Proposed Rule2025-00321
Guidance Regarding Certain Matters Relating to Nonrecognition of Gain or Loss in Corporate Separations, Incorporations, and Reorganizations
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Published
January 16, 2025
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains proposed regulations regarding certain matters relating to corporate separations, incorporations, and reorganizations qualifying, in whole or in part, for nonrecognition of gain or loss. These matters include distributions and retentions of controlled corporation stock, assumptions of liabilities by controlled corporations, exchanges of property between distributing corporations and controlled corporations, and distributions and transfers of consideration to distributing corporation shareholders and creditors. The proposed regulations would affect corporations and their shareholders and security holders. Proposed regulations modifying the reporting requirements for corporate separations are published elsewhere in the Proposed Rules section of this issue of the Federal Register.
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[Federal Register Volume 90, Number 10 (Thursday, January 16, 2025)]
[Proposed Rules]
[Pages 5220-5295]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2025-00321]
[[Page 5219]]
Vol. 90
Thursday,
No. 10
January 16, 2025
Part VII
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Guidance Regarding Certain Matters Relating to Nonrecognition of Gain
or Loss in Corporate Separations, Incorporations, and Reorganizations;
Proposed Rule
Federal Register / Vol. 90, No. 10 / Thursday, January 16, 2025 /
Proposed Rules
[[Page 5220]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-112261-24]
RIN 1545-BR32
Guidance Regarding Certain Matters Relating to Nonrecognition of
Gain or Loss in Corporate Separations, Incorporations, and
Reorganizations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations regarding certain
matters relating to corporate separations, incorporations, and
reorganizations qualifying, in whole or in part, for nonrecognition of
gain or loss. These matters include distributions and retentions of
controlled corporation stock, assumptions of liabilities by controlled
corporations, exchanges of property between distributing corporations
and controlled corporations, and distributions and transfers of
consideration to distributing corporation shareholders and creditors.
The proposed regulations would affect corporations and their
shareholders and security holders. Proposed regulations modifying the
reporting requirements for corporate separations are published
elsewhere in the Proposed Rules section of this issue of the Federal
Register.
DATES: Written or electronic comments and requests for a public hearing
must be received by March 17, 2025.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically via the Federal eRulemaking Portal at <a href="https://www.regulations.gov">https://www.regulations.gov</a> (indicate IRS and REG-112261-24) by following the
online instructions for submitting comments. Requests for a public
hearing must be submitted as prescribed in the ``Comments and Requests
for a Public Hearing'' section. Once submitted to the Federal
eRulemaking Portal, comments cannot be edited or withdrawn. The
Department of the Treasury (Treasury Department) and the IRS will
publish for public availability any comments to the IRS's public
docket. Send paper submissions to CC:PA:01:PR (REG-112261-24), Room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Justin R. Du Mouchel at (202) 317-6975 (not a toll-free number);
concerning submissions of comments and requests for a hearing, contact
the Publications and Regulations branch at (202) 317-6901 (not a toll-
free number) or by email to <a href="/cdn-cgi/l/email-protection#15656077797c767d7074677c7b7266557c67663b727a63"><span class="__cf_email__" data-cfemail="daaaafb8b6b3b9b2bfbba8b3b4bda99ab3a8a9f4bdb5ac">[email protected]</span></a> (preferred).
SUPPLEMENTARY INFORMATION:
Authority
This document contains proposed regulations under sections 355,
357, 361, and 368 of the Internal Revenue Code (Code) that would amend
26 CFR part 1 (Income Tax Regulations) by providing guidance regarding
certain matters relating to corporate separations, reorganizations, and
incorporations qualifying, in whole or in part, for nonrecognition of
gain or loss. The proposed additions and amendments to the Income Tax
Regulations are issued pursuant to the express delegations of authority
to the Secretary of the Treasury or her delegate (Secretary) provided
under sections 337(d), 361(b)(3), and 7805(a) of the Code.
Section 337(d) states, in part, that ``[t]he Secretary shall
prescribe such regulations as may be necessary or appropriate to carry
out the purposes of the amendments made by subtitle D of title VI of
the Tax Reform Act of 1986,'' including regulations ``to ensure that
such purposes may not be circumvented through the use of any provision
of law or regulations (including the consolidated return regulations
and part III of this subchapter).'' Relating to the treatment of
transfers to creditors, the second sentence of section 361(b)(3) states
that ``[t]he Secretary may prescribe such regulations as may be
necessary to prevent avoidance of tax through abuse of the preceding
sentence or [section 361](c)(3).'' Finally, section 7805(a) authorizes
the Secretary to ``prescribe all needful rules and regulations for the
enforcement of [the Code], including all rules and regulations as may
be necessary by reason of any alteration of law in relation to internal
revenue.''
Background
I. Overview of Section 355
A. Section 355 Transactions
1. In General
If a transaction satisfies the requirements of section 355 (section
355 transaction) and other relevant provisions of the Code and Income
Tax Regulations, the transaction may occur without recognition of any
gain or loss to the distributing corporation (within the meaning of
section 355(a)(1)(A)) and without recognition of any gain or loss to,
or the inclusion of any amount in the income of, the shareholders or
security holders of the distributing corporation. A section 355
transaction may take one of the following forms: (i) a spin-off, which
is a pro rata distribution of stock of the controlled corporation
(within the meaning of section 355(a)(1)(A)) to shareholders of the
distributing corporation; (ii) a split-off, which is a distribution of
stock of the controlled corporation to some (but not all) shareholders
of the distributing corporation in exchange for some or all of their
stock of the distributing corporation; or (iii) a split-up, which is a
liquidating distribution in which the distributing corporation
distributes to its shareholders, either pro rata or non-pro rata, the
stock of more than one controlled corporation. As discussed in parts
I.A.3 and I.A.4 of this Background, a section 355 transaction may occur
either as a ``section 355(c) distribution'' or as part of a ``divisive
reorganization.''
2. General Utilities Repeal
In General Utilities & Operating Co. v. Helvering, 296 U.S. 200
(1935), the Supreme Court of the United States (Supreme Court) held
that corporations generally could distribute appreciated property to
their shareholders without the recognition of any corporate-level gain
(General Utilities doctrine). Congress repealed the General Utilities
doctrine beginning with legislation in 1969 and culminating with the
Tax Reform Act of 1986 (Public Law 99-514, 100 Stat. 2085), which,
among other changes, amended sections 311, 336, and 337 of the Code
(originally enacted in the Internal Revenue Code of 1954 (1954 Code)
(Public Law 83-591, 68A Stat. 3) to apply gain and loss recognition to
non-liquidating and liquidating distributions, respectively.
Notwithstanding the repeal of the General Utilities doctrine,
section 355 allows a distributing corporation to distribute the stock
and securities of a subsidiary (that is, a controlled corporation) to
its shareholders without imposing a corporate-level tax on the
distribution. Accordingly, as observed by the United States Tax Court
(Tax Court), ``more attention has been directed toward [s]ection 355
today than was ever the case in the past [because] it is one of the few
(some might say the only) viable opportunity to escape the repeal of
the General Utilities doctrine.'' McLaulin v. Comm'r, 115 T.C. 255, 266
(2000).
In connection with the repeal of the General Utilities doctrine,
Congress authorized the Treasury Department to promulgate regulations
to carry out the purposes of that repeal, including by
[[Page 5221]]
preventing its avoidance. Specifically, section 337(d) directs the
Secretary to prescribe regulations that are necessary or appropriate to
carry out the purposes of General Utilities repeal, including
``regulations to ensure that such purposes may not be circumvented
through the use of any provision of law or regulations (including . . .
part III of this subchapter).'' Section 355, among other corporate
organization and reorganization provisions, is included in part III of
subchapter C of chapter 1 of the Code (subchapter C).
3. Section 355(c) Distributions
The general rule set forth in section 355(c)(1) provides that no
gain or loss is recognized to a distributing corporation upon any
distribution to which section 355 (or so much of section 356 of the
Code as relates to section 355) applies and that is not made pursuant
to a plan of reorganization (section 355(c) distribution). However, if
the distributing corporation distributes any property other than stock
or securities of a controlled corporation (that is, any property other
than qualified property, as defined in section 355(c)(2)(B)) in a
section 355(c) distribution, and if the fair market value of that
property exceeds the distributing corporation's adjusted basis in that
property, then section 355(c)(2)(A) requires the distributing
corporation to recognize gain as if the property were sold to the
distributee at its fair market value. This Federal income tax treatment
reflects the status of section 355 as a narrow exception to General
Utilities repeal. Compare section 311(b).
Because a section 355(c) distribution is not made pursuant to a
plan of reorganization, a section 355(c) distribution (unlike a
divisive reorganization) does not permit the distributing corporation
to satisfy distributing corporation debt constituting securities with
property other than qualified property. In other words, because a
section 355(c) distribution does not qualify as a reorganization under
the definitional provisions of section 368(a)(1), the operative
provision set forth in section 361(b)(3) is not applicable. Therefore,
in a section 355(c) distribution, a distributing corporation cannot
transfer any property other than qualified property to its creditors
(including its security holders) without recognizing gain or loss on
that transfer.
4. Divisive Reorganizations
A distributing corporation may carry out a section 355 transaction
as part of a transaction that qualifies as a reorganization under
section 368(a)(1)(D) or (G) and to which section 354 of the Code (or so
much of section 356 as relates to section 354) does not apply (divisive
reorganization). Section 368(a)(1)(D) provides, in part, that a
reorganization includes a transfer by the distributing corporation of
all or a part of its assets to a controlled corporation if, immediately
after the transfer, the distributing corporation or one or more of its
shareholders (including persons who were shareholders immediately
before the transfer) are in control (within the meaning of section
368(c)) of the controlled corporation; but only if, pursuant to the
plan of reorganization, stock or securities of the controlled
corporation are distributed in a transaction that qualifies under
section 355 or 356.
Under section 368(a)(1)(G), a transfer by a distributing
corporation of all or a part of its assets to a controlled corporation
in a case under title 11 of the United States Code or a similar case
described in section 368(a)(3)(A)(ii) (title 11 or similar case) also
is a divisive reorganization if, pursuant to the plan of
reorganization, stock or securities of the controlled corporation are
distributed in a transaction that qualifies under section 355 (or so
much of section 356 as relates to section 355). Section 368(a)(3)(C)
provides an ordering rule under which a transaction that would qualify
both under section 368(a)(1)(G) and, among other provisions, under
section 368(a)(1)(D) or section 351 of the Code, is treated as
qualifying solely under section 368(a)(1)(G) for all purposes of
subchapter C other than section 357(c)(1).
If a transaction satisfies the definitional requirements of section
368(a)(1)(D) or (G), the distributing corporation may qualify for
nonrecognition treatment for (i) its exchange of property with the
controlled corporation, (ii) its distribution of certain property to
its shareholders, and (iii) its transfer of certain property to its
creditors. Under section 357(a), the controlled corporation generally
may assume distributing corporation liabilities without the
distributing corporation recognizing gain or loss, except as provided
in (i) section 357(b) (if the principal purpose for the liability
assumption is to avoid Federal income tax or is not a bona fide
business purpose), and (ii) section 357(c) (if the sum of the amount of
liabilities assumed by the controlled corporation is greater than the
total adjusted basis of assets transferred in the exchange).
Under section 361(a), the distributing corporation recognizes no
gain or loss if it exchanges property pursuant to the plan of
reorganization solely for stock and securities in the controlled
corporation. Under section 361(b)(1)(A), if section 361(a) would apply
to an exchange but for the fact that the property received by the
distributing corporation also includes money or other property, no gain
will be recognized by the distributing corporation if it distributes
the money or other property pursuant to the plan of reorganization.
Under section 361(b)(3), the distributing corporation also generally
may transfer that money or other property in connection with the
reorganization to its creditors in satisfaction of distributing
corporation debt held by those creditors, without recognition of gain
or loss under section 361(b)(1)(A) to the extent the sum of the money
and the fair market value of the other property transferred to such
creditors does not exceed the adjusted bases of such assets transferred
(reduced by the amount of liabilities assumed within the meaning of
section 357(c)).
Under section 361(c)(1), the distributing corporation recognizes
neither gain nor loss on its distribution of qualified property to its
shareholders pursuant to the plan of reorganization. For this purpose,
section 361(c)(2)(B) defines ``qualified property'' as any stock in,
right to acquire stock in, or obligation of (i) the distributing
corporation, or (ii) another corporation that is a party to the
reorganization (for example, the controlled corporation) if such stock,
stock right, or obligation is received by the distributing corporation
in the exchange. In connection with the reorganization, the
distributing corporation also generally may transfer that qualified
property to its creditors in satisfaction of distributing corporation
debt held by those creditors, without recognition of gain or loss under
section 361(c).
For purposes of this preamble, the term ``section 361
consideration'' means, as described in section 361(a) and (b), the
consideration received by a target corporation from an acquiring
corporation in exchange for property transferred by the target
corporation to the acquiring corporation pursuant to a plan of
reorganization. Accordingly, in the context of a divisive
reorganization, the term ``section 361 consideration'' means, for
purposes of this preamble, the consideration received by the
distributing corporation from the controlled corporation in exchange
for property transferred by the distributing corporation to the
controlled corporation pursuant to the plan of reorganization.
[[Page 5222]]
B. General Federal Income Tax Consequences to Distributing Corporation
Shareholders
Section 355(a)(1) provides that, if a distributing corporation
distributes to its shareholders with respect to its stock, or
distributes to its security holders in exchange for their securities,
solely stock or securities of a controlled corporation, and if certain
other requirements are satisfied, then no gain or loss is recognized
by, and no amount is included in the income of, the distributing
corporation's shareholders or security holders upon the receipt of
stock or securities of the controlled corporation. However, if any
property is received that is not permitted to be received under section
355(a)(1), then section 356 (and not section 355) applies to the
receipt of such property as provided in sections 355(a)(4)(A) and 356.
C. General Requirements for Qualification Under Section 355
To qualify as a section 355 transaction under section 355(a)(1), a
transaction must satisfy the following requirements. First, under
section 355(a)(1)(A), the distributing corporation must distribute
stock or securities of a controlled corporation to a shareholder with
respect to distributing corporation stock, or to a security holder in
exchange for its securities. Second, under section 355(a)(1)(B), the
transaction may not be used principally as a device for the
distribution of the earnings and profits of the distributing
corporation, the controlled corporation, or both. Third, under section
355(a)(1)(C), the distributing corporation and each controlled
corporation must satisfy the active trade or business requirements of
section 355(b).
With particular regard to these proposed regulations, section
355(a)(1) imposes a fourth requirement regarding distributions of
controlled corporation stock and securities. Specifically, section
355(a)(1)(D) requires that, ``as part of the distribution,'' the
distributing corporation must distribute either (i) all stock and
securities in the controlled corporation held by the distributing
corporation immediately before the distribution, or (ii) an amount of
stock in the controlled corporation constituting ``control'' within the
meaning of section 368(c) (control distribution). In the case of
distributions of less than 100 percent of stock in the controlled
corporation, it must be established to the satisfaction of the
Secretary that the retention by the distributing corporation of stock
(or stock and securities) of the controlled corporation was not
pursuant to a plan having as one of its principal purposes the
avoidance of Federal income tax. For purposes of this preamble, such a
retention of controlled corporation stock (or stock and securities) by
the distributing corporation is referred to as a ``retention,'' and the
requirements in section 355(a)(1)(D) are referred to collectively as
the ``distribution requirement.''
D. The Distribution Requirement and Retentions
1. Overview
As described in part I.C of this Background, the distribution
requirement consists of two alternative rules. Under section
355(a)(1)(D)(i), the distributing corporation will satisfy the
distribution requirement if it distributes all stock and securities in
the controlled corporation held by the distributing corporation
immediately before the distribution. Alternatively, under section
355(a)(1)(D)(ii), the distributing corporation will satisfy the
distribution requirement if it satisfies the following two discrete
requirements: (i) the distributing corporation distributes an amount of
controlled corporation stock sufficient to qualify as a control
distribution; and (ii) the distributing corporation establishes to the
satisfaction of the Secretary that the retention of any controlled
corporation stock or securities was not pursuant to a plan having as
one of its principal purposes the avoidance of Federal income tax.
2. Requirements for Control Distribution; Commissioner v. Gordon
Section 355(a)(1)(D) provides that, if a distributing corporation
does not distribute all its stock and securities in the controlled
corporation, the distributing corporation must make a control
distribution as ``part of the distribution.'' However, section
355(a)(1)(D) does not expressly impose a temporal requirement for
making a control distribution. Accordingly, section 355(a)(1)(D) could
be read as permitting a control distribution to occur over multiple
taxable years of the distributing corporation.
In Commissioner v. Gordon, 391 U.S. 83 (1968), the Supreme Court
considered the application of the distribution requirement to
distributions by Pacific Telephone and Telegraph Company (Pacific) of
stock of a newly formed, wholly owned subsidiary (Northwest) over
multiple taxable years of Pacific. American Telephone and Telegraph
Company (AT&T), which owned approximately 90 percent of the stock of
Pacific, decided to separate Pacific into two separate companies and,
to effectuate that separation, caused Pacific to engage in the
following transactions. First, pursuant to a plan of reorganization
submitted to its shareholders, Pacific issued to its shareholders
(including the taxpayer) transferable rights to acquire approximately
57 percent of the stock of Northwest on September 29, 1961. That plan
of reorganization also provided that Pacific had an ``expectation''
that the remaining 43 percent of Northwest stock would be offered to
Pacific's shareholders. Among other reasons for not distributing 100
percent of its Northwest stock, Pacific desired to achieve an
appropriate capital structure and avoid potential State regulatory
issues. On June 12, 1963, Pacific issued to its shareholders
transferable rights to acquire the remaining 43 percent of Northwest
stock. The taxpayer contended that the 1961 and 1963 distributions
collectively qualified under section 355.
The Court concluded that neither distribution qualified under
section 355, notwithstanding Pacific's ``expectation'' regarding the
second distribution and its purposes for making multiple distributions.
Gordon, 391 U.S. at 98. In its analysis, the Court expressed a general
principle of Federal income tax that, ``[a]bsent other specific
directions from Congress, Code provisions must be interpreted so as to
conform to the basic premise of annual tax accounting.'' Id. at 96.
With regard to the distribution requirement, the Court noted that, if
an initial transfer of less than a controlling interest in the
controlled corporation is to be treated for Federal income tax purposes
as a mere first step in the divestiture of control, ``it must at least
be identifiable as such at the time it is made.'' Id. The Court further
stated that the requirement that the character of a transaction be
determinable ``does not mean that the entire divestiture must
necessarily occur within a single tax year,'' but it does mean that, if
one transaction is to be characterized as a ``first step,'' then
``there must be a binding commitment to take the later steps.'' Id. Of
particular relevance to both the IRS's administrative function and the
objective of these proposed regulations to provide increased certainty
(see part IV of this Background), the Court expressed that it would be
wholly inconsistent with the annual accounting premise to hold that the
essential character of a transaction, and its Federal income tax
impact, should remain ``not only undeterminable but unfixed for an
[[Page 5223]]
indefinite and unlimited period in the future, awaiting events that
might or might not happen.'' Id.
The Court found that the facts and circumstances of Pacific's
staggered distributions of Northwest stock, as reflected in Pacific's
plan of reorganization, failed the binding-commitment standard set
forth by the Court. Id. at 97. Although Pacific's plan of
reorganization evidenced an expectation to distribute its remaining
Northwest stock within a three-year period following its initial 57-
percent distribution, the Court emphasized that ``there is obviously no
promise to sell any particular amount of stock, at any particular time,
at any particular price'' set forth in that document. Id. Instead,
Pacific's plan of reorganization merely stated that such subsequent
distributions would occur ``[a]t a time or times related to its
(Pacific's) need for new capital.'' Id. Consequently, the Court
reasoned that, ``[i]f the 1961 distribution played a part in what later
proved to be a total divestiture of the Northwest stock, it was not, in
1961, either a total divestiture or a step in a plan of total
divestiture.'' Id. at 97-98.
3. Retentions
Section 1.355-2(e), which reiterates the distribution requirement,
provides that the corporate business purpose or purposes for the
distribution ordinarily will require the distribution of all stock and
securities of the controlled corporation. If the distributing
corporation retains any controlled corporation stock or securities, and
if it is not established to the satisfaction of the Commissioner that
the retention was not pursuant to a plan having as one of its principal
purposes the avoidance of Federal income tax, section 355 does not
apply to the entire distribution (that is, the entire distribution
fails to qualify as a section 355 transaction).
In Rev. Rul. 75-321, 1975-2 C.B. 123, the IRS addressed whether the
retention by a widely held and publicly traded corporation
(Distributing) of stock in its banking subsidiary (Controlled) complied
with section 355(a)(1)(D)(ii) (that is, whether the retention was
pursuant to a plan having as one of its principal purposes the
avoidance of Federal income tax). In this revenue ruling, Distributing
distributed 95 percent of the stock of Controlled to Distributing's
shareholders to comply with Federal banking laws in a transaction that
otherwise satisfied the requirements of section 355. Distributing
retained 5 percent of Controlled's stock to meet collateral
requirements for short-term financing. The IRS concluded that the
retention was not pursuant to a plan having as one of its principal
purposes the avoidance of Federal income tax, because (i) a genuine
separation of the corporate entities was effectuated, (ii) retention of
a 5-percent stock interest in Controlled would not enable Distributing
to maintain practical control over Controlled following the
distribution, and (iii) a sufficient corporate business purpose existed
for Distributing's retention of the 5-percent interest in Controlled.
See also Rev. Rul. 75-469, 1975-2 C.B. 126 (similar ruling with respect
to a distributing corporation's retention of controlled corporation
securities to serve as collateral for a bank loan to the distributing
corporation).
Similarly, in G.C.M. 32136 (Oct. 23, 1961), the IRS considered
whether the retention by a distributing corporation (Distributing) of
stock in a newly formed controlled corporation (Controlled) was
pursuant to a plan having as one of its principal purposes the
avoidance of Federal income tax. Under the facts described in that
memorandum, Distributing distributed 80 percent of Controlled stock to
Distributing's shareholders to comply with State banking laws in a
transaction that otherwise satisfied the requirements of section 355,
and Distributing retained 20 percent of Controlled stock. The avowed
purpose for the retention was to permit a controlling group of
Distributing's shareholders to maintain effective control over
Controlled. In concluding that Distributing had a Federal income tax
avoidance purpose for the retention, the IRS determined that the
requirement that a retention be specially justified ``seems most likely
to be intended to insure a genuine separation.'' See also G.C.M. 32380
(Aug. 24, 1962) (reiterating that view).
II. Definitional and Operative Provisions Regarding Reorganizations
A. Overview
Subchapter C generally includes (i) definitional provisions,
including under section 368, and (ii) operative provisions, including
under sections 354, 356, 357, and 361. See, for example, Microdot, Inc.
v. United States, 728 F.2d 593, 598 (2d Cir. 1984) (``Section 368(a)(1)
is a definitional section, wholly distinct from [section] 354.''). As
described in greater detail in part II.B of this Background, section
368(a)(1) defines the term ``reorganization'' as seven specifically
described types of transactions under subparagraphs (A) through (G).
Qualification of a transaction (or series of transactions) for a
definitional provision under section 368(a)(1) is the sole manner by
which the application of an operative provision relating to a
reorganization can occur. This statutory structure ensures that the
tax-advantaged treatment provided by such operative provisions applies
exclusively to those transactions that satisfy all statutory,
regulatory, and judicial requirements for a particular definitional
provision (for example, the continuity of interest and continuity of
business enterprise requirements). As discussed in greater detail in
part III of this Background, a primary purpose of the ``plan of
reorganization'' requirement is to ensure that a transaction to which
an operative provision is purported to apply is sufficiently connected
to a reorganization defined in section 368(a)(1).
B. Section 368: Definitions Relating to Corporate Reorganizations
Section 368(a)(1) is the primary definitional provision of
subchapter C with regard to reorganizations. For purposes of parts I
through III of subchapter C, section 368(a)(1) defines the term
``reorganization'' to mean any of the seven types of transactions
described in section 368(a)(1)(A) through (G), including triangular
reorganizations (as defined in Sec. 1.358-6(b)(2)) that are variants
of such transactions and divisive reorganizations described in section
368(a)(1)(D) and (G). Section 368(a)(2) provides special rules that
support the definitional provisions set forth in section 368(a)(1), and
section 368(a)(3) similarly provides additional rules relating to title
11 or similar cases.
Section 368(b) and (c) also contains definitional provisions. For
purposes of part III of subchapter C, section 368(b) generally defines
the term ``a party to a reorganization'' to include (i) a corporation
resulting from a reorganization, and (ii) both corporations, in the
case of a reorganization resulting from the acquisition by one
corporation of stock or properties of another. Section 368(b) defines
other corporations as parties to a transaction depending on the type of
transaction. See also Sec. 1.368-2(f).
For purposes of subchapter C (other than sections 304 and 385 of
the Code), section 368(c) defines the term ``control'' to mean the
ownership of (i) stock possessing at least 80 percent of the total
combined voting power of all classes of stock entitled to vote, and
(ii) at least 80 percent of the total number of shares of all other
classes of stock of the corporation. See also Rev. Rul. 59-259, 1959-2
C.B. 115 (requiring
[[Page 5224]]
ownership of (i) stock possessing at least 80 percent of the total
combined voting power of all classes of voting stock, and (ii) at least
80 percent of the total number of shares of each class of outstanding
non-voting stock).
C. Section 357: Assumptions of Liabilities by Transferee Corporations
1. Overview
Section 357 is an operative provision that facilitates exchanges
involving the assumption of liabilities by generally preventing such
assumptions from (i) being treated as the receipt of money or other
property in an exchange, and (ii) disqualifying the exchange for
nonrecognition treatment. See section 357(a); see also the anti-abuse
rule in section 357(b) and the adjusted basis limitation in section
357(c). Section 357 reflects Congress's view that, ``[i]n typical
transactions changing the form or entity of a business it is not
customary to liquidate the liabilities of the business and such
liabilities are almost invariably assumed by the corporation which
continues the business,'' but that nonrecognition treatment in section
357 should be limited solely to ``bona fide transactions of this
type.'' H.R. Rep. No. 76-855, at 19 (1939) (Conf. Rep.).
2. Response to United States v. Hendler
The original predecessor to current section 357, section 112(k) of
the Internal Revenue Code of 1939 (1939 Code), was enacted by Congress
as section 213(a) of the Revenue Act of 1939 (Public Law 76-155, 53
Stat. 862, 870) to address the adverse consequences of judicial and
taxpayer interpretations of the Supreme Court's decision in United
States v. Hendler, 303 U.S. 564 (1938). See S. Rep. No. 76-648, at 3
(1939) (referencing the Hendler opinion by name). In Hendler, the Court
examined the Federal income tax consequences of a transaction that
qualified as a reorganization under section 112 of the Revenue Act of
1928 (Public Law 70-562, 45 Stat. 791). As part of the reorganization,
the transferee corporation (Borden Company) assumed and paid the
indebtedness of the transferor (Hendler Company). The Court regarded
the assumption and payment in substance as though the Borden Company
had made the payment directly to the Hendler Company. Hendler, 303 U.S.
at 566. Based on that treatment, the Court viewed the Hendler Company
in substance as receiving money or other property that it failed to
distribute to its shareholders (because that payment was made to a
Hendler Company creditor, albeit in form by the Borden Company). Id.
Accordingly, the Court held that the Hendler Company recognized gain in
the amount of that payment. Id. at 567.
Following the Hendler decision, Congress observed that the Court's
analysis had ``been broadly interpreted to require that, if a
taxpayer's liabilities are assumed by another party in what is
otherwise a tax-free reorganization, gain is recognized to the extent
of the assumption.'' H.R. Rep. No. 76-855, at 19 (emphasis added). In
other words, as successfully argued by the IRS in cases following
Hendler, a transferee corporation's lack of payment of the liabilities
was immaterial for the Hendler analysis to apply to treat the
transferee corporation's assumption of a transferor's liabilities as a
cash payment to the transferor. See Haass v. Comm'r, 37 B.T.A. 948, 955
(1938). The IRS advocated for this broad interpretation in response to
an aggressive position taken by taxpayers, who relied on the Hendler
decision to argue that the basis of stock they had received in prior
exchanges should be increased by the amount of gain that should have
been recognized and taxed by reason of the transferee corporation's
assumption of liabilities, even though that gain had not actually been
taxed by the IRS (and that tax had not been paid).
However, this broad interpretation jeopardized the nonrecognition
treatment of bona fide assumptions carried out as part of
reorganizations that Congress originally had intended to facilitate
through the enactment of the reorganization provisions. See H.R. Rep.
No. 76-855, at 19 (``Your committee therefore believes that such a
broad interpretation as is indicated above will largely nullify the
provisions of existing law which postpone the recognition of gain in
such cases.'').
3. Enactment of Section 357(a) and (b)
Congress enacted section 112(k) of the 1939 Code to balance (i) the
need to facilitate the bona fide assumption of liabilities in
transactions that satisfy the definitional requirements of a
reorganization, with (ii) the need to minimize abusive tax planning
through such assumptions (including through transitory transactions).
Accordingly, section 112(k) of the 1939 Code provided for both (i) the
general nonrecognition treatment adopted by section 357(a) of the 1954
Code and set forth in current section 357(a), and (ii) a supporting
anti-abuse provision adopted by section 357(b) of the 1954 Code and set
forth in current section 357(b).
Under section 357(b)(1), the total amount of liabilities assumed in
an assumption described in section 357(a) is treated for purposes of
section 351 or 361 (as applicable) as money received by the transferor
in the exchange if it appears that the principal purpose of the
transferor with respect to the assumption was (i) to avoid Federal
income tax on the exchange, or (ii) not a bona fide business purpose.
In effect, section 357(b) can apply to a transaction to preserve the
treatment required by Hendler for such abusive assumptions.
In making the determination required by section 357(b)(1), the
nature of the liabilities and the circumstances under which the
arrangement for the assumption was made are taken into account. In
addition, section 357(b)(2) provides that, in any suit or proceeding in
which the burden is on the transferor to prove that the liability
assumption should not be treated as money received in the exchange, the
transferor must meet that burden by a clear preponderance of the
evidence.
4. Application of Section 357(b) to Divisive Reorganizations
In Rev. Rul. 79-258, 1979-2 C.B. 143, the IRS considered the
application of section 357(b) to the assumption by a newly formed
transferee corporation (Controlled) of a liability incurred by the
transferor (Distributing) in close temporal proximity to, and in
anticipation of, a transaction that qualified as a divisive
reorganization under sections 355 and 368(a)(1)(D). One of the
Distributing liabilities that Distributing desired Controlled to assume
was a $4,000x portion of a $25,000x long-term debt owed to an insurance
company that Distributing had incurred in connection with the business
transferred to Controlled, and that had been outstanding for several
years before the divisive reorganization (historical Distributing
debt). However, Distributing could not apportion the historical
Distributing debt between it and Controlled because the insurance
company refused to relieve Distributing of its primary liability for
repayment.
Therefore, in exchange for $4,000x in loan proceeds, Distributing
issued a new long-term note for which Distributing was primarily liable
to a bank (new Distributing debt). Distributing then caused Controlled
to assume the new Distributing debt in the divisive reorganization, and
Distributing was relieved of its primary repayment liability
(Controlled assumption). The proceeds of the new Distributing debt were
used by Distributing to pay off $4,000x of the historical Distributing
debt. Distributing then distributed the Controlled stock to
Distributing's shareholders.
[[Page 5225]]
From Distributing's standpoint, having Controlled assume the new
Distributing debt was desirable because, absent Controlled's assumption
of this debt, Distributing's assets would be reduced by the value of
the Controlled stock (which was distributed to Distributing's
shareholders), but Distributing's liabilities would not be reduced by
the $4,000x liability attributable to the business transferred to
Controlled. As a result, Distributing's ability to borrow (and its
ability to pay off the portion of the historical Distributing debt
attributable to the business transferred to Controlled) could be
adversely affected if Controlled did not assume the new Distributing
debt.
To determine the potential application of section 357(b), the IRS
engaged in a detailed analysis of the facts and circumstances relating
to the issuance of the new Distributing debt and the Controlled
assumption. First, the IRS observed that Distributing used the proceeds
of the new Distributing debt to satisfy $4,000x of the historical
Distributing debt, thereby placing Distributing and Controlled in the
same net economic position after the Controlled assumption as each
corporation would have been in had Controlled been able to assume
$4,000x of the historical Distributing debt. Second, the IRS observed
that the incurrence of the new Distributing debt and the Controlled
assumption not only were necessary to effectuate the divisive
reorganization, but also were a normal adjunct to the divisive
reorganization given the non-assumable nature of part of the historical
Distributing debt. Third, the IRS observed that Distributing's
incurrence of the new Distributing debt and the Controlled assumption
merely were in substitution for Controlled's assumption of a pro rata
portion of the historical Distributing debt that Controlled could not
assume. In that regard, because the divisive reorganization resulted in
Controlled assuming a liability in an amount that properly related to
its business operations and would be satisfied from earnings generated
by those operations, the IRS viewed the incurrence of the new
Distributing debt and the Controlled assumption as consistent with
sound business practice. Accordingly, the IRS concluded that tax
avoidance was not a principal purpose of the transaction and,
therefore, that section 357(b) did not apply to the Controlled
assumption.
Additionally, the IRS determined that the acquisition of the new
Distributing debt and the Controlled assumption would not be viewed for
Federal income tax purposes as if Controlled had obtained the new
Distributing debt and transferred the proceeds to Distributing. In this
regard, the IRS found it immaterial that Distributing and Controlled
may have been able to arrange their affairs in another manner, because
the taxpayer satisfied its burden of proof as required under section
357(b). See Simpson v. Comm'r, 43 T.C. 900, 916 (1965) (stating that
the application of section 357(b) is limited to transactions ``arranged
primarily so that the assumption of the [transferor]'s liability in the
transaction itself results in tax avoidance for the transferor, or has
no bona fide business purpose,'' and that section 357(b) was not
intended to require recognition of gain on bona fide transactions
designed to rearrange one's business affairs in such a manner as to
minimize taxes in the future, consistent with existing provisions of
the law); ISC Industries, Inc. v. Comm'r, T.C. Memo. 1971-283
(concluding that petitioner's principal purpose in having a new
subsidiary assume liabilities placed upon the assets transferred to the
subsidiary was not to avoid Federal income taxes on the transfer, but
rather was to protect lines of credit for petitioner's finance
business, and finding it immaterial that petitioner may have been able
to arrange its affairs in another manner, or in a manner that produced
more tax revenue, because section 357(b) clearly looks to the
taxpayer's motives for doing what actually occurred).
5. Application of Section 357(c)
In the case of an exchange to which section 351 applies (section
351 exchange) or to which section 361 applies by reason of a divisive
reorganization that qualifies under sections 355 and 368(a)(1)(D),
section 357(c)(1) generally provides that, if the sum of the amount of
the transferor's liabilities assumed by the transferee corporation
exceeds the total adjusted basis of the assets transferred by the
transferor to the transferee corporation in the exchange, then such
excess is considered as a gain from the sale or exchange of a capital
asset or of property that is not a capital asset, as the case may be.
See also section 368(a)(3)(C) (providing that a reorganization that
would qualify under both section 368(a)(1)(D) and (G) is treated as
qualifying under section 368(a)(1)(D) for purposes of section
357(c)(1)).
However, section 357(c)(2) provides that the general rule in
section 357(c)(1) does not apply to any exchange (i) to which section
357(b) applies, or (ii) that is pursuant to a plan of reorganization
within the meaning of section 368(a)(1)(G) in which no former
shareholder of the transferor receives any consideration for its stock.
Rev. Rul. 2007-8, 2007-1 C.B. 469, holds that the general rule in
section 357(c)(1) does not apply to a section 351 exchange if that
transaction also qualifies as a reorganization described in section
368(a)(1)(A), (C), (D) (provided the requirements of section 354(b)(1)
are satisfied), or (G) (provided the requirements of section 354(b)(1)
are satisfied).
Furthermore, under section 357(c)(3), if the transferor transfers
in a section 351 exchange (including a divisive reorganization that
overlaps with a section 351 exchange; see section 357(c)(3)
(referencing an exchange to which section 357(c)(1) applies)) a
liability the payment of which either would give rise to a deduction or
would be described in section 736(a) of the Code (concerning payments
made in liquidation of the partnership interest of a retiring or
deceased partner), the amount of such liability is excluded in
determining the amount of liabilities assumed under section 357(c)(1)
unless the incurrence of the liability resulted in the creation of (or
an increase in) the basis of any property. In addition, liabilities the
payment of which would give rise to a capital expenditure are not
included for purposes of section 357(c)(1) unless the incurrence of the
liability resulted in the creation of (or an increase in) the basis of
any property. See Rev. Rul. 95-74, 1995-2 C.B. 36.
D. Section 361: Distributions to Shareholders of Target Corporation
1. Overview
Section 361 is an operative provision applicable to certain
exchanges and distributions of property in a transaction that satisfies
the definitional requirements for qualification as a reorganization
under section 368(a)(1). Section 361(a) and (b) provides the Federal
income tax consequences to a target corporation (such as a distributing
corporation in a divisive reorganization) that (i) is a party to a
reorganization, and (ii) pursuant to the plan of reorganization,
exchanges property with an acquiring corporation (such as a controlled
corporation in a divisive reorganization) that also is a party to the
reorganization. Section 361(c) provides the Federal income tax
consequences to the target corporation (such as a distributing
corporation in a divisive reorganization) of the distribution by the
target corporation to its shareholders, or transfer to its creditors,
of certain property in pursuance of or in
[[Page 5226]]
connection with the plan of reorganization that includes the exchange
of property with an acquiring corporation (such as a controlled
corporation in a divisive reorganization) that also is a party to the
reorganization. See the discussion in part III.A of this Background
(noting that the phrases ``in pursuance of'' and ``in connection with''
in section 361 convey the same meaning).
2. Enactment of Section 361(a): Purely Paper Transactions
The original predecessor to current section 361(a) was enacted by
Congress as part of section 202(b) of the Revenue Act of 1918 (Pub. L.
65-254, 40 Stat. 1057, 1060 (1919)). The applicable part of section
202(b) of the Revenue Act of 1918 was subsequently incorporated in
section 112 of the 1939 Code before being adopted as section 361(a) of
the 1954 Code and thereafter as current section 361(a).
Congress enacted the applicable part of section 202(b) of the
Revenue Act of 1918 ``to establish the rule for determining taxable
gains in the case of exchanges of property and to negate the assertion
of tax in the case of certain purely paper transactions.'' S. Rep. No.
65-617, at 5 (1918). As stated in the legislative history, the
substance of the original predecessor to section 361(a) is that (i)
when property is exchanged for other property, the property received in
the exchange should be treated as the equivalent of cash in the amount
of its fair market value, but (ii) when, in connection with the
reorganization or consolidation of a corporation, a person receives, in
place of stock or securities, new stock or securities of no greater
aggregate par value, or when a person receives, in place of property,
stock of a corporation formed to take over such property, no gain or
loss should be deemed to occur from the exchange. See id. at 5-6.
More than a century after the enactment of its original
predecessor, section 361(a) continues to provide generally that a
corporation (that is, the target corporation) that is a party to a
reorganization (such as the distributing corporation in a divisive
reorganization) recognizes no gain or loss if it exchanges property
pursuant to the plan of reorganization solely for stock and securities
in another corporation (that is, the acquiring corporation) that is a
party to the reorganization (such as a controlled corporation in a
divisive reorganization).
3. Enactment of Section 361(b): Conduit for Distribution to
Shareholders
The original predecessor to current section 361(b) was enacted by
Congress as section 203(e) of the Revenue Act of 1924 (Pub. L. 68-176,
43 Stat. 253, 256). Section 203(e) of the Revenue Act of 1924 was
subsequently incorporated in section 112 of the 1939 Code before being
adopted as section 361(b) of the 1954 Code and thereafter as current
section 361(b).
Congress enacted section 203(e) of the Revenue Act of 1924 to
provide that (i) if the corporation that sells its assets in connection
with the reorganization ``acts merely as a conduit'' in passing the
sale proceeds on to its shareholders, no gain to the corporation is to
be recognized, but (ii) if the corporation ``retains the entire amount
of proceeds with the result that the transaction is in substance a real
sale, then the gain shall be recognized.'' S. Rep. No. 68-398, at 16
(1924). This stated policy is reflected in current section 361(b)(1).
Section 361(b)(1)(A) provides that, if section 361(a) would apply
to an exchange but for the fact that the property received by the
target corporation also includes money or other property, no gain will
be recognized by the target corporation if it distributes the money or
other property pursuant to the plan of reorganization. Congress has
enacted no limitation on the aggregate amount of cash and the fair
market value of other property that a target corporation can distribute
to its shareholders (as opposed to creditors) under section
361(b)(1)(A) (although section 368 limits the amount of money or other
property that may be received in certain corporate reorganizations).
Section 361(b)(1)(B), which reflects congressional intent with
respect to a target corporation's failure to act solely as a conduit in
distributing the sale proceeds (that is, money or other property) to
its shareholders, provides that the target corporation (such as the
distributing corporation in a divisive reorganization) recognizes gain
in an amount that does not exceed the sum of the money and fair market
value of the other property that the corporation fails to distribute
pursuant to the plan of reorganization.
4. Section 361(c): Distributions of Appreciated Property to Target
Corporation Shareholders
Section 361(c) originally was enacted by Congress as section
1804(g)(1) of the Tax Reform Act of 1986. As part of a wholesale
rewrite of section 361, Congress amended section 361(c) by enacting
section 1018(d)(5)(A) of the Technical and Miscellaneous Revenue Act of
1988 (Pub. L. 100-647, 102 Stat. 3342, 3578) so that the statute
``conforms the treatment of distributions of property by a corporation
to its shareholders in pursuance of a plan of reorganization to the
treatment of nonliquidating distributions (under section 311).'' S.
Rep. No. 100-445, at 393 (1988).
Section 311(a) generally provides that, except as provided in
section 311(b) (concerning distributions of appreciated property), no
gain or loss is recognized by a corporation on the distribution (not in
complete liquidation) with respect to its stock of (i) its stock (or
rights to acquire its stock), or (ii) property. Accordingly, section
361(c)(1) generally provides that, except as provided in section
361(c)(2) (concerning distributions of appreciated property), no gain
or loss is recognized by a target corporation that is a party to a
reorganization upon a distribution of property to its shareholders
pursuant to a plan of reorganization.
Consistent with section 311(b), section 361(c)(2)(A) provides that,
if the target corporation distributes property other than qualified
property in a distribution described in section 361(c)(1), and if the
fair market value of that other property exceeds the corporation's
adjusted basis in that other property, then gain is recognized by the
target corporation as if the property were sold to the distributee at
its fair market value. The term ``qualified property'' is defined in
section 361(c)(2)(B) to mean (i) any stock, right to acquire stock, or
obligation (including a security) of the corporation, and (ii) any
stock, right to acquire stock, or obligation (including a security) of
another corporation that is a party to the reorganization received by
the target corporation in the exchange.
Therefore, although a target corporation would recognize no gain on
an exchange described in section 361(a) (section 361(a) exchange) if
that corporation received appreciated non-qualified property and
distributed that property to its shareholders pursuant to section
361(b)(1)(A), that corporation nonetheless would recognize gain on the
distribution to its shareholders under section 361(c)(2)(A). If any
such property is subject to a liability, or if the shareholder assumes
a liability of the target corporation in connection with the
distribution, section 361(c)(2)(C) provides that the fair market value
of that property is treated as not less than the amount of that
liability for purposes of section 361(c)(2)(A).
[[Page 5227]]
5. Safe Harbors for Transfers to Creditors of the Distributing
Corporation
Congress added section 361(b)(3) and (c)(3) as part of the
wholesale rewrite of section 361 in the Technical and Miscellaneous
Revenue Act of 1988. Section 361(b)(3) provides that, for purposes of
section 361(b)(1), any transfer of the money or other property received
in the exchange by the target corporation to its creditors in
connection with the reorganization is treated as a distribution
pursuant to the plan of reorganization. Similarly, section 361(c)(3)
provides that, for purposes of section 361(c), any transfer of
qualified property by the target corporation to its creditors in
connection with the reorganization is treated as a distribution to its
shareholders pursuant to the plan of reorganization.
6. Response to Supreme Court's Decision in Minnesota Tea Company
In Minnesota Tea Co. v. Helvering, 302 U.S. 609 (1938), the Supreme
Court held that a distribution by a target corporation to its
shareholders of cash received from an acquiring corporation in a
reorganization was not a qualifying ``distribution'' for purposes of
the predecessor to section 361(b)(1)(A), because the shareholders
immediately used that distributed cash to pay the target corporation's
creditors as part of a prearranged plan. Citing Gregory v. Helvering,
293 U.S. 465, 469 (1935), as providing the ``controlling principle''
for its decision, the Court determined that the payment of
indebtedness, and not the distribution of dividends, ``was, from the
beginning, the aim of the understanding with the stockholders and was
the end accomplished by carrying that understanding into effect.''
Minnesota Tea, 302 U.S. at 613-14. Because the Minnesota Tea Company
``received the same benefit as though it had retained that amount from
[the] distribution and applied it to the payment of such
indebtedness,'' the Court concluded that the company failed to satisfy
the predecessor to section 361(b)(1)(A). See id. at 613 (emphasis
added).
In describing the rationale for enacting section 361(b)(3) and
(c)(3), the legislative history explains that each provision
``overrules the holding in Minnesota Tea Company v. Helvering.'' S.
Rep. No. 100-445, at 393 n.102 (1988); see also H.R. Rep. 100-795, at
372 (1988). The legislative history described the substance of the safe
harbor in section 361(b)(3) as providing that ``transfers of property
to creditors in satisfaction of the corporation's indebtedness in
connection with the reorganization are treated as distributions
pursuant to the plan of reorganization for this purpose.'' S. Rep. No.
100-445, at 393 (1988) (emphasis added). Likewise, the legislative
history described the corresponding safe harbor in section 361(c)(3) as
providing that ``the transfer of qualified property by a corporation to
its creditors in satisfaction of indebtedness is treated as a
distribution pursuant to the plan of reorganization.'' Id. (emphasis
added). By treating transfers of property to creditors in satisfaction
of indebtedness as distributions pursuant to the plan of
reorganization, Congress balanced the dual policy objectives of (i)
preserving consistency with the fundamental requirement of section 361
that property be distributed, and (ii) enacting a provision to address
transfers to creditors in satisfaction of indebtedness that overruled
the holding in Minnesota Tea.
7. Adjusted Basis Limitation for Purposes of Section 361(b)(3)
In the case of a divisive reorganization described in sections 355
and 368(a)(1)(D), the third sentence in section 361(b)(3) (adjusted
basis limitation) limits the extent to which a transfer of money or
other property to a creditor is treated as a distribution pursuant to
the plan of reorganization for the purposes of section 361.
Specifically, section 361(b)(3) applies solely to the extent the sum of
the money and the fair market value of the other property transferred
to creditors of the distributing corporation does not exceed the
aggregate adjusted bases of the assets transferred to the controlled
corporation in the section 361(a) exchange, reduced by the amount of
the distributing corporation's liabilities that the controlled
corporation actually assumes within the meaning of section 357(c).
Congress enacted the adjusted basis limitation in section 361(b)(3)
as part of the American Jobs Creation Act of 2004 (Pub. L. 108-357, 118
Stat. 1418) based on the concern stated in the legislative history that
taxpayers had developed tax-planning strategies to circumvent the
adjusted basis limitation in section 357(c) on actual assumptions by
controlled corporations in divisive reorganizations. See S. Rep. No.
108-192, at 185 (2003). Specifically, the committee report observed
that a distributing corporation (i) could cause the controlled
corporation to borrow money from a financial institution and transfer
that money to the distributing corporation in the section 361(a)
exchange, and then (ii) could use that money to pay its creditors. Id.
The committee report concluded that, although this series of
transactions does not involve an actual assumption by the controlled
corporation within the meaning of section 357, it is ``economically
similar to the actual assumption'' because, at the end of the series of
transactions, the distributing corporation has reduced its indebtedness
to its creditor and the controlled corporation has become indebted to a
creditor (albeit a different creditor) for an equal amount. See id.
Accordingly, ``because section 361(b) [did] not contain a limitation on
the amount that can be distributed to creditors,'' Congress limited the
scope of the section 361(b)(3) safe harbor to ``the amount of the basis
of the assets contributed to a controlled corporation in a divisive
reorganization.'' Id.
8. Express Grant of Authority
As stated previously in the Authority section of this preamble, the
second sentence of section 361(b)(3) provides the Secretary with an
express grant of authority to prescribe such regulations as may be
necessary to prevent avoidance of Federal income tax through abuse of
the safe harbors in section 361(b)(3) and (c)(3). Congress included
this grant of authority in section 361(b)(3) when Congress enacted both
provisions as part of the Technical and Miscellaneous Revenue Act of
1988.
III. Plan of Reorganization; Party to a Reorganization
A. Overview
For more than a century, the ``plan of reorganization'' requirement
has served to limit the application of the operative provisions in
subchapter C solely to those transactions with a sufficiently proximate
relationship to transactions that satisfy the definitional requirements
in subchapter C for a reorganization (proximate relationship
requirement). For example, see section 202(b) of the Revenue Act of
1918 (providing that an exchange did not qualify for nonrecognition
treatment unless the transaction was ``in connection with'' a
reorganization). In other words, Congress has long viewed the proximate
relationship requirement as an integral tool for preventing the
nonrecognition provisions in subchapter C from applying to transactions
to which general gain or loss provisions of the Code (for example,
section 1001 of the Code) should apply.
This long-standing congressional purpose is illustrated by the
evolution of section 202(c)(1) of the Revenue Act
[[Page 5228]]
of 1921 (Pub. L. 67-98, 42 Stat. 227). That provision originally
provided nonrecognition treatment for an exchange of property held for
investment or for productive use in a trade or business, with no
exception for stock or securities, and with no proximate relationship
requirement. Tax advisors took advantage of this provision by
structuring exchanges of portfolio investment securities for other
securities in transactions that resulted in no recognition of Federal
income tax. After receiving a request from the Treasury Department to
address this abuse, Congress amended section 202(c)(1) by removing
exchanges of stock and securities from nonrecognition treatment except
for exchanges occurring in the context of a reorganization. See An Act
to Amend the Revenue Act of 1921 in Respect to Exchanges of Property,
Public Law 67-545, 42 Stat. 1560 (1923); J. Seidman, Legislative
History of Federal Income Tax Laws: 1938-1861, at 798 (1938); see also
Letter from A. W. Mellon, Secretary of the Treasury, to Congressman
William R. Green, Acting Chairman of the Committee on Ways and Means
(Jan. 13, 1923).
Since first establishing the proximate relationship requirement,
Congress has implemented that requirement through various linguistic
formulations over time. However, Congress has indicated that such
variations in language were not intended to reflect substantive
differences. For example, Congress replaced ``in connection with'' in
section 202(b) of the Revenue Act of 1918 with ``in the
reorganization'' in section 202(c) of the Revenue Act of 1921. When
describing section 202(c) of the Revenue Act of 1921, a congressional
committee print explicitly referred to the proximate relationship under
that section as requiring an ``in connection with'' relationship. See
S. Comm. on Finance, 68th Cong., Statement of the Changes Made in the
Revenue Act of 1921 by H.R. 6715 and the Reasons Therefor, at 5-6
(Comm. Print 1924).
In section 203(c) of the Revenue Act of 1924, Congress restated the
proximate relationship requirement as requiring an ``in pursuance of a
plan of reorganization'' relationship. This requirement, like the ``in
connection with'' requirement, exists in the current definitional and
operative provisions of subchapter C. The legislative history
underlying section 203 of the Revenue Act of 1924 explicitly refers to
the ``in pursuance of the plan of reorganization'' formulation in
several instances as ``in connection with the reorganization.'' See
H.R. Rep. No. 68-179, at 13-16 (1924). In particular, at one point, the
Committee on Ways and Means described the change in formulation of the
proximate relationship requirement as a result of ``minor changes in
phraseology.'' See id. at 13.
B. Definition of ``Plan of Reorganization''
The term ``plan of reorganization'' is not defined in subchapter C.
Instead, the sole authoritative guidance defining this term is set
forth in the Income Tax Regulations. Specifically, Sec. 1.368-2(g)
provides that the term ``plan of reorganization'' refers to a
``consummated transaction specifically defined as a reorganization
under section 368(a),'' and that ``[s]ection 368(a) contemplates
genuine corporate reorganizations which are designed to effect a
readjustment of continuing interests under modified corporate forms.''
Section 1.368-2(g) further provides that the term ``plan of
reorganization'' ``is not to be construed as broadening the definition
of reorganization as set forth in section 368(a),'' but rather ``is to
be taken as limiting the nonrecognition of gain or loss to such
exchanges or distributions as are directly a part of the transaction
specifically described as a reorganization in section 368(a).'' Section
1.368-2(g) further provides that the transaction (or series of
transactions) ``embraced in a plan of reorganization must not only come
within the specific language of section 368(a),'' but also that ``the
readjustments involved in the exchanges or distributions effected in
the consummation [of the plan of reorganization] must be undertaken for
reasons germane to the continuance of the business of a corporation a
party to the reorganization.''
However, significant uncertainty and confusion have arisen
regarding the scope, purpose, and application of Sec. 1.368-2(g). As
expressed by the Tax Court in an observation often referenced by courts
and commentators, ``the above definition is imbued with qualities of
flexibility and vagueness, with the result that it does not present
precise self-executing guidelines.'' Int'l Telephone & Telegraph Corp.
v. Comm'r, 77 T.C. 60, 75 (1981); see also J.E. Seagram Corp. v.
Comm'r, 104 T.C. 75, 96 (1995) (relying on the quote in Int'l Telephone
in observing that Sec. 1.368-2(g) provides ``substantial
elasticity''). As a result, Sec. 1.368-2(g) (including its proximate
relationship requirement) has created significant uncertainty and
confusion for taxpayers and the IRS in determining the scope of
transactions that properly should be taken into account for purposes of
applying the definitional and operative provisions of subchapter C.
Section 1.368-1(c) further describes the ``plan of reorganization''
concept and provides important context regarding the application of
this concept and its embedded proximate relationship requirement.
Specifically, Sec. 1.368-1(c) provides, in part, that ``[t]he
provisions of [part III of subchapter C] referred to in this paragraph
are inapplicable unless there is a plan of reorganization'' (emphasis
added). Section 1.368-1(c) further provides that ``[a] plan of
reorganization must contemplate the bona fide execution of one of the
transactions specifically described as a reorganization in section
368(a) and for the bona fide consummation of each of the requisite acts
under which nonrecognition of gain is claimed.'' That transaction, and
those acts, must be an ``ordinary and necessary incident of the conduct
of the enterprise and must provide for a continuation of the
enterprise.'' Id. Finally, Sec. 1.368-1(c) provides that a scheme
involving ``an abrupt departure from normal reorganization procedure in
connection with a transaction on which the imposition of tax is
imminent, such as a mere device that puts on the form of a corporate
reorganization as a disguise for concealing its real character, and the
object and accomplishment of which is the consummation of a
preconceived plan having no business or corporate purpose, is not a
plan of reorganization.''
Consistent with the discussion in part III.A of this Background,
Sec. 1.368-1(c) reflects the function of the ``plan of
reorganization'' concept and its embedded proximate relationship
requirement--namely, to limit the application of the definitional and
operative provisions of subchapter C to those transactions included in
the plan of reorganization. Section 1.368-1(c) also requires all
transactions properly included in the plan of reorganization to be
consistent with, and to facilitate satisfaction of, a principal
requirement for nonrecognition treatment under the reorganization
provisions of subchapter C (that is, the continuation of an
enterprise). Finally, Sec. 1.368-1(c) reflects that devices and sham
transactions cannot properly be included in a plan of reorganization.
C. Party to a Reorganization
Section 368(b) generally provides that the term ``a party to a
reorganization'' includes (i) a corporation resulting from a
reorganization, and (ii) both corporations, in the case of a
reorganization resulting from the
[[Page 5229]]
acquisition by one corporation of stock or properties of another.
Consistent with section 368(b), Sec. 1.368-2(f) defines the term
``party to a reorganization'' as including ``a corporation resulting
from a reorganization, and both corporations in a transaction
qualifying as a reorganization where one corporation acquires stock or
properties of another corporation.'' Section 1.368-2(f) further
articulates which entities are parties to a reorganization in various
types of reorganizations defined in section 368(a)(1). However, the
uncertainty regarding the meaning of ``plan of reorganization,''
described in part III.B of this Background, has resulted in confusion
regarding the proper identification of parties to a reorganization.
D. Reporting and Recordkeeping Requirements for Corporate
Reorganizations
Section 1.368-3 sets forth reporting and recordkeeping requirements
for corporate reorganizations. Section 1.368-3(a) requires a plan of
reorganization to be adopted by each corporation that is a party to the
reorganization, and it requires each such corporation to include a
statement with its Federal income tax return that includes certain
limited information about the reorganization. However, Sec. 1.368-3(a)
provides no additional detail on the manner in which the plan of
reorganization must be adopted, and it does not require the plan of
reorganization to be reflected in any documentation or records of the
parties to the reorganization.
Current Sec. 1.368-3(a) contrasts starkly with a prior version of
Sec. 1.368-3(a), which provided that the plan of reorganization ``must
be adopted by each of the corporations parties thereto; and the
adoption must be shown by the acts of its duly constituted responsible
officers, and appear upon the official records of the corporation.''
See Sec. 1.368-3(a) (effective from November 26, 1960, to May 29,
2006) (prior Sec. 1.368-3(a)).
Prior Sec. 1.368-3(a) also imposed additional requirements to
facilitate the IRS's administration of the reorganization provisions in
part III of subchapter C. In particular, prior Sec. 1.368-3(a)
required the parties to a reorganization to file with the IRS a ``copy
of the plan of reorganization, together with a statement, executed
under the penalties of perjury, showing in full the purposes thereof
and in detail all transactions incident to, or pursuant to, the plan.''
In contrast, taxpayers currently are not required by Sec. 1.368-3 to
provide as part of their Federal income tax return a plan of
reorganization that describes the transactions to which taxpayers
intend to apply the nonrecognition provisions of subchapter C.
In addition, prior Sec. 1.368-3(a) required taxpayers to file with
the IRS ``a complete statement of all facts pertinent to the
nonrecognition of gain or loss in connection with the reorganization.''
Current Sec. 1.368-3(a) contains no such requirement. Therefore, the
IRS currently does not receive as part of a taxpayer's Federal income
tax return a statement of facts necessary to determine the proper
application of the nonrecognition provisions of subchapter C to the
transactions comprising a corporate reorganization.
Instead, current Sec. 1.368-3(a) merely requires each corporate
party to a reorganization to include a statement, on or with its return
for the taxable year of the exchange, that includes: (i) the names and
employer identification numbers (if any) of all such parties; (ii) the
date of the reorganization; (iii) the value and basis of the assets,
stock, or securities of the target corporation transferred in the
transaction, determined immediately before the transfer in the manner
described in Sec. 1.368-3(a); and (iv) the date and control number of
any one or more private letter rulings issued by the IRS in connection
with the reorganization. Current Sec. 1.368-3(b) imposes similar
requirements on significant holders of stock or securities of the
target corporation.
Like prior Sec. 1.368-3(c), current Sec. 1.368-3(d) requires
taxpayers to retain their permanent records with respect to a corporate
reorganization.
IV. TIGTA Report To Improve Enforcement of Corporate M&A Transactions
In 2019, the Treasury Inspector General for Tax Administration
(TIGTA) published a report titled ``A Strategy Is Needed to Assess the
Compliance of Corporate Mergers and Acquisitions With Federal Tax
Requirements,'' Ref. No. 2019-30-050 (Sept. 5, 2019) (TIGTA Report). In
that report, TIGTA considered the scope of information required to be
provided under Sec. 1.368-3(a) and expressed that ``the forms
previously detailed represent only a small portion of the information
that may be filed, and certain forms used to report merger and
acquisition (M&A) transactions may not be providing sufficient
information to identify noncompliance.'' Id. at 14-15.
Accordingly, TIGTA recommended that, if the IRS finds that the
current forms do not contain information sufficient for identifying
potential noncompliance in M&A transactions, the IRS ``should consider
amending the filing criteria and information required in the forms to
develop useful compliance tools.'' Id. at 14. The IRS agreed with this
recommendation, stating that it will continue to consider how to use
M&A transaction information in its compliance efforts.
V. Reporting Requirements for Section 355 Transactions
In a notice of proposed rulemaking (REG-116085-23) published
elsewhere in the Proposed Rules section of this issue of the Federal
Register, the Treasury Department and the IRS are issuing proposed
regulations to revise current Sec. 1.355-5 (proposed Sec. 1.355-5) to
enhance the IRS's ability to administer and enforce the requirements of
section 355. Similar to current Sec. 1.368-3 (previously discussed in
part III.D of this Background), current Sec. 1.355-5 requires the
distributing corporation and each significant distributee (as defined
in current Sec. 1.355-5(c)(1)) to include a statement with its tax
return that includes certain limited information about the section 355
transaction. To implement the recommendation in the TIGTA Report
described in part IV of this Background, proposed Sec. 1.355-5 would
require taxpayers to submit new IRS Form 7216, Multi-Year Reporting
Related to Section 355 Transactions (or any successor form), to provide
the IRS with additional information to help the IRS identify potential
noncompliance in section 355 transactions.
VI. Revenue Procedure 2024-24 and Notice 2024-38
On May 2, 2024, the Treasury Department and the IRS released Rev.
Proc. 2024-24, 2024-21 I.R.B. 1214, to provide procedures for
requesting private letter rulings from the IRS regarding certain
matters relating to section 355 transactions. Rev. Proc. 2024-24
superseded Rev. Proc. 2018-53, 2018-43 I.R.B. 667, and made several
significant changes to the requirements of that revenue procedure and
to Rev. Proc. 2017-52, 2017-41 I.R.B. 283.
Also on May 2, 2024, the Treasury Department and the IRS released
Notice 2024-38, 2024-21 I.R.B. 1211, to describe their views and
concerns relating to certain matters addressed in Rev. Proc. 2024-24,
and to solicit feedback on the provisions set forth in Rev. Proc 2024-
24. In section 2.01 of Notice 2024-38, the Treasury Department and the
IRS requested that such feedback take into account the
[[Page 5230]]
following three objectives for potential future guidance: (i) the
guidance will be consistent with all relevant provisions of the Code
(compliance objective); (ii) the guidance will provide certainty to
taxpayers and the IRS regarding the application of all relevant
provisions of the Code to purported section 355 transactions (increased
certainty objective); and (iii) the guidance will be responsive to the
manner in which section 355 transactions are engaged in by taxpayers
and reflect current market practices and preferences (transaction
facilitation objective), to the extent that such approach does not
conflict with the first two objectives.
Explanation of Provisions
The purpose of these proposed regulations is to establish a
comprehensive set of rules to implement certain core definitional and
operative provisions of subchapter C that address corporate
separations, incorporations, and reorganizations. The current
regulatory framework underlying these provisions is incomplete,
outdated, and not reflective of their importance to the Federal
corporate income tax system, given the trillions of dollars of
corporate transactions governed by these statutory provisions. Due to
the lack of up-to-date regulatory guidance, taxpayers and the IRS must
rely on a patchwork of caselaw, IRS revenue rulings and revenue
procedures, and non-authoritative IRS documents to discern the current
state of the law with respect to these core provisions of subchapter C.
Accordingly, providing comprehensive regulatory guidance to
facilitate the implementation of these core definitional and operative
provisions of subchapter C would promote taxpayer certainty and sound
tax administration. Although Notice 2024-38 focused on Federal income
tax issues regarding section 355 transactions, these core definitional
and operative provisions also address incorporations and acquisitive
reorganizations. Therefore, the proposed regulations would implement
those statutory provisions for all corporate M&A transactions, in a
manner that reflects the three objectives described in section 2.01 of
Notice 2024-38 (that is, the compliance objective, the increased
certainty objective, and the transaction facilitation objective) in
accordance with their respective priorities as set forth therein.
A principal objective of the Treasury Department and the IRS in
issuing these proposed regulations is to significantly improve
horizonal equities among taxpayers and tax advisors. In other words,
based on feedback from tax advisors, the lack of authoritative guidance
in this area effectively has transformed a taxpayer's option to request
a private letter ruling on the application of certain definitional and
operative provisions into a requirement. Indeed, tax advisors have
directly reached out to the Treasury Department and the IRS to
emphasize the mandatory nature of private letter rulings on certain
topics in this area because, based on the current state of
authoritative guidance, those tax advisors could not provide tax
opinions at a sufficient level of comfort in the absence of a private
letter ruling. Therefore, these tax advisors have stressed the
importance of engaging in bar association panels and other professional
speaking engagements to access the perspectives of Treasury Department
and IRS officials regarding the government's current views on certain
fundamental corporate tax issues.
These proposed regulations would provide, through publicly
accessible authoritative guidance, core definitional and operative
provisions. This guidance is intended to facilitate the ability for
taxpayers to achieve increased comfort on the Federal income tax
treatment of their corporate M&A transactions without the need for a
private letter ruling. Just as importantly, this guidance is intended
to encourage the submission of private letter ruling requests and
facilitate the IRS private letter ruling process. In particular, these
proposed regulations are intended to help direct the focus of tax
advisors to those issues that raise significant Federal income tax
compliance concerns, and consequently improve the organization and
focus of their private letter ruling submissions. Similarly, these
proposed regulations are intended to increase the efficiency of the
private letter ruling program by allowing submission reviewers to focus
primarily on such significant issues, rather than those issues that
would be addressed directly by this guidance.
In explaining the provisions of these proposed regulations, this
Explanation of Provisions discusses issues described in Notice 2024-38
and the feedback received in response to Notice 2024-38. Such feedback
has informed the development of these proposed regulations. This
Explanation of Provisions also references proposed regulations,
published elsewhere in the Proposed Rules section of this issue of the
Federal Register, that would implement enhanced reporting requirements
for section 355 transactions. Those enhanced reporting requirements are
integral to the proposed substantive guidance set forth in these
proposed regulations. Specifically, as described further in this
Explanation of Provisions, this proposed substantive guidance reflects
the long-standing reality that corporate transactions typically are
carried out over multiple taxable years. The increased transactional
flexibility that would be provided by these proposed regulations is
conditioned on the IRS's ability to track the execution of these
transactions throughout their lifecycle, and the enhanced reporting
requirements for section 355 transactions would facilitate the IRS's
ability to carry out its administrative function with respect to these
transactions.
I. Distinction Between Delayed Distributions and Retentions; Rules for
Qualifying Retentions
A. Notice 2024-38
Section 2.02(1) of Notice 2024-38 stated the view of the Treasury
Department and the IRS that the Code provides separate and distinct
treatment for three instances in which a distributing corporation
temporarily continues to hold controlled corporation stock or
securities following the date on which the distributing corporation has
distributed an amount of controlled corporation stock constituting
control (within the meaning of section 368(c)) (control distribution
date). These three instances are: (i) a delayed distribution of
controlled corporation stock or securities that is ``part of the
distribution'' (within the meaning of section 355(a)(1)(D)); (ii) a
delayed distribution of controlled corporation stock or securities that
is ``in pursuance of the plan of reorganization'' (within the meaning
of section 361); and (iii) a retention of controlled corporation stock
or securities.
Section 2.02(2) of Notice 2024-38 stated the view of the Treasury
Department and the IRS that section 355(a)(1)(D) effectively creates a
rebuttable presumption that any retention evidences a plan to achieve a
Federal income tax avoidance purpose. Section 2.02(2) of Notice 2024-38
also stated that the Treasury Department and the IRS are considering
the degree to which connections between the distributing corporation
and the controlled corporation (and, as appropriate, the DSAG and the
CSAG) after the control distribution date would prevent a transaction
from qualifying under section 355. (The terms ``DSAG'' and ``CSAG''
mean the separate affiliated group (as defined in section 355(b)(3)(B))
of which the distributing
[[Page 5231]]
corporation or the controlled corporation, respectively, is the common
parent.)
Section 2.02(2) of Notice 2024-38 also stated the view of the
Treasury Department and the IRS that overlapping directors, officers,
or key employees and the existence of continuing contractual agreements
between the distributing corporation (and other members of the DSAG)
and the controlled corporation (and other members of the CSAG) that
include provisions that are not arm's-length weigh against a
determination of qualification under section 355.
B. Stakeholder Input
1. Existence of Rebuttable Presumption Under Section 355(a)(1)(D)(ii)
As an initial matter, some stakeholders have contended that section
355(a)(1)(D)(ii) does not create a rebuttable presumption that a
retention evidences a plan with a principal purpose of avoiding Federal
income tax, notwithstanding the explicit statutory requirement that the
Secretary must be satisfied that such a purpose does not exist.
Instead, these stakeholders have asserted that Congress's intent in
including the ``no tax avoidance purpose'' language in section
355(a)(1)(D)(ii) is unclear, and that the legislative history of
section 355 does not give further details about the meaning of this
language.
Accordingly, these stakeholders have suggested that, rather than
include a rebuttable presumption, the proposed regulations should place
greater emphasis on (i) an examination of the corporate business
purpose for the section 355 transaction, and (ii) a determination of
whether the retained controlled corporation stock is disposed of as
``part of the distribution'' (see section 355(a)(1)(D)) or ``in
pursuance of the plan of reorganization'' (see section 361(c)). These
stakeholders contend that their view is supported by sections 354, 355,
and 361, as well as by Sec. 1.368-2(g), which requires readjustments
involved in the exchanges or distributions effected in consummating a
plan of reorganization to be ``undertaken for reasons germane to the
continuance of the business of a corporation a party to the
reorganization.''
2. Application of Plan of Reorganization With Regard to Section
355(a)(1)(D)(ii)
Stakeholders also have requested clarification in the proposed
regulations that all delayed distributions, whether before or after the
control distribution date, are treated as part of the distribution
(within the meaning of section 355(a)(1)(D)) if they are effectuated
pursuant to the plan of reorganization. Relatedly, stakeholders have
recommended that the proposed regulations employ the same standard
(that is, the same level of proximate relationship) in considering
whether a transaction is ``part of the distribution'' and ``in
pursuance of a plan of reorganization.'' Stakeholders have further
requested confirmation in the proposed regulations that the ``no tax
avoidance purpose'' requirement in section 355(a)(1)(D)(ii) applies
only to the extent a delayed distribution fails to qualify under the
operative provisions.
Based on their analogy to their view of the ``plan of
reorganization'' concept, these stakeholders have contended that the
``as part of the distribution'' requirement in section 355(a)(1)(D)
provides substantial flexibility to the distributing corporation
regarding the timing and manner of dispositions of controlled
corporation stock (for example, in a delayed distribution of controlled
corporation stock to shareholders of the distributing corporation). In
this regard, stakeholders have recommended that the phrase ``as part of
the distribution'' be interpreted to provide section 355 qualification
for situations in which the distributing corporation contemplates--but
provides no further level of commitment to--a spectrum of potential
dispositions of controlled corporation stock, so long as the
distributing corporation eventually achieves one or more of those
contemplated possibilities or related variants. As described by such
stakeholders, the distributing corporation need not identify the timing
of those dispositions (regardless of whether they span multiple taxable
years of the distributing corporation), the potential recipients of
controlled corporation stock (for example, creditors of the
distributing corporation), or the method of disposing of that stock.
The stakeholder input described in the foregoing paragraphs
ultimately focuses on two aspects of the IRS private letter ruling
program for section 355 transactions: (i) the requirement set forth in
section 3.03(3)(a)(ii) of Rev. Proc. 2024-24 (the so-called ``pick a
lane'' requirement); and (ii) the elimination under that revenue
procedure of so-called ``backstop retention rulings.''
With regard to the ``pick a lane'' requirement, these stakeholders
read section 3.03(3)(a)(ii) of Rev. Proc. 2024-24 as providing that the
IRS will entertain a request for rulings that: (i) a delayed
distribution of controlled corporation stock or securities will be, as
applicable, ``part of the distribution'' (within the meaning of section
355(a)(1)(D)) or ``in pursuance of the plan of reorganization'' (within
the meaning of section 361); and (ii) a retention of controlled
corporation stock or securities that is not included in a ruling
request described in clause (i) of this sentence will not be in
pursuance of a plan having as one of its principal purposes the
avoidance of Federal income tax (within the meaning of section
355(a)(1)(D)(ii)). Stakeholders have further stated that, to comply
with the so-called ``pick a lane'' requirement, a taxpayer must specify
the portions of controlled corporation stock remaining after the
control distribution (i) to which the taxpayer intends section 361(c)
to apply, and (ii) which the taxpayer intends to retain and not dispose
of under section 361(c). See section 3.03(3)(d) of Rev. Proc. 2024-24.
In practice, the ``pick a lane'' requirement requires a taxpayer to
identify to the IRS those transactions that the taxpayer intends to
carry out as part of its plan of reorganization. However, stakeholders
have contended that this requirement is problematic because Rev. Proc.
2024-24 also has eliminated the availability of ``backstop retention
rulings,'' which stakeholders have described as ``protective rulings''
affording taxpayers a determination by the IRS, before the first step
of a divisive reorganization, that a retention at no point will have
failed to satisfy the ``no tax avoidance purpose'' requirement in
section 355(a)(1)(D)(ii).
Stakeholders have contended that these changes in private letter
ruling policy, combined with the requirement that all controlled
corporation stock or securities be distributed within 12 months of the
date of the first distribution (first distribution date) to receive a
ruling that the distribution qualifies for nonrecognition treatment
under section 355 (see section 3.03(2)(b)(ii) of Rev. Proc. 2024-24),
have created an unnecessary risk for taxpayers that an intended
divisive reorganization could fail to qualify under section 355
(section 355(a)(1)(D)(ii) risk). For purposes of these proposed
regulations, the term ``first distribution'' means the earliest
distribution in a series of distributions made pursuant to the plan of
distribution or plan of reorganization, as appropriate.
Specifically, these stakeholders have asserted that, because
transactions intended to qualify for nonrecognition treatment under
section 361(c) often require most of a year to complete, tax advisors
now are faced with three undesirable options. First, tax advisors could
recommend the premature
[[Page 5232]]
termination of such transactions, which otherwise would have been
effectuated for bona fide business purposes for corporate taxpayers.
Second, tax advisors could attempt, in an unreasonably short timeframe,
to receive from the IRS a supplemental private letter ruling that the
``springing retention'' (that is, a retention that arises unexpectedly
during the 12-month period) satisfies the ``no tax avoidance purpose''
requirement. Third, tax advisors could provide an opinion that the
springing retention satisfies the ``no tax avoidance purpose''
requirement, notwithstanding the lack of authoritative guidance on that
issue.
C. Proposed Regulations
Consistent with the statement in section 2.02(2) of Notice 2024-38,
proposed Sec. 1.355-10(c)(1) would reflect the presumption that a
retention is pursuant to a plan having as one of its principal purposes
the avoidance of Federal income tax. However, the Treasury Department
and the IRS appreciate the views of stakeholders regarding delayed
distributions and retentions. In particular, the Treasury Department
and the IRS are sensitive to the potential negative impacts of the
``pick a lane'' requirement and related requirements in Rev. Proc.
2024-24 on divisive reorganizations, and to the lack of clear,
authoritative guidance regarding the ``no tax avoidance purpose''
requirement of section 355(a)(1)(D)(ii). Therefore, and consistent with
the compliance, increased certainty, and transaction facilitation
objectives of these proposed regulations, the Treasury Department and
the IRS have proposed rules to address the uncertainty highlighted by
stakeholders in a manner that facilitates the ability of (i) taxpayers
to carry out bona fide section 355 transactions, and (ii) the IRS to
ensure that such transactions comply with all requirements of the Code.
1. Proposed Safe Harbor To Address Section 355(a)(1)(D)(ii) Risk
a. Overview
In response to stakeholder concerns regarding the section
355(a)(1)(D)(ii) risk, these proposed regulations would provide a safe
harbor that incorporates objectively verifiable conditions for
retentions not to be treated as pursuant to a plan having as one of its
principal purposes the avoidance of Federal income tax (qualifying
retentions). The Treasury Department and the IRS have proposed this
safe harbor to enable taxpayers to satisfy the requirements of section
355(a)(1)(D)(ii) with greater certainty even in the absence of a
private letter ruling from the IRS--thereby achieving an increased
certainty and transaction facilitation objectives. For taxpayers that
do not satisfy the requirements of the proposed safe harbor, the
proposed regulations would provide for a general facts-and-
circumstances determination for whether a retention is a qualifying
retention.
b. Section 355(a)(1)(D)(ii) Safe Harbor
Under the section 355(a)(1)(D)(ii) safe harbor in proposed Sec.
1.355-10(c)(3), a distributing corporation would be treated as
satisfying the general facts-and-circumstances test in proposed Sec.
1.355-10(c)(2)(ii) for a qualifying retention if all six of the
following conditions are satisfied. First, the distributing corporation
must have a specific corporate business purpose for the retention as of
the date of adoption of the plan of distribution or plan of
reorganization, as appropriate, and at all times during the period of
retention. Second, stock of the controlled corporation must be widely
held during the period of retention after the first distribution date.
Third, any overlap between the officers, directors, or key employees of
the DSAG and of the CSAG must be limited in the manner described in
proposed Sec. 1.355-10(c)(3)(iv). Fourth, any continuing arrangements
between the distributing corporation and the controlled corporation
during the period of retention either (i) must be negotiated on and
reflect arm's-length terms, or (ii) within two years after the first
distribution date, must be terminated or renegotiated to reflect arm's-
length terms. Fifth, the plan of distribution or plan of
reorganization, as appropriate, must reflect a definite intent in the
official records of the distributing corporation that the distributing
corporation dispose of all retained controlled corporation stock (or
securities) by the end of the five-year period beginning on the first
distribution date. Sixth, the disposition of retained controlled
corporation stock (or securities) must not result in less Federal
income tax to the distributing corporation (determined based on the
fair market value and adjusted basis of that stock (or securities) as
of the first distribution date) than if that stock (or securities) had
been distributed in the first distribution. The distributing
corporation must include in its plan of distribution or plan of
reorganization (as applicable) a description of each agreement and
transaction that establishes the satisfaction of the foregoing six
conditions.
c. Rationale for Section 355(a)(1)(D)(ii) Safe Harbor
The safe harbor in proposed Sec. 1.355-10(c)(3) is intended to
balance taxpayers' need for certainty with the IRS's need to ensure
taxpayer compliance with section 355(a)(1)(D)(ii). As discussed in part
IV of the Background, TIGTA recommended that the IRS consider amending
the filing criteria and information required in current forms to
develop useful compliance tools. The inclusion of objective
requirements in the section 355(a)(1)(D)(ii) safe harbor is consistent
with both TIGTA's recommendation and the compliance, increased
certainty, and transaction facilitation objectives for guidance
described in section 2.01 of Notice 2024-38.
Moreover, under proposed Sec. 1.355-5 and new IRS Form 7216 (see
part V of the Background), and consistent with the recommendation in
the TIGTA Report, a taxpayer would be required to report key
information that would enable the IRS to ensure that the taxpayer,
during each taxable year of the retention period, continues to comply
with the requirements of the section 355(a)(1)(D)(ii) safe harbor.
Thus, the section 355(a)(1)(D)(ii) safe harbor, coupled with the
enhanced reporting requirements for section 355 transactions, would
increase taxpayer certainty (by reducing the so-called section
355(a)(1)(D)(ii) risk) and would facilitate IRS administration of
section 355(a)(1)(D)(ii). The Treasury Department and the IRS are of
the view that these two proposals would significantly help achieve all
three objectives of these proposed regulations.
The proposed regulations would not incorporate the stakeholders'
recommendation that the requirements of section 355(a)(1)(D)(ii) be
treated as satisfied so long as the distributing corporation disposes
of all controlled corporation stock pursuant to the plan of
reorganization. Such an approach would conflict with long-standing
Sec. 1.355-2(e)(2), which requires the consideration of factors aside
from the manner in which the distributing corporation disposes of its
retained controlled corporation stock (for example, if the distribution
would be treated to any extent as a distribution of ``other property''
under section 356). The stakeholders' recommendation would not be
consistent with section 355(a)(1)(D)(ii), because that recommendation,
by itself, would not ensure a genuine separation.
In addition, the proposed regulations would not incorporate
stakeholders' recommendation that a strong corporate
[[Page 5233]]
business purpose for a section 355 transaction be treated as sufficient
to satisfy the requirements under section 355(a)(1)(D)(ii). This
suggestion is inconsistent with the plain reading of the statute, which
requires a determination that the avoidance of Federal income tax was
not a principal purpose of the retention. In other words, the
distributing corporation could possess a strong corporate business
purpose for the section 355 transaction in general and for the
retention in particular, and yet also possess a principal purpose for
the retention of avoiding Federal income tax.
Ultimately, the stakeholders' recommended approaches would conflict
with the purpose of section 355(a)(1)(D), which is to ensure genuine
separations between the distributing and controlled corporations--a
policy reflected in the legislative history of section 355(a)(1)(D) and
the long-standing view of the Treasury Department and the IRS regarding
that purpose as fundamental to all section 355 transactions. The
legislative history of section 355(a)(1)(D) indicates that Congress's
initial preference was to provide no exception to the complete-
distribution requirement under section 355(a)(1)(D)(i), and that the
exception for retentions originated through a subsequent Senate
amendment. See H.R. Rep. No. 83-1337, at A121 (1954); S. Rep. No. 83-
1622, at 266 (1954). Indeed, Treasury regulations that predated the
enactment of section 355(a)(1)(D), and that tax advisors have
acknowledged as the basis for section 355(a)(1)(D), provided that the
business reasons supporting a distribution of controlled corporation
stock ordinarily required the distribution of all controlled
corporation stock owned by the distributing corporation. See Sec.
29.112(b)(11)-2(c) of Regulation 111 (issued under section 112(b)(11)
of the 1939 Code, the predecessor to section 355 of the 1954 Code); see
also Sec. 1.355-2(e)(2), which continues to reflect this language).
Long-standing revenue rulings and general counsel memoranda also
reflect the view that, under the plain reading of section
355(a)(1)(D)(ii), Congress intended to subject retentions to heightened
scrutiny to ensure that the section 355 transaction effectuates a
genuine separation of the distributing corporation and the controlled
corporation. See Rev. Rul. 75-469; Rev. Rul. 75-321; see also G.C.M.
32136 (Oct. 23, 1961).
2. Facts-and-Circumstances Test for Determining Compliance With Section
355(a)(1)(D)(ii)
If a taxpayer fails to satisfy the requirements of the section
355(a)(1)(D)(ii) safe harbor in proposed Sec. 1.355-10(c)(3), the
taxpayer may establish compliance with section 355(a)(1)(D)(ii) through
satisfaction of the facts-and-circumstances test in proposed Sec.
1.355-10(c)(2)(ii). As with qualification for the proposed section
355(a)(1)(D)(ii) safe harbor, satisfaction of the proposed facts-and-
circumstances test would require a determination that the distributing
corporation and the controlled corporation have genuinely separated,
among other requirements. This proposed facts-and-circumstances
approach combined with the proposed safe harbor would provide taxpayers
and the IRS with increased certainty regarding the application of
section 355(a)(1)(D)(ii).
Under the facts-and-circumstances approach of proposed Sec. 1.355-
10(c)(2)(ii), the distributing corporation first must establish that
the distribution resulted in a genuine separation of the DSAG and the
CSAG. Second, the distributing corporation must establish that the
retention does not allow the DSAG to retain any practical control over
the CSAG. Third, there must be a sufficient corporate business purpose
for the retention as of the date the plan of distribution or the plan
of reorganization (as applicable) is adopted. Fourth, there must be a
sufficient corporate business purpose for the retention at all times
during the period of retention. Fifth, the disposition of retained
controlled corporation stock (or securities) must not result in less
Federal income tax to the distributing corporation (determined based on
the fair market value and adjusted basis of that stock (or securities)
as of the first distribution date) than if that stock (or securities)
had been distributed in the first distribution.
Consistent with the views set forth in section 2.02(2) of Notice
2024-38, the existence of (i) overlapping officers, directors, or key
employees between the DSAG and the CSAG, and (ii) non-arm's-length
continuing contractual agreements between the DSAG and the CSAG, would
be facts and circumstances indicating that the retention fails the
requirements under section 355(a)(1)(D)(ii). For purposes of proposed
Sec. 1.355-10(c)(2)(ii), the relative weight of those indicia would
depend upon all facts and circumstances, including the corporate
business purpose for the section 355 transaction. For example, such
continuing relationships particularly would weigh against a
determination that the retention satisfies the requirements under
section 355(a)(1)(D)(ii) if the purported corporate business purpose
for the section 355 transaction is so-called ``fit and focus'' (that
is, a separation to enhance the success of the separated businesses by
resolving management, systemic, or other problems that arise by virtue
of the distributing corporation's operation of different businesses
within a single corporation or affiliated group).
3. Consistent Voting Requirements
Regardless of whether a section 355 transaction qualifies for the
section 355(a)(1)(D)(ii) safe harbor, if the section 355 transaction
involves a retention, proposed Sec. 1.355-10(c)(2)(iii) would require
the DSAG to vote any retained controlled corporation stock in
proportion to the votes cast by the controlled corporation's other
shareholders (other than persons related to the distributing
corporation). This proposed requirement is consistent with the long-
standing position of the Treasury Department and the IRS with regard to
section 355(a)(1)(D)(ii), as expressed through several revenue rulings,
revenue procedures, and other sub-regulatory guidance.
4. Plan of Distribution
Consistent with long-standing guidance, the Treasury Department and
the IRS continue to agree with stakeholders that the plan of
reorganization is relevant for determining the applicability of the
definitional and operative provisions under subchapter C to
dispositions of controlled corporation stock. Compare Rev. Rul. 2002-
85, 2002-2 C.B. 986 (concluding that an acquiring corporation's
contribution of a target corporation's assets to a subsidiary
corporation subsequent to a transaction otherwise qualifying as a
reorganization under section 368(a)(1)(D) was ``pursuant to the plan of
reorganization''; therefore, the continuity of business enterprise
(COBE) requirement was not violated); Rev. Rul. 69-142, 1969-1 C.B. 107
(concluding that an acquiring corporation's exchange of its debentures
for those held by bondholders of the target corporation was not part of
the reorganization exchange; therefore, the ``solely for voting stock''
requirement in section 368(a)(1)(B) was satisfied). In this regard, the
``plan of reorganization'' concept provides a useful analogy for
distinguishing distributions to which section 355 should apply from
those to
[[Page 5234]]
which other sections of the Code (such as section 311) should apply.
Accordingly, proposed Sec. 1.355-4 would set forth a series of
provisions pursuant to which a taxpayer would establish its plan of
distribution for distributions to which section 355(c) is purported to
apply. These proposed rules generally would parallel the proposed plan
of reorganization provisions in proposed Sec. 1.368-4, as discussed in
more detail in part III.C of this Explanation of Provisions.
Specifically, under the proposed rules, section 355 would apply to
those distributions that are properly included in the plan of
distribution and, therefore, are treated as ``part of the
distribution'' within the meaning of section 355(a)(1)(D). Thus, for
example, proposed Sec. 1.355-4(d)(2)(iii) would provide that
distributions that are carried out in close temporal proximity with a
section 355(c) distribution are not properly included in the plan of
distribution and therefore would not qualify for nonrecognition
treatment under section 355 unless Federal income tax principles
(including the step transaction doctrine) would apply to determine that
those distributions are in substance part of the plan of distribution
for the section 355(c) distribution.
Additionally, a distribution that is merely one of several (if not
more) contemplated possibilities would not be properly included in the
plan of distribution. Instead, proposed Sec. 1.355-4(d)(1) would
require the distributing corporation to evidence a definite intent to
carry out the distribution through a written commitment in one or more
official records that substantiate the plan of distribution. As
previously discussed in part I.B of this Explanation of Provisions, the
Treasury Department and the IRS disagree with the stakeholders' view
that a plan of distribution should reflect mere transactional
possibilities under a ``wait and see'' approach. Adoption of this
stakeholder recommendation would conflict with the requirement of
section 355(a)(1)(D)(ii) that the non-tax avoidance nature of a
retention be ``established to the satisfaction of the Secretary,''
because it would not be possible for the Secretary to establish the
actual nature of a hypothetical transaction. In addition, adopting this
stakeholder recommendation would both significantly compromise the
IRS's ability to administer and enforce the requirements of section 355
and reduce certainty regarding section 355 qualification.
Under proposed Sec. 1.355-4(a)(2)(i) and (b)(1), the term ``plan
of distribution'' generally would mean a plan of distribution
established by a distributing corporation that satisfies all
requirements set forth in proposed Sec. 1.355-4(c) and that is filed
with the IRS pursuant to proposed Sec. 1.355-5. Proposed Sec. 1.355-
4(a)(2)(iii) and (b)(2) would provide that a plan of distribution also
may be established based on corrections to the taxpayer-filed plan by
the Commissioner based on all relevant facts and circumstances, all
relevant provisions of the Code, and general principles of Federal
income tax law (including the step transaction doctrine). If the
taxpayer fails to file a plan of distribution under proposed Sec.
1.355-5, proposed Sec. 1.355-4(a)(2)(iv) and (b)(2) would provide that
the Commissioner may identify a plan of distribution for the
transaction.
Consistent with the objectives for guidance described in section
2.01 of Notice 2024-38, the proposed plan of distribution provisions
are intended to facilitate taxpayer certainty in identifying
distributions to which section 355 properly should be applied. See, for
example, proposed Sec. 1.355-4(c)(3)(i)(B) (providing a safe harbor
presumption for timely prosecuting the plan of distribution) and (d)
(providing rules for determining whether a distribution is properly
included in the plan of distribution).
In addition, the plan of distribution would provide the IRS with a
single, timely document that identifies all relevant distributions
necessary to determine the appropriate Federal income tax treatment of
the purported section 355(c) distribution. This proposal, combined with
the enhanced reporting requirements for section 355 transactions under
proposed Sec. 1.355-5, would reestablish an appropriate line of sight
for the IRS into taxpayer compliance under section 355, thereby helping
to achieve the compliance and increased certainty objectives. Compare
former Sec. 1.355-5 (effective from November 26, 1960, to May 29,
2006) (requiring the taxpayer to ``attach to its return for the year of
the distribution a detailed statement setting forth such data as may be
appropriate in order to show compliance with the provisions of [section
355]'').
5. Treatment of Delayed Distributions and Retentions
The Treasury Department and the IRS appreciate the feedback
received from stakeholders regarding the similarities between delayed
distributions and retentions. The Treasury Department and the IRS agree
with stakeholders that, because a section 355 transaction requires the
distribution of controlled corporation stock by the distributing
corporation, each of the following could apply to the same transaction:
(i) the ``part of the distribution'' requirement in section
355(a)(1)(D); (ii) the ``in pursuance of the plan of reorganization''
requirement in section 361; and (iii) the retention requirements in
section 355(a)(1)(D)(ii).
In particular, the Treasury Department and the IRS share the
stakeholders' view that, if the distributing corporation does not
distribute all its controlled corporation stock in the first
distribution, the ``delayed distribution'' and ``retention'' labels
give rise to a distinction without a difference in determining the
existence of a genuine separation between the distributing corporation
and the controlled corporation. In this respect, proposed Sec. 1.355-
2(e)(2)(iii) would focus on whether a genuine separation has occurred,
without regard to whether the controlled corporation stock not
distributed as part of the first distribution is disposed of through a
distribution or transfer under section 361(c) or a taxable sale under
section 1001.
However, the Treasury Department and the IRS continue to view the
``part of the distribution'' requirement in section 355(a)(1)(D), the
``in pursuance of the plan of reorganization'' requirement in section
361, and the ``no tax avoidance purpose'' requirement in section
355(a)(1)(D)(ii) as discrete requirements that address discrete issues
reflective of discrete policies. The ``part of the distribution''
requirement in section 355(a)(1)(D) serves as a scoping provision for
the applicability of section 355(a)(1)(D)(i) and (ii) to distributions
of controlled corporation stock. As discussed in parts I.C.4 and III.C
of this Explanation of Provisions, the proposed plan of distribution
and plan of reorganization rules would facilitate the determination of
which distributions are ``part of the distribution.''
As reflected in the legislative history of section 361, the ``in
pursuance of the plan of reorganization'' requirement serves in large
part to limit the application of the operative provisions in subchapter
C to those transactions with a sufficiently proximate relationship with
transactions that qualify under a definitional provision in subchapter
C. See part II.A of the Background.
Lastly, the ``no tax avoidance purpose'' requirement in section
355(a)(1)(D)(ii) serves to ensure there is a genuine separation of the
distributing corporation and the controlled corporation in situations
in which the distributing corporation continues to
[[Page 5235]]
hold controlled corporation stock following the first distribution.
This requirement applies regardless of whether that controlled
corporation stock is disposed of pursuant to the plan of reorganization
under section 361(c).
6. Timing Requirement for Control Distribution
Consistent with the Supreme Court's decision in Gordon (discussed
in part I.D.2 of the Background), proposed Sec. 1.355-2(e)(2) would
require a distributing corporation, pursuant to a plan of distribution
or plan of reorganization, as appropriate, to distribute an amount of
stock of the controlled corporation constituting control (within the
meaning of section 368(c)) either (i) within a single taxable year, or
(ii) over two taxable years, but only if all distributions up to and
including the control distribution are effectuated pursuant to a
binding commitment that is described in the plan of distribution or
plan of reorganization (as applicable). A two-year limitation for
distributing control would provide taxpayers with additional
transactional flexibility while facilitating the IRS's ability to
administer and enforce the requirements of section 355. This approach
would help achieve the increased certainty and transaction facilitation
objectives of these proposed regulations.
7. Requirements for Nonrecognition Treatment
In accordance with the foregoing discussion in this part I.C, these
proposed regulations would revise Sec. 1.355-2(e) to provide that a
distribution does not qualify for nonrecognition treatment under
section 355(a)(1) unless the following requirements are satisfied.
First, proposed Sec. 1.355-2(e)(2)(i) and (ii) would provide that the
distributing corporation must distribute an amount of stock of the
controlled corporation constituting control (within the meaning of
section 368(c)) either (i) within a single taxable year, or (ii) during
two taxable years, subject to the ``binding commitment'' requirement
described in part I.C.6 of this Explanation of Provisions. Second,
proposed Sec. 1.355-2(e)(2)(iii) would provide that any controlled
corporation stock not distributed as part of the first distribution
must satisfy the requirements for a qualifying retention in proposed
Sec. 1.355-10(c).
As previously discussed in parts I.C.1 through 3 of this
Explanation of Provisions, to satisfy the requirements for a qualifying
retention (and to thereby rebut the presumption of a tax avoidance
purpose for the retention), the distributing corporation must: (i)
either qualify for the section 355(a)(1)(D)(ii) safe harbor in proposed
Sec. 1.355-10(c)(3) or satisfy the facts-and-circumstances test in
proposed Sec. 1.355-10(c)(2)(ii); and (ii) vote any retained
controlled corporation stock in proportion to votes cast by the
controlled corporation's other shareholders (other than distributing
corporation related persons). See proposed Sec. 1.355-10(c)(2)(iii).
II. Non-Substantive Modifications to Section 355 Regulations
These proposed regulations would make certain non-substantive
revisions to current Sec. Sec. 1.355-1 and 1.355-4. For example, these
proposed regulations would modify current Sec. 1.355-1 by adding
general definitions that apply for purposes of the section 355
regulations, incorporating the rules in current Sec. 1.355-4 as
proposed Sec. 1.355-1, and moving the applicability dates from current
Sec. 1.355-1(a) to proposed Sec. 1.355-1(e). These revisions are not
intended to make any substantive change.
III. Plan of Reorganization; Party to a Reorganization
A. Notice 2024-38
As stated in section 2.02(4) of Notice 2024-38, the Treasury
Department and the IRS understand that confusion and disagreement
exists regarding the application of the ``plan of reorganization''
requirement to divisive reorganizations. For example, some stakeholders
view the applicability of the ``plan of reorganization'' requirement to
be potentially obviated by the temporal requirements set forth in
section 3.04(6) of Rev. Proc. 2018-53 (concerning delayed satisfaction
of distributing corporation debt). It is the view of the Treasury
Department and the IRS that this is incorrect.
Section 2.02(4) of Notice 2024-38 further states that, although the
``plan of reorganization'' requirement incorporates a degree of
transactional flexibility, such flexibility is limited by current
Sec. Sec. 1.368-1(c) and 1.368-2(g), and the Treasury Department and
the IRS view this requirement as helpful to ensure that delayed
distributions are not used to avoid the repeal of the General Utilities
doctrine (see part I.A.2 of the Background).
B. Stakeholder Input
The Treasury Department and the IRS have received a broad spectrum
of feedback from stakeholders regarding the ``plan of reorganization''
requirement. However, consistent with the view of the Treasury
Department and the IRS set forth in Notice 2024-38, stakeholders
uniformly have contended that this requirement should be applied in a
flexible manner.
Certain stakeholders have described the guidance in current Sec.
1.368-2(g) regarding the meaning and scope of the ``plan of
reorganization'' requirement as circular and incomplete. Those
stakeholders similarly have described Sec. 1.368-1(c) as providing
only conceptual guidance as to which transactions are properly included
in a plan of reorganization. These stakeholders also have described
Sec. 1.368-3(a) as requiring each party to the reorganization to adopt
that plan but then failing to provide any guidance on how such parties
are to satisfy that requirement. Stakeholders have aptly noted that
Notice 2024-38 provided little additional clarity regarding the ``plan
of reorganization'' requirement.
Additionally, certain stakeholders have noted that few cases
address the meaning and scope of the ``plan of reorganization''
concept, and that, even within such cases, courts often have applied
the step transaction doctrine and the substance-over-form doctrine to
determine the existence of a plan of reorganization. For example, one
stakeholder highlighted King Enterprises, Inc. v. United States, 418
F.2d 511 (Ct. Cl. 1969), in which the U.S. Court of Federal Claims
applied the step transaction doctrine to treat the acquisition of stock
of a target corporation (Tenco), followed by the merger of the target
corporation into the acquiring corporation (Minute Maid), as a
reorganization qualifying under section 368(a)(1)(A). The court
identified the threshold issue as ``whether the transfer of Tenco stock
to Minute Maid is to be treated for tax purposes as an independent
transaction of sale, or as a transitory step in a transaction
qualifying as a corporate reorganization,'' which dictated the
resolution of the central issue of ``whether the initial exchange of
stock was a step in a unified transaction pursuant to a `plan of
reorganization'.'' King Enterprises, 418 F.2d at 514-15. Based on an
analysis of the ``operative facts in this case,'' the court applied the
step transaction doctrine to conclude that the two transactions
comprised a single, unified transaction. Id. at 515-16, 519. Even
though no formal plan of reorganization existed, the court relied on
those facts and that analysis to identify a plan of reorganization for
that unified transaction. Id. at 519 n.11 (relying on Redfield v.
Commissioner, 34 B.T.A. 967 (1936), for the proposition
[[Page 5236]]
that ``[a] formal plan or reorganization is not necessary if the facts
of the case show a plan to have existed'').
In Seagram Corp. v. Commissioner, 104 T.C. 75 (1995), the Tax Court
considered whether to integrate (i) an acquisition of stock of a target
corporation (Conoco) through a first-step tender offer made by a
subsidiary of an acquiring corporation (DuPont Tenderor and DuPont,
respectively), and (ii) a subsequent merger of Conoco into DuPont
Tenderor. The court acknowledged that the tender offer and subsequent
merger each possessed independent significance, and that the subsequent
merger was subject to several contingencies. Seagram, 104 T.C. at 93-
94. However, the court emphasized that DuPont and DuPont Tenderor
``were under a binding and irrevocable commitment to complete the
culminating merger--the second step--upon the successful completion of
the DuPont tender offer--the first step.'' Id. at 98. Based on all
facts and circumstances of the tender offer and subsequent merger,
including official records of DuPont and DuPont Tenderor, the court
identified the existence of a plan of reorganization, reasoning that,
``because DuPont was contractually committed to undertake and complete
the second-step merger once it had undertaken and completed the first-
step tender offer, these carefully integrated transactions together
constituted a plan of reorganization within the contemplation of
section 354(a).'' Id. at 98-99 (relying principally on, and noting
satisfaction of, the Supreme Court's binding commitment standard in
Gordon).
Stakeholders also have noted that the Tax Court in Seagram
characterized the ``plan of reorganization'' concept expressed in Sec.
1.368-2(g) as one of ``substantial elasticity,'' relying on the court's
prior observations on that concept in Int'l Telephone. Seagram, 104
T.C. at 96. (In Int'l Telephone, the Tax Court noted that Sec. 1.368-
2(g) ``is imbued with qualities of flexibility and vagueness, with the
result that it does not present precise self-executing guidelines.'' 77
T.C. at 75.) The Tax Court in Seagram also relied on scholarly
commentary for the proposition that, even though Sec. 1.368-2(g) at
that time required a plan of reorganization to be filed with the IRS,
it was self-evident that the IRS and the courts could identify the
existence of a plan of reorganization in the event the taxpayer either
did not file one or filed one that was inaccurate. See Seagram, 104
T.C. at 96 (quoting Peter L. Faber, The Use and Misuse of the Plan of
Reorganization Concept, 38 Tax L. Rev. 515, 523 (1982-1983)).
Stakeholders also have commented on temporal considerations
relating to plans of reorganization. Stakeholders have contended that
the length of time between transactions effectuating a plan of
reorganization should not prevent any particular transaction from being
considered part of the plan. Conversely, these stakeholders have
contended that the temporal proximity of one transaction to another
transaction that is properly included in a plan of reorganization
should not be determinative as to whether the other transaction is
properly included in the plan. Stakeholders also have contended that
imposing a time limitation for completing a plan of reorganization
would be inappropriate.
Additionally, some stakeholders have recommended granting taxpayers
the flexibility to either execute the steps identified in the plan of
reorganization or change them at any time, based on each taxpayer's
judgment on how best to achieve the objectives of their transaction.
However, other stakeholders have recommended clarifying that entering
into a new transaction not contemplated by the plan, even in the
alternative, is not treated as pursuant to the plan of reorganization.
In sum, stakeholders uniformly have described the current
regulations addressing the ``plan of reorganization'' requirement as
lacking sufficient clarity and comprehensiveness. Accordingly, some
stakeholders have requested guidance regarding the metrics needed for a
taxpayer to establish a plan of reorganization. Specifically,
stakeholders have requested guidance regarding (i) the means by which
parties to a reorganization can adopt a plan of reorganization (in
particular, some stakeholders have recommended allowing actions of a
corporation's authorized representatives, and not just formal written
actions of the board, to be taken into account for this purpose), (ii)
transactions that may occur at a future time, are contingent, or are in
the alternative, and (iii) transactions that may develop as a result of
events arising after the plan of reorganization is adopted.
The stakeholder input received has highlighted not only the
deficiencies in authoritative guidance regarding the meaning and scope
of the ``plan of reorganization'' requirement, but also the importance
of this requirement in determining whether the operative provisions of
subchapter C apply to a particular transaction.
C. Proposed Regulations
1. Overview
The Treasury Department and the IRS agree with stakeholders that
the current guidance regarding the ``plan of reorganization''
requirement is inadequate and creates significant confusion. Consistent
with stakeholder recommendations, the proposed regulations would
clarify, among other items, (i) the metrics needed for a taxpayer to
establish a plan of reorganization, (ii) the manner whereby parties to
a reorganization can adopt a plan of reorganization, and (iii) the
requirements for prosecuting a plan of reorganization (including in the
event of a change in circumstances following adoption of the plan). In
proposing this guidance, the Treasury Department and the IRS have
endeavored to balance the importance of providing taxpayers with
transactional flexibility to effectuate bona fide business transactions
with the need to facilitate IRS administration of the reorganization
provisions of subchapter C. Accordingly, the Treasury Department and
the IRS believe that this guidance would help achieve the compliance,
increased certainty, and transaction facilitation objectives of these
proposed regulations. (See the discussion of the objectives for
guidance in part VI of the Background; see also the discussion of the
TIGTA Report in part IV of the Background.)
2. Proposed Rules Regarding Plan of Reorganization
a. Purpose and Effect of Plan of Reorganization
The Treasury Department and the IRS view a plan of reorganization
as serving two related purposes. First, a plan of reorganization serves
to identify those transactions to which the definitional and operative
provisions of subchapter C apply. Second, a plan of reorganization
serves to distinguish transactions the Federal income tax treatment of
which is governed by the reorganization provisions of subchapter C from
transactions to which the general recognition provisions of the Code
(such as section 1001) apply.
However, under the proposed regulations, a taxpayer's failure to
set forth a plan of reorganization in a single, comprehensive document
neither would be determinative as to the existence or scope of a plan
of reorganization for a transaction nor would govern the application of
any definitional or operative provision to that transaction. See
proposed Sec. 1.368-4(a)(3).
[[Page 5237]]
b. Determination of Plan of Reorganization
The proposed regulations would permit a plan of reorganization to
be determined in several different manners. Under the manner preferred
by the Treasury Department and the IRS, a taxpayer would prepare a
single, comprehensive document that satisfies all requirements set
forth in proposed Sec. 1.368-4(d) and file that document with the IRS
as required by proposed Sec. 1.368-3(a)(5) (taxpayer-filed plan of
reorganization). See proposed Sec. 1.368-4(b)(1). The taxpayer-filed
plan of reorganization would contain the information required by prior
and current Sec. 1.368-3(a) and incorporate recommendations of the
TIGTA Report.
Specifically, proposed Sec. 1.368-4(d) would set forth the
following requirements. First, the proposal would require the taxpayer-
filed plan of reorganization to identify (i) all parties to the
reorganization (as required by current Sec. 1.368-3(a)), (ii) all
transactions properly included in the plan of reorganization (as
required by prior Sec. 1.368-3(a)), and (iii) all liabilities
(including debt) to be assumed by the acquiring corporation and the
obligees (or creditors) of those liabilities, and (iv) all debt of the
target corporation that will be satisfied with section 361
consideration and the creditors of that debt. Second, the proposal
would require such plan to describe the intended Federal income tax
treatment of those transactions (which would facilitate implementing
the recommendations of the TIGTA Report). Third, the proposal would
require such plan to describe the corporate business purpose for each
transaction (consistent with current Sec. 1.368-2(g)). Lastly, the
proposal would require such plan to establish that each transaction
facilitates the continuance of the business of a corporation a party to
the reorganization (consistent with current Sec. 1.368-2(g)). See
proposed Sec. 1.368-4(d)(1).
The proposed regulations would reflect a preference that taxpayers
will timely file a complete and accurate plan of reorganization. See
proposed Sec. 1.368-4(c)(1). Accordingly, the Federal income tax
consequences of the subject transactions generally would be determined
in accordance with that plan. See proposed Sec. 1.368-4(a)(2)(i).
Throughout the duration of the transaction or series of transactions,
which potentially could span several taxable years, the IRS would
possess the ability to monitor the taxpayer's execution of that plan of
reorganization (for example, through the taxpayer's annual filing of
Form 7216 for divisive transactions). The Treasury Department and the
IRS intend the proposed approach (i) to increase taxpayer certainty
regarding the Federal income tax treatment of transactions properly
included in a plan of reorganization, and (ii) to facilitate IRS
administration of the reorganization provisions of subchapter C.
However, if a taxpayer files a plan of reorganization with the IRS
that fails to satisfy any requirement set forth in proposed Sec.
1.368-4(d), or if the taxpayer fails to file a plan of reorganization
with the IRS in accordance with proposed Sec. 1.368-3(a)(5), proposed
Sec. 1.368-4(c)(2)(i) recognizes that the Commissioner may correct or
identify a plan of reorganization. Under proposed Sec. 1.368-
4(c)(2)(ii), the Commissioner may determine that a transaction or
series of transactions should be included in, or excluded from, a plan
of reorganization based on (i) all facts and circumstances regarding
the transaction or series of transactions, and (ii) all relevant
provisions of the Code and general principles of Federal income tax
law, including the step transaction doctrine.
The proposed approach is consistent with long-standing caselaw
indicating that the existence and proper scope of a plan of
reorganization can be determined in the absence of formal
documentation. See, for example, Redfield, 34 B.T.A. at 973 (``It is
not necessary, however, that such a plan of reorganization be evidenced
by a formal written document, such as a contract or corporate minutes.
It is sufficient if the circumstances indicate that the various steps
taken were pursuant to a definite plan of reorganization.''); Fry v.
Comm'r, 5 T.C. 1058, 1070 (1945) (similar). The proposed regulations
would reflect this long-standing position because conditioning the
applicability of the definitional and operative provisions of
subchapter C on whether a plan of reorganization formally was prepared
and filed would, in particular and contrary to law, make the
reorganization regime entirely elective.
Nonetheless, the Treasury Department and the IRS are of the view
that formal documentation requirements for taxpayer-filed plans of
reorganization are necessary to facilitate the IRS's administration of
the reorganization provisions of subchapter C. See part III of the
Background. Moreover, the preference for complete and accurate
taxpayer-filed plans of reorganization under proposed Sec. 1.368-
4(c)(1) requires adequate substantiation with the IRS, which would be
provided by objectively verifiable, official corporate documents.
Accordingly, proposed Sec. 1.368-4(d) would enhance the current
reporting requirements for plans of reorganization.
c. Agreement by Parties to Plan of Reorganization; Beginning of Plan of
Reorganization
Proposed Sec. 1.368-4(d)(2) would provide that, prior to the first
step of a reorganization, the plan of reorganization or an original
plan of reorganization that becomes the amended plan of reorganization,
as applicable, must be finalized and adopted by the party to the
reorganization. Taxpayers would demonstrate satisfaction of this
requirement through (i) the acts of duly authorized officers and
directors of the corporation, and (ii) the official records of the
party to the reorganization.
The Treasury Department and the IRS are of the view that the
proposed approach would provide greater taxpayer certainty regarding
the means by which parties to a reorganization can adopt a plan of
reorganization than current Sec. 1.368-3(a), which provides only that
``[t]he plan of reorganization must be adopted by each of the
corporations that are parties thereto.'' As previously discussed in
part III.B of this Explanation of Provisions, the current regulations
have created significant uncertainty due to the lack of guidance on
what constitutes an ``adoption'' by the parties. The proposed
regulations would address this uncertainty in a manner consistent with
prior Sec. 1.368-3(a) and statutory law. See section 806(g)(3) of the
Tax Reform Act of 1976 (Public Law 94-455, 90 Stat. 1520, 1606)
(describing how a corporation is considered to have adopted a plan of
reorganization for purposes of determining the effective date of
certain modifications to sections 382 and 383).
In addition, the proposed substantiation requirements would
facilitate the IRS's administrative function by marking the beginning
of the taxpayer's plan of reorganization--a feature that the Tax Court
also views as important. See Seagram, 104 T.C. at 98 (emphasizing in
its plan of reorganization analysis that the DuPont/Conoco Agreement
``provides a discrete start and finish'').
d. Timing Requirement for Completion of Plan of Reorganization
i. General ``Expeditious Completion'' Requirement
Proposed Sec. 1.368-4(d)(3)(i)(A) and (ii)(A) would require that,
taking into account all facts and circumstances (including the one or
more corporate
[[Page 5238]]
business purposes for a reorganization), all parties to the
reorganization must complete the plan of reorganization as
expeditiously as practicable, and in the manner described in that plan.
The proposed approach takes into account taxpayers' need for
transactional flexibility and reflects the long-standing principle that
the passage of time is not determinative of whether a transaction is
part of a plan of reorganization. See, for example, Wilson v. Comm'r,
T.C. Memo. 1961-135 (``The mere lapse of time is not decisive. The
important thing is that the steps which are taken evidence a consistent
performance of the reorganization plan and purpose.'').
ii. Presumption of Satisfaction if Completion Within 24 Months
However, the Treasury Department and the IRS are concerned that the
lack of a time limitation for completing a plan of reorganization
raises administrability concerns for the IRS. Accordingly, the Treasury
Department and the IRS are (i) issuing proposed Sec. 1.355-5, and (ii)
introducing new Form 7216, to provide the IRS with information
regarding divisive transactions that span multiple tax years. See part
V of the Background.
Additionally, temporal guidelines would provide greater certainty
to taxpayers. In this regard, stakeholders have requested the inclusion
of safe harbors in these proposed regulations to mitigate uncertainty
arising from conceptual rules and facts-and-circumstances
determinations. Based on this feedback, proposed Sec. 1.368-
4(d)(3)(i)(B) would provide that the ``expeditious completion''
requirement is presumed to be satisfied if all parties to a
reorganization complete the plan of reorganization within the 24-month
period beginning on the date of the first step of the plan of
reorganization. This increased certainty would help achieve the
transaction facilitation objective of these proposed regulations, and
providing a 24-month safe harbor would help achieve the compliance
objective of these proposed regulations.
e. Requirements for Transactions To Be Treated as Properly Included in
Plan of Reorganization
i. Overview
Stakeholders have recommended various standards and approaches for
determining whether a transaction is properly included in a plan of
reorganization. As noted by stakeholders, neither current guidance nor
the caselaw regarding the ``plan of reorganization'' requirement
adequately addresses this issue. The proposed regulations would
synthesize the overarching principles of this caselaw into rules that
could be applied by taxpayers and the IRS with significantly greater
certainty than under current Treasury guidance and the caselaw.
ii. Definite Intent Requirement
As a threshold requirement, proposed Sec. 1.368-4(e)(1)(i) would
require that, prior to the first step of a plan of reorganization or an
original plan of reorganization that becomes the amended plan of
reorganization, one or more parties to the reorganization must evidence
a definite intent to carry out the transaction. This definite intent
must be evidenced through a written commitment in one or more official
records of the party that substantiate the plan of reorganization.
Under this proposal, the existence of contingencies or conditions would
not be conclusive in determining whether a party to the reorganization
satisfies this requirement.
The ``definite intent'' standard is intended to provide sufficient
transactional flexibility to encourage bona fide business transactions
in a manner consistent with long-standing caselaw. The origins of the
``definite intent'' standard can be traced back to judicial opinions of
the Board of Tax Appeals (BTA), the predecessor to the Tax Court. For
example, in Fry v. Commissioner, the BTA relied on this standard for
determining the existence of a plan of reorganization from ``what
appear[ed] on the minutes of the meeting of the stockholders and the
meeting of the board of directors of the old bank,'' which had
articulated the business objectives and transaction steps for the
reorganization. 5 T.C. at 1070; see also Redfield, 34 B.T.A. at 973
(noting that, although a formal written plan of reorganization is not
necessary, the circumstances evidencing that a reorganization occurred
need to indicate that the various steps taken in pursuance thereof were
taken ``pursuant to a definite plan of reorganization'') (emphasis
added); Seagram, 104 T.C. at 97 (observing that the DuPont/Conoco
Agreement ``definitively states the terms for `the acquisition of
[Conoco] by [DuPont Tenderor and]' sets out . . . the series of
transactions which in their totality were intended to accomplish a
section 368 reorganization'').
In contrast, courts have determined that transactions subject to a
lesser degree of intent or predominated by uncertainty are not properly
included in a plan of reorganization. For example, in National Bank of
Commerce in Memphis v. United States, 87 F. Supp. 302 (W.D. Tenn.
1949), the court concluded that a transaction contemplated prior to the
plan of reorganization was not properly included in that plan because
the transaction was uncertain and indefinite as of the time of the
first step of the plan of reorganization. 87 F. Supp. at 304. The court
emphasized that ``[a]n element in a plan of reorganization that cannot
be legally enforced and, in addition is fraught with much uncertainty,
is indefinite and not necessary to the reorganization, cannot be
considered as one of the steps resulting in the completed
transaction.'' Id. Accordingly, if the parties did not anticipate or
otherwise contemplate a transaction prior to the adoption of the plan
of reorganization, that transaction cannot be included in that plan.
See Atwood Grain & Supply Co. v. Comm'r, 60 T.C. 412, 423 (1973)
(observing that ``[t]here [wa]s no evidence that issuance of the
preferred stock was contemplated either in the merger negotiations or
in the merger agreement,'' and reasoning that, ``[i]n order to include
events occurring after a merger in the plan of merger there must be
some anticipation of the event in the merger'').
Stakeholders have noted that a ``plan of reorganization'' concept
that includes every possibility considered by any taxpayer in
connection with a reorganization would be overbroad and meaningless.
Indeed, a commenter relied upon by the Tax Court for its analysis in
Seagram noted that ``[t]he contemplated possibility standard is too
broad. . . . A more appropriate standard would be to link the later
transaction to the earlier one only if there is a firm commitment to
consummate it.'' Faber, The Use and Misuse of the Plan of
Reorganization Concept, 38 Tax L. Rev. at 547. The Treasury Department
and the IRS agree that such a standard would not be appropriate for the
proposed regulations. Accordingly, proposed Sec. 1.368-4(e)(1)(iii)(A)
would provide that mere contemplation that a transaction may be carried
out would not be sufficient to satisfy the ``definite intent''
requirement, regardless of whether that contemplated transaction is
included in an official record of the party.
However, the Treasury Department and the IRS recognize that the
``contemplated possibility'' standard is relevant for certain plan of
reorganization determinations. Accordingly, proposed Sec. 1.368-
4(e)(1)(iii)(B) would provide that a party's mere contemplation of a
transaction may be relevant for purposes of the correction or
identification of a plan of reorganization by the
[[Page 5239]]
Commissioner. As previously discussed in part III.C.2.b. of this
Explanation of Provisions, the Commissioner's determination under
proposed Sec. 1.368-4(c)(2)(ii) would be based on all facts and
circumstances pertaining to the transaction and the application of all
relevant Code provisions and Federal income tax principles, including
the step transaction doctrine.
Permitting the IRS to determine the outer reaches of the scope of
transactions potentially includable in a plan of reorganization through
an analysis of all facts and circumstances and Federal income tax
principles would be consistent with judicial authorities that have
applied a ``contemplated possibility'' test. For example, in Anheuser-
Busch, Inc. v. Commissioner, 40 B.T.A. 1100 (1939), the BTA relied on
substance-over-form principles to determine the scope of transactions
included in a plan of reorganization, based on its determination that a
first-step transfer to a parent corporation was ``transitory and
without real substance.'' 40 B.T.A. at 1106. As part of its analysis,
the court observed that the parent had ``contemplated,'' but was not
obligated to carry out, the immediate transfer of the property received
to its subsidiary, and the court expanded the scope of the plan of
reorganization to include that second-step transfer. Id. at 1106-07
(relying on the substance-over-form analysis of Helvering v. Bashford,
302 U.S. 454, 458 (1938)). Other judicial opinions similarly have used
the existence of a contemplated possibility in this manner. See, for
example, Avco Mfg. Corp. v. Comm'r, 25 T.C. 975, 984-85 (1956) (noting
that a ``subsequent transfer of the property . . . was a contemplated
possibility under the plan that actually eventuated'' and was properly
included within the scope of the plan of reorganization under the
mutual interdependence test); Transport Products Corp. v. Comm'r, 25
T.C. 853, 857-58 (1956).
Once a definite intent is established, the existence of
contingencies and other conditions that could affect prosecution of the
plan of reorganization are not treated as diminishing that level of
intent. See, for example, Seagram, 104 T.C. at 96 (``DuPont had an
indisputable legal obligation to complete the Merger with Conoco,
notwithstanding the possibility of intervening legal impediments, or
contingencies, which in fact, never materialized''). Accordingly,
proposed Sec. 1.368-4(e) would provide that, for purposes of
determining whether a party to a reorganization satisfies the
``definite intent'' requirement, the existence of contingencies or
conditions is not conclusive.
Section 355 transactions would be subject to a special definite
intent requirement under proposed Sec. Sec. 1.355-4(d)(1)(ii) and
1.368-4(e)(1)(ii). Specifically, if a control distribution occurs in a
later taxable year than the first distribution, the distributing
corporation would not be treated as establishing a definite intent
unless all distributions up to and including the control distribution
are effectuated pursuant to a binding commitment. This proposed special
``definite intent'' requirement would reflect the Supreme Court's
decision in Gordon. See also the discussion in part I.D.2 of the
Background.
iii. Proximate Relationship Requirement
(a) Overview
The proposed regulations would set forth standards for determining
whether a transaction shares a sufficient relationship with other
transactions to which a definitional or operative provision applies. To
reflect the distinct purposes for, and requirements of, the
definitional provisions and the operative provisions in subchapter C,
the proposed regulations would set forth two different sets of
proximate relationship requirements.
(b) Necessary or Integral Test for Qualification Under Definitional
Provisions
Under proposed Sec. 1.368-4(e)(2)(i)(A), a transaction would be
treated as part of the plan of reorganization for a reorganization to
which a definitional provision can apply only if, on its own or as part
of a series of transactions, the transaction either (i) is necessary to
satisfy one or more requirements of the definitional provision, or (ii)
is an integral part of a series of transactions carried out to satisfy
the requirements of the definitional provision. In practice, the
``integral part'' test generally would be relevant for transactions
that are not ``necessary to satisfy'' one or more requirements of a
definitional provision. The proposed regulations would require
satisfaction of either condition to be evidenced by a written
commitment in one or more official records of the party to the
reorganization. See proposed Sec. 1.368-4(e)(2)(i)(A).
The ``necessary to satisfy'' condition is intended to convey, with
more precision, a requirement set forth in current Sec. 1.368-2(g).
Section 1.368-2(g) states, in part, that ``[t]he term plan of
reorganization has reference to a consummated transaction specifically
defined as a reorganization under section 368(a).'' In addition,
current Sec. 1.368-2(g) provides that ``[t]he term is not to be
construed as broadening the definition of `reorganization' as set forth
in section 368(a).'' The Treasury Department and the IRS view the
``necessary to satisfy'' condition as already clear (given that the
definitional provisions in section 368(a)(1) describe the steps
necessary for qualification) but have rearticulated this standard to
eliminate the circularity and vagueness that courts and stakeholders
have identified in current Sec. 1.368-2(g). See Int'l Telephone, 77
T.C. at 75 (noting such vagueness); Seagram, 104 T.C. at 96
(highlighting the Tax Court's observation in Int'l Telephone).
The ``integral part'' condition also is embedded in current Sec.
1.368-2(g), which provides that the term ``plan of reorganization'' is
to be taken as limiting the nonrecognition of gain or loss to ``such
exchanges or distributions as are directly a part of the transaction
specifically described as a reorganization in section 368(a)''
(emphasis added). The Treasury Department and the IRS view this
``directly a part'' standard as less stringent than the ``necessary to
satisfy'' standard but nonetheless view it as mandating that a
transaction must be essential to qualifying a series of transactions as
a reorganization. Accordingly, the proposed regulations would replace
the phrase ``directly a part of the transaction'' with an ``integral
part'' standard.
The proposed ``integral part'' standard is intended to reflect the
structure of section 368(a)(1) and the long-standing position of the
IRS and the courts. For example, a distributing corporation that
retains controlled corporation stock may qualify under section 355--and
therefore ultimately may satisfy a condition in section 368(a)(1)(D)--
through multiple types of dispositions of controlled corporation stock.
In each instance, such disposition may be viewed as integral to section
368(a)(1)(D) qualification. (See also the requirements for qualifying
retentions previously discussed in part I.C of this Explanation of
Provisions.)
The foregoing principle is reflected in Rev. Rul. 57-518, 1957-2
C.B. 253, which addressed whether a transaction satisfied a prior
version of section 368(a)(1)(C) that did not yet impose a liquidation
requirement. In Rev. Rul. 57-518, a target corporation transferred 70
percent of its assets to an acquiring corporation for acquiring
corporation voting stock. The target corporation then disposed of all
its remaining assets in recognition transactions (that is, not under
the operative nonrecognition
[[Page 5240]]
provisions of subchapter C) and liquidated. Although the liquidation
was not described in, or required by, that prior version of section
368(a)(1)(C), the IRS concluded that the liquidation was part of the
plan of reorganization. Like the disposition by a distributing
corporation of retained controlled corporation stock in a transaction
to which section 1001 applies, the target corporation liquidation was
not necessary to achieve qualification under section 368(a)(1), but it
was an integral part of a series of transactions carried out to satisfy
the requirements of that definitional provision.
(c) But for, or Integral to, Test for Application of Operative
Provision
Under proposed Sec. 1.368-4(e)(2)(i)(B), a transaction would be
treated as part of the plan of reorganization to which an operative
provision can apply only if, on its own or as part of a series of
transactions, the transaction either (i) would not have occurred but
for the reorganization that is covered by the plan of reorganization,
or (ii) is an integral part of a series of transactions carried out to
satisfy the requirements of the definitional provision intended to
apply to the reorganization. The proposed regulations would require
satisfaction of either condition to be evidenced by a written
commitment in one or more official records of the party to the
reorganization. Both of these conditions are intended to replace the
``directly a part of'' standard set forth in current Sec. 1.368-2(g)
with standards that are clearer and more reflective of the purpose and
requirements of the operative provisions in subchapter C.
The proposed ``but for'' condition is embedded within the
``directly a part of'' requirement in current Sec. 1.368-2(g). Among
other objectives, this proposed condition is intended to help clarify
the determination of whether an operative provision applies to a
distribution that occurs within close temporal proximity to one or more
transactions that are properly included in a plan of reorganization.
For example, in determining whether section 361(b) should apply to a
distribution by a distributing corporation to its shareholders in close
temporal proximity to a divisive reorganization, the proposed ``but
for'' test would clarify that section 361(b) treatment would be
applicable only if that distribution would not have occurred ``but
for'' the divisive reorganization. See the examples in proposed Sec.
1.361-3(f)(2) through (5).
An ``integral part'' standard also would increase taxpayer
certainty as compared to the current ``directly a part of'' standard,
particularly because courts historically have applied an ``integral
part'' standard. For example, in Sheldon v. Commissioner, 6 T.C. 510
(1946), the Tax Court found that a transaction was integral to a merger
even though the transaction was not necessary for qualification for a
definitional provision under section 368(a)(1). In Sheldon, the Tax
Court considered whether a pre-merger distribution should be included
in the plan of reorganization for the merger. 6 T.C. at 517-18. The
court emphasized that the pre-merger distribution was made to equalize
values of the target corporation and the acquiring corporation so that
the merger could be one of equals, thereby satisfying a condition for
executing the merger. Id. In its analysis, the court provided that
``[t]he purpose of this distribution, its place in the sequence of
events, and the surrounding circumstances, lead to but one conclusion.
They all demonstrate that it was an integral part of the reorganization
transaction as a whole and must be treated in connection with it.'' Id.
at 517. See also Int'l Telephone, 77 T.C. at 76 (noting the absence of
``a binding agreement or other factors indicating that conversion [of
debentures] was an integral part of the plans of reorganization'').
Additionally, the Treasury Department and the IRS are of the view
that replacing the ``directly a part of'' standard in current Sec.
1.368-2(g) with the standards in proposed Sec. 1.368-4(e)(2)(i)(B)
would improve taxpayer certainty in determining the applicability of an
operative provision of subchapter C. Proposed Sec. 1.368-4(e) would
provide additional certainty by requiring the ``but for'' standard to
be applied in tandem with the ``definite intent'' requirement set forth
in proposed Sec. 1.368-4(e)(1). In other words, a transaction would
not be properly included in a plan of reorganization if the party to
the reorganization failed to evidence a definite intent to carry out
that transaction, regardless of whether the transaction would not have
occurred ``but for'' the reorganization.
This implementation of the ``but for'' standard would be consistent
with judicial authorities, including those cited by stakeholders. For
example, in International Telephone, the Tax Court considered exchanges
involving debentures that could not have occurred but for the execution
of a reorganization that qualified under section 368(a)(1)(C). 77 T.C.
at 72-78. Although the court observed the existence of that ``but for''
relationship, the court reasoned that ``[t]he fact that [the acquiring
corporation] assumed the conversion obligation as part of the plans of
reorganization does not mean . . . that the subsequent conversions and
retirement of the debentures were also part of the reorganizations.''
Id. at 76. Based on the lack of indicia indicating satisfaction of the
proposed ``direct intent'' requirement, the Tax Court concluded that
such exchanges were not properly included in the plan of
reorganization. See id. at 76-77 (noting the lack of any binding
agreement, any other type of obligation, or other facts that would
indicate satisfaction of the ``direct intent'' requirement). See also
Becher v. Comm'r, 22 T.C. 932 (1954) (treating a distribution as not
part of the plan of reorganization under the predecessor to section
368(a)(1)(D), and therefore not ``boot,'' based on an examination of
the facts and circumstances of the distribution and the transactions
comprising the reorganization).
(d) Independent Legal Significance; Temporal Proximity
Proposed Sec. 1.368-4(e)(2)(ii) would confirm that the independent
significance of a transaction (for example, the fact that the
transaction has a separate business motive apart from the
reorganization) does not preclude satisfaction of the proximate
relationship requirements in proposed Sec. 1.368-4(e)(2)(i)(A) and
(B). The Treasury Department and the IRS view this approach as
consistent with established caselaw (see Seagram, 104 T.C. at 91-93)
and reflective of the realities of bona fide business transactions. It
has long been the understanding of the Treasury Department and the IRS
that a transaction could be included in the plan of reorganization even
though it may have separate business motives, or separate and permanent
legal, economic, and business consequences, apart from the
reorganization.
Additionally, proposed Sec. 1.368-4(e)(2)(iii) would provide that
a transaction occurring in close temporal proximity to one or more
other transactions is not properly included in a plan of reorganization
unless Federal income tax principles (including the step transaction
doctrine) would apply to determine that the transaction was, in
substance, part of the plan of reorganization.
iv. Business Purpose Consistency Requirement
Lastly, in order for a transaction to be treated as properly
included in a plan of reorganization, proposed Sec. 1.368-4(e)(3)
would require the transaction (on its
[[Page 5241]]
own, or as part of a series of transactions) to be consistent with, and
directly related to, one or more corporate business purposes for the
reorganization (for example, the transaction directly furthers one or
more corporate business purposes for the reorganization).
The Treasury Department and the IRS view the proposed corporate
business purpose consistency requirement as reflective of established
caselaw. See Seagram, 104 T.C. at 83, 97 (noting that the tender offer
and the merger shared the same corporate business purpose of enabling
DuPont to acquire all the stock of Conoco). In addition, the Treasury
Department and the IRS view this proposed rule as conceptually grounded
in current Sec. 1.368-2(g), which provides that ``the readjustments
involved in the exchanges or distributions effected in the consummation
[of the reorganization] must be undertaken for reasons germane to the
continuance of the business of a corporation a party to the
reorganization.''
f. Amended Plan of Reorganization
The Treasury Department and the IRS recognize that, in certain
circumstances, taxpayers may need to amend their plans of
reorganization. Accordingly, proposed Sec. 1.368-4(f)(1) would provide
that, if a taxpayer amends a plan of reorganization after the first
step of the original plan (amended plan of reorganization), those
amendments do not cause the taxpayer to fail to satisfy the ``plan of
reorganization'' requirements set forth in proposed Sec. 1.368-4(d)
only if the following requirements are satisfied. First, the amendments
to the plan must be in direct response to an identifiable, unexpected,
and material change in market or business conditions that occurs after
the date on which the original plan of reorganization is adopted by the
party to the reorganization. Second, the amendments must be necessary
to effectuate the reorganization. Third, the amended plan of
reorganization must satisfy all requirements set forth in proposed
Sec. 1.368-4(d) to qualify as a plan of reorganization.
If the taxpayer satisfies the requirements in proposed Sec. 1.368-
4(f)(1), proposed Sec. 1.368-4(f)(2)(i) would provide that the
definitional and operative provisions described in proposed Sec.
1.368-1(c)(2)(i) and (ii) would apply to the transactions identified
in, and carried out pursuant to, the amended plan of reorganization. In
other words, the proposed regulations would confirm that the Federal
income tax consequences of all transactions properly included in the
amended plan of reorganization would be determined based on that plan
of reorganization (and not on the original plan of reorganization).
However, proposed Sec. 1.368-4(f)(2)(ii) would provide that, if the
amended plan of reorganization fails to satisfy the requirements in
proposed Sec. 1.368-4(f)(1), the Commissioner may correct or identify
the amended plan of reorganization.
3. Proposed Rules Regarding Party to a Reorganization
In addition to providing rules regarding the determination,
adoption, and prosecution of a plan of reorganization, the proposed
regulations would revise current Sec. 1.368-2(f) to further clarify
(i) which persons are parties to a reorganization, and (ii) the
consequences of determining that a person is (or is not) a party to a
reorganization.
Proposed Sec. 1.368-2(f)(1) generally would provide that the
definitional and operative provisions described in Sec. 1.368-
1(c)(2)(i) and (ii), respectively, apply solely to a transaction that
is carried out by, between, or among one or more parties to a
reorganization. For purposes of determining the scope of transactions
to which those provisions apply, the term ``party to a reorganization''
would be limited under proposed Sec. 1.368-2(f)(2) through (4) solely
to a corporation that (i) engages in a transaction or series of
transactions that satisfies a definitional provision set forth in
section 368(a)(1), and (ii) is determined to be a party to a
reorganization, as further described in the following paragraph.
In general, proposed Sec. 1.368-2(f)(4)(i) would provide that a
corporation's status as a party to a reorganization is established
solely by the inclusion and identification of the corporation as a
party to the reorganization in a plan of reorganization filed with the
IRS pursuant to proposed Sec. 1.368-3(a)(5). However, proposed Sec.
1.368-2(f)(4)(ii) would provide that the corporation's status as a
party to a reorganization may be determined by the Commissioner based
on (i) all facts and circumstances regarding the transaction or series
of transactions, and (ii) all relevant provisions of the Code and
general principles of tax law, including the step transaction doctrine.
Proposed Sec. 1.368-2(f)(3)(ii) would retain the rules in current
Sec. 1.368-2(f) regarding the impact of certain transfers of assets or
stock in a reorganization on a person's status as a party to the
reorganization.
IV. Application of Substance-Over-Form, Agency, and Other Relevant
Theories to Intermediated Exchanges and Direct Issuance Transactions
A. Notice 2024-38
In section 2.02(5) of Notice 2024-38, the Treasury Department and
the IRS announced that they are continuing to study the application of
the Code, as well as general principles of Federal income tax law
(including substance-over-form, agency, or other relevant theories), to
monetization transactions involving section 361 consideration. In
particular, this study continues to focus on intermediated exchanges,
which occur through (i) the acquisition by an intermediary (such as an
investment bank) of historical distributing corporation debt from
holders of that debt, and (ii) the subsequent satisfaction of that debt
by the distributing corporation using section 361 consideration.
As capital market transactions have evolved, this study also has
focused increasingly on direct issuance transactions, which typically
occur through: (i) the issuance of new debt by a distributing
corporation to an intermediary for cash in anticipation of a divisive
reorganization; (ii) the use of that cash by the distributing
corporation to satisfy historical distributing corporation debt, during
a potentially indefinite period; and (iii) the satisfaction of that new
debt by the distributing corporation through the transfer of section
361 consideration to the intermediary.
This study reflects the long-standing position of the Treasury
Department and the IRS that general principles of Federal income tax
law (including substance-over-form, agency, or other relevant theories)
apply to determine the Federal income tax consequences of all
transactions, including such monetization transactions. See United
States v. Fruehauf Corp., 577 F.2d 1038, 1068 (6th Cir. 1978) (``The
incidence of federal taxation has always depended upon the substance of
transactions . . .''). Indeed, this position is consistent with nearly
a century of Supreme Court precedent beginning with the Court's
decision in Gregory v. Helvering, which established that the
application of the Code to a transaction (or series of transactions)
turns on the substance of the transaction. See Gregory, 293 U.S. at
467-70 (concluding that the ``reorganization attempted was without
substance and must be disregarded [and] [t]o hold otherwise would be to
exalt artifice above reality and to deprive the statutory provision in
question of all serious purpose'');
[[Page 5242]]
United States v. Iles, 906 F.2d 1122, 1127 (6th Cir. 1990) (``The
Supreme Court has recognized, at least as far back as Gregory v.
Helvering . . . that substance over form governs federal taxation.'')
(citations omitted).
The application of substance-over-form and similar doctrines can
affect qualification for nonrecognition treatment under section 361.
Notice 2024-38 conveyed the long-standing view of the Treasury
Department and the IRS that the application of agency principles to an
intermediated exchange involving so-called ``old and cold''
distributing corporation debt could cause that transaction to be
recharacterized for Federal income tax purposes such that the
distributing corporation would not be treated as transferring section
361 consideration to a creditor in satisfaction of distributing
corporation debt. In other words, if the intermediary were found to be
acting on behalf of the distributing corporation under agency
principles, transfers of section 361 consideration to the intermediary
would not satisfy the requirements for nonrecognition under section
361. With respect to a direct issuance transaction in which the
distributing corporation issues and redeems the new debt in close
temporal proximity, the Treasury Department and the IRS are of the view
that the transaction could be recast under general principles of
Federal income tax law such that the nonrecognition requirements under
section 361 are not satisfied.
B. Stakeholder Input
1. Intermediated Exchanges
Stakeholders have contended that intermediated exchanges should not
be subject to recharacterization, provided that the distributing
corporation establishes the intermediary's status as a creditor acting
for its own account under agency principles. Stakeholders have stated
that this approach would be consistent with Rev. Rul. 2017-9, 2017-21
I.R.B. 1244, because intermediated exchanges (i) do not conflict with
the underlying policy of section 361(c)(3), (ii) do not avoid the
result intended by section 361(c)(3) (that is, the reallocation of
historical distributing corporation liabilities to the controlled
corporation), and (iii) do not produce results that are inconsistent
with the underlying intent of section 361(c)(3). In other words,
stakeholders have suggested that, in determining whether an
intermediated exchange should be recharacterized, the relevant question
is whether the distributing corporation debt acquired by the
intermediary was issued with a purpose of avoiding any requirement or
limitation under section 361.
In this regard, one stakeholder has requested guidance providing
that steps of an intermediated exchange will not be recast under
Federal income tax principles if (i) the intermediary acts on its own
account in acquiring distributing corporation debt from third parties
(that is, the intermediary becomes the owner of such debt for Federal
income tax purposes and the acquisition is not funded or guaranteed by
the distributing corporation), (ii) the intermediary assumes the risk
that the distributing corporation may default on its debt while such
debt is held by the intermediary, and (iii) the distributing
corporation debt acquired by the intermediary was not issued with a
purpose of avoiding the requirements or limitations of section 361.
Another stakeholder has recommended that the Treasury Department
and the IRS refrain from issuing substantive guidance given the fact-
intensive nature of determining whether an intermediated exchange
should be recast. The stakeholder has recommended that the IRS continue
to issue private letter rulings on a case-by-case basis to taxpayers
that are able to establish an intermediary's status as a creditor
acting for its own account by reference to the factors specified in a
series of technical advice memoranda previously issued by the IRS. See
T.A.M. 8815003 (Dec. 11, 1987); T.A.M. 8738003 (May 22, 1987); T.A.M.
8735007 (May 18, 1987); T.A.M. 8735006 (May 18, 1987).
2. Direct Issuances
Stakeholders have provided various recommendations to the Treasury
Department and the IRS regarding the treatment of direct issuance
transactions. Stakeholders uniformly have contended that the proposed
regulations should recast or recharacterize a direct issuance
transaction only if the transaction presents an abuse within the
meaning of section 361(b)(3). In addition, stakeholders consistently
have contended that the policy of section 361 confirms that direct
issuance transactions satisfy the requirements for nonrecognition
treatment under section 361. Although one stakeholder has acknowledged
that, in some circumstances, the Treasury Department and the IRS may
have a legitimate concern that a direct issuance transaction should be
treated as a sale of controlled corporation stock to the intermediary,
the stakeholder has noted that delineating the exact bounds of an
abusive transaction as it relates to section 361(b)(3) and (c)(3) would
be difficult. Accordingly, stakeholders generally have recommended that
the Treasury Department and the IRS continue to address the section 361
qualification of direct issuance transactions through the IRS's private
letter ruling program rather than through Treasury regulations.
Alternatively, stakeholders have recommended that the proposed
regulations set forth specific safe harbors for direct issuance
transactions that, after adequately taking into account commercial
considerations (which one stakeholder has referred to as ``commercially
grounded carveouts''), clearly would not present evidence of abuse. One
stakeholder has recommended that a direct issuance transaction be
respected as a borrowing if: (i) the newly issued debt qualifies as
debt for Federal income tax purposes; (ii) the new debt issuance and
the exchange agreement with the intermediary (regarding satisfaction of
the newly issued debt with controlled corporation stock or securities)
are pursuant to two legally separate agreements; (iii) the distributing
corporation is not under economic compulsion to satisfy the newly
issued debt with controlled corporation stock or securities at the time
of issuance because the distributing corporation has sufficient other
resources to repay the debt; (iv) the newly issued debt is satisfied
with controlled corporation stock or securities having a fair market
value equal to the principal amount and unpaid interest on the debt;
and (v) the distributing corporation retains tax ownership of the
controlled corporation stock or securities until the time of repayment.
Another stakeholder has suggested additional factors to be
considered, including (i) the number of days the newly issued debt is
outstanding before the exchange of that debt for controlled corporation
stock or securities, and (ii) whether the intermediary participating in
the direct issuance transaction is a member of a syndicate of lenders
that has historically provided debt financing to the distributing
corporation. Additionally, a stakeholder has recommended (i) limiting
permissible direct issuance transactions to situations in which the
proceeds of the new debt are used to retire historical debt, and (ii)
including a general anti-avoidance rule based on the distributing
corporation's business purpose for entering into the direct issuance
transaction.
[[Page 5243]]
C. Proposed Regulations
1. Overview
The Treasury Department and the IRS continue to be of the view
that, under certain circumstances, intermediated exchanges and direct
issuance transactions can be recast or otherwise recharacterized under
Federal income tax principles. Certain stakeholders have described the
aforementioned concerns of the Treasury Department and the IRS with
respect to such transactions as new or as deriving primarily from
direct issuance transactions or refinancing transactions.
However, these concerns are neither new nor unique. As confirmed
almost a century ago by the Supreme Court in Gregory v. Helvering, the
application of substance over form and other general Federal income tax
principles is inseparable from the application of the Code itself. See
also Newman v. Comm'r, 894 F.2d 560, 562 (2d Cir. 1990) (emphasizing
that, ``in reviewing a transaction for tax consequences, the substance
of the agreement takes precedence over its form''). Accordingly, one
objective of these proposed regulations is to clarify that general
Federal income tax principles apply with regard to the application of
section 361 just as such principles would apply with regard to the
application of other Code provisions.
With regard to the application of section 361 to intermediated
exchanges, the Treasury Department and the IRS note that concerns
regarding agency and substance over form date back decades to a series
of technical advice memoranda that considered the application of a
prior version of section 108 of the Code to conceptually similar
intermediated exchanges of stock and securities. See T.A.M. 8815003
(Dec. 11, 1987); T.A.M. 8738003 (May 22, 1987); T.A.M. 8735007 (May 18,
1987); T.A.M. 8735006 (May 18, 1987). The so-called ``5/14 standard''
in corporate private letter rulings developed out of concerns similar
to those discussed in those memoranda. (Under this standard, rulings
generally would be issued by the IRS if: (i) the intermediary purchased
distributing corporation debt; (ii) after at least five days, the
intermediary and the distributing corporation entered into an agreement
to exchange the purchased distributing corporation debt for section 361
consideration; and (iii) the exchange occurred at least 14 days after
the intermediary purchased the distributing corporation debt.)
With regard to the application of section 361 to direct issuance
transactions, the Treasury Department and the IRS have expressed
similar concerns for more than a decade. In particular, the Treasury
Department and the IRS ceased considering certain private letter ruling
requests under section 361 in part due to this type of section 361
monetization transaction. See section 5.01(10) of Rev. Proc. 2013-3,
2013-1 I.R.B. 113. As explained by Treasury Department and IRS
officials at that time, these transactions raised issues concerning the
application of general principles of Federal income tax, including the
substance-over-form doctrine. Stakeholders also raised similar issues
at that time.
In addition, certain stakeholders have mischaracterized the
concerns of the Treasury Department and the IRS as focused principally
on (i) whether the new debt should be respected as a debt instrument
for Federal income tax purposes, or (ii) temporal proximity. With
regard to the former point, certain stakeholders have provided feedback
on Notice 2024-38 emphasizing debt-equity factors or have noted that,
outside of Federal income tax (for example, under securities law), new
debt issued by a distributing corporation in a direct issuance
transaction would be treated as debt.
However, as previously discussed in this part IV.C.1, the Treasury
Department and the IRS are concerned with the application of the Code
and Federal income tax principles--not commercial law or other non-
Federal income tax law--to intermediated exchanges and direct issuance
transactions. In particular, as expressed in Notice 2024-38, the
concern is not simply the status of the newly issued distributing
corporation debt as debt for Federal income tax purposes, but also that
the form of those debt-elimination transactions should be respected and
not recharacterized under Federal income tax principles.
With regard to the latter point, the Treasury Department and the
IRS replaced the 5/14 standard for private letter rulings in Rev. Proc.
2018-53 with a standard based on a facts-and-circumstances analysis.
This change was made due to concerns that the 5/14 standard provided a
temporal requirement that was indifferent to the particular facts and
circumstances of the transaction, including the intermediary's
relationship with the distributing corporation. As a consequence, the
Treasury Department and the IRS observed that the 5/14 standard created
confusion for taxpayers as to whether temporal proximity is the sole
consideration with regard to the application of agency or substance-
over-form principles to intermediated exchanges and direct issuance
transactions.
The Treasury Department and the IRS also continue to be of the view
that Rev. Rul. 2017-9 and other revenue rulings mentioned by
stakeholders in their submitted feedback do not (and cannot) set forth
broadly applicable principles that would dictate the positions set
forth in these proposed regulations. One reason is that there are long-
established limitations on the precedential value of revenue rulings.
Specifically, ``[r]evenue rulings published in the [Internal Revenue]
Bulletin do not have the force and effect of Treasury Department
regulations (including Treasury Decisions), but are published to
provide precedents to be used in the disposition of other cases, and
may be cited and relied upon for that purpose.'' Section
601.601(d)(2)(v)(d) of the Statement of Procedural Rules (codifying
section 7.01(4) of Rev. Proc. 89-14, 1989-8 I.R.B. 20). In addition,
``[e]ach revenue ruling represents the conclusion of the Service as to
the application of the law to the entire statement of facts involved,''
as opposed to an application outside of that entire statement of
relevant facts. Section 601.601(d)(2)(v)(d) (codifying section 7.01(6)
of Rev. Proc. 89-14). Based on these limitations, ``taxpayers, Service
personnel, and others concerned are cautioned against reaching the same
conclusion in other cases unless the facts and circumstances are
substantially the same.'' Section 601.601(d)(2)(v)(e).
Another reason is that, in almost all instances, the facts and
circumstances set forth in the revenue rulings mentioned by
stakeholders are not substantially the same as the transaction facts
considered by the Treasury Department and the IRS in developing these
proposed regulations. See Rev. Rul. 2017-9 (providing that ``[t]his
revenue ruling provides guidance regarding the federal tax treatment of
certain transactions referred to as `north-south' transactions,''
rather than intermediated exchanges or direct issuance transactions);
Rev. Rul. 59-197, 1959-1 C.B. 77 (considering the potential effect of a
``cash sale to the key employee'' of the distributing corporation on
section 355 qualification, rather than an intermediated exchange or a
direct issuance transaction). Accordingly, those revenue rulings
address entirely different provisions of the Code. See Rev. Rul. 2017-9
(addressing the application of, and qualification under, sections 301,
351, 355, and 361(b)(1) and (2) (not section 361(b)(3) and (c)(3));
Rev. Rul. 59-197 (addressing the application of the device
[[Page 5244]]
and continuity of interest requirements under section 355, not section
361(b)(3) and (c)(3)).
However, the Treasury Department and the IRS are of the view that
the facts and analysis set forth in Rev. Rul. 79-258 are relevant for
purposes of developing proposed regulations under section 357(b).
Accordingly, based on a de novo consideration of the analysis set forth
in that revenue ruling, proposed Sec. 1.357-3(d)(4)(ii)(B) would
incorporate that analysis into proposed rules regarding the assumption
by a controlled corporation of distributing corporation debt issued in
close proximity to a divisive reorganization. See the discussion in
part VIII.C.3.b of this Explanation of Provisions. For the reasons
discussed in this part IV.C.1, the Treasury Department and the IRS do
not view it as appropriate for these proposed regulations to extend the
analysis of Rev. Rul. 79-258 to proposed rules addressing the
application of section 361.
2. General Approach of Proposed Regulations
The Treasury Department and the IRS appreciate the feedback
received from stakeholders on intermediated exchanges and direct
issuance transactions. As emphasized in Notice 2024-38, and consistent
with other aspects of these proposed regulations, the proposed rules
addressing these topics are intended (i) to be consistent with all
relevant provisions of the Code (that is, the compliance objective);
(ii) to provide certainty to taxpayers and the IRS regarding the
application of all relevant provisions of the Code to purported section
355 transactions (that is, the increased certainty objective); and
(iii) to be responsive to the manner in which section 355 transactions
are engaged in by taxpayers and reflect current market practices and
preferences (that is, the transaction facilitation objective), to the
extent that doing so does not conflict with the compliance and
increased certainty objectives.
With regard to the increased certainty objective, the Treasury
Department and the IRS have leveraged the expertise of IRS audit and
examination personnel to develop proposed rules that, to the extent
practicable, employ bright-line safe harbors, objectively verifiable
conditions for qualification, and other similar architecture that can
be readily reflected on Form 7216. These rules reflect the express
delegation of authority to the Secretary to prevent avoidance of tax
through abuse of section 361(b)(3) or (c)(3). The Treasury Department
and the IRS have endeavored to balance this increased certainty
objective with the transaction facilitation objective.
3. Specific Aspects of Proposed Regulations
a. General Requirements for Deemed Distribution Treatment
Proposed Sec. 1.361-5 would implement section 361(b)(3) and (c)(3)
by setting forth requirements that, if satisfied, would cause a
transfer of section 361 consideration by the distributing corporation
to its creditor to be treated as a distribution by the distributing
corporation to its shareholders pursuant to the plan of reorganization.
First, the creditor of the distributing corporation must be a
qualifying creditor, as determined under proposed Sec. 1.361-5(b).
Second, the distributing corporation debt that is satisfied with
section 361 consideration must constitute eligible distributing
corporation debt, as determined under proposed Sec. 1.361-5(c)(2).
Third, the amount of distributing corporation debt that can be
eliminated under the safe harbors of section 361(b)(3) and (c)(3)
cannot exceed a maximum amount, as determined under proposed Sec.
1.361-5(d). Lastly, the transfer by the distributing corporation of
section 361 consideration in exchange for eligible distributing
corporation debt must be carried out as part of a qualifying debt
elimination transaction, as determined under proposed Sec. 1.361-5(e).
Notwithstanding the satisfaction of the foregoing requirements,
proposed Sec. 1.361-5(f)(1)(i) would provide that the amount of
section 361 consideration treated as transferred by the distributing
corporation to a creditor of the distributing corporation in a
qualifying debt elimination transaction is reduced by the amount of
distributing corporation debt that is transitorily eliminated. See the
discussion in part VII.C of this Explanation of Provisions regarding
transitorily eliminated distributing corporation debt.
b. Qualifying Creditors
Proposed Sec. 1.361-5(b)(1) would require each creditor to which
the distributing corporation transfers section 361 consideration in a
divisive reorganization to be a creditor that holds eligible
distributing corporation debt (as described in proposed Sec. 1.361-
5(c)). Additionally, proposed Sec. 1.361-5(b)(1) and (b)(2)(i)
generally would prohibit the distributing corporation from satisfying
eligible distributing corporation debt held by a person related (within
the meaning of section 267(b) or section 707(b)(1)) (see proposed Sec.
1.361-1(b)(47)) to the distributing corporation (distributing
corporation related person), the controlled corporation (controlled
corporation related person), or a related person with regard to a
distributing corporation related person or a controlled corporation
related person (collectively, non-qualifying creditors). Creditors that
hold eligible distributing corporation debt, and that are not otherwise
disqualified as non-qualifying creditors under proposed Sec. 1.361-
5(b)(2), are referred to as ``qualifying creditors.''
Proposed Sec. 1.361-5(b)(2)(ii) would provide an exception to the
general related-creditor prohibition in proposed Sec. 1.361-5(b)(2)(i)
for a creditor that is a distributing corporation related person or a
related person with regard to a distributing corporation related person
if three requirements are satisfied. First, as part of the plan of
reorganization, proposed Sec. 1.361-5(b)(2)(ii)(A) would provide that
the section 361 consideration must be transferred to a creditor that is
neither a distributing corporation related person nor a related person
with regard to a distributing corporation related person (unrelated
ultimate creditor). Specifically, if the section 361 consideration is
money or other property, proposed Sec. 1.361-5(b)(2)(ii)(A)(1) would
provide that it must be transferred to an unrelated ultimate creditor
pursuant to the plan of reorganization no later than the end of the 12-
month period beginning on the date the distributing corporation
receives the money or other property (as appropriate). If the section
361 consideration is qualified property (as defined in proposed Sec.
1.361-1(b)(43)), proposed Sec. 1.361-5(b)(2)(ii)(A)(2) would provide
that it must be transferred to an unrelated ultimate creditor in an
expeditious manner pursuant to the plan of reorganization under
proposed Sec. 1.368-4(d)(3). Second, proposed Sec. 1.361-
5(b)(2)(ii)(B)(1) would provide a general provision that all debt for
which section 361 consideration is exchanged must be in existence as of
the earliest applicable date. Proposed Sec. 1.361-5(b)(2)(ii)(B)(2)
would provide that distributing corporation debt held directly by a
distributing corporation related person or a related person with regard
to a distributing corporation related person must qualify as historical
distributing corporation debt described in proposed Sec. 1.361-
5(c)(2)(i). Third, proposed Sec. 1.361-5(b)(2)(ii)(C) would provide
that each transaction (including each intermediate and unrelated
ultimate creditor transfer), creditor (including the unrelated ultimate
[[Page 5245]]
creditor), and debt satisfied with section 361 consideration must be
identified and described in the plan of reorganization with regard to
the divisive reorganization.
For purposes of the requirements in proposed Sec. 1.361-
5(b)(2)(ii)(A), proposed Sec. 1.361-5(b)(2)(ii)(A)(3) would permit one
or more intermediate transfers of section 361 consideration between or
among distributing corporation related persons or related persons with
regard to distributing corporation related persons to satisfy debts
(including the initial distributing corporation debt) if those
intermediate transfers culminate in a transfer of section 361
consideration to an unrelated ultimate creditor. Under proposed Sec.
1.361-5(b)(2)(iii), a person's status as a distributing corporation
related person or a controlled related person, or as a related person
with regard to any distributing corporation related person or as a
related person with respect to any controlled corporation related
person, would be determined at the time of that person's receipt of the
section 361 consideration in exchange for the satisfaction and
retirement of debt in a transfer or series of transfers described in
proposed Sec. 1.361-5(b)(2)(ii)(A).
c. Eligible Distributing Corporation Debt
i. In General
Proposed Sec. 1.361-5(c)(1) would provide that distributing
corporation debt is not eligible to be satisfied with section 361
consideration under proposed Sec. 1.361-5(a) unless that debt
qualifies as eligible distributing corporation debt.
(a) Historical Distributing Corporation Debt
In general, proposed Sec. 1.361-5(c)(2)(i) would provide that
distributing corporation debt that qualifies as historical distributing
corporation debt is eligible to be satisfied with section 361
consideration. In general, distributing corporation debt qualifies as
historical distributing corporation debt if that debt was incurred
before the ``earliest applicable date,'' and that debt has an original
term that ends after the date of the exchange described in Sec. 1.361-
2(a) or 1.361-3(a) and is identified in the plan of reorganization or
original plan of reorganization (if amended). The ``earliest applicable
date'' is defined in proposed Sec. 1.361-1(b)(27) as the earliest date
of three specified events: (i) the date of the first public
announcement (as defined in Sec. 1.355-7(h)(10)) of the divisive
reorganization or a similar transaction; (ii) the date the distributing
corporation entered into a written agreement to effectuate the divisive
reorganization or a similar transaction; and (iii) the date the
distributing corporation's board of directors approved the divisive
reorganization or a similar transaction.
However, the Treasury Department and the IRS are of the view that a
debt refinancing exception would be appropriate to help achieve the
transaction facilitation objective. Specifically, proposed Sec. 1.361-
5(c)(2)(ii) would provide that distributing corporation debt incurred
by the distributing corporation after the earliest applicable date is
treated as historical distributing corporation debt only if the
following four requirements are met. First, proposed Sec. 1.361-
5(c)(2)(ii)(A) would provide that the distributing corporation debt
must be (i) a refinancing of historical distributing corporation debt,
or (ii) a refinancing of refinanced historical distributing corporation
debt (that is, the debt must be traced directly through one or more
refinancings to debt that qualifies as historical distributing
corporation debt). Second, proposed Sec. 1.361-5(c)(2)(ii)(B) would
provide that the refinanced historical distributing corporation debt
must not have been incurred as part of a plan to incur debt in addition
to historical distributing corporation debt determined under proposed
Sec. 1.361-5(c)(2)(i) (or an amount of debt in addition to the amount
of historical distributing corporation debt determined under paragraph
(d) of that section, without regard to proposed Sec. 1.361-
5(d)(2)(iv)) in anticipation of the divisive reorganization (for
example, the incurrence of the refinanced historical distributing
corporation debt would have occurred without regard to the divisive
reorganization). Third, proposed Sec. 1.361-5(c)(2)(ii)(C) would
provide that the distributing corporation must engage in a qualifying
debt elimination transaction solely under proposed Sec. 1.361-5(e)(3)
or (4) to eliminate that refinanced historical distributing corporation
debt. Fourth, proposed Sec. 1.361-5(c)(2)(ii)(D) would provide that
the qualifying debt elimination transaction must be described and
identified in the plan of reorganization or original plan of
reorganization (if amended) for the divisive reorganization.
Proposed Sec. 1.361-5(c)(2)(iii) would provide that a revolving
credit agreement to which the distributing corporation is a debtor
qualifies as historical distributing corporation debt only if the
following requirements are met. First, the distributing corporation
must have entered into the agreement before the earliest applicable
date. Second, the agreement does not expire until after the date of the
exchange described in proposed Sec. 1.361-2(a) or 1.361-3(a). Third,
the agreement is identified in the plan of reorganization or original
plan of reorganization (if amended). The Treasury Department and the
IRS request comments regarding whether there are other arrangements
similar to revolving credit agreements that, based on the same
rationale employed by these proposed regulations, should be treated
similarly.
(b) Qualifying Trade Payables
Proposed Sec. 1.361-5(c)(2)(iv) would provide that qualifying
trade payables are eligible to be satisfied with section 361
consideration. For purposes of that qualification, the following
requirements must be met. First, the trade payables must be described
in a plan of reorganization or original plan of reorganization (if
amended). Second, the trade payables must have been incurred in the
ordinary course of business of the distributing corporation. Third, the
satisfaction of such trade payables is necessary (A) to ensure the
allocation to the controlled corporation of all liabilities properly
associated with the business assets transferred to that corporation and
(B) to result in the controlled corporation being allocated liabilities
in an amount that properly relates to its business operations, the
earnings of which will be used to properly satisfy those liabilities.
(c) Direct Issuance Debt
These proposed regulations would also provide that direct issuance
debt is eligible to be satisfied with section 361 consideration.
Specifically, proposed Sec. 1.361-5(c)(2)(v) would provide that direct
issuance debt incurred as part of a direct issuance transaction (as
defined in proposed Sec. 1.361-1(b)(17)) satisfying the requirements
of proposed Sec. 1.361-5(e)(4) is eligible to be satisfied with
section 361 consideration. See the discussion in part IV.C.3.d.iv
regarding qualifying direct issuance transactions.
ii. Amount of Distributing Corporation Debt Repaid
Under proposed Sec. 1.361-5(d)(1), the maximum amount of
distributing corporation debt that can be satisfied with section 361
consideration under proposed Sec. 1.361-5(a) would equal the amount
obtained by subtracting the aggregate amount of distributing
corporation debt that the controlled corporation assumes (in accordance
with proposed Sec. Sec. 1.357-2 through 1.357-4) pursuant to the plan
of reorganization from the lesser of (i) the
[[Page 5246]]
aggregate amount of distributing corporation debt (as determined under
proposed Sec. 1.361-5(c)(3)), and (ii) the aggregate amount of
distributing corporation debt determined under the eight-quarterly-
average test set forth in proposed Sec. 1.361-5(d)(2). The Treasury
Department and the IRS are of the view that incorporating the IRS's
long-standing, quarterly average test for advance ruling purposes
(which was expanded to an eight-quarterly-average test in Rev. Proc.
2018-53 to provide a more accurate determination) into this computation
would help achieve the increased certainty objective of these proposed
regulations.
(a) Aggregate Amount of Distributing Corporation Debt
Under proposed Sec. 1.361-5(c)(3)(ii), the aggregate amount of
distributing corporation debt would include solely the amounts
described in proposed Sec. 1.361-5(c)(3)(ii)(A) through (E), as
applicable, taking into account any reduction required by proposed
proposed Sec. 1.361-5(c)(3)(iii) (that is, offsetting debts).
Specifically, proposed Sec. 1.361-5(c)(3)(ii)(A) would provide that
the aggregate amount of historical distributing corporation debt would
equal the aggregate remaining principal amount, as of the earliest
applicable date, of all historical distributing corporation debt other
than historical distributing corporation debt that is eliminated as
part of a qualifying direct issuance transaction. With regard to
refinanced distributing corporation debt, proposed Sec. 1.361-
5(c)(3)(ii)(B) would provide that, if the distributing corporation
relies on the refinancing exception for historical distributing
corporatrion debt under proposed Sec. 1.361-5(c)(2)(ii), then the
amount of that debt distributing corporation debt would equal the
lesser of (i
[…truncated; see source link]Indexed from Federal Register on January 16, 2025.
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