Part I. Rulings — Internal Revenue Bulletin 1998-9

Section 354.—Exchanges of Stock and Securities in Certain Reorganizations

26 CFR 1.354–1: Exchanges of stocks and securities in certain reorganizations.

T.D. 8752

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Reorganizations/Treatment of Warrants as Securities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations

SUMMARY: This document contains final regulations that in certain instances provide for nonrecognition of gain or loss on the receipt, in pursuance of a reorganization, of rights to acquire stock of a corporation that is a party to the reorganization. These regulations change the existing rules for such rights under sections 354, 355, and 356 of the Internal Revenue Code. These regulations will affect holders of these rights who are involved in corporate reorganizations under sections 355 and 368.

DATES: These regulations are effective March 9, 1998.

FOR FURTHER INFORMATION CONTACT: Michael J. Danbury, (202) 6227750 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 23, 1996, the IRS and Treasury Department published a notice of proposed rulemaking (REG–249819–96

[1997–1 C.B. 793]) in the Federal Regis- ter (61 F.R. 67508) containing proposed amendments to the Income Tax Regulations (26 CFR part 1) under sections 354, 355, and 356, relating to exchanges of stock and securities in certain reorganizations and corporate divisions. Written and oral comments responding to this notice were received. There were no requests to attend a public hearing and none was held.

After consideration of all comments received, the proposed amendments are adopted as revised by this Treasury decision. The principal changes to the regulations, as well as the major comments and suggestions, are discussed below.

Explanation of Provisions

Elaboration on the Definition of “Rights To Acquire Stock” Commentators recommended that the final regulations include an explicit definition of rights to acquire stock . They submitted particular examples for inclusion in the definition.

The final regulations add a cross-reference to sections 305 and 317(a) in defining rights to acquire stock . This crossreference should provide sufficient guidance in most cases for taxpayers to determine the consequences on a receipt of rights. The IRS and Treasury believe that illustrating the terms of sections 305 and 317 is outside the scope of these regulations. Accordingly, the final regulations

A. The Proposed Regulations

In general, sections 354, 355, and 356 provide for nonrecognition of gain or loss, in whole or in part, to a stockholder or security holder on the exchange of stock or securities of parties to a reorganization and in pursuance of a plan of reorganization.

The proposed regulations would extend the nonrecognition rule of sections 354, 355, and 356 to certain rights to acquire stock. Thus, for purposes of sections 354, 355, and 356, the proposed regulations would treat rights to acquire stock issued by a corporation that is a party to a reorganization as securities of the corporation with no principal amount. The preamble to the proposed regulations provided that, for this purpose, the term rights to acquire stock issued by that corporation would have the same meaning as the term has in sections 305(d)(1) and 317(a). In addition, the preamble stated that the proposed regulations would have no effect on other Internal Revenue Code rules that pertain to securities, including sections 83 and 421 through 424 and the regulations thereunder.

B. Comments on the Proposed

Regulations

provide no definition other than the crossreference.

Treatment of Stock-For-Warrant Exchanges Section 1.354–1(d), Example 3, states that section 354 does not apply to a shareholder’s receipt of solely debt securities in exchange for stock. Commentators requested confirmation that section 354 also does not apply to a shareholder’s receipt of solely securities that are rights to acquire stock in exchange for stock. The final regulations confirm this result in Ex- ample 4 to §1.354–1(d).
Effective Date These final regulations are effective March 9, 1998. This accords with the delayed effective date in the proposed regulations. Commentators requested more immediate effectiveness.

The IRS and Treasury are concerned that taxpayers who have planned transactions based on the proposed regulations’ delayed effective date could be disadvantaged by a change in the effective date. Accordingly, the final regulations retain the delayed effective date.

Interrelationship With Section 83 The preamble to the proposed regulations noted that the rules would apply to rights to acquire stock only for purposes of sections 354 through 356, and that such rights may remain subject to other special rules under the Internal Revenue Code and the regulations including sections 83 and 421 through 424.

Commentators recommended an explicit statement to that effect in the final regulations. The regulations adopt this recommendation.

Effect in “B” Reorganizations Commentators requested a review of published guidance that concerns exchanges of rights to acquire stock as part of a larger transaction that includes a stock-for-stock reorganization under section 368(a)(1)(B). The IRS intends to address this issue in the near future.
No Principal Amount Commentators sought clarification of the proposed rule that rights to acquire stock would have no principal amount.

March 2, 1998 4 1998–9 I.R.B.

The IRS and Treasury add Examples 7, 8, and 9 to §1.356–3(b) to illustrate the effect of a right to acquire stock having no principal amount.

Comments Not Addressed in the Final Regulations Comments were received with regard to the tax issues of rights to acquire stock under sections 302, 305, 306, and 351. Resolution of these issues is beyond the scope of this project and they are not addressed herein.
Interrelationship With Nonqualified Preferred Stock Provisions In connection with the finalization of these regulations, the IRS and Treasury became aware that additional rules were needed to coordinate these regulations with the treatment of rights to acquire nonqualified preferred stock and new sections 354(a)(2)(C), 355(a)(3)(D), and 356(e). See §1.356–6T (T.D. 8753) on page 6 of this Bulletin.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations and, because these regulations do not impose a collection of information requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Michael J. Danbury of the Office of Assistant Chief Counsel (Corporate). However, other personnel from the IRS and Treasury Department participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par 2. Section 1.354–1 is amended by:

In paragraph (d), redesignating Ex- ample (1) through Example (3) as Exam- ple 1 through Example 3 .
Adding Example 4 to paragraph (d).
Revising paragraph (e). The addition and revision read as follows:

§1.354–1 Exchanges of stock and securities in certain reorganizations.

(d) * * *

Example 4. The facts are the same as in Example 3 of this paragraph (d), except that C receives solely rights to acquire stock in Corporation Z. Section 354 does not apply.

(e) Except as provided in §1.356–6T, for purposes of section 354, the term se- curities includes rights issued by a party to the reorganization to acquire its stock. For purposes of this section and section 356(d)(2)(B), a right to acquire stock has no principal amount. For this purpose, rights to acquire stock has the same meaning as it does under sections 305 and 317(a). Other Internal Revenue Code provisions governing the treatment of rights to acquire stock may also apply to certain exchanges occurring in connection with a reorganization. See, for example, sections 83 and 421 through 424 and the regulations thereunder. This paragraph (e) applies to exchanges occurring on or after March 9, 1998.

Par 3. Section 1.355–1 is amended by removing the last sentence of paragraph (b) and adding paragraph (c) to read as follows:

§1.355–1 Distribution of stock and securities of a controlled corporation.

(c) Stock rights. Except as provided in §1.356-6T, for purposes of section 355, the term securities includes rights issued by the distributing corporation or the controlled corporation to acquire the stock of that corporation. For purposes of this section and section 356(d)(2)(B), a right to acquire stock has no principal amount. For this purpose, rights to acquire stock has the same meaning as it does under sections 305 and 317(a). Other Internal Revenue Code provisions governing the treatment of rights to acquire stock may also apply to certain distributions occurring in connection with a transaction described in section 355. See, for example, sections 83 and 421 through 424 and the regulations thereunder. This paragraph (c) applies to distributions occurring on or after March 9, 1998.

Par 4 . Section 1.356–3 is amended by:

Redesignating paragraph (b) as paragraph (c).
Adding a new paragraph (b).
In newly designated paragraph (c), redesignating Example (1) through Ex- ample (6) as Example 1 through Example 6 .
Revising paragraph (c) introductory text.
Adding Example 7 through Example 9 to paragraph (c). The revisions and additions read as follows:

§1.356–3 Rules for treatment of securities as “other property.”

(b) Except as provided in §1.356–6T, for purposes of this section, a right to acquire stock that is treated as a security for purposes of section 354 or 355 has no principal amount. Thus, such right is not other property when received in a transaction to which section 356 applies (regardless of whether securities are surrendered in the exchange). This paragraph (b) applies to transactions occurring on or after March 9, 1998.

(c) In the examples in this paragraph (c), stock means common stock and war- rants means rights to acquire common stock. The following examples illustrate the rules of paragraph (a) of this section:

1998–9 I.R.B 5 March 2, 1998

Example 7 . G, an individual, exchanged stock for stock and a warrant. The warrant had no principal amount. Thus, G received no excess principal amount within the meaning of section 356(d).

Example 8. H, an individual, exchanged a warrant for stock and a warrant. The warrants had no principal amount. Thus, H received no excess principal amount within the meaning of section 356(d).

Example 9 . I, an individual, exchanged a warrant for stock and a debt security. The warrant had no principal amount. The debt security had a $100 principal amount. I received $100 of excess principal amount within the meaning of section 356(d).

Michael P. Dolan, Deputy Commissioner of

Internal Revenue.

Approved December 17, 1997.

Donald C. Lubick, Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on January 5, 1998, 8:45 a.m., and published in the issue of the Federal Register for January 6, 1998, 63 F.R. 409)

Section 356.—Receipt of Additional Consideration

26 CFR 1.356–6T: Rules for treatment of nonqualified preferred stock as “other property” (temporary).

T.D. 8753

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Reorganizations; Nonqualified Preferred Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains a temporary regulation providing guidance under section 356(e) of the Internal Revenue Code (Code) on when nonqualified preferred stock (as defined in section 351(g)(2)) will not be treated as stock or securities for purposes of sections 354, 355, and 356 of the Code. The guidance also addresses the treatment of the receipt of a right to acquire nonqualified preferred stock. The temporary regulation provides that in some circumstances the

terms stock and securities will not include nonqualified preferred stock, or a right to acquire such stock, when received in exchange for stock or rights to acquire stock. The text of this temporary regulation also serves as the text of REG– 121755–97, page 13 of this Bulletin.

DATES: This regulation is effective March 9, 1998.

FOR FURTHER INFORMATION CONTACT: Concerning the temporary regulation, Michael J. Danbury, (202) 622-7750 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

A. In General

This document contains a temporary regulation under section 356(e) of the Internal Revenue Code as added by section 1014 of the Taxpayer Relief Act of 1997 (TRA of 1997), Public Law 105–34. Section 1014 of the TRA of 1997, enacted on August 5, 1997, amended sections 351, 354, 355, 356, and 1036 of the Code. As amended, sections 354, 355, and 356, in general, provide that nonqualified preferred stock (as defined in section 351(g)(2)) received in exchange for stock other than nonqualified preferred stock will not be treated as stock or securities but, instead, will be treated as “other property” or “boot.” As a result, unless the transition rule of section 1014(f)(2) of TRA of 1997 or another exception applies, the receipt of nonqualified preferred stock will result in gain recognition.

Section 351(g)(4) provides authority to issue regulations coordinating the rules for nonqualified preferred stock with other provisions of the Code. In connection with the issuance of final regulations treating certain rights to acquire stock as securities which can be received tax-free under sections 354, 355, and 356 (see §§1.354–1(e), 1.355–1(c), and 1.356–3(b) (T.D. 8752) also published on page 4 of this Bulletin, the IRS and Treasury became aware that additional rules were needed to address the treatment of rights to acquire nonqualified preferred stock to coordinate with new sections 354(a)(2)(C), 355(a)(3)(D), and 356(e). Accordingly, this temporary regulation provides

that, notwithstanding §§1.354–1(e), 1.355–1(c), and 1.356–3(b), a right to acquire nonqualified preferred stock received in exchange for stock other than nonqualified preferred stock (or for a right to acquire stock other than nonqualified preferred stock) will not be treated as a security, and that nonqualified preferred stock received in exchange for stock other than nonqualified preferred stock (or for a right to acquire stock other than nonqualified preferred stock) will not be treated as stock or a security.

This regulation does not attempt to address all questions and issues that may arise regarding the exchange or receipt of nonqualified preferred stock. The IRS and Treasury recognize that further guidance is necessary on these matters and intend to provide it in the future. Accordingly, comments are requested not only on these temporary and proposed regulations, but also with regard to the types of guidance needed and other issues under section 351(g) and the related provisions.

B. Effective Date

Except as provided in section 1014(f)(2) of TRA of 1997, this temporary regulation applies to nonqualified preferred stock (or a right to acquire such stock) received in connection with a transaction occurring on or after March 9, 1998.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation. Because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking accompanying this regulation is being sent to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of this regulation is Michael J. Danbury of the Office of Assistant Chief Counsel (Corporate). How

March 2, 1998 6 1998–9 I.R.B.

ever, other personnel from the IRS and Treasury Department participated in its development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.356–6T is added to read as follows:

§1.356–6T Rules for treatment of nonqualified preferred stock as “other property” (temporary).

(a) In general . For purposes of §§1.354–1(e), 1.355–1(c), and 1.356– 3(b), the terms stock and securities do not include—

(1) Nonqualified preferred stock, as defined in section 351(g)(2), received in exchange for (or in a distribution with respect to) stock, or a right to acquire stock, other than nonqualified preferred stock; or

(2) A right to acquire such nonqualified preferred stock, received in exchange for (or in a distribution with respect to) stock, or a right to acquire stock, other than nonqualified preferred stock.

(b) Exceptions . The following exceptions apply:

(1) Certain recapitalizations. Paragraph (a) of this section does not apply in the case of a recapitalization under section 368(a)(1)(E) of a family-owned corporation as described in section 354(a)(2)(C)(ii)(II).

(2) Transition rule. Paragraph (a) of this section does not apply to a transaction described in section 1014(f)(2) of the Taxpayer Relief Act of 1997 (111 Stat. 921).

(c) Effective date. This section applies to nonqualified preferred stock, or a right to acquire such stock, received in connection with a transaction occurring on or after March 9, 1998.

Michael P. Dolan, Deputy Commissioner of

Internal Revenue.

Approved December 17, 1997.

Donald C. Lubick, Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on January 5, 1998, 8:45 a.m., and published in the issue of the Federal Register for January 6, 1998, 63 F.R. 411)

1998–9 I.R.B 7 March 2, 1998