Significant recent developments.

Author:Bakke, Don W.
Position:Consolidated tax returns


* Final regulations provide that E and F reorganizations are not subject to the COI and COBE requirements.

* Other final regulations address COI satisfaction when the issuing stock declines in value after the sing date, the interpretation of plans under Sec. 355(e) and loss disallowance on a sale of subsidiary stock.

* The Service issued additional guidance on the interpretation of plans under Sec. 355(e) and elections under new Sec. 362(e)(2)(C).


This article summarizes significant recent developments affecting C corporations and consolidated returns. It covers many new final, temporary and proposed regulations and noteworthy cases and ruling issued over the past year.

The following is a summary of income tax developments during the past year affecting corporations, including those that file consolidated returns. No significant legislation affecting corporations has been enacted since the American Jobs Creation Act of 2004 (AJCA) was signed in October 2004. (1) What follows, is a summary of regulatory and administrative guidance that has been issued in the past year.

Final Regs.

As a general matter, an acquisition by one corporation of another's stock must meet the requirements for "reorganization" status under Sec. 368 to qualify for non-recognition treatment at both the corporate and shareholder levels; otherwise, the acquisition will be treated as a taxable sale.

In achieving reorganization status, a transaction must fit one of the reorganization types (e.g., a statutory merger described in Sec. 368(a)(1)(A) (an A reorganization)) and meet other requirements in regulations, including continuity of interest (COI), measured at the shareholder level, and continuity of business enterprise (COBE), measured at the corporate level. Regs. Sec. 1.368-2(b) generally accords nonrecognition treatment to exchanges that represent only a readjustment of COI in property under modified corporate forms, and distinguishes them from sale transactions.

COI and COBE in E and F Reorgs.

Final regulations (2) provide that the COI and COBE requirements need not be met for Sec. 368(a)(1)(E) and (F) reorganizations. These rules were issued after proposed regulations (3) that contained the COI and COBE exclusionary provisions and four requirements needed to qualify a transaction as an F reorganization. Treasury decided to accelerate adoption of the rule providing that the COI and COBE requirements do not apply to F reorganizations, which was in response to comments on the proposed regulations. The remaining portions of the proposed regulations have not been finalized.

The final rules provide taxpayers with greater flexibility in structuring a transaction to qualify as a "mere change in identity, form, or place of organization" (a reorganization under Sec. 368(a)(1)(F)). For example, before these regulations, a prospective purchaser that wanted to organize a target corporation under the laws of a different state, could have reincorporated the target, pursuant to a single plan, by merging it into a newly formed corporation (new target) organized under the laws of the new state, and then sold the new target for cash. However, the purchaser would have run the risk of having the reincorporation disqualified as an F reorganization. Regs. Sec. 1.368-1(b), as amended, should now provide comfort that the reincorporation transfer, which involved a transfer of assets from one corporation to a new one, will not be disqualified as an F reorganization, even though the proprietary interests in the new target will be held entirely by new shareholders. (4) In addition, the COBE requirement no longer applies to bar the new target from disposing of a significant portion of its assets following the transaction. (5)

COI Testing Date

The Service issued final regulations (6) addressing whether COI is satisfied when the value of the issuing corporation's stock declines between the date the parties agree to the transaction's terms (the signing date) and the date the transaction closes. If the reorganization contract provides for fixed consideration, the consideration to be exchanged for a proprietary interest in the target will be valued on the last business day before such contract is binding. The final rules amend and finalize regulations initially proposed in August 2004 (7) and apply to transactions occurring under binding contracts entered into after Sept. 16, 2005.

Under the proposed regulations, consideration was treated as fixed if the contract states the number of shares of the issuing corporation and the amount of money (if any) to be exchanged for proprietary interests in the target. The final regulations expand the definition of "fixed consideration" to include a contract that provides for either the percentage (1) of the number of shares of each class of target stock or (2) by value of the target shares to be exchanged for issuing corporation stock, as long as such target shares, as well as the target shares to be exchanged for consideration other than issuing corporation stock, each represent an economically reasonable exchange.

Contingent consideration: Generally, a contract provision providing for contingent consideration prevents the con tract from being treated as providing for fixed consideration. However, the final regulations contain a limited exception in cases in which the (1) contingent consideration consists solely of the issuing corporation's stock and (2) execution of the potential reorganization would have resulted in the preservation of a substantial part of the value of the target shareholders' proprietary interests in the target if none of the contingent consideration were delivered to them (i.e., the proprietary interest in the issuing corporation could only increase, if the contingency is met).

Nature of nonstock consideration: Under the proposed regulations, the signing-date rule applied only when the nonstock element of consideration was money. The final regulations allow the signing-date rule to apply to transactions in which the nonstock consideration includes property other than money (e.g., securities, notes, etc.), which represents a significant expansion of the proposed regulations.

Valuation--the "as of the end of the last business day" rule: The final regulations clarify certain valuation issues. First, to permit an appropriate valuation of consideration tendered in exchange for target stock, they provide generally that consideration to be exchanged for target shares has to be valued the day before the contract is binding. In addition, there are rules for determining value when the issuing corporation issues a new class of stock not previously outstanding as consideration.

Escrowed stock: The final regulations also clarify that...

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