Final Stock Ownership Aggregation Rules Expand Definition of 'Entity'

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations relating to the use of certain corporate tax attributes under section 382 of the Internal Revenue Code of 1986 (the "Code") that are attributable to the period preceding an ownership change of the corporation. Section 382 was amended by the Tax Reform Act of 1986, the Revenue Act of 1987, the Technical and Miscellaneous Revenue Act of 1988 and the Revenue Reconciliation Act of 1989. These final regulations under section 382 provide guidance for the aggregation of stock ownership with respect to the definition of an entity.

 DATES: The regulations are effective as of March 27, 1992 and generally are applicable to testing dates occurring on or after November 20, 1990.

 FOR FURTHER INFORMATION CONTACT: Lori J. Brown of the Office of Assistant Chief Counsel (Corporate), Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224 (Attention: CC:CORP:1) or telephone (202) 566-3205 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document contains final regulations to be added to 26 CFR part 1 under section 382 of the Internal Revenue Code (the "Code"). On November 21, 1990, the Internal Revenue Service published in the Federal Register (55 FR 48639) a Notice of Proposed Rulemaking proposing amendments to the Income Tax Regulations under section 382. That document proposed amendments to the temporary regulations (T.D. 8149) under section 382 which were published in the Federal Register (52 FR 29668) on August 11, 1987. The temporary regulations (52 FR 29704) also published on August 11, 1987, also were proposed to be adopted as final regulations.

EXPLANATION OF PROVISIONS

 The only written comments received by the Internal Revenue Service with respect to the Notice of Proposed Rulemaking published on November 21, 1990, generally regarded the effect of the proposed amendments on acquisitions of stock made by investors sharing a common investment advisor or decision maker. This document takes those comments into account by amending the definition of an entity to include a group of persons having a formal or informal understanding among themselves to make a coordinated acquisition of stock. A principal element in determining if such an understanding exists is whether the investment decision of each member of a group is based upon the investment decision of one or more other members. The existing examples are modified, and a new example is provided, to reflect the amended definition of an entity.

 The regulations also clarify the treatment of creditors who receive stock in satisfaction of indebtedness as part of a bankruptcy reorganization or insolvency workout. A new sentence, added to the definition of an entity, provides that participation by creditors in formulating a plan for an insolvency workout or a reorganization in a title 11 or similar case, whether as members of a creditor's committee or otherwise, and the receipt of stock in satisfaction of indebtedness by creditors do not cause the creditors to be considered an entity.

 The regulations generally provide that the new rules apply to testing dates on or after November 20, 1990, but with respect to a group of persons that acquired stock prior to that date, the rules apply only if the group increases or decreases its ownership of stock of the loss corporation by five percentage points or more relative to the percentage ownership interest of such group on November 19, 1990. However, if such group consists only of regulated investment companies under section 851, qualified plans under section 401, common trust funds under section 584, or trusts or estates that are clients of a trust department of a bank defined in section 581, the new rules apply only if the group increases its ownership by five percentage points on or after November 20, 1990, relative to its percentage ownership interest at the close of November 19, 1990.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the Notice of Proposed Rulemaking for the regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comments on their impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Lori J. Brown of Office of Assistant Chief Counsel, Corporate, Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and Treasury Department participated in developing the regulation, on matters of both substance and style.

LIST OF SUBJECTS

26 CFR 1.381(a)-1 through 1.383-3

 Income taxes, Reporting and recordkeeping requirements.

Treasury Decision 8405

ADOPTION OF AMENDMENTS TO THE REGULATIONS.

Accordingly, 26 CFR part 1 is amended as follows:

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

Paragraph 1. The authority citation for part 1 is amended by revising the citations for sections 1.382-2, 1.383-1 and 1.383-2 to read as follows:

Authority: Sec. 7805, 68A Stat 917; 26 U.S.C. 7805, * * * Section 1.382-2 also issued under 26 U.S.C. 382(k)(1) and 26 U.S.C. 382(m). * * * Section 1.383-1 also issued under 26 U.S.C. 383. Section 1.383-2 also issued under 26 U.S.C. 383.

Par. 2. Section 1.382-2 is amended as follows:

1. A new paragraph (a)(3) is added.

SECTION 1.382-2 DEFINITION OF OWNERSHIP CHANGE UNDER SECTION 382 AS AMENDED BY THE TAX REFORM ACT OF 1986

(a) * * *

(3) ENTITY. (i) IN GENERAL -- An entity is any corporation, estate, trust, association, company, partnership or similar organization. An entity includes a group of persons who have a formal or informal understanding among themselves to make a coordinated acquisition of stock. A principal element in determining if such an understanding exists is whether the investment decision of each member of a group is based upon the investment decision of one or more other members. However, the participation by creditors in formulating a plan for an insolvency workout or a reorganization in a title 11 or similar case (whether as members of a creditors' committee or otherwise) and the receipt of stock by creditors in satisfaction of indebtedness pursuant to the workout or reorganization do not cause the creditors to be considered an entity.

(ii) EXAMPLES. The following examples illustrate the provisions of paragraph (a)(3)(i) of this section.

EXAMPLE 1. (i) L corporation has 1,000 shares of common stock outstanding. For the three-year period ending on October 1, 1992, L's stock was owned by unrelated individuals, none of whom owned five percent or more of L. A group of 20 individuals who previously owned no stock (the "Group") agree among themselves to acquire more than 5 percent of L's stock. The Group is not a corporation, trust, association, partnership or company. On October 1, 1992, pursuant to their understanding, the members of the Group purchase 600 shares of L common stock from the old shareholders of L (a total of 60 percent of L stock), with each member purchasing 30 shares.

(ii) Before the members of the Group acquired L's stock on October 1, 1992, no individual or entity owned, directly or indirectly, five percent or more of the stock of L. As a result, all shareholders were aggregated into a public group and L was considered to be owned by a single 5-percent shareholder ("Public L") in accordance with section 1.382-2T(g)(1) and (j)(1).

(iii) Under paragraph (a)(3)(i) of this section, the members of the Group have a formal or informal understanding among themselves to make a coordinated acquisition of stock and, therefore, the Group is an entity. Thus, the acquisition of more than five percent of the stock of L on October 1, 1992, by members of the Group is not disregarded under section 1.382-2T(e)(1)(ii). Because no member of the Group owns, directly or indirectly, five percent or more of the stock of L, sections 1.382-2T(g)(1) and (j)(1) require that the members of the Group be aggregated into a separate public group, which will be presumed to consist of persons unrelated to the members of Public L. Because there is a shift of more than fifty percentage points in the ownership of L stock during the three-year testing period ending on October 1, 1992, an ownership change occurs on October 1, 1992, as a result of the Group's purchase of the 600 shares.

EXAMPLE 2. (i) Prior to October 1, 1992, L's 1,000 shares of outstanding stock were owned by unrelated individuals, none of whom owned five percent or more of the stock of L. L's management is concerned that L may become subject to a takeover bid. In separate meetings, L's management meets with potential investors who own no stock and are friendly to management to convince them to acquire L's stock based on an understanding that L will assemble a group that in the aggregate will acquire more than 50 percent of L's stock. On October 1, 1991, 15 of these investors each purchase 4 percent of L's stock.

(ii) Under paragraph (a)(3)(i) of this section, the 15 investors (the "Group") are treated as an entity because the members of the Group purchase L stock pursuant to a formal or informal understanding among themselves to make a coordinated acquisition of stock. Sections 1.382-2T(g)(1) and (j)(1) require that on October 1, 1992, the Group be aggregated into a separate public group, which has increased its ownership of L stock by 60 percentage points over its lowest level of ownership in the three-year period ending on October 1, 1992. Accordingly, an ownership change occurs on that date.

EXAMPLE 3. (i) Prior to October 1, 1992, L's 1,000 shares of outstanding stock were owned by unrelated individuals, none of whom owned five percent or more of the stock of L. On October 1, 1992, an investment advisor advises its clients that it believes L's stock is undervalued and recommends that they acquire L stock. Acting on the investment advisor's recommendation, 20 unrelated individuals purchase 6 percent of L's stock in aggregate, with each individual purchasing less than 5 percent. Each client's decision was not based upon the investment decisions made by one or more other clients.

(ii) Because there is no formal or informal understanding among the clients to make a coordinated acquisition of L stock, their purchase of stock is not made by an entity under paragraph (a)(3)(i) of this section. As a result, they remain part of the public group which owns L stock, and no owner shift results upon their purchase of L stock under section 1.382-2T(e)(1)(ii).

(iii) The result in this example would be the same if the only additional fact was that the investment advisor is also the underwriter (without regard to whether it is a firm commitment or best efforts underwriting) for a primary or secondary offering of L stock.

(iv) Assume that the facts are the same except that, instead of an investment advisor recommending that clients purchase stock, the trustee of several trusts qualified under section 401(a) sponsored by unrelated corporations causes each trust to purchase the L stock. In this case, the result is the same, so long as the investment decision made on behalf of each trust was not based on the investment decision made on behalf of one or more of the other trusts.

(iii) EFFECTIVE DATE. (A) IN GENERAL. The second, third and fourth sentences of paragraph (a)(3)(i) of this section and Examples 1, 2 and 3 of paragraph (a)(3)(ii) of this section apply to testing dates (determined by applying such sentence and examples) on or after November 20, 1990, but with respect to any group of persons that pursuant to a formal or informal understanding among themselves makes a coordinated acquisition of stock before November 20, 1990, only if the group increases or decreases its ownership of stock of the loss corporation relative to its percentage ownership interest at the close of November 19, 1990, by five percentage points or more on or after November 20, 1990.

(B) SPECIAL RULE. If pursuant to a formal or informal understanding among themselves a group consisting only of regulated investment companies under section 851, qualified trusts under section 401, common trust funds under section 584, or trusts or estates that are clients of a trust department of a bank under section 581, make a coordinated acquisition of stock before November 20, 1990, the second, third and fourth sentences of paragraph (a)(3)(i) of this section and Examples 1, 2, and 3 of this section apply for testing dates (determined by applying such sentences and examples) on or after November 20, 1990, only if the group increases its ownership of stock of the loss corporation relative to its percentage ownership interest at the close of November 19, 1990, by five percentage points or more on or after November 20, 1990.

(C) EXAMPLE. The following example illustrates the provisions of paragraph (a)(3)(iii) of this section.

EXAMPLE 4. Prior to November 1, 1990, L, a loss corporation, is owned entirely by 1,000 unrelated individuals, none of whom owns as much as 5 percent of the stock of L ("Public L"). On November 1, 1990, 15 individuals (the "Group") each acquired 3 percent, or 45 percent, in total, of L stock pursuant to an understanding among themselves to make a coordinated acquisition of stock. The Group is not a corporation, trust, association, partnership or company. On March 1, 1992, six members of the Group each purchased an additional one percent of L stock, or 6 percent, in total, pursuant to the understanding. Accordingly, the Group increased its ownership in L stock by 51 percentage points during the three-year testing period ending on March 1, 1992. As a result, an ownership change of L occurs on March 1, 1992.

Par. 3. Section 1.382-2T is amended as follows:

1. Paragraph (f)(7) is revised to read as set forth below.

2. Paragraph (g)(4) is amended by adding a new EXAMPLE 5 as set forth below.

SECTION 1.382-2T DEFINITION OF OWNERSHIP CHANGE UNDER SECTION 382, AS AMENDED BY THE TAX REFORM ACT OF 1986 (TEMPORARY).

* * * * *

(f) * * *

(7) ENTITY. See section 1.382-2(a)(3) for the definition of an entity.

* * * * *

(g) * * *

(4) * * *

EXAMPLE 5. -- See section 1.382-2(a)(3)(ii) for additional examples with respect to the definition of an entity.

* * * * *