Revision of Section 338 Consistency Rules.

DEPARTMENT OF THE TREASURY

26 CFR Parts 1 and 602

[TD 8515]

RIN 1545-AQ05

Revision of Section 338 Consistency Rules.

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations that replace the

stock and asset consistency rules of the temporary Income Tax

Regulations. The final regulations substantially revise and simplify

the stock and asset consistency rules. The final regulations also

restate, simplify, and substantially shorten most of the other

regulations under section 338.

DATES: These regulations are effective on January 20, 1994.

For applicability of these regulations, see ``Effective Dates''

under the ``SUPPLEMENTARY INFORMATION'' portion of the preamble.

FOR FURTHER INFORMATION CONTACT: Don Leatherman at telephone (202) 622-

7520 (not a toll-free number) for domestic issues and Kenneth D.

Allison at telephone (202) 622-3860 (not a toll-free number) for

international issues.

SUPPLEMENTARY INFORMATION:

A. Paperwork Reduction Act

The collection of information contained in this final regulation

has been reviewed and approved by the Office of Management and Budget

in accordance with the requirements of the Paperwork Reduction Act (44

U.S.C. 3504(h)) under control number 1545-1295. The estimated annual

burden per respondent varies from .2 hours to 1 hour, depending on

individual circumstances, with an estimated average of .56 hours.

These estimates are an approximation of the average time expected

to be necessary for a collection of information. They are based on such

information as is available to the Internal Revenue Service. Individual

respondents or recordkeepers may require more or less time, depending

on their particular circumstances.

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, T: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.

B. Background.

On January 14, 1992, a notice of proposed rulemaking (CO-111-90)

under section 338 of the Internal Revenue Code was published in the

Federal Register (57 FR 1409). See 1992-1 C.B. 1000. The notice

proposed to restate most of the existing temporary regulations by (1)

replacing the asset and stock consistency rules of Secs. 1.338-4T and

1.338-5T of the temporary regulations, (2) revising the temporary

regulations regarding the international aspects of section 338, and (3)

generally restating the remainder of the temporary regulations under

section 338. Comments on the notice were received and a public hearing

was held on March 26, 1992. After considering the comments and

statements made at the hearing, the proposed regulations are adopted as

revised by this Treasury decision, and the corresponding temporary

regulations are removed.

C. The Consistency Rules

The final regulations adopt the consistency rules of the proposed

regulations with several minor modifications.

1. Carryover Basis Rule

Several commentors argued that the carryover basis rule should be

modified if the gain of a target (T) on the sale of an asset does not

result in an equivalent reduction in the gain of the selling group (S

or the S group) from the sale of the T stock. For example, they argued

that the carryover basis rule should be modified if S recognized a loss

on the sale of T stock that was disallowed under Sec. 1.1502-20, if T

sold gain and loss assets to the purchasing corporation (P), or if T

had separate return limitation year losses. Similarly, they suggested

that the rule be modified if the gain on the asset sale is not fully

reflected in the basis of T's stock because, for example, the asset is

sold by a subsidiary or conduit that is not wholly owned by T.

For purposes of simplification and administrative convenience, the

consistency rules in the final regulations apply in a more limited set

of circumstances than in the temporary regulations. Adopting the

suggested modifications, however, would substantially complicate the

regulations. In addition, the carryover basis rule generally will apply

only when the stock sale is contemplated at the time of the asset sale.

For these reasons, the suggestions have not been adopted.

2. Affiliated Groups

The final regulations apply the consistency rules in certain cases

where dividends qualifying for a 100 percent dividends received

deduction may be used in conjunction with asset dispositions to achieve

a result similar to that available under the consolidated return

investment adjustment rules. This provision applies only to amounts

treated as dividends under general tax principles. The substance-over-

form, step-transaction, and similar principles continue to apply to

treat certain amounts that are dividends in form as payments by P for

the T stock. See, e.g., Commissioner v. Waterman Steamship Corp., 430

F.2d 1185 (5th Cir. 1970), cert. denied, 401 U.S. 939 (1971).

As discussed in more detail below, these regulations also permit

section 338(h)(10) elections to be made for certain targets that are

members of affiliated, non-consolidated groups.

3. Controlled Foreign Corporations

Consistency rules for controlled foreign corporations generally are

not included in the final regulations. Instead, rules for controlled

foreign corporations are contained in temporary regulations that may be

found elsewhere in this issue of the Federal Register.

4. Anti-Abuse Rules

Some commentors requested that the anti-abuse rules of Sec. 1.338-

4(j) be narrowed and that these rules and the indirect acquisition rule

of Sec. 1.338-4(f) be stated as general principles. The Treasury

Department and the Service believe that the anti-abuse and indirect

acquisition rules are necessary to protect the final consistency rules.

Further, no statement of general principle has been identified that

provides adequate guidance to distinguish the cases described in the

proposed regulations from those not described. Accordingly, these rules

have been retained with minor modifications.

D. International Aspects

The final regulations under Secs. 1.338-1(g), 1.338-3(c)(3) through

(6) and (8), and 1.338-5 are substantially as proposed. The preamble to

the proposed regulations contains a discussion of the provisions. The

differences from the proposed regulations are noted below.

1. Section 338(h)(16)

In the notice of proposed rulemaking, the Service sought comments

on the proper application of section 338(h)(16), including its

application where the deemed sale of assets results in subpart F income

under section 952. The comments received will be considered in separate

proposed regulations.

2. Good Faith Effort To Notify

A commentor suggested that the Service provide examples of a good

faith effort, under Sec. 1.338-1(g)(4)(v) of the proposed regulations,

to notify affected U.S. shareholders of targets that are controlled

foreign corporations, passive foreign investment companies or foreign

personal holding companies. The regulations require that the

Commissioner determine, under all the facts and circumstances, whether

the taxpayer has vigorously attempted the notification. The suggestion

has not been adopted because the determination depends on the facts and

circumstances in each case.

3. Allocation of Foreign Income Taxes

One commentor pointed out that the allocation of foreign income

taxes between the pre- and post-acquisition U.S. taxable years of a

target in Sec. 1.338-5(d) of the proposed regulations is to be made

under the principles of Sec. 1.1502-76(b)(4) of the consolidated return

regulations. That provision has been interpreted to require taxes to be

allocated in proportion to U.S. taxable income. Because foreign income

taxes are paid with respect to foreign taxable income, an allocation

with respect to U.S. taxable income may incorrectly allocate the

foreign income taxes between taxable years. The final regulations

require foreign income taxes to be allocated in proportion to foreign

taxable income.

E. Other Changes to the Regulations

Several commentors argued that, if a section 338(h)(10) election is

made for T, new T should not be severally liable under Sec. 1.1502-6

for federal income tax liability of the S group, as provided in the

proposed and the existing temporary regulations. They reasoned that a

section 338(h)(10) election is intended to be equivalent to an asset

sale and that this liability does not continue in an asset sale.

However, one other commentor noted that, although the transaction is

treated as an asset sale for purposes of income recognition, it

continues to be treated as a stock sale for purposes of determining the

rights of T's creditors. The final regulations provide that new T

remains liable for the tax liabilities of old T (including tax

liabilities resulting from the deemed sale of assets and any liability

of old T under Sec. 1.1502-6).

Commentors requested that the formula price at which T is deemed to

sell its assets be modified to reflect buying and selling costs, as

appropriate. These suggestions have been adopted in the final

regulations.

Commentors asked that the availability of section 338(h)(10)

treatment be extended to situations in which T is not a member of a

consolidated group. The final regulations provide that a section

338(h)(10) election may be made for a non-consolidated T if a

corporation (the selling affiliate) sells an amount of T stock to P on

the acquisition date that satisfies the requirements of section

1504(a)(2). The election must be made jointly by P and the selling

affiliate. The instructions to the revised Form 8023 will provide more

guidance on making the election.

The final regulations also provide that a section 338(h)(10)

election may be made if T is an S corporation immediately before the

acquisition date. The deemed sale gain is reported on T's final S

corporation return and therefore is taken into account under section

1366 and 1367 in determining a T shareholder's basis in the T stock and

resulting gain or loss on the deemed liquidation of T. The section

338(h)(10) election must be made jointly by P and the T shareholders.

The instructions to the revised Form 8023 will provide more guidance on

making the election.

If a section 338(h)(10) election is made for T, for purposes of

subtitle A of the Internal Revenue Code, T is treated as selling all of

its assets and liquidating. Thus, as appropriate, the old T

shareholders recognize income, gain, or loss under sections 331 and

332.

Several other modifications to the proposed regulations have been

included in the final regulations. Minor editorial changes and

clarifications have been made. For example, the final regulations

clarify the amount of liabilities to be taken into account in

calculating deemed sale gain or loss and basis following a section 338

election. Further, the final regulations provide that the adjusted

deemed sale price (ADSP) must be calculated under a formula method.

(The temporary and proposed regulations referred to the formula method

as the elective ADSP formula.) Under the temporary regulations, the

ADSP could be calculated using the formula method or by separately

valuing each asset. Mandating the formula method is consistent with the

treatment under section 338(h)(10) and makes the regulations simpler

and easier to apply. The final regulations also simplify the ADSP

examples.

In addition, the final regulations contain a provision clarifying

that a target S corporation for which a section 338 election (other

than a section 338(h)(10) election) is made must file a deemed sale

return reporting the deemed asset sale as a C corporation. See H.R.

Rep. No. 432, Part 2, 98th Cong., 2d Sess., 1642 (March 5, 1984). No

implication is intended by that provision as to the status of an

acquired S corporation in the absence of a section 338 election.

F. Effective Dates

Commentors suggested that the final regulations be effective either

as of January 14, 1992 (the date the proposed regulations were filed)

or earlier (including as early as the effective date of the repeal of

the General Utilities doctrine by the Tax Reform Act of 1986).

The final regulations are generally effective for targets with

acquisition dates on or after January 20, 1994. The final regulations

also apply on an elective basis to targets with acquisition dates on or

after January 14, 1992 and before January 20, 1994. If an election is

made to apply the final regulations to targets with acquisition dates

on or after January 14, 1992 and before January 20, 1994, the

provisions for controlled foreign corporations that are issued as

temporary regulations elsewhere in the Federal Register will also apply

to such targets. Further, if that election is made, a protective

carryover basis election or offset prohibition election made under the

temporary regulations will have no effect.

Section 1.338(h)(10)-1(f) (relating to mandatory use of the MADSP

formula) is generally effective for targets with acquisition dates on

or after November 10, 1986.

Section 1.304-5 is effective on January 20, 1994.

Finally, the District Director's discretion to impose a section 338

election (other than with the taxpayer's consent) under section 338(e)

and Sec. 1.338-4T(f)(6)(i) is revoked for all open years.

Although comments were requested regarding transition issues raised

by the proposed effective date, no comments were received.

Consequently, no special rules relating to transition issues have been

provided.

G. Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in Executive Order 12866. It

also has been determined that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act 5

U.S.C. chapter 6) do not apply to these regulations, and therefore, a

Regulatory Flexibility Analysis is not required. Pursuant to section

7805(f) of the Internal Revenue Code, the notice of proposed rulemaking

was submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on the impact of the rules on small

business.

H. Drafting Information

The principal author of the international aspects of these

regulations is Kenneth D. Allison of the Office of Associate Chief

Counsel (International), within the Office of Chief Counsel, Internal

Revenue Service. However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recording requirements.

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 entry for ``Section 1.338-6T'' and adding entries in

numerical order to read as follows:

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

Section 1.304-5 also issued under 26 U.S.C. 304. * * *

Section 1.338-1 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-2 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-3 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-4 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338-5 also issued under 26 U.S.C. 337(d), 338, and

1502.

Section 1.338(b)-1 also issued under 26 U.S.C. 337(d), 338, and

1502. * * *

Section 1.338(h)(10)-1 also issued under 26 U.S.C. 337(d), 338,

and 1502.

Section 1.338(i)-1 also issued under 26 U.S.C. 337(d), 338, and

1502. * * *

Section 1.1502-75 also issued under 26 U.S.C. 1502. * * *

Par. 2. Section 1.304-5 is added to read as follows:

Sec. 1.304-5 Control.

(a) Control requirement in general. Section 304(c)(1) provides

that, for purposes of section 304, control means the ownership of stock

possessing at least 50 percent of the total combined voting power of

all classes of stock entitled to vote or at least 50 percent of the

total value of shares of all classes of stock. Section 304(c)(3) makes

section 318(a) (relating to constructive ownership of stock), as

modified by section 304(c)(3)(B), applicable to section 304 for

purposes of determining control under section 304(c)(1).

(b) Effect of section 304(c)(2)(B)--(1) In general. In determining

whether the control test with respect to both the issuing and acquiring

corporations is satisfied, section 304(a)(1) considers only the person

or persons that--

(i) Control the issuing corporation before the transaction;

(ii) Transfer issuing corporation stock to the acquiring

corporation for property; and

(iii) Control the acquiring corporation thereafter.

(2) Application. Section 317 defines property to include money,

securities, and any other property except stock (or stock rights) in

the distributing corporation. However, section 304(c)(2)(B) provides a

special rule to extend the relevant group of persons to be tested for

control of both the issuing and acquiring corporations to include the

person or persons that do not acquire property, but rather solely stock

from the acquiring corporation in the transaction. Section 304(c)(2)(B)

provides that if two or more persons in control of the issuing

corporation transfer stock of such corporation to the acquiring

corporation, and if the transferors are in control of the acquiring

corporation after the transfer, the person or persons in control of

each corporation include each of those transferors. Because the purpose

of section 304(c)(2)(B) is to include in the relevant control group the

person or persons that retain or acquire acquiring corporation stock in

the transaction, only the person or persons transferring stock of the

issuing corporation that retain or acquire any proprietary interest in

the acquiring corporation are taken into account for purposes of

applying section 304(c)(2)(B).

(3) Example. This section may be illustrated by the following

example.

Example. (a) A, the owner of 20% of T's only class of stock,

transfers that stock to P solely in exchange for all of the P stock.

Pursuant to the same transaction, P, solely in exchange for cash,

acquires the remaining 80% of the T stock from T's other

shareholder, B, who is unrelated to A and P.

(b) Although A and B together were in control of T (the issuing

corporation) before the transaction and A and B each transferred T

stock to P (the acquiring corporation), sections 304(a)(1) and

(c)(2)(B) do not apply to B because B did not retain or acquire any

proprietary interest in P in the transaction. Section 304(a)(1) also

does not apply to A because A (or any control group of which A was a

member) did not control T before the transaction and P after the

transaction.

(c) Effective date. This section is effective on January 20, 1994.

Par. 3. The following sections or paragraphs are amended as

follows:

(a) Sections 1.338-1T through 1.338-3T are removed.

(b) Sections 1.338-5T and 1.338-6T are removed.

(c) Section 1.338(b)-1T is removed.

(d) Section 1.338(b)-2T(a)(3) is removed.

(e) Section 1.338(b)-4T is removed.

(f) Section 1.338(h)(10)-1T is removed.

(g) Section 1.367(a)-4T(b)(4) is removed and reserved.

Par. 4. Sections 1.338-0 through 1.338-5 and Sec. 1.338(b)-1 are

added to read as follows:

Sec. 1.338-0 Outline of topics.

This section lists the captions contained in the regulations under

section 338.

Sec. 1.338-1 Elections under section 338.

(a) Scope.

(b) Nomenclature.

(c) Definitions.

(1) Acquisition date.

(2) Affiliated group.

(3) Common parent.

(4) Consistency period.

(5) Domestic corporation.

(6) Old target's final return.

(7) Purchasing corporation.

(8) Qualified stock purchase.

(9) Related persons.

(10) Section 338 election.

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

(12) Selling group.

(13) Target; old target; new target.

(14) Target affiliate.

(15) 12-month acquisition period.

(d) Time and manner of making election.

(e) Returns including tax liability from deemed 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 an S corporation.

(4) Combined deemed sale return.

(i) General rule.

(ii) Gain and loss offsets.

(iii) Procedure for filing a combined return.

(iv) Consequences of filing a combined return.

(5) Deemed sale excluded from purchasing corporation's

consolidated return.

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

(i) General rule.

(ii) Application of Sec. 1.1502-76(c).

(A) In general.

(B) Deemed extension.

(C) Erroneous filing of deemed sale return.

(D) Erroneous filing of return for regular tax year.

(E) Last date for payment of tax.

(7) Examples.

(f) 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.

(g) 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 election may be filed by United

States shareholders in certain cases.

(4) Notice requirement for U.S. persons holding stock in foreign

target.

(i) General rule.

(ii) Limitation.

(iii) Form of notice.

(iv) Timing of notice.

(v) Consequence of failure to comply.

(vi) Good faith effort to comply.

Sec. 1.338-2 Miscellaneous issues under section 338.

(a) Scope.

(b) Rules relating to qualified stock purchases.

(1) Purchasing corporation requirement.

(2) Purchase.

(i) Definition.

(ii) Examples.

(3) Date of purchase from related corporations.

(i) In general.

(ii) Examples.

(4) Acquisition date for tiered targets.

(i) Stock sold in deemed asset sale.

(ii) Examples.

(5) Effect of redemptions.

(i) General rule.

(ii) Redemptions from persons unrelated to the purchasing

corporation.

(iii) Redemptions from the purchasing corporation or related

persons during 12-month acquisition period.

(A) General rule.

(B) Exception for certain redemptions from related corporations.

(iv) Examples.

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

338 election.

(1) Post-acquisition elimination of target.

(2) Post-acquisition elimination of the purchasing corporation.

(d) Miscellaneous matters affecting new target.

(1) General rule for subtitle A.

(2) Exceptions for subtitle A.

(3) Taxable year of new target.

(4) General rule for other provisions of the Internal Revenue

Code.

Sec. 1.338-3 Deemed sale and aggregate deemed sale price.

(a) Scope.

(b) Definitions.

(1) ADSP.

(2) Allocable ADSP amount.

(3) Deemed sale gain.

(4) Classes of assets.

(c) Deemed sale of target affiliate stock.

(1) In general.

(2) General rule.

(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.

(d) Determination of ADSP.

(1) General rule.

(2) Grossed-up basis of the purchasing corporation's recently

purchased target stock.

(3) Liabilities.

(4) Other relevant items.

(5) Calculation of deemed sale gain and loss.

(6) Other rules apply in determining ADSP.

(7) Cross reference.

(8) Examples.

Sec. 1.338-4 Asset and stock consistency.

(a) Introduction.

(1) Overview.

(2) General application.

(3) Extensions of the general rules.

(4) Application where certain dividends are paid.

(5) Application to foreign target affiliates.

(6) Stock consistency.

(b) Consistency for direct acquisitions.

(1) General rule.

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

(c) Gain from disposition reflected in basis of target stock.

(1) General rule.

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

(3) Gain reflected by reason of distributions.

(4) Controlled foreign corporations.

(5) Gain recognized outside the consolidated group.

(d) Basis of acquired assets.

(1) Carryover basis rule.

(2) Exceptions to carryover basis rule for certain assets.

(3) Exception to carryover basis rule for de minimis assets.

(4) Mitigation rule.

(i) General rule.

(ii) Time for transfer.

(e) Examples.

(1) In general.

(2) Direct acquisitions.

(f) Extension of consistency to indirect acquisitions.

(1) Introduction.

(2) General rule.

(3) Basis of acquired assets.

(4) Examples.

(g) Extension of consistency if dividends qualifying for 100

percent dividends received deduction are paid.

(1) General rule for direct acquisitions from target.

(2) Other direct acquisitions having same effect.

(3) Indirect acquisitions.

(4) Examples.

(h) Special rules for controlled foreign corporations.

[Reserved]

(i) [Reserved]

(j) Anti-avoidance rules.

(1) Extension of consistency period.

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

(3) Acquisitions by conduits.

(i) Asset ownership.

(A) General rule.

(B) Application of carryover basis rule.

(ii) Stock acquisitions.

(A) Purchase by conduit.

(B) Purchase of conduit by corporation.

(C) Purchase of conduit by conduit.

(4) Conduit.

(5) Existence of arrangement.

(6) Predecessor and successor.

(i) Persons.

(ii) Assets.

(7) Examples.

Sec. 1.338-4T Asset and stock consistency (temporary).

(a) through (g) [Reserved]

(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.

(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.

(5) Examples.

(i) and (j) [Reserved]

(k) Effective dates.

Sec. 1.338-5 International aspects of section 338.

(a) Scope.

(b) Application of section 338 to foreign targets.

(1) In general.

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

(3) Carryover FT stock.

(i) Definition.

(ii) Carryover of earnings and profits.

(iii) Cap on carryover of earnings and profits.

(iv) Post-acquisition date distribution of old FT earnings and

profits.

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

date deficits.

(vi) Character of FT stock as carryover FT stock eliminated upon

disposition.

(4) Passive foreign investment company stock.

(c) Dividend treatment under section 1248(e).

(d) Allocation of foreign taxes.

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

(f) Examples.

Sec. 1.338(b)-1 Adjusted grossed-up basis.

(a) Scope.

(b) Adjustment events.

(c) AGUB.

(1) In general.

(2) Time when AGUB determined.

(d) Grossed-up basis of recently purchased stock.

(1) General rule.

(2) Application.

(e) Basis of nonrecently purchased stock.

(1) In general.

(2) Effect of gain recognition election.

(i) In general.

(ii) Basis amount.

(iii) Losses not recognized.

(iv) Stock subject to election.

(3) Procedure for making gain recognition election.

(i) In general.

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

(4) Comparison with ADSP formula.

(f) Liabilities of new target.

(1) In general.

(2) Excluded obligations.

(i) In general.

(ii) Time when excluded obligations taken into account.

(3) Liabilities taken into account in determining amount

realized on subsequent disposition.

(g) Other relevant items.

(1) In general.

(2) Flow-through of relevant item adjustment to target

subsidiary.

(3) Adjustments by the Internal Revenue Service.

(h) Examples.

Sec. 1.338(b)-2T Allocation of adjusted grossed-up basis among

target assets (temporary).

(a) Introduction.

(1) In general.

(2) Fair market value.

(b) General rule for allocating adjusted grossed-up basis.

(1) Cash and other items designated by the Internal Revenue

Service.

(2) Other assets.

(i) In general.

(ii) Class II assets.

(iii) Class III assets.

(iv) Class IV assets.

(c) Certain limitations and special rules for basis allocable to

an asset.

(1) Basis not to exceed fair market value.

(2) Assets subject to other limitations.

(3) Special rule for allocating adjusted grossed-up basis when

purchasing corporation has nonrecently purchased stock.

(i) Scope.

(ii) Determination of hypothetical purchase price.

(iii) Allocation of adjusted grossed-up basis.

(d) Examples.

Sec. 1.338(b)-3T Subsequent adjustments to adjusted grossed-up

basis (temporary).

(a) Scope.

(1) In general.

(2) Exceptions to applicability of section.

(3) Adjustment of aggregate deemed sale price.

(b) Definitions.

(1) Contingent liability.

(2) Contingent amount.

(3) Reduction amount.

(4) Acquisition date asset.

(c) General rule.

(1) Time when increases in adjusted grossed-up basis taken into

account.

(2) Time when decreases in adjusted grossed-up basis taken into

account.

(3) Amount of increases and decreases in adjusted grossed-up

basis.

(d) Allocation of increases in adjusted grossed-up basis.

(1) In general.

(2) Effect of disposition or depreciation of acquisition date

assets.

(e) Allocation of decreases in adjusted grossed-up basis.

(1) In general.

(2) Effect of disposition of assets or reduction of basis below

zero.

(3) Section 338 property.

(f) Special rule for allocation of increases (or decreases) in

adjusted grossed-up basis when hypothetical purchase price was used

in allocating adjusted grossed-up basis.

(1) Scope.

(2) Allocation of increases (decreases) in adjusted grossed-up

basis.

(3) Allocation to contingent income assets.

(g) Special rule for allocation of increases (decreases) in

adjusted grossed-up basis to specific assets.

(1) Patents and similar property.

(i) Scope.

(ii) Specific allocation.

(2) Internal Revenue Service authority.

(h) Changes in old target's aggregate deemed sale price of

assets.

(1) General rule.

(i) In general.

(ii) Redetermination of aggregate deemed sale price if the

elective formula under section 338(h)(11) is used.

(iii) Redetermination of aggregate deemed sale price if the

elective formula under section 338(h)(11) is not used.

(2) Procedure for transactions in which section 338(h)(10) is

not elected.

(i) Income or loss 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.

(i) [Reserved.]

(j) Examples.

Sec. 1.338(h)(10)-1 Deemed asset sale and liquidation.

(a) Scope.

(b) Nomenclature.

(c) Definitions.

(1) Section 338(h)(10) target.

(2) S corporation shareholders.

(3) Selling consolidated group.

(4) Selling affiliate.

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

(1) In general.

(2) Simultaneous joint election requirement.

(3) Irrevocability.

(4) Effect of invalid election.

(e) Certain consequences of section 338(h)(10) election.

(1) Old T.

(2) Selling consolidated group, selling affiliate, or S

corporation shareholders.

(i) In general.

(ii) Deemed liquidation of old T.

(iii) Basis of stock not acquired.

(iv) T stock sale.

(v) Example.

(3) Certain minority shareholders.

(i) In general.

(ii) T stock sale.

(iii) T stock not acquired.

(4) P.

(5) New T.

(6) Consolidated return of selling consolidated group.

(f) Deemed sale price.

(1) General rule.

(2) Formula.

(3) Liabilities.

(4) Other relevant items.

(5) Cross-reference.

(g) Examples.

(h) Inapplicability of provisions.

Sec. 1.338(i)-1 Effective dates.

(a) In general.

(b) Elective retroactive application.

(c) MADSP.

(d) Deemed election.

Sec. 1.338-1 Elections under section 338.

(a) Scope. This section prescribes rules relating to elections

under section 338. Paragraphs (c)(6), (e), and (g) of this section do

not apply to a target for which a section 338(h)(10) election is made.

(b) Nomenclature. For purposes of the regulations under section 338

(except as otherwise provided):

(1) T is a domestic corporation that has only one class of stock

outstanding.

(2) P is a domestic corporation that purchases stock of T in a

qualified stock purchase.

(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. resident or citizen, 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.

resident or citizen. Ownership of T by A and ownership of T by S are

mutually exclusive circumstances.)

(8) B, a U.S. resident or citizen, 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) 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 with each other.

(3) Common parent. The term common parent has the same meaning as

in section 1504.

(4) Consistency period. The consistency period is the period

described in section 338(h)(4)(A) unless extended pursuant to

Sec. 1.338-4(j)(1).

(5) 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.

(6) 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 of assets

under section 338. If the disaffiliation rule of paragraph (e)(2)(i) of

this section applies, target's deemed sale return is considered old

target's final return.

(7) Purchasing corporation. The term purchasing corporation has the

same meaning as in section 338(d)(1). 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).

(8) Qualified stock purchase. The term qualified stock purchase has

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

(9) 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.

(10) Section 338 election. A section 338 election is an election to

apply section 338(a) to target. A section 338 election may be made by

filing a statement of section 338 election pursuant to Sec. 1.338-1(d).

The form on which this statement is filed is referred to in the

regulations under section 338 as the Form 8023.

(11) 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 may be made by making a joint election for target under

Sec. 1.338(h)(10)-1.

(12) Selling group. The selling group is the affiliated group (as

defined in section 1504) that is eligible to file a consolidated return

that includes target for the target's taxable period that includes the

acquisition date and that does not have a target as common parent for

the taxable year including the acquisition date.

(13) 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 as of the close of the date of target's

deemed sale of assets. New target refers to target for subsequent

periods.

(14) 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.

(15) 12-month acquisition period. The 12-month acquisition period

is the period described in section 338(h)(1), unless extended pursuant

to Sec. 1.338-4(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.

(e) Returns including tax liability from deemed sale--(1) In

general. Except as provided in paragraphs (e)(2) and (3) of this

section, any tax liability resulting from the deemed sale of assets

under section 338 is included in the final return of old target filed

for old target's taxable year that ends at the close of the acquisition

date. If old target is the common parent of an affiliated group, the

final return may be a consolidated return (any such consolidated return

must also include any tax liability from any deemed sales under section

338 by subsidiaries in the consolidated group that have the same

acquisition date as old target and that are acquired by the purchasing

corporation).

(2) Old target's final taxable year otherwise included in

consolidated return of selling group--(i) General rule. If the selling

group files a consolidated return for the period that includes the

acquisition date, old target is disaffiliated from that group

immediately before its deemed sale of assets under section 338 and must

file a separate final return that includes only the items resulting

from the deemed sale and the carryover items specified in paragraph

(e)(2)(iii) of this section (deemed sale return). The deemed sale

occurs at the close of the acquisition date and is the last transaction

of old target. Any transactions of old target occurring on the

acquisition date other than the deemed sale are included in the selling

group's consolidated return. A deemed sale return includes a combined

return as defined in paragraph (e)(4) of this section.

(ii) Separate taxable year. The deemed sale included in the deemed

sale return under this paragraph (e)(2) occurs in a separate taxable

year, except that old target's taxable year of the sale and the

consolidated year of the selling group that includes the acquisition

date are treated as the same year for purposes of determining the

number of years in a carryover or carryback period.

(iii) Carryover and carryback of tax attributes. Target's

attributes may be carried over to, and carried back from, the deemed

sale return under the rules applicable to a corporation that ceases to

be a member of a consolidated group.

(iv) Old target is a component member of purchasing corporation's

controlled group. For purposes of its deemed sale return, target is a

component member of the controlled group of corporations including the

purchasing corporation unless target is treated as an excluded member

under section 1563(b)(2).

(3) Old target an S corporation. If target is an S corporation for

the period that ends on the day before the acquisition date, old target

must file a deemed sale return as a C corporation. For this purpose,

the principles of paragraph (e)(2) of this section apply.

(4) Combined deemed sale return--(i) General rule. Under section

338(h)(15), a combined deemed sale return (combined return) may be

filed for all targets from a single selling consolidated group (as

defined in Sec. 1.338(h)(10)-1(c)(3)) that are acquired by the

purchasing corporation on the same acquisition date and that otherwise

would be required to file separate deemed sale returns. The combined

return must include all such targets. For example, T and T1 may be

included in a combined return if--

(A) T and T1 are directly owned subsidiaries of S;

(B) S is the common parent of a consolidated group; and

(C) P makes qualified stock purchases of T and T1 on the same

acquisition date.

(ii) Gain and loss offsets. Gains and losses recognized on the

deemed sale of assets by targets included in a combined return are

treated as the gains and losses of a single target. In addition, loss

carryovers of a target that were not subject to the separate return

limitation year restrictions (SRLY restrictions) of the consolidated

return regulations while that target was a member of the selling

consolidated group may be applied without limitation to the gains of

other targets included in the combined return. If, however, a target

has loss carryovers that were subject to the SRLY restrictions while

that target was a member of the selling consolidated group, the use of

those losses in the combined return continues to be subject to those

restrictions, applied in the same manner as if the combined return were

a consolidated return. A similar rule applies, when appropriate, to

other tax attributes.

(iii) Procedure for filing a combined return. A combined return is

made by filing a single corporation income tax return in lieu of

separate deemed sale returns for all targets required to be included in

the combined return. The combined return reflects the deemed sales of

all targets required to be included in the combined return. If the

targets included in the combined return constitute a single affiliated

group within the meaning of section 1504(a), the income tax return is

signed by an officer of the common parent of that group. Otherwise, the

return must be signed by an officer of each target included in the

combined return. Rules similar to the rules in Sec. 1.1502-75(j) apply

for purposes of preparing the combined return. The combined return must

include an attachment prominently identified as an ``ELECTION TO FILE A

COMBINED RETURN UNDER SECTION 338(h)(15).'' The attachment must--

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

of each target required to be included in the combined return;

(B) Contain the following declaration (or a substantially similar

declaration): ``EACH TARGET IDENTIFIED IN THIS ELECTION TO FILE A

COMBINED RETURN CONSENTS TO THE FILING OF A COMBINED RETURN''; and

(C) For each target, be signed by a person who states under

penalties of perjury that he or she is authorized to act on behalf of

such target.

(iv) Consequences of filing a combined return. Each target included

in a combined return is severally liable for any tax associated with

the combined return. See Sec. 1.338-2(d)(1).

(5) Deemed sale excluded from purchasing corporation's consolidated

return. Old target may not be considered a member of any affiliated

group that includes the purchasing corporation with respect to the

deemed sale of target assets under section 338.

(6) Due date for old target's final return--(i) General rule. Old

target's final return is generally due on the 15th day of the third

calendar month following the month in which the acquisition date

occurs. See section 6072 (time for filing income tax returns).

(ii) Application of Sec. 1.1502-76(c)--(A) In general. Section

1.1502-76(c) applies to old target's final return if old target was a

member of a selling group that did not file consolidated returns for

the taxable year of the common parent that precedes the year that

includes old target's acquisition date. If the selling group has not

filed a consolidated return that includes old target's taxable period

that ends on the acquisition date, target may, on or before the final

return due date (including extensions), either--

(1) File a deemed sale return on the assumption that the selling

group will file the consolidated return; or

(2) File a return for so much of old target's taxable period as

ends at the close of the acquisition date on the assumption that the

consolidated return will not be filed.

(B) Deemed extension. For purposes of applying Sec. 1.1502-

76(c)(2), an extension of time to file old target's final return is

considered to be in effect until the last date for making the election

under section 338.

(C) Erroneous filing of deemed sale return. If, pursuant to this

paragraph (e)(6)(ii), target files a deemed sale return but the selling

group does not file a consolidated return, target must file a

substituted return for old target not later than the due date

(including extensions) for the return of the common parent with which

old target would have been included in the consolidated return. The

substituted return is for so much of old target's taxable year as ends

at the close of the acquisition date. Under Sec. 1.1502-76(c)(2), the

deemed sale return is not considered a return for purposes of section

6011 (relating to the general requirement of filing a return) if a

substituted return must be filed.

(D) Erroneous filing of return for regular tax year. If, pursuant

to this paragraph (e)(6)(ii), target files a return for so much of old

target's regular taxable year as ends at the close of the acquisition

date but the selling group files a consolidated return, target must

file an amended return for old target not later than the due date

(including extensions) for the selling group's consolidated return.

(The amended return is a deemed sale return.)

(E) Last date for payment of tax. If either a substituted or

amended final return of old target is filed pursuant to this paragraph

(e)(6)(ii), the last date prescribed for payment of tax is the final

return due date (as defined in paragraph (e)(6)(i) of this section).

(7) Examples. This paragraph (e) may be illustrated by the

following examples:

Example 1. (a) S is the common parent of a consolidated group

that includes T. The S group files calendar year consolidated

returns. At the close of June 30 of Year 1, P makes a qualified

stock purchase of T from S. P makes a section 338 election for T,

and the deemed sale of T's assets occurs as of the close of T's

acquisition date (June 30).

(b) T is considered disaffiliated for purposes of reporting the

deemed sale. Accordingly, T is included in the S group's

consolidated return through T's acquisition date except that the tax

liability resulting from the deemed sale of assets is reported in a

separate deemed sale return of T. Provided that T is not treated as

an excluded member under section 1563(b)(2), T is a component member

of P's controlled group for the taxable year represented by the

deemed sale, and the taxable income bracket amounts available in

calculating tax on the deemed sale return must be limited

accordingly.

(c) If P purchased the stock of T at 10 a.m. on June 30 of Year

1, the results would be the same. See paragraph (e)(2)(i) of this

section.

Example 2. The facts are the same as in Example 1, except that

the S group does not file consolidated returns. T must file a

separate return for its taxable year ending on June 30 of Year 1,

which includes the deemed sale.

(f) Waiver--(1) Certain additions to tax. An addition to tax or

additional amount (addition) under subchapter A of chapter 68 of the

Internal Revenue Code arising on or before the last day for making the

election under section 338, by reason of circumstances that would not

exist but for an election under section 338, is waived if--

(i) Under the particular statute the addition is excusable upon a

showing of reasonable cause; and

(ii) Corrective action is taken on or before the last day.

(2) Notification. The Service should be notified at the time of

correction (e.g., by attaching a statement to a return that constitutes

corrective action) that the waiver rule of this paragraph (f) is being

asserted.

(3) Elections or other actions required to be specified on a timely

filed return--(i) In general. If paragraph (f)(1) of this section

applies or would apply if there was an underpayment, any election or

other action that must be specified on a timely filed return for the

taxable period covered by the late filed return described in paragraph

(f)(1) of this section is considered timely if specified on a late-

filed return filed on or before the last day for making the election

under section 338.

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

new target is includible for its first taxable year in a consolidated

return filed by the affiliated group of which the purchasing

corporation is a member on or before the last day for making the

election under section 338, any election or other action that must be

specified in a timely filed return for new target's first taxable year

(but which is not specified in the consolidated return) is considered

timely if specified in an amended return filed on or before such last

day, at the place where the consolidated return was filed.

(4) Examples. This paragraph (f) may be illustrated by the

following examples:

Example 1. T is an unaffiliated corporation with a tax year

ending March 31. At the close of September 20 of Year 1, P makes a

qualified stock purchase of T. P does not join in filing a

consolidated return. P makes a section 338 election for T on or

before June 15 of Year 2, which causes T's taxable year to end as of

the close of September 20 of Year 1. An income tax return for T's

taxable period ending on September 20 of Year 1 was due on December

15 of Year 1. Additions to tax for failure to file a return and to

pay tax shown on a return will not be imposed if T's return is filed

and the tax paid on or before June 15 of Year 2. (This waiver

applies even if the acquisition date coincides with the last day of

T's former taxable year, i.e., March 31 of Year 2.) Interest on any

underpayment of tax for old T's short taxable year ending September

20 of Year 1 runs from December 15 of Year 1. A statement indicating

that the waiver rule of Sec. 1.338-1(f) is being asserted should be

attached to T's return.

Example 2. Assume the same facts as in Example 1. Assume further

that new T adopts the calendar year by filing, on or before June 15

of Year 2, its first return (for the period beginning on September

21 of Year 1 and ending on December 31 of Year 1) indicating that a

calendar year is chosen. See Sec. 1.338-2(d)(8). Any additions to

tax or amounts described in this paragraph (f) which arise by reason

of the late filing of a return for the period ending on December 31

of Year 1 are waived, because they are based on circumstances that

would not exist but for the section 338 election. Notwithstanding

this waiver, however, the return is still considered due March 15 of

Year 2, and interest on any underpayment runs from that date.

Example 3. Assume the same facts as in Example 2, except that

T's former taxable year ends on October 31. Although prior to the

election old T had a return due on January 15 of Year 2 for its year

ending October 31 of Year 1, that return need not be filed because a

timely election under section 338 was made. Instead, old T must file

a final return for the period ending on September 20 of Year 1,

which is due on December 15 of Year 1.

(g) 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 by reason of a section 338 election). A target

affiliate is taken into account for purposes of the preceding sentence

only if, during target's 12-month acquisition period, it is or becomes

a member of the affiliated group that includes the purchasing

corporation.

(iv) Triggering event. A triggering event occurs in the taxable

year of the qualifying foreign purchasing corporation in which either

that corporation or any corporation in its affiliated group becomes

subject to United States tax.

(v) Subject to United States tax. For purposes of this paragraph

(g)(1), a foreign corporation is considered subject to United States

tax--

(A) For the taxable year for which that corporation is required

under Sec. 1.6012-2(g) (other than Sec. 1.6012-2(g)(2)(i)(b)(2)) to

file a United States income tax return; or

(B) For the period during which that corporation is a controlled

foreign corporation, a passive foreign investment company for which an

election under section 1295 is in effect, a foreign investment company,

or a foreign corporation the stock ownership of which is described in

section 552(a)(2).

(2) Acquisition period. For purposes of this paragraph (g), the

term acquisition period means the period beginning on the first day of

the 12-month acquisition period and ending on the acquisition date.

(3) Statement of section 338 election may be filed by United States

shareholders in certain cases. The United States shareholders (as

defined in section 951(b)) of a foreign purchasing corporation that is

a controlled foreign corporation (as defined in section 957 (taking

into account section 953(c))) may file a statement of section 338

election on behalf of the purchasing corporation if the purchasing

corporation is not required under Sec. 1.6012-2(g) (other than

Sec. 1.6012-2(g)(2)(i)(b)(2)) to file a United States income tax return

for its taxable year that includes the acquisition date. Form 8023 must

be filed as described in the form and its instructions and also must be

attached to the Form 5471 (information 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 (g)(1)(i) of this

section applies to the election, for the purchasing corporation's

taxable year within which it becomes a controlled foreign corporation).

The provisions of Sec. 1.964-1(c) (including Sec. 1.964-1(c)(7)) do not

apply to an election made by the United States shareholders.

(4) Notice requirement for U.S. persons holding stock in foreign

target--(i) General rule. If a target subject to a section 338 election

was a controlled foreign corporation, a passive foreign investment

company, or a foreign personal holding company at any time during the

portion of its taxable year that ends on its acquisition date, the

purchasing corporation must deliver written notice of the election (and

a copy of Form 8023, its attachments and instructions) to--

(A) Each U.S. person (other than a member of the affiliated group

of which the purchasing corporation is a member (the purchasing group

member)) that, on the acquisition date of the foreign target, holds

stock in the foreign target; and

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

sells stock in the foreign target to a purchasing group member during

the foreign target's 12-month acquisition period.

(ii) Limitation. The notice requirement of this paragraph (g)(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 (g)(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 (g)(4)(i) of this section);

(B) Identify those corporations as the purchasing corporation and

the foreign target, respectively; and

(C) Contain the following declaration (or a substantially similar

declaration): ``THIS DOCUMENT SERVES AS NOTICE OF AN ELECTION UNDER

SECTION 338 FOR THE ABOVE CITED FOREIGN TARGET THE STOCK OF WHICH YOU

EITHER HELD OR SOLD UNDER THE CIRCUMSTANCES DESCRIBED IN TREASURY

REGULATIONS Sec. 1.338-1(g)(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 Sec. 1.338-5(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 (g)(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. If notice is delivered by United

States mail, the date of the United States postmark is deemed to be the

date of delivery.

(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 (g)(4). If the form of notice fails

to comply with all requirements of this paragraph (g)(4), the section

338 election is valid, but the waiver rule of paragraph (f)(1) of this

section does not apply.

(vi) Good faith effort to comply. The purchasing corporation will

be considered to have complied with this paragraph (g)(4), even though

it failed to provide notice or provide timely notice to each person

described in this paragraph (g)(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.

Sec. 1.338-2 Miscellaneous issues under section 338.

(a) Scope. This section provides guidance on 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

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 that

new P merges downstream into target, liquidates, or otherwise disposes

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) Examples. This paragraph (b)(2) may be illustrated by the

following examples:

Example 1. A, who owns all of the stock of P and T, sells the T

stock to P for cash. A is treated under section 304(a)(1) as

receiving a distribution in redemption of the P stock to which

section 301 applies. P is treated as receiving the T stock as a

contribution to its capital. Under section 362(a) and Sec. 1.304-

2(a), P's basis in the T stock is determined by reference to A's

adjusted basis in the stock. Further, stock owned by A would be

attributed to P under section 318(a)(3)(C). Thus, P is not

considered to have acquired the T stock by purchase. See sections

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

Example 2. P exchanges cash for all of the stock of N, a newly

formed corporation. N was formed for the sole purpose of acquiring

all of the T stock by means of a reverse subsidiary cash merger.

Prior to the merger, N conducted no activities other than those

required for the merger. Pursuant to the plan, N merges into T, and

the T shareholders receive cash for their T stock. No T shareholder

is related to P, and no group of T shareholders controls P within

the meaning of section 304(c). The existence of N is disregarded,

and P is considered to acquire the T stock directly from the T

shareholders for cash. Thus, P is considered to have acquired the T

stock by purchase.

(3) Date of purchase 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). However, if section 338(h)(3)(C) applies and the

purchasing corporation is treated as acquiring stock by purchase from

R, solely for purposes of determining when the stock is considered

acquired--

(A) 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)); and

(B) If such stock first may be considered owned by the purchasing

corporation on more than one date, such stock is deemed acquired on the

earliest date first to the extent thereof, then on the next earliest

date, and so on.

(ii) Examples. This paragraph (b)(3) may be illustrated by the

following examples:

Example 1. (a) On January 1 of Year 1, P purchases 75% 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.

(b) Of the 12 shares of T stock purchased by P from R on

December 1 of Year 1, 3 of those shares are deemed to have been

acquired by P on January 1 of Year 1, the date on which 3 of the 4

shares of T stock held by R on that date were first considered owned

by P under section 318(a)(2)(C) (i.e., 4 x .75). The remaining 9

shares of T stock purchased by P from R on December 1 of Year 1, are

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

which an additional 12 of the 20 shares of T stock owned by R on

that date were first considered owned by P under section

318(a)(2)(C) (i.e., (20 x .75) -3). Because stock acquisitions by P

sufficient for a qualified stock purchase of T occur within a 12-

month period (i.e., 3 shares constructively on January 1 of Year 1,

9 shares constructively on June 1 of Year 1, and 70 shares actually

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

December 1 of Year 1.

Example 2. (a) On February 1 of Year 1, P acquires 25% 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% in value of the R stock, and on January

1 of Year 2, P purchases another 25% 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.

(b) Of the 12 shares of the T stock purchased by P from R on

December 1 of Year 2, 2 of those shares are deemed to have been

acquired by P on June 1 of Year 1, the date on which 2 of the 4

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

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

of this attribution, the R stock need not be acquired by P by

purchase. See section 338(h)(1). (By contrast, the acquisition of

the T stock by P from R does not qualify as a purchase unless P has

acquired at least 50% in value of the R stock by purchase. Section

338(h)(3)(C)(i).) Of the remaining 10 shares of the T stock

purchased by P from R on December 1 of Year 2, 1 of those shares is

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

on which an additional 1 share of the 4 shares of the T stock held

by R on that date was first considered owned by P under section

318(a)(2)(C) (i.e., (4 x .75) -2). The remaining 9 shares of the T

stock purchased by P from R on December 1 of Year 2, are deemed to

have been acquired by P on June 1 of Year 2, the date on which an

additional 12 shares of the T stock held by R on that date were

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

(20 x .75) -3). Because a qualified stock purchase of T by P is made

on December 1 of Year 2, only if all 12 shares of the T stock

purchased by P from R on that date are considered acquired during a

12-month period ending on that date (so that, in conjunction with

the 68 shares of the T stock P purchased on that date from the

unrelated person, 80 of T's 100 shares are acquired by P during a

12-month period) and because 2 of those 12 shares are considered to

have been acquired by P more than 12 months before December 1 of

Year 2 (i.e., on June 1 of Year 1), a qualified stock purchase is

not made. (Under Sec. 1.338-4(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 3. Assume the same facts as in Example 2, except that on

February 1 of Year 1, P acquires 25% in value of the R stock by

purchase. The result is the same as in Example 2.

(4) Acquisition date for tiered targets--(i) Stock sold in deemed

asset sale. If an election under section 338 is made for target, old

target is deemed to sell target's assets and new target is deemed to

acquire those assets. Under section 338(h)(3)(B), new target's deemed

purchase of stock of another corporation is a purchase for purposes of

section 338(d)(3) on the acquisition date of target. If new target's

deemed purchase causes a qualified stock purchase of the other

corporation and if a section 338 election is made for the other

corporation, the acquisition date for the other corporation is the same

as the acquisition date of target. However, the deemed sale and

purchase of the other corporation's assets is considered to take place

after the deemed sale and purchase of target's assets.

(ii) Examples. This paragraph (b)(4) may be illustrated by the

following examples:

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 by reason of the section 338 election for

T and the actual purchase of 50 shares of X stock by P are treated

as purchases made by one corporation. Section 338(h)(8). For

purposes of determining whether those purchases occur within a 12-

month acquisition period as required by section 338(d)(3), T is

deemed to purchase its X stock on T's acquisition date, i.e.,

January 1 of Year 1.

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 by reason 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 sale of assets occurs pursuant to section

338(a). The deemed sale of assets 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 sale of assets. 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 the 12-month acquisition period satisfies the

percentage ownership requirements of section 338(d)(3).

(iii) Redemptions from the purchasing corporation or related

persons during 12-month acquisition period--(A) General rule. For

purposes of the percentage ownership requirements of section 338(d)(3),

a redemption of target stock during the 12-month acquisition period

from the purchasing corporation or from any person related to the

purchasing corporation is not taken into account as a reduction in

target's outstanding stock.

(B) Exception for certain redemptions from related corporations. A

redemption of target stock during the 12-month acquisition period from

a corporation related to the purchasing corporation is taken into

account as a reduction in target's outstanding stock to the extent that

the redeemed stock would have been considered purchased by the

purchasing corporation (by reason 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. This paragraph (b)(5) may be illustrated by the

following examples:

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 unrelated person more than 12 months

before stock purchase. A owns all 100 shares of T stock. On January

1 of Year 1, T redeems 25 of its shares. On January 15 of Year 2, P

purchases 60 shares of T stock from A. P makes a qualified stock

purchase of T on January 15 of Year 2. 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. It is irrelevant that the redemption

occurred before the 12-month acquisition period.

Example 4. Redemption from unrelated person more than 12 months

after stock purchase. The facts are the same as in Example 3, except

that the redemption occurs on April 1 of Year 3. P does not make a

qualified stock purchase of T on April 1 of Year 3, because 80% of

the T stock, as of April 1 of Year 3 had not been purchased in the

preceding 12 months. (Under Sec. 1.338-4(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 5. Redemption from purchasing corporation not taken into

account. On December 15 of Year 1, T redeems 30% of its stock from

P. The redeemed stock was held by P for several years and

constituted P's total interest in T. On December 1 of Year 2, P

purchases the remaining T stock from A. P does not make a qualified

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

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

of P's T stock on December 15 of Year 1 is not taken into account as

a reduction in T's outstanding stock.

Example 6. 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 (by reason of section

338(h)(3)(C)(i)) during the 12-month period ending on April 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) This paragraph (c)(1) may be illustrated by the following

examples:

Example 1. On January 1 of Year 1, P makes a qualified stock

purchase 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 sale of T's assets on January 1 of Year 1.

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

purchase of T. On that date, T owns the stock of T1. On March 1 of

Year 1, T sells the T1 stock to an unrelated person. On April 1 of

Year 1, P makes a section 338 election for T. Notwithstanding that

the T1 stock was sold on March 1 of Year 1, the section 338 election

for T on April 1 of Year 1, results in a qualified stock purchase by

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

section.

(2) Post-acquisition elimination of the purchasing corporation. An

election under section 338 may be made for target after the acquisition

of assets of the purchasing corporation by another corporation in a

transaction described in section 381(a), provided that the purchasing

corporation is considered for tax purposes as the purchaser of the

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

transaction may make an election under section 338 for target.

(d) Miscellaneous matters affecting new target--(1) General rule

for subtitle A. Except as provided in this paragraph (d), 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, in the

section 338(a)(1) deemed sale, new target is treated as purchasing

assets from an unrelated person, and--

(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.

(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, 120, 125, 127, and 129),

qualified pension, profit-sharing, stock bonus and annuity plans

(sections 401(a) and 403(a)), simplified employee pensions (section

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

(ii) Sections 1311-1314 (relating to the mitigation of the effect

of limitations) if a section 338(h)(10) election is not made for

target; and

(iii) Any other provision identified by the Commissioner.

(3) Taxable year of new target. Notwithstanding Sec. 1.441-

1T(b)(2), a new target may adopt a taxable year on or before the last

day for making the election under section 338 by filing its first

return for the desired taxable year on or before that date.

(4) General rule for other provisions of the Internal Revenue Code.

Except as provided in the regulations under section 338 or by the

Commissioner, new target is treated as a continuation of old target for

purposes other than subtitle A. For example--

(i) New target is liable for old target's federal income tax

liabilities, including tax liabilities resulting from the deemed asset

sale and those tax liabilities of the other members of any consolidated

group that included old target that are attributable to taxable years

in which those corporations and old target joined in the same

consolidated return (see Sec. 1.1502-6(a));

(ii) Wages earned by the employees of old target are considered

wages earned by such employees from new target for purposes of sections

3101 and 3111 (Federal Insurance Contributions Act) and section 3301

(Federal Unemployment Tax Act); and

(iii) Old target and new target must use the same employer

identification number.

Sec. 1.338-3 Deemed sale and aggregate deemed sale price.

(a) Scope. This section provides guidance regarding the recognition

of gain or loss on the deemed sale of target affiliate stock. This

section also provides guidance regarding the determination of the price

(the aggregate deemed sale price) at which old target is treated as

selling its assets in the section 338(a)(1) deemed sale for purposes of

determining the gain or loss recognized by target in the deemed sale.

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) Definitions. For purposes of the regulations under section 338:

(1) ADSP. The ADSP is the aggregate deemed sale price, i.e., the

price at which target is deemed to have sold all of its assets in the

deemed sale under section 338(a)(1). See paragraph (d) of this section

for the determination of the ADSP.

(2) Allocable ADSP amount. The allocable ADSP amount is the portion

of the ADSP that is allocable to a particular target asset. Deemed sale

gain on a target asset is computed by reference to the allocable ADSP

amount for that asset. Except as provided in section 7701(g) (relating

to fair market value in the case of nonrecourse indebtedness), the ADSP

is allocated among target assets for this purpose under the principles

of Sec. 1.338(b)-2T (without taking into account Sec. 1.338(b)-

2T(c)(2)). Appropriate adjustments to reflect accurately the fair

market value of assets must be made if stock of a target affiliate is

purchased in the section 338(a)(1) deemed sale, a section 338 election

is made for the target affiliate, and target recognizes no gain or loss

on the deemed sale of the target affiliate stock under paragraph (c) of

this section. See Example 4 of paragraph (d)(8) of this section.

(3) Deemed sale gain. Deemed sale gain is gain (or loss) that is

recognized in the section 338(a)(1) deemed sale. For purposes of

subtitle A of the Internal Revenue Code, deemed sale gain is taken into

account by treating the old target as if, on the acquisition date, it

sold all of its assets to an unrelated person in the deemed sale. See

Sec. 1.338-2(d)(1). For example, section 267 does not apply to loss

recognized on the deemed sale.

(4) Classes of assets. The four classes of assets are defined in

Sec. 1.338(b)-2T(b).

(c) Deemed sale of target affiliate stock--(1) In general. This

paragraph (c) prescribes rules relating to the treatment of gain or

loss realized on the deemed sale of stock of a target affiliate where a

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

for the target affiliate. For purposes of this paragraph (c), the

definition of domestic corporation in Sec. 1.338-1(c)(5) 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) General rule. Except as otherwise provided in this paragraph

(c), if a section 338 election is made for target, no gain or loss is

recognized by target on the deemed sale of stock of a target affiliate

having the same acquisition date and for which a section 338 election

is made if--

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

the requirements of section 1504(a)(2);

(ii) Target and the target affiliate are members of a consolidated

group filing a final consolidated return described in Sec. 1.338-

1(e)(1); or

(iii) Target and the target affiliate file a combined return under

Sec. 1.338-1(e)(4).

(3) Deemed sale of foreign target affiliate by a domestic target.

Gain or loss is recognized by a domestic target on the deemed sale of

stock of a foreign target affiliate. For the proper treatment of such

gain or loss, see, e.g., sections 1246, 1248, 1291 et seq., and

338(h)(16) and Sec. 1.338-5.

(4) Deemed sale producing effectively connected income. Gain or

loss is recognized by a foreign target 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). Gain (but not loss) is recognized by a domestic

target 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. Gain (but not loss) is

recognized by a foreign or domestic target 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. This paragraph (c) may be illustrated by the

following examples:

Example 1. (a) 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.

(b) 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.

(c) T1 recognizes gain of $100 on the deemed sale of its assets.

Example 2. The facts are the same as in Example 1, except that P

does not make a section 338 election for T1. Because a section 338

election is not made for T1, the $100 gain realized by T on the

deemed sale of the T1 stock is recognized.

Example 3. (a) 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 a section 338 election is made for

T1 and T2. T1 and T2 each own 50% 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 sales are reported on the T group's final consolidated

return. See Sec. 1.338-1(e)(1).

(b) 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. (a) 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.

(b) 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.

(c) T recognizes $125 of gain on the deemed sale of the FT1

stock under paragraph (c)(3) of this section. FT1's $75 of gain on

the deemed sale of the FT2 stock is not recognized under paragraph

(c)(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). Sec. 1.338-5(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).

(d) Determination of ADSP--(1) General rule. The ADSP is the sum

of--

(i) The grossed-up basis of the purchasing corporation's recently

purchased target stock (as defined in section 338(b)(6)(A));

(ii) The liabilities of new target (including any tax liabilities

resulting from the deemed sale); and

(iii) Other relevant items.

(2) Grossed-up basis of the purchasing corporation's recently

purchased target stock. The grossed-up basis of the purchasing

corporation's recently purchased target stock is an amount equal to the

purchasing corporation's basis in recently purchased target stock,

divided by the percentage of target stock (by value) attributable to

that recently purchased target stock. If target has a single class of

outstanding stock, the grossed-up basis of the purchasing corporation's

recently purchased target stock reflects the total price the purchasing

corporation would have paid for all outstanding target stock had it

purchased all such stock for a price per share equal to the average

price per share that it paid for the recently purchased target stock.

(3) Liabilities. Liabilities taken into account are the liabilities

of new target described in Sec. 1.338(b)-1(f). The amount of the

liabilities of new target taken into account to calculate ADSP is

determined as if old target had sold its assets to an unrelated person

for consideration that included the liabilities. Thus, the ADSP takes

into account both tax credit recapture liability arising by reason of

the deemed sale and the tax liability on deemed sale gain. The ADSP

reflects the fact that deemed sale gain (loss) both increases

(decreases) the ADSP by creating (reducing) a tax liability and is

computed by reference to the ADSP.

(4) Other relevant items. Other relevant items include reductions

for acquisition costs of the purchasing corporation incurred in

connection with the qualified stock purchase that are capitalized in

the basis of recently purchased target stock (e.g., brokerage

commissions and any similar costs paid by the purchasing corporation to

acquire target stock).

(5) Calculation of deemed sale gain and loss. Deemed sale gain on

each asset is computed by reference to the ADSP. In certain cases, the

determination of the tax liability resulting from the deemed sale and

therefore the determination of the ADSP may require trial and error

computations.

(6) Other rules apply in determining ADSP. The 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 the ADSP.

(7) Cross-reference. See Sec. 1.338(b)-3T(h) for adjustments to

ADSP because of events occurring after the acquisition date and

Sec. 1.338(h)(10)-1(f) for the determination of modified ADSP.

(8) Examples. (i) For purposes of the examples in this paragraph

(d)(8), unless otherwise stated, T is a calendar year taxpayer that

files separate returns and that has no loss, tax credit, or other

carryovers to Year 1. Depreciation for Year 1 is not taken into

account. T has no liabilities other than a federal income tax liability

resulting from the deemed sale of assets, and T has no other relevant

items. 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.

(ii) This paragraph (d) may be illustrated by the following

examples:

Example 1. One class. (a) 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.

(b) The ADSP may be determined as follows. (In the formula

below, G is the grossed-up basis in P's recently purchased T stock,

L is T's liabilities other than T's tax liabilities for deemed sale

gain determined by reference to the ADSP, 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

(c) Because the ADSP for T ($87,672.72) does not exceed the fair

market value of T's asset ($100,000), a Class III 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).

(d) The facts are the same as in paragraph (a) 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 basis in P's recently

purchased T stock (G) is $75,000 ($60,000/.8). Consequently, the

ADSP and deemed sale gain are the same as in paragraphs (b) and (c)

of this Example 1.

(e) The facts are the same as in paragraph (a) of this Example

1, except that T also has goodwill (a Class IV asset) with an

appraised value of $10,000. The results are the same as in

paragraphs (b) and (c) of this Example 1. Because the ADSP does not

exceed the fair market value of the Class III asset, no amount is

allocated to goodwill.

Example 2. More than one class. (a) P purchases all of the T

stock for $140,000. On July 1 of Year 1, T has liabilities (not

including the tax liability for deemed sale gain on its assets) of

$50,000, cash (a Class I asset) of $10,000, readily marketable

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

value of $10,000, goodwill (a Class IV asset) with a basis of

$3,000, and the following Class III assets:

------------------------------------------------------------------------

Asset Basis FMV Ratio

------------------------------------------------------------------------

1. Land............................ $5,000 $35,000 .14

2. Inventory....................... 10,000 50,000 .20

3. Equipment A..................... 5,000 90,000 .36

(recomputed basis $80,000)

4. Equipment B..................... 10,000 75,000 .30

(recomputed basis $20,000)

Totals......................... $30,000 250,000 1.00

------------------------------------------------------------------------

(b) The ADSP exceeds $20,000. Thus, $10,000 of the ADSP is

allocated to the cash and $10,000 to the marketable securities.

Except as provided in section 7701(g), the amount allocated to an

asset (other than a Class IV asset) cannot exceed its fair market

value. See Sec. 1.338(b)-2T(c)(1) (relating to fair market value

limitation).

(c) The portion of the ADSP allocable to the Class III 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.)

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

(ADSPIII-BIII)]

ADSPIII = ($140,000 -($10,000+$10,000)) + $50,000 +.34 x

[($10,000-$4,000) + (ADSPIII -($5,000+$10,000+$5,000+$10,000))]

ADSPIII=$161,840+.34ADSPIII

.66ADSPIII=$161,840

ADSPIII=$245,212.12

(d) Because, under the preliminary calculation of the ADSP, the

amount to be allocated to Class I, II, and III assets does not

exceed their aggregate fair market value, no ADSP amount is

allocated to the goodwill. Accordingly, the deemed sale of the

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

ADSP allocable to the Class III assets is finally determined by

taking into account this loss as follows:

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

(ADSPIII -BIII) + (ADSPIV -BIV)]

ADSPIII = ($140,000 -($10,000+$10,000))+$50,000+.34 x

[($10,000-$4,000) + (ADSPIII -$30,000)+(0-$3,000)]

ADSPIII=$160,820+.34ADSPIII

.66ADSPIII=$160,820

ADSPIII=$243,666.67

(e) The allocation of ADSPIII among the Class III assets is

in proportion to their fair market values, as follows:

------------------------------------------------------------------------

Asset ADSP Gain

------------------------------------------------------------------------

1. Land........... $34,113.33 $29,113.33

(capital gain)

2. Inventory...... 48,733.34 38,733.34

(ordinary income)

3. Equipment A.... 87,720.00 82,720.00

(75,000 ordinary income

7,720 capital gain)

4. Equipment B.... 73,100.00 63,100.00

(10,000 ordinary income

53,100 capital gain)

Totals........ 243,666.67 213,666.67

------------------------------------------------------------------------

Example 3. More than one class. (a) The facts are the same as in

Example 2, except that P purchases the T stock for $150,000, rather

than $140,000.

(b) As in Example 2, the ADSP exceeds $20,000. Thus, $10,000 of

the ADSP is allocated to the cash and $10,000 to the marketable

securities.

(c) The portion of the ADSP allocable to the Class III assets as

preliminarily determined under the formula set forth in paragraph

(c) of Example 2 is $260,363.64. The amount allocated to the Class

III assets cannot exceed their aggregate fair market value

($250,000). Thus, preliminarily, the ADSP amount allocated to Class

III assets is $250,000.

(d)(1) Based on this 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 III

assets as III.)

ADSP = G+L+TR x [(II-BII) + (III-BIII) + (ADSP

-(I+II+III+BIV))]

ADSP = $150,000+$50,000+.34 x [($10,000-$4,000) +

($250,000-$30,000) + (ADSP -($10,000+$10,000+$250,000+$3,000))]

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

.66ADSP=$184,020

ADSP=$278,818.18

(2) Because the ADSP as determined exceeds the aggregate fair

market value of the Class I, II, and III assets, the $250,000 amount

preliminarily allocated to Class III assets is appropriate. Thus,

the amount of the ADSP allocated to Class III assets equals their

aggregate fair market value ($250,000), and the allocated ADSP

amount for each Class III asset is its fair market value. Further,

the allocable ADSP amount for the Class IV asset (goodwill) is

$8,818.18 (the excess of the ADSP over the aggregate allocable ADSP

amounts for the Class I, II, and III assets).

Example 4. Amount allocated to T1 stock. (a) The facts are the

same as in Example 2, except that T owns all of the T1 stock

(instead of the inventory), and T1's only asset is the inventory.

The T1 stock and inventory each have a fair market value of $50,000,

and the inventory 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 a

tax liability resulting from the deemed sale gain. Under paragraph

(c) of this section, T recognizes no gain or loss on its deemed sale

of T1 stock.

(b) The ADSP exceeds $20,000. Thus, $10,000 of the ADSP is

allocated to the cash and $10,000 to the marketable securities.

(c) T1 stock is purchased in the deemed sale of T assets, T does

not recognize any gain on the deemed sale of the T1 stock under

paragraph (c) of this section, and a section 338 election is made

for T1. Thus, under paragraph (b)(2) of this section, in determining

the allocation of ADSP among T's Class III assets, including the T1

stock, appropriate adjustments must be made to reflect accurately

the fair market value of the T and T1 assets. In preliminarily

calculating ADSPIII 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, ADSPIII is

$243,666.67. See paragraph (d) of Example 2.

(d) Because the portion of the preliminary ADSP allocable to

Class III assets ($243,666.67) does not exceed their aggregate fair

market value ($250,000), no amount is allocated to Class IV assets

for T. Further, this amount is allocated among T's Class III assets

in proportion to their fair market values. See paragraph (e) of

Example 2. Tentatively, $48,733.34 of this amount is allocated to

the T1 stock.

(e) 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 x ($48,733.34 - $10,000)). Thus, the ADSP

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

amount for 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 the ADSP for T1, the

grossed-up basis of T's recently purchased T1 stock is $35,564.00.

(f) The facts are the same as in paragraph (a) of this Example

5, except that the T1 inventory has a $12,500 basis and $62,500

value, the T1 stock has a $62,500 value, and T owns 80% of the T1

stock. In preliminarily calculating ADSPIII, the T1 stock can

be disregarded but, because T owns only 80% of the T1 stock, only

80% of T1 asset basis and value should be taken into account in

calculating T's ADSP. By taking into account 80% of these amounts,

the remaining calculations and results are the same as in paragraphs

(b), (c), (d), and (e) of this Example 5, except that the grossed-up

basis in T's recently purchased T1 stock is $44,455.00 ($35,564.00/

0.8).

Sec. 1.338-4 Asset and stock consistency.

(a) Introduction--(1) Overview. This section implements the

consistency rules of sections 338(e) and (f). Under this section, no

election under section 338 is deemed made or required with respect to

target or any target affiliate. Instead, the person acquiring an asset

may have a carryover basis in the asset.

(2) General application. The consistency rules generally apply if

the purchasing corporation acquires an asset directly from target

during the target consistency period and target is a subsidiary in a

consolidated group. In such a case, gain from the sale of the asset is

reflected under the investment adjustment provisions of the

consolidated return regulations in the basis of target stock and may

reduce gain from the sale of the stock. See Sec. 1.1502-32 (investment

adjustment provisions). Under the consistency rules, the purchasing

corporation generally takes a carryover basis in the asset, unless a

section 338 election is made for target. Similar rules apply if the

purchasing corporation acquires an asset directly from a lower-tier

target affiliate if gain from the sale is reflected under the

investment adjustment provisions in the basis of target stock.

(3) Extensions of the general rules. If an arrangement exists,

paragraph (f) of this section generally extends the carryover basis

rule to certain cases in which the purchasing corporation acquires

assets indirectly from target (or a lower-tier target affiliate). To

prevent avoidance of the consistency rules, paragraph (j) of this

section also may extend the consistency period or the 12-month

acquisition period and may disregard the presence of conduits.

(4) Application where certain dividends are paid. Paragraph (g) of

this section extends the carryover basis rule to certain cases in which

dividends are paid to a corporation that is not a member of the same

consolidated group as the distributing corporation. Generally, this

rule applies where a 100 percent dividends received deduction is used

in conjunction with asset dispositions to achieve an effect similar to

that available under the investment adjustment provisions of the

consolidated return regulations.

(5) Application to foreign target affiliates. Section 1.338-4T(h)

extends the carryover basis rule to certain cases involving target

affiliates that are controlled foreign corporations.

(6) Stock consistency. This section limits the application of the

stock consistency rules to cases in which the rules are necessary to

prevent avoidance of the asset consistency rules. Following the general

treatment of a section 338(h)(10) election, a sale of a corporation's

stock is treated as a sale of the corporation's assets if a section

338(h)(10) election is made. Because gain from this asset sale may be

reflected in the basis of the stock of a higher-tier target, the

carryover basis rule may apply to the assets.

(b) Consistency for direct acquisitions--(1) General rule. The

basis rules of paragraph (d) of this section apply to an asset if--

(i) The asset is disposed of during the target consistency period;

(ii) The basis of target stock, as of the target acquisition date,

reflects gain from the disposition of the asset (see paragraph (c) of

this section); and

(iii) The asset is owned, immediately after its acquisition and on

the target acquisition date, by a corporation that acquires stock of

target in the qualified stock purchase (or by an affiliate of an

acquiring corporation).

(2) Section 338(h)(10) elections. For purposes of this section, if

a section 338(h)(10) election is made for a corporation acquired in a

qualified stock purchase--

(i) The acquisition is treated as an acquisition of the

corporation's assets (see Sec. 1.338(h)(10)-1); and

(ii) The corporation is not treated as target.

(c) Gain from disposition reflected in basis of target stock. For

purposes of this section:

(1) General rule. Gain from the disposition of an asset is

reflected in the basis of a corporation's stock if the gain is taken

into account under Sec. 1.1502-32, directly or indirectly, in

determining the basis of the stock, after applying section 1503(e) and

other provisions of the Internal Revenue Code.

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

Gain from the disposition of an asset that is otherwise reflected in

the basis of target stock as of the target acquisition date is not

considered reflected in the basis of target stock if a section 338

election is made for target.

(3) Gain reflected by reason of distributions. Gain from the

disposition of an asset is not considered reflected in the basis of

target stock merely by reason of the receipt of a distribution from a

target affiliate that is not a member of the same consolidated group as

the distributee. See paragraph (g) of this section for the treatment of

dividends eligible for a 100 percent dividends received deduction.

(4) Controlled foreign corporations. For a limitation applicable to

gain of a target affiliate that is a controlled foreign corporation,

see Sec. 1.338-4T(h)(2).

(5) Gain recognized outside the consolidated group. Gain from the

disposition of an asset by a person other than target or a target

affiliate is not reflected in the basis of a corporation's stock unless

the person is a conduit, as defined in paragraph (j)(4) of this

section.

(d) Basis of acquired assets--(1) Carryover basis rule. If this

paragraph (d) applies to an asset, the asset's basis immediately after

its acquisition is, for all purposes of the Internal Revenue Code, its

adjusted basis immediately before its disposition.

(2) Exceptions to carryover basis rule for certain assets. The

carryover basis rule of paragraph (d)(1) of this section does not apply

to the following assets--

(i) Any asset disposed of in the ordinary course of a trade or

business (see section 338(e)(2)(A));

(ii) Any asset the basis of which is determined wholly by reference

to the adjusted basis of the asset in the hands of the person that

disposed of the asset (see section 338(e)(2)(B));

(iii) Any debt or equity instrument issued by target or a target

affiliate (see Sec. 1.338-4T(h)(3) for an exception relating to the

stock of a target affiliate that is a controlled foreign corporation);

(iv) Any asset the basis of which immediately after its acquisition

would otherwise be less than its adjusted basis immediately before its

disposition; and

(v) Any asset identified by the Internal Revenue Service in a

revenue ruling or revenue procedure.

(3) Exception to carryover basis rule for de minimis assets. The

carryover basis rules of this section do not apply to an asset if the

asset is not disposed of as part of the same arrangement as the

acquisition of target and the aggregate amount realized for all assets

otherwise subject to the carryover basis rules of this section does not

exceed $250,000.

(4) Mitigation rule--(i) General rule. If the carryover basis rules

of this section apply to an asset and the asset is transferred to a

domestic corporation in a transaction to which section 351 applies or

as a contribution to capital and no gain is recognized, the

transferor's basis in the stock of the transferee (but not the

transferee's basis in the asset) is determined without taking into

account the carryover basis rules of this section.

(ii) Time for transfer. This paragraph (d)(4) applies only if the

asset is transferred before the due date (including extensions) for the

transferor's income tax return for the year that includes the last date

for which a section 338 election may be made for target.

(e) Examples--(1) In general. For purposes of the examples in this

section, unless otherwise stated, the basis of each asset is the same

for determining earnings and profits and taxable income, the exceptions

to paragraph (d)(1) of this section do not apply, the taxable year of

all persons is the calendar year, and the following facts apply: S is

the common parent of a consolidated group that includes T, T1, T2, and

T3; S owns all of the stock of T and T3; and T owns all of the stock of

T1, which owns all of the stock of T2. B is unrelated to the S group

and owns all of the stock of P, which owns all of the stock of P1. Y

and Y1 are partnerships that are unrelated to the S group but may be

related to the P group. Z is a corporation that is not related to any

of the other parties.

BILLING CODE 4830-01-U

TR20JA94.000

BILLING CODE 4830-01-C

(2) Direct acquisitions. Paragraphs (b), (c), and (d) of this

section may be illustrated by the following examples:

Example 1. Asset acquired from target by purchasing corporation.

(a) On February 1 of Year 1, T sells an asset to P1 and recognizes

gain. T's gain from the disposition of the asset is taken into

account under Sec. 1.1502-32 in determining S's basis in the T

stock. On January 1 of Year 2, P1 makes a qualified stock purchase

of T from S. No section 338 election is made for T.

(b) T disposed of the asset during its consistency period, gain

from the asset disposition is reflected in the basis of the T stock

as of T's acquisition date (January 1 of Year 2), and the asset is

owned both immediately after the asset disposition (February 1 of

Year 1) and on T's acquisition date by P1, the corporation that

acquired T stock in the qualified stock purchase. Consequently,

under paragraph (b) of this section, paragraph (d)(1) of this

section applies to the asset and P1's basis in the asset is T's

adjusted basis in the asset immediately before the sale to P1.

Example 2. Gain from section 338(h)(10) election reflected in

stock basis. (a) On February 1 of Year 1, P1 makes a qualified stock

purchase of T2 from T1. A section 338(h)(10) election is made for T2

and T2 recognizes gain on each of its assets. T2's gain is taken

into account under Sec. 1.1502-32 in determining S's basis in the T

stock. On January 1 of Year 2, P1 makes a qualified stock purchase

of T from S. No section 338 election is made for T.

(b) Under paragraph (b)(2) of this section, the acquisition of

the T2 stock is treated as an acquisition of T2's assets on February

1 of Year 1, because a section 338(h)(10) election is made for T2.

The gain recognized by T2 under section 338(h)(10) is reflected in

S's basis in the T stock as of T's acquisition date. Because the

other requirements of paragraph (b) of this section are satisfied,

paragraph (d)(1) of this section applies to the assets and new T2's

basis in its assets is old T2's adjusted basis in the assets

immediately before the disposition.

Example 3. Corporation owning asset ceases affiliation with

corporation purchasing target before target acquisition date. (a) On

February 1 of Year 1, T sells an asset to P1 and recognizes gain. On

December 1 of Year 1, P disposes of all of the P1 stock while P1

still owns the asset. On January 1 of Year 2, P makes a qualified

stock purchase of T from S. No section 338 election is made for T.

(b) Immediately after T's disposition of the asset, the asset is

owned by P1 which is affiliated on that date with P, the corporation

that acquired T stock in the qualified stock purchase. However, the

asset is owned by a corporation (P1) that is no longer affiliated

with P on T's acquisition date. Although the other requirements of

paragraph (b) of this section are satisfied, the requirements of

paragraph (b)(1)(iii) of this section are not satisfied.

Consequently, the basis rules of paragraph (d) of this section do

not apply to the asset by reason of P1's acquisition.

(c) If P acquires all of the Z stock and P1 transfers the asset

to Z on or before T's acquisition date (January 1 of Year 2), the

asset is owned by an affiliate of P both on February 1 of Year 1

(P1) and on January 1 of Year 2 (Z). Consequently, all of the

requirements of paragraph (b) of this section are satisfied and

paragraph (d)(1) of this section applies to the asset and P1's basis

in the asset is T's adjusted basis in the asset immediately before

the sale to P1.

Example 4. Gain reflected in stock basis notwithstanding

offsetting loss or distribution. (a) On April 1 of Year 1, T sells

an asset to P1 and recognizes gain. In Year 1, T distributes an

amount equal to the gain. On March 1 of Year 2, P makes a qualified

stock purchase of T from S. No section 338 election is made for T.

(b) Although, as a result of the distribution, there is no

adjustment with respect to the T stock under Sec. 1.1502-32 for Year

1, T's gain from the disposition of the asset is considered

reflected in S's basis in the T stock. The gain is considered to

have been taken into account under Sec. 1.1502-32 in determining the

adjustments to S's basis in the T stock because S's basis in the T

stock is different from what it would have been had there been no

gain.

(c) If T distributes an amount equal to the gain on February 1

of Year 2, rather than in Year 1, the results would be the same

because S's basis in the T stock is different from what it would

have been had there been no gain. If the distribution in Year 2 is

by reason of an election under Sec. 1.1502-32(f)(2), the results

would be the same.

(d) If, in Year 1, T does not make a distribution and the S

group does not file a consolidated return, but, in Year 2, the S

group does file a consolidated return and makes an election under

Sec. 1.1502-32(f)(2) for T, the results would be the same. S's basis

in the T stock is different from what it would have been had there

been no gain. Paragraph (c)(3) of this section (gain not considered

reflected by reason of distributions) does not apply to the deemed

distribution under the election because S and T are members of the

same consolidated group. If T distributes an amount equal to the

gain in Year 2 and no election is made under Sec. 1.1502-32(f)(2),

the results would be the same.

(e) If, in Year 1, T incurs an unrelated loss in an amount equal

to the gain, rather than distributing an amount equal to the gain,

the results would be the same because the gain is taken into account

under Sec. 1.1502-32 in determining S's basis in the T stock.

Example 5. Gain of a target affiliate reflected in stock basis

after corporate reorganization. (a) On February 1 of Year 1, T3

sells an asset to P1 and recognizes gain. On March 1 of Year 1, S

contributes the T3 stock to T in a transaction qualifying under

section 351. On January 15 of Year 2, P1 makes a qualified stock

purchase of T from S. No section 338 election is made for T.

(b) T3's gain from the asset sale is taken into account under

Sec. 1.1502-32 in determining S's basis in the T3 stock. Under

section 358, the gain that is taken into account under Sec. 1.1502-

32 in determining S's basis in the T3 stock is also taken into

account in determining S's basis in the T stock following S's

contribution of the T3 stock to T. Consequently, under paragraph (b)

of this section, paragraph (d)(1) of this section applies to the

asset and P1's basis in the asset is T3's adjusted basis in the

asset immediately before the sale to P1.

(c) If on March 1 of Year 1, rather than S contributing the T3

stock to T, S causes T3 to merge into T in a transaction qualifying

under section 368(a)(1)(D), the results would be the same.

Example 6. Gain not reflected if election under section 338

made. (a) On February 1 of Year 1, T1 sells an asset to P1 and

recognizes gain. On January 1 of Year 2, P1 makes a qualified stock

purchase of T1 from T. A section 338 election (but not a section

338(h)(10) election) is made for T1.

(b) Under paragraph (c)(2) of this section, because a section

338 election is made for T1, T's basis in the T1 stock is considered

not to reflect gain from the disposition. Consequently, the

requirement of paragraph (b)(1)(ii) of this section is not

satisfied. Thus, P1's basis in the asset is not determined under

paragraph (d) of this section. Although the section 338 election for

T1 results in a qualified stock purchase of T2, the requirement of

paragraph (b)(1)(ii) of this section is not satisfied with respect

to T2, whether or not a section 338 election is made for T2.

(c) If, on January 1 of Year 2, P1 makes a qualified stock

purchase of T from S and a section 338 election for T, rather than

T1, S's basis in the T stock is considered not to reflect gain from

T1's disposition of the asset. However, the section 338 election for

T results in a qualified stock purchase of T1. Because the gain is

reflected in T's basis in the T1 stock, the requirements of

paragraph (b) of this section are satisfied. Consequently, P1's

basis in the asset is determined under paragraph (d)(1) of this

section unless a section 338 election is also made for T1.

(f) Extension of consistency to indirect acquisitions--(1)

Introduction. If an arrangement exists (see paragraph (j)(5) of this

section), this paragraph (f) generally extends the consistency rules to

indirect acquisitions that have the same effect as direct acquisitions.

For example, this paragraph (f) applies if, pursuant to an arrangement,

target sells an asset to an unrelated person who then sells the asset

to the purchasing corporation.

(2) General rule. This paragraph (f) applies to an asset if,

pursuant to an arrangement--

(i) The asset is disposed of during the target consistency period;

(ii) The basis of target stock as of, or at any time before, the

target acquisition date reflects gain from the disposition of the

asset; and

(iii) The asset ownership requirements of paragraph (b)(1)(iii) of

this section are not satisfied, but the asset is owned, at any time

during the portion of the target consistency period following the

target acquisition date, by--

(A) A corporation--

(1) The basis of whose stock, as of, or at any time before, the

target acquisition date, reflects gain from the disposition of the

asset; and

(2) That is affiliated, at any time during the target consistency

period, with a corporation that acquires stock of target in the

qualified stock purchase; or

(B) A corporation that at the time it owns the asset is affiliated

with a corporation described in paragraph (f)(2)(iii)(A) of this

section.

(3) Basis of acquired assets. If this paragraph (f) applies to an

asset, the principles of the basis rules of paragraph (d) of this

section apply to the asset as of the date, following the disposition

with respect to which gain is reflected in the basis of target's stock,

that the asset is first owned by a corporation described in paragraph

(f)(2)(iii) of this section. If the principles of the carryover basis

rule of paragraph (d)(1) of this section apply to an asset, the asset's

basis also is reduced (but not below zero) by the amount of any

reduction in its basis occurring after the disposition with respect to

which gain is reflected in the basis of target's stock.

(4) Examples. This paragraph (f) may be illustrated by the

following examples:

Example 1. Acquisition of asset from unrelated party by

purchasing corporation. (a) On February 1 of Year 1, T sells an

asset to Z and recognizes gain. On February 15 of Year 1, P1 makes a

qualified stock purchase of T from S. No section 338 election is

made for T. P1 buys the asset from Z on March 1 of Year 1, before Z

has reduced the basis of the asset through depreciation or

otherwise.

(b) Paragraph (b) of this section does not apply to the asset

because the asset ownership requirements of paragraph (b)(1)(iii) of

this section are not satisfied. However, the asset ownership

requirements of paragraph (f)(2)(iii) of this section are satisfied

because, during the portion of T's consistency period following T's

acquisition date, the asset is owned by P1 while it is affiliated

with T. Consequently, paragraph (f) of this section applies to the

asset if there is an arrangement for T to dispose of the asset

during T's consistency period, for the gain to be reflected in S's

basis in the T stock as of T's acquisition date, and for P1 to own

the asset during the portion of T's consistency period following T's

acquisition date. If the arrangement exists, under paragraph (f)(3)

of this section, P1's basis in the asset is determined as of March 1

of Year 1, under the principles of paragraph (d) of this section.

Consequently, P1's basis in the asset is T's adjusted basis in the

asset immediately before the sale to Z.

(c) If P1 acquires the asset from Z on January 15 of Year 2

(rather than on March 1 of Year 1), and Z's basis in the asset has

been reduced through depreciation at the time of the acquisition,

P1's basis in the asset as of January 15 of Year 2 would be T's

adjusted basis in the asset immediately before the sale to Z,

reduced (but not below zero) by the amount of the depreciation. Z's

basis and depreciation are determined without taking into account

the basis rules of paragraph (d) of this section.

(d) If P, rather than P1, acquires the asset from Z, the results

would be the same.

(e) If, on March 1 of Year 1, P1 acquires the Z stock, rather

than acquiring the asset from Z, paragraph (f) of this section would

apply to the asset if an arrangement exists. However, under

paragraph (f)(3) of this section, Z's basis in the asset would be

determined as of February 1 of Year 1, the date the asset is first

owned by a corporation (Z) described in paragraph (f)(2)(iii) of

this section. Consequently, Z's basis in the asset as of February 1

of Year 1, determined under the principles of paragraph (d) of this

section, would be T's adjusted basis in the asset immediately before

the sale to Z.

Example 2. Acquisition of asset from target by target affiliate.

(a) On February 1 of Year 1, T contributes an asset to T1 in a

transaction qualifying under section 351 and in which T recognizes

gain under section 351(b) that is deferred under Sec. 1.1502-13. On

March 1 of Year 1, P1 makes a qualified stock purchase of T from S

and, pursuant to Sec. 1.1502-13(f), the deferred gain is taken into

account by T immediately before T ceases to be a member of the S

group. No section 338 election is made for T.

(b) Paragraph (b) of this section does not apply to the asset

because the asset ownership requirements of paragraph (b)(1)(iii) of

this section are not satisfied.

(c) T1 is not described in paragraph (f)(2)(iii)(A) of this

section because the basis of the T1 stock does not reflect gain from

the disposition of the asset. Although, under section

358(a)(1)(B)(ii), T's basis in the T1 stock is increased by the

amount of the gain, the gain is not taken into account directly or

indirectly under Sec. 1.1502-32 in determining T's basis in the T1

stock.

(d) T1 is described in paragraph (f)(2)(iii)(B) of this section

because, during the portion of T's consistency period following T's

acquisition date, T1 owns the asset while it is affiliated with T, a

corporation described in paragraph (f)(2)(iii)(A) of this section.

Consequently, paragraph (f) of this section applies to the asset if

there is an arrangement. Under paragraph (j)(5) of this section, the

fact that, at the time T1 acquires the asset from T, T1 is related

(within the meaning of section 267(b)) to T indicates that an

arrangement exists.

Example 3. Acquisition of asset from target and indirect

acquisition of target stock. (a) On February 1 of Year 1, T sells an

asset to P1 and recognizes gain. On March 1 of Year 1, Z makes a

qualified stock purchase of T from S. No section 338 election is

made for T. On January 1 of Year 2, P1 acquires the T stock from Z

other than in a qualified stock purchase.

(b) The asset ownership requirements of paragraph (b)(1)(iii) of

this section are not satisfied because the asset was never owned by

Z, the corporation that acquired T stock in the qualified stock

purchase (or by a corporation that was affiliated with Z at the time

it owned the asset). However, because the asset is owned by P1 while

it is affiliated with T during the portion of T's consistency period

following T's acquisition date, paragraph (f) of this section

applies to the asset if there is an arrangement. If there is an

arrangement, the principles of the carryover basis rule of paragraph

(d)(1) of this section apply to determine P1's basis in the asset

unless Z makes a section 338 election for T. See paragraph (c)(2) of

this section.

(c) If P1 also makes a qualified stock purchase of T from Z, the

results would be the same. If there is an arrangement, the

principles of the carryover basis rule of paragraph (d)(1) of this

section apply to determine P1's basis in the asset unless Z makes a

section 338 election for T. However, these principles apply to

determine P1's basis in the asset if P1, but not Z, makes a section

338 election for T. The basis of the T stock no longer reflects, as

of T's acquisition date by P1, the gain from the disposition of the

asset.

(d) Assume Z purchases the T stock other than in a qualified

stock purchase and P1 makes a qualified stock purchase of T from Z.

Paragraph (b) of this section does not apply to the asset because

gain from the disposition of the asset is not reflected in the basis

of T's stock as of T's acquisition date (January 1 of Year 2).

However, because the gain is reflected in S's basis in the T stock

before T's acquisition date and the asset is owned by P1 while it is

affiliated with T during the portion of T's consistency period

following T's acquisition date, paragraph (f) of this section

applies to the asset if there is an arrangement. If there is an

arrangement, the principles of the carryover basis rule of paragraph

(d)(1) of this section apply to determine P1's basis in the asset

even if P1 makes a section 338 election for T. The basis of the T

stock no longer reflects, as of T's acquisition date, the gain from

the disposition of the asset.

Example 4. Asset acquired from target affiliate by corporation

that becomes its affiliate. (a) On February 1 of Year 1, T1 sells an

asset to P1 and recognizes gain. On February 15 of Year 1, Z makes a

qualified stock purchase of T from S. No section 338 election is

made for T. On June 1 of Year 1, P1 acquires the T1 stock from T,

other than in a qualified stock purchase.

(b) The asset ownership requirements of paragraph (b)(1)(iii) of

this section are not satisfied because the asset was never owned by

Z, the corporation that acquired T stock in the qualified stock

purchase (or by a corporation that was affiliated with Z at the time

it owned the asset).

(c) P1 is not described in paragraph (f)(2)(iii)(A) of this

section because gain from the disposition of the asset is not

reflected in the basis of the P1 stock.

(d) P1 is described in paragraph (f)(2)(iii)(B) of this section

because the asset is owned by P1 while P1 is affiliated with T1

during the portion of T's consistency period following T's

acquisition date. T1 becomes affiliated with Z, the corporation that

acquired T stock in the qualified stock purchase, during T's

consistency period, and, as of T's acquisition date, the basis of

T1's stock reflects gain from the disposition of the asset.

Consequently, paragraph (f) of this section applies to the asset if

there is an arrangement.

Example 5. De minimis rules. (a) On February 1 of Year 1, T

sells an asset to P and recognizes gain. On February 15 of Year 1,

T1 sells an asset to Z and recognizes gain. The aggregate amount

realized by T and T1 on their respective sales of assets is not more

than $250,000. On March 1 of Year 1, T3 sells an asset to P and

recognizes gain. On April 1 of Year 1, P makes a qualified stock

purchase of T from S. No section 338 election is made for T. On June

1 of Year 1, P1 buys from Z the asset sold by T1.

(b) Under paragraph (b) of this section, the basis rules of

paragraph (d) of this section apply to the asset sold by T. Under

paragraph (f) of this section, the principles of the basis rules of

paragraph (d) of this section apply to the asset sold by T1 if there

is an arrangement. Because T3's gain is not reflected in the basis

of the T stock, the basis rules of this section do not apply to the

asset sold by T3.

(c) The de minimis rule of paragraph (d)(3) of this section

applies to an asset if the asset is not disposed of as part of the

same arrangement as the acquisition of T and the aggregate amount

realized for all assets otherwise subject to the carryover basis

rules does not exceed $250,000. The aggregate amount realized by T

and T1 does not exceed $250,000. (The asset sold by T3 is not taken

into account for purposes of the de minimis rule.) Thus, the de

minimis rule applies to the asset sold by T if the asset is not

disposed of as part of the same arrangement as the acquisition of T.

(d) If, under paragraph (f) of this section, the principles of

the carryover basis rules of paragraph (d)(1) of this section

otherwise apply to the asset sold by T1 because of an arrangement,

the de minimis rules of this section do not apply to the asset

because of the arrangement.

(e) Assume on June 1 of Year 1, Z acquires the T1 stock from T,

other than in a qualified stock purchase, rather than P1 buying the

T1 asset, and paragraph (f) of this section applies because there is

an arrangement. Because the asset was disposed of and the T1 stock

was acquired as part of the arrangement, the de minimis rules of

this section do not apply to the asset.

(g) Extension of consistency if dividends qualifying for 100

percent dividends received deduction are paid--(1) General rule for

direct acquisitions from target. Unless a section 338 election is made

for target, the basis rules of paragraph (d) of this section apply to

an asset if--

(i) Target recognizes gain (whether or not deferred) on disposition

of the asset during the portion of the target consistency period that

ends on the target acquisition date;

(ii) The asset is owned, immediately after the asset disposition

and on the target acquisition date, by a corporation that acquires

stock of target in the qualified stock purchase (or by an affiliate of

an acquiring corporation); and

(iii) During the portion of the target consistency period that ends

on the target acquisition date, the aggregate amount of dividends paid

by target, to which section 243(a)(3) applies, exceeds the greater of--

(A) $250,000; or

(B) 125 percent of the yearly average amount of dividends paid by

target, to which section 243(a)(3) applies, during the three calendar

years immediately preceding the year in which the target consistency

period begins (or, if shorter, the period target was in existence).

(2) Other direct acquisitions having same effect. The basis rules

of paragraph (d) of this section also apply to an asset if the effect

of a transaction described in paragraph (g)(1) of this section is

achieved through any combination of disposition of assets and payment

of dividends to which section 243(a)(3) applies (or any other dividends

eligible for a 100 percent dividends received deduction). See

Sec. 1.338-4T(h)(4) for additional rules relating to target affiliates

that are controlled foreign corporations.

(3) Indirect acquisitions. The principles of paragraph (f) of this

section also apply for purposes of this paragraph (g).

(4) Examples. This paragraph (g) may be illustrated by the

following examples:

Example 1. Asset acquired from target paying dividends to which

section 243(a)(3) applies. (a) The S group does not file a

consolidated return. In Year 1, Year 2, and Year 3, T pays dividends

to S to which section 243(a)(3) applies of $200,000, $250,000, and

$300,000, respectively. On February 1 of Year 4, T sells an asset to

P and recognizes gain. On January 1 of Year 5, P makes a qualified

stock purchase of T from S. No section 338 election is made for T.

During the portion of T's consistency period that ends on T's

acquisition date, T pays S dividends to which section 243(a)(3)

applies of $1,000,000.

(b) Under paragraph (g)(1) of this section, paragraph (d) of

this section applies to the asset. T recognizes gain on disposition

of the asset during the portion of T's consistency period that ends

on T's acquisition date, the asset is owned by P immediately after

the disposition and on T's acquisition date, and T pays dividends

described in paragraph (g)(1)(iii) of this section. Consequently,

under paragraph (d)(1) of this section, P's basis in the asset is

T's adjusted basis in the asset immediately before the sale to P.

(c) If T is a controlled foreign corporation, the results would

be the same if T pays dividends in the amount described in paragraph

(g)(1)(iii) of this section that qualify for a 100 percent dividends

received deduction. See sections 243(e) and 245.

(d) If S and T3 file a consolidated return in which T, T1, and

T2 do not join, the results would be the same because the dividends

paid by T are still described in paragraph (g)(1)(iii) of this

section.

(e) If T, T1, and T2 file a consolidated return in which S and

T3 do not join, the results would be the same because the dividends

paid by T are still described in paragraph (g)(1)(iii) of this

section.

Example 2. Asset disposition by target affiliate achieving same

effect. (a) The S group does not file a consolidated return. On

February 1 of Year 1, T2 sells an asset to P and recognizes gain. T

pays dividends to S described in paragraph (g)(1)(iii) of this

section. On January 1 of Year 2, P makes a qualified stock purchase

of T from S. No section 338 election is made for T.

(b) Paragraph (g)(1) of this section does not apply to the asset

because T did not recognize gain on the disposition of the asset.

However, under paragraph (g)(2) of this section, because the asset

disposition by T2 and the dividends paid by T achieve the effect of

a transaction described in paragraph (g)(1) of this section, the

carryover basis rule of paragraph (d)(1) of this section applies to

the asset. The effect was achieved because T2 is a lower-tier

affiliate of T and the dividends paid by T to S reduce the value to

S of T and its lower-tier affiliates.

(c) If T2 is a controlled foreign corporation, the results would

be the same because T2 is a lower-tier affiliate of T and the

dividends paid by T to S reduce the value to S of T and its lower-

tier affiliates.

(d) If P buys an asset from T3, rather than T2, the asset

disposition and the dividends do not achieve the effect of a

transaction described in paragraph (g)(1) of this section because T3

is not a lower-tier affiliate of T. Thus, the basis rules of

paragraph (d) of this section do not apply to the asset. The results

would be the same whether or not P also acquires the T3 stock

(whether or not in a qualified stock purchase).

Example 3. Dividends by target affiliate achieving same effect.

(a) The S group does not file a consolidated return. On February 1

of Year 1, T1 sells an asset to P and recognizes gain. On January 1

of Year 2, P makes a qualified stock purchase of T from S. No

section 338 election is made for T. T does not pay dividends to S

described in paragraph (g)(1)(iii) of this section. However, T1 pays

dividends to T that would be described in paragraph (g)(1)(iii) of

this section if T1 were a target.

(b) Paragraph (g)(1) of this section does not apply to the asset

because T did not recognize gain on the disposition of the asset and

did not pay dividends described in paragraph (g)(1)(iii) of this

section. Further, paragraph (g)(2) of this section does not apply

because the dividends paid by T1 to T do not reduce the value to S

of T and its lower-tier affiliates.

(c) If both S and T own T1 stock and T1 pays dividends to S that

would be described in paragraph (g)(1)(iii) of this section if T1

were a target, paragraph (g)(2) of this section would apply because

the dividends paid by T1 to S reduce the value to S of T and its

lower-tier affiliates. If T, rather than T1, sold the asset to P,

the results would be the same. Further, if T and T1 pay dividends to

S that, only when aggregated, would be described in paragraph

(g)(1)(iii) of this section (if they were all paid by T), the

results would be the same.

Example 4. Gain reflected by reason of dividends. (a) S and T

file a consolidated return in which T1 and T2 do not join. On

February 1 of Year 1, T1 sells an asset to P and recognizes gain. On

January 1 of Year 2, P makes a qualified stock purchase of T from S.

No section 338 election is made for T. T1 pays dividends to T that

would be described in paragraph (g)(1)(iii) of this section if T1

were a target.

(b) The requirements of paragraph (b) of this section are not

satisfied because, under paragraph (c)(3) of this section, gain from

T1's sale is not reflected in S's basis in the T stock by reason of

the dividends paid by T1 to T.

(c) Although the dividends paid by T1 to T do not reduce the

value to S of T and its lower-tier affiliates, paragraph (g)(2) of

this section applies because the dividends paid by T1 to T are taken

into account under Sec. 1.1502-32 in determining S's basis in the T

stock. Consequently, the carryover basis rule of paragraph (d)(1) of

this section applies to the asset.

(h) Special rules for controlled foreign corporations. [Reserved]

(i) [Reserved]

(j) Anti-avoidance rules. For purposes of this section--

(1) Extension of consistency period. The target consistency period

is extended to include any continuous period that ends on, or begins

on, any day of the consistency period during which a purchasing

corporation, or any person related, within the meaning of section

267(b) or 707(b)(1), to a purchasing corporation, has an arrangement--

(i) To purchase stock of target; or

(ii) To own an asset to which the carryover basis rules of this

section apply, taking into account the extension.

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

12-month acquisition period is extended if, pursuant to an arrangement,

a corporation acquires by purchase stock of another corporation

satisfying the requirements of section 1504(a)(2) over a period of more

than 12 months.

(3) Acquisitions by conduits--(i) Asset ownership--(A) General

rule. A corporation is treated as owning any portion of an asset

attributed to the corporation from a conduit under section 318(a)

(treating any asset as stock for this purpose), for purposes of--

(1) The asset ownership requirements of this section; and

(2) Determining whether a controlled foreign corporation is a

target affiliate for purposes of Sec. 1.338-4T(h).

(B) Application of carryover basis rule. If the basis rules of this

section apply to the asset, the basis rules of this section apply to

the entire asset (not just the portion for which ownership is

attributed).

(ii) Stock acquisitions--(A) Purchase by conduit. A corporation is

treated as purchasing stock of another corporation attributed to the

corporation from a conduit under section 318(a) on the day the stock is

purchased by the conduit. The corporation is not treated as purchasing

the stock, however, if the conduit purchased the stock more than two

years before the date the stock is first attributed to the corporation.

(B) Purchase of conduit by corporation. If a corporation purchases

an interest in a conduit (treating the interest as stock for this

purpose), the corporation is treated as purchasing on that date any

stock owned by a conduit on that date and attributed to the corporation

under section 318(a) with respect to the interest in the conduit that

was purchased.

(C) Purchase of conduit by conduit. If a conduit (the first

conduit) purchases an interest in a second conduit (treating the

interest as stock for this purpose), the first conduit is treated as

purchasing on that date any stock owned by a conduit on that date and

attributed to the first conduit under section 318(a) with respect to

the interest in the second conduit that was purchased.

(4) Conduit. A person (other than a corporation) is a conduit as to

a corporation if--

(i) The corporation would be treated under section 318(a)(2)(A) and

(B) (attribution from partnerships, estates, and trusts) as owning any

stock owned by the person; and

(ii) The corporation, together with its affiliates, would be

treated as owning an aggregate of at least 50 percent of the stock

owned by the person.

(5) Existence of arrangement. The existence of an arrangement is

determined under all the facts and circumstances. For an arrangement to

exist, there need not be an enforceable, written, or unconditional

agreement, and all the parties to the transaction need not have

participated in each step of the transaction. One factor indicating the

existence of an arrangement is the participation of a related party.

For this purpose, persons are related if they are related within the

meaning of section 267(b) or 707(b)(1).

(6) Predecessor and successor--(i) Persons. A reference to a person

(including target, target affiliate, and purchasing corporation)

includes, as the context may require, a reference to a predecessor or

successor. For this purpose, a predecessor is a transferor or

distributor of assets to a person (the successor) in a transaction--

(A) To which section 381(a) applies; or

(B) In which the successor's basis for the assets is determined,

directly or indirectly, in whole or in part, by reference to the basis

of the transferor or distributor.

(ii) Assets. A reference to an asset (the first asset) includes, as

the context may require, a reference to any asset the basis of which is

determined, directly or indirectly, in whole or in part, by reference

to the first asset.

(7) Examples. This paragraph (j) may be illustrated by the

following examples:

Example 1. Asset owned by conduit treated as owned by purchaser

of target stock. (a) P owns a 60-percent interest in Y. On March 1

of Year 1, T sells an asset to Y and recognizes gain. On January 1

of Year 2, P makes a qualified stock purchase of T from S. No

section 338 election is made for T.

(b) Under paragraph (j)(4) of this section, Y is a conduit with

respect to P. Consequently, under paragraph (j)(3)(i)(A) of this

section, P is treated as owning 60% of the asset on March 1 of Year

1 and January 1 of Year 2. Because P is treated as owning part or

all of the asset both immediately after the asset disposition and on

T's acquisition date, paragraph (b) of this section applies to the

asset. Consequently, paragraph (d)(1) of this section applies to the

asset and Y's basis in the asset is T's adjusted basis in the asset

immediately before the sale to Y.

Example 2. Corporation whose stock is owned by conduit treated

as affiliate. (a) P owns an 80-percent interest in Y. Y owns all of

the stock of Z. On March 1 of Year 1, T sells an asset to Z and

recognizes gain. On January 1 of Year 2, P makes a qualified stock

purchase of T from S. No section 338 election is made for T.

(b) Under paragraph (j)(4) of this section, Y is a conduit with

respect to P. Consequently, under paragraph (j)(3)(i)(A) of this

section, P is treated as owning 80% of the Z stock and Z is

therefore treated as an affiliate of P for purposes of applying the

asset ownership requirements of paragraph (b)(1)(iii) of this

section. Because Z, an affiliate of P, owns the asset both

immediately after the asset disposition and on T's acquisition date,

paragraph (b) of this section applies to the asset, and the asset's

basis is determined under paragraph (d) of this section.

(c) If, instead of owning an 80-percent interest in Y, P owned a

79-percent interest in Y, Z would not be treated as an affiliate of

P and paragraph (b) of this section would not apply to the asset.

Example 3. Qualified stock purchase by reason of stock purchase

by conduit. (a) P owns a 90-percent interest in Y. Y owns a 60-

percent interest in Y1. On February 1 of Year 2, T sells an asset to

P and recognizes gain. On January 1 of Year 3, P purchases 70% of

the T stock from S and Y1 purchases the remaining 30% of the T stock

from S.

(b) Under paragraph (j)(3)(ii)(A) of this section, P is treated

as purchasing on January 1 of Year 3, the 16.2% of the T stock that

is attributed to P from Y and Y1 under section 318(a). Thus, for

purposes of this section, P is treated as making a qualified stock

purchase of T on January 1 of Year 3, paragraph (b) of this section

applies to the asset, and the asset's basis is determined under

paragraph (d) of this section. However, because P is not treated as

having made a qualified stock purchase of T for purposes of making

an election under section 338, no election can be made for T.

(c) If Y1 purchases 20% of the T stock from S on December 1 of

Year 1, rather than 30% on January 1 of Year 3, P would be treated

as purchasing 10.8% of the T stock on December 1 of Year 1. Thus, if

paragraph (j)(2) of this section (relating to extension of the 12-

month acquisition period) does not apply, P would not be treated as

making a qualified stock purchase of T, because P is not treated as

purchasing T stock satisfying the requirements of section 1504(a)(2)

within a 12-month period.

Example 4. Successor asset. (a) On February 1 of Year 1, T sells

stock of X to P1 and recognizes gain. On December 1 of Year 1, P1

exchanges its X stock for stock in new X in a reorganization

qualifying under section 368(a)(1)(F). On January 1 of Year 2, P1

makes a qualified stock purchase of T from S. No section 338

election is made for T.

(b) The asset ownership requirements of paragraph (b)(1)(iii) of

this section are satisfied because, under paragraph (j)(6)(ii) of

this section, P1 is treated as owning the X stock on T's acquisition

date. P1 is treated as owning the X stock on that date because P1

owns the new X stock and P1's basis in the new X stock is determined

by reference to P1's basis in the X stock. Consequently, under

paragraph (d)(1) of this section, P1's basis in the X stock on

February 1 of Year 1 is T's adjusted basis in the X stock

immediately before the sale to P1.

Sec. 1.338-5 International aspects of section 338.

(a) Scope. This section provides guidance regarding international

aspects of section 338. As provided in Sec. 1.338-1(c)(14), a foreign

corporation, a DISC, or a corporation for which a section 936 election

has been made is considered a target affiliate for all purposes of

section 338. In addition, stock described in section 338(h)(6)(B)(ii)

held by a target affiliate is not excluded from the operation of

section 338.

(b) Application of section 338 to foreign targets--(1) In general.

For purposes of subtitle A, the deemed sale gain, as defined in

Sec. 1.338-3(b)(4), of a foreign target for which a section 338

election is made (FT), and the corresponding earnings and profits, are

taken into account in determining the taxation of FT and FT's direct

and indirect shareholders. See, however, section 338(h)(16). For

example, the income and earnings and profits of FT are determined, for

purposes of sections 551, 951, 1248, and 1293, by taking into account

the deemed sale gain.

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

transfers FT stock to the purchasing corporation on FT's acquisition

date is considered to own the transferred stock at the close of FT's

acquisition date. See, e.g., Sec. 1.951-1(f) (relating to determination

of holding period for purposes of sections 951 through 964). If on the

acquisition date the purchasing corporation owns a block of FT stock

that was acquired before FT's acquisition date, the purchasing

corporation is considered to own such block of stock at the close of

the acquisition date.

(3) Carryover FT stock--(i) Definition. FT stock is carryover FT

stock if--

(A) FT was a controlled foreign corporation within the meaning of

section 957 (taking into account section 953(c)) at any time during the

portion of the 12-month acquisition period that ends on the acquisition

date; and

(B) Such stock is owned as of the beginning of the day after FT's

acquisition date by a person other than a purchasing corporation, or by

a purchasing corporation if the stock is nonrecently purchased and is

not subject to a gain recognition election under Sec. 1.338(b)-1(e)(2).

(ii) Carryover of earnings and profits. The earnings and profits of

old FT (and associated foreign taxes) attributable to the carryover FT

stock (adjusted to reflect deemed sale gain) carry over to new FT

solely for purposes of--

(A) Characterizing an actual distribution with respect to a share

of carryover FT stock as a dividend;

(B) Characterizing gain on a post-acquisition date transfer of a

share of carryover FT stock as a dividend under section 1248 (if such

section is otherwise applicable);

(C) Characterizing an investment of earnings in United States

property as income under sections 951(a)(1)(B) and 956 (if such

sections are otherwise applicable); and

(D) Determining foreign taxes deemed paid under sections 902 and

960 with respect to the amount treated as a dividend or income by

virtue of this paragraph (b)(3)(ii) (subject to the operation of

section 338(h)(16)).

(iii) Cap on carryover of earnings and profits. The amount of

earnings and profits of old FT taken into account with respect to a

share of carryover FT stock is limited to the amount that would have

been included in gross income of the owner of such stock as a dividend

under section 1248 if--

(A) The shareholder transferred that share to the purchasing

corporation on FT's acquisition date for a consideration equal to the

fair market value of that share on that date; or

(B) In the case of nonrecently purchased FT stock treated as

carryover FT stock, a gain recognition election under section

338(b)(3)(A) applied to that share. For purposes of the preceding

sentence, a shareholder that is a controlled foreign corporation is

considered to be a United States person, and the principle of section

1248(c)(2)(D)(ii) (concerning a United States person's indirect

ownership of stock in a foreign corporation) applies in determining the

correct holding period.

(iv) Post-acquisition date distribution of old FT earnings and

profits. A post-acquisition date distribution with respect to a share

of carryover FT stock is considered to be derived first from earnings

and profits derived after FT's acquisition date and then from earnings

and profits derived on or before FT's acquisition date.

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

deficits. The carryover amount for a share of carryover FT stock is not

reduced by deficits in earnings and profits incurred by new FT. This

rule applies for purposes of determining the amount of foreign taxes

deemed paid regardless of the fact that there are no accumulated

earnings and profits. For example, a distribution by new FT with

respect to a share of carryover FT stock is treated as a dividend by

the distributee to the extent of the carryover amount for that share

notwithstanding that new FT has no earnings and profits.

(vi) Character of FT stock as carryover FT stock eliminated upon

disposition. A share of FT stock is not considered carryover FT stock

after it is disposed of provided that all gain realized on the transfer

is recognized at the time of the transfer, or that, if less than all of

the realized gain is recognized, the recognized amount equals or

exceeds the remaining carryover amount for that share.

(4) Passive foreign investment company stock. Stock that is owned

as of the beginning of the day after FT's acquisition date by a person

other than a purchasing corporation, or by a purchasing corporation if

the FT stock is nonrecently purchased stock not subject to a gain

recognition election under Sec. 1.338(b)-1(e)(2), is treated as passive

foreign investment company stock to the extent provided in section

1297(b)(1).

(c) Dividend treatment under section 1248(e). The principles of

this paragraph (b) apply to shareholders of a domestic corporation

subject to section 1248(e).

(d) Allocation of foreign taxes. If a section 338 election is made

for target (whether foreign or domestic), and target's taxable year

under foreign law (if any) does not close at the end of the acquisition

date, foreign income taxes attributable to the foreign taxable income

earned by target during such foreign taxable year are allocated to old

target and new target. Such allocation is made under the principles of

Sec. 1.1502-76(b).

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

(f) Examples. (1) Except as otherwise provided, all corporations

use the calendar year as the taxable year, have no earnings and profits

(or deficit) accumulated for any taxable year, and have only one class

of outstanding stock.

(2) This section may be illustrated by the following examples:

Example 1. Gain recognition election for carryover FT stock. (a)

A has owned 90 of the 100 shares of CFCT stock since CFCT was

organized on March 13, 1989. P has owned the remaining 10 shares of

CFCT stock since CFCT was organized. Those 10 shares constitute

nonrecently purchased stock in P's hands within the meaning of

section 338(b)(6)(B). On November 1, 1994, P purchases A's 90 shares

of CFCT stock for $90,000 and makes a section 338 election for CFCT.

P also makes a gain recognition election under section 338(b)(3)(A)

and Sec. 1.338(b)-1(e)(2).

(b) CFCT's earnings and profits for its short taxable year

ending on November 1, 1994, are $50,000, determined without taking

into account the deemed asset sale. Assume A recognizes gain of

$81,000 on the sale of the CFCT stock. Further, assume that CFCT

recognizes gain of $40,000 by reason of its deemed sale of assets

under section 338(a)(1).

(c) A's sale of CFCT stock to P is a transfer to which section

1248 and paragraphs (b) (

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