Corporate Reorganizations; Guidance on the Measurement of Continuity of Interest, 78540-78545 [2011-32078]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 76, Number 243 (Monday, December 19, 2011)]
[Rules and Regulations]
[Pages 78540-78545]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-32078]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9565]
RIN 1545-BG15


Corporate Reorganizations; Guidance on the Measurement of 
Continuity of Interest

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that provide guidance 
regarding the continuity of interest requirement for corporate 
reorganizations. The guidance is necessary to establish the date upon 
which continuity of interest is measured. These regulations affect 
corporations and their shareholders.

DATES: Effective Date: These regulations are effective on December 19, 
2011.
    Applicability Date: For dates of applicability, see Sec.  1.368-
1(e)(9)(ii).

FOR FURTHER INFORMATION CONTACT: Richard Starke at (202) 622-7790 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    The Internal Revenue Code of 1986 (Code) provides for general non-
recognition treatment for reorganizations described in section 368 of 
the Code. In addition to satisfying the statutory requirements of a 
reorganization, a transaction also must satisfy certain non-statutory 
requirements, such as continuity of interest (COI). COI requires that, 
in substance, a substantial part of the value of the proprietary 
interests in the target corporation be preserved in the reorganization. 
A proprietary interest in the target corporation is preserved if, in a 
potential reorganization, it is exchanged for a proprietary interest in 
the issuing corporation, it is exchanged by the acquiring corporation 
for a direct interest in the target corporation enterprise, or it 
otherwise continues as a proprietary interest in the target 
corporation. See Sec.  1.368-1(e)(1)(i).
    On August 10, 2004, the IRS and the Treasury Department published a 
notice of proposed rulemaking (REG-129706-04, 2004-2 CB 479) in the 
Federal Register (69 FR 48429) (2004 proposed regulations) identifying 
certain circumstances in which the determination of whether a 
proprietary interest in the target corporation is preserved would be 
made by reference to the value of the issuing corporation's stock on 
the day before there is an agreement to effect the potential 
reorganization. Specifically, the 2004 proposed regulations provided 
that, in determining whether a proprietary interest in the target 
corporation is preserved, the consideration to be exchanged for the 
proprietary interests in the target corporation pursuant to a contract 
to effect the potential reorganization is valued on the last business 
day before the first date such contract is a binding contract (the Pre-
Signing Date), if such consideration was fixed at the signing date (the 
signing date rule). On September 16, 2005, the IRS and the Treasury 
Department published final regulations (TD 9225, 2005-2 CB 716) in the 
Federal Register (70 FR 54631) (2005 final regulations) that retained 
the general framework of the 2004 proposed regulations but made several 
modifications in response to comments received regarding the proposed 
regulations. After consideration of comments relating to the 2005 final 
regulations, the IRS and the Treasury Department published temporary 
(TD 9316, 2007-1 CB 962) and proposed (REG-146247-06, 2007-1 CB 977) 
regulations in the Federal Register (72 FR 12974 and 72 FR 13058 
respectively) (the 2007 temporary regulations). The 2007 temporary 
regulations generally narrowed the definition of fixed consideration, 
and accordingly, limited the application of the signing date rule. The 
preamble explained that the signing date rule is based on the principle 
that, where a binding contract provides for fixed consideration, the 
target corporation shareholders can generally be viewed as being 
subject to the economic fortunes of the issuing corporation as of the 
signing date. However, if the contract does not provide for fixed 
consideration, the signing date value of the issuing corporation stock 
is not relevant for purposes of determining the extent to which a 
proprietary interest in the target corporation is preserved.
    On March 17, 2010, the IRS released Notice 2010-25 (the Notice), 
2010-1 CB 527. Notice 2010-25 acknowledged that the 2007 temporary 
regulations would, as required by sunset provisions of section 
7805(e)(2), expire on March 19, 2010. It also noted that proposed 
regulations (REG-146247-06, 2007-1 CB 977) previously published in the 
Federal Register (72 FR 13058) had the same text as the expiring 
temporary regulations and would remain outstanding after that 
expiration. The Notice provided that, until the issuance of new 
regulations, taxpayers could choose, as long as a specified condition 
of consistency among parties was satisfied, to apply the rules in the 
proposed regulations. The ability of taxpayers to elect to apply the 
rules of the proposed regulations, as provided in the Notice, is 
incorporated into Sec.  1.368-1(e)(9)(ii), the effective/applicability 
date of these final regulations. See Sec.  601.601(d)(2)(ii)(b).

Explanation of Revisions

    These final regulations adopt the 2007 temporary regulations with 
only minor changes. First, questions were raised concerning whether a 
contract can provide for fixed consideration under the general 
definition of fixed consideration if the contract provides for a 
shareholder election. These final regulations clarify that a 
shareholder election does not prevent a contract from satisfying the 
general definition of fixed consideration if that requirement is 
otherwise met. Second, Example 9 is modified to address a more typical 
fact pattern.
    In response to comments regarding the application of the signing 
date rule and after further consideration of the purpose and operation 
of that rule, the IRS and the Treasury Department have proposed a 
regulation, published elsewhere in this issue of the Federal Register, 
under which application of the signing date principles would be 
expanded. That notice of proposed rulemaking (REG-124627-11) also 
requests comments regarding the propriety of applying signing date 
principles more generally to transactions in which the target 
corporation shareholders, pursuant to a binding contract to effect a 
potential reorganization, become subject to the economic fortunes of 
issuing corporation consideration between the signing date and the 
closing date. In

[[Page 78541]]

these cases, a more liberal application of signing date principles may 
result in valuing issuing corporation consideration at one or more 
dates between the signing date and the closing date.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13565. Therefore, a regulatory 
assessment is not required. It also has been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to this regulation 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. Therefore, a 
Regulatory Flexibility Analysis is not required. Pursuant to section 
7805(f) of the Internal Revenue Code, the notice of proposed rulemaking 
preceding this regulation was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small businesses.

Drafting Information

    The principal author of these final regulations is Richard Starke 
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 record keeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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


0
Par. 2. Section 1.368-1 is amended by revising paragraph (e)(2), 
revising the paragraph heading of (e)(9)(i), and revising paragraph 
(e)(9)(ii) to read as follows:


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

* * * * *
    (e) * * *
    (2) Measuring continuity of interest--(i) In general. In 
determining whether a proprietary interest in the target corporation is 
preserved, the consideration to be exchanged for the proprietary 
interests in the target corporation pursuant to a contract to effect 
the potential reorganization shall be valued on the last business day 
before the first date such contract is a binding contract (the pre-
signing date), if such contract provides for fixed consideration. If a 
portion of the consideration provided for in such a contract consists 
of other property identified by value, then this specified value of 
such other property is used for purposes of determining the extent to 
which a proprietary interest in the target corporation is preserved. If 
the contract does not provide for fixed consideration, this paragraph 
(e)(2)(i) is not applicable.
    (ii) Binding contract--(A) In general. A binding contract is an 
instrument enforceable under applicable law against the parties to the 
instrument. The presence of a condition outside the control of the 
parties (including, for example, regulatory agency approval) shall not 
prevent an instrument from being a binding contract. Further, the fact 
that insubstantial terms remain to be negotiated by the parties to the 
contract, or that customary conditions remain to be satisfied, shall 
not prevent an instrument from being a binding contract.
    (B) Modifications--(1) In general. If a term of a binding contract 
that relates to the amount or type of the consideration the target 
shareholders will receive in a potential reorganization is modified 
before the closing date of the potential reorganization, and the 
contract as modified is a binding contract, the date of the 
modification shall be treated as the first date there is a binding 
contract.
    (2) Modification of a transaction that preserves continuity of 
interest. Notwithstanding paragraph (e)(2)(ii)(B)(1) of this section, a 
modification of a term that relates to the amount or type of 
consideration the target shareholders will receive in a transaction 
that would have resulted in the preservation of a substantial part of 
the value of the target corporation shareholders' proprietary interests 
in the target corporation if there had been no modification will not be 
treated as a modification if--
    (i) The modification has the sole effect of providing for the 
issuance of additional shares of issuing corporation stock to the 
target corporation shareholders;
    (ii) The modification has the sole effect of decreasing the amount 
of money or other property to be delivered to the target corporation 
shareholders; or
    (iii) The modification has the effect of decreasing the amount of 
money or other property to be delivered to the target corporation 
shareholders and providing for the issuance of additional shares of 
issuing corporation stock to the target corporation shareholders.
    (3) Modification of a transaction that does not preserve continuity 
of interest. Notwithstanding paragraph (e)(2)(ii)(B)(1) of this 
section, a modification of a term that relates to the amount or type of 
consideration the target shareholders will receive in a transaction 
that would not have resulted in the preservation of a substantial part 
of the value of the target corporation shareholders' proprietary 
interests in the target corporation if there had been no modification 
will not be treated as a modification if--
    (i) The modification has the sole effect of providing for the 
issuance of fewer shares of issuing corporation stock to the target 
corporation shareholders;
    (ii) The modification has the sole effect of increasing the amount 
of money or other property to be delivered to the target corporation 
shareholders; or
    (iii) The modification has the effect of increasing the amount of 
money or other property to be delivered to the target corporation 
shareholders and providing for the issuance of fewer shares of issuing 
corporation stock to the target corporation shareholders.
    (C) Tender offers. For purposes of this paragraph (e)(2), a tender 
offer that is subject to section 14(d) of the Securities and Exchange 
Act of 1934 [15 U.S.C. 78n(d)(1)] and Regulation 14D (17 CFR 240.14d-1 
through 240.14d-101) and is not pursuant to a binding contract, is 
treated as a binding contract made on the date of its announcement, 
notwithstanding that it may be modified by the offeror or that it is 
not enforceable against the offerees. If a modification (not pursuant 
to a binding contract) of such a tender offer is subject to the 
provisions of Regulation 14d-6(c) (17 CFR 240.14d-6(c)) and relates to 
the amount or type of the consideration received in the tender offer, 
then the date of the modification shall be treated as the first date 
there is a binding contract.
    (iii) Fixed consideration--(A) In general. A contract provides for 
fixed consideration if it provides the number of shares of each class 
of stock of the issuing corporation, the amount of money, and the other 
property (identified either by value or by specific description), if 
any, to be exchanged for all the proprietary interests in the target 
corporation, or to be exchanged for each proprietary interest in the 
target

[[Page 78542]]

corporation. A shareholder's election to receive a number of shares of 
stock of the issuing corporation, money, or other property (or some 
combination of stock of the issuing corporation, money, or other 
property) in exchange for all of the shareholder's proprietary 
interests in the target corporation, or each of the shareholder's 
proprietary interests in the target corporation, will not prevent a 
contract from satisfying the definition of fixed consideration provided 
for in this paragraph (e)(2)(iii)(A).
    (B) Shareholder elections. A contract that provides a target 
corporation shareholder with an election to receive a number of shares 
of stock of the issuing corporation, money, or other property (or some 
combination of stock of the issuing corporation, money, or other 
property) in exchange for all of the shareholder's proprietary 
interests in the target corporation, or each of the shareholder's 
proprietary interests in the target corporation, provides for fixed 
consideration if the determination of the number of shares of issuing 
corporation stock to be provided to the target corporation shareholder 
is determined using the value of the issuing corporation stock on the 
last business day before the first date there is a binding contract. 
This is the case even though the shareholder election may preclude a 
determination, prior to the closing date, of the number of shares of 
each class of the issuing corporation, the amount of money, and the 
other property (or the combination of shares, money and other property) 
to be exchanged for each proprietary interest in the target 
corporation.
    (C) Contingent adjustments to the consideration--(1) In general. 
Except as provided in paragraph (e)(2)(iii)(C)(2) of this section, a 
contract that provides for contingent adjustments to the consideration 
will be treated as providing for fixed consideration if it would 
satisfy the requirements of paragraph (e)(2)(iii)(A) of this section 
without the contingent adjustment provision.
    (2) Exceptions. A contract will not be treated as providing for 
fixed consideration if the contract provides for contingent adjustments 
to the consideration that prevent (to any extent) the target 
corporation shareholders from being subject to the economic benefits 
and burdens of ownership of the issuing corporation stock after the 
last business day before the first date the contract is a binding 
contract. For example, a contract will not be treated as providing for 
fixed consideration if the contract provides for contingent adjustments 
to the consideration in the event that the value of the stock of the 
issuing corporation, the value of the assets of the issuing 
corporation, or the value of any surrogate for either the value of the 
stock of the issuing corporation or the assets of the issuing 
corporation increases or decreases after the last business day before 
the first date there is a binding contract. Similarly, a contract will 
not be treated as providing for fixed consideration if the contract 
provides for contingent adjustments to the number of shares of the 
issuing corporation stock to be provided to the target corporation 
shareholders computed using any value of the issuing corporation shares 
after the last business day before the first date there is a binding 
contract.
    (D) Escrows. Placing part of the consideration to be exchanged for 
proprietary interests in the target corporation in escrow to secure 
target's performance of customary pre-closing covenants or customary 
target representations and warranties will not prevent a contract from 
being treated as providing for fixed consideration.
    (E) Anti-dilution clauses. The presence of a customary anti-
dilution clause will not prevent a contract from being treated as 
providing for fixed consideration. However, the absence of such a 
clause will prevent a contract from being treated as providing for 
fixed consideration if the issuing corporation alters its capital 
structure between the first date there is an otherwise binding contract 
to effect the transaction and the effective date of the transaction in 
a manner that materially alters the economic arrangement of the parties 
to the binding contract. If the number of shares of the issuing 
corporation to be issued to the target corporation shareholders is 
altered pursuant to a customary anti-dilution clause, the value of the 
shares determined under paragraph (e)(2)(i) of this section must be 
adjusted accordingly.
    (F) Dissenters' rights. The possibility that some shareholders may 
exercise dissenters' rights and receive consideration other than that 
provided for in the binding contract will not prevent the contract from 
being treated as providing for fixed consideration.
    (G) Fractional shares. The fact that money may be paid in lieu of 
issuing fractional shares will not prevent a contract from being 
treated as providing for fixed consideration.
    (iv) New issuances. For purposes of applying paragraph (e)(2)(i) of 
this section, any class of stock, securities, or indebtedness that the 
issuing corporation issues to the target corporation shareholders 
pursuant to the potential reorganization and that does not exist before 
the first date there is a binding contract to effect the potential 
reorganization is deemed to have been issued on the last business day 
before the first date there is a binding contract to effect the 
potential reorganization.
    (v) Examples. For purposes of the examples in this paragraph 
(e)(2)(v), P is the issuing corporation, T is the target corporation, S 
is a wholly owned subsidiary of P, all corporations have only one class 
of stock outstanding, A is an individual, no transactions other than 
those described occur, and the transactions are not otherwise subject 
to recharacterization. The following examples illustrate the 
application of this paragraph (e)(2):

    Example 1. Application of signing date rule. On January 3 of 
year 1, P and T sign a binding contract pursuant to which T will be 
merged with and into P on June 1 of year 1. Pursuant to the 
contract, the T shareholders will receive 40 P shares and $60 of 
cash in exchange for all of the outstanding stock of T. Twenty of 
the P shares, however, will be placed in escrow to secure customary 
target representations and warranties. The P stock is listed on an 
established market. On January 2 of year 1, the value of the P stock 
is $1 per share. On June 1 of year 1, T merges with and into P 
pursuant to the terms of the contract. On that date, the value of 
the P stock is $.25 per share. None of the stock placed in escrow is 
returned to P. Because the contract provides for the number of 
shares of P and the amount of money to be exchanged for all of the 
proprietary interests in T, under this paragraph (e)(2), there is a 
binding contract providing for fixed consideration as of January 3 
of year 1. Therefore, whether the transaction satisfies the 
continuity of interest requirement is determined by reference to the 
value of the P stock on the pre-signing date. Because, for 
continuity of interest purposes, the T stock is exchanged for $40 of 
P stock and $60 of cash, the transaction preserves a substantial 
part of the value of the proprietary interest in T. Therefore, the 
transaction satisfies the continuity of interest requirement.

    Example 2. Treatment of forfeited escrowed stock. (i) Escrowed 
stock. The facts are the same as in Example 1 except that T's breach 
of a representation results in the escrowed consideration being 
returned to P. Because the contract provides for the number of 
shares of P and the amount of money to be exchanged for all of the 
proprietary interests in T, under this paragraph (e)(2), there is a 
binding contract providing for fixed consideration as of January 3 
of year 1. Therefore, whether the transaction satisfies the 
continuity of interest requirement is determined by reference to the 
value of the P stock on the pre-signing date. Pursuant to paragraph 
(e)(1)(i) of this section, for continuity of interest purposes, the 
T stock is exchanged for $20 of P stock and $60 of cash, and the 
transaction does not preserve a substantial part of the value of the 
proprietary interest in T. Therefore, the

[[Page 78543]]

transaction does not satisfy the continuity of interest requirement.
    (ii) Escrowed stock and cash. The facts are the same as in 
paragraph (i) of this Example 2 except that the consideration placed 
in escrow consists solely of eight of the P shares and $12 of the 
cash. Because the contract provides for the number of shares of P 
and the amount of money to be exchanged for all of the proprietary 
interests in T, under this paragraph (e)(2), there is a binding 
contract providing for fixed consideration as of January 3 of year 
1. Therefore, whether the transaction satisfies the continuity of 
interest requirement is determined by reference to the value of the 
P stock on the pre-signing date. Pursuant to paragraph (e)(1)(i) of 
this section, for continuity of interest purposes, the T stock is 
exchanged for $32 of P stock and $48 of cash, and the transaction 
preserves a substantial part of the value of the proprietary 
interest in T. Therefore, the transaction satisfies the continuity 
of interest requirement.

    Example 3. Redemption of stock received pursuant to binding 
contract. The facts are the same as in Example 1 except that A owns 
50 percent of the outstanding stock of T immediately prior to the 
merger and receives 10 P shares and $30 in the merger and an 
additional 10 P shares upon the release of the stock placed in 
escrow. In connection with the merger, A and S agree that, 
immediately after the merger, S will purchase any P shares that A 
acquires in the merger for $1 per share. Shortly after the merger, S 
purchases A's P shares for $20. Because the contract provides for 
the number of shares of P and the amount of money to be exchanged 
for all of the proprietary interests in T, under this paragraph 
(e)(2), there is a binding contract providing for fixed 
consideration as of January 3 of year 1. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-
signing date. In addition, S is a person related to P under 
paragraph (e)(4)(i)(A) of this section. Accordingly, A is treated as 
exchanging his T shares for $50 of cash. Because, for continuity of 
interest purposes, the T stock is exchanged for $20 of P stock and 
$80 of cash, the transaction does not preserve a substantial part of 
the value of the proprietary interest in T. Therefore, the 
transaction does not satisfy the continuity of interest requirement.

    Example 4. Modification of binding contract--continuity not 
preserved. The facts are the same as in Example 1 except that on 
April 1 of year 1, the parties modify their contract. Pursuant to 
the modified contract, which is a binding contract, the T 
shareholders will receive 50 P shares (an additional 10 shares) and 
$75 of cash (an additional $15 of cash) in exchange for all of the 
outstanding T stock. On March 31 of year 1, the value of the P stock 
is $.50 per share. Under this paragraph (e)(2), although there was a 
binding contract providing for fixed consideration as of January 3 
of year 1, terms of that contract relating to the consideration to 
be provided to the target shareholders were modified on April 1 of 
year 1. The execution of the transaction without modification would 
have resulted in the preservation of a substantial part of the value 
of the target corporation shareholders' proprietary interests in the 
target corporation if there had been no modification. However, 
because the modified contract provides for additional P stock and 
cash to be exchanged for all the proprietary interests in T, the 
exception in paragraph (e)(2)(ii)(B)(2) of this section does not 
apply to preserve the original signing date. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on March 31 of 
year 1. Because, for continuity of interest purposes, the T stock is 
exchanged for $25 of P stock and $75 of cash, the transaction does 
not preserve a substantial part of the value of the proprietary 
interest in T. Therefore, the transaction does not satisfy the 
continuity of interest requirement.

    Example 5. Modification of binding contract disregarded--
continuity preserved. The facts are the same as in Example 4 except 
that, pursuant to the modified contract, which is a binding 
contract, the T shareholders will receive 60 P shares (an additional 
20 shares as compared to the original contract) and $60 of cash in 
exchange for all of the outstanding T stock. In addition, on March 
31 of year 1, the value of the P stock is $.40 per share. Under this 
paragraph (e)(2), although there was a binding contract providing 
for fixed consideration as of January 3 of year 1, terms of that 
contract relating to the consideration to be provided to the target 
shareholders were modified on April 1 of year 1. Nonetheless, the 
modification has the sole effect of providing for the issuance of 
additional P shares to the T shareholders. In addition, the 
execution of the terms of the contract without regard to the 
modification would have resulted in the preservation of a 
substantial part of the value of the T shareholders' proprietary 
interest in T because, for continuity of interest purposes, the T 
stock would have been exchanged for $40 of P stock and $60 of cash. 
Pursuant to paragraph (e)(2)(ii)(B)(2) of this section, the 
modification is not treated as a modification for purposes of 
paragraph (e)(2)(ii)(B)(1) of this section. Accordingly, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on the pre-
signing date. Because, for continuity of interest purposes, the T 
stock is exchanged for $60 of P stock and $60 of cash, the 
transaction preserves a substantial part of the value of the 
proprietary interest in T. Therefore the transaction satisfies the 
continuity of interest requirement.

    Example 6. New issuance. The facts are the same as in Example 1, 
except that, instead of cash, the T shareholders will receive a new 
class of P securities that will be publicly traded. In the 
aggregate, the securities will have a stated principal amount of $60 
and bear interest at the average LIBOR (London Interbank Offered 
Rates) during the 10 days prior to the potential reorganization. If 
the T shareholders had been issued the P securities on January 2 of 
year 1, the P securities would have had a value of $60 (determined 
by reference to the value of comparable publicly traded securities). 
Whether the transaction satisfies the continuity of interest 
requirement is determined by reference to the value of the P stock 
and the P securities to be issued to the T shareholders on January 2 
of year 1. Under paragraph (e)(2)(iv) of this section, for purposes 
of valuing the new P securities, they will be treated as having been 
issued on the pre-signing date. Because, for continuity of interest 
purposes, the T stock is exchanged for $40 of P stock and $60 of 
other property, the transaction preserves a substantial part of the 
value of the proprietary interest in T. Therefore, the transaction 
satisfies the continuity of interest requirement.
    Example 7. Fixed consideration--continuity not preserved. On 
January 3 of year 1, P and T sign a binding contract pursuant to 
which T will be merged with and into P on June 1 of year 1. Pursuant 
to the contract, 60 shares of the T stock will be exchanged for $80 
of cash and 40 shares of the T stock will be exchanged for 20 shares 
of P stock. On January 2 of year 1, the value of the P stock is $1 
per share. On June 1 of year 1, T merges with and into P pursuant to 
the terms of the contract. This contract provides for fixed 
consideration and therefore whether the transaction satisfies the 
continuity of interest requirement is determined by reference to the 
value of the P stock on the pre-signing date. However, applying the 
signing date rule, the P stock represents only 20 percent of the 
value of the total consideration to be received by the T 
shareholders. Accordingly, based on the economic realities of the 
exchange, the transaction does not preserve a substantial part of 
the value of the proprietary interest in T. Therefore, the 
transaction does not satisfy the continuity of interest requirement.

    Example 8. Anti-dilution clause. (i) Absence of anti-dilution 
clause. On January 3 of year 1, P and T sign a binding contract 
pursuant to which T will be merged with and into P on June 1 of year 
1. Pursuant to the contract, the T shareholders will receive 40 P 
shares and $60 of cash in exchange for all of the outstanding stock 
of T. The contract does not contain a customary anti-dilution 
provision. The P stock is listed on an established market. On 
January 2 of year 1, the value of the P stock is $1 per share. On 
April 10 of year 1, P issues its stock to effect a stock split; each 
shareholder of P receives an additional share of P for each P share 
that it holds. On April 11 of year 1, the value of the P stock is 
$.50 per share. Because P altered its capital structure between 
January 3 and June 1 of year 1 in a manner that materially alters 
the economic arrangement of the parties, under paragraph 
(e)(2)(iii)(E) of this section, the contract is not treated as a 
binding contract that provides for fixed consideration. Accordingly, 
whether the transaction satisfies the continuity of interest 
requirement cannot be determined by reference to the value of the P 
stock on January 2 of year 1.
    (ii) Adjustment for anti-dilution clause. The facts are the same 
as in paragraph (i) of this Example 8 except that the contract 
contains a customary anti-dilution provision, and the T shareholders 
receive 80 P shares and $60 of cash in exchange for all of the 
outstanding stock of T. Under paragraph

[[Page 78544]]

(e)(2)(iii)(E) of this section, the contract is treated as a binding 
contract that provides for fixed consideration as of January 3 of 
year 1. Therefore, whether the transaction satisfies the continuity 
of interest requirement is generally determined by reference to the 
value of the P stock on January 2 of year 1. However, under 
paragraph (e)(2)(iii)(E) of this section, the value of the P stock 
on the pre-signing date must be adjusted to take the stock split 
into account. For continuity of interest purposes, the T stock is 
exchanged for $40 of P stock (($1/2) x 80) and $60 of cash. 
Therefore, the transaction satisfies the continuity of interest 
requirement.

    Example 9. Shareholder election. On January 3 of year 1, P and T 
sign a binding contract pursuant to which T will be merged with and 
into P on June 1 of year 1. On January 2 of year 1, the value of the 
P stock and the T stock is $1 per share. Pursuant to the contract, 
at the shareholders' election, each share of T's 100 shares will be 
exchanged for cash of $1, or alternatively, P stock. The contract 
provides that the determination of the number of shares of P stock 
to be exchanged for a share of T stock is made using the value of 
the P stock on the last business day before the first date there is 
a binding contract (that is, $1 per share). The contract further 
provides that, in the aggregate, 40 shares of P stock and $60 will 
be delivered, and contains a proration mechanism in the event that 
either item of consideration is oversubscribed. On the closing date, 
the value of the P stock is $.20 per share, and all target 
shareholders elect to receive cash. Pursuant to the proration 
provision, each target share is exchanged for $.60 of cash and $.08 
of P stock. Pursuant to paragraph (e)(2)(iii)(A) of this section, 
the contract provides for fixed consideration because it provides 
for the number of shares of P stock and the amount of money to be 
exchanged for all the proprietary interests in the target 
corporation. Furthermore, pursuant to paragraph (e)(2)(iii)(B) of 
this section, the contract provides for fixed consideration because 
the number of shares of issuing corporation stock to be provided to 
the target corporation shareholders is determined using the pre-
signing date value of P stock. Accordingly, whether the transaction 
satisfies the continuity of interest requirement is determined by 
reference to the value of the P stock on January 2 of year 1. 
Because, for continuity purposes, the T stock is exchanged for $40 
of P stock and $60 of cash, the transaction preserves a substantial 
part of the value of the proprietary interest in T. Therefore, the 
transaction satisfies the continuity of interest requirement.

    Example 10. Contingent adjustment based on the value of the 
issuing corporation stock--continuity not preserved. On January 3 of 
year 1, P and T sign a binding contract pursuant to which T will be 
merged with and into P on June 1 of year 1. On January 2 of year 1, 
the value of the P stock is $1 per share. Pursuant to the contract, 
if the value of the P stock does not decrease after January 2 of 
year 1, the T shareholders will receive 40 P shares and $60 of cash 
in exchange for all of the outstanding stock of T. Furthermore, the 
contract provides that the T shareholders will receive $.16 of 
additional P shares and $.24 for every $.01 decrease in the value of 
one share of P stock after January 2 of year 1. On June 1 of year 1, 
T merges with and into P pursuant to the terms of the contract. On 
that date, the value of the P stock is $.40 per share. Pursuant to 
the terms of the contract, the consideration is adjusted so that the 
T shareholders receive 24 more P shares ((60 x $.16)/$.40) and 
$14.40 more cash (60 x $.24) than they would absent an adjustment. 
Accordingly, at closing the T shareholders receive 64 P shares and 
$74.40 of cash. Because the contract provides that additional P 
shares and cash will be delivered to the T shareholders if the value 
of the stock of P decreases after January 2 of year 1, under 
paragraph (e)(2)(iii)(C)(2) of this section, the contract is not 
treated as providing for fixed consideration, and therefore whether 
the transaction satisfies the continuity of interest requirement 
cannot be determined by reference to the value of the P stock on 
January 2 of year 1. For continuity of interest purposes, the T 
stock is exchanged for $25.60 of P stock (64 x $.40) and $74.40 of 
cash and the transaction does not preserve a substantial part of the 
value of the proprietary interest in T. Therefore, the transaction 
does not satisfy the continuity of interest requirement.
    Example 11. Contingent adjustment to boot based on the value of 
the target corporation stock--continuity not preserved. On January 3 
of year 1, P and T sign a binding contract pursuant to which T will 
be merged with and into P on June 1 of year 1. On January 2 of year 
1, T has 100 shares outstanding, and each T share is worth $1. On 
January 2 of year 1, each P share is worth $1. Pursuant to the 
contract, if the value of the T stock does not increase after 
January 3 of year 1, the T shareholders will receive 40 P shares and 
$60 of cash in exchange for all of the outstanding stock of T. 
Furthermore, the contract provides that the T shareholders will 
receive $1 of additional cash for every $.01 increase in the value 
of one share of T stock after January 3 of year 1. On June 1 of year 
1, the value of the T stock is $1.40 per share and the value of the 
P stock is $.75 per share. Pursuant to the terms of the contract, 
the consideration is adjusted so that the T shareholders receive $40 
more cash (40 x $1) than they would absent an adjustment. 
Accordingly, at closing the T shareholders receive 40 P shares and 
$100 of cash. Because the contract provides the number of shares of 
P stock and the amount of money to be exchanged for all the 
proprietary interests in T, and the contingent adjustment to the 
cash consideration is not based on changes in the value of the P 
stock, P assets, or any surrogate thereof, after January 2 of year 
1, there is a binding contract providing for fixed consideration as 
of January 3 of year 1. Therefore, whether the transaction satisfies 
the continuity of interest requirement is determined by reference to 
the value of the P stock on January 2 of year 1. For continuity of 
interest purposes, the T stock is exchanged for $40 of P stock (40 x 
$1) and $100 of cash. Therefore, the transaction does not satisfy 
the continuity of interest requirement.

    Example 12. Contingent adjustment to stock based on the value of 
the target corporation stock--continuity preserved. On January 3 of 
year 1, P and T sign a binding contract pursuant to which T will be 
merged with and into P on June 1 of year 1. On that date T has 100 
shares outstanding, and each T share is worth $1. On January 2 of 
year 1, each P share is worth $1. Pursuant to the contract, if the 
value of the T stock does not decrease after January 3 of year 1, 
the T shareholders will receive 40 P shares and $60 of cash in 
exchange for all of the outstanding stock of T. Furthermore, the 
contract provides that the T shareholders will receive $.40 less P 
stock and $.60 less cash for every $.01 decrease in the value of one 
share of T stock after January 3 of year 1. The contract also 
provides that the number of P shares by which the consideration will 
be reduced as a result of this adjustment will be determined based 
on the value of the P stock on January 2 of year 1. On June 1 of 
year 1, T merges with and into P pursuant to the terms of the 
contract. On that date, the value of the T stock is $.70 per share 
and the value of the P stock is $.75 per share. Pursuant to the 
terms of the contract, the consideration is adjusted so that the T 
shareholders receive 12 fewer P shares ((30 x $.40)/$1) and $18 less 
cash (30 x $.60) than they would absent an adjustment. Accordingly, 
at closing the T shareholders receive 28 P shares and $42 of cash. 
Because the contract provides for the number of shares of P stock 
and the amount of money to be exchanged for all of the proprietary 
interests in T, the contract does not provide for contingent 
adjustments to the consideration based on a change in value of the P 
stock, P assets, or any surrogate thereof, after January 2 of year 
1, and the adjustment to the number of P shares the T shareholders 
receive is determined based on the value of the P shares on January 
2 of year 1, there is a binding contract providing for fixed 
consideration as of January 3 of year 1. Therefore, whether the 
transaction satisfies the continuity of interest requirement is 
determined by reference to the value of the P stock on January 2 of 
year 1. For continuity of interest purposes, the T stock is 
exchanged for $28 of P stock (28 x $1) and $42 of cash. Accordingly, 
the transaction satisfies the continuity of interest requirement.
* * * * *
    (9) Effective/applicability dates--(i) * * *
    (ii) COI measurement date. Paragraph (e)(2) of this section applies 
to transactions occurring pursuant to binding contracts entered into 
after December 19, 2011. For transactions entered into after March 19, 
2010, and occurring pursuant to binding contracts entered into on or 
before December 19, 2011, the parties to the transaction may elect to 
apply the provisions of Sec.  1.368-1T as contained in 26 CFR, Part 1, 
Sec. Sec.  1.301-1.400, revised as of April 1, 2009. However, the 
target corporation, the issuing corporation, the controlling 
corporation of the acquiring corporation if stock thereof is provided 
as consideration in the transaction, and any direct or indirect 
transferee of transferred basis property from any of the foregoing, may 
not elect to apply the

[[Page 78545]]

provisions of Sec.  1.368-1T as contained in 26 CFR, Part 1, Sec. Sec.  
1.301-1.400, revised as of April 1, 2009, unless all such taxpayers 
elect to apply such provisions. This election requirement will be 
satisfied if none of the specified parties adopts inconsistent 
treatment. For transactions entered into on or before March 19, 2010, 
see Sec.  1.368-1T as contained in 26 CFR, Part 1, Sec. Sec.  1.301-
1.400, revised as of April 1, 2009.


Sec.  1.368-1T  [Removed]

0
Par. 3. Section 1.368-1T is removed.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.

    Approved: December 6, 2011.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2011-32078 Filed 12-16-11; 8:45 am]
BILLING CODE 4830-01-P