Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations 4183

corporation. Control is defined under section

368(c).

Example 2. Transfers of acquired stock to

controlled corporations. (i) Facts. The facts

are the same as Example 1 except that S–1

acquires all of the T stock rather than the T

assets, and as part of the plan of

reorganization, S–1 transfers all of the T

stock to S–2, and S–2 transfers all of the T

stock to S–3.

(ii) Analysis. Under this paragraph (k), the

transaction, otherwise qualifying as a

reorganization under section 368(a)(1)(B), is

not disqualified by reason of the fact of the

successive transfers of all of the acquired

stock from S–1 to S–2, and from S–2 to S–

3 because in each transfer, the transferee

corporation is controlled by the transferor

corporation.

Example 3. Transfers of acquired stock to

partnerships. (i) Facts. The facts are the same

as in Example 2. However, as part of the plan

of reorganization, S–2 and S–3 form a new

partnership, PRS. Immediately thereafter, S–

3 transfers all of the T stock to PRS in

exchange for an 80 percent partnership

interest, and S–2 transfers cash to PRS in

exchange for a 20 percent partnership

interest.

(ii) Analysis. This paragraph (k) describes

the successive transfer of the T stock to S–

3, but does not describe S–3’s transfer of the

T stock to PRS. Therefore, the

characterization of this transaction must be

determined under the relevant provisions of

law, including the step transaction doctrine.

See § 1.368–1(a). The transaction fails to meet

the control requirement of a reorganization

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

immediately after the acquisition of the T

stock, the acquiring corporation does not

have control of T.

(4) This paragraph (k) applies to

transactions occurring after January 28,

1998, except that it does not apply to

any transaction occurring pursuant to a

written agreement which is binding on

January 28, 1998, and at all times

thereafter.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

Approved: January 12, 1998.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 98–1819 Filed 1–23–98; 12:15 pm]

BILLING CODE 4830–01–U

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8761]

RIN 1545–AV80

Continuity of Interest

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains

temporary regulations providing

guidance regarding satisfaction of the

continuity of interest requirement for

corporate reorganizations. The

temporary regulations affect

corporations and their shareholders.

Final regulations published elsewhere

in this issue of the Federal Register also

provide guidance regarding satisfaction

of the continuity of interest requirement

for corporate reorganizations. These

temporary regulations amplify the final

regulations. The text of these temporary

regulations also serves as the text of

proposed regulations published

elsewhere in this issue of the Federal

Register.

DATES: These regulations are effective

January 28, 1998.

Applicability: These regulations apply

to transactions occurring after January

28, 1998, except that they do not apply

to any transaction occurring pursuant to

a written agreement which is (subject to

customary conditions) binding on

January 28, 1998, and at all times

thereafter.

FOR FURTHER INFORMATION CONTACT:

Phoebe Bennett, (202) 622–7750 (not a

toll-free number).

SUPPLEMENTARY INFORMATION: This

document contains amendments to the

Income Tax Regulations (26 CFR part 1)

under section 368. These temporary

regulations provide that, in determining

whether the continuity of interest

requirement for corporate

reorganizations is satisfied with respect

to a potential reorganization, a

proprietary interest in the target

corporation is not preserved if, in

connection with a potential

reorganization, it is redeemed or

acquired by a person related to the

target corporation, or to the extent that,

prior to and in connection with a

potential reorganization, an

extraordinary distribution is made with

respect to it.

Background

On December 23, 1996, the IRS

published a notice of proposed

rulemaking (REG–252231–96) in the

Federal Register (61 FR 67512) relating

to the continuity of interest

requirement. Many written comments

were received in response to this notice

of proposed rulemaking. A public

hearing on the proposed regulations was

held on May 7, 1997. After

consideration of all comments, the

regulations proposed by REG–252231–

96 are adopted as final regulations, and

published elsewhere in this issue of the

Federal Register. These temporary

regulations supplement the final

regulations.

Explanation of Provisions

Final regulations published elsewhere

in this issue of the Federal Register

provide that in determining whether the

continuity of interest (COI) requirement

for corporate reorganizations is satisfied,

dispositions of stock of the target

corporation (T) by a T shareholder

generally are not taken into account.

Redemptions of T Stock or

Extraordinary Distributions With

Respect to T Stock

Commentators requested guidance on

the circumstances under which a

redemption by T of its stock would

adversely affect satisfaction of the COI

requirement.

Some commentators suggested that

the IRS and Treasury Department adopt

an approach that would identify either

the issuing corporation (P) or T as the

source of the funds for the redemption.

If, in connection with an acquisition of

T, the facts and circumstances indicate

that P did not directly or indirectly

furnish funds used by T to redeem T

shareholders, these commentators

suggested that satisfaction of the COI

requirement should not be adversely

affected. In many transactions, however,

such a tracing approach would be

extremely difficult to administer. For

example, if P acquired the assets, rather

than the stock, of T or if T redeemed

stock for a note, it would be unclear in

many circumstances whether in

substance T or P assets were used to

fund the redemption or to repay the

note.

Another commentator suggested that

redemptions by T in connection with a

potential reorganization should

adversely affect satisfaction of the COI

requirement because the effect on COI is

the same as if P had furnished the

redemption consideration in the

transaction. The temporary regulations

generally adopt this approach because it

reflects that T and P will be combined

economically and because of the

difficulties of administering a tracing

approach, as previously described.

Treatment of stock redeemed by T as

proprietary interests that are not

preserved in the reorganization also

accords the same tax result to

transactions that reach the same result

by different steps. For example, T could

merge into P for a combination of

consideration, of which 30 percent is P

stock and 70 percent is a P promissory

note. Conversely, T could issue its

promissory note to redeem 70 percent of

the T stock and then P would assume

the T note in the merger, in which the
4184 Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations

remaining T shareholders receive solely

P stock. From the perspective of P, T,

and the T shareholders, these two

transactions are substantively identical,

and the COI requirement is not satisfied

in the first transaction. The temporary

regulations provide that the second

transaction likewise does not satisfy the

COI requirement.

In addition, this approach

corresponds with the rule of the final

regulations that a proprietary interest in

T is not preserved if, in connection with

the potential reorganization, P stock

furnished in exchange for a proprietary

interest in T in the potential

reorganization is redeemed. Because the

final regulations do not inquire, in the

case of a subsequent P redemption,

whether the source of consideration

furnished in the redemption was former

T assets or historic P assets, the

temporary regulations similarly do not

make an inquiry in the case of a prior

T redemption. Instead, for purposes of

the COI requirement, the temporary

regulations treat T and P as a combined

economic enterprise. In an asset

acquisition, this approach avoids the

difficult process of identifying the

source of payments as between T and P.

Commentators have suggested that

this approach is inconsistent with

authorities which hold that redemptions

of stock of the target corporation with

assets of the target corporation do not

violate the solely-for-voting-stock

requirement applicable to section

368(a)(1)(B) reorganizations. See, e.g.,

Rev. Rul. 55–440 (1955–2 C.B. 226).

None of these authorities address the

effect on continuity of interest of such

redemptions. For the reasons stated

above, the temporary regulations take

such redemptions into account for

continuity purposes.

The temporary regulations provide

that a proprietary interest in T is not

preserved if, in connection with a

potential reorganization, it is redeemed

or to the extent that, prior to and in

connection with a potential

reorganization, an extraordinary

distribution is made with respect to it.

An extraordinary distribution with

respect to T stock, followed by a sale of

the remaining T stock to P, has the same

effect on the value of the proprietary

interest in T as a pro rata redemption by

T followed by a sale of the outstanding

T stock to P.

The temporary regulations do not

provide guidance on the determination

of whether a distribution will be treated

as an extraordinary distribution, except

that the rules of section 1059 do not

apply for this purpose. The IRS and

Treasury Department invite comments

on whether the regulations should

provide more specific guidance in this

area.

A section 355 distribution of

controlled corporation stock by T will

preserve a proprietary interest in T,

except to the extent that the T

shareholders receive other property or

money to which section 356(a) applies

or the distribution is extraordinary in

amount and is a distribution of property

or money to which section 356(b)

applies.

Related Person Rule

In determining whether the COI

requirement is satisfied, dispositions of

T stock to persons that are not related

to T or P are disregarded. The final

regulations provide that a proprietary

interest in T is not preserved if, in

connection with a potential

reorganization, a person related to P

acquires, with consideration other than

a proprietary interest in P, T stock or P

stock furnished in exchange for a

proprietary interest in T in the potential

reorganization. Consistent with the final

regulations, the temporary regulations

provide that a proprietary interest in T

is not preserved if, prior to and in

connection with a potential

reorganization, a person related to T

acquires T stock with consideration

other than T stock or P stock.

Definition of Related Person of T

The final regulations include as

related persons any corporation that is

a member of the affiliated group, within

the meaning of section 1504, of which

P is a member, and any corporation

whose purchase of P stock would be

treated as a redemption of that stock

under section 304(a)(2). The section

1504 test was adopted because the IRS

and Treasury Department were

concerned that acquisitions of T stock or

P stock by P affiliated corporations were

no different in substance than

acquisitions or redemptions by P. This

concern does not generally extend to

members of T’s affiliated group that are

not also considered related to T under

section 304(a)(2) because such

corporations are T shareholders

participating in the potential

reorganization along with the other

shareholders of the target corporation.

The temporary regulations treat two

corporations as related persons if a

purchase of the stock of one corporation

by another corporation would be treated

as a distribution in redemption of the

stock of the first corporation under

section 304(a)(2) (determined without

regard to § 1.1502–80(b)).

Effect on Other Authorities

These COI regulations apply solely for

purposes of determining whether the

COI requirement is satisfied. No

inference should be drawn from any

provision of this regulation as to

whether other reorganization

requirements are satisfied, or as to the

characterization of a related transaction.

See, e.g., § 1.301–1(1).

Effect on Other Documents

Rev. Proc. 77–37 (1977–2 C.B. 568)

and Rev. Proc. 86–42 (1986–2 C.B. 722)

will be modified to the extent

inconsistent with these temporary

regulations.

Effective Date

These regulations apply to

transactions occurring after January 28,

1998, except that they do not apply to

any transaction occurring pursuant to a

written agreement which is (subject to

customary conditions) binding on

January 28, 1998, and at all times

thereafter.

Special Analyses

It has been determined that these

temporary regulations are not a

significant regulatory action as defined

in EO 12866. Therefore, a regulatory

assessment is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these

temporary regulations and, because the

temporary regulations do not impose a

collection of information on small

entities, the Regulatory Flexibility Act

(5 U.S.C. chapter 6) does not apply.

Therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, these regulations will be

submitted to the Chief Counsel for

Advocacy of the Small Business

Administration for comment on its

impact on small business.

Drafting Information

The principal author of these

regulations is Phoebe Bennett of the

Office of the Assistant Chief Counsel

(Corporate), IRS. However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

amended as follows:
Federal Register / Vol. 63, No. 18 /Wednesday, January 28, 1998 /Rules and Regulations 4185

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 1.368–1T is added to

read as follows:

§ 1.368–1T Purpose and scope of

exception of reorganization exchanges

(temporary).

(a) through (e)(1)(i) [Reserved] For

further guidance see § 1.368–1(a)

through (e)(1)(i).

(e)(1)(ii)(A) General rule. A

proprietary interest in the target

corporation (other than one held by the

acquiring corporation) is not preserved

if, prior to and in connection with a

potential reorganization, it is redeemed

or to the extent that, prior to and in

connection with a potential

reorganization, an extraordinary

distribution is made with respect to it.

The determination of whether a

distribution with respect to stock of the

target corporation is an extraordinary

distribution for purposes of this

paragraph (e)(1)(ii) will be made on the

basis of all of the facts and

circumstances, but the treatment of the

distribution under section 1059 (relating

to extraordinary dividends) will not be

taken into account.

(B) Exception. Paragraph (e)(1)(ii)(A)

of this section does not apply to a

distribution of stock by the target

corporation to which section 355(a) (or

so much of section 356 as relates to

section 355) applies, except to the

extent that—

(1) The target corporation

shareholders receive other property or

money to which section 356(a) applies;

or

(2) The distribution is extraordinary

in amount and is a distribution of

property or money to which section

356(b) applies.

(2)(i) [Reserved] For further guidance,

see § 1.368–1(e)(2)(i).

(ii) A proprietary interest in the target

corporation is not preserved if, prior to

and in connection with a potential

reorganization, a person related (as

defined in § 1.368–1(e)(3) determined

without regard to § 1.368–1(e)(3)(i)(A))

to the target corporation acquires stock

of the target corporation, with

consideration other than stock of either

the target corporation or the issuing

corporation.

(e)(3) through (e)(6) Example 9.

[Reserved] For further guidance, see

§ 1.368–1(e)(3) through (e)(6) Example

9.

(e)(6) Example 10. Acquisition of target

corporation stock before merger. (i)

Redemption by target corporation. A owns 85

percent and B owns 15 percent of the stock

of T. The fair market value of T is $100x.

Neither A nor B own stock of P. Prior to and

in connection with the merger of T into P,

T redeems A’s T stock for $85x and issues

to A its promissory note in exchange for the

stock. At the time of the merger T has a value

of $15x, after giving effect to the redemption

of its stock. In the merger, B receives solely

P stock. The continuity of interest

requirement is not satisfied because T

redeemed A’s stock, and a substantial part of

the value of the proprietary interest in T is

not preserved. See paragraph (e)(1)(ii)(A) of

this section.

(ii) Purchase by person related to target

corporation. The facts are the same as

paragraph (i) of this Example 10, except that

X, T’s wholly owned subsidiary, acquires A’s

T stock prior to and in connection with the

merger for cash of $85x. Under paragraph

(e)(2)(ii) of this section and § 1.368–

1(e)(3)(i)(B), X’s acquisition of A’s T stock is

an acquisition by a related person. The

continuity of interest requirement is not

satisfied, because X acquired T stock, for

consideration other than P stock, and a

substantial part of the value of the

proprietary interest in T is not preserved. See

paragraph (e)(2)(ii) of this section.

Example 11. Extraordinary distribution

before merger. A owns all of the stock of T.

The fair market value of T is $100x. Prior to

and in connection with the merger of T into

P, T pays A an extraordinary distribution of

an $85x note. T merges into P, and A receives

solely P stock. P assumes T’s obligation on

the note. The continuity of interest

requirement is not satisfied, because T paid

A an extraordinary distribution, and a

substantial part of the value of the

proprietary interest in T is not preserved. See

paragraph (e)(1)(ii)(A) of this section.

(f) Effective date. This section applies

to transactions occurring after January

28, 1998, except that it does not apply

to any transaction occurring pursuant to

a written agreement which is (subject to

customary conditions) binding on

January 28, 1998, and at all times

thereafter.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

Approved: January 12, 1998.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 98–1818 Filed 1–23–98; 12:15 pm]

BILLING CODE 4830–01–U

DEPARTMENT OF THE TREASURY

Fiscal Service

31 CFR Part 356

Sale and Issue of Marketable BookEntry Treasury Bills, Notes, and Bonds

(Department of the Treasury Circular,

Public Debt Series No. 1–93)

AGENCY: Bureau of the Public Debt,

Fiscal Service, Department of the

Treasury.

ACTION: Final rule.

SUMMARY: The Department of the

Treasury (‘‘Treasury’’ or ‘‘Department’’)

is issuing in final form an amendment

to 31 CFR Part 356 (Uniform Offering

Circular for the Sale and Issue of

Marketable Book-Entry Treasury Bills,

Notes, and Bonds). This final rule

incorporates a change in the timeframe

for certain restrictions pertaining to

bidders that bid noncompetitively in

Treasury auctions. The amendment

states that between the date of the

offering announcement and the time of

the official announcement by the

Department of the auction results, a

noncompetitive bidder may not hold, at

any time, a position for its own account

in when-issued trading or in futures or

forward contracts in the security being

auctioned or enter into any agreement to

purchase or sell or otherwise dispose of

the securities it is acquiring in the

auction.

EFFECTIVE DATE: January 28, 1998.

ADDRESSES: This final rule is available

for downloading from the Bureau of the

Public Debt’s Internet site at the

following address:

www.publicdebt.treas.gov. It is also

available for public inspection and

copying at the Treasury Department

Library, FOIA Collection, Room 5030,

Main Treasury Building, 1500

Pennsylvania Avenue, N.W.,

Washington, D.C., 20220. Persons

wishing to visit the library should call

(202) 622–0990 for an appointment.

FOR FURTHER INFORMATION CONTACT:

Kerry Lanham (Acting Director) or Lee

Grandy (Government Securities

Specialist), Bureau of the Public Debt,

Government Securities Regulations

Staff, (202) 219–3632.

SUPPLEMENTARY INFORMATION: 31 CFR

Part 356, also referred to as the uniform

offering circular, sets out the terms and

conditions for the sale and issuance by

the Department of the Treasury to the

public of marketable Treasury bills,

notes, and bonds. The uniform offering

circular, in conjunction with offering

announcements, represents a

comprehensive statement of those terms