all property exchanged therefor. If in an exchange or distribution to
which section 351, 356, or 361 applies both nonrecognition property and
``other property'' are received, the basis of all the property except
``other property'' held after the transaction shall be determined as
described in the preceding three sentences decreased by the sum of the
money and the fair market value of the ``other property'' (as of the
date of the transaction) and increased by the sum of the amount treated
as a dividend (if any) and the amount of the gain recognized on the
exchange, but the term gain as here used does not include any portion of
the recognized gain that was treated as a dividend. In any case in which
a taxpayer transfers property with respect to which loss is recognized,
such loss shall be reflected in determining the basis of the property
received in the exchange. The basis of the ``other property'' is its
fair market value as of the
[[Page 254]]
date of the transaction. See Sec. 1.460-4(k)(3)(iv)(A) for rules
relating to stock basis adjustments required where a contract accounted
for using a long-term contract method of accounting is transferred in a
transaction described in section 351 or a reorganization described in
section 368(a)(1)(D) with respect to which the requirements of section
355 (or so much of section 356 as relates to section 355) are met.
(b) The application of paragraph (a) of this section may be
illustrated by the following example:
Example. A purchased a share of stock in Corporation X in 1935 for
$150. Since that date A has received distributions out of other than
earnings and profits (as defined in section 316) totaling $60, so that
A's adjusted basis for the stock is $90. In a transaction qualifying
under section 356, A exchanged this share for one share in Corporation
Y, worth $100, cash in the amount of $10, and other property with a fair
market value of $30. The exchange had the effect of the distribution of
a dividend. A's ratable share of the earnings and profits of Corporation
X accumulated after February 28, 1913, was $5. A realized a gain of $50
on the exchange, but the amount recognized is limited to $40, the sum of
the cash received and the fair market value of the other property. Of
the gain recognized, $5 is taxable as a dividend, and $35 is taxable as
a gain from the exchange of property. The basis to A of the one share of
stock of Corporation Y is $90, that is, the adjusted basis of the one
share of stock of Corporation X ($90), decreased by the sum of the cash
received ($10) and the fair market value of the other property received
($30) and increased by the sum of the amount treated as a dividend ($5)
and the amount treated as a gain from the exchange of property ($35).
The basis of the other property received is $30.
(c) This section applies to exchanges and distributions of stock and
securities occurring on or after January 23, 2006.
[T.D. 9244, 71 FR 4269, Jan. 26, 2006; 71 FR 19118, Apr. 13, 2006; 71 FR
62556, Oct. 26, 2006]
Sec. 1.358-2 Allocation of basis among nonrecognition property.
(a) Allocation of basis in exchanges or distributions to which
section 354, 355, or 356 applies. (1) As used in this paragraph the term
stock means stock which is not ``other property'' under section 356. The
term securities means securities (including, where appropriate,
fractional parts of securities) which are not ``other property'' under
section 356. Stock, or securities, as the case may be, which differ
either because they are in different corporations or because the rights
attributable to them differ (although they are in the same corporation)
are considered different classes of stock or securities, as the case may
be, for purposes of this section.
(2)(i) If a shareholder or security holder surrenders a share of
stock or a security in an exchange under the terms of section 354, 355,
or 356, the basis of each share of stock or security received in the
exchange shall be the same as the basis of the share or shares of stock
or security or securities (or allocable portions thereof) exchanged
therefor (as adjusted under Sec. 1.358-1). If more than one share of
stock or security is received in exchange for one share of stock or one
security, the basis of the share of stock or security surrendered shall
be allocated to the shares of stock or securities received in the
exchange in proportion to the fair market value of the shares of stock
or securities received. If one share of stock or security is received in
exchange for more than one share of stock or security or if a fraction
of a share of stock or security is received, then the basis of the
shares of stock or securities surrendered must be allocated to the
shares of stock or securities (or allocable portions thereof) received
in a manner that reflects, to the greatest extent possible, that a share
of stock or security received is received in respect of shares of stock
or securities that were acquired on the same date and at the same price.
To the extent it is not possible to allocate basis in this manner, the
basis of the shares of stock or securities surrendered must be allocated
to the shares of stock or securities (or allocable portions thereof)
received in a manner that minimizes the disparity in the holding periods
of the surrendered shares of stock or securities whose basis is
allocated to any particular share of stock or security received.
(ii) If a shareholder or security holder surrenders a share of stock
or a security in an exchange under the terms of section 354, 355, or
356, and receives shares of stock or securities of more
[[Page 255]]
than one class, or receives ``other property'' or money in addition to
shares of stock or securities, then, to the extent the terms of the
exchange specify that shares of stock or securities of a particular
class or ``other property'' or money is received in exchange for a
particular share of stock or security or a particular class of stock or
securities, for purposes of applying the rules of this section, such
terms shall control provided such terms are economically reasonable. To
the extent the terms of the exchange do not specify that shares of stock
or securities of a particular class or ``other property'' or money is
received in exchange for a particular share of stock or security or a
particular class of stock or securities, then, for purposes of applying
the rules of paragraph (a)(2)(i) of this section, a pro rata portion of
the shares of stock and securities of each class received and a pro rata
portion of the ``other property'' and money received shall be treated as
received in exchange for each share of stock and security surrendered,
based on the fair market value of the stock and securities surrendered.
(iii) For purposes of this section, if a shareholder or security
holder surrenders a share of stock or a security in a transaction under
the terms of section 354 (or so much of section 356 as relates to
section 354) in which such shareholder or security holder receives no
property or property (including property permitted by section 354 to be
received without the recognition of gain or ``other property'' or money)
with a fair market value less than that of the stock or securities
surrendered in the transaction, such shareholder or security holder
shall be treated as follows. First, the shareholder or security holder
shall be treated as receiving the stock, securities, other property, and
money actually received by the shareholder or security holder in the
transaction and an amount of stock of the issuing corporation (as
defined in Sec. 1.368-1(b)) that has a value equal to the excess of the
value of the stock or securities the shareholder or security holder
surrendered in the transaction over the value of the stock, securities,
other property, and money the shareholder or security holder actually
received in the transaction. If the shareholder owns only one class of
stock of the issuing corporation the receipt of which would be
consistent with the economic rights associated with each class of stock
of the issuing corporation, the stock deemed received by the shareholder
pursuant to the previous sentence shall be stock of such class. If the
shareholder owns multiple classes of stock of the issuing corporation
the receipt of which would be consistent with the economic rights
associated with each class of stock of the issuing corporation, the
stock deemed received by the shareholder shall be stock of each such
class owned by the shareholder immediately prior to the transaction, in
proportion to the value of the stock of each such class owned by the
shareholder immediately prior to the transaction. The basis of each
share of stock or security deemed received and actually received shall
be determined under the rules of this section. Second, the shareholder
or security holder shall then be treated as surrendering all of its
shares of stock and securities in the issuing corporation, including
those shares of stock or securities held immediately prior to the
transaction, those shares of stock or securities actually received in
the transaction, and those shares of stock deemed received pursuant to
the previous sentence, in a reorganization under section 368(a)(1)(E) in
exchange for the shares of stock and securities of the issuing
corporation that the shareholder or security holder actually holds
immediately after the transaction. The basis of each share of stock and
security deemed received in the reorganization under section
368(a)(1)(E) shall be determined under the rules of this section.
(iv) If a shareholder or security holder receives one or more shares
of stock or one or more securities in a distribution under the terms of
section 355 (or so much of section 356 as relates to section 355), the
basis of each share of stock or security of the distributing corporation
(as defined in Sec. 1.355-1(b)), as adjusted under Sec. 1.358-1, shall
be allocated between the share of stock or security of the distributing
corporation with respect to which the distribution is made and the share
or shares of
[[Page 256]]
stock or security or securities (or allocable portions thereof) received
with respect to the share of stock or security of the distributing
corporation in proportion to their fair market values. If one share of
stock or security is received with respect to more than one share of
stock or security or if a fraction of a share of stock or security is
received, then the basis of each share of stock or security of the
distributing corporation must be allocated to the shares of stock or
securities (or allocable portions thereof) received in a manner that
reflects that, to the greatest extent possible, a share of stock or
security received is received with respect to shares of stock or
securities acquired on the same date and at the same price. To the
extent it is not possible to allocate basis in this manner, the basis of
each share of stock or security of the distributing corporation must be
allocated to the shares of stock or securities (or allocable portions
thereof) received in a manner that minimizes the disparity in the
holding periods of the shares of stock or securities with respect to
which such shares of stock or securities are received.
(v) If a shareholder or security holder receives shares of stock or
securities of more than one class, or receives ``other property'' or
money in addition to stock or securities in a distribution under the
terms of section 355 (or so much of section 356 as relates to section
355), then, to the extent the terms of the distribution specify that
shares of stock or securities of a particular class or ``other
property'' or money is received with respect to a particular share of
stock or security of the distributing corporation or a particular class
of stock or securities of the distributing corporation, for purposes of
applying the rules of this section, such terms shall control provided
that such terms are economically reasonable. To the extent the terms of
the distribution do not specify that shares of stock or securities of a
particular class or ``other property'' or money is received with respect
to a particular share of stock or security of the distributing
corporation or a particular class of stock or securities of the
distributing corporation, then, for purposes of applying the rules of
this section, a pro rata portion of the shares of stock and securities
of each class received and a pro rata portion of the ``other property''
and money received shall be treated as received with respect to each
share of stock and security of the distributing corporation with respect
to which the distribution is made, based on the fair market value of
each such share of stock or security.
(vi) If a share of stock or a security is received in exchange for,
or with respect to, more than one share of stock or security and such
shares or securities were acquired on different dates or at different
prices, the share of stock or security received shall be divided into
segments based on the relative fair market values of the shares of stock
or securities surrendered in exchange for such share or security or the
relative fair market values of the shares of stock or securities with
respect to which the share of stock or security is received in a
distribution under the terms of section 355 (or so much of section 356
as relates to section 355)). Each segment shall have a basis determined
under the rules of paragraph (a)(2) of this section and a corresponding
holding period.
(vii) If a shareholder or security holder that purchased or acquired
shares of stock or securities in a corporation on different dates or at
different prices exchanges such shares of stock or securities under the
terms of section 354, 355, or 356, or receives a distribution of shares
of stock or securities under the terms of section 355 (or so much of
section 356 as relates to section 355), and the shareholder or security
holder is not able to identify which particular share of stock or
security (or allocable portion of a share of stock or security) is
received (or deemed received) in exchange for, or with respect to, a
particular share of stock or security, the shareholder or security
holder may designate which share of stock or security is received in
exchange for, or with respect to, a particular share of stock or
security, provided that such designation is consistent with the terms of
the exchange or distribution (or an exchange deemed to have occurred
pursuant to paragraph (a)(2)(iii) of this section), and the other rules
of this
[[Page 257]]
section. In the case of an exchange under the terms of section 354 or
356 (including a deemed exchange as a result of the application of
paragraph (a)(2)(iii) of this section), the designation must be made on
or before the first date on which the basis of a share of stock or a
security received (or deemed received in the reorganization under
section 368(a)(1)(E) in the case of a transaction to which paragraph
(a)(2)(iii) of this section applies) is relevant. In the case of an
exchange or distribution under the terms of section 355 (or so much of
section 356 as relates to section 355), the designation must be made on
or before the first date on which the basis of a share of stock or a
security of the distributing corporation or the controlled corporation
(as defined in Sec. 1.355-1(b)) is relevant. The basis of the shares or
securities received in an exchange under the terms of section 354 or
section 356, for example, is relevant when such shares or securities are
sold or otherwise transferred. The designation will be binding for
purposes of determining the Federal tax consequences of any sale or
transfer of, or distribution with respect to, the shares or securities
received. If the shareholder fails to make a designation in a case in
which the shareholder is not able to identify which share of stock is
received in exchange for, or with respect to, a particular share of
stock, then the shareholder will not be able to identify which shares
are sold or transferred for purposes of determining the basis of
property sold or transferred under section 1012 and Sec. 1.1012-1(c)
and, instead, will be treated as selling or transferring the share
received in respect of the earliest share purchased or acquired.
(viii) This paragraph (a)(2) shall not apply to determine the basis
of a share of stock or security received by a shareholder or security
holder in an exchange described in both section 351 and section 354 or
section 356, if, in connection with the exchange, the shareholder or
security holder exchanges property for stock or securities in an
exchange to which neither section 354 nor section 356 applies or
liabilities of the shareholder or security holder are assumed.
(ix) This paragraph (a)(2) shall apply to determine the basis of a
share of stock or security received by a shareholder or security holder
in an exchange described in both section 1036 and section 354 or section
356.
(b) Allocation of basis in exchanges to which section 351 or 361
applies. (1) As used in this paragraph (b), the term stock refers only
to stock which is not ``other property'' under section 351 or 361 and
the term securities refers only to securities which are not ``other
property'' under section 351 or 361.
(2) If in an exchange to which section 351 or 361 applies property
is transferred to a corporation and the transferor receives stock or
securities of more than one class or receives both stock and securities,
then the basis of the property transferred (as adjusted under Sec.
1.358-1) shall be allocated among all of the stock and securities
received in proportion to the fair market values of the stock of each
class and the securities of each class.
(c) Examples. The application of paragraphs (a) and (b) of this
section is illustrated by the following examples:
Example 1. (i) Facts. J, an individual, acquired 20 shares of
Corporation X stock on Date 1 for $3 each and 10 shares of Corporation X
stock on Date 2 for $6 each. On Date 3, Corporation Y acquires the
assets of Corporation X in a reorganization under section 368(a)(1)(A).
Pursuant to the terms of the plan of reorganization, J receives 2 shares
of Corporation Y stock in exchange for each share of Corporation X
stock. Therefore, J receives 60 shares of Corporation Y stock. Pursuant
to section 354, J recognizes no gain or loss on the exchange. J is not
able to identify which shares of Corporation Y stock are received in
exchange for each share of Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 40
shares of Corporation Y stock each of which has a basis of $1.50 and is
treated as having been acquired on Date 1 and 20 shares of Corporation Y
stock each of which has a basis of $3 and is treated as having been
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or
before the date on which the basis of a share of Corporation Y stock
received becomes relevant, J may designate which of the shares of
Corporation Y stock have a basis of $1.50 and which have a basis of $3.
Example 2. (i) Facts. The facts are the same as in Example 1, except
that instead of receiving 2 shares of Corporation Y stock in exchange
for each share of Corporation X
[[Page 258]]
stock, J receives 1\1/2\ shares of Corporation Y stock in exchange for
each share of Corporation X stock. Therefore, J receives 45 shares of
Corporation Y stock. Again, J is not able to identify which shares (or
portions of shares) of Corporation Y stock are received in exchange for
each share of Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 30
shares of Corporation Y stock each of which has a basis of $2 and is
treated as having been acquired on Date 1 and 15 shares of Corporation Y
stock each of which has a basis of $4 and is treated as having been
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or
before the date on which the basis of a share of Corporation Y stock
received becomes relevant, J may designate which of the shares of
Corporation Y stock received have a basis of $2 and which have a basis
of $4.
Example 3. (i) Facts. J, an individual, acquired 10 shares of Class
A stock of Corporation X on Date 1 for $3 each, 10 shares of Class A
stock of Corporation X on Date 2 for $9 each, and 10 shares of Class B
stock of Corporation X on Date 3 for $3 each. On Date 4, J surrenders
all of J's shares of Class A stock in exchange for 20 shares of new
Class C stock and 20 shares of new Class D stock in a reorganization
under section 368(a)(1)(E). Pursuant to section 354, J recognizes no
gain or loss on the exchange. On the date of the exchange, the fair
market value of each share of Class A stock is $6, the fair market value
of each share of Class C stock is $2, and the fair market value of each
share of Class D stock is $4. The terms of the exchange do not specify
that shares of Class C stock or shares of Class D stock of Corporation X
are received in exchange for particular shares of Class A stock of
Corporation X.
(ii) Analysis. Under paragraph (a)(2)(ii) of this section, because
the terms of the exchange do not specify that shares of Class C stock or
shares of Class D stock of Corporation X are received in exchange for
particular shares of Class A stock of Corporation X, a pro rata portion
of the shares of Class C stock and shares of Class D stock received will
be treated as received in exchange for each share of Class A stock based
on the fair market value of the surrendered shares of Class A stock.
Therefore, J is treated as receiving one share of Class C stock and one
share of Class D stock in exchange for each share of Class A stock.
Under paragraph (a)(2)(i) of this section, J has 10 shares of Class C
stock, each of which has a basis of $1 and is treated as having been
acquired on Date 1 and 10 shares of Class C stock, each of which has a
basis of $3 and is treated as having been acquired on Date 2. In
addition, J has 10 shares of Class D stock, each of which has a basis of
$2 and is treated as having been acquired on Date 1 and 10 shares of
Class D stock, each of which has a basis of $6 and is treated as having
been acquired on Date 2. J's basis in each share of Class B stock
remains $3. Under paragraph (a)(2)(vii) of this section, on or before
the date on which the basis of a share of Class C stock or Class D stock
received becomes relevant, J may designate which of the shares of Class
C stock have a basis of $1 and which have a basis of $3, and which of
the shares of Class D stock have a basis of $2 and which have a basis of
$6.
Example 4. (i) Facts. J, an individual, acquired 10 shares of Class
A stock of Corporation X on Date 1 for $2 each, 10 shares of Class A
stock of Corporation X on Date 2 for $4 each, and 20 shares of Class B
stock of Corporation X on Date 3 for $6 each. On Date 4, Corporation Y
acquires the assets of Corporation X in a reorganization under section
368(a)(1)(A). Pursuant to the terms of the plan of reorganization, J
surrenders all of J's shares of Corporation X stock for 40 shares of
Corporation Y stock and $200 of cash. On the date of the exchange, the
fair market value of each share of Class A stock of Corporation X is
$10, the fair market value of each share of Class B stock of Corporation
X is $10, and the fair market value of each share of Corporation Y stock
is $5. The terms of the exchange do not specify that shares of
Corporation Y stock or cash are received in exchange for particular
shares of Class A stock or Class B stock of Corporation X.
(ii) Analysis. Under paragraph (a)(2)(ii) of this section and under
Sec. 1.356-1(b), because the terms of the exchange do not specify that
shares of Corporation Y stock or cash are received in exchange for
particular shares of Class A stock or Class B stock of Corporation X, a
pro rata portion of the shares of Corporation Y stock and cash received
will be treated as received in exchange for each share of Class A stock
and Class B stock of Corporation X surrendered based on the fair market
value of such stock. Therefore, J is treated as receiving one share of
Corporation Y stock and $5 of cash in exchange for each share of Class A
stock of Corporation X and one share of Corporation Y stock and $5 of
cash in exchange for each share of Class B stock of Corporation X. J
realizes a gain of $140 on the exchange of shares of Class A stock of
Corporation X, $100 of which is recognized under Sec. 1.356-1(a). J
realizes a gain of $80 on the exchange of Class B stock of Corporation
X, all of which is recognized under Sec. 1.356-1(a). Under paragraph
(a)(2)(i) of this section, J has 10 shares of Corporation Y stock, each
of which has a basis of $2 and is treated as having been acquired on
Date 1, 10 shares of Corporation Y stock, each of which has a basis of
$4 and is treated as having been acquired on Date 2, and 20 shares of
Corporation Y stock, each of which has a basis of $5 and is treated as
having been acquired on Date 3. Under paragraph (a)(2)(vii) of this
section, on or before
[[Page 259]]
the date on which the basis of a share of Corporation Y stock received
becomes relevant, J may designate which of the shares of Corporation Y
stock received have a basis of $2, which have a basis of $4, and which
have a basis of $5.
Example 5. (i) Facts. The facts are the same as in Example 4, except
that the terms of the plan of reorganization specify that J receives 40
shares of stock of Corporation Y in exchange for J's shares of Class A
stock of Corporation X and $200 of cash in exchange for J's shares of
Class B stock of Corporation X.
(ii) Analysis. Under paragraph (a)(2)(ii) of this section and under
Sec. 1.356-1(b), because the terms of the exchange specify that J
receives 40 shares of stock of Corporation Y in exchange for J's shares
of Class A stock of Corporation X and $200 of cash in exchange for J's
shares of Class B stock of Corporation X and such terms are economically
reasonable, such terms control. J realizes a gain of $140 on the
exchange of shares of Class A stock of Corporation X, none of which is
recognized under Sec. 1.356-1(a). J realizes a gain of $80 on the
exchange of shares of Class B stock of Corporation X, all of which is
recognized under Sec. 1.356-1(a). Under paragraph (a)(2)(i) of this
section, J has 20 shares of Corporation Y stock, each of which has a
basis of $1 and is treated as having been acquired on Date 1, and 20
shares of Corporation Y stock, each of which has a basis of $2 and is
treated as having been acquired on Date 2. Under paragraph (a)(2)(vii)
of this section, on or before the date on which the basis of a share of
Corporation Y stock received becomes relevant, J may designate which of
the shares of Corporation Y stock received have a basis of $1 and which
have a basis of $2.
Example 6. (i) Facts. J, an individual, acquired 10 shares of stock
of Corporation X on Date 1 for $2 each, and a security issued by
Corporation X to J on Date 2 with a principal amount of $100 and a basis
of $100. On Date 3, Corporation Y acquires the assets of Corporation X
in a reorganization under section 368(a)(1)(A). Pursuant to the terms of
the plan of reorganization, J surrenders all of J's shares of
Corporation X stock in exchange for 10 shares of Corporation Y stock and
surrenders J's Corporation X security in exchange for a Corporation Y
security. On the date of the exchange, the fair market value of each
share of stock of Corporation X is $10, the fair market value of J's
Corporation X security is $100, the fair market value of each share of
Corporation Y stock is $10, and the fair market value and principal
amount of the Corporation Y security received by J is $100.
(ii) Analysis. Under paragraph (a)(2)(ii) of this section and under
Sec. 1.354-1(a), because the terms of the exchange specify that J
receives 10 shares of stock of Corporation Y in exchange for J's shares
of Class A stock of Corporation X and a Corporation Y security in
exchange for its Corporation X security and such terms are economically
reasonable, such terms control. Pursuant to section 354, J recognizes no
gain on either exchange. Under paragraph (a)(2)(i) of this section, J
has 10 shares of Corporation Y stock, each of which has a basis of $2
and is treated as having been acquired on Date 1, and a security that
has a basis of $100 and is treated as having been acquired on Date 2.
Example 7. (i) Facts. J, an individual, acquired 10 shares of
Corporation X stock on Date 1 for $2 each and 10 shares of Corporation X
stock on Date 2 for $5 each. On Date 3, Corporation Y acquires the stock
of Corporation X in a reorganization under section 368(a)(1)(B).
Pursuant to the terms of the plan of reorganization, J receives one
share of Corporation Y stock in exchange for every 2 shares of
Corporation X stock. Pursuant to section 354, J recognizes no gain or
loss on the exchange. J is not able to identify which portion of each
share of Corporation Y stock is received in exchange for each share of
Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 5
shares of Corporation Y stock each of which has a basis of $4 and is
treated as having been acquired on Date 1 and 5 shares of Corporation Y
stock each of which has a basis of $10 and is treated as having been
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or
before the date on which the basis of a share of Corporation Y stock
received becomes relevant, J may designate which of the shares of
Corporation Y stock received have a basis of $4 and which have a basis
of $10.
Example 8. (i) Facts. The facts are the same as in Example 7, except
that, in addition to transferring the stock of Corporation X to
Corporation Y, J transfers land to Corporation Y. In addition, after the
transaction, J owns stock of Corporation Y satisfying the requirements
of section 368(c). J's transfer of the Corporation X stock to
Corporation Y is an exchange described in sections 351 and 354. J's
transfer of land to Corporation Y is an exchange described in section
351.
(ii) Analysis. Under paragraph (a)(2)(viii) of this section, because
neither section 354 nor section 356 applies to the transfer of land to
Corporation Y, the rules of paragraph (a)(2) of this section do not
apply to determine J's basis in the Corporation Y stock received in the
transaction.
Example 9. (i) Facts. J, an individual, acquired 10 shares of
Corporation X stock on Date 1 for $3 each and 10 shares of Corporation X
stock on Date 2 for $6 each. On Date 3, Corporation Z, a newly formed,
wholly owned subsidiary of Corporation Y, merges with and into
Corporation X with Corporation X surviving. As part of the plan of
merger, J receives one share of Corporation Y
[[Page 260]]
stock in exchange for each share of Corporation X stock. In connection
with the transaction, Corporation Y assumes a liability of J. In
addition, after the transaction, J owns stock of Corporation Y
satisfying the requirements of section 368(c). J's transfer of the
Corporation X stock to Corporation Y is an exchange described in
sections 351 and 354.
(ii) Analysis. Under paragraph (a)(2)(viii) of this section,
because, in connection with the transfer of the Corporation X stock to
Corporation Y, Corporation Y assumed a liability of J, the rules of
paragraph (a)(2) of this section do not apply to determine J's basis in
the Corporation Y stock received in the transaction.
Example 10. (i) Facts. Each of Corporation X and Corporation Y has a
single class of stock outstanding, all of which is owned by J, an
individual. J acquired 100 shares of Corporation X stock on Date 1 for
$1 each and 100 shares of Corporation Y stock on Date 2 for $2 each. On
Date 3, Corporation Y acquires the assets of Corporation X in a
reorganization under section 368(a)(1)(D). Pursuant to the terms of the
plan of reorganization, J surrenders J's 100 shares of Corporation X
stock but does not receive any additional Corporation Y stock.
Immediately before the effective time of the reorganization, the fair
market value of each share of Corporation X stock and each share of
Corporation Y stock is $1. Pursuant to section 354, J recognizes no gain
or loss.
(ii) Analysis. Under paragraph (a)(2)(iii) of this section, J is
deemed to have received shares of Corporation Y stock with an aggregate
fair market value of $100 in exchange for J's Corporation X shares.
Given the number of outstanding shares of stock of Corporation Y and
their value immediately before the effective time of the reorganization,
J is deemed to have received 100 shares of stock of Corporation Y in the
reorganization. Under paragraph (a)(2)(i) of this section, each of those
shares has a basis of $1 and is treated as having been acquired on Date
1. Then, the stock of Corporation Y is deemed to be recapitalized in a
reorganization under section 368(a)(1)(E) in which J receives 100 shares
of Corporation Y stock in exchange for those shares of Corporation Y
stock that J held immediately prior to the reorganization and those
shares J is deemed to have received in the reorganization. Under
paragraph (a)(2)(i), immediately after the reorganization, J holds 50
shares of Corporation Y stock each of which has a basis of $2 and is
treated as having been acquired on Date 1 and 50 shares of Corporation Y
stock each of which has a basis of $4 and is treated as having been
acquired on Date 2. Under paragraph (a)(2)(vii) of this section, on or
before the date on which the basis of any share of J's Corporation Y
stock becomes relevant, J may designate which of the shares of
Corporation Y have a basis of $2 and which have a basis of $4.
Example 11. (i) Facts. Corporation X has a single class of stock
outstanding, all of which is owned by J, an individual. J acquired 100
shares of Corporation X stock on Date 1 for $1 each. Corporation Y has
two classes of stock outstanding, common stock and nonvoting preferred
stock. On Date 2, J acquired 100 shares of Corporation Y common stock
for $2 each and 100 shares of Corporation Y preferred stock for $4 each.
On Date 3, Corporation Y acquires the assets of Corporation X in a
reorganization under section 368(a)(1)(D). Pursuant to the terms of the
plan of reorganization, J surrenders J's 100 shares of Corporation X
stock but does not receive any additional Corporation Y stock.
Immediately before the effective time of the reorganization, the fair
market value of each share of Corporation X stock is $10, the fair
market value of each share of Corporation Y common stock is $10, and the
fair market value of each share of Corporation Y preferred stock is $20.
Pursuant to section 354, J recognizes no gain or loss.
(ii) Analysis. Under paragraph (a)(2)(iii) of this section, J is
deemed to have received shares of Corporation Y stock with an aggregate
fair market value of $1,000 in exchange for J's Corporation X shares.
Consistent with the economics of the transaction and the rights
associated with each class of stock of Corporation Y owned by J, J is
deemed to receive additional shares of Corporation Y common stock.
Because the value of the common stock indicates that the liquidation
preference associated with the Corporation Y preferred stock could be
satisfied even if the reorganization did not occur, it is not
appropriate to deem the issuance of additional Corporation Y preferred
stock. Given the number of outstanding shares of common stock of
Corporation Y and their value immediately before the effective time of
the reorganization, J is deemed to have received 100 shares of common
stock of Corporation Y in the reorganization. Under paragraph (a)(2)(i)
of this section, each of those shares has a basis of $1 and is treated
as having been acquired on Date 1. Then, the common stock of Corporation
Y is deemed to be recapitalized in a reorganization under section
368(a)(1)(E) in which J receives 100 shares of Corporation Y common
stock in exchange for those shares of Corporation Y common stock that J
held immediately prior to the reorganization and those shares of
Corporation Y common stock that J is deemed to have received in the
reorganization. Under paragraph (a)(2)(i), immediately after the
reorganization, J holds 50 shares of Corporation Y common stock, each of
which has a basis of $2 and is treated as having been acquired on Date
1, and 50 shares of Corporation Y common stock, each of which has a
basis of $4 and is treated as having been acquired on
[[Page 261]]
Date 2. Under paragraph (a)(2)(vii) of this section, on or before the
date on which the basis of any share of J's Corporation Y common stock
becomes relevant, J may designate which of those shares have a basis of
$2 and which have a basis of $4.
Example 12. (i) Facts. J, an individual, acquired 5 shares of
Corporation X stock on Date 1 for $4 each and 5 shares of Corporation X
stock on Date 2 for $8 each. Corporation X owns all of the outstanding
stock of Corporation Y. The fair market value of the stock of
Corporation X is $1800. The fair market value of the stock of
Corporation Y is $900. In a distribution to which section 355 applies,
Corporation X distributes all of the stock of Corporation Y pro rata to
its shareholders. No stock of Corporation X is surrendered in connection
with the distribution. In the distribution, J receives 2 shares of
Corporation Y stock with respect to each share of Corporation X stock.
Pursuant to section 355, J recognizes no gain or loss on the receipt of
the shares of Corporation Y stock. J is not able to identify which share
of Corporation Y stock is received in respect of each share of
Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(iv) of this section, because J
receives 2 shares of Corporation Y stock with respect to each share of
Corporation X stock, the basis of each share of Corporation X stock is
allocated between such share of Corporation X stock and two shares of
Corporation Y stock in proportion to the fair market value of those
shares. Therefore, each of the 5 shares of Corporation X stock acquired
on Date 1 will have a basis of $2 and each of the 10 shares of
Corporation Y stock received with respect to those shares will have a
basis of $1. In addition, each of the 5 shares of Corporation X stock
acquired on Date 2 will have a basis of $4 and each of the 10 shares of
Corporation Y stock received with respect to those shares will have a
basis of $2. Under paragraph (a)(2)(vii) of this section, on or before
the date on which the basis of a share of Corporation Y stock received
becomes relevant, J may designate which of the shares of Corporation Y
stock have a basis of $1 and which have a basis of $2.
Example 13. (i) Facts. J, an individual, acquired 20 shares of
Corporation X stock on Date 1 for $2 each and 20 shares of Corporation X
stock on Date 2 for $4 each. Corporation X has 80 shares of stock
outstanding. Corporation X owns 40 shares of stock of Corporation Y,
which represents all of the outstanding stock of Corporation Y. The fair
market value of the stock of Corporation X is $80. The fair market value
of the stock of Corporation Y is $40. Corporation X distributes all of
the stock of Corporation Y in a transaction to which section 355
applies. In the transaction, J surrenders 20 shares of stock of
Corporation X in exchange for 20 shares of stock of Corporation Y. J
retains 20 shares of Corporation X stock. Pursuant to section 355, J
recognizes no gain or loss on the receipt of the shares of Corporation Y
stock. J is not able to identify which shares of Corporation X stock are
surrendered. In addition, J is not able to identify which shares of
Corporation Y stock are received in exchange for each surrendered share
of Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 20
shares of Corporation Y stock each of which is treated as received in
exchange for one share of Corporation X stock. The basis of the 20
shares of Corporation X stock that are retained by J will remain
unchanged. Under paragraph (a)(2)(vii) of this section, on or before the
date on which the basis of a share of Corporation X or Corporation Y
stock becomes relevant, J may designate which shares of Corporation X
stock J surrendered in the exchange and which share of the Corporation Y
stock received is received for each share of Corporation X stock
surrendered. Therefore, it is possible that a share of Corporation Y
stock would have a basis of $2 and be treated as having been acquired on
Date 1, or would have a basis of $4 and be treated as having been
acquired on Date 2.
Example 14. (i) Facts. J, an individual, acquired 10 shares of
Corporation X stock on Date 1 for $3 each, 10 shares of Corporation X
stock on Date 2 for $18 each, 10 shares of Corporation X stock on Date 3
for $6 each, and 10 shares of Corporation X stock on Date 4 for $9 each.
On Date 5, Corporation Y acquires the assets of Corporation X in a
reorganization under section 368(a)(1)(A). Pursuant to the terms of the
plan of reorganization, J receives a \3/4\ share of Corporation Y stock
in exchange for each share of Corporation X stock. Therefore, J receives
30 shares of Corporation X stock. Pursuant to section 354, J recognizes
no gain or loss on the exchange. J is not able to identify which shares
of Corporation Y stock are received in exchange for each share (or
portions of shares) of Corporation X stock.
(ii) Analysis. Under paragraph (a)(2)(i) of this section, J has 7
shares of Corporation Y stock each of which has a basis of $4 and is
treated as having been acquired on Date 1, 7 shares of Corporation Y
stock each of which has a basis of $24 and is treated as having been
acquired on Date 2, 7 shares of Corporation Y stock each of which has a
basis of $8 and is treated as having been acquired on Date 3, and 7
shares of Corporation Y stock each of which has a basis of $12 and is
treated as having been acquired on Date 4. In addition, J has two shares
of Corporation Y stock, each of which is divided into two equal segments
under paragraph (a)(2)(vi) of this section. The first of those two
shares has one segment with a basis of $2 that is treated as having been
acquired on Date 1 and a second segment with a basis of $12 that
[[Page 262]]
is treated as having been acquired on Date 2. The second of those two
shares has one segment with a basis of $4 that is treated as having been
acquired on Date 3 and a second segment with a basis of $6 that is
treated as having been acquired on Date 4. Under paragraph (a)(2)(vii),
on or before the date on which a share of Corporation Y stock received
becomes relevant, J may designate which of the shares of Corporation Y
stock have a basis of $4, which have a basis of $24, which have a basis
of $8, which have a basis of $12, and which share has a split basis of
$2 and $12, and which share has a split basis of $4 and $6.
(d) Effective date. This section applies to exchanges and
distributions of stock and securities occurring on or after January 23,
2006.
[T.D. 6500, 25 FR 11607, Nov. 26, 1960, as amended by T.D. 7616, 44 FR
26869, May 8, 1979; T.D. 8648, 60 FR 66079, Dec. 21, 1995; T.D. 9244, 71
FR 4270, Jan. 26, 2006; 71 FR 19118, Apr. 13, 2006; 71 FR 62556, Oct.
26, 2006]
Sec. 1.358-3 Treatment of assumption of liabilities.
(a) For purposes of section 358, where a party to the exchange
assumes a liability of a distributee or acquires from him property
subject to a liability, the amount of such liability is to be treated as
money received by the distributee upon the exchange, whether or not the
assumption of liabilities resulted in a recognition of gain or loss to
the taxpayer under the law applicable to the year in which the exchange
was made.
(b) The application of paragraph (a) of this section may be
illustrated by the following examples:
Example 1. A, an individual, owns property with an adjusted basis of
$100,000 on which there is a purchase money mortgage of $25,000. On
December 1, 1945, A organizes Corporation X to which he transfers the
property in exchange for all the stock of Corporation X and the
assumption by Corporation X of the mortgage. The capital stock of the
Corporation X has a fair market value of $150,000. Under sections 351
and 357, no gain or loss is recognized to A. The basis in A's hands of
the stock of Corporation X is $75,000, computed as follows:
Adjusted basis of property transferred...................... $100,000
Less: Amount of money received (amount of liabilities --25,000
assumed)...................................................
-----------
Basis of Corporation X stock to A.......................... 75,000
Example 2. A, an individual, owns property with an adjusted basis of
$25,000 on which there is a mortgage of $50,000. On December 1, 1954, A
organizes Corporation X to which he transfers the property in exchange
for all the stock of Corporation X and the assumption by Corporation X
of the mortgage. The stock of Corporation X has a fair market value of
$50,000. Under sections 351 and 357, gain is recognized to A in the
amount of $25,000. The basis in A's hands of the stock of Corporation X
is zero, computed as follows:
Adjusted basis of property transferred...................... $25,000
Less: Amount of money received (amount of liabilities)...... --50,000
Plus: Amount of gain recognized to taxpayer................. 25,000
-----------
Basis of Corporation X stock to A.......................... 0
Sec. 1.358-4 Exceptions.
(a) Plan of reorganization adopted after October 22, 1968. In the
case of a plan of reorganization adopted after October 22, 1968, section
358 does not apply in determining the basis of property acquired by a
corporation in connection with such reorganization by the exchange of
its stock or securities (or by the exchange of stock or securities of a
corporation which is in control of the acquiring corporation) as the
consideration in whole or in part for the transfer of the property to
it. See section 362 and the regulations pertaining to that section for
rules relating to basis to corporations of property acquired in such
cases.
(b) Plan of reorganization adopted before October 23, 1968. In the
case of a plan of reorganization adopted before October 23, 1968,
section 358 does not apply in determining the basis of property acquired
by a corporation in connection with such reorganization by the issuance
of stock or securities of such corporation (or by the issuance of stock
or securities of another corporation which is in control of such
corporation) as the consideration in whole or in part for the transfer
of the property to it. The term issuance of stock or securities includes
any transfer of stock or securities, including stock or securities which
were purchased or were acquired as a contribution to capital. See
section 362 and the regulations pertaining to that section for rules
relating to basis to corporations of property acquired in such cases.
[T.D. 7422, 41 FR 26569, June 28, 1976]
[[Page 263]]
Sec. 1.358-5 Special rules for assumption of liabilities.
(a) In general. Section 358(h)(2)(B) does not apply to an exchange
occurring on or after May 9, 2008.
(b) Effective/Applicability date. For exchanges occurring on or
after June 24, 2003, and before May 9, 2008, see Sec. 1.358-5T as
contained in 26 CFR part 1 in effect on April 1, 2007.
[T.D. 9397, 73 FR 26322, May 9, 2008]
Sec. 1.358-6 Stock basis in certain triangular reorganizations.
(a) Scope. This section provides rules for computing the basis of a
controlling corporation in the stock of a controlled corporation as the
result of certain reorganizations involving the stock of the controlling
corporation as described in paragraph (b) of this section. The rules of
this section are in addition to rules under other provisions of the
Internal Revenue Code and principles of law. See, e.g., section 1001 for
the recognition of gain or loss by the controlled corporation on the
exchange of property for the assets or stock of a target corporation in
a reorganization described in section 368.
(b) Triangular reorganizations--(1) Nomenclature. For purposes of
this section--
(i) P is a corporation--
(A) That is a party to a reorganization,
(B) That is in control (within the meaning of section 368(c)) of
another party to the reorganization, and
(C) Whose stock is transferred pursuant to the reorganization.
(ii) S is a corporation--
(A) That is a party to the reorganization, and
(B) That is controlled by P.
(iii) T is a corporation that is another party to the
reorganization.
(2) Definitions of triangular reorganizations. This section applies
to the following reorganizations (which are referred to collectively as
triangular reorganizations):
(i) Forward triangular merger. A forward triangular merger is a
statutory merger of T and S, with S surviving, that qualifies as a
reorganization under section 368(a)(1)(A) or (G) by reason of the
application of section 368(a)(2)(D).
(ii) Triangular C reorganization. A triangular C reorganization is
an acquisition by S of substantially all of T's assets in exchange for P
stock in a transaction that qualifies as a reorganization under section
368(a)(1)(C).
(iii) Reverse triangular merger. A reverse triangular merger is a
statutory merger of S and T, with T surviving, that qualifies as a
reorganization under section 368(a)(1)(A) by reason of the application
of section 368(a)(2)(E).
(iv) Triangular B reorganization. A triangular B reorganization is
an acquisition by S of T stock in exchange for P stock in a transaction
that qualifies as a reorganization under section 368(a)(1)(B).
(v) Triangular G reorganization. A triangular G reorganization is an
acquisition by S (other than by statutory merger) of substantially all
of T's assets in a title 11 or similar case in exchange for P stock in a
transaction that qualifies as a reorganization under section
368(a)(1)(G) by reason of the application of section 368(a)(2)(D).
(c) General rules. Subject to the special rule provided in paragraph
(d) of this section, P's basis in the stock of S or T, as applicable, as
a result of a triangular reorganization, is adjusted under the following
rules--
(1) Forward triangular merger or triangular C reorganization--(i) In
general. In a forward triangular merger or a triangular C
reorganization, P's basis in its S stock is adjusted as if--
(A) P acquired the T assets acquired by S in the reorganization (and
P assumed any liabilities which S assumed or to which the T assets
acquired by S were subject) directly from T in a transaction in which
P's basis in the T assets was determined under section 362(b); and
(B) P transferred the T assets (and liabilities which S assumed or
to which the T assets acquired by S were subject) to S in a transaction
in which P's basis in S stock was determined under section 358.
(ii) Limitation. If, in applying section 358, the amount of T
liabilities assumed by S or to which the T assets acquired by S are
subject equals or exceeds T's aggregate adjusted basis in its assets,
the amount of the adjustment under paragraph (c)(1)(i) of this section
is
[[Page 264]]
zero. P recognizes no gain under section 357(c) as a result of a
triangular reorganization.
(2) Reverse triangular merger--(i) In general--(A) Treated as a
forward triangular merger. Except as otherwise provided in this
paragraph (c)(2), P's basis in its T stock acquired in a reverse
triangular merger equals its basis in its S stock immediately before the
transaction adjusted as if T had merged into S in a forward triangular
merger to which paragraph (c)(1) of this section applies.
(B) Allocable share. If P acquires less than all of the T stock in
the transaction, the basis adjustment described in paragraph
(c)(2)(i)(A) of this section is reduced in proportion to the percentage
of T stock not acquired in the transaction. The percentage of T stock
not acquired in the transaction is determined by taking into account the
fair market value of all classes of T stock.
(C) Special rule if P owns T stock before the transaction. Solely
for purposes of paragraphs (c)(2)(i)(A) and (B) of this section, if P
owns T stock before the transaction, P may treat that stock as acquired
in the transaction or not, without regard to the form of the
transaction.
(ii) Reverse triangular merger that qualifies as a section 351
transfer or section 368(a)(1)(B) reorganization. Notwithstanding
paragraph (c)(2)(i) of this section, if a reorganization qualifies as
both a reverse triangular merger and as a section 351 transfer or as
both a reverse triangular merger and a reorganization under section
368(a)(1)(B), P can--
(A) Determine the basis in its T stock as if paragraph (c)(2)(i) of
this section applies; or
(B) Determine the basis in the T stock acquired as if P acquired
such stock from the former T shareholders in a transaction in which P's
basis in the T stock was determined under section 362(b).
(3) Triangular B reorganization. In a triangular B reorganization,
P's basis in its S stock is adjusted as if--
(i) P acquired the T stock acquired by S in the reorganization
directly from the T shareholders in a transaction in which P's basis in
the T stock was determined under section 362(b); and
(ii) P transferred the T stock to S in a transaction in which P's
basis in its S stock was determined under section 358.
(4) Examples. The rules of this paragraph (c) are illustrated by the
following examples. For purposes of these examples, P, S, and T are
domestic corporations, P and S do not file consolidated returns, P owns
all of the only class of S stock, the P stock exchanged in the
transaction satisfies the requirements of the applicable triangular
reorganization provisions, and the facts set forth the only corporate
activity.
Example 1. Forward triangular merger--(a) Facts. T has assets with
an aggregate basis of $60 and fair market value of $100 and no
liabilities. Pursuant to a plan, P forms S with $5 cash (which S
retains), and T merges into S. In the merger, the T shareholders receive
P stock worth $100 in exchange for their T stock. The transaction is a
reorganization to which sections 368(a)(1)(A) and (a)(2)(D) apply.
(b) Basis adjustment. Under Sec. 1.358-6(c)(1), P's $5 basis in its
S stock is adjusted as if P acquired the T assets acquired by S in the
reorganization directly from T in a transaction in which P's basis in
the T assets was determined under section 362(b). Under section 362(b),
P would have an aggregate basis of $60 in the T assets. P is then
treated as if it transferred the T assets to S in a transaction in which
P's basis in the S stock was determined under section 358. Under section
358, P's $5 basis in its S stock would be increased by the $60 basis in
the T assets deemed transferred. Consequently, P has a $65 basis in its
S stock as a result of the reorganization.
(c) Use of pre-existing S. The facts are the same as paragraph (a)
of this Example 1, except that S is an operating company with
substantial assets that has been in existence for several years. P has a
$110 basis in the S stock. Under Sec. 1.358-6(c)(1), P's $110 basis in
its S stock is increased by the $60 basis in the T assets deemed
transferred. Consequently, P has a $170 basis in its S stock as a result
of the reorganization.
(d) Mixed consideration. The facts are the same as paragraph (a) of
this Example 1, except that the T shareholders receive P stock worth $80
and $20 cash from P. Under section 358, P's $5 basis in its S stock is
increased by the $60 basis in the T assets deemed transferred.
Consequently, P has a $65 basis in its S stock as a result of the
reorganization.
(e) Liabilities. The facts are the same as paragraph (a) of this
Example 1, except that T's assets are subject to $50 of liabilities, and
the T shareholders receive $50 of P stock in
[[Page 265]]
exchange for their T stock. Under section 358, P's basis in its S stock
is increased by the $60 basis in the T assets deemed transferred and
decreased by the $50 of liabilities to which the T assets acquired by S
are subject. Consequently, P has a net basis adjustment of $10, and a
$15 basis in its S stock as a result of the reorganization. For certain
triangular reorganizations where the surviving corporation (S or T) is
foreign, see Sec. 1.367(b)-13.
(f) Liabilities in excess of basis. The facts are the same as in
paragraph (a) of this Example 1, except that T's assets are subject to
liabilities of $90, and the T shareholders receive $10 of P stock in
exchange for their T stock in the reorganization. Under Sec. 1.358-
6(c)(1)(ii), the adjustment under Sec. 1.358-6(c) is zero if the amount
of the liabilities which S assumed or to which the T assets acquired by
S are subject exceeds the aggregate adjusted basis in T's assets.
Consequently, P has no adjustment in its S stock, and P has a $5 basis
in its S stock as a result of the reorganization.
Example 2. Reverse triangular merger. (a) Facts. T has assets with
an aggregate basis of $60 and a fair market value of $100 and no
liabilities. P has a $110 basis in its S stock. Pursuant to a plan, S
merges into T with T surviving. In the merger, the T shareholders
receive $10 cash from P and P stock worth $90 in exchange for their T
stock. The transaction is a reorganization to which sections
368(a)(1)(A) and (a)(2)(E) apply.
(b) Basis adjustment. Under Sec. 1.358-6(c)(2)(i)(A), P's basis in
the T stock acquired is P's $110 basis in its S stock before the
transaction, adjusted as if T had merged into S in a forward triangular
merger to which Sec. 1.358-6(c)(1) applies. In such a case, P's $110
basis in its S stock before the transaction would have been increased by
the $60 basis of the T assets deemed transferred. Consequently, P has a
$170 basis in its T stock immediately after the transaction.
(c) Reverse triangular merger that also qualifies under section
368(a)(1)(B). The facts relating to T are the same as in paragraph (a)
of this Example 2. P, however, forms S pursuant to the plan of
reorganization. The T shareholders receive $100 worth of P stock (and no
cash) in exchange for their T stock. The T shareholders have an
aggregate basis in their T stock of $85 immediately before the
reorganization. The reorganization qualifies as both a reverse
triangular merger and a reorganization under section 368(a)(1)(B). Under
Sec. 1.358-6(c)(2)(ii), P may determine its basis in its T stock either
as if Sec. 1.358-6(c)(2)(i) applied to the T stock acquired, or as if P
acquired the T stock from the former T shareholders in a transaction in
which P's basis in the T stock was determined under section 362(b).
Accordingly, P may determine a basis in its T stock of $60 (T's net
asset basis) or $85 (the T shareholders' aggregate basis in the T stock
immediately before the reorganization).
(d) Allocable share in a reverse triangular merger. The facts are
the same as in paragraph (a) of this Example 2, except that X, a 10%
shareholder of T, does not participate in the transaction. The remaining
T shareholders receive $10 cash from P and P stock worth $80 for their T
stock. P owns 90% of the T stock after the transaction. Under Sec.
1.358-6(c)(2)(i)(A), P's basis in its T stock is P's $110 basis in its S
stock before the reorganization, adjusted as if T had merged into S in a
forward triangular merger. In such a case, P's basis would have been
adjusted by the $60 basis in the T assets deemed transferred. Under
Sec. 1.358-6(c)(2)(i)(B), however, the basis adjustment determined
under Sec. 1.358-6(c)(2)(i)(A) is reduced in proportion to the
percentage of T stock not acquired by P in the transaction. The
percentage of T stock not acquired in the transaction is 10%. Therefore,
P reduces its $60 basis adjustment by 10%, resulting in a net basis
adjustment of $54. Consequently, P has a $164 basis in its T stock as a
result of the transaction.
(e) P's ownership of T stock. The facts are the same as in paragraph
(a) of this Example 2, except that P owns 10% of the T stock before the
transaction. P's basis in that T stock is $8. All the T shareholders
other than P surrender their T stock for $10 cash from P and P stock
worth $80. P does not surrender the stock in the transaction. Under
Sec. 1.358-6(c)(2)(i)(C), P may treat its T stock owned before the
transaction as acquired in the transaction or not. If P treats that T
stock as acquired in the transaction, P's basis in that T stock and the
T stock actually acquired in the transaction equals P's $110 basis in
its S stock before the transaction, adjusted by the $60 basis of the T
assets deemed transferred, for a total basis of $170. If P treats its T
stock as not acquired, P retains its $8 pre-transaction basis in that
stock. P's basis in its other T shares equals P's $110 basis in its S
stock before the transaction, adjusted by $54 (the $60 basis in the T
assets deemed transferred, reduced by 10%), for a total basis of $164 in
those shares. See Sec. 1.358-6(c)(2)(i)(A) and (B). Consequently, if P
treats its T shares as not acquired, P's total basis in all of its T
shares is $172.
Example 3. Triangular B reorganization. (a) Facts. T has assets with
a fair market value of $100 and no liabilities. The T shareholders have
an aggregate basis in their T stock of $85 immediately before the
reorganization. Pursuant to a plan, P forms S with $5 cash and S
acquires all of the T stock in exchange for $100 of P stock. The
transaction is a reorganization to which section 368(a)(1)(B) applies.
(b) Basis adjustment. Under Sec. 1.358-6(c)(3), P adjusts its $5
basis in its S stock by treating P as if it acquired the T stock
acquired by S in the reorganization directly from the T
[[Page 266]]
shareholders in exchange for the P stock in a transaction in which P's
basis in the T stock was determined under section 362(b). Under section
362(b), P would have an aggregate basis of $85 in the T stock received
by S in the reorganization. P is then treated as if it transferred the T
stock to S in a transaction in which P's basis in the S stock was
determined under section 358. Under section 358, P's basis in its S
stock would be increased by the $85 basis in the T stock deemed
transferred. Consequently, P has a $90 basis in its S stock as a result
of the reorganization.
(d) Special rule for consideration not provided by P--(1) In
general. The amount of P's adjustment to basis in its S or T stock, as
applicable, described in paragraph (c) of this section is decreased by
the fair market value of any consideration (including P stock in which
gain or loss is recognized, see Sec. 1.1032-2(c)) that is exchanged in
the reorganization and that is not provided by P pursuant to the plan of
reorganization. This paragraph (d) does not apply to the amount of T
liabilities assumed by S or to which the T assets acquired by S are
subject under paragraph (c)(1) of this section (or deemed assumed or
taken subject to by S under paragraph (c)(2)(i) of this section).
(2) Limitation. P makes no adjustment to basis under this section if
the decrease required under paragraph (d)(1) of this section equals or
exceeds the amount of the adjustment described in paragraph (c) of this
section.
(3) Example. The rules of this paragraph (d) are illustrated by the
following example. For purposes of this example, P, S, and T are
domestic corporations, P and S do not file consolidated returns, P owns
all of the only class of S stock, the P stock exchanged in the
transaction satisfies the requirements of the applicable triangular
reorganization provisions, and the facts set forth the only corporate
activity.
Example. (a) Facts. T has assets with an aggregate basis of $60 and
fair market value of $100 and no liabilities. S is an operating company
with substantial assets that has been in existence for several years. P
has a $100 basis in its S stock. Pursuant to a plan, T merges into S and
the T shareholders receive $70 of P stock provided by P pursuant to the
plan and $30 of cash provided by S in exchange for their T stock. The
transaction is a reorganization to which sections 368(a)(1)(A) and
(a)(2)(D) apply.
(b) Basis adjustment. Under Sec. 1.358-6(c)(1), P's $100 basis in
its S stock is increased by the $60 basis in the T assets deemed
transferred. Under Sec. 1.358-6(d)(1), the $60 adjustment is decreased
by the $30 of cash provided by S in the reorganization. Consequently, P
has a net adjustment of $30 in its S stock, and P has a $130 basis in
its S stock as a result of the reorganization.
(c) Appreciated asset. The facts are the same as in paragraph (a) of
this Example, except that in the reorganization S provides an asset with
a $20 adjusted basis and $30 fair market value instead of $30 of cash.
The basis results are the same as in paragraph (b) of this Example. In
addition, S recognizes $10 of gain under section 1001 on its disposition
of the asset in the reorganization.
(d) Depreciated asset. The facts are the same as in paragraph (c) of
this Example, except that S has a $60 adjusted basis in the asset. The
basis results are the same as in paragraph (b) of this Example. In
addition, S recognizes $30 of loss under section 1001 on its disposition
of the asset in the reorganization.
(e) P stock. The facts are the same as in paragraph (a) of this
Example, except that in the reorganization S provides P stock with a
fair market value of $30 instead of $30 of cash. S acquired the P stock
in an unrelated transaction several years before the reorganization. S
has a $20 adjusted basis in the P stock. The basis results are the same
as in paragraph (b) of this Example. In addition, S recognizes $10 of
gain on its disposition of the P stock in the reorganization. See Sec.
1.1032-2(c).
(e) Cross-reference regarding triangular reorganizations involving
members of a consolidated group. For rules relating to stock basis
adjustments made as a result of a triangular reorganization in which P
and S, or P and T, as applicable, are, or become, members of a
consolidated group, see Sec. 1.1502-30. However, if a transaction is a
group structure change, stock basis adjustments are determined under
Sec. 1.1502-31 and not under Sec. 1.1502-30, even if the transaction
also qualifies as a triangular reorganization otherwise subject to Sec.
1.1502-30.
(f) Effective/applicability dates--(1) General rule. Except as
otherwise provided in this paragraph (f), this section applies to
triangular reorganizations occurring on or after December 23, 1994.
(2) Special rule for reverse triangular mergers. For a reverse
triangular merger occurring before December 23, 1994, P may--
[[Page 267]]
(i) Determine the basis in its T stock as if paragraph (c)(2)(i) of
this section applied; or
(ii) Determine the basis in its T stock acquired as if P acquired
such stock from the former T shareholders in a transaction in which P's
basis in the T stock was determined under section 362(b).
(3) Triangular G reorganization and special rule for triangular
reorganizations involving members of a consolidated group. Paragraphs
(b)(2)(v) and (e) of this section shall apply to triangular
reorganizations occurring on or after September 17, 2008. However,
taxpayers may apply paragraph (b)(2)(v) of this section to triangular
reorganizations occurring before September 17, 2008 and on or after
December 23, 1994.
[T.D. 8648, 60 FR 66079, Dec. 21, 1995; 61 FR 11547, Mar. 21, 1996; T.D.
9243, 71 FR 4282, Jan. 26, 2006; T.D. 9424, 73 FR 53947, Sept. 17, 2008;
73 FR 62204, Oct. 20, 2008]
Sec. 1.358-7 Transfers by partners and partnerships to corporations.
(a) Transfers by partners of partnership interests. For purposes of
section 358(h), a transfer of a partnership interest to a corporation is
treated as a transfer of the partner's share of each of the
partnership's assets and an assumption by the corporation of the
partner's share of partnership liabilities (including section 358(h)
liabilities, as defined in paragraph (d) of this section). See paragraph
(e) Example 2 of this section.
(b) Transfers by partnerships. If a corporation assumes a section
358(h) liability from a partnership in an exchange to which section
358(a) applies, then, for purposes of applying section 705
(determination of basis of partner's interest) and Sec. 1.704-1(b), any
reduction, under section 358(h)(1), in the partnership's basis in
corporate stock received in the transaction is treated as an expenditure
of the partnership described in section 705(a)(2)(B). See paragraph (e)
Example 1 of this section. This expenditure must be allocated among the
partners in accordance with section 704(b) and (c) and Sec. 1.752-7(c).
If a partner's share of the reduction, under section 358(h)(1), in the
partnership's basis in corporate stock exceeds the partner's basis in
the partnership interest, then the partner recognizes gain equal to the
excess, which is treated as gain from the sale or exchange of a
partnership interest. This paragraph does not apply to the extent that
Sec. 1.752-7(j)(4) applies to the assumption of the Sec. 1.752-7
liability by the corporation.
(c) Assumption of section 358(h) liability by partnership followed
by transfer of partnership interest or partnership property to a
corporation--trade or business exception. Where a partnership assumes a
section 358(h) liability from a partner and, subsequently, the partner
transfers all or part of the partner's partnership interest to a
corporation in an exchange to which section 358(a) applies, then, for
purposes of applying section 358(h)(2), the section 358(h) liability is
treated as associated only with the contribution made to the partnership
by that partner. See paragraph (e) Example 2 of this section. Similar
rules apply where a partnership assumes a section 358(h) liability of a
partner and a corporation subsequently assumes that section 358(h)
liability from the partnership in an exchange to which section 358(a)
applies.
(d) Section 358(h) liabilities defined. For purposes of this
section, section 358(h) liabilities are liabilities described in section
358(h)(3).
(e) Examples. The following examples illustrate the provisions of
this section. Assume, for purposes of these examples, that the
obligation assumed by the corporation does not reduce the shareholder's
basis in the corporate stock under section 358(d). The examples are as
follows:
Example 1. Transfer of partnership property to corporation. In 2004,
in an exchange to which section 351(a) applies, PRS, a cash basis
taxpayer, transfers $2,000,000 cash to Corporation X, also a cash basis
taxpayer, in exchange for Corporation X shares and the assumption by
Corporation X of $1,000,000 of accounts payable incurred by PRS. At the
time of the exchange, PRS has two partners, A, a 90% partner, who has a
$2,000,000 basis in the PRS interest, and B, a 10% partner, who has a
$50,000 basis in the PRS interest. Assume that, under section 358(h)(1),
PRS's basis in the Corporation X stock is reduced by the accounts
payable assumed by Corporation X ($1,000,000). Under paragraph (b) of
this section, A's and B's bases in PRS must be reduced, but not below
zero, by their respective shares of the section 358(h)(1) basis
reduction. If either partner's share of the section 358(h)(1) basis
reduction exceeds
[[Page 268]]
the partner's basis in the partnership interest, then the partner
recognizes gain equal to the excess. A's share of the section 358(h)
basis reduction is $900,000 (90% of $1,000,000). Therefore, A's basis in
the PRS interest is reduced to $1,100,000 ($2,000,000 - $900,000). B's
share of the section 358(h) basis reduction is $100,000 (10% of
$1,000,000). Because B's share of the section 358(h) basis reduction
($100,000) exceeds B's basis in the PRS interest ($50,000), B's basis in
the PRS interest is reduced to $0 and B recognizes $50,000 of gain. This
gain is treated as gain from the sale of the PRS interest.
Example 2. Transfer of partnership interest to corporation. In 2004,
A contributes undeveloped land with a value and basis of $4,000,000 in
exchange for a 50% interest in PRS and an assumption by PRS of
$2,000,000 of pension liabilities from a separate business that A
conducts. A's basis in the PRS interest immediately after the
contribution is A's basis in the land, $4,000,000, unreduced by the
amount of the pension liabilities. PRS develops the land as a landfill.
Before PRS has economically performed with respect to the pension
liabilities, A transfers A's interest in PRS to Corporation X, in an
exchange to which section 351 applies. At the time of the exchange, the
value of A's PRS interest is $2,000,000, A's basis in PRS is $4,000,000,
and A has no share of partnership liabilities other than the pension
liabilities. For purposes of applying section 358(h), the transfer of
the PRS interest to Corporation X is treated as a transfer to
Corporation X of A's share of PRS assets and an assumption by
Corporation X of A's share of the pension liabilities of PRS
($2,000,000). Because the pension liabilities were not assumed by PRS
from A in an exchange in which the trade or business associated with the
liability was transferred to PRS, the transfer of the PRS interest to
Corporation X is not excepted from section 358(h) under section
358(h)(2). See paragraph (c) of this section. Under section 358(h), A's
basis in the Corporation X stock is reduced by the $2,000,000 of pension
liabilities.
(f) Effective date. This section applies to assumptions of
liabilities by a corporation occurring on or after June 24, 2003.
[T.D. 9207, 70 FR 30341, May 26, 2005]
effects on corporation
Sec. 1.361-1 Nonrecognition of gain or loss to corporations.
Section 361 provides the general rule that no gain or loss shall be
recognized if a corporation, a party to a reorganization, exchanges
property in pursuance of the plan of reorganization solely for stock or
securities in another corporation, a party to the reorganization. This
provision includes only stock and securities received in connection with
a reorganization defined in section 368(a). It also includes nonvoting
stock and securities in a corporation, a party to a reorganization,
received in a transaction to which section 368(a)(1)(C) is applicable
only by reason of section 368(a)(2)(B).
Sec. 1.362-1 Basis to corporations.
(a) In general. Section 362 provides, as a general rule, that if
property was acquired on or after June 22, 1954, by a corporation (1) in
connection with a transaction to which section 351 (relating to transfer
of property to corporation controlled by transferor) applies, (2) as
paid-in surplus or as a contribution to capital, or (3) in connection
with a reorganization to which part III, subchapter C, chapter 1 of the
Code applies, then the basis shall be the same as it would be in the
hands of the transferor, increased in the amount of gain recognized to
the transferor on such transfer. (See also Sec. 1.362-2.) 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 transfers described in section
351 and certain reorganizations described in section 368(a).
(b) Exceptions. (1) In the case of a plan of reorganization adopted
after October 22, 1968, section 362 does not apply if the property
acquired in connection with such reorganization consists of stock or
securities in a corporation a party to the reorganization, unless
acquired by the exchange of stock or securities of the transferee (or of
a corporation which is in control of the transferee) as the
consideration in whole or in part for the transfer.
(2) In the case of a plan of reorganization adopted before October
23, 1968, section 362 does not apply if the property acquired in
connection with such reorganization consists of stock or securities in a
corporation a party to the reorganization, unless acquired by the
issuance of stock or securities of the transferee (or, in the case of
transactions occurring after December 31,
[[Page 269]]
1963, of a corporation which is in control of the transferee) as the
consideration in whole or in part for the transfer. The term issuance of
stock or securities includes any transfer of stock or securities,
including stock or securities which were purchased or were acquired as a
contribution to capital.
[T.D. 7422, 41 FR 26569, June 28, 1976, as amended by T.D. 8995, 67 FR
34605, May 15, 2002]
Sec. 1.362-2 Certain contributions to capital.
The following regulations shall be used in the application of
section 362(c):
(a) Property deemed to be acquired with contributed money shall be
that property, if any, the acquisition of which was the purpose
motivating the contribution;
(b) In the case of an excess of the amount of money contributed over
the cost of the property deemed to be acquired with such money (as
defined in paragraph (a) of this section) such excess shall be applied
to the reduction of the basis (but not below zero) of other properties
held by the corporation, on the last day of the 12-month period
beginning on the day the contribution is received, in the following
order--
(1) All property of a character subject to an allowance for
depreciation (not including any properties as to which a deduction for
amortization is allowable),
(2) Property with respect to which a deduction for amortization is
allowable,
(3) Property with respect to which a deduction for depletion is
allowable under section 611 but not under section 613, and
(4) All other remaining properties.
The reduction of the basis of each of the properties within each of the
above categories shall be made in proportion to the relative bases of
such properties.
(c) With the consent of the Commissioner, the taxpayer may, however,
have the basis of the various units of property within a particular
category adjusted in a manner different from the general rule set forth
in paragraph (b) of this section. Variations from such rule may, for
example, involve adjusting the basis of only certain units of the
taxpayer's property within a given category. A request for variations
from the general rule should be filed by the taxpayer with its return
for the taxable year for which the transfer of the property has
occurred.
Sec. 1.362-4 Limitations on built-in loss duplication.
(a) Purpose and scope--(1) In general. [Reserved]
(2) Intercompany transactions. For rules relating to the application
of section 362(e)(2) to transfers between members of a consolidated
group on or after October 22, 2004, see Sec. 1.1502-80(h).
(b) [Reserved]
[T.D. 9424, 73 FR 53948, Sept. 17, 2008]
Sec. 1.367(a)-1 Transfers to foreign corporations subject to section 367(a):
In general.
(a) through (d)(2) [Reserved]
(3) [Reserved] For further guidance, see Sec. 1.367(a)-1T(d)(3).
(d)(4) through (g) [Reserved]
[T.D. 9441, 74 FR 348, Jan. 5, 2009]
Sec. 1.367(a)-1T Transfers to foreign corporations subject to section 367(a):
In general (temporary).
(a) Purpose and scope of regulations. These regulations set forth
rules relating to the provisions of section 367(a) concerning certain
transfers of property to foreign corportions. This section provides
general rules explaining the effect of section 367(a)(1) and describing
the transfers of property that are subject to the rule of that section.
Section 1.367(a)-2T provides rules concerning the exception from the
rule of section 367(a)(1) for transfers of property to be used in the
active conduct of a trade or business outside of the United States.
Rules concerning the application of section 367(a)(1) to transfers of
stock or securities are provided in Sec. 1.367(a)-3, while Sec.
1.367(a)-4T provides special rules regarding other specified transfers
of property. Section 1.367(a)-5T describes types of property that are
subject to the rule of section 367(a)(1) regardless of whether they are
transferred for use in a trade or business. Section 1.367(a)-6T provides
rules concerning the application of section 367(a) to the transfer of a
branch with previously deducted losses. Finally,
[[Page 270]]
Sec. 1.367(a)-7T contains transitional rules concerning transfers of
intangible property to foreign corporations made after June 6, 1984 and
before January 1, 1985. Rules explaining the operation of section
367(d), concerning transfers of intangible property pursuant to an
exchange described in section 351 or 361, are provided in Sec.
1.367(d)-1T. Rules concerning the reporting requirements of section
6038B are provided in Sec. Sec. 1.6038B-1 and 1.6038B-1T.
(b) General rules--(1) Foreign corporation not considered a
corporation for purposes of certain transfers. If a U.S. person
transfers property to a foreign corporation in connection with an
exchange described in section 332, 351, 354, 355, 356, or 361, then
pursuant to section 367(a)(1) the foreign corporation shall not be
considered to be a corporation for purposes of determining the extent to
which gain shall be recognized on the transfer. Section 367(a)(1) denies
nonrecognition treatment only to transfers of items of property on which
gain is realized. Thus, the amount of gain recognized because of section
367(a)(1) is unaffected by the transfer of items of property on which
loss is realized (but not recognized). The transfers of property that
are subject to section 367(a)(1) are further described in paragraph (c)
of this section, and relevant definitions are provided in paragraph (d)
of this section.
(2) Cases in which foreign corporate status is not disregarded.
Section 367(a)(1) shall not apply, and a foreign corporate transferee
shall, thus, be considered to be a corporation, in the case of any of
the following:
(i) [Reserved]
(ii) The transfer of property for use in the active conduct of a
trade or business outside of the United States in accordance with the
rules of Sec. Sec. 1.367(a)-2T through 1.367(a)-6T; or
(iii) Certain other transfers of property described in Sec. Sec.
1.367(a)-2T through 1.367(a)-6T.
(3) Limitation of gain required to be recognized--(i) In general. If
a U.S. person transfers property to a foreign corporation in a
transaction on which gain is required to be recognized under section
367(a) and regulations thereunder, then the gain required to be
recognized by the U.S. person shall in no event exceed the gain that
would have been recognized on a taxable sale of those items of property
if sold individually and without offsetting individual losses against
individual gains.
(ii) Losses. No loss may be recognized by reason of the operation of
section 367.
(iii) Ordinary income and capital gain. If section 367(a) and
regulations thereunder require the recognition of ordinary income and
capital gain in excess of the limitation described in paragraph
(b)(3)(i) of this section, then the limitation shall be imposed by
making proportionate reductions in the amounts or ordinary income and
capital gain, regardless of the character of the gain that would have
been recognized on a taxable sale of the property.
(4) Character, source, and adjustments--(i) In general. If a U.S.
person is required to recognize gain under section 367 upon a transfer
of property to a foreign corporation, then--
(A) The character and source of such gain shall be determined as if
the property had been disposed of in a taxable exchange with the
transferee foreign corporation (unless otherwise provided by
regulation); and
(B) Appropriate adjustments to earnings and profits, basis, and
other affected items shall be made according to otherwise applicable
rules, taking into account the gain recognized because of section
367(a)(1). Any increase in the basis of the property received by the
foreign corporation resulting from the application of section 367(a) and
section 362 (a) or (b) shall be allocated over the transferred property
with respect to which gain is recognized in proportion to the amount
realized by the U.S. person on the transfer of each item of that
property. See paragraph (c)(3) of this section for special rules
applicable to transfers of partnership interests.
(ii) Example. The rules of this paragraph (b)(4) are illustrated by
the following example.
Example. Domestic corporation DC transfers inventory with a fair
market value of $1 million and adjusted basis of $800,000 to foreign
corporation FC in an exchange for stock of FC that is described in
section 351 (a). Title passes within the U.S. Pursuant to section
367(a), DC is required to recognize gain of $200,000 upon the transfer.
Under the rule
[[Page 271]]
of this paragraph (b)(4), such gain shall be treated as ordinary income
(sections 1201 and 1221) from sources within the U.S. (section 861)
arising from a taxable exchange with FC. Appropriate adjustments to
earnings and profits, basis, etc., shall be made as if the transfer were
subject to section 351. Thus, for example, DC's basis in the FC stock
received, and FC's basis in the transferred inventory, will each be
increased by the $200,000 gain recognized by DC, pursuant to sections
358(a)(1) and 362(a), respectively.
(c) Transfers described in section 367(a)(1)--(1) In general. A
transfer described in section 367(a)(1) is any transfer of property by a
U.S. person to a foreign corporation pursuant to an exchange described
in section 332, 351, 354, 355, 356, or 361. Section 367(a)(1) applies to
such a transfer whether it is made directly, indirectly, or
constructively. Indirect or constructive transfers that are described in
section 367(a)(1) include the transfers described in subparagraphs (2)
through (7) of this paragraph (c).
(2) Indirect transfers in certain reorganizations. [Reserved]. For
further guidance, see Sec. 1.367(a)-3(d).
(3) Indirect transfers involving partnerships and interests
therein--(i) Transfer by partnership treated as transfer by partners--
(A) In general. If a partnership (whether foreign or domestic) transfers
property to a foreign corporation in an exchange described in section
367(a)(1), then a U.S. person that is a partner in the partnership shall
be treated as having transferred a proportionate share of the property
in an exchange described in section 367(a)(1). A U.S. person's
proportionate share of partnership property shall be determined under
the rules and principles of sections 701 through 761 and the regulations
thereunder. The rule of this paragraph (c)(3)(i)(A) is illustrated by
the following example.
Example. P is a partnership having five equal general partners, two
of whom are United States persons. P transfers property to F, a foreign
corporation, in connection with an exchange described in section 351.
The exchange includes an indirect transfer of property by the partners
to F. The transfers of property attributable to those partners who are
United States persons, that is, 40 percent of each asset transferred to
F, are transfers described in section 367(a)(1). The gain (if any)
recognized on the transfer of 40 percent of each asset to F is
attributable to the two partners who are United States persons.
(B) Special adjustments to basis. If a U.S. person is treated under
the rule of this paragraph (c)(3)(i) as having transferred a
proportionate share of the property of a partnership in an exchange
described in section 367(a), and is therefore required to recognize gain
upon the transfer, then--
(1) The U.S. person's basis in the partnership shall be increased by
the amount of gain recognized by him;
(2) Solely for purposes of determining the basis of the partnership
in the stock of the transferee foreign corporation, the U.S. person
shall be treated as having newly acquired an interest in the partnership
(for an amount equal to the gain recognized), permitting the partnership
to make an optional adjustment to basis pursuant to sections 743 and
754; and
(3) The transferee foreign corporation's basis in the property
acquired from the partnership shall be increased by the amount of gain
recognized by U.S. persons under this paragraph (c)(3)(i).
(ii) Transfer of partnership interest treated as transfer of
proportionate share of assets--(A) In general. If a U.S. person
transfers an interest as a partner in a partnership (whether foreign or
domestic) in an exchange described in section 367(a)(1), then that
person shall be treated as having transferred a proportionate share of
the property of the partnership in an exchange described in section
367(a)(1). Accordingly, the applicability of the exception to section
367(a)(1) provided in Sec. 1.367(a)-2T shall be determined with
reference to the property of the partnership rather than the partnership
interest itself. A U.S. person's proportionate share of partnership
property shall be determined under the rules and principles of sections
701 through 761 and the regulations thereunder.
(B) Special adjustments to basis. If a U.S. person is treated under
the rule of paragraph (c)(3)(ii)(A) of this section as having
transferred a proportionate share of the property of a partnership in an
exchange described in section 367(a), and is therefore required to
recognize gain upon the transfer, then--
[[Page 272]]
(1) The U.S. person's basis in the stock of the transferee foreign
corporation shall be increased by the amount of gain so recognized by
that person;
(2) The transferee foreign corporation's basis in the transferred
partnership interest shall be increased by the amount of gain recognized
by the U.S. person; and
(3) Solely for purposes of determining the partnership's basis in
the property held by it, the U.S. person shall be treated as having
newly acquired an interest in the partnership (for an amount equal to
the gain recognized), permitting the partnership to make an optional
adjustment to basis pursuant to sections 743 and 754.
(C) Limited partnership interest. The transfer by a U.S. person of
an interest in a partnership shall not be subject to the rules of
paragraph (c)(3)(ii)(A) and (B) if--
(1) The interest transferred is a limited partnership interest; and
(2) Such interest is regularly traded on an established securities
market.
Instead, the transfer of such an interest shall be treated in the same
manner as a transfer of stock or securities. Thus, the consequences of
such a transfer shall be determined under the rules of Sec. 1.367(a)-3.
For purposes of this section, a limited partnership interest is an
interest as a limited partner in a partnership that is organized under
the laws of any State of the United States or the District of Columbia.
Whether such an interest is regularly traded on an established
securities market shall be determined under the provisions of paragraph
(c)(3)(ii)(D) of this section.
(D) Regularly traded on an established securities market--(1)
Established securities market. For purposes of this paragraph
(c)(3)(ii), an established securities market is--
(i) A national securities exchange which is registered under section
6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f);
(ii) A foreign national securities exchange which is officially
recognized, sanctioned, or supervised by governmental authority; and
(iii) An over-the-counter market. An over-the-counter market is any
market reflected by the existence of an inter-dealer quotation system.
An inter-dealer quotation system is any system of general circulation to
brokers and dealers which regularly disseminates quotations of stock and
securities by identified brokers or dealers, other than by quotation
sheets which are prepared and distributed by a broker or dealer in the
regular course of business and which contain only quotations of such
broker or dealer.
(2) Regularly traded. A class of interests that is traded on an
established securities market is considered to be regularly traded if it
is regularly quoted by brokers or dealers making a market in such
interests. A class of interests shall be presumed to be regularly traded
if the entity has a total of 500 or more interest-holders.
(4) Transfers by trusts and estates--(i) In general. For purposes of
section 367(a), a transfer of property by an estate or trust shall be
treated as a transfer by the entity itself and not as an indirect
transfer by its beneficiaries. Thus, a transfer of property by a foreign
trust or estate (as defined in section 7701(a)(31)) is not described in
section 367(a)(1), regardless of whether the beneficiaries of the trust
or estate are U.S. persons. Similarly, a transfer of property by a
domestic trust or estate may be described in section 367(a)(1),
regardless of whether the beneficiaries of the trust or estate are
foreign persons.
(ii) Grantor trusts. A transfer of a portion or all of the assets of
a foreign or domestic trust to a foreign corporation in an exchange
described in section 367(a)(1) is considered a transfer by any U.S.
person who is treated as the owner of any such portion or all of the
assets of the trust under sections 671 through 679.
(5) Termination of election under section 1504(d). Section 367(A)
applies to the constructive reorganization and transfer of property from
a domestic corporation to a foreign corporation that occurs upon the
termination of an election under section 1504(d), which permits the
treatment of certain contiguous country corporations as domestic
corporations. The rule of this paragraph (c)(5) is illustrated by the
following example.
Example. Domestic corporation Y previously made a valid election
under section
[[Page 273]]
1504(d) to have its wholly owned Canadian subsidiary, C, treated as a
domestic corporation. On July, 1, 1986, C fails to continue to qualify
for the election under section 1504 (d). A constructive reorganization
described in section 368(a)(1)(D) occurs. The resulting constructive
transfer of assests by ``domestic'' corporation C to Canadian
corporation C upon the termination of the election is a transfer of
property described in section 367(a)(1).
(6) Changes in classification of an entity. If a foreign entity is
classified as an entity other than an association taxable as a
corporation for United States tax purposes, and subsequently a change is
made in the governing documents, articles, or agreements of the entity
so that the entity is thereafter classified as an association taxable as
a corporation, the change in classification is considered a transfer of
property to a foreign corporation in connection with an exchange
described in section 351. For purposes of section 367(a)(1), the
transfer of property is considered as made by the persons determined
under the rules set forth in paragraph (c)(3) of this section with
respect to partnerships, and paragraph (c)(4)(i) or (ii), with respect
to trusts and estates, and the rules of such paragraphs apply
determining whether a transfer described in section 367(a)(1) has been
made.
(7) Contributions to capital. For rules with respect to the
treatment of a contribution to the capital of a foreign corporation as a
transfer described in section 367(a)(1), see section 367(c)(2) and the
regulations thereunder.
(d) Definitions. The following definitions apply for purposes of
this section and Sec. 1.367(d)-1T.
(1) United States person. The term United States person includes
those persons described in section 7701(a)(30). The term includes a
citizen or resident of the United States, a domestic partnership, a
domestic corporation, and any estate or trust other than a foreign
estate or trust. (For definitions of these terms, see section 7701 and
regulations thereunder.) For purposes of this section, an individual
with respect to whom an election has been made under section 6013 (g) or
(h) is considered to be a resident of the United States while such
election is in effect. A nonresident alien or a foreign corporation will
not be considered a United States person because of its actual or deemed
conduct of a trade or business within the United States during a taxable
year.
(2) Foreign corporation. The term foreign corporation has the
meaning set forth in section 7701(a)(3) and (5) and Sec. 301.7701-5.
(3) Transfer. For purposes of section 367 and regulations
thereunder, the term transfer means any transaction that constitutes a
transfer for purposes of sections 332, 351, 354, 355, 356, or 361, as
applicable. A person's entering into a cost sharing arrangement under
Sec. 1.482-7T or acquiring rights to intangible property under such an
arrangement shall not be considered a transfer of property described in
section 367(a)(1). See Sec. 1.6038B-1T(b)(3) for the date on which the
transfer is considered to be made.
(4) Property. For purposes of section 367 and regulations
thereunder, the term property means any item that constitutes property
for purposes of sections 332, 351, 354, 355, 356, or 361, as applicable.
(5) Intangible property--(i) In general. For purposes of section 367
and regulations thereunder, the term intangible property means
knowledge, rights, documents, and any other intangible item within the
meaning of section 936(h)(3)(B) that constitutes property for purposes
of sections 332, 351, 354, 355, 356, or 361, as applicable. Such
property shall be treated as intangible property for purposes of section
367 (a) and (d) and the regulations thereunder without regard to whether
it is used or developed in the United States or in a foreign country and
without regard to whether it is used in manufacturing activities or in
marketing activities. A working interest in oil and gas properties shall
not be considered to be intangible property for purposes of section 367
and the regulations thereunder.
(ii) Operating intangibles. An operating intangible is any
intangible property of a type not ordinarily licensed or otherwise
transferred in transactions between unrelated parties for
[[Page 274]]
consideration contingent upon the licensee's or transferee's use of the
property. Examples of operating intangibles may include long-term
purchase or supply contracts, surveys, studies, and customer lists.
(iii) Foreign goodwill or going concern value. Foreign goodwill or
going concern value is the residual value of a business operation
conducted outside of the United States after all other tangible and
intangible assets have been identified and valued. For purposes of
section 367 and regulations thereunder the value of the right to use a
corporate name in a foreign country shall be treated as foreign goodwill
or going concern value.
(iv) Transitional rule for certain marketing intangibles. For
transfers occurring after December 31, 1984, and before May 16, 1986,
for foreign trademarks, tradenames, brandnames, and similar marketing
intangibles developed by a foreign branch shall be treated as foreign
goodwill or going concern value.
(e) Close of taxable year in certain section 368(a)(1)(F)
reorganizations. If a domestic corporation is the transferor corporation
in a reorganization described in section 368(a)(1)(F) after March 30,
1987, in which the acquiring corporation is a foreign corporation, then
the taxable year of the transferor corporation shall end with the close
of the date of the transfer and the taxable year of the acquiring
corporation shall end with the close of the date on which the
transferor's taxable year would have ended but for the occurrence of the
transfer. With regard to the consequences of the closing of the taxable
year, see section 381 and the regulations thereunder.
(f) Exchanges under sections 354(a) and 361(a) in certain section
368(a)(1)(F) reorganizations. In every reorganization under section
368(a)(1)(F), where the transferor corporation is a domestic corporation
and the acquiring corporation is a foreign corporation, there is
considered to exist--
(1) A transfer of assets by the transferor corporation to the
acquiring corporation under section 361(a) in exchange for stock of the
acquiring corporation and the assumption by the acquiring corporation of
the transferor corporation's liabilities;
(2) A distribution of the stock (or stock and securities) of the
acquiring corporation by the transferor corporation to the shareholders
(or shareholders and security holders) of the transferor corporation;
and
(3) An exchange by the transferor corporation's shareholders (or
shareholders and security holders) of the stock of the transferor
corporation for stock (or stock and securities) of the acquiring
corporation under section 354(a).
For this purpose, it shall be immaterial that the applicable foreign or
domestic law treats the acquiring corporation as a continuance of the
transferor corporation.
(g) Effective date of certain section--
(1) In general. Except as specifically provided to the contrary
elsewhere in these sections, Sec. Sec. 1.367(a)-1T through 1.367(a)-6T
apply to transfers occurring after December 31, 1984.
(2) Private rulings. The taxpayer may rely on a private ruling under
section 367(a) received by him before June 16, 1986.
(3) Certain indirect transfers. Sections 1.367(a)-1T(c)(2)(i) and
(iii) and 1.367(a)-1T(c)(3) apply to transfers made after June 16, 1986.
For transfers made before that date, see 26 CFR 1.367(a)-1(b) (revised
as of April 1, 1986).
[T.D. 8087, 51 FR 17938, May 16, 1986, as amended by T.D. 8280, 55 FR
1408, Jan. 16, 1990; T.D. 8770, 63 FR 33555, June 19, 1998; T.D. 9441,
74 FR 348, Jan. 5, 2009]
Sec. 1.367(a)-2T Exception for transfers of property for use in the active
conduct of a trade or business (temporary).
(a) In general. Section 367(a)(1) shall not apply to property
transferred to a foreign corporation if--
(1) Such property is transferred for use by that corporation in the
active conduct of a trade or business outside of the United States; and
(2) The U.S. person that transfers the property complies with the
reporting requirements of section 6038B and regulations thereunder.
Where these conditions are satisifed, the foreign corporate transferee
of the property shall be considered to be a corporation for purposes of
determining the extent to which gain or loss
[[Page 275]]
is required to be recognized upon the transfer pursuant to section 332,
351, 354 [reserved as to section 355 or so much of section 356 as
relates to section 355], 356, or 361. Paragraph (b) of this section
provides rules concerning the requirement that property be transferred
for use in the active conduct of a trade or business outside of the
United States, while paragraph (c) concerns the application of the
requirement where the transferee itself re-transfers the property. In
addition, Sec. 1.367(a)-3T provides rules concerning the treatment of
stock or securities transferred to a foreign corporation in an exchange
described in section 367(a)(1), and Sec. 1.367(a)-4T provides special
rules concerning the treatment of other specified types of property.
Finally, Sec. Sec. 1.367(a)-5T and 1.367(a)-6T provide rules concerning
certain transfers of property that are subject to section 367(a)(1)
regardless of whether the property is used in the active conduct of a
trade or business.
(b) Active conduct of a trade or business outside the United
States--(1) In general. Property qualifies for the exception provided by
this section if it is transferred to a foreign corporation for use in
the active conduct of a trade or business outside of the United States.
Therefore, to determine whether property is subject to the exception
provided by this section, four factual determinations must be made:
(i) What is the trade or business of the transferee;
(ii) Do the activities of the transferee constitute the active
conduct of that trade or business;
(iii) Is the trade or business conducted outside of the United
States; and
(iv) Is the transferred property used or held for use in the trade
or business?
Rules concerning these four determinations are provided in paragraphs
(b)(2), (3), (4), and (5) of this section.
(2) Trade or business. Whether the activities of a foreign
corporation constitute a trade or business must be determined under all
the facts and circumstances. In general, a trade or business is a
specific unified group of activities that constitute (or could
constitute) an independent economic enterprise carried on for profit.
For example, the activities of a foreign selling subsidiary could
constitute a trade or business if they could be independently carried on
for profit, even though the subsidiary acts exclusively on behalf of,
and has operations fully integrated with, its parent corporation. To
constitute a trade or business, a group of activities must ordinarily
include every operation which forms a part of, or a step in, a process
by which an enterprise may earn income or profit. In this regard, one or
more of such activities may be carried on by independent contractors
under the direct control of the foreign corporation. (However, see
paragraph (b)(3) of this section.) The group of activities must
ordinarily include the collection of income and the payment of expenses.
If the activities of a foreign corporation do not constitute a trade or
business, then the exception provided by this section does not apply,
regardless of the level of activities carried on by the corporation. The
following activities are not considered to constitute by themselves a
trade or business for purposes of this section:
(i) Any activity giving rise to expenses that would be deductible
only under section 212 if the activities were carried on by an
individual; or
(ii) The holding for one's own account of investments in stock,
securities, land, or other property, including casual sales thereof.
(3) Active conduct. Whether a trade or business is actively
conducted must be determined under all the facts and circumstances. In
general, a corporation actively conducts a trade or business only if the
officers and employees of the corporation carry out substantial
managerial and operational activities. A corporation may be engaged in
the active conduct of a trade or business even though incidental
activities of the trade or business are carried out on behalf of the
corporation by independent contractors. In determining whether the
officers and employees of the corporation carry out substantial
managerial and operational activities, however, the activities of
independent contractors shall be disregarded. On the other hand, the
officers and employees
[[Page 276]]
of the corporation are considered to include the officers and employees
of related entities who are made available to and supervised on a day-
to-day basis by, and whose salaries are paid by (or reimbursed to the
lending related entity by), the transferee foreign corporation. Whether
a trade or business that produces rents or royalties is actively
conducted shall be determined under the principles of Sec. 1.954-
2(d)(1) (but without regard to whether the rents or royalties are
received from an unrelated person). The rule of this paragraph (b)(3) is
illustrated by the following example.
Example. X, a domestic corporation, and Y, a foreign corporation not
related to X, transfer property to Z, a newly formed foreign corporation
organized for the purpose of combining the research activities of X and
Y. Z contracts all of its operational and research activities to Y for
an arm's-length fee. Z's activities do not constitute the active conduct
of a trade or business.
(4) Outside of the United States. Whether a foreign corporation
conducts a trade or business outside of the United States must be
determined under all the facts and circumstances. Generally, the primary
managerial and operational activities of the trade or business must be
conducted outside the United States and immediately after the transfer
the transferred assets must be located outside the United States. Thus,
the exception provided by this section would not apply to the transfer
of the assets of a domestic business to a foreign corporation if the
domestic business continued to operate in the United States after the
transfer. In such a case, the primary operational activities of the
business would continue to be conducted in the United States. Moreover,
the transferred assets would be located in the United States. However,
it is not necessary that every item of property transferred be used
outside of the United States. As long as the primary managerial and
operational activities of the trade or business are conducted outside of
the United States and substantially all of the transferred assets are
located outside the United States, incidental items of transferred
property located in the United States may be considered to have been
transferred for use in the active conduct of a trade or business outside
of the United States.
(5) Use in the trade or business. Whether property is used or held
for use in a trade or business must be determined under all the facts
and circumstances. In general, property is used or held for use in a
foreign corporation's trade or business if it is--
(i) Held for the principal purpose of promoting the present conduct
of the trade or business;
(ii) Acquired and held in the ordinary course of the trade or
business; or
(iii) Otherwise held in a direct relationship to the trade or
business. Property is considered held in a direct relationship to a
trade or business if it is held to meet the present needs of that trade
or business and not its anticipated future needs.
Thus, property will not be considered to be held in a direct
relationship to a trade or business if it is held for the purpose of
providing for future diversification into a new trade or business,
future expansion of trade or business activities, future plant
replacement, or future business contingencies.
(c) Property transferred by transferee corporation--(1) General
rule. If a foreign corporation receives property in an exchange
described in section 367(a)(1) and as part of the same transaction
transfers the property to another person, then the exception provided by
this section shall not apply to the initial transfer. For purposes of
the preceding sentence, a subsequent transfer within six months of the
initial transfer shall be considered to be part of the same transaction,
and a subsequent transfer more than six months after the initial
transfer may be considered to be part of the same transaction upon the
application of step-transaction principles.
(2) Exception. Notwithstanding paragraph (c)(1) of this section, the
active conduct exception provided by this section shall apply to the
initial transfer if--
(i) The initial transfer is followed by one or more subsequent
transfers described in section 351 or 721; and
(ii) Each subsequent transferee is either a partnership in which the
preceding transferor is a general partner
[[Page 277]]
or a corporation in which the preceding transferor owns common stock;
and
(iii) The ultimate transferee uses the property in the active
conduct of a trade or business outside the United States.
(d) Transitional rule. Notwithstanding any other provision of this
section, property shall be considered to have been transferred for use
in the active conduct of a trade or business outside of the United
States, if--
(1) The property was transferred after December 31, 1984, and before
June 16, 1986;
(2) The property was, or would have been, considered to be
transferred for use by the transferee foreign corporation in the active
conduct, in any foreign country, or a trade or business, under the
principles of section 3.02(1) of Revenue Procedure 68-23, 1968-1 C.B.
821; and
(3) Based on all of the facts and circumstances, it was, or would
have been, determined under section 2.02 of Revenue Procedure 68-23 that
tax avoidance was not one of the principal purposes of the transaction.
(e) Special rules for certain transfers occurring on or after May 2,
2006--(1) General rule. Whether a trade or business that produces rents
or royalties is actively conducted shall be determined under the
principles of section 954(c)(2)(A) and the accompanying regulations (but
without regard to whether the rents or royalties are received from an
unrelated party). See Sec. 1.954-2(c) and (d).
(2) Effective/applicability date. The rules of this paragraph (e)
apply to transfers occurring on or after May 2, 2006. However, if the
transferor makes the election to apply the provisions of Sec. 1.367(a)-
4T(c)(3)(i) for transfers occurring on or after October 22, 2004, then
paragraph (e)(1) will also be applicable for the transfers occurring on
or after October 22, 2004.
(3) Expiration date. The applicability of this paragraph (e) will
expire on July 1, 2011.
[T.D. 8087, 51 FR 17942, May 16, 1986, as amended by T.D. 9406, 73 FR
38115, July 3, 2008]
Sec. 1.367(a)-3 Treatment of transfers of stock or securities to foreign
corporations.
(a) In general. This section provides rules concerning the transfer
of stock or securities by a U.S. person to a foreign corporation in an
exchange described in section 367(a). In general, a transfer of stock or
securities by a U.S. person to a foreign corporation that is described
in section 351, 354 (including a reorganization described in section
368(a)(1)(B) and including an indirect stock transfer described in
paragraph (d) of this section), 356 or section 361(a) or (b) is subject
to section 367(a)(1) and, therefore, is treated as a taxable exchange,
unless one of the exceptions set forth in paragraph (b) of this section
(regarding transfers of foreign stock or securities), paragraph (c) of
this section (regarding transfers of domestic stock or securities), or
paragraph (e) of this section (regarding transfers of stock or
securities in a section 361 exchange) applies. For rules applicable
when, pursuant to section 304(a)(1), a United States person is treated
as transferring stock of a domestic or foreign corporation to a foreign
corporation in exchange for stock of such foreign corporation in a
transaction to which section 351(a) applies, see Sec. 1.367(a)-9T. In
addition, if, in an exchange described in section 354 or 356, a U.S.
person exchanges stock or securities of a foreign corporation in a
reorganization described in section 368(a)(1)(E), or a U.S. person
exchanges stock or securities of a domestic or foreign corporation
pursuant to an asset reorganization that is not treated as an indirect
stock transfer under paragraph (d) of this section, such section 354 or
356 exchange is not a transfer to a foreign corporation subject to
section 367(a). See paragraph (d)(3) Example 16 of this section. For
purposes of this section, an asset reorganization is defined as a
reorganization described in section 368(a)(1) involving a transfer of
assets under section 361. If, in a transfer described in section 361, a
domestic merging corporation transfers stock of a controlling
corporation to a foreign surviving corporation in a reorganization
described in sections 368(a)(1)(A) and (a)(2)(E), such section 361
transfer is not subject to section 367(a) if the
[[Page 278]]
stock of the controlling corporation is provided to the merging
corporation by the controlling corporation pursuant to the plan of
reorganization; a section 361 transfer of other property, including
stock of the controlling corporation not provided by the controlling
corporation pursuant to the plan of reorganization, by the domestic
merging corporation to the foreign surviving corporation pursuant to
such a reorganization is subject to section 367(a). For special basis
and holding period rules involving foreign corporations that are parties
to certain triangular reorganizations under section 368(a)(1), see Sec.
1.367(b)-13. For additional rules relating to an exchange involving a
foreign corporation in connection with which there is a transfer of
stock, see section 367(b) and the regulations under that section. For
additional rules regarding a transfer of stock or securities in an
exchange described in section 361(a) or (b), see section 367(a)(5) and
any regulations under that section. For rules regarding reporting
requirements with respect to transfers described under section 367(a),
see section 6038B and the regulations thereunder. For rules related to
expatriated entities, see section 7874 and the regulations thereunder.
(b) Transfers by U.S. persons of stock or securities of foreign
corporations to foreign corporations--(1) General rule.Except as
provided in section 367(a)(5) and paragraph (e) of this section, a
transfer of stock or securities of a foreign corporation by a U.S.
person to a foreign corporation that would otherwise be subject to
section 367(a)(1) under paragraph (a) of this section shall not be
subject to section 367(a)(1) if either--
(i) Less than 5-percent shareholder. The U.S. person owns less than
five percent (applying the attribution rules of section 318, as modified
by section 958(b)) of both the total voting power and the total value of
the stock of the transferee foreign corporation immediately after the
transfer; or
(ii) 5-percent shareholder. The U.S. person enters into a five-year
gain recognition agreement with respect to the transferred stock or
securities as provided in Sec. 1.367(a)-8.
(2) Certain transfers subject to sections 367(a) and (b)--(i) In
general. A transfer of stock or securities described in section 367(a)
or the regulations thereunder as well as in section 367(b) or the
regulations thereunder shall be subject concurrently to sections 367(a)
and (b) and the respective regulations thereunder, except as provided in
paragraph (b)(2)(i)(A) through (C) of this section. See paragraph (d)(3)
Examples 11 and 14 of this section.
(A) Section 367(b) and the regulations thereunder shall not apply if
a foreign corporation is not treated as a corporation under section
367(a)(1). See the example in paragraph (b)(2)(ii) of this section and
paragraph (d)(3) Example 14 of this section.
(B) If a foreign corporation transfers assets to a domestic
corporation in a transaction to which Sec. 1.367(b)-3(a) and (b) and
the indirect stock transfer rules of paragraph (d) of this section
apply, and all the earnings and profits amount attributable to the stock
of an exchanging shareholder under Sec. 1.367(b)-3(b) is greater than
the amount of gain in such stock subject to section 367(a) pursuant to
the indirect stock transfer rules of paragraph (d) of this section, then
the rules of section 367(b), and not the rules of section 367(a), shall
apply to the exchange. See paragraph (d)(3) Example 15 of this section.
(C) [Reserved] For further guidance, see Sec. 1.367(a)-
3T(b)(2)(i)(C).
(ii) Example. The following example illustrates the provisions of
this paragraph (b)(2):
Example. (i) Facts. DC, a domestic corporation, owns all of the
stock of FC1, a controlled foreign corporation within the meaning of
section 957(a). DC's basis in the stock of FC1 is $50, and the value of
such stock is $100. The section 1248 amount with respect to such stock
is $30. FC2, also a foreign corporation, is owned entirely by foreign
individuals who are not related to DC or FC1. In a reorganization
described in section 368(a)(1)(B), FC2 acquires all of the stock of FC1
from DC in exchange for 20 percent of the voting stock of FC2. FC2 is
not a controlled foreign corporation after the reorganization.
(ii) Result without gain recognition agreement. Under the provisions
of this paragraph (b), if DC fails to enter into a gain recognition
agreement, DC is required to recognize in the year of the transfer the
$50 of gain that it realized upon the transfer, $30 of
[[Page 279]]
which will be treated as a dividend under section 1248.
(iii) Result with gain recognition agreement. If DC enters into a
gain recognition agreement under Sec. 1.367(a)-8 with respect to the
transfer of FC1 stock, the exchange will also be subject to the
provisions of section 367(b) and the regulations thereunder to the
extent that it is not subject to tax under section 367(a)(1). In such
case, DC will be required to recognize the section 1248 amount of $30 on
the exchange of FC1 for FC2 stock. See Sec. 1.367(b)-4(b). The deemed
dividend of $30 recognized by DC will increase its basis in the FC1
stock exchanged in the transaction and, therefore, the basis of the FC2
stock received in the transaction. The remaining gain of $20 realized by
DC (otherwise recognizable under section 367(a)) in the exchange of FC1
stock will not be recognized if DC enters into a gain recognition
agreement with respect to the transfer. (The result would be unchanged
if, for example, the exchange of FC1 stock for FC2 stock qualified as a
section 351 exchange, or as an exchange described in both sections 351
and 368(a)(1)(B).)
(c) Transfers by U.S. persons of stock or securities of domestic
corporations to foreign corporations--(1) In general. Except as provided
in section 367(a)(5) and paragraph (e) of this section, a transfer of
stock or securities of a domestic corporation by a U.S. person to a
foreign corporation that would otherwise be subject to section 367(a)(1)
under paragraph (a) of this section shall not be subject to section
367(a)(1) if the domestic corporation the stock or securities of which
are transferred (referred to as the U.S. target company) complies with
the reporting requirements in paragraph (c)(6) of this section and if
each of the following four conditions is met:
(i) Fifty percent or less of both the total voting power and the
total value of the stock of the transferee foreign corporation is
received in the transaction, in the aggregate, by U.S. transferors
(i.e., the amount of stock received does not exceed the 50-percent
ownership threshold).
(ii) Fifty percent or less of each of the total voting power and the
total value of the stock of the transferee foreign corporation is owned,
in the aggregate, immediately after the transfer by U.S. persons that
are either officers or directors of the U.S. target company or that are
five-percent target shareholders (as defined in paragraph (c)(5)(iii) of
this section) (i.e., there is no control group). For purposes of this
paragraph (c)(1)(ii), any stock of the transferee foreign corporation
owned by U.S. persons immediately after the transfer will be taken into
account, whether or not it was received in the exchange for stock or
securities of the U.S. target company.
(iii) Either--
(A) The U.S. person is not a five-percent transferee shareholder (as
defined in paragraph (c)(5)(ii) of this section); or
(B) The U.S. person is a five-percent transferee shareholder and
enters into a five-year agreement to recognize gain with respect to the
U.S. target company stock or securities it exchanged in the form
provided in Sec. 1.367(a)-8; and
(iv) The active trade or business test (as defined in paragraph
(c)(3) of this section) is satisfied.
(2) Ownership presumption. For purposes of paragraph (c)(1) of this
section, persons who transfer stock or securities of the U.S. target
company in exchange for stock of the transferee foreign corporation are
presumed to be U.S. persons. This presumption may be rebutted in
accordance with paragraph (c)(7) of this section.
(3) Active trade or business test--(i) In general. The tests of this
paragraph (c)(3), collectively referred to as the active trade or
business test, are satisfied if:
(A) The transferee foreign corporation or any qualified subsidiary
(as defined in paragraph (c)(5)(vii) of this section) or any qualified
partnership (as defined in paragraph (c)(5)(viii) of this section) is
engaged in an active trade or business outside the United States, within
the meaning of Sec. 1.367(a)-2T(b)(2) and (3), for the entire 36-month
period immediately before the transfer;
(B) At the time of the transfer, neither the transferors nor the
transferee foreign corporation (and, if applicable, the qualified
subsidiary or qualified partnership engaged in the active trade or
business) have an intention to substantially dispose of or discontinue
such trade or business; and
(C) The substantiality test (as defined in paragraph (c)(3)(iii) of
this section) is satisfied.
[[Page 280]]
(ii) Special rules. For purposes of paragraphs (c)(3)(i)(A) and (B)
of this section, the following special rules apply:
(A) The transferee foreign corporation, a qualified subsidiary, or a
qualified partnership will be considered to be engaged in an active
trade or business for the entire 36-month period preceding the exchange
if it acquires at the time of, or any time prior to, the exchange a
trade or business that has been active throughout the entire 36-month
period preceding the exchange. This special rule shall not apply,
however, if the acquired active trade or business assets were owned by
the U.S. target company or any affiliate (within the meaning of section
1504(a) but excluding the exceptions contained in section 1504(b) and
substituting ``50 percent'' for ``80 percent'' where it appears therein)
at any time during the 36-month period prior to the acquisition. Nor
will this special rule apply if the principal purpose of such
acquisition is to satisfy the active trade or business test.
(B) An active trade or business does not include the making or
managing of investments for the account of the transferee foreign
corporation or any affiliate (within the meaning of section 1504(a) but
excluding the exceptions contained in section 1504(b) and substituting
``50 percent'' for ``80 percent'' where it appears therein). (This
paragraph (c)(3)(ii)(B) shall not create any inference as to the scope
of Sec. 1.367(a)-2T(b)(2) and (3) for other purposes.)
(iii) Substantiality test--(A) General rule. A transferee foreign
corporation will be deemed to satisfy the substantiality test if, at the
time of the transfer, the fair market value of the transferee foreign
corporation is at least equal to the fair market value of the U.S.
target company.
(B) Special rules. (1) For purposes of paragraph (c)(3)(iii)(A) of
this section, the value of the transferee foreign corporation shall
include assets acquired outside the ordinary course of business by the
transferee foreign corporation within the 36-month period preceding the
exchange only if either--
(i) Both--
(A) At the time of the exchange, such assets or, as applicable, the
proceeds thereof, do not produce, and are not held for the production
of, passive income as defined in section 1297(b); and
(B) Such assets are not acquired for the principal purpose of
satisfying the substantiality test; or
(ii) Such assets consist of the stock of a qualified subsidiary or
an interest in a qualified partnership. See paragraph (c)(3)(iii)(B)(2)
of this section.
(2) For purposes of paragraph (c)(3)(iii)(A) of this section, the
value of the transferee foreign corporation shall not include the value
of the stock of any qualified subsidiary or the value of any interest in
a qualified partnership, held directly or indirectly, to the extent that
such value is attributable to assets acquired by such qualified
subsidiary or partnership outside the ordinary course of business and
within the 36-month period preceding the exchange unless those assets
satisfy the requirements in paragraph (c)(3)(iii)(B)(1) of this section.
(3) For purposes of paragraph (c)(3)(iii)(A) of this section, the
value of the transferee foreign corporation shall not include the value
of assets received within the 36-month period prior to the acquisition,
notwithstanding the special rule in paragraph (c)(3)(iii)(B)(1) of this
section, if such assets were owned by the U.S. target company or an
affiliate (within the meaning of section 1504(a) but without the
exceptions under section 1504(b) and substituting ``50 percent'' for
``80 percent'' where it appears therein) at any time during the 36-month
period prior to the transaction.
(4) Special rules--(i) Treatment of partnerships. For purposes of
this paragraph (c), if a partnership (whether domestic or foreign) owns
stock or securities in the U.S. target company or the transferee foreign
corporation, or transfers stock or securities in an exchange described
in section 367(a), each partner in the partnership, and not the
partnership itself, is treated as owning and as having transferred, or
as owning, a proportionate share of the stock or securities. See Sec.
1.367(a)-1T(c)(3).
(ii) Treatment of options. For purposes of this paragraph (c), one
or more options (or an interest similar to an option) will be treated as
exercised and
[[Page 281]]
thus will be counted as stock for purposes of determining whether the
50-percent threshold is exceeded or whether a control group exists if a
principal purpose of the issuance or the acquisition of the option (or
other interest) was the avoidance of the general rule contained in
section 367(a)(1).
(iii) U.S. target has a vestigial ownership interest in transferee
foreign corporation. In cases where, immediately after the transfer, the
U.S. target company owns, directly or indirectly (applying the
attribution rules of sections 267(c)(1) and (5)), stock of the
transferee foreign corporation, that stock will not in any way be taken
into account (and, thus, will not be treated as outstanding) in
determining whether the 50-percent threshold under paragraph (c)(1)(i)
of this section is exceeded or whether a control group under paragraph
(c)(1)(ii) of this section exists.
(iv) Attribution rule. Except as otherwise provided in this section,
the rules of section 318, as modified by the rules of section 958(b)
shall apply for purposes of determining the ownership or receipt of
stock, securities or other property under this paragraph (c).
(5) Definitions--(i) Ownership statement. An ownership statement is
a statement, signed under penalties of perjury, stating--
(A) The identity and taxpayer identification number, if any, of the
person making the statement;
(B) That the person making the statement is not a U.S. person (as
defined in paragraph (c)(5)(iv) of this section);
(C) That the person making the statement either--
(1) Owns less than 1 percent of the total voting power and total
value of a U.S. target company the stock of which is described in Rule
13d-1(d) of Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or
regulation to generally the same effect) promulgated by the Securities
and Exchange Commission under the Securities and Exchange Act of 1934
(15 USC 78m), and such person did not acquire the stock with a principal
purpose to enable the U.S. transferors to satisfy the requirement
contained in paragraph (c)(1)(i) of this section; or
(2) Is not related to any U.S. person to whom the stock or
securities owned by the person making the statement are attributable
under the rules of section 958(b), and did not acquire the stock with a
principal purpose to enable the U.S. transferors to satisfy the
requirement contained in paragraph (c)(1)(i) of this section;
(D) The citizenship, permanent residence, home address, and U.S.
address, if any, of the person making the statement; and
(E) The ownership such person has (by voting power and by value) in
the U.S. target company prior to the exchange and the amount of stock of
the transferee foreign corporation (by voting power and value) received
by such person in the exchange.
(ii) Five-percent transferee shareholder. A five-percent transferee
shareholder is a person that owns at least five percent of either the
total voting power or the total value of the stock of the transferee
foreign corporation immediately after the transfer described in section
367(a)(1). For special rules involving cases in which stock is held by a
partnership, see paragraph (c)(4)(i) of this section.
(iii) Five-percent target shareholder and certain other 5-percent
shareholders. A five-percent target shareholder is a person that owns at
least five percent of either the total voting power or the total value
of the stock of the U.S. target company immediately prior to the
transfer described in section 367(a)(1). If the stock of the U.S. target
company (or any company through which stock of the U.S. target company
is owned indirectly or constructively) is described in Rule 13d-1(d) of
Regulation 13D (17 CFR 240.13d-1(d)) (or any rule or regulation to
generally the same effect), promulgated by the Securities and Exchange
Commission under the Securities Exchange Act of 1934 (15 USC 78m), then,
in the absence of actual knowledge to the contrary, the existence or
absence of filings of Schedule 13-D or 13-G (or any similar schedules)
may be relied upon for purposes of identifying five-percent target
shareholders (or a five-percent shareholder of a corporation which
itself is a five-percent shareholder of the U.S. target company). For
special rules involving cases
[[Page 282]]
in which U.S. target company stock is held by a partnership, see
paragraph (c)(4)(i) of this section.
(iv) U.S. Person. For purposes of this section, a U.S. person is
defined by reference to Sec. 1.367(a)-1T(d)(1). For application of the
rules of this section to stock or securities owned or transferred by a
partnership that is a U.S. person, however, see paragraph (c)(4)(i) of
this section.
(v) U.S. Transferor. A U.S. transferor is a U.S. person (as defined
in paragraph (c)(5)(iv) of this section) that transfers stock or
securities of one or more U.S. target companies in exchange for stock of
the transferee foreign corporation in an exchange described in section
367.
(vi) Transferee foreign corporation. Except as provided in paragraph
(d)(2)(i)(B) of this section, a transferee foreign corporation is the
foreign corporation whose stock is received in the exchange by U.S.
persons.
(vii) Qualified Subsidiary. A qualified subsidiary is a foreign
corporation whose stock is at least 80-percent owned (by total voting
power and total value), directly or indirectly, by the transferee
foreign corporation. However, a corporation will not be treated as a
qualified subsidiary if it was affiliated with the U.S. target company
(within the meaning of section 1504(a) but without the exceptions under
section 1504(b) and substituting ``50 percent'' for ``80 percent'' where
it appears therein) at any time during the 36-month period prior to the
transfer. Nor will a corporation be treated as a qualified subsidiary if
it was acquired by the transferee foreign corporation at any time during
the 36-month period prior to the transfer for the principal purpose of
satisfying the active trade or business test, including the
substantiality test.
(viii) Qualified partnership. (A) Except as provided in paragraph
(c)(5)(viii)(B) or (C) of this section, a qualified partnership is a
partnership in which the transferee foreign corporation--
(1) Has active and substantial management functions as a partner
with regard to the partnership business; or -
(2) Has an interest representing a 25 percent or greater interest in
the partnership's capital and profits.
(B) A partnership is not a qualified partnership if the U.S. target
company or any affiliate of the U.S. target company (within the meaning
of section 1504(a) but without the exceptions under section 1504(b) and
substituting ``50 percent'' for ``80 percent'' where it appears therein)
held a 5 percent or greater interest in the partnership's capital and
profits at any time during the 36-month period prior to the transfer.
(C) A partnership is not a qualified partnership if the transferee
foreign corporation's interest was acquired by that corporation at any
time during the 36-month period prior to the transfer for the principal
purpose of satisfying the active trade or business test, including the
substantiality test.
(6) Reporting requirements of U.S. target company. (i) In order for
a U.S. person that transfers stock or securities of a domestic
corporation to qualify for the exception provided by this paragraph (c)
to the general rule under section 367(a)(1), in cases where 10 percent
or more of the total voting power or the total value of the stock of the
U.S. target company is transferred by U.S. persons in the transaction,
the U.S. target company must comply with the reporting requirements
contained in this paragraph (c)(6). The U.S. target company must attach
to its timely filed U.S. income tax return for the taxable year in which
the transfer occurs a statement titled ``Section 367(a)--Reporting of
Cross-Border Transfer Under Reg. Sec. 1.367(a)-3(c)(6),'' signed under
penalties of perjury by an officer of the corporation to the best of the
officer's knowledge and belief, disclosing the following information--
(A) A description of the transaction in which a U.S. person or
persons transferred stock or securities in the U.S. target company to
the transferee foreign corporation in a transfer otherwise subject to
section 367(a)(1);
(B) The amount (specified as to the percentage of the total voting
power and the total value) of stock of the transferee foreign
corporation received in the transaction, in the aggregate, by persons
who transferred stock or securities of the U.S. target company. For
[[Page 283]]
additional information that may be required to rebut the ownership
presumption of paragraph (c)(2) of this section in cases where more than
50 percent of either the total voting power or the total value of the
stock of the transferee foreign corporation is received in the
transaction, in the aggregate, by persons who transferred stock or
securities of the U.S. target company, see paragraph (c)(7) of this
section;
(C) The amount (if any) of transferee foreign corporation stock
owned directly or indirectly (applying the attribution rules of sections
267(c)(1) and (5)) immediately after the exchange by the U.S. target
company;
(D) A statement that there is no control group within the meaning of
paragraph (c)(1)(ii) of this section;
(E) A list of U.S. persons who are officers, directors or five-
percent target shareholders and the percentage of the total voting power
and the total value of the stock of the transferee foreign corporation
owned by such persons both immediately before and immediately after the
transaction; and
(F) A statement that includes the following--
(1) A statement that the active trade or business test described in
paragraph (c)(3) of this section is satisfied by the transferee foreign
corporation and a description of such business;
(2) A statement that on the day of the transaction, there was no
intent on the part of the transferee foreign corporation (or its
qualified subsidiary, if relevant) or the transferors of the transferee
foreign corporation (or qualified subsidiary, if relevant) to
substantially discontinue its active trade or business; and
(3) A statement that the substantiality test described in paragraph
(c)(3)(iii) of this section is satisfied, and documentation that such
test is satisfied, including the value of the transferee foreign
corporation and the value of the U.S. target company on the day of the
transfer, and either one of the following--
(i) A statement demonstrating that the value of the transferee
foreign corporation 36 months prior to the acquisition, plus the value
of any assets described in paragraph (c)(3)(iii)(B) of this section
(including stock) acquired by the transferee foreign corporation within
the 36-month period, less the amount of any liabilities acquired during
that period, exceeds the value of the U.S. target company on the
acquisition date; or
(ii) A statement demonstrating that the value of the transferee
foreign corporation on the date of the acquisition, reduced by the value
of any assets not described in paragraph (c)(3)(iii)(B) of this section
(including stock) acquired by the transferee foreign corporation within
the 36-month period, exceeds the value of the U.S. target company on the
date of the acquisition.
(ii) For purposes of this paragraph (c)(6), an income tax return
will be considered timely filed if such return is filed, together with
the statement required by this paragraph (c)(6), on or before the last
date for filing a Federal income tax return (taking into account any
extensions of time therefor) for the taxable year in which the transfer
occurs. If a return is not timely filed within the meaning of this
paragraph (c)(6), the District Director may make a determination, based
on all facts and circumstances, that the taxpayer had reasonable cause
for its failure to file a timely filed return and, if such a
determination is made, the requirement contained in this paragraph
(c)(6) shall be waived.
(7) Ownership statements. To rebut the ownership presumption of
paragraph (c)(2) of this section, the U.S. target company must obtain
ownership statements (described in paragraph (c)(5)(i) of this section)
from a sufficient number of persons that transfer U.S. target company
stock or securities in the transaction that are not U.S. persons to
demonstrate that the 50-percent threshold of paragraph (c)(1)(i) of this
section is not exceeded. In addition, the U.S. target company must
attach to its timely filed U.S. income tax return (as described in
paragraph (c)(6)(ii) of this section) for the taxable year in which the
transfer occurs a statement, titled ``Section 367(a)--Compilation of
Ownership Statements Under Reg. Sec. 1.367(a)-3(c),'' signed under
penalties of perjury by an officer of the corporation, disclosing the
following information:
[[Page 284]]
(i) The amount (specified as to the percentage of the total voting
power and the total value) of stock of the transferee foreign
corporation received, in the aggregate, by U.S. transferors;
(ii) The amount (specified as to the percentage of total voting
power and total value) of stock of the transferee foreign corporation
received, in the aggregate, by foreign persons that filed ownership
statements;
(iii) A summary of the information tabulated from the ownership
statements, including--
(A) The names of the persons that filed ownership statements stating
that they are not U.S. persons;
(B) The countries of residence and citizenship of such persons; and
(C) Each of such person's ownership (by voting power and by value)
in the U.S. target company prior to the exchange and the amount of stock
of the transferee foreign corporation (by voting power and value)
received by such persons in the exchange.
(8) Certain transfers in connection with performance of services.
Section 367(a)(1) shall not apply to a domestic corporation's transfer
of its own stock or securities in connection with the performance of
services, if the transfer is considered to be to a foreign corporation
solely by reason of Sec. 1.83-6(d)(1). The transfer may still, however,
be reportable under section 6038B. See Sec. 1.6038B-1(b)(2)(i)(A)(4)
and (b)(2)(i)(B)(4).
(9) Private letter ruling option. The Internal Revenue Service may,
in limited circumstances, issue a private letter ruling to permit the
taxpayer to qualify for an exception to the general rule under section
367(a)(1) if--
(i) A taxpayer is unable to satisfy all of the requirements of
paragraph (c)(3) of this section relating to the active trade or
business test of paragraph (c)(1)(iv) of this section, but such taxpayer
meets all of the other requirements contained in paragraphs (c)(1)(i)
through (c)(1)(iii) of this section, and such taxpayer is substantially
in compliance with the rules set forth in paragraph (c)(3) of this
section; or
(ii) A taxpayer is unable to satisfy any requirement of paragraph
(c)(1) of this section due to the application of paragraph (c)(4)(iv) of
this section. Notwithstanding the preceding sentence, in no event will
the Internal Revenue Service rule on the issue of whether the principal
purpose of an acquisition was to satisfy the active trade or business
test, including the substantiality test.
(10) Examples. This paragraph (c) may be illustrated by the
following examples:
Example 1. Ownership presumption. (i) FC, a foreign corporation,
issues 51 percent of its stock to the shareholders of S, a domestic
corporation, in exchange for their S stock, in a transaction described
in section 367(a)(1).
(ii) Under paragraph (c)(2) of this section, all shareholders of S
who receive stock of FC in the exchange are presumed to be U.S. persons.
Unless this ownership presumption is rebutted, the condition set forth
in paragraph (c)(1)(i) of this section will not be satisfied, and the
exception in paragraph (c)(1) of this section will not be available. As
a result, all U.S. persons that transferred S stock will recognize gain
on the exchange. To rebut the ownership presumption, S must comply with
the reporting requirements contained in paragraph (c)(6) of this
section, obtaining ownership statements (described in paragraph
(c)(5)(i) of this section) from a sufficient number of non-U.S. persons
who received FC stock in the exchange to demonstrate that the amount of
FC stock received by U.S. persons in the exchange does not exceed 50
percent.
Example 2. Filing of Gain Recognition Agreement. (i) The facts are
the same as in Example 1, except that FC issues only 40 percent of its
stock to the shareholders of S in the exchange. FC satisfies the active
trade or business test of paragraph (c)(1)(iv) of this section. A, a
U.S. person, owns 10 percent of S's stock immediately before the
transfer. All other shareholders of S own less than five percent of its
stock. None of S's officers or directors owns any stock in FC
immediately after the transfer. A will own 15 percent of the stock of FC
immediately after the transfer, 4 percent received in the exchange, and
the balance being stock in FC that A owned prior to and independent of
the transaction. No S shareholder besides A owns five percent or more of
FC immediately after the transfer. The reporting requirements under
paragraph (c)(6) of this section are satisfied.
(ii) The condition set forth in paragraph (c)(1)(i) of this section
is satisfied because, even after application of the presumption in
paragraph (c)(2) of this section, U.S. transferors could not receive
more than 50 percent of FC's stock in the transaction. There is no
control group because five-percent target shareholders and officers and
directors of S do not, in the aggregate, own more than 50 percent of the
stock of FC immediately after
[[Page 285]]
the transfer (A, the sole five-percent target shareholder, owns 15
percent of the stock of FC immediately after the transfer, and no
officers or directors of S own any stock of FC immediately after the
transfer). Therefore, the condition set forth in paragraph (c)(1)(ii) of
this section is satisfied. The facts assume that the condition set forth
in paragraph (c)(1)(iv) of this section is satisfied. Thus, U.S. persons
that are not five-percent transferee shareholders will not recognize
gain on the exchange of S shares for FC shares. A, a five-percent
transferee shareholder, will not be required to include in income any
gain realized on the exchange in the year of the transfer if he files a
5-year gain recognition agreement (GRA) and complies with section 6038B.
Example 3. Control Group. (i) The facts are the same as in Example
2, except that B, another U.S. person, is a 5-percent target
shareholder, owning 25 percent of S's stock immediately before the
transfer. B owns 40 percent of the stock of FC immediately after the
transfer, 10 percent received in the exchange, and the balance being
stock in FC that B owned prior to and independent of the transaction.
(ii) A control group exists because A and B, each a five-percent
target shareholder within the meaning of paragraph (c)(5)(iii) of this
section, together own more than 50 percent of FC immediately after the
transfer (counting both stock received in the exchange and stock owned
prior to and independent of the exchange). As a result, the condition
set forth in paragraph (c)(1)(ii) of this section is not satisfied, and
all U.S. persons (not merely A and B) who transferred S stock will
recognize gain on the exchange.
Example 4. Partnerships. (i) The facts are the same as in Example 3,
except that B is a partnership (domestic or foreign) that has five equal
partners, only two of whom, X and Y, are U.S. persons. Under paragraph
(c)(4)(i) of this section, X and Y are treated as the owners and
transferors of 5 percent each of the S stock owned and transferred by B
and as owners of 8 percent each of the FC stock owned by B immediately
after the transfer. U.S. persons that are five-percent target
shareholders thus own a total of 31 percent of the stock of FC
immediately after the transfer (A's 15 percent, plus X's 8 percent, plus
Y's 8 percent).
(ii) Because no control group exists, the condition in paragraph
(c)(1)(ii) of this section is satisfied. The conditions in paragraphs
(c)(1)(i) and (iv) of this section also are satisfied. Thus, U.S.
persons that are not five-percent transferee shareholders will not
recognize gain on the exchange of S shares for FC shares. A, X, and Y,
each a five-percent transferee shareholder, will not be required to
include in income in the year of the transfer any gain realized on the
exchange if they file 5-year GRAs and comply with section 6038B.
(11) Effective date. This paragraph (c) applies to transfers
occurring after January 29, 1997. However, taxpayers may elect to apply
this section in its entirety to all transfers occurring after April 17,
1994, provided that the statute of limitations of the affected tax year
or years is open.
(d) Indirect stock transfers in certain nonrecognition transfers--
(1) In general. For purposes of this section, a U.S. person who
exchanges, under section 354 (or section 356) stock or securities in a
domestic or foreign corporation for stock or securities in a foreign
corporation (or in a domestic corporation in control of a foreign
acquiring corporation in a triangular section 368(a)(1)(B)
reorganization) in connection with a transaction described in paragraphs
(d)(1)(i) through (v) of this section (or who is deemed to make such an
exchange under paragraph (d)(1)(vi) of this section) shall, except as
provided in paragraph (d)(2)(vii) of this section, be treated as having
made an indirect transfer of such stock or securities to a foreign
corporation that is subject to the rules of this section, including, for
example, the requirement, where applicable, that the U.S. transferor
enter into a gain recognition agreement to preserve nonrecognition
treatment under section 367(a). If the U.S. person exchanges stock or
securities of a foreign corporation, see also section 367(b) and the
regulations thereunder. For examples of the concurrent application of
the indirect stock transfer rules under section 367(a) and the rules of
section 367(b), see paragraph (d)(3) Examples 14 and 15 of this section.
For purposes of this paragraph (d), if a corporation acquiring assets in
an asset reorganization transfers all or a portion of such assets to a
corporation controlled (within the meaning of section 368(c)) by the
acquiring corporation as part of the same transaction, the subsequent
transfer of assets to the controlled corporation will be referred to as
a controlled asset transfer. See section 368(a)(2)(C).
(i) Mergers described in sections 368(a)(1)(A) and (a)(2)(D) and
reorganizations described in sections 368(a)(1)(G) and (a)(2)(D). A U.S.
person exchanges
[[Page 286]]
stock or securities of a corporation (the acquired corporation) for
stock or securities of a foreign corporation that controls the acquiring
corporation in a reorganization described in either sections
368(a)(1)(A) and (a)(2)(D), or in sections 368(a)(1)(G) and (a)(2)(D).
See paragraph (d)(3) Example 1 of this section for an example of a
reorganization described in sections 368(a)(1)(A) and (a)(2)(D)
involving domestic acquired and acquiring corporations, and see
paragraph (d)(3) Example 10 of this section for an example involving a
domestic acquired corporation and a foreign acquiring corporation.
(ii) Mergers described in sections 368(a)(1)(A) and (a)(2)(E). A
U.S. person exchanges stock or securities of a corporation (the
acquiring corporation) for stock or securities in a foreign corporation
that controls the acquired corporation in a reorganization described in
sections 368(a)(1)(A) and (a)(2)(E). See paragraph (d)(3) Example 2 of
this section for an example of a reorganization described in sections
368(a)(1)(A) and (a)(2)(E) involving domestic acquired and acquiring
corporations, and see paragraph (d)(3) Example 11 of this section for an
example involving a domestic acquired corporation and a foreign
acquiring corporation.
(iii) Triangular reorganizations described in section 368(a)(1)(B)--
(A) A U.S. person exchanges stock or securities of the acquired
corporation for voting stock or securities of a foreign corporation that
is in control (as defined in section 368(c)) of the acquiring
corporation in a reorganization described in section 368(a)(1)(B). See
paragraph (d)(3) Example 5 of this section.
(B) A U.S. person exchanges stock or securities of the acquired
corporation for voting stock or securities of a domestic corporation
that is in control (as defined in section 368(c)) of a foreign acquiring
corporation in a reorganization described in section 368(a)(1)(B). See
paragraph (d)(3) Example 5A of this section.
(iv) Triangular reorganizations described in section 368(a)(1)(C). A
U.S. person exchanges stock or securities of a corporation (the acquired
corporation) for voting stock or securities of a foreign corporation
that controls the acquiring corporation in a reorganization described in
section 368(a)(1)(C). See, e.g., paragraph (d)(3) Example 6 of this
section (for an example of a triangular section 368(a)(1)(C)
reorganization involving domestic acquired and acquiring corporations),
and paragraph (d)(3) Example 8 of this section (for an example involving
a domestic acquired corporation and a foreign acquiring corporation). If
the acquired corporation is a foreign corporation, see paragraph (d)(3)
Example 14 of this section, and section 367(b) and the regulations
thereunder.
(v) Transfers of assets to subsidiaries in certain section 368(a)(1)
reorganizations. A U.S. person exchanges stock or securities of a
corporation (the acquired corporation) for stock or securities of a
foreign acquiring corporation in an asset reorganization (other than a
triangular section 368(a)(1)(C) reorganization described in paragraph
(d)(1)(iv) of this section, a reorganization described in sections
368(a)(1)(A) and (a)(2)(D) or sections 368(a)(1)(G) and (a)(2)(D)
described in paragraph (d)(1)(i) of this section, a reorganization
described in sections 368(a)(1)(A) and (a)(2)(E) described in paragraph
(d)(1)(ii) of this section, or a same-country section 368(a)(1)(F)
reorganization) that is followed by a controlled asset transfer. For
purposes of this section, a same-country section 368(a)(1)(F)
reorganization is a reorganization described in section 368(a)(1)(F) in
which both the acquired corporation and the acquiring corporation are
foreign corporations and are created or organized under the laws of the
same foreign country. In the case of a transaction described in this
paragraph (d)(1)(v) in which some but not all of the assets of the
acquired corporation are transferred in a controlled asset transfer, the
transaction shall be considered to be an indirect transfer of stock or
securities subject to this paragraph (d) only to the extent of the
assets so transferred. The remaining assets shall be treated as having
been transferred by the acquired corporation in an asset transfer rather
than an indirect stock transfer, and, if the acquired corporation is a
domestic corporation, such asset transfer shall be subject to the other
provisions of section 367, including sections 367(a)(1),
[[Page 287]]
(3), and (5), and (d). See paragraph (d)(3) Examples 6A and 6B of this
section.
(vi) Successive transfers of property to which section 351 applies.
A U.S. person transfers property (other than stock or securities) to a
foreign corporation in an exchange described in section 351, and all or
a portion of such assets transferred to the foreign corporation by such
person are, in connection with the same transaction, transferred to a
second corporation that is controlled by the foreign corporation in one
or more exchanges described in section 351. For purposes of this
paragraph (d)(1) and Sec. 1.367(a)-8, the initial transfer by the U.S.
person shall be deemed to be a transfer of stock described in section
354. (Any assets transferred to the foreign corporation that are not
transferred by the foreign corporation to a second corporation shall be
treated as a transfer of assets subject to the general rules of section
367, including sections 367(a)(1), (3), (5) and (d), and not as an
indirect stock transfer under the rules of this paragraph (d).) See,
e.g., paragraph (d)(3) Example 13 and Example 13A of this section.
(2) Special rules for indirect transfers. If a U.S. person is
considered to make an indirect transfer of stock or securities described
in paragraph (d)(1) of this section, the rules of this section and Sec.
1.367(a)-8 shall apply to the transfer. For purposes of applying the
rules of this section and Sec. 1.367(a)-8:
(i) Transferee foreign corporation--(A) General rule. Except as
provided in paragraph (d)(2)(i)(B) of this section, the transferee
foreign corporation shall be the foreign corporation that issues stock
or securities to the U.S. person in the exchange.
(B) Special rule for triangular reorganizations described in
paragraph (d)(1)(iii)(B) of this section. In the case of a triangular
reorganization described in paragraph (d)(1)(iii)(B) of this section,
the transferee foreign corporation shall be the foreign acquiring
corporation. See paragraph (d)(3) Example 5A of this section.
(ii) Transferred corporation. The transferred corporation shall be
the acquiring corporation, except as provided in this paragraph
(d)(2)(ii). In the case of a triangular section 368(a)(1)(B)
reorganization described in paragraph (d)(1)(iii) of this section, the
transferred corporation shall be the acquired corporation. In the case
of an indirect stock transfer described in paragraph (d)(1)(i), (ii), or
(iv) of this section followed by a controlled asset transfer, or an
indirect stock transfer described in paragraph (d)(1)(v) of this
section, the transferred corporation shall be the controlled corporation
to which the assets are transferred. In the case of successive section
351 transfers described in paragraph (d)(1)(vi) of this section, the
transferred corporation shall be the corporation to which the assets are
transferred in the final section 351 transfer. The transferred property
shall be the stock or securities of the transferred corporation, as
appropriate under the circumstances.
(iii) Amount of gain. For purposes of determining the amount of gain
that a U.S. person is required to include in income as a result of a
triggering event, see Sec. 1.367(a)-8(c)(1)(i).
(iv) Gain recognition agreements involving multiple parties. The
U.S. person's agreement to recognize gain, as provided in Sec.
1.367(a)-8, shall include appropriate provisions consistent with the
principles of Sec. 1.367(a)-8. See Examples 5 and 5A of this section
and Sec. 1.367(a)-8(j)(9).
(v) Determination of whether substantially all of the transferred
corporation's assets are disposed of. For purposes of applying Sec.
1.367(a)-8(j)(2)(i) to determine whether substantially all of the assets
of the transferred corporation have been disposed of, the following
assets shall be taken into account (but only if such assets are not
fully taxable under section 367 in the taxable year that includes the
indirect transfer)--
(A) In the case of a reorganization described in paragraph (d)(1)(i)
of this section (a reorganization described in sections 368(a)(1)(A) and
(a)(2)(D) or sections 368(a)(1)(G) and (a)(2)(D)) or a reorganization
described in section (d)(1)(iv) of this section (a triangular section
368(a)(1)(C) reorganization), the assets of the acquired corporation;
(B) In the case of a sections 368(a)(1)(A) and (a)(2)(E)
reorganization described in paragraph (d)(1)(ii) of this section, the
assets of the acquiring corporation immediately prior to the
transaction;
[[Page 288]]
(C) In the case of an asset reorganization followed by a controlled
asset transfer, as described in paragraph (d)(1)(v) of this section, the
assets of the acquired corporation that are transferred to the
corporation controlled by the acquiring corporation;
(D) In the case of a triangular reorganization described in section
368(a)(1)(C) followed by a controlled asset transfer, a reorganization
described in sections 368(a)(1)(A) and (a)(2)(D) followed by a
controlled asset transfer, or a reorganization described in sections
368(a)(1)(G) and (a)(2)(D) followed by a controlled asset transfer, the
assets of the acquired corporation including those transferred to the
corporation controlled by the acquiring corporation;
(E) In the case of a reorganization described in sections
368(a)(1)(A) and (a)(2)(E) followed by a controlled asset transfer, the
assets of the acquiring corporation including those transferred to the
corporation controlled by the acquiring corporation; and
(F) In the case of successive section 351 exchanges described in
paragraph (d)(1)(vi) of this section, the assets that are both
transferred initially to the foreign corporation, and transferred by the
foreign corporation to a second corporation.
(vi) Coordination between asset transfer rules and indirect stock
transfer rules--(A) General rule. Except as otherwise provided in this
paragraph (d)(2)(vi), if, pursuant to any of the transactions described
in paragraph (d)(1) of this section, a U.S. person transfers (or is
deemed to transfer) assets to a foreign corporation in an exchange
described in section 351 or section 361, the rules of section 367,
including sections 367(a)(1), (a)(3), and (a)(5), as well as section
367(d), and the regulations thereunder shall apply prior to the
application of the rules of this section.
(B) Exceptions. (1) If a transaction is described in paragraph
(d)(2)(vi)(A) of this section, sections 367(a) and (d) shall not apply
to the extent a domestic corporation (domestic acquired corporation)
transfers its assets to a foreign corporation (foreign acquiring
corporation) in an asset reorganization, and such assets (re-transferred
assets) are transferred to a domestic corporation (domestic controlled
corporation) in a controlled asset transfer, provided that the domestic
controlled corporation's basis in such assets is no greater than the
basis that the domestic acquired corporation had in such assets and the
conditions contained in either of the following paragraphs are
satisfied:
(i) The domestic acquired corporation is controlled (within the
meaning of section 368(c)) by 5 or fewer domestic corporations,
appropriate basis adjustments as provided in section 367(a)(5) are made
to the stock of the foreign acquiring corporation, and any other
conditions as provided in regulations under section 367(a)(5) are
satisfied. For purposes of determining whether the domestic acquired
corporation is controlled by 5 or fewer domestic corporations, all
members of the same affiliated group within the meaning of section 1504
shall be treated as 1 corporation.
(ii) The requirements of paragraphs (c)(1)(i), (ii), and (iv), and
(c)(6) of this section are satisfied with respect to the indirect
transfer of stock in the domestic acquired corporation, and the domestic
acquired corporation attaches a statement described in paragraph
(d)(2)(vi)(C) of this section to its U.S. income tax return for the
taxable year of the transfer.
(2) Sections 367(a) and (d) shall not apply to transfers described
in paragraph (d)(1)(vi) of this section where a U.S. person transfers
assets to a foreign corporation in a section 351 exchange, to the extent
that such assets are transferred by such foreign corporation to a
domestic corporation in another section 351 exchange, but only if the
domestic transferee's basis in the assets is no greater than the basis
that the U.S. transferor had in such assets.
(C) Required statement. The statement required by paragraph
(d)(2)(vi)(B)(1)(ii) of this section shall be entitled ``Required
Statement under Sec. 1.367(a)-3(d) for Assets Transferred to a Domestic
Corporation'' and shall be signed under penalties of perjury by an
authorized officer of the domestic acquired corporation and by an
authorized officer of the foreign acquiring corporation. The required
statement shall contain a
[[Page 289]]
certification that, if the foreign acquiring corporation disposes of any
stock of the domestic controlled corporation in a transaction described
in paragraph (d)(2)(vi)(D) of this section, the domestic acquired
corporation shall recognize gain as described in paragraph (d)(2)(vi)(E)
of this section. The domestic acquired corporation (or the foreign
acquiring corporation on behalf of the domestic acquired corporation)
shall file a U.S. income tax return (or an amended U.S. tax return, as
the case may be) for the year of the transfer reporting such gain.
(D) Gain recognition transaction. (1) A transaction described in
this paragraph (d)(2)(vi)(D) is one where a principal purpose of the
transfer by the domestic acquired corporation is the avoidance of U.S.
tax that would have been imposed on the domestic acquired corporation on
the disposition of the re-transferred assets. A transfer may have a
principal purpose of tax avoidance even though the tax avoidance purpose
is outweighed by other purposes when taken together.
(2) For purposes of paragraph (d)(2)(vi)(D)(1) of this section, a
transaction is deemed to have a principal purpose of tax avoidance if
the foreign acquiring corporation disposes of any stock of the domestic
controlled corporation (whether in a recognition or non-recognition
transaction) within 2 years of the transfer described in paragraph
(d)(2)(vi)(A) of this section. The rule in this paragraph
(d)(2)(vi)(D)(2) shall not apply if the domestic acquired corporation
(or the foreign acquiring corporation on behalf of the domestic acquired
corporation) demonstrates to the satisfaction of the Commissioner that
the avoidance of U.S. tax was not a principal purpose of the
transaction.
(E) Amount of gain recognized and other matters. (1) In the case of
a transaction described in paragraph (d)(2)(vi)(D) of this section,
solely for purposes of this paragraph (d)(2)(vi)(E), the domestic
acquired corporation shall be treated as if, immediately prior to the
transfer described in paragraph (d)(2)(vi)(A) of this section, it
transferred the re-transferred assets, including any intangible assets,
directly to a domestic corporation in exchange for stock of such
domestic corporation in a transaction that is treated as a section 351
exchange, and immediately sold such stock to an unrelated party for its
fair market value in a sale in which it shall recognize gain, if any
(but not loss). Any gain recognized by the domestic acquired corporation
pursuant to this paragraph (d)(2)(vi)(E) will increase the basis that
the foreign acquiring corporation has in the stock of the domestic
controlled corporation immediately before the transaction described in
paragraph (d)(2)(vi)(D) of this section, but will not increase the basis
of the re-transferred assets held by the domestic controlled
corporation. Section 1.367(d)-1T(g)(6) shall not apply with respect to
any intangible property included in the re-transferred assets described
in this paragraph.
(2) If additional tax is required to be paid as a result of a
transaction described in paragraph (d)(2)(vi)(D) of this section, then
interest must be paid on that amount at rates determined under section
6621 with respect to the period between the date prescribed for filing
the domestic acquired corporation's income tax return for the year of
the transfer and the date on which the additional tax for that year is
paid.
(F) Examples. For illustrations of the rules in paragraph (d)(2)(vi)
of this section, see paragraph (d)(3) Examples 6B, 6C, 9, and 13A of
this section.
(vii) Change in status of a domestic acquired corporation to a
foreign corporation. (A) A U.S. person that exchanges stock or
securities of a domestic corporation for stock or securities of a
foreign corporation under section 354 (or section 356) will be treated
for purposes of this section as having made an indirect stock transfer
of the stock or securities of a foreign corporation (and not of a
domestic corporation) to a foreign corporation under paragraph (b) of
this section (but not paragraph (c) of this section), if the acquired
domestic corporation is a subsidiary member (within the meaning of Sec.
1.1502-1(c)) of a consolidated group (within the meaning of Sec.
1.1502-1(h)) immediately before the transaction, and if the transaction
is either of the following:
(1) Described in paragraph (d)(1)(i) or (iv) of this section, but
only if the acquiring corporation is foreign. See
[[Page 290]]
paragraph (d)(3) Examples 8, 9, 10 and 12 of this section.
(2) Described in paragraph (d)(1)(v) of this section, but only to
the extent the controlled asset transfer is to a foreign corporation.
See paragraph (d)(3) Example 6A of this section.
(B) The rules of paragraph (d)(2)(vii)(A) of this section will not
apply to the extent assets transferred to the foreign acquiring
corporation in a transaction described in paragraph (d)(2)(vii)(A)(1) of
this section, or assets transferred to a foreign corporation in a
controlled asset transfer in a transaction described in paragraph
(d)(2)(vii)(A)(2) of this section, are retransferred to a domestic
controlled corporation in one or more successive transfers as part of
the same transaction. See paragraph (d)(3) Example 9 of this section.
(3) Examples. The rules of this paragraph (d) and Sec. 1.367(a)-8
are illustrated by the following examples. For purposes of these
examples, assume section 7874 does not apply.
Example 1. Section 368(a)(1)(A)/(a)(2)(D) reorganization--(i) Facts.
F, a foreign corporation, owns all the stock of Newco, a domestic
corporation. A, a domestic corporation, owns all of the stock of W, also
a domestic corporation. A and W file a consolidated Federal income tax
return. A does not own any stock in F (applying the attribution rules of
section 318, as modified by section 958(b)). In a reorganization
described in sections 368(a)(1)(A) and (a)(2)(D), Newco acquires all of
the assets of W, and A receives 40% of the stock of F in an exchange
described in section 354.
(ii) Result. Pursuant to paragraph (d)(1)(i) of this section, the
reorganization is subject to the indirect stock transfer rules. F is
treated as the transferee foreign corporation, and Newco is treated as
the transferred corporation. Provided that the requirements of paragraph
(c)(1) of this section are satisfied, including the requirement that A
enter into a five-year gain recognition agreement as described in Sec.
1.367(a)-8, A's exchange of W stock for F stock under section 354 will
not be subject to section 367(a)(1). If F disposes (within the meaning
of Sec. 1.367(a)-8(j)(1)) of all (or a portion) of Newco's stock within
the five-year term of the agreement (and A has not made a valid election
under Sec. 1.367(a)-8(c)(2)(vi)), A is required to file an amended
return for the year of the transfer and include in income, with
interest, the gain realized but not recognized on the initial section
354 exchange. If A has made a valid election under Sec. 1.367(a)-
8(c)(2)(vi) to include the amount subject to the gain recognition
agreement in the year of the triggering event, A would instead include
the gain on its tax return for the taxable year that includes the
triggering event, together with interest.
Example 1A. Transferor is a subsidiary in consolidated group--(i)
Facts. The facts are the same as in Example 1, except that A is owned by
P, a domestic corporation, and for the taxable year in which the
transaction occurred, P, A and W filed a consolidated Federal income tax
return.
(ii) Result. Even though A is the U.S. transferor, P is required
under Sec. 1.367(a)-8(d)(3) and (e)(1)(i) to enter into the gain
recognition agreement and comply with the requirements under Sec.
1.367(a)-8. If A leaves the P group, the gain recognition agreement
would be triggered pursuant to Sec. 1.367(a)-8(j)(5), unless the
exception provided under Sec. 1.367(a)-8(k)(10) applies.
Example 2. Section 368(a)(1)(A)/(a)(2)(E) reorganization--(i) Facts.
The facts are the same as in Example 1, except that Newco merges into W
and Newco receives stock of W which it distributes to F in a
reorganization described in sections 368(a)(1)(A) and (a)(2)(E).
Pursuant to the reorganization, A receives 40 percent of the stock of F
in an exchange described in section 354.
(ii) Result. The consequences of the transfer are similar to those
described in Example 1. Pursuant to paragraph (d)(1)(ii) of this
section, A is considered to have transferred its W stock to F pursuant
to the indirect stock transfer rules. F is treated as the transferee
foreign corporation, and W is treated as the transferred corporation.
Provided that the requirements of paragraph (c)(1) of this section are
satisfied, including the requirement that A enter into a five-year gain
recognition agreement as described in Sec. 1.367(a)-8, A's exchange of
W stock for F stock under section 354 will not be subject to section
367(a)(1).
Example 3. Taxable transaction pursuant to indirect stock transfer
rules--(i) Facts. The facts are the same as in Example 1, except that A
receives 55 percent of either the total voting power or the total value
of the stock of F in the transaction.
(ii) Result. A is required to include in income in the year of the
exchange the amount of gain realized on such exchange. See paragraph
(c)(1)(i) of this section. If A fails to include the income on its
timely-filed return, A will also be liable for the penalty under section
6038B (together with interest and other applicable penalties) unless A's
failure to include the income is due to reasonable cause and not willful
neglect. See Sec. 1.6038B-1(f).
Example 4. Disposition by U.S. transferred corporation of
substantially all of its assets--(i) Facts. The facts are the same as in
Example 1, except that, during the third year
[[Page 291]]
of the gain recognition agreement, Newco disposes of substantially all
(as described in Sec. 1.367(a)-8(j)(2)(i)) of the assets described in
paragraph (d)(2)(v)(A) of this section for cash and recognizes currently
all of the gain realized on the disposition.
(ii) Result. Under Sec. 1.367(a)-8(j)(2), the gain recognition
agreement is generally triggered when the transferred corporation
disposes of substantially all of its assets. However, under the special
rule contained in Sec. 1.367(a)-8(o)(4), because A owned an amount of
stock in W described in section 1504(a)(2) immediately before the
transaction, because A and W filed a consolidated Federal income tax
return prior to the transaction, and Newco, the transferred corporation,
is a domestic corporation, the gain recognition agreement is terminated
and has no further effect.
Example 5. Triangular section 368(a)(1)(B) reorganization--(i)
Facts. F, a foreign corporation, owns all the stock of S, a domestic
corporation. U, a domestic corporation, owns all of the stock of Y, also
a domestic corporation. U does not own any of the stock of F (applying
the attribution rules of section 318, as modified by section 958(b)). In
a triangular reorganization described in section 368(a)(1)(B) and
paragraph (d)(1)(iii)(A) of this section, S acquires all the stock of Y,
and U receives 10% of the voting stock of F.
(ii) Result. U's exchange of Y stock for F stock will not be subject
to section 367(a)(1), provided that all of the requirements of paragraph
(c)(1) are satisfied, including the requirement that U enter into a
five-year gain recognition agreement. For purposes of this section, F is
treated as the transferee foreign corporation and Y is treated as the
transferred corporation. See paragraphs (d)(2)(i) and (ii) of this
section. Under Sec. 1.367(a)-8(j)(9), the gain recognition agreement
would be triggered if F sold all or a portion of the stock of S.
Example 5A. Triangular section 368(a)(1)(B) reorganization--(i)
Facts. The facts are the same as in Example 5, except that F is a
domestic corporation and S is a foreign corporation.
(ii) Result. U's exchange of Y stock for stock of F, a domestic
corporation in control of S, the foreign acquiring corporation, is
treated as an indirect transfer of Y stock to a foreign corporation
under paragraph (d)(1)(iii)(B) of this section. U's exchange of Y stock
for F stock will not be subject to section 367(a)(1) provided that all
of the requirements of paragraph (c)(1) of this section are satisfied,
including the requirement that U enter into a five-year gain recognition
agreement. In satisfying the 50 percent or less ownership requirements
of paragraphs (c)(1)(i) and (ii) of this section, U's indirect ownership
of S stock (through its direct ownership of F) will determine whether
the requirement of paragraph (c)(1)(i) of this section is satisfied and
will be taken into account in determining whether the requirement of
paragraph (c)(1)(ii) of this section is satisfied. See paragraph
(c)(4)(iv) of this section. For purposes of this section, S is treated
as the transferee foreign corporation (see paragraph (d)(2)(i)(B) of
this section). If Y sold substantially all of its assets (within the
meaning of section 368(a)(1)(C)), the gain recognition agreement would
be terminated because U owned an amount of stock in Y described in
section 1504(a)(2) immediately before the transaction and Y is a
domestic corporation. See Sec. 1.367(a)-8(o)(4).
Example 6. Triangular section 368(a)(1)(C) reorganization--(i)
Facts. F, a foreign corporation, owns all of the stock of R, a domestic
corporation that operates an historical business. V, a domestic
corporation, owns all of the stock of Z, also a domestic corporation. V
does not own any of the stock of F (applying the attribution rules of
section 318 as modified by section 958(b)). In a triangular
reorganization described in section 368(a)(1)(C) (and paragraph
(d)(1)(iv) of this section), R acquires all of the assets of Z, and V
receives 30% of the voting stock of F.
(ii) Result. The consequences of the transfer are similar to those
described in Example 1; V is required to enter into a 5-year gain
recognition agreement under Sec. 1.367(a)-8 to secure nonrecognition
treatment under section 367(a). Under paragraphs (d)(2)(i) and (ii) of
this section, F is treated as the transferee foreign corporation and R
is treated as the transferred corporation. In determining whether, in a
later transaction, R has disposed of substantially all of its assets
under Sec. 1.367(a)-8(j)(2)(i), see paragraph (d)(2)(v)(A) of this
section.
Example 6A. Section 368(a)(1)(C) reorganization followed by section
368(a)(2)(C) exchange--(i) Facts. The facts are the same as in Example
6, except that the transaction is structured as a section 368(a)(1)(C)
reorganization with Z transferring its assets to F, followed by a
controlled asset transfer, and R is a foreign corporation. The following
additional facts are present. Z has 3 businesses: Business A with a
basis of $10 and a value of $50, Business B with a basis of $10 and a
value of $40, and Business C with a basis of $10 and a value of $30. V
and Z file a consolidated Federal income tax return and V has a basis of
$30 in the Z stock, which has a value of $120. Assume that Businesses A
and B consist solely of assets that will satisfy the section 367(a)(3)
active trade or business exception; none of Business C's assets will
satisfy the exception. Z transfers all 3 businesses to F in exchange for
30 percent of the F stock, which Z distributes to V pursuant to a
section 368(a)(1)(C) reorganization. F then contributes Businesses B and
C to R in a controlled asset transfer.
(ii) Result. The transfer of the Business A assets by Z to F does
not constitute an indirect stock transfer under paragraph (d) of
[[Page 292]]
this section, and, subject to section 367(a)(5), the Business A assets
qualify for the section 367(a)(3) active trade or business exception and
are not subject to section 367(a). The transfer by Z of the Business B
and C assets to F must first be tested under sections 367(a)(1), (3) and
(5). Z recognizes $20 of gain on the outbound transfer of the Business C
assets, as such assets do not qualify for an exception to section
367(a)(1). Subject to section 367(a)(5), the Business B assets may
qualify for the exception under section 367(a)(3) and Sec. 1.367(a)-
2T(c)(2) for assets that will be used by R in an active trade or
business outside the United States. Pursuant to paragraphs (d)(1) and
(d)(2)(vii)(A)(2) of this section, V is deemed to transfer the stock of
a foreign corporation to F in a section 354 exchange subject to the
rules of paragraphs (b) and (d) of this section. V must enter into the
gain recognition agreement in the amount of $30 to preserve Z's
nonrecognition treatment with respect to its transfer of Business B
assets. Under paragraphs (d)(2)(i) and (ii) of this section, F is the
transferee foreign corporation and R is the transferred corporation.
Example 6B. Section 368(a)(1)(C) reorganization followed by a
controlled asset transfer to a domestic controlled corporation--(i)
Facts. The facts are the same as in Example 6A, except that R is a
domestic corporation.
(ii) Result. As in Example 6A, the outbound transfer of the Business
A assets to F is not affected by the rules of this paragraph (d) and is
subject to the general rules under section 367. However, subject to
section 367(a)(5), the Business A assets qualify for the section
367(a)(3) active trade or business exception and are not subject to
section 367(a). The Business B and C assets are part of an indirect
stock transfer under this paragraph (d) but must first be tested under
section 367(a) and (d). The Business B assets qualify for the active
trade or business exception under section 367(a)(3); the Business C
assets do not. However, pursuant to paragraph (d)(2)(vi)(B) of this
section, the Business B and C assets are not subject to section 367(a)
or (d), provided that the basis of the Business B and C assets in the
hands of R is no greater than the basis of the assets in the hands of Z,
and appropriate basis adjustments are made pursuant to section 367(a)(5)
to the stock of F held by V. V also is deemed to make an indirect
transfer of Z stock under the rules of paragraph (d) of this section to
the extent the assets are transferred to R. To preserve non-recognition
treatment under section 367(a), and assuming the other requirements of
paragraph (c) of this section are satisfied, V must enter into a 5-year
gain recognition agreement in the amount of $50, the amount of the
appreciation in the Business B and C assets, as the transfer of such
assets by Z was not taxable under section 367(a)(1) and constituted an
indirect stock transfer.
Example 6C. Section 368(a)(1)(C) reorganization followed by a
controlled asset transfer to a domestic controlled corporation--(i)
Facts. The facts are the same as in Example 6B, except that Z is owned
by U.S. individuals, none of whom qualify as five-percent target
shareholders with respect to Z within the meaning of paragraph
(c)(5)(iii) of this section. The following additional facts are present.
No U.S. persons that are either officers or directors of Z own any stock
of F immediately after the transfer. F is engaged in an active trade or
business outside the United States that satisfies the test set forth in
paragraph (c)(3) of this section.
(ii) Result. The Business A assets transferred to F are not re-
transferred to R and therefore Z's transfer of these assets is not
subject to the rules of paragraph (d) of this section. However, the
transfer of such assets is subject to gain recognition under section
367(a)(1), because the section 367(a)(3) active trade or business
exception is inapplicable pursuant to section 367(a)(5). The Business B
and C assets are part of an indirect stock transfer under this paragraph
(d) but must first be tested with respect to Z under section 367(a) and
(d), as provided in paragraph (d)(2)(vi) of this section. The transfer
of the Business B assets (which otherwise would satisfy the section
367(a)(3) active trade or business exception) generally is subject to
section 367(a)(1) pursuant to section 367(a)(5). The transfer of the
Business C assets generally is subject to section 367(a)(1) because
these assets do not qualify for the active trade or business exception
under section 367(a)(3). However, pursuant to paragraph (d)(2)(vi)(B) of
this section, the transfer of the Business B and C assets is not subject
to sections 367(a)(1) and (d), provided the basis of the Business B and
C assets in the hands of R is no greater than the basis in the hands of
Z and certain other requirements are satisfied. Even though Z is not
controlled within the meaning of section 368(c) by 5 or fewer domestic
corporations, Z may avoid immediate gain recognition under section
367(a) and (d) on the transfers of the Business B and Business C assets
to F if, pursuant to paragraph (d)(3)(vi)(B) of this section, the
indirect transfer of Z stock satisfies the requirements of paragraphs
(c)(1)(i), (ii), and (iv), and (c)(6) of this section, and Z attaches a
statement described in paragraph (d)(2)(vi)(C) of this section to its
U.S. income tax return for the taxable year of the transfer. In general,
the statement must contain a certification that, if F disposes of the
stock of R (in a recognition or nonrecognition transaction) and a
principal purpose of the transfer is the avoidance of U.S. tax that
would have been imposed on Z on the disposition of the Business B and C
assets transferred to R, then Z (or F on behalf of Z) will
[[Page 293]]
file a return (or amended return as the case may be) recognizing gain
($50), as if, immediately prior to the reorganization, Z transferred the
Business B and C assets to a domestic corporation in exchange for stock
in a transaction treated as a section 351 exchange and immediately sold
such stock to an unrelated party for its fair market value. A
transaction is deemed to have a principal purpose of U.S. tax avoidance
if F disposes of R stock within two years of the transfer, unless Z (or
F on behalf of Z) can rebut the presumption to the satisfaction of the
Commissioner. See paragraph (d)(2)(vi)(D)(2) of this section. With
respect to the indirect transfer of Z stock, assume the requirements of
paragraphs (c)(1)(i), (ii), and (iv) of this section are satisfied.
Thus, assuming Z attaches the statement described in paragraph
(d)(2)(vi)(C) of this section to its U.S. income tax return and
satisfies the reporting requirements of (c)(6) of this section, the
transfer of Business B and C assets is not subject to immediate gain
recognition under section 367(a) or (d).
Example 7. Triangular section 368(a)(1)(C) reorganization followed
by 351 exchange--(i) Facts. The facts are the same as in Example 6,
except that, during the fourth year of the gain recognition agreement, R
transfers substantially all of the assets received from Z to K, a
wholly-owned domestic subsidiary of R, in an exchange described in
section 351.
(ii) Result. The disposition by R, the transferred corporation, of
substantially all of its assets would terminate the gain recognition
agreement if the assets were disposed of in a taxable transaction
because V owned an amount of stock in Z described in section 1504(a)(2)
immediately before the transaction, and R is a domestic corporation. See
Sec. 1.367(a)-8(o)(4). Because the assets were transferred in an
exchange to which section 351 applies, such transfer does not trigger
the gain recognition agreement if V complies with the requirements
contained in Sec. 1.367(a)-8(k)(4). See also paragraph (d)(2)(iv) of
this section. To determine whether substantially all of the assets are
disposed of, any assets of Z that were transferred by Z to R and then
contributed by R to K are taken into account.
Example 7A. Triangular section 368(a)(1)(C) reorganization followed
by section 351 exchange with foreign transferee--(i) Facts. The facts
are the same as in Example 7 except that K is a foreign corporation.
(ii) Result. This transfer of assets by R to K must be analyzed to
determine its effect upon the gain recognition agreement, and such
transfer is also an outbound transfer of assets that is taxable under
section 367(a)(1) unless the active trade or business exception under
section 367(a)(3) applies. If the transfer is fully taxable under
section 367(a)(1), the transfer is treated as if the transferred
company, R, sold substantially all of its assets. Thus, the gain
recognition agreement would terminate because V owned an amount of stock
in Z described in section 1504(a)(2) immediately before the transaction,
and R is a domestic corporation. See Sec. 1.367(a)-8(o)(4). If each
asset transferred qualifies for nonrecognition treatment under section
367(a)(3) and the regulations thereunder (which require, under Sec.
1.367(a)-2T(a)(2), the transferor to comply with the reporting
requirements under section 6038B), the result is the same as in Example
7. If a portion of the assets transferred qualify for nonrecognition
treatment under section 367(a)(3) and a portion are taxable under
section 367(a)(1) (but such portion does not result in the disposition
of substantially all of the assets), the gain recognition agreement will
not be triggered if such information is reported as required under Sec.
1.367(a)-8(g) and V satisfies the requirements contained in Sec.
1.367(a)-8(k)(4).
Example 8. Concurrent application of asset transfer and indirect
stock transfer rules in consolidated return setting--(i) Facts. Assume
the same facts as in Example 6, except that R is a foreign corporation
and V and Z file a consolidated return for Federal income tax purposes.
The properties of Z consist of Business A assets, with an adjusted basis
of $50 and fair market value of $90, and Business B assets, with an
adjusted basis of $50 and a fair market value of $110. Assume that the
Business A assets do not qualify for the active trade or business
exception under section 367(a)(3), but that the Business B assets do
qualify for the exception. V's basis in the Z stock is $100, and the
value of such stock is $200.
(ii) Result. Under paragraph (d)(2)(vi), the assets of Businesses A
and B that are transferred to R must be tested under sections 367(a)(3)
and (a)(5) prior to consideration of the indirect stock transfer rules
of this paragraph (d). Thus, Z must recognize $40 of income under
section 367(a)(1) on the outbound transfer of Business A assets. Under
Sec. 1.1502-32, because V and Z file a consolidated return, V's basis
in its Z stock increases from $100 to $140 as a result of Z's $40 gain.
Pursuant to paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, V
is deemed to transfer the stock of a foreign corporation to F in a
section 354 exchange subject to the rules of paragraphs (b) and (d) of
this section, and therefore must enter into a gain recognition agreement
in the amount of $60 (the gain realized but not recognized by V in the
stock of Z after the $40 basis adjustment). If F sells a portion of its
stock in R during the term of the agreement, V will be required to
recognize a portion of the $60 gain subject to the agreement. To
determine whether R disposes of substantially all of its assets (under
Sec. 1.367(a)-8(j)(2)(i)), only the Business B assets will be
considered (because the transfer of the Business A assets was taxable to
Z under
[[Page 294]]
section 367). See paragraph (d)(2)(v)(A) of this section.
Example 8A. Concurrent application without consolidated returns--(i)
Facts. The facts are the same as in Example 8, except that V and Z do
not file consolidated income tax returns.
(ii) Result. Z would still recognize $40 of gain on the transfer of
its Business A assets, and the Business B assets would still qualify for
the active trade or business exception under section 367(a)(3). However,
V's basis in its stock of Z would not be increased by the amount of Z's
gain. V's indirect transfer of stock will be taxable unless V enters
into a gain recognition agreement (as described in Sec. 1.367(a)-8) for
the $100 of gain realized but not recognized with respect to the stock
of Z.
Example 8B. Concurrent application with individual U.S.
shareholder--(i) Facts. The facts are the same as in Example 8, except
that V is an individual U.S. citizen.
(ii) Result. Section 367(a)(5) would prevent the application of the
active trade or business exception under section 367(a)(3). Thus, Z's
transfer of assets to R would be fully taxable under section 367(a)(1).
Z would recognize $100 of income. V's basis in its stock of Z is not
increased by this amount. V is taxable with respect to its indirect
transfer of its Z stock unless V enters into a gain recognition
agreement in the amount of the $100, the gain realized but not
recognized with respect to its Z stock.
Example 8C. Concurrent application with nonresident alien
shareholder--(i) Facts. The facts are the same as in Example 8, except
that V is a nonresident alien.
(ii) Result. Pursuant to section 367(a)(5), the active trade or
business exception under section 367(a)(3) is not available with respect
to Z's transfer of assets to R. Thus, Z has $100 of gain with respect to
the Business A and B assets. Because V is a nonresident alien, however,
V is not subject to section 367(a) with respect to its indirect transfer
of Z stock.
Example 9. Indirect stock transfer by reason of a controlled asset
transfer--(i) Facts. The facts are the same as in Example 8, except that
R transfers the Business A assets to M, a wholly owned domestic
subsidiary of R, in a controlled asset transfer. In addition, V's basis
in its Z stock is $90.
(ii) Result. Pursuant to paragraph (d)(2)(vi)(B) of this section,
sections 367(a) and (d) do not apply to Z's transfer of the Business A
assets to R, because such assets are re-transferred to M, a domestic
corporation, provided that the basis of the Business A assets in the
hands of M is no greater than the basis of the assets in the hands of Z,
and certain other requirements are satisfied. Because Z is controlled
(within the meaning of section 368(c)) by V, a domestic corporation,
appropriate basis adjustments must be made pursuant to section 367(a)(5)
to the stock of F held by V. Section 367(a)(1) does not apply to Z's
transfer of its Business B assets to R (which are not re-transferred to
M) because such assets qualify for an exception to gain recognition
under section 367(a)(3), subject to section 367(a)(5). Pursuant to
paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, V is generally
deemed to transfer the stock of a foreign corporation to F in a section
354 exchange subject to the rules of paragraphs (b) and (d) of this
section, including the requirement that V enter into a 5-year gain
recognition agreement and comply with the requirements of Sec.
1.367(a)-8. However, pursuant to paragraph (d)(2)(vii)(B) of this
section, paragraph (d)(2)(vii)(A)(1) of this section does not apply to
the extent of the transfer of business A assets by R to M, a domestic
corporation. As a result, to the extent of the business A assets
transferred by R to M, V is deemed to transfer the stock of Z (a
domestic corporation) to F in a section 354 exchange subject to the
rules of paragraphs (c) and (d) of this section. Thus, with respect to
V's indirect transfer of Z stock to F, such transfer is not subject to
gain recognition under section 367(a)(1) if the requirements of
paragraph (c) of this section are satisfied, including the requirement
that V enter into a 5-year gain recognition agreement and comply with
the requirements of Sec. 1.367(a)-8. Under paragraphs (d)(2)(i) and
(ii) of this section, the transferee foreign corporation is F and the
transferred corporation is M. Pursuant to paragraph (d)(2)(iv) of this
section, a disposition by F of the stock of R, or a disposition by R of
the stock of M, will trigger the gain recognition agreement. To
determine whether there is a triggering event underSec. 1.367(a)-
8(j)(2)(i), both the Business A assets in M and the Business B assets in
R must be considered.
Example 10. Concurrent application of asset transfer and indirect
stock transfer rules in section 368(a)(1)(A)/(a)(2)(D) reorganization--
(i) Facts. The facts are the same as in Example 8, except that R
acquires all of the assets of Z in a reorganization described in
sections 368(a)(1)(A) and (a)(2)(D). Pursuant to the reorganization, V
receives 30 percent of the stock of F in a section 354 exchange.
(ii) Result. The consequences of the transaction are similar to
those in Example 8. The assets of Businesses A and B that are
transferred to R must be tested under section 367(a) and (d) prior to
the consideration of the indirect stock transfer rules of this paragraph
(d). The Business B assets qualify for the active trade or business
exception under section 367(a)(3), subject to section 367(a)(5). Because
the Business A assets do not qualify for the exception, Z must recognize
$40 of gain under section 367(a) on the transfer of Business A assets to
R. Further, because V and Z file a consolidated return, V's basis in the
stock of Z is increased from $100 to $140
[[Page 295]]
as a result of Z's $40 gain. Pursuant to paragraphs (d)(1) and
(d)(2)(vii)(A)(1) of this section, V is deemed to transfer the stock of
a foreign corporation to F in a section 354 exchange subject to the
rules of paragraphs (b) and (d) of this section. V's indirect transfer
of foreign stock will be taxable under section 367(a) unless V enters
into a gain recognition agreement in the amount of $60 ($200 value of Z
stock less $140 adjusted basis).
Example 11. Concurrent application of section 367(a) and (b) in
section 368(a)(1)(A)/(a)(2)(E) reorganization--(i) Facts. F, a foreign
corporation, owns all the stock of D, a domestic corporation. V, a
domestic corporation, owns all the stock of Z, a foreign corporation. V
has a basis of $100 in the stock of Z which has a fair market value of
$200. D is an operating corporation with assets valued at $100 with a
basis of $60. In a reorganization described in sections 368(a)(1)(A) and
(a)(2)(E), D merges into Z, and V exchanges its Z stock for 55 percent
of the outstanding F stock.
(ii) Result. Under paragraph (d)(1)(ii) of this section, V is
treated as making an indirect transfer of Z stock to F. V's exchange of
Z stock for F stock will be taxable under section 367(a) (and section
1248 will be applicable) if V fails to enter into a 5-year gain
recognition agreement in accordance with the requirements of Sec.
1.367(a)-8. Under paragraph (b)(2) of this section, if V enters into a
gain recognition agreement, the exchange will be subject to the
provisions of section 367(b) and the regulations thereunder as well as
section 367(a). Under Sec. 1.367(b)-4(b), however, no income inclusion
is required because both F and Z are controlled foreign corporations
with respect to which V is a section 1248 shareholder immediately after
the exchange. Under paragraphs (d)(2)(i) and (ii) of this section, the
transferee foreign corporation is F, and the transferred corporation is
Z (the acquiring corporation). If F disposes (within the meaning of
Sec. 1.367(a)-8(j)(1)) of all (or a portion) of Z stock within the 5-
year term of the agreement (and V has not made a valid election
underSec. 1.367(a)-8(c)(2)(vi), V is required to file an amended return
for the year of the transfer and include in income, with interest, the
gain realized but not recognized on the initial section 354 exchange. To
determine whether Z (the transferred corporation) disposes of
substantially all of its assets, only the assets of Z immediately prior
to the transaction are taken into account, pursuant to paragraph
(d)(2)(v)(B) of this section. Because D is owned by F, a foreign
corporation, section 367(a)(5) precludes any assets of D from qualifying
for nonrecognition under section 367(a)(3). Thus, D recognizes $40 of
gain on the transfer of its assets to Z under section 367(a)(1).
Example 12. Concurrent application of direct and indirect stock
transfer rules--(i) Facts. F, a foreign corporation, owns all of the
stock of O, also a foreign corporation. D, a domestic corporation, owns
all of the stock of E, also a domestic corporation, which owns all of
the stock of N, also a domestic corporation. Prior to the transactions
described in this Example 12, D, E and N filed a consolidated income tax
return. D has a basis of $100 in the stock of E, which has a fair market
value of $160. The N stock has a fair market value of $100, and E has a
basis of $60 in such stock. In addition to the stock of N, E owns the
assets of Business X. The assets of Business X have a fair market value
of $60, and E has a basis of $50 in such assets. Assume that the
Business X assets qualify for nonrecognition treatment under section
367(a)(3). D does not own any stock in F (applying the attribution rules
of section 318 as modified by section 958(b)). In a triangular
reorganization described in section 368(a)(1)(C) and paragraph
(d)(1)(iv) of this section, O acquires all of the assets of E, and D
exchanges its stock in E for 40% of the voting stock of F.
(ii) Result. E's transfer of its assets, including the N stock, must
be tested under the general rules of section 367(a) before consideration
of D's indirect transfer of the stock of E. E's transfer of the assets
of Business X qualify for nonrecognition under section 367(a)(3). E's
transfer of its N stock could qualify for nonrecognition treatment if D
satisfies the requirements in Sec. 1.367(a)-3(e). O is the transferee
foreign corporation; N is the transferred corporation. Pursuant to
paragraphs (d)(1) and (d)(2)(vii)(A)(1) of this section, D is deemed to
transfer the stock of a foreign corporation to F in a section 354
exchange subject to the rules of paragraphs (b) and (d) of this section,
and therefore may enter into a gain recognition agreement for such
indirect stock transfer as provided in paragraph (b) of this section and
Sec. 1.367(a)-8. As to this transfer, F is the transferee foreign
corporation; O is the transferred corporation. The amount of the gain
recognition agreement is $60. See also section 367(a)(5) and any
regulations issued thereunder.
Example 13. Successive section 351 exchanges--(i) Facts. D, a
domestic corporation, owns all the stock of X, a controlled foreign
corporation that operates an historical business, which owns all the
stock of Y, a controlled foreign corporation that also operates an
historical business. The properties of D consist of Business A assets,
with an adjusted basis of $50 and a fair market value of $90, and
Business B assets, with an adjusted basis of $50 and a fair market value
of $110. Assume that the Business B assets qualify for the exception
under section 367(a)(3) and Sec. 1.367(a)-2T(c)(2), but that the
Business A assets do not qualify for the exception. In an exchange
described in section 351, D transfers the assets of Businesses A and B
to X, and, in connection with the same transaction, X transfers the
assets of Business B
[[Page 296]]
to Y in another exchange described in section 351.
(ii) Result. Under paragraph (d)(1)(vi) of this section, this
transaction is treated as an indirect stock transfer for purposes of
section 367(a), but the transaction is not recharacterized for purposes
of section 367(b). Moreover, under paragraph (d)(2)(vi) of this section,
the assets of Businesses A and B that are transferred to X must be
tested under section 367(a)(3). The Business A assets, which were not
transferred to Y, are subject to the general rules of section 367(a),
and not the indirect stock transfer rules described in this paragraph
(d). D must recognize $40 of income on the outbound transfer of Business
A assets. The transfer of the Business B assets is subject to both the
asset transfer rules (under section 367(a)(3)) and the indirect stock
transfer rules of this paragraph (d) and Sec. 1.367(a)-8. Thus, D's
transfer of the Business B assets will not be subject to section
367(a)(1) if D enters into a five-year gain recognition agreement with
respect to the stock of Y. Under paragraphs (d)(2)(i) and (ii) of this
section, X will be treated as the transferee foreign corporation and Y
will be treated as the transferred corporation for purposes of applying
the terms of the agreement. If X sells all or a portion of the stock of
Y during the term of the agreement, D will be required to recognize a
proportionate amount of the $60 gain that was realized by D on the
initial transfer of the Business B assets.
Example 13A. Successive section 351 exchanges with ultimate domestic
transferee--(i) Facts. The facts are the same as in Example 13, except
that Y is a domestic corporation.
(ii) Result. As in Example 13, D must recognize $40 of income on the
outbound transfer of the Business A assets. Although the Business B
assets qualify for the exception under section 367(a)(3) (and end up in
U.S. corporate solution, in Y), the $60 of gain realized on the Business
B assets is nevertheless taxable under paragraphs (c)(1) and (d)(1)(vi)
of this section because the transaction is considered to be a transfer
by D of stock of a domestic corporation, Y, in which D receives more
than 50 percent of the stock of the transferee foreign corporation, X. A
gain recognition agreement is not permitted.
Example 14. Concurrent application of indirect stock transfer rules
and section 367(b)--(i) Facts. F, a foreign corporation, owns all of the
stock of Newco, which is also a foreign corporation. P, a domestic
corporation, owns all of the stock of S, a foreign corporation that is a
controlled foreign corporation within the meaning of section 957(a). P's
basis in the stock of S is $50 and the value of S is $100. The section
1248 amount with respect to S stock is $30. In a reorganization
described in section 368(a)(1)(C) (and paragraph (d)(1)(iv) of this
section), Newco acquires all of the properties of S, and P exchanges its
stock in S for 49 percent of the stock of F.
(ii) Result. P's exchange of S stock for F stock under section 354
will be taxable under section 367(a) (and section 1248 will be
applicable) if P fails to enter into a 5-year gain recognition agreement
in accordance with Sec. 1.367(a)-8. Under paragraph (b)(2) of this
section, if P enters into a gain recognition agreement, the exchange
will be subject to the provisions of section 367(b) and the regulations
thereunder as well as section 367(a). Under Sec. 1.367(b)-4(b), P must
recognize the section 1248 amount of $30 because P exchanged stock of a
controlled foreign corporation, S, for stock of a foreign corporation
that is not a controlled foreign corporation, F. The indirect stock
transfer rules do not apply with respect to section 367(b). The deemed
dividend of $30 recognized by P will increase P's basis in the F stock
received in the transaction, and F's basis in the Newco stock. Thus, the
amount of the gain recognition agreement is $20 ($50 gain realized on
the transfer less the $30 inclusion under section 367(b)). Under
paragraphs (d)(2)(i) and (ii) of this section, F is treated as the
transferee foreign corporation and Newco is the transferred corporation.
Example 14A. Triangular section 368(a)(1)(C) reorganization
involving foreign acquired corporation--(i) Facts. Assume the same facts
as in Example 14, except that P receives 51 percent of the stock of F.
(ii) Result. Assuming Sec. 1.367(b)-4(b) does not apply, there is
no income inclusion under section 367(b), and the amount of the gain
recognition agreement is $50.
Example 15. Concurrent application of indirect stock transfer rules
and section 367(b)--(i) Facts. F, a foreign corporation, owns all of the
stock of Newco, a domestic corporation. P, a domestic corporation, owns
all of the stock of FC, a foreign corporation. P's basis in the stock of
FC is $50 and the value of FC stock is $100. The all earnings and
profits amount with respect to the FC stock held by P is $60. See Sec.
1.367(b)-2(d). In a reorganization described in sections 368(a)(1)(A)
and (a)(2)(D) (and paragraph (d)(1)(i) of this section), Newco acquires
all of the properties of FC, and P exchanges its stock in FC for 20
percent of the stock in F.
(ii) Result. P's section 354 exchange is considered an indirect
stock transfer under paragraph (d)(1)(i) of this section. Further,
because the assets of FC were acquired by Newco, a domestic corporation,
in an asset reorganization, the transaction is within Sec. 1.367(b)-
3(a) and (b). Because the transaction is subject to Sec. 1.367(b)-3 and
the indirect stock rules of paragraph (d) of this section, and because
the all earnings and profits amount with respect to the FC stock
exchanged by P ($60) is greater than the gain in such stock subject to
section 367(a) ($50), the section 367(b) rules (and not the section
[[Page 297]]
367(a) rules) apply to the exchange. See Sec. 1.367(a)-3(b)(2)(i)(B).
Under the rules of section 367(b), P must include in income the all
earnings and profits amount of $60 with respect to its FC stock. See
Sec. 1.367(b)-3. Alternatively, if P's all earnings and profits amount
with respect to its FC stock were $30 (which is less than the gain in
such stock subject to section 367(a) ($50)), section 367(b) and the
regulations thereunder would not apply if there is gain recognition
under section 367(a). Thus, if P failed to enter into a 5-year gain
recognition agreement in accordance with Sec. 1.367(a)-8, then P would
recognize $50 of gain under section 367(a) and there would be no income
inclusion under section 367(b). If, instead, P enters into a 5-year gain
recognition agreement under Sec. 1.367(a)-8, thereby avoiding immediate
gain recognition on the entire $50 of section 367(a) gain, P is required
to include in income the all earnings and profits amount of $30. In such
a case, P will adjust its basis in the FC stock pursuant to Sec.
1.367(b)-2(e)(3)(ii) and enter into a gain recognition agreement in the
amount of $20.
Example 16. Direct asset reorganization not subject to stock
transfer rules--(i) Facts. D is a domestic corporation that owns all the
stock of F1 and F2, both foreign corporations. In a reorganization
described in section 368(a)(1)(D), F2 acquires all of the assets of F1,
and D receives 30 percent of the stock of F2 in an exchange described in
section 354.
(ii) Result. The section 368(a)(1)(D) reorganization is not an
indirect stock transfer described in paragraph (d) of this section.
Moreover, the section 354 exchange by D of F1 stock for F2 stock is not
an exchange described under section 367(a). See paragraph (a) of this
section.
(e) Transfers by a domestic corporation to a foreign corporation in
a section 361 exchange--(1) General rule. If a domestic corporation
(U.S. transferor) transfers stock or securities to a foreign corporation
(transferee foreign corporation) in an exchange described in section
361(a) or (b), or in an exchange described in section 351 that is also
described in section 361(a) or (b) (collectively, a section 361
exchange), such transfer shall be subject to section 367(a)(1), unless
the conditions of paragraphs (e)(1)(i) through (iv) of this section are
satisfied.
(i) The conditions set forth in section 367(a)(5) and any
regulations under that section have been satisfied including that:
(A) The U.S. transferor is controlled (within the meaning of section
368(c)) by five or fewer (but at least one) domestic corporations
(control group members) at the time of the section 361 exchange;
(B) The U.S. transferor recognizes the amount of the gain realized
in the section 361 exchange that is allocable to any shareholder that is
not a control group member (based on the value of the ownership interest
in the U.S. transferor held by the shareholder at the time of the
section 361 exchange);
(C) The U.S. transferor recognizes the amount of the gain realized
in the section 361 exchange allocable to a control group member that
cannot be preserved in the stock received by the control group member in
the transaction; and
(D) Appropriate adjustments are made to the basis of the stock
received by each control group member in the transaction.
(ii) If the stock or securities transferred in the section 361
exchange are of a domestic corporation, the conditions in paragraphs
(c)(1)(i), (ii), and (iv) of this section are satisfied.
(iii) Each control group member that owns five percent or more
(applying the attribution rules of section 318, as modified by section
958(b)) of the total voting power or the total fair market value of the
stock of the transferee foreign corporation immediately after the
transaction enters into a gain recognition agreement as provided in
Sec. 1.367(a)-8. The amount of gain subject to the gain recognition
agreement shall equal the amount of the gain realized by the U.S.
transferor on the transfer of the stock or securities in the section 361
exchange that is allocable to such control group member (based on the
ownership interest (by value) in the U.S. transferor held by the control
group member at the time of the section 361 exchange) reduced by the
amount of such allocable gain that is recognized by the U.S. transferor
with respect to the control group member. The gain recognition agreement
shall designate the control group member as the U.S. transferor for
purposes of paragraphs (b) and (c) of this section and Sec. 1.367(a)-8.
(iv) Each control group member that enters into a gain recognition
agreement pursuant to paragraph (e)(1)(iii)
[[Page 298]]
of this section makes the election described in Sec. 1.367(a)-
8(c)(2)(vi).
(2) Certain triangular asset reorganizations. If a transfer of stock
or securities described in paragraph (e)(1) of this section is pursuant
to a triangular asset reorganization described in Sec. 1.358-6(b)(2)(i)
through (iii), the gain recognition agreement filed by a control group
member pursuant to paragraph (e)(1)(iii) of this section shall include
provisions consistent with the principles of Sec. 1.367(a)-8 to account
for all the parties to the reorganization. See Sec. 1.367(a)-8(j)(9).
(3) Examples. The following examples illustrate the provisions of
paragraph (e)(1) of this section. Except as otherwise indicated, assume
US1, US2, USP, and UST are domestic corporations; US1 and US2 are not
related; CFC1, CFC2, FA, and FC are foreign corporations; the section
1248 amount attributable to the stock of a foreign corporation is zero;
and section 7874 does not apply to the transaction.
Example 1. Outbound asset reorganization. (i) Facts. US1 and US2 own
60% and 40%, respectively, of the outstanding stock of UST. UST wholly
owns FC. The FC stock held by UST has a $20x basis and a $100x fair
market value. UST merges with and into FC in an asset reorganization
described in section 368(a)(1)(A). In the section 361 exchange that is
part of the reorganization, UST transfers all of its FC stock to FA. UST
distributes the FA stock it received in the section 361 exchange to US1
and US2 pursuant to the plan of reorganization. The conditions set forth
in the second sentence of section 367(a)(5) and the regulations under
that section are satisfied, including adjusting the basis of the FA
stock received by US1 and US2 in the reorganization, as appropriate.
After the reorganization, US1 and US2 own 6% and 4%, respectively, of
the outstanding stock of FA.
(ii) Result. If the conditions of paragraph (e)(1)(i) through (iv)
of this section are satisfied, the transfer of the FC stock by UST to FA
in the section 361 exchange is not subject to section 367(a)(1). Because
US1 and US2 complied with the requirements of section 367(a)(5), the
requirement of paragraph (e)(1)(i) of this section is satisfied.
Paragraph (e)(1)(ii) of this section is not applicable because FC is a
foreign corporation. Pursuant to paragraph (e)(1)(iii) of this section,
US1 enters into a gain recognition agreement with respect to its share
of the gain realized by UST on the transfer of the FC stock to FA in the
section 361 exchange ($48x, or 60% of $80x). The amount of gain subject
to the gain recognition agreement is $48x because UST did not recognize
any amount of such gain under section 367(a)(5) or the regulations under
that section with respect to US1. US1 is designated as the U.S.
transferor on the gain recognition agreement for purposes of paragraph
(b) of this section and Sec. 1.367(a)-8. US1 makes the election
described in Sec. 1.367(a)-8(c)(2)(vi) with respect to the gain
recognition agreement. Because US2 owns less than 5% of the stock of FA
after the reorganization, US2 is not required to enter into a gain
recognition agreement with respect to its share of the gain realized by
UST on the transfer of the FC stock to FA in the section 361 exchange.
(iii) Alternate facts. The facts are the same as in paragraph (i) of
this Example, except that, in year 4, FA disposes of 25% of the FC stock
in a taxable exchange. Under Sec. 1.367(a)-8(c)(1)(i) and (j)(1), the
partial disposition of the FC stock requires US1 to include in income
25% of the gain subject to the gain recognition agreement filed in year
1 ($12x, or 25% of $48x) and pay applicable interest on any additional
tax due on such inclusion.
(iv) Alternate facts. The facts are the same as in paragraph (iii)
of this Example, except that US1 and US2 are members of a consolidated
group of which USP is the common parent. Because US2 is considered to
own at least 5% of the stock of FA following the reorganization by
reason of the attribution rules of section 318, as modified by section
958(b), a gain recognition agreement must also be entered into on behalf
of US2 with respect to the amount of the gain realized but not
recognized by UST on the transfer of the FC stock to FA that is
allocable to US2 ($32x, or 40% of $80x). Under Sec. 1.367(a)-8(d)(3)
and Sec. 1.1502-77(a)(1), USP enters into the gain recognition
agreements on behalf of US1 and US2. In year 4, US1 and US2 must include
in income 25% of the amount of gain subject to their respective gain
recognition agreement ($12x for US1 and $8x for US2) and pay applicable
interest on any additional tax due on such inclusion.
Example 2. Divisive reorganization. (i) Facts. US1 wholly owns UST.
The UST stock has a $120x basis and $150x fair market value. UST wholly
owns CFC2. The CFC2 stock has a $20x basis and a $50x fair market value.
UST also owns Business A that has a fair market value of $100x. In a
divisive reorganization that satisfies the requirements of section
368(a)(1)(D), UST transfers the CFC2 stock to CFC1, a newly-formed
corporation, in exchange solely for CFC1 stock. The transfer of the CFC2
stock to CFC1 is a section 361 exchange. UST then distributes the CFC1
stock to US1 in a transaction that qualifies under section 355. Under
section 358, the pre-exchange basis in the UST stock ($120x) is
allocated between the UST stock and the CFC1 stock based on the relative
fair market values of such stock. Therefore, immediately
[[Page 299]]
after the transaction, the basis of the UST stock is $80x ($120x
multiplied by $100x/$150x), and the basis of the CFC1 stock is $40x
($120x multiplied by $50x/$150x). The conditions set forth in section
367(a)(5) and the regulations under that section are satisfied,
including reducing the basis of the CFC1 stock received by US1 in the
transaction by $20x so that the $30x built-in gain in the CFC2 stock
transferred in the section 361 exchange is preserved in the CFC1 stock
received by US1 in the transaction.
(ii) Result. Because US1 complied with the requirements of section
367(a)(5) and regulations under that section, the requirement of
paragraph (e)(1)(i) of this section is satisfied. Paragraph (e)(1)(ii)
of this section is not applicable because CFC2 is a foreign corporation.
Pursuant to paragraph (e)(1)(iii) of this section, US1 enters into a
gain recognition agreement with respect to its share of the gain
realized by UST on the transfer of the CFC2 stock to CFC1 in the section
361 exchange ($30x). The amount of gain subject to the gain recognition
agreement is $30x because UST did not recognize any amount of such gain
under section 367(a)(5) or the regulations under that section with
respect to US1. US1 is designated as the U.S. transferor on the gain
recognition agreement for purposes of paragraph (b) of this section and
Sec. 1.367(a)-8. US1 makes the election described in Sec. 1.367(a)-
8(c)(2)(vi) with respect to the gain recognition agreement.
(4) Cross-references. For other examples that illustrate the
application of this paragraph (e), see Sec. 1.367(a)-8(q)(2), Examples
6 and 24. For rules relating to an acquisition of the stock of a foreign
corporation by another foreign corporation in a section 361 exchange,
see Sec. 1.367(b)-4(b)(1)(iii), Example 4. For rules relating to
certain distributions of stock of a foreign corporation by a domestic
corporation, see section 1248(f) and the regulations under that section.
(f) [Reserved]
(g) Effective/applicability date--(1) Rules of applicability--(i)
Except as otherwise provided in this paragraph (g), the rules in
paragraphs (a), (b), and (d) of this section apply to transfers
occurring on or after July 20, 1998.
(ii) The following rules apply to transactions occurring on or after
January 23, 2006--
(A) The rules in paragraphs (a) and (d) of this section, as they
apply to section 368(a)(1)(A) reorganizations (including reorganizations
described in section 368(a)(2)(D) or (E)) involving a foreign acquiring
or foreign acquired corporation;
(B) The rules in paragraph (b)(2)(i)(B) of this section;
(C) The rules in paragraph (d) of this section, as they apply to
section 368(a)(1)(G) reorganizations (including reorganizations
described in section 368(a)(2)(D));
(D) The rules of paragraph (d)(1) and (d)(2)(iv), as they relate to
exchanges by a U.S. person of securities of an acquired corporation for
voting stock or securities of a foreign corporation in control of the
acquiring corporation in a triangular section 368(a)(1)(B)
reorganization;
(E) The rules in paragraph (d)(1) and (d)(2)(iv) of this section, as
they relate to exchanges by a U.S. person of stock or securities of an
acquired corporation for voting stock or securities of a domestic
corporation in control of the foreign acquiring corporation in a
triangular section 368(a)(1)(B) reorganization; and
(F) The rules in paragraph (d)(2)(vii) of this section.
(iii) The rules of paragraph (a) of this section that apply to
transfers of securities in a section 354 or 356 exchange (pursuant to a
section 368(a)(1)(E) reorganization or an asset reorganization that is
not treated as an indirect stock transfer) that is not subject to
section 367(a) apply only to transfers occurring after January 5, 2005
(although taxpayers may apply such provision to transfers of securities
occurring on or after July 20, 1998, and on or before January 5, 2005,
if done consistently to all transactions).
(iv) The rules in paragraph (d)(1)(v) of this section apply to:
(A) A reorganization described in section 368(a)(1)(C) followed by a
controlled asset transfer if such reorganization occurs on or after July
20, 1998;
(B) A reorganization described in section 368(a)(1)(D) followed by a
controlled asset transfer if such reorganization occurs after December
9, 2002 (for additional guidance concerning such reorganizations that
occur on or after July 20, 1998 and on or before December 9, 2002, see
Rev. Rul. 2002-85 (2002-2 C.B. 986) and Sec. 601.601(d)(2) of this
chapter); and
[[Page 300]]
(C) A reorganization described in section 368(a)(1)(A), (F), or (G)
followed by a controlled asset transfer if such reorganization occurs on
or after January 23, 2006.
(v) The rules of paragraph (d)(2)(vi) of this section apply only to
transactions occurring on or after January 23, 2006. See Sec. 1.367(a)-
3(d)(2)(vi), as contained in 26 CFR part 1 revised as of April 1, 2005,
for transactions occurring on or after July 20, 1998 and before January
23, 2006.
(vi) With respect to certain transfers of domestic stock or
securities, the rules in paragraph (c) of this section are generally
applicable for transfers occurring after January 29, 1997. See Sec.
1.367(a)-3(c)(11). For transition rules regarding certain transfers of
domestic stock or securities after December 16, 1987, and before January
30, 1997, and transfers of foreign stock or securities after December
16, 1987, and before July 20, 1998, see paragraph (j) of this section.
(vii) Except as otherwise provided in this paragraph (g)(1)(G), the
third sentence of paragraph (a) of this section shall apply to section
304(a)(1) transactions occurring on or after February 21, 2006. However,
taxpayers may rely on the third sentence of paragraph (a) of this
section for all section 304(a)(1) transactions occurring in open tax
years; in such cases any gain recognition agreements filed pursuant to
Sec. 1.367(a)-8 with respect to such transactions shall terminate and
have no further effect.
(viii)(A) Except as provided in this paragraph (g)(1)(viii), the
rules of paragraph (e) of this section apply to transfers of stock or
securities occurring on or after March 13, 2009. For matters covered in
this section for periods before March 13, 2009, but on or after March 7,
2007, the rules of Sec. 1.367(a)-3T(e) (see 26 CFR part 1, revised
April 1, 2007) apply. For matters covered in this section for periods
before March 7, 2007, but on or after July 20, 1998, the rule of Sec.
1.367(a)-8(f)(2)(i) (see 26 CFR part 1, revised April 1, 2006) applies.
(B) Taxpayers may apply the rules of Sec. 1.367(a)-3(e) to
transfers occurring before March 13, 2009, and during a taxable year for
which the period of limitations on assessments under section 6501(a) has
not closed, if done consistently to all such transfers occurring during
each taxable year. A taxpayer applies the rules of Sec. 1.367(a)-3(e)
to transfers occurring before March 13, 2009, and during a taxable year
for which the period of limitations on assessments under section 6501(a)
has not closed, by including the gain recognition agreement, annual
certification, or other information filing, that is required as a result
of the rules of Sec. 1.367(a)-3(e) applying to such a transfer, with an
amended tax return for the taxable year in which the transfer occurs
that is filed on or before August 10, 2009. A taxpayer that wishes to
apply the rules of Sec. 1.367(a)-3(e) to transfers occurring before
March 13, 2009, and during a taxable year for which the period of
limitations on assessments under section 6501(a) has not closed but that
fails to meet the filing requirement described in the preceding sentence
must request relief for reasonable cause for such failure as provided in
Sec. 1.367(a)-8.
(2) Election. Notwithstanding paragraphs (g)(1) and (j) of this
section, taxpayers may, by timely filing an original or amended return,
elect to apply paragraphs (b) and (d) of this section to all transfers
of foreign stock or securities occurring after December 16, 1987, and
before July 20, 1998, except to the extent that a gain recognition
agreement has been triggered prior to July 20, 1998. If an election is
made under this paragraph (g)(2), the provisions of Sec. 1.367(a)-3T(g)
(see 26 CFR part 1, revised April 1, 1998) shall apply, and, for this
purpose, the term substantial portion under Sec. 1.367(a)-3T(g)(3)(iii)
(see 26 CFR part 1, revised April 1, 1998) shall be interpreted to mean
substantially all as defined in section 368(a)(1)(C). In addition, if
such an election is made, the taxpayer must apply the rules under
section 367(b) and the regulations thereunder to any transfers occurring
within that period as if the election to apply Sec. 1.367(a)-3(b) and
(d) to transfers occurring within that period had not been made, except
that in the case of an exchange described in section 351 the taxpayer
must apply section 367(b) and the regulations thereunder as if the
exchange was described in Sec. 7.367(b)-7 of this chapter (as in effect
[[Page 301]]
before February 23, 2000; see 26 CFR part 1, revised as of April 1,
1999). For example, if a U.S. person, pursuant to a section 351
exchange, transfers stock of a controlled foreign corporation in which
it is a United States shareholder but does not receive back stock of a
controlled foreign corporation in which it is a United States
shareholder, the U.S. person must include in income under Sec.
7.367(b)-7 of this chapter (as in effect before February 23, 2000; see
26 CFR part 1, revised as of April 1, 1999) the section 1248 amount
attributable to the stock exchanged (to the extent that the fair market
value of the stock exchanged exceeds its adjusted basis). Such inclusion
is required even though Sec. 7.367(b)-7 of this chapter (as in effect
before February 23, 2000; see 26 CFR part 1, revised as of April 1,
1999), by its terms, did not apply to section 351 exchanges.
(h) Former 10-year gain recognition agreements. If a taxpayer elects
to apply the rules of this section to all prior transfers occurring
after December 16, 1987, any 10-year gain recognition agreement that
remains in effect (has not been triggered in full) on July 20, 1998 will
be considered by the Internal Revenue Service to be a 5-year gain
recognition agreement with a duration of five full taxable years
following the close of the taxable year of the initial transfer.
(i) [Reserved]
(j) Transition rules regarding certain transfers of domestic or
foreign stock or securities after December 16, 1987, and prior to July
20, 1998--(1) Scope. Transfers of domestic stock or securities described
under section 367(a) that occurred after December 16, 1987, and prior to
April 17, 1994, and transfers of foreign stock or securities described
under section 367(a) that occur after December 16, 1987, and prior to
July 20, 1998 are subject to the rules contained in section 367(a) and
the regulations thereunder, as modified by the rules contained in
paragraph (j)(2) of this section. For transfers of domestic stock or
securities described under section 367(a) that occurred after April 17,
1994 and before January 30, 1997, see Temporary Income Regulations under
section 367(a) in effect at the time of the transfer (Sec. 1.367(a)-
3T(a) and (c), 26 CFR part 1, revised April 1, 1996) and paragraph
(c)(11) of this section. For transfers of domestic stock or securities
described under section 367(a) that occur after January 29, 1997, see
Sec. 1.367(a)-3(c).
(2) Transfers of domestic or foreign stock or securities: Additional
substantive rules--(i) Rule for less than 5-percent shareholders. Unless
paragraph (j)(2)(iii) of this section applies (in the case of domestic
stock or securities) or paragraph (j)(2)(iv) of this section applies (in
the case of foreign stock or securities), a U.S. transferor that
transfers stock or securities of a domestic or foreign corporation in an
exchange described in section 367(a) and owns less than 5 percent of
both the total voting power and the total value of the stock of the
transferee foreign corporation immediately after the transfer (taking
into account the attribution rules of section 958) is not subject to
section 367(a)(1) and is not required to enter into a gain recognition
agreement.
(ii) Rule for 5-percent shareholders. Unless paragraph (j)(2)(iii)
or (iv) of this section applies, a U.S. transferor that transfers
domestic or foreign stock or securities in an exchange described in
section 367(a) and owns at least 5 percent of either the total voting
power or the total value of the stock of the transferee foreign
corporation immediately after the transfer (taking into account the
attribution rules under section 958) may qualify for nonrecognition
treatment by filing a gain recognition agreement in accordance with
Sec. 1.367(a)-3T(g) in effect prior to July 20, 1998 (see 26 CFR part
1, revised April 1, 1998) for a duration of 5 or 10 years. The duration
is 5 years if the U.S. transferor (5-percent shareholder) determines
that all U.S. transferors, in the aggregate, own less than 50 percent of
both the total voting power and the total value of the transferee
foreign corporation immediately after the transfer. The duration is 10
years in all other cases. See, however, Sec. 1.367(a)-3(h). If a 5-
percent shareholder fails to properly enter into a gain recognition
agreement, the exchange is taxable to such shareholder under section
367(a)(1).
[[Page 302]]
(iii) Gain recognition agreement option not available to controlling
U.S. transferor if U.S. stock or securities are transferred.
Notwithstanding the provisions of paragraph (j)(2)(ii) of this section,
in no event will any exception to section 367(a)(1) apply to the
transfer of stock or securities of a domestic corporation where the U.S.
transferor owns (applying the attribution rules of section 958) more
than 50 percent of either the total voting power or the total value of
the stock of the transferee foreign corporation immediately after the
transfer (i.e., the use of a gain recognition agreement to qualify for
nonrecognition treatment is unavailable in this case).
(iv) Loss of United States shareholder status in the case of a
transfer of foreign stock. Notwithstanding the provisions of paragraphs
(j)(2)(i) and (ii) of this section, in no event will any exception to
section 367(a)(1) apply to the transfer of stock of a foreign
corporation in which the U.S. transferor is a United States shareholder
(as defined in Sec. 7.367(b)-2(b) of this chapter (as in effect before
February 23, 2000; see 26 CFR part 1, revised as of April 1, 1999) or
section 953(c)) unless the U.S. transferor receives back stock in a
controlled foreign corporation (as defined in section 953(c), section
957(a) or section 957(b)) as to which the U.S. transferor is a United
States shareholder immediately after the transfer.
[T.D. 8702, 61 FR 68637, Dec. 30, 1996, as amended by T.D. 8770, 63 FR
33556, June 19, 1998; 64 FR 15687, Apr. 1, 1999; T.D. 8850, 64 FR 72550,
Dec. 28, 1999; T.D. 8862, 65 FR 3596, Jan. 24, 2000; T.D. 9243, 71 FR
4282, Jan. 26, 2006; T.D. 9250, 71 FR 8804, Feb. 21, 2006; T.D. 9311, 72
FR 5182, 5183, Feb. 5, 2007; T.D. 9400, 73 FR 30303, May 27, 2008; T.D.
9444, 74 FR 6826, Feb. 11, 2009; T.D. 9446, 74 FR 6957, 6958, Feb. 11,
2009]
Sec. 1.367(a)-3T Treatment of transfers of stock or securities to foreign
corporations (temporary).
(a) through (b)(2)(i)(B) [Reserved] For further guidance, see Sec.
1.367(a)-3(a) through (b)(2)(i)(B).
(b)(2)(i)(C) If in connection with a transaction described in Sec.
1.367(b)-14T, one or more U.S. persons transfer stock of T, as defined
in Sec. 1.358-6(b)(1)(iii), to a corporation in a transfer described in
section 367(a), and the amount of gain in the T stock that would
otherwise be recognized under section 367(a) is less than the deemed
distribution that would result from the adjustments made under Sec.
1.367(b)-14T and that would be treated as a dividend under section
301(c)(1), then section 367(b), and not section 367(a), shall apply to
such transaction. This paragraph (b)(2)(i)(C) applies to transfers
occurring on or after May 23, 2008.
(b)(2)(ii) through (f) [Reserved] For further guidance, see Sec.
1.367(a)-3(b)(2)(ii) through (f).
(g) Effective/applicability date. Paragraph (b)(2)(i)(C) of this
section applies to transfers occurring on or after May 23, 2008.
(h) Expiration date. The applicability of paragraph (b)(2)(i)(C) of
this section expires on May 23, 2011.
[T.D. 9446, 74 FR 13340, Mar. 27, 2009]
Sec. 1.367(a)-4T Special rules applicable to specified transfers of property
(temporary).
(a) In general. This section provides special rules for determining
the applicability of section 367(a)(1) to specified transfers of
property. Paragraph (b) of this section provides a special rule
requiring the recapture of depreciation upon the transfer abroad of
property previously used in the United States. Paragraphs (c) through
(f) of this section provide rules for determining whether certain types
of property are transferred for use in the active conduct of a trade or
business outside of the United States. Paragraph (g) excepts certain
transfers to FSCs from the operation of section 367(a)(1). The treatment
of any transfer of property described in this section shall be
determined exclusively under the rules of this section.
(b) Depreciated property used in the U.S.--(1) In general. If a U.S.
person transfers U.S. depreciated property (as defined in paragraph
(b)(2) of this section) to a foreign corporation in an exchange
described in section 367(a)(1), then that person shall include in its
gross income for the taxable year in which the transfer occurs ordinary
income equal to the gain realized that would have been includible in the
transferor's gross income as ordinary income under section 617(d)(1),
1245(a),
[[Page 303]]
1250(a), 1252(a), or 1254(a), whichever is applicable, if at the time of
the transfer the transferor had sold the property at its fair market
value. Recapture of depreciation under this paragraph (b) shall be
required regardless of whether any exception to section 367(a)(1) (such
as the exception for property transferred for use in the active conduct
of a foreign trade or business) would otherwise apply to the transfer.
However, any applicable exception shall apply with respect to realized
gain that is not included in ordinary income pursuant to this paragraph
(b).
(2) U.S. depreciated property. U.S. depreciated property subject to
the rules of this paragraph (b) is any property that--
(i) Is either mining property (as defined in section 617(f)(2)),
section 1245 property (as defined in section 1245(a)(3)), section 1250
property (as defined in section 1250(c)), farm land (as defined in
section 1252(a)(2)), or oil, gas, or geothermal property (as defined in
section 1254(a)(3)); and
(ii) Has been used in the United States or has qualified as section
38 property by virtue of section 48(a)(2)(B) prior to its transfer.
(3) Property used within and without the U.S. If U.S. depreciated
property has been used partly within and partly without the United
States, then the amount required to be included in ordinary income
pursuant to this paragraph (b) shall be reduced to an amount determined
in accordance with the following formula:
U.S. use
Full recapture amount X -------------
Total use
----------------------------------------------------------------------------------------------------------------
For purposes of the above fraction, the full recapture amount is the
amount that would otherwise be included in the transferor's income under
paragraph (b)(1) of this section. U.S. use is the number of months that
the property either was used within the United States or qualified as
section 38 property by virtue of section 48(a)(2)(B), and was subject to
depreciation by the transferor or a related person. Total use is the
total number of months that the property was used (or available for
use), and subject to depreciation, by the transferor or a related
person. For purposes of this paragraph (b)(3), property shall not be
considered to have been in use outside of the United States during any
period in which such property was, for purposes of section 48 or 168,
treated as property not used predominantly outside the United States
pursuant to the provisions of section 48(a)(2)(B). For purposes of this
paragraph (b)(3) the term related person shall have the meaning set
forth in Sec. 1.367(d)-1T(h).
(4) [Reserved]
(5) Effective date. This paragraph (b) applies to transfers
occurring on or after June 16, 1986.
(c) Property to be leased--(1) Leasing business of transferee.
Tangible property transferred to a foreign corporation that will be
leased to other persons by the foreign corporation shall be considered
to be transferred for use in the active conduct of a trade or business
outside of the United States only if--
(i) The transferee's leasing of the property constitutes the active
conduct of a leasing business;
(ii) The lessee of the property is not expected to, and does not,
use the property in the United States; and
(iii) The transferee has need for substantial investment in assets
of the type transferred.
The active conduct of a leasing business requires that the employees of
the foreign corporation perform substantial marketing, customer service,
repair and maintenance, and other substantial operational activities
with respect to the transferred property outside of the United States.
Tangible property subject to the rules of this paragraph (c) includes
real property located outside of the United States. The rules of Sec.
1.367(a)-5T(b) shall apply to transfers of property described in that
section regardless of satisfaction of the rules of this paragraph (c).
(2) De minimis leasing by transferee. Tangible property transferred
to a foreign corporation that will be leased to other persons by the
foreign corporation and that does not satisfy the conditions of
paragraph (b)(1) of this section shall, nevertheless, be considered to
be transferred for use in the active conduct of a trade or business if
either--
[[Page 304]]
(i) The property transferred will be used by the transferee foreign
corporation in the active conduct of a trade or business but will be
leased during occasional brief periods when the property would otherwise
be idle, such as an airplane leased during periods of excess capacity;
or
(ii) The property transferred is real property located outside the
United States and--
(A) The property will be used primarily in the active conduct of a
trade or business of the transferee foreign corporation; and
(B) Not more than ten percent of the square footage of the property
will be leased to others.
(3) Aircraft and vessels leased in foreign commerce--(i) In general.
For the purposes of satisfying paragraph (c)(1) of this section,
aircraft or vessels, including component parts such as engines leased
separately from aircraft or vessels, transferred to a foreign
corporation and leased to other persons by the foreign corporation shall
be considered to be transferred for use in the active conduct of a trade
or business if--
(A) The employees of the foreign corporation perform substantial
managerial and operational activities of leasing aircraft or vessels
outside the United States; and
(B) The leased tangible personal property is predominantly used
outside the United States, as determined under Sec. 1.954-2T(c)(2)(v).
(d) Property to be sold. Property shall not be considered to be
transferred for use in the active conduct of a trade or business and a
transfer of stock or securities shall not be excepted from section
367(a)(1) under the rules of Sec. 1.367(a)-3T if, at the time of the
transfer, it is reasonable to believe that, in the reasonably
foreseeable future, the transferee will sell or otherwise dispose of any
material portion of the transferred stock, securities, or other property
other than in the ordinary course of business.
(e) Oil and gas working interests--(1) In general. A working
interest in oil and gas properties shall be considered to be transferred
for use in the active conduct of a trade or business if--
(i) The transfer satisfies the conditions of paragraph (e)(2) of
this section;
(ii) At the time of the transfer, the transferee has no intention to
farmout or otherwise transfer any part of the transferred working
interest; and
(iii) During the first three years after the transfer there are no
farmouts or other transfers of any part of the transferred working
interest as a result of which the transferee retains less than a 50
percent share of the transferred working interest.
(2) Active use of working interest. Working interests in oil and gas
properties shall be considered to be transferred for use in the active
conduct of a trade or business if--
(i) The transferor is regularly and substantially engaged in
exploration for and extraction of minerals, either directly or through
working interests in joint ventures, other than by reason of the
property that is transferred;
(ii) The terms of the working interest transferred were actively
negotiated among the joint venturers;
(iii) The working interest transferred constitutes at least a five
percent working interest;
(iv) Prior to and at the time of the transfer, through its own
employees or officers, the transferor was regularly and actively engaged
in--
(A) Operating the working interest, or
(B) Analyzing technical data relating to the activities of the
venture;
(v) Prior to and at the time of the transfer, through its own
employees or officers, the transferor was regularly and actively
involved in decisionmaking with respect to the operations of the
venture, including decisions relating to exploration, development,
production, and marketing; and
(vi) After the transfer, the transferee foreign corporation will for
the foreseeable future satisfy the requirements of subdivisions (iv) and
(v) of this paragraph (d)(2).
(3) Start-up operations. Working interests in oil and gas properties
that do not satisfy the requirements of paragraph (e)(2) of this section
shall, nevertheless, be considered to be transferred for use in the
active conduct of a trade or business if--
(i) The working interest was acquired by the transferor immediately
prior to
[[Page 305]]
the transfer and for the specific purpose of transferring it to the
transferee foreign corporation;
(ii) The requirements of paragraph (e)(2)(ii) and (iii) of this
section are satisfied; and
(iii) The transferee foreign corporation will for the foreseeable
future satisfy the requirements of paragraph (e)(2)(iv) and (v) of this
section.
(4) Other applicable rules. Oil and gas interests not described in
this paragraph (e) may nonetheless qualify for the exception to section
367(a)(1) contained in Sec. 1.367(a)-2T, relating to transfers of
property for use in the active conduct of a trade or business outside of
the United States. However, a mere royalty interest in oil and gas
properties will not be treated as transferred for use in the active
conduct of a trade or business outside the United States. Moreover, a
royalty or similar interest that constitutes intangible property will be
subject to the rules of Sec. 1.367(d)-1T, relating to transfers of
intangible property.
(f) Compulsory transfers. Property shall be presumed to be
transferred for use in the active conduct of a trade or business outside
of the United States, if--
(1) The property was previously in use in the country in which the
transferee foreign corporation is organized; and
(2) The transfer is either:
(i) Legally required by the foreign government as a necessary
condition of doing business in that country; or
(ii) Compelled by a genuine threat of immediate expropriation by the
foreign government.
(g) Relationship to other sections. The rules of Sec. Sec.
1.367(a)-5T, 1.367(a)-6T, and 1.367(d)-1T apply to transfers of property
whether or not the property is transferred for use in the active conduct
of a trade or business outside the United States. See Sec. 1.367(d)-
1T(g)(2)(ii) for a special election with respect to compulsory transfers
of intangible property.
(h) Transfers of certain property to FSCs--(1) In general. The
provisions of section 367 (a) and (d) and the regulations thereunder
shall not apply to a transfer of property by a U.S. person to a foreign
corporation that constitutes a FSC, as defined in section 922(a), if--
(i) The transferee FSC uses the property to generate exempt foreign
trade income, as defined in section 923(a);
(ii) The property is not excluded property, as defined in section
927(a)(2); and
(iii) The property consists of a corporate name or tangible property
that is appropriate for use in the operation of a FSC office.
(2) Exception. The general rule in paragraph (g)(1) of this section
shall not apply if, within three years after the original transfer, the
original transferee FSC (or a subsequent transferee FSC) disposes of the
property other than in the ordinary course of business or through a
transfer to another FSC. Thus, the U.S. transferor may recognize gain in
the taxable year in which the original transfer occurred through the
application of section 367 and the regulations thereunder.
(i) Effective/applicability date. (1) The rules of paragraph (c)(3)
of this section apply for transfers of property occurring on or after
May 2, 2006. Transferors may elect to apply these provisions to
transfers occurring on or after October 22, 2004, by citing the
provisions of paragraph (c)(3) of this section in the documentation for
such transfers required by Sec. 1.6038B-1T(c)(4)(i) and (iv).
(2) Expiration date. The applicability of paragraph (c)(3) of this
section will expire on July 1, 2011.
[T.D. 8087, 51 FR 17947, May 16, 1986, as amended by T.D. 8515, 59 FR
2960, Jan. 20, 1994; T.D. 9406, 73 FR 38116, July 3, 2008]
Sec. 1.367(a)-5T Property subject to section 367(a)(1) regardless of use in
trade or business (temporary).
(a) In general. Section 367(a)(1) shall apply to a transfer of
property described in this section regardless of whether the property is
transferred for use in the active conduct of a trade or business.
Certain exceptions to the operation of this rule are provided in this
section, and a special gain limitation rule is provided in paragraph
(e). A transfer of property described in this section is subject to
section 367(a)(1) even if the transfer is a compulsory transfer
described in Sec. 1.367(a)-4T(f).
[[Page 306]]
(b) Inventory, etc. Regardless of use in an active trade or
business, section 367(a)(1) shall apply to the transfer of--
(1) Stock in trade of the taxpayer or other property of a kind which
would properly be included in the inventory of the 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; and
(2) A copyright, a literary, musical, or artistic composition, a
letter or memorandum, or similar property, held by--
(i) A taxpayer whose personal efforts created such property;
(ii) In the case of a letter, memorandum, or similar property, a
taxpayer from whom such property was prepared or produced; or
(iii) A taxpayer in whose hands the basis of such property is
determined, for purposes of determining gain from a sale or exchange, in
whole or part by reference to the basis of such property in the hands of
a taxpayer described in subdivision (i) or (ii) of this paragraph
(b)(2).
For purposes of this section, the term inventory includes raw materials
and supplies, partially completed goods, and finished products.
(c) Installment obligations, etc. Regardless of use in an active
trade or business, section 367(a)(1) shall apply to the transfer of
installment obligations, accounts receivable, or similar property, but
only to the extent that the principal amount of any such obligation has
not previously been included by the taxpayer in its taxable income.
(d) Foreign currency, etc.--(1) In general. Regardless of use in an
active trade or business, section 367(a)(1) shall apply to the transfer
of foreign currency or other property denominated in foreign currency,
including installment obligations, futures contracts, forward contracts,
accounts receivable, or any other obligation entitling its payee to
receive payment in a currency other than U.S. dollars.
(2) Exception for certain obligations. If transferred property
denominated in a foreign currency--
(i) Is denominated in the currency of the country in which the
transferee foreign corporation is organized; and
(ii) Was acquired in the ordinary course of the business of the
transferor that will be carried on by the transferee foreign
corporation,
then section 367(a)(1) shall apply to the transfer only to the extent
that gain is required to be recognized with respect to previously
realized income reflected in installment obligations subject to
paragraph (c) of this section. The rule of this paragraph (d)(2) shall
not apply to transfers of foreign currency.
(3) Limitation of gain required to be recognized. If section
367(a)(1) applies to a transfer of property described in this paragraph,
then the gain required to be recognized shall be limited to--
(i) The gain realized upon the transfer of property described in
this paragraph (d), minus
(ii) Any loss realized as part of the same transaction upon the
transfer of property described in this paragraph (d).
This limitation applies in lieu of the rule in Sec. 1.367(a)-1T(b)(1).
No loss shall be recognized with respect to property described in this
paragraph (d).
(e) Intangible property. Regardless of use in an active trade or
business, a transfer of intangible property pursuant to section 332
shall be subject to section 367(a)(1), unless it constitutes foreign
goodwill or going concern value, as defined in Sec. 1.367(a)-
1T(d)(5)(iii). For rules concerning transfers of intangible property
pursuant to section 351 or 361, see section 367(d) and Sec. 1.367(d)-
1T.
(f) Leased tangible property. Regardless of use in an active trade
or business, section 367(a)(1) shall apply to a transfer of tangible
property with respect to which the transferor is a lessor at the time of
the transfer, unless--
(1) With respect to property that will not be leased by the
transferee to third persons, the transferee was the lessee of the
property at the time of the transfer; or
(2) With respect to property that will be leased by the transferee
to third persons, the transferee satisfies the conditions set forth in
Sec. 1.367(a)-4T(c)(1) or (2).
(3)(i) With respect to vessels and aircraft, including their
component parts, that will be leased by the transferee to third persons,
the transferee satisfies
[[Page 307]]
the conditions set forth in Sec. 1.367(a)-4T(c).
(ii) Effective/applicability date. The rules of this paragraph
(f)(3) apply for transfers of property occurring on or after May 2,
2006. If the transferor makes the election to apply the provisions of
Sec. 1.367(a)-4T(c)(3) to transfers occurring on or after October 22,
2004, then paragraph (f)(3)(i) of this section will also be applicable
for the transfers affected by that election.
(iii) Expiration date. The applicability of this paragraph (f)(3)
will expire on July 1, 2011.
[T.D. 8087, 51 FR 17949, May 16, 1986, as amended by T.D. 9406, 73 FR
38116, July 3, 2008]
Sec. 1.367(a)-6T Transfer of foreign branch with previously deducted losses
(temporary).
(a) In general. This section provides special rules relating to the
transfer of the assets of a foreign branch with previously deducted
losses. Paragraph (b) of this section provides generally that such
losses must be recaptured by the recognition of the gain realized on the
transfer. Paragraph (c) of this section sets forth rules concerning the
character of, and limitations on, the gain required to be recognized.
Paragraph (d) of this section defines the term previously deducted
losses. Paragraph (e) of this section describes certain reductions that
are made to the previously deducted losses before they are taken into
income under this section. Finally, paragraph (g) of this section
defines the term foreign branch.
(b) Recognition of gain required--(1) In general. If a U.S. person
transfers any assets of a foreign branch to a foreign corporation in an
exchange described in section 367(a)(1), then the transferor shall
recognize gain equal to--
(i) The sum of the previously deducted branch ordinary losses as
defined and reduced in paragraphs (d) and (e) of this section; and
(ii) The sum of the previously deducted branch capital losses as
defined and reduced in paragraphs (d) and (e) of this section.
(2) No active conduct exception. The rules of this paragraph (b)
shall apply regardless of whether the assets of the foreign branch are
transferred for use in the active conduct of a trade or business outside
the United States.
(c) Special rules concerning gain recognized--(1) Character and
source of gain. The gain described in paragraph (b)(1)(i) of this
section shall be treated as ordinary income of the transferor, and the
gain described in paragraph (b)(1)(ii) of this section shall be treated
as long-term capital gain of the transferor. Gain that is recognized
pursuant to the rules of this section shall be treated as income from
sources outside the United States. Such recognized gain shall be treated
as foreign oil and gas extraction income (as defined in section 907) in
the same proportion that previously deducted foreign oil and gas
extraction losses bore to the total amount of previously deducted
losses.
(2) Gain limitation. For a rule limiting the amount of gain required
to be recognized under section 367(a) upon any transfer of property to a
foreign corporation, including the transfer of assets of a foreign
branch with previously deducted losses, see Sec. 1.367(a)-1T(b)(3).
(3) Foreign goodwill and going concern value. For purposes of this
section, the assets of a foreign branch shall include foreign goodwill
and going concern value related to the business of the foreign branch,
as defined in Sec. 1.367(a)-1T(d)(5)(iii). Thus, gain realized upon the
transfer of the foreign goodwill or going concern value of a foreign
branch to a foreign corporation will be taken into account in computing
the limitation on loss recapture under paragraph (c)(2) of this section.
(4) Transfers of certain intangible property. Gain realized on the
transfer of intangible property (computed with reference to the fair
market value of the intangible property as of the date of the transfer)
that is an asset of a foreign branch shall be taken into account in
computing the limitation on loss recapture under paragraph (c)(2) of
this section. For rules relating to the crediting of gain recognized
under this section against income deemed to arise by operation of
section 367(d), see Sec. 1.367(d)-1T(g)(3).
(d) Previously deducted losses--(1) In general. This paragraph (d)
provides rules for determining, for purposes of paragraph (b)(1) of this
section, the
[[Page 308]]
previously deducted losses of a foreign branch any of whose assets are
transferred to a foreign corporation in an exchange described in section
367(a)(1). Initially, the two previously deducted losses of a foreign
branch for a taxable year are the total ordinary loss (``previously
deducted branch ordinary loss'') and the total capital loss
(``previously deducted branch capital loss'') that were realized by the
foreign branch in that taxable year (a ``branch loss year'') prior to
the transfer and that were or will be reflected on a U.S. income tax
return of the transferor. The previously deducted branch ordinary loss
for each branch loss year is reduced by expired net ordinary losses
under paragraph (d)(2) of this section, while the previously deducted
capital loss for each loss year is reduced by expired net capital losses
under paragraph (d)(3) of this section. For each branch loss year, the
remaining previously deducted branch ordinary loss and the remaining
previously deducted branch capital loss are then reduced, proceeding
from the first branch loss year to the last branch loss year, to reflect
expired foreign tax credits under paragraph (d)(4) of this section. The
reductions are made in the order of the taxable years in which the
foreign tax credits arose. Finally, similar reductions are made to
reflect expired investment credits under paragraph (d)(5) of this
section.
(2) Reduction by expired net ordinary loss--(i) In general. The
previously deducted branch ordinary loss for each branch loss year shall
be reduced under this paragraph (d)(2) by the amount of any expired net
ordinary loss with respect to that branch loss year. Expired net
ordinary losses arising in years other than the branch loss year shall
reduce the previously deducted branch ordinary loss for the branch loss
year only to the extent that the previously deducted branch ordinary
loss exceeds the net operating loss, if any, incurred by the transferor
in the branch loss year. The previously deducted branch ordinary losses
shall be reduced proceeding from the first branch loss year to the last
branch loss year. For each branch loss year, expired net operating
losses shall be applied to reduce the previously deducted branch
ordinary loss for that year in the order in which the expired net
ordinary losses arose.
(ii) Existence of expired net ordinary loss. An expired net ordinary
loss exists with respect to a branch loss year to the extent that--
(A) The transferor incurred a net operating loss (within the meaning
of section 172(c));
(B) That net operating loss arose in the branch loss year or was
available for carryover or carryback to the branch loss year under
section 172(b)(1);
(C) That net operating loss has neither given rise to a net
operating loss deduction (within the meaning of section 172(a)) for any
taxable year prior to the year of the transfer, nor given rise to a
reduction of any previously deducted branch ordinary loss (pursuant to
paragraph (d)(2) of this section) of any foreign branch of the
transferor upon a previous transfer to a foreign corporation; and
(D) The period during which the transferor may claim a net operating
loss deduction with respect to that net operating loss has expired.
(3) Reduction by expired net capital loss--(i) In general. The
previously deducted branch capital loss for each branch loss year shall
be reduced under this paragraph (d)(3) by the amount of any expired net
capital loss with respect to that branch loss year. Expired net capital
losses arising in years other than the branch loss year shall reduce the
previously deducted branch capital loss for the branch loss year only to
the extent that the previously deducted branch capital loss exceeds the
net capital loss, if any, incurred by the transferor in the branch loss
year. The previously deducted branch capital losses shall be reduced
proceeding from the first branch loss year to the last branch loss year.
For each branch loss year, expired net capital losses shall be applied
to reduce the previously deducted branch capital loss for that year in
the order in which the expired net capital losses arose.
(ii) Existence of expired net capital loss. An expired net capital
loss exists with respect to a branch loss year to the extent that--
(A) The transferor incurred a net capital loss (within the meaning
of section 1222(10));
[[Page 309]]
(B) That net capital loss arose in the branch loss year or was
available for carryover or carryback to the branch loss year under
section 1212;
(C) That net capital loss has neither been allowed for any taxable
year prior to the year of the transfer, nor given rise to a reduction of
any previously deducted branch capital loss (pursuant to paragraph
(c)(3) of this section) of any foreign branch of the transferor upon any
previous transfer to a foreign corporation; and
(D) The period during which the transferor may claim a capital loss
deduction with respect to that net capital loss has expired.
(4) Reduction for expired foreign tax credit--(i) In general. The
previously deducted branch ordinary loss and the previously deducted
branch capital loss for each branch loss year remaining after the
reductions described in paragraph (d)(2) and (3) of this section shall
be further reduced under this paragraph (d)(4) proportionately by the
amount of any expired foreign tax credit loss equivalent with respect to
that branch loss year. The previously deducted branch losses shall be
reduced proceeding from the first branch loss year to the last branch
loss year. For each branch loss year, expired foreign tax credit loss
equivalents shall be applied to reduce the previously deducted branch
loss for that year in the order in which the expired foreign tax credits
arose.
(ii) Existence of foreign tax credit loss equivalent. A foreign tax
credit loss equivalent exists with respect to a branch loss year if--
(A) The transferor paid, accrued, or is deemed under section 902 or
960 to have paid creditable foreign taxes in a taxable year;
(B) The creditable foreign taxes were paid, accrued, or deemed paid
in the branch loss year or were available for carryover or carryback to
the branch loss year under section 904(c);
(C) No foreign tax credit with respect to the foreign taxes paid,
accrued, or deemed paid has been taken because of the operation of
section 904(a) or similar limitations provided by the Code or an
applicable treaty, and such taxes have not given rise to a reduction
(pursuant to this paragraph (d)(5)) of any previously deducted branch
loss of the foreign branch for a prior taxable year or of any previously
deducted branch losses of any foreign branch of the transferor upon a
prior transfer to a foreign corporation; and
(D) The period during which the transferor may claim a foreign tax
credit for the foreign taxes paid, accrued, or deemed paid has expired.
(iii) Amount of foreign tax credit loss equivalent. The amount of
the foreign tax credit loss equivalent for the branch loss year with
respect to the creditable foreign taxes described in paragraph
(d)(4)(ii) of this section is the amount of those creditable foreign
taxes divided by the highest rate of tax to which the transferor was
subject in the loss year.
(5) Reduction for expired investment credits--(i) In general. The
previously deducted branch ordinary loss and the previously deducted
branch capital loss for each branch loss year shall be further reduced
under this paragraph (d)(5) proportionately by the amount of any expired
investment credit loss equivalent with respect to that branch year. The
previously deducted branch losses shall be reduced proceeding from the
first branch loss year to the last branch loss year. For each branch
loss year, expired investment credit loss equivalents shall be applied
to reduce the previously deducted branch loss for that year in the order
in which the expired investment credits were earned.
(ii) Existence of investment credit loss equivalent. An investment
credit loss equivalent exists with respect to a branch loss year if--
(A) The transferor earned an investment credit (within the meaning
of section 46(a)) in a taxable year;
(B) The investment credit was earned in the branch loss year or was
available for carryover or carryback to the branch loss year under
section 39;
(C) The investment credit earned by the transferor in the credit
year has been denied by section 38(a) or by similar provisions of the
Code and has not given rise to a reduction (pursuant to this paragraph
(d)(5)) of any previously deducted branch loss of the foreign branch for
a preceding taxable year or of the previously deducted losses of any
foreign branch of the transferor upon
[[Page 310]]
any previous transfer to a foreign corporation; and
(D) The period during which the transferor may claim the investment
credit has expired.
(iii) Amount of investment tax credit loss equivalent. The amount of
the investment credit loss equivalent for the branch loss year with
respect to the investment credit described in paragraph (d)(5)(ii) of
this section is 85 percent of the amount of that investment credit
divided by the highest rate of tax to which the transferor was subject
in the loss year.
(e) Amounts that reduce previously deducted losses subject to
recapture--(1) In general. This paragraph (e) describes five amounts
that reduce the sum of the previously deducted branch ordinary losses
and the sum of the previously deducted branch capital losses before they
are taken into income under paragraph (b) of this section. Amounts
representing ordinary income shall be applied to reduce first the sum of
the previously deducted branch ordinary losses to the extent thereof,
and then the sum of the previously deducted branch capital losses to the
extent thereof. Similarly, amounts representing capital gains shall be
applied to reduce first the sum of the previously deducted branch
capital losses and then the sum of the previously deducted branch
ordinary losses.
(2) Taxable income. The previously deducted losses shall be reduced
by any taxable income of the foreign branch recognized through the close
of the taxable year of the transfer, whether before or after any taxable
year in which losses were incurred.
(3) Amounts currently recaptured under section 904(f)(3). The
previously deducted losses shall be reduced by the amount recognized
under section 904(f)(3) on account of the transfer.
(4) Gain recognized under section 367(a). The previously deducted
branch losses shall be reduced by any gain recognized pursuant to
section 367(a)(1) (other than by reason of the provisions of this
section) upon the transfer of the assets of the foreign branch to the
foreign corporation.
(5) Amounts previously recaptured under section 904(f)(3)--(i) In
general. The previously deducted branch losses shall be reduced by the
portion of any amount recognized under section 904(f)(3) upon a previous
transfer of property that was attributable to the losses of the foreign
branch, provided that the amount did not reduce any gain otherwise
required to be recognized under section 367(a)(3)(C) and this section
(or Revenue Ruling 78-201, 1978-1 C.B. 91).
(ii) Portion attributable to the losses of the foreign branch--(A)
Branch property. The full amount recognized under section 904(f)(3) upon
a previous transfer of property of the branch shall be treated as
attributable to the losses of the foreign branch.
(B) Non-branch property. The portion of the amount previously
recognized under section 904(f)(3) upon a transfer of non-branch
property that was attributable to the losses of the foreign branch shall
be the sum, over the taxable years in which the transferor sustained an
overall foreign loss some portion of which was recaptured on the
disposition, of the recaptured portions of those overall foreign losses
after multiplication by the following fraction:
[GRAPHIC] [TIFF OMITTED] TR25SE06.009
For purposes of this fraction, the term losses of the foreign branch for
the year means the losses of the foreign branch that were taken into
account under section 904(f)(2) in determining the amount of the
transferor's overall foreign loss for the year, and the term all foreign
losses for the year means all of the losses of the transferor that were
taken into account under section 904(f)(2).
[[Page 311]]
(6) Amounts previously recognized under the rules of this section.
The previously deducted losses shall be reduced by the amounts
previously recognized under the rules of this section upon a previous
transfer of assets of the foreign branch.
(f) Example. The rules of paragraphs (b) through (e) of this section
are illustrated by the following example.
Example. (i) Facts. X, a U.S. corporation, is a calendar year
taxpayer. On January 1, 1981, X established a branch in foreign country
A to manufacture and sell X's products in country A. On July 1, 1986, X
organized corporation Y, a country A subsidiary, and transferred to Y
all of the assets of its country A branch, including goodwill and going
concern value. During the period from January 1, 1981, through July 1,
1986, X's country A branch earned income and incurred losses in the
following amounts:
Country A Branch
------------------------------------------------------------------------
Ordinary Capital
Year income gain
(loss) (loss)
------------------------------------------------------------------------
1981................................................ (200) 0
1982................................................ (300) (100)
1983................................................ (400) 0
1984................................................ (200) 0
1985................................................ (100) 0
1986................................................ 50 0
------------------------------------------------------------------------
At the time of the transfer of X's country A branch assets to Y,
those assets had a fair market value of $2,500 and an adjusted basis of
$1,000. For each of the assets, fair market value exceeded adjusted
basis. X had no net capital loss or unused investment credit during any
taxable year relevant to the transfer. In 1984, X incurred a net
operating loss of $400, $200 of which was carried back to prior years.
An additional $50 of the 1984 net operating loss was carried over to
1985. The remaining $150 of the 1984 net operating loss was not used in
any year prior to the transfer. In 1979, X paid creditable foreign taxes
of $330 that could not be claimed as a credit in that year or any
earlier year because of section 904. Of those foreign taxes, $100 were
carried over and claimed as a credit in 1983, but the remaining $230
were not used in any year prior to the transfer. X was not required to
recognize any gain under section 904(f)(3) on account of the 1986
transfer or any prior transfer. X was not required to recognize gain
upon the transfer under section 367(a) (other than by reason of the
provisions of this section).
(ii) Previously deducted losses. The previously deducted losses of
X's country A branch are $575 of ordinary losses and $25 of capital
losses, computed as follows: Initially, the branch has previously
deducted ordinary losses of $1,000 ($200+$300+$400+$100), and previously
deducted capital losses of $100. (See paragraph (d)(1) of this section.)
(iii) Expired losses and credits. Under the facts of this example,
there are no reductions for expired net ordinary losses or expired net
capital losses under paragraph (d)(2) or (3) of this section. However,
the previously deducted losses are reduced proceeding from the first
branch loss year to the last branch loss year to reflect the expired
foreign tax credit from 1979. The amount of the foreign tax credit loss
equivalent with respect to 1981 is $500 ($230/.46). It reduces the
previously deducted losses for 1981 proportionately. Thus, the
previously deducted ordinary loss for 1981 is reduced from $200 to $0.
(See paragraph (d)(4) of this section.) The amount of the foreign tax
credit loss equivalent with respect to 1982 is $300 ($500-$200, i.e.,
$138/.46). (See paragraph (d)(4)(ii)(C) of this section.) It reduces the
previously deducted losses for 1982 proportionately. Thus, the
previously deducted ordinary loss for 1982 is reduced from $300 to $75,
and the previously deducted capital loss for 1982 is reduced from $100
to $25.
(iv) Further reductions. The previously deducted ordinary losses of
$575 and the previously deducted capital losses of $25 are reduced by
the taxable income earned by the branch prior to the date of the
transfer ($250). (See paragraph (e)(2) of this section.) Since that
income was ordinary income, it is applied first to reduce the previously
deducted ordinary losses of $575 to $325. (See paragraph (e)(1) of this
section.)
(v) Recapture. Since the gain realized by X upon its transfer of the
branch assets to Y exceeds the sum of the previously deducted branch
losses as defined and reduced above $325+$25), the limitation in
paragraph (c)(2) of this section does not apply. Thus, X is required to
recognize $325 of ordinary income and $25 of long-term capital gain upon
the transfer. (See paragraph (b) and (c)(1) of this section.)
(g) Definition of foreign branch--(1) In general. For purposes of
this section, the term foreign branch means an integral business
operation carried on by a U.S. person outside the United States. Whether
the activities of a U.S. person outside the United States constitute a
foreign branch operation must be determined under all the facts and
circumstances. Evidence of the existence of a foreign branch includes,
but is not limited to, the existence of a separate set of books and
records, and the existence of an office or other fixed place of business
used by employees or officers of the U.S. person in carrying out
business activities outside the United
[[Page 312]]
States. Activities outside the United States shall be deemed to
constitute a foreign branch for purposes of this section if the
activities constitute a permanent establishment under the terms of a
treaty between the United States and the country in which the activities
are carried out. Any U.S. person may be treated as having a foreign
branch for purposes of this section, whether that person is a
corporation, partnership, trust, estate, or individual.
(2) More than one branch. If a U.S. person carries on more than one
branch operation outside the United States, then the rules of this
section must be separately applied with respect to each foreign branch
that is transferred to a foreign corporation. Thus, the previously
deducted losses of one branch may not be offset, for purposes of
determining the gain required to be recognized under the rules of this
section, by the income of another branch that is also transferred to a
foreign corporation. Similarly, the losses of one branch shall not be
recaptured upon a transfer of the assets of a separate branch. Whether
the foreign activities of a U.S. person are carried out through more
than one branch must be determined under all of the facts and
circumstances. In general, a separate branch exists if a particular
group of activities is sufficiently integrated to constitute a single
business that could be operated as an independent enterprise. For
purposes of determining the combination of activities that constitute a
branch operation as defined in this paragraph (g), the nominal
relationship among those activities shall not be controlling. Factors
suggesting that nominally separate business operations constitute a
single foreign branch include a substantial identity of products,
customers, operational facilities, operational processes, accounting and
record-keeping functions, management, employees, distribution channels,
or sales and purchasing forces. For examples of the application of the
principles of this paragraph (g)(2), see Revenue Ruling 81-82, 1981-1
C.B. 127.
(3) Consolidated group. For purposes of this section, the activities
of each of two domestic corporations outside the United States will be
considered to constitute a single foreign branch if--
(i) The two corporations are members of the same consolidated group
of corporations; and
(ii) The activities of the two corporations in the aggregate would
constitute a single foreign branch if conducted by a single corporation.
Notwithstanding the preceding rule of this paragraph (g)(3), gains of a
foreign branch of a domestic corporation arising in a year in which that
corporation did not file a consolidated return with a second domestic
corporation shall not be applied to reduce the previously deducted
losses of a foreign branch of the second corporation (but may be applied
to reduce such losses of the foreign branch of the first corporation)
upon the transfer of the two branches to a foreign corporation, even
though the two domestic corporations file a consolidated return for the
year in which the transfer occurs and the two branches are considered at
that time to constitute a single foreign branch. For an example of the
application of the principles of this paragraph (g)(3), see Revenue
Ruling 81-89, 1981-1 C.B. 129.
(4) Property not transferred. A U.S. transferor's failure to
transfer any property of a foreign branch shall be irrelevant to the
determination of the previously deducted losses of the branch subject to
recapture under the rules of this section. Thus, if the activities with
respect to untransferred property constituted a part of the branch
operation under the rules of this paragraph (g), then the losses
generated by those activities shall be subject to recapture,
notwithstanding the failure to transfer the property. For an example of
the application of the principles of this paragraph (g)(4), see Revenue
Ruling 80-247, 1980-2 C.B. 127, relating to property abandoned by the
U.S. transferor.
(h) Anti-abuse rule. If--
(1) A U.S. person transfers property of a foreign branch to a
domestic corporation for a principal purpose of avoiding the effect of
this section; and
(2) The domestic corporation thereafter transfers the property of
the foreign branch to a foreign corporation,
Then, solely for purposes of this section, that U.S. person shall be
treated as having transferred the property of
[[Page 313]]
the branch directly to the foreign corporation. A U.S. person shall be
presumed to have transferred property of a foreign branch for a
principal purpose of avoiding the effect of this section if the property
is transferred to the domestic corporation less than two years prior to
the domestic corporation's transfer of the property to a foreign
corporation. This presumption may be rebutted by clear evidence that the
subsequent transfer of the property was not contemplated at the time of
the initial transfer to the domestic corporation and that avoidance of
the effect of this section was not a principal purpose for the
transaction. A transfer may have more than one principal purpose.
(i) Basis adjustments. Basis adjustments reflecting gain recognized
pursuant to this section shall be made as described in Sec. 1.367(a)-
1T(b)(4)(ii).
[T.D. 8087, 51 FR 17950, May 16, 1986]
Sec. 1.367(a)-8 Gain recognition agreement requirements.
(a) Scope. This section provides the terms and conditions for a gain
recognition agreement entered into by a United States person pursuant to
Sec. 1.367(a)-3(b) through (e) in connection with a transfer of stock
or securities to a foreign corporation pursuant to an exchange that
would otherwise be subject to section 367(a)(1). Paragraph (b) of this
section provides definitions and special rules. Paragraphs (c) through
(h) of this section identify the form, content, and other conditions of
a gain recognition agreement. Paragraph (i) of this section is reserved.
Paragraph (j) of this section identifies certain events that may require
gain to be recognized under a gain recognition agreement. Paragraph (k)
of this section provides exceptions for certain events that would
otherwise require gain to be recognized under a gain recognition
agreement. Paragraph (l) of this section is reserved. Paragraph (m) of
this section provides rules that require gain to be recognized under a
gain recognition agreement in connection with certain events to which an
exception under paragraph (k) of this section otherwise applies.
Paragraph (n) of this section provides special rules in the case of a
distribution of property with respect to stock to which section 301
applies. Paragraph (o) of this section provides rules for certain
transactions that terminate or reduce the amount of gain subject to a
gain recognition agreement. Paragraph (p) of this section provides
relief for reasonable cause for certain failures to comply with the
requirements of this section. Paragraph (q) of this section provides
examples that illustrate the rules of the section. Paragraph (r) of this
section provides effective dates for the provisions of this section.
(b) Definitions and special rules. The following definitions and
special rules apply for purposes of this section.
(1) Definitions--(i) Asset reorganization--(A) General rule. Except
as provided in paragraph (b)(1)(i)(B) of this section, an asset
reorganization is a reorganization described in section 368(a)(1) that
involves an exchange of property described in section 361(a) or (b) (a
section 361 exchange).
(B) Exceptions. An asset reorganization does not include the
following:
(1) A reorganization described in section 368(a)(1)(D) or (G) if the
requirements of section 354(b)(1)(A) and (B) are not met.
(2) For purposes of paragraphs (j)(2)(ii)(B), (k)(6)(ii), and
(k)(6)(iii) of this section, a triangular asset reorganization. For
rules applicable to a triangular asset reorganization, see paragraph
(k)(7) of this section.
(ii) A consolidated group has the meaning set forth in Sec. 1.1502-
1(h).
(iii) Disposition. Except as provided in this paragraph (b)(1)(iii),
a disposition includes any transfer that would constitute a disposition
for any purpose of the Internal Revenue Code. A disposition includes an
indirect disposition of the stock of the transferred corporation as
described in Sec. 1.367(a)-3(d). Except as provided in paragraph (n)(1)
of this section, a disposition does not include the receipt of a
distribution of property with respect to stock to which section 301
applies (including by reason of section 302(d)). See paragraphs (n)(2)
and (o)(3) of this section for rules that apply if gain is recognized
under section 301(c)(3). A complete or partial disposition by
installment sale (under section 453) shall be
[[Page 314]]
treated as a disposition in the year of the installment sale.
(iv) A gain recognition event is an event described in paragraphs
(j) through (o) of this section that requires gain to be recognized
under a gain recognition agreement.
(v) The initial transfer means a transfer of stock or securities
(transferred stock or securities) to a foreign corporation pursuant to
an exchange that would otherwise be subject to section 367(a)(1) but
with respect to which a gain recognition agreement is entered into by a
United States person pursuant to Sec. 1.367(a)-3(b) through (e).
(vi) An intercompany item has the meaning set forth in Sec. 1.1502-
13(b)(2).
(vii) An intercompany transaction has the meaning set forth in Sec.
1.1502-13(b)(1).
(viii) A nonrecognition transaction has the meaning set forth in
section 7701(a)(45). In addition, a nonrecognition transaction includes
an exchange described in section 351(b) or 356 even if all gain realized
in the exchange is recognized.
(ix) The terms P, S, and T have the meanings set forth in Sec.
1.358-6(b)(1)(i), (ii), and (iii), respectively.
(x) The determination of whether substantially all of the assets of
the transferred corporation have been disposed of is based on all the
facts and circumstances.
(xi) A timely-filed return is a Federal income tax return filed by
the due date set forth in section 6072(a) or (b), plus any extension of
time to file such return granted under section 6081.
(xii) Transferee foreign corporation. Except as provided in this
paragraph (b)(1)(xii), the transferee foreign corporation is the foreign
corporation to which the transferred stock or securities are transferred
in the initial transfer. In the case of an indirect stock transfer, the
transferee foreign corporation has the meaning set forth in Sec.
1.367(a)-3(d)(2)(i). The transferee foreign corporation also includes a
corporation designated as the transferee foreign corporation in the case
of a new gain recognition agreement entered into under this section.
(xiii) Transferred corporation. Except as provided in this paragraph
(b)(1)(xiii), the transferred corporation is the corporation the stock
or securities of which are transferred in the initial transfer. In the
case of an indirect stock transfer, the transferred corporation has the
meaning set forth in Sec. 1.367(a)-3(d)(2)(ii). The transferred
corporation also includes a corporation designated as the transferred
corporation in the case of a new gain recognition agreement entered into
under this section.
(xiv) A triangular asset reorganization is a reorganization
described in Sec. 1.358-6(b)(2)(i), (ii), (iii), or (v).
(xv) The U.S. transferor is the United States person (as defined in
Sec. 1.367(a)-1T(d)(1)) that transfers the transferred stock or
securities to the transferee foreign corporation in the initial
transfer. For purposes of determining the U.S. transferor in the case of
a transfer by a partnership, see Sec. 1.367(a)-1T(c)(3)(i). The U.S.
transferor also includes the United States person designated as the U.S.
transferor in the case of a new gain recognition agreement entered into
under this section including, for example, under paragraph (k)(14) of
this section.
(2) Special rules--(i) Stock deemed received or transferred.
References to stock received include stock deemed received (for example,
pursuant to section 367(c)(2)). References to a transfer of stock or
securities include a deemed transfer of stock or securities.
(ii) Stock of the transferee foreign corporation. References to
stock of the transferee foreign corporation include any stock of the
transferee foreign corporation the basis of which is determined, in
whole or in part, by reference to the basis of the stock of the
transferee foreign corporation received by the U.S. transferor in the
initial transfer.
(iii) Transferred stock or securities. References to transferred
stock or securities include any stock or securities of the transferred
corporation the basis of which is determined, in whole or in part, by
reference to the basis of the stock or securities transferred in the
initial transfer.
(c) Gain recognition agreement--(1) Terms of agreement--(i) General
rule. Except as provided in this paragraph (c)(1)(i), if a gain
recognition event occurs during the period beginning on the
[[Page 315]]
date of the initial transfer and ending as of the close of the fifth
full taxable year (not less than 60 months) following the close of the
taxable year in which the initial transfer occurs (GRA term), the U.S.
transferor must include in income the gain realized but not recognized
on the initial transfer by reason of entering into the gain recognition
agreement. In the case of a gain recognition event that occurs as a
result of a partial disposition of stock, securities, or a partnership
interest, as applicable, the U.S. transferor is required to recognize a
proportionate amount of the gain subject to the gain recognition
agreement, determined based on the fair market value of the stock,
securities, or partnership interest, as applicable, disposed of
(measured at the time of the partial disposition) as compared to the
fair market value of all the stock, securities, or partnership interest,
as applicable (measured at the time of the partial disposition). If the
U.S. transferor must recognize gain under this paragraph as a result of
an event described in paragraph (m) or (n) of this section, see those
paragraphs to determine the amount of the gain that must be recognized.
The amount of gain subject to the gain recognition agreement shall be
reduced by the amount of gain recognized under this paragraph. If the
amount of gain subject to the gain recognition agreement is reduced to
zero, the gain recognition agreement shall terminate without further
effect.
(ii) Ordering rule for gain recognized under multiple gain
recognition agreements. If a gain recognition event occurs that requires
gain to be recognized under multiple gain recognition agreements, gain
shall first be recognized under the gain recognition agreement that
relates to the earliest initial transfer, then under the gain
recognition agreement that relates to the immediately following initial
transfer and so forth until the appropriate amount of gain has been
recognized under each gain recognition agreement. The amount of gain
recognized under a gain recognition agreement shall be determined after
taking into account, as appropriate, any increase to basis (including
the basis of the transferred stock or securities) under paragraph (c)(4)
of this section resulting from gain recognized under another gain
recognition agreement. For an illustration of this ordering rule, see
paragraph (q)(2) of this section, Example 6.
(iii) Taxable year in which gain is reported--(A) Year of initial
transfer. Except as provided in paragraph (c)(1)(iii)(B) of this
section, the U.S. transferor must report any gain recognized under
paragraph (c)(1)(i) of this section on an amended Federal income tax
return for the taxable year of the initial transfer. The amended return
must be filed on or before the 90th day following the date on which the
gain recognition event occurs.
(B) Year of gain recognition event. If an election under paragraph
(c)(2)(vi) of this section is made with the gain recognition agreement
or if paragraph (c)(5)(ii) of this section applies to the gain
recognition agreement, the U.S. transferor must report any gain
recognized under paragraph (c)(1)(i) of this section on its Federal
income tax return for the taxable year during which the gain recognition
event occurs. If an election under paragraph (c)(2)(vi) of this section
is made with the gain recognition agreement or if paragraph (c)(5)(ii)
of this section applies to the gain recognition agreement but the U.S.
transferor does not report the gain recognized on its Federal income tax
return for the taxable year during which the gain recognition event
occurs, the Commissioner may require the U.S. transferor to report the
gain on an amended Federal income tax return for the taxable year during
which the initial transfer occurred.
(iv) Offsets. No special limitations apply with respect to
offsetting gain recognized under paragraph (c)(1)(i) of this section
with net operating losses, capital losses, credits against tax, or
similar items.
(v) Payment and reporting of interest. Interest must be paid on any
additional tax due with respect to gain recognized by the U.S.
transferor under paragraph (c)(1)(i) of this section. Any interest due
shall be determined based on the rates under section 6621 for the period
between the date that was prescribed for filing the Federal income tax
return of the U.S. transferor for the year
[[Page 316]]
of the initial transfer and the date on which the additional tax due is
paid. If paragraph (c)(1)(iii)(B) of this section applies, any interest
due must be included with the payment of tax due with the Federal income
tax return of the U.S. transferor for the taxable year during which the
gain recognition event occurs (or should reduce the amount of any refund
due to the U.S. transferor for such taxable year). A schedule entitled
``Calculation of Section 367 Tax and Interest'' that separately
identifies and calculates any additional tax and interest due must be
included with the Federal income tax return on which any interest due is
reported.
(2) Content of gain recognition agreement. The gain recognition
agreement must be entitled ``GAIN RECOGNITION AGREEMENT UNDER Sec.
1.367(a)-8'' and include the information described in paragraphs
(c)(2)(i) through (viii) of this paragraph with the corresponding
paragraph numbers. The information required under this paragraph (c)(2)
and paragraph (c)(3) of this section must be included in the gain
recognition agreement as filed.
(i) A statement that the document constitutes an agreement by the
U.S. transferor to recognize gain in accordance with the requirements of
this section.
(ii) A description of the transferred stock or securities and other
information as required in paragraph (c)(3) of this section.
(iii) A statement that the U.S. transferor agrees to comply with all
the conditions and requirements of this section, including to recognize
gain under the gain recognition agreement in accordance with paragraph
(c)(1)(i) of this section, extend the statute of limitations on
assessments of tax as provided in paragraph (f) of this section, and
file the certification described in paragraph (g) of this section.
(iv) A statement that arrangements have been made to ensure that the
U.S. transferor is informed of any events that affect the gain
recognition agreement, including triggering events or other gain
recognition events.
(v) In the case of a new gain recognition agreement filed under this
section--
(A) A description of the event (such as a triggering event) and the
applicable exception, if any, that gave rise to the new gain recognition
agreement (such as a triggering event exception), including the date of
the event and the name, address, and taxpayer identification number (if
any) of each person that is a party to the event;
(B) As applicable, a description of the class, amount, and
characteristics of the stock, securities or partnership interest
received in the transaction; and
(C) As applicable, a calculation of the amount of gain that remains
subject to the new gain recognition agreement as a result of the
application of paragraph (m), (n), or (o) of this section.
(vi) A statement whether the U.S. transferor elects to include in
income any gain recognized under paragraph (c)(1)(i) of this section in
the taxable year during which a gain recognition event occurs. See
paragraph (c)(5)(ii) of this section for a rule that requires, in
certain cases, for the gain recognized pursuant to a new gain
recognition agreement to be included in income during the taxable year
in which the gain recognition event occurs.
(vii) A statement whether a gain recognition event has occurred
during the taxable year of the initial transfer.
(viii) A statement describing any disposition of assets of the
transferred corporation during such taxable year other than in the
ordinary course of business.
(3) Description of transferred stock or securities and other
information. The gain recognition agreement shall include the following:
(i) A description of the transferred stock or securities including--
(A) The type or class, amount, and characteristics of the
transferred stock or securities;
(B) A calculation of the amount of the built-in gain in the
transferred stock or securities that are subject to the gain recognition
agreement, reflecting the basis and fair market value on the date of the
initial transfer;
(C) The amount of any gain recognized by the U.S. transferor on the
initial transfer; and
(D) The percentage (by voting power and value) that the transferred
stock (if any) represents of the total stock
[[Page 317]]
outstanding of the transferred corporation on the date of the initial
transfer.
(ii) The name, address, place of incorporation, and taxpayer
identification number (if any) of the transferred corporation.
(iii) The date on which the U.S. transferor acquired the transferred
stock or securities.
(iv) The name, address and place of incorporation of the transferee
foreign corporation, and a description of the stock or securities
received by the U.S. transferor in the initial transfer, including the
percentage of stock (by vote and value) of the transferee foreign
corporation received in such exchange.
(v) If the initial transfer is described in Sec. 1.367(a)-3(e), a
statement that the conditions of section 367(a)(5) and any regulations
under that section have been satisfied, and a description of any
adjustments to the basis of the stock received in the transaction or
other adjustments made pursuant to section 367(a)(5) and any regulations
under that section.
(vi) If the transferred corporation is domestic, a statement
describing the application of section 7874 to the transaction, and
indicating that the requirements of Sec. 1.367(a)-3(c)(1) are
satisfied.
(vii) If the transferred corporation is foreign, a statement
indicating whether the U.S. transferor was a section 1248 shareholder
(as defined in Sec. 1.367(b)-2(b)) of the transferred corporation
immediately before the initial transfer, and whether the U.S. transferor
is a section 1248 shareholder with respect to the transferee foreign
corporation immediately after the initial transfer, and whether any
reporting requirements or other rules contained in regulations under
section 367(b) are applicable, and, if so, whether they have been
satisfied.
(viii) If the initial transfer involves a transfer by a partnership
(see Sec. 1.367(a)-1T(c)(3)(i)) or a transfer of a partnership interest
(see section 367(a)(4) and Sec. 1.367(a)-1T(c)(3)(ii)) a complete
description of the transfer, including a description of the partners in
the partnership.
(ix) If the transaction involved the transfer of property other than
the transferred stock or securities and the transaction was subject to
the indirect stock transfer rules of Sec. 1.367(a)-3(d), a statement
indicating whether--
(A) The reporting requirements under section 6038B have been
satisfied with respect to the transfer of such other property;
(B) Whether gain was recognized under section 367(a)(1);
(C) Whether section 367(d) applied to the transfer of such property;
and
(D) Whether the other property transferred qualified for the active
foreign trade or business exception under section 367(a)(3).
(4) Basis adjustments for gain recognized. The following basis
adjustments shall be made if gain is recognized under paragraph
(c)(1)(i) of this section.
(i) Stock or securities of transferee foreign corporation. The basis
of the stock or securities, as applicable, of the transferee foreign
corporation received by the U.S. transferor in the initial transfer
shall be increased as of the date of the initial transfer by the amount
of gain recognized.
(ii) Transferred stock or securities. The basis of the transferred
stock or securities shall be increased as of the date of the initial
transfer by the amount of the gain recognized.
(iii) Other appropriate adjustments. The basis of other stock,
securities, or a partnership interest shall be increased, as
appropriate, in accordance with the principles of this paragraph (c)(4).
Under no circumstances shall the basis of stock, securities, or of a
partnership interest held by a U.S. person that does not recognize gain
under paragraph (c)(1)(i) of this section be increased under this
paragraph (c)(4). In addition, under no circumstances shall the basis of
any property be increased by the amount of any additional tax due or
interest paid with respect to such tax, nor shall the basis of the
assets of the transferred corporation be increased as a result of gain
recognized by the U.S. transferor under paragraph (c)(1)(i) of this
section.
(iv) Cross-reference. See paragraph (q)(2) of this section, Examples
1, 2, 3, and 5 for illustrations of the rules of this paragraph (c)(4).
See also Sec. 1.367(a)-
[[Page 318]]
1T(b)(4) for rules that determine the increase to basis of property
resulting from the application of section 367(a).
(5) Terms and conditions of a new gain recognition agreement--(i)
General rule. A new gain recognition agreement entered into pursuant to
this section shall replace the existing gain recognition agreement,
which shall terminate without further effect. The term of the new gain
recognition agreement shall be the remaining term of the existing gain
recognition agreement. The amount of gain subject to the new gain
recognition agreement shall equal the amount of gain subject to the
existing gain recognition agreement, reduced by any gain recognized
under paragraph (c)(1)(i) of this section with respect to the existing
gain recognition agreement by reason of the gain recognition event that
gives rise to the new gain recognition agreement. The new gain
recognition agreement shall, as applicable, be subject to the conditions
and requirements of this section to the same extent as the existing gain
recognition agreement. For example, a triggering event with respect to
the new gain recognition agreement will generally include a disposition
of the transferred stock or securities or of substantially all the
assets of the transferred corporation. If, however, the transferred
stock is canceled or redeemed pursuant to the disposition or other event
that gives rise to the new gain recognition agreement (for example,
pursuant to a liquidation where the transferee foreign corporation is
the corporate distributee (within the meaning of section 334(b)(2)), or
an asset reorganization where the transferee foreign corporation is the
acquiring corporation) the transferred stock is not subject to the new
gain recognition agreement.
(ii) Special rule for inclusion of gain. If the U.S. transferor with
respect to the new gain recognition agreement is not the U.S. transferor
with respect to the existing gain recognition agreement, or a member of
the consolidated group of which the U.S. transferor with respect to the
existing gain recognition agreement was a member on the date of the
initial transfer, then any gain recognized under paragraph (c)(1)(i) of
this section with respect to the new gain recognition agreement must be
included in income in the taxable year during which the gain recognition
event occurs.
(d) Filing requirements--(1) General rule. A gain recognition
agreement entered into with respect to an initial transfer must be
included with the timely-filed return of the U.S. transferor for the
taxable year during which the initial transfer occurs.
(2) Special requirements--(i) New gain recognition agreement. A new
gain recognition agreement entered into under this section must be
included with the timely-filed return of the U.S. transferor (as
identified in the new gain recognition agreement) for the taxable year
during which the disposition or event that requires the new gain
recognition agreement occurs. If the new gain recognition agreement is
entered into by the U.S. transferor that entered into the existing gain
recognition agreement, the new gain recognition agreement is in lieu of
the annual certification otherwise required for such taxable year under
paragraph (g) of this section with respect to the existing gain
recognition agreement.
(ii) Multiple events within a taxable year. Except as otherwise
provided in this paragraph (d)(2)(ii), if the initial transfer and one
or more dispositions or other events (even if a triggering event
exception applies) that affect the gain recognition agreement entered
into by the U.S. transferor with respect to the initial transfer occur
within the same taxable year of such U.S. transferor, or if multiple
dispositions or other events occur in a taxable year of the U.S.
transferor that does not include the initial transfer, only one gain
recognition agreement is required to be entered into and included with
the timely-filed return of the U.S. transferor for such taxable year.
The gain recognition agreement must describe the initial transfer and/or
each disposition or other event that affects the gain recognition
agreement (even if a triggering event exception applies). This paragraph
does not apply, however, if any such disposition or other event requires
a new gain recognition agreement to be entered into by a United States
person other than the
[[Page 319]]
U.S. transferor with respect to the initial transfer or that entered
into the existing gain recognition agreement, as applicable.
(3) Common parent as agent for U.S. transferor. If the U.S.
transferor is a member but not the common parent of a consolidated
group, the common parent of the consolidated group is the agent for the
U.S. transferor under Sec. 1.1502-77(a)(1). Thus, the common parent
must file the gain recognition agreement on behalf of the U.S.
transferor. References in this section to the timely-filed return of the
U.S. transferor include the timely-filed return of the consolidated
group of which the U.S. transferor is a member, as applicable.
(e) Signatory--(1) General rule. The gain recognition agreement must
be signed under penalties of perjury by an agent of the U.S. transferor
that is authorized to sign under a general or specific power of
attorney, or by the appropriate party based on the category of the U.S.
transferor described in this paragraph (e)(1).
(i) If the U.S. transferor is a corporation but not a member of a
consolidated group, a responsible officer of the U.S. transferor. If the
U.S. transferor is a member of a consolidated group, a responsible
officer of the common parent of the consolidated group.
(ii) If the U.S. transferor is an individual, the individual.
(iii) If the U.S. transferor is a trust or estate, a trustee,
executor, or equivalent fiduciary of the U.S. transferor.
(iv) In a bankruptcy case under Title 11, United States Code, a
debtor in possession or trustee.
(2) Signature requirement. The inclusion of an unsigned copy of the
gain recognition agreement with the timely-filed return of the U.S.
transferor shall satisfy the signature requirement of paragraph (e)(1)
of this section if the U.S. transferor retains the original signed gain
recognition agreement in the manner specified by Sec. 1.6001-1(e).
(f) Extension of period of limitations on assessments of tax--(1)
General rule. In connection with the filing of a gain recognition
agreement, the U.S. transferor must extend the period of limitations on
assessments of tax with respect to the gain realized but not recognized
on the initial transfer through the close of the eighth full taxable
year following the taxable year during which the initial transfer
occurs. The U.S. transferor extends the period of limitations by filing
Form 8838 ``Consent to Extend the Time to Assess Tax Under Section 367--
Gain Recognition Agreement.'' The Form 8838 must be signed by a person
authorized to sign the gain recognition agreement under paragraph (e)(1)
of this section.
(2) New gain recognition agreement. If a new gain recognition
agreement is entered into under this section, the U.S. transferor must
extend the period of limitations on assessments of tax on the initial
transfer through the close of the eighth full taxable year following the
taxable year during which the initial transfer occurs, consistent with
paragraph (f)(1) of this section, unless the U.S. transferor with
respect to the new gain recognition agreement is the U.S. transferor
with respect to the existing gain recognition agreement, or a member of
the consolidated group of which the U.S. transferor with respect to the
existing gain recognition agreement was a member on the date of the
initial transfer.
(g) Annual certification. Except as provided in paragraph (d)(2)(i)
of this section, the U.S. transferor must include with its timely-filed
return for each of the five full taxable years following the taxable
year of the initial transfer a certification (annual certification) that
includes the information described in paragraphs (g)(1) through (3) of
this section, as appropriate. The annual certification must be signed by
a person authorized under paragraph (e)(1) of this section to sign the
gain recognition agreement for the initial transfer. The inclusion of an
unsigned copy of the annual certification with the relevant timely-filed
return of the U.S. transferor shall satisfy the signature requirement of
paragraph (e)(1) of this section provided the U.S. transferor retains
the original signed certification in the manner specified by Sec.
1.6001-1(e).
(1) A statement of whether a gain recognition event has or has not
occurred during such taxable year. If a gain recognition event has
occurred during such taxable year, the annual certification must state:
[[Page 320]]
(i) The amount of gain subject to the gain recognition agreement at
the time of the gain recognition event;
(ii) The amount of gain recognized under the gain recognition
agreement by reason of the gain recognition event; and
(iii) A calculation of the reduction to the amount of gain subject
to the gain recognition agreement by reason of the gain recognition
event (for example, in the case of a gain recognition event described in
paragraph (n)(2) of this section).
(2) A complete description of any event occurring during such
taxable year that has terminated or reduced the amount of gain subject
to the gain recognition agreement (for example, an event described in
paragraph (o) of this section), including a calculation of any reduction
to the amount of gain subject to the gain recognition agreement.
(3) A statement describing any disposition of assets of the
transferred corporation during the taxable year not in the ordinary
course of business.
(h) Use of security. The U.S. transferor may be required to furnish
a bond or other security that satisfies the requirements of Sec.
301.7101-1 if the Area Director, Field Examination, Small Business/Self
Employed or the Director of Field Operations, Large and Mid-Size
Business (Director) determines that such security is necessary to ensure
the payment of any tax on the gain realized, but not recognized, upon
the initial transfer. Such bond or security generally will be required
only if the transferred stock or securities are a principal asset of the
U.S. transferor and the Director has reason to believe that a
disposition of the stock or securities may be contemplated.
(i) [Reserved]
(j) Triggering events. Except as provided in this section, if an
event described in paragraphs (j)(1) through (10) of this section
(triggering event) occurs during the GRA term, the U.S. transferor must
recognize gain under the gain recognition agreement in accordance with
paragraph (c)(1)(i) of this section. This paragraph (j) generally
requires the U.S. transferor to recognize gain (and pay applicable
interest with respect to any additional tax due as provided in paragraph
(c)(1)(v) of this section) under the gain recognition agreement to the
extent the transferred stock or securities are disposed of, directly or
indirectly. This paragraph (j) also requires the U.S. transferor to
recognize gain under the gain recognition agreement in certain cases
where it is not appropriate for the gain recognition agreement to
continue. See paragraph (k) of this section for exceptions available for
certain events that would otherwise constitute triggering events under
this paragraph (j). See paragraph (o) of this section for certain events
that terminate or reduce the amount of gain subject to a gain
recognition agreement.
(1) Disposition of transferred stock or securities. A complete or
partial disposition of the transferred stock or securities. See
paragraph (q)(2) of this section, Example 2 for an illustration of the
rule of this paragraph (j)(1).
(2) Disposition of substantially all of the assets of the
transferred corporation--(i) General rule. Except as provided in
paragraph (j)(2)(ii) of this section, a disposition in one or more
related transactions of substantially all of the assets of the
transferred corporation (including stock or securities in a subsidiary
corporation or a partnership interest). If the transferred corporation
is domestic, see paragraph (o)(4) of this section.
(ii) Exceptions. For purposes of paragraph (j)(2)(i) of this
section, the following dispositions shall be disregarded--
(A) Dispositions of property described in section 1221(a)(1)
occurring in the ordinary course of business;
(B) An exchange of stock or securities described in section 354 that
is pursuant to an asset reorganization; and
(C) An exchange of stock by a corporate distributee (as defined in
section 334(b)(2)) pursuant to a complete liquidation to which section
332 applies.
(3) Disposition of certain partnership interests. If the initial
transfer occurs by reason of the transfer of a partnership interest, a
complete or partial disposition of such partnership interest. See
section 367(a)(4) and Sec. 1.367(a)-1T(c)(3)(ii).
[[Page 321]]
(4) Disposition of stock of the transferee foreign corporation. A
complete or partial disposition of the stock of the transferee foreign
corporation received by the U.S. transferor in the initial transfer. For
purposes of this section, an individual U.S. transferor that loses U.S.
citizenship or ceases to be a lawful permanent resident of the United
States (within the meaning of section 7701(b)(6)) shall be treated as
disposing of all the stock of the transferee foreign corporation
received in the initial transfer as of the date before the loss of such
status.
(5) Deconsolidation. A U.S. transferor that is a member of a
consolidated group ceases to be a member of the consolidated group,
other than by reason of an acquisition of the assets of the U.S.
transferor in a transaction to which section 381(a) applies, or by
reason of the U.S. transferor joining another consolidated group as part
of the same transaction.
(6) Consolidation. A U.S. transferor becomes a member of a
consolidated group, including a U.S. transferor that is a member of a
consolidated group and that becomes a member of another consolidated
group.
(7) Death of an individual; trust or estate ceases to exist. A U.S.
transferor that is an individual dies, or a U.S. transferor that is a
trust or estate ceases to exist.
(8) Failure to comply. The U.S. transferor fails to comply in any
material respect with any requirement of this section or with the terms
of the gain recognition agreement, including failure to file an annual
certification under paragraph (g) of this section. If a failure to
include information in a gain recognition agreement as filed constitutes
a failure to comply in a material respect, the U.S. transferor cannot
avoid the application of this paragraph (j)(8) by subsequently making
such information available. A material failure under this paragraph
(j)(8) shall extend the period of limitations on assessments of tax
until the close of the third full taxable year ending after the date on
which the Director of Field Operations or Area Director receives actual
notice of the failure to comply from the U.S. transferor.
(9) Gain recognition agreement filed in connection with indirect
stock transfers and certain triangular asset reorganizations. With
respect to a gain recognition agreement entered into in connection with
an indirect stock transfer (as defined in Sec. 1.367(a)-3(d)), or a
triangular asset reorganization under Sec. 1.367(a)-3(e)(2), an
indirect disposition of the transferred stock or securities. For
example, in the case of an indirect stock transfer described in Sec.
1.367(a)-3(d)(1)(iii)(A), a complete or partial disposition of the stock
of the acquiring corporation.
(10) Gain recognition agreement filed pursuant to paragraph (k)(14)
of this section. In the case of a gain recognition agreement entered
into pursuant to paragraph (k)(14) of this section, in addition to any
disposition or other event described in paragraphs (j)(1) through (9) of
this section,--
(i) Any disposition or other event identified as a triggering event
in a new gain recognition agreement as required under paragraph
(k)(14)(iii) of this section; and
(ii) Any disposition or other event that is inconsistent with the
principles of paragraph (k) of this section including, for example, an
indirect disposition of the transferred stock or securities.
(k) Triggering event exceptions. Notwithstanding paragraph (j) of
this section, a disposition or other event described in paragraphs
(k)(1) through (14) of this section shall not constitute a triggering
event. This paragraph (k) generally provides exceptions for certain
dispositions that constitute nonrecognition transactions but only if,
immediately after the disposition, a U.S. transferor retains, as
applicable, a direct or indirect interest in the transferred stock or
securities, or in the assets of the transferred corporation, and a new
gain recognition agreement is entered into with respect to the initial
transfer in accordance with this paragraph (k). Notwithstanding the
application of this paragraph (k), if a gain recognition event described
under paragraphs (m) and (n) of this section occurs during the GRA term
the U.S. transferor may be required to recognize gain under the gain
recognition agreement in accordance with paragraph
[[Page 322]]
(c)(1)(i) of this section. See paragraph (o) of this section which
provides that, notwithstanding paragraph (j) of this section, certain
dispositions or other events shall instead terminate or reduce the
amount of gain subject to a gain recognition agreement.
(1) Transfers of stock of the transferee foreign corporation to a
corporation or partnership. A disposition of stock of the transferee
foreign corporation received in the initial transfer pursuant to an
exchange to which section 351, 354 (but only in a reorganization
described in section 368(a)(1)(B) that is not a triangular
reorganization), 361 (but only in a divisive reorganization to which
section 355 applies), or 721 applies, shall not constitute a triggering
event if a new gain recognition agreement is entered into in accordance
with paragraphs (k)(1)(i) through (iv) of this section, as applicable.
In the case of an exchange to which section 354 applies that is pursuant
to a triangular reorganization described in section 368(a)(1)(B), see
paragraph (k)(14) of this section and paragraph (q)(2) of this section,
Example 4.
(i) In the case of an exchange to which section 351 or 354 applies
in which stock of a foreign acquiring corporation is received, the U.S.
transferor includes with the new gain recognition agreement a statement
that a complete or partial disposition of the stock of the foreign
acquiring corporation received in the exchange shall constitute a
triggering event. The principles of paragraph (o)(1)(i) or (ii), as
appropriate, shall be applied to determine whether a subsequent complete
or partial disposition of the stock of the foreign acquiring corporation
received in the exchange shall instead terminate or reduce the amount of
the new gain recognition agreement.
(ii) In the case of an exchange to which section 351 or 354 applies
in which stock of a domestic acquiring corporation is received, the
domestic acquiring corporation enters into the new gain recognition
agreement, which must designate the domestic acquiring corporation as
the U.S. transferor for purposes of this section. For an illustration of
the rule provided by this paragraph (k)(1)(ii), see paragraph (q)(2) of
this section, Example 3.
(iii) In the case of a section 361 exchange that is pursuant to a
divisive reorganization to which section 355 applies and in which stock
of a domestic corporation (domestic controlled corporation) is received,
the domestic controlled corporation enters into the new gain recognition
agreement, which must designate the domestic controlled corporation as
the U.S. transferor for purposes of this section. For an illustration of
the rule provided by this paragraph (k)(1)(iii), see paragraph (q)(2) of
this section, Example 11.
(iv) In the case of an exchange to which section 721 applies, the
U.S. transferor includes with the new gain recognition agreement a
statement that a complete or partial disposition of the partnership
interest received in the exchange shall constitute a triggering event
for purposes of the new gain recognition agreement.
(2) Complete liquidation of U.S. transferor under sections 332 and
337. A distribution by the U.S. transferor of the stock of the
transferee foreign corporation received in the initial transfer to which
section 337 applies, that is pursuant to a complete liquidation under
section 332, shall not constitute a triggering event if the corporate
distributee (as defined in section 334(b)(2)) is a domestic corporation
(domestic corporate distributee) and the domestic corporate distributee
enters into a new gain recognition agreement. The new gain recognition
agreement must designate the domestic corporate distributee as the U.S.
transferor for purposes of this section.
(3) Transfers of transferred stock or securities to a corporation or
partnership. A disposition of the transferred stock or securities
pursuant to an exchange to which section 351, 354 (but only in a
reorganization described in section 368(a)(1)(B)), or 721 applies, shall
not constitute a triggering event if the U.S. transferor enters in to a
new gain recognition agreement that provides that the dispositions
described in paragraphs (k)(3)(i) and (ii) of this section shall
constitute triggering events for purposes of the new gain recognition
agreement.
(i) A complete or partial disposition of the stock, securities, or
partnership
[[Page 323]]
interest (as applicable) received in exchange for the transferred stock
or securities.
(ii) Any other event that is inconsistent with the principles of
this paragraph (k), including the indirect disposition of the
transferred stock or securities.
(4) Transfers of substantially all of the assets of the transferred
corporation. A disposition of substantially all of the assets of the
transferred corporation pursuant to an exchange to which section 351,
354 (but only in a reorganization described in section 368(a)(1)(B)), or
721 applies, shall not constitute a triggering event if the U.S.
transferor enters into a new gain recognition agreement that provides
that a complete or partial disposition of the stock, securities, or
partnership interest (as applicable) received in exchange for the assets
shall constitute a triggering event for purposes of the new gain
recognition agreement.
(5) Recapitalizations and section 1036 exchanges. A complete or
partial disposition of the transferred stock or securities, or of the
stock of the transferee foreign corporation received in the initial
transfer, pursuant to a reorganization described under section
368(a)(1)(E), or pursuant to a transaction to which section 1036
applies, shall not constitute a triggering event if the U.S. transferor
enters into a new gain recognition agreement.
(6) Certain asset reorganizations--(i) Stock of transferee foreign
corporation. If stock of the transferee foreign corporation received in
the initial transfer is transferred to a domestic acquiring corporation
in a section 361 exchange that is pursuant to an asset reorganization,
the exchanges made pursuant to the asset reorganization shall not
constitute triggering events if the domestic acquiring corporation
enters into a new gain recognition agreement that designates the
domestic acquiring corporation as the U.S. transferor for purposes of
this section. For an illustration of the rule provided by this paragraph
(k)(6), see paragraph (q)(2) of this section, Example 5. If the
acquiring corporation is foreign, see paragraph (k)(14) of this section
and paragraph (q)(2) of this section, Example 6.
(ii) Transferred stock or securities. If the transferred stock or
securities are transferred to a foreign acquiring corporation in a
section 361 exchange that is pursuant to an asset reorganization, the
exchanges made pursuant to the asset reorganization shall not constitute
triggering events if the U.S. transferor enters into a new gain
recognition agreement that designates the foreign acquiring corporation
as the transferee foreign corporation for purposes of this section. For
an illustration of the rule provided by this paragraph, see paragraph
(q)(2) of this section, Example 7. If the transfer is to a domestic
acquiring corporation, or is pursuant to a triangular asset
reorganization, see paragraph (k)(14) or (o)(5) of this section.
(iii) Assets of transferred corporation. If substantially all of the
assets of the transferred corporation are transferred to a foreign or
domestic acquiring corporation in a section 361 exchange that is
pursuant to an asset reorganization, the exchanges made pursuant to the
asset reorganization shall not constitute triggering events if the U.S.
transferor enters into a new gain recognition agreement that, unless the
acquiring corporation is the transferee foreign corporation, designates
the acquiring corporation as the transferred corporation for purposes of
this section. Only the assets of the transferred corporation received by
the acquiring corporation shall be treated as assets of the transferred
corporation for purposes of this section (for example, only such assets
will be taken into account for purposes of paragraph (j)(2) of this
section). For an illustration of the rule provided by this paragraph,
see paragraph (q)(2) of this section, Example 8. If the transferred
corporation is domestic, see section 367(a)(1) and (a)(5), and paragraph
(o)(4) of this section. If the transfer is pursuant to a triangular
asset reorganization, see paragraph (k)(14) of this section.
(7) Certain triangular reorganizations--(i) Transferee foreign
corporation. If substantially all of the assets of the transferee
foreign corporation are transferred to a foreign acquiring corporation
in a section 361 exchange that is pursuant to a triangular asset
reorganization, the exchanges made pursuant
[[Page 324]]
to the reorganization shall not constitute triggering events if a new
gain recognition agreement is entered into in accordance with paragraphs
(k)(7)(i)(A) through (C) of this section. If the acquiring corporation
is domestic, see paragraph (k)(14) of this section. For rules that apply
to gain recognition agreements entered into as a result of an indirect
stock transfer, see Sec. 1.367(a)-3(d)(2)(iv) and paragraph (j)(9) of
this section.
(A) If P is foreign, the new gain recognition agreement designates P
as the transferee foreign corporation and includes a statement that the
U.S. transferor agrees to treat a complete or partial disposition of the
S stock held by P as a triggering event.
(B) Except as provided in paragraph (k)(7)(i)(C) of this section, if
P is domestic, P enters into the new gain recognition agreement that
designates P as the U.S. transferor and S as the transferee foreign
corporation.
(C) If the triangular asset reorganization is described in section
368(a)(1)(A) by reason of section 368(a)(2)(E) and the transferee
foreign corporation is the merged corporation, the U.S. transferor
enters into the new gain recognition agreement and designates the
surviving corporation as the transferee foreign corporation.
(ii) Transferred corporation. If substantially all of the assets of
the transferred corporation are transferred in a section 361 exchange
pursuant to a triangular asset reorganization, the exchanges made
pursuant to the reorganization shall not constitute triggering events if
the U.S. transferor enters into a new gain recognition agreement in
accordance with paragraph (k)(7)(ii)(A) of this section and, as
applicable, paragraph (k)(7)(ii)(B) or (C) of this section.
(A) The new gain recognition agreement includes a statement that the
U.S. transferor agrees to treat a complete or partial disposition of the
P stock received in the reorganization as a triggering event.
(B) If the triangular asset reorganization is described in section
368(a)(1)(C), or section 368(a)(1)(A) or (G) by reason of section
368(a)(2)(D), the new gain recognition agreement includes a statement
that the U.S. transferor agrees to treat a complete or partial
disposition of the S stock held by P as a triggering event.
(C) If the triangular asset reorganization is described in section
368(a)(1)(A) by reason of section 368(a)(2)(E) and the transferred
corporation is the merged corporation, the new gain recognition
agreement includes a statement that the U.S. transferor agrees to treat
a complete or partial disposition of the stock of the surviving
corporation as a triggering event.
(8) Complete liquidation of transferred corporation. A distribution
of substantially all of the assets of the transferred corporation to
which section 337 applies, and the related exchange of the transferred
stock to which section 332 applies, shall not constitute triggering
events, if the U.S. transferor enters into a new gain recognition
agreement. If the transferred corporation is domestic, see Sec.
1.367(e)-2 and paragraph (o)(4) of this section. See paragraph (q)(2) of
this section, Example 9 for an illustration of the rules provided in
this paragraph (k)(8).
(9) Death of U.S. transferor. The death of a U.S. transferor shall
not constitute a triggering event if the person winding up the affairs
of the U.S. transferor--
(i) Retains sufficient assets of the U.S. transferor to satisfy any
possible Federal tax liability of the U.S. transferor under the gain
recognition agreement for the duration of the extended period of
limitations on assessments of tax on the gain realized but not
recognized in the initial transfer;
(ii) Provides security as required under paragraph (h) of this
section for any possible Federal tax liability of the U.S. transferor
under the gain recognition agreement; or
(iii) Obtains a ruling from the Internal Revenue Service providing
for one or more successors to the U.S. transferor under the gain
recognition agreement.
(10) Deconsolidation. A deconsolidation of the U.S. transferor shall
not constitute a triggering event if the U.S. transferor enters into a
new gain recognition agreement.
(11) Consolidation. A consolidation of the U.S. transferor shall not
constitute a triggering event if the U.S. transferor enters into a new
gain recognition
[[Page 325]]
agreement. See paragraph (d)(3) of this section.
(12) Intercompany transactions--(i) General rule. If, pursuant to an
intercompany transaction, the U.S. transferor disposes of stock of the
transferee foreign corporation received in the initial transfer, this
paragraph (k)(12) applies to such disposition to the extent the
intercompany transaction creates an intercompany item that is not taken
into account in the taxable year during which the intercompany
transaction occurs. To the extent this paragraph (k)(12) applies, the
disposition shall not constitute a triggering event, and the U.S.
transferor shall remain subject to the gain recognition agreement if the
conditions of paragraphs (k)(12)(i)(A) and (B) of this section are
satisfied. To the extent the intercompany transaction does not create an
intercompany item see, for example, paragraph (k)(1) and paragraph
(q)(2) of this section, Example 20. See paragraph (o)(6) of this section
for the effect on a gain recognition agreement when an intercompany item
from an intercompany transaction to which this paragraph (k)(12)(i)
applies is taken into account.
(A) At the time of the disposition, the basis of the stock of the
transferee foreign corporation received in the initial transfer that is
disposed of in the intercompany transaction is not greater than the sum
of the amounts described in paragraphs (k)(12)(i)(A)(1) through (3) of
this section. If only a portion of the stock of the transferee foreign
corporation received in the initial transfer is disposed of, then the
basis of such stock shall be compared with a proportionate amount
(measured by value as determined at the time of the disposition) of the
amounts described in paragraph (k)(12)(i)(A)(1) through (3) of this
section. To satisfy the basis condition of this paragraph (k)(12)(i)(A),
the U.S. transferor may reduce the basis of the stock of the transferee
foreign corporation received in the initial transfer that is disposed of
in the intercompany transaction in accordance with the principles of
paragraph (o)(1)(iii) of this section.
(1) The aggregate basis of the transferred stock or securities at
the time of the initial transfer;
(2) The amount of any increase to the basis of the transferred stock
or securities by reason of gain recognized by the U.S. transferor on the
initial transfer; and
(3) The amount of any increase to the basis of the stock disposed of
by reason of an income inclusion by the U.S. transferor with respect to
such stock (for example, pursuant to section 961(a)).
(B) The annual certification filed with respect to the existing gain
recognition agreement for the taxable year during which the intercompany
transaction occurs includes a complete description of the intercompany
transaction and a schedule illustrating how the basis condition of
paragraph (k)(12)(i)(A) of this section is satisfied.
(ii) Certain dispositions following intercompany transaction. A
subsequent disposition of stock of the transferee foreign corporation
that is transferred in an intercompany transaction to which the
exception provided by paragraph (k)(12)(i) of this section applies shall
not constitute a triggering event if--
(A) The stock is transferred to a member of the consolidated group
that includes the U.S. transferor immediately after the disposition, and
(B) The annual certification filed with respect to the existing gain
recognition agreement for the taxable year during which the subsequent
disposition occurs includes a complete description of the disposition.
(13) Deemed asset sales pursuant to section 338(g) elections. A
deemed sale of the assets of the transferred corporation or the
transferee foreign corporation as a result of an election under section
338(g) shall not constitute a triggering event. This paragraph does not
apply to the sale of the stock of the target corporation (within the
meaning of section 338(d)(2)) with respect to which such election is
made.
(14) Other dispositions or events. A disposition or other event that
would constitute a triggering event, without regard to this paragraph
(k)(14), shall not constitute a triggering event if the conditions of
paragraph (k)(14)(i) through (iii) of this section, as applicable, are
satisfied. See paragraph (q)(2), Examples 4, 6, 10, 12, 17, 21, and 23
of this
[[Page 326]]
section for illustrations of the rules provided by this paragraph
(k)(14).
(i) The disposition qualifies as a nonrecognition transaction.
(ii) Immediately after the disposition or other event, a U.S.
transferor retains a direct or indirect interest in the transferred
stock or securities or, as applicable, in substantially all of the
assets of the transferred corporation (for example, in a case where the
transferred corporation has been liquidated pursuant to section 332).
If, as a result of the disposition or other event, a foreign corporation
acquires the transferred stock or securities or, as applicable,
substantially all the assets of the transferred corporation, the
condition of this paragraph (k)(14)(ii) shall be satisfied only if the
U.S. transferor owns at least five percent (applying the attribution
rules of section 318, as modified by section 958(b)) of the total voting
power and the total value of the outstanding stock of such foreign
corporation.
(iii) A new gain recognition agreement is entered into by the U.S.
transferor described in paragraph (k)(14)(ii) of this section that
includes--
(A) An explanation of why this paragraph (k)(14) applies to the
disposition or other event; and
(B) A description of each subsequent disposition or other event that
would constitute a triggering event, other than those described in
paragraph (j) of this section, with respect to the new gain recognition
agreement based on the principles of paragraphs (j) and (k) of this
section including, for example, an indirect disposition of the
transferred stock or securities.
(l) [Reserved]
(m) Receipt of boot in nonrecognition transactions--(1) Dispositions
of transferred stock or securities. Notwithstanding paragraph (k) of
this section, if gain is required to be recognized (not including any
gain that would be treated as a dividend under section 356(a)(2)) in
connection with a disposition of the transferred stock or securities to
which an exception under paragraph (k) of this section otherwise applies
(triggering event exception), the U.S. transferor shall recognize gain
under paragraph (c)(1)(i) of this section equal to the amount of gain
required to be recognized in connection with the disposition, but not in
excess of the amount of gain subject to the gain recognition agreement.
For purposes of this paragraph (m)(1), the amount of gain required to be
recognized in connection with the disposition shall be determined before
taking into account any increase to the basis of the transferred stock
or securities under paragraph (c)(4)(ii) of this section. See paragraph
(q)(2) of this section, Example 13, for an illustration of the rule
provided by this paragraph (m)(1).
(2) Dispositions of assets of transferred corporation. If gain is
required to be recognized (not including any gain that would be treated
as a dividend under section 356(a)(2)) in connection with a disposition
of substantially all of the assets of the transferred corporation to
which a triggering event exception otherwise applies, the U.S.
transferor shall recognize gain under paragraph (c)(1)(i) of this
section equal to the amount of gain required to be recognized in
connection with the disposition, but not in excess of the amount of gain
subject to the gain recognition agreement.
(n) Special rules for distributions with respect to stock--(1)
Certain dividend equivalent redemptions treated as dispositions. A
redemption of the transferred stock or of stock of the transferee
foreign corporation received in the initial transfer that is treated by
reason of section 302(d) as a distribution of property to which section
301 applies shall constitute a disposition for purposes of this section
unless the U.S. transferor enters into a new gain recognition agreement
that includes appropriate provisions to account for the redemption. For
an illustration of the rule of this paragraph (n)(1), see paragraph
(q)(2) of this section, Example 14.
(2) Gain recognized under section 301(c)(3). If gain is required to
be recognized under section 301(c)(3) with respect to the transferred
stock, the U.S. transferor shall recognize gain under the gain
recognition agreement in accordance with paragraph (c)(1)(i) of this
section in an amount equal to the gain required to be recognized under
section 301(c)(3), but not in excess of the amount of gain subject to
the gain recognition agreement. For this purpose, the amount of gain
required to be
[[Page 327]]
recognized under section 301(c)(3) shall be determined before taking
into account any increase in the basis of the transferred stock under
paragraph (c)(4)(ii) of this section.
(o) Dispositions or other events that terminate or reduce the amount
of gain subject to the gain recognition agreement. Notwithstanding
paragraph (j) of this section, the following dispositions or other
events shall not constitute triggering events but instead shall
terminate or reduce the amount of gain subject to the gain recognition
agreement.
(1) Taxable disposition of stock of the transferee foreign
corporation--(i) Complete disposition. Except as otherwise provided in
this paragraph (o)(1)(i), if the U.S. transferor disposes of all the
stock of the transferee foreign corporation received in the initial
transfer in a transaction in which all gain realized is recognized and
included in taxable income during the taxable year of the disposition,
the gain recognition agreement shall terminate without further effect
if, at the time of the disposition, the aggregate basis of such stock is
not greater than the sum of the amounts described in paragraphs
(o)(1)(i)(A) through (C) of this section. This paragraph shall not apply
to a disposition of stock of the transferee foreign corporation pursuant
to an intercompany transaction to which paragraph (k)(12) of this
section applies. This paragraph shall also not apply to an individual
U.S. transferor that loses U.S. citizenship or ceases to be a lawful
permanent resident of the United States (within the meaning of section
7701(b)(6)).
(A) The aggregate basis of the transferred stock or securities at
the time of the initial transfer;
(B) The amount of any increase to the basis of the transferred stock
or securities by reason of gain recognized by the U.S. transferor on the
initial transfer; and
(C) The amount of any increase to the basis of the stock disposed of
by reason of an income inclusion by the U.S. transferor with respect to
such stock (for example, pursuant to section 961(a)).
(ii) Partial dispositions. A partial disposition by the U.S.
transferor of the stock of the transferee foreign corporation received
in the initial transfer in a transaction otherwise described in
paragraph (o)(1)(i) of this section shall reduce the amount of gain
subject to the gain recognition agreement based on the relative fair
market value of the stock disposed of (measured at the time of the
disposition) compared to the fair market value of all of the stock of
the transferee foreign corporation received in the initial transfer
(measured at the time of the disposition). For determining whether the
basis condition of paragraph (o)(1)(i) of this section is satisfied in
the case of a partial disposition, the aggregate basis of the stock
disposed of is compared to a proportionate amount (based on fair market
value, as measured at the time of the partial disposition) of the
amounts described in paragraphs (o)(1)(i)(A) through (C) of this
section. For an illustration of the rules of this paragraph (o)(1)(ii),
see paragraph (q)(2), Example 15, of this section.
(iii) Reduction of stock basis. For purposes of satisfying the basis
condition of paragraph (o)(1)(i) or (ii) of this section, the U.S.
transferor may reduce the aggregate basis of the stock of the transferee
foreign corporation received in the initial transfer, effective
immediately before the disposition. For an illustration of the rules of
this paragraph (o)(1)(iii), see paragraph (q)(2), Example 16, of this
section. The U.S. transferor reduces the basis of the stock of the
transferee foreign corporation by including a statement with the timely-
filed return of the U.S. transferor for the taxable year in which the
disposition occurs, entitled ``Election to Reduce Stock Basis Under
Sec. 1.367(a)-8(o)(1)(iii)'' and that includes--
(A) A description, including the date, of the disposition;
(B) A description of the stock of the transferee foreign corporation
disposed of and the basis adjustments made under this paragraph
(o)(1)(iii); and
(C) The fair market value of all the stock of the transferee foreign
corporation held by the U.S. transferor at the time of the disposition.
(2) Gain recognized in connection with certain nonrecognition
transactions. If the U.S. transferor recognizes gain in connection with
a complete or partial disposition of stock of the transferee
[[Page 328]]
foreign corporation received in the initial transfer that is described
in paragraph (k) of this section, and the basis condition of paragraph
(o)(1)(i) or (ii) of this section, as applicable, is satisfied with the
respect to such disposition, the amount of gain subject to the new gain
recognition agreement filed under paragraph (k) of this section as a
result of such disposition shall equal the amount of gain subject to the
existing gain recognition agreement reduced by the amount of gain
recognized by the U.S. transferor on the disposition. If the U.S.
transferor recognizes gain in connection with a complete or partial
disposition of the stock of the transferee foreign corporation received
in the initial transfer that is described in paragraph (k) of this
section, and the condition of paragraph (o)(1)(i) or (ii) of this
section, as applicable, is satisfied with the respect to the
disposition, but a new gain recognition agreement is not filed with
respect to such disposition so that a triggering event exception does
not apply to the disposition, the amount of gain required to be
recognized by the U.S. transferor under the existing gain recognition
agreement shall be reduced by the amount of the gain recognized on the
disposition.
(3) Gain recognized under section 301(c)(3). If the U.S. transferor
recognizes gain under section 301(c)(3) with respect to the stock of the
transferee foreign corporation received in the initial transfer, the
amount of gain subject to the gain recognition agreement shall be
reduced by the amount of such recognized gain.
(4) Dispositions of substantially all of the assets of a domestic
transferred corporation. Except as otherwise provided in this paragraph
(o)(4), the gain recognition agreement shall terminate without further
effect if substantially all of the assets of the transferred corporation
are disposed of in a transaction in which all gain realized is
recognized and included in taxable income during the taxable year of the
disposition, but only if, at the time of the initial transfer, the U.S.
transferor owned stock in the transferred corporation satisfying the
requirements of section 1504(a)(2) and the U.S. transferor and the
transferred corporation were members of the same consolidated group. If
the initial transfer was part of an indirect stock transfer, the gain
recognition agreement shall terminate without further effect if
substantially all of the assets of the transferred corporation (taking
into account Sec. 1.367(a)-3(d)(2)(v)) are disposed of in a transaction
in which all gain realized is recognized and included in taxable income
during the taxable year of the disposition, but only if at the time of
the initial transfer the U.S. transferor owned stock in the transferred
corporation satisfying the requirements of section 1504(a)(2) (for
example, in the case of a reorganization described in section
368(a)(1)(A) by reason of section 368(a)(2)(E)) and the U.S. transferor
and the transferred corporation were members of the same consolidated
group.
(5) Certain distributions or transfers of transferred stock or
securities to U.S. persons. To the extent a distribution or transfer of
the transferred stock or securities satisfies the conditions of
paragraphs (o)(5)(i) through (iii) of this section, the gain recognition
agreement shall terminate without further effect, or the amount of gain
subject to the gain recognition agreement shall be reduced, as
appropriate.
(i) Distributions or transfers described in section 337, 355, or
361. The transferred stock or securities are distributed or transferred
pursuant to a transaction described in paragraph (o)(5)(i)(A) through
(D) of this section, as appropriate.
(A) A distribution described in section 337 that is pursuant to a
complete liquidation described in section 332. See paragraph (q)(2) of
this section, Example 18, for an illustration of the rule provided by
this paragraph (o)(5)(i)(A).
(B) A distribution to which section 355 applies. See paragraph
(q)(2) of this section, Example 19, for an illustration of the rule
provided by this paragraph (o)(5)(i)(B).
(C) A section 361 exchange that is pursuant to an asset
reorganization. See paragraph (q)(2) of this section, Example 22, for an
illustration of the rule provided by this paragraph (o)(5)(i)(C).
(D) A distribution to which section 361(c) applies that is pursuant
to an asset reorganization. See paragraph (q)(2) of this section,
Example 22, for an
[[Page 329]]
illustration of the rule provided by this paragraph (o)(5)(i)(D).
(ii) Qualified recipient. The recipient of the transferred stock or
securities in the relevant transaction described in paragraph (o)(5)(i)
of this section (qualified recipient) is--
(A) The U.S. transferor;
(B) A member of the consolidated group that includes the U.S.
transferor immediately after the transaction; or
(C) An individual that is a United States person.
(iii) Basis requirement--(A) General rule. Immediately after the
relevant transaction described in paragraph (o)(5)(i) of this section,
the aggregate basis of the transferred stock or securities received by
the qualified recipient is not greater than the aggregate basis of such
stock or securities at the time of the initial transfer (as adjusted for
gain recognized by the U.S. transferor on the initial transfer
attributable to such stock or securities). For this purpose, the basis
of the transferred stock in the hands of the qualified recipient shall
be determined without regard to any basis attributable to income
inclusions with respect to the stock (for example, under section
961(a)). In the case of a distribution to which section 355 applies, any
adjustments to basis under Sec. 1.367(b)-5(c) shall be made before
determining whether the basis condition of this paragraph is satisfied.
(B) Election to reduce basis in transferred stock or securities. If
the basis condition of paragraph (o)(5)(iii)(A) of this section is not
satisfied, each qualified recipient may reduce the basis of the
transferred stock or securities received in the transaction to the
extent necessary to satisfy the basis condition. A qualified recipient
reduces the basis of the transferred stock or securities by including a
statement with its timely-filed return for the taxable year during which
the distribution or transfer occurs entitled ``Election to Reduce Stock
Basis Under Sec. 1.367(a)-8(o)(5)(iii)(B)'' and that includes--
(1) A complete description and the date of the distribution or
transfer;
(2) The fair market value of the transferred stock or securities
received by the qualified recipient in the transaction; and
(3) The basis of the transferred stock or securities received by the
qualified recipient immediately before and after the basis reduction.
(6) Dispositions or other event following certain intercompany
transactions. If, subsequent to an intercompany transaction to which
paragraph (k)(12) of this section applies, a disposition or other event
occurs that requires the U.S. transferor to take into account the
intercompany item related to the intercompany transaction (under the
provisions of Sec. 1.1502-13), the gain recognition agreement shall
terminate without further effect or the amount of gain subject to the
gain recognition agreement shall be reduced based on the principles of
paragraph (o)(1)(i) or (ii) of this section, as appropriate. For an
illustration of the rules of this paragraph (o)(6), see paragraph (q)(2)
of this section, Example 20.
(7) Expropriations under foreign law. The amount of gain subject to
the gain recognition agreement shall be reduced to the extent the stock
or securities of the transferee foreign corporation received in the
initial transfer, the transferred stock or securities, or substantially
all the assets of the transferred corporation, are expropriated, seized,
or subjected to a similar taking of such property by the government of a
foreign country, any political subdivision thereof, or any agency or
instrumentality of the foregoing. Principles similar to those of
paragraph (o)(1)(i) or (o)(1)(ii) of this paragraph, as relevant, shall
be applied to determine the amount of the reduction.
(p) Relief for reasonable cause for failure to comply--(1) Request
for relief. A U.S. transferor that fails to file timely a gain
recognition agreement, waiver of period of limitations on assessments of
tax, annual certification, or other information required under this
section shall be considered to have satisfied the timeliness requirement
with respect to such filing, and a failure to comply in any material
respect with any requirement of this section or with the terms of the
gain recognition agreement that would otherwise constitute a triggering
event shall not constitute a triggering event, if a request for relief
is filed as provided under paragraph (p)(2) of this section
[[Page 330]]
and the U.S. transferor is able to demonstrate to the Area Director,
Field Examination, Small Business/Self Employed or the Director of Field
Operations, Large and Mid-Size Business (Director) having jurisdiction
of the tax return of the U.S. transferor for the taxable year to which
the failure relates, that such failure was due to reasonable cause and
not willful neglect. Whether the failure was due to reasonable cause and
not willful neglect will be determined by the Director after considering
all the facts and circumstances. The Director shall notify the U.S.
transferor in writing within 120 days if it is determined that the
failure was not due to reasonable cause, or if additional time will be
needed to make a determination. For this purpose, the 120-day period
shall begin on the date the Internal Revenue Service notifies the U.S.
transferor in writing that the request for reasonable cause relief has
been received and assigned for review. If the U.S. transferor is not
again notified before the close of the 120-day period, the U.S.
transferor shall be deemed to have established that the failure to file
timely or comply was due to reasonable cause and not willful neglect.
(2) Procedures for filing requests for relief--(i) Time of
submission. Requests for relief under paragraph (p)(1) of this section
shall be considered only if, as soon as the U.S. transferor becomes
aware of the failure to file timely or comply in any material respect
with any requirement of this section, an amended return is filed for the
taxable year to which the failure relates that includes the information
that should have been included with the original return for such taxable
year or otherwise complies with the rules of this section and that
includes a written statement explaining the reasons for the failure to
file timely or comply. The amended return must be filed with the
applicable Internal Revenue Service Center with which the U.S.
transferor filed its original return for such taxable year.
(ii) Notice requirement. In addition to the requirement of paragraph
(p)(2)(i) of this section, the U.S. transferor must comply with the
requirements of paragraph (p)(2)(ii)(A) or (B) of this section, as
applicable.
(A) If any taxable year of the U.S. transferor is under examination
when the amended return is filed, a copy of the amended return and any
information required to be included with such return must be delivered
to the Internal Revenue Service personnel conducting the examination.
(B) If no taxable year of the U.S. transferor is under examination
when the amended return is filed, a copy of the amended return and any
information required to be included with such return must be delivered
to the Director having jurisdiction over the return.
(q) Examples--(1) Presumed facts and references. For purposes of the
examples in paragraph (q)(2) of this section, and except where otherwise
indicated, the following is presumed.
(i) UST, USP, and DC are domestic corporations that each use a
calendar taxable year.
(ii) USP wholly owns UST and is the common parent of the
consolidated group of which UST is a member.
(iii) TFC, TFD, F1, and FA are foreign corporations.
(iv) UST wholly owns TFD.
(v) In a section 351 exchange, UST transfers all of the stock of TFD
(TFD stock) to TFC in exchange solely for stock of TFC (the initial
transfer).
(vi) Pursuant to Sec. 1.367(a)-3(b)(1)(ii) and this section, UST
enters into a gain recognition agreement in connection with the initial
transfer and makes the election described under paragraph (c)(2)(vi) of
this section with respect to the gain recognition agreement.
(vii) As applicable, the section 1248 amount (within the meaning of
Sec. 1.367(b)-2(c)) or all earnings and profits amount (within the
meaning of Sec. 1.367(b)-2(d)) attributable to the stock of a foreign
corporation is zero.
(viii) All transactions are respected under general principles of
tax law, including the step transaction doctrine.
(ix) References to a U.S. transferor entering into a gain
recognition agreement mean, where applicable, that the common parent of
the consolidated group of which the U.S. transferor is a member has
filed the gain recognition agreement on behalf of the U.S. transferor in
accordance with paragraph (d)(3) of this section.
[[Page 331]]
(x) Taxable years during the GRA term are referred to, for example,
as year 1 and year 2.
(2) Examples. The following examples illustrate the application of
the rules of this section.
Example 1. Basis adjustments from gain recognized under the gain
recognition agreement. (i) Facts. TFC wholly owns F1. In year 3,
pursuant to a section 351 exchange, TFC transfers all of the TFD stock
to F1 in exchange solely for voting stock of F1. UST enters into a new
gain recognition agreement with respect to the initial transfer under
paragraph (k)(3) of this section, and therefore the transfer by TFC of
the TFD stock to F1 is not a triggering event. Under paragraph (c)(5)(i)
of this section, the existing gain recognition agreement terminates
without further effect. In year 4, in an exchange to which section 721
applies, UST contributes the TFC stock received in the initial transfer
to PRS, a domestic partnership, in exchange for a partnership interest.
UST enters into a new gain recognition agreement with respect to the
initial transfer under paragraph (k)(1) of this section, and therefore
the transfer by UST of the TFC stock to PRS is not a triggering event.
Under paragraph (c)(5)(i) of this section, the new gain recognition
agreement filed by UST in year 3 terminates without further effect. In
year 5, TFD disposes of substantially all of its assets in a transaction
that constitutes a triggering event under paragraph (j)(2)(i) of this
section. Under paragraph (c)(1)(i) of this section, UST recognizes the
gain realized but not recognized on the initial transfer by reason of
entering into the gain recognition agreement.
(ii) Result. Under paragraph (c)(4) of this section, the basis of
the PRS interest held by UST, the TFC stock held by PRS that was
received from UST in year 4, the F1 stock held by TFC that was received
in exchange for the TFD stock in year 3, and the TFD stock held by F1
that was received from TFC in year 3 is increased by the amount of gain
recognized by UST (but not by the additional tax or interest paid as
result of such gain) with respect to the initial transfer under the gain
recognition agreement. However, the basis of the assets of TFD
(including the assets disposed of in year 5) is not increased as a
result of the gain recognized by UST.
Example 2. Impact of gain recognition event on computation of
income. (i) Facts. At the time of the initial transfer, the TFD stock
has a $50x basis, a $100x fair market value, and a $30x section 1248
amount. The amount of gain subject to the gain recognition agreement is
$50x. UST did not make an election under paragraph (c)(2)(vi) of this
section with respect to the gain recognition agreement. In year 3, TFC
disposes of the TFD stock received in the initial transfer in exchange
for $120x cash.
(ii) Result--(A) Gain recognition without an election. The
disposition by TFC of the TFD stock in year 3 is a triggering event
under paragraph (j)(1) of this section. As a result, under paragraph
(c)(1)(i) of this section, UST must recognize and include in income $50x
gain under the gain recognition agreement. Under paragraph
(c)(1)(iii)(A) of this section, UST must report the $50x gain on an
amended return filed for the taxable year of the initial transfer. Under
paragraph (c)(1)(v) of this section, UST must pay applicable interest on
any additional tax due with respect to the $50x gain recognized. Under
section 1248(a), $30x of the gain recognized by UST under the gain
recognition agreement is recharacterized as a dividend. Under paragraph
(c)(4) of this section, as of the date of the initial transfer, the
basis of the TFC stock received by UST in the initial transfer and the
TFD stock received by TFC in the initial transfer, respectively, is
increased by $50x. After taking into account the increase to the basis
of the TFD stock, TFC recognizes $20x gain on the disposition of the TFD
stock in year 3.
(B) Gain recognition with an election. If UST made an election under
paragraph (c)(2)(vi) of this section with the gain recognition agreement
filed for the initial transfer, the result would be the same as in
paragraph (ii)(A) of this Example 2, except that UST must include in
income the $50x gain recognized under the gain recognition agreement on
its tax return filed for year 3. Any additional tax due with respect to
the $50x gain and applicable interest on the additional tax due must be
included with such return. The amount, if any, of the $50x gain
recognized by UST under the gain recognition agreement that is
characterized as a dividend under section 1248(a) is determined in year
3.
Example 3. Transfer of stock of the transferee foreign corporation
to a domestic corporation in a section 351 exchange. (i) Facts. UST
wholly owns DC. In year 3, pursuant to a section 351 exchange, UST
transfers all of the TFC stock received in the initial transfer to DC in
an exchange solely for voting stock of DC.
(ii) Result. The year 3 transfer of the TFC stock by UST to DC
constitutes a triggering event under paragraph (j)(4) of this section.
However, the transfer shall not constitute a triggering event pursuant
to paragraph (k)(1)(ii) of this section if DC enters into a new gain
recognition agreement with respect to the initial transfer that
designates DC as the U.S. transferor for purposes of this section.
Pursuant to paragraphs (c)(4)(i) and (ii) of this section, if DC is
required to recognize gain under the new gain recognition agreement, the
basis of the stock of TFC and TFD would be increased by the amount of
gain recognized. However, pursuant to paragraph (c)(4)(iii) of this
section, no adjustment
[[Page 332]]
would be made to the basis of the DC voting stock received by UST in
year 3 as a result of such gain recognition. Alternatively, if the
conditions for the application of paragraph (k)(14) of this section are
satisfied UST could instead enter into the new gain recognition
agreement with respect to the initial transfer.
Example 4. Transfer of stock of the transferee foreign corporation
in a triangular section 368(a)(1)(B) reorganization. (i) Facts. DC
wholly owns FA. In year 3, pursuant to a triangular reorganization
described in section 368(a)(1)(B), UST transfers all of the TFC stock
received in the initial transfer to FA in exchange solely for 20% of the
outstanding voting stock of DC. At the time of the reorganization, the
TFC stock has a basis in excess of fair market value.
(ii) Result. (A) The transfer by UST of the TFC stock to FA is an
indirect stock transfer under Sec. 1.367(a)-3(d)(1)(iii)(B).
Accordingly, to preserve nonrecognition treatment, UST must enter into a
separate gain recognition agreement under this section with respect to
such transfer.
(B) With respect to the gain recognition agreement filed for the
initial transfer of the TFD stock, the transfer by UST of the TFC stock
to FA is a triggering event under paragraph (j)(4) of this section.
However, the transfer shall not constitute a triggering event if the
conditions of the exception provided by paragraph (k)(14) of this
section are satisfied.
(1) The condition of paragraph (k)(14)(i) of this section is
satisfied because the transfer qualifies as a nonrecognition transaction
(assuming UST enters into a gain recognition agreement as described in
paragraph (ii)(A) of this Example 4).
(2) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the transfer DC, a domestic
corporation that is eligible to be a U.S. transferor, owns at least 5%
(applying the attribution rules of section 318, as modified by section
958(b)) of the total voting power and total fair market value of the
outstanding stock of FA. As a result, DC is treated as retaining an
indirect interest in the TFD stock immediately following the transfer.
(3) The condition of paragraph (k)(14)(iii) of this section is
satisfied if DC enters into a new gain recognition agreement with
respect to the initial transfer of the TFD stock that, based on the
principles of paragraph (j) of this section, describes the subsequent
dispositions or other events that would constitute triggering events for
purposes of the new gain recognition agreement (other than the
dispositions and other events described in paragraph (j) of this
section). For example, a complete or partial disposition of the stock of
FA would constitute a triggering event for purposes of the new gain
recognition agreement.
Example 5. Transfer of stock of the transferee foreign corporation
to a domestic corporation pursuant to an asset reorganization. (i)
Facts. At the time of the initial transfer the TFD stock has a $50x
basis and a $100x fair market value. Therefore, the amount of gain
subject to the gain recognition agreement is $50x. In year 3, pursuant
to an asset reorganization described in section 368(a)(1)(A), UST
transfers its assets to DC in exchange solely for 20% of the outstanding
stock of DC. UST distributes the stock of DC to USP pursuant to the plan
of reorganization.
(ii) Result. The transfer by UST of the TFC stock to DC constitutes
a triggering event under paragraph (j)(4) of this section. However,
pursuant to paragraph (k)(6)(i) of this section, if DC enters into a new
gain recognition agreement with respect to the initial transfer that
designates DC as the U.S. transferor, the transfer shall not constitute
a triggering event.
Example 6. Transfer of stock of the transferee foreign corporation
to a foreign corporation pursuant to an asset reorganization. (i) Facts.
The facts are the same as in Example 5, except the acquiring corporation
in the asset reorganization is FA, and, at the time of the asset
reorganization, the TFC stock transferred by UST to FA has a $50x basis
and a $150x fair market value. All of the conditions under section
367(a)(5) and the regulations under that section are satisfied, and no
adjustment is required to the basis of the FA stock received by USP in
the transaction.
(ii) Result. (A) The transfer by UST of the TFC stock to FA is
described in section 361(a) and is therefore subject to section
367(a)(5). In general, UST cannot file a gain recognition agreement with
respect to such transfer, and the transfer therefore is subject to the
general rule of section 367(a)(1). However, if the conditions of Sec.
1.367(a)-3(e)(1)(i) through (iv) are satisfied, USP can enter into a
gain recognition agreement with respect to the transfer to avoid the
recognition of gain by UST on the transfer under section 367(a)(1). If
the exception provided by paragraph (k)(14) of this section applies so
that the transfer by UST of the TFC stock to FA is not a triggering
event with respect to the gain recognition agreement filed for the
initial transfer (discussed in paragraph (ii)(B) of this Example 6), the
amount of gain subject to the gain recognition agreement (if entered
into) with respect to the transfer by UST of the TFC stock to FA in the
asset reorganization is $100x.
(B) Under paragraph (j)(4) of this section, the transfer of the TFC
stock by UST to FA is a triggering event with respect to the gain
recognition agreement for the initial transfer. The exception provided
by paragraph (k)(6)(i) of this section does not apply to such transfer
because FA, the acquiring corporation in the asset reorganization, is
foreign. However, the transfer shall not constitute a
[[Page 333]]
triggering event if the conditions of the exception provided by
paragraph (k)(14) of this section are satisfied.
(1) The condition of paragraph (k)(14)(i) of this section is
satisfied because the transfer of the TFC stock to FA qualifies as a
nonrecognition transaction (assuming USP enters into a gain recognition
agreement with respect to such transfer).
(2) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the transfer USP, a domestic
corporation that is eligible to be a U.S. transferor, owns at least 5%
(applying the attribution rules of section 318, as modified by section
958(b)) of the total voting power and total fair market value of the
outstanding stock of FA. As a result, USP is treated as retaining an
indirect interest in the TFD stock immediately following the transfer.
(3) The condition of paragraph (k)(14)(iii) of this section is
satisfied if USP enters into a new gain recognition agreement with
respect to the initial transfer of the TFD stock that, based on the
principles of paragraph (j) of this section, describes the subsequent
dispositions or other events that would constitute triggering events for
purposes of the new gain recognition agreement, other than those already
provided in paragraph (j) of this section. For example, a disposition of
the stock of FA would constitute such a triggering event for purposes of
the new gain recognition agreement.
(iii) Alternate facts. Assume the same facts as in paragraph (i) of
this Example 6, including that paragraph (k)(14) of this section applies
to the year 3 reorganization so that USP enters into a new gain
recognition agreement with respect to the initial transfer of the TFD
stock that occurred in year 1 (GRA 1), and that under Sec. 1.367(a)-
3(e) USP enters into a separate gain recognition agreement with respect
to the initial transfer of the TFC stock by UST to FA pursuant to the
year 3 asset reorganization (GRA 2). Assume further that in year 4 TFC
disposes of 10% of the TFD stock pursuant to a transaction that
constitutes a triggering event with respect to GRA 1. The disposition of
the TFD stock is not a triggering event with respect to GRA 2 because
the TFD stock disposed of does not constitute substantially all the
assets of TFC. Under paragraphs (j)(1) and (c)(1)(i) of this section,
USP must recognize $5x gain (10% of $50x) under GRA 1. Under paragraph
(c)(4)(i) and (ii) of this section, as of the date of the initial
transfer (with respect to which GRA 1 was filed), the basis of the TFC
stock and TFD stock, respectively, is increased by $5x. Under paragraph
(c)(1)(i) of this section, the amount of gain subject to GRA 1 is
reduced from $50x to $45x. Similarly, because the transferred stock for
purposes of GRA 2 is the TFC stock, the amount of gain subject to GRA 2
is reduced from $100x to $95x to reflect the increase to the basis of
the TFC stock.
Example 7. Transfer of transferred stock to a foreign corporation
pursuant to an asset reorganization. (i) Facts. UST wholly owns FA. In
year 4, pursuant to a reorganization described in section 368(a)(1)(D),
TFC transfers all of the TFD stock to FA in exchange solely for stock of
FA. TFC distributes the FA stock to UST pursuant to the plan of
reorganization.
(ii) Analysis. In general, the year 4 transfer by TFC of the TFD
stock to FA and the exchange by UST of the TFC stock for FA stock
constitute triggering events under paragraphs (j)(1) and (4) of this
section, respectively. However, under paragraph (k)(6)(ii) of this
section, the transfers shall not constitute triggering events if UST
enters into a new gain recognition agreement with respect to the initial
transfer that designates FA as the transferee foreign corporation.
Example 8. Transfer of substantially all the assets of the
transferred corporation pursuant to an asset reorganization. (i) Facts.
In year 4, pursuant to an asset reorganization described in section
368(a)(1)(C), TFD transfers all of its assets to FA in exchange solely
for voting stock of FA. TFD distributes the FA voting stock to TFC
pursuant to the plan of reorganization.
(ii) Analysis. The year 4 transfer by TFD of all its assets to FA
and the exchange by TFC of its TFD stock for FA voting stock pursuant to
the reorganization constitute triggering events under paragraphs (j)(2)
and (j)(1) of this section, respectively. However, under paragraph
(k)(6)(iii) of this section, the transfers shall not constitute
triggering events if UST enters into a new gain recognition agreement
with respect to the initial transfer that designates FA as the
transferred corporation. In addition, under paragraph (k)(6)(iii) of
this section only the assets of TFD acquired by FA in the asset
reorganization shall be treated as assets of the transferred corporation
for purposes of the new gain recognition agreement.
Example 9. Complete liquidation of transferred corporation into
transferee foreign corporation. (i) Facts. UST does not make an election
under paragraph (c)(2)(vi) of this section in connection with the gain
recognition agreement entered into with respect to the initial transfer.
In year 3, TFD distributes all of its assets to TFC pursuant to a
complete liquidation to which sections 332 and 337 apply. Under
paragraph (k)(8) of this section, UST enters into a new gain recognition
agreement with respect to the initial transfer such that the liquidation
is not a triggering event. Under paragraph (c)(5)(i) of this section,
the new gain recognition agreement is subject to the conditions and
requirements of this section to the same extent as the existing gain
recognition agreement, except
[[Page 334]]
that the transferred stock is no longer subject to the gain recognition
agreement because the transferred stock is cancelled by reason of the
liquidation. In year 5 TFC disposes of substantially all of the assets
received from TFD in the year 3 liquidation.
(ii) Result. The year 5 disposition by TFC of substantially all of
the assets received from TFD in the year 3 liquidation is a triggering
event under paragraph (j)(2) of this section, and therefore UST must
recognize the gain subject to the gain recognition agreement. UST must
report the gain recognized on an amended return for the taxable year
during which the initial transfer occurred. UST must also pay applicable
interest on any additional tax due with respect to the gain recognized.
Under paragraph (c)(4)(i) of this section, the basis of the TFC stock
received by UST in the initial transfer is increased as of the date of
the initial transfer by the amount of gain recognized under the gain
recognition agreement. The basis of the assets of TFD, however, is not
increased.
Example 10. Transfer of transferred stock to foreign corporation in
section 351 exchange, followed by a section 332 liquidation of the
foreign corporation. (i) Facts. In year 3, pursuant to a section 351
exchange, TFC transfers the TFD stock to F1, a newly formed corporation,
in exchange solely for voting stock of F1. The transfer by TFC of the
TFD stock to F1 is not a triggering event because UST complies with the
conditions of paragraph (k)(3) of this section. In year 5, F1
distributes all of its assets to TFC in a complete liquidation to which
sections 332 and 337 apply.
(ii) Result. The distribution of the TFD stock by F1, and the
exchange of F1 stock by TFC pursuant to the year 5 liquidation of F1
constitute triggering events under paragraphs (j)(1) and (k)(3)(i) of
this section, respectively. However, if paragraph (k)(14) of this
section applies, neither the distribution of the TFD stock by F1, nor
the exchange by TFC of the F1 stock, shall constitute a triggering
event.
(A) The condition of paragraph (k)(14)(i) of this section is
satisfied because the distribution of the TFD stock, and the exchange of
F1 stock, both qualify as nonrecognition transactions.
(B) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the distribution UST, a domestic
corporation that is eligible to be a U.S. transferor, owns at least 5%
(applying the attribution rules of section 318, as modified by section
958(b)) of the stock of TFC. As a result, UST is treated as retaining an
indirect interest in the TFD stock following the complete liquidation of
F1.
(C) The condition of paragraph (k)(14)(iii) of this section is
satisfied if UST enters into a new gain recognition agreement. Because
after the complete liquidation of F1, UST wholly owns TFC, which wholly
owns TFD, as was the case immediately after the initial transfer, UST is
not required to describe, with the new gain recognition agreement, other
dispositions or events that would constitute triggering events based on
the principles of paragraph (j) of this section, other than the
dispositions or events described in paragraph (j) of this section.
Example 11. Disposition of stock of transferee foreign corporation
pursuant to a divisive reorganization. (i) Facts. In year 3, pursuant to
a divisive reorganization described in section 368(a)(1)(D), UST
transfers all of the TFC stock to DC, a newly-formed corporation, in
exchange solely for stock of DC. UST then distributes all of the DC
stock to USP in a transaction to which section 355 applies.
(ii) Result. The transfer of the TFC stock by UST to DC constitutes
a triggering event under paragraph (j)(4) of this section. However,
under paragraph (k)(1)(iii) of this section, the transfer of the TFC
stock shall not constitute a triggering event if DC enters into a new
gain recognition agreement that designates DC as the U.S. transferor for
purposes of this section.
(iii) Alternate facts. The facts are the same as in paragraph (i) of
this Example 11, except that UST transfers only 90% of the TFC stock to
DC. Paragraph (k)(1)(iii) of this section applies only with respect to
the TFC stock transferred to DC. Thus, the conditions of paragraph
(k)(1)(iii) of this section are satisfied if DC enters into a new gain
recognition agreement with respect to the TFC stock received from UST.
The amount of gain subject to the new gain recognition agreement entered
into by DC equals 90% of the amount of gain subject to the gain
recognition agreement entered into by UST with respect to the initial
transfer. The amount of gain subject to the gain recognition agreement
entered into by UST with respect to the initial transfer is reduced by
the amount of gain subject to the new gain recognition agreement entered
into by DC. The gain recognition agreement entered into by UST with
respect to the initial transfer continues to apply to the remaining TFC
stock held by UST.
Example 12. Disposition of transferred stock pursuant to a divisive
reorganization. (i) Facts. In year 3, pursuant to a divisive
reorganization described in section 368(a)(1)(D), TFC transfers all of
the TFD stock to F1, a newly formed corporation, in exchange solely for
all of the outstanding stock of F1. TFC then distributes all of the F1
stock to UST in a transaction to which section 355 applies.
(ii) Result. The transfer by TFC of the TFD stock to F1 constitutes
a triggering event under paragraph (j)(1) of this section. However, if
paragraph (k)(14) of this section applies, neither the transfer of the
TFD stock by TFC to F1, nor the distribution of the F1 stock by TFC to
UST, shall constitute triggering events.
[[Page 335]]
(A) The condition of paragraph (k)(14)(i) of this section is
satisfied because the dispositions of the TFD stock and F1 stock qualify
as nonrecognition transactions.
(B) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the transfer UST, an eligible U.S.
transferor, owns at least 5% (applying the attribution rules of section
318, as modified by section 958(b)) of the total voting power and the
total fair market value of the outstanding stock of F1. As a result, UST
is treated as retaining an indirect interest in the TFD stock following
the dispositions.
(C) The condition of paragraph (k)(14)(iii) of this section is
satisfied if UST enters into a new gain recognition agreement with
respect to the initial transfer that describes the subsequent
dispositions or other events that would constitute triggering events
based on the principles of paragraph (j) of this section, other than
those described in paragraph (j) of this section. For example, a
complete or partial disposition of the F1 stock would constitute a
triggering event for purposes of the new gain recognition agreement
(subject to the exceptions provided by paragraph (k) of this section).
Example 13. Receipt of boot by the transferee foreign corporation in
a subsequent section 351 exchange. (i) Facts. At the time of the initial
transfer, the TFD stock has a $50x basis and $100x fair market value.
The amount of gain subject to the gain recognition agreement is $50x. In
year 3, TFC and X, an unrelated foreign corporation, form F1. TFC
transfers the TFD stock to F1 in exchange for $35x cash and $65x stock
of F1. At the time of the transfer, the TFD stock has a $50x basis and
$100x fair market value. The F1 stock received by TFC represents 25% of
the outstanding stock of F1. Without regard to the gain recognized under
the gain recognition agreement and any adjustments to basis under
paragraph (c)(4)(ii) of this section, under section 351(b) TFC would
recognize $35x gain in connection with the transfer of the TFD stock to
F1. UST complies with the conditions of paragraph (k)(3) of this
section, and therefore the disposition by TFC of the TFD stock does not
constitute a triggering event.
(ii) Result. Under paragraph (m)(1) of this section, UST must
recognize $35x gain under the gain recognition agreement as a result of
the year 3 disposition by TFC of the TFD stock. Thus, the amount of gain
subject to the new gain recognition agreement entered into by UST
pursuant to paragraph (k)(3) of this section is $15x. Under paragraph
(c)(4)(ii) of this section, as of the date of the initial transfer, the
basis of the TFD stock held by TFC is increased by $35x, the amount of
the gain recognized by UST under the gain recognition agreement. Under
paragraph (c)(4)(i) of this section, the basis of the TFC stock received
by UST in the initial transfer is also increased by $35x. After taking
into account the increase to the basis of the TFD stock under paragraph
(c)(4)(ii) of this section, TFC recognizes $15x gain under section
351(b) in connection with the year 3 transfer of the TFD stock to F1.
Under section 362(a), the basis of the TFD stock in the hands of F1 is
$100x.
Example 14. Complete disposition of transferred stock pursuant to a
section 304(a)(1) transaction. (i) Facts. UST wholly owns FA. In year 3,
in a transaction to which section 304(a)(1) applies, TFC transfers all
of the TFD stock to FA in exchange for cash. Under section 304(a)(1),
TFC and FA are treated as if TFC transferred the TFD stock to FA in a
section 351 exchange in exchange solely for FA stock, and then FA
redeemed the FA stock deemed issued in exchange for the cash. Under
section 302(d), the redemption of the FA stock deemed issued by FA to
TFC under section 304(a)(1) is treated as a distribution to which
section 301 applies.
(ii) Result. (A) In general, the deemed contribution by TFC of the
TFD stock to FA in the section 351 exchange is a triggering event under
paragraph (j)(1) of this section. However, under paragraph (k)(3) of
this section the deemed contribution shall not be a triggering event if
UST enters into a new gain recognition agreement with respect to the
initial transfer in which it agrees to treat as a triggering event a
complete or partial disposition of the FA stock deemed received by TFC.
(B) Under paragraph (n)(1) of this section, the redemption of the FA
stock deemed received by TFC in exchange for the TFD stock shall not
constitute a disposition if UST enters into a new gain recognition
agreement with respect to the initial transfer that includes appropriate
provisions to take into account such redemption. Therefore, under the
new gain recognition agreement UST must agree to treat as a triggering
event a complete or partial disposition of the stock of FA. Pursuant to
paragraph (d)(2)(ii) of this section, UST is permitted to enter into a
single new gain recognition agreement in year 3, but the gain
recognition agreement must provide a complete description of the section
304(a)(1) transaction including the deemed section 351 exchange and
redemption of the FA stock.
Example 15. Reduction in amount of gain subject to gain recognition
agreement, followed by triggering event. (i) Facts. In year 3, UST
disposes of 60% of the TFC stock received in the initial transfer in a
transaction in which the conditions of paragraph (o)(1)(ii) of this
section are satisfied. Thus, the amount of gain subject to the gain
recognition agreement is reduced by 60%. In year 5, TFC disposes of 50%
of the TFD stock in a transaction that constitutes a triggering event.
(ii) Result. As a result of the year 5 disposition by TFC of 50% of
the TFD stock, under
[[Page 336]]
paragraphs (j)(1) and (c)(1)(i) of this section, UST must recognize and
include in income 50% of the gain subject to the gain recognition
agreement (because of the year 3 disposition of TFC stock, the amount of
gain subject to the gain recognition agreement equals 40% of the gain
realized, but not recognized, on the initial transfer). UST must pay
applicable interest on any additional tax due with respect to the gain
recognized. The amount of gain subject to the gain recognition agreement
is reduced by the amount of gain recognized by UST (the remaining gain
equals 20% of the gain realized, but not recognized, by UST on the
initial transfer).
Example 16. Taxable sale of stock of transferee foreign corporation
and election to reduce stock basis. (i) Facts. UST wholly owns F1 and
TFD. The F1 stock has a $100x basis and $90x fair market value, and the
TFD stock has a $0x basis and $100x fair market value. UST also owns
real property with a $10x basis and $10x fair market value. In year 1,
pursuant to a section 351 exchange, UST transfers the real property, the
TFD stock, and the F1 stock to TFC in exchange solely for 20 shares of
TFC stock. UST enters into a gain recognition agreement with respect to
the transfer of the TFD stock. The amount of the gain recognition
agreement is $100x. UST takes the position that the basis of each share
of TFC stock received in the exchange is $5.5x (a proportionate amount
of the $110x aggregate basis of the transferred property). In year 3,
UST disposes of all its TFC stock in a transaction in which all gain
realized is recognized and included in taxable income.
(ii) Result. The year 3 disposition of the TFC stock is a triggering
event under paragraph (j)(4) of this section. The disposition does not
terminate the gain recognition agreement pursuant to paragraph (o)(1)(i)
of this section because the basis of each share of TFC stock received in
exchange for the TFD stock in the initial transfer is $5.5x, which
exceeds the $0x basis of the TFD stock at time of the initial transfer.
However, under paragraph (o)(1)(iii) of this section, to satisfy the
basis condition of paragraph (o)(1)(i) of this section, UST can reduce
the basis of the 10 shares of the TFC stock received in exchange for the
TFD stock to $0x. If UST reduces the basis of the 10 shares of TFC stock
to $0x, under paragraph (o)(1)(i) of this section the disposition of the
TFC stock shall not constitute a triggering event but instead shall
terminate the gain recognition agreement without further effect.
Example 17. Successive section 351 exchanges, section 301
distributions, and transactions involving partnerships. (i) Facts. UST
owns a 40 percent capital and profits interest in a foreign partnership
(PRS). PRS wholly owns TFD and other assets with basis equal to fair
market value. The TFD stock has a $50x basis and $200x fair market
value. TFC wholly owns F1. On day 1 of year 1, in a section 351
exchange, UST transfers its PRS interest to TFC in exchange solely for
stock of TFC (initial transfer). On that same day, in a section 351
exchange, TFC transfers the PRS interest received from UST to F1 in
exchange solely for stock of F1. In year 3, PRS receives a $150x
distribution from TFD to which section 301 applies. Under section
301(c), $25x of the distribution constitutes a dividend, $50x is applied
against and reduces the basis of the TFD stock held by PRS, and the
remaining $75x is treated as gain from the sale or exchange of property.
With respect to the TFD stock deemed transferred by UST in the initial
transfer, under section 301(c), $10x (40% of $25x) of the distribution
constitutes a dividend, $20x (40% of $50x) is applied against and
reduces the basis of TFD stock, and $30x (40% of $75x) is treated as
gain from the sale or exchange of property. In year 5, pursuant to a
distribution to which section 731 applies, PRS distributes all of the
TFD stock to F1.
(ii) Result. (A) Successive section 351 transfers. Under section
367(a)(4) and Sec. 1.367(a)-1T(c)(3)(ii), the transfer of the PRS
interest by UST to TFC is treated, for purposes of section 367(a), as a
transfer by UST to TFC of its proportionate share of the TFD stock held
by PRS (the initial transfer). The initial transfer by UST of the TFD
stock to TFC is subject to the general rule of section 367(a)(1), unless
UST enters into a gain recognition agreement with respect to such
transfer pursuant to Sec. 1.367(a)-3(b)(1)(ii) and this section. Under
paragraph (c)(3)(viii) of this section, the gain recognition agreement
must include a complete description of the transfer, including a
description of the partners of PRS. Even if UST enters into a gain
recognition agreement with respect to the initial transfer, under
paragraph (j)(3) of this section, the subsequent transfer by TFC of the
PRS interest to F1 is a triggering event unless UST enters into a new
gain recognition agreement with respect to the initial transfer under
paragraph (k)(14) that provides that, in addition to the triggering
events provided in paragraph (j) of this section, a complete or partial
disposition of the F1 stock received by TFC in exchange for the PRS
interest shall constitute a triggering event for purposes of the gain
recognition agreement. The new gain recognition agreement must also
provide that any other disposition that is inconsistent with the
principles of paragraph (k), including an indirect disposition of the
TFD stock or of substantially all of the assets of TFD, shall constitute
a triggering event for purposes of the new gain recognition agreement.
Under paragraph (d)(2)(ii) of this section, UST is permitted to enter
into a single gain recognition agreement with respect to the initial
transfer and the subsequent transfer by TFC of the PRS interest, but the
agreement must include a complete description of the initial
[[Page 337]]
transfer and the subsequent transfer of the PRS interest.
(B) Section 301 distribution from TFD to PRS. Under paragraph
(b)(1)(iii) of this section, the section 301 distribution received by
PRS from TFD is not a disposition (and therefore does not affect the
gain recognition agreement) to the extent it is described in section
301(c)(1) or (2). However, under paragraph (n)(2) of this section, to
the extent the distribution is described in section 301(c)(3), UST must
recognize gain ($30x) under the gain recognition agreement. For this
purpose, the amount of the distribution that is described in section
301(c)(3) is determined before taking into account the increase to the
basis of the TFD stock under paragraph (c)(4)(ii) of this section.
(C) Distribution of TFD stock by PRS to F1. The year 5 distribution
of the TFD stock by PRS to F1 is a triggering event under paragraph
(j)(1) of this section, unless paragraph (k)(14) of this section
applies.
(1) The condition of paragraph (k)(14)(i) of this section is
satisfied because the distribution qualifies as a nonrecognition
transaction.
(2) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the distribution UST, a domestic
corporation that is eligible to be a U.S. transferor, owns at least 5%
(applying the attribution rules of section 318, as modified by section
958(b)) of the total voting power and total value of the outstanding
stock of F1. As a result, UST is treated as retaining an indirect
interest in the TFD stock following the distribution.
(3) The condition of paragraph (k)(14)(iii) of this section is
satisfied if UST enters into a new gain recognition agreement with
respect to the initial transfer. The new gain recognition agreement need
not describe additional dispositions or other events that would
constitute triggering events because, pursuant to paragraph (c)(5) of
this section, the dispositions or other events described in paragraph
(j) of this section or in the existing gain recognition agreement apply
to the new gain recognition agreement.
Example 18. Complete liquidation of transferee foreign corporation.
(i) Facts. TFD has 10 shares of stock outstanding immediately before the
initial transfer. On the date of the initial transfer, the TFD stock has
a $0x basis and $90x fair market value. In year 2, in exchange for 1
share of TFD stock TFC transfers real estate to TFD with a $10x basis
and $10x fair market value. In year 4, TFC distributes the 11 shares of
TFD stock to UST in a complete liquidation to which sections 332 and 337
apply.
(ii) Result. In determining whether the gain recognition agreement
entered into by UST with respect to the initial transfer is terminated
under paragraph (o)(5) of this section, or triggered under paragraphs
(j)(1) and (j)(4) of this section, only the 10 shares of TFD stock
transferred by UST in the initial transfer are considered. Thus, the 1
share of TFD stock received by TFC in exchange for the real estate in
year 2 is not taken into account.
Example 19. Spin-off of transferred corporation. (i) Facts. Before
the initial transfer, the TFD stock has an $80x basis and a $100x fair
market value, and the TFC stock has a $100x basis and a $100x fair
market value. In year 4, TFC distributes all of the TFD stock to UST in
a transaction to which section 355 applies. At the time of the
distribution, the TFD stock has a $200x fair market value, and the TFC
stock (without regard to the value of the TFD stock held by TFC) has a
$100x fair market value. At such time, the TFC stock has a $180x basis.
As determined under section 358, immediately after the distribution, the
TFC stock has a $60x basis, and the TFD stock has a $120x basis.
(ii) Result. The distribution of the TFD stock by TFC in year 4 is a
triggering event under paragraph (j)(1) of this section. The
distribution does not terminate the gain recognition agreement under
paragraph (o)(5) of this section because after the distribution, the
basis of the TFD stock in the hands of UST ($120x) is greater than the
basis of the TFD stock at the time of the initial transfer ($80x).
However, if UST reduces the basis of the TFD stock to $80x (as provided
under paragraph (o)(5)(iii) of this section) the gain recognition
agreement will terminate without further effect. If UST does not elect
to reduce the basis of the TFD stock, see paragraph (k)(14) of this
section.
Example 20. Intercompany transaction followed by disposition to
nonmember. (i) Facts. At the time of the initial transfer, the TFD stock
has a $50x basis and $100x fair market value. The amount of the gain
recognition agreement is $50x. In year 3, UST distributes all of the TFC
stock to USP in a transaction to which section 301 applies. At the time
of the distribution, the TFC stock has a $50x basis and $90x fair market
value. Under section 311(b), UST must recognize $40x gain (the
intercompany item) on the distribution, but because the distribution is
an intercompany transaction, under the provisions of Sec. 1.1502-13,
the $40x gain is not taken into account in year 3. In year 4, USP sells
all of the TFC stock to X, an unrelated corporation. Under the
provisions of Sec. 1.1502-13, in year 4 UST takes into account the $40x
intercompany item as a result of the sale of the TFC stock to X.
(ii) Result. (A) The year 3 distribution of the TFC stock by UST to
USP does not terminate the gain recognition agreement under paragraph
(o)(1) of this section because UST does not include the $40x gain in
taxable income during year 3. Under paragraph (j)(4) of this section,
the year 3 distribution of the TFC stock by UST to USP is generally
[[Page 338]]
a triggering event; however, because the distribution is an intercompany
transaction that creates an intercompany item, the distribution shall
not constitute a triggering event if the conditions of paragraph
(k)(12)(i) of this section are satisfied.
(1) The condition of paragraph (k)(12)(i)(A) of this section is
satisfied because the aggregate basis of the TFC stock distributed
($50x) is not greater than the sum of the aggregate basis of the TFD
stock at the time of the initial transfer ($50x).
(2) The condition of paragraph (k)(12)(i)(B) of this section is
satisfied if the next annual certification for the existing gain
recognition agreement includes a complete description of the
intercompany transaction and an explanation of how the basis condition
of paragraph (k)(12)(i)(A) of this section is satisfied.
(B) Under paragraph (o)(6) of this section and the principles of
paragraph (o)(1)(i) of this section, because the year 4 sale of the TFC
stock to X requires UST to take into account the $40x gain (the
intercompany item) from the year 3 distribution, the year 4 sale
terminates the gain recognition agreement. If, alternatively, in year 4
USP had sold only 30% of the TFC stock, then under paragraph (o)(6) of
this section and the principles of paragraph (o)(1)(ii) of this section
the amount of gain subject to the gain recognition agreement would be
reduced by 30%.
(iii) Alternate facts. Intercompany transaction followed by sale of
transferee foreign corporation to member. Assume the same facts as in
paragraph (i) of this Example 20, except that, instead of USP selling
the TFC stock to X, in year 4 USP sells the TFC stock to USS in exchange
for $90x cash. UST and USS are members of the USP consolidated group
immediately after the sale. The results of the year 3 distribution of
the TFC stock by UST to USP are the same as in paragraph (ii) of this
Example 20. In addition, under paragraph (k)(12)(ii) of this section,
the year 4 sale by USP of the TFC stock to USS is not a triggering
event, provided UST includes a complete description of the sale with the
annual certification filed for the gain recognition agreement in year 4.
(iv) Alternate facts. Intercompany transaction followed by complete
liquidation of transferee foreign corporation. Assume the same facts as
in paragraph (i) of this Example 20, except that, instead of USP selling
the TFC stock to X, in year 4 TFC distributes all of its assets to USP
in a complete liquidation to which sections 332 and 337 apply. The
result is the same as in paragraph (ii) of this Example 20 because,
under the provisions of Sec. 1.1502-13, in year 4 UST takes into
account the $40x gain (the intercompany item) from the year 3
distribution.
(v) Alternate facts. Intercompany transaction followed by triggering
event. Assume the same facts as in paragraph (i) of this Example 20,
except that instead of USP selling the TFC stock to X, in year 4 TFC
disposes of all of the TFD stock in a transaction that constitutes a
triggering event under paragraph (j)(1) of this section. Under paragraph
(c)(1)(i) of this section UST must recognize $50x gain under the gain
recognition agreement. Under paragraphs (c)(4)(i) and (ii) of this
section, as of the date of the initial transfer the basis of the TFC
stock and TFD stock, respectively, is increased by $50x.
(vi) Alternate facts. Intercompany transaction followed by section
351 transfer to member. The facts are the same as in paragraph (i) of
this Example 20, except that, in year 3, in a section 351 exchange UST
transfers all of the TFC stock to USS in exchange for $10x cash and $80x
of stock of USS. USS is a member of the USP consolidated group
immediately after the exchange. The transfer of the TFC stock by UST to
USS is an intercompany transaction. Under section 351(b), UST must
generally recognize $10x gain (intercompany item) in connection with the
transfer; however, under the provisions of Sec. 1.1502-13, UST does not
take the $10x gain into account in year 3. Under paragraph (k)(12) of
this section, as result of the intercompany transaction creating an
intercompany item ($10x gain), the existing gain recognition agreement
($50x gain) must be divided between UST and USS. UST shall remain
subject to a gain recognition agreement of $10x (equal to the amount of
the intercompany item). The amount of the gain recognition agreement
entered into by USS under paragraph (k)(1) of this section is $40x
(equal to the amount of the existing gain recognition agreement, reduced
by the amount of the of the gain recognition agreement to which UST
remains subject).
Example 21. Transfer of transferred stock to United States person
other than U.S. transferor. (i) Facts. An individual (A) that is a
United States citizen wholly owns TFD, TFC, and DC. A transfers the TFD
stock to TFC in a section 351 exchange and enters into a gain
recognition agreement with respect to such transfer. In year 5, pursuant
to an asset reorganization, TFC transfers all of its assets to DC in
exchange solely for DC stock. TFC distributes the DC stock to A pursuant
to the plan of reorganization.
(ii) Result. The transfer by TFC of the TFD stock to DC and the
exchange by A of the TFC stock for DC stock pursuant to the asset
reorganization are triggering events under paragraphs (j)(1) and (j)(4)
of this section, respectively. The gain recognition agreement does not
terminate under paragraph (o)(5) of this section because DC is neither
the U.S. transferor, nor an individual that is a United States person,
nor a member of the same consolidated group of which the U.S. transferor
is a member. However, if paragraph (k)(14) of this section applies the
[[Page 339]]
exchanges shall not constitute triggering events.
(A) The condition of paragraph (k)(14)(i) of this section is
satisfied because the transfer of the TFD stock to DC qualifies as a
nonrecognition transaction.
(B) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the transfer DC, a domestic
corporation that is eligible to be a U.S. transferor, retains a direct
interest in the TFD stock following the transfer.
(C) The condition of paragraph (k)(14)(iii) of this section is
satisfied if DC enters into a new gain recognition agreement with
respect to the initial transfer. Under paragraph (k)(14)(iii)(B) of this
section, DC is not required to describe any subsequent dispositions or
other events that (based on the principles of paragraph (j) of this
section) would constitute triggering events for purposes of the new gain
recognition agreement, other than the dispositions or other events
described in paragraph (j) of this section, because DC holds a direct
interest in TFD after the asset reorganization.
Example 22. Transfer of transferred stock to consolidated group
member. (i) Facts. UST wholly owns DC, a member of the USP consolidated
group that includes UST. In year 5, pursuant to an asset reorganization
described in section 368(a)(1)(A) TFC merges with and into DC.
Immediately after the asset reorganization, DC wholly owns TFD, and the
basis of the TFD stock is not greater than the aggregate basis of such
stock at the time of the initial transfer.
(ii) Result. The gain recognition agreement filed by UST with
respect to the initial transfer terminates without further effect if the
conditions of paragraph (o)(5) of this section are satisfied.
(A) The condition of paragraph (o)(5)(i) of this section is
satisfied because the transfer of the TFD stock is a section 361
exchange.
(B) The condition of paragraph (o)(5)(ii) of this section is
satisfied because DC is a member of the consolidated group that includes
UST immediately after the section 361 exchange.
(C) The condition of paragraph (o)(5)(iii) of this section is
satisfied because the aggregate basis of the TFD stock immediately after
the section 361 exchange is not greater than the aggregate basis of the
TFD stock at the time of the initial transfer (as adjusted for any gain
recognized by UST on such transfer). If the basis condition of paragraph
(o)(5)(iii) were not satisfied, under paragraph (o)(5)(iii) of this
section, DC could reduce the basis of the TFD stock received in the
reorganization. Alternatively, a new gain recognition agreement could be
entered into if paragraph (k)(14) of this section applied to the
disposition of the TFD stock pursuant to the section 361 exchange.
(iii) Alternate facts. The facts are the same as in paragraph (i) of
this Example 22, except that instead of TFC merging into DC, TFC merges
into TFD in a reorganization described in section 368(a)(1)(A). The gain
recognition agreement terminates without further effect if the
conditions of paragraph (o)(5) of this section are satisfied.
(A) The condition of paragraph (o)(5)(i) of this section is
satisfied because the TFD stock issued by TFD to TFC in the
reorganization, which is treated as transferred stock under paragraph
(b)(2)(iii) of this section, is distributed by TFC to UST pursuant to
section 361(c).
(B) The condition of paragraph (o)(5)(ii) of this section is
satisfied because UST is the U.S. transferor.
(C) The condition of paragraph (o)(5)(iii) of this section is
satisfied if the aggregate basis of the TFD stock received by UST from
TFC is not greater than the aggregate basis of the TFD stock at the time
of the initial transfer (as adjusted for any gain recognized by UST on
such transfer). If the basis condition of paragraph (o)(5)(iii) were not
satisfied, under paragraph (o)(5)(iii) of this section, UST could reduce
the basis of the TFD stock received in the reorganization.
Example 23. Split-off of transferred stock. (i) Facts. X, a domestic
corporation that is unrelated to USP and UST, wholly owns TFC. Pursuant
to a reorganization described in section 368(a)(1)(B), UST transfers all
of the TFD stock to TFC in exchange for 50% of the outstanding voting
stock of TFC. UST enters into a gain recognition agreement with respect
to such transfer. In year 4, in a split-off transaction to which section
355 applies, TFC distributes all of the TFD stock to X in exchange for
all the TFC stock held by X.
(ii) Result. Under paragraph (j)(1) of this section, the year 4
distribution of the TFD stock to X constitutes a triggering event.
However, the distribution shall not constitute a triggering event if
paragraph (k)(14) of this section applies. The gain recognition
agreement does not terminate under paragraph (o)(5) of this section
because X is not a recipient described in paragraph (o)(5)(ii) of this
section.
(A) The condition of paragraph (k)(14)(i) of this section is
satisfied because the distribution of the TFD stock qualifies as a
nonrecognition transaction.
(B) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the distribution X, a domestic
corporation that is eligible to be a U.S. transferor, retains a direct
interest in the TFD stock.
(C) The condition of paragraph (k)(14)(iii) of this section is
satisfied if X enters into a new gain recognition agreement with respect
to the initial transfer. Under paragraph
[[Page 340]]
(k)(14)(iii)(B) of this section, X is not required to describe, with the
new gain recognition agreement, any subsequent dispositions or other
events that (based on the principles of paragraph (j) of this section)
would constitute triggering events, other than the dispositions
described in paragraph (j) of this section, because X directly owns TFD
after the distribution.
(D) If X were a United States citizen, the gain recognition
agreement would terminate if the condition of paragraph (o)(5)(iii) of
this section were satisfied. Alternatively, the gain recognition
agreement would continue for its remaining term if the conditions for
the application of paragraph (k)(14) of this section were satisfied.
(iii) Alternate facts. Distribution to unrelated foreign
corporation. The facts are the same as in paragraph (i) of this Example
23, except that X is a foreign corporation wholly owned by DC. DC is
unrelated to UST. The results are the same as in paragraph (ii) of this
Example 23, except as follows.
(A) The condition of paragraph (k)(14)(ii) of this section is
satisfied because immediately after the distribution DC, a domestic
corporation that is eligible to be a U.S. transferor, owns at least 5%
(applying the attribution rules of section 318, as modified by section
958(b)) of the total voting power and total value of the outstanding
stock of X. As a result, DC is treated as retaining an indirect interest
in the TFD stock immediately following the distribution.
(B) The condition of paragraph (k)(14)(iii) of this section is
satisfied if DC enters into a new gain recognition agreement with
respect to the initial transfer. Under paragraph (k)(14)(iii)(B) of this
section, DC must, in addition to the dispositions described in paragraph
(j) of this section, include as a triggering event a complete or partial
disposition of the stock of X.
(iv) Alternate facts. Distribution to nonresident alien individual.
The facts are the same as in paragraph (i) of this Example 23, except
that X is a nonresident alien individual. Paragraph (k)(14) of this
section does not apply to the distribution because the conditions of
paragraph (k)(14)(ii) and (iii) of this section cannot be satisfied.
Therefore, the distribution is a triggering event, and UST will
recognize gain under the gain recognition agreement as required under
paragraphs (c)(1)(i) and (v) of this section. The result would be the
same if X were a foreign corporation and, immediately after the
distribution, no United States person owned at least 5% (applying the
attribution rules of section 318, as modified by section 958(b)) of the
total voting power and value of the outstanding stock of X.
Example 24. Applicability of this section to gain recognition
agreements filed before March 13, 2009. (i) Facts. The facts are the
same as in paragraph (i) of Example 6, except that the initial transfer
occurred on March 7, 2007, and the asset reorganization occurred on July
1, 2008.
(ii) Result. Under paragraph (r)(1)(ii) of this section, the rules
of Sec. 1.367(a)-8T (see 26 CFR part 1, revised April 1, 2007) apply to
the transfers pursuant to the asset reorganization because the initial
transfer occurred on March 7, 2007. As a result of the disposition of
the TFC stock pursuant to the asset reorganization, under Sec.
1.367(a)-8T(d), USP is required to recognize the gain subject to the
gain recognition agreement and pay applicable interest on any additional
tax due with respect to such gain. Because the acquiring corporation in
the asset reorganization is foreign, an exception under Sec. 1.367(a)-
8T(e) is not available for the exchange of TFC stock by USP. However,
pursuant to paragraph (r)(2)(i) of this section, because the exception
provided by paragraph (k)(14) of this section is not included in Sec.
1.367(a)-8T, USP may apply paragraph (k)(14) of this section to such
exchange (provided the conditions of paragraph (k)(14) of this section
are satisfied), if the statute of limitations on assessments of tax for
the 2007 tax year has not closed. If USP applies paragraph (k)(14) of
this section to its exchange of the TFC stock pursuant to the asset
reorganization, under paragraph (r)(2)(ii) of this section USP must
include the new gain recognition agreement required under paragraph
(k)(14)(iii) of this section with an amended Federal income tax return
for its 2008 tax year that is filed August 10, 2009.
Example 25. Applicability of this section to gain recognition
agreements filed before March 13, 2009. (i) Facts. The initial transfer
occurs in 2004. In 2005, pursuant to a section 351 exchange, TFC
transfers the TFD stock to F1 in exchange solely for F1 voting stock.
UST does not file a new gain recognition agreement under Sec. 1.367(a)-
8(g)(2) with respect to the exchange.
(ii) Result. Under paragraph (r)(1)(ii) of this section, the rules
of Sec. 1.367(a)-8 (see 26 CFR part 1, revised April 1, 2006) apply to
the year 2005 disposition of the TFD stock because UST filed the gain
recognition agreement after July 20, 1998, but before March 7, 2007.
Under Sec. 1.367(a)-8(e) (see 26 CFR part 1, revised April 1, 2006), as
a result of the disposition of the TFD stock by TFC, UST must recognize
the amount of gain subject to the gain recognition agreement. Paragraph
(r)(2)(i) of this section does not apply because the rule provided by
paragraph (k)(3) of this section was included in Sec. 1.367(a)-8(g)(2)
(see 26 CFR part 1, revised April 1, 2006). However, UST may request
relief for reasonable cause under Sec. 1.367(a)-8(c)(2) (see 26 CFR
part 1, revised April 1, 2006) to file a new gain recognition agreement
with respect to the disposition of the TFD stock by TFC in 2005.
[[Page 341]]
(r) Effective/applicability date--(1) General rule--(i) Transfers
occurring on or after March 13, 2009. The rules of this section apply to
gain recognition agreements filed with respect to transfers of stock or
securities occurring on or after March 13, 2009. However, the rules of
this section do not apply to gain recognition agreements filed with
respect to any such transfer occurring on or after March 13, 2009, if
such transfer was entered into pursuant to a written agreement that was
(subject to customary conditions) binding before February 11, 2009, and
at all times thereafter. Solely for purposes of this paragraph (r), a
transfer described in the preceding sentence shall be deemed to be a
transfer occurring before March 13, 2009 to which the rules of Sec.
1.367(a)-8 (see 26 CFR part 1, revised April 1, 2006) apply. See
paragraph (r)(2)(iii) of this section for the ability to apply the rules
of this section with respect to gain recognition agreements filed for
taxable years ending before March 13, 2009.
(ii) Transfers occurring before March 13, 2009. For matters covered
in this section for periods before March 13, 2009 but on or after March
7, 2007, the corresponding rules of Sec. 1.367(a)-8T (see 26 CFR part
1, revised April 1, 2007) apply. For matters covered in this section for
periods before March 7, 2007 but on or after July 20, 1998, the
corresponding rules of Sec. 1.367(a)-8 (see 26 CFR part 1, revised
April 1, 2006) apply. For matters covered in this section for periods
before July 20, 1998, the corresponding rules of Sec. 1.367(a)-3T(g)
(see 26 CFR part 1, revised April 1, 1998) and Notice 87-85 (1987-2 CB
395) apply. In addition, if a U.S. transferor entered into a gain
recognition agreement for transfers before July 20, 1998, then the rules
of Sec. 1.367(a)-3T(g) (see 26 CFR part 1, revised April 1, 1998)
continue to apply in lieu of this section in the event of any direct or
indirect nonrecognition transfer of the same property. See also, Sec.
1.367(a)-3(h).
(2) Applicability to transfers occurring before March 13, 2009--(i)
General rule. Taxpayers may apply the rules of this regulation Sec.
1.367(a)-8 that were not included in Sec. 1.367(a)-8T (see 26 CFR part
1, revised April 1, 2007), to gain recognition agreements filed with
respect to transfers of stock or securities for all open taxable years,
if done consistently to all transfers. A U.S. transferor subject to
section 877 and Sec. 1.367(a)-8T(d)(6) shall not apply the rules of
this regulation to reach a contrary result. A taxpayer that failed to
file a gain recognition agreement for a transfer, or to comply
materially with any requirement of this section with respect to an
existing gain recognition agreement, must obtain relief for reasonable
cause for such failure under Sec. 1.367(a)-8T(e)(10) before applying
the rules of this regulation Sec. 1.367(a)-8 that were not included in
Sec. 1.367(a)-8T as permitted by this paragraph (r)(2). See paragraph
(q)(2) of this section, Examples 24 and 25 for illustrations of the rule
provided by this paragraph (r)(2)(i).
(ii) Taxable years ending before March 13, 2009. Notwithstanding the
requirements of Sec. 1.367(a)-8(d), any gain recognition agreement or
other filing required by reason of electing to apply the rules of this
regulation Sec. 1.367(a)-8 that were not included in Sec. 1.367(a)-8T,
as permitted by this paragraph (r)(2), for a taxable year ending before
March 13, 2009 shall be considered filed in accordance with the
requirements of Sec. 1.367(a)-8(d), provided the gain recognition
agreement or other filing is attached to an original or amended return
for such taxable year. An amended return required to be filed by reason
of electing to apply the rules of this regulation Sec. 1.367(a)-8 that
were not included in Sec. 1.367(a)-8T, as permitted by this paragraph
(r)(2), must be filed on or before August 10, 2009. A taxpayer that
wishes to apply the rules of this regulation Sec. 1.367(a)-8 that were
not included in Sec. 1.367(a)-8T, as permitted by this paragraph
(r)(2), but that fails to meet the filing requirement described in the
preceding sentence must request relief for reasonable cause under
paragraph (p) of this section.
(iii) Taxable years ending after effective date. A taxpayer that
entered into a gain recognition agreement to which Sec. 1.367(a)-8T
(see 26 CFR part 1, revised April 1, 2007) applies may apply the rules
of this section in a tax year ending on or after March 13, 2009 by
attaching the agreement, certification, or other information related to
such
[[Page 342]]
gain recognition agreement that the rules of this section require in
accordance with the rules of this section and with the time and manner
rules provided in Sec. 1.367(a)-8(d).
[T.D. 9446, 74 FR 6960, Feb. 11, 2009; 74 FR 10175, Mar. 10, 2009, as
amended at T.D. 9446, 74 FR 13340, Mar. 27, 2009]
Sec. 1.367(a)-9T Treatment of deemed section 351 exchanges pursuant to
section 304(a)(1) (temporary).
(a) Scope and general rule. This section applies to the extent that,
pursuant to section 304(a)(1), a United States person is treated as
transferring stock of a domestic or foreign corporation to a foreign
corporation (foreign acquiring corporation) in exchange for stock of the
foreign acquiring corporation in a transaction to which section 351(a)
applies (deemed section 351 exchange). Except to the extent provided in
paragraph (b) of this section, a transfer of stock by a United States
person to a foreign acquiring corporation in a deemed section 351
exchange is not subject to section 367(a)(1).
(b) Special rule. Notwithstanding paragraph (a) of this section, if
the distribution received by the United States person in redemption of
the stock of the foreign acquiring corporation deemed issued in the
deemed section 351 exchange is applied against and reduces (in whole or
in part), pursuant to section 301(c)(2), the basis of stock of the
foreign acquiring corporation held by the United States person other
than the stock deemed issued in the deemed section 351 exchange, the
United States person shall recognize gain pursuant to this paragraph
(b). The exceptions described in Sec. 1.367(a)-3(b)(1) and (c)(1) shall
not apply to a transfer of stock described in paragraph (a) of this
section. The amount of gain recognized by a United States person
pursuant to this paragraph (b) shall equal the amount, if any, by
which--
(1) The gain realized by the United States person with respect to
the transferred stock in connection with the deemed section 351 exchange
exceeds;
(2) The amount of the distribution received by the United States
person in redemption of the stock of the foreign acquiring corporation
deemed issued in the deemed section 351 exchange that is treated as a
dividend under section 301(c)(1) and included in gross income by the
United States person.
(c) Ordering rule. For purposes of paragraph (b)(1) of this section,
the amount of gain realized by the United States person in connection
with the deemed section 351 exchange shall be determined without regard
to the amount of gain recognized by the United States person under
paragraph (b) of this section.
(d) Allocation of recognized gain. Gain recognized by a United
States person pursuant to paragraph (b) of this section shall be treated
as recognized with respect to the stock transferred in the deemed
section 351 exchange in proportion to the amount of gain realized by the
United States person with respect to such stock. See Sec. 1.367(a)-
1T(b)(4) for additional rules on the character, source, and adjustments
relating to gain recognized under section 367(a).
(e) Example. The following example illustrates the rules of this
section:
Example. (i) Facts. (A) USP, a domestic corporation, wholly owns FC1
and FC2, each a foreign corporation. USP, FC1 and FC2 use a calendar
taxable year. The FC1 stock has a $40x basis and $100x fair market
value. The FC2 stock has a $100x basis and $100x fair market value. As
of December 31, year 1, FC1 has zero earnings and profits, and FC2 has
$20x earnings and profits. On December 31, year 1, in a transaction
described in section 304(a)(1), USP sells the FC1 stock to FC2 for $100x
cash.
(B) Because USP wholly owns FC1 before the transactions and is
treated, under section 318, as indirectly owning 100% of the FC1 stock
after the transfer, under section 304(a)(1), USP and FC2 are treated in
the same manner as if USP contributed the FC1 stock to FC2 in a deemed
section 351 exchange in exchange solely for $100x of FC2 stock, and then
FC2 redeemed for $100x cash its stock deemed issued to USP. Because USP
wholly owns FC1 before the sale and is treated as owning 100% of FC1
after the sale, section 302(a) does not apply to the redemption.
Instead, under section 302(d), the redemption is treated as a
distribution to which section 301 applies. Pursuant to section
304(b)(2), $20x of the distribution is treated as a dividend from FC2.
With respect to the remaining $80x, USP takes the position that $40x is
applied against and reduces the basis of the FC2 stock issued in the
deemed section 351 exchange, and $40x is applied against and reduces the
basis of the
[[Page 343]]
FC2 stock held by USP prior to (and after) the transaction.
(ii) Analysis. Under paragraph (b) of this section, USP must
recognize gain of $40x on its transfer of the FC1 stock to FC2 in the
deemed section 351 exchange (the amount by which the $60x gain realized
by USP on the deemed section 351 exchange with respect to the F1 stock
exceeds the $20x dividend inclusion). Pursuant to paragraph (b) of this
section, the exception under Sec. 1.367(a)-3(b) is not available to the
transfer of the FC1 stock by USP to FC2 in the deemed section 351
exchange. Thus, USP cannot avoid gain recognition under paragraph (b) of
this section by entering into a gain recognition agreement with respect
to its transfer of the FC1 stock to FC2 in the deemed section 351
exchange. Under paragraph (d) of this section, the $40x gain recognized
is allocated among the shares of FC1 stock transferred to FC2 in the
deemed section 351 exchange in proportion to the gain realized by USP on
the transfer of such shares. Under paragraph (c) of this section, the
application of paragraph (b) of this section is determined prior to
taking into account the $40x increase to the basis of the FC1 stock
transferred by USP. Under section 362, the basis of the FC1 stock in the
hands of FC2 is increased by $40x, the amount of gain recognized by the
USP on the transfer of the FC1 stock under paragraph (b) of this
section. Under section 358, the basis of the FC2 stock received by USP
in the deemed section 351 exchange is similarly increased by $40x. See
Sec. 1.367(a)-1T(b)(4). The $40x increase to the basis of the FC2 stock
is taken into account before determining the consequences of the
redemption of such stock under section 304(a)(1).
(f) Effective/applicability date. This section applies to transfers
occurring on or after February 10, 2009. See Sec. 1.367(a)-3(a), as
contained in 26 CFR part 1 revised as of April 1, 2008, for transfers
occurring on or after February 21, 2006, and before February 10, 2009.
(g) Expiration date. This section expires on or before February 10,
2012.
[T.D. 9444, 74 FR 6826, Feb. 11, 2009; 74 FR 10175, Mar. 10, 2009]
Sec. 1.367(b)-0 Table of contents.
This section lists the paragraphs contained in Sec. Sec. 1.367(b)-1
through 1.367(b)-9.
Sec. 1.367(b)-1 Other transfers.
(a) Scope.
(b) General rules.
(1) Rules.
(2) Example.
(c) Notice required.
(1) In general.
(2) Persons subject to section 367(b) notice.
(3) Time and manner for filing notice.
(i) United States persons described in Sec. 1.367(b)-1(c)(2).
(ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2).
(4) Information required.
(5) Abbreviated notice provision for shareholders that make the
election described in Sec. 1.367(b)-3(c)(3).
(6) Supplemental published guidance.
Sec. 1.367(b)-2 Definitions and special rules.
(a) Controlled foreign corporation.
(b) Section 1248 shareholder.
(c) Section 1248 amount.
(1) Rule.
(2) Examples.
(d) All earnings and profits amount.
(1) General rule.
(2) Rules for determining earnings and profits.
(i) Domestic rules generally applicable.
(ii) Certain adjustments to earnings and profits.
(iii) Effect of section 332 liquidating distribution.
(3) Amount attributable to a block of stock.
(i) Application of section 1248 principles.
(A) In general.
(1) Rule.
(2) Example.
(B) Foreign shareholders.
(ii) Limitation on amounts attributable to holding periods
determined under section 1223.
(A) Rule.
(B) Example.
(iii) Exclusion of lower-tier earnings.
(e) Treatment of deemed dividends.
(1) In general.
(2) Consequences of dividend characterization.
(3) Ordering rules.
(4) Examples.
(f) Deemed asset transfer and closing of taxable year in certain
section 368(a)(1)(F) reorganizations.
(1) Scope.
(2) Deemed asset transfer.
(3) Other applicable rules.
(4) Closing of taxable year.
(g) Stapled stock under section 269B.
(h) Section 953(d) domestication elections.
(1) Effect of election.
(2) Post-election exchanges.
(i) Section 1504(d) elections.
(j) Sections 985 through 989.
(1) Change in functional currency of a qualified business unit.
(i) Rule.
(ii) Example.
(2) Previously taxed earnings and profits.
(i) Exchanging shareholder that is a United States person.
[[Page 344]]
(ii) Exchanging shareholder that is a foreign corporation.
(3) Other rules.
(k) Partnerships, trusts and estates.
(l) Additional definitions.
(1) Foreign income taxes.
(2) Post-1986 undistributed earnings.
(3) Post-1986 foreign income taxes.
(4) Pre-1987 accumulated profits.
(5) Pre-1987 foreign income taxes.
(6) Pre-1987 section 960 earnings and profits.
(7) Pre-1987 section 960 foreign income taxes.
(8) Earnings and profits.
(9) Pooling corporation.
(10) Nonpooling corporation.
(11) Separate category.
(12) Passive category.
(13) General category
Sec. 1.367(b)-3 Repatriation of foreign corporate assets in certain
nonrecognition transactions.
(a) Scope.
(b) Exchange of stock owned directly by a United States shareholder
or by certain foreign corporate shareholders.
(1) Scope.
(2) United States shareholder.
(3) Income inclusion.
(i) Inclusion of all earnings and profits amount.
(ii) Examples.
(iii)Recognition of exchange gain or loss with respect to capital.
[Reserved]
(4) [Reserved]
(c) Exchange of stock owned by a United States person that is not a
United States shareholder.
(1) Scope.
(2) Requirement to recognize gain.
(3) Election to include all earnings and profits amount.
(4) De minimis exception.
(5) Examples.
(d) Carryover of certain foreign taxes.
(1) Rule.
(2) Example.
(e) Net operating loss and capital loss carryovers.
(f) Carryover of earnings and profits.
(1) General rule.
(2) Previously taxed earnings and profits. [Reserved
Sec. 1.367(b)-4 Acquisition of foreign corporate stock or assets by a
foreign corporation in certain nonrecognition transactions.
(a) Scope.
(b) Income inclusion.
(1) Exchange that results in loss of status as section 1248
shareholder.
(i) Rule.
(ii) Examples.
(2) Receipt by exchanging shareholder of preferred or other stock in
certain instances.
(i) Rule.
(ii) Examples.
(3) Certain recapitalizations.
(c) Exclusion of deemed dividend from foreign personal holding
company income.
(1) Rule.
(2) Example.
(d) Rules for subsequent exchanges.
(1) In general.
(2) Subsequent dispositions by a foreign acquiring corporation.
(3) Examples.
Sec. 1.367(b)-5 Distributions of stock described in section 355.
(a) In general.
(1) Scope.
(2) Treatment of distributees as exchanging shareholders.
(b) Distribution by a domestic corporation.
(1) General rule.
(2) Section 367(e) transactions.
(3) Determining whether distributees are individuals.
(4) Applicable cross-references.
(c) Pro rata distribution by a controlled foreign corporation.
(1) Scope.
(2) Adjustment to basis in stock and income inclusion.
(3) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
(4) Basis redistribution.
(d) Non-pro rata distribution by a controlled foreign corporation.
(1) Scope.
(2) Treatment of certain shareholders as distributees.
(3) Inclusion of excess section 1248 amount by exchanging
shareholder.
(4) Interaction with Sec. 1.367(b)-2(e)(3)(ii).
(i) Limited application.
(ii) Interaction with predistribution amount.
(e) Definitions.
(1) Predistribution amount.
(2) Postdistribution amount.
(f) Exclusion of deemed dividend from foreign personal holding
company income.
(g) Examples.
Sec. 1.367(b)-6 Effective dates and coordination rules.
(a) Effective date.
(1) In general.
(2) Exception.
(b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3).
(c) Use of reasonable method to comply with prior published
guidance.
(1) Prior exchanges.
(2) Future exchanges.
(d) Effect of removal of attribution rules.
Sec. 1.367(b)-12 Subsequent treatment of amounts attributed or included
in income.
(a) In general.
[[Page 345]]
(b) Applicable rules.
(c) Effective date.
Sec. 1.367(b)-7 Carryover of earnings and profits and foreign income
taxes in certain foreign-to-foreign nonrecognition transactions.
(a) Scope.
(b) General rules.
(1) Non-previously taxed earnings and profits and related taxes.
(2) Previously taxed earnings and profits. [Reserved]
(c) Ordering rule for post-transaction distributions.
(1) If foreign surviving corporation is a pooling corporation.
(2) If foreign surviving corporation is a nonpooling corporation.
(d) Post-1986 pool.
(1) In general.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(2) Hovering deficit.
(i) In general.
(ii) Offset rule.
(iii) Related taxes.
(3) Examples.
(e) Pre-pooling annual layers.
(1) If foreign surviving corporation is a pooling corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated profits.
(C) Aggregate deficit in pre-1987 accumulated profits.
(D) Deficit and positive separate categories within annual layers
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(2) If foreign surviving corporation is a nonpooling corporation.
(i) Qualifying earnings and taxes.
(ii) Carryover rule.
(iii) Deficits.
(A) In general.
(B) Aggregate positive pre-1987 accumulated profits.
(C) Aggregate deficit in pre-1987 accumulated profits.
(D) Deficit and positive separate categories within annual layers.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes.
(v) Examples.
(f) Special rules.
(1) Treatment of deficit.
(i) General rule.
(ii) Exceptions.
(iii) Examples.
(2) Reconciling taxable years.
(3) Post-transaction change of status.
(4) Ordering rule for multiple hovering deficits.
(i) Rule.
(ii) Example.
(5) Pro rata rule for earnings and deficits during transaction year.
(g) Effective date.
Sec. 1.367(b)-8 Allocation of earnings and profits and foreign income
taxes in certain foreign corporate separations. [Reserved]
Sec. 1.367(b)-9 Special rule for F reorganizations and similar
transactions.
(a) Scope.
(b) Hovering deficit rules inapplicable.
(c) Foreign divisive transactions. [Reserved]
(d) Examples.
(e) Effective date.
[T.D. 8862, 65 FR 3596, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as
amended by T.D. 8937, 66 FR 2257, Jan. 11, 2001; T.D. 9273, 71 FR 44984,
Aug. 8, 2006]
Sec. 1.367(b)-1 Other transfers.
(a) Scope. The regulations promulgated under section 367(b) (the
section 367(b) regulations) set forth rules regarding the proper
inclusions and adjustments that must be made as a result of an exchange
described in section 367(b) (a section 367(b) exchange). A section
367(b) exchange is any exchange described in section 332, 351, 354, 355,
356 or 361, with respect to which the status of a foreign corporation as
a corporation is relevant for determining the extent to which income
shall be recognized or for determining the effect of the transaction on
earnings and profits, basis of stock or securities, basis of assets, or
other relevant tax attributes. For rules coordinating the concurrent
application of sections 367(a) and (b), see Sec. 1.367(a)-3(b)(2).
(b) General rules--(1) Rules. The following general rules apply
under the section 367(b) regulations--
(i) A foreign corporation in a section 367(b) exchange is considered
to be a corporation and, as a result, all of the related provisions
(e.g., section 381) shall apply, except to the extent provided in the
section 367(b) regulations; and
(ii) Nothing in the section 367(b) regulations shall permit--
(A) The nonrecognition of income that would otherwise be required to
be recognized under another provision of the Internal Revenue Code or
the regulations thereunder; or
[[Page 346]]
(B) The recognition of a loss or deduction that would otherwise not
be recognized under another provision of the Internal Revenue Code or
the regulations thereunder.
(2) Example. The following example illustrates the rules of this
paragraph (b):
Example. (i) Facts. DC, a domestic corporation, owns 90 percent of
P, a partnership. The remaining 10 percent of P is owned by a person
unrelated to DC. P owns all of the outstanding stock of FC, a controlled
foreign corporation. FC liquidates into P.
(ii) Result. FC's liquidation is not a transaction described in
section 332. Nothing in the section 367(b) regulations, including Sec.
1.367(b)-2(k), permits FC's liquidation to qualify as a liquidation
described in section 332.
(c) Notice Required--(1) In general. A notice under this paragraph
(c) (section 367(b) notice) must be filed with regard to any person
described in paragraph (c)(2) of this section. A section 367(b) notice
must be filed in the time and manner described in paragraph (c)(3) of
this section and must include the information described in paragraph
(c)(4) of this section.
(2) Persons subject to section 367(b) notice. The following persons
are described in this paragraph (c)(2)--
(i) A shareholder described in Sec. 1.367(b)-3(b)(1) that realizes
income in a transaction described in Sec. 1.367(b)-3(a);
(ii) A shareholder that makes the election described in Sec.
1.367(b)-3(c)(3);
(iii) A shareholder described in Sec. 1.367(b)-4(b)(1)(i)(A)(1) or
(2) that realizes income in a transaction described in Sec. 1.367(b)-
4(a);
(iv) A shareholder that realizes income in a transaction described
in Sec. 1.367(b)-5(c) or 1.367(b)-5(d) and that is either--
(A) A section 1248 shareholder of the distributing or controlled
corporation; or
(B) A foreign corporation with one or more shareholders that are
described in paragraph (c)(2)(iv)(A) of this section; and
(v) A foreign surviving corporation described in Sec. 1.367(b)-
7(a).
(3) Time and manner for filing notice--(i) United States persons
described in Sec. 1.367(b)-1(c)(2). A United States person described in
paragraph (c)(2) of this section must file a section 367(b) notice
attached to a timely filed Federal tax return (including extensions) for
the person's taxable year in which income is realized in the section
367(b) exchange. In the case of a shareholder that makes the election
described in Sec. 1.367(b)-3(c)(3), notification of such election must
be sent to the foreign acquired corporation (or its successor in
interest) on or before the date the section 367(b) notice is filed, so
that appropriate corresponding adjustments can be made in accordance
with the rules of Sec. 1.367(b)-2(e).
(ii) Foreign corporations described in Sec. 1.367(b)-1(c)(2). Each
United States person listed in this paragraph (c)(3)(ii) must file a
section 367(b) notice with regard to a foreign corporation described in
paragraph (c)(2) of this section. Such notice must be attached to a
timely filed Federal tax return (including extensions) for the United
States person's taxable year in which income is realized in the section
367(b) exchange and, if the United States person is required to file a
Form 5471 (Information Return of U.S. Persons With Respect to Certain
Foreign Corporations), the section 367(b) notice must be attached to the
Form 5471. The following persons are listed in this paragraph
(c)(3)(ii)--
(A) United States shareholders (as defined in Sec. 1.367(b)-
3(b)(2)) of foreign corporations described in paragraph (c)(2)(i) or (v)
of this section; and
(B) Section 1248 shareholders of foreign corporations described in
paragraph (c)(2)(iii) or (iv) of this section.
(4) Information required. Except as provided in paragraph (c)(5) of
this section, a section 367(b) notice shall include the following
information--
(i) A statement that the exchange is a section 367(b) exchange;
(ii) A complete description of the exchange;
(iii) A description of any stock, securities or other consideration
transferred or received in the exchange;
(iv) A statement that describes any amount (or amounts) required,
under the section 367(b) regulations, to be taken into account as income
or loss or as an adjustment (including an adjustment under Sec.
1.367(b)-7 or 1.367(b)-9) to
[[Page 347]]
basis, earnings and profits, or other tax attributes as a result of the
exchange;
(v) Any information that is or would be required to be furnished
with a Federal income tax return pursuant to regulations under section
332, 351, 354, 355, 356, 361, 368, or 381 (whether or not a Federal
income tax return is required to be filed), if such information has not
otherwise been provided by the person filing the section 367(b) notice;
(vi) Any information required to be furnished with respect to the
exchange under sections 6038, 6038A, 6038B, 6038C or 6046, or the
regulations under those sections, if such information has not otherwise
been provided by the person filing the section 367(b) notice; and
(vii) If applicable, a statement that the shareholder is making the
election described in Sec. 1.367(b)-3(c)(3). This statement must
include--
(A) A copy of the information the shareholder received from the
foreign acquired corporation (or its successor in interest) establishing
and substantiating the shareholder's all earnings and profits amount
with respect to the shareholder's stock in the foreign acquired
corporation; and
(B) A representation that the shareholder has notified the foreign
acquired corporation (or its successor in interest) that the shareholder
is making the election described in Sec. 1.367(b)-3(c)(3).
(5) Abbreviated notice provision for shareholders that make the
election described in Sec. 1.367(b)-3(c)(3). In the case of a foreign
acquired corporation that has never had earnings and profits that would
result in any shareholder having an all earnings and profits amount, a
shareholder making the election described in Sec. 1.367(b)-3(c)(3) may
satisfy the information requirements of paragraph (c)(4) of this section
by filing a section 367(b) notice that includes--
(i) A statement from the foreign acquired corporation (or its
successor in interest) that the foreign acquired corporation has never
had any earnings and profits that would result in any shareholder having
an all earnings and profits amount; and
(ii) The information described in paragraphs (c)(4) (i) through
(iii) of this section.
(6) Supplemental published guidance. The section 367(b) notice
requirements may be updated or amended by revenue procedure or other
published guidance.
[T.D. 8862, 65 FR 3597, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as
amended by T.D. 9243, 71 FR 4288, Jan. 26, 2006; T.D. 9273, 71 FR 44894,
Aug. 8, 2006]
Sec. 1.367(b)-2 Definitions and special rules.
(a) Controlled foreign corporation. The term controlled foreign
corporation means a controlled foreign corporation as defined in section
957 (taking into account section 953(c)).
(b) Section 1248 shareholder. The term section 1248 shareholder
means any United States person that satisfies the ownership requirements
of section 1248 (a)(2) or (c)(2) with respect to a foreign corporation.
(c) Section 1248 amount--(1) Rule. The term section 1248 amount with
respect to stock in a foreign corporation means the net positive
earnings and profits (if any) that would have been attributable to such
stock and includible in income as a dividend under section 1248 and the
regulations thereunder if the stock were sold by the shareholder. In the
case of a transaction in which the shareholder is a foreign corporation
(foreign shareholder), the following additional rules shall apply--
(i) The foreign shareholder shall be deemed to be a United States
person for purposes of this paragraph (c), except that the foreign
shareholder shall not be considered a United States person for purposes
of determining whether the stock owned by the foreign shareholder is
stock of a controlled foreign corporation; and
(ii) The foreign shareholder's holding period in the stock of the
foreign corporation shall be determined by reference to the period that
the foreign shareholder's section 1248 shareholders held (directly or
indirectly) an interest in the foreign corporation. This paragraph
(c)(1)(ii) applies in addition to the section 1248 regulations'
incorporation of section 1223 holding periods. See Sec. 1.1248-8.
(2) Examples. The following examples illustrate the rules of this
paragraph (c):
Example 1. (i) Facts. DC, a domestic corporation, owns all of the
outstanding stock of FC1, a controlled foreign corporation
[[Page 348]]
(CFC). FC1 owns all of the outstanding stock of FC2, a CFC. DC has
always owned all of the stock of FC1, and FC1 has always owned all of
the stock of FC2.
(ii) Result. Under this paragraph (c), DC's section 1248 amount with
respect to its FC1 stock is computed by reference to all of FC1's and
FC2's earnings and profits. See section 1248(c)(2). Because FC1's
section 1248 shareholder (DC) always indirectly held all of the stock of
FC2, FC1's section 1248 amount with respect to its FC2 stock is computed
by reference to all of FC2's earnings and profits.
Example 2. (i) Facts. DC, a domestic corporation, owns 40 percent of
the outstanding stock of FC1, a foreign corporation. The other 60
percent of FC1 stock is owned (directly and indirectly) by foreign
persons that are unrelated to DC. FC1 owns all of the outstanding stock
of FC2, a foreign corporation. On January 1, 2001, DC purchases the
remaining 60 percent of FC1 stock.
(ii) Result. Under this paragraph (c), DC's section 1248 amount with
respect to its FC1 stock is computed by reference to FC1's and FC2's
earnings and profits that accumulated on or after January 1, 2001, the
date FC1 and FC2 became controlled foreign corporations (CFCs). See
section 1248(a). Because FC1 is not considered a United States person
for purposes of determining whether FC2 is a CFC, FC1's section 1248
amount with respect to its FC2 stock is computed by reference to FC2's
earnings and profits that accumulated on or after January 1, 2001, the
date FC2 became an actual CFC.
Example 3. (i) Facts. FC1, a foreign corporation, owns all of the
outstanding stock of FC2, a foreign corporation. DC is a domestic
corporation that is unrelated to FC1, FC2, and their direct and indirect
owners. On January 1, 2001, DC purchases all of the outstanding stock of
FC1.
(ii) Result. Under this paragraph (c), DC's section 1248 amount with
respect to its FC1 stock is computed by reference to FC1's and FC2's
earnings and profits that accumulated on or after January 1, 2001, the
first day DC held the stock of FC1. See section 1248(a). FC1's section
1248 amount with respect to its FC2 stock is computed by reference to
FC2's earnings and profits that accumulated on or after January 1, 2001,
the first day FC1's section 1248 shareholder (DC) indirectly held the
stock of FC2.
(d) All earnings and profits amount--(1) General rule. The term all
earnings and profits amount with respect to stock in a foreign
corporation means the net positive earnings and profits (if any)
determined as provided under paragraph (d)(2) of this section and
attributable to such stock as provided under paragraph (d)(3) of this
section. The all earnings and profits amount shall be determined without
regard to the amount of gain that would be realized on a sale or
exchange of the stock of the foreign corporation.
(2) Rules for determining earnings and profits--(i) Domestic rules
generally applicable. For purposes of this paragraph (d), except as
provided in sections 312(k)(4) and (n)(8), 964 and 986, the earnings and
profits of a foreign corporation for any taxable year shall be
determined according to principles substantially similar to those
applicable to domestic corporations.
(ii) Certain adjustments to earnings and profits. Notwithstanding
paragraph (d)(2)(i) of this section, for purposes of this paragraph (d),
the earnings and profits of a foreign corporation for any taxable year
shall not include the amounts specified in section 1248(d). In the case
of amounts specified in section 1248(d)(4), the preceding sentence
requires that the earnings and profits for any taxable year be decreased
by the net positive amount (if any) of earnings and profits attributable
to activities described in section 1248(d)(4), and increased by the net
reduction (if any) in earnings and profits attributable to activities
described in section 1248(d)(4).
(iii) Effect of section 332 liquidating distribution. The all
earnings and profits amount with respect to stock of a corporation that
distributes all of its property in a liquidation described in section
332 shall be determined without regard to the adjustments prescribed by
section 312(a) and (b) resulting from the distribution of such property
in liquidation, except that gain or loss realized by the corporation on
the distribution shall be taken into account to the extent provided in
section 312(f)(1). See Sec. 1.367(b)-3(b)(3)(ii) Example 3.
(3) Amount attributable to a block of stock--(i) Application of
section 1248 principles--(A) In general--(1) Rule. The all earnings and
profits amount with respect to stock of a foreign corporation is
determined according to the attribution principles of section 1248 and
the regulations thereunder. The attribution principles of section 1248
shall
[[Page 349]]
apply without regard to the requirements of section 1248 that are not
relevant to the determination of a shareholder's pro rata portion of
earnings and profits. Thus, for example, the all earnings and profits
amount is determined without regard to whether the foreign corporation
was a controlled foreign corporation at any time during the five years
preceding the section 367(b) exchange in question, without regard to
whether the shareholder owned a 10 percent or greater interest in the
stock, and without regard to whether the earnings and profits of the
foreign corporation were accumulated in post-1962 taxable years or while
the corporation was a controlled foreign corporation.
(2) Example. The following example illustrates the rules of this
paragraph (d)(3)(i)(A):
Example. (i) Facts. On January 1, 2001, DC, a domestic corporation,
purchases 9 percent of the outstanding stock of FC, a foreign
corporation. On January 1, 2002, DC purchases an additional 1 percent of
FC stock. On January 1, 2003, DC exchanges its stock in FC in a section
367(b) exchange in which DC is required to include the all earnings and
profits amount in income. FC was not a controlled foreign corporation
during the entire period DC held its FC stock.
(ii) Result. The all earnings and profits amount with respect to
DC's stock in FC is computed by reference to 9 percent of FC's earnings
and profits from January 1, 2001, through December 31, 2001, and by
reference to 10 percent of FC's earnings and profits from January 1,
2002, through January 1, 2003.
(B) Foreign shareholders. In the case of a transaction in which the
exchanging shareholder is a foreign corporation (foreign shareholder),
the following additional rules shall apply--
(1) The attribution principles of section 1248 shall apply without
regard to whether the person directly owning the stock is a United
States person; and
(2) The foreign shareholder's holding period in the stock of the
foreign acquired corporation shall be determined by reference to the
period that the foreign shareholder's United States shareholders (as
defined in Sec. 1.367(b)-3(b)(2)) held (directly or indirectly) an
interest in the foreign acquired corporation. This paragraph
(d)(3)(i)(B)(2) applies in addition to the section 1248 regulations'
incorporation of section 1223 holding periods. See Sec. 1.1248-8.
(ii) Exclusion of lower-tier earnings. In applying the attribution
principles of section 1248 and the regulations thereunder to determine
the all earnings and profits amount with respect to stock of a foreign
corporation, the earnings and profits of subsidiaries of the foreign
corporation shall not be taken into account notwithstanding section
1248(c)(2).
(e) Treatment of deemed dividends--(1) In general. In certain
circumstances these regulations provide that an exchanging shareholder
shall include an amount in income as a deemed dividend. This paragraph
provides rules for the treatment of the deemed dividend.
(2) Consequences of dividend characterization. A deemed dividend
described in paragraph (e)(1) of this section shall be treated as a
dividend for purposes of the Internal Revenue Code. The deemed dividend
shall be considered as paid out of the earnings and profits with respect
to which the amount of the deemed dividend was determined. Thus, for
example, a deemed dividend that is determined by reference to the all
earnings and profits amount or the section 1248 amount will never be
considered as paid out of (and therefore will never reduce) earnings and
profits specified in section 1248(d), because such earnings and profits
are excluded in computing the all earnings and profits amount (under
paragraph (d)(2)(ii) of this section) and the section 1248 amount (under
section 1248(d) and paragraph (c)(1) of this section). If the deemed
dividend is determined by reference to the earnings and profits of a
foreign corporation that is owned indirectly (i.e., through one or more
tiers of intermediate owners) by the person that is required to include
the deemed dividend in income, the deemed dividend shall be considered
as having been paid by such corporation to such person through the
intermediate owners, rather than directly to such person.
[[Page 350]]
(3) Ordering rules. In the case of an exchange of stock in which the
exchanging shareholder is treated as receiving a deemed dividend from a
foreign corporation, the following ordering rules concerning the timing,
treatment, and effect of such a deemed dividend shall apply. See also
paragraph (j)(2) of this section.
(i) For purposes of the section 367(b) regulations, the gain
realized by an exchanging shareholder shall be determined before
increasing (as provided in paragraph (e)(3)(ii) of this section) the
basis in the stock of the foreign corporation by the amount of the
deemed dividend.
(ii) Except as provided in paragraph (e)(3)(i) of this section, the
deemed dividend shall be considered to be received immediately before
the exchanging shareholder's receipt of consideration for its stock in
the foreign corporation, and the shareholder's basis in the stock
exchanged shall be increased by the amount of the deemed dividend. Such
basis increase shall be taken into account before determining the gain
otherwise recognized on the exchange (for example, under section 356),
the basis that the exchanging shareholder takes in the property that it
receives in the exchange (under section 358(a)(1)), and the basis that
the transferee otherwise takes in the transferred stock (under section
362).
(iii) Except as provided in paragraph (e)(3)(i) of this section, the
earnings and profits of the appropriate foreign corporation shall be
reduced by the deemed dividend amount before determining the
consequences of the recognition of gain in excess of the deemed dividend
amount (for example, under section 356(a)(2) or sections 356(a)(1) and
1248).
(4) Examples. The following examples illustrate the rules of this
paragraph (e):
Example 1. DC, a domestic corporation, exchanges stock in FC, a
foreign corporation, in a section 367(b) exchange in which DC includes
the all earnings and profits amount in income as a deemed dividend.
Under paragraph (e)(2) of this section, a deemed dividend is treated as
a dividend for purposes of the Internal Revenue Code. As a result, if
the requirements of section 902 are met, DC may qualify for a deemed
paid foreign tax credit with respect to the deemed dividend that it
receives from FC.
Example 2. DC, a domestic corporation, exchanges stock in FC1, a
foreign corporation that is a controlled foreign corporation, in a
transaction in which DC is required to include the section 1248 amount
in income as a deemed dividend. A portion of the section 1248 amount is
determined by reference to the earnings and profits of FC1 (the upper-
tier portion of the section 1248 amount), and the remainder of the
section 1248 amount is determined by reference to the earnings and
profits of FC2, which is a wholly owned foreign subsidiary of FC1 (the
lower-tier portion of the section 1248 amount). Under paragraph (e)(2)
of this section, DC computes its deemed paid foreign tax credit as if
the lower-tier portion of the section 1248 amount were distributed as a
dividend by FC2 to FC1, and as if such portion and the upper-tier
portion of the section 1248 amount were then distributed as a dividend
by FC1 to DC.
Example 3. DC, a domestic corporation, exchanges stock in FC, a
foreign corporation that is a controlled foreign corporation, in a
transaction in which DC realizes gain of $100 (prior to the application
of the section 367(b) regulations). In connection with the transaction,
DC is required to include $40 in income as a deemed dividend under the
section 367(b) regulations. In addition to receiving property permitted
to be received under section 354 without the recognition of gain, DC
also receives cash in the amount of $70. Under paragraph (e)(3) of this
section, the $40 deemed dividend increases DC's basis in its FC stock
before determining the gain to be recognized under section 356. Thus, in
applying section 356, DC is considered to realize $60 of gain on the
exchange, all of which is recognized under section 356(a)(1).
(f) Deemed asset transfer and closing of taxable year in certain
section 368(a)(1)(F) reorganizations--(1) Scope. This paragraph applies
to a reorganization described in section 368(a)(1)(F) in which the
transferor corporation is a foreign corporation.
(2) Deemed asset transfer. In a reorganization described in
paragraph (f)(1) of this section, there is considered to exist--
(i) A transfer of assets by the foreign transferor corporation to
the acquiring corporation in exchange for stock (or stock and
securities) of the acquiring corporation and the assumption by the
acquiring corporation of the foreign transferor corporation's
liabilities;
(ii) A distribution of such stock (or stock and securities) by the
foreign
[[Page 351]]
transferor corporation to its shareholders (or shareholders and security
holders); and
(iii) An exchange by the foreign transferor corporation's
shareholders (or shareholders and security holders) of their stock (or
stock and securities) for stock (or stock and securities) of the
acquiring corporation.
(3) Other applicable rules. For purposes of this paragraph (f), it
is immaterial that the applicable foreign or domestic law treats the
acquiring corporation as a continuation of the foreign transferor
corporation.
(4) Closing of taxable year. In a reorganization described in
paragraph (f)(1) of this section, the taxable year of the foreign
transferor corporation shall end with the close of the date of the
transfer and, except as otherwise required under the Internal Revenue
Code (e.g. section 1502 and the regulations thereunder), the taxable
year of the acquiring corporation shall end with the close of the date
on which the transferor's taxable year would have ended but for the
occurrence of the reorganization if--
(i) The acquiring corporation is a domestic corporation; or
(ii) The foreign transferor corporation has effectively connected
earnings and profits (as defined in section 884(d)) or accumulated
effectively connected earnings and profits (as defined in section
884(b)(2)(B)(ii)).
(g) Stapled stock under section 269B. For rules addressing the
deemed conversion of a foreign corporation to a domestic corporation
under section 269B, see Sec. 1.269B-1(c).
(h) Section 953(d) domestication elections--(1) Effect of election.
A foreign corporation that elects under section 953(d) to be treated as
a domestic corporation shall be treated for purposes of section 367(b)
as transferring, as of the first day of the first taxable year for which
the election is effective, all of its assets to a domestic corporation
in a reorganization described in section 368(a)(1)(F). Notwithstanding
paragraph (d) of this section, for purposes of determining the
consequences of the reorganization under Sec. 1.367(b)-3, the all
earnings and profits amount shall not be considered to include earnings
and profits accumulated in taxable years beginning before January 1,
1988.
(2) Post-election exchanges. For purposes of applying section 367(b)
to post-election exchanges with respect to a corporation that has made a
valid election under section 953(d) to be treated as a domestic
corporation, such corporation shall be treated as a domestic corporation
as to earnings and profits that were taken into account at the time of
the section 953(d) election or which accrue after such election, and
shall be treated as a foreign corporation as to earnings and profits
accumulated in taxable years beginning before January 1, 1988. Thus, for
example, if the section 953(d) corporation subsequently transfers its
assets to a domestic corporation (other than another section 953(d)
corporation) in a transaction described in section 381(a), the rules of
Sec. 1.367(b)-3 shall apply to such transaction to the extent of the
section 953(d) corporation's earnings and profits accumulated in taxable
years beginning before January 1, 1988.
(i) Section 1504(d) elections. An election under section 1504(d),
which permits certain foreign corporations to be treated as domestic
corporations, is treated as a transfer of property to a domestic
corporation and will generally constitute a reorganization described in
section 368(a)(1)(F). However, if an election under section 1504(d) is
made with respect to a foreign corporation from the first day of the
foreign corporation's existence, then the foreign corporation shall be
treated as a domestic corporation, and the section 367(b) regulations
will not apply.
(j) Sections 985 through 989--(1) Change in functional currency of a
qualified business unit--(i) Rule. If, as a result of a section 367(b)
exchange described in section 381(a), a qualified business unit (as
defined in section 989(a)) (QBU) has a different functional currency
determined under the rules of section 985(b) than it used prior to the
transaction, then the QBU shall be deemed to have automatically changed
its functional currency immediately prior to the transaction. A QBU that
is deemed to change its functional currency pursuant to this paragraph
(j) must make the adjustments described in Sec. 1.985-5.
[[Page 352]]
(ii) Example. The following example illustrates the rule of this
paragraph (j)(1):
Example. (i) Facts. DC, a domestic corporation, owns 100 percent of
FC1, a foreign corporation. FC1 owns and operates a qualified business
unit (QBU) (B1) in France, whose functional currency is the euro. FC2,
an unrelated foreign corporation, owns and operates a QBU (B2) in
France, whose functional currency is the dollar. FC2 acquires FC1's
assets (including B1) in a reorganization described in section
368(a)(1)(C). As a part of the reorganization, B1 and B2 combine their
operations into one QBU. Applying the rules of section 985(b), the
functional currency of the combined operations of B1 and B2 is the euro.
(ii) Result. FC2's acquisition of FC1's assets is a section 367(b)
exchange that is described in section 381(a). Because the functional
currency of the combined operations of B1 and B2 after the exchange is
the euro, B2 is deemed to have automatically changed its functional
currency to the euro immediately prior to the section 367(b) exchange.
B2 must make the adjustments described in Sec. 1.985-5.
(2) Previously taxed earnings and profits--(i) Exchanging
shareholder that is a United States person. If an exchanging shareholder
that is a United States person is required to include in income either
the all earnings and profits amount or the section 1248 amount under the
provisions of Sec. 1.367(b)-3 or 1.367(b)-4, then immediately prior to
the exchange, and solely for the purpose of computing exchange gain or
loss under section 986(c), the exchanging shareholder shall be treated
as receiving a distribution of previously taxed earnings and profits
from the appropriate foreign corporation that is attributable (under the
principles of section 1248) to the exchanged stock. If an exchanging
shareholder that is a United States person is a distributee in an
exchange described in Sec. 1.367(b)-5(c) or (d), then immediately prior
to the exchange, and solely for the purpose of computing exchange gain
or loss under section 986(c), the exchanging shareholder shall be
treated as receiving a distribution of previously taxed earnings and
profits from the appropriate foreign corporation to the extent such
shareholder has a diminished interest in such previously taxed earnings
and profits after the exchange. The exchange gain or loss recognized
under this paragraph (j)(2)(i) will increase or decrease the exchanging
shareholder's adjusted basis in the stock of the foreign corporation,
including for purposes of computing gain or loss realized with respect
to the stock on the transaction. The exchanging shareholder's dollar
basis with respect to each account of previously taxed income shall be
increased or decreased by the exchange gain or loss recognized.
(ii) Exchanging shareholder that is a foreign corporation. If an
exchanging shareholder that is a foreign corporation is required to
include in income either the all earnings and profits amount or the
section 1248 amount under the provisions of Sec. 1.367(b)-3 or
1.367(b)-4, then, immediately prior to the exchange, the exchanging
shareholder shall be treated as receiving a distribution of previously
taxed earnings and profits from the appropriate foreign corporation that
is attributable (under the principles of section 1248) to the exchanged
stock. If an exchanging shareholder that is a foreign corporation is a
distributee in an exchange described in Sec. 1.367(b)-5(c) or (d), then
the exchanging shareholder shall be treated as receiving (immediately
prior to the exchange) a distribution of previously taxed earnings and
profits from the appropriate foreign corporation. Such distribution
shall be measured by the extent to which the exchanging shareholder's
direct or indirect United States shareholders (as defined in section
951(b)) have a diminished interest in such previously taxed earnings and
profits after the exchange.
(3) Other rules. See sections 985 through 989 for other currency
rules that may apply in connection with a section 367(b) exchange.
(k) Partnerships, trusts and estates. In applying the section 367(b)
regulations, stock of a corporation that is owned by a foreign
partnership, trust or estate shall be considered as owned
proportionately by its partners, owners, or beneficiaries under the
principles of Sec. 1.367(e)-1(b)(2). Stock owned by an entity that is
disregarded as an entity separate from its owner under Sec. 301.7701-3
is owned directly by the owner of such entity. In applying Sec.
1.367(b)-5(b), the principles of Sec. 1.367(e)-1(b)(2) shall also apply
to a domestic partnership, trust or estate.
[[Page 353]]
(l) Additional definitions--(1) Foreign income taxes. The term
foreign income taxes has the meaning set forth in Sec. 1.902-1(a)(7).
(2) Post-1986 undistributed earnings. The term post-1986
undistributed earnings has the meaning set forth in Sec. 1.902-1(a)(9).
(3) Post-1986 foreign income taxes. The term post-1986 foreign
income taxes has the meaning set forth in Sec. 1.902-1(a)(8).
(4) Pre-1987 accumulated profits. The term pre-1987 accumulated
profits means the earnings and profits described in Sec. 1.902-
1(a)(10)(i), computed in accordance with the rules of Sec. 1.902-
1(a)(10)(ii).
(5) Pre-1987 foreign income taxes. The term pre-1987 foreign income
taxes has the meaning set forth in Sec. 1.902-1(a)(10)(iii).
(6) Pre-1987 section 960 earnings and profits. The term pre-1987
section 960 earnings and profits means the earnings and profits of a
foreign corporation accumulated in taxable years beginning before
January 1, 1987, computed under Sec. 1.964-1(a) through (e), and
translated into the functional currency (as determined under section
985) of the foreign corporation at the spot rate on the first day of the
foreign corporation's first taxable year beginning after December 31,
1986. For further guidance, see Notice 88-70 (1988-2 C.B. 369, 370) (see
also Sec. 601.601(d)(2) of this chapter). The term pre-1987 section 960
earnings and profits does not include earnings and profits that
represent previously taxed earnings and profits described in section
959.
(7) Pre-1987 section 960 foreign income taxes. The term pre-1987
section 960 foreign income taxes means the foreign income taxes related
to pre-1987 section 960 earnings and profits, determined in accordance
with the principles of Sec. 1.902-1(a)(10)(iii), except that the U.S.
dollar amounts of pre-1987 section 960 foreign income taxes are
determined by reference to the exchange rates in effect when the taxes
were paid or accrued.
(8) Earnings and profits. For purposes of Sec. Sec. 1.367(b)-7 and
1.367(b)-9, the term earnings and profits means post-1986 undistributed
earnings, pre-1987 accumulated profits, and pre-1987 section 960
earnings and profits.
(9) Pooling corporation. The term pooling corporation means a
foreign corporation with respect to which the requirements of section
902(c)(3)(B) have been met in the current taxable year or any prior
taxable year.
(10) Nonpooling corporation. The term nonpooling corporation means a
foreign corporation that is not a pooling corporation.
(11) Separate category. The term separate category has the meaning
set forth in section 904(d)(1), and shall also include any other
category of income to which section 904(a), (b), and (c) are applied
separately under any other provision of the Internal Revenue Code (e.g.,
sections 56(g)(4)(C)(iii)(IV), 245(a)(10), 865(h), 901(j), and
904(h)(10) (or section 904(g)(10) for taxable years beginning on or
before December 31, 2006).
(12) Passive category. The term passive category means the separate
category that includes income described in section 904(d)(1)(A).
(13) General category. The term general category means the separate
category that includes income described in section 904(d)(1)(B) (or
section 904(d)(1)(I) for taxable years beginning on or before December
31, 2006).
[T.D. 8862, 65 FR 3598, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as
amended by T.D. 9216, 70 FR 43760, July 29, 2005; T.D. 9273, 71 FR
44894, Aug. 8, 2006; T.D. 9345, 72 FR 41444, July 30, 2007; T.D. 9400,
73 FR 30303, May 27, 2008]
Sec. 1.367(b)-3 Repatriation of foreign corporate assets in certain
nonrecognition transactions.
(a) Scope. This section applies to an acquisition by a domestic
corporation (the domestic acquiring corporation) of the assets of a
foreign corporation (the foreign acquired corporation) in a liquidation
described in section 332 or an asset acquisition described in section
368(a)(1).
(b) Exchange of stock owned directly by a United States shareholder
or by certain foreign corporate shareholders--(1) Scope. This paragraph
(b) applies in the case of an exchanging shareholder that is either--
(i) A United States shareholder of the foreign acquired corporation;
or
(ii) A foreign corporation with respect to which there are one or
more United States shareholders.
[[Page 354]]
(2) United States shareholder. For purposes of this section (and for
purposes of the other section 367(b) regulation provisions that
specifically refer to this paragraph (b)(2)), the term United States
shareholder means any shareholder described in section 951(b) (without
regard to whether the foreign corporation is a controlled foreign
corporation), and also any shareholder described in section 953(c)(1)(A)
(but only if the foreign corporation is a controlled foreign corporation
as defined in section 953(c)(1)(B) subject to the rules of section
953(c)).
(3) Income inclusion--(i) Inclusion of all earnings and profits
amount. An exchanging shareholder shall include in income as a deemed
dividend the all earnings and profits amount with respect to its stock
in the foreign acquired corporation. For the consequences of the deemed
dividend, see Sec. 1.367(b)-2(e). Notwithstanding Sec. 1.367(b)-2(e),
however, a deemed dividend from the foreign acquired corporation to an
exchanging foreign corporate shareholder shall not qualify for the
exception from foreign personal holding company income provided by
section 954(c)(3)(A)(i), although it may qualify for the look-through
treatment provided by section 904(d)(3) if the requirements of that
section are met with respect to the deemed dividend.
(ii) Examples. The following examples illustrate the rules of
paragraph (b)(3)(i) of this section:
Example 1. (i) Facts. DC, a domestic corporation, owns all of the
outstanding stock of FC, a foreign corporation. The stock of FC has a
value of $100, and DC has a basis of $30 in such stock. The all earnings
and profits amount attributable to the FC stock owned by DC is $20, of
which $15 is described in section 1248(a) and the remaining $5 is not
(for example, because it accumulated prior to 1963). FC has a basis of
$50 in its assets. In a liquidation described in section 332, FC
distributes all of its property to DC, and the FC stock held by DC is
canceled.
(ii) Result. Under paragraph (b)(3)(i) of this section, DC must
include $20 in income as a deemed dividend from FC. Under section 337(a)
FC does not recognize gain or loss in the assets that it distributes to
DC, and under section 334(b), DC takes a basis of $50 in such assets.
Because the requirements of section 902 are met, DC qualifies for a
deemed paid foreign tax credit with respect to the deemed dividend that
it receives from FC.
Example 2. (i) Facts. DC, a domestic corporation, owns all of the
outstanding stock of FC, a foreign corporation. The stock of FC has a
value of $100, and DC has a basis of $30 in such stock. The all earnings
and profits amount attributable to the FC stock owned by DC is $75. FC
has a basis of $50 in its assets. In a liquidation described in section
332, FC distributes all of its property to DC, and the FC stock held by
DC is canceled.
(ii) Result. Under paragraph (b)(3)(i) of this section, DC must
include $75 in income as a deemed dividend from FC. Under section 337(a)
FC does not recognize gain or loss in the assets that it distributes to
DC, and under section 334(b), DC takes a basis of $50 in such assets.
Because the requirements of section 902 are met, DC qualifies for a
deemed paid foreign tax credit with respect to the deemed dividend that
it receives from FC.
Example 3. (i) Facts. DC, a domestic corporation, owns 80 percent of
the outstanding stock of FC, a foreign corporation. DC has owned its 80
percent interest in FC since FC was incorporated. The remaining 20
percent of the outstanding stock of FC is owned by a person unrelated to
DC (the minority shareholder). The stock of FC owned by DC has a value
of $80, and DC has a basis of $24 in such stock. The stock of FC owned
by the minority shareholder has a value of $20, and the minority
shareholder has a basis of $18 in such stock. FC's only asset is land
having a value of $100, and FC has a basis of $50 in the land. Gain on
the land would not generate earnings and profits qualifying under
section 1248(d) for an exclusion from earnings and profits for purposes
of section 1248. FC has earnings and profits of $20 (determined under
the rules of Sec. 1.367(b)-2(d)(2) (i) and (ii)), $16 of which is
attributable to the stock owned by DC under the rules of Sec. 1.367(b)-
2(d)(3). FC subdivides the land and distributes to the minority
shareholder land with a value of $20 and a basis of $10. As part of the
same transaction, in a liquidation described in section 332, FC
distributes the remainder of its land to DC, and the FC stock held by DC
and the minority shareholder is canceled.
(ii) Result. Under section 336, FC must recognize the $10 of gain it
realizes in the land it distributes to the minority shareholder, and
under section 331 the minority shareholder recognizes its gain of $2 in
the stock of FC. Such gain is included in income by the minority
shareholder as a dividend to the extent provided in section 1248 if the
minority shareholder is a United States person that is described in
section 1248(a)(2). Under Sec. 1.367(b)-2(d)(2)(iii), the $10 of gain
recognized by FC increases its earnings and profits for purposes of
computing the all earnings and profits amount and, as a result, $8
[[Page 355]]
of such increase (80 percent of $10) is considered to be attributable to
the FC stock owned by DC under Sec. 1.367(b)-2(d)(3)(i)(A)(1). DC's all
earnings and profits amount with respect to its stock in FC is $24 (the
$16 of initial all earnings and profits amount with respect to the FC
stock held by DC, plus the $8 addition to such amount that results from
FC's recognition of gain on the distribution to the minority
shareholder). Under paragraph (b)(3)(i) of this section, DC must include
the $24 all earnings and profits amount in income as a deemed dividend
from FC.
Example 4. (i) Facts. DC1, a domestic corporation, owns all of the
outstanding stock of DC2, a domestic corporation. DC1 also owns all of
the outstanding stock of FC, a foreign corporation. The stock of FC has
a value of $100, and DC1 has a basis of $30 in such stock. The assets of
FC have a value of $100. The all earnings and profits amount with
respect to the FC stock owned by DC1 is $20. In a reorganization
described in section 368(a)(1)(D), DC2 acquires all of the assets of FC
solely in exchange for DC2 stock. FC distributes the DC2 stock to DC1,
and the FC stock held by DC1 is canceled.
(ii) Result. DC1 must include $20 in income as a deemed dividend
from FC under paragraph (b)(3)(i) of this section. Under section 361, FC
does not recognize gain or loss in the assets that it transfers to DC2
or in the DC2 stock that it distributes to DC1, and under section 362(b)
DC2 takes a basis in the assets that it acquires from FC equal to the
basis that FC had therein. Under Sec. 1.367(b)-2(e)(3)(ii) and section
358(a)(1), DC1 takes a basis of $50 (its $30 basis in the stock of FC,
plus the $20 that was treated as a deemed dividend to DC1) in the stock
of DC2 that it receives in exchange for the stock of FC. Under Sec.
1.367(b)-2(e)(3)(iii) and section 312(a), the earnings and profits of FC
are reduced by the $20 deemed dividend.
Example 5. (i) Facts. DC1, a domestic corporation, owns all of the
outstanding stock of FC1, a foreign corporation. FC1 owns all of the
outstanding stock of FC2, a foreign corporation. The all earnings and
profits amount with respect to the FC2 stock owned by FC1 is $20. In a
reorganization described in section 368(a)(1)(A), DC2, a domestic
corporation unrelated to FC1 or FC2, acquires all of the assets and
liabilities of FC2 pursuant to a State W merger. FC2 receives DC2 stock
and distributes such stock to FC1. The FC2 stock held by FC1 is
canceled, and FC2 ceases its separate legal existence.
(ii) Result. FC1 must include $20 in income as a deemed dividend
from FC2 under paragraph (b)(3)(i) of this section. The deemed dividend
is treated as a dividend for purposes of the Internal Revenue Code as
provided in Sec. 1.367(b)-2(e)(2); however, under paragraph (b)(3)(i)
of this section the deemed dividend cannot qualify for the exception
from foreign personal holding company income provided by section
954(c)(3)(A)(i), even if the provisions of that section would otherwise
have been met in the case of an actual dividend.
Example 6. (i) Facts. DC1, a domestic corporation, owns 99 percent
of USP, a domestic partnership. The remaining 1 percent of USP is owned
by a person unrelated to DC1. DC1 and USP each directly own 9 percent of
the outstanding stock of FC, a foreign corporation that is not a
controlled foreign corporation subject to the rule of section 953(c). In
a reorganization described in section 368(a)(1)(C), DC2, a domestic
corporation, acquires all of the assets and liabilities of FC in
exchange for DC2 stock. FC distributes to its shareholders DC2 stock,
and the FC stock held by its shareholders is canceled.
(ii) Result. (A) DC1 and USP are United States persons that are
exchanging shareholders in a transaction described in paragraph (a) of
this section. As a result, DC1 and USP are subject to the rules of
paragraph (b) of this section if they qualify as United States
shareholders as defined in paragraph (b)(2) of this section.
Alternatively, if they do not qualify as United States shareholders as
defined in paragraph (b)(2) of this section, DC1 and USP are subject to
the rules of paragraph (c) of this section. Paragraph (b)(2) of this
section defines the term United States shareholder to include any
shareholder described in section 951(b) (without regard to whether the
foreign corporation is a controlled foreign corporation). A shareholder
described in section 951(b) is a United States person that is considered
to own, applying the rules of section 958(a) and 958(b), 10 percent or
more of the total combined voting power of all classes of stock entitled
to vote of a foreign corporation. Under section 958(b), the rules of
section 318(a), as modified by section 958(b) and the regulations
thereunder, apply so that, in general, stock owned directly or
indirectly by a partnership is considered as owned proportionately by
its partners, and stock owned directly or indirectly by a partner is
considered as owned by the partnership. Thus, under section 958(b), DC1
is treated as owning its proportionate share of FC stock held by USP,
and USP is treated as owning all of the FC stock held by DC1.
(B) Accordingly, for purposes of determining whether DC1 is a United
States shareholder under paragraph (b)(2) of this section, DC1 is
considered as owning 99 percent of the 9 percent of FC stock held by
USP. Because DC1 also owns 9 percent of FC stock directly, DC1 is
considered as owning more than 10 percent of FC stock. DC1 is thus a
United States shareholder of FC under paragraph (b)(2) of this section
and, as a result, is subject to the rules of paragraph (b) of this
section. However, for purposes of determining DC1's all earnings and
profits amount, DC1 is not treated as owning the FC stock held by USP.
Under Sec. 1.367(b)-2(d)(3),
[[Page 356]]
DC1's all earnings and profits amount is determined by reference to the
9 percent of FC stock that it directly owns.
(C) For purposes of determining whether USP is a United States
shareholder under paragraph (b)(2) of this section, USP is considered as
owning the 9 percent of FC stock held by DC1. Because USP also owns 9
percent of FC stock directly, USP is considered as owning more than 10
percent of FC stock. USP is thus a United States shareholder of FC under
paragraph (b)(2) of this section and, as a result, is subject to the
rules of paragraph (b) of this section. However, for purposes of
determining USP's all earnings and profits amount, USP is not treated as
owning the FC shares held by DC1. Under Sec. 1.367(b)-2(d)(3), USP's
all earnings and profits amount is determined by reference to the 9
percent of FC stock that it directly owns.
(iii) Recognition of exchange gain or loss with respect to capital.
[Reserved]
(4) Reserved. For further guidance concerning section 367(b)
exchanges occurring before February 23, 2001, see Sec. 1.367(b)-
3T(b)(4).
(c) Exchange of stock owned by a United States person that is not a
United States shareholder--(1) Scope. This paragraph (c) applies in the
case of an exchanging shareholder that is a United States person not
described in paragraph (b)(1)(i) of this section (i.e., a United States
person that is not a United States shareholder of the foreign acquired
corporation).
(2) Requirement to recognize gain. An exchanging shareholder
described in paragraph (c)(1) of this section shall recognize realized
gain (but not loss) with respect to the stock of the foreign acquired
corporation.
(3) Election to include all earnings and profits amount. In lieu of
the treatment prescribed by paragraph (c)(2) of this section, an
exchanging shareholder described in paragraph (c)(1) of this section may
instead elect to include in income as a deemed dividend the all earnings
and profits amount with respect to its stock in the foreign acquired
corporation. For the consequences of a deemed dividend, see Sec.
1.367(b)-2(e). Such election may be made only if--
(i) The foreign acquired corporation (or its successor in interest)
has provided the exchanging shareholder information to substantiate the
exchanging shareholder's all earnings and profits amount with respect to
its stock in the foreign acquired corporation; and
(ii) The exchanging shareholder complies with the section 367(b)
notice requirement described in Sec. 1.367(b)-1(c), including the
specific rules contained therein concerning the time and manner for
electing to apply the rules of this paragraph (c)(3).
(4) De minimis exception. This paragraph (c) shall not apply in the
case of an exchanging shareholder whose stock in the foreign acquired
corporation has a fair market value of less than $50,000 on the date of
the section 367(b) exchange.
(5) Examples. The following examples illustrate the rules of this
paragraph (c):
Example 1. (i) Facts. DC1, a domestic corporation, owns 5 percent of
the outstanding stock of FC, a foreign corporation that is not a
controlled foreign corporation subject to the rule of section 953(c).
Persons unrelated to DC1 own the remaining 95 percent of the outstanding
stock of FC. DC1 has owned its 5 percent interest in FC since FC was
incorporated. DC1's stock in FC has a basis of $40,000 and a value of
$100,000. The all earnings and profits amount with respect to DC1's
stock in FC is $50,000. In a reorganization described in section
368(a)(1)(C), DC2, a domestic corporation, acquires all of the assets
and liabilities of FC in exchange for DC2 stock. FC distributes DC2
stock to its shareholders, and the FC stock held by its shareholders is
canceled.
(ii) Alternate result 1. If DC1 does not make the election described
in paragraph (c)(3) of this section, then the general rule of paragraph
(c)(2) of this section applies and DC1 must recognize its $60,000 gain
in the FC stock. Under section 358(a)(1), DC1 has a $100,000 basis (its
$40,000 basis in the FC stock, plus the $60,000 recognized gain) in the
DC2 stock that it receives in exchange for its FC stock. Because DC1 is
not a shareholder described in section 1248(a)(2), section 1248 does not
apply to recharacterize any of DC1's gain as a dividend.
(iii) Alternate result 2. If DC1 makes a valid election under
paragraph (c)(3) of this section, then DC1 must include in income as a
deemed dividend the $50,000 all earnings and profits amount with respect
to its FC stock. Under Sec. 1.367(b)-2(e)(3) and section 358(a)(1), DC1
has a $90,000 basis (its $40,000 basis in the FC stock, plus the $50,000
that was treated as a deemed dividend to DC1) in the DC2 stock that it
receives in exchange for its FC stock. Because DC1 owns less than 10
percent of the voting stock of FC, DC1 does not qualify for a deemed
paid foreign tax credit under section 902.
[[Page 357]]
Example 2. (i) Facts. The facts are the same as in Example 1, except
that DC1's stock in FC has a fair market value of $48,000 on the date
DC1 receives the DC2 stock.
(ii) Result. Because DC1's stock in FC has a fair market value of
less than $50,000 on the date of the section 367(b) exchange, the de
minimis exception of paragraph (c)(4) of this section applies. As a
result, DC1 is not subject to the gain or income inclusion requirements
of this paragraph (c).
(d) Carryover of certain foreign taxes--(1) Rule. Excess foreign
taxes under section 904(c) allowable to the foreign acquired corporation
under section 906 shall carry over to the domestic acquiring corporation
and become allowable under section 901, subject to the limitations
prescribed by the Internal Revenue Code (for example, sections 383, 904
and 907). The domestic acquiring corporation shall not succeed to any
other foreign taxes paid or incurred by the foreign acquired
corporation.
(2) Example. The following example illustrates the rules of this
paragraph (d):
Example. (i) Facts. DC, a domestic corporation owns 100 percent of
the outstanding stock of FC, a foreign corporation. FC has net positive
earnings and profits, none of which are attributable to DC's FC stock
under Sec. 1.367(b)-2(d)(3). FC has paid foreign taxes that are not
eligible for credit under section 906. In a liquidation described in
section 332, FC distributes all of its property to DC, and the FC stock
held by DC is canceled.
(ii) Result. The liquidation of FC into DC is a section 367(b)
exchange. Thus, DC is subject to the section 367(b) regulations, and
must file a section 367(b) notice pursuant to Sec. 1.367(b)-1(c).
Pursuant to the provisions of paragraph (d)(1) of this section, the
foreign taxes paid by FC do not carryover to DC because FC's foreign
taxes are not eligible for credit under section 906.
(e) Net operating loss and capital loss carryovers. A net operating
loss or capital loss carryover of the foreign acquired corporation is
described in section 381(c)(1) and (c)(3) and thus is eligible to carry
over from the foreign acquired corporation to the domestic acquiring
corporation only to the extent the underlying deductions or losses were
allowable under chapter 1 of subtitle A of the Internal Revenue Code.
Thus, only a net operating loss or capital loss carryover that is
effectively connected with the conduct of a trade or business within the
United States (or that is attributable to a permanent establishment, in
the context of an applicable United States income tax treaty) is
eligible to be carried over under section 381. For further guidance, see
Rev. Rul. 72-421 (1972-2 C.B. 166) (see also Sec. 601.601(d)(2) of this
chapter).
(f) Carryover of earnings and profits--(1) General rule. Except to
the extent otherwise specifically provided (see, e.g., Notice 89-79
(1989-2 C.B. 392) (see also Sec. 601.601(d)(2) of this chapter)),
earnings and profits of the foreign acquired corporation that are not
included in income as a deemed dividend under the section 367(b)
regulations (or deficit in earnings and profits) are eligible to carry
over from the foreign acquired corporation to the domestic acquiring
corporation under section 381(c)(2) only to the extent such earnings and
profits (or deficit in earnings and profits) are effectively connected
with the conduct of a trade or business within the United States (or are
attributable to a permanent establishment in the United States, in the
context of an applicable United States income tax treaty). All other
earnings and profits (or deficit in earnings and profits) of the foreign
acquired corporation shall not carry over to the domestic acquiring
corporation and, as a result, shall be eliminated.
(2) Previously taxed earnings and profits. [Reserved]
[T.D. 8862, 65 FR 3601, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as
amended by T.D. 9243, 71 FR 4288, Jan. 26, 2006; T.D. 9273, 71 FR 44895,
Aug. 8, 2006]
Sec. 1.367(b)-3T Repatriation of foreign corporate assets in certain
nonrecognition transactions (temporary).
(a)-(b)(3). [Reserved]. For further guidance, see Sec. 1.367(b)-
3(a) through (b)(3).
(4) Election of taxable exchange treatment--(i) Rules--(A) In
general. In lieu of the treatment prescribed by Sec. 1.367(b)-
3(b)(3)(i), an exchanging shareholder described in Sec. 1.367(b)-
3(b)(1) may instead elect to recognize the gain (but not loss) that it
realizes in the exchange (taxable exchange election). To make a taxable
exchange
[[Page 358]]
election, the following requirements must be satisfied--
(1) The exchanging shareholder (and its direct or indirect owners
that would be affected by the election, in the case of an exchanging
shareholder that is a foreign corporation) reports the exchange in a
manner consistent therewith (see, e.g., sections 954(c)(1)(B)(i), 1001
and 1248);
(2) The notification requirements of paragraph (b)(4)(i)(C) of this
section are satisfied; and
(3) The adjustments described in paragraph (b)(4)(i)(B) of this
section are made when the following circumstances are present--
(i) The transaction is described in section 332 or is an asset
acquisition described in section 368(a)(1), with regard to which one
U.S. person owns (directly or indirectly) 100 percent of the foreign
acquired corporation; and
(ii) The all earnings and profits amount described in Sec.
1.367(b)-3(b)(3)(i) with respect to the exchange exceeds the gain
recognized by the exchanging shareholder.
(B) Attribute reduction--(1) Reduction of NOL carryovers. The amount
by which the all earnings and profits amount exceeds the gain recognized
by the exchanging shareholder (the excess earnings and profits amount)
shall be applied to reduce the net operating loss carryovers (if any) of
the foreign acquired corporation to which the domestic acquiring
corporation would otherwise succeed under section 381(a) and (c)(1). See
also Rev. Rul. 72-421 (1972-2 C.B. 166) (see Sec. 601.601(d)(2) of this
chapter).
(2) Reduction of capital loss carryovers. After the application of
paragraph (b)(4)(i)(B)(1) of this section, any remaining excess earnings
and profits amount shall be applied to reduce the capital loss
carryovers (if any) of the foreign acquired corporation to which the
domestic acquiring corporation would otherwise succeed under section
381(a) and (c)(3).
(3) Reduction of basis. After the application of paragraph
(b)(4)(i)(B)(2) of this section, any remaining excess earnings and
profits amount shall be applied to reduce (but not below zero) the basis
of the assets (other than dollar-denominated money) of the foreign
acquired corporation that are acquired by the domestic acquiring
corporation. Such remaining excess earnings and profits amount shall be
applied to reduce the basis of such assets in the following order:
first, tangible depreciable or depletable assets, according to their
class lives (beginning with those assets with the shortest class life);
second, other non-inventory tangible assets; third, intangible assets
that are amortizable; and finally, the remaining assets of the foreign
acquired corporation that are acquired by the domestic acquiring
corporation. Within each of these categories, if the total basis of all
assets in the category is greater than the excess earnings and profits
amount to be applied against such basis, the taxpayer may choose to
which specific assets in the category the basis reduction first applies.
(C) Notification. The exchanging shareholder shall elect to apply
the rules of this paragraph (b)(4)(i) by attaching a statement of its
election to its section 367(b) notice. See Sec. 1.367(b)-1(c) For the
rules concerning filing a section 367(b) notice.
(D) Example. The following example illustrates the rules of this
paragraph (b)(4)(i):
Example. (i) Facts. DC, a domestic corporation, owns all of the
outstanding stock of FC, a foreign corporation. The stock of FC has a
value of $100, and DC has a basis of $80 in such stock. The assets of FC
are one parcel of land with a value of $60 and a basis of $30, and
tangible depreciable assets with a value of $40 and a basis of $80. FC
has no net operating loss carryovers or capital loss carryovers. The all
earnings and profits amount with respect to the FC stock owned by DC is
$30, of which $19 is described in section 1248(a) and the remaining $11
is not (for example, because it was earned prior to 1963). In a
liquidation described in section 332, FC distributes all of its property
to DC, and the FC stock held by DC is canceled. Rather than including in
income as a deemed dividend the all earnings and profits amount of $30
as provided in Sec. 1.367(b)-3(b)(3)(i), DC instead elects taxable
exchange treatment under paragraph (b)(4)(i)(A) of this section.
(ii) Result. DC recognizes the $20 of gain it realizes on its stock
in FC. Of this $20 amount, $19 is included in income by DC as a dividend
pursuant to section 1248(a). (For the source of the remaining $1 of gain
recognized by DC, see section 865. For the treatment of the $1 for
purposes of the foreign tax credit limitation, see generally section
[[Page 359]]
904(d)(2)(A)(i).) Because the transaction is described in section 332
and because the all earnings and profits amount with respect to the FC
stock held by DC ($30) exceeds by $10 the income recognized by DC ($20),
the attribute reduction rules of paragraph (b)(4)(i)(B) of this section
apply. Accordingly, the $10 excess earnings and profits amount is
applied to reduce the basis of the tangible depreciable assets of FC,
beginning with those assets with the shortest class lives. Under section
337(a) FC does not recognize gain or loss in the assets that it
distributes to DC, and under section 334(b) (which is applied taking
into account the basis reduction prescribed by paragraph (b)(4)(i)(A)(3)
of this section) DC takes a basis of $30 in the land and $70 in the
tangible depreciable assets that it receives from FC.
(ii) Effective date. This paragraph (b)(4) applies for section
367(b) exchanges that occur between February 23, 2000, and February 23,
2001.
(c)-(d) [Reserved]. For further guidance, see Sec. 1.367(b)-3(c)
through (d).
[T.D. 8863, 65 FR 3588, Jan. 24, 2000, as amended by T.D. 9243, 71 FR
4288, Jan. 26, 2006]
Sec. 1.367(b)-4 Acquisition of foreign corporate stock or assets by a foreign
corporation in certain nonrecognition transactions.
(a) Scope. This section applies to an acquisition by a foreign
corporation (the foreign acquiring corporation) of the stock or assets
of a foreign corporation (the foreign acquired corporation) in an
exchange described in section 351 or a reorganization described in
section 368(a)(1). For rules applicable when, pursuant to section
304(a)(1), a foreign acquiring corporation is treated as acquiring the
stock of a foreign acquired corporation in a transaction to which
section 351(a) applies, see Sec. 1.367(b)-4T(e). In the case of a
reorganization described in sections 368(a)(1)(A) and (a)(2)(E), this
section applies if stock of the foreign surviving corporation is
exchanged for stock of a foreign corporation in control of the merging
corporation; in such a case, the foreign surviving corporation is
treated as a foreign acquired corporation for purposes of this section.
A foreign corporation that undergoes a reorganization described in
section 368(a)(1)(E) is treated as both the foreign acquired corporation
and the foreign acquiring corporation for purposes of this section. See
Sec. 1.367(a)-3(b)(2) for transactions subject to the concurrent
application of this section and section 367(a).
(b) Income inclusion. If an exchange is described in paragraph
(b)(1)(i), (2)(i) or (3) of this section, the exchanging shareholder
shall include in income as a deemed dividend the section 1248 amount
attributable to the stock that it exchanges.
(1) Exchange that results in loss of status as section 1248
shareholder--(i) General rule. Except as provided in paragraph
(b)(1)(ii) of this section, an exchange is described in this paragraph
(b)(1)(i) if--
(A) Immediately before the exchange, the exchanging shareholder is--
(1) A United States person that is a section 1248 shareholder with
respect to the foreign acquired corporation; or
(2) A foreign corporation, and a United States person is a section
1248 shareholder with respect to such foreign corporation and with
respect to the foreign acquired corporation; and
(B) Either of the following conditions is satisfied--
(1) Immediately after the exchange, the stock received in the
exchange is not stock in a corporation that is a controlled foreign
corporation as to which the United States person described in paragraph
(b)(1)(i)(A) of this section is a section 1248 shareholder; or
(2) Immediately after the exchange, the foreign acquiring
corporation or the foreign acquired corporation (if any, such as in a
transaction described in section 368(a)(1)(B) and/or section 351), is
not a controlled foreign corporation as to which the United States
person described in paragraph (b)(1)(i)(A) of this section is a section
1248 shareholder.
(ii) Exception. In the case of a triangular reorganization described
in Sec. 1.358-6(b)(2), or a reorganization described in sections
368(a)(1)(G) and (a)(2)(D), an exchange is not described in paragraph
(b)(1)(i) of this section if the stock received in the exchange is stock
of a domestic corporation and, immediately after the exchange, such
domestic corporation is a section 1248 shareholder of the acquired
corporation (in the case of a triangular B reorganization) or the
surviving corporation
[[Page 360]]
(in the case of a triangular C reorganization, a forward triangular
merger, a reorganization described in sections 368(a)(1)(G) and
(a)(2)(D), or a reverse triangular merger) and such acquired or
surviving corporation is a controlled foreign corporation. See Sec.
1.367(b)-13(c) for rules regarding such domestic corporation's basis in
the stock of the surviving corporation. See paragraph (b)(1)(iii) of
this section, Example 3B for an illustration of this rule.
(iii) Examples. The following examples illustrate the rules of this
paragraph (b)(1):
Example 1. (i) Facts. FC1 is a foreign corporation that is owned,
directly and indirectly (applying the ownership rules of section 958),
solely by foreign persons. DC is a domestic corporation that is
unrelated to FC1. DC owns all of the outstanding stock of FC2, a foreign
corporation. Thus, under Sec. 1.367(b)-2(a) and (b), DC is a section
1248 shareholder with respect to FC2, and FC2 is a controlled foreign
corporation. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount
attributable to the stock of FC2 held by DC is $20. In a reorganization
described in section 368(a)(1)(C), FC1 acquires all of the assets and
assumes all of the liabilities of FC2 in exchange for FC1 voting stock.
The FC1 voting stock received does not represent more than 50 percent of
the voting power or value of FC1's stock. FC2 distributes the FC1 stock
to DC, and the FC2 stock held by DC is canceled.
(ii) Result. FC1 is not a controlled foreign corporation immediately
after the exchange. As a result, the exchange is described in paragraph
(b)(1)(i) of this section. Under paragraph (b) of this section, DC must
include in income, as a deemed dividend from FC2, the section 1248
amount ($20) attributable to the FC2 stock that DC exchanged.
Example 2. (i) Facts. The facts are the same as in Example 1, except
that the voting stock of FC1, which is received by FC2 in exchange for
its assets and distributed by FC2 to DC, represents more than 50 percent
of the voting power of FC1's stock under the rules of section 957(a).
(ii) Result. Paragraph (b)(1)(i) of this section does not apply to
require inclusion in income of the section 1248 amount, because FC1 is a
controlled foreign corporation as to which DC is a section 1248
shareholder immediately after the exchange.
Example 3. (i) Facts. The facts are the same as in Example 1, except
that FC2 receives and distributes voting stock of FP, a foreign
corporation that is in control (within the meaning of section 368(c)) of
FC1, instead of receiving and distributing voting stock of FC1.
(ii) Result. For purposes of section 367(a), the transfer is an
indirect stock transfer subject to section 367(a). See Sec. 1.367(a)-
3(d)(1)(iv). Accordingly, DC's exchange of FC2 stock for FP stock under
section 354 will be taxable under section 367(a) (and section 1248 will
be applicable) if DC fails to enter into a gain recognition agreement in
accordance with Sec. 1.367(a)-8. Under Sec. 1.367(a)-3(b)(2), if DC
enters into a gain recognition agreement, the exchange will be subject
to the provisions of section 367(b) and the regulations thereunder, as
well as section 367(a). If FP and FC1 are controlled foreign
corporations as to which DC is a (direct or indirect) section 1248
shareholder immediately after the reorganization, then the section
367(b) result is the same as in Example 2--that is, paragraph (b)(1)(i)
of this section does not apply to require inclusion in income of the
section 1248 amount. Under these circumstances, the amount of the gain
recognition agreement would equal the amount of the gain realized on the
indirect stock transfer. If FP or FC1 is not a controlled foreign
corporation as to which DC is a (direct or indirect) section 1248
shareholder immediately after the exchange, then the section 367(b)
result is the same as in Example 1--that is, DC must include in income,
as a deemed dividend from FC2, the section 1248 amount ($20)
attributable to the FC2 stock that DC exchanged. Under these
circumstances, the amount of the gain recognition agreement would equal
the amount of the gain realized on the indirect stock transfer, less the
$20 section 1248 amount inclusion.
Example 3A. (i) Facts. The facts are the same as in Example 3,
except that FC1 merges into FC2 in a reorganization described in
sections 368(a)(1)(A) and (a)(2)(E). Pursuant to the reorganization, DC
exchanges its FC2 stock for stock of FP.
(ii) Result. The result is similar to the result in Example 3. The
transfer is an indirect stock transfer subject to section 367(a). See
Sec. 1.367(a)-3(d)(1)(ii). Accordingly, DC's exchange of FC2 stock for
FP stock will be taxable under section 367(a) (and section 1248 will be
applicable) if DC fails to enter into a gain recognition agreement. If
DC enters into a gain recognition agreement, the exchange will be
subject to the provisions of section 367(b) and the regulations
thereunder, as well as section 367(a). If FP and FC2 are controlled
foreign corporations as to which DC is a section 1248 shareholder
immediately after the reorganization, then paragraph (b)(1)(i) of this
section does not apply to require DC to include in income the section
1248 amount attributable to the FC2 stock that was exchanged and the
amount of the gain recognition agreement is the amount of gain realized
on the indirect stock transfer. If FP or FC2 is not a controlled foreign
corporation as to which DC is a section
[[Page 361]]
1248 shareholder immediately after the exchange, then DC must include in
income as a deemed dividend from FC2 the section 1248 amount ($20)
attributable to the FC2 stock that DC exchanged. Under these
circumstances, the gain recognition agreement would be the amount of
gain realized on the indirect transfer, less the $20 section 1248 amount
inclusion.
Example 3B. (i) Facts. The facts are the same as Example 3, except
that USP, a domestic corporation, owns the controlling interest (within
the meaning of section 368(c)) in FC1 stock. In addition, FC2 merges
into FC1 in a reorganization described in sections 368(a)(1)(A) and
(a)(2)(D). Pursuant to the reorganization, DC exchanges its FC2 stock
for USP stock.
(ii) Result. Because DC receives stock of a domestic corporation,
USP, in the section 354 exchange, the transfer is not an indirect stock
transfer subject to section 367(a). Accordingly, the exchange will be
subject only to the provisions of section 367(b) and the regulations
thereunder. Under paragraph (b)(1)(ii) of this section, because the
stock received is stock of a domestic corporation (USP) and, immediately
after the exchange, USP is a section 1248 shareholder of FC1 (the
surviving corporation) and FC1 is a controlled foreign corporation, the
exchange is not described in paragraph (b)(1)(i) of this section and DC
is not required to include in income the section 1248 amount
attributable to the FC2 stock that was exchanged. See Sec. 1.367(b)-
13(c) for the basis and holding period rules applicable to this
transaction, which cause USP's adjusted basis and holding period in the
stock of FC1 after the transaction to reflect the basis and holding
period that DC had in its FC2 stock.
Example 4. (i) Facts. DC1, a domestic corporation, owns all of the
outstanding stock of DC2, a domestic corporation. DC2 owns various
assets including all of the outstanding stock of FC2, a foreign
corporation. The stock of FC2 has a value of $100, and DC2 has a basis
of $30 in such stock. The section 1248 amount attributable to the FC2
stock held by DC2 is $20. DC2 does not own any other stock in a foreign
corporation. FC1 is a foreign corporation that is unrelated to DC1, DC2
and FC2. In a reorganization described in section 368(a)(1)(C), FC1
acquires all of the assets and liabilities of DC2 in exchange for FC1
voting stock that represents 20 percent of the outstanding voting stock
of FC1. DC2 distributes the FC1 stock to DC1, and the DC2 stock held by
DC1 is canceled. DC1 properly files a gain recognition agreement under
Sec. 1.367(a)-8 to qualify for nonrecognition treatment under section
367(a) with respect to DC2's transfer of the FC2 stock to FC1. SeeSec.
1.367(a)-3(e).
(ii) Result. Pursuant to paragraph (b)(1)(i)(A) of this section, DC2
is the exchanging shareholder that is a section 1248 shareholder with
respect to FC2, the foreign acquired corporation. Immediately after the
exchange, DC2 is not a section 1248 shareholder with respect to FC1, the
corporation whose stock is received in the exchange (because the DC2
stock is canceled). Thus, paragraph (b)(1)(i)(B) of this section is
satisfied and, as a result, paragraph (b)(1)(i) of this section applies
to DC2's section 361 exchange of FC2 stock. Accordingly, under paragraph
(b) of this section, DC2 must include in income, as a deemed dividend
from FC2, the section 1248 amount ($20) attributable to the FC2 stock
that DC2 exchanges. This result arises without regard to whether FC1 and
FC2 are controlled foreign corporations immediately after the exchange.
For the tax treatment of DC2's transfer of assets (other than stock) to
FC1, see sections 367(a)(1) and (a)(3), and the regulations thereunder.
Because the exchange is also described in section 361(a) or (b), see
section 367(a)(5) and any regulations thereunder. If any of the assets
transferred are intangible assets, see section 367(d) and the
regulations thereunder.
(2) Receipt by exchanging shareholder of preferred or other stock in
certain instances--(i) Rule. An exchange is described in this paragraph
(b)(2)(i) if--
(A) Immediately before the exchange, the foreign acquired
corporation and the foreign acquiring corporations are not members of
the same affiliated group (within the meaning of section 1504(a), but
without regard to the exceptions set forth in section 1504(b), and
substituting the words ``more than 50'' in place of the words ``at least
80'' in sections 1504(a)(2)(A) and (B));
(B) Immediately after the exchange, a domestic corporation meets the
ownership threshold specified by section 902(a) or (b) such that it may
qualify for a deemed paid foreign tax credit if it receives a
distribution from the foreign acquiring corporation (directly or through
tiers); and
(C) The exchanging shareholder receives preferred stock (other than
preferred stock that is fully participating with respect to dividends,
redemptions and corporate growth) in consideration for common stock or
preferred stock that is fully participating with respect to dividends,
redemptions and corporate growth, or, in the discretion of the
Commissioner or the Commissioner's delegate (and without regard to
whether the stock exchanged is common stock or preferred stock),
receives stock that entitles it to participate
[[Page 362]]
(through dividends, redemption payments or otherwise) disproportionately
in the earnings generated by particular assets of the foreign acquired
corporation or foreign acquiring corporation.
(ii) Examples. The following examples illustrate the rules of this
paragraph (b)(2):
Example 1. (i) Facts. FC1 is a foreign corporation. DC is a domestic
corporation that is unrelated to FC1. DC owns all of the outstanding
stock of FC2, a foreign corporation, and FC2 has no outstanding
preferred stock. The value of FC2 is $100 and DC has a basis of $50 in
the stock of FC2. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount
attributable to the stock of FC2 held by DC is $20. In a reorganization
described in section 368(a)(1)(B), FC1 acquires all of the stock of FC2
and, in exchange, DC receives FC1 voting preferred stock that
constitutes 10 percent of the voting stock of FC1 for purposes of
section 902(a). Immediately after the exchange, FC1 and FC2 are
controlled foreign corporations and DC is a section 1248 shareholder of
FC1 and FC2, so paragraph (b)(1)(i) of this section does not require
inclusion in income of the section 1248 amount.
(ii) Result. Pursuant to Sec. 1.367(a)-3(b)(2), the transfer is
subject to both section 367(a) and section 367(b). Under Sec. 1.367(a)-
3(b)(1), DC will not be subject to tax under section 367(a)(1) if it
enters into a gain recognition agreement in accordance with Sec.
1.367(a)-8. Even though paragraph (b)(1)(i) of this section does not
apply to require inclusion in income by DC of the section 1248 amount,
DC must nevertheless include the $20 section 1248 amount in income as a
deemed dividend from FC2 under paragraph (b)(2)(i) of this section.
Thus, if DC enters into a gain recognition agreement, the amount is $30
(the $50 gain realized less the $20 recognized under section 367(b)). If
DC fails to enter into a gain recognition agreement, it must include in
income under section 367(a)(1) the $50 of gain realized ($20 of which is
treated as a dividend under section 1248). Section 367(b) does not apply
in such case.
Example 2. (i) Facts. The facts are the same as in Example 1, except
that DC owns all of the outstanding stock of FC1 immediately before the
transaction.
(ii) Result. Both section 367(a) and section 367(b) apply to the
transfer. Paragraph (b)(2)(i) of this section does not apply to require
inclusion of the section 1248 amount. Under paragraph (b)(2)(i)(A) of
this section, the transaction is outside the scope of paragraph
(b)(2)(i) of this section because FC1 and FC2 are, immediately before
the transaction, members of the same affiliated group (within the
meaning of such paragraph). Thus, if DC enters into a gain recognition
agreement in accordance with Sec. 1.367(a)-8, the amount of such
agreement is $50. As in Example 1, if DC fails to enter into a gain
recognition agreement, it must include in income $50, $20 of which will
be treated as a dividend under section 1248.
Example 3. (i) Facts. FC1 is a foreign corporation. DC is a domestic
corporation that is unrelated to FC1. DC owns all of the outstanding
stock of FC2, a foreign corporation. The section 1248 amount
attributable to the stock of FC2 held by DC is $20. In a reorganization
described in section 368(a)(1)(B), FC1 acquires all of the stock of FC2
in exchange for FC1 voting stock that constitutes 10 percent of the
voting stock of FC1 for purposes of section 902(a). The FC1 voting stock
received by DC in the exchange carries voting rights in FC1, but by
agreement of the parties the shares entitle the holder to dividends,
amounts to be paid on redemption, and amounts to be paid on liquidation,
that are to be determined by reference to the earnings or value of FC2
as of the date of such event, and that are affected by the earnings or
value of FC1 only if FC1 becomes insolvent or has insufficient capital
surplus to pay dividends.
(ii) Result. Under Sec. 1.367(a)-3(b)(1), DC will not be subject to
tax under section 367(a)(1) if it enters into a gain recognition
agreement with respect to the transfer of FC2 stock to FC1. Under Sec.
1.367(a)-3(b)(2), the exchange will be subject to the provisions of
section 367(b) and the regulations thereunder to the extent that it is
not subject to tax under section 367(a)(1). Furthermore, even if DC
would not otherwise be required to recognize income under this section,
the Commissioner or the Commissioner's delegate may nevertheless require
that DC include the $20 section 1248 amount in income as a deemed
dividend from FC2 under paragraph (b)(2)(i) of this section.
(3) Certain recapitalizations. An exchange pursuant to a
recapitalization under section 368(a)(1)(E) shall be deemed to be an
exchange described in this paragraph (b)(3) if the following conditions
are satisfied--
(i) During the 24-month period immediately preceding or following
the date of the recapitalization, the corporation that undergoes the
recapitalization (or a predecessor of, or successor to, such
corporation) also engages in a transaction that would be described in
paragraph (b)(2)(i) of this section but for paragraph (b)(2)(i)(C) of
this section, either as the foreign acquired corporation or the foreign
acquiring corporation; and
(ii) The exchange in the recapitalization is described in paragraph
(b)(2)(i)(C) of this section.
[[Page 363]]
(c) Exclusion of deemed dividend from foreign personal holding
company income--(1) Rule. In the event the section 1248 amount is
included in income as a deemed dividend by a foreign corporation under
paragraph (b) of this section, such deemed dividend shall not be
included as foreign personal holding company income under section
954(c).
(2) Example. The following example illustrates the rule of this
paragraph (c):
Example. (i) Facts. FC1 is a foreign corporation that is owned,
directly and indirectly (applying the ownership rules of section 958),
solely by foreign persons. DC is a domestic corporation that is
unrelated to FC1. DC owns all of the outstanding stock of FC2, a foreign
corporation. FC2 owns all of the outstanding stock of FC3, a foreign
corporation. Under Sec. 1.367(b)-2(c)(1), the section 1248 amount
attributable to the stock of FC3 held by FC2 is $20. In a reorganization
described in section 368(a)(1)(B), FC1 acquires from FC2 all of the
stock of FC3 in exchange for FC1 voting stock. The FC1 voting stock
received by FC2 does not represent more than 50 percent of the voting
power or value of FC1's stock.
(ii) Result. FC1 is not a controlled foreign corporation immediately
after the exchange. Under paragraph (b)(1) of this section, FC2 must
include in income, as a deemed dividend from FC3, the section 1248
amount ($20) attributable to the FC3 stock that FC2 exchanged. The
deemed dividend is treated as a dividend for purposes of the Internal
Revenue Code as provided in Sec. 1.367(b)-2(e)(2); however, under this
paragraph (c) the deemed dividend is not foreign personal holding
company income to FC2.
(d) Rules for subsequent sales or exchanges--(1) Rule. If an
exchanging shareholder (as defined in Sec. 1.1248-8(b)(1)(iv)) is not
required to include in income as a deemed dividend the section 1248
amount under paragraph (b) of this section in a section 367(b) exchange
described in paragraph (a) of this section (non-inclusion exchange),
then, for purposes of applying section 367(b) or section 1248 to
subsequent sales or exchanges, and subject to the limitation of Sec.
1.367(b)-2(d)(3)(ii) (in the case of a transaction described in Sec.
1.367(b)-3), the determination of the earnings and profits attributable
to the stock an exchanging shareholder receives in the non-inclusion
exchange shall be determined pursuant to the rules of section 1248 and
the regulations under that section.
(2) Example. The following example illustrates the rules of this
section. For purposes of the example, assume that--
(i) There is no immediate gain recognition pursuant to section
367(a)(1) and the regulations under that section (either through
operation of the rules or because the appropriate parties have entered
into a gain recognition agreement under Sec. Sec. 1.367(a)-3(b) and
1.367(a)-8);
(ii) References to earnings and profits are to earnings and profits
that would be includible in income as a dividend under section 1248 and
the regulations under that section if stock to which the earnings and
profits are attributable were sold or exchanged by its shareholder;
(iii) Each corporation has only a single class of stock outstanding
and uses the calendar year as its taxable year; and
(iv) Each transaction is unrelated to all other transactions.
Example. Acquisition of the stock of a foreign corporation that
controls a foreign acquiring corporation in a reorganization described
in section 368(a)(1)(C). (i) Facts. DC1, a domestic corporation, has
owned all the stock of CFC1, a controlled foreign corporation, since its
formation on January 1, year 1. CFC1 has owned all the stock of CFC2, a
controlled foreign corporation, since its formation on January 1, year
1. FC, a foreign corporation that is not a controlled foreign
corporation, has owned all of the stock of FC2, a foreign corporation,
since its formation on January 1, year 2. On December 31, year 3,
pursuant to a restructuring transaction that was a triangular
reorganization described in section 368(a)(1)(C), CFC1 transfers all of
its assets, including the CFC2 stock, to FC2 in exchange for 80% of the
voting stock of FC. CFC1 transfers the voting stock of FC to DC1 and the
CFC1 stock is cancelled. Pursuant to section 1223(1), DC1 is considered
to have held the stock of FC since January 1, year 1. Under section
1223(2), FC2 is considered to have held the stock of CFC2 since January
1, year 1. On December 31, year 3, CFC1 has $100 of earnings and
profits. From January 1, year 4, until December 31, year 5, FC (a
controlled foreign corporation after the restructuring transaction)
accumulates an additional $50 of earnings and profits. FC2, a controlled
foreign corporation after the restructuring transaction, accumulates
$100 of earnings and profits from January 1, year 4, until December 31,
year 5. On December 31, year 5, FC is liquidated into DC1 in a
transaction described in section 332.
[[Page 364]]
(ii) Result. Generally, this paragraph (d) requires that DC1 include
in income the earnings and profits attributable to its stock in FC as
determined under Sec. 1.1248-8. However, since the liquidation of FC
into DC1 is a transaction described in Sec. 1.367(b)-3, the earnings
and profits attributable to the stock of FC are limited by Sec.
1.367(b)-2(d) (3)(ii) to that portion of the earnings and profits
accumulated by FC itself before or after the restructuring transaction,
and do not include the earnings and profits of FC's subsidiaries
accumulated before or after the restructuring transaction. Thus, DC1
will include $40 of earnings and profits in income (80% of the $50 of
earnings and profits accumulated by FC after the restructuring
transaction).
(e) [Reserved] For further guidance, see Sec. 1.367(b)-4T(e).
(f) [Reserved] For further guidance, see Sec. 1.367(b)-4T(f).
(g) [Reserved] For further guidance, see Sec. 1.367(b)-4T(g).
[T.D. 8862, 65 FR 3603, Jan. 24, 2000; 65 FR 66501, Nov. 6, 2000, as
amended by T.D. 9243, 71 FR 4288, Jan. 26, 2006; T.D. 9250, 71 FR 8804,
Feb. 21, 2006; T.D. 9311, 72 FR 5183, Feb. 5, 2007; T.D. 9345, 72 FR
41444, July 30, 2007; T.D. 9444, 74 FR 6826, Feb. 11, 2009; T.D. 9446,
74 FR 6958, Feb. 11, 2009]
Sec. 1.367(b)-4T Acquisition of foreign corporate stock or assets by a
foreign corporation in certain nonrecognition transactions (temporary).
(a) through (d) [Reserved] For further guidance, see Sec. 1.367(b)-
4(a) through (d).
(e) Application of section 367(b) to transactions described in
section 304(a)(1)--(1) Scope and general rule. This section applies to
the extent that, pursuant to section 304(a)(1), an exchanging
shareholder is treated as transferring the stock of a foreign acquired
corporation to a foreign acquiring corporation in a transaction to which
section 351(a) applies (deemed section 351 exchange). Except to the
extent provided in paragraph (e)(2) of this section, a transfer of stock
of a foreign acquired corporation by an exchanging shareholder in a
deemed section 351 exchange shall not be subject to paragraph (b) of
this section.
(2) Special rule. Notwithstanding paragraph (e)(1) of this section,
a transfer of stock of a foreign acquired corporation by an exchanging
shareholder to a foreign acquiring corporation in a deemed section 351
exchange shall be subject to paragraph (b) of this section to the extent
the distribution received by the exchanging shareholder in redemption of
the stock of the foreign acquiring corporation is applied against and
reduces, pursuant to section 301(c)(2), the basis of stock of the
foreign acquiring corporation held by the exchanging shareholder other
than the stock deemed issued by the foreign acquiring corporation in the
deemed section 351 exchange.
(3) Allocation of income inclusion. If the income inclusion
resulting from the application of paragraph (e)(2) of this section is
less than the section 1248 amount attributable to the shares of stock of
the foreign acquired corporation transferred by the exchanging
shareholder in the deemed section 351 exchange, the amount of the income
inclusion attributable to each share of stock transferred in the deemed
section 351 exchange shall be determined by multiplying the income
inclusion by the percentage that the section 1248 amount attributable to
such share of stock bears to the aggregate section 1248 amount
attributable to all of the shares of stock transferred in the deemed
section 351 exchange.
(4) Example. The rules of this paragraph (e) are illustrated by the
following example:
Example. (i) Facts. (A) FP, a foreign corporation, wholly owns USP,
a domestic corporation. USP wholly owns CFC1, and CFC1 wholly owns CFC2.
CFC2 wholly owns CFC3. CFC1, CFC2 and CFC3 are controlled foreign
corporations within the meaning of section 957(a). USP, CFC1, CFC2 and
CFC3 use a calendar taxable year. CFC1 owns 30% of the outstanding stock
of FS, a foreign corporation. FP owns the remaining 70% of the
outstanding stock of FS. The CFC2 stock has a $40x basis and $100x fair
market value. The FS stock held by CFC1 has a $60x basis and $100x fair
market value. As of December 31, year 1, CFC2 has $20x of section 1248
earnings and profits, CFC3 has $40x of section 1248 earnings and
profits, and FS has zero earnings and profits. On December 31, year 1,
in a transaction described in section 304(a)(1), CFC1 sells the CFC2
stock to FS for $100x cash. FS is not a controlled foreign corporation
(within the meaning section 957(a)) either before or after the sale of
the CFC2 stock.
(B) Because CFC1 wholly owns CFC2 before the transaction and is
treated, under section 318, as indirectly owning 100% of the CFC2 stock
after the transaction, under section 304(a)(1), CFC2 and FS are treated
as if CFC1
[[Page 365]]
contributed the CFC2 stock to FS in a deemed section 351 exchange in
exchange solely for $100x of FS stock, and then FS redeemed for $100x
cash its stock deemed issued to CFC1. Because CFC1 wholly owned CFC2
before the transaction and is treated, under section 318, as indirectly
owning 100% of CFC2 after the transaction, section 302(a) does not apply
to the redemption. Instead, under section 302(d), the redemption is
treated as a distribution to which section 301 applies. Pursuant to
section 304(b)(2), $20x of the distribution is treated as a dividend
from the earnings and profits of CFC2. With respect to the remaining
$80x, CFC1 takes the position that $40x is applied against and reduces
the basis of the FS stock deemed issued in the transaction, and $40x is
applied against and reduces the basis of the FS stock held by CFC1 prior
to (and after) the transaction.
(ii) Analysis. Under paragraph (e)(2) of this section, the transfer
by CFC1 of the CFC2 stock to FS in the deemed section 351 exchange is
subject to paragraph (b) of this section to the extent the distribution
received by CFC1 in redemption of the FS stock issued in the deemed
section 351 exchange is applied against and reduces, under section
301(c)(2), the basis of the FS stock held by CFC1 before (and after) the
transaction. Thus, because $40x of the distribution received by CFC1
from FS in redemption of the FS stock issued in the deemed section 351
exchange is applied against and reduces, under section 301(c)(2), the
basis of the FS stock held by CFC1 before (and after) the transaction,
under paragraph (b) of this section, CFC1 must include $40x in income as
a deemed dividend. See Sec. 1.367(b)-2(e) for the treatment of the $40x
income inclusion. In total, CFC1 recognizes dividend income of $60x,
$20x from the application of section 304(a)(1) to the sale of the CFC2
stock to FS and $40x under paragraph (b) of this section by reason of
the application of paragraph (e)(2) of this section.
(f) Effective/applicability date. Paragraph (e) of this section
applies to transfers occurring on or after February 10, 2009. See Sec.
1.367(b)-4, as contained in 26 CFR part 1 revised as of April 1, 2008,
for transfers occurring on or after February 21, 2006, and before
February 10, 2009.
(g) Expiration date. This section expires on or before February 10,
2012.
[T.D. 9444, 74 FR 6826, Feb. 11, 2009]
Sec. 1.367(b)-5 Distributions of stock described in section 355.
(a) In general--(1) Scope. This section provides rules relating to a
distribution described in section 355 (or so much of section 356 as
relates to section 355) and to which section 367(b) applies. For
purposes of this section, the terms distributing corporation, controlled
corporation, and distributee have the same meaning as used in section
355 and the regulations thereunder.
(2) Treatment of distributees as exchanging shareholders. For
purposes of the section 367(b) regulations, all distributees in a
transaction described in paragraph (b), (c), or (d) of this section
shall be treated as exchanging shareholders that realize income in a
section 367(b) exchange.
(b) Distribution by a domestic corporation--(1) General rule. In a
distribution described in section 355, if the distributing corporation
is a domestic corporation and the controlled corporation is a foreign
corporation, the following general rules shall apply--
(i) If the distributee is a corporation, then the controlled
corporation shall be considered to be a corporation; and
(ii) If the distributee is an individual, then, solely for purposes
of determining the gain recognized by the distributing corporation, the
controlled corporation shall not be considered to be a corporation, and
the distributing corporation shall recognize any gain (but not loss)
realized on the distribution.
(2) Section 367(e) transactions. The rules of paragraph (b)(1) of
this section shall not apply to a foreign distributee to the extent gain
is recognized under section 367(e)(1) and the regulations thereunder.
(3) Determining whether distributees are individuals. All
distributees in a distribution described in paragraph (b)(1) of this
section are presumed to be individuals. However, the shareholder
identification principles of Sec. 1.367(e)-1(d) (including the
reporting procedures in Sec. 1.367(e)-1(d)(2) and (3)) shall apply for
purposes of rebutting this presumption.
(4) Applicable cross-references. For rules with respect to a
distributee that is a partnership, trust or estate, see Sec. 1.367(b)-
2(k). For additional rules relating to a distribution of stock of a
foreign corporation by a domestic corporation, see section 1248(f) and
the regulations thereunder. For additional rules relating to a
distribution described in section 355 by a domestic
[[Page 366]]
corporation to a foreign distributee, see section 367(e)(1) and the
regulations thereunder.
(c) Pro rata distribution by a controlled foreign corporation--(1)
Scope. This paragraph (c) applies to a distribution described in section
355 in which the distributing corporation is a controlled foreign
corporation and in which the stock of the controlled corporation is
distributed pro rata to each of the distributing corporation's
shareholders.
(2) Adjustment to basis in stock and income inclusion. If the
distributee's postdistribution amount (as defined in paragraph (e)(2) of
this section) with respect to the distributing or controlled corporation
is less than the distributee's predistribution amount (as defined in
paragraph (e)(1) of this section) with respect to such corporation, then
the distributee's basis in such stock immediately after the distribution
(determined under the normal principles of section 358) shall be reduced
by the amount of the difference. However, the distributee's basis in
such stock shall not be reduced below zero, and to the extent the
foregoing reduction would have reduced basis below zero, the distributee
shall instead include such amount in income as a deemed dividend from
such corporation.
(3) Interaction with Sec. 1.367(b)-2(e)(3)(ii). The basis increase
provided in Sec. 1.367(b)-2(e)(3)(ii) shall not apply to a deemed
dividend that is included in income pursuant to paragraph (c)(2) of this
section.
(4) Basis redistribution. If a distributee reduces the basis in the
stock of the distributing or controlled corporation (or has an inclusion
with respect to such stock) under paragraph (c)(2) of this section, the
distributee shall increase its basis in the stock of the other
corporation by the amount of the basis decrease (or deemed dividend
inclusion) required by paragraph (c)(2) of this section. However, the
distributee's basis in such stock shall not be increased above the fair
market value of such stock and shall not be increased to the extent the
increase diminishes the distributee's postdistribution amount with
respect to such corporation.
(d) Non-pro rata distribution by a controlled foreign corporation--
(1) Scope. This paragraph (d) applies to a distribution described in
section 355 in which the distributing corporation is a controlled
foreign corporation and in which the stock of the controlled corporation
is not distributed pro rata to each of the distributing corporation's
shareholders.
(2) Treatment of certain shareholders as distributees. For purposes
of the section 367(b) regulations, all persons owning stock of the
distributing corporation immediately after a transaction described in
paragraph (d)(1) of this section shall be treated as distributees of
such stock. For other applicable rules, see paragraph (a)(2) of this
section.
(3) Inclusion of excess section 1248 amount by exchanging
shareholder. If the distributee's postdistribution amount (as defined in
paragraph (e)(2) of this section) with respect to the distributing or
controlled corporation is less than the distributee's predistribution
amount (as defined in paragraph (e)(1) of this section) with respect to
such corporation, then the distributee shall include in income as a
deemed dividend the amount of the difference. For purposes of this
paragraph (d)(3), if a distributee owns no stock in the distributing or
controlled corporation immediately after the distribution, the
distributee's postdistribution amount with respect to such corporation
shall be zero.
(4) Interaction with Sec. 1.367(b)--2(e)(3)(ii)--(i) Limited
application. The basis increase provided in Sec. 1.367(b)--2(e)(3)(ii)
shall apply to a deemed dividend that is included in income pursuant to
paragraph (d)(3) of this section only to the extent that such basis
increase does not increase the distributee's basis above the fair market
value of such stock and does not diminish the distributee's
postdistribution amount with respect to such corporation.
(ii) Interaction with predistribution amount. For purposes of this
paragraph (d), the distributee's predistribution amount (as defined in
paragraph (e)(1) of this section) shall be determined without regard to
any basis increase permitted under paragraph (d)(4)(i) of this section.
[[Page 367]]
(e) Definitions--(1) Predistribution amount. For purposes of this
section, the predistribution amount with respect to a distributing or
controlled corporation is the distributee's section 1248 amount (as
defined in Sec. 1.367(b)--2(c)(1)) computed immediately before the
distribution (and after any section 368(a)(1)(D) transfer connected with
the section 355 distribution), but only to the extent that such amount
is attributable to the distributing corporation and any corporations
controlled by it immediately before the distribution (the distributing
group) or the controlled corporation and any corporations controlled by
it immediately before the distribution (the controlled group), as the
case may be, under the principles of Sec. Sec. 1.1248-1(d)(3), 1.1248-2
and 1.1248-3. However, the predistribution amount with regard to the
distributing group shall be computed without taking into account the
distributee's predistribution amount with respect to the controlled
group.
(2) Postdistribution amount. For purposes of this section, the
postdistribution amount with respect to a distributing or controlled
corporation is the distributee's section 1248 amount (as defined in
Sec. 1.367(b)-2(c)(1)) with respect to such stock, computed immediately
after the distribution (but without regard to paragraph (c) or (d) of
this section (whichever is applicable)). The postdistribution amount
under this paragraph (e)(2) shall be computed before taking into account
the effect (if any) of any inclusion under section 356(a) or (b).
(f) Exclusion of deemed dividend from foreign personal holding
company income. In the event an amount is included in income as a deemed
dividend by a foreign corporation under paragraph (c) or (d) of this
section (including amounts received as an intermediate owner under the
rule of Sec. 1.367(b)-2(e)(2)), such deemed dividend shall not be
included as foreign personal holding company income under section
954(c).
(g) Examples. The following examples illustrate the rules of this
section:
Example 1. (i) Facts. USS, a domestic corporation, owns 40 percent
of the outstanding stock of FD, a controlled foreign corporation (CFC).
USS has owned the stock since FD was incorporated, and FD has always
been a CFC. USS has a basis of $80 in its FD stock, which has a fair
market value of $200. FD owns 100 percent of the outstanding stock of
FC, a foreign corporation. FD has owned the stock since FC was
incorporated. Neither FD nor FC own stock in any other corporation. FD
has earnings and profits of $0 and a fair market value of $250 (not
considering its ownership of FC). FC has earnings and profits of $300,
none of which is described in section 1248(d), and a fair market value
of $250. In a pro rata distribution described in section 355, FD
distributes to USS stock in FC worth $100; thereafter, USS's FD stock is
worth $100 as well.
(ii) Result--(A) FD's distribution is a transaction described in
paragraph (c)(1) of this section. Under paragraph (c)(2) of this
section, USS must compare its predistribution amounts with respect to FD
and FC to its respective postdistribution amounts. Under paragraph
(e)(1) of this section, USS's predistribution amount with respect to FD
or FC is its section 1248 amount computed immediately before the
distribution, but only to the extent such amount is attributable to FD
or FC. Under Sec. 1.367(b)-2(c)(1), USS's section 1248 amount computed
immediately before the distribution is $120, all of which is
attributable to FC. Thus, USS's predistribution amount with respect to
FD is $0, and its predistribution amount with respect to FC is $120.
These amounts are computed as follows: If USS had sold its FD stock
immediately before the transaction, it would have recognized $120 of
gain ($200 fair market value $80 basis). All of the gain would have been
treated as a dividend under section 1248, and all of the section 1248
amount would have been attributable to FC (based on USS's pro rata share
of FC's earnings and profits (40 percent x $300)).
(B) Under paragraph (e)(2) of this section, USS's postdistribution
amount with respect to FD or FC is its section 1248 amount with respect
to such corporation, computed immediately after the distribution (but
without regard to paragraph (c) of this section). Under Sec. 1.367(b)-
2(c)(1), USS's section 1248 amounts computed immediately after the
distribution with respect to FD and FC are $0 and $60, respectively.
These amounts, which are USS's postdistribution amounts, are computed as
follows: Under the normal principles of section 358, USS allocates its
$80 predistribution basis in FD between FD and FC according to the stock
blocks' relative values, yielding a $40 basis in each block. If USS sold
its FD stock immediately after the distribution, none of the resulting
gain would be treated as a dividend under section 1248. If USS sold its
FC stock immediately after the distribution, it would have a $60 gain
($100 fair market value--$40 basis), all of which would be treated as a
dividend under section 1248.
[[Page 368]]
(C) The basis adjustment and income inclusion rules of paragraph
(c)(2) of this section apply to the extent of any difference between
USS's postdistribution and predistribution amounts. In the case of FD,
there is no difference between the two amounts and, as a result, no
adjustment or income inclusion is required. In the case of FC, USS's
postdistribution amount is $60 less than its predistribution amount.
Accordingly, under paragraph (c)(2) of this section, USS is required to
reduce its basis in its FC stock from $40 to $0 and include $20 in
income as a deemed dividend. Under Sec. 1.367(b)-2(e)(2), the $20
deemed dividend is considered as having been paid by FC to FD, and by FD
to USS, immediately prior to the distribution. Under paragraph (f) of
this section, the deemed dividend is not included by FD as foreign
personal holding company income under section 954(c). Under paragraph
(c)(3) of this section, the basis increase provided in Sec. 1.367(b)-
2(e)(3)(ii) does not apply with regard to the $20 deemed dividend. Under
the rules of paragraph (c)(4) of this section, USS increases its basis
in FD by the amount by which it decreased its basis in FC, as well as by
the amount of its deemed dividend inclusion ($40 + $40 + $20 = $100).
Example 2. (i) Facts. USS1 and USS2, domestic corporations, each own
50 percent of the outstanding stock of FD, a controlled foreign
corporation (CFC). USS1 and USS2 have owned their FD stock since it was
incorporated, and FD has always been a CFC. USS1 and USS2 each have a
basis of $500 in their FD stock, and the fair market value of each block
of FD stock is $750. FD owns 100 percent of the outstanding stock of FC,
a foreign corporation. FD owned the stock since FC was incorporated.
Neither FD nor FC own stock in any other corporation. FD has earnings
and profits of $0 and a fair market value of $750 (not considering its
ownership of FC). FC has earnings and profits of $500, none of which is
described in section 1248(d), and a fair market value of $750. In a non-
pro rata distribution described in section 355, FD distributes all of
the stock of FC to USS2 in exchange for USS2's FD stock.
(ii) Result--(A) FD's distribution is a transaction described in
paragraph (d)(1) of this section. Under paragraph (d)(2) of this
section, USS1 is considered a distributee of FD stock. Under paragraph
(d)(3) of this section, USS1 and USS2 must compare their predistribution
amounts with respect to FD and FC stock to their respective
postdistribution amounts. Under paragraph (e)(1) of this section, USS1's
predistribution amount with respect to FD or FC is USS1's section 1248
amount computed immediately before the distribution, but only to the
extent such amount is attributable to FD or FC. USS2's predistribution
amount is determined in the same manner. Under Sec. 1.367(b)-2(c)(1),
USS1 and USS2 each have a section 1248 amount computed immediately
before the distribution of $250, all of which is attributable to FC.
Thus, USS1 and USS2 each have a predistribution amount with respect to
FD of $0, and each have a predistribution amount with respect to FC of
$250. These amounts are computed as follows: If either USS1 or USS2 had
sold its FD stock immediately before the transaction, it would have
recognized $250 of gain ($750 fair market value--$500 basis). All of the
gain would have been treated as a dividend under section 1248, and all
of the section 1248 amount would have been attributable to FC (based on
USS1's and USS2's pro rata shares of FC's earnings and profits (50
percent x $500)).
(B) Under paragraph (d)(3) of this section, a distributee that owns
no stock in the distributing or controlled corporation immediately after
the distribution has a postdistribution amount with regard to that stock
of zero. Accordingly, USS2 has a postdistribution amount of $0 with
respect to FD and USS1 has a postdistribution amount of $0 with respect
to FC. Under paragraph (e)(2) of this section, USS1's postdistribution
amount with respect to FD is its section 1248 amount with respect to
such corporation, computed immediately after the distribution (but
without regard to paragraph (d) of this section). USS2's
postdistribution amount with respect to FC is determined in the same
manner. Under Sec. 1.367(b)-2(c)(1), USS1's section 1248 amount
computed immediately after the distribution with respect to FD is $0 and
USS2's section 1248 amount computed immediately after the distribution
with respect to FC is $250. These amounts, which are USS1's and USS2's
postdistribution amounts, are computed as follows: After the non-pro
rata distribution, USS1 owns all the stock of FD and USS2 owns all the
stock of FC. If USS1 sold its FD stock immediately after the
distribution, none of the resulting $250 gain ($750 fair market value
$500 basis) would be treated as a dividend under section 1248. If USS2
sold its FC stock immediately after the distribution, it would have a
$250 gain ($750 fair market value--$500 basis), all of which would be
treated as a dividend under section 1248.
(C) The income inclusion rule of paragraph (d)(3) of this section
applies to the extent of any difference between USS1's and USS2's
postdistribution and predistribution amounts. In the case of USS2, there
is no difference between the two amounts with respect to either FD or FC
and, as a result, no income inclusion is required. In the case of USS1,
there is no difference between the two amounts with respect to its FD
stock. However, USS1's postdistribution amount with respect to FC is
$250 less than its predistribution amount. Accordingly, under paragraph
(d)(3) of this section, USS1 is required to include $250 in income as a
deemed dividend. Under Sec. 1.367(b)-2(e)(2), the $250
[[Page 369]]
deemed dividend is considered as having been paid by FC to FD, and by FD
to USS1, immediately prior to the distribution. This deemed dividend
increases USS1's basis in FD ($500 + $250 = $750). Under paragraph (f)
of this section, the deemed dividend is not included by FD as foreign
personal holding company income under section 954(c).
[T.D. 8862, 65 FR 3606, Jan. 24, 2000; 65 FR 66502, Nov. 6, 2000]
Sec. 1.367(b)-6 Effective dates and coordination rules.
(a) Effective date--(1) In general. Except as otherwise provided in
this paragraph (a)(1), Sec. Sec. 1.367(b)-1 through 1.367(b)-5, and
this section, apply to section 367(b) exchanges that occur on or after
February 23, 2000. The rules of Sec. Sec. 1.367(b)-3 and 1.367(b)-4, as
they apply to reorganizations described in section 368(a)(1)(A)
(including reorganizations described in section 368(a)(2)(D) or (E))
involving a foreign acquiring or foreign acquired corporation, apply
only to transfers occurring on or after January 23, 2006. Section
1.367(b)-4(b)(1)(ii) applies to all triangular reorganizations and
reorganizations described in section 368(a)(1)(G) and (a)(2)(D)
occurring on or after January 23, 2006, although taxpayers may apply
Sec. 1.367(b)-4(b)(1)(ii) to triangular B reorganizations occurring on
or after February 23, 2000, in a taxable year that is not closed by the
period of limitations if done consistently with respect to all such
triangular B reorganizations. The second sentence of paragraph (a) in
Sec. 1.367(b)-4 shall apply to section 304(a)(1) transactions occurring
on or after February 23, 2006; however, taxpayers may rely on this
sentence for all section 304(a)(1) transactions occurring in open
taxable years. Section 1.367(b)-1(c)(2)(v), (c)(3)(ii)(A), (c)(4)(iv),
(c)(4)(v), 1.367(b)-2(j)(1)(i), (l), and 1.367(b)-3(e) and (f), apply to
section 367(b) exchanges that occur on or after November 6, 2006. For
guidance with respect to Sec. 1.367(b)-1(c)(3)(ii)(A) and (c)(4)(iv)
and (v) and Sec. 1.367(b)-2(j)(1)(i) for exchanges that occur before
November 6, 2006, see 26 CFR part 1 revised as of April 1, 2006.
(2) Exception. A taxpayer may, however, elect to have Sec. Sec.
1.367(b)-1 through 1.367(b)-5, and this section, apply to section 367(b)
exchanges that occur (or occurred) before February 23, 2000, if the due
date for the taxpayer's timely filed Federal tax return (including
extensions) for the taxable year in which the section 367(b) exchange
occurs (or occurred) is after February 23, 2000. The election under this
paragraph (a)(2) will be valid only if--
(i) The electing taxpayer makes the election on a timely filed
section 367(b) notice;
(ii) In the case of an exchanging shareholder that is a foreign
corporation, the election is made on the section 367(b) notice that is
filed by each of its shareholders listed in Sec. 1.367(b)-1(c)(3)(ii);
and
(iii) The electing taxpayer provides notice of the election to all
corporations (or their successors in interest) whose earnings and
profits are affected by the election on or before the date the section
367(b) notice is filed.
(b) Certain recapitalizations described in Sec. 1.367(b)-4(b)(3).
In the case of a recapitalization described in Sec. 1.367(b)-4(b)(3)
that occurred prior to July 20, 1998, the exchanging shareholder shall
include the section 1248 amount on its tax return for the taxable year
that includes the exchange described in Sec. 1.367(b)-4(b)(3)(i) (and
not in the taxable year of the recapitalization), except that no
inclusion is required if both the recapitalization and the exchange
described in Sec. 1.367(b)-4(b)(3)(i) occurred prior to July 20, 1998.
(c) Use of reasonable method to comply with prior published
guidance--(1) Prior exchanges. The taxpayer may use a reasonable method
to comply with the following prior published guidance to the extent such
guidance relates to section 367(b): Notice 88-71 (1988-2 C.B. 374);
Notice 89-30 (1989-1 C.B. 670); and Notice 89-79 (1989-2 C.B. 392) (see
Sec. 601.601(d)(2) of this chapter). This rule applies to section
367(b) exchanges that occur (or occurred) before February 23, 2000, or,
if a taxpayer makes the election described in paragraph (a)(2) of this
section, for section 367(b) exchanges that occur (or occurred) before
the date described in paragraph (a)(2) of this section. This rule also
applies to section 367(b) exchanges and distributions described in
paragraph (d) of this section.
(2) Future exchanges. Section 367(b) exchanges that occur on or
after February 23, 2000, (or, if a taxpayer makes
[[Page 370]]
the election described in paragraph (a)(2) of this section, for section
367(b) exchanges that occur on or after the date described in paragraph
(a)(2) of this section) are governed by the section 367(b) regulations
and, as a result, paragraph (c)(1) of this section shall not apply.
(d) Effect of removal of attribution rules. To the extent that the
rules under Sec. Sec. 7.367(b)-9 and 7.367(b)-10(h) of this chapter, as
in effect prior to February 23, 2000 (see 26 CFR part 1, revised as of
April 1, 1999), attributed earnings and profits to the stock of a
foreign corporation in connection with an exchange described in section
351, 354, 355, or 356 before February 23, 2000, the foreign corporation
shall continue to be subject to the rules of Sec. 7.367(b)-12 of this
chapter in the event of any subsequent exchanges and distributions with
respect to such stock, notwithstanding the fact that such subsequent
exchange or distribution occurs on or after the effective date described
in paragraph (a) of this section.
[T.D. 8862, 65 FR 3608, Jan. 24, 2000, as amended by T.D. 9243, 71 FR
4289, Jan. 26, 2006; T.D. 9250, 71 FR 8805, Feb. 21, 2006; T.D. 9243, 71
FR 28266, May 16, 2006; T.D. 9273, 71 FR 44895, Aug. 8, 2006; 73 FR
14386, Mar. 18, 2008]
Sec. 1.367(b)-7 Carryover of earnings and profits and foreign income taxes in
certain foreign-to-foreign nonrecognition transactions.
(a) Scope. This section applies to an acquisition by a foreign
corporation (foreign acquiring corporation) of the assets of another
foreign corporation (foreign target corporation) in a transaction
described in section 381 (foreign section 381 transaction). This section
describes the manner and extent to which earnings and profits and
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation carry over to the surviving foreign
corporation (foreign surviving corporation) and the ordering of
distributions by the foreign surviving corporation. See Sec. 1.367(b)-9
for special rules governing reorganizations described in section
368(a)(1)(F) and foreign section 381 transactions involving foreign
corporations that hold no property and have no tax attributes
immediately before the transaction, other than a nominal amount of
assets (and related tax attributes).
(b) General rules--(1) Non-previously taxed earnings and profits and
related taxes. Earnings and profits and related foreign income taxes of
the foreign acquiring corporation and the foreign target corporation
(pre-transaction earnings and pre-transaction taxes, respectively) shall
carry over to the foreign surviving corporation in the manner described
in paragraphs (d), (e), and (f) of this section. Dividend distributions
by the foreign surviving corporation (post-transaction distributions)
shall be out of earnings and profits and shall reduce related foreign
income taxes in the manner described in paragraph (c) of this section.
(2) Previously taxed earnings and profits. [Reserved]
(c) Ordering rule for post-transaction distributions. Dividend
distributions out of a foreign surviving corporation's earnings and
profits shall be ordered in accordance with the rules of paragraph
(c)(1) or (2) of this section, depending on whether the foreign
surviving corporation is a pooling corporation or a nonpooling
corporation.
(1) If foreign surviving corporation is a pooling corporation. In
the case of a foreign surviving corporation that is a pooling
corporation, post-transaction distributions shall be first out of the
post-1986 pool (as described in paragraph (d) of this section) and
second out of the pre-pooling annual layers (as described in paragraph
(e)(1) of this section) under an annual last-in, first-out (LIFO)
method.
(2) If foreign surviving corporation is a nonpooling corporation. In
the case of a foreign surviving corporation that is a nonpooling
corporation, post-transaction distributions shall be out of the pre-
pooling annual layers (as described in paragraph (e)(2) of this section)
under the LIFO method.
(d) Post-1986 pool. If the foreign surviving corporation is a
pooling corporation, then the post-1986 pool shall be determined under
the rules of this paragraph (d).
(1) In general--(i) Qualifying earnings and taxes. The post-1986
pool shall consist of the post-1986 undistributed earnings and related
post-1986 foreign income taxes of the foreign acquiring
[[Page 371]]
corporation and the foreign target corporation.
(ii) Carryover rule. Subject to paragraph (d)(2) of this section,
the amounts described in paragraph (d)(1)(i) of this section
attributable to the foreign acquiring corporation and the foreign target
corporation shall carry over to the foreign surviving corporation and
shall be combined on a separate category-by-separate category basis.
(2) Hovering deficit--(i) In general. If immediately prior to the
foreign section 381 transaction either the foreign acquiring corporation
or the foreign target corporation has a deficit in one or more separate
categories of post-1986 undistributed earnings or an aggregate deficit
in pre-1987 accumulated profits, such deficit will be a hovering deficit
of the foreign surviving corporation. The rules of this paragraph (d)(2)
apply to hovering deficits in separate categories of post-1986
undistributed earnings. See paragraphs (e)(1)(iii) and (e)(2)(iii) of
this section for rules that apply to hovering deficits in pre-1987
accumulated profits. If the foreign acquiring corporation and the
foreign target corporation each have a post-1986 hovering deficit in the
same separate category of post-1986 undistributed earnings, such
deficits and their related post-1986 foreign income taxes shall be
combined for purposes of applying this paragraph (d)(2). See also
paragraphs (f)(1) and (4) of this section (describing other rules
applicable to a deficit described in this paragraph (d)(2)).
(ii) Offset rule. A hovering deficit in a separate category of post-
1986 undistributed earnings shall offset only earnings and profits
accumulated by the foreign surviving corporation after the foreign
section 381 transaction (post-transaction earnings) in the same separate
category of post-1986 undistributed earnings. For purposes of this rule,
however, post-transaction earnings do not include post-1986
undistributed earnings in the same category that are earned after the
foreign section 381 transaction, but are distributed or deemed
distributed in the same year they are earned (that is, that do not
become accumulated). The offset shall occur as of the first day of the
foreign surviving corporation's first taxable year following the year in
which the post-transaction earnings accumulated.
(iii) Related taxes. Post-1986 foreign income taxes that are related
to a hovering deficit in a separate category of post-1986 undistributed
earnings shall only be added to the foreign surviving corporation's
post-1986 foreign income taxes in that separate category on a pro rata
basis as the hovering deficit is absorbed. Pro rata means in the same
proportion as the portion of the hovering deficit that offsets post-
transaction earnings in the separate category under paragraph (d)(2)(ii)
of this section bears to the total amount of the hovering deficit.
(3) Examples. The following examples illustrate the rules of this
paragraph (d). The examples assume the following facts: Foreign
corporations A and B are controlled foreign corporations (CFCs) that
were incorporated after December 31, 1986, have always been pooling
corporations, and have always had calendar taxable years. None of the
shareholders of foreign corporations A and B are required to include any
amount in income under Sec. 1.367(b)-4 as a result of the foreign
section 381 transaction. Foreign corporations A and B (and all of their
respective qualified business units as defined in section 989) maintain
a ``u'' functional currency. Finally, unless otherwise stated, any post-
1986 undistributed earnings in the passive category resulted from a
look-through dividend that was paid by a lower-tier CFC out of earnings
accumulated when the CFC was a noncontrolled section 902 corporation and
that qualified for the subpart F same-country exception under section
954(c)(3)(A). The examples are as follows:
Example 1. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
Foreign Corporation A
------------------------------------------------------------------------
General......................................... 300u $60
Passive......................................... 100u 40
-----------------------
400u $100
------------------------------------------------------------------------
[[Page 372]]
Foreign Corporation B
------------------------------------------------------------------------
General......................................... 300u $70
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraph (d)(1) of this
section, foreign surviving corporation has the following post-1986
undistributed earnings and post-1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General......................................... 600u $130
Passive......................................... 100u 40
-----------------------
700u $170
------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 350u to its shareholders. Under the
rules described in Sec. 1.902-1(d)(1) and paragraph (c)(1) of this
section, the distribution is out of, and reduces, post-1986
undistributed earnings and post-1986 foreign income taxes in the
separate categories on a pro rata basis, as follows:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General......................................... 300u $65
Passive......................................... 50u 20
-----------------------
350u $85
------------------------------------------------------------------------
(B) The foreign income taxes deemed paid by qualifying shareholders
of foreign surviving corporation upon the distribution are subject to
generally applicable rules and limitations, such as those of sections
78, 902, and 904(d).
(C) Immediately after the distribution, foreign surviving
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General......................................... 300u $65
Passive......................................... 50u 20
-----------------------
350u $85
------------------------------------------------------------------------
Example 2. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
Foreign Corporation A
------------------------------------------------------------------------
General......................................... 200u $30
Passive......................................... (100u) 10
-----------------------
100u $40
------------------------------------------------------------------------
Foreign Corporation B
------------------------------------------------------------------------
General......................................... 300u $60
Passive......................................... 100u 30
-----------------------
400u $90
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (d)(1) and (2)
of this section, foreign surviving corporation has the following post-
1986 undistributed earnings and post-1986 foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 500u ........... $ 90 ...........
Passive..................................................... 100u (100u) 30 $10
---------------------------------------------------
600u (100u) $120 $10
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 300u to its shareholders. Under the
rules described in Sec. 1.902-1(d)(1) and paragraph (c)(1) of this
section, the distribution is out of, and reduces, post-1986
undistributed earnings and post-1986 foreign income taxes on a pro rata
basis as follows:
[[Page 373]]
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General......................................... 250u $45
Passive......................................... 50u 15
-----------------------
300u $60
------------------------------------------------------------------------
(B) The foreign income taxes deemed paid by qualifying shareholders
of foreign surviving corporation upon the distribution are subject to
generally applicable rules and limitations, such as those of sections
78, 902, and 904(d).
(C) Immediately after the distribution, foreign surviving
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 250u ........... $45 ...........
Passive..................................................... 50u (100u) 15 $10
---------------------------------------------------
300u (100u) $60 $10
----------------------------------------------------------------------------------------------------------------
(iv) Post-transaction earnings--(A) In its taxable year ending on
December 31, 2008, foreign surviving corporation accumulates earnings
and profits and pays related foreign income taxes as follows:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General....................................... 100u $20
Passive....................................... 50u $10
-------------------------
150u $40
------------------------------------------------------------------------
(B) None of foreign surviving corporation's earnings and profits for
its 2008 taxable year qualifies as subpart F income as defined in
section 952(a). Under the rules described in paragraphs (d)(2)(ii) and
(iii) of this section, the hovering deficit in the passive category will
offset the post-transaction earnings in that category and a
proportionate amount of the foreign taxes related to the hovering
deficit will be added to the post-1986 foreign income taxes pool.
Because the post-transaction earnings in the passive category are half
of the amount of the hovering deficit, half of the related taxes are
added to the post-1986 foreign income taxes pool. Accordingly, foreign
surviving corporation has the following post-1986 undistributed earnings
and post-1986 foreign income taxes on January 1, 2009:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 350u ........... $65 ...........
Passive..................................................... 50u (50u) 30 $5
---------------------------------------------------
400u (50u) $95 $5
----------------------------------------------------------------------------------------------------------------
Example 3. (i) Facts. The facts are the same as Example 2, except
that the 50u of earnings in the passive category accrued by foreign
surviving corporation during 2008 is subpart F income, all of which is
included in income under section 951(a) by United States shareholders
(as defined in section 951(b)). This example assumes that none of the
United States shareholders are able to reduce their subpart F income
inclusion with a qualified deficit under section 952(c)(1)(B).
(ii) Result. (A) Under the rule described in paragraph (f)(1) of
this section, the (100u) hovering deficit in the passive category does
not reduce foreign surviving corporation's
[[Page 374]]
current passive earnings and profits for purposes of determining subpart
F income or associated deemed paid credits. Thus, foreign surviving
corporation's United States shareholders include their pro rata shares
of 50u in taxable income for the year and are eligible for a deemed paid
foreign tax credit under section 960, computed by reference to their pro
rata shares of $12.50 (50u subpart F inclusion / (50u + 50u post-1986
undistributed earnings in the passive category = 100u) = 50%, x $25
post-1986 foreign income taxes in the passive category = $12.50). The
United States shareholders will also include their pro rata shares of
the deemed-paid taxes of $12.50 in taxable income for the year as a
deemed dividend pursuant to section 78.
(B) Immediately after the subpart F inclusion and section 960 deemed
paid taxes (and taking into account the taxable year 2008 earnings and
profits and related taxes in the general category), foreign surviving
corporation has the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign
-------------------------- taxes
------------
Foreign Foreign
Separate category taxes taxes
Positive Hovering available associated
E&P deficit with
hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 350u ........... $65.00 ...........
Passive..................................................... 50u (100u) 12.50 $10
---------------------------------------------------
400u (100u) 77.50 10
----------------------------------------------------------------------------------------------------------------
(C) The 50u included as subpart F income constitutes previously
taxed earnings and profits under section 959.
Example 4. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
Foreign Corporation A
------------------------------------------------------------------------
General......................................... 50u $10
------------------------------------------------------------------------
Foreign Corporation B
------------------------------------------------------------------------
General......................................... (100u) $20
------------------------------------------------------------------------
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. (A) Under the rules described in paragraphs (d)(1) and
(2) of this section, foreign surviving corporation has the following
post-1986 undistributed earnings and post-1986 foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign
-------------------------- taxes
------------
Foreign Foreign
Separate category taxes taxes
Positive Hovering available associated
E&P deficit with
hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 50u (100u) $10 $20
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction earnings and distribution. (A) In its taxable
year ending on December 31, 2007, foreign surviving corporation earns
100u in the general category and pays related foreign income taxes of
$24. On December 31, 2007, foreign surviving corporation distributes 75u
to its shareholders.
(B) Result. For purposes of determining the dividend amount under
section 316 and the foreign income taxes deemed paid with respect to
that dividend under section 902, under paragraph (d)(2)(ii) of this
section the hovering deficit does not offset the post-transaction
current year earnings. Accordingly, the full 75u will be a dividend
under section 316. The deemed paid taxes on that dividend are $17 (75u
distribution / (100u current earnings + 50u accumulated earnings) = 50%,
x ($10 accumulated foreign taxes + $24 current year foreign taxes) =
$17). The 25u of
[[Page 375]]
undistributed earnings and profits in 2007 will be offset by (25u) of
the hovering deficit for purposes of determining the opening balance of
the post-1986 undistributed earnings pool in 2008. Because the amount of
earnings offset by the hovering deficit is 25% of the amount of the
hovering deficit, under paragraph (d)(2)(iii) of this section $5 (25% of
$20) of the related taxes are added to the post-1986 foreign income
taxes pool at the beginning of the next taxable year. Accordingly,
foreign surviving corporation has the following post-1986 undistributed
earnings and post-1986 foreign income taxes on January 1, 2008:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 50u (75u) $22 $15
----------------------------------------------------------------------------------------------------------------
(e) Pre-pooling annual layers--(1) If foreign surviving corporation
is a pooling corporation. If the foreign surviving corporation is a
pooling corporation, the pre-pooling annual layers shall be determined
under the rules of this paragraph (e)(1).
(i) Qualifying earnings and taxes. The pre-pooling annual layers
shall consist of the pre-1987 accumulated profits and the pre-1987
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation.
(ii) Carryover rule. Subject to paragraph (e)(1)(iii) of this
section, the amounts described in paragraph (e)(1)(i) of this section
shall carry over to the foreign surviving corporation but shall not be
combined. If the foreign acquiring corporation and the foreign target
corporation have pre-1987 accumulated profits in the same year and a
distribution is made therefrom, the rules of Sec. 1.902-1(b)(2)(ii) and
(b)(3) shall apply separately to reduce pre-1987 accumulated profits and
pre-1987 foreign income taxes of the foreign acquiring corporation and
the foreign target corporation on a pro rata basis. For further
guidance, see Rev. Rul. 68-351 (1968-2 C.B. 307); Rev. Rul. 70-373
(1970-2 C.B. 152) (see also Sec. 601.601(d)(2) of this chapter); see
also paragraph (f)(2) of this section (governing the reconciliation of
taxable years).
(iii) Deficit--(A) In general. The rules of this paragraph
(e)(1)(iii) apply when, immediately prior to the foreign section 381
transaction, the foreign acquiring corporation or the foreign target
corporation (or both) has a deficit in earnings and profits for one or
more of the years that comprise its pre-1987 accumulated profits (see
also paragraphs (f)(1) and (4) of this section, describing other rules
applicable to a deficit described in this paragraph (e)(1)(iii)).
(B) Aggregate positive pre-1987 accumulated profits. If the foreign
acquiring corporation or the foreign target corporation (or both) has an
aggregate positive (or zero) amount of pre-1987 accumulated profits, but
a deficit in earnings and profits for one or more years, then the rules
otherwise applicable to such deficits shall apply separately to the pre-
1987 accumulated profits and related pre-1987 foreign income taxes of
such corporation. A deficit in pre-1987 accumulated profits for one or
more years is applied to reduce pre-1987 accumulated profits on a LIFO
basis. Any remaining deficit shall be applied to reduce pre-1987
accumulated profits in succeeding years. See Rev. Rul. 74-550 (1974-2
C.B. 209) (see also Sec. 601.601(d)(2) of this chapter); Champion Int'l
Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in result, 1987-2 C.B.
1; Rev. Rul. 87-72 (1987-2 C.B. 170) (see also Sec. 601.601(d)(2) of
this chapter). As a result, no amount in excess of the aggregate
positive amount of pre-1987 accumulated profits shall be distributed
from the pre-transaction earnings of the foreign acquiring corporation
or the foreign target corporation.
(C) Aggregate deficit in pre-1987 accumulated profits. If the
foreign acquiring corporation or the foreign target corporation (or
both) has an aggregate deficit in pre-1987 accumulated profits, a
hovering deficit as defined under paragraph (d)(2)(i) of this section,
then
[[Page 376]]
the rules under Sec. 1.902-2(b) shall apply to such hovering deficit
(and related pre-1987 foreign income taxes) immediately prior to the
transaction, except that the aggregate hovering deficit that is carried
forward into the foreign surviving corporation's post-1986 pool shall
offset only post-transaction earnings accumulated by the foreign
surviving corporation in the same separate category of post-1986
undistributed earnings to which the relevant portion of the hovering
deficit is attributable. Post-transaction earnings do not include
earnings and profits that are earned after the foreign section 381
transaction but distributed or deemed distributed in the same year they
are earned.
(D) Deficit and positive separate categories within annual layers.
For purposes of applying the rules of paragraphs (e)(1)(iii)(B) and (C)
of this section, if within a single pre-pooling annual layer, the
foreign acquiring corporation or the foreign target corporation (or
both) has a deficit in pre-1987 accumulated profits in a separate
category and positive pre-1987 accumulated profits in another separate
category, the deficit shall first be used to offset the positive pre-
1987 accumulated profits in the other separate category in the same pre-
pooling annual layer. Any remaining deficit shall be carried forward or
back to other years according to the rules of paragraph (e)(1)(iii)(B)
or (C) of this section as applicable.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes. The pre-1987 section 960 earnings and profits and pre-1987
section 960 foreign income taxes of the foreign acquiring corporation
and the foreign target corporation shall carry over to the foreign
surviving corporation but shall not be combined. The rules otherwise
applicable to such amounts shall apply separately to the pre-1987
section 960 earnings and profits and pre-1987 section 960 foreign income
taxes of the foreign acquiring corporation and the foreign target
corporation on a pro rata basis. For further guidance, see Notice 88-70
(1988-2 C.B. 369) (see also Sec. 601.601(d)(2) of this chapter).
(v) Examples. The following examples illustrate the rules of this
paragraph (e)(1). The examples assume the following facts: Foreign
corporation A was incorporated in 2003 and was a nonpooling corporation
through December 31, 2004. Foreign corporation A became a CFC on January
1, 2005 and, as a result, began to maintain a pool of post-1986
undistributed earnings on that date. Foreign corporation B was
incorporated in 2003 and has always been owned by foreign shareholders
(and thus never has met the requirements of section 902(c)(3)(B)). Both
foreign corporation A and foreign corporation B have always had calendar
taxable years. Foreign corporations A and B (and all of their respective
qualified business units as defined in section 989) maintain a ``u''
functional currency. Finally, unless otherwise stated, all earnings and
profits of foreign corporations A and B are in the general category. The
examples are as follows:
Example 1. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool................................ 1,000u $350
2004.......................................... 400u 160u
2003.......................................... 100u 5u
-----------------------
1,500u ..........
Foreign Corporation B:
2006........................................ 100u 20u
2005........................................ 150u 30u
2004........................................ 0u 50u
2003........................................ 50u 5u
-----------------------
300u 105u
------------------------------------------------------------------------
[[Page 377]]
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (e)(1)(i) and
(ii) of this section, foreign surviving corporation has the following
earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Post-1986 Pool.................................. 1,000u $350
2006............................................ 100u 20u
2005............................................ 150u 30u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)......... 400u 160u
2004 layer 2 (from Corp B)......... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)......... 100u 5u
2003 layer 2 (from Corp B)......... 50u 5u
-----------------------
1,800u ..........
------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 1,725u to its shareholders. Under the
rules of paragraph (c)(1) of this section, the distribution is first out
of the post-1986 pool, and then out of the pre-pooling annual layers
under the LIFO method, as follows:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Post-1986 pool................................ 1,000u $350
2006.......................................... 100u 20u
2005.......................................... 150u 30u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1..................... 400u 160u
2004 layer 2..................... 0u 0u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... * 50u 2.5u
2003 layer 2..................... ** 25u 2.5u
-------------------------
1,725u
------------------------------------------------------------------------
* 100u in layer/150u aggregate 2003 earnings = 66.67% x 75u
distribution.
** 50u in layer/150u aggregate 2003 earnings = 33.33% x 75u
distribution.
(B) The foreign income taxes deemed paid by qualifying shareholders
of foreign surviving corporation upon the distribution are subject to
generally applicable rules and limitations, such as those of sections
78, 902, and 904(d).
(C) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
2004 layer 2......................... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... 50u 2.5u
2003 layer 2..................... 25u 2.5u
�����������������������������������������������
75u 55u
------------------------------------------------------------------------
(iv) Post-transaction earnings. For the taxable year ending on
December 31, 2008, foreign surviving corporation has 500u of current
earnings and profits in the general category, none of which qualify as
subpart F income under section 952(a), and pays $70 in foreign income
taxes. As of the close of the
[[Page 378]]
2008 taxable year, foreign surviving corporation has the following
earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Post-1986 pool................................ 500u $70
2004.......................................... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... 50u 2.5u
2003 layer 2..................... 25u 2.5u
-------------------------
575u
------------------------------------------------------------------------
Example 2. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool.............................. 1,000u $350
2004...................................... 100u 20u
2003...................................... (50u) 5u
-------------------------
1,050u
Foreign Corporation B:
2006...................................... 100u 20u
2005...................................... (50u) 5u
2004...................................... 0u 50u
2003...................................... 100u 10u
-------------------------
150u 85u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Because foreign corporations A and B have aggregate
positive amounts of pre-1987 accumulated profits with a deficit in one
or more years, the rules of paragraph (e)(1)(iii)(B) of this section
apply. Accordingly, after the foreign section 381 transaction, foreign
surviving corporation has the following earnings and profits and foreign
income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
Foreign taxes
Positive Deficit E&P taxes assoicated
E&P available with
deficit E&P
----------------------------------------------------------------------------------------------------------------
Post-1986 pool.............................................. 1,000u ........... $350 ...........
2006........................................................ 100u ........... 20u ...........
2005........................................................ ........... (50u) ........... 5u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)..................... 100u ........... 20u ...........
2004 layer 2 (from Corp B)..................... 0u ........... 50u ...........
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)..................... ........... (50u) ........... 5u
2003 layer 2 (from Corp B)..................... 100u ........... 10u ...........
---------------------------------------------------
1,300u (100u) ........... 10u
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 1,175u to its shareholders. Under the
rules described in paragraphs (c)(1)
[[Page 379]]
and (e)(1)(iii)(B) of this section, the distribution is first out of the
post-1986 pool, and then out of the pre-pooling annual layers, as
follows:
------------------------------------------------------------------------
Foreign
Distribution E&P taxes
------------------------------------------------------------------------
Post-1986 pool................................ 1,000u $350
2006.......................................... 100u 20u
2005.......................................... 0u 0u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1..................... 50u 20u
2004 layer 2..................... 0u 0u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... 0u 0u
2003 layer 2..................... 25u 5u
-------------------------
1,175u ...........
------------------------------------------------------------------------
(B) Under paragraph (e)(1)(iii)(B) of this section, the rules
otherwise applicable when a foreign corporation has an aggregate
positive (or zero) amount of pre-1987 accumulated profits, but a deficit
in one or more years, apply separately to the pre-1987 accumulated
profits and related foreign income taxes of foreign corporation A and
foreign corporation B. As a result, distributions out of the pre-pooling
annual layers of foreign corporation A and foreign corporation B cannot
exceed the aggregate positive amount of pre-1987 accumulated profits of
each corporation. Accordingly, only 50u can be distributed from foreign
corporation A's pre-pooling annual layers and is out of its 2004 layer
1 (after rolling forward the (50u) deficit in 2003 layer
1 to reduce earnings in 2004 layer 1 to 50u (100u -
50u)). Under the principles of Sec. 1.902-1(b)(3), the full 20u of
taxes related to 2004 layer 1 is reduced or deemed paid ($20 x
(50/50)). 100u is distributed from foreign corporation B's 2006 annual
layer. Foreign corporation B's (50u) deficit in 2005 is then rolled back
to offset its 2003 annual layer to reduce earnings in that layer to 50u,
25u of which is distributed. Thus, after the distribution, 25u remains
in 2003 layer 2 along with 5u of foreign income taxes (10u x
(25u/50u)).
(C) The foreign income taxes deemed paid by qualifying shareholders
of foreign surviving corporation upon the distribution are subject to
generally applicable rules and limitations, such as those of sections
78, 902, and 904(d).
(D) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
2005.......................................... 0u 5u
2004 layer 2......................... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... 0u 5u
2003 layer 2..................... 25u 5u
-------------------------
25u 65u
------------------------------------------------------------------------
(E) Under paragraph (e)(1)(iii)(B) of this section, the 5u, 50u, and
5u of pre-1987 foreign income taxes related to foreign surviving
corporation's 2005 layer, 2004 layer 2, and 2003 layer
1, respectively, remain in those layers. These foreign income
taxes generally will not be reduced or deemed paid unless a foreign tax
refund restores a positive balance to the associated earnings pursuant
to section 905(c), and thus will be trapped. See Sec. 1.902-2(b)(2).
Example 3. (i) Facts. (A) On December 31, 2006, foreign corporations
A and B have the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool................................ 1,000u $350
2004...................................... 150u 20u
2003...................................... 100u 5u
-------------------------
1,250u ...........
[[Page 380]]
Foreign Corporation B:
2006...................................... 100u 20u
2005...................................... (250u) 5u
2004...................................... 0u 50u
2003...................................... 100u 10u
-------------------------
(50u) 85u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. (A) Because foreign corporation B has an aggregate
hovering deficit in pre-1987 accumulated profits, the rules of paragraph
(e)(1)(iii)(C) of this section apply. Accordingly, Sec. 1.902-2(b)
applies immediately prior to the foreign section 381 transaction, except
that the hovering deficit is carried forward into the foreign surviving
corporation's post-1986 undistributed earnings pool and will offset only
post-transaction earnings accumulated by foreign surviving corporation
in the general category. Accordingly, after the foreign section 381
transaction, foreign surviving corporation has the following earnings
and profits and foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Positive Hovering Foreign assoicated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool.............................................. 1,000u (50u) $350 $0
2006........................................................ 0u ........... 20u ...........
2005........................................................ 0u ........... 5u ...........
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)..................... 150u ........... 20u ...........
2004 layer 2 (from Corp B)..................... 0u ........... 50u ...........
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)..................... 100u ........... 5u ...........
2003 layer 2 (from Corp B)..................... 0u ........... 10u ...........
---------------------------------------------------
1,250u (50u) ........... $0
----------------------------------------------------------------------------------------------------------------
(B) Under paragraph (e)(1)(iii)(C) of this section, the 20u, 5u,
50u, and 10u of pre-1987 foreign income taxes associated with foreign
corporation B's pre-1987 accumulated profits for 2006, 2005, 2004 layer
2, and 2003 layer 2, respectively, remain in those
layers. These foreign income taxes generally will not be reduced or
deemed paid unless a foreign tax refund restores a positive balance to
the associated earnings pursuant to section 905(c), and thus will be
trapped. See Sec. 1.902-2(b)(2).
(2) If foreign surviving corporation is a nonpooling corporation. If
the foreign surviving corporation is a nonpooling corporation, then the
pre-pooling annual layers shall be determined under the rules of this
paragraph (e)(2).
(i) Qualifying earnings and taxes. The pre-pooling annual layers
shall consist of the pre-1987 accumulated profits and the pre-1987
foreign income taxes of the foreign acquiring corporation and the
foreign target corporation. If the foreign acquiring corporation or the
foreign target corporation (or both) has post-1986 undistributed
earnings or a deficit in post-1986 undistributed earnings, then those
earnings or deficits and any related post-1986 foreign income taxes
shall be recharacterized as pre-1987 accumulated profits or deficits and
pre-1987 foreign income taxes of the foreign acquiring corporation or
the foreign target corporation accumulated immediately prior to the
foreign section 381 transaction.
(ii) Carryover rule. Subject to paragraph (e)(2)(iii) of this
section, the amounts described in paragraph (e)(2)(i) of this section
shall carry over to the foreign surviving corporation but shall not be
combined. If the foreign acquiring corporation and the foreign target
corporation have pre-1987
[[Page 381]]
accumulated profits in the same year and a distribution is made
therefrom, the principles of Sec. 1.902-1(b)(2)(ii) and (3) shall apply
separately to reduce pre-1987 accumulated profits and pre-1987 foreign
income taxes of the foreign acquiring corporation and the foreign target
corporation on a pro rata basis. For further guidance, see Rev. Rul. 68-
351 (1968-2 C.B. 307); Rev. Rul. 70-373 (1970-2 C.B. 152) (see also
Sec. 601.601(d)(2) of this chapter); see also paragraph (f)(2) of this
section (governing the reconciliation of taxable years).
(iii) Deficits--(A) In general. The rules of this paragraph
(e)(2)(iii) apply when, immediately prior to the foreign section 381
transaction (and after application of the last sentence of paragraph
(e)(2)(i) of this section), the foreign acquiring corporation or the
foreign target corporation (or both) has a deficit in one or more years
that comprise its pre-1987 accumulated profits. See also paragraphs
(f)(1) and (4) of this section (describing other rules applicable to a
deficit described in this paragraph (e)(2)(iii)).
(B) Aggregate positive pre-1987 accumulated profits. If the foreign
acquiring corporation or the foreign target corporation (or both) has an
aggregate positive (or zero) amount of pre-1987 accumulated profits, but
a deficit in pre-1987 accumulated profits in one or more years, then the
rules otherwise applicable to such deficits shall apply separately to
the pre-1987 accumulated profits and related foreign income taxes of
such corporation. A deficit in pre-1987 accumulated profits for one or
more years is applied to reduce pre-1987 accumulated profits on a LIFO
basis. Any remaining deficit shall be applied to reduce pre-1987
accumulated profits in succeeding years. See Rev. Rul. 74-550 (1974-2
C.B. 209) (see also Sec. 601.601(d)(2) of this chapter); Champion Int'l
Corp. v. Commissioner, 81 T.C. 424 (1983), acq. in result, 1987-2 C.B.
1; Rev. Rul. 87-72 (1987-2 C.B. 170) (see also Sec. 601.601(d)(2) of
this chapter). As a result, no amount in excess of the aggregate
positive amount of pre-1987 accumulated profits shall be distributed
from the pre-transaction earnings of the foreign acquiring corporation
or the foreign target corporation.
(C) Aggregate deficit in pre-1987 accumulated profits. If the
foreign acquiring corporation or the foreign target corporation (or
both) has an aggregate deficit in pre-1987 accumulated profits, a
hovering deficit as defined under paragraph (d)(2)(i) of this section,
then the rules otherwise applicable to such hovering deficits shall
apply separately to the pre-transaction earnings and profits and related
taxes of the relevant corporation. See, e.g., sections 316(a) and
381(c)(2)(B). Thus, any hovering deficit shall offset only post-
transaction earnings accumulated by the foreign surviving corporation in
the same separate category of earnings and profits to which the relevant
portion of the hovering deficit is attributable. Post-transaction
earnings do not include earnings and profits that are earned after the
foreign section 381 transaction but distributed or deemed distributed in
the same year they are earned. Following the principles of Sec. 1.902-
2(b), if there is an aggregate deficit in pre-1987 accumulated profits,
any related pre-1987 foreign income taxes generally will not be reduced
or deemed paid unless a foreign tax refund restores a positive balance
to the associated earnings pursuant to section 905(c), and creates a
pre-transaction aggregate positive balance for pre-1987 accumulated
profits.
(D) Deficit and positive separate categories within annual layers.
For purposes of applying the rules of paragraphs (e)(2)(iii)(B) and (C)
of this section, if within a single pre-pooling annual layer, the
foreign acquiring corporation or the foreign target corporation (or
both) has a deficit in pre-1987 accumulated profits in a separate
category and positive pre-1987 accumulated profits in another separate
category, the deficit shall first be used to offset the positive pre-
1987 accumulated profits in the other separate category in the same pre-
pooling annual layer. Any remaining deficit shall be carried forward or
back to other years according to the rules of paragraph (e)(2)(iii)(B)
or (C) as applicable.
(iv) Pre-1987 section 960 earnings and profits and foreign income
taxes. The pre-1987 section 960 earnings and profits and pre-1987
section 960 foreign income
[[Page 382]]
taxes of the foreign acquiring corporation and the foreign target
corporation shall carry over to the foreign surviving corporation but
shall not be combined. The rules otherwise applicable to such amounts
shall apply separately to the pre-1987 section 960 earnings and profits
and pre-1987 section 960 foreign income taxes of the foreign acquiring
corporation and the foreign target corporation on a pro rata basis. For
further guidance, see Notice 88-70 (1988-2 C.B. 369) (see also Sec.
601.601(d)(2) of this chapter).
(v) Examples. The following examples illustrate the rules of this
paragraph (e)(2). The examples assume the following facts: Both foreign
corporation A and foreign corporation B have always had calendar taxable
years. Foreign corporations A and B (and all of their respective
qualified business units as defined in section 989) maintain a ``u''
functional currency, and 1u = US$1 at all times. Finally, unless
otherwise stated, all earnings and profits of foreign corporations A and
B are in the general category. The examples are as follows:
Example 1. (i) Facts. (A) Foreign corporations A and B both were
incorporated in 2003. Nine percent of the voting stock of foreign
corporation A is owned by domestic corporate shareholder C. Nine percent
of the voting stock of foreign corporation B is owned by domestic
corporate shareholder D. Shareholders C and D are unrelated. The
remaining 91% of the voting stock of each foreign corporation is owned
by unrelated foreign shareholders. Thus, neither corporation meets the
requirements of section 902(c)(3)(B). On December 31, 2006, foreign
corporations A and B have the following earnings and profits and foreign
income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A:
2006...................................... 500u 350u
2005...................................... 400u 300u
2004...................................... 400u 160u
2003...................................... 100u 5u
=============------------
1,400u 815u
Foreign Corporation B:
2006...................................... 100u 20u
2005...................................... 300u 60u
2004...................................... 0u 50u
2003...................................... 50u 5u
-------------------------
450u 135u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a nonpooling corporation that does not
meet the requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in paragraphs (e)(2)(i) and
(ii) of this section, foreign surviving corporation has the following
earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A)....... 500u 350u
2006 layer 2 (from Corp B)....... 100u 20u
Two Side-by-Side Layers of 2005 E&P:
2005 layer 1 (from Corp A)....... 400u 300u
2005 layer 2 (from Corp B)....... 300u 60u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)....... 400u 160u
2004 layer 2 (from Corp B)....... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)....... 100u 5u
2003 layer 2 (from Corp B)....... 50u 5u
-------------------------
[[Page 383]]
1,850u 950u
------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 600u to its shareholders. Under the
rules of paragraph (c)(3) of this section, the distribution is out of
pre-pooling annual layers under the LIFO method as follows:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A)....... 500u 350u
2006 layer 2 (from Corp B)....... 100u 20u
-------------------------
600u 370u
------------------------------------------------------------------------
(B) Foreign surviving corporation's foreign income tax accounts are
reduced to reflect the distribution of earnings and profits
notwithstanding that no shareholders are eligible to claim deemed paid
foreign income taxes under section 902. See Sec. 1.902-1(a)(10)(iii).
(C) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2005 E&P:
2005 layer 1 (from Corp A)....... 400u 300u
2005 layer 2 (from Corp B)....... 300u 60u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)....... 400u 160u
2004 layer 2 (from Corp B)....... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)....... 100u 5u
2003 layer 2 (from Corp B)....... 50u 5u
-------------------------
1,250u 580u
------------------------------------------------------------------------
Example 2. (i) Facts. (A) The facts are the same as in Example 1
(i)(A), except that foreign corporation A met the requirements of
section 902(c)(3)(B) on January 1, 2005, when U.S. corporate shareholder
C acquired an additional 1% of voting stock for a total ownership
interest of 10%; foreign corporation A thereby became a pooling
corporation. On December 31, 2006, foreign corporations A and B have the
following earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool............................ 900u $650
2004...................................... 400u 160u
2003...................................... 100u 5u
-------------------------
1,400u ...........
=========================
Foreign Corporation B:
2006...................................... 100u 20u
2005...................................... 300u 60u
2004...................................... 0u 50u
2003...................................... 50u 5u
-------------------------
450u 135u
------------------------------------------------------------------------
[[Page 384]]
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a nonpooling corporation that does not
meet the requirements of section 902(c)(3)(B).
(ii) Result. Under the rules described in paragraphs (e)(2)(i) and
(ii) of this section, foreign surviving corporation has the following
earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A's pool) 900u $650
2006 layer 2 (from Corp B's 100u 20u
layer)...................................
2005 (from Corp B):....................... 300u 60u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)....... 400u 160u
2004 layer 2 (from Corp B)....... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)....... 100u 5u
2003 layer 2 (from Corp B)....... 50u 5u
-------------------------
1,850u
------------------------------------------------------------------------
(iii) Subsequent ownership change. On July 1, 2010, USS (a domestic
corporation) acquires 100% of the stock of foreign surviving
corporation. Under the rules of paragraph (f)(3) of this section,
foreign surviving corporation begins to pool its earnings and profits
under section 902(c)(3) as of January 1, 2010. Foreign surviving
corporation's earnings and profits and foreign income taxes accrued
before January 1, 2010 retain their character as pre-1987 accumulated
profits and pre-1987 foreign income taxes.
Example 3. (i) Facts. (A) The facts are the same as in Example
2(i)(A), except that on December 31, 2006, foreign corporations A and B
have the following earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P Taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool............................ 1,000u $500
2004...................................... (200u) 10u
2003...................................... 400u 5u
-------------------------
1,200u ...........
=========================
Foreign Corporation B
2006...................................... 300u 20u
2005...................................... (100u) 60u
2004...................................... 0u 50u
2003...................................... 50u 5u
-------------------------
250u 135u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a nonpooling corporation that does not
meet the requirements of section 902(c)(3)(B).
(ii) Result. Because foreign corporations A and B have aggregate
positive amounts of pre-1987 accumulated profits with a deficit in one
or more years, the rules of paragraph (e)(2)(iii)(B) of this section
apply. Accordingly, after the foreign section 381 transaction, foreign
surviving corporation has the following earnings and profits and foreign
income taxes:
[[Page 385]]
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
Foreign taxes
Positive Deficit E&P taxes associated
E&P available with
deficit E&P
----------------------------------------------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A's pool).............. 1,000u ........... $500 ...........
2006 layer 2 (from Corp B's layer)............. 300u ........... 20u
2005 (from Corp B)...................................... ........... (100u) ........... 60u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)..................... ........... (200u) ........... 10u
2004 layer 2 (from Corp B)..................... 0u ........... 50u ...........
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)..................... 400u ........... 5u ...........
2003 layer 2 (from Corp B)..................... 50u ........... 5u ...........
---------------------------------------------------
1,750u (300u) ........... 70u
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 1,300u to its shareholders. Under the
rules described in paragraphs (c)(3) and (e)(2)(iii)(B) of this section,
the distribution is out of the pre-pooling annual layers, as follows:
----------------------------------------------------------------------------------------------------------------
E&P Foreign taxes
----------------------------------------------------------------------------------------------------------------
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1................ 1,000u $500
2006 layer 2................ 250u 20u
2003 E&P:
----------------------------------------------------------------------
2003 layer 1................ 50u 1.25u (25% of 5u taxes)
1,300u ........................................................
----------------------------------------------------------------------------------------------------------------
(B) Under paragraph (e)(2)(iii)(B) of this section, the rules
otherwise applicable when a foreign corporation has an aggregate
positive (or zero) amount of pre-1987 accumulated profits, but a deficit
in one or more years, apply separately to the pre-1987 accumulated
profits and related pre-1987 foreign income taxes of foreign corporation
A and foreign corporation B. As a result, distributions out of the pre-
pooling annual layers of foreign corporation A and foreign corporation B
cannot exceed the aggregate positive amount of pre-1987 accumulated
profits of each corporation. Accordingly, only 1,200u and 250u can be
distributed out of foreign corporation A's and foreign corporation B's
pre-pooling annual layers, respectively. Thus, 1,000u of the
distribution is out of foreign corporation A's 2006 layer 1 and
250u is out of foreign corporation B's 2006 layer 2 (after
rolling forward (50u) of the deficit in 2005 layer to reduce earnings in
2006 layer 1 to 250u (300u-50u)). Under the principles of Sec.
1.902-1(b)(3), all of the taxes in each of those respective layers are
reduced. The remaining 50u is distributed from foreign corporation A's
2003 layer 1 (after rolling back the (200u) deficit in 2004
layer 1 to reduce earnings in 2003 layer 1 to 200u
(400u-200u)). Thus, after the distribution, 150u remains in the 2003
layer 1 along with 3.75u of foreign income taxes (5u x (150u/
200u)).
(C) Foreign surviving corporation's foreign income tax accounts are
reduced to reflect the distribution of earnings and profits
notwithstanding that no shareholders are eligible to claim a credit for
deemed paid foreign income taxes under section 902. See Sec. 1.902-
1(a)(10)(iii).
(D) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign income
taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
2005.......................................... 0u 60u
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1..................... 0u 10u
2004 layer 2..................... 0u 50u
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1..................... 150u 3.75u
[[Page 386]]
2003 layer 2..................... 0u 5u
-------------------------
150u 128.75u
------------------------------------------------------------------------
(E) Under paragraph (e)(2)(iii)(B) of this section, the 60u, 10u,
50u, and 5u of foreign income taxes related to foreign surviving
corporation's 2005 layer, 2004 layer 1, 2004 layer 2,
and 2003 layer 2, respectively, remain in those layers. These
foreign income taxes generally will not be reduced or deemed paid unless
a foreign tax refund restores a positive balance to the associated
earnings pursuant to section 905(c), and thus will be trapped. See Sec.
1.902-2(b)(2).
Example 4. (i) Facts. (A) The facts are the same as in Example 2
(i)(A), except that on December 31, 2006, foreign corporations A and B
have the following earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P Taxes
------------------------------------------------------------------------
Foreign Corporation A:
Post-1986 pool............................ (1,000u) $20
2004...................................... (200u) 10u
2003...................................... 400u 5u
-------------------------
(800u)
Foreign Corporation B:
=========================
2006...................................... 100u 20u
2005...................................... 300u 60u
2004...................................... 0u 50u
2003...................................... 50u 5u
-------------------------
450u 135u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation A acquires the assets of
foreign corporation B in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a nonpooling corporation.
(ii) Result. (A) Under paragraph (e)(2)(i) of this section, foreign
corporation A's post-1986 pool is recharacterized as a 2006 layer of
pre-1987 accumulated profits. Because after the foreign section 381
transaction foreign corporation A has an aggregate deficit in pre-1987
accumulated profits, the rules of paragraph (e)(2)(iii)(C) of this
section apply and the rules otherwise applicable apply separately to the
pre-1987 accumulated profits that carry over to foreign surviving
corporation from foreign corporation A. The (800u) aggregate deficit in
foreign corporation A's pre-1987 accumulated profits is a hovering
deficit that will offset only post-transaction earnings accumulated by
foreign surviving corporation in the general category. Accordingly,
after the foreign section 381 transaction, foreign surviving corporation
has the following earnings and profits and foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
Positive Foreign taxes
E&P Deficit E&P taxes associated
available deficit E&P
----------------------------------------------------------------------------------------------------------------
Hovering deficit from Corp A's annual layers................ ........... (800u) ........... 0
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A's pool).............. ........... 0u ........... $20
2006 layer 2 (from Corp B's layer)............. 100u ........... 20u ...........
2005 (from Corp B)...................................... 300u ........... 60u ...........
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)..................... ........... 0u ........... 10u
2004 layer 2 (from Corp B)..................... 0u ........... 50u ...........
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)..................... 0u ........... 5u ...........
2003 layer 2 (from Corp B)..................... 50u ........... 5u ...........
---------------------------------------------------
450u (800u) 140u ...........
----------------------------------------------------------------------------------------------------------------
[[Page 387]]
(B) Under paragraph (e)(2)(iii)(C) of this section, the $20, 10u,
and 5u of pre-1987 foreign income taxes associated with foreign
corporation A's pre-1987 accumulated profits for 2006 layer 1,
2004 layer 1, and 2003 layer 1, respectively, remain
in those layers. These foreign income taxes generally will not be
reduced or deemed paid unless a foreign tax refund restores a positive
balance to the associated earnings pursuant to section 905(c), and thus
will be trapped. See Sec. 1.902-2(b)(2).
(iii) Post-transaction distribution. (A) During 2007, foreign
surviving corporation does not accumulate any earnings and profits or
pay or accrue any foreign income taxes. On December 31, 2007, foreign
surviving corporation distributes 200u to its shareholders. Under the
rules described in paragraph (e)(2)(iii)(C) of this section, no
distribution can be made out of the pre-1987 accumulated profits of
foreign corporation A (and the (800u) aggregate hovering deficit will
offset only post-transaction earnings accumulated by foreign surviving
corporation). Thus, the distribution is out of pre-pooling annual layers
as follows:
------------------------------------------------------------------------
Foreign
E&P taxes paid
------------------------------------------------------------------------
2006 layer 2......................... 100u 20u
2005.......................................... 100u 20u
-------------------------
200u 40u
------------------------------------------------------------------------
(B) Foreign surviving corporation's foreign income tax accounts are
reduced to reflect the distribution of earnings and profits
notwithstanding that no shareholders are eligible to claim deemed paid
foreign income taxes under section 902. See Sec. 1.902-1(a)(10)(iii).
(C) Immediately after the distribution, foreign surviving
corporation has the following earnings and profits and foreign income
taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
Foreign taxes
Positive Deficit E&P taxes associated
E&P available with
deficit E&P
----------------------------------------------------------------------------------------------------------------
Hovering deficit from Corp A's annual layers................ ........... (800u) ........... 0
Two Side-by-Side Layers of 2006 E&P:
2006 layer 1 (from Corp A's pool).............. ........... 0u ........... $20
2006 layer 2 (from Corp B's layer)............. 0u ........... 0u ...........
2005 (from Corp B)...................................... 200u ........... 40u ...........
Two Side-by-Side Layers of 2004 E&P:
2004 layer 1 (from Corp A)..................... ........... 0u ........... 10u
2004 layer 2 (from Corp B)..................... 0u ........... 50u ...........
Two Side-by-Side Layers of 2003 E&P:
2003 layer 1 (from Corp A)..................... 0u ........... 5u ...........
2003 layer 2 (from Corp B)..................... 50u ........... 5u ...........
250u (800u) 140u ...........
----------------------------------------------------------------------------------------------------------------
(f) Special rules--(1) Treatment of deficit--(i) General rule. Any
deficit described in paragraph (d)(2), (e)(1)(iii), or (e)(2)(iii) of
this section shall not be taken into account in determining current or
accumulated earnings and profits of a foreign surviving corporation
other than to offset post-transaction accumulated earnings, as defined
in paragraph (d)(2)(ii) of this section, including for purposes of
calculating--
(A) The earnings and profits limitation of section 952(c)(1)(A); and
(B) The amount of the foreign surviving corporation's subpart F
income as defined in section 952(a).
(ii) Exceptions. The rule in paragraph (i) shall not apply for
purposes of calculating an earnings and profits limitation under section
952(c)(1)(B) or (C).
(iii) Examples. The following examples illustrate the principles of
this paragraph (f)(1). The examples assume the following facts: foreign
corporation A, incorporated in 2002, is and always has been a wholly
owned subsidiary of USP, a domestic corporation. Foreign corporation B,
incorporated in 2004, is
[[Page 388]]
and always has been a wholly owned subsidiary of foreign corporation A.
Both foreign corporation A and foreign corporation B are organized under
the laws of foreign country X and have always had a calendar taxable
year. Foreign corporations A and B (and all of their respective
qualified business units as defined in section 989) maintain a ``u''
functional currency. Unless otherwise stated, any earnings and profits
or deficit in earnings and profits of foreign corporation A and B in the
general category are attributable to subpart F income derived from
foreign base company sales income. Foreign corporation C is a wholly
owned subsidiary of USP2 and was organized in 2004 under the laws of
foreign country Y. Foreign corporation C (and all of its qualified
business units as defined in section 989) maintains a ``u'' functional
currency. Earnings and profits of foreign corporation C in the general
category are not attributable to subpart F income. The examples are as
follows:
Example 1. (i) Facts. (A) On December 31, 2007, foreign corporations
A and B have the following post-1986 undistributed earnings and post-
1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A Separate Category:
General................................... (100u) $25
Foreign Corporation B Separate Category:
General................................... 0u $10
------------------------------------------------------------------------
(B) On January 1, 2008, foreign corporation B elects under Sec.
301.7701-3(c) of this chapter to be disregarded as an entity separate
from foreign corporation A. Accordingly, foreign corporation B is deemed
to have distributed all its property to foreign corporation A in a
liquidation described in section 332.
(ii) Result. Under the rules described in paragraphs (d)(1) and (2)
of this section, foreign surviving corporation A has the following post-
1986 undistributed earnings and post-1986 foreign income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits: Foreign taxes:
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 0u (100u) $10 $25
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction earnings and subpart F limitations. (A) In
its taxable year ending on December 31, 2008, foreign surviving
corporation A earns 300u of subpart F general category income with
respect to which it pays $50 in foreign income taxes. The hovering
deficit of (100u) meets the requirements under section 952(c)(1)(B) and
therefore is taken into account as a qualified deficit that may be used
by USP to offset a portion of its income inclusion related to foreign
surviving corporation A's subpart F income of 300u in the 2008 taxable
year. Accordingly, USP includes 200u in taxable income for the year and
is eligible for a deemed paid foreign tax credit under section 960 of
$40 (200u subpart F inclusion/300 post-1986 undistributed earnings in
the general category = 66.67%, x $60 foreign income taxes in the general
category = $40). USP will also include the deemed paid foreign taxes of
$40 in taxable income for the year as a deemed dividend pursuant to
section 78. The 100u offset under section 952(c)(1)(B) does not result
in a reduction of the hovering deficit for purposes of section 316 or
section 902.
(B) Foreign surviving corporation A's 100u of subpart F income not
included in income by USP will accumulate and be added to its post-1986
undistributed earnings as of the beginning of 2009. This 100u of post-
transaction earnings will be offset by the (100u) hovering deficit.
Because the amount of earnings offset by the hovering deficit is 100% of
the total amount of the hovering deficit, all $25 of the related taxes
are added to the post-1986 foreign income taxes pool as well.
Accordingly, foreign surviving corporation A has the following post-1986
undistributed earnings and post-1986 foreign income taxes on January 1,
2009:
[[Page 389]]
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 0u (0u) $45 $0
----------------------------------------------------------------------------------------------------------------
(C) The 200u included as subpart F income constitutes previously
taxed earnings under section 959.
Example 2. (i) Facts. (A) On July 1, 2007, foreign corporation B
elects under Sec. 301.7701-3(c) of this chapter to be disregarded as an
entity separate from foreign corporation A. Accordingly, foreign
corporation B is deemed to have distributed all of its property to
foreign corporation A in a liquidation described in section 332.
(B) Neither foreign corporation A nor B has any post-1986
undistributed earnings or post-1986 foreign income taxes as of the
beginning of the 2007 taxable year. For its short taxable year ending on
June 30, 2007, foreign corporation B has the following post-1986
undistributed earnings and post-1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
Separate category E&P taxes
------------------------------------------------------------------------
General....................................... (200u) $30
------------------------------------------------------------------------
(C) For the 2007 taxable year, foreign surviving corporation A earns
a total of 200u of subpart F foreign based company sales income in the
general category with respect to which it pays $40 in foreign income
taxes.
(ii) Result. (A) Under paragraph (d)(2) of this section, foreign
corporation B's (200u) deficit carries over to foreign surviving
corporation A as a hovering deficit. Nevertheless, because it is a
deficit of a qualified chain member for a taxable year ending within the
2007 taxable year of foreign surviving corporation A, the (200u) deficit
meets the requirements under section 952(c)(1)(C) and therefore may
still be taken into account for purposes of limiting foreign surviving
corporation A's subpart F income. Accordingly, foreign surviving
corporation A's 200u of subpart F income for the 2007 taxable year is
fully offset by the (200u) deficit of foreign corporation B, and USP
will have no subpart F income inclusion for the 2007 taxable year. The
offset under section 952(c)(1)(C) does not result in a reduction of the
hovering deficit for purposes of section 316 or section 902. The
hovering deficit may not also be taken into account under section
952(c)(1)(B).
(B) Because USP has no subpart F income inclusion, foreign surviving
corporation A's subpart F earnings of 200u will accumulate and be added
to its post-1986 undistributed earnings as of the beginning of 2008.
Under the rules of paragraph (f)(5) of this section, a pro rata amount,
in this case 50% or 100u, will be deemed to have been accumulated prior
to the foreign section 381 transaction and the other 50%, or 100u, will
be deemed to have been accumulated after the foreign section 381
transaction. The 100u of post-transaction earnings will be offset by
(100u) of the hovering deficit for purposes of determining the opening
balance of the post-1986 undistributed earnings pool in 2008. Because
the amount of earnings offset by the hovering deficit is 50% of the
total amount of the hovering deficit, $15 (50% of $30) of the related
taxes are added to the post-1986 foreign income taxes pool as well. The
100u of pre-transaction earnings remain in the post-1986 undistributed
earnings pool. Accordingly, foreign surviving corporation A has the
following post-1986 undistributed earnings and post-1986 foreign income
taxes on January 1, 2008:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Positive Hoverinig Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... 100u (100u) $55 $15
----------------------------------------------------------------------------------------------------------------
[[Page 390]]
Example 3. (i) Facts. (A) On January 1, 2007, foreign corporation B
and foreign corporation C have the following post-1986 undistributed
earnings and post-1986 foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation B Separate Category:
General................................... (100u) $0
Foreign Corporation C Separate Category:
General................................... 0u $10
------------------------------------------------------------------------
(B) On July 1, 2007, foreign corporation B acquires the assets of
foreign corporation C in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation B is a CFC.
(C) During the 2007 taxable year foreign surviving corporation B has
a current deficit of (400u) and $60 of related foreign income taxes.
During its short taxable year ending on June 30, 2007, foreign
corporation C has no additional earnings and pays or accrues no foreign
income taxes.
(ii) Result. (A) Under the rules of paragraph (f)(5) of this
section, a pro rata amount, in this case 50% or (200u), of foreign
surviving corporation B's (400u) current year deficit for the 2007
taxable year will be deemed to have been accumulated prior to the
foreign section 381 transaction and be treated as a hovering deficit.
The other 50%, or (200u) of the deficit will be deemed to have been
accumulated after the foreign section 381 transaction. The related
foreign income taxes of $60 will also be allocated on a similar 50/50
basis.
(B) Under the rules described in paragraphs (d)(1) and (2) of this
section, foreign surviving corporation B has the following post-1986
undistributed earnings and post-1986 foreign income taxes as of January
1, 2008:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Separate category Hovering Foreign assoicated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
General..................................................... (200u) (300u) $40 $30
----------------------------------------------------------------------------------------------------------------
(iii) Subpart F income limitations. Even though (200u) of the
current year deficit is treated as a hovering deficit, the full (400u)
current year deficit in 2007 of foreign surviving corporation B meets
the requirements under section 952(c)(1)(C) and therefore is available
as a limitation on subpart F income, to the extent foreign corporation
A, which wholly owns foreign surviving corporation B, earns any subpart
F income in the 2007 taxable year. Any such offset under section
952(c)(1)(C) will have no effect on the earnings and profits and foreign
income tax accounts above of foreign surviving corporation B for
purposes of sections 316 and 902. Moreover, to the extent the hovering
deficit reduces subpart F income under section 952(c)(1)(C), it may not
also be taken into account under section 952(c)(1)(B).
(2) Reconciling taxable years. If a foreign acquiring corporation
and a foreign target corporation had taxable years ending on different
dates, then the pro rata distribution rules of paragraphs (e)(1)(ii) and
(e)(2)(ii) of this section shall apply with respect to the taxable years
that end within the same calendar year.
(3) Post-transaction change of status. If a foreign surviving
corporation that is subject to the rules of paragraph (c)(2) of this
section subsequently becomes a pooling corporation (by reason, for
example, of a reorganization, liquidation, or change of ownership), then
post-1986 undistributed earnings and post-1986 foreign income taxes that
were recharacterized as pre-1987 accumulated profits and pre-1987
foreign income taxes, respectively, under paragraph (e)(2)(i) of this
section retain their characterization as a pre-pooling annual layer.
(4) Ordering rule for multiple hovering deficits--(i) Rule. A
foreign surviving corporation shall apply the deficit rules of
paragraphs (d)(2), (e)(1)(iii), and (e)(2)(iii) of this section in that
[[Page 391]]
order if more than one of such rules applies to the foreign surviving
corporation.
(ii) Example. The following example illustrates the principles of
this paragraph (f)(4). The example assumes the following facts: Foreign
corporation A has been a pooling corporation since its incorporation on
January 1, 1998. Foreign corporation B has been a nonpooling corporation
since its incorporation on January 1, 2000. Foreign corporations A and B
have always had calendar taxable years. Foreign corporations A and B
(and all of their respective qualified business units as defined in
section 989) maintain a ``u'' functional currency. All earnings and
profits of foreign corporation B are in the general category. Finally,
unless otherwise stated, any earnings and profits in the passive
category resulted from a look-through dividend that was paid by a lower-
tier CFC out of earnings accumulated when the CFC was a noncontrolled
section 902 corporation and that qualified for the subpart F same-
country exception under section 954(c)(3)(A). The example is as follows:
Example. (i) Facts. (A) On December 31, 2006, foreign corporations A
and B have the following earnings and profits and foreign income taxes:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Foreign Corporation A Post-1986 Pool Separate
Category:
Passive................................... 400u $160
General................................... (300u) 25
-------------------------
100u 185
Foreign Corporation B:
2006...................................... (300u) 50u
2005...................................... 100u 25u
-------------------------
(200u) 75u
------------------------------------------------------------------------
(B) On January 1, 2007, foreign corporation B acquires the assets of
foreign corporation A in a reorganization described in section
368(a)(1)(C). Immediately following the foreign section 381 transaction,
foreign surviving corporation is a CFC.
(ii) Result. Under the rules described in paragraphs (d)(1), (d)(2),
(e)(1)(i), (e)(1)(ii), and (e)(1)(iii) of this section, foreign
surviving corporation has the following earnings and profits and foreign
income taxes:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Positive Hovering Foreign associated
E&P deficit taxes with
availabe hovering
deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool separate category:
Passive................................................. 400u ........... $160 ...........
General................................................. ........... (300u) ........... $25
Carryforward pre-pooling deficit from Corp B............ ........... (200u) ........... 0
2006 (from Corp B)...................................... 0u ........... 50u ...........
2005 (from Corp B)...................................... 0u ........... 25u ...........
---------------------------------------------------
400u (500u) ........... $25
----------------------------------------------------------------------------------------------------------------
(iii) Post-transaction earnings. (A) In the taxable year ending on
December 31, 2007, foreign surviving corporation accumulates earnings
and profits and pays related foreign income taxes as follows:
------------------------------------------------------------------------
Foreign
E&P taxes
------------------------------------------------------------------------
Post-1986 pool separate category:
Passive................................... 150u $40
General................................... 400u 60
-------------------------
[[Page 392]]
550u 100
------------------------------------------------------------------------
(B) None of the earnings and profits qualify as subpart F income as
defined in section 952(a). Under paragraph (f)(4)(i) of this section,
the rules of paragraph (d)(2) of this section apply before the rules of
paragraph (e)(1)(iii) of this section. Accordingly, post-transaction
earnings in a separate category are first offset by a hovering deficit
in the same separate category in the post-1986 pool. Thus, foreign
surviving corporation's (300u) deficit in the general category offsets
300u of post-transaction earnings in the general category. After
application of paragraph (d)(2) of this section, the (200u) deficit in
the general category carried forward from foreign corporation B's pre-
pooling aggregate deficit offsets the remaining 100u of post-transaction
earnings in the general category. Accordingly, foreign surviving
corporation has the following earnings and profits and foreign income
taxes at the end of 2007:
----------------------------------------------------------------------------------------------------------------
Earnings & profits Foreign taxes
---------------------------------------------------
Foreign
taxes
Positive Hovering Foreign associated
E&P deficit taxes with
available hovering
deficit
----------------------------------------------------------------------------------------------------------------
Post-1986 pool separate category:
Passive................................................. 550u ........... $200 ...........
General................................................. ........... ........... $85 ...........
Carryforward pre-pooling deficit from Corp B................ ........... (100u) ........... $0
2006 (from Corp B).......................................... 0u ........... 50u ...........
2005 (from Corp B).......................................... 0u ........... 25u ...........
---------------------------------------------------
550u (100u) ........... $0
----------------------------------------------------------------------------------------------------------------
(C) Under paragraph (d)(2)(iii) of this section, all of the $25 of
post-1986 foreign income taxes related to the (300u) hovering deficit in
the general category is added to the foreign surviving corporation's
post-1986 foreign income taxes of $60 in that category (because post-
transaction earnings in the general category have exceeded the deficit
in that category). Under paragraph (e)(1)(iii)(C) of this section, the
50u and 25u of foreign income taxes associated with foreign corporation
B's pre-1987 accumulated profits for 2006 and 2005 remain in those
layers. These foreign income taxes generally will not be reduced or
deemed paid unless a foreign tax refund restores a positive balance to
the associated earnings pursuant to section 905(c), and thus will be
trapped. See Sec. 1.902-2(b)(2).
(5) Pro rata rule for earnings and deficits during transaction year.
(i) For purposes of offsetting post-transaction earnings of a foreign
surviving corporation under the rules described in paragraphs (d)(2),
(e)(1)(iii), and (e)(2)(iii) of this section, the earnings and profits,
and any related foreign income taxes, in each separate category for the
taxable year of the foreign surviving corporation in which the
transaction occurs shall be deemed to have been accumulated after such
transaction in an amount which bears the same ratio to the undistributed
earnings and profits of the foreign surviving corporation for such
taxable year (computed without regard to any earnings and profits
carried over) as the number of days in the taxable year after the date
of transaction bears to the total number of days in the taxable year.
See, e.g., Sec. 1.381(c)(2)-1(a)(7) Example 2 (illustrating application
of this rule with respect to domestic corporations).
(ii) For purposes of determining the amount of pre-transaction
deficits described in paragraphs (d)(2), (e)(1)(iii), and (e)(2)(iii) of
this section, of a foreign surviving corporation that has a deficit in
earnings and profits in any separate category for its taxable year in
which the transaction occurs, unless the actual accumulated earnings and
profits, or deficit, as of such date can be shown, such pre-transaction
deficit, and any related foreign income taxes, shall be deemed to have
accumulated in a manner similar to that described in paragraph (f)(5)(i)
of this section. See, e.g., Sec. 1.381(c)(2)-1(a)(7) Example 4
[[Page 393]]
(illustrating application of this rule with respect to domestic
corporations).
(g) Effective date. This section shall apply to section 367(b)
transactions that occur on or after November 6, 2006.
[T.D. 9273, 71 FR 44985, Aug. 8, 2006; 71 FR 57889, Oct. 2, 2006, as
amended at 71 FR 70876, Dec. 7, 2006]