[Federal Register Volume 70, Number 3 (Wednesday, January 5, 2005)]
[Proposed Rules]
[Pages 746-749]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-202]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-117969-00]
RIN 1545-BD76


Statutory Mergers and Consolidations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION:  Amendment of previously proposed regulations and notice of 
public hearing.

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SUMMARY: This document amends previously proposed regulations published 
in the Federal Register on January 24, 2003 (REG-126485-01, 2003-9 
I.R.B. 542, 68 FR 3477) by cross-reference to temporary regulations. 
Those regulations define the term statutory merger or consolidation as 
that term is used in section 368(a)(1)(A). This notice of proposed 
rulemaking affects corporations engaging in mergers and consolidations 
and their shareholders. It is being issued concurrently with proposed 
regulations under sections 358, 367, and 884. (See REG-125628-01 in the 
proposed rulemaking section of this issue of the Federal Register).

DATES: Written and electronic comments and requests to speak and 
outlines of topics to be discussed at the public hearing scheduled for 
May 19, 2005, to be held in the IRS Auditorium (7th floor) must be 
received by April 28, 2005.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-117969-00), Room 5203, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-117969-
00), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the IRS 
Internet site at http://www.irs.gov/regs or via the Federal eRulemaking 
Portal at http://www.regulations.gov (IRS-REG-117969-00). The public 
hearing will be held in the IRS Auditorium (7th floor), Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Vincent Daly, (202) 622-7770; concerning submissions, the hearing, or 
placement on the building access list to attend the hearing, Robin 
Jones, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

    Before 1934, the term merger, as used in the reorganization 
provisions, included statutory mergers as well as other combinations of 
corporate entities. In 1934, congress amended the definition of a 
reorganization to provide separately for statutory mergers or 
consolidations and for the other types of transactions previously 
included in the definition of a merger. There is no indication in the 
legislative history of the 1934 changes to the definition of 
reorganization that Congress intended to exclude transactions effected 
under foreign law.
    In 1935, Treasury regulations interpreted the term statutory merger 
under the revised provision to mean a merger or consolidation effected 
pursuant to the corporation laws of a State or Territory or the 
District of Columbia. The requirement that the transaction be effected 
under domestic law remains in place, with minor variations. The 
Treasury Department and IRS believe that this interpretation is 
reasonable; nevertheless, the Treasury Department and IRS believe that 
a reexamination is warranted in light of the purposes of the statute 
and changes in domestic and foreign law since 1935.
    The states have revised their laws to offer a greater variety of 
business entities and greater flexibility in effecting business 
combinations. Accordingly, the Treasury Department and IRS thought it 
advisable to define a merger or consolidation functionally, to 
supplement the reference to State law. Accordingly, the Treasury 
Department and IRS developed and proposed such a functional definition 
in 2003. See Notice of Proposed Rulemaking (REG-126485-01, 2003-9 
I.R.B. 542, 68 FR 3477), cross-referencing temporary regulations (TD 
9038, 2003-9, I.R.B. 524, 68 FR 3384) (January 24, 2003).
    Many foreign jurisdictions now have merger or consolidation 
statutes that operate in material respects like those of the states, 
i.e., all assets and liabilities move by operation of law. The Treasury 
Department and IRS believe that transactions affected pursuant to these 
statutes should be treated as reorganizations if they satisfy the 
functional criteria applicable to transactions under domestic statutes.
    This document proposes a revised definition of a statutory merger 
or consolidation. The previously proposed definition of a statutory 
merger required that it be a transaction effected ``pursuant to the 
laws of the United States or a State or the District of Columbia.'' See 
REG-126485-01 (2003-9 I.R.B. 542, 68 FR 3477). The new proposed 
definition contained in this document replaces the quoted language with 
``pursuant to the statute or statutes necessary to effect the merger or 
consolidation.'' This proposed change would allow a transaction 
effected pursuant to the statutes of a foreign jurisdiction or of a 
United States possession to qualify as a statutory merger or 
consolidation under section 368(a)(1)(A), provided it otherwise 
qualifies as a reorganization. The phrase statute or statutes is not 
intended to prevent transactions effected pursuant to legislation from 
qualifying as mergers or consolidations where such legislation is 
supplemented by administrative or case law.
    This notice of proposed rulemaking also proposes to remove Sec.  
1.368-2(b)(1)(iii) of the previously proposed regulations. That section 
imposes limitations on the use of disregarded entities in statutory 
mergers or consolidations when certain entities are not organized under 
the laws of the United States or a State or the District of Columbia.
    Although this document revises the terms of the proposed definition 
of a statutory merger or consolidation for purposes of section 368, the 
provisions of the temporary regulations will remain in effect until 
this proposal is incorporated in temporary or final regulations after 
notice and comment.
    Section 1.368-2(b)(1)(B)(iv), Examples 1 and 2 in the previously 
proposed regulations each specified that one of the parties to the 
transaction described in the example ``is not treated as owning any 
assets of an entity that is disregarded as an entity separate from its 
owner for Federal tax purposes.'' The results in those examples would 
be the same in each case whether or not a party to the transaction held 
such assets. See

[[Page 747]]

Sec.  1.368-2(b)(1)(B)(iv), Example 3 in the previously proposed 
regulations. To avoid any possible implication to the contrary, the 
Treasury Department and IRS propose removal of the sentence specifying 
that condition from each example. The Treasury Department and IRS are 
continuing to study other comments received on the earlier proposed 
regulations.
    A notice of proposed rulemaking proposing amendments to the 
regulations under sections 358, 367, and 884 (including special rules 
for determining basis and holding period in certain transactions 
involving one or more foreign corporations) is being published 
simultaneously with the publication of this notice of proposed 
rulemaking. See REG-125628-01 in the proposed rulemaking section of 
this issue of the Federal Register.

Proposed Effective Date

    These regulations are proposed to apply to transactions occurring 
after the date final regulations are published in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in 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. Because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department specifically request 
comments on the clarity of the proposed regulations and on how they can 
be made easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing has been scheduled for May 19, 2005, beginning at 
10 a.m. in the IRS Auditorium (7th floor), Internal Revenue Building, 
1111 Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For information about having your name placed on the 
building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT portion of this preamble.
    The rules of 26 CFR 601.601 (a)(3) apply to the hearing. Persons 
who wish to present oral comments must submit written or electronic 
comments and an outline of the topics to be discussed and the time to 
be devoted to each topic (asigned original and eight (8) copies) by 
April 29, 2005. A period of 10 minutes will be allotted to each person 
for making comments. An agenda showing the scheduling of the speakers 
will be prepared after the deadline for receiving outlines has passed. 
Copies of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Vincent Daly, 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.

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. Paragraph (b)(1) of Sec.  1.368-2 as proposed on January 
24, 2003, at 68 FR 3477, is proposed to be revised to read as follows:


Sec.  1.368-2  Definition of terms.

* * * * *
    (b)(1)(i) Definitions. The following definitions apply for purposes 
of this paragraph (b)(1):
    (A) Disregarded entity. A disregarded entity is a business entity 
(as defined in Sec.  301.7701-2(a) of this chapter) that is disregarded 
as an entity separate from its owner for Federal tax purposes. Examples 
of disregarded entities include a domestic single member limited 
liability company that does not elect to be classified as a corporation 
for Federal tax purposes, a corporation (as defined in Sec.  301.7701-
2(b) of this chapter) that is a qualified REIT subsidiary (within the 
meaning of section 856(i)(2)), and a corporation that is a qualified 
subchapter S subsidiary (within the meaning of section 1361(b)(3)(B)).
    (B) Combining entity. A combining entity is a business entity that 
is a corporation (as defined in Sec.  301.7701-2(b) of this chapter) 
that is not a disregarded entity.
    (C) Combining unit. A combining unit is composed solely of a 
combining entity and all disregarded entities, if any, the assets of 
which are treated as owned by such combining entity for Federal tax 
purposes.
    (ii) Statutory merger or consolidation generally. For purposes of 
section 368(a)(1)(A), a statutory merger or consolidation is a 
transaction effected pursuant to the statute or statutes necessary to 
effect the merger or consolidation, in which transaction, as a result 
of the operation of such statute or statutes, the following events 
occur simultaneously at the effective time of the transaction--
    (A) All of the assets (other than those distributed in the 
transaction) and liabilities (except to the extent satisfied or 
discharged in the transaction) of each member of one or more combining 
units (each a transferor unit) become the assets and liabilities of one 
or more members of one other combining unit (the transferee unit); and
    (B) The combining entity of each transferor unit ceases its 
separate legal existence for all purposes; provided, however, that this 
requirement will be satisfied even if, under applicable law, after the 
effective time of the transaction, the combining entity of the 
transferor unit (or its officers, directors, or agents) may act or be 
acted against, or a member of the transferee unit (or its officers, 
directors, or agents) may act or be acted against in the name of the 
combining entity of the transferor unit, provided that such actions 
relate to assets or obligations of the combining entity of the 
transferor unit that arose, or relate to activities engaged in by such 
entity, prior to the effective time of the transaction, and such 
actions are not inconsistent with the requirements of paragraph 
(b)(1)(ii)(A) of this section.
    (iii) Examples. The following examples illustrate the rule of 
paragraph (b)(1) of this section. In each of the examples, except as 
otherwise provided, each of V, Y, and Z is a C corporation. X is a 
limited liability company. Except

[[Page 748]]

as otherwise provided, X is wholly owned by Y and is disregarded as an 
entity separate from Y for Federal tax purposes. The examples are as 
follows:

    Example 1. Divisive transaction pursuant to a merger statute. 
(i) Under State W law, Z transfers some of its assets and 
liabilities to Y, retains the remainder of its assets and 
liabilities, and remains in existence following the transaction. The 
transaction qualifies as a merger under State W corporate law.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because of all the assets 
and liabilities of Z, the combining entity of the transferor unit, 
do not become the assets and liabilities of Y, the combining entity 
and sole member of the transferee unit. In addition, the transaction 
does not satisfy the requirements of paragraph (b)(1)(ii)(B) of this 
section because the separate legal existence of Z does not cease for 
all purposes. Accordingly, the transaction does not qualify as a 
statutory merger or consolidation under section 368(a)(1)(A).
    Example 2. Merger of a target corporation into a disregarded 
entity in exchange for stock of the owner. (i) Under State W law, Z 
merges into X. Pursuant to such law, the following events occur 
simultaneously at the effective time of the transaction: All of the 
assets and liabilities of Z become the assets and liabilities of X 
and Z's separate legal existence ceases for all purposes. In the 
merger, the Z shareholders exchange their stock of Z for stock of Y.
    (ii) The transaction satisfies the requirements of paragraph 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the following events occur 
simultaneously at the effective time of the transaction: All of the 
assets and liabilities of Z, the combining entity and sole member of 
the transferor unit, become the assets and liabilities of one or 
more members of the transferee unit that is comprised of Y, the 
combining entity of the transferee unit, and X, a disregarded entity 
the assets of which Y is treated as owning for Federal tax purposes, 
and Z ceases its separate legal existence for all purposes. 
Accordingly, the transaction qualifies as a statutory merger or 
consolidation for purposes of section 368(a)(1)(A).
    Example 3. Merger of a target S corporation that owns a QSub 
into a disregarded entity. (i) The facts are the same as in Example 
2, except that Z is an S corporation and owns all of the stock of U, 
a QSub.
    (ii) The deemed formation by Z of U pursuant to Sec.  1.1361-
5(b)(1) (as a consequence of the termination of U's QSub election) 
is disregarded for Federal income tax purposes. The transaction is 
treated as a transfer of the assets of U to X, followed by X's 
transfer of these assets to U in exchange for stock of U. See Sec.  
1.1361-5(b)(3), Example 9. The transaction will, therefore, satisfy 
the requirements of paragraph (b)(1)(ii) of this section because the 
transaction is effected pursuant to State W law and the following 
events occur simultaneously at the effective time of the 
transaction: all of the the assets and liabilities of Z and U, the 
sole members of the transferor unit, become the assets and 
liabilities of one or more members of the transferee unit that is 
comprised of Y, the combining entity of the transferee unit, and X, 
a disregarded entity the assets of which Y is treated as owning for 
Federal tax purposes, and Z ceases its separate legal existence for 
all purposes. Moreover, the deemed transfer of the assets of U in 
exchange for U stock does not cause the transaction to fail to 
qualify as a statutory merger or consolidation. See section 
368(a)(2)(C). Accordingly, the transaction qualifies as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 4. Triangular merger of a target corporation into a 
disregarded entity. (i) The facts are the same as in Example 2, 
except that V owns 100 percent of the outstanding stock of Y and, in 
the merger of Z into X, the Z shareholders exchange their stock of Z 
for stock of V. In the transaction, Z transfers substantially all of 
its properties to X.
    (ii) The transactions is not prevented from qualifying as a 
statutory merger or consolidation under section 368(a)(1)(A), 
provided the requirements of section 368(a)(2)(D) are satisfied. 
Because the assets of X are treated for Federal tax purposes as the 
assets of Y, Y will be treated as acquiring substantially all of the 
properties of Z in the merger for purposes of determining whether 
the merger satisfies the requirements of section 368(a)(2)(D). As a 
result, the Z shareholders that receive stock of V will be treated 
as receiving stock of a corporation that is in control of Y, the 
combining entity of the transferee unit that is the acquiring 
corporation for purposes of section 368(a)(2)(D). Accordingly, the 
merger will satisfy the requirements of section 368(a)(2)(D).
    Example 5. Merger of a target corporation into a disregarded 
entity owned by a partnership. (i) The facts are the same as in 
Example 2, except that Y is organized as a partnership under the 
laws of State W and is classified as a partnership for Federal tax 
purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section. All of the assets and 
liabilities of Z, the combining entity and sole member of the 
transferor unit, do not become the assets and liabilities of one or 
more members of a transferee unit because neither X nor Y qualifies 
as a combining entity. Accordingly, the transaction cannot qualify 
as a statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 6. Merger of a disregarded entity into a corporation. 
(i) Under State W law, X merges into Z. Pursuant to such law, the 
following events occur simultaneously at the effective time of the 
transaction: All of the assets and liabilities of X (but not the 
assets and liabilities of Y other than those of X) become the assets 
and liabilities of Z and X's separate legal existence ceases for all 
purposes.
    (ii) The transaction does not satisfy the requirements of 
paragraph (b)(1)(ii)(A) of this section because all of the assets 
and liabilities of a transferor unit do not become the assets and 
liabilities of one or more members of the transferee unit. The 
transaction also does not satisfy the requirements of paragraph 
(b)(12)(ii)(B) of this section because X does not qualify as a 
combining entity. Accordingly, the transaction cannot qualify as a 
statutory merger or consolidation for purposes of section 
368(a)(1)(A).
    Example 7. Merger of a corporation into a disregarded entity in 
exchange for interests in the disregarded entity. (i) Under State W 
law, Z merges into X. Pursuant to such law, the following events 
occur simultaneously at the effective time of the transaction: All 
of the assets and liabilities of Z become the assets and liabilities 
of X and Z's separate legal existence ceases for all purposes. In 
the merger of Z into X, the Z shareholders exchange their stock of Z 
for interests in X so that, immediately after the merger, X is not 
disregarded as an entity separate from Y for Federal tax purposes. 
Following the merger, pursuant to Sec.  301.7701-3(b)(1)(i) of this 
chapter, X is classified as a partnership for Federal tax purposes. 
(ii) The transaction does not satisfy the requirements of paragraph 
(b)(1)(ii)(A) of this section because immediately after the merger X 
is not disregarded as an entity separate from Y and, consequently, 
all of the assets and liabilities of Z, the combining entity of the 
transferor unit, do not become the assets and liabilities of one or 
more members of a transferee unit. Accordingly, the transaction 
cannot qualify as a statutory merger or consolidation for purposes 
of section 368(a)(1)(A).
    Example 8. Merger transaction preceded by distribution. (i) Z 
operates two unrelated businesses, Business P and Business Q, each 
of which represents 50 percent of the value of the assets of Z. Y 
desires to acquire and continue operating Business P, but does not 
want to acquire Business Q. Pursuant to a single plan, Z sells 
Business Q for cash to parties unrelated to Z and Y in a taxable 
transaction, and then distributes the proceeds of the sale pro rata 
to its shareholders. Then, pursuant to State W law, Z merges into Y. 
Pursuant to such law, the following events occur simultaneously at 
the effective time of the transaction: All of the assets and 
liabilities of Z related to Business P become the assets and 
liabilities of Y and Z's separate legal existence ceases for all 
purposes. In the merger, the Z shareholders exchange their Z stock 
for Y stock.
    (ii) The transaction satisfies the requirements of paragraph 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to State W law and the

[[Page 749]]

following events occur simultaneously at the effective time of the 
transaction: All of the assets and liabilities of Z, the combining 
entity and sole member of the transferor unit, become the assets and 
liabilities of Y, the combining entity and sole member of the 
transferee unit, and Z ceases its separate legal existence for all 
purposes. Accordingly, the transaction qualifies as a statutory 
merger or consolidation for purposes of section 368(a)(1)(A).
    Example 9. Transaction effected pursuant to foreign statutes. 
(i) Z and Y are entities organized under the laws of Country Q and 
classified as corporations for Federal tax purposes. Z and Y 
combine. Pursuant to statutes of Country Q the following events 
occur simultaneously: All of the assets and liabilities of Z become 
the assets and liabilities of Y and Z's separate legal existence 
ceases for all purposes.
    (ii) The transaction satisfies the requirements of paragraphs 
(b)(1)(ii) of this section because the transaction is effected 
pursuant to statutes of Country Q and the following events occur 
simultaneously at the effective time of the transaction: All of the 
assets and liabilities of Z, the combining entity of the transferor 
unit, become the assets and liabilities of Y, the combining entity 
and sole member of the transferee unit, and Z ceases its separate 
legal existence for all purposes. Accordingly, the transaction 
qualifies as a statutory merger or consolidation for purposes of 
section 368(a)(1)(A).

    (iv) Effective dates. This paragraph (b)(1) applies to transactions 
occurring after the date these regulations are published as final 
regulations in the Federal Register. For rules regarding statutory 
mergers or consolidations on or after January 24, 2003, and before 
these regulations are published as final regulations in the Federal 
Register, see Sec.  1.368-2T(b)(1). For rules regarding statutory 
mergers or consolidations before January 24, 2003, see Sec.  1.368-
2(b)(1) as it applies before January 24, 2003 (see 26 CFR part 1, 
revised April 1, 2002).
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 05-202 Filed 1-4-05; 8:45 am]
BILLING CODE 4830-01-M