The IRS has issued final regulations (TD 9361), effective October 25, 2007, that provide guidance regarding the effect of certain transfers of assets or stock on the continuing qualification of transactions as reorganizations under Sec. 368(a). The regulations also provide guidance on the continuity-of-business-enterprise requirement and the definitions of “qualified group” and “party to a reorganization.”
Sec. 368 affords various types of reorganizations tax-free treatment. The theory underlying this treatment is that such transactions “effect only a readjustment of continuing interest in property under modified corporate forms” (Regs. Sec. 1.368-1(b)). This principle is expressed in the continuity-of-interest and continuity-of-business-enterprise requirements.
Sec. 368(a)(2)(C) allows tax-free reorganizations in which part or all of the acquired assets or stock is transferred to a corporation controlled (as defined in Sec. 368(c)) by the acquiring corporation. Regs. Sec. 1.368-2(k), as in effect prior to these final regulations, expanded the scope of Sec. 368(a)(2)(C) by permitting successive transfers of the acquired assets or stock to one or more corporations, provided that the transferee corporation was controlled in each transfer by the transferor corporation. Administratively, the Service has since interpreted Sec. 368(a)(2)(C) and Regs. Sec. 1.368-2(k) as permissive rather than exclusive or restrictive, concluding that certain transfers not specifically described in either of those provisions did not disqualify the reorganization. (See, e.g., Rev. Ruls. 2001-24 and 2002-85.)
The new regulations do not contain separate rules addressing remote continuity because the Service believes these issues are adequately addressed by the rules adopted to implement the continuity-of-business-enterprise requirement (see TD 8760). Similarly, the rules relating to the continuity-of-business-enterprise requirement have been broadened over the years to permit transactions that adequately preserve the link between the former target corporation’s shareholders and the target’s business assets. Under Regs. Sec. 1.368-1(d), as in effect prior to these final regulations, the continuity-of-business-enterprise requirement generally is satisfied as long as a member of the qualified group (or, in certain cases, a partnership) either continues the target’s historic business or uses a significant portion of the target’s historic business assets in a business.
A qualified group was defined in Regs. Sec. 1.368-1(d)(4)(ii), as in effect prior to these final regulations, as one or more chains of corporations connected through stock ownership with the issuing corporation, but only if the issuing corporation directly owns stock meeting the requirements of Sec. 368(c) in at least one of the corporations, and stock meeting the requirements of Sec. 368(c) in each of the corporations (other than the issuing corporation) is owned directly by one of the other corporations.
These final regulations continue the trend of broadening the rules on transfers of assets or stock following an otherwise tax-free reorganization where the transaction adequately preserves the link between the former target corporation’s shareholders and the target’s business assets. Accordingly, the definition of a qualified group in Regs. Sec. 1.368-1(d)(4)(ii) and the rules regarding stock or asset transfers in Regs. Sec. 1.368-2(k) have been expanded. Conforming changes to Regs. Sec. 1.368-2(f), relating to the definition of “a party to a reorganization,” also have been made.
Revised Regs. Sec. 1.368-1(d)(4)(ii) permits qualified group members to aggregate their direct stock ownership of a corporation in determining whether they own the requisite Sec. 368(c) control in the corporation, provided that the issuing corporation directly owns stock meeting the control requirement in at least one other corporation. (This aggregation concept is similar to the affiliated group concept found in Sec. 1504(a).)
The final regulations also provide that a transaction otherwise qualifying as a reorganization will not be disqualified or recharacterized as a result of one or more transfers (that do not constitute distributions) of assets or stock, or both, of the acquired corporation, the acquiring corporation, or the surviving corporation, as the case may be, provided the continuity-of-business-enterprise requirement is satisfied, and the acquired corporation, the acquiring corporation, or the surviving corporation, as the case may be, does not terminate its corporate existence in connection with the transfer(s). In the case of stock transfers of the acquired corporation, the acquiring corporation, or the surviving corporation, as the case may be, the final regulations only protect the transaction from disqualification or recharacterization if the transfers do not cause the corporation to cease to be a member of the qualified group.
The final regulations permit both distributions of stock of the acquired corporation and other transfers of stock of the acquired corporation, the acquiring corporation, or the surviving corporation, as the case may be, provided the transfer of stock does not cause the transferred corporation to cease to be a member of the qualified group. The regulations have been expanded to provide that if members of the qualified group own interests in a partnership that meet requirements equivalent to the control definition in Sec. 368(c), any stock owned by the partnership is attributed to and treated as owned by members of the qualified group. Accordingly, this full stock attribution rule treats partnerships in a manner similar to members of the qualified group.
