Resurrecting transactions to qualify under secs. 338 and 338(h) (10).

• Author: Bloom, Gilbert D.

Although it is readily apparent that a long-standing, significant stock interest in a target corporation precludes a subsequent Sec. 338 transaction, it is less well known that a Sec. 338(h)(10) transaction is also precluded, even if the stock interest was recently acquired. There is, however, a way to substantively negate the prior ownership and permit free use of Sec. 338, with or without a concomitant Sec. 338(h)(10) election.

Example: Corporate Buyer (B) acquired 25% of the only class of outstanding Target (T) common stock from corporate Seller (S) for cash three years ago. The other 75% of T stock continues to be owned by S. B acquired its stock in T as an investment, but now would like to obtain all of T's assets and business operations. From a tax point of view, S is amiable and is willing to sell its T stock or to cause T assets to be sold. From an economic point of view, however, the transaction must be structured as a stock acquisition, because T has valuable nonassignable licenses, leases and contracts.

If B were to purchase the remaining 75% of the T stock from S, a Sec. 338 election f or T would not be possible. A Sec. 338 election requires a "qualified stock purchase," which in general means an acquisition of 80% of the stock of T by "purchase" within a 12-month period (Sec. 338(d)(3)).

If B's acquisition of its 25% interest in T occurred three months ago, rather than three years ago, B could acquire the remaining 75% stock interest and make a Sec. 338 election. The combined two-step purchase within a 12-month period would satisfy the qualified stock purchase requirement.

This approach will, however, result in dual tax, once to S on the sale of its 75% stock interest in T, and once to T on the deemed sale of its assets pursuant to the Sec. 338 election. To avoid the dual tax associated with a straight Sec. 338 election, the parties would like to make a Sec. 338(h)(10) election. The effect of that election would be to cause the stock acquisition to be disregarded and the transaction treated as if there had been a deemed sale of T assets to New T (owned by B) (Regs. Sec. 1.338(h)(10)-1(e)(1)).

This seems to solve the dual tax problem, but the prior ownership interest may still be a concern. An election under Sec. 338(h)(10) is deemed to take place on the "acquisition date," i.e., the day that 80% of the stock is acquired. On that date, S and T must either file a consolidated return together or be affiliated (Regs. Sec...