Treasury and Internal Revenue Service Issue New Temporary Regulations on "All Cash" Type D Reorganizations
In TD 9558, issued late last year, Temporary Regulations were promulgated on the determination of the basis of stock or securities in a reorganization where no stock or securities of the issuing corporation are issued and distributed in the transaction, and, in particular, the treatment of “all cash D reorganizations”. Where no stock or securities of the issuing corporation (“acquiring corporation”) are issued and distributed in the transaction, the ability to designate the share of stock of the issuing corporation to which the basis, if any, of the stock or securities surrendered will be connected to applies only to a shareholder owning stock in the issuing corporation. This limits the ability to allocate basis in stock, for example, to members of lower-tier corporate chains which still have the same ultimate indirect shareholder(s). Background On December 19, 2006, the IRS and the Treasury Department published a notice of proposed rulemaking) that included regulations under section 368 (the Temporary Regulations) which set forth rules for determining whether the distribution requirement under §§368(a)(1)(D) and 354(b)(1)(B) is complied with where there is no actual distribution of stock or securities. Three years later, final regulations were published which, in addition to providing guidance regarding the qualification of certain transactions as reorganizations within §368(a)(1)(D), amended Treas.Reg. § 1.358- 2(a)(2)(iii) to provide that in the case of a reorganization in which the property received consists solely of non-qualifying property equal to the value of the assets transferred (as well as a nominal share described in the final regulations), the shareholder or security holder may designate the share of stock of the issuing corporation to which the basis, if any, of the stock or securities surrendered will attach. Treas. Reg. §1.358-2(a)(2)(iii) as amended stated: “If a shareholder or security holder surrenders a share of stock or a security in a transaction under the terms of Section 354 (or so much of Section 356 as relates to Section 354) in which such shareholder or security holder is deemed to receive a nominal share described in Reg. 1.368-2(l), such shareholder may, after adjusting the basis of the nominal share in accordance with the rules of Reg. 1.358-1, designate the share of stock of the issuing corporation to which the basis, if any, of the nominal share will attach.” The National Office of the IRS and the Treasury Department became aware that existing rules could be construed as allowing an inappropriate allocation of basis by persons that do not own actual shares of stock in the issuing corporation, such as a lower-tier ownership chain of a consolidated group. More specifically, the rules could be interpreted to allow persons who do not own actual shares of stock of the issuing corporation to allocate the adjusted basis of the nominal share to an actual share of stock of the issuing corporation directly owned by someone else before the nominal share is deemed to be further transferred through the chains of ownership to reflect the actual ownership of the target and issuing corporations. Under this interpretation of the rules, the actual share to which the basis was allocated could then be sold to purposely recognize a loss, and taxpayers would avoid losing the nominal share's basis, which would otherwise be zero following its deemed transfer through the chains of ownership to the actual shareholder of the issuing corporation. All Cash D Reorganization and Distribution Rule Under Treas. Reg. §1.368-2(l)(1), to qualify as a “D” reorganization a transferor corporation (combining entity) must transfer all or part of its assets to another corporation (another combining entity) and immediately after the transfer, the transferor corporation, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, must be in control of the transferee corporation, but only if, in pursuance of the plan, stock or securities of the transferee are distributed in a transaction that qualifies under §§ 354, 355, or 356. Treas. Reg. §1.368-2(l)(2)(i) provides that a transaction otherwise described in §368(a)(1)(D) will be treated as satisfying the requirements of §§ 368(a)(1)(D) and 354(b)(1)(B) even where there is no actual issuance of stock or securities of the transferee corporation provided the same person or persons own, directly or indirectly, all of the stock of the transferor and transferee corporations in identical proportions. Where no consideration is received or the value of the consideration received in the transaction is less than the fair market value of the transferor corporation's assets, the transferee corporation will be treated as issuing stock with a value equal to the excess of the fair market value of the transferor corporation's assets over the value of the consideration actually received in the transaction. Treas. Reg. §1.368-2(l)(2)(i) also provides that if the value of the consideration received in the transaction is equal to the fair market value of the transferor corporation's assets, the transferee corporation will be deemed to issue a nominal share of stock to the transferor corporation in addition to the actual consideration exchanged for the transferor corporation's assets. The nominal share of stock in the transferee corporation will then be deemed to be distributed by the transferor corporation to the shareholders of the transferor corporation. When appropriate, the nominal share will be further transferred through chains of ownership to the extent necessary to reflect the actual ownership of the transferor and transferee corporations. Treatment similar to that in the preceding two sentences will apply where the transferee corporation is treated as issuing stock with a value equal to the excess of the fair market value of the transferor corporation's assets over the value of the consideration actually received in the transaction. Other rules are provided in the regulations. See Treas. Reg. §1.368-2(l)(2), 1.358-6(b)(2). New Temporary Regulations The preamble to the final regulation noted that the IRS and the Treasury Department believe the ability to designate any remaining basis is consistent with current law regarding basis determination, as a similar result would occur under Treas. Reg. § 1.358-2 if an amount of issuing corporation stock was actually issued. Where stock is actually issued in a lower-tier transfer, such stock would then be transferred through chains of ownership, and in the process, if basis in the stock exceeded value, the basis in the shares would be reduced to the fair market value of the shares in the hands of the distributee, under §301(d). Accordingly, in such a case, basis in excess of the value of the issuing corporation shares would generally be preserved only where the shareholder of the transferor corporation does not further distribute the stock of the issuing corporation in a transaction to which §301 applies. The new temporary regulations clarify and amend the final regulations under Treas. Reg. § 1.358-2(a)(2)(iii) to provide that where an actual shareholder of the issuing corporation is deemed to receive a nominal share of stock of the issuing corporation per Treas. Reg. § 1.368-2(l), such shareholder must, after allocating and adjusting the basis of the nominal share in accordance with the rules of this section and Treas. Reg. § 1.358-1, and after adjusting the basis in the nominal share for any transfers described in Treas. Reg. § 1.358-1, designate the share of stock of the issuing corporation to which the basis, if any, of the nominal share will attach. The new temporary regulation provides: “Section 1.358-2T is added to read as follows: § 1.358-2T Allocation of basis among nonrecognition property (temporary). (a)(1) through (a)(2)(ii) [Reserved]. For further guidance, see § 1.358-2(a)(1) through (a)(2)(ii). (iii) For purposes of this section, if a shareholder or security holder surrenders a share of stock or a security in a transaction under the terms of section 354 (or so much of section 356 as relates to section 354) in which such shareholder or security holder receives no property or property (including property permitted by section 354 to be received without the recognition of gain or “other property” or money) with a fair market value less than that of the stock or securities surrendered in the transaction, such shareholder or security holder shall be treated as follows. ((A)) First, the shareholder or security holder shall be treated as receiving the stock, securities, other property, and money actually received by the shareholder or security holder in the transaction and an amount of stock of the issuing corporation (as defined in § 1.368-1(b)) that has a value equal to the excess of the value of the stock or securities the shareholder or security holder surrendered in the transaction over the value of the stock, securities, other property, and money the shareholder or security holder actually received in the transaction. If the shareholder owns only one class of stock of the issuing corporation the receipt of which would be consistent with the economic rights associated with each class of stock of the issuing corporation, the stock deemed received by the shareholder pursuant to the previous sentence shall be stock of such class. If the shareholder owns multiple classes of stock of the issuing corporation the receipt of which would be consistent with the economic rights associated with each class of stock of the issuing corporation, the stock deemed received by the shareholder shall be stock of each such class owned by the shareholder immediately prior to the transaction, in proportion to the value of the stock of each such class owned by the shareholder immediately prior to the transaction. The basis of each share of stock or security deemed received and actually received shall be determined under the rules of this section. ((B)) Second, the shareholder or security holder shall then be treated as surrendering all of its shares of stock and securities in the issuing corporation, including those shares of stock or securities held immediately prior to the transaction, those shares of stock or securities actually received in the transaction, and those shares of stock deemed received pursuant to the previous sentence, in a reorganization under section 368(a)(1)(E) in exchange for the shares of stock and securities of the issuing corporation that the shareholder or security holder actually holds immediately after the transaction. The basis of each share of stock and security deemed received in the reorganization under section 368(a)(1)(E) shall be determined under the rules of this section. ((C)) If an actual shareholder of the issuing corporation is deemed to receive a nominal share of stock of the issuing corporation described in § 1.368-2(l), such shareholder must, after allocating and adjusting the basis of the nominal share in accordance with the rules of this section and § 1.358-1, and after adjusting the basis in the nominal share for any transfers described in § 1.368- 2(l), designate the share of stock of the issuing corporation to which the basis, if any, of the nominal share will attach. (a)(2)(iv) through (c), Example 14 [Reserved]. For further guidance, see § 1.358-2(a)(2)(iv) through (c), Example 14. Example 15. (i) Facts. Each of Corporation X and Corporation Y has a single class of stock outstanding, all of which is owned by J, an individual. J acquired 100 shares of Corporation X stock on Date 1 for $1.50 each. On Date 2, Corporation Y acquires the assets of Corporation X for $100 of cash, their fair market value, in a transaction described in § 1.368-2(l). Pursuant to the terms of the exchange, Corporation X does not receive any Corporation Y stock. Corporation X Rules and Regulations distributes the $100 of cash to J in liquidation. Pursuant to § 1.368-2(l), Corporation Y will be deemed to issue a nominal share of Corporation Y stock to Corporation X in addition to the $100 of cash actually exchanged for the Corporation X assets, and Corporation X will be deemed to distribute all of the consideration to J. J will have a basis of $50 in the nominal share of Corporation Y stock under section 358(a). (ii) Analysis. Under paragraph (a)(2)(iii) of this section, J is the actual shareholder of Corporation Y, the issuing corporation, deemed to receive the nominal share of Corporation Y stock described in § 1.368-2(l). Therefore, J must designate any share of Corporation Y stock to which the basis of $50 in the nominal share of Corporation Y stock will attach. Example 16. (i) Facts. Each of Corporation X and Corporation Y has a single class of stock outstanding, all of which is owned by Corporation P. Corporation T has a single class of stock outstanding, all of which is owned by Corporation X. The corporations do not join in the filing of a consolidated return. Corporation X acquired 100 shares of Corporation T stock on Date 1 for $1.50 each. On Date 2, Corporation Y acquires the assets of Corporation T for $100 of cash, their fair market value, in a transaction described in § 1.368-2(l). Pursuant to the terms of the exchange, Corporation T does not receive any Corporation Y stock. Corporation T distributes the $100 of cash to Corporation X in liquidation. Pursuant to § 1.368-2(l), Corporation Y will be deemed to issue a nominal share of Corporation Y stock to Corporation T in addition to the $100 of cash actually exchanged for the Corporation T assets, and Corporation T will be deemed to distribute all of the consideration to Corporation X. Corporation X will have a basis of $50 in the nominal share of Corporation Y stock under section 358(a). Corporation X will be deemed to distribute the nominal share of Corporation Y stock to Corporation P. Corporation X does not recognize the loss on the deemed distribution of the nominal share to Corporation P under section 311(a). Corporation P's basis in the nominal share is zero, its fair market value, under section 301(d). (ii) Analysis. Corporation X is deemed to receive the nominal share of Corporation Y stock described in § 1.368-2(l). However, under paragraph (a)(2)(iii) of this section, Corporation X is not an actual shareholder of Corporation Y, the issuing corporation. Therefore, Corporation X cannot designate any share of Corporation Y stock to which the basis, if any, of the nominal share of Corporation Y stock will attach. Furthermore, Corporation P cannot designate a share of Corporation Y stock to which basis will attach because Corporation P receives the nominal share with a basis of zero. (d) Effective/applicability date. This section applies to exchanges and distributions of stock and securities occurring on or after November 21, 2011. (e) Expiration date. This section expires on or before November 18, 2014.”
