Guidance Under Section 355(e); Recognition of Gain on Certain Distributions of Stock or Securities in Connection With an Acquisition

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-116733-98]

RIN 1545-AW79

Guidance Under Section 355(e); Recognition of Gain on Certain

Distributions of Stock or Securities in Connection With an Acquisition

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

recognition of gain on certain distributions of stock or securities of

a controlled corporation in connection with an acquisition. Changes to

the applicable law were made by the Taxpayer Relief Act of 1997. These

proposed regulations affect corporations and are necessary to provide

them with guidance needed to comply with these changes. This document

also provides notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by January 5,

2000. Outlines of topics to be discussed at the public hearing

scheduled for January 26, 2000, at 10 a.m. must be received by January

5, 2000.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-116733-98), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-

116733-98), 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/tax__regs/

regslist.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 proposed regulations,

Brendan O'Hara, (202) 622-7530; concerning submissions of comments,

delivering comments, the hearing, and/or to be placed on the building

access list to attend the hearing, LaNita Van Dyke, (202) 622-7190 (not

toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. State of the Law Before Section 355(e)

Section 355 generally provides that, if a corporation distributes

to its shareholders stock of a corporation which it controls

immediately before the distribution and certain other conditions are

met, neither the distributing corporation nor its shareholders

recognize gain or loss. A number of the conditions for tax free

treatment (for example, the continuity of interest requirement of

Sec. 1.355-2(c), the ``no device'' requirement of section 355(a)(1)(B),

the five-year active business requirement of section 355(b), and the

limitation on disqualified stock under section 355(d)) operate to limit

the circumstances in which the distributing or controlled corporation

can undergo changes of control in conjunction with a distribution that

qualifies for corporate and shareholder-level nonrecognition under

section 355. Nevertheless, prior to the enactment of section 355(e), it

was possible for such changes to occur, for example, in the context of

tax free reorganizations, while qualifying for tax free treatment under

section 355. See, e.g., Commissioner v. Mary Archer W. Morris Trust,

367 F.2d 794 (4th Cir. 1966).

B. Legislative Proposals Leading to Section 355(e)

As part of its Fiscal Year 1997 Budget, the Administration proposed

a provision that would require a distributing corporation to recognize

gain on the distribution of a controlled

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corporation's stock unless the direct and indirect shareholders of the

distributing corporation, as a group, controlled at least 50 percent of

the vote and value of both corporations at all times during the 4-year

period beginning 2 years before the distribution. See Department of the

Treasury, General Explanation of the Administration's Revenue

Proposals, p. 86 (March 1996) (hereinafter referred to as the

``Administration Proposal''). Under the Administration Proposal, the

retained 50-percent interest must consist of ``permissible stock,''

which includes, in addition to stock retained over the 4-year period,

stock of the distributing or controlled corporation ``received by the

shareholder in a transaction which is unrelated to the distribution * *

*.'' Revenue Proposals Contained in President Clinton's Budget Plan as

Released on Mar. 19, 1996, Sec. 9522, [1996] 83 Stand. Fed. Tax Rep.

(CCH) No. 15A.

The Administration Proposal described an unrelated transaction as,

``[a] transaction that is not pursuant to a common plan or arrangement

that includes the distribution,'' and cited a hostile acquisition of

the distributing or controlled corporation commencing after the

distribution as an example of an unrelated transaction. The

Administration Proposal contrasted this with a friendly acquisition,

which generally would be considered related to the distribution if the

acquisition was pursuant to an arrangement negotiated prior to the

distribution, even if the acquisition was subject to various conditions

at the time of the distribution.

On April 17, 1997, House Ways and Means Committee Chairman Archer

and Senate Finance Committee Chairman Roth and Ranking Member Moynihan

introduced identical bills (H.R. 1365, 105th Cong. (1997) and S. 612,

105th Cong. (1997), hereinafter referred to as the ``Bills'') that

provided for a new section 355(e) that is similar to the enacted

version. The Bills were concerned with a ``plan (or series of related

transactions) pursuant to which a person acquires stock representing a

50-percent or greater interest in the distributing corporation or any

controlled corporation * * *.'' S. 612, 105th Cong. (1997). The

introductory statement to the legislation contained a reference to

acquisitions ``pursuant to a plan or arrangement in existence on the

date of distribution * * *.'' The statement further explained:

``Whether a corporation is acquired would be determined under rules

similar to those of present-law section 355(d), except that

acquisitions would not be restricted to purchase transactions. Thus an

acquisition would occur if a person--or persons acting in concert--* *

* acquired * * * stock * * * pursuant to a plan or arrangement.'' See

143 Cong. Rec. E703 (Apr. 17, 1997) (introductory statement of Chairman

Archer); 143 Cong. Rec. S3360 (Apr. 17, 1997) (introductory statement

of Chairman Roth).

C. Enactment of Section 355(e)

Section 355(e) was enacted in 1997. Public Law 105-34, section

1012(a) (1997). The committee reports state that section 355 was

intended to permit the tax free division of existing business

arrangements among existing shareholders. The reports state that ``[i]n

cases in which it is intended that new shareholders will acquire

ownership of a business in connection with a spin off, the transaction

more closely resembles a corporate level disposition of the portion of

the business that is acquired'' and provide that gain is recognized

``if, pursuant to a plan or arrangement in existence on the date of

distribution, either the controlled or distributing corporation is

acquired * * *.'' H.R. Rep. No. 105-148, at 462 (1997); see also S.

Rep. No. 105-33, at 139-40 (1997) (slight variation in language). The

Conference Report adds, ``[a]s under the House bill and Senate

amendment, a public offering of sufficient size can result in an

acquisition that causes gain recognition under the provision.'' H.R.

Conf. Rep. No. 105-220, at 533 (1997).

The statute as enacted contained two important changes from the

Administration Proposal and Bills relevant to determining whether an

acquisition is part of a plan (or series of related transactions) that

includes the distribution. In the Bills, proposed sections

355(e)(2)(A)(ii) and (4)(C)(i) provided that a ``person,'' as modified

by section 355(d)(7), must acquire 50 percent or more of the

distributing or controlled corporation. The term ``plan or

arrangement'' used in section 355(d)(7)(B) treats two or more persons

acting ``pursuant to a plan or arrangement'' with regard to a stock

acquisition as one person. However, when section 355(e) was enacted,

the reference in section 355(e)(2)(A)(ii) to acquisitions by a

``person'' was changed to ``1 or more persons.'' In addition, the

reference to section 355(d)(7)(B) (treating two or more persons acting

``pursuant to a plan or arrangement'' as one person) was deleted from

section 355(e)(4)(C)(i). The effect of these two changes is to remove

the requirement that 50 percent or more of the stock of the

distributing or controlled corporation must be acquired by acquirors

acting in concert for section 355(e) to apply.

In addition, the reference in the Conference Report to public

offerings as transactions that could cause gain to be recognized under

section 355(e) indicates Congress did not believe negotiations between

the distributing corporation and an acquiror were necessary in order

for an acquisition to be pursuant to a plan that included the

distribution. Thus, to determine whether a plan of acquisition exists,

one must look at all parties to the transaction, including the

distributing and controlled corporations and their shareholders, not

just the potential acquirors.

As enacted, section 355(e)(1) provides that the stock of a

controlled corporation will not be qualified property under section

355(c)(2) or section 361(c)(2) if, under section 355(e)(2)(A), the

stock is distributed as ``part of a plan (or series of related

transactions) pursuant to which 1 or more persons acquire directly or

indirectly stock representing a 50-percent or greater interest in the

distributing corporation or any controlled corporation.'' Thus, if

section 355(e)(1) applies to a distribution, the distributing

corporation is taxed on the amount by which the distributed stock's

fair market value exceeds its basis. Distributee shareholders receive

the controlled corporation stock tax free, but do not increase their

bases to reflect the corporate level gain recognized by the

distributing corporation on the distribution.

Explanation of Provisions

The proposed regulations under section 355(e) provide guidance

concerning the interpretation of the phrase ``plan (or series of

related transactions).'' The proposed regulations also address the

determination of the distributing corporation's gain when multiple

controlled corporations are distributed and the distributions are part

of a plan (or series of related transactions) pursuant to which a 50-

percent or greater interest in one or more, but not all, of the

distributed controlled corporations is acquired. The Department of the

Treasury and the IRS plan to issue regulations addressing other issues

arising under section 355(e), including aggregation and attribution

rules (including provisions for public trading) and the administration

of the statute of limitations provision of section 355(e)(4)(E).

Comments concerning the proposed regulations and additional

[[Page 46157]]

issues that should be addressed in regulations are welcome.

A. Plan or Series of Related Transactions

Whether two transactions are part of the same ``plan (or series of

related transactions)'' under section 355(e)(2)(A) is a subjective

test, depending ultimately on the intentions and expectations of the

relevant parties. As discussed above, indications are that Congress

intended ``plan (or series of related transactions)'' to be interpreted

broadly. Unlike the Administration Proposal and the Bills, which

utilized the section 355(d) concept of ``a person'' (with aggregation)

as the reference for relevant acquirors, the statute, as enacted,

expanded the universe of transactions to which section 355(e)

potentially applies by providing that the relevant acquirors could be

``1 or more persons.'' Also, the guidance in the Conference Report that

public offerings of a sufficient size could trigger section 355(e)

suggests that there does not necessarily have to be an identified

acquiror on the date of the distribution for section 355(e) to apply,

nor is the intent of the acquiror at the time of the distribution

necessarily relevant in determining whether there is a plan.

The proposed regulations rely on a variety of factors to determine

the existence of a plan (or series of related transactions)

(hereinafter referred to as a ``plan''). These factors include the

business purpose or purposes for the distribution; the intentions of

the parties; the existence of agreements, understandings, arrangements,

or substantial negotiations; the timing of the transactions; the

likelihood of an acquisition; and the causal connection between the

distribution and the acquisition.

Congress specified one factor, temporal proximity, as affecting the

determination of whether a plan exists. Specifically, section

355(e)(2)(B) provides a presumption that a plan exists if ``1 or more

persons acquire directly or indirectly stock representing a 50-percent

or greater interest in the distributing corporation or any controlled

corporation during the 4-year period beginning on the date which is 2

years before the date of the distribution.'' Accordingly, the proposed

regulations provide that distributions within 2 years of an acquisition

of the distributing corporation or a controlled corporation are

presumed to be part of a plan. The proposed regulations outline the

elements the distributing corporation must establish to rebut the

statutory presumption.

1. Acquisitions On or After a Distribution

General Rebuttal

In the case of an acquisition occurring within 2 years after a

distribution, the proposed regulations allow the distributing

corporation to rebut the presumption by establishing by clear and

convincing evidence that (i) the distribution was motivated in whole or

substantial part by a corporate business purpose (other than an intent

to facilitate an acquisition or decrease the likelihood of the

acquisition of one or more businesses by separating those businesses

from others that are likely to be acquired) and (ii) the acquisition

occurred more than 6 months after the distribution and there was no

agreement, understanding, arrangement, or substantial negotiations

concerning the acquisition at the time of the distribution or within 6

months thereafter. Decreasing ``the likelihood of the acquisition of

one or more businesses by separating those businesses from others that

are likely to be acquired'' generally refers to transactions in which

one business, a perceived takeover target, is separated from another

via a stock distribution in an attempt to spare the other business from

acquisition. Distributions intended to ``decrease the likelihood of the

acquisition of one or more businesses by separating those businesses

from others that are likely to be acquired'' are often difficult to

differentiate from those intended to ``facilitate an acquisition.''

Both relate to a perceived possibility of acquisition and should

receive similar treatment.

In this general rebuttal, the proposed regulations rely on

corporate business purpose as a key factor indicating whether a

distribution and an acquisition are part of a plan. Corporate business

purpose is an important concept in the overall administration of

section 355. The existence of a nonacquisition related corporate

business purpose that prompted, in whole or substantial part, the

distributing corporation to make the stock distribution suggests there

is not a significant causal connection between the distribution and

acquisition. The intent of the distributing corporation, the controlled

corporation, or the controlling shareholders of either the distributing

or controlled corporation to facilitate an acquisition or decrease the

likelihood of the acquisition of one or more businesses by separating

those businesses from others that are likely to be acquired is relevant

in determining the extent to which the distribution was motivated in

whole or substantial part by another corporate business purpose within

the meaning of Sec. 1.355-2. Analyzing whether there is another

substantial corporate business purpose for the distribution in light of

an acquisition-related purpose is similar to analyzing whether there is

a corporate business purpose for a distribution in light of the

potential avoidance of federal taxes. See Sec. 1.355-2(b)(1) and (5),

Example 8. Thus, another business purpose must be real and substantial

even in light of the acquisition business purpose.

The reliance on business purpose in the general rebuttal is

consistent with the suggestions of many commentators writing about

section 355(e), who identified corporate business purpose as an

important factor in determining whether an acquisition and distribution

are part of a plan.

Alternative Rebuttal

Reliance on a substantial nonacquisition business purpose as proof

of no ``plan'' is appropriate when the distribution and acquisition are

separated by a sufficient amount of time. Thus, the general rebuttal is

not satisfied in certain cases, including where an acquisition occurs

within 6 months after a distribution or where a distribution was not

substantially motivated by a corporate business purpose other than an

intention to facilitate (or decrease the likelihood of) an acquisition.

These acquisitions occur in circumstances more likely to indicate the

existence of a plan at the time of the distribution. Thus, these

acquisitions are subject to heightened scrutiny and will be considered

part of a plan unless taxpayers satisfy a more stringent alternative

rebuttal.

Unlike the general rebuttal, a nonacquisition business purpose

alone is not sufficient under the alternative rebuttal. Rather,

taxpayers must satisfy all prongs of a three-prong test.

The first prong of the alternative rebuttal may be satisfied in

either of two ways. The distributing corporation must establish by

clear and convincing evidence either that (i) at the time of the

distribution, the distributing corporation, the controlled corporation,

and their controlling shareholders did not intend that one or more

persons would acquire a 50-percent or greater interest in the

distributing or any controlled corporation during the statutory

presumption period (or later pursuant to an agreement, understanding,

or arrangement existing at the time of the distribution or within 6

months thereafter) or (ii) the distribution was not motivated in whole

or substantial part by an intention to

[[Page 46158]]

facilitate an acquisition of an interest in the distributing or

controlled corporation. Clause (i) may be satisfied even in situations

where one or more of the relevant parties intend that the distribution

will facilitate an acquisition or acquisitions, so long as the parties

do not intend that there be a 50-percent or greater change in ownership

during the statutory presumption period. Alternatively, clause (ii) may

be satisfied where the parties intend a 50-percent or greater change in

ownership during the presumption period, provided that the parties do

not intend that the distribution will facilitate any part of the

acquisitions.

Under the second prong of the alternative rebuttal, the

distributing corporation must establish by clear and convincing

evidence that, at the time of the distribution, neither the

distributing corporation, the controlled corporation, nor their

controlling shareholders reasonably would have anticipated that it was

more likely than not that one or more persons would acquire a 50-

percent or greater interest in the distributing corporation or the

controlled corporation within 2 years after the distribution (or later

pursuant to an agreement, understanding, or arrangement existing at the

time of the distribution or within 6 months thereafter) who would not

have acquired such interests if the distribution had not occurred.

This prong of the alternative rebuttal (hereinafter referred to as

the ``reasonable anticipation'' test) incorporates two important

concepts. First, it identifies reasonably anticipated acquisitions of

the distributing or controlled corporation that would not have occurred

but for the distribution and, because a causal connection exists

between the two transactions, treats them as part of a plan. Second, it

reflects the idea that reasonable anticipation, not just the presence

of negotiations, is important in determining whether a plan exists.

Considering reasonable anticipation of certain acquisitions is

consistent with the legislative history. Though descriptions of the

Administration Proposal included references to negotiations and

distinctions between hostile and friendly acquisitions, the focus of

section 355(e), as enacted, is whether a relationship exists between

the distribution and the fact that persons other than the existing

shareholders became owners of the distributing or controlled

corporation.

A reasonable anticipation standard is necessary to implement

section 355(e). Otherwise, a distributing corporation could attempt to

avoid section 355(e) by distributing a controlled corporation under

circumstances that virtually assure an acquisition of the distributing

or controlled corporation, but arguing that, despite the imminence of

the acquisition, effectuating the acquisition was not a motive for the

distribution. A part of planning any transaction includes attempting to

foresee actions others might take in response. Consistent with this

business practice, it is appropriate, especially for acquisitions

subject to heightened scrutiny, to require the distributing corporation

to take into account the reasonably anticipated, likely actions of

others to demonstrate that a distribution and acquisition are not part

of a plan.

The second prong of the alternative rebuttal is not satisfied if,

at the time of the distribution, the relevant parties would reasonably

anticipate that the distribution would give rise to all of an

acquisition of a 50 percent interest in the distributing or controlled

corporation. (The rebuttal is satisfied if the distributing corporation

establishes by clear and convincing evidence that the relevant parties

would not reasonably anticipate an acquisition of a 50 percent or

greater interest by persons who would not acquire such interests absent

the distribution.) This standard is to be contrasted with the first

prong of the rebuttal, which is not satisfied if one or more of the

relevant parties intended that there be a 50 percent or greater

acquisition of distributing or controlled during the applicable time

period, and the distribution is intended to facilitate all or any part

of that acquisition. Because some acquisitions might be reasonably

anticipated to occur without regard to whether the distribution takes

place, the Department of the Treasury and the IRS believe that the

distribution must be directly linked to all 50 percent of the

acquisition to fail the ``reasonable anticipation'' test. However, a

different result is called for where the relevant parties intend a 50

percent acquisition. In that case, it would appear that the aggregation

of the various acquisitions comprising the 50 percent acquisition are

themselves part of a single plan, so a distribution intended to

facilitate only some of those acquisitions would be part of a plan also

involving those other acquisitions not directly facilitated by the

acquisition.

In developing the reasonable anticipation test, the Department of

the Treasury and the IRS rejected suggestions by some commentators that

serious negotiations or agreement with an acquiror need to have taken

place at the time of distribution for a plan to exist. Requiring mutual

agreement or negotiation is inappropriate because Congress intended the

statute to apply in situations beyond those in which a distribution is

made prior to and as part of an acquisition by a specifically

identified acquiror. Section 355(e)(2)(B) makes clear that the section

is intended to apply to acquisitions before and after a distribution.

The legislative history also clarifies that a public offering after a

distribution can trigger section 355(e) even though presumably no

public buyer would have been negotiated with or even identified at the

time of the distribution. Because Congress intended distributions

designed to facilitate public offerings to be covered, other

transactions that are economically similar also should be covered.

These transactions include a private placement of the distributing or

controlled corporation's stock or an auction of such stock by an

investment banker. Like public offerings, these transactions do not

necessarily involve predistribution negotiations or agreements

regarding subsequent acquisitions and yet may still be part of the

distributing or controlled corporation's plan.

Thus, we believe that section 355(e) was intended to apply to a

range of transactions, not limited to those in which a mutual agreement

or negotiations relating to the acquisition occurred prior to the

distribution. To require negotiations or agreements to be present prior

to a distribution either would inappropriately exclude certain

transactions from the coverage of the statute or would create a higher

threshold for the existence of a plan in certain acquisitions than in

other acquisitions.

The third prong of the alternative rebuttal reiterates a

requirement in the general rebuttal. The distributing corporation must

establish by clear and convincing evidence that the distribution was

not motivated in whole or substantial part by an intention to decrease

the likelihood of the acquisition of one or more businesses by

separating those businesses from others that are likely to be acquired.

For purposes of applying the alternative rebuttal, the consequences

of the application of section 355(e), directly or by indemnity, are

disregarded in determining the intentions, motivations, and reasonable

anticipations of the relevant parties. To do otherwise might give rise

to a circularity in the application of the rules. If the consequences

of the application of section 355(e) were relevant in determining such

intentions, motivations, and reasonable anticipations, the distributing

corporation could argue that objective evidence indicated that it would

satisfy

[[Page 46159]]

the alternative rebuttal, since arguably it would not be reasonable for

an acquiror to act in a manner that would cause liability for tax under

section 355(e). Conversely, the IRS could argue that the presence of an

indemnity agreement indicated that the parties anticipated liability

for tax under section 355(e).

Acquisitions More Than 2 Years After a Distribution

To prevent taxpayers from attempting to avoid the presumption

period by delaying a planned acquisition beyond 2 years from the date

of distribution, the proposed regulations provide that an acquisition

occurring more than 2 years after the distribution is presumed part of

a plan if there was an agreement, understanding, or arrangement

concerning the acquisition at the time of the distribution or within 2

years thereafter. The distributing corporation may rebut the

presumption using the general or alternative rebuttal discussed above.

To provide certainty for transactions that, because of their separation

in time, are unlikely to be part of a plan, the proposed regulations

provide that, if there was no agreement, understanding, or arrangement

concerning the acquisition at the time of the distribution or within 2

years thereafter, a distribution and an acquisition occurring more than

2 years afterwards are not part of a plan.

2. Acquisitions Before a Distribution

Acquisitions Within 2 Years Before a Distribution

Section 355(e) also applies to transactions in which an acquisition

of the distributing or controlled corporation's stock precedes a

distribution of the controlled corporation. When the transactions being

tested as part of a plan occur in this order, the most reliable

indicators that a plan exists are an intent to make the distribution at

the time of the acquisition and a causal connection between the

acquisition and the distribution. In particular, if a person becomes a

controlling shareholder by acquisition, that person's intention becomes

the single best indicator of whether a later distribution was part of a

plan. The proposed regulations allow a distributing corporation to

rebut the presumption by establishing by clear and convincing evidence

that, at the time of the acquisition, the distributing corporation and

its controlling shareholders (determined immediately after the

acquisition) did not intend to effectuate a distribution.

Alternatively, the distributing corporation can rebut the presumption

by establishing by clear and convincing evidence that the distribution

would have occurred at approximately the same time and under

substantially the same terms regardless of the acquisition (and, in the

case of an issuance of stock, all acquisitions that are part of such

issuance), unless a person acquiring an interest becomes a controlling

shareholder by reason of the acquisition or at any point thereafter and

before the end of the 2-year period beginning on the date of the

distribution (or later pursuant to an agreement, understanding, or

arrangement existing at the time of the distribution or within 6 months

thereafter).

Acquisitions More Than 2 Years Before a Distribution

If an acquisition of an interest in the distributing corporation or

the controlled corporation occurs more than 2 years before a

distribution, the presumption shifts in favor of the taxpayer. The

acquisition and the distribution are presumed not to be part of a plan

unless the Commissioner can establish by clear and convincing evidence

that, at the time of the acquisition, (i) the distributing corporation

or its controlling shareholders intended to effectuate the distribution

and (ii) that the distribution would not have occurred at approximately

the same time and under substantially the same terms regardless of that

acquisition (and, in the case of an issuance of stock, all acquisitions

that are part of such issuance) or that a person acquiring an interest

in that acquisition becomes a controlling shareholder by reason of that

acquisition or at any point thereafter and before the end of the 2-year

period beginning on the date of the distribution (or later pursuant to

an agreement, understanding, or arrangement existing at the time of the

distribution or within six months thereafter). Because the passage of

time makes it less likely that an acquisition and distribution are part

of a plan, after two years the proposed regulations shift the burden of

proof to the IRS to prove the existence of a plan. However, the

proposed regulations do not allow a taxpayer to avoid section 355(e) by

delaying the distribution when the distribution clearly was intended at

the time of the acquisition.

3. Agreement, Understanding, Arrangement, or Substantial Negotiations

The proposed regulations do not define with precision the terms

agreement, understanding, arrangement, or substantial negotiations. A

binding contract is clearly included as an agreement, but, depending on

all relevant facts and circumstances, parties can have an agreement,

understanding, or arrangement even though they have not reached

agreement on all terms. Under certain circumstances, such as in public

offerings or auctions of the distributing or controlled corporation's

stock by an investment banker, an agreement, understanding,

arrangement, or substantial negotiations can take place regarding an

acquisition even if the acquiror has not been specifically identified.

The Department of the Treasury and the IRS are particularly interested

in receiving comments regarding transactions that involve an investment

banker and when contacts by the distributing corporation or the

controlled corporation with an investment banker or contacts with

potential acquirors by an investment banker on behalf of the

distributing corporation or the controlled corporation should or should

not be considered an agreement, understanding, arrangement, or

substantial negotiations.

4. Options

The proposed regulations also treat certain options as agreements.

If stock of the distributing or controlled corporation is acquired

pursuant to an option, the option is treated as an agreement unless the

distributing corporation establishes by clear and convincing evidence

that, on the later of the date of distribution or issuance, the option

was not more likely than not to be exercised. Generally, call options,

warrants, convertible obligations, the conversion feature of

convertible stock, put options, redemption agreements, restricted

stock, and any other instruments that provide for the right or

possibility to issue, redeem, or transfer stock, cash settlement

options, and other similar interests are treated as options. An option

on an option is treated as an option under the proposed regulations. If

there is an agreement, understanding, or arrangement to issue an option

before the end of the 6 month period beginning on the date of the

distribution, the option will be treated as issued on the date of the

agreement, understanding, or arrangement. If an agreement,

understanding, or arrangement to issue an option is reached, or an

option is issued, more than 6 months but not more than 2 years after

the distribution, and there were substantial negotiations regarding the

issuance of the option or the acquisition of the stock underlying the

option before the end of the 6 month period beginning on the date of

the distribution, the option will be treated as issued 6 months after

the

[[Page 46160]]

distribution. If there is an agreement, understanding, or an

arrangement to issue an option more than 6 months but not more than 2

years after the distribution, and there were no substantial

negotiations regarding the issuance of the option or the acquisition of

the stock underlying the option before the end of the 6 month period

beginning on the date of the distribution, the option will be treated

as issued on the date of the agreement, understanding, or arrangement.

The proposed regulations exempt certain options from treatment as

options unless they are issued, transferred, or listed with a principal

purpose of avoiding the application of section 355(e) or the proposed

regulations. The enumerated exceptions cover certain commercially

customary options unlikely to be used to avoid section 355(e) or the

proposed regulations.

5. Aggregating Acquisitions That are Pursuant to a Plan

Under the proposed regulations, each acquisition of stock of a

distributing or controlled corporation must be tested to determine

whether the acquisition is pursuant to a plan involving a distribution.

Each acquisition of stock of a corporation acquired pursuant to a plan

involving a distribution is aggregated with all acquisitions of stock

of that corporation acquired pursuant to a plan involving that

distribution to determine whether an acquisition of a 50-percent or

greater interest as proscribed in section 355(e)(2)(A)(ii) has

occurred.

B. Any Controlled Corporation

Section 355(e)(2)(A)(ii) provides that section 355(e)(1), which

causes the distributing corporation to recognize its gain in the

controlled corporation stock as if the distributing corporation had

sold the stock for its fair market value, applies to any distribution

to which section 355 applies and ``which is part of a plan * * *

pursuant to which 1 or more persons acquire directly or indirectly

stock representing a 50-percent or greater interest in the distributing

corporation or any controlled corporation'' (emphasis added). A

question has arisen concerning the measure of gain to the distributing

corporation if, pursuant to a plan, the stock of more than one

controlled corporation is distributed and stock representing a 50-

percent or greater interest is acquired in some, but not all, of the

distributed controlled corporations. The proposed regulations clarify

that under those circumstances, the distributing corporation only

recognizes gain on the stock of the distributed controlled corporations

that were subject to 50-percent or greater acquisitions. If the

distributing corporation is the acquired corporation, it must recognize

gain on all of the distributed controlled corporations.

Proposed Effective Date

The regulations in this section are proposed to apply to

distributions occurring after the regulations in this section are

published as final regulations 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 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, and, because

the regulations do 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 (8) copies) and comments sent via the

Internet that are submitted timely to the IRS. The IRS and the

Department of the Treasury specifically request comments on the clarity

of the proposed regulations and how they may be made easier to

understand. All comments will be available for public inspection and

copying.

A public hearing has been scheduled for January 26, 2000, beginning

at 10 a.m. in Room 2615, Internal Revenue Building, 1111 Constitution

Avenue, NW., Washington, DC. Due to building security procedures,

visitors must enter at the 10th Street entrance, located between

Constitution and Pennsylvania Avenues, NW. In addition, all visitors

must present photo identification to enter the building. Because of

access restrictions, visitors will not be admitted beyond the immediate

entrance area more than 15 minutes before the hearing starts. For

information about having your name placed on the building access list

to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section

of this preamble.

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 written or

electronic comments and an outline of the topics to be discussed and

the time to be devoted to each topic (preferably a signed original and

eight (8) copies) by January 5, 2000. 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 proposed

regulations is Brendan O'Hara, Office of the 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 is amended by adding

an entry in numerical order to read in part as follows:

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

Section 1.355-7 also issued under 26 U.S.C. 355(e)(5). * * *

Par. 2. Section 1.355-0 is amended by revising the section heading

and adding introductory text and an entry for Sec. 1.355-7 to read as

follows:

Sec. 1.355-0 Outline of sections.

In order to facilitate the use of Secs. 1.355-1 through 1.355-7,

this section lists the major paragraphs in those sections as follows:

* * * * *

Sec. 1.355-7 Recognition of gain on certain distributions of stock

or securities in connection with an acquisition.

(a) Plan or series of related transactions.

(1) In general.

(2) Distributions within 2 years of an acquisition.

(i) Presumption.

(ii) Rebuttal for acquisitions after a distribution.

(iii) Alternative rebuttal for acquisitions on or after a

distribution.

(iv) Operating rules for paragraph (a)(2)(iii) of this section.

[[Page 46161]]

(v) Rebuttals for acquisitions before a distribution.

(A) General rebuttal.

(B) Alternative rebuttal.

(3) Distributions more than 2 years from an acquisition.

(i) Acquisitions after a distribution.

(ii) Acquisitions before a distribution.

(4) Controlling shareholder.

(5) Agreement, understanding, or arrangement.

(6) Multiple acquisitions.

(7) Stock acquired by exercise of options, warrants, convertible

obligations, and other similar interests.

(i) Treatment of options.

(A) General rule.

(B) Agreement, understanding, arrangement, or substantial

negotiations to issue an option.

(ii) Instruments treated as options.

(iii) Instruments generally not treated as options.

(A) Escrow, pledge, or other security agreements.

(B) Compensatory options.

(C) Options exercisable only upon death, disability, mental

incompetency, or retirement.

(D) Rights of first refusal.

(E) Other enumerated instruments.

(8) Examples.

(b) Multiple controlled corporations.

(c) Valuation.

(d) Effective date.

Par. 3. Section 1.355-7 is added to read as follows:

Sec. 1.355-7 Recognition of gain on certain distributions of stock or

securities in connection with an acquisition.

(a) Plan or series of related transactions--(1) In general. (i)

Except as provided in section 355(e) and this section, section 355(e)

applies to any distribution--

(A) To which section 355 (or so much of section 356 as relates to

section 355) applies; and

(B) Which is part of a plan (or series of related transactions)

pursuant to which one or more persons acquire directly or indirectly

stock representing a 50-percent or greater interest in the distributing

corporation or any controlled corporation.

(ii) For purposes of this section, a controlled corporation is a

corporation the stock of which is distributed in a distribution to

which section 355 applies.

(iii) The existence of a plan (or series of related transactions)

does not depend on whether or not more than one person acts in concert.

(2) Distributions within 2 years of an acquisition--(i)

Presumption. If a distribution occurs within 2 years of an acquisition

by one or more persons of an interest in the distributing corporation

or any controlled corporation, the distribution and that acquisition

are presumed to be part of a plan (or series of related transactions).

(ii) Rebuttal for acquisitions after a distribution. (A) In the

case of an acquisition occurring after a distribution, the distributing

corporation may rebut the presumption of paragraph (a)(2)(i) of this

section by establishing by clear and convincing evidence that--

(1) The distribution was motivated in whole or substantial part by

a corporate business purpose within the meaning of Sec. 1.355-2(b)

(other than an intent to facilitate an acquisition or decrease the

likelihood of the acquisition of one or more businesses by separating

those businesses from others that are likely to be acquired); and

(2) The acquisition occurred more than 6 months after the

distribution and there was no agreement, understanding, arrangement, or

substantial negotiations concerning the acquisition at the time of the

distribution or within 6 months thereafter.

(B) The intent of the distributing corporation, the controlled

corporation, or the controlling shareholders of either the distributing

or controlled corporation to facilitate an acquisition or decrease the

likelihood of the acquisition of one or more businesses by separating

those businesses from others that are likely to be acquired is relevant

in determining the extent to which the distribution was motivated by a

corporate business purpose within the meaning of Sec. 1.355-2(b) (other

than an intent to facilitate an acquisition or decrease the likelihood

of the acquisition of one or more businesses by separating those

businesses from others that are likely to be acquired).

(iii) Alternative rebuttal for acquisitions on or after a

distribution. In the case of an acquisition occurring on or after a

distribution, the distributing corporation also may rebut the

presumption of paragraph (a)(2)(i) of this section by establishing by

clear and convincing evidence that--

(A)(1) At the time of the distribution, the distributing

corporation, the controlled corporation, and their controlling

shareholders did not intend that one or more persons would acquire a

50-percent or greater interest in the distributing or any controlled

corporation during the 2-year period beginning on the date of the

distribution (or later pursuant to an agreement, understanding, or

arrangement existing at the time of the distribution or within 6 months

thereafter); or

(2) The distribution was not motivated in whole or substantial part

by an intention to facilitate an acquisition of an interest in the

distributing or controlled corporation; and

(B) At the time of the distribution, neither the distributing

corporation, the controlled corporation, nor their controlling

shareholders would reasonably have anticipated that it was more likely

than not that one or more persons would acquire a 50-percent or greater

interest in the distributing corporation or the controlled corporation

within 2 years after the distribution (or later pursuant to an

agreement, understanding, or arrangement existing at the time of the

distribution or within 6 months thereafter) who would not have acquired

such interests if the distribution had not occurred; and

(C) The distribution was not motivated in whole or substantial part

by an intention to decrease the likelihood of the acquisition of one or

more businesses by separating those businesses from others that are

likely to be acquired.

(iv) Operating rules for paragraph (a)(2)(iii) of this section. (A)

For purposes of paragraph (a)(2)(iii)(A)(1) of this section, if an

acquisition by one or more persons of an interest in the distributing

corporation or any controlled corporation before the distribution is

part of a plan (or series of related transactions) involving the

distribution, the distributing corporation, the controlled corporation,

and their controlling shareholders must include the amount of stock

acquired in that acquisition as an amount they intended at the time of

the distribution to be acquired during the 2-year period beginning on

the date of the distribution.

(B) For purposes of paragraph (a)(2)(iii)(B) of this section,

persons who more likely than not would have acquired interests in the

distributing corporation if the distribution had not occurred are also

treated as persons who more likely than not would have acquired

proportionate interests in the controlled corporation if the

distribution had not occurred. No other persons are treated as persons

who would have acquired interests in the controlled corporation if the

distribution had not occurred.

(C) For purposes of paragraph (a)(2)(iii)(B) of this section, if an

acquisition by one or more persons of an interest in the distributing

corporation or any controlled corporation before the distribution is

part of a plan (or series of related transactions) involving the

distribution, the distributing corporation, the controlled corporation,

and their controlling shareholders must treat the amount of stock

acquired in

[[Page 46162]]

that acquisition as an amount they would reasonably have anticipated

was more likely than not to be acquired within 2 years after the

distribution that would not have been acquired if the distribution had

not occurred.

(D) For purposes of determining the intentions, motivations, and

reasonable anticipations of the relevant parties under paragraph

(a)(2)(iii) of this section, the consequences of the application of

section 355(e), directly or by indemnity, are disregarded.

(v) Rebuttals for acquisitions before a distribution--(A) General

rebuttal. In the case of an acquisition occurring before a

distribution, the distributing corporation may rebut the presumption of

paragraph (a)(2)(i) of this section by establishing by clear and

convincing evidence that, at the time of the acquisition, the

distributing corporation and its controlling shareholders (determined

immediately after the acquisition) did not intend to effectuate a

distribution.

(B) Alternative rebuttal. In the case of an acquisition occurring

before a distribution, the distributing corporation may rebut the

presumption of paragraph (a)(2)(i) of this section by establishing by

clear and convincing evidence that the distribution would have occurred

at approximately the same time and under substantially the same terms

regardless of that acquisition (and, in the case of an issuance of

stock, all acquisitions that are part of such issuance), provided no

person acquiring an interest in that acquisition becomes a controlling

shareholder by reason of that acquisition or at any point thereafter

and before the end of the 2-year period beginning on the date of the

distribution (or later pursuant to an agreement, understanding, or

arrangement existing at the time of the distribution or within 6 months

thereafter).

(3) Distributions more than 2 years from an acquisition--(i)

Acquisitions after a distribution. (A) If an acquisition by one or more

persons of an interest in the distributing corporation or any

controlled corporation occurs more than 2 years after a distribution,

the distribution and that acquisition are presumed part of a plan (or

series of related transactions) only if there was an agreement,

understanding, or arrangement concerning the acquisition at the time of

the distribution or within 2 years thereafter. The distributing

corporation may rebut the presumption under paragraph (a)(2)(ii) or

(a)(2)(iii) of this section.

(B) If an acquisition by one or more persons of an interest in the

distributing corporation or any controlled corporation occurs more than

2 years after a distribution, and there was no agreement,

understanding, or arrangement concerning the acquisition at the time of

the distribution or within 2 years thereafter, the acquisition and the

distribution are not part of a plan (or series of related

transactions).

(ii) Acquisitions before a distribution. If an acquisition by one

or more persons of an interest in the distributing corporation or the

controlled corporation occurs more than 2 years before a distribution,

the acquisition and the distribution are not part of a plan (or series

of related transactions) unless the Commissioner can establish by clear

and convincing evidence that--

(A) At the time of the acquisition, the distributing corporation or

its controlling shareholders (determined immediately after the

acquisition) intended to effectuate the distribution; and

(B)(1) The distribution would not have occurred at approximately

the same time and under substantially the same terms regardless of that

acquisition (and, in the case of an issuance of stock, all acquisitions

that are part of such issuance); or

(2) A person acquiring an interest in that acquisition becomes a

controlling shareholder by reason of that acquisition or at any point

thereafter and before the end of the 2-year period beginning on the

date of the distribution (or later pursuant to an agreement,

understanding, or arrangement existing at the time of the distribution

or within 6 months thereafter).

(4) Controlling shareholder. For purposes of paragraphs (a) (2) and

(3) of this section, a controlling shareholder is any person who,

directly or indirectly, or together with related persons (as described

in sections 267(b) and 707(b)), possesses voting power in the

distributing or controlled corporation representing a meaningful voice

in the governance of the corporation. A controlling shareholder of a

publicly traded corporation is any person who, directly or indirectly,

or together with related persons (as described in sections 267(b) and

707(b)), owns 5 percent or more of any class of stock of the

distributing or controlled corporation and who actively participates in

the management or operation of the corporation. If a distribution

precedes an acquisition, the controlled corporation's controlling

shareholders immediately after the distribution are considered the

controlled corporation's controlling shareholders at the time of the

distribution.

(5) Agreement, understanding, or arrangement. For purposes of this

section, the parties do not necessarily have to have entered into a

binding contract or have reached agreement on all terms to have an

``agreement, understanding, or arrangement.''

(6) Multiple acquisitions. Each acquisition of stock of a

corporation acquired pursuant to a plan (or series of related

transactions) involving a distribution will be aggregated with all

acquisitions of stock of that corporation acquired pursuant to a plan

(or series of related transactions) involving that distribution to

determine whether an acquisition described in section 355(e)(2)(A)(ii)

occurred. The appropriate presumption and rules for rebuttal will be

applied to each acquisition depending on when the acquisition occurred.

(7) Stock acquired by exercise of options, warrants, convertible

obligations, and other similar interests--(i) Treatment of options--(A)

General rule. For purposes of this section, if stock of the

distributing or controlled corporation is acquired pursuant to an

option, the option will be treated as an agreement on the date of

issuance unless the distributing corporation establishes by clear and

convincing evidence that, on the later of the date of distribution or

date of issuance, the option was not more likely than not to be

exercised. The determination of whether an option was more likely than

not to be exercised is based on all the facts and circumstances. In

applying the previous sentence, the fair market value of stock

underlying an option is determined by taking into account control

premiums and minority and blockage discounts.

(B) Agreement, understanding, arrangement, or substantial

negotiations to issue an option. If there is an agreement,

understanding, or arrangement to issue an option before the end of the

6-month period beginning on the date of the distribution, the option

will be treated as issued on the date of the agreement, understanding,

or arrangement. If an agreement, understanding, or arrangement to issue

an option is reached, or an option is issued, more than 6 months but

not more than 2 years after the distribution, and there were

substantial negotiations regarding the issuance of the option or the

acquisition of the stock underlying the option before the end of the 6-

month period beginning on the date of the distribution, the option will

be treated as issued 6 months after the distribution. If there is an

agreement, understanding, or an arrangement to issue an option more

than 6 months but not more than 2 years after the distribution, and

there were no

[[Page 46163]]

substantial negotiations regarding the issuance of the option or the

acquisition of the stock underlying the option before the end of the 6

month period beginning on the date of the distribution, the option will

be treated as issued on the date of the agreement, understanding, or

arrangement.

(ii) Instruments treated as options. For purposes of this paragraph

(a)(7), except to the extent provided in paragraph (a)(7)(iii) of this

section, call options, warrants, convertible obligations, the

conversion feature of convertible stock, put options, redemption

agreements (including rights to cause the redemption of stock),

restricted stock, any other instruments that provide for the right or

possibility to issue, redeem, or transfer stock (including an option on

an option), cash settlement options, or any other similar interests are

treated as options.

(iii) Instruments generally not treated as options. For purposes of

this paragraph (a)(7), the following are not treated as options unless

issued, transferred (directly or indirectly), or listed with a

principal purpose of avoiding the application of section 355(e) or this

section:

(A) Escrow, pledge, or other security agreements. An option that is

part of a security arrangement in a typical lending transaction

(including a purchase money loan), if the arrangement is subject to

customary commercial conditions. For this purpose, a security

arrangement includes, for example, an agreement for holding stock in

escrow or under a pledge or other security agreement, or an option to

acquire stock contingent upon a default under a loan.

(B) Compensatory options. An option to acquire stock in the

distributing or controlled corporation with customary terms and

conditions provided to an employee or director in connection with the

performance of services for the corporation or a person related to it

under section 355(d)(7)(A) (and that is not excessive by reference to

the services performed) and that immediately after the distribution and

within 6 months thereafter--

(1) Is nontransferable within the meaning of Sec. 1.83-3(d); and

(2) Does not have a readily ascertainable fair market value as

defined in Sec. 1.83-7(b).

(C) Options exercisable only upon death, disability, mental

incompetency, or retirement. Any option entered into between

stockholders of a corporation (or a stockholder and the corporation)

that is exercisable only upon the death, disability, or mental

incompetency of the stockholder, or, in the case of stock acquired in

connection with the performance of services for the corporation or a

person related to it under section 355(d)(7)(A) (and that is not

excessive by reference to the services performed), the stockholder's

retirement.

(D) Rights of first refusal. A bona fide right of first refusal

regarding the corporation's stock with customary terms, entered into

between stockholders of a corporation (or between the corporation and a

stockholder).

(E) Other enumerated instruments. Any other instruments specified

in regulations, a revenue ruling, or a revenue procedure. See

Sec. 601.601(d)(2) of this chapter.

(8) Examples. The following examples illustrate this paragraph (a).

Throughout these examples, assume that the distributing corporation (D)

owns all of the stock of the controlled corporation (C). Assume further

that D distributes the stock of C in a distribution to which section

355 applies and to which section 355(d) does not apply. For purposes of

these examples, unless otherwise stated, assume that all transactions

described are respected under applicable general tax principles. No

inference should be drawn from any example concerning whether any

requirements of section 355 other than those of section 355(e) are

satisfied. The examples are as follows:

Example 1. To facilitate a stock offering by D of 50 percent of

its stock, D distributes C pro rata to its shareholders. D issues

new shares amounting to 50 percent of its stock to the public in a

public offering within 6 months of the distribution. Under paragraph

(a)(2)(i) of this section, the distribution and acquisition are

presumed to be part of a plan (or series of related transactions)

because the acquisition occurred within 2 years of the distribution.

Because the acquisition occurred within 6 months after the

distribution, D must rely on the rules of paragraph (a)(2)(iii) of

this section to rebut the presumption. D will not be able to rebut

the presumption because D cannot establish either that D did not

intend that one or more persons would acquire a 50-percent or

greater interest in D during the relevant period under paragraph

(a)(2)(iii)(A)(1) of this section or that the distribution was not

motivated in whole or substantial part by an intention to facilitate

an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2)

of this section. Because the presumption of paragraph (a)(2)(i) of

this section cannot be rebutted regarding the acquisition of a 50-

percent or greater interest in D, section 355(e) applies to the

distribution of C.

Example 2. (i) X corporation announces an intention to acquire

D, principally to acquire C's business. Due to market conditions,

X's available capital, and X's success in acquiring other

corporations, D would reasonably anticipate that an acquisition of a

50-percent or greater interest in D is more likely than not to occur

within 2 years. To lower its financing costs and, in substantial

part, to deter the acquisition of D (by separating it from the more

attractive C), D distributes C pro rata to the D shareholders. X

acquires C within 6 months of the distribution.

(ii) Under paragraph (a)(2)(i) of this section, the distribution

and acquisition are presumed to be part of a plan (or series of

related transactions) because the acquisition occurred within 2

years of the distribution. Because the acquisition occurred within 6

months after the distribution, D must rely on the rules of paragraph

(a)(2)(iii) of this section to rebut the presumption. Under

paragraph (a)(2)(iii)(A)(2) of this section, D will be able to

establish that the distribution was not motivated in whole or

substantial part by an intention to facilitate an acquisition of an

interest in D or C. Under paragraph (a)(2)(iv)(B) of this section,

for purposes of paragraph (a)(2)(iii)(B) of this section, persons

who more likely than not would have acquired interests in D if the

distribution had not occurred are also treated as persons who more

likely than not would have acquired proportionate interests in C if

the distribution had not occurred. Therefore, under paragraph

(a)(2)(iii)(B) of this section, D will be able to establish that, at

the time of the distribution, neither D, C, nor their controlling

shareholders would reasonably have anticipated that it was more

likely than not that one or more persons would acquire a 50-percent

or greater interest in D or C within 2 years after the distribution

who would not have acquired such interests if the distribution had

not occurred.

(iii) Under paragraph (a)(2)(iii)(C) of this section, D will not

be able to establish that the distribution was not motivated in

whole or substantial part by an intention to decrease the likelihood

of the acquisition of D's business by separating it from the C

business that was likely to be acquired. Because the presumption of

paragraph (a)(2)(i) of this section cannot be rebutted regarding the

acquisition by X of a 50-percent or greater interest in C, section

355(e) applies to the distribution of C.

Example 3. The facts are the same as Example 2 except the

acquisition takes place 1 year after the distribution. The parties

had not reached an agreement, understanding, or arrangement

concerning, and had not substantially negotiated, the acquisition of

C stock within 6 months after the distribution. Under paragraph

(a)(2)(i) of this section, the distribution and acquisition are

presumed to be part of a plan (or series of related transactions)

because the acquisition occurred within 2 years of the distribution.

Under paragraph (a)(2)(ii)(B) of this section, D's intent to deter

an acquisition of D is a factor tending to disprove that the

distribution was motivated in substantial part by the desire to

lower its financing costs. If D can establish by clear and

convincing evidence that the distribution was nonetheless motivated

in substantial part by the need to lower its financing costs, D can

rebut the presumption using paragraph (a)(2)(ii) of this section. D

will not be able to rebut the presumption by using the

[[Page 46164]]

alternative rebuttal under paragraph (a)(2)(iii) of this section for

the same reason as in Example 2.

Example 4. D is a widely held, publicly traded corporation. D

distributes C pro rata to D's shareholders. By contract, C agrees to

indemnify D for any imposition of tax under section 355(e). The

distribution is motivated solely by a corporate business purpose

within the meaning of Sec. 1.355-2(b) (other than an intent to

facilitate an acquisition or decrease the likelihood of the

acquisition of one or more businesses by separating those businesses

from others that are likely to be acquired). At the time of the

distribution, although D has not been approached by any potential

acquirors of C, D would reasonably anticipate that, under current

market conditions, if C is separated from D, an acquisition of a 50-

percent or greater interest in C is more likely than not to occur

within 2 years by persons who would not have acquired a

proportionate interest in D if the distribution of C had not

occurred. C is acquired within 6 months after the distribution.

Under paragraph (a)(2)(i) of this section, the distribution and

acquisition are presumed to be part of a plan (or series of related

transactions) because the acquisition occurred within 2 years of the

distribution. Because the acquisition occurred within 6 months after

the distribution, D must rely on the rules of paragraph (a)(2)(iii)

of this section to rebut the presumption. D will be able to

establish that the distribution was not motivated in whole or

substantial part by an intention to facilitate an acquisition of an

interest in D or C under paragraph (a)(2)(iii)(A)(2) of this

section. However, D will not be able to establish the requirements

of paragraph (a)(2)(iii)(B) of this section. Under paragraph

(a)(2)(iv)(B) of this section, for purposes of paragraph

(a)(2)(iii)(B) of this section, only persons who more likely than

not would have acquired interests in D if the distribution had not

occurred are treated as persons who more likely than not would have

acquired proportionate interests in C if the distribution had not

occurred. Therefore, under paragraph (a)(2)(iii)(B) of this section,

D will not be able to establish that, at the time of the

distribution, neither D, C, nor their controlling shareholders would

reasonably have anticipated that it was more likely than not that

one or more persons would acquire a 50-percent or greater interest

in D or C within 2 years after the distribution who would not have

acquired such interests if the distribution had not occurred. Under

paragraph (a)(2)(iv)(D) of this section, the consequences of the

indemnity agreement are disregarded for purposes of applying

paragraph (a)(2)(iii)(B) of this section. Because the presumption of

paragraph (a)(2)(i) of this section cannot be rebutted regarding the

acquisition of a 50-percent or greater interest in C, section 355(e)

applies to the distribution of C.

Example 5. (i) D believes it would be a more attractive

acquisition candidate if it did not own C. To achieve significant

nontax cost savings and, in substantial part, to maximize the

possibility of D's acquisition, D distributes C pro rata. At the

time of the distribution, D has not, directly or indirectly,

solicited or received any indication of interest from potential

acquirors. At the end of 6 months after the distribution, no

agreement, arrangement, understanding, or substantial negotiations

regarding the acquisition of D have taken place. Seven months after

the distribution, D engages an investment banker to conduct an

auction of D. One of the bidders acquires D 1 year after the

distribution. Under paragraph (a)(2)(i) of this section, the

distribution and acquisition are presumed to be part of a plan (or

series of related transactions) because the acquisition occurred

within 2 years of the distribution. Because there was no agreement,

understanding, arrangement, or substantial negotiations concerning

the acquisition at the time of the distribution or within 6 months

thereafter, D can use the rebuttal under paragraph (a)(2)(ii) of

this section if D can establish that the distribution was motivated

in whole or substantial part by the corporate business purpose of

achieving significant nontax cost savings. Under paragraph

(a)(2)(ii)(B) of this section, D's intent to facilitate an

acquisition of D is a factor tending to disprove that the

distribution was motivated in substantial part by the desire to

achieve nontax cost savings. If D can establish by clear and

convincing evidence that the distribution was nonetheless motivated

in substantial part by the need to achieve nontax cost savings for D

and C, D can rebut the presumption using paragraph (a)(2)(ii) of

this section.

(ii) D cannot rebut the presumption using the rules of paragraph

(a)(2)(iii) of this section because D cannot establish either that D

did not intend that one or more persons would acquire a 50-percent

or greater interest in D during the relevant period under paragraph

(a)(2)(iii)(A)(1) of this section or that the distribution was not

motivated in whole or substantial part by an intention to facilitate

an acquisition of an interest in D under paragraph (a)(2)(iii)(A)(2)

of this section.

Example 6. D announces that it will distribute C pro rata to D's

shareholders. The distribution is motivated solely by a corporate

business purpose within the meaning of Sec. 1.355-2(b) (other than

an intent to facilitate an acquisition or decrease the likelihood of

the acquisition of one or more businesses by separating those

businesses from others that are likely to be acquired). After the

announcement but before the distribution, D acquires X, a widely

held corporation. The X shareholders receive D stock in exchange for

their X stock. No person who acquired D stock in the X acquisition

became a controlling shareholder of D, as defined in paragraph

(a)(4) of this section, within the time period described in

paragraph (a)(2)(v)(B) of this section. Under paragraph (a)(2)(i) of

this section, the distribution and the acquisition of D stock by the

X shareholders are presumed to be part of a plan (or series of

related transactions) because the acquisition occurred within 2

years of the distribution. If D can establish by clear and

convincing evidence that the distribution of C would have occurred

at approximately the same time and under substantially the same

terms regardless of the acquisition of X, D may rebut the

presumption under paragraph (a)(2)(v)(B) of this section.

Example 7. (i) D engages in business 1. C engages in business 2.

D is interested in expanding business 1 through acquisitions, but

D's ownership of C has been an impediment to acquisitions using D

stock. On the advice of its investment banker, D plans to distribute

its C stock to its shareholders solely to facilitate acquisitions by

D. D has no specific goals regarding how much D stock will be

acquired after the distribution. D and its investment banker have

identified X and Y as potential acquisition targets. After D decides

to distribute its C stock, but before the distribution date, D

negotiates with and acquires X, but has no contact with Y. A, X's

sole shareholder, receives 30 percent of D's stock, becoming a

controlling shareholder of D within the meaning of paragraph (a)(4)

of this section. One year after the distribution, D acquires Y. Y's

shareholders receive 19 percent of D's stock. After the

distribution, D and its investment banker identify Z as another

desirable target. Eighteen months after the distribution, D acquires

Z. Z's shareholders receive 17 percent of D's stock.

(ii) Under paragraph (a)(2)(i) of this section, the distribution

and each acquisition are presumed to be part of a plan (or series of

related transactions) because each acquisition occurred within 2

years of the distribution. In addition, under paragraph (a)(6) of

this section, all acquisitions for which the presumption is not

rebutted are aggregated to determine whether an acquisition

described in section 355(e)(2)(A)(ii) has occurred.

(iii) Regarding the acquisition of X, D will not be able to

rebut the presumption under paragraph (a)(2)(v)(A) of this section

because D cannot establish that at the time A acquired D stock, D

did not intend to effectuate a distribution. In addition, D cannot

rebut the presumption under paragraph (a)(2)(v)(B) of this section

because that paragraph does not apply to an acquisition in which a

person becomes a controlling shareholder.

(iv) Regarding the acquisitions of Y and Z, D will not be able

to rebut the presumption under paragraph (a)(2)(ii)(A) of this

section because D cannot establish that the distribution was

motivated in whole or substantial part by a corporate business

purpose within the meaning of Sec. 1.355-2(b) (other than an intent

to facilitate an acquisition or decrease the likelihood of the

acquisition of one or more businesses by separating those businesses

from others that are likely to be acquired).

(v) To rebut the presumption with regard to each acquisition of

Y and Z using the alternative rebuttal of paragraph (a)(2)(iii) of

this section, D must establish three facts. First, under paragraph

(a)(2)(iii)(A)(1) of this section, D must establish that, at the

time of the distribution, D and its controlling shareholders did not

intend that one or more persons would acquire a 50-percent or

greater interest in D or C during the presumption period described

in that paragraph. For that purpose, the interests intended to be

acquired in D or C will include A's acquisition of D stock under

paragraph (a)(2)(iv)(A) of this section. Second, under paragraph

(a)(2)(iii)(B) of this section, D must establish that, at the time

of the distribution, neither D, C, nor their controlling

[[Page 46165]]

shareholders would reasonably have anticipated that it was more

likely than not that one or more persons would acquire a 50-percent

or greater interest in D or C within 2 years after the distribution

(or later pursuant to an agreement, understanding, or arrangement

existing at the time of the distribution or within 6 months

thereafter) who would not have acquired such interests if the

distribution had not occurred. Under paragraph (a)(2)(iv)(C) of this

section, D, C, and their controlling shareholders must treat the

amount of D stock acquired by A as an amount they would reasonably

have anticipated was more likely than not to be acquired within 2

years after the distribution that would not have been acquired if

the distribution had not occurred. Third, under paragraph

(a)(2)(iii)(C) of this section, D will be able to establish that the

distribution was not motivated in whole or substantial part by an

intention to decrease the likelihood of the acquisition of one or

more businesses by separating those businesses from others that are

likely to be acquired.

Example 8. D plans to distribute C pro rata to its shareholders.

The distribution is substantially motivated by a corporate business

purpose within the meaning of Sec. 1.355-2(b) (other than an intent

to facilitate an acquisition or decrease the likelihood of the

acquisition of one or more businesses by separating those businesses

from others that are likely to be acquired). After the announcement

date, D's investment banker informs D's management that there is a

lot of interest in new investment in D now that it will no longer

own C. At the time of the distribution, D would reasonably

anticipate that it was more likely than not that one or more persons

would acquire a 50-percent or greater interest in D within 2 years

(or later pursuant to an agreement, understanding, or arrangement

existing at the time of the distribution or within 6 months

thereafter) who would not acquire such interests absent the

distribution. Three months after the distribution, D issues an

option to X to purchase 50 percent of the D stock. At the time of

issuance, the facts and circumstances indicate that the option is

more likely than not to be exercised. Two years after issuance, X

exercises the option and purchases 50 percent of the D stock. Under

paragraph (a)(7)(i)(A) of this section, the option is treated as an

agreement on the date it is issued. Under paragraph (a)(3)(i)(A) of

this section, the distribution and the acquisition are presumed to

be part of a plan (or series of related transactions) because there

was an agreement concerning the acquisition within 2 years of the

distribution. D will not be able to rebut the presumption using the

rebuttals of paragraphs (a)(2)(ii) or (a)(2)(iii) of this section.

The rebuttal of paragraph (a)(2)(ii) of this section is unavailable

because there was an agreement concerning the acquisition within 6

months of the distribution. The rebuttal of paragraph (a)(2)(iii) of

this section is unavailable because D cannot establish that, at the

time of the distribution, neither D, C, nor their controlling

shareholders would reasonably have anticipated that it was more

likely than not that one or more persons would acquire a 50-percent

or greater interest in D within 2 years (or later pursuant to an

agreement, understanding, or arrangement existing at the time of the

distribution or within 6 months thereafter) who would not have

acquired such interests absent the distribution. Because the

presumption relating to the acquisition of a 50-percent interest in

D cannot be rebutted, section 355(e) applies to the distribution of

C.

Example 9. (i) D distributes C pro rata to its shareholders

solely to facilitate a stock offering by C. To take advantage of

favorable market conditions, C issues new shares amounting to 20

percent of its stock in a public offering followed 1 month later by

the distribution. The public offering documents disclosed the

intended distribution of C. Neither D, C, nor their controlling

shareholders intended any further transactions involving D or C

stock. In addition, at the time of the distribution, neither D, C,

nor their controlling shareholders would reasonably anticipate that

it was more likely than not that one or more persons would acquire a

50-percent interest in D or C within 2 years (or later pursuant to

an agreement, understanding, or arrangement existing at the time of

the distribution or within 6 months thereafter) who would not have

acquired such interests absent the distribution. Two months after

the distribution, C is approached unexpectedly regarding an

opportunity to acquire X. Five months after the distribution, C

acquires X in exchange for 40 percent of the C stock. Under

paragraph (a)(2)(i) of this section, the distribution and each

acquisition are presumed to be part of a plan (or series of related

transactions) because each acquisition occurred within 2 years of

the distribution.

(ii) Regarding the public offering, D cannot rebut the

presumption using paragraph (a)(2)(v) of this section. At the time

of the acquisition, D and its controlling shareholders intended to

effectuate the distribution. Also, the distribution would not have

occurred at approximately the same time and under substantially the

same terms regardless of the public offering.

(iii) Regarding C's acquisition of X, D will not be able to

rebut the presumption using paragraph (a)(2)(ii) of this section

because the acquisition occurred within 6 months after the

distribution. However, D will be able to rebut the presumption

regarding the acquisition of X using paragraph (a)(2)(iii) of this

section. Neither D, C, nor their controlling shareholders intended

that one or more persons would acquire a 50-percent or greater

interest in D or C during the relevant period under paragraph

(a)(2)(iii)(A)(1) of this section. Under paragraph (a)(2)(iii)(B) of

this section, at the time of the distribution, neither D, C, nor

their controlling shareholders would reasonably have anticipated

that it was more likely than not that one or more persons would

acquire a 50-percent or greater interest in C within 2 years who

would not have acquired such interests if the distribution had not

occurred. Under paragraph (a)(2)(iii)(C) of this section, the

distribution was not motivated in whole or substantial part by an

intention to decrease the likelihood of the acquisition of one or

more businesses by separating those businesses from others that are

likely to be acquired. Because only the 20-percent acquisition by

public offering is part of a plan (or series of related

transactions) involving the distribution, section 355(e) does not

apply.

(b) Multiple controlled corporations. Only the stock or securities

of a controlled corporation in which one or more persons acquire

directly or indirectly stock representing a 50-percent or greater

interest as part of a plan (or series of related transactions)

involving the distribution of that corporation will be treated as not

qualified property under section 355(e)(1) if--

(1) The stock or securities of more than one controlled corporation

are distributed in distributions to which section 355 applies; and

(2) One or more persons do not acquire, directly or indirectly,

stock representing a 50-percent or greater interest in the distributing

corporation pursuant to a plan (or series of related transactions)

involving any of those distributions.

(c) Valuation. Except as provided in paragraph (a)(7)(i)(A) of this

section, for purposes of section 355(e) and this section, all shares of

stock within a single class are considered to have the same value.

Thus, control premiums and minority and blockage discounts within a

single class are not taken into account.

(d) Effective date. The regulations in this section apply to

distributions occurring after the regulations in this section are

published as final regulations in the Federal Register.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 99-21876 Filed 8-19-99; 1:37 pm]

BILLING CODE 4830-01-U