September 4, 2008

IRS PROPOSAL: CERTAIN “STOCK DISPOSITIONS” COULD BE DEEMED ASSET SALES

The IRS has proposed regulations under section 336(e) of the Internal Revenue Code which would, effective for dispositions on or after the regulations are published as final regulations, allow a parent corporation to make an election to treat certain “qualified stock dispositions” of subsidiary stock as a deemed sale of the subsidiary corporation’s assets. The deemed asset sale election allows for a step-up in the subsidiary’s tax basis in its assets for US federal income tax purposes.

A “qualified stock disposition” is any transaction or series of transactions in which at least 80 percent of the stock (measured by voting power and value) of a domestic corporation (target) is either sold, exchanged or distributed, or disposed of in any combination of sales, exchanges or distributions, by another domestic corporation (parent) during a 12-month disposition period.

While the proposed regulations apply to acquisitions by corporations as well as noncorporate persons, such as individuals and other entities, the proposed regulations do not apply to transactions in which either the parent seller or the target is a foreign corporation, nor to transactions between related persons (with related party status determined immediately after the transaction).

Sample transactions in which this election could be of importance include the following:

  • Taxable spin-off — The parent would recognize gain under section 311(b) on a distribution of target stock in a transaction not qualifying for non-recognition of gain under section 355(c) — for example, because the parent or target does not satisfy the “active business” requirement, or because the “continuity of interest” requirement is not satisfied.


  • Tax-free spin-off, but parent recognizes gain — The parent would recognize gain under section 355(d) or 355(e) on a distribution of target stock in a transaction otherwise qualifying for non-recognition treatment with respect to the parent’s shareholders—for example, because 50 percent or more of the target or parent stock was recently acquired by purchase or because the distribution is part of a plan pursuant to which 50 percent or more of the parent or target stock will be acquired.


  • Taxable sale/338(h)(10) election unavailable — The parent would recognize gain on a taxable sale of target stock to a non-corporate purchaser, when a section 338(h)(10) election is not available.

In the absence of this election, there is the possibility of triple tax if the target were to subsequently sell its assets at a gain and distribute the proceeds to target shareholders, with the parent recognizing gain on the disposition based on the difference between the sales price of the target stock or the fair market value of the target stock and the parent’s basis in the target stock, target recognizing gain on the subsequent sale of its assets, and the target shareholder’s recognizing income or gain based on the target’s subsequent distribution of after-tax sale proceeds.

The results of a section 336(e) election are intended to coincide with those of a section 338(h)(10) election. Whenever possible, the proposed regulations rely upon and use the structure and principles established under section 338(h)(10) and the underlying regulations.

The purchaser/recipient of target stock will still be treated as acquiring target stock and not target assets, whether or not a section 336(e) election is made, but the section 336(e) election could nevertheless affect the recipient. For example, in the case of a taxable distribution of target stock to a parent’s shareholders, any increase in the parent’s earnings and profits as a result of the deemed asset disposition and deemed liquidation may increase the amount of the distribution treated as a taxable dividend.