Final sec. 338 regs. on solely-for-voting-stock requirement.

• Author: Madden, David
• Position: IRC section 338 regulations on tax-free reorganizations following a qualified stock purchase

On Feb. 2, 2001, Treasury issued final Secs. 338 and 1060 regulations (Final Regulations), which include rules for allocating the amount realized and bases of assets transferred in either an actual asset acquisition or a deemed asset acquisition under Sec. 338. In addition to the allocation provisions, the Final Regulations include other provisions that affect tax-free reorganizations following a qualified stock purchase (QSP).

Generally, a transaction qualifies as a C reorganization if a corporation acquires substantially all of the assets of a target solely in exchange for the acquiring corporation's voting stock (Sec. 368(a)(1)(C)). Since the 1950s, the state of the law has been if an acquiring corporation owned some target stock and, in exchange for the target's assets, the acquiring corporation surrendered the target stock, it could violate the solely-for-voting-stock requirement (depending on the amount of target stock the acquiring corporation owned); see Bausch & Lomb Optical Co., 267 F2d 75 (2d Cir. 1959) and Rev. Rul. 54-396, which addressed the same facts as Bausch & Lomb.

Newly issued Regs. Sec. 1.368-2(d)(4) (the" anti-Bausch & Lomb regulations") effectively overturned the long-standing Bausch & Lomb doctrine, by providing that target stock historically owned by an acquiring corporation no longer counts against the solely-for-voting-stock requirement in a C reorganization. However, the use of property (other than the acquiring corporation's voting stock) to acquire target stock in connection with a subsequent transfer of the target's assets to the acquiring corporation is outside the scope of these regulations and could invalidate a C reorganization by violating the solely-for-voting-stock requirement (Regs. Sec. 1.368-2(d)(4)(ii), Ex. 2).

With the forgoing as a backdrop, the Final Regulations provide that, when a corporation's acquisition of a target's stock is a QSP, special rules apply. Generally, a QSP is a transaction in which stock possessing at least 80% of a corporation's vote and value (Sec. 1504(a)(2)) is "purchased" by another corporation within a 12-month period (Sec. 338(d)(3)). A "purchase" is generally any stock acquisition in a taxable acquisition; see Sec. 338(h)(3) for specific rules. The Final Regulations now provide that the acquisition of a target's stock for consideration other than solely an acquiring corporation's voting stock only in connection with a QSP does not prevent the subsequent transfer of the...