Daily Tax Update - January 24, 2006

IRS and Treasury Issue final regulations on statutory mergers and consolidations:
Today, the IRS and Treasury issued final regulations defining the term "statutory merger or consolidation" as that term is used in the definition of an "A" reorganization under section 368(a)(1)(A) of the Internal Revenue Code (the "Code"). Temporary regulations were issued on January 24, 2003 and proposed regulations were issued on January 5, 2005. The most notable difference between the temporary and proposed regulations was that the proposed regulations provided that a transaction involving a foreign entity and effected pursuant to the laws of a foreign jurisdiction may qualify as a statutory merger or consolidation and therefore an "A" reorganization. The final regulations adopt the proposed regulations, with certain modifications.

  • The preamble to the final regulations clarifies that a transaction involving a state law conversion of a corporation into a limited liability company that is disregarded for Federal income tax purposes does not qualify as a statutory merger or consolidation because the entity that is converted in such a transaction continues to exist under state law.
  • In contrast, the preamble to the final regulations clarifies that transactions effected under state law consolidation statutes or foreign law amalgamation statutes do qualify under the definition of statutory merger or consolidation.
  • In addition, the final regulations include an example of the application of section 368(a)(2)(D) to a triangular amalgamation. The preamble to the final regulations states that the IRS and Treasury do not believe that section 368(a)(2)(D) requires the corporation the stock of which is used in the transaction to control the acquiring corporation immediately prior to the transaction and that such corporation’s control of the acquiring corporation immediately after the transaction is sufficient to satisfy that requirement of section 368(a)(2)(D).
  • Finally, the preamble to the final regulations clarifies that a transaction in which two corporations together own all of the membership interests in an LLC and one corporation merges into the LLC (and as a result the LLC becomes a disregarded entity) qualifies as a statutory merger or consolidation. The final regulations include an example illustrating this clarification.
  • For additional information, contact Mark J. Silverman via e-mail or Lisa M. Zarlenga - via e-mail.

IRS and Treasury issue final regulations amending regulations under various provisions of the code to account for statutory mergers or consolidations involving foreign corporations:
In conjunction with the final regulations defining statutory mergers and consolidations, the IRS and Treasury issued final regulations under sections 367, 884, and 6038B to account for the expansion of the definition of statutory merger or consolidation to include transactions involving foreign corporations. The final regulations adopt the proposed regulations that were issued in conjunction with the proposed statutory merger regulations described above, with certain modifications.

  • The final regulations contain numerous rules that apply outside the scope of statutory mergers and consolidations. These rules are similar to those in the proposed regulations and include special basis rules that are intended to preserve section 1248 amounts in certain reorganizations and rules prioritizing the application of section 367(a) and (b) to transactions were both provisions apply. The final regulations also contain rules regarding: (i) the application of the indirect stock transfer rules of section 367 to certain triangular reorganizations and the transfer of assets subsequent to an asset reorganization under section 368(a)(1); (ii) the coordination of the indirect stock transfer and asset transfer rules under section 367; (iii) the application of section 367(b) to certain triangular reorganizations; and (iv) the application of section 367(b) to certain outbound reorganizations.
  • The final regulations contain numerous technical modifications, but in general adopt the above rules as set forth in the proposed regulations.
  • For additional information, contact Mark J. Silverman via email or Lisa M. Zarlenga via e-mail.

IRS and Treasury Issue final Regulations regarding determination of stock basis in certain transactions:
Today, the IRS and Treasury issued final regulations under section 358 regarding the determination of the basis of stock or securities received in exchange for, or with respect to, stock or securities in certain transactions. The final regulations adopt the temporary regulations issued on May 3, 2004, with certain modifications.

  • The final regulations adopt the tracing approach that was set forth in the temporary regulations. Pursuant to this method, the basis of each share of stock or security received in a reorganization is traced to the basis of each surrendered share of stock or security, and each share of stock or security received in a section 355 distribution is allocated basis from a share of stock or security of the distributing corporation.
  • The preamble to the final regulations reiterated the view of the IRS and Treasury that a reorganization is not an event that justifies averaging the bases of exchanged stock or securities that have been purchased at different times and at different prices.
  • The preamble to the final regulations confirms that any terms of exchange between parties that specifies which shares are received in exchange for shares or classes of shares will be respected for purposes of determining basis, provided that the terms of exchange are economically reasonable.
  • The final regulations adopt rules governing the allocation of boot among stock and securities surrendered that are consistent with the rules regarding designation of exchanges and allocation of basis. To extent there are terms that specify property or money is received in exchange for particular shares, such terms will control (provided such terms are economically reasonable). To the extent there are no such terms, a pro rata portion of the boot will be treated as received in exchange for each share of stock and security surrendered based on fair market value at the time of the exchange.
  • The preamble to the final regulations clarifies that if one share of stock or security is received in exchange for multiple shares of stock or securities, the tracing approach may require the received share of stock or security to have a split basis and/or split holding period. The preamble states that the IRS and Treasury believe that a single, aggregated basis approach, even when applied to a single share of stock or security, is inconsistent with the tracing regime and is therefore not permitted.
  • The preamble to the final regulations states that the IRS and Treasury declined to expand the tracing rules to section 351 transactions. However, the preamble states that the IRS and Treasury will continue to study whether such expansion is appropriate.

IRS and Treasury Issue temporary Regulations governing excess loss accounts: Today, the IRS and Treasury issued temporary regulations under section 1502 that govern certain basis determinations and adjustments of subsidiary stock in certain transactions involving members of a consolidated group. These temporary regulations were issued in conjunction with the final basis determination regulations discussed above. The temporary regulations expand the application of section 1.1502-19(d) to reduce or eliminate the creation of excess loss accounts in certain circumstances.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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