Reorganizations; Receipt of Securities

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-249819-96]

RIN 1545-AU67

Reorganizations; Receipt of Securities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the

receipt, as part of a reorganization, of rights to acquire stock of a

corporation that is a party to the reorganization. This document also

provides notice of a public hearing on these regulations.

DATES: Written comments must be received by March 24, 1997. Requests to

appear and outlines of topics to be discussed at the public hearing

scheduled for March 25, 1997, must be received by March 4, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R [REG-249819-96], room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

[REG-249819-96], Courier's Desk, Internal Revenue Service, 1111

Constitution Avenue NW., Washington, DC., or, electronically, via the

IRS Internet site at: http://www.irs.ustreas.gov/prod/tax_regs/

comments.html.

The public hearing will be held in the Commissioner's Conference

Room, room 3313, 1111 Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,

Michael J. Danbury, (202) 622-7750; concerning submissions and the

public hearing, Evangelista Lee at (202) 622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Background

A. General Information

This document contains proposed amendments to the Income Tax

Regulations (26 CFR part 1) under sections 354, 355, and 356 of the

Internal Revenue Code of 1986 (Code), relating to exchanges of stock

and securities in certain reorganizations. In particular, the proposed

regulations address the receipt, as part of a reorganization, of rights

to acquire stock of a corporation that is a party to the

reorganization.

Section 354 generally provides for the nonrecognition of gain or

loss from the exchange of stock or securities in a corporation that is

a party to a reorganization for stock or securities in the same

corporation or in another corporation that is a party to the

reorganization. Gain realized on an exchange of securities is not

recognized provided that the principal amount of the securities

received does not exceed the principal amount of any securities

surrendered pursuant to the plan of reorganization.

Section 355 provides for the nonrecognition of gain or loss upon a

distribution by a corporation with respect to its stock of stock in a

controlled corporation, or an exchange of securities in a controlled

corporation for its securities. As in the case of a transaction

described in section 354, gain realized on an exchange of securities is

not recognized provided that the principal amount of the securities

received does not exceed the principal amount of the securities

surrendered pursuant to the plan of reorganization.

Section 356 provides rules for recognition of gain, but not loss,

if a shareholder or security holder receives nonqualifying property

(i.e., boot) as well as qualifying property in a transaction to which

section 354 or 355 would otherwise apply. In particular, realized gain

is recognized in an amount not in excess of the fair market value of

the excess principal amount of the securities received over the

principal amount of any securities surrendered as part of the plan of

reorganization.

[[Page 67509]]

B. Existing Regulations

Existing regulations under sections 354 and 355 provide that stock

rights and stock warrants are not included in the term ``stock or

securities.'' Prior to the promulgation of these regulations in 1955,

the treatment of such instruments was unclear. Although the Supreme

Court had held that stock warrants do not constitute ``stock'' for

purposes of determining whether a transaction is a reorganization, the

Board of Tax Appeals had held that stock warrants did constitute

``securities'' for purposes of section 112(b)(3) of the 1932 Act (a

predecessor to section 354 of the Code). Compare Helvering v. Southwest

Consolidated Corp., 315 U.S. 194 (1942), with Raymond v. Commissioner,

37 B.T.A. 423 (1938).

Since 1955, courts have avoided concluding whether stock rights or

stock warrants constitute ``securities'' for purposes of sections 354

and 355. See, e.g., Carlberg v. United States, 281 F.2d 507, 509 n.3

(8th Cir. 1960); Bateman v. Commissioner, 40 T.C. 408 (1963); Estate of

Smith v. Commissioner, 63 T.C. 722 (1975).

C. Reasons for Change

A purpose of the reorganization provisions of the Code is to defer

the recognition of gain and loss in certain readjustments of corporate

structure. Generally, the Code extends nonrecognition to an exchange of

stock which effects only a readjustment of continuing interest in

modified corporate form. Although a right to acquire stock is not

stock, the IRS and Treasury believe that it may generally represent a

form of investment in the capital structure of the corporation that

justifies nonrecognition treatment as a security under sections 354 and

355. Other provisions of the Code expressly acknowledge the role that

stock rights play in the capital structure of a corporation. See, e.g.,

sections 317 and 1032. Accordingly, the proposed regulations provide

that for purposes of sections 354 and 355 the term securities includes

``rights to acquire stock'' issued by a corporation that is a party to

a reorganization.

Explanation of Provisions

A. Scope of Proposed Rules

The proposed regulations treat rights to acquire stock issued by a

corporation that is a party to a reorganization as securities of the

corporation. For this purpose, the term ``rights to acquire stock'' of

an issuing corporation has the same meaning as the term has in sections

305(d)(1) and 317(a). It does not include rights exercisable against

persons other than the issuer of the stock, or rights that relate to

property other than stock of the issuer of the rights. As under current

law, a conversion privilege contained in a stock or debt instrument

generally will not be considered a separate property right received as

part of the reorganization. See Rev. Rul. 69-265 (1969-1 C.B. 109).

B. Consequences Upon Receipt of Stock Rights

For purposes of sections 354, 355 and 356, the proposed regulations

treat rights to acquire stock as securities having no principal amount.

As a result, a taxpayer will not be required to recognize any gain

under section 356 upon the receipt of a stock right. This will

generally be the case regardless of whether the taxpayer surrenders

stock, stock rights, or debt securities.

C. Effect on Other Authorities

The proposed rules apply only for the purpose of determining the

amount of gain to be recognized in connection with exchanges occurring

pursuant to transactions otherwise qualifying under section 368 or 355.

They do not address issues concerning the qualification of a

transaction under section 368 or 355. For example, the proposed rules

do not permit rights to acquire stock to be taken into account in

determining continuity of shareholder interest. See Southwest

Consolidated Corp. (stock options are not stock).

The proposed rules have no effect on other Code provisions

governing the treatment of stock options or similar interests for other

purposes. Thus, for example, the treatment of an instrument under these

rules is not relevant in determining whether the holder of the

instrument is treated as holding stock of the issuer for various

purposes. See, e.g., sections 318(a)(4), 382(k)(6), and 1504(a)(5).

Similarly, an instrument treated as a stock right under these rules may

be subject to special rules under other provisions of the Code or

regulations relating to compensation related stock options. See, e.g.,

sections 83 and 421-424 and the regulations thereunder. Nor is any

inference intended as to the treatment of an exchange, substitution, or

assumption of such options under current law.

D. Proposed Effective Dates

The proposed regulations change a long-standing regulatory

position. To afford taxpayers the opportunity to plan for the change,

these regulations are proposed to be effective 60 days after the

Treasury decision adopting these rules as final regulations is filed

with the Office of the Federal Register.

E. Comments Regarding Need for Further Guidance

Comments are requested as to whether additional guidance is needed

with respect to the scope of these regulations and the general

treatment of rights to acquire stock. For example, comments are invited

with respect to: the need for additional guidance or special rules to

address transactions involving exchanges, substitutions, or assumptions

of compensation related stock options; the application of section 306

to the transfer of a right to acquire common stock if the right is

received tax-free pursuant to section 305 or 354; whether section 302

should apply to the cash settlement or repurchase of a stock right, for

example by treating the holder as having purchased the stock pursuant

to the terms of the right and the issuer as having then redeemed that

stock for cash; and any other administrative guidance which may be

helpful in light of these proposed rules, including suggestions as to

existing revenue rulings or revenue procedures that should be modified,

reconsidered, or revoked. Note that comments outside of the scope of

these regulations will be considered as suggestions for other future

guidance.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It has also

been determined that section 553(b) of the Administrative Procedure Act

(5 U.S.C. chapter 5) does not apply to these regulations. Because the

regulation does not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Pursuant to section 7805(f) of the Code, this notice of proposed

rulemaking will be submitted to the Chief Counsel for Advocacy of the

Small Business Administration for comment on its impact on small

business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any comments submitted timely (in the

manner described under the ADDRESSES caption) to the IRS. All comments

will be available for public inspection and copying.

A public hearing is scheduled for March 25, 1997, at 10 a.m., in

the Commissioner's Conference Room, room

[[Page 67510]]

3313. Because of access restrictions, visitors will not be admitted

beyond the Internal Revenue Building lobby more than 15 minutes before

the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons who wish to present oral comments at the hearing must

submit an outline of the topics to be discussed by March 4, 1997.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is David B. Friedel,

formerly of the Office of Assistant Chief Counsel (Corporate). However,

other personnel from the IRS and Treasury Department participated in

their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

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

Par 2. Section 1.354-1 is amended by revising paragraph (e) to read

as follows:

Sec. 1.354-1 Exchanges of stock and securities in certain

reorganizations.

* * * * *

(e) For purposes of section 354, the term securities includes

rights issued by a party to the reorganization (the issuing

corporation) to acquire its stock. For purposes of this section and

section 356(d)(2)(B), a right to acquire stock has no principal amount.

This paragraph (e) applies to exchanges occurring on or after the day

that is 60 days after the Treasury decision adopting these regulations

is filed with the Federal Register.

Par 3. Section 1.355-1 is amended by removing the last sentence of

paragraph (b) and adding paragraph (c) to read as follows:

Sec. 1.355-1 Distribution of stock and securities of a controlled

corporation.

* * * * *

(c) Stock rights. For purposes of section 355, the term securities

includes rights to acquire the stock of the distributing corporation or

the controlled corporation (the issuing corporation). For purposes of

this section and section 356(d)(2)(B), a right to acquire stock has no

principal amount. This paragraph (c) applies to distributions occurring

on or after the day that is 60 days after the Treasury decision

adopting these regulations is filed with the Federal Register.

Par 4. Section 1.356-3 is amended by:

1. Redesignating existing paragraph (b) as paragraph (c).

2. Adding a new paragraph (b) to read as follows:

Sec. 1.356-3 Rules for treatment of securities as ``other property''.

* * * * *

(b) For purposes of this section, a right to acquire stock of the

issuing corporation is treated as a security with no principal amount.

Thus, such right is not other property when received in a transaction

to which section 356 applies (regardless of whether securities are

surrendered in the exchange). This paragraph (b) applies to

transactions occurring on or after the day that is 60 days after the

Treasury decision adopting these regulations is filed with the Federal

Register.

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 96-32040 Filed 12-20-96; 8:45 am]

BILLING CODE 4830-01-U