The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 9, April 2001, Panel Publishers, New York, NY.

ASSET ALLOCATION REGS FINALIZED

By Robert W. Wood

In mid-February, the IRS published final regulations on determining the amount realized (and the amount of basis allocated) to each asset transferred in a deemed or actual asset acquisition. The Treasury Decision (T.D. 8940), adopts (with modifications) regulations that were proposed in August of 1999 (REG-107069-97), and the temporary regulations that were published in January of 2000 (T.D. 8858).

Looking through regulations on purchase price allocations may not be everyone's idea of an exciting evening by the fire. Still, these final regulations are quite important. If one doesn't want to read them cover to cover, there are at least a handful of provisions in the final regulations that are truly important to note. One of them, certainly, is the anti-abuse rule. The proposed regulations had set out an anti-abuse rule that seemed extremely broad in scope. It basically could apply wherever there was a transfer of assets from their original location to more than an insignificant extent. This "to more than an insignificant extent" phrase was changed in the final regulations to the much more flexible "primarily." The idea, says the Service, is to clarify that some continuing use in the original location of an asset transferred to or from the target is permissible.

Another change concerns purchasers acquire stock of a subsidiary member of a consolidated group. It has been argued that such a purchaser could, after acquiring the stock of the target, cause the target to sell all of its assets to another person later on the closing date (in other words, later during the same day), and then make a unilateral Section 338(g) election. Perhaps this is just arguing about how many angels can dance on the head of a pin. Still, it seemed like a significant issue.

The final regulations, therefore, provide a new rule that requires the application of a "next day rule" in a Section 338 context. When the target engages in a transaction outside the ordinary course of business on the acquisition date after the event resulting in a qualified stock purchase, the next day rule applies.

Single Definition of Purchase

The final regulations provide a single definition of the term "purchase," applying to both targets and target affiliates. Under the new definition, stock in a target or target affiliate may be considered if, under general principles of tax law, the purchasing corporation owns stock of the target or target affiliate meeting the requirements of Section 1504(a)(2), notwithstanding that no amount may be paid for or allocated to the stock.

Transactions After Qualified Stock Purchases

Since 1995, the regulations under Section 338 have provided special rules that apply to certain transfers of target assets following a qualified stock purchase of a target's stock if a Section 338 election is not made for the target. These provisions modify the normal operation of the "continuity of interest" requirement under Section 368, and the interpretation of the term "shareholder" for purposes of Section 368(a)(1)(D).

The idea of these rules was to effectuate Congressional intent in replacing now-repealed Section 334(b)(2) with Section 338. Remember the very simple and straightforward Section 334(b)(2) liquidation — that Congress thought would be so much simpler by enacting Section 338? Every so often, I long for the old and simple two-year liquidation rule that was replaced by the behemoth of Section 338!. The reason for the special rules governing transactions after qualified stock purchases was the notion that the deemed sale results provided by Section 338 should not be available through transactions with the purchasing group after the acquisition (these rules are located in Section 1.338-3(d) of the regulations).

The 1995 amendments did not provide any special rule to modify the application of these rules for C reorganizations. However, the newly-published final regulations indicate that the considerations justifying the modified application of the continuity of interest rule (and the shareholder definition for D reorganizations) also justify an analogous modification of the "solely for voting stock" requirement for post-acquisition C reorganizations.

Thus, the final regulations provide that consideration other than voting stock which is issued in connection with a qualified stock purchase will be ignored in determining whether a subsequent transfer of assets by the target corporation to a member of its new affiliate group satisfies the "solely for voting stock" requirement of a C reorganization. (For this rule, see Reg. §1.338-3(d)(4).)

Treatment of Liabilities

The proposed regulations had eliminated the prior distinction between "modified aggregate deemed sale price" (sometimes called "MADSP") on the one hand, and "aggregate deemed sale price" (or "ADSP") on the other. This distinction was apparently based on the notion that the new target generally will not bear the tax liability of the deemed sale where a Section 338(h)(10) election has been made. On the other hand, the new target generally will bear the tax liability where a regular Section 338 election has been made. The Preamble to the new final regulations indicates that these generalizations were not universally correct. And, there was a fair amount of commentary on this topic.

Instead of providing more specific guidance which the Service now apparently believes would be inconsistent with the overall philosophy of deferring to general tax principles governing actual transactions, the final regulations simplify the discussion of liabilities. Except for the fact that the new target remains liable for the old target's tax liabilities, and that a buyer's assumption of a seller's income tax liability with respect to the sale causes the consideration to "gross up" the liability, a tax liability is treated like any other type of liability. The status of any particular type of tax liability as a liability includable in either ADSP or adjusted grossed-up basis should be determined under general principles. See Reg. §1.338-1(b)(3)(i).

Various other topics are also detailed in the final regulations, including:

For further details of these regulations, see 66 Fed. Reg. 9925-9957, T.D. 8940, Tax Analysts Doc. No. 2001-4434, 2001 TNT 30-5.

Asset Allocation Regs Finalized, Vol. 9, No. 9, M&A Tax Report (April 2001), p. 1.