Guidance Under Section 355(e);
Recognition of Gain on Certain Distributions of Stock or
Securities in Connection with an Acquisition

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8960] RIN 1545-BA01

TITLE Guidance under section 355(e); Recognition of Gain on Certain
Distributions of Stock or Securities In Connection with an
Acquisition

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to
recognition of gain on certain distributions of stock or securities
of a controlled corporation in connection with an acquisition.
Changes to the applicable law were made by the Taxpayer Relief Act
of 1997. These temporary regulations affect corporations and are
necessary to provide them with guidance needed to comply with these
changes.

EFFECTIVE DATES: These temporary regulations are effective August 3,
2001.

FOR FURTHER INFORMATION CONTACT: Megan R. Fitzsimmons of the Office
of Associate Chief Counsel (Corporate), (202) 622-7790 (not a toll-
free number).

SUPPLEMENTARY INFORMATION:

Background

On January 2, 2001, the IRS and Treasury published in the Federal
Register (REG-107566-00, 66 FR 66; (2001-3 I.R.B. 346)) a notice of
proposed rulemaking (the Proposed Regulations) under section 355(e)
of the Internal Revenue Code of 1986. Section 355(e) provides that
the stock of a controlled corporation will not be qualified.2
property under section 355(c)(2) or 361(c)(2) if the stock is
distributed as "part of a plan (or series of related transactions)
pursuant to which 1 or more persons acquire directly or indirectly
stock representing a 50-percent or greater interest in the
distributing corporation or any controlled corporation."

The Proposed Regulations provide guidance concerning the
interpretation of the phrase "plan (or series of related
transactions)." The Proposed Regulations generally provide that
whether a distribution and an acquisition are part of a plan is
determined based on all the facts and circumstances. They also set
forth six safe harbors, the satisfaction of which would confirm that
a distribution and an acquisition are not part of a plan.

A public hearing regarding the Proposed Regulations was held on May
15, 2001. In addition, written comments were received. A number of
commentators have indicated that the lack of guidance under section
355(e) is hindering the ability to undertake acquisitions and
divestitures. These commentators have requested that the IRS and
Treasury provide immediate guidance pending the finalization of
those regulations. In response to these requests, the IRS and
Treasury are promulgating the Proposed Regulations as temporary
regulations in this Treasury Decision. The temporary regulations are
identical to the Proposed Regulations, except that the temporary
regulations reserve section 1.355-7(e)(6) (suspending the running of
any time period prescribed in the Proposed Regulations during which
there is a substantial diminution of risk of loss under the
principles of section 355(d)(6)(B)) and Example 7 of.3 the Proposed
Regulations (interpreting the term "similar acquisition" in the
context of a situation involving multiple acquisitions).

The IRS and Treasury continue to study all of the comments received
regarding the Proposed Regulations. The IRS and Treasury will
continue to devote significant resources to analyzing the comments
and, in the near future, expect to issue additional guidance
regarding the interpretation of the phrase "plan (or series of
related transactions)."

Special Analyses

It has been determined that these temporary regulations are not a
significant regulatory action as defined in Executive Order 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 temporary regulations,
and, because the temporary regulations do 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, these temporary regulations will be 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 temporary regulations is Brendan P.
O'Hara, Office of the Associate Chief Counsel (Corporate). However,
other personnel from the

DEPARTMENT OF THE TREASURY and the IRS participated in their
development. List of Subjects in 26 CFR Part 1.4

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regu ations Accordingly, 26 CFR part 1
is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.355-7T also issued under 26 U.S.C. 355(e)(5). * * *

Par. 2. Section 1.355-0 is amended by revising the section heading
and the introductory text and adding an entry for §1.355-7T to
read in part as follows: §1.355-0 Outline of sections.

In order to facilitate the use of §§1.355-1 through
1.355-7T, this section lists the major paragraphs in those sections
as follows:

* * * * *

§1.355-7T Recognition of gain on certain distributions of stock
or securities in connection with an acquisition.

(a) In general.

(b) Plan.

(c) Multiple acquisitions.

(d) Facts and circumstances.

(e) Operating rules.

(1) Reasonable certainty evidence of business purpose to facilitate
an acquisition.

(2) Internal discussion evidence of business purpose.

(3) Hostile takeover defense.

(4) Effect of distribution on trading in stock.

(5) Consequences of section 355(e) disregarded for certain purposes.

(6) Substantial diminution of risk. [Reserved]

(f) Safe harbors.

(1) Safe Harbor I..5

(2) Safe Harbor II.

(3) Safe Harbor III.

(4) Safe Harbor IV.

(5) Safe Harbor V.

(i) In general.

(ii) Special rules.

(6) Safe Harbor VI.

(g) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests.

(1) Treatment of options.

(i) General rule.

(ii) Agreement, understanding, arrangement, or substantial
negotiations to write an option.

(2) Instruments treated as options.

(3) Instruments generally not treated as options.

(i) Escrow, pledge, or other security agreements.

(ii) Compensatory options.

(iii) Options exercisable only upon death, disability, mental
incompetency, or separation from service.

(iv) Rights of first refusal.

(v) Other enumerated instruments.

(h) Multiple controlled corporations.

(i) [Reserved]

(j) Valuation.

(k) Definitions.

(1) Agreement, understanding, arrangement, or substantial
negotiations.

(2) Controlled corporation.

(3) Controlling shareholder.

(4) Established market.

(5) Five-percent shareholder.

(l) [Reserved]

(m) Examples.

(n) Effective date. Par. 3. Section 1.355-7T is added to read as
follows: §1.355-7T Recognition of gain on certain distributions
of stock or securities in connection with an acquisition.

(a) In general. Except as provided in section 355(e) and in this
section, section 355(e) applies to any distribution--.6

(1) To which section 355 (or so much of section 356 as relates to
section 355) applies; and

(2) That is part of a plan (or series of related transactions)
(referred to elsewhere in this section as "plan") pursuant to which
1 or more persons acquire directly or indirectly stock representing
a 50-percent or greater interest in the distributing corporation
(Distributing) or any controlled corporation (Controlled).

(b) Plan. (1) Whether a distribution and an acquisition are part of
a plan is determined based on all the facts and circumstances. In
general, in the case of an acquisition after a distribution, the
distribution and the acquisition are considered part of a plan if
Distributing, Controlled, or any of their respective controlling
shareholders intended, on the date of the distribution, that the
acquisition or a similar acquisition occur in connection with the
distribution. In general, in the case of an acquisition before a
distribution, the acquisition and the distribution are considered
part of a plan if Distributing, Controlled, or any of their
respective controlling shareholders intended, on the date of the
acquisition, that a distribution occur in connection with the
acquisition.

(2) For purposes of paragraph (b)(1) of this section, the actual
acquisition and the intended acquisition may be similar even though
the identity of the person acquiring stock of Distributing or
Controlled (acquirer), the timing of the acquisition or the terms of
the actual acquisition are different from the intended acquisition.
For example, in the case of a public offering or auction, the actual
acquisition and the intended acquisition may be similar even though
there are changes in the terms of the stock, the class of.7 stock
being offered, the size of the offering, the timing of the offering,
the price of the stock, or the participants in the public offering
or auction.

(c) Multiple acquisitions. All acquisitions of stock of Distributing
or Controlled that are considered to be part of a plan with a
distribution pursuant to paragraph (b) of this section will be
aggregated for purposes of the 50-percent test of paragraph (a)(2)
of this section.

(d) Facts and circumstances. (1) The facts and circumstances to be
considered in demonstrating whether a distribution and an
acquisition are part of a plan include, but are not limited to, the
facts and circumstances specified in paragraphs (d)(2) and (3) of
this section. The weight to be given each of the facts and
circumstances depends on the particular case. Therefore, whether a
distribution and an acquisition are part of a plan does not depend
on the relative number of facts and circumstances present under
paragraph (d)(2) of this section as compared to paragraph (d)(3) of
this section.

(2) Among the facts and circumstances tending to show that a
distribution and an acquisition are part of a plan are the
following:

(i) In the case of an acquisition (other than involving a public
offering or auction) after a distribution, Distributing or
Controlled and the acquirer (or any of their respective controlling
shareholders) discussed the acquisition or a similar acquisition by
the acquirer before the distribution. The weight to be accorded the
discussions depends on the nature, extent and timing of the
discussions. The existence of an agreement, understanding,
arrangement or substantial negotiations at the time of the
distribution is given substantial weight..8 (ii) In the case of an
acquisition (other than involving a public offering or auction)
after a distribution, Distributing or Controlled and a potential
acquirer (or any of their respective controlling shareholders)
discussed an acquisition before the distribution and a similar
acquisition by a different person occurred after the distribution.
The weight to be accorded the discussions depends on the nature,
extent and timing of the discussions and the similarity of the
acquisition actually occurring to the acquisition discussed before
the distribution.

(iii) In the case of an acquisition involving a public offering or
auction after a distribution, Distributing or Controlled (or any of
their respective controlling shareholders) discussed the acquisition
with an investment banker or other outside adviser before the
distribution. The weight to be accorded the discussions depends on
the nature, extent and timing of the discussions.

(iv) In the case of an acquisition before a distribution,
Distributing or Controlled and the acquirer (or any of their
respective controlling shareholders) discussed a distribution before
the acquisition. The weight to be accorded the discussions depends
on the nature, extent and timing of the discussions.

(v) In the case of an acquisition before a distribution,
Distributing or Controlled and a potential acquirer (or any of their
respective controlling shareholders) discussed a distribution before
the acquisition and a similar acquisition by a different person
occurred before the distribution. The weight to be accorded the
discussions depends on the nature, extent and timing of the
discussions and the similarity of the acquisition actually occurring
to the potential acquisition that was discussed..9 (vi) In the case
of an acquisition involving a public offering or auction before a
distribution, Distributing or Controlled (or any of their respective
controlling shareholders) discussed a distribution with an
investment banker or other outside adviser before the acquisition.
The weight to be accorded the discussions depends on the nature,
extent and timing of the discussions.

(vii) In the case of an acquisition either before or after a
distribution, the distribution was motivated by a business purpose
to facilitate the acquisition or a similar acquisition of
Distributing or Controlled.

(viii) In the case of an acquisition either before or after a
distribution, the acquisition and the distribution occurred within 6
months of each other or there was an agreement, understanding,
arrangement, or substantial negotiations regarding the second
transaction within 6 months after the first transaction. Also, in
the case of an acquisition occurring after a distribution, there was
an agreement, understanding, arrangement, or substantial
negotiations regarding a similar acquisition at the time of the
distribution or within 6 months thereafter.

(ix) In the case of an acquisition either before or after a
distribution, the debt allocation between Distributing and
Controlled made an acquisition of Distributing or Controlled likely
in order to service the debt.

(3) Among the facts and circumstances tending to show that a
distribution and an acquisition are not part of a plan are the
following:

(i) In the case of an acquisition (other than involving a public
offering or auction) after a distribution, neither Distributing nor
Controlled and the acquirer or any potential.10 acquirer (nor any of
their respective controlling shareholders) discussed the acquisition
or a similar acquisition before the distribution.

(ii) In the case of an acquisition involving a public offering or
auction after a distribution, neither Distributing nor Controlled
(nor any of their respective controlling shareholders) discussed the
acquisition with an investment banker or other outside adviser
before the distribution.

(iii) In the case of an acquisition after a distribution, there was
an identifiable, unexpected change in market or business conditions
occurring after the distribution that resulted in the acquisition
that was otherwise unexpected at the time of the distribution.

(iv) In the case of an acquisition (other than involving a public
offering or auction) before a distribution, neither Distributing nor
Controlled and the acquirer (nor any of their respective controlling
shareholders) discussed a distribution before the acquisition. This
paragraph (d)(3)(iv) does not apply if the acquisition occurred
after the date of the public announcement of the planned
distribution.

(v) In the case of an acquisition before a distribution, there was
an identifiable, unexpected change in market or business conditions
occurring after the acquisition that resulted in a distribution that
was otherwise unexpected.

(vi) In the case of an acquisition either before or after a
distribution, the distribution was motivated in whole or substantial
part by a corporate business purpose (within the meaning of
§1.355-2(b)) other than a business purpose to facilitate the
acquisition or a similar acquisition of Distributing or Controlled.
The presence of a business purpose to.11 facilitate the acquisition
or a similar acquisition of Distributing or Controlled is relevant
in determining the extent to which the distribution was motivated by
a corporate business purpose (within the meaning of
§1.355-2(b)) other than a business purpose to facilitate the
acquisition or a similar acquisition of Distributing or Controlled.

(vii) In the case of an acquisition either before or after a
distribution, the distribution would have occurred at approximately
the same time and in similar form regardless of the acquisition or a
similar acquisition (including a previously proposed similar
acquisition that did not occur).

(e) Operating rules. The operating rules contained in this paragraph
(e) apply for all purposes of this section.

(1) Reasonable certainty evidence of business purpose to facilitate
an acquisition.

(i) In the case of an acquisition after a distribution, if, at the
time of the distribution, it was reasonably certain that before a
date that is 6 months after the distribution an acquisition would
occur, an agreement, understanding, or arrangement would exist, or
substantial negotiations would occur regarding an acquisition of
Distributing or Controlled, the reasonable certainty is evidence of
a business purpose to facilitate an acquisition of Distributing or
Controlled.

(ii) In the case of an acquisition before a distribution, if the
acquisition occurred after the date of the public announcement of
the planned distribution, or if, at the time of the acquisition, it
was reasonably certain that before a date that is 6 months after the
acquisition the distribution would occur, an agreement,
understanding, or arrangement would exist, or substantial
negotiations would occur regarding the distribution, the.12 public
announcement or reasonable certainty is evidence of a business
purpose to facilitate an acquisition of Distributing or Controlled.

(2) Internal discussions evidence of business purpose. The fact that
internal discussions regarding an acquisition occurred may be
indicative of the business purpose that motivated the distribution.

(3) Hostile takeover defense. If Distributing distributes Controlled
stock intending, in whole or substantial part, to decrease the
likelihood of the acquisition of Distributing or Controlled by
separating it from another corporation that is likely to be
acquired, Distributing will be treated as having a business purpose
to facilitate the acquisition of the corporation that was likely to
be acquired.

(4) Effect of distribution on trading in stock. The fact that the
distribution made all or a part of the stock of Controlled available
for trading or made Distributing or Controlled's stock trade more
actively is not taken into account in determining whether the
distribution and an acquisition of Distributing or Controlled stock
were part of a plan.

(5) Consequences of section 355(e) disregarded for certain purposes.
For purposes of determining the intentions of the relevant parties
under this section, the consequences of the application of section
355(e), and the existence of any contractual indemnity by Controlled
for tax resulting from the application of section 355(e) caused by
an acquisition of Controlled, are disregarded.

(6) Substantial diminution of risk. [Reserved].13

(f) Safe harbors--(1) Safe Harbor I.

(i) A distribution and an acquisition occurring after the
distribution will not be considered part of a plan if--

(A) The acquisition occurred more than 6 months after the
distribution and there was no agreement, understanding, arrangement,
or substantial negotiations concerning the acquisition before a date
that is 6 months after the distribution; and

(B) The distribution was motivated in whole or substantial part by a
corporate business purpose (within the meaning of §1.355-2(b))
other than a business purpose to facilitate an acquisition of
Distributing or Controlled.

(ii) For purposes of paragraph (f)(1)(i)(B) of this section, the
presence of a business purpose to facilitate an acquisition of
Distributing or Controlled is relevant in determining the extent to
which the distribution was motivated by a corporate business purpose
(within the meaning of §1.355-2(b)) other than a business
purpose to facilitate an acquisition of Distributing or Controlled.

(2) Safe Harbor II. A distribution and an acquisition occurring
after the distribution will not be considered part of a plan if--

(i) The acquisition occurred more than 6 months after the
distribution and there was no agreement, understanding, arrangement,
or substantial negotiations concerning the acquisition before a date
that is 6 months after the distribution; and

(ii) The distribution was motivated in whole or substantial part by
a corporate business purpose (within the meaning of
§1.355-2(b)) to facilitate an acquisition or acquisitions of no
more than 33 percent of the stock of Distributing or Controlled, and
no more than 20 percent of the stock of the corporation (whose stock
was acquired in.14 the acquisition or acquisitions that motivated
the distribution) was either acquired or the subject of an
agreement, understanding, arrangement, or substantial negotiations
before a date that is 6 months after the distribution.

(3) Safe Harbor III. If an acquisition occurs more than 2 years
after a distribution and there was no agreement, understanding,
arrangement, or substantial negotiations concerning the acquisition
at the time of the distribution or within 6 months thereafter, the
acquisition and the distribution are not part of a plan.

(4) Safe Harbor IV. If an acquisition occurs more than 2 years
before a distribution, and there was no agreement, understanding,
arrangement, or substantial negotiations concerning the distribution
at the time of the acquisition or within 6 months thereafter, the
acquisition and the distribution are not part of a plan.

(5) Safe Harbor V--

(i) In general. An acquisition of Distributing or Controlled stock
that is listed on an established market is not part of a plan if the
acquisition is pursuant to a transfer between shareholders of
Distributing or Controlled, neither of whom is a 5- percent
shareholder. For purposes of the preceding sentence, the term 5-
percent shareholder is defined in paragraph (k)(5) of this section,
except that the corporation can rely on Schedules 13D and 13G (or
any similar schedules) filed with the Securities and Exchange
Commission to identify its 5-percent shareholders.

(ii) Special rules. (A) This paragraph (f)(5) does not apply to
public offerings or redemptions.

(b) This paragraph (f)(5) does not apply to a transfer of stock by
or to a person who, pursuant to a formal or informal understanding
with other persons (the coordinating.15 group), has joined in
coordinated transfers of stock if, at any time during the period the
understanding exists, the coordinating group owns, in the aggregate,
5 percent or more of the stock of the corporation whose stock is
transferred (determined by vote or value) immediately before or
after each transfer or at the time of the distribution. A principal
element in determining if such an understanding exists is whether
the investment decision of each person is based on the investment
decision of 1 or more other existing or prospective shareholders.

(c) This paragraph (f)(5) does not apply to a transfer of stock by
or to a person if the corporation the stock of which is being
transferred knows, or has reason to know, that the person (or a
coordinating group, treating it as a single person) intends to
become a 5-percent shareholder at any time during the 4-year period
beginning 2 years before the distribution.

(6) Safe Harbor VI. If stock of Distributing or Controlled is
acquired by an employee or director of Distributing, Controlled, or
a person related to Distributing or Controlled under section 355(d)
(7)(A), in connection with the performance of services as an
employee or director for the corporation or a person related to it
under section 355(d)(7)(A) (and that is not excessive by reference
to the services performed) in a transaction to which section 83
applies, the acquisition is not an acquisition that is part of a
plan as described in paragraph (b)(1) of this section.

(g) Stock acquired by exercise of options, warrants, convertible
obligations, and other similar interests--(1) Treatment of options--

(i) General rule. For purposes of this section, if stock of
Distributing or Controlled is acquired pursuant to an option, the.16
option will be treated as an agreement to acquire the stock on the
date the option is written unless Distributing establishes that on
the later of the date of the stock distribution or the writing of
the option, the option was not more likely than not to be exercised.
The determination of whether an option was more likely than not to
be exercised is based on all the facts and circumstances, taking
control premiums and minority and blockage discounts into account in
determining the fair market value of stock underlying an option.

(ii) Agreement, understanding, arrangement, or substantial
negotiations to write an option. If there is an agreement,
understanding, or arrangement to write an option, the option will be
treated as written on the date of the agreement, understanding, or
arrangement. If an agreement, understanding, or arrangement to write
an option is reached, or an option is written, more than 6 months
but not more than 2 years after the distribution, and there were
substantial negotiations regarding the writing of the option or the
acquisition of the stock underlying the option before the end of the
6-month period beginning on the date of the distribution, the option
will be treated as written within 6 months after the distribution.

(2) Instruments treated as options. For purposes of this paragraph
(g), except to the extent provided in paragraph (g)(3) of this
section, call options, warrants, convertible obligations, the
conversion feature of convertible stock, put options, redemption
agreements (including rights to cause the redemption of stock), any
other instruments that provide for the right or possibility to
issue, redeem, or transfer stock (including an option on an option),
or any other similar interests are treated as options..17

(3) Instruments generally not treated as options. For purposes of
this paragraph

(g), the following are not treated as options unless (in the case of
paragraphs (g)(3)(i),

(iii), and (iv) of this section) written, transferred (directly or
indirectly), or listed with a principal purpose of avoiding the
application of section 355(e) or this section.

(i) Escrow, pledge, or other security agreements. An option that is
part of a security arrangement in a typical lending transaction
(including a purchase money loan), if the arrangement is subject to
customary commercial conditions. For this purpose, a security
arrangement includes, for example, an agreement for holding stock in
escrow or under a pledge or other security agreement, or an option
to acquire stock contingent upon a default under a loan.

(ii) Compensatory options. An option to acquire stock in
Distributing or Controlled with customary terms and conditions
provided to an employee or director of Distributing, Controlled, or
a person related to Distributing or Controlled under section 355(d)
(7)(A), in connection with the performance of services as an
employee or director for the corporation or a person related to it
under section 355(d)(7)(A) (and that is not excessive by reference
to the services performed) and that immediately after the
distribution and within 6 months thereafter--

(A) Is nontransferable within the meaning of §1.83-3(d); and

(B) Does not have a readily ascertainable fair market value as
defined in §1.83-7(b).

(iii) Options exercisable only upon death, disability, mental
incompetency, or separation from service. Any option entered into
between shareholders of a corporation (or a shareholder and the
corporation) that is exercisable only upon the.18 death, disability,
or mental incompetency of the shareholder, or, in the case of stock
acquired in connection with the performance of services for the
corporation or a person related to it under section 355(d)(7)(A)
(and that is not excessive by reference to the services performed),
the shareholder's separation from service.

(iv) Rights of first refusal. A bona fide right of first refusal
regarding the corporation's stock with customary terms, entered into
between shareholders of a corporation (or between the corporation
and a shareholder).

(v) Other enumerated instruments. Any other instrument the
Commissioner may designate in revenue procedures, notices, or other
guidance published in the Internal Revenue Bulletin. See
§601.601(d)(2) of this chapter.

(h) Multiple controlled corporations. Only the stock or securities
of a controlled corporation in which 1 or more persons acquire
directly or indirectly stock representing a 50-percent or greater
interest as part of a plan involving the distribution of that
corporation will be treated as not qualified property under section
355(e)(1) if--

(1) The stock or securities of more than 1 controlled corporation
are distributed in distributions to which section 355 (or so much of
section 356 as relates to section 355) applies; and

(2) One or more persons do not acquire, directly or indirectly,
stock representing a 50-percent or greater interest in Distributing
pursuant to a plan involving any of those distributions.

(i) [Reserved].19

(j) Valuation. Except as provided in paragraph (g)(1)(i) of this
section, for purposes of section 355(e) and this section, all shares
of stock within a single class are considered to have the same
value. Thus, control premiums and minority and blockage discounts
within a single class are not taken into account.

(k) Definitions--(1) Agreement, understanding, arrangement, or
substantial negotiations. Whether an agreement, understanding, or
arrangement exists depends on the facts and circumstances. The
parties do not necessarily have to have entered into a binding
contract or have reached agreement on all terms to have an
agreement, understanding, or arrangement. However, an agreement,
understanding, or arrangement clearly exists if enforceable rights
to acquire stock exist. In public offerings or auctions by
Distributing or Controlled of Distributing or Controlled's stock, an
agreement, understanding, arrangement, or substantial negotiations
can exist even if the acquirer has not been specifically identified.
The existence of such an agreement, understanding, arrangement, or
substantial negotiations will be based on discussions with an
investment banker or other outside adviser.

(2) Controlled corporation. For purposes of this section, a
controlled corporation is a corporation the stock of which is
distributed in a distribution to which section 355 (or so much of
section 356 as relates to section 355) applies.

(3) Controlling shareholder.

(i) A controlling shareholder of a corporation the stock of which is
not listed on an established market is any person who, directly or
indirectly, or together with related persons (as described in
sections 267(b) and 707(b)),.20 possesses voting power in
Distributing or Controlled representing a meaningful voice in the
governance of the corporation.

(ii) A controlling shareholder of a corporation the stock of which
is listed on an established market is a 5-percent shareholder who
actively participates in the management or operation of the
corporation.

(iii) For purposes of this section, a person is a controlling
shareholder if that person meets the definition of controlling
shareholder in this paragraph (k)(3) immediately before or
immediately after the acquisition being tested.

(iv) If a distribution precedes an acquisition, Controlled's
controlling shareholders immediately after the distribution are
considered Controlled's controlling shareholders at the time of the
distribution.

(4) Established market. An established market is--

(i) A national securities exchange registered under section 6 of the
Securities Exchange Act of 1934 (15 U.S.C. 78f);

(ii) An interdealer quotation system sponsored by a national
securities association registered under section 15A of the
Securities Act of 1934 (15 U.S.C. 78o-3); or

(iii) Any additional market that the Commissioner may designate in
revenue procedures, notices, or other guidance published in the
Internal Revenue Bulletin (see §601.601(d)(2) of this chapter).

(5) Five-percent shareholder. A person will be considered a 5-
percent shareholder of a corporation the stock of which is listed on
an established market if the person owns, directly or indirectly, or
together with related persons (as described in sections.21 267(b)
and 707(b)) 5 percent or more of any class of stock of the
corporation whose stock is transferred. A person is a 5-percent
shareholder if the person meets the requirements of the preceding
sentence immediately before or after each transfer. All options are
treated as exercised for the purpose of determining whether the
shareholder is a 5-percent shareholder.

(l) [Reserved]

(m) Examples. The following examples illustrate paragraphs (a)
through (k) of this section. Throughout these examples, assume that
Distributing (D) owns all of the stock of Controlled (C). Assume
further that D distributes the stock of C in a distribution to which
section 355 applies and to which section 355(d) does not apply.
Unless otherwise stated, assume the corporations do not have
controlling shareholders. No inference should be drawn from any
example concerning whether any requirements of section 355 other
than those of section 355(e) are satisfied. The examples are as
follows:

Example 1. Unwanted assets.

(i) D is in business 1. C is in business 2. D is relatively small in
its industry. D wants to combine with X, a larger corporation also
engaged in business 1. X and D begin negotiating for X to acquire D,
but X does not want to acquire C. To facilitate the acquisition of D
by X, D agrees to distribute all the stock of C pro rata before the
acquisition. D and X enter into a binding contract for D to merge
into X subject to several conditions. D distributes C and D merges
into X one month later. As a result of the merger, D's former
shareholders own less than 50 percent of the stock of X.

(ii) No Safe Harbor applies to this acquisition.

(iii) The issue is whether the distribution of C and the merger of D
into X are part of a plan. To determine whether the distribution of
C and the merger of D into X are part of a plan, D must consider all
the facts and circumstances, including those described in paragraph
(d) of this section..22

(iv) The following tends to show that the distribution of C and the
merger of D into X are part of a plan: X and D discussed the
acquisition before the distribution (paragraph (d)(2)(i) of this
section), D was motivated by a business purpose to facilitate the
merger (paragraph (d)(2)(vii) of this section), and the distribution
and the merger occurred within 6 months of each other (paragraph (d)
(2)(viii) of this section). Because the merger was not only
discussed, but was agreed to, before the distribution, the fact
described in paragraph (d)(2)(i) of this section is given
substantial weight.

(v) None of the facts and circumstances listed in paragraph (d)(3)
of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.

(vi) The distribution of C and the merger of D into X are part of a
plan under paragraph (b)(1) of this section.

Example 2. Substituted acquirer.

(i) The facts are the same as in Example 1, except that after D
distributes C, X is unable to fulfill one of the conditions of the
merger agreement and the merger of D into X does not occur. Y, one
of X's competitors, perceives this as an opportunity and begins
discussing with D a merger into Y. Five months after D distributes
C, D merges into Y. As a result of the merger, the D shareholders
own less than 50 percent of the outstanding Y stock.

(ii) No Safe Harbor applies to this acquisition.

(iii) The issue is whether the distribution of C and the merger of D
into Y are part of a plan. To determine whether the distribution of
C and the merger of D into Y are part of a plan, D must consider all
the facts and circumstances, including those described in paragraph
(d) of this section.

(iv) The following tends to show that the distribution of C and the
merger of D into Y are part of a plan: X, a potential acquirer, and
D discussed an acquisition before the distribution and a similar
acquisition by Y occurred (paragraph (d)(2)(ii) of this section), D
was motivated by a business purpose to facilitate an acquisition
similar to the merger with Y (paragraph (d)(2)(vii) of this
section), and the distribution and the merger occurred within 6
months of each other (paragraph (d)(2)(viii) of this section).

(v) As in Example 1, none of the facts and circumstances listed in
paragraph (d)(3) of this section exist in this case. Although a
substituted acquirer acquired D, the merger of D into Y was similar
to the negotiated merger of D into X.

(vi) The distribution of C and the merger of D into Y are part of a
plan under paragraph (b)(1) of this section..23 Example 3. Public
offering.

(i) D's managers, directors, and investment banker discuss the
possibility of offering D stock to the public. They decide a public
offering of 50 percent of D's stock with D as a stand alone
corporation would be in D's best interest. To facilitate a stock
offering by D of 50 percent of its stock, D distributes all the
stock of C pro rata to D's shareholders. D issues new shares
amounting to 50 percent of its stock to the public in a public
offering 7 months after the distribution.

(ii) No Safe Harbor applies to this acquisition. Safe Harbor V,
relating to public trading, does not apply to public offerings
(paragraph (f)(5)(ii)(A) of this section).

(iii) The issue is whether the distribution of C and the public
offering by D are part of a plan. To determine whether the
distribution of C and the public offering by D are part of a plan, D
must consider all the facts and circumstances, including those
described in paragraph (d) of this section.

(iv) The following tends to show that the distribution of C and the
public offering by D are part of a plan: D discussed the public
offering with its investment banker before the distribution
(paragraph (d)(2)(iii) of this section), D was motivated by a
business purpose to facilitate the public offering (paragraph (d)(2)
(vii) of this section), and there were substantial negotiations
regarding the public offering within 6 months after the distribution
(paragraph (d)(2)(viii) of this section).

(v) None of the facts and circumstances listed in paragraph (d)(3)
of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.

(vi) The distribution of C and the public offering by D are part of
a plan under paragraph (b)(1) of this section.

Example 4. Public offering followed by unexpected opportunity.

      (i) Facts.

     D's managers, directors, and investment banker discuss the
possibility of offering C stock to the public. D decides to
distribute C pro rata to D's shareholders solely to facilitate a 20
percent stock offering by C. To take advantage of favorable market
conditions, C issues new shares amounting to 20 percent of its stock
in a public offering 1 month before D distributes its remaining 80
percent of the C stock. The public offering documents disclose the
intended distribution of C, which is expected to occur shortly after
the public offering. At the time of the distribution, it is not
reasonably certain that an acquisition will occur, an agreement,
understanding, or arrangement concerning an acquisition will exist,
or substantial negotiations concerning an acquisition will occur
within 6 months. Two months after the distribution, C is approached
unexpectedly regarding an opportunity to acquire X. Five months
after the distribution, C acquires X in exchange for 40 percent of
the C stock..24 (ii) Public offering. (A) No Safe Harbor applies to
the public offering. Safe Harbor V, related to public trading, does
not apply to public offerings (paragraph (f)(5)(ii)(A) of this
section).

(b) The issue is whether the 20 percent public offering by C and the
distribution by D of the remaining C stock are part of a plan. To
determine whether the distribution and the public offering are part
of a plan, D must consider all the facts and circumstances,
including those described in paragraph (d) of this section.

(c) Under paragraph (d)(2) of this section, the following tends to
show that the distribution of C and the public offering are part of
a plan: D discussed the distribution with its investment banker
before the public offering (paragraph (d)(2)(vi) of this section), D
was motivated by a business purpose to facilitate the public
offering (paragraph (d)(2)(vii) of this section), and the public
offering and the distribution occurred within 6 months of each other
(paragraph (d)(2)(viii) of this section).

(d) None of the facts and circumstances listed in paragraph (d)(3)
of this section, tending to show that a distribution and an
acquisition are not part of a plan, exist in this case.

(e) The public offering of C and the distribution of C are part of a
plan under paragraph (b)(1) of this section.

(iii) X acquisition. (A) No Safe Harbor applies to the X
acquisition.

(b) The issue is whether the distribution of C and the acquisition
by C of X are part of a plan. To determine whether the distribution
of C and the acquisition by C of X are part of a plan, D must
consider all the facts and circumstances, including those described
in paragraph (d) of this section.

(c) Under paragraph (d)(2) of this section, the following tends to
show that the distribution of C and acquisition by C of X are part
of a plan: The distribution and the acquisition occurred within 6
months of each other (paragraph (d)(2)(viii) of this section). The
fact described in paragraph (d)(2)(vii) of this section does not
exist in this case because D's business purpose was to facilitate
the public offering and C's acquisition of X is not similar to that
acquisition.

(d) Under paragraph (d)(3) of this section, the following tends to
show that the distribution of C and the acquisition by C of X are
not part of a plan: Neither D, C, nor their respective controlling
shareholders discussed the acquisition of X or a similar acquisition
with potential acquirers before the distribution (paragraph (d)(3)
(i) of this section), D had a substantial business purpose for the
distribution other than a business purpose to facilitate the
acquisition of X or a similar acquisition (paragraph (d)(3)(vi) of
this section), and the distribution would have occurred at
approximately the.25 same time and in similar form regardless of the
acquisition of X (paragraph (d)(3)(vii) of this section). The
distribution was announced and accomplished to facilitate the 20
percent public offering by C. D and C were unaware of the
opportunity to acquire X at the time of the distribution.

(e) Weighing the facts and circumstances, the acquisition by C of X
and the distribution of C by D are not part of a plan under
paragraph (b)(1) of this section.

(f) If C's acquisition of X had occurred more than 6 months after
the distribution and had not been the subject of an agreement,
understanding, arrangement, or substantial negotiations before the
date that is 6 months after the distribution, Safe Harbor II would
have applied to C's acquisition of X.

Example 5. Hot market.

(i) D is a widely held corporation the stock of which is listed on
an established market. D announces a distribution of C and
distributes C pro rata to D's shareholders. By contract, C agrees to
indemnify D for any imposition of tax under section 355(e) caused by
the acts of C. The distribution is motivated by a desire to improve
D's access to financing at preferred customer interest rates, which
will be more readily available if D separates from C. At the time of
the distribution, although D has not been approached by any
potential acquirer of C, it is reasonably certain that within 6
months after the distribution either an acquisition of C will occur
or there will be an agreement, understanding, arrangement, or
substantial negotiations regarding an acquisition of C. Corporation
Y acquires C in a merger described in section 368(a)(2)(E) within 6
months after the distribution. The C shareholders receive less than
50 percent of the stock of Y in the exchange.

(ii) No Safe Harbor applies to this acquisition.

(iii) The issue is whether the distribution of C and the acquisition
of C by Y are part of a plan. To determine whether the distribution
of C and the acquisition of C by Y are part of a plan, D must
consider all the facts and circumstances, including those described
in paragraph (d) of this section.

(iv) Under paragraph (d)(2) of this section, the following tends to
show that the distribution of C and the acquisition of C by Y are
part of a plan: The acquisition and the distribution occurred within
6 months of each other (paragraph (d)(2)(viii) of this section). In
addition, the distribution may be motivated by a business purpose to
facilitate the acquisition or a similar acquisition because there is
evidence of a business purpose to facilitate an acquisition by
reason of the fact that at the time of the distribution it was
reasonably certain that an acquisition of C would occur or there
would be an agreement, understanding, arrangement, or substantial
negotiations regarding an acquisition of C within 6 months after the
distribution (paragraphs (d)(2)(vii) and (e)(1)(i) of this
section)..26 (v) Under paragraph (d)(3) of this section, the
following tends to show that the distribution of C and the
acquisition of C by Y are not part of a plan: Neither D, C, nor
their respective controlling shareholders discussed the acquisition
or a similar acquisition with Y or any other potential acquirers
before the distribution (paragraph (d)(3)(i) of this section).
Furthermore, D may be able to demonstrate that the distribution was
motivated in whole or substantial part by a corporate business
purpose other than a business purpose to facilitate the acquisition
or a similar acquisition (paragraph (d)(3)(vi) of this section). D's
stated purpose for the distribution (facilitating D's access to
favorable financing) must be evaluated in light of the evidence of a
business purpose to facilitate an acquisition. D also may be able to
demonstrate that the distribution would have occurred at
approximately the same time and in similar form regardless of the
acquisition (paragraph (d)(3)(vii) of this section).

(vi) Under paragraph (e)(5) of this section, the existence of the
indemnity is irrelevant in analyzing whether the distribution and
acquisition of C are part of a plan.

(vii) In determining whether the distribution of C and the
acquisition of C by Y are part of a plan, one should consider the
importance of D's stated business purpose for the distribution in
light of the reasonable certainty that C would be acquired or there
would be an agreement, understanding, arrangement, or substantial
negotiations regarding an acquisition of C within 6 months after the
distribution. If D's stated business purpose for the distribution is
substantial even though the reasonable certainty that C would be
acquired is evidence of a business purpose to facilitate an
acquisition, and if D would have distributed C regardless of Y's
acquisition of C, Y's acquisition of C and D's distribution of C are
not part of a plan.

Example 6. Unexpected opportunity.

(i) D, the stock of which is listed on an established market,
announces that it will distribute all the stock of C pro rata to D's
shareholders. At the time of the announcement, the distribution is
motivated wholly by a corporate business purpose (within the meaning
of §1.355-2(b)) other than a business purpose to facilitate an
acquisition. After the announcement but before the distribution,
widely held X becomes available as an acquisition target. There were
no discussions between D and X before the announcement. D negotiates
with and acquires X before the distribution. After the acquisition,
X's former shareholders own 55 percent of D's stock. D distributes
the stock of C pro rata within 6 months after the acquisition of X.

(ii) No Safe Harbor applies to this acquisition.

(iii) The issue is whether the acquisition of X by D and the
distribution of C are part of a plan. To determine whether the
distribution of C and the acquisition of X by D are part of a plan,
D must consider all the facts and circumstances, including those
described in paragraph (d) of this section..27 (iv) Under paragraph
(d)(2) of this section, the following tends to show that the
acquisition of X by D and the distribution of C are part of a plan:
The acquisition and the distribution occurred within 6 months of
each other (paragraph (d)(2)(viii) of this section). Also, the
distribution may be motivated by a business purpose to facilitate
the acquisition or a similar acquisition because there is evidence
of a business purpose to facilitate an acquisition by reason of the
fact that the acquisition occurred after the public announcement of
the planned distribution (paragraphs (d)(2)(vii) and (e)(1)(ii) of
this section).

(v) Under paragraph (d)(3) of this section, D would assert that the
following tends to show that the distribution of C and the
acquisition of X by D are not part of a plan: The distribution was
motivated by a corporate business purpose other than a business
purpose to facilitate the acquisition or a similar acquisition
(paragraph (d)(3)(vi) of this section), and the distribution would
have occurred at approximately the same time and in similar form
regardless of the acquisition (paragraph (d)(3)(vii) of this
section). That D decided to distribute C and announced that decision
before it became aware of the opportunity to acquire X suggests that
the distribution would have occurred at approximately the same time
and in similar form regardless of D's acquisition of X. X's lack of
participation in the decision also helps establish that fact.

(vi) In determining whether the distribution of C and acquisition of
X by D are part of a plan, one should consider the importance of D's
business purpose for the distribution in light of D's opportunity to
acquire X. If D can establish that the distribution continued to be
motivated by the stated business purpose, and if D would have
distributed C regardless of D's acquisition of X, then D's
acquisition of X and D's distribution of C are not part of a plan.

Example 7. Multiple acquisitions. [Reserved] (n) Effective date.
This section applies to distributions occurring after August 3,
2001.

Mark A. Weinberger Robert E. Wenzel
Assistant Secretary of the Treasury 

Approved: July 26, 2001

Deputy Commissioner of Internal Revenue

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