Guidance Under Section 355(e); Recognition of Gain on Certain Distributions of Stock or Securities in Connection With an Acquisition, 20279-20291 [05-7811]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 70, Number 74 (Tuesday, April 19, 2005)]
[Rules and Regulations]
[Pages 20279-20291]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-7811]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9198]
RIN 1545-AY42


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: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations under section 355(e) 
of the Internal Revenue Code relating to the 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 
regulations affect corporations and are necessary to provide them with 
guidance needed to comply with those changes.

DATES: Effective Date: These regulations are effective April 19, 2005.
    Applicability Date: For dates of applicability, see Sec.  1.355-
7(k).

FOR FURTHER INFORMATION CONTACT: Amber R. Cook, (202) 622-7530 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

    This document contains amendments to 26 CFR part 1 under section 
355(e) of the Internal Revenue Code (Code). Section 355(e) provides 
that the stock of a controlled corporation will not be qualified 
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.''
    On April 26, 2002, temporary regulations (TD 8988) (the 2002 
temporary regulations) were published in the Federal Register (67 FR 
20632). The 2002 temporary regulations provide guidance concerning the 
interpretation of the phrase ``plan (or series of related 
transactions).'' A notice of proposed rulemaking (REG-163892-01) (the 
2002 proposed regulations) cross-referencing the 2002 temporary 
regulations was published in the Federal Register for the same day (67 
FR 20711).
    The 2002 temporary regulations provide that whether a distribution 
and an acquisition are part of a plan is determined based on all the 
facts and circumstances and set forth a nonexclusive list of factors 
that are relevant in making that determination. The 2002 temporary 
regulations also provide that a distribution and a post-distribution 
acquisition not involving a public offering can be part of a plan only 
if there was an agreement, understanding, arrangement, or substantial 
negotiations regarding the acquisition or a similar acquisition at some 
time during the two-year period preceding the distribution (the post-
distribution acquisition rule). Finally, the 2002 temporary regulations 
set forth seven safe harbors. The satisfaction of any one of these safe 
harbors confirms that a distribution and an acquisition are not part of 
a plan.
    No public hearing was requested or held for the 2002 proposed 
regulations. Written and electronic comments responding to the notice 
of proposed rulemaking were received. After consideration of the 
comments, the 2002 proposed regulations are adopted as amended by this 
Treasury decision, and the corresponding temporary regulations are 
removed. The more significant comments and revisions are discussed 
below.

A. Pre-Distribution Acquisitions Not Involving a Public Offering

    The 2002 temporary regulations include a safe harbor, Safe Harbor 
IV, that may be available for a pre-distribution acquisition. That safe 
harbor provides that an acquisition and a distribution that occurs more 
than two years after the acquisition are not part of a plan if there 
was no agreement, understanding, arrangement, or substantial 
negotiations concerning the distribution at the time of the acquisition 
or within six months thereafter. In addition to Safe Harbor IV, the 
2002 temporary regulations identify a number of factors that are 
relevant in determining whether a distribution and a pre-distribution 
acquisition not involving a public offering are part of a plan. Among 
the factors tending to show that a distribution and a pre-distribution 
acquisition not involving a public offering are not part of a plan is 
the absence of discussions by the distributing corporation 
(Distributing) or the controlled corporation (Controlled) with the 
acquirer regarding a distribution during the two-year period before the 
acquisition (the no-discussions factor). The absence of such 
discussions, however, will not tend to show that a distribution and an 
acquisition are not part of a plan if the acquisition occurs after the 
date of the public announcement of the planned distribution (the public 
announcement restriction).
    Commentators have suggested that, under the 2002 temporary 
regulations, it is more difficult to establish that a distribution and 
a pre-distribution acquisition not involving a public offering are not 
part of a plan than it is to establish that a distribution and a post-
distribution acquisition are not part of a plan. This suggestion is 
based in part on the fact that the 2002 temporary regulations include 
the post-distribution acquisition rule for post-distribution 
acquisitions but no analogous rule for pre-distribution acquisitions.
    Commentators have proposed extending the availability of Safe 
Harbor IV by reducing the period between the acquisition and the 
distribution from two years to one year. They have also suggested 
adopting a new safe harbor that would be available for acquisitions of 
Distributing that occur before a pro rata distribution. Finally, 
commentators have suggested that the public announcement restriction on 
the no-discussions factor be eliminated because a public announcement, 
as a practical matter, commits Distributing to attempt the distribution 
and, thus, is strong evidence that the distribution would

[[Page 20280]]

have occurred regardless of the acquisition.
    The IRS and Treasury Department believe that it is desirable to 
provide for additional bright-line rules for determining whether a 
distribution and a pre-distribution acquisition not involving a public 
offering are part of a plan. Accordingly, these final regulations amend 
Safe Harbor IV, add a new safe harbor for acquisitions of Distributing 
prior to a pro rata distribution, and amend the no-discussions factor.
1. Revisions to Safe Harbor IV of the 2002 Temporary Regulations
    The IRS and Treasury Department generally believe that if an 
acquirer had no knowledge of Distributing's intention to effect a 
distribution and had no intention or ability to cause a distribution, a 
pre-distribution acquisition and a distribution should not be 
considered part of a plan, regardless of whether the distribution 
occurs more than two years after the acquisition. The IRS and Treasury 
Department, however, are concerned that conditioning the availability 
of a safe harbor on an absence of knowledge may be inadministrable and 
lead to uncertainty. Accordingly, these final regulations amend Safe 
Harbor IV of the 2002 temporary regulations to provide that a 
distribution and a pre-distribution acquisition not involving a public 
offering will not be considered part of a plan if the acquisition 
occurs before the first disclosure event regarding the distribution. 
The final regulations define a disclosure event as any communication by 
an officer, director, controlling shareholder, or employee of 
Distributing, Controlled, or a corporation related to Distributing or 
Controlled, or an outside advisor of any of those persons (where such 
advisor makes the communication on behalf of such person), regarding 
the distribution, or the possibility thereof, to the acquirer or any 
other person (other than an officer, director, controlling shareholder, 
or employee of Distributing, Controlled, or a corporation related to 
Distributing or Controlled, or an outside advisor of any of those 
persons).
    To ensure that Safe Harbor IV of the 2002 temporary regulations is 
not available for acquisitions by persons who could participate in the 
decision to effect a distribution, these final regulations provide that 
Safe Harbor IV is not available for acquisitions by a person that was a 
controlling shareholder or a ten-percent shareholder of the acquired 
corporation at any time during the period beginning immediately after 
the acquisition and ending on the date of the distribution. The safe 
harbor is also unavailable if the acquisition occurs in connection with 
a transaction in which the aggregate acquisitions represent 20 percent 
or more of the stock of the acquired corporation by vote or value.
2. New Safe Harbor for Acquisitions Before a Pro Rata Distribution
    The IRS and Treasury Department believe that acquisitions of 
Distributing not involving a public offering that occur before a pro 
rata distribution are not likely to be part of a plan including the 
distribution where there has been a public announcement of the 
distribution prior to the acquisition, there were no discussions 
regarding the acquisition prior to the public announcement, and the 
acquirer did not have the ability to participate in or influence the 
distribution decision. The facts that the distribution was publicly 
announced prior to discussions regarding the acquisition and that the 
acquisition was small in size suggest that the distribution would have 
occurred regardless of the acquisition. Moreover, the fact that a pre-
distribution shareholder of Distributing has the same interest in both 
Distributing and Controlled, directly or indirectly, both immediately 
before and immediately after a pro rata distribution reduces the 
likelihood that the acquisition and the distribution were part of a 
plan. Accordingly, these final regulations include a new safe harbor, 
Safe Harbor V, that applies to acquisitions of Distributing not 
involving a public offering that occur prior to a pro rata 
distribution. That safe harbor provides that a distribution that is pro 
rata among the Distributing shareholders and a pre-distribution 
acquisition of Distributing not involving a public offering will not be 
considered part of a plan if the acquisition occurs after the date of a 
public announcement regarding the distribution and there were no 
discussions by Distributing or Controlled with the acquirer regarding a 
distribution on or before the date of the first public announcement 
regarding the distribution. A public announcement regarding the 
distribution is any communication by Distributing or Controlled 
regarding Distributing's intention to effect the distribution where the 
communication is generally available to the public. A public 
announcement includes, for example, a press release issued by 
Distributing announcing the distribution. It also includes a 
conversation between an officer of Distributing and stock analysts in 
which the officer communicates Distributing's intention to effect a 
distribution. New Safe Harbor V is intended to apply only to 
acquisitions by persons that do not have the ability to effect the 
distribution. Therefore, new Safe Harbor V is unavailable for 
acquisitions by persons that were controlling shareholders or ten-
percent shareholders of Distributing at any time during the period 
beginning immediately after the acquisition and ending on the date of 
the distribution. In addition, new Safe Harbor V is unavailable if the 
acquisition occurs in connection with a transaction in which the 
aggregate acquisitions represent 20 percent or more of the stock of 
Distributing by vote or value.
3. No-Discussions Factor
    As discussed above, the IRS and Treasury Department believe that 
the occurrence of a public announcement of a distribution before the 
discussion of an acquisition not involving a public offering suggests 
that the distribution would have occurred regardless of the 
acquisition. Therefore, these final regulations amend the no-
discussions factor to remove the public announcement restriction.

B. Public Offerings

    The 2002 temporary regulations distinguish between acquisitions not 
involving a public offering and acquisitions involving a public 
offering. A number of commentators have suggested that it is difficult 
to apply the 2002 temporary regulations to acquisitions involving 
public offerings and have requested (1) clarification of the definition 
of public offering, (2) additional safe harbors for acquisitions 
involving public offerings, and (3) guidance regarding when an 
acquisition is similar to a potential acquisition involving a public 
offering. These final regulations address these requests.
1. Definition of Public Offering
    Questions have arisen regarding whether a public offering includes 
stock issuances that are not for cash, including stock issuances for 
assets or stock in tax-free reorganizations. These final regulations 
define an acquisition involving a public offering as a stock 
acquisition for cash where the terms of the acquisition are established 
by the acquired corporation (Distributing or Controlled) or the seller 
with the involvement of one or more investment bankers, and the 
potential acquirers have no opportunity to negotiate the terms of the 
acquisition. Under this definition, while an initial public offering 
and a secondary offering will be treated as public offerings, a private

[[Page 20281]]

placement involving bilateral discussions and a stock issuance for 
assets or stock in a tax-free reorganization will not be treated as 
public offerings.
2. New Safe Harbor for Public Offerings
    These final regulations add new Safe Harbor VI. Under new Safe 
Harbor VI, a distribution and an acquisition involving a public 
offering occurring before the distribution will not be considered part 
of a plan if the acquisition occurs before the first disclosure event 
regarding the distribution in the case of an acquisition of stock that 
is not listed on an established market, or before the date of the first 
public announcement regarding the distribution in the case of an 
acquisition of stock that is listed on an established market. The new 
safe harbor is based on the view of the IRS and Treasury Department 
that a public offering and a distribution are not likely to be part of 
a plan if the acquirers in the offering are unaware that a distribution 
will occur.
3. Similar Acquisitions Involving Public Offerings
    In the plan and non-plan factors and a number of safe harbors, the 
2002 temporary regulations refer to acquisitions that are similar to 
the actual acquisition. The 2002 temporary regulations provide that an 
acquisition involving a public offering may be similar to another 
acquisition involving a public offering even though there are changes 
in the terms of the stock, the class of stock being offered, the size 
of the offering, the timing of the offering, the price of the stock, or 
the participants in the offering. This provision is intended to ensure 
that certain changes in the terms of the offering that is intended at 
the time of the distribution do not prevent the distribution and the 
offering that actually occurs from being considered part of a plan.
    Commentators have requested further guidance regarding when an 
acquisition will be treated as similar to another acquisition involving 
a public offering. The IRS and Treasury Department believe, and these 
final regulations provide, that more than one actual acquisition may be 
similar to a potential acquisition involving a public offering. 
However, the IRS and Treasury Department also believe, and these final 
regulations provide that, if there is an actual acquisition involving a 
public offering (the first public offering) that is the same as, or 
similar to, a potential acquisition involving a public offering, then 
another actual acquisition involving a public offering (the second 
public offering) cannot be similar to the potential acquisition unless 
the purpose of the second public offering is similar to that of the 
potential acquisition and occurs close in time to the first public 
offering. The final regulations include three new examples that 
illustrate the application of this rule.

C. Acquisitions Pursuant to Publicly Offered Options

    The IRS and Treasury Department believe that, in certain cases, 
whether an acquisition that is pursuant to an option and a distribution 
are part of a plan should be determined pursuant to the rules related 
to acquisitions involving a public offering. In particular, suppose 
that, after consulting with its investment banker, Distributing issues 
options to acquire its stock. The options are marketed and sold through 
a distribution process that is similar to that utilized in a public 
offering. In these cases, the acquirer may never discuss the 
acquisition with Distributing. The investment banker, however, will 
discuss the acquisition with Distributing. Therefore, it seems more 
appropriate to analyze whether a distribution and an acquisition of 
stock pursuant to such an option are part of a plan under the rules 
that apply to acquisitions involving a public offering, rather than the 
rules that apply to acquisitions not involving a public offering. 
Accordingly, these final regulations provide that, if an option is 
issued for cash, the terms of the acquisition of the option and the 
terms of the option are established by the corporation the stock of 
which is subject to the option (Distributing or Controlled) or the 
writer with the involvement of one or more investment bankers, and the 
potential acquirers of the option have no opportunity to negotiate the 
terms of the acquisition of the option or the terms of the option, then 
an acquisition pursuant to that option will be treated as an 
acquisition involving a public offering occurring after a distribution 
if the option is exercised after the distribution or an acquisition 
involving a public offering occurring before the distribution if the 
option is exercised before the distribution. Otherwise, an acquisition 
pursuant to an option will be treated as an acquisition not involving a 
public offering.

D. Agreement, Understanding, or Arrangement

    Throughout the 2002 temporary regulations reference is made to the 
phrase ``agreement, understanding, or arrangement.'' The 2002 temporary 
regulations provide that whether an agreement, understanding, or 
arrangement exists depends on the facts and circumstances. One 
commentator questioned whether an agreement by a person who does not 
actively participate in the management of the acquired corporation 
should be treated as an agreement, understanding, or arrangement. The 
IRS and Treasury Department believe that the activities of those who 
have the authority to act on behalf of Distributing or Controlled as 
well as the activities of the controlling shareholders of Distributing 
and Controlled are relevant to the determination of whether a 
distribution and an acquisition are part of a plan. Therefore, these 
final regulations provide that an agreement, understanding, or 
arrangement generally requires either (1) an agreement, understanding, 
or arrangement by one or more officers or directors acting on behalf of 
Distributing or Controlled, by a controlling shareholder of 
Distributing or Controlled, or by another person with the implicit or 
explicit permission of one or more of such persons, with the acquirer 
or with a person or persons with the implicit or explicit permission of 
the acquirer; or (2) an agreement, understanding, or arrangement by an 
acquirer that is a controlling shareholder of Distributing or 
Controlled immediately after the acquisition that is the subject of the 
agreement, understanding, or arrangement, or by a person or persons 
with the implicit or explicit permission of such acquirer, with the 
transferor or with a person or persons with the implicit or explicit 
permission of the transferor. These final regulations also make 
conforming changes to the rules related to when an option will be 
treated as an agreement, understanding, or arrangement to acquire 
stock, and the definition of substantial negotiations.

E. Substantial Negotiations and Discussions

    Under the 2002 temporary regulations, the presence or absence of 
``substantial negotiations'' or ``discussions'' regarding an 
acquisition or a distribution is relevant to the determination of 
whether a distribution and an acquisition are part of a plan. The 2002 
temporary regulations provide that, in the case of an acquisition other 
than a public offering, substantial negotiations generally require 
discussions of significant economic terms by one or more officers, 
directors, or controlling shareholders of Distributing or Controlled, 
or another person or persons with the implicit or explicit permission 
of one or more officers, directors, or controlling

[[Page 20282]]

shareholders of Distributing or Controlled, with the acquirer or a 
person or persons with the implicit or explicit permission of the 
acquirer. In addition, the 2002 temporary regulations provide that (i) 
discussions by Distributing or Controlled generally require discussions 
by one or more officers, directors, or controlling shareholders of 
Distributing or Controlled, or another person or persons with the 
implicit or explicit permission of one or more officers, directors, or 
controlling shareholders of Distributing or Controlled; and (ii) 
discussions with the acquirer generally require discussions with the 
acquirer or a person or persons with the implicit or explicit 
permission of the acquirer.
    Commentators have requested that final regulations clarify that, 
where the acquirer is a corporation, substantial negotiations and 
discussions must involve one or more officers, directors, or 
controlling shareholders of the acquirer, or another person or persons 
with the implicit or explicit permission of one or more of such 
officers, directors, or controlling shareholders. These final 
regulations reflect those clarifications.

F. Safe Harbor VI of the 2002 Temporary Regulations

1. Asset Reorganizations Involving Distributing or Controlled
    Safe Harbor VI of the 2002 temporary regulations generally provides 
that if stock of Distributing or Controlled is acquired by a person in 
connection with such person's performance of services as an employee, 
director, or independent contractor for Distributing, Controlled, or a 
related person in a transaction to which section 83 or section 421(a) 
applies, the acquisition and the distribution will not be considered 
part of a plan. Questions have arisen regarding whether this safe 
harbor is available for an acquisition of Distributing or Controlled 
stock to which section 83 or section 421(a) applies when the acquirer 
performed services for a corporation other than Distributing, 
Controlled, or a person related to Distributing or Controlled. For 
example, assume that X, a corporation unrelated to Distributing and 
Controlled, grants A, an employee, an incentive stock option in 
connection with A's performance of services as an employee of X. Before 
A exercises the option, Distributing acquires the assets of X in a 
reorganization under section 368(a)(1)(A) and A's incentive stock 
option to acquire stock of X is substituted within the meaning of Sec.  
1.424-1(a) with an incentive stock option to acquire stock of 
Distributing. Commentators have asked whether Safe Harbor VI of the 
2002 temporary regulations applies to A's exercise of the option to 
acquire stock of Distributing, even though A performed services for X 
rather than Distributing. These final regulations modify this safe 
harbor (Safe Harbor VIII of these final regulations) to ensure its 
availability in this and similar situations.
2. Disqualifying Dispositions
    As described above, Safe Harbor VI of the 2002 temporary 
regulations may be available for acquisitions of stock in a transaction 
to which section 421(a) applies. In order to qualify as a transaction 
to which section 421(a) applies, the acquirer must satisfy the 
requirements of section 422(a) or section 423(a), including the holding 
period requirements of section 422(a)(1) or section 423(a)(1). In 
particular, the acquirer must not dispose of the acquired stock within 
two years from the date of the granting of the option or within one 
year after the transfer of such stock to the acquirer. The IRS and 
Treasury Department do not believe that a disposition of stock acquired 
pursuant to an option that otherwise satisfies the requirements of 
section 422 or section 423 prior to the period prescribed in section 
422(a)(1) or 423(a)(1) evidences that the acquisition of stock pursuant 
to the option and the distribution are part of a plan. Therefore, these 
final regulations extend the application of Safe Harbor VI of the 2002 
temporary regulations to not only transactions to which section 421(a) 
applies, but also transactions to which section 421(b) applies.

G. Safe Harbor VII of the 2002 Temporary Regulations

    Safe Harbor VII of the 2002 temporary regulations generally 
provides that if stock of Distributing or Controlled is acquired by an 
employer's retirement plan that qualifies under section 401(a) or 
403(a), the acquisition and the distribution will not be considered 
part of a plan. That safe harbor, however, does not apply to the extent 
that the stock acquired by all of the employer's qualified plans during 
the four-year period beginning two years before the distribution, in 
the aggregate, represents ten percent or more of the total combined 
voting power of all classes of stock entitled to vote, or ten percent 
or more of the total value of shares of all classes of stock, of the 
acquired corporation. Questions have arisen regarding whether this safe 
harbor is available at all if the acquisitions by the employer's 
retirement plans exceed ten percent of the acquired corporation's stock 
during the prescribed period.
    These final regulations revise Safe Harbor VII of the 2002 
temporary regulations (Safe Harbor IX of these final regulations) to 
clarify that, if the acquisitions by an employer's retirement plan 
total in excess of ten percent, the safe harbor is available for the 
first ten percent acquired during the prescribed period. These final 
regulations also revise this safe harbor to reflect that it is only 
available for acquisitions by a retirement plan of Distributing, 
Controlled, or any person that is treated as the same employer as 
Distributing or Controlled under section 414(b), (c), (m), or (o).

H. Compensatory Options

    The 2002 temporary regulations include special rules that treat an 
option as an agreement, understanding, or arrangement to acquire the 
stock subject to the option on the earliest of the date the option was 
written, transferred, or modified, if on that date the option was more 
likely than not to be exercised. The 2002 temporary regulations except 
compensatory options from these rules. For this purpose, a compensatory 
option is an option to acquire stock in Distributing or Controlled with 
customary terms and conditions provided to a person in connection with 
such person's performance of services as an employee, director, or 
independent contractor for the corporation or a related person (and 
that is not excessive by reference to the services performed), provided 
that the transfer of stock pursuant to such option is described in 
section 421(a) or the option is nontransferable within the meaning of 
Sec.  1.83-3(d) and does not have a readily ascertainable fair market 
value as defined in Sec.  1.83-7(b).
    The IRS and Treasury Department have become aware that arrangements 
using compensatory options have been structured to prevent an 
acquisition of stock from being treated as part of a plan that includes 
a distribution in avoidance of section 355(e). Accordingly, these final 
regulations revise the 2002 temporary regulations to treat compensatory 
options as options.

Special Analysis

    It has been determined that this Treasury decision 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 Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and, because 
these regulations do not impose a collection

[[Page 20283]]

of information requirement on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on their impact on small business.

Drafting Information

    The principal author of these regulations is Amber R. Cook of the 
Office of Associate Chief Counsel (Corporate). However, other personnel 
from the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.355-7T and adding the following entry to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.355-7 also issued under 26 U.S.C. 355(e)(5). * * *


0
Par. 2. Section 1.355-0 is amended as follows:
0
1. Revise the introductory text.
0
2. Remove the entries for Sec.  1.355-7T and add the entries for Sec.  
1.355-7.
    The revision and addition read as follows:


Sec.  1.355-0.  Outline of sections.

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

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

    (a) In general.
    (b) Plan.
    (1) In general.
    (2) Certain post-distribution acquisitions.
    (3) Plan factors.
    (4) Non-plan factors.
    (c) Operating rules.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose.
    (2) Takeover defense.
    (3) Effect of distribution on trading in stock.
    (4) Consequences of section 355(e) disregarded for certain 
purposes.
    (5) Multiple acquisitions.
    (d) Safe harbors.
    (1) Safe Harbor I.
    (2) Safe Harbor II.
    (i) In general.
    (ii) Special rule.
    (3) Safe Harbor III.
    (4) Safe Harbor IV.
    (i) In general.
    (ii) Special rules.
    (5) Safe Harbor V.
    (i) In general.
    (ii) Special rules.
    (6) Safe Harbor VI.
    (7) Safe Harbor VII.
    (i) In general.
    (ii) Special rules.
    (8) Safe Harbor VIII.
    (i) In general.
    (ii) Special rule.
    (9) Safe Harbor IX.
    (i) In general.
    (ii) Special rule.
    (e) Options, warrants, convertible obligations, and other 
similar interests.
    (1) Treatment of options.
    (i) General rule.
    (ii) Agreement, understanding, or arrangement to write, 
transfer, or modify an option.
    (iii) Substantial negotiations related to options.
    (2) Stock acquired pursuant to options.
    (3) Instruments treated as options.
    (4) Instruments generally not treated as options.
    (i) Escrow, pledge, or other security agreements.
    (ii) Options exercisable only upon death, disability, mental 
incompetency, or separation from service.
    (iii) Rights of first refusal.
    (iv) Other enumerated instruments.
    (f) Multiple controlled corporations.
    (g) Valuation.
    (h) Definitions.
    (1) Agreement, understanding, arrangement, or substantial 
negotiations.
    (2) Controlled corporation.
    (3) Controlling shareholder.
    (4) Coordinating group.
    (5) Disclosure event.
    (6) Discussions.
    (7) Established market.
    (8) Five-percent shareholder.
    (9) Implicit permission.
    (10) Public announcement.
    (11) Public offering.
    (12) Similar acquisition (not involving a public offering).
    (13) Similar acquisition involving a public offering.
    (i) One public offering.
    (ii) More than one public offering.
    (iii) Potential acquisition involving a public offering.
    (14) Ten-percent shareholder.
    (i) [Reserved].
    (j) Examples.
    (k) Effective dates.


0
Par. 3. Section 1.355-7 is added to read as follows:


Sec.  1.355-7  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--
    (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) 
(hereinafter, 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) In general. Whether a distribution and an acquisition 
are part of a plan is determined based on all the facts and 
circumstances. 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 set 
forth in paragraphs (b)(3) and (4) of this section. In general, the 
weight to be given each of the facts and circumstances depends on the 
particular case. Whether a distribution and an acquisition are part of 
a plan does not depend on the relative number of facts and 
circumstances set forth in paragraph (b)(3) that evidence that a 
distribution and an acquisition are part of a plan as compared to the 
relative number of facts and circumstances set forth in paragraph 
(b)(4) that evidence that a distribution and an acquisition are not 
part of a plan.
    (2) Certain post-distribution acquisitions. In the case of an 
acquisition (other than involving a public offering) after a 
distribution, the distribution and the acquisition can be part of a 
plan only if there was an agreement, understanding, arrangement, or 
substantial negotiations regarding the acquisition or a similar 
acquisition at some time during the two-year period ending on the date 
of the distribution. In the case of an acquisition (other than 
involving a public offering) after a distribution, the existence of an 
agreement, understanding, arrangement, or substantial negotiations 
regarding the acquisition or a similar acquisition at some time during 
the two-year period ending on the date of the distribution tends to 
show that the distribution and the acquisition are part of a plan. See 
paragraph (b)(3)(i) of this section. However, all facts and 
circumstances must be considered to determine whether the distribution 
and the acquisition are part of a plan. For example, in the case of an 
acquisition

[[Page 20284]]

(other than involving a public offering) after a distribution, if the 
distribution was motivated in whole or substantial part by a corporate 
business purpose (within the meaning of Sec.  1.355-2(b)) other than a 
business purpose to facilitate the acquisition or a similar acquisition 
of Distributing or Controlled (see paragraph (b)(4)(v) of this section) 
and would have occurred at approximately the same time and in similar 
form regardless of whether the acquisition or a similar acquisition was 
effected (see paragraph (b)(4)(vi) of this section), the taxpayer may 
be able to establish that the distribution and the acquisition are not 
part of a plan.
    (3) Plan factors. 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) after a distribution, at some time during the two-year period 
ending on the date of the distribution, there was an agreement, 
understanding, arrangement, or substantial negotiations regarding the 
acquisition or a similar acquisition. The weight to be accorded this 
fact depends on the nature, extent, and timing of the agreement, 
understanding, arrangement, or substantial negotiations. The existence 
of an agreement, understanding, or arrangement at the time of the 
distribution is given substantial weight.
    (ii) In the case of an acquisition involving a public offering 
after a distribution, at some time during the two-year period ending on 
the date of the distribution, there were discussions by Distributing or 
Controlled with an investment banker regarding the acquisition or a 
similar acquisition. The weight to be accorded this fact depends on the 
nature, extent, and timing of the discussions.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, at some time during the two-year 
period ending on the date of the acquisition, there were discussions by 
Distributing or Controlled with the acquirer regarding a distribution. 
The weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions. In addition, in the case of an acquisition 
(other than involving a public offering) before a distribution, the 
acquirer intends to cause a distribution and, immediately after the 
acquisition, can meaningfully participate in the decision regarding 
whether to make a distribution.
    (iv) In the case of an acquisition involving a public offering 
before a distribution, at some time during the two-year period ending 
on the date of the acquisition, there were discussions by Distributing 
or Controlled with an investment banker regarding a distribution. The 
weight to be accorded this fact depends on the nature, extent, and 
timing of the discussions.
    (v) 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.
    (4) Non-plan factors. 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 involving a public offering after 
a distribution, during the two-year period ending on the date of the 
distribution, there were no discussions by Distributing or Controlled 
with an investment banker regarding the acquisition or a similar 
acquisition.
    (ii) 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.
    (iii) In the case of an acquisition (other than involving a public 
offering) before a distribution, during the two-year period ending on 
the date of the earlier to occur of the acquisition or the first public 
announcement regarding the distribution, there were no discussions by 
Distributing or Controlled with the acquirer regarding a distribution. 
Paragraph (b)(4)(iii) of this section does not apply to an acquisition 
where the acquirer intends to cause a distribution and, immediately 
after the acquisition, can meaningfully participate in the decision 
regarding whether to make a distribution.
    (iv) 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.
    (v) 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 Sec.  
1.355-2(b)) other than a business purpose to facilitate the acquisition 
or a similar acquisition.
    (vi) 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.
    (c) Operating rules. The operating rules contained in this 
paragraph (c) apply for all purposes of this section.
    (1) Internal discussions and discussions with outside advisors 
evidence of business purpose. Discussions by Distributing or Controlled 
with outside advisors and internal discussions may be indicative of one 
or more business purposes for the distribution and the relative 
importance of such purposes.
    (2) Takeover defense. If Distributing engages in discussions with a 
potential acquirer regarding an acquisition of Distributing or 
Controlled and 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.
    (3) 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's 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.
    (4) 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.
    (5) 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) Safe harbors--(1) Safe Harbor I. A distribution and an 
acquisition occurring after the distribution will not be considered 
part of a plan if--
    (i) The distribution was motivated in whole or substantial part by 
a corporate business purpose (within the meaning of Sec.  1.355-2(b)), 
other than a business purpose to facilitate an acquisition of the 
acquired corporation (Distributing or Controlled); and
    (ii) The acquisition occurred more than six months after the 
distribution and there was no agreement, understanding, arrangement, or

[[Page 20285]]

substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins one year before the 
distribution and ends six months thereafter.
    (2) Safe Harbor II--(i) In general. A distribution and an 
acquisition occurring after the distribution will not be considered 
part of a plan if--
    (A) The distribution was not motivated by a business purpose to 
facilitate the acquisition or a similar acquisition;
    (B) The acquisition occurred more than six months after the 
distribution and there was no agreement, understanding, arrangement, or 
substantial negotiations concerning the acquisition or a similar 
acquisition during the period that begins one year before the 
distribution and ends six months thereafter; and
    (C) No more than 25 percent of the stock of the acquired 
corporation (Distributing or Controlled) was either acquired or the 
subject of an agreement, understanding, arrangement, or substantial 
negotiations during the period that begins one year before the 
distribution and ends six months thereafter.
    (ii) Special rule. For purposes of paragraph (d)(2)(i)(C) of this 
section, acquisitions of stock that are treated as not part of a plan 
pursuant to Safe Harbor VII, Safe Harbor VIII, or Safe Harbor IX are 
disregarded.
    (3) Safe Harbor III. If an acquisition occurs after a distribution, 
there was no agreement, understanding, or arrangement concerning the 
acquisition or a similar acquisition at the time of the distribution, 
and there was no agreement, understanding, arrangement, or substantial 
negotiations concerning the acquisition or a similar acquisition within 
one year after the distribution, the acquisition and the distribution 
will not be considered part of a plan.
    (4) Safe Harbor IV--(i) In general. A distribution and an 
acquisition (other than involving a public offering) occurring before 
the distribution will not be considered part of a plan if the 
acquisition occurs before the date of the first disclosure event 
regarding the distribution.
    (ii) Special rules. (A) Paragraph (d)(4)(i) of this section does 
not apply to a stock acquisition if the acquirer or a coordinating 
group of which the acquirer is a member is a controlling shareholder or 
a ten-percent shareholder of the acquired corporation (Distributing or 
Controlled) at any time during the period beginning immediately after 
the acquisition and ending on the date of the distribution.
    (B) Paragraph (d)(4)(i) of this section does not apply to an 
acquisition that occurs in connection with a transaction in which the 
aggregate acquisitions are of stock possessing 20 percent or more of 
the total voting power of the stock of the acquired corporation 
(Distributing or Controlled) or stock having a value of 20 percent or 
more of the total value of the stock of the acquired corporation 
(Distributing or Controlled).
    (5) Safe Harbor V--(i) In general. A distribution that is pro rata 
among the Distributing shareholders and an acquisition (other than 
involving a public offering) of Distributing stock occurring before the 
distribution will not be considered part of a plan if--
    (A) The acquisition occurs after the date of a public announcement 
regarding the distribution; and
    (B) There were no discussions by Distributing or Controlled with 
the acquirer regarding a distribution on or before the date of the 
first public announcement regarding the distribution.
    (ii) Special rules. (A) Paragraph (d)(5)(i) of this section does 
not apply to a stock acquisition if the acquirer or a coordinating 
group of which the acquirer is a member is a controlling shareholder or 
a ten-percent shareholder of Distributing at any time during the period 
beginning immediately after the acquisition and ending on the date of 
the distribution.
    (B) Paragraph (d)(5)(i) of this section does not apply to an 
acquisition that occurs in connection with a transaction in which the 
aggregate acquisitions are of stock possessing 20 percent or more of 
the total voting power of the stock of Distributing or stock having a 
value of 20 percent or more of the total value of the stock of 
Distributing.
    (6) Safe Harbor VI. A distribution and an acquisition involving a 
public offering occurring before the distribution will not be 
considered part of a plan if the acquisition occurs before the date of 
the first disclosure event regarding the distribution in the case of an 
acquisition of stock that is not listed on an established market 
immediately after the acquisition, or before the date of the first 
public announcement regarding the distribution in the case of an 
acquisition of stock that is listed on an established market 
immediately after the acquisition.
    (7) Safe Harbor VII--(i) In general. An acquisition (other than 
involving a public offering) of Distributing or Controlled stock that 
is listed on an established market is not part of a plan if, 
immediately before or immediately after the transfer, none of the 
transferor, the transferee, and any coordinating group of which either 
the transferor or the transferee is a member is--
    (A) The acquired corporation (Distributing or Controlled);
    (B) A corporation that the acquired corporation (Distributing or 
Controlled) controls within the meaning of section 368(c);
    (C) A member of a controlled group of corporations within the 
meaning of section 1563 of which the acquired corporation (Distributing 
or Controlled) is a member;
    (D) A controlling shareholder of the acquired corporation 
(Distributing or Controlled); or
    (E) A ten-percent shareholder of the acquired corporation 
(Distributing or Controlled).
    (ii) Special rules. (A) Paragraph (d)(7)(i) of this section 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 of which such person is a 
member intends to become a controlling shareholder or a ten-percent 
shareholder of the acquired corporation (Distributing or Controlled) at 
any time after the acquisition and before the date that is two years 
after the distribution.
    (B) If a transfer of stock to which paragraph (d)(7)(i) of this 
section applies results immediately, or upon a subsequent event or the 
passage of time, in an indirect acquisition of voting power by a person 
other than the transferee, paragraph (d)(7)(i) of this section does not 
prevent an acquisition of stock (with the voting power such stock 
represents after the transfer to which paragraph (d)(7)(i) of this 
section applies) by such other person from being treated as part of a 
plan.
    (8) Safe Harbor VIII--(i) In general. If, in a transaction to which 
section 83 or section 421(a) or (b) applies, stock of Distributing or 
Controlled is acquired by a person in connection with such person's 
performance of services as an employee, director, or independent 
contractor for Distributing, Controlled, a related person, a 
corporation the assets of which Distributing, Controlled, or a related 
person acquires in a reorganization under section 368(a), or a 
corporation that acquires the assets of Distributing or Controlled in 
such a reorganization (and the stock acquired is not excessive by 
reference to the services performed), the acquisition and the 
distribution will not be considered part of a plan. For purposes of 
this paragraph (d)(8)(i), a related person is a person related to 
Distributing or Controlled under section 355(d)(7)(A).

[[Page 20286]]

    (ii) Special rule. Paragraph (d)(8)(i) of this section does not 
apply to a stock acquisition if the acquirer or a coordinating group of 
which the acquirer is a member is a controlling shareholder or a ten-
percent shareholder of the acquired corporation (Distributing or 
Controlled) immediately after the acquisition.
    (9) Safe Harbor IX--(i) In general. If stock of Distributing or 
Controlled is acquired by a retirement plan of Distributing or 
Controlled (or a retirement plan of any other person that is treated as 
the same employer as Distributing or Controlled under section 414(b), 
(c), (m), or (o)) that qualifies under section 401(a) or 403(a), the 
acquisition and the distribution will not be considered part of a plan.
    (ii) Special rule. Paragraph (d)(9)(i) of this section does not 
apply to the extent that the stock acquired pursuant to acquisitions by 
all of the qualified plans of the persons described in paragraph 
(d)(9)(i) of this section during the four-year period beginning two 
years before the distribution, in the aggregate, represents more than 
ten percent of the total combined voting power of all classes of stock 
entitled to vote, or more than ten percent of the total value of shares 
of all classes of stock, of the acquired corporation (Distributing or 
Controlled).
    (e) 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 that is written by Distributing, Controlled, or a 
person that is a controlling shareholder of Distributing or Controlled 
at the time the option is written, or that is acquired by a person that 
is a controlling shareholder of Distributing or Controlled immediately 
after the option is written, the option will be treated as an 
agreement, understanding, or arrangement to acquire the stock on the 
earliest of the following dates: the date that the option is written, 
if the option was more likely than not to be exercised as of such date; 
the date that the option is transferred if, immediately before or 
immediately after the transfer, the transferor or transferee was 
Distributing, Controlled, a corporation that Distributing or Controlled 
controls within the meaning of section 368(c), a member of a controlled 
group of corporations within the meaning of section 1563 of which 
Distributing or Controlled is a member, or a controlling shareholder or 
a ten-percent shareholder of Distributing or Controlled and the option 
was more likely than not to be exercised as of such date; and the date 
that the option is modified in a manner that materially increases the 
likelihood of exercise, if the option was more likely than not to be 
exercised as of such date; provided, however, if the writing, transfer, 
or modification had a principal purpose of avoiding section 355(e), the 
option will be treated as an agreement, understanding, arrangement, or 
substantial negotiations to acquire the stock on the date of the 
distribution. 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, or arrangement to write, transfer, 
or modify 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 there 
is an agreement, understanding, or arrangement to transfer an option, 
the option will be treated as transferred on the date of the agreement, 
understanding, or arrangement. If there is an agreement, understanding, 
or arrangement to modify an option in a manner that materially 
increases the likelihood of exercise, the option will be treated as so 
modified on the date of the agreement, understanding, or arrangement.
    (iii) Substantial negotiations related to options. If an option is 
treated as an agreement, understanding, or arrangement to acquire the 
stock on the date that the option is written, substantial negotiations 
to acquire the option will be treated as substantial negotiations to 
acquire the stock subject to such option. If an option is treated as an 
agreement, understanding, or arrangement to acquire the stock on the 
date that the option is transferred, substantial negotiations regarding 
the transfer of the option will be treated as substantial negotiations 
to acquire the stock subject to such option. If an option is treated as 
an agreement, understanding, or arrangement to acquire the stock on the 
date that the option is modified in a manner that materially increases 
the likelihood of exercise, substantial negotiations regarding such 
modifications to the option will be treated as substantial negotiations 
to acquire the stock subject to such option.
    (2) Stock acquired pursuant to options. For purposes of this 
section, if an option is issued for cash, the terms of the acquisition 
of the option and the terms of the option are established by the 
corporation the stock of which is subject to the option (Distributing 
or Controlled) or the writer with the involvement of one or more 
investment bankers, and the potential acquirers of the option have no 
opportunity to negotiate the terms of the acquisition of the option or 
the terms of the option, then an acquisition pursuant to such option 
shall be treated as an acquisition involving a public offering 
occurring after the distribution if the option is exercised after the 
distribution or an acquisition involving a public offering before a 
distribution if the option is exercised before the distribution. 
Otherwise, an acquisition pursuant to an option shall be treated as an 
acquisition not involving a public offering.
    (3) Instruments treated as options. For purposes of this section, 
except to the extent provided in paragraph (e)(4) 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.
    (4) Instruments generally not treated as options. For purposes of 
this section, the following are not treated as options unless (in the 
case of paragraphs (e)(4)(i), (ii), and (iii) of this section) written, 
transferred (directly or indirectly), modified, 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) 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 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

[[Page 20287]]

not excessive by reference to the services performed), the 
shareholder's separation from service.
    (iii) 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).
    (iv) Other enumerated instruments. Any other instrument the 
Commissioner may designate in revenue procedures, notices, or other 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2) of this chapter).
    (f) Multiple controlled corporations. Only the stock or securities 
of a controlled corporation in which one 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 one 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.
    (g) Valuation. Except as provided in paragraph (e)(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.
    (h) Definitions. For purposes of this section, the following 
definitions shall apply:
    (1) Agreement, understanding, arrangement, or substantial 
negotiations. (i) An agreement, understanding, or arrangement generally 
requires either--
    (A) An agreement, understanding, or arrangement by one or more 
officers or directors acting on behalf of Distributing or Controlled, 
by controlling shareholders of Distributing or Controlled, or by 
another person or persons with the implicit or explicit permission of 
one or more of such officers, directors, or controlling shareholders, 
with the acquirer or with a person or persons with the implicit or 
explicit permission of the acquirer; or
    (B) An agreement, understanding, or arrangement by an acquirer that 
is a controlling shareholder of Distributing or Controlled immediately 
after the acquisition that is the subject of the agreement, 
understanding, or arrangement, or by a person or persons with the 
implicit or explicit permission of such acquirer, with the transferor 
or with a person or persons with the implicit or explicit permission of 
the transferor.
    (ii) In the case of an acquisition by a corporation, an agreement, 
understanding, or arrangement with the acquiring corporation generally 
requires an agreement, understanding, or arrangement with one or more 
officers or directors acting on behalf of the acquiring corporation, 
with controlling shareholders of the acquiring corporation, or with 
another person or persons with the implicit or explicit permission of 
one or more of such officers, directors, or controlling shareholders.
    (iii) 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 significant economic terms to have an agreement, understanding, 
or arrangement. However, an agreement, understanding, or arrangement 
clearly exists if a binding contract to acquire stock exists.
    (iv) Substantial negotiations in the case of an acquisition (other 
than involving a public offering) generally require discussions of 
significant economic terms, e.g., the exchange ratio in a 
reorganization, either--
    (A) By one or more officers or directors acting on behalf of 
Distributing or Controlled, by controlling shareholders of Distributing 
or Controlled, or by another person or persons with the implicit or 
explicit permission of one or more of such officers, directors, or 
controlling shareholders, with the acquirer or with a person or persons 
with the implicit or explicit permission of the acquirer; or
    (B) If the acquirer is a controlling shareholder of Distributing or 
Controlled immediately after the acquisition that is the subject of 
substantial negotiations, by the acquirer or by a person or persons 
with the implicit or explicit permission of the acquirer, with the 
transferor or with a person or persons with the implicit or explicit 
permission of the transferor.
    (v) In the case of an acquisition (other than involving a public 
offering) by a corporation, substantial negotiations generally require 
discussions of significant economic terms with one or more officers or 
directors acting on behalf of the acquiring corporation, with 
controlling shareholders of the acquiring corporation, or with another 
person or persons with the implicit or explicit permission of one or 
more of such officers, directors, or controlling shareholders.
    (vi) In the case of an acquisition involving a public offering, the 
existence of an agreement, understanding, arrangement, or substantial 
negotiations will be based on discussions by one or more officers or 
directors acting on behalf of Distributing or Controlled, by 
controlling shareholders of Distributing or Controlled, or by another 
person or persons with the implicit or explicit permission of one or 
more of such officers, directors, or controlling shareholders, with an 
investment banker.
    (2) Controlled corporation. 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 listed on an established market is a 
five-percent shareholder who actively participates in the management or 
operation of the corporation. For purposes of this paragraph (h)(3)(i), 
a corporate director will be treated as actively participating in the 
management of the corporation.
    (ii) A controlling shareholder of a corporation the stock of which 
is not listed on an established market is any person that owns stock 
possessing voting power representing a me