CONSOLIDATED RETURN REGULATIONS PROVIDE FOR ADJUSTMENTS OF BASIS AND E&P FOLLOWING AFFILIATED GROUP RESTRUCTURINGS.

The Service explained that the new basis adjustment rules are intended to reach the transaction in which a holding company acquires the stock of an affiliated group's common parent in exchange for the stock of the holding company, and the group remains in existence under regulation section 1.1502-75(d)(2) or (3). The Service noted that a group can adopt a holding company structure without changing its common parent by transferring, or "dropping down," all the assets and liabilities of the common parent to a newly formed subsidiary in exchange for the subsidiary's stock.

In other nonrecognition transactions, the Service said, a newly created holding company becomes the common parent and determines its basis in the former parent's stock according to the stock's basis in the hands of the former common parent's shareholders or the inside net asset basis of the former common parent. According to the Service, the inconsistent basis results of these transactions are eliminated by regulation section 1.1502-31T, which provides rules that "approximate the effects of a dropdown of the assets by the common parent into a newly formed subsidiary." Under the new regulation, the holding company's basis in the stock of the former common parent is a "net inside basis."

New temporary regulation section 1.1502-33, the Service explained, provides for adjustments to earnings and profits following a change in a group's structure. According to the Service, the new rules provide that if there is a change in a group's common parent, but the group remains in existence and the stockholders of the former common parent immediately before the change own 80 percent or more of the value of the stock of the new common parent immediately after the change, the earnings and profits of the new common parent are adjusted to reflect the earnings and profits of the former common parent. Additional rules apply to a change in structure among lower tier members. The regulations also address dividend distributions requiring negative investment adjustments and their effect on a distributee's earnings and profits.

Finally, temporary regulation section 1.1502-77T provides for alternative agents for the group, for purposes of mailing notices of deficiencies and for giving waivers of the statute of limitations, when the corporation that is the common parent of the group ceases to be the common parent.

Written comments and requests for a public hearing must be delivered or mailed by November 7, 1988. For further information, contact Judith C. Winkler of the Office of Chief Counsel, L&R Division (Attn.: CC:LR:T, LR-66-88), IRS, Washington, DC, 20224, or telephone (202) 566-3458.

ACTION: Notice of proposed rulemaking by cross-reference to temporary and final regulations.

SUMMARY: In the Rules and Regulations portion of this issue of the Federal Register, the Internal Revenue Service is issuing temporary and final regulations that provide rules for determining the basis and the earnings and profits of members of an affiliated group filing consolidated returns following certain changes in the structure of the group, where the group remains in existence. The temporary and final regulations also provide for alternative agents of the group if the common parent ceases to be the common parent. The text of the temporary and final regulations also serves as the comment document for this notice of proposed rulemaking.

DATES:

PROPOSED EFFECTIVE DATES

The final regulations under section 1502 are generally proposed to be applied to changes in the structure of a group after September 7, 1988.

DATES FOR COMMENTS AND REQUESTS FOR A PUBLIC HEARING

Written comments and requests for a public hearing must be delivered or mailed by November 7, 1988.

ADDRESS: Send comments and requests for a public hearing to: Commissioner of Internal Revenue, Attention: CC:LR:T [LR-66-88], Washington, D.C. 20224.

FOR FURTHER INFORMATION CONTACT: Judith C. Winkler of the Legislation and Regulations Division, Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224 (Attention: CC:LR:T) Telephone: 202-566-3458 (not a toll- free number).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)). Comments on the collection of information should be sent to the Office of Management and Budget, Paperwork Reduction Project, Washington, D.C. 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer TR:FP, Washington, D.C. 20224.

The collection of information in this regulation is in section 26 CFR 1.1502-31T(b). This information is required and will be used by the Internal Revenue Service to determine if a consolidated group has elected to adjust its basis and earnings and profits to reflect a restructuring of the group that occurred on or before September 8, 1988. The likely respondents are businesses or other for-profit institutions.

The following estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents/recordkeepers may require greater or less time, depending on their particular circumstances.

Estimated total annual reporting and/or recordkeeping burden: 50 hours.

Estimated average annual burden hours per respondent and/or recordkeeper: .5 hours

Estimated number of respondents and/or recordkeepers: 100.

Estimated annual frequency of responses: One time generally.

BACKGROUND

Temporary regulations published in the Rules and Regulations portion of this issue of the Federal Register add new temporary regulations sections 1.1502-31T, 1.1502-33T, and 1.1502-77T to part 1 of Title 26 of the Code of Federal Regulations ("CFR") and make conforming amendments to sections 1.1502-31, 1.1502-33 and 1.1502-77. Final regulations are proposed to be based on the temporary regulations. The final regulations would provide rules for determining the basis and the earnings and profits of members following certain changes in the structure of the group, where the group remains in existence. They would also provide for alternative agents of the group when the corporation that is the common parent of the group ceases to be the common parent. For the text of the new temporary regulations, see T.D. 8226 published in the Rules and Regulations portion of this issue of the Federal Register. The preamble to the temporary regulations explains the additions to the regulations.

SPECIAL ANALYSES

The Commissioner of Internal Revenue has determined that this proposed rule is not a major rule as defined in Executive Order 12291 and that a Regulatory Impact Analysis is therefore not required.

The Secretary of the Treasury has certified that this rule, if issued, will not have a significant economic impact on a substantial number of small entities. The rule applies only to affiliated groups of corporations that have elected to file consolidated returns, which tend to be larger businesses. It would not significantly alter the reporting or recordkeeping duties of small entities. A regulatory flexibility analysis is therefore not required under the Regulatory Flexibility Act (5 U.S.C. chapter 6).

COMMENTS AND REQUEST FOR A PUBLIC HEARING

Before these proposed regulations are adopted, consideration will be given to any written comments that are submitted (preferably eight copies) to the Commissioner of Internal Revenue. All comments will be available for public inspection and copying. A public hearing will be held upon written request to the Commissioner by any person who has submitted written comments. If a public hearing is held, notice of the time and place will be published in the Federal Register.

DRAFTING INFORMATION

The principal author of these proposed regulations is Judith C. Winkler of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service. However, other personnel of the Internal Revenue Service and Treasury Department participated in developing the regulations, on matters of both substance and style.

Charles H. Brennan

ACTION: Temporary and final regulations.

SUMMARY: This Treasury Decision amends regulations sections 1.1502-31, 1.1502-33, and 1.1502-77 and adds new sections 1.1502-31T, 1.1502-33T, and 1.1502-77T to the consolidated return regulations. The temporary and final regulations supplement the existing regulations by providing rules for determining the basis and the earnings and profits of members of an affiliated group filing consolidated returns following certain changes in the structure of the group, where the group remains in existence. The temporary and final regulations also supplement the rules that make the common parent the agent of the group by providing for alternative agents of the group if a corporation ceases to be the common parent, whether or not the group remains in existence. The text of the temporary and final regulations set forth in this document also serves as the text of the proposed regulations cross-referenced in the notice of proposed rulemaking in the proposed rules section of this issue of the Federal Register.

EFFECTIVE DATE: These regulations are effective September 8, 1988 and generally apply to changes in the structure of the group after September 7, 1988.

FOR FURTHER INFORMATION CONTACT: Judith C. Winkler of the Legislation and Regulations Division, Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, Attention: CC:LR:T, (Telephone 202-566-3458, not a toll- free number).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

This regulation is being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 533). For this reason, the collection of information contained in this regulation has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget (OMB) under control number 1545-1046. The estimated average burden associated with the collection of information in this regulation is 30 minutes per respondent or recordkeeper.

These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents/recordkeepers may require greater or less time, depending on their particular circumstances

For further information concerning this collection of information, and where to submit comments on this collection of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- reference notice of proposed rulemaking published elsewhere in this issue of the Federal Register.

BACKGROUND

This document adds new temporary regulations sections 1.1502- 31T, 1.1502-33T, and 1.1502-77T to Part 1 of Title 26 of the Code of Federal Regulations and makes conforming amendments to sections 1.1502-31, 1.1502-33, and 1.1502-77. The temporary and final regulations added by this document will remain in effect until superseded by later temporary or final regulations relating to these matters.

EXPLANATION OF PROVISIONS

SECTION 1.1502-31T

The temporary regulations provide new basis rules for certain transactions by which the common parent of the group ceases to be the common parent as a result of a nonrecognition transaction, but the group remains in existence, and the stockholders of the former common parent immediately before the change own 80% or more of the value of the stock of the new common parent immediately after the change. The principal transaction covered by the temporary regulations is one in which a holding company acquires the stock of the common parent in exchange for the stock of the holding company, and the group remains in existence under section 1.1502-75(d)(2) or (3).

A group can adopt a holding company structure without changing its common parent simply by transferring ("dropping down") all the assets and liabilities of the common parent to a newly formed subsidiary in exchange for the subsidiary's stock. In general, under section 358(a), the common parent's basis in the stock of the subsidiary is the same as its basis in the assets transferred. Under section 358(d), basis is reduced by any liabilities of the common parent assumed by the subsidiary or to which the transferred property is subject. Section 357(c) provides that if the liabilities assumed by the subsidiary, plus the liabilities to which the transferred property is subject, exceed the adjusted basis of the transferred property, the excess is treated as gain.

If, on the other hand, the group adopts a holding company structure in which a newly created holding company becomes the common parent in a nonrecognition transaction, the result is essentially the same, but the holding company's basis in the stock of the former common parent (or its successor) may be determined by reference to its basis in the hands of the former common parent's shareholders or the inside net asset basis of the former common parent, depending on how the transaction is accomplished. The different basis results are not appropriate, since the structure that results from the transactions is essentially the same. In addition, the difference is inconsistent with section 1.1502-75(d), which provides for the continued existence of the group in these circumstances, in recognition of the fact that the group is essentially unchanged.

The temporary regulations provide basis rules for these transactions that approximate the effects of a dropdown of the assets by the common parent into a newly formed subsidiary. Under section 1.1502-31T, the holding company's basis in the stock of the former common parent is a "net inside basis". In general, net inside basis is the amount of money and the basis of the property of the former common parent, minus the liabilities of the former common parent and the liabilities to which its property is subject. If the liabilities exceed the sum of the amount of money and the basis of the property of the former common parent, the excess is treated as an excess loss account in the stock of the former common parent. This is analogous to the treatment under section 1.1502-14(a)(2) of nondividend distributions by a subsidiary in excess of the basis of its stock. If the group structure change is accomplished by a merger of a corporation into the former common parent, the former common parent's basis is increased by the basis of the stock of the merged corporation. In addition, adjustments may be required with respect to other property transferred into or out of the former common parent in connection with the change.

If the former common parent does not remain in existence after the change, the rules previously described apply to other members to the extent they have acquired the former common parent's assets or assumed its liabilities. For example, if a member acquires the assets and assumes the liabilities of the former common parent, the basis of the stock of the member is adjusted to reflect the net basis of those assets and liabilities.

SECTION 1.1502-33T

Under section 1.1502-33, the earnings and profits account of any member, including the common parent, generally reflects the earnings and profits of that member and its share of the earnings and profits of every member below it in the chain, earned during the period of their consolidation. Because the present rules do not adjust members' earnings and profits accounts following certain structural changes, distributions from the parent may not be characterized as dividends notwithstanding the presence of sufficient earnings and profits in the group.

Under the present rules, when a lower-tier corporation distributes earnings and profits to its parent as a dividend, adjustments are made to prevent earnings and profits that already have been included in the parent's earnings and profits from being reflected by the parent a second time. Although the parent's earnings and profits are increased by the amount of the dividend (section 1.1502-33(c)(1)), they are reduced by the same amount by reflecting in earnings and profits the reduction in the basis of the stock of its subsidiary (sections 1.1502-32(b)(2)(iii)(a) and 1.1502- 33(c)(4)(ii)(a)). These adjustments offset each other, leaving the parent's earnings and profits account at the same level before and after the distribution.

For example, assume that a group consists of P and its wholly owned subsidiary, S, and that P and S have earned $100 and $200 respectively. S has $200 of earnings and profits. P's earnings and profits account is $300, representing $100 of its own earnings and profits plus the $200 of earnings and profits of S under sections 1.1502-32(b)(1)(i), section 1.1502-32(e)(2), and 1.1502-33(c)(4)(ii). If S distributes all of its earnings and profits, the earnings and profits of P are first increased, then decreased by the amount of the distribution ($200), so that after the distribution P's earnings and profits are still $300 and S's earnings and profits are zero.

However, assume that P's shareholders organize a new corporation, HC. HC organizes a wholly owned subsidiary, T, and T merges into P in a reverse acquisition. The group remains in existence with HC as the new common parent. Because HC is a newly created corporation, it has no earnings and profits attributable to its own operations. In addition, HC's earnings and profits account does not reflect P's $300 of earnings and profits. If P distributes its earnings and profits to HC, a literal application of the consolidated return regulations would require offsetting adjustments to HC's earnings and profits account, even though the reason for making these adjustments, to avoid the duplication of the same earnings and profits in a single corporation, is not present. HC could then distribute the group's $300 of earnings to its shareholders (formerly the shareholders of P) without dividend treatment.

New section 1.1502-33T(a)(1) provides, in general, that if there is a change in the common parent of a group, but the group remains in existence and the stockholders of the former common parent immediately before the change own 80 percent or more of the value of the stock of the new common parent immediately after the change, the earnings and profits of the new common parent are adjusted to reflect the earnings and profits of the former common parent.

Under section 1.1502-33T(a)(2), similar rules apply to a change in structure among lower tier members. Appropriate adjustments to earnings and profits are made when the position of a member in a chain of includible corporations changes, and the group remains in existence.

New section 1.1502-33T(b) provides that if section 1.1502-33T(a) does not apply to a change in the group's structure but the group remains in existence, then the negative investment adjustment made by the distributee with respect to a dividend distribution in a taxable year ending after September 7, 1988, does not apply to reduce the earnings and profits of the distributee to the extent that the distribution is out of earnings and profits that are not reflected in the earnings and profits of the distributee, but would have been so reflected if the new rule had applied. The effect is that such a distribution will increase the distributee's earnings and profits.

SECTION 1.1502-77T

Section 1.1502-77T supplements section 1.1502-77 by providing for alternative agents for the group, for purposes of mailing notices of deficiencies and for giving waivers of the statute of limitations, when the corporation that is the common parent of the group ceases to be the common parent. Under section 1.1502-77T, any one or more of the corporations listed below are deemed to be agents of the group for these purposes:

(a) The common parent of the group for all or any part of the year to which the notice or waiver applies,

(b) A successor to the former common parent in a transaction to which section 381(a) applies,

(c) The agent designated by the group under section 1.1502- 77(d), or

(d) If the group remains in existence under section 1.1502- 75(d)(2) or (3), the common parent of group at the time the notice is mailed or the waiver given.

SPECIAL ANALYSES

A general notice of proposed rulemaking is not required by 5 U.S.C. 553 for temporary regulations. Accordingly, the temporary regulations do not constitute regulations subject to the Regulatory Flexibility Act (5 U.S.C. Chapter 6). The Commissioner of Internal Revenue has determined that this temporary rule is not a major rule as defined in Executive Order 12291 and that a regulatory impact analysis therefore is not required.

DRAFTING INFORMATION

The principal author of the temporary regulations is Judith C. Winkler of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service. However, other personnel of the Internal Revenue Service and Treasury Department participated in developing the regulations, on matters of both substance and style.

LIST OF SUBJECTS IN 26 CFR 1.1501-1 through 1.1564-1

Income taxes, Controlled group of corporations, Consolidated returns.

LIST OF SUBJECTS IN 26 CFR PART 602

Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, Parts 1 and 602 of Title 26 of the Code of Federal Regulations are amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for Part I is amended by adding the following citations:

Authority: 26 U.S.C. 7805; * * * sections 1.1502-31T, 1.1502- 33T, and 1.1502-77T also issued under 26 U.S.C. 1502.

Par. 2. Section 1.1502-31 is amended by adding paragraph (c) to read as follows:

SECTION 1.1502-31 BASIS OF PROPERTY.

* * * *

(c) CROSS-REFERENCE TO TEMPORARY REGULATIONS. For rules relating to the basis of stock of a subsidiary when a group is restructured and the common parent is changed, see section 1.1502-31T.

Par. 3. There is added immediately after section 1.1502-31 a new section 1.1502-31T to read as follows.

SECTION 1.1503-31T BASIS OF STOCK OF SUBSIDIARY (TEMPORARY).

(a) BASIS OF STOCK FOLLOWING CERTAIN CHANGES IN STRUCTURE OF GROUP -- (1) APPLICATION. This paragraph (a) applies to a nonrecognition transaction, as defined in section 7701(a)(45), occurring after September 7, 1988 in which the corporation that is the common parent of the group ceases to be the common parent (the "former common parent"), and --

(i) The group remains in existence under section 1.1502- 75(d)(2) or

(ii) The group remains in existence under section 1.1502- 75(d)(3), and the stockholders of the common parent immediately before the transaction own, immediately after the transaction, 80 percent or more of the fair market value of the outstanding stock of the new common parent.

For purposes of this section, the terms "group structure change" and "change" refer to a transaction described in this paragraph (a)(1).

(2). FORMER COMMON PARENT REMAINS IN EXISTENCE -- (i) GENERAL RULE. If the former common parent remains in existence after a group structure change, the basis of its stock in the hands of another member (the "owning member"), immediately after the transaction, equals the sum of --

(A) The net inside basis of the property of the former common parent (other than property received in the group structure change) immediately after the group structure change,

(B) The owning member's basis (or excess loss account, treated for this purpose as negative basis), immediately before the change, in the stock of any corporation whose assets or liabilities were acquired by the former common parent in the change (the "merged corporation"), and

(C) The amount (whether positive or negative determined by subtracting from --

(1) The aggregate adjusted basis of property transferred by the owning member to the merged corporation in the group structure change that is not transferred in the change to the shareholders of the former common parent,

(2) The aggregate amount of any liabilities (other than liabilities described in section 357(c)(3)) of the owning member assumed by the former common parent or to which the transferred property is subject.

(ii) NET INSIDE BASIS DEFINED. For purposes of paragraph (a)(2)(i)(A) of this section, the net inside basis of the former common parent equals the amount (whether positive or negative) determined by subtracting from --

(A) The amount of money and the aggregate adjusted basis of the property of the former common parent (other than property received in the group structure change),

(B) The aggregate amount of any liabilities of the former common parent (other than liabilities described in section 357(c)(3) and liabilities assumed or acquired in the group structure change), immediately after the group structure change.

(iii) ALLOCATION OF NET INSIDE BASIS. A member may take into account under paragraph (a)(2)(i)(A) only the percentage of net inside basis equal to the percentage of the stock of the former common parent the member owns immediately after the group structure change. If the former common parent has more than one class of stock outstanding immediately after the group structure change, net inside basis is first allocated among the classes in proportion to the value of each class.

(iv) PROPERTY TRANSFERRED TO FORMER COMMON PARENT SHAREHOLDERS. A member's basis in the stock of the former common parent, as determined under paragraph (a)(2)(i) of this section, is reduced (below zero if necessary) by the fair market value of any consideration transferred to the shareholders of the former common parent with respect to their stock in the former common parent in the group structure change and furnished by the merged corporation.

(v) NEGATIVE BASIS TREATED AS AN EXCESS LOSS ACCOUNT. If an owning member's basis in the stock of the former common parent, as determined under this paragraph (a)(2), in negative, the member shall treat the negative basis as an excess loss account with respect to the stock, and the member's basis in the stock immediately after the change is zero.

(vi) ADJUSTMENTS TO HIGHER TIERS. If stock of the former common parent is acquired by a member other than the new common parent, appropriate adjustments shall be made to the basis (in the hands of a member) of the stock of each member that owns directly or indirectly stock in the former common parent to take into account the amounts described in paragraph (a)(2)(i)(A) and (C) and (a)(2)(iii) and (iv) of this section.

(vii) SUBSEQUENT DISTRIBUTIONS. All distributions out of earnings and profits, accumulated before the change, of a former common parent whose stock basis is determined under this paragraph (a)(2) are deemed to be out of earnings and profits accumulated in prior consolidated return years beginning after December 31, 1965.

(3) FORMER COMMON PARENT DOES NOT REMAIN IN EXISTENCE -- (i) GENERAL RULE. If the former common parent goes out of existence in a group structure change, the basis in the hands of a member (the "owning member") of the stock of each member that acquires property from the former common parent, or assumes liabilities of the former common parent (the "acquiring member"), immediately after the change, equals the sum of --

(A) The owning member's basis (or excess loss account, treated for this purposes as negative basis) in the acquiring member's stock immediately before the acquisition of property or liabilities of the former common parent,

(B) The former common parent's net basis in the property acquired from it by the acquiring member in the group structure change, and

(C) The net basis of property acquired in the group structure change by the acquiring member from the owning member that is not transferred in the change to the former common parent or its shareholders.

(ii) NET BASIS DEFINED. For purposes of paragraph (a)(3)(i)(B) and (C) of this section, net basis equals the amount (whether positive or negative) determined by subtracting from --

(A) The amount of money and the aggregate adjusted basis of the acquired property.

(B) The aggregate amount of any liabilities of the former common parent (other than liabilities described in section 357(c)(3)) assumed by the acquiring member or to which the acquired property is subject.

(ii) ADJUSTMENTS. The owning member's basis in the stock of the acquiring member, as determined under paragraph (a)(3)(i) of this section, is --

(A) Decreased (below zero if necessary) by the fair market value of any consideration exchanged for the former common parent's assets in the group structure change and furnished by the acquiring member in the group structure change, and

(B) Increased by the amount of any gain recognized by the former common parent of the transfer of its assets to the acquiring member in the group structure change.

(iv) NEGATIVE BASIS TREATED AS AN EXCESS LOSS ACCOUNT. If an owning member's in the stock of an acquiring member, as determined under this paragraph (a)(3), is negative, the member shall treat the negative basis as an excess loss account with respect to the stock, and the member's basis in the stock immediately after the group structure change is zero.

(v) ADJUSTMENT TO HIGHER TIERS. If assets or liabilities of the former common parent are acquired by a member other than a member that is owned directly by the new common parent, appropriate adjustments shall be made to the basis (in the hands of a member) of the stock of each member that owns directly or indirectly assets or liabilities of the former common parent to take into account amounts described in paragraphs (a)(3)(i)(B) and (c) and (a)(3)(iii) of this section.

(vi) SUBSEQUENT DISTRIBUTIONS. All distributions by a member whose stock basis is determined under paragraph (a)(3)(i) of this section out of accumulated earnings and profits that the member acquires from the former common parent are deemed to be out of earnings and profits accumulated in prior consolidated return years beginning after December 31, 1965.

(vii) EXAMPLE. The following example illustrates the operation of paragraph (a)(3) of this section.

EXAMPLE. (a) For several years, Corporation P has owned all the stock of Corporation S. P has a basis of $100 in the S stock. P has 200 shares of a single class of stock outstanding. P contributes 800 shares of newly issued P stock to S. Corporation X, the common parent of another group filing consolidated returns, merges into S in a forward triangular merger qualifying under section 368(a)(1)(A) by reason of the application of section 368(a)(2)(D). In the merger of X into S, X's shareholders exchange their X stock for the 800 shares of P stock and $50 of S's cash. At the time of the merger, the aggregate basis of X's property is $600. X has no liabilities. The merger is a reverse acquisition under section 1.1502- 75(d)(3), and the X group continues in existence after the merger, with P as the common parent.

(b) Since the stockholders of X receive in exchange for their X stock 80 percent of the P stock, P's basis in its S stock is determined under paragraph (a)(3) of this section. P's $100 basis in the S stock is increased by $600, the net basis of X's assets and decreased by $50, the amount S furnished to X's shareholders in connection with the merger. P's basis in the S stock is $650 (its basis before the transaction, $100, plus $600 net basis of X's assets, minus $50 furnished by S in the merger).

(4) ANTI-DUPLICATION RULE. No increase or decrease in the basis of a member's stock shall be made under this paragraph (a) to the extent the increase or decrease would duplicate and amount otherwise taken into account in the basis of the member's stock.

(b) ELECTION TO APPLY PARAGRAPH (a). If a group has had a change in structure to which paragraph (a) of this section would apply except that the change occurred on or before September 7, 1988, then the group may elect apply paragraph (a). An election to apply paragraph (a) of this section constitutes an election apply section 1.1502-33T(a) relating to adjustments in earnings and profits. The election apply Section 1.1502-33T(a) will adjust the earnings and profits of the common parent to reflect the earnings and profits of the former common parent at the time of the change that are not, at the time of the election, reflected in the common parent's earnings and profits. The election is made by attaching a statement to the return of the group for the taxable year that includes September 7, 1988 and is effective as of the first day of that year. The election shall contain a certification that the members of the group have the information necessary to determine the adjustments required by paragraph (a) of this section and paragraph (a) of section 1.1502- 33T.

Par. 4. Section 1.1502-33 is amended by adding paragraph (c)(6) to read as follows:

SECTION 1.1502-33 EARNING AND PROFITS.

* * *

(c) * * *

(6) CROSS-REFERENCE TO TEMPORARY REGULATIONS. For rules relating to adjustments in earnings and profits of members resulting from a change in the structure of a group, see section 1.1502-33T.

Par. 5. There is added immediately after section 1.1502-33 a new section 1.1502-33T to read as follows:

SECTION 1.1502-33T EARNINGS AND PROFITS (TEMPORARY).

(a) CHANGES IN STRUCTURE OF GROUP AFTER September 7, 1988 -- CHANGE OF COMMON PARENT. If the corporation that is the common parent of the group ceases to be the common parent in a change in the structure of the group to which section 1.1502-31T(a) applies, the earnings and profits of the new common parent shall be adjusted to reflect the earnings and profits of the former common parent at the time of the change.

(2) CHANGES IN SUBSIDIARIES. If, because of a change in the structure of the group (including a change described in paragraph (a)(1) of this section), after September 7, 1988, the position of a member in a chain of includible corporations changes and the group remains in existence, proper adjustments shall be made to the earnings and profits of the members (other than the new common parent).

(3) SECTION 381 TRANSACTIONS. For purposes of the anti- duplication rule of section 1.1502-33(c)(5), earnings and profits reflected under this paragraph (a) are treated as earnings and profits reflected under section 1.1502-33(c)(4).

(4) EXAMPLE. The following example illustrates the application of paragraph (a) of this section.

EXAMPLE. (a) On January 1, 1989, the stock of corporation P, the common parent of a group filing a consolidated return on a calendar year basis , is acquired by X, the common parent of an unrelated group filing consolidated returns on a calendar year basis, in a reverse acquisition to which section 1.1502- 75(d)(3) applies. The P shareholders receive, in exchange for their P stock, common stock of X representing 80 percent of the value of the X stock outstanding after the acquisition. Immediately before the acquisition, P has earnings and profits of $100 and X has earnings and profit of $20.

(b) Under section 1.1502-75(d)(3), the P group remains in existence with X as its common parent. Under paragraph (a)(1) of this section, X's earnings and profits are increased by $100, the amount of P's earnings and profits immediately before the acquisition. Thus, immediately after the acquisition X has $120 of earnings and profits and P has $100 of earnings and profits.

(b) CHANGES IN STRUCTURE TO WHICH PARAGRAPH (a) DOES NOT APPLY -- (1) GENERAL RULE. If paragraph (a) of this section does not apply to a change in structure of the group, but the group remains in existence under section 1.1502-75(d)(2) or (3), then, in the case of a distribution in a taxable year ending after September 7, 1988, Section 1.1502-32(b)(2)(iii)(a) or (c)(2)(i) shall not reduce the earnings and profits of the distributee member to the extent that the distribution is out of earnings and profits that are not reflected in the earnings and profits of the distributee member, but would have been so reflected if paragraph (a) of this section had applied.

(2) EXAMPLE. The following example illustrates the application of paragraph (b)(1) of this section.

EXAMPLE. (a) The facts are the same as in the example in paragraph (a)(4) of this section, except that the reverse acquisition takes place on January 1, 1988. P has no earnings and profits for 1988. No election is made under section 1.1502- 31T(b).

(b) Paragraph (a) of this section does not apply, and X's earnings and profits remain $20 following the acquisition. However, if P makes a $100 distribution on November 15, 1988, of its earnings and profits to X, the distribution increases X's earnings and profits by $100. X reflects the $100 distribution in its earnings and profits under section 1.1502-33(c)(1), but under paragraph (b) of this section it does not reflect in its earnings and profits under section 1.1502-33(c)(4)(ii) the $100 negative adjustment that it makes in the basis of the P stock under section 1.1502-32(b)(2)(iii) with respect to the distribution.

(c) The result of the distribution in this example would be the same if the shareholders of P received less than 80 percent of the value of the X stock outstanding after the acquisition, provided that the P group remains in existence under section 1.1502-75(d)(3) and the distribution is made in a taxable year ending after September 7, 1988.

(c) CROSS-REFERENCE. See section 1.1502-31T(b) for an election to apply to section 1.1502-31T(a) and paragraph (a) of this section even though a change in the structure of the group occurred on or before September 7, 1988.

Par. 6. Section 1.1502-77 is amended by adding paragraph (e) to read as follows:

SECTION 1.1502-77 COMMON PARENT AGENT FOR SUBSIDIARIES.

* * * * *

(e) CROSS-REFERENCE TO TEMPORARY REGULATIONS. For rules relating to alternative agents of the group, see section 1.1502-77T.

Par. 7. There is added immediately after section 1.1502-77 a new section 1.1502-77T to read as follows:

SECTION 1.1502-77T ALTERNATIVE AGENTS OF THE GROUP (TEMPORARY).

(a) GENERAL RULES -- (1) SCOPE. This section applies if the corporation that is the common parent of the group ceases to be the common parent, whether or not the group remains in existence under section 1.1502-75(d).

(2) NOTICE OF DEFICIENCY. A notice of deficiency mailed to any one or more corporations referred to in paragraph (a)(4) of this section is deemed for purposes of section 1.1502-77 to be mailed to the agent of the group. If the group has designated an agent that has been approved by the district director under section 1.1502-77(d), a notice of deficiency shall be mailed to that designated agent in addition to any other corporation referred to in paragraph (a)(4) of this section. However, failure by the district director to mail a notice of deficiency to that designated agent shall not invalidate the notice of deficiency mailed to any other corporation referred to in paragraph (a)(4) of this section.

(3) WAIVER OF STATUTE OF LIMITATIONS. A waiver of the statute of limitations with respect to the group given by any one or more corporations referred to in paragraph (a)(4) of this section is deemed to be given by the agent of the group.

(4) ALTERNATIVE AGENTS. The corporations referred to in paragraph (a)(2) and (3) of this section are --

(i) The common parent of the group for all or any part of the year to which the notice or waiver applies,

(ii) A successor to the former common parent in a transaction to which section 381(a) applies,

(iii) The agent designated by the group under section 1.1502- 77(d), or

(iv) If the group remains in existence under section 1.1502- 75(d)(2) or (3), the common parent of the group at the time the notice is mailed or the waiver given.

(b) EFFECTIVE DATE. Paragraph (a) of this section applies to statutory notices and waivers of the statute of limitations for taxable years for which the due date (without extensions) of the consolidated return is after September 7, 1988.

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 8. The authority citation for 26 CFR Part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 9. Section 602.101(c) is amended by inserting in the appropriate place in the table "1.1502-31T, 1.1502-33T, and 1.1502- 77T * * * 1545-1046".

The provisions contained in this Treasury Decision are needed to provide for proper basis and proper earnings and profits adjustments in cases where there is a change in the structure of the group but the group remains in existence, and to provide for alternative agents of the group where a corporation has ceased to be the common parent of the group. It is therefore found impracticable and contrary to the public interest to issue this Treasury Decision with notice and public procedure under subsection (b) of section 553 of title 5 of the United States Code or subject to the effective date limitation of subsection (d) of that section.

Charles H. Brennan