[Federal Register Volume 63, Number 184 (Wednesday, September 23, 1998)]
[Rules and Regulations]
[Pages 50757-50759]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-25444]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8783]
RIN 1545-AW45
Continuity of Interest Requirement for Corporate Reorganizations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Amendment to final regulations.
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SUMMARY: This document amends final regulations providing guidance
regarding satisfaction of the continuity of interest requirement for
corporate reorganizations. The amendment to the final regulations
affects corporations and their shareholders. This amendment to the
final regulations is necessary to provide clarification regarding an
example illustrating the relationship created in connection with
potential reorganization.
DATES: Effective date: This amendment is effective September 23, 1998.
Applicability date: This amendment applies to transactions
occurring after January 28, 1998, except that it does not apply to any
transaction occurring pursuant to a written agreement which is (subject
to customary conditions) binding on January 28, 1998, and at all times
thereafter.
FOR FURTHER INFORMATION CONTACT: Phoebe Bennett, (202) 622-7750 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 28, 1998, the IRS published final regulations (REG-
252231-96) in the Federal Register (63 FR 4174) relating to the
continuity of interest (COI) requirement.
Explanation of Provisions
The final COI regulation provides that acquisitions of target (T)
stock for cash by a corporation related to the issuing corporation (P)
generally do not preserve continuity of interest. See Sec. 1.368-
1(e)(2). Two corporations are related if they are members of the same
affiliated group as defined in section 1504, or if a purchase of P
stock by another corporation would be treated as a distribution in
redemption of P stock under section 304(a)(2). See Sec. 1.368-1(e)(3).
A corporation will be treated as related to another corporation if such
relationship exists immediately before or immediately after the
acquisition of T stock, or if the relationship is created in connection
with the potential reorganization. See Sec. 1.368-1(e)(3)(ii). Thus, a
purchase by a corporation that was not initially related to P, but
purchased T stock and became related to P in the potential
reorganization, would not preserve continuity to the extent of the
purchase.
Section 1.368-1(e)(6), Example 2 was intended to illustrate this
principle. In the example, A owns all of the stock of T. X, a
corporation which owns 60 percent of the P stock and none of the T
stock, buys A's T stock for cash prior to the merger of T into P. X
exchanges the T stock for P stock in the merger which, when combined
with X's prior ownership of P stock, constitutes 80 percent of the
stock of P. The example shows that X is related to P because X becomes
affiliated with P in the merger.
Section 1.338-2(c)(3) provides that, by virtue of section 338, COI
is satisfied for certain persons if, following a qualified stock
purchase (QSP) of T by the purchasing corporation, the purchasing
corporation or a member of the purchasing corporation s affiliated
group acquired the T assets. Commentators have questioned whether
Sec. 1.338-2(c)(3) applies to the transaction described in Example 2.
It is not intended that these final regulations provide guidance under
section 338. To avoid any such implication, Example 2 is amended so
that X's acquisition of A's T stock is not a QSP.
In addition, the amendment to the final regulation illustrates the
proper application of the related party rule that treats two
corporations as related if a purchase of P stock by another corporation
would be treated as a distribution in redemption of P stock under
section 304(a)(2). See Sec. 1.368-1(e)(3)(i). Commentators have
questioned why, in Example 2, X is not already related to P under the
section 304(a)(2) rule even before the merger, because X owned more
than 50 percent of the P stock. Section 304(a)(2) requires that the
issuing corporation control the acquiring corporation (within the
meaning of section 304(c)). In Example 2, P is the issuing corporation
and X is the acquiring corporation. X is not related to P under section
304(a)(2) because P does not control X; instead, X controls P. A
sentence is added to Example 2 to illustrate this point.
Applicability Date
The amendment to these final regulations applies to transactions
occurring after January 28, 1998, except that it does not apply to any
transaction occurring pursuant to a written agreement which is (subject
to customary conditions) binding on January 28, 1998, and at all times
thereafter.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because these regulations do
not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal Revenue Code, the notices
of proposed rulemaking preceding these regulations were submitted to
the Chief Counsel for Advocacy of the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal author of this amendment to the final regulations is
Phoebe Bennett of the Office of the Assistant Chief Counsel
(Corporate), IRS. However, other personnel from the IRS and Treasury
Department participated in its development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In Sec. 1.368-1, paragraph (e)(6) Example 2 is revised to
read as follows:
Sec. 1.368-1 Purpose and scope of exception of reorganization
exchanges.
* * * * *
(e) * * *
(6) * * *
Example 2. Relationship created in connection with potential
reorganization. Corporation X owns 60 percent of the stock of P and
30 percent of the stock of T. A owns the remaining 70 percent of the
stock of T. X buys A s T stock for cash in a transaction which is
not a qualified stock purchase within the meaning of section 338. T
then merges into P. In the merger, X exchanges all of its T stock
for additional stock of P. As a result of the issuance of the
additional stock to X in the merger, X s ownership interest in P
increases from 60 to 80 percent of the stock of P. X is not a person
related to P under paragraph (e)(3)(i)(B) of this section, because a
purchase of stock of P by X would not be treated as a distribution
in redemption of the stock of P under section 304(a)(2). However, X
is a person related to P under paragraphs (e)(3)(i)(A) and (ii)(B)
of this section, because X becomes affiliated with P in the merger.
The continuity of interest requirement is not satisfied, because X
acquired a proprietary interest in T for consideration other than P
stock, and a substantial part of the value of
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the proprietary interest in T is not preserved. See paragraph (e)(2)
of this section.
* * * * *
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: September 14, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 98-25444 Filed 9-22-98; 8:45 am]
BILLING CODE 4830-01-U