Guidance Under Section 1032 Relating to the Treatment of a Disposition by One Corporation of the Stock of Another Corporation in a Taxable Transaction

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106221-98]

RIN 1545-AW53

Guidance Under Section 1032 Relating to the Treatment of a

Disposition by One Corporation of the Stock of Another Corporation in a

Taxable Transaction

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

treatment of a disposition by a corporation (the acquiring corporation)

of the stock of another corporation (the issuing corporation) in a

taxable transaction. The proposed regulations interpret section 1032 of

the Internal Revenue Code. The proposed regulations affect corporations

and their subsidiaries.

DATES: Written comments must be received by December 22, 1998. Requests

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

scheduled for Thursday, January 7, 1999 must be received by Thursday,

December 17, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106221-98), room

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

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-106221-98), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting the ``Tax Regs'' option on

the IRS Home Page, or by submitting comments directly to the IRS

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

comments.html. The public hearing will be held in room 2615, Internal

Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Lee A.

Dean, (202) 622-7550; concerning submissions and the hearing, LaNita

VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 1032(a) provides that no gain or loss shall be recognized

to a corporation on the receipt of money or other property in exchange

for stock (including treasury stock) of such corporation. No gain or

loss shall be recognized by a corporation with respect to any lapse or

acquisition of an option to buy or sell its stock (including treasury

stock).

Before the enactment of section 1032 in 1954, Treasury regulations

provided that ``where a corporation deals in its own shares as it might

in the shares of another corporation, the resulting gain or loss is to

be computed in the same manner as though the corporation were dealing

in the shares of another.'' (Treas. Reg. 111, Sec. 29.22(a)-15 (1934)).

As applied, this regulation resulted in the recognition of gain or

loss on the disposition by a corporation of its treasury stock, even

though the corporation would not have recognized gain or loss on the

disposition of newly issued shares. See, e.g., Firestone Tire & Rubber

Co. v. Commissioner, 2 T.C. 827 (1943). This disparity of treatment

gave rise to tax avoidance possibilities. A corporation expecting a

gain upon disposition of treasury shares might avoid such gain by

canceling its treasury shares and issuing new stock, whereas a

corporation might produce a fictitious loss by purchasing its own

shares and reselling them at a lower price.

Congress enacted section 1032(a) in 1954 to eliminate this

potential disparity between the tax treatment of a disposition by a

corporation of its treasury stock and a disposition of newly issued

stock. H.R. No. 1337, 83d Cong., 2d Sess. 268 (1954).

Rev. Rul. 74-503 (1974-2 C.B. 117) considers the tax consequences

of a parent corporation's transfer to its subsidiary of its own

treasury stock in a transaction to which section 351 applies. The

ruling states that ``[t]he transfer of [parent] stock was not for the

purpose of enabling [the subsidiary corporation] to acquire property by

the use of such stock.'' Rev. Rul. 74-503 holds that, since the basis

of previously unissued parent stock in the hands of the parent

corporation is zero, the basis of the parent corporation's treasury

stock in the hands of the parent corporation is also zero. Accordingly,

under the transferred basis rule of section 362(a), the subsidiary

corporation's basis of the treasury stock of the parent corporation is

also zero (the zero basis result).

Section 1.1032-2(b), applicable to certain triangular

reorganizations occurring on or after December 23, 1994, eliminates

gain recognition in certain cases when an acquiring corporation (S)

acquires property or stock of another corporation (T) in exchange for

stock of the corporation (P) in control of S. Section 1.1032-2(b)

provides that, ``For purposes of Sec. 1.1032-1(a), in the case of a

forward triangular merger, a triangular C reorganization, or a

triangular B reorganization (as described in Sec. 1.358-6(b)), P stock

provided by P to S, or directly to T or T's shareholders on behalf of

S, pursuant to the plan of reorganization is treated as a disposition

by P of its own stock for T's assets or stock, as applicable.'' Section

1.1032-2(c) provides that S must recognize gain or loss on its exchange

of P stock if S did not receive the P stock pursuant to the plan of

reorganization.

Section 1.1502-13(f)(6)(ii), initially published as temporary

regulations applicable to transactions occurring on or after July 12,

1995 (TD 8598, 1995-2 C.B. 188), eliminates gain recognition under

certain conditions on a member's disposition of the stock of its common

parent. If the requirements of that section are satisfied, Sec. 1.1502-

13(f)(6)(ii) provides that ``If a member, M, would otherwise recognize

gain on a qualified disposition of P stock, then immediately before the

qualified disposition, M is treated as purchasing the P stock from P

for fair market value with cash contributed to M by P (or, if

necessary, through any intermediate members).'' Among other

requirements, the member must, pursuant to a plan, transfer the stock

``immediately to a nonmember that is not related.'' See Sec. 1.1502-

13(f)(6)(ii)(B). The preamble to the temporary regulations explains

that the gain relief provisions ``prevent taxpayers from being subject

to inappropriate taxation on gains in certain transactions.'' (TD 8598,

1995-2 C.B. 188, 189.)

Section 83 provides rules for property, including parent's stock,

transferred in connection with the performance of services. Section

83(h) provides, in part, that ``there shall be allowed as a deduction

under section 162, to the person for whom were performed the services

in connection with which such property was transferred, an amount equal

to the amount included * * * in the gross income of the person who

performed such services.'' Section 1.83-6(b) provides that ``[e]xcept

as provided in section 1032, at the time of the transfer of property in

connection with the performance of services the transferor recognizes

gain to the extent that the transferor receives an amount that exceeds

the transferor's basis in the property.'' Section 1.83-6(d) provides

[[Page 50817]]

that, ``[i]f a shareholder of a corporation transfers property to an

employee of such corporation * * * in consideration of services

performed for the corporation, the transaction shall be considered to

be a contribution of such property to the capital of such corporation

by the shareholder, and immediately thereafter a transfer of such

property by the corporation to the employee. * * * .''

Rev. Rul. 80-76 (1980-1 C.B. 15) addresses the use of a parent

corporation's stock as compensation to an employee of a subsidiary

corporation. Under the facts, A, a shareholder of P, transfers P stock

directly to B, an employee of S. The ruling holds in part that,

``because section 83 applies to the transfer of P stock to B, S does

not recognize gain or loss on the transfer of the P stock.''

Explanation of Provisions

Some of the concerns that ultimately led to the enactment of

section 1032 are present where a subsidiary corporation holds the stock

of a parent corporation. For example, a parent corporation could place

treasury stock in a subsidiary corporation in order to attempt to

recognize losses if the price of the parent corporation stock goes

down, or could sell shares directly if the price rises. See Rev. Rul.

74-503 (1974-2 C.B. 117). The zero basis result limits such planning

opportunities.

These tax avoidance possibilities are not present, however, in

transactions where one corporation transfers its own stock to another

corporation pursuant to a plan by which the second corporation

immediately transfers the stock of the first corporation to acquire

money or other property. The risk of selective loss recognition does

not arise where the stock of the parent corporation is used immediately

by the subsidiary corporation to acquire money or other property and

therefore does not have sufficient time to depreciate in value. This

concept is reflected in Rev. Rul. 74-503, which provides a factual

carve-out for transfers of parent corporation stock made for the

purpose of enabling a subsidiary corporation to acquire property. Also,

the IRS and the Treasury have not applied the zero basis result in such

integrated transactions, regardless of whether such a disposition of

stock is part of a tax-free reorganization or is part of a taxable

acquisition. See Secs. 1.1502-13(f)(6)(ii) and 1.1032-2(b). These

proposed regulations provide that no gain or loss is recognized in

certain taxable transactions where one corporation immediately disposes

of the stock of another corporation pursuant to a plan to acquire money

or other property. The IRS and Treasury believe that, in such

transactions, the nonapplicability of the zero basis result avoids

inappropriate gain recognition and is consistent with the purposes of

section 1032. No inference is intended regarding the applicability of

the zero basis result to transactions outside of the scope of these

proposed regulations.

If the conditions of these proposed regulations are satisfied, no

gain or loss is recognized on the disposition of the stock of one

corporation (the issuing corporation) by another corporation (the

acquiring corporation). The proposed regulations apply if, pursuant to

a plan to acquire money or other property, (1) the acquiring

corporation acquires stock of the issuing corporation directly or

indirectly from the issuing corporation in a transaction in which, but

for this section, the basis of the stock of the issuing corporation in

the hands of the acquiring corporation would be determined with respect

to the issuing corporation's basis in the issuing corporation's stock

under section 362(a); (2) the acquiring corporation immediately

transfers the stock of the issuing corporation to acquire money or

other property; and (3) no party receiving stock of the issuing

corporation from the acquiring corporation receives a substituted basis

in the stock of the issuing corporation within the meaning of section

7701(a)(42). For purposes of this section, ``property'' includes

services. See Sec. 1.1032-1.

Mechanics of Proposed Regulations

These proposed regulations adopt the cash purchase model used in

Sec. 1.1502-13(f)(6)(ii) to provide relief from gain.

In transactions to which the proposed regulations apply,

immediately before the disposition of the issuing corporation's stock,

the acquiring corporation is treated as purchasing the issuing

corporation's stock from the issuing corporation for fair market value

with cash contributed to the acquiring corporation by the issuing

corporation (or, if necessary, through intermediate corporations).

As a result of this deemed cash purchase of stock, the acquiring

corporation will have a fair market value basis in the issuing

corporation's stock pursuant to section 1012, and the issuing

corporation will increase its basis in the stock of the acquiring

corporation (and, if necessary, the stock basis of intermediate

corporations) by that amount. See, e.g., section 358.

No inference is intended regarding whether circular cash flows

would be respected apart from this regulation. Similarly, no inference

is intended with respect to other methods of avoiding gain on the

acquiring corporation's use of the issuing corporation's stock.

A cross-reference in Sec. 1.83-6(d) to the proposed regulations

clarifies that the mechanics of the proposed regulations--rather than

the mechanics of Sec. 1.83-6(d)--apply to a corporate shareholder's

transfer of its own stock to any person in consideration of services

performed for another corporation where the conditions of these

proposed regulations are satisfied.

The cash purchase model of these proposed regulations preserves the

acquiring corporation's deduction under section 162 for the use of the

issuing corporation's stock to compensate the acquiring corporation's

employees. In addition, as in Rev. Rul. 80-76, the cash purchase model

of these proposed regulations provides that the acquiring corporation

will not recognize gain or loss on the transfer of the stock of the

issuing corporation. The proposed regulations provide that the cash

purchase model is applicable only when the acquiring corporation

immediately transfers the stock of the issuing corporation to acquire

money or other property. The IRS and the Treasury believe that these

proposed regulations address the same issues as in Rev. Rul. 80-76 and,

when issued in final form, will render Rev. Rul. 80-76 obsolete.

Stock Options

Section 1032(a), in conjunction with the rules governing the

taxation of options, also operates to prevent selective loss

recognition in the case where a corporation issues options to buy or

sell its own stock. See Deficit Reduction Act of 1984, H.R. Rep. No.

432, 98th Cong., 2d. Sess. pt. 2 1196 (1984) (expanding section 1032(a)

to provide that a corporation does not recognize gain or loss with

respect to any lapse or acquisition of an option to buy or sell its

stock, including treasury stock). As in the case of a subsidiary

corporation's dealings in parent corporation stock, however, section

1032 may not always prevent selective loss recognition where a

subsidiary corporation deals in options on parent corporation stock.

Again, the zero basis result serves to limit such planning

opportunities.

The Treasury and the IRS have determined that the concerns

underlying section 1032 are not present where the issuing corporation

transfers options on its own stock to the acquiring corporation

pursuant to a plan by which the acquiring corporation immediately

transfers those options to acquire money or other property.

Accordingly, these proposed regulations

[[Page 50818]]

apply to an option issued by an issuing corporation to buy or sell its

own stock in the same manner as they apply to stock of an issuing

corporation.

Amendment to Sec. 1.1032-2

The preamble to the final regulations under Sec. 1.1032-2 states

that the tax treatment of a disposition by the acquiring corporation

(S) of stock options of the corporation (P) in control of S was beyond

the scope of the project. (Preamble to Final Regulations under sections

358, 1032 and 1502 [TD 8648, 1996-1 C.B. 37, 39].) The IRS and the

Treasury believe that the tax treatment of stock options of the issuing

corporation in these triangular reorganizations also should be

addressed under section 1032. Accordingly, these proposed regulations

amend Sec. 1.1032-2 to provide that Sec. 1.1032-2 shall apply to an

option to buy or sell P stock issued by P in the same manner as that

section applies to the stock of P.

Proposed Effective Date

The regulations are proposed to be effective on the date that final

regulations are published in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 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, and 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 Internal Revenue 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 written comments (preferably a

signed original and eight copies) that are timely submitted to the IRS.

All comments will be available for public inspection and copying.

A public hearing has been scheduled for Thursday, January 7, 1999

beginning at 10 a.m., in room 2615, Internal Revenue Building, 1111

Constitution Avenue, NW., Washington, DC. 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

request to speak, and submit an outline of topics to be discussed and

the time to be devoted to each topic by Thursday, December 17, 1998.

A period of ten minutes will be allocated 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 proposed regulations is Lee A. Dean

of the Office of the Assistant Chief Counsel (Corporate), IRS. 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 1.83-6 is amended by adding two sentences to the

end of paragraph (d)(1) to read as follows:

Sec. 1.83-6 Deduction by employer.

* * * * *

(d)(1) * * * For special rules that may apply to a corporate

shareholder's transfer of its own stock to any person in consideration

of services performed for another corporation, see Sec. 1.1032-3. The

preceding sentence applies to transfers of stock occurring on or after

the date these regulations are published as final regulations in the

Federal Register.

* * * * *

Par. 3. Section 1.1032-2 is amended by:

1. Revising paragraph (e);

2. Adding paragraph (f).

The addition and revision read as follows:

Sec. 1.1032-2 Disposition by a corporation of stock of a controlling

corporation in certain triangular reorganizations.

* * * * *

(e) Stock options. The rules of this section shall apply to an

option to buy or sell P stock issued by P in the same manner as the

rules of this section apply to P stock.

(f) Effective dates. This section applies to triangular

reorganizations occurring on or after December 23, 1994. Paragraph (e)

applies to transfers of stock options occurring on or after the date

these regulations are published as final regulations in the Federal

Register.

Par. 4. Section 1.1032-3 is added to read as follows:

Sec. 1.1032-3 Disposition of stock or stock options in certain

transactions not qualifying under any other nonrecognition provision.

(a) Scope. This section provides rules for certain transactions in

which one corporation (the acquiring corporation) acquires money or

other property (as defined in Sec. 1.1032-1) in exchange, in whole or

in part, for stock of another corporation (the issuing corporation).

(b) General rule. In a transaction to which this section applies,

no gain or loss is recognized on the disposition of the issuing

corporation's stock by the acquiring corporation. The transaction is

treated as if, immediately before the acquiring corporation disposes of

the stock of the issuing corporation, the acquiring corporation

purchased the issuing corporation's stock from the issuing corporation

for fair market value with cash contributed to the acquiring

corporation by the issuing corporation (or, if necessary, through

intermediate corporations).

(c) Applicability. The rules of this section apply only if,

pursuant to a plan to acquire money or other property--

(1) The acquiring corporation acquires stock of the issuing

corporation directly or indirectly from the issuing corporation in a

transaction in which, but for this section, the basis of the stock of

the issuing corporation in the hands of the acquiring corporation would

be determined with respect to the issuing corporation's basis in the

issuing corporation's stock under section 362(a);

(2) The acquiring corporation immediately transfers the stock of

the issuing corporation to acquire money or other property; and

(3) No party receiving stock of the issuing corporation from the

acquiring corporation receives a substituted basis in the stock of the

issuing corporation within the meaning of section 7701(a)(42).

(d) Stock options. The rules of this section shall apply to an

option issued by a corporation to buy or sell its own stock in the same

manner as the rules of this section apply to the stock of an issuing

corporation.

[[Page 50819]]

(e) Examples. The following examples illustrate the application of

this section:

Example 1. (i) X, a corporation, owns all of the stock of Y

corporation. Y reaches an agreement with A, an individual, to

acquire a truck from A in exchange for 10 shares of X stock with a

fair market value of $100. To effectuate Y's agreement with A, X

transfers to Y the X stock in a transaction in which, but for this

section, the basis of the X stock in the hands of Y would be

determined with respect to X's basis in the X stock under section

362(a). Y immediately transfers the X stock to A to acquire the

truck.

(ii) In this Example 1, no gain or loss is recognized on the

disposition of the X stock by Y. Immediately before Y's disposition

of the X stock, Y is treated as purchasing the X stock from X for

$100 of cash contributed to Y by X.

Example 2. (i) Assume the same facts as Example 1, except that,

rather than X stock, X transfers an option with a fair market value

of $100 to buy X stock.

(ii) In this Example 2, no gain or loss is recognized on the

disposition of the X stock option by Y. Immediately before Y's

disposition of the X stock option, Y is treated as purchasing the X

stock option from X for $100 of cash contributed to Y by X.

Example 3. (i) X, a corporation, owns all of the outstanding

stock of Y corporation. A, an individual, is an employee of Y.

Pursuant to an agreement between X and Y to compensate A for

services provided to Y, X transfers to A 10 shares of X stock with a

fair market value of $100. Under Sec. 1.83-6(d), but for this

section, the transfer of X stock by X to A would be treated as a

contribution of the X stock by X to the capital of Y, and

immediately thereafter, a transfer of the X stock by Y to A. But for

this section, the basis of the X stock in the hands of Y would be

determined with respect to X's basis in the X stock under section

362(a).

(ii) In this Example 3, no gain or loss is recognized on the

deemed disposition of the X stock by Y. Immediately before Y's

deemed disposition of the X stock, Y is treated as purchasing the X

stock from X for $100 of cash contributed to Y by X.

Example 4. (i) X, a corporation, issues 10 shares of X stock

subject to a substantial risk of forfeiture to compensate Y's

employee, A, for services. A does not have an election under section

83(b) in effect with respect to the X stock. X retains a

reversionary interest in the X stock in the event that A forfeits

the right to the stock. At the time the stock vests, the 10 shares

of X stock have a fair market value of $100. Under Sec. 1.83-6(d),

but for this section, the transfer of the X stock by X to A would be

treated, at the time the stock vests, as a contribution of the X

stock by X to the capital of Y, and immediately thereafter, a

disposition of the X stock by Y to A. The basis of the X stock in

the hands of Y, but for this section, would be determined with

respect to X's basis in the X stock under section 362(a).

(ii) In this Example 4, no gain or loss is recognized on the

deemed disposition of X stock by Y when the stock vests. mmediately

before Y's deemed disposition of the X stock, Y is treated as

purchasing X's stock from X for $100 of cash contributed to Y by X.

Example 5. (i) Assume the same facts as in Example 4, except

that Y (rather than X) retains a reversionary interest in the X

stock in the event that A forfeits the right to the stock. Several

years after X's transfer of the X shares, the stock vests.

(ii) This section does not apply to Y's deemed disposition of

the X shares. For the tax consequences to Y on the deemed

disposition of the X stock, see Sec. 1.83-6(b).

(f) Effective date. This section applies to transfers of stock or

stock options of the issuing corporation occurring on or after the date

these regulations are published as final regulations in the Federal

Register.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 98-25342 Filed 9-22-98; 8:45 am]

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