Proposed section 368 regulations - remote continuity-of-interest doctrine - Tax Executive Institute's comments submitted to IRS on April 30, 1997

Tax Executive, The, May-June, 1997

On April 30, 1997, Tax Executives Institute submitted the following comments to the Internal Revenue Service on proposed regulations under section 368, which would significantly relax the "remote" continuity-of-interest doctrine for certain tax-free reorganizations. The comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is David L. Klausman of Westinghouse Electric Corporation. Philip C. Cohen of Unilever United States Inc. and David A. Heywood of Union Pacific Corp. contributed materially to the preparation of the submission.

On January 2, 1997, the Internal Revenue Service issued proposed regulations under section 368 that would significantly relax the "remote" continuity-of-interest doctrine for certain tax-free reorganizations. The proposed regulations (REG-252233-96) were published in the Federal Register on January 3, 1997 (62 Fed. Reg. 361), and in the Internal Revenue Bulletin (1997-9 I.R.B. 19).(1) The proposed regulations would also modify the rules relating to the continuity of business enterprise doctrine. A public hearing on the proposed rules is scheduled for May 7, 1997. Tax Executives Institute is pleased to submit the following comments on the proposed regulations.

Background

Tax Executives Institute is the principal association of business tax executives in North America. The Institute's more than 5,000 members represent 2,800 of the largest companies in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

TEI members are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations relating to the remote continuity-of-interest doctrine in certain tax-free reorganizations.

Overview of Proposed

Regulations

As noted in the preamble, Congress has amended section 368 a number of times, beginning in 1954, to ameliorate the effects of the remote continuity-of-interest doctrine. In the case of transactions otherwise qualifying as tax-free reorganizations under section 368(a)(1)(A), (B), (C), or (G) (meeting the requirements of sections 354(b)(1)(a) and (B)), section 368(a)(2)(c) permits the acquiring corporation to transfer the acquired assets or stock to a corporation "controlled" by the acquiring corporation. Changes have also been made to permit various forms of triangular reorganizations where the stock of a corporation in "control" of the acquiring corporation is employed to effect the acquisitive reorganization. In each instance, "control," which is determined by reference to section 368(c), is defined as the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of all other classes of stock.

For transactions otherwise qualifying as tax-free reorganizations under section 368(a)(1)(A), (B), (C), or (G), the proposed regulations would change the continuity-of-interest requirements in current Treas. Reg. [sections] 1.368-1(b) and, in addition, permit transfers beyond those explicitly permitted by section 368(a)(2)(C). Corresponding changes would be made to the continuity-of-business enterprise requirements in current Treas. Reg. [sections] 1.368-1(d).

Under carefully prescribed conditions, the proposed regulations would permit the acquiring corporation to transfer the acquired assets or stock to a partnership. In addition, the corporations to which such transfers may be made would be expanded to include any member of the "qualified group." Prop. Reg. [sections] 1.368-1(d)(5)(iii) defines the "qualified group" as one or more chains of corporations connected through direct stock ownership, where each link in the chain of corporations to the "issuing corporation" satisfies the control requirement in section 368(c). Prop. Reg. [sections] 1.368-1(d)(5)(iv) defines the "issuing corporation" as the acquiring corporation (as that term is used in section 368), except in those transactions where use of the stock of a corporation in control of the acquiring corporation is permitted. Where stock in the controlling corporation is used to acquire a target corporation's stock or assets, the controlling corporation would be the "issuing corporation."

In general, the Treasury Department and IRS are to be commended for proposing significant changes restricting the "emote continuity" doctrine. TEI recommends, however, that the Treasury and IRS go further. For the reasons set forth below, the proposed regulations should be amended in two respects before they are finalized. First, the types of permissible transfers of assets or stock should be expanded to include transfers to any member of an affiliated group filing consolidated returns, whether or not that member meets the "control" requirement in section 368(c). Second, the changes should be made effective retroactively, at least on an elective basis.