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Bulletin No. 2000–4

January 24, 2000

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

EMPLOYEE PLANS

Rev. Rul. 2000–4, page 331.

Business expenses; capital expenditures; ISO 9000

costs. Cost incurred by a taxpayer to obtain, maintain,

and renew ISO 9000 certification are deductible as ordinary and necessary business expenses under section 162

of the Code, except to the extent they result in the creation or acquisition of an asset having a useful life substantially beyond the taxable year (e.g., a quality manual).

Rev. Proc. 99–49 modified and amplified.

T.D. 8853, page 377.

Final regulations under section 7701(l) of the Code recharacterize fast-pay stock arrangements. The regulations

also impose reporting requirements on certain participants in fast-pay stock arrangements.

Notice 2000–3, page 413.

This notice provides additional guidance on the safe harbor

methods contained in sections 401(k)(12) and 401(m)(11) of

the Code for satisfying the nondiscrimination tests contained

in section 401(k) and 401(m). The notice also requests public comments on certain issues affecting cash or deferred

arrangements. Notice 98–52 modified.

Notice 2000–8, page 420.

Weighted average interest rate update. The weighted

average interest rate for January 2000 and the resulting permissible range of interest rates used to calculate current liability for purposes of the full funding limitation of section

412(c)(7) of the Code are set forth.

T.D. 8857, page 365.

Final regulations under section 832(b) of the Code relate to the

determination of underwriting income by insurance companies

other than life insurance companies by providing guidance for

purposes of determining the amount of unearned premiums

that are subject to the 20 percent reduction rule.

T.D. 8858, page 332.

Temporary regulations revise the rules governing allocation of

purchase price in deemed and actual asset acquisitions, and

other rules, under sections 338 and 1060 of the Code.

EXCISE TAX

T.D. 8855, page 374.

Final regulations under section 4251 of the Code relate to

prepaid telephone cards.

Announcement 2000–5, page 427.

Comments are requested on proposed regulations relating

to requirements for excise tax returns and deposits.

(Continued on the page following the Introduction)

Finding Lists begin on page ii.

Department of the Treasury

Internal Revenue Service

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The IRS Mission

Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness to

all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents are consolidated semiannually into

Cumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis,

and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

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ADMINISTRATIVE

research activities for members of a controlled group of taxpayers. A public hearing is scheduled for April 26, 2000.

Rev. Proc. 2000–12, page 387.

Notice 2000–7, page 419.

This procedure contains the qualified intermediary (QI)

withholding agreement as well as guidance for entering

into the agreement. The objective of the QI withholding

agreement is to simplify withholding and reporting obligations for payments of income (including interest, dividends, royalties, and gross proceeds) made to an account

holder through one or more foreign intermediaries. Rev.

Proc. 98–27 superseded and Notice 99–8 obsoleted.

Section 1504(d) elections; deferral of termination.

This notice provides guidance regarding the effect of the repeal of certain Canadian banking legislation on elections

under section 1504(d) of the Code.

REG–105606–99, page 421.

Proposed regulations under section 41(f) of the Code relate

to the computation and allocation of the credit for increasing

2000–4 I.R.B.

Announcement 2000–6, page 428.

This announcement corrects final regulations T.D. 8845,

1999–51 I.R.B. 684, under section 6501 of the Code relating to the valuation of prior gifts in determining estate and

gift tax liability, and to the period of assesing and collecting

gift tax.

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 162.–Trade or Business

Expenses

26 CFR 1.162-1: Business expenses.

(Also §§ 263, 263A; §§ 1.263(a)-1, 1.263(a)–2,

1.263A–1)

Business expenses; capital expenditures; ISO 9000 costs. Costs incurred by

a taxpayer to obtain, maintain, and renew

ISO 9000 certification are deductible as

ordinary and necessary business expenses

under section 162 of the Code, except to

the extent they result in the creation or acquisition of an asset having a useful life

substantially beyond the taxable year

(e.g., a quality manual). Rev. Proc. 99–49

modified and amplified.

Rev. Rul. 2000–4

ISSUE

Are costs incurred by a taxpayer to obtain, maintain, and renew ISO 9000 certification deductible as ordinary and necessary business expenses under § 162 of the

Internal Revenue Code, or must they be

capitalized under §§ 263 or 263A?

FACTS

ISO 9000 is a series of international

standards for quality management systems that was developed by the International Organization for Standardization

(ISO). The ISO 9000 series of standards

is comprised of several specific requirements that are intended to ensure a quality

process in providing services or products

to an organization’s customers.

To obtain ISO 9000 certification, an organization may incur internal and external

costs to assess its current quality processes,

create a quality manual, train its employees,

and implement the new quality system. In

addition, the organization incurs costs to obtain formal certification from an independent

auditor (or “registrar”) that its quality management system conforms to a specific ISO

9000 standard. This certification generally

lasts from two to four years. After the initial

certification, the organization incurs additional costs for periodic audits to maintain its

certification and to renew the certification

upon expiration of the initial certification pe-

2000–4 I.R.B.

riod. All these expenditures are referred to

herein as “ISO 9000 costs.”

Although ISO 9000 certification is voluntary, it increasingly is a contractual requirement for doing business with many

organizations, both public and private,

worldwide. ISO 9000 certification also is

an alternative to product certification in

some foreign markets, particularly the

European Union.

LAW AND ANALYSIS

Section 162 and § 1.162–1(a) of the Income Tax Regulations generally allow a

deduction for all the ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or

business. Courts generally have construed

§ 162 as containing five conditions that an

expenditure must meet to qualify for deduction. The expenditure must be (1) an

expense, (2) ordinary, (3) necessary, (4)

paid or incurred during the taxable year,

and (5) made to carry on a trade or business. See Commissioner v. Lincoln Sav.

and Loan Ass’n, 403 U.S. 345 (1971).

Section 263(a) and § 1.263(a)–1(a) provide that no deduction is allowed for any

amount paid out for permanent improvements or betterments made to increase the

value of any property or estate. Section

1.263(a)–2(a) provides that capital expenditures include the cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures,

and similar property having a useful life

substantially beyond the taxable year.

Section 263A provides that the direct

and indirect costs properly allocable to real

or tangible personal property produced by

the taxpayer or real or personal property described in § 1221(1) that is acquired by the

taxpayer for resale must be capitalized.

Section 1.263A–1(e)(4)(iv)(F) cites quality

control policy as an example of an indirect

cost that generally is not allocated to production or resale activities.

Through provisions such as §§ 162(a),

263(a), and 263A, the Code generally endeavors to match expenses with the revenues of the taxable period to which the expenses are properly attributable, thereby

resulting in a more accurate calculation of

net income for tax purposes. See, e.g., INDOPCO, Inc. v. Commissioner, 503 U.S.

331

79, 84 (1992); Commissioner v. Idaho

Power Co., 418 U.S. 1, 16 (1974). Moreover, as the Supreme Court has specifically

recognized, the “decisive distinctions [between capital and ordinary expenditures]

are those of degree and not of kind,” and a

careful examination of the particular facts

of each case is required. Deputy v. du

Pont, 308 U.S. 488, 496 (1940); Welch v.

Helvering, 290 U.S. 111, 114 (1933).

In determining whether a current deduction or capitalization is the appropriate tax

treatment for an expenditure, it is important

to consider the extent to which the expenditure will produce future benefits. See INDOPCO, 503 U.S. at 87–88. ISO 9000

certification potentially results in a number

of benefits for a taxpayer. For example, certification may improve the overall quality of

the taxpayer’s business operations, give the

taxpayer a marketing advantage by differentiating it from non-certified competitors, enable the taxpayer to retain customers that

begin requiring their suppliers to be certified, and enable the taxpayer to expand its

existing business to new markets and new

customers that require their suppliers to be

certified. These benefits generally both relate to the current taxable year and extend

beyond the taxable year in which the taxpayer obtains ISO 9000 certification. Section 263(a), however, requires an examination of not only the duration of the benefits,

but also the extent of the benefits. See INDOPCO, 503 U.S. at 87 (the mere presence

of an incidental future benefit may not warrant capitalization). See also Rev. Rul.

96–62, 1996–2 C.B. 9 (training costs generally are deductible under § 162 even though

they may have some future benefit); Rev.

Rul. 94–12, 1994–1 C.B. 36 (incidental repair costs generally are deductible under §

162 even though they may have some future

benefit); Rev. Rul. 92–80, 1992–2 C.B. 57

(advertising costs generally are deductible

under § 162 even though they may have

some future effect on business activities).

ISO 9000 certification does not result in

future benefits that are more than incidental.

The benefits derived from ISO 9000 certification are akin to the current benefits derived from advertising, training, and similar

expenditures incurred in operating the taxpayer’s business, retaining existing customers, or simply improving the overall

quality or attractiveness of the taxpayer’s

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business operations. Although the enhanced marketability of the taxpayer’s services or products resulting from ISO 9000

certification may yield future benefits such

as repeat business or increased market

share, these future benefits are incidental to

the primary benefit of current sales. Expenditures that primarily benefit current operations generally are deductible. See, e.g., Van

Iderstine Co. v. Commissioner, 261 F.2d

211 (2nd Cir. 1958) (payments made to suppliers to ensure a continuing supply of raw

materials were deductible); Snow v. Commissioner, 31 T.C. 585 (1958), acq., 1959–2

C.B. 7 (payments made to protect and supplement the taxpayer’s income from its existing law business were deductible). See

also T.J. Enterprises, Inc. v. Commissioner,

101 T.C. 581 (1993) (expenses incurred to

protect, maintain, or preserve a taxpayer’s

business generally are deductible).

Further, even if ISO 9000 certification

facilitates the expansion of the taxpayer’s

existing business, the mere ability to sell in

new markets and to new customers, without more, does not result in significant future benefits. Compare Briarcliff Candy

Corp. v. Commissioner, 475 F.2d 775 (2nd

Cir. 1973) (expenditures incurred by the

taxpayer to develop a new market for

wholesale customers, which gave the taxpayer little more than an expectation or

hope of future sales, were deductible under

§ 162); Sun Microsystems v. Commissioner,

T.C. Memo 1993–467 (costs incurred to

promote sales of computer workstations

were not capital expenditures because the

anticipated long-term benefits from the

customer relationship were “softer” and

more speculative than the immediate benefits from the sales) with FMR Corp. v.

Commissioner, 110 T.C. 402 (1998) (costs

to develop and launch mutual funds, which

resulted in new long-term management

contracts, were capital expenditures).

Because ISO 9000 certification yields

only incidental future benefits, ISO 9000

costs are distinguishable from costs incurred

to obtain licenses, stock trading privileges,

state bar certifications, and similar marketentry requirements that have been held to be

capital expenditures. Unlike ISO 9000 certification, these requirements are an essential element to the establishment of the taxpayer’s business and result either in a

separate and distinct asset or in significant

future benefits. See, e.g., Nachman v. Commissioner, 191 F.2d 934 (5th Cir. 1951)

January 24, 2000

(payment to obtain liquor license was a capital expenditure); Harman v. Commissioner,

72 T.C. 362 (1979) (initiation fees required

to obtain a seat on the New York Stock Exchange were capital expenditures); Sharon

v. Commissioner, 66 T.C. 515 (1976), aff’d,

591 F.2d 1273 (9th Cir. 1978) (costs incurred by an attorney for admission to various bars were capital expenditures).

Accordingly, ISO 9000 certification does

not itself result in the creation of an asset

having a useful life substantially beyond the

taxable year. To the extent the ISO 9000

certification process results in the creation

of an asset, however, § 263(a) requires capitalizing the costs allocable to creating that

asset. For example, the costs of creating a

quality manual must be capitalized, even

though costs of periodic updates to the manual may be deducted. § 263A; §

1.263A–2(a)(2)(ii), Domestic Management

Bureau v. Commissioner, 38 B.T.A. 640

(1938) (costs of preparing and printing a

training manual were capital expenditures);

Rev. Rul. 96–62 (costs of routine updates of

training materials are deductible). In addition, if the certification process requires the

acquisition of an asset, such as machinery

and equipment, the costs of that asset must

be capitalized under § 263(a).

Further, ISO 9000 costs, other than costs

incurred during the certification process that

are allocable to creating an asset such as a

quality manual, are not costs that are allocable to production or resale activities for purposes of the uniform capitalization rules of

§ 263A, and thus are not subject to the rules

set forth in that section or the regulations

thereunder. See § 1.263A–1(e)(4)(iv)(F)

(quality control expenditures generally excepted from uniform capitalization rules).

A taxpayer wanting to change its method

of accounting to conform with the holding

in this revenue ruling must follow the automatic change in accounting method provisions of Rev. Proc. 99–49, 1999–52

I.R.B. 725, except that the scope limitations in section 4.02 of Rev. Proc. 99-49

do not apply. However, if the taxpayer is

under examination, before an appeals office, or before a federal court with respect

to any income tax issue, the taxpayer

must provide a copy of the Form 3115,

Application for Change in Accounting

Method, to the examining agent(s), appeals officer, or counsel for the government, as appropriate, at the same time that

it files the copy of the Form 3115 with the

national office. The Form 3115 must contain the name(s) and telephone number(s)

of the examining agent(s), appeals officer,

or counsel for the government, as appropriate.

HOLDING

26 CFR 1.263(a)–1: Capital expenditures; in

general.

Costs incurred by a taxpayer to obtain,

maintain, and renew ISO 9000 certification are deductible as ordinary and necessary business expenses under § 162,

except to the extent they result in the creation or acquisition of an asset having a

useful life substantially beyond the taxable year (e.g., a quality manual).

APPLICATION

Any change in a taxpayer’s method of

accounting to conform with this revenue

ruling is a change in method of accounting to which the provisions of §§ 446 and

481 and the regulations thereunder apply.

332

EFFECT ON OTHER DOCUMENTS

Rev. Proc. 99–49 is modified and amplified to include the prospective change

in accounting method in the APPENDIX.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Kimberly L. Koch of the Office

of Assistant Chief Counsel (Income Tax

and Accounting). For further information

regarding this revenue ruling, contact Ms.

Koch at (202) 622-4950 (not a toll-free

call).

Section 263.—Capital

Expenditures

Are costs incurred by a taxpayer to obtain, maintain, and renew ISO 9000 certification deductible as

ordinary and necessary business expenses under

§162, except to the extent they result in the creation

or acquisition of an asset having a useful life substantially beyond the taxable year (e.g., a quality

manual)? See Rev. Rul. 2000–4, page 331.

Section 338.—Certain Stock

Purchases Treated As Asset

Acquisitions

26 CFR 1.338–1T: General principles; status of old

target and new target (temporary).

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T.D. 8858

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Purchase Price Allocations in

Deemed and Actual Asset

Acquisitions

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains

temporary regulations relating to the allocation of purchase price in deemed and

actual asset acquisitions. The temporary

regulations determine the amount realized

and the amount of basis allocated to each

asset transferred in a deemed or actual

asset acquisition and affect transactions

reported on either Form 8023 or Form

8594. The intended effect of the temporary regulations is to remove and replace

many of the current temporary and final

regulations sections under sections 338

and 1060 and renumber others.

DATES: Effective Date: These regulations are effective January 6, 2000.

Applicability Dates: For dates of applicability of these regulations, see

§1.338(i)–1T and §1.1060–1T(a)(2).

FOR FURTHER INFORMATION CONTACT: Richard Starke of the Office of

Assistant Chief Counsel (Corporate),

(202) 622-7790 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these temporary regulations

have been reviewed and approved by the

Office of Management and Budget in accordance with the Paperwork Reduction

Act of 1995 (44 U.S.C. 3507(d)) under

the control number 1545-1658.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

The collections of information in these

2000–4 I.R.B.

temporary regulations are in §§1.338–2T(d),

1.338–2T(e)(4),

1.338–5T(d)(3),

1.338–10T(a)(4), 1.338(h)(10)–1T(d)(2),

and 1.1060–1T(e)(ii)(A) and (B). The collections of information are necessary to

make an election to treat a sale of stock as a

sale of assets, to calculate and collect the appropriate amount of tax in a deemed or actual asset acquisition, and to determine the

bases of assets acquired in a deemed or actual asset acquisition.

These collections of information are required to obtain a benefit. The likely respondents and/or recordkeepers are small

businesses or organizations, businesses,

or other for-profit institutions, and farms.

The regulation provides that a section

338 election is made by filing Form 8023.

The burden for this requirement is reflected in the burden of Form 8023. The

regulation also provides that both a seller

and a purchaser must each file an asset acquisition statement on Form 8594. The

burden for this requirement is reflected in

the burden of Form 8594.

The burden for the collection of information in §1.338–2T(e)(4) is as follows:

Estimated total annual reporting/recordkeeping burden: 25 hours

Estimated average annual burden per respondent/recordkeeper: 0.56 hours

Estimated number of respondents/recordkeepers: 45

Estimated annual frequency of responses:

On occasion

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to the

Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and to the Office

of Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

On August 10, 1999, the IRS and Treasury published in the Federal Register

(REG–107069–97, 64 FR 43461 (1999–36

333

I.R.B. 346)) a notice of proposed rulemaking. The notice contained proposed regulations under sections 338 and 1060 of the Internal Revenue Code of 1986. The

temporary and final regulations promulgated in this Treasury decision are substantively the same as the proposed regulations

published on August 10, 1999. The Service and Treasury believe that the comments received on the proposed regulations

warrant further consideration. For instance,

the Service and the Treasury received several comments requesting reconsideration

of (1) the provision in §1.338–3(b)(2)(ii) of

the proposed regulations stating that a purchase of target stock occurs only so long as

more than a nominal amount is paid for

such share, and (2) the example in

§1.338–1(a)(2) of the proposed regulations

stating that if target is an insurance company for which a section 338 election is

made, then the deemed asset sale will be

characterized and taxed as an assumptionreinsurance transaction. The temporary

regulations reserve the purchase issue addressed in §1.338–3(b)(2)(ii) of the proposed regulations pending further consideration of the comments. The temporary

regulations retain the assumption-reinsurance example because the example properly illustrates the principles of the proposed and temporary regulations. The

Service and Treasury will give further consideration to the interaction of section 338

and the assumption-reinsurance rules and

the need for additional guidance on how the

assumption-reinsurance rules should work

in the context of a deemed asset sale.

Notwithstanding such comments, the

proposed regulations generally were favorably received, and the Service and Treasury

are convinced that, in general, the proposed

regulations provide clearer guidance and

better rules than the current final and temporary regulations under sections 338 and

1060. Accordingly, pending further review

of the comments received on the proposed

regulations, the Service and Treasury are

replacing existing temporary and final regulations with the proposed rules published

on August 10, 1999.

As soon as feasible, final regulations

will be promulgated, replacing these new

temporary regulations. All comments received in response to the requests for

comments contained in the notice of August 10, 1999, will be considered in the

course of preparing the final regulations.

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Special Analyses

ther information would be arbitrary. Instead, these regulations authorize the

Commissioner to exclude certain transactions from the reporting requirements.

This analysis is required under the Regulatory Flexibility Act (5 U.S.C. chapter

6). This regulatory action is intended to

simplify and clarify the current rules relating to both deemed and actual asset acquisitions. The current rules were developed over a long period of time and have

been repeatedly amended. The IRS and

Treasury believe these temporary regulations will significantly improve the clarity

of the rules relating to both deemed and

actual asset acquisitions.

The major objective of these temporary

regulations is to modify the rules for allocating purchase price in both deemed and

actual asset acquisitions. In addition,

these temporary regulations replace the

general rules for electing to treat a stock

sale as an asset sale.

These collections of information may affect small businesses if the stock of a corporation which is a small entity is acquired

in a qualified stock purchase or if a trade or

business which is also a small business is

transferred in a taxable transaction. Form

8023 (on which an election to treat a stock

sale as an asset sale is filed) has been submitted to and approved by the Office of

Management and Budget. With respect to

Form 8023, the IRS estimated that 201

forms would be filed each year and that

each taxpayer would require 12.98 hours to

comply. Form 8594 (on which a sale or acquisition of assets constituting a trade or

business is reported) has also been submitted to and approved by the Office of Management and Budget. With respect to Form

8594, the IRS estimated that 20,000 forms

would be filed each year and that each taxpayer would require 12.25 hours to comply.

These estimates have been made available

for public comment and no public comments have been received. The regulations

do not impose new requirements on small

businesses and, in fact, should lessen any

difficulties associated with the existing reporting requirements by clarifying the rules

associated with deemed and actual asset acquisitions.

The collections of information require

taxpayers to file an election in order to

treat a stock sale as an asset sale. In addition, taxpayers must file a statement regarding the amount of consideration allocated to each class of assets under the

residual method. The professional skills

that would be necessary to make the election or allocate the consideration would

be the same as those required to prepare a

return for the small business.

Consideration was given to limiting the

reporting requirements under section

1060 to trades or businesses meeting a

threshold level of business activity. However, any threshold derived without fur-

Section

Remove

Add

1.56(g)–1(k)(1)

of §1.338(b)–2T(b),

if otherwise

of §1.338–6T(b),

if otherwise

1.56(g)–1(k)(1)

of §§1.338(b)–2T(c)(1)

and (2) also

of §1.338–6T(c)(1)

and (2) also

1.368–1(a)

(k) and 1.338–2(c)(3).

(k) and 1.338–3T(c)(3).

1.368–1(e)(6), Example

4, paragraph (ii)

see §1.338–2(c)(3) (which

see §1.338–3T(c)(3) (which

1.597–2(d)(5)(iii)(B)

(see §1.338(b)–3T)

(see §1.338–7T)

It has been determined that these temporary regulations are not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is

not required. It has been determined that a

final regulatory flexibility analysis is required for the collection of information in

this Treasury decision under 5 U.S.C. 604.

This analysis is set forth below under the

heading “Final Regulatory Flexibility Act

Analysis.” Pursuant to section 7805(f) of

the Internal Revenue Code, these temporary

regulations will be submitted to the Chief

Counsel for Advocacy of the Small Business

Administration for comment on their impact

on small business.

Final Regulatory Flexibility Act

Analysis

January 24, 2000

334

Drafting Information

The principal author of these regulations is Richard Starke, Office of the Assistant Chief Counsel (Corporate). However, other personnel from the IRS and

Treasury Department participated extensively in their development.

* * * * *

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by removing the entries

for 1.338(b)–1, 1.338(b)–3T, and

1.1060–1T and by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.338–6T also issued under 26

U.S.C. 337(d), 338, and 1502.

Section 1.338–7T also issued under 26

U.S.C. 337(d), 338, and 1502.

Section 1.338–8 also issued under 26

U.S.C. 337(d), 338, and 1502.

Section 1.338–9 also issued under 26

U.S.C. 337(d), 338, and 1502.

Section 1.338–10T also issued under 26

U.S.C. 337(d), 338, and 1502.* * *

Section 1.1060–1T also issued under 26

U.S.C. 1060.* * *

Par. 2. In the list below, for each section indicated in the left column, remove

the language in the middle column and

add the language in the right column:

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1.597–5(c)(3)(i)

under §§1.338(b)–2T(b),

(c)(1) and (2).

under §1.338–6T(b),

(c)(1) and (2).

1.597–5(d)(2)(i)

under §§1.338(b)–2T(b),

(c)(1) and (2).

under §1.338–6T(b),

(c)(1) and (2).

1.921–1T(b)(1), A–1

and §1.338–1(d).

and §1.338–2T(d).

1.1031(d)–1T

see §1.1060–1T(b), (d),

and (g) Example (3).

see §1.1060–1T(b), (c),

and (d) Example 1.

1.1031(j)–1(b)(2)(iii)

in §1.1060–1T(d).

in §1.338–6T(b), to

which reference is made

by §1.1060–1T(c)(2).

1.1502–75(k)

See §1.338(h)(10)–

1(e)(6) for

See §1.338(h)(10)–

1T(d)(7) for

1.1502–76(b)(1)(ii)(A)(1)

See §1.338–1(e)(5)

(deemed

See §1.338–10T(a)(5)

(deemed

§1.338–0 through 1.338–3 [Removed]

Par. 3. Sections 1.338–0 through

1.338–3 are removed.

Par. 4. Sections 1.338–0T through

1.338–3T are added to read as follows:

§1.338–0T Outline of topics (temporary).

This section lists the captions contained

in the regulations under section 338 as

follows:

§1.338–1T General principles; status of

old target and new target (temporary).

(6) Deemed asset sale.

(7) Deemed sale gain.

(8) Deemed sale return.

(9) Domestic corporation.

(10) Old target’s final return.

(11) Purchasing corporation.

(12) Qualified stock purchase.

(13) Related persons.

(14) Section 338 election.

(15) Section 338(h)(10) election.

(16) Selling group.

(17) Target; old target; new target.

(18) Target affiliate.

(19) 12-month acquisition period.

(d) Time and manner of making election.

(e) Special rules for foreign corporations

or DISCs.

(1) Elections by certain foreign purchasing corporations.

(i) General rule.

(ii) Qualifying foreign purchasing corporation.

(iii) Qualifying foreign target.

(iv) Triggering event.

(v) Subject to United States tax.

(2) Acquisition period.

(3) Statement of section 338 may be filed

by United States shareholders in certain cases.

(4) Notice requirement for U.S. persons

holding stock in foreign market.

(i) General rule.

(ii) Limitation.

(iii) Form of notice.

(iv) Timing of notice.

(v) Consequence of failure to comply.

(vi) Good faith effort to comply.

(a) In general.

(1) Deemed transaction.

(2) Application of other rules of law.

(3) Overview.

(b) Treatment of target under other provisions of the Internal Revenue Code.

(1) General rule for subtitle A.

(2) Exceptions for subtitle A.

(3) General rule for other provisions of

the Internal Revenue Code.

(c) Anti-abuse rule.

(1) In general.

(2) Examples.

§1.338–2T Nomenclature and definitions; mechanics of the section 338 election (temporary).

(a) Scope.

(b) Nomenclature.

(c) Definitions.

(1) Acquisition date.

(2) Acquisition date assets.

(3) Affiliated group.

(4) Common parent.

(5) Consistency period.

2000–4 I.R.B.

335

§1.338–3T Qualification for the section

338 election (temporary).

(a) Scope.

(b) Rules relating to qualified stock purchases.

(1) Purchasing corporation requirement.

(2) Purchase.

(i) Definition.

(ii) Purchase of target. [Reserved]

(iii) Purchase of target affiliate.

(3) Acquisitions of stock from related

corporations.

(i) In general.

(ii) Time for testing relationship.

(iii) Cases where section 338(h)(3)(C) applies—acquisitions treated as purchases.

(iv) Examples.

(4) Acquisition date for tiered targets.

(i) Stock sold in deemed asset sale.

(ii) Examples.

(5) Effect of redemptions.

(i) General rule.

(ii) Redemptions from persons unrelated

to the purchasing corporation.

(iii) Redemptions from the purchasing

corporation or related persons during

12-month acquisition period.

(A) General rule.

(B) Exception for certain redemptions

from related corporations.

(iv) Examples.

(c) Effect of post-acquisition events on eligibility for section 338 election.

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(1) Post-acquisition elimination of target.

(2) Post-acquisition elimination of the

purchasing corporation.

(3) Consequences of post-acquisition

elimination of target.

(i) Scope.

(ii) Continuity of interest.

(iii) Control requirement.

(iv) Example.

§1.338-4T Aggregate deemed sale price;

various aspects of taxation of the deemed

asset sale (temporary).

(a) Scope.

(b) Determination of ADSP.

(1) General rule.

(2) Time and amount of ADSP.

(i) Original determination.

(ii) Redetermination of ADSP.

(iii) Example.

(c) Grossed-up amount realized on the

sale to the purchasing corporation of

the purchasing corporation’s recently

purchased target stock.

(1) Determination of amount.

(2) Example.

(d) Liabilities of old target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(e) Calculation of deemed sale gain.

(f) Other rules apply in determining

ADSP.

(g) Examples.

(h) Deemed sale of target affiliate stock.

(1) Scope.

(2) In general.

(3) Deemed sale of foreign target affiliate

by a domestic target.

(4) Deemed sale producing effectively

connected income.

(5) Deemed sale of insurance company

target affiliate electing under section

953(d).

(6) Deemed sale of DISC target affiliate.

(7) Anti-stuffing rule.

(8) Examples.

§1.338–5T Adjusted grossed-up basis

(temporary).

(a) Scope.

(b) Determination of AGUB.

(1) General rule.

(2) Time and amount of AGUB.

(i) Original determination.

(ii) Redetermination of AGUB.

(iii) Examples.

(c) Grossed-up basis of recently pur-

January 24, 2000

chased stock.

(d) Basis of nonrecently purchased stock;

gain recognition election.

(1) No gain recognition election.

(2) Procedure for making gain recognition election.

(3) Effect of gain recognition election.

(i) In general.

(ii) Basis amount.

(iii) Losses not recognized.

(iv) Stock subject to election.

(e) Liabilities of new target.

(1) In general.

(2) Time and amount of liabilities.

(3) Interaction with deemed sale gain.

(f) Adjustments by the Internal Revenue

Service.

(g) Examples.

§1.338–6T Allocation of ADSP and

AGUB among target assets (temporary).

(a) Scope.

(1) In general.

(2) Fair market value.

(i) In general.

(ii) Transaction costs.

(iii) Internal Revenue Service authority.

(b) General rule for allocating ADSP and

AGUB.

(1) Reduction in the amount of consideration for Class I assets.

(2) Other assets.

(i) In general.

(ii) Class II assets.

(iii) Class III assets.

(iv) Class IV assets.

(v) Class V assets.

(vi) Class VI assets.

(vii) Class VII assets.

(3) Other items designated by the Internal

Revenue Service.

(c) Certain limitations and other rules for

allocation to an asset.

(1) Allocation not to exceed fair market

value.

(2) Allocation subject to other rules.

(3) Special rule for allocating AGUB

when purchasing corporation has nonrecently purchased stock.

(i) Scope.

(ii) Determination of hypothetical purchase price.

(iii) Allocation of AGUB.

(4) Liabilities taken into account in determining amount realized on subsequent

disposition.

(d) Examples.

§1.338–7T Allocation of redetermined

336

ADSP and AGUB among target assets

(temporary).

(a) Scope.

(b) Allocation of redetermined ADSP and

AGUB.

(c) Special rules for ADSP.

(1) Increases or decreases in deemed sale

gain taxable notwithstanding old target ceases to exist.

(2) Procedure for transactions in which

section 338(h)(10) is not elected.

(i) Deemed sale gain included in new target’s return.

(ii) Carryovers and carrybacks.

(A) Loss carryovers to new target taxable

years.

(B) Loss carrybacks to taxable years of

old target.

(C) Credit carryovers and carrybacks.

(3) Procedure for transactions in which

section 338(h)(10) is elected.

(d) Special rules for AGUB.

(1) Effect of disposition or depreciation of

acquisition date assets.

(2) Section 38 property.

(e) Examples.

§1.338–8 Asset and stock consistency.

(a) Introduction.

(1) Overview.

(2) General application.

(3) Extension of the general rules.

(4) Application where certain dividends

are paid.

(5) Application to foreign target affiliates.

(6) Stock consistency.

(b) Consistency for direct acquisitions.

(1) General rule.

(2) Section 338(h)(10) elections.

(c) Gain from disposition reflected in

basis of target stock.

(1) General rule.

(2) Gain not reflected if section 338 election made for target.

(3) Gain reflected by reason of distributions.

(4) Controlled foreign corporations.

(5) Gain recognized outside the consolidated group.

(d) Basis of acquired assets.

(1) Carryover basis rule.

(2) Exceptions to carryover basis rule for

certain assets.

(3) Exception to carryover basis rule for

de minimis assets.

(4) Mitigation rule.

(i) General rule.

(ii) Time for transfer.

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(e) Examples.

(1) In general.

(2) Direct acquisitions.

(f) Extension of consistency to indirect

acquisitions.

(1) Introduction.

(2) General rule.

(3) Basis of acquired assets.

(4) Examples.

(g) Extension of consistency if dividends

qualifying for 100 percent dividends

received deduction are paid.

(1) General rule for direct acquisitions

from target.

(2) Other direct acquisitions having same

effect.

(3) Indirect acquisitions.

(4) Examples.

(h) Consistency for target affiliates that

are controlled foreign corporations.

(1) In general.

(2) Income or gain resulting from asset

dispositions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Operating rule.

(iv) Increase in asset or stock basis.

(3) Stock issued by target affiliate that is a

controlled foreign corporation.

(4) Certain distributions.

(i) General rule.

(ii) Basis of controlled foreign corporation stock.

(iii) Increase in asset or stock basis.

(5) Examples.

(i) [Reserved]

(j) Anti-avoidance rules.

(1) Extension of consistency rules.

(2) Qualified stock purchase and 12month acquisition period.

(3) Acquisitions by conduits.

(i) Asset ownership.

(A) General rule.

(B) Application of carryover basis rule.

(ii) Stock acquisitions.

(A) Purchase by conduit.

(B) Purchase of conduit by corporation.

(C) Purchase of conduit by conduit.

(4) Conduit.

(5) Existence of arrangement.

(6) Predecessor and successor.

(i) Persons.

(ii) Assets.

(7) Examples.

§1.338–9 International aspects of section

338.

2000–4 I.R.B.

(a) Scope.

(b) Application of section 338 to foreign

targets.

(1) In general.

(2) Ownership of FT stock on the acquisition date.

(3) Carryover FT stock.

(i) Definition.

(ii) Carryover of earnings and profits.

(iii) Cap on carryover of earnings and

profits.

(iv) Post-acquisition date distribution of

old FT earnings and profits.

(v) Old FT earnings and profits unaffected by post-acquisition date

deficits.

(vi) Character of FT stock as carryover

FT stock eliminated upon disposition.

(4) Passive foreign investment company

stock.

(c) Dividend treatment under section

1248(e).

(d) Allocation of foreign taxes.

(e) Operation of section 338(h)(16). [Reserved]

(f) Examples.

§1.338–10T Filing of returns (temporary).

(a) Returns including tax liability from

deemed asset sale.

(1) In general.

(2) Old target’s final taxable year otherwise included in consolidated return

of selling group.

(i) General rule.

(ii) Separate taxable year.

(iii) Carryover and carryback of tax attributes.

(iv) Old target is a component member of

purchasing corporation’s controlled

group.

(3) Old target is an S corporation.

(4) Combined deemed sale return.

(i) General rule.

(ii) Gain and loss offsets.

(iii) Procedure for filing a combined return.

(iv) Consequences of filing a combined

return.

(5) Deemed sale excluded from purchasing corporation’s consolidated return.

(6) Due date for old target’s final return.

(i) General rule.

(ii) Application of §1.1502–76(c).

(A) In general.

(B) Deemed extension.

(C) Erroneous filing of deemed sale re-

337

turn.

(D) Erroneous filing of return for regular

tax year.

(E) Last date for payment of tax.

(7) Examples.

(b) Waiver.

(1) Certain additions to tax.

(2) Notification.

(3) Elections or other actions required to

be specified on a timely filed return.

(i) In general.

(ii) New target in purchasing corporation’s consolidated return.

(4) Examples.

§1.338(h)(10)–1T Deemed asset sale and

liquidation (temporary).

(a) Scope.

(b) Definitions.

(1) Consolidated target.

(2) Selling consolidated group.

(3) Selling affiliate; affiliated target.

(4) S corporation target

(5) S corporation shareholders.

(6) Liquidation.

(c) Section 338(h)(10) election.

(1) In general.

(2) Simultaneous joint election requirement.

(3) Irrevocability.

(4) Effect of invalid election.

(d) Certain consequences of section

338(h)(10) election.

(1) P.

(2) New T.

(3) Old T—deemed sale.

(i) In general.

(ii) Tiered targets.

(4) Old T and selling consolidated group,

selling affiliate, or S corporation

shareholders—deemed liquidation;

tax characterization.

(i) In general.

(ii) Tiered targets.

(5) Selling consolidated group, selling affiliate, or S corporation shareholders.

(i) In general.

(ii) Basis and holding period of T stock

not acquired.

(iii) T stock sale.

(6) Nonselling minority shareholders

other than nonselling S corporation

shareholders.

(i) In general.

(ii) T stock sale.

(iii) T stock not acquired.

(7) Consolidated return of selling consolidated group.

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(8) Availability of the section 453 installment method.

(i) In deemed asset sale.

(ii) In deemed liquidation.

(9) Treatment consistent with an actual

asset sale.

(e) Examples.

(f) Inapplicability of provisions.

(g) Required information.

§1.338(i)–1T Effective dates (temporary).

§1.338–1T General principles; status of

old target and new target (temporary).

(a) In general—(1) Deemed transaction. Elections are available under section 338 when a purchasing corporation

acquires the stock of another corporation

(the target) in a qualified stock purchase.

One type of election, under section

338(g), is available to the purchasing corporation. Another type of election, under

section 338(h)(10), is, in more limited circumstances, available jointly to the purchasing corporation and the sellers of the

stock. (Rules concerning eligibility for

these elections are contained in §§

1.338–2T,

1.338–3T,

and

1.338(h)(10)–1T.) Although target is a

single corporation under corporate law, if

a section 338 election is made, then two

separate corporations, old target and new

target, generally are considered to exist

for purposes of subtitle A of the Internal

Revenue Code. Old target is treated as

transferring all of its assets to an unrelated

person in exchange for consideration that

includes the assumption of, or taking subject to, liabilities, and new target is treated

as acquiring all of its assets from an unrelated person in exchange for consideration that includes the assumption of or

taking subject to liabilities. (Such transaction is, without regard to its characterization for Federal income tax purposes,

referred to as the deemed asset sale and

the income tax consequences thereof as

the deemed sale gain.) If a section

338(h)(10) election is made, old target is

also deemed to liquidate following the

deemed asset sale.

(2) Application of other rules of law.

Other rules of law apply to determine the

tax consequences to the parties as if they

had actually engaged in the transactions

deemed to occur under section 338 and

§§1.338–0T through 1.338–7T, 1.338–8,

1.338–9, 1.338–10T, 1.338(h)(10)–1T,

and 1.338(i)–1T except to the extent otherwise provided in §§1.338–0T through

January 24, 2000

1.338–7T, 1.338–8, 1.338–9, 1.338–10T,

1.338(h)(10)–1T, and 1.338(i)–1T. See

also §1.338–6T(c)(2). Other rules of law

may characterize the transaction as something other than or in addition to a sale

and purchase of assets; however, it must

be a taxable transaction. For example, if

target is an insurance company for which

a section 338 election is made, the

deemed asset sale would be characterized

and taxed as an assumption–reinsurance

transaction under applicable Federal income tax law. See §1.817–4(d).

(3) Overview. Definitions and special

nomenclature and rules for making the

section 338 election are provided in

§1.338–2T. Qualification for the section

338 election is addressed in §1.338–3T.

The amount for which old target is treated

as selling all of its assets (the aggregate

deemed sale price, or ADSP) is addressed

in §1.338–4T. The amount for which new

target is deemed to have purchased all its

assets (the adjusted grossed-up basis, or

AGUB) is addressed in §1.338–5T. Section 1.338–6T addresses allocation both

of ADSP among the assets old target is

deemed to have sold and of AGUB among

the assets new target is deemed to have

purchased. Section 1.338–7T addresses

allocation of ADSP or AGUB when those

amounts change after the close of new target’s first taxable year. Asset and stock

consistency are addressed in §1.338–8.

International aspects of section 338 are

covered in §1.338–9. Rules for the filing

of returns are provided in §1.338–10T.

Eligibility for and treatment of section

338(h)(10) elections is addressed in

§1.338(h)(10)–1T.

(b) Treatment of target under other provisions of the Internal Revenue Code—(1)

General rule for subtitle A. Except as

provided in this section, new target is

treated as a new corporation that is unrelated to old target for purposes of subtitle

A of the Internal Revenue Code. Thus—

(i) New target is not considered related

to old target for purposes of section 168

and may make new elections under section 168 without taking into account the

elections made by old target; and

(ii) New target may adopt, without obtaining prior approval from the Commissioner, any taxable year that meets the requirements of section 441 and any

method of accounting that meets the requirements of section 446. Notwithstand-

338

ing §1.441–1T(b)(2), a new target may

adopt a taxable year on or before the last

day for making the election under section

338 by filing its first return for the desired

taxable year on or before that date.

(2) Exceptions for subtitle A. New target and old target are treated as the same

corporation for purposes of—

(i) The rules applicable to employee

benefit plans (including those plans described in sections 79, 104, 105, 106, 125,

127, 129, 132, 137, and 220), qualified

pension, profit-sharing, stock bonus and

annuity plans (sections 401(a) and

403(a)), simplified employee pensions

(section 408(k)), tax qualified stock option plans (sections 422 and 423), welfare

benefit funds (sections 419, 419A,

512(a)(3), and 4976), voluntary employee

benefit associations (section 501(c)(9)

and the regulations thereunder);

(ii) Sections 1311 through 1314 (relating to the mitigation of the effect of limitations) if a section 338(h)(10) election is

not made for target;

(iii) Section 108(e)(5) (relating to the

reduction of purchase money debt);

(iv) Section 45A (relating to the Indian

Employment Credit), section 51 (relating

to the Work Opportunity Credit), section

51A (relating to the Welfare to Work

Credit), and section 1396 (relating to the

Empowerment Zone Act);

(v) Sections 401(h) and 420 (relating to

medical benefits for retirees);

(vi) Section 414 (relating to definitions

and special rules);

and

(vii) Any other provision designated in

the Internal Revenue Bulletin by the Internal Revenue Service.

See

§601.601(d)(2)(ii) of this chapter (relating to the Internal Revenue Bulletin). See

§1.1001–3(e)(4)(F) providing that an

election under section 338 does not result

in the substitution of a new obligor on target’s debt.

(3) General rule for other provisions of

the Internal Revenue Code. Except as

provided in the regulations under section

338 or in the Internal Revenue Bulletin by

the Internal Revenue Service (see

§601.601(d)(2)(ii) of this chapter), new

target is treated as a continuation of old

target for purposes other than subtitle A of

the Internal Revenue Code. For example—

(i) New target is liable for old target’s

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Federal income tax liabilities, including

the tax liability for the deemed sale gain

and those tax liabilities of the other members of any consolidated group that included old target that are attributable to

taxable years in which those corporations

and old target joined in the same consolidated return (see §1.1502–6(a));

(ii) Wages earned by the employees of

old target are considered wages earned by

such employees from new target for purposes of sections 3101 and 3111 (Federal

Insurance Contributions Act) and section

3301 (Federal Unemployment Tax Act);

and

(iii) Old target and new target must use

the same employer identification number.

(c) Anti-abuse rule—(1) In general.

For purposes of applying the residual

method of §§1.338–0T through 1.338–7T,

1.338–8,

1.338–9,

1.338–10T,

1.338(h)(10)–1T, and 1.338(i)–1T, the

Commissioner is authorized to treat any

property (including cash) transferred by

old target in connection with the transactions resulting in the application of the

residual method as, nonetheless, property

of target at the close of the acquisition

date if the property so transferred, within

24 months after the deemed asset sale, is

owned by new target, or is owned, directly or indirectly, by a member of the

affiliated group of which new target is a

member and continues after the election

to be held or used to more than an insignificant extent in connection with one

or more of the activities of new target.

The Commissioner is authorized to treat

any property (including cash) transferred

to old target in connection with the transactions resulting in the application of the

residual method as, nonetheless, not being

property of target at the close of the acquisition date if the property so transferred by the transferor is, within 24

months after the deemed asset sale, not

owned by new target but owned, directly

or indirectly, by a member of the affiliated

group of which new target is a member or

owned by new target but held or used to

more than an insignificant extent in connection with an activity conducted, directly or indirectly, by another member of

the affiliated group of which new target is

a member in combination with other

property acquired, directly or indirectly,

from the transferor of the property (or a

member of the same affiliated group) to

2000–4 I.R.B.

old target. For purposes of this paragraph (c)(1), an interest in an entity is

considered held or used in connection

with an activity if property of the entity is

so held or used. The authority under this

paragraph (c)(1) includes the making of

any necessary correlative adjustments.

(2) Examples. The following examples

illustrate this paragraph (c):

Example 1. Prior to a qualified stock purchase

under section 338, target transfers one of its assets to

a related party. The purchasing corporation then

purchases the target stock and also purchases the

transferred asset from the related party. After its

purchase of target, the purchasing corporation and

target are members of the same affiliated group. A

section 338 election is made. Under an arrangement

with the purchaser, target continues to use the separately transferred asset to more than an insignificant

extent in connection with its own activities. Applying the anti-abuse rule of this paragraph (c), the

Commissioner may consider target to own the transferred asset for purposes of applying section 338 and

its allocation rules.

Example 2. Target (T) owns all the stock of T1.

T1 leases intellectual property to T, which T uses in

connection with its own activities. P, a purchasing

corporation, wishes to buy the T-T1 chain of corporations. P, in connection with its planned purchase

of the T stock, contracts to consummate a purchase

of all the stock of T1 on March 1 and of all the stock

of T on March 2. Section 338 elections are thereafter made for both T and T1. Immediately after the

purchases, P, T and T1 are members of the same affiliated group. T continues to lease the intellectual

property from T1 and to use the property to more

than an insignificant extent in connection with its

own activities. Thus, an asset of T, the T1 stock,

was removed from T ‘s own assets prior to the qualified stock purchase of the T stock, T1’s own assets

are used after the deemed asset sale in connection

with T’s own activities, and the T1 stock is after the

deemed asset sale owned by P, a member of the

same affiliated group of which T is a member. Applying the anti-abuse rule of this paragraph (c), the

Commissioner may, for purposes of application of

section 338 both to T and to T1, consider P to have

bought only the stock of T, with T at the time of the

qualified stock purchases of both T and T1 (the qualified stock purchase of T1 being triggered by the

deemed sale under section 338 of T’s assets) owning

T1. The Commissioner would accordingly apply

section 338 first at the T level and then at the T1

level.

§1.338–2T Nomenclature and definitions; mechanics of the section 338 election (temporary).

(a) Scope. This section prescribes rules

relating to elections under section 338.

(b) Nomenclature. For purposes of the

regulations under section 338 (except as

otherwise provided):

(1) T is a domestic target corporation

that has only one class of stock outstanding. Old T refers to T for periods ending

339

on or before the close of T’s acquisition

date; new T refers to T for subsequent periods.

(2) P is the purchasing corporation.

(3) The P group is an affiliated group of

which P is a member.

(4) P1, P2, etc., are domestic corporations that are members of the P group.

(5) T1, T2, etc., are domestic corporations that are target affiliates of T. These

corporations (T1, T2, etc.) have only one

class of stock outstanding and may also

be targets.

(6) S is a domestic corporation (unrelated to P and B) that owns T prior to the

purchase of T by P. (S is referred to in

cases in which it is appropriate to consider the effects of having all of the outstanding stock of T owned by a domestic

corporation.)

(7) A, a U.S. citizen or resident, is an

individual (unrelated to P and B) who

owns T prior to the purchase of T by P.

(A is referred to in cases in which it is appropriate to consider the effects of having

all of the outstanding stock of T owned by

an individual who is a U.S. citizen or resident. Ownership of T by A and ownership

of T by S are mutually exclusive circumstances.)

(8) B, a U.S. citizen or resident, is an

individual (unrelated to T, S, and A) who

owns the stock of P.

(9) F, used as a prefix with the other

terms in this paragraph (b), connotes foreign, rather than domestic, status. For example, FT is a foreign corporation (as defined in section 7701(a)(5)) and FA is an

individual other than a U.S. citizen or resident.

(10) CFC, used as a prefix with the

other terms in this paragraph (b) referring

to a corporation, connotes a controlled

foreign corporation (as defined in section

957, taking into account section 953(c)).

A corporation identified with the prefix F

may be a controlled foreign corporation.

The prefix CFC is used when the corporation’s status as a controlled foreign corporation is significant.

(c) Definitions. For purposes of the

regulations under section 338 (except as

otherwise provided):

(1) Acquisition date. The term acquisition date has the same meaning as in section 338(h)(2).

(2) Acquisition date assets. Acquisition

date assets are the assets of the target held

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at the beginning of the day after the acquisition date (other than assets that were not

assets of old target).

(3) Affiliated group. The term affiliated group has the same meaning as in

section 338(h)(5). Corporations are affiliated on any day they are members of the

same affiliated group.

(4) Common parent. The term common

parent has the same meaning as in section

1504.

(5) Consistency period. The consistency period is the period described in

section 338(h)(4)(A) unless extended pursuant to §1.338–8(j)(1).

(6) Deemed asset sale. The deemed

asset sale is the transaction described in

§1.338–1T(a)(1) that is deemed to occur

for purposes of subtitle A of the Internal

Revenue Code if a section 338 election is

made.

(7) Deemed sale gain. Deemed sale

gain refers to, in the aggregate, the Federal income tax consequences (generally,

the income, gain, deduction, and loss) of

the deemed asset sale. Deemed sale gain

also refers to the Federal income tax consequences of the transfer of a particular

asset in the deemed asset sale.

(8) Deemed sale return. The deemed

sale return is the return on which target’s

deemed sale gain is reported that does not

include any other items of target. Target

files a deemed sale return when a section

338 election (but not a section 338(h)(10)

election) is filed for target and target is a

member of a selling group (defined in

paragraph (c)(16) of this section) that files

a consolidated return for the period that

includes the acquisition date or is an S

corporation. See §1.338–10T.

(9) Domestic corporation. A domestic

corporation is a corporation—

(i) That is domestic within the meaning

of section 7701(a)(4) or that is treated as

domestic for purposes of subtitle A of the

Internal Revenue Code (e.g., to which an

election under section 953(d) or 1504(d)

applies); and

(ii) That is not a DISC, a corporation

described in section 1248(e), or a corporation to which an election under section

936 applies.

(10) Old target’s final return. Old target’s final return is the income tax return

of old target for the taxable year ending at

the close of the acquisition date that includes the deemed sale gain. If the disaf-

January 24, 2000

filiation rule of §1.338–10T(a)(2)(i) applies or if target is an S corporation, target’s deemed sale return is considered old

target’s final return.

(11) Purchasing corporation. The term

purchasing corporation has the same

meaning as in section 338(d)(1). The purchasing corporation may also be referred

to as purchaser. Unless otherwise provided, any reference to the purchasing

corporation is a reference to all members

of the affiliated group of which the purchasing corporation is a member. See

sections 338(h)(5) and (8). Also, unless

otherwise provided, any reference to the

purchasing corporation is, with respect to

a deemed purchase of stock under section

338(a)(2), a reference to new target with

respect to its own deemed purchase of

stock in another target.

(12) Qualified stock purchase. The

term qualified stock purchase has the

same meaning as in section 338(d)(3).

(13) Related persons. Two persons are

related if stock in a corporation owned by

one of the persons would be attributed

under section 318(a) (other than section

318(a)(4)) to the other.

(14) Section 338 election. A section

338 election is an election to apply section 338(a) to target. A section 338 election is made by filing a statement of section 338 election pursuant to paragraph

(d) of this section. The form on which

this statement is filed is referred to in the

regulations under section 338 as the Form

8023 Elections Under Section 338 for

Corporations Making Qualified Stock

Purchases.

(15) Section 338(h)(10) election. A

section 338(h)(10) election is an election

to apply section 338(h)(10) to target. A

section 338(h)(10) election is made by

making a joint election for target under

§1.338(h)(10)–1T.

(16) Selling group. The selling group

is the affiliated group (as defined in section 1504) eligible to file a consolidated

return that includes target for the taxable

period in which the acquisition date occurs. However, a selling group is not an

affiliated group of which target is the

common parent on the acquisition date.

(17) Target; old target; new target.

Target is the target corporation as defined

in section 338(d)(2). Old target refers to

target for periods ending on or before the

close of target’s acquisition date. New

340

target refers to target for subsequent periods.

(18) Target affiliate. The term target

affiliate has the same meaning as in section 338(h)(6) (applied without section

338(h)(6)(B)(i)). Thus, a corporation described in section 338(h)(6)(B)(i) is considered a target affiliate for all purposes

of section 338. If a target affiliate is acquired in a qualified stock purchase, it is

also a target.

(19) 12–Month acquisition period. The

12-month acquisition period is the period

described in section 338(h)(1), unless extended pursuant to §1.338–8(j)(2).

(d) Time and manner of making election. The purchasing corporation makes a

section 338 election for target by filing a

statement of section 338 election on Form

8023 in accordance with the instructions

to the form. The section 338 election

must be made not later than the 15th day

of the 9th month beginning after the

month in which the acquisition date occurs. A section 338 election is irrevocable. See §1.338(h)(10)–1T(c)(2) for section 338(h)(10) elections.

(e) Special rules for foreign corporations or DISCs—(1) Elections by certain

foreign purchasing corporations—(i)

General rule. A qualifying foreign purchasing corporation is not required to file

a statement of section 338 election for a

qualifying foreign target before the earlier

of 3 years after the acquisition date and

the 180th day after the close of the purchasing corporation’s taxable year within

which a triggering event occurs.

(ii) Qualifying foreign purchasing corporation. A purchasing corporation is a

qualifying foreign purchasing corporation only if, during the acquisition period

of a qualifying foreign target, all the corporations in the purchasing corporation’s

affiliated group are foreign corporations

that are not subject to United States tax.

(iii) Qualifying foreign target. A target

is a qualifying foreign target only if target

and its target affiliates are foreign corporations that, during target’s acquisition period, are not subject to United States tax

(and will not become subject to United

States tax during such period because of a

section 338 election). A target affiliate is

taken into account for purposes of the preceding sentence only if, during target’s

12-month acquisition period, it is or becomes a member of the affiliated group

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that includes the purchasing corporation.

(iv) Triggering event. A triggering

event occurs in the taxable year of the

qualifying foreign purchasing corporation

in which either that corporation or any

corporation in its affiliated group becomes subject to United States tax.

(v) Subject to United States tax. For

purposes of this paragraph (e)(1), a foreign corporation is considered subject to

United States tax—

(A) For the taxable year for which that

corporation is required under §1.6012–2(g)

(other than §1.6012–2(g)(2)(i)(B)(2)) to

file a United States income tax return; or

(B) For the period during which that

corporation is a controlled foreign corporation, a passive foreign investment company for which an election under section

1295 is in effect, a foreign investment

company, or a foreign corporation the

stock ownership of which is described in

section 552(a)(2).

(2) Acquisition period. For purposes of

this paragraph (e), the term acquisition

period means the period beginning on the

first day of the 12-month acquisition period and ending on the acquisition date.

(3) Statement of section 338 election

may be filed by United States shareholders in certain cases. The United States

shareholders (as defined in section

951(b)) of a foreign purchasing corporation that is a controlled foreign corporation (as defined in section 957 (taking into

account section 953(c))) may file a statement of section 338 election on behalf of

the purchasing corporation if the purchasing corporation is not required under

§1.6012–2(g)

(other

than

§1.6012–2(g)(2)(i)(B)(2)) to file a United

States income tax return for its taxable

year that includes the acquisition date.

Form 8023 must be filed as described in

the form and its instructions and also must

be attached to the Form 5471 (information return with respect to a foreign corporation) filed with respect to the purchasing corporation by each United States

shareholder for the purchasing corporation’s taxable year that includes the acquisition date (or, if paragraph (e)(1)(i) of

this section applies to the election, for the

purchasing corporation’s taxable year

within which it becomes a controlled foreign corporation). The provisions of

§1.964–1(c) (including §1.964–1(c)(7))

do not apply to an election made by the

2000–4 I.R.B.

United States shareholders.

(4) Notice requirement for U.S. persons

holding stock in foreign market—(i) General rule. If a target subject to a section

338 election was a controlled foreign corporation, a passive foreign investment

company, or a foreign personal holding

company at any time during the portion of

its taxable year that ends on its acquisition

date, the purchasing corporation must deliver written notice of the election (and a

copy of Form 8023, its attachments and

instructions) to—

(A) Each U.S. person (other than a

member of the affiliated group of which

the purchasing corporation is a member

(the purchasing group member)) that, on

the acquisition date of the foreign target,

holds stock in the foreign target; and

(B) Each U.S. person (other than a purchasing group member) that sells stock in

the foreign target to a purchasing group

member during the foreign target’s 12month acquisition period.

(ii) Limitation. The notice requirement

of this paragraph (e)(4) applies only

where the section 338 election for the foreign target affects income, gain, loss, deduction, or credit of the U.S. person described in paragraph (e)(4)(i) of this

section under section 551, 951, 1248, or

1293.

(iii) Form of notice. The notice to U.S.

persons must be identified prominently as

a notice of section 338 election and

must—

(A) Contain the name, address, and employer identification number (if any) of,

and the country (and, if relevant, the

lesser political subdivision) under the

laws of which is organized, the purchasing corporation and the relevant target

(i.e., target the stock of which the particular U.S. person held or sold under the circumstances described in paragraph

(e)(4)(i) of this section);

(B) Identify those corporations as the

purchasing corporation and the foreign

target, respectively; and

(C) Contain the following declaration

(or a substantially similar declaration):

THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER SECTION 338 FOR THE ABOVE CITED

FOREIGN TARGET THE STOCK OF

WHICH YOU EITHER HELD OR

SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREA-

341

SURY REGULATIONS SECTION

1.338-2T(e)(4).

FOR POSSIBLE

UNITED STATES FEDERAL INCOME

TAX CONSEQUENCES UNDER SECTION 551, 951, 1248, OR 1293 OF THE

INTERNAL REVENUE CODE OF 1986

THAT MAY APPLY TO YOU, SEE

TREASURY REGULATIONS SECTION

1.338-9(b). YOU MAY BE REQUIRED

TO ATTACH THE INFORMATION ATTACHED TO THIS NOTICE TO CERTAIN RETURNS.

(iv) Timing of notice. The notice required by this paragraph (e)(4) must be

delivered to the U.S. person on or before

the later of the 120th day after the acquisition date of the particular target or the day

on which Form 8023 is filed. The notice

is considered delivered on the date it is

mailed to the proper address (or an address similar enough to complete delivery), unless the date it is mailed cannot be

reasonably determined. The date of mailing will be determined under the rules of

section 7502. For example, the date of

mailing is the date of U.S. postmark or the

applicable date recorded or marked by a

designated delivery service.

(v) Consequence of failure to comply.

A statement of section 338 election is not

valid if timely notice is not given to one

or more U.S. persons described in this

paragraph (e)(4). If the form of notice

fails to comply with all requirements of

this paragraph (e)(4), the section 338

election is valid, but the waiver rule of

§1.338-10T(b)(1) does not apply.

(vi) Good faith effort to comply. The

purchasing corporation will be considered

to have complied with this paragraph

(e)(4), even though it failed to provide notice or provide timely notice to each person described in this paragraph (e)(4), if

the Commissioner determines that the

purchasing corporation made a good faith

effort to identify and provide timely notice to those U.S. persons.

§1.338-3T Qualification for the section

338 election (temporary).

(a) Scope. This section provides rules

on whether certain acquisitions of stock

are qualified stock purchases and on other

miscellaneous issues under section 338.

(b) Rules relating to qualified stock

purchases—(1) Purchasing corporation

requirement. An individual cannot make

a qualified stock purchase of target. Section 338(d)(3) requires, as a condition of a

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Page 342

qualified stock purchase, that a corporation purchase the stock of target. If an individual forms a corporation (new P) to

acquire target stock, new P can make a

qualified stock purchase of target if new P

is considered for tax purposes to purchase

the target stock. Facts that may indicate

that new P does not purchase the target

stock include new P’s merging downstream into target, liquidating, or otherwise disposing of the target stock following the purported qualified stock

purchase.

(2) Purchase—(i) Definition. The term

purchase has the same meaning as in section 338(h)(3).

(ii) Purchase of target. [Reserved]

(iii) Purchase of target affiliate. Stock

in a target affiliate acquired by new target

in the deemed asset sale of target’s assets

is considered purchased if, under general

principles of tax law, new target is considered to own stock of the target affiliate

meeting the requirements of section

1504(a)(2), notwithstanding that no

amount may be allocated to target’s stock

in the target affiliate.

(3) Acquisitions of stock from related

corporations—(i) In general. Stock acquired by a purchasing corporation from a

related corporation (R) is generally not

considered acquired by purchase. See

section 338(h)(3)(A)(iii).

(ii) Time for testing relationship. For

purposes of section 338(h)(3)(A)(iii), a

purchasing corporation is treated as related to another person if the relationship

specified in section 338(h)(3)(A)(iii) exists—

(A) In the case of a single transaction,

immediately after the purchase of Target

stock;

(B) In the case of a series of acquisitions otherwise constituting a qualified

stock purchase within the meaning of section 338(d)(3), immediately after the last

acquisition in such series; and

(C) In the case of a series of transactions effected pursuant to an integrated

plan to dispose of Target stock, immediately after the last transaction in such series.

(iii) Cases where section 338(h)(3)(C)

applies—acquisitions treated as purchases. If section 338(h)(3)(C) applies

and the purchasing corporation is treated

as acquiring stock by purchase from R,

solely for purposes of determining when

January 24, 2000

the stock is considered acquired, target

stock acquired from R is considered to

have been acquired by the purchasing corporation on the day on which the purchasing corporation is first considered to own

that stock under section 318(a) (other than

section 318(a)(4)).

(iv) Examples. The following examples illustrate this paragraph (b)(3):

Example 1. (i) S is the parent of a group of corporations that are engaged in various businesses. Prior

to January 1, Year 1, S decided to discontinue its involvement in one line of business. To accomplish

this, S forms a new corporation, Newco, with a nominal amount of cash. Shortly thereafter, on January 1,

Year 1, S transfers all the stock of the subsidiary conducting the unwanted business (Target) to Newco in

exchange for 100 shares of Newco common stock

and a Newco promissory note. Prior to January 1,

Year 1, S and Underwriter (U) had entered into a

binding agreement pursuant to which U would purchase 60 shares of Newco common stock from S and

then sell those shares in an Initial Public Offering

(IPO). On January 6, Year 1, the IPO closes.

(ii) Newco’s acquisition of Target stock is one of

a series of transactions undertaken pursuant to one

integrated plan. The series of transactions ends with

the closing of the IPO and the transfer of all the

shares of stock in accordance with the agreements.

Immediately after the last transaction effected pursuant to the plan, S owns 40 percent of Newco,

which does not give rise to a relationship described

in

section

338(h)(3)(A)(iii).

See

§1.338–2T(b)(3)(ii)(C). Accordingly, S and Newco

are not related for purposes of section

338(h)(3)(A)(iii).

(iii) Further, because Newco’s basis in the Target

stock is not determined by reference to S’s basis in

the Target stock and because the transaction is not an

exchange to which section 351, 354, 355, or 356 applies, Newco’s acquisition of the Target stock is a

purchase within the meaning of section 338(h)(3).

Example 2. (i) On January 1 of Year 1, P purchases 75 percent in value of the R stock. On that

date, R owns 4 of the 100 shares of T stock. On June

1 of Year 1, R acquires an additional 16 shares of T

stock. On December 1 of Year 1, P purchases 70

shares of T stock from an unrelated person and 12 of

the 20 shares of T stock held by R.

(ii) Of the 12 shares of T stock purchased by P

from R on December 1 of Year 1, 3 of those shares

are deemed to have been acquired by P on January 1

of Year 1, the date on which 3 of the 4 shares of T

stock held by R on that date were first considered

owned by P under section 318(a)(2)(C) (i.e., 4 ( .75).

The remaining 9 shares of T stock purchased by P

from R on December 1 of Year 1, are deemed to

have been acquired by P on June 1 of Year 1, the

date on which an additional 12 of the 20 shares of T

stock owned by R on that date were first considered

owned by P under section 318(a)(2)(C) (i.e., (20 (

.75) -3). Because stock acquisitions by P sufficient

for a qualified stock purchase of T occur within a

12-month period (i.e., 3 shares constructively on

January 1 of Year 1, 9 shares constructively on June

1 of Year 1, and 70 shares actually on December 1 of

Year 1), a qualified stock purchase is made on December 1 of Year 1.

342

Example 3. (i) On February 1 of Year 1, P acquires

25 percent in value of the R stock from B (the sole

shareholder of P). That R stock is not acquired by

purchase. See section 338(h)(3)(A)(iii). On that date,

R owns 4 of the 100 shares of T stock. On June 1 of

Year 1, P purchases an additional 25 percent in value

of the R stock, and on January 1 of Year 2, P purchases another 25 percent in value of the R stock. On

June 1 of Year 2, R acquires an additional 16 shares of

the T stock. On December 1 of Year 2, P purchases

68 shares of the T stock from an unrelated person and

12 of the 20 shares of the T stock held by R.

(ii) Of the 12 shares of the T stock purchased by P

from R on December 1 of Year 2, 2 of those shares

are deemed to have been acquired by P on June 1 of

Year 1, the date on which 2 of the 4 shares of the T

stock held by R on that date were first considered

owned by P under section 318(a)(2)(C) (i.e., 4 ( .5).

For purposes of this attribution, the R stock need not

be acquired by P by purchase. See section 338(h)(1).

(By contrast, the acquisition of the T stock by P from

R does not qualify as a purchase unless P has acquired at least 50 percent in value of the R stock by

purchase. Section 338(h)(3)(C)(i).) Of the remaining 10 shares of the T stock purchased by P from R

on December 1 of Year 2, 1 of those shares is deemed

to have been acquired by P on January 1 of Year 2,

the date on which an additional 1 share of the 4

shares of the T stock held by R on that date was first

considered owned by P under section 318(a)(2)(C)

(i.e., (4 ( .75) –2). The remaining 9 shares of the T

stock purchased by P from R on December 1 of Year

2, are deemed to have been acquired by P on June 1

of Year 2, the date on which an additional 12 shares

of the T stock held by R on that date were first considered owned by P under section 318(a)(2)(C) (i.e.,

(20 ( .75) –3). Because a qualified stock purchase of

T by P is made on December 1 of Year 2, only if all

12 shares of the T stock purchased by P from R on

that date are considered acquired during a 12-month

period ending on that date (so that, in conjunction

with the 68 shares of the T stock P purchased on that

date from the unrelated person, 80 of T’s 100 shares

are acquired by P during a 12-month period) and because 2 of those 12 shares are considered to have

been acquired by P more than 12 months before December 1 of Year 2 (i.e., on June 1 of Year 1), a qualified stock purchase is not made. (Under

§1.338–8(j)(2), for purposes of applying the consistency rules, P is treated as making a qualified stock

purchase of T if, pursuant to an arrangement, P purchases T stock satisfying the requirements of section

1504(a)(2) over a period of more than 12 months.)

Example 4. Assume the same facts as in Example

3, except that on February 1 of Year 1, P acquires 25

percent in value of the R stock by purchase. The result is the same as in Example 3.

(4) Acquisition date for tiered targets—

(i) Stock sold in deemed asset sale. If an

election under section 338 is made for target, old target is deemed to sell target’s

assets and new target is deemed to acquire

those assets. Under section 338(h)(3)(B),

new target’s deemed purchase of stock of

another corporation is a purchase for purposes of section 338(d)(3) on the acquisition date of target. If new target’s deemed

purchase causes a qualified stock pur-

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chase of the other corporation and if a

section 338 election is made for the other

corporation, the acquisition date for the

other corporation is the same as the acquisition date of target. However, the

deemed sale and purchase of the other

corporation’s assets is considered to take

place after the deemed sale and purchase

of target’s assets.

(ii) Examples. The following examples

illustrate this paragraph (b)(4):

Example 1. A owns all of the T stock. T owns 50

of the 100 shares of X stock. The other 50 shares of

X stock are owned by corporation Y, which is unrelated to A, T, or P. On January 1 of Year 1, P makes a

qualified stock purchase of T from A and makes a

section 338 election for T. On December 1 of Year 1,

P purchases the 50 shares of X stock held by Y. A

qualified stock purchase of X is made on December 1

of Year 1, because the deemed purchase of 50 shares

of X stock by new T because of the section 338 election for T and the actual purchase of 50 shares of X

stock by P are treated as purchases made by one corporation. Section 338(h)(8). For purposes of determining whether those purchases occur within a 12month acquisition period as required by section

338(d)(3), T is deemed to purchase its X stock on T’s

acquisition date, i.e., January 1 of Year 1.

Example 2. On January 1 of Year 1, P makes a

qualified stock purchase of T and makes a section

338 election for T. On that day, T sells all of the

stock of T1 to A. Although T held all of the T1 stock

on T’s acquisition date, T is not considered to have

purchased the T1 stock because of the section 338

election for T. In order for T to be treated as purchasing the T1 stock, T must hold the T1 stock when

T’s deemed asset sale occurs. The deemed asset sale

is considered the last transaction of old T at the close

of T’s acquisition date. Accordingly, the T1 stock

actually disposed of by T on the acquisition date is

not included in the deemed asset sale. Thus, T does

not make a qualified stock purchase of T1.

(5) Effect of redemptions—(i) General

rule. Except as provided in this paragraph (b)(5), a qualified stock purchase is

made on the first day on which the percentage ownership requirements of section 338(d)(3) are satisfied by reference to

target stock that is both—

(A) Held on that day by the purchasing

corporation; and

(B) Purchased by the purchasing corporation during the 12-month period ending

on that day.

(ii) Redemptions from persons unrelated to the purchasing corporation. Target stock redemptions from persons unrelated to the purchasing corporation that

occur during the 12-month acquisition period are taken into account as reductions

in target’s outstanding stock for purposes

of determining whether target stock purchased by the purchasing corporation in

2000–4 I.R.B.

the 12-month acquisition period satisfies

the percentage ownership requirements of

section 338(d)(3).

(iii) Redemptions from the purchasing

corporation or related persons during 12month acquisition period—(A) General

rule. For purposes of the percentage

ownership requirements of section

338(d)(3), a redemption of target stock

during the 12-month acquisition period

from the purchasing corporation or from

any person related to the purchasing corporation is not taken into account as a reduction in target’s outstanding stock.

(B) Exception for certain redemptions

from related corporations. A redemption

of target stock during the 12-month acquisition period from a corporation related to

the purchasing corporation is taken into

account as a reduction in target’s outstanding stock to the extent that the redeemed stock would have been considered purchased by the purchasing

corporation (because of section

338(h)(3)(C)) during the 12-month acquisition period if the redeemed stock had

been acquired by the purchasing corporation from the related corporation on the

day of the redemption. See paragraph

(b)(3) of this section.

(iv) Examples. The following examples illustrate this paragraph (b)(5):

Example 1. QSP on stock purchase date; redemption from unrelated person during 12-month

period. A owns all 100 shares of T stock. On January 1 of Year 1, P purchases 40 shares of the T stock

from A. On July 1 of Year 1, T redeems 25 shares

from A. On December 1 of Year 1, P purchases 20

shares of the T stock from A. P makes a qualified

stock purchase of T on December 1 of Year 1, because the 60 shares of T stock purchased by P within

the 12-month period ending on that date satisfy the

80-percent ownership requirements of section

338(d)(3) (i.e., 60/75 shares), determined by taking

into account the redemption of 25 shares.

Example 2. QSP on stock redemption date; redemption from unrelated person during 12-month period. The facts are the same as in Example 1, except

that P purchases 60 shares of T stock on January 1 of

Year 1 and none on December 1 of Year 1. P makes a

qualified stock purchase of T on July 1 of Year 1, because that is the first day on which the T stock purchased by P within the preceding 12-month period

satisfies the 80-percent ownership requirements of

section 338(d)(3) (i.e., 60/75 shares), determined by

taking into account the redemption of 25 shares.

Example 3. Redemption from purchasing corporation not taken into account. On December 15 of

Year 1, T redeems 30 percent of its stock from P.

The redeemed stock was held by P for several years

and constituted P’s total interest in T. On December

1 of Year 2, P purchases the remaining T stock from

A. P does not make a qualified stock purchase of T

on December 1 of Year 2. For purposes of the 80-

343

percent ownership requirements of section

338(d)(3), the redemption of P’s T stock on December 15 of Year 1 is not taken into account as a reduction in T’s outstanding stock.

Example 4. Redemption from related person

taken into account. On January 1 of Year 1, P purchases 60 of the 100 shares of X stock. On that date,

X owns 40 of the 100 shares of T stock. On April 1

of Year 1, T redeems X’s T stock and P purchases the

remaining 60 shares of T stock from an unrelated

person. For purposes of the 80-percent ownership

requirements of section 338(d)(3), the redemption of

the T stock from X (a person related to P) is taken

into account as a reduction in T’s outstanding stock.

If P had purchased the 40 redeemed shares from X

on April 1 of Year 1, all 40 of the shares would have

been considered purchased (because of section

338(h)(3)(C)(i)) during the 12-month period ending

on April 1 of Year 1 (24 of the 40 shares would have

been considered purchased by P on January 1 of

Year 1 and the remaining 16 shares would have been

considered purchased by P on April 1 of Year 1).

See paragraph (b)(3) of this section. Accordingly, P

makes a qualified stock purchase of T on April 1 of

Year 1, because the 60 shares of T stock purchased

by P on that date satisfy the 80-percent ownership

requirements of section 338(d)(3) (i.e., 60/60

shares), determined by taking into account the redemption of 40 shares.

(c) Effect of post-acquisition events on

eligibility for section 338 election— (1)

Post-acquisition elimination of target. (i)

The purchasing corporation may make an

election under section 338 for target even

though target is liquidated on or after the

acquisition date. If target liquidates on the

acquisition date, the liquidation is considered to occur on the following day and immediately after new target’s deemed purchase of assets. The purchasing

corporation may also make an election

under section 338 for target even though

target is merged into another corporation,

or otherwise disposed of by the purchasing

corporation provided that, under the facts

and circumstances, the purchasing corporation is considered for tax purposes as the

purchaser of the target stock.

(ii) The following examples illustrate

this paragraph (c)(1):

Example 1. On January 1 of Year 1, P purchases

100 percent of the outstanding common stock of T.

On June 1 of Year 1, P sells the T stock to an unrelated person. Assuming that P is considered for tax

purposes as the purchaser of the T stock, P remains

eligible, after June 1 of Year 1, to make a section 338

election for T that results in a deemed asset sale of

T’s assets on January 1 of Year 1.

Example 2. On January 1 of Year 1, P makes a

qualified stock purchase of T. On that date, T owns

the stock of T1. On March 1 of Year 1, T sells the

T1 stock to an unrelated person. On April 1 of Year

1, P makes a section 338 election for T. Notwithstanding that the T1 stock was sold on March 1 of

Year 1, the section 338 election for T on April 1 of

Year 1 results in a qualified stock purchase by T of

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T1 on January 1 of Year 1. See paragraph (b)(4)(i)

of this section.

(2) Post-acquisition elimination of the

purchasing corporation. An election

under section 338 may be made for target

after the acquisition of assets of the purchasing corporation by another corporation in a transaction described in section

381(a), provided that the purchasing corporation is considered for tax purposes as

the purchaser of the target stock. The acquiring corporation in the section 381(a)

transaction may make an election under

section 338 for target.

(3) Consequences of post-acquisition

elimination of target—(i) Scope. The

rules of this paragraph (c)(3) apply to the

transfer of target assets to the purchasing

corporation (or another member of the

same affiliated group as the purchasing

corporation) (the transferee) following a

qualified stock purchase of target stock, if

the purchasing corporation does not make

a section 338 election for target.

Notwithstanding the rules of this paragraph (c)(3), section 354(a) (and so much

of section 356 as relates to section 354)

cannot apply to any person other than the

purchasing corporation or another member of the same affiliated group as the

purchasing corporation unless the transfer

of target assets is pursuant to a reorganization as determined without regard to

this paragraph (c)(3).

(ii) Continuity of interest. By virtue of

section 338, in determining whether the

continuity of interest requirement of

§1.368-1(b) is satisfied on the transfer of

assets from target to the transferee, the

purchasing corporation’s target stock acquired in the qualified stock purchase represents an interest on the part of a person

who was an owner of the target’s business

enterprise prior to the transfer that can be

continued in a reorganization.

(iii) Control requirement. By virtue of

section 338, the acquisition of target stock

in the qualified stock purchase will not

prevent the purchasing corporation from

qualifying as a shareholder of the target

transferor for the purpose of determining

whether, immediately after the transfer of

target assets, a shareholder of the transferor is in control of the corporation to

which the assets are transferred within the

meaning of section 368(a)(1)(D).

(iv) Example. The following example

illustrates this paragraph (c)(3):

Example. (i) Facts. P, T, and X are domestic cor-

January 24, 2000

porations. T and X each operate a trade or business.

A and K, individuals unrelated to P, own 85 and 15

percent, respectively, of the stock of T. P owns all of

the stock of X. The total adjusted basis of T’s property exceeds the sum of T’s liabilities plus the

amount of liabilities to which T’s property is subject.

P purchases all of A’s T stock for cash in a qualified

stock purchase. P does not make an election under

section 338(g) with respect to its acquisition of T

stock. Shortly after the acquisition date, and as part

of the same plan, T merges under applicable state

law into X in a transaction that, but for the question

of continuity of interest, satisfies all the requirements of section 368(a)(1)(A). In the merger, all of

T’s assets are transferred to X. P and K receive X

stock in exchange for their T stock. P intends to retain the stock of X indefinitely.

(ii) Status of transfer as a reorganization. By

virtue of section 338, for the purpose of determining

whether the continuity of interest requirement of

§1.368–1(b) is satisfied, P’s T stock acquired in the

qualified stock purchase represents an interest on the

part of a person who was an owner of T’s business

enterprise prior to the transfer that can be continued

in a reorganization through P’s continuing ownership of X. Thus, the continuity of interest requirement is satisfied and the merger of T into X is a reorganization within the meaning of section

368(a)(1)(A). Moreover, by virtue of section 338,

the requirement of section 368(a)(1)(D) that a target

shareholder control the transferee immediately after

the transfer is satisfied because P controls X immediately after the transfer. In addition, all of T’s assets are transferred to X in the merger and P and K

receive the X stock exchanged therefor in pursuance

of the plan of reorganization. Thus, the merger of T

into X is also a reorganization within the meaning of

section 368(a)(1)(D).

(iii) Treatment of T and X. Under section 361(a),

T recognizes no gain or loss in the merger. Under

section 362(b), X’s basis in the assets received in the

merger is the same as the basis of the assets in T’s

hands. X succeeds to and takes into account the

items of T as provided in section 381.

(iv) Treatment of P. By virtue of section 338, the

transfer of T assets to X is a reorganization. Pursuant to that reorganization, P exchanges its T stock

solely for stock of X, a party to the reorganization.

Because P is the purchasing corporation, section 354

applies to P’s exchange of T stock for X stock in the

merger of T into X. Thus, P recognizes no gain or

loss on the exchange. Under section 358, P’s basis

in the X stock received in the exchange is the same

as the basis of P’s T stock exchanged therefor.

(v) Treatment of K. Because K is not the purchasing corporation (or an affiliate thereof), section

354 cannot apply to K’s exchange of T stock for X

stock in the merger of T into X unless the transfer of

T’s assets is pursuant to a reorganization as determined without regard to this paragraph (c)(3).

Under general principles of tax law applicable to reorganizations, the continuity of interest requirement

is not satisfied because P’s stock purchase and the

merger of T into X are pursuant to an integrated

transaction in which A, the owner of 85 percent of

the stock of T, received solely cash in exchange for

A’s T stock. See, e.g., Yoc Heating v. Commissioner,

61 T.C. 168 (1973); Kass v. Commissioner, 60 T.C.

218 (1973), aff’d, 491 F.2d 749 (3d Cir. 1974).

Thus, the requisite continuity of interest under

344

§1.368–1(b) is lacking and section 354 does not

apply to K’s exchange of T stock for X stock. K recognizes gain or loss, if any, pursuant to section

1001(c) with respect to its T stock.

§§1.338–4 and 1.338–5 [Redesignated

as §§1.338–8 and 1.338–9]

Par. 5. Sections 1.338–4 and 1.338–5

are redesignated as §§1.338–8 and

1.338–9, respectively.

Par. 6. New §§1.338–4T and 1.338–5T

are added to read as follows:

§1.338–4T Aggregate deemed sale price;

various aspects of taxation of the deemed

asset sale (temporary).

(a) Scope. This section provides rules

under section 338(a)(1) to determine the

aggregate deemed sale price (ADSP) for

target. ADSP is the amount for which old

target is deemed to have sold all of its assets in the deemed asset sale. ADSP is allocated among target’s assets in accordance with §1.338–6T to determine the

amount for which each asset is deemed to

have been sold. When an increase or decrease with respect to an element of ADSP

is required, under general principles of tax

law, after the close of new target’s first

taxable year, redetermined ADSP is allocated among target’s assets in accordance

with §1.338–7T. This section also provides rules regarding the recognition of

gain or loss on the deemed sale of target

affiliate stock. Notwithstanding section

338(h)(6)(B)(ii), stock held by a target affiliate in a foreign corporation or in a corporation that is a DISC or that is described

in section 1248(e) is not excluded from

the operation of section 338.

(b) Determination of ADSP—(1) General rule. ADSP is the sum of—

(i) The grossed-up amount realized on

the sale to the purchasing corporation of

the purchasing corporation’s recently purchased target stock (as defined in section

338(b)(6)(A)); and

(ii) The liabilities of old target.

(2) Time and amount of ADSP—(i)

Original determination. ADSP is initially

determined at the beginning of the day

after the acquisition date of target. General principles of tax law apply in determining the timing and amount of the elements of ADSP.

(ii) Redetermination of ADSP. ADSP is

redetermined at such time and in such

amount as an increase or decrease would be

required, under general principles of tax

law, for the elements of ADSP. For exam-

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ple, ADSP is redetermined because of an

increase or decrease in the amount realized

for recently purchased stock or because liabilities not originally taken into account in

determining ADSP are subsequently taken

into account. An increase or decrease to

one element of ADSP may cause an increase or decrease to the other element of

ADSP. For example, if an increase in the

amount realized for recently purchased

stock of target is taken into account after

the acquisition date, any increase in the tax

liability of target for the deemed sale gain is

also taken into account when ADSP is redetermined. Increases or decreases with respect to the elements of ADSP that are

taken into account before the close of new

target’s first taxable year are taken into account for purposes of determining ADSP

and the deemed sale gain as if they had

been taken into account at the beginning of

the day after the acquisition date. Increases

or decreases with respect to the elements of

ADSP that are taken into account after the

close of new target’s first taxable year result in the reallocation of ADSP among target’s assets under §1.338–7T.

(iii) Example. The following example

illustrates this paragraph (b)(2):

Example. In Year 1, T, a manufacturer, purchases

a customized delivery truck from X with purchase

money indebtedness having a stated principal

amount of $100,000. P acquires all of the stock of T

in Year 3 for $700,000 and makes a section 338 election for T. Assume T has no liabilities other than its

purchase money indebtedness to X. In Year 4, when

T is neither insolvent nor in a title 11 case, T and X

agree to reduce the amount of the purchase money

indebtedness to $80,000. Assume further that the reduction would be a purchase price reduction under

section 108(e)(5). T and X’s agreement to reduce

the amount of the purchase money indebtedness

would not, under general principles of tax law that

would apply if the deemed asset sale had actually

occurred, change the amount of liabilities of old target taken into account in determining its amount realized. Accordingly, ADSP is not redetermined at

the time of the reduction. See §1.338–5T(b)(2)(iii)

Example 1 for the effect on AGUB.

(c) Grossed-up amount realized on the

sale to the purchasing corporation of the

purchasing corporation’s recently purchased target stock—(1) Determination

of amount. The grossed-up amount realized on the sale to the purchasing corporation of the purchasing corporation’s recently purchased target stock is an

amount equal to—

(i) The amount realized on the sale to

the purchasing corporation of the purchasing corporation’s recently purchased

target stock determined as if old target

2000–4 I.R.B.

were the selling shareholder and the installment method were not available and

determined without regard to the selling

costs taken into account in paragraph

(c)(1)(iii) of this section;

(ii) Divided by the percentage of target

stock (by value, determined on the acquisition date) attributable to that recently

purchased target stock;

(iii) Less the selling costs incurred by

the selling shareholders in connection

with the sale to the purchasing corporation of the purchasing corporation’s recently purchased target stock that reduce

their amount realized on the sale of the

stock (e.g., brokerage commissions and

any similar costs to sell the stock).

(2) Example. The following example

illustrates this paragraph (c):

Example. T has two classes of stock outstanding,

voting common stock and preferred stock not taken

into account for purposes of section 1504(a)(2). On

March 1 of Year 1, P purchases 40 percent of the

outstanding T stock from S1 for $500, 20 percent of

the outstanding T stock from S2 for $225, and 20

percent of the outstanding T stock from S3 for $275.

On that date, the fair market value of all the T voting

common stock is $1,250 and the preferred stock

$750. S1, S2, and S3 respectively incur $40, $35,

and $25 of selling costs. S1 continues to own the remaining 20 percent of the outstanding T stock. The

grossed-up amount realized on the sale to P of P’s

recently purchased T stock is calculated as follows:

The total amount realized (without regard to selling

costs) is $1,000 (500 + 225 + 275). The percentage

of T stock by value on the acquisition date attributable to the recently purchased T stock is 50%

(1,000/(1,250 + 750)). The selling costs are $100

(40 + 35 + 25). The grossed-up amount realized is

$1,900 (1,000/.5 å100).

(d) Liabilities of old target—(1) In general. The liabilities of old target are the liabilities of target (and the liabilities to

which target’s assets are subject) as of the

beginning of the day after the acquisition

date (other than liabilities that were neither

liabilities of old target nor liabilities to

which old target’s assets were subject). In

order to be taken into account in ADSP, a

liability must be a liability of target that is

properly taken into account in amount realized under general principles of tax law

that would apply if old target had sold its

assets to an unrelated person for consideration that included that person’s assumption

of, or taking subject to, the liability. Thus,

ADSP takes into account both tax credit recapture liability arising because of the

deemed asset sale and the tax liability for

the deemed sale gain unless the tax liability

is borne by some person other than the target. For example, ADSP would not take

345

into account the tax liability for the

deemed sale gain when a section

338(h)(10) election is made for a target S

corporation because the S corporation

shareholders bear that liability. However,

if a target S corporation is subject to a tax

under section 1374 or 1375, the liability

for tax imposed by those sections is a liability of target taken into account in ADSP

(unless the S corporation shareholders expressly assume that liability).

(2) Time and amount of liabilities. The

time for taking into account liabilities of

old target in determining ADSP and the

amount of the liabilities taken into account is determined as if old target had

sold its assets to an unrelated person for

consideration that included the unrelated

person’s assumption of or taking subject

to the liabilities. For example, if no

amount of a target liability is properly

taken into account in amount realized as

of the beginning of the day after the acquisition date, the liability is not initially

taken into account in determining ADSP

(although it may be taken into account at

some later date). As a further example, an

increase or decrease in a liability that does

not affect the amount of old target’s basis,

deductions, or noncapital nondeductible

items arising from the incurrence of the liability is not taken into account in redetermining ADSP.

(3) Interaction with deemed sale gain.

Though deemed sale gain increases or decreases ADSP by creating or reducing a

tax liability, the amount of the tax liability

itself is a function of the size of the

deemed sale gain. Thus, the determination of ADSP may require trial and error

computations.

(e) Calculation of deemed sale gain.

Deemed sale gain on each asset is computed by reference to the ADSP allocated

to that asset.

(f) Other rules apply in determining

ADSP. ADSP may not be applied in such

a way as to contravene other applicable

rules. For example, a capital loss cannot

be applied to reduce ordinary income in

calculating the tax liability on the deemed

sale for purposes of determining ADSP.

(g) Examples. The following examples

illustrate this section. For purposes of the

examples in this paragraph (g), unless otherwise stated, T is a calendar year taxpayer

that files separate returns and that has no

loss, tax credit, or other carryovers to Year

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1. Depreciation for Year 1 is not taken into

account. T has no liabilities other than the

Federal income tax liability resulting from

the deemed asset sale, and the T shareholders have no selling costs. Assume that T’s

tax rate for any ordinary income or net

capital gain resulting from the deemed sale

of assets is 34 percent and that any capital

loss is offset by capital gain. On July 1 of

Year 1, P purchases all of the stock of T

and makes a section 338 election for T.

The examples are as follows:

Example 1. One class. (i) On July 1 of Year 1,

T’s only asset is an item of section 1245 property

with an adjusted basis to T of $50,400, a recomputed

basis of $80,000, and a fair market value of

$100,000. P purchases all of the T stock for

$75,000, which also equals the amount realized for

the stock determined as if old target were the selling

shareholder.

(ii) ADSP is determined as follows (In the following formula, G is the grossed-up amount realized

on the sale to P of P’s recently purchased T stock, L

is T’s liabilities other than T’s tax liability for the

deemed sale gain, TR is the applicable tax rate, and

B is the adjusted basis of the asset deemed sold):

ADSP = G + L + TR x (ADSP - B)

ADSP = ($75,000/1) + $0 + .34 x (ADSP $50,400)

ADSP = $75,000 + .34ADSP - $17,136

.66ADSP = $57,864

ADSP = $87,672.72

(iii) Because ADSP for T ($87,672.72) does not

exceed the fair market value of T’s asset ($100,000),

a Class V asset, T’s entire ADSP is allocated to that

asset. Thus, T has deemed sale gain of $37,272.72

(consisting of $29,600 of ordinary income and

$7,672.72 of capital gain).

(iv) The facts are the same as in paragraph (i) of

this Example 1, except that on July 1 of Year 1, P

purchases only 80 of the 100 shares of T stock for

$60,000. The grossed-up amount realized on the

Asset

Basis

sale to P of P’s recently purchased T stock (G) is

$75,000 ($60,000/.8). Consequently, ADSP and

deemed sale gain are the same as in paragraphs (ii)

and (iii) of this Example 1.

(v) The facts are the same as in paragraph (i) of

this Example 1, except that T also has goodwill (a

Class VII asset) with an appraised value of $10,000.

The results are the same as in paragraphs (ii) and (iii)

of this Example 1. Because ADSP does not exceed

the fair market value of the Class V asset, no amount

is allocated to the Class VII asset (goodwill).

Example 2. More than one class. (i) P purchases

all of the T stock for $140,000, which also equals the

amount realized for the stock determined as if old

target were the selling shareholder. On July 1 of

Year 1, T has liabilities (not including the tax liability for the deemed sale gain) of $50,000, cash (a

Class I asset) of $10,000, actively traded securities

(a Class II asset) with a basis of $4,000 and a fair

market value of $10,000, goodwill (a Class VII

asset) with a basis of $3,000, and the following

Class V assets:

FMV

Ratio of

asset fmv

to total

Class V

fmv

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 5,000

$ 35,000

.14

Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10,000

50,000

.20

Equipment A (Recomputed basis $80,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5,000

90,000

.36

Equipment B (Recomputed basis $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10,000

75,000

.30

Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 30,000

$ 250,000

1.00

(ii) ADSP exceeds $20,000. Thus, $10,000 of

ADSP is allocated to the cash and $10,000 to the actively traded securities. The amount allocated to an

asset (other than a Class VII asset) cannot exceed its

fair market value (however, the fair market value of

any property subject to nonrecourse indebtedness is

treated as being not less than the amount of such indebtedness; see §1.338–6T(a)(2)).

See

§1.338–6T(c)(1) (relating to fair market value limitation).

(iii) The portion of ADSP allocable to the Class V

assets is preliminarily determined as follows (in the

formula, the amount allocated to the Class I assets is

referred to as I and the amount allocated to the Class

II assets as II):

ADSPV = (G - (I + II)) + L + TR ( [(II - BII) +

(ADSPV - BV)]

ADSPV = ($140,000 - ($10,000 + $10,000)) +

$50,000 + .34 ( [($10,000 - $4,000) + (ADSPV ($5,000 + $10,000 + $5,000 + $10,000))]

ADSPV = $161,840 + .34 ADSPV

.66 ADSPV = $161,840

ADSPV = $245,212.12

(iv) Because, under the preliminary calculations of

ADSP, the amount to be allocated to the Class I, II, III,

IV, V, and VI assets does not exceed their aggregate

fair market value, no ADSP amount is allocated to

goodwill. Accordingly, the deemed sale of the good-

Asset

ADSP

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 34,113.33

will results in a capital loss of $3,000. The portion of

ADSP allocable to the Class V assets is finally determined by taking into account this loss as follows:

ADSPV = (G å (I + II)) + L + TR ( [(II å BII) +

(ADSPV å BV) + (ADSPVII å BVII)]

ADSPV = ($140,000 å ($10,000 + $10,000)) +

$50,000 + .34 ( [($10,000 å $4,000) + (ADSPV å

$30,000) + ($0 å $3,000)]

ADSPV = $160,820 + .34 ADSPV

.66 ADSPV = $160,820

ADSPV = $243,666.67

(v) The allocation of ADSPV among the Class V

assets is in proportion to their fair market values, as

follows:

Gain

$ 29,113.33

(capital gain)

Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48,733.34

38,733.34

(capital gain)

Equipment A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87,720.00

82,720.00

(75,000 ordinary income

7,720 capital gain)

Equipment B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73,100.00

63,100.00

(10,000 ordinary income

53,100 capital gain)

Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 243,666.67

January 24, 2000

346

$ 213,666.67

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Example 3. More than one class. (i) The facts

are the same as in Example 2, except that P purchases the T stock for $150,000, rather than

$140,000. The amount realized for the stock determined as if old target were the selling shareholder is

also $150,000.

(ii) As in Example 2, ADSP exceeds $20,000.

Thus, $10,000 of ADSP is allocated to the cash and

$10,000 to the actively traded securities.

(iii) The portion of ADSP allocable to the Class V

assets as preliminarily determined under the formula

set forth in paragraph (iii) of Example 2 is

$260,363.64. The amount allocated to the Class V

assets cannot exceed their aggregate fair market

value ($250,000). Thus, preliminarily, the ADSP

amount allocated to Class V assets is $250,000.

(iv) Based on the preliminary allocation, the

ADSP is determined as follows (in the formula, the

amount allocated to the Class I assets is referred to

as I, the amount allocated to the Class II assets as II,

and the amount allocated to the Class V assets as V):

ADSP = G + L + TR ( [(II - BII) + (V - BV) +

(ADSP - (I + II + V+ BVII))]

ADSP = $150,000 + $50,000 + .34 ( [($10,000 $4,000) + ($250,000 - $30,000) + (ADSP ($10,000 + $10,000 + $250,000 + $3,000))]

ADSP = $200,000 + .34ADSP - $15,980

.66ADSP = $184,020

ADSP = $278,818.18

(v) Because ADSP as determined exceeds the aggregate fair market value of the Class I, II, III, IV, V,

and VI assets, the $250,000 amount preliminarily allocated to the Class V assets is appropriate. Thus,

the amount of ADSP allocated to Class V assets

equals their aggregate fair market value ($250,000),

and the allocated ADSP amount for each Class V

asset is its fair market value. Further, because there

are no Class VI assets, the allocable ADSP amount

for the Class VII asset (goodwill) is $8,818.18 (the

excess of ADSP over the aggregate ADSP amounts

for the Class I, II, III, IV, V and VI assets).

Example 4. Amount allocated to T1 stock. (i)

The facts are the same as in Example 2, except that T

owns all of the T1 stock (instead of the building),

and T1’s only asset is the building. The T1 stock

and the building each have a fair market value of

$50,000, and the building has a basis of $10,000. A

section 338 election is made for T1 (as well as T),

and T1 has no liabilities other than the tax liability

for the deemed sale gain. T is the common parent of

a consolidated group filing a final consolidated return described in §1.338–10T(a)(1).

(ii) ADSP exceeds $20,000. Thus, $10,000 of

ADSP is allocated to the cash and $10,000 to the actively traded securities.

(iii) Because T does not recognize any gain on

the deemed sale of the T1 stock under paragraph

(h)(2) of this section, appropriate adjustments must

be made to reflect accurately the fair market value

of the T and T1 assets in determining the allocation

of ADSP among T’s Class V assets (including the

T1 stock). In preliminarily calculating ADSPV in

this case, the T1 stock can be disregarded and, because T owns all of the T1 stock, the T1 asset can

be treated as a T asset. Under this assumption,

ADSPV is $243,666.67. See paragraph (iv) of Example 2.

(iv) Because the portion of the preliminary ADSP

allocable to Class V assets ($243,666.67) does not exceed their fair market value ($250,000), no amount is

2000–4 I.R.B.

allocated to Class VII assets for T. Further, this

amount ($243,666.67) is allocated among T’s Class V

assets in proportion to their fair market values. See

paragraph (v) of Example 2. Tentatively, $48,733.34

of this amount is allocated to the T1 stock.

(v) The amount tentatively allocated to the T1

stock, however, reflects the tax incurred on the

deemed sale of the T1 asset equal to $13,169.34 (.34 (

($48,733.34 å $10,000)). Thus, the ADSP allocable to

the Class V assets of T, and the ADSP allocable to the

T1 stock, as preliminarily calculated, each must be reduced by $13,169.34. Consequently, these amounts,

respectively, are $230,497.33 and $35,564.00. In determining ADSP for T1, the grossed-up amount realized on the deemed sale to new T of new T’s recently

purchased T1 stock is $35,564.00.

(vi) The facts are the same as in paragraph (i) of

this Example 4, except that the T1 building has a

$12,500 basis and a $62,500 value, all of the outstanding T1 stock has a $62,500 value, and T owns

80 percent of the T1 stock. In preliminarily calculating ADSPV, the T1 stock can be disregarded but, because T owns only 80 percent of the T1 stock, only

80 percent of T1 asset basis and value should be

taken into account in calculating T’s ADSP. By taking into account 80 percent of these amounts, the remaining calculations and results are the same as in

paragraphs (ii), (iii), (iv), and (v) of this Example 4,

except that the grossed-up amount realized on the

sale of the recently purchased T1 stock is

$44,455.00 ($35,564.00/0.8).

(h) Deemed sale of target affiliate stock—

(1) Scope. This paragraph (h) prescribes

rules relating to the treatment of gain or loss

realized on the deemed sale of stock of a target affiliate when a section 338 election (but

not a section 338(h)(10) election) is made

for the target affiliate. For purposes of this

paragraph (h), the definition of domestic corporation in §1.338–2T(c)(9) is applied without the exclusion therein for DISCs, corporations described in section 1248(e), and

corporations to which an election under section 936 applies.

(2) In general. Except as otherwise

provided in this paragraph (h), if a section

338 election is made for target, target recognizes no gain or loss on the deemed

sale of stock of a target affiliate having

the same acquisition date and for which a

section 338 election is made if—

(i) Target directly owns stock in the target affiliate satisfying the requirements of

section 1504(a)(2);

(ii) Target and the target affiliate are

members of a consolidated group filing a

final consolidated return described in

§1.338-10T(a)(1); or

(iii) Target and the target affiliate file a

combined return under §1.338–10T(a)(4).

(3) Deemed sale of foreign target affiliate by a domestic target. A domestic target recognizes gain or loss on the deemed

347

sale of stock of a foreign target affiliate.

For the proper treatment of such gain or

loss, see, e.g., sections 1246, 1248, 1291

et seq., and 338(h)(16) and §1.338–9.

(4) Deemed sale producing effectively

connected income. A foreign target recognizes gain or loss on the deemed sale of

stock of a foreign target affiliate to the extent that such gain or loss is effectively

connected (or treated as effectively connected) with the conduct of a trade or

business in the United States.

(5) Deemed sale of insurance company

target affiliate electing under section

953(d). A domestic target recognizes gain

(but not loss) on the deemed sale of stock

of a target affiliate that has in effect an election under section 953(d) in an amount

equal to the lesser of the gain realized or the

earnings and profits described in section

953(d)(4)(B).

(6) Deemed sale of DISC target affiliate.

A foreign or domestic target recognizes

gain (but not loss) on the deemed sale of

stock of a target affiliate that is a DISC or a

former DISC (as defined in section 992(a))

in an amount equal to the lesser of the gain

realized or the amount of accumulated

DISC income determined with respect to

such stock under section 995(c). Such gain

is included in gross income as a dividend as

provided in sections 995(c)(2) and 996(g).

(7) Anti-stuffing rule. If an asset the adjusted basis of which exceeds its fair market value is contributed or transferred to a

target affiliate as transferred basis property

(within the meaning of section

7701(a)(43)) and a purpose of such transaction is to reduce the gain (or increase the

loss) recognized on the deemed sale of such

target affiliate’s stock, the gain or loss recognized by target on the deemed sale of

stock of the target affiliate is determined as

if such asset had not been contributed or

transferred.

(8) Examples. The following examples

illustrate this paragraph (h):

Example 1. (i) P makes a qualified stock purchase

of T and makes a section 338 election for T. T’s sole

asset, all of the T1 stock, has a basis of $50 and a fair

market value of $150. T’s deemed purchase of the T1

stock results in a qualified stock purchase of T1 and a

section 338 election is made for T1. T1’s assets have a

basis of $50 and a fair market value of $150.

(ii) T realizes $100 of gain on the deemed sale of

the T1 stock, but the gain is not recognized because

T directly owns stock in T1 satisfying the requirements of section 1504(a)(2) and a section 338 election is made for T1.

(iii) T1 recognizes gain of $100 on the deemed

sale of its assets.

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Example 2. The facts are the same as in Example

1, except that P does not make a section 338 election

for T1. Because a section 338 election is not made

for T1, the $100 gain realized by T on the deemed

sale of the T1 stock is recognized.

Example 3. (i) P makes a qualified stock purchase of T and makes a section 338 election for T. T

owns all of the stock of T1 and T2. T’s deemed purchase of the T1 and T2 stock results in a qualified

stock purchase of T1 and T2 and section 338 elections are made for T1 and T2. T1 and T2 each own

50 percent of the vote and value of T3 stock. The

deemed purchases by T1 and T2 of the T3 stock result in a qualified stock purchase of T3 and a section

338 election is made for T3. T is the common parent

of a consolidated group and all of the deemed asset

sales are reported on the T group’s final consolidated

return. See §1.338–10T(a)(1).

(ii) Because T, T1, T2 and T3 are members of a

consolidated group filing a final consolidated return,

no gain or loss is recognized by T, T1 or T2 on their

respective deemed sales of target affiliate stock.

Example 4. (i) T’s sole asset, all of the FT1 stock,

has a basis of $25 and a fair market value of $150.

FT1’s sole asset, all of the FT2 stock, has a basis of

$75 and a fair market value of $150. FT1 and FT2

each have $50 of accumulated earnings and profits for

purposes of section 1248(c) and (d). FT2’s assets

have a basis of $125 and a fair market value of $150,

and their sale would not generate subpart F income

under section 951. The sale of the FT2 stock or assets

would not generate income effectively connected

with the conduct of a trade or business within the

United States. FT1 does not have an election in effect

under section 953(d) and neither FT1 nor FT2 is a

passive foreign investment company.

(ii) P makes a qualified stock purchase of T and

makes a section 338 election for T. T’s deemed purchase of the FT1 stock results in a qualified stock

purchase of FT1 and a section 338 election is made

for FT1. Similarly, FT1’s deemed purchase of the

FT2 stock results in a qualified stock purchase of

FT2 and a section 338 election is made for FT2.

(iii) T recognizes $125 of gain on the deemed

sale of the FT1 stock under paragraph (h)(3) of this

section. FT1 does not recognize $75 of gain on the

deemed sale of the FT2 stock under paragraph (h)(2)

of this section. FT2 recognizes $25 of gain on the

deemed sale of its assets. The $125 gain T recognizes on the deemed sale of the FT1 stock is included in T’s income as a dividend under section

1248, because FT1 and FT2 have sufficient earnings

and profits for full recharacterization ($50 of accumulated earnings and profits in FT1, $50 of accumulated earnings and profits in FT2, and $25 of deemed

sale earnings and profits in FT2). §1.338–9(b). For

purposes of sections 901 through 908, the source

and foreign tax credit limitation basket of $25 of the

recharacterized gain on the deemed sale of the FT1

stock is determined under section 338(h)(16).

§1.338–5T Adjusted grossed-up basis

(temporary).

(a) Scope. This section provides rules

under section 338(b) to determine the adjusted grossed-up basis (AGUB) for target. AGUB is the amount for which new

target is deemed to have purchased all of

its assets in the deemed purchase under

January 24, 2000

section 338(a)(2). AGUB is allocated

among target’s assets in accordance with

§1.338–6T to determine the price at

which the assets are deemed to have been

purchased. When an increase or decrease

with respect to an element of AGUB is required, under general principles of tax

law, after the close of new target’s first

taxable year, redetermined AGUB is allocated among target’s assets in accordance

with §1.338–7T.

(b) Determination of AGUB—(1) General rule. AGUB is the sum of—

(i) The grossed-up basis in the purchasing corporation’s recently purchased target stock;

(ii) The purchasing corporation’s basis

in nonrecently purchased target stock; and

(iii) The liabilities of new target.

(2) Time and amount of AGUB—(i)

Original determination. AGUB is initially determined at the beginning of the

day after the acquisition date of target.

General principles of tax law apply in determining the timing and amount of the

elements of AGUB.

(ii) Redetermination of AGUB. AGUB

is redetermined at such time and in such

amount as an increase or decrease would be

required, under general principles of tax

law, with respect to an element of AGUB.

For example, AGUB is redetermined because of an increase or decrease in the

amount paid or incurred for recently purchased stock or nonrecently purchased

stock or because liabilities not originally

taken into account in determining AGUB

are subsequently taken into account. An increase or decrease to an element of ADSP

may cause an increase or decrease to an element of AGUB. For example, if an increase in the amount realized for recently

purchased stock of target is taken into account after the acquisition date, any increase in tax liability of target for the

deemed sale gain is also taken into account

when AGUB is redetermined. An increase

or decrease to one element of AGUB may

also cause an increase or decrease to another element of AGUB. For example, if

there is an increase in the amount paid or

incurred for recently purchased stock after

the acquisition date, any increase in the

basis of nonrecently purchased stock because a gain recognition election was made

is also taken into account when AGUB is

redetermined. Increases or decreases with

respect to the elements of AGUB that are

348

taken into account before the close of new

target’s first taxable year are taken into account for purposes of determining AGUB

and the basis of target’s assets as if they had

been taken into account at the beginning of

the day after the acquisition date. Increases

or decreases with respect to the elements of

AGUB that are taken into account after the

close of new target’s first taxable year result in the reallocation of AGUB among

target’s assets under §1.338–7T.

(iii) Examples. The following examples illustrate this paragraph (b)(2):

Example 1. In Year 1, T, a manufacturer, purchases a customized delivery truck from X with purchase money indebtedness having a stated principal

amount of $100,000 . P acquires all of the stock of T

in Year 3 for $700,000 and makes a section 338 election for T. Assume T has no liabilities other than its

purchase money indebtedness to X. In Year 4, when

T is neither insolvent nor in a title 11 case, T and X

agree to reduce the amount of the purchase money

indebtedness to $80,000. Assume that the reduction

would be a purchase price reduction under section

108(e)(5). T and X’s agreement to reduce the

amount of the purchase money indebtedness would,

under general principles of tax law that would apply

if the deemed asset sale had actually occurred,

change the amount of liabilities of old target taken

into account in determining its basis. Accordingly,

AGUB is redetermined at the time of the reduction.

See paragraph (e)(2) of this section. Thus the purchase price reduction affects the basis of the truck

only indirectly, through the mechanism of

§§1.338–6T

and

1.338–7T.

See

§1.338–4T(b)(2)(iii) Example for the effect on

ADSP.

Example 2. T, an accrual basis taxpayer, is a

chemical manufacturer. In Year 1, T is obligated to

remediate environmental contamination at the site of

one of its plants. Assume that all the events have occurred that establish the fact of the liability and the

amount of the liability can be determined with reasonable accuracy but economic performance has not

occurred with respect to the liability within the

meaning of section 461(h). P acquires all of the

stock of T in Year 1 and makes a section 338 election for T. Assume that, if a corporation unrelated to

T had actually purchased T’s assets and assumed T’s

obligation to remediate the contamination, the corporation would not satisfy the economic performance requirements until Year 5. Under section

461(h), the assumed liability would not be treated as

incurred and taken into account in basis until that

time. The incurrence of the liability in Year 5 under

the economic performance rules is an increase in the

amount of liabilities properly taken into account in

basis and results in the redetermination of AGUB.

(Respecting ADSP, compare §1.461–4(d)(5), which

provides that economic performance occurs for old

T as the amount of the liability is properly taken into

account in amount realized on the deemed asset sale.

Thus ADSP is not redetermined when new T satisfies the economic performance requirements.)

(c) Grossed-up basis of recently purchased stock. The purchasing corporation’s grossed-up basis of recently pur-

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chased target stock (as defined in section

338(b)(6)(A)) is an amount equal to—

(1) The purchasing corporation’s basis

in recently purchased target stock at the

beginning of the day after the acquisition

date determined without regard to the acquisition costs taken into account in paragraph (c)(3) of this section;

(2) Multiplied by a fraction, the numerator of which is 100 percent minus the

percentage of target stock (by value, determined on the acquisition date) attributable to the purchasing corporation’s nonrecently purchased target stock, and the

denominator of which is the percentage of

target stock (by value, determined on the

acquisition date) attributable to the purchasing corporation’s recently purchased

target stock;

(3) Plus the acquisition costs the purchasing corporation incurred in connection with its purchase of the recently purchased stock that are capitalized in the

basis of such stock (e.g., brokerage commissions and any similar costs incurred

by the purchasing corporation to acquire

the stock).

(d) Basis of nonrecently purchased

stock; gain recognition election—(1) No

gain recognition election. In the absence

of a gain recognition election under section 338(b)(3) and this section, the purchasing corporation retains its basis in the

nonrecently purchased stock.

(2) Procedure for making gain recognition election. A gain recognition election

may be made for nonrecently purchased

stock of target (or a target affiliate) only if

a section 338 election is made for target

(or the target affiliate). The gain recognition election is made by attaching a gain

recognition statement to a timely filed

Form 8023 for target. The gain recognition statement must contain the information specified in the form and its instructions. The gain recognition election is

irrevocable. If a section 338(h)(10) election is made for target, see

§1.338(h)(10)–1T(d)(1) (providing that

the purchasing corporation is automatically deemed to have made a gain recognition election for its nonrecently purchased T stock).

(3) Effect of gain recognition

election—(i) In general. If the purchasing corporation makes a gain recognition

election, then for all purposes of the Internal Revenue Code—

2000–4 I.R.B.

(A) The purchasing corporation is

treated as if it sold on the acquisition date

the nonrecently purchased target stock for

the basis amount determined under paragraph (d)(3)(ii) of this section; and

(B) The purchasing corporation’s basis

on the acquisition date in nonrecently purchased target stock immediately following the deemed sale in paragraph

(d)(3)(i)(A) of this section is the basis

amount.

(ii) Basis amount. The basis amount is

equal to the amount in paragraph (c)(1) of

this section (the purchasing corporation’s

basis in recently purchased target stock at

the beginning of the day after the acquisition date determined without regard to the

acquisition costs taken into account in

paragraph (c)(3) of this section) multiplied by a fraction the numerator of which

is the percentage of target stock (by value,

determined on the acquisition date) attributable to the purchasing corporation’s

nonrecently purchased target stock and

the denominator of which is 100 percent

minus the numerator amount. Thus, if

target has a single class of outstanding

stock, the purchasing corporation’s basis

in each share of nonrecently purchased

target stock after the gain recognition

election is equal to the average price per

share of the purchasing corporation’s recently purchased target stock.

(iii) Losses not recognized. Only gains

(unreduced by losses) on the nonrecently

purchased target stock are recognized.

(iv) Stock subject to election. The gain

recognition election applies to—

(A) All nonrecently purchased target

stock; and

(B) Any nonrecently purchased stock in

a target affiliate having the same acquisition date as target if such target affiliate

stock is held by the purchasing corporation on such date.

(e) Liabilities of new target—(1) In

general. The liabilities of new target are

the liabilities of target (and the liabilities

to which target’s assets are subject) as of

the beginning of the day after the acquisition date (other than liabilities that were

neither liabilities of old target nor liabilities to which old target’s assets were subject). In order to be taken into account in

AGUB, a liability must be a liability of

target that is properly taken into account

in basis under general principles of tax

law that would apply if new target had ac-

349

quired its assets from an unrelated person

for consideration that included the assumption of, or taking subject to, the liability. See §1.338–4T(d)(1) for examples

of when tax liabilities are considered liabilities assumed by new target.

(2) Time and amount of liabilities. The

time for taking into account liabilities of

old target in determining AGUB and the

amount of the liabilities taken into account is determined as if new target had

acquired its assets from an unrelated person for consideration that included the assumption of, or taking subject to, the liabilities. For example, an increase or

decrease in a liability that does not affect

the amount of new target’s basis arising

from the assumption of, or taking subject

to, the liability is not taken into account in

redetermining AGUB.

(3) Interaction with deemed sale gain.

See §1.338–4T(d)(3).

(f) Adjustments by the Internal Revenue

Service. In connection with the examination of a return, the District Director may

increase (or decrease) AGUB under the

authority of section 338(b)(2) and allocate

such amounts to target’s assets under the

authority of section 338(b)(5) so that

AGUB and the basis of target’s assets

properly reflect the cost to the purchasing

corporation of its interest in target’s assets. Such items may include distributions from target to the purchasing corporation, capital contributions from the

purchasing corporation to target during

the 12-month acquisition period, or acquisitions of target stock by the purchasing

corporation after the acquisition date from

minority shareholders.

(g) Examples. The following examples

illustrate this section. For purposes of the

examples in this paragraph (g), T has no

liabilities other than the tax liability for

the deemed sale gain, T shareholders

incur no costs in selling the T stock, and P

incurs no costs in acquiring the T stock.

The examples are as follows:

Example 1. (i) Before July 1 of Year 1, P purchases 10 of the 100 shares of T stock for $5,000.

On July 1 of Year 2, P purchases 80 shares of T stock

for $60,000 and makes a section 338 election for T.

As of July 1 of Year 2, T’s only asset is raw land with

an adjusted basis to T of $50,400 and a fair market

value of $100,000. T has no loss or tax credit carryovers to Year 2. T’s marginal tax rate for any ordinary income or net capital gain resulting from the

deemed asset sale is 34 percent. The 10 shares purchased before July 1 of Year 1 constitute nonrecently

purchased T stock with respect to P’s qualified stock

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purchase of T stock on July 1 of Year 2.

(ii) The ADSP formula as applied to these facts is

the same as in §1.338–4T(g) Example 1. Accordingly, the ADSP for T is $87,672.72. The existence

of nonrecently purchased T stock is irrelevant for

purposes of the ADSP formula, because that formula

treats P’s nonrecently purchased T stock in the same

manner as T stock not held by P.

(iii) The total tax liability resulting from T’s

deemed asset sale, as calculated under the ADSP

formula, is $12,672.72.

(iv) If P does not make a gain recognition election, the AGUB of new T’s assets is $85,172.72, determined as follows (In the following formula

below, GRP is the grossed-up basis in P’s recently

purchased T stock, BNP is P’s basis in nonrecently

purchased T stock, L is T’s liabilities, and X is P’s

acquisition costs for the recently purchased T stock):

AGUB = GRP + BNP + L + X

AGUB = $60,000 ( [(1 - .1)/.8] + $5,000 +

$12,672.72 + 0

AGUB = $85,172.72

(v) If P makes a gain recognition election, the

AGUB of new T’s assets is $87,672.72, determined

as follows:

AGUB = $60,000 ( [(1 - .1)/.8] + $60,000 ( [(1 .1)/.8] ( [.1/(1 - .1)] + $12,672.72

AGUB = $87,672.72

(vi) The calculation of AGUB if P makes a gain

recognition election may be simplified as follows:

AGUB = $60,000/.8 + $12,672.72

AGUB = $87,672.72

(vii) As a result of the gain recognition election,

P’s basis in its nonrecently purchased T stock is increased from $5,000 to $7,500 (i.e., $60,000 ( [(1 å

.1)/.8] ( [.1/(1 å .1)]). Thus, P recognizes a gain in

Year 2 with respect to its nonrecently purchased T

stock of $2,500 (i.e., $7,500 å $5,000).

Example 2. On January 1 of Year 1, P purchases

one-third of the T stock. On March 1 of Year 1, T

distributes a dividend to all of its shareholders. On

April 15 of Year 1, P purchases the remaining T

stock and makes a section 338 election for T. In appropriate circumstances, the District Director may

decrease the AGUB of T to take into account the

payment of the dividend and properly reflect the fair

market value of T’s assets deemed purchased.

Example 3. (i) T’s sole asset is a building worth

$100,000. At this time, T has 100 shares of stock

outstanding. On August 1 of Year 1, P purchases 10

of the 100 shares of T stock for $8,000. On June 1

of Year 2, P purchases 50 shares of T stock for

$50,000. On June 15 of Year 2, P contributes a tract

of land to the capital of T and receives 10 additional

shares of T stock as a result of the contribution.

Both the basis and fair market value of the land at

that time are $10,800. On June 30 of Year 2, P purchases the remaining 40 shares of T stock for

$40,000 and makes a section 338 election for T. The

AGUB of T is $108,800.

(ii) To prevent the shifting of basis from the contributed property to other assets of T, the District Director may allocate $10,800 of the AGUB to the

land, leaving $98,000 to be allocated to the building.

See paragraph (f) of this section. Otherwise, applying the allocation rules of §1.338–6T would, on

these facts, result in an allocation to the recently

contributed land of an amount less than its value of

$10,800, with the difference being allocated to the

building already held by T.

January 24, 2000

Par. 7. Sections 1.338–6T and

1.338–7T are added to read as follows:

§1.338–6T Allocation of ADSP and

AGUB among target assets (temporary).

(a) Scope—(1) In general. This section

prescribes rules for allocating ADSP and

AGUB among the acquisition date assets

of a target for which a section 338 election is made.

(2) Fair market value—(i) In general.

Generally, the fair market value of an asset is

its gross fair market value (i.e., fair market

value determined without regard to mortgages, liens, pledges, or other liabilities).

However, for purposes of determining the

amount of old target’s deemed sale gain, the

fair market value of any property subject to a

nonrecourse indebtedness will be treated as

being not less than the amount of such indebtedness. (For purposes of the preceding

sentence, a liability that was incurred because of the acquisition of the property is

disregarded to the extent that such liability

was not taken into account in determining

old target’s basis in such property.)

(ii) Transaction costs. Transaction

costs are not taken into account in allocating ADSP or AGUB to assets in the

deemed sale (except indirectly through

their effect on the total ADSP or AGUB to

be allocated).

(iii) Internal Revenue Service authority. In connection with the examination of

a return, the Internal Revenue Service

may challenge the taxpayer’s determination of the fair market value of any asset

by any appropriate method and take into

account all factors, including any lack of

adverse tax interests between the parties.

For example, in certain cases the Internal

Revenue Service may make an independent showing of the value of goodwill and

going concern value as a means of calling

into question the validity of the taxpayer’s

valuation of other assets.

(b) General rule for allocating ADSP

and AGUB—(1) Reduction in the amount

of consideration for Class I assets. Both

ADSP and AGUB, in the respective allocation of each, are first reduced by the

amount of Class I acquisition date assets.

Class I assets are cash and general deposit

accounts (including savings and checking

accounts) other than certificates of deposit held in banks, savings and loan associations, and other depository institutions. If the amount of Class I assets

exceeds AGUB, new target will immedi-

350

ately realize ordinary income in an

amount equal to such excess. The amount

of ADSP or AGUB remaining after the reduction is to be allocated to the remaining

acquisition date assets.

(2) Other assets—(i) In general. Subject to the limitations and other rules of

paragraph (c) of this section, ADSP and

AGUB (as reduced by the amount of

Class I assets) are allocated among Class

II acquisition date assets of target in proportion to the fair market values of such

Class II assets at such time, then among

Class III assets so held in such proportion,

then among Class IV assets so held in

such proportion, then among Class V assets so held in such proportion, then

among Class VI assets so held in such

proportion, and finally to Class VII assets.

(ii) Class II assets. Class II assets are actively traded personal property within the

meaning of section 1092(d)(1) and

§1.1092(d)–1 (determined without regard

to section 1092(d)(3)). In addition, Class II

assets include certificates of deposit and

foreign currency even if they are not actively traded personal property. Examples

of Class II assets include U.S. government

securities and publicly traded stock.

(iii) Class III assets. Class III assets are

accounts receivable, mortgages, and credit

card receivables from customers which

arise in the ordinary course of business.

(iv) Class IV assets. Class IV assets are

stock in trade of the taxpayer or other

property of a kind which would properly

be included in the inventory of taxpayer if

on hand at the close of the taxable year, or

property held by the taxpayer primarily

for sale to customers in the ordinary

course of its trade or business.

(v) Class V assets. Class V assets are

all assets other than Class I, II, III, IV, VI,

and VII assets.

(vi) Class VI assets. Class VI assets

are all section 197 intangibles, as defined

in section 197, except goodwill and going

concern value.

(vii) Class VII assets. Class VII assets

are goodwill and going concern value

(whether or not the goodwill or going

concern value qualifies as a section 197

intangible).

(3) Other items designated by the Internal Revenue Service. Similar items may be

added to any class described in this paragraph (b) by designation in the Internal Revenue Bulletin by the Internal Revenue Ser-

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vice (see §601.601(d)(2) of this Chapter).

(c) Certain limitations and other rules

for allocation to an asset—(1) Allocation

not to exceed fair market value. The

amount of ADSP or AGUB allocated to

an asset (other than Class VII assets) cannot exceed the fair market value of that

asset at the beginning of the day after the

acquisition date.

(2) Allocation subject to other rules. The

amount of ADSP or AGUB allocated to an

asset is subject to other provisions of the Internal Revenue Code or general principles

of tax law in the same manner as if such

asset were transferred to or acquired from

an unrelated person in a sale or exchange.

For example, if the deemed asset sale is a

transaction described in section 1056(a)

(relating to basis limitation for player contracts transferred in connection with the

sale of a franchise), the amount of AGUB

allocated to a contract for the services of an

athlete cannot exceed the limitation imposed by that section. As another example,

the amount of AGUB allocated to an amortizable section 197 intangible resulting

from an assumption-reinsurance transaction is determined under section 197(f)(5).

(3) Special rule for allocating AGUB

when purchasing corporation has nonrecently purchased stock—(i) Scope. This

paragraph (c)(3) applies if at the beginning

of the day after the acquisition date—

(A) The purchasing corporation holds

nonrecently purchased stock for which a

gain recognition election under section

338(b)(3) and §1.338–5T(d) is not made;

and

(B) The hypothetical purchase price determined under paragraph (c)(3)(ii) of this

section exceeds the AGUB determined

under §1.338–5T(b).

(ii) Determination of hypothetical purchase price. Hypothetical purchase price

is the AGUB that would result if a gain

recognition election were made.

(iii) Allocation of AGUB. Subject to

the limitations in paragraphs (c)(1) and

(2) of this section, the portion of AGUB

(after reduction by the amount of Class I

assets) to be allocated to each Class II, III,

IV, V, VI, and VII asset of target held at

the beginning of the day after the acquisition date is determined by multiplying—

(A) The amount that would be allocated to such asset under the general rules

of this section were AGUB equal to the

hypothetical purchase price; by

(B) A fraction, the numerator of which

is actual AGUB (after reduction by the

amount of Class I assets) and the denominator of which is the hypothetical purchase price (after reduction by the amount

of Class I assets).

(4) Liabilities taken into account in determining amount realized on subsequent

disposition. In determining the amount

realized on a subsequent sale or other disposition of property deemed purchased by

new target, the entire amount of any liability taken into account in AGUB is considered to be an amount taken into account in determining new target’s basis in

property that secures the liability for purposes of applying §1.1001–2(a). Thus, if

a liability is taken into account in AGUB,

§1.1001–2(a)(3) does not prevent the

amount of such liability from being

treated as discharged within the meaning

of §1.1001–2(a)(4) as a result of new target’s sale or disposition of the property

which secures such liability.

(d) Examples. The following examples

illustrate §§1.338–4T, 1.338–5T, and this

section:

Example 1. (i) T owns 90 percent of the outstanding

T1 stock. P purchases 100 percent of the outstanding T

stock for $2,000. There are no acquisition costs. P

makes a section 338 election for T and, as a result, T1 is

considered acquired in a qualified stock purchase. A

section 338 election is made for T1. The grossed-up

basis of the T stock is $2,000 (i.e., $2,000 ( 1/1).

(ii) The liabilities of T as of the beginning of the

day after the acquisition date (including the tax liability for the deemed sale gain) that would, under

general principles of tax law, be properly taken into

account before the close of new T’s first taxable

year, are as follows:

Liabilities (nonrecourse mortgage plus unsecured liabilities) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 700

Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

300

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,000

(iii) The AGUB of T is determined as follows:

Grossed-up basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,000

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,000

AGUB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 3,000

(iv) Assume that ADSP is also $3,000.

(v) Assume that, at the beginning of the day after the acquisition date, T’s cash and the fair market values of T’s Class II, III, IV, and V assets

are as follows:

Asset

Class

Asset

Fair

market

value

I

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 200*

II

Portfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

300

III

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

600

IV

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

300

V

Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

800

V

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

200

V

Investment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

450

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,850

*Amount.

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(vi) Under paragraph (b)(1) of this section, the

amount of ADSP and AGUB allocable to T’s Class

II, III, IV, and V assets is reduced by the amount of

cash to $2,800, i.e., $3,000 å $200. $300 of ADSP

and of AGUB is then allocated to actively traded securities. $600 of ADSP and of AGUB is then allocated to accounts receivable. $300 of ADSP and of

AGUB is then allocated to the inventory. Since the

remaining amount of ADSP and of AGUB is $1,600

(i.e., $3,000 å ($200 + $300 + $600 + $300)), an

amount which exceeds the sum of the fair market

values of T’s Class V assets, the amount of ADSP

and of AGUB allocated to each Class V asset is its

fair market value:

Building . . . . . . . . . . . . . . . . . .

800

Land . . . . . . . . . . . . . . . . . . . . .

200

Investment in T1 . . . . . . . . . . . .

450

Total . . . . . . . . . . . . . . . . . . . . .

$ 1,450

(vii) T has no Class VI assets. The amount of

ADSP and of AGUB allocated to T’s Class VII assets (goodwill and going concern value) is $150, i.e.,

$1,600 - $1,450.

(viii) The grossed-up basis of the T1 stock is

$500, i.e., $450 ( 1/.9.

(ix) The liabilities of T as of the beginning of the

day after the acquisition date (including the tax liability for the deemed sale gain) that would, under

general principles of tax law, be properly taken into

account before the close of new T’s first taxable

year, are as follows:

General Liabilities . . . . . . . . . . .

$ 100

Taxes Payable . . . . . . . . . . . . . .

20

Total . . . . . . . . . . . . . . . . . . .

$ 120

(x) The AGUB of T1 is determined as follows:

Grossed-up basis of T1 Stock . .

$ 500

Liabilities . . . . . . . . . . . . . . . . .

120

AGUB . . . . . . . . . . . . . . . . . . . .

$ 620

(xi) Assume that ADSP is also $620.

(xii) Assume that at the beginning of the day after

the acquisition date, T1’s cash and the fair market

values of its Class IV and VI assets are as follows:

Asset

Asset

Fair

Class

Market

Value

I

Cash . . . . . . . . . . . . . .

$ 50*

IV

Inventory . . . . . . . . . .

200

VI

Patent . . . . . . . . . . . . .

350

Total . . . . . . . . . . . .

$ 600

* Amount.

(xiii) The amount of ADSP and of AGUB allocable to T1’s Class IV and VI assets is first reduced by

the $50 of cash.

(xiv) Because the remaining amount of ADSP

and of AGUB ($570) is an amount which exceeds

the fair market value of T1’s only Class IV asset, the

inventory, the amount allocated to the inventory is

its fair market value ($200). After that, the remaining amount of ADSP and of AGUB ($370) exceeds

the fair market value of T1’s only Class VI asset, the

patent. Thus, the amount of ADSP and of AGUB allocated to the patent is its fair market value ($350).

(xv) The amount of ADSP and of AGUB allocated to T1’s Class VII assets (goodwill and going

concern value) is $20, i.e., $570 å $550.

Example 2. (i) Assume that the facts are the same

as in Example 1 except that P has, for five years,

owned 20 percent of T’s stock, which has a basis in

P’s hands at the beginning of the day after the acquisition date of $100, and P purchases the remaining

80 percent of T’s stock for $1,600. P does not make

a gain recognition election under section 338(b)(3).

(ii) Under §1.338–5T(c), the grossed-up basis of

recently purchased T stock is $1,600, i.e., $1,600 (

(1 - .2)/.8.

(iii) The AGUB of T is determined as follows:

Grossed-up basis of recently

purchased stock as determined

under §1.338–5T(c) ($1,600 x

Class

Asset

I

II

III

IV

V

V

V

VII

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Portfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . .

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Investment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Goodwill and going concern value . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(1 - .2)/.8) . . . . . . . . . . . . . . . . . . . . .

$ 1,600

Basis of nonrecently purchased

stock . . . . . . . . . . . . . . . . . . . . . . . . .

100

Liabilities . . . . . . . . . . . . . . . . . . . . .

1,000

AGUB . . . . . . . . . . . . . . . . . . . . .

$ 2,700

(iv) Since P holds nonrecently purchased stock,

the hypothetical purchase price of the T stock must

be computed and is determined as follows:

Grossed-up basis of recently

purchased stock as

determined under

§1.338–5T(c)

($1,600 ( (1 - .2)/.8) . . . . . . . . . . . .

$ 1,600

Basis of nonrecently purchased

stock as if the gain recognition

election under §1.338–5T(d)(2)

had been made ($1,600

( .2/(1 å .2)) . . . . . . . . . . . . . . . . . . .

400

Liabilities . . . . . . . . . . . . . . . . . . . . .

1,000

Total . . . . . . . . . . . . . . . . . . . . . .

$ 3,000

(v) Since the hypothetical purchase price

($3,000) exceeds the AGUB ($2,700) and no gain

recognition election is made under section

338(b)(3), AGUB is allocated under paragraph

(c)(3) of this section.

(vi) First, an AGUB amount equal to the hypothetical purchase price ($3,000) is allocated among

the assets under the general rules of this section.

The allocation is set forth in the column below entitled Original Allocation. Next, the allocation to

each asset in Class II through Class VII is multiplied

by a fraction having a numerator equal to the actual

AGUB reduced by the amount of Class I assets

($2,700 å $200 = $2,500) and a denominator equal

to the hypothetical purchase price reduced by the

amount of Class I assets ($3,000 å $200 = $2,800),

or 2,500/2,800. This produces the Final Allocation:

Original

Allocation

$ 200

300

600

300

800

200

450

150

$ 3,000

Final

Allocation

$ 200

268*

536

268

714

178

402

134

$ 2,700

* All numbers rounded for convenience.

§1.338–7T Allocation of redetermined

ADSP and AGUB among target assets

(temporary).

(a) Scope. ADSP and AGUB are redetermined at such time and in such amount

as an increase or decrease would be required under general principles of tax law

for the elements of ADSP or AGUB. This

section provides rules for allocating redetermined ADSP or AGUB when increases

or decreases with respect to the elements

of ADSP or AGUB are required after the

close of new target’s first taxable year.

January 24, 2000

For determining and allocating ADSP or

AGUB when increases or decreases are

required with respect to the elements of

ADSP or AGUB before the close of new

target’s first taxable year, see §§1.338–4T,

1.338–5T, and 1.338–6T.

(b) Allocation of redetermined ADSP

and AGUB. When ADSP or AGUB is redetermined, a new allocation of ADSP or

AGUB is made by allocating the redetermined ADSP or AGUB amount under the

rules of §1.338–6T. If the allocation of

the redetermined ADSP or AGUB amount

352

under §1.338–6T to a given asset is different from the original allocation to it, the

difference is added to or subtracted from

the original allocation to the asset, as appropriate. Amounts allocable to an acquisition date asset (or with respect to a disposed-of acquisition date asset) are

subject to all the asset allocation rules (for

example, the fair market value limitation

in §1.338–6T(c)(1)) as if the redetermined ADSP or AGUB were the ADSP or

AGUB on the acquisition date.

(c) Special rules for ADSP—(1) In-

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creases or decreases in deemed sale gain

taxable notwithstanding old target ceases

to exist. To the extent general principles

of tax law would require a seller in an actual asset sale to account for events relating to the sale that occur after the sale

date, target must make such an accounting. Target is not precluded from realizing additional deemed sale gain because

the target is treated as a new corporation

after the acquisition date.

(2) Procedure for transactions in which

section 338(h)(10) is not elected— (i)

Deemed sale gain included in new target’s

return. If an election under section

338(h)(10) is not made, any additional

deemed sale gain of old target resulting

from an increase or decrease in the ADSP

is included in new target’s income tax return for new target’s taxable year in which

the increase or decrease is taken into account. For example, if after the acquisition date there is an increase in the allocable ADSP of section 1245 property for

which the recomputed basis (but not the

adjusted basis) exceeds the portion of the

ADSP allocable to that particular asset on

the acquisition date, the additional gain is

treated as ordinary income to the extent it

does not exceed such excess amount. See

paragra

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