# Revision of Section 338 Consistency Rules.

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## Record

- **Collection:** Federal Register
- **Document type:** Uncategorized Document
- **Published:** January 20, 1994

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A94-665. Public record. Not legal advice.