Federal Register: PROPOSED RULES Income taxes: [26 CFR Part 1]

DEPARTMENT OF THE TREASURY

CFR Citation: 26 CFR Part 1

RIN ID: RIN 1545-BC94

REG ID: [REG-123365-03]

NOTICE: PROPOSED RULES

ACTION: Income taxes:

DOCUMENT ACTION: Notice of proposed rulemaking.

SUBJECT CATEGORY: Guidance Regarding the Active Trade or Business Requirement Under Section 355(b)

DATES: Written or electronic comments and requests for a public hearing must be received by August 6, 2007.

DOCUMENT SUMMARY: This document contains proposed regulations that provide guidance regarding the active trade or business requirement under section 355(b) of the Internal Revenue Code. These proposed regulations provide guidance on issues involving the active trade or business requirement under section 355(b), including guidance resulting from the enactment of section 355(b)(3). These proposed regulations will affect corporations and their shareholders.

SUMMARY: Active trade or business requirement section 355 guidance,

SUPPLEMENTAL INFORMATION

Background and Explanation of Provisions
A. Background and Overview of the Key Aspects of the Proposed Regulations

1. Background

Section 355(a) of the Internal Revenue Code (Code) provides that, under certain circumstances, a corporation may distribute stock and securities of a corporation it controls to its shareholders and security holders without causing either the corporation or its shareholders and security holders to recognize income, gain or loss. Sections 355(a)(1)(C) and 355(b)(1) generally require that the distributing corporation (distributing) and controlled corporation (controlled) each be engaged, immediately after the distribution, in the active conduct of a trade or business. Section 355(b)(2)(A) provides that a corporation shall be treated as engaged in the active conduct of a trade or business if and only if it is engaged in the active conduct of a trade or business, or substantially all of its assets consist of stock and securities of a corporation controlled by it (immediately after the distribution) which is so engaged. For this purpose, control is defined under section 368(c). All references to control in this preamble are references to control as defined in section 368(c).

Section 202 of the Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109222 (120 Stat. 345, 348) (TIPRA) amended section 355(b) by adding section 355(b)(3). Section 355(b)(3)(A), as amended by Division A, Section 410 of the Tax Relief and Health Care Act of 2006, Public Law 109432 (120 Stat. 2922, 2963), provides that in the case of any distribution made after May 17, 2006, a corporation shall be treated as meeting the requirement of section 355(b)(2)(A) if and only if such corporation is engaged in the active conduct of a trade or business. Section 355(b)(3)(B) provides that for purposes of section 355(b)(3)(A) (and, consequently, section 355(b)(2)(A)), all members of such corporation's separate affiliated group (SAG) shall be treated as one corporation (SAG rule). For purposes of the preceding sentence, a corporation's SAG is the affiliated group which would be determined under section 1504(a) if such corporation were the common parent and section 1504(b) did not apply.

Thus, the separate affiliated group of distributing (DSAG) is the affiliated group that consists of distributing as the common parent and all corporations affiliated with distributing through stock ownership described in section 1504(a)(1)(B) (regardless of whether the corporations are includible corporations under section 1504(b)). The separate affiliated group of controlled (CSAG) is determined in a similar manner (with controlled as the common parent). Accordingly, unlike prior law, a corporation is not treated as engaged in the active conduct of a trade or business solely as a result of substantially all of its assets consisting of stock, or stock and securities, of one or more
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corporations that are merely controlled by it (immediately after the distribution) each of which is engaged in the active conduct of a trade or business.

Section 355(b)(2)(B) requires that the trade or business have been actively conducted throughout the fiveyear period ending on the date of the distribution (predistribution period). Section 355(b)(2)(C) provides that the trade or business must not have been acquired in a transaction in which gain or loss was recognized, in whole or in part, within the predistribution period. Section 355(b)(2)(D), as amended in 1987 and 1988, provides that control of a corporation which (at the time of acquisition of control) was conducting the trade or business must not have been directly or indirectly acquired by any distributee corporation or by distributing during the predistribution period in a transaction in which gain or loss was recognized, in whole or in part. See Public Law 100203 (101 Stat. 1330, 1330411 (1987)) and Public Law 100647 (102 Stat. 3342, 3605 (1988)). For purposes of section 355(b)(2)(D), all distributee corporations which are members of the same affiliated group (as defined in section 1504(a) without regard to section 1504(b)) shall be treated as one distributee corporation. The requirements under section 355(b) are collectively referred to in this preamble as either the active trade or business requirement or the requirements of section 355(b).

Accordingly, the requirements of section 355(b) are generally satisfied if distributing and controlled each have engaged in the active conduct of a trade or business throughout the predistribution period, are so engaged immediately after the distribution, and there have been no acquisitions of control of distributing or controlled during such period.

The active trade or business requirement is one of several requirements that must be satisfied in order for a distribution to qualify under section 355. For example, section 355(a)(1)(B) states that a transaction must not be used principally as a device for distributing the earnings and profits of distributing, controlled, or both. In addition, Sec. 1.3552(b)(1) provides that section 355 will apply to a transaction only if it is carried out for one or more corporate business purposes.

The active trade or business requirement, in tandem with the device prohibition and business purpose requirement, limits a corporation's ability to convert dividend income into capital gain through the use of a section 355 distribution. See S. Rep. No. 831622, at 5051 (1954) and Coady v. Commissioner, 33 TC 771, 777 (1960), acq., 19652 CB 4, aff'd, 289 F.2d 490 (6th Cir. 1961). In Coady, the Tax Court stated that one purpose of section 355(b) is ``to prevent the taxfree separation of active and inactive assets into active and inactive corporate entities.'' The court also stated that a taxfree separation under section 355 ``will involve the separation only of those assets attributable to the carrying on of an active trade or business * * *.'' Coady, 33 TC at 777.

The IRS and Treasury Department are aware of a number of issues that have arisen regarding the active trade or business requirement, including issues arising as a result of the enactment of section 355(b)(3). The following sections describe the active trade or business requirement and the significant issues that are addressed in these proposed regulations. No inference should be drawn from these proposed regulations regarding the definition of trade or business or active trade or business under any other provision of the Code or Treasury regulations, even if such provision specifically references section 355. Comments are requested as to whether or the extent to which these proposed regulations should apply to other provisions that specifically reference section 355.

2. Overview of the Key Aspects of the Proposed Regulations

Principally, these proposed regulations provide guidance regarding the application of section 355(b)(3), the application of the acquisition rules in section 355(b)(2)(C) and (D) and the impact thereon of section 355(b)(3), and the determination of whether a corporation is engaged in a trade or business through the attribution of trade or business assets and activities from a partnership.

As discussed in section A.1. of this preamble, section 355(b)(3) treats all SAG members as one corporation. Accordingly, as discussed in detail in section B. of this preamble, these proposed regulations provide that subsidiary SAG members (SAG members that are not the common parent of such SAG) are treated like divisions of distributing or controlled, as the case may be. These proposed regulations also clarify that controlled may be a DSAG member during the pre distribution period. Most significantly, these provisions treat a stock acquisition that results in a corporation becoming a subsidiary SAG member as an asset acquisition. As a result, the applicability of section 355(b)(2)(D) is substantially reduced. Further, as discussed in section E. of this preamble, this treatment alters the analysis regarding whether an existing business may be expanded as a result of a stock acquisition.

Notwithstanding that these proposed regulations provide that certain stock acquisitions may be treated as asset acquisitions under section 355(b)(3), purchases of stock of controlled during the pre distribution period may be subject to section 355(a)(3)(B). See section F. of this preamble.

As discussed in detail in section C. and section D. of this preamble, these proposed regulations interpret section 355(b)(2)(C) and (D) to mean that a corporation generally cannot use its assets to acquire a trade or business to be relied on to facilitate a distribution under section 355. Accordingly, these proposed regulations generally prohibit acquisitions made in exchange for distributing's assets even if no gain or loss is recognized in connection with the acquisition. Further, these proposed regulations provide certain exceptions to the literal application of section 355(b)(2)(C) and (D) for acquisitions in which gain or loss is recognized where the purposes of that section are not violated. However, these proposed regulations do not disregard the recognition of gain or loss in transactions between affiliates unless the affiliates are members of the same SAG. See section G. of this preamble.

Section I. of this preamble explains how these proposed regulations clarify a corporation's ability to be attributed the trade or business assets and activities of a partnership. Most significantly, these partnership provisions yield results similar to the rules regarding the satisfaction of the continuity of business enterprise requirement, and thus allow a partner to be attributed the partnership's trade or business assets and activities where the partner owns a significant interest in the partnership.

B. TIPRA

Congress enacted section 355(b)(3) because it was concerned that, prior to a distribution under section 355, corporate groups conducting business in separate corporate entities often had to undergo elaborate restructurings to place active businesses in the proper entities to satisfy the active trade or business requirement. See, for example, H.R. Rep. No. 109304, at 53, 54 (2005). By treating a SAG as one corporation, Congress believed that it would greatly reduce the need for such restructurings. However, the introduction of the affiliation based SAG rule into the active trade or business requirement [[Page 26014]]
significantly impacts the application of section 355(b)(2) in certain situations.

Accordingly, consistent with congressional intent, these proposed regulations provide several rules interpreting section 355(b)(3) in a manner that diminishes the need for predistribution restructurings while fully integrating the various provisions in section 355(b). These rules are intended to more closely reflect the way corporate groups structure their businesses while, at the same time, ensuring that the purposes underlying section 355(b)(2)(C) and (D) are not circumvented.

Specifically, to accomplish these objectives the IRS and Treasury Department believe that it is appropriate to apply the SAG rule by disregarding the separate existence of all subsidiary SAG members for purposes of determining whether distributing and controlled satisfy the requirements of section 355(b).

1. SAG Rule Applicable During the PreDistribution Period

The IRS and Treasury Department believe that it is appropriate to apply the SAG rule for purposes of determining whether the trade or business was actively conducted throughout the predistribution period and whether the requirements of section 355(b)(2)(C) or (D) have been violated.

The SAG rule applies for purposes of determining whether distributing and controlled are engaged in the active conduct of a trade or business immediately after the distribution. Specifically, the legislative history to section 355(b)(3) describes the corporations included in the DSAG and CSAG by reference to postdistribution affiliation. See H.R. Rep. No. 109455, at 88 (2006) (Conf. Rep.); H.R. Rep. No. 109304, at 54 (2005). However, there is nothing in the statute or legislative history that precludes the SAG rule from applying throughout the predistribution period.

The IRS and Treasury Department believe that applying the SAG rule throughout the predistribution period is consistent with the single entity approach. If the SAG rule is not applied during the pre distribution period, there may be unintended consequences. For example, assume that an active trade or business is segmented among the SAG members in a manner that precludes any one member from individually being treated as engaged in an active trade or business. Under the SAG rule the segments are aggregated and may be treated as a single active trade or business immediately after the distribution. However, if the SAG rule is not applied throughout the predistribution period, there would be no fiveyear active trade or business because no one member would be engaged in that trade or business. The IRS and Treasury Department do not believe there is any policy reason to apply the SAG rule in such a disparate manner. Accordingly, these proposed regulations apply the SAG rule throughout the predistribution period. This approach is consistent with Congressional intent to view SAGs as an aggregate for purposes of the active trade or business requirement.

Because the SAG rule treats all SAG members as one corporation, the separate existence of subsidiary SAG members are disregarded and all assets (and activities) owned (and performed) by SAG members are treated as owned (and performed) by distributing or controlled, as the case may be, for purposes of determining whether distributing or controlled is engaged in a fiveyear active trade or businesses. Therefore, where one DSAG or CSAG member satisfies the active trade or business requirement, distributing or controlled, as the case may be, satisfies the active trade or business requirement.

Consistent with the foregoing, these proposed regulations provide that the SAG rule also applies for purposes of determining whether there has been an impermissible acquisition, as discussed in section C. of this preamble, of a trade or business during the predistribution period under section 355(b)(2)(C) or (D). Because the SAG rule disregards the separate existence of subsidiary SAG members, these proposed regulations generally treat stock acquisitions that result in a corporation becoming a subsidiary SAG member as a direct acquisition of any assets (or activities) owned (or performed) by the acquired corporation. Further, these proposed regulations generally disregard transfers of assets (or activities) that are owned (or performed) by the SAG immediately before and immediately after the transfer. Such transfers cannot result in an acquisition. Under the SAG rule, such transfers have the effect of a transfer between divisions of a single corporation.
2. The DSAG May Include CSAG Members Throughout the PreDistribution Period

The IRS and Treasury Department believe that it is appropriate to include the CSAG members in the DSAG during the predistribution period if the applicable affiliation requirements are satisfied. The IRS and Treasury Department believe this approach is consistent with the purposes of section 355(b)(3) and the SAG rule's general singleentity approach, and provides flexibility for the division of SAG members between distributing and controlled.

For example, assume that during the predistribution period, segments or portions of the business to be conducted by controlled are held by distributing (or other subsidiaries that are not directly or indirectly owned by controlled) and that distributing intends to transfer those portions of the business to controlled immediately prior to the distribution. If the DSAG does not include the CSAG members throughout the predistribution period, it is possible that neither SAG would be engaged in the active conduct of that trade or business throughout the predistribution period, because neither SAG would have all the appropriate segments of that business to satisfy the active trade or business requirement. The IRS and Treasury Department believe that such a result is inconsistent with the purposes of section 355(b)(3). Accordingly, by including the CSAG members in the DSAG throughout the predistribution period if the ownership requirements are satisfied, these proposed regulations give appropriate credit to fiveyear active trades or businesses regardless of how the assets and activities may be owned (and performed) by the SAG members throughout the predistribution period.

3. Acquisitions of Stock in Subsidiary SAG Members

Section 355(b)(3) treats SAG members as one corporation for purposes of satisfying the requirements of section 355(b). As a result, the SAG rule alters the application of section 355(b)(2)(C) and (D) with respect to the acquisition of stock of a corporation that is or becomes a subsidiary SAG member. Further, because section 355(b)(3) supplanted the holding company rule in section 355(b)(2)(A), section 355(b)(2)(D) is now only applicable to certain acquisitions of stock of distributing and certain acquisitions of stock of controlled.

The SAG rule alters the application of section 355(b)(2)(C) and (D) with respect to the acquisition of stock of a corporation that is or becomes a subsidiary SAG member. Section 355(b)(3) treats SAG members as one corporation for purposes of satisfying section 355(b). Consequently, a transaction that results in a corporationincluding controlledbecoming a subsidiary SAG member is treated as a direct acquisition of all the assets (and activities) owned (and performed) by the acquired corporation
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at the time of the acquisition. Thus, such an acquisition is tested under section 355(b)(2)(C) rather than section 355(b)(2)(D). Nevertheless, as discussed in sections B.4 and C.3.a.ii. of this preamble, section 355(b)(2)(D) has continuing limited application.

In addition, an acquisition that results in a corporation becoming a subsidiary SAG member in a transaction in which gain or loss is recognized might satisfy the requirements of section 355(b)(2)(C) as an expansion of one of the acquiring SAG's existing businesses, as discussed in section E. of this preamble. Finally, because the SAG rule treats subsidiary SAG members like divisions, the acquisition of additional stock of a current subsidiary SAG member has no effect for purposes of applying section 355(b)(2)(C).
4. Acquisitions of Control of Controlled Where It Is Not a DSAG Member

While section 355(b)(2)(D) is not applicable to acquisitions of stock of subsidiary SAG members, the requirements of section 355(b)(2)(D) must be satisfied where the DSAG acquires control of controlled where controlled is not and does not become a DSAG member prior to the distribution. This rule applies where distributing acquires stock constituting control of controlled but not stock meeting the requirements of section 1504(a)(2).

C. Acquisitions of a Trade or Business

Section 355(b)(2)(C) and (D) generally provide that a trade or business acquired, directly or indirectly, during the predistribution period will not satisfy the active trade or business requirement unless it was acquired in a transaction in which no gain or loss was recognized. The IRS and Treasury Department believe that these provisions have been and should continue to be interpreted and applied in a manner consistent with the overall purposes of section 355. For example, in certain situations, transactions in which gain or loss is recognized have been found not to violate the purposes of section 355(b)(2)(C) and (D). See, for example, C.I.R. v. Gordon, 382 F.2d 499 (2d Cir.1967), rev'd on other grounds, 391 U.S. 83 (1968) (discussed in section C.2. of this preamble). Additionally, while the enactment of section 355(b)(3) substantially revised how distributing and controlled may satisfy the active trade or business requirement, TIPRA did not contain conforming amendments to section 355(b)(2)(C) and (D). As such, the IRS and Treasury Department also believe that a purposebased interpretation of section 355(b)(2) is essential to harmonize these provisions. Accordingly, these proposed regulations interpret and apply section 355(b)(2)(C) and (D), and section 355(b)(3), in a manner consistent with their purpose, even if not always consistent with the literal language of the statute.

1. Purpose of Section 355(b)(2)(C) and (D)

Section 355 ``contemplates that a taxfree separation shall involve only the separation of assets attributable to the carrying on of an active business.'' S. Rep. No. 831622, at 50 (1954). The active trade or business requirement is intended to ensure that only these types of separations qualify under section 355. Further, it operates as an additional safeguard to the device prohibition (a prohibition against disguised dividends) in section 355(a)(1)(B).

As discussed in section A. of this preamble, the active trade or business requirement is designed to limit the potential for the conversion of dividend income into capital gain through a section 355 distribution. Specifically, section 355(b)(2)(C) and (D) is intended to prevent dividend avoidance otherwise available through the purchase of a new business in order to facilitate a taxfree distribution under section 355. See Gordon, 382 F.2d at 506507 (stating that ``[t]o safeguard against this possibility, subsections (b)(2)(C) and (D) prohibit acquisition of a trade or business, or of a corporation, in a transaction in which gain or loss was recognized.''). Thus, the statute prohibits acquisitions of a trade or business in which gain or loss is recognized. Nevertheless, the recognition of gain or loss, in and of itself, does not violate the purposes of section 355. Rather, recognition of gain or loss is generally indicative of the type of consideration used in the transaction. Typically, a transaction in which gain or loss is recognized consists of an acquisition in exchange for assets. On the other hand, a transaction in which no gain or loss is recognized typically consists of an acquisition in exchange for the corporation's equity.

Accordingly, the IRS and Treasury Department believe that the common purpose of section 355(b)(2)(C) and (D) is to prevent distributing from using assetsinstead of its stock or stock of a corporation in control of distributingto acquire a new trade or business in anticipation of distributing that trade or business (or facilitating the distribution of another trade or business) to its shareholders in a taxfree distribution. A distribution of a corporation holding assets that would have been used to effect a purchase generally would be treated as a dividend and section 355 was not intended to allow a taxfree separation of such assets. Acquiring a new trade or business using these assets and distributing it (or an existing trade or business) would effectively accomplish such a separation, and should not qualify under section 355.

Complementing the principle that the common purpose of section 355(b)(2)(C) and (D) is to prevent distributing from using it assets instead of its stock, or stock of a corporation in control of distributingto acquire a new trade or business is the notion that section 355 is intended to apply to separations of active trades or businesses with which the participants have a historic relationship. Section 355, like the reorganization provisions, involves the maintenance by the shareholders of a continuing interest in their business or businesses in modified corporate forms. For section 355 to apply to a divisive transaction, it is essential that distributing and its shareholders have a historic relationship with the active trades or businesses in the two resulting corporations. See, for example, Sec. 1.3551(b) (``[section 355] applies only to the separation of existing businesses that have been in active operation for at least five years * * * and which, in general, have been owned, directly or indirectly, for at least five years by the distributing corporation''). These requirements ensure that the historic owners of the acquired trade or business are participants in the divisive transaction and minimize the potential for transactions that violate the common purpose of section 355(b)(2)(C) and (D).

Where distributing issues its own equity (or uses the equity of a corporation in control of distributing) to acquire an active trade or business in a transaction in which no gain or loss is recognized, distributing is not acquiring the trade or business in exchange for its assets and the historic owners of the trade or business will be participants in the divisive transaction. In such cases, the common purpose of section 355(b)(2)(C) and (D) is carried out.

Finally, an additional purpose of section 355(b)(2)(D) is to prevent a distributee corporation from acquiring control of distributing in anticipation of a distribution to which section 355 would otherwise apply, enabling the disposition of controlled without the proper recognition of corporate level gain. See H.R. Rep. No. 100 391, at 1080, 10821083 (1987).
[[Page 26016]]

2. Current Law and the Sec. 1.3553(b)(4) Regulations

Under current law, several authorities depart from the literal language of section 355(b)(2)(C) and (D) in order to carry out the common purpose underlying section 355(b)(2)(C) and (D). For example, in Gordon, gain was recognized when distributing transferred a trade or business to controlled. The Second Circuit concluded that, even though gain was recognized, section 355(b)(2)(C) was not violated because new assets were not brought within the combined corporate shells of distributing and controlled. Therefore, the common purpose of section 355(b)(2)(C) and (D) was not violated. Furthermore, Rev. Rul. 69461 (19692 CB 52) held that a firsttier subsidiary's taxable distribution of stock of a secondtier subsidiary to its parent did not violate section 355(b)(2)(D). The ruling stated that section 355(b)(2)(D) is intended to prevent the acquisition of control of a corporation from a party not within the direct or indirect control of distributing. In addition, Rev. Rul. 78442 (19782 CB 143) held that gain under section 357(c) on the transfer from distributing to controlled does not violate section 355(b)(2)(C). Rev. Rul. 78442 stated that section 355(b)(2)(C) is intended to prevent the acquisition of a trade or business by distributing or controlled from an outside party in a taxable transaction within five years of a distribution.

Similarly, Sec. 1.3553(b)(4) (generally applicable to distributions on or before December 15, 1987, but applied in various situations by the IRS administratively to distributions occurring after that date) provides an exception from the literal language of section 355(b)(2)(C) and (D) for the direct or indirect acquisition of a trade or business by one member of an affiliated group from another member of the group, stating that an acquisition from another member of the affiliated group ``is not the type of transaction to which section 355(b)(2)(C) and (D) is intended to apply.'' See Sec. 1.355 3(b)(4)(iii).

Section 1.3553(b)(4) also departs from the literal language of section 355(b) in providing that a trade or business acquired, directly or indirectly, within the predistribution period in a transaction in which the basis of the assets acquired was not determined in whole or in part by reference to the transferor's basis does not qualify under section 355(b)(2), even though no gain or loss was recognized by the transferor. See Sec. 1.3553(b)(4)(i). The reason for this departure is that in some circumstances a transaction in which no gain or loss is recognized may nevertheless constitute a prohibited acquisition of a trade or business in exchange for assets.

3. The Proposed Regulations

Consistent with current law (and Sec. 1.3553(b)(4)), these proposed regulations generally prohibit acquisitions in which gain or loss was recognized but apply section 355(b)(2)(C) and (D) in a manner consistent with their purposes. Accordingly, these proposed regulations provide for certain exceptions for acquisitions in which gain or loss is recognized, and prohibit certain transactions in which no gain or loss is recognized.
a. Certain Transactions in Which Recognized Gain or Loss Is Disregarded

Under these proposed regulations, certain acquisitions are excepted from the general rule under section 355(b)(2)(C) and (D) that a trade or business, or control of a corporation engaged in a trade or business, cannot satisfy the active trade or business requirement if it was acquired during the predistribution period in a transaction in which gain or loss was recognized. These transactions are so excepted because they do not violate the purposes of section 355(b)(2)(C) and (D).

i. Certain Acquisitions by the DSAG or CSAG

These proposed regulations provide a number of exceptions to the application of section 355(b)(2)(C) and (D) not contained in the current regulations (or Sec. 1.3553(b)(4)). One of these exceptions disregards any gain or loss recognized in connection with an acquisition by the CSAG from the DSAG of a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business. This exception is appropriate because it is not a use of distributing's assets to acquire the trade or business

Another exception disregards gain or loss recognized in an acquisition solely as a result of the payment of cash to shareholders for fractional shares where the cash paid represents a mere rounding off of the fractional shares in the exchange and is not separately bargained for consideration. The IRS and Treasury Department believe that this is not the type of transaction to which section 355(b)(2)(C) or (D) is intended to apply. Although such a transaction involves a small use of assets, these proposed regulations except such acquisitions because the small amount of assets are not separately bargained for and are used merely to simplify the exchange. Other authorities reach similar conclusions in the context of
reorganizations. See Rev. Rul. 66365 (19662 CB 116), amplified by Rev. Rul. 8181 (19811 CB 122) (concluding that cash in lieu of fractional shares does not violate the solely for voting stock requirement of section 368(a)(1)(B) and (C) because it was merely a mathematical rounding off for simplicity, and the transaction ``was for all practical purposes ``solely in exchange for voting stock''').

In addition, as discussed in section G. of this preamble, these proposed regulations provide a limited exception for taxable acquisitions from affiliates that are members of the same SAG. Specifically, acquisitions between SAG members (where the assets (or activities) are owned (or performed) by the SAG immediately before and immediately after the transfer) are disregarded whether they are taxable or not.

Like the current regulations, these proposed regulations provide that acquisitions that expand a preexisting business are generally exempted from the nonrecognition requirement. See Sec. 1.355 3(b)(3)(ii). While these transactions may involve the use of the DSAG's or CSAG's assets, they are not acquisitions of a new or different trade or business. Because the DSAG or CSAG, as the case may be, is already in the business, such transactions are not considered acquisitions of a trade or business under section 355(b)(2)(C) and (D).

ii. Certain Acquisitions by a Distributee Corporation

Consistent with the principles of Rev. Rul. 745 (19741 CB 82), obsoleted by Rev. Rul. 8937 (19891 CB 107), these proposed regulations disregard the recognition of gain or loss in applying section 355(b)(2)(D) to certain acquisitions of the stock of distributing by a distributee corporation. Prior to the 1987 and 1988 amendments noted in section A.1 of this preamble, section 355(b)(2)(D) was not violated in a case where distributing distributed the stock of controlled even though a purchaser acquired distributing's stock during the predistribution period in a transaction in which gain or loss was recognized. See Rev. Rul. 745 (reasoning that the purpose of section 355(b)(2)(D) was to prevent distributing, rather than the shareholder of distributing, from accumulating excess funds to purchase the stock of a corporation engaged in an active trade or business). However, Rev. Rul. 745 held that the purchaser could not then further distribute the stock of controlled until five years after such
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purchase, reasoning that the purchaser, the distributing corporation in the second distribution, indirectly acquired the stock of controlled through another corporation, the distributing corporation in the first distribution.

The 1987 and 1988 amendments to section 355(b)(2)(D) prohibited such transactions because of a concern that such acquisitions were similar to transactions that permitted a corporation to dispose of an appreciated subsidiary without the proper recognition of gain contrary to the repeal of the General Utilities doctrine. For example, assume P, a corporation, acquired the stock of D in a transaction in which gain or loss was recognized and D immediately distributed the stock of C to P in a section 355 transaction. P would allocate its basis in the newly acquired D stock between the D stock and the C stock received in the distribution. P could then potentially sell the C stock without the appropriate recognition of gain. See H.R. Rep. No. 100391, at 1080, 10821083 (1987).

However, there are transactions that violate the literal requirements of section 355(b)(2)(D) but do not violate the purpose of the 1987 and 1988 amendments. For example, assume that for more than five years, T, a corporation, owned all of the stock of D, which in turn owned all the stock of C. Throughout this period, D and C have each engaged in the active conduct of a trade or business. In year 6, P acquires the stock of T in a transaction in which gain or loss is recognized, and holds the T stock with a cost basis determined under section 1012. In year 7, P liquidates T in a transaction to which section 332 applies and in which no gain or loss is recognized, thereby eliminating its cost basis in the T stock. Thereafter, P holds the D stock with a basis equal to T's basis in the D stock. In year 8, D distributes the C stock to P. Under these facts, P cannot dispose of the D or C stock without recognizing the same amount of gain or loss that T would have recognized.

Similarly, assume the same facts as the previous example, except that in year 6 P acquires all of T's assets, including the D stock, in exchange for P stock and cash in a reorganization described in section 368(a)(1)(A). Because all of the cash is distributed to the T shareholders, T does not recognize any gain, and P's basis in the D stock is equal to T's basis in the D stock. See section 362(b). In year 7, D distributes the C stock to P. Under these facts, P cannot dispose of the D or C stock without recognizing the same amount of gain or loss that T would have recognized.

The IRS and Treasury Department believe that the distributee corporation language in section 355(b)(2)(D)(i) is intended only to prevent transactions that are contrary to the repeal of the General Utilities doctrine. In both of the examples just described, neither the D stock nor C stock can be disposed of in a manner that is contrary to the repeal of the General Utilities doctrine. Accordingly, these proposed regulations provide that section 355(b)(2)(D) is not violated where there is a direct or indirect acquisition by a distributee corporation of control of distributing in one or more transactions in which gain or loss is recognized where the basis of the acquired distributing stock in the hands of the distributee corporation is determined in whole by reference to the transferor's basis. However, consistent with the principles of Rev. Rul. 745, this rule is only applicable with respect to a distribution by the acquired distributing, and does not apply for purposes of any subsequent distribution by any distributee corporation.
b. Certain Nonrecognition Transactions Treated as Recognition Transactions

Because the IRS and Treasury Department believe that acquisitions made in exchange for assets violate the common purpose of section 355(b)(2)(C) and (D) even if no gain or loss is recognized, these proposed regulations provide that such transactions are treated as transactions in which gain or loss is recognized.

i. Acquisitions in Exchange for Assets

As discussed in section C.1 of this preamble, the common purpose underlying section 355(b)(2)(C) and (D) is that distributing generally should not be able to use its assets to acquire a new trade or business in anticipation of distributing that trade or business (or facilitating the distribution of another trade or business) to its shareholders in a taxfree transaction. Similarly, and also discussed in section C.1. of this preamble, section 355(b), by permitting the use of distributing stock to acquire a trade or business, ensures a historic relationship between the distributing shareholders and the trades or businesses relied upon to satisfy the active trade or business requirement.

The following examples illustrate distributing's use of its assets to acquire a new trade or business.

First, assume that D, a corporation that does not directly conduct a fiveyear active trade or business, owns all of the stock of C, a corporation with a fiveyear active trade or business. D wishes to spinoff C to its shareholders, but to do so D must satisfy the active trade or business requirement. Accordingly, D contributes assets to an unrelated partnership that is engaged in a fiveyear active trade or business in a transaction to which section 721 applies in exchange for an interest in the partnership that otherwise satisfies the requirements for D to be attributed the trade or business assets and activities of the partnership, as discussed in section I. of this preamble. Two years after the transfer, when D's only active trade or business is the business conducted by the partnership, D distributes the C stock pro rata to the D shareholders.

Alternatively, assume that D, a corporation with a fiveyear active trade or business, transfers assets to unrelated T, a corporation with a fiveyear active trade or business, in a transaction to which section 351 applies in exchange for an amount of T stock constituting control. Two years after the transfer, when T's only active trade or business is the business T conducted before D's transfer, D distributes the T stock pro rata to the D shareholders.

Similarly, assume that D, a corporation with a fiveyear active trade or business, owns all of the stock of C, a corporation that does not have a fiveyear active trade or business but has other assets. To cause C to satisfy the active trade or business requirement, D arranges for C to acquire a fiveyear active trade or business from T, an unrelated corporation, in a reorganization described in section 368(a)(1)(A). In the reorganization, the shareholders of T receive solely common stock of C representing 20 percent or less of the voting power of all classes of C stock. Two years after the reorganization, D distributes the C stock pro rata to the D shareholders.

In each of these examples, D has directly or indirectly acquired a trade or business in exchange for assets. See and compare Situation 2 of Rev. Rul. 200249 (20022 CB 288) (corporation's use of appreciated securities to acquire a trade or business of a partnership in a transaction to which section 721 applies is treated as an acquisition in which gain or loss was recognized); section 4.01(29) of Rev. Proc. 20073 (20071 IRB 108) (the IRS will not ordinarily rule where distributing acquires control of controlled by transferring inactive assets in a transaction meeting the requirements of section 351(a) or section 368(a)(1)(D) and in which no gain or loss is recognized). While these transactions satisfy the literal requirements of section 355(b)(2)(C) or (D), the underlying common purpose of those provisions has been violated. In each case, distributing has acquired in exchange for distributing's assets, either
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directly or indirectly through the issuance of controlled stock the trade or business to be relied on by distributing or controlled.

Furthermore, in each of these examples, the historic owners have supplied a trade or business for distributing or controlled, but they are not participants in the divisive transaction. Not being shareholders of D, the position of the historic owners of the acquired business is not altered by the distribution of the controlled stock. Accordingly, neither distributing nor the distributing shareholders have a historic relationship with the separated businesses, and the distribution of the controlled stock is not the type of transaction to which section 355 was intended to apply.

By contrast, had D issued its own stock in the reorganization in the last example, the substance of the transaction would be different. D would not have indirectly acquired a trade or business in exchange for assets but rather for its own equity. Because D would not be purchasing a business for its shareholders, the distribution is not a substitute for a taxable distribution of the consideration that would have been used in the purchase. Furthermore, where D stock is used as the consideration the former T shareholders would have joined D's shareholder base, and become participants in the divisive

reorganization.

These proposed regulations prohibit the acquisition of a trade or business directly or indirectly in exchange for assets in order to ensure that the common purpose of section 355(b)(2)(C) and (D) are satisfied. Such an acquisition also would include a swap of an interest in an existing fiveyear active trade or business for an interest in a new active trade or business. This type of an acquisition could occur through the formation of a joint venture structure.

For example, assume D and X form a partnership joint venture in which D contributes a fiveyear active trade or business (ATBD) and X contributes a different fiveyear active trade or business (ATBX). D and X each receive a 50percent interest in the partnership. D's interest is sufficient to satisfy the requirements for D to be attributed the partnership's trade or business assets and activities (as discussed in section I. of this preamble). Prior to a potential section 355 distribution by D, and within five years of the contribution, the partnership sells ATBD.

D cannot rely on ATBX until five years after the acquisition of its interest in the partnership because, in effect, at the time of the contributions D exchanged a 50percent undivided interest in ATBD for a 50percent undivided interest in ATBX. Therefore, D acquired its interest in ATBX in exchange for its assets. While this was a transaction in which no gain or loss was recognized, the exchange of assets violates the common purpose of section 355(b)(2)(C) and (D). Further, the historic owner of ATBX would not participate in any distribution of controlled stock by D. Accordingly, such a distribution would not be the type of transaction to which section 355 was intended to apply.

Similarly, a corporation can effectively swap its assets through the issuance of stock of a subsidiary (including controlled). Accordingly, these proposed regulations provide a specific rule to address taxfree acquisitions involving the issuance of subsidiary stock. These proposed regulations provide that if a SAG directly or indirectly owns stock of a subsidiary (including a subsidiary SAG member) and the subsidiary directly or indirectly acquires a trade or business, an interest in a partnership engaged in a trade or business, or stock of a corporation engaged in a trade or business from a person other than such SAG in exchange for stock of such subsidiary in a transaction in which no gain or loss is recognized (the acquisition), solely for purposes of applying section 355(b)(2)(C) or (D) with respect to the trade or business, partnership interest, or stock acquired by the subsidiary in the acquisition, the subsidiary's stock directly or indirectly owned by the SAG immediately after the acquisition is treated as acquired at the time of the acquisition in a transaction in which gain or loss is recognized.

This rule reflects the fact that although the acquiring subsidiary did not make the acquisition in exchange for its assets (it issued its own stock), the SAG that owns stock of the subsidiary has exchanged an indirect interest in the subsidiary's assets for an indirect interest in the trade or business acquired by the subsidiary in the acquisition. Thus, the SAG has indirectly acquired a portion of the subsidiary's newly acquired trade or business (equal to the shareholder's stock interest in the subsidiary immediately after the acquisition) in exchange for assets. Further, the IRS and Treasury Department believe that it would be inappropriate to allow such acquired trade or business to be relied on to satisfy the active trade or business requirement within five years of its acquisition because the historic owners of that trade or business would not participate in any distribution of controlled stock.

However, because such a transaction does not result in an acquisition of any preexisting trade or business of the subsidiary, this rule merely treats the SAG's stock in the subsidiary immediately after the acquisition as acquired in a gain or loss transaction for purposes of applying section 355(b)(2)(C) or (D) to the newly acquired trade or business. Further, the impact of such a transaction on the ability to rely on the newly acquired trade or business to satisfy the requirements of section 355(b) depends upon how much subsidiary stock the SAG owns immediately after the transaction.

For example, assume D owns all of the sole class of stock of S, a corporation that does not conduct a fiveyear active trade or business. T, an unrelated corporation with a fiveyear active trade or business (ATBT), merges into S in a reorganization described in section 368(a)(1)(A) and (D) solely in exchange for 80 percent of the S stock, and no gain or loss is recognized. Immediately after the merger, D owns only 20 percent of the sole class of S stock. Solely for purposes of determining whether ATBT can be relied on to satisfy the active trade or business requirement, D is treated as having acquired its 20 percent of the S stock at the time of the merger of T into S in a transaction in which gain or loss was recognized. Accordingly, as described in section D.2.a. of this preamble regarding certain multistep acquisitions of a subsidiary SAG member, if D subsequently acquired the 80 percent of the S stock held by the other shareholders solely in exchange for D voting stock in a reorganization described in section 368(a)(1)(B) in which no gain or loss was recognized, S would become a DSAG member and D could rely on ATBT to satisfy the active trade or business requirement.

Accordingly, in light of all of these concerns, these proposed regulations generally provide that acquisitions paid for in whole or in part, directly or indirectly, with assets of the DSAG will be treated as acquisitions in which gain or loss is recognized. However, if a DSAG member or controlled acquires the trade or business solely in exchange for distributing stock, distributing acquires control of controlled solely in exchange for distributing stock, or controlled acquires the trade or business from distributing solely in exchange for stock of controlled, in a transaction in which no gain or loss is recognized, the requirements of section 355(b)(2)(C) and (D) are satisfied. Such acquisitions are
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not made in exchange for assets of the DSAG.

An additional question arising under section 355(b)(2)(C) and (D) is whether the assumption of liabilities is treated as a payment of money or other property, and hence the use of assets. See United States v. Hendler, 303 U.S. 564, reh'g denied, 304 U.S. 588 (1938) (viewing an assumption of a liability by a transferee as in substance a payment to the transferor). Congress has indicated that the assumption of liabilities is not to be treated as the payment of money or other property in certain transactions in which no gain or loss is recognized. For example, the assumption of liabilities is not treated as the payment of money or other property in certain exchanges to which section 351 or 361 applies. See section 357(a). Further, the assumption of liabilities does not violate the solely for voting stock requirement in a reorganization described in section 368(a)(1)(C) where the acquiring corporation does not otherwise exchange money or other property. See section 368(a)(1)(C) and (a)(2)(B). Because Congress has granted this special treatment for liability assumptions in certain nonrecognition transactions, the IRS and Treasury Department believe that similar treatment is generally appropriate for purposes of section 355(b)(2)(C) and (D). Accordingly, these proposed regulations provide that the assumption by the DSAG or CSAG of liabilities of a transferor shall not, in and of itself, be treated as the payment of assets if such assumption is not treated as the payment of money or other property under any other applicable provision.

Finally, these proposed regulations clarify that an acquisition to which section 304(a)(1) applies does not satisfy the requirements of section 355(b)(2)(C) or (D). The IRS and Treasury Department believe that a stock acquisition to which section 304 applies is a transaction in which gain or loss is recognized for purposes of section 355(b)(2)(C) and (D) even if it merely results in the transferor's receipt of dividend income. These proposed regulations clarify that, regardless of the tax consequences to the transferor, such a transaction is an acquisition made in exchange for assets, and therefore does not satisfy the requirements of section 355(b)(2)(C) and (D).

ii. Partnership Distributions

These proposed regulations provide that an acquisition consisting of a distribution from a partnership is generally treated as a transaction in which gain or loss is recognized because it constitutes an acquisition in exchange for assets. That is, the distributee partner is generally exchanging an indirect interest in all the assets of the partnership for a direct interest in the property distributed. However, these proposed regulations provide that if the corporation is already attributed the trade or business assets and activities of a partnership, the corporation's acquisition of such trade or business assets and activities from the partnership is not, in and of itself, the acquisition of a new trade or business. Further, these proposed regulations provide that an acquisition consisting of a pro rata distribution from a partnership of stock or an interest in a lowertier partnership is not an acquisition in exchange for assets to the extent the distributee partner did not acquire the interest in the distributing partnership during the predistribution period in a transaction in which gain or loss was recognized and to the extent the distributing partnership did not acquire the distributed stock or partnership interest within such period. In such a case, the distributee partner has merely exchanged an indirect interest for a direct interest in the distributed stock or partnership interest, and continues to possess the same indirect interest in the remaining assets of the partnership.

iii. Lack of Transferred Basis

Section 1.3553(b)(4)(i) provides that a trade or business acquired, directly or indirectly, within the predistribution period in a transaction in which the basis of the assets acquired was not determined in whole or in part by reference to the transferor's basis does not qualify under section 355(b)(2), even though no gain or loss was recognized by the transferor. These proposed regulations do not include a similar provision. The IRS and Treasury Department believe that the prohibition against acquisitions in exchange for assets fully addresses such acquisitions.
c. Application of Section 355(b)(2)(C) and (D) to Predecessors

Unlike Sec. 1.3553(b)(4)(i), which only took ``a predecessor in interest'' into account for purposes of applying section 355(b)(2)(D), these proposed regulations provide that any reference to a corporation includes a reference to a predecessor of such corporation in applying both section 355(b)(2)(C) and (D). The IRS and Treasury Department believe that predecessors should be taken into account in applying both section 355(b)(2)(C) and (D) because the same policy concerns exist regardless of whether the transaction involves the acquisition of assets or stock. For this purpose, the proposed regulations define a predecessor of a corporation as a corporation that transfers its assets to such corporation in a transaction to which section 381 applies. The IRS and Treasury Department believe that it is appropriate to take predecessors into account in applying these provisions in order to appropriately minimize the significance of which corporation is the acquiror and which corporation is the target.

Further, because the SAG rule effectively treats SAG members as a singlyentity for purposes of section 355(b), these proposed regulations also apply section 355(b)(2)(C) and (D) to acquisitions during the predistribution period by corporations that later become DSAG or CSAG members. These types of acquisitions are similar to predecessor asset acquisitions.
4. Requests for Comments Regarding Exceptions to Section 355(b)(2)(C) and (D)

The IRS and Treasury Department request comments regarding whether any additional exceptions to section 355(b)(2)(C) and (D) are appropriate. In particular, the IRS and Treasury Department request comments regarding whether acquisitions in which gain is recognized solely as a result of the application of section 367 should be treated as violating section 355(b)(2)(C) or (D). The IRS and Treasury Department also request comments regarding whether an exception should exist for taxable acquisitions made by distributing solely in exchange for distributing stock because such acquisitions are not made in exchange for distributing's assets and do not appear to violate the common purpose of section 355(b)(2)(C) and (D).

In addition, the IRS and Treasury Department request comments regarding whether a redemption of stock should be a transaction to which section 355(b)(2)(C) or (D) applies. Under current law, no relief is provided for such transactions. See McLaulin v. Commissioner, 276 F.3d 1269 (11th Cir. 2001) (concluding that section 355(b)(2)(D) applies when distributing acquires control of a subsidiary through a redemption of subsidiary stock). Compare Rev. Rul. 57144 (19571 CB 123). Specifically, comments are requested on whether all types of redemptions should be subject to the same rule, whether the treatment of redemptions should be determined by the source of payment, whether the redemption constitutes an indirect exchange for assets of distributing or controlled, and the method of making these determinations. Alternatively, the
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IRS and Treasury Department request comments on whether an exception should be provided for redemptions of shareholders that exercise dissenters' rights. Compare Rev. Rul. 68285 (19681 CB 147) (concluding that cash paid to dissenting target corporation shareholders by the target corporation does not violate the solely for voting stock requirement of section 368(a)(1)(B)) with Rev. Rul. 73102 (19731 CB 186) (concluding that cash paid to dissenting target corporation shareholders by the acquiring corporation is treated as money or other property paid by the acquiring corporation for the properties of the target corporation in a reorganization under section 368(a)(1)(C)). These proposed regulations do not include an exception for redemptions generally or for those in connection with the exercise of dissenters' rights.

Finally, the IRS and Treasury Department request comments regarding whether a transaction in which a distributee corporation acquires in a transaction in which no gain or loss is recognized newly issued stock of distributing in exchange for money or property previously acquired for cash during the predistribution period should be treated as a transaction in which gain or loss is recognized. For example, assume D and C have each engaged in the active conduct of a trade or business for more than five years. During the predistribution period, P, an unrelated corporation, purchases trucks and transfers them to D in exchange for D stock meeting the requirements of section 368(c) in a transaction to which section 351 applies. No gain or loss is recognized. D subsequently distributes all the C stock to P in a separate transaction within five years of P's acquisition of the D stock. Notwithstanding that this transaction satisfies the literal requirements of section 355(b)(2)(D), it appears to violate the General Utilities doctrine because it permits the distributee corporation, P, to receive a fair market value basis (or close to a fair market value basis) in the distributing stock, enabling the potential sale of controlled stock without the appropriate recognition of gain. Additionally, the IRS and Treasury Department are studying whether the principles of the foregoing rule should be extended to any distributee in regulations under section 355(d), and request comments on this point.

D. Treatment of Certain MultiStep Acquisitions

These proposed regulations provide specific rules regarding the application of section 355(b)(2)(C) and (D) to certain multistep acquisitions. Based on the interpretation of section 355(b)(2)(D), and the enactment of section 355(b)(3), the IRS and Treasury Department believe that it is appropriate to apply section 355(b)(2)(C) and (D) to multistep acquisitions in a consistent manner. Further, the IRS and Treasury Department believe that it is appropriate to treat certain multistep acquisitions of target corporation stock as satisfying the requirements of section 355(b)(2)(C) or (D) (as applicable) notwithstanding that some portion of the stock may have been acquired in a separate transaction in which gain or loss was recognized. 1. MultiStep Acquisition of Control of Distributing or Controlled a. Direct Acquisitions

Section 355(b)(2)(D) provides that control of distributing or controlled may be acquired within the predistribution period provided that ``in each case in which such control was so acquired, it was so acquired, only by reason of transactions in which gain or loss was not recognized in whole or in part, or only by reason of such transactions combined with acquisitions before the beginning of such period.'' The IRS and Treasury Department interpret this language to mean that at the time control is first acquired, the acquiring corporation (or its SAG) is required to own stock meeting the requirements of section 368(c) that was acquired in one or more transactions in which no gain or loss was recognized or by reason of such transactions combined with acquisitions before the beginning of the predistribution period. Thus, at the time an acquiring corporation (or its SAG) first satisfies the section 368(c) control requirement, the acquiring corporation (or its SAG) must possess section 368(c) control without relying on any stock acquired in a transaction in which gain or loss was recognized during the predistribution period.

For example, assume that C has two classes of stock outstanding. X owns all 95 shares of the class A stock of C representing 95 percent of the voting power and 70 percent of the value and Y owns all of the class B stock of C representing five percent of the voting power and 30 percent of the value. In year 1, unrelated D acquires 10 shares of the class A C stock from X in a transaction in which gain or loss is recognized. In year 2, D acquires an additional 80 shares of class A C stock from X in a separate transaction in which no gain or loss is recognized. In year 3, D acquires the remaining five shares of class A C stock from X in a separate transaction in which gain or loss is recognized. In year 4, D distributes the 95 shares of class A C stock to the D shareholders. Assuming all of the other requirements of section 355(b) are satisfied, the requirements of section
355(b)(2)(D)(ii) are satisfied because at the time D first acquired control of C (immediately after the year 2 acquisition), D owned an amount of C stock constituting control that was acquired in a transaction in which no gain or loss was recognized (the 80 shares of class A C stock acquired in year 2). (However, the 10 shares of class A C stock acquired in year 1 and the five shares of class A C stock acquired in year 3 may be treated as moot under section 355(a)(3)(B).)

On the other hand, assume the same facts as the previous example, except that, in year 2, D acquires only 75 shares of class A C stock from X. The requirements of section 355(b)(2)(D)(ii) are not satisfied because at the time D first acquired control of C (immediately after the year 2 acquisition), D did not own an amount of C stock constituting control that was acquired in one or more transactions in which no gain or loss was recognized or acquired prior to the pre distribution period. D only owns C voting stock representing 75 percent of the total voting power that was acquired in a transaction in which no gain or loss was recognized. The result would be the same if the year 3 acquisition was also a transaction in which no gain or loss was recognized.

b. Indirect Acquisitions

These proposed regulations also provide that the principles of this rule will be applied with respect to an indirect acquisition of distributing or controlled stock. For example, assume T corporation owns stock of C (an unaffiliated subsidiary) constituting control (and no more). Unrelated D acquires 10 percent of the sole outstanding class of stock of T in a transaction in which gain or loss is recognized. In a separate transaction, T merges into D solely in exchange for D stock in a transaction in which no gain or loss is recognized. In applying this multistep acquisition rule to D's subsequent acquisition of control of C in the merger, the prior acquisition of T stock in the transaction in which gain or loss was recognized is treated as an acquisition of 10 percent of the C stock owned by T (representing 8 percent of the total combined voting power of the C stock) in a transaction in which gain or loss is recognized. Accordingly, the requirements of section 355(b)(2)(D)(ii) are not satisfied because at the time D first acquires control of C, D does not own an amount of C stock constituting
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control that was acquired in one or more transactions in which no gain or loss is recognized or acquired prior to the predistribution period. At that time, D had only acquired C stock representing 72 percent of the total combined voting power of the C stock in a transaction in which no gain or loss is recognized.

2. Other MultipleStep Acquisitions

As discussed in sections A.1., B.1., and B.3. of this preamble, if D acquires section 1504(a)(2) stock of a corporation, the acquired corporation will become a DSAG member and the corporation will be treated like a division of D for purposes of the active trade or business requirement. As such, D is treated as if it acquired the assets and activities of the new subsidiary SAG member, and the acquisition must satisfy the requirements of section 355(b)(2)(C) rather than section 355(b)(2)(D). If D subsequently acquires the remaining stock of the corporation in a separate transaction, such acquisition is disregarded for purposes of satisfying the active trade or business requirement (regardless of whether gain or loss was recognized in the separate transaction) because the subsidiary is already treated as a division of D for this purpose. The

FOR FURTHER INFORMATION CONTACT Concerning the proposed regulations, Russell P. Subin, (202) 6227790; concerning submissions and the hearing, Kelly Banks, (202) 6227180 (not tollfree numbers).