26012 Federal Register / Vol. 72, No. 88 / Tuesday, May 8, 2007 / Proposed Rules 

Correction of Publication 

Accordingly, the publication of 

proposed rulemaking (REG–144859–04), 

which was the subject of FR Doc. E7–

6764, is corrected as follows: 

1. On page 18417, column 3, in the 

preamble, under the caption DATES:, 

first sentence of the paragraph, the 

language ‘‘Written or electronic 

comments and requests for a public 

hearing must be received by July 11, 

2007.’’ is corrected to read ‘‘Written or 

electronic comments must be received 

by July 10, 2007.’’. 

2. On page 18418, column 1, in the 

preamble, under the caption FOR

FURTHER INFORMATION CONTACT:, lines six 

through eleven, the language ‘‘attend the 

hearing, Richard Hurst at (202) 622–

2949 (TDD Telephone) (not toll free 

numbers) and his e-mail address is 

Richard.A.Hurst@irscounsel.treas.gov, 

(202) 622–7180 (not toll-free numbers).’’

is corrected to read ‘‘attend the hearing, 

Richard Hurst at 

Richard.A.Hurst@irscounsel.treas.gov, 

(202) 622–7180 (not toll-free numbers). 

3. On page 18420, column 2, in the 

preamble, under the paragraph heading 

‘‘Comments and Public Hearing’’, the 

second paragraph of the column, first 

line, the language ‘‘The rules of 26 CFR 

606.601(a)(3)’’ is corrected to read ‘‘The 

rules of 26 CFR 601.601(a)(3)’’. 

§ 1.1367–2 [Corrected] 

4. On page 18422, column 1, 

§ 1.1367–2, first paragraph of the 

column, third line of the paragraph, the 

language ‘‘1. The section heading is 

revised.’’ is corrected to read ‘‘1. The 

section heading and paragraph are 

revised.’’. 

5. On page 18422, column 1, 

§ 1.1367–2, first paragraph of the 

column, lines four through seven are 

removed. 

§ 1.1367–3 [Corrected] 

6. On page 18422, column 1, 

§ 1.1367–3, second paragraph of the 

column, the language of the paragraph 

heading ‘‘§ 1.1367–3 Effective dates and 

transitional rules.’’ is corrected to read 

‘‘§ 1.1367–3 Effective date.’’. 

LaNita Van Dyke, 

Chief, Publications and Regulations Branch, 

Legal Processing Division, Associate Chief 

Counsel (Procedure and Administration). 

[FR Doc. E7–8705 Filed 5–7–07; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–123365–03] 

RIN 1545–BC94 

Guidance Regarding the Active Trade 

or Business Requirement Under 

Section 355(b) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations that provide 

guidance regarding the active trade or 

business requirement under section 

355(b) of the Internal Revenue Code. 

These proposed regulations provide 

guidance on issues involving the active 

trade or business requirement under 

section 355(b), including guidance 

resulting from the enactment of section 

355(b)(3). These proposed regulations 

will affect corporations and their 

shareholders. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by August 6, 2007. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–123365–03), room 

5203, Internal Revenue Service, PO Box 

7604, Ben Franklin Station, Washington, 

DC 20044. Submissions may be handdelivered Monday through Friday 

between the hours of 8 a.m. and 4 p.m. 

to CC:PA:LPD:PR (REG–123365–03), 

Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC, or sent 

electronically via the Federal 

eRulemaking Portal at 

www.regulations.gov (IRS REG–123365–

03). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Russell P. Subin, (202) 622–7790; 

concerning submissions and the 

hearing, Kelly Banks, (202) 622–7180 

(not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Background and Explanation of 

Provisions 

A. Background and Overview of the Key 

Aspects of the Proposed Regulations 

1. Background 

Section 355(a) of the Internal Revenue 

Code (Code) provides that, under certain 

circumstances, a corporation may 

distribute stock and securities of a 

corporation it controls to its 

shareholders and security holders 

without causing either the corporation 

or its shareholders and security holders 

to recognize income, gain or loss. 

Sections 355(a)(1)(C) and 355(b)(1) 

generally require that the distributing 

corporation (distributing) and controlled 

corporation (controlled) each be 

engaged, immediately after the 

distribution, in the active conduct of a 

trade or business. Section 355(b)(2)(A) 

provides that a corporation shall be 

treated as engaged in the active conduct 

of a trade or business if and only if it 

is engaged in the active conduct of a 

trade or business, or substantially all of 

its assets consist of stock and securities 

of a corporation controlled by it 

(immediately after the distribution) 

which is so engaged. For this purpose, 

control is defined under section 368(c). 

All references to control in this 

preamble are references to control as 

defined in section 368(c). 

Section 202 of the Tax Increase 

Prevention and Reconciliation Act of 

2005, Public Law 109–222 (120 Stat. 

345, 348) (TIPRA) amended section 

355(b) by adding section 355(b)(3). 

Section 355(b)(3)(A), as amended by 

Division A, Section 410 of the Tax 

Relief and Health Care Act of 2006, 

Public Law 109–432 (120 Stat. 2922, 

2963), provides that in the case of any 

distribution made after May 17, 2006, a 

corporation shall be treated as meeting 

the requirement of section 355(b)(2)(A) 

if and only if such corporation is 

engaged in the active conduct of a trade 

or business. Section 355(b)(3)(B) 

provides that for purposes of section 

355(b)(3)(A) (and, consequently, section 

355(b)(2)(A)), all members of such 

corporation’s separate affiliated group 

(SAG) shall be treated as one 

corporation (SAG rule). For purposes of 

the preceding sentence, a corporation’s 

SAG is the affiliated group which would 

be determined under section 1504(a) if 

such corporation were the common 

parent and section 1504(b) did not 

apply. 

Thus, the separate affiliated group of 

distributing (DSAG) is the affiliated 

group that consists of distributing as the 

common parent and all corporations 

affiliated with distributing through 

stock ownership described in section 

1504(a)(1)(B) (regardless of whether the 

corporations are includible corporations 

under section 1504(b)). The separate 

affiliated group of controlled (CSAG) is 

determined in a similar manner (with 

controlled as the common parent). 

Accordingly, unlike prior law, a 

corporation is not treated as engaged in 

the active conduct of a trade or business 

solely as a result of substantially all of 

its assets consisting of stock, or stock 

and securities, of one or more 


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corporations that are merely controlled 

by it (immediately after the distribution) 

each of which is engaged in the active 

conduct of a trade or business. 

Section 355(b)(2)(B) requires that the 

trade or business have been actively 

conducted throughout the five-year 

period ending on the date of the 

distribution (pre-distribution period). 

Section 355(b)(2)(C) provides that the 

trade or business must not have been 

acquired in a transaction in which gain 

or loss was recognized, in whole or in 

part, within the pre-distribution period. 

Section 355(b)(2)(D), as amended in 

1987 and 1988, provides that control of 

a corporation which (at the time of 

acquisition of control) was conducting 

the trade or business must not have 

been directly or indirectly acquired by 

any distributee corporation or by 

distributing during the pre-distribution 

period in a transaction in which gain or 

loss was recognized, in whole or in part. 

See Public Law 100–203 (101 Stat. 1330, 

1330–411 (1987)) and Public Law 100–

647 (102 Stat. 3342, 3605 (1988)). For 

purposes of section 355(b)(2)(D), all 

distributee corporations which are 

members of the same affiliated group (as 

defined in section 1504(a) without 

regard to section 1504(b)) shall be 

treated as one distributee corporation. 

The requirements under section 355(b) 

are collectively referred to in this 

preamble as either the active trade or 

business requirement or the 

requirements of section 355(b). 

Accordingly, the requirements of 

section 355(b) are generally satisfied if 

distributing and controlled each have 

engaged in the active conduct of a trade 

or business throughout the predistribution period, are so engaged 

immediately after the distribution, and 

there have been no acquisitions of 

control of distributing or controlled 

during such period. 

The active trade or business 

requirement is one of several 

requirements that must be satisfied in 

order for a distribution to qualify under 

section 355. For example, section 

355(a)(1)(B) states that a transaction 

must not be used principally as a device 

for distributing the earnings and profits 

of distributing, controlled, or both. In 

addition, § 1.355–2(b)(1) provides that 

section 355 will apply to a transaction 

only if it is carried out for one or more 

corporate business purposes. 

The active trade or business 

requirement, in tandem with the device 

prohibition and business purpose 

requirement, limits a corporation’s 

ability to convert dividend income into 

capital gain through the use of a section 

355 distribution. See S. Rep. No. 83–

1622, at 50–51 (1954) and Coady v. 

Commissioner, 33 TC 771, 777 (1960), 

acq., 1965–2 CB 4, aff’d, 289 F.2d 490 

(6th Cir. 1961). In Coady, the Tax Court 

stated that one purpose of section 355(b) 

is ‘‘to prevent the tax-free separation of 

active and inactive assets into active 

and inactive corporate entities.’’ The 

court also stated that a tax-free 

separation under section 355 ‘‘will 

involve the separation only of those 

assets attributable to the carrying on of 

an active trade or business * * *.’’

Coady, 33 TC at 777. 

The IRS and Treasury Department are 

aware of a number of issues that have 

arisen regarding the active trade or 

business requirement, including issues 

arising as a result of the enactment of 

section 355(b)(3). The following sections 

describe the active trade or business 

requirement and the significant issues 

that are addressed in these proposed 

regulations. No inference should be 

drawn from these proposed regulations 

regarding the definition of trade or 

business or active trade or business 

under any other provision of the Code 

or Treasury regulations, even if such 

provision specifically references section 

355. Comments are requested as to 

whether or the extent to which these 

proposed regulations should apply to 

other provisions that specifically 

reference section 355. 

2. Overview of the Key Aspects of the 

Proposed Regulations 

Principally, these proposed 

regulations provide guidance regarding 

the application of section 355(b)(3), the 

application of the acquisition rules in 

section 355(b)(2)(C) and (D) and the 

impact thereon of section 355(b)(3), and 

the determination of whether a 

corporation is engaged in a trade or 

business through the attribution of trade 

or business assets and activities from a 

partnership. 

As discussed in section A.1. of this 

preamble, section 355(b)(3) treats all 

SAG members as one corporation. 

Accordingly, as discussed in detail in 

section B. of this preamble, these 

proposed regulations provide that 

subsidiary SAG members (SAG 

members that are not the common 

parent of such SAG) are treated like 

divisions of distributing or controlled, 

as the case may be. These proposed 

regulations also clarify that controlled 

may be a DSAG member during the predistribution period. Most significantly, 

these provisions treat a stock acquisition 

that results in a corporation becoming a 

subsidiary SAG member as an asset 

acquisition. As a result, the applicability 

of section 355(b)(2)(D) is substantially 

reduced. Further, as discussed in 

section E. of this preamble, this 

treatment alters the analysis regarding 

whether an existing business may be 

expanded as a result of a stock 

acquisition. 

Notwithstanding that these proposed 

regulations provide that certain stock 

acquisitions may be treated as asset 

acquisitions under section 355(b)(3), 

purchases of stock of controlled during 

the pre-distribution period may be 

subject to section 355(a)(3)(B). See 

section F. of this preamble. 

As discussed in detail in section C. 

and section D. of this preamble, these 

proposed regulations interpret section 

355(b)(2)(C) and (D) to mean that a 

corporation generally cannot use its 

assets to acquire a trade or business to 

be relied on to facilitate a distribution 

under section 355. Accordingly, these 

proposed regulations generally prohibit 

acquisitions made in exchange for 

distributing’s assets even if no gain or 

loss is recognized in connection with 

the acquisition. Further, these proposed 

regulations provide certain exceptions 

to the literal application of section 

355(b)(2)(C) and (D) for acquisitions in 

which gain or loss is recognized where 

the purposes of that section are not 

violated. However, these proposed 

regulations do not disregard the 

recognition of gain or loss in 

transactions between affiliates unless 

the affiliates are members of the same 

SAG. See section G. of this preamble. 

Section I. of this preamble explains 

how these proposed regulations clarify 

a corporation’s ability to be attributed 

the trade or business assets and 

activities of a partnership. Most 

significantly, these partnership 

provisions yield results similar to the 

rules regarding the satisfaction of the 

continuity of business enterprise 

requirement, and thus allow a partner to 

be attributed the partnership’s trade or 

business assets and activities where the 

partner owns a significant interest in the 

partnership. 

B. TIPRA 

Congress enacted section 355(b)(3) 

because it was concerned that, prior to 

a distribution under section 355, 

corporate groups conducting business in 

separate corporate entities often had to 

undergo elaborate restructurings to 

place active businesses in the proper 

entities to satisfy the active trade or 

business requirement. See, for example, 

H.R. Rep. No. 109–304, at 53, 54 (2005). 

By treating a SAG as one corporation, 

Congress believed that it would greatly 

reduce the need for such restructurings. 

However, the introduction of the 

affiliation-based SAG rule into the 

active trade or business requirement 


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significantly impacts the application of 

section 355(b)(2) in certain situations. 

Accordingly, consistent with 

congressional intent, these proposed 

regulations provide several rules 

interpreting section 355(b)(3) in a 

manner that diminishes the need for 

pre-distribution restructurings while 

fully integrating the various provisions 

in section 355(b). These rules are 

intended to more closely reflect the way 

corporate groups structure their 

businesses while, at the same time, 

ensuring that the purposes underlying 

section 355(b)(2)(C) and (D) are not 

circumvented. 

Specifically, to accomplish these 

objectives the IRS and Treasury 

Department believe that it is appropriate 

to apply the SAG rule by disregarding 

the separate existence of all subsidiary 

SAG members for purposes of 

determining whether distributing and 

controlled satisfy the requirements of 

section 355(b). 

1. SAG Rule Applicable During the PreDistribution Period 

The IRS and Treasury Department 

believe that it is appropriate to apply 

the SAG rule for purposes of 

determining whether the trade or 

business was actively conducted 

throughout the pre-distribution period 

and whether the requirements of section 

355(b)(2)(C) or (D) have been violated. 

The SAG rule applies for purposes of 

determining whether distributing and 

controlled are engaged in the active 

conduct of a trade or business 

immediately after the distribution. 

Specifically, the legislative history to 

section 355(b)(3) describes the 

corporations included in the DSAG and 

CSAG by reference to post-distribution 

affiliation. See H.R. Rep. No. 109–455, 

at 88 (2006) (Conf. Rep.); H.R. Rep. No. 

109–304, at 54 (2005). However, there is 

nothing in the statute or legislative 

history that precludes the SAG rule 

from applying throughout the predistribution period. 

The IRS and Treasury Department 

believe that applying the SAG rule 

throughout the pre-distribution period 

is consistent with the single-entity 

approach. If the SAG rule is not applied 

during the pre-distribution period, there 

may be unintended consequences. For 

example, assume that an active trade or 

business is segmented among the SAG 

members in a manner that precludes 

any one member from individually 

being treated as engaged in an active 

trade or business. Under the SAG rule 

the segments are aggregated and may be 

treated as a single active trade or 

business immediately after the 

distribution. However, if the SAG rule is 

not applied throughout the predistribution period, there would be no 

five-year active trade or business 

because no one member would be 

engaged in that trade or business. The 

IRS and Treasury Department do not 

believe there is any policy reason to 

apply the SAG rule in such a disparate 

manner. Accordingly, these proposed 

regulations apply the SAG rule 

throughout the pre-distribution period. 

This approach is consistent with 

Congressional intent to view SAGs as an 

aggregate for purposes of the active 

trade or business requirement. 

Because the SAG rule treats all SAG 

members as one corporation, the 

separate existence of subsidiary SAG 

members are disregarded and all assets 

(and activities) owned (and performed) 

by SAG members are treated as owned 

(and performed) by distributing or 

controlled, as the case may be, for 

purposes of determining whether 

distributing or controlled is engaged in 

a five-year active trade or businesses. 

Therefore, where one DSAG or CSAG 

member satisfies the active trade or 

business requirement, distributing or 

controlled, as the case may be, satisfies 

the active trade or business requirement. 

Consistent with the foregoing, these 

proposed regulations provide that the 

SAG rule also applies for purposes of 

determining whether there has been an 

impermissible acquisition, as discussed 

in section C. of this preamble, of a trade 

or business during the pre-distribution 

period under section 355(b)(2)(C) or (D). 

Because the SAG rule disregards the 

separate existence of subsidiary SAG 

members, these proposed regulations 

generally treat stock acquisitions that 

result in a corporation becoming a 

subsidiary SAG member as a direct 

acquisition of any assets (or activities) 

owned (or performed) by the acquired 

corporation. Further, these proposed 

regulations generally disregard transfers 

of assets (or activities) that are owned 

(or performed) by the SAG immediately 

before and immediately after the 

transfer. Such transfers cannot result in 

an acquisition. Under the SAG rule, 

such transfers have the effect of a 

transfer between divisions of a single 

corporation. 

2. The DSAG May Include CSAG 

Members Throughout the PreDistribution Period 

The IRS and Treasury Department 

believe that it is appropriate to include 

the CSAG members in the DSAG during 

the pre-distribution period if the 

applicable affiliation requirements are 

satisfied. The IRS and Treasury 

Department believe this approach is 

consistent with the purposes of section 

355(b)(3) and the SAG rule’s general 

single-entity approach, and provides 

flexibility for the division of SAG 

members between distributing and 

controlled. 

For example, assume that during the 

pre-distribution period, segments or 

portions of the business to be conducted 

by controlled are held by distributing 

(or other subsidiaries that are not 

directly or indirectly owned by 

controlled) and that distributing intends 

to transfer those portions of the business 

to controlled immediately prior to the 

distribution. If the DSAG does not 

include the CSAG members throughout 

the pre-distribution period, it is possible 

that neither SAG would be engaged in 

the active conduct of that trade or 

business throughout the pre-distribution 

period, because neither SAG would 

have all the appropriate segments of that 

business to satisfy the active trade or 

business requirement. The IRS and 

Treasury Department believe that such a 

result is inconsistent with the purposes 

of section 355(b)(3). Accordingly, by 

including the CSAG members in the 

DSAG throughout the pre-distribution 

period if the ownership requirements 

are satisfied, these proposed regulations 

give appropriate credit to five-year 

active trades or businesses regardless of 

how the assets and activities may be 

owned (and performed) by the SAG 

members throughout the predistribution period. 

3. Acquisitions of Stock in Subsidiary 

SAG Members 

Section 355(b)(3) treats SAG members 

as one corporation for purposes of 

satisfying the requirements of section 

355(b). As a result, the SAG rule alters 

the application of section 355(b)(2)(C) 

and (D) with respect to the acquisition 

of stock of a corporation that is or 

becomes a subsidiary SAG member. 

Further, because section 355(b)(3) 

supplanted the holding company rule in 

section 355(b)(2)(A), section 

355(b)(2)(D) is now only applicable to 

certain acquisitions of stock of 

distributing and certain acquisitions of 

stock of controlled. 

The SAG rule alters the application of 

section 355(b)(2)(C) and (D) with respect 

to the acquisition of stock of a 

corporation that is or becomes a 

subsidiary SAG member. Section 

355(b)(3) treats SAG members as one 

corporation for purposes of satisfying 

section 355(b). Consequently, a 

transaction that results in a 

corporation—including controlled—

becoming a subsidiary SAG member is 

treated as a direct acquisition of all the 

assets (and activities) owned (and 

performed) by the acquired corporation 


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at the time of the acquisition. Thus, 

such an acquisition is tested under 

section 355(b)(2)(C) rather than section 

355(b)(2)(D). Nevertheless, as discussed 

in sections B.4 and C.3.a.ii. of this 

preamble, section 355(b)(2)(D) has 

continuing limited application. 

In addition, an acquisition that results 

in a corporation becoming a subsidiary 

SAG member in a transaction in which 

gain or loss is recognized might satisfy 

the requirements of section 355(b)(2)(C) 

as an expansion of one of the acquiring 

SAG’s existing businesses, as discussed 

in section E. of this preamble. Finally, 

because the SAG rule treats subsidiary 

SAG members like divisions, the 

acquisition of additional stock of a 

current subsidiary SAG member has no 

effect for purposes of applying section 

355(b)(2)(C). 

4. Acquisitions of Control of Controlled 

Where It Is Not a DSAG Member 

While section 355(b)(2)(D) is not 

applicable to acquisitions of stock of 

subsidiary SAG members, the 

requirements of section 355(b)(2)(D) 

must be satisfied where the DSAG 

acquires control of controlled where 

controlled is not and does not become 

a DSAG member prior to the 

distribution. This rule applies where 

distributing acquires stock constituting 

control of controlled but not stock 

meeting the requirements of section 

1504(a)(2). 

C. Acquisitions of a Trade or Business 

Section 355(b)(2)(C) and (D) generally 

provide that a trade or business 

acquired, directly or indirectly, during 

the pre-distribution period will not 

satisfy the active trade or business 

requirement unless it was acquired in a 

transaction in which no gain or loss was 

recognized. The IRS and Treasury 

Department believe that these 

provisions have been and should 

continue to be interpreted and applied 

in a manner consistent with the overall 

purposes of section 355. For example, in 

certain situations, transactions in which 

gain or loss is recognized have been 

found not to violate the purposes of 

section 355(b)(2)(C) and (D). See, for 

example, C.I.R. v. Gordon, 382 F.2d 499 

(2d Cir.1967), rev’d on other grounds, 

391 U.S. 83 (1968) (discussed in section 

C.2. of this preamble). Additionally, 

while the enactment of section 355(b)(3) 

substantially revised how distributing 

and controlled may satisfy the active 

trade or business requirement, TIPRA 

did not contain conforming 

amendments to section 355(b)(2)(C) and 

(D). As such, the IRS and Treasury 

Department also believe that a purposebased interpretation of section 355(b)(2) 

is essential to harmonize these 

provisions. Accordingly, these proposed 

regulations interpret and apply section 

355(b)(2)(C) and (D), and section 

355(b)(3), in a manner consistent with 

their purpose, even if not always 

consistent with the literal language of 

the statute. 

1. Purpose of Section 355(b)(2)(C) and 

(D) 

Section 355 ‘‘contemplates that a taxfree separation shall involve only the 

separation of assets attributable to the 

carrying on of an active business.’’ S. 

Rep. No. 83–1622, at 50 (1954). The 

active trade or business requirement is 

intended to ensure that only these types 

of separations qualify under section 355. 

Further, it operates as an additional 

safeguard to the device prohibition (a 

prohibition against disguised dividends) 

in section 355(a)(1)(B). 

As discussed in section A. of this 

preamble, the active trade or business 

requirement is designed to limit the 

potential for the conversion of dividend 

income into capital gain through a 

section 355 distribution. Specifically, 

section 355(b)(2)(C) and (D) is intended 

to prevent dividend avoidance 

otherwise available through the 

purchase of a new business in order to 

facilitate a tax-free distribution under 

section 355. See Gordon, 382 F.2d at 

506–507 (stating that ‘‘[t]o safeguard 

against this possibility, subsections 

(b)(2)(C) and (D) prohibit acquisition of 

a trade or business, or of a corporation, 

in a transaction in which gain or loss 

was recognized.’’). Thus, the statute 

prohibits acquisitions of a trade or 

business in which gain or loss is 

recognized. Nevertheless, the 

recognition of gain or loss, in and of 

itself, does not violate the purposes of 

section 355. Rather, recognition of gain 

or loss is generally indicative of the type 

of consideration used in the transaction. 

Typically, a transaction in which gain or 

loss is recognized consists of an 

acquisition in exchange for assets. On 

the other hand, a transaction in which 

no gain or loss is recognized typically 

consists of an acquisition in exchange 

for the corporation’s equity. 

Accordingly, the IRS and Treasury 

Department believe that the common 

purpose of section 355(b)(2)(C) and (D) 

is to prevent distributing from using 

assets—instead of its stock or stock of a 

corporation in control of distributing—

to acquire a new trade or business in 

anticipation of distributing that trade or 

business (or facilitating the distribution 

of another trade or business) to its 

shareholders in a tax-free distribution. A 

distribution of a corporation holding 

assets that would have been used to 

effect a purchase generally would be 

treated as a dividend and section 355 

was not intended to allow a tax-free 

separation of such assets. Acquiring a 

new trade or business using these assets 

and distributing it (or an existing trade 

or business) would effectively 

accomplish such a separation, and 

should not qualify under section 355. 

Complementing the principle that the 

common purpose of section 355(b)(2)(C) 

and (D) is to prevent distributing from 

using it assets—instead of its stock, or 

stock of a corporation in control of 

distributing—to acquire a new trade or 

business is the notion that section 355 

is intended to apply to separations of 

active trades or businesses with which 

the participants have a historic 

relationship. Section 355, like the 

reorganization provisions, involves the 

maintenance by the shareholders of a 

continuing interest in their business or 

businesses in modified corporate forms. 

For section 355 to apply to a divisive 

transaction, it is essential that 

distributing and its shareholders have a 

historic relationship with the active 

trades or businesses in the two resulting 

corporations. See, for example, § 1.355–

1(b) (‘‘[section 355] applies only to the 

separation of existing businesses that 

have been in active operation for at least 

five years * * * and which, in general, 

have been owned, directly or indirectly, 

for at least five years by the distributing 

corporation’’). These requirements 

ensure that the historic owners of the 

acquired trade or business are 

participants in the divisive transaction 

and minimize the potential for 

transactions that violate the common 

purpose of section 355(b)(2)(C) and (D). 

Where distributing issues its own 

equity (or uses the equity of a 

corporation in control of distributing) to 

acquire an active trade or business in a 

transaction in which no gain or loss is 

recognized, distributing is not acquiring 

the trade or business in exchange for its 

assets and the historic owners of the 

trade or business will be participants in 

the divisive transaction. In such cases, 

the common purpose of section 

355(b)(2)(C) and (D) is carried out. 

Finally, an additional purpose of 

section 355(b)(2)(D) is to prevent a 

distributee corporation from acquiring 

control of distributing in anticipation of 

a distribution to which section 355 

would otherwise apply, enabling the 

disposition of controlled without the 

proper recognition of corporate level 

gain. See H.R. Rep. No. 100–391, at 

1080, 1082–1083 (1987). 


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2. Current Law and the § 1.355–3(b)(4) 

Regulations 

Under current law, several authorities 

depart from the literal language of 

section 355(b)(2)(C) and (D) in order to 

carry out the common purpose 

underlying section 355(b)(2)(C) and (D). 

For example, in Gordon, gain was 

recognized when distributing 

transferred a trade or business to 

controlled. The Second Circuit 

concluded that, even though gain was 

recognized, section 355(b)(2)(C) was not 

violated because new assets were not 

brought within the combined corporate 

shells of distributing and controlled. 

Therefore, the common purpose of 

section 355(b)(2)(C) and (D) was not 

violated. Furthermore, Rev. Rul. 69–461 

(1969–2 CB 52) held that a first-tier 

subsidiary’s taxable distribution of stock 

of a second-tier subsidiary to its parent 

did not violate section 355(b)(2)(D). The 

ruling stated that section 355(b)(2)(D) is 

intended to prevent the acquisition of 

control of a corporation from a party not 

within the direct or indirect control of 

distributing. In addition, Rev. Rul. 78–

442 (1978–2 CB 143) held that gain 

under section 357(c) on the transfer 

from distributing to controlled does not 

violate section 355(b)(2)(C). Rev. Rul. 

78–442 stated that section 355(b)(2)(C) 

is intended to prevent the acquisition of 

a trade or business by distributing or 

controlled from an outside party in a 

taxable transaction within five years of 

a distribution. 

Similarly, § 1.355–3(b)(4) (generally 

applicable to distributions on or before 

December 15, 1987, but applied in 

various situations by the IRS 

administratively to distributions 

occurring after that date) provides an 

exception from the literal language of 

section 355(b)(2)(C) and (D) for the 

direct or indirect acquisition of a trade 

or business by one member of an 

affiliated group from another member of 

the group, stating that an acquisition 

from another member of the affiliated 

group ‘‘is not the type of transaction to 

which section 355(b)(2)(C) and (D) is 

intended to apply.’’ See § 1.355–

3(b)(4)(iii). 

Section 1.355–3(b)(4) also departs 

from the literal language of section 

355(b) in providing that a trade or 

business acquired, directly or indirectly, 

within the pre-distribution period in a 

transaction in which the basis of the 

assets acquired was not determined in 

whole or in part by reference to the 

transferor’s basis does not qualify under 

section 355(b)(2), even though no gain 

or loss was recognized by the transferor. 

See § 1.355–3(b)(4)(i). The reason for 

this departure is that in some 

circumstances a transaction in which no 

gain or loss is recognized may 

nevertheless constitute a prohibited 

acquisition of a trade or business in 

exchange for assets. 

3. The Proposed Regulations 

Consistent with current law (and 

§ 1.355–3(b)(4)), these proposed 

regulations generally prohibit 

acquisitions in which gain or loss was 

recognized but apply section 

355(b)(2)(C) and (D) in a manner 

consistent with their purposes. 

Accordingly, these proposed regulations 

provide for certain exceptions for 

acquisitions in which gain or loss is 

recognized, and prohibit certain 

transactions in which no gain or loss is 

recognized. 

a. Certain Transactions in Which 

Recognized Gain or Loss Is Disregarded 

Under these proposed regulations, 

certain acquisitions are excepted from 

the general rule under section 

355(b)(2)(C) and (D) that a trade or 

business, or control of a corporation 

engaged in a trade or business, cannot 

satisfy the active trade or business 

requirement if it was acquired during 

the pre-distribution period in a 

transaction in which gain or loss was 

recognized. These transactions are so 

excepted because they do not violate the 

purposes of section 355(b)(2)(C) and (D). 

i. Certain Acquisitions by the DSAG or 

CSAG 

These proposed regulations provide a 

number of exceptions to the application 

of section 355(b)(2)(C) and (D) not 

contained in the current regulations (or 

§ 1.355–3(b)(4)). One of these exceptions 

disregards any gain or loss recognized in 

connection with an acquisition by the 

CSAG from the DSAG of a trade or 

business, an interest in a partnership 

engaged in a trade or business, or stock 

of a corporation engaged in a trade or 

business. This exception is appropriate 

because it is not a use of distributing’s 

assets to acquire the trade or business 

Another exception disregards gain or 

loss recognized in an acquisition solely 

as a result of the payment of cash to 

shareholders for fractional shares where 

the cash paid represents a mere 

rounding off of the fractional shares in 

the exchange and is not separately 

bargained for consideration. The IRS 

and Treasury Department believe that 

this is not the type of transaction to 

which section 355(b)(2)(C) or (D) is 

intended to apply. Although such a 

transaction involves a small use of 

assets, these proposed regulations 

except such acquisitions because the 

small amount of assets are not 

separately bargained for and are used 

merely to simplify the exchange. Other 

authorities reach similar conclusions in 

the context of reorganizations. See Rev. 

Rul. 66–365 (1966–2 CB 116), amplified 

by Rev. Rul. 81–81 (1981–1 CB 122) 

(concluding that cash in lieu of 

fractional shares does not violate the 

solely for voting stock requirement of 

section 368(a)(1)(B) and (C) because it 

was merely a mathematical rounding off 

for simplicity, and the transaction ‘‘was 

for all practical purposes ‘‘solely in 

exchange for voting stock’’’). 

In addition, as discussed in section G. 

of this preamble, these proposed 

regulations provide a limited exception 

for taxable acquisitions from affiliates 

that are members of the same SAG. 

Specifically, acquisitions between SAG 

members (where the assets (or activities) 

are owned (or performed) by the SAG 

immediately before and immediately 

after the transfer) are disregarded 

whether they are taxable or not. 

Like the current regulations, these 

proposed regulations provide that 

acquisitions that expand a pre-existing 

business are generally exempted from 

the nonrecognition requirement. See 

§ 1.355–3(b)(3)(ii). While these 

transactions may involve the use of the 

DSAG’s or CSAG’s assets, they are not 

acquisitions of a new or different trade 

or business. Because the DSAG or 

CSAG, as the case may be, is already in 

the business, such transactions are not 

considered acquisitions of a trade or 

business under section 355(b)(2)(C) and 

(D). 

ii. Certain Acquisitions by a Distributee 

Corporation 

Consistent with the principles of Rev. 

Rul. 74–5 (1974–1 CB 82), obsoleted by 

Rev. Rul. 89–37 (1989–1 CB 107), these 

proposed regulations disregard the 

recognition of gain or loss in applying 

section 355(b)(2)(D) to certain 

acquisitions of the stock of distributing 

by a distributee corporation. Prior to the 

1987 and 1988 amendments noted in 

section A.1 of this preamble, section 

355(b)(2)(D) was not violated in a case 

where distributing distributed the stock 

of controlled even though a purchaser 

acquired distributing’s stock during the 

pre-distribution period in a transaction 

in which gain or loss was recognized. 

See Rev. Rul. 74–5 (reasoning that the 

purpose of section 355(b)(2)(D) was to 

prevent distributing, rather than the 

shareholder of distributing, from 

accumulating excess funds to purchase 

the stock of a corporation engaged in an 

active trade or business). However, Rev. 

Rul. 74–5 held that the purchaser could 

not then further distribute the stock of 

controlled until five years after such 


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purchase, reasoning that the purchaser, 

the distributing corporation in the 

second distribution, indirectly acquired 

the stock of controlled through another 

corporation, the distributing corporation 

in the first distribution. 

The 1987 and 1988 amendments to 

section 355(b)(2)(D) prohibited such 

transactions because of a concern that 

such acquisitions were similar to 

transactions that permitted a 

corporation to dispose of an appreciated 

subsidiary without the proper 

recognition of gain contrary to the 

repeal of the General Utilities doctrine. 

For example, assume P, a corporation, 

acquired the stock of D in a transaction 

in which gain or loss was recognized 

and D immediately distributed the stock 

of C to P in a section 355 transaction. 

P would allocate its basis in the newly 

acquired D stock between the D stock 

and the C stock received in the 

distribution. P could then potentially 

sell the C stock without the appropriate 

recognition of gain. See H.R. Rep. No. 

100–391, at 1080, 1082–1083 (1987). 

However, there are transactions that 

violate the literal requirements of 

section 355(b)(2)(D) but do not violate 

the purpose of the 1987 and 1988 

amendments. For example, assume that 

for more than five years, T, a 

corporation, owned all of the stock of D, 

which in turn owned all the stock of C. 

Throughout this period, D and C have 

each engaged in the active conduct of a 

trade or business. In year 6, P acquires 

the stock of T in a transaction in which 

gain or loss is recognized, and holds the 

T stock with a cost basis determined 

under section 1012. In year 7, P 

liquidates T in a transaction to which 

section 332 applies and in which no 

gain or loss is recognized, thereby 

eliminating its cost basis in the T stock. 

Thereafter, P holds the D stock with a 

basis equal to T’s basis in the D stock. 

In year 8, D distributes the C stock to P. 

Under these facts, P cannot dispose of 

the D or C stock without recognizing the 

same amount of gain or loss that T 

would have recognized. 

Similarly, assume the same facts as 

the previous example, except that in 

year 6 P acquires all of T’s assets, 

including the D stock, in exchange for 

P stock and cash in a reorganization 

described in section 368(a)(1)(A). 

Because all of the cash is distributed to 

the T shareholders, T does not recognize 

any gain, and P’s basis in the D stock is 

equal to T’s basis in the D stock. See 

section 362(b). In year 7, D distributes 

the C stock to P. Under these facts, P 

cannot dispose of the D or C stock 

without recognizing the same amount of 

gain or loss that T would have 

recognized. 

The IRS and Treasury Department 

believe that the distributee corporation 

language in section 355(b)(2)(D)(i) is 

intended only to prevent transactions 

that are contrary to the repeal of the 

General Utilities doctrine. In both of the 

examples just described, neither the D 

stock nor C stock can be disposed of in 

a manner that is contrary to the repeal 

of the General Utilities doctrine. 

Accordingly, these proposed regulations 

provide that section 355(b)(2)(D) is not 

violated where there is a direct or 

indirect acquisition by a distributee 

corporation of control of distributing in 

one or more transactions in which gain 

or loss is recognized where the basis of 

the acquired distributing stock in the 

hands of the distributee corporation is 

determined in whole by reference to the 

transferor’s basis. However, consistent 

with the principles of Rev. Rul. 74–5, 

this rule is only applicable with respect 

to a distribution by the acquired 

distributing, and does not apply for 

purposes of any subsequent distribution 

by any distributee corporation. 

b. Certain Nonrecognition Transactions 

Treated as Recognition Transactions 

Because the IRS and Treasury 

Department believe that acquisitions 

made in exchange for assets violate the 

common purpose of section 355(b)(2)(C) 

and (D) even if no gain or loss is 

recognized, these proposed regulations 

provide that such transactions are 

treated as transactions in which gain or 

loss is recognized. 

i. Acquisitions in Exchange for Assets 

As discussed in section C.1 of this 

preamble, the common purpose 

underlying section 355(b)(2)(C) and (D) 

is that distributing generally should not 

be able to use its assets to acquire a new 

trade or business in anticipation of 

distributing that trade or business (or 

facilitating the distribution of another 

trade or business) to its shareholders in 

a tax-free transaction. Similarly, and 

also discussed in section C.1. of this 

preamble, section 355(b), by permitting 

the use of distributing stock to acquire 

a trade or business, ensures a historic 

relationship between the distributing 

shareholders and the trades or 

businesses relied upon to satisfy the 

active trade or business requirement. 

The following examples illustrate 

distributing’s use of its assets to acquire 

a new trade or business. 

First, assume that D, a corporation 

that does not directly conduct a fiveyear active trade or business, owns all 

of the stock of C, a corporation with a 

five-year active trade or business. D 

wishes to spin-off C to its shareholders, 

but to do so D must satisfy the active 

trade or business requirement. 

Accordingly, D contributes assets to an 

unrelated partnership that is engaged in 

a five-year active trade or business in a 

transaction to which section 721 applies 

in exchange for an interest in the 

partnership that otherwise satisfies the 

requirements for D to be attributed the 

trade or business assets and activities of 

the partnership, as discussed in section 

I. of this preamble. Two years after the 

transfer, when D’s only active trade or 

business is the business conducted by 

the partnership, D distributes the C 

stock pro rata to the D shareholders. 

Alternatively, assume that D, a 

corporation with a five-year active trade 

or business, transfers assets to unrelated 

T, a corporation with a five-year active 

trade or business, in a transaction to 

which section 351 applies in exchange 

for an amount of T stock constituting 

control. Two years after the transfer, 

when T’s only active trade or business 

is the business T conducted before D’s 

transfer, D distributes the T stock pro 

rata to the D shareholders. 

Similarly, assume that D, a 

corporation with a five-year active trade 

or business, owns all of the stock of C, 

a corporation that does not have a fiveyear active trade or business but has 

other assets. To cause C to satisfy the 

active trade or business requirement, D 

arranges for C to acquire a five-year 

active trade or business from T, an 

unrelated corporation, in a 

reorganization described in section 

368(a)(1)(A). In the reorganization, the 

shareholders of T receive solely 

common stock of C representing 20 

percent or less of the voting power of all 

classes of C stock. Two years after the 

reorganization, D distributes the C stock 

pro rata to the D shareholders. 

In each of these examples, D has 

directly or indirectly acquired a trade or 

business in exchange for assets. See and 

compare Situation 2 of Rev. Rul. 2002–

49 (2002–2 CB 288) (corporation’s use of 

appreciated securities to acquire a trade 

or business of a partnership in a 

transaction to which section 721 applies 

is treated as an acquisition in which 

gain or loss was recognized); section 

4.01(29) of Rev. Proc. 2007–3 (2007–1 

IRB 108) (the IRS will not ordinarily 

rule where distributing acquires control 

of controlled by transferring inactive 

assets in a transaction meeting the 

requirements of section 351(a) or section 

368(a)(1)(D) and in which no gain or 

loss is recognized). While these 

transactions satisfy the literal 

requirements of section 355(b)(2)(C) or 

(D), the underlying common purpose of 

those provisions has been violated. In 

each case, distributing has acquired in 

exchange for distributing’s assets, either 


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directly or indirectly through the 

issuance of controlled stock the trade or 

business to be relied on by distributing 

or controlled. 

Furthermore, in each of these 

examples, the historic owners have 

supplied a trade or business for 

distributing or controlled, but they are 

not participants in the divisive 

transaction. Not being shareholders of 

D, the position of the historic owners of 

the acquired business is not altered by 

the distribution of the controlled stock. 

Accordingly, neither distributing nor 

the distributing shareholders have a 

historic relationship with the separated 

businesses, and the distribution of the 

controlled stock is not the type of 

transaction to which section 355 was 

intended to apply. 

By contrast, had D issued its own 

stock in the reorganization in the last 

example, the substance of the 

transaction would be different. D would 

not have indirectly acquired a trade or 

business in exchange for assets but 

rather for its own equity. Because D 

would not be purchasing a business for 

its shareholders, the distribution is not 

a substitute for a taxable distribution of 

the consideration that would have been 

used in the purchase. Furthermore, 

where D stock is used as the 

consideration the former T shareholders 

would have joined D’s shareholder base, 

and become participants in the divisive 

reorganization. 

These proposed regulations prohibit 

the acquisition of a trade or business 

directly or indirectly in exchange for 

assets in order to ensure that the 

common purpose of section 355(b)(2)(C) 

and (D) are satisfied. Such an 

acquisition also would include a swap 

of an interest in an existing five-year 

active trade or business for an interest 

in a new active trade or business. This 

type of an acquisition could occur 

through the formation of a joint venture 

structure. 

For example, assume D and X form a 

partnership joint venture in which D 

contributes a five-year active trade or 

business (ATBD) and X contributes a 

different five-year active trade or 

business (ATBX). D and X each receive 

a 50-percent interest in the partnership. 

D’s interest is sufficient to satisfy the 

requirements for D to be attributed the 

partnership’s trade or business assets 

and activities (as discussed in section I. 

of this preamble). Prior to a potential 

section 355 distribution by D, and 

within five years of the contribution, the 

partnership sells ATBD. 

D cannot rely on ATBX until five 

years after the acquisition of its interest 

in the partnership because, in effect, at 

the time of the contributions D 

exchanged a 50-percent undivided 

interest in ATBD for a 50-percent 

undivided interest in ATBX. Therefore, 

D acquired its interest in ATBX in 

exchange for its assets. While this was 

a transaction in which no gain or loss 

was recognized, the exchange of assets 

violates the common purpose of section 

355(b)(2)(C) and (D). Further, the 

historic owner of ATBX would not 

participate in any distribution of 

controlled stock by D. Accordingly, 

such a distribution would not be the 

type of transaction to which section 355 

was intended to apply. 

Similarly, a corporation can 

effectively swap its assets through the 

issuance of stock of a subsidiary 

(including controlled). Accordingly, 

these proposed regulations provide a 

specific rule to address tax-free 

acquisitions involving the issuance of 

subsidiary stock. These proposed 

regulations provide that if a SAG 

directly or indirectly owns stock of a 

subsidiary (including a subsidiary SAG 

member) and the subsidiary directly or 

indirectly acquires a trade or business, 

an interest in a partnership engaged in 

a trade or business, or stock of a 

corporation engaged in a trade or 

business from a person other than such 

SAG in exchange for stock of such 

subsidiary in a transaction in which no 

gain or loss is recognized (the 

acquisition), solely for purposes of 

applying section 355(b)(2)(C) or (D) with 

respect to the trade or business, 

partnership interest, or stock acquired 

by the subsidiary in the acquisition, the 

subsidiary’s stock directly or indirectly 

owned by the SAG immediately after 

the acquisition is treated as acquired at 

the time of the acquisition in a 

transaction in which gain or loss is 

recognized. 

This rule reflects the fact that 

although the acquiring subsidiary did 

not make the acquisition in exchange for 

its assets (it issued its own stock), the 

SAG that owns stock of the subsidiary 

has exchanged an indirect interest in the 

subsidiary’s assets for an indirect 

interest in the trade or business 

acquired by the subsidiary in the 

acquisition. Thus, the SAG has 

indirectly acquired a portion of the 

subsidiary’s newly acquired trade or 

business (equal to the shareholder’s 

stock interest in the subsidiary 

immediately after the acquisition) in 

exchange for assets. Further, the IRS and 

Treasury Department believe that it 

would be inappropriate to allow such 

acquired trade or business to be relied 

on to satisfy the active trade or business 

requirement within five years of its 

acquisition because the historic owners 

of that trade or business would not 

participate in any distribution of 

controlled stock. 

However, because such a transaction 

does not result in an acquisition of any 

pre-existing trade or business of the 

subsidiary, this rule merely treats the 

SAG’s stock in the subsidiary 

immediately after the acquisition as 

acquired in a gain or loss transaction for 

purposes of applying section 

355(b)(2)(C) or (D) to the newly acquired 

trade or business. Further, the impact of 

such a transaction on the ability to rely 

on the newly acquired trade or business 

to satisfy the requirements of section 

355(b) depends upon how much 

subsidiary stock the SAG owns 

immediately after the transaction. 

For example, assume D owns all of 

the sole class of stock of S, a corporation 

that does not conduct a five-year active 

trade or business. T, an unrelated 

corporation with a five-year active trade 

or business (ATBT), merges into S in a 

reorganization described in section 

368(a)(1)(A) and (D) solely in exchange 

for 80 percent of the S stock, and no 

gain or loss is recognized. Immediately 

after the merger, D owns only 20 percent 

of the sole class of S stock. Solely for 

purposes of determining whether ATBT 

can be relied on to satisfy the active 

trade or business requirement, D is 

treated as having acquired its 20 percent 

of the S stock at the time of the merger 

of T into S in a transaction in which 

gain or loss was recognized. 

Accordingly, as described in section 

D.2.a. of this preamble regarding certain 

multi-step acquisitions of a subsidiary 

SAG member, if D subsequently 

acquired the 80 percent of the S stock 

held by the other shareholders solely in 

exchange for D voting stock in a 

reorganization described in section 

368(a)(1)(B) in which no gain or loss 

was recognized, S would become a 

DSAG member and D could rely on 

ATBT to satisfy the active trade or 

business requirement. 

Accordingly, in light of all of these 

concerns, these proposed regulations 

generally provide that acquisitions paid 

for in whole or in part, directly or 

indirectly, with assets of the DSAG will 

be treated as acquisitions in which gain 

or loss is recognized. However, if a 

DSAG member or controlled acquires 

the trade or business solely in exchange 

for distributing stock, distributing 

acquires control of controlled solely in 

exchange for distributing stock, or 

controlled acquires the trade or business 

from distributing solely in exchange for 

stock of controlled, in a transaction in 

which no gain or loss is recognized, the 

requirements of section 355(b)(2)(C) and 

(D) are satisfied. Such acquisitions are 


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not made in exchange for assets of the 

DSAG. 

An additional question arising under 

section 355(b)(2)(C) and (D) is whether 

the assumption of liabilities is treated as 

a payment of money or other property, 

and hence the use of assets. See United 

States v. Hendler, 303 U.S. 564, reh’g 

denied, 304 U.S. 588 (1938) (viewing an 

assumption of a liability by a transferee 

as in substance a payment to the 

transferor). Congress has indicated that 

the assumption of liabilities is not to be 

treated as the payment of money or 

other property in certain transactions in 

which no gain or loss is recognized. For 

example, the assumption of liabilities is 

not treated as the payment of money or 

other property in certain exchanges to 

which section 351 or 361 applies. See 

section 357(a). Further, the assumption 

of liabilities does not violate the solely 

for voting stock requirement in a 

reorganization described in section 

368(a)(1)(C) where the acquiring 

corporation does not otherwise 

exchange money or other property. See 

section 368(a)(1)(C) and (a)(2)(B). 

Because Congress has granted this 

special treatment for liability 

assumptions in certain nonrecognition 

transactions, the IRS and Treasury 

Department believe that similar 

treatment is generally appropriate for 

purposes of section 355(b)(2)(C) and (D). 

Accordingly, these proposed regulations 

provide that the assumption by the 

DSAG or CSAG of liabilities of a 

transferor shall not, in and of itself, be 

treated as the payment of assets if such 

assumption is not treated as the 

payment of money or other property 

under any other applicable provision. 

Finally, these proposed regulations 

clarify that an acquisition to which 

section 304(a)(1) applies does not satisfy 

the requirements of section 355(b)(2)(C) 

or (D). The IRS and Treasury 

Department believe that a stock 

acquisition to which section 304 applies 

is a transaction in which gain or loss is 

recognized for purposes of section 

355(b)(2)(C) and (D) even if it merely 

results in the transferor’s receipt of 

dividend income. These proposed 

regulations clarify that, regardless of the 

tax consequences to the transferor, such 

a transaction is an acquisition made in 

exchange for assets, and therefore does 

not satisfy the requirements of section 

355(b)(2)(C) and (D). 

ii. Partnership Distributions 

These proposed regulations provide 

that an acquisition consisting of a 

distribution from a partnership is 

generally treated as a transaction in 

which gain or loss is recognized because 

it constitutes an acquisition in exchange 

for assets. That is, the distributee 

partner is generally exchanging an 

indirect interest in all the assets of the 

partnership for a direct interest in the 

property distributed. However, these 

proposed regulations provide that if the 

corporation is already attributed the 

trade or business assets and activities of 

a partnership, the corporation’s 

acquisition of such trade or business 

assets and activities from the 

partnership is not, in and of itself, the 

acquisition of a new trade or business. 

Further, these proposed regulations 

provide that an acquisition consisting of 

a pro rata distribution from a 

partnership of stock or an interest in a 

lower-tier partnership is not an 

acquisition in exchange for assets to the 

extent the distributee partner did not 

acquire the interest in the distributing 

partnership during the pre-distribution 

period in a transaction in which gain or 

loss was recognized and to the extent 

the distributing partnership did not 

acquire the distributed stock or 

partnership interest within such period. 

In such a case, the distributee partner 

has merely exchanged an indirect 

interest for a direct interest in the 

distributed stock or partnership interest, 

and continues to possess the same 

indirect interest in the remaining assets 

of the partnership. 

iii. Lack of Transferred Basis 

Section 1.355–3(b)(4)(i) provides that 

a trade or business acquired, directly or 

indirectly, within the pre-distribution 

period in a transaction in which the 

basis of the assets acquired was not 

determined in whole or in part by 

reference to the transferor’s basis does 

not qualify under section 355(b)(2), even 

though no gain or loss was recognized 

by the transferor. These proposed 

regulations do not include a similar 

provision. The IRS and Treasury 

Department believe that the prohibition 

against acquisitions in exchange for 

assets fully addresses such acquisitions. 

c. Application of Section 355(b)(2)(C) 

and (D) to Predecessors 

Unlike § 1.355–3(b)(4)(i), which only 

took ‘‘a predecessor in interest’’ into 

account for purposes of applying section 

355(b)(2)(D), these proposed regulations 

provide that any reference to a 

corporation includes a reference to a 

predecessor of such corporation in 

applying both section 355(b)(2)(C) and 

(D). The IRS and Treasury Department 

believe that predecessors should be 

taken into account in applying both 

section 355(b)(2)(C) and (D) because the 

same policy concerns exist regardless of 

whether the transaction involves the 

acquisition of assets or stock. For this 

purpose, the proposed regulations 

define a predecessor of a corporation as 

a corporation that transfers its assets to 

such corporation in a transaction to 

which section 381 applies. The IRS and 

Treasury Department believe that it is 

appropriate to take predecessors into 

account in applying these provisions in 

order to appropriately minimize the 

significance of which corporation is the 

acquiror and which corporation is the 

target. 

Further, because the SAG rule 

effectively treats SAG members as a 

singly-entity for purposes of section 

355(b), these proposed regulations also 

apply section 355(b)(2)(C) and (D) to 

acquisitions during the pre-distribution 

period by corporations that later become 

DSAG or CSAG members. These types 

of acquisitions are similar to 

predecessor asset acquisitions. 

4. Requests for Comments Regarding 

Exceptions to Section 355(b)(2)(C) and 

(D) 

The IRS and Treasury Department 

request comments regarding whether 

any additional exceptions to section 

355(b)(2)(C) and (D) are appropriate. In 

particular, the IRS and Treasury 

Department request comments regarding 

whether acquisitions in which gain is 

recognized solely as a result of the 

application of section 367 should be 

treated as violating section 355(b)(2)(C) 

or (D). The IRS and Treasury 

Department also request comments 

regarding whether an exception should 

exist for taxable acquisitions made by 

distributing solely in exchange for 

distributing stock because such 

acquisitions are not made in exchange 

for distributing’s assets and do not 

appear to violate the common purpose 

of section 355(b)(2)(C) and (D). 

In addition, the IRS and Treasury 

Department request comments regarding 

whether a redemption of stock should 

be a transaction to which section 

355(b)(2)(C) or (D) applies. Under 

current law, no relief is provided for 

such transactions. See McLaulin v. 

Commissioner, 276 F.3d 1269 (11th Cir. 

2001) (concluding that section 

355(b)(2)(D) applies when distributing 

acquires control of a subsidiary through 

a redemption of subsidiary stock). 

Compare Rev. Rul. 57–144 (1957–1 CB 

123). Specifically, comments are 

requested on whether all types of 

redemptions should be subject to the 

same rule, whether the treatment of 

redemptions should be determined by 

the source of payment, whether the 

redemption constitutes an indirect 

exchange for assets of distributing or 

controlled, and the method of making 

these determinations. Alternatively, the 


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IRS and Treasury Department request 

comments on whether an exception 

should be provided for redemptions of 

shareholders that exercise dissenters’

rights. Compare Rev. Rul. 68–285 

(1968–1 CB 147) (concluding that cash 

paid to dissenting target corporation 

shareholders by the target corporation 

does not violate the solely for voting 

stock requirement of section 

368(a)(1)(B)) with Rev. Rul. 73–102 

(1973–1 CB 186) (concluding that cash 

paid to dissenting target corporation 

shareholders by the acquiring 

corporation is treated as money or other 

property paid by the acquiring 

corporation for the properties of the 

target corporation in a reorganization 

under section 368(a)(1)(C)). These 

proposed regulations do not include an 

exception for redemptions generally or 

for those in connection with the 

exercise of dissenters’ rights. 

Finally, the IRS and Treasury 

Department request comments regarding 

whether a transaction in which a 

distributee corporation acquires in a 

transaction in which no gain or loss is 

recognized newly issued stock of 

distributing in exchange for money or 

property previously acquired for cash 

during the pre-distribution period 

should be treated as a transaction in 

which gain or loss is recognized. For 

example, assume D and C have each 

engaged in the active conduct of a trade 

or business for more than five years. 

During the pre-distribution period, P, an 

unrelated corporation, purchases trucks 

and transfers them to D in exchange for 

D stock meeting the requirements of 

section 368(c) in a transaction to which 

section 351 applies. No gain or loss is 

recognized. D subsequently distributes 

all the C stock to P in a separate 

transaction within five years of P’s 

acquisition of the D stock. 

Notwithstanding that this transaction 

satisfies the literal requirements of 

section 355(b)(2)(D), it appears to violate 

the General Utilities doctrine because it 

permits the distributee corporation, P, to 

receive a fair market value basis (or 

close to a fair market value basis) in the 

distributing stock, enabling the potential 

sale of controlled stock without the 

appropriate recognition of gain. 

Additionally, the IRS and Treasury 

Department are studying whether the 

principles of the foregoing rule should 

be extended to any distributee in 

regulations under section 355(d), and 

request comments on this point. 

D. Treatment of Certain Multi-Step 

Acquisitions 

These proposed regulations provide 

specific rules regarding the application 

of section 355(b)(2)(C) and (D) to certain 

multi-step acquisitions. Based on the 

interpretation of section 355(b)(2)(D), 

and the enactment of section 355(b)(3), 

the IRS and Treasury Department 

believe that it is appropriate to apply 

section 355(b)(2)(C) and (D) to multistep acquisitions in a consistent 

manner. Further, the IRS and Treasury 

Department believe that it is appropriate 

to treat certain multi-step acquisitions of 

target corporation stock as satisfying the 

requirements of section 355(b)(2)(C) or 

(D) (as applicable) notwithstanding that 

some portion of the stock may have 

been acquired in a separate transaction 

in which gain or loss was recognized. 

1. Multi-Step Acquisition of Control of 

Distributing or Controlled 

a. Direct Acquisitions 

Section 355(b)(2)(D) provides that 

control of distributing or controlled may 

be acquired within the pre-distribution 

period provided that ‘‘in each case in 

which such control was so acquired, it 

was so acquired, only by reason of 

transactions in which gain or loss was 

not recognized in whole or in part, or 

only by reason of such transactions 

combined with acquisitions before the 

beginning of such period.’’ The IRS and 

Treasury Department interpret this 

language to mean that at the time 

control is first acquired, the acquiring 

corporation (or its SAG) is required to 

own stock meeting the requirements of 

section 368(c) that was acquired in one 

or more transactions in which no gain 

or loss was recognized or by reason of 

such transactions combined with 

acquisitions before the beginning of the 

pre-distribution period. Thus, at the 

time an acquiring corporation (or its 

SAG) first satisfies the section 368(c) 

control requirement, the acquiring 

corporation (or its SAG) must possess 

section 368(c) control without relying 

on any stock acquired in a transaction 

in which gain or loss was recognized 

during the pre-distribution period. 

For example, assume that C has two 

classes of stock outstanding. X owns all 

95 shares of the class A stock of C 

representing 95 percent of the voting 

power and 70 percent of the value and 

Y owns all of the class B stock of C 

representing five percent of the voting 

power and 30 percent of the value. In 

year 1, unrelated D acquires 10 shares 

of the class A C stock from X in a 

transaction in which gain or loss is 

recognized. In year 2, D acquires an 

additional 80 shares of class A C stock 

from X in a separate transaction in 

which no gain or loss is recognized. In 

year 3, D acquires the remaining five 

shares of class A C stock from X in a 

separate transaction in which gain or 

loss is recognized. In year 4, D 

distributes the 95 shares of class A C 

stock to the D shareholders. Assuming 

all of the other requirements of section 

355(b) are satisfied, the requirements of 

section 355(b)(2)(D)(ii) are satisfied 

because at the time D first acquired 

control of C (immediately after the year 

2 acquisition), D owned an amount of C 

stock constituting control that was 

acquired in a transaction in which no 

gain or loss was recognized (the 80 

shares of class A C stock acquired in 

year 2). (However, the 10 shares of class 

A C stock acquired in year 1 and the five 

shares of class A C stock acquired in 

year 3 may be treated as moot under 

section 355(a)(3)(B).) 

On the other hand, assume the same 

facts as the previous example, except 

that, in year 2, D acquires only 75 shares 

of class A C stock from X. The 

requirements of section 355(b)(2)(D)(ii) 

are not satisfied because at the time D 

first acquired control of C (immediately 

after the year 2 acquisition), D did not 

own an amount of C stock constituting 

control that was acquired in one or more 

transactions in which no gain or loss 

was recognized or acquired prior to the 

pre-distribution period. D only owns C 

voting stock representing 75 percent of 

the total voting power that was acquired 

in a transaction in which no gain or loss 

was recognized. The result would be the 

same if the year 3 acquisition was also 

a transaction in which no gain or loss 

was recognized. 

b. Indirect Acquisitions 

These proposed regulations also 

provide that the principles of this rule 

will be applied with respect to an 

indirect acquisition of distributing or 

controlled stock. For example, assume T 

corporation owns stock of C (an 

unaffiliated subsidiary) constituting 

control (and no more). Unrelated D 

acquires 10 percent of the sole 

outstanding class of stock of T in a 

transaction in which gain or loss is 

recognized. In a separate transaction, T 

merges into D solely in exchange for D 

stock in a transaction in which no gain 

or loss is recognized. In applying this 

multi-step acquisition rule to D’s 

subsequent acquisition of control of C in 

the merger, the prior acquisition of T 

stock in the transaction in which gain or 

loss was recognized is treated as an 

acquisition of 10 percent of the C stock 

owned by T (representing 8 percent of 

the total combined voting power of the 

C stock) in a transaction in which gain 

or loss is recognized. Accordingly, the 

requirements of section 355(b)(2)(D)(ii) 

are not satisfied because at the time D 

first acquires control of C, D does not 

own an amount of C stock constituting 


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control that was acquired in one or more 

transactions in which no gain or loss is 

recognized or acquired prior to the predistribution period. At that time, D had 

only acquired C stock representing 72 

percent of the total combined voting 

power of the C stock in a transaction in 

which no gain or loss is recognized. 

2. Other Multiple-Step Acquisitions 

As discussed in sections A.1., B.1., 

and B.3. of this preamble, if D acquires 

section 1504(a)(2) stock of a corporation, 

the acquired corporation will become a 

DSAG member and the corporation will 

be treated like a division of D for 

purposes of the active trade or business 

requirement. As such, D is treated as if 

it acquired the assets and activities of 

the new subsidiary SAG member, and 

the acquisition must satisfy the 

requirements of section 355(b)(2)(C) 

rather than section 355(b)(2)(D). If D 

subsequently acquires the remaining 

stock of the corporation in a separate 

transaction, such acquisition is 

disregarded for purposes of satisfying 

the active trade or business requirement 

(regardless of whether gain or loss was 

recognized in the separate transaction) 

because the subsidiary is already treated 

as a division of D for this purpose. The 

IRS and Treasury Department believe 

that the order of these acquisitions 

should not be determinative in applying 

section 355(b)(2)(C), provided that at the 

time the corporation first becomes a 

subsidiary SAG member, the SAG owns 

section 1504(a)(2) stock in the 

corporation without relying on any 

stock acquired in a transaction in which 

gain or loss was recognized during the 

pre-distribution period. 

a. Direct SAG Acquisitions 

Consistent with the treatment of 

multi-step acquisitions of control of a 

corporation discussed in section D.1. of 

this preamble, these proposed 

regulations provide that multi-step 

acquisitions of stock resulting in a 

corporation becoming a subsidiary SAG 

member will satisfy the requirements of 

section 355(b)(2)(C), provided that at the 

time the corporation first becomes a 

subsidiary SAG member, the SAG owns 

section 1504(a)(2) stock in the 

corporation without relying on any 

stock acquired in a transaction in which 

gain or loss was recognized during the 

pre-distribution period. 

For example, assume that in year 1, D 

does not conduct an active trade or 

business and has owned control of C for 

more than five years. C and T, an 

unrelated corporation, have each 

engaged in the active conduct of a trade 

or business for more than five years. In 

year 1, D acquires 10 percent of T’s sole 

outstanding class of stock in a 

transaction in which gain or loss was 

recognized. In year 2, D acquires an 

additional 80 percent of T’s stock in a 

separate transaction in which no gain or 

loss was recognized. T becomes a DSAG 

member as a result of the year 2 stock 

acquisition. In year 3, D distributes the 

C stock to the D shareholders. Assuming 

all of the other requirements of section 

355(b) are satisfied, the requirements of 

section 355(b)(2)(C) are satisfied because 

at the time T first became a DSAG 

member (immediately after the year 2 

acquisition), D owned an amount of T 

stock meeting the requirements of 

section 1504(a)(2) that was acquired in 

a transaction in which no gain or loss 

was recognized (the T stock acquired in 

year 2). 

On the other hand, assume the same 

facts as the previous example except 

that, in year 2, D only acquires an 

additional 75 percent of T’s stock. The 

requirements of section 355(b)(2)(C) are 

not satisfied because at the time T first 

became a DSAG member (immediately 

after the year 2 acquisition), D did not 

own an amount of T stock meeting the 

requirements of section 1504(a)(2) that 

was acquired in one or more 

transactions in which no gain or loss 

was recognized or acquired prior to the 

pre-distribution period. D owns only 75 

percent of T’s stock that was acquired in 

a transaction in which no gain or loss 

was recognized. The result would be the 

same even if, in year 3 prior to the 

distribution of the C stock, D acquired 

the remaining 15 percent of the T stock 

in a transaction in which no gain or loss 

is recognized. 

b. Indirect SAG Acquisitions 

Similar to the rule regarding multistep acquisitions of control of 

distributing or controlled, these 

proposed regulations also provide that 

the principles of this rule will be 

applied with respect to an indirect 

acquisition by the SAG of stock of a 

corporation that becomes a SAG 

member. For example, assume a DSAG 

member acquires 25 percent of the sole 

outstanding class of stock of T, a 

corporation that wholly owns S, in a 

transaction in which gain or loss is 

recognized. In a separate transaction, 

another DSAG member acquires all of 

the stock of S from T solely in exchange 

for D voting stock in a reorganization 

described in section 368(a)(1)(B) in 

which no gain or loss is recognized. As 

a result, S becomes a DSAG member. In 

applying this multi-step acquisition rule 

to the DSAG’s subsequent acquisition of 

S stock, the acquisition of 25 percent of 

the T stock in the transaction in which 

gain or loss was recognized will be 

treated as an acquisition of 25 percent 

of the S stock in a transaction in which 

gain or loss is recognized. Accordingly, 

the requirements of section 355(b)(2)(C) 

are not satisfied because at the time S 

first becomes a DSAG member, the 

DSAG does not own section 1504(a)(2) 

stock of S that was acquired in one or 

more transactions in which no gain or 

loss is recognized or acquired prior to 

the pre-distribution period. 

c. Multi-Step Asset Acquisitions 

Because stock acquisitions that result 

in a corporation becoming a subsidiary 

SAG member are treated as direct 

acquisitions of the target corporation’s 

assets for purposes of applying section 

355(b), these proposed regulations apply 

a comparable multi-step acquisition rule 

to acquisitions of stock in non-SAG 

members where such non-members’

assets are subsequently directly 

acquired by a SAG member. 

Specifically, these proposed regulations 

provide that if immediately before a 

SAG’s direct acquisition of a trade or 

business (or an interest in a partnership 

engaged in a trade or business) held by 

a corporation (owner) in a transaction to 

which section 381 applies and in which 

no gain or loss is recognized, the SAG 

owns an amount of stock of the owner 

that it acquired in one or more 

transactions during the pre-distribution 

period in which gain or loss was 

recognized such that all of the other 

stock of the owner does not meet the 

requirements of section 1504(a)(2), such 

direct acquisition shall be treated as a 

transaction in which gain or loss was 

recognized. Thus, these proposed 

regulations apply section 355(b)(2)(C) to 

multi-step acquisitions in the same 

manner regardless of whether the 

separate steps result in the target 

corporation becoming a subsidiary SAG 

member or result in a direct acquisition 

of the target corporation’s assets. 

For example, assume that in year 1, D 

does not conduct an active trade or 

business, and has owned control of C for 

more than five years. C and T, an 

unrelated corporation, have each 

engaged in the active conduct of a trade 

or business for more than five years. In 

year 1, D acquires 10 percent of T’s sole 

outstanding class of stock in a 

transaction in which gain or loss was 

recognized. In year 2, in a separate 

reorganization described in section 

368(a)(1)(A), T merges into D and the T 

shareholders receive solely D stock in 

exchange for their T stock. No gain or 

loss is recognized in the merger. In year 

3, D distributes the stock of C to the D 

shareholders. Assuming all of the other 

requirements of section 355(b) are 

satisfied, the requirements of section 


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355(b)(2)(C) are satisfied because, at the 

time D acquires T’s active trade or 

business, D did not own an amount of 

T stock that was acquired in one or 

more transactions during the predistribution period in which gain or loss 

was recognized such that all of the other 

T stock does not meet the requirements 

of section 1504(a)(2). 

On the other hand, assume the same 

facts as the previous example except 

that in year 1 D acquires 21 percent of 

T’s stock. The requirements of section 

355(b)(2)(C) are not satisfied because, at 

the time D acquires T’s active trade or 

business, D owned an amount of T stock 

that was acquired in one or more 

transactions during the pre-distribution 

period in which gain or loss was 

recognized such that all of the other T 

stock does not meet the requirements of 

section 1504(a)(2). 

These proposed regulations also 

provide that the principles of this rule 

will be applied with respect to an 

indirect acquisition of the target 

corporation’s stock by the SAG. 

E. Expansion Acquisitions 

The legislative history, the courts, and 

the current regulations acknowledge 

that a trade or business can undergo 

many changes during the predistribution period and still satisfy the 

requirements of section 355(b). See H.R. 

No. 83–2543, at 37, 38 (1954) (Conf. 

Rep.); Estate of Lockwood v. 

Commissioner, 350 F.2d 712 (8th Cir. 

1965); and § 1.355–3(b)(3)(ii). 

Furthermore, § 1.355–3(b)(3)(ii) 

provides ‘‘if a corporation engaged in 

the active conduct of one trade or 

business during that five-year period 

purchased, created, or otherwise 

acquired another trade or business in 

the same line of business, then the 

acquisition of that other business is 

ordinarily treated as an expansion of the 

original business, all of which is treated 

as having been actively conducted 

during that five-year period, unless that 

purchase, creation, or other acquisition 

effects a change of such a character as 

to constitute the acquisition of a new or 

different business.’’ Therefore, an 

acquired trade or business that is an 

expansion of the original trade or 

business inherits the business history of 

the expanded business. 

None of these authorities, however, 

addresses whether an existing trade or 

business can be expanded by acquiring 

the stock of a corporation engaged in a 

trade or business in the same line of 

business as the acquiror. Because the 

SAG rule causes a stock acquisition in 

which the acquired corporation 

becomes a subsidiary SAG member to be 

treated as an asset acquisition, a 

corporation engaged in a trade or 

business should be able to expand its 

existing trade or business by acquiring 

stock of a corporation (including 

controlled) engaged in a trade or 

business in the same line of business 

provided the acquisition results in the 

acquired corporation becoming a 

subsidiary SAG member. 

On the other hand, section 355(b)(3) 

does not allow a corporation to rely on 

the trade or business of a non-SAG 

subsidiary—even if the corporation 

controls the subsidiary—to satisfy the 

active trade or business requirement. As 

such, it effectively precludes stock 

expansions where the acquired 

corporation does not become a 

subsidiary SAG member. The IRS and 

Treasury Department believe that 

section 355(b)(3) is the exclusive means 

by which a corporation is attributed the 

assets (or activities) owned (or 

conducted) by another corporation. 

Accordingly, a stock acquisition that 

does not result in the acquired 

corporation becoming a subsidiary SAG 

member should not be an expansion of 

the SAG’s original business. 

In addition, these proposed 

regulations provide certain facts and 

circumstances to be considered in 

determining whether one trade or 

business is in the same line of business 

as another trade or business. The 

inclusion of these facts and 

circumstances in these proposed 

regulations is not intended to be a 

substantive change, but merely to clarify 

and restate the current law regarding 

expansions. See Rev. Rul. 2003–18 

(2003–1 CB 467) and Rev. Rul. 2003–38 

(2003–1 CB 811). Some of the examples 

from the current regulations have been 

altered in these proposed regulations to 

reflect this inclusion (as well as certain 

stylistic changes). 

F. Rules Related to Hot Stock 

Section 355(a)(3)(B) provides that 

stock of controlled acquired by 

distributing during the pre-distribution 

period in a transaction in which gain or 

loss is recognized is treated as boot. 

Section 1.355–2(g) provides guidance 

regarding the application of section 

355(a)(3)(B). The IRS and Treasury 

Department request comments regarding 

whether § 1.355–2(g) should be 

amended to adopt rules under section 

355(a)(3)(B) similar to those provided in 

these proposed regulations for 

determining whether an acquisition is 

one in which gain or loss is recognized 

for purposes of section 355(b)(2)(C) or 

(D). 

In particular, the IRS and Treasury 

Department request comments 

concerning the application of section 

355(a)(3)(B) to acquisitions of stock of 

controlled in gain or loss transactions 

that, under these proposed regulations, 

are not treated as violating the 

requirements of section 355(b). For 

example, where distributing acquires 

stock of controlled in a gain or loss 

transaction that is treated as an 

expansion of distributing’s existing 

trade or business (because controlled is 

in distributing’s line of business and 

becomes a DSAG member), what 

portion, if any, of the acquired stock 

should be subject to section 

355(a)(3)(B)? 

The current authorities may suggest a 

linkage between the interpretation of 

sections 355(a)(3)(B) and 355(b). See 

§ 1.355–2(g)(1) (not applying section 

355(a)(3)(B) to a taxable acquisition 

from an affiliate); Rev. Rul. 78–442 

(stating ‘‘[l]ikewise, for the same reasons 

[that section 355(b)(2)(C) does not 

apply], section 355(a)(3)[(B)] of the Code 

is not applicable’’). However, section 

355(b)(3) by its literal terms does not 

appear to apply for purposes section 

355(a)(3)(B). 

The IRS and Treasury Department 

continue to study how to coordinate the 

application of these provisions and 

request comments in this regard. 

Accordingly, these proposed regulations 

contain no proposal to change § 1.355–

2(g) at this time. 

G. Limited Affiliate Exception 

Other than with respect to transfers of 

assets (or activities) that are owned (or 

performed) by the SAG immediately 

before and immediately after the 

transfer, these proposed regulations do 

not include the special treatment 

accorded affiliated group members in 

§ 1.355–3(b)(4)(iii). Thus, these 

proposed regulations treat non-SAG 

member affiliates of distributing or 

controlled in the same manner as 

unrelated persons for purposes of 

applying section 355(b)(2)(C) and (D). 

While distributing is the common 

parent of its SAG, distributing may be 

a subsidiary member of a larger 

affiliated group. Therefore, not all 

members of distributing’s affiliated 

group are DSAG members. 

Section 1.355–3(b)(4)(iii) provides 

that acquisitions by one member of an 

affiliated group from another member of 

the group are disregarded in applying 

section 355(b)(2)(C) and (D), even if gain 

or loss is recognized. Section 1.355–

3(b)(4)(iii) provides for this treatment 

for affiliates because although ‘‘[t]he 

requirements of section 355(b)(2)(C) and 

(D) are intended to prevent the direct or 

indirect acquisition of a trade or 

business by a corporation in 

anticipation of a distribution by the 


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corporation of that trade or business in 

a distribution to which section 355 

would otherwise apply[,]’’ acquisitions 

from affiliates are not the type of 

transaction to which these provisions 

were intended to apply. Section 1.355–

3(b)(4)(iv) defines the term ‘‘affiliated 

group’’ as an affiliated group as defined 

in section 1504(a) (without regard to 

section 1504(b)), except that the term 

‘‘stock’’ includes nonvoting stock 

described in section 1504(a)(4). 

The IRS and Treasury Department 

believe that limiting this special 

treatment to transfers in which the 

assets (or activities) remain in the SAG 

(as opposed to the larger affiliated 

group) is more consistent with the 

purposes of section 355(b)(3). As 

discussed in section A.1. of this 

preamble, section 355(b)(3) states, in 

effect, that in determining whether 

distributing or controlled is engaged in 

a trade or business all DSAG or CSAG 

members, as the case may be, are treated 

as one corporation. Therefore, a transfer 

of trade or business assets (or activities) 

from one SAG member to another SAG 

member is disregarded, and is not an 

acquisition for purposes of section 

355(b)(2)(C) (or section 355(b)(2)(D) in 

the case of stock of controlled that is not 

a DSAG member). The SAG rule implies 

a corollary, which is that if the trade or 

business assets (or activities) are not 

owned (or performed) by the SAG, such 

assets (or activities) should generally 

not be able to be acquired from outside 

the SAG in a transaction in which gain 

or loss is recognized. Thus, these 

proposed regulations generally do not 

permit taxable acquisitions of an active 

trade or business from outside the SAG. 

The IRS and Treasury Department 

recognize that not providing this special 

treatment for non-SAG member affiliates 

is a change from how the law has been 

administered in various situations. 

Further, the IRS and Treasury 

Department recognize that this change 

can represent a relaxing or tightening of 

the law in this area, depending upon the 

circumstances. For example, under 

these proposed regulations the 

requirements of section 355(b)(2)(C) are 

satisfied where P, a higher-tier affiliate 

of distributing, purchases a trade or 

business for cash and contributes it to 

distributing solely in exchange for 

distributing stock in a transaction in 

which no gain or loss is recognized. On 

the other hand, under these proposed 

regulations, the requirements of section 

355(b)(2)(C) are not satisfied where P 

has actively conducted a trade or 

business for more than five years and 

sells it to D in exchange for cash. 

H. Activities Performed by Certain 

Related Parties 

Current § 1.355–3(b)(2)(iii) provides, 

in part, that to satisfy the active trade or 

business requirement, the corporation 

itself generally is required to perform 

active and substantial management and 

operational functions. That regulation 

further provides that activities 

performed by the corporation itself 

generally do not include activities 

performed by independent contractors. 

In this regard, ‘‘a corporation must 

engage in entrepreneurial endeavors of 

such a nature and to such an extent as 

to qualitatively distinguish its 

operations from mere investments 

[, and] * * * there should be objective 

indicia of such corporate operations.’’

Rafferty v. Commissioner, 452 F.2d 767, 

772 (1st Cir. 1971) cert. denied 408 U.S. 

922 (1972) (concluding that a 

corporation that did not pay salaries or 

rent, did not employ independent 

contractors, and merely collected rent, 

paid taxes, and kept separate books, 

failed to satisfy these requirements). The 

IRS and Treasury Department believe 

that a corporation may rely on the 

activities performed by certain related 

parties in conducting its 

‘‘entrepreneurial endeavors,’’ and such 

activities can constitute ‘‘objective 

indicia’’ of corporate operations. 

While section 355(b)(3) treats all SAG 

members as one corporation, the IRS 

and Treasury Department are aware that 

affiliated groups of corporations that 

include non-SAG member affiliates 

might use employees of one member of 

the group to perform management or 

operational functions for another 

member of the group. The IRS and the 

Treasury Department believe that a 

corporation can satisfy the active trade 

or business requirement even if all the 

management and operational functions 

are performed by employees of affiliates 

that are not members of either the DSAG 

or CSAG. In other words, the DSAG or 

CSAG can be engaged in 

‘‘entrepreneurial endeavors’’ that are 

distinguishable from mere passive 

investment even if the management and 

operational functions are performed for 

the DSAG or CSAG by employees of 

non-SAG affiliates. Such individuals 

bear a close enough relationship to the 

DSAG or CSAG to be distinguished from 

mere independent contractors for 

purposes of the active trade or business 

requirement. The IRS and Treasury 

Department believe that this treatment 

is appropriate and consistent with 

previously published guidance. 

Issued prior to the enactment of 

section 355(b)(3), Rev. Rul. 79–394 

(1979–2 CB 141), amplified by Rev. Rul. 

80–181 (1980–2 CB 121), concludes that 

controlled satisfies the active trade or 

business requirement even though all of 

the operational activities of its business 

are conducted by an affiliate’s 

employees before the distribution. The 

IRS and Treasury Department believe 

that extending the principles of Rev. 

Rul. 79–394 and Rev. Rul. 80–181 to the 

performance of management (in 

addition to operational) functions by 

employees of an affiliate is consistent 

with the purposes underlying the active 

trade or business requirement. 

Accordingly, these proposed regulations 

provide that, in determining whether a 

corporation is engaged in the active 

conduct of a trade or business, activities 

(including management and operational 

functions) performed by employees of 

the corporation’s affiliates (including 

non-SAG members) are taken into 

account. 

Furthermore, the IRS and Treasury 

Department believe that a corporation 

can satisfy the active trade or business 

requirement even if all the management 

and operational functions are performed 

by shareholders of the corporation if it 

is closely held. The shareholders of 

closely held corporations possess a 

close relationship with the corporation, 

similar to employees of affiliates. 

Accordingly, these proposed regulations 

provide that, in determining whether a 

corporation is engaged in the active 

conduct of a trade or business, activities 

(including management and operational 

functions) performed by shareholders of 

a closely held corporation are taken into 

account in certain cases. 

The IRS and Treasury Department do 

not believe that the absence of an 

exception for acquisitions from nonSAG member affiliates is inconsistent 

with concluding that a corporation can 

satisfy the active trade or business 

requirement by relying on the 

management and operational functions 

performed by employees of non-SAG 

member affiliates. Relying on the 

activities of such employees does not 

involve the acquisition of a trade or 

business. As such, it is not the type of 

transaction or arrangement section 

355(b)(2) was intended to address. 

Accordingly, the IRS and Treasury 

Department believe it is appropriate to 

apply a broader standard with respect to 

relying on employees of non-SAG 

member affiliates. 

While it is appropriate to consider the 

management and operational activities 

of employees of all affiliates in 

determining whether a corporation 

satisfies the active trade or business 

requirement, the IRS and Treasury 

Department believe that a corporation 

should satisfy the active trade or 


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business requirement only if it (or 

another SAG member, or a partnership 

from which the trade or business assets 

and activities are attributed) is the 

principal owner of the goodwill and 

significant assets of the trade or 

business for Federal income tax 

purposes. Accordingly, a corporation 

will be treated as engaged in the active 

conduct of a trade or business only if, 

for Federal income tax purposes, it (or 

its SAG member, or a partnership from 

which the trade or business assets and 

activities are attributed) is the principal 

owner of the goodwill and significant 

assets of the trade or business. 

Accordingly, some of the examples from 

the current regulations have been 

altered in these proposed regulations to 

reflect this goodwill and significant 

asset standard (as well as certain 

stylistic changes). 

I. Activities Conducted by a Partnership 

Revenue Ruling 92–17 (1992–1 CB 

142) and Rev. Rul. 2002–49 (2002–2 CB 

288) address in a number of fact 

situations whether a corporation that is 

a partner in a partnership can satisfy the 

active trade or business requirement by 

reason of its ownership of the 

partnership interest where the 

partnership conducts a trade or 

business. Those rulings illustrate that a 

corporation owning a 20-percent 

interest in a state law partnership or 

limited liability company (LLC) that is 

classified as a partnership for Federal 

income tax purposes can be treated as 

engaged in the active conduct of the 

trade or business of the partnership if 

the corporation performs active and 

substantial management functions for 

the partnership’s business. In addition, 

Rev. Rul. 2002–49 concludes that such 

a corporation can be treated as engaged 

in the active conduct of a partnership’s 

trade or business, even if another 

partner also performs active and 

substantial management functions for 

the partnership’s trade or business. 

Consistent with the principles set 

forth in Rev. Rul. 92–17 and Rev. Rul. 

2002–49 regarding satisfying the active 

trade or business requirement through 

an interest in a partnership, these 

proposed regulations provide that for 

purposes of section 355(b) a partner will 

be attributed the trade or business assets 

and activities of a partnership if the 

partner (1) Performs active and 

substantial management functions for 

the partnership with respect to the trade 

or business assets or activities (for 

example, makes decisions regarding 

significant business issues of the 

partnership and regularly participates in 

the overall supervision, direction, and 

control of the employees performing the 

operational functions for the 

partnership), and (2) owns a meaningful 

interest in the partnership. Further, 

because a partnership might only 

conduct a portion of a trade or business, 

the IRS and Treasury Department 

believe that a partner that satisfies these 

requirements can be attributed the 

portions of a trade or business (or assets 

and activities) that are conducted by a 

partnership. Under these circumstances 

the IRS and Treasury Department 

believe that it is appropriate to aggregate 

the partnership’s trade or business 

assets and activities with those of the 

partner for purposes of determining 

whether the partner satisfies the active 

trade or business requirement. However, 

the stock of a corporation held by the 

partnership is not attributed to a 

partner. 

The IRS and Treasury Department 

understand that the facts presented in 

Rev. Rul. 92–17 and Rev. Rul. 2002–49 

do not necessarily reflect the exclusive 

methods by which corporations engage 

in a trade or business through a 

partnership. In particular, the IRS and 

Treasury Department understand that 

both the management and operational 

activities of an LLC are often conducted 

by the LLC itself, rather than by its 

members, to protect its members from 

liability for the LLC’s activities. In these 

cases, Rev. Rul. 92–17 and Rev. Rul. 

2002–49 do not explicitly support the 

conclusion that a corporation may rely 

on the trade or business assets and 

activities of an LLC to satisfy the active 

trade or business requirement, since no 

activities are performed by the corporate 

partner. 

The IRS and Treasury Department 

believe that, in certain cases, a partner 

that owns a significant interest in an 

entity that is treated as a partnership for 

Federal income tax purposes should be 

attributed the trade or business assets 

and activities of a partnership, even if 

the partner does not directly conduct 

any activities relating to the business of 

the partnership. By comparison, the IRS 

and Treasury Department have 

promulgated regulations regarding the 

treatment of acquired assets held by a 

partnership for purposes of satisfying 

the continuity of business enterprise 

requirement applicable to 

reorganizations. Those regulations 

provide that a partner will be treated as 

owning the acquired target business 

assets used in the business of a 

partnership in satisfaction of the 

continuity of business enterprise 

requirement if the members of the 

qualified group, in the aggregate, own 

an interest in the partnership 

representing a significant interest in that 

partnership business. See § 1.368–

1(d)(4)(iii)(B)(1). Those regulations 

include an example concluding that the 

continuity of business enterprise 

requirement is satisfied where a partner 

owns a one-third interest in a 

partnership that continues the business 

of the target corporation, even though 

the partner performs no management or 

operational functions for that business. 

See § 1.368–1(d)(5) Example 9. 

These proposed regulations yield 

results similar to the continuity of 

business enterprise rule in determining 

whether the active trade or business 

requirement is satisfied when a 

corporation conducts a trade or business 

or portions of a trade or business 

through a partnership but does not 

participate in the partnership’s 

activities. Specifically, these proposed 

regulations provide that for purposes of 

section 355(b) a partner will be 

attributed the trade or business assets 

and activities of a partnership provided 

the partner owns a significant interest in 

the partnership. The IRS and Treasury 

Department intend that the term 

‘‘significant interest’’ requires an 

ownership interest that is greater than 

that suggested by the term ‘‘meaningful 

interest,’’ which is the level of 

ownership required for a partner to be 

attributed the trade or business assets 

and activities of a partnership in cases 

where the partner performs active and 

substantial management functions for 

the partnership. 

However, a partner will be attributed 

the trade or business assets and 

activities of a partnership only during 

the period it owns a significant interest 

or alternatively owns a meaningful 

interest and performs active and 

substantial management functions. 

J. Additional Requests for Comments 

The IRS and Treasury Department 

request comments regarding whether 

the regulations should include a rule 

that would treat an acquisition in which 

no gain or loss is recognized as an 

acquisition in which gain or loss is 

recognized if that would be the 

treatment had the transaction been 

executed in the opposite direction. For 

example, assume that, in year 1, P, a 

corporation not engaged in an active 

trade or business, acquires 50 percent of 

all of the outstanding stock of D (which 

is engaged in an active trade or 

business, and owns control of C, which 

is also engaged in an active trade or 

business) in a transaction in which gain 

or loss is recognized, and then, in a 

separate transaction in year 3, D merges 

into P solely in exchange for P stock in 

a transaction described in section 

368(a)(1)(A) in which no gain or loss is 

recognized. P then distributes the C 


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stock to its shareholders in year 4. 

Under these proposed regulations, P is 

treated as having acquired D’s trade or 

business and control of C during the 

pre-distribution period in a transaction 

in which gain or loss is recognized 

because P acquired more than 20 

percent of D’s stock during the predistribution period in a transaction in 

which gain or loss was recognized (see 

sections D.1.b. and D.2.c of this 

preamble). However, if P merges 

downstream into D solely in exchange 

for D stock in a reorganization described 

in section 368(a)(1)(A) and (D) in which 

no gain or loss is recognized, there 

literally is not an acquisition in which 

gain or loss is recognized under these 

proposed regulations, because D did not 

acquire any interest in an active trade or 

business from P. Comments are 

requested regarding whether the result 

should differ depending upon the 

direction of the merger. See and 

compare § 1.355–3(b)(4)(ii) (predecessor 

of distributing acquiring control of 

distributing). 

Further, the IRS and Treasury 

Department request comments regarding 

the appropriate methods of measuring 

indirect acquisitions of stock for 

purposes of the rules regarding multistep acquisitions, as discussed in 

section D. of this preamble. Specifically, 

comments are requested regarding how 

the indirect acquisition should be 

measured where the acquired 

corporation has multiple classes of stock 

outstanding, or where the acquired 

entity is a partnership. For example, 

assume T is a corporation that owns all 

of the stock of a subsidiary, S, and T has 

class A common stock, class B common 

stock, and preferred stock outstanding. 

If D acquires 10 percent of the T class 

A common stock, how should one 

determine what percentage of S stock D 

has indirectly acquired? Should it be 

based on the value of the T stock D 

acquired relative to the value of all of 

the T stock or other factors? How should 

the voting power of the acquired T stock 

be taken into account in applying these 

rules to potential indirect acquisitions 

of control? 

In addition, the IRS and Treasury 

Department request comments regarding 

whether the parameters of the good faith 

and inadvertence exceptions in Notice 

2004–37 (2004–1 CB 947) regarding the 

value requirement in section 

1504(a)(2)(B) should apply for purposes 

of determining whether corporations are 

SAG members even if they are not 

members of a consolidated group. That 

is, the IRS and Treasury Department 

request comments regarding whether 

the policies underlying the SAG rule 

and the reference to section 1504(a) in 

section 355(b)(3)(B) suggest that the 

good faith and inadvertence exceptions 

should apply and be interpreted in the 

same way for SAG membership as for 

affiliation for purposes of filing 

consolidated returns. 

The IRS and Treasury Department 

also request comments regarding 

whether the regulations should clarify 

the circumstances under which the 

separation of a segment of an active 

trade or business should be treated as a 

separate active trade or business after it 

is spun off and, if so, what the 

governing principle should be. See, for 

example, § 1.355–3(c) Example (9) 

(separation of a corporation’s research 

department from the rest of its 

manufacturing business). 

Although these regulations are 

generally proposed to be applicable to 

distributions that occur after the date 

these regulations are published as final 

regulations in the Federal Register, the 

IRS and Treasury Department invite 

comments regarding whether it would 

be appropriate and desirable to allow 

taxpayers to elect to apply these 

provisions retroactively (subject to the 

applicability of section 355(b)(3)). 

Proposed Effective Date 

These proposed regulations are 

proposed to apply to distributions that 

occur after the date these regulations 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 these 

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 Code, these 

regulations have been submitted to the 

Chief Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small businesses. 

Comments and Requests for Public 

Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. The IRS 

and Treasury Department request 

comments on the clarity of the proposed 

rules and how they can be made easier 

to understand. All comments will be 

available for public inspection and 

copying. A public hearing will be 

scheduled if requested in writing by any 

person that timely submits written 

comments. If a public hearing is 

scheduled, notice of the date, time, and 

place for the public hearing will be 

published in the Federal Register. 

Drafting Information 

The principal author of these 

proposed regulations is Russell P. Subin 

of the Office of Associate Chief Counsel 

(Corporate). However, other personnel 

from the IRS and Treasury Department 

participated in their development. 

Availability of IRS Documents 

IRS revenue rulings, procedures, and 

notices cited in this preamble are made 

available by the Superintendent of 

Documents, U.S. Government Printing 

Office, Washington, DC 20402. 

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 1.355–0 is amended by 

revising the entries under § 1.355–3. 

The revisions are as follows: 

§ 1.355–0 Outline of sections. 

* * * * * 

§ 1.355–3 Active conduct of a trade or 

business. 

(a) General requirements. 

(b) Active conduct of a trade or business 

defined. 

(1) In general. 

(i) Directly engaged in a trade or business. 

(ii) Treatment of a separate affiliated group. 

(iii) Separate affiliated group defined. 

(2) Active conduct of a trade or business 

immediately after the distribution. 

(i) In general. 

(ii) Trade or business. 

(iii) Active conduct. 

(iv) Limitations. 

(v) Partner attributed the trade or business 

assets and activities of a partnership. 

(A) In general. 

(B) Significant interest. 

(C) Meaningful interest. 

(D) Other factors. 

(3) Active conduct for the pre-distribution 

period. 

(i) In general. 

(ii) Change and expansion. 


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(iii) Certain transactions with partnerships 

that do not constitute acquisitions. 

(4) Special rules for an acquisition of a 

trade or business. 

(i) In general. 

(A) Application of section 355(b)(2)(C). 

(B) Application of section 355(b)(2)(D). 

(C) Gain or loss recognized. 

(ii) Certain transactions treated as 

transactions in which gain or loss is 

recognized. 

(A) Certain tax-free acquisitions made in 

exchange for assets. 

(B) Distributions from partnerships. 

(iii) Certain transactions in which 

recognized gain or loss is disregarded. 

(A) Transfers to controlled. 

(B) Cash for fractional shares. 

(C) Certain acquisitions of control of 

distributing. 

(iv) Operating rules for acquisitions. 

(A) Predecessors. 

(B) Certain multi-step acquisitions of 

control of distributing or controlled. 

(C) Certain multi-step acquisitions of a 

subsidiary SAG member. 

(D) Certain multi-step asset acquisitions. 

(E) Acquisitions involving the issuance of 

subsidiary stock. 

(F) Acquisitions of controlled stock where 

controlled is or becomes a DSAG member. 

(G) Treatment of stock received in certain 

tax-free exchanges. 

(H) Situations where the separate existence 

of a subsidiary SAG member is respected. 

(c) Definitions. 

(1) Affiliate. 

(2) Controlled. 

(3) Distributing. 

(4) Pre-distribution period. 

(d) Conventions and examples. 

(1) Conventions. 

(2) Examples. 

* * * * * 

Par. 3. Section 1.355–1 is amended by 

revising paragraph (a) to read as follows: 

§ 1.355–1 Distribution of stock and 

securities of a controlled corporation. 

(a) Effective date of certain sections. 

Except as otherwise provided, §§ 1.355–

1, 1.355–2, and 1.355–4 apply to 

transactions occurring after February 6, 

1989. Section 1.355–3 applies to 

distributions after the date these 

regulations are published as final 

regulations in the Federal Register. For 

transactions occurring on or before that 

date but after February 6, 1989, see 26 

CFR 1.355–3 (revised as of April 1, 

2007). For all transactions occurring on 

or before February 6, 1989, see 26 CFR 

1.355–1 through 1.355–4 (revised as of 

April 1, 1987). Sections 1.355–1, 1.355–

2, and 1.355–4 do not reflect the 

amendments to section 355 made by the 

Revenue Act of 1987 and the Technical 

and Miscellaneous Revenue Act of 1988. 

For the effective date of §§ 1.355–6 and 

1.355–7, see §§ 1.355–6(g) and 1.355–

7(k), respectively. 

* * * * * 

Par. 4. Section 1.355–3 is revised to 

read as follows: 

§ 1.355–3 Active conduct of a trade or 

business. 

(a) General requirements. Under 

section 355(b)(1), a distribution of stock, 

or stock and securities, of controlled (as 

defined in paragraph (c)(2) of this 

section) qualifies under section 355 only 

if—

(1) Distributing (as defined in 

paragraph (c)(3) of this section) and 

controlled are each engaged in the 

active conduct of a trade or business 

immediately after the distribution 

(section 355(b)(1)(A)); or 

(2) Immediately before the 

distribution, distributing had no assets 

other than stock or securities of the 

controlled corporations (without regard 

to paragraph (b)(1)(ii) of this section), 

and each of the controlled corporations 

is engaged in the active conduct of a 

trade or business immediately after the 

distribution (section 355(b)(1)(B)). A de 

minimis amount of assets held by 

distributing shall be disregarded for 

purposes of this paragraph (a)(2). 

(b) Active conduct of a trade or 

business defined—(1) In general—(i) 

Directly engaged in a trade or business. 

Section 355(b)(2) provides rules for 

determining whether a corporation is 

treated as engaged in the active conduct 

of a trade or business under section 

355(b)(1). Sections 355(b)(2)(A) and 

(b)(3)(A) provide that a corporation is 

treated as engaged in the active conduct 

of a trade or business if and only if such 

corporation is engaged in the active 

conduct of a trade or business. 

Accordingly, except as provided in 

paragraph (b)(1)(ii) of this section, a 

corporation is not treated as engaged in 

the active conduct of a trade or business 

under such Internal Revenue Code 

sections solely as a result of 

substantially all of its assets consisting 

of stock, or stock and securities, of one 

or more corporations controlled by it 

(immediately after the distribution) each 

of which is engaged in the active 

conduct of a trade or business. 

(ii) Treatment of a separate affiliated 

group. Under section 355(b)(3)(B), solely 

for purposes of determining whether a 

corporation is engaged in the active 

conduct of a trade or business, all 

members of a corporation’s separate 

affiliated group (SAG) (as defined in 

paragraph (b)(1)(iii) of this section) shall 

be treated as one corporation. This 

treatment applies for all purposes of 

determining whether a corporation is 

engaged in the active conduct of a trade 

or business. Accordingly, for this 

purpose, transfers of assets (or activities) 

that are owned (or performed) by the 

SAG immediately before and 

immediately after the transfer are 

disregarded and are not acquisitions 

under paragraph (b)(4) of this section. 

Further, a transaction that results in a 

corporation becoming a subsidiary SAG 

member (a SAG member that is not the 

common parent of such SAG) is treated 

as an acquisition of any assets (or 

activities) that are owned (or performed) 

by the acquired corporation at such 

time. Therefore, the acquisition of 

additional stock of a current subsidiary 

SAG member has no effect for purposes 

of applying paragraph (b)(4)(i)(A) of this 

section. 

(iii) Separate affiliated group defined. 

A corporation’s SAG is the affiliated 

group which would be determined 

under section 1504(a) if such 

corporation were the common parent 

and section 1504(b) did not apply. Thus, 

the separate affiliated group of 

distributing (DSAG) is the affiliated 

group that consists of distributing as the 

common parent and all corporations 

affiliated with distributing through 

stock ownership described in section 

1504(a)(1)(B) (regardless of whether the 

corporations are includible corporations 

under section 1504(b)). The separate 

affiliated group of controlled (CSAG) is 

determined in a similar manner (with 

controlled as the common parent). 

Accordingly, prior to a distribution, the 

DSAG may include CSAG members if 

the applicable ownership requirements 

are met. Further, the determination of 

whether a corporation is a DSAG or 

CSAG member shall be made separately 

for each distribution, and without 

regard to whether such corporation is a 

SAG member with respect to any other 

distribution. Any reference to DSAG or 

CSAG is a reference to distributing or 

controlled, respectively, if such 

corporation is not the common parent of 

a SAG (that is, such corporation does 

not own stock in any corporation that is 

a subsidiary member of its SAG). 

Further, any reference to a SAG is a 

reference to distributing or controlled, 

as the context may require, if such 

corporation is not the common parent of 

a SAG. 

(2) Active conduct of a trade or 

business immediately after the 

distribution—(i) In general. For 

purposes of section 355(b), a 

corporation shall be treated as engaged 

in the active conduct of a trade or 

business immediately after the 

distribution if the assets and activities of 

the corporation satisfy the requirements 

and limitations described in paragraphs 

(b)(2)(ii), (b)(2)(iii), and (b)(2)(iv) of this 

section. See paragraph (b)(2)(v) of this 

section for additional special rules that 

apply to determine whether a 


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corporation is attributed the trade or 

business assets and activities of a 

partnership. 

(ii) Trade or business. A corporation 

shall be treated as engaged in a trade or 

business immediately after the 

distribution if a specific group of 

activities is being carried on by the 

corporation for the purpose of earning 

income or profit, and the activities 

included in such group include every 

operation that forms a part of, or a step 

in, the process of earning income or 

profit. Such group of activities 

ordinarily must include the collection of 

income and the payment of expenses. 

(iii) Active conduct. For purposes of 

section 355(b), the determination of 

whether a trade or business is actively 

conducted will be made from all of the 

facts and circumstances. Generally, the 

corporation is required itself to perform 

active and substantial management and 

operational functions. Activities 

performed by a corporation include 

activities performed by employees of an 

affiliate (as defined in paragraph (c)(1) 

of this section), and in certain cases by 

shareholders of a closely held 

corporation, if such activities are 

performed for the corporation. For 

example, activities performed by a 

corporation include activities performed 

for the corporation by its sole 

shareholder. However, the activities of 

employees of affiliates (or, in certain 

cases, shareholders) are only taken into 

account during the period such 

corporations are affiliates (or persons 

are shareholders) of the corporation. A 

corporation will not be treated as 

engaged in the active conduct of a trade 

or business unless it (or its SAG, or a 

partnership from which the trade or 

business assets and activities are 

attributed) is the principal owner of the 

goodwill and significant assets of the 

trade or business for Federal income tax 

purposes. Activities performed by a 

corporation generally do not include 

activities performed by persons outside 

the corporation, including independent 

contractors, unless those activities are 

performed by employees of an affiliate 

(or, in certain cases, by shareholders). 

However, a corporation may satisfy the 

requirements of this paragraph (b)(2)(iii) 

through the activities that it performs 

itself, even though some of its activities 

are performed by persons that are not its 

employees, or employees of an affiliate 

(or, in certain cases, shareholders). 

Separations of real property all or 

substantially all of which is occupied 

before the distribution by the DSAG or 

CSAG will be carefully scrutinized in 

applying the requirements of section 

355(b) and this section. 

(iv) Limitations. The active conduct of 

a trade or business does not include—

(A) The holding for investment 

purposes of stock, securities, land, or 

other property; or 

(B) The ownership and operation 

(including leasing) of real or personal 

property used in a trade or business, 

unless the owner performs significant 

services with respect to the operation 

and management of the property. 

(v) Partner attributed the trade or 

business assets and activities of a 

partnership—(A) In general. For 

purposes of section 355(b), a partner in 

a partnership will be attributed the trade 

or business assets and activities of that 

partnership during the period that such 

partner satisfies the requirements of 

paragraph (b)(2)(v)(B) or (b)(2)(v)(C) of 

this section. However, for purposes of 

this paragraph (b)(2)(v), the stock of a 

corporation owned by the partnership is 

not attributed to a partner. For purposes 

of determining the activities that are 

conducted by the partnership that may 

be attributed to the partner under this 

paragraph (b)(2)(v), the activities of 

independent contractors, and partners 

that are not affiliates (or, in certain 

cases, shareholders) of the partner, are 

not taken into account. For this purpose, 

the activities of partners that are 

affiliates (or, in certain cases, 

shareholders) of the partner are only 

taken into account during the period 

that such partners are affiliates (or, in 

certain cases, shareholders) of the 

partner. 

(B) Significant interest. The trade or 

business assets and activities of a 

partnership will be attributed to a 

partner if the partner (or its SAG) 

directly (or indirectly through one or 

more other partnerships) owns a 

significant interest in the partnership. 

(C) Meaningful interest. The trade or 

business assets and activities of a 

partnership will be attributed to a 

partner if the partner or affiliates (or, in 

certain cases, shareholders) of the 

partner performs active and substantial 

management functions for the 

partnership with respect to the trade or 

business assets and activities (for 

example, makes decisions regarding 

significant business issues of the 

partnership and regularly participates in 

the overall supervision, direction, and 

control of the employees performing the 

operational functions for the 

partnership), and the partner (or its 

SAG) directly (or indirectly through one 

or more other partnerships) owns a 

meaningful interest in the partnership. 

Whether such active and substantial 

management functions are performed 

with respect to the trade or business 

assets and activities of the partnership 

will be determined from all of the facts 

and circumstances. The number of 

partners providing management 

functions will not be determinative. 

(D) Other factors. In deciding whether 

the requirements of paragraph 

(b)(2)(v)(B) or (b)(2)(v)(C) of this section 

are satisfied, the formal description of 

the partnership interest (for example, 

general or limited) will not be 

determinative and the extent to which 

the partner is responsible for liabilities 

of the partnership will not be relevant. 

(3) Active conduct for the predistribution period—(i) In general. 

Under section 355(b)(2), a trade or 

business that is relied upon to meet the 

requirements of section 355(b) must 

have been actively conducted 

throughout the pre-distribution period 

(as defined in paragraph (c)(4) of this 

section) by the DSAG or CSAG, or 

actively conducted throughout the predistribution period and acquired during 

such period by the DSAG or CSAG in 

a transaction in which no gain or loss 

is recognized as provided in paragraph 

(b)(4) of this section. For purposes of 

section 355(b)(2)(B), activities that 

constitute a trade or business under 

paragraph (b)(2) of this section shall be 

treated as described in the preceding 

sentence if such activities were actively 

conducted throughout the predistribution period. 

(ii) Change and expansion. The fact 

that a trade or business underwent 

change during the pre-distribution 

period (for example, by the addition of 

new or the dropping of old products, 

changes in production capacity, and the 

like) shall be disregarded, provided that 

the changes are not of such a character 

as to constitute the acquisition of a new 

or different business. In particular, if a 

SAG engaged in the active conduct of 

one trade or business during the predistribution period (the original 

business) purchased, created, or 

otherwise acquired (either directly, 

through an interest in a partnership, or 

as a result of a corporation becoming a 

subsidiary SAG member) another trade 

or business (the acquired business) in 

the same line of business, the 

acquisition of the acquired business is 

ordinarily treated as an expansion of the 

original business, all of which is treated 

as having been actively conducted by 

the acquiring SAG during the predistribution period, unless the acquired 

business effects a change of such a 

character as to constitute the acquisition 

of a new or different business. For 

purposes of this paragraph (b)(3)(ii), in 

determining whether an acquired 

business is in the same line of business 

as the original business, all facts and 


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26028 Federal Register / Vol. 72, No. 88 / Tuesday, May 8, 2007 / Proposed Rules 

circumstances shall be considered, 

including the following—

(A) Whether the product of the 

acquired business is similar to that of 

the original business; 

(B) Whether the business activities 

associated with the operation of the 

acquired business are the same as the 

business activities associated with the 

operation of the original business; and 

(C) Whether the operation of the 

acquired business involves the use of 

the experience and know-how that the 

owner of the original business 

developed in the operation of the 

original business or, alternatively, 

whether the operation of the acquired 

business draws to a significant extent on 

the existing experience and know-how 

of the owner of the original business 

and the success of the acquired business 

will depend in large measure on the 

goodwill associated with the original 

business and the name of the original 

business. 

(iii) Certain transactions with 

partnerships that do not constitute 

acquisitions. If a partner is attributed 

the trade or business assets and 

activities of a partnership under 

paragraph (b)(2)(v) of this section, the 

partner’s acquisition of such trade or 

business assets and activities from the 

partnership is not, in and of itself, the 

acquisition of a new or different trade or 

business. In addition, if a partner 

transfers to a partnership trade or 

business assets and activities that the 

partner actively conducted immediately 

before the transfer and, immediately 

after the transfer, the partner is 

attributed the trade or business assets 

and activities of the partnership under 

paragraph (b)(2)(v) of this section, such 

transfer is not, in and of itself, the 

acquisition of a new or different trade or 

business by the transferor partner. 

(4) Special rules for an acquisition of 

a trade or business—(i) In general—(A) 

Application of section 355(b)(2)(C). 

Under sections 355(b)(2)(C) and (b)(3), a 

trade or business or an interest in a 

partnership engaged in a trade or 

business relied on to meet the 

requirements of section 355(b) must not 

have been acquired by either the DSAG 

or CSAG during the pre-distribution 

period unless it was acquired in a 

transaction in which no gain or loss was 

recognized. Further, a trade or business 

must not have been acquired by either 

the DSAG or CSAG during the predistribution period as a result of a 

corporation becoming a subsidiary SAG 

member unless such corporation 

became a subsidiary SAG member as a 

result of one or more transactions in 

which no gain or loss was recognized or 

by reasons of such transactions 

combined with acquisitions before the 

pre-distribution period. This paragraph 

(b)(4)(i)(A) also applies with respect to 

any acquisition during the predistribution period of a trade or 

business, an interest in a partnership 

engaged in a trade or business, or stock 

of a corporation engaged in a trade or 

business by a corporation that later 

becomes a subsidiary SAG member. See 

paragraphs (b)(4)(iv)(C) and (b)(4)(iv)(D) 

of this section regarding the application 

of this paragraph (b)(4)(i)(A) to certain 

multi-step acquisitions. 

(B) Application of section 

355(b)(2)(D). Under section 355(b)(2)(D), 

control of distributing must not have 

been acquired (at the time it was 

conducting the trade or business to be 

relied on) directly or indirectly by any 

distributee corporation, and control of 

controlled must not have been acquired 

(at the time it was conducting the trade 

or business to be relied on) directly or 

indirectly by the DSAG, during the predistribution period in one or more 

transactions in which gain or loss was 

recognized. This paragraph (b)(4)(i)(B) 

also applies with respect to any 

acquisition of stock of controlled during 

the pre-distribution period by a 

corporation that later becomes a DSAG 

member. For purposes of this paragraph 

(b)(4)(i)(B), and paragraphs (b)(4)(iii)(C) 

and (b)(4)(iv)(B) of this section, all 

distributee corporations that are 

affiliates shall be treated as one 

distributee corporation. This paragraph 

(b)(4)(i)(B) does not apply with respect 

to an acquisition of stock of any 

corporation other than distributing or 

controlled. See paragraph (b)(4)(iv)(B) of 

this section regarding the application of 

this paragraph (b)(4)(i)(B) to certain 

multi-step acquisitions of control. 

Further, see paragraph (b)(4)(iv)(F) of 

this section regarding certain 

acquisitions of stock in controlled to 

which paragraph (b)(4)(i)(A) of this 

section (and not this paragraph 

(b)(4)(i)(B)) applies. 

(C) Gain or loss recognized. Any 

reference to gain or loss recognized 

includes gain or loss treated as 

recognized under paragraphs (b)(4)(ii) or 

(b)(4)(iv) of this section. 

(ii) Certain transactions treated as 

transactions in which gain or loss is 

recognized. The common purpose of 

section 355(b)(2)(C) and (D) is to prevent 

the direct or indirect acquisition of the 

trade or business to be relied on by a 

corporation in exchange for assets in 

anticipation of a distribution to which 

section 355 would otherwise apply. 

Generally, if a DSAG member or 

controlled acquires the trade or business 

solely in exchange for distributing stock, 

distributing acquires control of 

controlled solely in exchange for 

distributing stock, or controlled acquires 

the trade or business from distributing 

solely in exchange for stock of 

controlled, in a transaction in which no 

gain or loss was recognized, the 

requirements of section 355(b)(2)(C) and 

(D) are satisfied. On the other hand, if 

the trade or business is acquired in 

exchange for assets of distributing (other 

than stock of a corporation in control of 

distributing used in a reorganization) 

the requirements of section 355(b)(2)(C) 

and (D) are generally not satisfied. For 

example, acquisitions by controlled 

(while controlled by distributing) from 

an unrelated party made in exchange for 

controlled stock have the effect of an 

indirect acquisition by distributing in 

exchange for distributing’s assets. Such 

acquisitions violate the purpose of 

section 355(b)(2)(C) even if no gain or 

loss is recognized. Therefore, as 

provided in paragraphs (b)(4)(ii)(A) and 

(b)(4)(ii)(B) of this section, if the DSAG 

or CSAG acquires a trade or business, an 

interest in a partnership engaged in a 

trade or business, or stock of a 

corporation engaged in a trade or 

business in exchange for assets of the 

DSAG in a transaction in which no gain 

or loss is recognized, for purposes of 

paragraph (b)(4)(i) of this section such 

acquisition will be treated as one in 

which gain or loss is recognized. 

(A) Certain tax-free acquisitions made 

in exchange for assets. An acquisition 

paid for in whole or in part, directly or 

indirectly, with assets of the DSAG will 

be treated as an acquisition in which 

gain or loss is recognized even if no gain 

or loss is actually recognized. 

Acquisitions described in this paragraph 

(b)(4)(ii)(A) include for example, a 

transaction in which the DSAG or CSAG 

acquires stock of a corporation engaged 

in the trade or business to be relied on 

by transferring assets not constituting 

the trade or business to be relied on to 

such corporation in exchange for stock 

of such corporation, the DSAG or CSAG 

acquires an interest in a partnership 

engaged in the trade or business to be 

relied on by contributing assets not 

constituting the trade or business to be 

relied on to the partnership, the DSAG 

or CSAG acquires stock of a corporation 

engaged in the trade or business in an 

exchange to which section 304(a)(1) 

applies, or distributing acquires a trade 

or business in exchange for its stock and 

assets in a transaction in which no loss 

is recognized by virtue of section 351(b). 

See also paragraph (b)(4)(iv)(E) of this 

section regarding the extent to which an 

acquisition involving the issuance of 

subsidiary stock constitutes an 

acquisition paid for with assets. 


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However, the assumption by the DSAG 

or CSAG of liabilities of a transferor 

shall not, in and of itself, be treated as 

the payment of assets if such 

assumption is not treated as the 

payment of money or other property 

under any other applicable provision. In 

addition, an acquisition in which no 

gain or loss is recognized consisting of 

a pro rata distribution to which section 

355 applies (to the extent the stock with 

respect to which the distribution is 

made was not acquired during the predistribution period in a transaction in 

which gain or loss was recognized), a 

distribution from a partnership that is 

explicitly excluded from paragraph 

(b)(4)(ii)(B) of this section, a 

reorganization described in section 

368(a)(1)(E) or (F), and an exchange to 

which section 1036 applies, are not 

acquisitions described in this paragraph 

(b)(4)(ii)(A). 

(B) Distributions from partnerships. 

An acquisition consisting of a 

distribution from a partnership is 

generally an acquisition paid for with 

assets of the DSAG, and will be treated 

as an acquisition in which gain or loss 

is recognized even if no gain or loss is 

actually recognized. However, an 

acquisition consisting of a pro rata 

distribution from a partnership of stock 

or an interest in lower-tier partnership 

is not an acquisition described in this 

paragraph (b)(4)(ii)(B) (and 

consequently not described in 

paragraph (b)(4)(ii)(A) of this section) to 

the extent the distributee partner did 

not acquire the interest in the 

distributing partnership during the predistribution period in a transaction in 

which gain or loss was recognized and 

to the extent the distributing 

partnership did not acquire the 

distributed stock or partnership interest 

within such period. This paragraph 

(b)(4)(ii)(B) (and consequently 

paragraph (b)(4)(ii)(A) of this section) 

does not apply to any partnership 

distribution to which paragraph 

(b)(3)(iii) of this section (regarding 

distributions from partnerships that are 

not, in and of themselves, the 

acquisition of a new or different trade or 

business) applies. 

(iii) Certain transactions in which 

recognized gain or loss is disregarded. 

The common purpose of section 

355(b)(2)(C) and (D) is to prevent the 

direct or indirect acquisition of the trade 

or business to be relied on by a 

corporation in exchange for assets in 

anticipation of a distribution to which 

section 355 would otherwise apply. An 

additional purpose of section 

355(b)(2)(D) is to prevent a distributee 

corporation from acquiring control of 

distributing in anticipation of a 

distribution to which section 355 would 

otherwise apply, enabling the 

disposition of controlled stock without 

recognizing the appropriate amount of 

gain. The acquisitions described in 

paragraphs (b)(4)(iii)(A) through 

(b)(4)(iii)(C) of this section are not the 

types of acquisitions to which section 

355(b)(2)(C) or (D) is intended to apply. 

Therefore, for purposes of paragraph 

(b)(4)(i) of this section, the recognition 

of gain or loss is disregarded if a trade 

or business, an interest in a partnership 

engaged in a trade or business, or stock 

of a corporation engaged in a trade or 

business is acquired in a transaction 

described in any of paragraphs 

(b)(4)(iii)(A) through (b)(4)(iii)(C) of this 

section. 

(A) Transfers to controlled. An 

acquisition by the CSAG from the DSAG 

provided the DSAG controls controlled 

immediately after the acquisition. 

(B) Cash for fractional shares. An 

acquisition that would satisfy the 

requirements of paragraph (b)(4)(i) of 

this section but for the payment of cash 

to shareholders for fractional shares in 

the transaction, provided that the cash 

paid represents a mere rounding off of 

the fractional shares in the exchange 

and is not separately bargained for 

consideration. 

(C) Certain acquisitions of control of 

distributing. A direct or indirect 

acquisition by a distributee corporation 

of control of distributing, in one or more 

transactions, where the basis of the 

acquired distributing stock in the hands 

of the distributee corporation is 

determined in whole by reference to the 

transferor’s basis. This paragraph 

(b)(4)(iii)(C) is only applicable with 

respect to a distribution by the acquired 

distributing, and does not apply for 

purposes of any subsequent distribution 

by any distributee corporation. 

(iv) Operating rules for acquisitions—

(A) Predecessors. References to a 

corporation shall include references to a 

predecessor of such corporation. For 

this purpose, a predecessor of a 

corporation is a corporation that 

transfers its assets to such corporation 

in a transaction to which section 381 

applies. 

(B) Certain multi-step acquisitions of 

control of distributing or controlled. A 

distributee corporation’s acquisition of 

stock in distributing or a DSAG’s 

acquisition of stock in controlled in one 

or more transactions in which gain or 

loss was recognized during the predistribution period will not prevent a 

distributee corporation’s acquisition of 

distributing stock or a DSAG’s 

acquisition of controlled stock 

constituting control of distributing or 

controlled in one or more separate 

transactions in which no gain or loss is 

recognized from satisfying the 

requirements of paragraph (b)(4)(i)(B) of 

this section, provided that, at the time 

control of distributing or controlled is 

first acquired, the acquiring distributee 

corporation owns an amount of 

distributing stock or the acquiring 

DSAG owns an amount of controlled 

stock, as the case may be, constituting 

control that was acquired in one or more 

transactions in which no gain or loss 

was recognized or by reason of such 

transactions combined with acquisitions 

before the pre-distribution period. The 

principles of this paragraph (b)(4)(iv)(B) 

will be applied with respect to an 

indirect acquisition of distributing or 

controlled stock. 

(C) Certain multi-step acquisitions of 

a subsidiary SAG member. An 

acquisition of stock in a corporation 

(target) by a SAG in one or more 

transactions in which gain or loss was 

recognized during the pre-distribution 

period will not prevent a SAG’s 

acquisition of target stock resulting in 

target becoming a subsidiary SAG 

member in one or more separate 

transactions in which no gain or loss is 

recognized from satisfying the 

requirements of paragraph (b)(4)(i)(A) of 

this section, provided that, at the time 

that target first becomes a subsidiary 

SAG member, the SAG owns an amount 

of target stock meeting the requirements 

of section 1504(a)(2) that was acquired 

in one or more transactions in which no 

gain or loss was recognized or by reason 

of such transactions combined with 

acquisitions before the pre-distribution 

period. The principles of this paragraph 

(b)(4)(iv)(C) will be applied with respect 

to an indirect acquisition of target stock 

by the SAG. 

(D) Certain multi-step asset 

acquisitions. Notwithstanding 

paragraph (b)(4)(i)(A) of this section, if 

immediately before a SAG’s direct 

acquisition of a trade or business (or an 

interest in a partnership engaged in a 

trade or business) held by a corporation 

(owner) in a transaction to which 

section 381 applies and in which no 

gain or loss is recognized, the SAG owns 

an amount of stock of the owner that it 

acquired in one or more transactions 

during the pre-distribution period in 

which gain or loss was recognized such 

that all of the other stock of the owner 

does not meet the requirements of 

section 1504(a)(2), such direct 

acquisition shall be treated as a 

transaction in which gain or loss was 

recognized. The principles of this 

paragraph (b)(4)(iv)(D) will be applied 

with respect to an indirect acquisition of 

the owner stock by the SAG. 


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(E) Acquisitions involving the 

issuance of subsidiary stock. If a SAG 

directly or indirectly owns stock of a 

subsidiary (including a subsidiary SAG 

member) and the subsidiary directly or 

indirectly acquires a trade or business, 

an interest in a partnership engaged in 

a trade or business, or stock of a 

corporation engaged in a trade or 

business from a person other than such 

SAG in exchange for stock of such 

subsidiary in a transaction in which no 

gain or loss is recognized (the 

acquisition), solely for purposes of 

applying this paragraph (b)(4) with 

respect to the trade or business, 

partnership interest, or stock acquired 

by the subsidiary in the acquisition, the 

subsidiary’s stock directly or indirectly 

owned by the SAG immediately after 

the acquisition is treated as acquired at 

the time of the acquisition in a 

transaction in which gain or loss is 

recognized. 

(F) Acquisitions of controlled stock 

where controlled is or becomes a DSAG 

member. With respect to an acquisition 

of stock in controlled, if controlled is or 

becomes a DSAG member, paragraph 

(b)(4)(i)(A) of this section applies and 

paragraph (b)(4)(i)(B) of this section 

does not apply for purposes of 

determining whether the requirements 

of section 355(b) are satisfied with 

respect to controlled. 

(G) Treatment of stock received in 

certain tax-free exchanges. Any stock 

received in a reorganization described 

in section 368(a)(1)(E) or (F), or in an 

exchange to which section 1036 applies, 

in which no gain or loss is recognized 

is treated as acquired in the same 

manner as the stock surrendered. 

(H) Situations where the separate 

existence of a subsidiary SAG member 

is respected. The separate existence of a 

subsidiary SAG member will be 

respected for purposes of determining 

whether a transaction qualifies for 

nonrecognition treatment under other 

provisions of the Internal Revenue 

Code. For example, for purposes of 

determining whether section 351 

applies or whether the transaction 

qualifies as a reorganization described 

in section 368(a), the separate existence 

of the subsidiary SAG member is 

respected. 

(c) Definitions. For purposes of this 

section the following definitions apply: 

(1) Affiliate. An affiliate is any 

member of an affiliated group as defined 

in section 1504(a) (without regard to 

section 1504(b)). 

(2) Controlled. Controlled is the 

controlled corporation. 

(3) Distributing. Distributing is the 

distributing corporation. 

(4) Pre-distribution period. The predistribution period is the five-year 

period ending on the date of the 

distribution. 

(d) Conventions and examples—(1) 

Conventions. The examples in 

paragraph (d)(2) of this section illustrate 

section 355(b) and this section. No 

inference should be drawn from any of 

these examples as to whether any 

requirements of section 355 other than 

those of section 355(b), as specified, are 

satisfied. Throughout these examples, C, 

D, D2, P, S, S1, S2, S3, T, X, Y, and Z 

are corporations, and Partnership is an 

entity that is treated as a partnership for 

Federal income tax purposes under 

§ 301.7701–3 of this chapter. Further, 

assume any transfer described in 

Examples 1 through 25 that is not 

identified as a purchase (defined in 

paragraph (d)(1)(iii) of this section) 

satisfies all the requirements of 

paragraph (b)(4) of this section as a 

transaction in which no gain or loss is 

recognized. Except as otherwise 

provided, for more than five years D has 

owned section 368(c) stock (as defined 

in paragraph (d)(1)(iv) of this section) 

but not section 1504(a)(2) stock (as 

defined in paragraph (d)(1)(v) of this 

section) of C. Furthermore, the 

following definitions apply: 

(i) ATB. ATB is any active trade or 

business. ATB1 and ATB2 are not in the 

same line of business under paragraph 

(b)(3)(ii) of this section. 

(ii) New subsidiary. A new subsidiary 

is a newly formed wholly owned 

corporation. 

(iii) Purchase. A purchase is an 

acquisition for cash. 

(iv) Section 368(c) stock. Section 

368(c) stock is stock constituting control 

within the meeting of section 368(c). 

(v) Section 1504(a)(2) stock. Section 

1504(a)(2) stock is stock meeting the 

requirements of section 1504(a)(2). 

(2) Examples. Generally, Examples 1 

and 2 illustrate the general requirements 

in paragraph (a) of this section, 

Examples 3 through 9 illustrate the SAG 

rules in paragraphs (b)(1)(ii) and 

(b)(1)(iii) of this section, Examples 10 

through 25 illustrate the rules regarding 

the active trade or business and active 

conduct for the pre-distribution period 

in paragraphs (b)(2) and (b)(3) of this 

section, Examples 26 through 40 

illustrate the acquisition rules in 

paragraphs (b)(4)(i) through (b)(4)(iii) of 

this section, and Examples 41 through 

51 illustrate the operating rules for 

acquisitions in paragraph (b)(4)(iv) of 

this section. The examples are as 

follows: 

Example 1. Spin-off. For more than five 

years, D and C have engaged in the active 

conduct of ATB1 and ATB2, respectively. D 

distributes the C stock to the D shareholders, 

and each corporation continues the active 

conduct of its respective trade or business. 

Because both D and C are engaged in the 

active conduct of a trade or business 

immediately after the distribution and such 

trades or businesses have been actively 

conducted by such corporations throughout 

the pre-distribution period, the requirements 

of section 355(b) have been satisfied. See 

paragraphs (a)(1) and (b)(3) of this section. 

Example 2. Split-up. The facts are the same 

as Example 1 except that D transfers all of its 

assets (including ATB1) other than the C 

stock to new subsidiary S, and then 

distributes the C stock and S stock to the D 

shareholders. Because C and S are 

respectively engaged in the active conduct of 

ATB2 and ATB1 immediately after the 

distribution, ATB2 has been actively 

conducted by C throughout the predistribution period, and together D (prior to 

the transfer to S) and S (after the transfer to 

S) have actively conducted ATB1 throughout 

the pre-distribution period, the requirements 

of section 355(b) have been satisfied. See 

paragraphs (a)(2) and (b)(3) of this section. 

Example 3. Subsidiary SAG member’s 

business. For more than five years, D has 

owned section 1504(a)(2) stock but not 

section 368(c) stock of S . Throughout this 

period, C and S have engaged in the active 

conduct of ATB1 and ATB2, respectively. In 

year 8, D distributes the C stock to the D 

shareholders. Because D owns section 

1504(a)(2) stock of S, S is a DSAG member. 

See paragraph (b)(1)(iii) of this section. D and 

S are treated as one corporation for purposes 

of determining whether D is engaged in an 

active trade or business. See paragraph 

(b)(1)(ii) of this section. Therefore, D is 

engaged in the active conduct of ATB2 both 

throughout the pre-distribution period and 

immediately after the distribution. 

Accordingly, D and C both satisfy the 

requirements of section 355(b). 

Example 4. Additional subsidiary SAG 

member shares acquired. The facts are the 

same as Example 3 except that in year 6, D 

acquires the remaining S stock. D’s 

acquisition of the remaining S stock in year 

6 has no effect for purposes of determining 

whether D satisfies the requirements of 

section 355(b)(2)(C) because the DSAG is 

already engaged in the active conduct of 

ATB2. See paragraph (b)(1)(ii) of this section. 

Section 355(b)(2)(D) does not apply to D’s 

acquisition of S stock. See paragraph 

(b)(4)(i)(B) of this section. Accordingly, D and 

C both satisfy the requirements of section 

355(b). 

Example 5. Segmented CSAG business. For 

more than five years, C has owned all the 

stock of S1, S2, and S3. Throughout this 

period, D has engaged in the active conduct 

of ATB1. Throughout this same period, S1, 

S2, and S3 have each engaged in a different 

essential segment of ATB2. While the three 

segments of ATB2 would together constitute 

the active conduct of a trade or business, 

none of S1, S2, or S3 would be considered 

engaged in the active conduct of an ATB 

individually. In year 6, D distributes the C 

stock to the D shareholders. C owns section 

1504(a)(2) stock of S1, S2, and S3, therefore, 


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C, S1, S2, and S3 are CSAG members. See 

paragraph (b)(1)(iii) of this section. C, S1, S2, 

and S3 are treated as one corporation for 

purposes of determining whether C is 

engaged in the active conduct of a trade or 

business. See paragraph (b)(1)(ii) of this 

section. Therefore, C is engaged in the active 

conduct of ATB2 both throughout the predistribution period and immediately after the 

distribution. Accordingly, D and C both 

satisfy the requirements of section 355(b). 

Example 6. Segmented DSAG business. 

The facts are the same as Example 5 except 

that D owns all of the C stock and all of the 

S3 stock, and D transfers the S3 stock to C 

immediately prior to the distribution. Prior to 

D’s transfer of the S3 stock to C, D owns 

section 1504(a)(2) stock of S3 and C, and C 

owns section 1504(a)(2) stock of S1 and S2, 

therefore, D, C, S1, S2, and S3 are DSAG 

members. See paragraph (b)(1)(iii) of this 

section. D, C, S1, S2, and S3 are treated as 

one corporation for purposes of determining 

whether D and C are engaged in the active 

conduct of a trade or business, and 

accordingly the transfer of the S3 stock to C 

is disregarded. See paragraph (b)(1)(ii) of this 

section. After the transfer, C owns section 

1504(a)(2) stock of S3, and the CSAG 

includes C, S1, S2, and S3. See paragraph 

(b)(1)(iii) of this section. C, S1, S2, and S3 are 

treated as one corporation for purposes of 

determining whether C is engaged in the 

active conduct of a trade or business. See 

paragraph (b)(1)(ii) of this section. 

Throughout the pre-distribution period, D, C, 

S1, S2, and S3 are treated as one corporation 

and both D and C are engaged in the active 

conduct of ATB1 and ATB2. See paragraphs 

(b)(1) and (b)(2) of this section. Immediately 

after the distribution, D is engaged in the 

active conduct of ATB1 and C is engaged in 

the active conduct of ATB2. Because D and 

C were engaged in the active conduct of 

ATB1 and ATB2 throughout the predistribution period and, immediately after 

the distribution, D is engaged in the active 

conduct of ATB1 and C is engaged in the 

active conduct of ATB2, D and C both satisfy 

the requirements of section 355(b). 

Example 7. Failed segmented business. 

The facts are the same as Example 6 except 

that D owns section 368(c) stock but not 

section 1504(a)(2) stock of C. Prior to D’s 

transfer of the S3 stock, the DSAG includes 

only D and S3, and the CSAG includes only 

C, S1, and S2. See paragraph (b)(1)(iii) of this 

section. Therefore, prior to the transfer of the 

S3 stock, ATB2 does not exist because no one 

SAG conducts all three of the essential 

segments of the trade or business. 

Accordingly, C does not satisfy the 

requirements of section 355(b) because ATB2 

was not actively conducted throughout the 

pre-distribution period. See paragraph 

(b)(3)(i) of this section. 

Example 8. Jointly owned partnership. For 

more than five years, D has owned all of the 

stock of C, and D and C each have owned a 

17-percent interest in Partnership. 

Throughout this period, D and Partnership 

have engaged in the active conduct of ATB1 

and ATB2, respectively. In year 6, D transfers 

its 17-percent interest in Partnership to C and 

distributes all of the C stock to the D 

shareholders. Because D owns section 

1504(a)(2) stock of C, C is a DSAG member. 

See paragraph (b)(1)(iii) of this section. D and 

C are treated as one corporation for purposes 

of determining whether D and C are engaged 

in the active conduct of a trade or business. 

See paragraph (b)(1)(ii) of this section. 

Accordingly, throughout the pre-distribution 

period, D and C are each treated as owning 

a 34-percent interest in Partnership. As such, 

both D and C are treated as engaged in the 

active conduct of both ATB1 and ATB2 

throughout the pre-distribution period. See 

paragraphs (b)(2)(v)(A) and (b)(2)(v)(B) of this 

section. The transfer of the Partnership 

interest is disregarded because it is between 

SAG members. See paragraph (b)(1)(ii) of this 

section. After the distribution, C owns 34 

percent of Partnership and is therefore 

engaged in the active conduct of ATB2. See 

paragraphs (b)(2)(v)(A) and (b)(2)(v)(B) of this 

section. Therefore, D and C both satisfy the 

requirements of section 355(b). 

Example 9. Sequential application of the 

SAG rule—(i) Facts. For more than five years, 

D2 has owned all of the stock of D, and D 

has owned all of the stock of C. Throughout 

this period, D2 has engaged in the active 

conduct of ATB1 and ATB2, and D has 

engaged in the active conduct of ATB1. C, 

individually, has not engaged in the active 

conduct of any ATB. In year 6, D distributes 

all of the C stock to D2 (first distribution). 

Immediately thereafter, D2 transfers ATB2 to 

C and distributes all of the C stock to the D2 

shareholders (second distribution). 

(ii) Analysis—first distribution. Because D 

owns section 1504(a)(2) stock of C, C is a 

DSAG member prior to the first distribution. 

See paragraph (b)(1)(iii) of this section. D and 

C are treated as one corporation for purposes 

of determining whether D and C are engaged 

in the active conduct of a trade or business 

with respect to the first distribution. See 

paragraphs (b)(1)(ii) and (b)(1)(iii) of this 

section. Accordingly, throughout the predistribution period, D and C are each treated 

as engaged in ATB1 with respect to the first 

distribution. However, for purposes of 

determining whether D’s distribution of the 

C stock to D2 satisfies the requirements of 

section 355(b) immediately after the first 

distribution, C is the only CSAG member (D2 

is not a member of any SAG with respect to 

the first distribution). See paragraph 

(b)(1)(iii) of this section. Accordingly, C does 

not satisfy the requirements of section 355(b) 

with respect to the first distribution because 

C is not engaged in the active conduct of an 

ATB immediately after the first distribution. 

(iii) Analysis—second distribution. 

Because D2 owns section 1504(a)(2) stock of 

D and C (and D owned section 1504(a)(2) 

stock of C before the first distribution), D2, 

D, and C are D2 SAG members throughout 

the pre-distribution period with respect to 

the second distribution. See paragraph 

(b)(1)(iii) of this section. Further, for 

purposes of the second distribution D’s 

distribution of the C stock to D2 is 

disregarded because it is between D2 SAG 

members. See paragraphs (b)(1)(ii) and 

(b)(1)(iii) of this section. D2, D, and C are 

treated as one corporation for purposes of 

determining whether D2 and C are engaged 

in the active conduct of a trade or business 

with respect to the second distribution. See 

paragraphs (b)(1)(ii) and (b)(1)(iii) of this 

section. Accordingly, throughout the predistribution period, D2 and C are each treated 

as engaged in the active conduct of ATB1 and 

ATB2 with respect to the second distribution. 

The transfer of ATB2 to C is disregarded 

because it is between D2 SAG members. See 

paragraph (b)(1)(ii) of this section. 

Immediately after the second distribution, C 

is engaged the active conduct of ATB2. 

Therefore, D2 and C both satisfy the 

requirements of section 355(b) with respect 

to the second distribution. 

Example 10. Limitations—securities and 

vacant land. For more than five years, D has 

owned investment securities and vacant 

land. D has conducted no activities with 

respect to the vacant land, but D will 

subsequently subdivide the vacant land, 

install streets and utilities, and sell the 

developed lots to various homebuilders. D 

cannot currently satisfy the requirements of 

section 355(b) because the holding of 

investment securities does not constitute the 

active conduct of a trade or business. See 

paragraph (b)(2)(iv)(A) of this section. 

Furthermore, no significant development 

activities have been conducted with respect 

to the vacant land. See paragraph (b)(3) of 

this section. 

Example 11. Limitations—occupied real 

estate—active. For more than five years, D, a 

bank, has owned an eleven-story office 

building, the ground floor of which D has 

occupied while engaged in the active 

conduct of its banking business. The 

remaining ten floors are rented to various 

tenants. Throughout this period, the building 

has been managed, operated, repaired, and 

maintained by employees of D. D transfers 

the building along with the significant assets 

used to operate the building and the goodwill 

associated with the building to new 

subsidiary C and distributes the C stock to 

the D shareholders. Henceforth, C’s 

employees will manage, operate, repair, and 

maintain the building. D and C both satisfy 

the requirements of section 355(b). See 

paragraph (b)(3) of this section. 

Example 12. Limitations—occupied real 

estate—not active. For more than five years, 

D, a bank, has owned a two-story building, 

the ground floor and one half of the second 

floor of which D has occupied while engaged 

in the active conduct of its banking business. 

The other half of the second floor has been 

rented as storage space to a neighboring retail 

merchant. D transfers the building and the 

goodwill associated with the building to new 

subsidiary C and distributes the C stock to 

the D shareholders. After the distribution, D 

leases from C the space in the building that 

it formerly occupied. Under the lease, D will 

repair and maintain its portion of the 

building and pay property taxes and 

insurance. C does not satisfy the 

requirements of section 355(b) because it is 

not engaged in the active conduct of a trade 

or business immediately after the 

distribution. See paragraph (b)(2)(iv)(A) of 

this section. This example does not address 

the question of whether the activities of D 

with respect to the building prior to the 

separation would constitute the active 

conduct of a trade or business. 

Example 13. No significant activities. For 

more than five years, D owned land on which 


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it has engaged in the active conduct of the 

ranching business. Oil has been discovered 

in the area, and it is apparent that oil may 

be found under the land on which the 

ranching business is conducted. D has 

engaged in no significant activities in 

connection with its mineral rights. D 

transfers its mineral rights to new subsidiary 

C and distributes the C stock to the D 

shareholders. C will actively pursue the 

development of the oil producing potential of 

the property. C does not satisfy the 

requirements of section 355(b) after the 

distribution because D was not engaged in 

significant exploitation activities with 

respect to the mineral rights throughout the 

pre-distribution period. See paragraph (b)(3) 

of this section. 

Example 14. Vertical division—state 

contracts. For more than five years, D has 

engaged in the active conduct of a single 

business of constructing sewage disposal 

plants and other facilities. D transfers one 

half of its assets to new subsidiary C. These 

assets include a contract for the construction 

of a sewage disposal plant in State M, 

construction equipment, cash, goodwill, and 

other tangible and significant assets. D 

retains a contract for the construction of a 

sewage disposal plant in State N, 

construction equipment, cash, goodwill, and 

other tangible and significant assets. D 

distributes the C stock to one of D’s 

shareholders in exchange for all of his D 

stock. D and C both satisfy the requirements 

of section 355(b). See paragraphs (b)(2) and 

(b)(3)(i) of this section. 

Example 15. Vertical division—location. 

For more than five years, D has engaged in 

the active conduct of owning and operating 

two men’s retail clothing stores, one in the 

downtown area of the City of G and one in 

a suburban area of G. D transfers the store 

building, fixtures, inventory, and other 

significant assets related to the operations of 

the suburban store and the goodwill 

attributable to that store to new subsidiary C. 

D also transfers to C the delivery trucks and 

delivery personnel that formerly served both 

stores. Henceforth, D will contract with a 

local public delivery service to make its 

deliveries. D retains the warehouses that 

formerly served both stores. Henceforth, C 

will lease warehouse space from an unrelated 

public warehouse company. D then 

distributes the C stock to the D shareholders. 

D and C both satisfy the requirements of 

section 355(b). See paragraphs (b)(2) and 

(b)(3)(i) of this section. 

Example 16. Horizontal division—

research. For more than five years, D has 

engaged in the active conduct of 

manufacturing and sale of household 

products. Throughout this period, D has 

maintained a research department for use in 

connection with its manufacturing activities. 

The research department has 30 employees 

actively engaged in the development of new 

products. D transfers the research department 

(which has significant assets and goodwill) to 

new subsidiary C and distributes the C stock 

to the D shareholders. After the distribution, 

C continues its research operations on a 

contractual basis with several corporations, 

including D. D and C both satisfy the 

requirements of section 355(b). See 

paragraphs (b)(2) and (b)(3)(i) of this section. 

The result is the same if, after the 

distribution, C continues its research 

operations but furnishes its services only to 

D. See paragraphs (b)(2) and (b)(3)(i) of this 

section. However, see § 1.355–2(d)(2)(iv)(C) 

(related function device factor) for possible 

evidence of device. 

Example 17. Horizontal division—sales. 

For more than five years, D has engaged in 

the active conduct of processing and selling 

meat products. D derives income from no 

other source. D separates the sales function 

from the processing function by transferring 

the significant business assets related to the 

sales function, the goodwill associated with 

the sales function, and cash for working 

capital to new subsidiary C. D then 

distributes the C stock to the D shareholders. 

After the distribution, C purchases for resale 

the meat products processed by D. D and C 

both satisfy the requirements of section 

355(b). See paragraphs (b)(2) and (b)(3)(i) of 

this section. However, see § 1.355–

2(d)(2)(iv)(C) (related function device factor) 

for possible evidence of device. 

Example 18. Expansion and vertical 

division—location. For more than five years, 

D has engaged in the active conduct of 

owning and operating hardware stores in 

several states. In year 6, D purchased all of 

the assets of a hardware store in State M, 

where D had not previously conducted 

business. In year 8, D transfers the State M 

hardware store and related significant assets 

and goodwill to new subsidiary C and 

distributes the C stock to the D shareholders. 

After the distribution, the State M hardware 

store has its own manager and is operated 

independently of the other stores. Because—

(i) The product of the State M hardware 

store is similar to the product of D’s 

hardware stores in the other states; 

(ii) The business activities associated with 

the operation of the State M hardware store 

are the same as the business activities 

associated with the operation of D’s hardware 

stores in the other states; and 

(iii) The operation of a hardware store in 

State M involves the use of the experience 

and know-how that D developed in the 

operation of the hardware stores in the other 

states, the hardware store in State M is in the 

same line of business as the hardware stores 

in the other states. Therefore, the acquisition 

of the State M hardware store constitutes an 

expansion of D’s existing business and its 

acquisition does not constitute the 

acquisition of a new or different business 

under paragraph (b)(3)(ii) of this section. 

Accordingly, D and C both satisfy the 

requirements of section 355(b). 

Example 19. Expansion and horizontal 

division—Internet. For more than five years, 

D has engaged in the active conduct of 

operating a retail shoe store business, under 

the name D. Throughout this period, D’s sales 

are made exclusively to customers who 

frequent its retail stores in shopping malls 

and other locations. D’s business enjoys 

favorable name recognition, customer loyalty, 

and other elements of goodwill in the retail 

shoe market. D creates an Internet Web site 

and begins selling shoes at retail on the Web 

site. To a significant extent, the operation of 

the Web site draws upon D’s existing 

experience and know-how. The Web site is 

named ‘‘D.com’’ to take advantage of the 

name recognition, customer loyalty, and 

other elements of goodwill associated with D 

and the D name and to enhance the Web 

site’s chances for success in its initial stages. 

Eight months after beginning to sell shoes on 

the Web site, D transfers all of the Web site’s 

assets and liabilities (all of which include the 

significant assets and goodwill associated 

with the Web site’s business) to new 

subsidiary C and distributes the C stock to 

the D shareholders. The product of the retail 

shoe store business and the product of the 

Web site are the same (shoes), and the 

principal business activities of the retail shoe 

store business are the same as those of the 

Web site (purchasing shoes at wholesale and 

reselling them at retail). Although selling 

shoes on a Web site requires some know-how 

not associated with operating a retail store, 

such as familiarity with different marketing 

approaches, distribution chains, and 

technical operations issues, the Web site’s 

operation does draw to a significant extent on 

D’s existing experience and know-how, and 

the Web site’s success will depend in large 

measure on the goodwill associated with D 

and the D name. Therefore, the creation by 

D of the Internet Web site does not constitute 

the acquisition of a new or different business 

under paragraph (b)(3)(ii) of this section. 

Accordingly, it is an expansion of D’s retail 

shoe store business, all of which is treated as 

having been actively conducted throughout 

the pre-distribution period. Therefore, D and 

C both satisfy the requirements of section 

355(b). 

Example 20. Expansion—acquiring a SAG 

member. For more than five years, D has 

owned all of the stock of C. Throughout this 

period, C and unrelated T have engaged in 

the active conduct of ATB1. In year 6, D 

purchases all of the T stock. In year 8, D 

distributes all of the C stock to the D 

shareholders. Throughout the period that C is 

a DSAG member, D is engaged in the active 

conduct of ATB1. See paragraph (b)(1)(ii) of 

this section. Moreover, because D acquired 

section 1504(a)(2) stock of T, D is treated as 

having acquired T’s assets (and activities), 

and that acquisition constitutes an expansion 

of ATB1. See paragraphs (b)(1)(ii) and 

(b)(3)(ii) of this section. Therefore, D and C 

both satisfy the requirements of section 

355(b). The result would be the same if D had 

owned all of the T stock for more than five 

years, and purchased all of the C stock in 

year 6. See paragraphs (b)(1)(ii), (b)(3)(ii), 

(b)(4)(i), and (b)(4)(iv)(F) of this section. 

Example 21. No expansion—acquiring only 

control of controlled. For more than five 

years, D and unrelated C have engaged in the 

active conduct of ATB1. In year 6, D 

purchases section 368(c) stock but not 

section 1504(a)(2) stock of C. In year 8, D 

distributes the C stock to the D shareholders. 

While D and C are in the same line of 

business, the acquisition does not result in an 

expansion of D’s business under paragraph 

(b)(3)(ii) of this section because D is not 

treated as having acquired C’s assets (and 

activities). Accordingly, D has acquired 

control of C in violation of section 

355(b)(2)(D). See paragraph (b)(4)(i)(B) of this 

section. However, if D acquires additional C 


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stock thereby causing C to become a DSAG 

member, D would be treated as having 

acquired C’s assets (and activities) and the 

acquisition would constitute an expansion of 

ATB1. See paragraphs (b)(1)(ii), (b)(3)(ii), 

(b)(4)(i), and (b)(4)(iv)(F) of this section. In 

such a case, D and C both would satisfy the 

requirements of section 355(b). 

Example 22. Partnership—meaningful but 

not significant. For more than five years, 

unrelated X and Y have owned a 20-percent 

and 33 1/3-percent interest, respectively, in 

Partnership. The remaining interests in 

Partnership are owned by unrelated parties. 

For more than five years, Partnership has 

manufactured power equipment. But for the 

performance of all its management functions 

by employees of X, Partnership would satisfy 

all the requirements of paragraph (b)(2)(i) of 

this section. X and/or Y will be attributed the 

trade or business assets and activities of 

Partnership only if the corporation satisfies 

the requirements of paragraph (b)(2)(v)(B) or 

(b)(2)(v)(C) of this section. See paragraph 

(b)(2)(v)(A) of this section. While X does not 

satisfy the requirements of paragraph 

(b)(2)(v)(B) of this section because X’s 

interest in Partnership is not significant, 

under paragraph (b)(2)(v)(C) of this section, X 

owns a meaningful interest in Partnership 

and performs active and substantial 

management functions for the trade or 

business assets and activities of Partnership. 

Therefore, X is attributed the trade or 

business assets and activities of Partnership. 

Accordingly, X is engaged in the active 

conduct of the business of manufacturing 

power equipment. See paragraph (b)(2) of 

this section. In determining whether Y is 

engaged in the business of manufacturing 

power equipment, the management functions 

performed by X for Partnership are not taken 

into account. See paragraph (b)(2)(v)(A) of 

this section. Therefore, although Y is 

attributed Partnership’s trade or business 

assets and activities under paragraph 

(b)(2)(v)(B) of this section because Y owns a 

significant interest in Partnership, Y is not 

engaged in the business of manufacturing 

power equipment because neither Y nor 

Partnership perform any management 

functions for the business. See paragraph 

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

Example 23. Partnership—significant but 

not meaningful. The facts are the same as 

Example 22 except that all the management 

functions related to the business of 

Partnership are performed by employees of 

Partnership. Because employees of 

Partnership perform all of the management 

functions related to the trade or business 

assets and activities of manufacturing power 

equipment, Partnership itself satisfies all the 

requirements of paragraph (b)(2)(i) of this 

section. X neither owns a significant interest 

in Partnership nor performs active and 

substantial management functions with 

respect to the trade or business assets and 

activities of Partnership. Accordingly, X does 

not satisfy the requirements of paragraph 

(b)(2)(v)(B) or (b)(2)(v)(C) of this section, X is 

not attributed the trade or business assets and 

activities of Partnership’s business of 

manufacturing power equipment, and X is 

not engaged in the active conduct of the 

business of manufacturing power equipment. 

On the other hand, because Y owns a 

significant interest in Partnership, Y satisfies 

the requirements of paragraph (b)(2)(v)(B) of 

this section. Therefore, Y is attributed the 

trade or business assets and activities of 

Partnership’s business. Accordingly, Y 

satisfies the requirements of paragraph 

(b)(2)(i) of this section and is engaged in the 

active conduct of the business of 

manufacturing power equipment. 

Example 24. Partnership—significant by 

many. The facts are the same as Example 23 

except that X, Y, and Z each own a 33 1/3- 

percent interest in Partnership. Because X, Y, 

and Z each own a significant interest in 

Partnership, each of X, Y, and Z satisfy the 

requirements of paragraph (b)(2)(v)(B) of this 

section. Accordingly, each of X, Y, and Z are 

attributed the trade or business assets and 

activities of Partnership, satisfy the 

requirements of paragraph (b)(2)(i) of this 

section, and are engaged in the active 

conduct of the business of manufacturing 

power equipment. 

Example 25. Non-SAG affiliates—(i) Facts. 

For more than five years, X has owned 10 

percent of the stock of D2, D2 has owned all 

the stock of D and S, and D has owned all 

the stock of C. Throughout this period, D has 

manufactured furniture that it sells to 

furniture stores and has been the principal 

owner of the goodwill and significant assets 

associated with that business and C has 

owned and operated a laundry business and 

has been the principal owner of the goodwill 

and significant assets associated with that 

business. Throughout this period, however, 

employees of S have performed all the active 

and substantial management and operational 

functions of the furniture business for D and 

the laundry business for C. D distributes the 

C stock to D2 (first distribution) and D2 

distributes the C stock to X in exchange for 

all of X’s D2 stock (second distribution). 

After the distributions, employees of X 

perform all the active and substantial 

management and operational functions of the 

laundry business for C that the employees of 

S performed before the distributions and the 

employees of S continue to perform the same 

activities for D as they did before the 

distributions. 

(ii) Analysis—first distribution. In 

determining whether the furniture 

manufacturing business and laundry 

business have been actively conducted 

throughout the pre-distribution period and 

immediately after the first distribution, the 

activities performed for those businesses 

include activities performed by employees of 

affiliates of D and C (even if they are not 

DSAG or CSAG members). Accordingly, such 

activities include the activities performed by 

the employees of S for D and C. See 

paragraph (b)(2)(iii) of this section. D and C 

own the goodwill and significant assets 

associated with their respective businesses 

both throughout the pre-distribution period 

and immediately after the first distribution, 

and are treated as performing active and 

substantial management and operational 

functions for their respective businesses both 

throughout the pre-distribution period and 

immediately after the first distribution. 

Therefore, D and C both satisfy the 

requirements of section 355(b) with respect 

to the first distribution. 

(iii) Analysis—second distribution. 

Because D2 owns section 1504(a)(2) stock of 

D, C, and S (and D owned section 1504(a)(2) 

stock of C before the first distribution), D2, 

D, C, and S are D2 SAG members throughout 

the pre-distribution period with respect to 

the second distribution. See paragraph 

(b)(1)(iii) of this section. Accordingly, D2, D, 

C, and S are treated as one corporation for 

purposes of determining whether D2 is 

engaged in an active trade or business with 

respect to the second distribution. See 

paragraph (b)(1)(ii) of this section. 

Accordingly, for purposes of the second 

distribution, D2 has been engaged in the 

furniture manufacturing business and the 

laundry business throughout the predistribution period. Further, for purposes of 

the second distribution D’s distribution of the 

C stock to D2 is disregarded because it is 

between D2 SAG members. See paragraph 

(b)(1)(ii) of this section. D and S continue to 

be D2 SAG members immediately after the 

second distribution. See paragraph (b)(1)(iii) 

of this section. Accordingly, D2 is engaged in 

the furniture manufacturing business 

immediately after the second distribution. In 

determining whether C is engaged in the 

active conduct of a trade or business 

immediately after the second distribution, 

the activities performed for the laundry 

business include activities performed by 

employees of affiliates of C (even if they are 

not CSAG members). Accordingly, 

immediately after the second distribution, 

such activities include the activities 

performed for C by the employees of X. See 

paragraph (b)(2)(iii) of this section. C owns 

the goodwill and significant assets associated 

with the laundry business both throughout 

the pre-distribution period and immediately 

after the second distribution, and is treated 

as performing active and substantial 

management and operational functions both 

throughout the pre-distribution period and 

immediately after the second distribution. 

Therefore, D2 and C both satisfy the 

requirements of section 355(b) with respect 

to the second distribution. 

Example 26. Purchased ATB and SAG 

member. For more than five years, P has 

owned all of the stock of D and S1, and D 

and S1 have owned all of the stock of S2 and 

S3, respectively. Throughout this period, S1 

and S3 have engaged in the active conduct 

of ATB1 and ATB2, respectively. In year 6, 

S2 purchases ATB1 and all of the S3 stock 

from S1 on the same day. In year 6, the DSAG 

acquired ATB1 and ATB2 (as a result of S3 

becoming a DSAG member) in a transaction 

in which gain or loss was recognized. 

Accordingly, if D were to make a 

distribution, it could not rely on ATB1 or 

ATB2 to satisfy the requirements of section 

355(b) unless the DSAG’s year 6 acquisition 

of ATB1 and ATB2 is not in the predistribution period. See paragraph (b)(4)(i)(A) 

of this section. The fact that S2 acquired 

ATB1 and the S3 stock from an affiliate is not 

relevant. 

Example 27. Purchased ATB prior to 

entering. For more than five years, T has 

engaged in the active conduct of ATB1. In 

year 6, S purchased ATB1 from T. In year 7, 

D acquired all of the S stock from the S 

shareholders solely in exchange for D stock 


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in a transaction to which section 351 applied 

and in which no gain or loss was recognized. 

As a result, S became a DSAG member. 

Although S became a DSAG member in a 

transaction in which no gain or loss was 

recognized, S, a corporation that later became 

a DSAG member, acquired ATB1 in a 

transaction in which gain or loss was 

recognized. Accordingly, if the D were to 

make a distribution, it could not rely on 

ATB1 to satisfy the requirements of section 

355(b) unless S’s year 6 acquisition of ATB1 

is not in the pre-distribution period. See 

paragraph (b)(4)(i)(A) of this section. 

Example 28. ATB (or new SAG member) for 

stock of distributing or a corporation in 

control of distributing in a reorganization—

transfer of ATB to controlled. For more than 

five years, unrelated T and Z have owned all 

of the stock of X and Y, respectively, and X 

and Y have engaged in the active conduct of 

ATB1 and ATB2, respectively. Unrelated P 

owns all of the stock of D. In year 6, D 

acquires all of X’s assets (including ATB1) 

from X solely in exchange for D stock in a 

reorganization described in section 

368(a)(1)(A), and all of Y’s assets (including 

ATB2) from Y solely in exchange for P stock 

in a reorganization described in section 

368(a)(1)(A) by reason of section 368(a)(2)(D). 

No gain or loss is recognized on either 

acquisition. In a separate transaction, D 

transfers ATB2 to new subsidiary C in 

exchange for all of the C stock in a 

transaction that satisfies the requirements of 

section 351 and in which no gain or loss is 

recognized. If D were to distribute the C stock 

in a separate transaction, D and C can rely 

on ATB1 and ATB2, respectively, to satisfy 

the requirements of section 355(b). ATB1 and 

ATB2 were acquired in transactions in which 

no gain or loss was recognized, and were not 

acquired in exchange for assets of the DSAG. 

See paragraph (b)(4)(ii) of this section. The 

result would be the same if D acquired all of 

the assets of T (including the X stock) and Z 

(including the Y stock) in the reorganizations 

instead of acquiring the assets of X and Y, 

and then transferred the Y stock to C. See 

paragraphs (b)(1)(ii) and (b)(4)(ii) of this 

section. 

Example 29. Taxable transfer of ATB by 

distributing to controlled. The facts are the 

same as the original facts in Example 28 

except that before and after the transfer to C, 

D owned section 368(c) stock but not section 

1504(a)(2) stock of C, and recognized gain 

under section 357(c) gain on the transfer of 

ATB2 to C. D and C can rely on ATB1 and 

ATB2, respectively, to satisfy the 

requirements of section 355(b). See paragraph 

(b)(4)(iii)(A) of this section. The result would 

be the same if C purchased ATB2 from D. 

The result would also be the same if D 

acquired all of the assets of T (including the 

X stock) and Z (including the Y stock) in the 

reorganizations instead of acquiring the 

assets of X and Y, and then C purchased the 

Y stock from D. See paragraphs (b)(1)(ii) and 

(b)(4)(iii)(A) of this section. 

Example 30. Assets for controlled stock in 

a section 351 transaction. For more than five 

years, unrelated D and C have engaged in the 

active conduct of ATB1 and ATB2, 

respectively. In year 6, D transfers trucks to 

C to be used in ATB2 in exchange for section 

368(c) stock of C in a transaction to which 

section 351 applies and in which no gain or 

loss is recognized. If D were to distribute the 

C stock, C could not rely on ATB2 to satisfy 

the requirements of section 355(b) unless D’s 

year 6 acquisition of the C stock is not in the 

pre-distribution period because D acquired 

section 368(c) stock of C, a corporation 

engaged in ATB2, in exchange for assets not 

constituting the trade or business. See 

paragraphs (b)(4)(i)(B) and (b)(4)(ii)(A) of this 

section. The result would be the same even 

if C became a DSAG member as a result of 

the year 6 transfer. See paragraphs (b)(4)(i)(A) 

and (b)(4)(ii)(A) of this section. 

Example 31. ATB for controlled stock in a 

reorganization. For more than five years, 

unrelated D and T have engaged in the active 

conduct of ATB1 and ATB2, respectively. 

Throughout this period, D has owned all of 

the sole class of C stock. In year 6, T merges 

into C solely in exchange for C stock in a 

reorganization described in section 

368(a)(1)(A) and in which no gain or loss is 

recognized. As a result, the T shareholders 

receive 20 percent of the sole class of C stock. 

Because C acquired ATB2 in exchange for C 

stock, solely for purposes of determining 

whether ATB2 can be relied on to satisfy the 

requirements of section 355(b), D is treated 

as having acquired its 80 percent of the C 

stock in year 6 in a transaction in which gain 

or loss was recognized. See paragraph 

(b)(4)(iv)(E) of this section. Accordingly, if D 

were to distribute the C stock, C could not 

rely on ATB2 to satisfy the requirements of 

section 355(b) unless C’s year 6 acquisition 

of ATB2 is not in the pre-distribution period 

because ATB2 was in effect indirectly 

acquired in exchange for D’s assets. See 

paragraphs (b)(4)(i)(A), (b)(4)(ii)(A), and 

(b)(4)(iv)(E) of this section. 

Example 32. ATB and controlled stock for 

distributing stock in a section 351 

transaction. For more than five years, T and 

unrelated C have engaged in the active 

conduct of ATB1 and ATB2, respectively. 

Unrelated P owns all of the stock of D. In 

year 6, P purchases ATB1 from T, and section 

368(c) stock of C from the C shareholders. In 

year 6, P contributes the C stock and ATB1 

to D solely in exchange for additional D stock 

in a transaction to which section 351 applies 

and in which no gain or loss is recognized. 

If D were to subsequently distribute the C 

stock in a separate transaction, D can rely on 

ATB1, and C can rely on ATB2 to satisfy the 

requirements of section 355(b) because 

neither ATB1 nor control of C were acquired 

in exchange for assets of the DSAG. See 

paragraphs (b)(4)(i)(A), (b)(4)(i)(B), and 

(b)(4)(ii) of this section. The fact that P, an 

affiliate of D, purchased ATB1 and section 

368(c) stock of C in year 6 is not relevant. 

Example 33. ATB for distributing stock in 

a section 351 transaction with section 357(c) 

gain. The facts are the same as Example 32 

except that D has owned section 368(c) stock 

of C for more than five years, P only 

purchases ATB1 from T, and P recognizes 

under section 357(c) gain on the transfer of 

ATB1 to D as a result of D assuming 

liabilities of P. D cannot rely on ATB1 to 

satisfy the requirements of section 355(b) 

until D’s year 6 acquisition of ATB1 is no 

longer in the pre-distribution period because 

D acquired ATB1 in a transaction in which 

gain or loss was recognized. See paragraph 

(b)(4)(i)(A) of this section. 

Example 34. Partnership distributions. For 

more than five years, X and Y have engaged 

in the active conduct of ATB1 and ATB2, 

respectively. Throughout this period, 

unrelated D has owned a 90-percent interest 

in Partnership. D is attributed any trade or 

business assets and activities of Partnership 

under paragraph (b)(2)(v) of this section. In 

year 6, Partnership purchases ATB1 from X 

and all of the Y stock from its owner. In year 

9, Partnership distributes ATB1 and all of the 

Y stock to D in a non-liquidating distribution. 

Assume that no gain or loss is recognized by 

Partnership or any partner on the 

distribution. As a result of the distribution, 

Y becomes a DSAG member, and D is treated 

as having acquired Y’s assets (and activities). 

See paragraphs (b)(1)(ii) and (b)(1)(iii) of this 

section. If D were to make a distribution, 

ATB1 could not be relied on to satisfy the 

requirements of section 355(b) unless 

Partnership’s year 6 acquisition of ATB1 is 

not in the pre-distribution period. See 

paragraphs (b)(2)(v), (b)(3)(iii), and 

(b)(4)(ii)(B) of this section. If D were to make 

a distribution, ATB2 could not be relied on 

to satisfy the requirements of section 355(b) 

unless D’s year 9 acquisition of the Y stock 

is not in the pre-distribution period. See 

paragraphs (b)(2)(v)(A) and (b)(4)(ii)(B) of this 

section. Alternatively, if in year 9 Partnership 

only makes a pro rata distribution of all the 

Y stock to its partners such that D receives 

90 percent of the Y stock, ATB2 cannot be 

relied on until Partnership’s year 6 

acquisition of all of the Y stock is no longer 

in the pre-distribution period. See paragraph 

(b)(4)(ii)(B) of this section. 

Example 35. Partnership distribution (new 

SAG member). For more than five years, D 

has owned a 50-percent interest in 

Partnership. The remaining interests in 

Partnership are owned by unrelated parties. 

Throughout this period, Partnership has 

engaged in the active conduct of ATB1, and 

D has been attributed the trade or business 

assets and activities of Partnership’s ATB1 

under paragraph (b)(2)(v) of this section. In 

year 6, pursuant to an integrated plan, 

Partnership contributes ATB1 to new 

subsidiary S, and distributes all of the S stock 

to D in liquidation of D’s 50-percent interest 

in Partnership. Assume that no gain or loss 

is recognized by Partnership or any partner 

on the distribution. As a result, S becomes a 

DSAG member, and D is treated as having 

acquired S’s assets (and activities). See 

paragraphs (b)(1)(ii) and (b)(1)(iii) of this 

section. Because D was attributed ATB1 

immediately before the incorporation and 

distribution by Partnership, and S became a 

DSAG member as a result of the distribution, 

Partnership’s distribution of the S stock to D 

is not an acquisition of ATB1. See paragraphs 

(b)(3)(iii) and (b)(4)(ii)(B) of this section. 

Accordingly, if D were to make a 

distribution, it can rely on ATB1 to satisfy 

the requirements of section 355(b). 

Example 36. Transfer of partnership in a 

reorganization and distributions. For more 

than five years, T has owned a 40-percent 

interest in Partnership which has engaged in 

the active conduct of ATB1. Throughout this 


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period, T has been attributed the trade or 

business assets and activities of Partnership’s 

ATB1 under paragraph (b)(2)(v) of this 

section. In year 6, T merges into S, a wholly 

owned subsidiary of unrelated D, solely in 

exchange for D stock in a reorganization 

described in section 368(a)(1)(A) by reason of 

section 368(a)(2)(D). No gain or loss is 

recognized. If D were to make a distribution, 

D can rely on ATB1 because ATB1 has been 

actively conducted throughout the predistribution period, and the interest in 

Partnership was acquired in a transaction in 

which no gain or loss was recognized and 

was not acquired in exchange for assets of the 

DSAG. See paragraphs (b)(2)(v), (b)(3)(i), and 

(b)(4)(ii) of this section. The results would be 

the same if T owned only a 20-percent 

interest in Partnership, employees of T 

performed active and substantial 

management functions for Partnership’s trade 

or business assets and activities prior to the 

merger, and employees of S (or an affiliate of 

S) performed active and substantial 

management functions for Partnership’s trade 

or business assets and activities after the 

merger. See paragraphs (b)(2)(iii), (b)(2)(v), 

(b)(3), and (b)(4)(ii) of this section. 

Example 37. Transferred ATB sold (SAG 

member). For more than five years, D and 

unrelated T have engaged in the active 

conduct of ATB1 and ATB2, respectively. In 

year 6, D contributes ATB1 to T in exchange 

for T stock in a transaction to which section 

351 applies. No gain or loss is recognized on 

the contribution. Immediately after the 

contribution T is a DSAG member. In year 8, 

in response to unanticipated market changes, 

T sells ATB1 to an unrelated third party. 

Although T became a DSAG member as a 

result of D acquiring T stock in exchange for 

ATB1 in a transaction in which no gain or 

loss was recognized, ATB1 is not the trade 

or business to be relied upon. Accordingly, 

D cannot rely on ATB2 until the year 6 

transaction is no longer in the predistribution period because D acquired ATB2 

in exchange for D’s assets not constituting the 

active trade or business to be relied on. See 

paragraphs (b)(4)(i)(A) and (b)(4)(ii)(A) of this 

section. 

Example 38. Transferred ATB sold 

(partnership). The facts are the same as 

Example 37 except that, in year 6, D and T 

contribute ATB1 and ATB2, respectively, to 

Partnership in a transaction to which section 

721 applies. In the exchange, D and T each 

receive a 50-percent interest in Partnership. 

In year 8, in response to unanticipated 

market changes, Partnership sells ATB1 to an 

unrelated third party. If D were to make a 

distribution, D could not rely on ATB2 under 

paragraph (b)(2)(v)(B) of this section unless 

the year 6 transaction is not in the predistribution period because D acquired ATB2 

in exchange for D’s assets not constituting the 

trade or business to be relied on. See 

paragraphs (b)(4)(i)(A) and (b)(4)(ii)(A) of this 

section. 

Example 39. Indirect acquisition of control 

of distributing’s ATB. For more than five 

years, D and T have engaged in the active 

conduct of ATB1 and ATB2, respectively. All 

of the T stock is owned by individuals. In 

year 6, T purchases all the stock of D in a 

transaction in which gain or loss is 

recognized. In a separate transaction, T 

merges downstream into D solely in 

exchange for D stock in a reorganization 

described in section 368(a)(1)(A) and (D). No 

gain or loss is recognized. In year 7, D 

transfers ATB2 formerly conducted by T to 

new subsidiary C, and then distributes the C 

stock to the D shareholders. Although D 

acquired ATB2 solely in exchange for D stock 

in a transaction in which no gain or loss was 

recognized, the requirements of section 

355(b) are not satisfied because ATB1, the 

business of D, was indirectly acquired by T, 

a predecessor of D, during the predistribution period in a transaction in which 

gain or loss was recognized. See paragraphs 

(b)(4)(i)(A) and (b)(4)(iv)(A) of this section. 

The result would also be the same if prior to 

the year 6 acquisition D and wholly owned 

subsidiary C were engaged in the active 

conduct of ATB1 and ATB2, respectively, 

and T had no ATB. 

Example 40. Exception for corporate 

distributee. For more than five years, T has 

owned all of the stock of D which in turn 

owned all of the stock of C. Throughout this 

period, D and C have engaged in the active 

conduct of ATB1 and ATB2, respectively. In 

year 6, P purchases all the stock of T. In year 

7, P liquidates T in a transaction in which 

no gain or loss is recognized under section 

332. Under section 334(b), P’s basis in the D 

stock is determined in whole by reference to 

T’s basis in the D stock. In year 8, D 

distributes the C stock to P. While the D stock 

was indirectly acquired in a taxable 

transaction, the adjusted basis that P, the 

distributee corporation, has in the D stock 

was determined in whole by reference to T’s 

adjusted basis. Accordingly, D and C satisfy 

the requirements of section 355(b). See 

paragraph (b)(4)(iii)(C) of this section. If P 

were to distribute either the D stock or C 

stock, neither ATB1 nor ATB2 could be 

relied on unless the year 6 acquisition of the 

T stock is not in the pre-distribution period. 

See paragraph (b)(4)(iii)(C) of this section. 

The result would be the same if P acquired 

all of T’s assets in exchange for P stock and 

other property in a reorganization described 

in section 368(a)(1)(A). 

Example 41. Acquisition of section 368(c) 

stock of controlled, DSAG member. For more 

than five years, D has owned section 

1504(a)(2) stock but not section 368(c) stock 

of C. Throughout this period, C has engaged 

in the active conduct of ATB1. In year 6, D 

purchased additional shares of C stock. As a 

result, D acquired section 368(c) stock of C. 

If D were to make a distribution of the C 

stock, C could rely on ATB1 to satisfy the 

requirement of section 355(b). C was a DSAG 

member, so D was engaged in ATB1 prior to 

the year 6 purchase of additional C stock. 

Accordingly, D’s acquisition of additional 

stock of a DSAG member is disregarded in 

applying paragraph (b)(4)(i)(A) of this 

section, and paragraph (b)(4)(i)(B) of this 

section does not apply to this acquisition of 

additional C stock. See paragraphs (b)(1)(ii) 

and (b)(4)(iv)(F) of this section. 

Example 42. Controlled becoming a DSAG 

member. For more than five years, D has 

owned section 368(c) stock but not section 

1504(a)(2) stock of C. Throughout this period, 

D and C have engaged in the active conduct 

of ATB1 and ATB2, respectively. In year 6, 

D purchases the remaining C stock. If D 

distributes all the C stock, C could not rely 

on ATB2 to satisfy the requirements of 

section 355(b) because C became a DSAG 

member (and thus D acquired ATB2) in a 

transaction in which gain or loss was 

recognized. See paragraphs (b)(1)(ii), 

(b)(4)(i)(A), and (b)(4)(iv)(F) of this section. 

Example 43. Nontaxable multi-step 

acquisition of control. For more than five 

years, unrelated D and C have engaged in the 

active conduct of ATB1 and ATB2, 

respectively. C has two classes of stock 

outstanding. X owns all 95 shares of the class 

A stock of C, representing 95 percent of the 

voting power and 70 percent of the value, 

and Y owns all of the class B stock of C, 

representing five percent of the voting power 

and 30 percent of the value. In year 6, D 

acquires 10 shares of class A C stock from X 

in a transaction in which gain or loss was 

recognized. In year 7, in a separate 

transaction, D acquires an additional 80 

shares of class A C stock from X solely in 

exchange for D voting stock in a 

reorganization described in section 

368(a)(1)(B). No gain or loss is recognized. In 

year 8, in a separate transaction, D acquires 

the remaining five shares of class A C stock 

from X in a transaction in which gain or loss 

was recognized. Because D only acquires 70 

percent of the value of C stock, C does not 

become a DSAG member. In year 9, D 

distributes the 95 shares of class A C stock 

to the D shareholders. At the time D first 

acquired control of C, D owned an amount 

of C stock constituting control that was 

acquired in a transaction in which no gain or 

loss was recognized. Accordingly, D and C 

both satisfy the requirements of section 

355(b). See paragraphs (b)(4)(i)(B) and 

(b)(4)(iv)(B) of this section. 

Example 44. Taxable multi-step 

acquisition of control. The facts are the same 

as Example 43 except that in year 7 D 

acquires 70 shares of class A C stock solely 

in exchange for D voting stock in a 

reorganization described in section 

368(a)(1)(B). No gain or loss is recognized. At 

the time D first acquired control of C, D did 

not own an amount of C stock constituting 

control that was acquired in one or more 

transactions in which no gain or loss was 

recognized or by reason of such transactions 

combined with acquisitions before the predistribution period. Accordingly, C cannot 

rely on ATB2 to satisfy the requirements of 

section 355(b) until D’s year 6 acquisition of 

the 10 shares of class A C stock is no longer 

in the pre-distribution period. See paragraphs 

(b)(4)(i)(B) and (b)(4)(iv)(B) of this section. 

Example 45. Taxable acquisition of 

control. For more than five years, unrelated 

D and C have engaged in the active conduct 

of ATB1 and ATB2, respectively. In year 6, 

D acquires section 368(c) stock but not 

section 1504(a)(2) stock of C from unrelated 

T in a reorganization described in section 

368(a)(1)(A) by reason of section 368(a)(2)(E) 

through the use of a newly created transitory 

subsidiary of D. In the reorganization, T 

receives consideration 95 percent of which is 

D voting common stock and five percent of 

which is cash. Because D acquired control of 

C in a single transaction in which gain or loss 


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was recognized, paragraph (b)(4)(iv)(B) of this 

section does not apply. Accordingly, C 

cannot rely on ATB2 to satisfy the 

requirements of section 355(b) until D’s year 

6 acquisition of control of C is no longer in 

the pre-distribution period. See paragraph 

(b)(4)(i)(B) of this section. 

Example 46. Taxable multi-step indirect 

acquisition of control. For more than five 

years, C has engaged in the active conduct of 

ATB1. T owns exactly 80 percent of the total 

combined voting power of all classes of C 

stock entitled to vote and 80 percent of the 

total number of shares of all other classes of 

C stock, but T owns less than 80 percent of 

the total value of the C stock. In year 6, 

unrelated D acquires 10 percent of the sole 

outstanding class of stock of T in a 

transaction in which gain or loss is 

recognized. In year 8, in a separate 

transaction, T merges into D solely in 

exchange for D stock in a reorganization 

described in section 368(a)(1)(A). No gain or 

loss is recognized. As a result, D owns 

section 368(c) stock of C. Because D 

indirectly acquired 10 percent of the C stock 

owned by T in year 6, at the time D first 

acquired control of C, D did not own stock 

constituting control of C that it acquired in 

one or more transactions in which no gain or 

loss was recognized or by reason of such 

transactions combined with acquisitions 

before the pre-distribution period. 

Accordingly, C cannot rely on ATB1 to 

satisfy the requirements of section 355(b) 

until D’s year 6 acquisition of the T stock is 

no longer in the pre-distribution period. See 

paragraphs (b)(4)(i)(B) and (b)(4)(iv)(B) of this 

section. 

Example 47. Nontaxable multi-step 

acquisition of SAG member (or ATB). For 

more than five years, S has engaged in the 

active conduct of ATB1. X owns all 100 

shares of the sole outstanding class of S 

stock. In year 6, unrelated D acquires 10 

shares of S stock from X in a transaction in 

which gain or loss was recognized. In year 7, 

in a separate transaction, D acquires an 

additional 80 shares of S stock from X solely 

in exchange for D voting stock in a 

reorganization described in section 

368(a)(1)(B). No gain or loss is recognized. As 

a result, S becomes a DSAG member. In year 

8, in a separate transaction, D acquires 

another 5 shares of S stock from X in a 

transaction in which gain or loss was 

recognized. Because at the time S first 

became a DSAG member, D owned an 

amount of S stock meeting the requirements 

of section 1504(a)(2) that was acquired in a 

transaction in which no gain or loss was 

recognized, D can rely on ATB1 to satisfy the 

requirements of section 355(b) as of the year 

7 transaction. See paragraphs (b)(4)(i)(A) and 

(b)(4)(iv)(C) of this section. The acquisition 

by D of other S stock in a separate transaction 

in which gain or loss was recognized during 

the pre-distribution period is disregarded. 

See paragraph (b)(1)(ii) of this section. The 

result would be the same if, in year 7, instead 

of acquiring S stock in a reorganization 

described in section 368(a)(1)(B), S merged 

into D in exchange for D stock in a 

reorganization described in section 

368(a)(1)(A) in which no gain or loss was 

recognized. See paragraphs (b)(4)(i)(A) and 

(b)(4)(iv)(D) of this section. 

Example 48. Taxable multi-step 

acquisition of SAG member (or ATB). The 

facts are the same as Example 47 except that 

in year 6 D acquires 21 shares of S stock in 

a transaction in which gain or loss was 

recognized, and in year 7, in a separate 

transaction, D acquires an additional 79 

shares of S stock solely in exchange for D 

voting stock in a reorganization described in 

section 368(a)(1)(B). No gain or loss is 

recognized, and S becomes a DSAG member. 

D cannot rely on ATB1 to satisfy the 

requirements of section 355(b) until D’s year 

6 acquisition of the 21 shares of S stock is 

no longer in the pre-distribution period 

because at the time S first became a DSAG 

member D did not own an amount of S stock 

meeting the requirements of section 

1504(a)(2) that was acquired in one or more 

transactions in which no gain or loss was 

recognized or by reason of such transactions 

combined with acquisitions before the predistribution period. See paragraphs 

(b)(4)(i)(A) and (b)(4)(iv)(C) of this section. 

The result would be the same if, in year 7, 

in a separate transaction, instead of D’s 

acquiring S stock, S merged into D in 

exchange for D stock in a reorganization 

described in section 368(a)(1)(A) in which no 

gain or loss was recognized. See paragraphs 

(b)(4)(i)(A) and (b)(4)(iv)(D) of this section. 

The result would also be the same if in year 

6 D acquired 10 shares of S stock in a 

transaction in which gain or loss was 

recognized and, in year 7, in a separate 

transaction, D acquired an additional 70 

shares of S stock solely in exchange for D 

voting stock in a reorganization described in 

section 368(a)(1)(B). See paragraphs 

(b)(4)(i)(A) and (b)(4)(iv)(C) of this section. 

Example 49. Nontaxable multi-step 

indirect acquisition using subsidiary stock. 

For more than five years, X has owned all of 

the sole outstanding class of S stock. 

Throughout this period, S and unrelated T 

have engaged in the active conduct of ATB1 

and ATB2, respectively. In year 6, T merges 

into S solely in exchange for S stock in a 

reorganization described in section 

368(a)(1)(A). No gain or loss is recognized. 

Immediately after the merger, X and the 

former T shareholders own 80 percent and 20 

percent of the S stock, respectively. In year 

8, unrelated D acquires all of the S shares 

held by X solely in exchange for D voting 

stock in a reorganization described in section 

368(a)(1)(B). No gain or loss is recognized. As 

a result, S becomes a DSAG member. Because 

D acquired ATB1 and ATB2 in a transaction 

in which no gain or loss was recognized, 

solely in exchange for D stock, D can rely on 

both ATB1 and ATB2 to satisfy the 

requirements of section 355(b). Because X is 

neither a predecessor of D nor a DSAG 

member, paragraph (b)(4)(iv)(E) of this 

section is not applicable. 

Example 50. Taxable multi-step indirect 

acquisition using subsidiary stock. The facts 

are the same as Example 49 except that, for 

more than five years, D has owned 50 percent 

of the sole outstanding class of X stock. In 

year 8, instead of D acquiring the S stock, S 

merges into D solely in exchange for D stock 

in a reorganization described in section 

368(a)(1)(A). No gain or loss is recognized. 

Because D indirectly owned S stock and S 

acquired ATB2 in exchange for S stock, 

paragraph (b)(4)(iv)(E) of this section is 

applicable. Under paragraph (b)(4)(iv)(E) of 

this section, for purposes of applying 

paragraph (b)(4) of this section with respect 

to ATB2, D is treated as having indirectly 

acquired in year 6 the S stock it indirectly 

owns immediately after the merger of T into 

S in a transaction in which gain or loss was 

recognized. Thus, D is treated as having 

indirectly acquired 40 percent of the S stock 

in a transaction in which gain or loss is 

recognized at the time of the merger of T into 

S. Further, if the merger of T into S is in the 

pre-distribution period, under paragraph 

(b)(4)(iv)(D) of this section, D will be treated 

as having acquired ATB2 in a transaction in 

which gain or loss is recognized because, 

immediately before the merger of S into D, 

D indirectly owned 40 percent of the S stock 

that had been acquired in a transaction in 

which gain or loss was recognized. 

Accordingly, D cannot rely on ATB2 to 

satisfy the requirements of section 355(b) 

until the year 6 merger of T into S is no 

longer in the pre-distribution period. 

However, D can rely on ATB1 to satisfy the 

requirements of section 355(b). Alternatively, 

if X, instead if S, merged into D, S would 

become a DSAG member and X would be a 

predecessor of D. If so, for purposes of 

applying paragraph (b)(4) of this section with 

respect to ATB2, D is treated as having 

acquired 80 percent of the S stock in year 6 

in a transaction in which gain or loss was 

recognized. Accordingly, D cannot rely on 

ATB2 to satisfy the requirements of section 

355(b) until the year 6 merger of T into S is 

no longer in the pre-distribution period. See 

paragraphs (b)(1)(iii), (b)(4)(i)(A), 

(b)(4)(iv)(A), and (b)(4)(iv)(E) of this section. 

However, D can rely on ATB1 to satisfy the 

requirements of section 355(b). 

Example 51. Taxable multi-step indirect 

acquisition of SAG member (or ATB). For 

more than five years, T has engaged in the 

active conduct of ATB1. Throughout this 

period, X owned all of the sole outstanding 

class of T stock, and D owned 50 percent of 

the sole outstanding stock of S. In year 6, S 

acquires 50 percent of the sole outstanding 

class of the X stock in a transaction in which 

gain or loss is recognized. In year 8, X merges 

into D solely in exchange for D stock. No gain 

or loss is recognized. As a result, T becomes 

a DSAG member. Because D indirectly 

acquired more than 20 percent of the T stock 

(D indirectly acquired 25 percent of T) in 

year 6, at the time T first became a DSAG 

member D did not own an amount of T stock 

meeting the requirements of section 

1504(a)(2) that it acquired in one or more 

transactions in which no gain or loss was 

recognized or by reason of such transactions 

combined with acquisitions before the 

predistribution period. Accordingly, D 

cannot rely on ATB1 to satisfy the 

requirements of section 355(b) until D’s year 

6 indirect acquisition of the T stock is no 

longer in the pre-distribution period. See 

paragraphs (b)(4)(i)(A) and (b)(4)(iv)(C) of this 

section. The result would be the same if, 

instead of X, in year 8, T merged into D 

solely in exchange for D stock. See 


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Federal Register / Vol. 72, No. 88 / Tuesday, May 8, 2007 / Proposed Rules 26037 

paragraphs (b)(4)(i) and (b)(4)(iv) of this 

section. 

Kevin M. Brown, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 07–2269 Filed 5–4–07; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF JUSTICE 

28 CFR Part 16 

[AAG/A Order No. 010–2007] 

Privacy Act of 1974; Implementation 

AGENCY: Department of Justice. 

ACTION: Proposed rule. 

SUMMARY: The Department of Justice 

proposes to amend the Privacy Act 

exemptions to the National Security 

Division’s system of records as 

described in today’s notice section of 

the Federal Register: Foreign 

Intelligence and Counterintelligence 

Records System (JUSTICE/NSD–001), 

which incorporates three previous 

systems of records of the Office of 

Intelligence Policy and Review (OIPR). 

These systems of records are the ‘‘Policy 

and Operational Records System, OIPR–

001’’ last published in the Federal 

Register January 26, 1984 (49 FR 3281); 

‘‘Foreign Intelligence Surveillance Act 

Records System, OIPR–002’’ last 

published in the Federal Register 

January 26, 1984 (49 FR 3282); and 

‘‘Litigation Records System, OIPR–003’’

last published in the Federal Register 

January 26, 1984 (49 FR 3284). 

DATES: Submit any comments by June 

18, 2007. 

ADDRESSES: Address all comments to 

Mary Cahill, Management and Planning 

Staff, Justice Management Division, 

Department of Justice, 1331 

Pennsylvania Avenue, NW., 

Washington, DC 20530 (1400 National 

Place Building), Facsimile Number (202) 

307–1853. To ensure proper handling, 

please reference the AAG/A Order No. 

on your correspondence. You may 

review an electronic version of this 

proposed rule at http:// 

www.regulations.gov. You may also 

comment via the Internet to the DOJ/ 

Justice Management Division at the 

following e-mail address: 

DOJPrivacyACTProposedRegulations

@usdoj.gov; or by using the http:// 

www.regulations.gov comment form for 

this regulation. When submitting 

comments electronically, you must 

include the AAG/A Order No. in the 

subject box. 

FOR FURTHER INFORMATION CONTACT: 

GayLa Sessoms, (202) 616–5460. 

SUPPLEMENTARY INFORMATION: The 

Department proposes to exempt 

JUSTICE/NSD–001 from 5 U.S.C. 

552a(c)(3) and (4); (d); (e)(1), (2), (3), 

(4)(G), (H) and (I), (5) and (8); (f); (g); and 

(h). These exemptions will be applied 

only to the extent that information in a 

record is subject to exemption pursuant 

to 5 U.S.C. 552a(j)(2), (k)(1), (2) or (5). 

This order relates to individuals 

rather than small business entities. 

Nevertheless, pursuant to the 

requirements of the Regulatory 

Flexibility Act, 5 U.S.C. 601–612, this 

order will not have a significant impact 

on a substantial number of small 

business entities. 

List of Subjects in 28 CFR Part 16 

Administrative practices and 

procedures, Courts, Freedom of 

Information, and Privacy. 

Pursuant to the authority vested in the 

Attorney General by 5 U.S.C. 552a and 

delegated to me by Attorney General 

Order No. 793–78, it is proposed to 

amend 28 CFR part 16 as follows: 

PART 16—PRODUCTION OR 

DISCLOSURE OF MATERIAL OR 

INFORMATION 

1. The authority for part 16 continues 

to read as follows: 

Authority: 5 U.S.C. 301, 552, 552a, 552b(g), 

and 553; 18 U.S.C. 4203(a)(1); 28 U.S.C. 509, 

510, 534; 31 U.S.C. 3717, and 9701. 

2. Section 16.74 is revised to read as 

follows: 

§ 16.74 Exemption of National Security 

Division System-limited access. 

(a) The following system of records is 

exempted from subsections (c)(3) and 

(4); (d); (e)(1), (2), (3), (4)(G), (H) and (I), 

(5) and (8); (f); (g); and (h) of the Privacy 

Act pursuant to 5 U.S.C. 552a(j)(2), 

(k)(1), (2) and (5): Foreign Intelligence 

and Counterintelligence Records System 

(JUSTICE/NSD–001). These exemptions 

apply only to the extent that 

information in the system is subject to 

exemption pursuant to 5 U.S.C. 

552a(j)(2), (k)(1), (2), and (5). 

(b) Exemptions from the particular 

subsections are justified for the 

following reasons: 

(1) Subsection (c)(3). To provide the 

target of a surveillance or collection 

activity with the disclosure accounting 

records concerning him or her would 

hinder authorized United States 

intelligence activities by informing that 

individual of the existence, nature, or 

scope of information that is properly 

classified pursuant to Executive Order 

12958, as amended, and thereby cause 

damage to the national security. 

(2) Subsection (c)(4). This subsection 

is inapplicable to the extent that an 

exemption is being claimed for 

subsection (d). 

(3) Subsection (d)(1). Disclosure of 

foreign intelligence and 

counterintelligence information would 

interfere with collection activities, 

reveal the identity of confidential 

sources, and cause damage to the 

national security of the United States. 

To ensure unhampered and effective 

collection and analysis of foreign 

intelligence and counterintelligence 

information, disclosure must be 

precluded. 

(4) Subsection (d)(2). Amendment of 

the records would interfere with 

ongoing intelligence activities thereby 

causing damage to the national security. 

(5) Subsections (d)(3) and (4). These 

subsections are inapplicable to the 

extent exemption is claimed from (d)(1) 

and (2). 

(6) Subsection (e)(1). It is often 

impossible to determine in advance if 

intelligence records contained in this 

system are relevant and necessary, but, 

in the interests of national security, it is 

necessary to retain this information to 

aid in establishing patterns of activity 

and provide intelligence leads. 

(7) Subsection (e)(2). Although this 

office does not conduct investigations, 

the collection efforts of agencies that 

supply information to this office would 

be thwarted if the agencies were 

required to collect information with the 

subject’s knowledge. 

(8) Subsection (e)(3). To inform 

individuals as required by this 

subsection could reveal the existence of 

collection activity and compromise 

national security. For example, a target 

could, once made aware that collection 

activity exists, alter his or her manner 

of engaging in intelligence or terrorist 

activities in order to avoid detection. 

(9) Subsections (e)(4)(G), (H) and (I), 

and (f). These subsections are 

inapplicable to the extent that this 

system is exempt from the access 

provisions of subsection (d). 

(10) Subsection (e)(5). It is often 

impossible to determine in advance if 

intelligence records contained in this 

system are accurate, relevant, timely 

and complete, but, in the interests of 

national security, it is necessary to 

retain this information to aid in 

establishing patterns of activity and 

providing intelligence leads. 

(11) Subsection (e)(8). Serving notice 

could give persons sufficient warning to 

evade intelligence collection and antiterrorism efforts. 

(12) Subsections (g) and (h). These 

subsections are inapplicable to the 

extent that this system is exempt from 


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