NYSBA Tax Section Submits Report on Accelerated Share Repurchases

January 5, 2018

The Honorable David Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William M. Paul
Principal Deputy Chief Counsel and
Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable David Kautter
Acting Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Report No. 1384 on the Treatment of Share Repurchases under Section 355(e)

Dear Messrs. Kautter and Paul:

I am pleased to submit the attached report of the Tax Section of the New York State Bar Association. The report addresses repurchases made by a public corporation on the open market, in an accelerated share repurchase (“ASR”) program, or through a self-tender generally open to all shareholders (“Public Share Repurchases”). As described below, the report recommends that the Treasury Department and the Internal Revenue Service publish a revenue ruling providing certain counting conventions for measuring the shift in ownership for purposes of Section 355(e) of the Internal Revenue Code resulting from Public Share Repurchases.

Specifically, we make the following recommendations:

We appreciate your consideration of our recommendations. If you have any questions or comments regarding this report, please feel free to contact us and we will be glad to discuss or assist in any way.

Respectfully submitted,

Michael Farber
Chair
New York State Bar Association
Tax Section

Attachment

cc:
Dana L. Trier
Deputy Assistant Secretary (Tax Policy)
Department of the Treasury

Thomas C. West
Tax Legislative Counsel
Department of the Treasury

Krishna Vallabhaneni
Deputy Tax Legislative Counsel
Department of the Treasury

Robert H. Wellen
Associate Chief Counsel (Corporate)
Internal Revenue Service

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New York State Bar Association Tax Section

Report on the Treatment of Share Repurchases under Section 355(e)

January 5, 2018

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TABLE OF CONTENTS

I. INTRODUCTION

II. SUMMARY OF RECOMMENDATIONS: COUNTING CONVENTIONS FOR PUBLIC SHARE REPURCHASES

III. BACKGROUND — COUNTING CONVENTIONS FOR PUBLIC SHARE REPURCHASES

IV. PRORATION

V. NETTING

VI. EFFECT OF NON-PLAN REPURCHASES

VII. CONCLUSION

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New York State Bar Association Tax Section

Report on the Treatment of Share Repurchases under Section 355(e)

I. INTRODUCTION

This report (the “Report”) of the Tax Section of the New York State Bar Association comments on the treatment of share repurchases under Section 355(e) of the Code.¹ In particular, the Report addresses repurchases made by a public corporation on the open market, in an accelerated share repurchase (“ASR”) program, or through a self-tender generally open to all shareholders (“Public Share Repurchases”). As described below, the Report recommends that the Treasury Department (“Treasury”) and the Internal Revenue Service (the “Service,” and, together with Treasury, the “government”) publish a revenue ruling providing certain counting conventions for measuring the shift in ownership for Section 355(e) purposes resulting from Public Share Repurchases.²

II. SUMMARY OF RECOMMENDATIONS: COUNTING CONVENTIONS FOR PUBLIC SHARE REPURCHASES

We recommend that the government publish a revenue ruling reaching the following technical conclusions:

III. BACKGROUND – COUNTING CONVENTIONS FOR PUBLIC SHARE REPURCHASES

Under Section 355(e), a distribution by a distributing corporation (“D”) of the stock of a controlled corporation (“C”) that otherwise satisfies the requirements for non-recognition treatment under Section 355 or Section 361 will be taxable to D if the distribution “is part of a plan (or series of related transactions) pursuant to which 1 or more persons acquire directly or indirectly stock representing a 50-percent or greater interest in” D or C (a “Section 355(e) Plan”).⁴ A “50-percent or greater interest” is stock in a corporation having at least 50% of the total combined voting power of all classes of stock entitled to vote or at least 50% of the total value of the shares of all classes of stock.⁵

Neither the Code nor the regulations promulgated thereunder, including Treasury Regulations Section 1.355-7 (which provides further guidance on the application of the general rule in Section 355(e)), define the term “acquire” for this purpose. A question that often arises in applying Section 355(e) is whether, and to what extent, a repurchase of stock by D or C from its respective shareholders (a “repurchase”) constitutes an acquisition for purposes of Section 355(e). A repurchase can be viewed as an indirect acquisition of D or C stock by shareholders who do not participate in such repurchase (i.e., as an increase in the proportionate ownership by non-redeemed shareholders of D or C)⁶ and, indeed, the Service's ruling history supports this view.⁷

Assuming that a repurchase can result in an “acquisition” within the meaning of Section 355(e), the issuer must then determine whether such acquisition is part of a Section 355(e) Plan. If a repurchase (and any resulting acquisition) is not part of a Section 355(e) Plan, then such acquisition generally should have no bearing on the Section 355(e) analysis.⁸ If, however, a repurchase (and/or any resulting acquisition) is part of a Section 355(e) Plan (i.e., under the rules of Treasury Regulations Section 1.355-7), the taxpayer must calculate the percentage of the vote and value of the relevant corporation (D or C) acquired (the “Section 355(e) Ownership Shift”) as a result of such repurchase. This calculation raises a number of questions that are the subject of this Report.

A. Basic Computational Approach to Repurchases

Calculating the Section 355(e) Ownership Shift where shares are acquired pursuant to a Section 355(e) Plan (a “Plan Acquisition” and the shares acquired in such transaction “Plan Shares”) is relatively straightforward in the context of a direct acquisition of shares. Conceptually, the Section 355(e) Ownership Shift can be determined by comparing the shareholder's ownership immediately before and after the Plan Acquisition. Mathematically, the Section 355(e) Ownership Shift can be expressed as a percentage, calculated by dividing the total number of Plan Shares acquired (the “Numerator”) by the total number of shares outstanding immediately after the Plan Acquisition (the “Denominator” and such quotient, the “Plan Acquisition Percentage”).

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership
A	50	50%	60	60%
B	50	50%	40	40%
Total	100	100%	100	100%

In this example, the Section 355(e) Ownership Shift is 10%. Immediately before the Plan Acquisition, A owned 50% of the stock of D, and immediately after the Plan Acquisition, A owns 60% of the stock of D. A has acquired 10 Plan Shares and the Plan Acquisition Percentage is 10% (i.e., 10 Plan Shares/100 total shares outstanding immediately after the Plan Acquisition). While the computational results in the case of a single direct acquisition are relatively straightforward, the results in the case of a repurchase occurring pursuant to a Section 355(e) Plan (a “Plan Repurchase”) are more nuanced because the repurchase reduces the number of shares outstanding.

Example 2: D has outstanding 100 shares of stock. A and B each own 50 shares. D distributes 100% of the stock of its wholly owned subsidiary, C, to D's shareholders. On Date 1, D redeems 10 D shares from B in a Plan Acquisition.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership
A	50	50%	50	55.5%
B	50	50%	40	44.5%
Total	100	100%	90	100%

At first blush, it may seem appropriate to create parity between the Plan Repurchase in Example 2 and the direct acquisition between shareholders in Example 1, because both cases involve an acquisition of 10 shares. However, given that Section 355(e) focuses on percentage changes in economic ownership and voting power pursuant to Section 355(e)(3)(A)(iv) and (e)(4)(C), this approach is inappropriate, as evidenced by the fact that the two transactions have different economic results. Namely, the Plan Repurchase in Example 2 has increased A's stock ownership in D from 50% to approximately 55.5%, rather than from 50% to 60% as in Example 1. Consequently, if one were to deem the Plan Repurchase in Example 2 as resulting in an acquisition of 10 Plan Shares by A, the Plan Acquisition Percentage of Example 2 would overstate the amount of the Section 355(e) Ownership Shift. Instead, it is necessary to calculate the number of Plan Shares indirectly acquired by shareholders who do not participate in the repurchase (the “Non-Participating Shareholders”) in a Plan Repurchase. Conceptually, the number of Plan Shares indirectly acquired by A is measured by the extent to which A under-participated in the repurchase; if the repurchase had been pro rata among all D's shareholders, D would have redeemed 5 shares from A. Thus, the Numerator (as compared to Example 1) should, in fact, be 5.⁹ Furthermore, the Plan Repurchase reduces the Denominator by 10. Consequently, the Plan Acquisition Percentage is approximately 5.55% (i.e., 5 Plan Shares/90 total shares outstanding immediately after the Plan Acquisition).

IV. PRORATION

As demonstrated above, in calculating the Section 355(e) Ownership Shift resulting from a Plan Repurchase, the issuer must determine the number of Plan Shares indirectly acquired by the Non-Participating Shareholders. However, this calculation rests on a determination of which shareholders should be treated as participating in the repurchase (the “Participating Shareholders”). In fact patterns where the identity of the Participating Shareholders and the extent of their participation in the repurchase is known, this determination is straightforward.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership
Sh. 1	10	10%	0	0%
Sh. 2	10	10%	0	0%
Sh. 3	10	10%	0	0%
Sh. 4	10	10%	0	0%
Sh. 5	10	10%	0	0%
Sh. 6	10	10%	10	20%
Sh. 7	10	10%	10	20%
Sh. 8	10	10%	10	20%
Sh. 9	10	10%	10	20%
Sh. 10	10	10%	10	20%
Total	100	100%	50	100%

Under these facts, D has had a Section 355(e) Ownership Shift of 50%. The Non-Participating Shareholders have indirectly acquired 25 Plan Shares (or have under-participated in the repurchase by 25 shares, i.e., had the repurchase been made pro rata among all shareholders, D would have redeemed 5 shares from each of the five Non-Participating Shareholders),¹¹ and the Plan Acquisition Percentage is 50% (i.e., 25 Plan Shares/50 total shares outstanding immediately after the Plan Acquisition). Because D privately negotiated the repurchases with 5 shareholders and is able to identify the Participating Shareholders and the extent of their participation, the appropriate results are clear.

However, the determination as to who should be treated as a Participating Shareholder and the calculation of the Section 355(e) Ownership Shift is not straightforward in many fact patterns. What if D's stock is publicly traded and widely held and D undertakes open-market repurchases that are available to all D shareholders (and is indifferent as to participation by any particular shareholder or group of shareholders), such that there is no reasonable way to identify Participating and Non-Participating Shareholders and the extent of any such participation or under-participation?

In this context, the proper calculation of the Section 355(e) Ownership Shift is unclear. There are two possible approaches. One approach would be to treat the repurchase as being made entirely from a fictional group of shareholders who own an amount of stock in D equal to the amount of the repurchase (i.e., 5,000,000 shares) (the “Fictional Group Approach”).¹² Under the Fictional Group Approach, the Non-Participating Shareholders would be treated as indirectly acquiring 2,500,000 Plan Shares (i.e., 5,000,000 shares owned by Non-Participating Shareholders x the Repurchase Percentage (5,000,000 shares repurchased/10,000,000 total shares outstanding immediately prior to the repurchase)), and the Plan Acquisition Percentage would be 50% (i.e., 2,500,000 Plan Shares/5,000,000 total shares outstanding immediately after the Plan Acquisition). In cases where the identity of the Participating Shareholders and the extent of their participation in the repurchase is not known, the Fictional Group Approach is unduly punitive, assuming counterfactually that a fictional block of shareholders has been fully redeemed and overstating the resulting Section 355(e) Ownership Shift.

A second approach would be to treat the repurchase as being made pro rata from all of D's Public Shareholders (“Proration Treatment”). Thus, as a result of the repurchase, each of D's shareholders (assuming all of them are Public Shareholders) would reduce the number of shares it owns by the same relative amount as each other D shareholder, with each D shareholder's percentage ownership immediately prior to the repurchase remaining equal to each D shareholder's percentage ownership immediately following the repurchase. Therefore, there is no indirect acquisition (because there are no Non-Participating Shareholders), there are no Plan Shares acquired in the repurchase, and the Plan Acquisition Percentage and Section 355(e) Ownership Shift are 0%.

A. Service's Current Ruling Practice

In situations involving fact patterns similar to Example 4, including in at least eight private letter rulings issued since 2009,¹³ the Service has applied Proration Treatment, to the extent a repurchase is otherwise treated as part of a Section 355(e) Plan, to reduce¹⁴ or eliminate an indirect acquisition by the Non-Participating Shareholders.

In a recent ruling adopting Proration Treatment, Private Letter Ruling 201721002,¹⁵ the Service ruled that post-distribution repurchases of shares of C stock would be treated as made pro rata from all Public Shareholders. The ruling was, in part, based on the fact the repurchases were (1) made with respect to widely held shares, (2) made in open-market tractions and/or repurchases under an ASR,¹⁶ and (3) not motivated by a desire to increase or decrease the ownership percentage of any particular shareholder or group of shareholders. Other private rulings reach the same result based on similar facts and representations.¹⁷ For example, Private Letter Ruling 201627001¹⁸ involved a pre-distribution merger transaction between D and two merger partners, and both pre- and post-distribution repurchases of the stock of each such corporation were relevant, including repurchases conducted via tender offer. The taxpayer in that ruling also made certain representations regarding the absence of Controlling Shareholders and 10% Shareholders, and the Service applied Proration Treatment, deeming the repurchases as being made pro rata from all Public Shareholders.

In Private Letter Ruling 201037024,¹⁹ the Service issued a similar ruling with respect to open-market repurchases of D stock, where such stock was held by certain significant shareholders, and D engaged in privately negotiated repurchases as well as open-market repurchases. One shareholder (“Shareholder”) owned a certain (presumably significant) percentage of D stock and had a nomination right with respect to certain of D's and C's directors, but did not and would not actively participate in the management or operations of D, and another shareholder (“Person”) owned a certain percentage of D stock and had the right to vote all of the shares of D stock owned by Shareholder. The taxpayer represented that, other than Shareholder, Person, and two investment advisors (who presumably did not have beneficial ownership of D stock nominally held), there were no other shareholders who held five percent or more of D stock (effectively representing that there were no 10% Shareholders). The Service ruled that pre-and post-distribution open-market repurchases would be treated as being made pro rata from shareholders other than Controlling Shareholders, Shareholder, and Person, to the extent D could demonstrate that such repurchases were not made from a Controlling Shareholder, Shareholder, or Person. In support of this ruling, the taxpayer represented that (1) all D shareholders were permitted to participate in, and benefit from, the open-market repurchases, (2) D was indifferent as to which of its shareholders participated in the open-market repurchases, and (3) the open-market repurchases were not motivated to any extent by a desire to increase or decrease the ownership percentage of any particular shareholder or group of shareholders.

In at least three private rulings (Private Letter Rulings 201601009,²⁰ 201250021,²¹ and 201249011²²), the Service appears to have drawn a distinction between Controlling Shareholders and 10% Shareholders for purposes of determining whether Proration Treatment should apply. In each such ruling, in the context of a post-distribution acquisition of a target corporation by D or C in exchange for stock D or C, as applicable, the taxpayer made certain representations regarding the absence of Controlling Shareholders, but no similar representations were made with respect to 10% Shareholders. Further, the taxpayer represented that (1) no discussions were had regarding the repurchases with any particular shareholders or groups of shareholders, (2) all shareholders of the repurchasing corporation were allowed to participate in and benefit from the repurchases, (3) the repurchasing corporation was indifferent as to which shareholders participated, and (4) the repurchasing corporation would not know the identity of any shareholder from which stock was repurchased.²³ In each ruling, the Service ruled that the repurchases would be treated as being made pro rata from all holders of D stock (i.e., including, if relevant, 10% Shareholders) for purposes of Section 355(e).

Indeed, in at least two private rulings (Private Letter Rulings 201047016²⁴ and 201004001²⁵), the Service ruled that post-distribution repurchases of C stock (or its successor's) stock would be treated as being made pro rata from all holders of C stock (or stock of C's successor) for purposes of Section 355(e), without any specific representations regarding the existence (or non-existence) of Controlling Shareholders or 10% Shareholders.²⁶

While there are nuanced differences in the Service's application of Proration Treatment to pre- and post-distribution open-market repurchases of widely held stock of D, C, or their relevant predecessors or successors, especially with respect to the appropriate scope and treatment of “non-public shareholders,” the Service appears to have applied Proration Treatment consistently. We believe this represents a sensible solution in the context of Public Share Repurchases.

B. Discussion

We believe that Proration Treatment, appropriately modified to account for the existence of significant shareholders or different classes of stock, is the better method of calculating the impact of pre- and post-distribution Public Share Repurchases that occur pursuant to a Section 355(e) Plan in most situations involving widely held, publicly traded stock of D or C (or their relevant predecessors or successors). However, because taxpayers cannot rely on private letter rulings issued to other taxpayers,²⁷ despite the consistent nature of the Service's application of Proration Treatment, taxpayers do not have certainty as to whether Proration Treatment will apply to particular Public Share Repurchases. Where certainty in the calculation of the Section 355(e) Ownership Shift (including the methodology for determining the impact of repurchases) is crucial to determining whether a distribution will satisfy the requirements of Section 355 (i.e., where the aggregate impact of acquisitions that are part of a Section 355(e) Plan would, without application of Proration Treatment, potentially result in a 50% or greater Section 355(e) Ownership Shift), taxpayers will often seek individual private letter rulings.²⁸ In light of the Service's consistent ruling position, we believe that publishing guidance in the form of a revenue ruling on which all taxpayers may rely would be appropriate and efficient, avoiding the need to devote both government and taxpayer resources to the request for, and issuance of, private rulings in this area. Thus, we recommend that the Service publish a revenue ruling adopting Proration Treatment in Public Share Repurchases subject to the limitations and conditions described below (the “Proration Rule”).

The revenue ruling would provide that, to the extent, for purposes of Section 355(e), a repurchase of shares of D or C is part of a plan (or series of related transactions) including a distribution otherwise qualifying under Section 355, such repurchase will be treated as being made from all Public Shareholders of the repurchasing corporation owning stock of the same class as the repurchased shares on a pro rata basis, if the following criteria are satisfied: (1) the class of shares of repurchased stock is widely held and listed on an established market²⁹ (i.e., the Widely Held Requirement) and (2) such repurchase is made in the open market, through an ASR program, or through a tender offer generally available to all Public Shareholders (i.e., the Open Participation Requirement). Finally, to the extent such repurchase is made pursuant to an AUA designed to increase or decrease the ownership percentage of any particular shareholder or group of shareholders, or there is actual knowledge of the increase or decrease of any particular shareholder or group of shareholders, this will be taken into account for purposes of computing the Section 355(e) Ownership Shift resulting from such repurchase (i.e., the Knowledge Based Counting Convention).

1. Elements of the Proration Rule

Each of the Widely Held Requirement, the Open Participation Requirement, the Knowledge-Based Counting Convention, and the limited application of Proration Treatment to Public Shareholders is intended to ensure that repurchases subject to the Proration Rule reflect the factual underpinnings of the Service's private rulings that have afforded Proration Treatment and that the computational effects of Proration Treatment are not at odds with the actual or intended effects of a repurchase on ownership percentages.

The principle underlying the Widely Held Requirement is that the Proration Rule should only apply in situations where there are significant practical difficulties associated with identifying Participating and Non-Participating Shareholders (and distinguishing shareholders' transactions as part of the repurchase from those independent of the repurchase). As an initial matter, although we acknowledge that the term “widely held” lacks precision, we note that the term has been used without precise definition in prior guidance³⁰ and in each of the Service's rulings applying Proration Treatment discussed above, which included a statement that the stock to be repurchased was widely held and/or publicly traded.

We believe that the Widely Held Requirement should be satisfied in all instances where stock is publicly traded, regardless of concentration of ownership, as there are significant practical difficulties associated with tracking ownership changes of all publicly traded stock due to the virtual impossibility of matching a particular buyer with a particular seller. If a precise definition is necessary, we recommend importing the definition from Section 897, which, for purposes of defining the term “United States real property interest,” exempts “any class of stock of a corporation [that] is regularly traded on an established securities market.”³¹ However, if the government feel that concentration of ownership should also be a relevant characteristic in determining satisfaction of the Widely Held Requirement, we recommend importing the definition from Section 856(h), which provides that an entity is “closely held” if more than 50% of the value of its shares is owned directly or indirectly by or for five or fewer individuals at any time during the last half of the entity's tax year.

The Open Participation Requirement is intended to confirm that the repurchasing corporation (1) offers the opportunity to tender to all Public Shareholders (such that any resulting ownership shifts are caused by shareholders' independent investment decisions about whether or not to participate and not by the design of the issuer) and (2) does not have control over the identity of or participation by particular shareholders from whom repurchases are made. The repurchasing corporation's inability to control the impact of the repurchases on the relative ownership among shareholders suggests that it did not undertake the repurchases for the purpose of facilitating a particular acquisition and supports the idea that Proration Treatment is a reasonable methodology that is not inconsistent with the underlying transaction (i.e., if the repurchasing corporation cannot control the result achieved by Public Share Repurchases among Public Shareholders of a particular class — or even have any significant visibility into the result so achieved – it is difficult to imagine what deemed result would be more appropriate than one that maintains pro rata ownership as a proxy for the uncontrollable actual result). Further, Proration Treatment mitigates certain administrative difficulties that would arise when attempting to calculate the impact of the repurchases in the absence of complete information about the makeup of Participating and Non-Participating Shareholders.³²

Consistent with the Service's ruling practice, we believe that a repurchase made pursuant to a tender offer open to all shareholders or a typical ASR program should be treated the same as an open-market repurchase for purposes of the Open Participation Requirement. For example, an ASR program in its typical form merely provides a mechanic for a repurchasing corporation to repurchase a desired number of shares quickly and efficiently through a third-party bank intermediary.³³ Despite the fact that, in form, the repurchasing corporation acquires its shares from a single “shareholder” (the bank), the bank is in effect merely acting as an intermediary between the repurchasing corporation and its existing and future Public Shareholders. From the perspective of the repurchasing corporation and with respect to the lack of control over the identity of and participation by Participating Shareholders, there is little substantive difference between repurchases made in the open market and those made pursuant to an ASR program. This rationale also supports the extension of the Proration Rule to repurchases made via tender offers.

The Knowledge-Based Counting Convention ensures that application of the Proration Rule does not lead to inappropriate results in situations where the repurchasing corporation utilizes a repurchase to shift ownership levels between particular shareholders or groups of shareholders.³⁴ If repurchasing corporations attempt to facilitate targeted ownership shifts in such a manner, the Proration Rule should operate to reflect the realities of the transactions that occurred. If a repurchase is made pursuant to an AUA, such AUA will be taken into account when applying the Proration Rule. For example, if a repurchasing corporation has an AUA with a particular group of Public Shareholders not to participate in the repurchase, the Proration Rule should not apply to that particular group of Public Shareholders (but it may still apply to other groups of Public Shareholders, assuming the other requirements are satisfied). Similarly, where there is actual knowledge regarding participation in a repurchase by a particular shareholder or group of shareholders, the Proration Rule will not apply to deem a result that is contrary to such actual knowledge; rather, computation of the Section 355(e) Ownership Shift should take into account any actual knowledge regarding participation in a repurchase.

Finally, limiting the application of Proration Treatment to Public Shareholders (i.e., deeming all Public Share Repurchases to have been made pro rata among Public Shareholders only, regardless of the existence of or participation by 10% Shareholders or Controlling Shareholders) ensures that repurchases are not eligible for the Proration Rule to the extent that such repurchases are made from significant shareholders who either are actively involved in the management of the repurchasing corporation or whose ownership stake is sufficiently large that tracking their participation in repurchases is not likely to raise similar administrative concerns.³⁵

2. Rationale for the Proration Rule

The Proration Rule is rooted in both administrative and policy-based considerations. As an administrative matter, it is impractical for the taxpayers or for the Service to determine the identity of Participating and Non-Participating Shareholders and the extent to which such shareholders participate or refrain from participating. Where the Widely Held Requirement and the Open Participation Requirement are satisfied, it is practically impossible to calculate the actual Section 355(e) Ownership Shift. Especially in light of trading frequency and daily trading volume, it is impractical for taxpayers to determine which shareholders tendered shares, which shareholders retained shares, and which shareholders transacted in the open market (in secondary transactions) independent from the relevant repurchases. Some form of counting convention seems necessary as an administrative matter. Moreover, where these requirements are satisfied, as discussed above, the repurchasing corporation cannot control or influence the result achieved by any Public Share Repurchase, suggesting that Proration Treatment is an appropriate proxy for the actual result that arises based on the independent investment decisions of Participating and Non-Participating Shareholders.

Without guidance on which taxpayers can rely absent a private letter ruling, in order to ensure that there has not been a Section 355(e) Ownership Shift of 50% or more, taxpayers may be forced to apply an unduly punitive approach — i.e., the Fictional Group Approach. The Fictional Group Approach is unrealistic as a practical matter because it assumes that each Participating Shareholder sold all of its shares and no Public Shareholder sold only some of its shares. Moreover, this approach may achieve an unjustifiably harsh result, often overstating the Section 355(e) Ownership Shift by a substantial amount.³⁶

While the Proration Rule also is not realistic in making the assumption that every Public Shareholder participates in a pro rata fashion, we believe that it is preferable as a policy matter. While the repurchasing corporation may engage in a Plan Repurchase, the resulting Section 355(e) Ownership Shift should measure only the impact of the repurchases on shareholders other than Public Shareholders (“Non-Public Shareholders”) or Public Shareholders of a class of stock not participating in the Plan Repurchase. This the Proration Rule achieves.

Application of the Proration Rule only affects whether a portion of the Public Shareholders of the class of stock participating in the Plan Repurchases will be treated as indirectly acquiring Plan Shares. Because the Proration Rule has no differential effect on the Denominator (as compared to the Fictional Group Approach), the Proration Rule accurately measures the Section 355(e) Ownership Shift attributable to Non-Public Shareholders.

Proration Rule

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership
P	80	80%	60	75%
Total	100	100%	80	100%

Fictional Group Approach

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership
A	20	20%	20	25%
P1	60	60%	60	75%
P2	20	20%	0	0%
Total	100	100%	80	100%

The Section 355(e) Ownership Shift attributable to A is 25% (20 Plan Shares/80 total shares outstanding immediately after the last Plan Acquisition) whether the Proration Rule or the Fictional Group Approach is applied. The only difference is in whether some of the Public Shareholders will be treated as indirectly acquiring Plan Shares as a result of the Plan Repurchase. Applying the Proration Rule, there is no Section 355(e) Ownership Shift attributable to P while, under the Fictional Group Approach, P1 has a Section 355(e) Ownership Shift of 15% (12 Plan Shares³⁷/80 total shares outstanding immediately after the last Plan Acquisition). As this example demonstrates, the Section 355(e) Ownership Shift attributable to Non-Public Shareholders is fully captured regardless of whether the Proration Rule applies.³⁸

In contrast, if the repurchase program is open to all shareholders (and there is no AUA between the repurchasing corporation and any shareholder or group of shareholders regarding non-participation in the Plan Repurchases), any resulting ownership shifts (i.e., acquisitions) among Public Shareholders occur as the result of independent investment decisions by those shareholders, such that those acquisitions are not within the control of the repurchasing corporation. The inability to apply the Proration Rule in this circumstance would result in these acquisitions being taken into account in the calculation of the Section 355(e) Ownership Shift, despite the fact that the actions of the individual shareholders were independent of any Section 355(e) Plan and the repurchasing corporation had no control over the ultimate makeup of Participating Shareholders. Where the requirements of the Proration Rule are satisfied, we think a measurement method that assumes repurchases to have occurred on a pro rata basis is as appropriate as any other. In particular, the Knowledge-Based Counting Convention ensures that the Proration Rule is not utilized to achieve inappropriate results under Section 355(e).³⁹

In this sense, the Proration Rule is conceptually consistent with Safe Harbor VII in Treasury Regulations Section 1.355-7(d)(7), which provides that an acquisition of stock by one shareholder from another shareholder (in each case, other than where such shareholders are certain parties related to D and/or C or Controlling Shareholders or 10% Shareholders thereof) where such stock is listed on an established market is not considered part of a Section 355(e) Plan. Safe Harbor VII is supported by (i) the general understanding that actions by Public Shareholders are not within the control of the relevant corporation and therefore should not be attributed to such corporation for purposes of deeming such actions to be undertaken pursuant to a Section 355(e) Plan and (ii) the administrative burden and impracticality of tracking the sale and exchange of stock among Public Shareholders. Thus, when two Public Shareholders not involved in the issuing corporation's management determine to transact, resulting in an acquisition for purposes of Section 355(e), the regulations allow taxpayers to treat any such acquisition as not being part of a Section 355(e) Plan.

The result is substantially similar in Public Share Repurchases from Public Shareholders, where Public Shareholders who are not involved in the repurchasing corporation's decision to undertake a repurchase decide to participate, effectively shifting all or a portion of their ownership to other Public Shareholders. If the Participating and Non-Participating Shareholders had instead effected the ownership shift via a secondary market transaction, the resulting acquisition would clearly be deemed not to have been made pursuant to a Section 355(e) Plan. Absent the ability to apply the Proration Rule, where the repurchase is a Plan Repurchase, the resulting indirect acquisition by Non-Participating Shareholders would be taken into account in calculating the Section 355(e) Ownership Shift. It does not seem, however, that this result is appropriate. For example, while the repurchasing corporation controls the decision whether or not to undertake a repurchase, in situations covered by the Proration Rule, the repurchasing corporation cannot control the impact of the repurchase on the relative ownership of shareholders. Equally, the requirements of the Proration Rule ensure that the Participating Shareholders did not participate in the repurchasing corporation's “plan.” It would be incongruous to treat an indirect acquisition by a Non-Participating Shareholder as an acquisition pursuant to a Section 355(e) Plan where a direct acquisition by the same shareholder in a secondary market transaction would not be taken into account for purposes of Section 355(e). Allowing taxpayers to neutralize the impact of such acquisitions by adopting the Proration Rule would put similar transactions on more equal footing and consistently reflect the fact that independent investment decisions by Public Shareholders should not give rise to Plan Acquisitions.

V. NETTING

A second issue that arises is how properly to calculate the Section 355(e) Ownership Shift when there are multiple transactions occurring pursuant to a Section 355(e) Plan. There is no published guidance that addresses how to compute the Section 355(e) Ownership Shift in the context of multiple Plan Acquisitions.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership
A	25	25%	15	15%	15	20%
P1	75	75%	75	75%	50	66.6%
B	0	0%	10	10%	10	13.3%
Total	100	100%	100	100%	75	100%

There are multiple possible approaches to calculating the Section 355(e) Ownership Shift. One possibility is to calculate the Plan Acquisition Percentage after each Plan Acquisition, and aggregate the total of each individual calculation (the “Gross Aggregation Approach”). Under this approach, D would have a Section 355(e) Ownership Shift of 18.3%, determined by adding the 10% Plan Acquisition Percentage from the Date 1 transaction (i.e., 10 Plan Shares/100 total shares outstanding immediately after the Plan Acquisition) and the approximately 8.3% Plan Acquisition Percentage from the Date 2 transaction (i.e., A indirectly acquires 3.75 Plan Shares (or under-participates in the repurchase by 3.75 shares)⁴⁰ and B indirectly acquires 2.5 Plan Shares (or under-participates in the repurchase by 2.5 shares)⁴¹ so the Plan Acquisition Percentage from the Date 2 transaction is (6.25 Plan Shares/75 total shares outstanding immediately after the Plan Acquisition)). Under the Gross Aggregation Approach, this result is reached notwithstanding the fact that, following the Date 2 transaction, the historic shareholders of D, A and P1, have retained approximately 86.6% of the stock of D. Furthermore, it is possible that Plan Shares can be “double counted” under the Gross Aggregation Approach.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership	# of Shares (Date 3)	% Ownership
A	25	25%	0	0%	0	0%	0	0%
P1	75	75%	75	75%	75	75%	75	75%
B	0	0%	25	25%	0	0%	0	0%
E	0	0%	0	0%	25	25%	0	0%
F	0	0%	0	0%	0	0%	25	25%
Total	100	100%	100	100%	100	100%	100	100%

Under these facts and under the Gross Aggregation Method, D would have a Section 355(e) Ownership Shift of 75%, determined by aggregating the Plan Acquisition Percentages from Dates 1, 2, and 3. Given that the historic shareholders of D have retained 75% of the D stock, there should not be a 50% or greater Section 355(e) Ownership Shift on these facts. However, “double counting” is illustrative of an extreme application of the logic underlying the Gross Aggregation Approach, namely, that each Plan Acquisition should be considered without regard to the impact of other Plan Acquisitions.

An alternative approach is to compute the Section 355(e) Ownership Shift by a cumulative determination of the percentage of stock in the relevant corporation actually acquired during a testing period that is bounded by two points in time: (i) immediately before the earlier of the first Plan Acquisition or the distribution of C and (ii) immediately after the later of the last Plan Acquisition and the distribution of C (the “Testing Period Netting Method” and such period, the “testing period”).⁴² Under the Testing Period Netting Method, any increase, directly or indirectly, in a shareholder's ownership percentage in the relevant corporation is taken into account for purposes of Section 355(e) only after reducing such increase to reflect any reductions that occur as a result of Plan Acquisitions occurring during the testing period. Under the Testing Period Netting Method, the Plan Acquisition Percentage would only be calculated once, at the end of the testing period. In applying the Testing Period Netting Method to Example 6, the Numerator would have 10 Plan Shares. The indirect acquisition by A as a result of the Date 2 Plan Repurchase is not reflected in the Numerator because A's percentage ownership in D has decreased from 25% to 20% over the testing period (i.e., from 25 shares/100 total shares outstanding to 15 shares/75 total shares outstanding). Furthermore, the indirect acquisition by B will be taken into account by reducing the Denominator to reflect the 75 shares outstanding immediately after the Plan Repurchase. As a result, the Plan Acquisition Percentage is 13.33% (i.e., 10 Plan Shares/75 total shares outstanding immediately after the Plan Acquisitions). This result comports with the cumulative economic results of the transactions and reflects the fact that the historic shareholders of D have retained 86.67% of D's stock.

A. Service's Current Ruling Practice

The Service has approved various forms of netting in a number of private letter rulings. Private Letter Ruling 201627001,⁴³ discussed above, involved a pre-distribution merger between D and two merger partners, and both pre- and post-distribution repurchases of the stock of each such corporation were relevant, including repurchases conducted via tender offer. The Service ruled that “[a]ny increase in either voting power or value of the stock of [the relevant corporation] owned by a shareholder by virtue of the [repurchase] will be taken into account for purposes of Section 355(e) only after reducing such increase for any reduction, directly or indirectly, in such shareholder's interest resulting from the [repurchase].”

The Service reached a similar conclusion in Private Letter Ruling 201603005.⁴⁴ In that ruling, Distributing 2 distributed all the stock of Controlled 2 to its shareholder. Controlled 2 then merged with another corporation, Controlled 1, with Controlled 2 surviving. As part of the overall transaction, certain persons received exchange rights that allowed them to receive cash for each of their units equal to the value of a share of Controlled 2 stock, with Controlled 2 having the option of giving those persons Controlled 2 stock instead of cash. The Service ruled that, in applying Section 355(e)(2)(A)(ii) to Controlled 2, “any increase in the percentage, by vote or value, of Controlled 2 common stock owned by a shareholder as a result of the exercise of the Controlled 2 Exchange Rights will offset and reduce any decrease in that shareholder's percentage owned, by vote or value, of the Controlled 1 common stock as a result of the [merger] (determined without regard to any other acquisition).”

Similarly, in Private Letter Ruling 201538015,⁴⁵ Distributing 1 conducted negotiations and was evaluating “one or more possible acquisitions or combination transactions (the “Acquisitions”)” and believed that it was “highly likely” that it would pursue one or more of them. The Service ruled that “[p]rovided the Acquisitions are treated as pursuant to a plan under § 355(e)(2)(A)(ii), the increases in the percentage of either voting power or value of the stock of Distributing 1, Distributing 2, or Distributing 3 acquired, directly or indirectly, by Third Parties in the Exchanges will be treated as acquisitions that are taken into account for purposes of § 355(e) only after reducing such increases for any dilution, directly or indirectly, in such respective interests resulting from any Acquisition.” Accordingly, in Private Letter Ruling 201538015, the Service netted the shifts in stock ownership resulting from a series of plan acquisitions.⁴⁶

B. Discussion

We believe that netting is the appropriate way to calculate the impact of a Plan Repurchase on the Section 355(e) Ownership Shift in the context of multiple Plan Acquisitions, at least in certain circumstances. As noted above, although the Service has consistently applied netting in its ruling practice, taxpayers cannot rely on private letter rulings issued to other taxpayers. Published guidance regarding the application of netting to Plan Repurchases in the context of multiple Plan Acquisitions involving repurchases would eliminate the need to devote government and taxpayer resources to requesting and issuing rulings in this context and provide taxpayers with additional certainty as to how to calculate the Section 355(e) Ownership Shift in similar fact patterns.

Furthermore, the issuance of published guidance would be appropriate because the application of netting is consistent with the pertinent statutory language and regulatory framework under Section 355(e). First, netting flows logically from the text of Section 355(e)(2)(A)(ii), which focuses on whether there has been an acquisition of a 50% or greater interest in stock of a corporation “as part of a plan (or series of related transactions).” For example, by calculating the Section 355(e) Ownership Shift by reference to the cumulative changes in share ownership over the testing period in appropriate circumstances, the Testing Period Netting Method disregards temporary fluctuations in share ownership that may occur during the testing period.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership	# of Shares (Date 3)	% Ownership
A	25	25%	15	15%	15	16.7%	5	5.6%
P1	75	75%	75	75%	65	72.2%	65	72.2%
P2	0	0%	0	0%	0	0%	10	11.1%
B	0	0%	10	10%	10	11.1%	10	11.1%
Total	100	100%	100	100%	90	100%	90	100%

At the end of the testing period, there are two new shareholders that have increased their ownership pursuant to a Section 355(e) Plan: Shareholder B and Public 2. Although the Plan Repurchase on Date 2 causes A's ownership of D to increase temporarily from 15% to 16.7%, this increase is not taken into account because A's dispositions ultimately reduce A's ownership to 5.6%. Consequently, the Testing Period Netting Method avoids overstating the amount of the Section 355(e) Ownership Shift. Computationally, the Plan Acquisition Percentage is approximately 22.2% (i.e., 10 + 10 Plan Shares/90 total shares outstanding immediately after the Plan Acquisitions). Thus, applying the Testing Period Netting Method, the Section 355(e) Ownership Shift is 22.2% in Example 8.

The appropriateness of this result is confirmed by the observation that A and Public 1, the historic shareholders of D, have retained, collectively, 77.8% of the stock of D. As this example demonstrates, in these circumstances, the Testing Period Netting Method more accurately reflects the extent to which the Plan Acquisitions result in an acquisition of Plan Shares by taking all changes to the capital structure and ownership into account. In this manner, the Testing Period Netting Method is consistent with the text of Treasury Regulations Section 1.355-7(c)(5), which states that “[a]ll acquisitions of stock of Distributing or Controlled that are considered to be part of a plan with a distribution. . . will be aggregated for purposes of the 50-percent test.” ⁴⁷

Under the Testing Period Netting Method, a testing period of a long duration could give rise to results that violate the policy of Section 355(e). For example, it would allow a 50% or greater Section 355(e) Ownership Shift to persist for a long period. We believe that this would be inappropriate as a policy matter. For purposes of issuing sub-regulatory guidance, such as a revenue ruling, we recommend that the facts of the revenue ruling confine the testing period to a reasonable duration, such as 1 to 2 years. In addition, we recommend that the revenue ruling state as a pivotal fact that a principal purpose for engaging in a Plan Acquisition is not to extend the testing period.

As an alternative to the Testing Period Netting Method, a “testing date” approach to netting (the “Testing Date Netting Method”) could be employed. Under the Testing Date Netting Method, the cumulative Section 355(e) Ownership Shift would be tested on each date on which there is a Plan Acquisition. If the cumulative Section 355(e) Ownership Shift equals or exceeds 50% on any testing date, Section 355(e) would be violated. However, under the Testing Date Netting Method, netting would be applied where (a) two or more Plan Acquisitions are reasonably proximate to each other (say, within 90 days of each other) or (b) at the time of the first Plan Acquisition, there is an AUA⁴⁸ for one or more Plan Acquisitions to occur subsequently within a reasonably short time period (within 90 days). As above, the applicable period to which the Testing Date Netting Method applies could not be extended by a Plan Acquisition (or AUA) undertaken with a principal purpose of extending the period.

While a majority of the Tax Section believe the Testing Period Netting Method was the more appropriate approach, a significant minority of the Tax Section favored the Testing Date Netting Method.

VI. EFFECT OF NON-PLAN REPURCHASES

A final question arises as to how properly to count the impact, if any, of a repurchase that does not occur pursuant to a Section 355(e) Plan (a “Non-Plan Repurchase”). If a Plan Repurchase can cause an indirect acquisition for purposes of Section 355(e), the obverse proposition is that a Non-Plan Repurchase should not have any effect on the computation of the Section 355(e) Ownership Shift.⁴⁹

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership
A	25	25%	15	15%	15	20%
P1	75	75%	75	75%	50	66.7%
B	0	0%	10	10%	10	13.3%
Total	100	100%	100	100%	75	100%

Immediately after the Date 1 transaction, D has a Section 355(e) Ownership Shift of 10%. D's Plan Acquisition Percentage immediately after the Date 1 transaction is 10% (i.e., 10 Plan Shares/100 total shares outstanding immediately after the Plan Acquisition). Although the Non-Plan Repurchase has the effect of increasing B's actual percentage ownership of D from 10% (i.e., 10 shares/100 total shares outstanding immediately prior to the Non-Plan Repurchase) to approximately 13.3% (i.e., 10 shares/75 total shares outstanding immediately after the Non-Plan Repurchase), this increase should not be taken into account because it does not occur pursuant to a Section 355(e) Plan. Computationally, this means the Non-Plan Repurchase should have no effect on either the Numerator or the Denominator of the Plan Acquisition Percentage. As a result, D's Plan Acquisition Percentage immediately after the Date 2 transaction remains 10% (i.e., 10 Plan Shares/100 total shares deemed outstanding). Importantly, even though D's shares have actually been redeemed, they are treated as outstanding for purposes of the Plan Acquisition Percentage.

A. Service's Current Ruling Practice

The Service has issued a number of private letter rulings providing that a Non-Plan Repurchase will not be taken into account for purposes of Section 355(e). In Private Letter Ruling 200644012,⁵⁰ Distributing sought a ruling concerning the effect of D's stock repurchase program. Previously, D had merged with an unrelated corporation in which the shareholders of the target corporation received D stock (the “Merger”). Subsequently, D distributed C pro rata to its shareholders. D made certain representations that generally established that the stock repurchases would constitute Non-Plan Repurchases. The Service ruled that the stock repurchases would not have any effect on the determination of whether there had been an acquisition of a 50% or greater interest in D. As a result, D's stock repurchases would not impact the computation of the Section 355(e) Ownership Shift resulting from the Merger. The Service has reached similar conclusions in a number of private letter rulings, including certain rulings discussed above.⁵¹

B. Discussion

As a general matter, a Non-Plan Repurchase should have no effect on the computation of the Section 355(e) Ownership Shift. To the extent that a repurchase can constitute an indirect acquisition by the Non-Participating Shareholders, such acquisition should not be taken into account for purposes of Section 355(e) if it does not occur pursuant to a Section 355(e) Plan. In this manner, an indirect acquisition occurring via a Non-Plan Repurchase should be disregarded just as a direct acquisition between shareholders would be disregarded if it does not occur pursuant to a Section 355(e) Plan.

As an initial matter, it seems clear that a Non-Plan Repurchase generally should not extend the Testing Period.⁵² The Testing Period has to have a finite end in order for the Testing Period Netting Method to function properly, and it makes no sense to extend the Testing Period to sweep in transactions that are not part of the Plan.

The more challenging question is how to account for a Non-Plan Repurchase that occurs between two Plan Acquisitions. Under the rationale discussed above, it seems clear, at least in determining the effect of a later Non-Plan Repurchase on a prior Plan Acquisition, that the Non-Plan Repurchase itself should not affect the Numerator or the Denominator; the Plan Acquisition represented a particular percentage of the repurchasing corporation at the time of such Plan Acquisition, and a subsequent change in the number of shares outstanding that does not occur pursuant to the Section 355(e) Plan should not alter the Section 355(e) Ownership Shift as a general matter. However, it is less clear to what extent the Non-Plan Repurchase should indirectly influence the calculation of the Plan Acquisition Percentage due to the indirect effect of the Non-Plan Repurchase on subsequent Plan Acquisitions. Depending on the approach adopted, the sequence of a Non-Plan Repurchase vis-à-vis Plan Acquisitions may impact the amount of the Section 355(e) Ownership Shift.

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership	# of Shares (Date 3)	~% Ownership
A	45	45%	45	45%	45	50%	45	50%
B	35	35%	25	25%	25	27.77%	15	16.67%
P1	20	20%	20	20%	10	11.11%	10	11.11%
E	0	0%	10	10%	10	11.11%	10	11.11%
F	0	0%	0	0%	0	0%	10	11.11%
Total	100	100%	100	100%	90	100%	90	100%

As to the effect of the Non-Plan Repurchase itself, the indirect increase by A, B, and E as a result of the Non-Plan Repurchase should not affect the Section 355(e) Ownership Shift. Stated differently, it is clear that a Non-Plan Repurchase does not impact the Numerator of the Plan Acquisition Percentage. With respect to the effect of the Date 2 Non-Plan Repurchase on the Date 1 Plan Acquisition, the results also should be straightforward — that is, the Non-Plan Repurchase should not have any impact on the Section 355(e) Ownership Shift caused by the Date 1 Plan Acquisition. Immediately after the Date 1 Plan Acquisition, D has a Section 355(e) Ownership Shift of 10%. D's Plan Acquisition Percentage is 10% (i.e., 10 Plan Shares/100 total shares outstanding immediately after the Plan Acquisition). Because the Non-Plan Repurchase is not taken into account for purposes of Section 355(e), the indirect increase by A, B and E as a result of the Non-Plan Repurchase on Date 2 should not affect the Section 355(e) Ownership Shift as calculated immediately prior to the Non-Plan Repurchase, and the Section 355(e) Ownership Shift (attributable solely to E's Date 1 Plan Acquisition) should remain 10% (i.e., 10 Plan Shares/100 total shares deemed outstanding).

The appropriate results are less certain with respect to the effect of the Date 2 Non-Plan Repurchase on the Date 3 Plan Acquisition. The key question is what effect a Non-Plan Repurchase should have on the Denominator when calculating the Section 355(e) Ownership Shift attributable to a Plan Acquisition occurring after such Non-Plan Repurchase. One alternative is to treat the Non-Plan Repurchase as having no effect on the Denominator (i.e., the redeemed shares are treated as still outstanding) in calculating the Section 355(e) Ownership Shift from the later transaction. Under this approach, in Example 10, the Section 355(e) Ownership Shift attributable to F's Date 3 Plan Acquisition would be 10% (i.e., 10 Plan Shares/(90 shares actually outstanding immediately after the Plan Acquisition + 10 shares deemed outstanding)). The other alternative is to reduce the Denominator for purposes of calculating the Section 355(e) Ownership Shift resulting from the Date 3 Plan Acquisition. Under this approach, the Section 355(e) Ownership Shift attributable to F's Date 3 Plan Acquisition would be 11.11% (i.e., 10 Plan Shares/90 shares actually outstanding immediately after the Plan Acquisition).

Valid arguments can be made in support of either approach. Although reducing the Denominator for the Non-Plan Repurchase has the effect of indirectly taking the Non-Plan Repurchase into account, F has actually purchased 11.11% of the stock of D in a Plan Acquisition. Accordingly, requiring that Non-Plan Repurchases reduce the Denominator for purposes of measuring the effect of a subsequent Plan Acquisition may be appropriate in the sense that it more accurately measures the actual economic impact of such Plan Acquisition. Further, although the rule places a premium on sequence, with calculations differing depending on whether the Plan Acquisition occurs before or after the Non-Plan Repurchase, the economic impact of the Non-Plan Repurchase on E and F would differ as well. In this vein, if the sequence of a Plan Acquisition and a Non-Plan Repurchase has economic significance, there is logic to calculating the Section 355(e) Ownership Shift in a manner that gives effect to that difference.

On the other hand, indirectly taking the Non-Plan Repurchase into account for purposes of calculating the Section 355(e) Ownership Shift resulting from a subsequent Plan Acquisition is arguably inconsistent with Section 355(e)(2)(A)(ii), which focuses on whether there has been an acquisition of a 50% or greater interest in stock of a corporation “as part of a plan (or series of related transactions).” [Emphasis added.] Although E and F achieve the same ultimate ownership of D, the calculation of the Section 355(e) Ownership Shift resulting from the Plan Acquisition undertaken by each is different, and this difference arises from the effect of a Non-Plan Repurchase, which is, by definition, not part of the same plan as the Date 1 or Date 3 Plan Acquisitions.

In addition, we note that reducing the Denominator for purposes of calculating the Section 355(e) Ownership Shift attributable to Plan Acquisitions subsequent to Non-Plan Repurchases may involve a high degree of administrative complexity. Because the Denominator changes over the testing period, the ownership percentages will not add to 100%, which is counterintuitive.⁵³ Moreover, a Non-Plan Repurchase may be implemented through a program involving periodic (perhaps daily) repurchases conducted over months or years. Similarly, a Plan Acquisition may occur in the form of a series of small transactions (e.g., a large shareholder selling down its stake). Consequently, computing the Section 355(e) Ownership Shift could involve dozens or hundreds of calculations dependent on actual knowledge of the precise amount of shares repurchased prior to the particular day on which a Plan Acquisition occurs.

As a general matter, because a Non-Plan Repurchase and any Plan Acquisitions are, by definition, unrelated, and because of the potential computational complexity associated with reducing the Denominator, we think, on balance, the better answer is that Non-Plan Repurchases should not affect the Denominator, consistent with what appears to be the Service's current ruling policy. Nonetheless, we acknowledge that reasonable people could disagree about the correct result and further note there may be unusual circumstances in which it may be appropriate to take a Non-Plan Repurchase into account when computing the Section 355(e) Ownership Shift even where the Plan Acquisition occurs before the Non-Plan Repurchase (including, potentially, when the Non-Plan Repurchase occurs after the Testing Period).

Shareholder	# of Shares (Start)	% Ownership	# of Shares (Date 1)	% Ownership	# of Shares (Date 2)	% Ownership	# of Shares (Date 3)	~% Ownership
A	0	0%	25	25%	25	27.8%	49	54.4%
P1	100	100%	75	75%	65	72.2%	41	45.6%
Total	100	100%	100	100%	90	100%	90	100%

In this example, if the Non-Plan Repurchase is not taken into account, the Section 355(e) Ownership Shift is 49% because the Non-Plan Repurchase does not reduce the Denominator (i.e., 25 + 24 Plan Shares/90 shares actually outstanding immediately after the Plan Acquisitions + 10 shares deemed outstanding). However, A has actually acquired 54.4% of the stock of D. Because of the previously announced buyback program, A could know with reasonable certainty that its acquisition of 49 shares ultimately would result in A's ownership of 50% or more of the stock of D. Consequently, in these circumstances, disregarding a Non-Plan Repurchase could facilitate a result contrary to the intent of Section 355(e) — the acquisition of a 50% or greater interest in stock of a corporation pursuant to a Section 355(e) Plan. In circumstances where A and D actually coordinate their respective acquisitions and repurchases to effectuate this result, it seems clear that the repurchase will constitute a Plan Repurchase and will, accordingly, be taken into account in computing the Section 355(e) Ownership Shift. However, where a repurchase is clearly a Non-Plan Repurchase but is also reasonably certain to occur (e.g., a buyback program), then it may be possible for a shareholder to utilize a Non-Plan Repurchase to acquire a 50% or greater interest in the stock of a corporation pursuant to a Section 355(e) Plan. We believe that in the unusual situations where a single shareholder (or group of shareholders acting in concert) acquire a concentrated position in a corporation's stock with the intent of utilizing a Non-Plan Repurchase that is reasonably certain to occur in order to ultimately acquire a 50% or greater interest pursuant to the Section 355(e) Plan could be appropriately addressed by an anti-abuse provision that operates to reduce the Denominator to reflect a Non-Plan Repurchase for the purpose of calculating the Section 355(e) Ownership Shift attributable to any Plan Acquisition undertaken with such intent.⁵⁴

C. Pre-Existing Share Repurchase Programs and Plan Analysis

A question related to the appropriate counting convention for Non-Plan Repurchases is whether the government should issue guidance providing a safe harbor treating certain repurchases made by public corporations as not resulting in Plan Acquisitions. The determination of whether an acquisition is a Plan Acquisition is based on all facts and circumstances.⁵⁵ The regulations set forth non-exclusive factors to be considered in demonstrating whether an acquisition is a Plan Acquisition, as well as certain safe harbors establishing when an acquisition is a non-Plan Acquisition. Acquisitions during the four-year period beginning on the date which is two years before the date of the distribution are presumed to be Plan Acquisitions unless established to the contrary.⁵⁶ In light of this statutory presumption, in conjunction with the uncertain application of existing safe harbors in the Regulations to repurchases, we believe that the government should consider issuing guidance specifying that certain Public Share Repurchases made pursuant to a pre-existing share repurchase program will be presumed not to result in Plan Acquisitions.⁵⁷

Treasury Regulations Section 1.355-7(b)(4)(iv) provides that the fact that a distribution would have occurred at approximately the same time and in similar form regardless of the acquisition or a similar acquisition is among the factors tending to establish that a post-distribution acquisition is a non-Plan Acquisition. Consistent with this, we believe that the government should issue a revenue ruling setting forth a safe harbor which provides that Public Share Repurchases under a share repurchase program will be Non-Plan Repurchases where (i) the share repurchase program was neither established nor modified in contemplation of the distribution; and (ii) the distribution has no or minimal impact on the timing or amount of the repurchases (i.e., repurchases are expected, in all material respects, to occur at approximately the same times, and to be in the same or lesser amount, as the repurchases that would have occurred in the absence of a distribution).

We believe that the impact of one transaction on the timing and form of another transaction is a significant fact in establishing the level of relatedness between transactions. While the regulations focus on the time and amount of the distribution,⁵⁸ private letter rulings addressing share repurchase programs tend to focus instead on the timing and amount of repurchases. For example, the Service has ruled that pre-distribution repurchases by D pursuant to a share repurchase program would not be treated as occurring pursuant to a Section 355(e) Plan where the taxpayer represented that the prior repurchases were not related to the proposed transaction and “the amount and timing of such repurchases would have been the same regardless of the [proposed transaction].”⁵⁹ In Private Letter Ruling 201627001,⁶⁰ the taxpayer similarly represented, with respect to post-distribution repurchases, that such repurchases were not, and would not be, related to the proposed transaction, and were expected to occur at approximately the same times, and to be in the same or lesser amount, as the repurchases that would have occurred if no distribution had been made to the public shareholders. The Service applied Proration Treatment, but only to the extent the repurchases were otherwise treated for purposes of Section 355(e) as part of a plan with the relevant distributions.⁶¹ The Service did not address whether the repurchases would be treated as a Plan Repurchase based on the representations given.

We believe the proposed safe harbor could be implemented through the issuance of a revenue ruling addressing the criteria described above. In order to make clear that the criteria set forth establish only a safe harbor, the ruling should include a factual scenario in which the safe harbor criteria are not met, and conclude that the determination of whether a Section 355(e) Plan exists is to be made based on all of the facts and circumstances.

VII. CONCLUSION

As described above, publication of a sub-regulatory guidance on the proper treatment of repurchases, focusing principally on the applicable counting conventions in a manner essentially consistent with the Service's existing ruling policies, would provide greater certainty to taxpayers and the government alike. Moreover, such guidance would obviate the need for taxpayers to seek repetitive private rulings, reducing compliance burdens for taxpayers and conserving government resources.