Proposed guidance on transfers of target assets if Sec. 338 not elected and....

• Author: Josephs, Stuart R.

Regs. Sec. 1.338-2(c)(3), proposed Feb. 16, 1995, deals with transfers of target assets to another corporation after a qualified stock purchase QSP)-if a Sec. 338 election is not made for the target. These proposed regulations implement the Service's and the Treasury's belief that Yoc Heating, 61 TC 168 (1973), is inconsistent with Sec. 338's legislative intent.

The Yoc Heating case

In Yoc Heating, a corporation bought 85% of a target's stock for cash and notes. As part of the same plan, the target subsequently transferred its assets to a newly formed subsidiary of the purchaser and dissolved. The purchaser received additional stock of its subsidiary in exchange for the purchaser's target stock and the minority shareholders received cash in exchange for their target stock.

The Tax Court viewed the stock purchase and asset acquisition as an integrated transaction in which the purchaser acquired all of the target's assets for cash and notes, and held that there was insufficient continuity of interest to qualify the asset transfer as a reorganization under Sec. 368: the target's shareholders before the stock purchase received no stock in the acquiring entity. As a result, the subsidiary received a cost basis in the target's assets.

The Yoc Heating court's analysis of the transaction as a taxable asset acquisition by the subsidiary is consistent with generally applied Federal income tax principles. For example, in Kimbell-Diamond Milling Co., 14 TC 74 (1950), aff'd per curiam, 187 F2d 718 (5th Cir., 1951), cert. denied, an acquiring corporation's purchase of a target's stock followed by the target's liquidation wag treated for Federal income tax purposes as a direct purchase of,the target's assets by the acquiring corporation. The Tax Court's characterization in Kimbell-Diamond was based on a finding that the acquiring corporation intended to obtain the target's assets rather than its stock. As a result, the acquiring corporation's basis in the target's assets was determined by reference to the purchase price of the target's stock.

Congressional action

In 1954, Congress codified principles derived from Kimbell-Diamond by enacting former Sec. 334(b)(2), which created an objective test that permitted a stock purchase followed by liquidation of the target to be treated as an asset acquisition.

In 1982, Congress repealed Sec. 334(b)(2) and replaced it with Sec. 338, which provides that, if a corporation makes a QSP of a target's stock, the...