Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54631 

5 JCM asserts that providing the requested relief 

will exacerbate and extend investor confusion with 

respect to fee-based accounts. We disagree. Brokerdealers already are required to comply with the 

specific disclosure provisions of rule 202(a)(11)–

1(a)(1)(ii). 

6See section 553(b)(3)(B) of the Administrative 

Procedure Act (5 U.S.C. 553(b)(3)(B)) (‘‘APA’’) (an 

agency may dispense with prior notice and 

comment when it finds, for good cause, that notice 

and comment are ‘‘impracticable, unnecessary, or 

contrary to the public interest). The change to the 

compliance date is effective upon publication in the 

Federal Register, which is less than 30 days after 

publication. The APA allows effective dates less 

than 30 days after publication in the Federal 

Register for ‘‘a substantive rule which grants or 

recognizes an exemption or relieves a restriction.’’

See section 553(d)(1) of the APA. 

extension in delaying the anticipated 

benefits of the rule, in our judgment a 

limited extension of the compliance 

date is, on balance, appropriate. Our 

judgment is based on the 

representations made by the SIA, the 

ACLI, and the FSI (whose members are 

required to comply with the rule and 

thus are in a position to assess the level 

of difficulty and time involved in their 

complying with the rule) and our 

experience in overseeing the industry. 

We are not, however, persuaded that a 

delay of up to an additional six months 

is necessary given that we already 

afforded broker-dealers approximately a 

six-month compliance period, and that 

these provisions will provide investors 

with important protections.5

Accordingly, the Commission believes it 

is appropriate to extend the compliance 

date for rule 202(a)(11)–1(b)(2) and 

(b)(3) until January 31, 2006. The rule’s 

effective date of April 15, 2005 remains 

unchanged. 

The Commission for good cause finds 

that, for the reasons cited above, 

including the brief length of the 

extension we are granting, notice and 

solicitation of comment regarding the 

extension of the compliance date for 

rule 202(a)(11)–1(b)(2) and (b)(3) are 

impracticable, unnecessary, or contrary 

to the public interest.6 In this regard, the 

Commission notes that broker-dealers 

need to be informed as soon as possible 

of the extension and its length in order 

to plan and adjust their implementation 

processes accordingly. 

Dated: September 12, 2005. 

By the Commission. 

Jonathan G. Katz, 

Secretary. 

[FR Doc. 05–18384 Filed 9–15–05; 8:45 am] 

BILLING CODE 8010–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9225] 

RIN 1545–BD53 

Corporate Reorganizations; Guidance 

on the Measurement of Continuity of 

Interest 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulation. 

SUMMARY: This document contains final 

regulations that provide guidance 

regarding the satisfaction of the 

continuity of interest requirement for 

corporate reorganizations. The final 

regulations affect corporations and their 

shareholders. 

DATES: Effective Date: These regulations 

are effective September 16, 2005. 

FOR FURTHER INFORMATION CONTACT: 

Jeffrey B. Fienberg, at (202) 622–7770 

(not a toll free number). 

SUPPLEMENTARY INFORMATION: 

Background 

The Internal Revenue Code of 1986 

(Code) provides for general 

nonrecognition treatment for 

reorganizations described in section 368 

of the Code. In addition to complying 

with the statutory and certain other 

requirements, to qualify as a 

reorganization, a transaction generally 

must satisfy the continuity of interest 

(COI) requirement. COI requires that, in 

substance, a substantial part of the value 

of the proprietary interests in the target 

corporation be preserved in the 

reorganization. 

On August 10, 2004, the IRS and 

Treasury Department published a notice 

of proposed rulemaking (REG–129706–

04) in the Federal Register (69 FR 

48429) (hereinafter the proposed 

regulations) identifying certain 

circumstances in which the 

determination of whether a proprietary 

interest in the target corporation is 

preserved would be made by reference 

to the value of the issuing corporation’s 

stock on the day before there is an 

agreement to effect the potential 

reorganization. In particular, in cases in 

which the consideration to be tendered 

to the target corporation’s shareholders 

is fixed in a binding contract and 

includes only stock of the issuing 

corporation and money, the issuing 

corporation stock to be exchanged for 

the proprietary interests in the target 

corporation would be valued as of the 

end of the last business day before the 

first date there is a binding contract to 

effect the potential reorganization (the 

signing date rule). Under the proposed 

regulations, consideration is fixed in a 

contract if the contract states the 

number of shares of the issuing 

corporation and the amount of money, 

if any, to be exchanged for the 

proprietary interests in the target 

corporation. The signing date rule is 

based on the principle that, in cases in 

which a binding contract provides for 

fixed consideration, the target 

corporation shareholders generally can 

be viewed as being subject to the 

economic fortunes of the issuing 

corporation as of the signing date. 

No public hearing regarding the 

proposed regulations was requested or 

held. However, several written and 

electronic comments regarding the 

notice of proposed rulemaking were 

received. After consideration of the 

comments, the proposed regulations are 

adopted as revised by this Treasury 

decision. 

Explanation of Provisions 

These final regulations retain the 

general framework of the proposed 

regulations but make several 

modifications in response to the 

comments received. The following 

sections describe the most significant 

comments and the extent to which they 

have been incorporated into these final 

regulations. 

A. Fixed Consideration 

As stated above, the proposed 

regulations require that the 

consideration in a contract be fixed in 

order for the signing date rule to apply. 

One commentator identified a number 

of contractual arrangements that do not 

provide for fixed consideration within 

the meaning of the proposed 

regulations, but, nevertheless, are 

arrangements in which the 

consideration should be treated as fixed 

and, therefore, eligible for the signing 

date rule. In particular, the commentator 

identified a number of circumstances in 

which, rather than stating the number of 

shares and money to be exchanged for 

target corporation shares, a contract may 

provide that a certain percentage of 

target corporation shares will be 

exchanged for stock of the issuing 

corporation. One such circumstance is 

where a merger agreement permits the 

target corporation some flexibility in 

issuing its shares between the signing 

date and effective date of the potential 

reorganization. Such an issuance may 

occur, for example, upon the exercise of 

employee stock options. As a result, the 

total number of outstanding target 

corporation shares at the effective time 

54632 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 

of the merger and, therefore, the total 

number of shares of the acquiring 

corporation to be issued in the merger, 

may not be known when the merger 

agreement is signed. 

In addition, a contract may permit the 

target corporation shareholders to elect 

to receive stock (the number of shares of 

which may be determined pursuant to a 

collar) and/or money or other property 

in respect of target corporation stock, 

but provide that a particular percentage 

of target corporation shares will be 

exchanged for stock of the issuing 

corporation and a particular percentage 

of target corporation stock will be 

exchanged for money. In these cases, if 

either the stock or the cash 

consideration is oversubscribed, 

adjustments are made to the 

consideration to be tendered in respect 

of the target corporation shares such 

that the specified percentage of target 

corporation shares is, in fact, exchanged 

for stock of the issuing corporation. 

The IRS and Treasury Department 

agree that a contract that provides for 

either the percentage of the number of 

shares of each class of target corporation 

stock, or the percentage by value of the 

target corporation shares, to be 

exchanged for issuing corporation stock 

should be treated as providing for fixed 

consideration, as long as the target 

corporation shares to be exchanged for 

issuing corporation stock and the target 

corporation shares to be exchanged for 

consideration other than issuing 

corporation stock each represents an 

economically reasonable exchange. Just 

as in cases in which the contract states 

the number of shares of the issuing 

corporation and the amount of money, 

if any, to be exchanged for the 

proprietary interests in the target 

corporation, in these cases, the target 

corporation shareholders generally can 

be viewed as being subject to the 

economic fortunes of the issuing 

corporation as of the signing date. 

Accordingly, these final regulations 

include an expanded set of 

circumstances in which a contract will 

be treated as providing for fixed 

consideration. 

B. Contingent Consideration 

The fact that a contract provides for 

contingent consideration will generally 

prevent a contract from being treated as 

providing for fixed consideration. One 

commentator suggested that a contract 

should not be treated as failing to 

provide for fixed consideration solely 

because it provides for contingent 

consideration that can only increase the 

proportion of issuing corporation stock 

to cash to be exchanged for target 

corporation shares. Where stock of the 

issuing corporation is the only type of 

consideration that is subject to a 

contingency, the delivery of any of the 

contingent consideration to the target 

corporation shareholders will enhance 

the preservation of the target 

corporation’s shareholders’ proprietary 

interests. Therefore, these final 

regulations provide for a limited 

exception to the general rule that an 

arrangement that provides for 

contingent consideration will not be one 

to which the signing date rule applies. 

The exception applies to cases in which 

the contingent consideration consists 

solely of stock of the issuing corporation 

and the execution of the potential 

reorganization would have resulted in 

the preservation of a substantial part of 

the value of the target corporation 

shareholders’ proprietary interests in 

the target corporation if none of the 

contingent consideration were delivered 

to the target corporation shareholders. 

The IRS and Treasury Department 

continue to study whether other 

arrangements involving contingent 

consideration should be within the 

scope of the signing date rule. Among 

these arrangements are cases in which 

the contingent consideration consists 

not only of issuing corporation stock but 

also of money or other property and 

cases in which the issuing corporation 

stock to be issued in respect of target 

corporation stock is determined 

pursuant to a collar. 

C. Nature of Consideration 

As described above, under the 

proposed regulations, the signing date 

rule applies only when the 

consideration to be provided in respect 

of target corporation shares includes 

only stock of the issuing corporation 

and money. One commentator suggested 

that the signing date rule should be 

expanded to apply to transactions in 

which the non-stock consideration 

includes property other than money. 

Under these final regulations, the 

signing date rule may apply in such 

cases. Therefore, under these final 

regulations, the signing date rule may 

apply, for example, in cases in which 

proprietary interests in the target 

corporation are exchanged for stock and 

securities of the issuing corporation. 

D. Valuation 

1. The ‘‘As of the End of the Last 

Business Day’’ Rule 

The proposed regulations require that, 

if the signing date rule applies, the 

consideration to be tendered in respect 

of the target corporation shares 

surrendered be valued as of the end of 

the last business day before the first date 

there is a binding contract to effect the 

potential reorganization. One comment 

requested clarification of the meaning of 

as of the end of the last business day. 

That comment suggested that an average 

of the high and low trade price on that 

day should be an acceptable value for 

this purpose. Alternatively, the 

comment suggested that if a single trade 

were to determine the value of the 

issuing corporation stock, the closing 

price of the issuing corporation stock on 

the relevant market should be used. The 

comment further described an approach 

for identifying the relevant stock 

market. 

In response to these comments, these 

final regulations remove the 

requirement that the consideration be 

valued as of the end of the last business 

day before the first date that there is a 

binding contract. Instead, they provide 

general guidance that the consideration 

to be exchanged for target corporation 

shares pursuant to a contract must be 

valued the day before such contract is 

a binding contract. 

2. New Issuances 

The IRS and Treasury Department 

recognize that the application of the 

requirement that the consideration to be 

exchanged for proprietary interests in 

the target corporation be valued on the 

last business day before the first date 

there is a binding contract to effect the 

potential reorganization may be unclear 

in cases in which the consideration does 

not exist prior to the effective date of the 

reorganization. For example, suppose 

that, in the potential reorganization, the 

issuing corporation will issue a new 

class of its stock in exchange for the 

shares of the target corporation. The 

question has arisen as to how to value 

those to be issued shares under the 

signing date rule, given that they do not 

exist on the last business day before the 

first date that there is a binding contract 

to effect the potential reorganization. 

Thus, these final regulations clarify that 

this new class of stock will be deemed 

to have been issued on the last business 

day before the first date there is a 

binding contract to effect the potential 

reorganization for purposes of applying 

the signing date rule. 

E. Escrowed Stock 

1. Pre-Closing Covenants 

The proposed regulations provide that 

placing part of the stock issued or 

money paid into escrow to secure 

customary target representations and 

warranties will not prevent the 

consideration in a contract from being 

fixed. One comment suggested that this 

rule should be expanded to include 

Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54633 

consideration placed in escrow to 

secure target’s performance of 

customary pre-closing covenants (rather 

than representations and warranties). 

That commentator stated that there is no 

reason to distinguish between 

customary pre-closing covenants, on the 

one hand, and customary 

representations and warranties, on the 

other hand. The IRS and Treasury 

Department agree. Accordingly, these 

final regulations extend the rule related 

to escrows to include consideration 

placed in escrow to secure target’s 

performance of customary pre-closing 

covenants. 

2. Effect of Escrowed Consideration on 

Satisfaction of COI 

Some commentators have indicated 

that certain examples in the proposed 

regulations suggest that escrowed stock, 

even if it is forfeited to the issuing 

corporation, is treated as preserving the 

target shareholders’ proprietary interests 

in the target corporation. The IRS and 

Treasury Department believe that 

escrowed consideration that is forfeited 

should not be taken into account in 

determining whether the COI 

requirement is satisfied. This 

conclusion reflects the view that the 

forfeiture of escrowed consideration is 

in substance a purchase price 

adjustment. Accordingly, the examples 

in these final regulations reflect that 

forfeited stock is not treated as 

preserving the target corporation 

shareholders’ proprietary interests in 

the target corporation and forfeited nonstock consideration is not treated as 

counting against the preservation of the 

target corporation’s shareholders’

proprietary interest in the target 

corporation. The IRS and Treasury 

Department continue to consider the 

effect on COI of escrowed consideration 

and contingent consideration. 

3. Revenue Procedure 84–42 

One commentator requested 

clarification regarding the impact of the 

proposed regulations on Revenue 

Procedure 84–42 (1984–1 C.B. 521). Rev. 

Proc. 84–42 includes certain operating 

rules of the IRS regarding the issuance 

of letter rulings, including the 

circumstances in which the placing of 

stock in escrow will not prevent the IRS 

from issuing a private letter ruling. The 

IRS and Treasury Department continue 

to review the existing revenue 

procedures relating to reorganizations in 

light of the numerous regulatory 

changes since the publication of these 

procedures and the policy against 

issuing rulings in the reorganization 

area unless there is a significant issue, 

which is reflected in Rev. Proc. 2005–

3. Rev. Proc. 84–42 is not amended at 

this time. 

F. Anti-Dilution Provisions 

One comment suggested that 

consideration in a contract should not 

be treated as fixed unless the contract 

includes a customary anti-dilution 

provision. The commentator posited an 

example in which the absence of an 

anti-dilution clause and the occurrence 

of a stock split with respect to the stock 

of the issuing corporation prior to the 

effective date of a potential 

reorganization results in the value of the 

consideration received in respect of the 

target corporation shares being 

substantially different from its value on 

the day before the first date there is a 

binding contract. 

The IRS and Treasury Department do 

not believe that the absence of a 

customary anti-dilution provision 

should necessarily preclude the 

application of the signing date rule as 

dilution may not, in fact, occur. 

However, the IRS and Treasury 

Department are concerned that 

application of the signing date rule is 

not appropriate if the contract does not 

contain an anti-dilution clause relating 

to the stock of the issuing corporation 

and the issuing corporation alters its 

capital structure between the first date 

there is an otherwise binding contract to 

effect the potential reorganization and 

the effective date of the potential 

reorganization in a manner that 

materially alters the economic 

arrangement of the parties to the 

binding contract. Accordingly, these 

final regulations provide that, in such 

cases, the consideration will not be 

treated as fixed. 

G. Contract Modifications 

The proposed regulations require that 

if a term of a binding contract that 

relates to the amount or type of 

consideration the target shareholders 

will receive in a potential reorganization 

is modified before the closing date of 

the potential reorganization, and the 

contract as modified is a binding 

contract, then the date of the 

modification shall be treated as the first 

date there is a binding contract. Thus, 

such a modification requires that the 

stock of the issuing corporation be 

valued as of the end of the last business 

day before the date of the modification 

in order to determine whether the 

transaction satisfies the COI 

requirement. 

One commentator suggested that a 

contract should not be treated as being 

modified for this purpose if the 

modification has the sole effect of 

increasing the number of shares of the 

issuing corporation to be received by the 

target shareholders. The IRS and 

Treasury Department agree that, because 

such a modification only enhances the 

preservation of the target corporation’s 

shareholders’ proprietary interests, it is 

not appropriate to value the 

consideration to be provided to the 

target corporation shareholders as of the 

day before the date of the modification 

rather than as of the day before the date 

of the original contract, at least in cases 

in which the transaction would have 

satisfied the COI requirement under the 

signing date rule if there had been no 

modification. Therefore, these final 

regulations provide that a modification 

that has the sole effect of providing for 

the issuance of additional shares of 

issuing corporation stock to the target 

corporation shareholders will not be 

treated as a modification if the 

execution of the potential reorganization 

would have resulted in the preservation 

of a substantial part of the value of the 

target corporation shareholders’

proprietary interest in the target 

corporation if there had been no 

modification. In such cases, the 

determination of whether a proprietary 

interest in the target corporation has 

been preserved is made by reference to 

the value of the consideration as of the 

last business day before the first date the 

contract was binding, not the last 

business day before the modification. 

The IRS and Treasury Department 

continue to consider whether this 

exception should be extended to certain 

cases in which the modification results 

in not only additional shares of the 

issuing corporation to be issued to target 

corporation shareholders, but also 

additional money or other property to 

be transferred to target corporation 

shareholders. 

H. Application of Principle Illustrated 

by Examples 

One commentator asked whether the 

principle that the COI requirement is 

satisfied where 40 percent of the target 

corporation stock is exchanged for stock 

in the issuing corporation that is 

illustrated in the examples of the 

proposed regulations (which relate to 

the application of the signing date rule) 

also applies in cases in which the 

signing date rule does not apply. The 

IRS and Treasury Department believe 

that this principle is equally applicable 

to cases in which the signing date rule 

does not apply as it is to cases in which 

the signing date rule does apply. 

I. Restricted Stock 

The IRS and Treasury Department are 

continuing to consider the appropriate 

treatment of restricted stock in the 

54634 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 

determination of whether the COI 

requirement is satisfied. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 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 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. Therefore, a 

Regulatory Flexibility Analysis is not 

required. Pursuant to section 7805(f) of 

the Code, the proposed regulations 

preceding these regulations were 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on their 

impact on small business. 

Drafting Information 

The principal author of these 

regulations is Christopher M. Bass of the 

Office of the Associate Chief Counsel 

(Corporate). However, other personnel 

from the IRS and Treasury Department 

participated in their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Adoption of Amendments to the 

Regulations 

■ Accordingly, 26 CFR part 1 is 

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 1.368–1 is amended as 

follows: 

■ 1. Paragraph (e)(1)(i) is amended as 

follows: 

■ A. Removing the language ‘‘(e)(3)’’

and adding in its place ‘‘(e)(4)’’

wherever it appears. 

■ B. Removing the language 

‘‘(e)(3)(i)(A)’’ and adding ‘‘(e)(4)(i)(A)’’

in its place. 

■ 2. Redesignating paragraphs (e)(2) 

through (e)(7) as (e)(3) through (e)(8), 

respectively. 

■ 3. Adding a new paragraph (e)(2). 

■ 4. In newly designated paragraphs 

(e)(3) through (e)(8), remove the 

language ‘‘(e)(6)’’ wherever it appears, 

and add the language ‘‘(e)(7)’’ in its 

place. 

■ 5. In newly designated paragraphs 

(e)(3) through (e)(8), remove the 

language ‘‘(e)(4)’’ wherever it appears, 

and add the language ‘‘(e)(5)’’ in its 

place. 

■ 6. In newly designated paragraphs 

(e)(3) through (e)(8), remove the 

language ‘‘(e)(3)’’ wherever it appears, 

and add the language ‘‘(e)(4)’’ in its 

place. 

■ 7. In newly designated paragraphs 

(e)(3) through (e)(8), remove the 

language ‘‘(e)(2)’’ wherever it appears, 

and add the language ‘‘(e)(3)’’ in its 

place. 

■ 8. In newly designated paragraph 

(e)(4)(ii)(B), remove the language 

‘‘(e)(3)(i)(A)’’ wherever it appears, and 

add the language ‘‘(e)(4)(i)(A)’’ in its 

place. 

■ 9. In newly designated paragraph 

(e)(7), Example 1, remove the language 

‘‘(e)(1) and (2)’’ whenever it appears, 

and add the language ‘‘(e)(1) and (3)’’ in 

its place. 

■ 10. In newly designated paragraph 

(e)(7), Example 2, make the following 

revisions: 

■ A. Remove the language ‘‘(e)(3)(i)(B)’’

wherever it appears, and add the 

language (e)(4)(i)(B)’’ in its place. 

■ B. Remove the language ‘‘(e)(3)(i)(A) 

and (ii)(B)’’ wherever it appears, and 

add the language ‘‘(e)(4)(i)(A) and 

(ii)(B)’’ in its place. 

■ 11. In newly designated paragraph 

(e)(7), Example 3, where the language 

‘‘(e)(1) and (2)’’ wherever it appears, and 

add the language ‘‘(e)(1) and (3)’’ in its 

place. 

■ 12. In newly designated paragraph 

(e)(7), Example 4, paragraph (iii), 

remove the language ‘‘(e)(3)(i)(A) and 

(B)’’ wherever it appears, and add the 

language ‘‘(e)(4)(i)(A) and (B)’’ in its 

place. 

■ 13. In newly designated paragraph 

(e)(7), Example 6, remove the language 

‘‘(e)(3)(i)(A) and (B)’’ wherever it 

appears, and add the language 

‘‘(e)(4)(i)(A) and (B)’’ in its place. 

■ 14. In newly designated paragraph 

(e)(7), Example 8, remove the language 

‘‘(e)(3)(i)(A)’’ wherever it appears, and 

add the language ‘‘(e)(4)(i)(A)’’ in its 

place. 

■ 15. Revising newly designated 

paragraph (e)(8). 

The addition and revision read as 

follows: 

§ 1.368–1 Purpose and scope of exception 

of reorganization exchanges. 

* * * * * 

(e) * * * 

(2) Measuring continuity of interest—

(i) In general. In determining whether a 

proprietary interest in the target 

corporation is preserved, the 

consideration to be exchanged for the 

proprietary interests in the target 

corporation pursuant to a contract to 

effect the potential reorganization shall 

be valued on the last business day 

before the first date such contract is a 

binding contract, if such contract 

provides for fixed consideration. 

(ii) Binding contract—(A) In general. 

A binding contract is an instrument 

enforceable under applicable law 

against the parties to the instrument. 

The presence of a condition outside the 

control of the parties (including, for 

example, regulatory agency approval) 

shall not prevent an instrument from 

being a binding contract. Further, the 

fact that insubstantial terms remain to 

be negotiated by the parties to the 

contract, or that customary conditions 

remain to be satisfied, shall not prevent 

an instrument from being a binding 

contract. 

(B) Modifications—(1) In general. If a 

term of a binding contract that relates to 

the amount or type of the consideration 

the target shareholders will receive in a 

potential reorganization is modified 

before the closing date of the potential 

reorganization, and the contract as 

modified is a binding contract, the date 

of the modification shall be treated as 

the first date there is a binding contract. 

(2) Exception. Notwithstanding 

paragraph (e)(2)(ii)(B)(1) of this section, 

a modification of a term that relates to 

the amount or type of consideration the 

target shareholders will receive in a 

potential reorganization will not be 

treated as a modification for purposes of 

that provision if—

(i) That modification has the sole 

effect of providing for the issuance of 

additional shares of issuing corporation 

stock to the target corporation 

shareholders; and 

(ii) The execution of the potential 

reorganization would have resulted in 

the preservation of a substantial part of 

the value of the target corporation 

shareholders’ proprietary interest in the 

target corporation if there had been no 

modification. 

(C) Tender offers. For purposes of this 

paragraph (e)(2), a tender offer that is 

subject to section 14(d) of the Securities 

and Exchange Act of 1934 [15 U.S.C. 

78n(d)(1)] and Regulation 14D (17 CFR 

240.14d–1 through 240.14d–101) and is 

not pursuant to a binding contract, is 

treated as a binding contract made on 

the date of its announcement, 

notwithstanding that it may be modified 

by the offeror or that it is not 

enforceable against the offerees. If a 

modification (not pursuant to a binding 

contract) of such a tender offer is subject 

to the provisions of Regulation 14d–6(c) 

(17 CFR 240.14d–6(c)) and relates to the 

amount or type of the consideration 

received in the tender offer, then the 

Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54635 

date of the modification shall be treated 

as the first date there is a binding 

contract. 

(iii) Fixed consideration—(A) In 

general. A contract provides for fixed 

consideration if it provides—

(1) The number of shares of each class 

of stock of the issuing corporation, the 

amount of money, and the other 

property (identified either by value or 

by specific description), if any, to be 

exchanged for all of the proprietary 

interests in the target corporation; 

(2) The number of shares of each class 

of stock of the issuing corporation, the 

amount of money, and the other 

property (identified either by value or 

by specific description), if any, to be 

exchanged for each proprietary interest 

in the target corporation; 

(3) The percentage of the number of 

shares of each class of proprietary 

interests in the target corporation, or the 

percentage (by value) of the proprietary 

interests in the target corporation, to be 

exchanged for stock of the issuing 

corporation, provided that the 

proprietary interests in the target 

corporation to be exchanged for stock of 

the issuing corporation and the 

proprietary interests in the target 

corporation to be exchanged for 

consideration other than stock of the 

issuing corporation each represents an 

economically reasonable exchange as of 

the last business day before the first date 

there is a binding contract to effect the 

potential reorganization; or 

(4) The percentage of each proprietary 

interest in the target corporation to be 

exchanged for stock of the issuing 

corporation, provided that the portion of 

each proprietary interest in the target 

corporation to be exchanged for stock of 

the issuing corporation and the portion 

of each proprietary interest in the target 

corporation to be exchanged for 

consideration other than stock of the 

issuing corporation each represents an 

economically reasonable exchange as of 

the last business day before the first date 

there is a binding contract to effect the 

potential reorganization. 

(B) Shareholder elections—(1) In 

general. A contract that is not described 

in paragraph (e)(2)(iii)(A) of this section 

and pursuant to which a target 

corporation shareholder has an election 

to receive stock and/or money and other 

property in respect of target corporation 

stock is treated as providing for fixed 

consideration if the contract provides—

(i) The minimum number of shares of 

each class of stock of the issuing 

corporation and the maximum amount 

of money and other property (identified 

either by value or by specific 

description) to be exchanged for all of 

the proprietary interests in the target 

corporation; or 

(ii) The minimum percentage of the 

number of shares of each class of 

proprietary interests in the target 

corporation, or the minimum percentage 

(by value) of the proprietary interests in 

the target corporation, to be exchanged 

for stock of the issuing corporation, 

provided that the proprietary interests 

in the target corporation to be 

exchanged for stock of the issuing 

corporation and the proprietary interests 

in the target corporation to be 

exchanged for consideration other than 

stock of the issuing corporation each 

represents an economically reasonable 

exchange as of the last business day 

before the first date there is a binding 

contract to effect the potential 

reorganization. 

(2) Special rules. (i) In the case of a 

shareholder election described in 

paragraph (e)(2)(iii)(B)(1)(i) of this 

section, the determination of whether a 

proprietary interest in the target 

corporation is preserved shall be made 

by assuming the issuance by the issuing 

corporation of the minimum number of 

shares of each class of stock of the 

issuing corporation and the maximum 

amount of money and other property 

allowable under the contract and 

without regard to the number of shares 

of each class of stock of the issuing 

corporation and the amount of money 

and other property actually exchanged 

thereafter for proprietary interests in the 

target corporation. 

(ii) In the case of a shareholder 

election described in paragraph 

(e)(2)(iii)(B)(1)(ii) of this section, the 

determination of whether a proprietary 

interest in the target corporation is 

preserved shall be made by assuming 

the issuance of issuing corporation stock 

in exchange for the minimum 

percentage of the number of shares of 

each class of proprietary interests in the 

target corporation, or the minimum 

percentage (by value) of proprietary 

interests in the target corporation, as the 

case may be, to be exchanged for stock 

of the issuing corporation allowable 

under the contract and without regard to 

the percentage of the number of shares 

of each class of proprietary interests in 

the target corporation, or the percentage 

(by value) of proprietary interests in the 

target corporation, actually exchanged 

for stock of the issuing corporation. 

(C) Contingent consideration—(1) In 

general. In general, the fact that a 

contract provides for contingent 

consideration will prevent a contract 

from being treated as providing for fixed 

consideration. However, a contract will 

not fail to be treated as providing for 

fixed consideration solely as a result of 

a provision that provides for contingent 

consideration, if—

(i) The contingent consideration 

consists solely of stock of the issuing 

corporation; and 

(ii) The execution of the potential 

reorganization would have resulted in 

the preservation of a substantial part of 

the value of the target corporation 

shareholders’ proprietary interests in 

the target corporation if none of the 

contingent consideration were delivered 

to the target corporation shareholders. 

(2) Exception for escrows. For 

purposes of paragraph (e)(2)(iii)(C)(1) of 

this section, contingent consideration 

does not include consideration paid in 

escrow to secure target’s performance of 

customary pre-closing covenants or 

customary target representations and 

warranties. 

(D) Escrows. Placing part of the 

consideration to be exchanged for 

proprietary interests in the target 

corporation in escrow to secure target’s 

performance of customary pre-closing 

covenants or customary target 

representations and warranties will not 

prevent a contract from being treated as 

providing for fixed consideration. 

(E) Anti-dilution clauses. The 

presence of a customary anti-dilution 

clause will not prevent a contract from 

being treated as providing for fixed 

consideration. However, the absence of 

such a clause will prevent a contract 

from being treated as providing for fixed 

consideration if the issuing corporation 

alters its capital structure between the 

first date there is an otherwise binding 

contract to effect the potential 

reorganization and the effective date of 

the potential reorganization in a manner 

that materially alters the economic 

arrangement of the parties to the 

binding contract. 

(F) Dissenters’ rights. The possibility 

that some shareholders may exercise 

dissenters’ rights and receive 

consideration other than that provided 

for in the binding contract will not 

prevent the contract from being treated 

as providing for fixed consideration. 

(G) Fractional shares. The fact that 

money may be paid in lieu of issuing 

fractional shares will not prevent a 

contract from being treated as providing 

for fixed consideration. 

(iv) Valuation of new issuances. For 

purposes of applying paragraph (e)(2)(i) 

of this section, any class of stock, 

securities, or indebtedness that the 

issuing corporation issues to the target 

corporation shareholders pursuant to 

the potential reorganization and that 

does not exist before the first date there 

is a binding contract to effect the 

potential reorganization is deemed to 

have been issued on the last business 

54636 Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 

day before the first date there is a 

binding contract to effect the potential 

reorganization. 

(v) Examples. For purposes of the 

examples in this paragraph (e)(2)(v), P is 

the issuing corporation, T is the target 

corporation, S is a wholly owned 

subsidiary of P, all corporations have 

only one class of stock outstanding, A 

is an individual, no transactions other 

than those described occur, and the 

transactions are not otherwise subject to 

recharacterization. The following 

examples illustrate the application of 

this paragraph (e)(2): 

Example 1. Application of signing date 

rule. On January 3 of Year 1, P and T sign 

a binding contract pursuant to which T will 

be merged with and into P on June 1 of Year 

1. Pursuant to the contract, the T 

shareholders will receive 40 P shares and $60 

of cash in exchange for all of the outstanding 

stock of T. Twenty of the P shares, however, 

will be placed in escrow to secure customary 

target representations and warranties. The P 

stock is listed on an established market. On 

January 2 of Year 1, the value of the P stock 

is $1 per share. On June 1 of Year 1, T merges 

with and into P pursuant to the terms of the 

contract. On that date, the value of the P 

stock is $.25 per share. None of the stock 

placed in escrow is returned to P. Because 

the contract provides for the number of 

shares of P and the amount of money to be 

exchanged for all of the proprietary interests 

in T, under paragraph (e)(2) of this section, 

there is a binding contract providing for fixed 

consideration as of January 3 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on January 2 of Year 1. Because, for 

continuity of interest purposes, the T stock 

is exchanged for $40 of P stock and $60 of 

cash, the transaction preserves a substantial 

part of the value of the proprietary interest 

in T. Therefore, the transaction satisfies the 

continuity of interest requirement. 

Example 2. Treatment of forfeited 

escrowed stock. (i) The facts are the same as 

in Example 1 except that T’s breach of a 

representation results in the escrowed 

consideration being returned to P. Because 

the contract provides for the number of 

shares of P and the amount of money to be 

exchanged for all of the proprietary interests 

in T, under paragraph (e)(2) of this section, 

there is a binding contract providing for fixed 

consideration as of January 3 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on January 2 of Year 1. Because, for 

continuity of interest purposes, the T stock 

is exchanged for $20 of P stock and $60 of 

cash, the transaction does not preserve a 

substantial part of the value of the 

proprietary interest in T. Therefore, the 

transaction does not satisfy the continuity of 

interest requirement. 

(ii) The facts are the same as in Example 

2 (i) except that the consideration placed in 

escrow consists solely of eight of the P shares 

and $12 of the cash. Because the contract 

provides for the number of shares of P and 

the amount of money to be exchanged for all 

of the proprietary interests in T, under 

paragraph (e)(2) of this section, there is a 

binding contract providing for fixed 

consideration as of January 3 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on January 2 of Year 1. Because, for 

continuity of interest purposes, the T stock 

is exchanged for $32 of P stock and $48 of 

cash, the transaction preserves a substantial 

part of the value of the proprietary interest 

in T. Therefore, the transaction satisfies the 

continuity of interest requirement. 

Example 3. Redemption of stock received 

pursuant to binding contract. The facts are 

the same as in Example 1 except that A owns 

50 percent of the outstanding stock of T 

immediately prior to the merger and receives 

10 P shares and $30 in the merger and an 

additional 10 P shares upon the release of the 

stock placed in escrow. In connection with 

the merger, A and S agree that, immediately 

after the merger, S will purchase any P shares 

that A acquires in the merger for $1 per 

share. Shortly after the merger, S purchases 

A’s P shares for $20. Because the contract 

provides for the number of shares of P and 

the amount of money to be exchanged for all 

of the proprietary interests in T, under 

paragraph (e)(2) of this section, there is a 

binding contract providing for fixed 

consideration as of January 3 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on January 2 of Year 1. In addition, 

S is a person related to P under paragraph 

(e)(4)(i)(A) of this section. Accordingly, A is 

treated as exchanging his T shares for $50. 

Because, for continuity of interest purposes, 

the T stock is exchanged for $20 of P stock 

and $80 of cash, the transaction does not 

preserve a substantial part of the value of the 

proprietary interest in T. Therefore, the 

transaction does not satisfy the continuity of 

interest requirement. 

Example 4. Modification of binding 

contract—continuity not preserved. The facts 

are the same as in Example 1 except that on 

April 1 of Year 1, the parties modify their 

contract. Pursuant to the modified contract, 

which is a binding contract, the T 

shareholders will receive 50 P shares (an 

additional 10 shares) and $75 of cash (an 

additional $15 of cash) in exchange for all of 

the outstanding T stock. On March 31 of Year 

1, the value of the P stock is $.50 per share. 

Under paragraph (e)(2) of this section, 

although there was a binding contract 

providing for fixed consideration as of 

January 3 of Year 1, terms of that contract 

relating to the consideration to be provided 

to the target shareholders were modified on 

April 1 of Year 1. Because the modified 

contract provides for the number of P shares 

and the amount of money to be exchanged for 

all of the proprietary interests in T, under 

paragraph (e)(2) of this section, the modified 

contract is a binding contract providing for 

fixed consideration as of April 1 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on March 31 of Year 1. Because, for 

continuity of interest purposes, the T stock 

is exchanged for $25 of P stock and $75 of 

cash, the transaction does not preserve a 

substantial part of the value of the 

proprietary interest in T. Therefore, the 

transaction does not satisfy the continuity of 

interest requirement. 

Example 5. Modification of binding 

contract disregarded—continuity preserved. 

The facts are the same as in Example 4 

except that, pursuant to the modified 

contract, which is a binding contract, the T 

shareholders will receive 60 P shares (an 

additional 20 shares as compared to the 

original contract) and $60 of cash in 

exchange for all of the outstanding T stock. 

In addition, on March 31 of Year 1, the value 

of the P stock is $.40 per share. Under 

paragraph (e)(2) of this section, although 

there was a binding contract providing for 

fixed consideration as of January 3 of Year 1, 

terms of that contract relating to the 

consideration to be provided to the target 

shareholders were modified on April 1 of 

Year 1. Nonetheless, the modification has the 

sole effect of providing for the issuance of 

additional P shares to the T shareholders. In 

addition, the execution of the terms of the 

contract without regard to the modification 

would have resulted in the preservation of a 

substantial part of the value of the T 

shareholders’ proprietary interest in T 

because, for continuity of interest purposes, 

the T stock would have been exchanged for 

$40 of P stock and $60 of cash. Therefore, the 

modification is not treated as a modification 

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

Accordingly, whether the transaction 

satisfies the continuity of interest 

requirement is determined by reference to the 

value of the P stock on January 2 of Year 1. 

Despite the modification, the transaction 

continues to satisfy the continuity of interest 

requirement. 

Example 6. New issuance. The facts are the 

same as in Example 1, except that, in lieu of 

the $60 of cash, the T shareholders will 

receive a new class of P securities that will 

be publicly traded. In the aggregate, the 

securities will have a stated principal amount 

of $60 and bear interest at the average LIBOR 

(London Interbank Offered Rates) during the 

10 days prior to the potential reorganization. 

If the T shareholders had been issued the P 

securities on January 2 of Year 1, the P 

securities would have had a value of $60 

(determined by reference to the value of 

comparable publicly traded securities). 

Whether the transaction satisfies the 

continuity of interest requirement is 

determined by reference to the value of the 

P stock and the P securities to be issued to 

the T shareholders on January 2 of Year 1. 

Under paragraph (e)(2)(iv) of this section, for 

purposes of valuing the new P securities, 

they will be treated as having been issued on 

January 2 of Year 1. Because, for continuity 

of interest purposes, the T stock is exchanged 

for $40 of P stock and $60 of other property, 

the transaction preserves a substantial part of 

the value of the proprietary interest in T. 

Therefore, the transaction satisfies the 

continuity of interest requirement. 

Example 7. Economically unreasonable 

exchange. On January 3 of Year 1, P and T 

Federal Register / Vol. 70, No. 179 / Friday, September 16, 2005 / Rules and Regulations 54637 

sign a binding contract pursuant to which T 

will be merged with and into P on June 2 of 

Year 1. At that time, A is T’s sole 

shareholder. Pursuant to the contract, 60 

percent of the T stock will be exchanged for 

$80 of cash and 40 percent of the T stock will 

be exchanged for 20 shares of P stock. As of 

January 2, 20 shares of P stock have a value 

of $20, representing only 20 percent of the 

value of the total consideration to be received 

by the T shareholders. Because the 

percentage of proprietary interests in the 

target corporation to be exchanged for stock 

of the issuing corporation and the proprietary 

interests in the target corporation to be 

exchanged for money do not each represent 

an economically reasonable exchange as of 

the last business day before the first date 

there is a binding contract to effect the 

potential reorganization, under paragraph 

(e)(2)(iii)(A)(3) of this section, the contract is 

not treated as a binding contract that 

provides for fixed consideration. 

Example 8. Absence of anti-dilution 

clause. On January 3 of Year 1, P and T sign 

a binding contract pursuant to which T will 

be merged with and into P on June 1 of Year 

1. Pursuant to the contract, the T 

shareholders will receive 40 P shares and $60 

of cash in exchange for all of the outstanding 

stock of T. The contract does not contain a 

customary anti-dilution provision. The P 

stock is listed on an established market. On 

January 2 of Year 1, the value of the P stock 

is $1 per share. On April 10 of Year 1, P 

issues its stock to effect a stock split; each 

shareholder of P receives an additional share 

of P for each P share that it holds. On April 

11 of Year 1, the value of the P stock is $.50 

per share. Because P altered its capital 

structure between January 3 and June 1 of 

Year 1 in a manner that materially alters the 

economic arrangement of the parties, under 

paragraph (e)(2)(iii)(E) of this section, the 

contract is not treated as a binding contract 

that provides for fixed consideration. 

Example 9. Shareholder election with a 

proration mechanism. On January 3 of Year 

1, P and T sign a binding contract pursuant 

to which T will be merged with and into P 

on June 1 of Year 1. Pursuant to the contract, 

at the shareholders’ election, each share of T 

will be exchanged for cash of $1 or, 

alternatively, P stock that has a value of $1, 

if the value of each share of P stock is at least 

$.80 and no more than $1.20 on the effective 

date of the potential reorganization; 1.25 

shares of P stock, if the value of each share 

of P stock is less than $.80 on the effective 

date of the potential reorganization; or .83 

shares of P stock, if the value of each share 

of P stock is more than $1.20 on the effective 

date of the potential reorganization. In 

addition, the contract provides for a 

proration mechanism to ensure that 50 

percent of the T shares will be exchanged for 

cash and 50 percent of the T shares will be 

exchanged for P stock. On January 2 of Year 

1, T has 100 shares outstanding. The P stock 

is listed on an established market. On 

January 2 of Year 1, the value of the P stock 

is $1 per share. Because the contract provides 

for the percentage of the number of shares of 

each class of proprietary interests in T, and 

the percentage (by value) of the proprietary 

interests in T, to be exchanged for stock of 

P and the other requirements of paragraph 

(e)(2)(iii)(A)(3) of this section are satisfied, 

there is a binding contract providing for fixed 

consideration as of January 3 of Year 1. 

Therefore, whether the transaction satisfies 

the continuity of interest requirement is 

determined by reference to the value of the 

P stock on January 2 of Year 1. Because, for 

continuity of interest purposes, the T stock 

is exchanged for $50 of P stock and $50 of 

cash, the transaction preserves a substantial 

part of the value of the proprietary interest 

in T. Therefore, the transaction satisfies the 

continuity of interest requirement. 

* * * * * 

(8) Effective date. Paragraphs (e)(1) 

and (e)(3) through (e)(7) of this section 

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 binding on January 28, 1998, and at 

all times thereafter. Paragraph (e)(1)(ii) 

of this section, however, applies to 

transactions occurring after August 30, 

2000, unless the transaction occurs 

pursuant to a written agreement that is 

(subject to customary conditions) 

binding on that date and at all times 

thereafter. Taxpayers who entered into a 

binding agreement on or after January 

28, 1998, and before August 30, 2000, 

may request a private letter ruling 

permitting them to apply the final 

regulation to their transaction. A private 

letter ruling will not be issued unless 

the taxpayer establishes to the 

satisfaction of the IRS that there is not 

a significant risk of different parties to 

the transaction taking inconsistent 

positions, for Federal tax purposes, with 

respect to the applicability of the final 

regulations to the transaction. Paragraph 

(e)(2) of this section applies to 

transactions occurring pursuant to 

binding contracts entered into after 

September 16, 2005. 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: September 6, 2005. 

Eric Solomon, 

Acting Deputy Assistant Secretary of the 

Treasury (Tax Policy). 

[FR Doc. 05–18263 Filed 9–15–05; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 117 

[CGD05–05–112] 

RIN 1625–AA–09 

Drawbridge Operation Regulations; 

James River, VA 

AGENCY: Coast Guard, DHS. 

ACTION: Notice of temporary deviation 

from regulations. 

SUMMARY: The Commander, Fifth Coast 

Guard District, has approved a 

temporary deviation from the 

regulations governing the operation of 

the James River Bridge, mile 5.0, across 

the James River between Isle of Wight 

and Newport News, Virginia. This 

deviation allows the drawbridge to 

remain closed-to-navigation on two 3- 

day closure periods from 7 a.m. on 

October 14 through 5 p.m. October 17, 

2005, and from 7 a.m. on November 18 

through 5 p.m. November 21, 2005, to 

facilitate mechanical repairs. 

DATES: This deviation is effective from 

7 a.m. on October 14, 2005, until 5 p.m. 

on November 21, 2005. 

ADDRESSES: Materials referred to in this 

document are available for inspection or 

copying at Commander (obr), Fifth Coast 

Guard District, Federal Building, 1st 

Floor, 431 Crawford Street, Portsmouth, 

VA 23704–5004 between 8 a.m. and 4 

p.m., Monday through Friday, except 

Federal holidays. The telephone number 

is (757) 398–6222. Commander (obr), 

Fifth Coast Guard District maintains the 

public docket for this temporary 

deviation. 

FOR FURTHER INFORMATION CONTACT: Bill 

H. Brazier, Bridge Management 

Specialist, Fifth Coast Guard District, at 

(757) 398–6422. 

SUPPLEMENTARY INFORMATION: The James 

River Bridge, a vertical-lift drawbridge, 

has a vertical clearance in the closed 

position to vessels of 60 feet and 145 

feet in the full open position, at mean 

high water. 

Electrical Motor Services Industrial, 

Inc. (EMS), is the contractor engaged to 

perform these repairs for the Virginia 

Department of Transportation (VDOT), 

the bridge owner. EMS, on behalf of 

VDOT, requested a temporary deviation 

from the operating regulations for the 

James River Bridge, set out in 33 CFR 

117.5, that requires the bridge to open 

promptly and fully for the passage of 

vessels when a request to open is given. 

EMS requested the temporary 

deviation to close the James River