Updated guidance on the determination of basis of stock in transferred basis transactions.

• Author: Pineda, Rina M.

Rev. Proc. 2011-35 was issued in response to the increasing difficulty of determining the transferred basis in stock associated with type B reorganizations as defined in Sec. 368(a)(1)(B), particularly when the stock is publicly traded. Under Sec. 368(a)(1)(B), a type B reorganization is a corporate acquisition where an exchange of all or part of voting stock occurs in order to gain a controlling interest in the target corporation. Rev. Proc. 20111-35 provides four safe-harbor methodologies that a corporation may use to establish its basis in the stock of another corporation in a type B reorganization or certain other transferred basis transactions.

This most recent revenue procedure updates and clarifies Rev. Proc. 81-70, Notice 2004-44, and Notice 2009-4. Rev. Proc. 81-70 established that the most effective way for the acquirer to determine the target stock's transferred basis is to survey the target shareholders' basis in their stock at time of surrender, in conjunction with statistical sampling guidelines. However, securities market operations have changed considerably since the issuance of Rev. Proc. 81-70.

The most significant change in the current market is that stock is typically held by nominees (i.e., clearinghouses or financial institutions) that are required to maintain the confidentiality of their clients' identities. This created a challenge to effectively survey the target shareholders, thus making it very difficult to determine the transferred basis in the current market. Notice 2004-44 and Notice 2009-4 identified and confirmed the need for a revision of Rev. Proc. 81-70. Rev. Proc. 2011-35 adopts the safe harbors offered in Notice 2009-4 but has been altered to allow the use of data easily accessible to the acquiring corporations (discussed below). Finally, Rev. Proc. 2011-35 allows the applicability of the valuation methodologies to all transferred basis transactions beyond type B reorganizations, such as Sec. 351 exchanges and some triangular reorganizations.

Rev. Proc. 2011-35

The primary purpose of Rev. Proc. 2011-35 is to provide detailed guidance on the four methodologies that are available to determine the carryover basis in transferred stock, applying the safe harbors of Notice 2009-4 as follows:

* A full survey for shares surrendered either by the shareholder or by the nominee on behalf of the reporting shareholders;

* A combination of statistical sampling and survey for the target shareholders or nominee;

* A...