[Federal Register Volume 60, Number 154 (Thursday, August 10, 1995)]
[Proposed Rules]
[Pages 40794-40796]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-19449]
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DEPARTMENT OF THE TREASURY
26 CFR Part 1
[CO-19-95]
RIN 1545-AT43
Transfers to Investment Companies
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document proposes amendments to regulations relating to
transfers to investment companies. The amendments are necessary to
clarify existing regulations relating to certain transfers to a
controlled corporation. Generally, the regulations will be amended to
provide when certain transfers will not cause a diversification of the
transferors' interests.
DATES: Written comments and requests for a public hearing must be
received by November 8, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (CO-19-95), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (CO-19-95),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: Andrew M. Eisenberg, (202) 622-7790
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document proposes amendments to the Income Tax Regulations (26
CFR part 1) under section 351 of the Internal Revenue Code of 1986.
Section 351(a) provides that no gain or loss will be recognized if one
or more persons transfer property to a corporation solely in exchange
for stock in the corporation and immediately after the exchange the
transferors control the transferee corporation. Section 351(e)(1)
provides that section 351(a) will not apply to a transfer of property
to an investment company.
The rule of section 351(e)(1) was enacted as part of the Foreign
Investors Tax Act of 1966, with the goal of preventing individuals from
achieving tax-free diversification by the transfer of one or a few
stocks or securities to a corporation (referred to as a swap fund). See
generally H. Rep. No. 1049, 94th Cong., 2d Sess. (Apr. 27, 1976).
Section 1.351-1(c)(1) states that a transfer to an investment
company will occur when (i) the transfer results in diversification of
the transferors' interests and (ii) the transferee is a Regulated
Investment Company (RIC), Real Estate Investment Trust (REIT), or a
corporation more than 80 percent of the value of whose assets
(excluding cash and non-convertible debt obligations) are readily
marketable stocks or securities. Section 1.351-1(c)(5) provides that a
transfer ordinarily results in the diversification of the transferors'
interests if two or more persons transfer nonidentical assets to a
corporation in the exchange.
As part of the Tax Reform Act of 1976 (the 1976 Act), Congress
enacted sections 683(a) and 721(b), which incorporate the section
351(e) rules for transfers to a trust and a partnership, respectively.
The 1976 Act also addressed reorganizations of investment companies
by enacting section 368(a)(2)(F). This legislation was intended to
prevent the tax-free merger of a closely held corporation holding an
undiversified group of assets into a publicly held diversified
investment company, resulting in a tax-free diversification of the
interests of the target shareholders.
Section 368(a)(2)(F)(i) provides that a transaction between two
``investment companies'' otherwise qualifying as a reorganization will
not qualify as a reorganization for any corporation in the transaction
that is not a RIC, REIT, or corporation described in section
368(a)(2)(F)(ii). Section 368(a)(2)(F)(iii) defines an investment
company as a RIC, REIT, or corporation with at least 50 percent of its
assets comprised of stocks or securities and 80 percent of its assets
held for investment. A corporation satisfies section 368(a)(2)(F)(ii)
if not more than 25 percent of the value of its total assets is
invested in the stock and securities of any one issuer and not more
than 50 percent of the value of its total assets is invested in the
stock and securities of five or fewer issuers. For purposes of the
section 368(a)(2)(F)(ii) test, all members of a controlled group of
corporations (within the meaning of section 1563(a)) shall be treated
as one issuer. Also, a person holding stock in a RIC, REIT, or other
investment company (as defined in section 368(a)(2)(F)(iii)) that meets
the requirements of section 368(a)(2)(F)(ii) shall be treated as
holding its proportionate share of the assets held by the company.
Section 368(a)(2)(F)(iv) provides that in determining total assets,
certain assets shall be excluded, including cash and cash items
(including receivables), Government securities, and assets acquired to
meet section 368(a)(2)(F)(ii) or to cease to be an investment company.
Section 368(a)(2)(F)(v) provides that section 368(a)(2)(F) shall not
apply if the stock of each investment company is owned substantially by
the same persons in the same proportions. Section 368(a)(2)(F)(vii)
defines securities for purposes of clauses (ii) and (iii) of section
368(a)(2)(F).
[[Page 40795]]
Reasons for Change
The IRS wants to clarify that Sec. 1.351-1(c)(5) does not prevent
tax-free combinations of already diversified portfolios, and that
combinations of already diversified portfolios are not inconsistent
with the purposes of section 351(e) (i.e., preventing the tax-free
transfer of one or a few stocks or securities to swap funds). For
example, RICs often transfer portfolios of investment assets to
partnerships under section 721(a) (which is subject to the section
351(e) rules pursuant to section 721(b)). These transactions are
appropriately tax-free because the RICs are not transferring one or a
few stocks or securities, but rather, the RICs are transferring
diversified portfolios of stocks and securities.
Also, the nonidentical asset standard of Sec. 1.351-1(c)(5) is
stricter than the test applied for combinations of investment companies
under the corporate reorganization provisions (see section
368(a)(2)(F)(ii)). Transfers of certain diversified portfolios to a
corporation may be taxable under section 351(e), while the same
portfolios could be combined through a merger that may qualify as a
tax-free reorganization.
Explanation of Provisions
The proposed amendments to Sec. 1.351-1(c) provide that transfers
of assets will not be treated as transfers that result in
diversification of the transferors' interests for purposes of
Sec. 1.351-1(c)(1)(i) if each transferor transfers assets that satisfy
section 368(a)(2)(F)(ii), as modified. Under this rule, no transfers of
nonidentical assets to a corporation described in Sec. 1.351-
1(c)(1)(ii) will qualify for nonrecognition treatment under section 351
unless each transferor transfers assets that satisfy section
368(a)(2)(F)(ii), as modified.
For purposes of Sec. 1.351-1(c), relevant provisions of section
368(a)(2)(F) will apply to the section 368(a)(2)(F)(ii) test. Those
provisions include the controlled group and look-through rules found in
clause (ii) (members of a controlled group of corporations are
considered as one issuer and persons holding stock in certain
investment companies are treated as holding a proportionate share of
the investment company's assets), the common ownership rule found in
clause (v) (diversification will not be considered to occur if the
interests in the assets to be transferred are held substantially by the
same persons in the same proportions as the interests in the
transferee), and the definition of securities found in clause (vii)
(the term securities includes investments constituting a security
within the meaning of the Investment Company Act of 1940 (15 U.S.C.
80a-2(36)). The definition of total assets in section 368(a)(2)(F)(iv)
will apply, except that Government securities will be included in
determining total assets, unless the Government securities are acquired
to meet section 368(a)(2)(F)(ii).
The proposed modification of the definition of total assets to
include Government securities addresses a problem caused by transfers
of funds consisting mostly of Government securities. For example, if 95
percent of a money market fund's assets are invested in Government
securities and five percent are invested in the stock of corporation X,
the Government securities would not be treated as securities (see
section 368(a)(2)(F)(vii)) and, without the modification, would be
excluded from total assets for purposes of the 25 and 50 percent test
of section 368(a)(2)(F)(ii). As a result, the unmodified test would
treat 100 percent of the fund's assets as X stock and the fund would
not satisfy the 25 and 50 percent test of section 368(a)(2)(F)(ii). The
modified test would include Government securities in total assets. The
fund would satisfy the modified test because the stock of one issuer
would constitute only five percent of the fund's portfolio. The IRS
believes that the modification is appropriate because the presence of a
small amount of nondiversified property in a Government securities
portfolio (otherwise qualifying under section 368(a)(2)(F)(ii)) should
not disqualify the portfolio from tax-free treatment.
The adoption of the modified section 368(a)(2)(F)(ii) test is
intended to limit section 351(e) to cases more analogous to the typical
swap fund cases that were the focus of the section 351(e) legislation.
Also, the adoption of this test should minimize the different tax
treatment of a section 351 transfer and a section 368 reorganization
under economically similar situations. This test will also apply for
purposes of sections 683(a) and 721(b). Finally, a proposed revision to
Sec. 1.584-4(a) adopts this test.
Proposed Effective Date
These regulations are proposed to apply to transfers of assets
occurring on or after the date of publication as final regulations in
the Federal Register.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. 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) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying. A public
hearing may be scheduled if requested in writing by a person that
timely submits written comments. If a public hearing is scheduled,
notice of the date, time, and place for the hearing will be published
in the Federal Register.
Drafting Information
The principal author of these regulations is Andrew M. Eisenberg,
Office of Assistant Chief Counsel (Corporate), IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendment to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 as proposed to be
amended in a document published elsewhere in this issue of the Federal
Register continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.351-1 also issued under 26 U.S.C. 351 * * *.
Par. 2. Section 1.351-1 is amended by:
1. Redesignating paragraph (c)(6) as paragraph (c)(7).
2. Adding new paragraph (c)(6) to read as follows:
Sec. 1.351-1 Transfer to corporation controlled by transferor.
* * * * *
[[Page 40796]]
(c) * * *
(6) For purposes of paragraph (c)(5) of this section, a transfer of
assets will not be treated as resulting in a diversification of the
transferors' interests if each transferor transfers a diversified
portfolio of assets. For purposes of this paragraph, a portfolio of
assets is diversified if it satisfies section 368(a)(2)(F)(ii),
applying the relevant provisions of section 368(a)(2)(F), except that,
in applying section 368(a)(2)(F)(iv), Government securities are
included in determining total assets, unless the Government securities
are acquired to meet section 368(a)(2)(F)(ii).
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-19449 Filed 8-9-95; 8:45 am]
BILLING CODE 4830-01-U