Transactions Involving the Transfer of No Net Value, 11903-11912 [05-4384]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 70, Number 46 (Thursday, March 10, 2005)]
[Proposed Rules]
[Pages 11903-11912]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-4384]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-163314-03]
RIN 1545-BC88


Transactions Involving the Transfer of No Net Value

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations providing guidance 
regarding corporate formations, reorganizations, and liquidations of 
insolvent corporations. These regulations provide rules requiring the 
exchange (or, in the case of section 332, a distribution) of net value 
for the nonrecognition rules of subchapter C to apply to the 
transaction. The regulations also provide guidance on determining when 
and to what extent creditors of a corporation will be treated as 
proprietors of the corporation in determining whether continuity of 
interest is preserved in a potential reorganization. Finally, the 
regulations provide guidance on whether a distribution in cancellation 
or redemption of less than all of the shares one corporation owns in 
another corporation satisfies the requirements of section 332. The 
proposed regulations affect corporations and their shareholders.

DATES: Written and electronic comments and requests for a public 
hearing must be received by June 8, 2005.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-163314-03), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. to 4 p.m. to CC:PA:LPD:PR (REG-
163314-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington DC or sent electronically, via the IRS Internet 
site at https://www.irs.gov/regs or via the Federal eRulemaking Portal 
at https://www.regulations.gov (IRS and REG-163314-03).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations on 
the reorganization provisions and regarding issues raised by the 
proposed regulations with respect to provisions other than those 
related to corporate liquidations and subchapter K, Jean Brenner, (202) 
622-7790; concerning the proposed regulations on corporate 
liquidations, Sean McKeever, (202) 622-7750; concerning the application 
of the principles of the proposed regulations to transfers of property 
to partnerships under subchapter K, Jeanne Sullivan or Michael Goldman, 
(202) 622-3070; concerning submissions of comments and/or requests for 
a public hearing, Treena Garrett, (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

General Background

    The IRS and the Treasury Department believe that there is a need to 
provide a comprehensive set of rules addressing the application of the 
nonrecognition rules of subchapter C of the Internal Revenue Code 
(Code) to transactions involving insolvent corporations and to other 
transactions that raise similar issues. The proposed regulations 
provide three sets of rules, the principal one of which is that the 
nonrecognition rules of subchapter C do not apply unless there is an 
exchange (or, in the case of section 332, a distribution) of net value 
(the ``net value requirement''). The proposed regulations also provide 
guidance on the circumstances in which (and the extent to which) 
creditors of a corporation will be treated as proprietors of the 
corporation in determining whether continuity of interest is preserved 
in a potential reorganization. The proposed regulations further provide 
guidance on whether a distribution in cancellation or redemption of 
less than all of the shares one corporation owns in another corporation 
satisfies the requirements of section 332. Each of these rules is 
discussed separately in this preamble.

[[Page 11904]]

Explanation of Provisions

Exchange of Net Value Requirement

Background
    In subchapter C, each of the rules described below that provides 
for the general nonrecognition of gain or loss refers to a distribution 
in cancellation or redemption of stock or an exchange for stock. 
Section 332 provides, in part, that ``[n]o gain or loss shall be 
recognized on the receipt by a corporation of property distributed in 
complete liquidation of another corporation * * * only if * * * the 
distribution is by such other corporation in complete cancellation or 
redemption of all its stock.'' Section 351 provides, in part, that 
``[n]o gain or loss shall be recognized if property is transferred to a 
corporation by one or more persons solely in exchange for stock in such 
corporation.'' Section 354 provides, in part, that ``[n]o gain or loss 
shall be recognized if stock or securities in a corporation a party to 
a reorganization are * * * exchanged solely for stock or securities * * 
* in another corporation a party to the reorganization.'' Finally, 
section 361 provides that ``[n]o gain or loss shall be recognized to a 
corporation if such corporation is a party to a reorganization and 
exchanges property * * * solely for stock or securities in another 
corporation a party to the reorganization.''
    The authorities interpreting section 332 have consistently 
concluded that the language of the statute referring to a distribution 
in complete cancellation or redemption of stock requires a distribution 
of net value. Section 1.332-2(b) provides that section 332 applies only 
if a parent receives at least partial payment for the stock that it 
owns in the liquidating corporation. Such payment could not occur 
unless there were a distribution of net value. The courts have focused 
in numerous cases on the effect of liabilities on the distribution 
requirement of section 332. In H. G. Hill Stores, Inc. v. Commissioner, 
44 B.T.A. 1182 (1941), a subsidiary liquidated and distributed its 
assets and liabilities to its parent in cancellation of its 
indebtedness to its parent. The court interpreted the phrase ``in 
complete cancellation or redemption of all its stock'' as requiring 
that a distribution be made to the parent in its capacity as a 
stockholder in order for section 112(b)(6) (the predecessor of section 
332) to apply and, thus, held that section 112(b)(6) did not apply 
because the parent corporation received payment in its capacity as a 
creditor and not in its capacity as a stockholder. See also Rev. Ruls. 
2003-125 (2003-52 I.R.B. 1243), 70-489 (1970-2 C.B. 53), and 59-296 
(1959-2 C.B. 87).
    Rev. Rul. 59-296 holds that the principles relevant to liquidations 
under section 332 also apply to reorganizations under section 368. 
However, other authorities are not consistent with the approach of Rev. 
Rul. 59-296. Most notably, in Norman Scott, Inc. v. Commissioner, 48 
T.C. 598 (1967), the Tax Court held that a transaction involving an 
insolvent target corporation qualified as a reorganization under 
section 368(a)(1)(A).
    The IRS and the Treasury Department have decided to resolve the 
uncertainties by generally adopting a net value requirement for each of 
the described nonrecognition rules in subchapter C. The net value 
requirement generally requires that there be an exchange of property 
for stock, or in the case of section 332, a distribution of property in 
cancellation or redemption of stock. The IRS and the Treasury 
Department believe that the net value requirement is the appropriate 
unifying standard because it is more consistent with the statutory 
framework of subchapter C, case law, and published guidance than any 
other approach considered. In addition, the IRS and the Treasury 
Department believe that the net value requirement is the appropriate 
standard because transactions that fail the requirement, that is, 
transfers of property in exchange for the assumption of liabilities or 
in satisfaction of liabilities, resemble sales and should not receive 
nonrecognition treatment.
    The IRS and the Treasury Department considered several other 
approaches to unify and rationalize the nonrecognition rules of 
subchapter C as they applied to transactions involving insolvent 
corporations. The IRS and the Treasury Department considered whether 
there should be special rules for potential nonrecognition transactions 
between members of a consolidated group. Such rules might disregard the 
various exchange requirements in the statute because of the single 
entity principles generally applicable to corporations joining in the 
filing of a consolidated return. This approach was rejected because 
there is no consolidated return policy that compels a different set of 
rules for potential nonrecognition transactions between members of a 
consolidated group. Cf. Sec.  1.1502-35T(f)(1); Notice 94-49 (1994-1 
C.B. 358). The current intercompany transaction rules (in particular 
those regarding successors in Sec.  1.1502-13(j)) could be modified to 
extend deferral of gain and loss to additional situations as long as 
the assets remained in the consolidated group pending later 
acceleration events that befall the assets or successor entities. 
However, no such rules are being proposed because the case for treating 
the transferor and transferee members as a single entity seems weakest 
when the group's equity investment in the transferor has been 
eliminated.
    The IRS and the Treasury Department also considered whether 
satisfying the words of the relevant statutory provisions that describe 
the relationship of the parties to a transaction should be sufficient 
for applying the nonrecognition rules to a transaction between the 
parties. This approach would essentially take the position that the 
words of distribution or exchange in the statute do not state a 
separate requirement but merely describe the most common form of the 
transaction to which the provision is intended to apply. For example, 
under this approach, it would be sufficient for a transaction to 
qualify as a distribution in complete liquidation under section 332 if 
the corporation to which assets are transferred owned stock meeting the 
requirements of section 1504(a)(2) at the time of the transfer. Also, 
under this approach, it would be sufficient for a transaction to 
qualify as a transfer under section 351 if a transferor of assets were 
in control (as defined in section 368(c)) of the corporation to which 
assets are transferred immediately after the transaction. However, this 
approach would require distinguishing, when the structure of the 
statute does not, between parts of a statute that impose requirements 
and other parts that do not.

Explanation of rules

Net Value Requirement
    For potential liquidations under section 332, the net value 
requirement is effected by the partial payment rule in Sec.  1.332-2(b) 
of the current regulations. The proposed regulations make no 
modifications to this rule, except, as discussed below, for 
transactions in which the recipient corporation owns shares of multiple 
classes of stock in the dissolving corporation. The proposed 
regulations also make minor changes to other sections of the 
regulations under section 332 to conform those regulations to changes 
in the statute.
    For potential transactions under section 351, the proposed 
regulations add Sec.  1.351-1(a)(1)(iii)(A), which requires a surrender 
of net value and, in paragraph (a)(1)(iii)(B), a receipt of net value. 
This rule is similar to that for potential asset reorganizations,

[[Page 11905]]

discussed below. The proposed regulations make minor changes to other 
sections of the regulations under section 351 to conform those 
regulations to changes in the statute.
    For potential reorganizations under section 368, the proposed 
regulations modify Sec.  1.368-1(b)(1) to add the requirement that 
there be an exchange of net value. Section 1.368-1(f) of the proposed 
regulations sets forth the rules for determining whether there is an 
exchange of net value. These rules require, in paragraph (f)(2)(i) for 
potential asset reorganizations and paragraph (f)(3)(i) for potential 
stock reorganizations, a surrender of net value and, in paragraph 
(f)(2)(ii) for potential asset reorganizations and paragraph (f)(3)(ii) 
for potential stock reorganizations, a receipt of net value. In a 
potential asset reorganization (one in which the target corporation 
would not recognize gain or loss under section 361), the target 
corporation surrenders net value if the fair market value of the 
property transferred by it to the acquiring corporation exceeds the sum 
of the amount of liabilities of the target corporation that are assumed 
by the acquiring corporation and the amount of any money and the fair 
market value of any property (other than stock permitted to be received 
under section 361(a) without the recognition of gain) received by the 
target corporation. This rule ensures that a target corporation 
transfers property in exchange for stock. The IRS and the Treasury 
Department believe that the proposed rule better identifies whether a 
target corporation transfers property in exchange for stock than a rule 
that looks to the issuance or failure to issue stock because, when the 
parties are related, the issuance or failure to issue stock might be 
meaningless.
    In a potential stock reorganization (one which would be described 
in section 368(a)(1)(B) or section 368(a)(1)(A) by reason of section 
368(a)(2)(E)), the rules are modified to reflect the fact that the 
target corporation remains in existence. A potential reorganization 
under section 368(a)(1)(A) by reason of section 368(a)(2)(E) must 
satisfy the asset reorganization test for the merger of the controlled 
corporation into the target corporation (for which test the controlled 
corporation is treated as the target corporation) and the stock 
reorganization test for the acquisition of the target corporation.
    In a potential asset reorganization, the target corporation 
receives net value if the fair market value of the assets of the 
issuing corporation exceeds the amount of its liabilities immediately 
after the exchange. This rule ensures that the target corporation 
receives stock (or is deemed to receive stock under the ``meaningless 
gesture'' doctrine) having value. This rule is necessary because the 
IRS and the Treasury Department believe that the receipt of worthless 
stock in exchange for assets cannot be part of an exchange for stock.
Scope of Net Value Requirement
    The proposed regulations provide in Sec.  1.368-1(b)(1) that the 
net value requirement does not apply to reorganizations under section 
368(a)(1)(E) and 368(a)(1)(F). The IRS and the Treasury Department 
recently issued final regulations (T.D. 9182, 70 FR 9219 (Feb. 25, 
2005)) stating that a continuity of business enterprise and a 
continuity of interest are not required for a transaction to qualify as 
a reorganization under section 368(a)(1)(E) or (F) because applying the 
requirements in those contexts is not necessary to protect the policies 
underlying the reorganization provisions. Because the purpose 
underlying the net value requirement is the same as that underlying the 
continuity of interest requirement, the IRS and the Treasury Department 
have similarly concluded that applying the net value requirement to 
transactions under section 368(a)(1)(E) or (F) is not necessary to 
protect the policies underlying the reorganization provisions.
    The proposed regulations also provide in Sec.  1.368-1(b)(1) and 
Sec.  1.368-1(f)(4) that the net value requirement does not apply to a 
limited class of transactions that qualify as reorganizations under 
section 368(a)(1)(D). That class of transactions are the transactions 
exemplified by James Armour, Inc. v. Commissioner, 43 T.C. 295 (1964), 
and Rev. Rul. 70-240 (1970-1 C.B. 81). The IRS and the Treasury 
Department acknowledge that the conclusions of the described 
authorities are inconsistent with the principles of the net value 
requirement. Nevertheless, the IRS and the Treasury Department 
currently desire to preserve the conclusions of these authorities while 
they more broadly study issues relating to acquisitive reorganizations 
under section 368(a)(1)(D), including the continuing vitality of 
various liquidation-reincorporation authorities after the enactment of 
the Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 2085 (1986)). 
Consistent with the described authorities, the exception is limited to 
acquisitive reorganizations of solvent target corporations. The 
proposed regulations provide no specific guidance (other than in an 
example incorporating the facts of Rev. Rul. 70-240 (1980-1 C.B. 81)), 
other than with regard to the application of the net value requirement, 
on when a transaction will qualify as a reorganization under section 
368(a)(1)(D). In this regard, compare Armour with Warsaw Photographic 
Associates, Inc. v. Commissioner, 84 T.C. 21 (1985).
Definition of Liabilities
    In applying the proposed regulations, taxpayers must determine the 
amount of liabilities of the target corporation that are assumed by the 
acquiring corporation. Although the proposed regulations do not define 
the term liability, the IRS and the Treasury Department intend that the 
term be interpreted broadly. Thus, for purposes of the proposed 
regulations, a liability should include any obligation of a taxpayer, 
whether the obligation is debt for federal income tax purposes or 
whether the obligation is taken into account for the purpose of any 
other Code section. Generally, an obligation is something that reduces 
the net worth of the obligor. The IRS and the Treasury Department have 
proposed adopting a similar definition of liability for purposes of 
implementing section 358(h) in subchapter K. See Prop. Reg. Sec.  
1.752-1(a)(1)(ii) and Prop. Reg. Sec.  1.752-7(b)(2)(ii) (REG-106736-
00, 68 FR 37434 (June 24, 2003), 2003-28 I.R.B. 46).
Amount of Liabilities
    The proposed regulations provide no specific guidance on 
determining the amount of a liability. The IRS and the Treasury 
Department are currently considering various approaches to determining 
the amount of a liability. One approach would be to treat the amount of 
a liability represented by a debt instrument as its adjusted issue 
price determined under sections 1271 through 1275 of the Code (the OID 
rules) (perhaps with exceptions for certain contingent payment debt 
instruments) while treating the amount of other liabilities as the 
value of such liabilities. Another approach would be to treat the 
amount of all liabilities as the value of such liabilities. Other 
approaches could borrow in whole or in part from other authorities such 
as those relevant to the determination of insolvency under section 
108(d)(3). One method for valuing liabilities is to determine the 
amount of cash that a willing assignor would pay to a willing assignee 
to assume the liability in an arm's-length transaction. Cf. Prop. Reg. 
Sec.  1.752-7(b)(2)(ii).

[[Page 11906]]

    In the course of developing these regulations, the IRS and the 
Treasury Department considered special issues related to the assumption 
of nonrecourse liabilities in the context of a transaction to which 
section 332, 351, or 368 might apply. The IRS and the Treasury 
Department are considering a rule similar to the one in Rev. Rul. 92-53 
(1992-2 C.B. 48) that would disregard the amount by which a nonrecourse 
liability exceeds the fair market value of the property securing the 
liability when determining the amount of liabilities that are assumed. 
For example, under such a rule, if an individual transfers an apartment 
building with a fair market value of $175x subject to a nonrecourse 
obligation of $190x and an adjacent lot of land with a fair market 
value of $10x to a corporation, the transferor will have surrendered 
net value because the fair market value of the assets transferred 
($175x + $10x) exceeds the amount of the liabilities assumed ($190x-
$15x, the amount of the excess nonrecourse indebtedness). Any rule 
disregarding excess nonrecourse indebtedness would be limited to the 
application of the net value requirement and would have no relevance 
for other federal income tax purposes, such as the determination of the 
amount realized under section 1001. Comments are requested regarding 
the treatment of nonrecourse indebtedness and the effect of such 
treatment when both property subject to the nonrecourse indebtedness 
and other property are transferred.
Assumption of Liabilities
    In general, the IRS and the Treasury Department believe that the 
principles of section 357(d) should be applied to determine whether a 
liability is assumed when more than one person might bear 
responsibility for the liability. Comments are requested regarding 
whether and to what extent the principles of section 357(d) should be 
incorporated into the regulations.
    The IRS and the Treasury Department believe that transfers of 
assets in satisfaction of liabilities should be treated the same as 
transfers of assets in exchange for the assumption of liabilities. 
Accordingly, in determining whether there is a surrender of net value, 
the proposed regulations treat any obligation of the target corporation 
for which the acquiring corporation is the obligee as a liability 
assumed by the acquiring corporation.
In Connection With
    The proposed regulations take into account not only liabilities 
assumed in the exchange, but also liabilities assumed ``in connection 
with'' the exchange. The proposed regulations include this rule so that 
the timing of an acquiring corporation's assumption of a target 
corporation's liability (or a creditor's discharge of a target 
corporation's indebtedness), whether before an exchange, in the 
exchange, or after the exchange, will have the same effect in 
determining whether there is a surrender of net value in the exchange. 
The proposed regulations also take into account, in determining whether 
there is a surrender of net value, money and other nonstock 
consideration received by the target corporation in connection with the 
exchange.
    The IRS and the Treasury Department intend that the substance-over-
form doctrine and other nonstatutory doctrines be used in addition to 
the ``in connection with'' rule in determining whether the purposes and 
requirements of the net value requirement are satisfied. Cf. Rev. Rul. 
68-602 (1968-2 C.B. 135) (holding that a parent corporation's 
cancellation of a wholly-owned subsidiary's indebtedness to it that is 
an integral part of a liquidation is transitory and, therefore, 
disregarded).
Section 368(a)(1)(C)
    The proposed regulations remove the statement in Sec.  1.368-
2(d)(1) that the assumption of liabilities may so alter the character 
of a transaction as to place the transaction outside the purposes and 
assumptions of the reorganization provisions. Because the proposed 
regulations provide more specific guidance regarding when the 
assumption of liabilities will prevent a transaction from qualifying as 
a reorganization under section 368(a)(1)(C), the IRS and the Treasury 
Department believe the statement is unnecessary.
Section 721
    The IRS and the Treasury Department recognize that the principles 
in the proposed rules under section 351 may be applied by analogy to 
other Code sections that are somewhat parallel in scope and effect, 
such as section 721, dealing with the contribution of property to a 
partnership in exchange for a partnership interest. The IRS and the 
Treasury Department request comments on whether rules similar to the 
rules of the proposed regulations should be proposed in the context of 
subchapter K and the considerations that might justify distinguishing 
the relevant provisions in subchapter K from those provisions that are 
the subject of these proposed regulations.

Continuity of Interest

Background
    The Code provides general nonrecognition treatment for 
reorganizations described in section 368. A transaction must comply 
with both the statutory requirements of the reorganization provisions 
and various nonstatutory requirements, including the continuity of 
interest requirement, to qualify as a reorganization. See Sec.  1.368-
1(b). The purpose of the continuity of interest requirement is to 
ensure that reorganizations are limited to readjustments of continuing 
interests in property under modified corporate form and to prevent 
transactions that resemble sales from qualifying for nonrecognition of 
gain or loss available to corporate reorganizations. See Sec. Sec.  
1.368-1(b), 1.368-1(e)(1). Continuity of interest requires that a 
substantial part of the value of the proprietary interests in the 
target corporation be preserved in the reorganization. See Sec.  1.368-
1(e)(1); see also LeTulle v. Scofield, 308 U.S. 415 (1940); Helvering 
v. Minnesota Tea Co., 296 U.S. 378 (1935); Pinellas Ice & Cold Storage 
Co. v. Commissioner, 287 U.S. 462 (1933); Cortland Specialty Co. v. 
Commissioner, 60 F.2d 937 (2d Cir. 1932), cert. denied, 288 U.S. 599 
(1933).
    Generally, it is the shareholders who hold the proprietary 
interests in a corporation. However, when a corporation is in 
bankruptcy, the corporation's stock may be worthless and eliminated in 
the restructuring. In this case, when the corporation engages in a 
potential reorganization, its creditors may receive acquiring 
corporation stock in exchange for their claims and its shareholders may 
receive nothing. Thus, without special rules, most potential 
reorganizations of corporations in bankruptcy would fail the continuity 
of interest requirement. The Supreme Court addressed this problem in 
Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942), in 
which it held that, for practical purposes, the old continuity of 
interest in the shareholders shifted to the creditors not later than 
the time ``when the creditors took steps to enforce their demands 
against the insolvent debtor. In this case, that was the date of the 
institution of bankruptcy proceedings. From that time on, they had 
effective command over the property.'' See also Palm Springs Holding 
Corp. v. Commissioner, 315 U.S. 185 (1942) (holding that the legal 
procedure employed by the creditors to obtain effective command over a 
corporation's property was not material when the corporation was 
insolvent).

[[Page 11907]]

Notwithstanding Palm Springs, it is not clear when creditors of an 
insolvent corporation not in a title 11 or similar case may be 
considered proprietors for purposes of satisfying the continuity of 
interest requirement.
    In Atlas Oil & Refining Corp. v. Commissioner, 36 T.C. 675 (1961), 
the court held that only creditors who in fact receive stock in the 
acquiring corporation, by relation back, can be deemed to have been 
equity owners at the time of the transfer. The court stated that the 
fact that a more senior class of creditors may have had ``effective 
command'' over the assets in the case will not make them proprietors if 
they do not in fact exercise their right to receive stock in the 
acquiring corporation.
    In the Bankruptcy Tax Act of 1980, Public Law 96-589 (94 Stat. 3389 
(1980)), Congress added section 368(a)(1)(G), providing for a new type 
of reorganization applicable to corporations in title 11 or similar 
cases. In the legislative history to that statute, Congress stated its 
expectation that the courts and the Treasury Department would determine 
whether the continuity of interest requirement is satisfied in a 
potential reorganization under section 368(a)(1)(G) by treating as 
proprietors the most senior class of creditors who received stock, 
together with all interests equal and junior to them, including 
shareholders. See S. Rep. No. 1035, 96th Cong., 2d Sess. 36-37 (1980). 
This formulation is similar to the relation back analysis that the Tax 
Court used in Atlas Oil.
Explanation of Provisions
    The proposed regulations add new Sec.  1.368-1(e)(6), which 
describes the circumstances in which creditors of a corporation 
generally, and which creditors in particular, will be treated as 
holding a proprietary interest in a target corporation immediately 
before a potential reorganization. In general, the proposed rules adopt 
the standard for reorganizations under section 368(a)(1)(G) recommended 
in the Senate Finance Committee Report to the Bankruptcy Tax Act of 
1980. The proposed regulations also provide that creditors of an 
insolvent target corporation not in a title 11 or similar case may be 
treated as holding a proprietary interest in the corporation even 
though they take no steps to obtain effective command over the 
corporation's property, other than their agreement to receive stock in 
the potential reorganization. The proposed regulations, at Sec.  1.368-
1(e)(6)(ii), provide specific guidance on how to quantify the 
proprietary interest of the target corporation so that taxpayers may 
determine whether a substantial part of the value of the proprietary 
interests in the target corporation is preserved in the potential 
reorganization. Because a creditor of a corporation may hold claims in 
more than one class, the proposed regulations generally refer to claims 
of a particular class of creditors rather than to creditors in a 
particular class.
    The proposed regulations treat claims of the most senior class of 
creditors to receive a proprietary interest in the issuing corporation 
and claims of all equal classes of creditors (together, the senior 
claims) differently from the claims of classes of creditors junior to 
the senior claims (the junior claims). The proposed regulations treat 
senior claims as representing, in part, a creditor claim against the 
corporation, and, in part, a proprietary interest in the corporation. 
This rule mitigates the adverse effect on continuity of interest of 
senior creditors seeking payment primarily in nonstock consideration 
while still taking some payment in shares of stock of the acquiring 
corporation. The determination of what part of a senior claim is a 
proprietary interest in the target corporation is made by calculating 
the average treatment for all senior claims. Thus, the proposed 
regulations, at Sec.  1.368-1(e)(2)(ii)(B), provide that the value of a 
proprietary interest in the target corporation represented by a senior 
claim is determined by multiplying the fair market value of the 
creditor's claim by a fraction, the numerator of which is the fair 
market value of the proprietary interests in the issuing corporation 
that are received in the aggregate in exchange for the senior claims, 
and the denominator of which is the sum of the amount of money and the 
fair market value of all other consideration (including the proprietary 
interests in the issuing corporation) received in the aggregate in 
exchange for such claims. The effect of this rule is that there is 100 
percent continuity of interest if each senior claim is satisfied with 
the same ratio of stock to nonstock consideration and no junior claim 
is satisfied with nonstock consideration.
    The proposed regulations, at Sec.  1.368-1(e)(6)(ii)(A), provide 
that the entire amount of a junior claim represents a proprietary 
interest in the target corporation immediately before the potential 
reorganization. Thus, the value of the proprietary interest represented 
by that claim is the fair market value of the claim (which value is 
generally determined by reference to the amount of money and the fair 
market value of the consideration received in exchange therefor).
    The rules in the proposed regulations are intended to work in 
conjunction with the current continuity of interest rules. Accordingly, 
the proposed regulations modify Sec.  1.368-1(e)(1)(ii), relating to 
the effect on continuity of interest of distributions or redemptions 
before a potential reorganization, and Sec.  1.368-1(e)(2), relating to 
the effect on continuity of interest of acquisitions of proprietary 
interests by persons related to the issuing corporation, to ensure that 
the purpose of these rules is effected when creditors' claims represent 
the proprietary interests in the target corporation.

Section 332

Background
    Section 332 requires that a subsidiary's liquidating distribution 
to its parent corporation be in complete cancellation or redemption of 
all its stock. In Spaulding Bakeries, Inc. v. Commissioner, 252 F.2d 
693 (2d Cir. 1958), aff'g 27 T.C. 684 (1957), the Second Circuit 
concluded that for a distribution to be made in cancellation or 
redemption of ``all the stock,'' payment must be made on each class of 
stock. See also H. K. Porter Co. v. Commissioner, 87 T.C. 689 (1986).
Explanation of Provisions
    The current regulations provide that section 332 applies only to 
those cases in which the recipient corporation receives at least 
partial payment for the stock that it owns in the liquidating 
corporation. The proposed regulations clarify that section 332 applies 
only to those cases in which the recipient corporation receives at 
least partial payment for each class of stock that it owns in the 
liquidating corporation, an interpretation consistent with the Second 
Circuit's holding in Spaulding Bakeries and the Tax Court's holding in 
H. K. Porter. The IRS and the Treasury Department have adopted this 
approach because they believe that it is appropriate for a taxpayer to 
recognize loss when it fails to receive a distribution on a class of 
stock in liquidation of its subsidiary. The recipient corporation would 
recognize such a loss if the distribution qualified as a 
reorganization.
    The proposed regulations also confirm that when the liquidation 
fails to qualify under section 332 because the recipient corporation 
did not receive at least partial payment for each class of stock but 
did receive at least partial payment for at least one class of stock, 
the transaction may qualify as a

[[Page 11908]]

corporate reorganization under section 368.

Proposed Effective Date

    These proposed regulations will apply to transactions that occur 
after the date they are published as final regulations in the Federal 
Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
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 Procedures 
Act (5 U.S.C. chapter 5) does not apply to these proposed regulations 
and, 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, this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and 8 copies) or comments transmitted via Internet that are submitted 
timely to the IRS. The IRS and the Treasury Department request comments 
on the clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Jean 
Brenner and Sean McKeever of the Office of Associate Chief Counsel 
(Corporate). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
revising the entry for ``Section 1.351-1'' to read, in part, as 
follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.351-1 also issued under 26 U.S.C. 351. * * *

    Par. 2. Section 1.332-2 is amended by:
    1. Revising the first sentence of paragraph (a).
    2. Revising paragraph (b).
    3. Revising the heading of the Example in paragraph (e).
    4. Adding Example 2 to paragraph (e).
    The revisions and addition read as follows:


Sec.  1.332-2  Requirements for nonrecognition of gain or loss.

    (a) The nonrecognition of gain or loss is limited to the receipt of 
property by a corporation that is the actual owner of stock (in the 
liquidating corporation) meeting the requirements of section 
1504(a)(2). * * *
    (b) Section 332 applies only when the recipient corporation 
receives at least partial payment for each class of stock that it owns 
in the liquidating corporation. If section 332 does not apply, see 
section 165(g) regarding the allowance of losses for worthless 
securities for a class of stock for which no payment is received. 
Further, if section 332 does not apply and the recipient corporation 
receives partial payment for at least one class of stock that it owns 
in the liquidating corporation, see section 368(a)(1) regarding 
potential qualification of the distribution as a reorganization. If 
section 332 does not apply and the distribution does not qualify as a 
reorganization, see section 331 for those classes of stock for which 
partial payment is received.
* * * * *
    (e) * * *
    Example 1.  * * *
    Example 2.  P Corporation owns all of the outstanding preferred 
and common stock of Q Corporation. The preferred stock is not stock 
described in section 1504(a)(4). The fair market value of Q 
Corporation's assets exceeds the amount of its liabilities but does 
not exceed the liquidation preference on the Q Corporation's 
preferred stock. Q Corporation liquidates and distributes all of its 
assets to P Corporation. P Corporation receives partial payment for 
its Q Corporation preferred stock but receives nothing for its Q 
Corporation common stock. The receipt by P Corporation of the 
properties of Q Corporation is not a distribution received by P 
Corporation in complete liquidation of Q Corporation within the 
meaning of section 332. Thus, under section 165(g), P Corporation is 
entitled to a worthless security deduction for its Q Corporation 
common stock. The transaction may qualify as a reorganization under 
section 368(a)(1)(C). If the transaction does not qualify as a 
reorganization, P Corporation will recognize gain or loss on its Q 
Corporation preferred stock under section 331.

    Par. 3. Section 1.351-1 is amended by:
    1. Revising the first sentence of paragraph (a)(1) introductory 
text.
    2. Adding a sentence after the last sentence in paragraph (a)(1) 
introductory text and revising the phrase ``For purposes of this 
section'' at the end of paragraph (a)(1) introductory text to read ``In 
addition, for purposes of this section''.
    3. Revising paragraphs (a)(1)(i) and (a)(1)(ii).
    4. Removing the concluding text immediately following paragraph 
(a)(1)(ii).
    5. Adding paragraphs (a)(1)(iii) and (a)(1)(iv).
    6. Adding Example 4 at the end of paragraph (a)(2).
    7. Revising paragraph (b)(1).
    The revisions, removal, and additions read as follows:


Sec.  1.351-1  Transfer to corporation controlled by transferor.

    (a)(1) Section 351(a) provides, in general, for the nonrecognition 
of gain or loss upon the transfer by one or more persons of property to 
a corporation solely in exchange for stock of such corporation if, 
immediately after the exchange, such person or persons are in control 
of the corporation to which the property was transferred. * * * For 
purposes of this section, stock rights and stock warrants are not 
included in the term stock. In addition, for purposes of this section--
    (i) Stock will not be treated as issued for property if it is 
issued for services rendered or to be rendered to or for the benefit of 
the issuing corporation;
    (ii) Stock will not be treated as issued for property if it is 
issued for property which is of relatively small value in comparison to 
the value of the stock already owned (or to be received for services) 
by the person who transferred such property and the primary purpose of 
the transfer is to qualify under this section the exchanges of property 
by other persons transferring property; and
    (iii) Stock will not be treated as issued for property if either--
    (A) The fair market value of the transferred property does not 
exceed the

[[Page 11909]]

sum of the amount of liabilities of the transferor that are assumed by 
the transferee in connection with the transfer and the amount of any 
money and the fair market value of any other property (other than stock 
permitted to be received under section 351(a) without the recognition 
of gain) received by the transferor in connection with the transfer. 
For this purpose, any obligation of the transferor for which the 
transferee is the obligee that is extinguished for federal income tax 
purposes in connection with the transfer is treated as a liability 
assumed by the transferee; or
    (B) The fair market value of the assets of the transferee does not 
exceed the amount of its liabilities immediately after the transfer;
    (iv) Paragraph (a)(1)(iii) of this section applies to transfers 
occurring after the date these proposed regulations are published as 
final regulations in the Federal Register.
    (2) * * *
* * * * *
    Example 4.  A, an individual, transfers an apartment building 
with a fair market value of $175x to Corporation X. The building is 
subject to a nonrecourse obligation of $190x and no other asset is 
subject to that liability. A receives 10 shares of Corporation X 
stock in the exchange. Immediately after the exchange, Corporation X 
is solvent and A owns 100% of its outstanding stock. Under paragraph 
(a)(1)(iii) of this section, the 10 shares of Corporation X stock 
received by A will not be treated as issued for property because the 
fair market value of the apartment building does not exceed the 
amount of A's liabilities assumed by Corporation X. Therefore, 
section 351 does not apply to the exchange.
* * * * *
    (b)(1) When property is transferred to a corporation by two or more 
persons in exchange for stock, as described in paragraph (a) of this 
section, and the stock received is received in disproportion to the 
transferor's prior interest in such property, the entire transaction 
will be given tax effect in accordance with its true nature, and the 
transaction may be treated as if the stock had first been received in 
proportion and then some of such stock had been used to make gifts 
(section 2501 et seq.), to pay compensation (sections 61(a)(1) and 
83(a)), or to satisfy obligations of the transferor of any kind.
* * * * *
    Par. 4. Section 1.368-1 is amended by:
    1. Removing the last sentence of paragraph (a).
    2. Redesignating paragraph (b) as paragraph (b)(1).
    3. Removing the third sentence of paragraph (b)(1) and adding two 
sentences in its place.
    4. Removing the seventh sentence of paragraph (b)(1).
    5. Adding paragraph (b)(2).
    6. Adding a sentence after the fifth sentence of paragraph 
(e)(1)(i).
    7. Adding a sentence at the end of paragraph (e)(1)(ii).
    8. Revising the text of paragraph (e)(2).
    9. Redesignating paragraphs (e)(6) and (e)(7) as paragraphs (e)(7) 
and (e)(8), respectively, and adding a new paragraph (e)(6).
    10. Adding Example 10 to the end of paragraph (e)(7).
    11. Adding a sentence at the end of paragraph (e)(8).
    12. Adding paragraph (f).
    The additions and revisions read as follows:


Sec.  1.368-1  Purpose and scope of exception to reorganization 
exchanges.

* * * * *
    (b)(1) * * * Requisite to a reorganization under the Internal 
Revenue Code are a continuity of business enterprise through the 
issuing corporation under the modified corporate form as described in 
paragraph (d) of this section, a continuity of interest as described in 
paragraph (e) of this section (except as provided in section 
368(a)(1)(D)), and an exchange of net value as described in paragraph 
(f) of this section. Notwithstanding the requirements of this paragraph 
(b)(1), an exchange of net value is not required for a transaction to 
qualify as a reorganization under section 368(a)(1)(E) or (F) and, to 
the extent provided in paragraph (f)(4), for a transaction to qualify 
as a reorganization under section 368(a)(1)(D). * * *
    (2) Effective dates. The third and fourth sentences of paragraph 
(b)(1) of this section apply to transactions occurring after the date 
these proposed regulations are published as final regulations in the 
Federal Register. The fifth and sixth sentences apply to transactions 
occurring after January 28, 1998, except that they do not apply to any 
transaction occurring pursuant to a written agreement which is binding 
on January 28, 1998, and at all times thereafter.
* * * * *
    (e) * * *
    (1) * * *
    (i) * * * See paragraph (e)(6) of this section for rules related to 
when a creditor's claim against a target corporation is a proprietary 
interest in the corporation. * * *
    (ii) * * * A proprietary interest in the target corporation is not 
preserved to the extent that creditors (or former creditors) of the 
target corporation that own a proprietary interest in the corporation 
under paragraph (e)(6) of this section (or would be so treated if they 
had received the consideration in the potential reorganization) receive 
payment for the claim prior to the potential reorganization.
    (2) * * * A proprietary interest in the target corporation is not 
preserved if, in connection with a potential reorganization, a person 
related (as defined in paragraph (e)(3) of this section) to the issuing 
corporation acquires either a proprietary interest in the target 
corporation or stock of the issuing corporation that was furnished in 
exchange for a proprietary interest in the target corporation for 
consideration other than stock of the issuing corporation. The 
preceding sentence does not apply to the extent those persons who were 
the direct or indirect owners of the target corporation prior to the 
potential reorganization maintain a direct or indirect proprietary 
interest in the issuing corporation.
* * * * *
    (6) Creditors' claims as proprietary interests--(i) In general. A 
creditor's claim against a target corporation may be a proprietary 
interest in the target corporation if the target corporation is in a 
title 11 or similar case (as defined in section 368(a)(3)) or the 
amount of the target corporation's liabilities exceeds the fair market 
value of its assets immediately prior to the potential reorganization. 
In such cases, if any creditor receives a proprietary interest in the 
issuing corporation in exchange for its claim, every claim of that 
class of creditors and every claim of all equal and junior classes of 
creditors (in addition to the claims of shareholders) is a proprietary 
interest in the target corporation immediately prior to the potential 
reorganization.
    (ii) Value of proprietary interest--(A) In general. Generally, if a 
creditor's claim is a proprietary interest in the target corporation, 
the value of the proprietary interest is the fair market value of the 
creditor's claim.
    (B) Claims of creditors of most senior classes. For a claim of the 
most senior class of creditors receiving a proprietary interest in the 
issuing corporation and a claim of any equal class of creditors, the 
value of the proprietary interest in the target corporation represented 
by the claim is determined by multiplying the fair market value of the 
claim by a fraction, the numerator of which is the fair market value of 
the proprietary interests in the issuing corporation that are received 
in the aggregate in

[[Page 11910]]

exchange for the claims of those classes of creditors, and the 
denominator of which is the sum of the amount of money and the fair 
market value of all other consideration (including the proprietary 
interests in the issuing corporation) received in the aggregate in 
exchange for such claims.
    (iii) Bifurcated claims. If a creditor's claim is bifurcated into a 
secured claim and an unsecured claim pursuant to an order in a title 11 
or similar case (as defined in section 368(a)(3)) or pursuant to an 
agreement between the creditor and the debtor, the bifurcation of the 
claim and the allocation of consideration to each of the resulting 
claims will be respected in applying the rules of this paragraph 
(e)(6).
    (iv) Effect of treating creditors as proprietors. The treatment of 
a creditor's claim as a proprietary interest in the target corporation 
shall not preclude treating shares of the target corporation as 
proprietary interests in the target corporation.
    (7) * * *
* * * * *
    Example 10. Creditors treated as owning a proprietary interest. 
T has assets with a fair market value of $150x and liabilities of 
$200x. T has two classes of creditors, the senior creditors with 
claims of $50x, and the junior creditors with claims of $150x. T 
transfers all of its assets to P in exchange for $95x and shares of 
P stock with a fair market value of $55x. The T senior creditors 
receive in the aggregate $40x and P stock with a fair market value 
of $10x in exchange for their claims. Each T senior creditor 
receives stock and nonstock consideration in the same proportion. 
The T junior creditors receive $55x and P stock with a fair market 
value of $45x in exchange for their claims. The T shareholders 
receive no consideration in exchange for their T stock. Under 
paragraph (e)(6) of this section, because the amount of T's 
liabilities exceeds the fair market value of its assets immediately 
prior to the potential reorganization, the claims of the creditors 
of T may be proprietary interests in T. Because the senior creditors 
receive proprietary interests in P in the transaction in exchange 
for their claims, their claims and the claims of the junior 
creditors and the T shareholders are treated as proprietary 
interests in T immediately prior to the transaction. Under paragraph 
(e)(6)(ii) of this section, the value of the senior creditors' 
proprietary interests in T is $10x, the value of the proprietary 
interests in P that they received in exchange for their claims. In 
addition, the value of the junior creditors' proprietary interests 
in T immediately prior to the transaction is $100x, the value of 
their claims. Because P is treated as acquiring 50 percent of the 
value of the proprietary interests in T in exchange for P stock 
($55x/$110x), a substantial part of the value of the proprietary 
interests in T is preserved. Therefore, the continuity of interest 
requirement is satisfied.

    (8) * * * The sixth sentence of paragraph (e)(1)(i) of this 
section, the last sentence of paragraph (e)(1)(ii) of this section, 
paragraph (e)(2) of this section, paragraph (e)(6) of this section, and 
Example 10 of paragraph (e)(7) of this section apply to transactions 
occurring after the date these proposed regulations are published as 
final regulations in the Federal Register.
    (f) Exchanges of net value--(1) General rule. An exchange of net 
value requires that there be both a surrender of net value and a 
receipt of net value. Whether there is a surrender of net value is 
determined by reference to the assets and liabilities of the target 
corporation. Whether there is a receipt of net value is determined by 
reference to the assets and liabilities of the issuing corporation (as 
defined in paragraph (b) of this section). The purpose of the exchange 
of net value requirement is to prevent transactions that resemble sales 
(including transfers of assets in satisfaction of liabilities) from 
qualifying for nonrecognition of gain or loss available to corporate 
reorganizations.
    (2) Asset transactions. There is an exchange of net value in a 
potential reorganization to which section 361 would apply only if--
    (i) Surrender of net value. The fair market value of the property 
transferred by the target corporation to the acquiring corporation 
exceeds the sum of the amount of liabilities of the target corporation 
that are assumed by the acquiring corporation in connection with the 
exchange and the amount of any money and the fair market value of any 
other property (other than stock permitted to be received under section 
361(a) without the recognition of gain) received by the target 
corporation in connection with the exchange. For this purpose, any 
obligation of the target corporation for which the acquiring 
corporation is the obligee that is extinguished for federal income tax 
purposes in connection with the exchange is treated as a liability 
assumed by the acquiring corporation; and
    (ii) Receipt of net value. The fair market value of the assets of 
the issuing corporation exceeds the amount of its liabilities 
immediately after the exchange.
    (3) Stock transactions. There is an exchange of net value in a 
potential reorganization under section 368(a)(1)(B) or section 
368(a)(1)(A) by reason of section 368(a)(2)(E) only if--
    (i) Surrender of net value. The fair market value of the assets of 
the target corporation exceeds the sum of the amount of the liabilities 
of the target corporation immediately prior to the exchange and the 
amount of any money and the fair market value of any other property 
(other than stock permitted to be received under section 354 without 
the recognition of gain and nonqualified preferred stock within the 
meaning of section 351(g)) received by the shareholders of the target 
corporation in connection with the exchange. For this purpose, assets 
of the target corporation that are not held immediately after the 
exchange and liabilities of the target corporation that are 
extinguished for federal income tax purposes in the exchange other than 
ones, if any, to the corporation into which the target corporation 
merges in the case of a potential reorganization under section 
368(a)(1)(A) by reason of section 368(a)(2)(E) are disregarded; and
    (ii) Receipt of net value. The fair market value of the assets of 
the issuing corporation exceeds the amount of its liabilities 
immediately after the exchange.
    (4) Exception. The requirement that there be an exchange of net 
value does not apply to a transaction that would otherwise qualify as a 
reorganization under section 368(a)(1)(D) by reason of section 354 or 
so much of section 356 as relates to section 354, provided that the 
fair market value of the property transferred to the acquiring 
corporation by the target corporation exceeds the amount of liabilities 
of the target corporation immediately before the exchange (including 
any liabilities cancelled, extinguished, or assumed in connection with 
the exchange), and the fair market value of the assets of the acquiring 
corporation equals or exceeds the amount of its liabilities immediately 
after the exchange.
    (5) Examples. For purposes of the examples in this paragraph 
(f)(5), each of P, S, and T is a corporation; all corporations have 
only one class of stock outstanding; A, B, C, and D are individuals; 
and the transaction is not otherwise subject to recharacterization. 
Except as otherwise provided, no person is related to any other person 
and the fair market value of the assets of each corporation exceeds the 
amount of its liabilities immediately prior to the transaction 
described in the example. The following examples illustrate the 
application of this paragraph (f).

    Example 1. T has assets with a fair market value of $50x and 
liabilities of $75x, all of which are owed to A. T transfers all of 
its assets to S in exchange for S stock with a fair market value of 
$50x. T distributes the S stock to A in exchange for the T debt owed 
to A. T dissolves. T's shareholders receive nothing in exchange for 
their T stock. Under paragraph (f)(2)(i) of this section, T 
surrenders net value because the fair market value of the property 
transferred by T ($50x)

[[Page 11911]]

exceeds the sum of the amount of liabilities that are assumed by S 
in connection with the exchange ($0x) and the amount of any money 
and the fair market value of any other property (other than stock 
permitted to be received under section 361(a) without the 
recognition of gain) received by T in connection with the exchange 
($0x). In addition, under paragraph (f)(2)(ii) of this section, T 
receives net value because the fair market value of the assets of S 
exceeds the amount of its liabilities immediately after the 
exchange. Therefore, under paragraph (f) of this section, there is 
an exchange of net value.
    Example 2. P owns all of the stock of both S and T. T has assets 
with a fair market value of $100x and liabilities of $160x, all of 
which are owed to P. T transfers all of its assets to S in exchange 
for S stock with a fair market value of $100x. T distributes the S 
stock to P in exchange for the T debt owed to P. T dissolves. P 
receives nothing in exchange for its T stock. Under paragraph 
(f)(2)(i) of this section, T surrenders net value because the fair 
market value of the property transferred by T ($100x) exceeds the 
sum of the amount of liabilities of T assumed by S in connection 
with the exchange ($0x) and the amount of any money and the fair 
market value of any other property (other than stock permitted to be 
received under section 361(a) without the recognition of gain) 
received by T in connection with the exchange ($0x). In addition, 
under paragraph (f)(2)(ii) of this section, T receives net value 
because the fair market value of the assets of S exceeds the amount 
of its liabilities immediately after the exchange. Therefore, under 
paragraph (f) of this section, there is an exchange of net value. 
The result would be the same if no S stock were issued.
    Example 3. The facts are the same as in Example 2, except that 
T's debt is owed to B. T transfers all of its assets to S in 
exchange for the assumption of T's liabilities. T dissolves. The 
obligation to B is outstanding immediately after the transfer. P 
receives nothing in exchange for its T stock. Under paragraph 
(f)(2)(i) of this section, T does not surrender net value because 
the fair market value of the property transferred by T ($100x) does 
not exceed the sum of the amount of liabilities of T assumed by S in 
connection with the exchange ($160x). Therefore, under paragraph (f) 
of this section, there is no exchange of net value. The result would 
be the same if S stock were issued.
    Example 4. The facts are the same as in Example 3, except that S 
first assumes the T debt owed to B and subsequently T transfers all 
of its assets to S in exchange for S stock with a fair market value 
of $100x. If S's assumption of the T debt is made in connection with 
the subsequent transfer of T assets to S, under paragraph (f)(2)(i) 
of this section, T does not surrender net value because the fair 
market value of the property transferred by T ($100x) does not 
exceed the sum of the amount of liabilities of T assumed by S in 
connection with the exchange ($160x). Therefore, under paragraph (f) 
of this section, there is no exchange of net value.
    Example 5. P owns 70% of the stock of T. A owns the remaining 
30% of the stock of T. T has assets with a fair market value of 
$100x and liabilities of $160x, all of which are owed to P. T merges 
into P. A receives nothing in exchange for its T stock. Under 
(f)(2)(i) of this section, even though T's obligation to P is 
extinguished in the transaction, it is treated as a liability 
assumed by P. Thus, under paragraph (f)(2)(i) of this section, T 
does not surrender net value because the fair market value of the 
property transferred by T ($100x) does not exceed the sum of the 
amount of liabilities of T assumed by P in connection with the 
exchange ($160x). Therefore, under paragraph (f) of this section, 
there is no exchange of net value.
    Example 6. A owns all of the stock of S. S has assets with a 
fair market value of $200x and liabilities of $500x, all of which 
are owed to T. The S debt has a fair market value of $200x. In 
addition to the S debt, T has other assets that have a fair market 
value of $700x. T has no liabilities. T transfers all of its assets 
to S in exchange for S stock with a fair market value of $900x. T 
distributes the S stock to its shareholders in exchange for their T 
stock. T dissolves. S cancels all of its stock held by its 
shareholders immediately prior to the exchange. Under paragraph 
(f)(2)(i) of this section, T surrenders net value because the fair 
market value of the property transferred by T ($900x) exceeds the 
sum of the amount of liabilities of T assumed by S in connection 
with the exchange ($0x) and the amount of any money and the fair 
market value of any other property (other than stock permitted to be 
received under section 361(a) without the recognition of gain) 
received by T in connection with the exchange ($0x). In addition, 
under paragraph (f)(2)(ii) of this section, T receives net value 
because the fair market value of the assets of S ($900x) exceeds the 
amount of the liabilities of S ($0x) immediately after the exchange. 
Therefore, under paragraph (f) of this section, there is an exchange 
of net value.
    Example 7. P owns all of the stock of S. T has assets with a 
fair market value of $300x and liabilities of $650x, $500x of which 
are owed to P and $150x of which are owed to A. T merges into S. In 
the merger, P stock is issued to A in satisfaction of the debt owed 
to A by T. Also in the merger, P contributes to the capital of T the 
debt P is owed. Assume the merger would qualify as a reorganization 
under section 368(a)(1)(A) by reason of section 368(a)(2)(D) if the 
exchange of net value requirement in paragraph (f)(1) of this 
section did not apply. Whether there is a surrender of net value is 
determined by reference to the actual merger of T into S. Thus, T 
surrenders net value because the fair market value of the property 
transferred by T ($300x) exceeds the sum of the amount of 
liabilities of T assumed by S in connection with the exchange ($0x) 
and the amount of any money and the fair market value of any other 
property (other than stock permitted to be received under section 
361(a) without the recognition of gain) received by T in connection 
with the exchange ($0x). Whether there is a receipt of net value is 
determined by reference to the issuing corporation, in this case, P. 
T receives net value because the fair market value of the assets of 
P exceeds the amount of the liabilities of P immediately after the 
exchange. Therefore, under paragraph (f) of this section, there is 
an exchange of net value.
    Example 8. P owns all of the stock of both S and T. T transfers 
all of its assets to S in exchange for $34x, the assets' fair market 
value. Following this transfer, T pays its debts of $2x and 
dissolves, distributing the remaining $32x to P. Assume the 
transaction would qualify as a reorganization under section 
368(a)(1)(D) by reason of section 354 or so much of section 356 as 
relates to section 354 if the net value requirement in paragraph 
(f)(1) of this section did not apply. Under paragraph (f)(2) of this 
section, there is no exchange of net value because the fair market 
value of the property transferred by T ($34x) does not exceed the 
amount of money received by T in connection with the exchange 
($34x). However, under paragraph (f)(4) of this section, because the 
transaction would otherwise qualify as a reorganization under 
section 368(a)(1)(D) and the other requirements of paragraph (f)(4) 
of this section are satisfied, the exchange of net value requirement 
does not apply. Accordingly, the transaction qualifies as a 
reorganization under section 368(a)(1)(D).
    Example 9. A and B own all of the stock of T. T has assets with 
a fair market value of $500x and liabilities of $900x, all of which 
are owed to C and D, security holders of T. P acquires all of the 
stock and securities of T in exchange for P voting stock. In the 
transaction, A and B receive nothing in exchange for their stock of 
T. C and D exchange all of their securities of T for stock of P. 
Un